[Title 26 CFR ]
[Code of Federal Regulations (annual edition) - April 1, 2014 Edition]
[From the U.S. Government Publishing Office]



[[Page i]]

          

          Title 26

Internal Revenue


________________________

Part 1 (Sec. Sec.  1.401 to 1.440)

                         Revised as of April 1, 2014

          Containing a codification of documents of general 
          applicability and future effect

          As of April 1, 2014
                    Published by the Office of the Federal Register 
                    National Archives and Records Administration as 
                    Special Edition of the Federal Register

[[Page ii]]

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[[Page iii]]




                            Table of Contents



                                                                    Page
  Explanation.................................................       v

  Title 26:
          Chapter I--Internal Revenue Service, Department of 
          the Treasury (Continued)                                   3
  Finding Aids:
      Table of CFR Titles and Chapters........................    1297
      Alphabetical List of Agencies Appearing in the CFR......    1317
      Table of OMB Control Numbers............................    1327
      List of CFR Sections Affected...........................    1345

[[Page iv]]





                     ----------------------------

                     Cite this Code: CFR
                     To cite the regulations in 
                       this volume use title, 
                       part and section number. 
                       Thus, 26 CFR 1.401-0 
                       refers to title 26, part 
                       1, section 401-0.

                     ----------------------------

[[Page v]]



                               EXPLANATION

    The Code of Federal Regulations is a codification of the general and 
permanent rules published in the Federal Register by the Executive 
departments and agencies of the Federal Government. The Code is divided 
into 50 titles which represent broad areas subject to Federal 
regulation. Each title is divided into chapters which usually bear the 
name of the issuing agency. Each chapter is further subdivided into 
parts covering specific regulatory areas.
    Each volume of the Code is revised at least once each calendar year 
and issued on a quarterly basis approximately as follows:

Title 1 through Title 16.................................as of January 1
Title 17 through Title 27..................................as of April 1
Title 28 through Title 41...................................as of July 1
Title 42 through Title 50................................as of October 1

    The appropriate revision date is printed on the cover of each 
volume.

LEGAL STATUS

    The contents of the Federal Register are required to be judicially 
noticed (44 U.S.C. 1507). The Code of Federal Regulations is prima facie 
evidence of the text of the original documents (44 U.S.C. 1510).

HOW TO USE THE CODE OF FEDERAL REGULATIONS

    The Code of Federal Regulations is kept up to date by the individual 
issues of the Federal Register. These two publications must be used 
together to determine the latest version of any given rule.
    To determine whether a Code volume has been amended since its 
revision date (in this case, April 1, 2014), consult the ``List of CFR 
Sections Affected (LSA),'' which is issued monthly, and the ``Cumulative 
List of Parts Affected,'' which appears in the Reader Aids section of 
the daily Federal Register. These two lists will identify the Federal 
Register page number of the latest amendment of any given rule.

EFFECTIVE AND EXPIRATION DATES

    Each volume of the Code contains amendments published in the Federal 
Register since the last revision of that volume of the Code. Source 
citations for the regulations are referred to by volume number and page 
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inserted following the text.

OMB CONTROL NUMBERS

    The Paperwork Reduction Act of 1980 (Pub. L. 96-511) requires 
Federal agencies to display an OMB control number with their information 
collection request.

[[Page vi]]

Many agencies have begun publishing numerous OMB control numbers as 
amendments to existing regulations in the CFR. These OMB numbers are 
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PAST PROVISIONS OF THE CODE

    Provisions of the Code that are no longer in force and effect as of 
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previous annual editions of the LSA. For changes to the Code prior to 
2001, consult the List of CFR Sections Affected compilations, published 
for 1949-1963, 1964-1972, 1973-1985, and 1986-2000.

``[RESERVED]'' TERMINOLOGY

    The term ``[Reserved]'' is used as a place holder within the Code of 
Federal Regulations. An agency may add regulatory information at a 
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editorially to indicate that a portion of the CFR was left vacant and 
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INCORPORATION BY REFERENCE

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This material, like any other properly issued regulation, has the force 
of law.
    What is a proper incorporation by reference? The Director of the 
Federal Register will approve an incorporation by reference only when 
the requirements of 1 CFR part 51 are met. Some of the elements on which 
approval is based are:
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CFR INDEXES AND TABULAR GUIDES

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alphabetical list of agencies publishing in the CFR are also included in 
this volume.

[[Page vii]]

    An index to the text of ``Title 3--The President'' is carried within 
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This index is based on a consolidation of the ``Contents'' entries in 
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the revision dates of the 50 CFR titles.

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in the Code of Federal Regulations.

INQUIRIES

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or write to the Director, Office of the Federal Register, National 
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    The e-CFR is a regularly updated, unofficial editorial compilation 
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available at www.ecfr.gov.

    Charles A. Barth,
    Director,
    Office of the Federal Register.
    April 1, 2014.







[[Page ix]]



                               THIS TITLE

    Title 26--Internal Revenue is composed of twenty volumes. The 
contents of these volumes represent all current regulations issued by 
the Internal Revenue Service, Department of the Treasury, as of April 1, 
2014. The first thirteen volumes comprise part 1 (Subchapter A--Income 
Tax) and are arranged by sections as follows: Sec. Sec.  1.0-1.60; 
Sec. Sec.  1.61-1.169; Sec. Sec.  1.170-1.300; Sec. Sec.  1.301-1.400; 
Sec. Sec.  1.401-1.440; Sec. Sec.  1.441-1.500; Sec. Sec.  1.501-1.640; 
Sec. Sec.  1.641-1.850; Sec. Sec.  1.851-1.907; Sec. Sec.  1.908-1.1000; 
Sec. Sec.  1.1001-1.1400; Sec. Sec.  1.1401-1.1550; and Sec.  1.1551 to 
end of part 1. The fourteenth volume containing parts 2-29, includes the 
remainder of subchapter A and all of Subchapter B--Estate and Gift 
Taxes. The last six volumes contain parts 30-39 (Subchapter C--
Employment Taxes and Collection of Income Tax at Source); parts 40-49; 
parts 50-299 (Subchapter D--Miscellaneous Excise Taxes); parts 300-499 
(Subchapter F--Procedure and Administration); parts 500-599 (Subchapter 
G--Regulations under Tax Conventions); and part 600 to end (Subchapter 
H--Internal Revenue Practice).

    The OMB control numbers for Title 26 appear in Sec.  602.101 of this 
chapter. For the convenience of the user, Sec.  602.101 appears in the 
Finding Aids section of the volumes containing parts 1 to 599.

    For this volume, Michele Bugenhagen was Chief Editor. The Code of 
Federal Regulations publication program is under the direction of the 
Managing Editor, assisted by Ann Worley.

[[Page 1]]



                       TITLE 26--INTERNAL REVENUE




         (This book contains part 1, Sec. Sec. 1.401 to 1.440)

  --------------------------------------------------------------------
                                                                    Part

chapter i--Internal Revenue Service, Department of the 
  Treasury (Continued)......................................           1

[[Page 3]]



    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)




  --------------------------------------------------------------------

                  SUBCHAPTER A--INCOME TAX (CONTINUED)
Part                                                                Page
1               Income taxes (Continued)....................           5

Supplementary Publications: Internal Revenue Service Looseleaf 
  Regulations System.

  Additional supplementary publications are issued covering Alcohol and 
Tobacco Tax Regulations, and Regulations Under Tax Conventions.

[[Page 5]]



                   SUBCHAPTER A_INCOME TAX (CONTINUED)





PART 1_INCOME TAXES (CONTINUED)--Table of Contents



                  Normal Taxes and Surtaxes (Continued)

                       DEFERRED COMPENSATION, ETC.

            Pension, Profit-Sharing, Stock Bonus Plans, etc.

Sec.
1.401-0 Scope and definitions.
1.401-1 Qualified pension, profit-sharing, and stock bonus plans.
1.401-2 Impossibility of diversion under the trust instrument.
1.401-3 Requirements as to coverage.
1.401-4 Discrimination as to contributions or benefits (before 1994).
1.401-5 Period for which requirements of section 401(a) (3), (4), (5), 
          and (6) are applicable with respect to plans put into effect 
          before September 2, 1974.
1.401-6 Termination of a qualified plan.
1.401-7 Forfeitures under a qualified pension plan.
1.401-8 Custodial accounts prior to January 1, 1974.
1.401-9 Face-amount certificates--nontransferable annuity contracts.
1.401-10 Definitions relating to plans covering self-employed 
          individuals.
1.401-11 General rules relating to plans covering self-employed 
          individuals.
1.401-12 Requirements for qualification of trusts and plans benefiting 
          owner-employees.
1.401-13 Excess contributions on behalf of owner-employees.
1.401-14 Inclusion of medical benefits for retired employees in 
          qualified pension or annuity plans.
1.401(a)-1 Post-ERISA qualified plans and qualified trusts; in general.
1.401(a)-2 Impossibility of diversion under qualified plan or trust.
1.401(a)-4 Optional forms of benefit (before 1994).
1.401(a)-11 Qualified joint and survivor annuities.
1.401(a)-12 Mergers and consolidations of plans and transfers of plan 
          assets.
1.401(a)-13 Assignment or alienation of benefits.
1.401(a)-14 Commencement of benefits under qualified trusts.
1.401(a)-15 Requirement that plan benefits are not decreased on account 
          of certain Social Security increases.
1.401(a)-16 Limitations on benefits and contributions under qualified 
          plans.
1.401(a)-19 Nonforfeitability in case of certain withdrawals.
1.401(a)-20 Requirements of qualified joint and survivor annuity and 
          qualified preretirement survivor annuity.
1.401(a)-21 Rules relating to the use of an electronic medium to provide 
          applicable notices and to make participant elections.
1.401(a)-30 Limit on elective deferrals.
1.401(a)-50 Puerto Rican trusts; election to be treated as a domestic 
          trust.
1.401(a)(2)-1 Refund of mistaken employer contributions and withdrawal 
          liability payments to multiemployer plans.
1.401(a)(4)-0 Table of contents.
1.401(a)(4)-1 Nondiscrimination requirements of section 401(a)(4).
1.401(a)(4)-2 Nondiscrimination in amount of employer contributions 
          under a defined contribution plan.
1.401(a)(4)-3 Nondiscrimination in amount of employer-provided benefits 
          under a defined benefit plan.
1.401(a)(4)-4 Nondiscriminatory availability of benefits, rights, and 
          features.
1.401(a)(4)-5 Plan amendments and plan terminations.
1.401(a)(4)-6 Contributory defined benefit plans.
1.401(a)(4)-7 Imputation of permitted disparity.
1.401(a)(4)-8 Cross-testing.
1.401(a)(4)-9 Plan aggregation and restructuring.
1.401(a)(4)-10 Testing of former employees.
1.401(a)(4)-11 Additional rules.
1.401(a)(4)-12 Definitions.
1.401(a)(4)-13 Effective dates and fresh-start rules.
1.401(a)(5)-1 Special rules relating to nondiscrimination requirements.
1.401(a)(9)-0 Required minimum distributions; table of contents.
1.401(a)(9)-1 Minimum distribution requirement in general.
1.401(a)(9)-2 Distributions commencing during an employee's lifetime.
1.401(a)(9)-3 Death before required beginning date.
1.401(a)(9)-4 Determination of the designated beneficiary.
1.401(a)(9)-5 Required minimum distributions from defined contribution 
          plans.
1.401(a)(9)-6 Required minimum distributions for defined benefit plans 
          and annuity contracts.
1.401(a)(9)-7 Rollovers and transfers.
1.401(a)(9)-8 Special rules.
1.401(a)(9)-9 Life expectancy and distribution period tables.
1.401(a)(17)-1 Limitation on annual compensation.
1.401(a)(26)-0 Table of contents.

[[Page 6]]

1.401(a)(26)-1 Minimum participation requirements.
1.401(a)(26)-2 Minimum participation rule.
1.401(a)(26)-3 Rules applicable to a defined benefit plan's prior 
          benefit structure.
1.401(a)(26)-4 Testing former employees.
1.401(a)(26)-5 Employees who benefit under a plan.
1.401(a)(26)-6 Excludable employees.
1.401(a)(26)-7 Testing methods.
1.401(a)(26)-8 Definitions.
1.401(a)(26)-9 Effective dates and transition rules.
1.401(a)(31)-1 Requirement to offer direct rollover of eligible rollover 
          distributions; questions and answers.
1.401(a)(35)-1 Diversification requirements for certain defined 
          contribution plans.
1.401(b)-1 Certain retroactive changes in plan.
1.401(e)-1 Definitions relating to plans covering self-employed 
          individuals.
1.401(e)-2 General rules relating to plans covering self-employed 
          individuals.
1.401(e)-3 Requirements for qualification of trusts and plans benefiting 
          owner-employees.
1.401(e)-4 Contributions for premiums on annuity, etc., contracts and 
          transitional rule for certain excess contributions.
1.401(e)-5 Limitation of contribution and benefit bases to first 
          $100,000 of annual compensation in case of plans covering 
          self-employed individuals.
1.401(e)-6 Special rules for shareholder-employers.
1.401(f)-1 Certain custodial accounts and annuity contracts.
1.401(k)-0 Table of contents.
1.401(k)-1 Certain cash or deferred arrangements.
1.401(k)-2 ADP test.
1.401(k)-3 Safe harbor requirements.
1.401(k)-4 SIMPLE 401(k) plan requirements.
1.401(k)-5 Special rules for mergers, acquisitions and similar events. 
          [Reserved]
1.401(k)-6 Definitions.
1.401(l)-0 Table of contents.
1.401(l)-1 Permitted disparity in employer-provided contributions or 
          benefits.
1.401(l)-2 Permitted disparity for defined contribution plans.
1.401(l)-3 Permitted disparity for defined benefit plans.
1.401(l)-4 Special rules for railroad plans.
1.401(l)-5 Overall permitted disparity limits.
1.401(l)-6 Effective dates and transition rules.
1.401(m)-0 Table of contents.
1.401(m)-1 Employee contributions and matching contributions.
1.401(m)-2 ACP test.
1.401(m)-3 Safe harbor requirements.
1.401(m)-4 Special rules for mergers, acquisitions and similar events. 
          [Reserved]
1.401(m)-5 Definitions.
1.402(a)-1 Taxability of beneficiary under a trust which meets the 
          requirements of section 401(a).
1.402(a)(5)-1T Rollovers of partial distributions from qualified trusts 
          and annuities. (Temporary)
1.402(b)-1 Treatment of beneficiary of a trust not exempt under section 
          501(a).
1.402(c)-1 Taxability of beneficiary of certain foreign situs trusts.
1.402(c)-2 Eligible rollover distributions; questions and answers.
1.402(d)-1 Effect of section 402(d).
1.402(e)-1 Certain plan terminations.
1.402(f)-1 Required explanation of eligible rollover distributions; 
          questions and answers.
1.402(g)-0 Limitation on exclusion for elective deferrals, table of 
          contents.
1.402(g)-1 Limitation on exclusion for elective deferrals.
1.402(g)-2 Increased limit for catch-up contributions.
1.402(g)(3)-1 Employer contributions to purchase a section 403(b) 
          contract under a salary reduction agreement.
1.402A-1 Designated Roth Accounts.
1.402A-2 Reporting and recordkeeping requirements with respect to 
          designated Roth accounts.
1.403(a)-1 Taxability of beneficiary under a qualified annuity plan.
1.403(a)-2 Capital gains treatment for certain distributions.
1.403(b)-0 Taxability under an annuity purchased by a section 501(c)(3) 
          organization or a public school.
1.403(b)-1 General overview of taxability under an annuity contract 
          purchased by a section 501(c)(3) organization or a public 
          school.
1.403(b)-2 Definitions.
1.403(b)-3 Exclusion for contributions to purchase section 403(b) 
          contracts.
1.403(b)-4 Contribution limitations.
1.403(b)-5 Nondiscrimination rules.
1.403(b)-6 Timing of distributions and benefits.
1.403(b)-7 Taxation of distributions and benefits.
1.403(b)-8 Funding.
1.403(b)-9 Special rules for church plans.
1.403(b)-10 Miscellaneous provisions.
1.403(b)-11 Applicable dates.
1.403(c)-1 Taxability of beneficiary under a nonqualified annuity.
1.404(a)-1 Contributions of an employer to an employees' trust or 
          annuity plan and compensation under a deferred payment plan; 
          general rule.
1.404(a)-1T Questions and answers relating to deductibility of deferred 
          compensation and deferred benefits for employees. (Temporary)
1.404(a)-2 Information to be furnished by employer claiming deductions; 
          taxable years ending before December 31, 1971.

[[Page 7]]

1.404(a)-2A Information to be furnished by employer; taxable years 
          ending on or after December 31, 1971, and before December 31, 
          1975.
1.404(a)-3 Contributions of an employer to or under an employees' 
          pension trust or annuity plan that meets the requirements of 
          section 401(a); application of section 404(a)(1).
1.404(a)-4 Pension and annuity plans; limitations under section 
          404(a)(1)(A).
1.404(a)-5 Pension and annuity plans; limitations under section 
          404(a)(1)(B).
1.404(a)-6 Pension and annuity plans; limitations under section 
          404(a)(1)(C).
1.404(a)-7 Pension and annuity plans; contributions in excess of 
          limitations under section 404(a)(1); application of section 
          404(a)(1)(D).
1.404(a)-8 Contributions of an employer under an employees' annuity plan 
          which meets the requirements of section 401(a); application of 
          section 404(a)(2).
1.404(a)(8)-1T Deductions for plan contributions on behalf of self-
          employed individuals. (Temporary)
1.404(a)-9 Contributions of an employer to an employees' profit-sharing 
          or stock bonus trust that meets the requirements of section 
          401(a); application of section 404(a)(3)(A).
1.404(a)-10 Profit-sharing plan of an affiliated group; application of 
          section 404(a)(3)(B).
1.404(a)-11 Trusts created or organized outside the United States; 
          application of section 404(a)(4).
1.404(a)-12 Contributions of an employer under a plan that does not meet 
          the requirements of section 401(a); application of section 
          404(a)(5).
1.404(a)-13 Contributions of an employer where deductions are allowable 
          under section 404(a) (1) or (2) and also under section 
          404(a)(3); application of section 404(a)(7).
1.404(a)-14 Special rules in connection with the Employee Retirement 
          Income Security Act of 1974.
1.404(b)-1 Method of contribution, etc., having the effect of a plan; 
          effect of section 404(b).
1.404(b)-1T Method or arrangement of contributions, etc., deferring the 
          receipt of compensation or providing for deferred benefits. 
          (Temporary)
1.404(c)-1 Certain negotiated plans; effect of section 404(c).
1.404(d)-1T Questions and answers relating to deductibility of deferred 
          compensation and deferred benefits for independent 
          contractors. (Temporary)
1.404(e)-1 Contributions on behalf of a self-employed individual to or 
          under a pension, annuity, or profit-sharing plan meeting the 
          requirements of section 401; application of section 404(a) 
          (8), (9), and (10) and section 404 (e) and (f).
1.404(e)-1A Contributions on behalf of a self-employed individual to or 
          under a qualified pension, annuity, or profit-sharing plan.
1.404(g)-1 Deduction of employer liability payments.
1.404(k)-1T Questions and answers relating to the deductibility of 
          certain dividend distributions. (Temporary)
1.404(k)-3 Disallowance of deduction for reacquisition payments.
1.405-1 Qualified bond purchase plans.
1.405-2 Deduction of contributions to qualified bond purchase plans.
1.405-3 Taxation of retirement bonds.
1.406-1 Treatment of certain employees of foreign subsidiaries as 
          employees of the domestic corporation.
1.407-1 Treatment of certain employees of domestic subsidiaries engaged 
          in business outside the United States as employees of the 
          domestic parent corporation.
1.408-1 General rules.
1.408-2 Individual retirement accounts.
1.408-3 Individual retirement annuities.
1.408-4 Treatment of distributions from individual retirement 
          arrangements.
1.408-5 Annual reports by trustees or issuers.
1.408-6 Disclosure statements for individual retirement arrangements.
1.408-7 Reports on distributions from individual retirement plans.
1.408-8 Distribution requirements for individual retirement plans.
1.408-11 Net income calculation for returned or recharacterized IRA 
          contributions.
1.408(q)-1 Deemed IRAs in qualified employer plans.
1.408A-0 Roth IRAs; table of contents.
1.408A-1 Roth IRAs in general.
1.408A-2 Establishing Roth IRAs.
1.408A-3 Contributions to Roth IRAs.
1.408A-4 Converting amounts to Roth IRAs.
1.408A-5 Recharacterized contributions.
1.408A-6 Distributions.
1.408A-7 Reporting.
1.408A-8 Definitions.
1.408A-9 Effective date.
1.408A-10 Coordination between designated Roth accounts and Roth IRAs.
1.409-1 Retirement bonds.
1.409A-0 Table of contents.
1.409A-1 Definitions and covered plans.
1.409A-2 Deferral elections.
1.409A-3 Permissible payments
1.409A-4 Calculation of income inclusion [Reserved]
1.409A-5 Funding [Reserved]
1.409A-6 Application of section 409A and effective dates.
1.409(p)-1 Prohibited allocation of securities in an S corporation.

[[Page 8]]

1.409(p)-1T Prohibited allocation of securities in an S corporation 
          (temporary).
1.410(a)-1 Minimum participation standards; general rules.
1.410(a)-2 Effective dates.
1.410(a)-3 Minimum age and service conditions.
1.410(a)-3T Minimum age and service conditions (temporary).
1.410(a)-4 Maximum age conditions and time of participation.
1.410(a)-5 Year of service; break in service.
1.410(a)-6 Amendment of break in service rules; transition period.
1.410(a)-7 Elapsed time.
1.410(a)-8 Five consecutive 1-year breaks in service, transitional rules 
          under the Retirement Equity Act of 1984.
1.410(a)-8T Year of service; break in service (temporary).
1.410(a)-9 Maternity and paternity absence.
1.410(a)-9T Elapsed time (temporary).
1.410(b)-0 Table of contents.
1.410(b)-1 Minimum coverage requirements (before 1994).
1.410(b)-2 Minimum coverage requirements (after 1993).
1.410(b)-3 Employees and former employees who benefit under a plan.
1.410(b)-4 Nondiscriminatory classification test.
1.410(b)-5 Average benefit percentage test.
1.410(b)-6 Excludable employees.
1.410(b)-7 Definition of plan and rules governing plan disaggregation 
          and aggregation.
1.410(b)-8 Additional rules.
1.410(b)-9 Definitions.
1.410(b)-10 Effective dates and transition rules.
1.410(d)-1 Election by church to have participation, vesting, funding, 
          etc. provisions apply.
1.411(a)-1 Minimum vesting standards; general rules.
1.411(a)-2 Effective dates.
1.411(a)-3 Vesting in employer-derived benefits.
1.411(a)-3T Vesting in employer-derived benefits (temporary).
1.411(a)-4 Forfeitures, suspensions, etc.
1.411(a)-4T Forfeitures, suspensions, etc. (temporary).
1.411(a)-5 Service included in determination of nonforfeitable 
          percentage.
1.411(a)-6 Year of service; hours of service; breaks in service.
1.411(a)-7 Definitions and special rules.
1.411(a)-8 Changes in vesting schedule.
1.411(a)-8T Changes in vesting schedule (temporary).
1.411(a)-9 Amendment of break in service rules; transitional period.
1.411(a)-11 Restriction and valuation of distributions.
1.411(a)(13)-1 Statutory hybrid plans.
1.411(b)-1 Accrued benefit requirements.
1.411(b)(5)-1 Reduction in rate of benefit accrual under a defined 
          benefit plan.
1.411(c)-1 Allocation of accrued benefits between employer and employee 
          contributions.
1.411(d)-1 Coordination of vesting and discrimination requirements. 
          [Reserved]
1.411(d)-2 Termination or partial termination; discontinuance of 
          contributions.
1.411(d)-3 Other special rules.
1.411(d)-4 Section 411(d)(6) protected benefits.
1.411(d)-5 Class year plans; plan years beginning after October 22, 
          1986.
1.412(b)-2 Amortization of experience gains in connection with certain 
          group deferred annuity contracts.
1.412(b)-5 Election of the alternative amortization method of funding.
1.412(c)(1)-1 Determinations to be made under funding method--terms 
          defined.
1.412(c)(1)-2 Shortfall method.
1.412(c)(1)-3 Applying the minimum funding requirements to restored 
          plans.
1.412(c)(1)-3T Applying the minimum funding requirements to restored 
          plans (temporary).
1.412(c)(2)-1 Valuation of plan assets; reasonable actuarial valuation 
          methods.
1.412(c)(3)-1 Reasonable funding methods.
1.412(c)(3)-2 Effective dates and transitional rules relating to 
          reasonable funding methods.
1.412(i)-1 Certain insurance contract plans.
1.412(l)(7)-1 Mortality tables used to determine current liability.
1.413-1 Special rules for collectively bargained plans.
1.413-2 Special rules for plans maintained by more than one employer.
1.414(b)-1 Controlled group of corporations.
1.414(c)-1 Commonly controlled trades or businesses.
1.414(c)-2 Two or more trades or businesses under common control.
1.414(c)-3 Exclusion of certain interests or stock in determining 
          control.
1.414(c)-4 Rules for determining ownership.
1.414(c)-5 Certain tax-exempt organizations.
1.414(c)-6 Effective date.
1.414(e)-1 Definition of church plan.
1.414(f)-1 Definition of multiemployer plan.
1.414(g)-1 Definition of plan administrator.
1.414(l)-1 Mergers and consolidations of plans or transfers of plan 
          assets.
1.414(q)-1 Highly compensated employee.
1.414(q)-1T Highly compensated employee (temporary).
1.414(r)-0 Table of contents.
1.414(r)-1 Requirements applicable to qualified separate lines of 
          business.
1.414(r)-2 Line of business.
1.414(r)-3 Separate line of business.
1.414(r)-4 Qualified separate line of business--fifty-employee and 
          notice requirements.

[[Page 9]]

1.414(r)-5 Qualified separate line of business--administrative scrutiny 
          requirement--safe harbors.
1.414(r)-6 Qualified separate line of business--administrative scrutiny 
          requirement--individual determinations.
1.414(r)-7 Determination of the employees of an employer's qualified 
          separate lines of business.
1.414(r)-8 Separate application of section 410(b).
1.414(r)-9 Separate application of section 401(a)(26).
1.414(r)-10 Separate application of section 129(d)(8). [Reserved]
1.414(r)-11 Definitions and special rules.
1.414(s)-1 Definition of compensation.
1.414(v)-1 Catch-up contributions.
1.414(w)-1 Permissible withdrawals from eligible automatic contribution 
          arrangements.
1.415(a)-1 General rules with respect to limitations on benefits and 
          contributions under qualified plans.
1.415(b)-1 Limitations for defined benefit plans.
1.415(b)-2 Multiple annuity starting dates [Reserved].
1.415(c)-1 Limitations for defined contribution plans.
1.415(c)-2 Compensation.
1.415(d)-1 Cost-of-living adjustments.
1.415(f)-1 Aggregating plans.
1.415(g)-1 Disqualification of plans and trusts.
1.415(j)-1 Limitation year.
1.416-1 Questions and answers on top-heavy plans.
1.417(a)(3)-1 Required explanation of qualified joint and survivor 
          annuity and qualified preretirement survivor annuity.
1.417(e)-1 Restrictions and valuations of distributions from plans 
          subject to sections 401(a)(11) and 417.
1.417(e)-1T Restrictions and valuations of distributions from plans 
          subject to sections 401(a)(11) and 417. (Temporary)
1.419-1T Treatment of welfare benefit funds. (Temporary)
1.419A-1T Qualified asset account limitation of additions to account. 
          (Temporary)
1.419A-2T Qualified asset account limitation for collectively bargained 
          funds. (Temporary)
1.419A(f)(6)-1 Exception for 10 or more employer plan.
1.420-1 Significant reduction in retiree health coverage during the cost 
          maintenance period.

                          Certain Stock Options

1.421-1 Effective dates and meaning and use of certain terms.
1.421-1 Meaning and use of certain terms.
1.421-2 General rules.
1.422-1 Incentive stock options; general rules.
1.422-2 Incentive stock options defined.
1.422-3 Stockholder approval of incentive stock option plans.
1.422-4 $100,000 limitation for incentive stock options.
1.423-1 Applicability of section 421(a).
1.423-2 Employee stock purchase plan defined.
1.424-1 Definitions and special rules applicable to statutory options.
1.426-1.429 [Reserved]
1.430(d)-1 Determination of target normal cost and funding target.
1.430(f)-1 Effect of prefunding balance and funding standard carryover 
          balance.
1.430(g)-1 Valuation date and valuation of plan assets.
1.430(h)(2)-1 Interest rates used to determine present value.
1.430(h)(3)-1 Mortality tables used to determine present value.
1.430(h)(3)-2 Plan-specific substitute mortality tables used to 
          determine present value.
1.430(i)-1 Special rules for plans in at-risk status.
1.431(c)(6)-1 Mortality tables used to determine current liability.
1.432-1.435 [Reserved]
1.436-0 Table of contents.
1.436-1 Limits on benefits and benefit accruals under single employer 
          defined benefit plans.
1.437-1.440 [Reserved]

    Authority: 26 U.S.C. 401(m)(9) and 26 U.S.C. 7805.
    Section 1.401-12 also issued under 26 U.S.C. 401(d)(1).
    Section 1.401(a)-1 also issued under 26 U.S.C. 401
    Section 1.401(a)(2)-1 also issued under Multiemployer Pension Plan 
Amendments Act, Public Law 96-364, 410, (94 Stat. 1208, 1308)(1980).
    Section 1.401(a)(5)-1 also issued under 26 U.S.C. 401(a)(5).
    Section 1.401(a)(9)-1 also issued under 26 U.S.C. 401(a)(9).
    Section 1.401(a)(9)-2 also issued under 26 U.S.C. 401(a)(9).
    Section 1.401(a)(9)-3 also issued under 26 U.S.C. 401(a)(9).
    Section 1.401(a)(9)-4 also issued under 26 U.S.C. 401(a)(9).
    Section 1.401(a)(9)-5 also issued under 26 U.S.C. 401(a)(9).
    Section 1.401(a)(9)-6 also issued under 26 U.S.C. 401(a)(9).
    Section 1.401(a)(9)-7 also issued under 26 U.S.C. 401(a)(9).
    Section 1.401(a)(9)-8 also issued under 26 U.S.C. 401(a)(9).
    Section 1.401(a)(9)-9 also issued under 26 U.S.C. 401(a)(9).

[[Page 10]]

    Section 1.401(a)(17)-1 also issued under 26 U.S.C. 401(a)(17).
    Sections 1.401(a)(26)-1 through (a)(26)-9 also issued under 26 
U.S.C. 401(a)(26).
    Section 1.401(a)(35)-1 is also issued under 26 U.S.C. 401(a)(35).
    Section 1.401(a)-21 also issued under 26 U.S.C. 401 and section 104 
of the Electronic Signatures in Global and National Commerce Act, Public 
Law 106-229 (114 Stat. 464).
    Section 1.401(b)-1 also issued under 26 U.S.C. 401(b).
    Section 1.401(k)-3 is also issued under 26 U.S.C. 401(m)(9).
    Section 1.401(l)-0 through 1.401(l)-6 also issued under 26 U.S.C. 
401(l).
    Section 1.402A-1 is also issued under 26 U.S.C. 402A
    Section 1.403(b)-6 also issued under 26 U.S.C. 403(b)(10).
    Section 1.408-2 also issued under 26 U.S.C. 408(a) and 26 U.S.C. 
408(q).
    Section 1.404(k)-3 is also issued under sections 26 U.S.C. 162(k) 
and 404(k)(5)(A).
    Section 1.408-4 also issued under 26 U.S.C. 408.
    Section 1.408-8 also issued under 26 U.S.C. 408(a)(6) and (b)(3).
    Section 1.408-11 also issued under 26 U.S.C. 408.
    Section 1.408(q)-1 also issued under 26 U.S.C. 408(q).
    Section 1.408A-1 also issued under 26 U.S.C. 408A.
    Section 1.408A-2 also issued under 26 U.S.C. 408A.
    Section 1.408A-3 also issued under 26 U.S.C. 408A.
    Section 1.408A-4 also issued under 26 U.S.C. 408A.
    Section 1.408A-5 also issued under 26 U.S.C. 408A.
    Section 1.408A-6 also issued under 26 U.S.C. 408A.
    Section 1.408A-7 also issued under 26 U.S.C. 408A.
    Section 1.408A-8 also issued under 26 U.S.C. 408A.
    Section 1.408A-9 also issued under 26 U.S.C. 408A.
    Section 1.409(p)-1 is also issued under 26 U.S.C. 409(p)(7).
    Section 1.410(b)-2 also issued under 26 U.S.C. 410(b)(6).
    Section 1.410(b)-3 also issued under 26 U.S.C. 410(b)(6).
    Section 1.410(b)-4 also issued under 26 U.S.C. 410(b)(6).
    Section 1.410(b)-5 also issued under 26 U.S.C. 410(b)(6).
    Section 1.410(b)-6 also issued under 26 U.S.C. 410(b)(6) and section 
664 of the Economic Growth and Tax Relief Reconciliation Act of 2001 
(Public Law 107-16, 115 Stat. 38).
    Section 1.410(b)-7 also issued under 26 U.S.C. 410(b)(6).
    Section 1.410(b)-8 also issued under 26 U.S.C. 410(b)(6).
    Section 1.410(b)-9 also issued under 26 U.S.C. 410(b)(6).
    Section 1.410(b)-10 also issued under 26 U.S.C. 410(b)(6).
    Section 1.411(a)-7 also issued under 26 U.S.C. 411(a)(7)(B)(i).
    Section 1.411(a)(13)-1 also issued under 26 U.S.C. 411(a)(13).
    Section 1.411(b)(5)-1 also issued under 26 U.S.C. 411(b)(5).
    Section 1.411(d)-3 also issued under 26 U.S.C. 411(d)(6) and section 
645(b) of the Economic Growth and Tax Relief Reconciliation Act of 2001, 
Public Law 107-16 (115 Stat. 38).
    Section 1.411(d)-4 also issued under 26 U.S.C. 411(d)(6).
    Section 1.411(d)-6 issued under Reorganization Plan No. 4 of 1978, 
29 U.S.C. 1001nt.
    Sec. Sec. 1.414(c)-1 through 1.414(c)-5 also issued under 26 U.S.C. 
414(c).
    Section 1.414(c)-5 also issued under 26 U.S.C. 414(b), (c), and (o).
    Section 1.414(q)-1T also issued under 26 U.S.C. 414(q).
    Sections 1.414(r)-0 through 1.414(r)-7 also issued under 26 U.S.C. 
414(r).
    Section 1.414(r)-8 also issued under 26 U.S.C. 410(b) and 414(r).
    Section 1.414(r)-9 also issued under 26 U.S.C. 401(a)(26) and 
414(r).
    Section 1.414(r)-10 also issued under 26 U.S.C. 129 and 414(r).
    Section 1.414(r)-1 also issued under 26 U.S.C. 414(r).
    Section 1.414(s)-1 also issued under 26 U.S.C. 414(s).
    Section 1.417(e)-1 also issued under 26 U.S.C. 417(e)(3)(A)(ii)(II).
    Section 1.417(e)-1T also issued under 26 U.S.C. 
417(e)(3)(A)(ii)(II).
    Section 1.419A(f)(6)-1 also issued under 26 U.S.C. 419A(i).
    Section 1.420-1 also issued under 26 U.S.C. 420(c)(3)(E).

                       DEFERRED COMPENSATION, ETC.

            Pension, Profit-Sharing, Stock Bonus Plans, etc.



Sec. 1.401-0  Scope and definitions.

    (a) In general. Sections 1.401 through 1.401-14 (inclusive) reflect 
the provisions of section 401 prior to amendment by the Employee 
Retirement Income Security Act of 1974. The sections following Sec. 
1.401-14 and preceding Sec. 1.402(a)-1 (hereafter referred to in this 
section as the ``Post-ERISA Regulations'') reflect the provisions of 
section 401 after amendment by such Act.
    (b) Definitions. For purposes of the Post-ERISA regulations--

[[Page 11]]

    (1) Qualified plan. The term ``qualified plan'' means a plan which 
satisfies the requirements of section 401(a).
    (2) Qualified trust. The term ``qualified trust'' means a trust 
which satisfies the requirements of section 401(a).

(Sec. 411 Internal Revenue Code of 1954 (88 Stat. 901; 26 U.S.C. 411))

[T.D. 7501, 42 FR 42320, Aug. 23, 1977]



Sec. 1.401-1  Qualified pension, profit-sharing, and stock bonus plans.

    (a) Introduction. (1) Sections 401 through 405 relate to pension, 
profit- sharing, stock bonus, and annuity plans, compensation paid under 
a deferred-payment plan, and bond purchase plans. Section 401(a) 
prescribes the requirements which must be met for qualification of a 
trust forming part of a pension, profit-sharing, or stock bonus plan.
    (2) A qualified pension, profit-sharing, or stock bonus plan is a 
definite written program and arrangement which is communicated to the 
employees and which is established and maintained by an employer--
    (i) In the case of a pension plan, to provide for the livelihood of 
the employees or their beneficiaries after the retirement of such 
employees through the payment of benefits determined without regard to 
profits (see paragraph (b)(1)(i) of this section);
    (ii) In the case of a profit-sharing plan, to enable employees or 
their beneficiaries to participate in the profits of the employer's 
trade or business, or in the profits of an affiliated employer who is 
entitled to deduct his contributions to the plan under section 
404(a)(3)(B), pursuant to a definite formula for allocating the 
contributions and for distributing the funds accumulated under the plan 
(see paragraph (b)(1)(ii) of this section); and
    (iii) In the case of a stock bonus plan, to provide employees or 
their beneficiaries benefits similar to those of profit-sharing plans, 
except that such benefits are distributable in stock of the employer, 
and that the contributions by the employer are not necessarily dependent 
upon profits. If the employer's contributions are dependent upon 
profits, the plan may enable employees or their beneficiaries to 
participate not only in the profits of the employer, but also in the 
profits of an affiliated employer who is entitled to deduct his 
contributions to the plan under section 404(a)(3)(B) (see paragraph 
(b)(1)(iii) of this section).
    (3) In order for a trust forming part of a pension, profit-sharing, 
or stock bonus plan to constitute a qualified trust under section 
401(a), the following tests must be met:
    (i) It must be created or organized in the United States, as defined 
in section 7701(a)(9), and it must be maintained at all times as a 
domestic trust in the United States;
    (ii) It must be part of a pension, profit-sharing, or stock bonus 
plan established by an employer for the exclusive benefit of his 
employees or their beneficiaries (see paragraph (b)(2) through (5) of 
this section);
    (iii) It must be formed or availed of for the purpose of 
distributing to the employees or their beneficiaries the corpus and 
income of the fund accumulated by the trust in accordance with the plan, 
and, in the case of a plan which covers (as defined in paragraph (a)(2) 
of Sec. 1.401-10) any self-employed individual, the time and method of 
such distribution must satisfy the requirements of section 401(a)(9) 
with respect to each employee covered by the plan (see paragraph (e) of 
Sec. 1.401-11);
    (iv) It must be impossible under the trust instrument at any time 
before the satisfaction of all liabilities with respect to employees and 
their beneficiaries under the trust, for any part of the corpus or 
income to be used for, or diverted to, purposes other than for the 
exclusive benefit of the employees or their beneficiaries (see Sec. 
1.401-2);
    (v) It must be part of a plan which benefits prescribed percentages 
of the employees, or which benefits such employees as qualify under a 
classification set up by the employer and found by the Commissioner not 
to be discriminatory in favor of certain specified classes of employees 
(see Sec. 1.401-3 and, in addition, see Sec. 1.401-12 for special 
rules as to plans covering owner-employees);
    (vi) It must be part of a plan under which contributions or benefits 
do not discriminate in favor of certain specified classes of employees 
(see Sec. 1.401-4);

[[Page 12]]

    (vii) It must be part of a plan which provides the nonforfeitable 
rights described in section 401(a)(7) (see Sec. 1.401-6);
    (viii) If the trust forms part of a pension plan, the plan must 
provide that forfeitures must not be applied to increase the benefits 
any employee would receive under such plan (see Sec. 1.401-7);
    (ix) It must, if the plan benefits any self-employed individual who 
is an owner-employee, satisfy the additional requirements for 
qualification contained in section 401(a)(10) and (d).
    (4) For taxable years beginning after December 31, 1962, self-
employed individuals may be included in qualified plans. See Sec. Sec. 
1.401-10 through 1.401-13.
    (b) General rules. (1)(i) A pension plan within the meaning of 
section 401(a) is a plan established and maintained by an employer 
primarily to provide systematically for the payment of definitely 
determinable benefits to his employees over a period of years, usually 
for life, after retirement. Retirement benefits generally are measured 
by, and based on, such factors as years of service and compensation 
received by the employees. The determination of the amount of retirement 
benefits and the contributions to provide such benefits are not 
dependent upon profits. Benefits are not definitely determinable if 
funds arising from forfeitures on termination of service, or other 
reason, may be used to provide increased benefits for the remaining 
participants (see Sec. 1.401-7, relating to the treatment of 
forfeitures under a qualified pension plan). A plan designed to provide 
benefits for employees or their beneficiaries to be paid upon retirement 
or over a period of years after retirement will, for the purposes of 
section 401(a), be considered a pension plan if the employer 
contributions under the plan can be determined actuarially on the basis 
of definitely determinable benefits, or, as in the case of money 
purchase pension plans, such contributions are fixed without being 
geared to profits. A pension plan may provide for the payment of a 
pension due to disability and may also provide for the payment of 
incidental death benefits through insurance or otherwise. However, a 
plan is not a pension plan if it provides for the payment of benefits 
not customarily included in a pension plan such as layoff benefits or 
benefits for sickness, accident, hospitalization, or medical expenses 
(except medical benefits described in section 401(h) as defined in 
paragraph (a) of Sec. 1.401-14).
    (ii) A profit-sharing plan is a plan established and maintained by 
an employer to provide for the participation in his profits by his 
employees or their beneficiaries. The plan must provide a definite 
predetermined formula for allocating the contributions made to the plan 
among the participants and for distributing the funds accumulated under 
the plan after a fixed number of years, the attainment of a stated age, 
or upon the prior occurrence of some event such as layoff, illness, 
disability, retirement, death, or severance of employment. A formula for 
allocating the contributions among the participants is definite if, for 
example, it provides for an allocation in proportion to the basic 
compensation of each participant. A plan (whether or not it contains a 
definite predetermined formula for determining the profits to be shared 
with the employees) does not qualify under section 401(a) if the 
contributions to the plan are made at such times or in such amounts that 
the plan in operation discriminates in favor of officers, shareholders, 
persons whose principal duties consist in supervising the work of other 
employees, or highly compensated employees. For the rules with respect 
to discrimination, see Sec. Sec. 1.401-3 and 1.401-4. A profit-sharing 
plan within the meaning of section 401 is primarily a plan of deferred 
compensation, but the amounts allocated to the account of a participant 
may be used to provide for him or his family incidental life or accident 
or health insurance.
    (iii) A stock bonus plan is a plan established and maintained by an 
employer to provide benefits similar to those of a profit-sharing plan, 
except that the contributions by the employer are not necessarily 
dependent upon profits and the benefits are distributable in stock of 
the employer company. For the purpose of allocating and distributing the 
stock of the employer which is to be shared among his employees or their 
beneficiaries, such a

[[Page 13]]

plan is subject to the same requirements as a profit-sharing plan.
    (iv) As to inclusion of full-time life insurance salesmen within the 
class of persons considered to be employees, see section 7701(a)(20).
    (2) The term ``plan'' implies a permanent as distinguished from a 
temporary program. Thus, although the employer may reserve the right to 
change or terminate the plan, and to discontinue contributions 
thereunder, the abandonment of the plan for any reason other than 
business necessity within a few years after it has taken effect will be 
evidence that the plan from its inception was not a bona fide program 
for the exclusive benefit of employees in general. Especially will this 
be true if, for example, a pension plan is abandoned soon after pensions 
have been fully funded for persons in favor of whom discrimination is 
prohibited under section 401(a). The permanency of the plan will be 
indicated by all of the surrounding facts and circumstances, including 
the likelihood of the employer's ability to continue contributions as 
provided under the plan. In the case of a profit-sharing plan, other 
than a profit-sharing plan which covers employees and owner-employees 
(see section 401(d)(2)(B)), it is not necessary that the employer 
contribute every year or that he contribute the same amount or 
contribute in accordance with the same ratio every year. However, merely 
making a single or occasional contribution out of profits for employees 
does not establish a plan of profit-sharing. To be a profit-sharing 
plan, there must be recurring and substantial contributions out of 
profits for the employees. In the event a plan is abandoned, the 
employer should promptly notify the district director, stating the 
circumstances which led to the discontinuance of the plan.
    (3) If the plan is so designed as to amount to a subterfuge for the 
distribution of profits to shareholders, it will not qualify as a plan 
for the exclusive benefit of employees even though other employees who 
are not shareholders are also included under the plan. The plan must 
benefit the employees in general, although it need not provide benefits 
for all of the employees. Among the employees to be benefited may be 
persons who are officers and shareholders. However, a plan is not for 
the exclusive benefit of employees in general if, by any device 
whatever, it discriminates either in eligibility requirements, 
contributions, or benefits in favor of employees who are officers, 
shareholders, persons whose principal duties consist in supervising the 
work of other employees, or the highly compensated employees. See 
section 401(a) (3), (4), and (5). Similarly, a stock bonus or profit-
sharing plan is not a plan for the exclusive benefit of employees in 
general if the funds therein may be used to relieve the employer from 
contributing to a pension plan operating concurrently and covering the 
same employees. All of the surrounding and attendant circumstances and 
the details of the plan will be indicative of whether it is a bona fide 
stock bonus, pension, or profit-sharing plan for the exclusive benefit 
of employees in general. The law is concerned not only with the form of 
a plan but also with its effects in operation. For example, section 
401(a)(5) specifies certain provisions which of themselves are not 
discriminatory. However, this does not mean that a plan containing these 
provisions may not be discriminatory in actual operation.
    (4) A plan is for the exclusive benefit of employees or their 
beneficiaries even though it may cover former employees as well as 
present employees and employees who are temporarily on leave, as, for 
example, in the Armed Forces of the United States. A plan covering only 
former employees may qualify under section 401(a) if it complies with 
the provisions of section 401(a)(3)(B), with respect to coverage, and 
section 401(a)(4), with respect to contributions and benefits, as 
applied to all of the former employees. The term ``beneficiaries'' of an 
employee within the meaning of section 401 includes the estate of the 
employee, dependents of the employee, persons who are the natural 
objects of the employee's bounty, and any persons designated by the 
employee to share in the benefits of the plan after the death of the 
employee.
    (5)(i) No specific limitations are provided in section 401(a) with 
respect to

[[Page 14]]

investments which may be made by the trustees of a trust qualifying 
under section 401(a). Generally, the contributions may be used by the 
trustees to purchase any investments permitted by the trust agreement to 
the extent allowed by local law. However, such a trust will be subject 
to tax under section 511 with respect to any ``unrelated business 
taxable income'' (as defined in section 512) realized by it from its 
investments.
    (ii) Where the trust funds are invested in stock or securities of, 
or loaned to, the employer or other person described in section 503(b), 
full disclosure must be made of the reasons for such arrangement and the 
conditions under which such investments are made in order that a 
determination may be made whether the trust serves any purpose other 
than constituting part of a plan for the exclusive benefit of employees. 
The trustee shall report any of such investments on the return which 
under section 6033 it is required to file and shall with respect to any 
such investment furnish the information required by such return. See 
Sec. 1.6033-1.
    (c) Portions of years. A qualified status must be maintained 
throughout the entire taxable year of the trust in order for the trust 
to obtain any exemption for such year. But see section 401(a)(6) and 
Sec. 1.401-3.
    (d) Plan of several employers. A trust forming part of a plan of 
several employers for their employees will be qualified if all the 
requirements are otherwise satisfied.
    (e) Determination of exemptions and returns. (1) An employees' trust 
may request a determination letter as to its qualification under section 
401 and exemption under section 501. For the procedure for obtaining 
such a determination letter see paragraph (l) of Sec. 601.201 of this 
chapter (Statement of Procedural Rules).
    (2) A trust which qualifies under section 401(a) and which is exempt 
under section 501(a) must file a return in accordance with section 6033 
and the regulations thereunder. See Sec. Sec. 1.6033-1 and 1.6033-
2(a)(3). In case such a trust realizes any unrelated business taxable 
income, as defined in section 512, such trust is also required to file a 
return with respect to such income. See paragraph (e) of Sec. 1.6012-2 
and paragraph (a)(5) of Sec. 1.6012-3 for requirements with respect to 
such returns. For information required to be furnished periodically by 
an employer with respect to the qualification of a plan, see Sec. Sec. 
1.404(a)-2, 1.404(a)-2A, and 1.6033-2(a)(2)(ii)(i).

[T.D. 6500, 25 FR 11670, Nov. 26, 1960, as amended by T.D. 6675, 28 FR 
10118, Sept. 17, 1963; T.D. 6722, 29 FR 5071, Apr. 14, 1964; T.D. 7168, 
37 FR 5024, Mar. 9, 1972; T.D. 7428, 41 FR 34619, Aug. 16, 1976]



Sec. 1.401-2  Impossibility of diversion under the trust instrument.

    (a) In general. (1) Under section 401(a)(2) a trust is not qualified 
unless under the trust instrument it is impossible (in the taxable year 
and at any time thereafter before the satisfaction of all liabilities to 
employees or their beneficiaries covered by the trust) for any part of 
the trust corpus or income to be used for, or diverted to, purposes 
other than for the exclusive benefit of such employees or their 
beneficiaries. This section does not apply to funds of the trust which 
are allocated to provide medical benefits described in section 401(h) as 
defined in paragraph (a) of Sec. 1.401-14. For the rules prohibiting 
diversion of such funds and the requirement of reversion to the employer 
after satisfaction of all liabilities under the medical benefits 
account, see paragraph (c) (4) and (5) of Sec. 1.401-14. For rules 
permitting reversion to the employer of amounts held in a section 415 
suspense acount, see Sec. 1.401(a)-2(b).
    (2) As used in section 401(a)(2), the phrase ``if under the trust 
instrument it is impossible'' means that the trust instrument must 
definitely and affirmatively make it impossible for the nonexempt 
diversion or use to occur, whether by operation or natural termination 
of the trust, by power of revocation or amendment, by the happening of a 
contingency, by collateral arrangement, or by any other means. Although 
it is not essential that the employer relinquish all power to modify or 
terminate the rights of certain employees covered by the trust, it must 
be impossible for the trust funds to be used or diverted for purposes 
other than for the

[[Page 15]]

exclusive benefit of his employees or their beneficiaries.
    (3) As used in section 401(a)(2), the phrase ``purposes other than 
for the exclusive benefit of his employees or their beneficiaries'' 
includes all objects or aims not solely designed for the proper 
satisfaction of all liabilities to employees or their beneficiaries 
covered by the trust.
    (b) Meaning of ``liabilities''. (1) The intent and purpose in 
section 401(a)(2) of the phrase ``prior to the satisfaction of all 
liabilities with respect to employees and their beneficiaries under the 
trust'' is to permit the employer to reserve the right to recover at the 
termination of the trust, and only at such termination, any balance 
remaining in the trust which is due to erroneous actuarial computations 
during the previous life of the trust. A balance due to an ``erroneous 
actuarial computation'' is the surplus arising because actual 
requirements differ from the expected requirements even though the 
latter were based upon previous actuarial valuations of liabilities or 
determinations of costs of providing pension benefits under the plan and 
were made by a person competent to make such determinations in 
accordance with reasonable assumptions as to mortality, interest, etc., 
and correct procedures relating to the method of funding. For example, a 
trust has accumulated assets of $1,000,000 at the time of liquidation, 
determined by acceptable actuarial procedures using reasonable 
assumptions as to interest, mortality, etc., as being necessary to 
provide the benefits in accordance with the provisions of the plan. Upon 
such liquidation it is found that $950,000 will satisfy all of the 
liabilities under the plan. The surplus of $50,000 arises, therefore, 
because of the difference between the amounts actuarially determined and 
the amounts actually required to satisfy the liabilities. This $50,000, 
therefore, is the amount which may be returned to the employer as the 
result of an erroneous actuarial computation. If, however, the surplus 
of $50,000 had been accumulated as a result of a change in the benefit 
provisions or in the eligibility requirements of the plan, the $50,000 
could not revert to the employer because such surplus would not be the 
result of an erroneous actuarial computation.
    (2) The term ``liabilities'' as used in section 401(a)(2) includes 
both fixed and contingent obligations to employees. For example, if 
1,000 employees are covered by a trust forming part of a pension plan, 
300 of whom have satisfied all the requirements for a monthly pension, 
while the remaining 700 employees have not yet completed the required 
period of service, contingent obligations to such 700 employees have 
nevertheless arisen which constitute ``liabilities'' within the meaning 
of that term. It must be impossible for the employer (or other non 
employee) to recover any amounts other than such amounts as remain in 
the trust because of ``erroneous actuarial computations'' after the 
satisfaction of all fixed and contingent obligations. Furthermore, the 
trust instrument must contain a definite affirmative provision to this 
effect, irrespective of whether the obligations to employees have their 
source in the trust instrument itself, in the plan of which the trust 
forms a part, or in some collateral instrument or arrangement forming a 
part of such plan, and regardless of whether such obligations are, 
technically speaking, liabilities of the employer, of the trust, or of 
some other person forming a part of the plan or connected with it.

[T.D. 6500, 25 FR 11672, Nov. 26, 1960, as amended by T.D. 6722, 29 FR 
5072, Apr. 14, 1964; T.D. 7748, 46 FR 1695, Jan. 7, 1981]



Sec. 1.401-3  Requirements as to coverage.

    (a)(1) In order to insure that stock bonus, pension, and profit-
sharing plans are utilized for the welfare of employees in general, and 
to prevent the trust device from being used for the principal benefit of 
shareholders, officers, persons whose principal duties consist in 
supervising the work of other employees, or highly paid employees, or as 
a means of tax avoidance, a trust will not be qualified unless it is 
part of a plan which satisfies the coverage requirements of section 
401(a)(3). However, if the plan covers any individual who is an owner-
employee, as defined in section 401(c)(3), the requirements of section 
401(a)(3) and this section are not applicable to such plan, but the plan 
must satisfy

[[Page 16]]

the requirements of section 401(d) (see Sec. 1.401-12).
    (2) The percentage requirements in section 401(a)(3)(A) refer to a 
percentage of all the active employees, including employees temporarily 
on leave, such as those in the Armed Forces of the United States, if 
such employees are eligible under the plan.
    (3) The application of section 401(a)(3)(A) may be illustrated by 
the following example:

    Example. A corporation adopts a plan at a time when it has 1,000 
employees. The plan provides that all full-time employees who have been 
employed for a period of two years and have reached the age of 30 shall 
be eligible to participate. The plan also requires participating 
employees to contribute 3 percent of their monthly pay. At the time the 
plan is made effective 100 of the 1,000 employees had not been employed 
for a period of two years. Fifty of the employees were seasonal 
employees whose customary employment did not exceed five months in any 
calendar year. Twenty-five of the employees were part-time employees 
whose customary employment did not exceed 20 hours in any one week. One 
hundred and fifty of the full-time employees who had been employed for 
two years or more had not yet reached age 30. The requirements of 
section 401(a)(3)(A) will be met if 540 employees are covered by the 
plan, as shown by the following computation:

(i) Total employees with respect to whom the percentage              825
 requirements are applicable (1,000 minus 175 (100 plus 50
 plus 25))...................................................
(ii) Employees not eligible to participate because of age            150
 requirements................................................
                                                              ----------
(iii) Total employees eligible to participate................        675
(iv) Percentage of employees in item (i) eligible to                81+%
 participate.................................................
(v) Minimum number of participating employees to qualify the         540
 plan (80 percent of 675)....................................
 


If only 70 percent, or 578, of the 825 employees satisfied the age and 
service requirements, then 462 (80 percent of 578) participating 
employees would satisfy the percentage requirements.

    (b) If a plan fails to qualify under the percentage requirements of 
section 401(a)(3)(A), it may still qualify under section 401(a)(3)(B) 
provided always that (as required by section 401(a) (3) and (4)) the 
plan's eligibility conditions, benefits, and contributions do not 
discriminate in favor of employees who are officers, shareholders, 
persons whose principal duties consist in supervising the work of other 
employees, or the highly compensated employees.
    (c) Since, for the purpose of section 401, a profit-sharing plan is 
a plan which provides for distributing the funds accumulated under the 
plan after a fixed number of years, the attainment of a stated age, or 
upon the prior occurrence of some event such as illness, disability, 
retirement, death, layoff, or severance of employment, employees who 
receive the amounts allocated to their accounts before the expiration of 
such a period of time or the occurrence of such a contingency shall not 
be considered covered by a profit-sharing plan in determining whether 
the plan meets the coverage requirements of section 401(a)(3) (A) and 
(B). Thus, in case a plan permits employees to receive immediately the 
amounts allocated to their accounts, or to have such amounts paid to a 
profit- sharing plan for them, the employees who receive the shares 
immediately shall not, for the purpose of section 401, be considered 
covered by a profit-sharing plan.
    (d) Section 401(a)(5) sets out certain classifications that will not 
in themselves be considered discriminatory. However, those so designated 
are not intended to be exclusive. Thus, plans may qualify under section 
401(a)(3)(B) even though coverage thereunder is limited to employees who 
have either reached a designated age or have been employed for a 
designated number of years, or who are employed in certain designated 
departments or are in other classifications, provided the effect of 
covering only such employees does not discriminate in favor of officers, 
shareholders, employees whose principal duties consist in supervising 
the work of other employees, or highly compensated employees. For 
example, if there are 1,000 employees, and the plan is written for only 
salaried employees, and consequently only 500 employees are covered, 
that fact alone will not justify the conclusion that the plan does not 
meet the coverage requirements of section 401(a)(3)(B). Conversely, if a 
contributory plan is offered to all of the employees but the 
contributions required of the employee participants are so burdensome as 
to make the plan acceptable only to the

[[Page 17]]

highly paid employees, the classification will be considered 
discriminatory in favor of such highly paid employees.
    (e)(1) Section 401(a)(5) contains a provision to the effect that a 
classification shall not be considered discriminatory within the meaning 
of section 401(a)(3)(B) merely because all employees whose entire annual 
remuneration constitutes ``wages'' under section 3121(a)(1) (for 
purposes of the Federal Insurance Contributions Act, chapter 21 of the 
Code) are excluded from the plan. A reference to section 3121(a)(1) for 
years after 1954 shall be deemed a reference to section 1426(a)(1) of 
the Internal Revenue Code of 1939 for years before 1955. This provision, 
in conjunction with section 401(a)(3)(B), is intended to permit the 
qualification of plans which supplement the old-age, survivors, and 
disability insurance benefits under the Social Security Act (42 U.S.C. 
ch. 7). Thus, a classification which excludes all employees whose entire 
remuneration constitutes ``wages'' under section 3121(a)(1), will not be 
considered discriminatory merely because of such exclusion. Similarly, a 
plan which includes all employees will not be considered discriminatory 
solely because the contributions or benefits based on that part of their 
remuneration which is excluded from wages under section 3121(a)(1) 
differ from the contributions or benefits based on that part of their 
remuneration which is not so excluded. However, in making his 
determination with respect to discrimination in classification under 
section 401(a)(3)(B), the Commissioner will consider whether the total 
benefits resulting to each employee under the plan and under the Social 
Security Act, or under the Social Security Act only, establish an 
integrated and correlated retirement system satisfying the tests of 
section 401(a). If, therefore, a classification of employees under a 
plan results in relatively or proportionately greater benefits for 
employees earning above any specified salary amount or rate than for 
those below any such salary amount or rate, it may be found to be 
discriminatory within the meaning of section 401(a)(3)(B). If, however, 
the relative or proportionate differences in benefits which result from 
such classification are approximately offset by the old-age, survivors, 
and disability insurance benefits which are provided by the Social 
Security Act and which are not attributable to employee contributions 
under the Federal Insurance Contributions Act, the plan will be 
considered to be properly integrated with the Social Security Act and 
will, therefore, not be considered discriminatory.
    (2)(i) For purposes of determining whether a plan is properly 
integrated with the Social Security Act, the amount of old-age, 
survivors, and disability insurance benefits which may be considered as 
attributable to employer contributions under the Federal Insurance 
Contributions Act is computed on the basis of the following:
    (A) The rate at which the maximum monthly old-age insurance benefit 
is provided under the Social Security Act is considered to be the 
average of (1) the rate at which the maximum benefit currently payable 
under the Act (i.e., in 1971) is provided to an employee retiring at age 
65, and (2) the rate at which the maximum benefit ultimately payable 
under the Act (i.e., in 2010) is provided to an employee retiring at age 
65. The resulting figure is 43 percent of the average monthly wage on 
which such benefit is computed.
    (B) The total old-age, survivors, and disability insurance benefits 
with respect to an employee is considered to be 162 percent of the 
employee's old-age insurance benefits. The resulting figure is 70 
percent of the average monthly wage on which it is computed.
    (C) In view of the fact that social security benefits are funded 
through equal contributions by the employer and employee, 50 percent of 
such benefits is considered attributable to employer contributions. The 
resulting figure is 35 percent of the average monthly wage on which the 
benefit is computed.

Under these assumptions, the maximum old-age, survivors, and disability 
insurance benefits which may be attributed to employer contributions 
under the Federal Insurance Contributions Act is an amount equal to 35 
percent of the earnings on which they are computed. These computations 
take into account all amendments to the

[[Page 18]]

Society Security Act through the Social Security Amendments of 1971 (85 
Stat. 6). It is recognized, however, that subsequent amendments to this 
Act may increase the percentages described in (A) or (B) of this 
subdivision (i), or both. If this occurs, the method used in this 
subparagraph for determining the integration formula may result in a 
figure under (C) of this subdivision (i) which is greater than 35 
percent and a plan could be amended to adopt such greater figure in its 
benefit formula. In order to minimize future plan amendments of this 
nature, an employer may anticipate future changes in the Social Security 
Act by immediately utilizing such a higher figure, but not in excess of 
37\1/2\ percent, in developing its benefit formula.
    (ii) Under the rules provided in this subparagraph, a classification 
of employees under a noncontributory pension or annuity plan which 
limits coverage to employees whose compensation exceeds the applicable 
integration level under the plan will not be considered discriminatory 
within the meaning of section 401(a)(3)(B), where:
    (A) The integration level applicable to an employee is his covered 
compensation, or is (1) in the case of an active employee, a stated 
dollar amount uniformly applicable to all active employees which is not 
greater than the covered compensation of any active employee, and (2) in 
the case of a retired employee an amount which is not greater than his 
covered compensation. (For rules relating to determination of an 
employee's covered compensation, see subdivision (iv) of this 
subparagraph.)
    (B) The rate at which normal annual retirement benefits are provided 
for any employee with respect to his average annual compensation in 
excess of the plan's integration level applicable to him does not exceed 
37\1/2\ percent.
    (C) Average annual compensation is defined to mean the average 
annual compensation over the highest 5 consecutive years.
    (D) There are no benefits payable in case of death before 
retirement.
    (E) The normal form of retirement benefits is a straight life 
annuity, and if there are optional forms, the benefit payments under 
each optional form are actuarially equivalent to benefit payments under 
the normal form.
    (F) In the case of any employee who reaches normal retirement age 
before completion of 15 years of service with the employer, the rate at 
which normal annual retirement benefits are provided for him with 
respect to his average annual compensation in excess of the plan's 
integration level applicable to him does not exceed 2\1/2\ percent for 
each year of service.
    (G) Normal retirement age is not lower than age 65.
    (H) Benefits payable in case of retirement or any other severance of 
employment before normal retirement age cannot exceed the actuarial 
equivalent of the maximum normal retirement benefits, which might be 
provided in accordance with (A) through (G) of this subdivision (ii), 
multiplied by a fraction, the numerator of which is the actual number of 
years of service of the employee at retirement or severance, and the 
denominator of which is the total number of years of service he would 
have had if he had remained in service until normal retirement age. A 
special disabled life mortality table shall not be used in determining 
the actuarial equivalent in the case of severance due to disability.
    (iii) (A) If a plan was properly integrated with old-age and 
survivors insurance benefits on July 5, 1968 (hereinafter referred to as 
an ``existing plan''), then, notwithstanding the fact that such plan 
does not satisfy the requirements of subdivision (ii) of this 
subparagraph, it will continue to be considered properly integrated with 
such benefits until January 1, 1972. Such plan will be considered 
properly integrated after December 31, 1971, so long as the benefits 
provided under the plan for each employee equal the sum of--
    (1) The benefits to which he would be entitled under a plan which, 
on July 5, 1968, would have been considered properly integrated with 
old-age and survivors insurance benefits, and under which benefits are 
provided at the same (or a lesser) rate with respect to the same portion 
of compensation with respect to which benefits are provided under the 
existing plan, multiplied by the percentage of his total service with

[[Page 19]]

the employer performed before a specified date not later than January 1, 
1972; and
    (2) The benefits to which he would be entitled under a plan 
satisfying the requirements of subdivision (ii) of this subparagraph, 
multiplied by the percentage of his total service with the employer 
performed on and after such specified date.
    (B) A plan which, on July 5, 1968, was properly integrated with old-
age and survivors insurance benefits will not be considered not to be 
properly integrated with such benefits thereafter merely because such 
plan provides a minimum benefit for each employee (other than an 
employee who owns, directly or indirectly, stock possessing more than 10 
percent of the total combined voting power or value of all classes of 
stock of the employer corporation) equal to the benefit to which he 
would be entitled under the plan as in effect on July 5, 1968, if he 
continued to earn annually until retirement the same amount of 
compensation as he earned in 1967.
    (C) If a plan was properly integrated with old-age and survivors 
insurance benefits on May 17, 1971, notwithstanding the fact that such 
plan does not satisfy the requirements of subdivision (ii) of this 
subparagraph, it will continue to be considered properly integrated with 
such benefits until January 1, 1972.
    (iv) For purposes of this subparagraph, an employee's covered 
compensation is the amount of compensation with respect to which old-age 
insurance benefits would be provided for him under the Social Security 
Act (as in effect at any uniformly applicable date occurring before the 
employee's separation from the service) if for each year until he 
attains age 65 his annual compensation is at least equal to the maximum 
amount of earnings subject to tax in each such year under the Federal 
Insurance Contributions Act. A plan may provide that an employee's 
covered compensation is the amount determined under the preceding 
sentence rounded to the nearest whole multiple of a stated dollar amount 
which does not exceed $600.
    (v) In the case of an integrated plan providing benefits different 
from those described in subdivision (ii) or (iii) (whichever is 
applicable) of this subparagraph, or providing benefits related to years 
of service, or providing benefits purchasable by stated employer 
contributions, or under the terms of which the employees contribute, or 
providing a combination of any of the foregoing variations, the plan 
will be considered to be properly integrated only if, as determined by 
the Commissioner, the benefits provided thereunder by employer 
contributions cannot exceed in value the benefits described in 
subdivision (ii) or (iii) (whichever is applicable) of this 
subparagraph. Similar principles will govern in determining whether a 
plan is properly integrated if participation therein is limited to 
employees earning in excess of amounts other than those specified in 
subdivision (iv) of this subparagraph, or if it bases benefits or 
contributions on compensation in excess of such amounts, or if it 
provides for an offset of benefits otherwise payable under the plan on 
account of old-age, survivors, and disability insurance benefits. 
Similar principles will govern in determining whether a profit-sharing 
or stock bonus plan is properly integrated with the Social Security Act.
    (3) A plan supplementing the Social Security Act and excluding all 
employees whose entire annual remuneration constitutes ``wages'' under 
section 3121(a)(1) will not, however, be deemed discriminatory merely 
because, for administrative convenience, it provides a reasonable 
minimum benefit not to exceed $20 a month.
    (4) Similar considerations, to the extent applicable in any case, 
will govern classifications under a plan supplementing the benefits 
provided by other Federal or State laws. See section 401(a)(5).
    (5) If a plan provides contributions or benefits for a self-employed 
individual, the rules relating to the integration of such a plan with 
the contributions or benefits under the Social Security Act are set 
forth in paragraph (c) of Sec. 1.401-11 and paragraph (h) of Sec. 
1.401-12.
    (6) This paragraph (e) does not apply to plan years beginning on or 
after January 1, 1989.
    (f) An employer may designate several trusts or a trust or trusts 
and an

[[Page 20]]

annuity plan or plans as constituting one plan which is intended to 
qualify under section 401(a)(3), in which case all of such trusts and 
plans taken as a whole may meet the requirements of such section. The 
fact that such combination of trusts and plans fails to qualify as one 
plan does not prevent such of the trusts and plans as qualify from 
meeting the requirements of section 401(a).
    (g) It is provided in section 401(a)(6) that a plan will satisfy the 
requirements of section 401(a)(3), if on at least one day in each 
quarter of the taxable year of the plan it satisfies such requirements. 
This makes it possible for a new plan requiring contributions from 
employees to qualify if by the end of the quarter-year in which the plan 
is adopted it secures sufficient contributing participants to meet the 
requirements of section 401(a)(3). It also affords a period of time in 
which new participants may be secured to replace former participants, so 
as to meet the requirements of either subparagraph (A) or (B) of section 
401(a)(3).

[T.D. 6500, 25 FR 11672, Nov. 26, 1960, as amended by T.D. 6675, 28 FR 
10119, Sept. 17, 1963; T.D. 6982, 33 FR 16499, Nov. 13, 1968; T.D. 7134, 
36 FR 13592, July 22, 1971; 36 FR 13990, July 29, 1971; T.D. 8359, 56 FR 
47614, Sept. 19, 1991]



Sec. 1.401-4  Discrimination as to contributions or benefits (before 1994).

    (a)(1)(i) In order to qualify under section 401(a), a trust must not 
only meet the coverage requirements of section 401(a)(3), but, as 
provided in section 401(a)(4), it must also be part of a plan under 
which there is no discrimination in contributions or benefits in favor 
of officers, shareholders, employees whose principal duties consist in 
supervising the work of other employees, or highly compensated employees 
as against other employees whether within or without the plan.
    (ii) Since, for the purpose of section 401, a profit-sharing plan is 
a plan which provides for distributing the funds accumulated under the 
plan after a fixed number of years, the attainment of a stated age, or 
upon the prior occurrence of some event such as illness, disability, 
retirement, death, layoff, or severance of employment, any amount 
allocated to an employee which is withdrawn before the expiration of 
such a period of time or the occurrence of such a contingency shall not 
be considered in determining whether the contributions under the plan 
discriminate in favor of officers, shareholders, employees whose 
principal duties consist in supervising the work of other employees, or 
highly compensated employees. Thus, in case a plan permits employees to 
receive immediately the whole or any part of the amounts allocated to 
their accounts, or to have the whole or any part of such amounts paid to 
a profit-sharing plan for them, any amounts which are received 
immediately shall not, for the purpose of section 401, be considered 
contributed to a profit-sharing plan.
    (iii) Funds in a stock bonus or profit-sharing plan arising from 
forfeitures on termination of service, or other reason, must not be 
allocated to the remaining participants in such a manner as will effect 
the prohibited discrimination. With respect to forfeitures in a pension 
plan, see Sec. 1.401-7.
    (2)(i) Section 401(a)(5) sets out certain provisions which will not 
in and of themselves be discriminatory within the meaning of section 401 
a) (3) or (4). See Sec. 1.401-3. Thus, a plan will not be considered 
discriminatory merely because the contributions or benefits bear a 
uniform relationship to total compensation or to the basic or regular 
rate of compensation, or merely because the contributions or benefits 
based on that part of the annual compensation of employees which is 
subject to the Federal Insurance Contributions Act (chapter 21 of the 
Code) differ from the contributions or benefits based on any excess of 
such annual compensation over such part. With regard to the application 
of the rules of section 401(a)(5) in the case of a plan which benefits a 
self-employed individual, see paragraph (c) of Sec. 1.401-11.
    (ii) The exceptions specified in section 401(a)(5) are not an 
exclusive enumeration, but are merely a recital of provisions frequently 
encountered which will not of themselves constitute forbidden 
discrimination in contributions or benefits.

[[Page 21]]

    (iii) Variations in contributions or benefits may be provided so 
long as the plan, viewed as a whole for the benefit of employees in 
general, with all its attendant circumstances, does not discriminate in 
favor of employees within the enumerations with respect to which 
discrimination is prohibited. Thus, benefits in a stock bonus or profit-
sharing plan which vary by reason of an allocation formula which takes 
into consideration years of service, or other factors, are not 
prohibited unless they discriminate in favor of such employees.
    (b) A plan which excludes all employees whose entire remuneration 
constitutes wages under section 3121(a)(1) (relating to the Federal 
Insurance Contributions Act), or a plan under which the contributions or 
benefits based on that part of an employee's remuneration which is 
excluded from ``wages'' under such act differs from the contributions or 
benefits based on that part of the employee's remuneration which is not 
so excluded, or a plan under which the contributions or benefits differ 
because of any retirement benefit created under State or Federal law, 
will not be discriminatory because of such exclusion or difference, 
provided the total benefits resulting under the plan and under such law 
establish an integrated and correlated retirement system satisfying the 
tests of section 401(a).
    (c)(1) Although a qualified plan may provide for termination at will 
by the employer or discontinuance of contributions thereunder, this will 
not of itself prevent a trust from being a qualified trust. However, a 
qualified pension plan must expressly incorporate provisions which 
comply with the restrictions contained in subparagraph (2) of this 
paragraph at the time the plan is established, unless (i) it is 
reasonably certain at the inception of the plan that such restrictions 
would not affect the amount of contributions which may be used for the 
benefit of any employee, or (ii) the Commissioner determines that such 
provisions are not necessary to prevent the prohibited discrimination 
that may occur in the event of any early termination of the plan. 
Although these provisions are the only provisions required to be 
incorporated in the plan to prevent the discrimination that may arise 
because of an early termination of the plan, the plan may in operation 
result in the discrimination prohibited by section 401(a)(4), unless 
other provisions are later incorporated in the plan. Any pension plan 
containing a provision described in this paragraph shall not fail to 
satisfy section 411(a), (d)(2) and (d)(3) merely by reason of such a 
plan provision. Paragraph (c)(7) of this section sets forth special 
early termination rules applicable to certain qualified defined benefit 
plans for plan years affected by the Employee Retirement Income Security 
Act of 1974 (``ERISA''). Paragraph (c)(7) of this section does not 
contain all the rules required by the enactment of ERISA.
    (2)(i) If employer contributions under a qualified pension plan may 
be used for the benefit of an employee who is among the 25 highest paid 
employees of the employer at the time the plan is established and whose 
anticipated annual pension under the plan exceeds $1,500, such plan must 
provide that upon the occurrence of the conditions described in 
subdivision (ii) of this subparagraph, the employer contributions which 
are used for the benefit of any such employee are restricted in 
accordance with subdivision (iii) of this subparagraph.
    (ii) The restrictions described in subdivision (iii) of this 
subparagraph become applicable if--
    (A) The plan is terminated within 10 years after its establishment,
    (B) The benefits of an employee described in subdivision (i) of this 
subparagraph become payable within 10 years after the establishment of 
the plan, or
    (C) The benefits of an employee described in subdivision (i) of this 
subparagraph become payable after the plan has been in effect for 10 
years, and the full current costs of the plan for the first 10 years 
have not been funded. In the case of an employee described in (B) of 
this subdivision, the restrictions will remain applicable until the plan 
has been in effect for 10 years, but if at that time the full current 
costs have been funded the restrictions will no longer apply to the 
benefits payable to

[[Page 22]]

such an employee. In the case of an employee described in (B) or (C) of 
this subdivision, if at the end of the first 10 years the full current 
costs are not met, the restrictions will continue to apply until the 
full current costs are funded for the first time.
    (iii) The restrictions required under subdivision (i) of this 
subparagraph must provide that the employer contributions which may be 
used for the benefit of an employee described in such subdivision shall 
not exceed the greater of $20,000, or 20 percent of the first $50,000 of 
the annual compensation of such employee multiplied by the number of 
years between the date of the establishment of the plan and--
    (A) The date of the termination of the plan,
    (B) In the case of an employee described in subdivision (ii)(B) of 
this subparagraph, the date the benefit of the employee becomes payable, 
if before the date of the termination of the plan, or
    (C) In the case of an employee described in subdivision (ii)(C) of 
this subparagraph, the date of the failure to meet the full current 
costs of the plan. However, if the full current costs of the plan have 
not been met on the date described in (A) or (B) of this subdivision, 
whichever is applicable, then the date of the failure to meet such full 
current costs shall be substituted for the date referred to in (A) or 
(B) of this subdivision. For purposes of determining the contributions 
which may be used for the benefit of an employee when (b) of this 
subdivision applies, the number of years taken into account may be 
recomputed for each year if the full current costs of the plan are met 
for such year.
    (iv) For purposes of this subparagraph, the employer contributions 
which, at a given time, may be used for the benefits of an employee 
include any unallocated funds which would be used for his benefits if 
the plan were then terminated or the employee were then to withdraw from 
the plan, as well as all contributions allocated up to that time 
exclusively for his benefits.
    (v) The provisions of this subparagraph apply to a former or retired 
employee of the employer, as well as to an employee still in the 
employer's service.
    (vi) The following terms are defined for purposes of this 
subparagraph--
    (A) The term ``benefits'' includes any periodic income, any 
withdrawal values payable to a living employee, and the cost of any 
death benefits which may be payable after retirement on behalf of an 
employee, but does not include the cost of any death benefits with 
respect to an employee before retirement nor the amount of any death 
benefits actually payable after the death of an employee whether such 
death occurs before or after retirement.
    (B) The term full current costs means the normal cost, as defined in 
Sec. 1.404(a)-6, for all years since the effective date of the plan, 
plus interest on any unfunded liability during such period.
    (C) The term annual compensation of an employee means either such 
employee's average regular annual compensation, or such average 
compensation over the last five years, or such employee's last annual 
compensation if such compensation is reasonably similar to his average 
regular annual compensation for the five preceding years.
    (3) The amount of the employer contributions which can be used for 
the benefit of a restricted employee may be limited either by limiting 
the annual amount of the employer contributions for the designated 
employee during the period affected by the limitation, or by limiting 
the amount of funds under the plan which can be used for the benefit of 
such employee, regardless of the amount of employer contributions.
    (4) The restrictions contained in subparagraph (2) of this paragraph 
may be exceeded for the purpose of making current retirement income 
benefit payments to retired employees who would otherwise be subject to 
such restrictions, if--
    (i) The employer contributions which may be used for any such 
employee in accordance with the restrictions contained in subparagraph 
(2) of this paragraph are applied either (A) to provide level amounts of 
annuity in the basic form of benefit provided for under the plan for 
such employee at retirement (or, if he has already retired, beginning 
immediately), or (B) to provide level amounts of annuity in an optional

[[Page 23]]

form of benefit provided under the plan if the level amount of annuity 
under such optional form of benefit is not greater than the level amount 
of annuity under the basic form of benefit provided under the plan;
    (ii) The annuity thus provided is supplemented, to the extent 
necessary to provide the full retirement income benefits in the basic 
form called for under the plan, by current payments to such employee as 
such benefits come due; and
    (iii) Such supplemental payments are made at any time only if the 
full current costs of the plan have then been met, or the aggregate of 
such supplemental payments for all such employees does not exceed the 
aggregate employer contributions already made under the plan in the year 
then current.


If disability income benefits are provided under the plan, the plan may 
contain like provisions with respect to the current payment of such 
benefits.
    (5) If a plan has been changed so as to increase substantially the 
extent of possible discrimination as to contributions and as to benefits 
actually payable in event of the subsequent termination of the plan or 
the subsequent discontinuance of contributions thereunder, then the 
provisions of this paragraph shall be applied to the plan as so changed 
as if it were a new plan established on the date of such change. 
However, the provision in subparagraph (2)(iii) of this paragraph that 
the unrestricted amount of employer contributions on behalf of any 
employee is at least $20,000 is applicable to the aggregate amount 
contributed by the employer on behalf of such employee from the date of 
establishment of the original plan, and, for purposes of determining if 
the employee's anticipated annual pension exceeds $1,500, both the 
employer contributions on the employee's behalf prior to the date of the 
change in the plan and those expected to be made on his behalf 
subsequent to the date of the change (based on the employee's rate of 
compensation on the date of the change) are to be taken into account.
    (6) This paragraph shall apply to taxable years of a qualified plan 
commencing after September 30, 1963. In the case of an early termination 
of a qualified pension plan during any such taxable year, the employer 
contributions which may be used for the benefit of any employee must 
conform to the requirements of this paragraph. However, any pension plan 
which is qualified on September 30, 1963, will not be disqualified 
merely because it does not expressly include the provisions prescribed 
in this paragraph.
    (7)(i) A qualified defined benefit plan subject to section 412 
(without regard to section 412(h)(2)) shall not be required to contain 
the restriction described in paragraph (c)(2)(ii)(c) of this section 
applicable to an employee in a plan whose full current costs for the 
first 10 years have not been funded.
    (ii) A qualified defined benefit plan covered by section 4021(a) of 
ERISA (``qualified title IV plan'') shall satisfy the restrictions in 
paragraph (c)(2) of this section only if the plan satisfies this 
paragraph (c)(7). A plan satisfies this paragraph (c)(7) by providing 
that employer contributions which may be used for the benefit of an 
employee described in paragraph (c)(2) of this section who is a 
substantial owner, as defined in section 4022(b)(5) of ERISA, shall not 
exceed the greater of the dollar amount described in paragraph 
(c)(2)(iii) of this section or a dollar amount which equals the present 
value of the benefit guaranteed for such employee under section 4022 of 
ERISA, or if the plan has not terminated, the present value of the 
benefit that would be guaranteed if the plan terminated on the date the 
benefit commences, determined in accordance with regulations of the 
Pension Benefit Guaranty Corporation (``PBGC'').
    (iii) A plan satisfies this paragraph (c)(7) by providing that 
employer contributions which may be used for the benefit of all 
employees described in paragraph (c)(2) of this section (other than an 
employee who is a substantial owner as defined in section 4022(b)(5) of 
ERISA) shall not exceed the greater of the dollar amount described in 
paragraph (c)(2)(iii) of this section or a dollar amount which equals 
the present value of the maximum benefit described in section 
4022(b)(3)(B) of ERISA (determined on the date the plan terminates or on 
the date benefits

[[Page 24]]

commence, whichever is earlier and determined in accordance with 
regulations of PBGC) without regard to any other limitations in section 
4022 of ERISA.
    (iv) A plan provision satisfying this paragraph (c)(7) may be 
adopted by amendment or by incorporation at the time of establishment. 
Any allocation of assets attributable to employer contributions to an 
employee which exceeds the dollar limitation in this paragraph (c)(7) 
may be reallocated to prevent prohibited discrimination.
    (v) The early termination rules in the preceding subparagraphs (1) 
through (6) apply to a qualified title IV plan except where such rules 
are determined by the Commissioner to be inconsistent with the rules of 
this paragraph (c)(7), Sec. 1.411(d)-2, and section 4044(b)(4) of 
ERISA. The early termination rules of this paragraph (c)(7) contain some 
of the rules under section 401(a)(4) and (a)(7), as in effect on 
September 2, 1974, and section 411(d) (2) and (3). Section 1.411(d)-2 
also contains certain discrimination and vesting rules which are 
applicable to plan terminations.
    (vi) Paragraph (c)(7) of this section applies to plan terminations 
occurring on or after March 12, 1984. For distributions not on account 
of plan terminations, paragraph (c)(7) applies to distributions in plan 
years beginning after December 31, 1983. However, a plan may elect to 
apply that paragraph to distributions not on account of plan termination 
on or after January 10, 1984.
    (d)(1) Except as provided in paragraph (d)(2) of this section, the 
provisions of this section do not apply to plan years beginning on or 
after January 1, 1994. For rules applicable to plan years beginning on 
or after January 1, 1994, see Sec. Sec. 1.401(a)(4)-1 through 
1.401(a)(4)-13.
    (2) In the case of plans maintained by organizations exempt from 
income taxation under section 501(a), including plans subject to section 
403(b)(12)(A)(i) (nonelective plans), the provisions of this section do 
not apply to plan years beginning on or after January 1, 1996. For rules 
applicable to plan years beginning on or after January 1, 1996, see 
Sec. Sec. 1.401(a)(4)-1 through 1.401(a)(4)-13.

(Secs. 411 (d)(2) and (3) and 7805 of the Internal Revenue Code of 1954 
(68A Stat. 917, 88 Stat. 912; 26 U.S.C. 411(d)(2) and (3) and 7805))

[T.D. 6500, 25 FR 11674, Nov. 26, 1960, as amended by T.D. 6675, 28 FR 
10119, Sept. 17, 1963; T.D. 7934, 49 FR 1183, Jan. 10, 1984; 49 FR 2104, 
Jan. 18, 1984; T.D. 8360, 56 FR 47536, Sept. 19, 1991; T.D. 8485, 58 FR 
46778, Sept. 3, 1993]



Sec. 1.401-5  Period for which requirements of section 401(a) (3), (4), 
(5), and (6) are applicable with respect to plans put into effect 

before September 2, 1974.

    A pension, profit-sharing, stock bonus, or annuity plan shall be 
considered as satisfying the requirements of section 401(a) (3), (4), 
(5), and (6) for the period beginning with the date on which it was put 
into effect and ending with the 15th day of the third month following 
the close of the taxable year of the employer in which the plan was put 
into effect, if all the provisions of the plan which are necessary to 
satisfy such requirements are in effect by the end of such period and 
have been made effective for all purposes with respect to the whole of 
such period. Thus, if an employer in 1954 adopts such a plan as of 
January 1, 1954, and makes a return on the basis of the calendar year, 
he will have until March 15, 1955, to amend his plan so as to make it 
satisfy the requirements of section 401(a) (3), (4), (5), and (6) for 
the calendar year 1954 provided that by March 15, 1955, all provisions 
of such plan necessary to satisfy such requirements are in effect and 
have been made retroactive for all purposes to January 1, 1954, the 
effective date of the plan. If an employer is on a fiscal year basis, 
for example, April 1 to March 31, and in 1954 adopts such a plan 
effective as of April 1, 1954, he will have until June 15, 1955, to 
amend his plan so as to make it satisfy the requirements of section 
401(a) (3), (4), (5), and (6) for the fiscal year beginning April 1, 
1954, provided that by June 15, 1955, all provisions of such plan 
necessary to satisfy such requirements are in effect and have been made 
retroactive for all purposes to April 1, 1954, the effective date of the 
plan. It should be noted that under section 401(b) the period in which a 
plan may

[[Page 25]]

be amended to qualify under section 401(a) ends before the date on which 
taxpayers other than corporations are required to file income tax 
returns. See section 6072. This section shall not apply to any pension, 
profit-sharing, stock bonus, or annuity plan put into effect after 
September 1, 1974, and shall not apply with respect to any disqualifying 
provision to which Sec. 1.401(b)-1 applies.

[T.D. 6500, 25 FR 11674, Nov. 26, 1960; as amended by T.D. 7436, 41 FR 
42653, Sept. 28, 1976]



Sec. 1.401-6  Termination of a qualified plan.

    (a) General rules. (1) In order for a pension, profit-sharing, or 
stock bonus trust to satisfy the requirements of section 401, the plan 
of which such trust forms a part must expressly provide that, upon the 
termination of the plan or upon the complete discontinuance of 
contributions under the plan, the rights of each employee to benefits 
accrued to the date of such termination or discontinuance, to the extent 
then funded, or the rights of each employee to the amounts credited to 
his account at such time, are nonforfeitable. As to what constitutes 
nonforfeitable rights of an employee, see paragraph (a)(2) of Sec. 
1.402(b)-1.
    (2)(i) A qualified plan must also provide for the allocation of any 
previously unallocated funds to the employees covered by the plan upon 
the termination of the plan or the complete discontinuance of 
contributions under the plan. Such provision may be incorporated in the 
plan at its inception or by an amendment made prior to the termination 
of the plan or the discontinuance of contributions thereunder.
    (ii) Any provision for the allocation of unallocated funds is 
acceptable if it specifies the method to be used and does not conflict 
with the provisions of section 401(a)(4) and the regulations thereunder. 
The allocation of unallocated funds may be in cash or in the form of 
other benefits provided under the plan. However, the allocation of the 
funds contributed by the employer among the employees need not 
necessarily benefit all the employees covered by the plan. For example, 
an allocation may be satisfactory if priority is given to benefits for 
employees over the age of 50 at the time of the termination of the plan, 
or those who then have at least 10 years of service, if there is no 
possibility of discrimination in favor of employees who are officers, 
shareholders, employees whose principal duties consist in supervising 
the work of other employees, or highly compensated employees.
    (iii) Subdivisions (i) and (ii) of this subparagraph do not require 
the allocation of amounts to the account of any employee if such amounts 
are not required to be used to satisfy the liabilities with respect to 
employees and their beneficiaries under the plan (see section 
401(a)(2)).
    (b) Termination defined. (1) Whether a plan is terminated is 
generally a question to be determined with regard to all the facts and 
circumstances in a particular case. For example, a plan is terminated 
when, in connection with the winding up of the employer's trade or 
business, the employer begins to discharge his employees. However, a 
plan is not terminated, for example, merely because an employer 
consolidates or replaces that plan with a comparable plan. Similarly, a 
plan is not terminated merely because the employer sells or otherwise 
disposes of his trade or business if the acquiring employer continues 
the plan as a separate and distinct plan of its own, or consolidates or 
replaces that plan with a comparable plan. See paragraph (d)(4) of Sec. 
1.381(c)(11)-1 for the definition of comparable plan. In addition, the 
Commissioner may determine that other plans are comparable for purposes 
of this section.
    (2) For purposes of this section, the term termination includes both 
a partial termination and a complete termination of a plan. Whether or 
not a partial termination of a qualified plan occurs when a group of 
employees who have been covered by the plan are subsequently excluded 
from such coverage either by reason of an amendment to the plan, or by 
reason of being discharged by the employer, will be determined on the 
basis of all the facts and circumstances. Similarly, whether or not a 
partial termination occurs when benefits or employer contributions are

[[Page 26]]

reduced, or the eligibility or vesting requirements under the plan are 
made less liberal, will be determined on the basis of all the facts and 
circumstances. However, if a partial termination of a qualified plan 
occurs, the provisions of section 401(a)(7) and this section apply only 
to the part of the plan that is terminated.
    (c) Complete discontinuance defined. (1) For purposes of this 
section, a complete discontinuance of contributions under the plan is 
contrasted with a suspension of contributions under the plan, which is 
merely a temporary cessation of contributions by the employer. A 
complete discontinuance of contributions may occur although some amounts 
are contributed by the employer under the plan if such amounts are not 
substantial enough to reflect the intent on the part of the employer to 
continue to maintain the plan. The determination of whether a complete 
discontinuance of contributions under the plan has occurred will be made 
with regard to all the facts and circumstances in the particular case, 
and without regard to the amount of any contributions made under the 
plan by employees.
    (2) In the case of a pension plan, a suspension of contributions 
will not constitute a discontinuance if--
    (i) The benefits to be paid or made available under the plan are not 
affected at any time by the suspension, and
    (ii) The unfunded past service cost at any time (which includes the 
unfunded prior normal cost and unfunded interest on any unfunded cost) 
does not exceed the unfunded past service cost as of the date of 
establishment of the plan, plus any additional past service or 
supplemental costs added by amendment.
    (3) In any case in which a suspension of a profit-sharing plan is 
considered a discontinuance, the discontinuance becomes effective not 
later than the last day of the taxable year of the employer following 
the last taxable year of such employer for which a substantial 
contribution was made under the profit-sharing plan.
    (d) Contributions or benefits which remain forfeitable. The 
provisions of this section do not apply to amounts which are reallocated 
to prevent the discrimination prohibited by section 401(a)(4) (see 
paragraph (c) of Sec. 1.401-4).
    (e) Effective date. This section shall apply to taxable years of a 
qualified plan commencing after September 30, 1963. In the case of the 
termination or complete discontinuance (as defined in this section) of 
any qualified plan during any such taxable year, the rights accorded to 
each employee covered under the plan must conform to the requirements of 
this section. However, a plan which is qualified on September 30, 1963, 
will not be disqualified merely because it does not expressly include 
the provisions prescribed by this section.

[T.D. 6675, 28 FR 10120, Sept. 17, 1963]



Sec. 1.401-7  Forfeitures under a qualified pension plan.

    (a) General rules. In the case of a trust forming a part of a 
qualified pension plan, the plan must expressly provide that forfeitures 
arising from severance of employment, death, or for any other reason, 
must not be applied to increase the benefits any employee would 
otherwise receive under the plan at any time prior to the termination of 
the plan or the complete discontinuance of employer contributions 
thereunder. The amounts so forfeited must be used as soon as possible to 
reduce the employer's contributions under the plan. However, a qualified 
pension plan may anticipate the effect of forfeitures in determining the 
costs under the plan. Furthermore, a qualified plan will not be 
disqualified merely because a determination of the amount of forfeitures 
under the plan is made only once during each taxable year of the 
employer.
    (b) Examples. The rules of paragraph (a) of this section may be 
illustrated by the following examples:

    Example 1. The B Company Pension Trust forms a part of a pension 
plan which is funded by individual level annual premium annuity 
contracts. The plan requires ten years of service prior to obtaining a 
vested right to benefits under the plan. One of the company's employees 
resigns his position after two years of service. The insurance company 
paid to the trustees the cash surrender value of the contract--$750. The 
B Company must reduce its next contribution to the pension trust by this 
amount.

[[Page 27]]

    Example 2. The C Corporation's trusteed pension plan has been in 
existence for 20 years. It is funded by individual contracts issued by 
an insurance company, and the premiums thereunder are paid annually. 
Under such plan, the annual premium accrued for the year 1966 is due and 
is paid on January 2, 1966, and on July 1 of the same year the plan is 
terminated due to the liquidation of the employer. Some forfeitures were 
incurred and collected by the trustee with respect to those participants 
whose employment terminated between January 2 and July 1. The plan 
provides that the amount of such forfeitures is to be applied to provide 
additional annuity benefits for the remaining employees covered by the 
plan. The pension plan of the C Corporation satisfies the provisions of 
section 401(a)(8). Although forfeitures are used to increase benefits in 
this case, this use of forfeitures is permissible since no further 
contributions will be made under the plan.

    (c) Effective date. This section applies to taxable years of a 
qualified plan commencing after September 30, 1963. However, a plan 
which is qualified on September 30, 1963, will not be disqualified 
merely because it does not expressly include the provisions prescribed 
by this section.

[T.D. 6675, 28 FR 10121, Sept. 17, 1963]



Sec. 1.401-8  Custodial accounts prior to January 1, 1974.

    (a) Treatment of a custodial account as a qualified trust. For 
taxable years of a plan beginning after December 31, 1962, a custodial 
account may be used, in lieu of a trust, under any pension, profit-
sharing, or stock bonus plan, described in section 401 if the 
requirements of paragraph (b) of this section are met. A custodial 
account may be used under such a plan, whether the plan covers common-
law employees, self-employed individuals who are treated as employees by 
reason of section 401(c), or both. The use of a custodial account as 
part of a plan does not preclude the use of a trust or another custodial 
account as part of the same plan. A plan under which a custodial account 
is used may be considered in connection with other plans of the employer 
in determining whether the requirements of section 401 are satisfied. 
For regulations relating to the period after December 31, 1973, see 
Sec. 1.401(f)-11.
    (b) Rules applicable to custodial accounts. (1) A custodial account 
shall be treated for taxable years beginning after December 31, 1962, as 
a qualified trust under section 401 if such account meets the following 
requirements described in subdivisions (i) through (iii) of this 
subparagraph:
    (i) The custodial account must satisfy all the requirements of 
section 401 that are applicable to qualified trusts. See subparagraph 
(2) of this paragraph.
    (ii) The custodian of the custodial account must be a bank.
    (iii) The custodial agreement provides that the investment of the 
funds in the account is to be made--
    (A) Solely in stock of one or more regulated investment companies 
which is registered in the name of the custodian or its nominee and with 
respect to which an employee who is covered by the plan is the 
beneficial owner, or
    (B) Solely in annuity, endowment, or life insurance contracts, 
issued by an insurance company and held by the custodian until 
distributed pursuant to the terms of the plan. For purposes of the 
preceding sentence, a face-amount certificate described in section 
401(g) and Sec. 1.401-9 is treated as an annuity issued by an insurance 
company.

See subparagraphs (3) and (4) of this paragraph.
    (2) As a result of the requirement described in subparagraph (1)(i) 
of this paragraph (relating to the requirements applicable to qualified 
trusts), the custodial account must, for example, be created pursuant to 
a written agreement which constitutes a valid contract under local law. 
In addition, the terms of the contract must make it impossible, prior to 
the satisfaction of all liabilities with respect to the employees and 
their beneficiaries covered by the plan, for any part of the funds of 
the custodial account to be used for, or diverted to, purposes other 
than for the exclusive benefit of the employees or their beneficiaries 
as provided for in the plan (see paragraph (a) of Sec. 1.401-2).
    (3) The requirement described in subparagraph (1)(iii) of this 
paragraph, relating to the investment of the funds of the plan, applies, 
for example, to the employer contributions under the plan, any employee 
contributions under the plan, and any earnings on such contributions. 
Such requirement also applies to capital gains realized upon the

[[Page 28]]

sale of stock described in (A) of such subdivision, to any capital gain 
dividends received in connection with such stock, and to any refunds 
described in section 852(b)(3)(D)(ii) (relating to undistributed capital 
gains of a regulated investment company) which is received in connection 
with such stock. However, since such requirement relates only to the 
investment of the funds of the plan, the custodian may deposit funds 
with a bank, in either a checking or savings account, while accumulating 
sufficient funds to make additional investments or while awaiting an 
appropriate time to make additional investments.
    (4) The requirement in subparagraph (1)(iii)(A) of this paragraph 
that an employee covered by the plan be the beneficial owner of the 
stock does not mean that the employee who is the beneficial owner must 
have a nonforfeitable interest in the stock. Thus, a plan may provide 
for forfeitures of an employee's interest in such stock in the same 
manner as plans which use a trust. In the event of a forfeiture of an 
employee's beneficial ownership in the stock of a regulated investment 
company, the beneficial ownership of such stock must pass to another 
employee covered by the plan.
    (c) Effects of qualification. (1) Any custodial account which 
satisfies the requirements of section 401(f) shall be treated as a 
qualified trust for all purposes of the Internal Revenue Code of 1954. 
Accordingly, such a custodial account shall be treated as a separate 
legal person which is exempt from the income tax by section 501(a). On 
the other hand, such a custodial account is required to file the returns 
described in sections 6033 and 6047 and to supply any other information 
which a qualified trust is required to furnish.
    (2) In determining whether the funds of a custodial account are 
distributed or made available to an employee or his beneficiary, the 
rules which under section 402(a) are applicable to trusts will also 
apply to the custodial account as though it were a separate legal person 
and not an agent of the employee.
    (d) Effect of loss of qualification. If a custodial account which 
has qualified under section 401 fails to qualify under such section for 
any taxable year, such custodial account will not thereafter be treated 
as a separate legal person, and the funds in such account shall be 
treated as made available within the meaning of section 402(a)(1) to the 
employees for whom they are held.
    (e) Definitions. For purposes of this section--
    (1) The term bank means a bank as defined in section 401(d)(1).
    (2) The term regulated investment company means any domestic 
corporation which issues only redeemable stock and is a regulated 
investment company within the meaning of section 851(a) (but without 
regard to whether such corporation meets the limitations of section 
851(b)).

(Secs. 401(f)(2), 7805, Internal Revenue Code of 1954 (88 Stat. 939 and 
68A Stat. 917; 26 U.S.C. 401(f)(2), 7805))

[T.D. 6675, 28 FR 10121, Sept. 17, 1963, as amended by T.D. 7565, 43 FR 
41204, Sept. 15, 1978. Redesignated and amended by T.D. 7748, 46 FR 
1695, Jan. 7, 1981]



Sec. 1.401-9  Face-amount certificates--nontransferable annuity 
contracts.

    (a) Face-amount certificates treated as annuity contracts. Section 
401(g) provides that a face-amount certificate (as defined in section 
2(a)(15) of the Investment Company Act of 1940 (15 U.S.C. sec. 80a-2)) 
which is not transferable within the meaning of paragraph (b)(3) of this 
section shall be treated as an annuity contract for purposes of sections 
401 through 404 for any taxable year of a plan subject to such sections 
beginning after December 31, 1962. Accordingly, there may be established 
for any such taxable year a qualified plan under which such face-amount 
certificates are purchased for the participating employees without the 
creation of a trust or custodial account. However, for such a plan to 
qualify, the plan must satisfy all the requirements applicable to a 
qualified annuity plan (see section 403(a) and the regulations 
thereunder).
    (b) Nontransferability of face-amount certificates and annuity 
contracts. (1)(i) Section 401(g) provides that, in order for any face-
amount certificate, or any other contract issued after December 31, 
1962, to be subject to any provision under sections 401 through 404 
which is applicable to annuity contracts, as

[[Page 29]]

compared to other forms of investment, such certificate or contract must 
be nontransferable at any time when it is held by any person other than 
the trustee of a trust described in section 401(a) and exempt under 
section 501(a). Thus, for example, in order for a group or individual 
retirement income contract to be treated as an annuity contract, if such 
contract is not held by the trustee of an exempt employees' trust, it 
must satisfy the requirements of this section. Furthermore, a face-
amount certificate or an annuity contract will be subject to the tax 
treatment under section 403(b) only if it satisfies the requirements of 
section 401(g) and this section. Any certificate or contract in order to 
satisfy the provisions of this section must expressly contain the 
provisions that are necessary to make such certificate or contract not 
transferable within the meaning of this paragraph.
    (ii) In the case of any group contract purchased by an employer 
under a plan to which sections 401 through 404 apply, the restriction on 
transferability required by section 401(g) and this section applies to 
the interest of the employee participants under such group contract but 
not to the interest of the employer under such contract.
    (2) If a trust described in section 401(a) which is exempt from tax 
under section 501(a) distributes any annuity, endowment, retirement 
income, or life insurance contract, then the rules relating to the 
taxability of the distributee of any such contract are set forth in 
paragraph (a)(2) of Sec. 1.402(a)-1.
    (3) A face-amount certificate or an annuity contract is transferable 
if the owner can transfer any portion of his interest in the certificate 
or contract to any person other than the issuer thereof. Accordingly, 
such a certificate or contract is transferable if the owner can sell, 
assign, discount, or pledge as collateral for a loan or as security for 
the performance of an obligation or for any other purpose his interest 
in the certificate or contract to any person other than the issuer 
thereof. On the other hand, for purposes of section 401(g), a face-
amount certificate or annuity contract is not considered to be 
transferable merely because such certificate or contract, or the plan of 
which it is a part, contains a provision permitting the employee to 
designate a beneficiary to receive the proceeds of the certificate or 
contract in the event of his death, or contains a provision permitting 
the employee to elect to receive a joint and survivor annuity, or 
contains other similar provisions.
    (4) A material modification in the terms of an annuity contract 
constitutes the issuance of a new contract regardless of the manner in 
which it is made.
    (c) Examples. The rules of this section may be illustrated by the 
following examples:

    Example 1. The P Employees' Annuity Plan is a nontrusteed plan which 
is funded by individual annuity contracts issued by the Y Insurance 
Company. Each annuity contract issued by such company after December 31, 
1962, provides, on its face, that it is ``not transferable''. The terms 
of each such contract further provide that, ``This contract may not be 
sold, assigned, discounted, or pledged as collateral for a loan or as 
security for the performance of an obligation or for any other purpose, 
to any person other than this company.'' The annuity contracts of the P 
Employees' Annuity Plan satisfy the requirements of section 401(g) and 
this section.
    Example 2. The R Company Pension Trust forms a part of a pension 
plan which is funded by individual level premium annuity contracts. Such 
contracts are purchased by the trustee of the R Company Pension Trust 
from the Y Insurance Company. The trustee of the R Company Pension Trust 
is the legal owner of each such contract at all times prior to the 
distribution of such contract to a qualifying annuitant. The trustee 
purchases such a contract on January 3, 1963, in the name of an employee 
who qualifies on that date for coverage under the plan. At the time such 
contract is purchased, and while the contract is held by the trustee of 
the R Company Pension Trust, the contract does not contain any 
restrictions with respect to its transferability. The annuity contract 
purchased by the trustee of the R Company Pension Trust satisfies the 
requirements of section 401(g) and this section while it is held by the 
trustee.
    Example 3. A is the trustee of the X Corporation's Employees' 
Pension Trust. The trust forms a part of a pension plan which is funded 
by individual level premium annuity contracts. The trustee is the legal 
owner of such contracts, but the employees covered under the plan obtain 
beneficial interests in such contracts after ten years of service with 
the X Corporation. On January 15, 1980, A distributes to D an annuity 
contract issued

[[Page 30]]

to A in D's name on June 25, 1959, and distributes to E an annuity 
contract issued to A in E's name on September 30, 1963. The contract 
issued to D need not be nontransferable, but the contract issued to E 
must be nontransferable in order to satisfy the requirements of section 
401(g) and this section.
    Example 4. The corpus of the Y Corporation's Employees' Pension Plan 
consists of individual insurance contracts in the names of the covered 
employees and an auxiliary fund which is used to convert such policies 
to annuity contracts at the time a beneficiary of such trust retires. F 
retires on June 15, 1963, and the trustee converts the individual 
insurance contract on F's life to a life annuity which is distributed to 
him. The life annuity issued on F's life must be nontransferable in 
order to satisfy the requirements of section 401(g) and this section.

[T.D. 6675, 28 FR 10122, Sept. 17, 1963]



Sec. 1.401-10  Definitions relating to plans covering self-employed 
individuals.

    (a) In general. (1) Certain self-employed individuals may be covered 
by a qualified pension, annuity, or profit- sharing plan for taxable 
years beginning after December 31, 1962. This section contains 
definitions relating to plans covering self-employed individuals. The 
provisions of Sec. Sec. 1.401-1 through 1.401-9, relating to 
requirements which are applicable to all qualified plans, are also 
generally applicable to any plan covering a self-employed individual. 
However, in addition to such requirements, any plan covering a self-
employed individual is subject to the rules contained in Sec. Sec. 
1.401-11 through 1.401-13. Section 1.401-11 contains general rules which 
are applicable to any plan covering a self-employed individual who is an 
employee within the meaning of paragraph (b) of this section. Section 
1.401-12 contains special rules which are applicable to plans covering 
self-employed individuals when one or more of such individuals is an 
owner-employee within the meaning of paragraph (d) of this section. 
Section 1.401-13 contains rules relating to excess contributions by, or 
for, an owner-employee. The provisions of this section and of Sec. Sec. 
1.401-11 through 1.401-13 are applicable to taxable years beginning 
after December 31, 1962.
    (2) A self-employed individual is covered under a qualified plan 
during the period beginning with the date a contribution is first made 
by, or for, him under the qualified plan and ending when there are no 
longer funds under the plan which can be used to provide him or his 
beneficiaries with benefits.
    (b) Treatment of a self-employed individual as an employee. (1) For 
purposes of section 401, a self-employed individual who receives earned 
income from an employer during a taxable year of such employer beginning 
after December 31, 1962, shall be considered an employee of such 
employer for such taxable year. Moreover, such an individual will be 
considered an employee for a taxable year if he would otherwise be 
treated as an employee but for the fact that the employer did not have 
net profits for that taxable year. Accordingly, the employer may cover 
such an individual under a qualified plan during years of the plan 
beginning with or within a taxable year of the employer beginning after 
December 31, 1962.
    (2) If a self-employed individual is engaged in more than one trade 
or business, each such trade or business shall be considered a separate 
employer for purposes of applying the provisions of sections 401 through 
404 to such individual. Thus, if a qualified plan is established for one 
trade or business but not the others, the individual will be considered 
an employee only if he received earned income with respect to such trade 
or business and only the amount of such earned income derived from that 
trade or business shall be taken into account for purposes of the 
qualified plan.
    (3)(i) The term employee, for purposes of section 401, does not 
include a self-employed individual when the term ``common-law'' employee 
is used or when the context otherwise requires that the term 
``employee'' does not include a self-employed individual. The term 
``common- law'' employee also includes an individual who is treated as 
an employee for purposes of section 401 by reason of the provisions of 
section 7701(a)(20), relating to the treatment of certain full-time life 
insurance salesmen as employees. Furthermore, an individual who is a 
common-law employee is not a self-employed individual with respect to 
income attributable to such employment, even though such income 
constitutes net

[[Page 31]]

earnings from self-employment as defined in section 1402(a). Thus, for 
example, a minister who is a common-law employee is not a self-employed 
individual with respect to income attributable to such employment, even 
though such income constitutes net earnings from self-employment as 
defined in section 1402(a).
    (ii) An individual may be treated as an employee within the meaning 
of section 401(c)(1) of one employer even though such individual is also 
a common-law employee of another employer. For example, an attorney who 
is a common-law employee of a corporation and who, in the evenings 
maintains an office in which he practices law as a self-employed 
individual is an employee within the meaning of section 401(c)(1) with 
respect to the law practice. This example would not be altered by the 
fact that the corporation maintained a qualified plan under which the 
attorney is benefited as a common-law employee.
    (4) For the purpose of determining whether an employee within the 
meaning of section 401(c)(1) satisfies the requirements for eligibility 
under a qualified plan established by an employer, such an employer may 
take into account past services rendered by such an employee both as a 
self-employed individual and as a common-law employee if past services 
rendered by other employees, including common-law employees, are 
similarly taken into account. However, an employer cannot take into 
account only past services rendered by employees within the meaning of 
section 401(c)(1) if past services rendered to such employer by 
individuals who are, or were, common-law employees are not taken into 
account. Past service as described in this subparagraph may be taken 
into account for the purpose of determining whether an individual who 
is, or was, an employee within the meaning of section 401(c)(1) 
satisfies the requirements for eligibility even if such service was 
rendered prior to January 1, 1963. On the other hand, past service 
cannot be taken into account for purposes of determining the 
contributions which may be made on such an individual's behalf under a 
qualified plan.
    (c) Definition of earned income--(1) General rule. For purposes of 
section 401 and the regulations thereunder, ``earned income'' means, in 
general, net earnings from self-employment (as defined in section 
1402(a)) to the extent such net earnings constitute compensation for 
personal services actually rendered within the meaning of section 
911(b).
    (2) Net earnings from self-employment. (i) The computation of the 
net earnings from self-employment shall be made in accordance with the 
provisions of section 1402(a) and the regulations thereunder, with the 
modifications and exceptions described in subdivisions (ii) through (iv) 
of this subparagraph. Thus, an individual may have net earnings from 
self-employment, as defined in section 1402(a), even though such 
individual does not have self-employment income, as defined in section 
1402(b), and, therefore, is not subject to the tax on self-employment 
income imposed by section 1401.
    (ii) Items which are not included in gross income for purposes of 
chapter 1 of the Code and the deductions properly attributable to such 
items must be excluded from the computation of net earnings from self-
employment even though the provisions of section 1402(a) specifically 
require the inclusion of such items. For example, if an individual is a 
resident of Puerto Rico, so much of his net earnings from self-
employment as are excluded from gross income under section 933 must not 
be taken into account in computing his net earnings from self-employment 
which are earned income for purposes of section 401.
    (iii) In computing net earnings from self-employment for the purpose 
of determining earned income, a self-employed individual may disregard 
only deductions for contributions made on his own behalf under a 
qualified plan. However, such computation must take into account the 
deduction allowed by section 404 or 405 for contributions under a 
qualified plan on behalf of the common-law employees of the trade or 
business.
    (iv) For purposes of determining whether an individual has net 
earnings from self-employment and, thus, whether he is an employee 
within the

[[Page 32]]

meaning of section 401(c)(1), the exceptions in section 1402(c) (4) and 
(5) shall not apply. Thus, certain ministers, certain members of 
religious orders, doctors of medicine, and Christian Science 
practitioners are treated for purposes of section 401 as being engaged 
in a trade or business from which net earnings from self-employment are 
derived. In addition, the exceptions in section 1402(c)(2) shall not 
apply in the case of any individual who is treated as an employee under 
section 3121(d)(3) (A), (C), or (D). Therefore, such individuals are 
treated, for purposes of section 401, as being engaged in a trade or 
business from which net earnings from self-employment may be derived.
    (3) Compensation for personal services actually rendered. (i) For 
purposes of section 401, the term ``earned income'' includes only that 
portion of an individual's net earnings from self-employment which 
constitutes earned income as defined in section 911(b) and the 
regulations thereunder. Thus, such term includes only professional fees 
and other amounts received as compensation for personal services 
actually rendered by the individual. There is excluded from ``earned 
income'' the amount of any item of income, and any deduction properly 
attributable to such item, if such amount is not received as 
compensation for personal services actually rendered. Therefore, an 
individual who renders no personal services has no ``earned income'' 
even though such an individual may have net earnings from self-
employment from a trade or business.
    (ii) If a self-employed individual is engaged in a trade or business 
in which capital is a material income-producing factor, then, under 
section 911(b), his earned income is only that portion of the net 
profits from the trade or business which constitutes a reasonable 
allowance as compensation for personal services actually rendered. 
However, such individual's earned income cannot exceed 30 percent of the 
net profits of such trade or business. The net profits of the trade or 
business is not necessarily the same as the net earnings from self-
employment derived from such trade or business.
    (4) Minimum earned income when both personal services and capital 
are material income-producing factors. (i) If a self-employed individual 
renders personal services on a full-time, or substantially full-time, 
basis to only one trade or business, and if with respect to such trade 
or business capital is a material income-producing factor, then the 
amount of such individual's earned income from the trade or business is 
considered to be not less than so much of his share in the net profits 
of such trade or business as does not exceed $2,500.
    (ii) If a self-employed individual renders substantial personal 
services to more than one trade or business, and if with respect to all 
such trades or businesses such self-employed individual actually renders 
personal services on a full-time, or substantially full-time, basis, 
then the earned income of the self-employed individual from trades or 
businesses for which he renders substantial personal services and in 
which both personal services and capital are material income-producing 
factors is considered to be not less than--
    (A) So much of such individual's share of the net profits from all 
trades or businesses in which he renders substantial personal services 
as does not exceed $2,500, reduced by.
    (B) Such individual's share of the net profits of any trade or 
business in which only personal services is a material income-producing 
factor.

However, in no event shall the share of the net profits of any trade or 
business in which capital is a material income-producing factor be 
reduced below the amount which would, without regard to the provisions 
of this subdivision, be treated as the earned income derived from such 
trade or business under section 911(b). In making the computation 
required by this subdivision, any trade or business with respect to 
which the individual renders substantial personal services shall be 
taken into account irrespective of whether a qualified plan has been 
established by such trade or business.
    (iii) If the provisions of subdivision (ii) of this subparagraph 
apply in determining the earned income of a self-employed individual, 
and such individual is engaged in two or more trades or

[[Page 33]]

businesses in which capital and personal services are material income-
producing factors, then the total amount treated as the earned income 
shall be allocated to each such trade or business for which he performs 
substantial personal services in the same proportion as his share of net 
profits from each such trade or business bears to his share of the total 
net profits from all such trades or businesses. Thus, in such case, the 
amount of earned income attributable to any such trade or business is 
computed by multiplying the total earned income as determined under 
subdivision (ii) of this subparagraph by the individual's net profits 
from such trade or business and dividing that product by the 
individual's total net profits from all such trades or businesses.
    (iv) For purposes of this subparagraph, the determination of whether 
an individual renders personal services on a full-time, or substantially 
full-time, basis is to be made with regard to the aggregate of the 
trades and businesses with respect to which the employee renders 
substantial personal services as a common-law employee or as a self-
employed individual. However, for all other purposes in applying the 
rules of this subparagraph, a trade or business with respect to which an 
individual is a common-law employee shall be disregarded.
    (d) Definition of owner-employee. For purposes of section 401 and 
the regulations thereunder, the term ``owner-employee'' means a 
proprietor of a proprietorship, or, in the case of a partnership, a 
partner who owns either more than 10 percent of the capital interest, or 
more than 10 percent of the profits interest, of the partnership. Thus, 
an individual who owns only 2 percent of the profits interest but 11 
percent of the capital interest of a partnership is an owner-employee. A 
partner's interest in the profits and the capital of the partnership 
shall be determined by the partnership agreement. In the absence of any 
provision regarding the sharing of profits, the interest in profits of 
the partners will be determined in the same manner as their distributive 
shares of partnership taxable income. However, a guaranteed payment (as 
described in section 707(c)) is not considered a distributive share of 
partnership income for such purpose. See section 704(b), relating to the 
determination of the distributive share by the income or loss ratio, and 
the regulations thereunder. In the absence of a provision in the 
partnership agreement, a partner's capital interest in a partnership 
shall be determined on the basis of his interest in the assets of the 
partnership which would be distributable to such partner upon his 
withdrawal from the partnership, or upon liquidation of the partnership, 
whichever is the greater.
    (e) Definition of employer. (1) For purposes of section 401, a sole 
proprietor is considered to be his own employer, and the partnership is 
considered to be the employer of each of the partners. Thus, an 
individual partner is not an employer who may establish a qualified plan 
with respect to his services to the partnership.
    (2) Regardless of the provision of local law, a partnership is 
deemed, for purposes of section 401, to be continuing until such time as 
it is terminated within the meaning of section 708, relating to the 
continuation of a partnership.

[T.D. 6675, 28 FR 10123, Sept. 17, 1963]



Sec. 1.401-11  General rules relating to plans covering self-employed 
individuals.

    (a) Introduction. This section provides certain rules which 
supplement, and modify, the rules of Sec. Sec. 1.401-1 through 1.401-9 
in the case of a qualified pension, annuity, or profit-sharing plan 
which covers a self-employed individual who is an employee within the 
meaning of section 401(c)(1). The provisions of this section apply to 
taxable years beginning after December 31, 1962. Except as otherwise 
provided, paragraphs (b) through (m) of this section apply to taxable 
years beginning after December 31, 1962. Paragraph (n) of this section 
applies to plan years determined in accordance with paragraph (n)(1) of 
this section.
    (b) General rules. (1) If the amount of employer contributions for 
common-law employees covered under a qualified plan is related to the 
earned income (as defined in section 401(c)(2)) of a self-employed 
individual, or group of self-employed individuals, such a plan

[[Page 34]]

is a profit-sharing plan (as described in paragraph (b)(1)(ii) of Sec. 
1.401-1) since earned income is dependent upon the profits of the trade 
or business with respect to which the plan is established. Thus, for 
example, a plan, which provides that the employer will contribute 10 
percent of the earned income of a self-employed individual but no more 
than $2,500, and that the employer contribution on behalf of common-law 
employees shall be the same percentage of their salaries as the 
contribution on behalf of the self-employed individual bears to his 
earned income, is a profit-sharing plan, since the amount of the 
employer's contribution for common-law employees covered under the plan 
is related to the earned income of a self-employed individual and 
thereby to the profits of the trade or business. On the other hand, for 
example, a plan which defines the compensation of any self-employed 
individual as his earned income and which provides that the employer 
will contribute 10 percent of the compensation of each employee covered 
under the plan is a pension plan since the contribution on behalf of 
common-law employees is fixed without regard to whether the self-
employed individual has earned income or the amount thereof.
    (2) The Self-Employed Individuals Tax Retirement Act of 1962 (76 
Stat. 809) permits self-employed individuals to be treated as employees 
and therefore included in qualified plans, but it is clear that such law 
requires such self-employed individuals to provide benefits for their 
employees on a nondiscriminatory basis. Self-employed individuals will 
not be considered as providing contributions or benefits for an employee 
to the extent that the wages or salary of the employee covered under the 
plan are reduced at or about the time the plan is adopted.
    (3) In addition to permitting self-employed individuals to 
participate in qualified plans, the Self-Employed Individuals Tax 
Retirement Act of 1962 extends to such individuals some of the tax 
benefits allowed common-law employee-participants in such plans. 
However, the tax benefits allowed a self-employed individual are 
restricted by the limits which are placed on the deductions allowed for 
contributions on such an individual's behalf. In view of these 
restrictions on the tax benefits extended to any self-employed 
individual, a self-employed individual participating in a qualified plan 
may not participate in any forfeitures. Therefore, in the case of a 
qualified plan which covers any self-employed individual, a separate 
account must be established for each self-employed individual to which 
no forfeitures can be allocated.
    (c) Requirements as to coverage. (1) In general, section 401(a)(3) 
and the regulations thereunder prescribe the coverage requirements which 
a qualified plan must satisfy. However, if such a plan covers self-
employed individuals who are not owner-employees, it must, in addition 
to satisfying such requirements, satisfy the requirements of this 
paragraph. If any owner-employee is covered under a qualified plan, the 
provisions of this paragraph do not apply, but the provisions of section 
401(d), including section 401(d)(3), do apply (see Sec. 1.401-12).
    (2)(i) Section 401(a)(3)(B) provides that a plan may satisfy the 
coverage requirements for qualification if it covers such employees as 
qualify under a classification which is found not to discriminate in 
favor of employees who are officers, shareholders, persons whose 
principal duties consist in supervising the work of other employees, or 
highly compensated employees. Section 401(a)(5) sets forth certain 
classifications that will not in themselves be considered 
discriminatory. Under such section, a classification which excludes all 
employees whose entire remuneration constitutes ``wages'' under section 
3121(a)(1), will not be considered discriminatory merely because of such 
exclusion. Similarly, a plan which includes all employees will not be 
considered discriminatory solely because the contributions or benefits 
based on that part of their remuneration which is excluded from 
``wages'' under section 3121(a)(1) differ from the contributions or 
benefits based on that part of their remuneration which is not so 
excluded. However, in determining if a classification is discriminatory 
under section 401(a)(3)(B), consideration will be given to whether the 
total benefits resulting to each employee under the plan and

[[Page 35]]

under the Social Security Act, or under the Social Security Act only, 
establish an integrated and correlated retirement system satisfying the 
tests of section 401(a). A plan which covers self-employed individuals, 
none of whom is an owner-employee, may also be integrated with the 
contributions or benefits under the Social Security Act. In such a case, 
the portion of the earned income (as defined in section 401(c)(2)) of 
such an individual which does not exceed the maximum amount which may be 
treated as self-employment income under section 1402(b)(1), and which is 
derived from the trade or business with respect to which the plan is 
established, shall be treated as ``wages'' under section 3121(a)(1) 
subject to the tax imposed by section 3111 (relating to the tax on 
employers) for purposes of applying the rules of paragraph (e)(2) of 
Sec. 1.401-3, relating to the determination of whether a plan is 
properly integrated. However, if the plan covers an owner-employee, the 
rules relating to the integration of the plan with the contributions or 
benefits under the Social Security Act contained in paragraph (b) of 
Sec. 1.401-12 apply.
    (ii) Certain of the classifications enumerated in section 401(a)(5) 
do not apply to plans which provide contributions or benefits for any 
self-employed individual. Since self-employed individuals are not 
salaried or clerical employees, the provision in section 401(a)(5) 
permitting a plan, in certain cases to cover only this type of employee 
is inapplicable to plans which cover any self-employed individual.
    (iii) The classifications enumerated in section 401(a)(5) are not 
exclusive, and it is not necessary that a qualified plan cover all 
employees or all full-time employees. Plans may qualify even though 
coverage is limited in accordance with a particular classification 
incorporated in the plan, provided the effect of covering only such 
employees as satisfy such eligibility requirement does not result in the 
prohibited discrimination.
    (d) Discrimination as to contributions or benefits--(1) In general. 
In order for a plan to be qualified, there must be no discrimination in 
contributions or benefits in favor of employees who are officers, 
shareholders, supervisors, or highly compensated, as against other 
employees whether within or without the plan. A self-employed 
individual, by reason of the contingent nature of his compensation, is 
considered to be a highly-compensated employee, and thus is a member of 
the group in whose favor discrimination is prohibited. In determining 
whether the prohibited discrimination exists, the total employer 
contribution on behalf of a self-employed individual shall be taken into 
account regardless of the fact that only a portion of such contribution 
is allowed as a deduction. For additional rules relating to 
discrimination as to contributions or benefits with regard to plans 
covering any owner-employee, see Sec. 1.401-12.
    (2) Base for computing contributions or benefits. (i) A plan which 
is otherwise qualified is not considered discriminatory merely because 
the contributions or benefits provided under the plan bear a uniform 
relationship to the total compensation, basic compensation, or regular 
rate of compensation of the employees, including self-employed 
individuals, covered under the plan.
    (ii) In the case of a self-employed individual who is covered under 
a qualified plan, the total compensation of such individual is the 
earned income (as defined in section 401(c)(2)) which such individual 
derives from the employer's trade or business, or trades or businesses, 
with respect to which the qualified plan is established. Thus, for 
example, in the case of a partner, his total compensation includes both 
his distributive share of partnership income, whether or not 
distributed, and guaranteed payments described in section 707(c) made to 
him by the partnership establishing the plan, to the extent that such 
income constitutes earned income as defined in section 401(c)(2).
    (iii)(A) The basic or regular rate of compensation of any self-
employed individual is that portion of his earned income which bears the 
same ratio to his total earned income derived from the trade or 
business, or trades or businesses, with respect to which the qualified 
plan is established as the aggregate basic or regular compensation of 
all common-law employees covered

[[Page 36]]

under the plan bears to the aggregate total compensation of such 
employees derived from such trade or business, or trades or businesses.
    (B) If an employer establishes two or more plans which satisfy the 
requirements of section 401(a) separately, and only one such plan covers 
a self-employed individual, the determination of the basic or regular 
rate of compensation of such self-employed individual is made with 
regard to the compensation of common-law employees covered under the 
plan which provides contributions or benefits for such self-employed 
individual. On the other hand, if two or more plans must be considered 
together in order to satisfy the requirements of section 401(a), the 
computation of the basic or regular rate of compensation of a self-
employed individual must be made with regard to the compensation of the 
common-law employees covered by so many of such plans as are required to 
be taken together in order to satisfy the qualification requirements of 
section 401(a).
    (3) Discriminatory contributions. If a discriminatory contribution 
is made by, or for, a self-employed individual who is an employee within 
the meaning of section 401(c)(1) because of an erroneous assumption as 
to the earned income of such individual, the plan will not be considered 
discriminatory if adequate adjustment is made to remove such 
discrimination. In the case of any self-employed individual who is an 
owner-employee, the amount of any excess contribution to be returned and 
the manner in which it is to be repaid are determined by the provisions 
of section 401(d)(8) and (e). However, if any self-employed individual, 
including any owner-employee, has not made the full contribution 
permitted to be made on his behalf as an employee, then, if the plan 
expressly provides, so much of any excess contribution by such self-
employed individual's employer as may, under the provisions of the plan, 
be treated as a contribution made by such individual as an employee can 
be so treated.
    (e) Distribution of entire interest. (1) If a trust forms part of a 
plan which covers a self-employed individual, such trust shall 
constitute a qualified trust under section 401 only if the plan of which 
such trust is a part expressly provides that the entire interest of each 
employee, including any common-law employee, will be distributed in 
accordance with the provisions of subparagraph (2) or (3) of this 
paragraph.
    (2) Unless the provisions of subparagraph (3) of this paragraph 
apply, the entire interest of each employee (including contributions he 
has made on his own behalf, contributions made on his behalf by his 
employer, and interest thereon) must be actually distributed to such 
employee--
    (i) In the case of an employee, other than an individual who is, or 
has been, an owner-employee under the plan, not later than the last day 
of the taxable year of such employee in which he attains the age of 
70\1/2\, or not later than the last day of the taxable year in which 
such employee retires, whichever is later, and
    (ii) In the case of an employee who is, or has been, an owner-
employee under the plan, not later than the last day of the taxable year 
in which he attains the age of 70\1/2\.
    (3) In lieu of distributing an employee's entire interest in a 
qualified plan as provided in subparagraph (2) of this paragraph, such 
interest may be distributed commencing no later than the last taxable 
year described in such subparagraph (2). In such case, the plan must 
expressly provide that the entire interest of such an employee shall be 
distributed to him and his beneficiaries, in a manner which satisfies 
the requirements of subparagraph (5) of this paragraph, over any of the 
following periods (or any combination thereof)--
    (i) The life of the employee, or
    (ii) The lives of the employee and his spouse, or
    (iii) A period certain not longer than the life expectancy of the 
employee, or
    (iv) A period certain not longer than the joint life and last 
survivor expectancy of the employee and his spouse.
    (4) For purposes of subparagraphs (3) and (5) of this paragraph, the 
determination of the life expectancy of the employee or the joint life 
and last survivor expectancy of the employee and his spouse is to be 
made either (i) only

[[Page 37]]

once, at the time the employee receives the first distribution of his 
entire interest under the plan, or (ii) periodically, in a consistent 
manner. Such life expectancy or joint life and last survivor expectancy 
cannot exceed the period computed by the use of the expected return 
multiples in Sec. 1.72-9, or, in the case of payments under a contract 
issued by an insurance company, the period computed by use of the life 
expectancy tables of such company.
    (5) If an employee's entire interest is to be distributed over a 
period described in subparagraph (3) of this paragraph, then the amount 
to be distributed each year must be at least an amount equal to the 
quotient obtained by dividing the entire interest of the employee under 
the plan at the time the distribution is made (expressed in either 
dollars or units) by the life expectancy of the employee, or joint life 
and last survivor expectancy of the employee and his spouse (whichever 
is applicable), determined in accordance with the provisions of 
subparagraph (4) of this paragraph. However, no distribution need be 
made in any year, or a lesser amount may be distributed, if the 
aggregate amounts distributed by the end of that year are at least equal 
to the aggregate of the minimum amounts required by this subparagraph to 
have been distributed by the end of such year.
    (6) If an employee's entire interest is distributed in the form of 
an annuity contract, then the requirements of section 401(a)(9) are 
satisfied if the distribution of such contract takes place before the 
end of the latest taxable year described in subparagraph (2) of this 
paragraph, and if the employee's interest will be paid over a period 
described in subparagraph (3) of this paragraph and at a rate which 
satisfies the requirements of subparagraph (5) of this paragraph.
    (7) The requirements of section 401(a)(9) do not preclude 
contributions from being made on behalf of an owner-employee under a 
qualified plan subsequent to the taxable year in which the distribution 
of his entire interest is required to commence. Thus, if all other 
requirements for qualification are satisfied, a qualified plan may 
provide contributions for an owner-employee who has already attained age 
70\1/2\. However, a distribution of benefits attributable to 
contributions made on behalf of an owner-employee in a taxable year 
beginning after the taxable year in which he attains the age of 70\1/2\ 
must satisfy the requirements of subparagraph (3) of this paragraph. 
Thus, if an owner-employee has already attained the age of 70\1/2\ at 
the time the first contribution is made on his behalf, the distribution 
of his entire interest must commence in the year in which such 
contribution is first made on his behalf.
    (8) This paragraph shall not apply and an otherwise qualified trust 
will not be disqualified if the method of distribution under the plan is 
one which was designated by a common-law employee prior to October 10, 
1962, and such method of distribution is not in accordance with the 
provisions of section 401(a)(9). Such exception applies regardless of 
whether the actual distribution of the entire interest of an employee 
making such a designation, or any portion of such interest, has 
commenced prior to October 10, 1962.

[T.D. 6675, 28 FR 10124, Sept. 17, 1963, as amended by T.D. 6982, 33 FR 
16500, Nov. 13, 1968]



Sec. 1.401-12  Requirements for qualification of trusts and plans 
benefiting owner-employees.

    (a) Introduction. This section prescribes the additional 
requirements which must be met for qualification of a trust forming part 
of a pension or profit-sharing plan, or of an annuity plan, which covers 
any self-employed individual who is an owner-employee as defined in 
section 401(c)(3). However, to the extent that the provisions of Sec. 
1.401-11 are not modified by the provisions of this section, such 
provisions are also applicable to a plan which covers an owner-employee. 
The provisions of this section apply to taxable years beginning after 
December 31, 1962. Except as otherwise provided, paragraphs (b) through 
(m) of this section apply to taxable years beginning after December 31, 
1962. Paragraph (n) of this section applies to plan years determined in 
accordance with paragraph (n)(1) of the section.

[[Page 38]]

    (b) General rules. (1) The qualified plan and trust of an 
unincorporated trade or business does not have to satisfy the additional 
requirements for qualification merely because an owner-employee derives 
earned income (as defined in section 401(c)(2)) from the trade or 
business with respect to which the plan is established. Such additional 
requirements need be satisfied only if an owner-employee is actually 
covered under the plan of the employer. An owner-employee may only be 
covered under a plan of an employer if such owner-employee has so 
consented. However, the consent of the owner-employee may be either 
expressed or implied. Thus, for example, if contributions are, in fact, 
made on behalf of an owner-employee, such owner-employee is considered 
to have impliedly consented to being covered under the plan.
    (2) A qualified plan covering an owner-employee must be a definite 
written program and arrangement setting forth all provisions essential 
for qualification at the time such plan is established. Therefore, for 
example, even though the owner-employee is the only employee covered 
under the plan at the time the plan is established, the plan must 
incorporate all the provisions relating to the eligibility and benefits 
of future employees.
    (c) Bank trustee. (1)(i) If a trust created after October 9, 1962, 
is to form a part of a qualified pension or profit-sharing plan covering 
an owner-employee, or if a trust created before October 10, 1962, but 
not exempt from tax on October 9, 1962, is to form part of such a plan, 
the trustee of such trust must be a bank as defined in paragraph (c)(2) 
of this section, unless an exception contained in paragraph (c)(4) of 
this section applies, or paragraph (n) of this section applies.
    (ii) The provisions of this paragraph do not apply to an employees' 
trust created prior to October 10, 1962, if such trust was exempt from 
tax on October 9, 1962, even though the plan of which such trust forms a 
part is amended after December 31, 1962, to cover any owner-employee. 
Although the trustee of a trust described in the preceding sentence need 
not be a bank, all other requirements for the qualification of such a 
trust must be satisfied at the time an owner-employee is first covered 
under such plan.
    (2) The term bank as used in this paragraph means--
    (i) A bank as defined in section 581;
    (ii) A corporation which, under the laws of the State of its 
incorporation or under the laws of the District of Columbia, is subject 
to both the supervision of, and examination by, the authority in such 
jurisdiction in charge of the administration of the banking laws;
    (iii) In the case of a trust created or organized outside of the 
United States, that is, outside the States and the District of Columbia, 
a bank or trust company, wherever incorporated, exercising fiduciary 
powers and subject to both supervision and examination by governmental 
authority;
    (iv) Beginning on January 1, 1974, an insured credit union (within 
the meaning of section 101 (6) of the Federal Credit Union Act, 12 
U.S.C. 1752 (6)).
    (3) Although a bank is required to be the trustee of a qualified 
trust, another person, including the employer, may be granted the power 
in the trust instrument to control the investment of the trust funds 
either by directing investments, including reinvestments, disposals, and 
exchanges, or by disapproving proposed investments, including 
reinvestments, disposals, or exchanges.
    (4)(i) This paragraph does not apply to a trust created or organized 
outside the States and the District of Columbia before October 10, 1962, 
if, on October 9, 1962, such trust is described in section 402(c) as an 
organization treated as if it was a trust exempt from tax under section 
501(a).
    (ii) In addition, the requirement that the trustee must be a bank 
does not apply to a qualified trust forming a part of a pension or 
profit-sharing plan if--
    (A) The investments of all the funds in such trust are in annuity, 
endowment, or life insurance contracts, issued by a company which is a 
life insurance company as defined in section 801(a) during the taxable 
year immediately preceding the year that such contracts are originally 
purchased;

[[Page 39]]

    (B) All the proceeds which are, or may become, payable under the 
contract are payable directly to the employee or his beneficiary;
    (C) The plan contains a provision to the effect that the employer is 
to substitute a bank as a trustee or custodian of the contracts if the 
employer is notified by the district director that such substitution is 
required because the trustee is not keeping such records, or making such 
returns, or rendering such statements, as are required by forms or 
regulations.

However, a qualified trust may only purchase insurance protection to the 
extent permitted under a qualified plan (see paragraph (b)(1) (i) and 
(ii) of Sec. 1.401-1).
    (5) An employer may designate several trusts (or custodial accounts) 
or a trust or trusts and an annuity plan or plans as constituting parts 
of a single plan which is intended to satisfy the requirements for 
qualification. However, each trust (or custodial account) so designated 
which is part of a plan covering an owner-employee must satisfy the 
requirements of this paragraph. Thus, for example, if all other 
requirements for qualification are satisfied by the plan, a qualified 
profit-sharing plan may provide that a portion of the contributions 
under the plan will be paid to a custodial account, the custodian of 
which is a bank, for investment in stock of a regulated investment 
company, and the remainder of such contributions will be paid to a 
trust, the trustee of which is not a bank, for investment in annuity 
contracts.
    (d) Profit-sharing plan. (1) A profit-sharing plan, as defined in 
paragraph (b)(1)(ii) of Sec. 1.401-1, which covers any owner-employee 
must contain a definite formula for determining the contributions to be 
made by the employer on behalf of employees, other than owner-employees. 
A formula to be definite must specify the portion of profits to be 
contributed to the trust and must also define profits for plan purposes. 
A definite formula may contain a variable factor, if the value of such 
factor may not vary at the discretion of the employer. For example, the 
percentage of profits to be contributed each year may differ depending 
on the amount of profits. On the other hand, a formula which, for 
example, specifies that profits for plan purposes are not to exceed the 
cash on hand at the time the employer contribution is made is not a 
definite formula. The requirement that the plan formula be definite is 
satisfied if such formula limits the amount to be contributed on behalf 
of all employees covered under the plan to the amount which permits 
self-employed individuals to obtain the maximum deduction under section 
404(a). However, even though the plan formula is definite, the plan must 
satisfy all the other requirements for qualification, including the 
requirement that the contributions under the plan not discriminate in 
favor of any self-employed individual, and the requirement that the plan 
be for the exclusive benefit of the employees in general.
    (2) A definite contribution formula constitutes an integral part of 
a qualified profit-sharing plan and may not be amended except for a 
valid business reason.
    (3) The requirement that a profit-sharing plan contain a definite 
formula for determining the amount of contributions to be made on behalf 
of employees does not apply to contributions which are made on behalf of 
owner-employees. However, such contributions are subject to the 
requirement that they be nondiscriminatory with respect to other 
employees and must not exceed the limitations on allowable and 
deductible contributions which may be made by owner-employees.
    (e) Requirements as to coverage--(1) Coverage of all employees. The 
coverage requirements contained in section 401(a)(3) do not apply to a 
plan which covers any owner-employee. However, such a plan must satisfy 
the coverage requirements of section 401(d), including section 
401(d)(3). Accordingly, a plan which covers an owner-employee must 
benefit each employee of the trade or business (other than any owner-
employee who does not consent to be covered under the plan) whose 
customary period of employment has been for more than 20 hours a week 
for more than five months during each of three consecutive periods of 
twelve calendar months. Therefore, a plan may

[[Page 40]]

not provide, for example, that an employee, other than an owner-
employee, is ineligible to participate because he does not consent to be 
a participant or because he does not consent to make reasonable 
contributions under the plan.
    (2) Period of service. (i) In determining whether an employee 
renders service to the same employer, and, therefore, must be covered 
under the plan of such employer, a partnership is considered to be one 
employer during the entire period prior to the time it is terminated 
within the meaning of section 708 (see paragraph (e)(2) of Sec. 1.401-
10).
    (ii) In the case of a common-law employee who becomes an employee 
within the meaning of section 401(c)(1) with respect to the same trade 
or business, his period of employment is the aggregate of his service as 
a common-law employee and an employee within the meaning of section 
401(c)(1).
    (iii) In determining whether any employee, including any owner-
employee, has three years of service, past service of any such employee 
may be taken into account as provided in paragraph (b) of Sec. 1.401-
10. Thus, if an employer takes into account past service for any owner-
employee, he must take into account the past service of all his other 
employees to the same extent. However, a plan may provide for coverage 
after a period of service which is shorter than three years, but in no 
case may the plan require a waiting period for employees which is longer 
than that required for the owner-employees.
    (f) Discrimination in contributions or benefits. (1) Variations in 
contributions or benefits may be provided under the plan so long as the 
plan does not discriminate, either as to contributions or benefits, in 
favor of officers, employees whose principal duties consist in 
supervising the work of other employees, or highly compensated 
employees, as against other employees (see Sec. 1.401-4). For the 
purpose of determining whether the provisions of a plan which provide 
contributions or benefits for an owner-employee result in the prohibited 
discrimination, an owner-employee, like other self-employed individuals, 
is considered a highly compensated employee (see paragraph (d) of Sec. 
1.401-11). Whether or not a plan is discriminatory is determined by the 
actual operation of the plan as well as by its formal provisions.
    (2) The provisions of section 401(a)(5), relating to certain plan 
provisions which will not in and of themselves be considered 
discriminatory, are not applicable to any plan which covers any owner-
employee. Such a plan must, instead, satisfy the requirements of section 
401(a)(10) and section 401(d)(6). Accordingly, a plan is not 
discriminatory within the meaning of section 401(a)(4) merely because 
the contributions or benefits provided for the employees covered under 
the plan bear a uniform relationship to the total compensation, or to 
the basic or regular rate of compensation, of such employees. The total 
compensation or the basic or regular rate of compensation of an owner-
employee is computed in accordance with the provisions of paragraph 
(d)(2) of Sec. 1.401-11.
    (3) Even though the contributions under the plan do not bear a 
uniform relationship to the total compensation, or the basic or regular 
rate of compensation, of the employees covered thereunder and the plan 
would otherwise be considered discriminatory within the meaning of 
section 401(a)(4), the plan shall not be considered discriminatory if 
such variation is due to employer contributions on behalf of any owner-
employee which are required, under the plan, to be applied to pay 
premiums or other consideration on one or more level premium contracts 
described in section 401(e)(3)(A). In a taxable year to which the 
foregoing exception applies and, therefore, one in which the 
contributions under the plan would otherwise be discriminatory, the 
employer contributions to pay such premiums or other consideration must 
be the only employer contributions made for the owner-employee, and the 
contributions for such taxable year under such plan must not be in 
excess of the amount permitted to be paid toward the purchase of such a 
contract under the provisions of section 401(e)(3). Furthermore, the 
exception described in this subparagraph only applies to contributions 
made under a plan which otherwise satisfies the requirements of section 
401(a)(4) and the regulations thereunder. Thus,

[[Page 41]]

if a plan provides for the purchase, in accordance with section 
401(e)(3), of a level premium contract for an owner-employee, then such 
plan must provide either that the benefits for all employees are 
nondiscriminatory or, in the case of a money-purchase type of plan, that 
the contributions for all employees are based on compensation determined 
in a non-discriminatory manner. For example, since the contributions on 
behalf of the owner-employee are based on his earned income during the 
period preceding the purchase of the contract, the contributions for 
other employees must be based on their compensation during the same 
period if this will result in larger contributions on their behalf.
    (4) In the case of a plan which covers any owner-employee, the 
contributions or benefits provided under the plan cannot vary with 
respect to years of service except as provided in subparagraph (5) of 
this paragraph.
    (5) The provisions of section 401(d)(3) do not preclude the coverage 
of employees with less than three years of service if such coverage is 
provided on a nondiscriminatory basis. However, a plan will not be 
disqualified merely because the contributions or benefits for employees 
who have less than three years of service are not as favorable as the 
contributions or benefits for employees having more than three years of 
service.
    (g) Nonforfeitable rights. (1)(i) Except as provided in subparagraph 
(2) of this paragraph, if an owner-employee is covered under the plan of 
his employer, each employee's rights to the contributions, or to the 
benefits derived from the contributions, of such employer must be 
nonforfeitable at the time such contributions are paid to, or under, the 
plan. The employees who must obtain such nonforfeitable rights include 
the self-employed individuals who are covered under the plan. As to what 
constitutes nonforfeitable rights of an employee, see paragraph (a)(2) 
of Sec. 1.402(b)-1.
    (ii) Under section 401(d)(2), it is necessary that each employee 
obtain nonforfeitable rights to the employer contributions under the 
plan on his behalf from the time such contributions are paid. Thus, each 
employee must have a nonforfeitable interest to the portion of the funds 
under the plan which is allocable to the employer contributions made 
under the plan on his behalf.
    (2) The provisions of subparagraph (1) of this paragraph do not 
apply to the extent that employer contributions on behalf of any 
employee must remain forfeitable in order to satisfy the requirements of 
paragraph (c) of Sec. 1.401-4. However, employer contributions on 
behalf of employees whose rights are required to remain forfeitable to 
satisfy such requirements must be nonforfeitable except for such 
contingency.
    (h) Integration with social security. (1) If a qualified plan covers 
any owner-employee, then the rules relating to the integration of such 
plan with the contributions or benefits under the Social Security Act 
are provided in this paragraph. Accordingly, the provisions of paragraph 
(e) of Sec. 1.401-3 and paragraph (c) of Sec. 1.401-11 do not apply to 
such a plan. In the case of a plan which provides contributions or 
benefits for any owner-employee, integration of the plan with the Social 
Security Act for any taxable year of the employer can take place only if 
not more than one-third of the employer contributions under the plan 
which are deductible under section 404 for that year are made on behalf 
of the owner-employees. If such requirement is satisfied, then the plan 
may be integrated with the contributions or benefits under the Social 
Security Act in accordance with the rules of subparagraph (3) of this 
paragraph.
    (2)(i) For purposes of subparagraph (1) of this paragraph, in 
determining the total amount of employer contributions which are 
deductible under section 404, the provisions of section 404(a), 
including the provisions of section 404(a)(9) (relating to plans 
benefiting self-employed individuals), and section 404(e) (relating to 
the special limitations for self-employed individuals) are taken into 
account, but the provisions of section 404(a)(10) (relating to the 
special limitation on the amount allowed as a deduction for self-
employed individuals) are not taken into account.
    (ii) The amount of deductible employer contributions which are made

[[Page 42]]

on behalf of all owner-employees for the year is compared with the 
amount of deductible employer contributions for the year made on behalf 
of all employees covered under the plan (including self-employed 
individuals who are not owner-employees and owner-employees) for the 
purpose of determining whether the deductible contributions by the 
employer on behalf of owner-employees are not more than one-third of the 
total deductible contributions.
    (3) If a plan covering an owner-employee satisfies the requirement 
of subparagraph (1) of this paragraph, and if the employer wishes to 
integrate such plan with the contributions or benefits under the Social 
Security Act, then--
    (i) The employer contributions under the plan on behalf of any 
owner-employee shall be reduced by an amount determined by multiplying 
the earned income of such owner-employee which is derived from the trade 
or business with respect to which the plan is established and which does 
not exceed the maximum amount which may be treated as self-employment 
income under section 1402(b)(1), by the rate of tax imposed under 
section 1401(a); and
    (ii) The employer contributions under the plan on behalf of any 
employee other than an owner-employee may be reduced by an amount not in 
excess of the amount determined by multiplying the employee's wages 
under section 3121(a)(1) by the rate of tax imposed under section 
3111(a). For purposes of this subdivision, the earned income of a self-
employed individual which is derived from the trade or business with 
respect to which the plan is established and which is treated as self-
employment income under section 1402(b)(1), shall be treated as 
``wages'' under section 3121(a)(1).
    (4) A money purchase pension plan or a profit-sharing plan may 
provide that such plan will be integrated with the Social Security Act 
only for such taxable years of the employer in which the requirements 
for integration are satisfied. However, a qualified plan cannot provide 
that employer contributions are only to be made for taxable years in 
which the integration requirements are satisfied.
    (i) Limit on contributions on behalf of an owner-employee. (1) 
Section 401(d)(5) requires that a plan which covers any owner-employee 
must contain provisions which restrict the employer contributions that 
may be made on behalf of any owner-employee for each taxable year to an 
amount no greater than that which is deductible under section 404. In 
computing the amount deductible under section 404 for purposes of 
section 401(d)(5) and this paragraph, the limitations contained in 
section 404(a)(9) and (e), relating to special limitations for self-
employed individuals, are taken into account, but such amount is 
determined without regard to section 404(a)(10), relating to the special 
limitation on the amount allowed as a deduction for self-employed 
individuals. Accordingly, a qualified plan which covers any owner-
employee cannot permit employer contributions to be made on behalf of 
such owner-employee in excess of 10 percent of the earned income which 
is derived by such owner-employee from the trade or business with 
respect to which the plan is established, or permit the employer to 
contribute more than $2,500 on behalf of any such owner-employee for any 
taxable year.
    (2)(i) In determining whether the plan permits contributions to be 
made in excess of the limitations of subparagraph (1) of this paragraph, 
employer contributions under the plan which are allocable to the 
purchase of life, accident, health, or other insurance are not to be 
taken into account. To determine the amount of employer contributions 
under the plan which are allocable to the purchase of life, accident, 
health, or other insurance, see paragraph (f) of Sec. 1.404(e)-1 and 
paragraph (b) of Sec. 1.72-16. However, contributions for such 
insurance can be made only to the extent otherwise permitted under 
sections 401 through 404 and the regulations thereunder.
    (ii) A further exception to the limit on the amount of contributions 
which an employer may make under the plan on behalf of an owner-employee 
is made in the case of contributions which are required, under the plan, 
to be applied to pay premiums or other consideration for one or more 
annuity, endowment, or life insurance contracts

[[Page 43]]

described in section 401(e)(3) (see section 401(e)(3) and the 
regulations thereunder).
    (j) Excess contributions. The provisions of section 401(e) define 
the term ``excess contribution'' and indicate the consequences of making 
such a contribution (see Sec. 1.401-13). However, section 401(d)(8) 
provides that a qualified plan which provides contributions or benefits 
for any owner-employee must contain certain provisions which complement 
the rules contained in section 401(e). Under section 401(d)(8), a 
qualified plan must provide that--
    (1) The net amount of any excess contribution (determined in 
accordance with the provisions of Sec. 1.401-13) must be returned to 
the owner-employee on whose behalf it is made, together with the net 
income earned on such excess contribution;
    (2) For each taxable year for which the trust is considered to be a 
nonqualified trust with respect to an owner-employee under section 
401(e)(2) because the net amount of an excess contribution and the 
earnings thereon have not been returned to such owner-employee, the 
income of the trust for that taxable year attributable to the interest 
of such owner-employee is to be paid to him.
    (3) If an excess contribution is determined to be willfully made 
(within the meaning of section 401(e)(2)(E)), the entire interest of the 
owner-employee on whose behalf such contribution was made is required to 
be distributed to such owner-employee. Furthermore, the plan must 
require the distribution of an owner-employee's entire interest under 
the plan if a willful excess contribution is determined to have been 
made under any other plan in which the owner-employee is covered as an 
owner-employee.
    (k) Contributions of property under a qualified plan. (1) The 
contribution of property, other than money, prior to January 1, 1975, by 
the person who is the employer (within the meaning of section 401(c)(4)) 
to a qualified trust forming a part of a plan which covers employees 
some or all of whom are owner-employees who control (within the meaning 
of section 401(d)(9)(B) and the regulations thereunder) the trade or 
business with respect to which the plan is established is a prohibited 
transaction between such trust and the employer-grantor of such trust 
(see section 503(g) prior to its repeal by sec. 2003(b)(5) of the 
Employee Retirement Income Security Act of 1974 (88 Stat. 978)).
    (2) A contribution of property, other than money, prior to January 
1, 1975, to a qualified trust by an owner-employee who controls, or a 
member of a group of owner-employees who together control, the trade or 
business with respect to which the plan is established, or a 
contribution of property, other than money, to a qualified trust by a 
member of such an owner-employee's family (as defined in section 
267(c)(4)), is a prohibited transaction. (See section 503(g) prior to 
its repeal by section 2003(b)(5) of the Employee Retirement Income 
Security Act of 1974 (88 Stat. 978)).
    (3) See section 4975 and the regulations thereunder with respect to 
rules relating to the contribution of property, other than money, made 
after December 31, 1974.
    (l) Controlled trades or businesses--(1) Plans covering an owner-
employee who controls another trade or business. (i) A plan must not 
cover any owner-employee, or group of two or more owner-employees, if 
such owner-employee, or group of owner-employees, control (within the 
meaning of subparagraph (3) of this paragraph) any other trade or 
business, unless the employees of such other trade or business 
controlled by such owner-employee, or such group of owner-employees, are 
included in a plan which satisfies the requirements of section 401(a), 
including the qualification requirements of section 401(d). The 
employees who must be covered under the plan of the trade or business 
which is controlled include the self-employed individuals who are not 
owner-employees and the owner-employees who consent to be covered by 
such plan. Accordingly, the employer must determine whether any owner-
employee, or group of owner-employees, who may participate in the plan 
which is established by such employer controls any other trade or 
business, and whether the requirements of this subparagraph are 
satisfied with respect to the plan established in such other

[[Page 44]]

trade or business. The plan of an employer may exclude an owner-employee 
who controls another trade or business from coverage under the plan even 
though such owner-employee consents to be covered, if a plan which 
satisfies the requirements of subdivision (ii) of this subparagraph has 
not been established in the trade or business which such owner-employee 
controls.
    (ii) The qualified plan which the owner-employee, or owner-
employees, are required to provide for the employees of the trade or 
business which they control must provide contributions and benefits 
which are not less favorable than the contributions and benefits 
provided for the owner-employee, or owner-employees, under the plan of 
any trade or business which they do not control. Thus, for example, if 
the contributions or benefits for the owner-employee under the plan of 
the trade or business which he does not control are computed on the 
basis of his total (as compared to basic or regular rate) of 
compensation, then the contributions or benefits for employees covered 
under the plan of the trade or business which the owner controls must be 
computed on the basis of their total compensation. However, the 
requirements of this subdivision cannot be satisfied if the benefits and 
contributions provided under the plan for the employees of the trade or 
business which is controlled are not comparable to those provided under 
the plan covering the owner-employee, or group of owner-employees, in 
the trade or business which they do not control. Thus, for example, if 
the owner-employee is covered by a pension plan in the trade or business 
which he does not control, he may not satisfy the requirements of this 
subdivision by establishing a profit-sharing plan in the trade or 
business which he does control.
    (iii) If an individual is covered as an owner-employee under the 
plans of two or more trades or businesses which he does not control and 
such individual controls a trade or business, then the contributions or 
benefits of the employees under the plan of the trade or business which 
he does control must be as favorable as those provided for him under the 
most favorable plan of the trade or business which he does not control.
    (2) Owner-employees who control more than one trade or business. If 
the plan provides contributions or benefits for an owner-employee who 
controls, or group of owner-employees who together control, the trade or 
business with respect to which the plan is established, and such owner-
employee, or group of owner-employees, also control as owner-employees 
one or more other trades or businesses, plans must be established with 
respect to such controlled trades or businesses so that when taken 
together they form a single plan which satisfies the requirements of 
section 401 (a) and (d) with respect to the employees of all the 
controlled trades or businesses.
    (3) Control defined. (i) For purposes of this paragraph, an owner-
employee, or a group of two or more owner-employees, shall be considered 
to control a trade or business if such owner-employee, or such group of 
two or more owner-employees together--
    (A) Own the entire interest in an unincorporated trade or business, 
or
    (B) In the case of a partnership, own more than 50 percent of either 
the capital interest or the profits interest in such partnership.

In determining whether an owner-employee, or group of owner-employees, 
control a trade or business within the meaning of the preceding 
sentence, it is immaterial whether or not such individuals could be 
covered under a plan established with respect to the trade or business. 
For example, if an individual who is an owner-employee has a 60-percent 
capital interest in another trade or business, such individual controls 
such trade or business and the provisions of this paragraph apply even 
though the individual derives no earned income, as defined in section 
401(c)(2), from the controlled trade or business. For purposes of 
determining the ownership interest of an owner-employee, or group of 
owner-employees, an owner-employee, or group of owner-employees, is 
treated as owning any interest in a partnership which is owned, directly 
or indirectly, by a partnership controlled by such owner-employee, or 
group of owner-employees.

[[Page 45]]

    (ii) The provisions of subparagraphs (1) and (2) of this paragraph 
apply only if the owner-employee who controls, or the group of owner-
employees who control, a trade or business, or trades or businesses, 
within the meaning of subdivision (i) of this subparagraph is the same 
owner-employee, or group of owner-employees, covered under the plan 
intended to satisfy the requirements for qualification. Thus, for 
example, if A is a 50-percent partner in both the AB and AC partnership, 
and if the AB partnership wishes to establish a plan covering A and B, 
the provisions of subparagraphs (1) and (2) of this paragraph do not 
apply, since A does not control either partnership, and since B has no 
interest in the AC partnership.
    (m) Distribution of benefits. (1)(i) Section 401(d)(4)(B) requires 
that a qualified plan which provides contributions or benefits for any 
owner-employee must not provide for the payment of benefits to such 
owner-employee at any time before he has attained age 59\1/2\. An 
exception to the foregoing rule permits a qualified plan to provide for 
the distribution of benefits to an owner-employee prior to the time he 
attains age 59\1/2\ if he is disabled. For taxable years beginning after 
December 31, 1966, see section 72(m)(7) and paragraph (f) of Sec. 1.72-
17 for the meaning of disabled. For taxable years beginning before 
January 1, 1967, see section 213(g)(3) for the meaning of disabled. In 
general, both sections 72(m)(7) and 213(g)(3) provide that an individual 
is considered disabled if he is unable to engage in any substantial 
gainful activity because of a medically determinable physical or mental 
impairment which can be expected to result in death or to be of long-
continued and indefinite duration. In addition, section 401(d)(4)(B) 
does not preclude the distribution of benefits to the estate or other 
beneficiary of a deceased owner-employee prior to the time the owner-
employee would have attained age 59\1/2\ if he had lived.
    (ii) A qualified plan must provide that if, despite the restrictions 
in the plan to the contrary, an amount is prematurely distributed, or 
made available, to a participant in such plan who is, or has been, an 
owner-employee, then no contribution shall be made under the plan by, or 
for, such individual during any of the 5 taxable years of the plan 
beginning after the distribution is made.
    (2)(i) The provisions of subparagraph (1) of this paragraph preclude 
an owner-employee who is a participant in a qualified pension or profit-
sharing plan of his employer from withdrawing any part of the funds 
accumulated on his behalf except as provided in such subparagraph (1). 
However, the distribution of an owner-employee's interest, or any 
portion of such interest, after he attains age 59\1/2\ is determined by 
the provisions of the plan. Thus, for example, if a qualified pension 
plan provides that the normal retirement age under the plan is age 65, 
an owner-employee would not be entitled to a distribution of an amount 
under the plan merely because he attained age 59\1/2\.
    (ii) The provisions of subparagraph (1) of this paragraph do not 
preclude the establishment of a profit-sharing plan which provides for 
the distribution of all, or part, of participants' accounts after a 
fixed number of years. However, such a plan must not permit a 
distribution of any amount to any owner-employee prior to the time the 
owner-employee has attained age 59\1/2\ or becomes disabled within the 
meaning of section 72(m)(7) or section 213(g)(3), whichever is 
applicable. On the other hand, if a distribution would have been made 
under the plan to an owner-employee but for the fact that he had not 
attained age 59\1/2\, then the amount of such distribution (including 
any increment earned on such amount) must be distributed to such owner-
employee at such time as he attains age 59\1/2\.
    (3) A qualified pension, annuity, or profit-sharing plan which 
covers an owner-employee must provide that the distribution of an owner-
employee's entire interest under the plan must begin prior to the end of 
the taxable year in which he attains the age of 70\1/2\, and such 
distribution must satisfy the requirements of section 401(a)(9) and 
paragraph (e) of Sec. 1.401-11. Furthermore, section 401(d)(7) provides 
that, if an owner-employee dies prior to the

[[Page 46]]

time his entire interest has been distributed to him, such owner-
employee's entire remaining interest under the plan must, in general, 
either be distributed to his beneficiary, or beneficiaries, within 5 
years, or be used within that period to purchase an immediate annuity 
for his beneficiary, or beneficiaries. However, a distribution within 5 
years of the death of the owner-employee is not required if the 
distribution of his interest has commenced and such distribution is for 
a term certain over a period not extending beyond the joint life and 
survivor expectancy of the owner-employee and his spouse. Thus, for 
example, an annuity for the joint life and survivor expectancy of an 
owner-employee and his spouse which guarantees payments for 10 years is 
a distribution which is payable over a period which does not exceed the 
joint life and survivor expectancy of the owner-employee and his spouse 
if such expectancy is at least 10 years at the time the distribution 
first commences.

[T.D. 6675, 28 FR 10126, Sept. 17, 1963, as amended by T.D. 6982, 33 FR 
16500, Nov. 13, 1968; T.D. 6985, 33 FR 19815, Dec. 27, 1968; T.D. 7428, 
41 FR 34619, Aug. 16, 1976; T.D. 7611, 44 FR 23520, Apr. 20, 1979; T.D. 
8635, 60 FR 65549, Dec. 20, 1995]



Sec. 1.401-13  Excess contributions on behalf of owner-employees.

    (a) Introduction. (1) The provisions of this section prescribe the 
rules relating to the treatment of excess contributions made under a 
qualified pension, annuity, or profit-sharing plan on behalf of a self-
employed individual who is an owner-employee (as defined in paragraph 
(d) of Sec. 1.401-10). Paragraph (b) of this section defines the term 
``excess contribution''. Paragraph (c) of this section describes an 
exception to the definition of an excess contribution in the case of 
contributions which are applied to pay premiums on certain annuity, 
endowment, or life insurance contracts. Paragraph (d) of this section 
describes the effect of making an excess contribution which is not 
determined to have been willfully made, and paragraph (e) of this 
section describes the effect of making an excess contribution which is 
determined to have been willfully made.
    (2) Under section 401(c)(1), certain self-employed individuals are 
treated as employees for purposes of section 401. In addition, under 
section 401(c)(4), a proprietor is treated as his own employer, and the 
partnership is treated as the employer of the partners. Under section 
404, certain contributions on behalf of a self-employed individual are 
treated as deductible and taken into consideration in determining the 
amount allowed as a deduction under section 404(a). Such contributions 
are treated under section 401 and the regulations thereunder as employer 
contributions on behalf of the self-employed individual. However, in 
some cases, additional contributions may be made on behalf of a self-
employed individual. Such contributions are not taken into consideration 
in determining the amount deductible under section 404 and are not taken 
into consideration in computing the amount allowed as a deduction under 
section 404(a). For purposes of section 401 and the regulations 
thereunder, such contributions are treated as employee contributions by 
the self-employed individual. If a self-employed individual is an owner-
employee within the meaning of section 401(c)(3) and paragraph (d) of 
Sec. 1.401-10, then this section prescribes the rules applicable if 
contributions are made in excess of those permitted to be made under 
section 401.
    (b) Excess contributions defined. (1)(i) Except as provided in 
paragraph (c) relating to contributions which are applied to pay 
premiums on certain annuity, endowment, or life insurance contracts, an 
excess contribution is any amount described in subparagraphs (2) through 
(4) of this paragraph.
    (ii) For purposes of determining if the amount of any contribution 
made under the plan on behalf of an owner-employee is an excess 
contribution, the amount of any contribution made under the plan which 
is allocable to the purchase of life, accident, health, or other 
insurance is not taken into account. The amount of any contribution 
which is allocable to the cost of insurance protection is determined in 
accordance with the provisions of paragraph (f) of Sec. 1.404 (e)-1 and 
paragraph (b) of Sec. 1.72-16.

[[Page 47]]

    (2)(i) In the case of a taxable year of the plan for which employer 
contributions are made on behalf of only owner-employees, an excess 
contribution is the amount of any contribution for such taxable year on 
behalf of such owner-employee which is not deductible under section 404 
(determined without regard to section 404(a)(10)). This rule applies 
irrespective of whether the plan provides for contributions on behalf of 
common-law employees, or self-employed individuals who are not owner-
employees, when such employees or individuals become eligible for 
coverage under the plan, and irrespective of whether contributions are 
in fact made for such employees or such individuals for other taxable 
years of the plan.
    (ii) In the case of a taxable year of the plan for which employer 
contributions are made on behalf of both owner-employees and either 
common-law employees or self-employed individuals who are not owner-
employees, an excess contribution is the amount of any employer 
contribution on behalf of any owner-employee for such taxable year which 
exceeds the amount deductible under section 404 (determined without 
regard to section 404(a)(10)) unless such amount may be treated as an 
employee contribution under the plan in accordance with the rules of 
paragraph (d)(3) of Sec. 1.401-11 and is a permissible employee 
contribution under subparagraph (3) of this paragraph.
    (3)(i) In the case of a taxable year of the plan for which employer 
contributions are made on behalf of both an owner-employee and either 
common-law employees or self-employed individuals who are not owner-
employees, employee contributions on behalf of an owner-employee may be 
made for such taxable year of the plan. How-ever, the amount of such 
contributions, if any, which is described in subdivisions (ii), (iii), 
or (iv) of this subparagraph is an excess contribution.
    (ii) An excess contribution is the amount of any employee 
contribution made on behalf of any owner-employee during a taxable year 
of the plan at a rate in excess of the rate of contributions which may 
be made as employee contributions by common-law employees, or by self-
employed individuals who are not owner-employees, during such taxable 
year of the plan.
    (iii) An excess contribution is the amount of any employee 
contribution made on behalf of an owner-employee which exceeds the 
lesser of $2,500 or 10 percent of the earned income (as defined in 
paragraph (c) of Sec. 1.401-10) of such owner-employee for his taxable 
year in which such contributions are made.
    (iv) In the case of a taxable year of an owner-employee in which 
contributions are made on behalf of such owner-employee under more than 
one plan, an excess contribution is the amount of any employee 
contribution made on behalf of such owner-employee under all such plans 
during such taxable year which exceeds $2,500. If such an excess 
contribution is made, the amount of the excess contribution made on 
behalf of the owner-employee with respect to any one of such plans is 
the amount by which the employee contribution on his behalf under such 
plan for the year exceeds an amount which bears the same ratio to $2,500 
as the earned income of the owner-employee derived from the trade or 
business with respect to which the plan is established bears to his 
earned income derived from the trades or businesses with respect to 
which all such plans are established.
    (4) An excess contribution is the amount of any contribution on 
behalf of an owner-employee for any taxable year of the plan with 
respect to which the plan is treated, under section 401(e)(2), as not 
meeting the requirements of section 401(d) with respect to such owner-
employee.
    (c) Contributions for premiums on certain annuity, endowment, or 
life insurance contracts. (1) The term ``excess contribution'' does not 
include the amount of any employer contributions on behalf of an owner-
employee which, under the provisions of the plan, is expressly required 
to be applied (either directly or through a trustee) to pay the premiums 
or other consideration for one or more annuity, endowment, or life 
insurance contracts, if--
    (i) The employer contributions so applied meet the requirements of 
subparagraphs (2) through (4) of this paragraph, and

[[Page 48]]

    (ii) The total employer contributions required to be applied 
annually to pay premiums on behalf of any owner-employee for contracts 
described in this paragraph do not exceed $2,500. For purposes of 
computing such $2,500 limit, the total employer contributions includes 
amounts which are allocable to the purchase of life, accident, health, 
or other insurance.
    (2)(i) The employer contributions must be paid under a plan which 
satisfies all the requirements for qualification. Accordingly, for 
example, contributions can be paid under the plan for life insurance 
protection only to the extent otherwise permitted under sections 401 
through 404 and the regulations thereunder. However, certain of the 
requirements for qualification are modified with respect to a plan 
described in this paragraph (see section 401(a)(10)(A)(ii) and (d)(5)).
    (ii) A plan described in this paragraph is not disqualified merely 
because a contribution is made on behalf of an owner-employee by his 
employer during a taxable year of the employer for which the owner-
employee has no earned income. On the other hand, a plan will fail to 
qualify if a contribution is made on behalf of an owner-employee which 
results in the discrimination prohibited by section 401(a)(4) as 
modified by section 401(a)(10)(A)(ii) (see paragraph (f)(3) of Sec. 
1.401-12).
    (3) The employer contributions must be applied to pay premiums or 
other consideration for a contract issued on the life of the owner-
employee. For purposes of this subparagraph, a contract is not issued on 
the life of an owner-employee unless all the proceeds which are, or may 
become, payable under the contract are payable directly, or through a 
trustee of a trust described in section 401(a) and exempt from tax under 
section 501(a), to the owner-employee or to the beneficiary named in the 
contract or under the plan. Accordingly, for example, a nontransferable 
face-amount certificate (as defined in section 401(g) and the 
regulations thereunder) is considered an annuity on the life of the 
owner-employee if the proceeds of such contract are payable only to the 
owner-employee or his beneficiary.
    (4)(i) For any taxable year of the employer, the amount of 
contributions by the employer on behalf of the owner-employee which is 
applied to pay premiums under the contracts described in this paragraph 
must not exceed the average of the amounts deductible under section 404 
(determined without regard to section 404(a)(10)) by such employer on 
behalf of such owner-employee for the most recent three taxable years of 
the employer (ending prior to the date the latest contract was entered 
into or modified to provide additional benefits), in which the owner-
employee derived earned income from the trade or business with respect 
to which the plan is established. However, if such owner-employee has 
not derived earned income for at least three taxable years preceding 
such date, then, in determining the ``average of the amounts 
deductible'', only so many of such taxable years as such owner-employee 
was engaged in such trade or business and derived earned income 
therefrom are taken into account.
    (ii) For the purpose of making the computation described in 
subdivision (i) of this subparagraph, the taxable years taken into 
account include those years in which the individual derived earned 
income from the trade or business but was not an owner-employee with 
respect to such trade or business. Furthermore, taxable years of the 
employer preceding the taxable year in which a qualified plan is 
established are taken into account. If such taxable years began prior to 
January 1, 1963, the amount deductible is determined as if section 404 
included section 404(a) (8), (9), (10), and (e).
    (5) The amount of any employer contribution which is not deductible 
but which is not treated as an excess contribution because of the 
provisions of this paragraph shall be taken into account as an employee 
contribution made on behalf of the owner-employee during the owner-
employee's taxable year with, or within which, the taxable year of the 
person treated as his employer under section 401(c)(4) ends. However, 
such contribution is only treated as an employee contribution made on 
behalf of the owner-employee for the purpose of determining whether any 
other employee contribution made

[[Page 49]]

on behalf of the owner-employee during such period is an excess 
contribution described in paragraph (b)(3) of this section.
    (d) Effect of an excess contribution which is not willfully made. 
(1) If an excess contribution (as defined in paragraph (b) of this 
section) is made on behalf of an owner-employee, and if such 
contribution is not willfully made, then the provisions of this 
paragraph describe the effect of such an excess contribution. However, 
if the excess contribution made on behalf of an owner-employee is 
determined to have been willfully made, then the provisions of paragraph 
(e) of this section are applicable to such contribution.
    (2)(i) This paragraph does not apply to an excess contribution if 
the net amount of such excess contribution (as defined in subparagraph 
(4) of this paragraph) and the net income attributable to such amount 
are repaid to the owner-employee on whose behalf the excess contribution 
was made at any time before the end of six months beginning on the day 
on which the district director sends notice (by certified or registered 
mail) of the amount of the excess contribution to the trust, insurance 
company, or other person to whom such excess contribution was paid. The 
net income attributable to the net amount of the excess contribution is 
the aggregate of the amounts of net income attributable to the net 
amount of the excess contribution for each year of the plan beginning 
with the taxable year of the plan within which the excess contribution 
is made and ending with the close of the taxable year of the plan 
immediately preceding the taxable year of the plan in which the net 
amount of the excess contribution is repaid. The amount of net income 
attributable to the net amount of the excess contribution for each year 
is the amount of net income earned under the plan during the year which 
is allocated in a reasonable manner to the net amount of the excess 
contribution. For example, the amount of net income earned under the 
plan for the year which is attributable to the net amount of an excess 
contribution can be computed as the amount which bears the same ratio to 
the amount of the ``net income attributable to the interest of the 
owner-employee under the plan'' for such taxable year (determined in 
accordance with the provisions of subparagraph (5)(ii) of this 
paragraph) as the net amount of the excess contribution bears to the 
aggregate amount standing to the account of the owner-employee at the 
end of that year (including the net amount of any excess contribution).
    (ii) The notice described in subdivision (i) of this subparagraph 
shall not be mailed prior to the time that the amount of the tax under 
chapter 1 of the Code of the owner-employee to whom the excess 
contribution is to be repaid has been finally determined for his taxable 
year in which such excess contribution was made. For purposes of this 
subdivision, a final determination of the amount of tax liability of the 
owner-employee includes--
    (A)1 A decision by the Tax Court of the United States, or a 
judgment, decree, or other order by any court of competent jurisdiction, 
which has become final;
    (B) A closing agreement authorized by section 7121; or
    (C) The expiration of the period of limitation on suits by the 
taxpayer for refund, unless suit is instituted prior to the expiration 
of such period.
    (iii) For purposes of this subparagraph, an amount is treated as 
repaid to an owner-employee if an adequate adjustment is made to the 
account of the owner-employee. An adequate adjustment is made to the 
account of an owner-employee, for example, if the amount of the excess 
contribution (without any reduction for any loading or other 
administrative charge) and the net income attributable to such amount is 
taken into account as a contribution under the plan for the current 
year. In such a case, the gross income of the owner-employee for his 
taxable year in which such adjustment is made includes the amount of the 
net income attributable to the excess contribution.
    (iv) If the net amount of the excess contribution and the net income 
attributable thereto is repaid, within the period described in 
subdivision (i) of

[[Page 50]]

this subparagraph, to the owner-employee on whose behalf such 
contribution was made, then the net income attributable to the excess 
contribution is, pursuant to section 61(a), includible in the gross 
income of the owner-employee for his taxable year in which such amount 
is distributed, or made available, to him. However, such amount is not a 
distribution to which section 402 or 403 and section 72 apply (see 
subparagraph (6) of this paragraph).
    (3)(i) If the net amount of any excess contribution (as defined in 
subparagraph (4) of this paragraph) and the net income attributable to 
that excess contribution are not repaid to the owner-employee on whose 
behalf the excess contribution was made before the end of the six-month 
period described in subparagraph (2)(i) of this paragraph, the plan 
under which the excess contribution has been made is considered, for 
purposes of section 404, as not satisfying the requirements for 
qualification with respect to such owner-employee for all taxable years 
of the plan described in subdivision (ii) of this subparagraph. However, 
such disqualification only applies to the interest of the owner-employee 
on whose behalf an excess contribution has been made and does not 
disqualify the plan with respect to the other participants thereunder.
    (ii) The taxable years referred to in subdivision (i) of this 
subparagraph include the taxable year of the plan within which the 
excess contribution is made and each succeeding taxable year of the plan 
until the beginning of the taxable year of the plan in which the trust, 
insurance company, or other person to whom such excess contribution was 
paid repays to such owner-employee--
    (A) The net amount of the excess contribution, and
    (B) The amount of income attributable to his interest under the plan 
which is includible in his gross income for any taxable year by reason 
of the provisions of subparagraph (5) of this paragraph.
    (4) For purposes of this paragraph, the net amount of an excess 
contribution is the amount of such excess contribution, as defined in 
paragraph (b) of this section, reduced by the amount of any loading 
charge or other administrative charge ratably allocable to such excess 
contribution.
    (5)(i) If a plan is considered as not meeting the requirements for 
qualification with respect to an owner-employee by reason of the 
provisions of subparagraph (3) of this paragraph for any taxable year of 
the plan, such owner-employee's gross income for any of his taxable 
years with or within which such taxable year of the plan ends shall, for 
purposes of chapter 1 of the Code, include the portion of the net income 
earned under the plan for such taxable year of the plan which is 
attributable to the interest of the owner-employee under the plan.
    (ii) For purposes of this subparagraph, the term ``net income'' 
means the net income earned under the plan determined in accordance with 
generally accepted accounting principles consistently applied, and the 
``net income attributable to the interest of the owner-employee under 
the plan'' is the amount which bears the same ratio to the aggregate 
amount of net income earned under the plan for the taxable year of the 
plan as the amount standing to the account of the owner-employee at the 
end of that year (including the amount of any excess contribution which 
is credited to his account) bears to the aggregate amount of all funds 
under the plan for all employees at the end of that year (including the 
aggregate amount of excess contributions credited to the accounts of all 
owner-employees for that year).
    (iii) The provisions of this subparagraph may be illustrated by the 
following example:

    Example. A is an owner-employee covered under the X Employees' 
Pension Trust who files his return on the basis of a calendar year. An 
excess contribution was made on behalf of A during the plan year 
beginning on January 1, 1966. The net amount of the excess contribution 
and the net income attributable thereto was not repaid to A before the 
end of the six-month period described in subparagraph (2)(i) of this 
paragraph. Accordingly, the net income earned under the plan during 1966 
which is attributable to A's interest is to be included in his gross 
income for 1966. Assume that the trust which forms a part of the pension 
plan of the X Company also files its returns on a calendar year basis, 
and that during 1966 the trust had a

[[Page 51]]

gross income of $4,000 (including a long-term capital gain of $2,500) 
and expenses of $500. Assume, further, that the amount standing to A's 
account on December 31, 1966 (including the amount of the excess 
contribution), was $20,000, and that on that date the amount funded 
under the plan for all employees (including A) is $140,000. Then the net 
income of the trust for 1966 is $3,500 ($4,000-$500). The net income 
attributable to the interest of A under the plan is $500 (the amount 
which bears the same ratio to $3,500 as $20,000 bears to $140,000). 
Accordingly, $500 is included in A's gross income in accordance with the 
provisions of section 401(e)(2)(B) as the ``net income attributable to 
the interest of the owner-employee under the plan''.

    (6) The provisions of section 402 or 403 and section 72 do not apply 
to any amount distributed, or made available, to an owner-employee which 
is described in this paragraph. Accordingly, for example, the provisions 
of section 72(m)(5)(A)(i), relating to amounts subject to the penalty 
tax imposed by section 72(m), do not apply to the amount of the net 
income attributable to the interest of an owner-employee (as defined in 
subparagraph (5)(ii) of this paragraph) which is includible in his gross 
income. Furthermore, in such a case, the provisions of section 
401(d)(5)(C) do not apply to such amount.
    (7) Certain adjustments will be required with respect to the 
interest of an owner-employee after any amount previously allocated to 
his account has been returned to him pursuant to the provisions of this 
paragraph. For example, if the determination of whether life insurance 
benefits provided under the plan are incidental is made, in part, with 
regard to the contributions allocated to the accounts of the 
participants covered under the plan, an adjustment may have to be made 
with respect to the life insurance purchased under the plan for any 
owner-employee after any amount previously allocated to his account has 
been repaid to him. Furthermore, if, for example, an owner-employee has 
received annuity payments which were taxable under the exclusion ratio 
rule of section 72, and if such exclusion ratio took into account any 
amount credited to the account of the owner-employee which is 
subsequently repaid to him, then such exclusion ratio must be recomputed 
after the adjustment in such owner-employee's account has taken place.
    (8) Notwithstanding any other provision of law, in any case in which 
the plan is treated as not satisfying the requirements for qualification 
with respect to any owner-employee by reason of the provisions of 
section 401(e), the period for assessing, with respect to such owner-
employee, any deficiency arising by reason of--
    (i) The disallowance of any deduction under section 404 by reason of 
the provisions of subparagraph (3) of this paragraph, or
    (ii) The inclusion of amounts in the gross income of the owner-
employee by reason of the provisions of subparagraph (5) of this 
paragraph,

shall not expire prior to 18 months after the day the district director 
mails the notice with respect to the excess contribution (described in 
subparagraph (2)(i) of this paragraph) which gives rise to such 
disallowance or inclusion. Thus, for example, notwithstanding the 
provisions of section 6212(c) (relating to the restriction on the 
determination of additional deficiencies), if, after a final 
determination by the Tax Court of the income tax liability of an owner-
employee for a taxable year in which an excess contribution was made, 
the amount of such excess contribution and the net income attributable 
thereto is not paid to the owner-employee before the end of the six-
month period described in subparagraph (2)(i) of this paragraph, an 
additional deficiency assessment may be made for such taxable year with 
respect to such excess contribution.
    (e) Effect of an excess contribution which is determined to have 
been willfully made. If an excess contribution (as defined in paragraph 
(b) of this section) on behalf of an owner-employee is determined to 
have been willful ly made, then--
    (1) Only the provisions of this paragraph apply to such 
contribution;
    (2) There shall be distributed to the owner-employee on whose behalf 
such contribution was willfully made his entire interest in all plans in 
which he is a participant as an owner-employee;
    (3) The amount distributed under each such plan is an amount to 
which

[[Page 52]]

section 72 does apply (see section 72(m)(5)(A)(iii)); and
    (4) For purposes of section 404, no plan in which such individual is 
covered as an owner-employee shall be considered as meeting the 
requirements for qualification with respect to such owner-employee for 
any taxable year of the plan beginning with or within the calendar year 
in which it is determined that the excess contribution has been 
willfully made and with or within the five calendar years following such 
year.
    (f) Years to which this section applies. This section applies to 
contributions made in taxable years of employers beginning before 
January 1, 1976. Thus, for example, in the case of willful contributions 
made in taxable years of employers beginning before January 1, 1976, 
paragraphs (e) (1), (2), and (3) of this section apply to such taxable 
years beginning on or after such date. However, in such a case, because 
the application of paragraph (e)(4) of this section affects 
contributions made in taxable years of employers beginning on or after 
January 1, 1976, paragraph (e)(4) of this section does not apply to such 
taxable years; see paragraph (c) of Sec. 1.401(e)-4 (relating to 
transitional rules for excess contributions).

[T.D. 6676, 28 FR 10139, Sept. 17, 1963; as amended by T.D. 7636, 44 FR 
47053, Aug. 10, 1979]



Sec. 1.401-14  Inclusion of medical benefits for retired employees in 
qualified pension or annuity plans.

    (a) Introduction. Under section 401(h) a qualified pension or 
annuity plan may make provision for the payment of sickness, accident, 
hospitalization, and medical expenses for retired employees, their 
spouses, and their dependents. The term ``medical benefits described in 
section 401(h)'' is used in this section to describe such payments.
    (b) In general--(1) Coverage. Under section 401(h), a qualified 
pension or annuity plan may provide for the payment of medical benefits 
described in section 401(h) only for retired employees, their spouses, 
or their dependents. To be ``retired'' for purposes of eligibility to 
receive medical benefits described in section 401(h), an employee must 
be eligible to receive retirement benefits provided under the pension 
plan, or else be retired by an employer providing such medical benefits 
by reason of permanent disability. For purposes of the preceding 
sentence, an employee is not considered to be eligible to receive 
retirement benefits provided under the plan if he is still employed by 
the employer and a separation from employment is a condition to 
receiving the retirement benefits.
    (2) Discrimination. A plan which provides medical benefits described 
in section 401(h) must not discriminate in favor of officers, 
shareholders, supervisory employees, or highly compensated employees 
with respect to coverage and with respect to the contributions or 
benefits under the plan. The determination of whether such a plan so 
discriminates is made with reference to the retirement portion of the 
plan as well as the portion providing the medical benefits described in 
section 401(h). Thus, for example, a plan will not be qualified under 
section 401 if it discriminates in favor of employees who are officers 
or shareholders with respect to either portion of the plan.
    (3) Funding medical benefits. Contributions to provide the medical 
benefits described in section 401(h) may be made either on a 
contributory or noncontributory basis, without regard to whether the 
contributions to fund the retirement benefits are made on a similar 
basis. Thus, for example, the contributions to fund the medical benefits 
described in section 401(h) may be provided for entirely out of employer 
contributions even though the retirement benefits under the plan are 
determined on the basis of both employer and employee contributions.
    (4) Definitions. For purposes of section 401(h) and this section:
    (i) The term dependent shall have the same meaning as that assigned 
to it by section 152, and
    (ii) The term medical expense means expenses for medical care as 
defined in section 213(e)(1).
    (c) Requirements. The requirements which must be met for a qualified 
pension or annuity plan to provide medical benefits described in section 
401(h) are set forth in subparagraphs (1) through (5) of this paragraph.

[[Page 53]]

    (1) Benefits. (i) The plan must specify the medical benefits 
described in section 401(h) which will be available and must contain 
provisions for determining the amount which will be paid. Such benefits, 
when added to any life insurance protection provided for under the plan, 
must be subordinate to the retirement benefits provided by such plan. 
For purposes of this section, life insurance protection includes any 
benefit paid under the plan on behalf of an employee-participant as a 
result of the employee-participant's death to the extent such payment 
exceeds the amount of the reserve to provide the retirement benefits for 
the employee-participant existing at his death. The medical benefits 
described in section 401(h) are considered subordinate to the retirement 
benefits if at all times the aggregate of contributions (made after the 
date on which the plan first includes such medical benefits) to provide 
such medical benefits and any life insurance protection does not exceed 
25 percent of the aggregate contributions (made after such date) other 
than contributions to fund past service credits.
    (ii) The meaning of the term subordinate may be illustrated by the 
following example:

    Example. The X Corporation amends its qualified pension plan to 
provide medical benefits described in section 401(h) effective for the 
taxable year 1964. The total contributions under the plan (excluding 
those for past service credits) for the taxable year 1964 are $125,000, 
allocated as follows: $100,000 for retirement benefits, $10,000 for life 
insurance protection, and $15,000 for medical benefits described in 
section 401(h). The medical benefits described in section 401(h) are 
considered subordinate to the retirement benefits since the portion of 
the contributions allocated to the medical benefits described in section 
401(h) ($15,000) and to life insurance protection after such medical 
benefits were included in the plan ($10,000), or $25,000, does not 
exceed 25 percent of $125,000. For the taxable year 1965, the X 
Corporation contributes $140,000 (exclusive of contributions for past 
service credits) allocated as follows: $100,000 for retirement benefits, 
$10,000 for life insurance protection, and $30,000 for medical benefits 
described in section 401(h). The medical benefits described in section 
401(h) are considered subordinate to the retirement benefits since the 
aggregate contributions allocated to the medical benefits described in 
section 401(h) ($45,000) and to life insurance protection after such 
medical benefits were included in the plan ($20,000) or $65,000 does not 
exceed 25 percent of $265,000, the aggregate of the contributions made 
in 1964 and 1965.

    (2) Separate accounts. Where medical benefits described in section 
401(h) are provided for under a qualified pension or annuity plan, a 
separate account must be maintained with respect to contributions to 
fund such benefits. The separation required by this section is for 
recordkeeping purposes only. Consequently, the funds in the medical 
benefits account need not be separately invested. They may be invested 
with funds set aside for retirement purposes without identification of 
which investment properties are allocable to each account. However, 
where the investment properties are not allocated to each account, the 
earnings on such properties must be allocated to each account in a 
reasonable manner.
    (3) Reasonable and ascertainable. Section 401(h) further requires 
that amounts contributed to fund medical benefits therein described must 
be reasonable and ascertainable. For the rules relating to the deduction 
of such contributions, see paragraph (f) of Sec. 1.404(a)-3. The 
employer must, at the time he makes a contribution, designate that 
portion of such contribution allocable to the funding of medical 
benefits.
    (4) Impossibility of diversion prior to satisfaction of all 
liabilities. Section 401(h) further requires that it must be impossible, 
at any time prior to the satisfaction of all liabilities under the plan 
to provide for the payment of medical benefits described in section 
401(h), for any part of the corpus or income of the medical benefits 
account to be (within the taxable year or thereafter) used for, or 
diverted to, any purpose other than the providing of such benefits. 
Consequently, a plan which, for example, under its terms, permits funds 
in the medical benefits account to be used for any retirement benefit 
provided under the plan does not satisfy the requirements of section 
401(h) and will not qualify under section 401(a). However, the payment 
of any necessary or appropriate expenses attributable to the 
administration of the medical benefits account does not affect the 
qualification of the plan.

[[Page 54]]

    (5) Reversion upon satisfaction of all liabilities. The plan must 
provide that any amounts which are contributed to fund medical benefits 
described in section 401(h) and which remain in the medical benefits 
account upon the satisfaction of all liabilities arising out of the 
operation of the medical benefits portion of the plan are to be returned 
to the employer.
    (6) Forfeitures. The plan must expressly provide that in the event 
an individual's interest in the medical benefits account is forfeited 
prior to termination of the plan an amount equal to the amount of the 
forfeiture must be applied as soon as possible to reduce employer 
contributions to fund the medical benefits described in section 401(h).
    (d) Effective date. This section applies to taxable years of a 
qualified pension or annuity plan beginning after October 23, 1962.

[T.D. 6722, 29 FR 5072, Apr. 14, 1964]



Sec. 1.401(a)-1  Post-ERISA qualified plans and qualified trusts; in 
general.

    (a) Introduction--(1) In general. This section and the following 
regulation sections under section 401 reflect the provisions of section 
401 after amendment by the Employee Retirement Income Security Act of 
1974 (Pub. L. 93-406) (``ERISA'').
    (2) [Reserved]
    (b) Requirements for pension plans--(1) Definitely determinable 
benefits. (i) In order for a pension plan to be a qualified plan under 
section 401(a), the plan must be established and maintained by an 
employer primarily to provide systematically for the payment of 
definitely determinable benefits to its employees over a period of 
years, usually for life, after retirement or attainment of normal 
retirement age (subject to paragraph (b)(2) of this section). A plan 
does not fail to satisfy this paragraph (b)(1)(i) merely because the 
plan provides, in accordance with section 401(a)(36), that a 
distribution may be made from the plan to an employee who has attained 
age 62 and who is not separated from employment at the time of such 
distribution.
    (ii) Section 1.401-1(b)(1)(i), a pre-ERISA regulation, provides 
rules applicable to this requirement, and that regulation is applicable 
except as otherwise provided.
    (iii) The use of the type of plan provision described in Sec. 
1.415(a)-1(d)(1) which automatically freezes or reduces the rate of 
benefit accrual or the annual addition to insure that the limitations of 
section 415 will not be exceeded, will not be considered to violate the 
requirements of this subparagraph provided that the operation of such 
provision precludes discretion by the employer.
    (2) Normal retirement age--(i) General rule. The normal retirement 
age under a plan must be an age that is not earlier than the earliest 
age that is reasonably representative of the typical retirement age for 
the industry in which the covered workforce is employed.
    (ii) Age 62 safe harbor. A normal retirement age under a plan that 
is age 62 or later is deemed to be not earlier than the earliest age 
that is reasonably representative of the typical retirement age for the 
industry in which the covered workforce is employed.
    (iii) Age 55 to age 62. In the case of a normal retirement age that 
is not earlier than age 55 and is earlier than age 62, whether the age 
is not earlier than the earliest age that is reasonably representative 
of the typical retirement age for the industry in which the covered 
workforce is employed is based on all of the relevant facts and 
circumstances.
    (iv) Under age 55. A normal retirement age that is lower than age 55 
is presumed to be earlier than the earliest age that is reasonably 
representative of the typical retirement age for the industry in which 
the covered workforce is employed, unless the Commissioner determines 
that under the facts and circumstances the normal retirement age is not 
earlier than the earliest age that is reasonably representative of the 
typical retirement age for the industry in which the covered workforce 
is employed.
    (v) Age 50 safe harbor for qualified public safety employees. A 
normal retirement age under a plan that is age 50 or later is deemed to 
be not earlier than the earliest age that is reasonably representative 
of the typical retirement

[[Page 55]]

age for the industry in which the covered workforce is employed if 
substantially all of the participants in the plan are qualified public 
safety employees (within the meaning of section 72(t)(10)(B)).
    (3) Benefit distribution prior to retirement. For purposes of 
paragraph (b)(1)(i) of this section, retirement does not include a mere 
reduction in the number of hours that an employee works. Accordingly, 
benefits may not be distributed prior to normal retirement age solely 
due to a reduction in the number of hours that an employee works.
    (4) Effective date. Except as otherwise provided in this paragraph 
(b)(4), paragraphs (b)(2) and (3) of this section are effective May 22, 
2007. In the case of a governmental plan (as defined in section 414(d)), 
paragraphs (b)(2) and (3) of this section are effective for plan years 
beginning on or after January 1, 2009. In the case of a plan maintained 
pursuant to one or more collective bargaining agreements that have been 
ratified and are in effect on May 22, 2007, paragraphs (b)(2) and (3) of 
this section do not apply before the first plan year that begins after 
the last of such agreements terminate determined without regard to any 
extension thereof (or, if earlier, May 24, 2010. See Sec. 1.411(d)-4, 
A-12, for a special transition rule in the case of a plan amendment that 
increases a plan's normal retirement age pursuant to paragraph (b)(2) of 
this section.

[T.D. 7748, 46 FR 1695, Jan. 7, 1981, as amended by T.D. 9319, 72 FR 
16894, Apr. 5, 2007; T.D. 9325, 72 FR 28606, May 22, 2007]



Sec. 1.401(a)-2  Impossibility of diversion under qualified plan or 
trust.

    (a) General rule. Section 401(a)(2) requires that in order for a 
trust to be qualified, it must be impossible under the trust instrument 
(in the taxable year and at any time thereafter before the satisfaction 
of all liabilities to employees or their beneficiaries covered by the 
trust) for any part of the trust corpus or income to be used for, or 
diverted to, purposes other than for the exclusive benefit of those 
employees or their beneficiaries. Section 1.401-2, a pre-ERISA 
regulation, provides rules under section 401(a)(2) and that regulation 
is applicable except as otherwise provided.
    (b) Section 415 suspense account. Notwithstanding paragraph (a) of 
this section, a plan, or trust forming part of a plan, may provide for 
the reversion to the employer, upon termination of the plan, of amounts 
contributed to the plan that exceed the limitations imposed under 
section 415(c), to the extent set forth in rules prescribed by the 
Commissioner in revenue rulings, notices, or other guidance published in 
the Internal Revenue Bulletin (see Sec. 601.601(d)(2) of this chapter).

[T.D. 7748, 46 FR 1696, Jan. 7, 1981, as amended by T.D. 9319, 72 FR 
16894, Apr. 5, 2007]



Sec. 1.401(a)-4  Optional forms of benefit (before 1994).

    Q-1: How does section 401(a)(4) apply to optional forms of benefits?
    A-1: (a) In general--(1) Scope. The nondiscrimination requirements 
of section 401(a)(4) apply to the amount of contributions or benefits, 
optional forms of benefit, and other benefits, rights and features 
(e.g., actuarial assumptions, methods of benefit calculation, loans, 
social security supplements, and disability benefits) under a plan. This 
section addresses the application of section 401(a)(4) only to optional 
forms of benefit under a plan. Generally, the determination of whether 
an optional form is nondiscriminatory under section 401(a)(4) is made by 
reference to the availability of such optional form, and not by 
reference to the utilization or actual receipt of such optional form. 
See Q&A-2 of this section. Even though an optional form of benefit under 
a plan may be nondiscriminatory under section 401(a)(4) and this Sec. 
1.401(a)-4 because the availability of such optional form does not 
impermissibly favor employees in the highly compensated group, such plan 
may fail to satisfy section 401(a)(4) with respect to the amount of 
contributions or benefits or with respect to other benefits, rights and 
features if, for example, the method of calculation or the amount or 
value of benefits payable under such optional form impermissibly favors 
the highly compensated group. See Sec. 1.411(d)-4, Q&A-1 for the 
definition of ``optional form of benefit.''

[[Page 56]]

    (2) Nondiscrimination requirements. Each optional form of benefit 
provided under a plan is subject to the nondiscrimination requirement of 
section 401(a)(4) and thus the availability of each optional form of 
benefit must not discriminate in favor of the employees described in 
section 401(a)(4) in whose favor discrimination is prohibited (the 
``highly compensated group''). See paragraph (b) of this Q&A-1 for a 
description of the employees included in such group. This is true 
without regard to whether a particular optional form of benefit is the 
actuarial equivalent of any other optional form of benefit under the 
plan. Thus, for example, a plan may not condition, or otherwise limit, 
the availability of a single sum distribution of an employee's benefit 
in a manner that impermissibly favors the highly compensated group.
    (b) Highly compensated group. For plan years commencing prior to the 
applicable effective date for the amendment made to section 401(a)(4) by 
section 1114 of the Tax Reform Act of 1986 (TRA '86), the highly 
compensated group consists of those employees who are officers, 
shareholders, or highly compensated. For plan years beginning on or 
after the applicable effective date of the amendments to section 
401(a)(4) made by TRA '86, the highly compensated group consists of 
those employees who are highly compensated within the meaning of section 
414(q). The amendment to section 401(a)(4) made by section 1114 of TRA 
'86 is generally effective for plan years commencing after December 31, 
1988. See section 1114(a) of TRA '86.
    Q-2: How is it determined whether an optional form of benefit 
satisfies the nondiscrimination requirements of section 401(a)(4)?
    A-2: (a) Nondiscrimination requirement--(1) In general. An optional 
form of benefit under a plan is nondiscriminatory under section 
401(a)(4) only if the requirements of paragraphs (a)(2) and (a)(3) of 
this Q&A-2 are satisfied with respect to such optional form. The 
determination of whether an optional form of benefit satisfies these 
requirements is made by reference to the availability of the optional 
form, and not by reference to the utilization or actual receipt of such 
optional form. Thus, an optional form of benefit that satisfies the 
requirements of paragraphs (a)(2) and (a)(3) of this Q&A-2 is 
nondiscriminatory under section 401(a)(2) even though the highly 
compensated group disproportionately utilizes such optional form. 
However, the composition of the group of employees who actually receive 
benefits in an optional form may be relevant in determining whether such 
optional form satisfies the requirement of paragraph (a)(3) of this Q&A-
2 with respect to effective availability.
    (2) Current availability--(i) Plan years prior to TRA '86 effective 
date. Except as provided in paragraph (a)(2)(iii) of this Q&A-2, for 
plan years prior to the effective date of the amendments made to section 
401(b) by section 1112(a) of TRA '86, the requirement of this paragraph 
(a)(2) is satisfied only if the group of employees to whom the optional 
form is currently available satisfies either the seventy percent test of 
section 410(b)(1)(A) or the nondiscriminatory classification test of 
section 410(b)(1)(B).
    (ii) Plan years commencing on or after TRA '86 effective date. 
Except as provided in paragraph (a)(2)(iii) of this Q&A-2, for plan 
years commencing on or after the effective date on which the amendments 
made to section 410(b) by section 1112(a) of TRA '86 first apply to a 
plan, the requirement of this paragraph (a)(2) is satisfied only if the 
group of employees to whom the optional form is currently available 
satisfies either the percentage test set forth in section 410(b)(1)(A), 
the ratio test set forth in section 410(b)(1)(B), or the 
nondiscriminatory classification test set forth in section 
410(b)(2)(A)(i). The employer need not satisfy the average benefit 
percentage test in section 410(b)(2)(A)(ii) in order for the optional 
form to be currently available to a nondiscriminatory group of 
employees.
    (iii) Special rule for certain governmental or church plans. Plans 
described in section 410(c) will be treated as satisfying the current 
availability test of this paragraph (a)(2) if the group of employees 
with respect to whom the optional form is currently available satisfies 
the requirements of section 401(a)(3) as in effect on September 1, 1974.

[[Page 57]]

    (iv) Effective data for TRA '86 amendments to section 410(b). The 
amendments to section 410(b) made by section 1112(a) of TRA '86 are 
generally effective for plan years commencing after December 31, 1988. 
See section 1112(e)(1) of TRA '86.
    (v) Elimination of optional forms--(A) In general. Notwithstanding 
paragraphs (a)(2)(i) and (a)(2)(ii) of this Q&A-2, in the case of an 
optional form of benefit that has been eliminated under a plan with 
respect to specified employees for benefits accrued after the later of 
the eliminating amendment's adoption date or effective date, the 
determination of whether such optional form satisfies this paragraph 
(a)(2) with respect to such employees is to be made immediately prior to 
the elimination. Accordingly, if, as of the later of the adoption date 
or effective date of an amendment eliminating an optional form with 
respect to future benefit accruals, the current availability of such 
optional form immediately prior to such amendment satisfies this 
paragraph (a)(2), then the optional form will be treated as satisfying 
this paragraph (a)(2) for all subsequent years.
    (B) Example. A profit-sharing plan that provides for a single sum 
distribution available to all employees on termination of employment is 
amended January 1, 1990, to eliminate such single sum optional form of 
benefit with respect to benefits accrued after January 1, 1991. As of 
January 1, 1991, the single sum optional form of benefit is available to 
a group of employees that satisfies the percentage test of section 
410(b)(1)(A). As of January 1, 1995, all nonhighly compensated employees 
who were entitled to the single sum optional form of benefit have 
terminated from employment with the employer and taken a distribution of 
their benefits. The only remaining employees who have a right to take a 
portion of their benefits in the form of a single sum distribution on 
termination of employment are highly compensated employees. Because the 
availability of the single sum optional form of benefit satisfied the 
current availability test as of January 1, 1991, the availability of 
such optional form of benefit is deemed to continue to satisfy the 
current availability test of this paragraph (a)(2).
    (3) Effective availability--(i) In general. The requirement of this 
paragraph (a)(3) is satisfied only if, based on the facts and 
circumstances, the group of employees to whom the optional form is 
effectively available does not substantially favor the highly 
compensated group. This is the case even if the optional form is, or has 
been, currently available to a group of employees that satisfies the 
applicable requirements in paragraph (a)(2) (i) or (ii) of this Q&A-2.
    (ii) Examples. The provisions of paragraph (a)(3)(i) of this Q&A-2 
can be illustrated by the following examples:

    Example 1. Employer X maintains a defined benefit plan that covers 
both of the 2 highly compensated employees of the employer and 8 of the 
twelve nonhighly compensated employees of the employer. Plan X provides 
for a normal retirement benefit payable as an annuity and based on a 
normal retirement age of 65, and an early retirement benefit payable 
upon termination in the form of an annuity to employees who terminate 
from service with the employer on or after age 55 with 30 or more years 
of service. Each of the 2 employees of employer X who are in the highly 
compensated group currently meet the age and service requirement, or 
will have 30 years of service by the time they reach age 55. All but 2 
of the 8 nonhighly compensated employees of employer X who are covered 
by the plan were hired on or after age 35 and thus, cannot qualify for 
the early retirement benefit provision. Even though the group of 
employees to whom the early retirement benefit is currently available 
does not impermissibly favor the highly compensated group by reason of 
disregarding age and service, these facts and circumstances indicate 
that the effective availability of the early retirement benefit in plan 
X substantially favors the highly compensated group.
    Example 2. Assume the same facts as in Example 1 except that the 
early retirement benefit is added by a plan amendment first adopted, 
announced and effective December 1, 1991, and is available only to 
employees who terminate from employment with the employer prior to 
December 15, 1991. Further assume that all employees were hired prior to 
attaining age 25, and that the group of employees who have, or will have 
attained age 55 with 30 years of service, by December 15, 1991, 
satisfies the ratio test of section 410(b)(1)(B). Finally, assume that 
the only employees who terminate from employment with the employer 
during the two week period in which the early retirement benefit is

[[Page 58]]

available are employees in the highly compensated group. These facts and 
circumstances indicate that the effective availability of the early 
retirement benefit substantially favors the highly compensated group. 
This is the case even though the limitation of the early retirement 
benefit to a specified period satisfies section 411(d)(6).
    Example 3. Employer Y amends plan Y on June 30, 1990, to provide for 
a single sum distribution for employees who terminate from employment 
with the employer after June 30, 1990, and prior to January 1, 1991. The 
availability of this single sum distribution is conditioned on the 
employee having a particular disability at the time of termination of 
employment. The only employee of the employer who meets this disability 
requirement at the time of the amendment and thereafter through December 
31, 1990, is a highly compensated employee. Generally, a disability 
condition with respect to the availability of a single sum distribution 
may be disregarded in determining whether the current availability of 
such optional form of benefit is discriminatory. However, these facts 
and circumstances indicate that the effective availability of the 
optional form of benefit substantially favors the highly compensated 
group.
    Example 4. Employer Z maintains a money purchase pension plan that 
covers all employees of the employer. The plan provides for distribution 
in the form of a joint and survivor annuity, a life annuity, or equal 
installments over 10 years. During the 1992 calendar year the employer 
winds up his business. In December of 1992, only two employees remain in 
the employment of the employer, both of whom are highly compensated. 
Employer Z then amends the plan to provide for a single sum distribution 
to employees who terminate from employment on or after the date of the 
amendment. Both highly compensated employees terminate from employment 
on December 31, 1992, taking a single sum distribution of their 
benefits. These facts and circumstances indicate that the effective 
availability of the single sum optional form of benefit substantially 
favors the highly compensated group.

    (b) Application of tests--(1) Current availability--(i) In general. 
Except as otherwise provided in this paragraph (b), in determining 
whether an optional form of benefit that is subject to specified 
eligibility conditions is currently available to an employee for 
purposes of paragraph (a) of this Q&A-2, the determination of current 
availability generally is to be based on the current facts and 
circumstances with respect to the employee (e.g., the employee's current 
compensation or the employee's current net worth). Thus, for example, 
the fact that an employee may, in the future, satisfy an eligibility 
condition generally does not cause an optional form of benefit to be 
treated as currently available to such employee.
    (ii) Exceptions for age, service, employment termination and certain 
other conditions--(A) Age and service conditions. For purposes of 
applying paragraph (a)(2) of this Q&A-2, except as provided in paragraph 
(b)(1)(ii)(B) of this Q&A-2, an age condition, a service condition, or 
both are to be disregarded. For example, an employer that maintains a 
plan that provides for an early retirement benefit payable as an annuity 
for employees in division A, subject to a requirement that the employee 
has attained his or her 55th birthday and has at least twenty years of 
service with the employer, is to disregard the age and service 
conditions in determining the group of employees to whom the early 
retirement annuity benefit is currently available. Thus, the early 
retirement annuity benefit is treated as currently available to all 
employees of division A, without regard to their ages or years of 
service and without regard to whether they could potentially meet the 
age and service conditions prior to attaining the plan's normal 
retirement age.
    (B) Exception for certain age and service conditions. Age and 
service conditions that must be satisfied within a specified period of 
time may not be disregarded pursuant to paragraph (b)(1)(ii)(A) of this 
Q&A-2. However, in determining the current availability of an optional 
form of benefit subject to such an age condition, service condition, or 
both, an employer may project the age and service of employees to the 
last date on which the optional form of benefit subject to the age 
condition or service condition (or both) is available under the plan. An 
employer's ability to protect age and service to the last date on which 
the optional form of benefit is available under the plan is not cut off 
by a plan termination occurring prior to that date. Thus, for example, 
assume that an employer maintaining a plan that permits employees 
terminating from employment on or after age 55 between June 1, 1991 to 
May 31, 1992, to elect a single sum distribution,

[[Page 59]]

decides to terminate the plan on December 31, 1991. In determining the 
group of employees to whom the single sum optional form of benefit is 
currently available, this employer may project employees' ages through 
May 31, 1992.
    (C) Certain other conditions disregarded. Conditions on the 
availability of optional forms of benefit requiring termination of 
employment, death, satisfaction of a specified health condition (or 
failure to meet such condition), disability, hardship, marital status, 
default on a plan loan secured by a participant's account balance, or 
execution of a covenant not to compete may be disregarded in determining 
the group of employees to whom an optional form of benefit is currently 
available.
    (2) Employees taken into account. For purposes of applying paragraph 
(a) of this Q&A-2, the tests are to be applied on the basis of the 
employer's nonexcludable employees (whether or not they are participants 
in the plan) in the same manner as such tests would be applied in 
determining whether the plan providing the optional form of benefit 
satisfies the tests under section 410(b).
    (3) Definition of ``plan''. For purposes of applying paragraph (a) 
of this Q&A-2, the term ``plan'' has the meaning that such term has for 
purposes of determining whether the amount of contributions or benefits 
and whether other benefits, rights, and features are nondiscriminatory 
under section 401(a)(4).
    (4) Restructuring optional forms of benefit--(i) In general. For 
purposes of applying paragraph (a) of this Q&A-2, the availability of 
two or more optional forms of benefit under a plan may be tested by 
restructuring such benefits into two or more restructured optional forms 
of benefit and testing the availability of such restructured optional 
forms of benefit. If two or more optional forms of benefit under a plan 
contain both common and distinct components, such optional forms of 
benefit may be restructured as a single optional form of benefit 
comprising the common component, and one or more optional forms of 
benefit comprising each distinct component. Components of optional forms 
of benefit may be treated as common only if they are identical with 
respect to all characteristics taken into account under Q&A-1(b) of 
Sec. 1.411(d)-4. The availability of each restructured optional form of 
benefit must satisfy the applicable nondiscrimination requirements of 
paragraph (a) of this Q&A-2.
    (ii) Example. A profit-sharing plan covering all the employees of an 
employer provides a single sum distribution option upon termination from 
employment for all employees earning less than $50,000 and a single sum 
distribution option upon termination from employment after the 
attainment of age 55 for all employees earning $50,000 or more. These 
distribution options are identical in all other respects. For purposes 
of applying section 401(a)(4), such optional forms of benefit may be 
restructured into two different optional forms of benefit: (A) a single 
sum distribution option upon termination from employment after the 
attainment of age 55 for all employees (i.e., the common component), and 
(B) a single sum distribution option upon termination from employment 
before the attainment of age 55 for all employees earning less than 
$50,000. The availability of each of these restructured optional forms 
of benefit must satisfy section 401(a)(4).
    (c) Commissioner may provide additional tests. The Commissioner may 
provide such additional factors, tests, and safe harbors as are 
necessary or appropriate for purposes of determining whether the 
availability of an optional form of benefit is discriminatory under 
section 401(a)(4). In addition, the Commissioner may provide that 
additional eligibility conditions not related directly or indirectly to 
compensation or wealth may be disregarded under paragraph (b)(1)(ii)(C) 
of this Q&A-2 in determining the current availability of an optional 
form of benefit. The Commissioner may provide such additional guidance 
only through the publication of revenue rulings, notices or other 
documents of general applicability.
    Q-3: May a plan condition the availability of an optional form of 
benefit on employer discretion?

[[Page 60]]

    A-3: No. Even if the availability of an optional form of benefit 
that is conditioned on employer discretion satisfies the 
nondiscrimination requirements of section 401(a)(4), the plan providing 
the optional form of benefit will fail to satisfy certain other 
requirements of section 401(a), including, in applicable circumstances, 
the definitely determinable requirement of section 401(a) and the 
requirements of section 401(a)(25) and section 411(d)(6). See Sec. 
1.411(d)-4.
    Q-4: Will a plan provision violate section 401(a)(4) merely because 
it requires that an employee who terminates from service with the 
employer receive a single sum distribution in the event that the present 
value of the employee's benefit is not more than $3,500, as permitted by 
sections 411(a)(11) and 417(e)?
    A-4: No. A plan will not be treated as discriminatory under section 
401(a)(4) merely because the plan mandates a single sum distribution 
when the present value of an employee's benefit is not more than $3,500, 
as permitted by sections 411(a)(11) and 417(e). This is an exception to 
the general principles of this section. (No similar provision exists 
excepting such single sum distributions from the limits on employer 
discretion under section 411(d)(6). See Sec. 1.411(d)-4 Q&A-4.)
    Q-5: If the availability of an optional form of benefit 
discriminates, or may reasonably be expected to discriminate, in favor 
of the highly compensated group, what acceptable alternatives exist for 
amending the plan without violating section 411(d)(6)?
    A-5: (a) Transitional rules--(1) In general. The following rules 
apply for purposes of making necessary amendments to existing plans (as 
defined in Q&A-6 of this section) under which the availability of an 
optional form of benefit violates the nondiscrimination requirements of 
section 401(a)(4) or may reasonably be expected to violate such 
requirements. These transitional rules are provided under the authority 
of section 411(d)(6), which allows the elimination of certain optional 
forms of benefit if permitted by regulations, and section 7805(b).
    (2) Nondiscrimination--(i) In general. The determination of whether 
the availability of an optional form of benefit violates section 
401(a)(4) is to be made in accordance with Q&A-2 of this section. In 
addition, the availability of a particular optional form of benefit may 
reasonably be expected to violate the nondiscrimination requirements of 
section 401(a)(4) if, under the applicable facts and circumstances, 
there is a significant possibility that the current availability of such 
optional form of benefit will impermissibly favor the highly compensated 
group. This determination must be made on the basis of the seventy 
percent test of section 410(b)(1)(A) or the nondiscriminatory 
classification test of section 410(b)(1)(B) as such tests existed prior 
to the effective date of the amendments made to section 410(b) by 
section 1112(a) of TRA '86. Thus, a condition may not reasonably be 
expected to discriminate for purposes of these rules merely because it 
results in a significant possibility that discrimination will result 
because of the amendments made to section 410(b) by section 1112(a) of 
TRA '86. In addition, the availability of an optional form of benefit 
may not reasonably be expected to discriminate merely because of an age 
or service condition that may be disregarded in determining the current 
availability of such optional form of benefit under paragraph 
(b)(1)(ii)(A) of Q&A-2 of this section. Similarly, the availability of 
an optional form of benefit may not reasonably be expected to 
discriminate merely because of an age or service condition that, after 
permitted projection, does not cause such optional form to fail to 
satisfy the requirement of this paragraph (a)(2).
    (ii) Examples. The provisions of paragraph (a)(2)(i) of this Q&A-5 
can be illustrated by the following examples:

    Example 1. A plan provides that a single sum distribution option is 
available only to (A) employees earning $50,000 or more in the final 
year of employment, (B) employees who furnish evidence that they have a 
net worth above a certain specified amount, and (C) employees who 
present a letter from an accountant or attorney declaring that it is in 
the employee's best interest to receive a single sum distribution. 
Whether the availability of such optional form of benefit discriminates 
depends on whether it meets the requirements of Q&A-2 of this Sec. 
1.401(a)-4. However, each of the specified conditions

[[Page 61]]

limiting the availability of the optional form of benefit may reasonably 
be expected to discriminate in favor of the highly compensated group in 
operation because of the likelihood of a significant positive 
correlation between the ability to meet any of the specified conditions 
and membership in the highly compensated group.
    Example 2. A plan limits the availability of a single sum 
distribution option to employees employed in one particular division of 
the employer's company. All the employees of the company are 
participants in the plan. During the 1988 plan year, the division 
employs individuals who represent a nondiscriminatory classification of 
that company's employees (under section 410(b)(1)(B) prior to the 
effective date of the amendments made to section 410(b) by section 
1112(a) of TRA '86) and is unlikely to cease employing such a 
nondiscriminatory classification in the future. The availability of a 
single sum distribution under this plan does not result in 
discrimination during the 1988 plan year and may not reasonably be 
expected to do so.

    (b) Transitional alternatives. If the availability of an optional 
form of benefit under an existing plan is discriminatory under section 
401(a)(4), the plan must be amended either to eliminate the optional 
form of benefit or to make the availability of the optional form of 
benefit nondiscriminatory. For example, the availability of an optional 
form of benefit may be made nondiscriminatory by making such benefit 
available to sufficient additional employees who are not in the highly 
compensated group or by imposing nondiscriminatory objective criteria on 
its availability such that the group of employees to whom the benefit is 
available is nondiscriminatory. See Q&A-6 of Sec. 1.411(d)-4 for 
requirements with respect to such objective criteria. If, under an 
existing plan, the availability of an optional form of benefit may 
reasonably be expected to discriminate, the plan may be amended in the 
same manner permitted where the availability of an optional form of 
benefit is discriminatory. See paragraph (d) of this Q&A-5 for rules 
limiting the period during which the availability of optional forms of 
benefit may be eliminated or reduced under this paragraph.
    (c) Compliance and amendment date provisions--(1) Operational 
compliance requirement. On or before the applicable effective date for 
the plan (see Q&A-6 of this section), the plan sponsor must select one 
of the alternatives permitted under paragraph (b) of this Q&A-5 with 
respect to each affected optional form of benefit and the plan must be 
operated in accordance with this selection. This is an operational 
requirement and does not require a plan amendment prior to the period 
set forth in paragraph (c)(2) of this Q&A-5. There is no special 
reporting requirement under the Code or this section with respect to 
this selection.
    (2) Deferred amendment date. If paragraph (c)(1) of this Q&A-5 is 
satisfied, a plan amendment conforming the plan to the particular 
alternative selected under paragraph (b) of this Q&A-5 must be adopted 
within the time period permitted for amending plans in order to meet the 
requirements of section 410(b) as amended by TRA '86. Such conforming 
amendment must be consistent with the sponsor's selection as reflected 
by plan practice during the period from the effective date to the date 
the amendment is adopted. Thus, for example, if an existing calendar 
year noncollectively bargained defined benefit plan has a single sum 
distribution form subject to a discriminatory condition, that was 
available as of January 30, 1986 (subject to such condition), and such 
employer makes one or more single sum distributions available on or 
after the first day of the first plan year commencing on or after 
January 1, 1989, and before the plan amendment, then such employer may 
not adopt a plan amendment eliminating the single sum distribution form. 
Instead, such employer must adopt an amendment making the distribution 
form available to a nondiscriminatory group of employees while retaining 
the availability of such distribution form with respect to the group of 
employees to whom the benefit is already available. Similarly, any 
objective criteria that are adopted as part of such amendment must be 
consistent with the plan practice for the applicable period prior to the 
amendment. A conforming amendment under this paragraph (c)(2) must be 
made with respect to each optional form of benefit for which such 
amendment is required and must be retroactive to the applicable 
effective date.

[[Page 62]]

    (d) Limitation on transitional alternatives. The transitional 
alternatives permitting the elimination or reduction of optional forms 
of benefit will not violate section 411(d)(6) during the period prior to 
the applicable effective date for the plan (see Q&A-6 of this section). 
After the applicable effective date, any amendment (other than one 
described in paragraph (c)(2) of this Q&A-5) that eliminates or reduces 
an optional form of benefit or imposes new objective criteria 
restricting the availability of such optional form of benefit will fail 
to qualify for the exception to section 411(d)(6) provided in this Q&A-
5. This is the case without regard to whether the availability of the 
optional form of benefit is discriminatory or may reasonably be expected 
to be discriminatory.
    Q-6: For what period are the rules of this section effective?
    A-6: (a) General effective date--(1) In general. Except as otherwise 
provided in this section, the provisions of this section are effective 
January 30, 1986, and do not apply to plan years beginning on or after 
January 1, 1994. For rules applicable to plan years beginning on or 
after January 1, 1994, see Sec. Sec. 1.401(a)(4)-1 through 1.401(a)(4)-
13.
    (2) Plans of tax-exempt organizations. In the case of plans 
maintained by organizations exempt from income taxation under section 
501(a), including plans subject to section 403(b)(12)(A)(i) (nonelective 
plans), except as otherwise provided in this section, the provisions of 
this section are effective January 30, 1986, and do not apply to plan 
years beginning on or after January 1, 1996. For rules applicable to 
plan years beginning on or after January 1, 1996, see Sec. Sec. 
1.401(a)(4)-1 through 1.401(a)(4)-13.
    (b) New plans--(1) In general. Unless otherwise provided in 
paragraph (b)(2) of this Q&A-6, plans that are either adopted or made 
effective on or after January 30, 1986, are ``new plans''. With respect 
to such new plans, this section is effective January 30, 1986. This 
effective date is applicable to such plans whether or not they are 
collectively bargained.
    (2) Exception with respect to certain new plans. Plans that are new 
plans as defined in paragraph (b)(1) of this Q&A-6, under which the 
availability of an optional form of benefit is discriminatory or may 
reasonably be expected to be discriminatory, and that receive a 
favorable determination letter that covered such plan provisions with 
respect to an application submitted prior to July 11, 1988, will be 
treated as existing plans with respect to such optional form of benefit 
for purposes of the transitional rules of this section. Thus, such plans 
are eligible for the compliance and amendment alternatives set forth in 
the transitional rule in Q&A-5 of this section.
    (c) Existing plans--(1) In general. Plans that are both adopted and 
in effect prior to January 30, 1986, are ``existing plans''. In 
addition, new plans described in paragraph (b)(2) of this Q&A-6 are 
treated as existing plans with respect to certain forms of benefit. 
Subject to the limitations in paragraph (d) of this Q&A-6, the effective 
dates set forth in paragraphs (c)(2) and (c)(3) of this Q&A-6 apply to 
these existing plans for purposes of this section.
    (2) Existing noncollectively bargained plans. With respect to 
existing noncollectively bargained plans, this section is effective for 
the first day of the first plan year commencing on or after January 1, 
1989.
    (3) Existing collectively bargained plans. With respect to existing 
collectively bargained plans, this section is effective for the later of 
the first day of the first plan year commencing on or after January 1, 
1989, or the first day of the first plan year that the requirements of 
section 410(b) as amended by TRA '86 apply to such plan.
    (d) Delayed effective dates not applicable to new optional forms of 
benefit or conditions--(1) In general. The delayed effective dates in 
paragraph (c) (2) and (3) of this Q&A-6 for existing plans are 
applicable with respect to an optional form of benefit only if both the 
optional form of benefit and any applicable condition either causing the 
availability of such optional form of benefit to be discriminatory or 
making it reasonable to expect that the availability of such optional 
form will be discriminatory were both adopted and in effect prior to 
January 30, 1986. If the preceding sentence is not satisfied with 
respect to an optional form of benefit,

[[Page 63]]

this section is effective with respect to such optional form of benefit 
as if the plan were a new plan.
    (2) Exception for certain amendments covered by a favorable 
determination letter. If a condition causing the availability of an 
optional form of benefit to be discriminatory, or to be reasonably 
expected to discriminate, was adopted or made effective on or after 
January 30, 1986, and a favorable determination letter that covered such 
plan provision is or was received with respect to an application 
submitted before July 11, 1988, the effective date of this section with 
respect to such provision is the applicable effective date determined 
under the rules with respect to existing plans, as though such provision 
had been adopted and in effect prior to January 30, 1986.
    (e) Transitional rule effective date. The transitional rule provided 
in Q&A-5 of this section is effective January 30, 1986.

[53 FR 26054, July 11, 1988, as amended by T.D. 8360, 56 FR 47536, Sept. 
19, 1991; T.D. 8485, 58 FR 46778, Sept. 3, 1993; T.D. 8212, 61 FR 14247, 
Apr. 1, 1996]



Sec. 1.401(a)-11  Qualified joint and survivor annuities.

    (a) General rule--(1) Required provisions. A trust, to which section 
411 (relating to minimum vesting standards) applies without regard to 
section 411(e)(2), which is a part of a plan providing for the payment 
of benefits in any form of a life annuity (as defined in paragraph 
(b)(1) of this section), shall not constitute a qualified trust under 
section 401(a)(11) and this section unless such plan provides that:
    (i) Unless the election provided in paragraph (c)(1) of this section 
has been made, life annuity benefits will be paid in a form having the 
effect of a qualified joint and survivor annuity (as defined in 
paragraph (b)(2) of this section) with respect to any participant who--
    (A) Begins to receive payments under such plan on or after the date 
the normal retirement age is attained, or
    (B) Dies (on or after the date the normal retirement age is 
attained) while in active service of the employer maintaining the plan, 
or
    (C) In the case of a plan which provides for the payment of benefits 
before the normal retirement age, begins to receive payments under such 
plan on or after the date the qualified early retirement age (as defined 
in paragraph (b)(4) of this section) is attained, or
    (D) Separates from service on or after the date the normal 
retirement age (or the qualified early retirement age) is attained and 
after satisfaction of eligibility requirements for the payment of 
benefits under the plan (except for any plan requirement that there be 
filed a claim for benefits) and thereafter dies before beginning to 
receive life annuity benefits;
    (ii) Any participant may elect, as provided in paragraph (c)(1) of 
this section, not to receive life annuity benefits in the form of a 
qualified joint and survivor annuity; and
    (iii) If the plan provides for the payment of benefits before the 
normal retirement age, any participant may elect, as provided in 
paragraph (c)(2) of this section, that life annuity benefits be payable 
as an early survivor annuity (as defined in paragraph (b)(3) of this 
section) upon his death in the event that he--
    (A) Attains the qualified early retirement age (as defined in 
paragraph (b)(4) of this section), and
    (B) Dies on or before the day normal retirement age is attained 
while employed by an employer maintaining the plan.
    (2) Certain cash-outs. A plan will not fail to satisfy the 
requirements of section 401(a)(11) and this section merely because it 
provides that if the present value of the entire nonforfeitable benefit 
derived from employer contributions of a participant at the time of his 
separation from service does not exceed $1,750 (or such smaller amount 
as the plan may specify), such benefit will be paid to him in a lump 
sum.
    (3) Illustrations. The provisions of subparagraph (1) of this 
paragraph may be illustrated by the following examples:

    Example 1. The X Corporation Defined Contribution Plan was 
established in 1960. As in effect on January 1, 1974, the plan provided 
that, upon the participant's retirement, the participant may elect to 
receive the balance of his account in the form of (1) a single-sum cash 
payment, (2) a single-sum distribution consisting of X Corporation 
stock, (3) five

[[Page 64]]

equal annual cash payments, (4) a life annuity, or (5) a combination of 
options (1) through (4). The plan also provided that, if a participant 
did not elect another form of distribution, the balance of his account 
would be distributed to him in the form of a single-sum cash payment 
upon his retirement. Assume that section 401(a)(11) and this section 
became applicable to the plan as of its plan year beginning January 1, 
1976, with respect to persons who were active participants in the plan 
as of such date (see paragraph (f) of this section). If X Corporation 
Defined Contribution Plan continues to allow the life annuity payment 
option after December 31, 1975, it must be amended to provide that if a 
participant elects a life annuity option the life annuity benefit will 
be paid in a form having the effect of a qualified joint and survivor 
annuity, except to the extent that the participant elects another form 
of benefit payment. However, the plan can continue to provide that, if 
no election is made, the balance will be paid as a single-sum cash 
payment. If the trust is not so amended, it will fail to qualify under 
section 401(a).
    Example 2. The Corporation Retirement Plan provides that plan 
benefits are payable only in the form of a life annuity and also 
provides that a participant may retire before the normal retirement age 
of 65 and receive a benefit if he has completed 30 years of service. 
Under this plan, an employee who begins employment at the age of 18 will 
be eligible to receive retirement benefits at the age of 48 if he then 
has 30 years of service. This plan must allow a participant to elect in 
the time and manner prescribed in paragraph (c)(2) of this section an 
early survivor annuity (defined in paragraph (b)(3) of this section) to 
be payable on the death of the participant if death occurs while the 
participant is in active service for the employer maintaining the plan 
and on or after the date the participant reaches the qualified early 
retirement age of 55 (the later of the date the participant reaches the 
earliest retirement age (age 48) or 10 years before normal retirement 
age (age 55)) but before the day after the day the participant reaches 
normal retirement age (age 65).
    Example 3. Assume the same facts as in Example 2. A, B, and C began 
employment with Y Corporation when they each attained age 18. A retires 
and begins to receive benefit payments at age 48 after completing 30 
years of service. The plan is not required to pay a qualified joint and 
survivor annuity to A and his spouse at any time. B does not elect an 
early survivor annuity at age 55, but retires at age 57 after completing 
39 years of service. Unless B makes an election under subparagraph 
(1)(ii) of this paragraph, the plan is required to pay a qualified joint 
and survivor annuity to B and his spouse. C makes no elections described 
in subparagraph (1) of this paragraph, and dies while in active service 
at age 66 after completing 48 years of service. The plan is required to 
pay a qualified survivor annuity to C's spouse.

    (b) Definitions. As used in this section--(1) Life annuity. (i) The 
term ``life annuity'' means an annuity that provides retirement payments 
and requires the survival of the participant or his spouse as one of the 
conditions for any payment or possible payment under the annuity. For 
example, annuities that make payments for 10 years or until death, 
whichever occurs first or whichever occurs last, are life annuities.
    (ii) However, the term ``life annuity'' does not include an annuity, 
or that portion of an annuity, that provides those benefits which, under 
section 411(a)(9), would not be taken into account in the determination 
of the normal retirement benefit or early retirement benefit. For 
example, ``social security supplements'' described in the fourth 
sentence of section 411(a)(9) are not considered to be life annuities 
for the purposes of this section, whether or not an early retirement 
benefit is provided under the plan.
    (2) Qualified joint and survivor annuity. The term ``qualified joint 
and survivor annuity'' means an annuity for the life of the participant 
with a survivor annuity for the life of his spouse which is neither (i) 
less than one-half of, nor (ii) greater than, the amount of the annuity 
payable during the joint lives of the participant and his spouse. For 
purposes of the preceding sentence, amounts described in Sec. 1.401(a)-
11(b)(1)(ii) may be disregarded. A qualified joint and survivor annuity 
must be at least the actuarial equivalent of the normal form of life 
annuity or, if greater, of any optional form of life annuity offered 
under the plan. Equivalence may be determined, on the basis of 
consistently applied reasonable actuarial factors, for each participant 
or for all participants or reasonable groupings of participants, if such 
determination does not result in discrimination in favor of employees 
who are officers, shareholders, or highly compensated. An annuity is not 
a qualified joint and survivor annuity if payments to the spouse of a 
deceased participant are terminated, or reduced, because of such 
spouse's remarriage.

[[Page 65]]

    (3) Early survivor annuity. The term ``early survivor annuity'' 
means an annuity for the life of the participant's spouse the payments 
under which must not be less than the payments which would have been 
made to the spouse under the joint and survivor annuity if the 
participant had made the election described in paragraph (c)(2) of this 
section immediately prior to his retirement and if his retirement had 
occurred on the day before his death and within the period during which 
an election can be made under such paragraph (c)(2). For example, if a 
participant would be entitled to a single life annuity of $100 per month 
or a reduced amount under a qualified joint and survivor annuity of $80 
per month, his spouse is entitled to a payment of at least $40 per 
month. However, the payments may be reduced to reflect the number of 
months of coverage under the survivor annuity pursuant to paragraph (e) 
of this section.
    (4) Qualified early retirement age. The term ``qualified early 
retirement age'' means the latest of--
    (i) The earliest date, under the plan, on which the participant 
could elect (without regard to any requirement that approval of early 
retirement be obtained) to receive retirement benefits (other than 
disability benefits).
    (ii) The first day of the 120th month beginning before the 
participant reaches normal retirement age, or
    (iii) The date on which the participant begins participation.
    (5) Normal retirement age. The term ``normal retirement age'' has 
the meaning set forth in section 411(a)(8).
    (6) Annuity starting date. The term ``annuity starting date'' means 
the first day of the first period with respect to which an amount is 
received as a life annuity, whether by reason of retirement or by reason 
of disability.
    (7) Day. The term ``day'' means a calendar day.
    (c) Elections--(1) Election not to take joint and survivor annuity 
form--(i) In general. (A) A plan shall not be treated as satisfying the 
requirements of this section unless it provides that each participant 
may elect, during the election period described in subdivision (ii) of 
this subparagraph, not to receive a qualified joint and survivor 
annuity. However, if a plan provides that a qualified joint and survivor 
annuity is the only form of benefit payable under the plan with respect 
to a married participant, no election need be provided.
    (B) The election shall be in writing and clearly indicate that the 
participant is electing to receive all or, if permitted by the plan, 
part of his benefits under the plan in a form other than that of a 
qualified joint and survivor annuity. A plan will not fail to meet the 
requirements of this section merely because the plan requires the 
participant to obtain the written approval of his spouse in order for 
the participant to make this election or if the plan provides that such 
approval is not required.
    (ii) Election period. (A) For purposes of the election described in 
paragraph (c)(1)(i) of this section, the plan shall provide an election 
period which shall include a period of at least 90 days following the 
furnishing of all of the applicable information required by subparagraph 
(3)(i) of this paragraph and ending prior to commencement of benefits. 
In no event may the election period end earlier than the 90th day before 
the commencement of benefits. Thus, for example, the commencement of 
benefits may be delayed until the end of such election period because 
the amount of payments to be made to a participant cannot be ascertained 
before the end of such period; see Sec. 1.401(a)-14(d).

If a participant makes a request for additional information as provided 
in subparagraph (3)(iii) of this paragraph on or before the last day of 
the election period, the election period shall be extended to the extent 
necessary to include at least the 90 calendar days immediately following 
the day the requested additional information is personally delivered or 
mailed to the participant. Notwithstanding the immediately preceding 
sentence, a plan may provide in cases in which the participant has been 
furnished by mail or personal delivery all of the applicable information 
required by subparagraph (3)(i) of this paragraph, that a request for 
such additional information must be made on or before a date which is 
not less than 60 days from the date of such mailing or delivery; and if 
the

[[Page 66]]

plan does so provide, the election period shall be extended to the 
extent necessary to include at least the 60 calendar days following the 
day the requested additional information is personally delivered or 
mailed to the participant.
    (B) In the case of a participant in a plan to which this 
subparagraph applies who separated from service after section 401(a)(11) 
and this section became applicable to such plan with respect to such 
participant, and to whom an election required by this subparagraph has 
not been previously made available (and will not become available in 
normal course), the plan must provide an election to receive the balance 
of his benefits (properly adjusted, if applicable, for payments 
received, prior to the exercise of such election, in the form of a 
qualified joint and survivor annuity) in a form other than that of a 
qualified joint and survivor annuity. The provisions of paragraph 
(c)(1)(ii)(A) shall apply except that in no event shall the election 
period end before the 90th day after the date on which notice of the 
availability of such election and the applicable information required by 
subparagraph (3)(i) of this paragraph is given directly to the 
participant. If such notice and information is given by mail, it shall 
be treated as given on the date of mailing. If such participant has 
died, such election shall be made available to such participant's 
personal representative.
    (2) Election of early survivor annuity--(i) In general. (A) A plan 
described in subparagraph (a)(1)(iii) of this section shall not be 
treated as satisfying the requirements of this section unless it 
provides that each participant may elect, during the period described in 
subdivision (ii) of this subparagraph, an early survivor annuity as 
described in paragraph (a)(1)(iii) of this section. Breaks in service 
after the participant has attained the qualified early retirement age 
neither invalidate a previous election or revocation nor prevent an 
election from being made or revoked during the election period.
    (B) The election shall be in writing and clearly indicate that the 
participant is electing the early survivor annuity form.
    (C) A plan is not required to provide an election under this 
subparagraph if--
    (1) The plan provides that an early survivor annuity is the only 
form of benefit payable under the plan with respect to a married 
participant who dies while employed by an employer maintaining the plan,
    (2) In the case of a defined contribution plan, the plan provides a 
survivor benefit at least equal in value to the vested portion of the 
participant's account balance, if the participant dies while in active 
service with an employer maintaining the plan, or
    (3) In the case of a defined benefit plan, the plan provides a 
survivor benefit at least equal in value to the present value of the 
vested portion of the participant's normal form of the accrued benefit 
payable at normal retirement age (determined immediately prior to 
death), if the participant dies while in active service with an employer 
maintaining the plan. Any present values must be determined in 
accordance with either the actuarial assumptions or factors specified in 
the plan, or a variable standard independent of employer discretion for 
converting optional benefits specified in the plan.
    (ii) Election period. (A) For purposes of the election described in 
paragraph (c)(2)(i) of this section the plan shall provide an election 
period which, except as provided in the following sentence, shall begin 
not later than the later of either the 90th day before a participant 
attains the qualified early retirement age or the date on which his 
participation begins, and shall end on the date the participant 
terminates his employment. If such a plan contains a provision that any 
election made under this subparagraph does not become effective or 
ceases to be effective if the participant dies within a certain period 
beginning on the date of such election, the election period prescribed 
in this subdivision (ii) shall begin not later than the later of (1) a 
date which is 90 days plus such certain period before the participant 
attains the qualified early retirement age or (2) the date on which his 
participation begins. For example, if a plan provides that an election 
made under this subparagraph

[[Page 67]]

does not become effective if the participant dies less than 2 years 
after the date of such election, the period for making an election under 
this subparagraph must begin not later than the later of (1) 2 years and 
90 days before the participant attains the qualified early retirement 
age, or (2) the date on which his participation begins. However, the 
election period for an individual who was an active participant on the 
date this section became effective with regard to the plan need not 
begin earlier than such effective date.
    (B) In the case of a participant in a plan to which this 
subparagraph applies who dies after section 401(a)(11) and this section 
became applicable to such plan with respect to such participant and to 
whom an election required by this subparagraph has not been previously 
made available, the plan must give the participant's surviving spouse 
or, if dead, such spouse's personal representative the option of 
electing an early survivor annuity. The plan may reduce the surviving 
spouse's annuity to take into account any benefits already received. The 
period for making such election shall not end before the 90th day after 
the date on which written notice of the availability of such election 
and applicable information required by subparagraph (3)(i) of this 
paragraph is given directly to such surviving spouse or personal 
representative. If such notice and information is given by mail, if 
shall be treated as given on the date of mailing.
    (3) Information to be provided by plan. For rules regarding the 
information required to be provided with respect to the election to 
waive a QJSA or a QPSA, see Sec. 1.417(a)(3)-1.
    (4) Election is revocable. A plan to which this section applies must 
provide that any election made under this paragraph may be revoked in 
writing during the specified election period, and that after such 
election has been revoked, another election under this paragraph may be 
made during the specified election period.
    (5) Election by surviving spouse. A plan will not fail to meet the 
requirements of section 401(a)(11) and this section merely because it 
provides that the spouse of a deceased participant may elect to have 
benefits paid in a form other than a survivor annuity. If the plan 
provides that such a spouse may make such an election, the plan 
administrator must furnish to this spouse, within a reasonable amount of 
time after a written request has been made by this spouse, a written 
explanation in non-technical language of the survivor annuity and any 
other form of payment which may be selected. This explanation must state 
the financial effect (in terms of dollars) of each form of payment. A 
plan need not respond to more than one such request.
    (d) Permissible additional plan provisions--(1) In general. A plan 
will not fail to meet the requirements of section 401(a)(11) and this 
section merely because it contains one or more of the provisions 
described in paragraphs (d)(2) through (5) of this section.
    (2) Claim for benefits. A plan may provide that as a condition 
precedent to the payment of benefits, a participant must express in 
writing to the plan administrator the form in which he prefers benefits 
to be paid and provide all the information reasonably necessary for the 
payment of such benefits. However, if a participant files a claim for 
benefits with the plan administrator and provides the plan administrator 
with all the information necessary for the payment of benefits but does 
not indicate a preference as to the form for the payment of benefits, 
benefits must be paid in the form of a qualified joint and survivor 
annuity if the participant has attained the qualified early retirement 
age unless such participant has made an effective election not to 
receive benefits in such form. For rules relating to provisions in a 
plan to the effect that a claim for benefits must be filed before the 
payment of benefits will commence, see Sec. 1.401(a)-14.
    (3) Marriage requirements. A plan may provide that a joint and 
survivor annuity will be paid only if--
    (i) The participant and his spouse have been married to each other 
throughout a period (not exceeding one year) ending on the annuity 
starting date.

[[Page 68]]

    (ii) The spouse of the participant is not entitled to receive a 
survivor annuity (whether or not the election described in paragraph 
(c)(2) of this section has been made) unless the participant and his 
spouse have been married to each other throughout a period (not 
exceeding one year) ending on the date of such participant's death.
    (iii) The same spouse must satisfy the requirements of subdivisions 
(i) and (ii) of this subparagraph.
    (iv) The participant must notify the plan administrator (as defined 
by section 414(g)) of his marital status within any reasonable time 
period specified in the plan.
    (4) Effect of participant's death on an election or revocation of an 
election under paragraph (c). A plan may provide that any election 
described in paragraph (c) of this section or any revocation of any such 
election does not become effective or ceases to be effective if the 
participant dies within a period, not in excess of 2 years, beginning on 
the date of such election or revocation. However, a plan containing a 
provision described in the preceding sentence shall not satisfy the 
requirements of this section unless it also provides that any such 
election or any revocation of any such election will be given effect in 
any case in which--
    (i) The participant dies from accidental causes,
    (ii) A failure to give effect to the election or revocation would 
deprive the participant's survivor of a survivor annuity, and
    (iii) Such election or revocation is made before such accident 
occurred.
    (5) Benefit option approval by third party. (i) A plan may provide 
that an optional form of benefit elected by a participant is subject to 
the approval of an administrative committee or similar third party. 
However, the administrative committee cannot deny a participant any of 
the benefits required by section 401(a)(11). For example, if a plan 
offers a life annuity option, the committee may deny the participant a 
qualified joint and survivor annuity only by denying the participant 
access to all life annuity options without knowledge of whether the 
participant wishes to receive a qualified joint and survivor annuity. 
Alternatively, if the committee knows which form of life annuity the 
participant has chosen before the committee makes its decision, the 
committee cannot withhold its consent for payment of a qualified joint 
and survivor annuity event though it denies all other life annuity 
options. This subparagraph (5) only applies before the effective date of 
the amendment made to section 411(d)(6) by section 301 of the Retirement 
Equity Act of 1984. See section 411(d)(6) and the regulations thereunder 
for rules limiting employer discretion.
    (ii) The provisions of this subparagraph may be illustrated by the 
following example:

    Example. In 1980 plan M provides that the automatic form of benefit 
is a single sum distribution. The plan also permits, subject to approval 
by the administrative committee, the election of several optional forms 
of life annuity. On the election form that is reviewed by the 
administrative committee the participant indicates whether any life 
annuity option is preferred, without indicating the particular life 
annuity chosen. Thus, the committee approves or disapproves the election 
without knowledge of whether a qualified joint and survivor annuity will 
be elected. The administrative committee approval provision in Plan M 
does not cause the plan to fail to satisfy this section. On the other 
hand, if the form indicates which form of life annuity is preferred, 
committee disapproval of any election of the qualified joint and 
survivor annuity would cause the plan to fail to satisfy this section.

    (e) Costs of providing qualified joint and survivor annuity form or 
early survivor annuity form. A plan may take into account in any 
equitable manner consistent with generally accepted actuarial principles 
applied on a consistent basis any increased costs resulting from 
providing qualified joint and survivor annuity and early survivor 
annuity benefits. A plan may give a participant the option of paying 
premiums only if it provides another option under which an out-of-pocket 
expense by the participant is not required.
    (f) Application and effective date. Section 401(a)(11) and this 
section shall apply to a plan only with respect to plan years beginning 
after December 31, 1975, and shall apply only if--
    (1) The participant's annuity starting date did not fall within a 
plan year beginning before January 1, 1976, and

[[Page 69]]

    (2) The participant was an active participant in the plan on or 
after the first day of the first plan year beginning after December 31, 
1975.
    For purposes of this paragraph, the term ``active participant'' 
means a participant for whom benefits are being accrued under the plan 
on his behalf (in the case of a defined benefit plan), the employer is 
obligated to contribute to or under the plan on his behalf (in the case 
of a defined contribution plan other than a profit-sharing plan), or the 
employer either is obligated to contribute to or under the plan on his 
behalf or would have been obligated to contribute to or under the plan 
on his behalf if any contribution were made to or under the plan (in the 
case of a profit-sharing plan).

If benefits under a plan are provided by the distribution to the 
participants of individual annuity contracts, the annuity starting date 
will be considered for purposes of this paragraph to fall within a plan 
year beginning before January 1, 1976, with respect to any such 
individual contract that was distributed to the participant during a 
plan year beginning before January 1, 1976, if no premiums are paid with 
respect to such contract during a plan year beginning after December 31, 
1975. In the case of individual annuity contracts that are distributed 
to participants before January 1, 1978, and which contain an option to 
provide a qualified joint and survivor annuity, the requirements of this 
section will be considered to have been satisfied if, not later than 
January 1, 1978, holders of individual annuity contracts who are 
participants described in the first sentence of this paragraph are given 
an opportunity to have such contracts amended, so as to provide for a 
qualified joint and survivor annuity in the absence of a contrary 
election, within a period of not less than one year from the date such 
opportunity was offered. In no event, however, shall the preceding 
sentence apply with respect to benefits attributable to premiums paid 
after December 31, 1977.
    (g) Effect of REA 1984--(1) In general. The Retirement Equity Act of 
1984 (REA 1984) significantly changed the qualified joint and survivor 
annuity rules generally effective for plan years beginning after 
December 31, 1984. The new survivor annuity rules are primarily in 
sections 401(a)(11) and 417 as revised by REA 1984 and Sec. Sec. 
1.401(a)-20 and 417(e)-1.
    (2) Regulations after REA 1984. (i) REA and the regulations 
thereunder to the extent inconsistent with pre-REA 1984 section 
401(a)(11) and this section are controlling for years to which REA 1984 
applies. See e.g., paragraphs (a)(1) and (2) of this section, relating 
to required provisions and certain cash-outs, respectively and (e), 
relating to costs of providing annuities, for rules that are 
inconsistent with REA 1984 and, therefore, are not applicable to REA 
1984 years.
    (ii) To the extent that the pre-REA 1984 law either is the same as 
or consistent with REA 1984 and the new regulations hereunder, the rules 
in this section shall continue to apply for years to which REA 1984 
applies. (See, e.g., paragraph (c) (relating to how information is 
furnished participants and spouses) and paragraph (b) (defining a life 
annuity) for some of the rules that apply to REA 1984 years.) The rules 
in this section shall not apply for such years to the extent that they 
are inconsistent with REA 1984 and the regulations thereunder.
    (iii) The Commissioner may provide additional guidance as to the 
continuing effect of the various rules in this section for years to 
which REA 1984 applies.

(Secs. 401(a)(11), 7805 Internal Revenue Code of 1954, (88 Stat. 935, 
68A Stat. 917; (26 U.S.C. 401(a)(11), 7805)))

[T.D. 7458, 42 FR 1466, Jan. 7, 1977; 42 FR 6367, Feb. 2, 1977, as 
amended by T.D. 7510, 42 FR 53956, Oct. 4, 1977; T.D. 8219, 53 FR 31841, 
Aug. 22, 1988; 53 FR 48534, Dec. 1, 1988; T.D. 9099, 68 FR 70144, Dec. 
17, 2003]



Sec. 1.401(a)-12  Mergers and consolidations of plans and transfers 
of plan assets.

    A trust will not be qualified under section 401 unless the plan of 
which the trust is a part provides that in the case of any merger or 
consolidation with, or transfer of assets or liabilities to, another 
plan after September 2, 1974, each participant in the plan would receive 
a minimum benefit if the plan terminated immediately after the merger,

[[Page 70]]

consolidation, or transfer. This benefit must be equal to or greater 
than the benefit the participant would have been entitled to receive 
immediately before the merger, consolidation, or transfer if the plan in 
which he was a participant had then terminated. This section applies to 
a multiemployer plan only to the extent determined by the Pension 
Benefit Guaranty Corporation. For additional rules concerning mergers or 
consolidations of plans and transfers of plan assets, see section 414(l) 
and Sec. 1.414(l)-1.

[T.D. 7638, 44 FR 48195, Aug. 17, 1979]



Sec. 1.401(a)-13  Assignment or alienation of benefits.

    (a) Scope of the regulations. This section applies only to plans to 
which section 411 applies without regard to section 411(e)(2). Thus, for 
example, it does not apply to a governmental plan, within the meaning of 
section 414(d); a church plan, within the meaning of section 414(e), for 
which there has not been made the election under section 410(a) to have 
the participation, vesting, funding, etc. requirements apply; or a plan 
which at no time after September 2, 1974, provided for employer 
contributions.
    (b) No assignment or alienation--(1) General rule. Under section 
401(a)(13), a trust will not be qualified unless the plan of which the 
trust is a part provides that benefits provided under the plan may not 
be anticipated, assigned (either at law or in equity), alienated or 
subject to attachment, garnishment, levy, execution or other legal or 
equitable process.
    (2) Federal tax levies and judgments. A plan provision satisfying 
the requirements of subparagraph (1) of this paragraph shall not 
preclude the following:
    (i) The enforcement of a Federal tax levy made pursuant to section 
6331.
    (ii) The collection by the United States on a judgment resulting 
from an unpaid tax assessment.
    (c) Definition of assignment and alienation--(1) In general. For 
purposes of this section, the terms ``assignment'' and ``alienation'' 
include--
    (i) Any arrangement providing for the payment to the employer of 
plan benefits which otherwise would be due the participant under the 
plan, and
    (ii) Any direct or indirect arrangement (whether revocable or 
irrevocable) whereby a party acquires from a participant or beneficiary 
a right or interest enforceable against the plan in, or to, all or any 
part of a plan benefit payment which is, or may become, payable to the 
participant or beneficiary.
    (2) Specific arrangements not considered an assignment or 
alienation. The terms ``assignment'' and ``alienation'' do not include, 
and paragraph (e) of this section does not apply to, the following 
arrangements:
    (i) Any arrangement for the recovery of amounts described in section 
4045(b) of the Employee Retirement Income Security Act of 1974, 88 Stat. 
1027 (relating to the recapture of certain payments),
    (ii) Any arrangement for the withholding of Federal, State or local 
tax from plan benefit payments,
    (iii) Any arrangement for the recovery by the plan of overpayments 
of benefits previously made to a participant,
    (iv) Any arrangement for the transfer of benefit rights from the 
plan to another plan, or
    (v) Any arrangement for the direct deposit of benefit payments to an 
account in a bank, savings and loan association or credit union, 
provided such arrangement is not part of an arrangement constituting an 
assignment or alienation. Thus, for example, such an arrangement could 
provide for the direct deposit of a participant's benefit payments to a 
bank account held by the participant and the participant's spouse as 
joint tenants.
    (d) Exceptions to general rule prohibiting assignments or 
alienations--(1) Certain voluntary and revocable assignments or 
alienations. Not withstanding paragraph (b)(1) of this section, a plan 
may provide that once a participant or beneficiary begins receiving 
benefits under the plan, the participant or beneficiary may assign or 
alienate the right to future benefit payments provided that the 
provision is limited to assignments or alienations which--
    (i) Are voluntary and revocable;
    (ii) Do not in the aggregate exceed 10 percent of any benefit 
payment; and

[[Page 71]]

    (iii) Are neither for the purpose, nor have the effect, of defraying 
plan administration costs.

For purposes of this subparagraph, an attachment, garnishment, levy, 
execution, or other legal or equitable process is not considered a 
voluntary assignment or alienation.
    (2) Benefits assigned or alienated as security for loans. (i) 
Notwithstanding paragraph (b)(1) of this section, a plan may provide for 
loans from the plan to a participant or a beneficiary to be secured (by 
whatever means) by the participant's accrued nonforfeitable benefit 
provided that the following conditions are met.
    (ii) The plan provision providing for the loans must be limited to 
loans from the plan. A plan may not provide for the use of benefits 
accrued or to be accrued under the plan as security for a loan from a 
party other than the plan, regardless of whether these benefits are 
nonforfeitable within the meaning of section 411 and the regulations 
thereunder.
    (iii) The loan, if made to a participant or beneficiary who is a 
disqualified person (within the meaning of section 4975(e)(2)), must be 
exempt from the tax imposed by section 4975 (relating to the tax imposed 
on prohibited transactions) by reason of section 4975(d)(1). If the loan 
is made to a participant or beneficiary who is not a disqualified 
person, the loan must be one which would the exempt from the tax imposed 
by section 4975 by reason of section 4975(d)(1) if the loan were made to 
a disqualified person.
    (e) Special rule for certain arrangements--(1) In general. For 
purposes of this section and notwithstanding paragraph (c)(1) of this 
section, an arrangement whereby a participant or beneficiary directs the 
plan to pay all, or any portion, of a plan benefit payment to a third 
party (which includes the participant's employer) will not constitute an 
``assignment or alienation'' if--
    (i) It is revocable at any time by the participant or beneficiary; 
and
    (ii) The third party files a written acknowledgement with the plan 
administrator pursuant to subparagraph (2) of this paragraph.
    (2) Acknowledgement requirement for third party arrangements. In 
accordance with paragraph (e)(1)(ii) of this section, the third party is 
required to file a written acknowledgement with the plan administrator. 
This acknowledgement must state that the third party has no enforceable 
right in, or to, any plan benefit payment or portion thereof (except to 
the extent of payments actually received pursuant to the terms of the 
arrangement). A blanket written acknowledgement for all participants and 
beneficiaries who are covered under the arrangement with the third party 
is sufficient. The written acknowledgement must be filed with the plan 
administrator no later than the later of--
    (i) August 18, 1978; or
    (ii) 90 days after the arrangement is entered into.
    (f) Effective date. Section 401(a)(13) is applicable as of January 
1, 1976, and the plan provision required by this section must be 
effective as of that date. However, regardless of when the provision is 
adopted, it will not affect--
    (1) Attachments, garnishments, levies, or other legal or equitable 
process permitted under the plan that are made before January 1, 1976;
    (2) Assignments permitted under the plan that are irrevocable on 
December 31, 1975, including assignments made before January 1, 1976, as 
security for loans to a participant or beneficiary from a party other 
than the plan; and
    (3) Renewals or extensions of loans described in subparagraph (2) of 
this paragraph, if--
    (i) The principal amount of the obligation outstanding on December 
31, 1975 (or, if less, the principal amount outstanding on the date of 
renewal or extension), is not increased;
    (ii) The loan, as renewed or extended, does not bear a rate of 
interest in excess of the rate prevailing for similar loans at the time 
of the renewal or extensions; and
    (iii) With respect to loans that are renewed or extended to bear a 
variable interest rate, the formula for determining the applicable rate 
is consistent with the formula for formulae prevailing for similar loans 
at the time of the renewal or extension. For purposes of subparagraphs 
(2) and (3) of

[[Page 72]]

this paragraph, a loan from a party other than the plan made after 
December 31, 1975, will be treated as a new loan. This is so even if the 
lender's security interest for the loan arises from an assignment of the 
participant's accrued nonforfeitable benefit made before that date.
    (g) Special rules for qualified domestic relations orders--(1) 
Definition. The term ``qualified domestic relations order'' (QDRO) has 
the meaning set forth in section 414(p). For purposes of the Internal 
Revenue Code, a QDRO also includes any domestic relations order 
described in section 303(d) of the Retirement Equity Act of 1984.
    (2) Plan amendments. A plan will not fail to satisfy the 
qualification requirements of section 401(a) or 403(a) merely because it 
does not include provisions with regard to a QDRO.
    (3) Waiver of distribution requirements. A plan shall not be treated 
as failing to satisfy the requirements of sections 401 (a) and (k) and 
409(d) solely because of a payment to an alternate payee pursuant to a 
QDRO. This is the case even if the plan provides for payments pursuant 
to a QDRO to an alternate payee prior to the time it may make payments 
to a participant. Thus, for example, a pension plan may pay an alternate 
payee even though the participant may not receive a distribution because 
he continues to be employed by the employer.
    (4) Coordination with section 417--(i) Former spouse. (A) In 
general. Under section 414(p)(5), a QDRO may provide that a former 
spouse shall be treated as the current spouse of a participant for all 
or some purposes under sections 401(a)(11) and 417.
    (B) Consent. (1) To the extent a former spouse is treated as the 
current spouse of the participant by reason of a QDRO, any current 
spouse shall not be treated as the current spouse. For example, assume H 
is divorced from W, but a QDRO provides that H shall be treated as W's 
current spouse with respect to all of W's benefits under a plan. H will 
be treated as the surviving spouse under the QPSA and QJSA unless W 
obtains H's consent to waive the QPSA or QJSA or both. The fact that W 
married S after W's divorce from H is disregarded. If, however, the QDRO 
had provided that H shall be treated as W's current spouse only with 
respect to benefits that accrued prior to the divorce, then H's consent 
would be needed by W to waive the QPSA or QJSA with respect to benefits 
accrued before the divorce. S's consent would be required with respect 
to the remainder of the benefits.
    (2) In the preceding examples, if the QDRO ordered that a portion of 
W's benefit (either through separate accounts or a percentage of the 
benefit) must be distributed to H rather than ordering that H be treated 
as W's spouse, the survivor annuity requirements of sections 401(a)(11) 
and 417 would not apply to the part of W's benefit awarded H. Instead, 
the terms of the QDRO would determine how H's portion of W's accrued 
benefit is paid. W is required to obtain S's consent if W elects to 
waive either the QJSA or QPSA with respect to the remaining portion of 
W's benefit.
    (C) Amount of the QPSA or QJSA. (1) Where, because of a QDRO, more 
than one individual is to be treated as the surviving spouse, a plan may 
provide that the total amount to be paid in the form of a QPSA or 
survivor portion of a QJSA may not exceed the amount that would be paid 
if there were only one surviving spouse. The QPSA or survivor portion of 
the QJSA, as the case may be, payable to each surviving spouse must be 
paid as an annuity based on the life of each such spouse.
    (2) Where the QDRO splits the participant's accrued benefit between 
the participant and a former spouse (either through separate accounts or 
percentage of the benefit), the surviving spouse of the participant is 
entitled to a QPSA or QJSA based on the participant's accrued benefit as 
of the date of death or the annuity starting date, less the separate 
account or percentage that is payable to the former spouse. The 
calculation is made as if the separate account or percentage had been 
distributed to the participant prior to the relevant date.
    (ii) Current spouse. Under section 414(p)(5), even if the applicable 
election periods (i.e., the first day of the year in which the 
participant attains age 35 and 90 days before the annuity starting

[[Page 73]]

date) have not begun, a QDRO may provide that a current spouse shall not 
be treated as the current spouse of the participant for all or some 
purposes under sections 401(a)(11) and 417. A QDRO may provide that the 
current spouse waives all future rights to a QPSA or QJSA.
    (iii) Effects on benefits. (A) A plan is not required to provide 
additional vesting or benefits because of a QDRO.
    (B) If an alternate payee is treated pursuant to a QDRO as having an 
interest in the plan benefit, including a separate account or percentage 
of the participant's account, then the QDRO cannot provide the alternate 
payee with a greater right to designate a beneficiary for the alternate 
payee's benefit amount than the participant's right. The QJSA or QPSA 
provisions of section 417 do not apply to the spouse of an alternate 
payee.
    (C) If the former spouse who is treated as a current spouse dies 
prior to the participant's annuity starting date, then any actual 
current spouse of the participant is treated as the current spouse, 
except as otherwise provided in a QDRO.
    (iv) Section 415 requirements. Even though a participant's benefits 
are awarded to an alternate payee pursuant to a QDRO, the benefits are 
benefits of the participant for purposes of applying the limitations of 
section 415 to the participant's benefits.

[T.D. 7534, 43 FR 6943, Feb. 17, 1978, as amended by T.D. 8219, 53 FR 
31850, Aug. 22, 1988; 53 FR 48534, Dec. 1, 1988]



Sec. 1.401(a)-14  Commencement of benefits under qualified trusts.

    (a) In general. Under section 401(a)(14), a trust to which section 
411 applies (without regard to section 411(e)(2) is not qualified under 
section 401 unless the plan of which such trust is a part provides that 
the payment of benefits under the plan to the participant will begin not 
later than the 60th day after the close of the plan year in which the 
latest of the following events occurs--
    (1) The attainment by the participant of age 65, or, if earlier, the 
normal retirement age specified under the plan,
    (2) The 10th anniversary of the date on which the participant 
commenced participation in the plan,
    (3) The termination of the participant's service with the employer, 
or
    (4) The date specified in an election made pursuant to paragraph (b) 
of this section.

Notwithstanding the preceding sentence, a plan may require that a 
participant file a claim for benefits before payment of benefits will 
commence.
    (b) Election of later date--(1) General rule. A plan may permit a 
participant to elect that the payment to him of any benefit under a plan 
will commence at a date later than the dates specified under paragraphs 
(a)(1), (2), and (3) of this section.
    (2) Manner of election. A plan permitting an election under this 
paragraph shall require that such election must be made by submitting to 
the plan administrator a written statement, signed by the participant, 
which describes the benefit and the date on which the payment of such 
benefit shall commence.
    (3) Restriction. An election may not be made pursuant to a plan 
provision permitted by this paragraph if the exercise of such election 
will cause benefits payable under the plan with respect to the 
participant in the event of his death to be more than ``incidental'' 
within the meaning of paragraph (b)(1)(i) of Sec. 1.401-1.
    (c) Special early retirement rule--(1) Separation prior to early 
retirement age. A trust forming part of a plan which provides for the 
payment of an early retirement benefit is not qualified under section 
401 unless, upon satisfaction of the age requirement for such early 
retirement benefit, a participant who--
    (i) Satisfied the service requirements for such early retirement 
benefit, but
    (ii) Separated from service (with any nonforfeitable right to an 
accrued benefit) before satisfying such age requirement,

is entitled to receive not less than the reduced normal retirement 
benefit described in paragraph (c)(2) of this section. A plan may 
establish reasonable conditions for payments of early retirement 
benefits (including for example, a requirement that a claim for benefits

[[Page 74]]

be made) if the conditions are equally applicable to participants who 
separate from service when eligible for an early retirement benefit and 
participants who separate from service earlier.
    (2) Reduced normal retirement benefit. For purposes of this section, 
the reduced normal retirement benefit is the benefit to which the 
participant would have been entitled under the plan at normal retirement 
age, reduced in accordance with reasonable actuarial assumptions.
    (3) Separation prior to effective date of this section. The 
provisions of this paragraph shall not apply in the case of a plan 
participant who separates from service before attainment of early 
retirement age and prior to the effective date of this section set forth 
in paragraph (e) of this section.
    (4) Illustration. The provisions of this paragraph may be 
illustrated by the following example:

    Example. The X Corporation Defined Benefit Plan provides that a 
normal retirement benefit will be payable to a participant upon 
attainment of age 65. The plan also provides that an actuarially reduced 
retirement benefit will be payable, upon application, to any participant 
who has completed 10 years of service with the X Corporation and 
attained age 60. When he is 55 years of age and has completed 10 years 
of service with X Corporation, A, a participant in the plan, leaves the 
service of X Corporation and does not return. The plan will not be 
qualified under section 401 unless, upon attainment of age 60 and 
application for benefits, A is entitled to receive a reduced normal 
retirement benefit described in subparagraph (2) of this paragraph.

    (d) Retroactive payment rule. If the amount of the payment required 
to commence on the date determined under this section cannot be 
ascertained by such date, or if it is not possible to make such payment 
on such date because the plan administrator has been unable to locate 
the participant after making reasonable efforts to do so, a payment 
retroactive to such date may be made no later than 60 days after the 
earliest date on which the amount of such payment can be ascertained 
under the plan or the date on which the participant is located 
(whichever is applicable).
    (e) Effective date. This section shall apply to a plan for those 
plan years to which section 411 of the Code applies without regard to 
section 411(e)(2).

(Secs. 401(a)(14), 7805, Internal Revenue Code of 1954 (88 Stat. 937, 
68A Stat. 917; 26 U.S.C. 401(a)(14), 7805))

[T.D. 7436, 41 FR 42651, Sept. 28, 1976; 41 FR 44690, Oct. 12, 1976]



Sec. 1.401(a)-15  Requirement that plan benefits are not decreased 
on account of certain Social Security increases.

    (a) In general. Under section 401(a)(15), a trust which is part of a 
plan to which section 411 applies (without regard to section 411(e)(2)) 
is not qualified under section 401 unless, under the plan of which such 
trust is a part:
    (1) Benefit being received by participant or beneficiary. A benefit 
(including a death or disability benefit) being received under the plan 
by a participant or beneficiary (other than a participant to whom 
subparagraph (2)(ii) of this paragraph applies, or a beneficiary of such 
a participant) is not decreased by reason of any post-separation social 
security benefit increase effective after the later of--
    (i) September 2, 1974, or
    (ii) The date of first receipt of any retirement benefit, death 
benefit, or disability benefit under the plan by the participant or by a 
beneficiary of the participant (whichever receipt occurs first).
    (2) Benefit to which participant separated from service has 
nonforfeitable right. In the case of a benefit to which a participant 
has a nonforfeitable right under such plan--
    (i) If such participant is separated from service and does not 
subsequently return to service and resume participation in the plan, 
such benefit is not decreased by reason of any post-separation social 
security benefit increase effective after the later of September 2, 
1974, or separation from service, or
    (ii) If such participant is separated from service and subsequently 
returns to service and resumes participation in the plan, such benefit 
is not decreased by reason of any post-separation social security 
benefit increase effective after September 2, 1974, which occurs during 
separation from service and which would decrease such benefit to a level

[[Page 75]]

below the level of benefits to which he would have been entitled had he 
not returned to service after his separation.
    (b) Post-separation social security benefit increase. For purposes 
of this section, the term ``post-separation social security benefit 
increase'' means, with respect to a participant or a beneficiary of the 
participant, an increase in a benefit level or wage base under title II 
of the Social Security Act (whether such increase is a result of an 
amendment of such title II or is a result of the application of the 
provisions of such title II) occurring after the earlier of such 
participant's separation from service or commencement of benefits under 
the plan.
    (c) Illustrations. The provisions of paragraphs (a) and (b) of this 
section may be illustrated by the following examples:

    Example 1. A plan to which section 401(a)(15) applies provides an 
annual benefit at the normal retirement age, 65, in the form of a stated 
benefit formula amount less a specified percentage of the primary 
insurance amount payable under title II of the Social Security Act. The 
plan provides no early retirement benefits. In the case of a participant 
who separates from service before age 65 with a nonforfeitable right to 
a benefit under the plan, the plan defines the primary insurance amount 
as the amount which the participant is entitled to receive under title 
II of the Social Security Act at age 65, multiplied by the ratio of the 
number of years of service with the employer to the number of years of 
service the participant would have had if he had worked for the employer 
until age 65. The plan does not satisfy the requirements of section 
401(a)(15), because social security increases that occur after a 
participant's separation from service will reduce the benefit the 
participant will receive under the plan.
    Example 2. A plan to which section 401(a)(15) applies provides an 
annual benefit at the normal retirement age, 65, in the form of a stated 
benefit formula amount less a specified percentage of the primary 
insurance amount payable under title II of the Social Security Act. The 
plan provides no early retirement benefits. In the case of a participant 
who separates from service before age 65 with a nonforfeitable right to 
a benefit under the plan, the plan defines the primary insurance amount 
as the amount which the participant is entitled to receive under title 
II of the Social Security Act at age 65 based upon the assumption that 
he will continue to receive until reaching age 65 compensation which 
would be treated as wages for purposes of the Social Security Act at the 
same rate as he received such compensation at the time he separated from 
service, but determined without regard to any post-separation social 
security benefit increase, multiplied by the ratio of the number of 
years of service with the employer to the number of years of service the 
participant would have had if he had worked for the employer until age 
65. The plan satisfies the requirements of section 401(a)(15), because 
social security increases that occur after a participant's separation 
from service will not reduce the benefit the participant will receive 
under the plan.

    (d) Other Federal or State laws. To the extent applicable, the rules 
discussed in this section will govern classifications under a plan 
supplementing the benefits provided by other Federal or State laws, such 
as the Railroad Retirement Act of 1937. See section 206(b) of the 
Employee Retirement Income Security Act of 1974 (Public Law 93-406, 88 
Stat. 864).
    (e) Effect on prior law. Nothing in this section shall be construed 
as amending or modifying the rules applicable to post-separation social 
security increases prior to September 2, 1974. See paragraph (e) of 
Sec. 1.401-3.
    (f) Effective date. Section 401(a)(15) and this section shall apply 
to a plan only with respect to plan years to which section 411 (relating 
to minimum vesting standards) is applicable to the plan without regard 
to section 411(e)(2).

[T.D. 7434, 41 FR 42650, Sept. 28, 1976]



Sec. 1.401(a)-16  Limitations on benefits and contributions under 
qualified plans.

    A trust will not be a qualified trust and a plan will not be a 
qualified plan if the plan provides for benefits or contributions which 
exceed the limitations of section 415. Section 415 and the regulations 
thereunder provide rules concerning these limitations on benefits and 
contributions.

[T.D. 7748, 46 FR 1696, Jan. 7, 1981]



Sec. 1.401(a)-19  Nonforfeitability in case of certain withdrawals.

    (a) Application of section. Section 401(a)(19) and this section 
apply to a plan to which section 411(a) applies. (See section 411(e) and 
Sec. 1.411(a)-2 for applicability of section 411).

[[Page 76]]

    (b) Prohibited forfeitures--(1) General rule. A plan to which this 
section applies is not a qualified plan (and a trust forming a part of 
such plan is not a qualified trust) if, under such plan, any part of a 
participant's accrued benefit derived from employer contributions is 
forfeitable solely because a benefit derived from the participant's 
contributions under the plan is voluntarily withdrawn by him after he 
has become a 50 percent vested participant.
    (2) 50 percent vested participant. For purposes of subparagraph (1) 
of this paragraph, a participant is a 50 percent vested participant when 
he has a nonforfeitable right (within the meaning of section 411 and the 
regulations thereunder) to at least 50 percent of his accrued benefit 
derived from employer contributions. Whether or not a participant is 50 
percent vested shall be determined by the ratio of the participant's 
total nonforfeitable employer-derived accrued benefit under the plan to 
his total employer-derived accrued benefit under the plan.
    (3) Certain forfeitures. Paragraph (b)(1) of this section does not 
apply in the case of a forfeiture permitted by section 411(a)(3)(D)(iii) 
and Sec. 1.411(a)-7(d)(3) (relating to forfeitures of certain benefits 
accrued before September 2, 1974).
    (c) Supersession. Section 11.401(a)-(19) of the Temporary Income Tax 
Regulations under the Employee Retirement Income Security Act of 1974 is 
superseded by this section.

(Sec. 411 Internal Revenue Code of 1954 (88 Stat. 901; 26 U.S.C. 411))

[T.D. 7501, 42 FR 42320, Aug. 23, 1977]



Sec. 1.401(a)-20  Requirements of qualified joint and survivor annuity 
and qualified preretirement survivor annuity.

    Q-1: What are the survivor annuity requirements added to the Code by 
the Retirement Equity Act of 1984 (REA 1984)?
    A-1: REA 1984 replaced section 401(a)(11) with a new section 
401(a)(11) and added section 417. Plans to which new section 401(a)(11) 
applies must comply with the requirements of sections 401(a)(11) and 417 
in order to remain qualified under sections 401(a) or 403(a). In 
general, these plans must provide both a qualified joint and survivor 
annuity (QJSA) and a qualified preretirement survivor annuity (QPSA) to 
remain qualified. These survivor annuity requirements are applicable to 
any benefit payable under a plan, including a benefit payable to a 
participant under a contract purchased by the plan and paid by a third 
party.
    Q-2: Must annuity contracts purchased and distributed to a 
participant or spouse by a plan subject to the survivor annuity 
requirements of sections 401(a)(11) and 417 satisfy the requirements of 
those sections?
    A-2: Yes. Rights and benefits under section 401(a)(11) or 417 may 
not be eliminated or reduced because the plan uses annuity contracts to 
provide benefits merely because (a) such a contract is held by a 
participant or spouse instead of a plan trustee, or (b) such contracts 
are distributed upon plan termination. Thus, the requirements of 
sections 401(a)(11) and 417 apply to payments under the annuity 
contracts, not to the distributions of the contracts.
    Q-3: What plans are subject to the survivor annuity requirements of 
section 401(a)(11)?
    A-3: (a) Section 401(a)(11) applies to any defined benefit plan and 
to any defined contribution plan that is subject to the minimum funding 
standards of section 412. This section also applies to any participant 
under any other defined contribution plan unless all of the following 
conditions are satisfied--
    (1) The plan provides that the participant's nonforfeitable accrued 
benefit is payable in full, upon the participant's death, to the 
participant's surviving spouse (unless the participant elects, with 
spousal consent that satisfies the requirements of section 417(a)(2), 
that such benefit be provided instead to a designated beneficiary);
    (2) The participant does not elect the payment of benefits in the 
form of a life annuity; and
    (3) With respect to the participant, the plan is not a transferee or 
an offset plan. (See Q&A 5 of this section.)
    (b) A defined contribution plan not subject to the minimum funding 
standards of section 412 will not be treated as satisfying the 
requirement of paragraph (a)(1) unless both of the following conditions 
are satisfied--

[[Page 77]]

    (1) The benefit is available to the surviving spouse within a 
reasonable time after the participant's death. For this purpose, 
availability within the 90-day period following the date of death is 
deemed to be reasonable and the reasonableness of longer periods shall 
be determined based on the particular facts and circumstances. A time 
period longer than 90 days, however, is deemed unreasonable if it is 
less favorable to the surviving spouse than any time period under the 
plan that is applicable to other distributions. Thus, for example, the 
availability of a benefit to the surviving spouse would be unreasonable 
if the distribution was required to be made by the close of the plan 
year including the participant's death while distributions to employees 
who separate from service were required to be made within 90 days of 
separation.
    (2) The benefit payable to the surviving spouse is adjusted for 
gains or losses occurring after the participant's death in accordance 
with plan rules governing the adjustment of account balances for other 
plan distributions. Thus, for example, the plan may not provide for 
distributions of an account balance to a surviving spouse determined as 
of the last day of the quarter in which the participant's death occurred 
with no adjustments of an account balance for gains or losses after 
death if the plan provides for such adjustments for a participant who 
separates from service within a quarter.
    (c) For purposes of determining the extent to which section 
401(a)(11) applies to benefits under an employee stock ownership plan 
(as defined in section 4975(e)(7)), the portion of a participant's 
accrued benefit that is subject to section 409(h) is to be treated as 
though such benefit were provided under a defined contribution plan not 
subject to section 412.
    (d) The requirements set forth in section 401(a)(11) apply to other 
employee benefit plans that are covered by applicable provisions under 
title I of the Employee Retirement Income Security Act of 1974. For 
purposes of applying the regulations under sections 401(a)(11) and 417, 
plans subject to ERISA section 205 are treated as if they were described 
in section 401(a). For example, to the extent that section 205 covers 
section 403(b) contracts and custodial accounts they are treated as 
section 401(a) plans. Individual retirement plans (IRAs), including IRAs 
to which contributions are made under simplified employee pensions 
described in section 408(k) and IRAs that are treated as plans subject 
to title I, are not subject to these requirements.
    Q-4: What rules apply to a participant who elects a life annuity 
option under a defined contribution plan not subject to section 412?
    A-4: If a participant elects at any time (irrespective of the 
applicable election period defined in section 417(a)(6)) a life annuity 
option under a defined contribution plan not subject to section 412, the 
survivor annuity requirements of sections 401(a)(11) and 417 will always 
thereafter apply to all of the participant's benefits under such plan 
unless there is a separate accounting of the account balance subject to 
the election. A plan may allow a participant to elect an annuity option 
prior to the applicable election period described in section 417(a)(6). 
If a participant elects an annuity option, the plan must satisfy the 
applicable written explanation, consent, election, and withdrawal rules 
of section 417, including waiver of the QJSA within 90 days of the 
annuity starting date. If a participant selecting such an option dies, 
the surviving spouse must be able to receive the QPSA benefit described 
in section 417(c)(2) which is a life annuity, the actuarial equivalent 
of which is not less than 50 percent of the nonforfeitable account 
balance (adjusted for loans as described in Q&A 24(d) of this section). 
The remaining account balance may be paid to a designated nonspouse 
beneficiary.
    Q-5: How do sections 401(a)(11) and 417 apply to transferee plans 
which are defined contribution plans not subject to section 412?
    A-5: (a) Transferee plans. Although the survivor annuity 
requirements of sections 401(a)(11) and 417 generally do not apply to 
defined contribution plans not subject to section 412, such plans are 
subject to the survivor annuity requirements to the extent that they are 
transferee plans with respect to any participant. A defined contribution

[[Page 78]]

plan is a transferee plan with respect to any participant if the plan is 
a direct or indirect transferee of such participant's benefits held on 
or after January 1, 1985, by:
    (1) A defined benefit plan,
    (2) A defined contribution plan subject to section 412 or
    (3) A defined contribution plan that is subject to the survivor 
annuity requirements of sections 401(a)(11) and 417 with respect to that 
participant.

If through a merger, spinoff, or other transaction having the effect of 
a transfer, benefits subject to the survivor annuity requirements of 
sections 401(a)(11) and 417 are held under a plan that is not otherwise 
subject to such requirements, such benefits will be subject to the 
survivor annuity requirements even though they are held under such plan. 
Even if a plan satisfies the survivor annuity requirements, other rules 
apply to these transactions. See, e.g., section 411(d)(6) and the 
regulations thereunder. A transfer made before January 1, 1985, and any 
rollover contribution made at any time, are not transactions that 
subject the transferee plan to the survivor annuity requirements with 
respect to a participant. If a plan is a transferee plan with respect to 
a participant, the survivor annuity requirements do not apply with 
respect to other plan participants solely because of the transfer. Any 
plan that would not otherwise be subject to the survivor annuity 
requirements of sections 401(a)(11) and 417 whose benefits are used to 
offset benefits in a plan subject to such requirements is subject to the 
survivor annuity requirements with respect to those participants whose 
benefits are offset. Thus, if a stock bonus or profit-sharing plan 
offsets benefits under a defined benefit plan, such a plan is subject to 
the survivor annuity requirements.
    (b) Benefits covered. The survivor annuity requirements apply to all 
accrued benefits held for a participant with respect to whom the plan is 
a transferee plan unless there is an acceptable separate accounting 
between the transferred benefits and all other benefits under the plan. 
A separate accounting is not acceptable unless gains, losses, 
withdrawals, contributions, forfeitures, and other credits or charges 
are allocated on a reasonable and consistent basis between the accrued 
benefits subject to the survivor annuity requirements and other 
benefits. If there is an acceptable separate accounting between 
transferred benefits and any other benefits under the plan, only the 
transferred benefits are subject to the survivor annuity requirements.
    Q-6: Is a frozen or terminated plan required to satisfy the survivor 
annuity requirements of sections 401(a)(11) and 417?
    A-6: In general, benefits provided under a plan that is subject to 
the survivor annuity requirements of sections 401(a)(11) and 417 must be 
provided in accordance with those requirements even if the plan is 
frozen or terminated. However, any plan that has a termination date 
prior to September 17, 1985, and that distributed all remaining assets 
as soon as administratively feasible after the termination date, is not 
subject to the survivor annuity requirements. The date of termination is 
determined under section 411(d)(3) and Sec. 1.411(d)-2(c).
    Q-7: If the Pension Benefit Guaranty Corporation (PBGC) is 
administering a plan, are benefits payable in the form of a QPSA or 
QJSA-
    A-7: Yes, the PBGC will pay benefits in such forms.
    Q-8: How do the survivor annuity requirements of sections 401(a)(11) 
and 417 apply to participants?
    A-8: (a) If a participant dies before the annuity starting date with 
vested benefits attributable to employer or employee contributions (or 
both), benefits must be paid to the surviving spouse in the form of a 
QPSA. If a participant survives until the annuity starting date with 
vested benefits attributable to employer or employee contributions (or 
both), benefits must be provided to the participant in the form of a 
QJSA.
    (b) A participant may waive the QPSA or the QJSA (or both) if the 
applicable notice, election, and spousal consent requirements of section 
417 are satisfied.
    (c) Benefits are not required to be paid in the form of a QPSA or 
QJSA if at the time of death or distribution the

[[Page 79]]

participant was vested only in employee contributions and such death 
occurred, or distribution commenced, before October 22, 1986.
    (d) Certain mandatory distributions. A distribution may occur 
without satisfying the spousal consent requirements of section 417 (a) 
and (e) if the present value of the nonforfeitable benefit does not 
exceed the cash-out limit in effect underSec. 1.411(a)-11(c)(3)(ii). 
See Sec. 1.417(e)-1.
    Q-9: May separate portions of a participant's accrued benefit be 
subject to QPSA and QJSA requirements at any particular point in time?
    A-9: (a) Dual QPSA and QJSA rights. One portion of a participant's 
benefit may be subject to the QPSA and another portion to the QJSA 
requirements at the same time. For example, in order for a money 
purchase pension plan to distribute any portion of a married 
participant's benefit to the participant, the plan must distribute such 
portion in the form of a QJSA (unless the plan satisfies the applicable 
consent requirements of section 417 (a) and (e) with respect to such 
portion of the participant's benefit). This rule applies even if the 
distribution is merely an in-service distribution attributable to 
voluntary employee contributions and regardless of whether the 
participant has attained the normal retirement age under the plan. The 
QJSA requirements apply to such a distribution because the annuity 
starting date has occurred with respect to this portion of the 
participant's benefit. In the event of a participant's death following 
the commencement of a distribution in the form of a QJSA, the remaining 
payments must be made to the surviving spouse under the QJSA. In 
addition, the plan must satisfy the QPSA requirements with respect to 
any portion of the participant's benefits for which the annuity starting 
date had not yet occurred.
    (b) Example. Assume that participant A has a $100,000 account 
balance in a money purchase pension plan. A makes an in-service 
withdrawal of $20,000 attributable to voluntary employee contributions. 
The QJSA requirements apply to A's withdrawal of the $20,000. 
Accordingly, unless the QJSA form is properly waived such amount must be 
distributed in the form of a QJSA. A's remaining account balance 
($80,000) remains subject to the QPSA requirements because the annuity 
starting date has not occurred with respect to the $80,000. (If A 
survives until the annuity starting date, the $80,000 would be subject 
to the QJSA requirements.) If A died on the day following the annuity 
starting date for the withdrawal, A's spouse would be entitled to a QPSA 
with a value equal to at least $40,000 with respect to the $80,000 
account balance, in addition to any survivor benefit without respect to 
the $20,000. If the $20,000 payment to A had been the first payment of 
an annuity purchased with the entire $100,000 account balance rather 
than an in-service distribution, then the QJSA requirements would apply 
to the entire account balance at the time of the annuity starting date. 
In such event, the plan would have no obligation to provide A's spouse 
with a QPSA benefit upon A's death. Of course, A's spouse would receive 
the QJSA benefit (if the QJSA had not been waived) based on the full 
$100,000.
    Q-10: What is the relevance of the annuity starting date with 
respect to the survivor benefit requirements?
    A-10: (a) Relevance. The annuity starting date is relevant to 
whether benefits are payable as either a QJSA or QPSA, or other selected 
optional form of benefit. If a participant is alive on the annuity 
starting date, the benefits must be payable as a QJSA. If the 
participant is not alive on the annuity starting date, the surviving 
spouse must receive a QPSA. The annuity starting date is also used to 
determine when a spouse may consent to and a participant may waive a 
QJSA. A waiver is only effective if it is made 90 days before the 
annuity starting date. Thus, a deferred annuity cannot be selected and a 
QJSA waived until 90 days before payments commence under the deferred 
annuity. In some cases, the annuity starting date will have occurred 
with respect to a portion of the participant's accrued benefit and will 
not have occurred with respect to the remaining portion. (See Q&A-9.)
    (b) Annuity starting date--(1) General rule. For purposes of 
sections 401(a)(11), 411(a)(11) and 417, the annuity starting

[[Page 80]]

date is the first day of the first period for which an amount is paid as 
an annuity or any other form.
    (2) Annuity payments. The annuity starting date is the first date 
for which an amount is paid, not the actual date of payment. Thus, if 
participant A is to receive annuity payments as of the first day of the 
first month after retirement but does not receive any payments until 
three months later, the annuity starting date is the first day of the 
first month. For example, if an annuity is to commence on January 1, 
January 1 is the annuity starting date even though the payment for 
January is not actually made until a later date. In the case of a 
deferred annuity, the annuity starting date is the date for which the 
annuity payments are to commence, not the date that the deferred annuity 
is elected or the date the deferred annuity contract is distributed.
    (3) Administrative delay. A payment shall not be considered to occur 
after the annuity starting date merely because actual payment is 
reasonably delayed for calculation of the benefit amount if all payments 
are actually made.
    (4) Forfeitures on death. Prior to the annuity starting date, 
section 411(a)(3)(A) allows a plan to provide for a forfeiture of a 
participant's benefit, except in the case of a QPSA or a spousal benefit 
described in section 401(a)(11)(B)(iii)(I). Once the annuity starting 
date has occurred, even if actual payment has not yet been made, a plan 
must pay the benefit in the distribution form elected.
    (5) Surviving spouses, alternate payees, etc. The definition of 
``annuity starting date'' for surviving spouses, other beneficiaries and 
alternate payees under section 414(p) is the same as it is for 
participants.
    (c) Disability auxiliary benefit--(1) General rule. The annuity 
starting date for a disability benefit is the first day of the first 
period for which the benefit becomes payable unless the disability 
benefit is an auxiliary benefit. The payment of any auxiliary disability 
benefits is disregarded in determining the annuity starting date. A 
disability benefit is an auxiliary benefit if upon attainment of early 
or normal retirement age, a participant receives a benefit that 
satisfies the accrual and vesting rules of section 411 without taking 
into account the disability benefit payments up to that date.

    Example. (i) Assume that participant A at age 45 is entitled to a 
vested accrued benefit of $100 per month commencing at age 65 in the 
form of a joint and survivor annuity under Plan X. If prior to age 65 A 
receives a disability benefit under Plan X and the payment of such 
benefit does not reduce the amount of A's retirement benefit of $100 per 
month commencing at age 65, any disability benefit payments made to A 
between ages 45 and 65 are auxiliary benefits. Thus, A's annuity 
starting date does not occur until A attains age 65. A's surviving 
spouse B would be entitled to receive a QPSA if A died before age 65. B 
would be entitled to receive the survivor portion of a QJSA (unless 
waived) if A died after age 65. The QPSA payable to B upon A's death 
prior to age 65 would be computed by reference to the QJSA that would 
have been payable to A and B had A survived to age 65.
    (ii) If in the above example A's benefit payable at age 65 is 
reduced to $99 per month because a disability benefit is provided to A 
prior to age 65, the disability benefit would not be an auxiliary 
benefit. The benefit of $99 per month payable to A at age 65 would not, 
without taking into account the disability benefit payments to A prior 
to age 65, satisfy the minimum vesting and accrual rules of section 411. 
Accordingly, the first day of the first period for which the disability 
payments are to be made to A would constitute A's annuity starting date, 
and any benefit paid to A would be required to be paid in the form of a 
QJSA (unless waived by A with the consent of B).

    (d) Other rules--(1) Suspension of benefits. If benefit payments are 
suspended after the annuity starting date pursuant to a suspension of 
benefits described in section 411(a)(3)(B) after an employee separates 
from service, the recommencement of benefit payments after the 
suspension is not treated as a new annuity starting date unless the plan 
provides otherwise. In such case, the plan administrator is not required 
to provide new notices nor to obtain new waivers for the recommenced 
distributions if the form of distribution is the same as the form that 
was appropriately selected prior to the suspension. If benefits are 
suspended for an employee who continues in service without a separation 
and who never receives payments, the commencement

[[Page 81]]

of payments after the period of suspension is treated as the annuity 
starting date unless the plan provides otherwise.
    (2) Additional accruals. In the case of an annuity starting date 
that occurs on or after normal retirement age, such date applies to any 
additional accruals after the annuity starting date, unless the plan 
provides otherwise. For example, if a participant who continues to 
accrue benefits elects to have benefits paid in an optional form at 
normal retirement age, the additional accruals must be paid in the 
optional form selected unless the plan provides otherwise. In the case 
of an annuity starting date that occurs prior to normal retirement age, 
such date does not apply to any additional accruals after such date.
    Q-11: Do the survivor annuity requirements apply to benefits derived 
from both employer and employee contributions?
    A-11: Yes. The survivor annuity benefit requirements apply to 
benefits derived from both employer and employee contributions. Benefits 
are not required to be paid in the form of a QPSA or a QJSA if the 
participant was vested only in employee contributions at the time of 
death or distribution and such death or distribution occurred before 
October 22, 1986. All benefits provided under a plan, including benefits 
attributable to rollover contributions, are subject to the survivor 
annuity requirements.
    Q-12: To what benefits do the survivor annuity requirements of 
sections 401(a)(11) and 417 apply?
    A-12: (a) Defined benefit plans. Under a defined benefit plan, 
sections 401(a)(11) and 417 apply only to benefits in which a 
participant was vested immediately prior to death. They do not apply to 
benefits to which a participant's beneficiary becomes entitled by reason 
of death or to the proceeds of a life insurance contract to the extent 
such proceeds exceed the present value of the participant's 
nonforfeitable benefits that existed immediately prior to death.
    (b) Defined contribution plans. Sections 401(a)(11) and 417 apply to 
all nonforfeitable benefits which are payable under a defined 
contribution plan, whether nonforfeitable before or upon death, 
including the proceeds of insurance contracts.
    Q-13: Does the rule of section 411(a)(3)(A) which permits 
forfeitures on account of death apply to a QPSA or the spousal benefit 
described in section 401(a)(11)(B)(iii)?
    A-13: No. Section 411(a)(3)(A) permits forfeiture on account of 
death prior to the time all the events fixing payment occur. However, 
this provision does not operate to deprive a surviving spouse of a QPSA 
or the spousal benefit described in section 401(a)(11)(B)(iii). 
Therefore, sections 401(a)(11) and 417 apply to benefits that were 
nonforfeitable immediately prior to death (determined without regard to 
section 411(a)(3)(A)). Thus, in the case of the death of a married 
participant in a defined contribution plan not subject to section 412 
which provides that, upon a participant's death, the entire 
nonforfeitable accrued benefit is payable to the participant's spouse, 
the nonforfeitable benefit is determined without regard to the 
provisions of section 411(a)(3)(A).
    Q-14: Do sections 411(a)(11), 401(a)(11) and 417 apply to 
accumulated deductible employee contributions, as defined in section 
72(o)(5)(B) (Accumulated DECs)?
    A-14: (a) Employee consent, section 411. The requirements of section 
411(a)(11) apply to Accumulated DECs. Thus, Accumulated DECs may not be 
distributed without participant consent unless the applicable exemptions 
apply.
    (b) Survior requirements. Accumulated DECs are treated as though 
held under a separate defined contribution plan that is not subject to 
section 412. Thus, section 401(a)(11) applies to Accumulated DECs only 
as provided in section 401(a)(11)(B)(iii). All Accumulated DECs are 
treated in this manner, including Accumulated DECs that are the only 
benefit held under a plan and Accumulated DECs that are part of a 
defined benefit or a defined contribution plan.
    (c) Effective date. Sections 401(a)(11) and 411(a)(11) shall not 
apply to distributions of accumulated DECs until the first plan year 
beginning after December 31, 1988.

[[Page 82]]

    Q-15: How do the survivor annuity requirements of sections 
401(a)(11) and 417 apply to a defined benefit plan that includes an 
accrued benefit based upon a contribution to a separate account or 
mandatory employee contributions?
    A-15: (a) 414(k) plans. In the case of a section 414(k) plan that 
includes both a defined benefit plan and a separate account, the rules 
of sections 401(a)(11) and 417 apply separately to the defined benefit 
portion and the separate account portion of the plan. The separate 
account portion is subject to the survivor annuity requirements of 
sections 401(a)(11) and 417 and the special QPSA rules in section 
417(c)(2).
    (b) Employee contributions--(1) Voluntary. In the case of voluntary 
employee contributions to a defined benefit plan, the plan must maintain 
a separate account with respect to the voluntary employee contributions. 
This separate account is subject to the survivor annuity requirements of 
sections 401(a)(11) and 417 and the special QPSA rules in section 
417(c)(2).
    (2) Mandatory. In the case of a defined benefit plan providing for 
mandatory employee contributions, the entire accrued benefit is subject 
to the survivor annuity requirements of sections 401(a)(11) and 417 as a 
defined benefit plan.
    (c) Accumulated DECs. See Q&A 14 of this section for the rule 
applicable to accumulated deductible employee contributions.
    Q-16: Can a plan provide a benefit form more valuable than the QJSA 
and if a plan offers more than one annuity option satisfying the 
requirements of a QJSA, is spousal consent required when the participant 
chooses among the various forms?
    A-16: In the case of an unmarried participant, the QJSA may be less 
valuable than other optional forms of benefit payable under the plan. In 
the case of a married participant, the QJSA must be at least as valuable 
as any other optional form of benefit payable under the plan at the same 
time. Thus, if a plan has two joint and survivor annuities that would 
satisfy the requirements for a QJSA, but one has a greater actuarial 
value than the other, the more valuable joint and survivor annuity is 
the QJSA. If there are two or more actuarially equivalent joint and 
survivor annuities that satisfy the requirements for a QJSA, the plan 
must designate which one is the QJSA and, therefore, the automatic form 
of benefit payment. A plan, however, may allow a participant to elect 
out of such a QJSA, without spousal consent, in favor of another 
actuarially equivalent joint and survivor annuity that satisfies the 
QJSA conditions. Such an election is not subject to the requirement that 
it be made within the 90-day period before the annuity starting date. 
For example, if a plan designates a joint and 100% survivor annuity as 
the QJSA and also offers an actuarially equivalent joint and 50% 
survivor annuity that would satisfy the requirements of a QJSA, the 
participant may elect the joint and 50% survivor annuity without spousal 
consent. The participant, however, does need spousal consent to elect a 
joint and survivor annuity that was not actuarially equivalent to the 
automatic QJSA. A plan does not fail to satisfy the requirements of this 
Q&A-16 merely because the amount payable under an optional form of 
benefit that is subject to the minimum present value requirement of 
section 417(e)(3) is calculated using the applicable interest rate (and, 
for periods when required, the applicable mortality table) under section 
417(e)(3).
    Q-17: When must distributions to a participant under a QJSA 
commence?
    A-17: (a) QJSA benefits upon earliest retirement. A plan must permit 
a participant to receive a distribution in the form of a QJSA when the 
participant attains the earliest retirement age under the plan. Written 
consent of the participant is required. However, the consent of the 
participant's spouse is not required. Any payment not in the form of a 
QJSA is subject to spousal consent. For example, if the participant 
separates from service under a plan that allows for distributions on 
separation from service or if a plan allows for in-service 
distributions, the participant may receive a QJSA without spousal 
consent in such events. Payments in any other form, including a single 
sum, would require waiver of the QJSA by the participant's spouse.

[[Page 83]]

    (b) Earliest retirement age. (1) This paragraph (b) defines the term 
``earliest retirement age'' for purposes of sections 401(a)(11), 
411(a)(11) and 417.
    (2) In the case of a plan that provides for voluntary distributions 
that commence upon the participant's separation from service, earliest 
retirement age is the earliest age at which a participant could separate 
from service and receive a distribution. Death of a participant is 
treated as a separation from service.
    (3) In the case of a plan that provides for in-service 
distributions, earliest retirement age is the earliest age at which such 
distributions may be made.
    (4) In the case of a plan not described in subparagraph (2) or (3) 
of this paragraph, the rule below applies. Earliest retirement age is 
the early retirement age determined under the plan, or if no early 
retirement age, the normal retirement age determined under the plan. If 
the participant dies or separates from service before such age, then 
only the participant's actual years of service at the time of the 
participant's separation from service or death are taken into account. 
Thus, in the case of a plan under which benefits are not payable until 
the attainment of age 65, or upon attainment of age 55 and completion of 
10 years of service, the earliest retirement age of a participant who 
died or separated from service with 8 years of service is when the 
participant would have attained age 65 (if the participant had 
survived). On the other hand, if a participant died or separated from 
service after 10 years of service, the earliest retirement age is when 
the participant would have attained age 55 (if the participant had 
survived).
    Q-18: What is a qualified preretirement survivor annuity (QPSA) in a 
defined benefit plan?
    A-18: A QPSA is an immediate annuity for the life of the surviving 
spouse of a participant. Each payment under a QPSA under a defined 
benefit plan is not to be less than the payment that would have been 
made to the survivor under the QJSA payable under the plan if (a) in the 
case of a participant who dies after attaining the earliest retirement 
age under the plan, the participant had retired with a QJSA on the day 
before the participant's death, and (b) in the case of a participant who 
dies on or before the participant's earliest retirement age under the 
plan, the participant had separated from service at the earlier of the 
actual time of separation or death, survived until the earliest 
retirement age, retired at that time with a QJSA, and died on the day 
thereafter. If the participant elects before the annuity starting date a 
form of joint and survivor annuity that satisfies the requirements for a 
QJSA and dies before the annuity starting date, the elected form is 
treated as the QJSA and the QPSA must be based on such form.
    Q-19: What rules apply in determining the amount and forfeitability 
of a QPSA?
    A-19: The QPSA is calculated as of the earliest retirement age if 
the participant dies before such time, or at death if the participant 
dies after the earliest retirement age. The plan must make reasonable 
actuarial adjustments to reflect a payment earlier or later than the 
earliest retirement age. A defined benefit plan may provide that the 
QPSA is forfeited if the spouse does not survive until the date 
prescribed under the plan for commencement of the QPSA (i.e., the 
earliest retirement age). Similarly, if the spouse survives past the 
participant's earliest retirement age (or other earlier QPSA 
distribution date under the plan) and elects after the death of the 
participant to defer the commencement of the QPSA to a later date, a 
defined benefit plan may provide for a forfeiture of the QPSA benefit if 
the spouse does not survive until the deferred commencement date. The 
account balance in a defined contribution plan may not be forfeited even 
though the spouse does not survive until the time the account balance is 
used to purchase the QPSA. See Q&A-17 of this section for the meaning of 
earliest retirement age.
    Q-20: What preretirement survivor annuity benefits must a defined 
contibution plan subject to the survivor annuity requirements of 
sections 401(a)(11) and 417 provide?
    A-20: A defined contribution plan that is subject to the survivor 
annuity requirements of sections 401(a)(11) and

[[Page 84]]

417 must provide a preretirement survivor annuity with a value which is 
not less than 50 percent of the nonforfeitable account balance of the 
participant as of the date of the participant's death. If a contributory 
defined contribution plan has a forfeiture provision permitted by 
section 411(a)(3)(A), not more than a proportional percent of the 
account balance attributable to contributions that may not be forfeited 
at death (for example, employee and section 401(k) contributions) may be 
used to satisfy the QPSA benefit. Thus, for example, if the QPSA benefit 
is to be provided from 50 percent of the account balance, not more than 
50 percent of the nonforfeitable contributions may be used for the QPSA.
    Q-21: May a defined benefit plan charge the participant for the cost 
of the QPSA benefit?
    A-21: Prior to the later of the time the plan allows the participant 
to waive the QPSA or provides notice of the ability to waive the QPSA, a 
defined benefit plan may not charge the participant for the cost of the 
QPSA by reducing the participant's plan benefits or by any other method. 
The preceding sentence does not apply to any charges prior to the first 
plan year beginning after December 31, 1988. Once the participant is 
given the opportunity to waive the QPSA or the notice of the QPSA is 
later, the plan may charge the participant for the cost of the QPSA. A 
charge for the QPSA that reasonably reflects the cost of providing the 
QPSA will not fail to satisfy section 411 even if it reduces the accrued 
benefit.
    Q-22: When must distributions to a surviving spouse under a QPSA 
commence?
    A-22: (a) In the case of a defined benefit plan, the plan must 
permit the surviving spouse to direct the commencement of payments under 
QPSA no later than the month in which the participant would have 
attained the earliest retirement age. However, a plan may permit the 
commencement of payments at an earlier date.
    (b) In the case of a defined contribution plan, the plan must permit 
the surviving spouse to direct the commencement of payments under the 
QPSA within a reasonable time after the participant's death.
    Q-23: Must a defined benefit plan obtain the consent of a 
participant and the participant's spouse to commence payments in the 
form of a QJSA in order to avoid violating section 415 or 411(b)?
    A-23: No. A defined benefit plan may commence distributions in the 
form of a QJSA without the consent of the participant and spouse, even 
if consent would otherwise be required (see Sec. 1.417(e)-1(b)), to the 
extent necessary to avoid a violation of section 415 or 411(b). For 
example, assume a plan has a normal retirement age of 55. A is a married 
participant, age 55, and has accrued a $75,000 joint and 100 percent 
survivor annuity that satisfies section 415. If an actuarial increase 
would be required under section 411 because of deferred commencement and 
the increase would cause the benefit to exceed the applicable limit 
under section 415, the plan may commence payment of a QJSA at age 55 
without the participant's election or consent and without the spouse's 
concent.
    Q-24: What are the rules under sections 401(a)(11) and 417 
applicable to plan loans?
    A-24: (a) Consent rules. (1) A plan does not satisfy the survivor 
annuity requirements of sections 401(a)(11) and 417 unless the plan 
provides that, at the time the participant's accrued benefit is used as 
security for a loan, spousal consent to such use is obtained. Consent is 
required even if the accrued benefit is not the primary security for the 
loan. No spousal consent is necessary if, at the time the loan is 
secured, no consent would be required for a distribution under section 
417(a)(2)(B). Spousal consent is not required if the plan or the 
participant is not subject to section 401(a)(11) at the time the accrued 
benefit is used as security, or if the total accrued benefit subject to 
the security is not in excess of the cash-out limit in effect under 
Sec. 1.411(a)-11(c)(3)(ii). The spousal consent must be obtained no 
earlier than the beginning of the 90-day period that ends on the date on 
which the loan is to be so secured. The consent is subject to the 
requirements of section 417(a)(2). Therefore, the consent must be in 
writing, must acknowledge the effect of the

[[Page 85]]

loan and must be witnessed by a plan representative or a notary public.
    (2) Participant consent is deemed obtained at the time the 
participant agrees to use his accrued benefit as security for a loan for 
purposes of satisfying the requirements for participant consent under 
sections 401(a)(11), 411(a)(11) and 417.
    (b) Change in status. If spousal consent is obtained or is not 
required under paragraph (a) of this Q&A 24 at the time the benefits are 
used as security, spousal consent is not required at the time of any 
setoff of the loan against the accrued benefit resulting from a default, 
even if the participant is married to a different spouse at the time of 
the setoff. Similarly, in the case of a participant who secured a loan 
while unmarried, no consent is required at the time of a setoff of the 
loan against the accrued benefit even if the participant is married at 
the time of the setoff.
    (c) Renegotiation. For purposes of obtaining any required spousal 
consent, any renegotiation, extension, renewal, or other revision of a 
loan shall be treated as a new loan made on the date of the 
renegotiation, extension, renewal, or other revision.
    (d) Effect on benefits. For purposes of determining the amount of a 
QPSA or QJSA, the accrued benefit of a participant shall be reduced by 
any security interest held by the plan by reason of a loan outstanding 
to the participant at the time of death or payment, if the security 
interest is treated as payment in satisfaction of the loan under the 
plan. A plan may offset any loan outstanding at the participant's death 
which is secured by the participant's account balance against the 
spousal benefit required to be paid under section 401(a)(11)(B)(iii).
    (e) Effective date. Loans made prior to August 19, 1985, are deemed 
to satisfy the consent requirements of paragraph (a) of this Q&A 24.
    Q-25: How do the survivor annuity requirements of sections 
401(a)(11) and 417 apply with respect to participants who are not 
married or to surviving spouses and participants who have a change in 
marital status?
    A-25: (a) Unmarried participant rule. Plans subject to the survivor 
annuity requirements of sections 401(a)(11) and 417 must satisfy those 
requirements applicable to QJSAs with respect to participants who are 
not married. A QJSA for a participant who is not married is an annuity 
for the life of the participant. Thus, an unmarried participant must be 
provided the written explanation described in section 417(a)(3)(A) and a 
single life annuity unless another form of benefit is elected by the 
participant. An unmarried participant is deemed to have waived the QPSA 
requirements. This deemed waiver is null and void if the participant 
later marries.
    (b) Marital status change--(1) Remarriage. If a participant is 
married on the date of death, payments to a surviving spouse under a 
QPSA or QJSA must continue even if the surviving spouse remarries.
    (2) One-year rule. (i) A plan is not required to treat a participant 
as married unless the participant and the participant's spouse have been 
married throughout the one-year period ending on the earlier of (A) the 
participant's annuity starting date or (B) the date of the participant's 
death. Nevertheless, for purposes of the preceding sentence, a 
participant and the participant's spouse must be treated as married 
throughout the one-year period ending on the participant's annuity 
starting date even though they are married to each other for less than 
one year before the annuity starting date if they remain married to each 
other for at least one year. See section 417(d)(2). If a plan adopts the 
one-year rule provided in section 417(d), the plan must treat the 
participant and spouse who are married on the annuity starting date as 
married and must provide benefits which are to commence on the annuity 
starting date in the form of a QJSA unless the participant (with spousal 
consent) elects another form of benefit. The plan is not required to 
provide the participant with a new or retroactive election or the spouse 
with a new consent when the one-year period is satisfied. If the 
participant and the spouse do not remain married for at least one year, 
the plan may treat the participant as having not been married on the 
annuity starting date. In such event, the plan may provide that the 
spouse loses

[[Page 86]]

any survivor benefit right; further, no retroactive correction of the 
amount paid the participant is required.
    (ii) Example. Plan X provides that participants who are married on 
the annuity starting date for less than one year are treated as 
unmarried participants. Plan X provides benefits in the form of a QJSA 
or an optional single sum distribution. Participant A was married 6 
months prior to the annuity starting date. Plan X must treat A as 
married and must commence payments to A in the form of a QJSA unless 
another form of benefit is elected by A with spousal consent. If a QJSA 
is paid and A is divorced from his spouse S, within the first year of 
the marriage, S will no longer have any survivor rights under the 
annuity (unless a QDRO provides otherwise). If A continues to be married 
to S, and A dies within the one-year period, Plan X may treat A as 
unmarried and forfeit the OJSA benefit payable to S.
    (3) Divorce. If a participant divorces his spouse prior to the 
annuity starting date, any elections made while the participant was 
married to his former spouse remain valid, unless otherwise provided in 
a QDRO, or unless the participant changes them or is remarried. If a 
participant dies after the annuity starting date, the spouse to whom the 
participant was married on the annuity starting date is entitled to the 
QJSA protection under the plan. The spouse is entitled to this 
protection (unless waived and consented to by such spouse) even if the 
participant and spouse are not married on the date of the participant's 
death, except as provided in a QDRO.
    Q-26: In the case of a defined contribution plan not subject to 
section 412, does the requirement that a participant's nonforfeitable 
accrued benefit be payable in full to a surviving spouse apply to a 
spouse who has been married to the participant for less than one year?
    A-26: A plan may provide that a spouse who has not been married to a 
participant throughout the one-year period ending on the earlier of (a) 
the participant's annuity starting date or (b) the date of the 
participant's death is not treated as a surviving spouse and is not 
required to receive the participant's account balance. The special 
exception described in section 417(d)(2) and Q&A 25 of this section does 
not apply.
    Q-27: Are there circumstances when spousal consent to a 
participant's election to waive the QJSA or the QPSA is not required?
    A-27: Yes. If it is established to the satisfaction of a plan 
representative that there is no spouse or that the spouse cannot be 
located, spousal consent to waive the QJSA or the QPSA is not required. 
If the spouse is legally incompetnent to give consent, the spouse's 
legal guardian, even if the guardian is the participant, may give 
consent. Also, if the participant is legally separated or the 
participant has been abandoned (within the meaning of local law) and the 
participant has a court order to such effect, spousal consent is not 
required unless a QDRO provides otherwise. Similar rules apply to a plan 
subject to the requirements of section 401(a)(11)(B)(iii)(I).
    Q-28: Does consent contained in an antenuptial agreement or similar 
contract entered into prior to marriage satisfy the consent requirements 
of sections 401(a)(11) and 417?
    A-28: No. An agreement entered into prior to marriage does not 
satisfy the applicable consent requirements, even if the agreement is 
executed within the applicable election period.
    Q-29: If a participant's spouse consents under section 417(a)(2)(A) 
to the participant's waiver of a survivor annuity form of benefit, is a 
subsequent spouse of the same participant bound by the consent?
    A-29: No. A consent under section 417(a)(2)(A) by one spouse is 
binding only with respect to the consenting spouse. See Q&A-24 of this 
section for an exception in the case of plan benefits securing plan 
loans.
    Q-30: Does the spousal consent requirement of section 417(a)(2)(A) 
require that a spouse's consent be revocable?
    A-30: No. A plan may preclude a spouse from revoking consent once it 
has been given. Alternatively, a plan may also permit a spouse to revoke 
a consent after it has been given, and thereby to render ineffective the 
participant's prior election not to receive

[[Page 87]]

a QPSA or QJSA. A participant must always be allowed to change his 
election during the applicable election period. Spousal consent is 
required in such cases to the extent provided in Q&A 31, except that 
spousal consent is never required for a QJSA or QPSA.
    Q-31: What rules govern a participant's waiver of a QPSA or QJSA 
under section 417(a)(2)?
    A-31: (a) Specific beneficiary. Both the participant's waivers of a 
QPSA and QJSA and the spouse's consents thereto must state the specific 
nonspouse beneficiary (including any class of beneficiaries or any 
contingent beneficiaries) who will receive the benefit. Thus, for 
example, if spouse B consents to participant A's election to waive a 
QPSA, and to have any benefits payable upon A's death before the annuity 
starting date paid to A's children, A may not subsequently change 
beneficiaries without the consent of B (except if the change is back to 
a QPSA). If the designated beneficiary is a trust, A's spouse need only 
consent to the designation of the trust and need not consent to the 
designation of trust beneficiaries or any changes of trust 
beneficiaries.
    (b) Optional form of benefit--(1) QJSA. Both the participant's 
waiver of a QJSA (and any required spouse's consent thereto) must 
specify the particular optional form of benefit. The participant who has 
waived a QJSA with the spouse's consent in favor of another form of 
benefit may not subsequently change the optional form of benefit without 
obtaining the spouse's consent (except back to a QJSA). Of course, the 
participant may change the form of benefit if the plan so provides after 
the spouse's death or a divorce (other than as provided in a QDRO). A 
participant's waiver of a QJSA (and any required spouse's consent 
thereto) made prior to the first plan year beginning after December 31, 
1986, is not required to specify the optional form of benefit.
    (2) QPSA. A participant's waiver of a QPSA and the spouse's consent 
thereto are not required to specify the optional form of any 
preretirement benefit. Thus, a participant who waives the QPSA with 
spousal consent may subsequently change the form of the preretirement 
benefit, but not the nonspouse beneficiary, without obtaining the 
spouse's consent.
    (3) Change in form. After the participant's death, a beneficiary may 
change the optional form of survivor benefit as permitted by the plan.
    (c) General consent. In lieu of satisfying paragraphs (a) and (b) of 
this Q&A 31, a plan may permit a spouse to execute a general consent 
that satisfies the requirements of this paragraph (c). A general consent 
permits the participant to waive a QPSA or QJSA, and change the 
designated beneficary or the optional form of benefit payment without 
any requirement of further consent by such spouse. No general consent is 
valid unless the general consent acknowledges that the spouse has the 
right to limit consent to a specific beneficiary and a specific optional 
form of benefit, where applicable, and that the spouse voluntarily 
elects to relinquish both of such rights. Notwithstanding the previous 
sentence, a spouse may execute a general consent that is limited to 
certain beneficiaries or forms of benefit payment. In such case, 
paragraphs (a) and (b) of this Q&A 31 shall apply to the extent that the 
limited general consent is not applicable and this paragraph (c) shall 
apply to the extent that the limited general consent is applicable. A 
general consent, including a limited general consent, is not effective 
unless it is made during the applicable election period. A general 
consent executed prior to October 22, 1986 does not have to satisfy the 
specificity requirements of this Q&A 31.
    Q-32: What rules govern a participant's waiver of the spousal 
benefit under section 401(a)(11)(B)?
    A-32: (a) Application. In the case of a defined contribution plan 
that is not subject to the survivor annuity requirements of sections 
401(a)(11) and 417, a participant may waive the spousal benefit of 
section 401(a)(11)(B)(iii) if the conditions of paragraph (b) are 
satisfied. In general, a spousal benefit is the nonforfeitable account 
balance on the participant's date of death.
    (b) Conditions. In general, the same conditions, other than the age 
35 requirement, that apply to the participant's waiver of a QPSA and the

[[Page 88]]

spouse's consent thereto apply to the participant's waiver of the 
spousal benefit and the spouse's consent thereto. See Q&A-31. Thus, the 
participant's waiver of the spousal benefit must state the specific 
nonspouse beneficiary who will receive such benefit. The waiver is not 
required to specify the optional form of benefit. The participant may 
change the optional form of benefit, but not the nonspouse beneficiary, 
without obtaining the spouse's consent.
    Q-33: When and in what manner, may a participant waive a spousal 
benefit or a QPSA?
    A-33: (a) Plans not subject to section 401(a)(11). A participant in 
a plan that is not subject to the survivor annuity requirements of 
section 401(a)(11) (because of subparagraph (B)(iii) thereof) may waive 
the spousal benefit at any time, provided that no such waiver shall be 
effective unless the spouse has consented to the waiver. The spouse may 
consent to a waiver of the spousal benefit at any time, even prior to 
the participant's attaining age 35. No spousal consent is required for a 
payment to the participant or the use of the accrued benefit as security 
for a plan loan to the participant.
    (b) Plans subject to section 401(a)(11). A participant in a plan 
subject to the survivor annuity requirements of section 401(a)(11) 
generally may waive the QPSA benefit (with spousal consent) only on or 
after the first day of the plan year in which the participant attains 
age 35. However, a plan may provide for an earlier waiver (with spousal 
consent), provided that a written explanation of the QPSA is given to 
the participant and such waiver becomes invalid upon the beginning of 
the plan year in which the participant's 35th birthday occurs. If there 
is no new waiver after such date, the participant's spouse must receive 
the QPSA benefit upon the participant's death.
    Q-34: Must the written explanations required by section 417(a)(3) be 
provided to nonvested participants?
    A-34: Such written explantions must be provided to nonvested 
participants who are employed by an employer maintaining the plan. Thus, 
they are not required to be provided to those nonvested participants who 
are no longer employed by such an employer.
    Q-35: When must a plan provide the written explanation, required by 
section 417(a)(3)(B), of the QPSA to a participant?
    A-35: (a) General rule. A plan must provide the written explanation 
of the QPSA to a participant within the applicable period. Except as 
provided in paragraph (b), the applicable period means, with respect to 
a participant, whichever of the following periods ends last:
    (1) The period beginning with the first day of the plan year in 
which the participant attains age 32 and ending with the close of the 
plan year preceding the plan year in which the participant attains age 
35.
    (2) A reasonable period ending after the individual becomes a 
participant.
    (3) A reasonable period ending after the QPSA is no longer fully 
subsidized.
    (4) A reasonable period ending after section 401(a)(11) first 
applies to the participant. Section 401(a)(11) would first apply when a 
benefit is transferred from a plan not subject to the survivor annuity 
requirements of section 401(a)(11) to a plan subject to such section or 
at the time of an election of an annuity under a defined contribution 
plan described in section 401(a)(11)(B)(iii).
    (b) Pre-35 separations. In the case of a participant who separates 
from service before attaining age 35, the applicable period means the 
period beginning one year before the separation from service and ending 
one year after such separation. If such a participant returns to 
service, the plan must also comply with pragraph (a).
    (c) Reasonable period. For purposes of applying paragraph (a), a 
reasonable period ending after the enumerated events described in 
paragraphs (a) (2), (3) and (4) is the end of the one-year period 
beginning with the date the applicable event occurs. The applicable 
period for such events begins one year prior to the occurrence of the 
enumerated events.
    (d) Transition rule. In the case of an individual who was a 
participant in the plan on August 23, 1984, and, as of that date had 
attained age 34, the plan will satisfy the requriement of section

[[Page 89]]

417(a)(3)(B) if it provided the explanation not later than December 31, 
1985.
    Q-36: How do plans satisfy the requirements of providing 
participants explanations of QPSAs and QJSAs?
    A-36. For rules regarding the explanation of QPSAs and QJSAs 
required under section 417(a)(3), see Sec. 1.417(a)(3)-1. However, the 
rules of Sec. 1.401(a)-20, Q&A-36, as it appeared in 26 CFR part 1 
revised April 1, 2003, apply to the explanation of a QJSA under section 
417(a)(3) for an annuity starting date prior to February 1, 2006.
    Q-37: What are the consequences of fully subsidizing the cost of 
either a QJSA or a QPSA in accordance with section 417(a)(5)?
    A-37: If a plan fully subsidizes a QJSA or QPSA in accordance with 
section 417(a)(5) and does not allow a participant to waive such QJSA or 
QPSA or to select a nonspouse beneficiary, the plan is not required to 
provide the written explanation required by section 417(a)(3). However, 
if the plan offers an election to waive the benefit or designate a 
beneficiary, it must satisfy the election, consent, and notice 
requirements of section 417(a) (1), (2), and (3), with respect to such 
subsidized QJSA or QPSA, in accordance with section 417(a)(5).
    Q-38: What is a fully subsidized benefit?
    A-38: (a) QJSA--(1) General rule. A fully subsidized QJSA is one 
under which no increase in cost to, or decrease in actual amounts 
received by, the participant may result from the participant's failure 
to elect another form of benefit.
    (2) Examples.

    Example 1. . If a plan provides a joint and survivor annuity and a 
single sum option, the plan does not fully subsidize the joint and 
survivor annuity, regardless of the actuarial value of the joint and 
survivor annuity because, in the event of the participant's early death, 
the participant would have received less under the annuity than he would 
have received under the single sum option.
    Example 2. . If a plan provides for a life annuity of $100 per month 
and a joint and 100% survivor benefit of $99 per month, the plan does 
not fully subsidize the joint and survivor benefit.

    (b) QPSA. A QPSA is fully subsidized if the amount of the 
participant's benefit is not reduced because of the QPSA coverage and if 
no charge to the participant under the plan is made for the coverage. 
Thus, a QPSA is fully subsidized in a defined contribution plan.
    Q-39: When do the survivor annuity requirements of sections 
401(a)(11) and 417 apply to plans?
    A-39: Sections 401(a)(11) and 417 generally apply to plan years 
beginning after December 31, 1984. Sections 302 and 303 of REA 1984 
provide specific effective dates and transitional rules under which the 
QJSA or QPSA (or pre-REA 1984 section 401(a)(11)) requirements may be 
applicable to particular plans or with respect to benefits provided to 
(as amended by REA 1984) particular participants. In general, the 
section 401(a)(11) (as amended by REA 1984) survivor annuity 
requirements do not apply with respect to a participant who does not 
have at least one hour of service or one hour of paid leave under the 
plan after August 22, 1984.
    Q-40: Are there special effective dates for plans maintained 
pursuant to collective bargaining agreements?
    A-40: Yes. Section 302(b) of REA 1984 as amended by section 1898(g) 
of the Tax Reform Act of 1986 provides a special deferred effective date 
for such plans. Whether a plan is described in section 302(b) of REA 
1984 is determined under the principles applied under section 1017(c) of 
the Employee Retirement Income Security Act of 1974. See H.R. Rep. No. 
1280, 93d Cong., 2d Sess. 266 (1974). In addition, a plan will not be 
treated as maintained under a collective bargaining agreement unless the 
employee representatives satisfy section 7701(a)(46) of the Internal 
Revenue Code after March 31, 1984. See Sec. 301.7701-17T for other 
requirements for a plan to be considered to be collectively bargained. 
Nothing in section 302(b) of REA 1984 denies a participant or spouse the 
rights set forth in sections 303(c)(2), 303(c)(3), 303(e)(1), and 
303(e)(2) of REA 1984.
    Q-41: What is one hour of service or paid leave under the plan for 
purposes of the transition rules in section 303 of REA 1984?
    A-41: One hour of service or paid leave under the plan is one hour 
of service or paid leave recognized or required to be recognized under 
the plan

[[Page 90]]

for any purpose, e.g., participation, vesting percentage, or benefit 
accrual purposes. For plans that do not compute hours of service, one 
hour of service or paid leave means any service or paid leave recognized 
or required to be recognized under the plan for any purpose.
    Q-42: Must a plan be amended to provide for the QPSA required by 
section 303(c)(2) of REA 1984, or for the survivor annuities required by 
section 303(e) of REA 1984?
    A-42: A plan will not fail to satisfy the qualification requirements 
of section 401(a) or 403(a) merely because it is not amended to provide 
the QPSA required by section 303(c)(2) or the survivor annuities 
required by section 303(e). The plan must, however, satisfy those 
requirements in operation.
    Q-43: Is a participant's election, or a spouse's consent to an 
election, with respect to a QPSA, made before August 23, 1984, valid?
    A-43: No.
    Q-44: Is spousal consent required for certain survivor annuity 
elections made by the participant after December 31, 1984, and before 
the first plan year to which new sections 401(a)(11) and 417 apply?
    A-44: Yes. Section 303(c)(3) of REA 1984 provides that any election 
not to take a QJSA made after December 31, 1984, and before the date 
sections 401(a)(11) and 417 apply to the plan by a participant who has 1 
hour of service or leave under the plan after August 23, 1984, is not 
effective unless the spousal consent requirements of section 417 are met 
with respect to such election. Unless the participant's annuity starting 
date occurred before January 1, 1985, the spousal consent required by 
section 417 (a)(2) and (e) must be obtained even though the participant 
elected the benefit prior to January 1, 1985. The plan is not required 
to be amended to comply with section 303(c)(3) of REA 1984, but the plan 
must satisfy this requirement in operation.
    Q-45: Are there special rules for certain participants who separated 
from service prior to August 23, 1984?
    A-45: Yes. Section 303(e) of REA 1984 provides special rules for 
certain participants who separated from service before August 23, 1984. 
Section 303(e)(1), which applies only to plans subject to section 
401(a)(11) of the Code (as in effect on August 22, 1984), provides that 
participants whose annuity starting date did not occur before August 24, 
1984, and who had one hour of service on or after September 2, 1974, but 
not in a plan year beginning after December 31, 1975, may elect to 
receive the benefits required to be provided under section 401(a)(11) of 
the Code (as in effect on August 22, 1984). Section 303(e)(2) provides 
that certain participants who had one hour of service in a plan year 
beginning on or after January 1, 1976, but not after August 22, 1984, 
may elect QPSA coverage under new sections 401(a)(11) and 417 in plans 
subject to these provisions. Section 303(e)(4)(A) requires plans or plan 
administrators to notify those participants of the provisions of section 
303(e).
    Q-46: When must a plan provide the notice required by section 
303(e)(4)(A) of REA 1984?
    A-46: The notice required by section 303(e)(4)(A) must be provided 
no later than the earlier of:
    (a) The date the first summary annual report provided after 
September 17, 1985, is distributed to participants; or
    (b) September 30, 1985.

A plan will not fail to satisfy the preceding sentence if the plan 
provides a fully subsidized QPSA with respect to any participant 
described in section 303(e) who dies on or after July 19, 1985, and 
before the notice is received. If the plan ceases to fully subsidize the 
QPSA, the cessation must not be effective until the notice is given. For 
this purpose, an annuity payable to a nonspouse beneficiary elected by 
the participant, in lieu of a spouse, shall satisfy the QPSA 
requirement, so long as the survivor benefit is fully subsidized. The 
notice required by this paragraph must be in writing and sent to the 
participant's last known address.
    Q-47: Is there another time when plans must provide notice of the 
right, described in section 303(e)(1) of REA '84, to elect a pre-REA 
1984 qualified joint and survivor annuity?
    A-47: Yes. Notice of this right must also be provided to a 
participant at the

[[Page 91]]

time the participant applies for benefit payments.

[53 FR 31842, Aug. 22, 1988; 53 FR 48534, Dec. 1, 1988, as amended by 
T.D. 8794, 63 FR 70338, Dec. 21, 1998; T.D. 8891, 65 FR 44682, July 19, 
2000; T.D. 9099, 68 FR 70144, Dec. 17, 2003; T.D. 9256, 71 FR 14802, 
Mar. 24, 2006]



Sec. 1.401(a)-21  Rules relating to the use of an electronic medium 
to provide applicable notices and to make participant elections.

    (a) Introduction--(1) In general--(i) Permission to use an 
electronic medium. This section provides rules relating to the use of an 
electronic medium to provide applicable notices and to make participant 
elections as defined in paragraph (e)(1) and (6) of this section with 
respect to retirement plans, employee benefit arrangements, and 
individual retirement plans described in paragraph (a)(2) of this 
section. The rules in this section reflect the provisions of the 
Electronic Signatures in Global and National Commerce Act, Public Law 
106-229 (114 Stat. 464 (2000) (E-SIGN)).
    (ii) Notices and elections required to be in writing or in written 
form--(A) In general. The rules of this section must be satisfied in 
order to use an electronic medium to provide an applicable notice or to 
make a participant election if the notice or election is required to be 
in writing or in written form under the Internal Revenue Code, 
Department of Treasury regulations, or other guidance issued by the 
Commissioner.
    (B) Rules relating to applicable notices. An applicable notice that 
is provided using an electronic medium is treated as being provided in 
writing or in written form if and only if the requirements of paragraph 
(a)(5) of this section are satisfied and either the consumer consent 
requirements of paragraph (b) of this section or the requirements for 
exemption from the consumer consent requirements under paragraph (c) of 
this section are satisfied. For example, in order to provide a section 
402(f) notice electronically, a qualified plan must satisfy either the 
consumer consent requirements of paragraph (b) of this section or the 
requirements for exemption under paragraph (c) of this section. If a 
plan fails to satisfy either of these requirements, the plan must 
provide the section 402(f) notice using a written paper document in 
order to satisfy the requirements of section 402(f).
    (C) Rules relating to participant elections. A participant election 
that is made using an electronic medium is treated as being provided in 
writing or in written form if and only if the requirements of paragraphs 
(a)(5) and (d) of this section are satisfied.
    (iii) Safe harbor method for applicable notices and participant 
elections that are not required to be in writing or written form. For an 
applicable notice or a participant election that is not required to be 
in writing or in written form, the rules of this section provide a safe 
harbor method for using an electronic medium to provide the applicable 
notice or to make the participant election.
    (2) Application of rules--(i) Notices, elections, or consents under 
retirement plans. The rules of this section apply to any applicable 
notice or any participant election relating to the following retirement 
plans: A qualified retirement plan under section 401(a) or 403(a); a 
section 403(b) plan; a simplified employee pension (SEP) under section 
408(k); a simple retirement plan under section 408(p); or an eligible 
governmental plan under section 457(b).
    (ii) Notices, elections, or consents under other employee benefit 
arrangements. The rules of this section also apply to any applicable 
notice or any participant election relating to the following employee 
benefit arrangements: An accident and health plan or arrangement under 
sections 104(a)(3) and 105; a cafeteria plan under section 125; an 
educational assistance program under section 127; a qualified 
transportation fringe program under section 132; an Archer MSA under 
section 220; or a health savings account under section 223.
    (iii) Notices, elections, or consents under individual retirement 
plans. The rules of this section also apply to any applicable notice or 
any participant election relating to individual retirement plans, 
including a Roth IRA under section 408A; or a deemed IRA under a 
qualified employer plan described in section 408(q).
    (3) Limitation on application of rules--(i) In general. The rules of 
this section

[[Page 92]]

do not apply to any notice, election, consent, disclosure, or obligation 
required under the provisions of title I or IV of the Employee 
Retirement Income Security Act of 1974, as amended (ERISA), over which 
the Department of Labor or the Pension Benefit Guaranty Corporation has 
interpretative and enforcement authority. For example, the rules in 29 
CFR 2520.104b-1 of the Department of Labor Regulations apply with 
respect to an employee benefit plan providing disclosure documents, such 
as a summary plan description or a summary annual report. The rules in 
this section also do not apply to Internal Revenue Code section 
411(a)(3)(B) (relating to suspension of benefits), Internal Revenue Code 
section 4980B(f)(6) (relating to an individual's COBRA rights), or any 
other Internal Revenue Code provision over which Department of Labor or 
the Pension Benefit Guaranty Corporation has similar interpretative 
authority.
    (ii) Recordkeeping and other requirements. The rules in this section 
only apply with respect to applicable notices and participant elections 
relating to an individual's rights under a retirement plan, an employee 
benefit arrangement, or an individual retirement plan. Thus, the rules 
in this section do not alter the otherwise applicable requirements under 
the Internal Revenue Code, such as the requirements relating to tax 
reporting, tax records, or substantiation of expenses. See section 6001 
for rules relating to the maintenance of records, statements, and 
special returns. See also section 101(e) of E-SIGN, which provides that 
if an electronic record of an applicable notice or a participant 
election is not maintained in a form that is capable of being retained 
and accurately reproduced for later reference, then the legal effect, 
validity, or enforceability of such electronic record may be denied.
    (4) General requirements related to applicable notices and 
participant elections. The rules of this section supplement the general 
requirements related to each applicable notice and participant election. 
Thus, in addition to satisfying the rules for timing and content, the 
rules in this section must be satisfied.
    (5) Requirements related to the design of an electronic system used 
to deliver applicable notices and to make participant elections--(i) The 
electronic system must take into account the content of a notice. With 
respect to the content of an applicable notice, the electronic system 
must be reasonably designed to provide the information in the notice to 
a recipient in a manner that is no less understandable to the recipient 
than a written paper document.
    (ii) Identification of the significance of information in the 
notice. The electronic system must be designed to alert the recipient, 
at the time an applicable notice is provided, to the significance of the 
information in the notice (including identification of the subject 
matter of the notice), and provide any instructions needed to access the 
notice, in a manner that is readily understandable.
    (b) Consumer consent requirements--(1) Requirements. With respect to 
an applicable notice, the consumer consent requirements of this 
paragraph (b) are satisfied if--
    (i) The requirements in paragraphs (b)(2) through (4) of this 
section are satisfied; and
    (ii) In accordance with section 101(c)(6) of E-SIGN, the applicable 
notice is not provided through the use of oral communication or a 
recording of an oral communication.
    (2) Consent--(i) In general. The recipient must affirmatively 
consent to the delivery of the applicable notice using an electronic 
medium. This consent must be either--
    (A) Made electronically in a manner that reasonably demonstrates 
that the recipient can access the applicable notice in the electronic 
medium in the form that will be used to provide the notice; or
    (B) Made using a written paper document (or using another form not 
described in paragraph (b)(2)(i)(A) of this section), but only if the 
recipient confirms the consent electronically in a manner that 
reasonably demonstrates that the recipient can access the applicable 
notice in the electronic medium in the form that will be used to provide 
the notice.
    (ii) Withdrawal of consumer consent. The consent to receive 
electronic delivery requirement of this paragraph

[[Page 93]]

(b)(2) is not satisfied if the recipient withdraws his or her consent 
before the applicable notice is delivered.
    (3) Required disclosure statement. The recipient, prior to 
consenting under paragraph (b)(2)(i) of this section, must be provided 
with a clear and conspicuous statement containing the disclosures 
described in paragraphs (b)(3)(i) through (v) of this section:
    (i) Right to receive paper document--(A) In general. The statement 
informs the recipient of any right to have the applicable notice be 
provided using a written paper document or other nonelectronic form.
    (B) Post-consent request for paper copy. The statement informs the 
recipient how, after having provided consent to receive the applicable 
notice electronically, the recipient may, upon request, obtain a paper 
copy of the applicable notice and whether any fee will be charged for 
such copy.
    (ii) Right to withdraw consumer consent. The statement informs the 
recipient of the right to withdraw consent to receive electronic 
delivery of an applicable notice on a prospective basis at any time and 
explains the procedures for withdrawing that consent and any conditions, 
consequences, or fees in the event of the withdrawal.
    (iii) Scope of the consumer consent. The statement informs the 
recipient whether the consent to receive electronic delivery of an 
applicable notice applies only to the particular transaction that gave 
rise to the applicable notice or to other identified transactions that 
may be provided or made available during the course of the parties' 
relationship. For example, the statement may provide that a recipient's 
consent to receive electronic delivery will apply to all future 
applicable notices of the recipient relating to the employee benefit 
arrangement until the recipient is no longer a participant in the 
employee benefit arrangement (or withdraws the consent).
    (iv) Description of the contact procedures. The statement describes 
the procedures to update information needed to contact the recipient 
electronically.
    (v) Hardware or software requirements. The statement describes the 
hardware and software requirements needed to access and retain the 
applicable notice.
    (4) Post-consent change in hardware or software requirements. If, 
after a recipient provides consent to receive electronic delivery, there 
is a change in the hardware or software requirements needed to access or 
retain the applicable notice and such change creates a material risk 
that the recipient will not be able to access or retain the applicable 
notice in electronic format--
    (i) The recipient must receive a statement of--
    (A) The revised hardware or software requirements for access to and 
retention of the applicable notice; and
    (B) The right to withdraw consent to receive electronic delivery 
without the imposition of any fees for the withdrawal and without the 
imposition of any condition or consequence that was not previously 
disclosed in paragraph (b)(3) of this section; and
    (ii) The recipient must reaffirm consent to receive electronic 
delivery in accordance with the requirements of paragraph (b)(2) of this 
section.
    (c) Exemption from consumer consent requirements--(1) In general. 
This paragraph (c) is satisfied if the conditions in paragraphs (c)(2) 
and (3) of this section are satisfied. This paragraph (c) constitutes an 
exemption from the consumer consent requirements of section 101(c) of E-
SIGN pursuant to the authority granted in section 104(d)(1) of E-SIGN.
    (2) Effective ability to access. For purposes of this paragraph (c), 
the electronic medium used to provide an applicable notice must be a 
medium that the recipient has the effective ability to access.
    (3) Free paper copy of applicable notice. At the time the applicable 
notice is provided, the recipient must be advised that he or she may 
request and receive the applicable notice in writing on paper at no 
charge, and, upon request, that applicable notice must be provided to 
the recipient at no charge.
    (d) Special rules for participant elections--(1) In general. This 
paragraph (d) is satisfied if the conditions described in the following 
paragraphs (d)(2) through (6) are satisfied:
    (2) Effective ability to access. The electronic medium under an 
electronic system used to make a participant election must be a medium 
that the person

[[Page 94]]

who is eligible to make the election is effectively able to access. If 
the appropriate individual is not effectively able to access the 
electronic medium for making the participant election, the participant 
election will not be treated as made available to that individual. Thus, 
for example, the participant election will not be treated as made 
available to that individual for purposes of the rules under section 
401(a)(4).
    (3) Authentication. The electronic system used in making participant 
elections is reasonably designed to preclude any person other than the 
appropriate individual from making the election. Whether this condition 
is satisfied is based on facts and circumstances, including whether the 
participant election has the potential for a conflict of interest 
between the individuals involved in the election. See Examples 3, 4, and 
5 of paragraph (f) of this section for illustrations of electronic 
systems that satisfy the authentication requirement of this paragraph 
(d)(3).
    (4) Opportunity to review. The electronic system used in making 
participant elections provides the person making the participant 
election with a reasonable opportunity to review, confirm, modify, or 
rescind the terms of the election before the election becomes effective.
    (5) Confirmation of action. The person making the participant 
election receives, within a reasonable time, a confirmation of the 
effect of the election under the terms of the plan or arrangement 
through either a written paper document or an electronic medium under a 
system that satisfies the requirements of either paragraph (b) or (c) of 
this section (as if the confirmation were an applicable notice).
    (6) Participant elections, including spousal consents, that are 
required to be witnessed by a plan representative or a notary public--
(i) In general. In the case of a participant election which is required 
to be witnessed by a plan representative or a notary public (such as a 
spousal consent under section 417), the signature of the individual 
making the participant election is witnessed in the physical presence of 
a plan representative or a notary public.
    (ii) Electronic notarization permitted. If the requirements of 
paragraph (d)(6)(i) of this section are satisfied, an electronic 
notarization acknowledging a signature (in accordance with section 
101(g) of E-SIGN and State law applicable to notary publics) will not be 
denied legal effect if the signature of the individual is witnessed in 
the physical presence of a notary public.
    (iii) Delegation to Commissioner. In guidance published in the 
Internal Revenue Bulletin, the Commissioner may provide that the use of 
procedures under an electronic system is deemed to satisfy the physical 
presence requirement under paragraph (d)(6)(i) of this section, but only 
if those procedures with respect to the electronic system provide the 
same safeguards for participant elections as are provided through the 
physical presence requirement. See Sec. 601.601(d)(2)(ii)(b) of this 
chapter.
    (e) Definitions. The definitions in this paragraph (e) apply for 
purposes of this section.
    (1) Applicable notice. The term applicable notice includes any 
notice, report, statement, or other document required to be provided to 
a recipient under a retirement plan, employee benefit arrangement, or 
individual retirement plan as described in paragraph (a)(2) of this 
section.
    (2) Electronic. The term electronic means technology having 
electrical, digital, magnetic, wireless, optical, electromagnetic, 
voice-recording systems, or similar capabilities.
    (3) Electronic medium. The term electronic medium means an 
electronic method of communication (e.g., Web site, electronic mail, 
telephonic system, magnetic disk, and CD-ROM).
    (4) Electronic record. The term electronic record means an 
applicable notice or a participant election that is created, generated, 
sent, communicated, received, or stored by electronic media.
    (5) Electronic system. The term electronic system means a system 
designed for creating, generating, sending, receiving, storing, 
retrieving, displaying, or processing information that makes use of any 
electronic medium.
    (6) Participant election. The term participant election includes any 
consent,

[[Page 95]]

election, request, agreement, or similar communication made by or from a 
participant, beneficiary, alternate payee, or an individual entitled to 
benefits under a retirement plan, employee benefit arrangement, or 
individual retirement plan as described in paragraph (a)(2) of this 
section.
    (7) Recipient. The term recipient means a plan participant, 
beneficiary, employee, alternate payee, or any other person to whom an 
applicable notice is to be provided.
    (f) Examples. The following examples illustrate the rules of this 
section. Examples 1, 2, 3, and 6 assume that the requirements of 
paragraph (a)(4) and (5) of this section are satisfied.

    Example 1. (i) Facts involving using the consumer consent 
requirements to deliver a section 402(f) notice via e-mail. Plan A, a 
qualified plan, permits participants to request benefit distributions 
from the plan on Plan A's Internet Web site. Under Plan A's system for 
such transactions, a participant must enter his or her account number, 
personal identification number (PIN), and his or her e-mail address to 
which the notice is to be sent. The participant's PIN and account number 
must match the information in Plan A's records in order for the 
transaction to proceed. Participant H requests a distribution from Plan 
A on Plan A's Web site, and, at the time of the request for 
distribution, a disclosure statement appears on the computer screen that 
explains that Participant H can consent to receive the section 402(f) 
notice electronically. The disclosure statement provides information 
relating to the consent, including how to receive a paper copy of the 
notice, how to withdraw consent, the hardware and software requirements, 
and the procedures for accessing the section 402(f) notice, which is in 
a file format from a specific spreadsheet program. After reviewing the 
disclosure statement, which satisfies the requirements of paragraph 
(b)(3) of this section, Participant H consents to receive the section 
402(f) notice via e-mail by selecting the consent button at the end of 
the disclosure statement. As a part of the consent procedure, an e-mail 
is sent to Participant H's e-mail address in order to demonstrate that 
Participant H can access the spreadsheet program. In the e-mail, 
Participant H is prompted to answer a question from the spreadsheet 
program, which is in an attachment to the e-mail. Once Participant H 
correctly answers the question, the section 402(f) notice is then 
delivered to Participant H via e-mail.
    (ii) Conclusion. In this Example 1, Plan A's delivery of the section 
402(f) notice to Participant H satisfies the requirements of paragraph 
(b) of this section.
    Example 2. (i) Facts--(A) Facts involving using the alternative 
method to deliver a section 411(a)(11) notice via e-mail. Plan B, a 
qualified plan, permits participants to request benefit distributions 
from the plan on Plan B's Internet Web site. Under Plan B's system for 
such transactions, a participant must enter his or her account number 
and personal identification number (PIN), and his or her e-mail address 
to which the notice is to be sent. The participant's PIN and account 
number must match the information in Plan B's records in order for the 
transaction to proceed. After Participant K, a single employee, requests 
a distribution from Plan B on Plan B's Internet Web site, the plan 
administrator provides Participant K with a section 411(a)(11) notice in 
an attachment to an e-mail. Plan B sends the e-mail with a request for a 
computer generated notification that the message was received and 
opened. The e-mail instructs Participant K to read the attachment for 
important information regarding the request for a distribution. In 
addition, the e-mail also states that Participant K may request the 
section 411(a)(11) notice on a written paper document and that, if 
Participant K requests the notice on a written paper document, it will 
be provided at no charge. Plan B receives notification indicating that 
the e-mail was received and opened by Participant K.
    (B) Facts involving making a participant's consent to a 
distribution. In order to consent to a distribution, Plan B requires a 
participant to enter the participant's account number and PIN in order 
to preclude any person other than the participant from making the 
election. After the authentication process, Participant K completes a 
distribution request form on the Web site. After completing the request 
form, the Web site provides a summary of the information entered on the 
form and gives Participant K an opportunity to review or modify the 
distribution request form before the transaction is completed. Within a 
reasonable period of time after Participant K consents to the 
distribution, the plan administrator, by e-mail, sends confirmation of 
the terms (including the form) of the distribution to Participant K and 
advises Participant K that, upon request, the confirmation may be 
provided to Participant K on a written paper document at no charge. Plan 
B retains an electronic copy of the consent to the distribution in a 
form that is capable of being retained and accurately reproduced for 
later reference by Participant K.
    (ii) Conclusion. In this Example 2, Plan B's delivery of the section 
411(a)(11) notice and the electronic system used to make Participant K's 
consent to a distribution satisfy the requirements of paragraphs (a), 
(c), and (d) of this section.
    Example 3. (i) Facts involving the transmission of a spousal consent 
via electronic notarization. Plan C, a qualified money purchase

[[Page 96]]

pension plan, permits a married participant to request a plan loan 
through the Plan C's Internet Web site with the notarized consent of the 
spouse. Under Plan C's system for requesting a plan loan, a participant 
must enter his or her account number, personal identification number 
(PIN), and his or her e-mail address. The information entered by the 
participant must match the information in Plan C's records in order for 
the transaction to proceed. Participant M, a married participant, is 
effectively able to access the Web site available to apply for a plan 
loan. In order to apply for a loan, Plan C requires a participant to 
enter the participant's account number and PIN in order to preclude any 
person other than the participant from making the election. Participant 
M completes the loan application on Plan C's Web site. Within a 
reasonable period of time after submitting the plan loan application, 
the plan administrator, by e-mail, sends Participant M the loan 
application, including all attachments setting forth the terms of the 
loan agreement and all other required information. In the e-mail, Plan C 
also notifies Participant M that, upon request, the loan application may 
be provided to Participant M on a written paper document at no charge. 
Plan C then instructs Participant M that, in order for the loan 
application to proceed, Participant M must submit to the plan 
administrator a notarized spousal consent form. Participant M and M's 
spouse go to a notary public and the notary witnesses Participant M's 
spouse signing the spousal consent for the loan agreement on an 
electronic signature capture pad with adequate security. After 
witnessing M's spouse signing the spousal consent, the notary public 
sends an e-mail with an electronic acknowledgement that is attached to 
or logically associated with the signature of M's spouse to the plan 
administrator. The electronic acknowledgement is in accordance with 
section 101(g) of E-SIGN and the relevant State law applicable to notary 
publics. After the plan receives the e-mail, Plan C sends an e-mail to 
Participant M, giving M a reasonable period to review and confirm the 
completed loan application and to determine whether the loan application 
should be modified or rescinded. In addition, the e-mail to Participant 
M also provides that M may request the completed loan application on a 
written paper document and that, if M requests the written paper 
document, it will be provided at no charge. Plan C retains an electronic 
copy of the loan agreement, including the spousal consent, in a form 
that is capable of being retained and accurately reproduced for later 
reference by all parties.
    (ii) Conclusion. In this Example 3, the transmission of the plan 
loan agreement satisfies the requirements of paragraphs (a), (c), and 
(d) of this section. By requiring that the spouse sign the spousal 
consent on an electronic signature capture pad in the physical presence 
of a notary public, the electronic system satisfies the requirement that 
the system be reasonably designed to preclude any person other than the 
appropriate individual from making the election. Thus, the electronic 
notarization of spousal consent satisfies the requirements of paragraphs 
(a) and (d) of this section.
    Example 4. (i) Facts--(A) Facts involving using the alternative 
method of compliance to deliver a section 411(a)(11) notice via an 
automated telephone system. A qualified profit-sharing plan (Plan D) 
permits participants to request distributions through an automated 
telephone system. Under Plan D's system for such transactions, a 
participant must enter his or her account number and personal 
identification number (PIN); this information must match the information 
in Plan D's records in order for the transaction to proceed. Plan D 
provides only the following distribution options: single-sum payment; 
and annual installments over 5, 10, or 20 years. Participant N, a single 
participant, requests a distribution from Plan D by following the 
applicable instructions on the automated telephone system. After 
Participant N has requested the distribution, the automated telephone 
system recites the section 411(a)(11) notice over the phone. The 
automated telephone system also advises Participant N that, upon 
request, the notice may be provided on a written paper document and 
that, if Participant N so requests, the notice will be provided on a 
written paper document at no charge.
    (B) Facts involving making a participant's consent to a distribution 
via an automated telephone system. In order to consent to a 
distribution, Plan D requires a participant to enter the participant's 
account number and PIN in order to preclude any person other than the 
participant from making the election. Participant N requests a 
distribution by entering information on the automated telephone system. 
After completing the request, the automated telephone system provides a 
oral summary of the information entered and gives Participant N an 
opportunity to review or modify the distribution request before the 
transaction is completed. Plan D's automated telephone system confirms 
the distribution request to Participant N and advises Participant N 
that, upon request, a confirmation may be provided on a written paper 
document at no charge. Plan D retains an electronic copy of the consent 
to the distribution in a form that is capable of being retained and 
accurately reproduced for later reference by Participant N.
    (ii) Conclusion. In this Example 4, because Plan D has relatively 
few and simple distribution options, the provision of the section 
411(a)(11) notice through the automated telephone system is no less 
understandable

[[Page 97]]

to the participant than a written paper notice for purposes of paragraph 
(a)(5)(i) of this section. In addition, the automated telephone 
procedures of Plan D satisfy the applicable requirements of paragraphs 
(a), (c), and (d) of this section.
    Example 5. (i) Facts. Same facts as Example 4 of this paragraph (f), 
except that, pursuant to Plan D's system for processing such 
transactions, a participant who so requests is transferred to a customer 
service representative whose conversation with the participant is 
recorded. The customer service representative provides the section 
411(a)(11) notice from a prepared text and processes the participant's 
distribution in accordance with the predetermined instructions from the 
plan administrator.
    (ii) Conclusion. As in Example 4 of this paragraph (f), because Plan 
D has relatively few and simple distribution options, the provision of 
the section 411(a)(11) notice through the automated telephone system is 
no less understandable to the participant than a written paper notice 
for purposes of paragraph (a)(4) of this section. Further, in this 
Example 5, the customer service telephone procedures of Plan D satisfy 
the requirements of paragraphs (a), (c), and (d) of this section.
    Example 6. (i) Facts. Plan E, a qualified plan, permits participants 
to request distributions by e-mail on the employer's e-mail system. 
Under this system, a participant must enter his or her account number, 
personal identification number (PIN), and e-mail address. This 
information must match that in Plan E's records in order for the 
transaction to proceed. If a participant requests a distribution by e-
mail, the plan administrator provides the participant with a section 
411(a)(11) notice by e-mail. The plan administrator also advises the 
participant by e-mail that he or she may request the section 411(a)(11) 
notice on a written paper document and that, if the participant requests 
the notice on a written paper document, it will be provided at no 
charge. Participant Q requests a distribution and receives the section 
411(a)(11) notice from the plan administrator by reply e-mail. However, 
before Participant Q elects a distribution, Q terminates employment. 
Following termination of employment, Participant Q no longer has access 
to the employer's e-mail system.
    (ii) Conclusion. In this Example 6, Plan E does not satisfy the 
participant election requirements under paragraph (d) of this section 
because Participant Q is not effectively able to access the electronic 
medium used to make the participant election. Plan E must provide 
Participant Q with the opportunity to make the participant election 
through a written paper document or another system that Participant Q is 
effectively able to access, such as the automated telephone systems 
described in Example 4 and Example 5 of this paragraph (f).

    (g) Effective date. The rules provided in this section apply to 
applicable notices provided, and to participant elections made, on or 
after January 1, 2007. However, a retirement plan, an employee benefit 
arrangement, or an individual retirement plan that provides an 
applicable notice or makes a participant election that complies with the 
requirements set forth in these regulations on or after October 1, 2000, 
and before January 1, 2007, will not be treated as failing to provide an 
applicable notice or to make a participant election merely because the 
notice or election was not in writing or written form.

[T.D. 9294, 71 FR 61883, Oct. 20, 2006]



Sec. 1.401(a)-30  Limit on elective deferrals.

    (a) General Rule. A trust that is part of a plan under which 
elective deferrals may be made during a calendar year is not qualified 
under section 401(a) unless the plan provides that the elective 
deferrals on behalf of an individual under the plan and all other plans, 
contracts, or arrangements of the employer maintaining the plan may not 
exceed the applicable limit for the individual's taxable year beginning 
in the calendar year. A plan may incorporate the applicable limit by 
reference. In the case of a plan maintained by more than one employer to 
which section 413 (b) or (c) applies, section 401(a)(30) and this 
section are applied as if each employer maintained a separate plan. See 
Sec. 1.402(g)-1(e) for rules permitting the distribution of excess 
deferrals to prevent disqualification of a plan or trust for failure to 
comply in operation with section 401(a)(30).
    (b) Definitions. For purposes of this section:
    (1) Applicable limit. The term ``applicable limit'' has the meaning 
provided in Sec. 1.402(g)-1(d).
    (2) Elective deferrals. The term ``elective deferrals'' has the 
meaning provided in Sec. 1.402(g)-1(b).
    (c) Effective date--(1) In general. Except as otherwise provided in 
this paragraph (c), this section is effective for plan years beginning 
after December 31, 1987.

[[Page 98]]

    (2) Transition rule. For plan years beginning in l988, a plan may 
rely on a reasonable interpretation of the law as in effect on December 
31, 1987.
    (3) Deferrals under collective bargaining agreements. In the case of 
a plan maintained pursuant to one or more collective bargaining 
agreements between employee representatives and one or more employers 
ratified before March 1, 1986, this section does not apply to 
contributions made pursuant to a collective bargaining agreement for 
plan years beginning before the earlier of:
    (i) The later of January 1, 1988, or the date on which the last 
collective bargaining agreement terminates (determined without regard to 
any extension thereof after February 28, 1986), or
    (ii) January 1, 1989.

[T.D. 8357, 56 FR 40516, Aug. 15, 1991]



Sec. 1.401(a)-50  Puerto Rican trusts; election to be treated as a 
domestic trust.

    (a) In general. Section 401(a) requires, among other things, that a 
trust forming part of a pension, profit-sharing, or stock bonus plan 
must be created or organized in the United States to be a qualified 
trust. Section 1022(i)(2) of the Employee Retirement Income Security Act 
of 1974 (ERISA) (88 Stat. 942) provides that trusts under certain 
pension, etc., plans created or organized in Puerto Rico whose 
administrators have made the election referred to in section 1022(i)(2) 
are to be treated as trusts created or organized in the United States 
for purposes of section 401(a). Thus, if a plan otherwise satisfies the 
qualification requirements of section 401(a), any trust forming part of 
the plan for which an election is made will be treated as a qualified 
trust under that section.
    (b) Manner and effect of election. A plan administrator may make an 
election under ERISA section 1022(i)(2) by filing a statement making the 
election, along with a copy of the plan, with the Director's 
Representative of the Internal Revenue Service in Puerto Rico. The 
statement making the election must indicate that it is being made under 
ERISA section 1022(i)(2). The statement may also be filed in conjunction 
with a written request for a determination letter. If the election is 
made with a written request for a determination letter, the election may 
be conditioned upon issuance of a favorable determination letter and 
will be irrevocable upon issuance of such letter. Otherwise, once made, 
an election is irrevocable. It is generally effective for plan years 
beginning after the date it has been made. However, an election made 
before March 3, 1983 may, at the option of the plan administrator at the 
time he or she makes the election, be considered to have been made on 
any date between September 2, 1974, and the actual date of the election. 
The election will then be effective for plan years beginning on or after 
the date chosen by the plan administrator.
    (c) Annuities, custodial accounts, etc. See section 401 (f) for 
rules relating to the treatment of certain annuities, custodial accounts 
or other contracts, as trusts for purposes of section 401(a).
    (d) Source of plan distributions to participants and beneficiaries 
residing outside the United States. Except as provided under section 
871(f) (relating to amounts received as an annuity by nonresident 
aliens), the amount of a distribution from an electing plan that is to 
be treated as income from sources within the United States is determined 
as described below. The portion of the distribution considered to be a 
return of employer contributions is to be treated as income from sources 
within the United States in an amount equal to the portion of the 
distribution considered to be a return of employer contributions 
multiplied by the following fraction:

Days of performance of labor or services within the United States for 
the employer.
________________________________________________________________________
Total days of performance of labor or services for the employer.


The days of performance of labor or services within the United States 
shall not include the time period for which the employee's compensation 
is deemed not to be income from sources within the United States under 
subtitle A of the Code. Thus, for example, if an employee's compensation 
was not deemed to be income from sources within the United States under 
section 861(a)(3), then the time the emloyee was present in the United 
States while such compensation was earned would

[[Page 99]]

not be included in determining the days of performance of labor or 
services within the United States in the numerator of the above 
fraction. In addition, days of performance of labor or services for the 
employer in both the numerator and denominator of the above fraction are 
limited to days of plan participation by the employee and any service 
used for determining an employee's accrued benefit under the plan. The 
remaining portion of the distribution, that is, any amount other than 
the portion of the distribution considered to be a return of employer 
contributions, is not to be treated as income from sources within the 
United States. For example, if a distribution consists of amounts 
representing employer contributions, employee contributions, and 
earnings on employer and employee contributions, no part of the portion 
of the distribution attributable to employee contributions, or earnings 
on employer and employee contributions, will be treated as income from 
sources within the United States.

[T.D. 7859, 47 FR 54297, Dec. 2, 1982]



Sec. 1.401(a)(2)-1  Refund of mistaken employer contributions and 
withdrawal liability payments to multiemployer plans.

    (a) Introduction--(1) In general. Section 401(a)(2) provides that a 
contribution or payment of withdrawal liability made to a multiemployer 
plan due to a mistake of fact or mistake of law can be returned to the 
employer under certain conditions. This section specifies the conditions 
under which an employer's contribution or payment may be returned.
    (2) Effective dates. This section applies to refunds made after July 
22, 2002.
    (b) Conditions for return of contribution--(1) In general. In the 
case of a contribution or a withdrawal liability payment to a 
multiemployer plan which was made because of a mistake of fact or a 
mistake of law, the plan will not violate section 401(a)(2) merely 
because the contribution or payment is returned within six months after 
the date on which the plan administrator determines that the 
contribution or payment was the result of a mistake of fact or law. The 
contribution or payment is considered as returned within the required 
period if the employer establishes a right to a refund of the amount 
mistakenly contributed or paid by filing a claim with the plan 
administrator within six months after the date on which the plan 
administrator determines that a mistake did occur. For purposes of this 
section, plan administrator is defined in section 414(g) and the 
regulations thereunder.
    (2) Applicable conditions--(i) In general. The employer making the 
contribution or withdrawal liability payment to a multiemployer plan 
must demonstrate that an excessive contribution or overpayment has been 
made due to a mistake of fact or law. A mistake of fact or law relating 
to plan qualification under section 401 or to trust exemption under 
section 501 is not considered to be a mistake of fact or law which 
entitles an employer to a refund under this section. For purposes of 
this section, a multiemployer plan is defined in section 414(f) and the 
regulations thereunder.
    (ii) Amount to be returned--(A) General rule. The amount to be 
returned to the employer is the excess of the amount contributed or paid 
over the amount that would have been contributed or paid had no mistake 
been made. This amount is the excess contribution or overpayment. Except 
as provided in paragraph (b)(2)(ii)(B) of this section, interest or 
earnings attributable to an excess contribution shall not be returned to 
the employer, and any losses attributable to an excess contribution must 
reduce the amount returned to the employer. For purposes of the previous 
sentence, the application of plan-wide investment experience to the 
excess contribution would be an acceptable method of calculating losses. 
A refund of a mistaken contribution must in no event reduce a 
participant's account balance in a defined contribution plan to an 
amount less than that amount which would properly have been in that 
participant's account had no mistake occurred. Thus, to the extent that 
the refund of an excess contribution would reduce a participant's 
account balance in a defined contribution plan to an amount less than 
the amount which would properly be in the

[[Page 100]]

participant's account had no mistake occurred, the return of the excess 
contribution would be prohibited by this section.
    (B) Overpayment of withdrawal liability. In the case of an 
overpayment of withdrawal liability established by the plan sponsor 
under section 4219(c)(2) of ERISA, the plan will not fail to satisfy 
section 401(a)(2) if, in accordance with Pension Benefit Guaranty 
Corporation regulations regarding the overpayments of withdrawal 
liability (29 CFR 4219.31(d)), the overpayment, with interest, is 
returned to the employer.
    (c) Amount refunded includible in employer's income. In general, the 
amount of the excess contribution or overpayment must be included in 
gross income by the employer if the excess contribution or overpayment 
resulted in a tax benefit in a prior year. Any interest credited or paid 
on the refund of mistaken withdrawal liability payments must also be 
included in gross income by the employer.
    (d) Application of section 412. An amount returned under paragraph 
(b)(2)(ii) of this section is charged to the funding standard account 
under section 412 in the year in which the amount is returned.

[T.D. 9005, 67 FR 47693, July 22, 2002]



Sec. 1.401(a)(4)-0  Table of contents.

    This section contains a listing of the major headings of Sec. Sec. 
1.401(a)(4)-1 through 1.401(a)(4)-13.

 Sec. 1.401(a)(4)-1 Nondiscrimination requirements of section 401(a)(4)

(a) In general.
(b) Requirements a plan must satisfy.
    (1) In general.
    (2) Nondiscriminatory amount of contributions or benefits.
    (3) Nondiscriminatory availability of benefits, rights, and 
features.
    (4) Nondiscriminatory effect of plan amendments and terminations.
(c) Application of requirements.
    (1) In general.
    (2) Interpretation.
    (3) Plan-year basis of testing.
    (4) Application of section 410(b) rules.
    (5) Collectively-bargained plans.
    (6) Former employees.
    (7) Employee-provided contributions and benefits.
    (8) Allocation of earnings.
    (9) Rollovers, transfers, and buybacks.
    (10) Vesting.
    (11) Crediting service.
    (12) Governmental plans.
    (13) Employee stock ownership plans.
    (14) Section 401(h) benefits.
    (15) Definitions.
    (16) Effective dates and fresh-start rules.
(d) Additional guidance.

      Sec. 1.401(a)(4)-2 Nondiscrimination in amount of employer 
             contributions under a defined contribution plan

(a) Introduction.
    (1) Overview.
    (2) Alternative methods of satisfying nondiscriminatory amount 
requirement.
(b) Safe harbors.
    (1) In general.
    (2) Safe harbor for plans with uniform allocation formula.
    (3) Safe harbor for plans with uniform points allocation formula.
    (4) Use of safe harbors not precluded by certain plan provisions.
(c) General test for nondiscrimination in amount of contributions.
    (1) General rule.
    (2) Determination of allocation rates.
    (3) Satisfaction of section 410(b) by a rate group.
    (4) Examples.

  Sec. 1.401(a)(4)-3 Nondiscrimination in amount of employer-provided 
                  benefits under a defined benefit plan

(a) Introduction.
    (1) Overview.
    (2) Alternative methods of satisfying nondiscriminatory amount 
requirement.
(b) Safe harbors.
    (1) In general.
    (2) Uniformity requirements.
    (3) Safe harbor for unit credit plans.
    (4) Safe harbor for plans using fractional accrual rule.
    (5) Safe harbor for insurance contract plans.
    (6) Use of safe harbors not precluded by certain plan provisions.
(c) General test for nondiscrimination in amount of benefits.
    (1) General rule.
    (2) Satisfaction of section 410(b) by a rate group.
    (3) Certain violations disregarded.
    (4) Examples.
(d) Determination of accrual rates.
    (1) Definitions.
    (2) Rules of application.
    (3) Optional rules.
    (4) Examples.
(e) Compensation rules.
    (1) In general.
    (2) Average annual compensation.
    (3) Examples.
(f) Special rules.

[[Page 101]]

    (1) In general.
    (2) Certain qualified disability benefits.
    (3) Accruals after normal retirement age.
    (4) Early retirement window benefits.
    (5) Unpredictable contingent event benefits.
    (6) Determination of benefits on other than plan-year basis.
    (7) Adjustments for certain plan distributions.
    (8) Adjustment for certain QPSA charges.
    (9) Disregard of certain offsets.
    (10) Special rule for multiemployer plans.

Sec. 1.401(a)(4)-4 Nondiscriminatory availability of benefits, rights, 
                              and features

(a) Introduction.
(b) Current availability.
    (1) General rule.
    (2) Determination of current availability.
    (3) Benefits, rights, and features that are eliminated 
prospectively.
(c) Effective availability.
    (1) General rule.
    (2) Examples.
(d) Special rules.
    (1) Mergers and acquisitions.
    (2) Frozen participants.
    (3) Early retirement window benefits.
    (4) Permissive aggregation of certain benefits, rights, or features.
    (5) Certain spousal benefits.
    (6) Special ESOP rules.
    (7) Special testing rule for unpredictable contingent event 
benefits.
(e) Definitions.
    (1) Optional form of benefit.
    (2) Ancillary benefit.
    (3) Other right or feature.

        Sec. 1.401(a)(4)-5 Plan amendments and plan terminations

    (a) Introduction.
    (1) Overview.
    (2) Facts-and-circumstances determination.
    (3) Safe harbor for certain grants of benefits for past periods.
    (4) Examples.
(b) Pre-termination restrictions.
    (1) Required provisions in defined benefit plans.
    (2) Restriction of benefits upon plan termination.
    (3) Restrictions on distributions.
    (4) Operational restrictions on certain money purchase pension 
plans.

         Sec. 1.401(a)(4)-6 Contributory defined benefit plans

(a) Introduction.
(b) Determination of employer-provided benefit.
    (1) General rule.
    (2) Composition-of-work-force method.
    (3) Minimum-benefit method.
    (4) Grandfather rules for plans in existence on May 14, 1990.
    (5) Government-plan method.
    (6) Cessation of employee contributions.
(c) Rules applicable in determining whether employee-provided benefits 
          are nondiscriminatory in amount.
    (1) In general.
    (2) Same rate of contributions.
    (3) Total-benefits method.
    (4) Grandfather rule for plans in existence on May 14, 1990.

          Sec. 1.401(a)(4)-7 Imputation of permitted disparity

(a) Introduction.
(b) Adjusting allocation rates.
    (1) In general.
    (2) Employees whose plan year compensation does not exceed taxable 
wage base.
    (3) Employees whose plan year compensation exceeds taxable wage 
base.
    (4) Definitions.
    (5) Example.
(c) Adjusting accrual rates.
    (1) In general.
    (2) Employees whose average annual compensation does not exceed 
covered compensation.
    (3) Employees whose average annual compensation exceeds covered 
compensation.
    (4) Definitions.
    (5) Employees with negative unadjusted accrual rates.
    (6) Example.
(d) Rules of general application.
    (1) Eligible plans.
    (2) Exceptions from consistency requirements.
    (3) Overall permitted disparity.

                    Sec. 1.401(a)(4)-8 Cross-testing

(a) Introduction.
(b) Nondiscrimination in amount of benefits provided under a defined 
          contribution plan.
    (1) General rule and gateway.
    (2) Determination of equivalent accrual rates.
    (3) Safe-harbor testing method for target benefit plans.
(c) Nondiscrimination in amount of contributions under a defined benefit 
          plan.
    (1) General rule.
    (2) Determination of equivalent allocation rates.
    (3) Safe harbor testing method for cash balance plans.
(d) Safe-harbor testing method for defined benefit plans that are part 
          of a floor-offset arrangement.
    (1) General rule.
    (2) Application of safe-harbor testing method to qualified offset 
arrangements.

[[Page 102]]

         Sec. 1.401(a)(4)-9 Plan aggregation and restructuring

(a) Introduction.
(b) Application of nondiscrimination requirements to DB/DC plans.
    (1) General rule.
    (2) Special rules for demonstrating nondiscrimination in amount of 
contributions or benefits.
    (3) Optional rules for demonstrating nondiscrimination in 
availability of certain benefits, rights, and features.
(c) Plan restructuring.
    (1) General rule.
    (2) Identification of component plans.
    (3) Satisfaction of section 401(a)(4) by a component plan.
    (4) Satisfaction of section 410(b) by a component plan.
    (5) Effect of restructuring under other sections.
    (6) Examples.

            Sec. 1.401(a)(4)-10 Testing of former employees

(a) Introduction.
(b) Nondiscrimination in amount of contributions or benefits.
    (1) General rule.
    (2) Permitted disparity.
    (3) Examples.
(c) Nondiscrimination in availability of benefits, rights, or features.

                  Sec. 1.401(a)(4)-11 Additional rules

(a) Introduction.
(b) Rollovers, transfers, and buybacks.
    (1) Rollovers and elective transfers.
    (2) Other transfers. [Reserved]
    (3) Employee buybacks.
(c) Vesting.
    (1) General rule.
    (2) Deemed equivalence of statutory vesting schedules.
    (3) Safe harbor for vesting schedules.
    (4) Examples.
(d) Service-crediting rules.
    (1) Overview.
    (2) Manner of crediting service.
    (3) Service-crediting period.
(e) Family aggregation rules. [Reserved]
(f) Governmental plans. [Reserved]
(g) Corrective amendments.
    (1) In general.
    (2) Scope of corrective amendments.
    (3) Conditions for corrective amendments.
    (4) Corrective amendments must have substance.
    (5) Effect under other statutory requirements.
    (6) Examples.

                    Sec. 1.401(a)(4)-12 Definitions

       Sec. 1.401(a)(4)-13 Effective dates and fresh-start rules

(a) General effective dates.
    (1) In general.
    (2) Plans of tax-exempt organizations.
    (3) Compliance during transition period.
(b) Effective date for governmental plans.
(c) Fresh-start rules for defined benefit plans.
    (1) Introduction.
    (2) General rule.
    (3) Definition of frozen.
    (4) Fresh-start formulas.
    (5) Rules of application.
    (6) Examples.
(d) Compensation adjustments to frozen accrued benefits.
    (1) Introduction.
    (2) In general.
    (3) Plan requirements.
    (4) Meaningful coverage as of fresh-start date.
    (5) Meaningful ongoing coverage.
    (6) Meaningful current benefit accruals.
    (7) Minimum benefit adjustment.
    (8) Adjusted accrued benefit.
    (9) Examples.
(e) Determination of initial theoretical reserve for target benefit 
          plans.
    (1) General rule.
    (2) Example.
(f) Special fresh-start rules for cash balance plans.
    (1) In general.
    (2) Alternative formula.
    (3) Limitations on formulas.

[T.D. 8485, 58 FR 46778, Sept. 3, 1993, as amended by T.D. 8954, 66 FR 
34540, June 29, 2001]



Sec. 1.401(a)(4)-1  Nondiscrimination requirements of section 401(a)(4).

    (a) In general. Section 401(a)(4) provides that a plan is a 
qualified plan only if the contributions or the benefits provided under 
the plan do not discriminate in favor of HCEs. Whether a plan satisfies 
this requirement depends on the form of the plan and on its effect in 
operation. In making this determination, intent is irrelevant. This 
section sets forth the exclusive rules for determining whether a plan 
satisfies section 401(a)(4). A plan that complies in form and operation 
with the rules in this section therefore satisfies section 401(a)(4).
    (b) Requirements a plan must satisfy--(1) In general. In order to 
satisfy section 401(a)(4), a plan must satisfy each of the requirements 
of this paragraph (b).
    (2) Nondiscriminatory amount of contributions or benefits--(i) 
General rule. Either the contributions or the benefits provided under 
the plan must be

[[Page 103]]

nondiscriminatory in amount. It need not be shown that both the 
contributions and the benefits provided are nondiscriminatory in amount, 
but only that either the contributions alone or the benefits alone are 
nondiscriminatory in amount.
    (ii) Defined contribution plans--(A) General rule. A defined 
contribution plan satisfies this paragraph (b)(2) if the contributions 
allocated under the plan (including forfeitures) are nondiscriminatory 
in amount under Sec. 1.401(a)(4)-2. Alternatively, a defined 
contribution plan (other than an ESOP) satisfies this paragraph (b)(2) 
if the equivalent benefits provided under the plan are nondiscriminatory 
in amount under Sec. 1.401(a)(4)-8(b). Section 1.401(a)(4)-8(b) 
includes a safe-harbor testing method for contributions provided under a 
target benefit plan.
    (B) Section 401(k) plans and section 401(m) plans. A section 401(k) 
plan is deemed to satisfy this paragraph (b)(2) because Sec. 1.410(b)-9 
defines a section 401(k) plan as a plan consisting of elective 
contributions under a qualified cash or deferred arrangement (i.e., one 
that satisfies section 401(k)(3), the nondiscriminatory amount 
requirement applicable to qualified cash or deferred arrangements). A 
section 401(m) plan satisfies this paragraph (b)(2) only if the plan 
satisfies Sec. Sec. 1.401(m)-1(b) and 1.401(m)-2. Contributions under a 
nonqualified cash or deferred arrangement, elective contributions 
described in Sec. 1.401(k)-1(b)(4)(iv) that fail to satisfy the 
allocation and compensation requirements of Sec. 1.401(k)-2(a)(4)(i), 
matching contributions that fail to satisfy Sec. 1.401(m)-2(a)(4)(iii), 
and qualified nonelective contributions treated as elective or matching 
contributions for certain purposes under Sec. Sec. 1.401(k)-2(a)(6) and 
1.401(m)-2(a)(6), respectively, are not subject to the special rule in 
this paragraph (b)(2)(ii)(B), because they are not treated as part of a 
section 401(k) plan or section 401(m) plan as those terms are defined in 
Sec. 1.410(b)-9. The contributions described in the preceding sentence 
must satisfy paragraph (b)(2)(ii)(A) of this section.
    (iii) Defined benefit plans. A defined benefit plan satisfies this 
paragraph (b)(2) if the benefits provided under the plan are 
nondiscriminatory in amount under Sec. 1.401(a)(4)-3. Alternatively, a 
defined benefit plan satisfies this paragraph (b)(2) if the equivalent 
allocations provided under the plan are nondiscriminatory in amount 
under Sec. 1.401(a)(4)-8(c). Section 1.401(a)(4)-8(c) includes a safe-
harbor testing method for benefits provided under a cash balance plan. 
In addition, Sec. 1.401(a)(4)-8(d) provides a safe-harbor testing 
method for benefits provided under a defined benefit plan that is part 
of a floor-offset arrangement.
    (3) Nondiscriminatory availability of benefits, rights, and 
features. All benefits, rights, and features provided under the plan 
must be made available in the plan in a nondiscriminatory manner. Rules 
for determining whether this requirement is satisfied are set forth in 
Sec. 1.401(a)(4)-4.
    (4) Nondiscriminatory effect of plan amendments and terminations. 
The timing of plan amendments must not have the effect of discriminating 
significantly in favor of HCEs. Rules for determining whether this 
requirement is satisfied are set forth in Sec. 1.401(a)(4)-5(a). 
Section 1.401(a)(4)-5(b) provides additional requirements regarding plan 
terminations.
    (c) Application of requirements--(1) In general. The requirements of 
paragraph (b) of this section must be applied in accordance with the 
rules set forth in this paragraph (c).
    (2) Interpretation. The provisions of Sec. Sec. 1.401(a)(4)-1 
through 1.401(a)(4)-13 must be interpreted in a reasonable manner 
consistent with the purpose of preventing discrimination in favor of 
HCEs.
    (3) Plan-year basis of testing. The requirements of paragraph (b) of 
this section are generally applied on the basis of the plan year and on 
the basis of the terms of the plan in effect during the plan year. Thus, 
unless otherwise provided, the compensation, contributions, benefit 
accruals, and other items used to apply these requirements must be 
determined with respect to the plan year being tested. However, Sec. 
1.401(a)(4)-11(g) provides rules allowing for corrective amendments made 
after the close of the plan year to be taken into account in satisfying 
certain requirements under paragraph (b) of this section.

[[Page 104]]

    (4) Application of section 410(b) rules--(i) Relationship between 
sections 401(a)(4) and 410(b). To be a qualified plan, a plan must 
satisfy both sections 410(b) and 401(a)(4). Section 410(b) requires that 
a plan benefit a nondiscriminatory group of employees, and section 
401(a)(4) requires that the contributions or benefits provided to 
employees benefiting under the plan not discriminate in favor of HCEs. 
Consistent with this requirement, the definition of a plan subject to 
testing under section 401(a)(4) is the same as the definition of a plan 
subject to testing under section 410(b), i.e., the plan determined after 
applying the mandatory disaggregation rules of Sec. 1.410(b)-7(c) and 
the permissive aggregation rules of Sec. 1.410(b)-7(d). In addition, 
whichever testing option is used for the plan year under Sec. 1.410(b)-
8(a) (e.g., quarterly testing) must also be used for purposes of 
determining whether the plan satisfies section 401(a)(4) for the plan 
year.
    (ii) Special rules for certain aggregated plans. Special rules are 
set forth in Sec. 1.401(a)(4)-9(b) for applying the nondiscriminatory 
amount and availability requirements of paragraphs (b)(2) and (b)(3) of 
this section to a plan that includes one or more defined benefit plans 
and one or more defined contribution plans that have been permissively 
aggregated under Sec. 1.410(b)-7(d).
    (iii) Restructuring. In certain circumstances, a plan may be 
restructured on the basis of employee groups and treated as comprising 
two or more plans, each of which is treated as a separate plan that must 
independently satisfy sections 401(a)(4) and 410(b). Rules relating to 
restructuring plans for purposes of applying the requirements of 
paragraph (b) of this section are set forth in Sec. 1.401(a)(4)-9(c).
    (iv) References to section 410(b). Except as otherwise specifically 
provided, references to satisfying section 410(b) in Sec. Sec. 
1.401(a)(4)-1 through 1.401(a)(4)-13 mean satisfying Sec. 1.410(b)-2 
(taking into account any special rules available in satisfying that 
section, other than the permissive aggregation rules of Sec. 1.410(b)-
7(d)). In the case of a plan described in section 410(c)(1) that has not 
made the election described in section 410(d) and is not subject to 
section 403(b)(12)(A)(i), references in Sec. Sec. 1.401(a)(4)-1 through 
1.401(a)(4)-13 to satisfying section 410(b) mean satisfying section 
410(c)(2).
    (5) Collectively-bargained plans. The requirements of paragraph (b) 
of this section are treated as satisfied by a collectively-bargained 
plan that automatically satisfies section 410(b) under Sec. 1.410(b)-
2(b)(7).
    (6) Former employees. In applying the nondiscriminatory amount and 
availability requirements of paragraphs (b)(2) and (b)(3) of this 
section, former employees are tested separately from active employees, 
unless otherwise provided. Rules for applying paragraphs (b)(2) and 
(b)(3) of this section to former employees are set forth in Sec. 
1.401(a)(4)-10.
    (7) Employee-provided contributions and benefits. In applying the 
nondiscriminatory amount requirement of paragraph (b)(2) of this 
section, employee-provided contributions and benefits are tested 
separately from employer-provided contributions and benefits, unless 
otherwise provided. Rules for determining the amount of employer-
provided benefits under a defined benefit plan that include employee 
contributions not allocated to separate accounts are set forth in Sec. 
1.401(a)(4)-6(b), and rules for applying paragraph (b)(2) of this 
section to employee contributions under such a plan are set forth in 
Sec. 1.401(a)(4)-6(c). See paragraph (b)(2)(ii)(B) of this section for 
rules applicable to employee contributions allocated to separate 
accounts.
    (8) Allocation of earnings. Notwithstanding any other provision in 
Sec. Sec. 1.401(a)(4)-1 through 1.401(a)(4)-13, a defined contribution 
plan does not satisfy paragraph (b)(2) of this section if the manner in 
which income, expenses, gains, or losses are allocated to accounts under 
the plan discriminates in favor of HCEs or former HCEs.
    (9) Rollovers, transfers, and buybacks. In applying the requirements 
of paragraph (b) of this section, rollover (including direct rollover) 
contributions described in section 402(c), 402(e)(6), 403(a)(4), 
403(a)(5), or 408(d)(3), elective transfers described in Sec. 1.411(d)-
4, Q&A-3(b), transfers of assets and liabilities

[[Page 105]]

described in section 414(l), and employee buybacks are treated in 
accordance with the rules set forth in Sec. 1.401(a)(4)-11(b).
    (10) Vesting. A plan does not satisfy the nondiscriminatory amount 
requirement of paragraph (b)(2) of this section unless it satisfies 
Sec. 1.401(a)(4)-11(c) with respect to the manner in which employees 
vest in their accrued benefits.
    (11) Crediting service. A plan does not satisfy paragraphs (b)(2) 
and (b)(3) of this section unless it satisfies Sec. 1.401(a)(4)-11(d) 
with respect to the manner in which employees' service is credited under 
the plan. Service other than actual service with the employer may not be 
taken into account in determining whether the plan satisfies paragraphs 
(b)(2) and (b)(3) of this section except as provided in Sec. 
1.401(a)(4)-11(d).
    (12) Governmental plans. The rules of this section apply to a 
governmental plan within the meaning of section 414(d), except as 
provided in Sec. Sec. 1.401(a)(4)-11(f) and 1.401(a)(4)-13(b).
    (13) Employee stock ownership plans. [Reserved]
    (14) Section 401(h) benefits. In applying the requirements of 
paragraph (b) of this section, the portion of a plan providing benefits 
described in section 401(h) is tested separately from the portion of the 
same plan providing retirement benefits, and thus is not required to 
satisfy this section. Rules applicable to section 401(h) benefits are 
set forth in Sec. 1.401-14(b)(2).
    (15) Definitions. In applying the requirements of this section, the 
definitions in Sec. 1.401(a)(4)-12 govern.
    (16) Effective dates and fresh-start rules. In applying the 
requirements of this section, the effective dates set forth in Sec. 
1.401(a)(4)-13 govern. Section 1.401(a)(4)-13 also provides certain 
transition and fresh-start rules that apply for purposes of this 
section.
    (d) Additional guidance. The Commissioner may, in revenue rulings, 
notices, and other guidance, published in the Internal Revenue Bulletin, 
provide any additional guidance that may be necessary or appropriate in 
applying the nondiscrimination requirements of section 401(a)(4), 
including additional safe harbors and alternative methods and procedures 
for satisfying those requirements. See Sec. 601.601(d)(2)(ii)(b) of 
this chapter.

[T.D. 8485, 58 FR 46780, Sept. 3, 1993, as amended by T.D. 9169, 69 FR 
78153, Dec. 29, 2004 ]

    Editorial Note: By T.D. 9169, 69 FR 78153, Dec. 29, 2004, the 
Internal Revenue Service published a document in the Federal Register, 
attempting to amend paragraph (b)(2)(ii)(B) of Sec. 1.401-1(a)(4)-1 by 
removing ``1.401(k)-1(b)(4)'' and inserting ``1.401(k)-2(a)(5)(i)''. 
However, because of inaccurate amendatory language, this amendment could 
not be incorporated.



Sec. 1.401(a)(4)-2  Nondiscrimination in amount of employer contributions 
under a defined contribution plan.

    (a) Introduction--(1) Overview. This section provides rules for 
determining whether the employer contributions allocated under a defined 
contribution plan are nondiscriminatory in amount as required by Sec. 
1.401(a)(4)-1(b)(2)(ii)(A). Certain defined contribution plans that 
provide uniform allocations are permitted to satisfy this requirement by 
meeting one of the safe harbors in paragraph (b) of this section. Plans 
that do not provide uniform allocations may satisfy this requirement by 
satisfying the general test in paragraph (c) of this section. See Sec. 
1.401(a)(4)-1(b)(2)(ii)(B) for the exclusive tests applicable to section 
401(k) plans and section 401(m) plans.
    (2) Alternative methods of satisfying nondiscriminatory amount 
requirement. A defined contribution plan is permitted to satisfy 
paragraph (b)(2) or (c) of this section on a restructured basis pursuant 
to Sec. 1.401(a)(4)-9(c). Alternatively, a defined contribution plan 
(other than an ESOP) is permitted to satisfy the nondiscriminatory 
amount requirement of Sec. 1.401(a)(4)-1(b)(2)(ii)(A) on the basis of 
equivalent benefits pursuant to Sec. 1.401(a)(4)-8(b).
    (b) Safe harbors--(1) In general. The employer contributions 
allocated under a defined contribution plan are nondiscriminatory in 
amount for a plan year if the plan satisfies either of the safe harbors 
in paragraph (b)(2) or (b)(3) of this section. Paragraph (b)(4) of this 
section provides exceptions for certain plan provisions that do not 
cause a plan to fail to satisfy this paragraph (b).

[[Page 106]]

    (2) Safe harbor for plans with uniform allocation formula--(i) 
General rule. A defined contribution plan satisfies the safe harbor in 
this paragraph (b)(2) for a plan year if the plan allocates all amounts 
taken into account under paragraph (c)(2)(ii) of this section for the 
plan year under an allocation formula that allocates to each employee 
the same percentage of plan year compensation, the same dollar amount, 
or the same dollar amount for each uniform unit of service (not to 
exceed one week) performed by the employee during the plan year.
    (ii) Permitted disparity. If a plan satisfies section 401(l) in 
form, differences in employees' allocations under the plan attributable 
to uniform disparities permitted under Sec. 1.401(l)-2 (including 
differences in disparities that are deemed uniform under Sec. 1.401(l)-
2(c)(2)) do not cause the plan to fail to satisfy this paragraph (b)(2).
    (3) Safe harbor for plans with uniform points allocation formula--
(i) General rule. A defined contribution plan (other than an ESOP) 
satisfies the safe harbor in this paragraph (b)(3) for a plan year if it 
satisfies both of the following requirements:
    (A) The plan must allocate amounts under a uniform points allocation 
formula. A uniform points allocation formula defines each employee's 
allocation for the plan year as the product of the total of all amounts 
taken into account under paragraph (c)(2)(ii) of this section and a 
fraction, the numerator of which is the employee's points for the plan 
year and the denominator of which is the sum of the points of all 
employees in the plan for the plan year. For this purpose, an employee's 
points for a plan year equal the sum of the employee's points for age, 
service, and units of plan year compensation for the plan year. Under a 
uniform points allocation formula, each employee must receive the same 
number of points for each year of age, the same number of points for 
each year of service, and the same number of points for each unit of 
plan year compensation. (See Sec. 1.401(a)(4)-11(d)(3) regarding 
service that may be taken into account as years of service.) A uniform 
points allocation formula need not grant points for both age and 
service, but it must grant points for at least one of them. If the 
allocation formula grants points for years of service, the plan is 
permitted to limit the number of years of service taken into account to 
a single maximum number of years of service. A uniform points allocation 
formula need not grant points for units of plan year compensation, but 
if it does, the unit used must be a single dollar amount for all 
employees that does not exceed $200.
    (B) For the plan year, the average of the allocation rates for the 
HCEs in the plan must not exceed the average of the allocation rates for 
the NHCEs in the plan. For this purpose, allocation rates are determined 
in accordance with paragraph (c)(2) of this section, without imputing 
permitted disparity and without grouping allocation rates under 
paragraphs (c)(2) (iv) and (v) of this section, respectively.
    (ii) Example. The following example illustrates the safe harbor in 
this paragraph (b)(3):

    Example. (a) Plan A has a single allocation formula that applies to 
all employees, under which each employee's allocation for the plan year 
equals the product of the total of all amounts taken into account for 
all employees for the plan year under paragraph (c)(2)(ii) of this 
section and a fraction, the numerator of which is the employee's points 
for the plan year and the denominator of which is the sum of the points 
of all employees for the plan year. Plan A grants each employee 10 
points for each year of service (including pre-participation service and 
imputed service credited under Plan A that satisfies Sec. 1.401(a)(4)-
11(d)(3)) and one point for each $100 of plan year compensation. For the 
1994 plan year, the total allocations are $71,200, and the total points 
for all employees are 7,120. Each employee's allocation for the 1994 
plan year is set forth in the table below.

----------------------------------------------------------------------------------------------------------------
                                                                                                      Allocation
                   Employee                       Years of     Plan year      Points     Amount of       rate
                                                  service    compensation                allocation   (percent)
----------------------------------------------------------------------------------------------------------------
H1............................................           20      $150,000        1,700      $17,000         11.3
H2............................................           10       150,000        1,600       16,000         10.7
H3............................................           30       100,000        1,300       13,000         13.0
H4............................................            3       100,000        1,030       10,300         10.3

[[Page 107]]

 
N1............................................           10        40,000          500        5,000         12.5
N2............................................            5        35,000          400        4,000         11.4
N3............................................            3        30,000          330        3,300         11.0
N4............................................            1        25,000          260        2,600         10.4
                                               -----------------------------------------------------------------
    Total.....................................  ...........  ............        7,120       71,200  ...........
----------------------------------------------------------------------------------------------------------------

    (b) Under these facts, for the 1994 plan year, Plan A allocates 
amounts under a uniform points allocation formula within the meaning of 
paragraph (b)(3)(i)(A) of this section.
    (c) For the 1994 plan year, the average allocation rate for the HCEs 
(H1 through H4) is 11.3 percent, and the average allocation rate for 
NHCEs (N1 through N4) is 11.3 percent. Because the average of the 
allocation rates for the HCEs does not exceed the average of the 
allocation rates for the NHCEs, Plan A satisfies paragraph (b)(3)(i)(B) 
of this section and, thus, the safe harbor in this paragraph (b)(3) for 
the 1994 plan year.

    (4) Use of safe harbors not precluded by certain plan provisions--
(i) In general. A plan does not fail to satisfy this paragraph (b) 
merely because the plan contains one or more of the provisions described 
in this paragraph (b)(4). Unless otherwise provided, any such provision 
must apply uniformly to all employees.
    (ii) Entry dates. The plan provides one or more entry dates during 
the plan year as permitted by section 410(a)(4).
    (iii) Certain conditions on allocations. The plan provides that an 
employee's allocation for the plan year is conditioned on either the 
employee's employment on the last day of the plan year or the employee's 
completion of a minimum number of hours of service during the plan year 
(not to exceed 1,000), or both. Such a provision may include an 
exception from this condition for all employees whose employment 
terminates during the plan year or only for those employees whose 
employment terminates during the plan year on account of one or more of 
the following circumstances: retirement, disability, death, or military 
service.
    (iv) Certain limits on allocations. The plan limits allocations 
otherwise provided under the allocation formula to a maximum dollar 
amount or a maximum percentage of plan year compensation, limits the 
dollar amount of plan year compensation taken into account in 
determining the amount of allocations, or applies the restrictions of 
section 409(n) or the limits of section 415.
    (v) Lower allocations for HCEs. The allocations provided to one or 
more HCEs under the plan are less than the allocations that would 
otherwise be provided to those employees if the plan satisfied this 
paragraph (b) (without regard to this paragraph (b)(4)(v)).
    (vi) Multiple formulas--(A) General rule. The plan provides that an 
employee's allocation under the plan is the greater of the allocations 
determined under two or more formulas, or is the sum of the allocations 
determined under two or more formulas. This paragraph (b)(4)(vi) does 
not apply to a plan unless each of the formulas under the plan satisfies 
the requirements of paragraph (b)(4)(vi) (B) through (D) of this 
section.
    (B) Sole formulas. The formulas must be the only formulas under the 
plan.
    (C) Separate testing. Each of the formulas must separately satisfy 
this paragraph (b). A formula that is available solely to some or all 
NHCEs is deemed to satisfy this paragraph (b)(4)(vi)(C).
    (D) Availability--(1) General rule. All of the formulas must be 
available on the same terms to all employees.
    (2) Formulas for NHCEs. A formula does not fail to be available on 
the same terms to all employees merely because the formula is not 
available to any HCEs, but is available to some or all NHCEs on the same 
terms as all of the other formulas in the plan.
    (3) Top-heavy formulas. In the case of a plan that provides the 
greater of the allocations under two or more formulas, one of which is a 
top-heavy formula, the top-heavy formula does not fail to be available 
on the same terms to all employees merely because it is

[[Page 108]]

available solely to all non-key employees on the same terms as all the 
other formulas under the plan. Furthermore, the top-heavy formula does 
not fail to be available on the same terms as the other formulas under 
the plan merely because it is conditioned on the plan's being top-heavy 
within the meaning of section 416(g). Finally, the top-heavy formula 
does not fail to be available on the same terms as the other formulas 
under the plan merely because it is available to all employees described 
in Sec. 1.416-1, Q&A M-10 (i.e., all non-key employees who have not 
separated from service as of the last day of the plan year). The 
preceding sentence does not apply, however, unless the plan would 
satisfy section 410(b) if all employees who are benefiting under the 
plan solely as a result of receiving allocations under the top-heavy 
formula were treated as not currently benefiting under the plan. For 
purposes of this paragraph (b)(4)(vi)(D)(3), a top-heavy formula is a 
formula that provides the minimum benefit described in section 416(c)(2) 
(taking into account, if applicable, the modification in section 
416(h)(2)(A)(ii)(II)).
    (E) Provisions may be applied more than once. The provisions of this 
paragraph (b)(4)(vi) may be applied more than once. For example, a plan 
satisfies this paragraph (b) if an employee's allocation under the plan 
is the greater of the allocations under two or more formulas, and one or 
more of those formulas is the sum of the allocations under two or more 
other formulas, provided that each of the formulas under the plan 
satisfies the requirements of paragraph (b)(4)(vi) (B) through (D) of 
this section.
    (F) Examples. The following examples illustrate the rules in this 
paragraph (b)(4)(vi):

    Example 1. Under Plan A, each employee's allocation equals the sum 
of the allocations determined under two formulas. The first formula 
provides an allocation of five percent of plan year compensation. The 
second formula provides an allocation of $100. Plan A satisfies this 
paragraph (b)(4)(vi).
    Example 2. Under Plan B, each employee's allocation equals the 
greater of the allocations determined under two formulas. The first 
formula provides an allocation of seven percent of plan year 
compensation and is available to all employees who complete at least 
1,000 hours of service during the plan year and who have not separated 
from service as of the last day of the plan year. The second formula is 
a top-heavy formula that provides an allocation of three percent of plan 
year compensation and that is available to all employees described in 
Sec. 1.416-1, Q&A M-10. Plan B does not satisfy the general rule in 
paragraph (b)(4)(vi)(D)(1) of this section because the two formulas are 
not available on the same terms to all employees (i.e., an employee is 
required to complete 1,000 hours of service during the plan year to 
receive an allocation under the first formula, but not under the second 
formula). Nonetheless, because the second formula is a top-heavy 
formula, the special availability rules for top-heavy formulas in 
paragraph (b)(4)(vi)(D)(3) of this section apply. Thus, the second 
formula does not fail to be available on the same terms as the first 
formula merely because the second formula is available to all employees 
described in Sec. 1.416-1, Q&A M-10, as long as the plan would satisfy 
section 410(b) if all employees who are benefiting under the plan solely 
as a result of receiving allocations under the top-heavy formula were 
treated as not currently benefiting under the plan. This is true even if 
the plan conditions the availability of the second formula on the plan's 
being top-heavy for the plan year.
    Example 3. The facts are the same as in Example 2, except that the 
first formula is available to all employees who have not separated from 
service as of the last day of the plan year, regardless of whether they 
complete at least 1,000 hours of service during the plan year. Plan B 
still does not satisfy the general rule in paragraph (b)(4)(vi)(D)(1) of 
this section because the two formulas are not available on the same 
terms to all employees (i.e., the second formula is only available to 
all non-key employees). Nonetheless, because the second formula is a 
top-heavy formula, the special availability rules for top-heavy formulas 
in paragraph (b)(4)(vi)(D)(3) of this section apply. Thus, the second 
formula does not fail to be available on the same terms as the first 
formula merely because the second formula is available solely to all 
non-key employees.

    (c) General test for nondiscrimination in amount of contributions--
(1) General rule. The employer contributions allocated under a defined 
contribution plan are nondiscriminatory in amount for a plan year if 
each rate group under the plan satisfies section 410(b). For purposes of 
this paragraph (c), a rate group exists under a plan for each HCE and 
consists of the HCE and all other employees in the plan (both HCEs and 
NHCEs) who have an allocation rate

[[Page 109]]

greater than or equal to the HCE's allocation rate. Thus, an employee is 
in the rate group for each HCE who has an allocation rate less than or 
equal to the employee's allocation rate.
    (2) Determination of allocation rates--(i) General rule. The 
allocation rate for an employee for a plan year equals the sum of the 
allocations to the employee's account for the plan year, expressed 
either as a percentage of plan year compensation or as a dollar amount.
    (ii) Allocations taken into account. The amounts taken into account 
in determining allocation rates for a plan year include all employer 
contributions and forfeitures that are allocated or treated as allocated 
to the account of an employee under the plan for the plan year, other 
than amounts described in paragraph (c)(2)(iii) of this section. For 
this purpose, employer contributions include annual additions described 
in Sec. 1.415(c)-1(b)(4) (regarding amounts arising from certain 
transactions between the plan and the employer). In the case of a 
defined contribution plan subject to section 412, an employer 
contribution is taken into account in the plan year for which it is 
required to be contributed and allocated to employees' accounts under 
the plan, even if all or part of the required contribution is not 
actually made.
    (iii) Allocations not taken into account. Allocations of income, 
expenses, gains, and losses attributable to the balance in an employee's 
account are not taken into account in determining allocation rates.
    (iv) Imputation of permitted disparity. The disparity permitted 
under section 401(l) may be imputed in accordance with the rules of 
Sec. 1.401(a)(4)-7.
    (v) Grouping of allocation rates--(A) General rule. An employer may 
treat all employees who have allocation rates within a specified range 
above and below a midpoint rate chosen by the employer as having an 
allocation rate equal to the midpoint rate within that range. Allocation 
rates within a given range may not be grouped under this paragraph 
(c)(2)(v) if the allocation rates of HCEs within the range generally are 
significantly higher than the allocation rates of NHCEs in the range. 
The specified ranges within which all employees are treated as having 
the same allocation rate may not overlap and may be no larger than 
provided in paragraph (c)(2)(v)(B) of this section. Allocation rates of 
employees that are not within any of these specified ranges are 
determined without regard to this paragraph (c)(2)(v).
    (B) Size of specified ranges. The lowest and highest allocation 
rates in the range must be within five percent (not five percentage 
points) of the midpoint rate. If allocation rates are determined as a 
percentage of plan year compensation, the lowest and highest allocation 
rates need not be within five percent of the midpoint rate, if they are 
no more than one quarter of a percentage point above or below the 
midpoint rate.
    (vi) Consistency requirement. Allocation rates must be determined in 
a consistent manner for all employees for the plan year.
    (3) Satisfaction of section 410(b) by a rate group--(i) General 
rule. For purposes of determining whether a rate group satisfies section 
410(b), the rate group is treated as if it were a separate plan that 
benefits only the employees included in the rate group for the plan 
year. Thus, for example, under Sec. 1.401(a)(4)-1(c)(4)(iv), the ratio 
percentage of the rate group is determined taking into account all 
nonexcludable employees regardless of whether they benefit under the 
plan. Paragraph (c)(3) (ii) and (iii) of this section provide additional 
special rules for determining whether a rate group satisfies section 
410(b).
    (ii) Application of nondiscriminatory classification test. A rate 
group satisfies the nondiscriminatory classification test of Sec. 
1.410(b)-4 (including the reasonable classification requirement of Sec. 
1.410(b)-4(b)) if and only if the ratio percentage of the rate group is 
greater than or equal to the lesser of--
    (A) The midpoint between the safe and the unsafe harbor percentages 
applicable to the plan; and
    (B) The ratio percentage of the plan.
    (iii) Application of average benefit percentage test. A rate group 
satisfies the average benefit percentage test of Sec. 1.410(b)-5 if the 
plan of which it is a part satisfies Sec. 1.410(b)-5 (without regard to 
Sec. 1.410(b)-5(f)). In the case of a

[[Page 110]]

plan that relies on Sec. 1.410(b)-5(f) to satisfy the average benefit 
percentage test, each rate group under the plan satisfies the average 
benefit percentage test (if applicable) only if the rate group 
separately satisfies Sec. 1.410(b)-5(f).
    (4) Examples. The following examples illustrate the general test in 
this paragraph (c):

    Example 1. Employer X maintains two defined contribution plans, Plan 
A and Plan B, that are aggregated and treated as a single plan for 
purposes of sections 410(b) and 401(a)(4) pursuant to Sec. 1.410(b)-
7(d). For the 1994 plan year, Employee M has plan year compensation of 
$10,000 and receives an allocation of $200 under Plan A and an 
allocation of $800 under Plan B. Employee M's allocation rate under the 
aggregated plan for the 1994 plan year is 10 percent (i.e., $1,000 
divided by $10,000).
    Example 2. The employees in Plan C have the following allocation 
rates (expressed as a percentage of plan year compensation): 2.75 
percent, 2.80 percent, 2.85 percent, 3.25 percent, 6.65 percent, 7.33 
percent, 7.34 percent, and 7.35 percent. Because the first four rates 
are within a range of no more than one quarter of a percentage point 
above and below 3.0 percent (a midpoint rate chosen by the employer), 
under paragraph (c)(2)(v) of this section the employer may treat the 
employees who have those rates as having an allocation rate of 3.0 
percent (provided that the allocation rates of HCEs within the range 
generally are not significantly higher than the allocation rates of 
NHCEs within the range). Because the last four rates are within a range 
of no more than five percent above and below 7.0 percent (a midpoint 
rate chosen by the employer), the employer may treat the employees who 
have those rates as having an allocation rate of 7.0 percent (provided 
that the allocation rates of HCEs within the range generally are not 
significantly higher than the allocation rates of NHCEs within the 
range).
    Example 3. (a) Employer Y has only six nonexcludable employees, all 
of whom benefit under Plan D. The HCEs are H1 and H2, and the NHCEs are 
N1 through N4. For the 1994 plan year, H1 and N1 through N4 have an 
allocation rate of 5.0 percent of plan year compensation. For the same 
plan year, H2 has an allocation rate of 7.5 percent of plan year 
compensation.
    (b) There are two rate groups under Plan D. Rate group 1 consists of 
H1 and all those employees who have an allocation rate greater than or 
equal to H1's allocation rate (5.0 percent). Thus, rate group 1 consists 
of H1, H2, and N1 through N4. Rate group 2 consists only of H2 because 
no other employee has an allocation rate greater than or equal to H2's 
allocation rate (7.5 percent).
    (c) The ratio percentage for rate group 2 is zero percent--i.e., 
zero percent (the percentage of all nonhighly compensated nonexcludable 
employees who are in the rate group) divided by 50 percent (the 
percentage of all highly compensated nonexcludable employees who are in 
the rate group). Therefore rate group 2 does not satisfy the ratio 
percentage test under Sec. 1.410(b)-2(b)(2). Rate group 2 also does not 
satisfy the nondiscriminatory classification test of Sec. 1.410(b)-4 
(as modified by paragraph (c)(3) of this section). Rate group 2 
therefore does not satisfy section 410(b) and, as a result, Plan D does 
not satisfy the general test in paragraph (c)(1) of this section. This 
is true regardless of whether rate group 1 satisfies Sec. 1.410(b)-
2(b)(2).
    Example 4. (a) The facts are the same as in Example 3, except that 
N4 has an allocation rate of 8.0 percent.
    (b) There are two rate groups in Plan D. Rate group 1 consists of H1 
and all those employees who have an allocation rate greater than or 
equal to H1's allocation rate (5.0 percent). Thus, rate group 1 consists 
of H1, H2 and N1 through N4. Rate group 2 consists of H2, and all those 
employees who have an allocation rate greater than or equal to H2's 
allocation rate (7.5 percent). Thus, rate group 2 consists of H2 and N4.
    (c) Rate group 1 satisfies the ratio percentage test under Sec. 
1.410(b)-2(b)(2) because the ratio percentage of the rate group is 100 
percent--i.e., 100 percent (the percentage of all nonhighly compensated 
nonexcludable employees who are in the rate group) divided by 100 
percent (the percentage of all highly compensated nonexcludable 
employees who are in the rate group).
    (d) Rate group 2 does not satisfy the ratio percentage test of Sec. 
1.410(b)-2(b)(2) because the ratio percentage of the rate group is 50 
percent--i.e., 25 percent (the percentage of all nonhighly compensated 
nonexcludable employees who are in the rate group) divided by 50 percent 
(the percentage of all highly compensated nonexcludable employees who 
are in the rate group).
    (e) However, rate group 2 does satisfy the nondiscriminatory 
classification test of Sec. 1.410(b)-4 because the ratio percentage of 
the rate group (50 percent) is greater than the safe harbor percentage 
applicable to the plan under Sec. 1.410(b)-4(c)(4) (45.5 percent).
    (f) Under paragraph (c)(3)(iii) of this section, rate group 2 
satisfies the average benefit percentage test, if Plan D satisfies the 
average benefit percentage test. (The requirement that Plan D satisfy 
the average benefit percentage test applies even though Plan D satisfies 
the ratio percentage test and would ordinarily not need to run the 
average benefit percentage test.) If Plan D satisfies the average 
benefit percentage test, then rate group 2 satisfies section 410(b) and 
thus, Plan D satisfies the general test in paragraph (c)(1) of this 
section, because each

[[Page 111]]

rate group under the plan satisfies section 410(b).
    Example 5. (a) Plan E satisfies section 410(b) by satisfying the 
nondiscriminatory classification test of Sec. 1.410(b)-4 and the 
average benefit percentage test of Sec. 1.410(b)-5 (without regard to 
Sec. 1.410(b)-5(f)). See Sec. 1.410(b)-2(b)(3). Plan E uses the facts-
and-circumstances requirements of Sec. 1.410(b)-4(c)(3) to satisfy the 
nondiscriminatory classification test of Sec. 1.410(b)-4. The safe and 
unsafe harbor percentages applicable to the plan under Sec. 1.410(b)-
4(c)(4) are 29 and 20 percent, respectively. Plan E has a ratio 
percentage of 22 percent.
    (b) Rate group 1 under Plan E has a ratio percentage of 23 percent. 
Under paragraph (c)(3)(ii) of this section, the rate group satisfies the 
nondiscriminatory classification requirement of Sec. 1.410(b)-4, 
because the ratio percentage of the rate group (23 percent) is greater 
than the lesser of--
    (1) The ratio percentage for the plan as a whole (22 percent); and
    (2) The midpoint between the safe and unsafe harbor percentages 
(24.5 percent).
    (c) Under paragraph (c)(3)(iii) of this section, the rate group 
satisfies section 410(b) because the plan satisfies the average benefit 
percentage test of Sec. 1.410(b)-5.

[T.D. 8485, 58 FR 46781, Sept. 3, 1993, as amended by T.D. 9319, 72 FR 
16894, Apr. 5, 2007]



Sec. 1.401(a)(4)-3  Nondiscrimination in amount of employer-provided 
benefits under a defined benefit plan.

    (a) Introduction--(1) Overview. This section provides rules for 
determining whether the employer-provided benefits under a defined 
benefit plan are nondiscriminatory in amount as required by Sec. 
1.401(a)(4)-1(b)(2)(iii). Certain defined benefit plans that provide 
uniform benefits are permitted to satisfy this requirement by meeting 
one of the safe harbors in paragraph (b) of this section. Plans that do 
not provide uniform benefits may satisfy this requirement by satisfying 
the general test in paragraph (c) of this section. Paragraph (d) of this 
section provides rules for determining the individual benefit accrual 
rates needed for the general test. Paragraph (e) of this section 
provides rules for determining compensation for purposes of applying the 
requirements of this section. Paragraph (f) of this section provides 
additional rules that apply generally for purposes of both the safe 
harbors in paragraph (b) of this section and the general test in 
paragraph (c) of this section. See Sec. 1.401(a)(4)-6 for rules for 
determining the amount of employer-provided benefits under a 
contributory DB plan, and for determining whether the employee-provided 
benefits under such a plan are nondiscriminatory in amount.
    (2) Alternative methods of satisfying nondiscriminatory amount 
requirement. A defined benefit plan is permitted to satisfy paragraph 
(b) or (c) of this section on a restructured basis pursuant to Sec. 
1.401(a)(4)-9(c). Alternatively, a defined benefit plan is permitted to 
satisfy the nondiscriminatory amount requirement of Sec. 1.401(a)(4)-
1(b)(2)(iii) on the basis of equivalent allocations pursuant to Sec. 
1.401(a)(4)-8(c). In addition, a defined benefit plan that is part of a 
floor-offset arrangement is permitted to satisfy this section pursuant 
to Sec. 1.401(a)(4)-8(d).
    (b) Safe harbors--(1) In general. The employer-provided benefits 
under a defined benefit plan are nondiscriminatory in amount for a plan 
year if the plan satisfies each of the uniformity requirements of 
paragraph (b)(2) of this section and any one of the safe harbors in 
paragraphs (b)(3) (unit credit plans), (b)(4) (fractional accrual 
plans), and (b)(5) (insurance contract plans) of this section. Paragraph 
(b)(6) of this section provides exceptions for certain plan provisions 
that do not cause a plan to fail to satisfy this paragraph (b). 
Paragraph (f) of this section provides additional rules that apply in 
determining whether a plan satisfies this paragraph (b).
    (2) Uniformity requirements--(i) Uniform normal retirement benefit. 
The same benefit formula must apply to all employees. The benefit 
formula must provide all employees with an annual benefit payable in the 
same form commencing at the same uniform normal retirement age. The 
annual benefit must be the same percentage of average annual 
compensation or the same dollar amount for all employees who will have 
the same number of years of service at normal retirement age. (See Sec. 
1.401(a)(4)-11(d)(3) regarding service that may be taken into account as 
years of service.) The annual benefit must equal the employee's accrued 
benefit at normal retirement age (within the meaning of section

[[Page 112]]

411(a)(7)(A)(i)) and must be the normal retirement benefit under the 
plan (within the meaning of section 411(a)(9)).
    (ii) Uniform post-normal retirement benefit. With respect to an 
employee with a given number of years of service at any age after normal 
retirement age, the annual benefit commencing at that employee's age 
must be the same percentage of average annual compensation or the same 
dollar amount that would be payable commencing at normal retirement age 
to an employee who had that same number of years of service at normal 
retirement age.
    (iii) Uniform subsidies. Each subsidized optional form of benefit 
available under the plan must be currently available (within the meaning 
of Sec. 1.401(a)(4)-4(b)(2)) to substantially all employees. Whether an 
optional form of benefit is considered subsidized for this purpose may 
be determined using any reasonable actuarial assumptions.
    (iv) No employee contributions. The plan must not be a contributory 
DB plan.
    (v) Period of accrual. Each employee's benefit must be accrued over 
the same years of service that are taken into account in applying the 
benefit formula under the plan to that employee. For this purpose, any 
year in which the employee benefits under the plan (within the meaning 
of Sec. 1.410(b)-3(a)) is included as a year of service in which a 
benefit accrues. Thus, for example, a plan does not satisfy the safe 
harbor in paragraph (b)(4) of this section unless the plan uses the same 
years of service to determine both the normal retirement benefit under 
the plan's benefit formula and the fraction by which an employee's 
fractional rule benefit is multiplied to derive the employee's accrued 
benefit as of any plan year.
    (vi) Examples. The following examples illustrate the rules in this 
paragraph (b)(2):

    Example 1. Plan A provides a normal retirement benefit equal to two 
percent of average annual compensation times each year of service 
commencing at age 65 for all employees. Plan A provides that employees 
of Division S receive their benefit in the form of a straight life 
annuity and that employees of Division T receive their benefit in the 
form of a life annuity with an automatic cost-of-living increase. Plan A 
does not provide a uniform normal retirement benefit within the meaning 
of paragraph (b)(2)(i) of this section because the annual benefit is not 
payable in the same form to all employees.
    Example 2. Plan B provides a normal retirement benefit equal to 1.5 
percent of average annual compensation times each year of service at 
normal retirement age for all employees. The normal retirement age under 
the plan is the earlier of age 65 or the age at which the employee 
completes 10 years of service, but in no event earlier than age 62. Plan 
B does not provide a uniform normal retirement benefit within the 
meaning of paragraph (b)(2)(i) of this section because the same uniform 
normal retirement age does not apply to all employees.
    Example 3. Plan C is an accumulation plan under which the benefit 
for each year of service equals one percent of plan year compensation 
payable in the same form to all employees commencing at the same uniform 
normal retirement age. Under paragraph (e)(2) of this section, an 
accumulation plan may substitute plan year compensation for average 
annual compensation. Plan C provides a uniform normal retirement benefit 
within the meaning of paragraph (b)(2)(i) of this section, because all 
employees with the same number of years of service at normal retirement 
age will receive an annual benefit that is treated as the same 
percentage of average annual compensation.
    Example 4. The facts are the same as in Example 3, except that the 
benefit for each year of service equals one percent of plan year 
compensation increased by reference to the increase in the cost of 
living from the year of service to normal retirement age. Plan C does 
not provide a uniform normal retirement benefit, because the annual 
benefit defined by the benefit formula can vary for employees with the 
same number of years of service at normal retirement age, depending on 
the age at which those years of service were credited to the employee 
under the plan.
    Example 5. Plan D provides a normal retirement benefit of 50 percent 
of average annual compensation at normal retirement age (age 65) for 
employees with 30 years of service at normal retirement age. Plan D 
provides that, in the case of an employee with less than 30 years of 
service at normal retirement age, the normal retirement benefit is 
reduced on a pro rata basis for each year of service less than 30. 
However, if an employee with less than 30 years of service at normal 
retirement age continues to work past normal retirement age, Plan D 
provides that the additional years of service worked past normal 
retirement age are taken into account for purposes of the 30 years of 
service requirement. Thus, an employee who has 26 years of service at 
age 65 but who does not retire

[[Page 113]]

until age 69 with 30 years of service will receive a benefit of 50 
percent of average annual compensation. Plan D provides uniform post-
normal retirement benefits within the meaning of paragraph (b)(2)(ii) of 
this section.
    Example 6. (a) Plan E is amended on February 14, 1994, to provide an 
early retirement window benefit that consists of an unreduced early 
retirement benefit to employees who terminate employment after 
attainment of age 55 with 10 years of service and between June 1, 1994, 
and November 30, 1994. The early retirement window benefit is a single 
subsidized optional form of benefit. Paragraph (b)(2)(iii) of this 
section requires that the subsidized optional form of benefit be 
currently available (within the meaning of Sec. 1.401(a)(4)-4(b)(2)) to 
substantially all employees. Section 1.401(a)(4)-4(b)(2)(ii)(A)(2) 
provides that age and service requirements are not disregarded in 
determining the current availability of an optional form of benefit if 
those requirements must be satisfied within a specified period of time. 
Thus, the early retirement window benefit is not currently available to 
an employee unless the employee will satisfy the eligibility 
requirements for the early retirement window benefit by the close of the 
early retirement window benefit period. Plan E will fail to satisfy 
paragraph (b)(2)(iii) of this section unless substantially all of the 
employees satisfy the eligibility requirements for the early retirement 
window benefit by November 30, 1994. However, see Sec. 1.401(a)(4)-
9(c)(6), Example 2, for an example of how a plan with an early 
retirement window benefit may be restructured into two component plans, 
each of which satisfies the safe harbors of this paragraph (b).
    (b) A similar analysis would apply if, instead of an unreduced early 
retirement benefit, the early retirement window benefit consisted of a 
special schedule of early retirement factors, defined by starting with 
the plan's usual schedule and then treating each employee eligible for 
the early retirement window benefit as being five years older than the 
employee actually is, but not older than the employee's normal 
retirement age.
    Example 7. Plan F generally provides a normal retirement benefit of 
1.5 percent of an employee's average annual compensation multiplied by 
the employee's years of service with the employer. For employees 
transferred outside of the group of employees covered by the plan, the 
plan's benefit formula takes into account only years of service prior to 
the transfer, but determines average annual compensation taking into 
account section 414(s) compensation both before and after the transfer. 
Plan F does not satisfy the requirements of paragraph (b)(2)(v) of this 
section with respect to transferred employees, because their benefits 
are accrued over years of service (i.e., after transfer) that are not 
taken into account in applying the plan's benefit formula to them. 
However, see Example 2 of paragraph (b)(6)(x)(B) of this section for an 
example of how a plan that continues to take transferred employees' 
section 414(s) compensation into account after their transfer may still 
satisfy this paragraph (b).

    (3) Safe harbor for unit credit plans--(i) General rule. A plan 
satisfies the safe harbor in this paragraph (b)(3) for a plan year if it 
satisfies both of the following requirements:
    (A) The plan must satisfy the 133\1/3\ percent accrual rule of 
section 411(b)(1)(B).
    (B) Each employee's accrued benefit under the plan as of any plan 
year must be determined by applying the plan's benefit formula to the 
employee's years of service and (if applicable) average annual 
compensation, both determined as of that plan year.
    (ii) Example. The following example illustrates the rules in this 
paragraph (b)(3):

    Example. Plan A provides that the accrued benefit of each employee 
as of any plan year equals the employee's average annual compensation 
times a percentage that depends on the employee's years of service 
determined as of that plan year. The percentage is 2 percent for each of 
the first 10 years of service, plus 1.5 percent for each of the next 10 
years of service, plus 2 percent for all additional years of service. 
Plan A satisfies this paragraph (b)(3).

    (4) Safe harbor for plans using fractional accrual rule--(i) General 
rule. A plan satisfies the safe harbor in this paragraph (b)(4) for a 
plan year if it satisfies each of the following requirements:
    (A) The plan must satisfy the fractional accrual rule of section 
411(b)(1)(C).
    (B) Each employee's accrued benefit under the plan as of any plan 
year before the employee reaches normal retirement age must be 
determined by multiplying the employee's fractional rule benefit (within 
the meaning of Sec. 1.411(b)-1(b)(3)(ii)(A)) by a fraction, the 
numerator of which is the employee's years of service determined as of 
the plan year, and the denominator of which is the employee's projected 
years of service as of normal retirement age.

[[Page 114]]

    (C) The plan must satisfy one of the following requirements:
    (1) Under the plan, it must be impossible for any employee to accrue 
in a plan year a portion of the normal retirement benefit described in 
paragraph (b)(2)(i) of this section that is more than one-third larger 
than the portion of the same benefit accrued in that or any other plan 
year by any other employee, when each portion of the benefit is 
expressed as a percentage of each employee's average annual compensation 
or as a dollar amount. In making this determination, actual and 
potential employees in the plan with any amount of service at normal 
retirement must be taken into account (other than employees with more 
than 33 years of service at normal retirement age). In addition, in the 
case of a plan that satisfies section 401(l) in form, an employee is 
treated as accruing benefits at a rate equal to the excess benefit 
percentage in the case of a defined benefit excess plan or at a rate 
equal to the gross benefit percentage in the case of an offset plan.
    (2) The normal retirement benefit under the plan must be a flat 
benefit that requires a minimum of 25 years of service at normal 
retirement age for an employee to receive the unreduced flat benefit, 
determined without regard to section 415. For this purpose, a flat 
benefit is a benefit that is the same percentage of average annual 
compensation or the same dollar amount for all employees who have a 
minimum number of years of service at normal retirement age (e.g., 50 
percent of average annual compensation), with a pro rata reduction in 
the flat benefit for employees who have less than the minimum number of 
years of service at normal retirement age. An employee is permitted to 
accrue the maximum benefit permitted under section 415 over a period of 
less than 25 years, provided that the flat benefit under the plan, 
determined without regard to section 415, can accrue over no less than 
25 years.
    (3) The plan must satisfy the requirements of paragraph 
(b)(4)(i)(C)(2) of this section (other than the requirement that the 
minimum number of years of service for receiving the unreduced flat 
benefit is at least 25 years), and, for the plan year, the average of 
the normal accrual rates for all nonhighly compensated nonexcludable 
employees must be at least 70 percent of the average of the normal 
accrual rates for all highly compensated nonexcludable employees. The 
averages in the preceding sentence are determined taking into account 
all nonexcludable employees (regardless of whether they benefit under 
the plan). In addition, contributions and benefits under other plans of 
the employer are disregarded. For purposes of this paragraph 
(b)(4)(i)(C)(3), normal accrual rates are determined under paragraph (d) 
of this section.
    (ii) Examples. The following examples illustrate the rules in this 
paragraph (b)(4). In each example, it is assumed that the plan has never 
permitted employee contributions.

    Example 1. Plan A provides a normal retirement benefit equal to 1.6 
percent of average annual compensation times each year of service up to 
25. Plan A further provides that an employee's accrued benefit as of any 
plan year equals the employee's fractional rule benefit multiplied by a 
fraction, the numerator of which is the employee's years of service as 
of the plan year, and the denominator of which is the employee's 
projected years of service as of normal retirement age. The greatest 
benefit that an employee could accrue in any plan year is 1.6 percent of 
average annual compensation (this is the case for an employee with 25 or 
fewer years of projected service at normal retirement age). Among 
potential employees with 33 or fewer years of projected service at 
normal retirement age, the lowest benefit that an employee could accrue 
in any plan year is 1.212 percent of average annual compensation (this 
is the case for an employee with 33 years of projected service at normal 
retirement age). Plan A satisfies paragraph (b)(4)(i)(C)(1) of this 
section because 1.6 percent is not more than one third larger than 1.212 
percent.
    Example 2. Plan B provides a normal retirement benefit equal to 1.0 
percent of average annual compensation up to the integration level, and 
1.6 percent of average annual compensation above the integration level, 
times each year of service up to 35. Plan B further provides that an 
employee's accrued benefit as of any plan year equals the employee's 
fractional rule benefit multiplied by a fraction, the numerator of which 
is the employee's years of service as of the plan year and the 
denominator of which is the employee's projected years of service as of 
normal retirement age. For purposes of satisfying the one third larger 
rule in paragraph

[[Page 115]]

(b)(4)(i)(C)(1) of this section, because Plan B satisfies section 401(l) 
in form, all employees with less than 35 projected years of service are 
assumed to accrue benefits at the rate of 1.6 percent of average annual 
compensation (the excess benefit percentage under the plan). Plan B 
satisfies paragraph (b)(4)(i)(C) of this section because all employees 
with 33 or fewer years of projected service at normal retirement age 
accrue in each plan year a benefit of 1.6 percent of average annual 
compensation.
    Example 3. Plan C provides a normal retirement benefit equal to four 
percent of average annual compensation times each year of service up to 
10 and one percent of average annual compensation times each year of 
service in excess of 10 and not in excess of 30. Plan C further provides 
that an employee's accrued benefit as of any plan year equals the 
employee's fractional rule benefit multiplied by a fraction, the 
numerator of which is the employee's years of service as of the plan 
year, and the denominator of which is the employee's projected years of 
service as of normal retirement age. The greatest benefit that an 
employee could accrue in any plan year is four percent of average annual 
compensation (this is the case for an employee with 10 or fewer years of 
projected service at normal retirement age). Among employees with 33 or 
fewer years of projected service at normal retirement age, the lowest 
benefit that an employee could accrue in a plan year is 1.82 percent of 
average annual compensation (this is the case of an employee with 33 
years of projected service at normal retirement age). Plan C fails to 
satisfy this paragraph (b)(4) because four percent is more than one 
third larger than 1.82 percent. See also Sec. 1.401(a)(4)-9(c)(6), 
Example 3.
    Example 4. Plan D provides a normal retirement benefit of 100 
percent of average annual compensation, reduced by four percentage 
points for each year of service below 25 the employee has at normal 
retirement age. Plan D further provides that an employee's accrued 
benefit as of any plan year is equal to the employee's fractional rule 
benefit multiplied by a fraction, the numerator of which is the 
employee's years of service as of the plan year, and the denominator of 
which is the employee's projected years of service at normal retirement 
age. In the case of an employee who has five years of service as of the 
current plan year, and who is projected to have 10 years of service at 
normal retirement age, the employee's fractional rule benefit would be 
40 percent of average annual compensation, and the employee's accrued 
benefit as of the current plan year would be 20 percent of average 
annual compensation (the fractional rule benefit multiplied by a 
fraction of five years over 10 years). Plan D satisfies this paragraph 
(b)(4).
    Example 5. The facts are the same as in Example 4, except that the 
normal retirement benefit is 125 percent of average annual compensation, 
reduced by five percentage points for each year of service below 25 that 
the employee has at normal retirement age. Plan D satisfies this 
paragraph (b)(4), even though an employee may accrue the maximum benefit 
allowed under section 415 (i.e., 100 percent of the participant's 
average compensation for the high three years of service) in less than 
25 years.
    Example 6. The facts are the same as in Example 1, except that the 
plan determines each employee's accrued benefit by multiplying the 
employee's projected normal retirement benefit (rather than the 
fractional rule benefit) by the fraction described in Example 1. In 
determining an employee's projected normal retirement benefit, the plan 
defines each employee's average annual compensation as the average 
annual compensation the employee would have at normal retirement age if 
the employee's annual section 414(s) compensation in future plan years 
equaled the employee's plan year compensation for the prior plan year. 
Under these facts, Plan A does not satisfy paragraph (b)(4)(i)(B) of 
this section because the employee's accrued benefit is determined on the 
basis of a projected normal retirement benefit that is not the same as 
the employee's fractional rule benefit determined in accordance with 
Sec. 1.411(b)-1(b)(3)(ii)(A).
    Example 7. Plan E provides a normal retirement benefit of 50 percent 
of average annual compensation, with a pro rata reduction for employees 
with less than 30 years of service at normal retirement age. Plan E 
further provides that an employee's accrued benefit as of any plan year 
is equal to the employee's fractional rule benefit multiplied by a 
fraction, the numerator of which is the employee's years of service as 
of the plan year, and the denominator of which is the employee's 
projected years of service at normal retirement age. For purposes of 
determining this fraction, the plan limits the years of service taken 
into account for an employee to the number of years the employee has 
participated in the plan. However, all years of service (including years 
of service before the employee commenced participation in the plan) are 
taken into account in determining an employee's normal retirement 
benefit under the plan's benefit formula. Plan E fails to satisfy this 
paragraph (b)(4) because the years of service over which benefits accrue 
differ from the years of service used in applying the benefit formula 
under the plan. See paragraph (b)(2)(v) of this section.
    Example 8. (a) Plan F provides a normal retirement benefit equal to 
2.0 percent of average annual compensation, plus 0.65 percent of average 
annual compensation above covered compensation, for each year of service

[[Page 116]]

up to 25. Plan F further provides that an employee's accrued benefit as 
of any plan year equals the sum of--
    (1) The employee's fractional rule benefit (determined as if the 
normal retirement benefit under the plan equaled 2.0 percent of average 
annual compensation for each year of service up to 25) multiplied by a 
fraction, the numerator of which is the employee's years of service as 
of the plan year and the denominator of which is the employee's 
projected years of service as of normal retirement age; plus
    (2) 0.65 percent of the employee's average annual compensation above 
covered compensation multiplied by the employee's years of service (up 
to 25) as of the current plan year.
    (b) Although Plan F satisfies the fractional accrual rule of section 
411(b)(1)(C), the plan fails to satisfy this paragraph (b)(4) because 
the plan does not determine employees' accrued benefits in accordance 
with paragraph (b)(4)(i)(B) of this section.

    (5) Safe harbor for insurance contract plans. A plan satisfies the 
safe harbor in this paragraph (b)(5) if it satisfies each of the 
following requirements:
    (i) The plan must satisfy the accrual rule of section 411(b)(1)(F).
    (ii) The plan must be an insurance contract plan within the meaning 
of section 412(i).
    (iii) The benefit formula under the plan must be one that would 
satisfy the requirements of paragraph (b)(4) of this section if the 
stated normal retirement benefit under the formula accrued ratably over 
each employee's period of plan participation through normal retirement 
age in accordance with paragraph (b)(4)(i)(B) of this section. Thus, the 
benefit formula may not recognize years of service before an employee 
commenced participation in the plan because, otherwise, the definition 
of years of service for determining the normal retirement benefit would 
differ from the definition of years of service for determining the 
accrued benefit under paragraph (b)(4)(i)(B) of this section. See 
paragraph (b)(4)(ii), Example 7, of this section. Notwithstanding the 
foregoing, an insurance contract plan adopted and in effect on September 
19, 1991, may continue to recognize years of service prior to an 
employee's participation in the plan for an employee who is a 
participant in the plan on that date to the extent provided by the 
benefit formula in the plan on such date.
    (iv) The scheduled premium payments under an individual or group 
insurance contract used to fund an employee's normal retirement benefit 
must be level annual payments to normal retirement age. Thus, payments 
may not be scheduled to cease before normal retirement age.
    (v) The premium payments for an employee who continues benefiting 
after normal retirement age must be equal to the amount necessary to 
fund additional benefits that accrue under the plan's benefit formula 
for the plan year.
    (vi) Experience gains, dividends, forfeitures, and similar items 
must be used solely to reduce future premiums.
    (vii) All benefits must be funded through contracts of the same 
series. Among other requirements, contracts of the same series must have 
cash values based on the same terms (including interest and mortality 
assumptions) and the same conversion rights. A plan does not fail to 
satisfy this requirement, however, if any change in the contract series 
or insurer applies on the same terms to all employees. But see Sec. 
1.401(a)(4)-5(a)(4), Example 12 (change in insurer considered a plan 
amendment subject to Sec. 1.401(a)(4)-5(a)).
    (viii) If permitted disparity is taken into account, the normal 
retirement benefit stated under the plan's benefit formula must satisfy 
Sec. 1.401(l)-3. For this purpose, the 0.75-percent factor in the 
maximum excess or offset allowance in Sec. 1.401(l)-3(b)(2)(i) or 
(b)(3)(i), respectively, adjusted in accordance with Sec. 1.401(l)-
3(d)(9) and (e), is reduced by multiplying the factor by 0.80.
    (6) Use of safe harbors not precluded by certain plan provisions--
(i) In general. A plan does not fail to satisfy this paragraph (b) 
merely because the plan contains one or more of the provisions described 
in this paragraph (b)(6). Unless otherwise provided, any such provision 
must apply uniformly to all employees.
    (ii) Section 401(l) permitted disparity. The plan takes permitted 
disparity into account in a manner that satisfies section 401(l) in 
form. Thus, differences in employees' benefits under the plan 
attributable to uniform disparities permitted under Sec. 1.401(l)-3 
(including differences in disparities that are deemed uniform under 
Sec. 1.401(l)-3(c)(2)) do not

[[Page 117]]

cause a plan to fail to satisfy this paragraph (b).
    (iii) Different entry dates. The plan provides one or more entry 
dates during the plan year as permitted by section 410(a)(4).
    (iv) Certain conditions on accruals. The plan provides that an 
employee's accrual for the plan year is less than a full accrual 
(including a zero accrual) because of a plan provision permitted by the 
year-of-participation rules of section 411(b)(4).
    (v) Certain limits on accruals. The plan limits benefits otherwise 
provided under the benefit formula or accrual method to a maximum dollar 
amount or to a maximum percentage of average annual compensation (e.g., 
by limiting service taken into account in the benefit formula) or in 
accordance with section 401(a)(5)(D), applies the limits of section 415, 
or limits the dollar amount of compensation taken into account in 
determining benefits.
    (vi) Dollar accrual per uniform unit of service. The plan determines 
accruals based on the same dollar amount for each uniform unit of 
service (not to exceed one week) performed by each employee with the 
same number of years of service under the plan during the plan year. The 
preceding sentence applies solely for purposes of the unit credit safe 
harbor in paragraph (b)(3) of this section.
    (vii) Prior benefits accrued under a different formula. The plan 
determines benefits for years of service after a fresh-start date for 
all employees under a benefit formula and accrual method that differ 
from the benefit formula and accrual method previously used to determine 
benefit accruals for employees in a fresh-start group for years of 
service before the fresh-start date. This paragraph (b)(6)(vii) applies 
solely to plans that satisfy Sec. 1.401(a)(4)-13(c) with respect to the 
fresh start.
    (viii) Employee contributions. The plan is a contributory DB plan 
that would satisfy the requirements of paragraph (b) of this section if 
the plan's benefit formula provided benefits at employees' employer-
provided benefit rates determined under Sec. 1.401(a)(4)-6(b). This 
paragraph (b)(6)(viii) does not apply to a plan tested under paragraph 
(b)(4) or (b)(5) of this section unless the plan satisfies one of the 
methods in Sec. 1.401(a)(4)-6 (b)(4) through (b)(6). A minimum benefit 
added to the plan solely to satisfy Sec. 1.401(a)(4)-6(b)(3) is not 
taken into account in determining whether this paragraph (b)(6)(viii) is 
satisfied.
    (ix) Certain subsidized optional forms. The plan provides a 
subsidized optional form of benefit that is available to fewer than 
substantially all employees because the optional form of benefit has 
been eliminated prospectively as provided in Sec. 1.401(a)(4)-4(b)(3).
    (x) Lower benefits for HCEs--(A) General rule. The benefits 
(including any subsidized optional form of benefit) provided to one or 
more HCEs under the plan are inherently less valuable to those HCEs 
(determined by applying the principles of Sec. 1.401(a)(4)-4(d)(4)) 
than the benefits that would otherwise be provided to those HCEs if the 
plan satisfied this paragraph (b) (determined without regard to this 
paragraph (b)(6)(x)). These inherently less valuable benefits are deemed 
to satisfy this paragraph (b).
    (B) Examples. The following examples illustrate the rules in this 
paragraph (b)(6)(x):

    Example 1. Plan A would satisfy this paragraph (b) (determined 
without regard to this paragraph (b)(6)(x)), except for the fact that it 
fails to satisfy the requirement of paragraph (b)(2)(iii) of this 
section (i.e., a subsidized optional form must be available to 
substantially all employees on similar terms). Each subsidized optional 
form in the plan is available to all the NHCEs on similar terms, but one 
of the subsidized optional forms of benefit is not available to any of 
the HCEs. Plan A satisfies this paragraph (b), because Plan A is a safe 
harbor plan with respect to the NHCEs and provides inherently less 
valuable benefits to the HCEs.
    Example 2. (a) Plan B would satisfy this paragraph (b) (determined 
without regard to this paragraph (b)(6)(x)), except for the fact that 
some employees are not being credited with years of service under the 
plan, but are continuing to accrue benefits as a result of compensation 
increases. These are employees who have been transferred from the 
employer that sponsors Plan B to another member of the controlled group 
whose employees are not covered by Plan B. For these employees, Plan B 
fails to satisfy the requirement of paragraph (b)(2)(v) of this section 
(i.e., each employee's benefit must accrue over the same years of 
service used in applying the benefit formula).

[[Page 118]]

    (b) Plan B is restructured into two component plans under the 
provisions of Sec. 1.401(a)(4)-9(c). One component plan (Component Plan 
B1) consists of all NHCEs who are not being credited with years of 
service under the plan's benefit formula but are continuing to accrue 
benefits as a result of compensation increases, and the other component 
plan (Component Plan B2) consists of the balance of the employees.
    (c) Component Plan B1 satisfies this section and section 410(b), 
because it benefits only NHCEs.
    (d) Component Plan B2 is treated as satisfying this paragraph (b), 
because Plan B would satisfy this paragraph (b) (determined without 
regard to this paragraph (b)(6)(x)) with respect to the employees in 
Component Plan B2 but for the fact that it provides inherently less 
valuable benefits to some HCEs in that component plan (i.e., the 
employees who are credited only with compensation increases rather than 
both years of service and compensation increases).
    (e) Under Sec. 1.401(a)(4)-9(c), if Component Plan B2 satisfies 
section 410(b), then Plan B satisfies this section.

    (xi) Multiple formulas--(A) General rule. The plan provides that an 
employee's benefit under the plan is the greater of the benefits 
determined under two or more formulas, or is the sum of the benefits 
determined under two or more formulas. This paragraph (b)(6)(xi) does 
not apply to a plan unless each of the formulas under the plan satisfies 
the requirements of paragraph (b)(6)(xi) (B) through (D) of this 
section.
    (B) Sole formulas. The formulas must be the only formulas under the 
plan.
    (C) Separate testing. Each of the formulas must separately satisfy 
the uniformity requirements of paragraph (b)(2) of this section and also 
separately satisfy one of the safe harbors in paragraphs (b)(3) through 
(b)(5) of this section. A formula that is available solely to some or 
all NHCEs is deemed to satisfy this paragraph (b)(6)(xi)(C).
    (D) Availability--(1) General rule. All of the formulas must be 
available on the same terms to all employees.
    (2) Formulas for NHCEs. A formula does not fail to be available on 
the same terms to all employees merely because the formula is not 
available to any HCEs, but is available to some or all NHCEs on the same 
terms as all of the other formulas in the plan.
    (3) Top-heavy formulas. Rules parallel to those in Sec. 
1.401(a)(4)-2(b)(4)(vi)(D)(3) apply in the case of a plan that provides 
the greater of the benefits under two or more formulas, one of which is 
a top-heavy formula. For purposes of this paragraph (b)(6)(xi)(D)(3), a 
top-heavy formula is a formula that provides a benefit equal to the 
minimum benefit described in section 416(c)(1) (taking into account, if 
applicable, the modification in section 416(h)(2)(A)(ii)(I)).
    (E) Provisions may be applied more than once. The provisions of this 
paragraph (b)(6)(xi) may be applied more than once. See Sec. 
1.401(a)(4)-2(b)(4)(vi)(E) for an example of the application of these 
provisions more than once.
    (F) Examples. The following examples illustrate the rules in this 
paragraph (b)(6)(xi):

    Example 1. Under Plan A, each employee's benefit equals the sum of 
the benefits determined under two formulas. The first formula provides 
one percent of average annual compensation per year of service. The 
second formula provides $10 per year of service. Plan A is eligible to 
apply the rules in this paragraph (b)(6)(xi).
    Example 2. Under Plan B, each employee's benefit equals the greater 
of the benefits determined under two formulas. The first formula 
provides $15 per year of service and is available to all employees who 
complete at least 500 hours of service during the plan year. The second 
formula provides 1.5 percent of average annual compensation per year of 
service and is available to all employees who complete at least 1,000 
hours of service during the plan year. Plan B does not satisfy this 
paragraph (b)(6)(xi) because the two formulas are not available on the 
same terms to all employees.
    Example 3. Under Plan C, each employee's benefit equals the greater 
of the benefits determined under two formulas. The first formula 
provides $15 per year of service and is available to all employees who 
complete at least 1,000 hours of service during the plan year. The 
second formula provides the minimum benefit described in section 
416(c)(1) and is available to all non-key employees who complete at 
least 1,000 hours of service during the plan year. Plan C does not 
satisfy the general rule in paragraph (b)(6)(xi)(D)(1) of this section 
because the two formulas are not available on the same terms to all 
employees (i.e., the second formula is only available to all non-key 
employees). Nonetheless, because the second formula is a top-heavy 
formula, the special availability rules for top-heavy formulas in 
paragraph (b)(6)(xi)(D)(3) of this section apply. Thus, the second 
formula does not fail to be available on the same terms as the first 
formula

[[Page 119]]

merely because the second formula is available solely to all non-key 
employees on the same terms. This is true even if the plan conditions 
the availability of the second formula on the plan's being top-heavy for 
the plan year.
    Example 4. Under Plan D, each employee's benefit equals the greater 
of the benefits determined under two formulas. The first formula is 
available to all employees and provides a benefit equal to 1.5 percent 
of average annual compensation per year of service. The second formula 
is only available to NHCEs and provides a benefit equal to two percent 
of average annual compensation per year of service, minus two percent of 
the primary insurance amount per year of service. The amount of the 
offset is not limited to the maximum permitted offset under Sec. 
1.401(l)-3(b). Under paragraph (b)(6)(xi)(D)(2) of this section, both 
formulas are treated as available to all employees on the same terms. 
Furthermore, even though the second formula does not satisfy any of the 
safe harbors in this paragraph (b), the formula is deemed to satisfy the 
separate testing requirement under paragraph (b)(6)(xi)(C) of this 
section, because the formula is available solely to some or all NHCEs.
    Example 5. Plan E is a unit credit plan that provides a benefit of 
one percent of average annual compensation per year of service to all 
employees. In 1994, the plan is amended to provide a benefit of two 
percent of average annual compensation per year of service after 1993, 
while continuing to provide a benefit of one percent of average annual 
compensation per year of service for all years of service before 1994. 
Thus, the plan's amended benefit formula provides a benefit equal to the 
sum of the benefits determined under two benefit formulas: one percent 
of average annual compensation per year of service, plus one percent of 
average annual compensation per year of service after 1993. Plan E 
satisfies this paragraph (b)(6)(xi).
    Example 6. The facts are the same as in Example 5, except that the 
plan amendment in 1994 decreases the benefit to 0.75 percent of average 
annual compensation per year of service after 1993, while retaining the 
one-percent formula for all years of service before 1994. Thus, the 
plan's amended benefit formula provides a benefit equal to the sum of 
the benefits determined under two benefit formulas: 0.75 percent of 
average annual compensation per year of service, plus 0.25 percent of 
average annual compensation per year of service before 1994. Under these 
facts, the second formula does not separately satisfy any of the safe 
harbors in this paragraph (b) because the years of service over which 
each employee's benefit accrues under the second formula (i.e., all 
years of service) are not the same years of service that are taken into 
account in applying the benefit formula under the plan to that employee 
(i.e., years of service before 1994). See paragraph (b)(2)(v) of this 
section. But see paragraph (b)(6)(vii) of this section and Sec. 
1.401(a)(4)-13, which provide rules under which Plan E, as amended, may 
be able to satisfy this paragraph (b).
    Example 7. Plan F provides a benefit to all employees of one percent 
of average annual compensation per year of service. Employee M was hired 
as the president of the employer in December 1994 and was not a HCE 
under section 414(q) during the 1994 calendar plan year. In 1994, Plan F 
is amended to provide a benefit that is the greater of the benefit 
determined under the pre-existing formula in the plan and a new formula 
that is available solely to some NHCEs (including Employee M). The new 
formula does not satisfy the uniformity requirements of paragraph (b)(2) 
of this section, because it provides a different benefit for some NHCEs 
than for other NHCEs. As a result of this change, Employee M receives a 
higher accrual in 1994 than the NHCEs who are not eligible for the new 
formula. In 1995, when Employee M first becomes a HCE, the second 
formula no longer applies to Employee M. It would be inconsistent with 
the purpose of preventing discrimination in favor of HCEs for Plan F to 
use the special rule for a formula that is available solely to some or 
all NHCEs to satisfy the separate testing requirement of paragraph 
(b)(6)(xi)(C) of this section for the 1994 calendar plan year. See Sec. 
1.401(a)(4)-1(c)(2).

    (c) General test for nondiscrimination in amount of benefits--(1) 
General rule. The employer-provided benefits under a defined benefit 
plan are nondiscriminatory in amount for a plan year if each rate group 
under the plan satisfies section 410(b). For purposes of this paragraph 
(c)(1), a rate group exists under a plan for each HCE and consists of 
the HCE and all other employees (both HCEs and NHCEs) who have a normal 
accrual rate greater than or equal to the HCE's normal accrual rate, and 
who also have a most valuable accrual rate greater than or equal to the 
HCE's most valuable accrual rate. Thus, an employee is in the rate group 
for each HCE who has a normal accrual rate less than or equal to the 
employee's normal accrual rate, and who also has a most valuable accrual 
rate less than or equal to the employee's most valuable accrual rate.
    (2) Satisfaction of section 410(b) by a rate group. For purposes of 
determining whether a rate group satisfies section 410(b), the same 
rules apply as in Sec. 1.401(a)(4)-2(c)(3). See paragraph (c)(4) of 
this section and Sec. 1.401(a)(4)-2(c)(4),

[[Page 120]]

Example 3 through Example 5, for examples of this rule.
    (3) Certain violations disregarded. A plan is deemed to satisfy 
paragraph (c)(1) of this section if the plan would satisfy that 
paragraph by treating as not benefiting no more than five percent of the 
HCEs in the plan, and the Commissioner determines that, on the basis of 
all of the relevant facts and circumstances, the plan does not 
discriminate with respect to the amount of employer-provided benefits. 
For this purpose, five percent of the number of HCEs may be determined 
by rounding to the nearest whole number (e.g., 1.4 rounds to 1 and 1.5 
rounds to 2). Among the relevant factors that the Commissioner may 
consider in making this determination are--
    (i) The extent to which the plan has failed the test in paragraph 
(c)(1) of this section;
    (ii) The extent to which the failure is for reasons other than the 
design of the plan;
    (iii) Whether the HCEs causing the failure are five-percent owners 
or are among the highest paid nonexcludable employees;
    (iv) Whether the failure is attributable to an event that is not 
expected to recur (e.g., a plant closing); and
    (v) The extent to which the failure is attributable to benefits 
accrued under a prior benefit structure or to benefits accrued when a 
participant was not a HCE.
    (4) Examples. The following examples illustrate the rules in this 
paragraph (c):

    Example 1. (a) Employer X has 1100 nonexcludable employees, N1 
through N1000, who are NHCEs, and H1 through H100, who are HCEs. 
Employer X maintains Plan A, a defined benefit plan that benefits all of 
these nonexcludable employees. The normal and most valuable accrual 
rates (determined as a percentage of average annual compensation) for 
the employees in Plan A for the 1994 plan year are listed in the 
following table.

------------------------------------------------------------------------
                                                                 Most
                                                     Normal    valuable
                     Employee                       accrual     accrual
                                                      rate       rate
------------------------------------------------------------------------
N1 through N100..................................        1.0        1.4
N101 through N500................................        1.5        3.0
N501 through N750................................        2.0        2.65
N751 through N1000...............................        2.3        2.8
H1 through H50...................................        1.5        2.0
H51 through H100.................................        2.0        2.65
------------------------------------------------------------------------

    (b) There are 100 rate groups in Plan A because there are 100 HCEs 
in Plan A.
    (c) Rate group 1 consists of H1 and all those employees who have a 
normal accrual rate greater than or equal to H1's normal accrual rate 
(1.5 percent) and who also have a most valuable accrual rate greater 
than or equal to H1's most valuable accrual rate (2.0 percent). Thus, 
rate group 1 consists of H1 through H100 and N101 through N1000.
    (d) Rate group 1 satisfies the ratio percentage test of Sec. 
1.410(b)-2(b)(2) because the ratio percentage of the rate group is 90 
percent, i.e., 90 percent (the percentage of all nonhighly compensated 
nonexcludable employees who are in the rate group) divided by 100 
percent (the percentage of all highly compensated nonexcludable 
employees who are in the rate group).
    (e) Because H1 through H50 have the same normal accrual rates and 
the same most valuable accrual rates, the rate group with respect to 
each of them is identical. Thus, because rate group 1 satisfies section 
410(b), rate groups 2 through 50 also satisfy section 410(b).
    (f) Rate group 51 consists of H51 and all those employees who have a 
normal accrual rate greater than or equal to H51's normal accrual rate 
(2.0 percent) and who also have a most valuable accrual rate greater 
than or equal to H51's most valuable accrual rate (2.65 percent). Thus, 
rate group 51 consists of H51 through H100 and N501 through N1000. (Even 
though N101 through N500 have a most valuable accrual rate (3.0 percent) 
greater than H51's most valuable accrual rate (2.65 percent), they are 
not included in this rate group because their normal accrual rate (1.5 
percent) is less than H51's normal accrual rate (2.0 percent).)
    (g) Rate group 51 satisfies the ratio percentage test of Sec. 
1.410(b)-2(b)(2) because the ratio percentage of the rate group is 100 
percent, i.e., 50 percent (the percentage of all nonhighly compensated 
nonexcludable employees who are in the rate group) divided by 50 percent 
(the percentage of all highly compensated nonexcludable employees who 
are in the rate group).
    (h) Because H51 through H100 have the same normal accrual rates and 
the same most valuable accrual rates, the rate group with respect to 
each of them is identical. Thus, because rate group 51 satisfies section 
410(b), rate groups 52 through 100 also satisfy section 410(b).
    (i) The employer-provided benefits under Plan A are 
nondiscriminatory in amount because each rate group under the plan 
satisfies section 410(b).
    Example 2. The facts are the same as in Example 1, except that H96 
has a most valuable accrual rate of 3.5. Each of the rate groups is the 
same as in Example 1, except that rate group 96 consists solely of H96 
because no other employee has a most valuable accrual

[[Page 121]]

rate greater than 3.5. Because the plan would satisfy the test in 
paragraph (c)(1) of this section by treating H96 (who constitutes less 
than five percent of the HCEs in the plan) as not benefiting, the 
Commissioner may determine under paragraph (c)(3) of this section that, 
on the basis of all of the relevant facts and circumstances, the plan 
does not discriminate with respect to the amount of benefits.

    (d) Determination of accrual rates--(1) Definitions--(i) Normal 
accrual rate. The normal accrual rate for an employee for a plan year is 
the increase in the employee's accrued benefit (within the meaning of 
section 411(a)(7)(A)(i)) during the measurement period, divided by the 
employee's testing service during the measurement period, and expressed 
either as a dollar amount or as a percentage of the employee's average 
annual compensation.
    (ii) Most valuable accrual rate. The most valuable accrual rate for 
an employee for a plan year is the increase in the employee's most 
valuable optional form of payment of the accrued benefit during the 
measurement period, divided by the employee's testing service during the 
measurement period, and expressed either as a dollar amount or as a 
percentage of the employee's average annual compensation. The employee's 
most valuable optional form of payment of the accrued benefit is 
determined by calculating for the employee the normalized QJSA 
associated with the accrued benefit that is potentially payable in the 
current or any future plan year at any age under the plan and selecting 
the largest (per year of testing service). If the plan provides a QSUPP, 
the most valuable accrual rate also takes into account the QSUPP payable 
in conjunction with the QJSA at each age under the plan. Thus, the most 
valuable accrual rate reflects the value of all benefits accrued or 
treated as accrued under section 411(d)(6) that are payable in any form 
and at any time under the plan, including early retirement benefits, 
retirement-type subsidies, early retirement window benefits, and QSUPPs. 
In addition, the most valuable accrual rate must take into account any 
such benefits that are available during a plan year, even if the 
benefits cease to be available before the end of the current or any 
future plan year.
    (iii) Measurement period. The measurement period can be--
    (A) The current plan year;
    (B) The current plan year and all prior years; or
    (C) The current plan year and all prior and future years.
    (iv) Testing service--(A) General rule. Testing service means an 
employee's years of service as defined in the plan for purposes of 
applying the benefit formula under the plan, subject to the requirements 
of paragraph (d)(1)(iv)(B) of this section. Alternatively, testing 
service means service determined for all employees in a reasonable 
manner that satisfies the requirements of paragraph (d)(1)(iv)(B) of 
this section. For example, the number of plan years that an employee has 
benefited under the plan within the meaning of Sec. 1.410(b)-3(a) is an 
acceptable definition of testing service because it determines service 
in a reasonable manner and satisfies paragraph (d)(1)(iv)(B) of this 
section. See also Sec. 1.401(a)(4)-11(d)(3) (additional limits on 
service that may be taken into account as testing service).
    (B) Requirements for testing service--(1) Employees not credited 
with years of service under the benefit formula. An employee must be 
credited with testing service for any year in which the employee 
benefits under the plan (within the meaning of Sec. 1.410(b)-3(a)), 
unless that year is part of a period of service that may not be taken 
into account under Sec. 1.401(a)(4)-11(d)(3). This rule applies even if 
the employee does not receive service credit under the benefit formula 
for that year (e.g., because of a service cap in the benefit formula or 
because of a transfer out of the group of employees covered by the 
plan).
    (2) Current year testing service. In the case of a measurement 
period that is the current plan year, testing service for the plan year 
equals one (1).
    (2) Rules of application--(i) Consistency requirement. Both normal 
and most valuable accrual rates must be determined in a consistent 
manner for all employees for the plan year. Thus, for example, the same 
measurement periods must be used, and the rules of this paragraph (d)(2) 
and any available options described in paragraph (d)(3) of this section 
must be applied consistently. If plan benefits are not expressed

[[Page 122]]

as straight life annuities beginning at employees' testing ages, they 
must be normalized.
    (ii) Determining plan benefits, service and compensation--(A) In 
general. Potential plan benefits, testing service, and average annual 
compensation must be determined in a reasonable manner, reflecting 
actual or projected service and compensation only through the end of the 
measurement period. The determination of potential plan benefits is not 
reasonable if it incorporates an assumption that, in future years, an 
employee's compensation will increase or the employee will terminate 
employment before the employee's testing age (other than the assumptions 
under paragraph (d)(1)(ii) of this section that the employee's service 
will end in connection with the payment of each potential QJSA in future 
years).
    (B) Section 415 limits. For purposes of determining accrual rates 
under this paragraph (d), plan benefits are generally determined without 
regard to whether those benefits are permitted to be paid under section 
415. However, plan provisions implementing any of the limits of section 
415 may be taken into account in applying this paragraph (d) if the plan 
does not provide for benefit increases resulting from section 415(d)(1) 
adjustments for former employees who were employees in a plan year in 
which such plan provisions were taken into account in applying this 
paragraph (d). If the limits of section 415 are taken into account under 
this paragraph (d)(2)(ii)(B) as of the end of the measurement period, 
they must also be taken into account as of the beginning of the 
measurement period. If the limits of section 415 are not taken into 
account in testing the plan for the current plan year, but were taken 
into account in testing the plan for the preceding plan year, any 
resulting increase in the accrued benefits taken into account in testing 
the plan is treated as an increase in accrued benefits during the 
current plan year.
    (iii) Requirements for measurement period that includes future 
years--(A) Discriminatory pattern of accruals. A measurement period that 
includes future years (as described in paragraph (d)(1)(iii)(C) of this 
section) may not be used if the pattern of accruals under the plan 
discriminates in favor of HCEs (i.e., if projected benefits for HCEs are 
relatively frontloaded when compared to the degree of front loading or 
backloading for NHCEs). This determination is made based on all of the 
relevant facts and circumstances.
    (B) Future-period limitation. Future years beginning after an 
employee's attainment of the employee's testing age (or after the 
employee's assumed termination in the case of most valuable accrual 
rates) may not be included in the measurement period.
    (3) Optional rules--(i) Imputation of permitted disparity. The 
disparity permitted under section 401(l) may be imputed in accordance 
with the rules of Sec. 1.401(a)(4)-7.
    (ii) Grouping of accrual rates--(A) General rule. An employer may 
treat all employees who have accrual rates within a specified range 
above and below a midpoint rate chosen by the employer as having an 
accrual rate equal to the midpoint rate within that range. Accrual rates 
within a given range may not be grouped under this paragraph (d)(3)(ii) 
if the accrual rates of HCEs within the range generally are 
significantly higher than the accrual rates of NHCEs in the range. The 
specified ranges within which all employees are treated as having the 
same accrual rate may not overlap and may be no larger than provided in 
paragraph (d)(3)(ii)(B) of this section. Accrual rates of employees that 
are not within any of these specified ranges are determined without 
regard to this paragraph (d)(3)(ii).
    (B) Size of specified ranges. In the case of normal accrual rates, 
the lowest and highest accrual rates in the range must be within five 
percent (not five percentage points) of the midpoint rate. In the case 
of most valuable accrual rates, the lowest and highest accrual rates in 
the range must be within 15 percent (not 15 percentage points) of the 
midpoint rate. If accrual rates are determined as a percentage of 
average annual compensation, the lowest and highest accrual rates need 
not be within five percent (or 15 percent) of the midpoint rate, if they 
are no more than one twentieth of a percentage point above or below the 
midpoint rate.

[[Page 123]]

    (iii) Fresh-start alternative--(A) General rule. Notwithstanding the 
definition of measurement period provided in paragraph (d)(1)(iii) of 
this section, a measurement period for a fresh-start group is permitted 
to be limited to the period beginning after the fresh-start date with 
respect to that group if the plan makes a fresh start that satisfies 
Sec. 1.401(a)(4)-13(c) (without regard to Sec. 1.401(a)(4)-13(c)(2)(i) 
and (ii)). If the measurement period is so limited or the measurement 
period is the plan year (whether or not so limited), any compensation 
adjustments during the measurement period to the frozen accrued benefit 
as of the fresh-start date that are permitted under the rules of Sec. 
1.401(a)(4)-13(d) may be disregarded in determining the increase in 
accrued benefits during the measurement period, but only if--
    (1) The plan makes a fresh start as of the fresh-start date that 
satisfies Sec. 1.401(a)(4)-13(c) (without regard to Sec. 1.401(a)(4)-
13(c)(2)(ii)) in conjunction with a bona fide amendment to the benefit 
formula or accrual method under the plan; and
    (2) The amendment provides for adjustments to employees' frozen 
accrued benefits as of the fresh-start date in accordance with the rules 
of Sec. 1.401(a)(4)-13(d).
    (B) Application of consistency requirements. Limiting the 
application of the fresh-start alternative in this paragraph (d)(3)(iii) 
to a fresh-start group that consists of fewer than all employees does 
not violate the consistency requirement of paragraph (d)(2)(i) of this 
section.
    (iv) Floor on most valuable accrual rate. In lieu of determining an 
employee's most valuable accrual rate in accordance with the definition 
in paragraph (d)(1)(ii) of this section, an employer may determine an 
employee's most valuable accrual rate for the current plan year as the 
employee's highest most valuable accrual rate determined for any prior 
plan year. This option may be used only if the employee's normal accrual 
rate has not changed significantly from the normal accrual rate for the 
relevant prior plan year and, there have been no plan amendments in the 
interim period since that prior plan year that affect the determination 
of most valuable accrual rates.
    (4) Examples. The following examples illustrate the rules in this 
paragraph (d):

    Example 1. The employees in Plan A have the following normal accrual 
rates (expressed as percentage of average annual compensation): 0.8 
percent, 0.83 percent, 0.9 percent, 1.9 percent, 2.0 percent, and 2.1 
percent. Because the first three rates are within a range of no more 
than one twentieth of a percentage point above or below 0.85 percent (a 
midpoint rate chosen by the employer), the employer may treat the 
employees who have those rates as having an accrual rate of 0.85 percent 
(provided that the accrual rates of HCEs within the range are not 
significantly higher than the accrual rates for NHCEs within the range). 
Because the last three rates are within a range of no more than five 
percent above or below 2.0 percent (a midpoint rate chosen by the 
employer), the employer may treat the employees who have those rates as 
having an accrual rate of 2.0 percent (provided that the accrual rates 
of HCEs within the range are not significantly higher than the accrual 
rates for NHCEs within the range).
    Example 2. Employer X maintains a plan under which headquarters 
employees accrue a benefit of 1.25 percent of average compensation for 
the first 10 years of service and 0.75 percent of average compensation 
for subsequent years of service, while all other employees accrue a 
benefit of one percent of compensation for all years of service. Assume 
that the group of headquarters employees does not satisfy section 
410(b). Under these facts, the pattern of accruals under the plan 
discriminates in favor of HCEs, and, therefore, under paragraph 
(d)(2)(iii)(A) of this section, the measurement period for determining 
accrual rates under the plan may not include future service.

    (e) Compensation rules--(1) In general. This paragraph (e) provides 
rules for determining average annual compensation. Safe harbor plans 
that satisfy paragraph (b) of this section must determine benefits 
either as a dollar amount unrelated to employees' compensation or as a 
percentage of each employee's average annual compensation. In contrast, 
plans that must satisfy the general test of paragraph (c) of this 
section are not required under this section to determine benefits under 
any particular definition of compensation or in any particular manner, 
but the accrual rates used in testing these

[[Page 124]]

plans must be expressed either as a dollar amount or determined as a 
percentage of each employee's average annual compensation.
    (2) Average annual compensation--(i) General rule. An employee's 
average annual compensation is the average of the employee's annual 
section 414(s) compensation determined over the averaging period in the 
employee's compensation history during which the average of the 
employee's annual section 414(s) compensation is the highest. For this 
purpose, an averaging period must consist of three or more consecutive 
12-month periods, but need not be longer than the employee's period of 
employment. An employee's compensation history may begin at any time, 
but must be continuous, be no shorter than the averaging period, and end 
in the current plan year.
    (ii) Certain permitted modifications to average annual 
compensation--(A) Use of plan year compensation. If the measurement 
period for determination of accrual rates is the current plan year, or 
the plan is an accumulation plan that satisfies paragraph (b) of this 
section, then plan year compensation may be substituted for average 
annual compensation.
    (B) Drop-out years. Any of the following types of 12-month periods 
in an employee's compensation history may be disregarded in determining 
the employee's average annual compensation (including for purposes of 
the requirement to average section 414(s) compensation over consecutive 
12-month periods), but only if the plan disregards the employee's 
compensation for those periods in determining benefits--
    (1) The 12-month period in which the employee terminates employment;
    (2) All 12-month periods in which the employee performs no services; 
or
    (3) All 12-month periods in which the employee performs services for 
less than a specified number of hours or specified period of time in the 
12-month period. The specified number of hours or specified period of 
time may be selected by the employer, but may not exceed three quarters 
of the time that an employee in the same job category working on a full-
time basis would perform services during that 12-month period.
    (C) Drop-out months within 12-month periods. If a plan determines an 
employee's average annual compensation using 12-month periods that do 
not end on a fixed date (e.g., average annual compensation as of a date 
is defined as the average of the employee's section 414(s) compensation 
for the 60 consecutive months within the compensation history in which 
the average is highest), then, for purposes of determining a 12-month 
period, any of the following type of months may be disregarded 
(including for purposes of the requirement to average section 414(s) 
compensation over consecutive 12-month periods), but only if the plan 
disregards the employee's compensation for those months in determining 
benefits--
    (1) The month in which the employee terminates employment;
    (2) All months in which the employee performs no services; or
    (3) All months in which the employee performs services for less than 
a specified number of hours or specified period of time in the month. 
The specified number of hours or specified period of time may be 
selected by the employer, but may not exceed three quarters of the time 
that an employee in the same job category working on a full-time basis 
would perform services during that month.
    (D) Employees working less than full-time. In the case of an 
employee who normally works less than full-time, the rules in paragraphs 
(e)(2)(ii)(B)(3) and (e)(2)(ii)(C)(3) of this section may be applied in 
relation to that employee's normal work schedule (instead of a full- 
time employee's work schedule) by prorating the specified number of 
hours or specified period of time, based on the employee's normal work 
schedule as a fraction of a full-time schedule.
    (E) Exception from consecutive-periods requirement for certain 
plans. The requirement that the periods taken into account under 
paragraph (e)(2)(i) of this section be consecutive does not apply in the 
case of a plan that is not a section 401(l) plan, provided that it does 
not take permitted disparity into account under Sec. 1.401(a)(4)-7. 
This paragraph (e)(2)(ii)(E) applies only if the plan does not take into 
account whether 12-month periods of compensation

[[Page 125]]

are consecutive in determining average compensation for purposes of 
calculating benefits.
    (iii) Consistency requirements. Average annual compensation must be 
determined in a consistent manner for all employees.
    (3) Examples. The following examples illustrate the rules in this 
paragraph (e):

    Example 1. Plan A is a defined benefit plan. Plan A determines 
benefits on the basis of the average of each employee's annual 
compensation for the five consecutive plan years (or the employee's 
period of employment, if shorter) during the employee's compensation 
history in which the average of the employee's annual compensation is 
the highest. The compensation history used for this purpose is the last 
10 plan years, plus the current plan year. In determining compensation 
for each plan year in the compensation history, Plan A defines 
compensation using a single definition that satisfies section 414(s) as 
a safe harbor definition under Sec. 1.414(s)-1(c). Plan A determines 
benefits on the basis of average annual compensation.
    Example 2. Plan B is a defined benefit plan. Plan B determines 
benefits on the basis of the average of each employee's compensation for 
the five consecutive 12-month periods (or the employee's period of 
employment, if shorter) during the employee's compensation history in 
which the average of the employee's annual compensation is the highest. 
The compensation history used for this purpose is the 10 consecutive 12-
month periods ending on the employee's termination date. In determining 
the average, Plan B disregards all months in which the employee performs 
services for less than 100 hours (60 percent of a full-time work 
schedule of 173 hours). In the case of an employee whose normal work 
schedule is less than a full-time schedule, Plan B disregards all months 
in which that employee performs services for less than 60 percent of the 
employee's normal work schedule. Plan B defines compensation for each 
12-month period using a single definition that satisfies Sec. 1.414(s)-
1. Plan B determines benefits on the basis of average annual 
compensation.
    Example 3. (a) The facts are the same as in Example 1, except that, 
for plan years prior to 1996, the compensation for a plan year was 
determined under a rate of pay definition of compensation that satisfies 
section 414(s), while, for plan years after 1995, the compensation for a 
plan year is determined using a definition that satisfies section 414(s) 
as a safe harbor definition under Sec. 1.414(s)-1(c).
    (b) The underlying definition of compensation for each plan year in 
the employee's compensation history is section 414(s) compensation, 
because for each plan year the definition satisfies the requirements for 
section 414(s) compensation under Sec. 1.401(a)(4)-12. Therefore, Plan 
A determines benefits on the basis of average annual compensation, even 
though the underlying definition used to measure the amount of 
compensation for each plan year in an employee's compensation history is 
not the same for all plan years.
    Example 4. The facts are the same as in Example 1, except that Plan 
A determines benefits on the basis of the average of the employee's 
annual section 414(s) compensation for the five consecutive 12-month 
periods ending on June 30 during the employee's compensation history in 
which the average is highest. An employee's compensation history begins 
when the employee commences participation in the plan and ends in the 
current plan year. In the case of an employee with less than five 
consecutive years of plan participation as of June 30, the compensation 
history is extended prior to the employee's commencement of 
participation to include the five consecutive 12-month periods ending on 
June 30 of the current plan year (or the employee's total period of 
employment, if shorter). Plan A determines benefits on the basis of 
average annual compensation.
    Example 5. The facts are the same as in Example 4, except that Plan 
A determines benefits on the basis of the average of each employee's 
compensation for the employee's entire compensation history. Plan A 
determines benefits on the basis of average annual compensation.

    (f) Special rules--(1) In general. The special rules in this 
paragraph (f) apply for purposes of applying the provisions of this 
section to a defined benefit plan. Any special rule provided in this 
paragraph (f) that is optional must, if used, apply uniformly to all 
employees.
    (2) Certain qualified disability benefits. In general, qualified 
disability benefits (within the meaning of section 411(a)(9)) are not 
taken into account under this section. However, a qualified disability 
benefit that results from the crediting of compensation or service for a 
period of disability in the same manner as actual compensation or 
service is credited under a plan's benefit formula is permitted to be 
taken into account under this section as an accrued benefit upon the 
employee's return to service with the employer following the period of 
disability, provided that the qualified disability benefit is then 
treated in the same manner as an accrued benefit for all purposes under 
the plan.

[[Page 126]]

    (3) Accruals after normal retirement age--(i) General rule. An 
employee's accruals for any plan year after the plan year in which the 
employee attains normal retirement age are taken into account for 
purposes of this section. However, any plan provision that provides for 
increases in an employee's accrued benefit solely because the employee 
has delayed commencing benefits beyond the normal retirement age 
applicable to the employee under the plan may be disregarded, but only 
if--
    (A) The same uniform normal retirement age applies to all employees; 
and
    (B) The percentage factor used to increase the employee's accrued 
benefit is no greater than the largest percentage factor that could be 
applied to increase actuarially the employee's accrued benefit using any 
standard mortality table and any standard interest rate.
    (ii) Examples. The following examples illustrate the rules of this 
paragraph (f)(3). In each example, it is assumed that the plan satisfies 
the requirements of paragraph (f)(3)(i)(A) and (B) of this section.

    Example 1. Plan A provides a benefit of two percent of average 
annual compensation per year of service for all employees. In addition, 
Plan A provides an actuarial increase in an employee's accrued benefit 
of six percent for each year that an employee defers commencement of 
benefits beyond normal retirement age. For employees who continue in 
service beyond normal retirement age, the employee's two-percent accrual 
for the current plan year is offset by the six-percent actuarial 
increase, as permitted under section 411(b)(1)(H)(iii)(II). For purposes 
of this section, the actuarial increase (and hence the offset) may be 
disregarded, and thus all employees may be treated as if they were 
accruing at the rate of two percent of average annual compensation per 
year.
    Example 2. The facts are the same as in Example 1, except that the 
employee's two- percent accrual for the current plan year is not offset 
by the six-percent actuarial increase. The employer may disregard the 
actuarial increase and thus may treat all employees as if they were 
accruing at the rate of two percent of average annual compensation per 
year.

    (4) Early retirement window benefits--(i) General rule. In applying 
the requirements of this section, all early retirement benefits, 
retirement-type subsidies, QSUPPs, and other optional forms of benefit 
under a plan, and changes in the plan's benefit formula, are taken into 
account regardless of whether they are permanent features of the plan or 
are offered only to employees whose employment terminates within a 
limited period of time. Additional rules and examples relevant to the 
testing of early retirement window benefits are found in Example 6 of 
paragraph (b)(2)(vi) of this section; paragraph (b)(2)(ii)(A)(2), 
Example 2 of paragraph (c)(2), paragraph (d)(3), and Example 3 of 
paragraph (e)(1)(iii) of Sec. 1.401(a)(4)-4; paragraph (c)(4)(i) and 
Example 2 of paragraph (c)(6) of Sec. 1.401(a)(4)-9; and the definition 
of benefit formula in Sec. 1.401(a)(4)-12.
    (ii) Special rules--(A) Year in which early retirement window 
benefit taken into account. Notwithstanding paragraph (f)(4)(i) of this 
section, an early retirement window benefit is disregarded for purposes 
of determining whether a plan satisfies this section with respect to an 
employee for all plan years other than the first plan year in which the 
benefit is currently available (within the meaning of Sec. 1.401(a)(4)-
4(b)(2)) to the employee. For purposes of this paragraph (f)(4)(ii)(A), 
in determining which plan years the benefit is currently available, an 
early retirement window benefit that consists of a temporary change in 
the plan's benefit formula is treated as an optional form of benefit.
    (B) Treatment of early retirement window benefit that consists of 
temporary change in benefit formula. An early retirement window benefit 
is disregarded for purposes of determining an employee's normal accrual 
rate, even if the early retirement window benefit consists of a 
temporary change in a plan's benefit formula. However, if an early 
retirement window benefit consists of a temporary change in a plan's 
benefit formula, the plan does not satisfy paragraph (b) of this section 
during the period for which the change is effective unless the plan 
satisfies paragraph (b) of this section both reflecting the temporary 
change in the benefit formula and disregarding that change.
    (C) Effect of early retirement window benefit on most valuable 
accrual rate. In determining an employee's most valuable optional form 
of payment of the

[[Page 127]]

accrued benefit (which is used in determining the employee's most 
valuable accrual rate under paragraphs (d)(1)(ii) and (f)(4)(i) of this 
section), an early retirement window benefit that is currently available 
to the employee (within the meaning of paragraph (f)(4)(ii)(A) of this 
section) and that is not disregarded for a plan year under paragraph 
(f)(4)(ii)(A) of this section is taken into account in that plan year 
with respect to the employee's accrued benefit as of the earliest of the 
employee's date of termination, the close of the early retirement 
window, or the last day of that plan year.
    (D) Effect of early retirement window benefit on average benefit 
percentage test. Notwithstanding paragraph (c)(2) of this section, a 
rate group under a plan that provides an early retirement window benefit 
is deemed to satisfy the average benefit percentage test of Sec. 
1.410(b)-5 if--
    (1) All rate groups under the plan would satisfy the ratio 
percentage test of Sec. 1.410(b)-2(b)(2) if the early retirement window 
benefit were disregarded; and
    (2) The group of employees to whom the early retirement window 
benefit is currently available (within the meaning of paragraph 
(f)(4)(ii)(A) of this section) satisfies section 410(b) without regard 
to the average benefit percentage test of Sec. 1.410(b)-5.
    (iii) Early retirement window benefit defined. For purposes of this 
paragraph (f)(4), an early retirement window benefit is an early 
retirement benefit, retirement-type subsidy, QSUPP, or other optional 
form of benefit under a plan that is available, or a change in the 
plan's benefit formula that is applicable, only to employees who 
terminate employment within a limited period specified by the plan (not 
to exceed one year) under circumstances specified by the plan. A benefit 
does not fail to be described in the preceding sentence merely because 
the plan contains provisions under which certain employees may receive 
the benefit even though, for bona fide business reasons, they terminate 
employment within a reasonable period after the end of the limited 
period. An amendment to an early retirement window benefit that merely 
extends the periods in the preceding sentences is not treated as a 
separate early retirement window benefit, provided that the periods, as 
extended, satisfy the preceding sentences. However, any other amendment 
to an early retirement window benefit creates a separate early 
retirement window benefit.
    (iv) Examples. The following examples illustrate the rules of this 
paragraph (f)(4):

    Example 1. (a) Plan A provides a benefit of one percent of average 
annual compensation per year of service and satisfies the requirements 
of paragraph (b)(2) of this section. Thus, the plan provides the same 
benefit to all employees with the same years of service under the Plan. 
Plan A is amended to treat all employees with ten or more years of 
service who terminate employment after attainment of age 55 and between 
March 1, 1999, and January 31, 2000, as if they had an additional five 
years of service under the benefit formula. However, in order to ensure 
the orderly implementation of the early retirement window, the plan 
amendment provides that designated employees in the human resources 
department who would otherwise be eligible for the early retirement 
window benefit are eligible to be treated as having the additional five 
years of service only if they terminate between January 1, 2000, and 
April 30, 2000.
    (b) The additional benefits provided under this amendment are tested 
as benefits provided to employees rather than former employees. The 
effect of this amendment is temporarily to change the benefit formula 
for employees who are eligible for the early retirement window benefit 
because the amendment changes (albeit temporarily) the amount of the 
benefit payable to those employees at normal retirement age. See the 
definition of benefit formula in Sec. 1.401(a)(4)-12. Assume that the 
additional years of service credited to employees eligible for the 
window benefit do not represent past service (within the meaning of 
Sec. 1.401(a)(4)-11(d)(3)(i)(B)) or pre-participation or imputed 
service (within the meaning of Sec. 1.401(a)(4)-11(d)(3)(ii)(A) or (B), 
respectively) and thus may not be taken into account as years of 
service. See Sec. 1.401(a)(4)-11(d)(3)(i)(A) (regarding years of 
service that may not be taken into account under Sec. 1.401(a)(4)-
1(b)(2)). Thus, the window-eligible employees are entitled to a larger 
benefit (as a percentage of average annual compensation) than other 
employees with the same number of years of service, and the plan does 
not satisfy the uniform normal retirement benefit requirement of 
paragraph (b)(2)(i) of this section.
    (c) Plan A is restructured under the provisions of Sec. 
1.401(a)(4)-9(c) into two component plans: Component Plan A1, consisting 
of all

[[Page 128]]

employees who are not eligible for the early retirement window benefit 
and all of their accruals and benefits, rights, and features under the 
plan, and Component Plan A2, consisting of all employees who are 
eligible for the early retirement window benefit (including the 
designated employees in the human resource department) and all of their 
accruals and benefits, rights, and features under the plan.
    (d) Component Plan A1 still satisfies paragraph (b) of this section, 
because there has been no change for the employees in that component 
plan. Similarly, Component Plan A2 satisfies paragraph (b) of this 
section disregarding the change in the benefit formula.
    (e) Because the early retirement window benefit consists of a 
temporary change in the benefit formula, paragraph (f)(4)(ii)(B) of this 
section requires that the plan satisfy the requirements of paragraph (b) 
of this section reflecting the change in order to remain a safe harbor 
plan. After reflecting the change, Component Plan A2 still provides the 
same benefit (albeit higher than under the regular benefit formula) to 
all employees with the same years of service that may be taken into 
account in testing the plan, and thus the benefit formula (as 
temporarily amended) satisfies the requirements of paragraphs (b)(2) (i) 
and (ii) of this section.
    (f) Since Component Plan A2 also satisfies all of the other 
requirements of paragraph (b)(2) of this section and the safe harbor of 
paragraph (b)(3) of this section reflecting the change in the benefit 
formula, Component Plan A2 satisfies this paragraph (b) both reflecting 
and disregarding the change in the benefit formula. Thus, Component Plan 
A2 satisfies paragraph (b) of this section.
    Example 2. The facts are the same as in Example 1, except that Plan 
A's benefit formula used the maximum amount of permitted disparity under 
section 401(l) prior to the amendment. The analysis is the same as in 
paragraphs (a) through the first sentence of paragraph (e) of Example 1. 
In order to satisfy the requirements of paragraph (b)(2) of this 
section, a plan that uses permitted disparity must satisfy the 
requirements of section 401(l) after reflecting the change in the 
benefit formula. Because, as stated in Example 1, the additional five 
years of service may not be taken into account for purposes of 
satisfying paragraph (b) of this section, the disparity that results 
from crediting that service exceeds the maximum permitted disparity 
under section 401(l). Thus, Component Plan A2 does not satisfy the 
requirements of paragraph (b) of this section.
    Example 3. The facts are the same as in Example 1, except that Plan 
A is tested under the general test in paragraph (c) of this section. The 
early retirement window benefit is disregarded for purposes of 
determining the normal accrual rates, but is taken into account in 1999 
for purposes of determining the most valuable accrual rates, of 
employees who were eligible for the early retirement window benefit 
(regardless of whether they elected to receive it). As stated in Example 
1, the additional five years of service do not represent past service, 
pre-participation service, or imputed service, and thus under Sec. 
1.401(a)(4)-11(d)(3)(i)(A) may not be taken into account as testing 
service.

    (5) Unpredictable contingent event benefits--(i) General rule. In 
general, an unpredictable contingent event benefit (within the meaning 
of section 412(l)(7)(B)(ii)) is not taken into account under this 
section until the occurrence of the contingent event. Thus, the special 
rule in Sec. 1.401(a)(4)-4(d)(7) (treating the contingent event as 
having occurred) does not apply for purposes of this section. In the 
case of an unpredictable contingent event that is expected to result in 
the termination from employment of certain employees within a period of 
time consistent with the rules for defining an early retirement window 
benefit in paragraph (f)(4)(iii) of this section, the unpredictable 
contingent event benefit available to those employees is permitted to be 
treated as an early retirement window benefit, thus permitting the rules 
of paragraph (f)(4) of this section to be applied to it.
    (ii) Example. The following example illustrates the rules of this 
paragraph (f)(5):

    Example. (a) Employer X operates various manufacturing plants and 
maintains Plan A, a defined benefit plan that covers all of its 
nonexcludable employees. Plan A provides an early retirement benefit 
under which employees who retire after age 55 but before normal 
retirement age and who have at least 10 years of service receive a 
benefit equal to their normal retirement benefit reduced by four percent 
per year for each year prior to normal retirement age. Plan A also 
provides a plant-closing benefit under which employees who satisfy the 
conditions for receiving the early retirement benefit and who work at a 
plant where operations have ceased and whose employment has been 
terminated will receive an unreduced normal retirement benefit. The 
plant-closing benefit is an unpredictable contingent event benefit.
    (b) During the 1997 plan year, Employer X had no plant closings. 
Therefore, the plant-closing benefit is not taken into account for the 
1997 plan year in determining accrual rates or in applying the safe 
harbors in paragraph (b) of this section.

[[Page 129]]

    (c) During the 1998 plan year, Employer X begins to close one plant. 
Employees M through Z, who are employees at the plant that is closing, 
are expected to terminate employment with Employer X during the plan 
year and will satisfy the conditions for the plant-closing benefit. 
Therefore, in testing Plan A under this section for the 1998 plan year, 
the availability of the plant-closing benefit to Employees M through Z 
must be taken into account in determining their accrual rates or in 
determining whether the plan satisfies one of the safe harbors under 
paragraph (b) of this section.
    (d) Because the employees eligible for the unpredictable contingent 
event benefit are expected to terminate employment with Employer X 
during a period consistent with the rules for defining an early 
retirement window benefit, in testing Plan A under this section for the 
1998 plan year, the special rules in paragraph (f)(4)(ii) of this 
section may be applied. Thus, for example, normal accrual rates may be 
determined without reference to the unpredictable contingent event 
benefit.
    (e) Despite the closing of the plant, Employee Q remains an employee 
into the 1999 plan year. Under paragraph (f)(4)(ii)(A) of this section, 
the availability of the plant-closing benefit to Employee Q may be 
disregarded in the 1999 plan year.

    (6) Determination of benefits on other than plan-year basis. For 
purposes of this section, accruals are generally determined based on the 
plan year. Nevertheless, an employer may determine accruals on the basis 
of any period ending within the plan year as long as the period is at 
least 12 months in duration. For example, accruals for all employees may 
be determined based on accrual computation periods ending within the 
plan year.
    (7) Adjustments for certain plan distributions. For purposes of this 
section, an employee's accrued benefit includes the actuarial equivalent 
of prior distributions of accrued benefits from the plan to the employee 
if the years of service taken into account in determining the accrued 
benefits that were distributed continue to be taken into account under 
the plan for purposes of determining the employee's current accrued 
benefit. For purposes of this paragraph (f)(7), actuarial equivalence 
must be determined in a uniform manner for all employees using 
reasonable actuarial assumptions. A standard interest rate and a 
standard mortality table are among the assumptions considered reasonable 
for this purpose. Thus, for example, if an employee has commenced 
receipt of benefits in accordance with the minimum distribution 
requirements of section 401(a)(9), and the plan reduces the employee's 
accrued benefit to take into account the amount of the distributions, 
the employee's accrued benefit for purposes of this section is restored 
to the value it would have had if the distributions had not occurred.
    (8) Adjustment for certain QPSA charges. For purposes of this 
section, an employee's accrued benefit includes the cost of a qualified 
preretirement survivor annuity (QPSA) that reduces the employee's 
accrued benefit otherwise determined under the plan, as permitted under 
Sec. 1.401(a)-20, Q&A-21. Thus, an employee's accrued benefit for 
purposes of this section is determined as if the cost of the QPSA had 
not been charged against the accrued benefit. This paragraph (f)(8) 
applies only if the QPSA charges apply uniformly to all employees.
    (9) Disregard of certain offsets--(i) General rule. For purposes of 
this section, an employee's accrued benefit under a plan includes that 
portion of the benefit that is offset under an offset provision 
described in Sec. 1.401(a)(4)-11(d)(3)(i)(D). The rule in the preceding 
sentence applies only to the extent that the benefit by which the 
benefit under the plan being tested is offset is attributable to periods 
for which the plan being tested credits pre-participation service 
(within the meaning of Sec. 1.401(a)(4)-11(d)(3)(ii)(A)) that satisfies 
Sec. 1.401(a)(4)-11(d)(3)(iii) or past service (within the meaning of 
Sec. 1.401(a)(4)-11(d)(3)(i)(B)), and only if--
    (A) The benefit under the plan being tested is offset by either--
    (1) Benefits under a qualified defined benefit plan or defined 
contribution plan (whether or not terminated); or
    (2) Benefits under a foreign plan that are reasonably expected to be 
paid; and,
    (B) If any portion of the benefit that is offset is nonforfeitable 
(within the meaning of section 411), that portion is offset by a benefit 
(or portion of a benefit) that is also nonforfeitable (or vested, in the 
case of a foreign plan).

[[Page 130]]

    (ii) Examples. The following examples illustrate the rules in this 
paragraph (f)(9):

    Example 1. (a) Employer X maintains two qualified defined benefit 
plans, Plan A and Plan B. Plan B provides that, whenever an employee 
transfers to Plan B from Plan A, the service that was credited under 
Plan A is credited in determining benefits under Plan B. The Plan A 
service credited under Plan B is pre-participation service that 
satisfies Sec. 1.401(a)(4)-11(d)(3)(iii). Plan B offsets the benefits 
determined under Plan B by the employee's vested benefits under Plan A. 
Plan A does not credit additional benefit service or accrual service 
after employees transfer to Plan B.
    (b) The Plan B provision providing for an offset of benefits under 
Plan A satisfies Sec. 1.401(a)(4)-11(d)(3)(i)(D). This is because the 
provision applies to similarly-situated employees and the benefits under 
Plan A that are offset against the Plan B benefits are attributable to 
pre-participation service taken into account under Plan B.
    (c) This paragraph (f)(9) applies in determining the benefits that 
are taken into account under this section for employees in Plan B who 
are transferred from Plan A. This is because the offset provision is 
described in Sec. 1.401(a)(4)-11(d)(3)(i)(D), the benefits under the 
other plan by which the benefits under the plan being tested are offset 
are attributable solely to pre-participation service that satisfies 
Sec. 1.401(a)(4)-11(d)(3)(iii), and the benefits are offset solely by 
vested benefits under another qualified plan. Thus, for example, the 
accrual rates of employees in Plan B are determined as if there were no 
offset, i.e., by adding back the benefits that are offset to the net 
benefits under Plan B.
    (d) The result would be the same even if Plan A continued to 
recognize compensation paid after the transfer in the determination of 
benefits under Plan A. However, if Plan A continued to credit benefit or 
accrual service after the transfer, then, to the extent that Plan B's 
offset of benefits under Plan A increased as a result, the additional 
benefits offset under Plan B would not be added back in determining the 
benefits under Plan B that are taken into account under this section.
    Example 2. The facts are the same as in Example 1, except that Plan 
A is not a plan described in paragraph (f)(9)(i)(A) of this section. 
None of the benefits under Plan B that are offset by benefits under Plan 
A may be added back in determining the benefits under Plan B that are 
taken into account under this section. Thus, benefits under Plan B are 
tested on a net basis.

    (10) Special rule for multiemployer plans. For purposes of this 
section, if a multiemployer plan increases benefits for service prior to 
a specific date subject to a plan provision requiring employees to 
complete a specified amount of service (not to exceed five years) after 
that date, then benefits are permitted to be determined disregarding the 
service condition, provided that the condition is applicable to all 
employees in the multiemployer plan (including collectively bargained 
employees).

[T.D. 8485, 58 FR 46785, Sept. 3, 1993]



Sec. 1.401(a)(4)-4  Nondiscriminatory availability of benefits, 
rights, and features.

    (a) Introduction. This section provides rules for determining 
whether the benefits, rights, and features provided under a plan (i.e., 
all optional forms of benefit, ancillary benefits, and other rights and 
features available to any employee under the plan) are made available in 
a nondiscriminatory manner. Benefits, rights, and features provided 
under a plan are made available to employees in a nondiscriminatory 
manner only if each benefit, right, or feature satisfies the current 
availability requirement of paragraph (b) of this section and the 
effective availability requirement of paragraph (c) of this section. 
Paragraph (d) of this section provides special rules for applying these 
requirements. Paragraph (e) of this section defines optional form of 
benefit, ancillary benefit, and other right or feature.
    (b) Current availability--(1) General rule. The current availability 
requirement of this paragraph (b) is satisfied if the group of employees 
to whom a benefit, right, or feature is currently available during the 
plan year satisfies section 410(b) (without regard to the average 
benefit percentage test of Sec. 1.410(b)-5). In determining whether the 
group of employees satisfies section 410(b), an employee is treated as 
benefiting only if the benefit, right, or feature is currently available 
to the employee.
    (2) Determination of current availability--(i) General rule. Whether 
a benefit, right, or feature that is subject to specified eligibility 
conditions is currently available to an employee generally is determined 
based on the current facts and circumstances with respect to the 
employee (e.g., current

[[Page 131]]

compensation, accrued benefit, position, or net worth).
    (ii) Certain conditions disregarded--(A) Certain age and service 
conditions--(1) General rule. Notwithstanding paragraph (b)(2)(i) of 
this section, any specified age or service condition with respect to an 
optional form of benefit or a social security supplement is disregarded 
in determining whether the optional form of benefit or the social 
security supplement is currently available to an employee. Thus, for 
example, an optional form of benefit that is available to all employees 
who terminate employment on or after age 55 with at least 10 years of 
service is treated as currently available to an employee, without regard 
to the employee's current age or years of service, and without regard to 
whether the employee could potentially meet the age and service 
conditions prior to attaining the plan's normal retirement age.
    (2) Time-limited age or service conditions not disregarded. 
Notwithstanding paragraph (b)(2)(ii)(A)(1) of this section, an age or 
service condition is not disregarded in determining the current 
availability of an optional form of benefit or social security 
supplement if the condition must be satisfied within a limited period of 
time. However, in determining the current availability of an optional 
form of benefit or a social security supplement subject to such an age 
or service condition, the age and service of employees may be projected 
to the last date by which the age condition or service condition must be 
satisfied in order to be eligible for the optional form of benefit or 
social security supplement under the plan. Thus, for example, an 
optional form of benefit that is available only to employees who 
terminate employment between July 1, 1995, and December 31, 1995, after 
attainment of age 55 with at least 10 years of service is treated as 
currently available to an employee only if the employee could satisfy 
those age and service conditions by December 31, 1995.
    (B) Certain other conditions. Specified conditions on the 
availability of a benefit, right, or feature requiring a specified 
percentage of the employee's accrued benefit to be nonforfeitable, 
termination of employment, death, satisfaction of a specified health 
condition (or failure to meet such condition), disability, hardship, 
family status, default on a plan loan secured by a participant's account 
balance, execution of a covenant not to compete, application for 
benefits or similar ministerial or mechanical acts, election of a 
benefit form, execution of a waiver of rights under the Age 
Discrimination in Employment Act or other federal or state law, or 
absence from service, are disregarded in determining the employees to 
whom the benefit, right, or feature is currently available. In addition, 
if a multiemployer plan includes a reasonable condition that limits 
eligibility for an ancillary benefit, or other right or feature, to 
those employees who have recent service under the plan (e.g., a 
condition on a death benefit that requires an employee to have a minimum 
number of hours credited during the last two years) and the condition 
applies to all employees in the multiemployer plan (including the 
collectively bargained employees) to whom the ancillary benefit, or 
other right or feature, is otherwise currently available, then the 
condition is disregarded in determining the employees to whom the 
ancillary benefit, or other right or feature, is currently available.
    (C) Certain conditions relating to mandatory cash-outs. In the case 
of a plan that provides for mandatory cash-outs of all terminated 
employees who have a vested accrued benefit with an actuarial present 
value less than or equal to a specified dollar amount (not to exceed the 
cash-out limit in effect under Sec. 1.411(a)-11(c)(3)(ii)) as permitted 
by sections 411(a)(11) and 417(e), the implicit condition on any 
benefit, right, or feature (other than the mandatory cash-out) that 
requires the employee to have a vested accrued benefit with an actuarial 
present value in excess of the specified dollar amount is disregarded in 
determining the employees to whom the benefit, right, or feature is 
currently available.
    (D) Other dollar limits. A condition that the amount of an 
employee's vested accrued benefit or the actuarial present value of that 
benefit be less than or equal to a specified dollar amount is 
disregarded in determining

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the employees to whom the benefit, right, or feature is currently 
available.
    (E) Certain conditions on plan loans. In the case of an employee's 
right to a loan from the plan, the condition that an employee must have 
an account balance sufficient to be eligible to receive a minimum loan 
amount specified in the plan (not to exceed $1,000) is disregarded in 
determining the employees to whom the right is currently available.
    (3) Benefits, rights, and features that are eliminated 
prospectively--(i) Special testing rule. Notwithstanding paragraph 
(b)(1) of this section, a benefit, right, or feature that is eliminated 
with respect to benefits accrued after the later of the eliminating 
amendment's adoption or effective date (the elimination date), but is 
retained with respect to benefits accrued as of the elimination date, 
and that satisfies this paragraph (b) as of the elimination date, is 
treated as satisfying this paragraph (b) for all subsequent periods. 
This rule does not apply if the terms of the benefit, right, or feature 
(including the employees to whom it is available) are changed after the 
elimination date.
    (ii) Elimination of a benefit, right, or feature--(A) General rule. 
For purposes of this paragraph (b)(3), a benefit, right, or feature 
provided to an employee is eliminated with respect to benefits accrued 
after the elimination date if the amount or value of the benefit, right, 
or feature depends solely on the amount of the employee's accrued 
benefit (within the meaning of section 411(a)(7)) as of the elimination 
date, including subsequent income, expenses, gains, and losses with 
respect to that benefit in the case of a defined contribution plan.
    (B) Special rule for benefits, rights, and features that are not 
section 411(d)(6)-protected benefits. Notwithstanding paragraph 
(b)(3)(ii)(A) of this section, in the case of a benefit, right, or 
feature under a defined contribution plan that is not a section 
411(d)(6)-protected benefit (within the meaning of Sec. 1.411(d)-4, 
Q&A-1), e.g., the availability of plan loans, for purposes of this 
paragraph (b)(3)(ii) each employee's accrued benefit as of the 
elimination date may be treated, on a uniform basis, as consisting 
exclusively of the dollar amount of the employee's account balance as of 
the elimination date.
    (C) Special rule for benefits, rights, and features that depend on 
adjusted accrued benefits. For purposes of this paragraph (b)(3), a 
benefit, right, or feature provided to an employee under a plan that has 
made a fresh start does not fail to be eliminated as of an elimination 
date that is the fresh-start date merely because it depends solely on 
the amount of the employee's adjusted accrued benefit (within the 
meaning of Sec. 1.401(a)(4)-13(d)(8)).
    (c) Effective availability--(1) General rule. Based on all of the 
relevant facts and circumstances, the group of employees to whom a 
benefit, right, or feature is effectively available must not 
substantially favor HCEs.
    (2) Examples. The following examples illustrate the rules of this 
paragraph (c):

    Example 1. Employer X maintains Plan A, a defined benefit plan that 
covers both of its highly compensated nonexcludable employees and nine 
of its 12 nonhighly compensated nonexcludable employees. Plan A provides 
for a normal retirement benefit payable as an annuity and based on a 
normal retirement age of 65, and an early retirement benefit payable 
upon termination in the form of an annuity to employees who terminate 
from service with the employer on or after age 55 with 30 or more years 
of service. Both HCEs of Employer X currently meet the age and service 
requirement, or will have 30 years of service by the time they reach age 
55. All but two of the nine NHCEs of Employer X who are covered by Plan 
A were hired on or after age 35 and, thus, cannot qualify for the early 
retirement benefit. Even though the group of employees to whom the early 
retirement benefit is currently available satisfies the ratio percentage 
test of Sec. 1.410(b)-2(b)(2) when age and service are disregarded 
pursuant to paragraph (b)(2)(ii)(A) of this section, absent other facts, 
the group of employees to whom the early retirement benefit is 
effectively available substantially favors HCEs.
    Example 2. Employer Y maintains Plan B, a defined benefit plan that 
provides for a normal retirement benefit payable as an annuity and based 
on a normal retirement age of 65. By a plan amendment first adopted and 
effective December 1, 1998, Employer Y amends Plan B to provide an early 
retirement benefit that is available only to employees who terminate 
employment by December 15, 1998, and who are at least age 55 with 30 or 
more years of service. Assume

[[Page 133]]

that all employees were hired prior to attaining age 25 and that the 
group of employees who have, or will have, attained age 55 with 30 years 
of service by December 15, 1998, satisfies the ratio percentage test of 
Sec. 1.410(b)-2(b)(2). Assume, further, that the employer takes no 
steps to inform all eligible employees of the early retirement option on 
a timely basis and that the only employees who terminate from employment 
with the employer during the two-week period in which the early 
retirement benefit is available are HCEs. Under these facts, the group 
of employees to whom this early retirement window benefit is effectively 
available substantially favors HCEs.
    Example 3. Employer Z amends Plan C on June 30, 1999, to provide for 
a single sum optional form of benefit for employees who terminate from 
employment with Employer Z after June 30, 1999, and before January 1, 
2000. The availability of this single sum optional form of benefit is 
conditioned on the employee's having a particular disability at the time 
of termination of employment. The only employee of the employer who 
meets this disability requirement at the time of the amendment and 
thereafter through December 31, 1999, is a HCE. Under paragraph 
(b)(2)(ii)(B) of this section, the disability condition is disregarded 
in determining the current availability of the single sum optional form 
of benefit. Nevertheless, under these facts, the group of employees to 
whom the single sum optional form of benefit is effectively available 
substantially favors HCEs.

    (d) Special rules--(1) Mergers and acquisitions--(i) Special testing 
rule. A benefit, right, or feature available under a plan solely to an 
acquired group of employees is treated as satisfying paragraphs (b) and 
(c) of this section during the period that each of the following 
requirements is satisfied:
    (A) The benefit, right, or feature must satisfy paragraphs (b) and 
(c) of this section (determined without regard to the special rule in 
section 410(b)(6)(C)) on the date that is selected by the employer as 
the latest date by which an employee must be hired or transferred into 
the acquired trade or business for an employee to be included in the 
acquired group of employees. This determination is made with reference 
to the plan of the current employer and its nonexcludable employees.
    (B) The benefit, right, or feature must be available under the plan 
of the current employer after the transaction on the same terms as it 
was available under the plan of the prior employer before the 
transaction. This requirement is not violated merely because of a change 
made to the benefit, right, or feature that is permitted by section 
411(d)(6), provided that--
    (1) The change is a replacement of the benefit, right, or feature 
with another benefit, right, or feature that is available to the same 
employees as the original benefit, right, or feature, and the original 
benefit, right, or feature is of inherently equal or greater value 
(within the meaning of paragraph (d)(4)(i)(A) of this section) than the 
benefit, right, or feature that replaces it; or
    (2) The change is made before January 12, 1993.
    (ii) Scope of special testing rule. This paragraph (d)(1) applies 
only to benefits, rights, and features with respect to benefits accruing 
under the plan of the current employer, and not to benefits, rights, and 
features with respect to benefits accrued under the plan of the prior 
employer (unless, pursuant to the transaction, the plan of the prior 
employer becomes the plan of the current employer, or the assets and 
liabilities with respect to the acquired group of employees under the 
plan of the prior employer are transferred to the plan of the current 
employer in a plan merger, consolidation, or other transfer described in 
section 414(l)).
    (iii) Example. The following example illustrates the rules of this 
paragraph (d)(1):

    Example. Employer X maintains Plan A, a defined benefit plan with a 
single sum optional form of benefit for all employees. Employer Y 
acquires Employer X and merges Plan A into Plan B, a defined benefit 
plan maintained by Employer Y that does not otherwise provide a single 
sum optional form of benefit. Employer Y continues to provide the single 
sum optional form of benefit under Plan B on the same terms as it was 
offered under Plan A to all employees who were acquired in the 
transaction with Employer X (and to no other employees). The optional 
form of benefit satisfies paragraphs (b) and (c) of this section 
immediately following the transaction (determined without taking into 
account section 410(b)(6)(C)) when tested with reference to Plan B and 
Employer Y's nonexcludable employees. Under these facts, Plan B is 
treated as satisfying this section with respect to the single sum 
optional form

[[Page 134]]

of benefit for the plan year of the transaction and all subsequent plan 
years.

    (2) Frozen participants. A plan must satisfy the nondiscriminatory 
availability requirement of this section not only with respect to 
benefits, rights, and features provided to employees who are currently 
benefiting under the plan, but also separately with respect to benefits, 
rights, and features provided to nonexcludable employees with accrued 
benefits who are not currently benefiting under the plan (frozen 
participants). Thus, each benefit, right, and feature available to any 
frozen participant under the plan is separately subject to the 
requirements of this section. A plan satisfies paragraphs (b) and (c) of 
this section with respect to a benefit, right, or feature available to 
any frozen participant under the plan only if one or more of the 
following requirements is satisfied:
    (i) The benefit, right, or feature must be one that would satisfy 
paragraphs (b) and (c) of this section if it were not available to any 
employee currently benefiting under the plan.
    (ii) The benefit, right, or feature must be one that would satisfy 
paragraphs (b) and (c) of this section if all frozen participants were 
treated as employees currently benefiting under the plan.
    (iii) No change in the availability of the benefit, right, or 
feature may have been made that is first effective in the current plan 
year with respect to a frozen participant.
    (iv) Any change in the availability of the benefit, right, or 
feature that is first effective in the current plan year with respect to 
a frozen participant must be made in a nondiscriminatory manner. Thus, 
any expansion in the availability of the benefit, right, or feature to 
any highly compensated frozen participant must be applied on a 
consistent basis to all nonhighly compensated frozen participants. 
Similarly, any contraction in the availability of the benefit, right, or 
feature that affects any nonhighly compensated frozen participant must 
be applied on a consistent basis to all highly compensated frozen 
participants.
    (3) Early retirement window benefits. If a benefit, right, or 
feature meets the definition of an early retirement window benefit in 
Sec. 1.401(a)(4)-3(f)(4)(iii) (or would meet that definition if the 
definition applied to all benefits, rights, and features), the benefit, 
right, or feature is disregarded for purposes of applying this section 
with respect to an employee for all plan years other than the first plan 
year in which the benefit is currently available to the employee.
    (4) Permissive aggregation of certain benefits, rights, or 
features--(i) General rule. An optional form of benefit, ancillary 
benefit, or other right or feature may be aggregated with another 
optional form of benefit, ancillary benefit, or other right or feature, 
respectively, and the two may be treated as a single optional form of 
benefit, ancillary benefit, or other right or feature, if both of the 
following requirements are satisfied:
    (A) One of the two optional forms of benefit, ancillary benefit, or 
other rights or features must in all cases be of inherently equal or 
greater value than the other. For this purpose, one benefit, right, or 
feature is of inherently equal or greater value than another benefit, 
right, or feature only if, at any time and under any conditions, it is 
impossible for any employee to receive a smaller amount or a less 
valuable right under the first benefit, right, or feature than under the 
second benefit, right, or feature.
    (B) The optional form of benefit, ancillary benefit, or other right 
or feature of inherently equal or greater value must separately satisfy 
paragraphs (b) and (c) of this section (without regard to this paragraph 
(d)(4)).
    (ii) Aggregation may be applied more than once. The aggregation rule 
in this paragraph (d)(4) may be applied more than once. Thus, for 
example, an optional form of benefit may be aggregated with another 
optional form of benefit that itself constitutes two separate optional 
forms of benefit that are aggregated and treated as a single optional 
form of benefit under this paragraph (d)(4).
    (iii) Examples. The following examples illustrate the rules in this 
paragraph (d)(4):

    Example 1. Plan A is a defined benefit plan that provides a single 
sum optional form of benefit to all employees. The single sum optional 
form of benefit is available on the

[[Page 135]]

same terms to all employees, except that, for employees in Division S, a 
five-percent discount factor is applied and, for employees of Division 
T, a seven-percent discount factor is applied. Under paragraph (e)(1) of 
this section, the single sum optional form of benefit constitutes two 
separate optional forms of benefit. Assume that the single sum optional 
form of benefit available to employees of Division S separately 
satisfies paragraphs (b) and (c) of this section without taking into 
account this paragraph (d)(4). Because a lower discount factor is 
applied in determining the single sum optional form of benefit available 
to employees of Division S than is applied in determining the single sum 
optional form of benefit available to employees of Division T, the first 
single sum optional form of benefit is of inherently greater value than 
the second single sum optional form of benefit. Under these facts, these 
two single sum optional forms of benefit may be aggregated and treated 
as a single optional form of benefit for purposes of this section.
    Example 2. The facts are the same as in Example 1, except that, in 
order to receive the single sum optional form of benefit, employees of 
Division S (but not employees of Division T) must have completed at 
least 20 years of service. The single sum optional form of benefit 
available to employees of Division S is not of inherently equal or 
greater value than the single sum optional form of benefit available to 
employees of Division T, because an employee of Division S who 
terminates employment with less than 20 years of service would receive a 
smaller single sum amount (i.e., zero) than a similarly-situated 
employee of Division T who terminates employment with less than 20 years 
of service. Under these facts, the two single sum optional forms of 
benefit may not be aggregated and treated as a single optional form of 
benefit for purposes of this section.

    (5) Certain spousal benefits. In the case of a plan that includes 
two or more plans that have been permissively aggregated under Sec. 
1.410(b)-7(d), the aggregated plan satisfies this section with respect 
to the availability of any nonsubsidized qualified joint and survivor 
annuities, qualified preretirement survivor annuities, or spousal death 
benefits described in section 401(a)(11), if each plan that is part of 
the aggregated plan satisfies section 401(a)(11). Whether a benefit is 
considered subsidized for this purpose may be determined using any 
reasonable actuarial assumptions. For purposes of this paragraph (d)(5), 
a qualified joint and survivor annuity, qualified preretirement survivor 
annuity, or spousal death benefit is deemed to be nonsubsidized if it is 
provided under a defined contribution plan.
    (6) Special ESOP rules. An ESOP does not fail to satisfy paragraphs 
(b) and (c) of this section merely because it makes an investment 
diversification right or feature or a distribution option available 
solely to all qualified participants (within the meaning of section 
401(a)(28)(B)(iii)), or merely because the restrictions of section 
409(n) apply to certain individuals.
    (7) Special testing rule for unpredictable contingent event 
benefits. A benefit, right, or feature that is contingent on the 
occurrence of an unpredictable contingent event (within the meaning of 
section 412(l)(7)(B)(ii)) is tested under this section as if the event 
had occurred. Thus, the current availability of a benefit that becomes 
an optional form of benefit upon the occurrence of an unpredictable 
contingent event is tested by deeming the event to have occurred and by 
disregarding age and service conditions on the eligibility for that 
benefit to the extent permitted for optional forms of benefit under 
paragraph (b)(2) of this section.
    (e) Definitions--(1) Optional form of benefit--(i) General rule. The 
term optional form of benefit means a distribution alternative 
(including the normal form of benefit) that is available under a plan 
with respect to benefits described in section 411(d)(6)(A) or a 
distribution alternative that is an early retirement benefit or 
retirement-type subsidy described in section 411(d)(6)(B)(i), including 
a QSUPP. Except as provided in paragraph (e)(1)(ii) of this section, 
different optional forms of benefit exist if a distribution alternative 
is not payable on substantially the same terms as another distribution 
alternative. The relevant terms include all terms affecting the value of 
the optional form, such as the method of benefit calculation and the 
actuarial assumptions used to determine the amount distributed. Thus, 
for example, different optional forms of benefit may result from 
differences in terms relating to the payment schedule, timing, 
commencement, medium of distribution (e.g., in cash or in kind), 
election

[[Page 136]]

rights, differences in eligibility requirements, or the portion of the 
benefit to which the distribution alternative applies.
    (ii) Exceptions--(A) Differences in benefit formula or accrual 
method. A distribution alternative available under a defined benefit 
plan does not fail to be a single optional form of benefit merely 
because the benefit formulas, accrual methods, or other factors 
(including service-computation methods and definitions of compensation) 
underlying, or the manner in which employees vest in, the accrued 
benefit that is paid in the form of the distribution alternative are 
different for different employees to whom the distribution alternative 
is available. Notwithstanding the foregoing, differences in the normal 
retirement ages of employees or in the form in which the accrued benefit 
of employees is payable at normal retirement age under a plan are taken 
into account in determining whether a distribution alternative 
constitutes one or more optional forms of benefit.
    (B) Differences in allocation formula. A distribution alternative 
available under a defined contribution plan does not fail to be a single 
optional form of benefit merely because the allocation formula or other 
factors (including service-computation methods, definitions of 
compensation, and the manner in which amounts described in Sec. 
1.401(a)(4)-2(c)(2)(iii) are allocated) underlying, or the manner in 
which employees vest in, the accrued benefit that is paid in the form of 
the distribution alternative are different for different employees to 
whom the distribution alternative is available.
    (C) Distributions subject to section 417(e). A distribution 
alternative available under a defined benefit plan does not fail to be a 
single optional form of benefit merely because, in determining the 
amount of a distribution, the plan applies a lower interest rate to 
determine the distribution for employees with a vested accrued benefit 
having an actuarial present value not in excess of $25,000, as required 
by section 417(e)(3) and Sec. 1.417(e)-1.
    (D) Differences attributable to uniform normal retirement age. A 
distribution alternative available under a defined benefit plan does not 
fail to be a single optional form of benefit, to the extent that the 
differences are attributable to differences in normal retirement dates 
among employees, provided that the differences do not prevent the 
employees from having the same uniform normal retirement age under the 
definition of uniform normal retirement age in Sec. 1.401(a)(4)-12.
    (iii) Examples. The following examples illustrate the rules in this 
paragraph (e)(1):

    Example 1. Plan A is a defined benefit plan that benefits all 
employees of Divisions S and T. The plan offers a qualified joint and 
50-percent survivor annuity at normal retirement age, calculated by 
multiplying an employee's single life annuity payment by a factor. For 
an employee of Division S whose benefit commences at age 65, the plan 
provides a factor of 0.90, but for a similarly-situated employee of 
Division T the plan provides a factor of 0.85. The qualified joint and 
survivor annuity is not available to employees of Divisions S and T on 
substantially the same terms, and thus it constitutes two separate 
optional forms of benefit.
    Example 2. Plan B is a defined benefit plan that benefits all 
employees of Divisions U and V. The plan offers a single sum 
distribution alternative available on the same terms and determined 
using the same actuarial assumptions, to all employees. However, 
different benefit formulas apply to employees of each division. Under 
the exception provided in paragraph (e)(1)(ii)(A) of this section, the 
single sum optional form of benefit available to employees of Division U 
is not a separate optional form of benefit from the single sum optional 
form of benefit available to employees of Division V.
    Example 3. Defined benefit Plan C provides an early retirement 
benefit based on a schedule of early retirement factors that is a single 
optional form of benefit. Plan C is amended to provide an early 
retirement window benefit that consists of a temporary change in the 
plan's benefit formula (e.g., the addition of five years of service to 
an employee's actual service under the benefit formula) applicable in 
determining the benefits for certain employees who terminate employment 
within a limited period of time. Under the exception provided in 
paragraph (e)(1)(ii)(A) of this section, the early retirement optional 
form of benefit available to window-eligible employees is not a separate 
optional form of benefit from the early retirement optional form of 
benefit available to the other employees.


[[Page 137]]


    (2) Ancillary benefit. The term ancillary benefit means social 
security supplements (other than QSUPPs), disability benefits not in 
excess of a qualified disability benefit described in section 411(a)(9), 
ancillary life insurance and health insurance benefits, death benefits 
under a defined contribution plan, preretirement death benefits under a 
defined benefit plan, shut-down benefits not protected under section 
411(d)(6), and other similar benefits. Different ancillary benefits 
exist if an ancillary benefit is not available on substantially the same 
terms as another ancillary benefit. Principles similar to those in 
paragraph (e)(1)(ii) of this section apply in making this determination.
    (3) Other right or feature--(i) General rule. The term other right 
or feature generally means any right or feature applicable to employees 
under the plan. Different rights or features exist if a right or feature 
is not available on substantially the same terms as another right or 
feature.
    (ii) Exceptions to definition of other right or feature. 
Notwithstanding paragraph (e)(3)(i) of this section, a right or feature 
is not considered an other right or feature if it--
    (A) Is an optional form of benefit or an ancillary benefit under the 
plan;
    (B) Is one of the terms that are taken into account in determining 
whether separate optional forms of benefit or ancillary benefits exist, 
or that would be taken into account but for paragraph (e)(1)(ii) of this 
section (e.g., benefit formulas or the manner in which benefits vest); 
or
    (C) Cannot reasonably be expected to be of meaningful value to an 
employee (e.g., administrative details).
    (iii) Examples. Other rights and features include, but are not 
limited to--
    (A) Plan loan provisions (other than those relating to a 
distribution of an employee's accrued benefit upon default under a 
loan);
    (B) The right to direct investments;
    (C) The right to a particular form of investment, including, for 
example, a particular class or type of employer securities (taking into 
account, in determining whether different forms of investment exist, any 
differences in conversion, dividend, voting, liquidation preference, or 
other rights conferred under the security);
    (D) The right to make each rate of elective contributions described 
in Sec. 1.401(k)-6 (determining the rate based on the plan's definition 
of the compensation out of which the elective contributions are made 
(regardless of whether that definition satisfies section 414(s)), but 
also treating different rates as existing if they are based on 
definitions of compensation or other requirements or formulas that are 
not substantially the same);
    (E) The right to make after-tax employee contributions to a defined 
benefit plan that are not allocated to separate accounts;
    (F) The right to make each rate of after-tax employee contributions 
described in Sec. 1.401(m)-1(a)(3) (determining the rate based on the 
plan's definition of the compensation out of which the after-tax 
employee contributions are made (regardless of whether that definition 
satisfies section 414(s)), but also treating different rates as existing 
if they are based on definitions of compensation or other requirements 
or formulas that are not substantially the same);
    (G) The right to each rate of allocation of matching contributions 
described in Sec. 1.401(m)-1(a)(2) (determining the rate using the 
amount of matching, elective, and after-tax employee contributions 
determined after any corrections under Sec. Sec. 1.401(k)-2(b)(1)(i), 
1.401(m)-2(b)(1)(i), but also treating different rates as existing if 
they are based on definitions of compensation or other requirements or 
formulas that are not substantially the same);
    (H) The right to purchase additional retirement or ancillary 
benefits under the plan; and
    (I) The right to make rollover contributions and transfers to and 
from the plan.

[T.D. 8485, 58 FR 46796, Sept. 3, 1993, as amended by T.D. 8794, 63 FR 
70338, Dec. 21, 1998; T.D. 8891, 65 FR 44682, July 19, 2000; T.D. 9169, 
69 FR 78153, Dec. 29, 2004]

[[Page 138]]



Sec. 1.401(a)(4)-5  Plan amendments and plan terminations.

    (a) Introduction--(1) Overview. This paragraph (a) provides rules 
for determining whether the timing of a plan amendment or series of 
amendments has the effect of discriminating significantly in favor of 
HCEs or former HCEs. For purposes of this section, a plan amendment 
includes, for example, the establishment or termination of the plan, and 
any change in the benefits, rights, or features, benefit formulas, or 
allocation formulas under the plan. Paragraph (b) of this section sets 
forth additional requirements that must be satisfied in the case of a 
plan termination.
    (2) Facts-and-circumstances determination. Whether the timing of a 
plan amendment or series of plan amendments has the effect of 
discriminating significantly in favor of HCEs or former HCEs is 
determined at the time the plan amendment first becomes effective for 
purposes of section 401(a), based on all of the relevant facts and 
circumstances. These include, for example, the relative numbers of 
current and former HCEs and NHCEs affected by the plan amendment, the 
relative length of service of current and former HCEs and NHCEs, the 
length of time the plan or plan provision being amended has been in 
effect, and the turnover of employees prior to the plan amendment. In 
addition, the relevant facts and circumstances include the relative 
accrued benefits of current and former HCEs and NHCEs before and after 
the plan amendment and any additional benefits provided to current and 
former HCEs and NHCEs under other plans (including plans of other 
employers, if relevant). In the case of a plan amendment that provides 
additional benefits based on an employee's service prior to the 
amendment, the relevant facts and circumstances also include the 
benefits that employees and former employees who do not benefit under 
the amendment would have received had the plan, as amended, been in 
effect throughout the period on which the additional benefits are based.
    (3) Safe harbor for certain grants of benefits for past periods. The 
timing of a plan amendment that credits (or increases benefits 
attributable to) years of service for a period in the past is deemed not 
to have the effect of discriminating significantly in favor of HCEs or 
former HCEs if the period for which the service credit (or benefit 
increase) is granted does not exceed the five years immediately 
preceding the year in which the amendment first becomes effective, the 
service credit (or benefit increase) is granted on a reasonably uniform 
basis to all employees, benefits attributable to the period are 
determined by applying the current plan formula, and the service 
credited is service (including pre-participation or imputed service) 
with the employer or a previous employer that may be taken into account 
under Sec. 1.401(a)(4)-11(d)(3) (without regard to Sec. 1.401(a)(4)-
11(d)(3)(i)(B)). However, this safe harbor is not available if the plan 
amendment granting the service credit (or increasing benefits) is part 
of a pattern of amendments that has the effect of discriminating 
significantly in favor of HCEs or former HCEs.
    (4) Examples. The following examples illustrate the rules in this 
paragraph (a):

    Example 1. Plan A is a defined benefit plan that covered both HCEs 
and NHCEs for most of its existence. The employer decides to wind up its 
business. In the process of ceasing operations, but at a time when the 
plan covers only HCEs, Plan A is amended to increase benefits and 
thereafter is terminated. The timing of this plan amendment has the 
effect of discriminating significantly in favor of HCEs.
    Example 2. Plan B is a defined benefit plan that provides a social 
security supplement that is not a QSUPP. After substantially all of the 
HCEs of the employer have benefited from the supplement, but before a 
substantial number of NHCEs have become eligible for the supplement, 
Plan B is amended to reduce significantly the amount of the supplement. 
The timing of this plan amendment has the effect of discriminating 
significantly in favor of HCEs.
    Example 3. Plan C is a defined benefit plan that contains an 
ancillary life insurance benefit available to all employees. The plan is 
amended to eliminate this benefit at a time when life insurance payments 
have been made only to beneficiaries of HCEs. Because all employees 
received the benefit of life insurance coverage before Plan C was 
amended, the timing of this plan amendment does not have the effect of 
discriminating significantly in favor of HCEs or former HCEs.

[[Page 139]]

    Example 4. Plan D provides for a benefit of one percent of average 
annual compensation per year of service. Ten years after Plan D is 
adopted, it is amended to provide a benefit of two percent of average 
annual compensation per year of service, including years of service 
prior to the amendment. The amendment is effective only for employees 
currently employed at the time of the amendment. The ratio of HCEs to 
former HCEs is significantly higher than the ratio of NHCEs to former 
NHCEs. In the absence of any additional factors, the timing of this plan 
amendment has the effect of discriminating significantly in favor of 
HCEs.
    Example 5. The facts are the same as in Example 4, except that, in 
addition, the years of prior service are equivalent between HCEs and 
NHCEs who are current employees, and the group of current employees with 
prior service would satisfy the nondiscriminatory classification test of 
Sec. 1.410(b)-4 in the current and all prior plan years for which past 
service credit is granted. The timing of this plan amendment does not 
have the effect of discriminating significantly in favor of HCEs or 
former HCEs.
    Example 6. Employer V maintains Plan E, an accumulation plan. In 
1994, Employer V amends Plan E to provide that the compensation used to 
determine an employee's benefit for all preceding plan years shall not 
be less than the employee's average annual compensation as of the close 
of the 1994 plan year. The years of service and percentage increases in 
compensation for HCEs are reasonably comparable to those of NHCEs. In 
addition, the ratio of HCEs to former HCEs is reasonably comparable to 
the ratio of NHCEs to former NHCEs. The timing of this plan amendment 
does not have the effect of discriminating significantly in favor of 
HCEs or former HCEs.
    Example 7. Employer W currently has six nonexcludable employees, two 
of whom, H1 and H2, are HCEs, and the remaining four of whom, N1 through 
N4, are NHCEs. The ratio of HCEs to former HCEs is significantly higher 
than the ratio of NHCEs to former NHCEs. Employer W establishes Plan F, 
a defined benefit plan providing a benefit of one percent of average 
annual compensation per year of service, including years of service 
prior to the establishment of the plan. H1 and H2 each have 15 years of 
prior service, N1 has nine years of past service, N2 has five years, N3 
has three years, and N4 has one year. The timing of this plan 
establishment has the effect of discriminating significantly in favor of 
HCEs.
    Example 8. Assume the same facts as in Example 7, except that N1 
through N4 were hired in the current year, and Employer W never employed 
any NHCEs prior to the current year. Thus, no NHCEs would have received 
additional benefits had Plan F been in existence during the preceding 15 
years. The timing of this plan establishment does not have the effect of 
discriminating significantly in favor of HCEs or former HCEs.
    Example 9. The facts are the same as in Example 7, except that Plan 
F limits the grant of past service credit to five years, and the grant 
of past service otherwise satisfies the safe harbor in paragraph (a)(3) 
of this section. The timing of this plan establishment is deemed not to 
have the effect of discriminating significantly in favor of HCEs or 
former HCEs.
    Example 10. The facts are the same as in Example 9, except that, 
five years after the establishment of Plan F, Employer W amends the plan 
to provide a benefit equal to two percent of average annual compensation 
per year of service, taking into account all years of service since the 
establishment of the plan. The ratio of HCEs to former HCEs who 
terminated employment during the five-year period since the 
establishment of the plan is significantly higher than the ratio of 
NHCEs to former NHCEs who terminated employment during the five-year 
period since the establishment of the plan. Although the amendment 
described in this example might separately satisfy the safe harbor in 
paragraph (a)(3) of this section, the safe harbor is not available with 
respect to the amendment because, under these facts, the amendment is 
part of a pattern of amendments that has the effect of discriminating 
significantly in favor of HCEs.
    Example 11. Employer Y maintains Plan G, a defined benefit plan, 
covering all its employees. In 1995, Employer Y acquires Division S from 
Employer Z. Some of the employees of Division S had been covered under a 
defined benefit plan maintained by Employer Z. Soon after the 
acquisition, Employer Y amends Plan G to cover all employees of Division 
S and to credit those who were in Division S's defined benefit plan with 
years of service for years of employment with Employer Z. Because the 
timing of the plan amendment was determined by the timing of the 
transaction, the timing of this plan amendment does not have the effect 
of discriminating significantly in favor of HCEs or former HCEs. See 
also Sec. 1.401(a)(4)-11(d)(3) for other rules regarding the crediting 
of pre-participation service.
    Example 12. Plan H is an insurance contract plan within the meaning 
of section 412(i). For all plan years before 1999, Plan H purchases 
insurance contracts from Insurance Company J. In 1999, Plan H shifts 
future purchases of insurance contracts to Insurance Company K. The 
shift in insurance companies is a plan amendment subject to this 
paragraph (a).

    (b) Pre-termination restrictions--(1) Required provisions in defined 
benefit plans. A defined benefit plan has the effect of discriminating 
significantly in favor of

[[Page 140]]

HCEs or former HCEs unless it incorporates provisions restricting 
benefits and distributions as described in paragraph (b)(2) and (3) of 
this section at the time the plan is established or, if later, as of the 
first plan year to which Sec. Sec. 1.401(a)(4)-1 through 1.401(a)(4)-13 
apply to the plan under Sec. 1.401(a)(4)-13(a) or (b). This paragraph 
(b) does not apply if the Commissioner determines that such provisions 
are not necessary to prevent the prohibited discrimination that may 
occur in the event of an early termination of the plan. The restrictions 
in this paragraph (b) apply to a plan within the meaning of Sec. 
1.410(b)-7(b) (i.e., a section 414(l) plan). Any plan containing a 
provision described in this paragraph (b) satisfies section 411(d)(2) 
and does not fail to satisfy section 411(a) or (d)(3) merely because of 
the provision.
    (2) Restriction of benefits upon plan termination. A plan must 
provide that, in the event of plan termination, the benefit of any HCE 
(and any former HCE) is limited to a benefit that is nondiscriminatory 
under section 401(a)(4).
    (3) Restrictions on distributions--(i) General rule. A plan must 
provide that, in any year, the payment of benefits to or on behalf of a 
restricted employee shall not exceed an amount equal to the payments 
that would be made to or on behalf of the restricted employee in that 
year under--
    (A) A straight life annuity that is the actuarial equivalent of the 
accrued benefit and other benefits to which the restricted employee is 
entitled under the plan (other than a social security supplement); and
    (B) A social security supplement, if any, that the restricted 
employee is entitled to receive.
    (ii) Restricted employee defined. For purposes of this paragraph 
(b), the term restricted employee generally means any HCE or former HCE. 
However, an HCE or former HCE need not be treated as a restricted 
employee in the current year if the HCE or former HCE is not one of the 
25 (or a larger number chosen by the employer) nonexcludable employees 
and former employees of the employer with the largest amount of 
compensation in the current or any prior year. Plan provisions defining 
or altering this group can be amended at any time without violating 
section 411(d)(6).
    (iii) Benefit defined. For purposes of this paragraph (b), the term 
benefit includes, among other benefits, loans in excess of the amounts 
set forth in section 72(p)(2)(A), any periodic income, any withdrawal 
values payable to a living employee or former employee, and any death 
benefits not provided for by insurance on the employee's or former 
employee's life.
    (iv) Nonapplicability in certain cases. The restrictions in this 
paragraph (b)(3) do not apply, however, if any one of the following 
requirements is satisfied:
    (A) After taking into account payment to or on behalf of the 
restricted employee of all benefits payable to or on behalf of that 
restricted employee under the plan, the value of plan assets must equal 
or exceed 110 percent of the value of current liabilities, as defined in 
section 412(l)(7).
    (B) The value of the benefits payable to or on behalf of the 
restricted employee must be less than one percent of the value of 
current liabilities before distribution.
    (C) The value of the benefits payable to or on behalf of the 
restricted employee must not exceed the amount described in section 
411(a)(11)(A) (restrictions on certain mandatory distributions).
    (v) Determination of current liabilities. For purposes of this 
paragraph (b), any reasonable and consistent method may be used for 
determining the value of current liabilities and the value of plan 
assets.
    (4) Operational restrictions on certain money purchase pension 
plans. A money purchase pension plan that has an accumulated funding 
deficiency, within the meaning of section 412(a), or an unamortized 
funding waiver, within the meaning of section 412(d), must comply in 
operation with the restrictions on benefits and distributions as 
described in paragraphs (b)(2) and (b)(3) of this section. Such a plan 
does not fail to satisfy section 411(d)(6) merely because of 
restrictions imposed by the requirements of this paragraph (b)(4).

[T.D. 8485, 58 FR 46800, Sept. 3, 1993]

[[Page 141]]



Sec. 1.401(a)(4)-6  Contributory defined benefit plans.

    (a) Introduction. This section provides rules necessary for 
determining whether a contributory DB plan satisfies the 
nondiscriminatory amount requirement of Sec. 1.401(a)(4)-1(b)(2). 
Paragraph (b) of this section provides rules for determining the amount 
of benefits derived from employer contributions (employer-provided 
benefits) under a contributory DB plan for purposes of determining 
whether the plan satisfies Sec. 1.401(a)(4)-1(b)(2) with respect to 
such amounts. Paragraph (c) of this section provides the exclusive rules 
for determining whether a contributory DB plan satisfies Sec. 
1.401(a)(4)-1(b)(2) with respect to the amount of benefits derived from 
employee contributions not allocated to separate accounts (employee-
provided benefits). See Sec. 1.401(a)(4)-1(b)(2)(ii)(B) for the 
exclusive tests applicable to employee contributions allocated to 
separate accounts under a section 401(m) plan.
    (b) Determination of employer-provided benefit--(1) General rule. An 
employee's employer-provided benefit under a contributory DB plan for 
purposes of section 401(a)(4) equals the difference between the 
employee's total benefit and the employee's employee-provided benefit 
under the plan. The rules of section 411(c) generally must be used to 
determine the employee's employer-provided benefit for this purpose. 
However, paragraphs (b)(2) through (b)(6) of this section provide 
alternative methods for determining the employee's employer-provided 
benefit.
    (2) Composition-of-workforce method--(i) General rule. A 
contributory DB plan that satisfies paragraph (b)(2)(ii) (A) and (B) of 
this section may determine employees' employer-provided benefit rates 
under the rules of paragraph (b)(2)(iii) of this section.
    (ii) Eligibility requirements--(A) Uniform rate of employee 
contributions. A contributory DB plan satisfies this paragraph 
(b)(2)(ii)(A) if all employees make employee contributions at the same 
rate, expressed as a percentage of plan year compensation (the employee 
contribution rate). A plan does not fail to satisfy this paragraph 
(b)(2)(ii)(A) merely because it eliminates employee contributions for 
all employees with plan year compensation below a specified contribution 
breakpoint that is either a stated dollar amount or a stated percentage 
of covered compensation (within the meaning of Sec. 1.401(l)-1(c)(7)); 
or merely because all employees make employee contributions at the same 
rate (expressed as a percentage of plan year compensation) with respect 
to plan year compensation up to the contribution breakpoint (base 
employee contribution rate) and at a higher rate (expressed as a 
percentage of plan year compensation) that is the same for all employees 
with respect to plan year compensation above the contribution breakpoint 
(excess employee contribution rate). A plan described in paragraph 
(c)(4)(i) of this section that satisfies paragraph (c)(4)(iii) of this 
section is deemed to satisfy this paragraph.
    (B) Demographic requirements--(1) In general. A contributory DB plan 
satisfies this paragraph (b)(2)(ii)(B) if it satisfies either of the 
demographic tests in paragraph (b)(2)(ii)(B) (2) or (3) of this section.
    (2) Minimum percentage test. This test is satisfied only if more 
than 40 percent of the NHCEs in the plan have attained ages at least 
equal to the plan's target age, and more than 20 percent of the NHCEs in 
the plan have attained ages at least equal to the average attained age 
of the HCEs in the plan. For this purpose, a plan's target age is the 
lower of age 50 or the average attained age of the HCEs in the plan 
minus X years, where X equals 20 minus the product of five times the 
employee contribution rate under the plan. In no case, however, may X 
years be fewer than zero (0) years. Thus, for example, if the average 
attained age of the HCEs in the plan is 53 and the employee contribution 
rate is two percent of plan year compensation, the plan's target age is 
43 years (i.e., 53-(20-(5x2))).
    (3) Ratio test. This test is satisfied only if the percentage of all 
nonhighly compensated nonexcludable employees, who are in the plan and 
who have attained ages at least equal to the average attained age of the 
HCEs in the plan, is at least 70 percent of the percentage of all highly 
compensated nonexcludable employees, who are in the plan and who have 
attained ages at least equal to the average attained age

[[Page 142]]

of the HCEs in the plan. Attained ages must be determined as of the 
beginning of the plan year. In lieu of determining the actual 
distribution of the attained ages of the HCEs, an employer may assume 
that 50 percent of all HCEs have attained ages at least equal to the 
average attained age of the HCEs.
    (iii) Determination of employer-provided benefit--(A) Safe harbor 
plans other than section 401(l) plans. For purposes of applying the 
exception to the safe harbor in Sec. 1.401(a)(4)-3(b)(6)(viii) with 
respect to employer-provided benefits under a plan other than a section 
401(l) plan, the employee's entire accrued benefit is treated as 
employer-provided.
    (B) Section 401(l) plans--(1) General rule. For purposes of applying 
the exception to the safe harbor in Sec. 1.401(a)(4)-3(b)(6)(viii) with 
respect to employer-provided benefits under a section 401(l) plan, an 
employee's base benefit percentage and excess benefit percentage are 
reduced, or an employee's gross benefit percentage is reduced, by 
subtracting the product of the employee contribution rate and the factor 
determined under paragraph (b)(2)(iv) of this section from the 
respective percentages for the plan year. For this purpose, the employee 
contribution rate is the highest rate of employee contributions 
applicable to any potential level of plan year compensation for that 
plan year under the plan.
    (2) Excess plans with varying contribution rates. In the case of a 
defined benefit excess plan described in the second sentence of 
paragraph (b)(2)(ii)(A) of this section, solely for purposes of reducing 
an employee's base benefit percentage as required under paragraph 
(b)(2)(iii)(B)(1) of this section, it may be assumed that the employee's 
employee contribution rate equals the weighted average of the base 
employee contribution rate and the excess employee contribution rate. In 
determining this weighted average, the weight of the base employee 
contribution rate is equal to a fraction, the numerator of which is the 
lesser of the integration level and the contribution breakpoint and the 
denominator of which is the integration level. The weight of the excess 
employee contribution rate is equal to the difference between one and 
the weight of the base employee contribution rate.
    (3) Offset plans with varying contribution rates. In the case of an 
offset plan described in the second sentence of paragraph (b)(2)(ii)(A) 
of this section, an equivalent adjustment to the alternative method in 
paragraph (b)(2)(iii)(B)(2) of this section may be made to the offset 
percentage.
    (C) Employer-provided benefits under the general test. For purposes 
of applying the general test of Sec. 1.401(a)(4)-3(c) with respect to 
employer-provided benefits, an employee's normal and most valuable 
accrual rates otherwise determined under Sec. 1.401(a)(4)-3(d) (without 
applying any of the options under Sec. 1.401(a)(4)-3(d)(3) other than 
the fresh-start alternative of Sec. 1.401(a)(4)-3(d)(3)(iii)) are each 
reduced by subtracting the product of the employee's contributions 
(expressed as a percentage of plan year compensation) and the factor 
determined under paragraph (b)(2)(iv) of this section from the 
respective accrual rates. A plan may then apply the optional rules in 
Sec. 1.401(a)(4)-3(d)(3) (i) and (ii) to this resulting accrual rate.
    (D) Additional limitation. A plan may not use the composition-of-
workforce method provided in this paragraph (b)(2) to determine an 
employee's base benefit percentage, excess benefit percentage, gross 
benefit percentage, offset percentage, or accrual rates unless employee 
contributions have been made at the same rate (or rates) throughout the 
period after the fresh-start date or throughout the measurement period 
used to determine accrual rates.
    (iv) Determination of plan factor. The factor for a plan is 
determined under the following table based on the average entry age of 
the employees in the plan and on whether the plan determines benefits 
based on average compensation. For this purpose, average entry age 
equals the average attained age of all employees in the plan, minus the 
average years of participation of all employees in the plan. A plan is 
treated as determining benefits based on average compensation if it 
determines benefits based on compensation

[[Page 143]]

averaged over a specified period not exceeding five consecutive years 
(or the employee's entire period of employment with the employer, if 
shorter).

                            Table of Factors
------------------------------------------------------------------------
                                                        Factors
                                              --------------------------
                                                  Average
              Average entry age                compensation     Other
                                                  benefit      formulas
                                                  formula
------------------------------------------------------------------------
Less than 30.................................           0.5         0.75
30 to 40.....................................           0.4         0.6
Over 40......................................           0.2         0.3
------------------------------------------------------------------------

    (v) Examples. The following examples illustrate the rules of this 
paragraph (b)(2):

    Example 1. Plan A is a contributory DB plan that is a defined 
benefit excess plan providing a benefit equal to 2.0 percent of 
employees' average annual compensation at or below covered compensation, 
plus 2.5 percent of average annual compensation above covered 
compensation, times years of service up to 35. Under the plan, average 
annual compensation is determined using a five-consecutive-year period 
for purposes of Sec. 1.401(a)(4)-3(e)(2). The plan requires employee 
contributions at a rate of four percent of plan year compensation for 
all employees. Assume that the plan satisfies the demographic 
requirements of paragraph (b)(2)(ii)(B) of this section. Under these 
facts, the plan satisfies the eligibility requirements of paragraph 
(b)(2)(ii) of this section. Assume, further, that the average attained 
age for all employees in the plan is 55, and that the average years of 
participation of all employees in the plan is 10. The average entry age 
for the plan is therefore 45, and, accordingly, the appropriate factor 
under the table is 0.2. Thus, in applying the safe harbor requirements 
of Sec. 1.401(a)(4)-3(b) to this plan for the plan year (including the 
requirements of Sec. 1.401(l)-3), the employee's base benefit 
percentage and excess benefit percentage are each reduced by 0.8 percent 
(4 percentx0.2) and equal 1.2 percent and 1.7 percent, respectively.
    Example 2. The facts are the same as in Example 1, except that the 
employee contribution rate is two percent of plan year compensation up 
to the covered compensation level, and four percent for plan year 
compensation at or above that contribution breakpoint. The employer 
elects to apply the alternative method in paragraph (b)(2)(iii)(B)(2) of 
this section to determine the reduction in the base benefit percentage. 
Because the contribution breakpoint is equal to the integration level, 
the weight of the employee contribution rate below the contribution 
breakpoint is 100 percent, and the weight of the employee contribution 
rate above the contribution breakpoint is zero. Thus, the weighted 
average of employee contribution rates is two percent. Under the 
alternative method in paragraph (b)(2)(iii)(B)(2) of this section, the 
reduction in the employee's base benefit percentage is 0.4. In applying 
the safe harbor requirements of Sec. 1.401(a)(4)-3(b) to this plan 
(including the requirements of Sec. 1.401(l)-3), the employee's base 
benefit percentage is 1.6 percent, and the employee's excess benefit 
percentage is 1.7.
    Example 3. The facts are the same as in Example 1, except that the 
employee contribution rate is two percent of plan year compensation up 
to 50 percent of the covered compensation level, and four percent for 
plan year compensation at or above that contribution breakpoint. Because 
the contribution breakpoint is equal to 50 percent of the integration 
level, the weight of the employee contribution rate below the 
contribution breakpoint is 50 percent, and the weight of the employee 
contribution rate above the contribution breakpoint is 50 percent. Thus, 
the weighted average of employee contribution rates is three percent. 
Under the alternative method in paragraph (b)(2)(iii)(B)(2) of this 
section, the reduction in the employee's base benefit percentage is 0.6. 
In applying the safe harbor requirements of Sec. 1.401(a)(4)-3(b) to 
this plan (including the requirements of Sec. 1.401(l)-3), the 
employee's base benefit percentage is 1.4 percent, and the employee's 
excess benefit percentage is 1.7.
    Example 4. The facts are the same as in Example 1, except that the 
plan is tested using the general test in Sec. 1.401(a)(4)-3(c). Assume 
Employee M benefits under Plan A and has a normal accrual rate for the 
plan year (calculated with respect to Employee M's total accrued 
benefit) of 2.2 percent of average annual compensation. In applying the 
general test in Sec. 1.401(a)(4)-3(c) with respect to employer-provided 
benefits, this rate is reduced by 0.8 to yield a normal accrual rate of 
1.4 percent. This rate may then be adjusted using either of the optional 
rules in Sec. 1.401(a)(4)-3(d)(3)(i) or (ii).

    (3) Minimum-benefit method--(i) Application of uniform factors. A 
contributory DB plan that satisfies the uniform rate requirement of 
paragraph (b)(2)(ii)(A) of this section and the minimum benefit 
requirement of paragraph (b)(3)(ii) of this section may apply the 
adjustments provided in paragraph (b)(2)(iii) of this section as if the 
average entry age of employees in the plan were within the range of 30 
to 40, without regard to the actual demographics of the employees in the 
plan.

[[Page 144]]

    (ii) Minimum benefit requirement. This requirement is satisfied if 
the plan provides that, in plan years beginning on or after the 
effective date of these regulations, as set forth in Sec. 1.401(a)(4)-
13(a) and (b), each employee will accrue a benefit that equals or 
exceeds the sum of--
    (A) The accrued benefit derived from employee contributions made for 
plan years beginning on or after the effective date of these 
regulations, determined in accordance with section 411(c); and
    (B) Fifty percent of the total benefit accrued in plan years 
beginning on or after the effective date of these regulations, as 
determined under the plan benefit formula without regard to that portion 
of the formula designed to satisfy the minimum benefit requirement of 
this paragraph (b)(3)(ii).
    (iii) Example. The following example illustrates the minimum-benefit 
method of this paragraph (b)(3):

    Example. Plan A is contributory DB plan. For the plan year beginning 
in 1994, Employee M participates in Plan A and accrues a benefit under 
the terms of the plan (without regard to the minimum benefit requirement 
of paragraph (b)(3)(ii) of this section) of $3,000. The portion of 
Employee M's benefit accrual for the plan year beginning in 1994 derived 
from employee contributions is $2,000, determined by applying the rules 
of section 411(c) to such contributions. The requirement of paragraph 
(b)(3)(ii) of this section is not satisfied for the plan year beginning 
in 1994 unless the plan provides that Employee M's benefit accrual for 
the plan year beginning in 1994 is equal to $3,500 ($2,000+(50 
percentx$3,000)).

    (4) Grandfather rule for plans in existence on May 14, 1990. A 
contributory DB plan that satisfies paragraph (c)(4) of this section may 
determine an employee's employer-provided benefit by subtracting from 
the employee's total benefit the employee-provided benefits determined 
using any reasonable method set forth in the plan, provided that it is 
the same method used in determining whether the plan satisfies paragraph 
(c)(4)(ii)(D) of this section.
    (5) Government-plan method. A contributory DB plan that is 
established and maintained for its employees by the government of any 
state or political subdivision or by any agency or instrumentality 
thereof may treat an employee's total benefit as entirely employer-
provided.
    (6) Cessation of employee contributions. If a contributory DB plan 
provides that no employee contributions may be made to the plan after 
the last day of the first plan year beginning on or after the effective 
date of these regulations, as set forth in Sec. 1.401(a)(4)-13 (a) and 
(b), the plan may treat an employee's total benefit as entirely 
employer-provided.
    (c) Rules applicable in determining whether employee-provided 
benefits are nondiscriminatory in amount--(1) In general. A contributory 
DB plan satisfies Sec. 1.401(a)(4)-1(b)(2) with respect to the amount 
of employee-provided benefits for a plan year only if the plan satisfies 
the requirements of paragraph (c)(2), (c)(3), or (c)(4) of this section 
for the plan year. This requirement applies regardless of the method 
used to determine the amount of employer-provided benefits under 
paragraph (b) of this section.
    (2) Same rate of contributions. This requirement is satisfied for a 
plan year if the employee contribution rate (within the meaning of 
paragraph (b)(2)(ii)(A) of this section) is the same for all employees 
for the plan year.
    (3) Total-benefits method. This requirement is satisfied for a plan 
year if--
    (i) The total benefits (i.e., the sum of employer-provided and 
employee-provided benefits) under the plan would satisfy Sec. 
1.401(a)(4)-3 if all benefits were treated as employer-provided 
benefits; and
    (ii) The plan's contribution requirements satisfy paragraph 
(b)(2)(ii)(A) of this section.
    (4) Grandfather rules for plans in existence on May 14, 1990--(i) In 
general. This requirement is satisfied for a plan year if the plan 
contained provisions as of May 14, 1990, that meet the requirements of 
paragraph (c)(4)(ii) or (c)(4)(iii) of this section.
    (ii) Graded contribution rates. The plan's provisions meet the 
requirements of this paragraph (c)(4)(ii) if all the following 
requirements are met:
    (A) The provisions require employee contributions at a greater rate 
(expressed as a percentage of compensation) at higher levels of 
compensation than at lower levels of compensation.

[[Page 145]]

    (B) The required rate of employee contributions is not increased 
after May 14, 1990, although the level of compensation at which employee 
contributions are required may be increased or decreased.
    (C) All employees are permitted to make employee contributions under 
the plan at a uniform rate with respect to all compensation, beginning 
no later than the last day of the first plan year to which these 
regulations apply, as set forth in Sec. 1.401(a)(4)-13 (a) and (b).
    (D) The benefits provided on account of employee contributions at 
lower levels of compensation are comparable to those provided on account 
of employee contributions at higher levels of compensation.
    (iii) Prior year compensation. The plan's provisions meet the 
requirements of this paragraph (c)(4)(iii) if they are part of a plan 
maintained by more than one employer that requires employee 
contributions and the rate of required employee contributions, expressed 
as a percentage of compensation for the last calendar year ending before 
the beginning of the plan year, is the same for all employees.

[T.D. 8485, 58 FR 46802, Sept. 3, 1993]



Sec. 1.401(a)(4)-7  Imputation of permitted disparity.

    (a) Introduction. In determining whether a plan satisfies section 
401(a)(4) with respect to the amount of contributions or benefits, 
section 401(a)(5)(C) allows the disparities permitted under section 
401(l) to be taken into account. For purposes of satisfying the safe 
harbors of Sec. Sec. 1.401(a)(4)-2(b)(2) and 1.401(a)(4)-3(b), 
permitted disparity may be taken into account only by satisfying section 
401(l) in form in accordance with Sec. 1.401(l)-2 or 1.401(l)-3, 
respectively. For purposes of the general tests of Sec. Sec. 
1.401(a)(4)-2(c) and 1.401(a)(4)-3(c), permitted disparity may be taken 
into account only in accordance with the rules of this section. In 
general, this section allows permitted disparity to be arithmetically 
imputed with respect to employer-provided contributions or benefits by 
determining an adjusted allocation or accrual rate that appropriately 
accounts for the permitted disparity with respect to each employee. 
Paragraph (b) of this section provides rules for imputing permitted 
disparity with respect to employer-provided contributions by adjusting 
each employee's unadjusted allocation rate. Paragraph (c) of this 
section provides rules for imputing permitted disparity with respect to 
employer-provided benefits by adjusting each employee's unadjusted 
accrual rate. Paragraph (d) of this section provides rules of general 
application.
    (b) Adjusting allocation rates--(1) In general. The rules in this 
paragraph (b) produce an adjusted allocation rate for each employee by 
determining the excess contribution percentage under the hypothetical 
formula that would yield the allocation actually received by the 
employee, if the plan took into account the full disparity permitted 
under section 401(l)(2) and used the taxable wage base as the 
integration level. This adjusted allocation rate is used to determine 
whether the amount of contributions under the plan satisfies the general 
test of Sec. 1.401(a)(4)-2(c) and to apply the average benefit 
percentage test on the basis of contributions under Sec. 1.410(b)-5(d). 
Paragraphs (b)(2) and (b)(3) of this section apply to employees whose 
plan year compensation does not exceed and does exceed, respectively, 
the taxable wage base, and paragraph (b)(4) of this section provides 
definitions.
    (2) Employees whose plan year compensation does not exceed taxable 
wage base. If an employee's plan year compensation does not exceed the 
taxable wage base, the employee's adjusted allocation rate is the lesser 
of the A rate and the B rate determined under the formulas below, where 
the permitted disparity rate and the unadjusted allocation rate are 
determined under paragraph (b)(4) (ii) and (iv) of this section, 
respectively.

A Rate = 2xunadjusted allocation rate
B Rate = unadjusted allocation rate + permitted disparity rate

    (3) Employees whose plan year compensation exceeds taxable wage 
base. If an employee's plan year compensation exceeds the taxable wage 
base, the employee's adjusted allocation rate is the lesser of the C 
rate and the D rate determined under the formulas below, where 
allocations and the permitted disparity rate are determined under

[[Page 146]]

paragraph (b)(4) (i) and (ii) of this section, respectively.
[GRAPHIC] [TIFF OMITTED] TC05OC91.012

    (4) Definitions. In applying this paragraph (b), the following 
definitions govern--
    (i) Allocations. Allocations means the amount determined by 
multiplying the employee's plan year compensation by the employee's 
unadjusted allocation rate.
    (ii) Permitted disparity rate--(A) General rule. Permitted disparity 
rate means the rate in effect as of the beginning of the plan year under 
section 401(l)(2)(A)(ii) (e.g., 5.7 percent for plan years beginning in 
1990).
    (B) Cumulative permitted disparity limit. Notwithstanding paragraph 
(b)(4)(ii)(A) of this section, the permitted disparity rate is zero for 
an employee who has benefited under a defined benefit plan taken into 
account under Sec. 1.401(l)-5(a)(3) for a plan year that begins on or 
after one year from the first day of the first plan year to which these 
regulations apply, as set forth in Sec. 1.401(a)(4)-13 (a) and (b), if 
imputing permitted disparity would result in a cumulative disparity 
fraction for the employee, as defined in Sec. 1.401(l)-5(c)(2), that 
exceeds 35. See Sec. 1.401(l)-5(c)(1) for special rules for determining 
whether an employee has benefited under a defined benefit plan for this 
purpose.
    (iii) Taxable wage base. Taxable wage base means the taxable wage 
base, as defined in Sec. 1.401(l)-1(c)(32), in effect as of the 
beginning of the plan year.
    (iv) Unadjusted allocation rate. Unadjusted allocation rate means 
the employee's allocation rate determined under Sec. 1.401(a)(4)-
2(c)(2)(i) for the plan year (expressed as a percentage of plan year 
compensation), without imputing permitted disparity under this section.
    (5) Example. The following example illustrates the rules in this 
paragraph (b):

    Example. (a) Employees M and N participate in a defined contribution 
plan maintained by Employer X. Employee M has plan year compensation of 
$30,000 in the 1990 plan year and has an unadjusted allocation rate of 
five percent. Employee N has plan year compensation of $100,000 in the 
1990 plan year and has an unadjusted allocation rate of eight percent. 
The taxable wage base in 1990 is $51,300.
    (b) Because Employee M's plan year compensation does not exceed the 
taxable wage base, Employee M's A rate is 10 percent (2x5 percent), and 
Employee M's B rate is 10.7 percent (5 percent+5.7 percent). Thus, 
Employee M's adjusted allocation rate is 10 percent, the lesser of the A 
rate and the B rate.
    (c) Employee N's allocations are $8,000 (8 percentx$100,000). 
Because Employee N's plan year compensation exceeds the taxable wage 
base, Employee N's C rate is 10.76 percent ($8,000 divided by ($100,000-
(\1/2\x$51,300))), and Employee N's D rate is 10.92 percent (($8,000+ 
(5.7 percentx$51,300)) divided by $100,000). Thus, Employee N's adjusted 
allocation rate is 10.76 percent, the lesser of the C rate and the D 
rate.

    (c) Adjusting accrual rates--(1) In general. The rules in this 
paragraph (c) produce an adjusted accrual rate for each employee by 
determining the excess benefit percentage under the hypothetical plan 
formula that would yield the employer-provided accrual actually received 
by the employee, if the plan took into account the full permitted 
disparity under section 401(l)(3)(A) in each of the first 35 years of an 
employee's testing service under the plan and used the employee's 
covered compensation as the integration level. This adjusted accrual 
rate is used to determine whether the amount of employer-

[[Page 147]]

provided benefits under the plan satisfies the alternative safe harbor 
for flat benefit plans under Sec. 1.401(a)(4)-3(b)(4)(i)(C)(3) or the 
general test of Sec. 1.401(a)(4)-3(c), and to apply the average benefit 
percentage test on the basis of benefits under Sec. 1.410(b)-5. 
Paragraphs (c)(2) and (c)(3) of this section apply to employees whose 
average annual compensation does not exceed and does exceed, 
respectively, covered compensation, and paragraph (c)(4) of this section 
provides definitions. Paragraph (c)(5) of this section provides a 
special rule for employees with negative unadjusted accrual rates.
    (2) Employees whose average annual compensation does not exceed 
covered compensation. If an employee's average annual compensation does 
not exceed the employee's covered compensation, the employee's adjusted 
accrual rate is the lesser of the A rate and the B rate determined under 
the formulas below, where the permitted disparity factor and the 
unadjusted accrual rate are determined under paragraph (c)(4)(iii) and 
(v) of this section, respectively.
[GRAPHIC] [TIFF OMITTED] TC05OC91.013

    (3) Employees whose average annual compensation exceeds covered 
compensation. If an employee's average annual compensation exceeds the 
employee's covered compensation, the employee's adjusted accrual rate is 
the lesser of the C rate and D rate determined under the formulas below, 
where the employer-provided accrual and the permitted disparity factor 
are determined under paragraph (c)(4)(ii) and (iii) of this section, 
respectively.
[GRAPHIC] [TIFF OMITTED] TC05OC91.014

    (4) Definitions. For purposes of this paragraph (c), the following 
definitions apply.
    (i) Covered compensation. Covered compensation means covered 
compensation as defined in Sec. 1.401(l)-1(c)(7). Notwithstanding Sec. 
1.401(l)-1(c)(7)(iii), an employee's covered compensation must be 
automatically adjusted each plan year for purposes of applying this 
paragraph (c).
    (ii) Employer-provided accrual. Employer-provided accrual means the 
amount determined by multiplying the employee's average annual 
compensation by the employee's unadjusted accrual rate.
    (iii) Permitted disparity factor--(A) General rule. Permitted 
disparity factor for an employee means the sum of the employee's annual 
permitted disparity factors determined under paragraph (c)(4)(iii)(B) of 
this section for each of the years in the measurement period used for 
determining the employee's accrual rate in Sec. 1.401(a)(4)-3(d)(1), 
divided by the employee's testing service during that measurement 
period.
    (B) Annual permitted disparity factor--(1) Definition. An employee's 
annual permitted disparity factor is generally 0.75 percent adjusted, 
pursuant to Sec. 1.401(l)-3(e), using as the age at which benefits 
commence the lesser of age 65 or the employee's testing age. No 
adjustments are made in the annual permitted disparity factor unless an 
employee's testing age is different from

[[Page 148]]

the employee's social security retirement age. An annual permitted 
disparity factor that is less than the annual permitted disparity factor 
described in the first sentence of this paragraph (c)(4)(iii)(B)(1) may 
be used if it is a uniform percentage of that factor (e.g., 50 percent 
of the annual permitted disparity factor) or a fixed percentage (e.g., 
0.65 percent) for all employees.
    (2) Annual permitted disparity factor after 35 years. For purposes 
of determining the sum described in paragraph (c)(4)(iii)(A) of this 
section, the annual permitted disparity factor for each of the 
employee's first 35 years of testing service is the amount described in 
paragraph (c)(4)(iii)(B)(1) of this section, and the annual permitted 
disparity factor in any subsequent year equals zero. This rule applies 
regardless of whether the end of the measurement period extends beyond 
an employee's first 35 years of testing service. Thus, for example, if 
the measurement period is the current plan year and the employee 
completed 35 years of testing service prior to the beginning of the 
current plan year, under this paragraph (c)(4)(iii)(B)(2) the annual 
permitted disparity factor in the current plan year (and hence the sum 
of the annual permitted disparity factors for each year in the 
measurement period) is zero.
    (3) Cumulative permitted disparity limit. The 35 years used in 
paragraph (c)(4)(iii)(B)(2) of this section must be reduced by the 
employee's cumulative disparity fraction, as defined in Sec. 1.401(l)-
5(c)(2), but determined solely with respect to the employee's total 
years of service under all plans taken into account under Sec. 
1.401(l)-5(a)(3) during the measurement period, other than the plan 
being tested.
    (iv) Social security retirement age. Social security retirement age 
means social security retirement age as defined in section 415(b)(8).
    (v) Unadjusted accrual rate. Unadjusted accrual rate means the 
normal or most valuable accrual rate, whichever is being determined for 
the employee under Sec. 1.401(a)(4)-3(d), expressed as a percentage of 
average annual compensation, without imputing permitted disparity under 
this section.
    (5) Employees with negative unadjusted accrual rates. 
Notwithstanding the formulas in paragraph (c)(2) and (c)(3) of this 
section, if an employee's unadjusted accrual rate is less than zero, the 
employee's adjusted accrual rate is deemed to be the employee's 
unadjusted accrual rate.
    (6) Example. The following example illustrates the rules in this 
paragraph (c):

    Example. (a) Employees M and N participate in a defined benefit plan 
that uses a normal retirement age of 65. The plan is being tested for 
the plan year under Sec. 1.401(a)(4)-3(c), using unadjusted accrual 
rates determined using a plan year measurement period under Sec. 
1.401(a)(4)-3(d)(1)(iii)(A). Employee M has an unadjusted normal accrual 
rate of 1.48 percent, average annual compensation of $21,000, and an 
employer-provided accrual of $311 (1.48 percentx$21,000). Employee N has 
an unadjusted normal accrual rate of 1.7 percent, average annual 
compensation of $106,000, and an employer-provided accrual of $1,802 
(1.7 percentx$106,000). The covered compensation of both Employees M and 
N is $25,000, and social security retirement age for both employees is 
65. Neither employee has testing service of more than 35 years and 
neither has ever participated in another plan.
    (b) Because Employee M's average annual compensation does not exceed 
covered compensation, Employee M's A rate is 2.96 percent (2.0x1.48 
percent), and Employee M's B rate is 2.23 percent (1.48 percent+0.75 
percent). Thus, Employee M's adjusted accrual rate is 2.23 percent, the 
lesser of the A rate and the B rate.
    (c) Because Employee N's average annual compensation exceeds covered 
compensation, Employee N's C rate is 1.93 percent ($1,802/($106,000-
(0.5x$25,000))), and Employee N's D rate is 1.88 percent (($1,802+(0.75 
percentx$25,000))/$106,000). Thus, Employee N's adjusted accrual rate is 
1.88 percent, the lesser of the C rate and the D rate.

    (d) Rules of general application--(1) Eligible plans. The rules in 
this section may be used only for those plans to which the permitted 
disparity rules of section 401(l) are available. See Sec. 1.401(l)-
1(a)(3).
    (2) Exceptions from consistency requirements. A plan does not fail 
to satisfy the consistency requirements of Sec. 1.401(a)(4)-2(c)(2)(vi) 
or Sec. 1.401(a)(4)-3(d)(2)(i) merely because the plan does not impute 
disparity for some employees to the extent required to comply with 
paragraph (d)(3) of this section, or

[[Page 149]]

because the plan does not impute disparity for any employees (including 
self-employed individuals within the meaning of section 401(c)(1)) who 
are not covered by any of the taxes under section 3111(a), section 3221, 
or section 1401.
    (3) Overall permitted disparity. The annual overall permitted 
disparity limits of Sec. 1.401(l)-5(b) apply to the employer-provided 
contributions and benefits for an employee under all plans taken into 
account under Sec. 1.401(l)-5(a)(3). Thus, if an employee who benefits 
under the plan for the current plan year also benefits under a section 
401(l) plan for the plan year ending with or within the current plan 
year, permitted disparity may not be imputed for that employee for the 
plan year. See Sec. 1.401(l)-5(b)(9), Example 4. Similarly, if an 
employee who benefits under the plan for the current plan year also 
benefits under another plan of the employer for the plan year ending 
with or within the current plan year, disparity may be imputed for that 
employee under only one of the plans.

[T.D. 8485, 58 FR 46804, Sept. 3, 1993]



Sec. 1.401(a)(4)-8  Cross-testing.

    (a) Introduction. This section provides rules for testing defined 
benefit plans on the basis of equivalent employer-provided contributions 
and defined contribution plans on the basis of equivalent employer-
provided benefits under Sec. 1.401(a)(4)-1(b)(2). Paragraphs (b)(1) and 
(c)(1) of this section provide general tests for nondiscrimination based 
on individual equivalent accrual or allocation rates determined under 
paragraphs (b)(2) and (c)(2) of this section, respectively. Paragraphs 
(b)(3), (c)(3), and (d) of this section provide additional safe-harbor 
testing methods for target benefit plans, cash balance plans, and 
defined benefit plans that are part of floor-offset arrangements, 
respectively, that generally may be satisfied on a design basis.
    (b) Nondiscrimination in amount of benefits provided under a defined 
contribution plan--(1) General rule and gateway--(i) General rule. 
Equivalent benefits under a defined contribution plan (other than an 
ESOP) are nondiscriminatory in amount for a plan year if--
    (A) The plan would satisfy Sec. 1.401(a)(4)-2(c)(1) for the plan 
year if an equivalent accrual rate, as determined under paragraph (b)(2) 
of this section, were substituted for each employee's allocation rate in 
the determination of rate groups; and
    (B) For plan years beginning on or after January 1, 2002, the plan 
satisfies one of the following conditions--
    (1) The plan has broadly available allocation rates (within the 
meaning of paragraph (b)(1)(iii) of this section) for the plan year;
    (2) The plan has age-based allocation rates that are based on either 
a gradual age or service schedule (within the meaning of paragraph 
(b)(1)(iv) of this section) or a uniform target benefit allocation 
(within the meaning of paragraph (b)(1)(v) of this section) for the plan 
year; or
    (3) The plan satisfies the minimum allocation gateway of paragraph 
(b)(1)(vi) of this section for the plan year.
    (ii) Allocations after testing age. A plan does not fail to satisfy 
paragraph (b)(1)(i)(A) of this section merely because allocations are 
made at the same rate for employees who are older than their testing age 
(determined without regard to the current-age rule in paragraph (4) of 
the definition of testing age in Sec. 1.401(a)(4)-12) as they are made 
for employees who are at that age.
    (iii) Broadly available allocation rates--(A) In general. A plan has 
broadly available allocation rates for the plan year if each allocation 
rate under the plan is currently available during the plan year (within 
the meaning of Sec. 1.401(a)(4)-4(b)(2)), to a group of employees that 
satisfies section 410(b) (without regard to the average benefit 
percentage test of Sec. 1.410(b)-5). For this purpose, if two 
allocation rates could be permissively aggregated under Sec. 
1.401(a)(4)-4(d)(4), assuming the allocation rates were treated as 
benefits, rights or features, they may be aggregated and treated as a 
single allocation rate. In addition, the disregard of age and service 
conditions described in Sec. 1.401(a)(4)-4(b)(2)(ii)(A) does not apply 
for purposes of this paragraph (b)(1)(iii)(A).

[[Page 150]]

    (B) Certain transition allocations. In determining whether a plan 
has broadly available allocation rates for the plan year within the 
meaning of paragraph (b)(1)(iii)(A) of this section, an employee's 
allocation may be disregarded to the extent that the allocation is a 
transition allocation for the plan year. In order for an allocation to 
be a transition allocation, the allocation must comply with the 
requirements of paragraph (b)(1)(iii)(C) of this section and must be 
either--
    (1) A defined benefit replacement allocation within the meaning of 
paragraph (b)(1)(iii)(D) of this section; or
    (2) A pre-existing replacement allocation or pre-existing merger and 
acquisition allocation, within the meaning of paragraph (b)(1)(iii)(E) 
of this section.
    (C) Plan provisions relating to transition allocations--(1) In 
general. Plan provisions providing for transition allocations for the 
plan year must specify both the group of employees who are eligible for 
the transition allocations and the amount of the transition allocations.
    (2) Limited plan amendments. Allocations are not transition 
allocations within the meaning of paragraph (b)(1)(iii)(B) of this 
section for the plan year if the plan provisions relating to the 
allocations are amended after the date those plan provisions are both 
adopted and effective. The preceding sentence in this paragraph 
(b)(1)(iii)(C)(2) does not apply to a plan amendment that reduces 
transition allocations to HCEs, makes de minimis changes in the 
calculation of the transition allocations (such as a change in the 
definition of compensation to include section 132(f) elective 
reductions), or adds or removes a provision permitted under paragraph 
(b)(1)(iii)(C)(3) of this section.
    (3) Certain permitted plan provisions. An allocation does not fail 
to be a transition allocation within the meaning of paragraph 
(b)(1)(iii)(B) of this section merely because the plan provides that 
each employee who is eligible for a transition allocation receives the 
greater of such allocation and the allocation for which the employee 
would otherwise be eligible under the plan. In a plan that contains such 
a provision, for purposes of determining whether the plan has broadly 
available allocation rates within the meaning of paragraph 
(b)(1)(iii)(A) of this section, the allocation for which an employee 
would otherwise be eligible is considered currently available to the 
employee, even if the employee's transition allocation is greater.
    (D) Defined benefit replacement allocation. An allocation is a 
defined benefit replacement allocation for the plan year if it is 
provided in accordance with guidance prescribed by the Commissioner 
published in the Internal Revenue Bulletin (see Sec. 
601.601(d)(2)(ii)(b) of this chapter) and satisfies the following 
conditions--
    (1) The allocations are provided to a group of employees who 
formerly benefitted under an established nondiscriminatory defined 
benefit plan of the employer or of a prior employer that provided age-
based equivalent allocation rates;
    (2) The allocations for each employee in the group were reasonably 
calculated, in a consistent manner, to replace the retirement benefits 
that the employee would have been provided under the defined benefit 
plan if the employee had continued to benefit under the defined benefit 
plan;
    (3) Except as provided in paragraph (b)(1)(iii)(C) of this section, 
no employee who receives the allocation receives any other allocations 
under the plan for the plan year; and
    (4) The composition of the group of employees who receive the 
allocations is nondiscriminatory.
    (E) Pre-existing transition allocations--(1) Pre-existing 
replacement allocations. An allocation is a pre-existing replacement 
allocation for the plan year if the allocation satisfies the following 
conditions--
    (i) The allocations are provided pursuant to a plan provision 
adopted before June 29, 2001;
    (ii) The allocations are provided to employees who formerly 
benefitted under a defined benefit plan of the employer; and
    (iii) The allocations for each employee in the group are reasonably 
calculated, in a consistent manner, to replace some or all of the 
retirement benefits that the employee would have

[[Page 151]]

received under the defined benefit plan and any other plan or 
arrangement of the employer if the employee had continued to benefit 
under such defined benefit plan and such other plan or arrangement.
    (2) Pre-existing merger and acquisition allocations. An allocation 
is a pre-existing merger and acquisition allocation for the plan year if 
the allocation satisfies the following conditions--
    (i) The allocations are provided solely to employees of a trade or 
business that has been acquired by the employer in a stock or asset 
acquisition, merger, or other similar transaction occurring prior to 
August 28, 2001, involving a change in the employer of the employees of 
the trade or business;
    (ii) The allocations are provided only to employees who were 
employed by the acquired trade or business before a specified date that 
is no later than two years after the transaction (or January 1, 2002, if 
earlier);
    (iii) The allocations are provided pursuant a plan provision adopted 
no later than the specified date; and
    (iv) The allocations for each employee in the group are reasonably 
calculated, in a consistent manner, to replace some or all of the 
retirement benefits that the employee would have received under any plan 
of the employer if the new employer had continued to provide the 
retirement benefits that the prior employer was providing for employees 
of the trade or business.
    (F) Successor employers. An employer that accepts a transfer of 
assets (within the meaning of section 414(l)) from the plan of a prior 
employer may continue to treat any transition allocations provided under 
that plan as transition allocations under paragraph (b)(1)(iii)(B) of 
this section, provided that the successor employer continues to satisfy 
the applicable requirements set forth in paragraphs (b)(1)(iii)(C) 
through (E) of this section for the plan year.
    (iv) Gradual age or service schedule--(A) In general. A plan has a 
gradual age or service schedule for the plan year if the allocation 
formula for all employees under the plan provides for a single schedule 
of allocation rates under which--
    (1) The schedule defines a series of bands based solely on age, 
years of service, or the number of points representing the sum of age 
and years of service (age and service points), under which the same 
allocation rate applies to all employees whose age, years of service, or 
age and service points are within each band; and
    (2) The allocation rates under the schedule increase smoothly at 
regular intervals, within the meaning of paragraphs (b)(1)(iv)(B) and 
(C) of this section.
    (B) Smoothly increasing schedule of allocation rates. A schedule of 
allocation rates increases smoothly if the allocation rate for each band 
within the schedule is greater than the allocation rate for the 
immediately preceding band (i.e., the band with the next lower number of 
years of age, years of service, or age and service points) but by no 
more than 5 percentage points. However, a schedule of allocation rates 
will not be treated as increasing smoothly if the ratio of the 
allocation rate for any band to the rate for the immediately preceding 
band is more than 2.0 or if it exceeds the ratio of allocation rates 
between the two immediately preceding bands.
    (C) Regular intervals. A schedule of allocation rates has regular 
intervals of age, years of service or age and service points, if each 
band, other than the band associated with the highest age, years of 
service, or age and service points, is the same length. For this 
purpose, if the schedule is based on age, the first band is deemed to be 
of the same length as the other bands if it ends at or before age 25. If 
the first age band ends after age 25, then, in determining whether the 
length of the first band is the same as the length of other bands, the 
starting age for the first age band is permitted to be treated as age 25 
or any age earlier than 25. For a schedule of allocation rates based on 
age and service points, the rules of the preceding two sentences are 
applied by substituting 25 age and service points for age 25. For a 
schedule of allocation rates based on service, the starting service for 
the first service band is permitted to be treated as one year of service 
or any lesser amount of service.

[[Page 152]]

    (D) Minimum allocation rates permitted. A schedule of allocation 
rates under a plan does not fail to increase smoothly at regular 
intervals, within the meaning of paragraphs (b)(1)(iv)(B) and (C) of 
this section, merely because a minimum uniform allocation rate is 
provided for all employees or the minimum benefit described in section 
416(c)(2) is provided for all non-key employees (either because the plan 
is top heavy or without regard to whether the plan is top heavy) if the 
schedule satisfies one of the following conditions--
    (1) The allocation rates under the plan that are greater than the 
minimum allocation rate can be included in a hypothetical schedule of 
allocation rates that increases smoothly at regular intervals, within 
the meaning of paragraphs (b)(1)(iv)(B) and (C) of this section, where 
the hypothetical schedule has a lowest allocation rate no lower than 1% 
of plan year compensation; or
    (2) For a plan using a schedule of allocation rates based on age, 
for each age band in the schedule that provides an allocation rate 
greater than the minimum allocation rate, there could be an employee in 
that age band with an equivalent accrual rate that is less than or equal 
to the equivalent accrual rate that would apply to an employee whose age 
is the highest age for which the allocation rate equals the minimum 
allocation rate.
    (v) Uniform target benefit allocations. A plan has allocation rates 
that are based on a uniform target benefit allocation for the plan year 
if the plan fails to satisfy the requirements for the safe harbor 
testing method in paragraph (b)(3) of this section merely because the 
determination of the allocations under the plan differs from the 
allocations determined under that safe harbor testing method for any of 
the following reasons--
    (A) The interest rate used for determining the actuarial present 
value of the stated plan benefit and the theoretical reserve is lower 
than a standard interest rate;
    (B) The stated benefit is calculated assuming compensation increases 
at a specified rate; or
    (C) The plan computes the current year contribution using the actual 
account balance instead of the theoretical reserve.
    (vi) Minimum allocation gateway--(A) General rule. A plan satisfies 
the minimum allocation gateway of this paragraph (b)(1)(vi) if each NHCE 
has an allocation rate that is at least one third of the allocation rate 
of the HCE with the highest allocation rate.
    (B) Deemed satisfaction. A plan is deemed to satisfy the minimum 
allocation gateway of this paragraph (b)(1)(vi) if each NHCE receives an 
allocation of at least 5% of the NHCE's compensation within the meaning 
of section 415(c)(3), measured over a period of time permitted under the 
definition of plan year compensation.
    (vii) Determination of allocation rate. For purposes of paragraph 
(b)(1)(i)(B) of this section, allocations and allocation rates are 
determined under Sec. 1.401(a)(4)-2(c)(2), but without taking into 
account the imputation of permitted disparity under Sec. 1.401(a)(4)-7. 
However, in determining whether the plan has broadly available 
allocation rates as provided in paragraph (b)(1)(iii) of this section, 
differences in allocation rates attributable solely to the use of 
permitted disparity described in Sec. 1.401(l)-2 are disregarded.
    (viii) Examples. The following examples illustrate the rules in this 
paragraph (b)(1):

    Example 1. (i) Plan M, a defined contribution plan without a minimum 
service requirement, provides an allocation formula under which 
allocations are provided to all employees according to the following 
schedule:

------------------------------------------------------------------------
                                                               Ratio of
                                                              allocation
                                                               rate for
                                                 Allocation    band to
          Completed years of service              rate (in    allocation
                                                  percent)     rate for
                                                             immediately
                                                              preceding
                                                                 band
------------------------------------------------------------------------
0-5...........................................          3.0        (\1\)
6-10..........................................          4.5         1.50
11-15.........................................          6.5         1.44
16-20.........................................          8.5         1.31
21-25.........................................         10.0         1.18
26 or more....................................         11.5        1.15
------------------------------------------------------------------------
\1\ Not applicable.

    (ii) Plan M provides that allocation rates for all employees are 
determined using a single schedule based solely on service, as described 
in paragraph (b)(1)(iv)(A)(1) of this section. Therefore, if the 
allocation rates

[[Page 153]]

under the schedule increase smoothly at regular intervals as described 
in paragraph (b)(1)(iv)(A)(2) of this section, then the plan has a 
gradual age or service schedule described in paragraph (b)(1)(iv) of 
this section.
    (iii) The schedule of allocation rates under Plan M does not 
increase by more than 5 percentage points between adjacent bands and the 
ratio of the allocation rate for any band to the allocation rate for the 
immediately preceding band is never more than 2.0 and does not increase. 
Therefore, the allocation rates increase smoothly as described in 
paragraph (b)(1)(iv)(B) of this section. In addition, the bands (other 
than the highest band) are all 5 years long, so the increases occur at 
regular intervals as described in paragraph (b)(1)(iv)(C) of this 
section. Thus, the allocation rates under the plan's schedule increase 
smoothly at regular intervals as described in paragraph (b)(1)(iv)(A)(2) 
of this section. Accordingly, the plan has a gradual age or service 
schedule described in paragraph (b)(1)(iv) of this section.
    (iv) Under paragraph (b)(1)(i) of this section, Plan M satisfies the 
nondiscrimination in amount requirement of Sec. 1.401(a)(4)-1(b)(2) on 
the basis of benefits if it satisfies paragraph (b)(1)(i)(A) of this 
section, regardless of whether it satisfies the minimum allocation 
gateway of paragraph (b)(1)(vi) of this section.
    Example 2. (i) The facts are the same as in Example 1, except that 
the 4.5% allocation rate applies for all employees with 10 years of 
service or less.
    (ii) Plan M provides that allocation rates for all employees are 
determined using a single schedule based solely on service, as described 
in paragraph (b)(1)(iv)(A)(1) of this section. Therefore, if the 
allocation rates under the schedule increase smoothly at regular 
intervals as described in paragraph (b)(1)(iv)(A)(2) of this section, 
then the plan has a gradual age or service schedule described in 
paragraph (b)(1)(iv) of this section.
    (iii) The bands (other than the highest band) in the schedule are 
not all the same length, since the first band is 10 years long while 
other bands are 5 years long. Thus, the schedule does not have regular 
intervals as described in paragraph (b)(1)(iv)(C) of this section. 
However, under paragraph (b)(1)(iv)(D) of this section, the schedule of 
allocation rates does not fail to increase smoothly at regular intervals 
merely because the minimum allocation rate of 4.5% results in a first 
band that is longer than the other bands, if either of the conditions of 
paragraph (b)(1)(iv)(D)(1) or (2) of this section is satisfied.
    (iv) In this case, the schedule of allocation rates satisfies the 
condition in paragraph (b)(1)(iv)(D)(1) of this section because the 
allocation rates under the plan that are greater than the 4.5% minimum 
allocation rate can be included in the following hypothetical schedule 
of allocation rates that increases smoothly at regular intervals and has 
a lowest allocation rate of at least 1% of plan year compensation:

------------------------------------------------------------------------
                                                               Ratio of
                                                              allocation
                                                               rate for
                                                 Allocation    band to
          Completed years of service              rate (in    allocation
                                                  percent)     rate for
                                                             immediately
                                                              preceding
                                                                 band
------------------------------------------------------------------------
0-5...........................................          2.5        (\1\)
6-10..........................................          4.5         1.80
11-15.........................................          6.5         1.44
16-20.........................................          8.5         1.31
21-25.........................................         10.0         1.18
26 or more....................................         11.5        1.15
------------------------------------------------------------------------
\1\ Not applicable.

    (v) Accordingly, the plan has a gradual age or service schedule 
described in paragraph (b)(1)(iv) of this section. Under paragraph 
(b)(1)(i) of this section, Plan M satisfies the nondiscrimination in 
amount requirement of Sec. 1.401(a)(4)-1(b)(2) on the basis of benefits 
if it satisfies paragraph (b)(1)(i)(A) of this section, regardless of 
whether it satisfies the minimum allocation gateway of paragraph 
(b)(1)(vi) of this section.
    Example 3. (i) Plan N, a defined contribution plan, provides an 
allocation formula under which allocations are provided to all employees 
according to the following schedule:

------------------------------------------------------------------------
                                                               Ratio of
                                                              allocation
                                                               rate for
                                                 Allocation    band to
                      Age                         rate (in    allocation
                                                  percent)     rate for
                                                             immediately
                                                              preceding
                                                                 band
------------------------------------------------------------------------
Under 25......................................          3.0        (\1\)
25-34.........................................          6.0         2.00
35-44.........................................          9.0         1.50
45-54.........................................         12.0         1.33
55-64.........................................         16.0         1.33
65 or older...................................         21.0        1.31
------------------------------------------------------------------------
\1\ Not applicable.

    (ii) Plan N provides that allocation rates for all employees are 
determined using a single schedule based solely on age, as described in 
paragraph (b)(1)(iv)(A)(1) of this section. Therefore, if the allocation 
rates under the schedule increase smoothly at regular intervals as 
described in paragraph (b)(1)(iv)(A)(2) of this section, then the plan 
has a gradual age or service schedule described in paragraph (b)(1)(iv) 
of this section.
    (iii) The schedule of allocation rates under Plan N does not 
increase by more than 5 percentage points between adjacent bands and the 
ratio of the allocation rate for any band to the allocation rate for the 
immediately preceding band is never more than 2.0 and does not increase. 
Therefore, the allocation

[[Page 154]]

rates increase smoothly as described in paragraph (b)(1)(iv)(B) of this 
section. In addition, the bands (other than the highest band and the 
first band, which is deemed to be the same length as the other bands 
because it ends prior to age 25) are all 5 years long, so the increases 
occur at regular intervals as described in paragraph (b)(1)(iv)(C) of 
this section. Thus, the allocation rates under the plan's schedule 
increase smoothly at regular intervals as described in paragraph 
(b)(1)(iv)(A)(2) of this section. Accordingly, the plan has a gradual 
age or service schedule described in paragraph (b)(1)(iv) of this 
section.
    (iv) Under paragraph (b)(1)(i) of this section, Plan N satisfies the 
nondiscrimination in amount requirement of Sec. 1.401(a)(4)-1(b)(2) on 
the basis of benefits if it satisfies paragraph (b)(1)(i)(A) of this 
section, regardless of whether it satisfies the minimum allocation 
gateway of paragraph (b)(1)(vi) of this section.
    Example 4. (i) Plan O, a defined contribution plan, provides an 
allocation formula under which allocations are provided to all employees 
according to the following schedule:

------------------------------------------------------------------------
                                                               Ratio of
                                                              allocation
                                                               rate for
                                                 Allocation    band to
                      Age                         rate (in    allocation
                                                  percent)     rate for
                                                             immediately
                                                              preceding
                                                                 band
------------------------------------------------------------------------
Under 40......................................            3        (\1\)
40-44.........................................            6         2.00
45-49.........................................            9         1.50
50-54.........................................           12         1.33
55-59.........................................           16         1.33
60-64.........................................           20         1.25
65 or older...................................           25        1.25
------------------------------------------------------------------------
\1\ Not applicable.

    (ii) Plan O provides that allocation rates for all employees are 
determined using a single schedule based solely on age, as described in 
paragraph (b)(1)(iv)(A)(1) of this section. Therefore, if the allocation 
rates under the schedule increase smoothly at regular intervals as 
described in paragraph (b)(1)(iv)(A)(2) of this section, then the plan 
has a gradual age or service schedule described in paragraph (b)(1)(iv) 
of this section.
    (iii) The bands (other than the highest band) in the schedule are 
not all the same length, since the first band is treated as 15 years 
long while other bands are 5 years long. Thus, the schedule does not 
have regular intervals as described in paragraph (b)(1)(iv)(C) of this 
section. However, under paragraph (b)(1)(iv)(D) of this section, the 
schedule of allocation rates does not fail to increase smoothly at 
regular intervals merely because the minimum allocation rate of 3% 
results in a first band that is longer than the other bands, if either 
of the conditions of paragraph (b)(1)(iv)(D)(1) or (2) of this section 
is satisfied.
    (iv) In this case, in order to define a hypothetical schedule that 
could include the allocation rates in the actual schedule of allocation 
rates, each of the bands below age 40 would have to be 5 years long (or 
be treated as 5 years long). Accordingly, the hypothetical schedule 
would have to provide for a band for employees under age 30, a band for 
employees in the range 30-34 and a band for employees age 35-39.
    (v) The ratio of the allocation rate for the age 40-44 band to the 
next lower band is 2.0. Accordingly, in order for the applicable 
allocations rates under this hypothetical schedule to increase smoothly, 
the ratio of the allocation rate for each band in the hypothetical 
schedule below age 40 to the allocation rate for the immediately 
preceding band would have to be 2.0. Thus, the allocation rate for the 
hypothetical band applicable for employees under age 30 would be .75%, 
the allocation rate for the hypothetical band for employees in the range 
30-34 would be 1.5% and the allocation rate for employees in the range 
35-39 would be 3%.
    (vi) Because the lowest allocation rate under any possible 
hypothetical schedule is less than 1% of plan year compensation, Plan O 
will be treated as satisfying the requirements of paragraphs 
(b)(1)(iv)(B) and (C) of this section only if the schedule of allocation 
rates satisfies the steepness condition described in paragraph 
(b)(1)(iv)(D)(2) of this section. In this case, the steepness condition 
is not satisfied because the equivalent accrual rate for an employee age 
39 is 2.81%, but there is no hypothetical employee in the band for ages 
40-44 with an equal or lower equivalent accrual rate (since the lowest 
equivalent accrual rate for hypothetical employees within this band is 
3.74% at age 44).
    (vii) Since the schedule of allocation rates under the plan does not 
increase smoothly at regular intervals, Plan O's schedule of allocation 
rates is not a gradual age or service schedule. Further, Plan O does not 
provide uniform target benefit allocations. Therefore, under paragraph 
(b)(1)(i) of this section, Plan O cannot satisfy the nondiscrimination 
in amount requirement of Sec. 1.401(a)(4)-1(b)(2) for the plan year on 
the basis of benefits unless either Plan O provides for broadly 
available allocation rates for the plan year as described in paragraph 
(b)(1)(iii) of this section (i.e., the allocation rate at each age is 
provided to a group of employees that satisfies section 410(b) without 
regard to the average benefit percentage test), or Plan O satisfies the 
minimum allocation gateway of paragraph (b)(1)(vi) of this section for 
the plan year.
    Example 5. (i) Plan P is a profit-sharing plan maintained by 
Employer A that covers all of Employer A's employees, consisting of two 
HCEs, X and Y, and 7 NHCEs. Employee

[[Page 155]]

X's compensation is $170,000 and Employee Y's compensation is $150,000. 
The allocation for Employees X and Y is $30,000 each, resulting in an 
allocation rate of 17.65% for Employee X and 20% for Employee Y. Under 
Plan P, each NHCE receives an allocation of 5% of compensation within 
the meaning of section 415(c)(3), measured over a period of time 
permitted under the definition of plan year compensation.
    (ii) Because the allocation rate for X is not currently available to 
any NHCE, Plan P does not have broadly available allocation rates within 
the meaning of paragraph (b)(1)(iii) of this section. Furthermore, Plan 
P does not provide for age based-allocation rates within the meaning of 
paragraph (b)(1)(iv) or (v) of this section. Thus, under paragraph 
(b)(1)(i) of this section, Plan P can satisfy the nondiscrimination in 
amount requirement of Sec. 1.401(a)(4)-1(b)(2) for the plan year on the 
basis of benefits only if Plan P satisfies the minimum allocation 
gateway of paragraph (b)(1)(vi) of this section for the plan year.
    (iii) The highest allocation rate for any HCE under Plan P is 20%. 
Accordingly, Plan P would satisfy the minimum allocation gateway of 
paragraph (b)(1)(vi) of this section if all NHCEs have an allocation 
rate of at least 6.67%, or if all NHCEs receive an allocation of at 
least 5% of compensation within the meaning of section 415(c)(3) 
(measured over a period of time permitted under the definition of plan 
year compensation).
    (iv) Under Plan P, each NHCE receives an allocation of 5% of 
compensation within the meaning of section 415(c)(3) (measured over a 
period of time permitted under the definition of plan year 
compensation). Accordingly, Plan P satisfies the minimum allocation 
gateway of paragraph (b)(1)(vi) of this section.
    (v) Under paragraph (b)(1)(i) of this section, Plan P satisfies the 
nondiscrimination in amount requirement of Sec. 1.401(a)(4)-1(b)(2) on 
the basis of benefits if it satisfies paragraph (b)(1)(i)(A) of this 
section.

    (2) Determination of equivalent accrual rates--(i) Basic definition. 
An employee's equivalent accrual rate for a plan year is the annual 
benefit that is the result of normalizing the increase in the employee's 
account balance during the measurement period, divided by the number of 
years in which the employee benefited under the plan during the 
measurement period, and expressed either as a dollar amount or as a 
percentage of the employee's average annual compensation. A measurement 
period that includes future years may not be used for this purpose.
    (ii) Rules of application--(A) Determination of account balance. The 
increase in the account balance during the measurement period taken into 
account under paragraph (b)(2)(i) of this section does not include 
income, expenses, gains, or losses allocated during the measurement 
period that are attributable to the account balance as of the beginning 
of the measurement period, but does include any additional amounts that 
would have been included in the increase in the account balance but for 
the fact that they were previously distributed (including a reasonable 
adjustment for interest). In the case of a measurement period that is 
the current plan year, an employer may also elect to disregard the 
income, expenses, gains, and losses allocated during the current plan 
year that are attributable to the increase in account balance since the 
beginning of the year, and thus, determine the increase in account 
balance during the plan year taking into account only the allocations 
described in Sec. 1.401(a)(4)-2(c)(2)(ii). In addition, an employer may 
disregard distributions made to a NHCE as well as distributions made to 
any employee in plan years beginning before a selected date no later 
than January 1, 1986.
    (B) Normalization. The account balances determined under paragraph 
(b)(2)(ii)(A) of this section are normalized by treating them as single-
sum benefits that are immediately and unconditionally payable to the 
employee. A standard interest rate, and a straight life annuity factor 
that is based on the same or a different standard interest rate and on a 
standard mortality table, must be used in normalizing these benefits. In 
addition, no mortality may be assumed prior to the employee's testing 
age.
    (iii) Options. Any of the optional rules in Sec. 1.401(a)(4)-
3(d)(3) (e.g., imputation of permitted disparity) may be applied in 
determining an employee's equivalent accrual rate by substituting the 
employee's equivalent accrual rate (determined without regard to the 
option) for the employee's normal accrual rate (i.e., not most valuable 
accrual rate) in that section where appropriate. For this purpose, 
however, the

[[Page 156]]

last sentence of the fresh-start alternative in Sec. 1.401(a)(4)-
3(d)(3)(iii)(A) (dealing with compensation adjustments to the frozen 
accrued benefit) is not applicable. No other options are available in 
determining an employee's equivalent accrual rate except those (e.g., 
selection of alternative measurement periods) specifically provided in 
this paragraph (b)(2). Thus, for example, none of the optional special 
rules in Sec. 1.401(a)(4)-3(f) (e.g., determination of benefits on 
other than a plan year basis under Sec. 1.401(a)(4)-3(f)(6)) is 
available.
    (iv) Consistency rule. Equivalent accrual rates must be determined 
in a consistent manner for all employees for the plan year. Thus, for 
example, the same measurement periods and standard interest rates must 
be used, and any available options must be applied consistently if at 
all.
    (3) Safe-harbor testing method for target benefit plans--(i) General 
rule. A target benefit plan is a money purchase pension plan under which 
contributions to an employee's account are determined by reference to 
the amounts necessary to fund the employee's stated benefit under the 
plan. Whether a target benefit plan satisfies section 401(a)(4) with 
respect to an equivalent amount of benefits is generally determined 
under paragraphs (b)(1) and (b)(2) of this section. A target benefit 
plan is deemed to satisfy section 401(a)(4) with respect to an 
equivalent amount of benefits, however, if each of the following 
requirements is satisfied:
    (A) Stated benefit formula. Each employee's stated benefit must be 
determined as the straight life annuity commencing at the employee's 
normal retirement age under a formula that would satisfy the 
requirements of Sec. 1.401(a)(4)-3(b)(4)(i)(C) (1) or (2), and that 
would satisfy each of the uniformity requirements in Sec. 1.401(a)(4)-
3(b)(2) (taking into account the relevant exceptions provided in Sec. 
1.401(a)(4)-3(b)(6)), if the plan were a defined benefit plan with the 
same benefit formula. In determining whether these requirements are 
satisfied, the rules of Sec. 1.401(a)(4)-3(f) do not apply, and, in 
addition, except as provided in paragraph (b)(3)(vii) of this section, 
an employee's stated benefit at normal retirement age under the stated 
benefit formula is deemed to accrue ratably over the period ending with 
the plan year in which the employee is projected to reach normal 
retirement age and beginning with the latest of: the first plan year in 
which the employee benefited under the plan, the first plan year taken 
into account in the stated benefit formula, and any plan year 
immediately following a plan year in which the plan did not satisfy this 
paragraph (b)(3). Thus, except as provided in paragraph (b)(3)(vii) of 
this section, under Sec. 1.401(a)(4)-3(b)(2)(v) an employee's stated 
benefit may not take into account service in years prior to the first 
plan year that the employee benefited under the plan, and an employee's 
stated benefit may not take into account service in plan years prior to 
the current plan year unless the plan satisfied this paragraph (b)(3) in 
all of those prior plan years.
    (B) Employer and employee contributions. Employer contributions with 
respect to each employee must be based exclusively on the employee's 
stated benefit using the method provided in paragraph (b)(3)(iv) of this 
section, and forfeitures and any other amounts under the plan taken into 
account under Sec. 1.401(a)(4)-2(c)(2)(ii) (other than employer 
contributions) are used exclusively to reduce employer contributions. 
Employee contributions (if any) may not be used to fund the stated 
benefit.
    (C) Permitted disparity. If permitted disparity is taken into 
account, the stated benefit formula must satisfy Sec. 1.401(l)-3. For 
this purpose, the 0.75-percent factor in the maximum excess or offset 
allowance in Sec. 1.401(l)-3(b)(2)(i) or (b)(3)(i), respectively, as 
adjusted in accordance with Sec. 1.401(l)-3(d)(9) (and, if the 
employee's normal retirement age is not the employee's social security 
retirement age, Sec. 1.401(l)-3(e)), is further reduced by multiplying 
the factor by 0.80.
    (ii) Changes in stated benefit formula. A plan does not fail to 
satisfy paragraph (b)(3)(i) of this section merely because the plan 
determines each employee's stated benefit in the current

[[Page 157]]

plan year under a stated benefit formula that differs from the stated 
benefit formula used to determine the employee's stated benefit in prior 
plan years.
    (iii) Stated benefits after normal retirement age. A target benefit 
plan may limit increases in the stated benefit after normal retirement 
age consistent with the requirements applicable to defined benefit plans 
under section 411(b)(1)(H) (without regard to section 
411(b)(1)(H)(iii)), provided that the limitation applies on the same 
terms to all employees. Thus, post-normal retirement benefits required 
under Sec. 1.401(a)(4)-3(b)(2)(ii) must be provided under the stated 
benefit formula, subject to any uniformly applicable service cap under 
the formula.
    (iv) Method for determining required employer contributions--(A) 
General rule. An employer's required contribution to the account of an 
employee for a plan year is determined based on the employee's stated 
benefit and the amount of the employee's theoretical reserve as of the 
date the employer's required contribution is determined for the plan 
year (the determination date). Paragraph (b)(3)(iv)(B) of this section 
provides rules for determining an employee's theoretical reserve. 
Paragraph (b)(3)(iv) (C) and (D) of this section provides rules for 
determining an employer's required contributions.
    (B) Theoretical reserve--(1) Initial theoretical reserve. An 
employee's theoretical reserve as of the determination date for the 
first plan year in which the employee benefits under the plan, the first 
plan year taken into account under the stated benefit formula (if that 
is the current plan year), or the first plan year immediately following 
any plan year in which the plan did not satisfy this paragraph (b)(3), 
is zero.
    (2) Theoretical reserve in subsequent plan years. An employee's 
theoretical reserve as of the determination date for a plan year (other 
than a plan year described in paragraph (b)(3)(iv)(B)(1) of this 
section) is the employee's theoretical reserve as of the determination 
date for the prior plan year, plus the employer's required contribution 
for the prior plan year (as limited by section 415, but without regard 
to the additional contributions described in paragraph (b)(3)(v) of this 
section) both increased by interest from the determination date for the 
prior plan year through the determination date for the current plan 
year, but not beyond the determination date for the plan year that 
includes the employee's normal retirement date. (Thus, an employee's 
theoretical reserve as of the determination date for a plan year does 
not include the amount of the employer's required contribution for the 
plan year.) The interest rate for determining employer contributions 
that was in effect on the determination date in the prior plan year must 
be applied to determine the required interest adjustment for this 
period. For plan years beginning after the effective date applicable to 
the plan under Sec. 1.401(a)(4)-13(a) or (b), a standard interest rate 
must be used, and may not be changed except on the determination date 
for a plan year.
    (C) Required contributions for employees under normal retirement 
age. The required employer contributions with respect to an employee 
whose attained age is less than the employee's normal retirement age 
must be determined for each plan year as follows:
    (1) Determine the employee's fractional rule benefit (within the 
meaning of Sec. 1.411(b)-1(b)(3)(ii)(A)) under the plan's stated 
benefit formula as if the plan were a defined benefit plan with the same 
benefit formula.
    (2) Determine the actuarial present value of the fractional rule 
benefit determined in paragraph (b)(3)(iv)(C)(1) of this section as of 
the determination date for the current plan year, using a standard 
interest rate and a standard mortality table that are set forth in the 
plan and that are the same for all employees, and assuming no mortality 
before the employee's normal retirement age.
    (3) Determine the excess, if any, of the amount determined in 
paragraph (b)(3)(iv)(C)(2) of this section over the employee's 
theoretical reserve for the current plan year determined under paragraph 
(b)(3)(iv)(B) of this section.
    (4) Determine the required employer contribution for the current 
plan year by amortizing on a level annual basis, using the same interest 
rate used for

[[Page 158]]

paragraph (b)(3)(iv)(C)(2) of this section, the result in paragraph 
(b)(3)(iv)(C)(3) of this section over the period beginning with the 
determination date for the current plan year and ending with the 
determination date for the plan year in which the employee is projected 
to reach normal retirement age.
    (D) Required contributions for employees over normal retirement age. 
The required employer contributions with respect to an employee whose 
attained age equals or exceeds the employee's normal retirement age is 
the excess, if any, of the actuarial present value, as of the 
determination date for the current plan year, of the employee's stated 
benefit for the current plan year (determined using an immediate 
straight life annuity factor based on a standard interest rate and a 
standard mortality table, for an employee whose attained age equals the 
employee's normal retirement age) over the employee's theoretical 
reserve as of the determination date.
    (v) Effect of section 415 and 416 requirements. A target benefit 
plan does not fail to satisfy this paragraph (b)(3) merely because 
required contributions under the plan are limited by section 415 in a 
plan year. Similarly, a target benefit plan does not fail to satisfy 
this paragraph (b)(3) merely because additional contributions are made 
consistent with the requirements of section 416(c)(2) (regardless of 
whether the plan is top-heavy).
    (vi) Certain conditions on allocations. A target benefit plan does 
not fail to satisfy this paragraph (b)(3) merely because required 
contributions under the plan are subject to the conditions on 
allocations permitted under Sec. 1.401(a)(4)-2(b)(4)(iii).
    (vii) Special rules for target benefit plans qualified under prior 
law--(A) Service taken into account prior to satisfaction of this 
paragraph. For purposes of determining whether the stated benefit 
formula satisfies paragraph (b)(3)(i)(A) of this section (e.g., whether 
the period over which an employee's stated benefit is deemed to accrue 
is the same as the period taken into account under the stated benefit 
formula as required by paragraph (b)(3)(i)(A) of this section), a target 
benefit plan that was adopted and in effect on September 19, 1991, is 
deemed to have satisfied this paragraph (b)(3), and an employee is 
treated as benefiting under the plan, in any year prior to the effective 
date applicable to the plan under Sec. 1.401(a)(4)-13 (a) or (b) that 
was taken into account in the stated benefit formula under the plan on 
September 19, 1991, if the plan satisfied the applicable 
nondiscrimination requirements for target benefit plans for that prior 
year.
    (B) Initial theoretical reserve. Notwithstanding paragraph 
(b)(3)(iv)(B)(1) of this section, a target benefit plan under which the 
stated benefit formula takes into account service for an employee for 
plan years prior to the first plan year in which the plan satisfied this 
paragraph (b)(3), as permitted under paragraph (b)(3)(vii)(A) of this 
section, must determine an initial theoretical reserve for the employee 
as of the determination date for the last plan year beginning before 
such plan year under the rules of Sec. 1.401(a)(4)-13(e).
    (C) Satisfaction of prior law. In determining whether a plan 
satisfied the applicable nondiscrimination requirements for target 
benefit plans for any period prior to the effective date applicable to 
the plan under Sec. 1.401(a)(4)-13 (a) or (b), no amendments after 
September 19, 1991, other than amendments necessary to satisfy section 
401(l), are taken into account.
    (viii) Examples. The following examples illustrate the rules in this 
paragraph (b)(3):

    Example 1. (a) Employer X maintains a target benefit plan with a 
calendar plan year that bases contributions on a stated benefit equal to 
40 percent of each employee's average annual compensation, reduced pro 
rata for years of participation less than 25, payable annually as a 
straight life annuity commencing at normal retirement age. The UP-84 
mortality table and an interest rate of 7.5 percent are used to 
calculate the contributions necessary to fund the stated benefit. 
Required contributions are determined on the last day of each plan year. 
The normal retirement age under the plan is 65. Employee M is 39 years 
old in 1994, has participated in the plan for six years, and has average 
annual compensation equal to $60,000 for the 1994 plan year. Assume that 
Employee M's theoretical reserve as of the last day of the 1993 plan 
year is $13,909, determined under Sec. 1.401(a)(4)-13(e), and that 
required

[[Page 159]]

employer contributions for 1993 were determined using an interest rate 
of six percent.
    (b) Under these facts, Employer X's 1994 required contribution to 
fund Employee M's stated benefit is $1,318, calculated as follows:
    (1) Employee M's fractional rule benefit is $24,000 (40 percent of 
Employee M's average annual compensation of $60,000).
    (2) The actuarial present value of Employee M's fractional rule 
benefit as of the last day of the 1994 plan year is $30,960 (Employee 
M's fractional rule benefit of $24,000 multiplied by 1.290, the 
actuarial present value factor for an annual straight life annuity 
commencing at age 65 applicable to a 39-year-old employee, determined 
using the stated interest rate of 7.5 percent and the UP-84 mortality 
table, and assuming no mortality before normal retirement age).
    (3) The actuarial present value of Employee M's fractional rule 
benefit ($30,960) is reduced by Employee M's theoretical reserve as of 
the last day of the 1994 plan year. The theoretical reserve on that day 
is $14,744--the $13,909 theoretical reserve as of the last day of the 
1993 plan year, increased by interest for one year at the rate of six 
percent. Because the required contribution for the 1993 plan year is 
taken into account under Sec. 1.401(a)(4)-13(e)(2) in determining the 
theoretical reserve as of the last day of the 1993 plan year, it is not 
added to the theoretical reserve again in this paragraph (b)(3) of this 
Example 1. The resulting difference is $16,216 ($30,960-$14,744).
    (4) The $16,216 excess of the actuarial present value of Employee 
M's fractional rule benefit over Employee M's theoretical reserve is 
multiplied by 0.0813, the amortization factor applicable to a 39-year-
old employee determined using the stated interest rate of 7.5 percent. 
The product of $1,318 is the amount of the required employer 
contribution for Employee M for the 1994 plan year.
    Example 2. (a) The facts are the same as in Example 1, except that 
as of January 1, 1995, the plan's stated benefit formula is amended to 
provide for a stated benefit equal to 45 percent of average annual 
compensation, reduced pro rata for years of participation less than 25, 
payable annually as a straight life annuity commencing at normal 
retirement age. For the 1995 plan year, Employee M's average annual 
compensation continues to be $60,000. The mortality table used for the 
calculation of the employer's required contributions remains the same as 
in the prior plan year, but the plan's stated interest rate is changed 
to 8.0 percent effective as of December 31, 1995.
    (b) Under these facts, Employer X's required contribution for 
Employee M is $1,290, calculated as follows:
    (1) Employee M's fractional rule benefit is $27,000 (45 percent of 
$60,000).
    (2) The actuarial present value of Employee M's fractional rule 
benefit as of the last day of the 1995 plan year is $32,319 ($27,000 
multiplied by 1.197, the actuarial present value factor for an annuity 
commencing at age 65 applicable to a 40-year-old employee, determined 
using the stated interest rate of 8.0 percent and the UP-84 mortality 
table, and assuming no mortality before normal retirement age).
    (3) The actuarial present value of Employee M's fractional rule 
benefit ($32,319) is reduced by Employee M's theoretical reserve as of 
the last day of the 1995 plan year. The theoretical reserve as of that 
day is $17,267--the $14,744 theoretical reserve as of the last day of 
the 1994 plan year plus the $1,318 required contribution for the 1994 
plan year, both increased by interest for one year at the rate of 7.5 
percent. The resulting difference is $15,052 ($32,319-$17,267).
    (4) The result in paragraph (b)(3) of this Example 2 is multiplied 
by 0.0857, the amortization factor applicable to a 40-year-old employee 
determined using the stated interest rate of 8.0 percent. The product, 
$1,290, is the amount of the required employer contribution for Employee 
M for the 1995 plan year.

    (c) Nondiscrimination in amount of contributions under a defined 
benefit plan--(1) General rule. Equivalent allocations under a defined 
benefit plan are nondiscriminatory in amount for a plan year if the plan 
would satisfy Sec. 1.401(a)(4)-3(c)(1) (taking into account Sec. 
1.401(a)(4)-3(c)(3)) for the plan year if an equivalent normal and most 
valuable allocation rate, as determined under paragraph (c)(2) of this 
section, were substituted for each employee's normal and most valuable 
accrual rate, respectively, in the determination of rate groups.
    (2) Determination of equivalent allocation rates--(i) Basic 
definitions. An employee's equivalent normal and most valuable 
allocation rates for a plan year are, respectively, the actuarial 
present value of the increase over the plan year in the benefit that 
would be taken into account in determining the employee's normal and 
most valuable accrual rates for the plan year, expressed either as a 
dollar amount or as a percentage of the employee's plan year 
compensation. In the case of a contributory DB plan, the rules in Sec. 
1.401(a)(4)-6(b)(1), (b)(5), or (b)(6) must be used to determine the 
amount of each employee's employer-provided benefit that would be taken 
into account for this purpose.

[[Page 160]]

    (ii) Rules for determining actuarial present value. The actuarial 
present value of the increase in an employee's benefit must be 
determined using a standard interest rate and a standard mortality 
table, and no mortality may be assumed prior to the employee's testing 
age.
    (iii) Options. The optional rules in Sec. 1.401(a)(4)-2(c)(2)(iv) 
(imputation of permitted disparity) and (v) (grouping of rates) may be 
applied to determine an employee's equivalent normal and most valuable 
allocation rates by substituting those rates (determined without regard 
to the option) for the employee's allocation rate in that section where 
appropriate. In addition, the limitations under section 415 may be taken 
into account under Sec. 1.401(a)(4)-3(d)(2)(ii)(B), and qualified 
disability benefits may be taken into account as accrued benefits under 
Sec. 1.401(a)(4)-3(f)(2), in determining the increase in an employee's 
accrued benefit during a plan year for purposes of paragraph (c)(2)(i) 
of this section, if those rules would otherwise be available. No other 
options are available in determining an employee's equivalent normal and 
most valuable allocations rate except those (e.g., selection of 
alternative standard interest rates) specifically provided in this 
paragraph (c)(2). Thus, while all of the mandatory rules in Sec. 
1.401(a)(4)-3(d) and (f) for determining the amount of benefits used to 
determine an employee's normal and most valuable accrual rates (e.g., 
the treatment of early retirement window benefits in Sec. 1.401(a)(4)-
3(f)(4)) are applicable in determining an employee's equivalent normal 
and most valuable allocation rates, none of the optional rules under 
Sec. 1.401(a)(4)-3 is available (except the options relating to the 
section 415 limits and qualified disability benefits noted above).
    (iv) Consistency rule. Equivalent allocation rates must be 
determined in a consistent manner for all employees for the plan year. 
Thus, for example, the same standard interest rates must be used, and 
any available options must be applied consistently if at all.
    (3) Safe harbor testing method for cash balance plans--(i) General 
rule. A cash balance plan is a defined benefit plan that defines 
benefits for each employee by reference to the employee's hypothetical 
account. An employee's hypothetical account is determined by reference 
to hypothetical allocations and interest adjustments that are analogous 
to actual allocations of contributions and earnings to an employee's 
account under a defined contribution plan. Because a cash balance plan 
is a defined benefit plan, whether it satisfies section 401(a)(4) with 
respect to the equivalent amount of contributions is generally 
determined under paragraphs (c)(1) and (c)(2) of this section. However, 
a cash balance plan that satisfies each of the requirements in 
paragraphs (c)(3)(ii) through (xi) of this section is deemed to satisfy 
section 401(a)(4) with respect to an equivalent amount of contributions.
    (ii) Plan requirements in general. The plan must be an accumulation 
plan. The benefit formula under the plan must provide for hypothetical 
allocations for each employee in the plan that satisfy paragraph 
(c)(3)(iii) of this section, and interest adjustments to these 
hypothetical allocations that satisfy paragraph (c)(3)(iv) of this 
section. The benefit formula under the plan must provide that these 
hypothetical allocations and interest adjustments are accumulated as a 
hypothetical account for each employee, determined in accordance with 
paragraph (c)(3)(v) of this section. The plan must provide that an 
employee's accrued benefit under the plan as of any date is an annuity 
that is the actuarial equivalent of the employee's projected 
hypothetical account as of normal retirement age, determined in 
accordance with paragraph (c)(3)(vi) of this section. In addition, the 
plan must satisfy paragraphs (c)(3)(vii) through (xi) of this section 
(to the extent applicable) regarding optional forms of benefit, past 
service credits, post-normal retirement age benefits, certain uniformity 
requirements, and changes in the plan's benefit formula, respectively.
    (iii) Hypothetical allocations--(A) In general. The hypothetical 
allocations provided under the plan's benefit formula must satisfy 
either paragraph (c)(3)(iii)(B) or (C) of this section. Paragraph 
(c)(3)(iii)(B) of this section provides a design-based safe harbor that

[[Page 161]]

does not require the annual comparison of hypothetical allocations under 
the plan. Paragraph (c)(3)(iii)(C) of this section requires the annual 
comparison of hypothetical allocations.
    (B) Uniform hypothetical allocation formula. To satisfy this 
paragraph (c)(3)(iii)(B), the plan's benefit formula must provide for 
hypothetical allocations for all employees in the plan for all plan 
years of amounts that would satisfy Sec. 1.401(a)(4)-2(b)(3) for each 
such plan year if the hypothetical allocations were the only allocations 
under a defined contribution plan for the employees for those plan 
years. Thus, the plan's benefit formula must provide for hypothetical 
allocations for all employees in the plan for all plan years that are 
the same percentage of plan year compensation or the same dollar amount. 
In determining whether the hypothetical allocations satisfy Sec. 
1.401(a)(4)-2(b)(3), the only provisions of Sec. 1.401(a)(4)-2(b)(5) 
that apply are Sec. 1.401(a)(4)-2(b)(5)(ii) (section 401(l) permitted 
disparity, (iii) (entry dates), (vi) (certain limits on allocations), 
and (vii) (dollar allocation per uniform unit of service). Thus, for 
example, the plan's benefit formula may take permitted disparity into 
account in a manner allowed under Sec. 1.401(l)-2 for defined 
contribution plans.
    (C) Modified general test. To satisfy this paragraph (c)(3)(iii)(C), 
the plan's benefit formula must provide for hypothetical allocations for 
all employees in the plan for the plan year that would satisfy the 
general test in Sec. 1.401(a)(4)-2(c) for the plan year, if the 
hypothetical allocations were the only allocations for the employees 
taken into account under Sec. 1.401(a)(4)-2(c)(2)(ii) under a defined 
contribution plan for the plan year. In determining whether the 
hypothetical allocations satisfy Sec. 1.401(a)(4)-2(c), the provisions 
of Sec. 1.401(a)(4)-2(c)(2)(iii) through (v) apply. Thus, for example, 
permitted disparity may be imputed under Sec. 1.401(a)(4)-2(c)(2)(iv) 
in accordance with the rules of Sec. 1.401(a)(4)-7(b) applicable to 
defined contribution plans.
    (iv) Interest adjustments to hypothetical allocations--(A) General 
rule. The plan benefit formula must provide that the dollar amount of 
the hypothetical allocation for each employee for a plan year is 
automatically adjusted using an interest rate that satisfies paragraph 
(c)(3)(iv)(B) of this section, compounded no less frequently than 
annually, for the period that begins with a date in the plan year and 
that ends at normal retirement age. This requirement is not satisfied if 
any portion of the interest adjustments to a hypothetical allocation are 
contingent on the employee's satisfaction of any requirement. Thus, for 
example, the interest adjustments to a hypothetical allocation must be 
provided through normal retirement age, even though the employee 
terminates employment or commences benefits before that age.
    (B) Requirements with respect to interest rates. The interest rate 
must be a single interest rate specified in the plan that is the same 
for all employees in the plan for all plan years. The interest rate must 
be either a standard interest rate or a variable interest rate. If the 
interest rate is a variable interest rate, it must satisfy paragraph 
(c)(3)(iv)(C) of this section.
    (C) Variable interest rates--(1) General rule. The plan must specify 
the variable interest rate, the method for determining the current value 
of the variable interest rate, and the period (not to exceed 1 year) for 
which the current value of the variable interest rate applies. 
Permissible variable interest rates are listed in paragraph 
(c)(3)(iv)(C)(2) of this section. Permissible methods for determining 
the current value of the variable interest rate are provided in 
paragraph (c)(3)(iv)(C)(3) of this section.
    (2) Permissible variable interest rates. The variable interest rate 
specified in the plan must be one of the following--
    (i) The rate on 3-month Treasury Bills,
    (ii) The rate on 6-month Treasury Bills,
    (iii) The rate on 1-year Treasury Bills,
    (iv) The yield on 1-year Treasury Constant Maturities,
    (v) The yield on 2-year Treasury Constant Maturities,
    (vi) The yield on 5-year Treasury Constant Maturities,
    (vii) The yield on 10-year Treasury Constant Maturities,

[[Page 162]]

    (viii) The yield on 30-year Treasury Constant Maturities, or
    (ix) The single interest rate such that, as of a single age 
specified in the plan, the actuarial present value of a deferred 
straight life annuity of an amount commencing at the normal retirement 
age under the plan, calculated using that interest rate and a standard 
mortality table but assuming no mortality before normal retirement age, 
is equal to the actuarial present value, as of the single age specified 
in the plan, of the same annuity calculated using the section 417(e) 
rates applicable to distributions in excess of $25,000 (determined under 
Sec. 1.417(e)-1(d)), and the same mortality assumptions.
    (3) Current value of variable interest rate. The current value of 
the variable interest rate that applies for a period must be either the 
value of the variable interest rate determined as of a specified date in 
the period or the immediately preceding period, or the average of the 
values of the variable interest rate as of two or more specified dates 
during the current period or the immediately preceding period. The value 
as of a date of the rate on a Treasury Bill is the average auction rate 
for the week or month in which the date falls, as reported in the 
Federal Reserve Bulletin. The value as of a date of the yield on a 
Treasury Constant Maturity is the average yield for the week, month, or 
year in which the date falls, as reported in the Federal Reserve 
Bulletin. (The Federal Reserve Bulletin is published by the Board of 
Governors of the Federal Reserve System and is available from 
Publication Services, Mail Stop 138, Board of Governors of the Federal 
Reserve System, Washington DC 20551.) The plan may limit the current 
value of the variable interest rate to a maximum (not less than the 
highest standard interest rate), or a minimum (not more than the lowest 
standard interest rate), or both.
    (v) Hypothetical account--(A) Current value of hypothetical account. 
As of any date, the current value of an employee's hypothetical account 
must equal the sum of all hypothetical allocations and the respective 
interest adjustments to each such hypothetical allocation provided 
through that date for the employee under the plan's benefit formula 
(without regard to any interest adjustments provided under the plan's 
benefit formula for periods after that date).
    (B) Value of hypothetical account as of normal retirement age. Under 
paragraph (c)(3)(vi) of this section, the value of an employee's 
hypothetical account must be determined as of normal retirement age in 
order to determine the employee's accrued benefit as of any date at or 
before normal retirement age. As of any date at or before normal 
retirement age, the value of an employee's hypothetical account as of 
normal retirement age must equal the sum of each hypothetical allocation 
provided through that date for the employee under the plan's benefit 
formula, plus the interest adjustments provided through normal 
retirement age on each of those hypothetical allocations for the 
employee under the plan's benefit formula (without regard to any 
hypothetical allocations that might be provided after that date under 
the plan's benefit formula). If the interest rate specified in the plan 
is a variable interest rate, the plan must specify that the 
determination in the preceding sentence is made by assuming that the 
current value of the variable interest rate for all future periods is 
either the current value of the variable interest rate for the current 
period or the average of the current values of the variable interest 
rate for the current period and one or more periods immediately 
preceding the current period (not to exceed 5 years in the aggregate).
    (vi) Determination of accrued benefit--(A) Definition of accrued 
benefit. The plan must provide that at any date at or before normal 
retirement age the accrued benefit (within the meaning of section 
411(a)(7)(A)(i)) of each employee in the plan is an annuity commencing 
at normal retirement age that is the actuarial equivalent of the 
employee's hypothetical account as of normal retirement age (as 
determined under paragraph (c)(3)(v)(B) of this section). The separate 
benefit that each employee accrues for a plan year is an annuity that is 
the actuarial equivalent of the employee's hypothetical allocation for 
that plan year, including the

[[Page 163]]

automatic adjustments for interest through normal retirement age 
required under paragraph (c)(3)(iv) of this section.
    (B) Normal form of benefit. The annuity specified in paragraph 
(c)(3)(vi)(A) of this section must provide an annual benefit payable in 
the same form at the same uniform normal retirement age for all 
employees in the plan. The annual benefit must be the normal retirement 
benefit under the plan (within the meaning of section 411(a)(9)) under 
the plan.
    (C) Determination of actuarial equivalence. For purposes of this 
paragraph (c)(3)(vi) and paragraph (c)(3)(ix) of this section, actuarial 
equivalence must be determined using a standard mortality table and 
either a standard interest rate or the interest rate specified in the 
plan for making interest adjustments to hypothetical allocations. If the 
interest rate used is the interest rate specified in the plan, and that 
rate is a variable interest rate, the assumed value of the variable 
interest rate for all future periods must be the same value that would 
be assumed for purposes of paragraph (c)(3)(v)(B) of this section. The 
same actuarial assumptions must be used for all employees in the plan.
    (D) Effect of section 415 and 416 requirements. A plan does not fail 
to satisfy this paragraph (c)(3)(vi) merely because the accrued benefits 
under the plan are limited by section 415, or merely because the accrued 
benefits under the plan are the greater of the accrued benefits 
otherwise determined under the plan and the minimum benefit described in 
section 416(c)(1) (regardless of whether the plan is top-heavy).
    (vii) Optional forms of benefit--(A) In general. The plan must 
satisfy the uniform subsidies requirement of Sec. 1.401(a)(4)-
3(b)(2)(iv) with respect to all subsidized optional forms of benefit.
    (B) Limitation on subsidies. Unless hypothetical allocations are 
determined under a uniform hypothetical allocation formula that 
satisfies paragraph (c)(3)(iii)(B) of this section, the actuarial 
present value of any QJSA provided under the plan must not be greater 
than the single sum distribution to the employee that would satisfy 
paragraph (c)(3)(vii)(C) of this section assuming that it was 
distributed to the employee on the date of commencement of the QJSA.
    (C) Distributions subject to section 417(e). Except as otherwise 
required under section 415(b), if the plan provides for a distribution 
alternative that is subject to the interest rate restrictions under 
section 417(e), the actuarial present value of the benefit paid to an 
employee under the distribution alternative must equal the 
nonforfeitable percentage (determined under the plan's vesting schedule) 
of the greater of the following two amounts--
    (1) The current value of the employee's hypothetical account as of 
the date the distribution commences, calculated in accordance with 
paragraph (c)(3)(v)(A) of this section.
    (2) The actuarial present value (calculated in accordance with Sec. 
1.417(e)-1(d)) of the employee's accrued benefit.
    (D) Determination of actuarial present value. For purposes of this 
paragraph (c)(3)(vii), actuarial present value must be determined using 
a reasonable interest rate and mortality table. A standard interest rate 
and a standard mortality table are considered reasonable for this 
purpose.
    (viii) Past service credit. The benefit formula under the plan may 
not provide for hypothetical allocations in the curent plan year that 
are attributable to years of service before the current plan year, 
unless each of the following requirements is satisfied--
    (A) The years of past service credit are granted on a uniform basis 
to all current employees in the plan.
    (B) Hypothetical allocations for the current plan year are 
determined under a uniform hypothetical allocation formula that 
satisfies paragraph (c)(3)(iii)(B) of this section.
    (C) The hypothetical allocations attributable to the years of past 
service would have satisfied the uniform hypothetical allocation formula 
requirement of paragraph (c)(3)(iii)(B) of this section, and the 
interest adjustments to those hypothetical allocations would have 
satisfied paragraph (c)(3)(iv)(A) of this section, if the plan provision 
granting past service had been in effect for the entire period for which 
years of past service are granted

[[Page 164]]

to any employee. In order to satisfy this requirement, the hypothetical 
allocation attributable to a year of past service must be adjusted for 
interest in accordance with paragraph (c)(3)(iv) of this section for the 
period (including the retroactive period) beginning with the year of 
past service to which the hypothetical allocation is attributable and 
ending at normal retirement age. If the interest rate specified in the 
plan is a variable interest rate, the interest adjustments for the 
period prior to the current plan year either must be based on the 
current value of the variable interest rate for the period in which the 
grant of past service first becomes effective or must be reconstructed 
based on the then current value of the variable interest rate that would 
have applied during each prior period.
    (ix) Employees beyond normal retirement age. In the case of an 
employee who commences receipt of benefits after normal retirement age, 
the plan must provide that interest adjustments continue to be made to 
an employee's hypothetical account until the employee's benefit 
commencement date. In the case of an employee described in the previous 
sentence, the employee's accrued benefit is defined as an annuity that 
is the actuarial equivalent of the employee's hypothetical account 
determined in accordance with paragraph (c)(3)(v)(A) of this section as 
of the date of benefit commencement.
    (x) Additional uniformity requirements. In addition to any 
uniformity requirements provided elsewhere in this paragraph (c)(3), the 
plan must satisfy the uniformity requirements in Sec. 1.401(a)(4)-
3(b)(2)(v) (uniform vesting and service requirements) and (vi) (no 
employee contributions). A plan does not fail to satisfy the uniformity 
requirements of this paragraph (c)(3)(x) or any other uniformity 
requirement provided in this paragraph (c)(3) merely because the plan 
contains one or more of the provisions described in Sec. 1.401(a)(4)-
3(b)(8)(iv) (prior vesting schedules), (v) (certain conditions on 
accruals), or (xi) (multiple definitions of service).
    (xi) Changes in benefit formula, allocation formula, or interest 
rates. A plan does not fail to satisfy this paragraph (c)(3) merely 
because the plan is amended to change the benefit formula, hypothetical 
allocation formula, or the interest rate used to adjust hypothetical 
allocations for plan years after a fresh-start date, provided that the 
accrued benefits for plan years beginning after the fresh-start date are 
determined in accordance with Sec. 1.401(a)(4)-13(c), as modified by 
Sec. 1.401(a)(4)-13(f).
    (d) Safe-harbor testing method for defined benefit plans that are 
part of a floor-offset arrangement--(1) General rule. A defined benefit 
plan that is part of a floor-offset arrangement is deemed to satisfy the 
nondiscriminatory amount requirement of Sec. 1.401(a)(4)-1(b)(2) if all 
of the following requirements are satisfied:
    (i) Under the floor-offset arrangement, the accrued benefit (as 
defined in section 411(a)(7)(A)(i)) that would otherwise be provided to 
an employee under the defined benefit plan must be reduced solely by the 
actuarial equivalent of all or part of the employee's account balance 
attributable to employer contributions under a defined contribution plan 
maintained by the same employer (plus the actuarial equivalent of all or 
part of any prior distributions from that portion of the account 
balance). If any portion of the benefit that is being offset is 
nonforfeitable, that portion may be offset only by a benefit (or portion 
of a benefit) that is also nonforfeitable. In determining the actuarial 
equivalent of amounts provided under the defined contribution plan, an 
interest rate no higher than the highest standard interest rate must be 
used, and no mortality may be assumed in determining the actuarial 
equivalent of any prior distributions from the defined contribution plan 
or for periods prior to the benefit commencement date under the defined 
benefit plan.
    (ii) The defined benefit plan may not be a contributory DB plan 
(unless it satisfies Sec. 1.401(a)(4)-6(b)(6)), and benefits under the 
defined benefit plan may not be reduced by any portion of the employee's 
account balance under the defined contribution plan (or prior 
distributions from that account) that are attributable to employee 
contributions.

[[Page 165]]

    (iii) The defined benefit plan and the defined contribution plan 
must benefit the same employees.
    (iv) The offset under the defined benefit plan must be applied to 
all employees on the same terms.
    (v) All employees must have available to them under the defined 
contribution plan the same investment options and the same options with 
respect to the timing of preretirement distributions.
    (vi) The defined benefit plan must satisfy the uniformity 
requirements of Sec. 1.401(a)(4)-3(b)(2) and the unit credit safe 
harbor in Sec. 1.401(a)(4)-3(b)(3) without taking into account the 
offset described in paragraph (d)(1)(i) of this section (i.e., on a 
gross-benefit basis), and the defined contribution plan must satisfy any 
of the tests in Sec. 1.401(a)(4)-2(b) or (c). Alternatively, the 
defined benefit plan must satisfy any of the tests in Sec. 1.401(a)(4)-
3(b) or (c) without taking into account the offset described in 
paragraph (d)(1)(i) of this section, and the defined contribution plan 
must satisfy the uniform allocation safe harbor in Sec. 1.401(a)(4)-
2(b)(2).
    (vii) The defined contribution plan may not be a section 401(k) plan 
or a section 401(m) plan.
    (2) Application of safe-harbor testing method to qualified offset 
arrangements. A defined benefit plan that is part of a qualified offset 
arrangement as defined in section 1116(f)(5) of the Tax Reform Act of 
1986, Public Law No. 99-514, is deemed to satisfy the requirements of 
paragraph (d)(1)(vi) and (vii) of this section, if the only defined 
contribution plans included in the qualified offset arrangement are 
section 401(k) plans, section 401(m) plans, or both, and the defined 
benefit plan would satisfy the requirements of paragraph (d)(1)(vi) of 
this section assuming the elective contributions for each employee under 
the defined contribution plan were the same (either as a dollar amount 
or as a percentage of compensation) for all plan years since the 
establishment of the plan.

[T.D. 8360, 56 FR 47580, Sept. 19, 1991; 57 FR 4720, Feb. 7, 1992; 57 FR 
10952, 10953, Mar. 31, 1992, as amended by T.D. 8485, 58 FR 46807, Sept. 
3, 1993; T.D. 8954, 66 FR 34540, June 29, 2001]



Sec. 1.401(a)(4)-9  Plan aggregation and restructuring.

    (a) Introduction. Two or more plans that are permissively aggregated 
and treated as a single plan under Sec. Sec. 1.410(b)-7(d) must also be 
treated as a single plan for purposes of section 401(a)(4). See Sec. 
1.401(a)(4)-12 (definition of plan). An aggregated plan is generally 
tested under the same rules applicable to single plans. Paragraph (b) of 
this section, however, provides special rules for determining whether a 
plan that consists of one or more defined contribution plans and one or 
more defined benefit plans (a DB/DC plan) satisfies section 401(a)(4) 
with respect to the amount of employer-provided benefits and the 
availability of benefits, rights, and features. Paragraph (c) of this 
section provides rules allowing a plan to be treated as consisting of 
separate component plans and allowing the component plans to be tested 
separately under section 401(a)(4).
    (b) Application of nondiscrimination requirements to DB/DC plans--
(1) General rule. Except as provided in paragraph (b)(2) of this 
section, whether a DB/DC plan satisfies section 401(a)(4) is determined 
using the same rules applicable to a single plan. In addition, paragraph 
(b)(3) of this section provides an optional rule for demonstrating 
nondiscrimination in availability of benefits, rights, and features 
provided under a DB/DC plan.
    (2) Special rules for demonstrating nondiscrimination in amount of 
contributions or benefits--(i) Application of general tests. A DB/DC 
plan satisfies section 401(a)(4) with respect to the amount of 
contributions or benefits for a plan year if it would satisfy Sec. 
1.401(a)(4)-3(c)(1) (without regard to the special rule in Sec. 
1.401(a)(4)-3(c)(3)) for the plan year if an employee's aggregate normal 
and most valuable allocation rates, as determined under paragraph 
(b)(2)(ii)(A) of this section, or an employee's aggregate normal and 
most valuable accrual rates, as determined under paragraph (b)(2)(ii)(B) 
of this section, were substituted for each employee's normal and most 
valuable accrual rates, respectively, in the determination of rate 
groups.

[[Page 166]]

    (ii) Determination of aggregate rates--(A) Aggregate allocation 
rates. An employee's aggregate normal and most valuable allocation rates 
are determined by treating all defined contribution plans that are part 
of the DB/DC plan as a single plan, and all defined benefit plans that 
are part of the DB/DC plan as a separate single plan; and determining an 
allocation rate and equivalent normal and most valuable allocation rates 
for the employee under each plan under Sec. Sec. 1.401(a)(4)-2(c)(2) 
and 1.401(a)(4)-8(c)(2), respectively. The employee's aggregate normal 
allocation rate is the sum of the employee's allocation rate and 
equivalent normal allocation rate determined in this manner, and the 
employee's aggregate most valuable allocation rate is the sum of the 
employee's allocation rate and equivalent most valuable allocation rate 
determined in this manner.
    (B) Aggregate accrual rates. An employee's aggregate normal and most 
valuable accrual rates are determined by treating all defined 
contribution plans that are part of the DB/DC plan as a single plan, and 
all defined benefit plans that are part of the DB/DC plan as a separate 
single plan; and determining an equivalent accrual rate and normal and 
most valuable accrual rates for the employee under each plan under 
Sec. Sec. 1.401(a)(4)-8(b)(2) and 1.401(a)(4)-3(d), respectively. The 
employee's aggregate normal accrual rate is the sum of the employee's 
equivalent accrual rate and the normal accrual rate determined in this 
manner, and the employee's aggregate most valuable accrual rate is the 
sum of the employee's equivalent accrual rate and most valuable accrual 
rate determined in this manner.
    (iii) Options applied on an aggregate basis. The optional rules in 
Sec. 1.401(a)(4)-2(c)(2)(iv) (imputation of permitted disparity) and 
(v) (grouping of rates) may not be used to determine an employee's 
allocation or equivalent allocation rate, but may be applied to 
determine an employee's aggregate normal and most valuable allocation 
rates by substituting those rates (determined without regard to the 
option) for the employee's allocation rate in that section where 
appropriate. The optional rules in Sec. 1.401(a)(4)-3(d)(3) (e.g., 
imputation of permitted disparity) may not be used to determine an 
employee's accrual or equivalent accrual rate, but may be applied to 
determine an employee's aggregate normal and most valuable accrual rate 
by substituting those rates (determined without regard to the option) 
for the employee's normal and most valuable accrual rates, respectively, 
in that section where appropriate.
    (iv) Consistency rule--(A) General rule. Aggregate normal and most 
valuable allocation rates and aggregate normal and most valuable accrual 
rates must be determined in a consistent manner for all employees for 
the plan year. Thus, for example, the same measurement periods and 
interest rates must be used, and any available options must be applied 
consistently, if at all, for the entire DB/DC plan. Consequently, 
options that are not permitted to be used under Sec. 1.401(a)(4)-8 in 
cross-testing a defined contribution plan or a defined benefit plan 
(such as measurement periods that include future periods, non-standard 
interest rates, the option to disregard compensation adjustments 
described in Sec. 1.401(a)(4)-13(d), or the option to disregard plan 
provisions providing for actuarial increases after normal retirement age 
under Sec. 1.401(a)(4)-3(f)(3)) may not be used in testing a DB/DC plan 
on either a benefits or contributions basis, because their use would 
inevitably result in inconsistent determinations under the defined 
contribution and defined benefit portions of the plan.
    (B) Exception for section 415 alternative. A DB/DC plan does not 
fail to satisfy the consistency rule in paragraph (b)(2)(iv)(A) of this 
section merely because the limitations under section 415 are not taken 
into account, or may not be taken into account, under Sec. 1.401(a)(4)-
3(d)(2)(ii)(B) in determining employees' accrual or equivalent 
allocation rates under the defined benefit portion of the plan, even 
though those limitations are applied in determining employees' 
allocation and equivalent accrual rates under the defined contribution 
portion of the plan.
    (v) Eligibility for testing on a benefits basis--(A) General rule. 
For plan years beginning on or after January 1, 2002, unless, for the 
plan year, a DB/DC plan

[[Page 167]]

is primarily defined benefit in character (within the meaning of 
paragraph (b)(2)(v)(B) of this section) or consists of broadly available 
separate plans (within the meaning of paragraph (b)(2)(v)(C) of this 
section), the DB/DC plan must satisfy the minimum aggregate allocation 
gateway of paragraph (b)(2)(v)(D) of this section for the plan year in 
order to be permitted to demonstrate satisfaction of the 
nondiscrimination in amount requirement of Sec. 1.401(a)(4)-1(b)(2) on 
the basis of benefits.
    (B) Primarily defined benefit in character. A DB/DC plan is 
primarily defined benefit in character if, for more than 50% of the 
NHCEs benefitting under the plan, the normal accrual rate for the NHCE 
attributable to benefits provided under defined benefit plans that are 
part of the DB/DC plan exceeds the equivalent accrual rate for the NHCE 
attributable to contributions under defined contribution plans that are 
part of the DB/DC plan.
    (C) Broadly available separate plans. A DB/DC plan consists of 
broadly available separate plans if the defined contribution plan and 
the defined benefit plan that are part of the DB/DC plan each would 
satisfy the requirements of section 410(b) and the nondiscrimination in 
amount requirement of Sec. 1.401(a)(4)-1(b)(2) if each plan were tested 
separately and assuming that the average benefit percentage test of 
Sec. 1.410(b)-5 were satisfied. For this purpose, all defined 
contribution plans that are part of the DB/DC plan are treated as a 
single defined contribution plan and all defined benefit plans that are 
part of the DB/DC plan are treated as a single defined benefit plan. In 
addition, if permitted disparity is used for an employee for purposes of 
satisfying the separate testing requirement of this paragraph 
(b)(2)(v)(C) for plans of one type, it may not be used in satisfying the 
separate testing requirement for plans of the other type for the 
employee.
    (D) Minimum aggregate allocation gateway--(1) General rule. A DB/DC 
plan satisfies the minimum aggregate allocation gateway if each NHCE has 
an aggregate normal allocation rate that is at least one third of the 
aggregate normal allocation rate of the HCE with the highest such rate 
(HCE rate), or, if less, 5% of the NHCE's compensation, provided that 
the HCE rate does not exceed 25% of compensation. If the HCE rate 
exceeds 25% of compensation, then the aggregate normal allocation rate 
for each NHCE must be at least 5% increased by one percentage point for 
each 5-percentage-point increment (or portion thereof) by which the HCE 
rate exceeds 25% (e.g., the NHCE minimum is 6% for an HCE rate that 
exceeds 25% but not 30%, and 7% for an HCE rate that exceeds 30% but not 
35%).
    (2) Deemed satisfaction. A plan is deemed to satisfy the minimum 
aggregate allocation gateway of this paragraph (b)(2)(v)(D) if the 
aggregate normal allocation rate for each NHCE is at least 7\1/2\% of 
the NHCE's compensation within the meaning of section 415(c)(3), 
measured over a period of time permitted under the definition of plan 
year compensation.
    (3) Averaging of equivalent allocation rates for NHCEs. For purposes 
of this paragraph (b)(2)(v)(D), a plan is permitted to treat each NHCE 
who benefits under the defined benefit plan as having an equivalent 
normal allocation rate equal to the average of the equivalent normal 
allocation rates under the defined benefit plan for all NHCEs 
benefitting under that plan.
    (E) Determination of rates. For purposes of this paragraph 
(b)(2)(v), the normal accrual rate and the equivalent normal allocation 
rate attributable to defined benefit plans, the equivalent accrual rate 
attributable to defined contribution plans, and the aggregate normal 
allocation rate are determined under paragraph (b)(2)(ii) of this 
section, but without taking into account the imputation of permitted 
disparity under Sec. 1.401(a)(4)-7, except as otherwise permitted under 
paragraph (b)(2)(v)(C) of this section.
    (F) Examples. The following examples illustrate the application of 
this paragraph (b)(2)(v):

    Example 1. (i) Employer A maintains Plan M, a defined benefit plan, 
and Plan N, a defined contribution plan. All HCEs of Employer A are 
covered by Plan M (at a 1% accrual rate), but are not covered by Plan N. 
All NHCEs of Employer A are covered by Plan N (at a 3% allocation rate), 
but are not covered by Plan M. Because Plan M does not satisfy section 
410(b) standing alone, Plans M

[[Page 168]]

and N are aggregated for purposes of satisfying sections 410(b) and 
401(a)(4).
    (ii) Because none of the NHCEs participate in the defined benefit 
plan, the aggregated DB/DC plan is not primarily defined benefit in 
character within the meaning of paragraph (b)(2)(v)(B) of this section 
nor does it consist of broadly available separate plans within the 
meaning of paragraph (b)(2)(v)(C) of this section. Accordingly, the 
aggregated Plan M and Plan N must satisfy the minimum aggregate 
allocation gateway of paragraph (b)(2)(v)(D) of this section in order be 
permitted to demonstrate satisfaction of the nondiscrimination in amount 
requirement of Sec. 1.401(a)(4)-1(b)(2) on the basis of benefits.
    Example 2. (i) Employer B maintains Plan O, a defined benefit plan, 
and Plan P, a defined contribution plan. All of the six employees of 
Employer B are covered under both Plan O and Plan P. Under Plan O, all 
employees have a uniform normal accrual rate of 1% of compensation. 
Under Plan P, Employees A and B, who are HCEs, receive an allocation 
rate of 15%, and participants C, D, E and F, who are NHCEs, receive an 
allocation rate of 3%. Employer B aggregates Plans O and P for purposes 
of satisfying sections 410(b) and 401(a)(4). The equivalent normal 
allocation and normal accrual rates under Plans O and P are as follows:

------------------------------------------------------------------------
                                                Equivalent   Equivalent
                                                  normal       normal
                                                allocation     accural
                                                rates for     rates for
                                                  the 1%     the 15%/3%
                   Employee                      accural     allocation
                                                under plan  under plan P
                                                O (defined    (defined
                                                 benefit    contribution
                                                plan) (in     plan) (in
                                                 percent)     percent)
------------------------------------------------------------------------
HCE A (age 55)...............................         3.93          3.82
HCE B (age 50)...............................         2.61          5.74
C (age 60)...................................         5.91           .51
D (age 45)...................................         1.74          1.73
E (age 35)...................................          .77          3.90
F (age 25)...................................          .34          8.82
------------------------------------------------------------------------

    (ii) Although all of the NHCEs benefit under Plan O (the defined 
benefit plan), the aggregated DB/DC plan is not primarily defined 
benefit in character because the normal accrual rate attributable to 
defined benefit plans (which is 1% for each of the NHCEs) is greater 
than the equivalent accrual rate under defined contribution plans only 
for Employee C. In addition, because the 15% allocation rate is 
available only to HCEs, the defined contribution plan cannot satisfy the 
requirements of Sec. 1.401(a)(4)-2 and does not have broadly available 
allocation rates within the meaning of Sec. 1.401(a)(4)-8(b)(1)(iii). 
Further, the defined contribution plan does not satisfy the minimum 
allocation gateway of Sec. 1.401(a)(4)-8(b)(1)(vi) (3% is less than \1/
3\ of the 15% HCE rate). Therefore, the defined contribution plan within 
the DB/DC plan cannot separately satisfy Sec. 1.401(a)(4)-1(b)(2) and 
does not constitute a broadly available separate plan within the meaning 
of paragraph (b)(2)(v)(C) of this section. Accordingly, the aggregated 
plans are permitted to demonstrate satisfaction of the nondiscrimination 
in amounts requirement of Sec. 1.401(a)(4)-1(b)(2) on the basis of 
benefits only if the aggregated plans satisfy the minimum aggregate 
allocation gateway of paragraph (b)(2)(v)(D) of this section.
    (iii) Employee A has an aggregate normal allocation rate of 18.93% 
under the aggregated plans (3.93% from Plan O plus 15% from Plan P), 
which is the highest aggregate normal allocation rate for any HCE under 
the plans. Employee F has an aggregate normal allocation rate of 3.34% 
under the aggregated plans (.34% from Plan O plus 3% from Plan P) which 
is less than the 5% aggregate normal allocation rate that Employee F 
would be required to have to satisfy the minimum aggregate allocation 
gateway of paragraph (b)(2)(v)(D) of this section.
    (iv) However, for purposes of satisfying the minimum aggregate 
allocation gateway of paragraph (b)(2)(v)(D) of this section, Employer B 
is permitted to treat each NHCE who benefits under Plan O (the defined 
benefit plan) as having an equivalent allocation rate equal to the 
average of the equivalent allocation rates under Plan O for all NHCEs 
benefitting under that plan. The average of the equivalent allocation 
rates for all of the NHCEs under Plan O is 2.19% (the sum of 5.91%, 
1.74%, .77%, and .34%, divided by 4). Accordingly, Employer B is 
permitted to treat all of the NHCEs as having an equivalent allocation 
rate attributable to Plan O equal to 2.19%. Thus, all of the NHCEs can 
be treated as having an aggregate normal allocation rate of 5.19% for 
this purpose (3% from the defined contribution plan and 2.19% from the 
defined benefit plan) and the aggregated DB/DC plan satisfies the 
minimum aggregate allocation gateway of paragraph (b)(2)(v)(D) of this 
section.

    (3) Optional rules for demonstrating nondiscrimination in 
availability of certain benefits, rights, and features--(i) Current 
availability. A DB/DC plan is deemed to satisfy Sec. 1.401(a)(4)-
4(b)(1) with respect to the current availability of a benefit, right, or 
feature other than a single sum benefit, loan, ancillary benefit, or 
benefit commencement date (including the availability of in-service 
withdrawals), that is provided under only one type of plan (defined 
benefit or defined contribution) included in the DB/DC plan, if the 
benefit, right, or feature is currently available to all NHCEs in all 
plans of

[[Page 169]]

the same type as the plan under which it is provided.
    (ii) Effective availability. The fact that it may be difficult or 
impossible to provide a benefit, right, or feature described in 
paragraph (b)(3)(i) of this section under a plan of a different type 
than the plan or plans under which it is provided is one of the factors 
taken into account in determining whether the plan satisfies the 
effective availability requirement of Sec. 1.401(a)(4)-4(c)(1).
    (c) Plan restructuring--(1) General rule. A plan may be treated, in 
accordance with this paragraph (c), as consisting of two or more 
component plans for purposes of determining whether the plan satisfies 
section 401(a)(4). If each of the component plans of a plan satisfies 
all of the requirements of sections 401(a)(4) and 410(b) as if it were a 
separate plan, then the plan is treated as satisfying section 401(a)(4).
    (2) Identification of component plans. A plan may be restructured 
into component plans, each consisting of all the allocations, accruals, 
and other benefits, rights, and features provided to a selected group of 
employees. The employer may select the group of employees used for this 
purpose in any manner, and the composition of the groups may be changed 
from plan year to plan year. Every employee must be included in one and 
only one component plan under the same plan for a plan year.
    (3) Satisfaction of section 401(a)(4) by a component plan--(i) 
General rule. The rules applicable in determining whether a component 
plan satisfies section 401(a)(4) are the same as those applicable to a 
plan. Thus, for this purpose, any reference to a plan in section 
401(a)(4) and the regulations thereunder (other than this paragraph (c)) 
is interpreted as a reference to a component plan. As is true for a 
plan, whether a component plan satisfies the uniformity and other 
requirements applicable to safe harbor plans under Sec. Sec. 
1.401(a)(4)-2(b) and 1.401(a)(4)-3(b) is determined on a design basis. 
Thus, for example, plan provisions are not disregarded merely because 
they do not currently apply to employees in the component plan if they 
will apply to those employees as a result of the mere passage of time.
    (ii) Restructuring not available for certain testing purposes. The 
safe harbor in Sec. 1.401(a)(4)-2(b)(3) for plans with uniform points 
allocation formulas is not available in testing (and thus cannot be 
satisfied by) contributions under a component plan. Similarly, component 
plans cannot be used for purposes of determining whether a plan provides 
broadly available allocation rates (as defined in Sec. 1.401(a)(4)-
8(b)(1)(iii)), determining whether a plan has a gradual age or service 
schedule (as defined in Sec. 1.401(a)(4)-8(b)(1)(iv)), determining 
whether a plan has allocation rates that are based on a uniform target 
benefit allocation (as defined in Sec. 1.401(a)(4)-8(b)(1)(v)), or 
determining whether a plan is primarily defined benefit in character or 
consists of broadly available separate plans (as defined in paragraphs 
(b)(2)(v)(B) and (C) of this section). In addition, the minimum 
allocation gateway of Sec. 1.401(a)(4)-8(b)(1)(vi) and the minimum 
aggregate allocation gateway of paragraph (b)(2)(v)(D) of this section 
cannot be satisfied on the basis of component plans. See Sec. Sec. 
1.401(k)-1(b)(3)(iii) and 1.401(m)-1(b)(3)(ii) for rules regarding the 
inapplicability of restructuring to section 401(k) plans and section 
401(m) plans.
    (4) Satisfaction of section 410(b) by a component plan--(i) General 
rule. The rules applicable in determining whether a component plan 
satisfies section 410(b) are generally the same as those applicable to a 
plan. However, a component plan is deemed to satisfy the average benefit 
percentage test of Sec. 1.410(b)-5 if the plan of which it is a part 
satisfies Sec. 1.410(b)-5 (without regard to Sec. 1.410(b)-5(f)). In 
the case of a component plan that is part of a plan that relies on Sec. 
1.410(b)-5(f) to satisfy the average benefit percentage test, the 
component plan is deemed to satisfy the average benefit percentage test 
only if the component plan separately satisfies Sec. 1.410(b)-5(f). In 
addition, all component plans of a plan are deemed to satisfy the 
average benefit percentage test if the plan makes an early retirement 
window benefit (within the meaning of Sec. 1.401(a)(4)-3(f)(4)(iii)) 
currently available (within the meaning of Sec. 1.401(a)(4)-
3(f)(4)(ii)(A)) to a group of employees that satisfies section 410(b)

[[Page 170]]

(without regard to the average benefit percentage test), and if it would 
not be necessary for the plan or any rate group or component plan of the 
plan to satisfy that test in order for the plan to satisfy sections 
401(a)(4) and 410(b) in the absence of the early retirement window 
benefit.
    (ii) Relationship to satisfaction of section 410(b) by the plan. 
Satisfaction of section 410(b) by a component plan is relevant solely 
for purposes of determining whether the plan of which it is a part 
satisfies section 401(a)(4), and not for purposes of determining whether 
the plan satisfies section 410(b) itself. The plan must still 
independently satisfy section 410(b) in order to be a qualified plan. 
Similarly, satisfaction of section 410(b) by a plan is relevant solely 
for purposes of determining whether the plan, and not the component 
plan, satisfies section 410(b). Thus, for example, a component plan that 
does not satisfy the ratio percentage test of Sec. 1.410(b)-2(b)(2) 
must still satisfy the average benefit test of Sec. 1.410(b)-2(b)(3), 
even though the plan of which it is a part satisfies the ratio 
percentage test.
    (5) Effect of restructuring under other sections. The restructuring 
rules provided in this paragraph (c) apply solely for purposes of 
sections 401(a)(4) and 401(l), and those portions of sections 410(b), 
414(s), and any other provisions that are specifically applicable in 
determining whether the requirements of section 401(a)(4) are satisfied. 
Thus, for example, a component plan is not treated as a separate plan 
under section 401(a)(26).
    (6) Examples. The following examples illustrate the rules in this 
paragraph (c):

    Example 1. Employer X maintains a defined benefit plan. The plan 
provides a normal retirement benefit equal to 1.0 percent of average 
annual compensation times years of service to employees at Plant S, and 
1.5 percent of average annual compensation times years of service to 
employees at Plant T. Under paragraph (c)(2) of this section, the plan 
may be treated as consisting of two component defined benefit plans, one 
providing retirement benefits equal to 1.0 percent of average annual 
compensation times years of service to the employees at Plant S, and 
another providing benefits equal to 1.5 percent of average annual 
compensation times years of service to employees at Plant T. If each 
component plan satisfies sections 401(a)(4) and 410(b) as if it were a 
separate plan under the rules of this paragraph (c), then the entire 
plan satisfies section 401(a)(4).
    Example 2. (a) Employer Y maintains Plan A, a defined benefit plan, 
for its Employees M, N, O, P, Q, and R. Plan A provides benefits under a 
uniform formula that satisfies the requirements of Sec. 1.401(a)(4)-3 
(b)(2) and (b)(3) before it is amended on February 14, 1994. The 
amendment provides an early retirement window benefit that is a 
subsidized optional form of benefit under Sec. 1.401(a)(4)-3(b)(2)(iii) 
and that is available on the same terms to all employees who satisfy the 
eligibility requirements for the window. The early retirement window 
benefit is available only to employees who retire between June 1, 1994, 
and November 30, 1994.
    (b) Assume that Employees M, N, and O will be eligible to receive 
the window benefit by the end of the window period and Employees P, Q, 
and R will not. Because substantially all employees will not satisfy the 
eligibility requirements for the early retirement window benefit by the 
close of the early retirement window benefit period, Plan A fails to 
satisfy the uniform subsidies requirement of Sec. 1.401(a)(4)-
3(b)(2)(iii). See Sec. 1.401(a)(4)-3(b)(2)(vi), Example 6.
    (c) Under paragraph (c)(2) of this section, Employees M, N, O, P, Q, 
and R may be grouped into two component plans, one consisting of 
Employees M, N, and O, and all their accruals and other benefits, 
rights, and features under the plan (including the early retirement 
window benefit), and another consisting of Employees P, Q, and R, and 
all their accruals and other benefits, rights, and features under the 
plan. Each of the component plans identified in this manner satisfies 
the uniform subsidies requirement of Sec. 1.401(a)(4)-3(b)(2)(iii), and 
thus satisfies Sec. 1.401(a)(4)-3(b). The entire plan satisfies section 
401(a)(4) under the rules of this paragraph (c), if each of these 
component plans also satisfies section 410(b) as if it were a separate 
plan (including, if applicable, the reasonable classification 
requirement of Sec. 1.410(b)-4(b), and taking into account the special 
rule of paragraph (c)(4)(i) of this section that forgives the average 
benefit percentage test in certain situations in which the average 
benefit percentage test would be required solely as a result of the 
early retirement window benefit).
    Example 3. (a) Employer Z maintains Plan B, a defined benefit plan 
with a benefit formula that provides two percent of average annual 
compensation for each year of service up to 20 to each employee. Assume 
that Plan B would satisfy the fractional accrual rule safe harbor in 
Sec. 1.401(a)(4)-3(b)(4), except that some employees accrue a portion 
of their normal retirement benefit in the current

[[Page 171]]

plan year that is more than one-third larger than the portion of the 
same benefit accrued by other employees for the current plan year, and 
the plan therefore fails to satisfy the one-third-larger requirement of 
Sec. 1.401(a)(4)-3(b)(4)(i)(C)(1).
    (b) Employer Z restructures Plan B into two plans, one covering 
employees with 30 years or less of service at normal retirement age, and 
the other covering all other employees. Each component plan would 
separately satisfy the one-third-larger requirement of Sec. 
1.401(a)(4)-3(b)(4)(i)(C)(1) if the only employees taken into account 
were those employees included in the component plan in the current plan 
year. Under paragraph (c)(3)(i) of this section and Sec. 1.401(a)(4)-
3(b)(4)(i)(C)(1), however, the component plans do not satisfy the one-
third-larger requirement because the safe harbor determination is made 
taking into account the effect of the plan benefit formula on any 
potential employee in the component plan (other than employees with more 
than 33 years of service at normal retirement age), and not just those 
employees included in the component plan in the current plan year.

[T.D. 8485, 58 FR 46810, Sept. 3, 1993, as amended by T.D. 8954, 66 FR 
34544, June 29, 2001]

    Editorial Note: By T.D. 9169, 69 FR 78153, Dec. 29, 2004, the 
Internal Revenue Service published a document in the Federal Register, 
attempting to amend paragraph (c)(3)(ii) of Sec. 1.401-(a)(4)-9 by 
removing ``1.401(k)-1(b)(3)(ii) and 1.401(m)-1(b)(3)(ii)'' and inserting 
``1.401(k)-1(b)(4)(vi)(B) and 1.401(m)-1(b)(4)(iv)''. However, because 
of inaccurate amendatory language, this amendment could not be 
incorporated.



Sec. 1.401(a)(4)-10  Testing of former employees.

    (a) Introduction. This section provides rules for determining 
whether a plan satisfies the nondiscriminatory amount and 
nondiscriminatory availability requirements of Sec. 1.401(a)(4)-1(b)(2) 
and (3), respectively, with respect to former employees. Generally, this 
section is relevant only in the case of benefits provided through an 
amendment to the plan effective in the current plan year. See the 
definitions of employee and former employee in Sec. 1.401(a)(4)-12.
    (b) Nondiscrimination in amount of contributions or benefits--(1) 
General rule. A plan satisfies Sec. 1.401(a)(4)-1(b)(2) with respect to 
the amount of contributions or benefits provided to former employees if, 
under all of the relevant facts and circumstances, the amount of 
contributions or benefits provided to former employees does not 
discriminate significantly in favor of former HCEs. For this purpose, 
contributions or benefits provided to former employees includes all 
contributions or benefits provided to former employees or, at the 
employer's option, only those contributions or benefits arising out of 
the amendment providing the contributions or benefits. A plan under 
which no former employee currently benefits (within the meaning of Sec. 
1.410(b)-3(b)) is deemed to satisfy this paragraph (b).
    (2) Permitted disparity. Section 401(l) and Sec. 1.401(a)(4)-7 
generally apply to benefits provided to former employees in the same 
manner as those provisions apply to employees. Thus, for example, for 
purposes of determining a former employee's cumulative permitted 
disparity limit, the sum of the former employee's total annual disparity 
fractions (within the meaning of Sec. 1.401(l)-5) as an employee 
continues to be taken into account. However, the permitted disparity 
rate applicable to a former employee is determined under Sec. 1.401(l)-
3(e) as of the age the former employee commenced receipt of benefits, 
not as of the date the employee receives the accrual for the current 
plan year.
    (3) Examples. The following examples illustrate the rules in this 
paragraph (b):

    Example 1. Employer X maintains a section 401(l) plan, Plan A, that 
uses maximum permitted disparity. Plan A is amended to increase the 
benefits of all former employees in pay status. The percentage increase 
for each former employee is reasonably comparable to the adjustment in 
social security benefits under section 215(i)(2)(A) of the Social 
Security Act since the former employee commenced receipt of benefits. 
Plan A does not fail to satisfy this paragraph (b) merely because of the 
amendment.
    Example 2. The facts are the same as in Example 1, except that the 
amendment provides an across-the-board 20 percent increase in benefits 
for all former employees in pay status. The cost of living has increased 
at an average rate of three percent in the two years preceding the 
amendment, and some HCEs have retired and become former HCEs during that 
period. Because this amendment increases the disparity in the plan 
formula beyond the maximum permitted disparity adjusted for any 
reasonable approximation of the increase in the cost of living since the

[[Page 172]]

HCEs retired, Plan A discriminates significantly in favor of former 
HCEs, and thus does not satisfy this paragraph (b).
    Example 3. The facts are the same as in Example 1, except that Plan 
A is only amended to increase the benefits of former employees in pay 
status who terminated employment with Employer X after attaining early 
retirement age. The determination of whether the amendment causes Plan A 
to fail to satisfy this paragraph (b) must take into account the 
relative numbers of former HCEs and former NHCEs who have terminated 
employment with Employer X after attaining early retirement age.

    (c) Nondiscrimination in availability of benefits, rights, or 
features. A plan satisfies section 401(a)(4) with respect to the 
availability of benefits, rights, and features provided to former 
employees if any change in the availability of any benefit, right, or 
feature to any former employee is applied in a manner that, under all of 
the relevant facts and circumstances, does not discriminate 
significantly in favor of former HCEs. For purposes of demonstrating 
that a plan satisfies section 401(a)(4) with respect to the availability 
of loans provided to former employees, an employer may treat former 
employees who are parties in interest within the meaning of section 
3(14) of the Employee Retirement Income Security Act of 1974 as 
employees.

[T.D. 8485, 58 FR 46812, Sept. 3, 1993]



Sec. 1.401(a)(4)-11  Additional rules.

    (a) Introduction. This section provides additional rules for 
determining whether a plan satisfies section 401(a)(4). Paragraph (b) of 
this section provides rules for the treatment of the portion of an 
employee's accrued benefit or account balance that is attributable to 
rollovers, transfers between plans, and employee buybacks. Paragraph (c) 
of this section provides rules regarding vesting. Paragraph (d) of this 
section provides rules regarding service crediting. Paragraph (e) of 
this section, regarding family aggregation, and paragraph (f) of this 
section, regarding governmental plans, are reserved. Paragraph (g) of 
this section provides rules regarding the extent to which corrective 
amendments may be made for purposes of section 401(a).
    (b) Rollovers, transfers, and buybacks--(1) Rollovers and elective 
transfers. The portion of an employee's accrued benefit or account 
balance under a plan that is attributable to rollover (including direct 
rollover) contributions to the plan that are described in section 
402(c), 402(e)(6), 403(a)(4), 403(a)(5), or 408(d)(3), or elective 
transfers to the plan that are described in Sec. 1.411(d)-4, Q&A-3(b), 
is not taken into account in determining whether the plan satisfies the 
nondiscriminatory amount requirement of Sec. 1.401(a)(4)-1(b)(2).
    (2) Other transfers. [Reserved]
    (3) Employee buybacks--(i) Rehired employee buyback of previous 
service. An employee's repayment to a plan of a prior distribution from 
the plan (including reasonable interest from the time of the 
distribution) that results in the restoration of the employee's accrued 
benefit under the plan (or the service associated with that accrued 
benefit) that would otherwise be disregarded in determining the 
employee's accrued benefit in accordance with section 411 on account of 
the distribution is not treated as an employee contribution for purposes 
of Sec. Sec. 1.401(a)(4)-1 through 1.401(a)(4)-13.
    (ii) Make-up of missed employee contributions. If a contributory DB 
plan gives all employees who did not make employee contributions for a 
prior period the right to make the missed contributions at a later date 
(including reasonable interest from the time of the missed 
contributions) and, once the contributions have been made, determines 
benefits under the plan by treating the employee contributions 
(excluding the interest) as if they were actually made during that prior 
period, then those contributions must satisfy Sec. 1.401(a)(4)-6(c) as 
if they were employee contributions actually made during that prior 
period. Thus, for example, Sec. 1.401(a)(4)-6(c)(2) is not satisfied 
for the current plan year if the employee contribution rate (within the 
meaning of Sec. 1.401(a)(4)-6(b)(2)(ii)(A) but determined without 
regard to the interest) for the employees making up missed contributions 
is different than the employee contribution rate applicable to other 
employees during the prior period. The rule in this paragraph (b)(3)(ii) 
may be extended to employees who did not make employee contributions for 
a period of service that is or

[[Page 173]]

would otherwise have been credited under the plan and that preceded 
their participation in the plan.
    (c) Vesting--(1) General rule. A plan satisfies this paragraph (c) 
if the manner in which employees vest in their accrued benefits under 
the plan does not discriminate in favor of HCEs. Whether the manner in 
which employees vest in their accrued benefits under a plan 
discriminates in favor of HCEs is determined under this paragraph (c) 
based on all of the relevant facts and circumstances, taking into 
account any relevant provisions of sections 401(a)(5)(E), 411(a)(10), 
411(d)(1), 411(d)(2), 411(d)(3), 411(e), and 420(c)(2), and taking into 
account any plan provisions that affect the nonforfeitability of 
employees' accrued benefits (e.g., plan provisions regarding suspension 
of benefits permitted under section 411(a)(3)(B)), other than the method 
of crediting years of service for purposes of applying the vesting 
schedule provided in the plan.
    (2) Deemed equivalence of statutory vesting schedules. For purposes 
of this paragraph (c), the manner in which employees vest in their 
accrued benefits under the vesting schedules in section 411(a)(2) (A) 
and (B) are treated as equivalent to one another, and the manner in 
which employees vest in their accrued benefits under the vesting 
schedules in section 416(b)(1) (A) and (B) are treated as equivalent to 
one another.
    (3) Safe harbor for vesting schedules. The manner in which employees 
vest in their accrued benefits under a plan is deemed not to 
discriminate in favor of HCEs if each combination of plan provisions 
that affect the nonforfeitability of any employee's accrued benefit 
would satisfy the nondiscriminatory availability requirements of Sec. 
1.401(a)(4)-4 if that combination were an other right or feature.
    (4) Examples. The following examples illustrate the rules in this 
paragraph (c):

    Example 1. Plan A provides the six-year graded vesting schedule 
described in section 416(b)(1)(B). In 1996, Plan A is amended to provide 
the five-year vesting schedule described in section 411(a)(2)(A). To 
comply with section 411(a)(10)(B), the plan amendment also provides that 
all employees with at least three years of service may elect to retain 
the prior vesting schedule. The manner in which employees vest in their 
accrued benefits under Plan A does not discriminate in favor of HCEs 
merely because the prior vesting schedule continues to apply to the 
accrued benefits of electing employees, even if, at the time of the 
election or in future years, the prior vesting schedule applies only to 
a group of employees that does not satisfy section 410(b).
    Example 2. The facts are the same as in Example 1, except that, for 
administrative convenience in complying with section 411(a)(10)(B), the 
plan amendment automatically provides all employees employed on the date 
of the amendment with the higher of the nonforfeitable percentages 
determined under either schedule. The manner in which employees vest in 
their accrued benefits under Plan A does not discriminate in favor of 
HCEs merely because, for administrative convenience in complying with 
section 411(a)(10), the amendment exceeds the requirements of section 
411(a)(10). The result would be the same if the plan amendment 
automatically provided the higher of the nonforfeitable percentages only 
to those employees with at least three years of service.
    Example 3. (a) Employer Y maintains Plan B covering all of its 
employees. On January 1, 1996, Employer Y sells Division M to Employer 
Z, and all of the employees in Division M become employees of Employer 
Z. Employer Y obtains a determination letter that the resulting 
cessation of participation by these employees in Plan B constitutes a 
partial termination. Therefore, in order to satisfy section 411(d)(3), 
Plan B fully vests the accrued benefit of each of the employees of 
Division M whose participation in Plan B ceased as a result of the sale 
on January 1, 1996.
    (b) The manner in which employees vest in their accrued benefits 
under Plan B does not discriminate in favor of HCEs merely because, in 
order to satisfy section 411(d)(3), the accrued benefits of all 
employees affected by the partial termination become fully vested. This 
is true even if the affected group of employees does not satisfy section 
410(b).
    Example 4. (a) The facts are the same as in Example 3, except that 
Employer Y does not obtain a determination letter that the sale of 
Division M to Employer Z will cause a partial termination. Instead, 
based on its reasonable belief that the sale will cause a partial 
termination, and in order to ensure that Plan B will satisfy section 
411(d)(3), Employer Y amends Plan B to vest fully the accrued benefit on 
January 1, 1996 of each of the employees it reasonably believes to be an 
affected employee.
    (b) The manner in which employees vest in their accrued benefits 
under Plan B does not

[[Page 174]]

discriminate in favor of HCEs merely because, based on Employer Y's 
reasonable belief that the sale will cause a partial termination, Plan B 
is amended to vest fully the accrued benefits of each of the employees 
it reasonably believes to be an affected employee.

    (d) Service-crediting rules--(1) Overview--(i) In general. A defined 
benefit plan or a defined contribution plan does not satisfy this 
paragraph (d) with respect to the manner in which service is credited 
under the plan unless the plan satisfies paragraph (d)(2) of this 
section. Paragraph (d)(3) of this section provides rules for determining 
whether service other than actual service with the employer may be taken 
into account in determining whether a defined benefit plan or a defined 
contribution plan satisfies Sec. 1.401(a)(4)-1 (b)(2) or (b)(3). 
(However, for purposes of cross-testing a defined contribution plan, 
only years in which the employee benefited under the plan may be taken 
into account in determining equivalent accrual rates. See Sec. 
1.401(a)(4)-8(b)(2)(i).) The rules of this paragraph (d) apply 
separately to service credited under a plan for each different purpose 
under the plan, including, but not limited to: application of the 
benefit formula (benefit service), application of the accrual method 
(accrual service), application of the vesting schedule (vesting 
service), entitlement to benefits, rights, and features (entitlement 
service), application of the requirements for eligibility to participate 
in the plan (eligibility service).
    (ii) Special rule for pre-effective date service. A plan is deemed 
to satisfy this paragraph (d) with respect to service credited for 
periods prior to the effective date applicable to the plan under Sec. 
1.401(a)(4)-13 (a) or (b) under a plan provision adopted and in effect 
as of February 11, 1993 (and any such service may be taken into account 
for purposes of satisfying Sec. 1.401(a)(4)-1 (b)(2) or (b)(3)), if the 
plan satisfied the applicable nondiscrimination requirements with 
respect to the service that were in effect for all relevant periods 
prior to the applicable effective date.
    (2) Manner of crediting service--(i) General rule. A plan satisfies 
this paragraph (d)(2) if, on the basis of all of the relevant facts and 
circumstances, the manner in which employees' service is credited for 
all purposes under the plan does not discriminate in favor of HCEs.
    (ii) Equivalent service-crediting methods. For purposes of this 
paragraph (d)(2), a service-crediting method used for a specified 
purpose that is based on hours of service, as provided in 29 CFR 
2530.200b-2, and a service-crediting method used for the same purpose 
that is based on one of the equivalencies set forth in 29 CFR 2530.200b-
3, are treated as equivalent if the service-crediting methods are 
otherwise the same.
    (iii) Safe harbor for service-crediting. The manner in which service 
is credited under a plan for a specified purpose is deemed to satisfy 
this paragraph (d)(2) if each combination of service-crediting 
provisions applied for that purpose would satisfy the nondiscriminatory 
availability requirements of Sec. 1.401(a)(4)-4 if that combination 
were an other right or feature.
    (iv) Examples. The following examples illustrate the rules in this 
paragraph (d)(2):

    Example 1. (a) Plan A covers both salaried employees and hourly 
employees. All of the HCEs in Plan A are salaried employees. For 
administrative convenience, salaried employees in Plan A (none of whom 
are part-time) have their years of service calculated in accordance with 
the elapsed time provisions in Sec. 1.410(a)-7. Hourly employees in 
Plan A (most of whom are scheduled to work 2,000 hours in a year) have 
their hours of service calculated in accordance with 29 CFR 2530.200b-2 
and are credited with a year of service for each plan year in which they 
complete 1,000 hours of service.
    (b) Plan A does not fail to satisfy this paragraph (d)(2) merely 
because different service-crediting provisions are applied to salaried 
and hourly employees for administrative convenience. The service-
crediting provisions for hourly employees in Plan A are reasonably 
comparable to the service-crediting provisions for salaried employees. 
This is because the amount of service credited to hourly employees who 
complete fewer than 1,000 hours of service before termination of 
employment (i.e., quit, retirement, discharge, or death) during the plan 
year (and are treated less favorably than the salaried employees with 
the same period of employment during the plan year) is balanced by the 
amount of service credited to hourly employees who complete more than 
1,000 hours of service before termination of employment during the plan 
year (who are treated more favorably than the salaried employees with 
the same period of employment during the plan year).

[[Page 175]]

    Example 2. (a) The facts are the same as in Example 1, except Plan A 
requires hourly employees to complete 2,000 hours of service in order to 
be credited with a full year of service, with a pro rata reduction for 
hourly employees who complete fewer than 2,000 hours of service.
    (b) Plan A does not fail to satisfy this paragraph (d)(2) merely 
because different service-crediting provisions are applied to salaried 
and hourly employees for administrative convenience. The service-
crediting provisions for hourly employees in Plan A are reasonably 
comparable to the service-crediting provisions for salaried employees. 
This is because the amount of service credited to hourly employees whose 
employment terminates (i.e., quit, retire, are discharged, or die) 
during the plan year is reasonably comparable to the amount of service 
credited to salaried employees whose employment is terminated during the 
plan year with the same period of employment during the plan year.

    (3) Service-crediting period--(i) Limitation on service taken into 
account--(A) General rule. Except as otherwise provided in this 
paragraph (d)(3), service for periods in which an employee does not 
perform services as an employee of the employer or in which the employee 
did not participate in the plan may not be taken into account in 
determining whether the plan satisfies Sec. 1.401(a)(4)-1 (b)(2) and 
(b)(3). In addition, in determining whether a plan satisfies Sec. 
1.401(a)(4)-1 (b)(2) and (b)(3), no more than one year of service may be 
taken into account with respect to any 12-consecutive-month period (with 
adjustments for shorter periods, if appropriate) unless the additional 
service is required to be credited under section 410 or 411, whichever 
is applicable.
    (B) Past service. Notwithstanding paragraph (d)(3)(i)(A) of this 
section, service for periods in which an employee performed services as 
an employee of the employer and did not participate in a plan, but in 
which the employee would have participated in the plan but for the fact 
that the plan (or the plan amendment extending coverage to the employee) 
was not in existence during that period, may be taken into account in 
determining whether the plan satisfies Sec. 1.401(a)(4)-1 (b)(2) and 
(b)(3). This is because service for such periods generally would have 
been credited for the employee but for the timing of the plan 
establishment or amendment, and the timing of the plan establishment or 
amendment must satisfy Sec. 1.401(a)(4)-5(a).
    (C) Pre-participation and imputed service. Notwithstanding paragraph 
(d)(3)(i)(A) of this section, to the extent that a plan treats pre-
participation service and imputed service as actual service with the 
employer, such service may be taken into account in determining whether 
the plan satisfies Sec. 1.401(a)(4)-1 (b)(2) and (b)(3) if the service 
satisfies each of the requirements in paragraph (d)(3)(iii) of this 
section taking into account, in the case of imputed service, the 
additional rules in paragraph (d)(3)(iv) of this section.
    (D) Additional limitations on service-crediting in the case of 
certain offsets. Notwithstanding paragraphs (d)(3)(i) (B) and (C) of 
this section, if a plan credits benefit service or accrual service under 
paragraph (d)(3)(i) (B) or (C) of this section for a period before an 
employee becomes a participant in the plan, but offsets the benefits 
determined under the plan by benefits under another plan (whether or not 
qualified or terminated) that are attributable to the same period for 
which that service is credited, then that service may not be taken into 
account for purposes of determining whether the first plan satisfies 
Sec. 1.401(a)(4)-1 (b)(2) or (b)(3) unless the offset provision applies 
on the same basis to all similarly-situated employees (within the 
meaning of paragraph (d)(3)(iii)(A) of this section).
    (ii) Definitions--(A) Pre-participation service. For purposes of 
this section, pre-participation service includes all years of service 
credited under a plan for years of service with the employer or a prior 
employer for periods before the employee commenced or recommenced 
participation in the plan (other than past service described in 
paragraph (d)(3)(i)(B) of this section).
    (B) Imputed service. For purposes of this section, imputed service 
includes any service credited for periods after an employee has 
commenced participation in a plan while the employee is not performing 
services as an employee for the employer (including a period in which 
the employee performs services

[[Page 176]]

for another employer, e.g., a joint venture), or while the employee has 
a reduced work schedule and would not otherwise be credited with service 
at the level being credited under the general terms of the plan.
    (iii) Requirements for pre-participation and imputed service--(A) 
Provision applied to all similarly-situated employees--(1) General rule. 
A plan provision crediting pre-participation service or imputed service 
to any HCE must apply on the same terms to all similarly-situated NHCEs. 
Whether two employees are similarly situated for this purpose must be 
determined based on reasonable business criteria, generally taking into 
account only the circumstances resulting in the employees being covered 
under the plan or being granted imputed service and on the situation of 
the employees (e.g., the plan in which the employees benefit or the 
employer by which they are employed) during the period for which the 
pre-participation service or imputed service is credited. For example, 
employees who enter a plan as a result of a particular merger and who 
participated in the same plan of a prior employer are generally 
similarly situated. As another example, employees who are transferred to 
different joint ventures or different spun-off divisions are generally 
not similarly situated.
    (2) Examples. The following examples illustrate the rules in this 
paragraph (d)(3)(iii)(A):

    Example 1. Employer X maintains defined benefit Plans A and B and 
defined contribution Plan C. Plan A covers all employees who work at the 
headquarters of Employer X. Plan B covers some employees in Division M 
of Employer X, and Plan C covers the other employees of Division M. 
Plans B and C have not been aggregated for purposes of satisfying 
section 401(a)(4) or 410(b) for the period for which service is being 
credited. Plan A provides that, whenever an employee covered by Plan B 
transfers from Division M to the headquarters, the employee's service 
credited under Plan B is credited under Plan A, and the employee's 
benefit under Plan A is offset by the employee's benefit under Plan B. 
However, Plan A provides for no similar recognition of service or offset 
for employees covered by Plan C who transfer from Division M to the 
headquarters. Plan A does not fail to satisfy this paragraph 
(d)(3)(iii)(A) merely because it credits service for employees 
transferring from Plan B but not from Plan C, because it is reasonable 
to treat employees participating in different plans that have not been 
aggregated as not being similarly situated.
    Example 2. The facts are the same as in Example 1, except that 
Employer X acquires two trades or businesses from different employers. 
Employees of the acquired trades or businesses become employees of 
Division M and become covered by Plan B. In addition, Plan B is amended 
to credit service with one of the trades or businesses but not the 
other. Plan B does not fail to satisfy this paragraph (d)(3)(iii)(A) 
merely because it credits service for one acquired trade or business but 
not another, because it is reasonable to treat employees of one acquired 
trade or business as not similarly situated to employees of another 
acquired trade or business.

    (B) Legitimate business reason--(1) General rule. There must be a 
legitimate business reason, based on all of the relevant facts and 
circumstances, for a plan to credit imputed service or for a plan to 
credit pre-participation service for a period of service with another 
employer.
    (2) Relevant facts and circumstances when crediting service with 
another employer. The following are examples of relevant facts and 
circumstances for determining whether a legitimate business reason 
exists for a plan to credit pre-participation or imputed service for a 
period of service with another employer as service with the employer: 
whether one employer has a significant ownership, control, or similar 
interest in, or relationship with, the other employer (though not enough 
to cause the two employers to be treated as a single employer under 
section 414); whether the two employers share interrelated business 
operations; whether the employers maintain the same multiple-employer 
plan; whether the employers share similar attributes, such as operation 
in the same industry or the same geographic area; and whether the 
employees are an acquired group of employees or the employees became 
employed by the other employer in a transaction between the two 
employers that was a stock or asset acquisition, merger, or other 
similar transaction involving a change in the employer of the employees 
of a trade or business. Other factors may also be relevant for this 
purpose, such as the plan's treatment of service with other employers 
with which the employer has a similar

[[Page 177]]

relationship and the type of service being credited (e.g., vesting 
service as compared to benefit service or accrual service). A legitimate 
business reason is deemed to exist for a plan to credit military service 
as service with the employer.
    (3) Examples. The following examples illustrate the rules in this 
paragraph (d)(3)(iii)(B):

    Example 1. Twenty unrelated employers jointly sponsor a multiple-
employer plan that covers all employees of the employers. From time to 
time, employees transfer employment among the employers. There is a 
legitimate business reason for a disaggregated portion of the plan that 
benefits the employees of one of the employers to treat service with any 
of the other employers as service with the employer.
    Example 2. Employer X owns 20 percent of the outstanding stock of 
Employer Y. From time to time, employees transfer from Employer X to 
Employer Y at the request of Employer X. Employer X maintains defined 
benefit Plan A. Plan A provides that years of service include an 
employee's years of service with Employer Y. There is a legitimate 
business reason for Plan A to credit service with Employer Y because 
Employer X, through its 20-percent ownership interest, benefits from the 
service that the transferred employees provide to Employer Y.
    Example 3. Employer Z manufactures widgets and belongs to the 
National Widget Manufacturers' Association. From time to time, Employer 
Z hires employees from other widget manufacturers. Employer Z maintains 
a defined benefit plan, Plan B, which credits pre-participation service 
for periods of service with all other members of the Association located 
in the western half of the United States as service with Employer Z. 
There is a legitimate business reason for Plan B to treat service with 
other members of the Association as service with Employer Z.

    (C) No significant discrimination--(1) General rule. Based on all of 
the relevant facts and circumstances, a plan provision crediting pre-
participation or imputed service must not by design or in operation 
discriminate significantly in favor of HCEs.
    (2) Relevant facts and circumstances. The following are examples of 
relevant facts and circumstances for determining whether a plan 
provision crediting pre-participation service or imputed service 
discriminates significantly in favor of HCEs: whether the service credit 
does not duplicate benefits but merely makes an employee whole (i.e., 
prevents the employee from being disadvantaged with respect to benefits 
by a change in job or employer or provides the employee with benefits 
comparable to those of other employees); the degree of business ties 
between the current employer and the prior employer, such as the degree 
of ownership interest or other affiliation; the degree of excess 
coverage under section 410(b) of NHCEs for the plan crediting the 
service, taking into account employees who are credited with pre-
participation service; whether the other employer maintains a qualified 
plan for its employees; the existence of reciprocal service credit under 
other plans of the employer or the prior employer; the circumstances 
underlying the employee's transfer into the group of employees covered 
by the plan; the type of service being credited; and the relative number 
of employees other than five-percent owners or the most highly-paid HCEs 
of the employer (determined without regard to the one officer rule of 
section 414(q)(5)(B)) who are being credited with pre-participation 
service or imputed service. The relative number referred to in the last 
factor is determined taking into account all employees who have been 
over time, or are reasonably expected to be in the future, credited with 
such service.
    (3) Examples. The following examples illustrate the rules in this 
paragraph (d)(3)(iii)(C). It is assumed that facts not described in an 
example do not, in the aggregate, suggest that the relevant plan 
provision either does or does not discriminate significantly in favor of 
HCEs.

    Example 1. (a) Employer U maintains defined benefit Plans A and B. 
Plan A covers all employees who work at the headquarters of Employer U. 
Plan B covers all employees of Division M of Employer U. Plan A provides 
that, whenever an employee transfers from Division M to the 
headquarters, the employee's service credited under Plan B is credited 
under Plan A, and the employee's benefit under Plan A is offset by the 
employee's benefit under Plan B. Employees, including a meaningful 
number of NHCEs, are periodically transferred from Division M to the 
headquarters of Employer U for bona fide business reasons.

[[Page 178]]

    (b) The Plan A provision crediting service under Plan B does not 
discriminate significantly in favor of HCEs. The provision is designed 
only to prevent employees from being disadvantaged by being transferred 
from Division M to the headquarters, and a meaningful number of NHCEs 
can be expected to benefit from it.
    Example 2. (a) The facts are the same as in Example 1, except that 
the only employees transferred from Division M to the headquarters of 
Employer U are HCEs (but not the most highly-paid HCEs of Employer U).
    (b) Employer U determines that Plan A would have satisfied sections 
401(a)(4) and 410(b) for the period for which the transferred employees 
are being credited with pre-participation service had the employees 
participated in Plan A during that period. This determination is based 
on test results under sections 401(a)(4) and 410(b) for the current 
year, taking into account significant demographic changes over this 
period.
    (c) The Plan A provision crediting service under Plan B does not 
significantly discriminate in favor of HCEs in the current year. This 
conclusion is based on the fact that the circumstances underlying the 
transfers indicate that they were made for bona fide business reasons, 
that Plan A would have satisfied sections 401(a)(4) and 410(b) had the 
transferred employees participated in Plan A during the period for which 
the pre-participation service is credited, and that the transferred 
employees are not the most highly-paid HCEs of Employer U.
    Example 3. (a) The facts are the same as in Example 1, except that 
the only employee who is transferred from Division M to the headquarters 
of Employer U is Employee P, who is among the most highly-paid HCEs of 
Employer U. Plan A provides an unreduced early retirement benefit at age 
55 for employees with 20 years of service, but Plan B's early retirement 
benefits are not subsidized. Employee P is transferred to the 
headquarters with 20 years of service credited under Plan B and shortly 
before attainment of age 55. Employee P is expected to retire upon 
reaching age 55.
    (b) The Plan A provision crediting service under Plan B 
discriminates significantly in favor of HCEs in the year of the 
transfer. This is because the circumstances underlying this transfer 
(i.e., its occurrence shortly before Employee P's expected retirement 
and the fact that the transfer significantly increased Employee P's 
early retirement benefits) indicate that Employee P was transferred to 
the headquarters primarily to obtain the higher pension benefits 
provided under Plan A.
    (c) Because of this conclusion, the pre-participation service 
credited to Employee P cannot be taken into account in determining 
whether Plan A satisfies Sec. 1.401(a)(4)-1 (b)(2) and (b)(3). Thus, if 
Plan A credits the service, it cannot be a safe harbor plan because the 
benefit formula will take into account service that may not be taken 
into account under this paragraph (d)(3). In addition, Employee P's 
accrual rates under the general test in Sec. 1.401(a)(4)-3(c) are 
likely to be higher than those of other employees because, while the 
pre-participation service may be used to determine Employee P's benefits 
under Plan A, the service must be disregarded in determining Employee 
P's testing service. Also, if Employee P's pre-participation service is 
used in determining Employee P's entitlement to a benefit, right, or 
feature under Plan A, the fact that the service must be disregarded in 
determining Employee P's entitlement service for purposes of Sec. 
1.401(a)(4)-4 may cause the benefit, right, or feature to be treated as 
a separate benefit, right, or feature that is currently available only 
to Employee P.
    Example 4. (a) Employer V manufactures widgets and belongs to the 
National Widget Manufacturers' Association. Each member of the 
Association maintains a defined benefit plan that credits pre-
participation service for periods of service with other members and 
offsets benefits under the plan by benefits under the plans of the other 
members. Employer V maintains defined benefit Plan C. Employer V 
periodically hires employees from other widget manufacturers who are not 
among its most highly-paid HCEs. In 1997, however, the only employee 
hired by Employer V from another member of the Association is Employee 
Q, who is among Employer V's most highly-paid HCEs. Employee Q receives 
pre-participation service credit in accordance with the terms of Plan C. 
Some of the plans maintained by other members of the Association 
credited pre-participation service to NHCEs for the same period for 
which the pre-participation service is credited to Employee Q.
    (b) The provision of Plan C crediting pre-participation service with 
other members of the Association does not discriminate significantly in 
1997, despite the fact that the only employee who received pre-
participation service credit under the provision in that year was among 
the most highly-paid HCEs of Employer V. This conclusion is based on the 
relative number of employees other than Employer V's most highly-paid 
HCEs who have been credited in the past, or are reasonably expected to 
be credited in the future, with pre-participation service for periods of 
service with other members of the Association, and the fact that other 
employees who are NHCEs are being credited with pre-participation 
service under a reciprocal agreement.
    Example 5. Employer W owns 79 percent of the outstanding stock of 
Employer X. From time to time, employees transfer from Employer W to 
Employer X at the request of Employer W. The only employees who have

[[Page 179]]

ever been transferred are HCEs. Employer W maintains a defined benefit 
plan, Plan D, which credits employees transferred to Employer X with 
imputed benefit and accrual service while employed by Employer X. 
Employer X maintains no qualified plan. Plan D would fail either section 
401(a)(4) or section 410(b) in the current plan year if the individuals 
employed by Employer X were treated as employed by Employer W. In 
addition, Plan D would fail either section 401(a)(4) or section 410(b) 
in the current plan year if the portion of Plan D covering the 
transferred employees were treated as maintained by Employer X. The Plan 
D provision crediting imputed benefit and accrual service to employees 
transferred to Employer X significantly discriminates in favor of HCEs 
in the current plan year.
    Example 6. The facts are the same as in Example 5, except that Plan 
D credits the individuals who transfer to Employer X only with imputed 
vesting and entitlement service. The Plan D provision crediting imputed 
vesting and entitlement service to individuals transferred to Employer X 
does not significantly discriminate in favor of HCEs in the current plan 
year, because there is less potential for discrimination when the only 
types of service being imputed are vesting and entitlement service.

    (iv) Additional rules for imputed service--(A) Legitimate business 
reasons for crediting imputed service--(1) General rule. A legitimate 
business reason does not exist for a plan to impute service after an 
individual has permanently ceased to perform services as an employee 
(within the meaning of Sec. 1.410(b)-9) for the employer maintaining 
the plan, i.e., is not expected to resume performing services as an 
employee for the employer. The preceding sentence does not apply in the 
case of an individual who is not performing services for the employer 
because of disability or is performing services for another employer 
under an arrangement (such as a transfer of the employee to another 
employer) that provides some ongoing business benefit to the original 
employer. The first sentence in this paragraph (d)(3)(iv)(A)(1) also 
does not apply in the case of vesting and entitlement service if the 
employee is performing services for another employer that is being 
treated under the plan as actual service with the original employer.
    (2) Certain presumptions applicable. Whether an individual has 
permanently ceased to perform services as an employee for an employer is 
determined taking into account all of the relevant facts and 
circumstances. There is a rebuttable presumption for a period of up to 
two years that an individual who has ceased to perform services as an 
employee for an employer is nonetheless expected to resume performing 
services as an employee for the employer, if the employer continues to 
treat the individual as an employee for significant purposes unrelated 
to the plan. After two years, there is a rebuttable presumption that an 
individual who has ceased to perform services as an employee for the 
employer is not expected to resume performing services as an employee 
for the employer. The fact that an individual is absent to perform jury 
duty or military service automatically rebuts the latter presumption. 
Other evidence, such as the employer's layoff policy, the terms of an 
employment contract, or specific leave to pursue a degree requiring more 
than two years of study, may also rebut this presumption.
    (3) Imputed service for part-time employees. Rules similar to the 
rules in paragraph (d)(3)(iv)(A) (1) and (2) of this section apply in 
the case of an employee whose work hours are temporarily reduced and who 
therefore would normally be credited with service at a reduced rate, but 
who continues to be credited with service at the same rate as before the 
reduction (e.g., an employee who continues to be credited with service 
as if the employee were a full-time employee during a temporary change 
from a full-time to a part-time work schedule).
    (B) Additional factors for determining whether a provision crediting 
imputed service discriminates significantly. In addition to the factors 
described in paragraph (d)(3)(iii)(C)(2) of this section, relevant facts 
and circumstances for determining whether a plan provision crediting 
imputed service during a leave of absence or a period of reduced 
services discriminates significantly include any employer policies or 
practices that restrict the ability of employees to take leaves of 
absence or work temporarily on a part-time basis, respectively.

[[Page 180]]

    (v) Satisfaction of other service-crediting rules. A plan does not 
fail to satisfy this paragraph (d)(3) merely because it credits service 
to the extent necessary to satisfy the service-crediting rules in 
section 410(a), 411(a), 413, or 414(a), Sec. 1.410(a)-7 (elapsed-time 
method of service-crediting) or 29 CFR 2530.200b-2 (regarding hours of 
service to be credited), whichever is applicable, or 29 CFR Sec. 
2530.204-2(d) (regarding double proration of service and compensation).
    (e) Family aggregation rules. [Reserved]
    (f) Governmental plans. [Reserved]
    (g) Corrective amendments--(1) In general. A corrective amendment 
that satisfies the rules of this paragraph (g) is taken into account for 
purposes of satisfying certain section 401(a) requirements for a plan 
year, by treating the corrective amendment as if it were adopted and 
effective as of the first day of the plan year. These rules apply in 
addition to the rules of section 401(b). Paragraph (g)(2) of this 
section describes the scope of the corrective amendments that are 
permitted to be made. Paragraph (g)(3) of this section specifies the 
conditions under which a corrective amendment may be made. Paragraph 
(g)(4) of this section provides a rule prohibiting a corrective 
amendment from being taken into account to the extent that it does not 
have substance. Paragraph (g)(5) of this section discusses the effect of 
the corrective amendments permitted under this paragraph (g) under 
provisions other than section 401(a).
    (2) Scope of corrective amendments. For purposes of satisfying the 
minimum coverage requirements of section 410(b), the nondiscriminatory 
amount requirement of Sec. 1.401(a)(4)-1(b)(2), or the 
nondiscriminatory plan amendment requirement of Sec. 1.401(a)(4)-
1(b)(4), a corrective amendment may retroactively increase accruals or 
allocations for employees who benefited under the plan during the plan 
year being corrected, or may grant accruals or allocations to 
individuals who did not benefit under the plan during the plan year 
being corrected. In addition, for purposes of satisfying the 
nondiscriminatory current availability requirement of Sec. 1.401(a)(4)-
4(b) for benefits, rights, or features, a corrective amendment may make 
a benefit, right, or feature available to employees to whom it was 
previously not available. A corrective amendment may not, however, 
correct for a failure to incorporate the pre-termination restrictions of 
Sec. 1.401(a)(4)-5(b).
    (3) Conditions for corrective amendments--(i) In general. A 
corrective amendment is not taken into account prior to its adoption 
under this paragraph (g) unless it satisfies each of the requirements of 
paragraph (g)(3) (ii) through (vii) of this section, whichever are 
applicable. Thus, for example, if any of the applicable requirements are 
not satisfied, any additional accruals arising from an amendment adopted 
after the end of a plan year are not given retroactive effect and, thus, 
are tested in the plan year in which the amendment is adopted.
    (ii) Benefits not reduced. Except as permitted under paragraph 
(g)(3)(vi)(C)(2) of this section, the corrective amendment may not 
result in a reduction of an employee's benefits (including any benefit, 
right, or feature), determined based on the terms of the plan in effect 
immediately before the amendment.
    (iii) Amendment effective for all purposes. For purposes of 
determining an employee's rights and benefits under the plan, the 
corrective amendment must generally be effective as if the amendment had 
been made on the first day of the plan year being corrected. Thus, if 
the corrective amendment is made after the close of the plan year being 
corrected, an employee's allocations or accruals, along with the 
associated benefits, rights, and features, must be increased to the 
level at which they would have been had the amendment been in effect for 
the entire preceding plan year. Accordingly, such increases are taken 
into account for testing purposes as if the increases had actually 
occurred in the prior plan year. However, to the extent that an 
amendment makes a benefit, right, or feature available to a group of 
employees, the amendment does not fail to satisfy this paragraph 
(g)(3)(iii) merely because it is not effective prior to the date of 
adoption and, therefore, the benefit, right, or feature is not made 
currently

[[Page 181]]

available to those employees before that date.
    (iv) Time when amendment must be adopted and put into effect--(A) 
General rule. Any corrective amendment intended to apply to the 
preceding plan year must be adopted and implemented on or before the 
15th day of the 10th month after the close of the plan year in order to 
be taken into account for the preceding plan year.
    (B) Determination letter requested by employer or plan 
administrator. If, on or before the end of the period set forth in 
paragraph (g)(3)(iv)(A) of this section, the employer or plan 
administrator files a request pursuant to Sec. 601.201(o) of this 
chapter (Statement of Procedural Rules) for a determination letter on 
the amendment, the initial or continuing qualification of the plan, or 
the trust that is part of the plan, the period set forth in paragraph 
(g)(3)(iv)(A) of this section is extended in the same manner as provided 
for an extension of the remedial amendment period under Sec. 1.401(b)-
1(d)(3).
    (v) Corrective amendment for coverage or amounts testing--(A) 
Retroactive benefits must be provided to nondiscriminatory group. Except 
as provided in paragraph (g)(3)(v)(B) of this section, if the corrective 
amendment is adopted after the close of the plan year, the additional 
allocations or accruals for the preceding year resulting from the 
corrective amendment must separately satisfy section 401(a)(4) for the 
preceding plan year and must benefit a group of employees that 
separately satisfies section 410(b) (determined by applying the same 
rules as are applied in determining whether a component plan separately 
satisfies section 410(b) under Sec. 1.401(a)(4)-9(c)(4)). Thus, for 
example, in applying the rules of this paragraph (g)(3)(v), an employer 
may not aggregate the additional accruals or allocations for the 
preceding plan year resulting from the corrective amendment with the 
other accruals or allocations already provided under the terms of the 
plan as in effect during the preceding plan year without regard to the 
corrective amendment.
    (B) Corrective amendment to conform to safe harbor. The requirements 
of paragraph (g)(3)(v)(A) of this section need not be met if the 
corrective amendment is for purposes of conforming the plan to one of 
the safe harbors in Sec. 1.401(a)(4)-2(b) or Sec. 1.401(a)(4)-3(b) 
(including for purposes of applying the requirements of those safe 
harbors under the optional testing methods in Sec. 1.401(a)(4)-8 (b)(3) 
or (c)(3)), or ensuring that the plan continues to meet one of those 
safe harbors.
    (vi) Conditions for corrective amendment of the availability of 
benefits, rights, and features. A corrective amendment may not be taken 
into account under this paragraph (g) for purposes of satisfying Sec. 
1.401(a)(4)-4(b) for a given plan year unless--
    (A) The corrective amendment is not part of a pattern of amendments 
being used to correct repeated failures with respect to a particular 
benefit, right, or feature;
    (B) The relevant provisions of the plan immediately after the 
corrective amendment with respect to the benefit, right, or feature 
(including a corrective amendment eliminating the benefit, right, or 
feature) remain in effect until the end of the first plan year beginning 
after the date of the amendment; and
    (C) The corrective amendment either--
    (1) Expands the group of employees to whom the benefit, right, or 
feature is currently available so that for each plan year in which the 
corrective amendment is taken into account in determining whether the 
plan satisfies Sec. 1.401(a)(4)-4(b), the group of employees to whom 
the benefit, right, or feature is currently available, after taking into 
account the amendment, satisfies the nondiscriminatory classification 
requirement of Sec. 1.410(b)-4 (and thus the current availability 
requirement of Sec. 1.401(a)(4)-4(b)) with a ratio percentage greater 
than or equal to the lesser of--
    (i) The safe harbor percentage applicable to the plan; and
    (ii) The ratio percentage of the plan; or
    (2) Eliminates the benefit, right, or feature (to the extent 
permitted under section 411(d)(6)) on or before the last day of the plan 
year for which the corrective amendment is taken into account.

[[Page 182]]

    (vii) Special rules for section 401(k) plans and section 401(m) 
plans--(A) Minimum coverage requirements. In the case of a section 
401(k) plan, a corrective amendment may only be taken into account for 
purposes of satisfying Sec. 1.410(b)-3(a)(2)(i) under this paragraph 
(g) for a given plan year to the extent that the corrective amendment 
grants qualified nonelective contributions within the meaning of Sec. 
1.401(k)-6 (QNECs) to nonhighly compensated nonexcludable employees who 
were not eligible employees within the meaning of Sec. 1.401(k)-6 for 
the given plan year, and the amount of the QNECs granted to each 
nonhighly compensated nonexcludable employee equals the product of the 
nonhighly compensated nonexcludable employee's plan year compensation 
and the actual deferral percentage (within the meaning of section 
401(k)(3)(B)) for the given plan year for the group of NHCEs who are 
eligible employees. Similarly, in the case of a section 401(m) plan, a 
corrective amendment may only be taken into account for purposes of 
satisfying Sec. 1.410(b)-3(a)(2)(i) under this paragraph (g) for a 
given plan year to the extent that the corrective amendment grants 
qualified nonelective contributions (QNECs) to nonhighly compensated 
nonexcludable employees who were not eligible employees within the 
meaning of Sec. 1.401(m)-5 for the given plan year, and the amount of 
the QNECs granted to each nonhighly compensated nonexcludable employee 
equals the product of the nonhighly compensated nonexcludable employee's 
plan year compensation and the actual contribution percentage (within 
the meaning of section 401(m)(3)) for the given plan year for the group 
of NHCEs who are eligible employees.
    (B) Correction of rate of match. In the case of a section 401(m) 
plan, allocations for a given plan year granted under a corrective 
amendment to NHCEs who made contributions for the plan year eligible for 
a matching contribution may be treated as matching contributions. These 
allocations treated as matching contributions may be taken into account 
for purposes of satisfying the current availability requirement of Sec. 
1.401(a)(4)-4(b) with respect to the right to a rate of match, but may 
not be taken into account for satisfying other amounts testing.
    (4) Corrective amendments must have substance. A corrective 
amendment is not taken into account in determining whether a plan 
satisfies section 401(a)(4) or 410(b) to the extent the amendment 
affects nonvested employees whose employment with the employer 
terminated on or before the close of the preceding year, and who 
therefore would not have received any economic benefit from the 
amendment if it had been made in the prior year. Similarly, in 
determining whether the requirements of paragraph (g)(3)(vi)(C)(1) of 
this section are satisfied, a corrective amendment making a benefit, 
right, or feature available to employees is not taken into account to 
the extent the benefit, right, or feature is not currently available to 
any of those employees immediately after the amendment. However, a plan 
will not fail to satisfy the requirements of paragraph (g)(3)(vi)(C)(1) 
of this section by operation of the provisions in this paragraph (g)(4) 
if the benefit, right, or feature is made available to all employees in 
the plan as of the date of the amendment.
    (5) Effect under other statutory requirements. A corrective 
amendment under this paragraph (g) is treated as if it were adopted and 
effective as of the first day of the plan year only for the specific 
purposes described in this paragraph (g). Thus, for example, the 
corrective amendment is taken into account not only for purposes of 
sections 401(a)(4) and 410(b), but also for purposes of determining 
whether the plan satisfies sections 401(l). By contrast, the amendment 
is not given retroactive effect for purposes of section 404 (deductions 
for employer contributions) or section 412 (minimum funding standards), 
unless otherwise provided for in rules applicable to those sections.
    (6) Examples. The following examples illustrate the rules in this 
paragraph (g):

    Example 1. Employer U maintains a calendar year defined benefit plan 
that in 1994 is tested using the safe harbor for flat benefit plans in 
Sec. 1.401(a)(4)-3(b)(4). In 1996, Employer U is concerned that the 
plan will not satisfy the demographic requirement in Sec. 1.401(a)(4)-

[[Page 183]]

3(b)(4)(i)(C)(3) for the 1995 plan year because the average of the 
normal accrual rates for all NHCEs is less than 70 percent of the 
average of the normal accrual rates for all HCEs. Provided the 
corrective amendment would otherwise satisfy this paragraph (g), 
Employer U may make a corrective amendment to the plan to increase the 
number of NHCEs so that the amended plan satisfies the safe harbor for 
the 1995 plan year. The corrective amendment need not satisfy paragraph 
(g)(3)(v)(A) of this section because Employer U is retroactively 
amending the plan to conform to a safe harbor in Sec. 1.401(a)(4)-3(b). 
See paragraph (g)(3)(v)(B) of this section.
    Example 2. (a) Employer V maintains a calendar year defined 
contribution plan covering all the employees in Division M and Division 
N. Under the plan, only employees in Division M have the right to direct 
the investments in their account. For plan years prior to 1996, the plan 
met the current availability requirement of Sec. 1.401(a)(4)-4(b) 
because the employees in Division M were a group of employees that 
satisfied the nondiscriminatory classification test of Sec. 1.410(b)-4. 
Because of attrition in the employee population in Division M in 1996, 
the group of employees to whom the right to direct investments is 
available during that plan year no longer meets the nondiscriminatory 
classification test of Sec. 1.410(b)-4. Thus, the right to direct 
investments under the plan does not meet the current availability 
requirement of Sec. 1.401(a)(4)-4(b) during the 1996 plan year.
    (b) Employer V may amend the plan in 1997 (but on or before October 
15) to make the right to direct investments available from the date of 
the corrective amendment to a larger group of employees and the 
corrective amendment may be taken into account for purposes of 
satisfying the current availability requirement of Sec. 1.401(a)(4)-
4(b) for 1996 if the amendment satisfies this paragraph (g). Thus, for 
example, the group of employees to whom the right to direct investments 
is currently available, after taking into account the corrective 
amendment, must satisfy the nondiscriminatory classification test of 
Sec. 1.410(b)-4 for 1996 using a safe harbor percentage (or if lower, 
the ratio percentage of the plan for 1996). In addition, the corrective 
amendment making the right to direct investments available to a larger 
group of employees must remain in effect through the end of the 1998 
plan year.
    (c) In order for Employer V to take the corrective amendment into 
account for purposes of satisfying the current availability requirement 
of Sec. 1.401(a)(4)-4(b) for the portion of the 1997 plan year before 
the amendment, the group of employees to whom the right to direct 
investments is currently available, taking into account the amendment, 
must satisfy the nondiscriminatory classification test of Sec. 
1.410(b)-4 for 1997 using a safe harbor percentage (or if lower, the 
ratio percentage of the plan for 1997).
    (d) Alternatively, if Employer V adopts the corrective amendment 
before the end of the 1996 plan year, the corrective amendment need only 
remain in force through the end of the 1997 plan year, or the corrective 
amendment may eliminate the right to direct investments (provided that 
the elimination remains in effect through the end of the 1997 plan 
year).
    Example 3. The facts are the same as in Example 2. In 1997, Employer 
V makes a corrective amendment to extend the plan to employees of 
Division O as well as Divisions M and N. Assume that the corrective 
amendment satisfies paragraph (g)(3)(v)(A) of this section, and thus, 
may be taken into account for purposes of satisfying the 
nondiscriminatory amounts requirement of Sec. 1.401(a)(4)-1(b)(2) or 
the minimum coverage requirements of section 410(b). However, the 
employees in Division O will not be taken into account in determining 
whether the right to direct investments meets the current availability 
requirements of Sec. 1.401(a)(4)-4(b) unless the corrective amendment 
meets the requirements of paragraph (g)(3)(vi) of this section. Thus, 
for example, the group of employees to whom the right to direct 
investments is made available as a result of the expansion of coverage, 
after taking into account the corrective amendment, must satisfy the 
nondiscriminatory clarification test of Sec. 1.410(b)-4 for 1996 using 
a safe harbor percentage (or if lower, the ratio percentage of the plan 
for 1996). In addition, the amendment making the right to direct 
investments available to a larger group of employees must remain in 
effect though the end of the 1998 plan year.
    Example 4. Employer W maintains a defined benefit plan that covers 
all employees and that offsets an employee's benefit by the employee's 
projected primary insurance amount. The plan is not eligible to use the 
safe harbors under Sec. 1.401(a)(4)-3(b) because the plan does not 
satisfy section 401(l). Under the plan, the accrual rates for all HCEs 
(determined under the general test of Sec. 1.401(a)(4)-3(c)) for 1998 
are less than 1.5 percent of average annual compensation, and the 
accrual rates for all NHCEs (determined under the general test of Sec. 
1.401(a)(4)-3(c)) for 1998 are two percent of average annual 
compensation. If Employer W adopts a corrective amendment adopted in 
1999 that retroactively increases HCEs' benefits under the plan so that 
their accrual rates equal those of the NHCEs, the corrective amendment 
may not be taken into account in testing the 1998 plan year (i.e., the 
accruals that result from the corrective amendment are treated as 1999 
accruals), because the accruals for the 1998 plan year resulting from 
the corrective amendment would not separately satisfy sections 410(b) 
and 401(a)(4). This is the case

[[Page 184]]

even if, after taking the amendment into account, the plan would satisfy 
sections 410(b) and 401(a)(4) for the 1998 plan year.
    Example 5. Employer X maintains two plans--Plan A and Plan B. Plan A 
satisfies the ratio percentage test of Sec. 1.410(b)-2(b)(2), but Plan 
B does not. Thus, in order to satisfy section 410(b), Plan B must 
satisfy the average benefits test of Sec. 1.410(b)-2(b)(3). The average 
benefit percentage of Plan B is 60 percent. Employer X may take into 
account a corrective amendment that increases the accruals under either 
Plan A or Plan B so that the average benefit percentage meets the 70 
percent requirement of the average benefits test, if the amendment 
satisfies paragraph (g)(3)(v) of this section.
    Example 6. Employer Y maintains Plan C, which does not satisfy 
section 401(a)(4) in a plan year. Under the terms of paragraph (g)(2) of 
this section, Employer Y amends Plan C to increase the benefits of 
certain employees retroactively. In designing the amendment, Employer Y 
identifies those employees who have terminated without vested benefits 
during the period after the end of the prior plan year and before the 
adoption date of the amendment, and the amendment provides increases in 
benefits primarily to those employees. It would be inconsistent with the 
purpose of preventing discrimination in favor of HCEs for Plan C to 
treat the amendment as retroactively effective under this paragraph (g). 
See Sec. 1.401(a)(4)-1(c)(2).
    Example 7. Employer Z maintains both a section 401(k) plan and a 
section 401(m) plan that provides matching contributions at a rate of 50 
percent with respect to elective contributions under the section 401(k) 
plan. In plan year 1995, the section 401(k) plan fails to satisfy the 
actual deferral percentage test of section 401(k)(3). In order to 
satisfy section 401(k)(3), Employer Z makes corrective distributions to 
HCEs H1 through H10 of their excess contributions as provided under 
Sec. 1.401(k)-2(b). The matching contributions that H1 through H10 had 
received on account of their excess contributions are not forfeited, 
however. Thus, the effective rate of matching contributions provided to 
H1 through H10 is increased as a result of the corrective distributions. 
See Sec. 1.401(a)(4)-4(e)(3)(iii)(G). Since no NHCE in the section 
401(m) plan is provided with an equivalent rate of matching 
contributions, the rate of matching contributions provided to H1 through 
H10 does not satisfy the nondiscriminatory availability requirement of 
Sec. 1.401(a)(4)-4 in plan year 1995. Employer Z makes a corrective 
amendment by October 15, 1996, that grants allocations to NHCEs who made 
contributions for the 1995 plan year eligible for a matching 
contribution. Employer Z may treat the allocations granted under the 
corrective amendment to those NHCEs as matching contributions for the 
1995 plan year and, as a result, take them into account in determining 
whether the availability of the rate of matching contributions provided 
to H1 through H10 satisfies the current availability requirement of 
Sec. 1.401(a)(4)-4(b) for the 1995 plan year.

[T.D. 8485, 58 FR 46813, Sept. 3, 1993, as amended by T.D. 9169, 69 FR 
78153, Dec. 29, 2004]



Sec. 1.401(a)(4)-12  Definitions.

    Unless otherwise provided, the definitions in this section govern in 
applying the provisions of Sec. Sec. 1.401(a)(4)-1 through 1.401(a)(4)-
13.
    Accumulation plan. Accumulation plan means a defined benefit plan 
under which the benefit of every employee for each plan year is 
separately determined, using plan year compensation (if benefits are 
determined as a percentage of compensation rather as than a dollar 
amount) separately calculated for the plan year, and each employee's 
total accrued benefit as of the end of a plan year is the sum of the 
separately determined benefit for that plan year and the total accrued 
benefit as of the end of the preceding plan year.
    Acquired group of employees. Acquired group of employees means 
employees of a prior employer who become employed by the employer in a 
transaction between the employer and the prior employer that is a stock 
or asset acquisition, merger, or other similar transaction involving a 
change in the employer of the employees of a trade or business, plus 
employees hired by or transferred into the acquired trade or business on 
or before a date selected by the employer that is within the transition 
period defined in section 410(b)(6)(C)(ii). In addition, in the case of 
a transaction prior to the effective date of these regulations, the date 
by which employees must be hired by or transferred into the acquired 
trade or business in order to be included in the acquired group of 
employees may be any date prior to February 11, 1993, without regard to 
whether it is later than the end of the transition period defined in 
section 410(b)(6)(C)(ii).
    Actuarial equivalent. An amount or benefit is the actuarial 
equivalent of, or is actuarially equivalent to, another amount or 
benefit at a given time if the actuarial present value of the two 
amounts or benefits (calculated using

[[Page 185]]

the same actuarial assumptions) at that time is the same.
    Actuarial present value. Actuarial present value means the value as 
of a specified date of an amount or series of amounts due thereafter, 
where each amount is--
    (1) Multiplied by the probability that the condition or conditions 
on which payment of the amount is contingent will be satisfied; and
    (2) Discounted according to an assumed rate of interest to reflect 
the time value of money.
    Ancillary benefit. Ancillary benefit is defined in Sec. 
1.401(a)(4)-4(e)(2).
    Average annual compensation. Average annual compensation is defined 
in Sec. 1.401(a)(4)-3(e)(2).
    Base benefit percentage. Base benefit percentage is defined in Sec. 
1.401(l)-1(c)(3).
    Benefit formula. Benefit formula means the formula a defined benefit 
plan applies to determine the accrued benefit (within the meaning of 
section 411(a)(7)(A)(i)) in the form of an annual benefit commencing at 
normal retirement age of an employee who continues in service until 
normal retirement age. Thus, for example, the benefit formula does not 
include the accrual method the plan applies (in conjunction with the 
benefit formula) to determine the accrued benefit of an employee who 
terminates employment before normal retirement age. For purposes of this 
definition, a change in plan provisions that applies only to certain 
employees who terminate within a limited period of time (e.g., an early 
retirement window benefit) is treated as a change in the plan's benefit 
formula for the employees to whom the change is potentially applicable 
during the period that the change is potentially applicable to them. The 
preceding sentence applies only to the extent that the change in plan 
provisions would result in a change in the benefit formula if it were 
permanent and applied without regard to when the employees' employment 
was terminated.
    Benefit, right, or feature. Benefit, right, or feature means an 
optional form of benefit, an ancillary benefit, or an other right or 
feature within the meaning of Sec. 1.401(a)(4)-4(e).
    Contributory DB plan. Contributory DB plan means a defined benefit 
plan that includes employee contributions not allocated to separate 
accounts.
    Defined benefit excess plan. Defined benefit excess plan is defined 
in Sec. 1.401(l)-1(c)(16)(i).
    Defined benefit plan. Defined benefit plan is defined in Sec. 
1.410(b)-9.
    Defined contribution plan. Defined contribution plan is defined in 
Sec. 1.410(b)-9.
    Determination date. Determination date is defined in Sec. 
1.401(a)(4)-8(b)(3)(iv)(A).
    Employee. With respect to a plan for a given plan year, employee 
means an employee (within the meaning of Sec. 1.410(b)-9) who benefits 
as an employee under the plan for the plan year (within the meaning of 
Sec. 1.410(b)-3).
    Employer. Employer is defined in Sec. 1.410(b)-9.
    ESOP. ESOP is defined in Sec. 1.410(b)-9.
    Excess benefit percentage. Excess benefit percentage is defined in 
Sec. 1.401(l)-1(c)(14).
    Former employee. With respect to a plan for a given plan year, 
former employee means a former employee (within the meaning of Sec. 
1.410(b)-9).
    Former HCE. Former HCE means a highly compensated former employee as 
defined in Sec. 1.410(b)-9.
    Former NHCE. Former NHCE means a former employee who is not a former 
HCE.
    Fresh-start date. Fresh-start date is defined in Sec. 1.401(a)(4)-
13(c)(5)(iii).
    Fresh-start group. Fresh-start group is defined in Sec. 
1.401(a)(4)-13(c)(5)(ii).
    Gross benefit percentage. Gross benefit percentage is defined in 
Sec. 1.401(l)-1(c)(18).
    HCE. HCE means a highly compensated employee as defined in Sec. 
1.410(b)-9 who benefits under the plan for the plan year (within the 
meaning of Sec. 1.410(b)-3).
    Integration level. Integration level is defined in Sec. 1.401(l)-
1(c)(20).
    Measurement period. Measurement period is defined in Sec. 
1.401(a)(4)-3(d)(1)(iii).
    Multiemployer plan. Multiemployer plan is defined in Sec. 1.410(b)-
9.
    NHCE. NHCE means an employee who is not an HCE.
    Nonexcludable employee. Nonexcludable employee means an employee

[[Page 186]]

within the meaning of Sec. 1.410(b)-9, other than an excludable 
employee with respect to the plan as determined under Sec. 1.410(b)-6. 
A nonexcludable employee may be either a highly or nonhighly compensated 
nonexcludable employee, depending on the nonexcludable employee's status 
under section 414(q).
    Normalize. With respect to a benefit payable to an employee in a 
particular form, normalize means to convert the benefit to an 
actuarially equivalent straight life annuity commencing at the 
employee's testing age. The actuarial assumptions used in normalizing a 
benefit must be reasonable and must be applied on a gender-neutral 
basis. A standard interest rate and a standard mortality table are among 
the assumptions considered reasonable for this purpose.
    Offset plan. Offset plan is defined in Sec. 1.401(l)-1(c)(24).
    Optional form of benefit. Optional form of benefit is defined in 
Sec. 1.401(a)(4)-4(e)(1).
    Other right or feature. Other right or feature is defined in Sec. 
1.401(a)(4)-4(e)(3).
    Plan. Plan means a plan within the meaning of Sec. 1.410(b)-7 (a) 
and (b), after application of the mandatory disaggregation rules of 
Sec. 1.410(b)-7(c) and the permissive aggregation rules of Sec. 
1.410(b)-7(d).
    Plan year. Plan year is defined in Sec. 1.410(b)-9.
    Plan year compensation--(1) In general. Plan year compensation means 
section 414(s) compensation for the plan year determined by measuring 
section 414(s) compensation during one of the periods described in 
paragraphs (2) through (4) of this definition. Whichever period is 
selected must be applied uniformly to determine the plan year 
compensation of every employee.
    (2) Plan year. This period consists of the plan year.
    (3) Twelve-month period ending in the plan year. This period 
consists of a specified 12-month period ending with or within the plan 
year, such as the calendar year or the period for determining benefit 
accruals described in Sec. 1.401(a)(4)-3(f)(6).
    (4) Period of plan participation during the plan year. This period 
consists of the portion of the plan year during which the employee is a 
participant in the plan. This period may be used to determine plan year 
compensation for the plan year in which participation begins, the plan 
year in which participation ends, or both. This period may be used to 
determine plan year compensation when substituted for average annual 
compensation in Sec. 1.401(a)(4)-3(e)(2)(ii)(A) only if the plan year 
is also the period for determining benefit accruals under the plan 
rather than another period as permitted under Sec. 1.401(a)(4)-3(f)(6). 
Further, selection of this period must be made on a reasonably 
consistent basis from plan year to plan year in a manner that does not 
discriminate in favor of HCEs.
    (5) Special rule for new employees. Notwithstanding the uniformity 
requirement of paragraph (1) of this definition, if employees' plan year 
compensation for a plan year is determined based on a 12-month period 
ending within the plan year under paragraph (3) of this definition, then 
the plan year compensation of any employees whose date of hire was less 
than 12 months before the end of that 12-month period must be determined 
uniformly based either on the plan year or on the employees' periods of 
participation during the plan year, as provided in paragraphs (2) and 
(4), respectively, of this definition.
    QJSA. QJSA means a qualified joint and survivor annuity as defined 
in section 417(b).
    QSUPP--(1) In general. QSUPP or qualified social security supplement 
means a social security supplement that meets each of the requirements 
in paragraphs (2) through (6) of this definition.
    (2) Accrual--(i) General rule. The amount of the social security 
supplement payable at any age for which the employee is eligible for the 
social security supplement must be equal to the lesser of--
    (A) The employee's old-age insurance benefit, unreduced on account 
of age, under title II of the Social Security Act; and
    (B) The accrued social security supplement, determined under one of 
the methods in paragraph (2) (ii) through (iv) of this definition.
    (ii) Section 401(l) plans. In the case of a section 401(l) plan that 
is a defined benefit excess plan, each employee's

[[Page 187]]

accrued social security supplement equals the employee's average annual 
compensation up to the integration level, multiplied by the disparity 
provided by the plan for the employee's years of service used in 
determining the employee's accrued benefit under the plan. In the case 
of a section 401(l) plan that is an offset plan, each employee's accrued 
social security supplement equals the dollar amount of the offset 
accrued for the employee under the plan.
    (iii) PIA offset plan. In the case of a PIA offset plan, each 
employee's accrued social security supplement equals the dollar amount 
of the offset accrued for the employee under the plan. For this purpose, 
a PIA offset plan is a plan that reduces an employee's benefit by an 
offset based on a stated percentage of the employee's primary insurance 
amount under the Social Security Act.
    (iv) Other plans. In the case of any other plan, each employee's 
social security supplement accrues ratably over the period beginning 
with the later of the employee's commencement of participation in the 
plan or the effective date of the social security supplement and ending 
with the earliest age at which the social security supplement is payable 
to the employee. The effective date of the social security supplement is 
the later of the effective date of the amendment adding the social 
security supplement or the effective date of the amendment modifying an 
existing social security supplement to comply with the requirements of 
this definition. If, by the end of the first plan year to which these 
regulations apply, as set forth in Sec. 1.401(a)(4)-13 (a) and (b), an 
amendment is made to a social security supplement in existence on 
September 19, 1991, the employer may treat the accrued portion of the 
social security supplement, as determined under the plan without regard 
to amendments made after September 19, 1991, as included in the 
employee's accrued social security supplement, provided that the 
remainder of the social security supplement is accrued under the 
otherwise-applicable method.
    (3) Vesting. The plan must provide that an employee's right to the 
accrued social security supplement becomes nonforfeitable within the 
meaning of section 411 as if it were an early retirement benefit.
    (4) Eligibility. The plan must impose the same eligibility 
conditions on receipt of the social security supplement as on receipt of 
the early retirement benefit in conjunction with which the social 
security supplement is payable. Furthermore, if the service required for 
an employee to become eligible for the social security supplement 
exceeds 15 years, then the ratio percentage of the group of employees 
who actually satisfy the eligibility conditions on receipt of the QSUPP 
in the current plan year must equal or exceed the unsafe harbor 
percentage applicable to the plan under Sec. 1.410(b)-4(c)(4)(ii).
    (5) QJSA. At each age, the most valuable QSUPP commencing at that 
age must be payable in conjunction with the QJSA commencing at that age. 
In addition, the plan must provide that, in the case of a social 
security supplement payable in conjunction with a QJSA, the social 
security supplement will be paid after the employee's death on the same 
terms as the QJSA, but in no event for a period longer than the period 
for which the social security supplement would have been paid to the 
employee had the employee not died. For example, if the QJSA is in the 
form of a joint annuity with a 50-percent survivor's benefit, the social 
security supplement must provide a 50-percent survivor's benefit. When 
section 417(c) requires the determination of a QJSA for purposes of 
determining a qualified pre-retirement survivor's annuity as defined in 
section 417(c) (QPSA), the social security supplement payable in 
conjunction with that QJSA must be paid in conjunction with the QPSA.
    (6) Protection. The plan must specifically provide that the social 
security supplement is treated as an early retirement benefit that is 
protected under section 411(d)(6) (other than for purposes of sections 
401(a)(11) and 417). Thus, the accrued social security supplement must 
continue to be payable notwithstanding subsequent amendment of the plan 
(including the plan's termination), and an employee may meet the 
eligibility requirements for

[[Page 188]]

the social security supplement after plan termination.
    Qualified plan. Qualified plan means a plan that satisfies section 
401(a). For this purpose, a qualified plan includes an annuity plan 
described in section 403(a).
    Rate group. Rate group is defined in Sec. 1.401(a)(4)-2(c)(1) or is 
defined in Sec. 1.401(a)(4)-3(c)(1).
    Ratio percentage. Ratio percentage is defined in Sec. 1.410(b)-9.
    Section 401(a)(17) employee. Section 401(a)(17) employee is defined 
in Sec. 1.401(a)(17)-1(e)(2)(ii).
    Section 401(k) plan. Section 401(k) plan is defined in Sec. 
1.410(b)-9.
    Section 401(l) plan. Section 401(l) plan is defined in Sec. 
1.410(b)-9.
    Section 401(m) plan. Section 401(m) plan is defined in Sec. 
1.410(b)-9.
    Section 414(s) compensation--(1) General rule. When used with 
reference to compensation for a plan year, 12-month period, or other 
specified period, section 414(s) compensation means compensation 
measured using an underlying definition that satisfies section 414(s) 
for the applicable plan year. Whether an underlying definition of 
compensation satisfies section 414(s) is determined on a year-by-year 
basis, based on the provisions of section 414(s) in effect for the 
applicable plan year and, if relevant, the employer's HCEs and NHCEs for 
that plan year. See Sec. 1.414(s)-1(i) for transition rules for plan 
years beginning before the effective date applicable to the plan under 
Sec. 1.401(a)(4)-13 (a) or (b). For a plan year or 12-month period 
beginning before January 1, 1988, any underlying definition of 
compensation may be used to measure the amount of employees' 
compensation for purposes of this definition, provided that the 
definition was nondiscriminatory based on the facts and circumstances in 
existence for that plan year or for the plan year in which that 12-month 
period ends.
    (2) Determination period for section 414(s) nondiscrimination 
requirement--(i) General rule. If an underlying definition of 
compensation must satisfy the nondiscrimination requirement in Sec. 
1.414(s)-1(d)(3) in order to satisfy section 414(s) for a plan year, any 
one of the following determination periods may be used to satisfy the 
nondiscrimination requirement--
    (A) The plan year;
    (B) The calendar year ending in the plan year; or
    (C) The 12-month period ending in the plan year that is used to 
determine the underlying definition of compensation.
    (ii) Exception for partial plan year compensation. Notwithstanding 
the general rule in paragraph (2)(i) of this definition, if the period 
for measuring the underlying compensation is the portion of the plan 
year during which each employee is a participant in the plan (as 
provided in paragraph (4) of the definition of plan year compensation in 
this section), that period must be used as the determination period.
    (3) Plans using permitted disparity. In the case of a section 401(l) 
plan or a plan that imputes permitted disparity in accordance with Sec. 
1.401(a)(4)-7, an underlying definition of compensation is not section 
414(s) compensation if the definition results in significant under- 
inclusion of compensation for employees.
    (4) Double proration of service and compensation. If a defined 
benefit plan prorates benefit accruals as permitted under section 
411(b)(4)(B) by crediting less than full years of participation, then 
compensation for a plan year, 12-month period, or other specified period 
that is used to determine the amount of an employee's benefits under the 
plan will not fail to be section 414(s) compensation, merely because the 
amount of compensation for that period is adjusted to reflect the 
equivalent of full-time compensation to the extent necessary to satisfy 
the requirements of 29 CFR 2530.204-2(d) (regarding double proration of 
service and compensation). This adjustment is disregarded in determining 
whether the underlying definition of compensation used satisfies the 
requirements of section 414(s). Thus, for example, if the underlying 
definition of compensation is an alternative definition that must 
satisfy the nondiscrimination requirement of Sec. 1.414(s)-1(d)(3), in 
determining whether that requirement is satisfied with regard to the 
underlying definition, the compensation included for any employee is 
determined without

[[Page 189]]

any adjustment to reflect the equivalent of full-time compensation 
required by 29 CFR 2530.204-2(d).
    Social security supplement. Social security supplement is defined in 
Sec. 1.411(a)-7(c)(4)(ii).
    Standard interest rate. Standard interest rate means an interest 
rate that is neither less than 7.5 percent nor greater than 8.5 percent, 
compounded annually. The Commissioner may, in revenue rulings, notices, 
and other guidance of general applicability, change the definition of 
standard interest rate.
    Standard mortality table. Standard mortality table means one of the 
following tables: the UP-1984 Mortality Table (Unisex); the 1983 Group 
Annuity Mortality Table (1983 GAM) (Female); the 1983 Group Annuity 
Mortality Table (1983 GAM) (Male); the 1983 Individual Annuity Mortality 
Table (1983 IAM) (Female); the 1983 Individual Annuity Mortality Table 
(1983 IAM) (Male); the 1971 Group Annuity Mortality Table (1971 GAM) 
(Female); the 1971 Group Annuity Mortality Table (1971 GAM) (Male); the 
1971 Individual Annuity Mortality Table (1971 IAM) (Female); or the 1971 
Individual Annuity Mortality Table (1971 IAM) (Male). These standard 
mortality tables are available from the Society of Actuaries, 475 N. 
Martingale Road, Suite 800, Schaumberg, Illinois 60173. The Commissioner 
may, in revenue rulings, notices, and other guidance of general 
applicability, change the definition of standard mortality table. See 
Sec. 601.601(d)(2)(ii)(b) of this Chapter. The applicable mortality 
table under section 417(e)(3)(A)(ii)(I) is also a standard mortality 
table.
    Straight life annuity. Straight life annuity means an annuity 
payable in equal installments for the life of the employee that 
terminates upon the employee's death.
    Testing age. With respect to an employee, testing age means the age 
determined for the employee under the following rules:
    (1) If the plan provides the same uniform normal retirement age for 
all employees, the employee's testing age is the employee's normal 
retirement age under the plan.
    (2) If a plan provides different uniform normal retirement ages for 
different employees or different groups of employees, the employee's 
testing age is the employee's latest normal retirement age under any 
uniform normal retirement age under the plan, regardless of whether that 
particular uniform normal retirement age actually applies to the 
employee under the plan.
    (3) If the plan does not provide a uniform normal retirement age, 
the employee's testing age is 65.
    (4) If an employee is beyond the testing age otherwise determined 
for the employee under paragraphs (1) through (3) of this definition, 
the employee's testing age is the employee's current age. The rule in 
the preceding sentence does not apply in the case of a defined benefit 
plan that fails to satisfy the requirements of Sec. 1.401(a)(4)-
3(f)(3)(i) (permitting certain increases in benefits that commence after 
normal retirement age to be disregarded).
    Testing service. Testing service is defined in Sec. 1.401(a)(4)-
3(d)(1)(iv).
    Uniform normal retirement age--(1) General rule. Uniform normal 
retirement age means a single normal retirement age under the plan that 
does not exceed the maximum age in paragraph (2) of this definition and 
that is the same for all of the employees in a given group. A group of 
employees does not fail to have a uniform normal retirement age merely 
because the plan contains provisions described in paragraphs (3) and (4) 
of this definition.
    (2) Maximum age. The maximum age is generally 65. However, if all 
employees have the same social security retirement age (within the 
meaning of section 415(b)(8)), the maximum age is the employees' social 
security retirement age. Thus, for example, a component plan has a 
uniform normal retirement age of 67 if it defines normal retirement age 
as social security retirement age and all employees in the component 
plan have a social security retirement age of 67.
    (3) Stated anniversary date--(i) General rule. A group of employees 
does not fail to have a uniform normal retirement age merely because the 
plan provides that the normal retirement age of all employees in the 
group is the later of a stated age (not exceeding the maximum age in 
paragraph (2) of this definition) or a stated anniversary no later

[[Page 190]]

than the fifth anniversary of the time each employee commenced 
participation in the plan. For employees who commenced participation in 
the plan before the first plan year beginning on or after January 1, 
1988, the stated anniversary date may be later than the anniversary 
described in the preceding sentence if it is no later than the earlier 
of the tenth anniversary of the date the employee commenced 
participation in the plan (or such earlier anniversary selected by the 
employer, if less than 10) or the fifth anniversary of the first day of 
the first plan year beginning on or after January 1, 1988.
    (ii) Use of service other than anniversary of commencement of 
participation. In lieu of using a stated anniversary date as permitted 
under paragraph (3)(i) of this definition, a plan may use a stated 
number of years of service measured on another basis, provided that the 
determination is made on a basis that satisfies section 411(a)(8) and 
that the stated number of years of service does not exceed the number of 
anniversaries permitted under paragraph (3)(i) of this definition. For 
example, a uniform normal retirement age could be based on the earlier 
of the fifth anniversary of the commencement of participation and the 
completion of five years of vesting service.
    (4) Conversion of normal retirement age to normal retirement date. A 
group of employees does not fail to have a uniform normal retirement age 
merely because a defined benefit plan provides for the commencement of 
normal retirement benefits on different retirement dates for different 
employees if each employee's normal retirement date is determined on a 
reasonable basis with reference to an otherwise uniform normal 
retirement age and the difference between the normal retirement date and 
the uniform normal retirement age cannot exceed six months for any 
employee. Thus, for example, benefits under a plan do not fail to 
commence at a uniform normal retirement age of age 62 for purposes of 
Sec. 1.401(a)(4)-3(b)(2)(i), merely because the plan's normal 
retirement date is defined as the last day of the plan year nearest 
attainment of age 62.
    Year of service. Year of service means a year of service as defined 
in the plan for a specific purpose, including the method of crediting 
service for that purpose under the plan.

[T.D. 8485, 58 FR 46820, Sept. 3, 1993, as amended by T.D. 8954, 66 FR 
34545, June 29, 2001]



Sec. 1.401(a)(4)-13  Effective dates and fresh-start rules.

    (a) General effective dates--(1) In general. Except as otherwise 
provided in this section, Sec. Sec. 1.401(a)(4)-1 through 1.401(a)(4)-
13 apply to plan years beginning on or after January 1, 1994.
    (2) Plans of tax-exempt organizations. In the case of plans 
maintained by organizations exempt from income taxation under section 
501(a), including plans subject to section 403(b)(12)(A)(i) (nonelective 
plans), Sec. Sec. 1.401(a)(4)-1 through 1.401(a)(4)-13 apply to plan 
years beginning on or after January 1, 1996.
    (3) Compliance during transition period. For plan years beginning 
before the effective date of these regulations, as set forth in 
paragraph (a)(1) and (2) of this section, and on or after the first day 
of the first plan year to which the amendments made to section 410(b) by 
section 1112(a) of the Tax Reform Act of 1986 (TRA '86) apply, a plan 
must be operated in accordance with a reasonable, good faith 
interpretation of section 401(a)(4), taking into account pre-existing 
guidance and the amendments made by TRA '86 to related provisions of the 
Code (including, for example, sections 401(l), 401(a)(17), and 410(b)). 
Whether a plan is operated in accordance with a reasonable, good faith 
interpretation of section 401(a)(4) will generally be determined on the 
basis of all the relevant facts and circumstances, including the extent 
to which an employer has resolved unclear issues in its favor. A plan 
will be deemed to be operated in accordance with a reasonable, good 
faith interpretation of section 401(a)(4) if it is operated in 
accordance with the terms of Sec. Sec. 1.401(a)(4)-1 through 
1.401(a)(4)-13.
    (b) Effective date for governmental plans. In the case of 
governmental plans described in section 414(d), including plans subject 
to section 403(b)(12)(A)(i) (nonelective plans), Sec. Sec. 1.401(a)(4)-
1 through 1.401(a)(4)-13 apply to plan years beginning on or

[[Page 191]]

after the later of January 1, 1996, or 90 days after the opening of the 
first legislative session beginning on or after January 1, 1996, of the 
governing body with authority to amend the plan, if that body does not 
meet continuously. Such plans are deemed to satisfy section 401(a)(4) 
for plan years before that effective date. For purposes of this 
paragraph (b), the governing body with authority to amend the plan is 
the legislature, board, commission, council, or other governing body 
with authority to amend the plan.
    (c) Fresh-start rules for defined benefit plans--(1) Introduction. 
This paragraph (c) provides rules that must be satisfied in order to use 
the fresh-start testing options for defined benefit plans in Sec. 
1.401(a)(4)-3(b)(6)(vii) and (d)(3)(iii), relating to the safe harbors 
and the general test, respectively. Those fresh-start options are 
designed to allow a plan to be tested without regard to benefits accrued 
before a selected fresh-start date. To the extent provided in paragraph 
(d) of this section, those options also may be used to disregard certain 
increases in benefits attributable to compensation increases after a 
fresh-start date. Although this paragraph (c) generally requires a plan 
to be amended to freeze employees' accrued benefits as of a fresh-start 
date and to provide any additional accrued benefits after the fresh-
start date solely in accordance with certain specified formulas, certain 
of these requirements do not apply to a plan that is tested under the 
general test of Sec. 1.401(a)(4)-3(c). See Sec. 1.401(a)(4)-
3(b)(6)(vii) and (d)(3)(iii).
    (2) General rule. A defined benefit plan satisfies this paragraph 
(c) if--
    (i) Accrued benefits of employees in the fresh-start group are 
frozen as of the fresh-start date in accordance with paragraph (c)(3) of 
this section;
    (ii) Accrued benefits after the fresh-start date for employees in 
the fresh-start group are determined under one of the fresh-start 
formulas in paragraph (c)(4) of this section; and
    (iii) Paragraph (c)(5) of this section is satisfied.
    (3) Definition of frozen--(i) General rule. An employee's accrued 
benefit under a plan is frozen as of the fresh-start date if it is 
determined as if the employee terminated employment with the employer as 
of the fresh-start date (or the date the employee actually terminated 
employment with the employer, if earlier), and without regard to any 
amendment to the plan adopted after that date, other than amendments 
recognized as effective as of or before that date under section 401(b) 
or Sec. 1.401(a)(4)-11(g). The assumption that an employee has 
terminated employment applies solely for purposes of this paragraph 
(c)(3). Thus, for example, the fresh start has no effect on the service 
taken into account for purposes of determining vesting and eligibility 
for benefits, rights, and features under the plan.
    (ii) Permitted compensation adjustments. An employee's accrued 
benefit under a plan that satisfies paragraph (d) of this section does 
not fail to be frozen as of the fresh-start date merely because the plan 
makes the adjustments described in paragraph (d)(7) and (8) of this 
section with regard to the fresh-start date. In addition, if the frozen 
accrued benefit of an employee under the plan includes top-heavy minimum 
benefits, an employee's accrued benefit under a plan does not fail to be 
frozen as of the fresh-start date merely because the plan increases the 
frozen accrued benefit of each employee in the fresh-start group solely 
to the extent necessary to comply with the average compensation 
requirement of section 416(c)(1)(D)(i).
    (iii) Permitted changes in optional forms. An employee's accrued 
benefit under a plan does not fail to be frozen as of the fresh-start 
date merely because the plan provides a new optional form of benefit 
with respect to the frozen accrued benefit, if--
    (A) The optional form is provided with respect to each employee's 
entire accrued benefit (i.e., accrued both before and after the fresh-
start date);
    (B) The plan provided meaningful coverage as of the fresh-start 
date, as described in paragraph (d)(4) of this section; and
    (C) The plan provides meaningful current benefit accruals as 
described in paragraph (d)(6) of this section.
    (iv) Floor-offset plans. In the case of a plan that was a floor-
offset plan described in Sec. 1.401(a)(4)-8(d) prior to the

[[Page 192]]

fresh-start date, an employee's accrued benefit as of the fresh-start 
date does not fail to be frozen merely because the actuarial equivalent 
of the account balance in the defined contribution plan that is offset 
against the defined benefit plan varies as a result of investment return 
that is different from the assumed interest rate used to determine the 
actuarial equivalent of the account balance.
    (4) Fresh-start formulas--(i) Formula without wear-away. An 
employee's accrued benefit under the plan is equal to the sum of--
    (A) The employee's frozen accrued benefit; and
    (B) The employee's accrued benefit determined under the formula 
applicable to benefit accruals in the current plan year (current 
formula) as applied to the employee's years of service after the fresh-
start date.
    (ii) Formula with wear-away. An employee's accrued benefit under the 
plan is equal to the greater of--
    (A) The employee's frozen accrued benefit; or
    (B) The employee's accrued benefit determined under the current 
formula as applied to the employee's total years of service (before and 
after the fresh-start date) taken into account under the current 
formula.
    (iii) Formula with extended wear-away. An employee's accrued benefit 
under the plan is equal to the greater of--
    (A) The amount determined under paragraph (c)(4)(i) of this section; 
or
    (B) The amount determined under paragraph (c)(4)(ii)(B) of this 
section.
    (5) Rules of application--(i) Consistency requirement. This 
paragraph (c)(5) is not satisfied unless the fresh-start rules in this 
paragraph (c) (and paragraph (d) of this section, if applicable) are 
applied consistently to all employees in the fresh-start group. Thus, 
for example, the same fresh-start date and fresh-start formula (within 
the meaning of paragraph (c)(4) of this section) must apply to all 
employees in the fresh-start group. Similarly, if a plan makes a fresh 
start for all employees with accrued benefits on the fresh-start date 
and, for a later plan year, is aggregated for purposes of section 
401(a)(4) with another plan that did not make the same fresh start, the 
aggregated plan must make a new fresh start in order to use the fresh-
start rules for that later plan year or any subsequent plan year.
    (ii) Definition of fresh-start group. Generally, the fresh-start 
group with respect to a fresh start consists of all employees who have 
accrued benefits as of the fresh-start date and have at least one hour 
of service with the employer after that date. However, a fresh-start 
group with respect to a fresh start may consist exclusively of all 
employees who have accrued benefits as of the fresh-start date, have at 
least one hour of service with the employer after that date, and are--
    (A) Section 401(a)(17) employees;
    (B) Members of an acquired group of employees (provided the fresh-
start date is the date determined under paragraph (c)(5)(iii)(B) of this 
section); or
    (C) Employees with a frozen accrued benefit that is attributable to 
assets and liabilities transferred to the plan as of a fresh-start date 
in connection with the transfer (provided the fresh-start date is the 
date determined under paragraph (c)(5)(iii)(C) of this section) and for 
whom the current formula is different from the formula used to determine 
the frozen accrued benefit.
    (iii) Definition of fresh-start date. Generally, the fresh-start 
date is the last day of a plan year. However, a plan may use a fresh-
start date other than the last day of the plan year if--
    (A) The plan satisfied the safe harbor rules of Sec. 1.401(a)(4)-
3(b) for the period from the beginning of the plan year through the 
fresh-start date;
    (B) The fresh-start group is an acquired group of employees, and the 
fresh-start date is the latest date of hire or transfer into an acquired 
trade or business selected by the employer for any employees to be 
included in the acquired group of employees; or
    (C) The fresh-start group is the group of employees with a frozen 
accrued benefit that is attributable to assets and liabilities 
transferred to the plan and the fresh-start date is the date as of which 
the employees begin accruing benefits under the plan.
    (6) Examples. The following examples illustrate the rules in this 
paragraph (c):


[[Page 193]]


    Example 1. (a) Employer X maintains a defined benefit plan with a 
calendar plan year. The plan formula provides an employee with a normal 
retirement benefit at age 65 of one percent of average annual 
compensation up to covered compensation multiplied by the employee's 
years of service for Employer X, plus 1.5 percent of average annual 
compensation in excess of covered compensation, multiplied by the 
employee's years of service for Employer X up to 40.
    (b) For plan years beginning after 1994, Employer X amends the plan 
formula to provide a normal retirement benefit of 0.75 percent of 
average annual compensation up to covered compensation multiplied by the 
employee's total years of service for Employer X up to 35, plus 1.4 
percent of average annual compensation in excess of covered compensation 
multiplied by the employee's years of service for Employer X up to 35. 
For plan years after 1994, each employee's accrued benefit is determined 
under the fresh-start formula in paragraph (c)(4)(iii) of this section 
(formula with extended wear-away), using December 31, 1994, as the 
fresh-start date.
    (c) As of December 31, 1994, Employee M has 10 years of service for 
Employer X, has average annual compensation of $38,000, and has covered 
compensation of $30,000. Employee M's accrued benefit as of December 31, 
1994, is therefore $4,200 ((1 percentx$30,000x10 years)+(1.5 
percentx$8,000x10 years)). As of December 31, 1995, Employee M has 11 
years of service for Employer X, has average annual compensation of 
$40,000 (determined by taking into account compensation before and after 
the fresh-start date), and has covered compensation of $32,000. Employee 
M's accrued benefit as of December 31, 1995, is $4,552, the greater of--
    (1) $4,552, the sum of Employee M's accrued benefit frozen as of 
December 31, 1994, ($4,200) and the amended formula applied to Employee 
M's years of service after 1994 ((0.75 percentx$32,000x1 year)+(1.4 
percentx$8,000x1 year), or $352); or
    (2) $3,872, the amended formula applied to Employee M's total years 
of service ((0.75 percentx$32,000x11 years)+(1.4 percentx$8,000x11 
years)).
    Example 2. (a) Employer Y maintains a defined benefit plan, Plan A, 
that has a calendar plan year. For the 1995 plan year, Plan A satisfies 
the requirements for a safe harbor plan in Sec. 1.401(a)(4)-3(b). 
Employer Y selects a date in 1995 for all the employees, freezes the 
employees' accrued benefits as of that date under the rules of paragraph 
(c)(3) of this section, and, in accordance with the rules of this 
paragraph (c), amends Plan A to determine benefits for all employees 
after that date using the formula with wear-away described in paragraph 
(c)(4)(ii) of this section. The new benefit formula would satisfy the 
requirements for a safe harbor plan in Sec. 1.401(a)(4)-3(b) if all 
accrued benefits were determined under it.
    (b) Because Plan A satisfied the requirements for a safe harbor plan 
for the period from the beginning of the plan year through the selected 
date, paragraph (c)(5)(iii)(A) of this section permits the selected date 
to be a fresh-start date, even if it is not the last day of the plan 
year. Thus, Plan A satisfies the requirements in this paragraph (c) for 
a fresh start as of the fresh-start date.
    (c) Under Sec. 1.401(a)(4)-3(b)(6)(vii), a plan does not fail to 
satisfy the requirements of Sec. 1.401(a)(4)-3(b), merely because of 
benefits accrued under a different formula prior to a fresh-start date. 
Thus, Plan A still satisfies the safe harbor requirements of Sec. 
1.401(a)(4)-3(b) after the amendment to the benefit formula. Because 
Plan A satisfied the requirements for a safe harbor plan for the period 
from the beginning of the plan year, taking the amendment into account, 
Employer Y may select any date within the plan year (which may be the 
same date as the first fresh-start date) and apply the fresh-start rules 
in this paragraph (c) a second time as of that date.

    (d) Compensation adjustments to frozen accrued benefits--(1) 
Introduction. In addition to the fresh-start rules in paragraph (c) of 
this section, this paragraph (d) sets forth requirements that must be 
satisfied in order for a plan to disregard increases in benefits accrued 
as of a fresh-start date that are attributable to increases in 
employees' compensation after the fresh-start date.
    (2) In general. In the case of a defined benefit plan that is tested 
under the safe harbors in Sec. 1.401(a)(4)-3(b) or Sec. 1.401(a)(4)-
8(c)(3), an employee's adjusted accrued benefit (determined under the 
rules in paragraph (d)(8) of this section) may be substituted for the 
employee's frozen accrued benefit in applying the formulas in paragraph 
(c)(4) of this section (or paragraph (f)(2) of this section, if 
applicable) if paragraphs (d)(3) through (d)(7) of this section are 
satisfied. Thus, for example, in determining whether such a plan 
satisfies Sec. 1.401(a)(4)-3(b), any compensation adjustments to the 
employee's frozen accrued benefit described in paragraph (d)(8) of this 
section are disregarded. Similarly, in the case of a defined benefit 
plan tested under the general test in Sec. 1.401(a)(4)-3(c), the 
compensation adjustments described in paragraph (d)(8) of this section 
may be disregarded under the rules of Sec. 1.401(a)(4)-3(d)(3)(iii) if 
paragraphs (d)(3) through

[[Page 194]]

(d)(7) of this section are satisfied. Of course, any increases in 
accrued benefits exceeding these adjustments must be taken into account 
under the general test, and a plan providing such excess increases 
generally will fail to satisfy the safe harbor requirements of Sec. 
1.401(a)(4)-3(b). Where paragraphs (d)(3) through (d)(7) of this section 
are satisfied with respect to a plan as of the fresh-start date, but one 
or more of those paragraphs fail to be satisfied for a later plan year, 
further compensation adjustments described in paragraph (d)(8) of this 
section may not be disregarded in testing the plan under Sec. 
1.401(a)(4)-3.
    (3) Plan requirements--(i) Pre-fresh-start date. As of the fresh-
start date, the plan must have contained a benefit formula under which 
benefits of each employee in the fresh-start group that are accrued as 
of the fresh-start date and are attributable to service before the 
fresh-start date would be affected by the employee's compensation after 
the fresh-start date. A plan satisfies this requirement, for example, if 
it based benefits on an employee's highest average pay over a fixed 
period of years or on an employee's average pay over the employee's 
entire career with the employer. A plan does not satisfy this paragraph 
(d)(3)(i) if the Commissioner determines, based on all of the relevant 
facts and circumstances, that the plan provision described in the first 
sentence of this paragraph (d)(3) was added primarily in order to 
provide additional benefits to HCEs that are disregarded under the 
special testing rules described in this paragraph (d).
    (ii) Post-fresh-start date. The plan by its terms must provide that 
the accrued benefits of each employee in the fresh-start group after the 
fresh-start date be at least equal to the employee's adjusted accrued 
benefit (i.e., the frozen accrued benefit as of the fresh-start date, 
adjusted as provided under paragraph (d)(7) of this section, plus the 
compensation adjustments described in paragraph (d)(8) of this section).
    (4) Meaningful coverage as of fresh-start date. The plan must have 
provided meaningful coverage as of the fresh-start date. A plan provided 
meaningful coverage as of the fresh-start date if the group of employees 
with accrued benefits under the plan as of the fresh-start date 
satisfied the minimum coverage requirements of section 410(b) as in 
effect on that date (determined without regard to section 410(b)(6)(C)). 
In order to satisfy the requirement in the preceding sentence, an 
employer may amend the plan to grant past service credit under the 
formula in effect as of the fresh-start date to NHCEs, if the amount of 
past service granted them is reasonably comparable, on average, to the 
amount of past service HCEs have under the plan. Any benefit increase 
that results from the grant of past service credit to a NHCE under this 
paragraph (d)(4) is included in the employee's frozen accrued benefit.
    (5) Meaningful ongoing coverage--(i) General rule. The fresh-start 
group must have satisfied the minimum coverage requirements of section 
410(b) for all plan years from the first plan year beginning after the 
fresh-start date through the current plan year. Thus, if a fresh-start 
group fails to satisfy the minimum coverage requirements of section 
410(b) for any plan year, this paragraph (d)(5) is not satisfied for 
that plan year or any subsequent plan year; however, such a failure is 
not taken into account in determining whether this paragraph (d)(5) is 
satisfied for any previous plan year.
    (ii) Alternative rules. Notwithstanding paragraph (d)(5)(i) of this 
section, a fresh-start group is deemed to satisfy this paragraph (d)(5) 
for all plan years following the fresh-start date if any one of the 
following requirements is satisfied:
    (A) Section 410(b) coverage for first five years. The fresh-start 
group must have satisfied the minimum coverage requirements of section 
410(b) for the first five plan years beginning after the fresh-start 
date.
    (B) Ratio percentage coverage as of fresh-start date. The fresh-
start group must have satisfied the ratio percentage test of Sec. 
1.410(b)-2(b)(2) as of the fresh-start date.
    (C) Fresh start for acquired group of employees. The fresh-start 
group must consist of an acquired group of employees that satisfied the 
minimum coverage requirements of section 410(b) (determined without 
regard to section 410(b)(6)(C)) as of the fresh-start date.

[[Page 195]]

    (D) Fresh start before applicable effective date. The fresh-start 
date with respect to the fresh-start group must have been on or before 
the effective date applicable to the plan under paragraph (a) or (b) of 
this section.
    (6) Meaningful current benefit accruals. The benefit formula and 
accrual method under the plan that applies to the fresh-start group in 
the aggregate must provide benefit accruals in the current plan year 
(other than increases in benefits accrued as of the fresh-start date) at 
a rate that is meaningful in comparison to the rate at which benefits 
accrued for the fresh-start group in plan years beginning before the 
fresh-start date. Whether this requirement is satisfied with respect to 
a fresh-start group that does not include all employees in the plan with 
an hour of service after the fresh-start date may be determined taking 
into account the rate at which benefits are provided to other employees 
in the plan.
    (7) Minimum benefit adjustment--(i) In general. In the case of a 
section 401(l) plan or a plan that imputes disparity under Sec. 
1.401(a)(4)-7, the plan must make the minimum benefit adjustment 
described in paragraph (d)(7)(ii) or (iii) of this section.
    (ii) Excess or offset plans. In the case of a plan that is a defined 
benefit excess plan as of the fresh-start date, each employee's frozen 
accrued benefit is adjusted so that the base benefit percentage is not 
less than 50 percent of the excess benefit percentage. In the case of a 
plan that is a PIA offset plan (as defined in paragraph (2)(iii) of the 
definition of QSUPP in Sec. 1.401(a)(4)-12) as of the fresh-start date, 
each employee's offset as applied to determine the frozen accrued 
benefit is adjusted so that it does not exceed 50 percent of the benefit 
determined without applying the offset.
    (iii) Other plans. In the case of a plan that is not described in 
paragraph (d)(7)(ii) of this section, each employee's frozen accrued 
benefit is adjusted in a manner that is economically equivalent to the 
adjustment required under that paragraph, taking into account the plan's 
benefit formula, accrual rate, and relevant employee factors, such as 
period of service.
    (8) Adjusted accrued benefit--(i) General rule. The term adjusted 
accrued benefit means an employee's frozen accrued benefit that is 
adjusted as provided in paragraph (d)(7) of this section and then 
multiplied by a fraction (not less than one), the numerator of which is 
the employee's compensation for the current plan year and the 
denominator of which is the employee's compensation as of the fresh-
start date determined under the same definition. For purposes of this 
adjustment, the compensation definition must be either the same 
compensation definition and formula used to determine the frozen accrued 
benefit or average annual compensation (determined without regard to 
Sec. 1.401(a)(4)-3(e)(2)(ii)(A) (use of plan year compensation)).
    (ii) Alternative formula for pre-effective-date fresh starts. In the 
case of a fresh-start date before the effective date that applies to the 
plan under paragraph (a) or (b) of this section, the adjusted accrued 
benefit may be determined by multiplying the frozen accrued benefit by a 
fraction (not less than one) determined under this paragraph (d)(8)(ii). 
The numerator of the fraction is the employee's average annual 
compensation for the current plan year. The denominator of the fraction 
is the employee's reconstructed average annual compensation as of the 
fresh-start date. An employee's reconstructed average annual 
compensation is determined by--
    (A) Selecting a single plan year beginning after the fresh-start 
date but beginning not later than the last day of the first plan year to 
which these regulations apply under paragraph (a) or (b) of this 
section;
    (B) Determining the employee's average annual compensation for the 
selected plan year under the same method used to determine the 
employee's average annual compensation for the current plan year under 
this paragraph (d)(8)(ii); and
    (C) Multiplying the employee's average annual compensation for the 
selected plan year by a fraction, the numerator of which is the 
employee's compensation as of the fresh-start date determined under the 
same compensation definition and formula used to determine the 
employee's frozen accrued

[[Page 196]]

benefit and the denominator of which is the employee's compensation for 
the selected plan year determined under the compensation definition and 
formula used to determine the employee's frozen accrued benefit.
    (iii) Effect of section 401(a)(17). In determining the numerators 
and the denominators of the fractions described in this paragraph 
(d)(8), the annual compensation limit under section 401(a)(17) generally 
applies. See, however, Sec. 1.401(a)(17)-1(e)(4) for special rules 
applicable to section 401(a)(17) employees.
    (iv) Option to make less than the full permitted adjustment. A plan 
may limit the increase in an employee's frozen accrued benefit for the 
current and all future years to a percentage (not more than 100 percent) 
of the increase otherwise provided under this paragraph (d)(8). 
Furthermore, the plan may, at any time, terminate all future adjustments 
permitted under this paragraph (d).
    (v) Alternative determination of adjusted accrued benefit. In lieu 
of applying the fractions in paragraph (d)(8)(i) or (ii) of this 
section, a plan may determine an employee's adjusted accrued benefit by 
substituting the employee's compensation for the current plan year 
(determined under the same compensation formula and underlying 
definition of compensation used to determine the employee's frozen 
accrued benefit) in the benefit formula used to determine the frozen 
accrued benefit. For this purpose, insignificant changes in the 
underlying definition of compensation to reflect current compensation 
practices will not be treated as a change in the definition of 
compensation. A plan may apply the alternative in this paragraph 
(d)(8)(v), only if it is reasonable to expect as of the fresh-start date 
that, over time, the use of this method instead of the general rule of 
paragraph (d)(8)(i) will not discriminate significantly in favor of 
HCEs.
    (9) Examples. The following examples illustrate the rules of this 
paragraph (d).

    Example 1. (a) Employer X maintains a defined benefit plan that is 
an excess plan with a calendar plan year. For plan years before 1989, 
the plan is integrated with benefits provided under the Social Security 
Act, providing each employee with a normal retirement benefit equal to 
one percent of the employee's average annual compensation in excess of 
the employee's covered compensation, multiplied by the employee's years 
of service for Employer X. The benefit formula thus provides no benefit 
with respect to average annual compensation up to covered compensation.
    (b) As of December 31, 1988, Employee M has 10 years of service for 
Employer X and has covered compensation of $25,000 and average annual 
compensation of $20,000. Employee M's average annual compensation has 
never exceeded $20,000. Therefore, as of December 31, 1988, Employee M's 
accrued benefit under the plan is zero.
    (c) Effective with the 1989 plan year, the plan is amended to 
provide each employee with a normal retirement benefit of 0.6 percent of 
average annual compensation up to covered compensation plus 1.2 percent 
of average annual compensation in excess of covered compensation, 
multiplied by the employee's years of service up to 35. The plan also 
provides that, for plan years after 1988, each employee's accrued 
benefit is determined under the formula in paragraph (c)(4)(i) of this 
section (formula without wear-away) and, in applying the fresh-start 
formula, each employee's frozen accrued benefit under paragraph 
(c)(4)(i) of this section will be adjusted under this paragraph (d), 
using the same compensation definition and formula used to determine the 
frozen accrued benefit under paragraph (d)(8)(i) of this section.
    (d) The plan uses the permitted disparity of section 401(l) and thus 
must also make the minimum benefit adjustment under paragraph (d)(7) of 
this section. Because the excess benefit percentage under the plan for 
years before 1989 was one percent, the plan must provide a base benefit 
percentage for those years of at least 0.5 percent. After the minimum 
benefit adjustment, Employee M's accrued benefit as of December 31, 
1988, is $1,000 (0.5 percentx$20,000x10 years).
    (e) As of December 31, 1992, Employee M has 14 years of service and 
has covered compensation of $30,000 and average annual compensation of 
$35,000. Employee M's adjusted accrued benefit as of December 31, 1992, 
is $1,750 ($1,000x$35,000/$20,000), and Employee M's accrued benefit as 
of December 31, 1992, is $2,710 (the sum of $1,750 plus $960 ((0.6 
percentx$30,000x4 years) plus (1.2 percentx$5,000x4 years))).
    Example 2. (a) The facts are the same as in Example 1, except that 
in determining adjusted accrued benefits, the plan specifies the 
alternative method of paragraph (d)(8)(v) of this section. This method 
may be used because it is reasonable to expect as of the fresh-start 
date that, over time, the use of this method instead of the general rule 
of

[[Page 197]]

paragraph (d)(8)(i) will not discriminate significantly in favor of 
HCEs.
    (b) As of December 31, 1992, Employee M's adjusted accrued benefit 
is $2,000 (10 years of service prior to the fresh-start datex(0.5 
percent of $30,000+1.0 percent of the excess of $35,000 over $30,000)).
    (c) Alternatively, Employer X may choose to use the method of 
paragraph (d)(8)(v) of this section but freezes the covered compensation 
level at the dollar level in place as of the fresh-start date. In such 
case, Employee M's adjusted accrued benefit as of December 31, 1992, 
would have been $2,250 (10 years of service prior to the fresh-start 
datex(0.5 percent of $25,000+1.0 percent of the excess of $35,000 over 
$25,000)). This method may be used because it is reasonable to expect as 
of the fresh-start date that, over time, the use of this method instead 
of the general rule of paragraph (d)(8)(i) will not discriminate 
significantly in favor of HCEs.
    Example 3. (a) The facts are the same as in Example 1, except that 
for plan years before 1989, the plan provided a minimum benefit to 
certain employees equal to $120 per year of service. Employee M is 
entitled to the minimum benefit, and thus, Employee M's frozen accrued 
benefit as of December 31, 1988 was $1,200 (the greater of 10 years of 
servicex$120 and $1,000, Employee M's benefit under the underlying 
formula, after the minimum benefit adjustment of paragraph (d)(7) of 
this section).
    (b) Employer X's plan specifies instead the alternative method of 
adjusting accrued benefits described in paragraph (d)(8)(v) of this 
section. (The fact that a minimum benefit applying to certain employees 
is not adjusted under the alternative method of paragraph (d)(8)(v) of 
this section, but would be adjusted under the general rule of paragraph 
(d)(8)(i) of this section does not change the conclusion in Example 2, 
that the plan may apply the alternative method).

    (e) Determination of initial theoretical reserve for target benefit 
plans--(1) General rule. In the case of a target benefit plan the stated 
benefit formula under which takes into account service for years in 
which the plan did not satisfy Sec. 1.401(a)(4)-8(b)(3), as permitted 
under Sec. 1.401(a)(4)-8(b)(3)(vii), the theoretical reserve as of the 
determination date for the last plan year beginning before the first day 
of the first plan year in which the plan satisfies Sec. 1.401(a)(4)-
8(b)(3) of an employee who was a participant in the plan on that 
determination date, is determined as follows:
    (i) Determine the actuarial present value, as of that determination 
date, of the stated benefit that the employee is projected to have at 
the employee's normal retirement age, using the actuarial assumptions, 
the provisions of the plan, and the employee's compensation as of that 
determination date. For an employee whose attained age equals or exceeds 
the employee's normal retirement age, determine the actuarial present 
value of the employee's stated benefit at the employee's current age, 
but using an immediate straight life annuity factor for an employee 
whose attained age equals the employee's normal retirement age.
    (ii) Calculate the actuarial present value of future required 
employer contributions (without regard to limitations under section 415 
or additional contributions described in Sec. 1.401(a)(4)-8(b)(3)(v)) 
as of that determination date (i.e., the actuarial present value of the 
level contributions due for each plan year through the end of the plan 
year in which the employee attains normal retirement age). This 
calculation is made assuming that the required contribution in each 
future year will be equal to the required contribution for the plan year 
that includes that determination date, and applying the interest rate 
that was used in determining that required contribution.
    (iii) Determine the excess, if any, of the amount determined in 
paragraph (e)(1)(i) of this section over the amount determined in 
paragraph (e)(1)(ii) of this section. This excess is the employee's 
theoretical reserve on that determination date.
    (2) Example. The following example illustrates the determination of 
an employee's theoretical reserve.

    Example. (a) A target benefit plan was adopted and in effect before 
September 19, 1991, and satisfied the requirements of Rev. Rul. 76-464, 
1976-2 C.B. 115, with respect to all years credited under the stated 
benefit formula through 1993. The plan provides a stated benefit equal 
to 40 percent of compensation, payable annually as a straight life 
annuity beginning at normal retirement age. Normal retirement age under 
the plan is 65. The stated interest rate under the plan is six percent. 
The determination date for required contributions under the plan is the 
last day of the plan year. Employee M is 38 years old on the 
determination date for the 1993 plan year, has participated in the plan 
for five years, and has compensation equal to $60,000 in 1993. The 
amount of employer contribution to Employee M's account for 1993 was 
$2,468.

[[Page 198]]

    (b) Under these facts, Employee M's theoretical reserve is equal to 
$13,909, calculated as follows:
    (1) The actuarial present value of Employee M's stated benefit is 
calculated using the actuarial assumptions, provisions of the plan and 
Employee M's compensation as of the determination date for the 1993 plan 
year. This amount is equal to $46,512, Employee M's stated benefit of 
$24,000 ($60,000 multiplied by 40 percent), multiplied by 1.938, the 
actuarial present value factor applicable to a participant who is 38 
years old using a stated interest rate of six percent.
    (2) The actuarial present value of future employer contributions is 
calculated assuming that the required contribution in each future year 
will be equal to the required contribution for the 1993 plan year and 
assuming the same interest rate as was used in determining that 
contribution. This amount is equal to $32,603, which is equal to the 
amount of the level annual employer contribution ($2,468) multiplied by 
a factor of 13.2105 (the temporary annuity factor for a period of 27 
years, assuming the six percent interest rate that was used to determine 
the required employer contribution).
    (3) Employee M's theoretical reserve is $13,909, the excess of the 
amount determined in paragraph (b)(1) of this Example over the amount 
determined in paragraph (b)(2) of this Example.

    (f) Special fresh-start rules for cash balance plans--(1) In 
general. In order to satisfy the optional testing method of Sec. 
1.401(a)(4)-8(c)(3) after a fresh-start date, a cash balance plan must 
apply the rules of paragraph (c) of this section as modified under this 
paragraph (f). Paragraph (f)(2) of this section provides an alternative 
formula that may be used in addition to the formulas in paragraphs 
(c)(2) through (c)(4) of this section. Paragraph (f)(3) of this section 
sets forth certain limitations on use of the formulas in paragraph (c) 
or (f)(2) of this section.
    (2) Alternative formula--(i) In general. An employee's accrued 
benefit under the plan is equal to the greater of--
    (A) The employee's frozen accrued benefit, or
    (B) The employee's accrued benefit determined under the plan's 
benefit formula applicable to benefit accruals in the current plan year 
as applied to years of service after the fresh-start date, modified in 
accordance with paragraph (f)(2)(ii) of this section.
    (ii) Addition of opening hypothetical account. As of the first day 
after the fresh-start date, the plan must credit each employee's 
hypothetical account with an amount equal to the employee's opening 
hypothetical account (determined under paragraph (f)(2)(iii) of this 
section), adjusted for interest for the period that begins on the first 
day after the fresh-start date and that ends at normal retirement age. 
The interest adjustment in the preceding sentence must be made using the 
same interest rate applied to the hypothetical allocation for the first 
plan year beginning after the fresh-start date.
    (iii) Determination of opening hypothetical account--(A) General 
rule. An employee's opening hypothetical account equals the actuarial 
present value of the employee's frozen accrued benefit as of the fresh-
start date. For this purpose, if the plan provides for a single sum 
distribution as of the fresh-start date, the actuarial present value of 
the employee's frozen accrued benefit as of the fresh-start date equals 
the amount of a single sum distribution payable under the plan on that 
date, assuming that the employee terminated employment on the fresh-
start date, the employee's accrued benefit was 100-percent vested, and 
the employee satisfied all eligibility requirements under the plan for 
the single sum distribution. If the plan does not offer a single sum 
distribution as of the fresh-start date, the actuarial present value of 
the employee's frozen accrued benefit as of the fresh-start date must be 
determined using a standard mortality table and the applicable section 
417(e) rates, as defined in Sec. 1.417(e)-1(d).
    (B) Alternative opening hypothetical account. Alternatively, the 
employee's opening hypothetical account is the greater of the opening 
hypothetical account determined under paragraph (f)(2)(ii)(A) of this 
section and the employee's hypothetical account as of the fresh-start 
date determined in accordance with Sec. 1.401(a)(4)-8(c)(3)(v)(A) 
calculated under the plan's benefit formula applicable to benefit 
accruals in the current plan year as applied to the employee's total 
years of service through the fresh-start date in a manner that satisfies 
the past service credit rules of Sec. 1.401(a)(4)-8(c)(3)(viii).
    (3) Limitations on formulas--(i) Past service restriction. If the 
plan does not

[[Page 199]]

satisfy the uniform hypothetical allocation formula requirement of Sec. 
1.401(a)(4)-8(c)(3)(iii)(B) as of the fresh-start date, under Sec. 
1.401(a)(4)-8(c)(3)(viii) the plan may not provide for past service 
credits, and thus may not use the formula in paragraph (c)(3) of this 
section (formula with wear-away), the formula in paragraph (c)(4) of 
this section (formula with extended wear-away), or the alternative 
determination of the opening hypothetical account in paragraph 
(f)(2)(iii)(B) of this section.
    (ii) Change in interest rate. If the interest rate used to adjust 
employees' hypothetical allocations under Sec. 1.401(a)(4)-8(c)(3)(iv) 
for the plan year is different from the interest rate used for this 
purpose in the immediately preceding plan year, the plan must use the 
formula in paragraph (c)(2) of this section (formula without wear-away).
    (iii) Meaningful benefit requirement. A plan is permitted to use the 
formula provided in paragraph (f)(2) of this section only if the plan 
satisfies paragraphs (d)(3) through (d)(5) of this section (regarding 
coverage as of fresh-start date, current benefit accruals, and minimum 
benefit adjustment, respectively).

[T.D. 8360, 56 FR 47598, Sept. 19, 1991; 57 FR 4721, Feb. 7, 1992; 57 FR 
10953, Mar. 31, 1992, as amended by T.D. 8485, 58 FR 46823, Sept. 3, 
1993]



Sec. 1.401(a)(5)-1  Special rules relating to nondiscrimination 
requirements.

    (a) In general. Section 401(a)(5) sets out certain provisions that 
will not of themselves be discriminatory within the meaning of section 
410(b)(2)(A)(i) or section 401(a)(4). The exceptions specified in 
section 401(a)(5) are not an exclusive enumeration, but are merely a 
recital of provisions frequently encountered that will not of themselves 
constitute prohibited discrimination in contributions or benefits. See 
section 401(a)(4) and the regulations thereunder for the basic 
nondiscrimination rules. See Sec. 1.410(b)-4 for the rule of section 
410(b)(2)(A)(i) (relating to the nondiscriminatory classification test 
that is part of the minimum coverage requirements) referred to in 
section 401(a)(5)(A). See paragraphs (b) through (f) of this section for 
special rules used in applying the section 401(a)(4) nondiscrimination 
requirements under the remaining provisions of section 401(a)(5).
    (b) Salaried or clerical employees. A plan does not fail to satisfy 
the nondiscrimination requirements of section 401(a)(4) merely because 
contributions or benefits provided under the plan are limited to 
salaried or clerical employees.
    (c) Uniform relationship to compensation. A plan does not fail to 
satisfy the nondiscrimination requirements of section 401(a)(4) merely 
because the contributions or benefits of, or on behalf of, the employees 
under the plan bear a uniform relationship to the compensation (within 
the meaning of section 414(s)) of those employees.
    (d) Certain disparity permitted. Under section 401(a)(5)(C), a plan 
does not discriminate in favor of highly compensated employees (as 
defined in section 414(q)), within the meaning of section 401(a)(4), in 
the amount of employer-provided contributions or benefits solely 
because--
    (1) In the case of a defined contribution plan, employer 
contributions allocated to the accounts of employees favor highly 
compensated employees in a manner permitted by section 401(l) (relating 
to permitted disparity in plan contributions and benefits), and
    (2) In the case of a defined benefit plan, employer-provided 
benefits favor highly compensated employees in a manner permitted by 
section 401(l) (relating to permitted disparity in plan contributions 
and benefits).

See Sec. Sec. 1.401(l)-1 through 1.401(l)-6 for rules under which a 
plan may satisfy section 401(l) for purposes of the safe harbors of 
Sec. Sec. 1.401(a)(4)-2(b)(3) and 1.401(a)(4)-3(b).
    (e) Defined benefit plans integrated with social security--(1) In 
general. Under section 401(a)(5)(D), a defined benefit plan does not 
discriminate in favor of highly compensated employees (as defined in 
section 414(q)) with respect to the amount of employer-provided 
contributions or benefits solely because the plan provides that, with 
respect to each employee, the employer-provided accrued retirement 
benefit under the plan is limited to the excess (if any) of--

[[Page 200]]

    (i) The employee's final pay from the employer, over
    (ii) The employer-provided retirement benefit created under the 
Social Security Act and attributable to service by the employee for the 
employer.
    (2) Final pay. For purposes of paragraph (e)(1)(i) of this section, 
an employee's final pay from the employer as of a plan year is the 
employee's compensation (as defined in section 414(q)(7)) for the year 
(ending with or within the 5-plan-year period ending with the plan year 
in which the employee terminates from employment with the employer) in 
which the employee receives the highest compensation from the employer. 
Notwithstanding the preceding sentence, final pay for each employee 
under the plan may be determined with reference to the 5-plan-year 
period ending with the plan year before the plan year in which the 
employee terminates from employment with the employer. In determining an 
employee's final pay, the plan may specify any 12-month period (ending 
with or within the applicable 5-plan-year period) as a year provided the 
specified 12-month period is uniformly and consistently applied with 
respect to all employees. In determining an employee's final pay, 
compensation for any year in excess of the applicable limit under 
section 401(a)(17) for the year may not be taken into account.
    (3) Rules for determining amount of employer-provided social 
security retirement benefit. For purposes of paragraph (e)(1)(ii) of 
this section, the following rules apply.
    (i) The employer-provided retirement benefit on which any reduction 
or offset in the employee's accrued retirement benefit is based is 
limited solely to the employer-provided primary insurance amount payable 
under section 215 of the Social Security Act attributable to service by 
the employee for the employer.
    (ii) The employer-provided primary insurance amount attributable to 
service by the employee for the employer is determined by multiplying 
the employer-provided portion of the employee's projected primary 
insurance amount by a fraction (not exceeding 1), the numerator of which 
is the employee's number of complete years of covered service for the 
employer under the Social Security Act, and the denominator of which is 
35.
    (4) Projected primary insurance amount. (i) As of a plan year, an 
employee's projected primary insurance amount is the primary insurance 
amount, determined as of the close of the plan year (the ``determination 
date''), payable to the employee upon attainment of the employee's 
social security retirement age (as determined under section 415(b)(8)), 
assuming the employee's annual compensation from the employer that is 
treated as wages for purposes of the Social Security Act remains the 
same from the plan year until the employee's attainment of social 
security retirement age. With respect to service by the employee for the 
employer before the determination date, the actual compensation paid to 
the employee by the employer during all periods of service of the 
employee for the employer covered by the Social Security Act must be 
used in determining an employee's projected primary insurance amount. 
With respect to years before the employee's commencement of service for 
the employer, in determining the employee's projected primary insurance 
amount, it may be assumed that the employee received compensation in an 
amount computed by using a six-percent salary scale projected backwards 
from the determination date to the employee's 21st birthday. However, if 
the employee provides the employer with satisfactory evidence of the 
employee's actual past compensation for the prior years treated as wages 
under the Social Security Act at the time the compensation was earned 
and the actual past compensation results in a smaller projected primary 
insurance amount, the plan must use the actual past compensation. The 
plan administrator must give clear written notice to each employee of 
the employee's right to supply actual compensation history and of the 
financial consequences of failing to supply the history. The notice must 
be given each time the summary plan description is provided to the 
employee and must also be given upon the employee's separation from 
service. The notice must also state

[[Page 201]]

that the employee can obtain the actual compensation history from the 
Social Security Administration. In determining the employee's projected 
primary insurance amount, the employer may not take into account any 
compensation from any other employer while the employee is employed by 
the employer.
    (ii) As of a plan year, the employer-provided portion of the 
employee's projected primary insurance amount under the Social Security 
Act is 50 percent of the employee's projected primary insurance amount 
(as determined under paragraph (e)(4)(i) of this section).
    (5) Employer-provided accrued retirement benefit. For purposes of 
this section, the employee's employer-provided accrued retirement 
benefit as of a plan year is the employee's accrued retirement benefit 
under the plan (determined on an actual basis and not on a projected 
basis) attributable to employer contributions under the plan. With 
respect to plans that provide for employee contributions, see section 
411(c) for rules relating to the allocation of accrued benefits between 
employer contributions and employee contributions.
    (6) Additional rules. (i) As of a plan year, paragraph (e)(1) of 
this section does not apply to the extent that its application would 
result in a decrease in an employee's accrued benefit. See sections 
411(b)(1)(G) and 411(d)(6).
    (ii) Section 401(a)(5)(D) and this paragraph (e) do not apply to a 
plan maintained by an employer, determined for purposes of the Federal 
Insurance Contributions Act or the Railroad Retirement Tax Act, as 
applicable, that does not pay any wages within the meaning of section 
3121(a) or compensation within the meaning of section 3231(e). For this 
purpose, a plan maintained for a self-employed individual within the 
meaning of section 401(c)(1), who is also subject to the tax under 
section 1401, is deemed to be a plan maintained by an employer that pays 
wages within the meaning of section 3121(a).
    (iii) If a plan provides for the payment of an employee's accrued 
retirement benefit (whether or not subsidized) commencing before an 
employee's social security retirement age, the projected employer-
provided primary insurance amount attributable to service by the 
employee for the employer (as determined under paragraphs (e)(3) and 
(e)(4) of this section) that may be applied as an offset to limit the 
employee's accrued retirement benefit must be reduced in accordance with 
Sec. 1.401(l)-3(e)(1). The reduction is made by multiplying the 
employee's projected employer-provided primary insurance amount by a 
fraction, the numerator of which is the appropriate factor under Sec. 
1.401(l)-3(e)(1), and the denominator of which is 0.75 percent.
    (iv) The Commissioner may, in revenue rulings, notices or other 
documents of general applicability, prescribe additional rules that may 
be necessary or appropriate to carry out the purposes of this section, 
including rules relating to the determination of an employee's projected 
primary insurance amount attributable to the employee's service for 
former employers and rules applying section 401(a)(5)(D) with respect to 
an employer that pays wages within the meaning of section 3121(a) or 
compensation within the meaning of section 3231(e) for some years and 
not for other years.
    (7) Examples. The following examples illustrate this paragraph (e).

    Example 1. Employer Z maintains a noncontributory defined benefit 
plan that uses the calendar year as its plan year. The plan provides a 
normal retirement benefit, commencing at age 65, equal to $500 a year, 
multiplied by the employee's years of service for Z, limited to the 
excess of the amount of the employee's final pay from Z (as determined 
in accordance with paragraph (e)(2) of this section) over the employee's 
employer-provided primary insurance amount attributable to the 
employee's service for Z. If an employee's social security retirement 
age is greater than 65, the plan provides for reduction of the 
employee's employer-provided primary insurance amount in accordance with 
paragraph (e)(6)(iii) of this section. The plan provides no limitation 
on the number of years of service taken into account in determining 
benefits under the plan. Employee A retires on July 6, 1995, at A's 
social security retirement age of 65 with 35 years of service for Z. The 
plan uses the plan year as the 12- month period for determining an 
employee's year of final highest pay from the employer. A's compensation 
for A's final 5 plan years is as follows:

1995 plan year................................................   $10,500
1994 plan year................................................   $20,000

[[Page 202]]

 
1993 plan year................................................   $18,000
1992 plan year................................................   $17,000
1991 plan year................................................   $16,500
 

    A's annual primary insurance amount under social security, 
determined as of A's social security retirement age, is $9,000, of which 
$4,500 is the employer-provided portion attributable to A's service for 
Z ($9,000x50 percentx35/35). Under the plan's benefit formula 
(disregarding the final pay limitation), A would be entitled to receive 
a normal retirement benefit of $17,500 ($500x35 years). However, under 
the plan, A's otherwise determined normal retirement benefit of $17,500 
is limited to the excess of the amount of A's final pay from Z over A's 
employer-provided primary insurance amount under social security 
attributable to A's service for Z. Accordingly, A's normal retirement 
benefit is determined to be $15,500 ($20,000 (A's final pay from Z) less 
$4,500 (A's employer-provided primary insurance amount attributable to 
A's service for Z)) rather than $17,500. The final pay limitation in Z's 
plan satisfies section 401(a)(5)(D) and this paragraph (e). Accordingly, 
the plan maintained by Z does not discriminate in favor of highly 
compensated employees within the meaning of section 401(a)(4) merely 
because of the final pay limitation contained in the plan.
    Example 2. Assume the same facts as in Example 1, except that A has 
32 years of service for Z when A retires at A's social security 
retirement age. Under the plan's benefit formula (disregarding the final 
pay limitation), A would be entitled to receive an annual normal 
retirement benefit of $16,000 ($500x32 years). However, the plan 
provides that A's normal retirement benefit of $16,000 will be limited 
to $15,500 ($20,000 (the amount of A's final pay from Z) less $4,500 
(\1/2\ of A's primary insurance amount under the Social Security Act)). 
The final pay limitation does not satisfy this paragraph (e). The 
portion of A's employer-provided primary insurance amount under the 
Social Security Act attributable to A's service for Z is 32/35x$4,500, 
or $4,114. Therefore, to satisfy this paragraph (e), the final pay 
provision in Z's plan may not limit A's otherwise determined normal 
retirement benefit of $16,000 to less than $15,886 ($20,000 (the amount 
of X's final pay) minus $4,114 (the portion of A's employer-provided 
primary insurance amount attributable to A's service for Z)).
    Example 3. (a) Employer X maintains a noncontributory defined 
benefit plan that uses the calendar year as its plan year. The formula 
for determining benefits under the plan provides a normal retirement 
benefit at age 65 equal to 90 percent of an employee's final average 
compensation, with the benefit reduced by \1/30\th for each year of the 
employee's service less than 30 and limited to the employee's final pay 
(as determined in accordance with paragraph (e)(2) of this section) less 
the employee's employer-provided primary insurance amount under social 
security attributable to the employee's service for X. The plan 
determines an employee's employer-provided projected primary insurance 
amount under social security attributable to the employee's service for 
X in accordance with paragraph (e)(3) of this section and applies the 
reductions applicable under paragraph (e)(6)(iii) of this section if 
benefits commence before social security retirement age. The plan 
determines an employee's accrued benefit under the fractional accrual 
method of section 411(b)(1)(C).
    (b) Employee A commences participation in the plan on January 1, 
1990, when A is 35 years of age. A's social security retirement age is 
67. As of the close of the 2014 plan year, A's final average 
compensation from X is $15,000; A's final pay from X is $15,400, and A's 
projected employer-provided annual primary insurance amount under social 
security attributable to A's service for X is $4,000 (after the 
reduction applicable under paragraph (e)(6)(iii) of this section). Under 
the plan formula, A's accrued benefit as of the close of the 2014 plan 
year is $11,250 (90 percentx$15,000x25/30). As of the close of the 2014 
plan year, the plan's final pay limitation does not affect A's benefit 
because A's benefit under the plan as of the close of the plan year and 
before application of the final pay limitation ($11,250) does not exceed 
A's final pay of $15,400 from X, determined as of the close of the plan 
year, less A's employer-provided projected primary insurance amount 
under social security attributable to A's service for X ($4,000).
    (c) Assume that, as of the close of the 2015 plan year, A's final 
average compensation from X is $14,500 and A's final pay from X is 
$15,400. Assume also that as of the close of the 2015 plan year, A's 
employer-provided primary insurance amount attributable to A's service 
for X is $4,200 (after the reduction applicable under paragraph 
(e)(6)(iii) of this section). Accordingly, A's benefit as of the close 
of the 2015 plan year and before application of the final pay limitation 
is $11,310 (90 percentx$14,500x26/30). Under the plan's final pay 
limitation, A's benefit of $11,310 would be limited to $11,200, the 
amount of A's final pay from X ($15,400), less A's employer-provided 
projected primary insurance amount under social security attributable to 
A's service for X ($4,200). However, the plan's final pay limitation may 
not be applied to limit A's accrued benefit for the 2015 plan year to an 
amount below $11,250, which was A's accrued benefit under the plan at 
the close of the prior plan year. The foregoing is further illustrated 
in the following table for the plan years presented above and for 
additional years of service performed by A for X.

[[Page 203]]



                                                      Table
                                               [In dollar amounts]
----------------------------------------------------------------------------------------------------------------
                1                       2            3            4             5            6            7
----------------------------------------------------------------------------------------------------------------
                                                                            Employer-                 Benefit to
                                                                            provided                  which A is
                                                  Benefit                   projected    Benefit if    entitled
                                                 under plan                  primary     final pay   (smaller of
                                      Final       formula                   insurance    reduction   Column 6 or
        Years of service             average    (Column 2 x   Final pay   amount under   is applied   Column 3,
                                  compensation  0.9 x years                  social       in full      but not
                                                of service/                 security    (Column 4 -   less than
                                                    30)                   attributable   Column 5)     Column 7
                                                                           to service                 for prior
                                                                          for employer                  year)
----------------------------------------------------------------------------------------------------------------
25..............................       $15,000      $11,250      $15,400        $4,000      $11,400      $11,250
26..............................        14,500       11,310       15,400         4,200       11,200       11,250
27..............................        15,500       12,555       15,800         4,400       11,400       11,400
28..............................        15,500       13,020       16,000         4,500       11,500       11,500
29..............................        15,000       13,050       16,000         4,800       11,200       11,500
30..............................        14,500       13,050       16,000         5,000       11,000       11,500
----------------------------------------------------------------------------------------------------------------

    (f) Certain benefits not taken into account. In determining whether 
a plan satisfies section 401(a)(4) and this section, other benefits 
created under state or federal law (e.g., worker's compensation benefits 
or black lung benefits) may not be taken into account.
    (g) More than one plan treated as single plan. [Reserved]
    (h) Effective date--(1) In general. Except as provided in paragraph 
(h)(2) of this section, this section is effective for plan years 
beginning on or after January 1, 1994.
    (2) Plans of tax-exempt organizations. In the case of plans 
maintained by organizations exempt from income taxation under section 
501(a), including plans subject to section 403(b)(12)(A)(i) (nonelective 
plans), this section is effective for plan years beginning on or after 
January 1, 1996.
    (3) Compliance during transition period. For plan years beginning 
before the effective date of these regulations, as set forth in 
paragraphs (h)(1) and (h)(2) of this section, and on or after the first 
day of the first plan year to which the amendments made to section 
401(a)(5) by section 1111(b) of the Tax Reform Act of 1986 (TRA '86) 
apply, a plan must be operated in accordance with a reasonable, good 
faith interpretation of section 401(a)(5), taking into account pre-
existing guidance and the amendments made by TRA '86 to related 
provisions of the Code. Whether a plan is operated in accordance with a 
reasonable, good faith interpretation of section 401(a)(5) will 
generally be determined based on all of the relevant facts and 
circumstances, including the extent to which an employer has resolved 
unclear issues in its favor. A plan will be deemed to be operated in 
accordance with a reasonable, good faith interpretation of section 
401(a)(5) if it is operated in accordance with the terms of this 
section.

[T.D. 8359, 56 FR 47614, Sept. 19, 1991; 57 FR 10817, 10818, 10951, Mar. 
31, 1992, as amended by T.D. 8486, 58 FR 46830, Sept. 3, 1993]



Sec. 1.401(a)(9)-0  Required minimum distributions; table of contents.

    This table of contents lists the regulations relating to required 
minimum distributions under section 401(a)(9) of the Internal Revenue 
Code as follows:

Sec. 1.401(a)(9)-0 Required minimum distributions; table of contents.
Sec. 1.401(a)(9)-1 Minimum distribution requirement in general.
Sec. 1.401(a)(9)-2 Distributions commencing during an employee's 
          lifetime.
Sec. 1.401(a)(9)-3 Death before required beginning date.
Sec. 1.401(a)(9)-4 Determination of the designated beneficiary.
Sec. 1.401(a)(9)-5 Required minimum distributions from defined 
          contribution plans.
Sec. 1.401(a)(9)-6 Required minimum distributions for defined benefit 
          plans and annuity contracts.
Sec. 1.401(a)(9)-7 Rollovers and transfers.
Sec. 1.401(a)(9)-8 Special rules.
Sec. 1.401(a)(9)-9 Life expectancy and distribution period tables.

[T.D. 8987, 67 FR 18994, Apr. 17, 2002, as amended by T.D. 9130, 69 FR 
33293, June 15, 2004]

[[Page 204]]



Sec. 1.401(a)(9)-1  Minimum distribution requirement in general.

    Q-1. What plans are subject to the minimum distribution requirement 
under section 401(a)(9), this section, and Sec. Sec. 1.401(a)(9)-2 
through 1.401(a)(9)-9?
    A-1. Under section 401(a)(9), all stock bonus, pension, and profit-
sharing plans qualified under section 401(a) and annuity contracts 
described in section 403(a) are subject to required minimum distribution 
rules. See this section and Sec. Sec. 1.401(a)(9)-2 through 
1.401(a)(9)-9 for the distribution rules applicable to these plans. 
Under section 403(b)(10), annuity contracts or custodial accounts 
described in section 403(b) are subject to required minimum distribution 
rules. See Sec. 1.403(b)-6e for the distribution rules applicable to 
these annuity contracts or custodial accounts. Under section 408(a)(6) 
and 408(b)(3), individual retirement plans (including, for some 
purposes, Roth IRAs under section 408A) are subject to required minimum 
distribution rules. See Sec. 1.408-8 for the distribution rules 
applicable to individual retirement plans and see Sec. 1.408A-6 for the 
distribution rules applicable to Roth IRAs under section 408A. Under 
section 457(d)(2), certain deferred compensation plans for employees of 
tax exempt organizations or state and local government employees are 
subject to required minimum distribution rules.
    Q-2. Which employee account balances and benefits held under 
qualified trusts and plans are subject to the distribution rules of 
section 401(a)(9), this section, and Sec. Sec. 1.401(a)(9)-2 through 
1.401(a)(9)-9?
    A-2. (a) In general. The distribution rules of section 401(a)(9) 
apply to all account balances and benefits in existence on or after 
January 1, 1985. This section and Sec. Sec. 1.401(a)(9)-2 through 
1.401(a)(9)-9 apply for purposes of determining required minimum 
distributions for calendar years beginning on or after January 1, 2003.
    (b) Beneficiaries. (1) The distribution rules of this section and 
Sec. Sec. 1.401(a)(9)-2 through 1.401(a)(9)-9 apply to account balances 
and benefits held for the benefit of a beneficiary for calendar years 
beginning on or after January 1, 2003, even if the employee died prior 
to January 1, 2003. Thus, in the case of an employee who died prior to 
January 1, 2003, the designated beneficiary must be redetermined in 
accordance with the provisions of Sec. 1.401(a)(9)-4 and the applicable 
distribution period (determined under Sec. 1.401(a)(9)-5 or 
1.401(a)(9)-6, whichever is applicable) must be reconstructed for 
purposes of determining the amount required to be distributed for 
calendar years beginning on or after January 1, 2003.
    (2) A designated beneficiary that is receiving payments under the 5-
year rule of section 401(a)(9)(B)(ii), either by affirmative election or 
default provisions, may, if the plan so provides, switch to using the 
life expectancy rule of section 401(a)(9)(B)(iii) provided any amounts 
that would have been required to be distributed under the life 
expectancy rule of section 401(a)(9)(B)(iii) for all distribution 
calendar years before 2004 are distributed by the earlier of December 
31, 2003 or the end of the 5-year period determined under A-2 of Sec. 
1.401(a)(9)-3.
    (c) Trust documentation. If a trust fails to meet the rule of A-5 of 
Sec. 1.401(a)(9)-4 (permitting the beneficiaries of the trust, and not 
the trust itself, to be treated as the employee's designated 
beneficiaries) solely because the trust documentation was not provided 
to the plan administrator by October 31 of the calendar year following 
the calendar year in which the employee died, and such documentation is 
provided to the plan administrator by October 31, 2003, the 
beneficiaries of the trust will be treated as designated beneficiaries 
of the employee under the plan for purposes of determining the 
distribution period under section 401(a)(9).
    (d) Special rule for governmental plans. Notwithstanding anything to 
the contrary in this A-2, a governmental plan (within the meaning of 
section 414(d)), or an eligible governmental plan described in Sec. 
1.457-2(f), is treated as having complied with section 401(a)(9) for all 
years to which section 401(a)(9) applies to the plan if the plan 
complies with a reasonable and good faith interpretation of section 
401(a)(9).
    Q-3. What specific provisions must a plan contain in order to 
satisfy section 401(a)(9)?

[[Page 205]]

    A-3. (a) Required provisions. In order to satisfy section 401(a)(9), 
the plan must include the provisions described in this paragraph 
reflecting section 401(a)(9). First, the plan must generally set forth 
the statutory rules of section 401(a)(9), including the incidental death 
benefit requirement in section 401(a)(9)(G). Second, the plan must 
provide that distributions will be made in accordance with this section 
and Sec. Sec. 1.401(a)(9)-2 through 1.401(a)(9)-9. The plan document 
must also provide that the provisions reflecting section 401(a)(9) 
override any distribution options in the plan inconsistent with section 
401(a)(9). The plan also must include any other provisions reflecting 
section 401(a)(9) that are prescribed by the Commissioner in revenue 
rulings, notices, and other guidance published in the Internal Revenue 
Bulletin. See Sec. 601.601(d)(2)(ii)(b) of this chapter.
    (b) Optional provisions. The plan may also include written 
provisions regarding any optional provisions governing plan 
distributions that do not conflict with section 401(a)(9) and the 
regulations thereunder.
    (c) Absence of optional provisions. Plan distributions commencing 
after an employee's death will be required to be made under the default 
provision set forth in Sec. 1.401(a)(9)-3 for distributions unless the 
plan document contains optional provisions that override such default 
provisions. Thus, if distributions have not commenced to the employee at 
the time of the employee's death, distributions after the death of an 
employee are to be made automatically in accordance with the default 
provisions in A-4(a) of Sec. 1.401(a)(9)-3 unless the plan either 
specifies in accordance with A-4(b) of Sec. 1.401(a)(9)-3 the method 
under which distributions will be made or provides for elections by the 
employee (or beneficiary) in accordance with A-4(c) of Sec. 
1.401(a)(9)-3 and such elections are made by the employee or 
beneficiary.

[T.D. 8987, 67 FR 18994, Apr. 17, 2002, as amended by T.D. 9130, 69 FR 
33293, June 15, 2004; T.D. 9340, 72 FR 41159, July 26, 2007; T.D. 9459, 
74 FR 45994, Sept. 8, 2009]



Sec. 1.401(a)(9)-2  Distributions commencing during an employee's 
lifetime.

    Q-1. In the case of distributions commencing during an employee's 
lifetime, how must the employee's entire interest be distributed in 
order to satisfy section 401(a)(9)(A)?
    A-1. (a) In order to satisfy section 401(a)(9)(A), the entire 
interest of each employee must be distributed to such employee not later 
than the required beginning date, or must be distributed, beginning not 
later than the required beginning date, over the life of the employee or 
joint lives of the employee and a designated beneficiary or over a 
period not extending beyond the life expectancy of the employee or the 
joint life and last survivor expectancy of the employee and the 
designated beneficiary.
    (b) Section 401(a)(9)(G) provides that lifetime distributions must 
satisfy the incidental death benefit requirements.
    (c) The amount required to be distributed for each calendar year in 
order to satisfy section 401(a)(9)(A) and (G) generally depends on 
whether a distribution is in the form of distributions under a defined 
contribution plan or annuity payments under a defined benefit plan or 
under an annuity contract. For the method of determining the required 
minimum distribution in accordance with section 401(a)(9)(A) and (G) 
from an individual account under a defined contribution plan, see Sec. 
1.401(a)(9)-5. For the method of determining the required minimum 
distribution in accordance with section 401(a)(9)(A) and (G) in the case 
of annuity payments from a defined benefit plan or an annuity contract, 
see Sec. 1.401(a)(9)-6.
    Q-2. For purposes of section 401(a)(9)(C), what does the term 
required beginning date mean?
    A-2. (a) Except as provided in paragraph (b) of this A-2 with 
respect to a 5-percent owner, as defined in paragraph (c) of this A-2, 
the term required beginning date means April 1 of the calendar year 
following the later of the calendar year in which the employee attains 
age 70\1/2\ or the calendar year in which the employee retires from 
employment with the employer maintaining the plan.

[[Page 206]]

    (b) In the case of an employee who is a 5-percent owner, the term 
required beginning date means April 1 of the calendar year following the 
calendar year in which the employee attains age 70\1/2\ .
    (c) For purposes of section 401(a)(9), a 5-percent owner is an 
employee who is a 5-percent owner (as defined in section 416) with 
respect to the plan year ending in the calendar year in which the 
employee attains age 70\1/2\.
    (d) Paragraph (b) of this A-2 does not apply in the case of a 
governmental plan (within the meaning of section 414(d)) or a church 
plan. For purposes of this paragraph, the term church plan means a plan 
maintained by a church for church employees, and the term church means 
any church (as defined in section 3121(w)(3)(A)) or qualified church-
controlled organization (as defined in section 3121(w)(3)(B)).
    (e) A plan is permitted to provide that the required beginning date 
for purposes of section 401(a)(9) for all employees is April 1 of the 
calendar year following the calendar year in which an employee attains 
age 70\1/2\ regardless of whether the employee is a 5-percent owner.
    Q-3. When does an employee attain age 70\1/2\?
    A-3. An employee attains age 70\1/2\ as of the date six calendar 
months after the 70th anniversary of the employee's birth. For example, 
if an employee's date of birth was June 30, 1933, the 70th anniversary 
of such employee's birth is June 30, 2003. Such employee attains age 
70\1/2\ on December 30, 2003. Consequently, if the employee is a 5-
percent owner or retired, such employee's required beginning date is 
April 1, 2004. However, if the employee's date of birth was July 1, 
1933, the 70th anniversary of such employee's birth would be July 1, 
2003. Such employee would then attain age 70\1/2\ on January 1, 2004 and 
such employee's required beginning date would be April 1, 2005.
    Q-4. Must distributions made before the employee's required 
beginning date satisfy section 401(a)(9)?
    A-4. Lifetime distributions made before the employee's required 
beginning date for calendar years before the employee's first 
distribution calendar year, as defined in A-1(b) of Sec. 1.401(a)(9)-5, 
need not be made in accordance with section 401(a)(9). However, if 
distributions commence before the employee's required beginning date 
under a particular distribution option, such as in the form of an 
annuity, the distribution option fails to satisfy section 401(a)(9) at 
the time distributions commence if, under terms of the particular 
distribution option, distributions to be made for the employee's first 
distribution calendar year or any subsequent distribution calendar year 
will fail to satisfy section 401(a)(9).
    Q-5. If distributions have begun to an employee during the 
employee's lifetime (in accordance with section 401(a)(9)(A)(ii)), how 
must distributions be made after an employee's death?
    A-5. Section 401(a)(9)(B)(i) provides that if the distribution of 
the employee's interest has begun in accordance with section 
401(a)(9)(A)(ii) and the employee dies before his entire interest has 
been distributed to him, the remaining portion of such interest must be 
distributed at least as rapidly as under the distribution method being 
used under section 401(a)(9)(A)(ii) as of the date of his death. The 
amount required to be distributed for each distribution calendar year 
following the calendar year of death generally depends on whether a 
distribution is in the form of distributions from an individual account 
under a defined contribution plan or annuity payments under a defined 
benefit plan. For the method of determining the required minimum 
distribution in accordance with section 401(a)(9)(B)(i) from an 
individual account, see Sec. 1.401(a)(9)-5. In the case of annuity 
payments from a defined benefit plan or an annuity contract, see Sec. 
1.401(a)(9)-6.
    Q-6. For purposes of section 401(a)(9)(B), when are distributions 
considered to have begun to the employee in accordance with section 
401(a)(9)(A)(ii)?
    A-6. (a) General rule. Except as otherwise provided in A-10 of Sec. 
1.401(a)(9)-6, distributions are not treated as having begun to the 
employee in accordance with section 401(a)(9)(A)(ii) until the 
employee's required beginning date, without regard to whether payments 
have been made before that date. Thus, section 401(a)(9)(B)(i) only 
applies if an

[[Page 207]]

employee dies on or after the employee's required beginning date. For 
example, if employee A retires in 2003, the calendar year A attains age 
65\1/2\, and begins receiving installment distributions from a profit-
sharing plan over a period not exceeding the joint life and last 
survivor expectancy of A and A's spouse, benefits are not treated as 
having begun in accordance with section 401(a)(9)(A)(ii) until April 1, 
2009 (the April 1 following the calendar year in which A attains age 
70\1/2\). Consequently, if A dies before April 1, 2009 (A's required 
beginning date), distributions after A's death must be made in 
accordance with section 401(a)(9)(B)(ii) or (iii) and (iv) and Sec. 
1.401(a)(9)-3, and not section 401(a)(9)(B)(i). This is the case without 
regard to whether the plan has distributed the minimum distribution for 
the first distribution calendar year (as defined in A-1(b) of Sec. 
1.401(a)(9)-5) before A's death.
    (b) If a plan provides, in accordance with A-2(e) of this section, 
that the required beginning date for purposes of section 401(a)(9) for 
all employees is April 1 of the calendar year following the calendar 
year in which an employee attains age 70\1/2\, an employee who dies on 
or after the required beginning date determined under the plan terms is 
treated as dying after the employee's distributions have begun for 
purposes of this A-6 even though the employee dies before the April 1 
following the calendar year in which the employee retires.

[T.D. 8987, 67 FR 18994, Apr. 17, 2002, as amended by T.D. 9130, 69 FR 
33293, June 15, 2004]



Sec. 1.401(a)(9)-3  Death before required beginning date.

    Q-1. If an employee dies before the employee's required beginning 
date, how must the employee's entire interest be distributed in order to 
satisfy section 401(a)(9)?
    A-1. (a) Except as otherwise provided in A-10 of Sec. 1.401(a)(9)-
6, if an employee dies before the employee's required beginning date 
(and, thus, before distributions are treated as having begun in 
accordance with section 401(a)(9)(A)(ii)), distribution of the 
employee's entire interest must be made in accordance with one of the 
methods described in section 401(a)(9)(B)(ii) or (iii) and (iv). One 
method (the 5-year rule in section 401(a)(9)(B)(ii)) requires that the 
entire interest of the employee be distributed within 5 years of the 
employee's death regardless of who or what entity receives the 
distribution. Another method (the life expectancy rule in section 
401(a)(9)(B)(iii) and (iv)) requires that any portion of an employee's 
interest payable to (or for the benefit of) a designated beneficiary be 
distributed, commencing within one year of the employee's death, over 
the life of such beneficiary (or over a period not extending beyond the 
life expectancy of such beneficiary). Section 401(a)(9)(B)(iv) provides 
special rules where the designated beneficiary is the surviving spouse 
of the employee, including a special commencement date for distributions 
under section 401(a)(9)(B)(iii) to the surviving spouse.
    (b) See A-4 of this section for the rules for determining which of 
the methods described in paragraph (a) of this A-1 applies. See A-3 of 
this section to determine when distributions under the exception to the 
5-year rule in section 401(a)(9)(B)(iii) and (iv) must commence. See A-2 
of this section to determine when the 5-year period in section 
401(a)(9)(B)(ii) ends. For distributions using the life expectancy rule 
in section 401(a)(9)(B)(iii) and (iv), see Sec. 1.401(a)(9)-4 in order 
to determine the designated beneficiary under section 401(a)(9)(B)(iii) 
and (iv), see Sec. 1.401(a)(9)-5 for the rules for determining the 
required minimum distribution under a defined contribution plan, and see 
Sec. 1.401(a)(9)-6 for required minimum distributions under defined 
benefit plans.
    Q-2. By when must the employee's entire interest be distributed in 
order to satisfy the 5-year rule in section 401(a)(9)(B)(ii)?
    A-2. In order to satisfy the 5-year rule in section 
401(a)(9)(B)(ii), the employee's entire interest must be distributed by 
the end of the calendar year which contains the fifth anniversary of the 
date of the employee's death. For example, if an employee dies on 
January 1, 2003, the entire interest must be distributed by the end of 
2008, in order to satisfy the 5-year rule in section 401(a)(9)(B)(ii).

[[Page 208]]

    Q-3. When are distributions required to commence in order to satisfy 
the life expectancy rule in section 401(a)(9)(B)(iii) and (iv)?
    A-3. (a) Nonspouse beneficiary. In order to satisfy the life 
expectancy rule in section 401(a)(9)(B)(iii), if the designated 
beneficiary is not the employee's surviving spouse, distributions must 
commence on or before the end of the calendar year immediately following 
the calendar year in which the employee died. This rule also applies to 
the distribution of the entire remaining benefit if another individual 
is a designated beneficiary in addition to the employee's surviving 
spouse. See A-2 and A-3 of Sec. 1.401(a)(9)-8, however, if the 
employee's benefit is divided into separate accounts.
    (b) Spousal beneficiary. In order to satisfy the rule in section 
401(a)(9)(B)(iii) and (iv), if the sole designated beneficiary is the 
employee's surviving spouse, distributions must commence on or before 
the later of--
    (1) The end of the calendar year immediately following the calendar 
year in which the employee died; and
    (2) The end of the calendar year in which the employee would have 
attained age 70\1/2\.
    Q-4. How is it determined whether the 5-year rule in section 
401(a)(9)(B)(ii) or the life expectancy rule in section 
401(a)(9)(B)(iii) and (iv) applies to a distribution?
    A-4. (a) No plan provision. If a plan does not adopt an optional 
provision described in paragraph (b) or (c) of this A-4 specifying the 
method of distribution after the death of an employee, distribution must 
be made as follows:
    (1) If the employee has a designated beneficiary, as determined 
under Sec. 1.401(a)(9)-4, distributions are to be made in accordance 
with the life expectancy rule in section 401(a)(9)(B)(iii) and (iv).
    (2) If the employee has no designated beneficiary, distributions are 
to be made in accordance with the 5-year rule in section 
401(a)(9)(B)(ii).
    (b) Optional plan provisions. A plan may adopt a provision 
specifying either that the 5-year rule in section 401(a)(9)(B)(ii) will 
apply to certain distributions after the death of an employee even if 
the employee has a designated beneficiary or that distribution in every 
case will be made in accordance with the 5-year rule in section 
401(a)(9)(B)(ii). Further, a plan need not have the same method of 
distribution for the benefits of all employees in order to satisfy 
section 401(a)(9).
    (c) Elections. A plan may adopt a provision that permits employees 
(or beneficiaries) to elect on an individual basis whether the 5-year 
rule in section 401(a)(9)(B)(ii) or the life expectancy rule in section 
401(a)(9)(B)(iii) and (iv) applies to distributions after the death of 
an employee who has a designated beneficiary. Such an election must be 
made no later than the earlier of the end of the calendar year in which 
distribution would be required to commence in order to satisfy the 
requirements for the life expectancy rule in section 401(a)(9)(B)(iii) 
and (iv) (see A-3 of this section for the determination of such calendar 
year) or the end of the calendar year which contains the fifth 
anniversary of the date of death of the employee. As of the last date 
the election may be made, the election must be irrevocable with respect 
to the beneficiary (and all subsequent beneficiaries) and must apply to 
all subsequent calendar years. If a plan provides for the election, the 
plan may also specify the method of distribution that applies if neither 
the employee nor the beneficiary makes the election. If neither the 
employee nor the beneficiary elects a method and the plan does not 
specify which method applies, distribution must be made in accordance 
with paragraph (a) of this A-4.
    Q-5. If the employee's surviving spouse is the employee's sole 
designated beneficiary and such spouse dies after the employee, but 
before distributions have begun to the surviving spouse under section 
401(a)(9)(B)(iii) and (iv), how is the employee's interest to be 
distributed?
    A-5. Pursuant to section 401(a)(9)(B)(iv)(II), if the surviving 
spouse is the employee's sole designated beneficiary and dies after the 
employee, but before distributions to such spouse have begun under 
section 401(a)(9)(B)(iii) and (iv), the 5-year rule in section 
401(a)(9)(B)(ii) and the life expectancy rule in section 
401(a)(9)(B)(iii) are to be applied as if

[[Page 209]]

the surviving spouse were the employee. In applying this rule, the date 
of death of the surviving spouse shall be substituted for the date of 
death of the employee. However, in such case, the rules in section 
401(a)(9)(B)(iv) are not available to the surviving spouse of the 
deceased employee's surviving spouse.
    Q-6. For purposes of section 401(a)(9)(B)(iv)(II), when are 
distributions considered to have begun to the surviving spouse?
    A-6. Distributions are considered to have begun to the surviving 
spouse of an employee, for purposes of section 401(a)(9)(B)(iv)(II), on 
the date, determined in accordance with A-3 of this section, on which 
distributions are required to commence to the surviving spouse, even 
though payments have actually been made before that date. See A-11 of 
Sec. 1.401(a)(9)-6 for a special rule for annuities.

[T.D. 8987, 67 FR 18994, Apr. 17, 2002, as amended by T.D. 9130, 69 FR 
33293, June 15, 2004]



Sec. 1.401(a)(9)-4  Determination of the designated beneficiary.

    Q-1. Who is a designated beneficiary under section 401(a)(9)(E)?
    A-1. A designated beneficiary is an individual who is designated as 
a beneficiary under the plan. An individual may be designated as a 
beneficiary under the plan either by the terms of the plan or, if the 
plan so provides, by an affirmative election by the employee (or the 
employee's surviving spouse) specifying the beneficiary. A beneficiary 
designated as such under the plan is an individual who is entitled to a 
portion of an employee's benefit, contingent on the employee's death or 
another specified event. For example, if a distribution is in the form 
of a joint and survivor annuity over the life of the employee and 
another individual, the plan does not satisfy section 401(a)(9) unless 
such other individual is a designated beneficiary under the plan. A 
designated beneficiary need not be specified by name in the plan or by 
the employee to the plan in order to be a designated beneficiary so long 
as the individual who is to be the beneficiary is identifiable under the 
plan. The members of a class of beneficiaries capable of expansion or 
contraction will be treated as being identifiable if it is possible, to 
identify the class member with the shortest life expectancy. The fact 
that an employee's interest under the plan passes to a certain 
individual under a will or otherwise under applicable state law does not 
make that individual a designated beneficiary unless the individual is 
designated as a beneficiary under the plan. See A-6 of Sec. 
1.401(a)(9)-8 for rules which apply to qualified domestic relation 
orders.
    Q-2. Must an employee (or the employee's spouse) make an affirmative 
election specifying a beneficiary for a person to be a designated 
beneficiary under section 40l(a)(9)(E)?
    A-2. No, a designated beneficiary is an individual who is designated 
as a beneficiary under the plan whether or not the designation under the 
plan was made by the employee. The choice of beneficiary is subject to 
the requirements of sections 401(a)(11), 414(p), and 417.
    Q-3. May a person other than an individual be considered to be a 
designated beneficiary for purposes of section 401(a)(9)?
    A-3. No, only individuals may be designated beneficiaries for 
purposes of section 401(a)(9). A person that is not an individual, such 
as the employee's estate, may not be a designated beneficiary. If a 
person other than an individual is designated as a beneficiary of an 
employee's benefit, the employee will be treated as having no designated 
beneficiary for purposes of section 401(a)(9), even if there are also 
individuals designated as beneficiaries. However, see A-5 of this 
section for special rules that apply to trusts and A-2 and A-3 of Sec. 
1.401(a)(9)-8 for rules that apply to separate accounts.
    Q-4. When is the designated beneficiary determined?
    A-4. (a) General rule. In order to be a designated beneficiary, an 
individual must be a beneficiary as of the date of death. Except as 
provided in paragraph (b) and Sec. 1.401(a)(9)-6, the employee's 
designated beneficiary will be determined based on the beneficiaries 
designated as of the date of death who remain beneficiaries as of 
September 30

[[Page 210]]

of the calendar year following the calendar year of the employee's 
death. Consequently, except as provided in Sec. 1.401(a)(9)-6, any 
person who was a beneficiary as of the date of the employee's death, but 
is not a beneficiary as of that September 30 (e.g., because the person 
receives the entire benefit to which the person is entitled before that 
September 30), is not taken into account in determining the employee's 
designated beneficiary for purposes of determining the distribution 
period for required minimum distributions after the employee's death. 
Accordingly, if a person disclaims entitlement to the employee's 
benefit, pursuant to a disclaimer that satisfies section 2518 by that 
September 30 thereby allowing other beneficiaries to receive the benefit 
in lieu of that person, the disclaiming person is not taken into account 
in determining the employee's designated beneficiary.
    (b) Surviving spouse. As provided in A-5 of Sec. 1.401(a)(9)-3, if 
the employee's spouse is the sole designated beneficiary as of September 
30 of the calendar year following the calendar year of the employee's 
death, and the surviving spouse dies after the employee and before the 
date on which distributions have begun to the surviving spouse under 
section 401(a)(9)(B)(iii) and (iv), the rule in section 
40l(a)(9)(B)(iv)(II) will apply. Thus, for example, the relevant 
designated beneficiary for determining the distribution period after the 
death of the surviving spouse is the designated beneficiary of the 
surviving spouse. Similarly, such designated beneficiary will be 
determined based on the beneficiaries designated as of the date of the 
surviving spouse's death and who remain beneficiaries as of September 30 
of the calendar year following the calendar year of the surviving 
spouse's death. Further, if, as of that September 30, there is no 
designated beneficiary under the plan with respect to that surviving 
spouse, distribution must be made in accordance with the 5-year rule in 
section 401(a)(9)(B)(ii) and A-2 of Sec. 1.401(a)(9)-3.
    (c) Deceased beneficiary. For purposes of this A-4, an individual 
who is a beneficiary as of the date of the employee's death and dies 
prior to September 30 of the calendar year following the calendar year 
of the employee's death without disclaiming continues to be treated as a 
beneficiary as of the September 30 of the calendar year following the 
calendar year of the employee's death in determining the employee's 
designated beneficiary for purposes of determining the distribution 
period for required minimum distributions after the employee's death, 
without regard to the identity of the successor beneficiary who is 
entitled to distributions as the beneficiary of the deceased 
beneficiary. The same rule applies in the case of distributions to which 
A-5 of Sec. 1.401(a)(9)-3 applies so that, if an individual is 
designated as a beneficiary of an employee's surviving spouse as of the 
spouse's date of death and dies prior to September 30 of the year 
following the year of the surviving spouse's death, that individual will 
continue to be treated as a designated beneficiary.
    Q-5. If a trust is named as a beneficiary of an employee, will the 
beneficiaries of the trust with respect to the trust's interest in the 
employee's benefit be treated as having been designated as beneficiaries 
of the employee under the plan for purposes of determining the 
distribution period under section 401(a)(9)?
    A-5. (a) If the requirements of paragraph (b) of this A-5 are met 
with respect to a trust that is named as the beneficiary of an employee 
under the plan, the beneficiaries of the trust (and not the trust 
itself) will be treated as having been designated as beneficiaries of 
the employee under the plan for purposes of determining the distribution 
period under section 401(a)(9).
    (b) The requirements of this paragraph (b) are met if, during any 
period during which required minimum distributions are being determined 
by treating the beneficiaries of the trust as designated beneficiaries 
of the employee, the following requirements are met--
    (1) The trust is a valid trust under state law, or would be but for 
the fact that there is no corpus.
    (2) The trust is irrevocable or will, by its terms, become 
irrevocable upon the death of the employee.

[[Page 211]]

    (3) The beneficiaries of the trust who are beneficiaries with 
respect to the trust's interest in the employee's benefit are 
identifiable within the meaning of A-1 of this section from the trust 
instrument.
    (4) The documentation described in A-6 of this section has been 
provided to the plan administrator.
    (c) In the case of payments to a trust having more than one 
beneficiary, see A-7 of Sec. 1.401(a)(9)-5 for the rules for 
determining the designated beneficiary whose life expectancy will be 
used to determine the distribution period and A-3 of this section for 
the rules that apply if a person other than an individual is designated 
as a beneficiary of an employee's benefit. However, the separate account 
rules under A-2 of Sec. 1.401(a)(9)-8 are not available to 
beneficiaries of a trust with respect to the trust's interest in the 
employee's benefit.
    (d) If the beneficiary of the trust named as beneficiary of the 
employee's interest is another trust, the beneficiaries of the other 
trust will be treated as being designated as beneficiaries of the first 
trust, and thus, having been designated by the employee under the plan 
for purposes of determining the distribution period under section 
401(a)(9)(A)(ii), provided that the requirements of paragraph (b) of 
this A-5 are satisfied with respect to such other trust in addition to 
the trust named as beneficiary.
    Q-6. If a trust is named as a beneficiary of an employee, what 
documentation must be provided to the plan administrator?
    A-6. (a) Required minimum distributions before death. If an employee 
designates a trust as the beneficiary of his or her entire benefit and 
the employee's spouse is the sole beneficiary of the trust, in order to 
satisfy the documentation requirements of this A-6 so that the spouse 
can be treated as the sole designated beneficiary of the employee's 
benefits (if the other requirements of paragraph (b) of A-5 of this 
section are satisfied), the employee must either--
    (1) Provide to the plan administrator a copy of the trust instrument 
and agree that if the trust instrument is amended at any time in the 
future, the employee will, within a reasonable time, provide to the plan 
administrator a copy of each such amendment; or
    (2) Provide to the plan administrator a list of all of the 
beneficiaries of the trust (including contingent and remaindermen 
beneficiaries with a description of the conditions on their entitlement 
sufficient to establish that the spouse is the sole beneficiary) for 
purposes of section 401(a)(9); certify that, to the best of the 
employee's knowledge, this list is correct and complete and that the 
requirements of paragraph (b)(1), (2), and (3) of A-5 of this section 
are satisfied; agree that, if the trust instrument is amended at any 
time in the future, the employee will, within a reasonable time, provide 
to the plan administrator corrected certifications to the extent that 
the amendment changes any information previously certified; and agree to 
provide a copy of the trust instrument to the plan administrator upon 
demand.
    (b) Required minimum distributions after death. In order to satisfy 
the documentation requirement of this A-6 for required minimum 
distributions after the death of the employee (or spouse in a case to 
which A-5 of Sec. 1.401(a)(9)-3 applies), by October 31 of the calendar 
year immediately following the calendar year in which the employee died, 
the trustee of the trust must either--
    (1) Provide the plan administrator with a final list of all 
beneficiaries of the trust (including contingent and remaindermen 
beneficiaries with a description of the conditions on their entitlement) 
as of September 30 of the calendar year following the calendar year of 
the employee's death; certify that, to the best of the trustee's 
knowledge, this list is correct and complete and that the requirements 
of paragraph (b)(1), (2), and (3) of A-5 of this section are satisfied; 
and agree to provide a copy of the trust instrument to the plan 
administrator upon demand; or
    (2) Provide the plan administrator with a copy of the actual trust 
document for the trust that is named as a beneficiary of the employee 
under the plan as of the employee's date of death.
    (c) Relief for discrepancy between trust instrument and employee 
certifications or earlier trust instruments. (1) If required minimum 
distributions are determined

[[Page 212]]

based on the information provided to the plan administrator in 
certifications or trust instruments described in paragraph (a) or (b) of 
this A-6, a plan will not fail to satisfy section 401(a)(9) merely 
because the actual terms of the trust instrument are inconsistent with 
the information in those certifications or trust instruments previously 
provided to the plan administrator, but only if the plan administrator 
reasonably relied on the information provided and the required minimum 
distributions for calendar years after the calendar year in which the 
discrepancy is discovered are determined based on the actual terms of 
the trust instrument.
    (2) For purposes of determining the amount of the excise tax under 
section 4974, the required minimum distribution is determined for any 
year based on the actual terms of the trust in effect during the year.

[T.D. 8987, 67 FR 18994, Apr. 17, 2002, as amended by T.D. 9130, 69 FR 
33293, June 15, 2004]



Sec. 1.401(a)(9)-5  Required minimum distributions from defined 
contribution plans.

    Q-1. If an employee's benefit is in the form of an individual 
account under a defined contribution plan, what is the amount required 
to be distributed for each calendar year?
    A-1. (a) General rule. If an employee's accrued benefit is in the 
form of an individual account under a defined contribution plan, the 
minimum amount required to be distributed for each distribution calendar 
year, as defined in paragraph (b) of this A-1, is equal to the quotient 
obtained by dividing the account (determined under A-3 of this section) 
by the applicable distribution period (determined under A-4 or A-5 of 
this section, whichever is applicable). However, the required minimum 
distribution amount will never exceed the entire account balance on the 
date of the distribution. See A-8 of this section for rules that apply 
if a portion of the employee's account is not vested. Further, the 
minimum distribution required to be distributed on or before an 
employee's required beginning date is always determined under section 
401(a)(9)(A)(ii) and this A-1 and not section 401(a)(9)(A)(i).
    (b) Distribution calendar year. A calendar year for which a minimum 
distribution is required is a distribution calendar year. If an 
employee's required beginning date is April 1 of the calendar year 
following the calendar year in which the employee attains age 70\1/2\, 
the employee's first distribution calendar year is the year the employee 
attains age 70\1/2\. If an employee's required beginning date is April 1 
of the calendar year following the calendar year in which the employee 
retires, the employee's first distribution calendar year is the calendar 
year in which the employee retires. In the case of distributions to be 
made in accordance with the life expectancy rule in Sec. 1.401(a)(9)-3 
and in section 401(a)(9)(B)(iii) and (iv), the first distribution 
calendar year is the calendar year containing the date described in A-
3(a) or A-3(b) of Sec. 1.401(a)(9)-3, whichever is applicable.
    (c) Time for distributions. The distribution required to be made on 
or before the employee's required beginning date shall be treated as the 
distribution required for the employee's first distribution calendar 
year (as defined in paragraph (b) of this A-1). The required minimum 
distribution for other distribution calendar years, including the 
required minimum distribution for the distribution calendar year in 
which the employee's required beginning date occurs, must be made on or 
before the end of that distribution calendar year.
    (d) Minimum distribution incidental benefit requirement. If 
distributions of an employee's account balance under a defined 
contribution plan are made in accordance with this section, the minimum 
distribution incidental benefit requirement of section 401(a)(9)(G) is 
satisfied. Further, with respect to the retirement benefits provided by 
that account balance, to the extent the incidental benefit requirement 
of Sec. 1.401-1(b)(1)(i) requires a distribution, that requirement is 
deemed to be satisfied if distributions satisfy the minimum distribution 
incidental benefit requirement of section 401(a)(9)(G) and this section.

[[Page 213]]

    (e) Annuity contracts. Instead of satisfying this A-1, the minimum 
distribution requirement may be satisfied by the purchase of an annuity 
contract from an insurance company in accordance with A-4 of Sec. 
1.401(a)(9)-6 with the employee's entire individual account. If such an 
annuity is purchased after distributions are required to commence (the 
required beginning date, in the case of distributions commencing before 
death, or the date determined under A-3 of Sec. 1.401(a)(9)-3, in the 
case of distributions commencing after death), payments under the 
annuity contract purchased will satisfy section 401(a)(9) for 
distribution calendar years after the calendar year of the purchase if 
payments under the annuity contract are made in accordance with Sec. 
1.401(a)(9)-6T. In such a case, payments under the annuity contract will 
be treated as distributions from the individual account for purposes of 
determining if the individual account satisfies section 401(a)(9) for 
the calendar year of the purchase. An employee may also purchase an 
annuity contract with a portion of the employee's account under the 
rules of A-2(a)(3) of Sec. 1.401(a)(9)-8.
    Q-2. If an employee's benefit is in the form of an individual 
account and, in any calendar year, the amount distributed exceeds the 
minimum required, will credit be given in subsequent calendar years for 
such excess distribution?
    A-2. If, for any distribution calendar year, the amount distributed 
exceeds the minimum required, no credit will be given in subsequent 
calendar years for such excess distribution.
    Q-3. What is the amount of the account of an employee used for 
determining the employee's required minimum distribution in the case of 
an individual account?
    A-3. (a) In the case of an individual account, the benefit used in 
determining the required minimum distribution for a distribution 
calendar year is the account balance as of the last valuation date in 
the calendar year immediately preceding that distribution calendar year 
(valuation calendar year) adjusted in accordance with paragraphs (b) and 
(c) of this A-3.
    (b) The account balance is increased by the amount of any 
contributions or forfeitures allocated to the account balance as of 
dates in the valuation calendar year after the valuation date. For this 
purpose, contributions that are allocated to the account balance as of 
dates in the valuation calendar year after the valuation date, but that 
are not actually made during the valuation calendar year, are permitted 
to be excluded.
    (c) The account balance is decreased by distributions made in the 
valuation calendar year after the valuation date.
    (d) If an amount is distributed by one plan and rolled over to 
another plan (receiving plan), A-2 of Sec. 1.401(a)(9)-7 provides 
additional rules for determining the benefit and required minimum 
distribution under the receiving plan. If an amount is transferred from 
one plan (transferor plan) to another plan (transferee plan), A-3 and A-
4 of Sec. 1.401(a)(9)-7 provide additional rules for determining the 
amount of the required minimum distribution and the benefit under both 
the transferor and transferee plans.
    Q-4. For required minimum distributions during an employee's 
lifetime, what is the applicable distribution period?
    A-4. (a) General rule. Except as provided in paragraph (b) of this 
A-4, the applicable distribution period for required minimum 
distributions for distribution calendar years up to and including the 
distribution calendar year that includes the employee's date of death is 
determined using the Uniform Lifetime Table in A-2 of Sec. 1.401(a)(9)-
9 for the employee's age as of the employee's birthday in the relevant 
distribution calendar year. If an employee dies on or after the required 
beginning date, the distribution period applicable for calculating the 
amount that must be distributed during the distribution calendar year 
that includes the employee's death is determined as if the employee had 
lived throughout that year. Thus, a minimum required distribution, 
determined as if the employee had lived throughout that year, is 
required for the year of the employee's death and that amount must be

[[Page 214]]

distributed to a beneficiary to the extent it has not already been 
distributed to the employee.
    (b) Spouse is sole beneficiary--(1) General rule. Except as 
otherwise provided in paragraph (b)(2) of this A-4, if the sole 
designated beneficiary of an employee is the employee's surviving 
spouse, for required minimum distributions during the employee's 
lifetime, the applicable distribution period is the longer of the 
distribution period determined in accordance with paragraph (a) of this 
A-4 or the joint life expectancy of the employee and spouse using the 
employee's and spouse's attained ages as of the employee's and the 
spouse's birthdays in the distribution calendar year. The spouse is sole 
designated beneficiary for purposes of determining the applicable 
distribution period for a distribution calendar year during the 
employee's lifetime only if the spouse is the sole beneficiary of the 
employee's entire interest at all times during the distribution calendar 
year.
    (2) Change in marital status. If the employee and the employee's 
spouse are married on January 1 of a distribution calendar year, but do 
not remain married throughout that year (i.e., the employee or the 
employee's spouse die or they become divorced during that year), the 
employee will not fail to have a spouse as the employee's sole 
beneficiary for that year merely because they are not married throughout 
that year. If an employee's spouse predeceases the employee, the spouse 
will not fail to be the employee's sole beneficiary for the distribution 
calendar year that includes the date of the spouse's death solely 
because, for the period remaining in that year after the spouse's death, 
someone other than the spouse is named as beneficiary. However, the 
change in beneficiary due to the death or divorce of the spouse will be 
effective for purposes of determining the applicable distribution period 
under section 401(a)(9) in the distribution calendar year following the 
distribution calendar year that includes the date of the spouse's death 
or divorce.
    Q-5. For required minimum distributions after an employee's death, 
what is the applicable distribution period?
    A-5. (a) Death on or after the employee's required beginning date. 
If an employee dies after distribution has begun as determined under A-6 
of Sec. 1.401(a)(9)-2 (generally on or after the employee's required 
beginning date), in order to satisfy section 401(a)(9)(B)(i), the 
applicable distribution period for distribution calendar years after the 
distribution calendar year containing the employee's date of death is 
either--
    (1) If the employee has a designated beneficiary as of the date 
determined under A-4 of Sec. 1.401(a)(9)-4, the longer of--
    (i) The remaining life expectancy of the employee's designated 
beneficiary determined in accordance with paragraph (c)(1) or (2) of 
this A-5; and
    (ii) The remaining life expectancy of the employee determined in 
accordance with paragraph (c)(3) of this A-5; or
    (2) If the employee does not have a designated beneficiary as of the 
date determined under A-4 of Sec. 1.401(a)(9)-4, the remaining life 
expectancy of the employee determined in accordance with paragraph 
(c)(3) of this A-5.
    (b) Death before an employee's required beginning date. If an 
employee dies before distribution has begun, as determined under A-5 of 
Sec. 1.401(a)(9)-2 (generally before the employee's required beginning 
date), in order to satisfy section 401(a)(9)(B)(iii) or (iv) and the 
life expectancy rule described in A-1 of Sec. 1.401(a)(9)-3, the 
applicable distribution period for distribution calendar years after the 
distribution calendar year containing the employee's date of death is 
determined in accordance with paragraph (c) of this A-5. See A-4 of 
Sec. 1.401(a)(9)-3 to determine when the 5-year rule in section 
401(a)(9)(B)(ii) applies (e.g., there is no designated beneficiary or 
the 5-year rule is elected or specified by plan provision).
    (c) Life expectancy--(1) Nonspouse designated beneficiary. Except as 
otherwise provided in paragraph (c)(2), the applicable distribution 
period measured by the beneficiary's remaining life expectancy is 
determined using the beneficiary's age as of the beneficiary's birthday 
in the calendar year immediately following the calendar year of the 
employee's death. In subsequent calendar years, the applicable 
distribution period is reduced by one for each

[[Page 215]]

calendar year that has elapsed after the calendar year immediately 
following the calendar year of the employee's death.
    (2) Spouse designated beneficiary. If the surviving spouse of the 
employee is the employee's sole beneficiary, the applicable distribution 
period is measured by the surviving spouse's life expectancy using the 
surviving spouse's birthday for each distribution calendar year after 
the calendar year of the employee's death up through the calendar year 
of the spouse's death. For calendar years after the calendar year of the 
spouse's death, the applicable distribution period is the life 
expectancy of the spouse using the age of the spouse as of the spouse's 
birthday in the calendar year of the spouse's death, reduced by one for 
each calendar year that has elapsed after the calendar year of the 
spouse's death.
    (3) No designated beneficiary. If the employee does not have a 
designated beneficiary, the applicable distribution period measured by 
the employee's remaining life expectancy is the life expectancy of the 
employee using the age of the employee as of the employee's birthday in 
the calendar year of the employee's death. In subsequent calendar years 
the applicable distribution period is reduced by one for each calendar 
year that has elapsed after the calendar year of the employee's death.
    Q-6. What life expectancies must be used for purposes of determining 
required minimum distributions under section 401(a)(9)?
    A-6. Life expectancies for purposes of determining required minimum 
distributions under section 401(a)(9) must be computed using the Single 
Life Table in A-1 of Sec. 1.401(a)(9)-9 and the Joint and Last Survivor 
Table in A-3 of Sec. 1.401(a)(9)-9.
    Q-7. If an employee has more than one designated beneficiary, which 
designated beneficiary's life expectancy will be used to determine the 
applicable distribution period?
    A-7. (a) General rule--(1) Except as otherwise provided in paragraph 
(c) of this A-7, if more than one individual is designated as a 
beneficiary with respect to an employee as of the applicable date for 
determining the designated beneficiary under A-4 of Sec. 1.401(a)(9)-4, 
the designated beneficiary with the shortest life expectancy will be the 
designated beneficiary for purposes of determining the applicable 
distribution period.
    (2) See A-3 of Sec. 1.401(a)(9)-4 for rules that apply if a person 
other than an individual is designated as a beneficiary and see A-2 and 
A-3 of Sec. 1.401(a)(9)-8 for special rules that apply if an employee's 
benefit under a plan is divided into separate accounts and the 
beneficiaries with respect to a separate account differ from the 
beneficiaries of another separate account.
    (b) Contingent beneficiary. Except as provided in paragraph (c)(1) 
of this A-7, if a beneficiary's entitlement to an employee's benefit 
after the employee's death is a contingent right, such contingent 
beneficiary is nevertheless considered to be a beneficiary for purposes 
of determining whether a person other than an individual is designated 
as a beneficiary (resulting in the employee being treated as having no 
designated beneficiary under the rules of A-3 of Sec. 1.401(a)(9)-4) 
and which designated beneficiary has the shortest life expectancy under 
paragraph (a) of this A-7.
    (c) Successor beneficiary--(1) A person will not be considered a 
beneficiary for purposes of determining who is the beneficiary with the 
shortest life expectancy under paragraph (a) of this A-7, or whether a 
person who is not an individual is a beneficiary, merely because the 
person could become the successor to the interest of one of the 
employee's beneficiaries after that beneficiary's death. However, the 
preceding sentence does not apply to a person who has any right 
(including a contingent right) to an employee's benefit beyond being a 
mere potential successor to the interest of one of the employee's 
beneficiaries upon that beneficiary's death. Thus, for example, if the 
first beneficiary has a right to all income with respect to an 
employee's individual account during that beneficiary's life and a 
second beneficiary has a right to the principal but only after the death 
of the first income beneficiary (any portion of the principal 
distributed during the life of the first income beneficiary to be held 
in trust until that first beneficiary's death),

[[Page 216]]

both beneficiaries must be taken into account in determining the 
beneficiary with the shortest life expectancy and whether only 
individuals are beneficiaries.
    (2) If the individual beneficiary whose life expectancy is being 
used to calculate the distribution period dies after September 30 of the 
calendar year following the calendar year of the employee's death, such 
beneficiary's remaining life expectancy will be used to determine the 
distribution period without regard to the life expectancy of the 
subsequent beneficiary.
    (3) This paragraph (c) is illustrated by the following examples:

    Example 1. (i) Employer M maintains a defined contribution plan, 
Plan X. Employee A, an employee of M, died in 2005 at the age of 55, 
survived by spouse, B, who was 50 years old. Prior to A's death, M had 
established an account balance for A in Plan X. A's account balance is 
invested only in productive assets. A named a testamentary trust (Trust 
P) established under A's will as the beneficiary of all amounts payable 
from A's account in Plan X after A's death. A copy of the Trust P and a 
list of the trust beneficiaries were provided to the plan administrator 
of Plan X by October 31 of the calendar year following the calendar year 
of A's death. As of the date of A's death, the Trust P was irrevocable 
and was a valid trust under the laws of the state of A's domicile. A's 
account balance in Plan X was includible in A's gross estate under Sec. 
2039.
    (ii) Under the terms of Trust P, all trust income is payable 
annually to B, and no one has the power to appoint Trust P principal to 
any person other than B. A's children, who are all younger than B, are 
the sole remainder beneficiaries of the Trust P. No other person has a 
beneficial interest in Trust P. Under the terms of the Trust P, B has 
the power, exercisable annually, to compel the trustee to withdraw from 
A's account balance in Plan X an amount equal to the income earned on 
the assets held in A's account in Plan X during the calendar year and to 
distribute that amount through Trust P to B. Plan X contains no 
prohibition on withdrawal from A's account of amounts in excess of the 
annual required minimum distributions under section 401(a)(9). In 
accordance with the terms of Plan X, the trustee of Trust P elects, in 
order to satisfy section 401(a)(9), to receive annual required minimum 
distributions using the life expectancy rule in section 
401(a)(9)(B)(iii) for distributions over a distribution period equal to 
B's life expectancy. If B exercises the withdrawal power, the trustee 
must withdraw from A's account under Plan X the greater of the amount of 
income earned in the account during the calendar year or the required 
minimum distribution. However, under the terms of Trust P, and 
applicable state law, only the portion of the Plan X distribution 
received by the trustee equal to the income earned by A's account in 
Plan X is required to be distributed to B (along with any other trust 
income.)
    (iii) Because some amounts distributed from A's account in Plan X to 
Trust P may be accumulated in Trust P during B's lifetime for the 
benefit of A's children, as remaindermen beneficiaries of Trust P, even 
though access to those amounts are delayed until after B's death, A's 
children are beneficiaries of A's account in Plan X in addition to B and 
B is not the sole designated beneficiary of A's account. Thus the 
designated beneficiary used to determine the distribution period from 
A's account in Plan X is the beneficiary with the shortest life 
expectancy. B's life expectancy is the shortest of all the potential 
beneficiaries of the testamentary trust's interest in A's account in 
Plan X (including remainder beneficiaries). Thus, the distribution 
period for purposes of section 401(a)(9)(B)(iii) is B's life expectancy. 
Because B is not the sole designated beneficiary of the testamentary 
trust's interest in A's account in Plan X, the special rule in 
401(a)(9)(B)(iv) is not available and the annual required minimum 
distributions from the account to Trust M must begin no later than the 
end of the calendar year immediately following the calendar year of A's 
death.
    Example 2. (i) The facts are the same as Example 1 except that the 
testamentary trust instrument provides that all amounts distributed from 
A's account in Plan X to the trustee while B is alive will be paid 
directly to B upon receipt by the trustee of Trust P.
    (ii) In this case, B is the sole designated beneficiary of A's 
account in Plan X for purposes of determining the designated beneficiary 
under section 401(a)(9)(B)(iii) and (iv). No amounts distributed from 
A's account in Plan X to Trust P are accumulated in Trust P during B's 
lifetime for the benefit of any other beneficiary. Therefore, the 
residuary beneficiaries of Trust P are mere potential successors to B's 
interest in Plan X. Because B is the sole beneficiary of the 
testamentary trust's interest in A's account in Plan X, the annual 
required minimum distributions from A's account to Trust P must begin no 
later than the end of the calendar year in which A would have attained 
age 70\1/2\, rather than the calendar year immediately following the 
calendar year of A's death.

    Q-8. If a portion of an employee's individual account is not vested 
as of the employee's required beginning date, how is the determination 
of the required minimum distribution affected?

[[Page 217]]

    A-8. If the employee's benefit is in the form of an individual 
account, the benefit used to determine the required minimum distribution 
for any distribution calendar year will be determined in accordance with 
A-1 of this section without regard to whether or not all of the 
employee's benefit is vested. If any portion of the employee's benefit 
is not vested, distributions will be treated as being paid from the 
vested portion of the benefit first. If, as of the end of a distribution 
calendar year (or as of the employee's required beginning date, in the 
case of the employee's first distribution calendar year), the total 
amount of the employee's vested benefit is less than the required 
minimum distribution for the calendar year, only the vested portion, if 
any, of the employee's benefit is required to be distributed by the end 
of the calendar year (or, if applicable, by the employee's required 
beginning date). However, the required minimum distribution for the 
subsequent distribution calendar year must be increased by the sum of 
amounts not distributed in prior calendar years because the employee's 
vested benefit was less than the required minimum distribution.
    Q-9. Which amounts distributed from an individual account are taken 
into account in determining whether section 401(a)(9) is satisfied and 
which amounts are not taken into account in determining whether section 
401(a)(9) is satisfied?
    A-9. (a) General rule. Except as provided in paragraph (b), all 
amounts distributed from an individual account are distributions that 
are taken into account in determining whether section 401(a)(9) is 
satisfied, regardless of whether the amount is includible in income. 
Thus, for example, amounts that are excluded from income as recovery of 
investment in the contract under section 72 are taken into account for 
purposes of determining whether section 401(a)(9) is satisfied for a 
distribution calendar year. Similarly, amounts excluded from income as 
net unrealized appreciation on employer securities also are amounts 
distributed for purposes of determining if section 401(a)(9) is 
satisfied.
    (b) Exceptions. The following amounts are not taken into account in 
determining whether the required minimum amount has been distributed for 
a calendar year:
    (1) Elective deferrals (as defined in section 402(g)(3)) and 
employee contributions that, pursuant to rules prescribed by the 
Commissioner in revenue rulings, notices, or other guidance published in 
the Internal Revenue Bulletin (see Sec. 601.601(d)(2) of this chapter), 
are returned to the employee (together with the income allocable 
thereto) in order to comply with the section 415 limitations.
    (2) Corrective distributions of excess deferrals as described in 
Sec. 1.402(g)-1(e)(3), together with the income allocable to these 
distributions.
    (3) Corrective distributions of excess contributions under a 
qualified cash or deferred arrangement under section 401(k)(8) and 
excess aggregate contributions under section 401(m)(6), together with 
the income allocable to these distributions.
    (4) Loans that are treated as deemed distributions pursuant to 
section 72(p).
    (5) Dividends described in section 404(k) that are paid on employer 
securities. (Amounts paid to the plan that, pursuant to section 
404(k)(2)(A)(iii)(II), are included in the account balance and 
subsequently distributed from the account lose their character as 
dividends.)
    (6) The costs of life insurance coverage (P.S. 58 costs).
    (7) Similar items designated by the Commissioner in revenue rulings, 
notices, and other guidance published in the Internal Revenue Bulletin. 
See Sec. 601.601(d)(2)(ii)(b) of this chapter.

[T.D. 8987, 67 FR 18994, Apr. 17, 2002, as amended by T.D. 9130, 69 FR 
33293, June 15, 2004; T.D. 9319, 72 FR 16894, Apr. 5, 2007]



Sec. 1.401(a)(9)-6  Required minimum distributions for defined 
benefit plans and annuity contracts.

    Q-1. How must distributions under a defined benefit plan be paid in 
order to satisfy section 401(a)(9)?
    A-1. (a) General rules. In order to satisfy section 401(a)(9), 
except as otherwise provided in this section, distributions of the 
employee's entire interest under a defined benefit plan must be paid in 
the form of periodic annuity payments for the employee's life (or

[[Page 218]]

the joint lives of the employee and beneficiary) or over a period 
certain that does not exceed the maximum length of the period certain 
determined in accordance with A-3 of this section. The interval between 
payments for the annuity must be uniform over the entire distribution 
period and must not exceed one year. Once payments have commenced over a 
period, the period may only be changed in accordance with A-13 of this 
section. Life (or joint and survivor) annuity payments must satisfy the 
minimum distribution incidental benefit requirements of A-2 of this 
section. Except as otherwise provided in this section (such as permitted 
increases described in A-14 of this section), all payments (whether paid 
over an employee's life, joint lives, or a period certain) also must be 
nonincreasing.
    (b) Life annuity with period certain. The annuity may be a life 
annuity (or joint and survivor annuity) with a period certain if the 
life (or lives, if applicable) and period certain each meet the 
requirements of paragraph (a) of this A-1. For purposes of this section, 
if distributions are permitted to be made over the lives of the employee 
and the designated beneficiary, references to a life annuity include a 
joint and survivor annuity.
    (c) Annuity commencement. (1) Annuity payments must commence on or 
before the employee's required beginning date (within the meaning of A-2 
of Sec. 1.401(a)(9)-2). The first payment, which must be made on or 
before the employee's required beginning date, must be the payment which 
is required for one payment interval. The second payment need not be 
made until the end of the next payment interval even if that payment 
interval ends in the next calendar year. Similarly, in the case of 
distributions commencing after death in accordance with section 
401(a)(9)(B)(iii) and (iv), the first payment, which must be made on or 
before the date determined under A-3(a) or (b) (whichever is applicable) 
of Sec. 1.401(a)(9)-3, must be the payment which is required for one 
payment interval. Payment intervals are the periods for which payments 
are received, e.g., bimonthly, monthly, semi-annually, or annually. All 
benefit accruals as of the last day of the first distribution calendar 
year must be included in the calculation of the amount of annuity 
payments for payment intervals ending on or after the employee's 
required beginning date.
    (2) This paragraph (c) is illustrated by the following example:

    Example. A defined benefit plan (Plan X) provides monthly annuity 
payments of $500 for the life of unmarried participants with a 10-year 
period certain. An unmarried, retired participant (A) in Plan X attains 
age 70\1/2\ in 2005. In order to meet the requirements of this 
paragraph, the first monthly payment of $500 must be made on behalf of A 
on or before April 1, 2006, and the payments must continue to be made in 
monthly payments of $500 thereafter for the life and 10-year period 
certain.

    (d) Single sum distributions. In the case of a single sum 
distribution of an employee's entire accrued benefit during a 
distribution calendar year, the amount that is the required minimum 
distribution for the distribution calendar year (and thus not eligible 
for rollover under section 402(c)) is determined using either the rule 
in paragraph (d)(1) or the rule in paragraph (d)(2) of this A-1.
    (1) The portion of the single sum distribution that is a required 
minimum distribution is determined by treating the single sum 
distribution as a distribution from an individual account plan and 
treating the amount of the single sum distribution as the employee's 
account balance as of the end of the relevant valuation calendar year. 
If the single sum distribution is being made in the calendar year 
containing the required beginning date and the required minimum 
distribution for the employee's first distribution calendar year has not 
been distributed, the portion of the single sum distribution that 
represents the required minimum distribution for the employee's first 
and second distribution calendar years is not eligible for rollover.
    (2) The portion of the single sum distribution that is a required 
minimum distribution is permitted to be determined by expressing the 
employee's benefit as an annuity that would satisfy this section with an 
annuity starting date as of the first day of the distribution calendar 
year for which the required minimum distribution is

[[Page 219]]

being determined, and treating one year of annuity payments as the 
required minimum distribution for that year, and not eligible for 
rollover. If the single sum distribution is being made in the calendar 
year containing the required beginning date and the required minimum 
distribution for the employee's first distribution calendar year has not 
been made, the benefit must be expressed as an annuity with an annuity 
starting date as of the first day of the first distribution calendar 
year and the payments for the first two distribution calendar years 
would be treated as required minimum distributions, and not eligible for 
rollover.
    (e) Death benefits. The rule in paragraph (a) of this A-1, 
prohibiting increasing payments under an annuity applies to payments 
made upon the death of an employee. However, for purposes of this 
section, an ancillary death benefit described in this paragraph (e) may 
be disregarded in applying that rule. Such an ancillary death benefit is 
excluded in determining an employee's entire interest and the rules 
prohibiting increasing payments do not apply to such an ancillary death 
benefit. A death benefit with respect to an employee's benefit is an 
ancillary death benefit for purposes of this A-1 if--
    (1) It is not paid as part of the employee's accrued benefit or 
under any optional form of the employee's benefit; and
    (2) The death benefit, together with any other potential payments 
with respect to the employee's benefit that may be provided to a 
survivor, satisfy the incidental benefit requirement of Sec. 1.401-
1(b)(1)(i).
    (f) Additional guidance. Additional guidance regarding how 
distributions under a defined benefit plan must be paid in order to 
satisfy section 401(a)(9) may be issued by the Commissioner in revenue 
rulings, notices, or other guidance published in the Internal Revenue 
Bulletin. See Sec. 601.601(d)(2)(ii)(b) of this chapter.
    Q-2. How must distributions in the form of a life (or joint and 
survivor) annuity be made in order to satisfy the minimum distribution 
incidental benefit (MDIB) requirement of section 401(a)(9)(G) and the 
distribution component of the incidental benefit requirement of Sec. 
1.401-1(b)(1)(i)?
    A-2. (a) Life annuity for employee. If the employee's benefit is 
paid in the form of a life annuity for the life of the employee 
satisfying section 401(a)(9) without regard to the MDIB requirement, the 
MDIB requirement of section 401(a)(9)(G) will be satisfied.
    (b) Joint and survivor annuity, spouse beneficiary. If the 
employee's sole beneficiary, as of the annuity starting date for annuity 
payments, is the employee's spouse and the distributions satisfy section 
401(a)(9) without regard to the MDIB requirement, the distributions to 
the employee will be deemed to satisfy the MDIB requirement of section 
401(a)(9)(G). For example, if an employee's benefit is being distributed 
in the form of a joint and survivor annuity for the lives of the 
employee and the employee's spouse and the spouse is the sole 
beneficiary of the employee, the amount of the periodic payment payable 
to the spouse would not violate the MDIB requirement if it was 100 
percent of the annuity payment payable to the employee, regardless of 
the difference in the ages between the employee and the employee's 
spouse.
    (c) Joint and survivor annuity, nonspouse beneficiary--(1) 
Explanation of rule. If distributions commence under a distribution 
option that is in the form of a joint and survivor annuity for the joint 
lives of the employee and a beneficiary other than the employee's 
spouse, the minimum distribution incidental benefit requirement will not 
be satisfied as of the date distributions commence unless under the 
distribution option, the annuity payments to be made on and after the 
employee's required beginning date will satisfy the conditions of this 
paragraph (c). The periodic annuity payment payable to the survivor must 
not at any time on and after the employee's required beginning date 
exceed the applicable percentage of the annuity payment payable to the 
employee using the table in paragraph (c)(2) of this A-2. The applicable 
percentage is based on the adjusted employee/beneficiary age difference. 
The adjusted employee/beneficiary age difference is determined by first 
calculating the excess of the age of the employee over the age of the

[[Page 220]]

beneficiary based on their ages on their birthdays in a calendar year. 
Then, if the employee is younger than age 70, the age difference 
determined in the previous sentence is reduced by the number of years 
that the employee is younger than age 70 on the employee's birthday in 
the calendar year that contains the annuity starting date. In the case 
of an annuity that provides for increasing payments, the requirement of 
this paragraph (c) will not be violated merely because benefit payments 
to the beneficiary increase, provided the increase is determined in the 
same manner for the employee and the beneficiary.
    (2) Table.

------------------------------------------------------------------------
                                                             Applicable
       Adjusted employee/beneficiary age difference          percentage
------------------------------------------------------------------------
10 years or less..........................................           100
11........................................................            96
12........................................................            93
13........................................................            90
14........................................................            87
15........................................................            84
16........................................................            82
17........................................................            79
18........................................................            77
19........................................................            75
20........................................................            73
21........................................................            72
22........................................................            70
23........................................................            68
24........................................................            67
25........................................................            66
26........................................................            64
27........................................................            63
28........................................................            62
29........................................................            61
30........................................................            60
31........................................................            59
32........................................................            59
33........................................................            58
34........................................................            57
35........................................................            56
36........................................................            56
37........................................................            55
38........................................................            55
39........................................................            54
40........................................................            54
41........................................................            53
42........................................................            53
43........................................................            53
44 and greater............................................            52
------------------------------------------------------------------------

    (3) Example. This paragraph (c) is illustrated by the following 
example:

    Example. Distributions commence on January 1, 2003 to an employee 
(Z), born March 1, 1937, after retirement at age 65. Z's daughter (Y), 
born February 5, 1967, is Z's beneficiary. The distributions are in the 
form of a joint and survivor annuity for the lives of Z and Y with 
payments of $500 a month to Z and upon Z's death of $500 a month to Y, 
i.e., the projected monthly payment to Y is 100 percent of the monthly 
amount payable to Z. Accordingly, under A-10 of this section, compliance 
with the rules of this section is determined as of the annuity starting 
date. The adjusted employee/beneficiary age difference is calculated by 
taking the excess of the employee's age over the beneficiary's age and 
subtracting the number of years the employee is younger than age 70. In 
this case, Z is 30 years older than Y and is commencing benefit 4 years 
before attaining age 70 so the adjusted employee-beneficiary age 
difference is 26 years. Under the table in the paragraph (c)(2) of this 
A-2, the applicable percentage for a 26-year adjusted employee/
beneficiary age difference is 64 percent. As of January 1, 2003 (the 
annuity starting date) the plan does not satisfy the MDIB requirement 
because, as of such date, the distribution option provides that, as of 
Z's required beginning date, the monthly payment to Y upon Z's death 
will exceed 66 percent of Z's monthly payment.

    (d) Period certain and annuity features. If a distribution form 
includes a period certain, the amount of the annuity payments payable to 
the beneficiary need not be reduced during the period certain, but in 
the case of a joint and survivor annuity with a period certain, the 
amount of the annuity payments payable to the beneficiary must satisfy 
paragraph (c) of this A-2 after the expiration of the period certain.
    (e) Deemed satisfaction of incidental benefit rule. Except in the 
case of distributions with respect to an employee's benefit that include 
an ancillary death benefit described in paragraph A-1(e) of this 
section, to the extent the incidental benefit requirement of Sec. 
1.401-1(b)(1)(i) requires a distribution, that requirement is deemed to 
be satisfied if distributions satisfy the minimum distribution 
incidental benefit requirement of this A-2. If the employee's benefits 
include an ancillary death benefit described in paragraph A-1(e) of this 
section, the benefits (including the ancillary death benefit) must be 
distributed in accordance with the incidental benefit requirement 
described in Sec. 1.401-1(b)(1)(i) and the benefits (excluding the 
ancillary death benefit) must also satisfy the minimum distribution 
incidental benefit requirement of this A-2.
    Q-3. How long is a period certain under a defined benefit plan 
permitted to extend?

[[Page 221]]

    A-3. (a) Distributions commencing during the employee's life. The 
period certain for any annuity distributions commencing during the life 
of the employee with an annuity starting date on or after the employee's 
required beginning date generally is not permitted to exceed the 
applicable distribution period for the employee (determined in 
accordance with the Uniform Lifetime Table in A-2 of Sec. 1.401(a)(9)-
9) for the calendar year that contains the annuity starting date. See A-
10 of this section for the rule for annuity payments with an annuity 
starting date before the required beginning date. However, if the 
employee's sole beneficiary is the employee's spouse, the period certain 
is permitted to be as long as the joint life and last survivor 
expectancy of the employee and the employee's spouse, if longer than the 
applicable distribution period for the employee, provided the period 
certain is not provided in conjunction with a life annuity under A-1(b) 
of this section.
    (b) Distributions commencing after the employee's death. (1) If 
annuity distributions commence after the death of the employee under the 
life expectancy rule (under section 401(a)(9)(B)(iii) or (iv)), the 
period certain for any distributions commencing after death cannot 
exceed the applicable distribution period determined under A-5(b) of 
Sec. 1.401(a)(9)-5 for the distribution calendar year that contains the 
annuity starting date.
    (2) If the annuity starting date is in a calendar year before the 
first distribution calendar year, the period certain may not exceed the 
life expectancy of the designated beneficiary using the beneficiary's 
age in the year that contains the annuity starting date.
    Q-4. Will a plan fail to satisfy section 401(a)(9) merely because 
distributions are made from an annuity contract which is purchased from 
an insurance company?
    A-4. A plan will not fail to satisfy section 401(a)(9) merely 
because distributions are made from an annuity contract which is 
purchased with the employee's benefit by the plan from an insurance 
company, as long as the payments satisfy the requirements of this 
section. If the annuity contract is purchased after the required 
beginning date, the first payment interval must begin on or before the 
purchase date and the payment required for one payment interval must be 
made no later than the end of such payment interval. If the payments 
actually made under the annuity contract do not meet the requirements of 
section 401(a)(9), the plan fails to satisfy section 401(a)(9). See also 
A-14 of this section permitting certain increases under annuity 
contracts.
    Q-5. In the case of annuity distributions under a defined benefit 
plan, how must additional benefits that accrue after the employee's 
first distribution calendar year be distributed in order to satisfy 
section 401(a)(9)?
    A-5. (a) In the case of annuity distributions under a defined 
benefit plan, if any additional benefits accrue in a calendar year after 
the employee's first distribution calendar year, distribution of the 
amount that accrues in the calendar year must commence in accordance 
with A-1 of this section beginning with the first payment interval 
ending in the calendar year immediately following the calendar year in 
which such amount accrues.
    (b) A plan will not fail to satisfy section 401(a)(9) merely because 
there is an administrative delay in the commencement of the distribution 
of the additional benefits accrued in a calendar year, provided that the 
actual payment of such amount commences as soon as practicable. However, 
payment must commence no later than the end of the first calendar year 
following the calendar year in which the additional benefit accrues, and 
the total amount paid during such first calendar year must be no less 
than the total amount that was required to be paid during that year 
under A-5(a) of this section.
    Q-6. If a portion of an employee's benefit is not vested as of 
December 31 of a distribution calendar year, how is the determination of 
the required minimum distribution affected?
    A-6. In the case of annuity distributions from a defined benefit 
plan, if any portion of the employee's benefit is not vested as of 
December 31 of a distribution calendar year, the portion that is not 
vested as of such date will be treated as not having accrued for 
purposes

[[Page 222]]

of determining the required minimum distribution for that distribution 
calendar year. When an additional portion of the employee's benefit 
becomes vested, such portion will be treated as an additional accrual. 
See A-5 of this section for the rules for distributing benefits which 
accrue under a defined benefit plan after the employee's first 
distribution calendar year.
    Q-7. If an employee (other than a 5-percent owner) retires after the 
calendar year in which the employee attains age 70\1/2\, for what period 
must the employee's accrued benefit under a defined benefit plan be 
actuarially increased?
    A-7. (a) Actuarial increase starting date. If an employee (other 
than a 5-percent owner) retires after the calendar year in which the 
employee attains age 70\1/2\, in order to satisfy section 
401(a)(9)(C)(iii), the employee's accrued benefit under a defined 
benefit plan must be actuarially increased to take into account any 
period after age 70\1/2\ in which the employee was not receiving any 
benefits under the plan. The actuarial increase required to satisfy 
section 401(a)(9)(C)(iii) must be provided for the period starting on 
the April 1 following the calendar year in which the employee attains 
age 70\1/2\, or January 1, 1997, if later.
    (b) Actuarial increase ending date. The period for which the 
actuarial increase must be provided ends on the date on which benefits 
commence after retirement in an amount sufficient to satisfy section 
401(a)(9).
    (c) Nonapplication to plan providing same required beginning date 
for all employees. If, as permitted under A-2(e) of Sec. 1.401(a)(9)-2, 
a plan provides that the required beginning date for purposes of section 
401(a)(9) for all employees is April 1 of the calendar year following 
the calendar year in which the employee attains age 70\1/2\ (regardless 
of whether the employee is a 5-percent owner) and the plan makes 
distributions in an amount sufficient to satisfy section 401(a)(9) using 
that required beginning date, no actuarial increase is required under 
section 401(a)(9)(C)(iii).
    (d) Nonapplication to governmental and church plans. The actuarial 
increase required under this A-7 does not apply to a governmental plan 
(within the meaning of section 414(d)) or a church plan. For purposes of 
this paragraph, the term church plan means a plan maintained by a church 
for church employees, and the term church means any church (as defined 
in section 3121(w)(3)(A)) or qualified church-controlled organization 
(as defined in section 3121(w)(3)(B)).
    Q-8. What amount of actuarial increase is required under section 
401(a)(9)(C)(iii)?
    A-8. In order to satisfy section 401(a)(9)(C)(iii), the retirement 
benefits payable with respect to an employee as of the end of the period 
for actuarial increases (described in A-7 of this section) must be no 
less than: the actuarial equivalent of the employee's retirement 
benefits that would have been payable as of the date the actuarial 
increase must commence under paragraph (a) of A-7 of this section if 
benefits had commenced on that date; plus the actuarial equivalent of 
any additional benefits accrued after that date; reduced by the 
actuarial equivalent of any distributions made with respect to the 
employee's retirement benefits after that date. Actuarial equivalence is 
determined using the plan's assumptions for determining actuarial 
equivalence for purposes of satisfying section 411.
    Q-9. How does the actuarial increase required under section 
401(a)(9)(C)(iii) relate to the actuarial increase required under 
section 411?
    A-9. In order for any of an employee's accrued benefit to be 
nonforfeitable as required under section 411, a defined benefit plan 
must make an actuarial adjustment to an accrued benefit, the payment of 
which is deferred past normal retirement age. The only exception to this 
rule is that generally no actuarial adjustment is required to reflect 
the period during which a benefit is suspended as permitted under 
section 203(a)(3)(B) of the Employee Retirement Income Security Act of 
1974 (ERISA) (88 Stat. 829). The actuarial increase required under 
section 401(a)(9)(C)(iii) for the period described in A-7 of this 
section is generally the same as, and not in addition to, the actuarial 
increase required for the same period under section 411 to reflect any 
delay in the payment of retirement

[[Page 223]]

benefits after normal retirement age. However, unlike the actuarial 
increase required under section 411, the actuarial increase required 
under section 401(a)(9)(C)(iii) must be provided even during any period 
during which an employee's benefit has been suspended in accordance with 
ERISA section 203(a)(3)(B).
    Q-10. What rule applies if distributions commence to an employee on 
a date before the employee's required beginning date over a period 
permitted under section 401(a)(9)(A)(ii) and the distribution form is an 
annuity under which distributions are made in accordance with the 
provisions of A-1 of this section?
    A-10. (a) General rule. If distributions commence to an employee on 
a date before the employee's required beginning date over a period 
permitted under section 401(a)(9)(A)(ii) and the distribution form is an 
annuity under which distributions are made in accordance with the 
provisions of A-1 of this section, the annuity starting date will be 
treated as the required beginning date for purposes of applying the 
rules of this section and Sec. 1.401(a)(9)-2. Thus, for example, the 
designated beneficiary distributions will be determined as of the 
annuity starting date. Similarly, if the employee dies after the annuity 
starting date but before the required beginning date determined under A-
2 of Sec. 1.401(a)(9)-2, after the employee's death, the remaining 
portion of the employee's interest must continue to be distributed in 
accordance with this section over the remaining period over which 
distributions commenced. The rules in Sec. 1.401(a)(9)-3 and section 
401(a)(9)(B)(ii) or (iii) and (iv) do not apply.
    (b) Period certain. If, as of the employee's birthday in the year 
that contains the annuity starting date, the age of the employee is 
under 70, the following rule applies in applying the rule in paragraph 
(a) of A-3 of this section. The applicable distribution period for the 
employee is the distribution period for age 70, determined in accordance 
with the Uniform Lifetime Table in A-2 of Sec. 1.401(a)(9)-9, plus the 
excess of 70 over the age of the employee as of the employee's birthday 
in the year that contains the annuity starting date.
    (c) Adjustment to employee/beneficiary age difference. See A-2(c)(1) 
of this section for the determination of the adjusted employee/
beneficiary age difference in the case of an employee whose age on the 
annuity starting date is less than 70.
    Q-11. What rule applies if distributions commence to the surviving 
spouse of an employee over a period permitted under section 
401(a)(9)(B)(iii)(II) before the date on which distributions are 
required to commence and the distribution form is an annuity under which 
distributions are made as of the date distributions commence in 
accordance with the provisions of A-1 of this section.
    A-11. If distributions commence to the surviving spouse of an 
employee over a period permitted under section 401(a)(9)(B)(iii)(II) 
before the date on which distributions are required to commence and the 
distribution form is an annuity under which distributions are made as of 
the date distributions commence in accordance with the provisions of A-1 
of this section, distributions will be considered to have begun on the 
actual commencement date for purposes of section 401(a)(9)(B)(iv)(II). 
Consequently, in such case, A-5 of Sec. 1.401(a)(9)-3 and section 
401(a)(9)(B)(ii) and (iii) will not apply upon the death of the 
surviving spouse as though the surviving spouse were the employee. 
Instead, the annuity distributions must continue to be made, in 
accordance with the provisions of A-1 of this section, over the 
remaining period over which distributions commenced.
    Q-12. In the case of an annuity contract under an individual account 
plan that has not yet been annuitized, how is section 401(a)(9) 
satisfied with respect to the employee's or beneficiary's entire 
interest under the annuity contract for the period prior to the date 
annuity payments so commence?
    A-12. (a) General rule. Prior to the date that an annuity contract 
under an individual account plan is annuitized, the interest of an 
employee or beneficiary under that contract is treated as an individual 
account for purposes of section 401(a)(9). Thus, the required minimum 
distribution for any year with respect to that interest is determined 
under Sec. 1.401(a)(9)-5 rather than

[[Page 224]]

this section. See A-1 of Sec. 1.401(a)(9)-5 for rules relating to the 
satisfaction of section 401(a)(9) in the year that annuity payments 
commence and A-2(a)(3) of Sec. 1.401(a)(9)-8.
    (b) Entire interest. For purposes of applying the rules in Sec. 
1.401(a)(9)-5, the entire interest under the annuity contract as of 
December 31 of the relevant valuation calendar year is treated as the 
account balance for the valuation calendar year described in A-3 of 
Sec. 1.401(a)(9)-5. The entire interest under an annuity contract is 
the dollar amount credited to the employee or beneficiary under the 
contract plus the actuarial present value of any additional benefits 
(such as survivor benefits in excess of the dollar amount credited to 
the employee or beneficiary) that will be provided under the contract. 
However, paragraph (c) of this A-12 describes certain additional 
benefits that may be disregarded in determining the employee's entire 
interest under the annuity contract. The actuarial present value of any 
additional benefits described under this A-12 is to be determined using 
reasonable actuarial assumptions, including reasonable assumptions as to 
future distributions, and without regard to an individual's health.
    (c) Exclusions. (1) The actuarial present value of any additional 
benefits provided under an annuity contract described in paragraph (b) 
of this A-12 may be disregarded if the sum of the dollar amount credited 
to the employee or beneficiary under the contract and the actuarial 
present value of the additional benefits is no more than 120 percent of 
the dollar amount credited to the employee or beneficiary under the 
contract and the contract provides only for the following additional 
benefits:
    (i) Additional benefits that, in the case of a distribution, are 
reduced by an amount sufficient to ensure that the ratio of such sum to 
the dollar amount credited does not increase as a result of the 
distribution, and
    (ii) An additional benefit that is the right to receive a final 
payment upon death that does not exceed the excess of the premiums paid 
less the amount of prior distributions.
    (2) If the only additional benefit provided under the contract is 
the additional benefit described in paragraph (c)(1)(ii) of this A-12, 
the additional benefit may be disregarded regardless of its value in 
relation to the dollar amount credited to the employee or beneficiary 
under the contract.
    (3) The Commissioner in revenue rulings, notices, or other guidance 
published in the Internal Revenue Bulletin (see Sec. 601.601(d)(2) of 
this chapter) may provide additional guidance on additional benefits 
that may be disregarded.
    (d) Examples. The following examples, which use a 5 percent interest 
rate and the Mortality Table provided in Rev. Rul. 2001-62 (2001-2 C.B. 
632), illustrate the application of the rules in this A-12:

    Example 1. (i) G is the owner of a variable annuity contract 
(Contract S) under an individual account plan which has not been 
annuitized. Contract S provides a death benefit until the end of the 
calendar year in which the owner attains the age of 84 equal to the 
greater of the current Contract S notional account value (dollar amount 
credited to G under the contract) and the largest notional account value 
at any previous policy anniversary reduced proportionally for subsequent 
partial distributions (High Water Mark). Contract S provides a death 
benefit in calendar years after the calendar year in which the owner 
attains age 84 equal to the current notional account value. Contract S 
provides that assets within the contract may be invested in a Fixed 
Account at a guaranteed rate of 2 percent. Contract S provides no other 
additional benefits.
    (ii) At the end of 2008, when G has an attained age of 78 and 9 
months the notional account value of Contract S (after the distribution 
for 2008 of 4.93% of the notional account value as of December 31, 2007) 
is $550,000, and the High Water Mark, before adjustment for any 
withdrawals from Contract S in 2008 is $1,000,000. Thus, Contract S will 
provide additional benefits (i.e. the death benefits in excess of the 
notional account value) through 2014, the year S turns 84. The actuarial 
present value of these additional benefits at the end of 2008 is 
determined to be $84,300 (15 percent of the notional account value). In 
making this determination, the following assumptions are made: on the 
average, deaths occur mid-year; the investment return on his notional 
account value is 2 percent per annum; and minimum required distributions 
(determined without regard to additional benefits under the Contract S) 
are made at the end of each year. The following

[[Page 225]]

table summarizes the actuarial methodology used in determining the 
actuarial present value of the additional benefit.

----------------------------------------------------------------------------------------------------------------
                                                    End-of-year                                     End-of-year
                                   Death benefit     notional         Average      Withdrawal at     notional
              Year                  during year   account before     notional       end of year    account after
                                                    withdrawal        account                       withdrawal
----------------------------------------------------------------------------------------------------------------
2008............................      $1,000,000  ..............  ..............  ..............        $550,000
2009............................     \1\ 950,739    \2\ $561,000    \3\ $555,500     \4\ $28,205         532,795
2010............................         901,983         543,451         538,123          28,492         514,959
2011............................         853,749         525,258         520,109          28,769         496,490
2012............................         806,053         506,419         501,454          29,034         477,385
2013............................         758,916         486,933         482,159          29,287         457,645
2014............................         712,356         466,798         462,222          29,525        437,273
----------------------------------------------------------------------------------------------------------------
\1\ $1,000,000 death benefit reduced 4.93 percent for withdrawal during 2008.
\2\ Notional account value at end of prior year (after distribution) increased by 2 percent return for year.
\3\ Average of $550,000 notional account value at end of prior year (after distribution) and $561,000 notional
  account value at end of current year (before distribution).
\4\ December 31, 2008 notional account (before distribution) divided by uniform lifetime table age 79 factor of
  19.5.


----------------------------------------------------------------------------------------------------------------
                                                                                                    Discounted
                                                   Survivorship      Interest     Mortality rate    additional
                      Year                          to start of     discount to     during year      benefits
                                                       year         end of 2008                     within year
----------------------------------------------------------------------------------------------------------------
2008............................................
2009............................................         1.00000          .97590      \5\ .04426          17,070
2010............................................          .95574      \6\ .92943          .04946      \7\ 15,987
2011............................................      \8\ .90847          .88517          .05519          14,807
2012............................................          .85833          .84302          .06146          13,546
2013............................................          .80558          .80288          .06788          12,150
2014............................................          .75090          .76464          .07477          10,739
                                                                                                 ---------------
                                                  ..............  ..............  ..............        $84,300
----------------------------------------------------------------------------------------------------------------
\5\ One-quarter age 78 rate plus three-quarters age 79 rate.
\6\ Five percent discounted 18 months (1.05+(-1.5)).
\7\ Blended age 79/age 80 mortality rate (.04946) multiplied by the $363,860 excess of death benefit over the
  average notional account value (901,983 less 538,123) multiplied by .95574 probability of survivorship to the
  start of 2010 multiplied by 18 month interest discount of .92943.
\8\ Survivorship to start of preceding year (.95574) multiplied by probability of survivorship during prior year
  (1-.04946).

    (iii) Because Contract S provides that, in the case of a 
distribution, the value of the additional death benefit (which is the 
only additional benefit available under the contract) is reduced by an 
amount that is at least proportional to the reduction in the notional 
account value and, at age 78 and 9 months, the sum of the notional 
account value (dollar amount credited to the employee under the 
contract) and the actuarial present value of the additional death 
benefit is no more than 120 percent of the notional account value, the 
exclusion under paragraph (c)(2) of this A-12 is applicable for 2009. 
Therefore, for purposes of applying the rules in Sec. 1.401(a)(9)-5, 
the entire interest under Contract S may be determined as the notional 
account value (i.e. without regard to the additional death benefit).
    Example 2. (i) The facts are the same as in (Example 1 except that 
the notional account value is $450,000 at the end of 2008. In this 
instance, the actuarial present value of the death benefit in excess of 
the notional account value in 2008 is determined to be $108,669 (24 
percent of the notional account value). The following table summarizes 
the actuarial methodology used in determining the actuarial present 
value of the additional benefit.

----------------------------------------------------------------------------------------------------------------
                                                    End-of-year                                     End-of-year
                                   Death benefit     notional         Average      Withdrawal at     notional
              Year                  during year   account before     notional       end of year    account after
                                                    withdrawal        account                       withdrawal
----------------------------------------------------------------------------------------------------------------
2008............................      $1,000,000  ..............  ..............  ..............        $450,000
2009............................         950,739        $459,000        $454,500         $23,077         435,923
2010............................         901,983         444,642         440,282          23,311         421,330
2011............................         853,749         429,757         425,543          23,538         406,219
2012............................         806,053         414,343         410,281          23,755         390,588
2013............................         758,916         398,399         394,494          23,962         374,437

[[Page 226]]

 
2014............................         712,356         381,926         378,181          24,157         357,768
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                                                    Discounted
                                                   Survivorship      Interest     Mortality rate    additional
                      Year                          to start of     discount to     during year      benefits
                                                       year         end of 2008                     within year
----------------------------------------------------------------------------------------------------------------
2008............................................
2009............................................         1.00000          .97590          .04426         $21,432
2010............................................          .95574          .92943          .04946          20,286
2011............................................          .90847          .88517          .05519          19,004
2012............................................          .85833          .84302          .06146          17,601
2013............................................          .80558          .80288          .06788          15,999
2014............................................          .75090          .76464          .07477          14,347
                                                                                                 ---------------
                                                  ..............  ..............  ..............        $108,669
----------------------------------------------------------------------------------------------------------------

    (ii) Because the sum of the notional account balance and the 
actuarial present value of the additional death benefit is more than 120 
percent of the notional account value, the exclusion under paragraph 
(b)(1) of this A-12 does not apply for 2009. Therefore, for purposes of 
applying the rules in Sec. 1.401(a)(9)-5, the entire interest under 
Contract S must include the actuarial present value of the additional 
death benefit.

    Q-13: When can an annuity payment period be changed?
    A-13. (a) In general. An annuity payment period may be changed in 
accordance with the provisions set forth in paragraph (b) of this A-13 
or in association with an annuity payment increase described in A-14 of 
this section.
    (b) Reannuitization. If, in a stream of annuity payments that 
otherwise satisfies section 401(a)(9), the annuity payment period is 
changed and the annuity payments are modified in association with that 
change, this modification will not cause the distributions to fail to 
satisfy section 401(a)(9) provided the conditions set forth in paragraph 
(c) of this A-13 are satisfied, and either--
    (1) The modification occurs at the time that the employee retires or 
in connection with a plan termination;
    (2) The annuity payments prior to modification are annuity payments 
paid over a period certain without life contingencies; or
    (3) The annuity payments after modification are paid under a 
qualified joint and survivor annuity over the joint lives of the 
employee and a designated beneficiary, the employee's spouse is the sole 
designated beneficiary, and the modification occurs in connection with 
the employee becoming married to such spouse.
    (c) Conditions. In order to modify a stream of annuity payments in 
accordance with paragraph (b) of this A-13, the following conditions 
must be satisfied--
    (1) The future payments under the modified stream satisfy section 
401(a)(9) and this section (determined by treating the date of the 
change as a new annuity starting date and the actuarial present value of 
the remaining payments prior to modification as the entire interest of 
the participant);
    (2) For purposes of sections 415 and 417, the modification is 
treated as a new annuity starting date;
    (3) After taking into account the modification, the annuity stream 
satisfies section 415 (determined at the original annuity starting date, 
using the interest rates and mortality tables applicable to such date); 
and
    (4) The end point of the period certain, if any, for any modified 
payment period is not later than the end point available under section 
401(a)(9) to the employee at the original annuity starting date.
    (d) Examples. For the following examples in this A-13, assume that 
the Applicable Interest Rate throughout the period from 2005 through 
2008 is 5 percent and throughout 2009 is 4 percent, the Applicable 
Mortality Table

[[Page 227]]

throughout the period from 2005 to 2009 is the table provided in Rev. 
Rul. 2001-62 (2001-C.B. 632) and the section 415 limit in 2005 at age 70 
for a straight life annuity is $255,344:

    Example 1. (i) A participant (D), who has 10 years of participation 
in a frozen defined benefit plan (Plan W), attains age 70\1/2\ in 2005. 
D is not retired and elects to receive distributions from Plan W in the 
form of a straight life (i.e. level payment) annuity with annual 
payments of $240,000 per year beginning in 2005 at a date when D has an 
attained age of 70. Plan W offers non-retired employees in pay status 
the opportunity to modify their annuity payments due to an associated 
change in the payment period at retirement. Plan W treats the date of 
the change in payment period as a new annuity starting date for the 
purposes of sections 415 and 417. Thus, for example, the plan provides a 
new qualified and joint survivor annuity election and obtains spousal 
consent.
    (ii) Plan W determines modifications of annuity payment amounts at 
retirement such that the present value of future new annuity payment 
amounts (taking into account the new associated payment period) is 
actuarially equivalent to the present value of future pre-modification 
annuity payments (taking into account the pre-modification annuity 
payment period). Actuarial equivalency for this purpose is determined 
using the Applicable Interest Rate and the Applicable Mortality Table as 
of the date of modification.
    (iii) D retires in 2009 at the age of 74 and, after receiving four 
annual payments of $240,000, elects to receive his remaining 
distributions from Plan W in the form of an immediate final lump sum 
payment (calculated at 4 percent interest) of $2,399,809.
    (iv) Because payment of retirement benefits in the form of an 
immediate final lump sum payment satisfies (in terms of form) section 
401(a)(9), the condition under paragraph (c)(1) of this A-13 is met.
    (v) Because Plan W treats a modification of an annuity payment 
stream at retirement as a new annuity starting date for purposes of 
sections 415 and 417, the condition under paragraph (c)(2) of this A-13 
is met.
    (vi) After taking into account the modification, the annuity stream 
determined as of the original annuity starting date consists of annual 
payments beginning at age 70 of $240,000, $240,000, $240,000, $240,000, 
and $2,399,809. This benefit stream is actuarially equivalent to a 
straight life annuity at age 70 of $250,182, an amount less than the 
section 415 limit determined at the original annuity starting date, 
using the interest and mortality rates applicable to such date. Thus, 
the condition under paragraph (c)(3) of this A-13 is met.
    (vii) Thus, because a stream of annuity payments in the form of a 
straight life annuity satisfies section 401(a)(9), and because each of 
the conditions under paragraph (c) of this A-13 are satisfied, the 
modification of annuity payments to D described in this example meets 
the requirements of this A-13.
    Example 2. The facts are the same as in Example 1 except that the 
straight life annuity payments are paid at a rate of $250,000 per year 
and after D retires the lump sum payment at age 75 is $2,499,801. Thus, 
after taking into account the modification, the annuity stream 
determined as of the original annuity starting date consists of annual 
payments beginning at age 70 of $250,000, $250,000, $250,000, $250,000, 
and $2,499,801. This benefit stream is actuarially equivalent to a 
straight life annuity at age 70 of $260,606, an amount greater than the 
section 415 limit determined at the original annuity starting date, 
using the interest and mortality rates applicable to such date. Thus, 
the lump sum payment to D fails to satisfy the condition under paragraph 
(c)(3) of this A-13. Therefore, the lump sum payment to D fails to meet 
the requirements of this A-13 and thus fails to satisfy the requirements 
of section 401(a)(9).
    Example 3. (i) A participant (E), who has 10 years of participation 
in a frozen defined benefit plan (Plan X), attains age 70\1/2\ and 
retires in 2005 at a date when his attained age is 70. E was born in 
1935. E elects to receive annual distributions from Plan X in the form 
of a 27 year period certain annuity (i.e., a 27 year annuity payment 
period without a life contingency) paid at a rate of $37,000 per year 
beginning in 2005 with future payments increasing at a rate of 4 percent 
per year (i.e., the 2006 payment will be $38,480, the 2007 payment will 
be $40,019 and so on). Plan X offers participants in pay status whose 
annuity payments are in the form of a term-certain annuity the 
opportunity to modify their payment period at any time and treats such 
modifications as a new annuity starting date for the purposes of 
sections 415 and 417. Thus, for example, the plan provides a new 
qualified and joint survivor annuity election and obtains spousal 
consent.
    (ii) Plan X determines modifications of annuity payment amounts such 
that the present value of future new annuity payment amounts (taking 
into account the new associated payment period) is actuarially 
equivalent to the present value of future pre-modification annuity 
payments (taking into account the pre-modification annuity payment 
period). Actuarial equivalency for this purpose is determined using 5 
percent and the Applicable Mortality Table as of the date of 
modification.
    (iii) In 2008, E, after receiving annual payments of $37,000, 
$38,480, and $40,019, elects to receive his remaining distributions from 
Plan W in the form of a straight life annuity paid with annual payments 
of $92,133 per year.

[[Page 228]]

    (iv) Because payment of retirement benefits in the form of a 
straight life annuity satisfies (in terms of form) section 401(a)(9), 
the condition under paragraph (c)(1) of this A-13 is met.
    (v) Because Plan X treats a modification of an annuity payment 
stream at retirement as a new annuity starting date for purposes of 
sections 415 and 417, the condition under paragraph (c)(2) of this A-13 
is met.
    (vi) After taking into account the modification, the annuity stream 
determined as of the original annuity starting date consists of annual 
payments beginning at age 70 of $37,000, $38,480, $40,019, and a 
straight life annuity beginning at age 73 of $92,133. This benefit 
stream is equivalent to a straight life annuity at age 70 of $82,539, an 
amount less than the section 415 limit determined at the original 
annuity starting date, using the interest and mortality rates applicable 
to such date. Thus, the condition under paragraph (c)(3) of this A-13 is 
met.
    (vii) Thus, because a stream of annuity payments in the form of a 
straight life annuity satisfies section 401(a)(9), and because each of 
the conditions under paragraph (c) of this A-13 are satisfied, the 
modification of annuity payments to E described in this example meets 
the requirements of this A-13.

    Q-14. Are annuity payments permitted to increase?
    A-14. (a) General rules. Except as otherwise provided in this 
section, all annuity payments (whether paid over an employee's life, 
joint lives, or a period certain) must be nonincreasing or increase only 
in accordance with one or more of the following--
    (1) With an annual percentage increase that does not exceed the 
percentage increase in an eligible cost-of-living index as defined in 
paragraph (b) of this A-14 for a 12-month period ending in the year 
during which the increase occurs or the prior year;
    (2) With a percentage increase that occurs at specified times (e.g., 
at specified ages) and does not exceed the cumulative total of annual 
percentage increases in an eligible cost-of-living index as defined in 
paragraph (b) of this A-14 since the annuity starting date, or if later, 
the date of the most recent percentage increase. However, in cases 
providing such a cumulative increase, an actuarial increase may not be 
provided to reflect the fact that increases were not provided in the 
interim years;
    (3) To the extent of the reduction in the amount of the employee's 
payments to provide for a survivor benefit, but only if there is no 
longer a survivor benefit because the beneficiary whose life was being 
used to determine the period described in section 401(a)(9)(A)(ii) over 
which payments were being made dies or is no longer the employee's 
beneficiary pursuant to a qualified domestic relations order within the 
meaning of section 414(p);
    (4) To pay increased benefits that result from a plan amendment;
    (5) To allow a beneficiary to convert the survivor portion of a 
joint and survivor annuity into a single sum distribution upon the 
employee's death; or
    (6) To the extent increases are permitted in accordance with 
paragraph (c) or (d) of this A-14.
    (b) (1) For purposes of this A-14, an eligible cost-of-living index 
means an index described in paragraphs (b)(2), (b)(3), or (b)(4) of this 
A-14.
    (2) A consumer price index that is based on prices of all items (or 
all items excluding food and energy) and issued by the Bureau of Labor 
Statistics, including an index for a specific population (such as urban 
consumers or urban wage earners and clerical workers) and an index for a 
geographic area or areas (such as a given metropolitan area or state).
    (3) A percentage adjustment based on a cost-of-living index 
described in paragraph (b)(2) of this A-14, or a fixed percentage if 
less. In any year when the cost-of-living index is lower than the fixed 
percentage, the fixed percentage may be treated as an increase in an 
eligible cost-of-living index, provided it does not exceed the sum of:
    (i) The cost-of-living index for that year, and
    (ii) The accumulated excess of the annual cost-of-living index from 
each prior year over the fixed annual percentage used in that year 
(reduced by any amount previously utilized under this paragraph 
(b)(3)(ii)).
    (4) A percentage adjustment based on the increase in compensation 
for the position held by the employee at the time of retirement, and 
provided under either the terms of a governmental plan within the 
meaning of section 414(d) or under the terms of a nongovernmental plan 
as in effect on April 17, 2002.

[[Page 229]]

    (c) Additional permitted increases for annuity payments under 
annuity contracts purchased from insurance companies. In the case of 
annuity payments paid from an annuity contract purchased from an 
insurance company, if the total future expected payments (determined in 
accordance with paragraph (e)(3) of this A-14) exceed the total value 
being annuitized (within the meaning of paragraph (e)(1) of this A-14) , 
the payments under the annuity will not fail to satisfy the 
nonincreasing payment requirement in A-1(a) of this section merely 
because the payments are increased in accordance with one or more of the 
following--
    (1) By a constant percentage, applied not less frequently than 
annually;
    (2) To provide a final payment upon the death of the employee that 
does not exceed the excess of the total value being annuitized (within 
the meaning of paragraph (e)(1) of this A-14) over the total of payments 
before the death of the employee;
    (3) As a result of dividend payments or other payments that result 
from actuarial gains (within the meaning of paragraph (e)(2) of this A-
14), but only if actuarial gain is measured no less frequently than 
annually and the resulting dividend payments or other payments are 
either paid no later than the year following the year for which the 
actuarial experience is measured or paid in the same form as the payment 
of the annuity over the remaining period of the annuity (beginning no 
later than the year following the year for which the actuarial 
experience is measured); and
    (4) An acceleration of payments under the annuity (within the 
meaning of paragraph (e)(4) of this A-14).
    (d) Additional permitted increases for annuity payments from a 
qualified trust. In the case of annuity payments paid under a defined 
benefit plan qualified under section 401(a) (other than annuity payments 
under an annuity contract purchased from an insurance company that 
satisfy paragraph (c) of this section), the payments under the annuity 
will not fail to satisfy the nonincreasing payment requirement in A-1(a) 
of this section merely because the payments are increased in accordance 
with one of the following--
    (1) By a constant percentage, applied not less frequently than 
annually, at a rate that is less than 5 percent per year;
    (2) To provide a final payment upon the death of the employee that 
does not exceed the excess of the actuarial present value of the 
employee's accrued benefit (within the meaning of section 411(a)(7)) 
calculated as the annuity starting date using the applicable interest 
rate and the applicable mortality table under section 417(e) (or, if 
greater, the total amount of employee contributions) over the total of 
payments before the death of the employee; or
    (3) As a result of dividend payments or other payments that result 
from actuarial gains (within the meaning of paragraph (e)(2) of this A-
14), but only if--
    (i) Actuarial gain is measured no less frequently than annually;
    (ii) The resulting dividend payments or other payments are either 
paid no later than the year following the year for which the actuarial 
experience is measured or paid in the same form as the payment of the 
annuity over the remaining period of the annuity (beginning no later 
than the year following the year for which the actuarial experience is 
measured);
    (iii) The actuarial gain taken into account is limited to actuarial 
gain from investment experience;
    (iv) The assumed interest used to calculate such actuarial gains is 
not less than 3 percent; and
    (v) The payments are not increasing by a constant percentage as 
described in paragraph (d)(1) of this A-14.
    (e) Definitions. For purposes of this A-14, the following 
definitions apply--
    (1) Total value being annuitized means--
    (i) In the case of annuity payments under a section 403(a) annuity 
plan or under a deferred annuity purchased by a section 401(a) trust, 
the value of the employee's entire interest (within the meaning of A-12 
of this section) being annuitized (valued as of the date annuity 
payments commence);
    (ii) In the case of annuity payments under an immediate annuity 
contract purchased by a trust for a defined benefit plan qualified under 
section 401(a),

[[Page 230]]

the amount of the premium used to purchase the contract; and
    (iii) In the case of a defined contribution plan, the value of the 
employee's account balance used to purchase an immediate annuity under 
the contract.
    (2) Actuarial gain means the difference between an amount determined 
using the actuarial assumptions (i.e., investment return, mortality, 
expense, and other similar assumptions) used to calculate the initial 
payments before adjustment for any increases and the amount determined 
under the actual experience with respect to those factors. Actuarial 
gain also includes differences between the amount determined using 
actuarial assumptions when an annuity was purchased or commenced and 
such amount determined using actuarial assumptions used in calculating 
payments at the time the actuarial gain is determined.
    (3) Total future expected payments means the total future payments 
expected to be made under the annuity contract as of the date of the 
determination, calculated using the Single Life Table in A-1 of Sec. 
1.401(a)(9)-9 (or, if applicable, the Joint and Last Survivor Table in 
A-3 of in Sec. 1.401(a)(9)-9) for annuitants who are still alive, 
without regard to any increases in annuity payments after the date of 
determination, and taking into account any remaining period certain.
    (4) Acceleration of payments means a shortening of the payment 
period with respect to an annuity or a full or partial commutation of 
the future annuity payments. An increase in the payment amount will be 
treated as an acceleration of payments in the annuity only if the total 
future expected payments under the annuity (including the amount of any 
payment made as a result of the acceleration) is decreased as a result 
of the change in payment period.
    (f) Examples. Paragraph (c) of this A-14 is illustrated by the 
following examples:

    Example 1. Variable annuity. A retired participant (Z1) in defined 
contribution plan X attains age 70 on March 5, 2005, and thus, attains 
age 70\1/2\ in 2005. Z1 elects to purchase annuity Contract Y1 from 
Insurance Company W in 2005. Contract Y1 is a single life annuity 
contract with a 10-year period certain. Contract Y1 provides for an 
initial annual payment calculated with an assumed interest rate (AIR) of 
3 percent. Subsequent payments are determined by multiplying the prior 
year's payment by a fraction the numerator of which is 1 plus the actual 
return on the separate account assets underlying Contract Y1 since the 
preceding payment and the denominator of which is 1 plus the AIR during 
that period. The value of Z1's account balance in Plan X at the time of 
purchase is $105,000, and the purchase price of Contract Y1 is $105,000. 
Contract Y1 provides Z1 with an initial payment of $7,200 at the time of 
purchase in 2005. The total future expected payments to Z1 under 
Contract Y1 are $122,400, calculated as the initial payment of $7,200 
multiplied by the age 70 life expectancy of 17 provided in the Single 
Life Table in A-1 of Sec. 1.401(a)(9)-9. Because the total future 
expected payments on the purchase date exceed the total value used to 
purchase Contract Y1 and payments may only increase as a result of 
actuarial gain, with such increases, beginning no later than the next 
year, paid in the same form as the payment of the annuity over the 
remaining period of the annuity, distributions received by Z1 from 
Contract Y1 meet the requirements under paragraph (c)(3) of this A-14.
    Example 2. Participating annuity. A retired participant (Z2) in 
defined contribution plan X attains age 70 on May 1, 2005, and thus, 
attains age 70\1/2\ in 2005. Z2 elects to purchase annuity Contract Y2 
from Insurance Company W in 2005. Contract Y2 is a participating single 
life annuity contract with a 10-year period certain. Contract Y2 
provides for level annual payments with dividends paid in a lump sum in 
the year after the year for which the actuarial experience is measured 
or paid out levelly beginning in the year after the year for which the 
actuarial gain is measured over the remaining lifetime and period 
certain, i.e., the period certain ends at the same time as the original 
period certain. Dividends are determined annually by the Board of 
Directors of Company W based upon a comparison of actual actuarial 
experience to expected actuarial experience in the past year. The value 
of Z2's account balance in Plan X at the time of purchase is $265,000, 
and the purchase price of Contract Y2 is $265,000. Contract Y2 provides 
Z2 with an initial payment of $16,000 in 2005. The total future expected 
payments to Z2 under Contract Y2 are calculated as the annual initial 
payment of $16,000 multiplied by the age 70 life expectancy of 17 
provided in the Single Life Table in A-1 of Sec. 1.401(a)(9)-9 for a 
total of $272,000. Because the total future expected payments on the 
purchase date exceeds the total value used to purchase Contract Y2 and 
payments may only increase as a result of actuarial gain, with such 
increases, beginning no later than the next year, paid in the same form 
as the payment of the annuity over the remaining period of the annuity,

[[Page 231]]

distributions received by Z2 from Contract Y2 meet the requirements 
under paragraph (c)(3) of this A-14.
    Example 3. Participating annuity with dividend accumulation. The 
facts are the same as in Example 2 except that the annuity provides a 
dividend accumulation option under which Z2 may defer receipt of the 
dividends to a time selected by Z2. Because the dividend accumulation 
option permits dividends to be paid later than the end of the year 
following the year for which the actuarial experience is measured or as 
a stream of payments that only increase as a result of actuarial gain, 
with such increases beginning no later than the next year, paid in the 
same form as the payment of the annuity over the remaining period of the 
annuity in Example 2, the dividend accumulation option does not meet the 
requirements of paragraph (c)(3) of this A-14. Neither does the dividend 
accumulation option fit within any of the other increases described in 
paragraph (c) of this A-14. Accordingly, the dividend accumulation 
option causes the contract, and consequently any distributions from the 
contract, to fail to meet the requirements of this A-14 and thus fail to 
satisfy the requirements of section 401(a)(9).
    Example 4. Participating annuity with dividends used to purchase 
additional death benefits. The facts are the same as in Example 2 except 
that the annuity provides an option under which actuarial gain under the 
contract is used to provide additional death benefit protection for Z2. 
Because this option permits payments as a result of actuarial gain to be 
paid later than the end of the year following the year for which the 
actuarial experience is measured or as a stream of payments that only 
increase as a result of actuarial gain, with such increases beginning no 
later than the next year, paid in the same form as the payment of the 
annuity over the remaining period of the annuity in Example 2, the 
option does not meet the requirements of paragraph (c)(3) of this A-14. 
Neither does the option fit within any of the other increases described 
in paragraph (c) of this A-14. Accordingly, the addition of the option 
causes the contract, and consequently any distributions from the 
contract, to fail to meet the requirements of this A-14 and thus fail to 
satisfy the requirements of section 401(a)(9).
    Example 5. Annuity with a fixed percentage increase. A retired 
participant (Z3) in defined contribution plan X attains age 70\1/2\ in 
2005. Z3 elects to purchase annuity contract Y3 from Insurance Company 
W. Contract Y3 is a single life annuity contract with a 20-year period 
certain (which does not exceed the maximum period certain permitted 
under A-3(a) of this section) with fixed annual payments increasing 3 
percent each year. The value of Z3's account balance in Plan X at the 
time of purchase is $110,000, and the purchase price of Contract Y3 is 
$110,000. Contract Y3 provides Z3 with an initial payment of $6,000 at 
the time of purchase in 2005. The total future expected payments to Z3 
under Contract Y3 are $120,000, calculated as the initial annual payment 
of $6,000 multiplied by the period certain of 20 years. Because the 
total future expected payments on the purchase date exceed the total 
value used to purchase Contract Y3 and payments only increase as a 
constant percentage applied not less frequently than annually, 
distributions received by Z3 from Contract Y3 meet the requirements 
under paragraph (c)(1) of this A-14.
    Example 6. Annuity with excessive increases. The facts are the same 
as in Example 5 except that the initial payment is $5,400 and the annual 
rate of increase is 4 percent. In this example, the total future 
expected payments are $108,000, calculated as the initial payment of 
$5,400 multiplied by the period certain of 20 years. Because the total 
future expected payments are less than the total value of $110,000 used 
to purchase Contract Y3, distributions received by Z3 do not meet the 
requirements under paragraph (c) of this A-14 and thus fail to meet the 
requirements of section 401(a)(9).
    Example 7. Annuity with full commutation feature. (i) A retired 
participant (Z4) in defined contribution Plan X attains age 78 in 2005. 
Z4 elects to purchase Contract Y4 from Insurance Company W. Contract Y4 
provides for a single life annuity with a 10 year period certain (which 
does not exceed the maximum period certain permitted under A-3(a) of 
this section) with annual payments. Contract Y4 provides that Z4 may 
cancel Contract Y4 at any time before Z4 attains age 84, and receive, on 
his next payment due date, a final payment in an amount determined by 
multiplying the initial payment amount by a factor obtained from Table M 
of Contract Y4 using the Y4's age as of Y4's birthday in the calendar 
year of the final payment. The value of Z4's account balance in Plan X 
at the time of purchase is $450,000, and the purchase price of Contract 
Y4 is $450,000. Contract Y4 provides Z4 with an initial payment in 2005 
of $40,000. The factors in Table M are as follows:

------------------------------------------------------------------------
                    Age at final payment                        Factor
------------------------------------------------------------------------
79.........................................................         10.5
80.........................................................         10.0
81.........................................................          9.5
82.........................................................          9.0
83.........................................................          8.5
84.........................................................          8.0
------------------------------------------------------------------------

    (ii) The total future expected payments to Z4 under ContractY4 are 
$456,000, calculated as the initial payment of 40,000 multiplied by the 
age 78 life expectancy of 11.4 provided in the Single Life Table in A-1 
of Sec. 1.401(a)(9)-9. Because the total future expected payments

[[Page 232]]

on the purchase date exceed the total value being annuitized (i.e., the 
$450,000 used to purchase Contract Y4), the permitted increases set 
forth in paragraph (c) of this A-14 are available. Furthermore, because 
the factors in Table M are less than the life expectancy of each of the 
ages in the Single Life Table provided in A-1 of Sec. 1.401(a)(9)-9, 
the final payment is always less than the total future expected 
payments. Thus, the final payment is an acceleration of payments within 
the meaning of paragraph (c)(4) of this A-14.
    (iii) As an illustration of the above, if Participant Z4 were to 
elect to cancel Contract Y4 on the day before he was to attain age 84, 
his contractual final payment would be $320,000. This amount is 
determined as $40,000 (the annual payment amount due under Contract Y4) 
multiplied by 8.0 (the factor in Table M for the next payment due date, 
age 84). The total future expected payments under Contract Y4 at age 84 
before the final payment is $324,000, calculated as the initial payment 
amount multiplied by 8.1, the age 84 life expectancy provided in the 
Single Life Table in A-1 of Sec. 1.401(a)(9)-9. Because $320,000 (the 
total future expected payments under the annuity contract, including the 
amount of the final payment) is less than $324,000 (the total future 
expected payments under the annuity contract, determined before the 
election), the final payment is an acceleration of payments within the 
meaning of paragraph (c)(4) of this A-14.
    Example 8. Annuity with partial commutation feature. (i) The facts 
are the same as in Example 7 except that the annuity provides Z4 may 
request, at any time before Z4 attains age 84, an ad hoc payment on his 
next payment due date with future payments reduced by an amount equal to 
the ad hoc payment divided by the factor obtained from Table M (from 
Example 7) corresponding to Z4's age at the time of the ad hoc payment. 
Because, at each age, the factors in Table M are less than the 
corresponding life expectancies in the Single Life Table in A-1 of Sec. 
1.401(a)(9)-9, total future expected payments under Contract Y4 will 
decrease after an ad hoc payment. Thus, ad hoc distributions received by 
Z4 from Contract Y4 will satisfy the requirements under paragraph (c)(4) 
of this A-4.
    (ii) As an illustration of paragraph (i) of this Example 8, if Z4 
were to request, on the day before he was to attain age 84, an ad hoc 
payment of $100,000 on his next payment due date, his recalculated 
annual payment amount would be reduced to $27,500. This amount is 
determined as $40,000 (the amount of Z4's next annual payment) reduced 
by $12,500 (his $100,000 ad hoc payment divided by the Table M factor at 
age 84 of 8.0). Thus, Z4's total future expected payments after the ad 
hoc payment (and including the ad hoc payment) are equal to $322,750 
($100,000 plus $27,500 multiplied by the Single Life Table value of 
8.1). Note that this $322,750 amount is less than the amount of Z4's 
total future expected payments before the ad hoc payment ($324,000, 
determined as $40,000 multiplied by 8.1), and the requirements under 
paragraph (c)(4) of this A-4 are satisfied.
    Example 9. Annuity with excessive increases. (i) A retired 
participant (Z5) in defined contribution plan X attains age 70\1/2\ in 
2005. Z5 elects to purchase annuity Contract Y5 from Insurance Company W 
in 2005 with a premium of $1,000,000. Contract Y5 is a single life 
annuity contract with a 20-year period certain. Contract Y5 provides for 
an initial payment of $200,000, a second payment one year from the time 
of purchase of $40,000, and 18 succeeding annual payments each 
increasing at a constant percentage rate of 4.5 percent from the 
preceding payment.
    (ii) Contract Y5 fails to meet the requirements of section 401(a)(9) 
because the total future expected payments without regard to any 
increases in the annuity payment, calculated as $200,000 in year one and 
$40,000 in each of years two through twenty, is only $960,000 (i.e., an 
amount that does not exceed the total value used to purchase the 
annuity).

    Q-15: Are there special rules applicable to payments made under a 
defined benefit plan or annuity contract to a surviving child?
    A-15: Yes, pursuant to section 401(a)(9)(F), payments under a 
defined benefit plan or annuity contract that are made to an employee's 
child until such child reaches the age of majority (or dies, if earlier) 
may be treated, for purposes of section 401(a)(9), as if such payments 
were made to the surviving spouse to the extent they become payable to 
the surviving spouse upon cessation of the payments to the child. For 
purposes of the preceding sentence, a child may be treated as having not 
reached the age of majority if the child has not completed a specified 
course of education and is under the age of 26. In addition, a child who 
is disabled within the meaning of section 72(m)(7) when the child 
reaches the age of majority may be treated as having not reached the age 
of majority so long as the child continues to be disabled. Thus, when 
payments described in this paragraph A-15 become payable to the 
surviving spouse because the child attains the age of majority, recovers 
from a disabling illness, dies, or completes a specified course of 
education, there is not an increase in benefits under A-1 of this 
section. Likewise, the age of child

[[Page 233]]

receiving such payments is not taken into consideration for purposes of 
the minimum incidental benefit requirement of A-2 of this section.
    Q-16: What are the rules for determining required minimum 
distributions for defined benefit plans and annuity contracts for 
calendar years 2003, 2004, and 2005?
    A-16: A distribution from a defined benefit plan or annuity contract 
for calendar years 2003, 2004, and 2005 will not fail to satisfy section 
401(a)(9) merely because the payments do not satisfy A-1 through A-15 of 
this section, provided the payments satisfy section 401(a)(9) based on a 
reasonable and good faith interpretation of the provisions of section 
401(a)(9).

[T.D. 9130, 69 FR 33293, June 15, 2004; 69 FR 68077, Nov. 23, 2004; T.D. 
9459, 74 FR 45994, Sept. 8, 2009]



Sec. 1.401(a)(9)-7  Rollovers and transfers.

    Q-1. If an amount is distributed by one plan (distributing plan) and 
is rolled over to another plan, is the required minimum distribution 
under the distributing plan affected by the rollover?
    A-1. No, if an amount is distributed by one plan and is rolled over 
to another plan, the amount distributed is still treated as a 
distribution by the distributing plan for purposes of section 401(a)(9), 
notwithstanding the rollover. See A-1 of Sec. 1.402(c)-2 for the 
definition of a rollover and A-7 of Sec. 1.402(c)-2 for rules for 
determining the portion of any distribution that is not eligible for 
rollover because it is a required minimum distribution.
    Q-2. If an amount is distributed by one plan (distributing plan) and 
is rolled over to another plan (receiving plan), how are the benefit and 
the required minimum distribution under the receiving plan affected?
    A-2. If an amount is distributed by one plan (distributing plan) and 
is rolled over to another plan (receiving plan), the benefit of the 
employee under the receiving plan is increased by the amount rolled over 
for purposes of determining the required minimum distribution for the 
calendar year immediately following the calendar year in which the 
amount rolled over is distributed. If the amount rolled over is received 
after the last valuation date in the calendar year under the receiving 
plan, the benefit of the employee as of such valuation date, adjusted in 
accordance with A-3 of Sec. 1.401(a)(9)-5, will be increased by the 
rollover amount valued as of the date of receipt. In addition, if the 
amount rolled over is received in a different calendar year from the 
calendar year in which it is distributed, the amount rolled over is 
deemed to have been received by the receiving plan in the calendar year 
in which it was distributed.
    Q-3. In the case of a transfer of an amount of an employee's benefit 
from one plan (transferor plan) to another plan (transferee plan), are 
there any special rules for satisfying section 401(a)(9) or determining 
the employee's benefit under the transferor plan?
    A-3. (a) In the case of a transfer of an amount of an employee's 
benefit from one plan (transferor plan) to another (transferee plan), 
the transfer is not treated as a distribution by the transferor plan for 
purposes of section 401(a)(9). Instead, the benefit of the employee 
under the transferor plan is decreased by the amount transferred. 
However, if any portion of an employee's benefit is transferred in a 
distribution calendar year with respect to that employee, in order to 
satisfy section 401(a)(9), the transferor plan must determine the amount 
of the required minimum distribution with respect to that employee for 
the calendar year of the transfer using the employee's benefit under the 
transferor plan before the transfer. Additionally, if any portion of an 
employee's benefit is transferred in the employee's second distribution 
calendar year but on or before the employee's required beginning date, 
in order to satisfy section 401(a)(9), the transferor plan must 
determine the amount of the minimum distribution requirement for the 
employee's first distribution calendar year based on the employee's 
benefit under the transferor plan before the transfer. The transferor 
plan may satisfy the minimum distribution requirement for the calendar 
year of the transfer (and the prior year if applicable) by segregating 
the amount which must be distributed from the employee's benefit and not 
transferring that

[[Page 234]]

amount. Such amount may be retained by the transferor plan and must be 
distributed on or before the date required under section 401(a)(9).
    (b) For purposes of determining any required minimum distribution 
for the calendar year immediately following the calendar year in which 
the transfer occurs, in the case of a transfer after the last valuation 
date for the calendar year of the transfer under the transferor plan, 
the benefit of the employee as of such valuation date, adjusted in 
accordance with A-3 of Sec. 1.401(a)(9)-5, will be decreased by the 
amount transferred, valued as of the date of the transfer.
    Q-4. If an amount of an employee's benefit is transferred from one 
plan (transferor plan) to another plan (transferee plan), how are the 
benefit and the required minimum distribution under the transferee plan 
affected?
    A-4. In the case of a transfer from one plan (transferor plan) to 
another (transferee plan), the benefit of the employee under the 
transferee plan is increased by the amount transferred in the same 
manner as if it were a plan receiving a rollover contribution under A-2 
of this section.
    Q-5. How is a spinoff, merger or consolidation (as defined in Sec. 
1.414(l)-1) treated for purposes of determining an employee's benefit 
and required minimum distribution under section 401(a)(9)?
    A-5. For purposes of determining an employee's benefit and required 
minimum distribution under section 401(a)(9), a spinoff, a merger, or a 
consolidation (as defined in Sec. 1.414(l)-1) will be treated as a 
transfer of the benefits of the employees involved. Consequently, the 
benefit and required minimum distribution of each employee involved 
under the transferor and transferee plans will be determined in 
accordance with A-3 and A-4 of this section.

[T.D. 8987, 67 FR 18994, Apr. 17, 2002]



Sec. 1.401(a)(9)-8  Special rules.

    Q-1. What distribution rules apply if an employee is a participant 
in more than one plan?
    A-1. If an employee is a participant in more than one plan, the 
plans in which the employee participates are not permitted to be 
aggregated for purposes of testing whether the distribution requirements 
of section 401(a)(9) are met. The distribution of the benefit of the 
employee under each plan must separately meet the requirements of 
section 401(a)(9). For this purpose, a plan described in section 414(k) 
is treated as two separate plans, a defined contribution plan to the 
extent benefits are based on an individual account and a defined benefit 
plan with respect to the remaining benefits.
    Q-2. If an employee's benefit under a defined contribution plan is 
divided into separate accounts (or under a defined benefit plan is 
divided into segregated shares), do the distribution rules in section 
401(a)(9) and these regulations apply separately to each separate 
account?
    A-2. (a) Defined contribution plan. (1) Except as otherwise provided 
in this A-2, if an employee's benefit under a defined contribution plan 
is divided into separate accounts under the plan, the separate accounts 
will be aggregated for purposes of satisfying the rules in section 
401(a)(9). Thus, except as otherwise provided in this A-2, all separate 
accounts, including a separate account for employee contributions under 
section 72(d)(2), will be aggregated for purposes of section 401(a)(9).
    (2) If the employee's benefit in a defined contribution plan is 
divided into separate accounts and the beneficiaries with respect to one 
separate account differ from the beneficiaries with respect to the other 
separate accounts of the employee under the plan, for years subsequent 
to the calendar year containing the date as of which the separate 
accounts were established, or date of death if later, such separate 
account under the plan is not aggregated with the other separate 
accounts under the plan in order to determine whether the distributions 
from such separate account under the plan satisfy section 401(a)(9). 
Instead, the rules in section 401(a)(9) separately apply to such 
separate account under the plan. However, the applicable distribution 
period for each such separate account is determined disregarding the 
other beneficiaries of the employee's benefit only if the separate 
account is established on a date no later than the last day of

[[Page 235]]

the year following the calendar year of the employee's death. For 
example, if, in the case of a distribution described in section 
401(a)(9)(B)(iii) and (iv), the only beneficiary of a separate account 
under the plan established on a date no later than the end of the year 
following the calendar year of the employee's death is the employee's 
surviving spouse, and beneficiaries other than the surviving spouse are 
designated with respect to the other separate accounts with respect to 
the employee, distribution of the spouse's separate account under the 
plan need not commence until the date determined under the first 
sentence in A-3(b) of Sec. 1.401(a)(9)-3, even if distribution of the 
other separate accounts under the plan must commence at an earlier date. 
Similarly, in the case of a distribution after the death of an employee 
to which section 401(a)(9)(B)(i) does not apply, distribution from a 
separate account of an employee established on a date no later than the 
end of the year following the year of the employee's death may be made 
over a beneficiary's life expectancy in accordance with section 
401(a)(9)(B)(iii) and (iv) even though distributions from other separate 
accounts under the plan with different beneficiaries are being made in 
accordance with the 5-year rule in section 401(a)(9)(B)(ii).
    (3) A portion of an employee's account balance under a defined 
contribution plan is permitted to be used to purchase an annuity 
contract while another portion stays in the account. In that case, the 
remaining account under the plan must be distributed in accordance with 
Sec. 1.401(a)(9)-5 in order to satisfy section 401(a)(9) and the 
annuity payments under the annuity contract must satisfy Sec. 
1.401(a)(9)-6 in order to satisfy section 401(a)(9).
    (b) Defined benefit plan. The rules of paragraph (a)(2) and (3) of 
this A-2 also apply to benefits under a defined benefit plan where the 
benefits under the plan are separated into separate identifiable 
components which are separately distributed.
    Q-3. What are separate accounts for purposes of section 401(a)(9)?
    A-3. For purposes of section 401(a)(9), separate accounts in an 
employee's account are separate portions of an employee's benefit 
reflecting the separate interests of the employee's beneficiaries under 
the plan as of the date of the employee's death for which separate 
accounting is maintained. The separate accounting must allocate all 
post-death investment gains and losses, contributions, and forfeitures, 
for the period prior to the establishment of the separate accounts on a 
pro rata basis in a reasonable and consistent manner among the separate 
accounts. However, once the separate accounts are actually established, 
the separate accounting can provide for separate investments for each 
separate account under which gains and losses from the investment of the 
account are only allocated to that account, or investment gain or losses 
can continue to be allocated among the separate accounts on a pro rata 
basis. A separate accounting must allocate any post-death distribution 
to the separate account of the beneficiary receiving that distribution.
    Q-4. If a distribution is required to be made to an employee by 
section 401(a)(9)(A) or is required to be made to a surviving spouse 
under section 401(a)(9)(B), must the distribution be made even if the 
employee, or spouse where applicable, fails to consent to a distribution 
while a benefit is immediately distributable?
    A-4. Yes, section 411(a)(11) and section 417(e) (see Sec. Sec. 
1.411(a)(11)-1(c)(2) and 1.417(e)-1(c)) require employee and spousal 
consent to certain distributions of plan benefits while such benefits 
are immediately distributable. If an employee's normal retirement age is 
later than the employee's required beginning date and, therefore, 
benefits are still immediately distributable, the plan must, 
nevertheless, distribute plan benefits to the employee (or where 
applicable, to the spouse) in a manner that satisfies the requirements 
of section 401(a)(9). Section 401(a)(9) must be satisfied even though 
the employee (or spouse, where applicable) fails to consent to the 
distribution. In such a case, the plan may distribute in the form of a 
qualified joint and survivor annuity (QJSA) or in the form of a 
qualified preretirement survivor annuity (QPSA), as applicable, and the 
consent requirements of sections 411(a)(11) and 417(e) are deemed to be 
satisfied if the

[[Page 236]]

plan has made reasonable efforts to obtain consent from the employee (or 
spouse if applicable) and if the distribution otherwise meets the 
requirements of section 417. If, because of section 401(a)(11)(B), the 
plan is not required to distribute in the form of a QJSA to an employee 
or a QPSA to a surviving spouse, the plan may distribute the required 
minimum distribution amount to satisfy section 401(a)(9) and the consent 
requirements of sections 411(a)(11) and 417(e) are deemed to be 
satisfied if the plan has made reasonable efforts to obtain consent from 
the employee (or spouse if applicable) and if the distribution otherwise 
meets the requirements of section 417.
    Q-5. Who is an employee's spouse or surviving spouse for purposes of 
section 401(a)(9)?
    A-5. Except as otherwise provided in A-6(a) of this section (in the 
case of distributions of a portion of an employee's benefit payable to a 
former spouse of an employee pursuant to a qualified domestic relations 
order), for purposes of section 401(a)(9), an individual is a spouse or 
surviving spouse of an employee if such individual is treated as the 
employee's spouse under applicable state law. In the case of 
distributions after the death of an employee, for purposes of 
determining whether, under the life expectancy rule in section 
401(a)(9)(B)(iii) and (iv), the provisions of section 401(a)(9)(B)(iv) 
apply, the spouse of the employee is determined as of the date of death 
of the employee.
    Q-6. In order to satisfy section 401(a)(9), are there any special 
rules which apply to the distribution of all or a portion of an 
employee's benefit payable to an alternate payee pursuant to a qualified 
domestic relations order as defined in section 414(p) (QDRO)?
    A-6. (a) A former spouse to whom all or a portion of the employee's 
benefit is payable pursuant to a QDRO will be treated as a spouse 
(including a surviving spouse) of the employee for purposes of section 
401(a)(9), including the minimum distribution incidental benefit 
requirement, regardless of whether the QDRO specifically provides that 
the former spouse is treated as the spouse for purposes of sections 
401(a)(11) and 417.
    (b)(1) If a QDRO provides that an employee's benefit is to be 
divided and a portion is to be allocated to an alternate payee, such 
portion will be treated as a separate account (or segregated share) 
which separately must satisfy the requirements of section 401(a)(9) and 
may not be aggregated with other separate accounts (or segregated 
shares) of the employee for purposes of satisfying section 401(a)(9). 
Except as otherwise provided in paragraph (b)(2) of this A-6, 
distribution of such separate account allocated to an alternate payee 
pursuant to a QDRO must be made in accordance with section 401(a)(9). 
For example, in general, distribution of such account will satisfy 
section 401(a)(9)(A) if required minimum distributions from such account 
during the employee's lifetime begin not later than the employee's 
required beginning date and the required minimum distribution is 
determined in accordance with Sec. 1.401(a)(9)-5 for each distribution 
calendar year (using an applicable distribution period determined under 
A-4 of Sec. 1.401(a)(9)-5 for the employee in the distribution calendar 
year either using the Uniform Lifetime Table in A-2 of Sec. 
1.401(a)(9)-9 or using the joint life expectancy of the employee and a 
spousal alternate payee in the distribution calendar year if the spousal 
alternate payee is more than 10 years younger than the employee). The 
determination of whether distribution from such account after the death 
of the employee to the alternate payee will be made in accordance with 
section 401(a)(9)(B)(i) or section 401(a)(9)(B)(ii) or (iii) and (iv) 
will depend on whether distributions have begun as determined under A-6 
of Sec. 1.401(a)(9)-2 (which provides, in general, that distributions 
are not treated as having begun until the employee's required beginning 
date even though payments may actually have begun before that date). For 
example, if the alternate payee dies before the employee and 
distribution of the separate account allocated to the alternate payee 
pursuant to the QDRO is to be made to the alternate payee's beneficiary, 
such beneficiary may be treated as a designated beneficiary for purposes 
of determining the minimum distribution required from such account after 
the

[[Page 237]]

death of the employee if the beneficiary of the alternate payee is an 
individual and if such beneficiary is a beneficiary under the plan or 
specified to or in the plan. Specification in or pursuant to the QDRO is 
treated as specification to the plan.
    (2) Distribution of the separate account allocated to an alternate 
payee pursuant to a QDRO will satisfy the requirements of section 
401(a)(9)(A)(ii) if such account is to be distributed, beginning not 
later than the employee's required beginning date, over the life of the 
alternate payee (or over a period not extending beyond the life 
expectancy of the alternate payee). Also, if the plan permits the 
employee to elect whether distribution upon the death of the employee 
will be made in accordance with the 5-year rule in section 
401(a)(9)(B)(ii) or the life expectancy rule in section 
401(a)(9)(B)(iii) and (iv) pursuant to A-4(c) of Sec. 1.401(a)(9)-3, 
such election is to be made only by the alternate payee for purposes of 
distributing the separate account allocated to the alternate payee 
pursuant to the QDRO. If the alternate payee dies after distribution of 
the separate account allocated to the alternate payee pursuant to a QDRO 
has begun (determined under A-6 of Sec. 1.401(a)(9)-2) but before the 
employee dies, distribution of the remaining portion of that portion of 
the benefit allocated to the alternate payee must be made in accordance 
with the rules in Sec. 1.401(a)(9)-5 or 1.401(a)(9)-6 for distributions 
during the life of the employee. Only after the death of the employee is 
the amount of the required minimum distribution determined in accordance 
with the rules of section 401(a)(9)(B).
    (c) If a QDRO does not provide that an employee's benefit is to be 
divided but provides that a portion of an employee's benefit (otherwise 
payable to the employee) is to be paid to an alternate payee, such 
portion will not be treated as a separate account (or segregated share) 
of the employee. Instead, such portion will be aggregated with any 
amount distributed to the employee and will be treated as having been 
distributed to the employee for purposes of determining whether section 
401(a)(9) has been satisfied with respect to that employee.
    Q-7. Will a plan fail to satisfy section 401(a)(9) merely because it 
fails to distribute an amount otherwise required to be distributed by 
section 401(a)(9) during the period in which the issue of whether a 
domestic relations order is a QDRO is being determined?
    A-7. A plan will not fail to satisfy section 401(a)(9) merely 
because it fails to distribute an amount otherwise required to be 
distributed by section 401(a)(9) during the period in which the issue of 
whether a domestic relations order is a QDRO is being determined 
pursuant to section 414(p)(7), provided that the period does not extend 
beyond the 18-month period described in section 414(p)(7)(E). To the 
extent that a distribution otherwise required under section 401(a)(9) is 
not made during this period, any segregated amounts, as defined in 
section 414(p)(7)(A), will be treated as though the amounts are not 
vested during the period and any distributions with respect to such 
amounts must be made under the relevant rules for nonvested benefits 
described in either A-8 of Sec. 1.401(a)(9)-5 or A-6 of Sec. 
1.401(a)(9)-6, as applicable.
    Q-8. Will a plan fail to satisfy section 401(a)(9) where an 
individual's distribution from the plan is less than the amount 
otherwise required to satisfy section 401(a)(9) because distributions 
were being paid under an annuity contract issued by a life insurance 
company in state insurer delinquency proceedings and have been reduced 
or suspended by reasons of such state proceedings?
    A-8. A plan will not fail to satisfy section 401(a)(9) merely 
because an individual's distribution from the plan is less than the 
amount otherwise required to satisfy section 401(a)(9) because 
distributions were being paid under an annuity contract issued by a life 
insurance company in state insurer delinquency proceedings and have been 
reduced or suspended by reasons of such state proceedings. To the extent 
that a distribution otherwise required under section 401(a)(9) is not 
made during the state insurer delinquency proceedings, this amount and 
any additional amount accrued during this period will be treated as 
though such amounts are not vested during the period and any 
distributions with respect

[[Page 238]]

to such amounts must be made under the relevant rules for nonvested 
benefits described in either A-8 of Sec. 1.401(a)(9)-5 or A-6 of Sec. 
1.401(a)(9)-6, as applicable.
    Q-9. Will a plan fail to qualify as a pension plan within the 
meaning of section 401(a) solely because the plan permits distributions 
to commence to an employee on or after April 1 of the calendar year 
following the calendar year in which the employee attains age 70\1/2\ 
even though the employee has not retired or attained the normal 
retirement age under the plan as of the date on which such distributions 
commence?
    A-9. No, a plan will not fail to qualify as a pension plan within 
the meaning of section 401(a) solely because the plan permits 
distributions to commence to an employee on or after April 1 of the 
calendar year following the calendar year in which the employee attains 
age 70\1/2\ even though the employee has not retired or attained the 
normal retirement age under the plan as of the date on which such 
distributions commence. This rule applies without regard to whether the 
employee is a 5-percent owner with respect to the plan year ending in 
the calendar year in which distributions commence.
    Q-10. Is the distribution of an annuity contract a distribution for 
purposes of section 401(a)(9)?
    A-10. No, the distribution of an annuity contract is not a 
distribution for purposes of section 401(a)(9).
    Q-11. Will a payment by a plan after the death of an employee fail 
to be treated as a distribution for purposes of section 401(a)(9) solely 
because it is made to an estate or a trust?
    A-11. A payment by a plan after the death of an employee will not 
fail to be treated as a distribution for purposes of section 401(a)(9) 
solely because it is made to an estate or a trust. As a result, the 
estate or trust which receives a payment from a plan after the death of 
an employee need not distribute the amount of such payment to the 
beneficiaries of the estate or trust in accordance with section 
401(a)(9)(B). Pursuant to A-3 of Sec. 1.401(a)(9)-4, an estate may not 
be a designated beneficiary. Thus, pursuant to A-4 of Sec. 1.401(a)(9)-
3, distribution to the estate must satisfy the 5-year rule in section 
401(a)(9)(B)(iii) if the distribution to the employee had not begun (as 
defined in A-6 of Sec. 1.401(a)(9)-2) as of the employee's date of 
death. However, see A-5 and A-6 of Sec. 1.401(a)(9)-4 for provisions 
under which beneficiaries of a trust with respect to the trust's 
interest in an employee's benefit are treated as having been designated 
as beneficiaries of the employee under the plan.
    Q-12. Will a plan fail to satisfy section 411(d)(6) if the plan is 
amended to eliminate the availability of an optional form of benefit to 
the extent that the optional form does not satisfy section 401(a)(9)?
    A-12. No, pursuant to section 411(d)(6)(B), a plan will not fail to 
satisfy section 411(d)(6) merely because the plan is amended to 
eliminate the availability of an optional form of benefit to the extent 
that the optional form does not satisfy section 401(a)(9). (See also A-3 
of Sec. 1.401(a)(9)-1, which requires a plan to provide that, 
notwithstanding any other plan provision, it will not distribute 
benefits under any option that does not satisfy section 401(a)(9).)
    Q-13. Is a plan disqualified merely because it pays benefits under a 
designation made before January 1, 1984, in accordance with section 
242(b)(2) of the Tax Equity and Fiscal Responsibility Act (TEFRA)?
    A-13. No, even though the distribution requirements added by TEFRA 
were retroactively repealed by the Tax Reform Act of 1984 (TRA of 1984), 
the transitional election rule in section 242(b) of TEFRA was preserved. 
Satisfaction of the spousal consent requirements of section 417(a) and 
(e) (added by the Retirement Equity Act of 1984) will not be considered 
a revocation of the pre-1984 designation. However, sections 401(a)(11) 
and 417 must be satisfied with respect to any distribution subject to 
those sections. The election provided in section 242(b) of TEFRA is 
hereafter referred to as a section 242(b)(2) election.
    Q-14. If an amount is transferred from one plan (transferor plan) to 
another plan (transferee plan), may the transferee plan distribute the 
amount

[[Page 239]]

transferred in accordance with a section 242(b)(2) election made under 
either the transferor plan or under the transferee plan?
    A-14. (a) If an amount is transferred from one plan (transferor 
plan) to another plan (transferee plan), the amount transferred may be 
distributed in accordance with a section 242(b)(2) election made under 
the transferor plan if the employee did not elect to have the amount 
transferred and if the amount transferred is separately accounted for by 
the transferee plan. However, only the benefit attributable to the 
amount transferred, plus earnings thereon, may be distributed in 
accordance with the section 242(b)(2) election made under the transferor 
plan. If the employee elected to have the amount transferred, the 
transfer will be treated as a distribution and rollover of the amount 
transferred for purposes of this section.
    (b) In the case in which an amount is transferred from one plan to 
another plan, the amount transferred may not be distributed in 
accordance with a section 242(b)(2) election made under the transferee 
plan. If a section 242(b)(2) election was made under the transferee 
plan, the amount transferred must be separately accounted for. If the 
amount transferred is not separately accounted for under the transferee 
plan, the section 242(b)(2) election under the transferee plan is 
revoked and section 401(a)(9) will apply to subsequent distributions by 
the transferee plan.
    (c) A merger, spinoff, or consolidation, as defined in Sec. 
1.414(l)-1(b), will be treated as a transfer for purposes of the section 
242(b)(2) election.
    Q-15. If an amount is distributed by one plan (distributing plan) 
and rolled over into another plan (receiving plan), may the receiving 
plan distribute the amount rolled over in accordance with a section 
242(b)(2) election made under either the distributing plan or the 
receiving plan?
    A-15. No, if an amount is distributed by one plan (distributing 
plan) and rolled over into another plan (receiving plan), the receiving 
plan must distribute the amount rolled over in accordance with section 
401(a)(9) whether or not the employee made a section 242(b)(2) election 
under the distributing plan. Further, if the amount rolled over was not 
distributed in accordance with the election, the election under the 
distributing plan is revoked and section 401(a)(9) will apply to all 
subsequent distributions by the distributing plan. Finally, if the 
employee made a section 242(b)(2) election under the receiving plan and 
such election is still in effect, the amount rolled over must be 
separately accounted for under the receiving plan and distributed in 
accordance with section 401(a)(9). If amounts rolled over are not 
separately accounted for, any section 242(b)(2) election under the 
receiving plan is revoked and section 401(a)(9) will apply to subsequent 
distributions by the receiving plan.
    Q-16. May a section 242(b)(2) election be revoked after the date by 
which distributions are required to commence in order to satisfy section 
401(a)(9) and this section of the regulations?
    A-16. Yes, a section 242(b)(2) election may be revoked after the 
date by which distributions are required to commence in order to satisfy 
section 401(a)(9) and this section of the regulations. However, if the 
section 242(b)(2) election is revoked after the date by which 
distributions are required to commence in order to satisfy section 
401(a)(9) and this section of the regulations and the total amount of 
the distributions which would have been required to be made prior to the 
date of the revocation in order to satisfy section 401(a)(9), but for 
the section 242(b)(2) election, have not been made, the plan must 
distribute by the end of the calendar year following the calendar year 
in which the revocation occurs the total amount not yet distributed 
which was required to have been distributed to satisfy the requirements 
of section 401(a)(9) and continue distributions in accordance with such 
requirements.

[T.D. 8987, 67 FR 18994, Apr. 17, 2002, as amended by T.D. 9130, 69 FR 
33293, 33302, June 15, 2004]



Sec. 1.401(a)(9)-9  Life expectancy and distribution period tables.

    Q-1. What is the life expectancy for an individual for purposes of 
determining required minimum distributions under section 401(a)(9)?

[[Page 240]]

    A-1 The following table, referred to as the Single Life Table, is 
used for determining the life expectancy of an individual:

                            Single Life Table
------------------------------------------------------------------------
                                                                 Life
                            Age                               expectancy
------------------------------------------------------------------------
 0.........................................................         82.4
 1.........................................................         81.6
 2.........................................................         80.6
 3.........................................................         79.7
 4.........................................................         78.7
 5.........................................................         77.7
 6.........................................................         76.7
 7.........................................................         75.8
 8.........................................................         74.8
 9.........................................................         73.8
10.........................................................         72.8
11.........................................................         71.8
12.........................................................         70.8
13.........................................................         69.9
14.........................................................         68.9
15.........................................................         67.9
16.........................................................         66.9
17.........................................................         66.0
18.........................................................         65.0
19.........................................................         64.0
20.........................................................         63.0
21.........................................................         62.1
22.........................................................         61.1
23.........................................................         60.1
24.........................................................         59.1
25.........................................................         58.2
26.........................................................         57.2
27.........................................................         56.2
28.........................................................         55.3
29.........................................................         54.3
30.........................................................         53.3
31.........................................................         52.4
32.........................................................         51.4
33.........................................................         50.4
34.........................................................         49.4
35.........................................................         48.5
36.........................................................         47.5
37.........................................................         46.5
38.........................................................         45.6
39.........................................................         44.6
40.........................................................         43.6
41.........................................................         42.7
42.........................................................         41.7
43.........................................................         40.7
44.........................................................         39.8
45.........................................................         38.8
46.........................................................         37.9
47.........................................................         37.0
48.........................................................         36.0
49.........................................................         35.1
50.........................................................         34.2
51.........................................................         33.3
52.........................................................         32.3
53.........................................................         31.4
54.........................................................         30.5
55.........................................................         29.6
56.........................................................         28.7
57.........................................................         27.9
58.........................................................         27.0
59.........................................................         26.1
60.........................................................         25.2
61.........................................................         24.4
62.........................................................         23.5
63.........................................................         22.7
64.........................................................         21.8
65.........................................................         21.0
66.........................................................         20.2
67.........................................................         19.4
68.........................................................         18.6
69.........................................................         17.8
70.........................................................         17.0
71.........................................................         16.3
72.........................................................         15.5
73.........................................................         14.8
74.........................................................         14.1
75.........................................................         13.4
76.........................................................         12.7
77.........................................................         12.1
78.........................................................         11.4
79.........................................................         10.8
80.........................................................         10.2
81.........................................................          9.7
82.........................................................          9.1
83.........................................................          8.6
84.........................................................          8.1
85.........................................................          7.6
86.........................................................          7.1
87.........................................................          6.7
88.........................................................          6.3
89.........................................................          5.9
90.........................................................          5.5
91.........................................................          5.2
92.........................................................          4.9
93.........................................................          4.6
94.........................................................          4.3
95.........................................................          4.1
96.........................................................          3.8
97.........................................................          3.6
98.........................................................          3.4
99.........................................................          3.1
100........................................................          2.9
101........................................................          2.7
102........................................................          2.5
103........................................................          2.3
104........................................................          2.1
105........................................................          1.9
106........................................................          1.7
107........................................................          1.5
108........................................................          1.4
109........................................................          1.2
110........................................................          1.1
111+.......................................................          1.0
------------------------------------------------------------------------

    Q-2. What is the applicable distribution period for an individual 
account for purposes of determining required minimum distributions 
during an employee's lifetime under section 401(a)(9)?
    A-2. Table for determining distribution period. The following table, 
referred to as the Uniform Lifetime Table, is used for determining the 
distribution period for lifetime distributions to an employee in 
situations in which the employee's spouse is either not the sole 
designated beneficiary or is the sole designated beneficiary but is not 
more than 10 years younger than the employee.

[[Page 241]]



                         Uniform Lifetime Table
------------------------------------------------------------------------
                                                           Distribution
                     Age of employee                          period
------------------------------------------------------------------------
70......................................................            27.4
71......................................................            26.5
72......................................................            25.6
73......................................................            24.7
74......................................................            23.8
75......................................................            22.9
76......................................................            22.0
77......................................................            21.2
78......................................................            20.3
79......................................................            19.5
80......................................................            18.7
81......................................................            17.9
82......................................................            17.1
83......................................................            16.3
84......................................................            15.5
85......................................................            14.8
86......................................................            14.1
87......................................................            13.4
88......................................................            12.7
89......................................................            12.0
90......................................................            11.4
91......................................................            10.8
92......................................................            10.2
93......................................................             9.6
94......................................................             9.1
95......................................................             8.6
96......................................................             8.1
97......................................................             7.6
98......................................................             7.1
99......................................................             6.7
100.....................................................             6.3
101.....................................................             5.9
102.....................................................             5.5
103.....................................................             5.2
104.....................................................             4.9
105.....................................................             4.5
106.....................................................             4.2
107.....................................................             3.9
108.....................................................             3.7
109.....................................................             3.4
110.....................................................             3.1
111.....................................................             2.9
112.....................................................             2.6
113.....................................................             2.4
114.....................................................             2.1
115+....................................................             1.9
------------------------------------------------------------------------

    Q-3. What is the joint life and last survivor expectancy of an 
individual and beneficiary for purposes of determining required minimum 
distributions under section 401(a)(9)?
    A-3. The following table, referred to as the Joint and Last Survivor 
Table, is used for determining the joint and last survivor life 
expectancy of two individuals:

                                                              Joint and Last Survivor Table
--------------------------------------------------------------------------------------------------------------------------------------------------------
                             Ages                                  0        1        2        3        4        5        6        7        8        9
--------------------------------------------------------------------------------------------------------------------------------------------------------
0.............................................................     90.0     89.5     89.0     88.6     88.2     87.8     87.4     87.1     86.8     86.5
1.............................................................     89.5     89.0     88.5     88.1     87.6     87.2     86.8     86.5     86.1     85.8
2.............................................................     89.0     88.5     88.0     87.5     87.1     86.6     86.2     85.8     85.5     85.1
3.............................................................     88.6     88.1     87.5     87.0     86.5     86.1     85.6     85.2     84.8     84.5
4.............................................................     88.2     87.6     87.1     86.5     86.0     85.5     85.1     84.6     84.2     83.8
5.............................................................     87.8     87.2     86.6     86.1     85.5     85.0     84.5     84.1     83.6     83.2
6.............................................................     87.4     86.8     86.2     85.6     85.1     84.5     84.0     83.5     83.1     82.6
7.............................................................     87.1     86.5     85.8     85.2     84.6     84.1     83.5     83.0     82.5     82.1
8.............................................................     86.8     86.1     85.5     84.8     84.2     83.6     83.1     82.5     82.0     81.6
9.............................................................     86.5     85.8     85.1     84.5     83.8     83.2     82.6     82.1     81.6     81.0
10............................................................     86.2     85.5     84.8     84.1     83.5     82.8     82.2     81.6     81.1     80.6
11............................................................     85.9     85.2     84.5     83.8     83.1     82.5     81.8     81.2     80.7     80.1
12............................................................     85.7     84.9     84.2     83.5     82.8     82.1     81.5     80.8     80.2     79.7
13............................................................     85.4     84.7     84.0     83.2     82.5     81.8     81.1     80.5     79.9     79.2
14............................................................     85.2     84.5     83.7     83.0     82.2     81.5     80.8     80.1     79.5     78.9
15............................................................     85.0     84.3     83.5     82.7     82.0     81.2     80.5     79.8     79.1     78.5
16............................................................     84.9     84.1     83.3     82.5     81.7     81.0     80.2     79.5     78.8     78.1
17............................................................     84.7     83.9     83.1     82.3     81.5     80.7     80.0     79.2     78.5     77.8
18............................................................     84.5     83.7     82.9     82.1     81.3     80.5     79.7     79.0     78.2     77.5
19............................................................     84.4     83.6     82.7     81.9     81.1     80.3     79.5     78.7     78.0     77.3
20............................................................     84.3     83.4     82.6     81.8     80.9     80.1     79.3     78.5     77.7     77.0
21............................................................     84.1     83.3     82.4     81.6     80.8     79.9     79.1     78.3     77.5     76.8
22............................................................     84.0     83.2     82.3     81.5     80.6     79.8     78.9     78.1     77.3     76.5
23............................................................     83.9     83.1     82.2     81.3     80.5     79.6     78.8     77.9     77.1     76.3
24............................................................     83.8     83.0     82.1     81.2     80.3     79.5     78.6     77.8     76.9     76.1
25............................................................     83.7     82.9     82.0     81.1     80.2     79.3     78.5     77.6     76.8     75.9
26............................................................     83.6     82.8     81.9     81.0     80.1     79.2     78.3     77.5     76.6     75.8
27............................................................     83.6     82.7     81.8     80.9     80.0     79.1     78.2     77.4     76.5     75.6
28............................................................     83.5     82.6     81.7     80.8     79.9     79.0     78.1     77.2     76.4     75.5
29............................................................     83.4     82.6     81.6     80.7     79.8     78.9     78.0     77.1     76.2     75.4
30............................................................     83.4     82.5     81.6     80.7     79.7     78.8     77.9     77.0     76.1     75.2
31............................................................     83.3     82.4     81.5     80.6     79.7     78.8     77.8     76.9     76.0     75.1
32............................................................     83.3     82.4     81.5     80.5     79.6     78.7     77.8     76.8     75.9     75.0
33............................................................     83.2     82.3     81.4     80.5     79.5     78.6     77.7     76.8     75.9     74.9
34............................................................     83.2     82.3     81.3     80.4     79.5     78.5     77.6     76.7     75.8     74.9
35............................................................     83.1     82.2     81.3     80.4     79.4     78.5     77.6     76.6     75.7     74.8

[[Page 242]]

 
36............................................................     83.1     82.2     81.3     80.3     79.4     78.4     77.5     76.6     75.6     74.7
37............................................................     83.0     82.2     81.2     80.3     79.3     78.4     77.4     76.5     75.6     74.6
38............................................................     83.0     82.1     81.2     80.2     79.3     78.3     77.4     76.4     75.5     74.6
39............................................................     83.0     82.1     81.1     80.2     79.2     78.3     77.3     76.4     75.5     74.5
40............................................................     82.9     82.1     81.1     80.2     79.2     78.3     77.3     76.4     75.4     74.5
41............................................................     82.9     82.0     81.1     80.1     79.2     78.2     77.3     76.3     75.4     74.4
42............................................................     82.9     82.0     81.1     80.1     79.1     78.2     77.2     76.3     75.3     74.4
43............................................................     82.9     82.0     81.0     80.1     79.1     78.2     77.2     76.2     75.3     74.3
44............................................................     82.8     81.9     81.0     80.0     79.1     78.1     77.2     76.2     75.2     74.3
45............................................................     82.8     81.9     81.0     80.0     79.1     78.1     77.1     76.2     75.2     74.3
46............................................................     82.8     81.9     81.0     80.0     79.0     78.1     77.1     76.1     75.2     74.2
47............................................................     82.8     81.9     80.9     80.0     79.0     78.0     77.1     76.1     75.2     74.2
48............................................................     82.8     81.9     80.9     80.0     79.0     78.0     77.1     76.1     75.1     74.2
49............................................................     82.7     81.8     80.9     79.9     79.0     78.0     77.0     76.1     75.1     74.1
50............................................................     82.7     81.8     80.9     79.9     79.0     78.0     77.0     76.0     75.1     74.1
51............................................................     82.7     81.8     80.9     79.9     78.9     78.0     77.0     76.0     75.1     74.1
52............................................................     82.7     81.8     80.9     79.9     78.9     78.0     77.0     76.0     75.0     74.1
53............................................................     82.7     81.8     80.8     79.9     78.9     77.9     77.0     76.0     75.0     74.0
54............................................................     82.7     81.8     80.8     79.9     78.9     77.9     76.9     76.0     75.0     74.0
55............................................................     82.6     81.8     80.8     79.8     78.9     77.9     76.9     76.0     75.0     74.0
56............................................................     82.6     81.7     80.8     79.8     78.9     77.9     76.9     75.9     75.0     74.0
57............................................................     82.6     81.7     80.8     79.8     78.9     77.9     76.9     75.9     75.0     74.0
58............................................................     82.6     81.7     80.8     79.8     78.8     77.9     76.9     75.9     74.9     74.0
59............................................................     82.6     81.7     80.8     79.8     78.8     77.9     76.9     75.9     74.9     74.0
60............................................................     82.6     81.7     80.8     79.8     78.8     77.8     76.9     75.9     74.9     73.9
61............................................................     82.6     81.7     80.8     79.8     78.8     77.8     76.9     75.9     74.9     73.9
62............................................................     82.6     81.7     80.7     79.8     78.8     77.8     76.9     75.9     74.9     73.9
63............................................................     82.6     81.7     80.7     79.8     78.8     77.8     76.8     75.9     74.9     73.9
64............................................................     82.5     81.7     80.7     79.8     78.8     77.8     76.8     75.9     74.9     73.9
65............................................................     82.5     81.7     80.7     79.8     78.8     77.8     76.8     75.8     74.9     73.9
66............................................................     82.5     81.7     80.7     79.7     78.8     77.8     76.8     75.8     74.9     73.9
67............................................................     82.5     81.7     80.7     79.7     78.8     77.8     76.8     75.8     74.9     73.9
68............................................................     82.5     81.6     80.7     79.7     78.8     77.8     76.8     75.8     74.8     73.9
69............................................................     82.5     81.6     80.7     79.7     78.8     77.8     76.8     75.8     74.8     73.9
70............................................................     82.5     81.6     80.7     79.7     78.8     77.8     76.8     75.8     74.8     73.9
71............................................................     82.5     81.6     80.7     79.7     78.7     77.8     76.8     75.8     74.8     73.8
72............................................................     82.5     81.6     80.7     79.7     78.7     77.8     76.8     75.8     74.8     73.8
73............................................................     82.5     81.6     80.7     79.7     78.7     77.8     76.8     75.8     74.8     73.8
74............................................................     82.5     81.6     80.7     79.7     78.7     77.8     76.8     75.8     74.8     73.8
75............................................................     82.5     81.6     80.7     79.7     78.7     77.8     76.8     75.8     74.8     73.8
76............................................................     82.5     81.6     80.7     79.7     78.7     77.8     76.8     75.8     74.8     73.8
77............................................................     82.5     81.6     80.7     79.7     78.7     77.7     76.8     75.8     74.8     73.8
78............................................................     82.5     81.6     80.7     79.7     78.7     77.7     76.8     75.8     74.8     73.8
79............................................................     82.5     81.6     80.7     79.7     78.7     77.7     76.8     75.8     74.8     73.8
80............................................................     82.5     81.6     80.7     79.7     78.7     77.7     76.8     75.8     74.8     73.8
81............................................................     82.4     81.6     80.7     79.7     78.7     77.7     76.8     75.8     74.8     73.8
82............................................................     82.4     81.6     80.7     79.7     78.7     77.7     76.8     75.8     74.8     73.8
83............................................................     82.4     81.6     80.7     79.7     78.7     77.7     76.8     75.8     74.8     73.8
84............................................................     82.4     81.6     80.7     79.7     78.7     77.7     76.8     75.8     74.8     73.8
85............................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.8     75.8     74.8     73.8
86............................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
87............................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
88............................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
89............................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
90............................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
91............................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
92............................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
93............................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
94............................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
95............................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
96............................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
97............................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
98............................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
99............................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
100...........................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
101...........................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
102...........................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
103...........................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
104...........................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
105...........................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
106...........................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
107...........................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8

[[Page 243]]

 
108...........................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
109...........................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
110...........................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
111...........................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
112...........................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
113...........................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
114...........................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
115+..........................................................     82.4     81.6     80.6     79.7     78.7     77.7     76.7     75.8     74.8     73.8
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 244]]


--------------------------------------------------------------------------------------------------------------------------------------------------------
                   Ages                         10         11         12         13         14         15         16         17         18         19
--------------------------------------------------------------------------------------------------------------------------------------------------------
10........................................       80.0       79.6       79.1       78.7       78.2       77.9       77.5       77.2       76.8       76.5
11........................................       79.6       79.0       78.6       78.1       77.7       77.3       76.9       76.5       76.2       75.8
12........................................       79.1       78.6       78.1       77.6       77.1       76.7       76.3       75.9       75.5       75.2
13........................................       78.7       78.1       77.6       77.1       76.6       76.1       75.7       75.3       74.9       74.5
14........................................       78.2       77.7       77.1       76.6       76.1       75.6       75.1       74.7       74.3       73.9
15........................................       77.9       77.3       76.7       76.1       75.6       75.1       74.6       74.1       73.7       73.3
16........................................       77.5       76.9       76.3       75.7       75.1       74.6       74.1       73.6       73.1       72.7
17........................................       77.2       76.5       75.9       75.3       74.7       74.1       73.6       73.1       72.6       72.1
18........................................       76.8       76.2       75.5       74.9       74.3       73.7       73.1       72.6       72.1       71.6
19........................................       76.5       75.8       75.2       74.5       73.9       73.3       72.7       72.1       71.6       71.1
20........................................       76.3       75.5       74.8       74.2       73.5       72.9       72.3       71.7       71.1       70.6
21........................................       76.0       75.3       74.5       73.8       73.2       72.5       71.9       71.3       70.7       70.1
22........................................       75.8       75.0       74.3       73.5       72.9       72.2       71.5       70.9       70.3       69.7
23........................................       75.5       74.8       74.0       73.3       72.6       71.9       71.2       70.5       69.9       69.3
24........................................       75.3       74.5       73.8       73.0       72.3       71.6       70.9       70.2       69.5       68.9
25........................................       75.1       74.3       73.5       72.8       72.0       71.3       70.6       69.9       69.2       68.5
26........................................       75.0       74.1       73.3       72.5       71.8       71.0       70.3       69.6       68.9       68.2
27........................................       74.8       74.0       73.1       72.3       71.6       70.8       70.0       69.3       68.6       67.9
28........................................       74.6       73.8       73.0       72.2       71.3       70.6       69.8       69.0       68.3       67.6
29........................................       74.5       73.6       72.8       72.0       71.2       70.4       69.6       68.8       68.0       67.3
30........................................       74.4       73.5       72.7       71.8       71.0       70.2       69.4       68.6       67.8       67.1
31........................................       74.3       73.4       72.5       71.7       70.8       70.0       69.2       68.4       67.6       66.8
32........................................       74.1       73.3       72.4       71.5       70.7       69.8       69.0       68.2       67.4       66.6
33........................................       74.0       73.2       72.3       71.4       70.5       69.7       68.8       68.0       67.2       66.4
34........................................       73.9       73.0       72.2       71.3       70.4       69.5       68.7       67.8       67.0       66.2
35........................................       73.9       73.0       72.1       71.2       70.3       69.4       68.5       67.7       66.8       66.0
36........................................       73.8       72.9       72.0       71.1       70.2       69.3       68.4       67.6       66.7       65.9
37........................................       73.7       72.8       71.9       71.0       70.1       69.2       68.3       67.4       66.6       65.7
38........................................       73.6       72.7       71.8       70.9       70.0       69.1       68.2       67.3       66.4       65.6
39........................................       73.6       72.7       71.7       70.8       69.9       69.0       68.1       67.2       66.3       65.4
40........................................       73.5       72.6       71.7       70.7       69.8       68.9       68.0       67.1       66.2       65.3
41........................................       73.5       72.5       71.6       70.7       69.7       68.8       67.9       67.0       66.1       65.2
42........................................       73.4       72.5       71.5       70.6       69.7       68.8       67.8       66.9       66.0       65.1
43........................................       73.4       72.4       71.5       70.6       69.6       68.7       67.8       66.8       65.9       65.0
44........................................       73.3       72.4       71.4       70.5       69.6       68.6       67.7       66.8       65.9       64.9
45........................................       73.3       72.3       71.4       70.5       69.5       68.6       67.6       66.7       65.8       64.9
46........................................       73.3       72.3       71.4       70.4       69.5       68.5       67.6       66.6       65.7       64.8
47........................................       73.2       72.3       71.3       70.4       69.4       68.5       67.5       66.6       65.7       64.7
48........................................       73.2       72.2       71.3       70.3       69.4       68.4       67.5       66.5       65.6       64.7
49........................................       73.2       72.2       71.2       70.3       69.3       68.4       67.4       66.5       65.6       64.6
50........................................       73.1       72.2       71.2       70.3       69.3       68.4       67.4       66.5       65.5       64.6
51........................................       73.1       72.2       71.2       70.2       69.3       68.3       67.4       66.4       65.5       64.5
52........................................       73.1       72.1       71.2       70.2       69.2       68.3       67.3       66.4       65.4       64.5
53........................................       73.1       72.1       71.1       70.2       69.2       68.3       67.3       66.3       65.4       64.4
54........................................       73.1       72.1       71.1       70.2       69.2       68.2       67.3       66.3       65.4       64.4
55........................................       73.0       72.1       71.1       70.1       69.2       68.2       67.2       66.3       65.3       64.4
56........................................       73.0       72.1       71.1       70.1       69.1       68.2       67.2       66.3       65.3       64.3
57........................................       73.0       72.0       71.1       70.1       69.1       68.2       67.2       66.2       65.3       64.3

[[Page 245]]

 
58........................................       73.0       72.0       71.0       70.1       69.1       68.1       67.2       66.2       65.2       64.3
59........................................       73.0       72.0       71.0       70.1       69.1       68.1       67.2       66.2       65.2       64.3
60........................................       73.0       72.0       71.0       70.0       69.1       68.1       67.1       66.2       65.2       64.2
61........................................       73.0       72.0       71.0       70.0       69.1       68.1       67.1       66.2       65.2       64.2
62........................................       72.9       72.0       71.0       70.0       69.0       68.1       67.1       66.1       65.2       64.2
63........................................       72.9       72.0       71.0       70.0       69.0       68.1       67.1       66.1       65.2       64.2
64........................................       72.9       71.9       71.0       70.0       69.0       68.0       67.1       66.1       65.1       64.2
65........................................       72.9       71.9       71.0       70.0       69.0       68.0       67.1       66.1       65.1       64.2
66........................................       72.9       71.9       70.9       70.0       69.0       68.0       67.1       66.1       65.1       64.1
67........................................       72.9       71.9       70.9       70.0       69.0       68.0       67.0       66.1       65.1       64.1
68........................................       72.9       71.9       70.9       70.0       69.0       68.0       67.0       66.1       65.1       64.1
69........................................       72.9       71.9       70.9       69.9       69.0       68.0       67.0       66.1       65.1       64.1
70........................................       72.9       71.9       70.9       69.9       69.0       68.0       67.0       66.0       65.1       64.1
71........................................       72.9       71.9       70.9       69.9       69.0       68.0       67.0       66.0       65.1       64.1
72........................................       72.9       71.9       70.9       69.9       69.0       68.0       67.0       66.0       65.1       64.1
73........................................       72.9       71.9       70.9       69.9       68.9       68.0       67.0       66.0       65.0       64.1
74........................................       72.9       71.9       70.9       69.9       68.9       68.0       67.0       66.0       65.0       64.1
75........................................       72.8       71.9       70.9       69.9       68.9       68.0       67.0       66.0       65.0       64.1
76........................................       72.8       71.9       70.9       69.9       68.9       68.0       67.0       66.0       65.0       64.1
77........................................       72.8       71.9       70.9       69.9       68.9       68.0       67.0       66.0       65.0       64.1
78........................................       72.8       71.9       70.9       69.9       68.9       67.9       67.0       66.0       65.0       64.0
79........................................       72.8       71.9       70.9       69.9       68.9       67.9       67.0       66.0       65.0       64.0
80........................................       72.8       71.9       70.9       69.9       68.9       67.9       67.0       66.0       65.0       64.0
81........................................       72.8       71.8       70.9       69.9       68.9       67.9       67.0       66.0       65.0       64.0
82........................................       72.8       71.8       70.9       69.9       68.9       67.9       67.0       66.0       65.0       64.0
83........................................       72.8       71.8       70.9       69.9       68.9       67.9       67.0       66.0       65.0       64.0
84........................................       72.8       71.8       70.9       69.9       68.9       67.9       67.0       66.0       65.0       64.0
85........................................       72.8       71.8       70.9       69.9       68.9       67.9       66.9       66.0       65.0       64.0
86........................................       72.8       71.8       70.9       69.9       68.9       67.9       66.9       66.0       65.0       64.0
87........................................       72.8       71.8       70.9       69.9       68.9       67.9       66.9       66.0       65.0       64.0
88........................................       72.8       71.8       70.9       69.9       68.9       67.9       66.9       66.0       65.0       64.0
89........................................       72.8       71.8       70.9       69.9       68.9       67.9       66.9       66.0       65.0       64.0
90........................................       72.8       71.8       70.9       69.9       68.9       67.9       66.9       66.0       65.0       64.0
91........................................       72.8       71.8       70.9       69.9       68.9       67.9       66.9       66.0       65.0       64.0
92........................................       72.8       71.8       70.9       69.9       68.9       67.9       66.9       66.0       65.0       64.0
93........................................       72.8       71.8       70.9       69.9       68.9       67.9       66.9       66.0       65.0       64.0
94........................................       72.8       71.8       70.8       69.9       68.9       67.9       66.9       66.0       65.0       64.0
95........................................       72.8       71.8       70.8       69.9       68.9       67.9       66.9       66.0       65.0       64.0
96........................................       72.8       71.8       70.8       69.9       68.9       67.9       66.9       66.0       65.0       64.0
97........................................       72.8       71.8       70.8       69.9       68.9       67.9       66.9       66.0       65.0       64.0
98........................................       72.8       71.8       70.8       69.9       68.9       67.9       66.9       66.0       65.0       64.0
99........................................       72.8       71.8       70.8       69.9       68.9       67.9       66.9       66.0       65.0       64.0
100.......................................       72.8       71.8       70.8       69.9       68.9       67.9       66.9       66.0       65.0       64.0
101.......................................       72.8       71.8       70.8       69.9       68.9       67.9       66.9       66.0       65.0       64.0
102.......................................       72.8       71.8       70.8       69.9       68.9       67.9       66.9       66.0       65.0       64.0
103.......................................       72.8       71.8       70.8       69.9       68.9       67.9       66.9       66.0       65.0       64.0
104.......................................       72.8       71.8       70.8       69.9       68.9       67.9       66.9       66.0       65.0       64.0
105.......................................       72.8       71.8       70.8       69.9       68.9       67.9       66.9       66.0       65.0       64.0
106.......................................       72.8       71.8       70.8       69.9       68.9       67.9       66.9       66.0       65.0       64.0
107.......................................       72.8       71.8       70.8       69.9       68.9       67.9       66.9       66.0       65.0       64.0

[[Page 246]]

 
108.......................................       72.8       71.8       70.8       69.9       68.9       67.9       66.9       66.0       65.0       64.0
109.......................................       72.8       71.8       70.8       69.9       68.9       67.9       66.9       66.0       65.0       64.0
110.......................................       72.8       71.8       70.8       69.9       68.9       67.9       66.9       66.0       65.0       64.0
111.......................................       72.8       71.8       70.8       69.9       68.9       67.9       66.9       66.0       65.0       64.0
112.......................................       72.8       71.8       70.8       69.9       68.9       67.9       66.9       66.0       65.0       64.0
113.......................................       72.8       71.8       70.8       69.9       68.9       67.9       66.9       66.0       65.0       64.0
114.......................................       72.8       71.8       70.8       69.9       68.9       67.9       66.9       66.0       65.0       64.0
115+......................................       72.8       71.8       70.8       69.9       68.9       67.9       66.9       66.0       65.0       64.0
--------------------------------------------------------------------------------------------------------------------------------------------------------


--------------------------------------------------------------------------------------------------------------------------------------------------------
                   Ages                         20         21         22         23         24         25         26         27         28         29
--------------------------------------------------------------------------------------------------------------------------------------------------------
20........................................       70.1       69.6       69.1       68.7       68.3       67.9       67.5       67.2       66.9       66.6
21........................................       69.6       69.1       68.6       68.2       67.7       67.3       66.9       66.6       66.2       65.9
22........................................       69.1       68.6       68.1       67.6       67.2       66.7       66.3       65.9       65.6       65.2
23........................................       68.7       68.2       67.9       67.1       66.6       66.2       65.7       65.3       64.9       64.6
24........................................       68.3       67.7       67.2       66.6       66.1       65.6       65.2       64.7       64.3       63.9
25........................................       67.9       67.3       66.7       66.2       65.6       65.1       64.6       64.2       63.7       63.3
26........................................       67.5       66.9       66.3       65.7       65.2       64.6       64.1       63.6       63.2       62.8
27........................................       67.2       66.6       65.9       65.3       64.7       64.2       63.6       63.1       62.7       62.2
28........................................       66.9       66.2       65.6       64.9       64.3       63.7       63.2       62.7       62.1       61.7
29........................................       66.6       65.9       65.2       64.6       63.9       63.3       62.8       62.2       61.7       61.2
30........................................       66.3       65.6       64.9       64.2       63.6       62.9       62.3       61.8       61.2       60.7
31........................................       66.1       65.3       64.6       63.9       63.2       62.6       62.0       61.4       60.8       60.2
32........................................       65.8       65.1       64.3       63.6       62.9       62.2       61.6       61.0       60.4       59.8
33........................................       65.6       64.8       64.1       63.3       62.6       61.9       61.3       60.6       60.0       59.4
34........................................       65.4       64.6       63.8       63.1       62.3       61.6       60.9       60.3       59.6       59.0
35........................................       65.2       64.4       63.6       62.8       62.1       61.4       60.6       59.9       59.3       58.6
36........................................       65.0       64.2       63.4       62.6       61.9       61.1       60.4       59.6       69.0       58.3
37........................................       64.9       64.0       63.2       62.4       61.6       60.9       60.1       59.4       58.7       58.0
38........................................       64.7       63.9       63.0       62.2       61.4       60.6       59.9       59.1       58.4       57.7
39........................................       64.6       63.7       62.9       62.1       61.2       60.4       59.6       58.9       58.1       57.4
40........................................       64.4       63.6       62.7       61.9       61.1       60.2       59.4       58.7       57.9       57.1
41........................................       64.3       63.5       62.6       61.7       60.9       60.1       59.3       58.5       57.7       56.9
42........................................       64.2       63.3       62.5       61.6       60.8       59.9       59.1       58.3       57.5       56.7
43........................................       64.1       63.2       62.4       61.5       60.6       59.8       58.9       58.1       57.3       56.5
44........................................       64.0       63.1       62.2       61.4       60.5       59.6       58.8       57.9       57.1       56.3
45........................................       64.0       63.0       62.2       61.3       60.4       59.5       58.6       57.8       56.9       56.1
46........................................       63.9       63.0       62.1       61.2       60.3       59.4       58.5       57.7       56.8       56.0
47........................................       63.8       62.9       62.0       61.1       60.2       59.3       58.4       57.5       56.7       55.8
48........................................       63.7       62.8       61.9       61.0       60.1       59.2       58.3       57.4       56.5       55.7
49........................................       63.7       62.8       61.8       60.9       60.0       59.1       58.2       57.3       56.4       55.6
50........................................       63.6       62.7       61.8       60.8       59.9       59.0       58.1       57.2       56.3       55.4
51........................................       63.6       62.6       61.7       60.8       59.9       58.9       58.0       57.1       56.2       55.3
52........................................       63.5       62.6       61.7       60.7       59.8       58.9       58.0       57.1       56.1       55.2
53........................................       63.5       62.5       61.6       60.7       59.7       58.8       57.9       57.0       56.1       55.2
54........................................       63.5       62.5       61.6       60.6       59.7       58.8       57.8       56.9       56.0       55.1
55........................................       63.4       62.5       61.5       60.6       59.6       58.7       57.8       56.8       55.9       55.0
56........................................       63.4       62.4       61.5       60.5       59.6       58.7       57.7       56.8       55.9       54.9

[[Page 247]]

 
57........................................       63.4       62.4       61.5       60.5       59.6       58.6       57.7       56.7       55.8       54.9
58........................................       63.3       62.4       61.4       60.5       59.5       58.6       57.6       56.7       55.8       54.8
59........................................       63.3       62.3       61.4       60.4       59.5       58.5       57.6       56.7       55.7       54.8
60........................................       63.3       62.3       61.4       60.4       59.5       58.5       57.6       56.6       55.7       54.7
61........................................       63.3       62.3       61.3       60.4       59.4       58.5       57.5       56.6       55.6       54.7
62........................................       63.2       62.3       61.3       60.4       59.4       58.4       57.5       56.5       55.6       54.7
63........................................       63.2       62.3       61.3       60.3       59.4       58.4       57.4       56.5       55.6       54.6
64........................................       63.2       62.2       61.3       60.3       59.4       58.4       57.4       56.5       55.5       54.6
65........................................       63.2       62.2       61.3       60.3       59.3       58.4       57.4       56.5       55.5       54.6
66........................................       63.2       62.2       61.2       60.3       59.3       58.4       57.4       56.4       55.5       54.5
67........................................       63.2       62.2       61.2       60.3       59.3       58.3       57.4       56.4       55.5       54.5
68........................................       63.1       62.2       61.2       60.2       59.3       58.3       57.4       56.4       55.4       54.5
69........................................       63.1       62.2       61.2       60.2       59.3       58.3       57.3       56.4       55.4       54.5
70........................................       63.1       62.2       61.2       60.2       59.3       58.3       57.3       56.4       55.4       54.4
71........................................       63.1       62.1       61.2       60.2       59.2       58.3       57.3       56.4       55.4       54.4
72........................................       63.1       62.1       61.2       60.2       59.2       58.3       57.3       56.3       55.4       54.4
73........................................       63.1       62.1       61.2       60.2       59.2       58.3       57.3       56.3       55.4       54.4
74........................................       63.1       62.1       61.2       60.2       59.2       58.2       57.3       56.3       55.4       54.4
75........................................       63.1       62.1       61.1       60.2       59.2       58.2       57.3       56.3       55.3       54.4
76........................................       63.1       62.1       61.1       60.2       59.2       58.2       57.3       56.3       55.3       54.4
77........................................       63.1       62.1       61.1       60.2       59.2       58.2       57.3       56.3       55.3       54.4
78........................................       63.1       62.1       61.1       60.2       59.2       58.2       57.3       56.3       55.3       54.4
79........................................       63.1       62.1       61.1       60.2       59.2       58.2       57.2       56.3       55.3       54.3
80........................................       63.1       62.1       61.1       60.1       59.2       58.2       57.2       56.3       55.3       54.3
81........................................       63.1       62.1       61.1       60.1       59.2       58.2       57.2       56.3       55.3       54.3
82........................................       63.1       62.1       61.1       60.1       59.2       58.2       57.2       56.3       55.3       54.3
83........................................       63.1       62.1       61.1       60.1       59.2       58.2       57.2       56.3       55.3       54.3
84........................................       63.0       62.1       61.1       60.1       59.2       58.2       57.2       56.3       55.3       54.3
85........................................       63.0       62.1       61.1       60.1       59.2       58.2       57.2       56.3       55.3       54.3
86........................................       63.0       62.1       61.1       60.1       59.2       58.2       57.2       56.2       55.3       54.3
87........................................       63.0       62.1       61.1       60.1       59.2       58.2       57.2       56.2       55.3       54.3
88........................................       63.0       62.1       61.1       60.1       59.2       58.2       57.2       56.2       55.3       54.3
89........................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
90........................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
91........................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
92........................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
93........................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
94........................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
95........................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
96........................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
97........................................       60.3       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
98........................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
99........................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
100.......................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
101.......................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
102.......................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
103.......................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
104.......................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
105.......................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
106.......................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3

[[Page 248]]

 
107.......................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
108.......................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
109.......................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
110.......................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
111.......................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
112.......................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
113.......................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
114.......................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
115+......................................       63.0       62.1       61.1       60.1       59.1       58.2       57.2       56.2       55.3       54.3
--------------------------------------------------------------------------------------------------------------------------------------------------------


--------------------------------------------------------------------------------------------------------------------------------------------------------
                   Ages                         30         31         32         33         34         35         36         37         38         39
--------------------------------------------------------------------------------------------------------------------------------------------------------
30........................................       60.2       59.7       59.2       58.8       58.4       58.0       57.6       57.3       57.0       56.7
31........................................       59.7       59.2       58.7       58.2       57.8       57.4       57.0       56.6       56.3       56.0
32........................................       59.2       58.7       58.2       57.7       57.2       56.8       56.4       56.0       55.6       55.3
33........................................       58.8       58.2       57.7       57.2       56.7       56.2       55.8       55.4       55.0       54.7
34........................................       58.4       57.8       57.2       56.7       56.2       55.7       55.3       54.8       54.4       54.0
35........................................       58.0       57.4       56.8       56.2       55.7       55.2       54.7       54.3       53.8       53.4
36........................................       57.6       57.0       56.4       55.8       55.3       54.7       54.2       53.7       53.3       52.8
37........................................       57.3       56.6       56.0       55.4       54.8       54.3       53.7       53.2       52.7       52.3
38........................................       57.0       56.3       55.6       55.0       54.4       53.8       53.3       52.7       52.2       51.7
39........................................       56.7       56.0       55.3       54.7       54.0       53.4       52.8       52.3       51.7       51.2
40........................................       56.4       55.7       55.0       54.3       53.7       53.0       52.4       51.8       51.3       50.8
41........................................       56.1       55.4       54.7       54.0       53.3       52.7       52.0       51.4       50.9       50.3
42........................................       55.9       55.2       54.4       53.7       53.0       52.3       51.7       51.1       50.4       49.9
43........................................       55.7       54.9       54.2       53.4       52.7       52.0       51.3       50.7       50.1       49.5
44........................................       55.5       54.7       53.9       53.2       52.4       51.7       51.0       50.4       49.7       49.1
45........................................       55.3       54.5       53.7       52.9       52.2       51.5       50.7       50.0       49.4       48.7
46........................................       55.1       54.3       53.5       52.7       52.0       51.2       50.5       49.8       49.1       48.4
47........................................       55.0       54.1       53.3       52.5       51.7       51.0       50.2       49.5       48.8       48.1
48........................................       54.8       54.0       53.2       52.3       51.5       50.8       50.0       49.2       48.5       47.8
49........................................       54.7       53.8       53.0       52.2       51.4       50.6       49.8       49.0       48.2       47.5
50........................................       54.6       53.7       52.9       52.0       51.2       50.4       49.6       48.8       48.0       47.3
51........................................       54.5       53.6       52.7       51.9       51.0       50.2       49.4       48.6       47.8       47.0
52........................................       54.4       53.5       52.6       51.7       50.9       50.0       49.2       48.4       47.6       46.8
53........................................       54.3       53.4       52.5       51.6       50.8       49.9       49.1       48.2       47.4       46.6
54........................................       54.2       53.3       52.4       51.5       50.6       49.8       48.9       48.1       47.2       46.4
55........................................       54.1       53.2       52.3       51.4       50.5       49.7       48.8       47.9       47.1       46.3
56........................................       54.0       53.1       52.2       51.3       50.4       49.5       48.7       47.8       47.0       46.1
57........................................       54.0       53.0       52.1       51.2       50.3       49.4       48.6       47.7       46.8       46.0
58........................................       53.9       53.0       52.1       51.2       50.3       49.4       48.5       47.6       46.7       45.8
59........................................       53.8       52.9       52.0       51.1       50.2       49.3       48.4       47.5       46.6       45.7
60........................................       53.8       52.9       51.9       51.0       50.1       49.2       48.3       47.4       46.5       45.6
61........................................       53.8       52.8       51.9       51.0       50.0       49.1       48.2       47.3       46.4       45.5
62........................................       53.7       52.8       51.8       50.9       50.0       49.1       48.1       47.2       46.3       45.4
63........................................       53.7       52.7       51.8       50.9       49.9       49.0       48.1       47.2       46.3       45.3
64........................................       53.6       52.7       51.8       50.8       49.9       48.9       48.0       47.1       46.2       45.3
65........................................       53.6       52.7       51.7       50.8       49.8       48.9       48.0       47.0       46.1       45.2

[[Page 249]]

 
66........................................       53.6       52.6       51.7       50.7       49.8       48.9       47.9       47.0       46.1       45.1
67........................................       53.6       52.6       51.7       50.7       49.8       48.8       47.9       46.9       46.0       45.1
68........................................       53.5       52.6       51.6       50.7       49.7       48.8       47.8       46.9       46.0       45.0
69........................................       53.5       52.6       51.6       50.6       49.7       48.7       47.8       46.9       45.9       45.0
70........................................       53.5       52.5       51.6       50.6       49.7       48.7       47.8       46.8       45.9       44.9
71........................................       53.5       52.5       51.6       50.6       49.6       48.7       47.7       46.8       45.9       44.9
72........................................       53.5       52.5       51.5       50.6       49.6       48.7       47.7       46.8       45.8       44.9
73........................................       53.4       52.5       51.5       50.6       49.6       48.6       47.7       46.7       45.8       44.8
74........................................       53.4       52.5       51.5       50.5       49.6       48.6       47.7       46.7       45.8       44.8
75........................................       53.4       52.5       51.5       50.5       49.6       48.6       47.7       46.7       45.7       44.8
76........................................       53.4       52.4       51.5       50.5       49.6       48.6       47.6       46.7       45.7       44.8
77........................................       53.4       52.4       51.5       50.5       49.5       48.6       47.6       46.7       45.7       44.8
78........................................       53.4       52.4       51.5       50.5       49.5       48.6       47.6       46.6       45.7       44.7
79........................................       53.4       52.4       51.5       50.5       49.5       48.6       47.6       46.6       45.7       44.7
80........................................       53.4       52.4       51.4       50.5       49.5       48.5       47.6       46.6       45.7       44.7
81........................................       53.4       52.4       51.4       50.5       49.5       48.5       47.6       46.6       45.7       44.7
82........................................       53.4       52.4       51.4       50.5       49.5       48.5       47.6       46.6       45.6       44.7
83........................................       53.4       52.4       51.4       50.5       49.5       48.5       47.6       46.6       45.6       44.7
84........................................       53.4       52.4       51.4       50.5       49.5       48.5       47.6       46.6       45.6       44.7
85........................................       53.3       52.4       51.4       50.4       49.5       48.5       47.5       46.6       45.6       44.7
86........................................       53.3       52.4       51.4       50.4       49.5       48.5       47.5       46.6       45.6       44.6
87........................................       53.3       52.4       51.4       50.4       49.5       48.5       47.5       46.6       45.6       44.6
88........................................       53.3       52.4       51.4       50.4       49.5       48.5       47.5       46.6       45.6       44.6
89........................................       53.3       52.4       51.4       50.4       49.5       48.5       47.5       46.6       45.6       44.6
90........................................       53.3       52.4       51.4       50.4       49.5       48.5       47.5       46.6       45.6       44.6
91........................................       53.3       52.4       51.4       50.4       49.5       48.5       47.5       46.6       45.6       44.6
92........................................       53.3       52.4       51.4       50.4       49.5       48.5       47.5       46.6       45.6       44.6
93........................................       53.3       52.4       51.4       50.4       49.5       48.5       47.5       46.6       45.6       44.6
94........................................       53.3       52.4       51.4       50.4       49.5       48.5       47.5       46.6       45.6       44.6
95........................................       53.3       52.4       51.4       50.4       49.5       48.5       47.5       46.5       45.6       44.6
96........................................       53.3       52.4       51.4       50.4       49.5       48.5       47.5       46.5       45.6       44.6
97........................................       53.3       52.4       51.4       50.4       49.5       48.5       47.5       46.5       45.6       44.6
98........................................       53.3       52.4       51.4       50.4       49.5       48.5       47.5       46.5       45.6       44.6
99........................................       53.3       52.4       51.4       50.4       49.5       48.5       47.5       46.5       45.6       44.6
100.......................................       53.3       52.4       51.4       50.4       49.5       48.5       47.5       46.5       45.6       44.6
101.......................................       53.3       52.4       51.4       50.4       49.5       48.5       47.5       46.5       45.6       44.6
102.......................................       53.3       52.4       51.4       50.4       49.5       48.5       47.5       46.5       45.6       44.6
103.......................................       53.3       52.4       51.4       50.4       49.5       48.5       47.5       46.5       45.6       44.6
104.......................................       53.3       52.4       51.4       50.4       49.5       48.5       47.5       46.5       45.6       44.6
105.......................................       53.3       52.4       51.4       50.4       49.4       48.5       47.5       46.5       45.6       44.6
106.......................................       53.3       52.4       51.4       50.4       49.4       48.5       47.5       46.5       45.6       44.6
107.......................................       53.3       52.4       51.4       50.4       49.4       48.5       47.5       46.5       45.6       44.6
108.......................................       53.3       52.4       51.4       50.4       49.4       48.5       47.5       46.5       45.6       44.6
109.......................................       53.3       52.4       51.4       50.4       49.4       48.5       47.5       46.5       45.6       44.6
110.......................................       53.3       52.4       51.4       50.4       49.4       48.5       47.5       46.5       45.6       44.6
111.......................................       53.3       52.4       51.4       50.4       49.4       48.5       47.5       46.5       45.6       44.6
112.......................................       53.3       52.4       51.4       50.4       49.4       48.5       47.5       46.5       45.6       44.6
113.......................................       53.3       52.4       51.4       50.4       49.4       48.5       47.5       46.5       45.6       44.6
114.......................................       53.3       52.4       51.4       50.4       49.4       48.5       47.5       46.5       45.6       44.6
115+......................................       53.3       52.4       51.4       50.4       49.4       48.5       47.5       46.5       45.6       44.6
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 250]]


--------------------------------------------------------------------------------------------------------------------------------------------------------
                   Ages                         40         41         42         43         44         45         46         47         48         49
--------------------------------------------------------------------------------------------------------------------------------------------------------
40........................................       50.2       49.8       49.3       48.9       48.5       48.1       47.7       47.4       47.1       46.8
41........................................       49.8       49.3       48.8       48.3       47.9       47.5       47.1       46.7       46.4       46.1
42........................................       49.3       48.8       48.3       47.8       47.3       46.9       46.5       46.1       45.8       45.4
43........................................       48.9       48.3       47.8       47.3       46.8       46.3       45.9       45.5       45.1       44.8
44........................................       48.5       47.9       47.3       46.8       46.3       45.8       45.4       44.9       44.5       44.2
45........................................       48.1       47.5       46.9       46.3       45.8       45.3       44.8       44.4       44.0       43.6
46........................................       47.7       47.1       46.5       45.9       45.4       44.8       44.3       43.9       43.4       43.0
47........................................       47.4       46.7       46.1       45.5       44.9       44.4       43.9       43.4       42.9       42.4
48........................................       47.1       46.4       45.8       45.1       44.5       44.0       43.4       42.9       42.4       41.9
49........................................       46.8       46.1       45.4       44.8       44.2       43.6       43.0       42.4       41.9       41.4
50........................................       46.5       45.8       45.1       44.4       43.8       43.2       42.6       42.0       41.5       40.9
51........................................       46.3       45.5       44.8       44.1       43.5       42.8       42.2       41.6       41.0       40.5
52........................................       46.0       45.3       44.6       43.8       43.2       42.5       41.8       41.2       40.6       40.1
53........................................       45.8       45.1       44.3       43.6       42.9       42.2       41.5       40.9       40.3       39.7
54........................................       45.6       44.8       44.1       43.3       42.6       41.9       41.2       40.5       39.9       39.3
55........................................       45.5       44.7       43.9       43.1       42.4       41.6       40.9       40.2       39.6       38.9
56........................................       45.3       44.5       43.7       42.9       42.1       41.4       40.7       40.0       39.3       38.6
57........................................       45.1       44.3       43.5       42.7       41.9       41.2       40.4       39.7       39.0       38.3
58........................................       45.0       44.2       43.3       42.5       41.7       40.9       40.2       39.4       38.7       38.0
59........................................       44.9       44.0       43.2       42.4       41.5       40.7       40.0       39.2       38.5       37.8
60........................................       44.7       43.9       43.0       42.2       41.4       40.6       39.8       39.0       38.2       37.5
61........................................       44.6       43.8       42.9       42.1       41.2       40.4       39.6       38.8       38.0       37.3
62........................................       44.5       43.7       42.8       41.9       41.1       40.3       39.4       38.6       37.8       37.1
63........................................       44.5       43.6       42.7       41.8       41.0       40.1       39.3       38.5       37.7       36.9
64........................................       44.4       43.5       42.6       41.7       40.8       40.0       39.2       38.3       37.5       36.7
65........................................       44.3       43.4       42.5       41.6       40.7       39.9       39.0       38.2       37.4       36.6
66........................................       44.2       43.3       42.4       41.5       40.6       39.8       38.9       38.1       37.2       36.4
67........................................       44.2       43.3       42.3       41.4       40.6       39.7       38.8       38.0       37.1       36.3
68........................................       44.1       43.2       42.3       41.4       40.5       39.6       38.7       37.9       37.0       36.2
69........................................       44.1       43.1       42.2       41.3       40.4       39.5       38.6       37.8       36.9       36.0
70........................................       44.0       43.1       42.2       41.3       40.3       39.4       38.6       37.7       36.8       35.9
71........................................       44.0       43.0       42.1       41.2       40.3       39.4       38.5       37.6       36.7       35.9
72........................................       43.9       43.0       42.1       41.1       40.2       39.3       38.4       37.5       36.6       35.8
73........................................       43.9       43.0       42.0       41.1       40.2       39.3       38.4       37.5       36.6       35.7
74........................................       43.9       42.9       42.0       41.1       40.1       39.2       38.3       37.4       36.5       35.6
75........................................       43.8       42.9       42.0       41.0       40.1       39.2       38.3       37.4       36.5       35.6
76........................................       43.8       42.9       41.9       41.0       40.1       39.1       38.2       37.3       36.4       35.5
77........................................       43.8       42.9       41.9       41.0       40.0       39.1       38.2       37.3       36.4       35.5
78........................................       43.8       42.8       41.9       40.9       40.0       39.1       38.2       37.2       36.3       35.4
79........................................       43.8       42.8       41.9       40.9       40.0       39.1       38.1       37.2       36.3       35.4
80........................................       43.7       42.8       41.8       40.9       40.0       39.0       38.1       37.2       36.3       35.4
81........................................       43.7       42.8       41.8       40.9       39.9       39.0       38.1       37.2       36.2       35.3
82........................................       43.7       42.8       41.8       40.9       39.9       39.0       38.1       37.1       36.2       35.3
83........................................       43.7       42.8       41.8       40.9       39.9       39.0       38.0       37.1       36.2       35.3
84........................................       43.7       42.7       41.8       40.8       39.9       39.0       38.0       37.1       36.2       35.3
85........................................       43.7       42.7       41.8       40.8       39.9       38.9       38.0       37.1       36.2       35.2
86........................................       43.7       42.7       41.8       40.8       39.9       38.9       38.0       37.1       36.1       35.2
87........................................       43.7       42.7       41.8       40.8       39.9       38.9       38.0       37.0       36.1       35.2

[[Page 251]]

 
88........................................       43.7       42.7       41.8       40.8       39.9       38.9       38.0       37.0       36.1       35.2
89........................................       43.7       42.7       41.7       40.8       39.8       38.9       38.0       37.0       36.1       35.2
90........................................       43.7       42.7       41.7       40.8       39.8       38.9       38.0       37.0       36.1       35.2
91........................................       43.7       42.7       41.7       40.8       39.8       38.9       37.9       37.0       36.1       35.2
92........................................       43.7       42.7       41.7       40.8       39.8       38.9       37.9       37.0       36.1       35.1
93........................................       43.7       42.7       41.7       40.8       39.8       38.9       37.9       37.0       36.1       35.1
94........................................       43.7       42.7       41.7       40.8       39.8       38.9       37.9       37.0       36.1       35.1
95........................................       43.6       42.7       41.7       40.8       39.8       38.9       37.9       37.0       36.1       35.1
96........................................       43.6       42.7       41.7       40.8       39.8       38.9       37.9       37.0       36.1       35.1
97........................................       43.6       42.7       41.7       40.8       39.8       38.9       37.9       37.0       36.1       35.1
98........................................       43.6       42.7       41.7       40.8       39.8       38.9       37.9       37.0       36.0       35.1
99........................................       43.6       42.7       41.7       40.8       39.8       38.9       37.9       37.0       36.0       35.1
100.......................................       43.6       42.7       41.7       40.8       39.8       38.9       37.9       37.0       36.0       35.1
101.......................................       43.6       42.7       41.7       40.8       39.8       38.9       37.9       37.0       36.0       35.1
102.......................................       43.6       42.7       41.7       40.8       39.8       38.9       37.9       37.0       36.0       35.1
103.......................................       43.6       42.7       41.7       40.8       39.8       38.9       37.9       37.0       36.0       35.1
104.......................................       43.6       42.7       41.7       40.8       39.8       38.8       37.9       37.0       36.0       35.1
105.......................................       43.6       42.7       41.7       40.8       39.8       38.8       37.9       37.0       36.0       35.1
106.......................................       43.6       42.7       41.7       40.8       39.8       38.8       37.9       37.0       36.0       35.1
107.......................................       43.6       42.7       41.7       40.8       39.8       38.8       37.9       37.0       36.0       35.1
108.......................................       43.6       42.7       41.7       40.8       39.8       38.8       37.9       37.0       36.0       35.1
109.......................................       43.6       42.7       41.7       40.7       39.8       38.8       37.9       37.0       36.0       35.1
110.......................................       43.6       42.7       41.7       40.7       39.8       38.8       37.9       37.0       36.0       35.1
111.......................................       43.6       42.7       41.7       40.7       39.8       38.8       37.9       37.0       36.0       35.1
112.......................................       43.6       42.7       41.7       40.7       39.8       38.8       37.9       37.0       36.0       35.1
113.......................................       43.6       42.7       41.7       40.7       39.8       38.8       37.9       37.0       36.0       35.1
114.......................................       43.6       42.7       41.7       40.7       39.8       38.8       37.9       37.0       36.0       35.1
115+......................................       43.6       42.7       41.7       40.7       39.8       38.8       37.9       37.0       36.0       35.1
--------------------------------------------------------------------------------------------------------------------------------------------------------


--------------------------------------------------------------------------------------------------------------------------------------------------------
                   Ages                         50         51         52         53         54         55         56         57         58         59
--------------------------------------------------------------------------------------------------------------------------------------------------------
50........................................       40.4       40.0       39.5       39.1       38.7       38.3       38.0       37.6       37.3       37.1
51........................................       40.0       39.5       39.0       38.5       38.1       37.7       37.4       37.0       36.7       36.4
52........................................       39.5       39.0       38.5       38.0       37.6       37.2       36.8       36.4       36.0       35.7
53........................................       39.1       38.5       38.0       37.5       37.1       36.6       36.2       35.8       35.4       35.1
54........................................       38.7       38.1       37.6       37.1       36.6       36.1       35.7       35.2       34.8       34.5
55........................................       38.3       37.7       37.2       36.6       36.1       35.6       35.1       34.7       34.3       33.9
56........................................       38.0       37.4       36.8       36.2       35.7       35.1       34.7       34.2       33.7       33.3
57........................................       37.6       37.0       36.4       35.8       35.2       34.7       34.2       33.7       33.2       32.8
58........................................       37.3       36.7       36.0       35.4       34.8       34.3       33.7       33.2       32.8       32.3
59........................................       37.1       36.4       35.7       35.1       34.5       33.9       33.3       32.8       32.3       31.8
60........................................       36.8       36.1       35.4       34.8       34.1       33.5       32.9       32.4       31.9       31.3
61........................................       36.6       35.8       35.1       34.5       33.8       33.2       32.6       32.0       31.4       30.9
62........................................       36.3       35.6       34.9       34.2       33.5       32.9       32.2       31.6       31.1       30.5
63........................................       36.1       35.4       34.6       33.9       33.2       32.6       31.9       31.3       30.7       30.1
64........................................       35.9       35.2       34.4       33.7       33.0       32.3       31.6       31.0       30.4       29.8
65........................................       35.8       35.0       34.2       33.5       32.7       32.0       31.4       30.7       30.0       29.4
66........................................       35.6       34.8       34.0       33.3       32.5       31.8       31.1       30.4       29.8       29.1
67........................................       35.5       34.7       33.9       33.1       32.3       31.6       30.9       30.2       29.5       28.8
68........................................       35.3       34.5       33.7       32.9       32.1       31.4       30.7       29.9       29.2       28.6

[[Page 252]]

 
69........................................       35.2       34.4       33.6       32.8       32.0       31.2       30.5       29.7       29.0       28.3
70........................................       35.1       34.3       33.4       32.6       31.8       31.1       30.3       29.5       28.8       28.1
71........................................       35.0       34.2       33.3       32.5       31.7       30.9       30.1       29.4       28.6       27.9
72........................................       34.9       34.1       33.2       32.4       31.6       30.8       30.0       29.2       28.4       27.7
73........................................       34.8       34.0       33.1       32.3       31.5       30.6       29.8       29.1       28.3       27.5
74........................................       34.8       33.9       33.0       32.2       31.4       30.5       29.7       28.9       28.1       27.4
75........................................       34.7       33.8       33.0       32.1       31.3       30.4       29.6       28.8       28.0       27.2
76........................................       34.6       33.8       32.9       32.0       31.2       30.3       29.5       28.7       27.9       27.1
77........................................       34.6       33.7       32.8       32.0       31.1       30.3       29.4       28.6       27.8       27.0
78........................................       34.5       33.6       32.8       31.9       31.0       30.2       29.3       28.5       27.7       26.9
79........................................       34.5       33.6       32.7       31.8       31.0       30.1       29.3       28.4       27.6       26.8
80........................................       34.5       33.6       32.7       31.8       30.9       30.1       29.2       28.4       27.5       26.7
81........................................       34.4       33.5       32.6       31.8       30.9       30.0       29.2       28.3       27.5       26.6
82........................................       34.4       33.5       32.6       31.7       30.8       30.0       29.1       28.3       27.4       26.6
83........................................       34.4       33.5       32.6       31.7       30.8       29.9       29.1       28.2       27.4       26.5
84........................................       34.3       33.4       32.5       31.7       30.8       29.9       29.0       28.2       27.3       26.5
85........................................       34.3       33.4       32.5       31.6       30.7       29.9       29.0       28.1       27.3       26.4
86........................................       34.3       33.4       32.5       31.6       30.7       29.8       29.0       28.1       27.2       26.4
87........................................       34.3       33.4       32.5       31.6       30.7       29.8       28.9       28.1       27.2       26.4
88........................................       34.3       33.4       32.5       31.6       30.7       29.8       28.9       28.0       27.2       26.3
89........................................       34.3       33.3       32.4       31.5       30.7       29.8       28.9       28.0       27.2       26.3
90........................................       34.2       33.3       32.4       31.5       30.6       29.8       28.9       28.0       27.1       26.3
91........................................       34.2       33.3       32.4       31.5       30.6       29.7       28.9       28.0       27.1       26.3
92........................................       34.2       33.3       32.4       31.5       30.6       29.7       28.8       28.0       27.1       26.2
93........................................       34.2       33.3       32.4       31.5       30.6       29.7       28.8       28.0       27.1       26.2
94........................................       34.2       33.3       32.4       31.5       30.6       29.7       28.8       27.9       27.1       26.2
95........................................       34.2       33.3       32.4       31.5       30.6       29.7       28.8       27.9       27.1       26.2
96........................................       34.2       33.3       32.4       31.5       30.6       29.7       28.8       27.9       27.0       26.2
97........................................       34.2       33.3       32.4       31.5       30.6       29.7       28.8       27.9       27.0       26.2
98........................................       34.2       33.3       32.4       31.5       30.6       29.7       28.8       27.9       27.0       26.2
99........................................       34.2       33.3       32.4       31.5       30.6       29.7       28.8       27.9       27.0       26.2
100.......................................       34.2       33.3       32.4       31.5       30.6       29.7       28.8       27.9       27.0       26.1
101.......................................       34.2       33.3       32.4       31.5       30.6       29.7       28.8       27.9       27.0       26.1
102.......................................       34.2       33.3       32.4       31.4       30.5       29.7       28.8       27.9       27.0       26.1
103.......................................       34.2       33.3       32.4       31.4       30.5       29.7       28.8       27.9       27.0       26.1
104.......................................       34.2       33.3       32.4       31.4       30.5       29.6       28.8       27.9       27.0       26.1
105.......................................       34.2       33.3       32.3       31.4       30.5       29.6       28.8       27.9       27.0       26.1
106.......................................       34.2       33.3       32.3       31.4       30.5       29.6       28.8       27.9       27.0       26.1
107.......................................       34.2       33.3       32.3       31.4       30.5       29.6       28.8       27.9       27.0       26.1
108.......................................       34.2       33.3       32.3       31.4       30.5       29.6       28.8       27.9       27.0       26.1
109.......................................       34.2       33.3       32.3       31.4       30.5       29.6       28.7       27.9       27.0       26.1
110.......................................       34.2       33.3       32.3       31.4       30.5       29.6       28.7       27.9       27.0       26.1
111.......................................       34.2       33.3       32.3       31.4       30.5       29.6       28.7       27.9       27.0       26.1
112.......................................       34.2       33.3       32.3       31.4       30.5       29.6       28.7       27.9       27.0       26.1
113.......................................       34.2       33.3       32.3       31.4       30.5       29.6       28.7       27.9       27.0       26.1
114.......................................       34.2       33.3       32.3       31.4       30.5       29.6       28.7       27.9       27.0       26.1
115+......................................       34.2       33.3       32.3       31.4       30.5       29.6       28.7       27.9       27.0       26.1
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[[Page 253]]


--------------------------------------------------------------------------------------------------------------------------------------------------------
                   Ages                         60         61         62         63         64         65         66         67         68         69
--------------------------------------------------------------------------------------------------------------------------------------------------------
60........................................       30.9       30.4       30.0       29.6       29.2       28.8       28.5       28.2       27.9       27.6
61........................................       30.4       29.9       29.5       29.0       28.6       28.3       27.9       27.6       27.3       27.0
62........................................       30.0       29.5       29.0       28.5       28.1       27.7       27.3       27.0       26.7       26.4
63........................................       29.6       29.0       28.5       28.1       27.6       27.2       26.8       26.4       26.1       25.7
64........................................       29.2       28.6       28.1       27.6       27.1       26.7       26.3       25.9       25.5       25.2
65........................................       28.8       28.3       27.7       27.2       26.7       26.2       25.8       25.4       25.0       24.6
66........................................       28.5       27.9       27.3       26.8       26.3       25.8       25.3       24.9       24.5       24.1
67........................................       28.2       27.6       27.0       26.4       25.9       25.4       24.9       24.4       24.0       23.6
68........................................       27.9       27.3       26.7       26.1       25.5       25.0       24.5       24.0       23.5       23.1
69........................................       27.6       27.0       26.4       25.7       25.2       24.6       24.1       23.6       23.1       22.6
70........................................       27.4       26.7       26.1       25.4       24.8       24.3       23.7       23.2       22.7       22.2
71........................................       27.2       26.5       25.8       25.2       24.5       23.9       23.4       22.8       22.3       21.8
72........................................       27.0       26.3       25.6       24.9       24.3       23.7       23.1       22.5       22.0       21.4
73........................................       26.8       26.1       25.4       24.7       24.0       23.4       22.8       22.2       21.6       21.1
74........................................       26.6       25.9       25.2       24.5       23.8       23.1       22.5       21.9       21.3       20.8
75........................................       26.5       25.7       25.0       24.3       23.6       22.9       22.3       21.6       21.0       20.5
76........................................       26.3       25.6       24.8       24.1       23.4       22.7       22.0       21.4       20.8       20.2
77........................................       26.2       25.4       24.7       23.9       23.2       22.5       21.8       21.2       20.6       19.9
78........................................       26.1       25.3       24.6       23.8       23.1       22.4       21.7       21.0       20.3       19.7
79........................................       26.0       25.2       24.4       23.7       22.9       22.2       21.5       20.8       20.1       19.5
80........................................       25.9       25.1       24.3       23.6       22.8       22.1       21.3       20.6       20.0       19.3
81........................................       25.8       25.0       24.2       23.4       22.7       21.9       21.2       20.5       19.8       19.1
82........................................       25.8       24.9       24.1       23.4       22.6       21.8       21.1       20.4       19.7       19.0
83........................................       25.7       24.9       24.1       23.3       22.5       21.7       21.0       20.2       19.5       18.8
84........................................       25.6       24.8       24.0       23.2       22.4       21.6       20.9       20.1       19.4       18.7
85........................................       25.6       24.8       23.9       23.1       22.3       21.6       20.8       20.1       19.3       18.6
86........................................       25.5       24.7       23.9       23.1       22.3       21.5       20.7       20.0       19.2       18.5
87........................................       25.5       24.7       23.8       23.0       22.2       21.4       20.7       19.9       19.2       18.4
88........................................       25.5       24.6       23.8       23.0       22.2       21.4       20.6       19.8       19.1       18.3
89........................................       25.4       24.6       23.8       22.9       22.1       21.3       20.5       19.8       19.0       18.3
90........................................       25.4       24.6       23.7       22.9       22.1       21.3       20.5       19.7       19.0       18.2
91........................................       25.4       24.5       23.7       22.9       22.1       21.3       20.5       19.7       18.9       18.2
92........................................       25.4       24.5       23.7       22.9       22.0       21.2       20.4       19.6       18.9       18.1
93........................................       25.4       24.5       23.7       22.8       22.0       21.2       20.4       19.6       18.8       18.1
94........................................       25.3       24.5       23.6       22.8       22.0       21.2       20.4       19.6       18.8       18.0
95........................................       25.3       24.5       23.6       22.8       22.0       21.1       20.3       19.6       18.8       18.0
96........................................       25.3       24.5       23.6       22.8       21.9       21.1       20.3       19.5       18.8       18.0
97........................................       25.3       24.5       23.6       22.8       21.9       21.1       20.3       19.5       18.7       18.0
98........................................       25.3       24.4       23.6       22.8       21.9       21.1       20.3       19.5       18.7       17.9
99........................................       25.3       24.4       23.6       22.7       21.9       21.1       20.3       19.5       18.7       17.9
100.......................................       25.3       24.4       23.6       22.7       21.9       21.1       20.3       19.5       18.7       17.9
101.......................................       25.3       24.4       23.6       22.7       21.9       21.1       20.2       19.4       18.7       17.9
102.......................................       25.3       24.4       23.6       22.7       21.9       21.1       20.2       19.4       18.6       17.9
103.......................................       25.3       24.4       23.6       22.7       21.9       21.0       20.2       19.4       18.6       17.9
104.......................................       25.3       24.4       23.5       22.7       21.9       21.0       20.2       19.4       18.6       17.8
105.......................................       25.3       24.4       23.5       22.7       21.9       21.0       20.2       19.4       18.6       17.8
106.......................................       25.3       24.4       23.5       22.7       21.9       21.0       20.2       19.4       18.6       17.8
107.......................................       25.2       24.4       23.5       22.7       21.8       21.0       20.2       19.4       18.6       17.8

[[Page 254]]

 
108.......................................       25.2       24.4       23.5       22.7       21.8       21.0       20.2       19.4       18.6       17.8
109.......................................       25.2       24.4       23.5       22.7       21.8       21.0       20.2       19.4       18.6       17.8
110.......................................       25.2       24.4       23.5       22.7       21.8       21.0       20.2       19.4       18.6       17.8
111.......................................       25.2       24.4       23.5       22.7       21.8       21.0       20.2       19.4       18.6       17.8
112.......................................       25.2       24.4       23.5       22.7       21.8       21.0       20.2       19.4       18.6       17.8
113.......................................       25.2       24.4       23.5       22.7       21.8       21.0       20.2       19.4       18.6       17.8
114.......................................       25.2       24.4       23.5       22.7       21.8       21.0       20.2       19.4       18.6       17.8
115+......................................       25.2       24.4       23.5       22.7       21.8       21.0       20.2       19.4       18.6       17.8
--------------------------------------------------------------------------------------------------------------------------------------------------------


--------------------------------------------------------------------------------------------------------------------------------------------------------
                   Ages                         70         71         72         73         74         75         76         77         78         79
--------------------------------------------------------------------------------------------------------------------------------------------------------
70........................................       21.8       21.3       20.9       20.6       20.2       19.9       19.6       19.4       19.1       18.9
71........................................       21.3       20.9       20.5       20.1       19.7       19.4       19.1       18.8       18.5       18.3
72........................................       20.9       20.5       20.0       19.6       19.3       18.9       18.6       18.3       18.0       17.7
73........................................       20.6       20.1       19.6       19.2       18.8       18.4       18.1       17.8       17.5       17.2
74........................................       20.2       19.7       19.3       18.8       18.4       18.0       17.6       17.3       17.0       16.7
75........................................       19.9       19.4       18.9       18.4       18.0       17.6       17.2       16.8       16.5       16.2
76........................................       19.6       19.1       18.6       18.1       17.6       17.2       16.8       16.4       16.0       15.7
77........................................       19.4       18.8       18.3       17.8       17.3       16.8       16.4       16.0       15.6       15.3
78........................................       19.1       18.5       18.0       17.5       17.0       16.5       16.0       15.6       15.2       14.9
79........................................       18.9       18.3       17.7       17.2       16.7       16.2       15.7       15.3       14.9       14.5
80........................................       18.7       18.1       17.5       16.9       16.4       15.9       15.4       15.0       14.5       14.1
81........................................       18.5       17.9       17.3       16.7       16.2       15.6       15.1       14.7       14.2       13.8
82........................................       18.3       17.7       17.1       16.5       15.9       15.4       14.9       14.4       13.9       13.5
83........................................       18.2       17.5       16.9       16.3       15.7       15.2       14.7       14.2       13.7       13.2
84........................................       18.0       17.4       16.7       16.1       15.5       15.0       14.4       13.9       13.4       13.0
85........................................       17.9       17.3       16.6       16.0       15.4       14.8       14.3       13.7       13.2       12.8
86........................................       17.8       17.1       16.5       15.8       15.2       14.6       14.1       13.5       13.0       12.5
87........................................       17.7       17.0       16.4       15.7       15.1       14.5       13.9       13.4       12.9       12.4
88........................................       17.6       16.9       16.3       15.6       15.0       14.4       13.8       13.2       12.7       12.2
89........................................       17.6       16.9       16.2       15.5       14.9       14.3       13.7       13.1       12.6       12.0
90........................................       17.5       16.8       16.1       15.4       14.8       14.2       13.6       13.0       12.4       11.9
91........................................       17.4       16.7       16.0       15.4       14.7       14.1       13.5       12.9       12.3       11.8
92........................................       17.4       16.7       16.0       15.3       14.6       14.0       13.4       12.8       12.2       11.7
93........................................       17.3       16.6       15.9       15.2       14.6       13.9       13.3       12.7       12.1       11.6
94........................................       17.3       16.6       15.9       15.2       14.5       13.9       13.2       12.6       12.0       11.5
95........................................       17.3       16.5       15.8       15.1       14.5       13.8       13.2       12.6       12.0       11.4
96........................................       17.2       16.5       15.8       15.1       14.4       13.8       13.1       12.5       11.9       11.3
97........................................       17.2       16.5       15.8       15.1       14.4       13.7       13.1       12.5       11.9       11.3
98........................................       17.2       16.4       15.7       15.0       14.3       13.7       13.0       12.4       11.8       11.2
99........................................       17.2       16.4       15.7       15.0       14.3       13.6       13.0       12.4       11.8       11.2
100.......................................       17.1       16.4       15.7       15.0       14.3       13.6       12.9       12.3       11.7       11.1
101.......................................       17.1       16.4       15.6       14.9       14.2       13.6       12.9       12.3       11.7       11.1
102.......................................       17.1       16.4       15.6       14.9       14.2       13.5       12.9       12.2       11.6       11.0
103.......................................       17.1       16.3       15.6       14.9       14.2       13.5       12.9       12.2       11.6       11.0
104.......................................       17.1       16.3       15.6       14.9       14.2       13.5       12.8       12.2       11.6       11.0
105.......................................       17.1       16.3       15.6       14.9       14.2       13.5       12.8       12.2       11.5       10.9
106.......................................       17.1       16.3       15.6       14.8       14.1       13.5       12.8       12.2       11.5       10.9

[[Page 255]]

 
107.......................................       17.0       16.3       15.6       14.8       14.1       13.4       12.8       12.1       11.5       10.9
108.......................................       17.0       16.3       15.5       14.8       14.1       13.4       12.8       12.1       11.5       10.9
109.......................................       17.0       16.3       15.5       14.8       14.1       13.4       12.8       12.1       11.5       10.9
110.......................................       17.0       16.3       15.5       14.8       14.1       13.4       12.7       12.1       11.5       10.9
111.......................................       17.0       16.3       15.5       14.8       14.1       13.4       12.7       12.1       11.5       10.8
112.......................................       17.0       16.3       15.5       14.8       14.1       13.4       12.7       12.1       11.5       10.8
113.......................................       17.0       16.3       15.5       14.8       14.1       13.4       12.7       12.1       11.4       10.8
114.......................................       17.0       16.3       15.5       14.8       14.1       13.4       12.7       12.1       11.4       10.8
115+......................................       17.0       16.3       15.5       14.8       14.1       13.4       12.7       12.1       11.4       10.8
--------------------------------------------------------------------------------------------------------------------------------------------------------


--------------------------------------------------------------------------------------------------------------------------------------------------------
                   Ages                         80         81         82         83         84         85         86         87         88         89
--------------------------------------------------------------------------------------------------------------------------------------------------------
80........................................       13.8       13.4       13.1       12.8       12.6       12.3       12.1       11.9       11.7       11.5
81........................................       13.4       13.1       12.7       12.4       12.2       11.9       11.7       11.4       11.3       11.1
82........................................       13.1       12.7       12.4       12.1       11.8       11.5       11.3       11.0       10.8       10.6
83........................................       12.8       12.4       12.1       11.7       11.4       11.1       10.9       10.6       10.4       10.2
84........................................       12.6       12.2       11.8       11.4       11.1       10.8       10.5       10.3       10.1        9.9
85........................................       12.3       11.9       11.5       11.1       10.8       10.5       10.2        9.9        9.7        9.5
86........................................       12.1       11.7       11.3       10.9       10.5       10.2        9.9        9.6        9.4        9.2
87........................................       11.9       11.4       11.0       10.6       10.3        9.9        9.6        9.4        9.1        8.9
88........................................       11.7       11.3       10.8       10.4       10.1        9.7        9.4        9.1        8.8        8.6
89........................................       11.5       11.1       10.6       10.2        9.9        9.5        9.2        8.9        8.6        8.3
90........................................       11.4       10.9       10.5       10.1        9.7        9.3        9.0        8.6        8.3        8.1
91........................................       11.3       10.8       10.3        9.9        9.5        9.1        8.8        8.4        8.1        7.9
92........................................       11.2       10.7       10.2        9.8        9.3        9.0        8.6        8.3        8.0        7.7
93........................................       11.1       10.6       10.1        9.6        9.2        8.8        8.5        8.1        7.8        7.5
94........................................       11.0       10.5       10.0        9.5        9.1        8.7        8.3        8.0        7.6        7.3
95........................................       10.9       10.4        9.9        9.4        9.0        8.6        8.2        7.8        7.5        7.2
96........................................       10.8       10.3        9.8        9.3        8.9        8.5        8.1        7.7        7.4        7.1
97........................................       10.7       10.2        9.7        9.2        8.8        8.4        8.0        7.6        7.3        6.9
98........................................       10.7       10.1        9.6        9.2        8.7        8.3        7.9        7.5        7.1        6.8
99........................................       10.6       10.1        9.6        9.1        8.6        8.2        7.8        7.4        7.0        6.7
100.......................................       10.6       10.0        9.5        9.0        8.5        8.1        7.7        7.3        6.9        6.6
101.......................................       10.5       10.0        9.4        9.0        8.5        8.0        7.6        7.2        6.9        6.5
102.......................................       10.5        9.9        9.4        8.9        8.4        8.0        7.5        7.1        6.8        6.4
103.......................................       10.4        9.9        9.4        8.8        8.4        7.9        7.5        7.1        6.7        6.3
104.......................................       10.4        9.8        9.3        8.8        8.3        7.9        7.4        7.0        6.6        6.3
105.......................................       10.4        9.8        9.3        8.8        8.3        7.8        7.4        7.0        6.6        6.2
106.......................................       10.3        9.8        9.2        8.7        8.2        7.8        7.3        6.9        6.5        6.2
107.......................................       10.3        9.8        9.2        8.7        8.2        7.7        7.3        6.9        6.5        6.1
108.......................................       10.3        9.7        9.2        8.7        8.2        7.7        7.3        6.8        6.4        6.1
109.......................................       10.3        9.7        9.2        8.7        8.2        7.7        7.2        6.8        6.4        6.0
110.......................................       10.3        9.7        9.2        8.6        8.1        7.7        7.2        6.8        6.4        6.0
111.......................................       10.3        9.7        9.1        8.6        8.1        7.6        7.2        6.8        6.3        6.0
112.......................................       10.2        9.7        9.1        8.6        8.1        7.6        7.2        6.7        6.3        5.9
113.......................................       10.2        9.7        9.1        8.6        8.1        7.6        7.2        6.7        6.3        5.9
114.......................................       10.2        9.7        9.1        8.6        8.1        7.6        7.1        6.7        6.3        5.9
115+......................................       10.2        9.7        9.1        8.6        8.1        7.6        7.1        6.7        6.3        5.9
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 256]]


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                                                                                                                                                      AGES
                                                                                                                                                       90
                                                                                                                                                       91
                                                                                                                                                       92
                                                                                                                                                       93
                 Ages                       90         91         92         93         94         95         96         97         98         99      94
                                                                                                                                                       95
                                                                                                                                                       96
                                                                                                                                                       97
                                                                                                                                                       98
                                                                                                                                                       99
---------------------------------------------------------------------------------------------------------------------------------------------------- ------
90....................................        7.8        7.6        7.4        7.2        7.1        6.9        6.8        6.6        6.5        6.4
91....................................        7.6        7.4        7.2        7.0        6.8        6.7        6.5        6.4        6.3        6.1
92....................................        7.4        7.2        7.0        6.8        6.6        6.4        6.3        6.1        6.0        5.9
93....................................        7.2        7.0        6.8        6.6        6.4        6.2        6.1        5.9        5.8        5.6
94....................................        7.1        6.8        6.6        6.4        6.2        6.0        5.9        5.7        5.6        5.4
95....................................        6.9        6.7        6.4        6.2        6.0        5.8        5.7        5.5        5.4        5.2
96....................................        6.8        6.5        6.3        6.1        5.9        5.7        5.5        5.3        5.2        5.0
97....................................        6.6        6.4        6.1        5.9        5.7        5.5        5.3        5.2        5.0        4.9
98....................................        6.5        6.3        6.0        5.8        5.6        5.4        5.2        5.0        4.8        4.7
99....................................        6.4        6.1        5.9        5.6        5.4        5.2        5.0        4.9        4.7        4.5
100...................................        6.3        6.0        5.8        5.5        5.3        5.1        4.9        4.7        4.5        4.4
101...................................        6.2        5.9        5.6        5.4        5.2        5.0        4.8        4.6        4.4        4.2
102...................................        6.1        5.8        5.5        5.3        5.1        4.8        4.6        4.4        4.3        4.1
103...................................        6.0        5.7        5.4        5.2        5.0        4.7        4.5        4.3        4.1        4.0
104...................................        5.9        5.6        5.4        5.1        4.9        4.6        4.4        4.2        4.0        3.8
105...................................        5.9        5.6        5.3        5.0        4.8        4.5        4.3        4.1        3.9        3.7
106...................................        5.8        5.5        5.2        4.9        4.7        4.5        4.2        4.0        3.8        3.6
107...................................        5.8        5.4        5.1        4.9        4.6        4.4        4.2        3.9        3.7        3.5
108...................................        5.7        5.4        5.1        4.8        4.6        4.3        4.1        3.9        3.7        3.5
109...................................        5.7        5.3        5.0        4.8        4.5        4.3        4.0        3.8        3.6        3.4
110...................................        5.6        5.3        5.0        4.7        4.5        4.2        4.0        3.8        3.5        3.3
111...................................        5.6        5.3        5.0        4.7        4.4        4.2        3.9        3.7        3.5        3.3
112...................................        5.6        5.3        4.9        4.7        4.4        4.1        3.9        3.7        3.5        3.2
113...................................        5.6        5.2        4.9        4.6        4.4        4.1        3.9        3.6        3.4        3.2
114...................................        5.6        5.2        4.9        4.6        4.3        4.1        3.9        3.6        3.4        3.2
115+..................................        5.5        5.2        4.9        4.6        4.3        4.1        3.8        3.6        3.4        3.1
--------------------------------------------------------------------------------------------------------------------------------------------------------


--------------------------------------------------------------------------------------------------------------------------------------------------------
                   Ages                        100        101        102        103        104        105        106        107        108        109
--------------------------------------------------------------------------------------------------------------------------------------------------------
100.......................................        4.2        4.1        3.9        3.8        3.7        3.5        3.4        3.3        3.3        3.2
101.......................................        4.1        3.9        3.7        3.6        3.5        3.4        3.2        3.1        3.1        3.0
102.......................................        3.9        3.7        3.6        3.4        3.3        3.2        3.1        3.0        2.9        2.8
103.......................................        3.8        3.6        3.4        3.3        3.2        3.0        2.9        2.8        2.7        2.6
104.......................................        3.7        3.5        3.3        3.2        3.0        2.9        2.7        2.6        2.5        2.4
105.......................................        3.5        3.4        3.2        3.0        2.9        2.7        2.6        2.5        2.4        2.3
106.......................................        3.4        3.2        3.1        2.9        2.7        2.6        2.4        2.3        2.2        2.1
107.......................................        3.3        3.1        3.0        2.8        2.6        2.5        2.3        2.2        2.1        2.0
108.......................................        3.3        3.1        2.9        2.7        2.5        2.4        2.2        2.1        1.9        1.8
109.......................................        3.2        3.0        2.8        2.6        2.4        2.3        2.1        2.0        1.8        1.7
110.......................................        3.1        2.9        2.7        2.5        2.3        2.2        2.0        1.9        1.7        1.6
111.......................................        3.1        2.9        2.7        2.5        2.3        2.1        1.9        1.8        1.6        1.5
112.......................................        3.0        2.8        2.6        2.4        2.2        2.0        1.9        1.7        1.5        1.4
113.......................................        3.0        2.8        2.6        2.4        2.2        2.0        1.8        1.6        1.5        1.3
114.......................................        3.0        2.7        2.5        2.3        2.1        1.9        1.8        1.6        1.4        1.3
115+......................................        2.9        2.7        2.5        2.3        2.1        1.9        1.7        1.5        1.4        1.2
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 257]]


----------------------------------------------------------------------------------------------------------------
                  Ages                        110         111         112         113         114        115+
----------------------------------------------------------------------------------------------------------------
110.....................................         1.5         1.4         1.3         1.2         1.1         1.1
111.....................................         1.4         1.2         1.1         1.1         1.0         1.0
112.....................................         1.3         1.1         1.0         1.0         1.0         1.0
113.....................................         1.2         1.1         1.0         1.0         1.0         1.0
114.....................................         1.1         1.0         1.0         1.0         1.0         1.0
115+....................................         1.1         1.0         1.0         1.0         1.0         1.0
----------------------------------------------------------------------------------------------------------------

    Q-4. May the tables under this section be changed?
    A-4. The Single Life Table, Uniform Lifetime Table and Joint and 
Last Survivor Table provided in A-1 through A-3 of this section may be 
changed by the Commissioner in revenue rulings, notices, and other 
guidance published in the Internal Revenue Bulletin. See Sec. 
601.601(d)(2)(ii)(b) of this chapter.

[T.D. 8987, 67 FR 18994, Apr. 17, 2002; 67 FR 36676, May 24, 2002]



Sec. 1.401(a)(17)-1  Limitation on annual compensation.

    (a) Compensation limit requirement--(1) In general. In order to be a 
qualified plan, a plan must satisfy section 401(a)(17). Section 
401(a)(17) provides an annual compensation limit for each employee under 
a qualified plan. This limit applies to a qualified plan in two ways. 
First, a plan may not base allocations, in the case of a defined 
contribution plan, or benefit accruals, in the case of a defined benefit 
plan, on compensation in excess of the annual compensation limit. 
Second, the amount of an employee's annual compensation that may be 
taken into account in applying certain specified nondiscrimination rules 
under the Internal Revenue Code is subject to the annual compensation 
limit. These two limitations are set forth in paragraphs (b) and (c) of 
this section, respectively. Paragraph (d) of this section provides the 
effective dates of section 401(a)(17), the amendments made by section 
13212 of the Omnibus Budget Reconciliation Act of 1993 (OBRA '93), and 
this section. Paragraph (e) of this section provides rules for 
determining post-effective-date accrued benefits under the fresh-start 
rules.
    (2) Annual compensation limit for plan years beginning before 
January 1, 1994. For purposes of this section, for plan years beginning 
prior to the OBRA '93 effective date, annual compensation limit means 
$200,000, adjusted as provided by the Commissioner. The amount of the 
annual compensation limit is adjusted at the same time and in the same 
manner as under section 415(d). The base period for the annual 
adjustment is the calendar quarter ending December 31, 1988, and the 
first adjustment is effective on January 1, 1990. Any increase in the 
annual compensation limit is effective as of January 1 of a calendar 
year and applies to any plan year beginning in that calendar year. In 
any plan year beginning prior to the OBRA '93 effective date, if 
compensation for any plan year beginning prior to the statutory 
effective date is used for determining allocations or benefit accruals, 
or when applying any nondiscrimination rule, then the annual 
compensation limit for the first plan year beginning on or after the 
statutory effective date (generally $200,000) must be applied to 
compensation for that prior plan year.
    (3) Annual compensation limit for plan years beginning on or after 
January 1, 1994--(i) In general. For purposes of this section, for plan 
years beginning on or after the OBRA '93 effective date, annual 
compensation limit means $150,000, adjusted as provided by the 
Commissioner. The adjusted dollar amount of the annual compensation 
limit is determined by adjusting the $150,000 amount for changes in the 
cost of living as provided in paragraph (a)(3)(ii) of this section and 
rounding this adjusted dollar amount as provided in paragraph 
(a)(3)(iii) of this section. Any increase in the annual compensation 
limit is effective as of January 1 of a calendar year and applies to any 
plan year beginning in that calendar year. For example, if a plan has a 
plan year beginning July 1, 1994, and ending June 30, 1995, the annual 
compensation limit in effect on January 1, 1994 ($150,000), applies to 
the plan for the entire plan year.

[[Page 258]]

    (ii) Cost of living adjustment. The $150,000 amount is adjusted for 
changes in the cost of living by the Commissioner at the same time and 
in the same manner as under section 415(d). The base period for the 
annual adjustment is the calendar quarter ending December 31, 1993.
    (iii) Rounding of adjusted compensation limit. After the $150,000, 
adjusted in accordance with paragraph (a)(3)(ii) of this section, 
exceeds the annual compensation limit for the prior calendar year by 
$10,000 or more, the annual compensation limit will be increased by the 
amount of such excess, rounded down to the next lowest multiple of 
$10,000.
    (4) Additional guidance. The Commissioner may, in revenue rulings 
and procedures, notices, and other guidance, published in the Internal 
Revenue Bulletin (see Sec. 601.601(d)(2)(ii)(b) of this chapter), 
provide any additional guidance that may be necessary or appropriate 
concerning the annual limits on compensation under section 401(a)(17).
    (b) Plan limit on compensation--(1) General rule. A plan does not 
satisfy section 401(a)(17) unless it provides that the compensation 
taken into account for any employee in determining plan allocations or 
benefit accruals for any plan year is limited to the annual compensation 
limit. For purposes of this rule, allocations and benefit accruals under 
a plan include all benefits provided under the plan, including ancillary 
benefits.
    (2) Plan-year-by-plan-year requirement. For purposes of this 
paragraph (b), the limit in effect for the current plan year applies 
only to the compensation for that year that is taken into account in 
determining plan allocations or benefit accruals for the year. The 
compensation for any prior plan year taken into account in determining 
an employee's allocations or benefit accruals for the current plan year 
is subject to the applicable annual compensation limit in effect for 
that prior year. Thus, increases in the annual compensation limit apply 
only to compensation taken into account for the plan year in which the 
increase is effective. In addition, if compensation for any plan year 
beginning prior to the OBRA '93 effective date is used for determining 
allocations or benefit accruals in a plan year beginning on or after the 
OBRA '93 effective date, then the annual compensation limit for that 
prior year is the annual compensation limit in effect for the first plan 
year beginning on or after the OBRA '93 effective date (generally 
$150,000).
    (3) Application of limit to a plan year--(i) In general. For 
purposes of applying this paragraph (b), the annual compensation limit 
is applied to the compensation for the plan year on which allocations or 
benefit accruals are based.
    (ii) Compensation for the plan year. If a plan determines 
compensation used in determining allocations or benefit accruals for a 
plan year based on compensation for the plan year, then the annual 
compensation limit that applies to the compensation for the plan year is 
the limit in effect for the calendar year in which the plan year begins. 
Alternatively, if a plan determines compensation used in determining 
allocations or benefit accruals for the plan year on the basis of 
compensation for a 12-consecutive-month period, or periods, ending no 
later than the last day of the plan year, then the annual compensation 
limit applies to compensation for each of those periods based on the 
annual compensation limit in effect for the respective calendar year in 
which each 12-month period begins.
    (iii) Compensation for a period of less than 12-months--(A) 
Proration required. If compensation for a period of less than 12 months 
is used for a plan year, then the otherwise applicable annual 
compensation limit is reduced in the same proportion as the reduction in 
the 12-month period. For example, if a defined benefit plan provides 
that the accrual for each month in a plan year is separately determined 
based on the compensation for that month and the plan year accrual is 
the sum of the accruals for all months, then the annual compensation 
limit for each month is \1/12\th of the annual compensation limit for 
the plan year. In addition, if the period for determining compensation 
used in calculating an employee's allocation or accrual for a plan year 
is a short plan year (i.e., shorter than 12 months), the annual 
compensation

[[Page 259]]

limit is an amount equal to the otherwise applicable annual compensation 
limit multiplied by a fraction, the numerator of which is the number of 
months in the short plan year, and the denominator of which is 12.
    (B) No proration required for participation for less than a full 
plan year. Notwithstanding paragraph (b)(3)(iii)(A) of this section, a 
plan is not treated as using compensation for less than 12 months for a 
plan year merely because the plan formula provides that the allocation 
or accrual for each employee is based on compensation for the portion of 
the plan year during which the employee is a participant in the plan. In 
addition, no proration is required merely because an employee is covered 
under a plan for less than a full plan year, provided that allocations 
or benefit accruals are otherwise determined using compensation for a 
period of at least 12 months. Finally, notwithstanding paragraph 
(b)(3)(iii)(A) of this section, no proration is required merely because 
the amount of elective contributions (within the meaning of Sec. 
1.401(k)-6, matching contributions (within the meaning of Sec. 
1.401(m)-5, or employee contributions (within the meaning of Sec. 
1.401(m)-5 that is contributed for each pay period during a plan year is 
determined separately using compensation for that pay period.
    (4) Limits on multiple employer and multiemployer plans. For 
purposes of this paragraph (b), in the case of a plan described in 
section 413(c) or 414(f) (a plan maintained by more than one employer), 
the annual compensation limit applies separately with respect to the 
compensation of an employee from each employer maintaining the plan 
instead of applying to the employee's total compensation from all 
employers maintaining the plan.
    (5) Family aggregation. [Reserved]
    (6) Examples. The following examples illustrate the rules in this 
paragraph (b).

    Example 1. Plan X is a defined benefit plan with a calendar year 
plan year and bases benefits on the average of an employee's high 3 
consecutive years' compensation. The OBRA '93 effective date for Plan X 
is January 1, 1994. Employee A's high 3 consecutive years' compensation 
prior to the application of the annual compensation limits is $160,000 
(1994), $155,000 (1993), and $135,000 (1992). To satisfy this paragraph 
(b), Plan X cannot base plan benefits for Employee A in 1994 on 
compensation in excess of $145,000 (the average of $150,000 (A's 1994 
compensation capped by the annual compensation limit), $150,000 (A's 
1993 compensation capped by the $150,000 annual compensation limit 
applicable to all years before 1994), and $135,000 (A's 1992 
compensation capped by the $150,000 annual compensation limit applicable 
to all years before 1994)). For purposes of determining the 1994 
accrual, each year (1994, 1993, and 1992), not the average of the 3 
years, is subject to the 1994 annual compensation limit of $150,000.
    Example 2. Assume the same facts as Example 1, except that Employee 
A's high 3 consecutive years' compensation prior to the application of 
the limits is $185,000 (1997), $175,000 (1996), and $165,000 (1995). 
Assume that the annual compensation limit is first adjusted to $160,000 
for plan years beginning on or after January 1, 1997. Plan X cannot base 
plan benefits for Employee A in 1997 on compensation in excess of 
$153,333 (the average of $160,000 (A's 1997 compensation capped by the 
1997 limit), $150,000 (A's 1996 compensation capped by the 1996 limit), 
and $150,000 (A's 1995 compensation capped by the 1995 limit)).
    Example 3. Plan Y is a defined benefit plan that bases benefits on 
an employee's high consecutive 36 months of compensation ending within 
the plan year. Employee B's high 36 months are the period September 1995 
to August 1998, in which Employee B earned $50,000 in each month. Assume 
that the annual compensation limit is first adjusted to $160,000 for 
plan years beginning on or after January 1, 1997. The annual 
compensation limit is $150,000, $150,000, and $160,000 in 1995, 1996, 
and 1997, respectively. To satisfy this paragraph (b), Plan Y cannot 
base Employee B's plan benefits for the 1998 plan year on compensation 
in excess of $153,333. This amount is determined by applying the 
applicable annual compensation limit to compensation for each of the 
three 12-consecutive-month periods. The September 1995 to August 1996 
period is capped by the annual compensation limit of $150,000 for 1995; 
the September 1996 to August 1997 period is capped by the annual 
compensation limit of $150,000 for 1996; and the September 1997 to 
August 1998 period is capped by the annual compensation limit of 
$160,000 for 1997. The average of these capped amounts is the annual 
compensation limit applicable in determining benefits for the 1998 year.
    Example 4. (a) Employer P is a partnership. Employer P maintains 
Plan Z, a profit-sharing plan that provides for an annual allocation of 
employer contributions of 15 percent of plan year compensation for 
employees other than self-employed individuals, and 13.0435 percent of 
plan year compensation for self-employed individuals. The plan year of

[[Page 260]]

Plan Z is the calendar year. The OBRA '93 effective date for Plan Z is 
January 1, 1994. In order to satisfy section 401(a)(17), as amended by 
OBRA '93, the plan provides that, beginning with the 1994 plan year, the 
plan year compensation used in determining the allocation of employer 
contributions for each employee may not exceed the annual limit in 
effect for the plan year under OBRA '93. Plan Z defines compensation for 
self-employed individuals (employees within the meaning of section 
401(c)(1)) as the self-employed individual's net profit from self-
employment attributable to Employer P minus the amount of the self-
employed individual's deduction under section 164(f) for one-half of 
self-employment taxes. Plan Z defines compensation for all other 
employees as wages within the meaning of section 3401(a). Employee C and 
Employee D are partners of Employer P and thus are self-employed 
individuals. Neither Employee C nor Employee D owns an interest in any 
other business or is a common-law employee in any business. For the 1994 
calendar year, Employee C has net profit from self-employment of 
$80,000, and Employee D has net profit from self-employment of $175,000. 
The deduction for Employee C under section 164(f) for one-half of self-
employment taxes is $4,828. The deduction for Employee D under section 
164(f) for one-half of self-employment taxes is $6,101
    (b) The plan year compensation under the plan formula for Employee C 
is $75,172 ($80,000 minus $4,828). The allocation of employer 
contributions under the plan allocation formula for 1994 for Employee C 
is $9,805 ($75,172 (Employee C's plan year compensation for 1994) 
multiplied by 13.0435%). The plan year compensation under the plan 
formula before application of the annual limit under section 401(a)(17) 
for Employee D is $168,899 ($175,000 minus $6101). After application of 
the annual limit, the plan year compensation for the 1994 plan year for 
Employee D is $150,000 (the annual limit for 1994). Therefore, the 
allocation of employer contributions under the plan allocation formula 
for 1994 for Employee D is $19,565 ($150,000 (Employee D's plan year 
compensation after application of the annual limit for 1994) multiplied 
by 13.0435%).
    Example 5. The facts are the same as in Example 4, except that Plan 
Z provides that plan year compensation for self-employed individuals is 
defined as earned income within the meaning of section 401(c)(2) 
attributable to Employer P. In addition, Plan Z provides for an annual 
allocation of employer contributions of 15 percent of plan year 
compensation for all employees in the plan, including self-employed 
individuals, such as Employees C and D. The net profit from self-
employment for Employee C and the net profit from self-employment for 
Employee D are the same as provided in Example 4. However, the earned 
income of Employee C determined in accordance with section 401(c)(2) is 
$65,367 ($80,000 minus $4,828 minus $9,805). The earned income of 
Employee D determined in accordance with section 401(c)(2) is $146,869 
($175,000 minus $6,101 minus $22,030). Therefore, the allocation of 
employer contributions under the plan allocation formula for 1994 for 
Employee C is $9,805 ($65,367 (Employee C's plan year compensation for 
1994) multiplied by 15%). Employee D's earned income for 1994 does not 
exceed the 1994 annual limit of $150,000. Therefore, the allocation of 
employer contributions under the plan allocation formula for 1994 for 
Employee D is $22,030 ($146,869 (Employee D's plan year compensation for 
1994) multiplied by 15%).

    (c) Limit on compensation for nondiscrimination rules--(1) General 
rule. The annual compensation limit applies for purposes of applying the 
nondiscrimination rules under sections 401(a)(4), 401(a)(5), 401(l), 
401(k)(3), 401(m)(2), 403(b)(12), 404(a)(2) and 410(b)(2). The annual 
compensation limit also applies in determining whether an alternative 
method of determining compensation impermissibly discriminates under 
section 414(s)(3). Thus, for example, the annual compensation limit 
applies when determining a self-employed individual's total earned 
income that is used to determine the equivalent alternative compensation 
amount under Sec. 1.414(s)-1(g)(1). This paragraph (c) provides rules 
for applying the annual compensation limit for these purposes. For 
purposes of this paragraph (c), compensation means the compensation used 
in applying the applicable nondiscrimination rule.
    (2) Plan-year-by-plan-year requirement. For purposes of this 
paragraph (c), when applying an applicable nondiscrimination rule for a 
plan year, the compensation for each plan year taken into account is 
limited to the applicable annual compensation limit in effect for that 
year, and an employee's compensation for that plan year in excess of the 
limit is disregarded. Thus, if the nondiscrimination provision is 
applied on the basis of compensation determined over a period of more 
than one year (for example, average annual compensation), the annual 
compensation limit in effect for each of the plan years that is taken 
into account in determining the average applies to the respective plan 
year's compensation. In addition, if compensation for any plan

[[Page 261]]

year beginning prior to the OBRA '93 effective date is used when 
applying any nondiscrimination rule in a plan year beginning on or after 
the OBRA '93 effective date, then the annual compensation limit for that 
prior year is the annual compensation limit for the first plan year 
beginning on or after the OBRA '93 effective date (generally $150,000).
    (3) Plan-by-plan limit. For purposes of this paragraph (c), the 
annual compensation limit applies separately to each plan (or group of 
plans treated as a single plan) of an employer for purposes of the 
applicable nondiscrimination requirement. For this purpose, the plans 
included in the testing group taken into account in determining whether 
the average benefit percentage test of Sec. 1.410(b)-5 is satisfied are 
generally treated as a single plan.
    (4) Application of limit to a plan year. The rules provided in 
paragraph (b)(3) of this section regarding the application of the limit 
to a plan year apply for purposes of this paragraph (c).
    (5) Limits on multiple employer and multiemployer plans. The rule 
provided in paragraph (b)(4) of this section regarding the application 
of the limit to multiple employer and multiemployer plans applies for 
purposes of this paragraph (c).
    (d) Effective date--(1) Statutory effective date--(i) General rule. 
Except as otherwise provided in this paragraph (d), section 401(a)(17) 
applies to a plan as of the first plan year beginning on or after 
January 1, 1989. For purposes of this section, statutory effective date 
generally means the first day of the first plan year that section 
401(a)(17) is applicable to a plan. In the case of governmental plans, 
statutory effective date means the first day of the first plan year for 
which the plan is not deemed to satisfy section 401(a)(17) by reason of 
paragraph (d)(4) of this section.
    (ii) Exception for collectively bargained plans. In the case of a 
plan maintained pursuant to one or more collective bargaining agreements 
between employee representatives and one or more employers ratified 
before March 1, 1986, section 401(a)(17) applies to allocations and 
benefit accruals for plan years beginning on or after the earlier of--
    (A) January 1, 1991; or
    (B) The later of January 1, 1989, or the date on which the last of 
the collective bargaining agreements terminates (determined without 
regard to any extension or renegotiation of any agreement occurring 
after February 28, 1986). For purposes of this paragraph (d)(1)(ii), the 
rules of Sec. 1.410(b)-10(a)(2) apply for purposes of determining 
whether a plan is maintained pursuant to one or more collective 
bargaining agreements, and any extension or renegotiation of a 
collective bargaining agreement, which extension or renegotiation is 
ratified after February 28, 1986, is to be disregarded in determining 
the date on which the agreement terminates.
    (2) OBRA '93 effective date--(i) In general. For purposes of this 
section, OBRA '93 effective date means the first day of the first plan 
year beginning on or after January 1, 1994, except as provided in this 
paragraph (d)(2).
    (ii) Exception for collectively bargained plans--(A) In general. In 
the case of a plan maintained pursuant to one or more collective 
bargaining agreements between employee representatives and 1 or more 
employers ratified before August 10, 1993, OBRA '93 effective date means 
the first day of the first plan year beginning on or after the earlier 
of--
    (1) The latest of--
    (i) January 1, 1994;
    (ii) The date on which the last of such collective bargaining 
agreements terminates (without regard to any extension, amendment, or, 
modification of such agreements on or after August 10, 1993); or
    (iii) In the case of a plan maintained pursuant to collective 
bargaining under the Railway Labor Act, the date of execution of an 
extension or replacement of the last of such collective bargaining 
agreements in effect on August 10, 1993; or
    (2) January 1, 1997.
    (B) Determination of whether plan is collectively bargained. For 
purposes of this paragraph (d)(2)(ii), the rules of Sec. 1.410(b)-
10(a)(2) apply for purposes of determining whether a plan is maintained 
pursuant to one or more collective bargaining agreements, except that 
August 10, 1993, is substituted for

[[Page 262]]

March 1, 1986, as the date before which the collective bargaining 
agreements must be ratified.
    (3) Regulatory effective date. This Sec. 1.401(a)(17)-1 applies to 
plan years beginning on or after the OBRA '93 effective date. However, 
in the case of a plan maintained by an organization that is exempt from 
income taxation under section 501(a), including plans subject to section 
403(b)(12)(A)(i) (nonelective plans), this Sec. 1.401(a)(17)-1 applies 
to plan years beginning on or after January 1, 1996. For plan years 
beginning before the effective date of these regulations and on or after 
the statutory effective date, a plan must be operated in accordance with 
a reasonable, good faith interpretation of section 401(a)(17), taking 
into account, if applicable, the OBRA '93 reduction to the annual 
compensation limit under section 401(a)(17).
    (4) Special rules for governmental plans--(i) Deemed satisfaction by 
governmental plans. In the case of governmental plans described in 
section 414(d), including plans subject to section 403(b)(12)(A)(i) 
(nonelective plans), section 401(a)(17) is considered satisfied for plan 
years beginning before the later of January 1, 1996, or 90 days after 
the opening of the first legislative session beginning on or after 
January 1, 1996, of the governing body with authority to amend the plan, 
if that body does not meet continuously. For purposes of this paragraph 
(d)(4), the term governing body with authority to amend the plan means 
the legislature, board, commission, council, or other governing body 
with authority to amend the plan.
    (ii) Transition rule for governmental plans--(A) In general. In the 
case of an eligible participant in a governmental plan (within the 
meaning of section 414(d)), the annual compensation limit under this 
section shall not apply to the extent that the application of the 
limitation would reduce the amount of compensation that is allowed to be 
taken into account under the plan below the amount that was allowed to 
be taken into account under the plan as in effect on July 1, 1993. Thus, 
for example, if a plan as in effect on July 1, 1993, determined benefits 
without any reference to a limit on compensation, then the annual 
compensation limit in effect under this section will not apply to any 
eligible participant in any future year.
    (B) Eligible participant. For purposes of this paragraph (d)(4)(ii), 
an eligible participant is an individual who first became a participant 
in the plan prior to the first day of the first plan year beginning 
after the earlier of--
    (1) The last day of the plan year by which a plan amendment to 
reflect the amendments made by section 13212 of OBRA '93 is both adopted 
and effective; or
    (2) December 31, 1995.
    (C) Plan must be amended to incorporate limits. This paragraph 
(d)(4)(ii) shall not apply to any eligible participant in a plan unless 
the plan is amended so that the plan incorporates by reference the 
annual compensation limit under section 401(a)(17), effective with 
respect to noneligible participants for plan years beginning after 
December 31, 1995 (or earlier, if the plan amendment so provides).
    (5) Benefits earned prior to effective date--(i) In general. 
Allocations under a defined contribution plan or benefits accrued under 
a defined benefit plan for plan years beginning before the statutory 
effective date are not subject to the annual compensation limit. 
Allocations under a defined contribution plan or benefits accrued under 
a defined benefit plan for plan years beginning on or after the 
statutory effective date, but before the OBRA '93 effective date, are 
subject to the annual compensation limit under paragraph (a)(2) of this 
section. However, these allocations or accruals are not subject to the 
OBRA '93 reduction to the annual compensation limit described in 
paragraph (a)(3) of this section.
    (ii) Allocation for a plan year. The allocations for a plan year 
include amounts described in Sec. 1.401(a)(4)-2(c)(ii) or Sec. 
1.401(m)-1(f)(6) plus the earnings, expenses, gains, and losses 
attributable to those amounts.
    (iii) Benefits accrued for years before the effective date. The 
benefits accrued for plan years prior to a specified date by any 
employee are the employee's benefits accrued under the plan, determined 
as if those benefits had been frozen (as defined in Sec. 1.401(a)(4)-
13(c)(3)(i))

[[Page 263]]

as of the day immediately preceding such specified date. Thus, for 
example, benefits accrued for those plan years generally do not include 
any benefits accrued under an amendment increasing prior benefits that 
is adopted after the date on which the employee's benefits under the 
plan must be treated as frozen.
    (e) Determination of post-effective-date accrued benefits--(1) In 
general. The plan formula that is used to determine the amount of 
allocations or benefit accruals for plan years beginning on or after the 
dates described in paragraph (d)(1) or (2) must comply with section 
401(a)(17) as in effect on such date. This paragraph (e) provides rules 
for applying section 401(a)(17) in the case of section 401(a)(17) 
employees who accrue additional benefits under a defined benefit plan in 
a plan year beginning on or after the relevant effective date. Paragraph 
(e)(2) of this section contains definitions used in applying these 
rules. Paragraphs (e)(3) and (e)(4) of this section explain the 
application of the fresh-start rules in Sec. 1.401(a)(4)-13 to the 
determination of the accrued benefits of section 401(a)(17) employees.
    (2) Definitions. For purposes of this paragraph (e), the following 
definitions apply:
    (i) Section 401(a)(17) employee. An employee is a section 401(a)(17) 
employee as of a date, on or after the statutory effective date, if the 
employee's current accrued benefit as of that date is based on 
compensation for a year prior to the statutory effective date that 
exceeded the annual compensation limit for the first plan year beginning 
on or after the statutory effective date. In addition, an employee is a 
section 401(a)(17) employee as of a date, on or after the OBRA '93 
effective date, if the employee's current accrued benefit as of that 
date is based on compensation for a year prior to the OBRA '93 effective 
date that exceeded the annual compensation limit for the first plan year 
beginning on or after the OBRA '93 effective date. For this purpose, a 
current accrued benefit is not treated as based on compensation that 
exceeded the relevant annual compensation limit, if a plan makes a fresh 
start using the formula with wear-away described in Sec. 1.401(a)(4)-
13(c)(4)(ii), and the employee's accrued benefit determined under Sec. 
1.401(a)(4)-13(c)(4)(ii)(B), taking into account the annual compensation 
limit, exceeds the employee's frozen accrued benefit (or, if applicable, 
the employee's adjusted accrued benefit) as of the fresh-start date.
    (ii) Section 401(a)(17) fresh-start date. Section 401(a)(17) fresh-
start date means a fresh-start date as defined in Sec. 1.401(a)(4)-12 
not earlier than the last day of the last plan year beginning before the 
statutory effective date, and not later than the last day of the last 
plan year beginning before the effective date of these regulations.
    (iii) OBRA '93 fresh-start date. OBRA '93 fresh-start date means a 
fresh-start date as defined in Sec. 1.401(a)(4)-12 not earlier than the 
last day of the last plan year beginning before the OBRA '93 effective 
date, and not later than the last day of the last plan year beginning 
before the effective date of these regulations.
    (iv) Section 401(a)(17) frozen accrued benefit. Section 401(a)(17) 
frozen accrued benefit means the accrued benefit for any section 
401(a)(17) employee frozen (as defined in Sec. 1.401(a)(4)-13(c)(3)(i)) 
as of the last day of the last plan year beginning before the statutory 
effective date.
    (v) OBRA '93 frozen accrued benefit. OBRA '93 frozen accrued benefit 
means the accrued benefit for any section 401(a)(17) employee frozen (as 
defined in Sec. 1.401(a)(4)-13(c)(3)(i)) as of the OBRA '93 fresh-start 
date.
    (3) Application of fresh-start rules--(i) General rule. In order to 
satisfy section 401(a)(17), a defined benefit plan must determine the 
accrued benefit of each section 401(a)(17) employee by applying the 
fresh-start rules in Sec. 1.401(a)(4)-13(c). The fresh-start rules must 
be applied using a section 401(a)(17) fresh-start date and using the 
plan benefit formula, after amendment to comply with section 401(a)(17) 
and this section, as the formula applicable to benefit accruals in the 
current plan year. In addition, the fresh-start rules must be applied to 
determine the accrued benefit of each section 401(a)(17) employee using 
an OBRA '93 fresh-start date and using the plan benefit formula, after 
amendment to comply with the reduction in the section 401(a)(17) annual

[[Page 264]]

compensation limit described in paragraph (a)(3) of this section, as the 
formula applicable to benefit accruals in the current plan year.
    (ii) Consistency rules in Sec. 1.401(a)(4)-13(c) and (d)--(A) 
General rule. In applying the fresh-start rules of Sec. 1.401(a)(4)-
13(c) and (d), the group of section 401(a)(17) employees is a fresh-
start group. See Sec. 1.401(a)(4)-13(c)(5)(ii)(A). Thus, the 
consistency rules of those sections govern, unless otherwise provided. 
For example, if the plan is using a fresh-start date applicable to all 
employees and is not adjusting frozen accrued benefits under Sec. 
1.401(a)(4)-13(d) for employees who are not section 401(a)(17) 
employees, then the frozen accrued benefits for section 401(a)(17) 
employees may not be adjusted under Sec. 1.401(a)(4)-13(d) or this 
paragraph (e).
    (B) Determination of adjusted accrued benefit. If the fresh-start 
rules of Sec. 1.401(a)(4)-13(c) and (d) are applied to determine the 
benefits of all employees after a fresh-start date, the plan will not 
fail to satisfy the consistency requirement of Sec. 1.401(a)(4)-
13(c)(5)(i) merely because the plan makes the adjustment described in 
Sec. 1.401(a)(4)-13(d) to the frozen accrued benefits of employees who 
are not section 401(a)(17) employees, but does not make the adjustment 
to the frozen accrued benefits of section 401(a)(17) employees. In 
addition, the plan does not fail to satisfy the consistency requirement 
of Sec. 1.401(a)(4)-13(c)(5)(i) merely because the plan makes the 
adjustment described in Sec. 1.401(a)(4)-13(d) for section 401(a)(17) 
employees on the basis of the compensation formula that was used to 
determine the frozen accrued benefit (as required under paragraph 
(e)(4)(iii) of this section) but makes the adjustment for employees who 
are not section 401(a)(17) employees on the basis of any other method 
provided in Sec. 1.401(a)(4)-13(d)(8).
    (4) Permitted adjustments to frozen accrued benefit of section 
401(a)(17) employees--(i) General rule. Except as otherwise provided in 
paragraphs (e)(4)(ii) and (iii) of this section, the rules in Sec. 
1.401(a)(4)-13(c)(3) (permitting certain adjustments to frozen accrued 
benefits) apply to section 401(a)(17) frozen accrued benefits or OBRA 
'93 frozen accrued benefits.
    (ii) Optional forms of benefit. After either the section 401(a)(17) 
fresh-start date or the OBRA '93 fresh-start date, a plan may be amended 
either to provide a new optional form of benefit or to make an optional 
form of benefit available with respect to the section 401(a)(17) frozen 
accrued benefit or the OBRA '93 frozen accrued benefit, provided that 
the optional form of benefit is not subsidized. Whether an optional form 
is subsidized may be determined using any reasonable actuarial 
assumptions.
    (iii) Adjusting section 401(a)(17) accrued benefits--(A) In general. 
If the plan adjusts accrued benefits for employees under the rules of 
Sec. 1.401(a)(4)-13(d) as of a fresh-start date, the adjusted accrued 
benefit (within the meaning of section Sec. 1.401(a)(4)-13(d)) for each 
section 401(a)(17) employee must be determined after the fresh-start 
date by reference to the plan's compensation formula that was actually 
used to determine the frozen accrued benefit as of the fresh-start date. 
For this purpose, the plan's compensation formula incorporates the 
plan's underlying compensation definition and compensation averaging 
period. In making the adjustment, the denominator of the adjustment 
fraction described in Sec. 1.401(a)(4)-13(d)(8)(i) is the employee's 
compensation as of the fresh-start date using the plan's compensation 
formula as of that date and, in the case of an OBRA '93 fresh-start 
date, reflecting the annual compensation limits that applied as of the 
fresh-start date. The numerator of the adjustment fraction is the 
employee's updated compensation (i.e., compensation for the current plan 
year within the meaning of Sec. 1.401(a)(4)-13(d)(8)), determined after 
applying the annual compensation limits to each year's compensation that 
is used in the plan's compensation formula as of the fresh-start date. 
Similarly, in applying the alternative rule in Sec. 1.401(a)(4)-
13(d)(8)(v), the updated compensation that is substituted must be 
determined after applying the annual compensation limits to each year's 
compensation that is used in the plan's compensation formula. Thus, no 
adjustment will be permitted unless the updated compensation (determined 
after

[[Page 265]]

applying the annual compensation limit) exceeds the compensation that 
was used to determine the employee's frozen accrued benefit.
    (B) Multiple fresh starts. If a plan makes more than one fresh start 
with respect to a section 401(a)(17) employee, the employee's frozen 
accrued benefit as of the latest fresh-start date will either be 
determined by applying the current benefit formula to the employee's 
total years of service as of that fresh-start date or will consist of 
the sum of the employee's frozen accrued benefit (or adjusted accrued 
benefit (as defined in Sec. 1.401(a)(4)-13(d)(8)(i))) as of the 
previous fresh-start date plus additional frozen accruals since the 
previous fresh start. If the frozen accrued benefit consists of such a 
sum, in making the adjustments described in paragraph (e)(4)(iii)(A) of 
this section, separate adjustments must be made to that previously 
frozen accrued benefit (or adjusted accrued benefit) and the additional 
frozen accruals to the extent that the frozen accrued benefit and the 
additional accruals have been determined using different compensation 
formulas or different compensation limits (i.e., the section 401(a)(17) 
limit before and after the reduction in limit described in paragraph 
(a)(3) of this section). In this case, if the plan is applying the 
adjustment fraction of Sec. 1.401(a)(4)-13(d)(8)(i), the denominator of 
the separate adjustment fraction for adjusting each portion of the 
frozen accrued benefit must reflect the actual compensation formula, 
and, if applicable, compensation limit, originally used for determining 
that portion. For example, the frozen accrued benefit of a section 
401(a)(17) employee as of the OBRA '93 fresh-start date may be based on 
the sum of the section 401(a)(17) frozen accrued benefit (determined 
without any annual compensation limit) plus benefit accruals in the 
years between the statutory effective date and the OBRA '93 effective 
date (based on compensation that was subject to the annual compensation 
limits for those years). In this example, in adjusting the section 
401(a)(17) frozen accrued benefit, the denominator of the adjustment 
fraction does not reflect any annual compensation limit. Similarly, in 
adjusting the frozen accruals for years between the statutory effective 
date and the OBRA '93 effective date, the denominator of the adjustment 
fraction reflects the level of the annual compensation limit in effect 
for those years.
    (5) Examples. The following examples illustrate the rules in this 
paragraph (e).

    Example 1. (a) Employer X maintains Plan Y, a calendar year defined 
benefit plan providing an annual benefit for each year of service equal 
to 2 percent of compensation averaged over an employee's high 3 
consecutive calendar years' compensation. Section 401(a)(17) applies to 
Plan Y in 1989. As of the close of the last plan year beginning before 
January 1, 1989 (i.e., the 1988 plan year), Employee A, with 5 years of 
service, had accrued a benefit of $25,000 which equals 10 percent (2 
percent multiplied by 5 years of service) of average compensation of 
$250,000. Employer X decides to comply with the provisions of this 
section for plan years before the effective date of this section. 
Employer X decides to make the amendment effective for plan years 
beginning on or after January 1, 1989, and uses December 31, 1988 as the 
section 401(a)(17) fresh-start date. Plan Y, as amended, provides that, 
in determining an employee's benefit, compensation taken into account is 
limited in accordance with the provisions of this section to the annual 
compensation limit under section 401(a)(17), and that, for section 
401(a)(17) employees, the employee's accrued benefit is the greater of
    (i) The employee's benefit under the plan's benefit formula (after 
the plan formula is amended to comply with section 401(a)(17)) as 
applied to the employee's total years of service; and
    (ii) The employee's accrued benefit as of December 31, 1988, 
determined as though the employee terminated employment on that date 
without regard to any plan amendments after that date.
    Employer X decides not to amend Plan Y to provide for the 
adjustments permitted under Sec. 1.401(a)(4)-13(d) to the accrued 
benefit of section 401(a)(17) employees as of December 31, 1988.
    (b) Under Plan Y, Employee A's accrued benefit at the end of 1989 is 
$25,000, which is the greater of Employee A's accrued benefit as of the 
last day of the 1988 plan year ($25,000), and $24,000, which is Employee 
A's benefit based on the plan's benefit formula applied to Employee A's 
total years of service ($200,000 multiplied by (2 percent multiplied by 
6 years of service)). The formula of Plan Y applicable to section 
401(a)(17) employees for calculating their accrued benefits for years 
after the section 401(a)(17) fresh-start date is the formula in Sec. 
1.401(a)-

[[Page 266]]

13(c)(4)(ii) (formula with wear-away). The fresh-start formula is 
applied using a benefit formula for the 1989 plan year that satisfies 
section 401(a)(17) and this section, and the December 31, 1988 fresh-
start date used for the plan is a section 401(a)(17) fresh-start date 
within the meaning of paragraph (e)(2)(ii) of this section. Thus, Plan 
Y, as amended, satisfies paragraph (e)(3)(i) of this section for plan 
years commencing prior to the OBRA '93 effective date.
    Example 2. Assume the same facts as in Example 1, except that the 
plan formula provides that effective January 1, 1989, for section 
401(a)(17) employees, an employee's benefit will equal the sum of the 
employee's accrued benefit as of December 31, 1988 (determined as though 
the employee terminated employment on that date and without regard to 
any amendments after that date), and 2 percent of compensation averaged 
over an employee's high 3 consecutive years' compensation times years of 
service taking into account only years of service after December 31, 
1988. Thus, under Plan Y's formula, Employee A's accrued benefit as of 
December 31, 1989 is $29,000, which is equal to the sum of $25,000 
(Employee A's accrued benefit as of December 31, 1988) plus $4,000 
($200,000 multiplied by (2 percent multiplied by 1 year of service)). 
The formula of Plan Y applicable to section 401(a)(17) employees for 
calculating their accrued benefits for years after the section 
401(a)(17) fresh-start date is the formula in Sec. 1.401(a)-13(c)(4)(i) 
(formula without wear-away). The fresh-start formula is applied using a 
benefit formula for the 1989 plan year that satisfies section 401(a)(17) 
and this section, and the December 31, 1988 fresh-start date used for 
the plan is a section 401(a)(17) fresh-start date within the meaning of 
paragraph (e)(2)(ii) of this section. Thus, Plan Y, as amended, 
satisfies paragraph (e)(3)(i) of this section for plan years commencing 
prior to the OBRA '93 effective date.
    Example 3. (a) Assume the same facts as in Example 1, except that 
the plan formula provides that effective January 1, 1989, an employee's 
benefit equals the greater of the plan formulas in Example 1 and Example 
2. The formula of Plan Y applicable to section 401(a)(17) employees for 
calculating their accrued benefits for years after the section 
401(a)(17) fresh-start date is the formula in Sec. 1.401(a)-
13(c)(4)(iii) (formula with extended wear-away). The fresh-start formula 
is applied using a benefit formula for the 1989 plan year that satisfies 
section 401(a)(17) and this section, and the December 31, 1988 fresh-
start date used for the plan is a section 401(a)(17) fresh-start date 
within the meaning of paragraph (e)(2)(ii) of this section. Thus, Plan 
Y, as amended, satisfies paragraph (e)(3)(i) of this section for plan 
years commencing prior to the OBRA '93 effective date.
    (b) Assume that for each of the years 1991-93 Employee A's annual 
compensation under the plan compensation formula, disregarding the 
amendment to comply with section 401(a)(17) is $300,000. The annual 
compensation limit is adjusted to $222,220, $228,860, and $235,840 for 
plan years beginning January 1, 1991, 1992, and 1993, respectively. 
Because Employer X has decided to amend Plan Y to comply with the 
provisions of this section effective for plan years beginning on or 
after January 1, 1989, and has used December 31, 1988 as the section 
401(a)(17) fresh-start date, the compensation that may be taken into 
account for plan benefits in 1993 cannot exceed $228,973 (the average of 
$222,220, $228,860, and $235,840). Therefore, as of December 31, 1993, 
the benefit determined under the fresh-start formula with wear-away 
would be $45,795 ($228,973 multiplied by (2 percent multiplied by 10 
years of service)). The benefit determined under the fresh-start formula 
without wear-away would be $47,897, which is equal to $25,000 (Employee 
A's section 401(a)(17) frozen accrued benefit) plus $22,897 ($228,973 
multiplied by (2 percent multiplied by 5 years of service)). Because 
Employee A's accrued benefit is being determined using the fresh-start 
formula with extended wear-away, Employee A's accrued benefit as of 
December 31, 1993, is equal to $47,897, the greater of the two amounts.
    Example 4. (a) Assume the same facts as in Example 3, except that 
Plan Y satisfies Sec. 1.401(a)(4)-13(d)(3) through (d)(7) and that the 
amendment to Plan Y effective for plan years beginning after December 
31, 1988, also provided for adjustments to the section 401(a)(17) frozen 
accrued benefit in accordance with Sec. 1.401(a)(4)-13(d) using the 
fraction described in Sec. 1.401(a)(4)-13(d)(8)(i).
    (b) As of December 31, 1993, the numerator of Employee A's 
compensation fraction is $228,973 (the average of Employee A's annual 
compensation for 1991, 1992, and 1993, as limited by the respective 
annual limit for each of those years). The denominator of Employee A's 
compensation fraction determined in accordance with paragraph 
(e)(4)(iii) of this section is $250,000 (the average of Employee A's 
high 3 consecutive calendar year compensation as of December 31, 1988, 
determined without regard to section 401(a)(17)). Therefore, Employee 
A's compensation fraction is $228,973/$250,000. Because the compensation 
adjustment fraction is less than 1, Employee A's section 401(a)(17) 
frozen accrued benefit is not adjusted. Therefore, Employee A's accrued 
benefit as of December 31, 1993, would still be $47,897, which is equal 
to $25,000 (Employee A's section 401(a)(17) frozen accrued benefit) plus 
$22,897 ($228,973 multiplied by (2 percent multiplied by 5 years of 
service).
    Example 5. (a) Assume the same facts as in Example 3, except that as 
of January 1, 1994, Plan Y is amended to provide that benefits will be 
determined based on compensation of $150,000 (the limit in effect under 
section

[[Page 267]]

401(a)(17) for plan years beginning on or after the OBRA '93 effective 
date) and that for section 401(a)(17) employees, each employee's accrued 
benefit will be determined under Sec. 1.401(a)(4)-13(c)(4)(i) (formula 
without wear-away) using December 31, 1993 as the OBRA '93 fresh-start 
date.
    (b) Assume that for each of the years 1996-98 Employee A's annual 
compensation under the plan compensation definition, disregarding the 
amendment to comply with section 401(a)(17), is $400,000. Assume that 
the annual compensation limit is first adjusted to $160,000 for plan 
years beginning on or after January 1, 1997, and is not adjusted for the 
plan year beginning on or after January 1, 1998. The compensation that 
may be taken into account for the 1998 plan year cannot exceed $156,667 
(the average of $150,000 for 1996, $160,000 for 1997, and $160,000 for 
1998).
    (c) Therefore, at the end of December 31, 1998, Employee A's accrued 
benefit is $63,564, which is equal to $47,897 (Employee A's OBRA '93 
frozen accrued benefit) plus $15,667 ($156,667 multiplied by (2 percent 
multiplied by 5 years of service)).
    Example 6. (a) Assume the same facts as in Example 5, except that, 
for the fresh-start group (in this case the section 401(a)(17) 
employees), the amendments to Plan Y provide for adjustments to the 
section 401(a)(17) frozen accrued benefit and the OBRA '93 frozen 
accrued benefit in accordance with Sec. 1.401(a)(4)-13(d) using the 
fraction described in Sec. 1.401(a)(4)-13(d)(8)(i).
    (b) Employee A's frozen accrued benefit as of December 31, 1993, is 
adjusted as of December 31, 1998, as follows:
    (1) Employee A's frozen accrued benefit as of December 31, 1993, is 
the sum of Employee A's section 401(a)(17) frozen accrued benefit 
($25,000) and Employee A's frozen accruals for the years 1989-93 
($22,897).
    (2) The numerator of Employee A's adjustment fraction is $156,667 
(the average of $150,000, $160,000, and $160,000). The denominator of 
Employee A's adjustment fraction with respect to Employee A's section 
401(a)(17) frozen accrued benefit is $250,000, and the denominator of 
Employee A's adjustment fraction with respect to the rest of Employee 
A's frozen accrued benefit is $228,973 (the average of Employee A's 
annual compensation for 1991, 1992, and 1993, as limited by the 
respective annual limit for each of those years).
    (3) Employee A's section 401(a)(17) frozen accrued benefit as 
adjusted through December 31, 1998, remains $25,000. The compensation 
adjustment fraction determined in accordance with paragraph (e)(4)(iii) 
of this section is less than one ($156,667 divided by $250,000).
    (4) Employee A's frozen accruals for the years 1989-93, as adjusted 
through December 31, 1998, remain $22,897 because the adjustment 
fraction is less than one ($156,667 divided by $228,973).
    (5) Employee A's adjusted accrued benefit as of December 31, 1998, 
equals $47,897 (the sum of the $25,000 and $22,897 amounts from 
paragraphs (b)(3) and (b)(4), respectively, of this Example).
    (c) Employee A's section 401(a)(17) frozen accrued benefit will not 
be adjusted for compensation increases until the numerator of the 
fraction used to adjust that frozen accrued benefit exceeds the 
denominator of $250,000 used in determining those accruals.
    Similarly, the portion of Employee A's OBRA '93 frozen accrued 
benefit attributable to the frozen accruals for the years 1989-1993 will 
not be adjusted for compensation increases until the numerator of the 
fraction used to adjust those frozen accruals exceeds the denominator of 
$228,973 used in determining those accruals.

[T.D. 8547, 59 FR 32905, June 27, 1994, as amended by T.D. 9169, 69 FR 
78153, Dec. 29, 2004]

    Editorial Note: By T.D. 9169, 69 FR 78153, Dec. 29, 2004, the 
Internal Revenue Service published a document in the Federal Register, 
attempting to amend paragraph (d)(5)(ii) of Sec. 1.401-(a)(17)-1 by 
removing ``1.401(m)-(f)(6)'' and inserting ``1.401(m)-1(a)(3)''. 
However, because of inaccurate language, this amendment could not be 
incorporated.



Sec. 1.401(a)(26)-0  Table of contents.

    This section contains a listing of the headings of Sec. Sec. 1.401 
(a)(26)-1 through 1.401(a)(26)-9.

         Sec. 1.401(a)(26)-1 Minimum participation requirements

(a) General rule.
(b) Exceptions to section 401(a)(26).
    (1) Plans that do not benefit any highly compensated employees.
    (2) Multiemployer plans.
    (i) In general.
    (ii) Multiemployer plans covering noncollectively bargained 
employees.
    (A) In general.
    (B) Special testing rule.
    (3) Certain underfunded defined benefit plans.
    (i) In general.
    (ii) Eligible plans.
    (iii) Actuarial certification.
    (iv) Cessation of all benefit accruals.
    (4) Section 401(k) plan maintained by employers that include certain 
governmental or tax-exempt entities.
    (5) Certain acquisitions or dispositions.
    (i) General rule.
    (ii) Special rule for transactions that occur in the plan year prior 
to the first plan year to which section 401(a)(26) applies.

[[Page 268]]

    (iii) Definition of ``acquisition'' or ``disposition''.
(c) Additional rules.

             Sec. 1.401(a)(26)-2 Minimum participation rule

(a) General rule.
(b) Frozen plans.
(c) Plan.
(d) Disaggregation of certain plans.
    (1) Mandatory disaggregation.
    (i) ESOPs and non-ESOPs.
    (ii) Plans maintained by more than one employer.
    (A) Multiple employer plans.
    (B) Multiemployer plans.
    (iii) Defined benefit plans with other arrangements.
    (A) In general.
    (B) Examples.
    (iv) Plans benefiting employees of qualified separate lines of 
business.
    (2) Permissive disaggregation.
    (i) Plans benefiting collectively bargained employees.
    (ii) Plans benefiting otherwise excludable employees.

Sec. 1.401(a)(26)-3 Rules applicable to a defined benefit plan's prior 
                            benefit structure

(a) General rule.
(b) Prior benefit structure.
(c) Testing a prior benefit structure.
    (1) General rule.
    (2) Meaningful benefits.
(d) Multiemployer plan rule.

              Sec. 1.401(a)(26)-4 Testing former employees

(a) Scope.
(b) Minimum participation rule for former employees.
(c) Special rule.
(d) Excludable former employees.
    (1) General rule.
    (2) Exception.

         Sec. 1.401(a)(26)-5 Employees who benefit under a plan

(a) Employees benefiting under a plan.
    (1) In general.
    (2) Sequential or concurrent benefit offset arrangements.
    (i) In general.
    (ii) Offset by sequential or grandfathered benefits.
    (iii) Concurrent benefit offset arrangements.
    (A) General rule.
    (B) Special rules for certain section 414(n) employer-recipients.
(b) Former employees benefiting under a plan.

                Sec. 1.401(a)(26)-6 Excludable employees

(a) In general.
(b) Excludable employees.
    (1) Minimum age and service exclusions.
    (i) In general.
    (ii) Plans benefiting otherwise excludable employees.
    (iii) Examples.
    (2) Certain air pilots.
    (3) Certain nonresident aliens.
    (i) In general.
    (ii) Special treaty rule.
    (4) Employees covered pursuant to a collective bargaining agreement.
    (5) Employees not covered pursuant to a collective bargaining 
agreement.
    (6) Examples.
    (7) Certain terminating employees.
    (i) In general.
    (ii) Hours of service.
    (8) Employees of qualified separate lines of business.
(c) Former employees.
    (1) In general.
    (2) Employees terminated before a specified date.
    (3) Previously excludable employees.
    (4) Vested accrued benefits eligible for mandatory distribution.
(d) Certain police or firefighters.

                  Sec. 1.401(a)(26)-7 Testing methods

(a) Testing on each day of the plan year.
(b) Simplified testing method.
(c) Retroactive correction.

                    Sec. 1.401(a)(26)-8 Definitions

Collective bargaining agreement.
Collectively bargained employee.
Covered by a collective bargaining agreement.
Defined benefit plan.
Defined contribution plan.
Employee.
Employer.
ESOP.
Former employee.
Highly compensated employee.
Highly compensated former employee.
Multiemployer plan.
Noncollectively bargained employee.
Nonhighly compensated employee.
Nonhighly compensated former employee.
Plan.
Plan year.
Professional employee.
Section 401(k) plan.
Section 401(m) plan.

        Sec. 1.401(a)(26)-9 Effective dates and transition rules

(a) In general.
(b) Transition rules.
    (1) Governmental plans and certain section 403(b) annuities.
    (2) Early retirement ``window-period'' benefits.
    (3) Employees who do not benefit because of a minimum-period-of-
service requirement or a last-day requirement.

[[Page 269]]

    (4) Certain plan terminations.
    (i) In general.
    (ii) Exception.
    (5) ESOPs and non-ESOPs.
(c) Waiver of excise tax on reversions.
    (1) In general.
    (2) Termination date.
    (3) Failure to satisfy section 401(a)(26).
(d) Special rule for collective bargaining agreements.

[T.D. 8375, 56 FR 63413, Dec. 4, 1991]



Sec. 1.401(a)(26)-1  Minimum participation requirements.

    (a) General rule. A plan is a qualified plan for a plan year only if 
the plan satisfies section 401(a)(26) for the plan year. A plan that 
satisfies any of the exceptions described in paragraph (b) of this 
section passes section 401(a)(26) automatically for the plan year. A 
plan that does not satisfy one of the exceptions in paragraph (b) of 
this section must satisfy Sec. 1.401(a)(26)-2(a). In addition, a 
defined benefit plan must satisfy Sec. 1.401(a)(26)-3 with respect to 
its prior benefit structure. Finally, a defined benefit plan that 
benefits former employees (for example, a defined benefit plan that is 
amended to provide an ad hoc cost-of-living adjustment to former 
employees) must separately satisfy Sec. 1.401(a)(26)-4 with respect to 
its former employees.
    (b) Exceptions to section 401(a)(26)--(1) Plans that do not benefit 
any highly compensated employees. A plan, other than a frozen defined 
benefit plan as defined in Sec. 1.401(a)(26)-2(b), satisfies section 
401(a)(26) for a plan year if the plan is not a top-heavy plan under 
section 416 and the plan meets the following requirements:
    (i) The plan benefits no highly compensated employee or highly 
compensated former employee of the employer; and
    (ii) The plan is not aggregated with any other plan of the employer 
to enable the other plan to satisfy section 401(a)(4) or 410(b). The 
plan may, however, be aggregated with the employer's other plans for 
purposes of the average benefit percentage test in section 
410(b)(2)(A)(ii).
    (2) Multiemployer plans--(i) In genera1. The portion of a 
multiemployer plan that benefits only employees included in a unit of 
employees covered by a collective bargaining agreement may be treated as 
a separate plan that satisfies section 401(a)(26) for a plan year.
    (ii) Multiemployer plans covering noncollectively bargained 
employees--(A) In general. The rule provided in paragraph (b)(2)(i) does 
not apply to the portion of a multiemployer plan that benefits employees 
who are not included in any collective bargaining unit covered by a 
collective bargaining agreement. Thus, the portion of the plan 
benefiting these employees must separately satisfy section 401(a)(26).
    (B) Special testing rule. A multiemployer plan that benefits 
employees who are not included in any collective bargaining unit covered 
by a collective bargaining agreement satisfies section 401(a)(26) if the 
plan benefits 50 employees. For purposes of this special testing rule, 
employees who are included in a unit of employees covered by a 
collective bargaining agreement may be included in determining whether 
the plan benefits 50 employees.
    (3) Certain underfunded defined benefit plans--(i) In general. A 
defined benefit plan is deemed to satisfy section 401(a)(26) for a plan 
year if all of the conditions of paragraphs (b)(3)(ii) through 
(b)(3)(iv) of this section are satisfied with respect to the plan for 
the plan year.
    (ii) Eligible plans. This condition is satisfied for a plan year 
only if the plan is subject to title IV of the Employee Retirement 
Income Security Act of 1974 (ERISA) for the plan year or, if the plan is 
not a title IV plan under ERISA, it is not a top-heavy plan within the 
meaning of section 416. This condition does not apply for plan years 
beginning before January 1, 1992.
    (iii) Actuarial certification. This condition is satisfied for a 
plan year only if the employer's timely filed actuarial report, as 
required by section 6059, evidences that the plan does not have 
sufficient assets to satisfy all liabilities under the plan (determined 
in accordance with section 401(a)(2)).
    (iv) Cessation of all benefit accruals. This condition is satisfied 
for a plan year only if, for the plan year, no employee or former 
employee is benefiting within the meaning of Sec. 1.401(a)(26)-5(a) or 
(b). For this purpose, an employee is not treated as benefiting solely 
by reason of being a

[[Page 270]]

non-key employee receiving minimum benefit accruals required by section 
416.
    (4) Section 401(k) plan maintained by employers that include certain 
governmental or tax-exempt entities. Section 401(k)(4)(B) prevents 
certain State and local governments and tax-exempt organizations from 
maintaining a qualified cash or deferred arrangement. A plan (or portion 
of a plan) that is either a section 401(k) plan or a section 401(m) plan 
that is provided under the same general arrangement as a section 401(k) 
plan may be treated as a separate plan that satisfies section 401(a)(26) 
for a plan year if the following requirements are satisfied:
    (i) The section 401(k) plan is maintained by an employer who has 
employees precluded from being eligible employees under the arrangement 
by reason of section 401(k)(4)(B), and
    (ii) More than 95 percent of the employees of the employer who are 
not precluded from being eligible employees under a section 401(k) plan 
by reason of section 401(k)(4)(B) benefit under the section 401(k) plan.
    (5) Certain acquisitions or dispositions--(i) General rule. Rules 
similar to the rules prescribed under section 410(b)(6)(C) apply under 
section 401(a)(26). Pursuant to these rules, the requirements of section 
401(a)(26) are treated as satisfied for certain plans of an employer 
involved in an acquisition or disposition (transaction) for the 
transition period. The transition period begins on the date of the 
transaction and ends on the last day of the first plan year beginning 
after the date of the transaction.
    (ii) Special rule for transactions that occur in the plan year prior 
to the first plan year to which section 401(a)(26) applies. Where there 
has been a transaction described in section 410(b)(6)(C) in the plan 
year prior to the first plan year in which section 401(a)(26) applies to 
a plan, the plan satisfies section 401(a)(26) for the transition period 
if the plan benefited 50 employees or 40 percent of the employees of the 
employer immediately prior to the transaction.
    (iii) Definition of ``acquisition'' and ``disposition.'' For 
purposes of this paragraph (b)(5), the terms ``acquisition'' and 
``disposition'' refer to an asset or stock acquisition, merger, or other 
similar transaction involving a change in employer of the employees of a 
trade or business.
    (c) Additional rules. The Commissioner may, in revenue rulings, 
notices, and other guidance of general applicability, provide any 
additional rules that may be necessary or appropriate in applying the 
minimum participation requirements of section 401(a)(26).

[T.D. 8375, 56 FR 63413, Dec. 4, 1991, as amended by T.D. 8487, 58 FR 
46838, Sept. 3, 1993]



Sec. 1.401(a)(26)-2  Minimum participation rule.

    (a) General rule. A plan satisfies this paragraph (a) for a plan 
year only if the plan benefits at least the lesser of--
    (1) 50 employees of the employer, or
    (2) 40 percent of the employees of the employer.
    (b) Frozen plans. A plan under which no employee or former employee 
benefits (within the meaning of Sec. 1.401(a)(26)-5 (a) or (b)), is a 
frozen plan for purposes of this section and satisfies paragraph (a) of 
this section automatically. Thus, a frozen defined contribution plan 
satisfies section 401(a)(26) automatically and a frozen defined benefit 
plan satisfies section 401(a)(26) for a plan year by satisfying the 
prior benefit structure requirements in Sec. 1.401(a)(26)-3. For 
purposes of the rule in this paragraph (b), a defined benefit plan that 
provides only the minimum benefits for non-key employees required by 
section 416 is a frozen defined benefit plan.
    (c) Plan. ``Plan'' means a plan within the meaning of Sec. 
1.401(b)-7 (a) and (b), after the application of the mandatory 
disaggregation rules of paragraph (d)(1) of this section and, if 
applicable, the permissive disaggregation rules of paragraph (d)(2) of 
this section.
    (d) Disaggregation of certain plans--(1) Mandatory disaggregation--
(i) ESOPs and non-ESOPs. The portion of a plan that is an ESOP and the 
portion of the plan that is not an ESOP are treated as separate plans 
for purposes of section 401(a)(26), except as otherwise permitted under 
Sec. 54.4975-11(e) of this Chapter.
    (ii) Plans maintained by more than one employer--(A) Multiple 
employer plans. If

[[Page 271]]

a plan benefits employees of more than one employer and those employees 
are not included in a unit of employees covered by one or more 
collective bargaining agreements, the plan is a multiple employer plan. 
A multiple employer plan is treated as separate plans, each of which is 
maintained by a separate employer and must separately satisfy section 
401(a)(26) by reference only to that employer's employees.
    (B) Multiemployer plans. The portion of a multiemployer plan that 
benefits employees who are included in one or more units of employees 
covered by one or more collective bargaining agreements and the portion 
of that plan that benefits employees who are not included in a unit of 
employees covered pursuant to any collective bargaining agreement are 
treated as separate plans. The portion of a multiemployer plan that 
benefits employees who are not included in a unit of employees covered 
by a collective bargaining agreement is a multiple employer plan as 
described in paragraph (d)(1)(ii)(A) of this section. This paragraph 
(d)(1)(ii)(B) does not apply to the extent that the special testing rule 
in Sec. 1.401(a)(26)-1(b)(2)(ii) applies. Also, this paragraph 
(d)(1)(B)(2) does not apply for purposes of prior benefit structure 
testing under Sec. 1.401 (a)(26)-3.
    (iii) Defined benefit plans with other arrangements--(A) In general. 
A defined benefit plan is treated as comprising separate plans if, under 
the facts and circumstances, there is an arrangement (either under or 
outside the plan) that has the effect of providing any employee with a 
greater interest in a portion of the assets of a plan in a way that has 
the effect of creating separate accounts. Separate plans are not 
created, however, merely because a partnership agreement provides for 
allocation among partners, in proportion to their partnership interests, 
of either the cost of funding the plan or surplus assets upon plan 
termination.
    (B) Examples. The following examples illustrate certain situations 
in which other arrangements relating to a defined benefit plan are or 
are not treated as creating separate plans:

    Example 1. Employer A maintains a defined benefit plan under which 
each highly compensated employee can direct the investment of the 
portion of the plan's assets that represents the accumulated 
contributions with respect to that employee's plan benefits. In 
addition, by agreement outside the plan, if the product of the 
employee's investment direction exceeds the value needed to fund that 
employee's benefits, Employer A agrees to make a special payment to the 
participant. In this case, each separate portion of the pool of assets 
over which an employee has investment authority is a separate plan for 
the employee.
    Example 2. Employer B is a partnership that maintains a defined 
benefit plan. The partnership agreement provides that, upon termination 
of the plan, a special allocation of any excess plan assets after 
reversion is made to the partnership on the basis of partnership share. 
This arrangement does not create separate plans with respect to the 
partners.

    (iv) Plans benefiting employees of qualified separate lines of 
business. If an employer is treated as operating qualified separate 
lines of business for purposes of section 401(a)(26) in accordance with 
Sec. 1.414(r)-1(b), the portion of a plan that benefits employees of 
one qualified separate line of business is treated as a separate plan 
from the portions of the same plan that benefit employees of the other 
qualified separate lines of business of the employer. See Sec. Sec. 
1.414(r)-1(c)(3) and 1.414(r)-9 (separate application of section 
401(a)(26) to the employees of a qualified separate line of business). 
The rule in this paragraph (d)(6) does not apply to a plan that is 
tested under the special rule for employer-wide plans in Sec. 1.414(r)-
1(c)(3)(ii) for a plan year.
    (2) Permissive disaggregation--(i) Plans benefiting collectively 
bargained employees. For purposes of section 401(a)(26), an employer may 
treat the portion of a plan that benefits employees who are included in 
a unit of employees covered by a collective bargaining agreement as a 
plan separate from the portion of a plan that benefits employees who are 
not included in such a collective bargaining unit. This paragraph 
(d)(2)(i) applies separately to each collective bargaining agreement. 
Thus, for example, the portion of a plan that benefits employees 
included in a unit of employees covered by one collective bargaining 
agreement may be treated as a plan that is separate from the portion of 
the plan that benefits employees included in a unit of employees covered

[[Page 272]]

by another collective bargaining agreement.
    (ii) Plans benefiting otherwise excludable employees. If an employer 
applies section 401(a)(26) separately to the portion of a plan that 
benefits only employees who satisfy age and service conditions under the 
plan that are lower than the greatest minimum age and service conditions 
permissible under section 410(a), the plan is treated as comprising 
separate plans, one benefiting the employees who have not satisfied the 
lower minimum age and service but not the greatest minimum age and 
service conditions permitted under section 410(a) and one benefiting 
employees who have satisfied the greatest minimum age and service 
conditions permitted under section 410(a). See Sec. 1.401(a)(26)-
6(b)(1)(ii) for rules concerning testing of otherwise excludable 
employees.

[T.D. 8375, 56 FR 63414, Dec. 4, 1991]



Sec. 1.401(a)(26)-3  Rules applicable to a defined benefit plan's 
prior benefit structure.

    (a) General rule. A defined benefit plan that does not meet one of 
the exceptions in Sec. 1.401(a)(26)-1(b) must satisfy paragraph (c) of 
this section with respect to its prior benefit structure. Defined 
contribution plans are not subject to this section.
    (b) Prior benefit structure. Each defined benefit plan has only one 
prior benefit structure, and all accrued benefits under the plan as of 
the beginning of a plan year (including benefits rolled over or 
transferred to the plan) are included in the prior benefit structure for 
the year.
    (c) Testing a prior benefit structure--(1) General rule. A plan's 
prior benefit structure satisfies this paragraph if the plan provides 
meaningful benefits to a group of employees that includes the lesser of 
50 employees or 40 percent of the employer's employees. Thus, a plan 
satisfies the requirements of this paragraph (c) if at least 50 
employees or 40 percent of the employer's employees currently accrue 
meaningful benefits under the plan. Alternatively, a plan satisfies this 
paragraph if at least 50 employees and former employees or 40 percent of 
the employer's employees and former employees have meaningful accrued 
benefits under the plan.
    (2) Meaningful benefits. Whether a plan is providing meaningful 
benefits, or whether individuals have meaningful accrued benefits under 
a plan, is determined on the basis of all the facts and circumstances. 
The relevant factors in making this determination include, but are not 
limited to, the following: the level of current benefit accruals; the 
comparative rate of accruals under the current benefit formula compared 
to prior rates of accrual under the plan; the projected accrued benefits 
under the current benefit formula compared to accrued benefits as of the 
close of the immediately preceding plan year; the length of time the 
current benefit formula has been in effect; the number of employees with 
accrued benefits under the plan; and the length of time the plan has 
been in effect. A rule for determining whether an offset plan provides 
meaningful benefits is provided in Sec. 1.401(a)(26)-5(a)(2). A plan 
does not satisfy this paragraph (c) if it exists primarily to preserve 
accrued benefits for a small group of employees and thereby functions 
more as an individual plan for the small group of employees or for the 
employer.
    (d) Multiemployer plan rule. A multiemployer plan is deemed to 
satisfy the prior benefit structure rule in paragraph (c)(1) of this 
section for a plan year if the multiemployer plan provides meaningful 
benefits to at least 50 employees for a plan year, or 50 employees have 
meaningful accrued benefits under the plan. For purposes of this 
paragraph, all employees benefiting under the multiemployer plan may be 
considered, whether or not these employees are included in a unit of 
employees covered pursuant to any collective bargaining agreement.

[T.D. 8375, 56 FR 63415, Dec. 4, 1991]



Sec. 1.401(a)(26)-4  Testing former employees.

    (a) Scope. This section applies to any defined benefit plan that 
benefits former employees in a plan year within the meaning of Sec. 
1.401(a)(26)-5(b) and does not meet one of the exceptions in Sec. 
1.401(a)(26)-1(b).
    (b) Minimum participation rule for former employees. Except as set 
forth in

[[Page 273]]

paragraph (c) of this section, a plan that is subject to this section 
must benefit at least the lesser of:
    (1) 50 former employees of the employer, or
    (2) 40 percent of the former employees of the employer.
    (c) Special rule. A plan satisfies the minimum participation rule in 
paragraph (b) of this section if the plan benefits at least five former 
employees, and if either:
    (1) More than 95 percent of all former employees with vested accrued 
benefits under the plan benefit under the plan for the plan year, or
    (2) At least 60 percent of the former employees who benefit under 
the plan for the plan year are nonhighly compensated former employees.
    (d) Excludable former employees--(1) General rule. Whether a former 
employee is an excludable former employee for purposes of this section 
is determined under Sec. 1.401(a)(26)-6(c).
    (2) Exception. Solely for purposes of paragraph (c) of this section, 
the rule in Sec. 1.401(a)(26)-6(c)(4) (regarding vested accrued 
benefits eligible for mandatory distribution) does not apply to any 
former employee having a vested accrued benefit. Thus, a former employee 
who has a vested accrued benefit is not an excludable former employee 
merely because that vested accrued benefit does not exceed the cash-out 
limit in effect under Sec. 1.411(a)-11(c)(3)(ii).

[T.D. 8375, 56 FR 63416, Dec. 4, 1991, as amended by T.D. 8794, 63 FR 
70338, Dec. 21, 1998; T.D. 8891, 65 FR 44682, July 19, 2000]



Sec. 1.401(a)(26)-5  Employees who benefit under a plan.

    (a) Employees benefiting under a plan--(1) In general. Except as 
provided in paragraph (a)(2) of this section, an employee is treated as 
benefiting under a plan for a plan year if and only if, for that plan 
year, the employee would be treated as benefiting under the provisions 
of Sec. 1.410(b)-3(a), without regard to Sec. 1.410(b)-3(a)(iv).
    (2) Sequential or concurrent benefit offset arrangements--(i) In 
general. An employee is treated as accruing a benefit under a plan that 
includes an offset or reduction of benefits that satisfies either 
paragraph (a)(2)(ii) or (a)(2)(iii) of this section if either the 
employee accrues a benefit under the plan for the year, or the employee 
would have accrued a benefit if the offset or reduction portion of the 
benefit formula were disregarded. In addition, an employee is treated as 
accruing a meaningful benefit for purposes of prior benefit structure 
testing under Sec. 1.401(a)(26)-3 if the employee would have accrued a 
meaningful benefit if the offset or reduction portion of the benefit 
formula were disregarded.
    (ii) Offset by sequential or grandfathered benefits. An offset or 
reduction of benefits under a defined benefit plan satisfies this 
paragraph (a)(2) if the benefit formula provides that an employee will 
not accrue additional benefits under the current portion of the benefit 
formula until the employee has accrued, under such portion, a benefit in 
excess of such employee's benefit under one or more formulas in effect 
for prior years that are based wholly on prior years of service. The 
prior benefit may have accrued under the same or a separate plan, may be 
provided under the same or a separate plan and may relate to service 
with the same or previous employers. Benefits will not fail to be 
treated as based wholly on prior years if they are based, directly or 
indirectly, on compensation earned after such prior years (including 
compensation earned in the current year), if they are adjusted to 
reflect increases in the section 415 limitations, or if they are 
increased to provide an ad hoc cost of living adjustment designed to 
adjust, in whole or in part, for inflation. Furthermore, benefits do not 
fail to be treated as based wholly on prior years merely because the 
benefits (e.g., early retirement benefits) are subject to an age or 
years-of-service condition and, in applying the condition or conditions, 
the current and prior years are taken into account.
    (iii) Concurrent benefit offset arrangements--(A) General rule. An 
offset or reduction of benefits under a defined benefit plan satisfies 
the requirements of this paragraph (a)(2)(iii) if the benefit formula 
provides a benefit that is offset or reduced by contributions or 
benefits under another plan that is maintained by the same employer and 
the following additional requirements are met:

[[Page 274]]

    (1) The contributions or benefits under a plan that are used to 
offset or reduce the benefits under the positive portion of the fomu1a 
being tested accrued under such other plan;
    (2) The employees who benefit under the formula being tested also 
benefit under the other plan on a reasonable and uniform basis; and
    (3) The contributions or benefits under the plan that are used to 
offset or reduce the benefits under the formula being tested are not 
used to offset or reduce that employee's benefits under any other plan 
or any other formula.
    (B) Special rules for certain section 414(n) employer-recipients. 
The same employer requirement in the concurrent benefit offset rule in 
paragraph (a)(2)(iii)(A) of this section is waived for certain section 
414(n) employer-recipients. Under this exception, an employer-recipient 
(within the meaning of sections 414 (n) and (o)) may treat contributions 
or benefits under a plan maintained by a leasing organization as 
contributions or benefits accrued under the recipient organization plan 
provided the following requirements are met: the employer-recipient 
maintains a plan covering leased employees (which employees are treated 
as employees of the employer-recipient within the meaning of sections 
414(n)(2) and 414(o)(2)); the leased employees are also covered under a 
plan maintained by the leasing organization; and contributions or 
benefits under the plan maintained by the employer-recipient are offset 
or reduced by the contributions or benefits under the leasing 
organization plan that are attributable to service with the recipient 
organization. Also, for purposes of the benefiting condition requirement 
in paragraph (a)(2)(iii)(A)(2) of this section, the employees of the 
employer-recipient who are not leased from the leasing organization are 
not required to benefit under the plan of the leasing organization.
    (b) Former employees benefiting under a plan. A former employee is 
treated as benefiting for a plan year if and only if the former employee 
would be treated as benetiting under the rules in Sec. 1.410(b)-3(b).

[T.D. 8375, 56 FR 63416, Dec. 4, 1991]



Sec. 1.401(a)(26)-6  Excludable employees.

    (a) In general. For purposes of applying section 401(a)(26) with 
respect to either employees, former employees, or both employees and 
former employees, as applicable, all employees other than excludable 
employees described in paragraph (b) of this section, all former 
employees other than excludable former employees described in paragraph 
(c) of this section, or both, as the case may be, must be taken into 
account. Except as specifically provided otherwise in this section, the 
rules of this section are applied by reference only to the particular 
plan and must be applied on a uniform and consistent basis.
    (b) Excludable employees. An employee is an excludable employee if 
the employee is covered by one or more of the following exclusions:
    (1) Minimum age and service exclusions--(i) In general. If a plan 
applies minimum age and service eligibility conditions permissible under 
section 410(a)(1) and excludes all employees who do not meet those 
conditions from benefiting under the plan, tbn all employees who fail to 
satisfy those conditions may be treated as excludable employees with 
respect to that plan. An employee is treated as meeting the age and 
service requirements on the date any employee with the same age and 
service would be eligible to commence participation in the plan, as 
provided in section 410(b)(4)(C).
    (ii) Plans benefiting otherwise excludable employees. An employer 
may treat a plan benefiting otherwise excludable employees as two 
separate plans, one for the otherwise excludable employees and one for 
the other employees benefiting under the plan. The effect of this rule 
is that employees who would be excludable under paragraph (b)(1) of this 
section (applied without regard to section 410(a)(1)(B)), but for the 
fact that the plan does not apply the greatest permissible minimum age 
and service conditions, may be treated as excludable employees with 
respect to the plan. This treatment is only available if each of the 
following conditions is satisfied:
    (A) The plan under which the otherwise excludable employees benefit 
also

[[Page 275]]

benefits employees who are not otherwise excludable.
    (B) The plan under which the otherwise excludable employees benefit 
satisfies section 401(a)(26), both by reference only to otherwise 
excludable employees and by reference only to employees who are not 
otherwise excludable.
    (C) The contributions or benefits provided to the otherwise 
excludable employees (expressed as percentages of compensation) are not 
greater than the contributions or benefits provided to the employees who 
are not otherwise excludable under the plan.
    (D) No highly compensated employee is included in the group of 
otherwise excludable employees for more than one plan year.
    (iii) Examples. The following examples illustrate some of the 
minimum-age-and-service exclusion requirements:

    Example 1. Employer X maintains a defined contribution plan, Plan X, 
under which employees who have not completed 1 year of service are not 
eligible to participate. Employer X has six employees. Two of the 
employees participate in Plan X. The other four employees have not 
completed 1 year of service and are therefore not eligible to 
participate in Plan X. The four employees who have not completed 1 year 
of service are excludable employees and may be disregarded for purposes 
of applying the minimum participation test. Therefore, Plan X satisfies 
section 401(a)(26) because both of the two employees who must be 
considered are participants in Plan X.
    Example 2. Employer Y has 100 employees and maintains two plans, 
Plan 1 and Plan 2. Plan 1 provides that employees who have not completed 
1 year of service are not eligible to participate. Plan 2 has no minimum 
age or service requirement. Twenty of Y's employees do not meet the 
minimum service requirement under Plan 1. Each plan satisfies the ratio 
test under section 410(b)(1)(B). In testing Plan 1 to determine whether 
it satisfies section 401(a)(26), the 20 employees not meeting the 
minimum age and service requirement under Plan 1 are treated as 
excludable employees. In testing Plan 2 to determine whether it 
satisfies section 401(a)(26), no employees are treated as excludable 
employees because Plan 2 does not have a minimum age or service 
requirement.

    (2) Certain air pilots. An employee who is excluded from 
consideration under section 410(b)(3)(B) (relating to certain air 
pilots) may be treated as an excludable employee.
    (3) Certain nonresident aliens--(i) In general. An employee who is 
excluded from consideration under section 410(b)(3)(C) (relating to 
certain nonresident aliens) may be treated as an excludable employee.
    (ii) Special treaty rule. In addition, an employee who is a 
nonresident alien (within the meaning of section 7701(b)(1)(B)) and who 
does receive earned income (within the meaning of section 911(d)(2)) 
from the employer that constitutes income from sources within the United 
States (within the meaning of section 861(a)(3)) is permitted to be 
excluded, if all of the employee's earned income from the employer from 
sources within the United States is exempt from United States income tax 
under an applicable income tax convention. This paragraph (b)(3)(ii) 
applies only if all employees described in the preceding sentence are so 
excluded.
    (4) Employees covered pursuant to a collective bargaining agreement. 
When testing a plan benefiting only noncollectively bargained employees, 
an employee who is excluded from consideration under section 
410(b)(3)(A) (exclusion for employees included in a unit of employees 
covered by a collective bargaining agreement) may be treated as an 
excludable employee. This rule may be applied separately to each 
collective bargaining agreement. See Sec. 1.401(a)(26)-8 for the 
definitions of the terms ``collective bargaining agreement'', 
``collectively bargained employee,'' and ``covered pursuant to a 
collective bargaining agreement''.
    (5) Employees not covered pursuant to a collective bargaining 
agreement. When testing a plan that benefits only employees who are 
included in a group of employees who are covered pursuant to a 
collective bargaining agreement, an employee who is not included in the 
group of employees who are covered by the collective bargaining 
agreement may be treated as an excludable employee.
    (6) Examples. The following examples illustrate the excludable 
employee rules that relate to employees covered pursuant to collective 
bargaining

[[Page 276]]

agreements. For purposes of these examples assume that no other 
exclusion rules are applicable.

    Example 1. Employer W has 70 collectively bargained employees and 30 
non-collectively bargained employees. Employer W maintains Plan W, which 
benefits only the 30 non-collectively bargained employees. The 70 
collectively bargained employees may be treated as excludable employees 
and thus may be disregarded in applying section 401(a)(26) to Plan W.
    Example 2. Assume the same facts as Example I, except that the 
Commissioner has determined that the employee representative is not a 
bona fide employee representative under section 7701(a)(46) and thus 
there are no ``collectively bargained employees.'' In this case, all 
employees of W must be considered in determining whether section 
401(a)(26) is met.
    Example 3. Employer X has collectively bargained employees and 70 
noncollectively bargained employees. Employer X maintains Plan X, which 
benefits only the 30 collectively bargained employees. Employer X may 
treat the non-collectively bargained employees as excludable employees 
and disregard them in applying section 401(a)(26) to the collectively 
bargained plan.
    Example 4. Assume the same facts as Example 3, except that the 
Commissioner has determined that the employee representative is not a 
bona fide employee representative under section 7701(a)(46) and thus 
there is no recognized collective bargaining agreement. In this case, 
Employer X may not treat the non-collectively bargained employees of X 
as excludable employees.
    Example 5. Assume the same facts as Example 3, except that 3 percent 
of the 30 collectively bargained employees are professionals. In this 
case, Employer X may not treat the non-collectively bargained employees 
of X as excludable employees.
    Example 6. Employer Y has 100 collectively bargained employees. 
Thirty of Y's employees are represented by Collective Bargaining Unit 1 
and covered under Plan 1. Seventy of Y's employees are represented by 
Collective Bargaining Unit 2 and covered under Plan 2. For purposes of 
testing Plan 1, the employees of Collective Bargaining Unit 2 may be 
treated as excludable employees. Similarly, for purposes of testing Plan 
2, the employees of Collective Bargaining Unit 1 may be treated as 
excludable employees.

    (7) Certain terminating employees--(i) In general. An employee may 
be treated as an excludable employee for a plan year with respect to a 
particular plan if--
    (A) The employee does not benefit under the plan for the plan year,
    (B) The employee is eligible to participate in the plan,
    (C) The plan has a minimum period of service requirement or a 
requirement that an employee be employed on the last day of the plan 
year (last-day requirement) in order for an employee to accrue a benefit 
or receive an allocation for the plan year,
    (D) The employee fails to accrue a benefit or receive an allocation 
under the plan solely because of the failure to satisfy the minimum 
period of service or last-day requirement,
    (E) The employee terminates employment during the plan year with no 
more than 500 hours of service, and the employee is not an employee as 
of the last day of the plan year (for purposes of this paragraph 
(b)(7)(i)(E), a plan that uses the elapsed time method of determining 
years of service may use either 91 consecutive calendar days or 3 
consecutive calendar months instead of 500 hours of service, provided it 
uses the same convention for all employees during a plan year), and
    (F) If this paragraph (b)(7) is applied with respect to any employee 
with respect to a plan for a plan year, it is applied with respect to 
all employees with respect to the plan for the plan year.
    (ii) Hours of service. For purposes of this paragraph (b)(7), the 
term ``hour of service'' has the same meaning as set forth in 29 CFR 
2530.200b-2 under the general method of crediting service for the 
employee. If one of the equivalencies set forth in 29 CFR 2530.200b-3 is 
used for crediting service under the plan, the 500-hour requirement must 
be adjusted accordingly.
    (8) Employees of qualified separate lines of business. If an 
employer is treated as operating qualified separate lines of business 
for purposes of section 401(a)(26) in accordance with Sec. 1.414(r)-
1(b), in testing a plan that benefits employees of one qualified 
separate line of business, the employees of the other qualified separate 
lines of business of the employer are treated as excludable employees. 
See Sec. Sec. 1.414(r)-1(c)(3) and 1.414(r)-9 (separate application of 
section 401(a)(26) to the employees of a qualified separate line of 
business). The rule in this paragraph (b)(8) does not apply to a plan 
that is tested under the

[[Page 277]]

special rule for employer-wide plans in Sec. 1.414(r)-l(c)(3)(ii) for a 
plan year.
    (c) Former employees--(1) In general. For purposes of applying 
section 401(a)(26) with respect to former employees, all former 
employees of the employer are taken into account, except that the 
employer may treat a former employee described in paragraph (c)(2) 
through (c)(4) of this section as an excludable former employee. If any 
of the former employee exclusion rules under paragraphs (c)(2) through 
(c)(4) of this section is applied, it must be applied to all former 
employees for the plan year on a consistent basis.
    (2) Employees terminated before a specified date. The employer may 
treat a former employee as excludable if--
    (i) The former employee became a former employee either prior to 
January 1, 1984, or prior to the tenth calendar year preceding the 
calendar year in which the current plan year begins, and
    (ii) The former employee became a former employee in a calendar year 
that precedes the earliest calendar year in which any former employee 
who benefits under the plan in the current plan year became a former 
employee.
    (3) Previously excludable employees. The employer may treat a former 
employee as excludable if the former employee was an excludable employee 
(or would have been an excludable employee if these regulations had been 
in effect) under the rules of paragraphs (a) and (b) of this section 
during the plan year in which the former employee became a former 
employee. If the employer treats a former employee as excludable 
pursuant to this paragraph (c)(3), the former employee is not taken into 
account with respect to a plan even if the former employee is benefiting 
under the plan.
    (4) Vested accrued benefits eligible for mandatory distribution. A 
former employee may be treated as an excludable former employee if the 
present value of the former employee's vested accrued benefit does not 
exceed the cash-out limit in effect under Sec. 1.411(a)-11(c)(3)(ii). 
This determination is made in accordance with the rules of sections 
411(a)(11) and 417(e).
    (d) Certain police or firefighters. An employer may apply section 
401(a)(26) separately with respect to any classification of qualified 
public safety employees for whom a separate plan is maintained. Thus, 
for purposes of testing a separate plan covering a class of qualified 
public safety employees, all employees who are not in that 
classification are treated as excludable employees. Also, such employees 
need not be taken into account in determining whether or not any other 
plan satisfies section 401(a)(26). For purposes of this paragraph (d), 
qualified public safety employee means any employee of any police 
department or fire department organized and operated by a State or 
political subdivision if the employee provides police protection, 
firefighting services, or emergency medical services for any area within 
the jurisdiction of a State or political subdivision.

[T.D. 8375, 56 FR 63416, Dec. 4, 1991, as amended by T.D. 8794, 63 FR 
70338, Dec. 21, 1998; T.D. 8891, 65 FR 44682, July 19, 2000]



Sec. 1.401(a)(26)-7  Testing methods.

    (a) Testing on each day of the plan year. A plan satisfies section 
401(a)(26) for a plan year only if the plan satisfies section 401(a)(26) 
on each day of the plan year. An employee benefits on a day if the 
employee is a participant for such day and the employee benefits under 
the plan for the year under the rules in Sec. 1.401(a)(26)-5.
    (b) Simplified testing method. A plan is treated as satisfying the 
requirements of paragraph (a) of this section if it satisfies section 
401(a)(26) on any single plan day during the plan year, but only if that 
day is reasonably representative of the employer's workforce and the 
plan's coverage. A plan does not have to be tested on the same day each 
plan year.
    (c) Retroactive correction. If a plan fails to satisfy section 
401(a)(26) for a plan year, the plan may be retroactively amended during 
the same period and under the same conditions as provided for in Sec. 
1.401(a)(4)-11(g)(3) through (g)(5) to satisfy section 401(a)(26). A 
plan merger that occurs by the end of the period provided in Sec. 
l.401(a)(4)-11(g)(3)(iv) is treated solely for purposes of section 
401(a)(26) as if it were effective as of the first day of the

[[Page 278]]

plan year. The rule of this paragraph (c) may be illustrated by the 
following example.

    Example. Assume that an employer with 500 employees maintains two 
defined contribution plans. Plan A benefits 45 employees. Plan B 
benefits 50 employees. Immediately before the end of the period provided 
for in Sec. 1.401(a)(4)-11(g)(3)(iv), the employer expands coverage 
under Plan A to benefit 20 more employees retroactively for the plan 
year. Thus, Plan A satisfies paragraph (a) of this section for the plan 
year. Alternatively, before the end of the period provided for in Sec. 
1.401(a)(4)-11(g)(3)(iv), or later if a later period is applicable under 
section 401(b), the employer could merge Plan A with Plan B to satisfy 
section 401(a)(26).

[T.D. 8375, 56 FR 63418, Dec. 4, 1991]



Sec. 1.401(a)(26)-8  Definitions.

    In applying this section and Sec. Sec. 1.401(a)(26)-1 through 
1.401(a)(26)-9 the definitions in this section govern unless otherwise 
provided.
    Collective bargaining agreement. Collective bargaining agreement 
means an agreement that the Secretary of Labor finds to be a collective 
bargaining agreement between employee representatives and the employer 
that satisfies Sec. 301.7701-17T. Employees described in section 
413(b)(8) who are employees of the union or the plan and are treated as 
employees of an employer are not employees covered pursuant to a 
collective bargaining agreement for purposes of section 401(a)(26) 
unless the employees are actually covered pursuant to such an agreement.
    Collectively bargained employee. Collectively bargained employee 
means a collectively bargained employee within the meaning of Sec. 
1.410(b)-6(d)(2).
    Covered by a collective bargaining agreement. Covered by a 
collective bargaining agreement means covered by a collective bargaining 
agreement within the meaning of Sec. 1.410(b)-6(d)(2)(iii).
    Defined benefit plan. Defined benefit plan means a defined benefit 
plan within the meaning of Sec. 1.410(b)-9.
    Defined contribution plan. Defined contribution plan means a defined 
contribution plan within the meaning of Sec. 1.410(b)-9.
    Employee. Employee means an employee, within the meaning of Sec. 
1.410(b)-9.
    Employer. Employer means the employer within the meaning of Sec. 
1.410(b)-9.
    ESOP. ESOP means an employee stock ownership plan within the meaning 
of section 4975(e)(7) or a tax credit employee stock ownership plan 
within the meaning of section 409(a).
    Former employee. Former employee means a former employee within the 
meaning of Sec. 1.410(b)-9.
    Highly compensated employee. Highly compensated employee means an 
employee who is highly compensated within the meaning of section 414(q).
    Highly compensated former employee. Highly compensated former 
employee means a former employee who is highly compensated within the 
meaning of section 414(q)(9).
    Multiemployer plan. Multiemployer plan means a multiemployer plan 
within the meaning of section 414(f).
    Noncollectively bargained employee. Noncollectively bargained 
employee means an employee who is not a collectively bargained employee.
    Nonhighly compensated employee. Nonhighly compensated employee means 
an employee who is not a highly compensated employee.
    Nonhighly compensated former employee. Nonhighly compensated former 
employee means a former employee who is not a highly compensated former 
employee.
    Plan. Plan means plan as defined in Sec. 1.401(a)(26)-2(c).
    Plan year. Plan year means the plan year of the plan as defined in 
the written plan document. In the absence of a specifically designated 
plan year, the plan year is deemed to be the calendar year.
    Professional employee. Professional employee means a professional 
employee as defined in Sec. 1.410(b)-9.
    Section 401(k) plan. Section 401(k) plan means a plan consisting of 
elective contributions described in Sec. 1.401(k)-1 (g)(3) under a 
qualified cash or deferred arrangement described in Sec. 1.401(k)-
1(a)(4)(i).
    Section 401(m) plan. Section 401(m) plan means a plan consisting of 
employee contributions described in Sec. 1.401(m)-1(f)(6) or matching 
contributions described in Sec. 1.401(m)-1(f)(12), or both.

[T.D. 8375, 56 FR 63418, Dec. 4, 1991]

[[Page 279]]



Sec. 1.401(a)(26)-9  Effective dates and transition rules.

    (a) In general. Except as provided in paragraphs (b), (c), and (d) 
of this section, section 401(a)(26) and the regulations thereunder apply 
to plan years beginning on or after January 1, 1989.
    (b) Transition rules--(1) Governmental plans and certain section 
403(b) annuities. Section 401(a)(26) is treated as satisfied for plan 
years beginning before the later of January 1, 1996, or 90 days after 
the opening of the first legislative session beginning on or after 
January 1, 1996, of the governing body with authority to amend the plan, 
if that body does not meet continuously, in the case of governmental 
plans described in section 414(d), including plans subject to section 
403(b)(12)(A)(i) (nonelective plans). For purposes of this paragraph 
(b)(1), the term ``governing body with authority to amend the plan'' 
means the legislature, board, commission, council, or other governing 
body with authority to amend the plan.
    (2) Early retirement ``window-period'' benefits. Early retirement 
benefits available under a plan only to employees who retire within a 
limited period of time, not to exceed one year, are treated as 
satisfying section 401(a)(26) if such benefits are provided under plan 
terms that were adopted and in effect on or before March 14, 1989.
    (3) Employees who do not benefit because of a minimum-period-of-
service requirement or a last-day requirement. For the first plan year 
beginning after December 31, 1988, and before January 1, 1990, employees 
who are eligible to participate under the plan and who fail to accrue a 
benefit solely because of the failure to satisfy either a minimum-
period-of-service requirement of 1000 hours of service or less or a 
last-day requirement may be treated as benefiting under the plan.
    (4) Certain plan terminations--(i) In general. Except as provided in 
paragraph (b)(4)(ii) of this section, if a plan terminates after section 
401(a)(26) becomes effective with respect to the plan (as determined 
under paragraph (a) of this section), the plan is not treated as a 
qualified plan upon termination unless it complies with section 
401(a)(26) and the regulations thereunder (to the extent they are 
applicable) for all periods for which section 401(a)(26) is effective 
with respect to the plan.
    (ii) Exception. Notwithstanding paragraphs (a) and (b)(4)(i) of this 
section, a plan does not fail to be treated as a qualified plan upon 
termination merely because the plan fails to satisfy the requirements of 
section 401(a)(26) and the regulations thereunder if the plan is 
terminated with a termination date on or before December 31, 1989, and 
either of the following conditions is satisfied:
    (A) In the case of a defined benefit plan, no highly compensated 
employee has an accrued benefit under the plan exceeding the lesser of 
either the benefit the employee had accrued as of the close of the last 
plan year beginning before January 1, 1989, or the benefit the employee 
would have accrued as of the close of the last plan year under the terms 
of the plan in effect and applicable with respect to the employee on 
December 13, 1988.
    (B) In the case of a defined contribution plan, no highly 
compensated employee receives a contribution allocation for any plan 
year beginning after December 31, 1988. For this purpose, a contribution 
allocation with respect to an employee for a plan year beginning before 
January 1, 1989, may be treated as a contribution allocation for a plan 
year beginning after December 31, 1988, if the allocation for the prior 
year exceeds the allocation that the employee would have received for 
such year under the terms of the plan in effect and applicable with 
respect to the employee on December 13, 1988. An allocation of 
forfeitures to highly compensated employees with respect to 
contributions made for plan years beginning before January 1, 1988, does 
not cause a defined contribution plan to fail to satisfy the conditions 
of this paragraph (b)(4)(ii)(B).
    (5) ESOPs and non-ESOPs. Notwithstanding paragraph (a) of this 
section and Sec. 54.4975-11(a)(5) of this Chapter, an employer may 
treat the rule in Sec. 1.401(a)(26)-2(d)(1)(i), regarding mandatory 
disaggregation of ESOPs and non-ESOPs as not effective for plan years 
beginning before January 1, 1990.
    (c) Waiver of excise tax on reversions--(1) In general. Pursuant to 
section 1112(e)(3) of the Tax Reform Act of 1986

[[Page 280]]

(TRA '86), if certain conditions are satisfied, a waiver of the excise 
tax under section 4980 applies with respect to any employer reversion 
that occurs by reason of the termination or merger of a plan before the 
first year to which section 401(a)(26) applies to the plan. In general, 
the applicable conditions are that the plan must have been in existence 
on August 16, 1986; that if section 401(a)(26) was in effect for the 
plan year including August 16, 1986, the plan would have failed to 
satisfy the requirements of section 401(a)(26) and would have continued 
to fail the requirements at all times thereafter; that the plan 
satisfies the applicable conditions in paragraph (b)(4)(ii)(A) or (B) of 
this section; and that certain requirements regarding asset or liability 
transfers and mergers and spinoffs involving the plan after August 16, 
1986, are satisfied.
    (2) Termination date. An employer reversion with respect to a plan 
is eligible for the section 4980 excise tax waiver only if the employer 
reversion occurs by reason of the termination of the plan with a 
termination date prior to the first plan year for which section 
401(a)(26) applies to the plan. Solely for purposes of this waiver, the 
employer reversion is treated as satisfying this paragraph (c)(2) even 
though the plan's termination date is during the first plan year for 
which section 401(a)(26) applies to the plan if the plan's termination 
date is on or before May 31, 1989. If the termination date occurs in the 
first plan year for which section 401(a)(26) applied to the plan and the 
employer receives a reversion that is eligible for the waiver of the 
section 4980 tax, the plan is subject to the interest rate restriction 
set forth in section 11 12(e)(3)(B) of TRA '86 as amended.
    (3) Failure to satisfy section 401(a)(26). An employer reversion 
with respect to a plan is eligible for the excise tax waiver only if the 
plan was in existence on August 16, 1986, and, if section 401(a)(26) had 
applied to the plan for the plan year including such date, the plan 
would have failed to satisfy section 401(a)(26) for the plan year and 
continuously thereafter until the plan's termination or merger. For 
purposes of this paragraph (c)(3), a plan is treated as though it would 
have failed to satisfy section 401(a)(26) before such section actually 
applied to the plan only if the plan (as defined under section 414(1)) 
failed to benefit at least the lesser of 50 employees or 40 percent of 
the employer's employees. In general, this determination is to be made 
on the basis of only the applicable statutory provisions, without regard 
to the regulations under section 401(a)(26). Thus, for example, the 
prior benefit structure rules in Sec. 1.401(a)(26)-3 do not apply in 
determining whether a plan would have failed to satisfy section 
401(a)(26) for plan years beginning prior to the effective date of 
section 401(a)(26) with respect to the plan.
    (d) Special rule for collective bargaining agreements. In the case 
of a plan maintained pursuant to one or more collective bargaining 
agreements (as defined in Sec. 1.401(a)(26)-8(a)) that were ratified 
before March 1, 1986, section 401(a)(26) and the regulations thereunder 
shall not apply to plan years beginning before the earlier of--
    (1) January 1, 1991, or
    (2) The later of--
    (i) January 1, 1989, or
    (ii) The date on which the last of such collective bargaining 
agreements terminates. For purposes of this paragraph (d), any extension 
or renegotiation of any collective bargaining agreement that is ratified 
after February 28, 1986, is disregarded in determining the date on which 
such collective bargaining agreement terminates.

[T.D. 8375, 56 FR 63419, Dec. 4, 1991, as amended by T.D. 8487, 58 FR 
46838, Sept. 3, 1993]



Sec. 1.401(a)(31)-1  Requirement to offer direct rollover of eligible 
rollover distributions; questions and answers.

    The following questions and answers relate to the qualification 
requirement imposed by section 401(a)(31) of the Internal Revenue Code 
of 1986, pertaining to the direct rollover option for eligible rollover 
distributions from pension, profit-sharing, and stock bonus plans. 
Section 401(a)(31) was added by section 522(a) of the Unemployment 
Compensation Amendments of 1992, Public Law 102-318, 106 Stat. 290 
(UCA). For additional UCA guidance under sections 402(c), 402(f), 
403(b)(8) and (10), and

[[Page 281]]

3405(c), see Sec. Sec. 1.402(c)-2, 1.402(f)-1, and 1.403(b)-7(b), and 
Sec. 31.3405(c)-1 of this chapter, respectively.

                            List of Questions

    Q-1: What are the direct rollover requirements under section 
401(a)(31)?
    Q-2: Does section 401(a)(31) require that a qualified plan permit a 
direct rollover to be made to a qualified trust that is not part of a 
defined contribution plan?
    Q-3: What is a direct rollover that satisfies section 401(a)(31), 
and how is it accomplished?
    Q-4: Is providing a distributee with a check for delivery to an 
eligible retirement plan a reasonable means of accomplishing a direct 
rollover?
    Q-5: Is an eligible rollover distribution that is paid to an 
eligible retirement plan in a direct rollover currently includible in 
gross income or subject to 20-percent withholding?
    Q-6: What procedures may a plan administrator prescribe for electing 
a direct rollover, and what information may the plan administrator 
require a distributee to provide when electing a direct rollover?
    Q-7: May the plan administrator treat a distributee as having made 
an election under a default procedure where the distributee does not 
affirmatively elect to make or not make a direct rollover within a 
certain time period?
    Q-8: May the plan administrator establish a deadline after which the 
distributee may not revoke an election to make or not make a direct 
rollover?
    Q-9: Must the plan administrator permit a distributee to elect to 
have a portion of an eligible rollover distribution paid to an eligible 
retirement plan in a direct rollover and to have the remainder of that 
distribution paid to the distributee?
    Q-10: Must the plan administrator allow a distributee to divide an 
eligible rollover distribution into two or more separate distributions 
to be paid in direct rollovers to two or more eligible retirement plans?
    Q-11: Will a plan satisfy section 401(a)(31) if the plan 
administrator does not permit a distributee to elect a direct rollover 
if his or her eligible rollover distributions during a year are 
reasonably expected to total less than $200?
    Q-12: Is a plan administrator permitted to treat a distributee's 
election to make or not make a direct rollover with respect to one 
payment in a series of periodic payments as applying to all subsequent 
payments in the series?
    Q-13: Is the eligible retirement plan designated by a distributee to 
receive a direct rollover distribution required to accept the 
distribution?
    Q-14. If a plan accepts an invalid rollover contribution, whether or 
not as a direct rollover, how will the contribution be treated for 
purposes of applying the qualification requirements of section 401(a) or 
403(a) to the plan?
    Q-15: For purposes of applying the plan qualification requirements 
of section 401(a), is an eligible rollover distribution that is paid to 
an eligible retirement plan in a direct rollover a distribution and 
rollover or is it a transfer of assets and liabilities?
    Q-16: Must a direct rollover option be provided for an eligible 
rollover distribution that is in the form of a plan loan offset amount?
    Q-17: Must a direct rollover option be provided for an eligible 
rollover distribution from a qualified plan distributed annuity 
contract?
    Q-18: What assumptions may a plan administrator make regarding 
whether a benefit is an eligible rollover distribution?
    Q-19: When must a qualified plan be amended to comply with section 
401(a)(31)?

                          Questions and Answers

    Q-1: What are the direct rollover requirements under section 
401(a)(31)?
    A-1: (a) General rule. To satisfy section 401(a)(31), added by UCA, 
a plan must provide that if the distributee of any eligible rollover 
distribution elects to have the distribution paid directly to an 
eligible retirement plan, and specifies the eligible retirement plan to 
which the distribution is to be paid, then the distribution will be paid 
to that eligible retirement plan in a direct rollover described in Q&A-3 
of this section. Thus, the plan must give the distributee the option of 
having his or her distribution paid in a direct rollover to an eligible 
retirement plan specified by the distributee. For purposes of section 
401(a)(31) and this section, eligible rollover distribution has the 
meaning set forth in section 402(c)(4) and Sec. 1.402(c)-2, Q&A-3 
through Q&A-10 and Q&A-14, except as otherwise provided in Q&A-2 of this 
section, eligible retirement plan has the meaning set forth in section 
402(c)(8)(B) and Sec. 1.402(c)-2, Q&A-2.
    (b) Related Internal Revenue Code provisions--(1) Mandatory 
withholding. If a distributee of an eligible rollover distribution does 
not elect to have the eligible rollover distribution paid directly from 
the plan to an eligible retirement plan in a direct rollover under 
section

[[Page 282]]

401(a)(31), the eligible rollover distribution is subject to 20-percent 
income tax withholding under section 3405(c). See Sec. 31.3405(c)-1 of 
this chapter for guidance concerning the withholding requirements 
applicable to eligible rollover distributions.
    (2) Notice requirement. Section 402(f) requires the plan 
administrator of a qualified plan to provide, within a reasonable period 
of time before making an eligible rollover distribution, a written 
explanation to the distributee of the distributee's right to elect a 
direct rollover and the withholding consequences of not making that 
election. The explanation also is required to provide certain other 
relevant information relating to the taxation of distributions. See 
Sec. 1.402(f)-1 for guidance concerning the written explanation 
required under section 402(f).
    (3) Section 403(b) annuities. Section 403(b)(10) provides that 
requirements similar to those imposed by section 401(a)(31) apply to 
annuities described in section 403(b). See Sec. 1.403(b)-7(b) for 
guidance concerning the direct rollover requirements for distributions 
from annuities described in section 403(b).
    (c) Effective date--(1) Statutory effective date. Section 401(a)(31) 
applies to eligible rollover distributions made on or after January 1, 
1993.
    (2) Regulatory effective date. This section applies to eligible 
rollover distributions made on or after October 19, 1995. For eligible 
rollover distributions made on or after January 1, 1993 and before 
October 19, 1995, Sec. 1.401(a)(31)-1T (as it appeared in the April 1, 
1995 edition of 26 CFR part 1), applies. However, for any distribution 
made on or after January 1, 1993 but before October 19, 1995, a plan may 
satisfy section 401(a)(31) by substituting any or all provisions of this 
section for the corresponding provisions of Sec. 1.401(a)(31)-1T, if 
any.
    Q-2: Does section 401(a)(31) require that a qualified plan permit a 
direct rollover to be made to a qualified trust that is not part of a 
defined contribution plan?
    A-2: No. Section 401(a)(31)(D) limits the types of qualified trusts 
that are treated as eligible retirement plans to defined contribution 
plans that accept eligible rollover distributions. Therefore, although a 
plan is permitted, at a participant's election, to make a direct 
rollover to any type of eligible retirement plan, as defined in section 
402(c)(8)(B) (including a defined benefit plan), a plan will not fail to 
satisfy section 401(a)(31) solely because the plan will not permit a 
direct rollover to a qualified trust that is part of a defined benefit 
plan. In contrast, if a distributee elects a direct rollover of an 
eligible rollover distribution to an annuity plan described in section 
403(a), that distribution must be paid to the annuity plan, even if the 
recipient annuity plan is a defined benefit plan.
    Q-3: What is a direct rollover that satisfies section 401(a)(31), 
and how is it accomplished?
    A-3: A direct rollover that satisfies section 401(a)(31) is an 
eligible rollover distribution that is paid directly to an eligible 
retirement plan for the benefit of the distributee. A direct rollover 
may be accomplished by any reasonable means of direct payment to an 
eligible retirement plan. Reasonable means of direct payment include, 
for example, a wire transfer or the mailing of a check to the eligible 
retirement plan. If payment is made by check, the check must be 
negotiable only by the trustee of the eligible retirement plan. If the 
payment is made by wire transfer, the wire transfer must be directed 
only to the trustee of the eligible retirement plan. In the case of an 
eligible retirement plan that does not have a trustee (such as a 
custodial individual retirement account or an individual retirement 
annuity), the custodian of the plan or issuer of the contract under the 
plan, as appropriate, should be substituted for the trustee for purposes 
of this Q&A-3, and Q&A-4 of this section.
    Q-4: Is providing a distributee with a check for delivery to an 
eligible retirement plan a reasonable means of accomplishing a direct 
rollover?
    A-4: Providing the distributee with a check and instructing the 
distributee to deliver the check to the eligible retirement plan is a 
reasonable means of direct payment, provided that the check is made 
payable as follows: [Name of the trustee] as trustee of [name of the 
eligible retirement plan]. For example, if the name of the eligible

[[Page 283]]

retirement plan is ``Individual Retirement Account of John Q. Smith,'' 
and the name of the trustee is ``ABC Bank,'' the payee line of a check 
would read ``ABC Bank as trustee of Individual Retirement Account of 
John Q. Smith.'' Unless the name of the distributee is included in the 
name of the eligible retirement plan, the check also must indicate that 
it is for the benefit of the distributee. If the eligible retirement 
plan is not an individual retirement account or an individual retirement 
annuity, the payee line of the check need not identify the trustee by 
name. For example, the payee line of a check for the benefit of 
distributee Jane Doe might read, ``Trustee of XYZ Corporation Savings 
Plan FBO Jane Doe.''
    Q-5: Is an eligible rollover distribution that is paid to an 
eligible retirement plan in a direct rollover currently includible in 
gross income or subject to 20-percent withholding?
    A-5: No. An eligible rollover distribution that is paid to an 
eligible retirement plan in a direct rollover is not currently 
includible in the distributee's gross income under section 402(c) and is 
exempt from the 20-percent withholding imposed under section 3405(c)(2). 
However, when any portion of the eligible rollover distribution is 
subsequently distributed from the eligible retirement plan, that portion 
will be includible in gross income to the extent required under section 
402, 403, or 408.
    Q-6: What procedures may a plan administrator prescribe for electing 
a direct rollover, and what information may the plan administrator 
require a distributee to provide when electing a direct rollover?
    A-6: (a) Permissible procedures. Except as otherwise provided in 
paragraph (b) of this Q&A-6, the plan administrator may prescribe any 
procedure for a distributee to elect a direct rollover under section 
401(a)(31), provided that the procedure is reasonable. The procedure may 
include any reasonable requirement for information or documentation from 
the distributee in addition to the items of adequate information 
specified in Sec. 31.3405(c)-1(b), Q&A-7 of this chapter. For example, 
it would be reasonable for the plan administrator to require that the 
distributee provide a statement from the designated recipient plan that 
the plan will accept the direct rollover for the benefit of the 
distributee and that the recipient plan is, or is intended to be, an 
individual retirement account, an individual retirement annuity, a 
qualified annuity plan described in section 403(a), or a qualified trust 
described in section 401(a), as applicable. In the case of a designated 
recipient plan that is a qualified trust, it also would be reasonable 
for the plan administrator to require a statement that the qualified 
trust is not excepted from the definition of an eligible retirement plan 
by section 401(a)(31)(D) (i.e., is not a defined benefit plan).
    (b) Impermissible procedures. A plan will fail to satisfy section 
401(a)(31) if the plan administrator prescribes any unreasonable 
procedure, or requires information or documentation, that effectively 
eliminates or substantially impairs the distributee's ability to elect a 
direct rollover. For example, it would effectively eliminate or 
substantially impair the distributee's ability to elect a direct 
rollover if the recipient plan required the distributee to obtain an 
opinion of counsel stating that the eligible retirement plan receiving 
the rollover is a qualified plan or individual retirement account. 
Similarly, it would effectively eliminate or substantially impair the 
distributee's ability to elect a direct rollover if the distributing 
plan required a letter from the recipient eligible retirement plan 
stating that, upon request by the distributing plan, the recipient plan 
will automatically return any direct rollover amount that the 
distributing plan advises the recipient plan was paid incorrectly. It 
would also effectively eliminate or substantially impair the 
distributee's ability to elect a direct rollover if the distributing 
plan required, as a condition for making a direct rollover, a letter 
from the recipient eligible retirement plan indemnifying the 
distributing plan for any liability arising from the distribution.
    Q-7: May the plan administrator treat a distributee as having made 
an election under a default procedure

[[Page 284]]

where the distributee does not affirmatively elect to make or not make a 
direct rollover within a certain time period?
    A-7: Yes, the plan administrator may establish a default procedure 
whereby any distributee who fails to make an affirmative election is 
treated as having either made or not made a direct rollover election. 
However, the plan administrator may not make a distribution under any 
default procedure unless the distributee has received an explanation of 
the default procedure and an explanation of the direct rollover option 
as required under section 402(f) and Sec. 1.402(f)-1, Q&A-1 and unless 
the timing requirements described in Sec. 1.402(f)-1, Q&A-2 and Q&A-3 
have been satisfied with respect to the explanations of both the default 
procedure and the direct rollover option.
    Q-8: May the plan administrator establish a deadline after which the 
distributee may not revoke an election to make or not make a direct 
rollover?
    A-8: Yes, but the plan administrator is not permitted to prescribe 
any deadline or time period with respect to revocation of a direct 
rollover election that is more restrictive for the distributee than that 
which otherwise applies under the plan to revocation of the form of 
distribution elected by the distributee.
    Q-9: Must the plan administrator permit a distributee to elect to 
have a portion of an eligible rollover distribution paid to an eligible 
retirement plan in a direct rollover and to have the remainder of that 
distribution paid to the distributee?
    A-9: Yes, the plan administrator must permit a distributee to elect 
to have a portion of an eligible rollover distribution paid to an 
eligible retirement plan in a direct rollover and to have the remainder 
paid to the distributee. However, the plan administrator is permitted to 
require that, if the distributee elects to have only a portion of an 
eligible rollover distribution paid to an eligible retirement plan in a 
direct rollover, that portion be equal to at least a specified minimum 
amount, provided the specified minimum amount is less than or equal to 
$500 or any greater amount as prescribed by the Commissioner in revenue 
rulings, notices, and other guidance published in the Internal Revenue 
Bulletin. See Sec. 601.601(d)(2)(ii)(b) of this chapter. If the entire 
amount of the eligible rollover distribution is less than or equal to 
the specified minimum amount, the plan administrator need not allow the 
distributee to divide the distribution.
    Q-10: Must the plan administrator allow a distributee to divide an 
eligible rollover distribution into two or more separate distributions 
to be paid in direct rollovers to two or more eligible retirement plans?
    A-10: No. The plan administrator is not required (but is permitted) 
to allow the distributee to divide an eligible rollover distribution 
into separate distributions to be paid to two or more eligible 
retirement plans in direct rollovers. Thus, the plan administrator may 
require that the distributee select a single eligible retirement plan to 
which the eligible rollover distribution (or portion thereof) will be 
distributed in a direct rollover.
    Q-11: Will a plan satisfy section 401(a)(31) if the plan 
administrator does not permit a distributee to elect a direct rollover 
if his or her eligible rollover distributions during a year are 
reasonably expected to total less than $200?
    A-11: Yes. A plan will satisfy section 401(a)(31) even though the 
plan administrator does not permit any distributee to elect a direct 
rollover with respect to eligible rollover distributions during a year 
that are reasonably expected to total less than $200 or any lower 
minimum amount specified by the plan administrator. The rules described 
in Sec. 31.3405(c)-1, Q&A-14 of this chapter (relating to whether 
withholding under section 3405(c) is required for an eligible rollover 
distribution that is less than $200) also apply for purposes of 
determining whether a direct rollover election under section 401(a)(31) 
must be provided for an eligible rollover distribution that is less than 
$200 or the lower specified amount.
    Q-12: Is a plan administrator permitted to treat a distributee's 
election to make or not make a direct rollover with respect to one 
payment in a series

[[Page 285]]

of periodic payments as applying to all subsequent payments in the 
series?
    A-12: (a) Yes. A plan administrator is permitted to treat a 
distributee's election to make or not make a direct rollover with 
respect to one payment in a series of periodic payments as applying to 
all subsequent payments in the series, provided that:
    (1) The employee is permitted at any time to change, with respect to 
subsequent payments, a previous election to make or not make a direct 
rollover; and
    (2) The written explanation provided under section 402(f) explains 
that the election to make or not make a direct rollover will apply to 
all future payments unless the employee subsequently changes the 
election.
    (b) See Sec. 1.402(f)-1, Q&A-3 for further guidance concerning the 
rules for providing section 402(f) notices when eligible rollover 
distributions are made in a series of periodic payments.
    Q-13: Is the eligible retirement plan designated by a distributee to 
receive a direct rollover distribution required to accept the 
distribution?
    A-13: No. Although section 401(a)(31) requires qualified plans to 
provide distributees the option to make a direct rollover of their 
eligible rollover distributions to an eligible retirement plan, it 
imposes no requirement that any eligible retirement plan accept 
rollovers. Thus, a plan can refuse to accept rollovers. Alternatively, a 
plan can limit the circumstances under which it will accept rollovers. 
For example, a plan can limit the types of plans from which it will 
accept a rollover or limit the types of assets it will accept in a 
rollover (such as accepting only cash or its equivalent).
    Q-14. If a plan accepts an invalid rollover contribution, whether or 
not as a direct rollover, how will the contribution be treated for 
purposes of applying the qualification requirements of section 401(a) or 
403(a) to the plan?
    A-14. (a) Acceptance of invalid rollover contribution. If a plan 
accepts an invalid rollover contribution, the contribution will be 
treated, for purposes of applying the qualification requirements of 
section 401(a) or 403(a) to the receiving plan, as if it were a valid 
rollover contribution, if the following two conditions are satisfied. 
First, when accepting the amount from the employee as a rollover 
contribution, the plan administrator of the receiving plan reasonably 
concludes that the contribution is a valid rollover contribution. While 
evidence that the distributing plan is the subject of a determination 
letter from the Commissioner indicating that the distributing plan is 
qualified would be useful to the receiving plan administrator in 
reasonably concluding that the contribution is a valid rollover 
contribution, it is not necessary for the distributing plan to have such 
a determination letter in order for the receiving plan administrator to 
reach that conclusion. Second, if the plan administrator of the 
receiving plan later determines that the contribution was an invalid 
rollover contribution, the amount of the invalid rollover contribution, 
plus any earnings attributable thereto, is distributed to the employee 
within a reasonable time after such determination.
    (b) Definitions. For purposes of this Q&A-14:
    (1) An invalid rollover contribution is an amount that is accepted 
by a plan as a rollover within the meaning of Sec. 1.402(c)-2, Q&A-1 
(or as a rollover contribution within the meaning of section 
408(d)(3)(A)(ii)) but that is not an eligible rollover distribution from 
a qualified plan (or an amount described in section 408(d)(3)(A)(ii)) or 
that does not satisfy the other requirements of section 401(a)(31), 
402(c), or 408(d)(3) for treatment as a rollover or a rollover 
contribution.
    (2) A valid rollover contribution is a contribution that is accepted 
by a plan as a rollover within the meaning of Sec. 1.402(c)-2, Q&A-1 or 
as a rollover contribution within the meaning of section 408(d)(3) and 
that satisfies the requirements of section 401(a)(31), 402(c), or 
408(d)(3) for treatment as a rollover or a rollover contribution.
    (c) Examples. The provisions of paragraph (a) of this Q&A-14 are 
illustrated by the following examples:

    Example 1. (i) Employer X maintains for its employees Plan M, a 
profit sharing plan qualified under section 401(a). Plan M provides that 
any employee of Employer X may make a rollover contribution to Plan M. 
Employee A is an employee of Employer X, will

[[Page 286]]

not have attained age 70\1/2\ by the end of the year, and has a vested 
account balance in Plan O (a plan maintained by Employee A's prior 
employer). Employee A elects a single sum distribution from Plan O and 
elects that it be paid to Plan M in a direct rollover.
    (ii) Employee A provides the plan administrator of Plan M with a 
letter from the plan administrator of Plan O stating that Plan O has 
received a determination letter from the Commissioner indicating that 
Plan O is qualified.
    (iii) Based upon such a letter, absent facts to the contrary, a plan 
administrator may reasonably conclude that Plan O is qualified and that 
the amount paid as a direct rollover is an eligible rollover 
distribution.
    Example 2. (i) The facts are the same as Example 1, except that, 
instead of the letter provided in paragraph (ii) of Example 1, Employee 
A provides the plan administrator of Plan M with a letter from the plan 
administrator of Plan O representing that Plan O satisfies the 
requirements of section 401(a) (or representing that Plan O is intended 
to satisfy the requirements of section 401(a) and that the administrator 
of Plan O is not aware of any Plan O provision or operation that would 
result in the disqualification of Plan O).
    (ii) Based upon such a letter, absent facts to the contrary, a plan 
administrator may reasonably conclude that Plan O is qualified and that 
the amount paid as a direct rollover is an eligible rollover 
distribution.
    Example 3. (i) Same facts as Example 1, except that Employee A 
elects to receive the distribution from Plan O and wishes to make a 
rollover contribution described in section 402 rather than a direct 
rollover.
    (ii) When making the rollover contribution, Employee A certifies 
that, to the best of Employee A's knowledge, Employee A is entitled to 
the distribution as an employee and not as a beneficiary, the 
distribution from Plan O to be contributed to Plan M is not one of a 
series of periodic payments, the distribution from Plan O was received 
by Employee A not more than 60 days before the date of the rollover 
contribution, and the entire amount of the rollover contribution would 
be includible in gross income if it were not being rolled over.
    (iii) As support for these certifications, Employee A provides the 
plan administrator of Plan M with two statements from Plan O. The first 
is a letter from the plan administrator of Plan O, as described in 
Example 1, stating that Plan O has received a determination letter from 
the Commissioner indicating that Plan O is qualified. The second is the 
distribution statement that accompanied the distribution check. The 
distribution statement indicates that the distribution is being made by 
Plan O to Employee A, indicates the gross amount of the distribution, 
and indicates the amount withheld as Federal income tax. The amount 
withheld as Federal income tax is 20 percent of the gross amount of the 
distribution. Employee A contributes to Plan M an amount not greater 
than the gross amount of the distribution stated in the letter from Plan 
O and the contribution is made within 60 days of the date of the 
distribution statement from Plan O.
    (iv) Based on the certifications and documentation provided by 
Employee A, absent facts to the contrary, a plan administrator may 
reasonably conclude that Plan O is qualified and that the distribution 
otherwise satisfies the requirements of section 402(c) for treatment as 
a rollover contribution.
    Example 4. (i) The facts are the same as in Example 3, except that, 
rather than contributing the distribution from Plan O to Plan M, 
Employee A contributes the distribution from Plan O to IRA P, an 
individual retirement account described in section 408(a). After the 
contribution of the distribution from Plan O to IRA P, but before the 
year in which Employee A attains age 70\1/2\, Employee A requests a 
distribution from IRA P and decides to contribute it to Plan M as a 
rollover contribution. To make the rollover contribution, Employee A 
endorses the check received from IRA P as payable to Plan M.
    (ii) In addition to providing the certifications described in 
Example 3 with respect to the distribution from Plan O, Employee A 
certifies that, to the best of Employee A's knowledge, the contribution 
to IRA P was not made more than 60 days after the date Employee A 
received the distribution from Plan O, no amount other than the 
distribution from Plan O has been contributed to IRA P, and the 
distribution from IRA P was received not more than 60 days earlier than 
the rollover contribution to Plan M.
    (iii) As support for these certifications, in addition to the two 
statements from Plan O described in Example 3, Employee A provides 
copies of statements from IRA P. The statements indicate that the 
account is identified as an IRA, the account was established within 60 
days of the date of the letter from Plan O informing Employee A that an 
amount had been distributed, and the opening balance in the IRA does not 
exceed the amount of the distribution described in the letter from Plan 
O. There is no indication in the statements that any additional 
contributions have been made to IRA P since the account was opened. The 
date on the check from IRA P is less than 60 days before the date that 
Employee A makes the contribution to Plan M.
    (iv) Based on the certifications and documentation provided by 
Employee A, absent facts to the contrary, a plan administrator may 
reasonably conclude that Plan O is qualified and that the contribution 
by Employee A is a rollover contribution described in section 
408(d)(3)(A)(ii) that satisfies the

[[Page 287]]

other requirements of section 408(d)(3) for treatment as a rollover 
contribution.

    Q-15: For purposes of applying the plan qualification requirements 
of section 401(a), is an eligible rollover distribution that is paid to 
an eligible retirement plan in a direct rollover a distribution and 
rollover or is it a transfer of assets and liabilities?
    A-15: For purposes of applying the plan qualification requirements 
of section 401(a), a direct rollover is a distribution and rollover of 
the eligible rollover distribution and not a transfer of assets and 
liabilities. For example, if the consent requirements under section 
411(a)(11) or sections 401(a)(11) and 417(a)(2) apply to the 
distribution, they must be satisfied before the eligible rollover 
distribution may be distributed in a direct rollover. Similarly, the 
direct rollover is not a transfer of assets and liabilities that must 
satisfy the requirements of section 414(l). Finally, a direct rollover 
is not a transfer of benefits for purposes of applying the requirements 
under section 411(d)(6), as described in Sec. 1.411(d)-4, Q&A-3. 
Therefore, for example, the eligible retirement plan is not required to 
provide, with respect to amounts paid to it in a direct rollover, the 
same optional forms of benefits that were provided under the plan that 
made the direct rollover. The direct rollover requirements of section 
401(a)(31) do not affect the ability of a qualified plan to make an 
elective or nonelective transfer of assets and liabilities to another 
qualified plan in accordance with applicable law (such as section 
414(l)).
    Q-16: Must a direct rollover option be provided for an eligible 
rollover distribution that is in the form of a plan loan offset amount?
    A-16: A plan will not fail to satisfy section 401(a)(31) merely 
because the plan does not permit a distributee to elect a direct 
rollover of an eligible rollover distribution in the form of a plan loan 
offset amount. Section 1.402(c)-2(b), Q&A-9 defines a plan loan offset 
amount, in general, as a distribution that occurs when, under the terms 
governing a plan loan, the participant's accrued benefit is reduced 
(offset) in order to repay the loan. A plan administrator is permitted 
to allow a direct rollover of a participant note for a plan loan to a 
qualified trust described in section 401(a) or a qualified annuity plan 
described in section 403(a). See Sec. 1.402(c)-2, Q&A-9 for examples 
illustrating the rules for plan loan offset amounts that are set forth 
in this Q&A-16. See Sec. 31.3405(c)-1, Q&A-11 of this chapter for 
guidance concerning special withholding rules that apply to a 
distribution in the form of a plan loan offset amount.
    Q-17: Must a direct rollover option be provided for an eligible 
rollover distribution from a qualified plan distributed annuity 
contract?
    A-17: Yes. If any amount to be distributed under a qualified plan 
distributed annuity contract is an eligible rollover distribution (in 
accordance with Sec. 1.402(c)-2), Q&A-10 the annuity contract must 
satisfy section 401(a)(31) in the same manner as a qualified plan under 
section 401(a). Section 1.402(c)-2, Q&A-10 defines a qualified plan 
distributed annuity contract as an annuity contract purchased for a 
participant, and distributed to the participant, by a qualified plan. In 
the case of a qualified plan distributed annuity contract, the payor 
under the contract is treated as the plan administrator. See Sec. 
31.3405(c)-1, Q&A-13 of this chapter concerning the application of 
mandatory 20-percent withholding requirements to distributions from a 
qualified plan distributed annuity contract.
    Q-18: What assumptions may a plan administrator make regarding 
whether a benefit is an eligible rollover distribution?
    A-18: (a) General rule. For purposes of section 401(a)(31), a plan 
administrator may make the assumptions described in paragraphs (b) and 
(c) of this Q&A-18 in determining the amount of a distribution that is 
an eligible rollover distribution for which a direct rollover option 
must be provided. Section 31.3405(c)-1, Q&A-10 of this chapter provides 
assumptions for purposes of complying with section 3405(c). See Sec. 
1.402(c)-2, Q&A-15 concerning the effect of these assumptions for 
purposes of section 402(c).
    (b) $5,000 death benefit. A plan administrator is permitted to 
assume that a distribution from the plan that qualifies for the $5,000 
death benefit exclusion under section 101(b) is the only

[[Page 288]]

death benefit being paid with respect to a deceased employee that 
qualifies for that exclusion. Thus, to the extent that such a 
distribution would be excludible from gross income based on this 
assumption, the plan administrator is permitted to assume that it is not 
an eligible rollover distribution.
    (c) Determination of designated beneficiary. For the purpose of 
determining the amount of the minimum distribution required to satisfy 
section 401(a)(9)(A) for any calendar year, the plan administrator is 
permitted to assume that there is no designated beneficiary.
    Q-19: When must a qualified plan be amended to comply with section 
401(a)(31)?
    A-19: Even though section 401(a)(31) applies to distributions from 
qualified plans made on or after January 1, 1993, a qualified plan is 
not required to be amended before the last day by which amendments must 
be made to comply with the Tax Reform Act of 1986 and related 
provisions, as permitted in other administrative guidance of general 
applicability, provided that:
    (a) In the interim period between January 1, 1993, and the date on 
which the plan is amended, the plan is operated in accordance with the 
requirements of section 401(a)(31); and
    (b) The amendment applies retroactively to January 1, 1993.

[T.D. 8619, 60 FR 49204, Sept. 22, 1995, as amended by T.D. 8880, 65 FR 
21314, Apr. 21, 2000; 65 FR 34534, May 30, 2000; T.D. 9340, 72 FR 41159, 
July 26, 2007]



Sec. 1.401(a)(35)-1  Diversification requirements for certain defined 
contribution plans.

    (a) General rule--(1) Diversification requirements. Section 
401(a)(35) imposes diversification requirements on applicable defined 
contribution plans. A trust that is part of an applicable defined 
contribution plan is not a qualified trust under section 401(a) unless 
the plan--
    (i) Satisfies the diversification election requirements for elective 
deferrals and employee contributions set forth in paragraph (b) of this 
section;
    (ii) Satisfies the diversification election requirements for 
employer nonelective contributions set forth in paragraph (c) of this 
section;
    (iii) Satisfies the investment option requirement set forth in 
paragraph (d) of this section; and
    (iv) Does not apply any restrictions or conditions on investments in 
employer securities that violate the requirements of paragraph (e) of 
this section.
    (2) Definitions, effective dates, and transition rules. The 
definitions of applicable defined contribution plan, employer security, 
parent corporation, and publicly traded are set forth in paragraph (f) 
of this section. Applicability dates and transition rules are set forth 
in paragraph (g) of this section.
    (b) Diversification requirements for elective deferrals and employee 
contributions invested in employer securities--(1) General rule. With 
respect to any individual described in paragraph (b)(2) of this section, 
if any portion of the individual's account under an applicable defined 
contribution plan attributable to elective deferrals (as described in 
section 402(g)(3)(A)), employee contributions, or rollover contributions 
is invested in employer securities, then the plan satisfies the 
requirements of this paragraph (b) if the individual may elect to divest 
those employer securities and reinvest an equivalent amount in other 
investment options. The plan may limit the time for divestment and 
reinvestment to periodic, reasonable opportunities occurring no less 
frequently than quarterly.
    (2) Applicable individual with respect to elective deferrals and 
employee contributions. An individual is described in this paragraph 
(b)(2) if the individual is--
    (i) A participant;
    (ii) An alternate payee who has an account under the plan; or
    (iii) A beneficiary of a deceased participant.
    (c) Diversification requirements for employer nonelective 
contributions invested in employer securities--(1) General rule. With 
respect to any individual described in paragraph (c)(2) of this section, 
if a portion of the individual's account under an applicable defined 
contribution plan attributable to employer nonelective contributions is 
invested in employer securities, then the plan

[[Page 289]]

satisfies the requirements of this paragraph (c) if the individual may 
elect to divest those employer securities and reinvest an equivalent 
amount in other investment options. The plan may limit the time for 
divestment and reinvestment to periodic, reasonable opportunities 
occurring no less frequently than quarterly.
    (2) Applicable individual with respect to employer nonelective 
contributions. An individual is described in this paragraph (c)(2) if 
the individual is--
    (i) A participant who has completed at least three years of service;
    (ii) An alternate payee who has an account under the plan with 
respect to a participant who has completed at least three years of 
service; or
    (iii) A beneficiary of a deceased participant.
    (3) Completion of three years of service. For purposes of paragraph 
(c)(2) of this section, a participant completes three years of service 
on the last day of the vesting computation period provided for under the 
plan that constitutes the completion of the third year of service under 
section 411(a)(5). However, for a plan that uses the elapsed time method 
of crediting service for vesting purposes (or a plan that provides for 
immediate vesting without using a vesting computation period or the 
elapsed time method of determining vesting), a participant completes 
three years of service on the day immediately preceding the third 
anniversary of the participant's date of hire.
    (d) Investment options. An applicable defined contribution plan must 
offer not less than three investment options, other than employer 
securities, to which an individual who has the right to divest under 
paragraph (b)(1) or (c)(1) of this section may direct the proceeds from 
the divestment of employer securities. Each of the three investment 
options must be diversified and have materially different risk and 
return characteristics. For this purpose, investment options that 
constitute a broad range of investment alternatives within the meaning 
of Department of Labor Regulation section 2550.404c-1(b)(3) are treated 
as being diversified and having materially different risk and return 
characteristics.
    (e) Restrictions or conditions on investments in employer 
securities--(1) Impermissible restrictions or conditions--(i) General 
rule. Except as provided in paragraph (e)(2) of this section, an 
applicable defined contribution plan violates the requirements of this 
paragraph (e) if the plan imposes restrictions or conditions with 
respect to the investment of employer securities that are not imposed on 
the investment of other assets of the plan. A restriction or condition 
with respect to employer securities means--
    (A) A restriction on an individual's right to divest an investment 
in employer securities that is not imposed on an investment that is not 
employer securities; or
    (B) A benefit that is conditioned on investment in employer 
securities.
    (ii) Indirect restrictions or conditions--(A) Except as provided in 
paragraph (e)(3) of this section, a plan violates the requirements of 
this paragraph (e) if the plan imposes a restriction or condition 
described in paragraph (e)(1)(i)(A) or (B) of this section either 
directly or indirectly.
    (B) A plan imposes an indirect restriction on an individual's right 
to divest an investment in employer securities if, for example, the plan 
provides that a participant who divests his or her account balance with 
respect to the investment in employer securities is not permitted for a 
period of time thereafter to reinvest in employer securities.
    (C) A plan does not impose an indirect restriction or condition 
merely because there are tax consequences that result from an 
individual's divestment of an investment in employer securities. Thus, 
the loss of the special treatment for net unrealized appreciation 
provided under section 402(e)(4) with respect to employer securities is 
disregarded. Similarly, a plan does not impose an impermissible 
restriction or condition merely because it provides that an individual 
may not reinvest divested amounts in the same employer securities 
account but is permitted to invest such divested amounts in another 
employer securities account where the only relevant difference between 
the separate accounts is the section 402(e)(4) cost (or other basis) of 
the

[[Page 290]]

trust in the shares held in each account. (See Sec. 1.402(a)-1(b) for 
rules regarding section 402(e)(4).)
    (2) Permitted restrictions or conditions--(i) In general. An 
applicable defined contribution plan does not violate the requirements 
of this paragraph (e) merely because it imposes a restriction or a 
condition set forth in paragraph (e)(2)(ii) or (e)(2)(iii) of this 
section.
    (ii) Securities laws. A plan is permitted to impose a restriction or 
condition on the divestiture of employer securities that is either 
required in order to ensure compliance with applicable securities laws 
or is reasonably designed to ensure compliance with applicable 
securities laws. For example, it is permissible for a plan to limit 
divestiture rights for participants who are subject to section 16(b) of 
the Securities Exchange Act of 1934 (15 U.S.C. 78f) to a reasonable 
period (such as 3 to 12 days) following publication of the employer's 
quarterly earnings statements because it is reasonably designed to 
ensure compliance with Rule 10b-5 of the Securities and Exchange 
Commission.
    (iii) Deferred application of the diversification requirements--(A) 
Becoming an applicable defined contribution plan. An applicable defined 
contribution plan is permitted to restrict the application of the 
diversification requirements of section 401(a)(35) and this section for 
up to 90 days after the plan becomes an applicable defined contribution 
plan (for example, a plan becoming an applicable defined contribution 
plan because the employer securities held under the plan become publicly 
traded).
    (B) Loss of exception for indirect investments. In the case where an 
investment fund described in paragraph (f)(3)(ii)(A) of this section no 
longer meets the requirement in paragraph (f)(3)(ii)(B) of this section 
that the investment must be independent of the employer (including the 
situation where the fund no longer meets the percentage limitation rule 
in paragraph (f)(3)(ii)(C) of this section), the plan does not fail to 
satisfy the diversification requirements of section 401(a)(35) and this 
section merely because it does not offer those rights with respect to 
that investment fund for up to 90 days after the investment fund ceases 
to meet those requirements.
    (3) Permitted indirect restrictions or conditions--(i) In general. 
An applicable defined contribution plan does not violate the 
requirements of this paragraph (e) merely because it imposes an indirect 
restriction or condition set forth in this paragraph (e)(3).
    (ii) Limitation on investment in employer securities. A plan is 
permitted to limit the extent to which an individual's account balance 
can be invested in employer securities, provided the limitation applies 
without regard to a prior exercise of rights to divest employer 
securities. For example, a plan does not impose a restriction that 
violates this paragraph (e) merely because the plan prohibits a 
participant from investing additional amounts in employer securities if 
more than 10 percent of that participant's account balance is invested 
in employer securities.
    (iii) Trading frequency. A plan is permitted to impose reasonable 
restrictions on the timing and number of investment elections that an 
individual can make to invest in employer securities, provided that the 
restrictions are designed to limit short-term trading in the employer 
securities. For example, a plan could provide that a participant may not 
elect to invest in employer securities if the employee has elected to 
divest employer securities within a short period of time, such as seven 
days, prior to the election to invest in employer securities.
    (iv) Fees. The plan has not provided an indirect benefit that is 
conditioned on investment in employer securities merely because the plan 
imposes fees on other investment options that are not imposed on the 
investment in employer securities. In addition, the plan has not 
provided a restriction on the right to divest an investment in employer 
securities merely because the plan imposes a reasonable fee for the 
divestment of employer securities.
    (v) Stable value or similar fund. A plan is permitted to allow 
transfers to be made into or out of a stable value or similar fund more 
frequently than a fund invested in employer securities for purposes of 
paragraph (e)(1)(ii) of this section. Thus, a plan that includes

[[Page 291]]

a broad range of investment alternatives as described in paragraph (d) 
of this section, including a stable value or similar fund, does not 
impose an impermissible restriction under paragraph (e)(1)(ii) of this 
section merely because it permits transfers into or out of that fund 
more frequently than other funds under the plan, provided that the plan 
would otherwise satisfy this paragraph (e) (taking into account any 
restrictions or conditions imposed with respect to the other investment 
options under the plan). For purposes of this section, a stable value 
fund or similar fund means an investment product or fund designed to 
preserve or guarantee principal and provide a reasonable rate of return, 
while providing liquidity for benefit distributions or transfers to 
other investment alternatives (such as a product or fund described in 
Department of Labor Regulation Sec. 2550.404c-5(e)(4)(iv)(A) or 
(v)(A)).
    (vi) Transfers out of a qualified default investment alternative 
(QDIA). A plan is permitted to provide for transfers out of a QDIA 
within the meaning of Department of Labor Regulation section 2550.404c-
5(e) more frequently than a fund invested in employer securities.
    (vii) Frozen funds--(A) General rule. A plan is permitted to 
prohibit any further investment in employer securities. Thus, a plan is 
not treated as imposing an indirect restriction merely because it 
provides that an employee that divests an investment in employer 
securities is not permitted to reinvest in employer securities, but only 
if the plan does not permit additional contributions or other 
investments to be invested in employer securities. For this purpose, a 
plan does not provide for further investment in employer securities 
merely because dividends paid on employer securities under the plan are 
reinvested in employer securities.
    (B) Transitional relief for certain leveraged employee stock 
ownership plans (ESOPs). An employer stock fund does not fail to be a 
frozen fund under this paragraph (e)(3)(vii) merely because of the 
allocation of employer securities that are released as matching 
contributions from the plan's suspense account that holds employer 
securities acquired with an exempt loan under section 4975(d)(3). This 
paragraph (e)(3)(vii)(B) only applies to employer securities that were 
acquired in a plan year beginning before January 1, 2007, with the 
proceeds of an exempt loan within the meaning of section 4975(d)(3) 
which is not refinanced after the end of the last plan year beginning 
before January 1, 2007.
    (4) Delegation of authority to Commissioner. The Commissioner may 
provide for additional permitted restrictions or conditions or permitted 
indirect restrictions or conditions in revenue rulings, notices, or 
other guidance published in the Internal Revenue Bulletin.
    (f) Definitions--(1) Application of definitions. This paragraph (f) 
contains definitions that are applicable for purposes of this section.
    (2) Applicable defined contribution plan--(i) General rule. Except 
as provided in this paragraph (f)(2), an applicable defined contribution 
plan means any defined contribution plan which holds employer securities 
that are publicly traded. See paragraph (f)(2)(iv) of this section for a 
special rule that treats certain plans that hold employer securities 
that are not publicly traded as applicable defined contribution plans 
and paragraph (f)(3)(ii) of this section for a special rule that treats 
certain plans as not holding publicly traded employer securities for 
purposes of this section.
    (ii) Exception for certain ESOPs. An employee stock ownership plan 
(ESOP), as defined in section 4975(e)(7), is not an applicable defined 
contribution plan if the plan is a separate plan for purposes of section 
414(l) with respect to any other defined benefit plan or defined 
contribution plan maintained by the same employer or employers and holds 
no contributions (or earnings thereunder) that are (or were ever) 
subject to section 401(k) or 401(m). Thus, an ESOP is an applicable 
defined contribution plan if the ESOP is a portion of a larger plan 
(whether or not that larger plan includes contributions that are subject 
to section 401(k) or 401(m)). For purposes of this paragraph (f)(2)(ii), 
a plan is not considered to hold amounts ever subject to section 401(k) 
or 401(m) merely because the plan holds amounts attributable to rollover 
amounts in a separate account

[[Page 292]]

that were previously subject to section 401(k) or 401(m).
    (iii) Exception for one-participant plans. A one-participant plan, 
as defined in section 401(a)(35)(E)(iv), is not an applicable defined 
contribution plan.
    (iv) Certain defined contribution plans treated as holding publicly 
traded employer securities--(A) General rule. A defined contribution 
plan holding employer securities that are not publicly traded is treated 
as an applicable defined contribution plan if any employer maintaining 
the plan or any member of a controlled group of corporations that 
includes such employer has issued a class of stock which is publicly 
traded. For purposes of this paragraph (f)(2)(iv), a controlled group of 
corporations has the meaning given such term by section 1563(a), except 
that ``50 percent'' is substituted for ``80 percent'' each place it 
appears.
    (B) Exception for certain plans. Paragraph (f)(2)(iv)(A) of this 
section does not apply to a plan if--
    (1) No employer maintaining the plan (or a parent corporation with 
respect to such employer) has issued stock that is publicly traded; and
    (2) No employer maintaining the plan (or parent corporation with 
respect to such employer) has issued any special class of stock which 
grants to the holder or issuer particular rights, or bears particular 
risks for the holder or issuer, with respect to any employer maintaining 
the plan (or any member of a controlled group of corporations that 
includes such employer) which has issued any stock that is publicly 
traded.
    (3) Employer security--(i) General rule. Employer security has the 
meaning given such term by section 407(d)(1) of the Employee Retirement 
Income Security Act of 1974, as amended (ERISA).
    (ii) Certain defined contribution plans or investment funds not 
treated as holding employer securities--(A) Exception for certain 
indirect investments. Subject to paragraphs (f)(3)(ii)(B) and (C) of 
this section, a plan (and an investment option described in paragraph 
(d) of this section) is not treated as holding employer securities for 
purposes of this section to the extent the employer securities are held 
indirectly as part of a broader fund that is--
    (1) A regulated investment company described in section 851(a);
    (2) A common or collective trust fund or pooled investment fund 
maintained by a bank or trust company supervised by a State or a Federal 
agency;
    (3) A pooled investment fund of an insurance company that is 
qualified to do business in a State;
    (4) An investment fund managed by an investment manager within the 
meaning of section 3(38) of ERISA for a multiemployer plan; or
    (5) Any other investment fund designated by the Commissioner in 
revenue rulings, notices, or other guidance published in the Internal 
Revenue Bulletin.
    (B) Investment must be independent. The exception set forth in 
paragraph (f)(3)(ii)(A) of this section applies only if the investment 
in the employer securities is held in a fund under which--
    (1) There are stated investment objectives of the fund; and
    (2) The investment is independent of the employer (or employers) and 
any affiliate thereof.
    (C) Percentage limitation rule. For purposes of paragraph 
(f)(3)(ii)(B)(2) of this section, an investment in employer securities 
in a fund is not considered to be independent of the employer (or 
employers) and any affiliate thereof if the aggregate value of the 
employer securities held in the fund is in excess of 10 percent of the 
total value of all of the fund's investments for the plan year. The 
determination of whether the value of employer securities exceeds 10 
percent of the total value of the fund's investments for the plan year 
is made as of the end of the preceding plan year. The determination can 
be based on the information in the latest disclosure of the fund's 
portfolio holdings that was filed with the Securities and Exchange 
Commission (SEC) in that preceding plan year.
    (4) Parent corporation. Parent corporation has the meaning given 
such term by section 424(e).
    (5) Publicly traded--(i) In general. A security is publicly traded 
if it is readily tradable on an established securities market.

[[Page 293]]

    (ii) Readily tradable on an established securities market. For 
purposes of this paragraph (f)(5), except as provided by the 
Commissioner in revenue rulings, notices, or other guidance published in 
the Internal Revenue Bulletin, a security is readily tradable on an 
established securities market if--
    (A) The security is traded on a national securities exchange that is 
registered under section 6 of the Securities Exchange Act of 1934 (15 
U.S.C. 78f); or
    (B) The security is traded on a foreign national securities exchange 
that is officially recognized, sanctioned, or supervised by a 
governmental authority and the security is deemed by the SEC as having a 
``ready market'' under SEC Rule 15c3-1 (17 CFR 240.15c3-1).
    (g) Applicability date and transition rules--(1) Statutory effective 
date--(i) General rule. Except as otherwise provided in this paragraph 
(g) and section 901(c)(3)(A) and (B) of the Pension Protection Act of 
2006, Public Law 109-280 (120 Stat. 780 (2006)) (PPA '06), section 
401(a)(35) is effective for plan years beginning after December 31, 
2006.
    (ii) Collectively bargained plans--(A) Delayed statutory effective 
date. In the case of a plan maintained pursuant to one or more 
collective bargaining agreements between employee representatives and 
one or more employers ratified on or before August 17, 2006, section 
401(a)(35) is effective for plan years beginning after the earlier of--
    (1) The later of--
    (i) December 31, 2007; or
    (ii) The date on which the last such collective bargaining agreement 
terminates (determined without regard to any extension thereof); or
    (2) December 31, 2008.
    (B) Treatment of plans with both collectively bargained and non-
collectively bargained employees. If a collective bargaining agreement 
applies to some, but not all, of the plan participants, the definition 
of whether the plan is considered a collectively bargained plan for 
purposes of this paragraph (g)(1)(ii) is made in the same manner as the 
definition of whether a plan is collectively bargained under section 
436(f)(3).
    (2) Regulatory effective/applicability date. This section is 
effective and applicable for plan years beginning on or after January 1, 
2011.
    (3) Statutory transition rules--(i) General rule. Pursuant to 
section 401(a)(35)(H), in the case of the portion of an account to which 
paragraph (c) of this section applies and that consists of employer 
securities acquired in a plan year beginning before January 1, 2007, the 
requirements of paragraph (c) of this section only apply to the 
applicable percentage of such securities.
    (ii) Applicable percentage--(A) Phase-in percentage. For purposes of 
this paragraph (g)(3), the applicable percentage is determined as 
follows--

------------------------------------------------------------------------
   Plan year to which paragraph (c) of this section      The applicable
                       applies:                          percentage is:
------------------------------------------------------------------------
1st...................................................                33
2nd...................................................                66
3rd and following.....................................               100
------------------------------------------------------------------------

    (B) Special rule. For a plan for which the special effective date 
under section 901(c)(3) of PPA '06 applies, the applicable percentage 
under this paragraph (g)(3)(ii) is determined without regard to the 
delayed effective date in section 901(c)(3)(A) and (B) of PPA '06.
    (iii) Nonapplication for participants age 55 with three years of 
service. Paragraph (g)(3)(i) of this section does not apply to an 
individual who is a participant who attained age 55 and had completed at 
least three years of service (as defined in paragraph (c)(3) of this 
section) before the first day of the first plan year beginning after 
December 31, 2005.
    (iv) Separate application by class of securities. This paragraph 
(g)(3) applies separately with respect to each class of securities.

[T.D. 9484, 75 FR 27931, May 19, 2010]



Sec. 1.401(b)-1  Certain retroactive changes in plan.

    (a) General rule. Under section 401(b) a stock bonus, pension, 
profit-sharing, annuity, or bond purchase plan which does not satisfy 
the requirements of section 401(a) on any day solely as a result of a 
disqualifying provision (as defined in paragraph (b) of this section) 
shall be considered to have satisfied such requirements on such date if, 
on or before the last day of the remedial amendment period (as 
determined under paragraphs (d), (e) and (f) of this

[[Page 294]]

section) with respect to such disqualifying provision, all provisions of 
the plan which are necessary to satisfy all requirements of sections 
401(a), 403(a), or 405(a) are in effect and have been made effective for 
all purposes for the whole of such period. Under some facts and 
circumstances, it may not be possible to amend a plan retroactively so 
that all provisions of the plan which are necessary to satisfy the 
requirements of section 401(a) are in fact made effective for the whole 
remedial amendment period. If it is not possible, the requirements of 
this section will not be satisfied even if the employer adopts a 
retroactive plan amendment which, in form, appears to satisfy such 
requirements. Section 401(b) does not permit a plan to be made 
retroactively effective, for qualification purposes, for a taxable year 
prior to the taxable year of the employer in which the plan was adopted 
by such employer.
    (b) Disqualifying provisions. For purposes of this section, with 
respect to a plan described in paragraph (a) of this section, the term 
``disqualifying provision'' means:
    (1) A provision of a new plan, the absence of a provision from a new 
plan, or an amendment to an existing plan, which causes such plan to 
fail to satisfy the requirements of the Code applicable to qualification 
of such plan as of the date such plan or amendment is first made 
effective.
    (2) A plan provision which results in the failure of the plan to 
satisfy the qualification requirements of the Code by reason of a change 
in such requirements--
    (i) Effected by the Employee Retirement Income Security Act of 1974 
(Pub. L. 93-406, 88 Stat. 829), hereafter referred to as ``ERISA,'' or 
the Tax Equity and Fiscal Responsibility Act of 1982 (Pub. L. 97-248, 96 
Stat. 324), hereafter referred to as ``TEFRA,'' or
    (ii) Effective before the first day of the first plan year beginning 
after December 31, 1989 and that is effected by the Tax Reform Act of 
1986 (Pub. L. 99-514, 100 Stat. 2085, 2489), hereafter referred to as 
``TRA '86,'' the Omnibus Budget Reconciliation Act of 1986, (Pub. L. 99-
509, 100 Stat. 1874), hereafter referred to as ``OBRA '86,'' or the 
Omnibus Budget Reconciliation Act of 1987 (Pub. L. 100-203, 101 Stat. 
1330), hereafter referred to as ``OBRA '87.'' For purposes of this 
paragraph (b)(2)(ii), a disqualifying provision includes any plan 
provision that is integral to a qualification requirement changed by TRA 
'86, OBRA '86, or OBRA '87 or any requirement treated by the 
Commissioner, directly or indirectly, as if section 1140 of TRA '86 
applied to it, but only to the extent such provision is effective before 
the first day of the first plan year beginning after December 31, 1989. 
With respect to disqualifying provisions described in this paragraph 
(b)(2)(ii) effective before the first day of the first plan year which 
begins after December 31, 1988, there must be compliance with the 
conditions of section 1140 of TRA '86 (other than the requirement that 
the plan amendment be made on or before the last day of the first plan 
year beginning after December 31, 1988), including operation in 
accordance with the plan provision as of its effective date with respect 
to the plan.
    (3) A plan provision designated by the Commissioner, at the 
Commissioner's discretion, as a disqualifying provision that either--
    (i) Results in the failure of the plan to satisfy the qualification 
requirements of the Internal Revenue Code by reason of a change in those 
requirements; or
    (ii) Is integral to a qualification requirement of the Internal 
Revenue Code that has been changed.
    (c) Special rules applicable to disqualifying provisions--(1) 
Absence of plan provision. For purposes of paragraphs (b)(2) and (3) of 
this section, a disqualifying provision includes the absence from a plan 
of a provision required by, or, if applicable, integral to the 
applicable change to the qualification requirements of the Internal 
Revenue Code, if the plan was in effect on the date the change became 
effective with respect to the plan.
    (2) Method of designating disqualifying provisions. The Commissioner 
may designate a plan provision as a disqualifying provision pursuant to 
paragraph (b)(3) of this section only in revenue rulings, notices, and 
other guidance published in the Internal Revenue Bulletin. See Sec. 
601.601(d)(2) of this chapter.

[[Page 295]]

    (3) Authority to impose limitations. In the case of a provision that 
has been designated as a disqualifying provision by the Commissioner 
pursuant to paragraph (b)(3) of this section, the Commissioner may 
impose limits and provide additional rules regarding the amendments that 
may be made with respect to that disqualifying provision during the 
remedial amendment period. The Commissioner may provide guidance in 
revenue rulings, notices, and other guidance published in the Internal 
Revenue Bulletin. See Sec. 601.601(d)(2) of this chapter.
    (d) Remedial amendment period. (1) The remedial amendment period 
with respect to a disqualifying provision begins:
    (i) In the case of a provision of, or absence of a provision from, a 
new plan, described in paragraph (b)(1) of this section, the date the 
plan is put into effect,
    (ii) In the case of an amendment to an existing plan, described in 
paragraph (b)(1) of this section, the date the plan amendment is adopted 
or put into effect (whichever is earlier),
    (iii) In the case of a disqualifying provision described in 
paragraph (b)(2) of this section, the date on which the change effected 
by ERISA, TEFRA, TRA '86, OBRA '86, OBRA '87, or a qualification 
requirement that is treated, directly or indirectly, as subject to the 
conditions of section 1140 of TRA '86 described in paragraph (b)(2) of 
this section, became effective with respect to such plan or, in the case 
of a provision, described in paragraph (b)(2)(ii) of this section, that 
is integral to such qualification requirement, the first day on which 
the plan was operated in accordance with such provision, or
    (iv) In the case of a disqualifying provision described in paragraph 
(b)(3)(i) of this section, the date on which the change effected by an 
amendment to the Internal Revenue Code became effective with respect to 
the plan; or
    (v) In the case of a disqualifying provision described in paragraph 
(b)(3)(ii) of this section, the first day on which the plan was operated 
in accordance with such provision, as amended, unless another time is 
specified by the Commissioner in revenue rulings, notices, and other 
guidance published in the Internal Revenue Bulletin. See Sec. 
601.601(d)(2) of this chapter.
    (2) Unless further extended as provided by paragraph (e) of this 
section, the remedial amendment period ends with the latest of:
    (i) In the case of a plan maintained by one employer, the time 
prescribed by law, including extensions, for filing the income tax 
return (or partnership return of income) of the employer for the 
employer's taxable year in which falls the latest of:
    (A) The date on which the remedial amendment period begins.
    (B) The date on which a plan amendment described in paragraph (b)(1) 
of this section is adopted, or
    (C) The date on which a plan amendment described in paragraph (b)(1) 
of this section is made effective,
    (ii) In the case of a plan maintained by one employer, the last day 
of the plan year within which falls the latest of:
    (A) The date on which the remedial amendment period begins,
    (B) The date on which a plan amendment described in paragraph (b)(1) 
of this section is adopted, or
    (C) The date on which a plan amendment described in paragraph (b)(1) 
of this section is made effective,
    (iii) In the case of a plan maintained by more than one employer, 
the last day of the tenth month following the last day of the plan year 
in which falls the latest of:
    (A) The date on which the remedial amendment period begins,
    (B) The date on which a plan amendment described in paragraph (b)(1) 
of this section is adopted, or
    (C) The date of which a plan amendment described in paragraph (b)(1) 
of this section is made effective, or
    (iv) December 31, 1976, but only in the case of a plan to which 
section 411 (relating to minimum vesting standards) applies without 
regard to section 411(e)(2), and only in the case of a remedial 
amendment period which began on or after September 2, 1974.
    (3) For purposes of paragraphs (d)(2)(i), (d)(2)(ii), and 
(d)(2)(iii) of this section, for any disqualifying provision described 
in paragraph (b)(2)(ii) of this section, the remedial amendment period 
shall be deemed to have begun

[[Page 296]]

with the first day of the first plan year which begins after December 
31, 1988.
    (4) For purposes of this paragraph (d)(2) of this section, a master 
or prototype plan shall not be considered to be a plan maintained by 
more than one employer, and whether or not a plan is maintained by more 
than one employer, shall be determined without regard to section 414 (b) 
and (c) except that if a plan is maintained solely by an affiliated 
group of corporations (within the meaning of section 1504) which files a 
consolidated income tax return pursuant to section 1501 for a taxable 
year within which falls the latest of the dates described in paragraph 
(d)(2)(i) of this section, such plan shall be deemed to be maintained by 
one employer.
    (e) Extensions of remedial amendment period--(1) Opinion letter 
request by sponsoring organization of master or prototype plan. In the 
case of an employer who has adopted a master or prototype plan, a 
remedial amendment period that began on or after September 2, 1974, 
shall not end prior to the later of:
    (i) June 30, 1977, or
    (ii) The last day of the month that is six months after the month in 
which:
    (A) The opinion letter with respect to the request of the sponsoring 
organization is issued by the Internal Revenue Service,
    (B) Such request is withdrawn, or
    (C) Such request is otherwise disposed of by the Internal Revenue 
Service. The rules contained in this subparagraph apply only if the 
sponsoring organization of such master or prototype plan has, after 
September 2, 1974, and on or before December 31, 1976, filed a request 
for an opinion letter with respect to the initial or continuing 
qualification of the plan (or a trust which is part of the plan). The 
provisions of this paragraph (e)(1) apply to a master or prototype plan 
adopted to replace another plan even though the remedial amendment 
period applicable to the replaced plan has expired at the time of 
adoption of the replacement plan.
    (2) Notification letter request by law firm sponsor of district-
approved plan. In the case of an employer who has adopted a pattern 
plan, a remedial amendment period that began on or after September 2, 
1974, shall not end prior to the later of:
    (i) June 30, 1977, or
    (ii) The last day of the month that is six months after the month in 
which:
    (A) The notification letter with respect to the request of the 
sponsoring law firm is issued by the Internal Revenue Service,
    (B) Such request is withdrawn, or
    (C) Such request is otherwise disposed of by the Internal Revenue 
Service. The rules contained in this subparagraph shall apply only if 
the sponsoring law firm of such pattern plan has, on or before December 
31, 1976, filed a request for a notification letter with the Internal 
Revenue Service with respect to the initial or continuing qualification 
of the plan (or a trust which is part of the plan). The provisions of 
this paragraph (e)(2) apply to a pattern plan adopted to replace another 
plan even though the remedial amendment period applicable to the 
replaced plan has expired at the time of the adoption of the replacement 
plan.
    (3) Determination letter request by employer or plan administrator. 
If on or before the end of a remedial amendment period determined 
without regard to this paragraph (e), or in a case to which paragraph 
(e) (1) or (2) of this section applies, on or before the 90th day 
following the later of the dates described in paragraph (e) (1) or (2) 
of this section, the employer or plan administrator files a request 
pursuant to Sec. 601.201(s) of this chapter (Statement of Procedural 
Rules) for a determination letter with respect to the initial or 
continuing qualification of the plan, or a trust which is part of such 
plan, such remedial amendment period shall be extended until the 
expiration of 91 days after:
    (i) The date on which notice of the final determination with respect 
to such request for a determination letter is issued by the Internal 
Revenue Service, such request is withdrawn, or such request is otherwise 
finally disposed of by the Internal Revenue Service, or
    (ii) If a petition is timely filed with the United States Tax Court 
for a declaratory judgment under section 7476 with respect to the final 
determination (or the failure of the Internal Revenue Service to make a 
final determination)

[[Page 297]]

in response to such request, the date on which the decision of the 
United States Tax Court in such proceeding becomes final.
    (4) Transitional rule. In the case of a request for a determination 
letter described in and filed within the time prescribed in paragraph 
(e)(3) of this section with respect to which a final determination is 
issued by the Internal Revenue Service on or before September 28, 1976 
the remedial amendment period described in paragraph (d) of this section 
shall not end prior to the expiration of 150 days beginning on the date 
of such final determination by the Internal Revenue Service.
    (5) Disqualifying provision prior to September 2, 1974. If the 
remedial amendment period with respect to a disqualifying provision 
described in paragraph (b)(1) of this section began prior to September 
2, 1974, and the provisions of paragraphs (e)(5)(i), (ii) and (iii) of 
this section are satisfied, the remedial amendment period described in 
paragraph (d) shall not end prior to December 31, 1976. This 
subparagraph shall apply only if--
    (i) A request pursuant to Sec. 601.201 of this chapter for a 
determination letter with respect to the initial or continuing 
qualification of the plan (or a trust which is part of the plan) was 
filed not later than the later of:
    (A) The time prescribed by law, including extensions, for filing the 
income tax return (or partnership return of income) of the employer for 
the employer's taxable year in which falls the date on which the 
remedial amendment period began, or
    (B) The date 6 months after the close of such taxable year,
    (ii) The employer, either:
    (A) While such request for a determination letter is or was under 
consideration by the Internal Revenue Service or,
    (B) Promptly after the date on which notice of the final 
determination with respect to such request for a determination letter is 
issued by the Internal Revenue Service, such request is withdrawn, or 
such request is otherwise finally disposed of by the Internal Revenue 
Service, adopts or adopted either a plan amendment retroactive to the 
date on which the remedial amendment period began, or a prospective plan 
amendment, and
    (iii) The amendment described in paragraph (e)(5)(ii) of this 
section would have resulted in the plan's satisfying the requirements of 
section 401(a) of the Code from the beginning of the remedial amendment 
period to the date such amendment was made if this section had been in 
effect during such period, and in the case of a prospective amendment, 
if such amendment had been made retroactive to such beginning date.
    (f) Discretionary extensions. At his discretion, the Commissioner 
may extend the remedial amendment period or may allow a particular plan 
to be amended after the expiration of its remedial amendment period and 
any applicable extension of such period. In determining whether such an 
extension will be granted, the Commissioner shall consider, among other 
factors, whether substantial hardship to the employer would result if 
such an extension were not granted, whether such an extension is in the 
best interest of plan participants, and whether the granting of the 
extension is adverse to the interests of the Government. The mere 
absence of final regulations with respect to issues covered under the 
Special Reliance Procedure announced by the Internal Revenue Service in 
Technical Information Release 1416 on November 5, 1975, and as extended 
by Internal Revenue Service News Release IR-1616 on May 14, 1976, shall 
not be deemed to satisfy the criteria of this paragraph. With regard to 
a particular plan, a request for extension of time pursuant to this 
paragraph shall be submitted prior to the expiration of the remedial 
amendment period determined without regard to this paragraph, or within 
such time thereafter as the Internal Revenue Service may consider 
resonable under the circumstances. The request should be submitted to 
the appropriate District Director, determined under Sec. 
601.201(s)(3)(xii) of this chapter (Statement of Procedural Rules). This 
subparagraph applies to disqualifying provisions that were adopted or 
became effective prior to September 2, 1974, as

[[Page 298]]

well as disqualifying provisions adopted or made effective on or after 
September 2, 1974.

(Secs. 401(b), 7805, Internal Revenue Code of 1954 (88 Stat. 943, 68A 
Stat. 917; 26 U.S.C. 401(b), 7805))

[T.D. 7437, 41 FR 42653, Sept. 28, 1976, as amended by T.D. 7896, 48 FR 
23817, May 27, 1983; T.D. 7997, 49 FR 50645, Dec. 31, 1984; T.D. 8217, 
53 FR 29662, Aug. 8, 1988; T.D. 8727, 62 FR 41273, 41274, Aug. 1, 1997; 
T.D. 8871, 65 FR 5433, Feb. 4, 2000]



Sec. 1.401(e)-1  Definitions relating to plans covering self-employed 
individuals.

    (a) ``Keogh'' or ``H.R. 10'' plans, in general--(1) Introduction and 
organization of regulations. Certain self-employed individuals may be 
covered by a qualified pension, annuity, or profit-sharing plan. This 
section contains definitions contained in section 401(c) relating to 
plans covering self-employed individuals and is applicable to employer 
taxable years beginning after December 31, 1975, unless otherwise 
specified.
    The provisions of section 401(a) relating to qualification 
requirements which are generally applicable to all qualified plans, and 
other provisions relating to the special rules under section 401 (b), 
(f), (g), (h), and (i), are also generally applicable to any plan 
covering a self-employed individual. However, in addition to such 
requirements and special rules, any plan covering a self-employed 
individual is subject to the rules contained in Sec. Sec. 1.401 (e)-2, 
(e)-5, and (j)-1 through (j)-5. Section 1.401(e)-2 contains general 
rules, Sec. 1.401(e)-5 contains a special rule limiting the 
contribution and benefit base to the first $100,000 of annual 
compensation, and Sec. 1.401 (j)-1 through (j)-5 contains special rules 
for defined benefit plans. Section 1.401(e)-3 contains special rules 
which are applicable to plans covering self-employed individuals when 
one or more of such individuals is an owner-employee within the meaning 
of section 401(c)(3). Section 1.401(e)-4 contains rules relating to 
contributions on behalf of owner-employees for premiums on annuity, 
etc., contracts and a transitional rule for certain excess contributions 
made on behalf of owner-employees for employer taxable years beginning 
before January 1, 1976. The provisions of this section and of Sec. Sec. 
1.401(e)-2 through 1.401(e)-5 are applicable to employer taxable years 
beginning after December 31, 1975, unless otherwise specified.
    (2) [Reserved]
    (b) [Reserved]

[T.D. 7636, 44 FR 47053, Aug. 10, 1979]



Sec. 1.401(e)-2  General rules relating to plans covering self-employed 
individuals.

    (a) ``Keogh'' or ``H.R. 10'' plans; introduction and organization of 
regulations. This section provides certain rules which supplement, and 
modify, the qualification requirements of section 401(a) and the special 
rules provided by Sec. 1.401(b)-1 and other special rules under 
subsections (f), (g), (h), and (i) of section 401 in the case of a 
qualified pension, annuity, or profit-sharing plan which covers a self-
employed individual who is an employee within the meaning of section 
401(c)(1). Section 1.401(e)-1(a)(1) sets forth other provisions which 
also supplement, and modify, these requirements and special rules in the 
case of a plan described in this section. The provisions of this section 
apply to employer taxable years beginning after December 31, 1975, 
unless otherwise specified.
    (b) [Reserved]

[T.D. 7636, 44 FR 47053, Aug. 10, 1979]



Sec. 1.401(e)-3  Requirements for qualification of trusts and plans 
benefiting owner-employees.

    (a) ``Keogh'' or ``H.R. 10'' plans covering owner-employees; 
introduction and organization of regulations. This section prescribes 
the additional requirements which must be met for qualification of a 
trust forming part of a pension or profit-sharing plan, or of an annuity 
plan, which covers any self-employed individual who is an owner-employee 
as defined in section 401(c)(3). These additional requirements are 
prescribed in section 401(d) and are made applicable to such a trust by 
section 401(a)(10)(B) and to an annuity plan by section 404(a)(2). 
However, to the extent that the provisions of Sec. Sec. 1.401(e)-1 and 
1.401(e)-2 are not modified by the provisions of this section such 
provisions are also applicable to a plan which covers an owner-employee. 
The provisions

[[Page 299]]

of this section apply to taxable years beginning after December 31, 
1975, unless otherwise specified.
    (b) [Reserved]

[T.D. 7636, 44 FR 47053, Aug. 10, 1979]



Sec. 1.401(e)-4  Contributions for premiums on annuity, etc., contracts 
and transitional rule for certain excess contributions.

    (a) In general. The provisions of this section prescribe the rules 
specified in section 401(e) relating to certain contributions made under 
a qualified pension, annuity, or profit-sharing plan on behalf of a 
self-employed individual who is an owner-employee (as defined in section 
401(c)(3) and the regulations thereunder) in taxable years of the 
employer beginning after December 31, 1975. In addition, such plans are 
also subject to the limitations on contributions and benefits under 
section 415 for years beginning after December 31, 1975. However, the 
defined contribution compensation limitation described in section 
415(c)(1)(B) will not apply to any contribution described in this 
section provided that the requirements specified in section 415(c)(7) 
and Sec. 1.415-6(h) are satisfied. Solely for the purpose of applying 
section 4972(b) (relating to excise tax on excess contributions for 
self-employed individuals) to other contributions made by an owner-
employee as an employee, the amount of any employer contribution which 
is not deductible under section 404 for the employer's taxable year but 
which is described in section 401(e) and this section shall be taken 
into account as a contribution made by such owner-employee as an 
employee during the taxable year of his employer in which such 
contribution is made.
    (b) Contributions described in section 401(e)--(1) An employer 
contribution on behalf of an owner-employee is described in section 
401(e), if--
    (i) Under the provisions of the plan, the contribution is expressly 
required to be applied (either directly or through a trustee) to pay the 
premiums or other consideration for one or more annuity, endowment, or 
life insurance contracts on the life of the owner-employee.
    (ii) The employer contributions so applied meet the requirements of 
subparagraphs (2) through (5) of this paragraph.
    (iii) The amount of the contribution exceeds the amount deductible 
under section 404 with respect to contributions made by the employer on 
behalf of the owner-employee under the plan, and
    (iv) The total employer contributions required to be applied 
annually to pay premiums on behalf of any owner-employee for contracts 
described in this paragraph do not exceed $7,500. For purposes of 
computing such $7,500 limit, the total employer contributions include 
amounts which are allocable to the purchase of life, accident, health, 
or other insurance.
    (2)(i) The employer contributions must be paid under a plan which 
satisfies all the requirements for qualification. Accordingly, for 
example, contributions can be paid under the plan for life insurance 
protection only to the extent otherwise permitted under sections 401 
through 404 and the regulations thereunder. However, certain of the 
requirements for qualification are modified with respect to a plan 
described in this paragraph (see section 401(a)(10)(A)(ii) and (d)(5)).
    (ii) A plan described in this paragraph is not disqualified merely 
because a contribution is made on behalf of an owner-employee by his 
employer during a taxable year of the employer for which the owner-
employee has no earned income. On the other hand, a plan will fail to 
qualify if a contribution is made on behalf of an owner-employee which 
results in the discrimination prohibited by section 401(a)(4) as 
modified by section 401(a)(10)(A)(ii).
    (3) The employer contributions must be applied to pay premiums or 
other consideration for a contract issued on the life of the owner-
employee. For purposes of this subparagraph, a contract is not issued on 
the life of an owner-employee unless all the proceeds which are, or may 
become, payable under the contract are payable directly, or through a 
trustee of a trust described in section 401(a) and exempt from tax under 
section 501(a), to the owner-employee or to the beneficiary named in the 
contract or under the plan. For example, a nontransferable face-amount 
certificate described in

[[Page 300]]

section 401(g) and the regulations thereunder is considered an annuity 
on the life of the owner-employee if the proceeds of such contract are 
payable only to the owner-employee or his beneficiary.
    (4)(i) For any taxable year of the employer, the amount of 
contributions by the employer on behalf of the owner-employee which is 
applied to pay premiums under the contracts described in this paragraph 
must not exceed the average of the amounts deductible under section 404 
by such employer on behalf of such owner-employee for the most recent 
three taxable years of the employer which are described in the 
succeeding sentence. The three employer taxable years described in the 
preceding sentence must be years, ending prior to the date the latest 
contract was entered into or modified to provide additional, benefits, 
in which the owner-employee derived earned income from the trade or 
business with respect to which the plan is established. However, if such 
owner-employee has not derived earned income for at least three taxable 
years preceding such date, then, in determining the ``average of the 
amounts deductible'', only so many of such taxable years as such owner-
employee was engaged in such trade or business and derived earned income 
therefrom are taken into account.
    (ii) For the purpose of making the computation described in 
subdivision (i) of this subparagraph, the taxable years taken into 
account include those years in which the individual derived earned 
income from the trade or business but was not an owner-employee with 
respect to such trade or business. Furthermore, taxable years of the 
employer preceding the taxable year in which a qualified plan is 
established are taken into account.
    (iii) For purposes of making the computations described in 
subdivisions (i) and (ii) of this subparagraph for any taxable year of 
the employer the average of the amounts deductible under section 404 by 
the employer on behalf of an owner-employee for the most recent three 
relevant taxable years of the employer shall be determined as if section 
404, as in effect for the taxable year for which the computation is to 
be made, had been in effect for all three such years.
    (5) For any taxable year of an employer in which contributions are 
made on behalf of an individual as an owner-employee under more than one 
plan, the amount of contributions described in this section by the 
employer on behalf of such an owner-employee under all such plans must 
not exceed $7,500.
    (c) Transitional rule for excess contributions--(1)(i) The rules of 
this paragraph are inapplicable to a plan which was not in existence for 
any taxable year of an employer which begins before January 1, 1976. For 
taxable years of an employer which begin before January 1, 1976, the 
rules with respect to excess contributions on behalf of owner-employees 
set forth in section 401(d) (5) and (8) and in section 401(e), as these 
sections were in effect on September 1, 1974, prior to their amendment 
by section 2001(e) of the Employee Retirement Income Security Act of 
1974 (hereinafter in this paragraph referred to as the ``Act'') (88 
Stat. 954), shall apply except as provided by subparagraph (2) of this 
paragraph. Section 1.401-13 generally provides the rules for excess 
contributions on behalf of owner-employees set forth in these sections.
    (ii) Notwithstanding the provisions of subdivision (i) of this 
subparagraph, the rules set forth in such subsections (d) (5) and (8) 
and (e) of section 401 with respect to excess contributions for such 
taxable years beginning before January 1, 1976, apply even though the 
application of those rules affects a subsequent taxable year. Thus, for 
example, if, in 1975, a nonwillful excess contribution described in 
section 401(e)(1) (prior to such amendment) is made on behalf of an 
owner-employee, the plan will not be qualified unless the provisions 
required by subparagraphs (A) and (B) of such 401(d)(8) are contained in 
the plan and made applicable to excess contributions made for such 
taxable years beginning before January 1, 1976. In such case, the effect 
of such contribution on the plan, the employer, and the owner-employee 
would be determined under paragraph (2) of section 401(e), as in effect 
on September 1, 1974. By reason of section 401(e)(2)(F), as in effect

[[Page 301]]

on September 1, 1974, the period for assessing any deficiency by reason 
of the excess contribution will not expire until the expiration of the 
6-month period described in section 401(e)(2)(C), as in effect on 
September 1, 1974, even if the first day of such 6-month period falls in 
a taxable year beginning after December 31, 1975. For the rules 
applicable to a willful excess contribution, which generally divide an 
owner-employee's interest in a plan into two parts on the basis of 
employer taxable years beginning before and after December 31, 1975, see 
Sec. 1.72-17A(e)(2)(v). In the case of a willful excess contribution, 
the rule specified in section 401(e)(2)(E)(iii), as in effect on 
September 1, 1974, shall not apply to any taxable year of an employer 
beginning on or after January 1, 1976. Thus, for example, if a willful 
excess contribution was made to a plan on behalf of an owner-employee 
with respect to his employer's taxable year beginning January 1, 1975, 
the plan would not meet, for purposes of section 404, the requirements 
of section 401(d) with respect to that owner-employee for such year, but 
the 5 taxable years following such year would be unaffected because 
those years begin on or after January 1, 1976.
    (2)(i) For purposes of applying the excess contribution rules with 
respect to the employer taxable years specified in subparagraph (1) of 
this paragraph for such an employer taxable year which begins after 
December 31, 1973, see section 404(e) and Sec. 1.404(e)-1A for rules 
increasing the limitation on the amount of allowable employer deductions 
on behalf of owner-employees under section 404. For purposes of applying 
subparagraphs (A) and (B)(i) of section 401(e)(1) prior to the amendment 
made by section 2001(e)(3) of the Act (88 Stat. 954), the employer 
deduction allowable by section 404(e)(4) with respect to an owner-
employee in a defined contribution plan shall be deemed not to be an 
excess contribution (see Sec. 1.404(e)-1A(c)(4)).
    (ii) For purposes of applying the excess contribution rules with 
respect to the employer taxable years specified in subparagraph (1) of 
this paragraph to an employer's plan which was not in existence on 
January 1, 1974, or to a plan in existence on January 1, 1974, which 
elects under section 1017(d) of the Act (88 Stat. 934), in accordance 
with regulations, to have the funding provisions of section 412 apply to 
such an existing plan, see section 404 (a) (1), (a)(6), and (a)(7), as 
amended by section 1013(c)(1), (2), and (3) of the Act (88 Stat. 922 and 
923) for rules modifying the amount of employer deductions on behalf of 
owner-employees.

[T.D. 7636, 44 FR 47053, Aug. 10, 1979]



Sec. 1.401(e)-5  Limitation of contribution and benefit bases to first 
$100,000 of annual compensation in case of plans covering self-employed 

individuals.

    (a) General rules--General rule. (1) Under section 401(a)(17), a 
plan maintained by an employer which provided contributions or benefits 
for employees some or all of whom are employees within the meaning of 
section 401(c)(1) is a qualified plan only if the annual compensation of 
each employee taken into account under the plan does not exceed the 
first $100,000 of such compensation. For purposes of applying section 
401(a)(17) and the preceding sentence, all plans maintained by such an 
employer with respect to the same trade or business shall be treated as 
a single plan. See also sections 401(d)(9) and (10) (relating to 
controlled trades or businesses where a plan covers an owner-employee 
who controls more than one trade or business); section 404(e) (relating 
to special limitations for self-employed individuals); section 413(b)(7) 
(relating to determination of limitations provided by section 404(a) in 
the case of certain plans maintained pursuant to a collective bargaining 
agreement); and section 413(c)(6) (relating to determination of 
limitations provided by section 404(a) in the case of certain plans 
maintained by more than one employer).
    (2) Special section 414(b), (c) rule. This subparagraph (2) applies 
to plans maintained by employers that are trades or businesses (whether 
or not incorporated) that are under common control within the meaning of 
section 414(c). All such plans that are described in paragraph (a)(1) 
and Sec. 1.401(e)-6(a) (so called ``Subchapter S plans'') shall be 
treated as a single plan in applying the limitation of paragraph (a)(1).

[[Page 302]]

    (b) Integrated plans. (1) In the case of a qualified plan, other 
than a plan described in section 414(j), which is integrated with the 
Social Security Act (chapter 21 of the Code), or with contributions or 
benefits under chapter 2 of the Code (relating to tax on self-employment 
income) or under any other Federal of State law, the $100,000 limitation 
described in subparagraph (a) shall be determined without regard to any 
adjustments to contributions or benefits under the plan on account of 
such integration. See also subsections (a)(5), (a)(15), and (d)(6) of 
section 401 and the regulations thereunder for other rules with respect 
to plans which are integrated.
    (2) In the case of a qualified defined benefit plan described in 
section 414(j), see section 401(j)(4) for a special prohibition against 
integration.
    (c) Application of nondiscrimination requirement. (1) This paragraph 
shall apply--
    (i) In the case of a plan which provides contributions or benefits 
for employees some or all of whom are employees within the meaning of 
section 401(c)(1) and
    (ii) For a year in which the compensation of any employee covered by 
the plan exceeds $100,000. In the case of an employee who is an employee 
within the meaning of section 401(c)(1), compensation includes earned 
income within the meaning of section 401(c)(2).
    (2) In applying section 401(a)(4) under the circumstances described 
in subparagraph (1) of this paragraph, the determination whether the 
rate of contributions or benefits under the plan discriminates in favor 
of highly compensated employees shall be made as if the compensation for 
the year of each employee described in the first sentence of 
subparagraph (1)(ii) of this paragraph were $100,000, rather than the 
compensation actually received by him for such year.
    (d) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. A, a self-employed individual, has established the P 
Profit-Sharing Plan, which covers A and his two commonlaw employees, B 
and C. A's taxable year and the plan's plan year are both the calendar 
year. For 1976, A has earned income of $150,000, and B and C each 
receive compensation of less than $100,000 from A. If he wishes to 
contribute $7,500 to the plan on his behalf for 1976, A must also 
contribute to the accounts of B and C under the plan amounts at least 
equal to 7\1/2\ percent of their respective compensation for 1976.
    Example 2. D, an owner-employee within the meaning of section 
401(c)(3), is a participant in the Q Qualified Defined Contribution 
Plan, which, in 1975, satisfies the requirements of section 401(d)(6) 
and all other integration requirements applicable to qualified defined 
contribution plans. The taxable years of D, the employer of D within the 
meaning of section 401(c)(4), and the plan are all calendar years. The 
plan provides for an integration level of $13,200 and a contribution 
rate of 5 percent of compensation in excess of $13,200. For 1975, D has 
earned income of $115,000. The maximum amount of earned income upon 
which D's contribution can be determined is $86,800, and the 
contribution based upon this maximum amount of earned income is $4,340, 
computed as follows:

Maximum annual compensation which may be taken into account..   $100,000
Less: Social Security Act integration level..................     13,200
                                                              ----------
Plan contribution base.......................................    $86,800
Multiplied by: Contribution rate (percent)...................          5
                                                              ----------
    Total....................................................     $4,340
 

    (e) Years to which section applies. This section applies to taxable 
years of an employer beginning after December 31, 1975. However, if 
employer contributions made under a plan for any employee for taxable 
years of an employer beginning after December 31, 1973, exceed the 
amounts permitted to be deducted for that employee under section 404(e), 
as in effect on September 1, 1974, this section applies to such taxable 
years of an employer.
    Thus, for example, a plan of a calendar year employer which was 
adopted on January 1, 1974, would be subject to this section in 1974, if 
the employer made a contribution on behalf of any employee within the 
meaning of section 401(c)(1) for such year in excess of the $2,500 or 10 
percent earned income limit, whichever is applicable to that employee, 
specified in section 404(e)(1) as in effect prior to the amendment to 
such Code section made by section 2001(a)(1)(A) of the Employee 
Retirement Income Security Act of 1974 (88 Stat. 952). The plan 
described in the proceeding sentence would also be subject to this 
section in 1974, if the employer made a contribution on behalf of

[[Page 303]]

any employee within the meaning of section 401(c)(1) which is allowable 
as a deduction only because of the addition of paragraph (4) to Code 
section 404(e) made by section 2001(a)(3) of such Act (88 Stat. 952).
    (b) [Reserved]

[T.D. 7636, 44 FR 47055, Aug. 10, 1979; T.D. 7636, 60 FR 21435, May 2, 
1995]



Sec. 1.401(e)-6  Special rules for shareholder-employees.

    (a) Limitation of contributions and benefit bases to first $100,000 
of annual compensation in case of plans covering shareholder-employees. 
(1) Under section 401(a)(17), a plan which provides contributions or 
benefits for employees, some or all of whom are shareholder-employees 
within the meaning of section 1379(d), is subject to the same limitation 
on annual compensation as a plan which provides such contributions or 
benefits for employees some or all of whom are self-employed individuals 
within the meaning of section 401(c)(1). Thus, a plan which provides 
contributions or benefits for such shareholder-employees is subject to 
the rules provided by Sec. 1.401(e)-5, unless otherwise specified. See 
also section 1379. In the case of plans maintained by employers that are 
corporations described in section 414(b) and that are described in this 
subparagraph (1), the same rule described in Sec. 1.401(e)-5(a)(2) 
shall apply.
    (2) Subparagraph (1) applies to taxable years of an electing small 
business corporation beginning after December 31, 1975. However, if 
corporate contributions made under a plan on behalf of any shareholder-
employee for corporate taxable years beginning after December 31, 1973, 
exceed the lesser of the amount of contributions specified in section 
1379(b)(1) (A) or (B), as in effect on September 1, 1974, for that 
shareholder-employee, subparagraph (1) applies to such corporate taxable 
years. Thus, for example if an electing small business corporation whose 
taxable year is the calendar year adopted a plan on January 1, 1974, the 
plan would be subject to the provisions of subparagraph (1) of this 
section in 1974, if the corporation made a contribution in excess of 
$2,500 on behalf of any shareholder-employee for such year.
    (b) [Reserved]

[T.D. 7636, 44 FR 47056, Aug. 10, 1979]



Sec. 1.401(f)-1  Certain custodial accounts and annuity contracts.

    (a) Treatment of a custodial account or an annuity contract as a 
qualified trust. Beginning on January 1, 1974, a custodial account or an 
annuity contract may be used, in lieu of a trust, under any qualified 
pension, profitsharing, or stock bonus plan if the requirements of 
paragraph (b) of this section are met. A custodial account or an annuity 
contract may be used under such a plan, whether the plan covers common-
law employees, self-employed individuals who are treated as employees by 
reason of section 401(c), or both. The use of a custodial account or 
annuity contract as part of a plan does not preclude the use of a trust 
or another custodial account or another annuity contract as part of the 
same plan. A plan under which a custodial account or an annuity contract 
is used may be considered in connection with other plans of the employer 
in determining whether the requirements of section 401 are satisfied. 
For regulations relating to the period before January 1, 1974, see Sec. 
1.401-8.
    (b) Rules applicable to custodial accounts and annuity contracts. 
(1) Beginning on January 1, 1974, a custodial account or an annuity 
contract is treated as a qualified trust under section 401 if the 
following requirements are met:
    (i) The custodial account or annuity contract would, except for that 
fact that it is not a trust, constitute a qualified trust under section 
401; and
    (ii) In the case of a custodial account, the custodian either is a 
bank or is another person who demonstrates, to the satisfaction of the 
Commissioner, that the manner in which he will hold the assets will be 
consistent with the requirements of section 401. This demonstration must 
be made in the same manner as the demonstration required by Sec. 1.408-
2(e).
    (2) If a custodial account would, except for the fact that it is not 
a trust, constitute a qualified trust under section 401, it must, for 
example, be created pursuant to a written agreement which constitutes a 
valid contract under local law. In addition, the terms

[[Page 304]]

of the contract must make it impossible, prior to the satisfaction of 
all liabilities with respect to the employees and their beneficiaries 
covered by the plan. For any part of the funds of the custodial account 
to be used for, or diverted to, purposes other than for the exclusive 
benefit of the employees or their beneficiaries as provided for in the 
plan (see paragraph (a) of Sec. 1.401-2).
    (3) An annuity contract would, except for the fact that it is not a 
trust, constitute a qualified trust under section 401 if it is purchased 
by an employer for an employee under a plan which meets the requirements 
of section 404(a)(2) and the regulations thereunder, except that the 
plan may be either a pension or a profit-sharing plan.
    (c) Effect of this section. (1)(i) Any custodial account or annuity 
contract which satisfies the requirements of paragraph (b) of this 
section is treated as a qualified trust for all purposes of the Internal 
Revenue Code of 1954. Such a custodial account or annuity contract is 
treated as a separate legal person which is exempt from the income tax 
under section 501(a). In addition, the person holding the assets of such 
account or holding such contract is treated as the trustee thereof. 
Accordingly, such person is required to file the returns described in 
sections 6033 and 6047 and to supply any other information which the 
trustee of a qualified trust is required to furnish.
    (ii) Any procedure which has the effect of merely substituting one 
custodian for another shall not be considered as terminating or 
interrupting the legal existence of a custodial account which otherwise 
satisfies the requirements of paragraph (b) of this section.
    (2)(i) The beneficiary of a custodial account which satisfies the 
requirements of paragraph (b) of this section is taxed in accordance 
with section 402. In determining whether the funds of a custodial 
account are distributed or made available to an employee or his 
beneficiary, the rules which under section 402(a) are applicable to 
trusts will also apply to the custodial account as though it were a 
separate legal person and not an agent of the employee.
    (ii) If a custodial account which has qualified under section 401 
fails to qualify under such section for any taxable year, such custodial 
account will not thereafter be treated as a separate legal person, and 
the funds in such account shall be treated as made available within the 
meaning of section 402(a)(1) to the employees for whom they are held.
    (3) The beneficiary of an annuity contract which satisfies the 
requirements of paragraph (b) of this section is taxed as if he were the 
beneficiary of an annuity contract described in section 403(a).
    (d) Definitions. For purposes of this section--
    (1) The term bank means a bank as defined in section 408(n).
    (2) The term annuity means an annuity as defined in section 401(g). 
Thus, any contract or certificate issued after December 31, 1962, which 
is transferable is not treated as a qualified trust under this section.
    (e) Other contracts. For purposes of this section, other than the 
non-transferability restriction of paragraph (d)(2), a contract issued 
by an insurance company qualified to do business in a state shall be 
treated as an annuity contract. For purposes of the preceding sentence, 
the contract does not include a life, health or accident, property, 
casualty or liability insurance contract. For purposes of this 
paragraph, a contract which is issued by an insurance company will not 
be considered a life insurance contract merely because the contract 
provides incidental life insurance protection. The provisions of this 
paragraph are effective for taxable years beginning after December 31, 
1975.
    (f) Cross reference. For the requirement that the assets of an 
employee benefit plan be placed in trust, and exceptions thereto, see 
section 403 of the Employee Retirement Income Security Act of 1974, 29 
U.S.C. 1103, and the regulations prescribed thereunder by the Secretary 
of Labor.

(Secs. 401(f)(2), 7805, Internal Revenue Code of 1954 (88 Stat. 939 and 
68A Stat. 917; 26 U.S.C. 401(f)(2), 7805))

[43 FR 41204, Sept. 15, 1978. Redesignated and amended by T.D. 7748, 46 
FR 1695, 1696, Jan. 7, 1981; T.D. 8635, 60 FR 65549, Dec. 20, 1995]

[[Page 305]]



Sec. 1.401(k)-0  Table of contents.

    This section contains first a list of section headings and then a 
list of the paragraphs in each section in Sec. Sec. 1.401(k)-1 through 
1.401(k)-6.

                            List of Sections

Sec. 1.401(k)-1 Certain cash or deferred arrangements.
Sec. 1.401(k)-2 ADP test.
Sec. 1.401(k)-3 Safe harbor requirements.
Sec. 1.401(k)-4 SIMPLE 401(k) plan requirements.
Sec. 1.401(k)-5 Special rules for mergers, acquisitions and similar 
          events. [Reserved]
    Sec. 1.401(k)-6 Definitions.

                           List of Paragraphs

    Sec. 1.401(k)-1 Certain cash or deferred arrangements.
(a) General rules.
(1) Certain plans permitted to include cash or deferred arrangements.
(2) Rules applicable to cash or deferred arrangements generally.
(i) Definition of cash or deferred arrangement.
(ii) Treatment of after-tax employee contributions.
(iii) Treatment of ESOP dividend election.
(iv) Treatment of elective contributions as plan assets.
(3) Rules applicable to cash or deferred elections generally.
(i) Definition of cash or deferred election.
(ii) Automatic enrollment.
(iii) Rules related to timing.
(A) Requirement that amounts not be currently available.
(B) Contribution may not precede election.
(C) Contribution may not precede services.
(iv) Current availability defined.
(v) Certain one-time elections not treated as cash or deferred 
          elections.
(vi) Tax treatment of employees.
(vii) Examples.
(4) Rules applicable to qualified cash or deferred arrangements.
(i) Definition of qualified cash or deferred arrangement.
(ii) Treatment of elective contributions as employer contributions.
(iii) Tax treatment of employees.
(iv) Application of nondiscrimination requirements to plan that includes 
          a qualified cash or deferred arrangement.
(A) Exclusive means of amounts testing.
(B) Testing benefits, rights and features.
(C) Minimum coverage requirement.
(5) Rules applicable to nonqualified cash or deferred arrangements.
(i) Definition of nonqualified cash or deferred arrangement.
(ii) Treatment of elective contributions as nonelective contributions.
(iii) Tax treatment of employees.
(iv) Qualification of plan that includes a nonqualified cash or deferred 
          arrangement.
(A) In general.
(B) Application of section 401(a)(4) to certain plans.
(v) Example.
(6) Rules applicable to cash or deferred arrangements of self-employed 
          individuals.
(i) Application of general rules.
(ii) Treatment of matching contributions made on behalf of self-employed 
          individuals.
(iii) Timing of self-employed individual's cash or deferred election.
(iv) Special rule for certain payments to self-employed individuals.
(b) Coverage and nondiscrimination requirements.
(1) In general.
(2) Automatic satisfaction by certain plans.
(3) Anti-abuse provisions.
(4) Aggregation and restructuring.
(i) In general.
(ii) Aggregation of cash or deferred arrangements within a plan.
(iii) Aggregation of plans.
(A) In general.
(B) Plans with inconsistent ADP testing methods.
(iv) Disaggregation of plans and separate testing.
(A) In general.
(B) Restructuring prohibited.
(v) Modifications to section 410(b) rules.
(A) Certain disaggregation rules not applicable.
(B) Permissive aggregation of collective bargaining units.
(C) Multiemployer plans.
(vi) Examples.
(c) Nonforfeitability requirements.
(1) General rule.
(2) Definition of immediately nonforfeitable.
(3) Example.
(d) Distribution limitation.
(1) General rule.
(2) Rules applicable to distributions upon severance from employment.
(3) Rules applicable to hardship distributions.
(i) Distribution must be on account of hardship.
(ii) Limit on maximum distributable amount.
(A) General rule.
(B) Grandfathered amounts.
(iii) Immediate and heavy financial need.
(A) In general.
(B) Deemed immediate and heavy financial need.
(iv) Distribution necessary to satisfy financial need.
(A) Distribution may not exceed amount of need.
(B) No alternative means available.

[[Page 306]]

(C) Employer reliance on employee representation.
(D) Employee need not take counterproductive actions.
(E) Distribution deemed necessary to satisfy immediate and heavy 
          financial need.
(F) Definition of other plans.
(v) Commissioner may expand standards.
(4) Rules applicable to distributions upon plan termination.
(i) No alternative defined contribution plan.
(ii) Lump sum requirement for certain distributions.
(5) Rules applicable to all distributions.
(i) Exclusive distribution rules.
(ii) Deemed distributions.
(iii) ESOP dividend distributions.
(iv) Limitations apply after transfer.
(6) Examples.
(e) Additional requirements for qualified cash or deferred arrangements.
(1) Qualified plan requirement.
(2) Election requirements.
(i) Cash must be available.
(ii) Frequency of elections.
(3) Separate accounting requirement.
(i) General rule.
(ii) Satisfaction of separate accounting requirement.
(4) Limitations on cash or deferred arrangements of state and local 
          governments.
(i) General rule.
(ii) Rural cooperative plans and Indian tribal governments.
(iii) Adoption after May 6, 1986.
(iv) Adoption before May 7, 1986.
(5) One-year eligibility requirement.
(6) Other benefits not contingent upon elective contributions.
(i) General rule.
(ii) Definition of other benefits.
(iii) Effect of certain statutory limits.
(iv) Nonqualified deferred compensation.
(v) Plan loans and distributions.
(vi) Examples.
(7) Plan provision requirement.
(f) Special rules for designated Roth contributions.
(1) In general.
(2) Inclusion treatment.
(3) Separate accounting required.
(4) Designated Roth contributions must satisfy rules applicable to 
          elective contributions.
(i) In general.
(ii) Special rules for direct rollovers.
(5) Rules regarding designated Roth contribution elections.
(i) Frequency of elections.
(ii) Default elections.
(6) Effective date.
(g) Effective dates.
(1) General rule.
(2) Early implementation permitted.
(3) Collectively bargained plans.
(4) Applicability of prior regulations.

                        Sec. 1.401(k)-2 ADP Test

(a) Actual deferral percentage (ADP) Test.
(1) In general.
(i) ADP test formula.
(ii) HCEs as sole eligible employees.
(iii) Special rule for early participation.
(2) Determination of ADP.
(i) General rule.
(ii) Determination of applicable year under current year and prior year 
          testing method.
(3) Determination of ADR.
(i) General rule.
(ii) ADR of HCEs eligible under more than one arrangement.
(A) General rule.
(B) Plans not permitted to be aggregated.
(iii) Examples.
(4) Elective contributions taken into account under the ADP test.
(i) General rule.
(ii) Elective contributions for partners and self-employed individuals.
(iii) Elective contributions for HCEs.
(5) Elective contributions not taken into account under the ADP test.
(i) General rule.
(ii) Elective contributions for NHCEs.
(iii) Elective contributions treated as catch-up contributions.
(iv) Elective contributions used to satisfy the ACP test.
(v) Additional elective contributions pursuant to section 414(u).
(vi) Default elective contributions pursuant to section 414(w).
(6) Qualified nonelective contributions and qualified matching 
          contributions that may be taken into account under the ADP 
          test.
(i) Timing of allocation.
(ii) Requirement that amount satisfy section 401(a)(4).
(iii) Aggregation must be permitted.
(iv) Disporportionate contributions not taken into account.
(A) General rule.
(B) Definition of representative contribution rate.
(C) Definition of applicable contribution rate.
(D) Special rule for prevailing wage contributions.
(v) Qualified matching contributions.
(vi) Contributions only used once.
(7) Examples.
(b) Correction of excess contributions.
(1) Permissible correction methods.
(i) In general.
(A) Qualified nonelective contributions or qualified matching 
          contributions.
(B) Excess contributions distributed.
(C) Excess contributions recharacterized.
(ii) Combination of correction methods.
(iii) Exclusive means of correction.
(2) Corrections through distribution.

[[Page 307]]

(i) General rule.
(ii) Calculation of total amount to be distributed.
(A) Calculate the dollar amount of excess contributions for each HCE.
(B) Determination of the total amount of excess contributions.
(C) Satisfaction of ADP.
(iii) Apportionment of total amount of excess contributions among the 
          HCEs.
(A) Calculate the dollar amount of excess contributions for each HCE.
(B) Limit on amount apportioned to any individual.
(C) Apportionment to additional HCEs.
(iv) Income allocable to excess contributions.
(A) General rule.
(B) Method of allocating income.
(C) Alternative method of allocating plan year income.
(D) Plan years before 2008.
(E) Alternative method for allocating plan year and gap period income.
(v) Distribution.
(vi) Tax treatment of corrective distributions.
(A) Corrective distributions for plan years beginning on or after 
          January 1, 2008.
(B) Corrective distributions for plan years beginning before January 1, 
          2008.
(C) Corrective distributions attributable to designated Roth 
          contributions.
(vii) Other rules.
(A) No employee or spousal consent required.
(B) Treatment of corrective distributions as elective contributions.
(C) No reduction of required minimum distribution.
(D) Partial distributions.
(viii) Examples.
(3) Recharacterization of excess contributions.
(i) General rule.
(ii) Treatment of recharacterized excess contributions.
(iii) Additional rules.
(A) Time of recharacterization.
(B) Employee contributions must be permitted under plan.
(C) Treatment of recharacterized excess contributions.
(4) Rules applicable to all corrections.
(i) Coordination with distribution of excess deferrals.
(A) Treatment of excess deferrals that reduce excess contributions.
(B) Treatment of excess contributions that reduce excess deferrals.
(ii) Forfeiture of match on distributed excess contributions.
(iii) Permitted forfeiture of QMAC.
(iv) No requirement for recalculation.
(v) Treatment of excess contributions that are catch-up contributions.
(5) Failure to timely correct.
(i) Failure to correct within 2\1/2\ months after end of plan year.
(ii) Failure to correct within 12 months after end of plan year.
(iii) Special rule for eligible automatic contribution arrangements.
(c) Additional rules for prior year testing method.
(1) Rules for change in testing method.
(i) General rule.
(ii) Situations permitting a change to the prior year testing method.
(2) Calculation of ADP under the prior year testing method for the first 
          plan year.
(i) Plans that are not successor plans.
(ii) First plan year defined.
(iii) Successor plans.
(3) Plans using different testing methods for the ADP and ACP test.
(4) Rules for plan coverage changes.
(i) In general.
(ii) Optional rule for minor plan coverage changes.
(iii) Definitions.
(A) Plan coverage change.
(B) Prior year subgroup.
(C) Weighted average of the ADPs for the prior year subgroups.
(iv) Examples.
    Sec. 1.401(k)-3 Safe harbor requirements
(a) ADP test safe harbor.
(1) Section 401(k)(12) safe harbor.
(2) Section 401(k)(13) safe harbor.
(3) Requirements applicable to safe harbor contributions.
(b) Safe harbor nonelective contribution requirement.
(1) General rule.
(2) Safe harbor compensation defined.
(c) Safe harbor matching contribution requirement.
(1) In general.
(2) Basic matching formula.
(3) Enhanced matching formula.
(4) Limitation on HCE matching contributions.
(5) Use of safe harbor match not precluded by certain plan provisions.
(i) Safe harbor matching contributions on employee contributions.
(ii) Periodic matching contributions.
(6) Permissible restrictions on elective contributions by NHCEs.
(i) General rule.
(ii) Restrictions on election periods.
(iii) Restrictions on amount of elective contributions.
(iv) Restrictions on types of compensation that may be deferred.
(v) Restrictions due to limitations under the Internal Revenue Code.
(7) Examples.
(d) Notice requirement.
(1) General rule.
(2) Content requirement.
(i) General rule.
(ii) Minimum content requirement.

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(iii) References to SPD.
(3) Timing requirement.
(i) General rule.
(ii) Deemed satisfaction of timing requirement.
(e) Plan year requirement.
(1) General rule.
(2) Initial plan year.
(3) Change of plan year.
(4) Final plan year.
(f) Plan amendments adopting safe harbor nonelective contributions.
(1) General rule.
(2) Contingent notice provided.
(3) Follow-up notice requirement.
(g) Permissible reduction or suspension of safe harbor contributions.
(1) General rule.
(i) Matching contributions.
(ii) Nonelective contributions.
(2) Supplemental notice.
(h) Additional rules.
(1) Contributions taken into account.
(2) Use of safe harbor nonelective contributions to satisfy other 
          nondiscrimination tests.
(3) Early participation rules.
(4) Satisfying safe harbor contribution requirement under another 
          defined contribution plan.
(5) Contributions used only once.
(i) [Reserved]
(j) Qualified automatic contribution arrangement.
(1) Automatic contribution requirement.
(i) In general.
(ii) Automatic contribution arrangement.
(iii) Exception to automatic enrollment for certain current employees.
(2) Qualified percentage.
(i) In general.
(ii) Minimum percentage requirements.
(A) Initial-period requirement.
(B) Second-year requirement.
(C) Third-year requirement.
(D) Later years requirement.
(iii) Exception to uniform percentage requirement.
(iv) Treatment of periods without default contributions.
(k) Modifications to contribution requirements and notice requirements 
          for automatic contribution safe harbor.
(1) In general.
(2) Lower matching requirement.
(3) Modified nonforfeiture requirement.
(4) Additional notice requirements.
(i) In general.
(ii) Additional information.
(iii) Timing requirements.
    Sec. 1.401(k)-4 SIMPLE 401(k) Plan Requirements
(a) General rule.
(b) Eligible employer.
(1) General rule.
(2) Special rule.
(c) Exclusive plan.
(1) General rule.
(2) Special rule.
(d) Election and notice.
(1) General rule.
(2) Employee elections.
(i) Initial plan year of participation.
(ii) Subsequent plan years.
(iii) Election to terminate.
(3) Employee notices.
(e) Contributions.
(1) General rule.
(2) Elective contributions.
(3) Matching contributions.
(4) Nonelective contributions.
(5) SIMPLE compensation.
(f) Vesting.
(g) Plan year.
(h) Other rules.
    Sec. 1.401(k)-5 Special Rules for Mergers, Acquisitions and Similar 
Events. [Reserved]
    Sec. 1.401(k)-6 Definitions.

[T.D. 9169, 69 FR 78154, Dec. 29, 2004, as amended by T.D. 9237, 71 FR 9 
Jan. 3, 2006; T.D. 9324, 72 FR 21109, Apr. 30, 2007; T.D. 9447, 74 FR 
8207, Feb. 24, 2009; T.D. 9641, 78 FR 68737, Nov. 15, 2013]



Sec. 1.401(k)-1  Certain cash or deferred arrangements.

    (a) General rules--(1) Certain plans permitted to include cash or 
deferred arrangements. A plan, other than a profit-sharing, stock bonus, 
pre-ERISA money purchase pension, or rural cooperative plan, does not 
satisfy the requirements of section 401(a) if the plan includes a cash 
or deferred arrangement. A profit-sharing, stock bonus, pre-ERISA money 
purchase pension, or rural cooperative plan does not fail to satisfy the 
requirements of section 401(a) merely because the plan includes a cash 
or deferred arrangement. A cash or deferred arrangement is part of a 
plan for purposes of this section if any contributions to the plan, or 
accruals or other benefits under the plan, are made or provided pursuant 
to the cash or deferred arrangement.
    (2) Rules applicable to cash or deferred arrangements generally--(i) 
Definition of cash or deferred arrangement. Except as provided in 
paragraphs (a)(2)(ii) and (iii) of this section, a cash or deferred 
arrangement is an arrangement under which an eligible employee may make 
a cash or deferred election with respect to contributions to, or 
accruals or other benefits under, a plan that is intended to satisfy the 
requirements of section 401(a) (including a contract

[[Page 309]]

that is intended to satisfy the requirements of section 403(a)).
    (ii) Treatment of after-tax employee contributions. A cash or 
deferred arrangement does not include an arrangement under which amounts 
contributed under a plan at an employee's election are designated or 
treated at the time of contribution as after-tax employee contributions 
(e.g., by treating the contributions as taxable income subject to 
applicable withholding requirements). See also section 414(h)(1). A 
designated Roth contribution, however, is not treated as an after-tax 
contribution for purposes of this section, Sec. 1.401(k)-2 through 
Sec. 1.401(k)-6 and Sec. 1.401(m)-1 through Sec. 1.401(m)-5. A 
contribution can be an after-tax employee contribution under the rule of 
this paragraph (a)(2)(ii) even if the employee's election to make after-
tax employee contributions is made before the amounts subject to the 
election are currently available to the employee.
    (iii) Treatment of ESOP dividend election. A cash or deferred 
arrangement does not include an arrangement under an ESOP under which 
dividends are either distributed or invested pursuant to an election 
made by participants or their beneficiaries in accordance with section 
404(k)(2)(A)(iii).
    (iv) Treatment of elective contributions as plan assets. The extent 
to which elective contributions constitute plan assets for purposes of 
the prohibited transaction provisions of section 4975 and title I of the 
Employee Retirement Income Security Act of 1974 (88 Stat. 829), Public 
Law 93-406, is determined in accordance with regulations and rulings 
issued by the Department of Labor. See 29 CFR 2510.3-102.
    (3) Rules applicable to cash or deferred elections generally--(i) 
Definition of cash or deferred election. A cash or deferred election is 
any direct or indirect election (or modification of an earlier election) 
by an employee to have the employer either--
    (A) Provide an amount to the employee in the form of cash (or some 
other taxable benefit) that is not currently available; or
    (B) Contribute an amount to a trust, or provide an accrual or other 
benefit, under a plan deferring the receipt of compensation.
    (ii) Automatic enrollment. For purposes of determining whether an 
election is a cash or deferred election, it is irrelevant whether the 
default that applies in the absence of an affirmative election is 
described in paragraph (a)(3)(i)(A) of this section (i.e., the employee 
receives an amount in cash or some other taxable benefit) or in 
paragraph (a)(3)(i)(B) of this section (i.e., the employer contributes 
an amount to a trust or provides an accrual or other benefit under a 
plan deferring the receipt of compensation).
    (iii) Rules related to timing--(A) Requirement that amounts not be 
currently available. A cash or deferred election can only be made with 
respect to an amount that is not currently available to the employee on 
the date of the election. Further, a cash or deferred election can only 
be made with respect to amounts that would (but for the cash or deferred 
election) become currently available after the later of the date on 
which the employer adopts the cash or deferred arrangement or the date 
on which the arrangement first becomes effective.
    (B) Contribution may not precede election. A contribution is made 
pursuant to a cash or deferred election only if the contribution is made 
after the election is made.
    (C) Contribution may not precede services--(1) General rule. 
Contributions are made pursuant to a cash or deferred election only if 
the contributions are made after the employee's performance of service 
with respect to which the contributions are made (or when the cash or 
other taxable benefit would be currently available, if earlier).
    (2) Exception for bona fide administrative considerations. The 
timing of contributions will not be treated as failing to satisfy the 
requirements of this paragraph (a)(3)(iii)(C) merely because 
contributions for a pay period are occasionally made before the services 
with respect to that pay period are performed, provided the 
contributions are made early in order to accommodate bona fide 
administrative considerations (for example, the temporary absence of the 
bookkeeper with responsibility to transmit contributions to the

[[Page 310]]

plan) and are not paid early with a principal purpose of accelerating 
deductions.
    (iv) Current availability defined. Cash or another taxable benefit 
is currently available to the employee if it has been paid to the 
employee or if the employee is able currently to receive the cash or 
other taxable benefit at the employee's discretion. An amount is not 
currently available to an employee if there is a significant limitation 
or restriction on the employee's right to receive the amount currently. 
Similarly, an amount is not currently available as of a date if the 
employee may under no circumstances receive the amount before a 
particular time in the future. The determination of whether an amount is 
currently available to an employee does not depend on whether it has 
been constructively received by the employee for purposes of section 
451.
    (v) Certain one-time elections not treated as cash or deferred 
elections. A cash or deferred election does not include a one-time 
irrevocable election made no later than the employee's first becoming 
eligible under the plan or any other plan or arrangement of the employer 
that is described in section 219(g)(5)(A) (whether or not such other 
plan or arrangement has terminated), to have contributions equal to a 
specified amount or percentage of the employee's compensation (including 
no amount of compensation) made by the employer on the employee's behalf 
to the plan and a specified amount or percentage of the employee's 
compensation (including no amount of compensation) divided among all 
other plans or arrangements of the employer (including plans or 
arrangements not yet established) for the duration of the employee's 
employment with the employer, or in the case of a defined benefit plan 
to receive accruals or other benefits (including no benefits) under such 
plans. Thus, for example, employer contributions made pursuant to a one-
time irrevocable election described in this paragraph are not treated as 
having been made pursuant to a cash or deferred election and are not 
includible in an employee's gross income by reason of Sec. 1.402(a)-
1(d). In the case of an irrevocable election made on or before December 
23, 1994--
    (A) The election does not fail to be treated as a one-time 
irrevocable election under this paragraph (a)(3)(v) merely because an 
employee was previously eligible under another plan of the employer 
(whether or not such other plan has terminated); and
    (B) In the case of a plan in which partners may participate, the 
election does not fail to be treated as a one-time irrevocable election 
under this paragraph (a)(3)(v) merely because the election was made 
after commencement of employment or after the employee's first becoming 
eligible under any plan of the employer, provided that the election was 
made before the first day of the first plan year beginning after 
December 31, 1988, or, if later, March 31, 1989.
    (vi) Tax treatment of employees. An amount generally is includible 
in an employee's gross income for the taxable year in which the employee 
actually or constructively receives the amount. But for section 
402(e)(3), an employee is treated as having received an amount that is 
contributed to an exempt trust or plan described in section 401(a) or 
403(a) pursuant to the employee's cash or deferred election. This is the 
case even if the election to defer is made before the year in which the 
amount is earned, or before the amount is currently available. See Sec. 
1.402(a)-1(d).
    (vii) Examples. The following examples illustrate the application of 
this paragraph (a)(3):

    Example 1. (i) An employer maintains a profit-sharing plan under 
which each eligible employee has an election to defer an annual bonus 
payable on January 30 each year. The bonus equals 10% of compensation 
during the previous calendar year. Deferred amounts are not treated as 
after-tax employee contributions. The bonus is currently available on 
January 30.
    (ii) An election made prior to January 30 to defer all or part of 
the bonus is a cash or deferred election, and the bonus deferral 
arrangement is a cash or deferred arrangement.
    Example 2. (i) An employer maintains a profit-sharing plan which 
provides for discretionary profit sharing contributions and under which 
each eligible employee may elect to reduce his compensation by up to 10% 
and to have the employer contribute

[[Page 311]]

such amount to the plan. The employer pays each employee every two weeks 
for services during the immediately preceding two weeks. The employee's 
election to defer compensation for a payroll period must be made prior 
to the date the amount would otherwise be paid. The employer contributes 
to the plan the amount of compensation that each employee elected to 
defer, at the time it would otherwise be paid to the employee, and does 
not treat the contribution as an after-tax employee contribution.
    (ii) The election is a cash or deferred election and the 
contributions are elective contributions.
    Example 3. (i) The facts are the same as in Example 2, except that 
the employer makes a $10,000 contribution on January 31 of the plan year 
that is in addition to the contributions that satisfy the employer's 
obligation to make contributions with respect to cash or deferred 
elections for prior payroll periods. Employee A makes an election on 
February 15 to defer $2,000 from compensation that is not currently 
available and the employer reduces the employee's compensation to 
reflect the election.
    (ii) None of the additional $10,000 contributed January 31 is a 
contribution made pursuant to Employee A's cash or deferred election, 
because the contribution was made before the election was made. 
Accordingly, the employer must make an additional contribution of $2,000 
in order to satisfy its obligation to contribute an amount to the plan 
pursuant to Employee A's election. The $10,000 contribution may be 
allocated under the plan terms providing for discretionary profit 
sharing contributions.
    Example 4. (i) The facts are the same as in Example 3, except that 
Employee A had an outstanding election to defer $500 from each payroll 
period's compensation. The $10,000 additional payment that is 
contributed early is not made early in order to accommodate bona fide 
administrative considerations.
    (ii) None of the additional $10,000 contributed January 31 is a 
contribution made pursuant to Employee A's cash or deferred election for 
future payroll periods, because the contribution was made before the 
earlier of Employee A's performance of services to which the 
contribution is attributable or when the compensation would be currently 
available. Furthermore, the exception for early contributions in 
paragraph (a)(3)(iii)(C)(2) of this section does not apply. Accordingly, 
the employer must make an additional contribution of $500 per payroll 
period in order to satisfy its obligation to contribute an amount to the 
plan pursuant to Employee A's election. The $10,000 contribution may be 
allocated under the plan terms providing for discretionary profit 
sharing contributions.
    Example 5. (i) Employer B establishes a money purchase pension plan 
in 1986. This is the first qualified plan established by Employer B. All 
salaried employees are eligible to participate under the plan. Hourly-
paid employees are not eligible to participate under the plan. In 2000, 
Employer B establishes a profit-sharing plan under which all employees 
(both salaried and hourly) are eligible. Employer B permits all 
employees on the effective date of the profit-sharing plan to make a 
one-time irrevocable election to have Employer B contribute 5% of 
compensation on their behalf to the plan and make no other contribution 
to any other plan of Employer B (including plans not yet established) 
for the duration of the employee's employment with Employer B, and have 
their salaries reduced by 5%.
    (ii) The election provided under the profit-sharing plan is not a 
one-time irrevocable election within the meaning of paragraph (a)(3)(v) 
of this section with respect to the salaried employees of Employer B 
who, before becoming eligible to participate under the profit-sharing 
plan, became eligible to participate under the money purchase pension 
plan. The election under the profit-sharing plan is a one-time 
irrevocable election within the meaning of paragraph (a)(3)(v) of this 
section with respect to the hourly employees, because they were not 
previously eligible to participate under another plan of the employer.

    (4) Rules applicable to qualified cash or deferred arrangements--(i) 
Definition of qualified cash or deferred arrangement. A qualified cash 
or deferred arrangement is a cash or deferred arrangement that satisfies 
the requirements of paragraphs (b), (c), (d), and (e) of this section.
    (ii) Treatment of elective contributions as employer contributions. 
Except as otherwise provided in Sec. 1.401(k)-2(b)(3), elective 
contributions under a qualified cash or deferred arrangement (including 
designated Roth contributions) are treated as employer contributions. 
Thus, for example, elective contributions under such an arrangement are 
treated as employer contributions for purposes of sections 401(a), 
401(k), 402, 404, 409, 411, 412, 415, 416, and 417.
    (iii) Tax treatment of employees. Except as provided in section 
402(g), 402A (effective for taxable years beginning after December 31, 
2005), or Sec. 1.401(k)-2(b)(3), elective contributions under a 
qualified cash or deferred arrangement are neither includible in an 
employee's gross income at the time the cash would have been includible 
in the employee's gross income (but for the cash

[[Page 312]]

or deferred election), nor at the time the elective contributions are 
contributed to the plan. See Sec. 1.402(a)-1(d)(2)(i).
    (iv) Application of nondiscrimination requirements to plan that 
includes a qualified cash or deferred arrangement--(A) Exclusive means 
of amounts testing. Elective contributions (including elective 
contributions that are designated Roth contributions) under a qualified 
cash or deferred arrangement satisfy the requirements of section 
401(a)(4) with respect to amounts if and only if the amount of elective 
contributions satisfies the nondiscrimination test of section 401(k) 
under paragraph (b)(1) of this section. See Sec. 1.401(a)(4)-
1(b)(2)(ii)(B).
    (B) Testing benefits, rights and features. A plan that includes a 
qualified cash or deferred arrangement must satisfy the requirements of 
section 401(a)(4) with respect to benefits, rights and features in 
addition to the requirements regarding amounts described in paragraph 
(a)(4)(iv)(A) of this section. For example, the right to make each level 
of elective contributions under a cash or deferred arrangement and the 
right to make designated Roth contributions are rights or features 
subject to the requirements of section 401(a)(4). See Sec. 1.401(a)(4)-
4(e)(3)(i) and (iii)(D). Thus, for example, if all employees are 
eligible to make a stated level of elective contributions under a cash 
or deferred arrangement, but that level of contributions can only be 
made from compensation in excess of a stated amount, such as the Social 
Security taxable wage base, the arrangement will generally favor HCEs 
with respect to the availability of elective contributions and thus will 
generally not satisfy the requirements of section 401(a)(4).
    (C) Minimum coverage requirement. A qualified cash or deferred 
arrangement is treated as a separate plan that must satisfy the 
requirements of section 410(b). See Sec. 1.410(b)-7(c)(1) for special 
rules. The determination of whether a cash or deferred arrangement 
satisfies the requirements of section 410(b) must be made without regard 
to the modifications to the disaggregation rules set forth in paragraph 
(b)(4)(v) of this section. See also Sec. 1.401(a)(4)-11(g)(3)(vii)(A), 
relating to corrective amendments that may be made to satisfy the 
minimum coverage requirements of section 410(b).
    (5) Rules applicable to nonqualified cash or deferred arrangements--
(i) Definition of nonqualified cash or deferred arrangement. A 
nonqualified cash or deferred arrangement is a cash or deferred 
arrangement that fails to satisfy one or more of the requirements in 
paragraph (b), (c), (d) or (e) of this section.
    (ii) Treatment of elective contributions as nonelective 
contributions. Except as specifically provided otherwise, elective 
contributions under a nonqualified cash or deferred arrangement are 
treated as nonelective employer contributions. Thus, for example, the 
elective contributions under such an arrangement are treated as 
nonelective employer contributions for purposes of sections 401(a) 
(including section 401(a)(4)) and 401(k), 404, 409, 411, 412, 415, 416, 
and 417 and are not subject to the requirements of section 401(m).
    (iii) Tax treatment of employees. Elective contributions under a 
nonqualified cash or deferred arrangement are includible in an 
employee's gross income at the time the cash or other taxable amount 
that the employee would have received (but for the cash or deferred 
election) would have been includible in the employee's gross income. See 
Sec. 1.402(a)-1(d)(1).
    (iv) Qualification of plan that includes a nonqualified cash or 
deferred arrangement--(A) In general. A profit-sharing, stock bonus, 
pre-ERISA money purchase pension, or rural cooperative plan does not 
fail to satisfy the requirements of section 401(a) merely because the 
plan includes a nonqualified cash or deferred arrangement. In 
determining whether the plan satisfies the requirements of section 
401(a)(4), the nondiscrimination tests of sections 401(k), paragraph 
(b)(1) of this section, section 401(m)(2) and Sec. 1.401(m)-1(b) may 
not be used. See Sec. Sec. 1.401(a)(4)-1(b)(2)(ii)(B) and 1.410(b)-9 
(definition of section 401(k) plan).
    (B) Application of section 401(a)(4) to certain plans. The amount of 
employer contributions under a nonqualified cash or deferred arrangement 
is treated

[[Page 313]]

as satisfying section 401(a)(4) if the arrangement is part of a 
collectively bargained plan that automatically satisfies the 
requirements of section 410(b). See Sec. Sec. 1.401(a)(4)-(c)(5) and 
1.410(b)-2(b)(7). Additionally, the requirements of sections 401(a)(4) 
and 410(b) do not apply to a governmental plan (within the meaning of 
section 414(d)) maintained by a State or local government or political 
subdivision thereof (or agency or instrumentality thereof). See sections 
401(a)(5) and 410(c)(1)(A).
    (v) Example. The following example illustrates the application of 
this paragraph (a)(5):

    Example. (i) For the 2006 plan year, Employer A maintains a 
collectively bargained plan that includes a cash or deferred 
arrangement. Employer contributions under the cash or deferred 
arrangement do not satisfy the nondiscrimination test of section 401(k) 
and paragraph (b) of this section.
    (ii) The arrangement is a nonqualified cash or deferred arrangement. 
The employer contributions under the cash or deferred arrangement are 
considered to be nondiscriminatory under section 401(a)(4), and the 
elective contributions are generally treated as employer contributions 
under paragraph (a)(5)(ii) of this section. Under paragraph (a)(5)(iii) 
of this section and under Sec. 1.402(a)-1(d)(1), however, the elective 
contributions are includible in each employee's gross income.

    (6) Rules applicable to cash or deferred arrangements of self-
employed individuals--(i) Application of general rules. Generally, a 
partnership or sole proprietorship is permitted to maintain a cash or 
deferred arrangement, and individual partners or owners are permitted to 
make cash or deferred elections with respect to compensation 
attributable to services rendered to the entity, under the same rules 
that apply to other cash or deferred arrangements. For example, any 
contributions made on behalf of an individual partner or owner pursuant 
to a cash or deferred arrangement of a partnership or sole 
proprietorship are elective contributions unless they are designated or 
treated as after-tax employee contributions. In the case of a 
partnership, a cash or deferred arrangement includes any arrangement 
that directly or indirectly permits individual partners to vary the 
amount of contributions made on their behalf. Consistent with Sec. 
1.402(a)-1(d), the elective contributions under such an arrangement are 
includible in income and are not deductible under section 404(a) unless 
the arrangement is a qualified cash or deferred arrangement (i.e., the 
requirements of section 401(k) and this section are satisfied). Also, 
even if the arrangement is a qualified cash or deferred arrangement, the 
elective contributions are includible in gross income and are not 
deductible under section 404(a) to the extent they exceed the applicable 
limit under section 402(g). See also Sec. 1.401(a)-30.
    (ii) Treatment of matching contributions made on behalf of self-
employed individuals. Under section 402(g)(8), matching contributions 
made on behalf of a self-employed individual are not treated as elective 
contributions made pursuant to a cash or deferred election, without 
regard to whether such matching contributions indirectly permit 
individual partners to vary the amount of contributions made on their 
behalf.
    (iii) Timing of self-employed individual's cash or deferred 
election. For purposes of paragraph (a)(3)(iv) of this section, a 
partner's compensation is deemed currently available on the last day of 
the partnership taxable year and a sole proprietor's compensation is 
deemed currently available on the last day of the individual's taxable 
year. Accordingly, a self-employed individual may not make a cash or 
deferred election with respect to compensation for a partnership or sole 
proprietorship taxable year after the last day of that year. See Sec. 
1.401(k)-2(a)(4)(ii) for the rules regarding when these contributions 
are treated as allocated.
    (iv) Special rule for certain payments to self-employed individuals. 
For purposes of sections 401(k) and 401(m), the earned income of a self-
employed individual for a taxable year constitutes payment for services 
during that year. Thus, for example, if a partnership provides for cash 
advance payments during the taxable year to be made to a partner based 
on the value of the partner's services prior to the date of payment (and 
which do not exceed a reasonable estimate of the partner's earned income 
for the taxable year), a

[[Page 314]]

contribution of a portion of these payments to a profit sharing plan in 
accordance with an election to defer the portion of the advance payments 
does not fail to be made pursuant to a cash or deferred election within 
the meaning of paragraph (a)(3)(iii) of this section merely because the 
contribution is made before the amount of the partner's earned income is 
finally determined and reported. However, see Sec. 1.401(k)-2(a)(4)(ii) 
for rules on when earned income is treated as received.
    (b) Coverage and nondiscrimination requirements--(1) In general. A 
cash or deferred arrangement satisfies this paragraph (b) for a plan 
year only if--
    (i) The group of eligible employees under the cash or deferred 
arrangement (including any employees taken into account for purposes of 
section 410(b) pursuant to Sec. 1.401(a)(4)-11(g)(3)(vii)(A)) satisfies 
the requirements of section 410(b) (including the average benefit 
percentage test, if applicable); and
    (ii) The cash or deferred arrangement satisfies--
    (A) The ADP test of section 401(k)(3) described in Sec. 1.401(k)-2;
    (B) The ADP safe harbor provisions of section 401(k)(12) described 
in Sec. 1.401(k)-3; or
    (C) The ADP safe harbor provisions of section 401(k)(13) described 
in Sec. 1.401(k)-3; or
    (D) The SIMPLE 401(k) provisions of section 401(k)(11) described in 
Sec. 1.401(k)-4.
    (2) Automatic satisfaction by certain plans. Notwithstanding 
paragraph (b)(1) of this section, a governmental plan (within the 
meaning of section 414(d)) maintained by a State or local government or 
political subdivision thereof (or agency or instrumentality thereof) 
shall be treated as meeting the requirements of this paragraph (b).
    (3) Anti-abuse provisions. This section and Sec. Sec. 1.401(k)-2 
through 1.401(k)-6 are designed to provide simple, practical rules that 
accommodate legitimate plan changes. At the same time, the rules are 
intended to be applied by employers in a manner that does not make use 
of changes in plan testing procedures or other plan provisions to 
inflate inappropriately the ADP for NHCEs (which is used as a benchmark 
for testing the ADP for HCEs) or to otherwise manipulate the 
nondiscrimination testing requirements of this paragraph (b). Further, 
this paragraph (b) is part of the overall requirement that benefits or 
contributions not discriminate in favor of HCEs. Therefore, a plan will 
not be treated as satisfying the requirements of this paragraph (b) if 
there are repeated changes to plan testing procedures or plan provisions 
that have the effect of distorting the ADP so as to increase 
significantly the permitted ADP for HCEs, or otherwise manipulate the 
nondiscrimination rules of this paragraph, if a principal purpose of the 
changes was to achieve such a result.
    (4) Aggregation and restructuring--(i) In general. This paragraph 
(b)(4) contains the exclusive rules for aggregating and disaggregating 
plans and cash or deferred arrangements for purposes of this section, 
and Sec. Sec. 1.401(k)-2 through 1.401(k)-6.
    (ii) Aggregation of cash or deferred arrangements within a plan. 
Except as otherwise specifically provided in this paragraph (b)(4), all 
cash or deferred arrangements included in a plan are treated as a single 
cash or deferred arrangement and a plan must apply a single test under 
paragraph (b)(1)(ii) of this section with respect to all such 
arrangements within the plan. Thus, for example, if two groups of 
employees are eligible for separate cash or deferred arrangements under 
the same plan, all contributions under both cash or deferred 
arrangements must be treated as made under a single cash or deferred 
arrangement subject to a single test, even if they have significantly 
different features, such as different limits on elective contributions.
    (iii) Aggregation of plans--(A) In general. For purposes of this 
section and Sec. Sec. 1.401(k)-2 through 1.401(k)-6, the term plan 
means a plan within the meaning of Sec. 1.410(b)-7(a) and (b), after 
application of the mandatory disaggregation rules of Sec. 1.410(b)-
7(c), and the permissive aggregation rules of Sec. 1.410(b)-7(d), as 
modified by paragraph (b)(4)(v) of this section. Thus, for example, two 
plans (within the meaning of Sec. 1.410(b)-7(b)) that are treated as a 
single plan pursuant to the permissive aggregation rules of Sec. 
1.410(b)-7(d) are treated as a

[[Page 315]]

single plan for purposes of sections 401(k) and (m).
    (B) Plans with inconsistent ADP testing methods. Pursuant to 
paragraph (b)(4)(ii) of this section, a single testing method must apply 
with respect to all cash or deferred arrangements under a plan. Thus, in 
applying the permissive aggregation rules of Sec. 1.410(b)-7(d), an 
employer may not aggregate plans (within the meaning of Sec. 1.410(b)-
7(b)) that apply inconsistent testing methods. For example, a plan 
(within the meaning of Sec. 1.410(b)-7(b)) that applies the current 
year testing method may not be aggregated with another plan that applies 
the prior year testing method. Similarly, an employer may not aggregate 
a plan (within the meaning of Sec. 1.410(b)-7(b)) using the ADP safe 
harbor provisions of section 401(k)(12) and another plan that is using 
the ADP test of section 401(k)(3).
    (iv) Disaggregation of plans and separate testing--(A) In general. 
If a cash or deferred arrangement is included in a plan (within the 
meaning of Sec. 1.410(b)-7(b)) that is mandatorily disaggregated under 
the rules of section 410(b) (as modified by this paragraph (b)(4)), the 
cash or deferred arrangement must be disaggregated in a consistent 
manner. For example, in the case of an employer that is treated as 
operating qualified separate lines of business under section 414(r), if 
the eligible employees under a cash or deferred arrangement are in more 
than one qualified separate line of business, only those employees 
within each qualified separate line of business may be taken into 
account in determining whether each disaggregated portion of the plan 
complies with the requirements of section 401(k), unless the employer is 
applying the special rule for employer-wide plans in Sec. 1.414(r)-
1(c)(2)(ii) with respect to the plan. Similarly, if a cash or deferred 
arrangement under which employees are permitted to participate before 
they have completed the minimum age and service requirements of section 
410(a)(1) applies section 410(b)(4)(B) for determining whether the plan 
complies with section 410(b)(1), then the arrangement must be treated as 
two separate arrangements, one comprising all eligible employees who 
have met the age and service requirements of section 410(a)(1) and one 
comprising all eligible employees who have not met the age and service 
requirements under section 410(a)(1), unless the plan is using the rule 
in Sec. 1.401(k)-2(a)(1)(iii)(A).
    (B) Restructuring prohibited. Restructuring under Sec. 1.401(a)(4)-
9(c) may not be used to demonstrate compliance with the requirements of 
section 401(k). See Sec. 1.401(a)(4)-9(c)(3)(ii).
    (v) Modifications to section 410(b) rules--(A) Certain 
disaggregation rules not applicable. The mandatory disaggregation rules 
relating to section 401(k) plans and section 401(m) plans set forth in 
Sec. 1.410(b)-7(c)(1) and ESOP and non-ESOP portions of a plan set 
forth in Sec. 1.410(b)-7(c)(2) shall not apply for purposes of this 
section and Sec. Sec. 1.401(k)-2 through 1.401(k)-6. Accordingly, 
notwithstanding Sec. 1.410(b)-7(d)(2), an ESOP and a non-ESOP which are 
different plans (within the meaning of section 414(l), as described in 
Sec. 1.410(b)-7(b)) are permitted to be aggregated for these purposes.
    (B) Permissive aggregation of collective bargaining units. 
Notwithstanding the general rule under section 410(b) and Sec. 
1.410(b)-7(c) that a plan that benefits employees who are included in a 
unit of employees covered by a collective bargaining agreement and 
employees who are not included in the collective bargaining unit is 
treated as comprising separate plans, an employer can treat two or more 
separate collective bargaining units as a single collective bargaining 
unit for purposes of this section and Sec. Sec. 1.401(k)-2 through 
1.401(k)-6, provided that the combinations of units are determined on a 
basis that is reasonable and reasonably consistent from year to year. 
Thus, for example, if a plan benefits employees in three categories 
(e.g., employees included in collective bargaining unit A, employees 
included in collective bargaining unit B, and employees who are not 
included in any collective bargaining unit), the plan can be treated as 
comprising three separate plans, each of which benefits only one 
category of employees. However, if collective bargaining units A and B 
are treated as a single collective bargaining unit, the plan will be 
treated as comprising only two separate plans, one benefiting all 
employees

[[Page 316]]

who are included in a collective bargaining unit and another benefiting 
all other employees. Similarly, if a plan benefits only employees who 
are included in collective bargaining unit A and employees who are 
included in collective bargaining unit B, the plan can be treated as 
comprising two separate plans. However, if collective bargaining units A 
and B are treated as a single collective bargaining unit, the plan will 
be treated as a single plan. An employee is treated as included in a 
unit of employees covered by a collective bargaining agreement if and 
only if the employee is a collectively bargained employee within the 
meaning of Sec. 1.410(b)-6(d)(2).
    (C) Multiemployer plans. Notwithstanding Sec. 1.410(b)-
7(c)(4)(ii)(C), the portion of the plan that is maintained pursuant to a 
collective bargaining agreement (within the meaning of Sec. 1.413-
1(a)(2)) is treated as a single plan maintained by a single employer 
that employs all the employees benefiting under the same benefit 
computation formula and covered pursuant to that collective bargaining 
agreement. The rules of paragraph (b)(4)(v)(B) of this section 
(including the permissive aggregation of collective bargaining units) 
apply to the resulting deemed single plan in the same manner as they 
would to a single employer plan, except that the plan administrator is 
substituted for the employer where appropriate and that appropriate 
fiduciary obligations are taken into account. The noncollectively 
bargained portion of the plan is treated as maintained by one or more 
employers, depending on whether the noncollectively bargaining unit 
employees who benefit under the plan are employed by one or more 
employers.
    (vi) Examples. The following examples illustrate the application of 
this paragraph (b)(4):

    Example 1. (i) Employer A maintains Plan V, a profit-sharing plan 
that includes a cash or deferred arrangement in which all of the 
employees of Employer A are eligible to participate. For purposes of 
applying section 410(b), Employer A is treated as operating qualified 
separate lines of business under section 414(r) in accordance with Sec. 
1.414(r)-1(b). However, Employer A applies the special rule for 
employer-wide plans in Sec. 1.414(r)-1(c)(2)(ii) to the portion of its 
profit-sharing plan that consists of elective contributions under the 
cash or deferred arrangement (and to no other plans or portions of 
plans).
    (ii) Under these facts, the requirements of this section and 
Sec. Sec. 1.401(k)-2 through 1.401(k)-6 must be applied on an employer-
wide rather than a qualified separate line of business basis.
    Example 2. (i) Employer B maintains Plan W, a profit-sharing plan 
that includes a cash or deferred arrangement in which all of the 
employees of Employer B are eligible to participate. For purposes of 
applying section 410(b), the plan treats the cash or deferred 
arrangement as two separate plans, one for the employees who have 
completed the minimum age and service eligibility conditions under 
section 410(a)(1) and the other for employees who have not completed the 
conditions. The plan provides that it will satisfy the section 401(k) 
safe harbor requirement of Sec. 1.401(k)-3 with respect to the 
employees who have met the minimum age and service conditions and that 
it will meet the ADP test requirements of Sec. 1.401(k)-2 with respect 
to the employees who have not met the minimum age and service 
conditions.
    (ii) Under these facts, the cash or deferred arrangement must be 
disaggregated on a consistent basis with the disaggregation of Plan W. 
Thus, the requirements of Sec. 1.401(k)-2 must be applied by comparing 
the ADP for eligible HCEs who have not completed the minimum age and 
service conditions with the ADP for eligible NHCEs for the applicable 
year who have not completed the minimum age and service conditions.
    Example 3. (i) Employer C maintains Plan X, a stock-bonus plan 
including an ESOP. The plan also includes a cash or deferred arrangement 
for participants in the ESOP and non-ESOP portions of the plan.
    (ii) Pursuant to paragraph (b)(4)(v)(A) of this section the ESOP and 
non-ESOP portions of the stock-bonus plan are a single cash or deferred 
arrangement for purposes of this section and Sec. Sec. 1.401(k)-2 
through 1.401(k)-6. However, as provided in paragraph (a)(4)(iv)(C) of 
this section, the ESOP and non-ESOP portions of the plan are still 
treated as separate plans for purposes of satisfying the requirements of 
section 410(b).

    (c) Nonforfeitability requirements--(1) General rule. A cash or 
deferred arrangement satisfies this paragraph (c) only if the amount 
attributable to an employee's elective contributions are immediately 
nonforfeitable, within the meaning of paragraph (c)(2) of this section, 
are disregarded for purposes of applying section 411(a)(2) to other 
contributions or benefits, and the contributions remain nonforfeitable 
even if the employee makes no additional

[[Page 317]]

elective contributions under a cash or deferred arrangement.
    (2) Definition of immediately nonforfeitable. An amount is 
immediately nonforfeitable if it is immediately nonforfeitable within 
the meaning of section 411, and would be nonforfeitable under the plan 
regardless of the age and service of the employee or whether the 
employee is employed on a specific date. An amount that is subject to 
forfeitures or suspensions permitted by section 411(a)(3) does not 
satisfy the requirements of this paragraph (c).
    (3) Example. The following example illustrates the application of 
this paragraph (c):

    Example. (i) Employees B and C are covered by Employer Y's stock 
bonus plan, which includes a cash or deferred arrangement. All employees 
participating in the plan have a nonforfeitable right to a percentage of 
their account balance derived from all contributions (including elective 
contributions) as shown in the following table:

------------------------------------------------------------------------
                                                         Nonforfeitable
                   Years of service                        percentage
------------------------------------------------------------------------
Less than 1..........................................                  0
1....................................................                 20
2....................................................                 40
3....................................................                 60
4....................................................                 80
5 or more............................................                100
------------------------------------------------------------------------

    (ii) The cash or deferred arrangement does not satisfy paragraph (c) 
of this section because elective contributions are not immediately 
nonforfeitable. Thus, the cash or deferred arrangement is a nonqualified 
cash or deferred arrangement.

    (d) Distribution limitation--(1) General rule. A cash or deferred 
arrangement satisfies this paragraph (d) only if amounts attributable to 
elective contributions may not be distributed before one of the 
following events, and any distributions so permitted also satisfy the 
additional requirements of paragraphs (d)(2) through (5) of this section 
(to the extent applicable)--
    (i) The employee's death, disability, or severance from employment;
    (ii) In the case of a profit-sharing, stock bonus or rural 
cooperative plan, the employee's attainment of age 59\1/2\, or the 
employee's hardship; or
    (iii) The termination of the plan.
    (2) Rules applicable to distributions upon severance from 
employment. An employee has a severance from employment when the 
employee ceases to be an employee of the employer maintaining the plan. 
An employee does not have a severance from employment if, in connection 
with a change of employment, the employee's new employer maintains such 
plan with respect to the employee. For example, a new employer maintains 
a plan with respect to an employee by continuing or assuming sponsorship 
of the plan or by accepting a transfer of plan assets and liabilities 
(within the meaning of section 414(l)) with respect to the employee.
    (3) Rules applicable to hardship distributions--(i) Distribution 
must be on account of hardship. A distribution is treated as made after 
an employee's hardship for purposes of paragraph (d)(1)(ii) of this 
section if and only if it is made on account of the hardship. For 
purposes of this rule, a distribution is made on account of hardship 
only if the distribution both is made on account of an immediate and 
heavy financial need of the employee and is necessary to satisfy the 
financial need. The determination of the existence of an immediate and 
heavy financial need and of the amount necessary to meet the need must 
be made in accordance with nondiscriminatory and objective standards set 
forth in the plan.
    (ii) Limit on maximum distributable amount--(A) General rule. A 
distribution on account of hardship must be limited to the maximum 
distributable amount. The maximum distributable amount is equal to the 
employee's total elective contributions as of the date of distribution, 
reduced by the amount of previous distributions of elective 
contributions. Thus, the maximum distributable amount does not include 
earnings, QNECs or QMACs, unless grandfathered under paragraph 
(d)(3)(ii)(B) of this section.
    (B) Grandfathered amounts. If the plan so provides, the maximum 
distributable amount may be increased for amounts credited to the 
employee's account as of a date specified in the plan that is no later 
than December 31, 1988, or if later, the end of the last plan year 
ending before July 1, 1989 (or in the case of a collectively bargained 
plan, the earlier of--
    (1) The later of January 1, 1989, or the date on which the last of 
the collective

[[Page 318]]

bargaining agreements in effect on March 1, 1986 terminates (determined 
without regard to any extension thereof after February 28, 1986); or
    (2) January 1, 1991 and consisting of--
    (i) Income allocable to elective contributions;
    (ii) Qualified nonelective contributions and allocable income; and
    (iii) Qualified matching contributions and allocable income.
    (iii) Immediate and heavy financial need--(A) In general. Whether an 
employee has an immediate and heavy financial need is to be determined 
based on all the relevant facts and circumstances. Generally, for 
example, the need to pay the funeral expenses of a family member would 
constitute an immediate and heavy financial need. A distribution made to 
an employee for the purchase of a boat or television would generally not 
constitute a distribution made on account of an immediate and heavy 
financial need. A financial need may be immediate and heavy even if it 
was reasonably foreseeable or voluntarily incurred by the employee.
    (B) Deemed immediate and heavy financial need. A distribution is 
deemed to be on account of an immediate and heavy financial need of the 
employee if the distribution is for--
    (1) Expenses for (or necessary to obtain) medical care that would be 
deductible under section 213(d) (determined without regard to whether 
the expenses exceed 7.5% of adjusted gross income);
    (2) Costs directly related to the purchase of a principal residence 
for the employee (excluding mortgage payments);
    (3) Payment of tuition, related educational fees, and room and board 
expenses, for up to the next 12 months of post-secondary education for 
the employee, or the employee's spouse, children, or dependents (as 
defined in section 152, and, for taxable years beginning on or after 
January 1, 2005, without regard to section 152(b)(1), (b)(2) and 
(d)(1)(B));
    (4) Payments necessary to prevent the eviction of the employee from 
the employee's principal residence or foreclosure on the mortgage on 
that residence;
    (5) Payments for burial or funeral expenses for the employee's 
deceased parent, spouse, children or dependents (as defined in section 
152, and, for taxable years beginning on or after January 1, 2005, 
without regard to section 152(d)(1)(B)); or
    (6) Expenses for the repair of damage to the employee's principal 
residence that would qualify for the casualty deduction under section 
165 (determined without regard to whether the loss exceeds 10% of 
adjusted gross income).
    (iv) Distribution necessary to satisfy financial need--(A) 
Distribution may not exceed amount of need. A distribution is treated as 
necessary to satisfy an immediate and heavy financial need of an 
employee only to the extent the amount of the distribution is not in 
excess of the amount required to satisfy the financial need. For this 
purpose, the amount required to satisfy the financial need may include 
any amounts necessary to pay any federal, state, or local income taxes 
or penalties reasonably anticipated to result from the distribution.
    (B) No alternative means available. A distribution is not treated as 
necessary to satisfy an immediate and heavy financial need of an 
employee to the extent the need may be relieved from other resources 
that are reasonably available to the employee. This determination 
generally is to be made on the basis of all the relevant facts and 
circumstances. For purposes of this paragraph (d)(3)(iv), the employee's 
resources are deemed to include those assets of the employee's spouse 
and minor children that are reasonably available to the employee. Thus, 
for example, a vacation home owned by the employee and the employee's 
spouse, whether as community property, joint tenants, tenants by the 
entirety, or tenants in common, generally will be deemed a resource of 
the employee. However, property held for the employee's child under an 
irrevocable trust or under the Uniform Gifts to Minors Act (or 
comparable State law) is not treated as a resource of the employee.
    (C) Employer reliance on employee representation. For purposes of 
paragraph

[[Page 319]]

(d)(3)(iv)(B) of this section, an immediate and heavy financial need 
generally may be treated as not capable of being relieved from other 
resources that are reasonably available to the employee, if the employer 
relies upon the employee's representation (made in writing or such other 
form as may be prescribed by the Commissioner), unless the employer has 
actual knowledge to the contrary, that the need cannot reasonably be 
relieved--
    (1) Through reimbursement or compensation by insurance or otherwise;
    (2) By liquidation of the employee's assets;
    (3) By cessation of elective contributions or employee contributions 
under the plan;
    (4) By other currently available distributions (including 
distribution of ESOP dividends under section 404(k)) and nontaxable (at 
the time of the loan) loans, under plans maintained by the employer or 
by any other employer; or
    (5) By borrowing from commercial sources on reasonable commercial 
terms in an amount sufficient to satisfy the need.
    (D) Employee need not take counterproductive actions. For purposes 
of this paragraph (d)(3)(iv), a need cannot reasonably be relieved by 
one of the actions described in paragraph (d)(3)(iv)(C) of this section 
if the effect would be to increase the amount of the need. For example, 
the need for funds to purchase a principal residence cannot reasonably 
be relieved by a plan loan if the loan would disqualify the employee 
from obtaining other necessary financing.
    (E) Distribution deemed necessary to satisfy immediate and heavy 
financial need. A distribution is deemed necessary to satisfy an 
immediate and heavy financial need of an employee if each of the 
following requirements are satisfied--
    (1) The employee has obtained all other currently available 
distributions (including distribution of ESOP dividends under section 
404(k), but not hardship distributions) and nontaxable (at the time of 
the loan) loans, under the plan and all other plans maintained by the 
employer; and
    (2) The employee is prohibited, under the terms of the plan or an 
otherwise legally enforceable agreement, from making elective 
contributions and employee contributions to the plan and all other plans 
maintained by the employer for at least 6 months after receipt of the 
hardship distribution.
    (F) Definition of other plans. For purposes of paragraph 
(d)(3)(iv)(C)(4) and (E)(1) of this section, the phrase plans maintained 
by the employer means all qualified and nonqualified plans of deferred 
compensation maintained by the employer, including a cash or deferred 
arrangement that is part of a cafeteria plan within the meaning of 
section 125. However, it does not include the mandatory employee 
contribution portion of a defined benefit plan or a health or welfare 
benefit plan (including one that is part of a cafeteria plan). In 
addition, for purposes of paragraph (d)(3)(iv)(E)(2) of this section, 
the phrase plans maintained by the employer also includes a stock 
option, stock purchase, or similar plan maintained by the employer. See 
Sec. 1.401(k)-6 for the continued treatment of suspended employees as 
eligible employees.
    (v) Commissioner may expand standards. The Commissioner may 
prescribe additional guidance of general applicability, published in the 
Internal Revenue Bulletin (see Sec. 601.601(d)(2) of this chapter), 
expanding the list of deemed immediate and heavy financial needs and 
prescribing additional methods for distributions to be deemed necessary 
to satisfy an immediate and heavy financial need.
    (4) Rules applicable to distributions upon plan termination--(i) No 
alternative defined contribution plan. A distribution may not be made 
under paragraph (d)(1)(iii) of this section if the employer establishes 
or maintains an alternative defined contribution plan. For purposes of 
the preceding sentence, the definition of the term ``employer'' 
contained in Sec. 1.401(k)-6 is applied as of the date of plan 
termination, and a plan is an alternative defined contribution plan only 
if it is a defined contribution plan that exists at any time during the 
period beginning on the date of plan termination and ending 12 months 
after distribution of all assets from the terminated plan. However, if 
at all times

[[Page 320]]

during the 24-month period beginning 12 months before the date of plan 
termination, fewer than 2% of the employees who were eligible under the 
defined contribution plan that includes the cash or deferred arrangement 
as of the date of plan termination are eligible under the other defined 
contribution plan, the other plan is not an alternative defined 
contribution plan. In addition, a defined contribution plan is not 
treated as an alternative defined contribution plan if it is an employee 
stock ownership plan as defined in section 4975(e)(7) or 409(a), a 
simplified employee pension as defined in section 408(k), a SIMPLE IRA 
plan as defined in section 408(p), a plan or contract that satisfies the 
requirements of section 403(b), or a plan that is described in section 
457(b) or (f).
    (ii) Lump sum requirement for certain distributions. A distribution 
may be made under paragraph (d)(1)(iii) of this section only if it is a 
lump sum distribution. The term lump sum distribution has the meaning 
provided in section 402(e)(4)(D) (without regard to section 
402(e)(4)(D)(i)(I), (II), (III) and (IV)). In addition, a lump sum 
distribution includes a distribution of an annuity contract from a trust 
that is part of a plan described in section 401(a) and which is exempt 
from tax under section 501(a) or an annuity plan described in 403(a).
    (5) Rules applicable to all distributions--(i) Exclusive 
distribution rules. Amounts attributable to elective contributions may 
not be distributed on account of any event not described in this 
paragraph (d), such as completion of a stated period of plan 
participation or the lapse of a fixed number of years. For example, if 
excess deferrals (and income) for an employee's taxable year are not 
distributed within the time prescribed in Sec. 1.402(g)-1(e)(2) or (3), 
the amounts may be distributed only on account of an event described in 
this paragraph (d). Pursuant to section 401(k)(8), the prohibition on 
distributions set forth in this section does not apply to a distribution 
of excess contributions under Sec. 1.401(k)-2(b).
    (ii) Deemed distributions. The cost of life insurance (determined 
under section 72) is not treated as a distribution for purposes of 
section 401(k)(2) and this paragraph (d). The making of a loan is not 
treated as a distribution, even if the loan is secured by the employee's 
accrued benefit attributable to elective contributions or is includible 
in the employee's income under section 72(p). However, the reduction, by 
reason of default on a loan, of an employee's accrued benefit derived 
from elective contributions is treated as a distribution.
    (iii) ESOP dividend distributions. A plan does not fail to satisfy 
the requirements of this paragraph (d) merely by reason of a dividend 
distribution described in section 404(k)(2).
    (iv) Limitations apply after transfer. The limitations of this 
paragraph (d) generally continue to apply to amounts attributable to 
elective contributions (including QNECs and qualified matching 
contributions taken into account for the ADP test under Sec. 1.401(k)-
2(a)(6)) that are transferred to another qualified plan of the same or 
another employer. Thus, the transferee plan will generally fail to 
satisfy the requirements of section 401(a) and this section if 
transferred amounts may be distributed before the times specified in 
this paragraph (d). In addition, a cash or deferred arrangement fails to 
satisfy the limitations of this paragraph (d) if it transfers amounts to 
a plan that does not provide that the transferred amounts may not be 
distributed before the times specified in this paragraph (d). The 
transferor plan does not fail to comply with the preceding sentence if 
it reasonably concludes that the transferee plan provides that the 
transferred amounts may not be distributed before the times specified in 
this paragraph (d). What constitutes a basis for a reasonable conclusion 
is determined under standards comparable to those under the rules 
related to acceptance of rollover distributions. See Sec. 1.401(a)(31)-
1, A-14. The limitations of this paragraph (d) cease to apply after the 
transfer, however, if the amounts could have been distributed at the 
time of the transfer (other than on account of hardship), and the 
transfer is an elective transfer described in Sec. 1.411(d)-4, Q&A-
3(b)(1). The limitations of this paragraph (d) also do not apply to

[[Page 321]]

amounts that have been paid in a direct rollover to the plan after being 
distributed by another plan.
    (6) Examples. The following examples illustrate the application of 
this paragraph (d):

    Example 1. Employer M maintains Plan V, a profit-sharing plan that 
includes a cash or deferred arrangement. Elective contributions under 
the arrangement may be withdrawn for any reason after two years 
following the end of the plan year in which the contributions were made. 
Because the plan permits distributions of elective contributions before 
the occurrence of one of the events specified in section 401(k)(2)(B) 
and this paragraph (d), the cash or deferred arrangement is a 
nonqualified cash or deferred arrangement and the elective contributions 
are currently includible in income under section 402.
    Example 2. (i) Employer N maintains Plan W, a profit-sharing plan 
that includes a cash or deferred arrangement. Plan W provides for 
distributions upon a participant's severance from employment, death or 
disability. All employees of Employer N and its wholly owned subsidiary, 
Employer O, are eligible to participate in Plan W. Employer N agrees to 
sell all issued and outstanding shares of Employer O to an unrelated 
entity, Employer T, effective on December 31, 2006. Following the 
transaction, Employer O will be a wholly owned subsidiary of Employer T. 
Additionally, individuals who are employed by Employer O on the 
effective date of the sale continue to be employed by Employer O 
following the sale. Following the transaction, all employees of Employer 
O will cease to participate in Plan W and will become eligible to 
participate in the cash or deferred arrangement maintained by Employer 
T, Plan X. No assets will be transferred from Plan W to Plan X, except 
in the case of a direct rollover within the meaning of section 
401(a)(31).
    (ii) Employer O ceases to be a member of Employer N's controlled 
group as a result of the sale. Therefore, employees of Employer O who 
participated in Plan W will have a severance from employment and are 
eligible to receive a distribution from Plan W.
    Example 3. (i) Employer Q maintains Plan Y, a profit-sharing plan 
that includes a cash or deferred arrangement. Plan Y, the only plan 
maintained by Employer Q, does not provide for loans. However, Plan Y 
provides that elective contributions under the arrangement may be 
distributed to an eligible employee on account of hardship using the 
deemed immediate and heavy financial need provisions of paragraph 
(d)(3)(iii)(B) of this section and provisions regarding distributions 
necessary to satisfy financial need of paragraphs (d)(3)(iv)(A) through 
(D) of this section. Employee A is an eligible employee in Plan Y with 
an account balance of $50,000 attributable to elective contributions 
made by Employee A. The total amount of elective contributions made by 
Employee A, who has not previously received a distribution from Plan Y, 
is $20,000. Employee A requests a $15,000 hardship distribution of his 
elective contributions to pay 6 months of college tuition and room and 
board expenses for his dependent. At the time of the distribution 
request, the sole asset of Employee A (that is reasonably available to 
Employee A within the meaning of paragraph (d)(3)(iv)(B) of this 
section) is a savings account with an available balance of $10,000.
    (ii) A distribution is made on account of hardship only if the 
distribution both is made on account of an immediate and heavy financial 
need of the employee and is necessary to satisfy the financial need. 
Under paragraph (d)(3)(iii)(B) of this section, a distribution for 
payment of up to the next 12 months of post-secondary education and room 
and board expenses for Employee A's dependent is deemed to be on account 
of an immediate and heavy financial need of Employee A.
    (iii) A distribution is treated as necessary to satisfy Employee A's 
immediate and heavy financial need to the extent the need may not be 
relieved from other resources reasonably available to Employee A. Under 
paragraph (d)(3)(iv)(B) of this section, Employee A's $10,000 savings 
account is a resource that is reasonably available to the employee and 
must be taken into account in determining the amount necessary to 
satisfy Employee A's immediate and heavy financial need. Thus, Employee 
A may receive a distribution of only $5,000 of his elective 
contributions on account of this hardship, plus an amount necessary to 
pay any federal, state, or local income taxes or penalties reasonably 
anticipated to result from the distribution.
    Example 4. (i) The facts are the same as in Example 3. Employee B, 
another employee of Employer Q has an account balance of $25,000, 
attributable to Employee B's elective contributions. The total amount of 
elective contributions made by Employee B, who has not previously 
received a distribution from Plan Y, is $15,000. Employee B requests a 
$10,000 distribution of his elective contributions to pay 6 months of 
college tuition and room and board expenses for his child. Employee B 
makes a written representation (with respect to which Employer Q has no 
actual knowledge to the contrary) that the need cannot reasonably be 
relieved:
    (A) Through reimbursement or compensation by insurance or otherwise;
    (B) By liquidation of the employee's assets;
    (C) By cessation of elective contributions or employee contributions 
under the plan;
    (D) By other distributions or nontaxable (at the time of the loan) 
loans from plans

[[Page 322]]

maintained by the employer or by any other employer; or
    (E) By borrowing from commercial sources on reasonable commercial 
terms in an amount sufficient to satisfy the need.
    (ii) Under paragraph (d)(3)(iii)(B) of this section, a distribution 
for payment of up to the next 12 months of post-secondary education and 
room and board expenses for Employee B's child is deemed to be on 
account of an Employee B's immediate and heavy financial need. In 
addition, because Employer Q can rely on Employee B's written 
representation, the distribution is considered necessary to satisfy 
Employee B's immediate and heavy financial need. Therefore, Employee B 
may receive a $10,000 distribution of his elective contributions on 
account of hardship plus an amount necessary to pay any federal, state, 
or local income taxes or penalties reasonably anticipated to result from 
the distribution.
    Example 5. (i) The facts are the same as in Example 3, except Plan Y 
provides for hardship distributions using the safe harbor rule of 
paragraph (d)(3)(iv)(E) of this section. Accordingly, Plan Y provides 
for a 6 month suspension of an eligible employee's elective 
contributions and employee contributions to the plan after the receipt 
of a hardship distribution by such eligible employee.
    (ii) Under paragraph (d)(3)(iii)(B) of this section, a distribution 
for payment of up to the next 12 months of post-secondary education and 
room and board expenses for Employee A's dependent is deemed to be on 
account of an Employee A's immediate and heavy financial need. In 
addition, because Employee A is not eligible for any other distribution 
or loan from Plan Y and Plan Y suspends Employee A's elective 
contributions and employee contributions following receipt of the 
hardship distribution, the distribution will be deemed necessary to 
satisfy Employee A's immediate and heavy financial need (and Employee A 
is not required to first liquidate his savings account). Therefore, 
Employee A may receive a $15,000 distribution of his elective 
contributions on account of hardship plus an amount necessary to pay any 
federal, state, or local income taxes or penalties reasonably 
anticipated to result from the distribution.
    Example 6. Employer R maintains a pre-ERISA money purchase pension 
plan that includes a cash or deferred arrangement that is not a rural 
cooperative plan. Elective contributions under the arrangement may be 
distributed to an employee on account of hardship. Under paragraph 
(d)(1) of this section, hardship is a permissible distribution event 
only in a profit-sharing, stock bonus or rural cooperative plan. Since 
elective contributions under the arrangement may be distributed before a 
permissible distribution event occurs, the cash or deferred arrangement 
does not satisfy this paragraph (d), and is not a qualified cash or 
deferred arrangement. Moreover, the plan is not a qualified plan because 
a money purchase pension plan may not provide for payment of benefits 
upon hardship. See Sec. 1.401-1(b)(1)(i).

    (e) Additional requirements for qualified cash or deferred 
arrangements--(1) Qualified plan requirement. A cash or deferred 
arrangement satisfies this paragraph (e) only if the plan of which it is 
a part is a profit-sharing, stock bonus, pre-ERISA money purchase or 
rural cooperative plan that otherwise satisfies the requirements of 
section 401(a) (taking into account the cash or deferred arrangement). A 
plan that includes a cash or deferred arrangement may provide for other 
contributions, including employer contributions (other than elective 
contributions), employee contributions, or both. However, except as 
expressly permitted under section 401(m), 410(b)(2)(A)(ii) or 
416(c)(2)(A), elective contributions and matching contributions taken 
into account under Sec. 1.401(k)-2(a) may not be taken into account for 
purposes of determining whether any other contributions under any plan 
(including the plan to which the contributions are made) satisfy the 
requirements of section 401(a).
    (2) Election requirements--(i) Cash must be available. A cash or 
deferred arrangement satisfies this paragraph (e) only if the 
arrangement provides that the amount that each eligible employee may 
defer as an elective contribution is available to the employee in cash. 
Thus, for example, if an eligible employee is provided the option to 
receive a taxable benefit (other than cash) or to have the employer 
contribute on the employee's behalf to a profit-sharing plan an amount 
equal to the value of the taxable benefit, the arrangement is not a 
qualified cash or deferred arrangement. Similarly, if an employee has 
the option to receive a specified amount in cash or to have the employer 
contribute an amount in excess of the specified cash amount to a profit-
sharing plan on the employee's behalf, any contribution made by the 
employer on the employee's behalf in excess of the specified cash amount 
is not treated as made pursuant to a qualified cash or deferred 
arrangement, but

[[Page 323]]

would be treated as a matching contribution. This cash availability 
requirement applies even if the cash or deferred arrangement is part of 
a cafeteria plan within the meaning of section 125.
    (ii) Frequency of elections. A cash or deferred arrangement 
satisfies this paragraph (e) only if the arrangement provides an 
employee with an effective opportunity to make (or change) a cash or 
deferred election at least once during each plan year. Whether an 
employee has an effective opportunity is determined based on all the 
relevant facts and circumstances, including the adequacy of notice of 
the availability of the election, the period of time during which an 
election may be made, and any other conditions on elections.
    (3) Separate accounting requirement--(i) General rule. A cash or 
deferred arrangement satisfies this paragraph (e) only if the portion of 
an employee's benefit subject to the requirements of paragraphs (c) and 
(d) of this section is determined by an acceptable separate accounting 
between that portion and any other benefits. Separate accounting is not 
acceptable unless contributions and withdrawals are attributed to the 
separate accounts and gains, losses, and other credits or charges are 
separately allocated on a reasonable and consistent basis to the 
accounts subject to the requirements of paragraphs (c) and (d) of this 
section and to other accounts. Subject to section 401(a)(4), forfeitures 
are not required to be allocated to the accounts in which benefits are 
subject to paragraphs (c) and (d) of this section. The separate 
accounting requirement of this paragraph (e)(3)(i) applies at the time 
the elective contribution is contributed to the plan and continues to 
apply until the contribution is distributed under the plan.
    (ii) Satisfaction of separate accounting requirement. The 
requirements of paragraph (e)(3)(i) of this section are treated as 
satisfied if all amounts held under a plan that includes a qualified 
cash or deferred arrangement (and, if applicable, under another plan to 
which QNECs and QMACs are made) are subject to the requirements of 
paragraphs (c) and (d) of this section.
    (4) Limitations on cash or deferred arrangements of state and local 
governments--(i) General rule. A cash or deferred arrangement does not 
satisfy the requirements of this paragraph (e) if the arrangement is 
adopted after May 6, 1986, by a State or local government or political 
subdivision thereof, or any agency or instrumentality thereof (a 
governmental unit). For purposes of this paragraph (e)(4), an employer 
that has made a legally binding commitment to adopt a cash or deferred 
arrangement is treated as having adopted the arrangement on that date.
    (ii) Rural cooperative plans and Indian tribal governments. This 
paragraph (e)(4) does not apply to a rural cooperative plan or to a plan 
of an employer which is an Indian tribal government (as defined in 
section 7701(a)(40)), a subdivision of an Indian tribal government 
(determined in accordance with section 7871(d)), an agency or 
instrumentality of an Indian tribal government or subdivision thereof, 
or a corporation chartered under Federal, State or tribal law which is 
owned in whole or in part by any of the entities in this paragraph 
(e)(4)(ii).
    (iii) Adoption after May 6, 1986. A cash or deferred arrangement is 
treated as adopted after May 6, 1986, with respect to all employees of 
any employer that adopts the arrangement after such date.
    (iv) Adoption before May 7, 1986. If a governmental unit adopted a 
cash or deferred arrangement before May 7, 1986, then any cash or 
deferred arrangement adopted by the unit at any time is treated as 
adopted before that date. If an employer adopted an arrangement prior to 
such date, all employees of the employer may participate in the 
arrangement.
    (5) One-year eligibility requirement. A cash or deferred arrangement 
satisfies this paragraph (e) only if no employee is required to complete 
a period of service with the employer maintaining the plan extending 
beyond the period permitted under section 410(a)(1) (determined without 
regard to section 410(a)(1)(B)(i)) to be eligible to make a cash or 
deferred election under the arrangement.
    (6) Other benefits not contingent upon elective contributions--(i) 
General rule. A cash or deferred arrangement satisfies

[[Page 324]]

this paragraph (e) only if no other benefit is conditioned (directly or 
indirectly) upon the employee's electing to make or not to make elective 
contributions under the arrangement. The preceding sentence does not 
apply to--
    (A) Any matching contribution (as defined in Sec. 1.401(m)-1(a)(2)) 
made by reason of such an election;
    (B) Any benefit, right or feature (such as a plan loan) that 
requires, or results in, an amount to be withheld from an employee's pay 
(e.g. to pay for the benefit or to repay the loan), to the extent the 
cash or deferred arrangement restricts elective contributions to amounts 
available after such withholding from the employee's pay (after 
deduction of all applicable income and employment taxes);
    (C) Any reduction in the employer's top-heavy contributions under 
section 416(c)(2) because of matching contributions that resulted from 
the elective contributions; or
    (D) Any benefit that is provided at the employee's election under a 
plan described in section 125(d) in lieu of an elective contribution 
under a qualified cash or deferred arrangement.
    (ii) Definition of other benefits. For purposes of this paragraph 
(e)(6), other benefits include, but are not limited to, benefits under a 
defined benefit plan; nonelective contributions under a defined 
contribution plan; the availability, cost, or amount of health benefits; 
vacations or vacation pay; life insurance; dental plans; legal services 
plans; loans (including plan loans); financial planning services; 
subsidized retirement benefits; stock options; property subject to 
section 83; and dependent care assistance. Also, increases in salary, 
bonuses or other cash remuneration (other than the amount that would be 
contributed under the cash or deferred election) are benefits for 
purposes of this paragraph (e)(6). The ability to make after-tax 
employee contributions is a benefit, but that benefit is not contingent 
upon an employee's electing to make or not make elective contributions 
under the arrangement merely because the amount of elective 
contributions reduces dollar-for-dollar the amount of after-tax employee 
contributions that may be made. Additionally, benefits under any other 
plan or arrangement (whether or not qualified) are not contingent upon 
an employee's electing to make or not to make elective contributions 
under a cash or deferred arrangement merely because the elective 
contributions are or are not taken into account as compensation under 
the other plan or arrangement for purposes of determining benefits.
    (iii) Effect of certain statutory limits. Any benefit under an 
excess benefit plan described in section 3(36) of the Employee 
Retirement Income Security Act of 1974 (88 Stat. 829), Public Law 93-
406, that is dependent on the employee's electing to make or not to make 
elective contributions is not treated as contingent. Deferred 
compensation under a nonqualified plan of deferred compensation that is 
dependent on an employee's having made the maximum elective deferrals 
under section 402(g) or the maximum elective contributions permitted 
under the terms of the plan also is not treated as contingent.
    (iv) Nonqualified deferred compensation. Except as otherwise 
provided in paragraph (e)(6)(iii) of this section, participation in a 
nonqualified deferred compensation plan is treated as contingent for 
purposes of this paragraph (e)(6) to the extent that an employee may 
receive additional deferred compensation under the nonqualified plan to 
the extent the employee makes or does not make elective contributions.
    (v) Plan loans and distributions. A loan or distribution of elective 
contributions is not a benefit conditioned on an employee's electing to 
make or not make elective contributions under the arrangement merely 
because the amount of the loan or distribution is based on the amount of 
the employee's account balance.
    (vi) Examples. The following examples illustrate the application of 
this paragraph (e)(6):

    Example 1. Employer T maintains a cash or deferred arrangement for 
all of its employees. Employer T also maintains a nonqualified deferred 
compensation plan for two highly paid executives, Employees R and C. 
Under the terms of the nonqualified deferred compensation plan, R and C 
are eligible to participate only if they do not make elective 
contributions under the cash or deferred arrangement. Participation in 
the nonqualified plan is a contingent benefit for purposes of

[[Page 325]]

this paragraph (e)(6), because R's and C's participation is conditioned 
on their electing not to make elective contributions under the cash or 
deferred arrangement.
    Example 2. Employer T maintains a cash or deferred arrangement for 
all its employees. Employer T also maintains a nonqualified deferred 
compensation plan for two highly paid executives, Employees R and C. 
Under the terms of the arrangements, Employees R and C may defer a 
maximum of 10% of their compensation, and may allocate their deferral 
between the cash or deferred arrangement and the nonqualified deferred 
compensation plan in any way they choose (subject to the overall 10% 
maximum). Because the maximum deferral available under the nonqualified 
deferred compensation plan depends on the elective deferrals made under 
the cash or deferred arrangement, the right to participate in the 
nonqualified plan is a contingent benefit for purposes of this paragraph 
(e)(6).

    (7) Plan provision requirement. A plan that includes a cash or 
deferred arrangement satisfies this paragraph (e) only if it provides 
that the nondiscrimination requirements of section 401(k) will be met. 
Thus, the plan must provide for satisfaction of one of the specific 
alternatives described in paragraph (b)(1)(ii) of this section and, if 
with respect to that alternative there are optional choices, which of 
the optional choices will apply. For example, a plan that uses the ADP 
test of section 401(k)(3), as described in paragraph (b)(1)(ii)(A) of 
this section, must specify whether it is using the current year testing 
method or prior year testing method. Additionally, a plan that uses the 
prior year testing method must specify whether the ADP for eligible 
NHCEs for the first plan year is 3% or the ADP for the eligible NHCEs 
for the first plan year. Similarly, a plan that uses the safe harbor 
method of section 401(k)(12), as described in paragraph (b)(1)(ii)(B) of 
this section, must specify whether the safe harbor contribution will be 
the nonelective safe harbor contribution or the matching safe harbor 
contribution and is not permitted to provide that ADP testing will be 
used if the requirements for the safe harbor are not satisfied. In 
addition, a plan that uses the safe harbor method of section 401(k)(13), 
as described in paragraph (b)(1)(ii)(C) of this section, must specify 
the default percentages that apply for the plan year and whether the 
safe harbor contribution will be the nonelective safe harbor 
contribution or the matching safe harbor contribution, and is not 
permitted to provide that ADP testing will be used if the requirements 
for the safe harbor are not satisfied. For purposes of this paragraph 
(e)(7), a plan may incorporate by reference the provisions of section 
401(k)(3) and Sec. 1.401(k)-2 if that is the nondiscrimination test 
being applied. The Commissioner may, in guidance of general 
applicability, published in the Internal Revenue Bulletin (see Sec. 
601.601(d)(2) of this chapter), specify the options that will apply 
under the plan if the nondiscrimination test is incorporated by 
reference in accordance with the preceding sentence.
    (8) Section 415 compensation required. With respect to compensation 
that is paid (or would have been paid but for a cash or deferred 
election) in plan years beginning on or after July 1, 2007, a cash or 
deferred arrangement satisfies this paragraph (e) only if cash or 
deferred elections can only be made with respect to amounts that are 
compensation within the meaning of section 415(c)(3) and Sec. 1.415(c)-
2. Thus, for example, the arrangement is not a qualified cash or 
deferred arrangement if an eligible employee who is not in qualified 
military service (as that term is defined in section 414(u)) and who is 
not permanently and totally disabled (as defined in section 22(e)(3)) 
can make a cash or deferred election with respect to an amount paid 
after severance from employment, unless the amount is paid by the later 
of 2\1/2\ months after severance from employment or the end of the year 
that includes the date of severance from employment and is described in 
Sec. 1.415(c)-2(e)(3)(ii) or (iii).
    (f) Special rules for designated Roth contributions--(1) In general. 
The term designated Roth contribution means an elective contribution 
under a qualified cash or deferred arrangement that, to the extent 
permitted under the plan, is--
    (i) Designated irrevocably by the employee at the time of the cash 
or deferred election as a designated Roth contribution that is being 
made in lieu of all or a portion of the pre-tax elective contributions 
the employee is otherwise eligible to make under the plan;

[[Page 326]]

    (ii) Treated by the employer as not excludible from the employee's 
gross income (in accordance with paragraph (f)(2) of this section);
    (iii) Maintained by the plan in a separate account (in accordance 
with paragraph (f)(3) of this section).
    (2) Inclusion treatment. An elective contribution is generally 
treated as not excludible from gross income if it is treated as 
includible in gross income by the employer (e.g., by treating the 
contribution as wages subject to applicable income tax withholding). 
However, in the case of a self-employed individual, an elective 
contribution is treated as not excludible from gross income only if the 
individual does not claim a deduction for such amount. If an elective 
contribution would not have been includible in gross income if the 
amount had been paid directly to the employee (rather than being subject 
to a cash or deferral election), the elective contribution is 
nevertheless permitted to be a designated Roth contribution, provided 
the employee is entitled to treat the amount as an investment in the 
contract pursuant to section 72(f)(2).
    (3) Separate accounting required. Under the separate accounting 
requirement of this paragraph (f)(3), contributions and withdrawals of 
designated Roth contributions must be credited and debited to a 
designated Roth account maintained for the employee and the plan must 
maintain a record of the employee's investment in the contract (that is, 
designated Roth contributions that have not been distributed) with 
respect to the employee's designated Roth account. In addition, gains, 
losses, and other credits or charges must be separately allocated on a 
reasonable and consistent basis to the designated Roth account and other 
accounts under the plan. However, forfeitures may not be allocated to 
the designated Roth account and no contributions other than designated 
Roth contributions and rollover contributions described in section 
402A(c)(3)(B) may be allocated to such account. The separate accounting 
requirement applies at the time the designated Roth contribution is 
contributed to the plan and must continue to apply until the designated 
Roth account is completely distributed. A-13 of Sec. 1.402A-1 for 
additional requirements for separate accounting.
    (4) Designated Roth contributions must satisfy rules applicable to 
elective contributions--(i) In general. A designated Roth contribution 
must satisfy the requirements applicable to elective contributions made 
under a qualified cash or deferred arrangement. Thus, for example, a 
designated Roth contribution must satisfy the requirements of paragraphs 
(c) and (d) of this section and is treated as an employer contribution 
for purposes of sections 401(a), 401(k), 402, 404, 409, 411, 412, 415, 
416 and 417. In addition, the designated Roth contributions are treated 
as elective contributions for purposes of the ADP test. Similarly, the 
designated Roth account under the plan is subject to the rules of 
section 401(a)(9)(A) and (B) in the same manner as an account that 
contains pre-tax elective contributions.
    (ii) Special rules for direct rollovers. A direct rollover from a 
designated Roth account under a qualified cash or deferred arrangement 
may only be made to another designated Roth account under an applicable 
retirement plan described in section 402A(e)(1) or to a Roth IRA 
described in section 408A, and only to the extent the rollover is 
permitted under the rules of section 402(c). Moreover, a participant's 
designated Roth account and the participant's other accounts under a 
plan are treated as accounts held under two separate plans (within the 
meaning of section 414(l)) for purposes of applying the automatic 
rollover rules for mandatory distributions under section 
401(a)(31)(B)(i)(I) and the special rules in A-9 through A-11 of Sec. 
1.401(a)(31)-1.
    (5) Rules regarding designated Roth contribution elections--(i) 
Frequency of elections. The rules under paragraph (e)(2)(ii) of this 
section regarding frequency of elections apply in the same manner to 
both pre-tax elective contributions and designated Roth contributions. 
Thus, an employee must have an effective opportunity to make (or change) 
an election to make designated Roth contributions at least once during 
each plan year.
    (ii) Default elections--(A) In the case of a plan that provides for 
both pre-tax elective contributions and designated Roth contributions 
and in which, under

[[Page 327]]

paragraph (a)(3)(ii) of this section, the default in the absence of an 
affirmative election is to make a contribution under the cash or 
deferred arrangement, the plan terms must provide the extent to which 
the default contributions are pre-tax elective contributions and the 
extent to which the default contributions are designated Roth 
contributions.
    (B) If the default contributions under the plan are designated Roth 
contributions, then an employee who has not made an affirmative election 
is deemed to have irrevocably designated the contributions (in 
accordance with section 402A(c)(1)(B)) as designated Roth contributions.
    (6) Effective date. Section 402A and the provisions of this section 
1.401(k)-1(f) apply to taxable years beginning after December 31, 2005.
    (g) Effective dates--(1) General rule. Except as otherwise provided 
in this paragraph (g), this section and Sec. Sec. 1.401(k)-2 through 
1.401(k)-6 apply to plan years that begin on or after January 1, 2006.
    (2) Early implementation permitted. A plan is permitted to apply the 
rules of this section and Sec. Sec. 1.401(k)-2 through 1.401(k)-6 to 
any plan year that ends after December 29, 2004, provided the plan 
applies all the rules of this section and Sec. Sec. 1.401(k)-2 through 
1.401(k)-6 and all the rules of Sec. Sec. 1.401(m)-1 through 1.401(m)-
5, to the extent applicable, for that plan year and all subsequent plan 
years.
    (3) Collectively bargained plans. In the case of a plan maintained 
pursuant to one or more collective bargaining agreements between 
employee representatives and one or more employers in effect on the date 
described in paragraph (g)(1) of this section, the provisions of this 
section and Sec. Sec. 1.401(k)-2 through 1.401(k)-6 apply to the later 
of the first plan year beginning after the termination of the last such 
agreement or the first plan year described in paragraph (g)(1) of this 
section.
    (4) Applicability of prior regulations. For any plan year before a 
plan applies this section and Sec. Sec. 1.401(k)-2 through 1.401(k)-6 
(either the first plan year beginning on or after January 1, 2006, or 
such earlier year, as provided in paragraph (g)(2) of this section), 
Sec. 1.401(k)-1 (as it appeared in the April 1, 2004 edition of 26 CFR 
part 1) applies to the plan to the extent that section, as it so 
appears, reflects the statutory provisions of section 401(k) as in 
effect for the relevant year.

[T.D. 9169, 69 FR 78154, Dec. 29, 2004, as amended by T.D. 9237, 71 FR 9 
Jan. 3, 2006; T.D. 9319, 72 FR 16894, Apr. 5, 2007; T.D. 9324, 72 FR 
21109, Apr. 30, 2007; T.D. 9447, 74 FR 8207, Feb. 24, 2009]



Sec. 1.401(k)-2  ADP test.

    (a) Actual deferral percentage (ADP) test--(1) In general--(i) ADP 
test formula. A cash or deferred arrangement satisfies the ADP test for 
a plan year only if--
    (A) The ADP for the eligible HCEs for the plan year is not more than 
the ADP for the eligible NHCEs for the applicable year multiplied by 
1.25; or
    (B) The excess of the ADP for the eligible HCEs for the plan year 
over the ADP for the eligible NHCEs for the applicable year is not more 
than 2 percentage points, and the ADP for the eligible HCEs for the plan 
year is not more than the ADP for the eligible NHCEs for the applicable 
year multiplied by 2.
    (ii) HCEs as sole eligible employees. If, for the applicable year 
for determining the ADP of the NHCEs for a plan year, there are no 
eligible NHCEs (i.e., all of the eligible employees under the cash or 
deferred arrangement for the applicable year are HCEs), the arrangement 
is deemed to satisfy the ADP test for the plan year.
    (iii) Special rule for early participation. If a cash or deferred 
arrangement provides that employees are eligible to participate before 
they have completed the minimum age and service requirements of section 
410(a)(1)(A), and if the plan applies section 410(b)(4)(B) in 
determining whether the cash or deferred arrangement meets the 
requirements of section 410(b)(1), then in determining whether the 
arrangement meets the requirements under paragraph (a)(1) of this 
section, either--
    (A) Pursuant to section 401(k)(3)(F), the ADP test is performed 
under the plan (determined without regard to disaggregation under Sec. 
1.410(b)-7(c)(3)), using the ADP for all eligible HCEs for

[[Page 328]]

the plan year and the ADP of eligible NHCEs for the applicable year, 
disregarding all NHCEs who have not met the minimum age and service 
requirements of section 410(a)(1)(A); or
    (B) Pursuant to Sec. 1.401(k)-1(b)(4), the plan is disaggregated 
into separate plans and the ADP test is performed separately for all 
eligible employees who have completed the minimum age and service 
requirements of section 410(a)(1)(A) and for all eligible employees who 
have not completed the minimum age and service requirements of section 
410(a)(1)(A).
    (2) Determination of ADP--(i) General rule. The ADP for a group of 
eligible employees (either eligible HCEs or eligible NHCEs) for a plan 
year or applicable year is the average of the ADRs of the eligible 
employees in that group for that year. The ADP for a group of eligible 
employees is calculated to the nearest hundredth of a percentage point.
    (ii) Determination of applicable year under current year and prior 
year testing method. The ADP test is applied using the prior year 
testing method or the current year testing method. Under the prior year 
testing method, the applicable year for determining the ADP for the 
eligible NHCEs is the plan year immediately preceding the plan year for 
which the ADP test is being performed. Under the prior year testing 
method, the ADP for the eligible NHCEs is determined using the ADRs for 
the eligible employees who were NHCEs in that preceding plan year, 
regardless of whether those NHCEs are eligible employees or NHCEs in the 
plan year for which the ADP test is being calculated. Under the current 
year testing method, the applicable year for determining the ADP for the 
eligible NHCEs is the same plan year as the plan year for which the ADP 
test is being performed. Under either method, the ADP for eligible HCEs 
is the average of the ADRs of the eligible HCEs for the plan year for 
which the ADP test is being performed. See paragraph (c) of this section 
for additional rules for the prior year testing method.
    (3) Determination of ADR--(i) General rule. The ADR of an eligible 
employee for a plan year or applicable year is the sum of the employee's 
elective contributions taken into account with respect to such employee 
for the year, determined under the rules of paragraphs (a)(4) and (5) of 
this section, and the qualified nonelective contributions and qualified 
matching contributions taken into account with respect to such employee 
under paragraph (a)(6) of this section for the year, divided by the 
employee's compensation taken into account for the year. The ADR is 
calculated to the nearest hundredth of a percentage point. If no 
elective contributions, qualified nonelective contributions, or 
qualified matching contributions are taken into account under this 
section with respect to an eligible employee for the year, the ADR of 
the employee is zero.
    (ii) ADR of HCEs eligible under more than one arrangement--(A) 
General rule. Pursuant to section 401(k)(3)(A), the ADR of an HCE who is 
an eligible employee in more than one cash or deferred arrangement of 
the same employer is calculated by treating all contributions with 
respect to such HCE under any such arrangement as being made under the 
cash or deferred arrangement being tested. Thus, the ADR for such an HCE 
is calculated by accumulating all contributions under any cash or 
deferred arrangement (other than a cash or deferred arrangement 
described in paragraph (a)(3)(ii)(B) of this section) that would be 
taken into account under this section for the plan year, if the cash or 
deferred arrangement under which the contribution was made applied this 
section and had the same plan year. For example, in the case of a plan 
with a 12-month plan year, the ADR for the plan year of that plan for an 
HCE who participates in multiple cash or deferred arrangements of the 
same employer is the sum of all contributions during such 12-month 
period that would be taken into account with respect to the HCE under 
all such arrangements in which the HCE is an eligible employee, divided 
by the HCE's compensation for that 12-month period (determined using the 
compensation definition for the plan being tested), without regard to 
the plan year of the other plans and whether those plans are satisfying 
this section or Sec. 1.401(k)-3.

[[Page 329]]

    (B) Plans not permitted to be aggregated. Cash or deferred 
arrangements under plans that are not permitted to be aggregated under 
Sec. 1.401(k)-1(b)(4) (determined without regard to the prohibition on 
aggregating plans with inconsistent testing methods set forth in Sec. 
1.401(k)-1(b)(4)(iii)(B) and the prohibition on aggregating plans with 
different plan years set forth in Sec. 1.410(b)-7(d)(5)) are not 
aggregated under this paragraph (a)(3)(ii).
    (iii) Examples. The following examples illustrate the application of 
this paragraph (a)(3):

    Example 1. (i) Employee A, an HCE with compensation of $120,000, is 
eligible to make elective contributions under Plan S and Plan T, two 
profit-sharing plans maintained by Employer H with calendar year plan 
years, each of which includes a cash or deferred arrangement. During the 
current plan year, Employee A makes elective contributions of $6,000 to 
Plan S and $4,000 to Plan T.
    (ii) Under each plan, the ADR for Employee A is determined by 
dividing Employee A's total elective contributions under both 
arrangements by Employee A's compensation taken into account under the 
plan for the year. Therefore, Employee A's ADR under each plan is 8.33% 
($10,000/$120,000).
    Example 2. (i) The facts are the same as in Example 1, except that 
Plan T defines compensation (for deferral and testing purposes) to 
exclude all bonuses paid to an employee. Plan S defines compensation 
(for deferral and testing purposes) to include bonuses paid to an 
employee. During the current year, Employee A's compensation included a 
$10,000 bonus. Therefore, Employee A's compensation under Plan T is 
$110,000 and Employee A's compensation under Plan S is $120,000.
    (ii) Employee A's ADR under Plan T is 9.09% ($10,000/$110,000) and 
under Plan S, Employee A's ADR is 8.33% ($10,000/$120,000).
    Example 3. (i) Employer J sponsors two profit-sharing plans, Plan U 
and Plan V, each of which includes a cash or deferred arrangement. Plan 
U's plan year begins on July 1 and ends on June 30. Plan V has a 
calendar year plan year. Compensation under both plans is limited to the 
participant's compensation during the period of participation. Employee 
B is an HCE who participates in both plans. Employee B's monthly 
compensation and elective contributions to each plan for the 2005 and 
2006 calendar years are as follows:

------------------------------------------------------------------------
                                                 Monthly       Monthly
                                   Monthly      elective      elective
         Calendar year          compensation  contribution  contribution
                                                to Plan U     to Plan V
------------------------------------------------------------------------
2005..........................      $10,000          $500          $400
2006..........................       11,500           700           550
------------------------------------------------------------------------

    (ii) Under Plan U, Employee B's ADR for the plan year ended June 30, 
2006, is equal to Employee B's total elective contributions under Plan U 
and Plan V for the plan year ending June 30, 2006, divided by Employee 
B's compensation for that period. Therefore, Employee B's ADR under Plan 
U for the plan year ending June 30, 2006, is (($900 x 6) + ($1,250 x 6)) 
/ (($10,000 x 6) + ($11,500 x 6)), or 10%.
    (iii) Under Plan V, Employee B's ADR for the plan year ended 
December 31, 2005, is equal to total elective contributions under Plan U 
and V for the plan year ending December 31, 2005, divided by Employee 
B's compensation for that period. Therefore, Employee B's ADR under Plan 
V for the plan year ending December 31, 2005, is ($10,800/$120,000), or 
9%.
    Example 4. (i) The facts are the same as Example 3, except that 
Employee B first becomes eligible to participate in Plan U on January 1, 
2006.
    (ii) Under Plan U, Employee B's ADR for the plan year ended June 30, 
2006, is equal to Employee B's total elective contributions under Plan U 
and V for the plan year ending June 30, 2006, divided by Employee B's 
compensation for that period. Therefore, Employee B's ADR under Plan U 
for the plan year ending June 30, 2006, is (($400 x 6) + ($1,250 x 6)) / 
(($10,000 x 6) + ($11,500 x 6)), or 7.67%.

    (4) Elective contributions taken into account under the ADP test--
(i) General rule. An elective contribution is taken into account in 
determining the ADR for an eligible employee for a plan year or 
applicable year only if each of the following requirements is 
satisfied--
    (A) The elective contribution is allocated to the eligible 
employee's account under the plan as of a date within that year. For 
purposes of this rule, an elective contribution is considered allocated 
as of a date within a year only if--
    (1) The allocation is not contingent on the employee's participation 
in the plan or performance of services on any date subsequent to that 
date; and
    (2) The elective contribution is actually paid to the trust no later 
than the end of the 12-month period immediately following the year to 
which the contribution relates.

[[Page 330]]

    (B) The elective contribution relates to compensation that either--
    (1) Would have been received by the employee in the year but for the 
employee's election to defer under the arrangement; or
    (2) Is attributable to services performed by the employee in the 
year and, but for the employee's election to defer, would have been 
received by the employee within 2\1/2\ months after the close of the 
year, but only if the plan provides for elective contributions that 
relate to compensation that would have been received after the close of 
a year to be allocated to such prior year rather than the year in which 
the compensation would have been received.
    (ii) Elective contributions for partners and self-employed 
individuals. For purposes of this paragraph (a)(4), a partner's 
distributive share of partnership income is treated as received on the 
last day of the partnership taxable year and a sole proprietor's 
compensation is treated as received on the last day of the individual's 
taxable year. Thus, an elective contribution made on behalf of a partner 
or sole proprietor is treated as allocated to the partner's account for 
the plan year that includes the last day of the partnership taxable 
year, provided the requirements of paragraph (a)(4)(i) of this section 
are met.
    (iii) Elective contributions for HCEs. Elective contributions of an 
HCE must include any excess deferrals, as described in Sec. 1.402(g)-
1(a), even if those excess deferrals are distributed, pursuant to Sec. 
1.402(g)-1(e).
    (5) Elective contributions not taken into account under the ADP 
test--(i) General rule. Elective contributions that do not satisfy the 
requirements of paragraph (a)(4)(i) of this section may not be taken 
into account in determining the ADR of an eligible employee for the plan 
year or applicable year with respect to which the contributions were 
made, or for any other plan year. Instead, the amount of the elective 
contributions must satisfy the requirements of section 401(a)(4) 
(without regard to the ADP test) for the plan year for which they are 
allocated under the plan as if they were nonelective contributions and 
were the only nonelective contributions for that year. See Sec. Sec. 
1.401(a)(4)-1(b)(2)(ii)(B) and 1.410(b)-7(c)(1).
    (ii) Elective contributions for NHCEs. Elective contributions of an 
NHCE shall not include any excess deferrals, as described in Sec. 
1.402(g)-1(a), to the extent the excess deferrals are prohibited under 
section 401(a)(30). However, to the extent that the excess deferrals are 
not prohibited under section 401(a)(30), they are included in elective 
contributions even if distributed pursuant to Sec. 1.402(g)-1(e).
    (iii) Elective contributions treated as catch-up contributions. 
Elective contributions that are treated as catch-up contributions under 
section 414(v) because they exceed a statutory limit or employer-
provided limit (within the meaning of Sec. 1.414(v)-1(b)(1)) are not 
taken into account under paragraph (a)(4) of this section for the plan 
year for which the contributions were made, or for any other plan year.
    (iv) Elective contributions used to satisfy the ACP test. Except to 
the extent necessary to demonstrate satisfaction of the requirement of 
Sec. 1.401(m)-2(a)(6)(ii), elective contributions taken into account 
for the ACP test under Sec. 1.401(m)-2(a)(6) are not taken into account 
under paragraph (a)(4) of this section.
    (v) Additional elective contributions pursuant to section 414(u). 
Additional elective contributions made pursuant to section 414(u) by 
reason of an eligible employee's qualified military service are not 
taken into account under paragraph (a)(4) of this section for the plan 
year for which the contributions are made, or for any other plan year.
    (vi) Default elective contributions pursuant to section 414(w). 
Default elective contributions made under an eligible automatic 
contribution arrangement (within the meaning of Sec. 1.414(w)-1(b)) 
that are distributed pursuant to Sec. 1.414(w)-1(c) for plan years 
beginning on or after January 1, 2008, are not taken into account under 
paragraph (a)(4) of this section for the plan year for which the 
contributions are made, or for any other plan year.
    (6) Qualified nonelective contributions and qualified matching 
contributions that may be taken into account under the ADP

[[Page 331]]

test. Qualified nonelective contributions and qualified matching 
contributions may be taken into account in determining the ADR for an 
eligible employee for a plan year or applicable year but only to the 
extent the contributions satisfy the following requirements--
    (i) Timing of allocation. The qualified nonelective contribution or 
qualified matching contribution is allocated to the employee's account 
as of a date within that year within the meaning of paragraph 
(a)(4)(i)(A) of this section. Consequently, under the prior year testing 
method, in order to be taken into account in calculating the ADP for the 
eligible NHCEs for the applicable year, a qualified nonelective 
contribution or qualified matching contribution must be contributed no 
later than the end of the 12-month period immediately following the 
applicable year even though the applicable year is different than the 
plan year being tested.
    (ii) Requirement that amount satisfy section 401(a)(4). The amount 
of nonelective contributions, including those qualified nonelective 
contributions taken into account under this paragraph (a)(6) and those 
qualified nonelective contributions taken into account for the ACP test 
of section 401(m)(2) under Sec. 1.401(m)-2(a)(6), satisfies the 
requirements of section 401(a)(4). See Sec. 1.401(a)(4)-1(b)(2). The 
amount of nonelective contributions, excluding those qualified 
nonelective contributions taken into account under this paragraph (a)(6) 
and those qualified nonelective contributions taken into account for the 
ACP test of section 401(m)(2) under Sec. 1.401(m)-2(a)(6), satisfies 
the requirements of section 401(a)(4). See Sec. 1.401(a)(4)-1(b)(2). In 
the case of an employer that is applying the special rule for employer-
wide plans in Sec. 1.414(r)-1(c)(2)(ii) with respect to the cash or 
deferred arrangement, the determination of whether the qualified 
nonelective contributions satisfy the requirements of this paragraph 
(a)(6)(ii) must be made on an employer-wide basis regardless of whether 
the plans to which the qualified nonelective contributions are made are 
satisfying the requirements of section 410(b) on an employer-wide basis. 
Conversely, in the case of an employer that is treated as operating 
qualified separate lines of business, and does not apply the special 
rule for employer-wide plans in Sec. 1.414(r)-1(c)(2)(ii) with respect 
to the cash or deferred arrangement, then the determination of whether 
the qualified nonelective contributions satisfy the requirements of this 
paragraph (a)(6)(ii) is not permitted to be made on an employer-wide 
basis regardless of whether the plans to which the qualified nonelective 
contributions are made are satisfying the requirements of section 410(b) 
on that basis.
    (iii) Aggregation must be permitted. The plan that contains the cash 
or deferred arrangement and the plan or plans to which the qualified 
nonelective contributions or qualified matching contributions are made, 
are plans that would be permitted to be aggregated under Sec. 1.401(k)-
1(b)(4). If the plan year of the plan that contains the cash or deferred 
arrangement is changed to satisfy the requirement under Sec. 1.410(b)-
7(d)(5) that aggregated plans have the same plan year, qualified 
nonelective contributions and qualified matching contributions may be 
taken into account in the resulting short plan year only if such 
qualified nonelective contributions and qualified matching contributions 
could have been taken into account under an ADP test for a plan with the 
same short plan year.
    (iv) Disproportionate contributions not taken into account--(A) 
General rule. Qualified nonelective contributions cannot be taken into 
account for a plan year for an NHCE to the extent such contributions 
exceed the product of that NHCE's compensation and the greater of 5% or 
two times the plan's representative contribution rate. Any qualified 
nonelective contribution taken into account under an ACP test under 
Sec. 1.401(m)-2(a)(6) (including the determination of the 
representative contribution rate for purposes of Sec. 1.401(m)-
2(a)(6)(v)(B)), is not permitted to be taken into account for purposes 
of this paragraph (a)(6) (including the determination of the 
representative contribution rate under paragraph (a)(6)(iv)(B) of this 
section).

[[Page 332]]

    (B) Definition of representative contribution rate. For purposes of 
this paragraph (a)(6)(iv), the plan's representative contribution rate 
is the lowest applicable contribution rate of any eligible NHCE among a 
group of eligible NHCEs that consists of half of all eligible NHCEs for 
the plan year (or, if greater, the lowest applicable contribution rate 
of any eligible NHCE in the group of all eligible NHCEs for the plan 
year and who is employed by the employer on the last day of the plan 
year).
    (C) Definition of applicable contribution rate. For purposes of this 
paragraph (a)(6)(iv), the applicable contribution rate for an eligible 
NHCE is the sum of the qualified matching contributions taken into 
account under this paragraph (a)(6) for the eligible NHCE for the plan 
year and the qualified nonelective contributions made for the eligible 
NHCE for the plan year, divided by the eligible NHCE's compensation for 
the same period.
    (D) Special rule for prevailing wage contributions. Notwithstanding 
paragraph (a)(6)(iv)(A) of this section, qualified nonelective 
contributions that are made in connection with an employer's obligation 
to pay prevailing wages under the Davis-Bacon Act (46 Stat. 1494), 
Public Law 71-798, Service Contract Act of 1965 (79 Stat. 1965), Public 
Law 89-286, or similar legislation can be taken into account for a plan 
year for an NHCE to the extent such contributions do not exceed 10 
percent of that NHCE's compensation.
    (v) Qualified matching contributions. Qualified matching 
contributions satisfy this paragraph (a)(6) only to the extent that such 
qualified matching contributions are matching contributions that are not 
precluded from being taken into account under the ACP test for the plan 
year under the rules of Sec. 1.401(m)-2(a)(5)(ii).
    (vi) Contributions only used once. Qualified nonelective 
contributions and qualified matching contributions cannot be taken into 
account under this paragraph (a)(6) to the extent such contributions are 
taken into account for purposes of satisfying any other ADP test, any 
ACP test, or the requirements of Sec. 1.401(k)-3, 1.401(m)-3 or 
1.401(k)-4. Thus, for example, matching contributions that are made 
pursuant to Sec. 1.401(k)-3(c) cannot be taken into account under the 
ADP test. Similarly, if a plan switches from the current year testing 
method to the prior year testing method pursuant to Sec. 1.401(k)-2(c), 
qualified nonelective contributions that are taken into account under 
the current year testing method for a year may not be taken into account 
under the prior year testing method for the next year.
    (7) Examples. The following examples illustrate the application of 
this paragraph (a):

    Example 1. (i) Employer X has three employees, A, B, and C. Employer 
X sponsors a profit-sharing plan (Plan Z) that includes a cash or 
deferred arrangement. Each year, Employer X determines a bonus 
attributable to the prior year. Under the cash or deferred arrangement, 
each eligible employee may elect to receive none, all or any part of the 
bonus in cash. X contributes the remainder to Plan Z. The portion of the 
bonus paid in cash, if any, is paid 2 months after the end of the plan 
year and thus is included in compensation for the following plan year. 
Employee A is an HCE, while Employees B and C are NHCEs. The plan uses 
the current year testing method and defines compensation to include 
elective contributions and bonuses paid during each plan year. In 
February of 2005, Employer X determined that no bonuses will be paid for 
2004. In February of 2006, Employer X provided a bonus for each employee 
equal to 10% of regular compensation for 2005. For the 2005 plan year, 
A, B, and C have the following compensation and make the following 
elections:

------------------------------------------------------------------------
                                                             Elective
                Employee                   Compensation    contribution
------------------------------------------------------------------------
A.......................................        $100,000          $4,340
B.......................................          60,000           2,860
C.......................................          45,000           1,250
------------------------------------------------------------------------

    (ii) For each employee, the ratio of elective contributions to the 
employee's compensation for the plan year is:

------------------------------------------------------------------------
                                          Ratio of elective
                Employee                   contribution to       ADR
                                             compensation     (percent)
------------------------------------------------------------------------
A.......................................    $4,340/$100,000         4.34
B.......................................       2,860/60,000         4.77
C.......................................       1,250/45,000         2.78
------------------------------------------------------------------------

    (iii) The ADP for the HCEs (Employee A) is 4.34%. The ADP for the 
NHCEs is 3.78% ((4.77% + 2.78%)/2). Because 4.34% is less than 4.73% 
(3.78% multiplied by 1.25), the plan satisfies the ADP test under 
paragraph (a)(1)(i) of this section.

[[Page 333]]

    Example 2. (i) The facts are the same as in Example 1, except that 
elective contributions are made pursuant to a salary reduction agreement 
throughout the plan year, and no bonuses are paid. As provided by 
section 414(s)(2), Employer X includes elective contributions in 
compensation. During the year, B and C defer the same amount as in 
Example 1, but A defers $5,770. Thus, the compensation and elective 
contributions for A, B, and C are:

----------------------------------------------------------------------------------------------------------------
                                                                                        Elective         ADR
                              Employee                                Compensation    contributions   (percent)
----------------------------------------------------------------------------------------------------------------
A..................................................................        $100,000          $5,770         5.77
B..................................................................          60,000           2,860         4.77
C..................................................................          45,000           1,250         2.78
----------------------------------------------------------------------------------------------------------------

    (ii) The ADP for the HCEs (Employee A) is 5.77%. The ADP for the 
NHCEs is 3.78% ((4.77% + 2.78%)/2). Because 5.77% exceeds 4.73% (3.78% x 
1.25), the plan does not satisfy the ADP test under paragraph (a)(1)(i) 
of this section. However, because the ADP for the HCEs does not exceed 
the ADP for the NHCEs by more than 2 percentage points and the ADP for 
the HCEs does not exceed the ADP for the NHCEs multiplied by 2 (3.78% x 
2 = 7.56%), the plan satisfies the ADP test under paragraph (a)(1)(ii) 
of this section.
    Example 3. (i) Employees D through L are eligible employees in Plan 
T, a profit-sharing plan that contains a cash or deferred arrangement. 
The plan is a calendar year plan that uses the prior year testing 
method. Plan T provides that elective contributions are included in 
compensation (as provided under section 414(s)(2)). Each eligible 
employee may elect to defer up to 6% of compensation under the cash or 
deferred arrangement. Employees D and E are HCEs. The compensation, 
elective contributions, and ADRs of Employees D and E for the 2006 plan 
year are shown below:

----------------------------------------------------------------------------------------------------------------
                                                                                     Elective
                                                                   Compensation    contributions   ADR for 2006
                            Employee                               for 2006 plan   for 2006 plan     plan year
                                                                       year            year          (percent)
----------------------------------------------------------------------------------------------------------------
D...............................................................        $100,000         $10,000              10
E...............................................................          95,000           4,750               5
----------------------------------------------------------------------------------------------------------------

    (ii) During the 2005 plan year, Employees F through L were eligible 
NHCEs. The compensation, elective contributions and ADRs of Employees F 
through L for the 2005 plan year are shown in the following table:

----------------------------------------------------------------------------------------------------------------
                                                                                     Elective
                                                                   Compensation    contributions   ADR for 2005
                            Employee                               for 2005 plan   for 2005 plan     plan year
                                                                       year            year          (percent)
----------------------------------------------------------------------------------------------------------------
F...............................................................         $60,000          $3,600               6
G...............................................................          40,000           1,600               4
H...............................................................          30,000           1,200               4
I...............................................................          20,000             600               3
J...............................................................          20,000             600               3
K...............................................................          10,000             300               3
L...............................................................           5,000             150               3
----------------------------------------------------------------------------------------------------------------

    (iii) The ADP for 2006 for the HCEs is 7.5%. Because Plan T is using 
the prior year testing method, the applicable year for determining the 
NHCE ADP is the prior plan year (i.e., 2005). The NHCE ADP is determined 
using the ADRs for NHCEs eligible during the prior plan year (without 
regard to whether they are eligible under the plan during the plan 
year). The ADP for the NHCEs is 3.71% (the sum of the individual ADRs, 
26%, divided by 7 employees). Because 7.5% exceeds 4.64% (3.71% x 1.25), 
Plan T does not satisfy the ADP test under paragraph (a)(1)(i) of this 
section. In addition, because the ADP for the HCEs exceeds the ADP for 
the NHCEs by more than 2 percentage points, Plan T does not satisfy the 
ADP test under paragraph (a)(1)(ii) of this section. Therefore, the cash 
or deferred arrangement fails to be a qualified cash or deferred 
arrangement unless the ADP failure is corrected under paragraph (b) of 
this section.
    Example 4. (i) Plan U is a calendar year profit-sharing plan that 
contains a cash or deferred arrangement and uses the current year 
testing method. Plan U provides that elective contributions are included 
in compensation (as provided under section 414(s)(2)). The following 
amounts are contributed under Plan U for the 2006 plan year: QNECs equal 
to 2% of each employee's compensation; Contributions equal to 6% of each 
employee's compensation that are not immediately vested under the terms 
of the plan; 3% of each employee's compensation that the employee may 
elect to receive as cash or to defer under the plan. Both types of 
nonelective contributions are made for the HCEs (employees M and N) and 
the NHCEs (employees O through S) for the plan year and are contributed 
after the end of the plan year and before the end of the following plan 
year. In addition, neither type of nonelective contributions is used for 
any other ADP or ACP test.
    (ii) For the 2006 plan year, the compensation, elective 
contributions, and actual deferral ratios of employees M through S are 
shown in the following table:

----------------------------------------------------------------------------------------------------------------
                                                                                                      Actual
                            Employee                               Compensation      Elective     deferral ratio
                                                                                   contributions     (percent)
----------------------------------------------------------------------------------------------------------------
M...............................................................        $100,000          $3,000               3
N...............................................................         100,000           2,000               2
O...............................................................          60,000           1,800               3
P...............................................................          40,000               0               0
Q...............................................................          30,000               0               0
R...............................................................           5,000               0               0
S...............................................................          20,000               0               0
----------------------------------------------------------------------------------------------------------------

    (iii) The elective contributions alone do not satisfy the ADP test 
of section 401(k)(3) and paragraph (a)(1) of this section because the 
ADP for the HCEs, consisting of employees M and N, is 2.5% and the ADP 
for the NHCEs is 0.6%.

[[Page 334]]

    (iv) The 2% QNECs satisfies the timing requirement of paragraph 
(a)(6)(i) of this section because it is paid within 12-month after the 
plan year for which allocated. All nonelective contributions also 
satisfy the requirements relating to section 401(a)(4) set forth in 
paragraph (a)(6)(ii) of this section (because all employees receive an 
8% nonelective contribution and the nonelective contributions excluding 
the QNECs is 6% for all employees). In addition, the QNECs are not 
disproportionate under paragraph (a)(6)(iv) of this section because no 
QNEC for an NHCE exceeds the product of the plan's applicable 
contribution rate (2%) and that NHCE's compensation.
    (v) Because the rules of paragraph (a)(6) of this section are 
satisfied, the 2% QNECs may be taken into account in applying the ADP 
test of section 401(k)(3) and paragraph (a)(1) of this section. The 6% 
nonelective contributions, however, may not be taken into account 
because they are not QNECs.
    (vi) If the 2% QNECs are taken into account, the ADP for the HCEs is 
4.5%, and the actual deferral percentage for the NHCEs is 2.6%. Because 
4.5% is not more than two percentage points greater than 2.6 percent, 
and not more than two times 2.6, the cash or deferred arrangement 
satisfies the ADP test of section 401(k)(3) under paragraph (a)(1)(ii) 
of this section.
    Example 5. (i) The facts are the same as Example 4, except the plan 
uses the prior year testing method. In addition, the NHCE ADP for the 
2005 plan year (the prior plan year) is 0.8% and no QNECs are 
contributed for the 2005 plan year during 2005 or 2006.
    (ii) In 2007, it is determined that the elective contributions alone 
do not satisfy the ADP test of section 401(k)(3) and paragraph (a)(1) of 
this section for 2006 because the 2006 ADP for the eligible HCEs, 
consisting of employees M and N, is 2.5% and the 2005 ADP for the 
eligible NHCEs is 0.8%. An additional QNEC of 2% of compensation is made 
for each eligible NHCE in 2007 and allocated for 2005.
    (iii) The 2% QNECs that are made in 2007 and allocated for the 2005 
plan year do not satisfy the timing requirement of paragraph (a)(6)(i) 
of this section for the applicable year for the 2005 plan year because 
they were not contributed before the last day of the 2006 plan year. 
Accordingly, the 2% QNECs do not satisfy the rules of paragraph (a)(6) 
of this section and may not be taken into account in applying the ADP 
test of section 401(k)(3) and paragraph (a)(1) of this section for the 
2006 plan year. The cash or deferred arrangement fails to be a qualified 
cash or deferred arrangement unless the ADP failure is corrected under 
paragraph (b) of this section.
    Example 6. (i) The facts are the same as Example 4, except that the 
ADP for the HCEs is 4.6% and there is no 6% nonelective contribution 
under the plan. The employer would like to take into account the 2% QNEC 
in determining the ADP for the NHCEs but not in determining the ADP for 
the HCEs.
    (ii) The elective contributions alone fail the requirements of 
section 401(k) and paragraph (a)(1) of this section because the HCE ADP 
for the plan year (4.6%) exceeds 0.75% (0.6% x 1.25) and 1.2% (0.6% x 
2).
    (iii) The 2% QNECs may not be taken into account in determining the 
ADP of the NHCEs because they fail to satisfy the requirements relating 
to section 401(a)(4) set forth in paragraph (a)(6)(ii) of this section. 
This is because the amount of nonelective contributions, excluding those 
QNECs that would be taken into account under the ADP test, would be 2% 
of compensation for the HCEs and 0% for the NHCEs. Therefore, the cash 
or deferred arrangement fails to be a qualified cash or deferred 
arrangement unless the ADP failure is corrected under paragraph (b) of 
this section.
    Example 7. (i) The facts are the same as Example 6, except that 
Employee R receives a QNEC in an amount of $500 and no QNECs are made on 
behalf of the other employees.
    (ii) If the QNEC could be taken into account under paragraph (a)(6) 
of this section, the ADP for the NHCEs would be 2.6% and the plan would 
satisfy the ADP test. The QNEC is disproportionate under paragraph 
(a)(6)(iv) of this section, and cannot be taken into account under 
paragraph (a)(6) of this section, to the extent it exceeds the greater 
of 5% and two times the plan's representative contribution rate (0%), 
multiplied by Employee R's compensation. The plan's representative 
contribution rate is 0% because it is the lowest applicable contribution 
rate among a group of NHCEs that is at least half of all NHCEs, or all 
the NHCEs who are employed on the last day of the plan year. Therefore, 
the QNEC may be taken into account under the ADP test only to the extent 
it does not exceed 5% times Employee R's compensation (or $250) and the 
cash or deferred arrangement fails to satisfy the ADP test and must 
correct under paragraph (b) of this section.
    Example 8. (i) The facts are the same as in Example 4 except that 
the plan changes from the current year testing method to the prior year 
testing method for the following plan year (2007 plan year). The ADP for 
the HCEs for the 2007 plan year is 3.5%.
    (ii) The 2% QNECs may not be taken into account in determining the 
ADP for the NHCEs for the applicable year (2006 plan year) in satisfying 
the ADP test for the 2007 plan year because they were taken into account 
in satisfying the ADP test for the 2006 plan year. Accordingly, the NHCE 
ADP for the applicable year is 0.6%. The elective contributions for the 
plan year fail the requirements of section 401(k) and paragraph (a)(1)

[[Page 335]]

of this section because the HCE ADP for the plan year (3.5%) exceeds the 
ADP limit of 1.2% (the greater of 0.75% (0.6% x 1.25) and 1.2% (0.6% x 
2)), determined using the applicable year ADP for the NHCEs. Therefore, 
the cash or deferred arrangement fails to be a qualified cash or 
deferred arrangement unless the ADP failure is corrected under paragraph 
(b) of this section.
    Example 9. (i)(A) Employer N maintains Plan X, a profit sharing plan 
that contains a cash or deferred arrangement and that uses the current 
year testing method. Plan X provides for employee contributions, 
elective contributions, and matching contributions. Matching 
contributions on behalf of NHCEs are qualified matching contributions 
(QMACs) and are contributed during the 2005 plan year. Matching 
contributions on behalf of HCEs are not QMACs, because they fail to 
satisfy the nonforfeitability requirement of Sec. 1.401(k)-1(c). The 
elective contributions and matching contributions with respect to HCEs 
for the 2005 plan year are shown in the following table:

----------------------------------------------------------------------------------------------------------------
                                                                                            Matching
                                                            Elective     Total matching   contributions
                                                          contributions   contributions   that are not    QMACs
                                                                                              QMACs
----------------------------------------------------------------------------------------------------------------
Highly compensated employees...........................             15%              5%              5%       0%
----------------------------------------------------------------------------------------------------------------

    (B) The elective contributions and matching contributions with 
respect to the NHCEs for the 2005 plan year are shown in the following 
table:

----------------------------------------------------------------------------------------------------------------
                                                                                            Matching
                                                            Elective     Total matching   contributions
                                                          contributions   contributions   that are not    QMACs
                                                                                              QMACs
----------------------------------------------------------------------------------------------------------------
Nonhighly compensated employees........................             11%              4%              0%       4%
----------------------------------------------------------------------------------------------------------------

    (ii) The plan fails to satisfy the ADP test of section 401(k)(3)(A) 
and paragraph (a)(1) of this section because the ADP for HCEs (15%) is 
more than 125% of the ADP for NHCEs (11%), and more than 2 percentage 
points greater than 11%. However, the plan provides that QMACs may be 
used to meet the requirements of section 401(k)(3)(A)(ii) provided that 
they are not used for any other ADP or ACP test. QMACs equal to 1% of 
compensation are taken into account for each NHCE in applying the ADP 
test. After this adjustment, the applicable ADP and ACP (taking into 
account the provisions of Sec. 1.401(m)-2(a)(5)(ii)) for the plan year 
are as follows:

------------------------------------------------------------------------
                                              Actual          Actual
                                             deferral      contribution
                                            percentage      percentage
------------------------------------------------------------------------
HCEs....................................              15               5
Nonhighly compensated employees.........              12               3
------------------------------------------------------------------------

    (iii) The elective contributions and QMACs taken into account for 
purposes of the ADP test of section 401(k)(3) satisfy the requirements 
of section 401(k)(3)(A)(ii) under paragraph (a)(1)(ii) of this section 
because the ADP for HCEs (15%) is not more than the ADP for NHCEs 
multiplied by 1.25 (12% x 1.25 = 15%).

    (b) Correction of excess contributions--(1) Permissible correction 
methods--(i) In general. A cash or deferred arrangement does not fail to 
satisfy the requirements of section 401(k)(3) and paragraph (a)(1) of 
this section if the employer, in accordance with the terms of the plan 
that includes the cash or deferred arrangement, uses any of the 
following correction methods--
    (A) Qualified nonelective contributions or qualified matching 
contributions. The employer makes qualified nonelective contributions or 
qualified matching contributions that are taken into account under this 
section and, in combination with other amounts taken into account under 
paragraph (a) of this section, allow the cash or deferred arrangement to 
satisfy the requirements of paragraph (a)(1) of this section.
    (B) Excess contributions distributed. Excess contributions are 
distributed in accordance with paragraph (b)(2) of this section.
    (C) Excess contributions recharacterized. Excess contributions are 
recharacterized in accordance with paragraph (b)(3) of this section.
    (ii) Combination of correction methods. A plan may provide for the 
use of any of the correction methods described in

[[Page 336]]

paragraph (b)(1)(i) of this section, may limit elective contributions in 
a manner designed to prevent excess contributions from being made, or 
may use a combination of these methods, to avoid or correct excess 
contributions. A plan may permit an HCE to elect whether any excess 
contributions are to be recharacterized or distributed. Similarly, a 
plan may permit an HCE with elective contributions for a year that 
includes both pre-tax elective contributions and designated Roth 
contributions to elect whether the excess contributions are to be 
attributed to pre-tax elective contributions or designated Roth 
contributions. If the plan uses a combination of correction methods, any 
contribution made under paragraph (b)(1)(i)(A) of this section must be 
taken into account before application of the correction methods in 
paragraph (b)(1)(i)(B) or (C) of this section.
    (iii) Exclusive means of correction. A failure to satisfy the 
requirements of paragraph (a)(1) of this section may not be corrected 
using any method other than the ones described in paragraphs (b)(1)(i) 
and (ii) of this section. Thus, excess contributions for a plan year may 
not remain unallocated or be allocated to a suspense account for 
allocation to one or more employees in any future year. In addition, 
excess contributions may not be corrected using the retroactive 
correction rules of Sec. 1.401(a)(4)-11(g). See Sec. 1.401(a)(4)-
11(g)(3)(vii) and (5).
    (2) Corrections through distribution--(i) General rule. This 
paragraph (b)(2) contains the rules for correction of excess 
contributions through a distribution from the plan. Correction through a 
distribution generally involves a 4-step process. First, the plan must 
determine, in accordance with paragraph (b)(2)(ii) of this section, the 
total amount of excess contributions that must be distributed under the 
plan. Second, the plan must apportion the total amount of excess 
contributions among HCEs in accordance with paragraph (b)(2)(iii) of 
this section. Third, the plan must determine the income allocable to 
excess contributions in accordance with paragraph (b)(2)(iv) of this 
section. Finally, the plan must distribute the apportioned excess 
contributions and allocable income in accordance with paragraph 
(b)(2)(v) of this section. Paragraph (b)(2)(vi) of this section provides 
rules relating to the tax treatment of these distributions. Paragraph 
(b)(2)(vii) provides other rules relating to these distributions.
    (ii) Calculation of total amount to be distributed. The following 
procedures must be used to determine the total amount of the excess 
contributions to be distributed--
    (A) Calculate the dollar amount of excess contributions for each 
HCE. The amount of excess contributions attributable to a given HCE for 
a plan year is the amount (if any) by which the HCE's contributions 
taken into account under this section must be reduced for the HCE's ADR 
to equal the highest permitted ADR under the plan. To calculate the 
highest permitted ADR under a plan, the ADR of the HCE with the highest 
ADR is reduced by the amount required to cause that HCE's ADR to equal 
the ADR of the HCE with the next highest ADR. If a lesser reduction 
would enable the arrangement to satisfy the requirements of paragraph 
(b)(2)(ii)(C) of this section, only this lesser reduction is used in 
determining the highest permitted ADR.
    (B) Determination of the total amount of excess contributions. The 
process described in paragraph (b)(2)(ii)(A) of this section must be 
repeated until the arrangement would satisfy the requirements of 
paragraph (b)(2)(ii)(C) of this section. The sum of all reductions for 
all HCEs determined under paragraph (b)(2)(ii)(A) of this section is the 
total amount of excess contributions for the plan year.
    (C) Satisfaction of ADP. A cash or deferred arrangement satisfies 
this paragraph (b)(2)(ii)(C) if the arrangement would satisfy the 
requirements of paragraph (a)(1)(ii) of this section if the ADR for each 
HCE were determined after the reductions described in paragraph 
(b)(2)(ii)(A) of this section.
    (iii) Apportionment of total amount of excess contributions among 
the HCEs. The following procedures must be used in apportioning the 
total amount of excess contributions determined under paragraph 
(b)(2)(ii) of this section among the HCEs:

[[Page 337]]

    (A) Calculate the dollar amount of excess contributions for each 
HCE. The contributions of the HCE with the highest dollar amount of 
contributions taken into account under this section are reduced by the 
amount required to cause that HCE's contributions to equal the dollar 
amount of the contributions taken into account under this section for 
the HCE with the next highest dollar amount of contributions taken into 
account under this section. If a lesser apportionment to the HCE would 
enable the plan to apportion the total amount of excess contributions, 
only the lesser apportionment would apply.
    (B) Limit on amount apportioned to any individual. For purposes of 
this paragraph (b)(2)(iii), the amount of contributions taken into 
account under this section with respect to an HCE who is an eligible 
employee in more than one plan of an employer is determined by taking 
into account all contributions otherwise taken into account with respect 
to such HCE under any plan of the employer during the plan year of the 
plan being tested as being made under the plan being tested. However, 
the amount of excess contributions apportioned for a plan year with 
respect to any HCE must not exceed the amount of contributions actually 
contributed to the plan for the HCE for the plan year. Thus, in the case 
of an HCE who is an eligible employee in more than one plan of the same 
employer to which elective contributions are made and whose ADR is 
calculated in accordance with paragraph (a)(3)(ii) of this section, the 
amount required to be distributed under this paragraph (b)(2)(iii) shall 
not exceed the contributions actually contributed to the plan and taken 
into account under this section for the plan year.
    (C) Apportionment to additional HCEs. The procedure in paragraph 
(b)(2)(iii)(A) of this section must be repeated until the total amount 
of excess contributions determined under paragraph (b)(2)(ii) of this 
section has been apportioned.
    (iv) Income allocable to excess contributions--(A) General rule. For 
plan years beginning on or after January 1, 2008, the income allocable 
to excess contributions is equal to the allocable gain or loss through 
the end of the plan year. See paragraph (b)(2)(iv)(D) of this section 
for rules that apply to plan years beginning before January 1, 2008.
    (B) Method of allocating income. A plan may use any reasonable 
method for computing the income allocable to excess contributions, 
provided that the method does not violate section 401(a)(4), is used 
consistently for all participants and for all corrective distributions 
under the plan for the plan year, and is used by the plan for allocating 
income to participant's accounts. See Sec. 1.401(a)(4)-1(c)(8). A plan 
will not fail to use a reasonable method for computing the income 
allocable to excess contributions merely because the income allocable to 
excess contributions is determined on a date that is no more than 7 days 
before the distribution.
    (C) Alternative method of allocating plan year income. A plan may 
allocate income to excess contributions for the plan year by multiplying 
the income for the plan year allocable to the elective contributions and 
other amounts taken into account under this section (including 
contributions made for the plan year), by a fraction, the numerator of 
which is the excess contributions for the employee for the plan year, 
and the denominator of which is the sum of the--
    (1) Account balance attributable to elective contributions and other 
contributions taken into account under this section as of the beginning 
of the plan year, and
    (2) Any additional amount of such contributions made for the plan 
year.
    (D) Plan years before 2008. For plan years beginning before January 
1, 2008, the income allocable to excess contributions is determined 
under Sec. 1.401(k)-2(b)(2)(iv) (as it appeared in the April 1, 2007, 
edition of 26 CFR part 1).
    (v) Distribution. Within 12 months after the close of the plan year 
in which the excess contribution arose, the plan must distribute to each 
HCE the excess contributions apportioned to such HCE under paragraph 
(b)(2)(iii) of this section and the allocable income. Except as 
otherwise provided in this paragraph (b)(2)(v) and paragraph (b)(4)(i) 
of this section, a distribution

[[Page 338]]

of excess contributions must be in addition to any other distributions 
made during the year and must be designated as a corrective distribution 
by the employer. In the event of a complete termination of the plan 
during the plan year in which an excess contribution arose, the 
corrective distribution must be made as soon as administratively 
feasible after the date of termination of the plan, but in no event 
later than 12 months after the date of termination. If the entire 
account balance of an HCE is distributed prior to when the plan makes a 
distribution of excess contributions in accordance with this paragraph 
(b)(2), the distribution is deemed to have been a corrective 
distribution of excess contributions (and income) to the extent that a 
corrective distribution would otherwise have been required.
    (vi) Tax treatment of corrective distributions--(A) Corrective 
distributions for plan years beginning on or after January 1, 2008. 
Except as provided in this paragraph (b)(2)(vi), for plan years 
beginning on or after January 1, 2008, a corrective distribution of 
excess contributions (and allocable income) is includible in the 
employee's gross income for the employee's taxable year in which 
distributed. In addition, the corrective distribution is not subject to 
the early distribution tax of section 72(t). See paragraph (b)(5) of 
this section for additional rules relating to the employer excise tax on 
amounts distributed more than 2\1/2\ months (6 months in the case of 
certain plans that include an eligible automatic contribution 
arrangement within the meaning of section 414(w)) after the end of the 
plan year. See also Sec. 1.402(c)-2, A-4 for restrictions on rolling 
over distributions that are excess contributions.
    (B) Corrective distributions for plan years beginning before January 
1, 2008. The tax treatment of corrective distributions for plan years 
beginning before January 1, 2008, is determined under Sec. 1.401(k)-
2(b)(2)(vi) (as it appeared in the April 1, 2007, edition of 26 CFR Part 
1).
    (C) Corrective distributions attributable to designated Roth 
contributions. Notwithstanding paragraphs (b)(2)(vi)(A) and (B) of this 
section, a distribution of excess contributions is not includible in 
gross income to the extent it represents a distribution of designated 
Roth contributions. However, the income allocable to a corrective 
distribution of excess contributions that are designated Roth 
contributions is included in gross income in accordance with paragraph 
(b)(2)(vi)(A) or (B) of this section (i.e., in the same manner as income 
allocable to a corrective distribution of excess contributions that are 
pre-tax elective contributions).
    (vii) Other rules--(A) No employee or spousal consent required. A 
corrective distribution of excess contributions (and income) may be made 
under the terms of the plan without regard to any notice or consent 
otherwise required under sections 411(a)(11) and 417.
    (B) Treatment of corrective distributions as elective contributions. 
Excess contributions are treated as employer contributions for purposes 
of sections 404 and 415 even if distributed from the plan.
    (C) No reduction of required minimum distribution. A distribution of 
excess contributions (and income) is not treated as a distribution for 
purposes of determining whether the plan satisfies the minimum 
distribution requirements of section 401(a)(9). See Sec. 1.401(a)(9)-5, 
A-9(b).
    (D) Partial distributions. Any distribution of less than the entire 
amount of excess contributions (and allocable income) with respect to 
any HCE is treated as a pro rata distribution of excess contributions 
and allocable income.
    (viii) Examples. The following examples illustrate the application 
of this paragraph (b)(2). For purposes of these examples, none of the 
plans provide for catch-up contributions under section 414(v). The 
examples are as follows:

    Example 1. (i) Plan P, a calendar year profit-sharing plan that 
includes a cash or deferred arrangement, provides for distribution of 
excess contributions to HCEs to the extent necessary to satisfy the ADP 
test. For the 2006 plan year, Employee A, an HCE, has elective 
contributions of $12,000 and $200,000 in compensation, for an ADR of 6%, 
and Employee B, a second HCE, has elective contributions of $8,960 and 
compensation of $128,000, for an ADR of 7%. The ADP for the NHCEs is 3% 
for the 2006 plan year. Under the ADP test, the ADP of the two HCEs

[[Page 339]]

under the plan may not exceed 5% (i.e., 2 percentage points more than 
the ADP of the NHCEs under the plan). The ADP for the 2 HCEs under the 
plan is 6.5%. Therefore, there must be a correction of excess 
contributions for the 2006 plan year.
    (ii) The total amount of excess contributions for the HCEs is 
determined under paragraph (b)(2)(ii) of this section as follows: the 
elective contributions of Employee B (the HCE with the highest ADR) are 
reduced by $1,280 in order to reduce his ADR to 6% ($7,680/$128,000), 
which is the ADR of Employee A.
    (iii) Because the ADP of the HCEs determined after the $1,280 
reduction to Employee B still exceeds 5%, further reductions in elective 
contributions are necessary in order to reduce the ADP of the HCEs to 
5%. The elective contributions of Employee A and Employee B are each 
reduced by 1% of compensation ($2,000 and $1,280 respectively). Because 
the ADP of the HCEs determined after the reductions equals 5%, the plan 
would satisfy the requirements of (a)(1)(ii) of this section.
    (iv) The total amount of excess contributions ($4,560 = 
$1,280+$2,000+$1,280) is apportioned among the HCEs under paragraph 
(b)(2)(iii) of this section first to the HCE with the highest amount of 
elective contributions. Therefore, Employee A is apportioned $3,040 (the 
amount required to cause Employee A's elective contributions to equal 
the next highest dollar amount of elective contributions).
    (v) Because the total amount of excess contributions has not been 
apportioned, further apportionment is necessary. The balance ($1,520) of 
the total amount of excess contributions is apportioned equally among 
Employee A and Employee B ($760 to each).
    (vi) Therefore, the cash or deferred arrangement will satisfy the 
requirements of paragraph (a)(1) of this section if, by the end of the 
12 month period following the end of the 2006 plan year, Employee A 
receives a corrective distribution of excess contributions equal to 
$3,800 ($3,040 + $760) and allocable income and Employee B receives a 
corrective distribution of $760 and allocable income.
    Example 2. (i) The facts are the same as in Example 1, except 
Employee A's ADR is based on $3,000 of elective contributions to this 
plan and $9,000 of elective contributions to another plan of the 
employer.
    (ii) The total amount of excess contributions ($4,560 = 
$1,280+$2,000+$1,280) is apportioned among the HCEs under paragraph 
(b)(2)(iii) of this section first to the HCE with the highest amount of 
elective contributions. The amount of elective contributions for 
Employee A is $12,000. Therefore, Employee A is apportioned $3,040 (the 
amount required to cause Employee A's elective contributions to equal 
the next highest dollar amount of elective contributions). However, 
pursuant to paragraph (b)(2)(iii)(B) of this section, no more than the 
amount actually contributed to the plan may be apportioned to an HCE. 
Accordingly, no more than $3,000 may be apportioned to Employee A. 
Therefore, the remaining $1,560 must be apportioned to Employee B.
    (iii) The cash or deferred arrangement will satisfy the requirements 
of paragraph (a)(1) of this section if, by the end of the 12 month 
period following the end of the 2006 plan year, Employee A receives a 
corrective distribution of excess contributions equal to $3,000 (total 
amount of elective contributions actually contributed to the plan for 
Employee A) and allocable income and Employee B receives a corrective 
distribution of $1,560 and allocable income.

    (3) Recharacterization of excess contributions--(i) General rule. 
Excess contributions are recharacterized in accordance with this 
paragraph (b)(3) only if the excess contributions that would have to be 
distributed under (b)(2) of this section if the plan was correcting 
through distribution of excess contributions are recharacterized as 
described in paragraph (b)(3)(ii) of this section, and all of the 
conditions set forth in paragraph (b)(3)(iii) of this section are 
satisfied.
    (ii) Treatment of recharacterized excess contributions. 
Recharacterized excess contributions are includible in the employee's 
gross income as if such amounts were distributed under paragraph (b)(2) 
of this section. The recharacterized excess contributions are treated as 
employee contributions for purposes of section 72, sections 401(a)(4), 
401(m), Sec. 1.401(k)-1(d) and Sec. 1.401(k)-2. This requirement is 
not treated as satisfied unless the payor or plan administrator reports 
the recharacterized excess contributions as employee contributions to 
the Internal Revenue Service and the employee by timely providing such 
Federal tax forms and accompanying instructions and timely taking such 
other action as is prescribed by the Commissioner in revenue rulings, 
notices and other guidance published in the Internal Revenue Bulletin 
(see Sec. 601.601(d)(2) of this chapter) as well as the applicable 
Federal tax forms and accompanying instructions.
    (iii) Additional rules--(A) Time of recharacterization. Excess 
contributions may not be recharacterized under this

[[Page 340]]

paragraph (b)(3) after 2\1/2\ months after the close of the plan year to 
which the recharacterization relates. Recharacterization is deemed to 
have occurred on the date on which the last of those HCEs with excess 
contributions to be recharacterized is notified in accordance with 
paragraph (b)(3)(ii) of this section.
    (B) Employee contributions must be permitted under plan. The amount 
of recharacterized excess contributions, in combination with the 
employee contributions actually made by the HCE, may not exceed the 
maximum amount of employee contributions (determined without regard to 
the ACP test of section 401(m)(2)) permitted under the provisions of the 
plan as in effect on the first day of the plan year.
    (C) Treatment of recharacterized excess contributions. 
Recharacterized excess contributions continue to be treated as employer 
contributions for all purposes under the Internal Revenue Code (other 
than those specified in paragraph (b)(3)(ii) of this section), including 
section 401(a) and sections 404, 409, 411, 412, 415, 416, and 417. Thus, 
for example, recharacterized excess contributions remain subject to the 
requirements of Sec. 1.401(k)-1(c); must be deducted under section 404; 
and are treated as employer contributions described in section 
415(c)(2)(A).
    (4) Rules applicable to all corrections--(i) Coordination with 
distribution of excess deferrals--(A) Treatment of excess deferrals that 
reduce excess contributions. The amount of excess contributions (and 
allocable income) to be distributed under paragraph (b)(2) of this 
section or the amount of excess contributions recharacterized under 
paragraph (b)(3) of this section with respect to an employee for a plan 
year, is reduced by any amounts previously distributed to the employee 
from the plan to correct excess deferrals for the employee's taxable 
year ending with or within the plan year in accordance with section 
402(g)(2).
    (B) Treatment of excess contributions that reduce excess deferrals. 
Under Sec. 1.402(g)-1(e), the amount required to be distributed to 
correct an excess deferral to an employee for a taxable year is reduced 
by any excess contributions (and allocable income) previously 
distributed or excess contributions recharacterized with respect to the 
employee for the plan year beginning with or within the taxable year. 
The amount of excess contributions includible in the gross income of the 
employee, and the amount of excess contributions reported by the payer 
or plan administrator as includible in the gross income of the employee, 
does not include the amount of any reduction under Sec. 1.402(g)-
1(e)(6).
    (ii) Forfeiture of match on distributed excess contributions. A 
matching contribution is taken into account under section 401(a)(4) even 
if the match is with respect to an elective contribution that is 
distributed or recharacterized under this paragraph (b). This requires 
that, after correction of excess contributions, each level of matching 
contributions be currently and effectively available to a group of 
employees that satisfies section 410(b). See Sec. 1.401(a)(4)-
4(e)(3)(iii)(G). Thus, a plan that provides the same rate of matching 
contributions to all employees will not meet the requirements of section 
401(a)(4) if elective contributions are distributed under this paragraph 
(b) to HCEs to the extent needed to meet the requirements of section 
401(k)(3), while matching contributions attributable to those elective 
contributions remain allocated to the HCEs' accounts. Under section 
411(a)(3)(G) and Sec. 1.411(a)-4(b)(7), a plan may forfeit matching 
contributions attributable to excess contributions, excess aggregate 
contributions or excess deferrals to avoid a violation of section 
401(a)(4). See also Sec. 1.401(a)(4)-11(g)(3)(vii)(B) regarding the use 
of additional allocations to the accounts of NHCEs for the purpose of 
correcting a discriminatory rate of matching contributions.
    (iii) Permitted forfeiture of QMAC. Pursuant to section 
401(k)(8)(E), a qualified matching contribution is not treated as 
forfeitable under Sec. 1.401(k)-1(c) merely because under the plan it 
is forfeited in accordance with paragraph (b)(4)(ii) of this section or 
Sec. 1.414(w)-1(d)(2).
    (iv) No requirement for recalculation. If excess contributions are 
distributed or recharacterized in accordance with paragraphs (b)(2) and 
(3) of this section, the cash or deferred arrangement is

[[Page 341]]

treated as meeting the nondiscrimination test of section 401(k)(3) 
regardless of whether the ADP for the HCEs, if recalculated after the 
distributions or recharacterizations, would satisfy section 401(k)(3).
    (v) Treatment of excess contributions that are catch-up 
contributions. A cash or deferred arrangement does not fail to meet the 
requirements of section 401(k)(3) and paragraph (a)(1) of this section 
merely because excess contributions that are catch-up contributions 
because they exceed the ADP limit, as described in Sec. 1.414(v)-
1(b)(1)(iii), are not corrected in accordance with this paragraph (b).
    (5) Failure to timely correct--(i) Failure to correct within 2\1/2\ 
months after end of plan year. If a plan does not correct excess 
contributions within 2\1/2\ months after the close of the plan year for 
which the excess contributions are made, the employer will be liable for 
a 10% excise tax on the amount of the excess contributions. See section 
4979 and Sec. 54.4979-1 of this chapter. Qualified nonelective 
contributions and qualified matching contributions properly taken into 
account under paragraph (a)(6) of this section for a plan year may 
enable a plan to avoid having excess contributions, even if the 
contributions are made after the close of the 2\1/2\ month period.
    (ii) Failure to correct within 12 months after end of plan year. If 
excess contributions are not corrected within 12 months after the close 
of the plan year for which they were made, the cash or deferred 
arrangement will fail to satisfy the requirements of section 401(k)(3) 
for the plan year for which the excess contributions are made and all 
subsequent plan years during which the excess contributions remain in 
the trust.
    (iii) Special rule for eligible automatic contribution arrangements. 
In the case of excess contributions under a plan that includes an 
eligible automatic contribution arrangement within the meaning of 
section 414(w), 6 months is substituted for 2\1/2\ months in paragraph 
(b)(5)(i) of this section. The additional time described in this 
paragraph (b)(5)(iii) applies to a distribution of excess contributions 
for a plan year beginning on or after January 1, 2010 only where all the 
eligible NHCEs and eligible HCEs are covered employees under the 
eligible automatic contribution arrangement (within the meaning of Sec. 
1.414(w)-1(e)(3)) for the entire plan year (or for the portion of the 
plan year that the eligible NHCEs and eligible HCEs are eligible 
employees).
    (c) Additional rules for prior year testing method--(1) Rules for 
change in testing method--(i) General rule. A plan is permitted to 
change from the prior year testing method to the current year testing 
method for any plan year. A plan is permitted to change from the current 
year testing method to the prior year testing method only in situations 
described in paragraph (c)(1)(ii) of this section. For purposes of this 
paragraph (c)(1), a plan that uses the safe harbor method described in 
Sec. 1.401(k)-3 or a SIMPLE 401(k) plan is treated as using the current 
year testing method for that plan year.
    (ii) Situations permitting a change to the prior year testing 
method. The situations described in this paragraph (c)(1)(ii) are:
    (A) The plan is not the result of the aggregation of two or more 
plans, and the current year testing method was used under the plan for 
each of the 5 plan years preceding the plan year of the change (or if 
lesser, the number of plan years the plan has been in existence, 
including years in which the plan was a portion of another plan).
    (B) The plan is the result of the aggregation of two or more plans, 
and for each of the plans that are being aggregated (the aggregating 
plans), the current year testing method was used for each of the 5 plan 
years preceding the plan year of the change (or if lesser, the number of 
plan years since that aggregating plan has been in existence, including 
years in which the aggregating plan was a portion of another plan).
    (C) A transaction described in section 410(b)(6)(C)(i) and Sec. 
1.410(b)-2(f) occurs and--
    (1) As a result of the transaction, the employer maintains both a 
plan using the prior year testing method and a plan using the current 
year testing method; and

[[Page 342]]

    (2) The change from the current year testing method to the prior 
year testing method occurs within the transition period described in 
section 410(b)(6)(C)(ii).
    (2) Calculation of ADP under the prior year testing method for the 
first plan year--(i) Plans that are not successor plans. If, for the 
first plan year of any plan (other than a successor plan), the plan uses 
the prior year testing method, the plan is permitted to use either that 
first plan year as the applicable year for determining the ADP for 
eligible NHCEs, or use 3% as the ADP for eligible NHCEs, for applying 
the ADP test for that first plan year. A plan (other than a successor 
plan) that uses the prior year testing method but has elected for its 
first plan year to use that year as the applicable year is not treated 
as changing its testing method in the second plan year and is not 
subject to the limitations on double counting on QNECs under paragraph 
(a)(6)(vi) of this section for the second plan year.
    (ii) First plan year defined. For purposes of this paragraph (c)(2), 
the first plan year of any plan is the first year in which the plan 
provides for elective contributions. Thus, the rules of this paragraph 
(c)(2) do not apply to a plan (within the meaning of Sec. 1.410(b)-
7(b)) for a plan year if for such plan year the plan is aggregated under 
Sec. 1.401(k)-1(b)(4) with any other plan that provided for elective 
contributions in the prior year.
    (iii) Successor plans. A plan is a successor plan if 50% or more of 
the eligible employees for the first plan year were eligible employees 
under a qualified cash or deferred arrangement maintained by the 
employer in the prior year. If a plan that is a successor plan uses the 
prior year testing method for its first plan year, the ADP for the group 
of NHCEs for the applicable year must be determined under paragraph 
(c)(4) of this section.
    (3) Plans using different testing methods for the ADP and ACP test. 
Except as otherwise provided in this paragraph (c)(3), a plan may use 
the current year testing method or prior year testing method for the ADP 
test for a plan year without regard to whether the current year testing 
method or prior year testing method is used for the ACP test for that 
year. For example, a plan may use the prior year testing method for the 
ADP test and the current year testing method for its ACP test for the 
plan year. However, plans that use different testing methods under this 
paragraph (c)(3) cannot use--
    (i) The recharacterization method of paragraph (b)(3) of this 
section to correct excess contributions for a plan year;
    (ii) The rules of Sec. 1.401(m)-2(a)(6)(ii) to take elective 
contributions into account under the ACP test (rather than the ADP 
test); or
    (iii) The rules of paragraph (a)(6)(v) of this section to take 
qualified matching contributions into account under the ADP test (rather 
than the ACP test).
    (4) Rules for plan coverage changes--(i) In general. A plan that 
uses the prior year testing method and experiences a plan coverage 
change during a plan year satisfies the requirements of this section for 
that year only if the plan provides that the ADP for the NHCEs for the 
plan year is the weighted average of the ADPs for the prior year 
subgroups.
    (ii) Optional rule for minor plan coverage changes. If a plan 
coverage change occurs and 90% or more of the total number of the NHCEs 
from all prior year subgroups are from a single prior year subgroup, 
then, in lieu of using the weighted averages described in paragraph 
(c)(4)(i) of this section, the plan may provide that the ADP for the 
group of eligible NHCEs for the prior year under the plan is the ADP of 
the NHCEs for the prior year of the plan under which that single prior 
year subgroup was eligible.
    (iii) Definitions. The following definitions apply for purposes of 
this paragraph (c)(4):
    (A) Plan coverage change. The term plan coverage change means a 
change in the group or groups of eligible employees under a plan on 
account of--
    (1) The establishment or amendment of a plan;
    (2) A plan merger or spinoff under section 414(l);

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    (3) A change in the way plans (within the meaning of Sec. 1.410(b)-
7(b)) are combined or separated for purposes of Sec. 1.401(k)-1(b)(4) 
(e.g., permissively aggregating plans not previously aggregated under 
Sec. 1.410(b)-7(d), or ceasing to permissively aggregate plans under 
Sec. 1.410(b)-7(d));
    (4) A reclassification of a substantial group of employees that has 
the same effect as amending the plan (e.g., a transfer of a substantial 
group of employees from one division to another division); or
    (5) A combination of any of paragraphs (c)(4)(iii)(A)(1) through (4) 
of this section.
    (B) Prior year subgroup. The term prior year subgroup means all 
NHCEs for the prior plan year who, in the prior year, were eligible 
employees under a specific plan maintained by the employer that included 
a qualified cash or deferred arrangement and who would have been 
eligible employees in the prior year under the plan being tested if the 
plan coverage change had first been effective as of the first day of the 
prior plan year instead of first being effective during the plan year. 
The determination of whether an NHCE is a member of a prior year 
subgroup is made without regard to whether the NHCE terminated 
employment during the prior year.
    (C) Weighted average of the ADPs for the prior year subgroups. The 
term weighted average of the ADPs for the prior year subgroups means the 
sum, for all prior year subgroups, of the adjusted ADPs for the plan 
year. The term adjusted ADP with respect to a prior year subgroup means 
the ADP for the prior plan year of the specific plan under which the 
members of the prior year subgroup were eligible employees on the first 
day of the prior plan year, multiplied by a fraction, the numerator of 
which is the number of NHCEs in the prior year subgroup and denominator 
of which is the total number of NHCEs in all prior year subgroups.
    (iv) Examples. The following examples illustrate the application of 
this paragraph (c)(4):
    Example 1. (i) Employer B maintains two calendar year plans, Plan O 
and Plan P, each of which includes a cash or deferred arrangement. The 
plans were not permissively aggregated under Sec. 1.410(b)-7(d) for the 
2005 plan year. Both plans use the prior year testing method. Plan O had 
300 eligible employees who were NHCEs for the 2005 plan year, and their 
ADP for that year was 6%. Sixty of the eligible employees who were NHCEs 
for the 2005 plan year under Plan O, terminated their employment during 
that year. Plan P had 100 eligible employees who were NHCEs for 2005, 
and the ADP for those NHCEs for that plan was 4%. Plan O and Plan P are 
permissively aggregated under Sec. 1.410(b)-7(d) for the 2006 plan 
year.
    (ii) The permissive aggregation of Plan O and Plan P for the 2006 
plan year under Sec. 1.410(b)-7(d) is a plan coverage change that 
results in treating the plans as one plan (Plan OP) for purposes of 
Sec. 1.401(k)-1(b)(4). Therefore, the prior year ADP for the NHCEs 
under Plan OP for the 2006 plan year is the weighted average of the ADPs 
for the prior year subgroups: the Plan O prior year subgroup and the 
Plan P prior year subgroup.
    (iii) The Plan O prior year subgroup consists of the 300 employees 
who, in the 2005 plan year, were eligible NHCEs under Plan O and who 
would have been eligible under Plan OP for the 2005 plan year if Plan O 
and Plan P had been permissively aggregated for that plan year. The Plan 
P prior year subgroup consists of the 100 employees who, in the 2005 
plan year, were eligible NHCEs under Plan P and would have been eligible 
under Plan OP for the 2005 plan year if Plan O and Plan P had been 
permissively aggregated for that plan year.
    (iv) The weighted average of the ADPs for the prior year subgroups 
is the sum of the adjusted ADP for the Plan O prior year subgroup and 
the adjusted ADP for the Plan P prior year subgroup. The adjusted ADP 
for the Plan O prior year subgroup is 4.5%, calculated as follows: 6% 
(the ADP for the NHCEs under Plan O for the 2005 plan year) x 300/400 
(the number of NHCEs in the Plan O prior year subgroup divided by the 
total number of NHCEs in all prior year subgroups). The adjusted ADP for 
the Plan P prior year subgroup is 1%, calculated as follows: 4% (the ADP 
for the NHCEs under Plan P for the 2005 plan year) x 100/400 (the number 
of NHCEs in the Plan P prior year subgroup divided by the total number 
of NHCEs in all prior year subgroups). Thus, the prior year ADP for 
NHCEs under Plan OP for the 2006 plan year is 5.5% (the sum of adjusted 
ADPs for the prior year subgroups, 4.5% plus 1%).
    (v) As provided in paragraph (c)(4)(iii)(B) of this section, the 
determination of whether an NHCE is a member of a prior year subgroup is 
made without regard to whether that NHCE terminated employment during 
the prior year. Thus, the prior ADP for the NHCEs under Plan OP for the 
2006 plan year is unaffected by the termination of the 60 NHCEs covered 
by Plan O during the 2005 plan year.

[[Page 344]]

    Example 2. (i) The facts are the same as Example 1, except that the 
60 employees who terminated employment during the 2005 plan are instead 
spun-off to another plan.
    (ii) The permissive aggregation of Plan O and Plan P for the 2006 
plan year under Sec. 1.410(b)-7(d) is a plan coverage change that 
results in treating the plans as one plan (Plan OP) for purposes of 
Sec. 1.401(k)-1(b)(4) and the spin-off of the 60 employees is a plan 
coverage change. Therefore, the prior year ADP for the NHCEs under Plan 
OP for the 2006 plan year is the weighted average of the ADPs for the 
prior year subgroups: the Plan O prior year subgroup and the Plan P 
prior year subgroup.
    (iii) For purposes of determining the prior year subgroups, the 
employees who would have been eligible employees in the prior year under 
the plan being tested are determined as if both plan coverage changes 
had first been effective as of the first day of the prior plan year. The 
Plan O prior year subgroup consists of the 240 employees who, in the 
2005 plan year, were eligible NHCEs under Plan O and would have been 
eligible under Plan OP for the 2005 plan year if the spin-off had 
occurred at the beginning of the 2005 plan year and Plan O and Plan P 
had been permissively aggregated under Sec. 1.410(b)-7(d) for that plan 
year. The Plan P prior year subgroup consists of the 100 employees who, 
in the 2005 plan year, were eligible NHCEs under Plan P and would have 
been eligible under Plan OP for the 2005 plan year if Plan O and Plan P 
had been permissively aggregated under Sec. 1.410(b)-7(d) for that plan 
year.
    (iv) The weighted average of the ADPs for the prior year subgroups 
is the sum of the adjusted ADP with respect to the prior year subgroup 
consisting of eligible NHCEs from Plan O and the adjusted ADP with 
respect to the prior year subgroup consisting of eligible NHCEs from 
Plan P. The adjusted ADP for the prior year subgroup consisting of 
eligible NHCEs under Plan O is 4.23%, calculated as follows: 6% (the ADP 
for the NHCEs under Plan O for the 2005 plan year) x 240/340 (the number 
of NHCEs in that prior year subgroup divided by the total number of 
NHCEs in all prior year subgroups). The adjusted ADP for the prior year 
subgroup consisting of the eligible NHCEs from Plan P is 1.18%, 
calculated as follows: 4% (the ADP for the NHCEs under Plan P for the 
2005 plan year) x 100/340 (the number of NHCEs in that prior year 
subgroup divided by the total number of NHCEs in all prior year 
subgroups). Thus, the prior year ADP for NHCEs under Plan OP for the 
2006 plan year is 5.41% (the sum of adjusted ADPs for the prior year 
subgroups, 4.23% plus 1.18%).
    Example 3. (i) The facts are the same as in Example 1, except that 
instead of Plan O and Plan P being permissively aggregated for the 2006 
plan year, 200 of the employees eligible under Plan O were spun-off from 
Plan O and merged into Plan P.
    (ii) The spin-off from Plan O and merger to Plan P for the 2006 plan 
year are plan coverage changes for Plan P. Therefore, the prior year ADP 
for the NHCEs under Plan P for the 2006 plan year is the weighted 
average of the ADPs for the prior year subgroups under Plan P. There are 
2 subgroups under Plan P for the 2006 plan year. The Plan O prior year 
subgroup consists of the 200 employees who, in the 2005 plan year, were 
eligible NHCEs under Plan O and who would have been eligible under Plan 
P for the 2005 plan year if the spin-off and merger had occurred on the 
first day of the 2005 plan year. The Plan P prior year subgroup consists 
of the 100 employees who, in the 2005 plan year, were eligible NHCEs 
under Plan P for the 2005 plan year.
    (iii) The weighted average of the ADPs for the prior year subgroups 
is the sum of the adjusted ADP for the Plan O prior year subgroup and 
the adjusted ADP for the Plan P prior year subgroup. The adjusted ADP 
for the Plan O prior year subgroup is 4.0%, calculated as follows: 6% 
(the ADP for the NHCEs under Plan O for the 2005 plan year) x 200/300 
(the number of NHCEs in the Plan O prior year subgroup divided by the 
total number of NHCEs in all prior year subgroups). The adjusted ADP for 
the Plan P prior year subgroup is 1.33%, calculated as follows: 4% (the 
ADP for the NHCEs under Plan P for the 2005 plan year) x 100/300 (the 
number of NHCEs in the Plan P prior year subgroup divided by the total 
number of NHCEs in all prior year subgroups). Thus, the prior year ADP 
for NHCEs under Plan P for the 2006 plan year is 5.33% (the sum of 
adjusted ADPs for the 2 prior year subgroups, 4.0% plus 1.33%).
    (iv) The spin-off from Plan O for the 2006 plan year is a plan 
coverage change for Plan O. Therefore, the prior year ADP for the NHCEs 
under Plan O for the 2006 plan year is the weighted average of the ADPs 
for the prior year subgroups under Plan O. In this case, there is only 
one prior year subgroup under Plan O, the employees who were NHCEs of 
Employer B for the 2005 plan year and who were eligible for the 2005 
plan year under Plan O. Because there is only one prior year subgroup 
under Plan O, the weighted average of the ADPs for the prior year 
subgroup under Plan O is equal to the NHCE ADP for the prior year (2005 
plan year) under Plan O, or 6%.
    Example 4. (i) Employer C maintains a calendar year plan, Plan Q, 
which includes a cash or deferred arrangement that uses the prior year 
testing method. Plan Q covers employees of Division A and Division B. In 
2005, Plan Q had 500 eligible employees who were NHCEs, and the ADP for 
those NHCEs for 2005 was 2%. Effective January 1, 2006, Employer C 
amends the eligibility provisions

[[Page 345]]

under Plan Q to exclude employees of Division B effective January 1, 
2006. In addition, effective on that same date, Employer C establishes a 
new calendar year plan, Plan R, which includes a cash or deferred 
arrangement that uses the prior year testing method. The only eligible 
employees under Plan R are the 100 employees of Division B who were 
eligible employees under Plan Q.
    (ii) Plan R is a successor plan, within the meaning of paragraph 
(c)(2)(iii) of this section (because all of the employees were eligible 
employees under Plan Q in the prior year). Therefore, Plan R cannot use 
the first plan year rule set forth in paragraph (c)(2)(i) of this 
section.
    (iii) The amendment to the eligibility provisions of Plan Q and the 
establishment of Plan R are plan coverage changes within the meaning of 
paragraph (c)(4)(iii)(A) of this section for Plan Q and Plan R. 
Accordingly, each plan must determine the NHCE ADP for the 2006 plan 
year under the rules set forth in paragraph (c)(4) of this section.
    (iv) The prior year ADP for NHCEs under Plan Q is the weighted 
average of the ADPs for the prior year subgroups. Plan Q has only one 
prior year subgroup (because the only NHCEs who would have been eligible 
employees under Plan Q for the 2005 plan year if the amendment to the 
Plan Q eligibility provisions had occurred as of the first day of that 
plan year were eligible employees under Plan Q). Therefore, for purposes 
of the 2006 plan year under Plan Q, the ADP for NHCEs for the prior year 
is the weighted average of the ADPs for the prior year subgroups, or 2%, 
the same as if the plan amendment had not occurred.
    (v) Similarly, Plan R has only one prior year subgroup (because the 
only NHCEs who would have been eligible employees under Plan R for the 
2005 plan year if the plan were established as of the first day of that 
plan year were eligible employees under Plan Q). Therefore, for purposes 
of the 2006 testing year under Plan R, the ADP for NHCEs for the prior 
year is the weighted average of the ADPs for the prior year subgroups, 
or 2%, the same as that of Plan Q.
    Example 5. (i) The facts are the same as in Example 4, except that 
the provisions of Plan R extend eligibility to 50 hourly employees who 
previously were not eligible employees under any qualified cash or 
deferred arrangement maintained by Employer C.
    (ii) Plan R is a successor plan (because 100 of Plan R's 150 
eligible employees were eligible employees under another qualified cash 
or deferred arrangement maintained by Employer C in the prior year). 
Therefore, Plan R cannot use the first plan year rule set forth in 
paragraph (c)(2)(i) of this section.
    (iii) The establishment of Plan R is a plan coverage change that 
affects Plan R. Because the 50 hourly employees were not eligible 
employees under any qualified cash or deferred arrangement of Employer C 
for the prior plan year, they do not comprise a prior year subgroup. 
Accordingly, Plan R still has only one prior year subgroup. Therefore, 
for purposes of the 2006 testing year under Plan R, the ADP for NHCEs 
for the prior year is the weighted average of the ADPs for the prior 
year subgroups, or 2%, the same as that of Plan Q.

[T.D. 9169, 69 FR 78154, Dec. 29, 2004, as amended by T.D. 9237, 71 FR 
10, Jan. 3, 2006; T.D. 9447, 74 FR 8207, Feb. 24, 2009]



Sec. 1.401(k)-3  Safe harbor requirements.

    (a) ADP test safe harbor--(1) Section 401(k)(12) safe harbor. A cash 
or deferred arrangement satisfies the ADP safe harbor provision of 
section 401(k)(12) for a plan year if the arrangement satisfies the safe 
harbor contribution requirement of paragraph (b) or (c) of this section 
for the plan year, the notice requirement of paragraph (d) of this 
section, the plan year requirements of paragraph (e) of this section, 
and the additional rules of paragraphs (f), (g), and (h) of this 
section, as applicable.
    (2) Section 401(k)(13) safe harbor. For plan years beginning on or 
after January 1, 2008, a cash or deferred arrangement satisfies the ADP 
safe harbor provision of section 401(k)(13) for a plan year if the 
arrangement is described in paragraph (j) of this section and satisfies 
the safe harbor contribution requirement of paragraph (k) of this 
section for the plan year, the notice requirement of paragraph (d) of 
this section (modified to include the information set forth in paragraph 
(k)(4) of this section), the plan year requirements of paragraph (e) of 
this section, and the additional rules of paragraphs (f), (g), and (h) 
of this section, as applicable. A cash or deferred arrangement that 
satisfies the requirements of this paragraph (a)(2) is referred to as a 
qualified automatic contribution arrangement.
    (3) Requirements applicable to safe harbor contributions. Pursuant 
to section 401(k)(12)(E)(ii) and section 401(k)(13)(D)(iv), the safe 
harbor contribution requirement of paragraph (b), (c), or (k) of this 
section must be satisfied without regard to section 401(l). The 
contributions made under paragraph (b) or (c) of this section (and the 
corresponding contributions under

[[Page 346]]

paragraph (k) of this section) are referred to as safe harbor 
nonelective contributions and safe harbor matching contributions.
    (b) Safe harbor nonelective contribution requirement--(1) General 
rule. The safe harbor nonelective contribution requirement of this 
paragraph is satisfied if, under the terms of the plan, the employer is 
required to make a qualified nonelective contribution on behalf of each 
eligible NHCE equal to at least 3% of the employee's safe harbor 
compensation.
    (2) Safe harbor compensation defined. For purposes of this section, 
safe harbor compensation means compensation as defined in Sec. 
1.401(k)-6 (which incorporates the definition of compensation in Sec. 
1.414(s)-1); provided, however, that the rule in the last sentence of 
Sec. 1.414(s)-1(d)(2)(iii) (which generally permits a definition of 
compensation to exclude all compensation in excess of a specified dollar 
amount) does not apply in determining the safe harbor compensation of 
NHCEs. Thus, for example, the plan may limit the period used to 
determine safe harbor compensation to the eligible employee's period of 
participation.
    (c) Safe harbor matching contribution requirement--(1) In general. 
The safe harbor matching contribution requirement of this paragraph (c) 
is satisfied if, under the plan, qualified matching contributions are 
made on behalf of each eligible NHCE in an amount determined under the 
basic matching formula of section 401(k)(12)(B)(i)(I), as described in 
paragraph (c)(2) of this section, or under an enhanced matching formula 
of section 401(k)(12)(B)(i)(II), as described in paragraph (c)(3) of 
this section.
    (2) Basic matching formula. Under the basic matching formula, each 
eligible NHCE receives qualified matching contributions in an amount 
equal to the sum of--
    (i) 100% of the amount of the employee's elective contributions that 
do not exceed 3% of the employee's safe harbor compensation; and
    (ii) 50% of the amount of the employee's elective contributions that 
exceed 3% of the employee's safe harbor compensation but that do not 
exceed 5% of the employee's safe harbor compensation.
    (3) Enhanced matching formula. Under an enhanced matching formula, 
each eligible NHCE receives a matching contribution under a formula 
that, at any rate of elective contributions by the employee, provides an 
aggregate amount of qualified matching contributions at least equal to 
the aggregate amount of qualified matching contributions that would have 
been provided under the basic matching formula of paragraph (c)(2) of 
this section. In addition, under an enhanced matching formula, the ratio 
of matching contributions on behalf of an employee under the plan for a 
plan year to the employee's elective contributions may not increase as 
the amount of an employee's elective contributions increases.
    (4) Limitation on HCE matching contributions. The safe harbor 
matching contribution requirement of this paragraph (c) is not satisfied 
if the ratio of matching contributions made on account of an HCE's 
elective contributions under the cash or deferred arrangement for a plan 
year to those elective contributions is greater than the ratio of 
matching contributions to elective contributions that would apply with 
respect to any eligible NHCE with elective contributions at the same 
percentage of safe harbor compensation.
    (5) Use of safe harbor match not precluded by certain plan 
provisions--(i) Safe harbor matching contributions on employee 
contributions. The safe harbor matching contribution requirement of this 
paragraph (c) will not fail to be satisfied merely because safe harbor 
matching contributions are made on both elective contributions and 
employee contributions if safe harbor matching contributions are made 
with respect to the sum of elective contributions and employee 
contributions on the same terms as safe harbor matching contributions 
are made with respect to elective contributions. Alternatively, the safe 
harbor matching contribution requirement of this paragraph (c) will not 
fail to be satisfied merely because safe harbor matching

[[Page 347]]

contributions are made on both elective contributions and employee 
contributions if safe harbor matching contributions on elective 
contributions are not affected by the amount of employee contributions.
    (ii) Periodic matching contributions. The safe harbor matching 
contribution requirement of this paragraph (c) will not fail to be 
satisfied merely because the plan provides that safe harbor matching 
contributions will be made separately with respect to each payroll 
period (or with respect to all payroll periods ending with or within 
each month or quarter of a plan year) taken into account under the plan 
for the plan year, provided that safe harbor matching contributions with 
respect to any elective contributions made during a plan year quarter 
are contributed to the plan by the last day of the immediately following 
plan year quarter.
    (6) Permissible restrictions on elective contributions by NHCEs--(i) 
General rule. The safe harbor matching contribution requirement of this 
paragraph (c) is not satisfied if elective contributions by NHCEs are 
restricted, unless the restrictions are permitted by this paragraph 
(c)(6).
    (ii) Restrictions on election periods. A plan may limit the 
frequency and duration of periods in which eligible employees may make 
or change cash or deferred elections under a plan. However, an employee 
must have a reasonable opportunity (including a reasonable period after 
receipt of the notice described in paragraph (d) of this section) to 
make or change a cash or deferred election for the plan year. For 
purposes of this paragraph (c)(6)(ii), a 30-day period is deemed to be a 
reasonable period to make or change a cash or deferred election.
    (iii) Restrictions on amount of elective contributions. A plan is 
permitted to limit the amount of elective contributions that may be made 
by an eligible employee under a plan, provided that each NHCE who is an 
eligible employee is permitted (unless the employee is restricted under 
paragraph (c)(6)(v) of this section) to make elective contributions in 
an amount that is at least sufficient to receive the maximum amount of 
matching contributions available under the plan for the plan year, and 
the employee is permitted to elect any lesser amount of elective 
contributions. However, a plan may require eligible employees to make 
cash or deferred elections in whole percentages of compensation or whole 
dollar amounts.
    (iv) Restrictions on types of compensation that may be deferred. A 
plan may limit the types of compensation that may be deferred by an 
eligible employee under a plan, provided that each eligible NHCE is 
permitted to make elective contributions under a definition of 
compensation that would be a reasonable definition of compensation 
within the meaning of Sec. 1.414(s)-1(d)(2). Thus, the definition of 
compensation from which elective contributions may be made is not 
required to satisfy the nondiscrimination requirement of Sec. 1.414(s)-
1(d)(3).
    (v) Restrictions due to limitations under the Internal Revenue Code. 
A plan may limit the amount of elective contributions made by an 
eligible employee under a plan--
    (A) Because of the limitations of section 402(g) or 415; or
    (B) Because, on account of a hardship distribution, an employee's 
ability to make elective contributions has been suspended for 6 months 
in accordance with Sec. 1.401(k)-1(d)(3)(iv)(E).
    (7) Examples. The following examples illustrate the safe harbor 
contribution requirement of this paragraph (c):

    Example 1. (i) Beginning January 1, 2006, Employer A maintains Plan 
L covering employees in Divisions D and E, each of which includes HCEs 
and NHCEs. Plan L contains a cash or deferred arrangement and provides 
qualified matching contributions equal to 100% of each eligible 
employee's elective contributions up to 3% of compensation and 50% of 
the next 2% of compensation. For purposes of the matching contribution 
formula, safe harbor compensation is defined as all compensation within 
the meaning of section 415(c)(3) (a definition that satisfies section 
414(s)). Also, each employee is permitted to make elective contributions 
from all safe harbor compensation within the meaning of section 
415(c)(3) and may change a cash or deferred election at any time. Plan L 
limits the amount of an employee's elective contributions for purposes 
of section 402(g) and section 415, and, in the case of a hardship 
distribution, suspends an employee's ability to make elective 
contributions for 6 months in accordance with Sec. 1.401(k)-
1(d)(3)(iv)(E). All

[[Page 348]]

contributions under Plan L are nonforfeitable and are subject to the 
withdrawal restrictions of section 401(k)(2)(B). Plan L provides for no 
other contributions and Employer A maintains no other plans. Plan L is 
maintained on a calendar-year basis, and all contributions for a plan 
year are made within 12 months after the end of the plan year.
    (ii) Based on these facts, matching contributions under Plan L are 
safe harbor matching contributions because they are qualified matching 
contributions equal to the basic matching formula. Accordingly, Plan L 
satisfies the safe harbor contribution requirement of this paragraph 
(c).
    Example 2. (i) The facts are the same as in Example 1, except that 
instead of providing a basic matching contribution, Plan L provides a 
qualified matching contribution equal to 100% of each eligible 
employee's elective contributions up to 4% of safe harbor compensation.
    (ii) Plan L's formula is an enhanced matching formula because each 
eligible NHCE receives safe harbor matching contributions at a rate 
that, at any rate of elective contributions, provides an aggregate 
amount of qualified matching contributions at least equal to the 
aggregate amount of qualified matching contributions that would have 
been received under the basic safe harbor matching formula, and the rate 
of matching contributions does not increase as the rate of an employee's 
elective contributions increases. Accordingly, Plan L satisfies the safe 
harbor contribution requirement of this paragraph (c).
    Example 3. (i) The facts are the same as in Example 2, except that 
instead of permitting each employee to make elective contributions from 
all compensation within the meaning of section 415(c)(3), each 
employee's elective contributions under Plan L are limited to 15% of the 
employee's basic compensation. Basic compensation is defined under Plan 
L as compensation within the meaning of section 415(c)(3), but excluding 
overtime pay.
    (ii) The definition of basic compensation under Plan L is a 
reasonable definition of compensation within the meaning of Sec. 
1.414(s)-1(d)(2).
    (iii) Plan L will not fail to satisfy the safe harbor contribution 
requirement of this paragraph (c) merely because Plan L limits the 
amount of elective contributions and the types of compensation that may 
be deferred by eligible employees, provided that each eligible NHCE may 
make elective contributions equal to at least 4% of the employee's safe 
harbor compensation.
    Example 4. (i) The facts are the same as in Example 1, except that 
Plan L provides that only employees employed on the last day of the plan 
year will receive a safe harbor matching contribution.
    (ii) Even if the plan that provides for employee contributions and 
matching contributions satisfies the minimum coverage requirements of 
section 410(b)(1) taking into account this last-day requirement, Plan L 
would not satisfy the safe harbor contribution requirement of this 
paragraph (c) because safe harbor matching contributions are not made on 
behalf of all eligible NHCEs who make elective contributions.
    (iii) The result would be the same if, instead of providing safe 
harbor matching contributions, Plan L provides for a 3% safe harbor 
nonelective contribution that is restricted to eligible employees under 
the cash or deferred arrangement who are employed on the last day of the 
plan year.
    Example 5. (i) The facts are the same as in Example 1, except that 
instead of providing qualified matching contributions under the basic 
matching formula to employees in both Divisions D and E, employees in 
Division E are provided qualified matching contributions under the basic 
matching formula, while safe harbor matching contributions continue to 
be provided to employees in Division D under the enhanced matching 
formula described in Example 2.
    (ii) Even if Plan L satisfies Sec. 1.401(a)(4)-4 with respect to 
each rate of matching contributions available to employees under the 
plan, the plan would fail to satisfy the safe harbor contribution 
requirement of this paragraph (c) because the rate of matching 
contributions with respect to HCEs in Division D at a rate of elective 
contributions between 3% and 5% would be greater than that with respect 
to NHCEs in Division E at the same rate of elective contributions. For 
example, an HCE in Division D who would have a 4% rate of elective 
contributions would have a rate of matching contributions of 100% while 
an NHCE in Division E who would have the same rate of elective 
contributions would have a lower rate of matching contributions.

    (d) Notice requirement--(1) General rule. The notice requirement of 
this paragraph (d) is satisfied for a plan year if each eligible 
employee is given notice of the employee's rights and obligations under 
the plan and the notice satisfies the content requirement of paragraph 
(d)(2) of this section and the timing requirement of paragraph (d)(3) of 
this section. The notice must be in writing or in such other form as may 
be approved by the Commissioner. See Sec. 1.401(a)-21 of this chapter 
for rules permitting the use of electronic media to provide applicable 
notices to recipients with respect to retirement plans.
    (2) Content requirement--(i) General rule. The content requirement 
of this

[[Page 349]]

paragraph (d)(2) is satisfied if the notice is--
    (A) Sufficiently accurate and comprehensive to inform the employee 
of the employee's rights and obligations under the plan; and
    (B) Written in a manner calculated to be understood by the average 
employee eligible to participate in the plan.
    (ii) Minimum content requirement. Subject to the requirements of 
paragraph (d)(2)(iii) of this section, a notice is not considered 
sufficiently accurate and comprehensive unless the notice accurately 
describes--
    (A) The safe harbor matching contribution or safe harbor nonelective 
contribution formula used under the plan (including a description of the 
levels of safe harbor matching contributions, if any, available under 
the plan);
    (B) Any other contributions under the plan or matching contributions 
to another plan on account of elective contributions or employee 
contributions under the plan (including the potential for discretionary 
matching contributions) and the conditions under which such 
contributions are made;
    (C) The plan to which safe harbor contributions will be made (if 
different than the plan containing the cash or deferred arrangement);
    (D) The type and amount of compensation that may be deferred under 
the plan;
    (E) How to make cash or deferred elections, including any 
administrative requirements that apply to such elections;
    (F) The periods available under the plan for making cash or deferred 
elections;
    (G) Withdrawal and vesting provisions applicable to contributions 
under the plan; and
    (H) Information that makes it easy to obtain additional information 
about the plan (including an additional copy of the summary plan 
description) such as telephone numbers, addresses and, if applicable, 
electronic addresses, of individuals or offices from whom employees can 
obtain such plan information.
    (iii) References to SPD. A plan will not fail to satisfy the content 
requirements of this paragraph (d)(2) merely because, in the case of 
information described in paragraph (d)(2)(ii)(B) of this section 
(relating to any other contributions under the plan), paragraph 
(d)(2)(ii)(C) of this section (relating to the plan to which safe harbor 
contributions will be made) or paragraph (d)(2)(ii)(D) of this section 
(relating to the type and amount of compensation that may be deferred 
under the plan), the notice cross-references the relevant portions of a 
summary plan description that provides the same information that would 
be provided in accordance with such paragraphs and that has been 
provided (or is concurrently provided) to employees.
    (3) Timing requirement--(i) General rule. The timing requirement of 
this paragraph (d)(3) is satisfied if the notice is provided within a 
reasonable period before the beginning of the plan year (or, in the year 
an employee becomes eligible, within a reasonable period before the 
employee becomes eligible). The determination of whether a notice 
satisfies the timing requirement of this paragraph (d)(3) is based on 
all of the relevant facts and circumstances.
    (ii) Deemed satisfaction of timing requirement. The timing 
requirement of this paragraph (d)(3) is deemed to be satisfied if at 
least 30 days (and no more than 90 days) before the beginning of each 
plan year, the notice is given to each eligible employee for the plan 
year. In the case of an employee who does not receive the notice within 
the period described in the previous sentence because the employee 
becomes eligible after the 90th day before the beginning of the plan 
year, the timing requirement is deemed to be satisfied if the notice is 
provided no more than 90 days before the employee becomes eligible (and 
no later than the date the employee becomes eligible). Thus, for 
example, the preceding sentence would apply in the case of any employee 
eligible for the first plan year under a newly established plan that 
provides for elective contributions, or would apply in the case of the 
first plan year in which an employee becomes eligible under an existing 
plan that provides for elective contributions. If it is not practicable 
for the notice to be provided on or before the date specified in the 
plan that an employee becomes eligible, the notice will

[[Page 350]]

nonetheless be treated as provided timely if it is provided as soon as 
practicable after that date and the employee is permitted to elect to 
defer from all types of compensation that may be deferred under the plan 
earned beginning on the date the employee becomes eligible.
    (e) Plan year requirement--(1) General rule. Except as provided in 
this paragraph (e) or in paragraph (f) of this section, a plan will fail 
to satisfy the requirements of sections 401(k)(12), 401(k)(13), and this 
section unless plan provisions that satisfy the rules of this section 
are adopted before the first day of the plan year and remain in effect 
for an entire 12-month plan year. In addition, except as provided in 
paragraph (g) of this section or in guidance of general applicability 
published in the Internal Revenue Bulletin (see Sec. 
601.601(d)(2)(ii)(b) of this chapter), a plan which includes provisions 
that satisfy the rules of this section will not satisfy the requirements 
of Sec. 1.401(k)-1(b) if it is amended to change such provisions for 
that plan year. Moreover, if, as described under paragraph (h)(4) of 
this section, safe harbor matching or nonelective contributions will be 
made to another plan for a plan year, provisions under that other plan 
specifying that the safe harbor contributions will be made and providing 
that the contributions will be QNECs or QMACs must also be adopted 
before the first day of that plan year.
    (2) Initial plan year. A newly established plan (other than a 
successor plan within the meaning of Sec. 1.401(k)-2(c)(2)(iii)) will 
not be treated as violating the requirements of this paragraph (e) 
merely because the plan year is less than 12 months, provided that the 
plan year is at least 3 months long (or, in the case of a newly 
established employer that establishes the plan as soon as 
administratively feasible after the employer comes into existence, a 
shorter period). Similarly, a cash or deferred arrangement will not fail 
to satisfy the requirement of this paragraph (e) if it is added to an 
existing profit sharing, stock bonus, or pre-ERISA money purchase 
pension plan for the first time during that year provided that--
    (i) The plan is not a successor plan; and
    (ii) The cash or deferred arrangement is made effective no later 
than 3 months prior to the end of the plan year.
    (3) Change of plan year. A plan that has a short plan year as a 
result of changing its plan year will not fail to satisfy the 
requirements of paragraph (e)(1) of this section merely because the plan 
year has less than 12 months, provided that--
    (i) The plan satisfied the requirements of this section for the 
immediately preceding plan year; and
    (ii) The plan satisfies the requirements of this section (determined 
without regard to paragraph (g) of this section) for the immediately 
following plan year (or for the immediately following 12 months if the 
immediately following plan year is less than 12 months).
    (4) Final plan year. A plan that terminates during a plan year will 
not fail to satisfy the requirements of paragraph (e)(1) of this section 
merely because the final plan year is less than 12 months, provided that 
the plan satisfies the requirement of this section through the date of 
termination and either--
    (i) The plan would satisfy the requirements of paragraph (g) of this 
section, treating the termination of the plan as a reduction or 
suspension of safe harbor contributions, other than the requirements of 
paragraph (g)(1)(i)(A) or (g)(1)(ii)(A) of this section (relating to the 
employer's financial condition and information included in the initial 
notice for the plan year) and paragraph (g)(1)(i)(D) or (g)(1)(ii)(D) of 
this section (requiring that employees have a reasonable opportunity to 
change their cash or deferred elections and, if applicable, employee 
contribution elections); or
    (ii) The plan termination is in connection with a transaction 
described in section 410(b)(6)(C) or the employer incurs a substantial 
business hardship comparable to a substantial business hardship 
described in section 412(c).
    (f) Plan amendments adopting safe harbor nonelective contributions--
(1) General rule. Notwithstanding paragraph (e)(1) of this section, a 
plan that provides for

[[Page 351]]

the use of the current year testing method may be amended after the 
first day of the plan year and no later than 30 days before the last day 
of the plan year to adopt the safe harbor method of this section, 
effective as of the first day of the plan year, using nonelective 
contributions under paragraph (b) of this section, but only if the plan 
provides the contingent and follow-up notices described in this section. 
A plan amendment made pursuant to this paragraph (f)(1) for a plan year 
may provide for the use of the safe harbor method described in this 
section solely for that plan year and a plan sponsor is not limited in 
the number of years for which it is permitted to adopt an amendment 
providing for the safe harbor method of this section using nonelective 
contributions under paragraph (b) of this section and this paragraph 
(f).
    (2) Contingent notice provided. A plan satisfies the requirement to 
provide the contingent notice under this paragraph (f)(2) if it provides 
a notice that would satisfy the requirements of paragraph (d) of this 
section, except that, in lieu of setting forth the safe harbor 
contributions used under the plan as set forth in paragraph 
(d)(2)(ii)(A) of this section, the notice specifies that the plan may be 
amended during the plan year to include the safe harbor nonelective 
contribution and that, if the plan is amended, a follow-up notice will 
be provided.
    (3) Follow-up notice requirement. A plan satisfies the requirement 
to provide a follow-up notice under this paragraph (f)(3) if, no later 
than 30 days before the last day of the plan year, each eligible 
employee is given a notice that states that the safe harbor nonelective 
contributions will be made for the plan year. The notice must be in 
writing or in such other form as may be prescribed by the Commissioner 
and is permitted to be combined with a contingent notice provided under 
paragraph (f)(2) of this section for the next plan year.
    (g) Permissible reduction or suspension of safe harbor 
contributions--(1) General rule--(i) Matching contributions. A plan that 
provides for safe harbor matching contributions intended to satisfy the 
requirements of paragraph (c) of this section for a plan year will not 
fail to satisfy the requirements of section 401(k)(3) merely because the 
plan is amended during the plan year to reduce or suspend safe harbor 
matching contributions on future elective contributions (and, if 
applicable, employee contributions) provided that--
    (A) In the case of plan years beginning on or after January 1, 2015, 
the employer either--
    (1) Is operating at an economic loss as described in section 
412(c)(2)(A) for the plan year; or
    (2) Includes in the notice described in paragraph (d) of this 
section a statement that the plan may be amended during the plan year to 
reduce or suspend safe harbor matching contributions and that the 
reduction or suspension will not apply until at least 30 days after all 
eligible employees are provided notice of the reduction or suspension;
    (B) All eligible employees are provided a supplemental notice that 
satisfies the requirements of paragraph (g)(2) of this section;
    (C) The reduction or suspension of safe harbor matching 
contributions is effective no earlier than the later of the date the 
amendment is adopted or 30 days after eligible employees are provided 
the supplemental notice described in paragraph (g)(2) of this section;
    (D) Eligible employees are given a reasonable opportunity (including 
a reasonable period after receipt of the supplemental notice) prior to 
the reduction or suspension of safe harbor matching contributions to 
change their cash or deferred elections and, if applicable, their 
employee contribution elections;
    (E) The plan is amended to provide that the ADP test will be 
satisfied for the entire plan year in which the reduction or suspension 
occurs using the current year testing method described in Sec. 
1.401(k)-2(a)(2)(ii); and
    (F) The plan satisfies the requirements of this section (other than 
this paragraph (g)) with respect to amounts deferred through the 
effective date of the amendment.
    (ii) Nonelective contributions. For amendments adopted after May 18,

[[Page 352]]

2009, a plan that provides for safe harbor nonelective contributions 
intended to satisfy the requirements of paragraph (b) of this section 
for the plan year will not fail to satisfy the requirements of section 
401(k)(3) merely because the plan is amended during the plan year to 
reduce or suspend safe harbor nonelective contributions provided that--
    (A) The employer either--
    (1) Is operating at an economic loss, as described in section 
412(c)(2)(A) for the plan year; or
    (2) Includes in the notice described in paragraph (d) of this 
section a statement that the plan may be amended during the plan year to 
reduce or suspend safe harbor nonelective contributions and that the 
reduction or suspension will not apply until at least 30 days after all 
eligible employees are provided notice of the reduction or suspension;
    (B) All eligible employees are provided a supplemental notice that 
satisfies the requirements of paragraph (g)(2) of this section;
    (C) The reduction or suspension of safe harbor nonelective 
contributions is effective no earlier than the later of the date the 
amendment is adopted or 30 days after eligible employees are provided 
the supplemental notice described in paragraph (g)(2) of this section;
    (D) Eligible employees are given a reasonable opportunity (including 
a reasonable period after receipt of the supplemental notice) prior to 
the reduction or suspension of nonelective contributions to change their 
cash or deferred elections and, if applicable, their employee 
contribution elections;
    (E) The plan is amended to provide that the ADP test will be 
satisfied for the entire plan year in which the reduction or suspension 
occurs using the current year testing method described in Sec. 
1.401(k)-2(a)(2)(ii); and
    (F) The plan satisfies the requirements of this section (other than 
this paragraph (g)) with respect to safe harbor compensation paid 
through the effective date of the amendment.
    (2) Supplemental notice. The supplemental notice requirement of this 
paragraph (g)(2) is satisfied if each eligible employee is given a 
notice (in writing or such other form as prescribed by the Commissioner) 
that explains--
    (i) The consequences of the amendment that reduces or suspends 
future safe harbor contributions;
    (ii) The procedures for changing their cash or deferred elections 
and, if applicable, their employee contribution elections; and
    (iii) The effective date of the amendment.
    (h) Additional rules--(1) Contributions taken into account. A 
contribution is taken into account for purposes of this section for a 
plan year if and only if the contribution would be taken into account 
for such plan year under the rules of Sec. 1.401(k)-2(a) or 1.401(m)-
2(a). Thus, for example, a safe harbor matching contribution must be 
made within 12 months of the end of the plan year. Similarly, an 
elective contribution that would be taken into account for a plan year 
under Sec. 1.401(k)-2(a)(4)(i)(B)(2) must be taken into account for 
such plan year for purposes of this section, even if the compensation 
would have been received after the close of the plan year.
    (2) Use of safe harbor nonelective contributions to satisfy other 
nondiscrimination tests. A safe harbor nonelective contribution used to 
satisfy the nonelective contribution requirement under paragraph (b) of 
this section may also be taken into account for purposes of determining 
whether a plan satisfies section 401(a)(4). Thus, these contributions 
are not subject to the limitations on qualified nonelective 
contributions under Sec. 1.401(k)-2(a)(6)(ii), but are subject to the 
rules generally applicable to nonelective contributions under section 
401(a)(4). See Sec. 1.401(a)(4)-1(b)(2)(ii). However, pursuant to 
section 401(k)(12)(E)(ii) and section 401(k)(13)(D)(iv), to the extent 
they are needed to satisfy the safe harbor contribution requirement of 
paragraph (b) of this section, safe harbor nonelective contributions may 
not be taken into account under any plan for purposes of section 401(l) 
(including the imputation of permitted disparity under Sec. 
1.401(a)(4)-7).
    (3) Early participation rules. Section 401(k)(3)(F) and Sec. 
1.401(k)-2(a)(1)(iii)(A),

[[Page 353]]

which provide an alternative nondiscrimination rule for certain plans 
that provide for early participation, do not apply for purposes of 
section 401(k)(12), section 401(k)(13), and this section. Thus, a plan 
is not treated as satisfying this section with respect to the eligible 
employees who have not completed the minimum age and service 
requirements of section 410(a)(1)(A) unless the plan satisfies the 
requirements of this section with respect to such eligible employees. 
However, a plan is permitted to apply the rules of section 410(b)(4)(B) 
to treat the plan as two separate plans for purposes of section 410(b) 
and apply the safe harbor requirements of this section to one plan and 
apply the requirements of Sec. 1.401(k)-2 to the other plan. See Sec. 
1.401(k)-1(b)(4)(vi), Example 2.
    (4) Satisfying safe harbor contribution requirement under another 
defined contribution plan. Safe harbor matching or nonelective 
contributions may be made to the plan that contains the cash or deferred 
arrangement or to another defined contribution plan that satisfies 
section 401(a) or 403(a). If safe harbor contributions are made to 
another defined contribution plan, the safe harbor plan must specify the 
plan to which the safe harbor contributions are made and the 
contribution requirement of paragraph (b) or (c) of this section must be 
satisfied in the other defined contribution plan in the same manner as 
if the contributions were made to the plan that contains the cash or 
deferred arrangement. Consequently, the plan to which the contributions 
are made must have the same plan year as the plan containing the cash 
and deferred arrangement and each employee eligible under the plan 
containing the cash or deferred arrangement must be eligible under the 
same conditions under the other defined contribution plan. The plan to 
which the safe harbor contributions are made need not be a plan that can 
be aggregated with the plan that contains the cash or deferred 
arrangement.
    (5) Contributions used only once. Safe harbor matching or 
nonelective contributions cannot be used to satisfy the requirements of 
this section with respect to more than one plan.
    (i) [Reserved]
    (j) Qualified automatic contribution arrangement--(1) Automatic 
contribution requirement--(i) In general. A cash or deferred arrangement 
is described in this paragraph (j) if it is an automatic contribution 
arrangement described in paragraph (j)(1)(ii) of this section where the 
default election under that arrangement is a contribution equal to the 
qualified percentage described in paragraph (j)(2) of this section 
multiplied by the eligible employee's compensation from which elective 
contributions are permitted to be made under the cash or deferred 
arrangement. For plan years beginning on or after January 1, 2010, the 
compensation used for this purpose must be safe harbor compensation as 
defined under paragraph (b)(2) of this section.
    (ii) Automatic contribution arrangement. An automatic contribution 
arrangement is a cash or deferred arrangement within the meaning of 
Sec. 1.401(k)-1(a)(2) that provides that, in the absence of an eligible 
employee's affirmative election, a default election applies under which 
the employee is treated as having made an election to have a specified 
contribution made on his or her behalf under the plan. The default 
election begins to apply with respect to an eligible employee no earlier 
than a reasonable period of time after receipt of the notice describing 
the automatic contribution arrangement. The default election ceases to 
apply with respect to an eligible employee for periods of time with 
respect to which the employee has an affirmative election that is 
currently in effect to--
    (A) Have elective contributions made in a different amount on his or 
her behalf (in a specified amount or percentage of compensation); or
    (B) Not have any elective contributions made on his or her behalf.
    (iii) Exception to automatic enrollment for certain current 
employees. An automatic contribution arrangement will not fail to be a 
qualified automatic contribution arrangement merely because the default 
election provided under paragraph (j)(1)(i) of this section is not 
applied to an employee who was an eligible employee under the cash or 
deferred arrangement (or a predecessor arrangement) immediately prior to 
the

[[Page 354]]

effective date of the qualified automatic contribution arrangement and 
on that effective date had an affirmative election in effect (that 
remains in effect) to--
    (A) Have elective contributions made on his or her behalf (in a 
specified amount or percentage of compensation); or
    (B) Not have elective contributions made on his or her behalf.
    (2) Qualified percentage--(i) In general. A percentage is a 
qualified percentage only if it--
    (A) Is uniform for all employees (except to the extent provided in 
paragraph (j)(2)(iii) of this section);
    (B) Does not exceed 10 percent; and
    (C) Satisfies the minimum percentage requirements of paragraph 
(j)(2)(ii) of this section.
    (ii) Minimum percentage requirements--(A) Initial-period 
requirement. The minimum percentage requirement of this paragraph 
(j)(2)(ii)(A) is satisfied only if the percentage that applies for the 
initial period is at least 3 percent. For this purpose, the initial 
period begins when the employee first has contributions made pursuant to 
a default election under an arrangement that is intended to be a 
qualified automatic contribution arrangement for a plan year and ends on 
the last day of the following plan year.
    (B) Second-year requirement. The minimum percentage requirement of 
this paragraph (j)(2)(ii)(B) is satisfied only if the percentage that 
applies for the plan year immediately following the last day described 
in paragraph (j)(2)(ii)(A) of this section is at least 4 percent.
    (C) Third-year requirement. The minimum percentage requirement of 
this paragraph (j)(2)(ii)(C) is satisfied only if the percentage that 
applies for the plan year immediately following the plan year described 
in paragraph (j)(2)(ii)(B) of this section is at least 5 percent.
    (D) Later years requirement. A percentage satisfies the minimum 
percentage requirement of this paragraph (j)(2)(ii)(D) only if the 
percentage that applies for all plan years following the plan year 
described in paragraph (j)(2)(ii)(C) of this section is at least 6 
percent.
    (iii) Exception to uniform percentage requirement. A plan does not 
fail to satisfy the uniform percentage requirement of paragraph 
(j)(2)(i)(A) of this section merely because--
    (A) The percentage varies based on the number of years (or portions 
of years) since the beginning of the initial period for an eligible 
employee;
    (B) The rate of elective contributions under a cash or deferred 
election that is in effect for an employee immediately prior to the 
effective date of the default percentage under the qualified automatic 
contribution arrangement is not reduced;
    (C) The rate of elective contributions is limited so as not to 
exceed the limits of sections 401(a)(17), 402(g) (determined with or 
without catch-up contributions described in section 402(g)(1)(C) or 
402(g)(7)), and 415; or
    (D) The default election provided under paragraph (j)(1)(i) of this 
section is not applied during the period an employee is not permitted to 
make elective contributions in order for the plan to satisfy the 
requirements of Sec. 1.401(k)-3(c)(6)(v)(B).
    (iv) Treatment of periods without default contributions. The minimum 
percentages described in paragraph (j)(2)(ii) of this section are based 
on the date the initial period begins, regardless of whether the 
employee is eligible to make elective contributions under the plan after 
that date. Thus, for example, if an employee is ineligible to make 
contributions under the plan for 6 months because the employee had a 
hardship withdrawal and the 6-month period includes a date as of which 
the default minimum percentage is increased, then the default percentage 
must reflect that increase when the employee is permitted to resume 
contributions. However, for purposes of determining the date the initial 
period described in paragraph (j)(2)(ii)(A) of this section begins, a 
plan is permitted to treat an employee who for an entire plan year did 
not have contributions made pursuant to a default election under the 
qualified automatic contribution arrangement as if the employee had not 
had such contributions made for any prior plan year as well.
    (k) Modifications to contribution requirements and notice 
requirements for

[[Page 355]]

automatic contribution safe harbor--(1) In general. A cash or deferred 
arrangement satisfies the contribution requirements of this paragraph 
(k) only if it satisfies the contribution requirements of either 
paragraph (b) or (c) of this section, as modified by the rules of 
paragraphs (k)(2) and (k)(3) of this section. In addition, a cash or 
deferred arrangement satisfies the notice requirement of section 
401(k)(13)(E) only if the notice satisfies the additional requirements 
of paragraph (k)(4) of this section.
    (2) Lower matching requirement. In applying the requirement of 
paragraph (c) of this section in the case of a cash or deferred 
arrangement, the basic matching formula is modified so that each 
eligible NHCE must receive the sum of--
    (i) 100 percent of the employee's elective contributions that do not 
exceed 1 percent of the employee's safe harbor compensation; and
    (ii) 50 percent of the employee's elective contributions that exceed 
1 percent of the employee's safe harbor compensation but that do not 
exceed 6 percent of the employee's safe harbor compensation.
    (3) Modified nonforfeiture requirement. A cash or deferred 
arrangement described in paragraph (j) of this section will not fail to 
satisfy the requirements of paragraph (b) or (c) of this section, as 
applicable, merely because the safe harbor contributions are not 
qualified nonelective contributions or qualified matching contributions 
provided that--
    (i) The contributions are subject to the withdrawal restrictions 
that apply to QNECs and QMACs, as set forth in Sec. 1.401(k)-1(d); and
    (ii) Any employee who has completed 2 years of service (within the 
meaning of section 411(a)) has a nonforfeitable right to the account 
balance attributable to the safe harbor contributions.
    (4) Additional notice requirements--(i) In general. A notice 
satisfies the requirements of this paragraph (k)(4) only if it includes 
the additional information described in paragraph (k)(4)(ii) of this 
section and satisfies the timing requirements of paragraph (k)(4)(iii) 
of this section.
    (ii) Additional information. A notice satisfies the additional 
information requirement of this paragraph (k)(4)(ii) only if it 
explains--
    (A) The level of elective contributions which will be made on the 
employee's behalf if the employee does not make an affirmative election;
    (B) The employee's right under the arrangement to elect not to have 
elective contributions made on the employee's behalf (or to elect to 
have such contributions made in a different amount or percentage of 
compensation); and
    (C) How contributions under the arrangement will be invested 
(including, in the case of an arrangement under which the employee may 
elect among 2 or more investment options, how contributions will be 
invested in the absence of an investment election by the employee).
    (iii) Timing requirements. A notice satisfies the timing 
requirements of this paragraph (k)(4)(iii) only if it is provided 
sufficiently early so that the employee has a reasonable period of time 
after receipt of the notice to make the elections described under 
paragraph (k)(4)(ii)(B) and (C) of this section. However, the 
requirement in the preceding sentence that an employee have a reasonable 
period of time after receipt of the notice to make an alternative 
election does not permit a plan to make the default election effective 
any later than the earlier of--
    (A) The pay date for the second payroll period that begins after the 
date the notice is provided; and
    (B) The first pay date that occurs at least 30 days after the notice 
is provided.

[T.D. 9169, 69 FR 78154, Dec. 29, 2004, as amended by T.D. 9294, 71 FR 
61887, Oct. 20, 2006; T.D. 9447, 74 FR 8208, Feb. 24, 2009; T.D. 9641, 
78 FR 68737, Nov. 15, 2013]



Sec. 1.401(k)-4  SIMPLE 401(k) plan requirements.

    (a) General rule. A cash or deferred arrangement satisfies the 
SIMPLE 401(k) plan provision of section 401(k)(11) for a plan year if 
the arrangement satisfies the requirements of paragraphs (b) through (i) 
of this section for that year. A plan that contains a cash or deferred 
arrangement that satisfies this section is referred to as a SIMPLE 
401(k) plan. Pursuant to section

[[Page 356]]

401(k)(11), a SIMPLE 401(k) plan is treated as satisfying the ADP test 
of section 401(k)(3)(A)(ii) for that year.
    (b) Eligible employer--(1) General rule. A SIMPLE 401(k) plan must 
be established by an eligible employer. Eligible employer for purposes 
of this section means, with respect to any plan year, an employer that 
had no more than 100 employees who each received at least $5,000 of 
SIMPLE compensation, as defined in paragraph (e)(5) of this section, 
from the employer for the prior calendar year.
    (2) Special rule. An eligible employer that establishes a SIMPLE 
401(k) plan for a plan year and that fails to be an eligible employer 
for any subsequent plan year, is treated as an eligible employer for the 
2 plan years following the last plan year the employer was an eligible 
employer. If the failure is due to any acquisition, disposition, or 
similar transaction involving an eligible employer, the preceding 
sentence applies only if the provisions of section 410(b)(6)(C)(i) are 
satisfied.
    (c) Exclusive plan--(1) General rule. The SIMPLE 401(k) plan must be 
the exclusive plan for each SIMPLE 401(k) plan participant for the plan 
year. This requirement is satisfied if there are no contributions made, 
or benefits accrued, for services during the plan year on behalf of any 
SIMPLE 401(k) plan participant under any other qualified plan maintained 
by the employer. Other qualified plan for purposes of this section means 
any plan, contract, pension, or trust described in section 219(g)(5)(A) 
or (B).
    (2) Special rule. A SIMPLE 401(k) plan will not be treated as 
failing the requirements of this paragraph (c) merely because any SIMPLE 
401(k) plan participant receives an allocation of forfeitures under 
another plan of the employer.
    (d) Election and notice--(1) General rule. An eligible employer 
establishing or maintaining a SIMPLE 401(k) plan must satisfy the 
election and notice requirements in paragraphs (d)(2) and (3) of this 
section.
    (2) Employee elections--(i) Initial plan year of participation. For 
the plan year in which an employee first becomes eligible under the 
SIMPLE 401(k) plan, the employee must be permitted to make a cash or 
deferred election under the plan during a 60-day period that includes 
either the day the employee becomes eligible or the day before.
    (ii) Subsequent plan years. For each subsequent plan year, each 
eligible employee must be permitted to make or modify his cash or 
deferred election during the 60-day period immediately preceding such 
plan year.
    (iii) Election to terminate. An eligible employee must be permitted 
to terminate his cash or deferred election at any time. If an employee 
does terminate his cash or deferred election, the plan is permitted to 
provide that such employee cannot have elective contributions made under 
the plan for the remainder of the plan year.
    (3) Employee notices. The employer must notify each eligible 
employee within a reasonable time prior to each 60-day election period, 
or on the day the election period starts, that he or she can make a cash 
or deferred election, or modify a prior election, if applicable, during 
that period. The notice must state whether the eligible employer will 
make the matching contributions described in paragraph (e)(3) of this 
section or the nonelective contributions described in paragraph (e)(4) 
of this section.
    (e) Contributions--(1) General rule. A SIMPLE 401(k) plan satisfies 
the contribution requirements of this paragraph (e) for a plan year only 
if no contributions may be made to the SIMPLE 401(k) plan during such 
year, other than contributions described in this paragraph (e) and 
rollover contributions described in Sec. 1.402(c)-2, Q&A-1(a).
    (2) Elective contributions. Subject to the limitations on annual 
additions under section 415, each eligible employee must be permitted to 
make an election to have up to $10,000 of elective contributions made on 
the employee's behalf under the SIMPLE 401(k) plan for a plan year. The 
$10,000 limit is increased beginning in 2006 in the same manner as the 
$160,000 amount is adjusted under section 415(d), except that pursuant 
to section 408(p)(2)(E)(ii) the base period shall be the calendar 
quarter beginning July 1, 2004 and any increase which is not a multiple 
of $500 is rounded to the next lower multiple of $500.

[[Page 357]]

    (3) Matching contributions. Each plan year, the eligible employer 
must contribute a matching contribution to the account of each eligible 
employee on whose behalf elective contributions were made for the plan 
year. The amount of the matching contribution must equal the lesser of 
the eligible employee's elective contributions for the plan year or 3% 
of the eligible employee's SIMPLE compensation for the entire plan year.
    (4) Nonelective contributions. For any plan year, in lieu of 
contributing matching contributions described in paragraph (e)(3) of 
this section, an eligible employer may, in accordance with plan terms, 
contribute a nonelective contribution to the account of each eligible 
employee in an amount equal to 2% of the eligible employee's SIMPLE 
compensation for the entire plan year. The eligible employer may limit 
the nonelective contributions to those eligible employees who received 
at least $5,000 of SIMPLE compensation from the employer for the entire 
plan year.
    (5) SIMPLE compensation. Except as otherwise provided, the term 
SIMPLE compensation for purposes of this section means the sum of wages, 
tips, and other compensation from the eligible employer subject to 
federal income tax withholding (as described in section 6051(a)(3)) and 
the employee's elective contributions made under any other plan, and if 
applicable, elective deferrals under a section 408(p) SIMPLE IRA plan, a 
section 408(k)(6) SARSEP, or a plan or contract that satisfies the 
requirements of section 403(b), and compensation deferred under a 
section 457 plan, required to be reported by the employer on Form W-2 
(as described in section 6051(a)(8)). For self-employed individuals, 
SIMPLE compensation means net earnings from self-employment determined 
under section 1402(a) prior to subtracting any contributions made under 
the SIMPLE 401(k) plan on behalf of the individual.
    (f) Vesting. All benefits attributable to contributions described in 
paragraph (e) of this section must be nonforfeitable at all times.
    (g) Plan year. The plan year of a SIMPLE 401(k) plan must be the 
whole calendar year. Thus, in general, a SIMPLE 401(k) plan can be 
established only on January 1 and can be terminated only on December 31. 
However, in the case of an employer that did not previously maintain a 
SIMPLE 401(k) plan, the establishment date can be as late as October 1 
(or later in the case of an employer that comes into existence after 
October 1 and establishes the SIMPLE 401(k) plan as soon as 
administratively feasible after the employer comes into existence).
    (h) Other rules. A SIMPLE 401(k) plan is not treated as a top-heavy 
plan under section 416. See section 416(g)(4)(G).

[T.D. 9169, 69 FR 78154, Dec. 29, 2004]



Sec. 1.401(k)-5  Special rules for mergers, acquisitions and similar 
events. [Reserved]

[T.D. 9169, 69 FR 78154, Dec. 29, 2004]



Sec. 1.401(k)-6  Definitions.

    Unless otherwise provided, the definitions of this section govern 
for purposes of section 401(k) and the regulations thereunder.
    Actual contribution percentage (ACP) test. Actual contribution 
percentage test or ACP test means the test described in Sec. 1.401(m)-
2(a)(1).
    Actual deferral percentage (ADP). Actual deferral percentage or ADP 
means the ADP of the group of eligible employees as defined in Sec. 
1.401(k)-2(a)(2).
    Actual deferral percentage (ADP) test. Actual deferral percentage 
test or ADP test means the test described in Sec. 1.401(k)-2(a)(1).
    Actual deferral ratio (ADR). Actual deferral ratio or ADR means the 
ADR of an eligible employee as defined in Sec. 1.401(k)-2(a)(3).
    Cash or deferred arrangement. Cash or deferred arrangement is 
defined in Sec. 1.401(k)-1(a)(2).
    Cash or deferred election. Cash or deferred election is defined in 
Sec. 1.401(k)-1(a)(3).
    Compensation. Compensation means compensation as defined in section 
414(s) and Sec. 1.414(s)-1. The period used to determine an employee's 
compensation for a plan year must be either the plan year or the 
calendar year ending within the plan year. Whichever period is selected 
must be applied uniformly

[[Page 358]]

to determine the compensation of every eligible employee under the plan 
for that plan year. A plan may, however, limit the period taken into 
account under either method to that portion of the plan year or calendar 
year in which the employee was an eligible employee, provided that this 
limit is applied uniformly to all eligible employees under the plan for 
the plan year. In the case of an HCE whose ADR is determined under Sec. 
1.401(k)-2(a)(3)(ii), period of participation includes periods under 
another plan for which elective contributions are aggregated under Sec. 
1.401(k)-2(a)(3)(ii). See also section 401(a)(17) and Sec. 
1.401(a)(17)-1(c)(1).
    Current year testing method. Current year testing method means the 
testing method described in Sec. 1.401(k)-2(a)(2)(ii) or 1.401(m)-
2(a)(2)(ii) under which the applicable year is the current plan year.
    Designated Roth account. Designated Roth account means a separate 
account maintained by a plan to which only designated Roth contributions 
(including income, expenses, gains and losses attributable thereto) are 
made.
    Designated Roth contributions. Designated Roth contributions means 
designated Roth contributions as defined in Sec. 1.401(k)-1(f)(1).
    Elective contributions. Elective contributions means employer 
contributions made to a plan pursuant to a cash or deferred election 
under a cash or deferred arrangement (whether or not the arrangement is 
a qualified cash or deferred arrangement under Sec. 1.401(k)-1(a)(4)).
    Eligible employee--(1) General rule. Eligible employee means an 
employee who is directly or indirectly eligible to make a cash or 
deferred election under the plan for all or a portion of the plan year. 
For example, if an employee must perform purely ministerial or 
mechanical acts (e.g., formal application for participation or consent 
to payroll withholding) in order to be eligible to make a cash or 
deferred election for a plan year, the employee is an eligible employee 
for the plan year without regard to whether the employee performs the 
acts.
    (2) Conditions on eligibility. An employee who is unable to make a 
cash or deferred election because the employee has not contributed to 
another plan is also an eligible employee. By contrast, if an employee 
must perform additional service (e.g., satisfy a minimum period of 
service requirement) in order to be eligible to make a cash or deferred 
election for a plan year, the employee is not an eligible employee for 
the plan year unless the service is actually performed. See Sec. 
1.401(k)-1(e)(5), however, for certain limits on the use of minimum 
service requirements. An employee who would be eligible to make elective 
contributions but for a suspension due to a distribution, a loan, or an 
election not to participate in the plan, is treated as an eligible 
employee for purposes of section 401(k)(3) for a plan year even though 
the employee may not make a cash or deferred election by reason of the 
suspension. Finally, an employee does not fail to be treated as an 
eligible employee merely because the employee may receive no additional 
annual additions because of section 415(c)(1).
    (3) Certain one-time elections. An employee is not an eligible 
employee merely because the employee, no later than the employee's first 
becoming eligible to make a cash or deferred election under any plan or 
arrangement of the employer (described in section 219(g)(5)(A)), is 
given the one-time opportunity to elect, and the employee does in fact 
elect, not to be eligible to make a cash or deferred election under the 
plan or any other plan or arrangement maintained by the employer 
(including plans not yet established) for the duration of the employee's 
employment with the employer. This rule applies in addition to the rules 
in Sec. 1.401(k)-1(a)(3)(v) relating to the definition of a cash or 
deferred election. In no event is an election made after December 23, 
1994, treated as a one-time irrevocable election under this paragraph if 
the election is made by an employee who previously became eligible under 
another plan or arrangement (whether or not terminated) of the employer.
    Eligible HCE. Eligible HCE means an eligible employee who is an HCE.
    Eligible NHCE. Eligible NHCE means an eligible employee who is not 
an HCE.

[[Page 359]]

    Employee. Employee means an employee within the meaning of Sec. 
1.410(b)-9.
    Employee stock ownership plan (ESOP). Employee stock ownership plan 
or ESOP means the portion of a plan that is an ESOP within the meaning 
of Sec. 1.410(b)-7(c)(2).
    Employer. Employer means an employer within the meaning of Sec. 
1.410(b)-9.
    Excess contributions. Excess contributions means, with respect to a 
plan year, the amount of total excess contributions apportioned to an 
HCE under Sec. 1.401(k)-2(b)(2)(iii).
    Excess deferrals. Excess deferrals means excess deferrals as defined 
in Sec. 1.402(g)-1(e)(3).
    Highly compensated employee (HCE). Highly compensated employee or 
HCE has the meaning provided in section 414(q).
    Matching contributions. Matching contributions means matching 
contributions as defined in Sec. 1.401(m)-1(a)(2).
    Nonelective contributions. Nonelective contributions means employer 
contributions (other than matching contributions) with respect to which 
the employee may not elect to have the contributions paid to the 
employee in cash or other benefits instead of being contributed to the 
plan.
    Non-employee stock ownership plan (non-ESOP). Non-employee stock 
ownership plan or non-ESOP means the portion of a plan that is not an 
ESOP within the meaning of Sec. 1.410(b)-7(c)(2).
    Non-highly compensated employee (NHCE). Non-highly compensated 
employee or NHCE means an employee who is not an HCE.
    Plan. Plan is defined in Sec. 1.401(k)-1(b)(4).
    Pre-ERISA money purchase pension plan. (1) Pre-ERISA money purchase 
pension plan is a pension plan--
    (i) That is a defined contribution plan (as defined in section 
414(i));
    (ii) That was in existence on June 27, 1974, and as in effect on 
that date, included a salary reduction agreement; and
    (iii) Under which neither the employee contributions nor the 
employer contributions, including elective contributions, may exceed the 
levels (as a percentage of compensation) provided for by the 
contribution formula in effect on June 27, 1974.
    (2) A plan was in existence on June 27, 1974, if it was a written 
plan adopted on or before that date, even if no funds had yet been paid 
to the trust associated with the plan.
    Pre-tax elective contributions. Pre-tax elective contributions means 
elective contributions under a qualified cash or deferred arrangement 
that are not designated Roth contributions.
    Prior year testing method. Prior year testing method means the 
testing method under which the applicable year is the prior plan year, 
as described in Sec. 1.401(k)-2(a)(2)(ii) or 1.401(m)-2(a)(2)(ii).
    Qualified matching contributions (QMACs). Qualified matching 
contributions or QMACs means matching contributions that, except as 
provided otherwise in Sec. 1.401(k)-1(c) and (d), satisfy the 
requirements of Sec. 1.401(k)-1(c) and (d) as though the contributions 
were elective contributions, without regard to whether the contributions 
are actually taken into account under the ADP test under Sec. 1.401(k)-
2(a)(6) or the ACP test under Sec. 1.401(m)-2(a)(6). Thus, the matching 
contributions must satisfy the vesting requirements of Sec. 1.401(k)-
1(c) and be subject to the distribution requirements of Sec. 1.401(k)-
1(d) when they are contributed to the plan. See also Sec. 1.401(k)-
2(b)(4)(iii) for a rule providing that a matching contribution does not 
fail to qualify as a QMAC solely because it is forfeitable under section 
411(a)(3)(G) as a result of being a matching contribution with respect 
to an excess deferral, excess contribution, or excess aggregate 
contribution, or it is forfeitable under Sec. 1.414(w)-1(d)(2).
    Qualified nonelective contributions (QNECs). Qualified nonelective 
contributions or QNECs means employer contributions, other than elective 
contributions or matching contributions, that, except as provided 
otherwise in Sec. 1.401(k)-1(c) and (d), satisfy the requirements of 
Sec. 1.401(k)-1(c) and (d) as though the contributions were elective 
contributions, without regard to whether the contributions are actually 
taken into account under the ADP test under Sec. 1.401(k)-2(a)(6) or 
the ACP test under Sec. 1.401(m)-2(a)(6). Thus, the nonelective 
contributions must satisfy the

[[Page 360]]

vesting requirements of Sec. 1.401(k)-1(c) and be subject to the 
distribution requirements of Sec. 1.401(k)-1(d) when they are 
contributed to the plan.
    Rural cooperative plans. Rural cooperative plan means a plan 
described in section 401(k)(7).

[T.D. 9169, 69 FR 78154, Dec. 29, 2004, as amended by T.D. 9237, 71 FR 
10, Jan. 3, 2006; T.D. 9447, 74 FR 8210, Feb. 24, 2009]



Sec. 1.401(l)-0  Table of contents.

    This section contains a listing of the headings of Sec. Sec. 
1.401(l)-1 through 1.401(l)-6.

 Sec. 1.401(l)-1 Permitted disparity with respect to employer-provided 
                       contributions or benefits.

(a) Permitted disparity.
    (1) In general.
    (2) Overview.
    (3) Exclusive rules.
    (4) Exceptions.
    (5) Additional rules.
(b) Relationship to other requirements.
(c) Definitions.
    (1) Accumulation plan.
    (2) Average annual compensation.
    (3) Base benefit percentage.
    (4) Base contribution percentage.
    (5) Benefit formula.
    (6) Benefit, right, or feature.
    (7) Covered compensation.
    (i) In general.
    (ii) Special rules.
    (A) Rounded table.
    (B) Proposed regulation definition.
    (iii) Period for using covered compensation amount.
    (8) Defined benefit plan.
    (9) Defined contribution plan.
    (10) Disparity.
    (11) Employee.
    (12) Employer.
    (13) Employer contributions.
    (14) Excess benefit percentage.
    (15) Excess contribution percentage.
    (16) Excess plan.
    (i) Defined benefit excess plan.
    (ii) Defined contribution excess plan.
    (17) Final average compensation.
    (i) In general.
    (ii) Limitations.
    (iii) Determination of section 414(s) compensation.
    (18) Gross benefit percentage.
    (19) Highly compensated employee.
    (20) Integration level.
    (21) Nonexcludable employee.
    (22) Nonhighly compensated employee.
    (23) Offset level.
    (24) Offset percentage.
    (25) Offset plan.
    (26) PIA.
    (27) Plan.
    (28) Plan year compensation.
    (29) Qualified plan.
    (30) Section 401(l) plan.
    (31) Section 414(s) compensation.
    (32) Social security retirement age.
    (33) Straight life annuity.
    (34) Taxable wage base.
    (35) Year of service.

  Sec. 1.401(l)-2 Permitted disparity for defined contribution plans.

(a) Requirements.
    (1) In general.
    (2) Excess plan requirement.
    (3) Maximum disparity.
    (4) Uniform disparity.
    (5) Integration level.
(b) Maximum permitted disparity.
    (1) In general.
    (2) Maximum excess allowance.
(c) Uniform disparity.
    (1) In general.
    (2) Deemed uniformity.
    (i) In general.
    (ii) Overall permitted disparity.
    (iii) Non-FICA employees.
(d) Integration level.
    (1) In general.
    (2) Taxable wage base.
    (3) Single dollar amount.
    (4) Intermediate amount.
    (5) Prorated integration level for short plan year.
(e) Examples.

     Sec. 1.401(l)-3 Permitted disparity for defined benefit plans.

(a) Requirements.
    (1) In general.
    (2) Excess or offset plan requirement.
    (3) Maximum disparity.
    (4) Uniform disparity.
    (5) Integration or offset level.
    (6) Benefits, rights, and features.
(b) Maximum permitted disparity.
    (1) In general.
    (2) Maximum excess allowance.
    (3) Maximum offset allowance.
    (4) Rules of application.
    (i) Disparity provided for the plan year.
    (ii) Reductions in disparity rate.
    (iii) Normal and optional forms of benefit.
    (A) In general.
    (B) Level annuity forms.
    (C) Other forms.
    (D) Post-retirement cost-of-living adjustments.
    (1) In general.
    (2) Requirements.
    (E) Section 417(e) exception.
    (5) Examples.
(c) Uniform disparity.
    (1) In general.
    (2) Deemed uniformity.
    (i) In general.

[[Page 361]]

    (ii) Use of fractional accrual and disparity for 35 years.
    (iii) Use of fractional accrual and disparity for fewer than 35 
years.
    (iv) Different social security retirement ages.
    (v) Reduction for integration level.
    (vi) Overall permitted disparity.
    (A) In general.
    (B) Unit credit plans.
    (C) Fractional accrual plans.
    (vii) Non-FICA employees.
    (viii) Average annual compensation adjustment for offset plan.
    (ix) PIA offsets.
    (3) Examples.
(d) Requirements for integration level or offset compensation.
    (1) In general.
    (2) Covered compensation.
    (3) Uniform percentage of covered compensation.
    (4) Single dollar amount.
    (5) Intermediate amount.
    (6) Intermediate amount safe harbor.
    (7) Prorated integration level for short plan year.
    (8) Demographic requirements.
    (i) In general.
    (ii) Attained age requirement.
    (iii) Nondiscrimination requirement.
    (A) Minimum percentage test.
    (B) Ratio test.
    (C) High dollar amount test.
    (D) Individual disparity reductions.
    (9) Reduction in the 0.75-percent factor if integration or offset 
level exceeds covered compensation.
    (i) In general.
    (ii) Uniform percentage of covered compensation.
    (iii) Single dollar amount.
    (A) Plan-wide reduction.
    (B) Individual reductions.
    (iv) Reductions.
    (A) Table.
    (B) Interpolation.
    (10) Examples.
(e) Adjustments to the 0.75-percent factor for benefits commencing at 
          ages other than social security retirement age.
    (1) In general.
    (2) Adjustments.
    (i) Benefits commencing on or after age 55 and before social 
security retirement age.
    (ii) Benefits commencing after social security retirement age and on 
or before age 70.
    (iii) Benefits commencing before age 55.
    (iv) Benefits commencing after age 70.
    (3) Tables.
    (4) Benefit commencement date.
    (i) In general.
    (ii) Qualified social security supplement.
    (5) Examples.
(f) Benefits, rights, and features.
    (1) Defined benefit excess plan.
    (2) Offset plan.
    (3) Examples.
(g) No reductions in 0.75-percent factor for ancillary benefits.
(h) Benefits attributable to employee contributions not taken into 
          account.
(i) Multiple integration levels. [Reserved]
(j) Additional rules.

           Sec. 1.401(l)-4 Special rules for railroad plans.

(a) In general.
(b) Defined contribution plans.
    (1) In general.
    (2) Single integration level method.
    (i) In general.
    (ii) Definitions.
    (3) Two integration level method.
    (i) In general.
    (ii) Total disparity requirement.
    (iii) Intermediate disparity requirement.
    (iv) Definitions.
(c) Defined benefit excess plans.
    (1) In general.
    (2) Single integration level method.
    (i) In general.
    (ii) Definitions.
    (3) Two integration level method.
    (i) In general.
    (ii) Employee with lower covered compensation.
    (iii) Employee with lower railroad retirement covered compensation.
    (iv) Definitions.
(d) Offset plans.
    (1) In general.
    (2) Maximum tier 2 and supplementary annuity offset allowance.
(e) Additional rules.
    (1) Definitions.
    (2) Adjustments to 0.75-percent factor.
    (3) Adjustments to 0.56-percent factor.
    (4) Overall permitted disparity.

          Sec. 1.401(l)-5 Overall permitted disparity limits.

(a) Introduction.
    (1) In general.
    (2) Plan requirements.
    (3) Plans taken into account.
(b) Annual overall permitted disparity limit.
    (1) In general.
    (2) Total annual disparity fraction.
    (3) Annual defined contribution plan disparity fraction.
    (4) Annual defined benefit excess plan disparity fraction.
    (5) Annual offset plan disparity fraction.
    (i) In general.
    (ii) PIA offset plans.
    (6) Annual imputed disparity fraction.
    (7) Annual nondisparate fraction.
    (8) Determination of fraction.
    (i) General rule
    (ii) Multiple formulas.
    (iii) Offset arrangements.
    (A) In general.

[[Page 362]]

    (B) Defined benefit plans.
    (C) Defined contribution plans.
    (iv) Applicable percentages.
    (v) Fractional accrual plans.
    (9) Examples.
(c) Cumulative permitted disparity limit.
    (1) In general.
    (i) Employees who benefit under defined benefit plans.
    (ii) Employees who do not benefit under defined benefit plans.
    (iii) Certain plan years disregarded.
    (iv) Determination of type of plan.
    (v) Applicable plan years.
    (vi) Transition rule for defined contribution plans.
    (2) Cumulative disparity fraction.
    (3) Determination of total annual disparity fractions for prior 
years.
    (4) Special rules for greater of formulas and offset arrangements.
    (i) Greater of formulas.
    (A) In general.
    (B) Separate satisfaction by formulas.
    (C) Single plan.
    (ii) Offset arrangements.
    (A) In general.
    (B) Separate satisfaction by plans.
    (C) No other plan.
    (5) Examples.
(d) Additional rules.

         Sec. 1.401(l)-6 Effective dates and transition rules.

(a) Statutory effective date.
    (1) In general.
    (2) Collectively bargained plans.
(b) Regulatory effective date.
    (1) In general.
    (2) Plans of tax-exempt organizations.
    (3) Defined contribution plans.
    (4) Defined benefit plans.
    (c) Compliance during transition period.

[T.D. 8359, 56 FR 47617, Sept. 19, 1991; 57 FR 10818, Mar. 31, 1992, as 
amended by T.D. 8486, 58 FR 46830, Sept. 3, 1993]



Sec. 1.401(l)-1  Permitted disparity in employer-provided contributions 
or benefits.

    (a) Permitted disparity--(1) In general. Section 401(a)(4) provides 
that a plan is a qualified plan only if the amount of contributions or 
benefits provided under the plan does not discriminate in favor of 
highly compensated employees. See Sec. 1.401(a)(4)-1(b)(2). Section 
401(a)(5)(C) provides that a plan does not discriminate in favor of 
highly compensated employees merely because of disparities in employer-
provided contributions or benefits provided to, or on behalf of, 
employees under the plan that are permitted under section 401(l). Thus, 
if a plan satisfies section 401(l), permitted disparities in employer-
provided contributions or benefits under a plan are disregarded, by 
reason of section 401(a)(5)(C), in determining whether the plan 
satisfies any of the safe harbors under Sec. Sec. 1.401(a)(4)-2(b)(2) 
and 1.401(a)(4)-3(b). However, even if disparities in employer-provided 
contributions or benefits under a plan are permitted under section 
401(l) and thus do not cause the plan to fail to satisfy Sec. 
1.401(a)(4)-1(b)(2), the plan may still fail to satisfy section 
401(a)(4) for other reasons. Similarly, even if disparities in employer-
provided contributions or benefits under a plan are not permitted under 
section 401(l) and thus may not be disregarded under section 401(a)(4) 
by reason of section 401(l), the plan may still be found to be 
nondiscriminatory under the tests of section 401(a)(4), including the 
rules for imputing permitted disparity under Sec. 1.401(a)(4)-7.
    (2) Overview. Rules relating to disparities in employer-provided 
contributions under a defined contribution plan are provided in Sec. 
1.401(l)-2. For rules relating to disparities in employer-provided 
benefits under a defined benefit plan, see Sec. 401(l)-3. For rules 
relating to the application of section 401(l) to a plan maintained by a 
railroad employer, see Sec. 1.401(l)-4. For rules relating to the 
overall permitted disparity limits, see Sec. 1.401(l)-5. For rules 
relating to the effective date of section 401(l), see Sec. 1.401(l)-6.
    (3) Exclusive rules. The rules provided in Sec. Sec. 1.401(l)-1 
through 1.401(l)-6 are the exclusive means for a plan to satisfy 
sections 401(l) and 401(a)(5)(C). Accordingly, a plan that provides 
disparities in employer-provided contributions or benefits that are not 
permitted under Sec. Sec. 1.401(l)-1 through 1.401(l)-6 does not 
satisfy section 401(l) or 401(a)(5)(C).
    (4) Exceptions. Sections 401(a)(5)(C) and 401(l) are not available 
in the following arrangements--
    (i) A plan maintained by an employer, determined for purposes of the 
Federal Insurance Contributions Act or the Railroad Retirement Tax Act, 
as applicable, that does not pay any wages within the meaning of section 
3121(a) or compensation within the meaning of section 3231(e). For this

[[Page 363]]

purpose, a plan maintained for a self-employed individual within the 
meaning of section 401(c)(1), who is also subject to the tax under 
section 1401, is deemed to be a plan maintained by an employer that pays 
wages within the meaning of section 3121(a).
    (ii) A plan, or the portion of a plan, that is an employee stock 
ownership plan described in section 4975(e)(7) (an ESOP) or a tax credit 
employee stock ownership plan described in section 409(a) (a TRASOP), 
except as provided in Sec. 54.4975-11(a)(7)(ii) of this chapter, which 
contains a limited exception to this rule for certain ESOPs in existence 
on November 1, 1977.
    (iii) With respect to elective contributions as defined in Sec. 
1.401(k)-6 under a qualified cash or deferred arrangement as defined in 
Sec. 1.401(k)-1(a)(4)(i) or with respect to employee or matching 
contributions defined in Sec. 1.401(m)-1(a)(3) or (a)(2), respectively.
    (iv) With respect to contributions to a simplified employee pension 
made under a salary reduction arrangement described in section 408(k)(6) 
(a SARSEP).
    (5) Additional rules. The Commissioner may, in revenue rulings, 
notices, or other documents of general applicability, prescribe 
additional rules that may be necessary or appropriate to carry out the 
purposes of section 401(l), including rules applying section 401(l) with 
respect to an employer that pays wages within the meaning of section 
3121(a) or compensation within the meaning of section 3231(e) for some 
years and not other years.
    (b) Relationship to other requirements. Unless explicitly provided 
otherwise, section 401(l) does not provide an exception to any other 
requirement under section 401(a). Thus, for example, even if the plan 
complies with section 401(l), the plan may not provide a benefit lower 
than the minimum benefit required under section 416. Moreover, a plan 
may not adjust benefits in any manner that results in a decrease in any 
employee's accrued benefit in violation of section 411(d)(6) and section 
411(b)(1)(G). However, a plan does not fail to satisfy section 401(l) 
merely because, in order to ensure compliance with section 411, an 
employee's accrued benefit under the plan is defined as the greater of 
the employee's previously accrued benefit and the benefit determined 
under a strict application of the plan's benefit formula and accrual 
method. See section 401(a)(15) for additional rules relating to 
circumstances under which plan benefits may not be decreased because of 
increases in social security benefits.
    (c) Definitions. In applying Sec. Sec. 1.401(l)-1 through 1.401(l)-
6, the definitions in this paragraph (c) govern unless otherwise 
provided.
    (1) Accumulation plan. Accumulation plan means an accumulation plan 
within the meaning of Sec. 1.401(a)(4)-12.
    (2) Average annual compensation. Average annual compensation means 
average annual compensation within the meaning of Sec. 1.401(a)(4)-
3(e)(2).
    (3) Base benefit percentage. Base benefit percentage means the rate 
at which employer-provided benefits are determined under a defined 
benefit excess plan with respect to an employee's average annual 
compensation at or below the integration level (expressed as a 
percentage of such average annual compensation).
    (4) Base contribution percentage. Base contribution percentage means 
the rate at which employer contributions are allocated to the account of 
an employee under a defined contribution excess plan with respect to the 
employee's plan year compensation at or below the integration level 
(expressed as a percentage of such plan year compensation).
    (5) Benefit formula. Benefit formula means benefit formula within 
the meaning of Sec. 1.401(a)(4)-12.
    (6) Benefit, right, or feature. Benefit, right, or feature means a 
benefit, right, or feature within the meaning of Sec. 1.401(a)(4)-12.
    (7) Covered compensation--(i) In general. Covered compensation for 
an employee means the average (without indexing) of the taxable wage 
bases in effect for each calendar year during the 35-year period ending 
with the last day of the calendar year in which the employee attains (or 
will attain) social security retirement age. A 35-year period is used 
for all individuals regardless of the year of birth of the individual. 
In determining an employee's covered

[[Page 364]]

compensation for a plan year, the taxable wage base for all calendar 
years beginning after the first day of the plan year is assumed to be 
the same as the taxable wage base in effect as of the beginning of the 
plan year. An employee's covered compensation for a plan year beginning 
after the 35-year period applicable under this paragraph (c)(7)(i) is 
the employee's covered compensation for the plan year during which the 
35-year period ends. An employee's covered compensation for a plan year 
beginning before the 35-year period applicable under this paragraph 
(c)(7)(i) is the taxable wage base in effect as of the beginning of the 
plan year.
    (ii) Special rules--(A) Rounded table. For purposes of determining 
the amount of an employee's covered compensation under paragraph 
(c)(7)(i) of this section, a plan may use tables, provided by the 
Commissioner, that are developed by rounding the actual amounts of 
covered compensation for different years of birth.
    (B) Proposed regulation definition. For plan years beginning before 
January 1, 1995, in lieu of the definition of covered compensation 
contained in paragraph (c)(7)(i) of this section, a plan may define 
covered compensation as the average (without indexing) of the taxable 
wage bases in effect for each calendar year during the 35-year period 
ending with the last day of the calendar year preceding the calendar 
year in which the employee attains (or will attain) social security 
retirement age.
    (iii) Period for using covered compensation amount. A plan must 
generally provide that an employee's covered compensation is 
automatically adjusted for each plan year. However, a plan may use an 
amount of covered compensation for employees equal to each employee's 
covered compensation (as defined in paragraph (c)(7)(i) or (c)(7)(ii) of 
this section) for a plan year earlier than the current plan year, 
provided the earlier plan year is the same for all employees and is not 
earlier than the later of--
    (A) The plan year that begins 5 years before the current plan year, 
and
    (B) The plan year beginning in 1989.

In the case of an accumulation plan, the benefit accrued for an employee 
in prior years is not affected by changes in the employee's covered 
compensation that occur in later years.
    (8) Defined benefit plan. Defined benefit plan means a defined 
benefit plan within the meaning of Sec. 1.410(b)-9.
    (9) Defined contribution plan. Defined contribution plan means a 
defined contribution plan within the meaning of Sec. 1.410(b)-9. In 
addition, for purposes of Sec. Sec. 1.401(l)-1 through 1.401(l)-6, a 
defined contribution plan includes a simplified employee pension as 
defined in section 408(k) (SEP), other than a SEP (or portion or a SEP) 
that is a salary reduction arrangement described in section 408(k)(6) 
(SARSEP).
    (10) Disparity. Disparity means--
    (i) In the case of a defined contribution excess plan, the amount by 
which the excess contribution percentage exceeds the base contribution 
percentage,
    (ii) In the case of a defined benefit excess plan, the amount by 
which the excess benefit percentage exceeds the base benefit percentage, 
and
    (iii) In the case of an offset plan, the offset percentage.
    (11) Employee. Employee means employee within the meaning of Sec. 
1.401(a)(4)-12.
    (12) Employer. Employer means the employer within the meaning of 
Sec. 1.410(b)-9.
    (13) Employer contributions. Employer contributions means all 
amounts taken into account with respect to an employee under a plan 
under Sec. 1.401(a)(4)-2(c)(2)(ii).
    (14) Excess benefit percentage. Excess benefit percentage means the 
rate at which employer-provided benefits are determined under a defined 
benefit excess plan with respect to an employee's average annual 
compensation above the integration level (expressed as a percentage of 
such average annual compensation).
    (15) Excess contribution percentage. Excess contribution percentage 
means the rate at which employer contributions are allocated to the 
account of an employee under a defined contribution excess plan with 
respect to the employee's plan year compensation above the integration 
level (expressed as a percentage of such plan year compensation).

[[Page 365]]

    (16) Excess plan--(i) Defined benefit excess plan. Defined benefit 
excess plan means a defined benefit plan under which the rate at which 
employer-provided benefits are determined with respect to average annual 
compensation above the integration level under the plan (expressed as a 
percentage of such average annual compensation) is greater than the rate 
at which employer-provided benefits are determined with respect to 
average annual compensation at or below the integration level (expressed 
as a percentage of such average annual compensation).
    (ii) Defined contribution excess plan. Defined contribution excess 
plan means a defined contribution plan under which the rate at which 
employer contributions are allocated to the account of an employee with 
respect to plan year compensation above the integration level (expressed 
as a percentage of such plan year compensation) is greater than the rate 
at which employer contributions are allocated to the account of an 
employee with respect to plan year compensation at or below the 
integration level (expressed as a percentage of such plan year 
compensation).
    (17) Final average compensation--(i) In general. Final average 
compensation for an employee means the average of the employee's annual 
section 414(s) compensation for the 3-consecutive-year period ending 
with or within the plan year or for the employee's period of employment 
if shorter. The year in which an employee terminates employment may be 
disregarded in determining final average compensation. The definition of 
final average compensation used in the plan must be applied consistently 
with respect to all employees. For example, if the plan provides that 
the year in which the employee terminates employment is disregarded in 
determining final average compensation, the year must be disregarded for 
all employees who terminate employment in that year. The plan may 
specify any 3-consecutive-year period ending in the plan year, provided 
the period is determined consistently for all employees. See Sec. 
1.401(a)(4)-11(d)(3)(iii) and Sec. 1.414(s)-1(f) for rules permitting 
service and compensation with another employer to be taken into account 
for purposes of nondiscrimination testing, including satisfying section 
401(l).
    (ii) Limitations. In determining an employee's final average 
compensation under this paragraph (c)(17), annual section 414(s) 
compensation for any year in excess of the taxable wage base in effect 
at the beginning of that year must not be taken into account. A plan may 
provide that each employee's final average compensation for a plan year 
is limited to the employee's average annual compensation for the plan 
year.
    (iii) Determination of section 414(s) compensation. A plan must use 
the same definition of section 414(s) compensation to determine final 
average compensation as the plan uses to determine average annual 
compensation (or plan year compensation in the case of an accumulation 
plan).
    (18) Gross benefit percentage. Gross benefit percentage means the 
rate at which employer-provided benefits are determined under an offset 
plan (before application of the offset) with respect to an employee's 
average annual compensation (expressed as a percentage of average annual 
compensation).
    (19) Highly compensated employee. Highly compensated employee means 
HCE within the meaning of Sec. 1.401(a)(4)-12.
    (20) Integration level. Integration level means the dollar amount 
specified in an excess plan at or below which the rate of employer-
provided contributions or benefits (expressed in each case as a 
percentage of an employee's plan year compensation or average annual 
compensation up to the specified dollar amount) under the plan is less 
than the rate of employer-provided contributions or benefits (expressed 
in each case as a percentage of the employee's plan year compensation or 
average annual compensation above the specified dollar amount) under the 
plan above such dollar amount.
    (21) Nonexcludable employee. Nonexcludable employee means 
nonexcludable employee within the meaning of Sec. 1.401(a)(4)-12.
    (22) Nonhighly compensated employee. Nonhighly compensated employee 
means NHCE within the meaning of Sec. 1.401(a)(4)-12.
    (23) Offset level. Offset level means the dollar limit specified in 
the plan on the

[[Page 366]]

amount of each employee's final average compensation taken into account 
in determining the offset under an offset plan.
    (24) Offset percentage. Offset percentage means the rate at which an 
employee's employer-provided benefit is reduced or offset under an 
offset plan (expressed as a percentage of the employee's final average 
compensation up to the offset level).
    (25) Offset plan. Offset plan means a defined benefit plan that is 
not a defined benefit excess plan and that provides that each employee's 
employer-provided benefit is reduced or offset by a specified percentage 
of the employee's final average compensation up to the offset level 
under the plan.
    (26) PIA. PIA or primary insurance amount means the old-age 
insurance benefit under section 202 of the Social Security Act (42 
U.S.C. 402) payable to each employee at a single age that is not earlier 
than age 62 and not later than age 65. PIA must be determined under the 
Social Security Act as in effect at the time the employee's offset is 
determined. Thus, it is determined without assuming any future increases 
in compensation, any future increases in the taxable wage base, any 
changes in the formulas used under the Social Security Act to determine 
PIA (for example, changes in the breakpoints), or any future increases 
in the consumer price index. However, it may be assumed that the 
employee will continue to receive compensation at the same rate as that 
received at the time the offset is being determined, until reaching the 
single age described in the first sentence of this paragraph (c)(26). 
PIA must be determined in a consistent manner for all employees and in 
accordance with revenue rulings or other guidance provided by the 
Commissioner.
    (27) Plan. Plan means a plan within the meaning of Sec. 
1.401(a)(4)-12 or a component plan treated as a plan under Sec. 
1.401(a)(4)-9(c).
    (28) Plan year compensation. Plan year compensation means plan year 
compensation within the meaning of Sec. 1.401(a)(4)-12.
    (29) Qualified plan. Qualified plan means a qualified plan within 
the meaning of Sec. 1.401(a)(4)-12.
    (30) Section 401(l) plan. Section 401( l) plan means a section 
401(l) plan within the meaning of Sec. 1.401(a)(4)-12.
    (31) Section 414(s) compensation. Section 414(s) compensation means 
section 414(s) compensation within the meaning of Sec. 1.401(a)(4)-12.
    (32) Social security retirement age. Social security retirement age 
for an employee means the social security retirement age of the employee 
as determined under section 415(b)(8).
    (33) Straight life annuity. Straight life annuity means a straight 
life annuity within the meaning of Sec. 1.401(a)(4)-12.
    (34) Taxable wage base. Taxable wage base means the contribution and 
benefit base under section 230 of the Social Security Act (42 U.S.C. 
430).
    (35) Year of service. Year of service means a year of service as 
defined in the plan for purposes of the benefit formula and the accrual 
method under the plan, unless the context clearly indicates otherwise. 
See Sec. 1.401(a)(4)-11(d)(3) for rules on years of service that may be 
taken into account for purposes of nondiscrimination testing, including 
satisfying section 401(l).

[T.D. 8359, 56 FR 47618, Sept. 19, 1991; 57 FR 10818, 10951, Mar. 31, 
1992, as amended by T.D. 8486, 58 FR 46831, Sept. 3, 1993; T.D. 9169, 69 
FR 78153, Dec. 29, 2004]



Sec. 1.401(l)-2  Permitted disparity for defined contribution plans.

    (a) Requirements--(1) In general. Disparity in the rates of employer 
contributions allocated to employees' accounts under a defined 
contribution plan is permitted under section 401(l) and this section for 
a plan year only if the plan satisfies paragraphs (a)(2) through (a)(5) 
of this section. A plan that otherwise satisfies this paragraph (a) will 
not be considered to fail section 401(l) merely because it contains one 
or more provisions described in Sec. 1.401(a)(4)-2(b)(4). See Sec. 
1.401(a)(4)-8(b)(3)(i)(C) for special rules applicable to target benefit 
plans.
    (2) Excess plan requirement. The plan must be a defined contribution 
excess plan.
    (3) Maximum disparity. The disparity for all employees under the 
plan must not exceed the maximum permitted disparity prescribed in 
paragraph (b) of this section.

[[Page 367]]

    (4) Uniform disparity. The disparity for all employees under the 
plan must be uniform within the meaning of paragraph (c) of this 
section.
    (5) Integration level. The integration level specified in the plan 
must satisfy paragraph (d) of this section.
    (b) Maximum permitted disparity--(1) In general. The disparity 
provided for the plan year must not exceed the maximum excess allowance 
as defined in paragraph (b)(2) of this section. In addition, the plan 
must satisfy the overall permitted disparity limits of Sec. 1.401(l)-5.
    (2) Maximum excess allowance. The maximum excess allowance for a 
plan year is the lesser of--
    (i) The base contribution percentage, or
    (ii) The greater of--
    (A) 5.7 percent, reduced as required under paragraph (d) of this 
section, or
    (B) The percentage rate of tax under section 3111(a), in effect as 
of the beginning of the plan year, that is attributable to the old age 
insurance portion of the Old Age, Survivors and Disability Insurance 
provisions of the Social Security Act, reduced as required under 
paragraph (d) of this section. For a year in which the percentage rate 
of tax described in this paragraph (b)(2)(ii)(B) exceeds 5.7 percent, 
the Commissioner will publish the rate of such tax and a revised table 
under paragraph (d)(4) of this section.
    (c) Uniform disparity--(1) In general. The disparity provided under 
a plan is uniform only if the plan uses the same base contribution 
percentage and the same excess contribution percentage for all employees 
in the plan.
    (2) Deemed uniformity--(i) In general. The disparity under a plan 
does not fail to be uniform for purposes of this paragraph (c) merely 
because the plan contains one or more of the provisions described in 
paragraphs (c)(2) (ii) and (iii) of this section.
    (ii) Overall permitted disparity. The plan provides that, in the 
case of each employee who has reached the cumulative permitted disparity 
limit applicable to the employee under Sec. 1.401(l)-5(c), employer 
contributions are allocated to the account of the employee with respect 
to the employee's total plan year compensation at the excess 
contribution percentage.
    (iii) Non-FICA employees. The plan provides that, in the case of 
each employee under the plan with respect to whom none of the taxes 
under section 3111(a), section 3221, or section 1401 is required to be 
paid, employer contributions are allocated to the account of the 
employee with respect to the employee's total plan year compensation at 
the excess contribution percentage.
    (d) Integration level--(1) In general. The integration level under 
the plan must satisfy paragraph (d)(2), (d)(3), or (d)(4) of this 
section, as modified by paragraph (d)(5) of this section in the case of 
a short plan year. If a reduction applies to the disparity factor under 
this paragraph (d), the reduced factor is used for all purposes in 
determining whether the permitted disparity rules for defined 
contribution plans are satisfied.
    (2) Taxable wage base. The requirement of this paragraph (d)(2) is 
satisfied only if the integration level under the plan for each employee 
is the taxable wage base in effect as of the beginning of the plan year.
    (3) Single dollar amount. The requirement of this paragraph (d)(3) 
is satisfied only if the integration level under the plan for all 
employees is a single dollar amount (either specified in the plan or 
determined under a formula specified in the plan) that does not exceed 
the greater of $10,000 or 20 percent of the taxable wage base in effect 
as of the beginning of the plan year.
    (4) Intermediate amount. The requirement of this paragraph (d)(4) is 
satisfied only if--
    (i) The integration level under the plan for all employees is a 
single dollar amount (either specified in the plan or determined under a 
formula specified in the plan) that is greater than the highest amount 
determined under paragraph (d)(3) of this section and less than the 
taxable wage base, and
    (ii) The plan adjusts the factor determined under paragraph 
(b)(2)(ii) of this section in accordance with the table below.

[[Page 368]]



                                  Table
------------------------------------------------------------------------
               If the integration level                  The 5.7 percent
-------------------------------------------------------   factor in the
                                                         maximum excess
           Is more than             But not more than     allowance is
                                                          reduced to--
------------------------------------------------------------------------
Greater of $10,000 or 20% of       80% of taxable wage  4.3%
 taxable wage base.                 base.
80% of taxable wage base.........  Amount less than     5.4%
                                    taxable wage base.
------------------------------------------------------------------------

    (5) Prorated integration level for short plan year. If a plan uses 
paragraph (2) or (4) of the definition of plan year compensation under 
Sec. 1.401(a)(4)-12 (i.e., section 414(s) compensation for the plan 
year or the period of plan participation) and has a plan year that 
comprises fewer than 12 months, the integration level under the plan for 
each employee must be an amount equal to the otherwise applicable 
integration level described in paragraph (d)(2), (d)(3), or (d)(4) of 
this section, multiplied by a fraction, the numerator of which is the 
number of months in the plan year, and the denominator of which is 12. 
No adjustment to the maximum excess allowance is required as a result of 
the application of this paragraph (d)(5), other than any adjustment 
already required under paragraph (d)(4) of this section.
    (e) Examples. The following examples illustrate this section. In 
each example, 5.7 percent exceeds the percentage rate of tax described 
in paragraph (b)(2)(ii)(B) of this section.

    Example 1. Employer X maintains a profit-sharing plan with the 
calendar year as its plan year. For the 1989 plan year, the plan 
provides that the account of each employee who has plan year 
compensation in excess of the taxable wage base in effect at the 
beginning of the plan year will receive an allocation for the plan year 
of 5.7 percent of plan year compensation in excess of the taxable wage 
base. The plan provides that no allocation will be made to the account 
of any employee for the plan year with respect to plan year compensation 
not in excess of the taxable wage base. The maximum excess allowance is 
exceeded for the 1989 plan year because the excess contribution 
percentage (5.7 percent) for the plan year exceeds the base contribution 
percentage (0 percent) for the plan year by more than the lesser of the 
base contribution percentage (0 percent) or the percentage determined 
under paragraph (b)(2)(ii) of this section (5.7 percent) for the plan 
year.
    Example 2. Employer Y maintains a money purchase pension plan with 
the calendar year as its plan year. For the 1990 plan year, the plan 
provides that the account of each employee will receive an allocation of 
5 percent of the employee's plan year compensation up to the taxable 
wage base in effect at the beginning of the plan year plus an allocation 
of 10 percent of the employee's plan year compensation in excess of the 
taxable wage base. The maximum excess allowance is not exceeded for the 
plan year because the excess contribution percentage (10 percent) for 
the plan year does not exceed the base contribution percentage (5 
percent) for the plan year by more than the lesser of the base 
contribution percentage (5 percent) or the percentage determined under 
paragraph (b)(2)(ii) of this section (5.7 percent) for the plan year.
    Example 3. Assume the same facts as in Example 2, except that the 
plan provides that, with respect to plan year compensation in excess of 
the taxable wage base, the account of each employee will receive an 
allocation for the plan year of 12 percent of such compensation. The 
maximum excess allowance is exceeded for the plan year because the 
excess contribution percentage (12 percent) for the plan year exceeds 
the base contribution percentage (5 percent) for the plan year by more 
than the lesser of the base contribution percentage (5 percent) or the 
percentage determined under paragraph (b)(2)(ii) of this section (5.7 
percent) for the plan year.
    Example 4. Employer Z maintains a money purchase pension plan with a 
plan year beginning July 1 and ending June 30. The taxable wage base for 
the 1990 calendar year is $51,300 and the taxable wage base for the 1991 
calendar year is $53,400. For the plan year beginning July 1, 1990, and 
ending June 30, 1991, the plan provides that the account of each 
employee will receive an allocation of 4 percent of the employee's plan 
year compensation up to $53,400 plus an allocation of 6 percent of the 
employee's plan year compensation in excess of $53,400. Although the 
excess contribution percentage (6 percent) for the plan year does not 
exceed the base contribution percentage (4 percent) for the plan year by 
more than the lesser of the base contribution percentage (4 percent) or 
the percentage determined under paragraph (b)(2)(ii) of this section 
(5.7 percent), the plan does not satisfy paragraph (a)(5) of this 
section because the integration level of $53,400 exceeds the maximum 
permitted integration level of $51,300 (the taxable wage base in effect 
as of the beginning of the plan year).
    Example 5. Assume the same facts as in Example 4, except that for 
the plan year beginning July 1, 1990, and ending June 30, 1991, the plan 
provides that the account of each

[[Page 369]]

employee will receive an allocation of 5 percent of the employee's plan 
year compensation up to $30,000 plus an allocation of 9 percent of the 
employee's plan year compensation in excess of $30,000. The integration 
level of $30,000 is 58 percent of the taxable wage base of $51,300 for 
the 1990 calendar year. The maximum excess allowance is not exceeded for 
the plan year because the excess contribution percentage (9 percent) for 
the plan year does not exceed the base contribution percentage (5 
percent) for the plan year by more than the lesser of the base 
contribution percentage (5 percent) or the percentage determined under 
paragraphs (b)(2)(ii) and (d) of this section (4.3 percent) for the plan 
year.

[T.D. 8359, 56 FR 47621, Sept. 19, 1991; 57 FR 10818, 10951, Mar. 31, 
1992, as amended by T.D. 8486, 58 FR 46832, Sept. 3, 1993]



Sec. 1.401(l)-3  Permitted disparity for defined benefit plans.

    (a) Requirements--(1) In general. Disparity in the rates of 
employer-provided benefits under a defined benefit plan is permitted 
under section 401(l) and this section for a plan year only if the plan 
satisfies paragraphs (a)(2) through (a)(6) of this section. A plan that 
otherwise satisfies this paragraph (a) will not be considered to fail 
section 401(l) merely because it contains one or more provisions 
described in Sec. 1.401(a)(4)-3(b)(6) (such as multiple formulas). 
Section 401(a)(5)(D) and Sec. 1.401(a)(5)-1(d) provide other rules 
under which benefits provided under a defined benefit plan (including 
defined benefit excess and offset plans) may be limited. See Sec. 
1.401(a)(4)-3(b)(5)(viii) for special rules under which an insurance 
contract plan may satisfy Sec. 1.401(a)(4)-1(b)(2) and section 401(l). 
See Sec. 1.401(a)(4)-8(c)(3)(iii)(B) for special rules applicable to 
cash balance plans.
    (2) Excess or offset plan requirement. The plan must be a defined 
benefit excess plan or an offset plan.
    (3) Maximum disparity. The disparity for all employees under the 
plan must not exceed the maximum permitted disparity prescribed in 
paragraph (b) of this section.
    (4) Uniform disparity. The disparity for all employees under the 
plan must be uniform within the meaning of paragraph (c) of this 
section.
    (5) Integration or offset level. The integration or offset level 
specified in the plan must satisfy paragraph (d) of this section.
    (6) Benefits, rights, and features. The benefits, rights, and 
features provided under the plan must satisfy paragraph (f)(1) of this 
section.
    (b) Maximum permitted disparity--(1) In general. In the case of a 
defined benefit excess plan, the disparity provided for the plan year 
may not exceed the maximum excess allowance as defined in paragraph 
(b)(2) of this section. In the case of an offset plan, the disparity 
provided for the plan year may not exceed the maximum offset allowance 
as defined in paragraph (b)(3) of this section. In addition, either type 
of plan must satisfy the overall permitted disparity limits of Sec. 
1.401(l)-5.
    (2) Maximum excess allowance. The maximum excess allowance for a 
plan year is the lesser of--
    (i) 0.75 percent, reduced as required under paragraphs (d) and (e) 
of this section, or
    (ii) The base benefit percentage for the plan year.
    (3) Maximum offset allowance. The maximum offset allowance for a 
plan year is the lesser of--
    (i) 0.75 percent, reduced as required under paragraphs (d) and (e) 
of this section, or
    (ii) One-half of the gross benefit percentage, multiplied by a 
fraction (not to exceed one), the numerator of which is the employee's 
average annual compensation, and the denominator of which is the 
employee's final average compensation up to the offset level.
    (4) Rules of application--(i) Disparity provided for the plan year. 
Disparity provided for the plan year generally means the disparity 
provided under the plan's benefit formula for the employee's year of 
service with respect to the plan year. However, if a plan determines 
each employee's accrued benefit under the fractional accrual method of 
section 411(b)(1)(C), disparity provided under the plan also means the 
disparity in the benefit accrued for the employee for the plan year. 
Thus, a plan using the fractional accrual method must satisfy this 
paragraph (b) with respect to the plan's benefit formula and with 
respect to the benefits accrued for the plan year.

[[Page 370]]

    (ii) Reduction in disparity rate. Any reductions in the 0.75-percent 
factor required under paragraphs (d) and (e) of this section are 
cumulative.
    (iii) Normal and optional forms of benefit--(A) In general. A plan 
satisfies the maximum permitted disparity requirement of this paragraph 
(b) only if the plan satisfies this paragraph (b) with respect to each 
optional form of benefit (including the normal form of benefit) provided 
under the plan.
    (B) Level annuity forms. In the case of an optional form of benefit 
payable as a level annuity over a period of not less than the life of 
the employee, the optional form must satisfy the maximum permitted 
disparity requirement of this paragraph (b). Thus, for example, if the 
form of a defined benefit plan's normal retirement benefit is an annuity 
for life with a 10-year certain feature and the plan permits employees 
to elect an optional form of benefit in the form of a straight life 
annuity, the plan must satisfy the maximum disparity requirement of this 
paragraph (b) with respect to each of the optional forms of benefit. An 
annuity that decreases only after the death of the employee, or that 
decreases only after the death of either the employee or the joint 
annuitant, is considered a level annuity for purposes of this paragraph 
(b).
    (C) Other forms. In the case of an optional form of benefit that is 
not described in paragraph (b)(4)(iii)(B) of this section, the optional 
form must satisfy the maximum permitted disparity requirement of this 
paragraph (b), when the respective portions of the optional form are 
normalized under the rules of Sec. 1.401(a)(4)-12 to a straight life 
annuity commencing at the same time as the optional form of benefit, 
regardless of whether the straight life annuity form is actually 
provided under the plan. In the case of a defined benefit excess plan, 
the respective portions are the portion of the optional form 
attributable to average annual compensation up to the integration level 
(the ``base portion'') and the portion of the optional form attributable 
to average annual compensation in excess of the integration level (the 
``excess portion''). In the case of an offset plan, the respective 
portions are the optional form determined without regard to the offset 
(the ``gross amount'') and the offset applied to the gross amount to 
determine the optional form (the ``offset amount'').
    (D) Post-retirement cost-of-living adjustments--(1) In general. A 
benefit does not fail to be a level annuity described in paragraph 
(b)(4)(iii)(B) of this section merely because it provides an automatic 
post-retirement cost-of-living adjustment that satisfies paragraph 
(b)(4)(iii)(D)(2) of this section. Thus, increases in the employee's 
annuity pursuant to such a cost-of-living adjustment do not cause the 
disparity provided under the optional form of benefit to exceed the 
maximum disparity permitted under this paragraph (b). For rules on ad 
hoc post-retirement cost-of-living adjustments, see Sec. 1.401(a)(4)-
10(b).
    (2) Requirements. A cost-of-living adjustment satisfies this 
paragaph (b)(4)(iii)(D)(2) if--
    (i) It is included in the accrued benefit of all employees, and.
    (ii) It increases, on a uniform and consistent basis, the benefits 
of all former employees who are no younger than age 62, at a rate no 
greater than adjustments to social security benefits under section 
215(i)(2)(A) of the Social Security Act that have occurred since the 
later of the employee's attainment of age 62 or commencement of 
benefits.
    (E) Section 417(e) exception. A plan will not fail to satisfy this 
paragraph (b) merely because the disparity in a benefit that is subject 
to the interest rate restrictions of sections 401(a)(11) and 417(e) 
exceeds the maximum disparity that would otherwise be allowed under this 
paragraph (b) if the increase in disparity is required to satisfy Sec. 
1.417(e)-1(d). In applying the exception in this paragraph 
(b)(4)(iii)(E), for purposes of determining what is required under Sec. 
1.417(e)-1(d), a plan may use the rate described in Sec. 1.417(e)-
1(d)(2)(i) for all employees, without regard to whether the present 
value of an employee's vested benefit exceeds $25,000.
    (5) Examples. The following examples illustrate this paragraph (b). 
Unless otherwise provided, the following facts apply. The plan is 
noncontributory and is the only plan ever maintained by the

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employer. The plan uses a normal retirement age of 65 and contains no 
provision that would require a reduction in the 0.75-percent factor 
under paragraph (b)(2) or (b)(3) of this section. In the case of a 
defined benefit excess plan, the plan uses each employee's covered 
compensation as the integration level; in the case of an offset plan, 
the plan uses each employee's covered compensation as the offset level 
and provides that an employee's final average compensation is limited to 
the employee's average annual compensation. Each example discusses the 
benefit formula applicable to an employee who has a social security 
retirement age of 65.

    Example 1. Plan N is a defined benefit excess plan that provides a 
normal retirement benefit of 0.5 percent of average annual compensation 
in excess of the integration level, for each year of service. The plan 
provides no benefits with respect to average annual compensation up to 
the integration level. The disparity provided under the plan exceeds the 
maximum excess allowance because the excess benefit percentage (0.5 
percent) exceeds the base benefit percentage (0 percent) by more than 
the base benefit percentage (0 percent).
    Example 2. Plan O is an offset plan that provides a normal 
retirement benefit equal to 2 percent of average annual compensation, 
minus 0.75 percent of final average compensation up to the offset level, 
for each year of service up to 35. The disparity provided under the plan 
satisfies this paragraph (b) because the offset percentage (0.75 
percent) does not exceed the maximum offset allowance equal to the 
lesser of 0.75 percent or one-half of the gross benefit percentage (1 
percent).
    Example 3. Plan P is a defined benefit excess plan that provides a 
normal retirement benefit of 0.5 percent of average annual compensation 
up to the integration level, plus 1.25 percent of average annual 
compensation in excess of the integration level, for each year of 
service up to 35. The disparity provided under the plan exceeds the 
maximum excess allowance because the excess benefit percentage (1.25 
percent) exceeds the base benefit percentage (0.5 percent) by more than 
the base benefit percentage (0.5 percent).
    Example 4. Plan Q is an offset plan that provides a normal 
retirement benefit of 1 percent of average annual compensation, minus 
0.75 percent of final average compensation up to the offset level, for 
each year of service up to 35. The disparity under the plan exceeds the 
maximum offset allowance because the offset percentage exceeds one-half 
of the gross benefit percentage (0.5 percent).
    Example 5. (a) Plan R is an offset plan that provides a normal 
retirement benefit of 1 percent of average annual compensation, minus 
0.5 percent of final average compensation up to the offset level, for 
each year of service up to 35. The plan determines an employee's average 
annual compensation using an averaging period comprising five 
consecutive 12-month periods and taking into account the employee's 
compensation for the ten consecutive 12-month periods ending with the 
plan year. The plan does not provide that an employee's final average 
compensation is limited to the employee's average annual compensation.
    (b) Employee A has average annual compensation of $20,000, final 
average compensation of $25,000, and covered compensation of $32,000. 
The maximum offset allowance applicable to Employee A for the plan year 
under paragraph (b)(3) of this section is one-half of the gross benefit 
percentage multiplied by the ratio, not to exceed one, of Employee A's 
average annual compensation to Employee A's final average compensation 
up to the offset level. Thus, the maximum offset allowance is 0.4 
percent (\1/2\x1 percentx$20,000/$25,000). With respect to Employee A, 
the benefit formula provides an offset that exceeds the maximum offset 
allowance. The plan must therefore reduce Employee A's offset percentage 
to 0.4 percent. (Under paragraph (c)(2)(viii) of this section, Employee 
A's adjusted disparity rate is deemed uniform.)
    (c) Alternatively, under Sec. 1.401(l)-1(c)(17)(ii) (the definition 
of final average compensation), the plan could specify that an 
employee's final average compensation is limited to the amount of the 
employee's average annual compensation. Thus, the ratio of average 
annual compensation to final average compensation would always be equal 
to at least one, and the maximum offset allowance under the plan would 
be one-half of the gross benefit percentage.
    Example 6. Plan S is a defined benefit excess plan that provides a 
base benefit percentage of 1 percent of average annual compensation up 
to the integration level for each year of service. The plan also 
provides, for each of the first 10 years of service, an excess benefit 
percentage of 1.85 percent of average annual compensation in excess of 
the integration level. For each year of service after 10, the plan 
provides an excess benefit percentage of 1.65 percent of the employee's 
average annual compensation in excess of the integration level. The 
disparity provided under the plan exceeds the maximum excess allowance 
because the excess benefit percentage for each of the first ten years of 
service (1.85 percent) exceeds the base benefit percentage (1 percent) 
by more than 0.75 percent.

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    Example 7. The facts are the same as in Example 6, except that the 
plan provides an excess benefit percentage of 1.65 percent of average 
annual compensation in excess of the integration level for each of the 
first 10 years of service and an excess benefit percentage of 1.85 
percent of average annual compensation in excess of the integration 
level for each year of service after 10. The disparity provided under 
the plan exceeds the maximum excess allowance because the excess benefit 
percentage for each year of service after 10 (1.85 percent) exceeds the 
base benefit percentage (1 percent) by more than 0.75 percent.
    Example 8. Plan T is a defined benefit excess plan that provides a 
normal retirement benefit of 1.0 percent of average annual compensation 
up to the integration level, plus 1.7 percent of average annual 
compensation in excess of the integration level, for each year of 
service up to 35, payable in the form of a joint and survivor annuity. 
The plan also allows an employee to receive the retirement benefit in 
the form of an actuarially equivalent straight life annuity. The 
actuarially equivalent straight life annuity equals 1.09 percent of 
average annual compensation up to the integration level, plus 1.85 
percent of average annual compensation in excess of the integration 
level, for each year of service up to 35. The disparity provided under 
the plan with respect to the straight life annuity form of benefit (0.76 
percent) exceeds the maximum excess allowance because the excess benefit 
percentage (1.85 percent) exceeds the base benefit percentage (1.09 
percent) by more than 0.75 percent.
    Example 9. Plan U is a defined benefit excess plan that provides a 
normal retirement benefit of 1.0 percent of average annual compensation 
up to the integration level, plus 1.7 percent of average annual 
compensation in excess of the integration level, for each year of 
service up to 35, payable in the form of a straight life annuity. Plan U 
provides a single sum optional form of benefit at normal retirement age 
equal to 100 times the monthly annuity payable at that age. Thus, if an 
employee elects the single sum optional form of benefit, the base 
portion of the single sum benefit is 8.33 percent (100 times 1.0 
percent/12) of average annual compensation up to the integration level 
per year of service, and the excess portion of the single sum benefit is 
14.17 percent (100 times 1.7 percent/12) of average annual compensation 
in excess of the integration level per year of service. Each respective 
portion of the single sum option is normalized to a straight life 
annuity commencing at normal retirement age, using 8-percent interest 
and the UP-84 mortality table. After normalization, the base portion of 
the benefit is 1.02 percent of average annual compensation up to the 
integration level, and the excess portion of the benefit is 1.73 percent 
of average annual compensation in excess of the integration level. The 
single sum optional form of benefit satisfies this paragraph (b) because 
the disparity provided in the optional form of benefit does not exceed 
the maximum excess allowance.

    (c) Uniform disparity--(1) In general. The disparity provided under 
a defined benefit excess plan is uniform only if the plan uses the same 
base benefit percentage and the same excess benefit percentage for all 
employees with the same number of years of service. The disparity 
provided under an offset plan is uniform only if the plan uses the same 
gross benefit percentage and the same offset percentage for all 
employees with the same number of years of service. The disparity 
provided under a plan that determines each employee's accrued benefit 
under the fractional accrual method of section 411(b)(1)(C) is uniform 
only if the plan satisfies one of the deemed uniformity rules of 
paragraph (c)(2) (ii) or (iii) of this section.
    (2) Deemed uniformity--(i) In general. The disparity provided under 
a plan does not fail to be uniform for purposes of this paragraph (c) 
merely because the plan contains one or more of the provisions described 
in paragraphs (c)(2) (ii) through (ix) of this section.
    (ii) Use of fractional accrual and disparity for 35 years. The plan 
contains a benefit formula as described in paragraphs (c)(2)(ii) (A) and 
(B) of this section, and the plan determines each employee's accrued 
benefit under the method described in Sec. 1.401(a)(4)-3(b)(4)(i)(B), 
i.e., by multiplying the employee's fractional rule benefit (within the 
meaning of Sec. 1.411(b)-1(b)(3)(ii)(A)) by a fraction, the numerator 
of which is the employee's years of service determined as of the plan 
year, and the denominator of which is the employee's projected years of 
service as of normal retirement age.
    (A) For each year of service at least up to 35, the benefit plan 
formula provides the same base benefit percentage and the same excess 
benefit percentage for all employees in the case of a defined benefit 
excess plan or the same gross benefit percentage and the same offset 
percentage for all employees in the case of an offset plan.
    (B) For each additional year of service, the benefit formula 
provides a uniform percentage of all average annual

[[Page 373]]

compensation that is no greater than the excess benefit percentage or 
the gross benefit percentage under paragraph (c)(2)(ii)(A) of this 
section, whichever is applicable.
    (iii) Use of fractional accrual and disparity for fewer than 35 
years. The plan contains a benefit formula as described in paragraphs 
(c)(2)(iii) (A) through (C) of this section, and the plan determines 
each employee's accrued benefit under the method described in Sec. 
1.401(a)(4)-3(b)(4)(i)(B).
    (A) For each year in the employee's initial period of service 
comprising fewer than 35 years, the benefit formula provides the same 
base benefit percentage and the same excess benefit percentage for all 
employees in the case of a defined benefit excess plan or the same gross 
benefit percentage and the same offset percentage for all employees in 
the case of an offset plan.
    (B) For each year of service after the initial period and at least 
up to 35, the benefit formula provides a uniform percentage of all 
average annual compensation, that is equal to the excess benefit 
percentage or the gross benefit percentage under paragraph 
(c)(2)(iii)(A) of this section.
    (C) For each year of service after the period described in paragraph 
(c)(2)(iii)(B) of this section, the benefit formula provides a uniform 
percentage of all average annual compensation that is no greater than 
the excess benefit percentage or the gross benefit percentage under 
paragraph (c)(2)(iii)(A) of this section.
    (iv) Different social security retirement ages. The benefit formula 
uses the same excess benefit percentage or the same gross benefit 
percentage for all employees with the same number of years of service 
and, for employees with social security retirement ages later than age 
65, adjusts the 0.75-percent factor in the maximum excess or offset 
allowance as required under paragraph (e)(1) of this section, by 
increasing the base benefit percentage in the case of a defined benefit 
excess plan, or reducing the offset percentage in the case of an offset 
plan.
    (v) Reduction for integration level. The plan uses an integration 
level or offset level greater than each employee's covered compensation 
and makes individual reductions in the 0.75-percent factor, as permitted 
under paragraph (d)(9)(iii)(B) of this section, by increasing the base 
benefit percentage in the case of a defined benefit excess plan or 
reducing the offset percentage in the case of an offset plan.
    (vi) Overall permitted disparity--(A) In general. The benefit 
formula provides that, with respect to each employee's years of service 
after reaching the cumulative permitted disparity limit applicable to 
the employee under Sec. 1.401(l)-5(c), employer-provided benefits are 
determined with respect to the employee's total average annual 
compensation at a rate equal to the nondisparate percentage. For 
purposes of this paragraph (c)(2)(vi), the nondisparate percentage is 
generally the excess benefit percentage or gross benefit percentage 
otherwise applicable under the benefit formula to an employee with the 
same number of years of service.
    (B) Unit credit plans. In the case of a unit credit plan described 
in Sec. 1.401(a)(4)-3(b)(3), if the 411(b)(1)(B) limit percentage is 
less than the nondisparate percentage, the 411(b)(1)(B) limit percentage 
must be substituted for the nondisparate percentage. For this purpose, 
the 411(b)(1)(B) limit percentage is 133\1/3\ percent of the smallest 
base benefit percentage, or 133\1/3\ percent of the smallest difference 
between the gross benefit percentage and the offset percentage, 
whichever is applicable, where the smallest base benefit percentage or 
difference is determined by reference to the benefit formula as applied 
to employees with no more years of service than the employee.
    (C) Fractional accrual plans. In the case of a fractional accrual 
plan described in Sec. 1.401(a)(4)-3(b)(4), the benefit formula must 
provide for the nondisparate percentage with respect to years of service 
after the employee would reach the cumulative permitted disparity limit 
applicable to the employee under Sec. 1.401(l)-5(c) as modified by this 
paragraph (c)(2)(vi)(C). Solely for purposes of this paragraph 
(c)(2)(vi)(C), the employee's annual disparity fractions (and thus the 
year in which the employee would reach the cumulative permitted 
disparity limit) are determined using the disparity provided under the 
benefit formula (rather

[[Page 374]]

than the special rule for fractional accrual plans in Sec. 1.401(l)-
5(b)(8)(v)).
    (vii) Non-FICA employees. The plan provides that, in the case of 
each employee under the plan with respect to whom none of the taxes 
under section 3111(a), section 3221, or section 1401 is required to be 
paid, employer-provided benefits are determined with respect to the 
employee's total average annual compensation at the excess benefit 
percentage or gross benefit percentage applicable to an employee with 
the same number of years of service.
    (viii) Average annual compensation adjustment for offset plan. In 
the case of each employee whose final average compensation exceeds the 
employee's average annual compensation, the plan adjusts the offset 
percentage as required under paragraph (b)(3)(ii) of this section in 
order to satisfy the maximum offset allowance.
    (ix) PIA offsets. In the case of an offset plan, the plan provides 
that the offset applied to each employee's benefit is the lesser of a 
specified percentage of the employee's PIA and an offset that otherwise 
satisfies the requirements of this section (the ``section 401(l) 
overlay''). The specified percentage of PIA must be the same for all 
employees with the same number of years of service. In the case of a 
plan that determines each employee's accrued benefit under the 
fractional accrual method of section 411(b)(1)(C), the specified 
percentage of PIA is deemed to be the same for all employees with the 
same number of years of service if the plan satisfies either of the 
deemed uniformity rules in paragraph (c)(2)(ii) or (iii) of this 
section, substituting ``offset, expressed as a percentage of PIA, per 
year of service'' for the term ``offset percentage'' (in addition to 
satisfying either of those rules with respect to the section 401(l) 
overlay).
    (3) Examples. The following examples illustrate this paragraph (c). 
Unless otherwise provided, the following facts apply. The plan is 
noncontributory and is the only plan ever maintained by the employer. 
The plan uses a normal retirement age of 65 and contains no provision 
that would require a reduction in the 0.75-percent factor under 
paragraph (b)(2) or (b)(3) of this section. In the case of a defined 
benefit excess plan, the plan uses each employee's covered compensation 
as the integration level; in the case of an offset plan, the plan uses 
each employee's covered compensation as the offset level and provides 
that an employee's final average compensation is limited to the 
employee's average annual compensation. Each example discusses the 
benefit formula applicable to an employee who has a social security 
retirement age of 65.

    Example 1. Plan M is a defined benefit excess plan that satisfies 
the 133\1/3\ percent accrual rule of section 411(b)(1)(B). The plan 
provides a normal retirement benefit of 1.0 percent of average annual 
compensation up to the integration level, plus 1.65 percent of average 
annual compensation in excess of the integration level, for each year of 
service up to 25. The plan also provides a benefit of 1.0 percent of all 
average annual compensation for each year of service in excess of 25. 
The disparity provided under the plan is uniform because the plan uses 
the same base and excess benefit percentages for all employees with the 
same number of years of service. If the plan formula were the same 
except that it used a different excess benefit percentage for some of 
the years of service between one and 25, the disparity under the plan 
would continue to be uniform.
    Example 2. Plan O is a defined benefit excess plan that provides a 
normal retirement benefit of 50 percent of average annual compensation 
up to the integration level and 68.75 percent of average annual 
compensation in excess of the integration level, multiplied by a 
fraction, the numerator of which is the employee's service, up to 25 
years, and the denominator of which is 25. The plan determines an 
employee's accrued benefit as described in Sec. 1.401(a)(4)-
3(b)(4)(i)(B). The benefit formula thus provides a base benefit 
percentage of 2 percent (50 percentx\1/25\) and an excess benefit 
percentage of 2.75 percent (68.75 percentx\1/25\) for each of an 
employee's first 25 years of service and no benefit for years of service 
after 25. The disparity provided under the plan is not uniform within 
the meaning of this paragraph (c) because the benefit formula does not 
satisfy either of the uniform disparity rules for fractional accrual 
plans under paragraphs (c)(2) (ii) and (iii) of this section.
    Example 3. Plan P is an offset plan that provides a normal 
retirement benefit of 2 percent of average annual compensation for each 
year of service up to 35, minus 0.75 percent of the final average 
compensation up to the offset level for each year of service up to 25. 
The plan determines an employee's accrued benefit under the method 
described in Sec. 1.401(a)(4)-3(b)(4)(i)(B). Because the formula

[[Page 375]]

under the plan provides the same gross benefit percentage and offset 
percentage for 25 years of service (fewer than 35) and, for years of 
service after 25 and up to 35, provides a benefit at a uniform rate 
(equal to the gross benefit percentage) of all average annual 
compensation, and the plan accrues the benefit ratably, the disparity 
under the plan is deemed to be uniform under paragraph (c)(2)(iii) of 
this section.
    Example 4. Plan Q is an offset plan that benefits employees with 
social security retirement ages of 65, 66, and 67. For each year of 
service up to 35, the plan provides a normal retirement benefit equal to 
2 percent of average annual compensation, minus an offset based on the 
employee's final average compensation up to the offset level. For 
employees with a social security retirement age of 65, the offset 
percentage is 0.75 percent; for employees with a social security 
retirement age of 66, the offset percentage is 0.70 percent; and for 
employees with a social security retirement age of 67, the offset 
percentage is 0.65 percent. The disparity under the plan is deemed to be 
uniform under paragraph (c)(2)(iv) of this section because the plan uses 
the same gross benefit percentage for all employees and reduces the 
offset percentage for employees with social security retirement ages of 
66 and 67 to comply with the adjustments in the 0.75-percent factor in 
the maximum excess or offset allowance required under paragraph (e)(1) 
of this section. (Because Plan Q effectively provides unreduced benefits 
prior to the social security retirement age for employees with social 
security retirement ages of 66 and 67, the 0.75-percent factor in the 
maximum offset allowance must be reduced to 0.70 percent and 0.65 
percent, respectively.) Alternatively, Plan Q could satisfy this 
paragraph (c) if it provided a uniform offset percentage of 0.65 percent 
for all employees because 0.65 percent is the maximum offset allowance 
under the plan for an employee with a social security retirement age of 
67.
    Example 5. Plan R is an offset plan that provides a normal 
retirement benefit of 2 percent of average annual compensation, minus an 
offset determined as a percentage of total final average compensation, 
for each year of service up to 35. For an employee whose final average 
compensation does not exceed the employee's covered compensation, the 
offset percentage is 0.75 percent. For an employee whose final average 
compensation exceeds the employee's covered compensation, the plan 
reduces the offset percentage, as required by paragraph (d) of this 
section. The reduced offset percentage is determined by comparing the 
employee's final average compensation to the employee's covered 
compensation as permitted under paragraph (d)(9)(iii)(B) of this 
section. The disparity provided under the plan is deemed uniform under 
paragraph (c)(2)(v) of this section because the plan uses the same gross 
benefit percentage for all employees and makes individual reductions in 
the 0.75-percent factor, as permitted under paragraph (d)(9)(iii)(B) of 
this section, by reducing the offset percentage in the case of an 
employee whose final average compensation exceeds covered compensation.

    (d) Requirements for integration or offset level--(1) In general. 
The integration level under a defined benefit excess plan or the offset 
level under an offset plan must satisfy paragraphs (d)(2), (d)(3), 
(d)(4), (d)(5) or (d)(6) of this section, as modified by paragraph 
(d)(7) of this section in the case of a short plan year. Paragraph 
(d)(8) of this section contains demographic tests that apply to certain 
defined benefit plans. Paragraph (d)(9) of this section explains certain 
reductions required in the 0.75-percent factor under paragraph (b)(2) or 
(b)(3) of this section. Paragraph (d)(10) of this section contains 
examples. If a reduction applies to the 0.75-percent factor under this 
paragraph (d), the reduced factor is used for all purposes in 
determining whether the permitted disparity rules for defined benefit 
plans are satisfied.
    (2) Covered compensation. The requirement of this paragraph (d)(2) 
is satisfied only if the integration or offset level under the plan for 
each employee is the employee's covered compensation.
    (3) Uniform percentage of covered compensation. The requirement of 
this paragraph (d)(3) is satisfied only if--
    (i) The integration or offset level under the plan for each employee 
is a uniform percentage (greater than 100 percent) of each employee's 
covered compensation,
    (ii) In the case of a defined benefit excess plan, the integration 
level does not exceed the taxable wage base in effect for the plan year, 
and, in the case of an offset plan, the offset level does not exceed the 
employee's final average compensation, and
    (iii) The plan adjusts the 0.75-percent factor in the maximum excess 
or offset allowance in accordance with paragraph (d)(9) of this section.
    (4) Single dollar amount. The requirement of this paragraph (d)(4) 
is satisfied only if the integration or offset level under the plan for 
all employees

[[Page 376]]

is a single dollar amount (either specified in the plan or determined 
under a formula specified in the plan) that does not exceed the greater 
of $10,000 or one-half of the covered compensation of an individual who 
attains social security retirement age in the calendar year in which the 
plan year begins. In the case of a calendar year in which no individual 
could attain social security retirement age, for example, the year 2003, 
this rule is applied using covered compensation of an individual 
attaining social security retirement age in the preceding calendar year.
    (5) Intermediate amount. The requirement of this paragraph (d)(5) is 
satisfied only if--
    (i) The integration or offset level under the plan for all employees 
is a single dollar amount (either specified in the plan or determined 
under a formula specified in the plan) that is greater than the highest 
amount determined under paragraph (d)(4) of this section,
    (ii) In the case of a defined benefit excess plan, the single dollar 
amount does not exceed the taxable wage base in effect for the plan 
year, and, in the case of an offset plan, the single dollar amount does 
not exceed the employee's final average compensation,
    (iii) The plan satisfies the demographic requirements of paragraph 
(d)(8) of this section, and
    (iv) The plan adjusts the 0.75-percent factor in the maximum excess 
or offset allowance in accordance with paragraph (d)(9) of this section.

For purposes of this paragraph (d)(5), an offset level of each 
employee's final average compensation is considered a single dollar 
amount determined under a formula specified in the plan.
    (6) Intermediate amount safe harbor. The requirement of this 
paragraph (d)(6) is satisfied only if--
    (i) The integration or offset level under the plan for all employees 
is a single dollar amount described in paragraph (d)(5) of this section, 
and
    (ii) The 0.75-percent factor in the maximum excess or offset 
allowance under paragraph (b)(2) or (b)(3) of this section is reduced to 
the lesser of the adjusted factor determined under paragraph (d)(9) of 
this section or 80 percent of the otherwise applicable factor under 
paragraph (b)(2) or (b)(3) of this section, determined without regard to 
paragraph (d)(9) of this section.
    (7) Prorated integration level for short plan year. If an 
accumulation plan uses paragraph (2) or (4) of the definition of plan 
year compensation under Sec. 1.401(a)(4)-12 (i.e., section 414(s) 
compensation for the plan year or the period of plan participation) and 
has a plan year that comprises fewer than 12 months, the integration or 
offset level under the plan for each employee must be an amount equal to 
the otherwise applicable integration or offset level described in 
paragraph (d)(2), (d)(3), (d)(4), (d)(5), or (d)(6) of this section, 
multiplied by a fraction, the numerator of which is the number of months 
in the plan year and the denominator of which is 12. No adjustment to 
the maximum excess or offset allowance is required as a result of the 
application of this paragraph (d)(7), other than any adjustment already 
required under paragraph (d)(6) or (d)(9) of this section.
    (8) Demographic requirements--(i) In general. A plan that satisfies 
the demographic requirements of paragraphs (d)(8)(ii) and (iii) of this 
section may use an integration level described in paragraph (d)(5) of 
this section.
    (ii) Attained age requirement. The requirement of this paragraph 
(d)(8)(ii) is satisfied only if the average attained age of the 
nonhighly compensated employees in the plan is not greater than the 
greater of--
    (A) Age 50, or
    (B) 5 plus the average attained age of the highly compensated 
employees in the plan. For purposes of this paragraph (d)(8)(ii), 
attained ages are determined as of the beginning of the plan year.
    (iii) Nondiscrimination requirement. The requirement of this 
paragraph (d)(8)(iii) is satisfied only if at least one of the following 
tests in paragraphs (d)(8)(iii) (A) through (D) of this section is 
satisfied.
    (A) Minimum percentage test. This test is satisfied only if more 
than 50 percent of the nonhighly compensated employees in the plan have 
average annual compensation at least equal to 120 percent of the 
integration or offset level.

[[Page 377]]

    (B) Ratio test. This test is satisfied only if the percentage of 
nonhighly compensated nonexcludable employees, who are in the plan and 
who have average annual compensation at least equal to 120 percent of 
the integration or offset level, is at least 70 percent of the 
percentage of highly compensated nonexcludable employees who are 
employees in the plan.
    (C) High dollar amount test. This test is satisfied only if the 
integration or offset level exceeds 150 percent of the covered 
compensation of an individual who attains social security retirement age 
in the calendar year in which the plan year begins. In the case of a 
calendar year in which no individual could attain social security 
retirement age, for example, the year 2003, this rule is applied using 
covered compensation of an individual attaining social security 
retirement age in the preceding calendar year.
    (D) Individual disparity reductions. This test is satisfied only if 
the plan is an offset plan that uses an offset level of each employee's 
final average compensation and makes individual disparity reductions as 
permitted under paragraph (d)(9)(iii)(B) of this section.
    (9) Reduction in the 0.75-percent factor if integration or offset 
level exceeds covered compensation--(i) In general. If the integration 
or offset level specified under the plan is each employee's covered 
compensation as of the plan year, no reduction in the 0.75-percent 
factor in the maximum excess or offset allowance is required for the 
plan year under this paragraph (d)(9). If a plan specifies an 
integration or offset level that exceeds an employee's covered 
compensation, the 0.75-percent factor in the maximum excess or offset 
allowance must be reduced as required in paragraph (d)(9)(ii) or (iii) 
of this section. Paragraph (d)(9)(iv) of this section contains a table 
of the applicable reductions.
    (ii) Uniform percentage of covered compensation. If a plan specifies 
an integration or offset level that is a uniform percentage (in excess 
of 100 percent) of each employee's covered compensation, the 0.75-
percent factor in the maximum excess or offset allowance must be reduced 
in accordance with the table in paragraph (d)(9)(iv) of this section. 
Thus, for example, if a plan specifies an integration or offset level of 
120 percent of each employee's covered compensation, the 0.75-percent 
factor in the maximum excess or offset allowance must be reduced to 0.69 
percent in accordance with the table because the specified integration 
or offset level is more than covered compensation but not more than 125 
percent of covered compensation.
    (iii) Single dollar amount. If a plan specifies an integration or 
offset level of a single dollar amount as permitted under paragraph 
(d)(5) of this section (for example, $30,000), the applicable reduction 
in the maximum excess or offset allowance must be determined under 
paragraph (d)(9)(iii) (A) or (B) of this section, as specified under the 
plan.
    (A) Plan-wide reduction. The applicable reduction in the maximum 
excess or offset allowance under the table in paragraph (d)(9)(iv) of 
this section may be determined by comparing the single dollar amount 
specified in the plan to the covered compensation of an individual 
attaining social security retirement age in the calendar year in which 
the plan year begins. Thus, for example, if a plan specifies a single 
integration or offset level of $30,000 that is uniformly applicable to 
all employees for a plan year and the covered compensation of an 
individual attaining social security retirement age in the calendar year 
in which the plan year begins is $20,000, the 0.75-percent factor in the 
maximum excess or offset allowance must be reduced to 0.60 percent for 
all employees in accordance with the table in paragraph (d)(9)(iv) of 
this section because the specified integration or offset level of 
$30,000 is more than 125 percent of $20,000 but not more than 150 
percent of $20,000. In the case of a calendar year in which no 
individual could attain social security retirement age (for example, 
2003), the comparison is made with covered compensation of an individual 
who attained social security retirement age in the preceding calendar 
year. If an offset plan uses an offset level of each employee's final 
average compensation, the reduction under this paragraph (d)(9)(iii)(A) 
is determined by comparing the highest possible amount

[[Page 378]]

of final average compensation to the covered compensation of an 
individual attaining social security retirement age in the calendar year 
in which the plan year begins.
    (B) Individual reductions. The applicable reduction in the maximum 
excess or offset allowance under the table in paragraph (d)(9)(iv) of 
this section may be determined by comparing the single dollar amount 
specified in the plan to the covered compensation of each employee under 
the plan. Thus, for example, if a plan specifies a single integration or 
offset level of $30,000 that is uniformly applicable to all employees 
for a plan year, the 0.75-percent factor in the maximum excess or offset 
allowance must be reduced to 0.60 percent for an employee with covered 
compensation of $20,000, but need not be reduced for an employee whose 
covered compensation is $30,000 or greater.
    (iv) Reductions--(A) Table.

                                  Table
------------------------------------------------------------------------
                                          The permitted disparity factor
  If the integration or offset level is                 is
------------------------------------------------------------------------
100 percent of covered compensation.....  0.75 percent
125 percent of covered compensation.....  0.69 percent
150 percent of covered compensation.....  0.60 percent
175 percent of covered compensation.....  0.53 percent
200 percent of covered compensation.....  0.47 percent
The taxable wage base or final average    0.42 percent
 compensation.
------------------------------------------------------------------------

    (B) Interpolation. If the integration or offset level used under a 
plan is between the percentages of covered compensation in the table, 
the permitted disparity factor applicable to the plan can be determined 
either by straight-line interpolation between the permitted disparity 
factors in the table or by rounding the integration or offset level up 
to the next highest percentage of covered compensation in the table.
    (10) Examples. The following examples illustrate this paragraph (d). 
Unless otherwise provided, the following facts apply. The plan is 
noncontributory and is the only plan ever maintained by the employer. 
The plan uses a normal retirement age of 65 and contains no provision 
that would require a reduction in the 0.75-percent factor under 
paragraph (b)(2) or (b)(3) of this section. In the case of an offset 
plan, the plan provides that an employee's final average compensation is 
limited to the employee's average annual compensation. Each example 
discusses the benefit formula applicable to an employee who has a social 
security retirement age of 65.

    Example 1. (a) Plan M is a defined benefit excess plan that uses the 
calendar year as its plan year. For the 1989 plan year, the plan uses an 
integration level of $20,000, which is 118 percent of the 1989 covered 
compensation of $16,968 for an individual reaching social security 
retirement age in 1989. The plan may use that integration level without 
satisfying paragraph (d)(8) of this section, provided the adjustment to 
the 0.75-percent factor required under paragraph (d)(6) of this section 
is made. That adjustment is the lesser of the factor determined under 
paragraph (d)(9) of this section or 80 percent of the factor otherwise 
applicable under paragraph (b)(2) or (b)(3) of this section.
    (b) The plan determines the factor under paragraph (d)(9) of this 
section by comparing the integration level to the covered compensation 
of an individual attaining social security retirement age in the 
calendar year in which the plan year begins and by rounding the 
integration level up to 125 percent of that covered compensation amount. 
The 0.75-percent factor is therefore replaced by 0.69 percent pursuant 
to the table in paragraph (d)(9) of this section. The 0.69-percent 
factor is 92 percent of the 0.75-percent factor. Because the lesser of 
80 percent and 92 percent is 80 percent, the 0.75-percent factor is 
reduced to 0.6 percent (80 percent of 0.75 percent) under paragraph 
(d)(6) of this section. The 0.6-percent factor applies to benefits 
commencing at age 65 for an employee with a social security retirement 
age of 65. In determining normal retirement benefits for employees with 
social security retirement ages of 66 or 67, the applicable factors for 
benefits commencing at age 65 are, respectively, 0.56 percent (80 
percent of 0.7 percent) and 0.52 percent (80 percent of 0.65 percent).
    (c) The plan could also determine the factor under paragraph (d)(9) 
of this section by comparing the integration level to the covered 
compensation of each employee under the plan, or by straight line 
interpolation between the disparity factors contained in the table in 
paragraph (d)(9) of this section, or both. (Of course, if the plan 
satisfied paragraph (d)(8) of this section, the plan could use the 
factor determined under paragraph (d)(9) of this section.)
    Example 2. (a) Plan N, an accumulation plan, is a defined benefit 
excess plan that, for each year of service up to 35, accrues a normal 
retirement benefit of 1 percent of plan year compensation up to the 
taxable wage base, plus 1.75 percent of plan year compensation above the 
taxable wage base, for each year of service up to 35. An employee's

[[Page 379]]

total retirement benefit is the sum of the accruals for all years. The 
plan satisfies paragraph (d)(8) of this section.
    (b) Because the plan uses the taxable wage base (an amount above 
covered compensation) as the integration level, it must reduce the 0.75-
percent factor in the maximum excess allowance as required under 
paragraphs (d)(5) and (d)(9) of this section. The reduced factor, if 
determined on a plan-wide basis under paragraph (d)(9)(iii)(A) of this 
section, is 0.42 percent. The plan must therefore reduce the disparity 
in the plan so that it does not exceed 0.42 percent.
    Example 3. (a) For the 1990 plan year, Plan O provides a normal 
retirement benefit of 2 percent of average annual compensation, minus a 
percentage of final average compensation up to $48,000, for each year of 
service up to 35. The plan satisfies paragraph (d)(8) of this section. 
As permitted under paragraph (d)(9) of this section, the plan provides 
that each employee's offset percentage is determined by comparing 
$48,000 to the employee's covered compensation and by rounding the 
result up to the next highest percentage of covered compensation.
    (b) Employee A has a social security retirement age of 66 and 
covered compensation of $40,000. Because the plan provides for 
commencement of Employee A's benefit at age 65, the 0.75-percent factor 
in the maximum offset allowance is reduced to 0.7 percent under 
paragraph (e)(1) of this section (the ``paragraph (e) factor''). In 
addition, because $48,000 is rounded up to 125 percent of Employee A's 
covered compensation, the 0.75-percent factor in the maximum offset 
allowance is reduced to 0.69 percent under paragraph (d)(9) of this 
section (the ``paragraph (d) factor''). The reductions are cumulative 
under paragraph (b)(3)(ii) of this section.
    (c) The cumulative reductions can be made by multiplying the 
paragraph (e) facdtor by the ratio of the paragraph (d) factor to 0.75 
percent or by multiplying the paragraph (d) factor by the ratio of the 
paragraph (e) factor to 0.75 percent. The disparity factor for Employee 
A is therefore 0.64 percent ((0.7 percentx0.69 percent/0.75 percent) or 
(0.69 percentx0.7 percent/0.75 percent)).
    Example 4. Plan P is an offset plan that uses the calendar year as 
the plan year and uses an offset level of each employee's final average 
compensation. Assume that the taxable wage bases for 1990-1992 are the 
following:

1990--$51,300
1991--$53.400
1992--$58,000


Employee B's final average compensation, determined as of the close of 
the 1992 plan year, is the average of Employee B's annual compensation 
for the period 1990-1992. Employee B's annual compensation for each year 
is the following:

1990--$47,000
1991--$59,000
1992--$65,000

For purposes of determining the offset applied to Employee B's employer-
provided benefit under the plan. Employee's B's final average 
compensation as of the close of the 1992 plan year is $52,800 ($47,000 + 
$53,400 + $58,000/3). This is because annual compensation in excess of 
the taxable wage base in effect at the beginning of the year may not be 
taken into account in determining an employee's final average 
compensation or in determining the employee's offset. If the plan 
determines the offset applied to Employee B's benefit by reference to 
compensation in excess of $52,800, the plan fails to satisfy this 
paragraph (d).

    (e) Adjustments to the 0.75-percent factor for benefits commencing 
at ages other than social security retirement age--(1) In general. The 
0.75-percent factor in the maximum excess allowance and in the maximum 
offset allowance applies to a benefit commencing at an employee's social 
security retirement age. Except as provided in paragraph (g) of this 
section, if a benefit payable to an employee under a defined benefit 
excess plan or a defined benefit offset plan commences at an age before 
the employee's social security retirement age (including a benefit 
payable at the normal retirement age under the plan), the 0.75-percent 
factor in the maximum excess allowance or in the maximum offset 
allowance, respectively, is reduced in accordance with paragraph 
(e)(2)(i) of this section. If a benefit payable to an employee under a 
defined benefit excess plan or a defined offset plan commences at an age 
after the employee's social security retirement age, the 0.75-percent 
factor in the maximum excess allowance or in the maximum offset 
allowance, respectively, may be increased in accordance with paragraph 
(e)(2)(ii) of this section. Paragraph (e)(4) of this section provides 
rules on the age at which a benefit commences. See paragraph (f) of this 
section for the requirements applicable to optional forms of benefit.
    (2) Adjustments--(i) Benefits commencing on or after age 55 and 
before social security retirement age. If benefits commence before an 
employee's social security retirement age, the 0.75-percent factor in 
the maximum excess allowance and in the maximum offset allowance must be 
reduced for such early

[[Page 380]]

commencement of benefits in accordance with the tables set forth in 
paragraph (e)(3) of this section.
    (ii) Benefits commencing after social security retirement age and on 
or before age 70. If benefits commence after an employee's social 
security retirement age, the 0.75-percent factor in the maximum excess 
allowance and in the maximum offset allowance may be increased for such 
delayed commencement of benefits in accordance with the tables set forth 
in paragraph (e)(3) of this section.
    (iii) Benefits commencing before age 55. If benefits commence before 
the employee attains age 55, the 0.75-percent factor in the maximum 
excess allowance and in the maximum offset allowance is further reduced 
(on a monthly basis to reflect the month in which benefits commence) to 
a factor that is the actuarial equivalent of the 0.75-percent factor, as 
adjusted under the tables in paragraph (e)(3) of this section, 
applicable to a benefit commencing in the month in which the employee 
attains age 55. In determining actuarial equivalence for this purpose, a 
reasonable interest rate must be used. In addition, a reasonable 
mortality table must be used to determine the actuarial present value, 
as defined in Sec. 1.401(a)(4)-12, of the benefits commencing at age 55 
and at the earlier commencement age, and a reasonable mortality table 
may be used to determine the actuarial present value at the earlier 
commencement age of the benefits commencing at age 55. A standard 
interest rate and a standard mortality table, as defined in Sec. 
1.401(a)(4)-12, are considered reasonable.
    (iv) Benefits commencing after age 70. If benefits commence after 
the employee attains age 70, the 0.75-percent factor in the maximum 
excess allowance and in the maximum offset allowance may be further 
increased (on a monthly basis to reflect the month in which benefits 
commence) to a factor that is the actuarial equivalent of the 0.75-
percent factor (as adjusted in accordance with this paragraph (e)) 
applicable to a benefit commencing in the month in which the employee 
attains age 70. In determining actuarial equivalence for this purpose, a 
reasonable interest rate must be used. In addition, a reasonable 
mortality table must be used to determine the actuarial present value, 
as defined in Sec. 1.401(a)(4)-12, of the benefits commencing at age 70 
and at the later commencement age, and a reasonable mortality table may 
be used to determine the value at the later commencement age of the 
benefits commencing at age 70. A standard interest rate and a standard 
mortality table, as defined in Sec. 1.401(a)(4)-12, are considered 
reasonable.
    (3) Tables. Tables I, II, and III provide the adjustments in the 
0.75-percent factor in the maximum excess allowance and in the maximum 
offset allowance applicable to benefits commencing on or after age 55 
and on or before age 70 to an employee who has a social security 
retirement age of 65, 66 or 67. Table IV is a simplified table for a 
plan that uses a single disparity factor of 0.65 percent for all 
employees at age 65. The factors in the following tables are applicable 
to benefits that commence in the month the employee attains the 
specified age. Accordingly, if benefits commence in a month other than 
the month in which the employee attains the specified age, appropriate 
adjustments in the 0.75-percent factor in the maximum excess allowance 
and the maximum offset allowance must be made. For this purpose, 
adjustments may be based on straight-line interpolation from the factors 
in the tables or in accordance with the methods of adjustment specified 
in paragraphs (e)(2)(iii) and (iv) of this section.

                                 Table I
                   [Social security retirement age 67]
------------------------------------------------------------------------
                                       Annual factor in maximum excess
   Age at which benefits commence        allowance and maximum offset
                                             allowance (percent)
------------------------------------------------------------------------
                   70                                1.002
                   69                                0.908
                   68                                0.825
                   67                                0.750
                   66                                0.700
                   65                                0.650
                   64                                0.600
                   63                                0.550
                   62                                0.500
                   61                                0.475
                   60                                0.450
                   59                                0.425
                   58                                0.400
                   57                                0.375
                   56                                0.344
                   55                                0.316
------------------------------------------------------------------------


[[Page 381]]


                                Table II
                   [Social security retirement age 66]
------------------------------------------------------------------------
                                       Annual factor in maximum excess
   Age at which benefits commence        allowance and maximum offset
                                             allowance (percent)
------------------------------------------------------------------------
                   70                                1.101
                   69                                0.998
                   68                                0.907
                   67                                0.824
                   66                                0.750
                   65                                0.700
                   64                                0.650
                   63                                0.600
                   62                                0.550
                   61                                0.500
                   60                                0.475
                   59                                0.450
                   58                                0.425
                   57                                0.400
                   56                                0.375
                   55                                0.344
------------------------------------------------------------------------


                                Table III
                   [Social security retirement age 65]
------------------------------------------------------------------------
                                       Annual factor in maximum excess
   Age at which benefits commence        allowance and maximum offset
                                             allowance (percent)
------------------------------------------------------------------------
                   70                                1.209
                   69                                1.096
                   68                                0.996
                   67                                0.905
                   66                                0.824
                   65                                0.750
                   64                                0.700
                   63                                0.650
                   62                                0.600
                   61                                0.550
                   60                                0.500
                   59                                0.475
                   58                                0.450
                   57                                0.425
                   56                                0.400
                   55                                0.375
------------------------------------------------------------------------


                                Table IV
                           [Simplified table]
------------------------------------------------------------------------
                                       Annual factor in maximum excess
   Age at which benefits commence        allowance and maximum offset
                                             allowance (percent)
------------------------------------------------------------------------
                   70                                1.048
                   69                                0.950
                   68                                0.863
                   67                                0.784
                   66                                0.714
                   65                                0.650
                   64                                0.607
                   63                                0.563
                   62                                0.520
                   61                                0.477
                   60                                0.433
                   59                                0.412
                   58                                0.390
                   57                                0.368
                   56                                0.347
                   55                                0.325
------------------------------------------------------------------------

    (4) Benefit commencement date--(i) In general. Except as provided in 
paragraph (e)(4)(ii) of this section, a benefit commences for purposes 
of this paragraph (e) on the first day of the period for which the 
benefit is paid under the plan.
    (ii) Qualified social security supplement. If a plan uses a 
qualified social security supplement, as defined in Sec. 1.401(a)(4)-
12, to provide an aggregate benefit at retirement before social security 
retirement age that is a uniform percentage of average annual 
compensation, benefits will be considered to commence on the first day 
of the period for which the qualified social security supplement is no 
longer payable. In order for this paragraph (e)(4)(ii) to apply, the 
uniform percentage must be equal to the excess benefit percentage in the 
case of an excess plan or the gross benefit percentage in the case of an 
offset plan.
    (5) Examples. The following examples illustrate this paragraph (e). 
Unless otherwise provided, the following facts apply. The plan is 
noncontributory and is the only plan ever maintained by the employer. 
The plan uses a normal retirement age of 65 and contains no provision 
that would require a reduction in the 0.75-percent factor under 
paragraph (b)(2) or (b)(3) of this section. In the case of a defined 
benefit excess plan, the plan uses each employee's covered compensation 
as the integration level; in the case of an offset plan, the plan uses 
each employee's covered compensation as the offset level and provides 
that an employee's final average compensation is limited to the 
employee's average annual compensation. Each example discusses the 
benefit formula applicable to an employee who has a social security 
retirement age of 65.

    Example 1. Plan M is a defined benefit excess plan that, for an 
employee with a social security retirement age of 65, provides a normal 
retirement benefit of 1.25 percent of average annual compensation up to 
the integration level, plus 2.0 percent of average annual compensation 
in excess of the integration level, for each year of service up to 35. 
For an employee with at least 20 years of service, the plan provides a 
benefit commencing at age 55 that is equal to the benefit payable at age 
65. For that employee, the disparity provided under the plan at age 55 
is

[[Page 382]]

0.75 percent (2 percent-1.25 percent). Because this disparity exceeds 
the 0.375 percent factor provided in the table for a benefit payable at 
age 55 to an employee with a social security retirement age of 65, the 
plan fails to satisfy paragraphs (b) and (e) of this section with 
respect to the early retirement benefit.
    Example 2. Assume the same facts as in Example 1, except that the 
base benefit percentage under the plan is 1.75 percent. Thus, the 
disparity provided under the plan at age 55 is 0.25 percent (2 percent-
1.75 percent). Because the disparity does not exceed the 0.375 percent 
factor provided in the table for a benefit payable at age 55 to an 
employee with a social security retirement age of 65, the plan does not 
fail to satisfy paragraphs (b) and (e) of this section with respect to 
the early retirement benefit.
    Example 3. Plan N is an offset plan that, for an employee with a 
social security retirement age of 65, provides a normal retirement 
benefit of 1.75 percent of average annual compensation, minus 0.75 
percent of final average compensation up to the offset level, for each 
year of service up to 35. For an employee with at least 20 years of 
service, the plan provides a benefit commencing at age 55 that is equal 
to the benefit payable at age 65. For that employee, the disparity 
provided under the plan at age 55 is 0.75 percent. Because this 
disparity exceeds the 0.375-percent factor provided in the table for an 
offset applied to a benefit payable at age 55 to an employee with a 
social security retirement age of 65, the plan fails to satisfy 
paragraphs (b) and (e) of this section with respect to the early 
retirement benefit. The plan would not fail to satisfy paragraphs (b) 
and (e) of this section with respect to the early retirement benefit if 
the applicable factor for determining the offset applied to the benefit 
were reduced to 0.375 percent.
    Example 4. Plan O is a defined benefit excess plan that, for an 
employee with a social security retirement age of 65, provides a normal 
retirement benefit of 1.25 percent of average annual compensation up to 
the integration level, plus 2.0 percent of average annual compensation 
in excess of the integration level, for each year of service up to 35. 
The plan provides benefits commencing before normal retirement age with 
the following reductions:

------------------------------------------------------------------------
                                                Percentage of normal
                    Age                        retirement benefit (%)
------------------------------------------------------------------------
64........................................  90
63........................................  85
62........................................  80
------------------------------------------------------------------------


Under the plan, a benefit payable at age 64 is equal to 90 percent of 
the normal retirement benefit payable at age 65. Thus, the excess 
benefit percentage under the plan is 1.8 percent, the base benefit 
percentage under the plan is 1.125 percent, and the disparity provided 
under the plan at age 64 is 0.675 percent. Similarly, a benefit payable 
at age 63 is equal to 85 percent of the normal retirement benefit 
payable at age 65. Thus, the excess benefit percentage under the plan is 
1.7 percent, the base benefit percentage under the plan is 1.0625 
percent, and the disparity provided under the plan at age 63 is 0.6375 
percent. Finally, a benefit payable at age 62 is equal to 80 percent of 
the normal retirement benefit payable at age 65. Thus, the excess 
benefit percentage under the plan is 1.6 percent, the base benefit 
percentage under the plan is 1.0 percent, and the disparity provided 
under the plan at age 62 is 0.6 percent. Because the disparities 
provided under the plan at each early commencement age do not exceed the 
factors provided in the applicable table in paragraph (e)(3) of this 
section, the plan does not fail to satisfy paragraphs (b) and (e) of 
this section with respect to the early retirement benefits.
    Example 5. Plan P is a defined benefit excess plan that provides a 
normal retirement benefit of 0.75 percent of average annual compensation 
up to the integration level, plus 1.5 percent of average annual 
compensation in excess of the integration level, for each year of 
service up to 35. The plan does not provide any benefits, other than 
normal retirement benefits, commencing before an employee's social 
security retirement age. Employee A, born in 1947, has a social security 
retirement age of 66. Because the plan provides for the distribution of 
normal retirement benefits before Employee A's social security 
retirement age, the 0.75-percent factor in the maximum excess allowance 
applicable to Employee A must be reduced to 0.70 percent in accordance 
with this paragraph (e). Accordingly, the disparity provided to A under 
the plan exceeds the maximum excess allowance because the excess benefit 
percentage (1.5 percent) exceeds the base benefit percentage (0.75 
percent) by more than the maximum excess allowance of 0.70 percent, as 
reduced in accordance with this paragraph (e).
    Example 6. Assume the same facts as in Example 5, except that the 
plan also provides an early retirement benefit, commencing at age 62, to 
an employee who satisfies the conditions for early retirement specified 
in the plan. The early retirement benefit is based upon the employee's 
accrued benefit at early retirement age and equals the amount that would 
have been paid commencing at the employee's normal retirement age based 
upon the employee's average annual compensation, covered compensation 
and years of service at the date of the employee's early retirement. 
Employee B, who has a social security retirement age of 65, meets the 
conditions for early retirement under the plan and retires at age 62 
with 30 years of service. At the time of early retirement, Employee B

[[Page 383]]

has average annual compensation of $20,000 and covered compensation of 
$16,000. Under the plan's benefit formula, Employee B has accrued a 
normal retirement benefit, commencing at age 65, of $5,400 ((22.5 
percentx$16,000)+(45 percentx$4,000)) based on Employee B's average 
annual compensation, covered compensation and years of service at early 
retirement. Accordingly, under the plan's early retirement provisions, 
Employee B is entitled to receive, commencing at early retirement, a 
benefit of $5,400. Because the early retirement benefit is a benefit 
commencing at age 62 (before Employee B's social security retirement 
age), the 0.75-percent factor in the maximum excess allowance must be 
reduced to 0.60 percent in accordance with this paragraph (e). 
Accordingly, the disparity provided to Employee B under the plan at 
early retirement exceeds the maximum excess allowance.
    Example 7. (a) Plan Q is a defined benefit excess plan that provides 
a normal retirement benefit of 1.35 percent of average annual 
compensation up to the integration level, plus 2 percent of average 
annual compensation in excess of the integration level, for each year of 
service up to 35. The plan provides that an employee with 10 years of 
service at age 55 may receive an unreduced retirement benefit. The plan 
also provides that employee with a supplemental benefit of 0.65 percent 
of average annual compensation up to the integration level for each year 
of service up to 35, payable from early retirement until age 65. The 
supplemental benefit is a qualified social security supplement under 
Sec. 1.401(a)(4)-12. The effect of the supplement is to provide an 
employee with a uniform benefit of 2 percent of average annual 
compensation from early retirement until age 65, when the supplement is 
no longer payable. Therefore, for purposes of this paragraph (e), the 
employee's benefit will be considered to commence at age 65.
    (b) Assume that Plan Q is instead an offset plan that provides a 
normal retirement benefit of 2 percent of average annual compensation, 
minus 0.65 percent of final average compensation up to the offset level, 
for each year of service up to 35. The plan provides the same early 
retirement benefit on the same conditions, except that the supplement is 
0.65 percent of an employee's final average compensation up to the 
offset level. An employee at age 55 thus receives a uniform benefit of 2 
percent of average annual compensation until age 65, when the supplement 
is no longer payable. Therefore, for purposes of this paragraph (e), the 
employee's benefit will be considered to commence at age 65.

    (f) Benefits, rights, and features--(1) Defined benefit excess plan. 
In the case of a defined benefit excess plan, each benefit, right, or 
feature provided under the plan with respect to employer-provided 
benefits attributable to average annual compensation above the 
integration level (an ``excess benefit, right, or feature'') must also 
be provided on the same terms with respect to employer-provided benefits 
attributable to average annual compensation up to the integration level 
(a ``base benefit, right, or feature''). Alternatively, an excess 
benefit, right, or feature may be provided on different terms than the 
base benefit, right, or feature, if the terms used to determine the base 
benefit, right, or feature produce a benefit, right, or feature of 
inherently equal or greater value than the benefit, right, or feature 
that would be produced under the terms used to determine the excess 
benefit, right, or feature.
    (2) Offset plan. In the case of an offset plan, each benefit, right, 
or feature provided under the plan with respect to employer-provided 
benefits before application of the offset (a ``gross benefit, right, or 
feature'') must be provided on the same terms as those used to determine 
the offset applied to the gross benefit, right, or feature. 
Alternatively, a gross benefit, right, or feature may be provided on 
different terms from those used to determine the offset applied to the 
gross benefit, right, or feature, if the terms used to determine the 
gross benefit, right, or feature produce a benefit, right, or feature of 
inherently equal or greater value than the benefit, right, or feature 
that would be produced under the terms used to determine the offset 
applied to the gross benefit, right, or feature. In addition, if 
benefits commence before an employee's normal retirement age, the gross 
benefit percentage under the plan must be reduced by a number of 
percentage points that is not less than the number of percentage points 
by which the offset percentage must be reduced, from normal retirement 
age to the age at which benefits commence, under the rules of paragraph 
(e) of this section.
    (3) Examples. The following examples illustrate this paragraph (f). 
Unless otherwise provided, the following facts apply. The plan is 
noncontributory and is the only plan ever maintained by the

[[Page 384]]

employer. The plan uses a normal retirement age of 65 and contains no 
provision that would require a reduction in the 0.75-percent factor 
under paragraph (b)(2) or (b)(3) of this section. In the case of a 
defined benefit excess plan, the plan uses each employee's covered 
compensation as the integration level; in the case of an offset plan, 
the plan uses each employee's covered compensation as the offset level 
and provides that an employee's final average compensation is limited to 
the employee's average annual compensation. Each example discusses the 
benefit formula applicable to an employee who has a social security 
retirement age of 65. All optional forms of benefit under each plan are 
provided on the same terms.

    Example 1. Plan M is a defined benefit excess plan that provides a 
normal retirement benefit of 1 percent of average annual compensation up 
to the integration level, plus 1.65 percent of average annual 
compensation above the integration level, for each year of service up to 
35. The plan provides an early retirement benefit for any employee who 
terminates employment at or after age 55 with 10 or more years of 
service. In determining an employee's early retirement, the 1.65 percent 
excess benefit percentage is reduced in accordance with the table in 
paragraph (e)(3) of this section for a plan that uses a single disparity 
factor of 0.65 percent for all employees at age 65. However, a larger 
reduction factor is applied to determine the base benefit percentage at 
early retirement. The plan violates this paragraph (f) because the 
excess early retirement benefit is not provided on the same terms as the 
base early retirement benefit, nor do the terms used to determine the 
base early retirement benefit produce an early retirement benefit of 
inherently equal or greater value than the early retirement benefit that 
would be produced under the terms used to determine the excess benefit, 
right, or feature.
    Example 2. The facts are the same as in Example 1 except that the 
plan determines the early retirement benefit by applying the same 
reduction factors under paragraph (e)(3) of this section to the base and 
excess benefit percentages. Furthermore, if an employee terminates 
employment at or after age 55 with 30 or more years of service, the plan 
provides that the base benefit percentage of 1 percent is not reduced. 
Although the excess early retirement benefit is provided on different 
terms than the base early retirement benefit, the plan satisfies this 
paragraph (f) because the terms used to determine the base early 
retirement benefit produce an early retirement of inherently equal or 
greater value than the early retirement benefit that would be produced 
under the terms used to determine the excess benefit, right, or feature.
    Example 3. Plan N is an offset plan that provides a normal 
retirement benefit of 2 percent of average annual compensation, minus 
0.65 percent of final average compensation up to the offset level, for 
each year of service up to 35. In determining the qualified joint and 
survivor (``QJSA'') form of the normal retirement benefit, the plan 
applies a factor of 80 percent to the gross benefit percentage and a 
factor of 100 percent to the offset percentage. Thus, the QJSA form is 
1.6 percent of average annual compensation, minus 0.65 percent of final 
average compensation up to the offset level, for each year of service up 
to 35. The plan violates this paragraph (f) because the gross QJSA form 
is not provided on the same terms as the terms used to determine the 
offset applied to the QJSA, nor does it produce a QJSA benefit that is 
of inherently equal or greater value than the QJSA benefit that would be 
produced under the terms used to determine the offset under the plan.
    Example 4. Plan O is a defined benefit excess plan that provides a 
normal retirement benefit of 1 percent of average annual compensation up 
to the integration level, plus 1.65 percent of average annual 
compensation above the integration level, for each year of service up to 
35. The plan also provides a single sum optional form of benefit 
determined by applying a single interest rate and mortality assumption 
to the entire normal retirement benefit. The plan satisfies this 
paragraph (f) because the excess optional form is provided on the same 
terms as the base optional form. The plan would also satisfy this 
paragraph (f) if it used a lower interest rate to determine the base 
optional form than used to determine the excess optional form because 
the lower interest rate would produce an optional form of inherently 
equal or greater value than the optional form produced by using the same 
interest rate.
    Example 5. Plan R is a defined benefit excess plan that provides a 
normal retirement benefit of 1 percent of average annual compensation up 
to the integration level, plus 1.65 percent of average annual 
compensation above the integration level, for each year of service up to 
35. If an employee continues to work after normal retirement age, the 
plan provides that the employee receives credit for additional years of 
service up to the service limit of 35. The plan also provides that the 
disparity provided under the plan will increase as permitted under 
paragraph (e) of this section for benefits commencing after social 
security retirement age. However, the plan does not provide an increase 
in the base benefit percentage to reflect the fact that the employee has 
delayed commencement of

[[Page 385]]

benefits past normal retirement age. Thus, for example, for an employee 
at age 68, the plan provides a benefit of 1 percent of average annual 
compensation up to the integration level, plus 1.86 percent of average 
annual compensation above the integration level, for each year of 
service up to 35. The plan violates this paragraph (f) because the 
excess benefit provided for an employee after normal retirement age is 
not provided on the same terms as the base benefit, nor do the terms 
used to determine the base benefit produce a benefit of inherently equal 
or greater value than the benefit that would be produced under the terms 
used to determine the excess benefit.
    Example 6. Plan Q is an offset plan that provides a normal 
retirement benefit of 2 percent of average annual compensation, minus 
0.65 percent of final average compensation up to the offset level, for 
each year of service up to 35. In accordance with paragraph (e) of this 
section, the plan reduces the offset percentage under the plan for early 
retirement and provides a benefit at age 55 of 2 percent of average 
annual compensation, minus 0.325 percent of final average compensation 
up to the offset level, for each year of service up to 35. However, the 
early retirement benefit does not meet this paragraph (f) because an 
employee's gross benefit percentage is not reduced for early retirement.
    Example 7. The facts are the same as in Example 6 except that the 
plan reduces the gross benefit percentage for early retirement at age 55 
to 1.675 percent. Because the gross benefit percentage is reduced by 
0.325 percent (from 2.0 percent to 1.675 percent), the same percentage 
point reduction made in the offset percentage (from 0.65 percent to 
0.325 percent), the early retirement benefit meets this paragraph (f).

    (g) No reductions in 0.75-percent factor for ancillary benefits. For 
purposes of applying the maximum excess allowance or the maximum offset 
allowance under paragraph (b)(2) or (3) of this section, no reduction is 
made to the 0.75-percent factor merely because the plan provides 
disparity in qualified disability benefits (within the meaning of 
section 411(a)(9)) or preretirement death benefits and the relevant 
benefits are payable before an employee's social security retirement 
age.
    (h) Benefits attributable to employee contributions not taken into 
account. Benefits attributable to employee contributions to a defined 
benefit plan are not taken into account in determining whether the 
disparity provided under a defined benefit excess plan or an offset plan 
exceeds the maximum permitted disparity described in paragraph (b) of 
this section. See Sec. 1.401(a)(4)-6(b) for methods of determining the 
employer-provided benefit under a plan that includes employee 
contributions not allocated to separate accounts (i.e., a contributory 
DB plan), including Sec. 1.401(a)(4)-6(b)(2)(iii)(B) for adjustments to 
the base and excess benefit percentages or the gross benefit percentage 
under a section 401(l) plan. If, after adjustment, the employee's base 
benefit percentage or gross benefit percentage (whichever is applicable) 
is less than zero, such percentage is deemed to be zero for purposes of 
the maximum excess allowance or maximum offset allowance under paragraph 
(b)(2) or (3) of this section.
    (i) Multiple integration levels [Reserved]
    (j) Additional rules. The Commissioner may, in revenue rulings, 
notices or other documents of general applicability, prescribe 
additional rules as may be necessary or appropriate to carry out the 
purposes of this section, including updated tables under paragraphs (d) 
and (e) of this section providing for reductions in the 0.75-percent 
factor in the maximum excess allowance and in the maximum offset 
allowance and rules in paragraph (h) of this section for determining the 
portion of an employee's benefit attributable to employee contributions.

[T.D. 8359, 56 FR 47622, Sept. 19, 1991; 57 FR 10818, 10819, 10951, 
10952, Mar. 31, 1992, as amended by T.D. 8486, 58 FR 46832, Sept. 3, 
1993]



Sec. 1.401(l)-4  Special rules for railroad plans.

    (a) In general. Section 401(l)(6) provides that, in the case of a 
plan maintained by a railroad employer that covers employees who are 
entitled to benefits under the Railroad Retirement Act of 1974, in 
determining whether such a plan satisfies section 401(l), rules similar 
to the rules under section 401(l) apply and such rules take into account 
the employer-derived portion of tier 2 and supplemental annuity benefits 
provided under the railroad retirement system. In general, for purposes 
of determining whether a defined contribution plan or a defined benefit 
plan maintained by a railroad employer and

[[Page 386]]

covering employees described in te preceding sentence, satisfies section 
401(l), the employer-derived portion of an employee's tier 2 benefits 
and supplementary annuity benefits under the Railroad Retirement Act of 
1974 are treated as though such benefits were provided by the railroad 
employer under a qualified plan. Paragraph (b) of this section contains 
rules for defined contribution plans. Paragraph (c) of this section 
contains rules for defined benefit excess plans. Paragraph (d) of this 
section contains rules for offset plans. Paragraph (e) of this section 
contains definitions and additional rules of application.
    (b) Defined contribution plans--(1) In general. A defined 
contribution plan maintained by a railroad employer satisfies section 
401(l) and Sec. 1.401(l)-2 for a plan year only if the plan satisfies 
paragraph (b)(2) or (b)(3) of this section for the plan year.
    (2) Single integration level method--(i) In general. A plan 
satisfies this paragraph (b)(2) if--
    (A) The plan specifies a single integration level for all employees 
that does not exceed the railroad retirement taxable wage base in effect 
as of the beginning of the plan year,
    (B) The plan uses the same base contribution percentage and the same 
excess contribution percentage for all employees, and
    (C) The excess contribution percentage does not exceed the sum of 
11.4 percentage points and the base contribution percentage.
    (ii) Definitions. The following definitions govern for purposes of 
this paragraph (b)(2).
    (A) Base contribution percentage means the rate at which employer 
contributions are allocated to the account of an employee under the plan 
with respect to the employee's plan year compensation at or below the 
railroad retirement taxable wage base (expressed as a percentage of such 
plan year compensation).
    (B) Excess contribution percentage means the rate at which employer 
contributions are allocated to the account of an employee under the plan 
with respect to the employee's plan year compensation above the railroad 
retirement taxable wage base (expressed as a percentage of such plan 
year compensation).
    (3) Two integration level method--(i) In general. A plan satisfies 
this paragraph (b)(3) if--
    (A) The plan specifies two integration levels for all employees, 
equal to the railroad retirement taxable wage base in effect as of the 
beginning of the plan year and the taxable wage base in effect as of the 
beginning of the plan year, and
    (B) The plan satisfies paragraphs (b)(3) (ii) and (iii) of this 
section.
    (ii) Total disparity requirement. A plan satisfies this paragraph 
(b)(3)(ii) if--
    (A) The plan uses the same base contribution percentage and the same 
excess contribution percentage for all employees, and
    (B) The excess contribution percentage does not exceed the sum of 
11.4 percentage points and the base contribution percentage.
    (iii) Intermediate disparity requirement. A plan satisfies this 
paragraph (b)(3)(iii) if--
    (A) The plan uses the same base contribution percentage and the same 
intermediate contribution percentage for all employees, and
    (B) The intermediate contribution percentage does not exceed the sum 
of 5.7 percentage points and the base contribution percentage.
    (iv) Definitions. The following definitions govern for purposes of 
this paragraph (b)(3).
    (A) Base contribution percentage means the rate at which employer 
contributions are allocated to the account of an employee under the plan 
with respect to the employee's plan year compensation at or below the 
railroad retirement taxable wage base (expressed as a percentage of such 
plan year compensation).
    (B) Intermediate contribution percentage means the rate at which 
employer contributions are allocated to the account of an employee under 
the plan with respect to the employee's plan year compensation between 
the railroad retirement taxable wage base and the taxable wage base 
(expressed as a percentage of such plan year compensation).

[[Page 387]]

    (C) Excess contribution percentage means the rate at which employer 
contributions are allocated to the account of an employee under the plan 
with respect to the employee's plan year compensation above the taxable 
wage base (expressed as a percentage of such plan year compensation).
    (c) Defined benefit excess plans--(1) In general. A defined benefit 
excess plan maintained by a railroad employer satisfies section 401(l) 
and Sec. 1.401(l)-3 for a plan year only if the plan satisfies 
paragraph (c)(2) or (c)(3) of this section for the plan year.
    (2) Single integration level method--(i) In general. A plan 
satisfies this paragraph (c)(2) if--
    (A) The plan specifies a single integration level for all employees 
that does not exceed railroad retirement covered compensation,
    (B) The plan uses the same base benefit percentage and the same 
excess benefit percentage for all employees, and
    (C) The excess benefit percentage does not exceed the lesser of--
    (1) Two times the sum of 0.56 percent and the base benefit 
percentage, or
    (2) 0.56 percent plus the base benefit percentage plus 0.75 percent.
    (ii) Definitions. The following definitions govern for purposes of 
this paragraph (c)(2).
    (A) Base benefit percentage means the rate at which employer-
provided benefits are determined under the plan with respect to an 
employee's average annual compensation at or below the employee's 
railroad retirement covered compensation (expressed as a percentage of 
such average annual compensation).
    (B) Excess benefit percentage means the rate at which employer-
provided benefits are determined under the plan with respect to an 
employee's average annual compensation above the employee's railroad 
retirement covered compensation (expressed as a percentage of such 
average annual compensation).
    (3) Two integration level method--(i) In general. A plan satisfies 
this paragraph (c)(3) for a plan year if--
    (A) The plan specifies two integration levels for all employees, 
equal to each employee's railroad retirement covered compensation and 
each employee's covered compensation, and
    (B) The plan satisfies paragraph (c)(3) (ii) and (iii) of this 
section.
    (ii) Employee with lower covered compensation. A plan satisfies this 
paragraph (c)(3)(ii) if, with respect to each employee whose lower 
integration level is the employee's covered compensation--
    (A) The plan uses the same base benefit percentage and the same 
intermediate benefit percentage for all employees,
    (B) The intermediate benefit percentage does not exceed the base 
benefit percentage by more than the lesser of 0.75 percent or the base 
benefit percentage,
    (C) The plan uses the same intermediate benefit percentage and the 
same excess benefit percentage for all employees, and
    (D) The excess benefit percentage does not exceed the intermediate 
benefit percentage by more than 0.56 percent.
    (iii) Employee with lower railroad retirement covered compensation. 
A plan satisfies this paragraph (c)(3)(iii) if, with respect to each 
employee whose lower integration level is the employee's railroad 
retirement covered compensation--
    (A) The plan uses the same base benefit percentage and the same 
excess benefit percentage for all employees,
    (B) The excess benefit percentage does not exceed the lesser of--
    (1) Two times the sum of 0.56 percent and the base benefit 
percentage, or
    (2) The sum of 0.56 percent plus the base benefit percentage plus 
0.75 percent,
    (C) The plan uses the same the base benefit percentage and the same 
intermediate benefit percentage for all employees, and
    (D) The intermediate benefit percentage does not exceed the sum of 
0.56 percent plus the base benefit percentage.
    (iv) Definitions. The following definitions govern for purposes of 
this paragraph (c)(3).
    (A) Base benefit percentage means the rate at which employer-
provided benefits are determined under the plan with respect to an 
employee's average annual compensation at or below the

[[Page 388]]

lower integration level specified in the plan (expressed as a percentage 
of such average annual compensation).
    (B) Intermediate benefit percentage means the rate at which 
employer-provided benefits are determined under the plan with respect to 
an employee's average annual compensation between the lower and higher 
integration levels specified in the plan (expressed as a percentage of 
such average annual compensation).
    (C) Excess benefit percentage means the rate at which employer-
provided benefits are determined under the plan with respect to an 
employee's average annual compensation above the higher integration 
level specified in the plan (expressed as a percentage of such average 
annual compensation).
    (d) Offset plans--(1) In general. An offset plan maintained by a 
railroad employer satisfies section 401(l) and Sec. 1.401(l)-3 for a 
plan year only if--
    (i) The plan satisfies Sec. 1.401(l)-3 for the plan year without 
regard to the offset for the employer-derived portion of tier 2 and 
supplementary annuity benefits provided under the railroad retirement 
system, and
    (ii) The offset for the employer-derived portion of tier 2 and 
supplementary annuity benefits provided under the railroad retirement 
system does not exceed the maximum tier 2 and supplementary annuity 
offset allowance.
    (2) Maximum tier 2 and supplementary annuity offset allowance. For 
purposes of paragraph (d)(1) of this section, the maximum tier 2 and 
supplementary annuity offset allowance for a plan year is equal to 0.56 
percent of the employee's railroad retirement covered compensation for 
the plan year.
    (e) Additional rules--(1) Definitions. The following definitions 
govern for purposes of this section.
    (i) Railroad retirement taxable wage base means the applicable base, 
as determined under section 3231(e)(2)B)(ii), for purposes of the tax 
under section 3221(b) (the tier 2 tax).
    (ii) Railroad retirement covered compensation for an employee means 
12 multiplied by the average of the 60 highest monthly railroad 
retirement taxable wage bases in effect for the employee's period of 
employment. The monthly railroad retirement taxable wage base is 
determined by dividing the railroad retirement taxable wage base for the 
calendar year in which the month occurs by 12. An employee's railroad 
retirement covered compensation for the plan year is determined as of 
the beginning of the plan year. A plan must provide that an employee's 
railroad retirement covered compensation is automatically adjusted for 
each plan year. See Sec. 1.401(l)-1(b) for rules relating to prohibited 
decreases in an employee's accrued benefit within the meaning of section 
411(d)(6) or section 411(b)(1)(G).
    (2) Adjustments to 0.75-percent factor. The 0.75-percent factor in 
the maximum excess allowance and in the maximum offset allowance is 
subject to the reductions prescribed in Sec. 1.401(l)-3 (d) and (e), 
except that in the case of an employee with at least 30 years of service 
with a railroad employer, the following tables are substituted for 
Tables I through III contained in Sec. 1.401(l)-3(e)(3).

                                 Table I
                   [Social security retirement age 67]
------------------------------------------------------------------------
                                       Annual factor in maximum excess
   Age at which benefits commence        allowance and maximum offset
                                             allowance (percent)
------------------------------------------------------------------------
                   66                                0.750
                   65                                0.750
                   64                                0.750
                   63                                0.750
                   62                                0.750
                   61                                0.525
                   60                                0.525
                   59                                0.508
                   58                                0.490
                   57                                0.472
                   56                                0.433
                   55                                0.398
------------------------------------------------------------------------


                                Table II
                   [Social security retirement age 66]
------------------------------------------------------------------------
                                       Annual factor in maximum excess
   Age at which benefits commence        allowance and maximum offset
                                             allowance (percent)
------------------------------------------------------------------------
                   65                                0.750
                   64                                0.750
                   63                                0.750
                   62                                0.750
                   61                                0.563
                   60                                0.563
                   59                                0.544
                   58                                0.525
                   57                                0.506
                   56                                0.488

[[Page 389]]

 
                   55                                0.447
------------------------------------------------------------------------


                                Table III
                   [Social security retirement age 65]
------------------------------------------------------------------------
                                       Annual factor in maximum excess
   Age at which benefits commence        allowance and maximum offset
                                             allowance (percent)
------------------------------------------------------------------------
                   64                                0.750
                   63                                0.750
                   62                                0.750
                   61                                0.600
                   60                                0.600
                   59                                0.580
                   58                                0.560
                   57                                0.540
                   56                                0.520
                   55                                0.500
------------------------------------------------------------------------

    (3) Adjustments to 0.56-percent factor. The 0.56-percent factor for 
defined benefit excess plans and offset plans under paragraphs (c) and 
(d) of this section respectively is subject to the reductions prescribed 
in Sec. 1.401(l)-3 (d) and (e), except that, for purposes of applying 
this paragraph (e)(3)--
    (i) ``Railroad retirement covered compensation'' is substituted for 
``covered compensation'' in Sec. 1.401(l)-3(d),
    (ii) The reductions under Sec. 1.401(l)-3(d) are made by 
multiplying the 0.56-percent factor by the ratio of the applicable 
factor from the table in Sec. 1.401(l)-(3)(d)(9)(iv)(A) to 0.75, and
    (iii) The following tables are substituted for Tables I through III 
set forth in Sec. 1.401(l)-3(e)(3).
    (A) Tables applicable to 0.56% factor for employees covered by tier 
2 of railroad retirement with 30 or more years of railroad service.

                                 Table I
                   [Social security retirement age 67]
------------------------------------------------------------------------
                                       Annual factor in maximum excess
   Age at which benefits commence        allowance and maximum offset
                                             allowance (percent)
------------------------------------------------------------------------
                   66                                0.560
                   65                                0.560
                   64                                0.560
                   63                                0.560
                   62                                0.560
                   61                                0.560
                   60                                0.560
                   59                                0.541
                   58                                0.523
                   57                                0.504
                   56                                0.462
                   55                                0.425
------------------------------------------------------------------------


                                Table II
                   [Social security retirement age 66]
------------------------------------------------------------------------
                                       Annual factor in maximum excess
   Age at which benefits commence        allowance and maximum offset
                                             allowance (percent)
------------------------------------------------------------------------
                   65                                0.560
                   64                                0.560
                   63                                0.560
                   62                                0.560
                   61                                0.560
                   60                                0.560
                   59                                0.541
                   58                                0.523
                   57                                0.504
                   56                                0.485
                   55                                0.445
------------------------------------------------------------------------


                                Table III
                   [Social security retirement age 65]
------------------------------------------------------------------------
                                       Annual factor in maximum excess
   Age at which benefits commence        allowance and maximum offset
                                             allowance (percent)
------------------------------------------------------------------------
                   64                                0.560
                   63                                0.560
                   62                                0.560
                   61                                0.560
                   60                                0.560
                   59                                0.541
                   58                                0.523
                   57                                0.504
                   56                                0.485
                   55                                0.467
------------------------------------------------------------------------

    (B) Tables applicable to 0.56% factor for employees covered by tier 
2 of railroad retirement with less than 30 years of railroad service.

                                 Table I
                   [Social security retirement age 67]
------------------------------------------------------------------------
                                       Annual factor in maximum excess
   Age at which benefits commence        allowance and maximum offset
                                             allowance (percent)
------------------------------------------------------------------------
                   66                                0.523
                   65                                0.485
                   64                                0.448
                   63                                0.420
                   62                                0.392
                   61                                0.379
                   60                                0.366
                   59                                0.353

[[Page 390]]

 
                   58                                0.340
                   57                                0.327
                   56                                0.300
                   55                                0.275
------------------------------------------------------------------------


                                Table II
                   [Social security retirement age 66]
------------------------------------------------------------------------
                                       Annual factor in maximum excess
   Age at which benefits commence        allowance and maximum offset
                                             allowance (percent)
------------------------------------------------------------------------
                   65                                0.523
                   64                                0.485
                   63                                0.448
                   62                                0.420
                   61                                0.392
                   60                                0.378
                   59                                0.364
                   58                                0.350
                   57                                0.336
                   56                                0.322
                   55                                0.295
------------------------------------------------------------------------


                                Table III
                   [Social security retirement age 65]
------------------------------------------------------------------------
                                       Annual factor in maximum excess
   Age at which benefits commence        allowance and maximum offset
                                             allowance (percent)
------------------------------------------------------------------------
                   64                                0.523
                   63                                0.485
                   62                                0.448
                   61                                0.418
                   60                                0.388
                   59                                0.373
                   58                                0.358
                   57                                0.343
                   56                                0.329
                   55                                0.314
------------------------------------------------------------------------

    (4) Overall permitted disparity. The overall permitted disparity 
rules of Sec. 1.401(l)-5 apply to employees who benefit under a plan 
maintained by a railroad employer.

[T.D. 8359, 56 FR 47632, Sept. 19, 1991; 57 FR 10819, 10952, Mar. 31, 
1992]



Sec. 1.401(l)-5  Overall permitted disparity limits.

    (a) Introduction--(1) In general. The maximum excess allowance and 
maximum offset allowance limit the disparity that can be provided under 
a plan for a plan year. The overall permitted disparity rules apply to 
limit the disparity provided for a plan year if an employee benefits 
under more than one plan maintained by the employer (the ``annual 
overall permitted disparity limit'') and to limit the disparity provided 
for an employee's total years of service, either in a single plan or in 
more than one plan of the employer (the ``cumulative overall permitted 
disparity limit''). The overall permitted disparity rules take into 
account the disparity provided under a section 401(l) plan and the 
permitted disparity imputed under a plan that satisfies section 
401(a)(4) by relying on Sec. 1.401(a)(4)-7. A plan that is not a 
section 401(l) plan is generally deemed to impute permitted disparity 
under Sec. 1.401(a)(4)-7 unless established otherwise. Paragraph (b) of 
this section provides rules on the annual overall permitted disparity 
limit. Paragraph (c) of this section provides rules on the cumulative 
overall permitted disparity limit.
    (2) Plan requirements. In order to satisfy section 401(l), a plan 
must provide that the overall permitted disparity limits may not be 
exceeded and must specify how employer-provided contributions or 
benefits under the plan are adjusted, if necessary, to satisfy the 
overall permitted disparity limits. Any adjustments made to satisfy the 
overall permitted disparity limits must be made in a uniform manner for 
all employees.
    (3) Plans taken into account. For purposes of this section, all 
plans of the employer are taken into account. In addition, all plans of 
any other employer are taken into account for all periods of service 
with the other employer for which the employee receives credit for 
purposes of benefit accrual under any plan of the current employer.
    (b) Annual overall permitted disparity limit--(1) In general. If, in 
the plan year, an employee benefits under more than one plan, the annual 
overall permitted disparity limit is satisfied only if the employee's 
total annual disparity fraction, as defined in paragraph (b)(2) of this 
section, does not exceed one. Paragraphs (b)(3) through (b)(8) of this 
section explain the determination of an employee's annual disparity 
fractions. Paragraph (b)(9) of this section provides examples.

[[Page 391]]

    (2) Total annual disparity fraction. An employee's total annual 
disparity fraction is the sum of the employee's annual disparity 
fractions, as defined in paragraphs (b)(3) through (b)(7) of this 
section. An employee's total annual disparity fraction is determined as 
of the end of the current plan year, based on the employee's annual 
disparity fractions under all plans with plan years ending in the 
current plan year.
    (3) Annual defined contribution plan disparity fraction. For a plan 
year, the annual defined contribution plan disparity fraction for an 
employee benefiting under a defined contribution plan that is a section 
401(l) plan is a fraction--
    (i) The numerator of which is the disparity provided under the plan 
for the plan year, and
    (ii) The denominator of which is the maximum excess allowance under 
Sec. 1.401(l)-2(b)(2) for the plan year.
    (4) Annual defined benefit excess plan disparity fraction. For a 
plan year, the annual defined benefit excess plan disparity fraction for 
an employee benefiting under a defined benefit excess plan that is a 
section 401(l) plan is a fraction--
    (i) The numerator of which is the disparity provided under the plan 
for the plan year, and
    (ii) The denominator of which is the maximum excess allowance under 
Sec. 1.401(l)-3(b)(2) for the plan year.
    (5) Annual offset plan disparity fraction--(i) In general. For a 
plan year, the annual offset plan disparity fraction for an employee 
benefiting under an offset plan that is a section 401(l) plan is a 
fraction--
    (A) The numerator of which is the disparity provided under the plan 
for the plan year; and
    (B) The denominator of which is the maximum offset allowance under 
Sec. 1.401(l)-3(b)(3) for the plan year.
    (ii) PIA offset plans. In the case of an offset plan that applies an 
offset of a specified percentage of the employee's PIA, as permitted 
under Sec. 1.401(l)-3(c)(2)(ix), the numerator of the annual offset 
plan disparity fraction is the offset percentage used in the section 
401(l) overlay under the plan.
    (6) Annual imputed disparity fraction. For a plan year, the annual 
imputed disparity fraction for an employee benefiting under a plan that 
imputes permitted disparity with respect to the employee under Sec. 
1.401(a)(4)-7 is one.
    (7) Annual nondisparate fraction. For a plan year, the annual 
nondisparate fraction for an employee benefiting under a plan that 
neither is a section 401(l) plan nor imputes permitted disparity under 
Sec. 1.401(a)(4)-7 is zero.
    (8) Determination of fraction--(i) General rule. A separate annual 
disparity fraction is generally determined for each plan under which the 
employee benefits. Thus, for example, if two plans are aggregated and 
treated as a single plan for purposes of section 401(a)(4), a single 
annual disparity fraction applies to the aggregated plan.
    (ii) Multiple formulas. If a plan provides an allocation or benefit 
equal to the sum of two or more formulas, each formula is considered a 
separate plan for purposes of this section. If a plan provides an 
allocation or benefit equal to the greater of two or more formulas, an 
annual disparity fraction is calculated for the employee under each 
formula and the largest of the fractions is the employee's annual 
disparity fraction under the plan.
    (iii) Offset arrangements--(A) In general. If an employee benefits 
under two plans taken into account under paragraph (a)(3) of this 
section as described in paragraph (b)(8)(iii)(B) or (C) of this section, 
the employee's annual disparity fraction under both plans is the larger 
of the annual disparity fractions calculated separately under each plan.
    (B) Defined benefit plans. The employee's employer-provided accrued 
benefit under a defined benefit plan is offset by the employee's total 
employer-provided accrued benefit under another defined benefit plan or 
by the actuarial equivalent (as defined in Sec. 1.401(a)(4)-12) of the 
employee's total account balance under a defined contribution plan that 
is attributable to employer contributions.
    (C) Defined contribution plans. The amount allocated to the 
employee's account under a defined contribution plan is offset by the 
total amount allocated to the employee's account under another defined 
contribution plan.

[[Page 392]]

    (iv) Applicable percentages. The disparity provided under a plan is 
determined on the base and excess percentages under an excess plan and 
the offset percentage under an offset plan, regardless of whether the 
employee's plan year or average annual compensation exceeds the 
integration or offset level under the plan.
    (v) Fractional accrual plans. If a section 401(l) plan determines 
each employee's accrued benefit under the fractional accrual method of 
section 411(b)(1)(C), the numerator of an employee's annual disparity 
fraction is based on the disparity provided in the benefit accrued for 
the employee for the plan year.
    (9) Examples. The following examples illustrate this paragraph (b). 
Except as otherwise provided, each plan is a section 401(l) plan.

    Example 1. (a) Employee A benefits for the plan year under a defined 
contribution excess plan, Plan X, and a defined benefit excess plan, 
Plan Y, of the employer. Plans X and Y have the same plan year. Employee 
A benefits under no other plan of the employer for the plan year of any 
other plan ending in the plan year of Plans X and Y. Plan X provides a 
base contribution percentage of 5 percent and an excess contribution 
percentage of 7 percent, thus providing Employee A with disparity of 2 
percent for the plan year. The maximum excess allowance for the plan 
year under Plan X is 5 percent. Plan Y provides a base benefit 
percentage of 1 percent and an excess benefit percentage of 1.35 
percent, thus providing Employee A with disparity of 0.35 percent for 
the plan year. The maximum excess allowance for the plan year under Plan 
Y is 0.75 percent.
    (b) Employee A's annual defined contribution plan disparity fraction 
under Plan X for the plan year is 0.4 (2 percent divided by 5 percent). 
Employee A's annual defined benefit excess plan disparity fraction under 
Plan Y for the plan year is 0.47 (0.35 percent divided by 0.75 percent). 
Employee A's total annual disparity fraction is the sum of 0.4 and 0.47 
or 0.87. Because Employee A's total annual disparity fraction does not 
exceed one, the plans satisfy the annual overall permitted disparity 
limit with respect to Employee A for the plan year.
    Example 2. (a) The facts are the same as in Example 1, except that 
Plan Y is a defined contribution plan, rather than a defined benefit 
plan. Plan X and Plan Y cover the same employees and are identical in 
their terms except for the base and excess contribution percentages 
provided under the plans. Plan Y provides a base contribution percentage 
of 3 percent and an excess contribution percentage of 6 percent, thus 
providing Employee A with disparity of 3 percent for the plan year. The 
maximum excess allowance for the plan year under Plan Y is 3 percent.
    (b) Employee A's annual defined contribution plan disparity fraction 
under Plan X for the plan year is 0.4 (2 percent divided by 5 percent). 
Employee A's annual defined contribution plan disparity fraction under 
Plan Y for the plan year is 1 (3 percent divided by 3 percent). Because 
Employee A's total annual disparity fraction (the sum of 0.4 and 1 or 
1.4) exceeds one, the plans do not satisfy the annual overall permitted 
disparity requirements with respect to Employee A for the plan year.
    (c) Plan X and Plan Y are aggregated for purposes of section 
401(a)(4) and form a single section 401(l) plan. Under the plan, the 
base contribution percentage is 8 percent (5 percent plus 3 percent), 
and the excess contribution percentage is 13 percent (7 percent plus 6 
percent). A single annual defined contribution plan disparity fraction 
is determined for Employee A for the plan year, the numerator of which 
is the disparity of 5 percent provided under the plan (13 percent minus 
8 percent), and the denominator of which is 5.7 percent, the maximum 
excess allowance that applies to the plan. Because Employee A's only 
annual disparity fraction of 0.88 (5 percent divided by 5.7 percent) 
does not exceed one, Employee A's total annual disparity fraction also 
does not exceed one. The plan thus satisfies the annual overall 
permitted disparity limit with respect to Employee A for the plan year.
    Example 3. Assume the same facts as in Example 2, except that Plan X 
and Plan Y use different integration levels. Therefore, when Plan X and 
Plan Y are aggregated to form a single plan for purposes of section 
401(a)(4), the single plan does not satisfy section 401(l). In applying 
the general test of Sec. 1.401(a)(4)-2(c), the plan imputes disparity 
under Sec. 1.401(a)(4)-7. Employee A's only annual disparity fraction 
is the annual imputed disparity fraction of one. Employee A's total 
annual disparity fraction is also one, and the plan satisfies the annual 
overall permitted disparity limit with respect to Employee A for the 
plan year.
    Example 4. (a) Employee B participates in two plans: Plan M, which 
is a section 401(l) plan, and Plan N, which is subject to the general 
test under Sec. 1.401(a)(4)-3(c). Plan M provides that the disparity 
provided an employee for the plan year will be reduced to the extent 
necessary to satisfy the annual overall permitted disparity limits. The 
employer wishes to impute permitted disparity under Sec. 1.401(a)(4)-7 
in order for Plan N to satisfy section 401(a)(4). Employee B's imputed 
disparity fraction under Plan N is therefore one, and Plan M provides no 
disparity for Employee B for the plan year. As

[[Page 393]]

a result, Plan M provides disparity that is neither uniform nor deemed 
uniform under Sec. 1.401(l)-3(c); Plan M therefore does not satisfy 
section 401(l).
    (b) Assume instead that Plan M provides that the annual overall 
permitted disparity limits must be satisfied without reducing the 
disparity provided for an employee under Plan M, thus requiring a 
reduction in the employee's annual disparity fraction under another 
plan. In that case, the disparity provided under Plan M would be uniform 
for the plan year and Plan M would continue to satisfy section 401(l). 
However, imputation of permitted disparity with respect to Employee B 
would not be allowed under Plan N.

    (c) Cumulative permitted disparity limit--(1) In general--(i) 
Employees who benefit under defined benefit plans. In the case of an 
employee who has benefited under one or more defined benefit plans for a 
plan year described in paragraph (c)(1)(v) of this section, the 
cumulative permitted disparity limit is satisfied if the employee's 
cumulative disparity fraction, as defined in paragraph (c)(2) of this 
section, does not exceed 35.
    (ii) Employees who do not benefit under defined benefit plans. In 
the case of an employee who has not benefited under a defined benefit 
plan for any plan year described in paragraph (c)(1)(v) of this section, 
the cumulative permitted disparity limit is satisfied.
    (iii) Certain plan years disregarded. For purposes of this paragraph 
(c), an employee is not treated as benefiting under a defined benefit 
plan for a plan year described in paragraph (c)(1)(v) of this section if 
the employer can establish that for that plan year the defined benefit 
plan was not a section 401(l) plan and did not impute permitted 
disparity under Sec. 1.401(a)(4)-7.
    (iv) Determination of type of plan. For purposes of this paragraph 
(c), a target benefit plan that relies on the special rule of Sec. 
1.401(a)(4)-8(b)(3) to satisfy section 401(a)(4) and a DB/DC plan within 
the meaning of Sec. 1.401(a)(4)-9(a) are treated as defined benefit 
plans. Similarly, a cash balance plan that relies on the special rule of 
Sec. 1.401(a)(4)-8(c)(3) to satisfy section 401(a)(4) is treated as a 
defined contribution plan.
    (v) Applicable plan years. In applying paragraphs (c)(1) (i), (ii), 
and (iii) of this section, for purposes of determining whether an 
employee benefits under a defined benefit plan, the applicable plan 
years are all plan years that begin on or after the regulatory effective 
date, as set forth in Sec. 1.401(l)-6(b), or, in the case of 
governmental plans, as set forth in Sec. 1.401(a)(4)-13(b).
    (vi) Transition rule for defined contribution plans. A defined 
contribution plan is deemed to satisfy the cumulative permitted 
disparity limit for the first plan year to which these regulations 
apply, as set forth in Sec. 1.401(l)-6(b), or, in the case of 
governmental plans, as set forth in Sec. 1.401(a)(4)-13(b).
    (2) Cumulative disparity fraction. An employee's cumulative 
disparity fraction is the sum of the employee's total annual disparity 
fractions, as defined in paragraph (b)(2) of this section, attributable 
to the employee's total years of service under all plans.
    (3) Determination of total annual disparity fractions for prior 
years. For each of the employee's years of service credited as of the 
end of the last plan year beginning before January 1, 1989, not to 
exceed 35, under all plans as of that time that are taken into account 
under paragraph (a)(3) of this section (whether or not terminated), the 
employee's total annual disparity fraction is one. Therefore, if, before 
the first plan year beginning on or after January 1, 1989, an employee 
never participated in or benefited under any plan taken into account 
under paragraph (a)(3) of this section, the employee's total annual 
disparity fractions are determined without regard to this paragraph 
(c)(3). An employer may apply the rule in this paragraph (c)(3) with 
respect to all employees, using a year (including the current year) that 
is chosen by the employer and is later than 1989. Thus, for example, in 
lieu of calculating annual disparity fractions for all plan years, the 
employer may assume that the full disparity limit has been used in each 
prior plan year for which an employee has been credited with a year of 
service.
    (4) Special rules for greater of formulas and offset arrangements--
(i) Greater of formulas--(A) In general. A defined benefit plan that is 
a section 401(l) plan and that provides a benefit equal to the greater 
of the benefits determined under two or more formulas is deemed to 
satisfy the cumulative permitted

[[Page 394]]

disparity limit with respect to an employee if each of the requirements 
in paragraphs (c)(4)(i) (B) and (C) of this section is satisfied. For 
this purpose, a plan that uses a fresh-start formula that determines the 
accrued benefit as the greater of two amounts under Sec. 1.401(a)(4)-
13(c)(4) (ii) or (iii) provides a benefit equal to the greater of the 
benefits determined under two or more formulas.
    (B) Separate satisfaction by formulas. Each formula under the plan 
would satisfy the cumulative permitted disparity limit if it were the 
only formula under the plan. In the case of a current formula that 
applies to the employee's total years of service (as, for example, under 
Sec. 1.401(a)(4)-13(c)(4) (ii)(B) or (iii)(B)), for purposes of 
determining whether that formula would satisfy the cumulative permitted 
disparity limit if it were the only formula under the plan, the special 
rule for prior years under paragraph (c)(3) of this section may be 
disregarded.
    (C) Single plan. The employee has never benefited under another plan 
taken into account under paragraph (a)(3) of this section that is a 
section 401(l) plan or that satisfies section 401(a)(4) by relying on 
Sec. 1.401(a)(4)-7. For this purpose, if the benefit under the plan is 
offset in an offset arrangement described in paragraph (b)(8)(iii)(B) of 
this section, the other plan is disregarded. In addition, a plan does 
not fail the requirements of this paragraph (c)(4)(i)(C) merely because 
the employee benefits under another defined benefit plan, provided 
that--
    (1) With respect to each benefit formula under the plan, no years of 
service taken into account under that benefit formula are taken into 
account under a benefit formula of the other plan; and
    (2) Paragraph (c)(4)(i)(B) of this section would be satisfied if the 
plans were treated as a single plan that provided a benefit equal to the 
greater of the benefits provided under two or more formulas. For this 
purpose, a formula consists of the sum of a formula for the years of 
service taken into account under one plan and a formula for the years of 
service taken into account under the other plan. Thus, each possible 
combination of the formulas under the plans must satisfy paragraph 
(c)(4)(i)(B) of this section.
    (ii) Offset arrangements--(A) In general. If a defined benefit plan 
is a section 401(l) plan and the benefit under the plan (the gross 
benefit plan) is offset by the benefit under another plan (the 
offsetting plan) in an offset arrangement described in paragraph 
(b)(8)(iii)(B) of this section, the gross benefit plan is deemed to 
satisfy the cumulative permitted disparity limit with respect to an 
employee if each of the requirements in paragraphs (c)(4)(ii) (B) and 
(C) of this section is satisfied.
    (B) Separate satisfaction by plans. This requirement is satisfied if 
the gross benefit plan would satisfy the cumulative disparity limit if 
no offset applied, and the offsetting plan satisfies the cumulative 
permitted disparity limit, not taking into account the gross benefit 
plan.
    (C) No other plan. Except for the plans in the offset arrangement, 
the employee has never benefited under another plan taken into account 
under paragraph (a)(3) of this section that is a section 401(l) plan or 
that satisfies section 401(a)(4) by relying on Sec. 1.401(a)(4)-7. An 
offset arrangement does not fail the requirements of this paragraph 
(c)(4)(ii)(C) merely because the employee benefits under another defined 
benefit plan, provided no years of service taken into account under a 
benefit formula of any plan in the offset arrangement are also taken 
into account under a benefit formula of the other plan.
    (5) Examples. The following examples illustrate this paragraph (c). 
In each example the plan is noncontributory and, unless provided 
otherwise, is the only plan ever maintained by the employer. Each plan 
uses a normal retirement age of 65 and contains no provision that would 
require a reduction in the 0.75-percent factor under Sec. 1.401(l)-
3(b)(2) or (3). Each example discusses the benefit formula applicable to 
an employee who has a social security retirement age of 65.

    Example 1. Plan M is a defined benefit excess plan that provides a 
normal retirement benefit of 1 percent of average annual compensation up 
to covered compensation, plus 1.75 percent of average annual 
compensation

[[Page 395]]

above covered compensation, for each year of service without limit. The 
disparity provided under the plan for the plan year is 0.75 percent, the 
excess benefit percentage of 1.75 percent minus the base benefit 
percentage of 1 percent. The maximum excess allowance for the plan year 
is 0.75 percent. Thus, each employee's annual defined benefit excess 
plan disparity fraction under the plan for each plan year is one. 
Because the plan contains no limit on the years of service taken into 
account under the plan, the sum of the total annual disparity fractions 
for a potential employee with more than 35 years of service will exceed 
35. In addition, the plan does not provide that the overall permitted 
disparity limits may not be exceeded as required by paragraph (a)(2) of 
this section. The plan therefore does not satisfy the cumulative 
permitted disparity limit of this paragraph (c).
    Example 2. Plan N is an offset plan that provides a normal 
retirement benefit of 2 percent of average annual compensation, minus 
0.75 percent of final average compensation up to the lesser of covered 
compensation and average annual compensation, for each year of service 
up to 35. The disparity provided under the plan for the plan year is 
0.75 percent, the offset percentage. The maximum offset allowance for 
the plan year is 0.75 percent. Thus, each employee's annual offset plan 
disparity fraction under the plan for each plan year is one. Because the 
plan limits the years of service taken into account under the plan to 
35, the sum of the total annual disparity fractions for an employee 
cannot exceed 35. The plan therefore satisfies the cumulative permitted 
disparity limit of this paragraph (c).
    Example 3. Plan O is a defined benefit excess plan that provides a 
normal retirement benefit of 0.75 percent of average annual compensation 
up to covered compensation, plus 1.25 percent of average annual 
compensation above covered compensation, for each year of service up to 
45. The disparity provided under the plan for the plan year is 0.5 
percent, the excess benefit percentage of 1.25 percent minus the base 
benefit percentage of 0.75 percent. The maximum excess allowance for the 
plan year is 0.75 percent. Thus, each employee's annual defined benefit 
excess plan disparity fraction under the plan for each plan year is 0.67 
(0.5 percent divided by 0.75 percent). Because the plan limits the years 
of service taken into account under the plan to 45, the sum of the total 
annual disparity fractions for an employee cannot exceed 30 (0.67x45). 
The plan therefore satisfies the cumulative permitted disparity limit of 
this paragraph (c).
    Example 4. (a) Plan P is a defined contribution excess plan. Plan P 
provides a base contribution percentage of 6 percent and an excess 
contribution percentage of 11.7 percent, thus providing disparity of 5.7 
percent for the plan year. Because the maximum excess allowance for each 
plan year under Plan P is 5.7 percent, each employee's annual defined 
contribution plan disparity fraction under Plan P for each plan year is 
one. Plan Q is a defined benefit excess plan maintained by the same 
employer. Plan Q provides a base benefit percentage of 1 percent and an 
excess benefit percentage of 1.75 percent for each year of service up to 
35, thus providing disparity of 0.75 percent for the plan year. Because 
the maximum excess allowance for each plan year under Plan Q is 0.75 
percent, each employee's annual defined benefit excess plan disparity 
fraction under Plan Q for each plan year is one.
    (b) Employee A benefits under Plan P for the 1980 through the 1994 
plan years. The sum of Employee A's total annual disparity fractions 
under Plan P is 15. (Under paragraph (c)(3)(i) of this section, Employee 
A's annual disparity fraction for each year of service as of the end of 
the 1988 plan year is one.) As of the 1995 plan year, Employee A no 
longer benefits under Plan P and begins to benefit under Plan Q for the 
first time. In order to satisfy the cumulative permitted disparity limit 
of this paragraph (c), Plan Q must provide that no disparity will be 
provided if the sum of an employee's total annual disparity fractions 
reaches 35, taking into account the employee's annual defined 
contribution plan disparity fractions under Plan P as well as the 
employee's annual defined benefit excess plan disparity fractions under 
Plan Q. Thus, after Employee A has benefited under Plan Q for 20 years, 
Plan Q may not provide any disparity in additional benefits accrued for 
Employee A.
    Example 5. (a) Plan O is a noncontributory defined benefit excess 
plan. Plan O provides an employee whose social security retirement age 
is 65 with the greater of the benefits determined under two formulas. 
The first formula provides a benefit of 1 percent of average annual 
compensation up to covered compensation, plus 1.75 percent of average 
annual compensation above covered compensation, for each year of service 
up to 35. The second formula provides a benefit of 1 percent of average 
annual compensation up to covered compensation, plus 1.6 percent of 
average annual compensation above covered compensation, for each year of 
service up to 40.
    (b) Under paragraph (b)(4) of this section, an employee's annual 
defined benefit excess plan fraction for each of the 35 years under the 
first formula is 0.75/0.75 or one, and an employee's annual defined 
benefit excess plan fraction for each of the 40 years under the second 
formula is 0.6/0.75 or 0.8. Under paragraph (b)(8)(ii) of this section, 
an employee's annual defined benefit excess plan fraction (and total 
annual disparity fraction because the employee benefits only under

[[Page 396]]

Plan O) for the plan year is the larger fraction under the two formulas 
or one. Therefore, after 35 years, the employee has a cumulative 
disparity fraction of 35. The disparity provided under the second 
formula for years of service after 35 thus exceeds the cumulative 
permitted disparity limit unless the plan qualifies for the special rule 
in paragraph (c)(4)(i) of this section.
    (c) Assume the condition in paragraph (c)(4)(i)(C) of this section 
is satisfied because no employee has benefited under another plan taken 
into account under paragraph (a)(3) of this section. In addition, the 
largest cumulative disparity fraction possible under the first formula 
is 35 times one or 35, and the largest cumulative disparity fraction 
possible under the second formula is 40 times 0.8 or 32. Thus, the 
requirement of paragraph (c)(4)(i)(B) of this section is also satisfied 
because each formula would satisfy the cumulative permitted disparity 
limit if it were the only formula under the plan. Under paragraph 
(c)(4)(i) of this section, the plan is deemed to satisfy the cumulative 
permitted disparity limit with respect to an employee whose social 
security retirement age is 65.

    (d) Additional rules. The Commissioner may prescribe additional 
rules under this section as the Commissioner considers appropriate. 
Additional rules may include (without being limited to) rules for 
computing the fractions described in this section with respect to 
terminated plans, rules for applying the overall permitted disparity 
limits to employees who benefit under plans maintained by railroad 
employers, and rules for determining which plans do not satisfy section 
401(l) if the overall permitted disparity limits are exceeded.

[T.D. 8359, 56 FR 47634, Sept. 19, 1991; 57 FR 10819, 10952, Mar. 31, 
1992, as amended by T.D. 8486, 58 FR 46833, Sept. 3, 1993]



Sec. 1.401(l)-6  Effective dates and transition rules.

    (a) Statutory effective date--(1) In general. Except as otherwise 
provided in paragraph (a)(2) of this section, section 401(a)(5)(C) is 
effective for plan years beginning on or after January 1, 1989, and 
section 401(l) is effective with respect to plan years, and benefits 
attributable to plan years, beginning on or after January 1, 1989. The 
preceding sentence is applicable to a plan without regard to whether the 
plan was in existence as of a particular date.
    (2) Collectively bargained plans. (i) In the case of a plan 
maintained pursuant to 1 or more collective bargaining agreements 
between employee representatives and 1 or more employers ratified before 
March 1, 1986, sections 401(a)(5) and 401(l) are applicable for plan 
years beginning on or after the later of--
    (A) January 1, 1989; or
    (B) The date on which the last of such collective bargaining 
agreements terminates (determined without regard to any extension of any 
such agreement occurring on or after March 1, 1986). However, 
notwithstanding the preceding sentence, sections 401(a)(5) and 401(l) 
apply to plans described in this paragraph (a)(2) no later than the 
first plan year beginning after January 1, 1991.
    (ii) For purposes of paragraph (a)(2)(i)(B) of this section, a 
change made after October 22, 1986, in the terms or conditions of a 
collectively bargained plan, pursuant to a collective bargaining 
agreement ratified before March 1, 1986, is not treated as a change in 
the terms and conditions of the plan.
    (iii) In the case of a collectively bargained plan described in 
paragraph (a)(2)(i) of this section, if the date in paragraph 
(a)(2)(i)(B) of this section precedes November 15, 1988, then the date 
in this paragraph (a)(2) is replaced with the date on which the last of 
any collective bargaining agreements in effect on November 15, 1988, 
terminates, provided that the plan complies during this period with a 
reasonable good faith interpretation of section 401(l).
    (iv) Whether a plan is maintained pursuant to a collective 
bargaining agreement is determined under the principles applied under 
section 1017(c) of the Employee Retirement Income Security Act of 1974. 
See H.R. Rep. No. 1280, 93d Cong., 2d Sess. 266 (1974). In addition, a 
plan is not treated as maintained under a collective bargaining 
agreement unless the employee representatives satisfy section 
7701(a)(46) of the Internal Revenue Code after March 31, 1984. See Sec. 
301.7701-17T of this chapter for other requirements for a plan to be 
considered to be collectively bargained.
    (b) Regulatory effective date--(1) In general. Except as otherwise 
provided in paragraph (b)(2) of this section,

[[Page 397]]

Sec. Sec. 1.401(l)-1 through 1.401(l)-6 apply to plan years beginning 
on or after January 1, 1994.
    (2) Plans of tax-exempt organizations. In the case of plans 
maintained by an organization exempt from income taxation under section 
501(a), including plans subject to section 403(b)(12)(A)(i) (nonelective 
plans), Sec. Sec. 1.401(l)-1 through 1.401(l)-6 apply to plan years 
beginning on or after January 1, 1996.
    (3) Defined contribution plans. A defined contribution plan 
satisfies section 401(l) with respect to a plan year beginning on or 
after the effective date of these regulations, as set forth in 
paragraphs (b)(1) and (b)(2) of this section, if it satisfies the 
applicable requirements of Sec. Sec. 1.401(l)-1 through 1.401(l)-5 for 
the plan year.
    (4) Defined benefit plans. A defined benefit excess plan or offset 
plan satisfies section 401(l) with respect to all plan years, and 
benefits attributable to all plan years, beginning on or after the 
effective date of these regulations, as set forth in paragraphs (b)(1) 
and (b)(2) of this section, by satisfying the applicable requirements of 
Sec. Sec. 1.401(l)-1 through 1.401(l)-5 and the requirements of Sec. 
1.401(a)(4)-13(c) (and Sec. 1.401(a)(4)-13(d), if applicable), using a 
fresh-start date that is on or after December 31, 1988, and before the 
effective date of these regulations. A defined benefit excess plan or 
offset plan that does not satisfy section 401(l) with respect to all 
plan years beginning on or after the effective date of these regulations 
may, under the rules of Sec. 1.401(a)(4)-13(c) (and Sec. 1.401(a)(4)-
13(d), if applicable), satisfy section 401(l) for plan years beginning 
after a fresh-start date by satisfying the applicable requirements of 
Sec. Sec. 1.401(l)-1 through 1.401(l)-5 after the fresh-start date.
    (c) Compliance during transition period. For plan years beginning on 
or after January 1, 1989, and before the effective date of these 
regulations, as set forth in paragraph (b) of this section, a plan must 
be operated in accordance with a reasonable, good faith interpretation 
of section 401(l). Whether a plan is operated in accordance with a 
reasonable, good faith interpretation of section 401(l) will generally 
be determined based on all of the relevant facts and circumstances, 
including the extent to which an employer has resolved unclear issues in 
its favor. A plan will be deemed to be operated in accordance with a 
reasonable, good faith interpretation of section 401(l) if it is 
operated in accordance with the terms of Sec. Sec. 1.401(l)-1 through 
1.401(l)-5.

[T.D. 8486, 58 FR 46835, Sept. 3, 1993]



Sec. 1.401(m)-0  Table of contents.

    This section contains first a list of section headings and then a 
list of the paragraphs in each section in Sec. Sec. 1.401(m)-1 through 
1.401(m)-5.

                            List of Sections

    Sec. 1.401(m)-1 Employee contributions and matching contributions.
Sec. 1.401(m)-2 ACP test.
Sec. 1.401(m)-3 Safe harbor requirements.
Sec. 1.401(m)-4 Special rules for mergers, acquisitions and similar 
          events. [Reserved]
Sec. 1.401(m)-5 Definitions.

                           List of Paragraphs

    Sec. 1.401(m)-1 Employee contributions and matching contributions.
(a) General nondiscrimination rules.
(1) Nondiscriminatory amount of contributions.
(i) Exclusive means of amounts testing.
(ii) Testing benefits, rights and features.
(2) Matching contributions.
(i) In general.
(ii) Employer contributions made on account of an employee contribution 
          or elective deferral.
(iii) Employer contributions not on account of an employee contribution 
          or elective deferral.
(A) General rule.
(B) Special rule for forfeitures and released ESOP shares.
(C) Exception for bona fide administrative considerations.
(3) Employee contributions.
(i) In general.
(ii) Certain contributions not treated as employee contributions.
(iii) Qualified cost-of-living arrangements.
(b) Nondiscrimination requirements for amount of contributions.
(1) Matching contributions and employee contributions.
(2) Automatic satisfaction by certain plans.
(3) Anti-abuse provisions.
(4) Aggregation and restructuring.
(i) In general.
(ii) Aggregation of employee contributions and matching contributions 
          within a plan.
(iii) Aggregation of plans.
(A) In general.

[[Page 398]]

(B) Arrangements with inconsistent ACP testing methods.
(iv) Disaggregation of plans and separate testing.
(A) In general.
(B) Restructuring prohibited.
(v) Certain disaggregation rules not applicable.
(c) Additional requirements.
(1) Separate testing for employee contributions and matching 
          contributions.
(2) Plan provision requirement.
(d) Effective date.
(1) General rule.
(2) Early implementation permitted.
(3) Applicability of prior regulations.
    Sec. 1.401(m)-2 ACP test.
(a) Actual contribution percentage (ACP) test.
(1) In general.
(i) ACP test formula.
(ii) HCEs as sole eligible employees.
(iii) Special rule for early participation.
(2) Determination of ACP.
(i) General rule.
(ii) Determination of applicable year under current year and prior year 
          testing method.
(3) Determination of ACR.
(i) General rule.
(ii) ACR of HCEs eligible under more than one plan.
(A) General rule.
(B) Plans not permitted to be aggregated.
(iii) Example.
(4) Employee contributions and matching contributions taken into account 
          under the ACP test.
(i) Employee contributions.
(ii) Recharacterized elective contributions.
(iii) Matching contributions.
(5) Employee contributions and matching contributions not taken into 
          account under the ACP test.
(i) General rule.
(ii) Disproportionate matching contributions.
(A) Matching contributions in excess of 100%.
(B) Representative matching rate.
(C) Definition of matching rate.
(iii) Qualified matching contributions used to satisfy the ADP test.
(iv) Matching contributions taken into account under safe harbor 
          provisions.
(v) Treatment of forfeited matching contributions.
(vi) Additional employee contributions or matching contributions 
          pursuant to section 414(u).
(6) Qualified nonelective contributions and elective contributions that 
          may be taken into account under the ACP test.
(i) Timing of allocation.
(ii) Elective contributions taken into account under the ACP test.
(iii) Requirement that amount satisfy section 401(a)(4).
(iv) Aggregation must be permitted.
(v) Disproportionate contributions not taken into account.
(A) General rule.
(B) Definition of representative contribution rate.
(C) Definition of applicable contribution rate.
(D) Special rule for prevailing wage contributions.
(vi) Contribution only used once.
(7) Examples.
(b) Correction of excess aggregate contributions.
(1) Permissible correction methods.
(i) In general.
(A) Additional contributions.
(B) Excess aggregate contributions distributed or forfeited.
(ii) Combination of correction methods.
(iii) Exclusive means of correction.
(2) Correction through distribution.
(i) General rule.
(ii) Calculation of total amount to be distributed.
(A) Calculate the dollar amount of excess aggregate contributions for 
          each HCE.
(B) Determination of the total amount of excess aggregate contributions.
(C) Satisfaction of ACP.
(iii) Apportionment of total amount of excess aggregate contributions 
          among the HCEs.
(A) Calculate the dollar amount of excess aggregate contributions for 
          each HCE.
(B) Limit on amount apportioned to any HCE.
(C) Apportionment to additional HCEs.
(iv) Income allocable to excess aggregate contributions.
(A) General rule.
(B) Method of allocating income.
(C) Alternative method of allocating income for the plan year.
(D) Plan years before 2008.
(E) Alternative method of allocating plan year and gap period income.
(F) Allocable income for recharacterized elective contributions.
(v) Distribution and forfeiture.
(vi) Tax treatment of corrective distributions.
(A) Corrective distributions for plan years beginning on or after 
          January 1, 2008.
(B) Corrective distributions for plan years beginning before January 1, 
          2008.
(C) Corrective distributions attributable to designated Roth 
          contributions.
(3) Other rules.
(i) No employee or spousal consent required.
(ii) Treatment of corrective distributions and forfeited contributions 
          as employer contributions.
(iii) No reduction of required minimum distribution.

[[Page 399]]

(iv) Partial correction.
(v) Matching contributions on excess contributions, excess deferrals and 
          excess aggregate contributions.
(A) Corrective distributions not permitted.
(B) Coordination with section 401(a)(4).
(vi) No requirement for recalculation.
(4) Failure to timely correct.
(i) Failure to correct within 2\1/2\ months after end of plan year.
(ii) Failure to correct within 12 months after end of plan year.
(iii) Special rule for eligible automatic contribution arrangements.
(5) Examples.
(c) Additional rules for prior year testing method.
(1) Rules for change in testing method.
(2) Calculation of ACP under the prior year testing method for the first 
          plan year.
(i) Plans that are not successor plans.
(ii) First plan year defined.
(iii) Plans that are successor plans.
(3) Plans using different testing methods for the ACP and ADP test.
(4) Rules for plan coverage change.
(i) In general.
(ii) Optional rule for minor plan coverage changes.
(iii) Definitions.
(A) Plan coverage change.
(B) Prior year subgroup.
(C) Weighted average of the ACPs for the prior year subgroups.
(iv) Examples.
    Sec. 1.401(m)-3 Safe harbor requirements.
(a) ACP test safe harbor.
(1) Section 401(m)(11) safe harbor.
(2) Section 401(m)(12) safe harbor.
(3) Requirements applicable to safe harbor contributions.
(b) Safe harbor nonelective contribution requirement.
(c) Safe harbor matching contribution requirement.
(d) Limitation on contributions.
(1) General rule.
(2) Matching rate must not increase.
(3) Limit on matching contributions.
(4) Limitation on rate of match.
(5) HCEs participating in multiple plans.
(6) Permissible restrictions on elective deferrals by NHCEs.
(i) General rule.
(ii) Restrictions on election periods.
(iii) Restrictions on amount of contributions.
(iv) Restrictions on types of compensation that may be deferred.
(v) Restrictions due to limitations under the Internal Revenue Code.
(e) Notice requirement.
(f) Plan year requirement.
(1) General rule.
(2) Initial plan year.
(3) Change of plan year.
(4) Final plan year.
(g) Plan amendments adopting nonelective safe harbor contributions.
(h) Permissible reduction or suspension of safe harbor contributions.
(1) General rule.
(i) Matching contributions.
(ii) Nonelective contributions.
(2) Supplemental notice.
(j) Other rules.
(1) Contributions taken into account.
(2) Use of safe harbor nonelective contributions to satisfy other 
          nondiscrimination tests.
(3) Early participation rules.
(4) Satisfying safe harbor contribution requirement under another 
          defined contribution plan.
(5) Contributions used only once.
(6) Plan must satisfy ACP with respect to employee contributions.
    Sec. 1.401(m)-4 Special rules for mergers, acquisitions and similar 
events.
[Reserved]
    Sec. 1.401(m)-5 Definitions.

[T.D. 9169, 69 FR 78184, Dec. 29, 2004, as amended by T.D. 9237, 71 FR 
10, Jan. 3, 2006; T.D. 9447, 74 FR 8210, Feb. 24, 2009; T.D. 9641, 78 FR 
68738, Nov. 15, 2013]



Sec. 1.401(m)-1  Employee contributions and matching contributions.

    (a) General nondiscrimination rules--(1) Nondiscriminatory amount of 
contributions--(i) Exclusive means of amounts testing. A defined 
contribution plan does not satisfy section 401(a) for a plan year unless 
the amount of employee contributions and matching contributions to the 
plan for the plan year satisfies section 401(a)(4). The amount of 
employee contributions and matching contributions under a plan satisfies 
the requirements of section 401(a)(4) with respect to amounts if and 
only if the amount of employee contributions and matching contributions 
satisfies the nondiscrimination test of section 401(m) under paragraph 
(b) of this section and the plan satisfies the additional requirements 
of paragraph (c) of this section. See Sec. 1.401(a)(4)-1(b)(2)(ii)(B).
    (ii) Testing benefits, rights and features. A plan that provides for 
employee contributions or matching contributions must satisfy the 
requirements of section 401(a)(4) relating to benefits, rights and 
features in addition to the requirement regarding amounts described in 
paragraph (a)(1)(i) of this section. For example,

[[Page 400]]

the right to make each level of employee contributions and the right to 
each level of matching contributions under the plan are benefits, rights 
or features subject to the requirements of section 401(a)(4). See Sec. 
1.401(a)(4)-4(e)(3)(i) and (iii)(F) through (G).
    (2) Matching contributions--(i) In general. For purposes of section 
401(m), this section and Sec. Sec. 1.401(m)-2 through 1.401(m)-5, 
matching contributions are--
    (A) Any employer contribution (including a contribution made at the 
employer's discretion) to a defined contribution plan on account of an 
employee contribution to a plan maintained by the employer;
    (B) Any employer contribution (including a contribution made at the 
employer's discretion) to a defined contribution plan on account of an 
elective deferral; and
    (C) Any forfeiture allocated on the basis of employee contributions, 
matching contributions, or elective deferrals.
    (ii) Employer contributions made on account of an employee 
contribution or elective deferral. Whether an employer contribution is 
made on account of an employee contribution or an elective deferral is 
determined on the basis of all the relevant facts and circumstances, 
including the relationship between the employer contribution and 
employee actions outside the plan. An employer contribution made to a 
defined contribution plan on account of contributions made by an 
employee under an employer-sponsored savings arrangement that are not 
held in a plan that is intended to be a qualified plan or other 
arrangement described in Sec. 1.402(g)-1(b) is not a matching 
contribution.
    (iii) Employer contributions not on account of an employee 
contribution or elective deferral--(A) General rule. Employer 
contributions are not matching contributions made on account of elective 
deferrals if they are contributed before the cash or deferred election 
is made or before the employees' performance of services with respect to 
which the elective deferrals are made (or when the cash that is subject 
to the cash or deferred elections would be currently available, if 
earlier). In addition, an employer contribution is not a matching 
contribution made on account of an employee contribution if it is 
contributed before the employee contribution.
    (B) Exceptions for forfeitures and released ESOP shares. The rule of 
paragraph (a)(3)(iii)(A) of this section does not apply to a forfeiture 
that is allocated as a matching contribution. In addition, an allocation 
of shares from an ESOP loan suspense account described in Sec. 54.4975-
11(c) and (d) of this chapter will not fail to be treated as a matching 
contribution solely because the employer contribution that resulted in 
the release and allocation of those shares from the suspense account is 
made before the employees' performance of services with respect to which 
the elective deferrals are made (or when the cash that is subject to the 
cash or deferred elections would be currently available, if earlier) 
provided that--
    (1) The contribution is for a required payment that is due under the 
loan terms; and
    (2) The contribution is not made early with a principal purpose of 
accelerating deductions.
    (C) Exception for bona fide administrative considerations. The 
timing of contributions will not be treated as failing to satisfy the 
requirements of this paragraph (a)(3)(iii) merely because contributions 
are occasionally made before the employees' performance of services with 
respect to which the elective deferrals are made (or when the cash that 
is subject to the cash or deferred elections would be currently 
available, if earlier) in order to accommodate bona fide administrative 
considerations and are not paid early with a principal purpose of 
accelerating deductions.
    (3) Employee contributions--(i) In general. For purposes of section 
401(m), this section and Sec. Sec. 1.401(m)-2 through 1.401(m)-5, 
employee contributions are contributions to a plan that are designated 
or treated at the time of contribution as after-tax employee 
contributions (e.g., by treating the contributions as taxable income 
subject to applicable withholding requirements) and are allocated to an 
individual account for each eligible employee to which attributable 
earnings and losses are allocated. See Sec. 1.401(k)-1(a)(2)(ii).

[[Page 401]]

The term employee contributions includes--
    (A) Employee contributions to the defined contribution portion of a 
plan described in section 414(k);
    (B) Employee contributions applied to the purchase of whole life 
insurance protection or survivor benefit protection under a defined 
contribution plan;
    (C) Amounts attributable to excess contributions within the meaning 
of section 401(k)(8)(B) that are recharacterized as employee 
contributions under Sec. 1.401(k)-2(b)(3); and
    (D) Employee contributions to a plan or contract that satisfies the 
requirements of section 403(b).
    (ii) Certain contributions not treated as employee contributions. 
The term employee contributions does not include designated Roth 
contributions, repayment of loans, rollover contributions, repayment of 
distributions described in section 411(a)(7)(C), or employee 
contributions that are transferred to the plan from another plan.
    (iii) Qualified cost-of-living arrangements. Employee contributions 
to a qualified cost-of-living arrangement described in section 
415(k)(2)(B) are treated as employee contributions to a defined 
contribution plan, without regard to the requirement that the employee 
contributions be allocated to an individual account to which 
attributable earnings and losses are allocated.
    (b) Nondiscrimination requirements for amount of contributions--(1) 
Matching contributions and employee contributions. The matching 
contributions and employee contributions under a plan satisfy this 
paragraph (b) for a plan year only if the plan satisfies--
    (i) The ACP test of section 401(m)(2) described in Sec. 1.401(m)-2;
    (ii) The ACP safe harbor provisions of section 401(m)(11) described 
in Sec. 1.401(m)-3; or
    (iii) The ACP safe harbor provisions of section 401(m)(12) described 
in Sec. 1.401(m)-3; or
    (iv) The SIMPLE 401(k) provisions of sections 401(k)(11) and 
401(m)(10) described in Sec. 1.401(k)-4.
    (2) Automatic satisfaction by certain plans. Notwithstanding 
paragraph (b)(1) of this section, the requirements of this section are 
treated as satisfied with respect to employee contributions and matching 
contributions under a collectively bargained plan (or the portion of a 
plan) that automatically satisfies section 410(b). See Sec. Sec. 
1.401(a)(4)-1(c)(5) and 1.410(b)-2(b)(7). Additionally, the requirements 
of sections 401(a)(4) and 410(b) do not apply to a governmental plan 
(within the meaning of section 414(d)) maintained by a State or local 
government or political subdivision thereof (or agency or 
instrumentality thereof) and, accordingly such plans are not required to 
comply with this section. See sections 401(a)(5)(G), 403(b)(12)(C) and 
410(c)(1)(A).
    (3) Anti-abuse provisions. Sections 1.401(m)-1 through 1.401(m)-5 
are designed to provide simple, practical rules that accommodate 
legitimate plan changes. At the same time, the rules are intended to be 
applied by employers in a manner that does not make use of changes in 
plan testing procedures or other plan provisions to inflate 
inappropriately the ACP for NHCEs (which is used as a benchmark for 
testing the ACP for HCEs) or to otherwise manipulate the 
nondiscrimination testing requirements of this paragraph (b). Further, 
this paragraph (b) is part of the overall requirement that benefits or 
contributions not discriminate in favor of HCEs. Therefore, a plan will 
not be treated as satisfying the requirements of this paragraph (b) if 
there are repeated changes to plan testing procedures or plan provisions 
that have the effect of distorting the ACP so as to increase 
significantly the permitted ACP for HCEs, or otherwise manipulate the 
nondiscrimination rules of this paragraph, if a principal purpose of the 
changes was to achieve such a result.
    (4) Aggregation and restructuring--(i) In general. This paragraph 
(b)(4) contains the exclusive rules for aggregating and disaggregating 
plans that provide for employee contributions and matching contributions 
for purposes of this section and Sec. Sec. 1.401(m)-2 through 1.401(m)-
5.
    (ii) Aggregation of employee contributions and matching 
contributions within a plan. Except as otherwise specifically provided 
in this paragraph (b)(4) and Sec. 1.401(m)-3(j)(6), a plan must be 
subject

[[Page 402]]

to a single test under paragraph (b)(1) of this section with respect to 
all employee contributions and matching contributions and all eligible 
employees under the plan. Thus, for example, if two groups of employees 
are eligible for matching contributions under a plan, all employee 
contributions and matching contributions under the plan must be subject 
to a single test, even if they have significantly different features, 
such as different rates of match.
    (iii) Aggregation of plans--(A) In general. The term plan means a 
plan within the meaning of Sec. 1.410(b)-7(a) and (b), after 
application of the mandatory disaggregation rules of Sec. 1.410(b)-
7(c), and the permissive aggregation rules of Sec. 1.410(b)-7(d), as 
modified by paragraph (b)(4)(v) of this section. Thus, for example, two 
plans (within the meaning of Sec. 1.410(b)-7(b)) that are treated as a 
single plan pursuant to the permissive aggregation rules of Sec. 
1.410(b)-7(d) are treated as a single plan for purposes of sections 
401(k) and 401(m).
    (B) Arrangements with inconsistent ACP testing methods. Pursuant to 
paragraph (b)(4)(ii) of this section, a single testing method must apply 
with respect to all employee contributions and matching contributions 
and all eligible employees under a plan. Thus, in applying the 
permissive aggregation rules of Sec. 1.410(b)-7(d), an employer may not 
aggregate plans (within the meaning of Sec. 1.410(b)-7(b)) that apply 
inconsistent testing methods. For example, a plan (within the meaning of 
Sec. 1.410(b)-7) that applies the current year testing method may not 
be aggregated with another plan that applies the prior year testing 
method. Similarly, an employer may not aggregate a plan (within the 
meaning of Sec. 1.410(b)-7) that is using the ACP safe harbor 
provisions of section 401(m)(11) or 401(m)(12) and another plan that is 
using the ACP test of section 401(m)(2).
    (iv) Disaggregation of plans and separate testing--(A) In general. 
If employee contributions or matching contributions are included in a 
plan (within the meaning of Sec. 1.410(b)-7(b)) that is mandatorily 
disaggregated under the rules of section 410(b) (as modified by this 
paragraph (b)(4)), the matching contributions and employee contributions 
under that plan must be disaggregated in a consistent manner. For 
example, in the case of an employer that is treated as operating 
qualified separate lines of business under section 414(r), if the 
eligible employees under a plan which provides for employee 
contributions or matching contributions are in more than one qualified 
separate line of business, only those employees within each qualified 
separate line of business may be taken into account in determining 
whether each disaggregated portion of the plan complies with the 
requirements of section 401(m), unless the employer is applying the 
special rule for employer-wide plans in Sec. 1.414(r)-1(c)(2)(ii) with 
respect to the plan. Similarly, if a plan that provides for employee 
contributions or matching contributions under which employees are 
permitted to participate before they have completed the minimum age and 
service requirements of section 410(a)(1) applies section 410(b)(4)(B) 
for determining whether the plan complies with section 410(b)(1), then 
the plan must be treated as two separate plans, one comprising all 
eligible employees who have met the minimum age and service requirements 
of section 410(a)(1) and one comprising all eligible employees who have 
not met the minimum age and service requirements of section 410(a)(1), 
unless the plan is using the rule in Sec. 1.401(m)-2(a)(1)(iii)(A).
    (B) Restructuring prohibited. Restructuring under Sec. 1.401(a)(4)-
9(c) may not be used to demonstrate compliance with the requirements of 
section 401(m). See Sec. 1.401(a)(4)-9(c)(3)(ii).
    (v) Certain disaggregation rules not applicable. The mandatory 
disaggregation rules relating to section 401(k) plans and section 401(m) 
plans set forth in Sec. 1.410(b)-7(c)(1) and to ESOP and non-ESOP 
portions of a plan set forth in Sec. 1.410(b)-7(c)(2) shall not apply 
for purposes of this section and Sec. Sec. 1.401(m)-2 through 1.401(m)-
5. Accordingly, notwithstanding Sec. 1.410(b)-7(d)(2), an ESOP and a 
non-ESOP which are different plans (within the meaning of section 
414(l), as described in Sec. 1.410(b)-7(b)) are permitted to be 
aggregated for these purposes.
    (c) Additional requirements--(1) Separate testing for employee 
contributions and matching contributions. Under

[[Page 403]]

Sec. 1.410(b)-7(c)(1), the group of employees who are eligible to make 
employee contributions or eligible to receive matching contributions 
must satisfy the requirements of section 410(b) as if those employees 
were covered under a separate plan. The determination of whether the 
separate plan satisfies the requirements of section 410(b) must be made 
without regard to the modifications to the disaggregation rules set 
forth in paragraph (b)(4)(v) of this section. In addition, except as 
expressly permitted under section 401(k), 410(b)(2)(A)(ii), or 
416(c)(2)(A), employee contributions, matching contributions and 
elective contributions taken into account under Sec. 1.401(m)-2(a)(6) 
may not be taken into account for purposes of determining whether any 
other contributions under any plan (including the plan to which the 
employee contributions or matching contributions are made) satisfy the 
requirements of section 401(a). See also Sec. 1.401(a)(4)-11(g)(3)(vii) 
for special rules relating to corrections of violations of the minimum 
coverage requirements or discriminatory rates of matching contributions.
    (2) Plan provision requirement. A plan that provides for employee 
contributions or matching contributions satisfies this section only if 
it provides that the nondiscrimination requirements of section 401(m) 
will be met. Thus, the plan must provide for satisfaction of one of the 
specific alternatives described in paragraph (b)(1) of this section and, 
if with respect to that alternative there are optional choices, which of 
the optional choices will apply. For example, a plan that uses the ACP 
test of section 401(m)(2), as described in paragraph (b)(1)(i) of this 
section, must specify whether it is using the current year testing 
method or prior year testing method. Additionally, a plan that uses the 
prior year testing method must specify whether the ACP for eligible 
NHCEs for the first plan year is 3% or the ACP for the eligible NHCEs 
for the first plan year. Similarly, a plan that uses the safe harbor 
method of section 401(m)(11) or 401(m)(12), as described in paragraphs 
(b)(1)(ii) and (b)(1)(iii) of this section, must specify the default 
percentages that apply for the plan year and whether the safe harbor 
contribution will be the nonelective safe harbor contribution or the 
matching safe harbor contribution, and is not permitted to provide that 
ACP testing will be used if the requirements for the safe harbor are not 
satisfied. For purposes of this paragraph (c)(2), a plan may incorporate 
by reference the provisions of section 401(m)(2) and Sec. 1.401(m)-2 if 
that is the nondiscrimination test being applied. The Commissioner may, 
in guidance of general applicability, published in the Internal Revenue 
Bulletin (see Sec. 601.601(d)(2) of this chapter), specify the options 
that will apply under the plan if the nondiscrimination test is 
incorporated by reference in accordance with the preceding sentence.
    (d) Effective date--(1) General rule. Except as otherwise provided 
in this paragraph (d), this section and Sec. Sec. 1.401(m)-2 through 
1.401(m)-5 apply to plan years that begin on or after January 1, 2006.
    (2) Early implementation permitted. A plan is permitted to apply the 
rules of this section and Sec. Sec. 1.401(m)-2 through 1.401(m)-5 to 
any plan year that ends after December 29, 2004, provided the plan 
applies all the rules of this section and Sec. Sec. 1.401(m)-2 through 
1.401(m)-5 and all the rules of Sec. Sec. 1.401(k)-1 through 1.401(k)-
6, to the extent applicable, for that plan year and all subsequent plan 
years.
    (3) Applicability of prior regulations. For any plan year, before a 
plan applies this section and Sec. Sec. 1.401(m)-2 through 1.401(m)-5 
(either the first plan year beginning on or after January 1, 2006 or 
such earlier year, as provided in paragraph (d)(2) of this section), 
Sec. 1.401(m)-1 and Sec. 1.401(m)-2 (as they appeared in the April 1, 
2004 edition of 26 CFR part 1) apply to the plan to the extent those 
sections, as they so appear, reflect the statutory provisions of section 
401(m) as in effect for the relevant year.

[T.D. 9169, 69 FR 78184, Dec. 29, 2004, as amended by T.D. 9447, 74 FR 
8210, Feb. 24, 2009]



Sec. 1.401(m)-2  ACP test.

    (a) Actual contribution percentage (ACP) test--(1) In general--(i) 
ACP test formula. A plan satisfies the ACP test for a plan year only 
if--
    (A) The ACP for the eligible HCEs for the plan year is not more than 
the ACP

[[Page 404]]

for the eligible NHCEs for the applicable year multiplied by 1.25; or
    (B) The excess of the ACP for the eligible HCEs for the plan year 
over the ACP for the eligible NHCEs for the applicable year is not more 
than 2 percentage points, and the ACP for the eligible HCEs for the plan 
year is not more than the ACP for the eligible NHCEs for the applicable 
year multiplied by 2.
    (ii) HCEs as sole eligible employees. If, for the applicable year 
there are no eligible NHCEs (i.e., all of the eligible employees under 
the plan for the applicable year are HCEs), the plan is deemed to 
satisfy the ACP test.
    (iii) Special rule for early participation. If a plan providing for 
employee contributions or matching contributions provides that employees 
are eligible to participate before they have completed the minimum age 
and service requirements of section 410(a)(1)(A), and if the plan 
applies section 410(b)(4)(B) in determining whether the plan meets the 
requirements of section 410(b)(1), then in determining whether the plan 
meets the requirements under paragraph (a)(1) of this section either--
    (A) Pursuant to section 401(m)(5)(C), the ACP test is performed 
under the plan (determined without regard to disaggregation under Sec. 
1.410(b)-7(c)(3)), using the ACP for all eligible HCEs for the plan year 
and the ACP of eligible NHCEs for the applicable year, disregarding all 
NHCEs who have not met the minimum age and service requirements of 
section 410(a)(1)(A); or
    (B) Pursuant to Sec. 1.401(m)-1(b)(4), the plan is disaggregated 
into separate plans and the ACP test is performed separately for all 
eligible employees who have completed the minimum age and service 
requirements of section 410(a)(1)(A) and for all eligible employees who 
have not completed the minimum age and service requirements of section 
410(a)(1)(A).
    (2) Determination of ACP--(i) General rule. The ACP for a group of 
eligible employees (either eligible HCEs or eligible NHCEs) for a plan 
year or applicable year is the average of the ACRs of eligible employees 
in the group for that year. The ACP for a group of eligible employees is 
calculated to the nearest hundredth of a percentage point.
    (ii) Determination of applicable year under current year and prior 
year testing method. The ACP test is applied using the prior year 
testing method or the current year testing method. Under the prior year 
testing method, the applicable year for determining the ACP for the 
eligible NHCEs is the plan year immediately preceding the plan year for 
which the ACP test is being calculated. Under the prior year testing 
method, the ACP for the eligible NHCEs is determined using the ACRs for 
the eligible employees who were NHCEs in that preceding plan year, 
regardless of whether those NHCEs are eligible employees or NHCEs in the 
plan year for which the ACP test is being performed. Under the current 
year testing method, the applicable year for determining the ACP for 
eligible NHCEs is the same plan year as the plan year for which the ACP 
test is being calculated. Under either method, the ACP for the eligible 
HCEs is determined using the ACRs of eligible employees who are HCEs for 
the plan year for which the ACP test is being performed. See paragraph 
(c) of this section for additional rules for the prior year testing 
method.
    (3) Determination of ACR--(i) General rule. The ACR of an eligible 
employee for the plan year or applicable year is the sum of the employee 
contributions and matching contributions taken into account with respect 
to such employee (determined under the rules of paragraphs (a)(4) and 
(5) of this section), and the qualified nonelective and elective 
contributions taken into account under paragraph (a)(6) of this section 
for the year, divided by the employee's compensation taken into account 
for the year. The ACR is calculated to the nearest hundredth of a 
percentage point. If no employee contributions, matching contributions, 
elective contributions, or qualified nonelective contributions are taken 
into account under this section with respect to an eligible employee for 
the year, the ACR of the employee is zero.
    (ii) ACR of HCEs eligible under more than one plan--(A) General 
rule. Pursuant to section 401(m)(2)(B), the ACR of an HCE who is an 
eligible employee in more than one plan of an employer to

[[Page 405]]

which matching contributions or employee contributions are made is 
calculated by treating all contributions with respect to such HCE under 
any such plan as being made under the plan being tested. Thus, the ACR 
for such an HCE is calculated by accumulating all matching contributions 
and employee contributions under any plan (other than a plan described 
in paragraph (a)(3)(ii)(B) of this section) that would be taken into 
account under this section for the plan year, if the plan under which 
the contribution was made applied this section and had the same plan 
year. For example, in the case of a plan with a 12-month plan year, the 
ACR for the plan year of that plan for an HCE who participates in 
multiple plans of the same employer that provide for matching 
contributions or employee contributions is the sum of all such 
contributions during such 12-month period that would be taken into 
account with respect to the HCE under all plans in which the HCE is an 
eligible employee, divided by the HCE's compensation for that 12-month 
period (determined using the compensation definition for the plan being 
tested), without regard to the plan year of the other plans and whether 
those plans are satisfying this section or Sec. 1.401(m)-3.
    (B) Plans not permitted to be aggregated. Contributions under plans 
that are not permitted to be aggregated under Sec. 1.401(m)-1(b)(4) 
(determined without regard to the prohibition on aggregating plans with 
inconsistent testing methods set forth in Sec. 1.401(m)-1(b)(4)(iii)(B) 
and the prohibition on aggregating plans with different plan years set 
forth in Sec. 1.410(b)-7(d)(5)) are not aggregated under this paragraph 
(a)(3)(ii).
    (iii) Example. The following example illustrates the application of 
paragraph (a)(3)(ii) of this section. See also Sec. 1.401(k)-
2(a)(3)(iii) for additional examples of the application of the parallel 
rule under section 401(k)(3)(A). The example is as follows:

    Example. Employee A, an HCE with compensation of $120,000, is 
eligible to make employee contributions under Plan S and Plan T, two 
calendar-year profit-sharing plans of Employer H. Plan S and Plan T use 
the same definition of compensation. Plan S provides a match equal to 
50% of each employee's contributions and Plan T has no match. During the 
current plan year, Employee A elects to contribute $4,000 in employee 
contributions to Plan T and $4,000 in employee contributions to Plan S. 
There are no other contributions made on behalf of Employee A. Each plan 
must calculate Employee A's ACR by dividing the total employee 
contributions by Employee A and matching contributions under both plans 
by $120,000. Therefore, Employee A's ACR under each plan is 8.33% 
($4,000 + $4,000 + $2,000/$120,000).

    (4) Employee contributions and matching contributions taken into 
account under the ACP test--(i) Employee contributions. An employee 
contribution is taken into account in determining the ACR for an 
eligible employee for the plan year or applicable year in which the 
contribution is made. For purposes of the preceding sentence, an amount 
withheld from an employee's pay (or a payment by the employee to an 
agent of the plan) is treated as contributed at the time of such 
withholding (or payment) if the funds paid are transmitted to the trust 
within a reasonable period after the withholding (or payment).
    (ii) Recharacterized elective contributions. Excess contributions 
recharacterized in accordance with Sec. 1.401(k)-2(b)(3) are taken into 
account as employee contributions for the plan year that includes the 
time at which the excess contribution is includible in the gross income 
of the employee under Sec. 1.401(k)-2(b)(3)(ii).
    (iii) Matching contributions. A matching contribution is taken into 
account in determining the ACR for an eligible employee for a plan year 
or applicable year only if each of the following requirements is 
satisfied--
    (A) The matching contribution is allocated to the employee's account 
under the terms of the plan as of a date within that year;
    (B) The matching contribution is made on account of (or the matching 
contribution is allocated on the basis of) the employee's elective 
deferrals or employee contributions for that year; and
    (C) The matching contribution is actually paid to the trust no later 
than the end of the 12-month period immediately following the year that 
contains that date.

[[Page 406]]

    (5) Employee contributions and matching contributions not taken into 
account under the ACP test--(i) General rule. Matching contributions 
that do not satisfy the requirements of paragraph (a)(4)(iii) of this 
section may not be taken into account in the ACP test for the plan year 
with respect to which the contributions were made, or for any other plan 
year. Instead, the amount of the matching contributions must satisfy the 
requirements of section 401(a)(4) (without regard to the ACP test) for 
the plan year for which they are allocated under the plan as if they 
were nonelective contributions and were the only nonelective 
contributions for that year. See Sec. Sec. 1.401(a)(4)-1(b)(2)(ii)(B) 
and 1.410(b)-7(c)(1).
    (ii) Disproportionate matching contributions--(A) Matching 
contributions in excess of 100%. A matching contribution with respect to 
an elective deferral for an NHCE is not taken into account under the ACP 
test to the extent it exceeds the greatest of:
    (1) 5% of compensation;
    (2) the employee's elective deferrals for a year; and
    (3) the product of 2 times the plan's representative matching rate 
and the employee's elective deferrals for a year.
    (B) Representative matching rate. For purposes of this paragraph 
(a)(5)(ii), the plan's representative matching rate is the lowest 
matching rate for any eligible NHCE among a group of NHCEs that consists 
of half of all eligible NHCEs in the plan for the plan year who make 
elective deferrals for the plan year (or, if greater, the lowest 
matching rate for all eligible NHCEs in the plan who are employed by the 
employer on the last day of the plan year and who make elective 
deferrals for the plan year).
    (C) Definition of matching rate. For purposes of this paragraph 
(a)(5)(ii), the matching rate for an employee generally is the matching 
contributions made for such employee divided by the employee's elective 
deferrals for the year. If the matching rate is not the same for all 
levels of elective deferrals for an employee, the employee's matching 
rate is determined assuming that an employee's elective deferrals are 
equal to 6 percent of compensation.
    (D) Application to matching contributions that match employee 
contributions. If a plan provides a match with respect to the sum of the 
employee's employee contributions and elective deferrals, that sum is 
substituted for the amount of the employee's elective deferrals in 
paragraphs (a)(5)(ii) (A) and (C) of this section and employees who make 
either employee contributions or elective deferrals are taken into 
account under paragraph (a)(5)(ii)(B) of this section. Similarly, if a 
plan provides a match with respect to the employee's employee 
contributions, but not elective deferrals, the employee's employee 
contributions are substituted for the amount of the employee's elective 
deferrals in paragraphs (a)(5)(ii) (A) and (C) of this section and 
employees who make employee contributions are taken into account under 
paragraph (a)(5)(ii)(B) of this section.
    (iii) Qualified matching contributions used to satisfy the ADP test. 
Qualified matching contributions that are taken into account for the ADP 
test of section 401(k)(3) under Sec. 1.401(k)-2(a)(6) are not taken 
into account in determining an eligible employee's ACR.
    (iv) Matching contributions taken into account under safe harbor 
provisions. A plan that satisfies the ACP safe harbor requirements of 
section 401(m)(11) or 401(m)(12) for a plan year but nonetheless must 
satisfy the requirements of this section because it provides for 
employee contributions for such plan year is permitted to apply this 
section disregarding all matching contributions with respect to all 
eligible employees. In addition, a plan that satisfies the ADP safe 
harbor requirements of Sec. 1.401(k)-3 for a plan year using qualified 
matching contributions but does not satisfy the ACP safe harbor 
requirements of section 401(m)(11) or 401(m)(12) for such plan year is 
permitted to apply this section by excluding matching contributions with 
respect to all eligible employees that do not exceed 4 percent (3\1/2\ 
percent in the case of a plan that satisfies the ADP safe harbor under 
section 401(k)(13)) of each employee's compensation. If a plan 
disregards matching contributions pursuant to this paragraph (a)(5)(iv), 
the disregard must apply with respect to all eligible employees.

[[Page 407]]

    (v) Treatment of forfeited matching contributions. A matching 
contribution that is forfeited because the contribution to which it 
relates is treated as an excess contribution, excess deferral, excess 
aggregate contribution, or default elective contribution that is 
distributed under section 414(w), is not taken into account for purposes 
of this section.
    (vi) Additional employee contributions or matching contributions 
pursuant to section 414(u). Additional employee contributions and 
matching contributions made by reason of an eligible employee's 
qualified military service under section 414(u) are not taken into 
account under paragraph (a)(4) of this section for the plan year for 
which the contributions are made, or for any other plan year.
    (6) Qualified nonelective contributions and elective contributions 
that may be taken into account under the ACP test. Qualified nonelective 
contributions and elective contributions may be taken into account in 
determining the ACR for an eligible employee for a plan year or 
applicable year, but only to the extent the contributions satisfy the 
following requirements--
    (i) Timing of allocation. The qualified nonelective contribution is 
allocated to the employee's account as of a date within that year 
(within the meaning of Sec. 1.401(k)-2(a)(4)(i)(A)) and the elective 
contribution satisfies Sec. 1.401(k)-2(a)(4)(i). Consequently, under 
the prior year testing method, in order to be taken into account in 
calculating the ACP for the group of eligible NHCEs for the applicable 
year, a qualified nonelective contribution must be contributed no later 
than the end of the 12-month period following the applicable year even 
though the applicable year is different than the plan year being tested.
    (ii) Elective contributions taken into account under the ACP test. 
Elective contributions may be taken into account for the ACP test only 
if the cash or deferred arrangement under which the elective 
contributions are made is required to satisfy the ADP test in Sec. 
1.401(k)-2(a)(1) and, then only to the extent that the cash or deferred 
arrangement would satisfy that test, including such elective 
contributions in the ADP for the plan year or applicable year. Thus, for 
example, elective deferrals made pursuant to a salary reduction 
agreement under an annuity described in section 403(b) are not permitted 
to be taken into account in an ACP test. Similarly, elective 
contributions under a cash or deferred arrangement that is using the 
section 401(k) safe harbor described in Sec. 1.401(k)-3 cannot be taken 
into account in an ACP test. In addition, for plan years ending on or 
after November 8, 2007, elective contributions which are not permitted 
to be taken into account for the ADP test for the plan year under Sec. 
1.401(k)-2(a)(5)(ii), (iii), (v), or (vi) are not permitted to be taken 
into account for the ACP test.
    (iii) Requirement that amount satisfy section 401(a)(4). The amount 
of nonelective contributions, including those qualified nonelective 
contributions taken into account under this paragraph (a)(6) and those 
qualified nonelective contributions taken into account for the ADP test 
under paragraph Sec. 1.401(k)-2(a)(6), and the amount of nonelective 
contributions, excluding those qualified nonelective contributions taken 
into account under this paragraph (a)(6) for the ACP test and those 
qualified nonelective contributions taken into account for the ADP test 
under paragraph Sec. 1.401(k)-2(a)(6), satisfies the requirements of 
section 401(a)(4). See Sec. 1.401(a)(4)-1(b)(2). In the case of an 
employer that is applying the special rule for employer-wide plans in 
Sec. 1.414(r)-1(c)(2)(ii) with respect to the plan, the determination 
of whether the qualified nonelective contributions satisfy the 
requirements of this paragraph (a)(6)(iii) must be made on an employer-
wide basis regardless of whether the plans to which the qualified 
nonelective contributions are made are satisfying the requirements of 
section 410(b) on an employer-wide basis. Conversely, in the case of an 
employer that is treated as operating qualified separate lines of 
business, and does not apply the special rule for employer-wide plans in 
Sec. 1.414(r)-1(c)(2)(ii) with respect to the plan, then the 
determination of whether the qualifiednonelective contributions satisfy 
the requirements of this paragraph (a)(6)(iii) is not permitted to be 
made

[[Page 408]]

on an employer-wide basis regardless of whether the plans to which the 
qualified nonelective contributions are made are satisfying the 
requirements of section 410(b) on that basis.
    (iv) Aggregation must be permitted. The plan that provides for 
employee or matching contributions and the plan or plans to which the 
qualified nonelective contributions or elective contributions are made 
are plans that would be permitted to be aggregated under Sec. 1.401(m)-
1(b)(4). If the plan year of the plan that provides for employee or 
matching contributions is changed to satisfy the requirement under Sec. 
1.410(b)-7(d)(5) that aggregated plans have the same plan year, 
qualified nonelective contributions and elective contributions may be 
taken into account in the resulting short plan year only if such 
qualified nonelective and elective contributions could have been taken 
into account under an ADP test for a plan with that same short plan 
year.
    (v) Disproportionate contributions not taken into account--(A) 
General rule. Qualified nonelective contributions cannot be taken into 
account for an applicable year for an NHCE to the extent such 
contributions exceed the product of that NHCE's compensation and the 
greater of 5% and 2 times the plan's representative contribution rate. 
Any qualified nonelective contribution taken into account in an ADP test 
under Sec. 1.401(k)-2(a)(6) (including the determination of the 
representative contribution rate for purposes of Sec. 1.401(k)-
2(a)(6)(iv)(B)) is not permitted to be taken into account for purposes 
of this paragraph (a)(6) (including the determination of the 
representative contribution rate for purposes of paragraph (a)(6)(v)(B) 
of this section).
    (B) Definition of representative contribution rate. For purposes of 
this paragraph (a)(6)(v), the plan's representative contribution rate is 
the lowest applicable contribution rate of any eligible NHCE among a 
group of eligible NHCEs that consists of half of all eligible NHCEs for 
the plan year (or, if greater, the lowest applicable contribution rate 
of any eligible NHCE in the group of all eligible NHCEs for the 
applicable year and who is employed by the employer on the last day of 
the applicable year).
    (C) Definition of applicable contribution rate. For purposes of this 
paragraph (a)(6)(v), the applicable contribution rate for an eligible 
NHCE is the sum of the matching contributions taken into account under 
this section for the employee for the plan year and the qualified 
nonelective contributions made for that employee for the plan year, 
divided by that employee's compensation for the same period.
    (D) Special rule for prevailing wage contributions. Notwithstanding 
paragraph (a)(6)(v)(A) of this section, qualified nonelective 
contributions that are made in connection with an employer's obligation 
to pay prevailing wages under the Davis-Bacon Act (46 Stat. 1494), Pub. 
L. 71-798, Service Contract Act of 1965 (79 Stat. 1965), Pub. L. 89-286, 
or similar legislation can be taken into account for a plan year for an 
NHCE to the extent such contributions do not exceed 10 percent of that 
NHCE's compensation.
    (vi) Contribution only used once. Qualified nonelective 
contributions cannot be taken into account under this paragraph (a)(6) 
to the extent such contributions are taken into account for purposes of 
satisfying any other ACP test, any ADP test, or the requirements of 
Sec. 1.401(k)-3, 1.401(m)-3 or 1.401(k)-4. Thus, for example, qualified 
nonelective contributions that are made pursuant to Sec. 1.401(k)-3(b) 
cannot be taken into account under the ACP test. Similarly, if a plan 
switches from the current year testing method to the prior year testing 
method pursuant to Sec. 1.401(m)-2(c)(1), qualified nonelective 
contributions that are taken into account under the current year testing 
method for a plan year may not be taken into account under the prior 
year testing method for the next plan year.
    (7) Examples. The following examples illustrate the application of 
this paragraph (a). See Sec. 1.401(k)-2(a)(6) for additional examples 
of the parallel rules under section 401(k)(3)(A). The examples are as 
follows:

    Example 1. (i) Employer L maintains Plan U, a profit-sharing plan 
under which $.50 matching contributions are made for each dollar of 
employee contributions. Plan U uses the current year testing method. The

[[Page 409]]

chart below shows the average employee contributions (as a percentage of 
compensation) and matching contributions (as a percentage of 
compensation) for Plan U's HCEs and NHCEs for the 2006 plan year:

----------------------------------------------------------------------------------------------------------------
                                                        Employee            Matching
                                                      contributions       contributions      Actual contribution
                                                      (percentage)        (percentage)          (percentage)
----------------------------------------------------------------------------------------------------------------
Highly compensated employees......................                 4               2                     6
Nonhighly compensated employees...................                 3               1.5                   4.5
----------------------------------------------------------------------------------------------------------------

    (ii) The matching rate for all NHCEs is 50% and thus the matching 
contributions are not disproportionate under paragraph (a)(5)(ii) of 
this section. Accordingly, they are taken into account in determining 
the ACR of eligible employees.
    (iii) Because the ACP for the HCEs (6.0%) exceeds 5.63% (4.5%x1.25), 
Plan U does not satisfy the ACP test under paragraph (a)(1)(i)(A) of 
this section. However, because the ACP for the HCEs does not exceed the 
ACP for the NHCEs by more than 2 percentage points and the ACP for the 
HCEs does not exceed the ACP for the NHCEs multiplied by 2 (4.5%x2 = 
9%), the plan satisfies the ACP test under paragraph (a)(1)(i)(B) of 
this section.
    Example 2. (i) Employees A through F are eligible employees in Plan 
V, a profit-sharing plan of Employer M that includes a cash or deferred 
arrangement and permits employee contributions. Under Plan V, a $.50 
matching contribution is made for each dollar of elective contributions 
and employee contributions. Plan V uses the current year testing method 
and does not provide for elective contributions to be taken into account 
in determining an eligible employee's ACR. For the 2006 plan year, 
Employees A and B are HCEs and the remaining employees are NHCEs. The 
compensation, elective contributions, employee contributions, and 
matching contributions for the 2006 plan year are shown in the following 
table:

----------------------------------------------------------------------------------------------------------------
                                                                Elective          Employee          Matching
                Employee                    Compensation      contributions     contributions     contributions
----------------------------------------------------------------------------------------------------------------
A.......................................          $190,000           $15,000            $3,500            $9,250
B.......................................           100,000             5,000            10,000             7,500
C.......................................            85,000            12,000                 0             6,000
D.......................................            70,000             9,500                 0             4,750
E.......................................            40,000            10,000                 0             5,000
F.......................................            10,000                 0                 0                 0
----------------------------------------------------------------------------------------------------------------

    (ii) The matching rate for all NHCEs is 50% and thus the matching 
contributions are not disproportionate under paragraph (a)(5)(ii) of 
this section. Accordingly, they are taken into account in determining 
the ACR of eligible employees, as shown in the following table:

----------------------------------------------------------------------------------------------------------------
                                                             Employee          Matching
               Employee                  Compensation      contributions     contributions      ACR (percent)
----------------------------------------------------------------------------------------------------------------
A....................................          $190,000            $3,500            $9,250                 6.71
B....................................           100,000            10,000             7,500                17.50
C....................................            85,000                 0             6,000                 7.06
D....................................            70,000                 0             4,750                 6.79
E....................................            40,000                 0             5,000                12.50
F....................................            10,000                 0                 0                 0
----------------------------------------------------------------------------------------------------------------

    (iii) The ACP for the HCEs is 12.11% ((6.71% + 17.50%)/2). The ACP 
for the NHCEs is 6.59% ((7.06% + 6.79% + 12.50% + 0.%)/4). Plan V fails 
to satisfy the ACP test under paragraph (a)(1)(i)(A) of this section 
because the ACP of HCEs is more than 125% of the ACP of the NHCEs 
(6.59%x1.25=8.24%). In addition, Plan V fails to satisfy the ACP test 
under paragraph (a)(1)(i)(B) of this section because the ACP for the 
HCEs exceeds the ACP of the other employees by more than 2 percentage 
points (6.59% + 2% = 8.59%). Therefore, the plan fails to satisfy the 
requirements of section 401(m)(2) and paragraph (a)(1) of this section 
unless the ACP failure is corrected under paragraph (b) of this section.
    Example 3. (i) The facts are the same as Example 2, except that the 
plan provides that the NHCEs' elective contributions may be used to meet 
the requirements of section 401(m) to the extent needed under that 
section.

[[Page 410]]

    (ii) Pursuant to paragraph (a)(6)(ii) of this section, the $10,000 
of elective contributions for Employee E may be taken into account in 
determining the ACP rather than the ADP to the extent that the plan 
satisfies the requirements of Sec. 1.401(k)-2(a)(1) excluding from the 
ADP this $10,000. In this case, if the $10,000 were excluded from the 
ADP for the NHCEs, the ADP for the HCEs is 6.45% (7.89% + 5.00%) /2 and 
the ADP for the NHCEs would be 6.92% (14.12% + 13.57% + 0% +0%)/4) and 
the plan would satisfy the requirements of Sec. 1.401(k)-2(a)(1) 
excluding from the ADP the elective contributions for NHCEs that are 
taken into account under section 401(m).
    (iii) After taking into account the $10,000 of elective 
contributions for Employee E in the ACP test, the ACP for the NHCEs is 
12.84% (7.06% + 6.79% + 37.50 % + 0%) /4. Therefore the plan satisfies 
the ACP test because the ACP for the HCEs (12.11%) is less than 1.25 
times the ACP for the NHCEs.
    Example 4. (i) The facts are the same as Example 2, except that Plan 
V provides for a higher than 50% match rate on the elective 
contributions and employee contributions for all NHCEs. The match rate 
is defined as the rate, rounded up to the next whole percent, necessary 
to allow the plan to satisfy the ACP test, but not in excess of 100%. In 
this case, an increase in the match rate from 50% to 74% will be 
sufficient to allow the plan to satisfy the ACP test. Thus, for the 2006 
plan year, the compensation, elective contributions, employee 
contributions, matching contributions at a 74% match rate of the 
eligible NHCEs (employees C through F) are shown in the following table:

----------------------------------------------------------------------------------------------------------------
                                                                Elective          Employee          Matching
                Employee                    Compensation      contributions     contributions     contributions
----------------------------------------------------------------------------------------------------------------
C.......................................           $85,000           $12,000                $0            $8,880
D.......................................            70,000             9,500                 0             7,030
E.......................................            40,000            10,000                 0             7,400
F.......................................            10,000                 0                 0                 0
----------------------------------------------------------------------------------------------------------------

    (ii) The matching rate for all NHCEs is 74% and thus the matching 
contributions are not disproportionate under paragraph (a)(5)(ii) of 
this section. Therefore, the matching contributions may be taken into 
account in determining the ACP for the NHCEs.
    (iii) The ACP for the NHCEs is 9.75% (10.45% + 10.04% + 18.50% + 
0%)/4. Because the ACP for the HCEs (12.11%) is less than 1.25 times the 
ACP for the NHCEs, the plan satisfies the requirements of section 
401(m).
    Example 5. (i) The facts are the same as Example 4, except that: 
Employee E's elective contributions are $2,000 (rather than $10,000) and 
pursuant to paragraph (a)(6)(ii) of this section, the $2,000 of elective 
contributions for Employee E are taken into account in determining the 
ACP rather than the ADP. In addition, Plan V provides that the higher 
match rate is not limited to 100% and applies only for a specified group 
of NHCEs. The only member of that group is Employee E. Under the plan 
provision, the higher match rate is a 400% match. Thus, for the 2006 
plan year, the compensation, elective contributions, employee 
contributions, matching contributions of the eligible NHCEs (employees C 
through F) are shown in the following table:

----------------------------------------------------------------------------------------------------------------
                                                                Elective          Employee          Matching
                Employee                    Compensation      contributions     contributions     contributions
----------------------------------------------------------------------------------------------------------------
C.......................................           $85,000           $12,000                $0            $6,000
D.......................................            70,000             9,500                 0             4,750
E.......................................            40,000             2,000                 0             8,000
F.......................................            10,000                 0                 0                 0
----------------------------------------------------------------------------------------------------------------

    (ii) If the entire matching contribution made on behalf of Employee 
E were taken into account under the ACP test, Plan V would satisfy the 
test, because the ACP for the NHCEs would be 9.71% (7.06% + 6.79% + 
25.00% + 0%)/4. Because the ACP for the HCEs (12.11%) is less than 1.25 
times what the ACP for the NHCEs would be, the plan would satisfy the 
requirements of section 401(m).
    (iii) Pursuant to paragraph (a)(5)(ii) of this section, however, 
matching contributions for an eligible NHCE that exceed the greatest of 
5% of compensation, the employee's elective deferrals and 2 times the 
product of the plan's representative matching rate and the employee's 
elective deferrals cannot be taken into account in applying the ACP 
test. The plan's representative matching rate is the lowest matching 
rate for any eligible employee in a group of NHCEs that is at least half 
of all eligible employees who are NHCEs in the plan for the plan year 
who make elective contributions for the plan year. For Plan V, the group 
of NHCEs who

[[Page 411]]

make such contributions consists of Employees C, D and E. The matching 
rates for these three employees are 50%, 50% and 400% respectively. The 
lowest matching rate for a group of NHCEs that is at least half of all 
the NHCEs who make elective contributions (or 2 NHCEs) is 50%. Because 
400% is more than twice the plan's representative matching rate and the 
matching contributions exceed 5% of compensation, the full amount of 
matching contributions is not taken into account. Only $2,000 of the 
matching contributions made on behalf of Employee E (matching 
contributions that do not exceed the greatest of 5% of compensation, the 
employee's elective deferrals, or the product of 100% (2 times the 
representative matching rate) and the employee's elective deferrals) 
satisfy the requirements of paragraph (a)(5)(ii) of this section and may 
be taken into account under the ACP test. Accordingly, the ACP for the 
NHCEs is 5.96% (7.06% + 6.79% + 10% + 0%)/4 and the plan fails to 
satisfy the requirements of section 401(m)(2) and paragraph (a)(1) of 
this section unless the ACP failure is corrected under paragraph (b) of 
this section.
    Example 6. (i) The facts are the same as Example 2, except that Plan 
V provides a QNEC equal to 13% of pay for Employee F that will be taken 
into account under the ACP test to the extent the contributions satisfy 
the requirements of paragraph (a)(6) of this section.
    (ii) Pursuant to paragraph (a)(6)(v) of this section, a QNEC cannot 
be taken into account in determining an NHCE's ACR to the extent it 
exceeds the greater of 5% and the product of the employee's compensation 
and the plan's representative contribution rate. The plan's 
representative contribution rate is two times the lowest applicable 
contribution rate for any eligible employee in a group of NHCEs that is 
at least half of all eligible employees who are NHCEs in the plan for 
the plan year. For Plan V, the applicable contribution rates for 
Employees C, D, E and F are 7.06%, 6.79%, 12.5% and 13% respectively. 
The lowest applicable contribution rate for a group of NHCEs that is at 
least half of all the NHCEs is 12.50% (the lowest applicable 
contribution rate for the group of NHCEs that consists of Employees E 
and F).
    (iii) Under paragraph (a)(6)(v)(B) of this section, the plan's 
representative contribution rate is 2 times 12.50% or 25.00%. 
Accordingly, the QNECs for Employee F can be taken into account under 
the ACP test only to the extent they do not exceed 25.00% of 
compensation. In this case, all of the QNECs for Employee F may be taken 
into account under the ACP test.
    (iv) After taking into account the QNECs for Employee F, the ACP for 
the NHCEs is 9.84% (7.06% + 6.79% + 12.50% + 13%)/4. Because the ACP for 
the HCEs (12.11%) is less than 1.25 times the ACP for the NHCEs, the 
plan satisfies the requirements of section 401(m)(2) and paragraph 
(a)(1) of this section.

    (b) Correction of excess aggregate contributions--(1) Permissible 
correction methods--(i) In general. A plan that provides for employee 
contributions or matching contributions does not fail to satisfy the 
requirements of section 401(m)(2) and paragraph (a)(1) of this section 
if the employer, in accordance with the terms of the plan, uses either 
of the following correction methods--
    (A) Additional contributions. The employer makes additional 
contributions that are taken into account for the ACP test under this 
section that, in combination with the other contributions taken into 
account under this section, allow the plan to satisfy the requirements 
of paragraph (a)(1) of this section.
    (B) Excess aggregate contributions distributed or forfeited. Excess 
aggregate contributions are distributed or forfeited in accordance with 
paragraph (b)(2) of this section.
    (ii) Combination of correction methods. A plan may provide for the 
use of either of the correction methods described in paragraph (b)(1)(i) 
of this section, may limit employee contributions or matching 
contributions in a manner that prevents excess aggregate contributions 
from being made, or may use a combination of these methods, to avoid or 
correct excess aggregate contributions. If a plan uses a combination of 
correction methods, any contributions made under paragraph (b)(1)(i)(A) 
of this section must be taken into account before application of the 
correction method in paragraph (b)(1)(i)(B) of this section.
    (iii) Exclusive means of correction. A failure to satisfy the 
requirements of paragraph (a)(1) of this section may not be corrected 
using any method other than one described in paragraph (b)(1)(i) or (ii) 
of this section. Thus, excess aggregate contributions for a plan year 
may not be corrected by forfeiting vested matching contributions, 
distributing nonvested matching contributions, recharacterizing matching 
contributions, or not making matching contributions required under the 
terms of the plan. Similarly, excess aggregate contributions for a plan 
year may not remain unallocated or be allocated to a

[[Page 412]]

suspense account for allocation to one or more employees in any future 
year. In addition, excess aggregate contributions may not be corrected 
using the retroactive correction rules of Sec. 1.401(a)(4)-11(g). See 
Sec. 1.401(a)(4)-11(g)(3)(vii) and (5).
    (2) Correction through distribution--(i) General rule. This 
paragraph (b)(2) contains the rules for correction of excess aggregate 
contributions through a distribution from the plan. Correction through a 
distribution generally involves a 4-step process. First, the plan must 
determine, in accordance with paragraph (b)(2)(ii) of this section, the 
total amount of excess aggregate contributions that must be distributed 
under the plan. Second, the plan must apportion the total amount of 
excess aggregate contributions among the HCEs in accordance with 
paragraph (b)(2)(iii) of this section. Third, the plan must determine 
the income allocable to excess aggregate contributions in accordance 
with paragraph (b)(2)(iv) of this section. Finally, the plan must 
distribute the apportioned contributions, together with allocable income 
(or forfeit the apportioned matching contributions, if forfeitable) in 
accordance with paragraph (b)(2)(v) of this section. Paragraph 
(b)(2)(vi) of this section provides rules relating to the tax treatment 
of these distributions.
    (ii) Calculation of total amount to be distributed. The following 
procedures must be used to determine the total amount of the excess 
aggregate contributions to be distributed--
    (A) Calculate the dollar amount of excess aggregate contributions 
for each HCE. The amount of excess aggregate contributions attributable 
to an HCE for a plan year is the amount (if any) by which the HCE's 
contributions taken into account under this section must be reduced for 
the HCE's ACR to equal the highest permitted ACR under the plan. To 
calculate the highest permitted ACR under a plan, the ACR of the HCE 
with the highest ACR is reduced by the amount required to cause that 
HCE's ACR to equal the ACR of the HCE with the next highest ACR. If a 
lesser reduction would enable the plan to satisfy the requirements of 
paragraph (b)(2)(ii)(C) of this section, only this lesser reduction 
applies.
    (B) Determination of the total amount of excess aggregate 
contributions. The process described in paragraph (b)(2)(ii)(A) of this 
section must be repeated until the plan would satisfy the requirements 
of paragraph (b)(2)(ii)(C) of this section. The sum of all reductions 
for all HCEs determined under paragraph (b)(2)(ii)(A) of this section is 
the total amount of excess aggregate contributions for the plan year.
    (C) Satisfaction of ACP. A plan satisfies this paragraph 
(b)(2)(ii)(C) if the plan would satisfy the requirements of paragraph 
(a)(1)(i) of this section if the ACR for each HCE were determined after 
the reductions described in paragraph (b)(2)(ii)(A) of this section.
    (iii) Apportionment of total amount of excess aggregate 
contributions among the HCEs. The following procedures must be used in 
apportioning the total amount of excess aggregate contributions 
determined under paragraph (b)(2)(ii) of this section among the HCEs--
    (A) Calculate the dollar amount of excess aggregate contributions 
for each HCE. The contributions with respect to the HCE with the highest 
dollar amount of contributions taken account under this section are 
reduced by the amount required to cause that HCE's contributions to 
equal the dollar amount of contributions taken into account under this 
section for the HCE with the next highest dollar amount of such 
contributions. If a lesser apportionment to the HCE would enable the 
plan to apportion the total amount of excess aggregate contributions, 
only the lesser apportionment would apply.
    (B) Limit on amount apportioned to any HCE. For purposes of this 
paragraph (b)(2)(iii), the contributions for an HCE who is an eligible 
employee in more than one plan of an employer to which matching 
contributions and employee contributions are made is determined by 
adding together all contributions otherwise taken into account in 
determining the ACR of the HCE under the rules of paragraph (a)(3)(ii) 
of this section. However, the amount of contributions apportioned with 
respect to an HCE must not exceed the amount of contributions taken into 
account under this section that were actually made on behalf of the HCE 
to the plan for the

[[Page 413]]

plan year. Thus, in the case of an HCE who is an eligible employee in 
more than one plan of the same employer to which employee contributions 
or matching contributions are made and whose ACR is calculated in 
accordance with paragraph (a)(3)(ii) of this section, the amount 
distributed under this paragraph (b)(2)(iii) will not exceed such 
contributions actually contributed to the plan for the plan year that 
are taken into account under this section for the plan year.
    (C) Apportionment to additional HCEs. The procedure in paragraph 
(b)(2)(iii)(A) of this section must be repeated until the total amount 
of excess aggregate contributions have been apportioned.
    (iv) Income allocable to excess aggregate contributions--(A) General 
rule. For plan years beginning on or after January 1, 2008, the income 
allocable to excess aggregate contributions is equal to the allocable 
gain or loss through the end of the plan year. See paragraph 
(b)(2)(iv)(D) of this section for rules that apply to plan years 
beginning before January 1, 2008.
    (B) Method of allocating income. A plan may use any reasonable 
method for computing the income allocable to excess aggregate 
contributions, provided that the method does not violate section 
401(a)(4), is used consistently for all participants and for all 
corrective distributions under the plan for the plan year, and is used 
by the plan for allocating income to participants' accounts. See Sec. 
1.401(a)(4)-1(c)(8). A plan will not fail to use a reasonable method for 
computing the income allocable to excess contributions merely because 
the income allocable to excess aggregate contributions is determined on 
a date that is no more than 7 days before the distribution.
    (C) Alternative method of allocating income for the plan year. A 
plan may allocate income to excess aggregate contributions for the plan 
year by multiplying the income for the plan year allocable to employee 
contributions, matching contributions and other amounts taken into 
account under this section (including the contributions for the year), 
by a fraction, the numerator of which is the excess aggregate 
contributions for the employee for the plan year, and the denominator of 
which is the sum of the--
    (1) Account balance attributable to employee contributions and 
matching contributions and other amounts taken into account under this 
section as of the beginning of the plan year; and
    (2) Any additional such contributions for the plan year.
    (D) Plan years before 2008. For plan years beginning before January 
1, 2008, the income allocable to excess aggregate contributions is 
determined under Sec. 1.401(m)-2(b)(2)(iv) (as it appeared in the April 
1, 2007, edition of 26 CFR part 1).
    (E) Allocable income for recharacterized elective contributions. If 
recharacterized elective contributions are distributed as excess 
aggregate contributions, the income allocable to the excess aggregate 
contributions is determined as if recharacterized elective contributions 
had been distributed as excess contributions. Thus, income must be 
allocated to the recharacterized amounts distributed using the methods 
in Sec. 1.401(k)-2(b)(2)(iv).
    (v) Distribution and forfeiture. Within 12 months after the close of 
the plan year in which the excess aggregate contribution arose, the plan 
must distribute to each HCE the contributions apportioned to such HCE 
under paragraph (b)(2)(iii) of this section (and the allocable income) 
to the extent they are vested or forfeit such amounts, if forfeitable. 
Except as otherwise provided in this paragraph (b)(2)(v), a distribution 
of excess aggregate contributions must be in addition to any other 
distributions made during the year and must be designated as a 
corrective distribution by the employer. In the event of a complete 
termination of the plan during the plan year in which an excess 
aggregate contribution arose, the corrective distribution must be made 
as soon as administratively feasible after the date of termination of 
the plan, but in no event later than 12 months after the date of 
termination. If the entire account balance of an HCE is distributed 
prior to when the plan makes a distribution of excess aggregate 
contributions in accordance with this paragraph (b)(2), the distribution 
is

[[Page 414]]

deemed to have been a corrective distribution of excess aggregate 
contributions (and income) to the extent that a corrective distribution 
would otherwise have been required.
    (vi) Tax treatment of corrective distributions--(A) Corrective 
distributions for plan years beginning on or after January 1, 2008. 
Except as otherwise provided in this paragraph (b)(2)(vi), for plan 
years beginning on or after January 1, 2008, a corrective distribution 
of excess aggregate contributions (and allocable income) is includible 
in the employee's gross income in the taxable year of the employee in 
which distributed. The portion of the distribution that is treated as an 
investment in the contract and is therefore not subject to tax under 
section 72 is determined without regard to any plan contributions other 
than those distributed as excess aggregate contributions. Regardless of 
when the corrective distribution is made, it is not subject to the early 
distribution tax of section 72(t). See paragraph (b)(4) of this section 
for additional rules relating to the employer excise tax on amounts 
distributed more than 2\1/2\ months (6 months in the case of certain 
plans that include an eligible automatic contribution arrangement within 
the meaning of section 414(w)) after the end of the plan year. See also 
Sec. 1.402(c)-2, A-4, prohibiting rollover of distributions that are 
excess aggregate contributions.
    (B) Corrective distributions for plan years beginning before January 
1, 2008. The tax treatment of corrective distributions for plan years 
beginning before January 1, 2008, is determined under Sec. 1.401(m)-
2(b)(2)(vi) (as it appeared in the April 1, 2007, edition of 26 CFR Part 
1). If the total amount of excess aggregate contributions determined 
under this paragraph (b)(2), and excess contributions determined under 
Sec. 1.401(k)-2(b)(2) distributed to a recipient under a plan for any 
plan year is less than $100 (excluding income), a corrective 
distribution of excess aggregate contributions (and income) is 
includible in gross income in the recipient's taxable year in which the 
corrective distribution is made, except to the extent the corrective 
distribution is a return of employee contributions, or as provided in 
paragraph (b)(2)(vi)(C) of this section.
    (C) Corrective distributions attributable to designated Roth 
contributions. Notwithstanding paragraphs (b)(2)(vi)(A) and (B) of this 
section, a distribution of excess aggregate contributions is not 
includible in gross income to the extent it represents a distribution of 
designated Roth contributions. However, the income allocable to a 
corrective distribution of excess aggregate contributions that are 
designated Roth contributions is taxed in accordance with paragraph 
(b)(2)(vi)(A) or (B) of this section (i.e., in the same manner as income 
allocable to a corrective distribution of excess aggregate contributions 
that are not designated Roth contributions).
    (3) Other rules--(i) No employee or spousal consent required. A 
distribution of excess aggregate contributions (and income) may be made 
under the terms of the plan without regard to any notice or consent 
otherwise required under sections 411(a)(11) and 417.
    (ii) Treatment of corrective distributions and forfeited 
contributions as employer contributions. Excess aggregate contributions 
(other than amounts attributable to employee contributions), including 
forfeited matching contributions, are treated as employer contributions 
for purposes of sections 404 and 415 even if distributed from the plan. 
Forfeited matching contributions that are reallocated to the accounts of 
other participants for the plan year in which the forfeiture occurs are 
treated under section 415 as annual additions for the participants to 
whose accounts they are reallocated and for the participants from whose 
accounts they are forfeited.
    (iii) No reduction of required minimum distribution. A distribution 
of excess aggregate contributions (and income) is not treated as a 
distribution for purposes of determining whether the plan satisfies the 
minimum distribution requirements of section 401(a)(9). See Sec. 
1.401(a)(9)-5, A-9(b).
    (iv) Partial correction. Any distribution of less than the entire 
amount of excess aggregate contributions (and allocable income) is 
treated as a pro rata distribution of excess aggregate contributions and 
allocable income.

[[Page 415]]

    (v) Matching contributions on excess contributions, excess deferrals 
and excess aggregate contributions--(A) Corrective distributions not 
permitted. A matching contribution may not be distributed merely because 
the contribution to which it relates is treated as an excess 
contribution, excess deferral, or excess aggregate contribution.
    (B) Coordination with section 401(a)(4). A matching contribution is 
taken into account under section 401(a)(4) even if the match is 
distributed, unless the distributed contribution is an excess aggregate 
contribution. This requires that, after correction of excess aggregate 
contributions, each level of matching contributions be currently and 
effectively available to a group of employees that satisfies section 
410(b). See Sec. 1.401(a)(4)-4(e)(3)(iii)(G). Thus, a plan that 
provides the same rate of matching contributions to all employees will 
not meet the requirements of section 401(a)(4) if employee contributions 
are distributed under this paragraph (b) to HCEs to the extent needed to 
meet the requirements of section 401(m)(2), while matching contributions 
attributable to employee contributions remain allocated to the HCEs' 
accounts. This is because the level of matching contributions will be 
higher for a group of employees that consists entirely of HCEs. Under 
section 411(a)(3)(G) and Sec. 1.411(a)-4(b)(7), a plan may forfeit 
matching contributions attributable to excess contributions, excess 
aggregate contributions and excess deferrals to avoid a violation of 
section 401(a)(4). See also Sec. 1.401(a)(4)-11(g)(3)(vii)(B) regarding 
the use of additional allocations to the accounts of NHCEs for the 
purpose of correcting a discriminatory rate of matching contributions. A 
plan is permitted to provide for which contributions are to be 
distributed to satisfy the ACP test so as to avoid discriminatory 
matching rates that would otherwise violate section 401(a)(4). For 
example, the plan may provide that unmatched employee contributions will 
be distributed before matched employee contributions.
    (vi) No requirement for recalculation. If the distributions and 
forfeitures described in paragraph (b)(2) of this section are made, the 
employee contributions and matching contributions are treated as meeting 
the nondiscrimination test of section 401(m)(2) regardless of whether 
the ACP for the HCEs, if recalculated after the distributions and 
forfeitures, would satisfy section 401(m)(2).
    (4) Failure to timely correct--(i) Failure to correct within 2\1/2\ 
months after end of plan year. If a plan does not correct excess 
aggregate contributions within 2\1/2\ months after the close of the plan 
year for which the excess aggregate contributions are made, the employer 
will be liable for a 10% excise tax on the amount of the excess 
aggregate contributions. See section 4979 and Sec. 54.4979-1 of this 
chapter. Qualified nonelective contributions properly taken into account 
under paragraph (a)(6) of this section for a plan year may enable a plan 
to avoid having excess aggregate contributions, even if the 
contributions are made after the close of the 2\1/2\ month period.
    (ii) Failure to correct within 12 months after end of plan year. If 
excess aggregate contributions are not corrected within 12 months after 
the close of the plan year for which they were made, the plan will fail 
to meet the requirements of section 401(a)(4) for the plan year for 
which the excess aggregate contributions were made and all subsequent 
plan years in which the excess aggregate contributions remain in the 
trust.
    (iii) Special rule for eligible automatic contribution arrangements. 
In the case of excess aggregate contributions under a plan that includes 
an eligible automatic contribution arrangement (within the meaning of 
section 414(w)), 6 months is substituted for 2\1/2\ months in paragraph 
(b)(4)(i) of this section. The additional time described in this 
paragraph (b)(4)(iii) applies to a distribution of excess aggregate 
contributions for a plan year beginning on or after January 1, 2010 only 
where all the eligible NHCEs and eligible HCEs are covered employees 
under the eligible automatic contribution arrangement (within the 
meaning of Sec. 1.414(w)-1(e)(3)) for the entire plan year (or for the 
portion of the plan year that the eligible NHCEs and eligible HCEs are 
eligible employees).

[[Page 416]]

    (5) Examples. The following examples illustrate the application of 
this paragraph. See also Sec. 1.401(k)-2(b) for additional examples of 
the parallel correction rules applicable to cash or deferred 
arrangements. For purposes of these examples, none of the plans provide 
for catch-up contributions under section 414(v). The examples are as 
follows:

    Example 1. (i) Employer L maintains a plan that provides for 
employee contributions and fully vested matching contributions. The plan 
provides that failures of the ACP test are corrected by distribution. In 
2006, the ACP for the eligible NHCEs is 6%. Thus, the ACP for the 
eligible HCEs may not exceed 8%. The three HCEs who participate have the 
following compensation, contributions, and ACRs:

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                            Employee contributions and
                   Employee                            Compensation           matching contributions           Actual contribution ratio (percent)
--------------------------------------------------------------------------------------------------------------------------------------------------------
A.............................................                     200,000                      14,000  7
B.............................................                     150,000                      13,500  9
C.............................................                     100,000                      12,000  12
                                                ..........................  ..........................  Average 9.33
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (ii) The total amount of excess aggregate contributions for the HCEs 
is determined under paragraph (b)(2)(ii) of this section as follows: the 
matching and employee contributions of Employee C (the HCE with the 
highest ACR) is reduced by 3% of compensation (or $3,000) in order to 
reduce the ACR of that HCE to 9%, which is the ACR of Employee B.
    (iii) Because the ACP of the HCEs determined after the $3,000 
reduction still exceeds 8%, further reductions in matching contributions 
and employee contributions are necessary in order to reduce the ACP of 
the HCEs to 8%. The employee contributions and matching contributions 
for Employees B and C are reduced by an additional .5% of compensation 
or $1,250 ($750 and $500 respectively). Because the ACP of the HCEs 
determined after the reductions now equals 8%, the plan would satisfy 
the requirements of (a)(1)(ii) of this section.
    (iv) The total amount of excess aggregate contributions ($4,250) is 
apportioned among the HCEs under paragraph (b)(2)(iii) of this section 
first to the HCE with the highest amount of matching contributions and 
employee contributions. Therefore, Employee A is apportioned $500 (the 
amount required to cause A's matching contributions and employee 
contributions to equal the next highest dollar amount of matching 
contributions and employee contributions).
    (v) Because the total amount of excess aggregate contributions has 
not been apportioned, further apportionment is necessary. The balance 
($3,750) of the total amount of excess aggregate contributions is 
apportioned equally among Employees A and B ($1,500 to each, the amount 
required to cause their contributions to equal the next highest dollar 
amount of matching contributions and employee contributions).
    (vi) Because the total amount of excess aggregate contributions has 
not been apportioned, further apportionment is necessary. The balance 
($750) of the total amount of excess aggregate contributions is 
apportioned equally among Employees A, B and C ($250 to each, the amount 
required to allocate the total amount of excess aggregate contributions 
for the plan).
    (vii) Therefore, the plan will satisfy the requirements of paragraph 
(a)(1) of this section if, by the end of the 12 month period following 
the end of the 2006 plan year, Employee A receives a corrective 
distribution of excess aggregate contributions equal to $2,250 ($500 + 
$1,500 + $250) and allocable income, Employee B receives a corrective 
distribution of $250 and allocable income and Employee C receives a 
corrective distribution of $1,750 ($1,500 + $250) and allocable income.
    Example 2. (i) Employee D is the sole HCE who is eligible to 
participate in a cash or deferred arrangement maintained by Employer M. 
The plan that includes the arrangement, Plan X, permits employee 
contributions and provides a fully vested matching contribution equal to 
50% of elective contributions. Plan X is a calendar year plan. Plan X 
corrects excess contributions by recharacterization and provides that 
failures of the ACP test are corrected by distribution. For the 2006 
plan year, D's compensation is $200,000, and D's elective contributions 
are $15,000. The actual deferral percentages and actual contribution 
percentages for Employee D and the other eligible employees under Plan X 
are shown in the following table:

------------------------------------------------------------------------
                                                            Actual
                                     Actual deferral     contribution
                                        percentage        percentage
------------------------------------------------------------------------
Employee D.........................              7.5                3.75
NHCEs..............................              4                  2
------------------------------------------------------------------------

    (ii) In February 2007, Employer M determines that D's actual 
deferral ratio must be reduced to 6%, or $12,000, which requires a 
recharacterization of $3,000 as an employee

[[Page 417]]

contribution. This increases D's actual contribution ratio to 5.25% 
($7,500 in matching contributions plus $3,000 recharacterized as 
employee contributions, divided by $200,000 in compensation). Since D's 
actual contribution ratio must be limited to 4% for Plan X to satisfy 
the actual contribution percentage test, Plan X must distribute 1.25% or 
$2,500 of D's employee contributions and matching contributions together 
with allocable income. If $2,500 in matching contributions and allocable 
income is distributed, this will correct the excess aggregate 
contributions and will not result in a discriminatory rate of matching 
contributions. See Example 8.
    Example 3. (i) The facts are the same as in Example 2, except that 
Employee D also had elective contributions under Plan Y, maintained by 
an employer unrelated to M. In January 2007, D requests and receives a 
distribution of $1,200 in excess deferrals from Plan X. Pursuant to the 
terms of Plan X, D forfeits the $600 match on the excess deferrals to 
correct a discriminatory rate of match.
    (ii) The $3,000 that would otherwise have been recharacterized for 
Plan X to satisfy the actual deferral percentage test is reduced by the 
$1,200 already distributed as an excess deferral, leaving $1,800 to be 
recharacterized. See Sec. 1.401(k)-2(b)(4)(i)(A). D's actual 
contribution ratio is now 4.35% ($7,500 in matching contributions plus 
$1,800 in recharacterized contributions less $600 forfeited matching 
contributions attributable to the excess deferrals, divided by $200,000 
in compensation).
    (iii) The matching and employee contributions for Employee D must be 
reduced by .35% of compensation in order to reduce the ACP of the HCEs 
to 4%. The plan must provide for forfeiture of additional matching 
contributions to prevent a discriminatory rate of matching 
contributions. See Example 8.
    Example 4. (i) The facts are the same as in Example 3, except that D 
does not request a distribution of excess deferrals until March 2007. 
Employer X has already recharacterized $3,000 as employee contributions.
    (ii) Under Sec. 1.402(g)-1(e)(6), the amount of excess deferrals is 
reduced by the amount of excess contributions that are recharacterized. 
Because the amount recharacterized is greater than the excess deferrals, 
Plan X is neither required nor permitted to make a distribution of 
excess deferrals, and the recharacterization has corrected the excess 
deferrals.
    Example 5. (i) For the 2006 plan year, Employee F defers $10,000 
under Plan M and $6,000 under Plan N. Plans M and N, which have calendar 
plan years are maintained by unrelated employers. Plan M provides a 
fully vested, 100% matching contribution, does not take elective 
contributions into account under section 401(m) or take matching 
contributions into account under section 401(k) and provides that excess 
contributions and excess aggregate contributions are corrected by 
distribution. Under Plan M, Employee F is allocated excess contributions 
of $600 and excess aggregate contributions of $1,600. Employee F timely 
requests and receives a distribution of the $1,000 excess deferral from 
Plan M and, pursuant to the terms of Plan M, forfeits the corresponding 
$1,000 matching contribution.
    (ii) No distribution is required or permitted to correct the excess 
contributions because $1,000 has been distributed by Plan M as excess 
deferrals. The distribution required to correct the excess aggregate 
contributions (after forfeiting the matching contribution) is $600 
($1,600 in excess aggregate contributions minus $1,000 in forfeited 
matching contributions). If Employee F had corrected the excess 
deferrals of $1,000 by withdrawing $1,000 from Plan N, Plan M would have 
had to correct the $600 excess contributions in Plan M by distributing 
$600. Since Employee F then would have forfeited $600 (instead of 
$1,000) in matching contributions, Employee F would have had $1,000 
($1,600 in excess aggregate contributions minus $600 in forfeited 
matching contributions) remaining of excess aggregate contributions in 
Plan M. These would have been corrected by distributing an additional 
$1,000 from Plan M.
    Example 6. (i) Employee G is the sole HCE in a profit sharing plan 
under which the employer matches 100% of employee contributions up to 2% 
of compensation, and 50% of employee contributions up to the next 4% of 
compensation. For the 2008 plan year, Employee G has compensation of 
$100,000 and makes a 7% employee contribution of $7,000. Employee G 
receives a 4% matching contribution or $4,000. Thus, Employee G's actual 
contribution ratio (ACR) is 11%. The actual contribution percentage for 
the NHCEs is 5%, and the employer determines that Employee G's ACR must 
be reduced to 7% to comply with the rules of section 401(m).
    (ii) In this case, the plan satisfies the requirements of section if 
it distributes the unmatched employee contributions of $1,000, and 
$2,000 of matched employee contributions with their related matches of 
$1,000. This would leave Employee G with 4% employee contributions, and 
3% matching contributions, for an ACR of 7%. Alternatively, the plan 
could distribute all matching contributions and satisfy this section. 
However, the plan could not distribute $4,000 of Employee G's employee 
contributions without forfeiting the related matching contributions 
because this would result in a discriminatory rate of matching 
contributions. See also Example 7.
    Example 7. (i) Employee H is an HCE in Employer X's profit sharing 
plan, which matches 100% of employee contributions up

[[Page 418]]

to 5% of compensation. The matching contribution is vested at the rate 
of 20% per year. In 2006, Employee H makes $5,000 in employee 
contributions and receives $5,000 of matching contributions. Employee H 
is 60% vested in the matching contributions at the end of the 2006 plan 
year. In February 2007, Employer X determines that Employee H has excess 
aggregate contributions of $1,000. The plan provides that only matching 
contributions will be distributed as excess aggregate contributions.
    (ii) Employer X has two options available in distributing Employee 
H's excess aggregate contributions. The first option is to distribute 
$600 of vested matching contributions and forfeit $400 of nonvested 
matching contributions. These amounts are in proportion to Employee H's 
vested and nonvested interests in all matching contributions. The second 
option is to distribute $1,000 of vested matching contributions, leaving 
the nonvested matching contributions in the plan.
    (iii) If the second option is chosen, the plan must also provide a 
separate vesting schedule for vesting these nonvested matching 
contributions. This is necessary because the nonvested matching 
contributions must vest as rapidly as they would have had no 
distribution been made. Thus, 50% must vest in each of the next 2 years.
    (iv) The plan will not satisfy the nondiscriminatory availability 
requirement of section 401(a)(4) if only nonvested matching 
contributions are forfeited because the effect is that matching 
contributions for HCEs vest more rapidly than those for NHCEs. See Sec. 
1.401(m)-2(b)(3)(v)(B).
    Example 8. (i) Employer Y maintains a calendar year profit sharing 
plan that includes a cash or deferred arrangement. Elective 
contributions are matched at the rate of 100%. After-tax employee 
contributions are permitted under the plan only for NHCEs and are 
matched at the same rate. No employees make excess deferrals. Employee 
J, an HCE, makes an $8,000 elective contribution and receives an $8,000 
matching contribution.
    (ii) Employer Y performs the actual deferral percentage (ADP) and 
the actual contribution percentage (ACP). To correct failures of the ADP 
and ACP tests, the plan distributes to A $1,000 of excess contributions 
and $500 of excess aggregate contributions. After the distributions, 
Employee J's contributions for the year are $7,000 of elective 
contributions and $7,500 of matching contributions. As a result, 
Employee J has received a higher effective rate of matching 
contributions than NHCEs ($7,000 of elective contributions matched by 
$7,500 is an effective matching rate of 107 percent). If this amount 
remains in Employee J's account without correction, it will cause the 
plan to fail to satisfy section 401(a)(4), because only an HCE receives 
the higher matching contribution rate. The remaining $500 matching 
contribution may be forfeited (but not distributed) under section 
411(a)(3)(G), if the plan so provides. The plan could instead correct 
the discriminatory rate of matching contributions by making additional 
allocations to the accounts of NHCEs. See Sec. 1.401(a)(4)-
11(g)(3)(vii)(B) and (6), Example 7.

    (c) Additional rules for prior year testing method--(1) Rules for 
change in testing method. A plan is permitted to change from the prior 
year testing method to the current year testing method for any plan 
year. A plan is permitted to change from the current year testing method 
to the prior year testing method only in situations described in Sec. 
1.401(k)-2(c)(1)(ii). For purposes of this paragraph (c)(1), a plan that 
uses the safe harbor method described in Sec. 1.401(m)-3 or a SIMPLE 
401(k) plan is treated as using the current year testing method for that 
plan year
    (2) Calculation of ACP under the prior year testing method for the 
first plan year--(i) Plans that are not successor plans. If, for the 
first plan year of any plan (other than a successor plan), a plan uses 
the prior year testing method, the plan is permitted to use either that 
first plan year as the applicable year for determining the ACP for the 
eligible NHCEs, or 3% as the ACP for eligible NHCEs, for applying the 
ACP test for that first plan year. A plan (other than a successor plan) 
that uses the prior year testing method but has elected for its first 
plan year to use that year as the applicable year for determining the 
ACP for the eligible NHCEs is not treated as changing its testing method 
in the second plan year and is not subject to the limitations on double 
counting under paragraph (a)(6)(vi) of this section for the second plan 
year.
    (ii) First plan year defined. For purposes of this paragraph (c)(2), 
the first plan year of any plan is the first year in which the plan 
provides for employee contributions or matching contributions. Thus, the 
rules of this paragraph (c)(2) do not apply to a plan (within the 
meaning of Sec. 1.410(b)-7) for a plan year if for such plan year the 
plan is aggregated under Sec. 1.401(m)-1(b)(4) with any other plan that 
provides for employee or matching contributions in the prior year.

[[Page 419]]

    (iii) Plans that are successor plans. A plan is a successor plan if 
50% or more of the eligible employees for the first plan year were 
eligible employees under another plan maintained by the employer in the 
prior year that provides for employee contributions or matching 
contributions. If a plan that is a successor plan uses the prior year 
testing method for its first plan year, the ACP for the group of NHCEs 
for the applicable year must be determined under paragraph (c)(4) of 
this section.
    (3) Plans using different testing methods for the ACP and ADP test. 
Except as otherwise provided in this paragraph (c)(3), a plan may use 
the current year testing method or prior year testing method for the ACP 
test for a plan year without regard to whether the current year testing 
method or prior year testing method is used for the ADP test for that 
year. For example, a plan may use the prior year testing method for the 
ACP test and the current year testing method for its ADP test for the 
plan year. However, plans that use different testing methods under this 
paragraph (c)(3) cannot use--
    (i) The recharacterization method of Sec. 1.401(k)-2(b)(3) to 
correct excess contributions for a plan year;
    (ii) The rules of paragraph (a)(6)(ii) of this section to take 
elective contributions into account under the ACP test (rather than the 
ADP test); or
    (iii) The rules of paragraph Sec. 1.401(k)-2(a)(6) to take 
qualified matching contributions into account under the ADP test (rather 
than the ACP test).
    (4) Rules for plan coverage change--(i) In general. A plan that uses 
the prior year testing method that experiences a plan coverage change 
during a plan year satisfies the requirements of this section for that 
year only if the plan provides that the ACP for the NHCEs for the plan 
year is the weighted average of the ACPs for the prior year subgroups.
    (ii) Optional rule for minor plan coverage changes. If a plan 
coverage change occurs and 90% or more of the total number of the NHCEs 
from all prior year subgroups are from a single prior year subgroup, 
then, in lieu of using the weighted averages described in paragraph 
(c)(4)(i) of this section, the plan may provide that the ACP for the 
group of eligible NHCEs for the prior year under the plan is the ACP of 
the NHCEs for the prior year of the plan under which that single prior 
year subgroup was eligible.
    (iii) Definitions. The following definitions apply for purposes of 
this paragraph (c)(4)--
    (A) Plan coverage change. The term plan coverage change means a 
change in the group or groups of eligible employees under a plan on 
account of--
    (1) The establishment or amendment of a plan;
    (2) A plan merger or spinoff under section 414(l);
    (3) A change in the way plans (within the meaning of Sec. 1.410(b)-
7) are combined or separated for purposes of Sec. 1.401(m)-1(b)(4) 
(e.g., permissively aggregating plans not previously aggregated under 
Sec. 1.410(b)-7(d), or ceasing to permissively aggregate plans under 
Sec. 1.410(b)-7(d));
    (4) A reclassification of a substantial group of employees that has 
the same effect as amending the plan (e.g., a transfer of a substantial 
group of employees from one division to another division); or
    (5) A combination of any of paragraphs (c)(4)(iii)(A)(1) through (4) 
of this section.
    (B) Prior year subgroup. The term prior year subgroup means all 
NHCEs for the prior plan year who, in the prior year, were eligible 
employees under a specific plan that provides for employee contributions 
or matching contributions maintained by the employer and who would have 
been eligible employees in the prior year under the plan being tested if 
the plan coverage change had first been effective as of the first day of 
the prior plan year instead of first being effective during the plan 
year. The determination of whether an NHCE is a member of a prior year 
subgroup is made without regard to whether the NHCE terminated 
employment during the prior year.
    (C) Weighted average of the ACPs for the prior year subgroups. The 
term weighted average of the ACPs for the prior year subgroups means the 
sum, for all prior year subgroups, of the adjusted ACPs for the plan 
year. The

[[Page 420]]

term adjusted ACP with respect to a prior year subgroup means the ACP 
for the prior plan year of the specific plan under which the members of 
the prior year subgroup were eligible employees on the first day of the 
prior plan year, multiplied by a fraction, the numerator of which is the 
number of NHCEs in the prior year subgroup and denominator of which is 
the total number of NHCEs in all prior year subgroups.
    (iv) Example. The following example illustrate the application of 
this paragraph (c)(4). See also Sec. 1.401(k)-2(c)(4) for examples of 
the parallel rules applicable to the ADP test. The example is as 
follows:

    Example. (i) Employer B maintains two plans, Plan N and Plan P, each 
of which provides for employee contributions or matching contributions. 
The plans were not permissively aggregated under Sec. 1.410(b)-7(d) for 
the 2005 testing year. Both plans use the prior year testing method. 
Plan N had 300 eligible employees who were NHCEs for 2005, and their ACP 
for that year was 6%. Plan P had 100 eligible employees who were NHCEs 
for 2005, and the ACP for those NHCEs for that plan was 4%. Plan N and 
Plan P are permissively aggregated under Sec. 1.410(b)-7(d) for the 
2006 plan year.
    (ii) The permissive aggregation of Plan N and Plan P for the 2006 
testing year under Sec. 1.410(b)-7(d) is a plan coverage change that 
results in treating the plans as one plan (Plan NP). Therefore, the 
prior year ACP for the NHCEs under Plan NP for the 2006 testing year is 
the weighted average of the ACPs for the prior year subgroups.
    (iii) The first step in determining the weighted average of the ACPs 
for the prior year subgroups is to identify the prior year subgroups. 
With respect to the 2006 testing year, an employee is a member of a 
prior year subgroup if the employee was an NHCE of Employer B for the 
2005 plan year, was an eligible employee for the 2005 plan year under 
any section 401(k) plan maintained by Employer B, and would have been an 
eligible employee in the 2005 plan year under Plan NP if Plan N and Plan 
P had been permissively aggregated under Sec. 1.410(b)-7(d) for that 
plan year. The NHCEs who were eligible employees under separate plans 
for the 2005 plan year comprise separate prior year subgroups. Thus, 
there are two prior year subgroups under Plan NP for the 2006 testing 
year: the 300 NHCEs who were eligible employees under Plan N for the 
2005 plan year and the 100 NHCEs who were eligible employees under Plan 
P for the 2005 plan year.
    (iv) The weighted average of the ACPs for the prior year subgroups 
is the sum of the adjusted ACP with respect to the prior year subgroup 
that consists of the NHCEs who were eligible employees under Plan N, and 
the adjusted ACP with respect to the prior year subgroup that consists 
of the NHCEs who were eligible employees under Plan P. The adjusted ACP 
for the prior year subgroup that consists of the NHCEs who were eligible 
employees under Plan N is 4.5%, calculated as follows: 6% (the ACP for 
the NHCEs under Plan N for the prior year) x 300/400 (the number of 
NHCEs in that prior year subgroup divided by the total number of NHCEs 
in all prior year subgroups), which equals 4.5%. The adjusted ACP for 
the prior year subgroup that consists of the NHCEs who were eligible 
employees under Plan P is 1%, calculated as follows: 4% (the ACP for the 
NHCEs under Plan P for the prior year) x 100/400 (the number of NHCEs in 
that prior year subgroup divided by the total number of NHCEs in all 
prior year subgroups), which equals 1%. Thus, the prior year ACP for 
NHCEs under Plan NP for the 2006 testing year is 5.5% (the sum of 
adjusted ACPs for the prior year subgroups, 4.5% plus 1%).

[T.D. 9169, 69 FR 78184, Dec. 29, 2004, as amended by T.D. 9237, 71 FR 
10, Jan. 3, 2006; T.D. 9447, 74 FR 8210, Feb. 24, 2009; 74 FR 12551, 
Mar. 25, 2009]



Sec. 1.401(m)-3  Safe harbor requirements.

    (a) ACP test safe harbor--(1) Section 401(m)(11) safe harbor. 
Matching contributions under a plan satisfy the ACP safe harbor 
provisions of section 401(m)(11) for a plan year if the plan satisfies 
the safe harbor contribution requirement of paragraph (b) or (c) of this 
section for the plan year, the limitations on matching contributions of 
paragraph (d) of this section, the notice requirement of paragraph (e) 
of this section, the plan year requirements of paragraph (f) of this 
section, and the additional rules of paragraphs (g), (h) and (j) of this 
section, as applicable.
    (2) Section 401(m)(12) safe harbor. For a plan year beginning on or 
after January 1, 2008, matching contributions under a plan satisfy the 
ACP safe harbor provisions of section 401(m)(12) for a plan year if the 
matching contributions are made with respect to an automatic 
contribution arrangement described in paragraph Sec. 1.401(k)-3(j) that 
satisfies the safe harbor requirements of Sec. 1.401(k)-3, the 
limitations on matching contributions of paragraph (d) of this section, 
the notice requirement of paragraph (e) of this section,

[[Page 421]]

the plan year requirements of paragraph (f) of this section, and the 
additional rules of paragraphs (g), (h) and (j) of this section, as 
applicable.
    (3) Requirements applicable to safe harbor contributions. Pursuant 
to sections 401(k)(12)(E)(ii) and 401(k)(13)(D)(iv), the safe harbor 
contribution requirement of paragraph (b) or (c) of this section and 
Sec. 1.401(k)-3(k) must be satisfied without regard to section 401(l). 
The contributions made under paragraphs (b) and (c) of this section and 
Sec. 1.401(k)-3(k) are referred to as safe harbor nonelective 
contributions and safe harbor matching contributions.
    (b) Safe harbor nonelective contribution requirement. A plan 
satisfies the safe harbor nonelective contribution requirement of this 
paragraph (b) if it satisfies the safe harbor nonelective contribution 
requirement of Sec. 1.401(k)-3(b).
    (c) Safe harbor matching contribution requirement. A plan satisfies 
the safe harbor matching contribution requirement of this paragraph (c) 
if it satisfies the safe harbor matching contribution requirement of 
Sec. 1.401(k)-3(c).
    (d) Limitation on contributions--(1) General rule. A plan that 
provides for matching contributions meets the requirements of this 
section only if it satisfies the limitations on contributions set forth 
in this paragraph (d).
    (2) Matching rate must not increase. A plan that provides for 
matching contributions meets the requirements of this paragraph (d) only 
if the ratio of matching contributions on behalf of an employee under 
the plan for a plan year to the employee's elective deferrals and 
employee contributions, does not increase as the amount of an employee's 
elective deferrals and employee contributions increases.
    (3) Limit on matching contributions. A plan that provides for 
matching contributions satisfies the requirements of this section only 
if--
    (i) Matching contributions are not made with respect to elective 
deferrals or employee contributions that exceed 6% of the employee's 
safe harbor compensation (within the meaning of Sec. 1.401(k)-3(b)(2)); 
and
    (ii) Matching contributions that are discretionary do not exceed 4% 
of the employee's safe harbor compensation.
    (4) Limitation on rate of match. A plan meets the requirements of 
this section only if the ratio of matching contributions on behalf of an 
HCE to that HCE's elective deferrals or employee contributions (or the 
sum of elective deferrals and employee contributions) for that plan year 
is no greater than the ratio of matching contributions to elective 
deferrals or employee contributions (or the sum of elective deferrals 
and employee contributions) that would apply with respect to any NHCE 
for whom the elective deferrals or employee contributions (or the sum of 
elective deferrals and employee contributions) are the same percentage 
of safe harbor compensation. An employee is taken into account for 
purposes of this paragraph (d)(4) if the employee is an eligible 
employee under the cash or deferred arrangement with respect to which 
the contributions required by paragraph (b) or (c) of this section are 
being made for a plan year. A plan will not fail to satisfy this 
paragraph (d)(4) merely because the plan provides that matching 
contributions will be made separately with respect to each payroll 
period (or with respect to all payroll periods ending with or within 
each month or quarter of a plan year) taken into account under the plan 
for the plan year, provided that matching contributions with respect to 
any elective deferrals or employee contributions made during a plan year 
quarter are contributed to the plan by the last day of the immediately 
following plan year quarter.
    (5) HCEs participating in multiple plans. The rules of section 
401(m)(2)(B) and Sec. 1.401(m)-2(a)(3)(ii) apply for purposes of 
determining the rate of matching contributions under paragraph (d)(4) of 
this section. However, a plan will not fail to satisfy the safe harbor 
matching contribution requirements of this section merely because an HCE 
participates during the plan year in more than one plan that provides 
for matching contributions, provided that--
    (i) The HCE is not simultaneously an eligible employee under two 
plans that provide for matching contributions maintained by an employer 
for a plan year; and

[[Page 422]]

    (ii) The period used to determine compensation for purposes of 
determining matching contributions under each such plan is limited to 
periods when the HCE participated in the plan.
    (6) Permissible restrictions on elective deferrals by NHCEs--(i) 
General rule. A plan does not satisfy the safe harbor requirements of 
this section, if elective deferrals or employee contributions by NHCEs 
are restricted, unless the restrictions are permitted by this paragraph 
(d)(6).
    (ii) Restrictions on election periods. A plan may limit the 
frequency and duration of periods in which eligible employees may make 
or change contribution elections under a plan. However, an employee must 
have a reasonable opportunity (including a reasonable period after 
receipt of the notice described in paragraph (e) of this section) to 
make or change a contribution election for the plan year. For purposes 
of this section, a 30-day period is deemed to be a reasonable period to 
make or change a contribution election.
    (iii) Restrictions on amount of contributions. A plan is permitted 
to limit the amount of contributions that may be made by an eligible 
employee under a plan, provided that each NHCE who is an eligible 
employee is permitted (unless the employee is restricted under paragraph 
(d)(6)(v) of this section) to make contributions in an amount that is at 
least sufficient to receive the maximum amount of matching contributions 
available under the plan for the plan year, and the employee is 
permitted to elect any lesser amount of contributions. However, a plan 
may require eligible employees to make contribution elections in whole 
percentages of compensation or whole dollar amounts.
    (iv) Restrictions on types of compensation that may be deferred. A 
plan may limit the types of compensation that may be deferred or 
contributed by an eligible employee under a plan, provided that each 
eligible NHCE is permitted to make contributions under a definition of 
compensation that would be a reasonable definition of compensation 
within the meaning of Sec. 1.414(s)-1(d)(2). Thus, the definition of 
compensation from which contributions may be made is not required to 
satisfy the nondiscrimination requirement of Sec. 1.414(s)-1(d)(3).
    (v) Restrictions due to limitations under the Internal Revenue Code. 
A plan may limit the amount of contributions made by an eligible 
employee under a plan--
    (A) Because of the limitations of section 402(g) or section 415; or
    (B) Because, on account of a hardship distribution, an employee's 
ability to make contributions has been suspended for 6 months in 
accordance with Sec. 1.401(k)-1(d)(3)(iv)(E).
    (e) Notice requirement. A plan satisfies the notice requirement of 
this paragraph (e) if it satisfies the notice requirement of Sec. 
1.401(k)-3(d).
    (f) Plan year requirement--(1) General rule. Except as provided in 
this paragraph (f) or in paragraph (g) of this section, a plan will fail 
to satisfy the requirements of section 401(m)(11), section 401(m)(12), 
and this section unless plan provisions that satisfy the rules of this 
section are adopted before the first day of that plan year and remain in 
effect for an entire 12-month plan year. In addition, except as provided 
in paragraph (h) of this section or in guidance of general applicability 
published in the Internal Revenue Bulletin (see Sec. 
601.601(d)(2)(ii)(b) of this chapter), a plan which includes provisions 
that satisfy the rules of this section will not satisfy the requirements 
of Sec. 1.401(m)-1(b) if it is amended to change such provisions for 
that plan year. Moreover, if, as described in paragraph (j)(4) of this 
section, safe harbor matching or nonelective contributions will be made 
to another plan for a plan year, provisions under that other plan 
specifying that the safe harbor contributions will be made and providing 
that the contributions will be QNECs or QMACs must also be adopted 
before the first day of that plan year.
    (2) Initial plan year. A newly established plan (other than a 
successor plan within the meaning of Sec. 1.401(m)-2(c)(2)(iii)) will 
not be treated as violating the requirements of this paragraph (f) 
merely because the plan year is less than 12 months, provided that the 
plan year is at least 3 months long (or, in the case of a newly 
established employer that establishes the plan as soon as 
administratively feasible after

[[Page 423]]

the employer comes into existence, a shorter period). Similarly, a plan 
will not fail to satisfy the requirements of this paragraph (f) for the 
first plan year in which matching contributions are provided under the 
plan provided that--
    (i) The plan is not a successor plan; and
    (ii) The amendment providing for matching contributions is made 
effective at the same time as the adoption of a cash or deferred 
arrangement that satisfies the requirements of Sec. 1.401(k)-3, taking 
into account the rules of Sec. 1.401(k)-3(e)(2).
    (3) Change of plan year. A plan that has a short plan year as a 
result of changing its plan year will not fail to satisfy the 
requirements of paragraph (f)(1) of this section merely because the plan 
year has less than 12 months, provided that--
    (i) The plan satisfied the requirements of this section for the 
immediately preceding plan year; and
    (ii) The plan satisfies the requirements of this section (determined 
without regard to paragraph (h) of this section) for the immediately 
following plan year or for the immediately following 12 months if the 
immediately following plan year is less than 12 months.
    (4) Final plan year. A plan that terminates during a plan year will 
not fail to satisfy the requirements of paragraph (f)(1) of this section 
merely because the final plan year is less than 12 months, provided that 
the plan satisfies the requirement of this section through the date of 
termination and either--
    (i) The plan would satisfy the requirements of paragraph (h) of this 
section, treating the termination of the plan as a reduction or 
suspension of safe harbor contributions, other than the requirements of 
paragraph (h)(1)(i)(A) or (h)(1)(ii)(A) of this section (relating to the 
employer's financial condition and information included in the initial 
notice for the plan year) and paragraph (h)(1)(i)(D) or (h)(1)(ii)(D) of 
this section (requiring that employees have a reasonable opportunity to 
change their cash or deferred elections and, if applicable, employee 
contribution elections); or
    (ii) The plan termination is in connection with a transaction 
described in section 410(b)(6)(C) or the employer incurs a substantial 
business hardship, comparable to a substantial business hardship 
described in section 412(c).
    (g) Plan amendments adopting nonelective safe harbor contributions. 
Notwithstanding paragraph (f)(1) of this section, a plan that provides 
for the use of the current year testing method may be amended after the 
first day of the plan year and no later than 30 days before the last day 
of the plan year to adopt the safe harbor method of this section, 
effective as of the first day of the plan year, using nonelective 
contributions under paragraph (b) of this section if the plan satisfies 
the requirements of Sec. 1.401(k)-3(f).
    (h) Permissible reduction or suspension of safe harbor 
contributions--(1) General rule--(i) Matching contributions. A plan that 
provides for safe harbor matching contributions intended to satisfy the 
requirements of paragraph (c) of this section for a plan year will not 
fail to satisfy the requirements of section 401(m)(2) merely because the 
plan is amended during the plan year to reduce or suspend safe harbor 
matching contributions on future elective deferrals (and, if applicable, 
employee contributions) provided that--
    (A) In the case of plan years beginning on or after January 1, 2015, 
the employer either--
    (1) Is operating at an economic loss as described in section 
412(c)(2)(A) for the plan year; or
    (2) Includes in the notice described in paragraph (e) of this 
section, a statement that the plan may be amended during the plan year 
to reduce or suspend safe harbor matching contributions and that the 
reduction or suspension will not apply until at least 30 days after all 
eligible employees are provided notice of the reduction or suspension;
    (B) All eligible employees are provided a supplemental notice that 
satisfies the requirements of paragraph (h)(2) of this section;
    (C) The reduction or suspension of safe harbor matching 
contributions is effective no earlier than the later of the date the 
amendment is adopted or 30 days after eligible employees are

[[Page 424]]

provided the supplemental notice described in paragraph (h)(2) of this 
section;
    (D) Eligible employees are given a reasonable opportunity (including 
a reasonable period after receipt of the supplemental notice) prior to 
the reduction or suspension of safe harbor matching contributions to 
change their cash or deferred elections and, if applicable, their 
employee contribution elections;
    (E) The plan is amended to provide that the ACP test will be 
satisfied for the entire plan year in which the reduction or suspension 
occurs using the current year testing method described in Sec. 
1.401(m)-2(a)(2)(ii); and
    (F) The plan satisfies the requirements of this section (other than 
this paragraph (h)) with respect to amounts deferred through the 
effective date of the amendment.
    (ii) Nonelective contributions. For plan amendments adopted after 
May 18, 2009, a plan that provides for safe harbor nonelective 
contributions intended to satisfy the requirements of paragraph (b) of 
this section will not fail to satisfy the requirements of section 
401(m)(2) for the plan year merely because the plan is amended during 
the plan year to reduce or suspend safe harbor nonelective contributions 
provided that--
    (A) The employer either--
    (1) Is operating at an economic loss as described in section 
412(c)(2)(A) for the plan year; or
    (2) Includes in the notice described in paragraph (e) of this 
section a statement that the plan may be amended during the plan year to 
reduce or suspend safe harbor nonelective contributions and that the 
reduction or suspension will not apply until at least 30 days after all 
eligible employees are provided notice of the reduction or suspension;
    (B) All eligible employees are provided a supplemental notice that 
satisfies the requirements of paragraph (h)(2) of this section;
    (C) The reduction or suspension of safe harbor nonelective 
contributions is effective no earlier than the later of the date the 
amendment is adopted or 30 days after eligible employees are provided 
the supplemental notice described in paragraph (h)(2) of this section;
    (D) Eligible employees are given a reasonable opportunity (including 
a reasonable period after receipt of the supplemental notice) prior to 
the reduction or suspension of nonelective contributions to change their 
cash or deferred elections and, if applicable, their employee 
contribution elections;
    (E) The plan is amended to provide that the ACP test will be 
satisfied for the entire plan year in which the reduction or suspension 
occurs using the current year testing method described in Sec. 
1.401(m)-2(a)(2)(ii); and
    (F) The plan satisfies the requirements of this section (other than 
this paragraph
    (h)) with respect to safe harbor compensation paid through the 
effective date of the amendment.
    (2) Supplemental notice. The supplemental notice requirement of this 
paragraph (h)(2) is satisfied if each eligible employee is given a 
notice that satisfies the requirements of Sec. 1.401(k)-3(g)(2).
    (i) [Reserved]
    (j) Other rules--(1) Contributions taken into account. A 
contribution is taken into account for purposes of this section for a 
plan year under the same rules as Sec. 1.401(k)-3(h)(1).
    (2) Use of safe harbor nonelective contributions to satisfy other 
nondiscrimination tests. A safe harbor nonelective contribution used to 
satisfy the nonelective contribution requirement under paragraph (b) of 
this section may also be taken into account for purposes of determining 
whether a plan satisfies section 401(a)(4) under the same rules as Sec. 
1.401(k)-3(h)(2).
    (3) Early participation rules. Section 401(m)(5)(C) and Sec. 
1.401(m)-2(a)(1)(iii)(A), which provide an alternative nondiscrimination 
rule for certain plans that provide for early participation, do not 
apply for purposes of section 401(m)(11), section 401(m)(12), and this 
section. Thus, a plan is not treated as satisfying this section with 
respect to the eligible employees who have not completed the minimum age 
and service requirements of section 410(a)(1)(A) unless the plan 
satisfies the requirements of this section with respect to such eligible 
employees.

[[Page 425]]

    (4) Satisfying safe harbor contribution requirement under another 
defined contribution plan. Safe harbor matching or nonelective 
contributions may be made to another defined contribution plan under the 
same rules as Sec. 1.401(k)-3(h)(4). Consequently, each NHCE under the 
plan providing for matching contributions must be eligible under the 
same conditions under the other defined contribution plan and the plan 
to which the contributions are made must have the same plan year as the 
plan providing for matching contributions.
    (5) Contributions used only once. Safe harbor matching or 
nonelective contributions cannot be used to satisfy the requirements of 
this section with respect to more than one plan.
    (6) Plan must satisfy ACP with respect to employee contributions. If 
the plan provides for employee contributions, in addition to satisfying 
the requirements of this section, it must also satisfy the ACP test of 
Sec. 1.401(m)-2. See Sec. 1.401(m)-2(a)(5)(iv) for special rules under 
which the ACP test is permitted to be performed disregarding some or all 
matching when this section is satisfied with respect to the matching 
contributions.

[T.D. 9169, 69 FR 78184, Dec. 29, 2004, as amended by T.D. 9447, 74 FR 
8211, Feb. 24, 2009; T.D. 9641, 78 FR 68738, Nov. 15, 2013]



Sec. 1.401(m)-4  Special rules for mergers, acquisitions and similar 
events. [Reserved]



Sec. 1.401(m)-5  Definitions.

    Unless otherwise provided, the definitions of this section govern 
for purposes of section 401(m) and the regulations thereunder.
    Actual contribution percentage (ACP). Actual contribution percentage 
or ACP means the ACP of the group of eligible employees as defined in 
Sec. 1.401(m)-2(a)(2)(i).
    Actual contribution percentage (ACP) test. Actual contribution 
percentage test or ACP test means the test described in Sec. 1.401(m)-
2(a)(1).
    Actual contribution ratio (ACR). Actual contribution ratio or ACR 
means the ACR of an eligible employee as defined in Sec. 1.401(m)-
2(a)(3).
    Actual deferral percentage (ADP) test. Actual deferral percentage 
test or ADP test means the test described in Sec. 1.401(k)-2(a)(1).
    Compensation. Compensation means compensation as defined in section 
414(s) and Sec. 1.414(s)-1. The period used to determine an employee's 
compensation for a plan year must be either the plan year or the 
calendar year ending within the plan year. Whichever period is selected 
must be applied uniformly to determine the compensation of every 
eligible employee under the plan for that plan year. A plan may, 
however, limit the period taken into account under either method to that 
portion of the plan year or calendar year in which the employee was an 
eligible employee, provided that this limit is applied uniformly to all 
eligible employees under the plan for the plan year. See also section 
401(a)(17) and Sec. 1.401(a)(17)-1(c)(1). For this purpose, in case of 
an HCE whose ACR is determined under Sec. 1.401(m)-2(a)(3)(ii), period 
of participation includes periods under another plan for which matching 
contributions or employee contributions are aggregated under Sec. 
1.401(m)-2(a)(3)(ii).
    Current year testing method. Current year testing method means the 
testing method under which the applicable year is the current plan year, 
as described in Sec. 1.401(k)-2(a)(2)(ii) or 1.401(m)-2(a)(2)(ii)
    Designated Roth contributions. Designated Roth contributions means 
designated Roth contributions as defined in Sec. 1.401(k)-1(f)(1).
    Elective contributions. Elective contributions means elective 
contributions as defined in Sec. 1.401(k)-6.
    Elective deferrals. Elective deferrals means elective deferrals 
described in section 402(g)(3).
    Eligible employee--(1) General rule. Eligible employee means an 
employee who is directly or indirectly eligible to make an employee 
contribution or to receive an allocation of matching contributions 
(including matching contributions derived from forfeitures) under the 
plan for all or a portion of the plan year. For example, if an employee 
must perform purely ministerial or mechanical acts (e.g., formal 
application for participation or consent to

[[Page 426]]

payroll withholding) in order to be eligible to make an employee 
contribution for a plan year, the employee is an eligible employee for 
the plan year without regard to whether the employee performs these 
acts.
    (2) Conditions on eligibility. An employee who is unable to make 
employee contributions or to receive an allocation of matching 
contributions because the employee has not contributed to another plan 
is also an eligible employee. By contrast, if an employee must perform 
additional service (e.g., satisfy a minimum period of service 
requirement) in order to be eligible to make an employee contribution or 
to receive an allocation of matching contributions for a plan year, the 
employee is not an eligible employee for the plan year unless the 
service is actually performed. An employee who would be eligible to make 
employee contributions but for a suspension due to a distribution, a 
loan, or an election not to participate in the plan, is treated as an 
eligible employee for purposes of section 401(m) for a plan year even 
though the employee may not make employee contributions or receive an 
allocation of matching contributions by reason of the suspension. 
Finally, an employee does not fail to be treated as an eligible employee 
merely because the employee may receive no additional annual additions 
because of section 415(c)(1).
    (3) Certain one-time elections. An employee is not an eligible 
employee merely because the employee, no later than the employee's first 
becoming eligible under any plan or arrangement described in section 
219(g)(5)(A) and providing for employee or matching contributions, is 
given a one-time opportunity to elect, and the employee in fact does 
elect, not to be eligible to make employee contributions or to receive 
allocations of matching contributions under the plan or any other plan 
or arrangement maintained by the employer (including plans not yet 
established) for the duration of the employee's employment with the 
employer. In no event is an election made after December 23, 1994, 
treated as a one-time irrevocable election under this paragraph if the 
election is made by an employee who previously became eligible under 
another plan or arrangement (whether or not terminated) of the employer.
    Eligible HCE. Eligible HCE means an eligible employee who is an HCE.
    Eligible NHCE. Eligible NHCE means an eligible employee who is not 
an HCE.
    Employee. Employee means an employee within the meaning of Sec. 
1.410(b)-9.
    Employee contributions. Employee contributions means employee 
contributions as defined in Sec. 1.401(m)-1(a)(3).
    Employee stock ownership plan (ESOP). Employee stock ownership plan 
or ESOP the portion of a plan that is an ESOP within the meaning of 
Sec. 1.410(b)-7(c)(2).
    Employer. Employer means an employer within the meaning of Sec. 
1.410(b)-9.
    Excess aggregate contributions. Excess aggregate contributions 
means, with respect to a plan year, the amount of excess aggregate 
contributions apportioned to an HCE under Sec. 1.401(m)-2(b)(2)(iii).
    Excess contributions. Excess contributions means with respect to a 
plan year, the amount of excess contributions apportioned to an HCE 
under Sec. 1.401(k)-2(b)(2)(iii).
    Excess deferrals. Excess deferrals means excess deferrals as defined 
in Sec. 1.402(g)-1(e)(3).
    Highly compensated employee (HCE). Highly compensated employee or 
HCE has the meaning provided in section 414(q).
    Matching contributions. Matching contribution is defined in Sec. 
1.401(m)-1(a)(2).
    Nonelective contributions. Nonelective contributions means employer 
contributions (other than matching contributions) with respect to which 
the employee may not elect to have the contributions paid to the 
employee in cash or other benefits instead of being contributed to the 
plan.
    Non-employee stock ownership plan (non-ESOP). Non-employee stock 
ownership plan or non-ESOP means the portion of a plan that is not an 
ESOP within the meaning of Sec. 1.410(b)-7(c)(2).
    Non-highly compensated employee (NHCE). Non-highly compensated 
employee or NHCE means an employee who is not an HCE.
    Plan. Plan means plan as defined in Sec. 1.401(m)-1(b)(4).

[[Page 427]]

    Prior year testing method. Prior year testing method means the 
testing method under which the applicable year is the prior plan year, 
as described in Sec. 1.401(k)-2(a)(2)(ii) or 1.401(m)-2(a)(2)(ii)
    Qualified matching contributions (QMAC). Qualified matching 
contributions or QMAC means matching contributions that satisfy the 
requirements of Sec. 1.401(k)-1(c) and (d) at the time the contribution 
is made, without regard to whether the contributions are actually taken 
into account as elective contributions under Sec. 1.401(k)-2(a)(6). See 
also Sec. 1.401(k)-2(b)(4)(iii) for a rule providing that a matching 
contribution does not fail to qualify as a QMAC solely because it is 
forfeitable under section 411(a)(3)(G) because it is a matching 
contribution with respect to an excess deferral, excess contribution, or 
excess aggregate contribution.
    Qualified nonelective contributions (QNEC). Qualified nonelective 
contributions or QNEC means employer contributions, other than elective 
contributions or matching contributions, that satisfy the requirements 
of Sec. 1.401(k)-1(c) and (d) at the time the contribution is made, 
without regard to whether the contributions are actually taken into 
account under the ADP test under Sec. 1.401(k)-2(a)(6) or the ADP test 
under Sec. 1.401(m)-2(a)(6).

[T.D. 9169, 69 FR 78184, Dec. 29, 2004, as amended by T.D. 9237, 71 FR 
10, Jan. 3, 2006]



Sec. 1.402(a)-1  Taxability of beneficiary under a trust which meets 
the requirements of section 401(a).

    (a) In general. (1)(i) Section 402 relates to the taxation of the 
beneficiary of an employees' trust. If an employer makes a contribution 
for the benefit of an employee to a trust described in section 401(a) 
for the taxable year of the employer which ends within or with a taxable 
year of the trust for which the trust is exempt under section 501(a), 
the employee is not required to include such contribution in his income 
except for the year or years in which such contribution is distributed 
or made available to him. It is immaterial in the case of contributions 
to an exempt trust whether the employee's rights in the contributions to 
the trust are forfeitable or nonforfeitable either at the time the 
contribution is made to the trust or thereafter.
    (ii) The provisions of section 402(a) relate only to a distribution 
by a trust described in section 401(a) which is exempt under section 
501(a) for the taxable year of the trust in which the distribution is 
made. With two exceptions, the distribution from such an exempt trust 
when received or made available is taxable to the distributee to the 
extent provided in section 72 (relating to annuities). First, for 
taxable years beginning before January 1, 1964, section 72(e)(3) 
(relating to the treatment of certain lump sums), as in effect before 
such date, shall not apply to such distributions. For taxable years 
beginning after December 31, 1963, such distributions may be taken into 
account in computations under sections 1301 through 1305 (relating to 
income averaging). Secondly, certain total distributions described in 
section 402(a)(2) are taxable as long-term capital gains. For the 
treatment of such total distributions, see subparagraph (6) of this 
paragraph. Under certain circumstances, an amount representing the 
unrealized appreciation in the value of the securities of the employer 
is excludable from gross income for the year of distribution. For the 
rules relating to such exclusion, see paragraph (b) of this section. 
Furthermore, the exclusion provided by section 105(d) is applicable to a 
distribution from a trust described in section 401(a) and exempt under 
section 501(a) if such distribution constitutes wages or payments in 
lieu of wages for a period during which an employee is absent from work 
on account of a personal injury or sickness. See Sec. 1.72-15 for the 
rules relating to the tax treatment of accident or health benefits 
received under a plan to which section 72 applies.
    (iii) Except as provided in paragraph (b) of this section, a 
distribution of property by a trust described in section 401(a) and 
exempt under section 501(a) shall be taken into account by the 
distributee at its fair market value. In the case of a distribution of a 
life insurance contract, retirement income contract, endowment contract, 
or other contract providing life insurance protection, or any interest 
therein, the policy cash value and all other rights

[[Page 428]]

under such contract (including any supplemental agreements thereto and 
whether or not guaranteed) are included in determining the fair market 
value of the contract. In addition, in the case of a transfer of 
property that occurs on or after August 29, 2005 where a trust described 
in section 401(a) and exempt under section 501(a) transfers property to 
a plan participant or beneficiary in exchange for consideration and 
where the fair market value of the property transferred exceeds the 
value of the consideration, then the excess of the fair market value of 
the property transferred by the trust over the value of the 
consideration received by the trust is treated as a distribution to the 
distributee under the plan for all purposes under the Internal Revenue 
Code. Where such a transfer occurs before that date, the excess of the 
fair market value of the property transferred by the trust over the 
value of the consideration received by the trust is includible in the 
gross income of the participant or beneficiary under section 61. 
However, such a transfer of a life insurance contract, retirement income 
contract, endowment contract, or other contract providing life insurance 
protection occurring before that date is not treated as a distribution 
for purposes of applying the requirements of subchapter D of chapter 1 
of subtitle A of the Internal Revenue Code.
    (iv) If a trust is exempt for the taxable year in which the 
distribution occurs, but was not so exempt for one or more prior taxable 
years under section 501(a) (or under section 165(a) of the Internal 
Revenue Code of 1939 for years to which such section was applicable), 
the contributions of the employer which were includible in the gross 
income of the employee for the taxable year when made shall, in 
accordance with section 72(f), also be treated as part of the 
consideration paid by the employee.
    (v) If the trust is not exempt at the time the distribution is 
received by or made available to the employee, see section 402(b) and 
paragraph (b) of Sec. 1.402(b)-1.
    (vi) For the treatment of amounts paid to provide medical benefits 
described in section 401(h) as defined in paragraph (a) of Sec. 1.401-
14, see paragraph (h) of Sec. 1.72-15.
    (2) If a trust described in section 401(a) and exempt under section 
501(a) purchases an annuity contract for an employee and distributes it 
to the employee in a year in which the trust is exempt, and the contract 
contains a cash surrender value which may be available to an employee by 
surrendering the contract, such cash surrender value will not be 
considered income to the employee unless and until the contract is 
surrendered. For the rule as to nontransferability of annuity contracts 
issued after 1962, see Sec. 1.401-9(b)(1). For additional requirements 
regarding distributions of annuity contracts, see, e.g., Sec. Sec. 
1.401(a)-20, Q&A-2, 1.401(a)(31)-1, Q&A-17, and 1.401(a)(9)-6, Q&A-4. 
However, the distribution of an annuity contract must be treated as a 
lump sum distribution for purposes of determining the amount of tax 
under the 10-year averaging rule of section 402(e) (as in effect prior 
to amendment by the Tax Reform Act of 1986, Public Law 99-514, 100 Stat. 
2085). If, however, the contract distributed by such exempt trust is a 
life insurance contract, retirement income contract, endowment contract, 
or other contract providing life insurance protection, the fair market 
value of the contract at the time of distribution must be included in 
the distributee's income in accordance with the provisions of section 
402(a), except to the extent that, within 60 days after the distribution 
of the contract, all or any portion of such value is irrevocably 
converted into a contract under which no part of any proceeds payable on 
death at any time would be excludable under section 101(a) (relating to 
life insurance proceeds), or the contract is treated as a rollover 
contribution under section 402(c). If the contract distributed by such 
trust is a transferable annuity contract, or a retirement income, 
endowment, or other life insurance contract and such contract is not 
treated as a rollover contribution under section 402(c), then, 
notwithstanding the preceding sentence, the fair market value of the 
contract is includible in the distributee's gross income unless, within 
such 60 days, such contract is made nontransferable.

[[Page 429]]

    (3) For the rules applicable to premiums paid by a trust described 
in section 401(a) and exempt under section 501(a) for the purchase of 
retirement income, endowment, or other contracts providing life 
insurance protection payable upon the death of the employee-participant, 
see paragraph (b) of Sec. 1.72-16.
    (4) For the rules applicable to the amounts payable by reason of the 
death of an employee under a contract providing life insurance 
protection, or an annuity contract, purchased by a trust described in 
section 401(a) and exempt under section 501(a), see paragraph (c) of 
Sec. 1.72-16.
    (5) If pension or annuity payments or other benefits are paid or 
made available to the beneficiary of a deceased employee or a deceased 
retired employee by a trust described in section 401(a) which is exempt 
under section 501(a), such amounts are taxable in accordance with the 
rules of section 402(a) and this section. In case such amounts are 
taxable under section 72, the ``investment in the contract'' shall be 
determined by reference to the amount contributed by the employee and by 
applying the applicable rules of sections 72 and 101(b)(2)(D). In case 
the amounts paid to, or includible in the gross income of, the 
beneficiaries of the deceased employee or deceased retired employee 
constitute a distribution to which subparagraph (6) of this paragraph is 
applicable, the extent to which the distribution is taxable is 
determined by reference to the contributions of the employee, by 
reference to any prior distributions which were excludable from gross 
income as a return of employee contributions, and by applying the 
applicable rules of sections 72 and 101(b).
    (6)(i) If the total distributions payable with respect to any 
employee under a trust described in section 401(a) which in the year of 
distribution is exempt under section 501(a) are paid to, or includible 
in the gross income of, the distributee within one taxable year of the 
distributee on account of the employee's death or other separation from 
the service, or death after such separation from service, the amount of 
such distribution, to the extent it exceeds the net amount contributed 
by the employee, shall be considered a gain from the sale or exchange of 
a capital asset held for more than six months. The total distributions 
payable are includible in the gross income of the distributee within one 
taxable year if they are made available to such distributee and the 
distributee fails to make a timely election under section 72(h) to 
receive an annuity in lieu of such total distributions. The ``net amount 
contributed by the employee'' is the amount actually contributed by the 
employee plus any amounts considered to be contributed by the employee 
under the rules of section 72(f), 101(b), and subparagraph (3) of this 
paragraph, reduced by any amounts theretofore distributed to him which 
were excludable from gross income as a return of employee contributions. 
See, however, paragraph (b) of this section for rules relating to the 
exclusion of amounts representing net unrealized appreciation in the 
value of securities of the employer corporation. In addition, all or 
part of the amount otherwise includible in gross income under this 
paragraph by a non-resident alien individual in respect of a 
distribution by the United States under a qualified pension plan may be 
excludable from gross income under section 402(a)(4). For rules relating 
to such exclusion, see paragraph (c) of this section. For additional 
rules relating to the treatment of total distributions described in this 
subdivision in the case of a nonresident alien individual, see sections 
871 and 1441 and the regulations thereunder.
    (ii) The term ``total distributions payable'' means the balance to 
the credit of an employee which becomes payable to a distributee on 
account of the employee's death or other separation from the service or 
on account of his death after separation from the service. Thus, 
distributions made before a total distribution (for example, annuity 
payments received by the employee after retirement), will not defeat 
application of the capital gains treatment with respect to the total 
distributions received by a beneficiary upon the death of the employee 
after retirement. However, a distribution on separation from service 
will not receive capital gains treatment unless it

[[Page 430]]

constitutes the total amount in the employee's account at the time of 
his separation from service. If the total amount in the employee's 
account at the time of his death or other separation from the service or 
death after separation from the service is paid or includible in the 
gross income of the distributee within one taxable year of the 
distributee, such amount is entitled to the capital gains treatment 
notwithstanding that in a later taxable year an additional amount, 
attributable to the last year of service, is credited to the account of 
the employee and distributed.
    (iii) If an employee retires and commences to receive an annuity but 
subsequently, in some succeeding taxable year, is paid a lump sum in 
settlement of all future annuity payments, the capital gains treatment 
does not apply to such lump sum settlement paid during the lifetime of 
the employee since it is not a payment on account of separation from the 
service, or death after separation, but is on account of the settlement 
of future annuity payments.
    (iv) If the ``total distributions payable'' are paid or includible 
in the gross income of several distributees within one taxable year on 
account of the employee's death or other separation from the service or 
on account of his death after separation from the service, the capital 
gains treatment is applicable. The total distributions payable are paid 
within one taxable year of the distributees when, for example, a portion 
of such total is distributed in cash to one distributee and the balance 
is used to purchase an annuity contract which is distributed to the 
other distributee. However, if the share of any distributee is not paid 
or includible in his gross income within the same taxable year in which 
the shares of the other distributees are paid or includible in their 
gross income, none of the distributees is entitled to the capital gains 
treatment, since the total distributions payable are not paid or 
includible in the distributees' gross income within one taxable year. 
For example, if the total distributions payable are made available to 
each of two distributees and one elects to receive his share in cash 
while the other makes a timely election under section 72(h) to receive 
his share in installment payments from the trust, the capital gains 
treatment does not apply to either distributee.
    (v) For regulations as to certain plan terminations, see Sec. 
1.402(e)-1.
    (vi) The term ``total distributions payable'' does not include 
United States Retirement Plan Bonds held by a trust to the credit of an 
employee. Thus, a distribution by a qualified trust may constitute a 
total distributions payable with respect to an employee even though the 
trust retains retirement plan bonds registered in the name of such 
employee. Similarly, the proceeds of a retirement plan bond received as 
a part of the total amount to the credit of an employee will not be 
entitled to capital gains treatment. See section 405(e) and paragraph 
(a)(4) of Sec. 1.405-3.
    (vii) For purposes of determining whether the total distributions 
payable to an employee have been distributed within one taxable year, 
the term ``total distributions payable'' includes amounts held by a 
trust to the credit of an employee which are attributable to 
contributions on behalf of the employee while he was a self-employed 
individual in the business with respect to which the plan was 
established. Thus, a distribution by a qualified trust is not a total 
distributions payable with respect to an employee if the trust retains 
amounts which are so attributable.
    (viii) The term ``total distributions payable'' does not include any 
amount which has been placed in a separate account for the funding of 
medical benefits described in section 401(h) as defined in paragraph (a) 
of Sec. 1.401-14. Thus, a distribution by a qualified trust may 
constitute a total distributions payable with respect to an employee 
even though the trust retains amounts attributable to the funding of 
medical benefits described in section 401(h).
    (7) The capital gains treatment provided by section 402(a)(2) and 
subparagraph (6) of this paragraph is not applicable to distributions 
paid to a distributee to the extent such distributions are attributable 
to contributions made on behalf of an employee while

[[Page 431]]

he was a self-employed individual in the business with respect to which 
the plan was established. For the taxation of such amounts, see Sec. 
1.72-18. For the rules for determining the amount attributable to 
contributions on behalf of an employee while he was self-employed, see 
paragraphs (b)(4) and (c)(2) of such section.
    (8) For purposes of this section, the term ``employee'' includes a 
self-employed individual who is treated as an employee under section 
401(c)(1), and paragraph (b) of Sec. 1.401-10, and the term 
``employer'' means the person treated as the employer of such individual 
under section 401(c)(4).
    (b) Distributions including securities of the employer corporation--
(1) In general. (i) If a trust described in section 401(a) which is 
exempt under section 501(a) makes a distribution to a distributee, and 
such distribution includes securities of the employer corporation, the 
amount of any net unrealized appreciation in such securities shall be 
excluded from the distributee's income in the year of such distribution 
to the following extent:
    (A) If the distribution constitutes a total distribution to which 
the regulations of paragraph (a)(6) of this section are applicable, the 
amount to be excluded is the entire net unrealized appreciation 
attributable to that part of the total distribution which consists of 
securities of the employer corporation; and
    (B) If the distribution is other than a total distribution to which 
paragraph (a)(6) of this section is applicable, the amount to be 
excluded is that portion of the net unrealized appreciation in the 
securities of the employer corporation which is attributable to the 
amount considered to be contributed by the employee to the purchase of 
such securities.

The amount of net unrealized appreciation which is excludable under the 
regulations of (A) and (B) of this subdivision shall not be included in 
the basis of the securities in the hands of the distributee at the time 
of distribution for purposes of determining gain or loss on their 
subsequent disposition. In the case of a total distribution the amount 
of net unrealized appreciation which is not included in the basis of the 
securities in the hands of the distributee at the time of distribution 
shall be considered as a gain from the sale or exchange of a capital 
asset held for more than six months to the extent that such appreciation 
is realized in a subsequent taxable transaction. However, if the net 
gain realized by the distributee in a subsequent taxable transaction 
exceeds the amount of the net unrealized appreciation at the time of 
distribution, such excess shall constitute a long-term or short-term 
capital gain depending upon the holding period of the securities in the 
hands of the distributee.
    (ii) For purposes of section 402(a) and of this section, the term 
``securities'' means only shares of stock and bonds or debentures issued 
by a corporation with interest coupons or in registered form, and the 
term ``securities of the employer corporation'' includes securities of a 
parent or subsidiary corporation (as defined in subsections (e) and (f) 
of section 425) of the employer corporation.
    (2) Determination of net unrealized appreciation. (i) The amount of 
net unrealized appreciation in securities of the employer corporation 
which are distributed by the trust is the excess of the market value of 
such securities at the time of distribution over the cost or other basis 
of such securities to the trust. Thus, if a distribution consists in 
part of securities which have appreciated in value and in part of 
securities which have depreciated in value, the net unrealized 
appreciation shall be considered to consist of the net increase in value 
of all of the securities included in the distribution. For this purpose, 
two or more distributions made by a trust to a distributee in a single 
taxable year of the distributee shall be treated as a single 
distribution.
    (ii) For the purpose of determining the net unrealized appreciation 
on a distributed security of the employer corporation, the cost or other 
basis of such security to the trust shall be computed in accordance with 
whichever of the following rules is applicable:
    (A) If a security was earmarked for the account of a particular 
employee at the time it was purchased by or contributed to the trust so 
that the cost or

[[Page 432]]

other basis of such security to the trust is reflected in the account of 
such employee, such cost or other basis shall be used.
    (B) If as of the close of each taxable year of the trust (or other 
specified period of time not in excess of 12 consecutive calendar 
months) the trust allocates among the accounts of participating 
employees all securities acquired by the trust during the period 
(exclusive of securities unallocated under a plan providing for 
allocation in whole shares only), the cost or other basis to the trust 
of any securities allocated as of the close of a particular allocation 
period shall be the average cost or other basis to the trust of all 
securities of the same type which were purchased or otherwise acquired 
by the trust during such allocation period. For purposes of determining 
the average cost to the trust of securities included in a subsequent 
allocation, the actual cost to the trust of the securities unallocated 
as of the close of a prior allocation period shall be deemed to be the 
average cost or other basis to the trust of securities of the same type 
allocated as of the close of such prior allocation period.
    (C) In a case where neither (a) nor (b) of this subdivision is 
applicable, if the trust fund, or a specified portion thereof, is 
invested exclusively in one particular type of security of the employer 
corporation, and if during the period the distributee participated in 
the plan none of such securities has been sold except for the purpose of 
paying benefits under the trust or for the purpose of enabling the 
trustee to obtain funds with which to exercise rights which have accrued 
to the trust, the cost or other basis to the trust of all securities 
distributed to such distributee shall be the total amount credited to 
the account of such distributee (or such portion thereof as was 
available for investment in such securities) reduced by the amount 
available for investment but uninvested on the date of distribution. If 
at the time of distribution to a particular distributee a portion of the 
amount credited to his account is forfeited, appropriate adjustment 
shall be made with respect thereto in determining the cost or other 
basis to the trust of the securities distributed.
    (D)(1) In all other cases, there shall be used the average cost (or 
other basis) to the trust of all securities of the employer corporation 
of the type distributed to the distributee which the trust has on hand 
at the time of the distribution, or which the trust had on hand on a 
specified inventory date which date does not precede the date of 
distribution by more than twelve calendar months. If a distribution 
includes securities of the employer corporation of more than one type, 
the average cost (or other basis) to the trust of each type of security 
distributed shall be determined. The average cost to the trust of 
securities of the employer corporation on hand on a specified inventory 
date (or on hand at the time of distribution) shall be computed on the 
basis of their actual cost, considering the securities most recently 
purchased to be those on hand, or by means of a moving average 
calculated by subtracting from the total cost of securities on hand 
immediately preceding a particular sale or distribution an amount 
computed by multiplying the number of securities sold or distributed by 
the average cost of all securities on hand preceding such sale or 
distribution.
    (2) These methods of computing average cost may be illustrated by 
the following examples:

    Example 1. A, a distributee who makes his income tax returns on the 
basis of a calendar year, receives on August 1, 1954, in a total 
distribution, to which paragraph (a)(6) of this section is applicable, 
ten shares of class D stock of the employer corporation. On July 1, 1954 
(the specified inventory date of the trust), the trust had on hand 80 
shares of class D stock. The average cost of the 10 shares distributed, 
on the basis of the actual cost method, is $100 computed as follows:

------------------------------------------------------------------------
                                                          Cost
              Shares                  Purchase date       per     Total
                                                         share     cost
------------------------------------------------------------------------
20...............................  June 24, 1954......     $101   $2,020
40...............................  Jan. 10, 1953......      102    4,080
20...............................  Oct. 20, 1952......       95    1,900
----------------------------------                              --------
80...............................  ...................    8,000
------------------------------------------------------------------------

    Example 2. B, a distributee who makes his income tax returns on the 
basis of a calendar year, receives on October 31, 1954, in a total 
distribution, to which paragraph (a)(6) of this section is applicable, 
20 shares of class E

[[Page 433]]

stock of the employer corporation. The specified inventory date of the 
trust is the last day of each calendar year. The trust had on hand on 
December 31, 1952, 1,000 shares of class E stock of the employer 
corporation. During the calendar year 1953 the trust distributed to four 
distributees a total of 100 shares of such stock and acquired, through a 
number of purchases, a total of 120 shares. The average cost of the 20 
shares distributed to B, on the basis of the moving average method, is 
$52 computed as follows:

------------------------------------------------------------------------
                                                        Total    Average
                                              Shares    cost      cost
------------------------------------------------------------------------
On hand Dec. 31, 1952......................    1,000   $50,000       $50
Distributed during 1953 at average cost of       100     5,000       (0)
 $50.......................................
                                            ----------------------------
                                                 900    45,000       (0)
Purchased during 1953......................      120     8,000       (0)
On hand Dec. 31, 1953......................    1,020    53,040        52
------------------------------------------------------------------------

    (3) Unrealized appreciation attributable to employee contributions. 
In any case in which it is necessary to determine the amount of net 
unrealized appreciation in securities of the employer corporation which 
is attributable to contributions made by an employee:
    (i) The cost or other basis of the securities to the trust and the 
amount of net unrealized appreciation shall first be determined in 
accordance with the regulations in subparagraph (2) of this paragraph;
    (ii) The amount contributed by the employee to the purchase of the 
securities shall be solely the portion of his actual contributions to 
the trust properly allocable to such securities, and shall not include 
any part of the increment in the trust fund expended in the purchase of 
the securities;
    (iii) The amount of net unrealized appreciation in the securities 
distributed which is attributable to the contributions of the employee 
shall be that proportion of the net unrealized appreciation determined 
under the regulations of subparagraph (2) of this paragraph which the 
contributions of the employee properly allocable to such securities bear 
to the cost or other basis to the trust of the securities;
    (iv) If a distribution consists solely of securities of the employer 
corporation, the contributions of the employee expended in the purchase 
of such securities shall be allocated to the securities distributed in a 
manner consistent with the principles set forth in subparagraph (2)(ii) 
(a), (b), (c), or (d) of this paragraph, whichever is applicable. Thus, 
the amount of the employee's contribution which can be identified as 
having been expended in the purchase of a particular security shall be 
allocated to such security, and the amount of such contribution which 
cannot be so identified shall be allocated ratably among the securities 
distributed. If a distribution consists in part of securities of the 
employer corporation and in part of cash or other property, appropriate 
allocation of a portion of the employee's contribution to such cash or 
other property shall be made unless such a location is inconsistent with 
the terms of the plan or trust.
    (v) The application of this subparagraph may be illustrated by the 
following example:

    Example. A trust distributes ten shares of stock issued by the 
employer corporation each of which has an average cost to the trust of 
$100, consisting of employee contributions in the amount of $60 and 
employer contributions in the amount of $40, and on the date of 
distribution has a fair market value of $180. The portion of the net 
unrealized appreciation attributable to the contributions of the 
employee with respect to each of the shares of stock is $48 computed as 
follows:

(1) Value of one share of stock on distribution date............    $180
                                                                 =======
(2) Employee contributions......................................      60
(3) Employer contributions......................................      40
                                                                 -------
(4) Total contributions.........................................     100
                                                                 =======
(5) Net unrealized appreciation.................................      80
(6) Portion of net unrealized appreciation attributable to            48
 employee contributions \60/100\ (amount of employee
 contributions (item 2) over total contributions (item 4) of $80
 (item 5).......................................................
 

    (vi) For the purpose of determining gain or loss to the distributee 
in the year or years in which any share of stock referred to in the 
example in subdivision (v) of this subparagraph is sold or otherwise 
disposed of in a taxable transaction, the basis of each such share in 
the hands of the distributee at the time of the distribution by the 
trust will be $132 computed as follows:

(a) Employee contributions......................................     $60
(b) Employer contributions (taxable as ordinary income in the         40
 year the securities were distributed)..........................
(c) Portion of net unrealized appreciation attributable to            32
 employer contributions (item 5) minus (item 6) (taxable as
 ordinary income in the year the securities were distributed)...
                                                                 -------

[[Page 434]]

 
(d) Basis of stock..............................................     132
 

    (4) Change in exempt status of trust. For principles applicable in 
making appropriate adjustments if the trust was not exempt for one or 
more years before the year of distribution, see paragraph (a) of this 
section.
    (c) Certain distributions by United States to nonresident alien 
individuals. (1) This paragraph applies to a distribution--
    (i) Which is made by the United States under a pension plan 
described in section 401(a);
    (ii) Which is made in respect of services performed by an employee 
of the United States; and
    (iii) Which is received by, or made available to, a nonresident 
alien individual (including a nonresident alien individual who is a 
beneficiary of a deceased employee) during a taxable year beginning 
after December 31, 1959.


The amount of such a distribution that is includible in the gross income 
of the nonresident alien individual under section 402(a) (1) or (2) 
shall not exceed an amount which bears the same ratio to the amount 
which would be includible in gross income if it were not for this 
paragraph, as--
    (A) The aggregate basic salary paid by the United States to the 
employee for his services in respect of which the distribution is being 
made, reduced by the amount of such basic salary which was not 
includible in the employee's gross income by reason of being from 
sources without the United States, bears to
    (B) The aggregate basic salary paid by the United States to the 
employee for his services in respect of which the distribution is being 
made.


See section 402(a)(4). See, also, paragraph (a) of this section for 
rules relating to the amount that is includible in gross income under 
section 402(a) (1) or (2) in the case of a distribution under a pension 
plan described in section 401(a).
    (2) For purposes of applying section 402(a)(4) and this paragraph to 
distributions under the Civil Service Retirement Act (5 U.S.C. 2251), 
the term ``basic salary'' shall have the meaning provided in section 
1(d) of such Act. In applying section 402(a)(4) and this paragraph to 
distributions under any other qualified pension plan of the United 
States, such term shall have a similar meaning. Thus, for example, 
``basic salary'' does not, in any case, include bonuses, allowances, or 
overtime pay.
    (3) The rules in this paragraph may be illustrated by the following 
examples:

    Example 1. A, a retired employee of the United States who performed 
all of his services for the United States in a foreign country, 
receives, in respect of such services, a monthly pension of $200 under 
the Civil Service Retirement Act (a pension plan described in section 
410(a)). A received an aggregate basic salary for his services for the 
United States of $100,000. A was a nonresident alien individual during 
the whole of his employment with the United States and, therefore, his 
basic salary from the United States was not includible in his gross 
income by reason of being from sources without the United States. A 
would be requited, under section 72 but without regard to section 
402(a)(4) and this paragraph, to include $60 of each monthly pension 
payment in his gross income. The amount that is includible in A's gross 
income under section 402(a)(1) with respect to the monthly payments 
received during taxable years beginning after December 31, 1959, and 
while A is a nonresident alien individual, is computed as follows:

(i) Amount of distribution includible in gross income under          $60
 section 72 without regard to section 402(a)(4)...............
(ii) Aggregate basic salary for services for United States....   100,000
(iii) Aggregate basic salary for services for United States            0
 reduced by amount of such salary not includible in A's gross
 income by reason of being from sources without the United
 States.......................................................
(iv) Amount includible in A's gross income under section               0
 402(a)(1) ((iii)/(ii)x(i), or $0/$100,000x$60)...............
 

    Example 2. B, a retired employee of the United States who performed 
services for the United States both in a foreign country and in the 
United States, receives, in respect of such services, a monthly pension 
of $240 under the Civil Service Retirement Act. B received an aggregate 
basic salary for his services for the United States of $120,000; $80,000 
of which was for his services performed in the United States, and 
$40,000 of which was for his services performed in the foreign country. 
B was a nonresident alien individual during the whole of his employment 
with the United States and, consequently, the $40,000 basic salary for 
his services performed in the foreign country was not includible in his 
gross income by reason of being from sources without the United States. 
B would be required, under section 72 but without regard to section 
402(a)(4) and this paragraph, to include $165 of each monthly pension in 
his gross income.

[[Page 435]]

The amount that is includible in B's gross income under section 
402(a)(1) with respect to the monthly payments received during taxable 
years beginning after December 31, 1959, and while B is a nonresident 
alien individual, is computed as follows:

(i) Amount of distribution includible in gross income under         $165
 section 72 without regard to section 402(a)(4)...............
(ii) Aggregate basic salary for services for United States....   120,000
(iii) Aggregate basic salary for services for United States       80,000
 reduced by amount of such salary not includible in B's gross
 income by reason of being from sources without the United
 States ($120,000-$40,000)....................................
(iv) Amount includible in B's gross income under section             110
 402(a)(1)(iii)/(ii)x(i), or $80,000/$120,000x$165)...........
 

    (d) Salary reduction, cash or deferred arrangements--(1) Inclusion 
in income. Whether a contribution to an exempt trust or plan described 
in section 401(a) or 403(a) is made by the employer or the employee is 
determined on the basis of the particular facts and circumstances of 
each case. Nevertheless, an amount contributed to a plan or trust will, 
except as otherwise provided under paragraph (d)(2) of this section, be 
treated as contributed by the employee if it was contributed at the 
employee's election, even though the election was made before the year 
in which the amount was earned by the employee or before the year in 
which the amount became currently available to the employee. Any amount 
treated as contributed by the employee is includible in the gross income 
of the employee for the year in which the amount would have been 
received by the employee but for the election. Thus, for example, 
amounts contributed to an exempt trust or plan by reason of a salary 
reduction agreement under a cash or deferred arrangement are treated as 
received by the employee when they would have been received by the 
employee but for the election to defer. Accordingly, they are includible 
in the gross income of the employee for that year (except as provided 
under paragraph (d)(2) of this section). See Sec. 1.401(k)-1(a)(3)(iv) 
and (2)(iv) for the meaning of currently available and cash or deferred 
arrangement, respectively.
    (2) Amounts not included in income--(i) Qualified cash or deferred 
arrangement. Elective contributions as defined in Sec. 1.401(k)-6 for a 
plan year made by an employer on behalf of an employee pursuant to a 
cash or deferred election under a qualified cash or deferred 
arrangement, as defined in Sec. 1.401(k)-1(a)(4)(i), are not treated as 
received by or distributed to the employee or as employee contributions. 
For plan years beginning after December 31, 1992, whether a cash or 
deferred election is made under a qualified cash or deferred arrangement 
is determined without regard to the special rules for certain 
collectively bargained plans contained in Sec. 1.401(k)-1(a)(5)(iv)(B). 
As a result, elective contributions under these plans are treated as 
employee contributions for purposes of this section if the cash or 
deferred arrangement does not satisfy the actual deferral percentage 
test of section 401(k)(3) or otherwise fails to be a qualified cash or 
deferred arrangement.
    (ii) Matching contributions. Matching contributions described in 
Sec. 1.401(m)-1(a)(2) and section 401(m)(4) are not treated as 
contributed by an employee merely because they are made by the employer 
as a result of an employee's election.
    (iii) Effect of certain one-time elections. Amounts contributed to 
an exempt plan or trust described in section 401(a) or 403(a) pursuant 
to the one-time irrevocable employee election to participate in a plan 
described in Sec. 1.401(k)-1(a)(3)(v) are not treated as contributed by 
an employee. Similarly, amounts contributed to an exempt plan or trust 
described in section 401(a) or 403(a) in which self-employed individuals 
may participate pursuant to the one-time irrevocable election described 
in Sec. 1.401(k)-1(a)(3)(v)(B) are not treated as contributed by an 
employee.
    (3) Effective date and transition rules--(i) Effective date. In the 
case of a plan or trust that does not include a salary reduction or cash 
or deferred arrangement in existence on June 27, 1974, this paragraph 
applies to taxable years ending after that date.
    (ii) Transition rule for cash or deferred arrangements in existence 
on June 27, 1974--(A) General rule. In the case of a plan or trust that 
includes a salary reduction or a cash or deferred arrangement in 
existence on June 27, 1974, this paragraph applies to plan years 
beginning after December 31, 1979 (or, in the

[[Page 436]]

case of a pre-ERISA money purchase plan, as defined in Sec. 1.401(k)-
1(g)(12), plan years beginning after July 18, 1984). For plan years 
beginning prior to January 1, 1980 (or, in the case of a pre-ERISA money 
purchase plan, plan years beginning before July 19, 1984), the taxable 
year of inclusion in gross income of the employee of any amount so 
contributed by the employer to the trust is determined in a manner 
consistent with Rev. Rul. 56-497, 1956-2 CB 284, Rev. Rul. 63-180, 1963-
2 CB 189, and Rev. Rul. 68-89, 1968-1 CB 402.
    (B) Meaning of cash or deferred arrangement in existence on June 27, 
1974. A cash or deferred arrangement is considered as in existence on 
June 27, 1974, if, on or before that date, it was reduced to writing and 
adopted by the employer (including, in the case of a corporate employer, 
formal approval by the employer's board of directors and, if required, 
shareholders), even though no amounts had been contributed pursuant to 
the terms of the arrangement as of that date.
    (iii) Reasonable interpretation for plan years beginning after 1979 
and before 1992. For plan years beginning after December 31, 1979 (or in 
the case of a pre-ERISA money purchase plan, plan years beginning after 
July 18, 1984) and before January 1, 1992, a reasonable interpretation 
of the rules set forth in section 401(k) (as in effect during those 
years) may be relied upon to determine whether contributions were made 
under a qualified cash or deferred arrangement.
    (iv) Special rule for collectively bargained plans. For plan years 
beginning before January 1, 1993, a nonqualified cash or deferred 
arrangement will be treated as satisfying section 401(k)(3) solely for 
purposes of paragraph (d)(2)(i) of this section if it is part of a plan 
(or portion of a plan) that automatically satisfies section 401(a)(4) 
under Sec. 1.401(k)-1(a)(5)(iv)(B), relating to certain collectively 
bargained plans.
    (v) Special rule for governmental plans. For plan years beginning 
before the later of January 1, 1996, or 90 days after the opening of the 
first legislative session beginning on or after January 1, 1996, of the 
governing body with authority to amend the plan, if that body does not 
meet continuously, in the case of governmental plans described in 
section 414(d), a nonqualified cash or deferred arrangement will be 
treated as satisfying section 401(k)(3) solely for purposes of paragraph 
(d)(2)(i) of this section if it is part of a plan adopted by a state or 
local government before May 6, 1986. For purposes of this paragraph 
(d)(3)(v), the term governing body with authority to amend the plan 
means the legislature, board, commission, council, or other governing 
body with authority to amend the plan.

[T.D. 6500, 25 FR 11675, Nov. 26, 1960]

    Editorial Note: For Federal Register citations affecting Sec. 
1.402(a)-1, see the List of CFR Sections Affected, which appears in the 
Finding Aids section of the printed volume and at www.fdsys.gov.



Sec. 1.402(a)(5)-1T  Rollovers of partial distributions from qualified 
trusts and annuities. (Temporary)

    Q-1: Can an employee or the surviving spouse of a deceased employee 
roll over to an individual retirement account or annuity, described in 
section 408 (a) or (b), the taxable portion of a partial distribution 
from a qualifiedtrust described in section 401(a), a qualified plan 
described in section 403(a), or a tax-sheltered annuity contract under 
section 403(b)?
    A-1: Yes. For distributions made after July 18, 1984, the taxable 
portion of a partial distribution may be rolled over within 60 days of 
the distribution to an individual retirement account or annuity.
    Q-2: Are there special requirements applicable to rollovers of 
partial distributions?
    A-2: Yes. Section 402(a)(5)(D)(i) specifies that no part of a 
partial distribution may be rolled over unless the distribution is equal 
to at least 50 percent of the balance to the credit of the employee in 
the contract or plan immediately before the distribution, and the 
distribution is not one of a series of periodic payments. For purposes 
of this section, the balance to the credit of an employee does not 
include any accumulated deductible employee contributions (within the 
meaning of section 72(o)). In addition, in calculating the balance to 
the credit for purposes of the 50 percent test, qualified plans are

[[Page 437]]

not to be aggregated with other qualified plans and tax-sheltered 
annuity contracts are not to be aggregated with other tax-sheltered 
annuity contracts. Also, in applying the 50 percent test to a surviving 
spouse, the balance to the credit is the maximum amount the spouse is 
entitled to receive under the plan or contract, rather than the total 
balance to the credit of the employee. The rollover of a partial 
distribution may result in adverse tax consequences; see section 
402(a)(5)(D) (iii) and (iv).
    Q-3: Are there any other requirements applicable to rollovers of 
partial distribution?
    A-3: Yes. Section 402(a)(5)(D)(i)(III) requires the employee to 
elect, in conformance with Treasury regulations, to treat a contribution 
of a partial distribution to an IRA as a rollover contribution. An 
election is made by designating, in writing, to the trustee or issuer of 
the IRA at the time of the contribution that the contribution is to be 
treated as a rollover contribution. This requirement of a written 
designation to the trustee or issuer of the IRA is effective for 
contributions paid to the trustee or issuer of the IRA after March 20, 
1986. For contributions paid to the trustee or issuer before March 21, 
1986, an election is made by computing the individual's income tax 
liability on the income tax return for the taxable year in which the 
distribution occurs in a manner consistent with not including the 
distribution (or portion thereof) in gross income. Both such elections 
are irrevocable, except that an election made on an income tax return 
filed before March 21, 1986 is revocable.
    Q-4: Does the election requirement apply to rollovers of qualified 
total distributions or rollover contributions described in section 
402(a) (5) or (7), 403(a)(4), 403(b)(8), 405(d)(3), or 408(d)(3) to 
individual retirement accounts and annuities (IRAs)?
    A-4: Yes. No amounts may be treated as a rollover contribution to an 
IRA under section 402(a)(5), 402(a)(7), 403(a)(4), 403(b)(8), 405(d)(3) 
(as amended by section 491(c) of the TRA of 1984), or 408(d)(3) unless 
the requirements described in Q & A-3 of this section are satisfied. 
Thus, once any portion of a total distribution is irrevocably designated 
as a rollover contribution, such distribution is not taxable under 
section 402 or 403 and, therefore, is not eligible for the special 
capital gains and separate tax treatment under section 402 (a) and (e). 
Election requirements for rollover contributions to IRAs described in 
this Q &A-4 are subject to the same effective date rules set forth in Q 
&A-3.

[T.D. 8073, 51 FR 4320, Feb. 4, 1986]



Sec. 1.402(b)-1  Treatment of beneficiary of a trust not exempt under 
section 501(a).

    (a) Taxation by reason of employer contributions made after August 
1, 1969--(1) Taxation of contributions. Section 402(b) provides rules 
for taxing an employee on contributions made on his behalf by an 
employer to an employees' trust that is not exempt under section 501(a). 
In general, any such contributions made after August 1, 1969, during a 
taxable year of the employer which ends within or with a taxable year of 
the trust for which it is not so exempt shall be included as 
compensation in the gross income of the employee for his taxable year 
during which the contribution is made, but only to the extent that the 
employee's interest in such contribution is substantially vested at the 
time the contribution is made. The preceding sentence does not apply to 
contracts referred to in the transitional rule of paragraph (d)(1) (ii) 
or (iii) of this section. For the definition of the terms 
``substantially vested'' and ``substantially nonvested'' see Sec. 1.83-
3(b).
    (2) Determination of amount of employer contributions. If, for an 
employee, the actual amount of employer contributions referred to in 
paragraph (a)(1) of this section for any taxable year of the employee is 
not determinable or for any other reason is not known, then, except as 
set forth in rules prescribed by the Commissioner in revenue rulings, 
notices, or other guidance published in the Internal Revenue Bulletin 
(see Sec. 601.601(d)(2)(ii)(b) of this chapter), such amount shall be 
either--
    (i) The excess of--
    (A) The amount determined as of the end of such taxable year in 
accordance

[[Page 438]]

with the formula described in Sec. 1.403(b)-1(d)(4), as it appeared in 
the April 1, 2006, edition of 26 CFR Part 1; over
    (B) The amount determined as of the end of the prior taxable year in 
accordance with the formula described in paragraph (a)(2)(i)(A) of this 
section; or
    (ii) The amount determined under any other method utilizing 
recognized actuarial principles that are consistent with the provisions 
of the plan under which such contributions are made and the method 
adopted by the employer for funding the benefits under the plan.
    (b) Taxability of employee when rights under nonexempt trust change 
from nonvested to vested--(1) In general. If rights of an employee under 
a trust become substantially vested during a taxable year of the 
employee (ending after August 1, 1969), and a taxable year of the trust 
for which it is not exempt under section 501(a) ends with or within such 
year, the value of the employee's interest in the trust on the date of 
such change shall be included in his gross income for such taxable year, 
to the extent provided in paragraph (b)(3) of this section. When an 
employees' trust that was exempt under section 501(a) ceases to be so 
exempt, an employee shall include in his gross income only amounts 
contributed to the trust during a taxable year of the employer that ends 
within or with a taxable year of the trust in which it is not so exempt 
(to the same extent as if the trust had not been so exempt in all prior 
taxable years).
    (2) Value of an employee's interest in a trust. (i) For purposes of 
this section, the term ``the value of an employee's interest in a 
trust'' means the amount of the employee's beneficial interest in the 
net fair market value of all the assets in the trust as of any date on 
which some or all of the employee's interest in the trust becomes 
substantially vested. The net fair market value of all the assets in the 
trust is the total amount of the fair market values (determined without 
regard to any lapse restriction, as defined in Sec. 1.83-3(h)) of all 
the assets in the trust, less the amount of all the liabilities 
(including taxes) to which such assets are subject or which the trust 
has assumed (other than the rights of any employee in such assets), as 
of the date on which some or all of the employee's interest in the trust 
becomes substantially vested.
    (ii) If a separate account in a trust for the benefit of two or more 
employees is not maintained for each employee, the value of the 
employee's interest in such trust is determined in accordance with rules 
prescribed by the Commissioner under the authority in paragraph (a)(2) 
of this section.
    (iii) If there is no valuation of a nonexempt trust's assets on the 
date of the change referred to in paragraph (b)(1) of this section, the 
value of an employee's interest in such trust is determined by taking 
the weighted average of the values on the nearest valuation dates 
occurring before and after the date of such change. The average is to be 
determined in the manner described in Sec. 20.2031-2(b)(1).
    (3) Extent to which value of an employee's interest is includible in 
gross income. For purposes of paragraph (b)(1) of this section, there 
shall be included in the gross income of the employee for his taxable 
year in which his rights under the trust become substantially vested 
only that portion of the value of his interest in the trust that is 
attributable to contributions made by the employer after August 1, 1969. 
However, the preceding sentence shall not apply--
    (i) To the extent such value is attributable to a contribution made 
on the date of such change, and
    (ii) To the extent such value is attributable to contributions 
described in paragraph (d)(1) (ii) or (iii) of this section (relating to 
contributions made pursuant to a binding contract entered into before 
April 22, 1969).

For purposes of this (3), if the value of an employee's interest in a 
trust which is attributable to contributions made by the employer after 
August 1, 1969, is not known, it shall be deemed to be an amount which 
bears the same ratio to the value of the employee's interest as the 
contributions made by the employer after such date bear to the total 
contributions made by the employer.
    (4) Partial vesting. For purposes of paragraph (b)(1) of this 
section, if only part of an employee's interest in the trust becomes 
substantially vested during any taxable year, then only the 
corresponding part of the value of the

[[Page 439]]

employee's interest in such trust is includible in his gross income for 
such year. In such a case, it is first necessary to compute, under the 
rules in paragraphs (b) (1) and (2) of this section, the amount that 
would be includdible if his entire interest had changed to a 
substantially vested interest during such a year. The amount that is 
includible under this paragraph (4) is the amount determined under the 
preceding sentence multiplied by the percent of the employee's interest 
which became substantially vested during the taxable year.
    (5) Basis. The basis of any employee's interest in a trust to which 
this section applies shall be increased by the amount included in his 
gross income under this section.
    (6) Treatment as owner of trust. In general, a beneficiary of a 
trust to which this section applies may not be considered to be the 
owner under subpart E, part I, subchapter J, chapter I of the Code of 
any portion of such trust which is attributable to contributions to such 
trust made by the employer after August 1, 1969, or to incidental 
contributions made by the employee after such date. However, where 
contributions made by the employee are not incidental when compared to 
contributions made by the employer, such beneficiary shall be considered 
to be the owner of the portion of the trust attributable to 
contributions made by the employee, if the applicable requirements of 
such subpart E are satisfied. For purposes of this paragraph (6), 
contributions made by an employee are not incidental when compared to 
contributions made by the employer if the employee's total contributions 
as of any date exceed the employer's total contributions on behalf of 
the employee as of such date.
    (7) Example. The provisions in this paragraph may be illustrated by 
the following example:

    Example. On January 1, 1968 M corporation establishes an employees' 
trust, which is not exempt under section 501(a), for some of its 
employees, including A, reserving the right to discontinue contributions 
at any time. M corporation contributes $5,000 on A's behalf to the trust 
on February 1, 1968. At the time of contribution 50 percent of A's 
interest was substantially vested. On January 1, 1971, and January 1, 
1974, M corporation makes additional $5,000 contributions to the trust 
on A's behalf. A's interest in the trust changed from a 50 percent 
substantially vested to a 100 percent substantialy vested interest in 
the trust on December 31, 1974. Assume that the value of A's interest in 
the trust on December 31, 1974, which is attributable to employer 
contributions made after August 1, 1969, is calculated to be $11,000 
under paragraph (b)(3) of this section. The amount includible in A's 
gross income for 1971 and 1974 is computed as follows:
    (i) Amount of M corporation's contribution made on January 1, 1971, 
to the trust which is includible in A's gross income under paragraph 
(b)(1) of this section (50 percent substantially vested interest in the 
trust times $5,000 contribution)--$2,500.

                                  1974

    (i) Amount of M corporation's contribution made on January 1, 1974, 
to the trust which is includible in A's gross income under paragraph 
(b)(1) of this section (50 percent substantially vested interest in the 
trust times $5,000 contribution)--$2,500.
    (ii) Amount which would have been includible if A's entire interest 
had changed to a substantially vested interest (value of employee's 
interest in the trust attributable to employer contributions made after 
August 1, 1969--$11,000.
    (iii) Percent of A's interest that became substantially vested on 
December 31, 1974--50 percent.
    (iv) Amount includible in A's gross income for 1974 in respect of 
his percentage change from a substantially nonvested to a substantially 
vested interest in the trust (50 percent of $11,000)--$5,500.
    (v) Total amount includible in A's gross income for 1974 ((i) plus 
(iv))--$8,000.

    (c) Taxation of distributions from trust not exempt under section 
501(a)--(1) In general. Any amount actually distributed or made 
available to any distributee by an employees' trust in a taxable year in 
which it is not exempt under section 501(a) shall be taxable under 
section 72 (relating to annuities) to the distributee in the taxable 
year in which it is so distributed or made available. For taxable years 
beginning after December 31, 1963, such amounts may be taken into 
account in computations under sections 1301 through 1305 (relating to 
income averaging). If, for example, the distribution from such a trust 
consists of an annuity contract, the amount of the distribution shall be 
considered to be the entire value of the contract at the time of 
distribution.

[[Page 440]]

Such value is includible in the gross income of the distributee to the 
extent that such value exceeds the investment in the contract, 
determined by applying sections 72 and 101(b). The distributions by such 
a trust shall be taxed as provided in section 72 whether or not the 
employee's rights to the contributions become substantially vested 
beforehand. For rules relating to the treatment of employer 
contributions to a nonexempt trust as part of the consideration paid by 
the employee, see section 72(f). For rules relating to the treatment of 
the limited exclusion allowable under section 101(b)(2)(D) as additional 
consideration paid by the employee, see the regulations under that 
section.
    (2) Distributions before annuity starting date. Any amount 
distributed or made available to any distributee before the annuity 
starting date (as defined in section 72(c)(4)) by an employees' trust in 
a taxable year in which it is not exempt under section 501(a) shall be 
treated as distributed in the following order--
    (i) First, from that portion of the employee's interest in the trust 
attributable to contributions made by the employer after August 1, 1969 
(other than those referred to in paragraph (d)(1) (ii) or (iii) of this 
section) that has not been previously includible in the employee's gross 
income, to the extent that such a distribution is permitted under the 
trust (or the plan of which the trust is a part);
    (ii) Second, from that portion of the employee's interest in the 
trust attributable to contributions made by the employer on or before 
August 1, 1969 (or contributions referred to in paragraph (d)(1) (ii) or 
(iii) of this section);
    (iii) Third, from the remaining portion of the employee's interest 
in the trust attributable to contributions made by the employer.
    If the employee has made contributions to the trust, amounts 
attributable thereto shall be treated as distributed prior to any 
amounts attributable to the employer's contributions, to the extent 
provided by the trust (or the plan of which the trust is a part). 
However, the portion of such amounts attributable to income earned on 
the employee's contributions made after August 1, 1969, shall be treated 
as distributed prior to any return of such contributions.
    (d) Taxation by reason of employer contributions made on or before 
August 1, 1969. (1) Except as provided in section 402(d) (relating to 
taxable years beginning before January 1, 1977), any contribution to a 
trust made by an employer on behalf of an employee--
    (i) On or before August 1, 1969, or
    (ii) After such date, pursuant to a binding contract (as defined in 
Sec. 1.83-3(b)(2)) entered into before April 22, 1969, or
    (iii) After August 1, 1969, pursuant to a written plan in which the 
employee participated on April 22, 1969, and under which the obligation 
of the employer on such date was essentially the same as under a binding 
written contract, during a taxable year of the employer which ends 
within or with a taxable year of the trust for which the trust is not 
exempt under section 501(a) shall be included in income of the employee 
for his taxable year during which the contribution is made, if the 
employee's beneficial interest in the contribution is nonforfeitable at 
the time the contribution is made. If the employee's beneficial interest 
in the contribution is forfeitable at the time the contribution is made, 
even though his interest becomes nonforfeitable later the amount of such 
contribution is not required to be included in the income of the 
employee at the time his interest becomes nonforfeitable.
    (2)(i) An employee's beneficial interest in the contribution is 
nonforfeitable, within the meaning of sections 402(b), 403(c), and 
404(a)(5) prior to the amendments made thereto by the Tax Reform Act of 
1969 and section 403(b), at the time the contribution is made if there 
is no contingency under the plan that may cause the employee to lose his 
rights in the contribution. Similarly, an employee's rights under an 
annuity contract purchased for him by his employer change from 
forfeitable to nonforfeitable rights within the meaning of section 
403(d) prior to the repeal thereof by the Tax Reform Act of 1969 at that 
time when, for the first time, there is no contingency which may cause 
the employee to lose his

[[Page 441]]

rights under the contract. For example, if under the terms of a pension 
plan, an employee upon termination of his services before the retirement 
date, whether voluntarily or involuntarily, is entitled to a deferred 
annuity contract to be purchased with the employer's contributions made 
on his behalf, or is entitled to annuity payments which the trustee is 
abligated to make under the terms of the trust instrument based on the 
contributions made by the employer on his behalf, the employee's 
beneficial interest in such contributions is nonforfeitable.
    (ii) On the other hand, if, under the terms of a pension plan, an 
employee will lose the right to any annuity purchased from or to be 
provided by, contributions made by the employer if his services should 
be terminated before retirement, his beneficial interest in such 
contributions is nonforfeitable.
    (iii) The mere fact that an employee may not live to the retirement 
date, or may live only a short period after the retirement date, and may 
not be able to enjoy the receipt of annuity or pension payments, does 
not make his beneficial interest in the contributions made by the 
employer on his behalf forfeitable. If the employer's contributions have 
been irrevocably applied to purchase an annuity contract for the 
employee, or if the trustee is obligated to use the employer's 
contributions to provide an annuity for the employee provide only that 
the employee is alive on the dates the annuity payments are due, the 
employee's rights in the employer's contributions are nonforfeitable.

(Secs. 83 and 7805 of the Internal Revenue Code of 1954 (83 Stat. 588; 
68A Stat. 917; 26 U.S.C. 83 and 7805))

[T.D. 7554, 43 FR 31922, July 24, 1978, as amended by T.D. 9340, 72 FR 
41140, July 26, 2007]



Sec. 1.402(c)-1  Taxability of beneficiary of certain foreign situs 
trusts.

    Section 402(c) has the effect of treating, for purposes of section 
402, the distributions from a trust which at the time of the 
distribution is located outside the United States in the same manner as 
distributions from a trust which is located in the United States. If the 
trust would qualify for exemption from tax under section 501(a) except 
for the fact that it fails to comply with the provisions of paragraph 
(a)(3)(i) of Sec. 1.401-1, which restricts qualification to trusts 
created or organized in the United States and maintained here, section 
402(a) and Sec. 1.402(a)-1 are applicable to the distributions from 
such a trust. Thus, for example, a total distribution from such a trust 
is entitled to the long-term capital gains treatment of section 
402(a)(2), except in the case of a nonresident alien individual (see 
section 871 and 1441 and the regulations thereunder). However, if the 
plan fails to meet any requirement of section 401 and the regulations 
thereunder in addition to paragraph (a)(3)(i) of Sec. 1.401-1, section 
402(b) and Sec. 1.402(b)-1 are applicable to the distributions from 
such a trust.

[T.D. 6500, 25 FR 11679, Nov. 26, 1960]



Sec. 1.402(c)-2  Eligible rollover distributions; questions and 
answers.

    The following questions and answers relate to the rollover rules 
under section 402(c) of the Internal Revenue Code of 1986, as added by 
sections 521 and 522 of the Unemployment Compensation Amendments of 
1992, Public Law 102-318, 106 Stat. 290 (UCA). For additional UCA 
guidance under sections 401(a)(31), 402(f), 403(b)(8) and (10), and 
3405(c), see Sec. Sec. 1.401(a)(31)-1, 1.402(f)-1, and 1.403(b)-7(b), 
and Sec. 31.3405(c)-1 of this chapter, respectively.

                            List of Questions

    Q-1: What is the rule regarding distributions that may be rolled 
over to an eligible retirement plan?
    Q-2: What is an eligible retirement plan and a qualified plan?
    Q-3: What is an eligible rollover distribution?
    Q-4: Are there other amounts that are not eligible rollover 
distributions?
    Q-5: For purposes of determining whether a distribution is an 
eligible rollover distribution, how is it determined whether a series of 
payments is a series of substantially equal periodic payments over a 
period specified in section 402(c)(4)(A)?
    Q-6: What types of variations in the amount of a payment cause the 
payment to be independent of a series of substantially equal periodic 
payments and thus not part of the series?

[[Page 442]]

    Q-7: When is a distribution from a plan a required minimum 
distribution under section 401(a)(9)?
    Q-8: How are amounts that are not includible in gross income 
allocated for purposes of determining the required minimum distribution?
    Q-9: What is a distribution of a plan loan offset amount and is it 
an eligible rollover distribution?
    Q-10: What is a qualified plan distributed annuity contract, and is 
an amount paid under such a contract a distribution of the balance to 
the credit of the employee in a qualified plan for purposes of section 
402(c)?
    Q-11: If an eligible rollover distribution is paid to an employee, 
and the employee contributes all or part of the eligible rollover 
distribution to an eligible retirement plan within 60 days, is the 
amount contributed not currently includible in gross income?
    Q-12: How does section 402(c) apply to a distributee who is not the 
employee?
    Q-13: Must an employee's (or spousal distributee's) election to 
treat a contribution of an eligible rollover distribution to an 
individual retirement plan as a rollover contribution be irrevocable?
    Q-14: How is the $5,000 death benefit exclusion under section 101(b) 
treated for purposes of determining the amount that is an eligible 
rollover distribution?
    Q-15: May an employee (or spousal distributee) roll over more than 
the plan administrator determines to be an eligible rollover 
distribution using an assumption described in Sec. 1.401(a)(31)-1, Q&A-
18?
    Q-16: Is a rollover from a qualified plan to an individual 
retirement account or individual retirement annuity treated as a 
rollover contribution for purposes of the one-year look-back rollover 
limitation of section 408(d)(3)(B)?

                          Questions and Answers

    Q-1: What is the rule regarding distributions that may be rolled 
over to an eligible retirement plan?
    A-1: (a) General rule. Under section 402(c), as added by UCA, any 
portion of a distribution from a qualified plan that is an eligible 
rollover distribution described in section 402(c)(4) may be rolled over 
to an eligible retirement plan described in section 402(c)(8)(B). For 
purposes of section 402(c) and this section, a rollover is either a 
direct rollover as described in Sec. 1.401(a)(31)-1, Q&A-3 or a 
contribution of an eligible rollover distribution to an eligible 
retirement plan that satisfies the time period requirement in section 
402(c)(3) and Q&A-11 of this section and the designation requirement 
described in Q&A-13 of this section. See Q&A-2 of this section for the 
definition of an eligible retirement plan and a qualified plan.
    (b) Related Internal Revenue Code provisions--(1) Direct rollover 
option. Section 401(a)(31), added by UCA, requires qualified plans to 
provide a distributee of an eligible rollover distribution the option to 
elect to have the distribution paid directly to an eligible retirement 
plan in a direct rollover. See Sec. 1.401(a)(31)-1 for further guidance 
concerning this direct rollover option.
    (2) Notice requirement. Section 402(f) requires the plan 
administrator of a qualified plan to provide, within a reasonable time 
before making an eligible rollover distribution, a written explanation 
to the distributee of the distributee's right to elect a direct rollover 
and the withholding consequences of not making that election. The 
explanation also is required to provide certain other relevant 
information relating to the taxation of distributions. See Sec. 
1.402(f)-1 for guidance concerning the written explanation required 
under section 402(f).
    (3) Mandatory income tax withholding. If a distributee of an 
eligible rollover distribution does not elect to have the eligible 
rollover distribution paid directly from the plan to an eligible 
retirement plan in a direct rollover under section 401(a)(31), the 
eligible rollover distribution is subject to 20-percent income tax 
withholding under section 3405(c). See Sec. 31.3405(c)-1 of this 
chapter for provisions relating to the withholding requirements 
applicable to eligible rollover distributions.
    (4) Section 403(b) annuities. See Sec. 1.403(b)-7(b) for guidance 
concerning the direct rollover requirements for distributions from 
annuities described in section 403(b).
    (c) Effective date--(1) Statutory effective date. Section 402(c), 
added by UCA, applies to eligible rollover distributions made on or 
after January 1, 1993, even if the event giving rise to the distribution 
occurred on or before January 1, 1993 (e.g. termination of the 
employee's employment with the employer maintaining the plan before

[[Page 443]]

January 1, 1993), and even if the eligible rollover distribution is part 
of a series of payments that began before January 1, 1993.
    (2) Regulatory effective date. This section applies to any 
distribution made on or after October 19, 1995. For eligible rollover 
distributions made on or after January 1, 1993 and before October 19, 
1995, Sec. 1.402(c)-2T (as it appeared in the April 1, 1995 edition of 
26 CFR part 1), applies. However, for any distribution made on or after 
January 1, 1993 but before October 19, 1995, any or all of the 
provisions of this section may be substituted for the corresponding 
provisions of Sec. 1.402(c)-2T, if any.
    Q-2: What is an eligible retirement plan and a qualified plan?
    A-2: An eligible retirement plan, under section 402(c)(8)(B), means 
a qualified plan or an individual retirement plan. For purposes of 
section 402(c) and this section, a qualified plan is an employees' trust 
described in section 401(a) which is exempt from tax under section 
501(a) or an annuity plan described in section 403(a). An individual 
retirement plan is an individual retirement account described in section 
408(a) or an individual retirement annuity (other than an endowment 
contract) described in section 408(b).
    Q-3: What is an eligible rollover distribution?
    A-3: (a) General rule. Unless specifically excluded, an eligible 
rollover distribution means any distribution to an employee (or to a 
spousal distributee described in Q&A-12(a) of this section) of all or 
any portion of the balance to the credit of the employee in a qualified 
plan. Thus, except as specifically provided in Q&A-4(b) of this section, 
any amount distributed to an employee (or such a spousal distributee) 
from a qualified plan is an eligible rollover distribution, regardless 
of whether it is a distribution of a benefit that is protected under 
section 411(d)(6).
    (b) Exceptions. An eligible rollover distribution does not include 
the following:
    (1) Any distribution that is one of a series of substantially equal 
periodic payments made (not less frequently than annually) over any one 
of the following periods--
    (i) The life of the employee (or the joint lives of the employee and 
the employee's designated beneficiary);
    (ii) The life expectancy of the employee (or the joint life and last 
survivor expectancy of the employee and the employee's designated 
beneficiary); or
    (iii) A specified period of ten years or more;
    (2) Any distribution to the extent the distribution is a required 
minimum distribution under section 401(a)(9); or
    (3) The portion of any distribution that is not includible in gross 
income (determined without regard to the exclusion for net unrealized 
appreciation described in section 402(e)(4)). Thus, for example, an 
eligible rollover distribution does not include the portion of any 
distribution that is excludible from gross income under section 72 as a 
return of the employee's investment in the contract (e.g., a return of 
the employee's after-tax contributions), but does include net unrealized 
appreciation.
    Q-4: Are there other amounts that are not eligible rollover 
distributions?
    A-4: Yes. The following amounts are not eligible rollover 
distributions:
    (a) Elective deferrals (as defined in section 402(g)(3)) and 
employee contributions that, pursuant to rules prescribed by the 
Commissioner in revenue rulings, notices, or other guidance published in 
the Internal Revenue Bulletin (see Sec. 601.601(d)(2) of this chapter), 
are returned to the employee (together with the income allocable 
thereto) in order to comply with the section 415 limitations.
    (b) Corrective distributions of excess deferrals as described in 
Sec. 1.402(g)-1(e)(3), together with the income allocable to these 
corrective distributions.
    (c) Corrective distributions of excess contributions under a 
qualified cash or deferred arrangement described in Sec. 1.401(k)-
1(f)(4) and excess aggregate contributions described in Sec. 1.401(m)-
2(b)(2), together with the income allocable to these distributions.
    (d) Loans that are treated as deemed distributions pursuant to 
section 72(p).
    (e) Dividends paid on employer securities as described in section 
404(k).
    (f) The costs of life insurance coverage (P.S. 58 costs).

[[Page 444]]

    (g) Prohibited allocations that are treated as deemed distributions 
pursuant to section 409(p).
    (h) A distribution that is a permissible withdrawal from an eligible 
automatic contribution arrangement within the meaning of section 414(w).
    (i) [Reserved]
    (j) Similar items designated by the Commissioner in revenue rulings, 
notices, and other guidance published in the Internal Revenue Bulletin. 
See Sec. 601.601(d)(2)(ii)(b) of this chapter.
    Q-5: For purposes of determining whether a distribution is an 
eligible rollover distribution, how is it determined whether a series of 
payments is a series of substantially equal periodic payments over a 
period specified in section 402(c)(4)(A)?
    A-5: (a) General rule. Generally, whether a series of payments is a 
series of substantially equal periodic payments over a specified period 
is determined at the time payments begin, and by following the 
principles of section 72(t)(2)(A)(iv), without regard to contingencies 
or modifications that have not yet occurred. Thus, for example, a joint 
and 50-percent survivor annuity will be treated as a series of 
substantially equal payments at the time payments commence, as will a 
joint and survivor annuity that provides for increased payments to the 
employee if the employee's beneficiary dies before the employee. 
Similarly, for purposes of determining if a disability benefit payment 
is part of a series of substantially equal payments for a period 
described in section 402(c)(4)(A), any contingency under which payments 
cease upon recovery from the disability may be disregarded.
    (b) Certain supplements disregarded. For purposes of determining 
whether a distribution is one of a series of payments that are 
substantially equal, social security supplements described in section 
411(a)(9) are disregarded. For example, if a distributee receives a life 
annuity of $500 per month, plus a social security supplement consisting 
of payments of $200 per month until the distributee reaches the age at 
which social security benefits of not less than $200 a month begin, the 
$200 supplemental payments are disregarded and, therefore, each monthly 
payment of $700 made before the social security age and each monthly 
payment of $500 made after the social security age is treated as one of 
a series of substantially equal periodic payments for life. A series of 
payments that are not substantially equal solely because the amount of 
each payment is reduced upon attainment of social security retirement 
age (or, alternatively, upon commencement of social security early 
retirement, survivor, or disability benefits) will also be treated as 
substantially equal as long as the reduction in the actual payments is 
level and does not exceed the applicable social security benefit.
    (c) Changes in the amount of payments or the distributee. If the 
amount (or, if applicable, the method of calculating the amount) of the 
payments changes so that subsequent payments are not substantially equal 
to prior payments, a new determination must be made as to whether the 
remaining payments are a series of substantially equal periodic payments 
over a period specified in Q&A-3(b)(1) of this section. This 
determination is made without taking into account payments made or the 
years of payment that elapsed prior to the change. However, a new 
determination is not made merely because, upon the death of the 
employee, the spouse or former spouse of the employee becomes the 
distributee. Thus, once distributions commence over a period that is at 
least as long as either the first annuitant's life or 10 years (e.g., as 
provided by a life annuity with a five-year or ten-year-certain 
guarantee), then substantially equal payments to the survivor are not 
eligible rollover distributions even though the payment period remaining 
after the death of the employee is or may be less than the period 
described in section 402(c)(4)(A). For example, substantially equal 
periodic payments made under a life annuity with a five-year term 
certain would not be an eligible rollover distribution even when paid 
after the death of the employee with three years remaining under the 
term certain.
    (d) Defined contribution plans. The following rules apply in 
determining whether a series of payments from a defined contribution 
plan constitute substantially equal periodic payments

[[Page 445]]

for a period described in section 402(c)(4)(A):
    (1) Declining balance of years. A series of payments from an account 
balance under a defined contribution plan will be considered 
substantially equal payments over a period if, for each year, the amount 
of the distribution is calculated by dividing the account balance by the 
number of years remaining in the period. For example, a series of 
payments will be considered substantially equal payments over 10 years 
if the series is determined as follows. In year 1, the annual payment is 
the account balance divided by 10; in year 2, the annual payment is the 
remaining account balance divided by 9; and so on until year 10 when the 
entire remaining balance is distributed.
    (2) Reasonable actuarial assumptions. If an employee's account 
balance under a defined contribution plan is to be distributed in annual 
installments of a specified amount until the account balance is 
exhausted, then, for purposes of determining if the period of 
distribution is a period described in section 402(c)(4)(A), the period 
of years over which the installments will be distributed must be 
determined using reasonable actuarial assumptions. For example, if an 
employee has an account balance of $100,000, elects distributions of 
$12,000 per year until the account balance is exhausted, and the future 
rate of return is assumed to be 8% per year, the account balance will be 
exhausted in approximately 14 years. Similarly, if the same employee 
elects a fixed annual distribution amount and the fixed annual amount is 
less than or equal to $10,000, it is reasonable to assume that a future 
rate of return will be greater than 0% and, thus, the account will not 
be exhausted in less than 10 years.
    (e) Series of payments beginning before January 1, 1993. Except as 
provided in paragraph (c) of this Q&A, if a series of periodic payments 
began before January 1, 1993, the determination of whether the post-
December 31, 1992 payments are a series of substantially equal periodic 
payments over a specified period is made by taking into account all 
payments made, including payments made before January 1, 1993. For 
example, if a series of substantially equal periodic payments beginning 
on January 1, 1983, is scheduled to be paid over a period of 15 years, 
payments in the series that are made after December 31, 1992, will not 
be eligible rollover distributions even though they will continue for 
only five years after December 31, 1992, because the pre- January 1, 
1993 payments are taken into account in determining the specified 
period.
    Q-6: What types of variations in the amount of a payment cause the 
payment to be independent of a series of substantially equal periodic 
payments and thus not part of the series?
    A-6: (a) Independent payments. Except as provided in paragraph (b) 
of this Q&A, a payment is treated as independent of the payments in a 
series of substantially equal payments, and thus not part of the series, 
if the payment is substantially larger or smaller than the other 
payments in the series. An independent payment is an eligible rollover 
distribution if it is not otherwise excepted from the definition of 
eligible rollover distribution. This is the case regardless of whether 
the payment is made before, with, or after payments in the series. For 
example, if an employee elects a single payment of half of the account 
balance with the remainder of the account balance paid over the life 
expectancy of the distributee, the single payment is treated as 
independent of the payments in the series and is an eligible rollover 
distribution unless otherwise excepted. Similarly, if an employee's 
surviving spouse receives a survivor life annuity of $1,000 per month 
plus a single payment on account of death of $7,500, the single payment 
is treated as independent of the payments in the annuity and is an 
eligible rollover distribution unless otherwise excepted (e.g., $5,000 
of the $7,500 might qualify to be excluded from gross income as a death 
benefit under section 101(b)).
    (b) Special rules--(1) Administrative error or delay. If, due solely 
to reasonable administrative error or delay in payment, there is an 
adjustment after the annuity starting date to the amount of any payment 
in a series of payments that otherwise would constitute a series of 
substantially equal payments described in section 402(c)(4)(A) and this 
section, the adjusted payment or payments will be

[[Page 446]]

treated as part of the series of substantially equal periodic payments 
and will not be treated as independent of the payments in the series. 
For example, if, due solely to reasonable administrative delay, the 
first payment of a life annuity is delayed by two months and reflects an 
additional two months worth of benefits, that payment will be treated as 
a substantially equal payment in the series rather than as an 
independent payment. The result will not change merely because the 
amount of the adjustment is paid in a separate supplemental payment.
    (2) Supplemental payments for annuitants. A supplemental payment 
from a defined benefit plan to annuitants (e.g., retirees or 
beneficiaries) will be treated as part of a series of substantially 
equal payments, rather than as an independent payment, provided that the 
following conditions are met--
    (i) The supplement is a benefit increase for annuitants;
    (ii) The amount of the supplement is determined in a consistent 
manner for all similarly situated annuitants;
    (iii) The supplement is paid to annuitants who are otherwise 
receiving payments that would constitute substantially equal periodic 
payments; and
    (iv) The aggregate supplement is less than or equal to the greater 
of 10% of the annual rate of payment for the annuity, or $750 or any 
higher amount prescribed by the Commissioner in revenue rulings, 
notices, and other guidance published in the Federal Register. See Sec. 
601.601(d)(2)(ii)(b) of this chapter.
    (3) Final payment in a series. If a payment in a series of payments 
from an account balance under a defined contribution plan represents the 
remaining balance to the credit and is substantially less than the other 
payments in the series, the final payment must nevertheless be treated 
as a payment in the series of substantially equal payments and may not 
be treated as an independent payment if the other payments in the series 
are substantially equal and the payments are for a period described in 
section 402(c)(4)(A) based on the rules provided in paragraph (d)(2) of 
Q&A-5 of this section. Thus, such final payment will not be an eligible 
rollover distribution.
    Q-7: When is a distribution from a plan a required minimum 
distribution under section 401(a)(9)?
    A-7: (a) General rule. Except as provided in paragraphs (b) and (c) 
of this Q&A, if a minimum distribution is required for a calendar year, 
the amounts distributed during that calendar year are treated as 
required minimum distributions under section 401(a)(9), to the extent 
that the total required minimum distribution under section 401(a)(9) for 
the calendar year has not been satisfied. Accordingly, these amounts are 
not eligible rollover distributions. For example, if an employee is 
required under section 401(a)(9) to receive a required minimum 
distribution for a calendar year of $5,000 and the employee receives a 
total of $7,200 in that year, the first $5,000 distributed will be 
treated as the required minimum distribution and will not be an eligible 
rollover distribution and the remaining $2,200 will be an eligible 
rollover distribution if it otherwise qualifies. If the total section 
401(a)(9) required minimum distribution for a calendar year is not 
distributed in that calendar year (e.g., when the distribution for the 
calendar year in which the employee reaches age 70\1/2\ is made on the 
following April 1), the amount that was required but not distributed is 
added to the amount required to be distributed for the next calendar 
year in determining the portion of any distribution in the next calendar 
year that is a required minimum distribution.
    (b) Distribution before age 70\1/2\. Any amount that is paid before 
January 1 of the year in which the employee attains (or would have 
attained) age 70\1/2\ will not be treated as required under section 
401(a)(9) and, thus, is an eligible rollover distribution if it 
otherwise qualifies.
    (c) Special rule for annuities. In the case of annuity payments from 
a defined benefit plan, or under an annuity contract purchased from an 
insurance company (including a qualified plan distributed annuity 
contract (as defined in Q&A-10 of this section)), the entire amount of 
any such annuity payment made on or after January 1 of the year in which 
an employee attains (or would have attained) age 70\1/2\ will

[[Page 447]]

be treated as an amount required under section 401(a)(9) and, thus, will 
not be an eligible rollover distribution.
    Q-8: How are amounts that are not includible in gross income 
allocated for purposes of determining the required minimum distribution?
    A-8: If section 401(a)(9) has not yet been satisfied by the plan for 
the year with respect to an employee, a distribution is made to the 
employee that exceeds the amount required to satisfy section 401(a)(9) 
for the year for the employee, and a portion of that distribution is 
excludible from gross income, the following rule applies for purposes of 
determining the amount of the distribution that is an eligible rollover 
distribution. The portion of the distribution that is excludible from 
gross income is first allocated toward satisfaction of section 401(a)(9) 
and then the remaining portion of the required minimum distribution, if 
any, is satisfied from the portion of the distribution that is 
includible in gross income. For example, assume an employee is required 
under section 401(a)(9) to receive a minimum distribution for a calendar 
year of $4,000 and the employee receives a $4,800 distribution, of which 
$1,000 is excludible from income as a return of basis. First, the $1,000 
return of basis is allocated toward satisfying the required minimum 
distribution. Then, the remaining $3,000 of the required minimum 
distribution is satisfied from the $3,800 of the distribution that is 
includible in gross income, so that the remaining balance of the 
distribution, $800, is an eligible rollover distribution if it otherwise 
qualifies.
    Q-9: What is a distribution of a plan loan offset amount, and is it 
an eligible rollover distribution?
    A-9: (a) General rule. A distribution of a plan loan offset amount, 
as defined in paragraph (b) of this Q&A, is an eligible rollover 
distribution if it satisfies Q&A-3 of this section. Thus, an amount 
equal to the plan loan offset amount can be rolled over by the employee 
(or spousal distributee) to an eligible retirement plan within the 60-
day period under section 402(c)(3), unless the plan loan offset amount 
fails to be an eligible rollover distribution for another reason. See 
Sec. 1.401(a)(31)-1, Q&A-16 for guidance concerning the offering of a 
direct rollover of a plan loan offset amount. See Sec. 31.3405(c)-1, 
Q&A-11 of this chapter for guidance concerning special withholding rules 
with respect to plan loan offset amounts.
    (b) Definition of plan loan offset amount. For purposes of section 
402(c), a distribution of a plan loan offset amount is a distribution 
that occurs when, under the plan terms governing a plan loan, the 
participant's accrued benefit is reduced (offset) in order to repay the 
loan (including the enforcement of the plan's security interest in a 
participant's accrued benefit). A distribution of a plan loan offset 
amount can occur in a variety of circumstances, e.g., where the terms 
governing a plan loan require that, in the event of the employee's 
termination of employment or request for a distribution, the loan be 
repaid immediately or treated as in default. A distribution of a plan 
loan offset amount also occurs when, under the terms governing the plan 
loan, the loan is cancelled, accelerated, or treated as if it were in 
default (e.g., where the plan treats a loan as in default upon an 
employee's termination of employment or within a specified period 
thereafter). A distribution of a plan loan offset amount is an actual 
distribution, not a deemed distribution under section 72(p).
    (c) Examples. The rules with respect to a plan loan offset amount in 
this Q&A-9, Sec. 1.401(a)(31)-1, Q&A-16 and Sec. 31.3405(c)-1, Q&A-11 
of this chapter are illustrated by the following examples:

    Example 1. (a) In 1996, Employee A has an account balance of $10,000 
in Plan Y, of which $3,000 is invested in a plan loan to Employee A that 
is secured by Employee A's account balance in Plan Y. Employee A has 
made no after-tax employee contributions to Plan Y. Plan Y does not 
provide any direct rollover option with respect to plan loans. Upon 
termination of employment in 1996, Employee A, who is under age 70\1/2\ 
, elects a distribution of Employee A's entire account balance in Plan 
Y, and Employee A's outstanding loan is offset against the account 
balance on distribution. Employee A elects a direct rollover of the 
distribution.
    (b) In order to satisfy section 401(a)(31), Plan Y must pay $7,000 
directly to the eligible retirement plan chosen by Employee A in a 
direct rollover. When Employee A's account balance was offset by the 
amount of

[[Page 448]]

the $3,000 unpaid loan balance, Employee A received a plan loan offset 
amount (equivalent to $3,000) that is an eligible rollover distribution. 
However, under Sec. 1.401(a)(31)-1, Q&A-16 Plan Y satisfies section 
401(a)(31), even though a direct rollover option was not provided with 
respect to the $3,000 plan loan offset amount.
    (c) No withholding is required under section 3405(c) on account of 
the distribution of the $3,000 plan loan offset amount because no cash 
or other property (other than the plan loan offset amount) is received 
by Employee A from which to satisfy the withholding. Employee A may roll 
over $3,000 to an eligible retirement plan within the 60 day period 
provided in section 402(c)(3).
    Example 2. (a) The facts are the same as in Example 1, except that 
the terms governing the plan loan to Employee A provide that, upon 
termination of employment, Employee A's account balance is automatically 
offset by the amount of any unpaid loan balance to repay the loan. 
Employee A terminates employment but does not request a distribution 
from Plan Y. Nevertheless, pursuant to the terms governing the plan 
loan, Employee A's account balance is automatically offset by the amount 
of the $3,000 unpaid loan balance.
    (b) The $3,000 plan loan offset amount attributable to the plan loan 
in this example is treated in the same manner as the $3,000 plan loan 
offset amount in Example 1.
    Example 3. (a) The facts are the same as in Example 2, except that, 
instead of providing for an automatic offset upon termination of 
employment to repay the plan loan, the terms governing the plan loan 
require full repayment of the loan by Employee A within 30 days of 
termination of employment. Employee A terminates employment, does not 
elect a distribution from Plan Y, and also fails to repay the plan loan 
within 30 days. The plan administrator of Plan Y declares the plan loan 
to Employee A in default and executes on the loan by offsetting Employee 
A's account balance by the amount of the $3,000 unpaid loan balance.
    (b) The $3,000 plan loan offset amount attributable to the plan loan 
in this example is treated in the same manner as the $3,000 plan loan 
offset amount in Example 1 and in Example 2. The result in this Example 
3 is the same even though the plan administrator treats the loan as in 
default before offsetting Employee A's accrued benefit by the amount of 
the unpaid loan.
    Example 4. (a) The facts are the same as in Example 1, except that 
Employee A elects to receive the distribution of the account balance 
that remains after the $3,000 offset to repay the plan loan, instead of 
electing a direct rollover of the remaining account balance.
    (b) In this case, the amount of the distribution received by 
Employee A is $10,000, not $3,000. Because the amount of the $3,000 
offset attributable to the loan is included in determining the amount 
that equals 20 percent of the eligible rollover distribution received by 
Employee A, withholding in the amount of $2,000 (20 percent of $10,000) 
is required under section 3405(c). The $2,000 is required to be withheld 
from the $7,000 to be distributed to Employee A in cash, so that 
Employee A actually receives a check for $5,000.
    Example 5. The facts are the same as in Example 4, except that the 
$7,000 distribution to Employee A after the offset to repay the loan 
consists solely of employer securities within the meaning of section 
402(e)(4)(E). In this case, no withholding is required under section 
3405(c) because the distribution consists solely of the $3,000 plan loan 
offset amount and the $7,000 distribution of employer securities. This 
is the result because the total amount required to be withheld does not 
exceed the sum of the cash and the fair market value of other property 
distributed, excluding plan loan offset amounts and employer securities. 
Employee A may roll over the employer securities and $3,000 to an 
eligible retirement plan within the 60-day period provided in section 
402(c)(3).
    Example 6. Employee B, who is age 40, has an account balance in Plan 
Z, a profit sharing plan qualified under section 401(a) that includes a 
qualified cash or deferred arrangement described in section 401(k). Plan 
Z provides for no after-tax employee contributions. In 1990, Employee B 
receives a loan from Plan Z, the terms of which satisfy section 
72(p)(2), and which is secured by elective contributions subject to the 
distribution restrictions in section 401(k)(2)(B). In 1996, the loan 
fails to satisfy section 72(p)(2) because Employee B stops repayment. In 
that year, pursuant to section 72(p), Employee B is taxed on a deemed 
distribution equal to the amount of the unpaid loan balance. Under Q&A-4 
of this section, the deemed distribution is not an eligible rollover 
distribution. Because Employee B has not separated from service or 
experienced any other event that permits the distribution under section 
401(k)(2)(B) of the elective contributions that secure the loan, Plan Z 
is prohibited from executing on the loan. Accordingly, Employee B's 
account balance is not offset by the amount of the unpaid loan balance 
at the time Employee B stops repayment on the loan. Thus, there is no 
distribution of an offset amount that is an eligible rollover 
distribution in 1996.

    Q-10: What is a qualified plan distributed annuity contract, and is 
an amount paid under such a contract a distribution of the balance to 
the credit of the employee in a qualified plan for purposes of section 
402(c)?
    A-10: (a) Definition of a qualified plan distributed annuity 
contract. A qualified

[[Page 449]]

plan distributed annuity contract is an annuity contract purchased for a 
participant, and distributed to the participant, by a qualified plan.
    (b) Treatment of amounts paid as eligible rollover distributions. 
Amounts paid under a qualified plan distributed annuity contract are 
payments of the balance to the credit of the employee for purposes of 
section 402(c) and are eligible rollover distributions, if they 
otherwise qualify. Thus, for example, if the employee surrenders the 
contract for a single sum payment of its cash surrender value, the 
payment would be an eligible rollover distribution to the extent it is 
includible in gross income and not a required minimum distribution under 
section 401(a)(9). This rule applies even if the annuity contract is 
distributed in connection with a plan termination. See Sec. 
1.401(a)(31)-1, Q&A-17 and Sec. 31.3405(c)-1, Q&A-13 of this chapter 
concerning the direct rollover requirements and 20-percent withholding 
requirements, respectively, that apply to eligible rollover 
distributions from such an annuity contract.
    Q-11: If an eligible rollover distribution is paid to an employee, 
and the employee contributes all or part of the eligible rollover 
distribution to an eligible retirement plan within 60 days, is the 
amount contributed not currently includible in gross income?
    A-11: Yes, the amount contributed is not currently includible in 
gross income, provided that it is contributed to the eligible retirement 
plan no later than the 60th day following the day on which the employee 
received the distribution. If more than one distribution is received by 
an employee from a qualified plan during a taxable year, the 60-day rule 
applies separately to each distribution. Because the amount withheld as 
income tax under section 3405(c) is considered an amount distributed 
under section 402(c), an amount equal to all or any portion of the 
amount withheld can be contributed as a rollover to an eligible 
retirement plan within the 60-day period, in addition to the net amount 
of the eligible rollover distribution actually received by the employee. 
However, if all or any portion of an amount equal to the amount withheld 
is not contributed as a rollover, it is included in the employee's gross 
income to the extent required under section 402(a), and also may be 
subject to the 10-percent additional income tax under section 72(t). See 
Sec. 1.401(a)(31)-1, Q&A-14, for guidance concerning the qualification 
of a plan that accepts a rollover contribution.
    Q-12: How does section 402(c) apply to a distributee who is not the 
employee?
    A-12: (a) Spousal distributee. If any distribution attributable to 
an employee is paid to the employee's surviving spouse, section 402(c) 
applies to the distribution in the same manner as if the spouse were the 
employee. The same rule applies if any distribution attributable to an 
employee is paid in accordance with a qualified domestic relations order 
(as defined in section 414(p)) to the employee's spouse or former spouse 
who is an alternate payee. Therefore, a distribution to the surviving 
spouse of an employee (or to a spouse or former spouse who is an 
alternate payee under a qualified domestic relations order), including a 
distribution of ancillary death benefits attributable to the employee, 
is an eligible rollover distribution if it meets the requirements of 
section 402(c)(2) and (4) and Q&A-3 through Q&A-10 and Q&A-14 of this 
section. However, a qualified plan (as defined in Q&A-2 of this section) 
is not treated as an eligible retirement plan with respect to a 
surviving spouse. Only an individual retirement plan is treated as an 
eligible retirement plan with respect to an eligible rollover 
distribution to a surviving spouse.
    (b) Non-spousal distributee. A distributee other than the employee 
or the employee's surviving spouse (or a spouse or former spouse who is 
an alternate payee under a qualified domestic relations order) is not 
permitted to roll over distributions from a qualified plan. Therefore, 
those distributions do not constitute eligible rollover distributions 
under section 402(c)(4) and are not subject to the 20-percent income tax 
withholding under section 3405(c).
    Q-13: Must an employee's (or spousal distributee's) election to 
treat a contribution of an eligible rollover distribution to an 
individual retirement

[[Page 450]]

plan as a rollover contribution be irrevocable?
    A-13: (a) In general. Yes. In order for a contribution of an 
eligible rollover distribution to an individual retirement plan to 
constitute a rollover and, thus, to qualify for current exclusion from 
gross income, a distributee must elect, at the time the contribution is 
made, to treat the contribution as a rollover contribution. An election 
is made by designating to the trustee, issuer, or custodian of the 
eligible retirement plan that the contribution is a rollover 
contribution. This election is irrevocable. Once any portion of an 
eligible rollover distribution has been contributed to an individual 
retirement plan and designated as a rollover distribution, taxation of 
the withdrawal of the contribution from the individual retirement plan 
is determined under section 408(d) rather than under section 402 or 403. 
Therefore, the eligible rollover distribution is not eligible for 
capital gains treatment, five-year or ten-year averaging, or the 
exclusion from gross income for net unrealized appreciation on employer 
stock.
    (b) Direct rollover. If an eligible rollover distribution is paid to 
an individual retirement plan in a direct rollover at the election of 
the distributee, the distributee is deemed to have irrevocably 
designated that the direct rollover is a rollover contribution.
    Q-14: How is the $5,000 death benefit exclusion under section 101(b) 
treated for purposes of determining the amount that is an eligible 
rollover distribution?
    A-14: To the extent that a death benefit is a distribution from a 
qualified plan, the portion of the distribution that is excluded from 
gross income under section 101(b) is not an eligible rollover 
distribution. See Sec. 1.401(a)(31)-1, Q&A-18 for guidance concerning 
assumptions that a plan administrator may make with respect to whether 
and to what extent a distribution of a survivor benefit is excludible 
from gross income under section 101(b).
    Q-15: May an employee (or spousal distributee) roll over more than 
the plan administrator determines to be an eligible rollover 
distribution using an assumption described in Sec. 1.401(a)(31)-1, Q&A-
18?
    A-15: Yes. The portion of any distribution that an employee (or 
spousal distributee) may roll over as an eligible rollover distribution 
under section 402(c) is determined based on the actual application of 
section 402 and other relevant provisions of the Internal Revenue Code. 
The actual application of these provisions may produce different results 
than any assumption described in Sec. 1.401(a)(31)-1, Q&A-18 that is 
used by the plan administrator. Thus, for example, even though the plan 
administrator calculates the portion of a distribution that is a 
required minimum distribution (and thus is not made eligible for direct 
rollover under section 401(a)(31)), by assuming that there is no 
designated beneficiary, the portion of the distribution that is actually 
a required minimum distribution and thus not an eligible rollover 
distribution is determined by taking into account the designated 
beneficiary, if any. If, by taking into account the designated 
beneficiary, a greater portion of the distribution is an eligible 
rollover distribution, the distributee may rollover the additional 
amount. Similarly, even though a plan administrator assumes that a 
distribution from a qualified plan is the only death benefit with 
respect to an employee that qualifies for the $5,000 death benefit 
exclusion under section 101(b), to the extent that the death benefit 
exclusion is allocated to a different death benefit, a greater portion 
of the distribution may actually be includible in gross income and, 
thus, be an eligible rollover distribution, and the surviving spouse may 
roll over the additional amount if it otherwise qualifies.
    Q-16: Is a rollover from a qualified plan to an individual 
retirement account or individual retirement annuity treated as a 
rollover contribution for purposes of the one-year look-back rollover 
limitation of section 408(d)(3)(B)?
    A-16: No. A distribution from a qualified plan that is rolled over 
to an individual retirement account or individual retirement annuity is 
not treated for purposes of section 408(d)(3)(B) as an amount received 
by an individual from an individual retirement account or individual 
retirement annuity which

[[Page 451]]

is not includible in gross income because of the application of section 
408(d)(3).

[T.D. 8619, 60 FR 49208, Sept. 22, 1995, as amended by T.D. 8880, 65 FR 
21315, Apr. 21, 2000; T.D. 9169, 69 FR 78153, Dec. 29, 2004; T.D. 9302, 
71 FR 76137, Dec. 20, 2006; T.D. 9319, 72 FR 16894, Apr. 5, 2007; T.D. 
9340, 72 FR 41159, July 26, 2007; T.D. 9447, 74 FR 8211, Feb. 24, 2009]

    Editorial Note: By T.D. 9169, 69 FR 78153, Dec. 29, 2004, the 
Internal Revenue Service published a document in the Federal Register, 
attempting to amend Q&A-4(c) of Sec. 1.402(c)-2, by removing 
``1.401(k)-1(f)'' and inserting ``1.401(k)-2(b)(2)''. However, because 
of inaccurate language, this amendment could not be incorporated.



Sec. 1.402(d)-1  Effect of section 402(d).

    (a) If the requirements of section 402(d) are met, a contribution 
made by an employer on behalf of an employee to a trust which is not 
exempt under section 501(a) shall not be included in the income of the 
employee in the year in which the contribution is made. Such 
contribution will be taxable to the employee, when received in later 
years, as provided in section 72 (relating to annuities). For taxable 
years beginning before January 1, 1964, section 72(e)(3) (relating to 
the treatment of certain lump sums), as in effect before such date, 
shall not apply to such contributions. For taxable years beginning after 
December 31, 1963, such contributions, when received, may be taken into 
account in computations under sections 1301 through 1305 (relating to 
income averaging). See paragraph (b) of Sec. 1.403(c)-1. The intent and 
purpose of section 402(d) is to give those employees, covered under 
certain non-exempt trusts to which such section applies, essentially the 
same tax treatment as those covered by trusts described in section 
401(a) and exempt under section 501(a), except that the capital gains 
treatment referred to in section 402(a)(2) does not apply.
    (b) Every person claiming the benefit of section 402(d) must be able 
to demonstrate to the satisfaction of the Commissioner that all of the 
provisions of such section are met. The taxpayer must produce sufficient 
evidence to prove:
    (1) That, before October 21, 1942, he was employed by the particular 
employer making the contribution in question and was at such time 
definitely covered by a written agreement, entered into before October 
21, 1942, between himself and the employer, or between the employer and 
the trustee of a trust established by the employer before October 21, 
1942, and that the contribution by the employer was made pursuant to 
such agreement. The fact that an employee may have been potentially 
covered is not sufficient. Evidence that the employment was entered 
into, or the agreement executed, ``as of'' a date before October 21, 
1942, or that the agreement or trust instrument which did not 
theretofore meet the requirements of section 402(d) was modified or 
amended after October 20, 1942, so as to come within the provisions of 
such section, will not satisfy the requirements of section 402(d).
    (2) That such contribution, pursuant to the terms of such agreement, 
was to be applied for the purchase of an annuity contract for the 
taxpayer. In the case of a contribution by the employer of an annuity 
contract purchased by such employer and transferred by him to the 
trustee of the trust, evidence should be presented to prove that such 
contract was purchased for the taxpayer by the employer pursuant to the 
terms of a written agreement between the employer and the employee or 
between the employer and the trustee, entered into before October 21, 
1942.
    (3) That under the written terms of the trust agreement the taxpayer 
is not entitled during his lifetime, except with the consent of the 
trustee, to any payments other than annuity payments under the annuity 
contract or contracts purchased by the trustee or by the employer and 
transferred to the trustee, and that the trustee may grant or withhold 
such consent free from control by the taxpayer, the employer, or any 
other person. However, such control will not be presumed from the fact 
that the trustee is himself an officer or employee of the employer. As 
used in section 402(d) the phrase ``if * * * under the terms of the 
trust agreement the employee is not entitled'' means that the trust 
instrument must make it impossible for the prohibited distribution to 
occur whether by operation or natural termination of

[[Page 452]]

the trust, whether by power of revocation or amendment, other than with 
the consent of the trustee, whether by the happening of a contingency, 
by collateral arrangement, or any other means. It is not essential that 
the employer relinquish all power to modify or terminate the trust but 
it must be impossible, except with the consent of the trustee, to be 
received by the taxpayer contracts purchased by the trustee, or by the 
employer and transferred to the trustee, to be received by the taxpayer 
directly or indirectly, other than as annuity payments.
    (4) The nature and amount of such contribution and the extent to 
which income taxes have been paid thereon before January 1, 1949, and 
not credited or refunded.
    (5) If it is claimed that section 402(d) applies to amounts 
contributed to a trust after June 1, 1949, the taxpayer must prove to 
the satisfaction of the Commissioner that the trust did not, on June 1, 
1949, qualify for exemption under section 165(a) of the Internal Revenue 
Code of 1939. Where an employer buys an annuity contract which is 
transferred to the trustee, the date of the purchase of the annuity 
contract and not the date of the transfer to the trustee is the 
controlling date in determining whether or not the contribution was made 
to the trust after June 1, 1949.

[T.D. 6500, 25 FR 11679, Nov. 26, 1960, as amended by T.D. 6885, 31 FR 
7801, June 2, 1966]



Sec. 1.402(e)-1  Certain plan terminations.

    Distributions made after December 31, 1953, and before January 1, 
1955, as a result of the complete termination of an employees' trust 
described in section 401(a) which is exempt under section 501(a) shall 
be considered distributions on account of separation form service for 
purposes of section 402(a)(2) if the employer who established the trust 
is a corporation, and the termination of the plan is incident to the 
complete liquidation of the corporation before August 16, 1954, 
regardless of whether such liquidation is incident to a reorganization 
as defined in section 368.

[T.D. 6500, 25 FR 11680, Nov. 26, 1960]



Sec. 1.402(f)-1  Required explanation of eligible rollover 
distributions; questions and answers.

    The following questions and answers concern the written explanation 
requirement imposed by section 402(f) of the Internal Revenue Code of 
1986 relating to distributions eligible for rollover treatment. Section 
402(f) was amended by section 521(a) of the Unemployment Compensation 
Amendments of 1992, Public Law 102-318, 106 Stat. 290 (UCA). For 
additional UCA guidance under sections 401(a)(31), 402(c), 403(b)(8) and 
(10), and 3405(c), see Sec. Sec. 1.401(a)(31)-1, 1.402(c)-2, 1.403(b)-
7(b), and 31.3405(c)-1 of this chapter, respectively.

                            List of Questions

    Q-1: What are the requirements for a written explanation under 
section 402(f)?
    Q-2: When must the plan administrator provide the section 402(f) 
notice to a distributee?
    Q-3: Must the plan administrator provide a separate section 402(f) 
notice for each distribution in a series of periodic payments that are 
eligible rollover distributions?
    Q-4: May a plan administrator post the section 402(f) notice as a 
means of providing it to distributees?

                          Questions and Answers

    Q-1: What are the requirements for a written explanation under 
section 402(f)?
    A-1: (a) General rule. Under section 402(f), as amended by UCA, the 
plan administrator of a qualified plan is required, within a reasonable 
period of time before making an eligible rollover distribution, to 
provide the distributee with the written explanation described in 
section 402(f) (section 402(f) notice). The section 402(f) notice must 
be designed to be easily understood and must explain the following: the 
rules under which the distributee may elect that the distribution be 
paid in the form of a direct rollover to an eligible retirement plan; 
the rules that require the withholding of tax on the distribution if it 
is not paid in a direct rollover; the rules under which the distributee 
may defer tax on the distribution if it is contributed in a rollover to 
an eligible retirement plan within 60 days of the distribution; and if 
applicable, certain special rules regarding the

[[Page 453]]

taxation of the distribution as described in section 402(d) (averaging 
with respect to lump sum distributions) and (e) (other rules including 
treatment of net unrealized appreciation). See Sec. 1.401(a)(31)-1, 
Q&A-7 for additional information that must be provided if a plan 
provides a default procedure regarding the election of a direct 
rollover.
    (b) Model section 402(f) notice. The plan administrator will be 
deemed to have complied with the requirements of paragraph (a) of this 
Q&A-1 relating to the contents of the section 402(f) notice if the plan 
administrator provides the applicable model section 402(f) notice 
published by the Internal Revenue Service for this purpose in a revenue 
ruling, notice, or other guidance published in the Internal Revenue 
Bulletin. See Sec. 601.601(d)(2)(ii)(b) of this chapter.
    (c) Delegation to Commissioner. The Commissioner, in revenue 
rulings, notices, and other guidance, published in the Internal Revenue 
Bulletin, may modify, or provide any additional guidance with respect 
to, the notice requirement of this section. See Sec. 
601.601(d)(2)(ii)(b) of this chapter.
    (d) Effective date--(1) Statutory effective date. Section 402(f) 
applies to eligible rollover distributions made after December 31, 1992.
    (2) Regulatory effective date. This section applies to eligible 
rollover distributions made on or after October 19, 1995. For eligible 
rollover distributions made on or after January 1, 1993 and before 
October 19, 1995, Sec. 1.402(c)-2T, Q&A-11 through 15 (as it appeared 
in the April 1, 1995 edition of 26 CFR part 1), apply. However, for any 
distribution made on or after January 1, 1993 but before October 19, 
1995, a plan administrator or payor may satisfy the requirements of 
section 402(f) by substituting any or all provisions of this section for 
the corresponding provisions of Sec. 1.402(c)-1T, Q&A-11 through 15, if 
any.
    Q-2: When must the plan administrator provide the section 402(f) 
notice to a distributee?
    A-2: The plan administrator must provide the section 402(f) notice 
to a distributee at a time that satisfies either paragraph (a) or (b) of 
this Q&A-2.
    (a) This paragraph (a) is satisfied if the plan administrator 
provides a distributee with the section 402(f) notice no less than 30 
days and no more than 90 days before the date of a distribution. 
However, if the distributee, after having received the section 402(f) 
notice, affirmatively elects a distribution, a plan will not fail to 
satisfy section 402(f) merely because the distribution is made less than 
30 days after the section 402(f) notice was provided to the distributee, 
provided the plan administrator clearly indicates to the distributee 
that the distributee has a right to consider the decision of whether or 
not to elect a direct rollover for at least 30 days after the notice is 
provided. The plan administrator may use any method to inform the 
distributee of the relevant time period, provided that the method is 
reasonably designed to attract the attention of the distributee. For 
example, this information could be either provided in the section 402(f) 
notice or stated in a separate document (e.g., attached to the election 
form) that is provided at the same time as the notice. For purposes of 
satisfying the requirement in the first sentence of paragraph (a) of 
this Q&A-2, the plan administrator may substitute the annuity starting 
date, within the meaning of Sec. 1.401(a)-20, Q&A-10, for the date of 
the distribution.
    (b) This paragraph (b) is satisfied if the plan administrator--
    (1) Provides a distributee with the section 402(f) notice;
    (2) Provides the distributee with a summary of the section 402(f) 
notice within the time period described in paragraph (a) of this Q&A-2 
and
    (3) If the distributee so requests after receiving the summary 
described in paragraph (b)(2) of this Q&A-2, provides the section 402(f) 
notice to the distributee without charge and no less than 30 days before 
the date of a distribution (or the annuity starting date), subject to 
the rules for the distributee's waiver of that 30-day period. The 
summary described in paragraph (b)(2) of this Q&A-2 must set forth a 
summary of the principal provisions of the section 402(f) notice, must 
refer the distributee to the most recent version of the section 402(f) 
notice (and, in the case of a notice provided in any

[[Page 454]]

document containing information in addition to the notice, must identify 
that document and must provide a reasonable indication of where the 
notice may be found in that document, such as by index reference or by 
section heading), and must advise the distributee that, upon request, a 
copy of the section 402(f) notice will be provided without charge.
    Q-3: Must the plan administrator provide a separate section 402(f) 
notice for each distribution in a series of periodic payments that are 
eligible rollover distributions?
    A-3: No. In the case of a series of periodic payments that are 
eligible rollover distributions, the plan administrator is permitted to 
satisfy section 402(f) with respect to each payment in the series by 
providing the section 402(f) notice prior to the first payment in the 
series, in accordance with the rules in Q&A-1 and Q&A-2 of this section, 
and providing the notice at least once annually for as long as the 
payments continue. However, see Sec. 1.401(a)(31)-1, Q&A-12 for 
additional guidance if the plan administrator intends to treat a 
distributee's election to make or not make a direct rollover with 
respect to one payment in a series of periodic payments as applicable to 
all subsequent payments in the series (absent a subsequent change of 
election).
    Q-4: May a plan administrator post the section 402(f) notice as a 
means of providing it to distributees?
    A-4: No. The posting of the section 402(f) notice will not be 
considered provision of the notice. The written notice must be provided 
individually to any distributee of an eligible rollover distribution 
within the time period described in Q&A-2 and Q&A-3 of this section.
    Q-5: Will the requirements of section 402(f) be satisfied if a plan 
administrator provides a distributee with the section 402(f) notice or 
the summary of the notice described in paragraph (b)(2) of Q&A-2 of this 
section other than through a written paper document?
    A-5. Yes. See Sec. 1.401(a)-21 of this chapter for rules permitting 
the use of electronic media to provide applicable notices to recipients 
with respect to retirement plans.

    Example 1. (i) A qualified plan (Plan A) permits participants to 
request distributions by e-mail. Under Plan A's system for such 
transactions, a participant must enter his or her account number and 
personal identification number (PIN); this information must match that 
in Plan A's records in order for the transaction to proceed. If a 
participant requests a distribution from Plan A by e-mail and the 
distribution is an eligible rollover distribution, the plan 
administrator provides the participant with a section 402(f) notice by 
e-mail. The plan administrator also advises the participant that he or 
she may request the section 402(f) notice on a written paper document 
and that, if the participant requests the notice on a written paper 
document, it will be provided at no charge. To proceed with the 
distribution by e-mail, the participant must acknowledge receipt, 
review, and comprehension of the section 402(f) notice.
    (ii) In Example 1, Plan A does not fail to satisfy the notice 
requirement of section 402(f) merely because the notice is provided to 
the participant other than through a written paper document.
    Example 2. (i) A qualified plan (Plan B) permits participants to 
request distributions through the Plan B web site (Internet or 
intranet). Under Plan B's system for such transactions, a participant 
must enter his or her account number and personal identification number 
(PIN); this information must match that in Plan B's records in order for 
the transaction to proceed. A participant may request a distribution 
from Plan B by following the applicable instructions on the Plan B web 
site. After the participant has requested a distribution that is an 
eligible rollover distribution, the participant is automatically shown a 
page on the web site containing a section 402(f) notice. Although this 
page of the web site may be printed, the page also advises the 
participant that he or she may request the section 402(f) notice on a 
written paper document by calling a telephone number indicated on the 
web page and that, if the participant requests the notice on a written 
paper document, it will be provided at no charge. To proceed with the 
distribution by e-mail, the participant must acknowledge receipt, 
review, and comprehension of the section 402(f) notice.
    (ii) In this Example 2, Plan B does not fail to satisfy the notice 
requirement of section 402(f) merely because the notice is provided to 
the participant other than through a written paper document.
    Example 3. (i) A qualified plan (Plan C) permits participants to 
request distributions through Plan C's automated telephone system. Under 
Plan C's system for such transactions, a participant must enter his or 
her account number and personal identification number (PIN); this 
information must match that in Plan C's records in order for the

[[Page 455]]

transaction to proceed. Plan C provides the section 402(f) notice in the 
summary plan description, the most recent version of which was 
distributed to participants in 1997. A participant may request a 
distribution from Plan C by following the applicable instructions on the 
automated telephone system. In 1999, a participant, using Plan C's 
automated telephone system, requests a distribution that is an eligible 
rollover distribution. The automated telephone system refers the 
participant to the most recent version of the section 402(f) notice 
which was provided in the summary plan description, informs the 
participant where the section 402(f) notice may be located in the 
summary plan description, and provides an oral summary of the material 
provisions of the section 402(f) notice. The system also advises the 
participant that the participant may request the section 402(f) notice 
on a written paper document and that, if the participant requests the 
notice on a written paper document, it will be provided at no charge. 
Before proceeding with the distribution, the participant must 
acknowledge receipt, review, and comprehension of the summary. Under 
Plan C's system for processing such transactions, the participant's 
distribution will be made no more than 90 days and no fewer than 30 days 
after the participant requests the distribution and receives the summary 
of the section 402(f) notice (unless the participant waives the 30-day 
period).
    (ii) In this Example 3, Plan C does not fail to satisfy the notice 
requirement of section 402(f) merely because Plan C provides a summary 
of the section 402(f) notice or merely because the summary is provided 
to the participant other than through a written paper document.
    Example 4. (i) Same facts as Example 3, except that, pursuant to 
Plan C's system for processing such transactions, a participant who so 
requests is transferred to a customer service representative whose 
conversation with the participant is recorded. The customer service 
representative provides the summary of the section 402(f) notice by 
reading from a prepared text.
    (ii) In this Example 4, Plan C does not fail to satisfy the notice 
requirement of section 402(f) merely because Plan C provides a summary 
of the section 402(f) notice or merely because the summary of the 
section 402(f) notice is provided to the participant other than through 
a written paper document.
    Example 5. (i) Same facts as Example 3, except that Plan C does not 
provide the section 402(f) notice in the summary plan description. 
Instead, the automated telephone system reads the section 402(f) notice 
to the participant.
    (ii) In this Example 5, Plan C does not satisfy the notice 
requirement of section 402(f) because oral delivery alone of the section 
402(f) notice through the automated telephone system is not sufficient.
    Example 6. (i) The facts are the same as in Example 1, except that 
Participant D requested a distribution by e-mail, then terminated 
employment, and, following the termination, no longer has reasonable 
access to Plan A e-mail.
    (ii) In this Example 6, Plan A does not satisfy the notice 
requirement of section 402(f) because the electronic medium through 
which the notice is provided is not reasonably accessible to Participant 
D. Plan A must provide the section 402(f) notice to Participant D in a 
written paper document or by an electronic means that is reasonably 
accessible to Participant D.

[T.D. 8619, 60 FR 49213, Sept. 22, 1995, as amended by T.D. 8873, 65 FR 
6005, Feb. 8, 2000; T.D. 9294, 71 FR 61887, Oct. 20, 2006; T.D. 9340, 72 
FR 41159, July 26, 2007]



Sec. 1.402(g)-0  Limitation on exclusion for elective deferrals, 
table of contents.

    This section contains the captions that appear in Sec. 1.402(g)-1.

    Sec. 1.402(g)-1 Limitation on exclusion for elective deferrals.

(a) In general.
(b) Elective deferrals.
(c) Certain one-time irrevocable elections.
(d) Applicable limit.
    (1) In general.
    (2) Special adjustment for elective deferrals with respect to a 
section 403(b) annuity contract.
    (3) Special adjustment for elective deferrals with respect to a 
section 403(b) annuity contract for certain long-term employees.
    (4) Example.
(e) Treatment of excess deferrals.
    (1) Plan qualification.
    (i) Effect of excess deferrals.
    (ii) Treatment of excess deferrals as employer contributions.
    (iii) Definition of excess deferrals.
    (2) Correction of excess deferrals after the taxable year.
    (3) Correction of excess deferrals during taxable year.
    (4) Plan provisions.
    (5) Income allocable to excess deferrals.
    (i) General rule.
    (ii) Method of allocating income.
    (iii) Alternative method of allocating income.
    (iv) Safe harbor method of allocating gap period income.
    (6) Coordination with distribution or recharacterization of excess 
contributions.
    (7) No employee or spousal consent required.
    (8) Tax treatment.

[[Page 456]]

    (i) Corrective distributions on or before April 15 after close of 
taxable year.
    (ii) Special rule for 1987 and 1988 excess deferrals.
    (iii) Distributions of excess deferrals after correction period.
    (9) No reduction of required minimum distribution.
    (10) Partial correction.
    (11) Examples.
(f) Community property laws.
(g) Effective date.
    (1) In general.
    (2) Deferrals under collective bargaining agreements.
    (3) Transition rule.
    (4) Partnership cash or deferred arrangements.

[T.D. 8357, 56 FR 40545, Aug. 15, 1991]



Sec. 1.402(g)-1  Limitation on exclusion for elective deferrals.

    (a) In general. The excess of an individual's elective deferrals for 
any taxable year over the applicable limit for the year may not be 
excluded from gross income under sections 402(a)(8), 402(h)(1)(B), 
403(b), 408(k)(6), or 501(c)(18). Thus, an individual's elective 
deferrals in excess of the applicable limit for a taxable year (that is, 
the individual's excess deferrals for the year) must be included in 
gross income for the year, except to the extent the excess deferrals are 
comprised of designated Roth contributions, and thus, are already 
includible in gross income. A designated Roth contribution is treated as 
an excess deferral only to the extent that the total amount of 
designated Roth contributions for an individual exceeds the applicable 
limit for the taxable year or the designated Roth contributions are 
identified as excess deferrals and the individual receives a 
distribution of the excess deferrals and allocable income under 
paragraph (e)(2) or (e)(3) of this section.
    (b) Elective deferrals. An individual's elective deferrals for a 
taxable year are the sum of the following:
    (1) Any elective contribution under a qualified cash or deferred 
arrangement (as defined in section 401(k)) to the extent not includible 
in the individual's gross income for the taxable year on account of 
section 402(a)(8) (before applying the limits of section 402(g) or this 
section).
    (2) Any employer contribution to a simplified employee pension (as 
defined in section 408(k)) to the extent not includible in the 
individual's gross income for the taxable year on account of section 
402(h)(1)(B) (before applying the limits of section 402(g) or this 
section).
    (3) Any employer contribution to an annuity contract under section 
403(b) under a salary reduction agreement (within the meaning of section 
3121(a)(5)(D)) to the extent not includible in the individual's gross 
income for the taxable year on account of section 403(b) (before 
applying the limits of section 402(g) or this section).
    (4) Any employee contribution designated as deductible under a trust 
described in section 501(c)(18) to the extent deductible from the 
individual's income for the taxable year on account of section 
501(c)(18) (before appying the limits of section 402(g) or this 
section). For purposes of this section, the employee contribution is 
treated as though it were excluded from the individual's gross income.
    (5) Any designated Roth contributions described in section 402A 
(before applying the limits of section 402(g) or this section).
    (6) Any elective employer contributions to a SIMPLE retirement 
account, on behalf of an employee pursuant to a qualified salary 
reduction arrangement as described in section 408(p)(2) (before applying 
the limits of section 402(g) or this section).
    (c) Certain one-time irrevocable elections. An employer contribution 
is not treated as an elective deferral under paragraph (b) of this 
section if the contribution is made pursuant to a one-time irrevocable 
election made by the employee:
    (1) In the case of an annuity contract under section 403(b), at the 
time of initial eligibility to participate in the salary reduction 
agreement;
    (2) In the case of a qualified cash or deferred arrangement, at a 
time when, under Sec. 1.401(k)-1(a)(3)(v), the election is not treated 
as a cash or deferred election;
    (3) In the case of a trust described in section 501(c)(18), at the 
time of initial eligibility to have the employer contribute on the 
employee's behalf to the trust.

[[Page 457]]

    (d) Applicable limit--(1) In general. Except as provided under 
paragraph (d)(2) of this section, the applicable limit for an 
individual's taxable year is the applicable dollar amount set forth in 
section 402(g)(1)(B). This applicable dollar amount is increased for the 
taxable year beginning in 2007 and later years in the same manner as the 
dollar amount under section 415(b)(1)(A) is adjusted pursuant to section 
415(d). See Sec. 1.402(g)-2 for the treatment of catch-up contributions 
described in section 414(v).
    (2) Special adjustment for elective deferrals with respect to 
section 403(b) annuity contracts for certain long-term employees. The 
applicable limit for an individual who is a qualified employee (as 
defined in section 402(g)(7)(C)) and has elective deferrals described in 
paragraph (b)(3) or (5) of this section for a taxable year is adjusted 
by increasing the applicable limit otherwise determined under paragraph 
(d)(1) of this section in accordance with section 402(g)(7).
    (e) Treatment of excess deferrals--(1) Plan qualification--(i) 
Effect of excess deferrals. For plan years beginning before January 1, 
1988, a plan, annuity contract, simplified employee pension, or trust 
does not fail to meet the requirements of section 401(a), section 
403(b), section 408(k), or section 501(c)(18), respectively, merely 
because excess deferrals are made with respect to the plan, contract, 
pension, or trust. For plan years beginning after December 3l, 1987, see 
section 401(a)(30) and Sec. 1.401(a)-30 for the effect of excess 
deferrals on the qualification of a plan or trust under section 401(a). 
For purposes of determining whether a plan or trust complies in 
operation with section 401(a)(30), excess deferrals that are distributed 
under paragraph (e)(2) or (3) of this section are disregarded. Similar 
rules apply to annuity contracts under section 403(b), simplified 
employee pensions under section 408(k), and plans or trusts under 
section 501(c)(28).
    (ii) Treatment of excess deferrals as employer contributions. For 
other purposes of the Code, including sections 401(a)(4), 401(k)(3), 
404, 409, 411, 412, and 416, excess deferrals must be treated as 
employer contributions even if they are distributed in accordance with 
paragraph (e)(2) or (3) of this section. However, excess deferrals of a 
nonhighly compensated employee are not taken into account under section 
401(k)(3) (the actual deferral percentage test) to the extent the excess 
deferrals are prohibited under section 401(a)(30). Excess deferrals are 
also treated as employer contributions for purposes of section 415 
unless distributed under paragraph (e)(2) or (3) of this section.
    (iii) Definition of excess deferrals. The term ``excess deferrals'' 
means the excess of an individual's elective deferrals for any taxable 
year, as defined in Sec. 1.402(g)-1(b), over the applicable limit under 
section 402(g)(1) for the taxable year.
    (2) Correction of excess deferrals after the taxable year. A plan 
may provide that if any amount is an excess deferral under paragraph (a) 
of this section:
    (i) Not later than the first April 15 (or such earlier date 
specified in the plan) following the close of the individual's taxable 
year, the individual may notify each plan under which elective deferrals 
were made of the amount of the excess deferrals received by the plan. If 
any designated Roth contributions were made to a plan, the notification 
must also identify the extent, if any, to which the excess deferrals are 
comprised of designated Roth contributions. A plan may provide that an 
individual is deemed to have notified the plan of excess deferrals 
(including the portion of excess deferrals that are comprised of 
designated Roth contributions) to the extent the individual has excess 
deferrals for the taxable year calculated by taking into account only 
elective deferrals under the plan and other plans of the same employer 
and the plan may provide the extent to which such excess deferrals are 
comprised of designated Roth contributions. A plan may instead provide 
that the employer may notify the plan on behalf of the individual under 
these circumstances.
    (ii) Not later than the first April 15 following the close of the 
taxable year, the plan may distribute to the individual the amount 
designated under paragraph (e)(2)(i) of this section (and any income 
allocable to that amount).
    (3) Correction of excess deferrals during taxable year--(i) A plan 
may provide

[[Page 458]]

that an individual who has excess deferrals for a taxable year may 
receive a corrective distribution of excess deferrals during the same 
year. This corrective distribution may be made only if all of the 
following conditions are satisfied:
    (A) The individual designates the distribution as an excess 
deferral. A plan may provide that an individual is deemed to have 
designated the distribution to the extent the individual has excess 
deferrals for the taxable year calculated by taking into account only 
elective deferrals under the plan and other plans of the same employer. 
If any designated Roth contributions were made to a plan, the 
notification must identify the extent to which, if any, the excess 
deferrals are comprised of designated Roth contributions. A plan may 
provide that an individual is deemed to have notified the plan of excess 
deferrals (including the portion of excess deferrals that are comprised 
of designated Roth contributions) for the taxable year calculated by 
taking into account only elective deferrals under the plan and other 
plans of the same employer and the plan may provide the extent to which 
such excess deferrals are comprised of designated Roth contributions.
    (B) The correcting distribution is made after the date on which the 
plan received the excess deferral.
    (C) The plan designates the distribution as a distribution of excess 
deferrals.
    (ii) The provisions of this paragraph (e)(3) are illustrated by the 
following example:

    Example. S is a 62 year old individual who participates in Employer 
Y's qualified cash or deferred arrangement. In January 1991, S withdraws 
$5,000 from Y's cash or deferred arrangement. From February through 
September, S defers $900 per month. On October 1, S leaves Employer Y 
and becomes employed by Employer Z (unrelated to Y). During the 
remainder of 1991, S defers $1,800 under Z's qualified cash or deferred 
arrangement. In January 1992, S realizes that S has deferred a total of 
$9,000 in 1991, and therefore has a $525 excess deferral ($9,000 minus 
$8,475, the applicable limit for 1991). An additional $525 must be 
distributed to S before April 15, 1992, to correct the excess deferral. 
The $5,000 withdrawal did not correct the excess deferral because it 
occurred before the excess deferral was made.

    (4) Plan provisions. In order to distribute excess deferrals 
pursuant to paragraphs (e)(2) or (e)(3) of this section, a plan must 
contain language permitting distribution of excess deferrals. A plan may 
require the notification in paragraphs (e)(2) and (e)(3) of this section 
to be in writing and may require that the employee certify or otherwise 
establish that the designated amount is an excess deferral. A plan need 
not permit distribution of excess deferrals.
    (5) Income allocable to excess deferrals--(i) General rule. The 
income allocable to excess deferrals for a taxable year that begins on 
or after January 1, 2007 is equal to the sum of the allocable gain or 
loss for the taxable year of the individual and, to the extent the 
excess deferrals are or will be credited with gain or loss for the 
period after the close of the taxable year and prior to the distribution 
(the gap period) if the total account were to be distributed, the 
allocable gain or loss during that period. The income allocable to 
excess deferrals for a taxable year that begins before 2007 is 
determined using the 1.402(g)-1(e)(5) (as it appeared in the April 1, 
2006 edition of 26 CFR Part 1).
    (ii) Method of allocating income. A plan may use any reasonable 
method for computing the income allocable to excess deferrals, provided 
that the method does not violate section 401(a)(4), is used consistently 
for all participants and for all corrective distributions under a plan 
for the plan year, and is used by the plan for allocating income to 
participants' accounts. See Sec. 1.401(a)(4)-1(c)(8). A plan will not 
fail to use a reasonable method for computing the income allocable to 
excess deferrals merely because the income allocable to excess deferrals 
is determined on a date that is no more than 7 days before the 
distribution.
    (iii) Alternative method of allocating taxable year income. A plan 
may determine the income allocable to excess deferrals for the taxable 
year by multiplying the income for the taxable year allocable to 
elective deferrals by a fraction. The numerator of the fraction is the 
excess deferrals by the employee for the taxable year. The denominator 
of the fraction is equal to the sum of:

[[Page 459]]

    (A) The total account balance of the employee attributable to 
elective deferrals as of the beginning of the taxable year, plus
    (B) The employee's elective deferrals for the taxable year.
    (iv) Safe harbor method of allocating gap period income. Under the 
safe harbor method, income on excess deferrals for the gap period is 
equal to 10 percent of the income allocable to excess deferrals for the 
taxable year (calculated under the method described in paragraph 
(e)(5)(iii) of this section), multiplied by the number of calendar 
months that have elapsed since the end of the taxable year. For purposes 
of calculating the number of calendar months that have elapsed under the 
safe harbor method, a corrective distribution that is made on or before 
the fifteenth day of the month is treated as made on the last day of the 
preceding month. A distribution made after the fifteenth day of the 
month is treated as made on the first day of the next month.
    (v) Alternative method for allocating taxable year and gap period 
income. A plan may determine the allocable gain or loss for the 
aggregate of the taxable year and the gap period by applying the 
alternative method provided by paragraph (e)(5)(iii) of this section to 
this aggregate period. This is accomplished by substituting the income 
for the taxable year and the gap period for the income for the taxable 
year and by substituting the elective deferrals for the taxable year and 
the gap period for the elective deferrals for the taxable year in 
determining the fraction that is multiplied by that income.
    (6) Coordination with distribution or recharacterization of excess 
contributions. The amount of excess deferrals that may be distributed 
under this paragraph (e) with respect to an employee for a taxable year 
is reduced by any excess contributions previously distributed or 
recharacterized with respect to the employee for the plan year beginning 
with or within the taxable year. In the event of a reduction under this 
paragraph (e)(6), the amount of excess contributions includible in the 
gross income of the employee and reported by the employer as a 
distribution of excess contributions is reduced by the amount of the 
reduction under this paragraph (e)(6). See Sec. 1.401(k)-2(b)(4)(i). In 
no case may an individual receive from a plan as a corrective 
distribution for a taxable year under paragraph (e)(2) or (e)(3) of this 
section an amount in excess of the individual's total elective deferrals 
under the plan for the taxable year.
    (7) No employee or spousal consent required. A corrective 
distribution of excess deferrals (and income) may be made under the 
terms of the plan without regard to any notice or consent otherwise 
required under sections 411(a)(11) or 417.
    (8) Tax treatment--(i) Corrective distributions on or before April 
15 after close of taxable year. A corrective distribution of excess 
deferrals within the period described in paragraph (e)(2) or (e)(3) of 
this section is excludable from the employee's gross income. However, 
the income allocable to excess deferrals is includible in the employee's 
gross income for the taxable year in which the allocable income is 
distributed. The corrective distribution of excess deferrals (and 
income) is not subject to the early distribution tax of section 72(t) 
and is not treated as a distribution for purposes of applying the excise 
tax under section 4980A.
    (ii) Special rule for 1987 and 1988 excess deferrals. Income on 
excess deferrals for 1987 or 1988 that were timely distributed on or 
before April 17, 1989, may be reported by the recipient either in the 
year described in paragraph (e)(8)(i) of this section, or in the year in 
which the employee would have received the elective deferrals had the 
employee originally elected to receive the amounts in cash.
    (iii) Distributions of excess deferrals after correction period. If 
excess deferrals (and income) for a taxable year are not distributed 
within the period described in paragraphs (e)(2) and (e)(3) of this 
section, they may only be distributed when permitted under section 
401(k)(2)(B). These amounts are includible in gross income when 
distributed, and are treated for purposes of the distribution rules 
otherwise applicable to the plan as elective deferrals (and income) that 
were excludable from the individual's gross income under section 402(g). 
Thus, any amount includible in

[[Page 460]]

gross income for any taxable year under this section that is not 
distributed by April 15 of the following taxable year is not treated as 
an investment in the contract for purposes of section 72 and is 
includible in the employee's gross income when distributed from the 
plan. Excess deferrals that are distributed under this paragraph 
(e)(8)(iii) are treated as employer contributions for purposes of 
section 415 when they are contributed to the plan.
    (iv) Distributions of excess deferrals from a designated Roth 
account. The rules of paragraph (e)(8)(iii) of this section generally 
apply to distributions of excess deferrals that are designated Roth 
contributions and the attributable income. Thus, if a designated Roth 
account described in section 402A includes any excess deferrals, any 
distribution of amounts attributable to those excess deferrals are 
includible in gross income (without adjustment for any return of 
investment in the contract under section 72(e)(8)). In addition, such 
distributions cannot be qualified distributions described in section 
402A(d)(2) and are not eligible rollover distributions within the 
meaning of section 402(c)(4). For this purpose, if a designated Roth 
account includes any excess deferrals, any distributions from the 
account are treated as attributable to those excess deferrals until the 
total amount distributed from the designated Roth account equals the 
total of such deferrals and attributable income.
    (9) No reduction of required minimum distribution. A distribution of 
excess deferrals (and income) under paragraphs (e)(2) and (e)(3) of this 
section is not treated as a distribution for purposes of determining 
whether the plan meets the minimum distribution requirements of section 
401(a)(9).
    (10) Partial correction. Any distribution under paragraphs (e)(2) or 
(e)(3) of this section of less than the entire amount of excess 
deferrals (and income) is treated as a pro rata distribution of excess 
deferrals and income.
    (11) Examples. The provisions of this paragraph are illustrated by 
the following examples. Assume in Examples 1 and 2 that there is no 
income or loss allocable to the elective deferrals.

    Example 1. Employee A is a 60-year old highly compensated employee 
who participates in Employer M's cash or deferred arrangement. During 
the period of January through September of 1988, A contributed $7,000 to 
the arrangement in elective deferrals. During the same period A also 
contributed $813 in elective deferrals under a plan of an unrelated 
employer. In December of 1988, A made a withdrawal of $1,000 from 
Employer M's plan but did not designate this as a withdrawal of an 
excess deferral. In January of 1989, A notifies Employer M of an excess 
deferral, specifying a distribution of $500 for 1988. To correct the 
excess deferrals, A must receive this additional $500 even though A has 
already withdrawn $1,000 for 1988. A may exclude from income in 1988 
only $7,313. However, if the $500 is distributed by April 25, 1989, the 
distribution is excludable from A's gross income in 1989. Even if A 
withdraws the $500, M must take into account the entire $7,000 in 
computing A's actual deferral percentage for 1988.
    Example 2. (i) Corporation X maintains a cash or deferred 
arrangement. The plan year is the calendar year. For plan year 1989, all 
10 of X's employees are eligible to participate in the plan. The 
employees' compensation, contributions, and actual deferral ratios are 
shown in the following table:

------------------------------------------------------------------------
                                                                 Actual
                                                                deferral
           Employee             Compensation    Contribution     ratio
                                                               (percent)
------------------------------------------------------------------------
A............................        $140,000          $7,000        5.0
B............................          70,000           7,000       10.0
C............................          70,000           7,000       10.0
D............................          45,000           2,250        5.0
E............................          40,000           4,000       10.0
F............................          35,000           1,750        5.0
G............................          35,000             350        1.0
H............................          30,000           3,000       10.0
I............................          17,500               0          0
J............................          17,500               0        0.0
------------------------------------------------------------------------

    (ii) Employees A, B, and C are highly compensated employees within 
the meaning of section 414(q). Employees D, E, F, G, H, I, and J are 
nonhighly compensated employees. The actual deferral percentages for the 
highly compensated employees and nonhighly compensated employees are 
8.33 percent and 4.43 percent, respectively. These percentages do not 
satisfy the requirements of section 401(k)(3)(A)(ii). The actual 
deferral percentage for the highly compensated employees may not exceed 
6.43 percent.
    (iii) The plan reduces the actual deferral ratios of B and C to 7.14 
percent by distributing $2,002 ($7,000-.0714x$70,000) to each in January 
1990. Section 401(k)(3)(A)(ii) is therefore satisfied.
    (iv) In February 1990, B notifies X that B made elective deferrals 
of $2,000 under a qualified cash or deferred arrangement maintained by 
an unrelated employer in 1989, and

[[Page 461]]

requests distribution of $2,000 from X's plan. However, since B has 
already received a distribution of $2,002 to meet the ADP test, no 
additional amounts are required or are permitted to be distributed as 
excess deferrals by this plan, and the prior distribution of excess 
contributions has corrected the excess deferrals. But X must report 
$2,000 as a distribution of an excess deferral and $2 as a distribution 
of an excess contribution.
    Example 3. Employee T has excess deferrals of $1,000. The income 
attributable to excess deferrals is $100. T properly notifies the 
employer, and requests a distribution of the excess deferral (and 
income) on February 1. The plan distributes $1,000 to T by April 15. 
Because the plan did not distribute any additional amount as income, 
$909 is treated as a distribution of excess deferrals, and $91 is 
treated as a distribution of earnings. With respect to amounts remaining 
in the account, $91 is treated as an elective deferral and is not 
included in T's investment in the contract. Because it was not 
distributed by the required date, the $91 is includible in gross income 
upon distribution as well as in the year of deferral.

    (f) Community property laws. This section is applied without regard 
to community property laws.
    (g) Effective date--(1) In general. Except as otherwise provided, 
the provisions of this section are effective for taxable years beginning 
after December 31, 1986.
    (2) Deferrals under collective bargaining agreements. In the case of 
a plan maintained pursuant to one or more collective bargaining 
agreements between employee representatives and one or more employers 
ratified before March 1, 1986, the provisions of this section do not 
apply to contributions made pursuant to the collective bargaining 
agreement for taxable years beginning before the earlier of January 1, 
1989, or the date on which the agreement terminates (determined without 
regard to any extension thereof after February 28, 1986). These 
contributions under a collective bargaining agreement are taken into 
account for purposes of applying this section to elective deferrals 
under plans not described in this paragraph (g)(2).
    (3) Transition rule. For taxable years beginning before January 1, 
1992, a plan or an individual may rely on a reasonable interpretation of 
the rules set forth in section 402(g), as in effect during those years.
    (4) Partnership cash or deferred arrangements. For purposes of 
section 402(g), employer contributions for any plan year beginning after 
December 31, 1986, and before January 1, 1989, under an arrangement that 
directly or indirectly permits individual partners to vary the amount of 
contributions made on their behalf will be treated as elective 
contributions only if the arrangement was intended to satisfy and did 
satisfy the nondiscrimination test of section 401(k)(3) and Sec. 
1.401(k)-1(b) for the plan year.

[T.D. 8357, 56 FR 40546, Aug. 15, 1991, as amended by T.D. 8581, 59 FR 
66180, Dec. 23, 1994; T.D. 9169, 69 FR 78153, Dec. 29, 2004; T.D. 9324, 
72 FR 21110, Apr. 30, 2007]



Sec. 1.402(g)-2  Increased limit for catch-up contributions.

    (a) General rule. Under section 402(g)(1)(C), in determining the 
amount of elective deferrals that are includible in gross income under 
section 402(g) for a catch-up eligible participant (within the meaning 
of Sec. 1.414(v)-1(g)), the otherwise applicable dollar limit under 
section 402(g)(1)(B) (as increased under section 402(g)(7), to the 
extent applicable) shall be further increased by the applicable dollar 
catch-up limit as set forth under Sec. 1.414(v)-1(c)(2).
    (b) Participants in multiple plans. Paragraph (a) of this section 
applies without regard to whether the applicable employer plans (within 
the meaning of section 414(v)(6)) treat the elective deferrals as catch-
up contributions. Thus, a catch-up eligible participant who makes 
elective deferrals under applicable employer plans of two or more 
employers that in total exceed the applicable dollar amount under 
section 402(g)(1) by an amount that does not exceed the applicable 
dollar catch-up limit under either plan may exclude the elective 
deferrals from gross income, even if neither applicable employer plan 
treats those elective deferrals as catch-up contributions.
    (c) Effective date--(1) Statutory effective date. Section 
402(g)(1)(C) applies to contributions in taxable years beginning on or 
after January 1, 2002.
    (2) Regulatory effective date. Paragraphs (a) and (b) of this 
section apply

[[Page 462]]

to contributions in taxable years beginning on or after January 1, 2004.

[T.D. 9072, 68 FR 40515, July 8, 2003]



Sec. 1.402(g)(3)-1  Employer contributions to purchase a section 403(b) 
contract under a salary reduction agreement.

    (a) General rule. With respect to an annuity contract under section 
403(b), except as provided in paragraph (b) of this section, an elective 
deferral means an employer contribution to purchase an annuity contract 
under section 403(b) under a salary reduction agreement within the 
meaning of section 3121(a)(5)(D).
    (b) Special rule. Notwithstanding paragraph (a) of this section, for 
purposes of section 403(b), an elective deferral only includes a 
contribution that is made pursuant to a cash or deferred election (as 
defined at Sec. 1.401(k)-1(a)(3)). Thus, for purposes of section 
402(g)(3)(C), an elective deferral does not include a contribution that 
is made pursuant to an employee's one-time irrevocable election made on 
or before the employee's first becoming eligible to participate under 
the employer's plans or a contribution made as a condition of employment 
that reduces the employee's compensation.
    (c) Applicable date. This section is applicable for taxable years 
beginning after December 31, 2008.

[T.D. 9340, 72 FR 41140, July 26, 2007]



Sec. 1.402A-1  Designated Roth Accounts.

    Q-1. What is a designated Roth account?
    A-1. A designated Roth account is a separate account under a 
qualified cash or deferred arrangement under a section 401(a) plan, or 
under a section 403(b) plan, to which designated Roth contributions are 
permitted to be made in lieu of elective contributions and that 
satisfies the requirements of Sec. 1.401(k)-1(f) (in the case of a 
section 401(a) plan) or Sec. 1.403(b)-3(c) (in the case of a section 
403(b) plan).
    Q-2. How is a distribution from a designated Roth account taxed?
    A-2. (a) The taxation of a distribution from a designated Roth 
account depends on whether or not the distribution is a qualified 
distribution. A qualified distribution from a designated Roth account is 
not includible in the distributee's gross income.
    (b) Except as otherwise provided in paragraph (c) of this A-2, a 
qualified distribution is a distribution that is both--
    (1) Made after the 5-taxable-year period of participation defined in 
A-4 of this section has been completed; and
    (2) Made on or after the date the employee attains age 59\1/2\, made 
to a beneficiary or the estate of the employee on or after the 
employee's death, or attributable to the employee's being disabled 
within the meaning of section 72(m)(7).
    (c) A distribution from a designated Roth account is not a qualified 
distribution to the extent it consists of a distribution of excess 
deferrals and attributable income described in Sec. 1.402(g)-1(e). See 
A-11 of this section for other amounts that are not treated as qualified 
distributions, including excess contributions described in section 
401(k)(8), and excess aggregate contributions described in section 
401(m)(8), and income, on any of these excess amounts.
    Q-3. How is a distribution from a designated Roth account taxed if 
it is not a qualified distribution?
    A-3. Except as provided in A-11 of this section, a distribution from 
a designated Roth account that is not a qualified distribution is 
taxable to the distributee under section 402 in the case of a plan 
qualified under section 401(a) and under section 403(b)(1) in the case 
of a section 403(b) plan. For this purpose, a designated Roth account is 
treated as a separate contract under section 72. Thus, except as 
otherwise provided in A-5 of this section for a rollover, if a 
distribution is before the annuity starting date, the portion of any 
distribution that is includible in gross income as an amount allocable 
to income on the contract and the portion not includible in gross income 
as an amount allocable to investment in the contract is determined under 
section 72(e)(8), treating the designated Roth account as a separate 
contract. Similarly, in the case of any amount received as an annuity, 
if a distribution is on or after the annuity starting date, the portion 
of any annuity payment

[[Page 463]]

that is includible in gross income as an amount allocable to income on 
the contract and the portion not includible in gross income as an amount 
allocable to investment in the contract is determined under section 
72(b) or (d), as applicable, treating the designated Roth account as a 
separate contract. For purposes of section 72, designated Roth 
contributions are described in section 72(f)(1) or 72(f)(2), to the 
extent applicable.
    Q-4. What is the 5-taxable-year period of participation described in 
A-2 of this section?
    A-4. (a) The 5-taxable-year period of participation described in A-2 
of this section for a plan is the period of 5 consecutive taxable years 
that begins with the first day of the first taxable year in which the 
employee makes a designated Roth contribution to any designated Roth 
account established for the employee under the same plan and ends when 5 
consecutive taxable years have been completed. For this purpose, the 
first taxable year in which an employee makes a designated Roth 
contribution is the year in which the amount is includible in the 
employee's gross income. Notwithstanding the preceding, however, a 
contribution that is returned as an excess deferral or excess 
contribution does not begin the 5 taxable-year period of participation. 
Similarly, a contribution returned as a permissible withdrawal under 
section 414(w) does not begin the 5 taxable-year period of 
participation.
    (b) Generally, an employee's 5-taxable-year period of participation 
is determined separately for each plan (within the meaning of section 
414(l)) in which the employee participates. Thus, if an employee has 
elective deferrals made to designated Roth accounts under two or more 
plans, the employee may have two or more different 5-taxable-year 
periods of participation, depending on when the employee first had 
contributions made to a designated Roth account under each plan. 
However, if a direct rollover contribution of a distribution from a 
designated Roth account under another plan is made by the employee to 
the plan, the 5-taxable-year period of participation begins on the first 
day of the employee's taxable year in which the employee first had 
designated Roth contributions made to such other designated Roth 
account, if earlier than the first taxable year in which a designated 
Roth contribution is made to the plan. See A-5(c) of this section for 
additional rules on determining the start of the 5-taxable-year of 
participation in the case of an indirect rollover.
    (c) The beginning of the 5-taxable-year period of participation is 
not redetermined for any portion of an employee's designated Roth 
account. This is true even if the entire designated Roth account is 
distributed during the 5-taxable-year period of participation and the 
employee subsequently makes additional designated Roth contributions 
under the plan.
    (d) The rule in paragraph (c) of this section applies if the 
employee dies or the account is divided pursuant to a qualified domestic 
relations order (QDRO), and thus, a portion of the account is not 
payable to the employee and is payable to the employee's beneficiary or 
an alternate payee. In the case of distribution to an alternate payee or 
beneficiary, generally, the age, death, or disability of the employee is 
used to determine whether the distribution to an alternate payee or 
beneficiary is qualified. However, if an alternate payee or a spousal 
beneficiary rolls the distribution into a designated Roth account in a 
plan maintained by his or her own employer, such individual's age, 
disability, or death is used to determine whether a distribution from 
the recipient plan is qualified. In addition, if the rollover is a 
direct rollover contribution to the alternate payee's or spousal 
beneficiary's own designated Roth account, the 5-taxable-year period of 
participation under the recipient plan begins on the earlier of the date 
the employee's 5-taxable-year period of participation began under the 
distributing plan or the date the 5-taxable-year period of participation 
applicable to the alternate payee's or spousal beneficiary's designated 
Roth account began under the recipient plan.
    (e) If a designated Roth contribution is made by a reemployed 
veteran for a year of qualified military service pursuant to section 
414(u) that is before the year in which the contribution is

[[Page 464]]

actually made, the contribution is treated as having been made in the 
year of qualified military service to which the contribution relates, as 
designated by the reemployed veteran. Reemployed veterans may identify 
the year of qualified military service for which a contribution is made 
for other purposes, such as for entitlement to a match, and the 
treatment for the 5-taxable-year period of participation rule follows 
that identification. In the absence of such designation, for purposes of 
determining the first year of the five years of participation under 
section 402A(d)(2)(B), the contribution is treated as relating to the 
first year of qualified military service for which the reemployed 
veteran could have made designated Roth contributions under the plan, or 
if later the first taxable year in which designated Roth contributions 
could be made under the plan.
    Q-5. How do the taxation rules apply to a distribution from a 
designated Roth account that is rolled over?
    A-5. (a) An eligible rollover distribution from a designated Roth 
account is permitted to be rolled over into another designated Roth 
account or a Roth IRA, and the amount rolled over is not currently 
includible in gross income. In accordance with section 402(c)(2), to the 
extent that a portion of a distribution from a designated Roth account 
is not includible in income (determined without regard to the rollover), 
if that portion of the distribution is to be rolled over into a 
designated Roth account, the rollover must be accomplished through a 
direct rollover (i.e., a 60-day rollover to another designated Roth 
account is not available for this portion of the distribution). For this 
purpose, any amount paid in a direct rollover is treated as a separate 
distribution from any amount paid directly to the employee. If a 
distribution from a designated Roth account is instead made to the 
employee, the employee would still be able to roll over the entire 
amount (or any portion thereof) into a Roth IRA within the 60-day period 
described in section 402(c)(3).
    (b) In the case of an eligible rollover distribution from a 
designated Roth account that is not a qualified distribution and not 
paid as a direct rollover contribution, if less than the entire amount 
of the distribution is rolled over, the part that is rolled over is 
deemed to consist first of the portion of the distribution that is 
attributable to income under section 72(e)(8).
    (c) If an employee receives a distribution from a designated Roth 
account, the portion of the distribution that would be includible in 
gross income is permitted to be rolled over into a designated Roth 
account under another plan. In such a case, Sec. 1.402A-2, A-3, 
provides for additional reporting by the recipient plan. In addition, 
the employee's period of participation under the distributing plan is 
not carried over to the recipient plan for purposes of satisfying the 5-
taxable-year period of participation requirement under the recipient 
plan. Generally, the taxable year in which the recipient plan accepts 
such rollover contribution is the taxable year that begins the 
participant's new 5-taxable-year period of participation. However, if 
the participant is rolling over to a plan in which the participant 
already has a pre-existing designated Roth account with a longer period 
of participation, the starting date of the recipient account is used to 
measure the participant's 5-taxable-year period of participation.
    (d) The following example illustrates the application of this A-5:

    Example. Employee B receives a $14,000 eligible rollover 
distribution that is not a qualified distribution from B's designated 
Roth account, consisting of $11,000 of investment in the contract and 
$3,000 of income. Within 60 days of receipt, Employee B rolls over 
$7,000 of the distribution into a Roth IRA. The $7,000 is deemed to 
consist of $3,000 of income and $4,000 of investment in the contract. 
Because the only portion of the distribution that could be includible in 
gross income (the income) is rolled over, none of the distribution is 
includible in Employee B's gross income.

    (e) This A-5 applies for taxable years beginning on or after January 
1, 2006.
    Q-6. In the case of a rollover contribution to a designated Roth 
account, how is the amount that is treated as investment in the contract 
under section 72 determined?
    A-6. (a) If a distribution from a designated Roth account is rolled 
over to another designated Roth account in a

[[Page 465]]

direct rollover, the amount of the rollover contribution allocated to 
investment in the contract in the recipient designated Roth account is 
the amount that would not have been includible in gross income 
(determined without regard to section 402(e)(4)) if the distribution had 
not been rolled over. Thus, if an amount that is a qualified 
distribution is rolled over, the entire amount of the rollover 
contribution is allocated to investment in the contract.
    (b) If the entire account balance of a designated Roth account is 
rolled over to another designated Roth account in a direct rollover, 
and, at the time of the distribution, the investment in the contract 
exceeds the balance in the designated Roth account, the investment in 
the contract in the distributing plan is included in the investment in 
the contract of the recipient plan.
    Q-7. After a qualified distribution from a designated Roth account 
has been made, how is the remaining investment in the contract of the 
designated Roth account determined under section 72?
    A-7. (a) The portion of any qualified distribution that is treated 
as a recovery of investment in the contract is determined in the same 
manner as if the distribution were not a qualified distribution. (See A-
3 of this section) Thus, the remaining investment in the contract in a 
designated Roth account after a qualified distribution is determined in 
the same manner after a qualified distribution as it would be determined 
if the distribution were not a qualified distribution.
    (b) The following example illustrates the application of this A-7:

    Example. Employee C receives a $12,000 distribution, which is a 
qualified distribution that is attributable to the employee being 
disabled within the meaning of section 72(m)(7), from C's designated 
Roth account. Immediately prior to the distribution, the account 
consisted of $21,850 of investment in the contract (i.e., designated 
Roth contributions) and $1,150 of income. For purposes of determining 
recovery of investment in the contract under section 72, the 
distribution is deemed to consist of $11,400 of investment in the 
contract [$12,000 x 21,850/(1,150 + 21,850)], and $600 of income 
[$12,000 x 1,150/(1,150 + 21,850)]. Immediately after the distribution, 
C's designated Roth account consists of $10,450 of investment in the 
contract and $550 of income. This determination of the remaining 
investment in the contract will be needed if C subsequently is no longer 
disabled and takes a nonqualified distribution from the designated Roth 
account.

    Q-8. What is the relationship between the accounting for designated 
Roth contributions as investment in the contract for purposes of section 
72 and their treatment as elective deferrals available for a hardship 
distribution under section 401(k)(2)(B)?
    A-8. (a) There is no relationship between the accounting for 
designated Roth contributions as investment in the contract for purposes 
of section 72 and their treatment as elective deferrals available for a 
hardship distribution under section 401(k)(2)(B). A plan that makes a 
hardship distribution under section 401(k)(2)(B) from elective deferrals 
that includes designated Roth contributions must separately determine 
the amount of elective deferrals available for hardship and the amount 
of investment in the contract attributable to designated Roth 
contributions for purposes of section 72. Thus, the entire amount of a 
hardship distribution is treated as reducing the otherwise maximum 
distributable amount for purposes of applying the rule in section 
401(k)(2)(B) and Sec. 1.401(k)-1(d)(3)(ii) that generally limits 
hardship distributions to the principal amount of elective deferrals 
made less the amount of elective deferrals previously distributed from 
the plan, even if a portion of the distribution is treated as income 
under section 72(e)(8).
    (b) The following example illustrates the application of this A-8:

    Example. The facts are the same as in the Example in A-7 of this 
section, except that instead of being disabled, Employee C is receiving 
a hardship distribution. In addition, Employee C has made elective 
deferrals that are not designated Roth contributions totaling $20,000 
and has received no previous distributions of elective deferrals from 
the plan. The adjustment to the investment in the contract is the same 
as in A-7 of this section, but for purposes of determining the amount of 
elective deferrals available for future hardship distribution, the 
entire amount of the distribution is subtracted from the maximum 
distributable amount. Thus, Employee C has only $29,850 ($41,850-
$12,000) available for hardship distribution from C's designated Roth 
account.


[[Page 466]]


    Q-9. Can an employee have more than one separate contract for 
designated Roth contributions under a plan qualified under section 
401(a) or a section 403(b) plan?
    A-9. (a) Except as otherwise provided in paragraph (b) of this A-9, 
for purposes of section 72, there is only one separate contract for an 
employee with respect to the designated Roth contributions under a plan. 
Thus, if a plan maintains one separate account for designated Roth 
contributions made under the plan and another separate account for 
rollover contributions received from a designated Roth account under 
another plan (so that the rollover account is not required to be subject 
to the distribution restrictions otherwise applicable to the account 
consisting of designated Roth contributions made under the plan), both 
separate accounts are considered to be one contract for purposes of 
applying section 72 to the distributions from either account.
    (b) If a separate account with respect to an employee's accrued 
benefit consisting of designated Roth contributions is established and 
maintained for an alternate payee pursuant to a qualified domestic 
relations order and another designated Roth account is maintained for 
the employee, each account is treated as a separate contract for 
purposes of section 72. The alternate payee's designated Roth account is 
also a separate contract for purposes of section 72 with respect to any 
other account maintained for that alternate payee. Similarly, if 
separate accounts are established and maintained for different 
beneficiaries after the death of an employee, the separate account for 
each beneficiary is treated as a separate contract under section 72 and 
is also a separate contract with respect to any other account maintained 
for that beneficiary under the plan that is not a designated Roth 
account. When the separate account is established for an alternate payee 
or for a beneficiary (after an employee's death), each separate account 
must receive a proportionate amount attributable to investment in the 
contract.
    Q-10. What is the tax treatment of employer securities distributed 
from a designated Roth account?
    A-10. (a) If a distribution of employer securities from a designated 
Roth account is not a qualified distribution, section 402(e)(4)(B) 
applies. Thus, in the case of a lump-sum distribution that includes 
employer securities, unless the taxpayer elects otherwise, net 
unrealized appreciation attributable to the employer securities is not 
includible in gross income; and such net unrealized appreciation is not 
included in the basis of the distributed securities and is capital gain 
to the extent such appreciation is realized in a subsequent taxable 
transaction.
    (b) In the case of a qualified distribution of employer securities 
from a designated Roth account, the distributee's basis in the 
distributed securities for purposes of subsequent disposition is their 
fair market value at the time of distribution.
    Q-11. Can an amount described in A-4 of Sec. 1.402(c)-2 with 
respect to a designated Roth account be a qualified distribution?
    A-11. No. An amount described in A-4 of Sec. 1.402(c)-2 with 
respect to a designated Roth account cannot be a qualified distribution. 
Such an amount is taxable under the rules of Sec. Sec. 1.72-16(b), 
1.72(p)-1, A-11 through A-13, 1.402(g)-1(e)(8), 1.401(k)-2(b)(2)(vi), 
1.401(m)-2(b)(2)(vi), or 1.404(k)-1T. Thus, for example, loans that are 
treated as deemed distributions pursuant to section 72(p), or dividends 
paid on employer securities as described in section 404(k) are not 
qualified distributions even if the deemed distributions occur or the 
dividends are paid after the employee attains age 59\1/2\ and the 5-
taxable-year period of participation defined in A-4 of this section has 
been satisfied. However, if a dividend is reinvested in accordance with 
section 404(k)(2)(A)(iii)(II), the amount of such a dividend is not 
precluded from being a qualified distribution if later distributed. 
Further, an amount is not precluded from being a qualified distribution 
merely because it is described in section 402(c)(4) as an amount not 
eligible for rollover. Thus, a hardship distribution is not precluded 
from being a qualified distribution.
    Q-12. If any amount from a designated Roth account is included in a

[[Page 467]]

loan to an employee, do the plan aggregation rules of section 
72(p)(2)(D) apply for purposes of determining the total amount an 
employee is permitted to borrow from the plan, even though the 
designated Roth account generally is treated as a separate contract 
under section 72?
    A-12. Yes. If any amount from a designated Roth account is included 
in a loan to an employee, notwithstanding the general rule that the 
designated Roth account is treated as a separate contract under section 
72, the plan aggregation rules of section 72(p)(2)(D) apply for purposes 
of determining the maximum amount the employee is permitted to borrow 
from the plan and such amount is based on the total of the designated 
Roth contribution amounts and the other amounts under the plan. To the 
extent a loan is from a designated Roth account, the repayment 
requirement of section 72(p)(2)(C) must be satisfied separately with 
respect to that portion of the loan and with respect to the portion of 
the loan from other accounts under the plan.
    Q-13. Does a transaction or accounting methodology involving an 
employee's designated Roth account and any other accounts under the plan 
or plans of an employer that has the effect of transferring value from 
the other accounts into the designated Roth account violate the separate 
accounting requirement of section 402A?
    A-13. (a) Yes. Any transaction or accounting methodology involving 
an employee's designated Roth account and any other accounts under the 
plan or plans of an employer that has the effect of directly or 
indirectly transferring value from another account into the designated 
Roth account violates the separate accounting requirement under section 
402A. However, any transaction that merely exchanges investments between 
accounts at fair market value will not violate the separate accounting 
requirement.
    (b) In the case of an annuity contract which contains both a 
designated Roth account and any other accounts, the Commissioner may 
prescribe additional guidance of general applicability, published in the 
Internal Revenue Bulletin (see 601.601(d)(2) of this chapter), to 
provide additional rules for allocation of income, expenses, gains and 
losses among the accounts under the contract.
    (c) This A-13 applies to designated Roth accounts for taxable years 
beginning on or after January 1, 2006.
    Q-14. How is an annuity contract that is distributed from a 
designated Roth account treated for purposes of section 402A?
    A-14. A qualified plan distributed annuity contract within the 
meaning of Sec. 1.402(c)-2, A-10(a) that is distributed from a 
designated Roth account is not treated as a distribution for purposes of 
section 402 or 402A. Instead, the amounts paid under the annuity 
contract are treated as distributions for purposes of sections 402 and 
402A. Thus, the period after the annuity contract is distributed and 
before a payment from the annuity contract is made is included in 
determining whether the five-year period of participation is satisfied. 
Further, for purposes of determining if a distribution is a qualified 
distribution, the determination of whether a distribution is made on or 
after the date the employee attains age 59\1/2\, made to a beneficiary 
or the estate of the employee on or after the employee's death, or 
attributable to the employee's being disabled within the meaning of 
section 72(m)(7) is made based on the facts at the time the distribution 
is made from the annuity contract. Thus for example, if an employee 
first makes a designated Roth contribution to a designated Roth account 
in 2006 at age 56, receives a distributed annuity contract within the 
meaning of Sec. 1.402(c)-2, A-10(a) in 2007 purchased only with assets 
from the designated Roth account, and then receives a distribution from 
the contract in 2011 at age 60, the distribution is a qualified 
distribution.
    Q-15. When are section 402A and this Sec. 1.402A-1 applicable?
    A-15. Section 402A is applicable for taxable years beginning on or 
after January 1, 2006. Except as otherwise provided in A-5 and A-13 of 
this section, the rules of this Sec. 1.402A-1 apply for taxable years 
beginning on or after January 1, 2007.

[T.D. 9324, 72 FR 21111, Apr. 30, 2007; 72 FR 30974, June 5, 2007, as 
amended by T.D. 9340, 72 FR 41140, July 26, 2007]

[[Page 468]]



Sec. 1.402A-2  Reporting and recordkeeping requirements with respect 
to designated Roth accounts.

    Q-1. Who is responsible for keeping track of the 5-taxable-year 
period of participation and the investment in the contract, i.e., the 
amount of unrecovered designated Roth contributions for the employee?
    A-1. The plan administrator or other responsible party with respect 
to a plan with a designated Roth account is responsible for keeping 
track of the 5-taxable-year period of participation for each employee 
and the amount of investment in the contract (unrecovered designated 
Roth contributions) on behalf of such employee. For purposes of the 
preceding sentence, in the absence of actual knowledge to the contrary, 
the plan administrator or other responsible party is permitted to assume 
that an employee's taxable year is the calendar year. In the case of a 
direct rollover from another designated Roth account, the plan 
administrator or other responsible party of the recipient plan can rely 
on reasonable representations made by the plan administrator or 
responsible party with respect to the plan with the other designated 
Roth account. See A-2 of this section for statements required in the 
case of rollovers.
    Q-2. In the case of an eligible rollover distribution from a 
designated Roth account, what additional information must be provided 
with respect to such distribution?
    A-2. (a) Pursuant to section 6047(f), if an amount is distributed 
from a designated Roth account, the plan administrator or other 
responsible party with respect to the plan must provide a statement as 
described below in the following situations--
    (1) In the case of a direct rollover of a distribution from a 
designated Roth account under a plan to a designated Roth account under 
another plan, the plan administrator or other responsible party must 
provide to the plan administrator or responsible party of the recipient 
plan either a statement indicating the first year of the 5-taxable-year 
period described in A-1 of this section and the portion of the 
distribution that is attributable to investment in the contract under 
section 72, or a statement that the distribution is a qualified 
distribution.
    (2) If the distribution is not a direct rollover to a designated 
Roth account under another plan, the plan administrator or responsible 
party must provide to the employee, upon request, the same information 
described in paragraph (a)(1) of this A-2, except the statement need not 
indicate the first year of the 5-taxable-year period described in A-1 of 
this section.
    (b) The statement described in paragraph (a) of this A-2 must be 
provided within a reasonable period following the direct rollover or 
distributee request but in no event later than 30 days following the 
direct rollover or distributee request.
    Q-3. If a plan qualified under section 401(a) or a section 403(b) 
plan accepts a 60-day rollover of earnings from a designated Roth 
account, what report to the IRS must be provided with respect to such 
rollover contribution?
    A-3. To the extent required in Forms and Instructions, if a plan 
qualified under section 401(a), or a section 403(b) plan, accepts a 
rollover contribution (other than a direct rollover contribution) under 
section 402(c)(2), or section 403(b)(8)(B), of the portion of a 
distribution from a designated Roth account that would have been 
includable in gross income, the plan administrator or other responsible 
party for the recipient plan must notify the Commissioner of its 
acceptance of the rollover contribution no later than the due date for 
filing Form 1099-R, `` Distributions From Pensions, Annuities, 
Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.,.'' 
The Forms and Instructions will specify the address to which the 
notification is required to be sent and will require inclusion of the 
employee's name and social security number, the amount rolled over, the 
year in which the rollover contribution was made, and such other 
information as the Commissioner may prescribe in order to determine that 
the amount rolled over is a valid rollover contribution.
    Q-4. When is this Sec. 1.402A-2 applicable?

[[Page 469]]

    A-4. The rules of this Sec. 1.402A-2 are applicable for taxable 
years beginning on or after January 1, 2007.

[T.D. 9324, 72 FR 21111, Apr. 30, 2007; 72 FR 30974, June 5, 2007]



Sec. 1.403(a)-1  Taxability of beneficiary under a qualified annuity 
plan.

    (a) An employee or retired or former employee for whom an annuity 
contract is purchased by his employer is not required to include in his 
gross income the amount paid for the contract at the time such amount is 
paid, whether or not his rights to the contract are forfeitable, if the 
annuity contract is purchased under a plan which meets the requirements 
of section 404(a)(2). For purposes of the preceding sentence, it is 
immaterial whether the employer deducts the amounts paid for the 
contract under such section 404(a)(2). See Sec. 1.403(b)-1 through 
1.403(b)-10 for rules relating to annuity contracts which are not 
purchased under qualified plans but which are purchased by organizations 
described in section 501(c)(3) and exempt under section 501(a) or which 
are purchased for employees who perform services for certain public 
schools.
    (b) The amounts received by or made available to any employee 
referred to in paragraph (a) of this section under such annuity contract 
shall be included in gross income of the employee for the taxable year 
in which received or made available, as provided in section 72 (relating 
to annuities), except that certain total distributions described in 
section 403(a)(2) are taxable as long-term capital gains. For the 
treatment of such total distributions, see Sec. 1.403(a)-2. However, 
for taxable years beginning before January 1, 1964, section 72(e)(3) 
(relating to the treatment of certain lump sums), as in effect before 
such date, shall not apply to such amounts. For taxable years beginning 
after December 31, 1963, such amounts may be taken into account in 
computations under sections 1301 through 1305 (relating to income 
averaging).
    (c) If upon the death of an employee or of a retired employee, the 
widow or other beneficiary of such employee is paid, in accordance with 
the terms of the annuity contract relating to the deceased employee, an 
annuity or other death benefit, the extent to which the amounts received 
by or made available to the beneficiary must be included in the 
beneficiary's income under section 403(a) shall be determined in 
accordance with the rules presented in paragraph (a)(5) of Sec. 
1.402(a)-1.
    (d) An individual contract issued after December 31, 1962, or a 
group contract, which provides incidental life insurance protection may 
be purchased under a qualified annuity plan. For the rules as to 
nontransferability of such contracts issued after December 31, 1962, see 
Sec. 1.401-9. For the rules relating to the taxation of the cost of the 
life insurance protection and the proceeds thereunder, see Sec. 1.72-
16. Section 403(a) is not applicable to premiums paid after October 26, 
1956, for individual contracts which were issued prior to January 1, 
1963, and which provide life insurance protection.
    (e) As to inclusion of full-time life insurance salesmen within the 
class of persons considered to be employees, see section 7701(a)(20).
    (f) For purposes of this section and Sec. 1.403(a)-2, the term 
``employee'' includes a self-employed individual who is treated as an 
employee under section 401(c)(1) and paragraph (b) of Sec. 1.401-10, 
and the term ``employer'' means the person treated as the employer of 
such individual under section 401(c)(4). For the rules relating to 
annuity plans covering self-employed individuals, see section 404(a)(2) 
and Sec. Sec. 1.404(a)-8 and 1.401-10 through 1.401-13.
    (g) For the treatment of amounts paid to provide medical benefits 
described in section 401(h) as defined in Sec. 1.401-14, see paragraph 
(h) of Sec. 1.72-15.

[T.D. 6500, 25 FR 11680, Nov. 26, 1960, as amended by T.D. 6676, 28 FR 
10143, Sept. 17, 1963; T.D. 6722, 29 FR 5073, Apr. 14, 1964; T.D. 6783, 
29 FR 18359, Dec. 24, 1964; T.D. 6885, 31 FR 7801, June 2, 1966; T.D. 
9340, 72 FR 41159, July 26, 2007]



Sec. 1.403(a)-2  Capital gains treatment for certain distributions.

    (a) If the total amounts payable with respect to any employee for 
whom an annuity contract has been purchased by an employer under a plan 
which--
    (1) Is a plan described in section 403(a)(1) and Sec. 1.403(a)-1, 
and

[[Page 470]]

    (2) Requires that refunds of contributions with respect to annuity 
contracts purchased under such plan be used to reduce subsequent 
premiums on the contracts under the plan,

are paid to, or includible in gross income of, the payee within one 
taxable year of the payee by reason of the employee's death or other 
separation from the service, or death after such separation from the 
service, such total payments, to the extent they exceed the net amount 
contributed by the employee, shall be considered a gain from the sale or 
exchange of a capital asset held for more than six months. The ``net 
amount contributed by the employee'' is the amount actually contributed 
by the employee plus any amounts considered to be contributed by the 
employee under the rules of sections 72(f), 101(b), and paragraph (d) of 
Sec. 1.403(a)-1, reduced by any amounts theretofore distributed to him 
which were excludable from his gross income as a return of employee 
contributions. For example, if under an annuity contract purchased under 
a plan described in this section, the total distributions payable to the 
employee's widow are paid to her in the year in which the employee dies, 
in the amount of $8,000, and if $5,000 thereof is excludable under 
section 101(b), and if the employee made contributions of $600 and had 
received no payments, the remaining amount of $2,400 will be considered 
a gain from the sale or exchange of a capital asset held for more than 
six months.
    (b)(1) The term ``total amounts'' means the balance to the credit of 
an employee with respect to all annuities under the annuity plan which 
becomes payable to the payee by reason of the employee's death or other 
separation from the service, or by reason of his death after separation 
from the service. If an employee commences to receive annuity payments 
on retirement and then a lump sum payment is made to his widow upon his 
death, the capital gains treatment applies to the lump sum payment, but 
it does not apply to amounts received before the time the ``total 
amounts'' become payable. However, if the total amount to the credit of 
the employee at the time of his death or other separation from the 
service or death after separation from the service is paid or includible 
in the gross income of the payee within one taxable year of the payee, 
such amount is entitled to the capital gains treatment notwithstanding 
that in a later taxable year an additional amount is credited to the 
employee and paid to the payee.
    (2) If more than one annuity contract is received under the plan, 
the capital gains treatment does not apply to any amount received on the 
surrender thereof unless all contracts under the plan with respect to a 
particular employee are surrendered either at the time of the employee's 
death or other separation from the service or death after separation 
from the service. Thus, if an employee receives two contracts on 
separation from the service and surrenders one of them in the year of 
separation and receives payments under the other until his death, the 
capital gains treatment is applicable to the balance paid to his 
beneficiary on his death if paid within one taxable year of the 
beneficiary. The amount received by the employee on surrender of the 
contract in the year of his separation from the service, however, would 
not receive capital gains treatment since the balance to the credit of 
the employee with respect to all amounts under the plan did not become 
payable at that time.
    (3) If an employee retires and commences to receive an annuity but 
subsequently in some succeeding taxable year, he is paid a lump sum in 
settlement of all future annuity payments, the capital gains treatment 
does not apply to such lump sum settlement paid during the lifetime of 
the employee since it is not a payment on account of separation from the 
service, or death after separation, but is on account of the settlement 
of future annuity payments.
    (4) If the ``total amounts'' payable under all annuity contracts 
under the plan with respect to a particular employee are paid or 
includible in the gross income of several payees within one taxable year 
on account of the employee's death or other separation from the service 
or on account of his death after separation from the service, the 
capital gains treatment is applicable.

[[Page 471]]

Thus, if the balance to the credit of a deceased employee under all 
annuity contracts provided under an annuity plan becomes payable to two 
payees, the capital gains treatment is applicable provided the ``total 
amounts'' payable are received by or includible in the gross income of 
both payees within the same taxable year. However, if the ``total 
amounts'' payable are made available to each payee and one elects to 
receive his share in cash while the other makes a timely election under 
section 72(h) to receive his share as an annuity, the capital gains 
treatment does not apply to either payee.
    (5) For purposes of determining whether the total amounts payable to 
an employee have been paid within one taxable year, the term ``total 
amounts'' includes amounts under a plan which are attributable to 
contributions on behalf of an individual while he was self-employed in 
the business with respect to which the plan was established. Thus, the 
``total amounts'' payable are not paid within one taxable year if 
amounts remain payable which are so attributable.
    (6) The term ``total amounts'' does not include any amount which has 
been placed in a separate account for the funding of benefits described 
in section 401(h). Thus, a distribution under a qualified annuity plan 
may constitute a distribution of the total amounts payable with respect 
to an employee even though amounts attributable to the funding of 
section 401(h) medical benefits as defined in paragraph (a) of Sec. 
1.401-14 are not so distributed.
    (c) The provisions of this section are not applicable to any amounts 
paid to a payee to the extent such amounts are attributable to 
contributions made on behalf of an employee while he was a self-employed 
individual in the business with respect to which the plan was 
established. For the taxation of such amounts, see Sec. 1.72-18. For 
the rules for determining the amount attributable to contributions on 
behalf of an employee while he was self-employed, see paragraphs (b)(4) 
and (c)(2) of such section.

[T.D. 6500, 25 FR 11681, Nov. 26, 1960, as amended by T.D. 6676, 28 FR 
10143, Sept. 17, 1963; T.D. 6722, 29 FR 5073, Apr. 14, 1964]



Sec. 1.403(b)-0  Taxability under an annuity purchased by a section 
501(c)(3) organization or a public school.

    This section lists the headings that appear in Sec. Sec. 1.403(b)-1 
through 1.403(b)-11.

    Sec. 1.403(b)-1 General overview of taxability under an annuity 
   contract purchased by a section 501(c)(3) organization or a public 
                                 school.

                      Sec. 1.403(b)-2 Definitions.

(a) Application of definitions.
(b) Definitions.

Sec. 1.403(b)-3 Exclusion for contributions to purchase section 403(b) 
                               contracts.

(a) Exclusion for section 403(b) contracts.
(b) Application of requirements.
(c) Special rules for designated Roth section 403(b) contributions.
(d) Effect of failure.

               Sec. 1.403(b)-4 Contribution limitations.

(a) Treatment of contributions in excess of limitations.
(b) Maximum annual contribution.
(c) Section 403(b) elective deferrals.
(d) Employer contributions for former employees.
(e) Special rules for determining years of service.
(f) Excess contributions of deferrals.

                Sec. 1.403(b)-5 Nondiscrimination rules.

(a) Nondiscrimination rules for contributions other than section 403(b) 
          elective deferrals.
(b) Universal availability required for section 403(b) elective 
          deferrals.
(c) Plan required.
(d) Church plans exception.
(e) Other rules.

         Sec. 1.403(b)-6 Timing of distributions and benefits.

(a) Distributions generally.
(b) Distributions from contracts other than custodial accounts or 
          amounts attributable to section 403(b) elective deferrals.
(c) Distributions from custodial accounts that are not attributable to 
          section 403(b) elective deferrals.
(d) Distribution of section 403(b) elective deferrals.
(e) Minimum required distributions for eligible plans.
(f) Loans.
(g) Death benefits and other incidental benefits.
(h) Special rule regarding severance from employment.

[[Page 472]]

        Sec. 1.403(b)-7 Taxation of distributions and benefits.

(a) General rules for when amounts are included in gross income.
(b) Rollovers to individual retirement arrangements and other eligible 
          retirement plans.
(c) Special rules for certain corrective distributions.
(d) Amounts taxable under section 72(p)(1).
(e) Special rules relating to distributions from a designated Roth 
          account.
(f) Certain rules relating to employment taxes.

                        Sec. 1.403(b)-8 Funding.

(a) Investments.
(b) Contributions to the plan.
(c) Annuity contracts.
(d) Custodial accounts.
(e) Retirement income accounts.
(f) Combining assets.

            Sec. 1.403(b)-9 Special rules for church plans.

(a) Retirement income accounts.
(b) Retirement income account defined.
(c) Special deduction rule for self-employed ministers.

               Sec. 1.403(b)-10 Miscellaneous provisions.

(a) Plan terminations and frozen plans.
(b) Contract exchanges and plan-to-plan transfers.
(c) Qualified domestic relations orders.
(d) Rollovers to a section 403(b) contract.
(e) Deemed IRAs.
(f) Defined benefit plans.
(g) Other rules relating to section 501(c)(3) organizations.

                   Sec. 1.403(b)-11 Applicable date.

(a) General rule.
(b) Collective bargaining agreements.
(c) Church conventions.
(d) Special rules for plans that exclude certain types of employees from 
          elective deferrals.
(e) Special rules for plans that permit in-service distributions.
(f) Special rule for life insurance contracts.
(g) Special rule for contracts received in an exchange.

[T.D. 9340, 72 FR 41140, July 26, 2007]



Sec. 1.403(b)-1  General overview of taxability under an annuity 
contract purchased by a section 501(c)(3) organization or a public 

school.

    Section 403(b) and Sec. Sec. 1.403(b)-2 through 1.403(b)-10 provide 
rules for the Federal income tax treatment of an annuity purchased for 
an employee by an employer that is either a tax-exempt entity under 
section 501(c)(3) (relating to certain religious, charitable, 
scientific, or other types of organizations) or a public school, or for 
a minister described in section 414(e)(5)(A). See section 403(a) 
(relating to qualified annuities) for rules regarding the taxation of an 
annuity purchased under a qualified annuity plan that meets the 
requirements of section 404(a)(2), and see section 403(c) (relating to 
nonqualified annuities) for rules regarding the taxation of other types 
of annuities.

[T.D. 9340, 72 FR 41141, July 26, 2007]



Sec. 1.403(b)-2  Definitions.

    (a) Application of definitions. The definitions set forth in this 
section are applicable for purposes of Sec. 1.403(b)-1, this section 
and Sec. Sec. 1.403(b)-3 through 1.403(b)-11.
    (b) Definitions--(1) Accumulated benefit means the total benefit to 
which a participant or beneficiary is entitled under a section 403(b) 
contract, including all contributions made to the contract and all 
earnings thereon.
    (2) Annuity contract means a contract that is issued by an insurance 
company qualified to issue annuities in a State and that includes 
payment in the form of an annuity. See Sec. 1.401(f)-1(d)(2) and (e) 
for the definition of an annuity, and see Sec. 1.403(b)-8(c)(3) for a 
special rule for certain State plans. See also Sec. Sec. 1.403(b)-8(d) 
and 1.403(b)-9(a) for additional rules regarding the treatment of 
custodial accounts and retirement income accounts as annuity contracts.
    (3) Beneficiary means a person who is entitled to benefits in 
respect of a participant following the participant's death or an 
alternate payee pursuant to a qualified domestic relations order, as 
described in Sec. 1.403(b)-10(c).
    (4) Catch-up amount or catch-up limitation for a participant for a 
taxable year means a section 403(b) elective deferral permitted under 
section 414(v) (as described in Sec. 1.403(b)-4(c)(2)) or section 
402(g)(7) (as described in Sec. 1.403(b)-4(c)(3)).
    (5) Church means a church as defined in section 3121(w)(3)(A) and a 
qualified church-controlled organization as defined in section 
3121(w)(3)(B).
    (6) Church-related organization means a church or a convention or 
association of churches, including an organization described in section 
414(e)(3)(A).

[[Page 473]]

    (7) Elective deferral means an elective deferral under Sec. 
1.402(g)-1 (with respect to an employer contribution to a section 403(b) 
contract) and any other amount that constitutes an elective deferral 
under section 402(g)(3).
    (8) (i) Eligible employer means--
    (A) A State, but only with respect to an employee of the State 
performing services for a public school;
    (B) A section 501(c)(3) organization with respect to any employee of 
the section 501(c)(3) organization;
    (C) Any employer of a minister described in section 414(e)(5)(A), 
but only with respect to the minister; or
    (D) A minister described in section 414(e)(5)(A), but only with 
respect to a retirement income account established for the minister.
    (ii) An entity is not an eligible employer under paragraph 
(a)(8)(i)(A) of this section if it treats itself as not being a State 
for any other purpose of the Internal Revenue Code, and a subsidiary or 
other affiliate of an eligible employer is not an eligible employer 
under paragraph (a)(8)(i) of this section if the subsidiary or other 
affiliate is not an entity described in paragraph (a)(8)(i) of this 
section.
    (9) Employee means a common-law employee performing services for the 
employer, and does not include a former employee or an independent 
contractor. Subject to any rules in Sec. 1.403(b)-1, this section, and 
Sec. Sec. 1.403(b)-3 through 1.403(b)-11 that are specifically 
applicable to ministers, an employee also includes a minister described 
in section 414(e)(5)(A) when performing services in the exercise of his 
or her ministry.
    (10) Employee performing services for a public school means an 
employee performing services as an employee for a public school of a 
State. This definition is not applicable unless the employee's 
compensation for performing services for a public school is paid by the 
State. Further, a person occupying an elective or appointive public 
office is not an employee performing services for a public school unless 
such office is one to which an individual is elected or appointed only 
if the individual has received training, or is experienced, in the field 
of education. The term public office includes any elective or appointive 
office of a State.
    (11) Includible compensation means the employee's compensation 
received from an eligible employer that is includible in the 
participant's gross income for Federal income tax purposes (computed 
without regard to section 911) for the most recent period that is a year 
of service. Includible compensation for a minister who is self-employed 
means the minister's earned income as defined in section 401(c)(2) 
(computed without regard to section 911) for the most recent period that 
is a year of service. Includible compensation does not include any 
compensation received during a period when the employer is not an 
eligible employer. Includible compensation also includes any elective 
deferral or other amount contributed or deferred by the eligible 
employer at the election of the employee that would be includible in the 
gross income of the employee but for the rules of sections 125, 
132(f)(4), 402(e)(2), 402(h)(1)(B), 402(k), or 457(b). The amount of 
includible compensation is determined without regard to any community 
property laws. See section 415(c)(3)(A) through (D) for additional 
rules, and see Sec. 1.403(b)-4(d) for a special rule regarding former 
employees.
    (12) Participant means an employee for whom a section 403(b) 
contract is currently being purchased, or an employee or former employee 
for whom a section 403(b) contract has previously been purchased and who 
has not received a distribution of his or her entire accumulated benefit 
under the contract.
    (13) Plan means a plan as described in Sec. 1.403(b)-3(b)(3).
    (14) Public school means a State-sponsored educational organization 
described in section 170(b)(1)(A)(ii) (relating to educational 
organizations that normally maintain a regular faculty and curriculum 
and normally have a regularly enrolled body of pupils or students in 
attendance at the place where educational activities are regularly 
carried on).
    (15) Retirement income account means a defined contribution program 
established or maintained by a church-related organization to provide 
benefits

[[Page 474]]

under section 403(b) for its employees or their beneficiaries as 
described in Sec. 1.403(b)-9.
    (16) Section 403(b) contract; section 403(b) plan--(i) Section 
403(b) contract means a contract that satisfies the requirements of 
Sec. 1.403(b)-3. If for any taxable year an employer contributes to 
more than one section 403(b) contract for a participant or beneficiary, 
then, under section 403(b)(5), all such contracts are treated as one 
contract for purposes of section 403(b) and Sec. 1.403(b)-1, this 
section, and Sec. Sec. 1.403(b)-3 through 1.403(b)-11. See also Sec. 
1.403(b)-3(b)(1).
    (ii) Section 403(b) plan means the plan of the employer under which 
the section 403(b) contracts for its employees are maintained.
    (17) Section 403(b) elective deferral; designated Roth 
contribution--(i) Section 403(b) elective deferral means an elective 
deferral that is an employer contribution to a section 403(b) plan for 
an employee. See Sec. 1.403(b)-5(b) for additional rules with respect 
to a section 403(b) elective deferral.
    (ii) Designated Roth contribution under a section 403(b) plan means 
a section 403(b) elective deferral that satisfies Sec. 1.403(b)-3(c).
    (18) Section 501(c)(3) organization means an organization that is 
described in section 501(c)(3) (relating to certain religious, 
charitable, scientific, or other types of organizations) and exempt from 
tax under section 501(a).
    (19) Severance from employment means that the employee ceases to be 
employed by the employer maintaining the plan. See Sec. 1.401(k)-1(d) 
for additional guidance concerning severance from employment. See also 
Sec. 1.403(b)-6(h) for a special rule under which severance from 
employment is determined by reference to employment with the eligible 
employer.
    (20) State means a State, a political subdivision of a State, or any 
agency or instrumentality of a State. For this purpose, the District of 
Columbia is treated as a State. In addition, for purposes of determining 
whether an individual is an employee performing services for a public 
school, an Indian tribal government is treated as a State, as provided 
under section 7871(a)(6)(B). See also section 1450(b) of the Small 
Business Job Protection Act of 1996 (110 Stat. 1755, 1814) for special 
rules treating certain contracts purchased in a plan year beginning 
before January 1, 1995, that include contributions by an Indian tribal 
government as section 403(b) contracts, whether or not those 
contributions are for employees performing services for a public school.
    (21) Year of service means each full year during which an individual 
is a full-time employee of an eligible employer, plus fractional credit 
for each part of a year during which the individual is either a full-
time employee of an eligible employer for a part of the year or a part-
time employee of an eligible employer. See Sec. 1.403(b)-4(e) for rules 
for determining years of service.

[T.D. 9340, 72 FR 41141, July 26, 2007; 72 FR 54351, Sept. 25, 2007]



Sec. 1.403(b)-3  Exclusion for contributions to purchase section 403(b) 
contracts.

    (a) Exclusion for section 403(b) contracts. Amounts contributed by 
an eligible employer for the purchase of an annuity contract for an 
employee are excluded from the gross income of the employee under 
section 403(b) only if each of the requirements in paragraphs (a)(1) 
through (9) of this section is satisfied. In addition, amounts 
contributed by an eligible employer for the purchase of an annuity 
contract for an employee pursuant to a cash or deferred election (as 
defined at Sec. 1.401(k)-1(a)(3)) are not includible in an employee's 
gross income at the time the cash would have been includible in the 
employee's gross income (but for the cash or deferred election) if each 
of the requirements in paragraphs (a)(1) through (9) of this section is 
satisfied. However, the preceding two sentences generally do not apply 
to designated Roth contributions; see paragraph (c) of this section and 
Sec. 1.403(b)-7(e) for special taxation rules that apply with respect 
to designated Roth contributions under a section 403(b) plan.
    (1) Not a contract issued under qualified plan or eligible 
governmental plan. The annuity contract is not purchased under a 
qualified plan (under section 401(a) or 403(a)) or an eligible 
governmental plan under section 457(b).

[[Page 475]]

    (2) Nonforfeitability. The rights of the employee under the annuity 
contract (disregarding rights to future premiums) are nonforfeitable. An 
employee's rights under a contract fail to be nonforfeitable unless the 
employee for whom the contract is purchased has at all times a fully 
vested and nonforfeitable right (as defined in regulations under section 
411) to all benefits provided under the contract. See paragraph (d)(2) 
of this section for additional rules regarding the nonforfeitability 
requirement of this paragraph (a)(2).
    (3) Nondiscrimination. In the case of an annuity contract purchased 
by an eligible employer other than a church, the contract is purchased 
under a plan that satisfies section 403(b)(12) (relating to 
nondiscrimination requirements, including universal availability). See 
Sec. 1.403(b)-5.
    (4) Limitations on elective deferrals. In the case of an elective 
deferral, the contract satisfies section 401(a)(30) (relating to 
limitations on elective deferrals). A contract does not satisfy section 
401(a)(30) as required under this paragraph (a)(4) unless the contract 
requires that all elective deferrals for an employee not exceed the 
limits of section 402(g)(1), including elective deferrals for the 
employee under the contract and any other elective deferrals under the 
plan under which the contract is purchased and under all other plans, 
contracts, or arrangements of the employer. See Sec. 1.401(a)-30.
    (5) Nontransferability. The contract is not transferable. This 
paragraph (a)(5) does not apply to a contract issued before January 1, 
1963. See section 401(g).
    (6) Minimum required distributions. The contract satisfies the 
requirements of section 401(a)(9) (relating to minimum required 
distributions). See Sec. 1.403(b)-6(e).
    (7) Rollover distributions. The contract provides that, if the 
distributee of an eligible rollover distribution elects to have the 
distribution paid directly to an eligible retirement plan, as defined in 
section 402(c)(8)(B), and specifies the eligible retirement plan to 
which the distribution is to be paid, then the distribution will be paid 
to that eligible retirement plan in a direct rollover. See Sec. 
1.403(b)-7(b)(2).
    (8) Limitation on incidental benefits. The contract satisfies the 
incidental benefit requirements of section 401(a). See Sec. 1.403(b)-
6(g).
    (9) Maximum annual additions. The annual additions to the contract 
do not exceed the applicable limitations of section 415(c) (treating 
contributions and other additions as annual additions). See paragraph 
(b) of this section and Sec. 1.403(b)-4(b) and (f).
    (b) Application of requirements--(1) Aggregation of contracts. In 
accordance with section 403(b)(5), for purposes of determining whether 
this section is satisfied, all section 403(b) contracts purchased for an 
individual by an employer are treated as purchased under a single 
contract. Additional aggregation rules apply under section 402(g) for 
purposes of satisfying paragraph (a)(4) of this section and under 
section 415 for purposes of satisfying paragraph (a)(9) of this section.
    (2) Disaggregation for excess annual additions. In accordance with 
the last sentence of section 415(a)(2), if an excess annual addition is 
made to a contract that otherwise satisfies the requirements of this 
section, then the portion of the contract that includes such excess 
annual addition fails to be a section 403(b) contract (as further 
described in paragraph (d)(1) of this section) and the remaining portion 
of the contract is a section 403(b) contract. This paragraph (b)(2) is 
not satisfied unless, for the year of the excess and each year 
thereafter, the issuer of the contract maintains separate accounts for 
each such portion. Thus, the entire contract fails to be a section 
403(b) contract if an excess annual addition is made and a separate 
account is not maintained with respect to the excess.
    (3) Plan in form and operation. (i) A contract does not satisfy 
paragraph (a) of this section unless it is maintained pursuant to a 
plan. For this purpose, a plan is a written defined contribution plan, 
which, in both form and operation, satisfies the requirements of Sec. 
1.403(b)-1, Sec. 1.403(b)-2, this section, and Sec. Sec. 1.403(b)-4 
through 1.403(b)-11. For purposes of Sec. 1.403(b)-1, Sec. 1.403(b)-2, 
this section, and Sec. Sec. 1.403(b)-4 through 1.403(b)-11, the plan 
must contain all the material terms and conditions for eligibility, 
benefits, applicable limitations,

[[Page 476]]

the contracts available under the plan, and the time and form under 
which benefit distributions would be made. For purposes of Sec. 
1.403(b)-1, Sec. 1.403(b)-2, this section, and Sec. Sec. 1.403(b)-4 
through 1.403(b)-11, a plan may contain certain optional features that 
are consistent with but not required under section 403(b), such as 
hardship withdrawal distributions, loans, plan-to-plan or annuity 
contract-to-annuity contract transfers, and acceptance of rollovers to 
the plan. However, if a plan contains any optional provisions, the 
optional provisions must meet, in both form and operation, the relevant 
requirements under section 403(b), this section, and Sec. Sec. 
1.403(b)-4 through 1.403(b)-11.
    (ii) The plan may allocate responsibility for performing 
administrative functions, including functions to comply with the 
requirements of section 403(b) and other tax requirements. Any such 
allocation must identify responsibility for compliance with the 
requirements of the Internal Revenue Code that apply on the basis of the 
aggregated contracts issued to a participant under a plan, including 
loans under section 72(p) and the conditions for obtaining a hardship 
withdrawal under Sec. 1.403(b)-6. A plan is permitted to assign such 
responsibilities to parties other than the eligible employer, but not to 
participants (other than employees of the employer a substantial portion 
of whose duties are administration of the plan), and may incorporate by 
reference other documents, including the insurance policy or custodial 
account, which thereupon become part of the plan.
    (iii) This paragraph (b)(3) applies to contributions to an annuity 
contract by a church only if the annuity is part of a retirement income 
account, as defined in Sec. 1.403(b)-9.
    (4) Exclusion limited for former employees--(i) General rule. Except 
as provided in paragraph (b)(4)(ii) of this section and in Sec. 
1.403(b)-4(d), the exclusion from gross income provided by section 
403(b) does not apply to contributions made for former employees. For 
this purpose, a contribution is not made for a former employee if the 
contribution is with respect to compensation that would otherwise be 
paid for a payroll period that begins before severance from employment.
    (ii) Exceptions. The exclusion from gross income provided by section 
403(b) applies to contributions made for former employees with respect 
to compensation described in Sec. 1.415(c)-2(e)(3)(i) (relating to 
certain compensation paid by the later of 2\1/2\ months after severance 
from employment or the end of the limitation year that includes the date 
of severance from employment), and compensation described in Sec. 
1.415(c)-2(e)(4), Sec. 1.415(c)-2(g)(4), or Sec. 1.415(c)-2(g)(7) 
(relating to compensation paid to participants who are permanently and 
totally disabled or relating to qualified military service under section 
414(u)).
    (c) Special rules for designated Roth section 403(b) contributions. 
(1) The rules of Sec. 1.401(k)-1(f)(1) and (2) for designated Roth 
contributions under a qualified cash or deferred arrangement apply to 
designated Roth contributions under a section 403(b) plan. Thus, a 
designated Roth contribution under a section 403(b) plan is a section 
403(b) elective deferral that is designated irrevocably by the employee 
at the time of the cash or deferred election as a designated Roth 
contribution that is being made in lieu of all or a portion of the 
section 403(b) elective deferrals the employee is otherwise eligible to 
make under the plan; that is treated by the employer as includible in 
the employee's gross income at the time the employee would have received 
the amount in cash if the employee had not made the cash or deferred 
election (such as by treating the contributions as wages subject to 
applicable withholding requirements); and that is maintained in a 
separate account (within the meaning of Sec. 1.401(k)-1(f)(2)).
    (2) A designated Roth contribution under a section 403(b) plan must 
satisfy the requirements applicable to section 403(b) elective 
deferrals. Thus, for example, designated Roth contributions under a 
section 403(b) plan must satisfy the requirements of Sec. 1.403(b)-
6(d). Similarly, a designated Roth account under a section 403(b) plan 
is subject to the rules of sections 401(a)(9)(A) and (B) and Sec. 
1.403(b)-6(e).
    (d) Effect of failure--(1) General rules. (i) If a contract includes 
any amount

[[Page 477]]

that fails to satisfy the requirements of section 403(b), Sec. 
1.403(b)-1, Sec. 1.403(b)-2, this section, or Sec. Sec. 1.403(b)-4 
through 1.403(b)-11, then, except as otherwise provided in paragraph 
(d)(2) of this section (relating to failure to satisfy nonforfeitability 
requirements) or Sec. 1.403(b)-4(f) (relating to excess contributions 
under section 415 and excess deferrals under section 402(g)), the 
contract is not a section 403(b) contract. In addition, section 
403(b)(5) and paragraph (b)(1) of this section provide that, for 
purposes of determining whether a contract satisfies section 403(b), all 
section 403(b) contracts purchased for an individual by an employer are 
treated as purchased under a single contract. Thus, except as provided 
in paragraph (b)(2) of this section or as otherwise provided in this 
paragraph (d), a failure to satisfy section 403(b) with respect to any 
contract issued to an individual by an employer adversely affects all 
contracts issued to that individual by that employer.
    (ii) In accordance with paragraph (b)(3) of this section, a failure 
to operate in accordance with the terms of a plan adversely affects all 
of the contracts issued by the employer to the employee or employees 
with respect to whom the operational failure occurred. Such a failure 
does not adversely affect any other contract if the failure is neither a 
failure to satisfy the nondiscrimination requirements of Sec. 1.403(b)-
5 (a nondiscrimination failure) nor a failure of the employer to be an 
eligible employer as defined in Sec. 1.403(b)-2 (an employer 
eligibility failure). However, any failure that is not an operational 
failure adversely affects all contracts issued under the plan, 
including: a failure to have contracts issued pursuant to a written 
defined contribution plan which, in form, satisfies the requirements of 
Sec. 1.403(b)-1, Sec. 1.403(b)-2, this section, and Sec. Sec. 
1.403(b)-4 through 1.403(b)-11 (a written plan failure); a 
nondiscrimination failure; or an employer eligibility failure.
    (iii) See other applicable Internal Revenue Code provisions for the 
treatment of a contract that is not a section 403(b) contract, such as 
sections 61, 83, 402(b), and 403(c). Thus, for example, section 403(c) 
(relating to nonqualified annuities) applies if any annuity contract 
issued by an insurance company fails to satisfy section 403(b), based on 
the value of the contract at the time of the failure. However, see 
paragraph (d)(2) of this section for special rules with respect to the 
nonforfeitability requirement of paragraph (a)(2) of this section.
    (2) Failure to satisfy nonforfeitability requirement--(i) Treatment 
before contract becomes nonforfeitable. If an annuity contract issued by 
an insurance company would qualify as a section 403(b) contract but for 
the failure to satisfy the nonforfeitability requirement of paragraph 
(a)(2) of this section, then the contract is treated as a contract to 
which section 403(c) applies. See Sec. 1.403(b)-8(d)(4) for a rule 
under which a custodial account that fails to satisfy the 
nonforfeitability requirement of paragraph (a)(2) of this section is 
treated as a section 401(a) qualified plan for certain purposes.
    (ii) Treatment when contract becomes nonforfeitable--(A) In general. 
Notwithstanding paragraph (d)(2)(i) of this section, on or after the 
date on which the participant's interest in a contract described in 
paragraph (d)(2)(i) of this section becomes nonforfeitable, the contract 
may be treated as a section 403(b) contract if no election has been made 
under section 83(b) with respect to the contract, the participant's 
interest in the contract has been subject to a substantial risk of 
forfeiture (as defined in section 83) before becoming nonforfeitable, 
each contribution under the contract that is subject to a different 
vesting schedule is maintained in a separate account, and the contract 
has at all times satisfied the requirements of paragraph (a) of this 
section other than the nonforfeitability requirement of paragraph (a)(2) 
of this section. Thus, for example, for the current year and each prior 
year, no contribution can have been made to the contract that would 
cause the contract to fail to be a section 403(b) contract as a result 
of contributions exceeding the limitations of section 415 (except to the 
extent permitted under paragraph (b)(2) of this section) or to fail to 
satisfy the nondiscrimination rules described in Sec. 1.403(b)-5. See 
also Sec. 1.403(b)-10(a)(1) for a special rule in connection

[[Page 478]]

with termination of a section 403(b) plan.
    (B) Partial vesting. For purposes of applying this paragraph (d), if 
only a portion of a participant's interest in a contract becomes 
nonforfeitable in a year, then the portion that is nonforfeitable and 
the portion that fails to be nonforfeitable are each treated as separate 
contracts. In addition, for purposes of applying this paragraph (d), if 
a contribution is made to an annuity contract in excess of the 
limitations of section 415(c) and the excess is maintained in a separate 
account, then the portion of the contract that includes the excess 
contributions account and the remainder are each treated as separate 
contracts. Thus, if an annuity contract that includes an excess 
contributions account changes from forfeitable to nonforfeitable during 
a year, then the portion that is not attributable to the excess 
contributions account constitutes a section 403(b) contract (assuming it 
otherwise satisfies the requirements to be a section 403(b) contract) 
and is not included in gross income, and the portion that is 
attributable to the excess contributions account is included in gross 
income in accordance with section 403(c). See Sec. 1.403(b)-4(f) for 
additional rules.

[T.D. 9340, 72 FR 41141, July 26, 2007; 72 FR 54352, Sept. 25, 2007]



Sec. 1.403(b)-4  Contribution limitations.

    (a) Treatment of contributions in excess of limitations. The 
exclusion provided under Sec. 1.403(b)-3(a) applies to a participant 
only if the amounts contributed by the employer for the purchase of an 
annuity contract for the participant do not exceed the applicable limit 
under sections 415 and 402(g), as described in this section. Under Sec. 
1.403(b)-3(a)(4), a section 403(b) contract is required to include the 
limits on elective deferrals imposed by section 402(g), as described in 
paragraph (c) of this section. See paragraph (f) of this section for 
special rules concerning excess contributions and deferrals. Rollover 
contributions made to a section 403(b) contract, as described in Sec. 
1.403(b)-10(d), are not taken into account for purposes of the limits 
imposed by section 415, Sec. 1.403(b)-3(a)(9), section 402(g), Sec. 
1.403(b)-3(a)(4), and this section, but after-tax employee contributions 
are taken into account under section 415, Sec. 1.403(b)-3(a)(9), and 
paragraph (b) of this section.
    (b) Maximum annual contribution--(1) General rule. In accordance 
with section 415(a)(2) and Sec. 1.403(b)-3(a)(9), the contributions for 
any participant under a section 403(b) contract (namely, employer 
nonelective contributions (including matching contributions), section 
403(b) elective deferrals, and after-tax employee contributions) are not 
permitted to exceed the limitations imposed by section 415. Under 
section 415(c), contributions are permitted to be made for participants 
in a defined contribution plan, subject to the limitations set forth 
therein (which are generally the lesser of a dollar limit for a year or 
the participant's compensation for the year). For purposes of section 
415, contributions made for a participant are aggregated to the extent 
applicable under sections 414(b), (c), (m), (n), and (o). For purposes 
of section 415(a)(2), Sec. Sec. 1.403(b)-1 through 1.403(b)-3, this 
section, and Sec. Sec. 1.403(b)-5 through 1.403(b)-11, a contribution 
means any annual addition, as defined in section 415(c).
    (2) Special rules. See section 415(k)(4) for a special rule under 
which contributions to section 403(b) contracts are generally aggregated 
with contributions under other arrangements in applying section 415. For 
purposes of applying section 415(c)(1)(B) (relating to compensation) 
with respect to a section 403(b) contract, except as provided in section 
415(c)(3)(C), a participant's includible compensation (as defined in 
Sec. 1.403(b)-2) is substituted for the participant's compensation, as 
described in section 415(c)(3)(E). Any age 50 catch-up contributions 
under paragraph (c)(2) of this section are disregarded in applying 
section 415.
    (c) Section 403(b) elective deferrals--(1) Basic limit under section 
402(g)(1). In accordance with section 402(g)(1)(A), the section 403(b) 
elective deferrals for any individual are included in the individual's 
gross income to the extent the amount of such deferrals, plus all other 
elective deferrals for the individual, for the taxable year exceeds the 
applicable dollar amount under section

[[Page 479]]

402(g)(1)(B). The applicable annual dollar amount under section 
402(g)(1)(B) is $15,000, adjusted for cost-of-living after 2006 in the 
manner described in section 402(g)(4). See Sec. 1.403(b)-5(b) for a 
universal availability rule that applies if any employee is permitted to 
have any section 403(b) elective deferrals made on his or her behalf.
    (2) Age 50 catch-up--(i) In general. In accordance with section 
414(v) and the regulations thereunder, a section 403(b) contract may 
provide for catch-up contributions for a participant who is age 50 by 
the end of the year, provided that such age 50 catch-up contributions do 
not exceed the catch-up limit under section 414(v)(2) for the taxable 
year. The maximum amount of additional age 50 catch-up contributions for 
a taxable year under section 414(v) is $5,000, adjusted for cost-of-
living after 2006 in the manner described in section 414(v)(2)(C). For 
additional requirements, see regulations under section 414(v).
    (ii) Coordination with special section 403(b) catch-up. In 
accordance with sections 414(v)(6)(A)(ii) and 402(g)(7)(A), the age 50 
catch-up described in this paragraph (c)(2) may apply for any taxable 
year in which a participant also qualifies for the special section 
403(b) catch-up under paragraph (c)(3) of this section.
    (3) Special section 403(b) catch-up for certain organizations--(i) 
Amount of the special section 403(b) catch-up. In the case of a 
qualified employee of a qualified organization for whom the basic 
section 403(b) elective deferrals for any year are not less than the 
applicable dollar amount under section 402(g)(1)(B), the section 403(b) 
elective deferral limitation of section 402(g)(1) for the taxable year 
of the qualified employee is increased by the least of--
    (A) $3,000;
    (B) The excess of--
    (1) $15,000, over
    (2) The total elective deferrals described in section 
402(g)(7)(A)(ii) made for the qualified employee by the qualified 
organization for prior years; or
    (C) The excess of--
    (1) $5,000 multiplied by the number of years of service of the 
employee with the qualified organization, over
    (2) The total elective deferrals (as defined at Sec. 1.403(b)-2) 
made for the employee by the qualified organization for prior years.
    (ii) Qualified organization. (A) For purposes of this paragraph 
(c)(3), qualified organization means an eligible employer that is--
    (1) An educational organization described in section 
170(b)(1)(A)(ii);
    (2) A hospital;
    (3) A health and welfare service agency (including a home health 
service agency);
    (4) A church-related organization; or
    (5) Any organization described in section 414(e)(3)(B)(ii).
    (B) All entities that are in a church-related organization or an 
organization controlled by a church-related organization under section 
414(e)(3)(B)(ii) are treated as a single qualified organization (so that 
years of service and any special section 403(b) catch-up elective 
deferrals previously made for a qualified employee for a church or other 
entity within a church-related organization or an organization 
controlled by the church-related organization are taken into account for 
purposes of applying this paragraph (c)(3) to the employee with respect 
to any other entity within the same church-related organization or 
organization controlled by a church-related organization).
    (C) For purposes of this paragraph (c)(3)(ii), a health and welfare 
service agency means--
    (1) An organization whose primary activity is to provide services 
that constitute medical care as defined in section 213(d)(1) (such as a 
hospice);
    (2) A section 501(c)(3) organization whose primary activity is the 
prevention of cruelty to individuals or animals;
    (3) An adoption agency; or
    (4) An agency that provides substantial personal services to the 
needy as part of its primary activity (such as a section 501(c)(3) 
organization that either provides meals to needy individuals, is a home 
health service agency, provides services to help individuals who have 
substance abuse, or provides help to the disabled).
    (iii) Qualified employee. For purposes of this paragraph (c)(3), 
qualified employee means an employee who has

[[Page 480]]

completed at least 15 years of service (as defined under paragraph (e) 
of this section) taking into account only employment with the qualified 
organization. Thus, an employee who has not completed at least 15 years 
of service (as defined under paragraph (e) of this section) taking into 
account only employment with the qualified organization is not a 
qualified employee.
    (iv) Coordination with age 50 catch-up. In accordance with sections 
402(g)(1)(C) and 402(g)(7), any catch-up amount contributed by an 
employee who is eligible for both an age 50 catch-up and a special 
section 403(b) catch-up is treated first as an amount contributed as a 
special section 403(b) catch-up to the extent a special section 403(b) 
catch-up is permitted, and then as an amount contributed as an age 50 
catch-up (to the extent the catch-up amount exceeds the maximum special 
section 403(b) catch-up after taking into account sections 402(g) and 
415(c), this paragraph (c)(3), and any limitations on the special 
section 403(b) catch-up that are imposed by the terms of the plan).
    (4) Coordination with designated Roth contributions. See regulations 
under section 402A for rules for determining whether an elective 
deferral is a pre-tax elective deferral or a designated Roth 
contribution.
    (5) Examples. The provisions of this paragraph (c) are illustrated 
by the following examples:

    Example 1. (i) Facts illustrating application of the basic dollar 
limit. Participant B, who is 45, is eligible to participate in a State 
university section 403(b) plan in 2006. B is not a qualified employee, 
as defined in paragraph (c)(3)(iii) of this section. The plan permits 
section 403(b) elective deferrals, but no other employer contributions 
are made under the plan. The plan provides limitations on section 403(b) 
elective deferrals up to the maximum permitted under paragraphs (c)(1) 
and (3) of this section and the additional age 50 catch-up amount 
described in paragraph (c)(2) of this section. For 2006, B will receive 
includible compensation of $42,000 from the eligible employer. B desires 
to elect to have the maximum section 403(b) elective deferral possible 
contributed in 2006. For 2006, the basic dollar limit for section 403(b) 
elective deferrals under paragraph (c)(1) of this section is $15,000 and 
the additional dollar amount permitted under the age 50 catch-up is 
$5,000.
    (ii) Conclusion. B is not eligible for the age 50 catch-up in 2006 
because B is 45 in 2006. B is also not eligible for the special section 
403(b) catch-up under paragraph (c)(3) of this section because B is not 
a qualified employee. Accordingly, the maximum section 403(b) elective 
deferral that B may elect for 2006 is $15,000.
    Example 2. (i) Facts illustrating application of the includible 
compensation limitation. The facts are the same as in Example 1, except 
B's includible compensation is $14,000.
    (ii) Conclusion. Under section 415(c), contributions may not exceed 
100 percent of includible compensation. Accordingly, the maximum section 
403(b) elective deferral that B may elect for 2006 is $14,000.
    Example 3. (i) Facts illustrating application of the age 50 catch-
up. Participant C, who is 55, is eligible to participate in a State 
university section 403(b) plan in 2006. The plan permits section 403(b) 
elective deferrals, but no other employer contributions are made under 
the plan. The plan provides limitations on section 403(b) elective 
deferrals up to the maximum permitted under paragraphs (c)(1) and (c)(3) 
of this section and the additional age 50 catch-up amount described in 
paragraph (c)(2) of this section. For 2006, C will receive includible 
compensation of $48,000 from the eligible employer. C desires to elect 
to have the maximum section 403(b) elective deferral possible 
contributed in 2006. For 2006, the basic dollar limit for section 403(b) 
elective deferrals under paragraph (c)(1) of this section is $15,000 and 
the additional dollar amount permitted under the age 50 catch-up is 
$5,000. C does not have 15 years of service and thus is not a qualified 
employee, as defined in paragraph (c)(3)(iii) of this section.
    (ii) Conclusion. C is eligible for the age 50 catch-up in 2006 
because C is 55 in 2006. C is not eligible for the special section 
403(b) catch-up under paragraph (c)(3) of this section because C is not 
a qualified employee (as defined in paragraph (c)(3)(iii) of this 
section). Accordingly, the maximum section 403(b) elective deferral that 
C may elect for 2006 is $20,000 ($15,000 plus $5,000).
    Example 4. (i) Facts illustrating application of both the age 50 and 
the special section 403(b) catch-up. The facts are the same as in 
Example 3, except that C is a qualified employee for purposes of the 
special section 403(b) catch-up provisions in paragraph (c)(3) of this 
section. For 2006, the maximum additional section 403(b) elective 
deferral for which C qualifies under the special section 403(b) catch-up 
under paragraph (c)(3) of this section is $3,000.
    (ii) Conclusion. The maximum section 403(b) elective deferrals that 
C may elect for 2006 is $23,000. This is the sum of the basic limit on 
section 403(b) elective deferrals under paragraph (c)(1) of this section 
equal to $15,000, plus the $3,000 additional special

[[Page 481]]

section 403(b) catch-up amount for which C qualifies under paragraph 
(c)(3) of this section, plus the additional age 50 catch-up amount of 
$5,000.
    Example 5. (i) Facts illustrating calculation of years of service 
with a predecessor organization for purposes of the special section 
403(b) catch-up. Participant A is an employee of hospital H and is 
eligible to participate in a section 403(b) plan of H in 2006. A does 
not have 15 years of service with H, but A has previously made special 
section 403(b) catch-up deferrals to a section 403(b) plan maintained by 
hospital P which has since been acquired by H.
    (ii) Conclusion. The special section 403(b) catch-up amount for 
which A qualifies under paragraph (c)(3) of this section must be 
calculated taking into account A's prior years of service and section 
403(b) elective deferrals with the predecessor hospital if and only if A 
did not have any severance from service in connection with the 
acquisition.
    Example 6. (i) Facts illustrating application of the age 50 catch-up 
and the section 415(c) dollar limitation. The facts are the same as in 
Example 4, except that the employer makes a nonelective contribution for 
each employee equal to 20 percent of C's compensation (which is 
$48,000). Thus, the employer makes a nonelective contribution for C for 
2006 equal to $9,600. The plan provides that a participant is not 
permitted to make section 403(b) elective deferrals to the extent the 
section 403(b) elective deferrals would result in contributions in 
excess of the maximum permitted under section 415 and provides that 
contributions are reduced in the following order: the special section 
403(b) catch-up elective deferrals under paragraph (c)(3) of this 
section are reduced first; the age 50 catch-up elective deferrals under 
paragraph (c)(2) of this section are reduced second; and then the basic 
section 403(b) elective deferrals under paragraph (c)(1) of this section 
are reduced. For 2006, the applicable dollar limit under section 
415(c)(1)(A) is $44,000.
    (ii) Conclusion. The maximum section 403(b) elective deferral that C 
may elect for 2006 is $23,000. This is the sum of the basic limit on 
section 403(b) elective deferrals under paragraph (c)(1) of this section 
equal to $15,000, plus the $3,000 additional special section 403(b) 
catch-up amount for which C qualifies under paragraph (c)(3) of this 
section, plus the additional age 50 catch-up amount of $5,000. The limit 
in paragraph (b) of this section would not be exceeded because the sum 
of the $9,600 nonelective contribution and the $23,000 section 403(b) 
elective deferrals does not exceed the lesser of $49,000 (which is the 
sum of $44,000 plus the $5,000 additional age 50 catch-up amount) or 
$53,000 (which is the sum of C's includible compensation for 2006 
($48,000) plus the $5,000 additional age 50 catch-up amount).
    Example 7. (i) Facts further illustrating application of the age 50 
catch-up and the section 415(c) dollar limitation. The facts are the 
same as in Example 6, except that C's includible compensation for 2006 
is $58,000 and the plan provides for a nonelective contribution equal to 
50 percent of includible compensation, so that the employer nonelective 
contribution for C for 2006 is $29,000 (50 percent of $58,000).
    (ii) Conclusion. The maximum section 403(b) elective deferral that C 
may elect for 2006 is $20,000. A section 403(b) elective deferral in 
excess of this amount would exceed the sum of the limit in section 
415(c)(1)(A) plus the additional age 50 catch-up amount, because the sum 
of the employer's nonelective contribution of $29,000 plus a section 
403(b) elective deferral in excess of $20,000 would exceed $49,000 (the 
sum of the $44,000 limit in section 415(c)(1)(A) plus the $5,000 
additional age 50 catch-up amount). (Note that a section 403(b) elective 
deferral in excess of $20,000 would also exceed the limitations of 
section 402(g) unless a special section 403(b) catch-up were permitted.)
    Example 8. (i) Facts further illustrating application of the age 50 
catch-up and the section 415(c) dollar limitation. The facts are the 
same as in Example 7, except that the plan provides for a nonelective 
contribution for C equal to $44,000 (which is the limit in section 
415(c)(1)(A)).
    (ii) Conclusion. The maximum section 403(b) elective deferral that C 
may elect for 2006 is $5,000. A section 403(b) elective deferral in 
excess of this amount would exceed the sum of the limit in section 
415(c)(1)(A) plus the additional age 50 catch-up amount ($5,000), 
because the sum of the employer's nonelective contribution of $44,000 
plus a section 403(b) elective deferral in excess of $5,000 would exceed 
$49,000 (the sum of the $44,000 limit in section 415(c)(1)(A) plus the 
$5,000 additional age 50 catch-up amount).
    Example 9. (i) Facts illustrating application of the age 50 catch-up 
and the section 415(c) includible compensation limitation. The facts are 
the same as in Example 7, except that C's includible compensation for 
2006 is $28,000, so that the employer nonelective contribution for C for 
2006 is $14,000 (50 percent of $28,000).
    (ii) Conclusion. The maximum section 403(b) elective deferral that C 
may elect for 2006 is $19,000. A section 403(b) elective deferral in 
excess of this amount would exceed the sum of the limit in section 
415(c)(1)(B) plus the additional age 50 catch-up amount, because C's 
includible compensation is $28,000 and the sum of the employer's 
nonelective contribution of $14,000 plus a section 403(b) elective 
deferral in excess of $19,000 would exceed $33,000 (which is the sum of 
100 percent of C's includible compensation plus the $5,000 additional 
age 50 catch-up amount).
    Example 10. (i) Facts illustrating that section 403(b) elective 
deferrals cannot exceed compensation otherwise payable. Employee D is

[[Page 482]]

age 60, has includible compensation of $14,000, and wishes to contribute 
section 403(b) elective deferrals of $20,000 for the year. No 
nonelective contributions are made for Employee D.
    (ii) Conclusion. Because a contribution is a section 403(b) elective 
deferral only if it relates to an amount that would otherwise be 
included in the participant's compensation, the effective limitation on 
section 403(b) elective deferrals for a participant whose compensation 
is less than the basic dollar limit for section 403(b) elective 
deferrals is the participant's compensation. Thus, D cannot make section 
403(b) elective deferrals in excess of D's actual compensation, which is 
$14,000, even though the basic dollar limit exceeds that amount.
    Example 11. (i) Facts illustrating calculation of the special 
section 403(b) catch-up. For 2006, employee E, who is age 53, is 
eligible to participate in a section 403(b) plan of hospital H, which is 
a section 501(c)(3) organization. H's plan permits section 403(b) 
elective deferrals and provides for an employer contribution of 10 
percent of a participant's compensation. The plan provides limitations 
on section 403(b) elective deferrals up to the maximum permitted under 
paragraphs (c)(1), (2), and (3) of this section. For 2006, E's 
includible compensation is $50,000. E wishes to elect to have the 
maximum section 403(b) elective deferral possible contributed in 2006. E 
has previously made $62,000 of section 403(b) elective deferrals under 
the plan, but has never made an election for a special section 403(b) 
catch-up elective deferral. For 2006, the basic dollar limit for section 
403(b) elective deferrals under paragraph (c)(1) of this section is 
$15,000, the additional dollar amount permitted under the age 50 catch-
up is $5,000, E's employer will make a nonelective contribution of 
$5,000 (10% of $50,000 compensation), and E is a qualified employee of a 
qualified employer as defined in paragraph (c)(3) of this section.
    (ii) Conclusion. The maximum section 403(b) elective deferrals that 
E may elect under H's section 403(b) plan for 2006 is $23,000. This is 
the sum of the basic limit on section 403(b) elective deferrals for 2006 
under paragraph (c)(1) of this section equal to $15,000, plus the $3,000 
maximum additional special section 403(b) catch-up amount for which D 
qualifies in 2006 under paragraph (c)(3) of this section, plus the 
additional age 50 catch-up amount of $5,000. The limitation on the 
additional special section 403(b) catch-up amount is not less than 
$3,000 because the limitation at paragraph (c)(3)(i)(B) of this section 
is $15,000 ($15,000 minus zero) and the limitation at paragraph 
(c)(3)(i)(C) of this section is $13,000 ($5,000 times 15, minus $62,000 
of total deferrals in prior years). These conclusions would be 
unaffected if H were an eligible governmental employer under section 
457(b) that has a section 457(b) eligible governmental plan and E were 
in the past to have made annual deferrals to that plan, because 
contributions to a section 457(b) eligible governmental plan do not 
constitute elective deferrals; and these conclusions would also be the 
same if H had a section 401(k) plan and E were in the past to have made 
elective deferrals to that plan, assuming that those elective deferrals 
did not exceed $10,000 ($5,000 times 15, minus the sum of $62,000 plus 
$10,000, equals $3,000), so as to result in the limitation at paragraph 
(c)(3)(i)(C) of this section being less than $3,000.
    Example 12. (i) Facts illustrating calculation of the special 
section 403(b) catch-up in the next calendar year. The facts are the 
same as in Example 11, except that, for 2007, E has includible 
compensation of $60,000. For 2007, E now has previously made $85,000 of 
section 403(b) elective deferrals ($62,000 deferred before 2006, plus 
the $15,000 in basic section 403(b) elective deferrals in 2006, the 
$3,000 maximum additional special section 403(b) catch-up amount in 
2006, plus the $5,000 age 50 catch-up amount in 2006). However, the 
$5,000 age 50 catch-up amount deferred in 2006 is disregarded for 
purposes of applying the limitation at paragraph (c)(3)(i)(C) of this 
section to determine the special section 403(b) catch-up amount. Thus, 
for 2007, only $80,000 of section 403(b) elective deferrals are taken 
into account in applying the limitation at paragraph (c)(3)(i)(C) of 
this section. For 2007, the basic dollar limit for section 403(b) 
elective deferrals under paragraph (c)(1) of this section is assumed to 
be $16,000, the additional dollar amount permitted under the age 50 
catch-up is assumed to be $5,000, and E's employer contributes $6,000 
(10% of $60,000) as a non-elective contribution.
    (ii) Conclusion. The maximum section 403(b) elective deferral that D 
may elect under H's section 403(b) plan for 2007 is $21,000. This is the 
sum of the basic limit on section 403(b) elective deferrals under 
paragraph (c)(1) of this section equal to $16,000, plus the additional 
age 50 catch-up amount of $5,000. E is not entitled to any additional 
special section 403(b) catch-up amount for 2007 under paragraph (c)(3) 
of this section due to the limitation at paragraph (c)(3)(i)(C) of this 
section (16 times $5,000 equals $80,000, minus D's total prior section 
403(b) elective deferrals of $80,000 equals zero).

    (d) Employer contributions for former employees--(1) Includible 
compensation deemed to continue for nonelective contributions. For 
purposes of applying paragraph (b) of this section, a former employee is 
deemed to have monthly includible compensation for the period through 
the end of the taxable year of the employee in which he or she ceases

[[Page 483]]

to be an employee and through the end of each of the next five taxable 
years. The amount of the monthly includible compensation is equal to one 
twelfth of the former employee's includible compensation during the 
former employee's most recent year of service. Accordingly, nonelective 
employer contributions for a former employee must not exceed the 
limitation of section 415(c)(1) up to the lesser of the dollar amount in 
section 415(c)(1)(A) or the former employee's annual includible 
compensation based on the former employee's average monthly compensation 
during his or her most recent year of service.
    (2) Examples. The provisions of paragraph (d)(1) of this section are 
illustrated by the following examples:

    Example 1. (i) Facts. Private college M is a section 501(c)(3) 
organization operated on the basis of a June 30 fiscal year that 
maintains a section 403(b) plan for its employees. In 2004, M amends the 
plan to provide for a temporary early retirement incentive under which 
the college will make a nonelective contribution for any participant who 
satisfies certain minimum age and service conditions and who retires 
before June 30, 2006. The contribution will equal 110 percent of the 
participant's rate of pay for one year and will be payable over a period 
ending no later than the end of the fifth fiscal year that begins after 
retirement. It is assumed for purposes of this Example 1 that, in 
accordance with Sec. 1.401(a)(4)-10(b) and under the facts and 
circumstances, the post-retirement contributions made for participants 
who satisfy the minimum age and service conditions and retire before 
June 30, 2006, do not discriminate in favor of former employees who are 
highly compensated employees. Employee A retires under the early 
retirement incentive on March 12, 2006, and A's annual includible 
compensation for the period from March 1, 2005, through February 28, 
2006 (which is A's most recent one year of service) is $30,000. The 
applicable dollar limit under section 415(c)(1)(A) is assumed to be 
$44,000 for 2006 and $45,000 for 2007. The college contributes $30,000 
for A for 2006 and $3,000 for A for 2007 (totaling $33,000 or 110 
percent of $30,000). No other contributions are made to a section 403(b) 
contract for A for those years.
    (ii) Conclusion. The contributions made for A do not exceed A's 
includible compensation for 2006 or 2007.
    Example 2. (i) Facts. Private college N is a section 501(c)(3) 
organization that maintains a section 403(b) plan for its employees. The 
plan provides for N to make monthly nonelective contributions equal to 
20 percent of the monthly includible compensation for each eligible 
employee. In addition, the plan provides for contributions to continue 
for 5 years following the retirement of any employee after age 64 and 
completion of at least 20 years of service (based on the employee's 
average annual rate of base salary in the preceding 3 calendar years 
ended before the date of retirement). It is assumed for purposes of this 
Example 2 that, in accordance with Sec. 1.401(a)(4)-10(b) and under the 
facts and circumstances, the post-retirement contributions made for 
participants who satisfy the minimum age and service conditions do not 
discriminate in favor of former employees who are highly compensated 
employees. Employee B retires on July 1, 2006, at age 64 after 
completion of 20 or more years of service. At that date, B's annual 
includible compensation for the most recently ended fiscal year of N is 
$72,000 and B's average monthly rate of base salary for 2003 through 
2005 is $5,000. N contributes $1,200 per month (20 percent of 1/12th of 
$72,000) from January of 2006 through June of 2006 and contributes 
$1,000 (20 percent of $5,000) per month for B from July of 2006 through 
June of 2011. The applicable dollar limit under section 415(c)(1)(A) is 
$44,000 for 2006 through 2011. No other contributions are made to a 
section 403(b) contract for B for those years.
    (ii) Conclusion. The contributions made for B do not exceed B's 
includible compensation for any of the years from 2006 through 2010.
    Example 3. (i) Facts. A public university maintains a section 403(b) 
under which it contributes annually 10% of compensation for 
participants, including for the first 5 calendar years following the 
date on which the participant ceases to be an employee. The plan 
provides that if a participant who is a former employee dies during the 
first 5 calendar years following the date on which the participant 
ceases to be an employee, a contribution is made that is equal to the 
lesser of--
    (A) The excess of the individual's includible compensation for that 
year over the contributions previously made for the individual for that 
year; or
    (B) The total contributions that would have been made on the 
individual's behalf thereafter if he or she had survived to the end of 
the 5-year period.
    (ii) Individual C's annual includible compensation is $72,000 (so 
that C's monthly includible compensation is $6,000). A $600 contribution 
is made for C for January of the first taxable year following retirement 
(10% of individual C's monthly includible compensation of $6,000). 
Individual C dies during February of that year. The university makes a 
contribution for individual C for February equal to $11,400 (C's monthly 
includible compensation for January and February, reduced by $600).

[[Page 484]]

    (iii) Conclusion. The contribution does not exceed the amount of 
individual C's includible compensation for the taxable year for purposes 
of section 415(c), but any additional contributions would exceed C's 
includible compensation for purposes of section 415(c).

    (3) Disabled employees. See also section 415(c)(3)(C) which sets 
forth a special rule under which compensation may be treated as 
continuing for purposes of section 415 for certain former employees who 
are disabled.
    (e) Special rules for determining years of service--(1) In general. 
For purposes of determining a participant's includible compensation 
under paragraph (b)(2) of this section and a participant's years of 
service under paragraphs (c)(3) (special section 403(b) catch-up for 
qualified employees of certain organizations) and (d) (employer 
contributions for former employees) of this section, an employee must be 
credited with a full year of service for each year during which the 
individual is a full-time employee of the eligible employer for the 
entire work period, and a fraction of a year for each part of a work 
period during which the individual is a full-time or part-time employee 
of the eligible employer. An individual's number of years of service 
equals the aggregate of the annual work periods during which the 
individual is employed by the eligible employer.
    (2) Work period. A year of service is based on the employer's annual 
work period, not the employee's taxable year. For example, in 
determining whether a university professor is employed full time, the 
annual work period is the school's academic year. However, in no case 
may an employee accumulate more than one year of service in a twelve-
month period.
    (3) Service with more than one eligible employer--(i) General rule. 
With respect to any section 403(b) contract of an eligible employer, 
except as provided in paragraph (e)(3)(ii) of this section, any period 
during which an individual is not an employee of that eligible employer 
is disregarded for purposes of this paragraph (e).
    (ii) Special rule for church employees. With respect to any section 
403(b) contract of an eligible employer that is a church-related 
organization, any period during which an individual is an employee of 
that eligible employer and any other eligible employer that is a church-
related organization that has an association (as defined in section 
414(e)(3)(D)) with that eligible employer is taken into account on an 
aggregated basis, but any period during which an individual is not an 
employee of a church-related organization or is an employee of a church-
related organization that does not have an association with that 
eligible employer is disregarded for purposes of this paragraph (e).
    (4) Full-time employee for full year. Each annual work period during 
which an individual is employed full time by the eligible employer 
constitutes one year of service. In determining whether an individual is 
employed full-time, the amount of work which he or she actually performs 
is compared with the amount of work that is normally required of 
individuals performing similar services from which substantially all of 
their annual compensation is derived.
    (5) Other employees. (i) An individual is treated as performing a 
fraction of a year of service for each annual work period during which 
he or she is a full-time employee for part of the annual work period and 
for each annual work period during which he or she is a part-time 
employee either for the entire annual work period or for a part of the 
annual work period.
    (ii) In determining the fraction that represents the fractional year 
of service for an individual employed full time for part of an annual 
work period, the numerator is the period of time (such as weeks or 
months) during which the individual is a full-time employee during that 
annual work period, and the denominator is the period of time that is 
the annual work period.
    (iii) In determining the fraction that represents the fractional 
year of service of an individual who is employed part time for the 
entire annual work period, the numerator is the amount of work performed 
by the individual, and the denominator is the amount of work normally 
required of individuals who perform similar services and who are 
employed full time for the entire annual work period.

[[Page 485]]

    (iv) In determining the fraction representing the fractional year of 
service of an individual who is employed part time for part of an annual 
work period, the fractional year of service that would apply if the 
individual were a part-time employee for a full annual work period is 
multiplied by the fractional year of service that would apply if the 
individual were a full-time employee for the part of an annual work 
period.
    (6) Work performed. For purposes of this paragraph (e), in measuring 
the amount of work of an individual performing particular services, the 
work performed is determined based on the individual's hours of service 
(as defined under section 410(a)(3)(C)), except that a plan may use a 
different measure of work if appropriate under the facts and 
circumstances. For example, a plan may provide for a university 
professor's work to be measured by the number of courses taught during 
an annual work period in any case in which that individual's work 
assignment is generally based on a specified number of courses to be 
taught.
    (7) Most recent one-year period of service. For purposes of 
paragraph (d) of this section, in the case of a part-time employee or a 
full-time employee who is employed for only part of the year determined 
on the basis of the employer's annual work period, the employee's most 
recent periods of service are aggregated to determine his or her most 
recent one-year period of service. In such a case, there is first taken 
into account his or her service during the annual work period for which 
the last year of service's includible compensation is being determined; 
then there is taken into account his or her service during his or her 
next preceding annual work period based on whole months; and so forth 
until the employee's service equals, in the aggregate, one year of 
service.
    (8) Less than one year of service considered as one year. If, at the 
close of a taxable year, an employee has, after application of all of 
the other rules in this paragraph (e), some portion of one year of 
service (but has accumulated less than one year of service), the 
employee is deemed to have one year of service. Except as provided in 
the previous sentence, fractional years of service are not rounded up.
    (9) Examples. The provisions of this paragraph (e) are illustrated 
by the following examples:

    Example 1. (i) Facts. Individual G is employed half-time in 2004 and 
2005 as a clerk by H, a hospital which is a section 501(c)(3) 
organization. G earns $20,000 from H in each of those years, and retires 
on December 31, 2005.
    (ii) Conclusion. For purposes of determining G's includible 
compensation during G's last year of service under paragraph (d) of this 
section, G's most recent periods of service are aggregated to determine 
G's most recent one-year period of service. In this case, since D worked 
half-time in 2004 and 2005, the compensation D earned in those two years 
are aggregated to produce D's includible compensation for D's last full 
year in service. Thus, in this case, the $20,000 that D earned in 2004 
and 2005 for D's half-time work are aggregated, so that D has $40,000 of 
includible compensation for D's most recent one-year of service for 
purposes of applying paragraphs (b)(2), (c)(3), and (d) of this section.
    Example 2. (i) Facts. Individual H is employed as a part-time 
professor by public University U during the first semester of its two-
semester 2004-2005 academic year. While H teaches one course generally 
for 3 hours a week during the first semester of the academic year, U's 
full-time faculty members generally teach for 9 hours a week during the 
full academic year.
    (ii) Conclusion. For purposes of calculating how much of a year of 
service H performs in the 2004-2005 academic year (before application of 
the special rules of paragraphs (e)(7) and (8) of this section 
concerning less than one year of service), paragraph (e)(5)(iv) of this 
section is applied as follows: since H teaches one course at U for 3 
hours per week for 1 semester and other faculty members at U teach 9 
hours per week for 2 semesters, H is considered to have completed \3/18\ 
or \1/6\ of a year of service during the 2004-2005 academic year, 
determined as follows:
    (A) The fractional year of service if H were a part-time employee 
for a full year is 3/9 (number of hours employed divided by the usual 
number of hours of work required for that position).
    (B) The fractional year of service if H were a full-time employee 
for half of a year is \1/2\ (one semester, divided by the usual 2-
semester annual work period).
    (C) These fractions are multiplied to obtain the fractional year of 
service: \3/9\ times \1/2\, or \3/18\, equals \1/6\ of a year of 
service.

    (f) Excess contributions or deferrals--(1) Inclusion in gross 
income. Any contribution made for a participant to a section 403(b) 
contract for the taxable year

[[Page 486]]

that exceeds either the maximum annual contribution limit set forth in 
paragraph (b) of this section or the maximum annual section 403(b) 
elective deferral limit set forth in paragraph (c) of this section 
constitutes an excess contribution that is included in gross income for 
that taxable year. See Sec. 1.403(b)-3(d)(1)(iii) and (2)(i) for 
additional rules, including special rules relating to contracts that 
fail to be nonforfeitable. See also section 4973 for an excise tax 
applicable with respect to excess contributions to a custodial account 
and section 4979(f)(2)(B) for a special rule applicable if excess 
matching contributions, excess after-tax employee contributions, and 
excess section 403(b) elective deferrals do not exceed $100.
    (2) Separate account required for certain excess contributions; 
distribution of excess elective deferrals. A contract to which a 
contribution is made that exceeds the maximum annual contribution limit 
set forth in paragraph (b) of this section is not a section 403(b) 
contract unless the excess contribution is held in a separate account 
which constitutes a separate account for purposes of section 72. See 
also Sec. 1.403(b)-3(a)(4) and paragraph (f)(4) of this section for 
additional rules with respect to the requirements of section 401(a)(30) 
and any excess deferral.
    (3) Ability to distribute excess contributions. A contract does not 
fail to satisfy the requirements of Sec. 1.403(b)-3, the distribution 
rules of Sec. 1.403(b)-6 or 1.403(b)-9, or the funding rules of Sec. 
1.403(b)-8 solely by reason of a distribution made from a separate 
account under paragraph (f)(2) of this section or made under paragraph 
(f)(4) of this section.
    (4) Excess section 403(b) elective deferrals. A section 403(b) 
contract may provide that any excess deferral as a result of a failure 
to comply with the limitation under paragraph (c) of this section for a 
taxable year with respect to any section 403(b) elective deferral made 
for a participant by the employer will be distributed to the 
participant, with allocable net income, no later than April 15 of the 
following taxable year or otherwise in accordance with section 402(g). 
See section 402(g)(2)(A) for rules permitting the participant to 
allocate excess deferrals among the plans in which the participant has 
made elective deferrals, and see section 402(g)(2)(C) for special rules 
to determine the tax treatment of such a distribution.
    (5) Examples. The provisions of this paragraph (f) are illustrated 
by the following examples:

    Example 1. (i) Facts. Individual D's employer makes a $46,000 
contribution for 2006 to an individual annuity insurance policy for 
Individual D that would otherwise be a section 403(b) contract. The 
contribution does not include any elective deferrals and the applicable 
limit under section 415(c) is $44,000 for 2006. The $2,000 section 
415(c) excess is put into a separate account under the policy. Employer 
includes $2,000 in D's gross income as wages for 2006 and, to the extent 
of the amount held in the separate account for the section 415(c) excess 
contribution, does not treat the account as a contract to which section 
403(b) applies.
    (ii) Conclusion. The separate account for the section 415(c) excess 
contribution is a contract to which section 403(c) applies, but the 
excess contribution does not cause the rest of the contract to fail 
section 403(b).
    Example 2. (i) Facts. Same facts as Example 1, except that the 
contribution is made to purchase mutual funds that are held in a 
custodial account, instead of an individual annuity insurance policy.
    (ii) Conclusion. The conclusion is the same as in Example 1, except 
that the purchase constitutes a transfer described in section 83.
    Example 3. (i) Facts. Same facts as Example 1, except that the 
amount held in the separate account for the section 415(c) excess 
contribution is subsequently distributed to D.
    (ii) Conclusion. The distribution is included in gross income to the 
extent provided under section 72 relating to distributions from a 
section 403(c) contract.
    Example 4. (i) Facts. Individual E makes section 403(b) elective 
deferrals totaling $15,500 for 2006, when E is age 45 and the applicable 
limit on section 403(b) elective deferrals is $15,000. On April 14, 
2007, the plan refunds the $500 excess along with applicable earnings of 
$65.
    (ii) Conclusion. The $565 payment constitutes a distribution of an 
excess deferral under paragraph (f)(4) of this section. Under section 
402(g), the $500 excess deferral is included in E's gross income for 
2006. The additional $65 is included in E's gross income for 2007 and, 
because the distribution is made by April 15, 2007 (as provided in 
section

[[Page 487]]

402(g)(2)), the $65 is not subject to the additional 10 percent income 
tax on early distributions under section 72(t).

[T.D. 9340, 72 FR 41144, July 26, 2007, as amended by 72 FR 54352, Sept. 
25, 2007; 75 FR 65566, Oct. 26, 2010]



Sec. 1.403(b)-5  Nondiscrimination rules.

    (a) Nondiscrimination rules for contributions other than section 
403(b) elective deferrals--(1) General rule. Under section 
403(b)(12)(A)(i), employer contributions and after-tax employee 
contributions to a section 403(b) plan must satisfy all of the following 
requirements (the nondiscrimination requirements) in the same manner as 
a qualified plan under section 401(a):
    (i) Section 401(a)(4) (relating to nondiscrimination in 
contributions and benefits), taking section 401(a)(5) into account.
    (ii) Section 401(a)(17) (limiting the amount of compensation that 
can be taken into account).
    (iii) Section 401(m) (relating to matching and after-tax employee 
contributions).
    (iv) Section 410(b) (relating to minimum coverage).
    (2) Nonapplication to section 403(b) elective deferrals. The 
requirements of this paragraph (a) do not apply to section 403(b) 
elective deferrals.
    (3) Compensation for testing. Except as may otherwise be 
specifically permitted under the provisions referenced in paragraph 
(a)(1) of this section, compliance with those provisions is tested using 
compensation as defined in section 414(s) (and without regard to section 
415(c)(3)(E)). In addition, for purposes of paragraph (a)(1) of this 
section, there may be excluded employees who are permitted to be 
excluded under paragraph (b)(4)(ii)(D) and (E) of this section. However, 
as provided in paragraph (b)(4)(i) of this section, the exclusion of any 
employee listed in paragraph (b)(4)(ii)(D) or (E) of this section is 
subject to the conditions applicable under section 410(b)(4).
    (4) Employer aggregation rules. See regulations under section 
414(b), (c), (m), and (o) for rules treating entities as a single 
employer for purposes of the nondiscrimination requirements.
    (5) Special rules for governmental plans. Paragraphs (a)(1)(i), 
(iii), and (iv) of this section do not apply to a governmental plan as 
defined in section 414(d) (but contributions to a governmental plan must 
comply with paragraphs (a)(1)(ii) and (b) of this section).
    (b) Universal availability required for section 403(b) elective 
deferrals--(1) General rule. Under section 403(b)(12)(A)(ii), all 
employees of the eligible employer must be permitted to have section 
403(b) elective deferrals contributed on their behalf if any employee of 
the eligible employer may elect to have the organization make section 
403(b) elective deferrals. Further, the employee's right to make 
elective deferrals also includes the right to designate section 403(b) 
elective deferrals as designated Roth contributions.
    (2) Effective opportunity required. For purposes of paragraph (b)(1) 
of this section, an employee is not treated as being permitted to have 
section 403(b) elective deferrals contributed on the employee's behalf 
unless the employee is provided an effective opportunity that satisfies 
the requirements of this paragraph (b)(2). Whether an employee has an 
effective opportunity is determined based on all the relevant facts and 
circumstances, including notice of the availability of the election, the 
period of time during which an election may be made, and any other 
conditions on elections. A section 403(b) plan satisfies the effective 
opportunity requirement of this paragraph (b)(2) only if, at least once 
during each plan year, the plan provides an employee with an effective 
opportunity to make (or change) a cash or deferred election (as defined 
at Sec. 1.401(k)-1(a)(3)) between cash or a contribution to the plan. 
Further, an effective opportunity includes the right to have section 
403(b) elective deferrals made on his or her behalf up to the lesser of 
the applicable limits in Sec. 1.403(b)-4(c) (including any permissible 
catch-up elective deferrals under Sec. 1.403(b)-4(c)(2) and (3)) or the 
applicable limits under the contract with the largest limitation, and 
applies to part-time employees as well as full-time employees. An 
effective opportunity is not considered to exist if there are any other 
rights or benefits (other than rights or benefits listed in Sec. 
1.401(k)-1(e)(6)(i)(A), (B), or (D)) that are conditioned (directly or 
indirectly) upon a

[[Page 488]]

participant making or failing to make a cash or deferred election with 
respect to a contribution to a section 403(b) contract.
    (3) Special rules. (i) In the case of a section 403(b) plan that 
covers the employees of more than one section 501(c)(3) organization, 
the universal availability requirement of this paragraph (b) applies 
separately to each common law entity (that is, applies separately to 
each section 501(c)(3) organization). In the case of a section 403(b) 
plan that covers the employees of more than one State entity, this 
requirement applies separately to each entity that is not part of a 
common payroll. An eligible employer may condition the employee's right 
to have section 403(b) elective deferrals made on his or her behalf on 
the employee electing a section 403(b) elective deferral of more than 
$200 for a year.
    (ii) For purposes of this paragraph (b)(3), an employer that 
historically has treated one or more of its various geographically 
distinct units as separate for employee benefit purposes may treat each 
unit as a separate organization if the unit is operated independently on 
a day-to-day basis. Units are not geographically distinct if such units 
are located within the same Standard Metropolitan Statistical Area 
(SMSA).
    (4) Exclusions--(i) Exclusions for special types of employees. A 
plan does not fail to satisfy the universal availability requirement of 
this paragraph (b) merely because it excludes one or more of the types 
of employees listed in paragraph (b)(4)(ii) of this section. However, 
the exclusion of any employee listed in paragraph (b)(4)(ii)(D) or (E) 
of this section is subject to the conditions applicable under section 
410(b)(4). Thus, if any employee listed in paragraph (b)(4)(ii)(D) of 
this section has the right to have section 403(b) elective deferrals 
made on his or her behalf, then no employee listed in that paragraph 
(b)(4)(ii)(D) of this section may be excluded under this paragraph 
(b)(4) and, if any employee listed in paragraph (b)(4)(ii)(E) of this 
section has the right to have section 403(b) elective deferrals made on 
his or her behalf, then no employee listed in that paragraph 
(b)(4)(ii)(E) of this section may be excluded under this paragraph 
(b)(4).
    (ii) List of special types of excludible employees. The following 
types of employees are listed in this paragraph (b)(4)(ii):
    (A) Employees who are eligible under another section 403(b) plan, or 
a section 457(b) eligible governmental plan, of the employer which 
permits an amount to be contributed or deferred at the election of the 
employee.
    (B) Employees who are eligible to make a cash or deferred election 
(as defined at Sec. 1.401(k)-1(a)(3)) under a section 401(k) plan of 
the employer.
    (C) Employees who are non-resident aliens described in section 
410(b)(3)(C).
    (D) Subject to the conditions applicable under section 410(b)(4) 
(including section 410(b)(4)(B) permitting separate testing for 
employees not meeting minimum age and service requirements), employees 
who are students performing services described in section 3121(b)(10).
    (E) Subject to the conditions applicable under section 410(b)(4), 
employees who normally work fewer than 20 hours per week (or such lower 
number of hours per week as may be set forth in the plan).
    (iii) Special rules. (A) A section 403(b) plan is permitted to take 
into account coverage under another plan, as permitted in paragraphs 
(b)(4)(ii)(A) and (B) of this section, only if the rights to make 
elective deferrals with respect to that coverage would satisfy 
paragraphs (b)(2) and (4)(i) of this section if that coverage were 
provided under the section 403(b) plan.
    (B) For purposes of paragraph (b)(4)(ii)(E) of this section, an 
employee normally works fewer than 20 hours per week if and only if--
    (1) For the 12-month period beginning on the date the employee's 
employment commenced, the employer reasonably expects the employee to 
work fewer than 1,000 hours of service (as defined in section 
410(a)(3)(C)) in such period; and
    (2) For each plan year ending after the close of the 12-month period 
beginning on the date the employee's employment commenced (or, if the 
plan so provides, each subsequent 12-month period), the employee worked 
fewer than 1,000 hours of service in the preceding

[[Page 489]]

12-month period. (See, however, section 202(a)(1) of the Employee 
Retirement Income Security Act of 1974 (ERISA) (88 Stat. 829) Public Law 
93-406, and regulations under section 410(a) of the Internal Revenue 
Code applicable with respect to plans that are subject to title I of 
ERISA.)
    (c) Plan required. Contributions to an annuity contract do not 
satisfy the requirements of this section unless the contributions are 
made pursuant to a plan, as defined in Sec. 1.403(b)-3(b)(3), and the 
terms of the plan satisfy this section.
    (d) Church plans exception. This section does not apply to a section 
403(b) contract purchased by a church (as defined in Sec. 1.403(b)-2).
    (e) Other rules. This section only reflects requirements of the 
Internal Revenue Code applicable for purposes of section 403(b) and does 
not include other requirements. Specifically, this section does not 
reflect the requirements of ERISA that may apply with respect to section 
403(b) arrangements, such as the vesting requirements at 29 U.S.C. 1053.

[T.D. 9340, 72 FR 41144, July 26, 2007]



Sec. 1.403(b)-6  Timing of distributions and benefits.

    (a) Distributions generally. This section provides special rules 
regarding the timing of distributions from, and the benefits that may be 
provided under, a section 403(b) contract, including limitations on when 
early distributions can be made (in paragraphs (b) through (d) of this 
section), required minimum distributions (in paragraph (e) of this 
section), and special rules relating to loans (in paragraph (f) of this 
section) and incidental benefits (in paragraph (g) of this section).
    (b) Distributions from contracts other than custodial accounts or 
amounts attributable to section 403(b) elective deferrals. Except as 
provided in paragraph (c) of this section relating to distributions from 
custodial accounts, paragraph (d) of this section relating to 
distributions attributable to section 403(b) elective deferrals, Sec. 
1.403(b)-4(f) (relating to correction of excess deferrals), or Sec. 
1.403(b)-10(a) (relating to plan termination), a section 403(b) contract 
is permitted to distribute retirement benefits to the participant no 
earlier than upon the earlier of the participant's severance from 
employment or upon the prior occurrence of some event, such as after a 
fixed number of years, the attainment of a stated age, or disability. 
See Sec. 1.401-1(b)(1)(ii) for additional guidance. This paragraph (b) 
does not apply to after-tax employee contributions or earnings thereon.
    (c) Distributions from custodial accounts that are not attributable 
to section 403(b) elective deferrals. Except as provided in Sec. 
1.403(b)-4(f) (relating to correction of excess deferrals) or Sec. 
1.403(b)-10(a) (relating to plan termination), distributions from a 
custodial account, as defined in Sec. 1.403(b)-8(d)(2), may not be paid 
to a participant before the participant has a severance from employment, 
dies, becomes disabled (within the meaning of section 72(m)(7)), or 
attains age 59\1/2\. Any amounts transferred out of a custodial account 
to an annuity contract or retirement income account, including earnings 
thereon, continue to be subject to this paragraph (c). This paragraph 
(c) does not apply to distributions that are attributable to section 
403(b) elective deferrals.
    (d) Distribution of section 403(b) elective deferrals--(1) 
Limitation on distributions--(i) General rule. Except as provided in 
Sec. 1.403(b)-4(f) (relating to correction of excess deferrals) or 
Sec. 1.403(b)-10(a) (relating to plan termination), distributions of 
amounts attributable to section 403(b) elective deferrals may not be 
paid to a participant earlier than the earliest of the date on which the 
participant has a severance from employment, dies, has a hardship, 
becomes disabled (within the meaning of section 72(m)(7)), or attains 
age 59\1/2\.
    (ii) Special rule for pre-1989 section 403(b) elective deferrals. 
For special rules relating to amounts held as of the close of the 
taxable year beginning before January 1, 1989 (which does not apply to 
earnings thereon), see section 1123(e)(3) of the Tax Reform Act of 1986 
(100 Stat. 2085, 2475) Public Law 99-514, and section 1011A(c)(11) of 
the Technical and Miscellaneous Revenue Act of 1988 (102 Stat. 3342, 
3476) Public Law 100-647.
    (2) Hardship rules. A hardship distribution under this paragraph (d) 
has

[[Page 490]]

the same meaning as a distribution on account of hardship under Sec. 
1.401(k)-1(d)(3) and is subject to the rules and restrictions set forth 
in Sec. 1.401(k)-1(d)(3) (including limiting the amount of a 
distribution in the case of hardship to the amount necessary to satisfy 
the hardship). In addition, a hardship distribution is limited to the 
aggregate dollar amount of the participant's section 403(b) elective 
deferrals under the contract (and may not include any income thereon), 
reduced by the aggregate dollar amount of the distributions previously 
made to the participant from the contract.
    (3) Failure to keep separate accounts. If a section 403(b) contract 
includes both section 403(b) elective deferrals and other contributions 
and the section 403(b) elective deferrals are not maintained in a 
separate account, then distributions may not be made earlier than the 
later of--
    (i) Any date permitted under paragraph (d)(1) of this section; and
    (ii) Any date permitted under paragraph (b) or (c) of this section 
with respect to contributions that are not section 403(b) elective 
deferrals (whichever applies to the contributions that are not section 
403(b) elective deferrals).
    (e) Minimum required distributions for eligible plans--(1) In 
general. Under section 403(b)(10), a section 403(b) contract must meet 
the minimum distribution requirements of section 401(a)(9) (in both form 
and operation). See section 401(a)(9) for these requirements.
    (2) Treatment as IRAs. For purposes of applying the distribution 
rules of section 401(a)(9) to section 403(b) contracts, the minimum 
distribution rules applicable to individual retirement annuities 
described in section 408(b) and individual retirement accounts described 
in section 408(a) apply to section 403(b) contracts. Consequently, 
except as otherwise provided in this paragraph (e), the distribution 
rules in section 401(a)(9) are applied to section 403(b) contracts in 
accordance with the provisions in Sec. 1.408-8 for purposes of 
determining required minimum distributions.
    (3) Required beginning date. The required beginning date for 
purposes of section 403(b)(10) is April 1 of the calendar year following 
the later of the calendar year in which the employee attains age 70\1/2\ 
or the calendar year in which the employee retires from employment with 
the employer maintaining the plan. However, for any section 403(b) 
contract that is not part of a governmental plan or church plan, the 
required beginning date for a 5-percent owner is April 1 of the calendar 
year following the calendar year in which the employee attains age 70\1/
2\.
    (4) Surviving spouse rule does not apply. The special rule in Sec. 
1.408-8, A-5 (relating to spousal beneficiaries), does not apply to a 
section 403(b) contract. Thus, the surviving spouse of a participant is 
not permitted to treat a section 403(b) contract as the spouse's own 
section 403(b) contract, even if the spouse is the sole beneficiary.
    (5) Retirement income accounts. For purposes of Sec. 1.401(a)(9)-6, 
A-4 (relating to annuity contracts), annuity payments provided with 
respect to retirement income accounts do not fail to satisfy the 
requirements of section 401(a)(9) merely because the payments are not 
made under an annuity contract purchased from an insurance company, 
provided that the relationship between the annuity payments and the 
retirement income accounts is not inconsistent with any rules prescribed 
by the Commissioner in revenue rulings, notices, or other guidance 
published in the Internal Revenue Bulletin (see Sec. 
601.601(d)(2)(ii)(b) of this chapter). See also Sec. 1.403(b)-9(a)(5) 
for additional rules relating to annuities payable from a retirement 
income account.
    (6) Special rules for benefits accruing before December 31, 1986. 
(i) The distribution rules provided in section 401(a)(9) do not apply to 
the undistributed portion of the account balance under the section 
403(b) contract valued as of December 31, 1986, exclusive of subsequent 
earnings (pre-'87 account balance). The distribution rules provided in 
section 401(a)(9) apply to all benefits under section 403(b) contracts 
accruing after December 31, 1986 (post-'86 account balance), including 
earnings after December 31, 1986. Consequently, the post-'86 account 
balance includes earnings after December 31,

[[Page 491]]

1986, on contributions made before January 1, 1987, in addition to the 
contributions made after December 31, 1986, and earnings thereon.
    (ii) The issuer or custodian of the section 403(b) contract must 
keep records that enable it to identify the pre-'87 account balance and 
subsequent changes as set forth in paragraph (d)(6)(iii) of this section 
and provide such information upon request to the relevant employee or 
beneficiaries with respect to the contract. If the issuer or custodian 
does not keep such records, the entire account balance is treated as 
subject to section 401(a)(9).
    (iii) In applying the distribution rules in section 401(a)(9), only 
the post-'86 account balance is used to calculate the required minimum 
distribution for a calendar year. The amount of any distribution from a 
contract is treated as being paid from the post-'86 account balance to 
the extent the distribution is required to satisfy the minimum 
distribution requirement with respect to that contract for a calendar 
year. Any amount distributed in a calendar year from a contract in 
excess of the required minimum distribution for a calendar year with 
respect to that contract is treated as paid from the pre-'87 account 
balance, if any, of that contract.
    (iv) If an amount is distributed from the pre-'87 account balance 
and rolled over to another section 403(b) contract, the amount is 
treated as part of the post-'86 account balance in that second contract. 
However, if the pre-'87 account balance under a section 403(b) contract 
is directly transferred to another section 403(b) contract (as permitted 
under Sec. 1.403(b)-10(b)), the amount transferred retains its 
character as a pre-'87 account balance, provided the issuer of the 
transferee contract satisfies the recordkeeping requirements of 
paragraph (e)(6)(ii) of this section.
    (v) The distinction between the pre-'87 account balance and the 
post-'86 account balance provided for under this paragraph (e)(6) of 
this section has no relevance for purposes of determining the portion of 
a distribution that is includible in income under section 72.
    (vi) The pre-'87 account balance must be distributed in accordance 
with the incidental benefit requirement of Sec. 1.401-1(b)(1)(i). 
Distributions attributable to the pre-'87 account balance are treated as 
satisfying this requirement if all distributions from the section 403(b) 
contract (including distributions attributable to the post-'86 account 
balance) satisfy the requirements of Sec. 1.401-1(b)(1)(i) without 
regard to this section, and distributions attributable to the post-'86 
account balance satisfy the rules of this paragraph (e) (without regard 
to this paragraph (e)(6)). Distributions attributable to the pre-'87 
account balance are treated as satisfying the incidental benefit 
requirement if all distributions from the section 403(b) contract 
(including distributions attributable to both the pre-'87 account 
balance and the post-'86 account balance) satisfy the rules of this 
paragraph (e) (without regard to this paragraph (e)(6)).
    (7) Application to multiple contracts for an employee. The required 
minimum distribution must be separately determined for each section 
403(b) contract of an employee. However, because, as provided in 
paragraph (e)(2) of this section, the distribution rules in section 
401(a)(9) apply to section 403(b) contracts in accordance with the 
provisions in Sec. 1.408-8, the required minimum distribution from one 
section 403(b) contract of an employee is permitted to be distributed 
from another section 403(b) contract in order to satisfy section 
401(a)(9). Thus, as provided in Sec. 1.408-8, A-9, with respect to 
IRAs, the required minimum distribution amount from each contract is 
then totaled and the total minimum distribution taken from any one or 
more of the individual section 403(b) contracts. However, consistent 
with the rules in Sec. 1.408-8, A-9, only amounts in section 403(b) 
contracts that an individual holds as an employee may be aggregated. 
Amounts in section 403(b) contracts that an individual holds as a 
beneficiary of the same decedent may be aggregated, but such amounts may 
not be aggregated with amounts held in section 403(b) contracts that the 
individual holds as the employee or as the beneficiary of another 
decedent. Distributions from section 403(b) contracts do not satisfy the 
minimum distribution requirements for IRAs, nor do distributions

[[Page 492]]

from IRAs satisfy the minimum distribution requirements for section 
403(b) contracts.
    (8) Special rule for governmental plans. A section 403(b) contract 
that is part of a governmental plan (within the meaning of section 
414(d)) is treated as having complied with section 401(a)(9) for all 
years to which section 401(a)(9) applies to the contract, if the 
contract complies with a reasonable and good faith interpretation of 
section 401(a)(9).
    (f) Loans. The determination of whether the availability of a loan, 
the making of a loan, or a failure to repay a loan made from an issuer 
of a section 403(b) contract to a participant or beneficiary is treated 
as a distribution (directly or indirectly) for purposes of this section, 
and the determination of whether the availability of the loan, the 
making of the loan, or a failure to repay the loan is in any other 
respect a violation of the requirements of section 403(b) and Sec. Sec. 
1.403(b)-1 through 1.403(b)-5, this section, and Sec. Sec. 1.403(b)-7 
through 1.403(b)-11, depends on the facts and circumstances. Among the 
facts and circumstances are whether the loan has a fixed repayment 
schedule and bears a reasonable rate of interest, and whether there are 
repayment safeguards to which a prudent lender would adhere. Thus, for 
example, a loan must bear a reasonable rate of interest in order to be 
treated as not being a distribution. However, a plan loan offset is a 
distribution for purposes of this section. See Sec. 1.72(p)-1, Q&A-13. 
See also Sec. 1.403(b)-7(d) relating to the application of section 
72(p) with respect to the taxation of a loan made under a section 403(b) 
contract. (Further, see section 408(b)(1) of title I of ERISA and 29 CFR 
2550.408b-1 of the Department of Labor regulations concerning additional 
requirements applicable with respect to plans that are subject to title 
I of ERISA.)
    (g) Death benefits and other incidental benefits. An annuity is not 
a section 403(b) contract if it fails to satisfy the incidental benefit 
requirement of Sec. 1.401-1(b)(1)(ii) (in form or in operation). For 
purposes of this paragraph (g), to the extent the incidental benefit 
requirement of Sec. 1.401-1(b)(1)(ii) requires a distribution of the 
participant's or beneficiary's accumulated benefit, that requirement is 
deemed to be satisfied if distributions satisfy the minimum distribution 
requirements of section 401(a)(9). In addition, if a contract issued by 
an insurance company qualified to issue annuities in a State includes 
provisions under which, in the event a participant becomes disabled, 
benefits will be provided by the insurance carrier as if employer 
contributions were continued until benefit distribution commences, then 
that benefit is treated as an incidental benefit (as insurance for a 
deferred annuity benefit in the event of disability) that must satisfy 
the incidental benefit requirement of Sec. 1.401-1(b)(1)(ii) (taking 
into account any other incidental benefits provided under the plan).
    (h) Special rule regarding severance from employment. For purposes 
of this section, severance from employment occurs on any date on which 
an employee ceases to be an employee of an eligible employer, even 
though the employee may continue to be employed either by another entity 
that is treated as the same employer where either that other entity is 
not an entity that can be an eligible employer (such as transferring 
from a section 501(c)(3) organization to a for-profit subsidiary of the 
section 501(c)(3) organization) or in a capacity that is not employment 
with an eligible employer (for example, ceasing to be an employee 
performing services for a public school but continuing to work for the 
same State employer). Thus, this paragraph (h) does not apply if an 
employee transfers from one section 501(c)(3) organization to another 
section 501(c)(3) organization that is treated as the same employer or 
if an employee transfers from one public school to another public school 
of the same State employer.
    (i) Certain limitations do not apply to rollover contributions. The 
limitations on distributions in paragraphs (b) through (d) of this 
section do not apply to amounts held in a separate account for eligible 
rollover distributions as described in Sec. 1.403(b)-10(d).

[T.D. 9340, 72 FR 41144, July 26, 2007, as amended by 72 FR 54352, Sept. 
25, 2007; T.D. 9459, 74 FR 45994, Sept. 8, 2009; 75 FR 65566, Oct. 26, 
2010]

[[Page 493]]



Sec. 1.403(b)-7  Taxation of distributions and benefits.

    (a) General rules for when amounts are included in gross income. 
Except as provided in this section (or in Sec. 1.403(b)-10(c) relating 
to payments pursuant to a qualified domestic relations order), amounts 
actually distributed from a section 403(b) contract are includible in 
the gross income of the recipient participant or beneficiary (in the 
year in which so distributed) under section 72 (relating to annuities). 
For an additional income tax that may apply to certain early 
distributions that are includible in gross income, see section 72(t).
    (b) Rollovers to individual retirement arrangements and other 
eligible retirement plans--(1) Timing of taxation of rollovers. In 
accordance with sections 402(c), 403(b)(8), and 403(b)(10), a direct 
rollover in accordance with section 401(a)(31) is not includible in the 
gross income of a participant or beneficiary in the year rolled over. In 
addition, any payment made in the form of an eligible rollover 
distribution (as defined in section 402(c)(4)) is not includible in 
gross income in the year paid to the extent the payment is contributed 
to an eligible retirement plan (as defined in section 402(c)(8)(B)) 
within 60 days, including the contribution to the eligible retirement 
plan of any property distributed. For this purpose, the rules of section 
402(c)(2) through (7) and (c)(9) apply. Thus, to the extent that a 
portion of a distribution (including a distribution from a designated 
Roth account) would be excluded from gross income if it were not rolled 
over, if that portion of the distribution is to be rolled over into an 
eligible retirement plan that is not an IRA, the rollover must be 
accomplished through a direct rollover of the entire distribution to a 
plan qualified under section 401(a) or a section 403(b) plan and that 
plan must agree to separately account for the amount not includible in 
income (so that a 60-day rollover to a plan qualified under section 
401(a) or another section 403(b) plan is not available for this portion 
of the distribution).
    (2) Requirement that contract provide rollover options for eligible 
rollover distributions. As required in Sec. 1.403(b)-3(a)(7), an 
annuity contract is not a section 403(b) contract unless the contract 
provides that if the distributee of an eligible rollover distribution 
elects to have the distribution paid directly to an eligible retirement 
plan (as defined in section 402(c)(8)(B)) and specifies the eligible 
retirement plan to which the distribution is to be paid, then the 
distribution will be paid to that eligible retirement plan in a direct 
rollover. For purposes of determining whether a contract satisfies this 
requirement, the provisions of section 401(a)(31) apply to the annuity 
as though it were a plan qualified under section 401(a) unless otherwise 
provided in section 401(a)(31). Thus, the special rule in Sec. 
1.401(k)-1(f)(3)(ii) with respect to distributions from a designated 
Roth account that are expected to total less than $200 during a year 
applies to designated Roth accounts under a section 403(b) plan. In 
applying the provisions of this paragraph (b)(2), the payor of the 
eligible rollover distribution from the contract is treated as the plan 
administrator.
    (3) Requirement that contract payor provide notice of rollover 
option to distributees. To ensure that the distributee of an eligible 
rollover distribution from a section 403(b) contract has a meaningful 
right to elect a direct rollover, section 402(f) requires that the 
distributee be informed of the option. Thus, within a reasonable time 
period before making the initial eligible rollover distribution, the 
payor must provide an explanation to the distributee of his or her right 
to elect a direct rollover and the income tax withholding consequences 
of not electing a direct rollover. For purposes of satisfying the 
reasonable time period requirement, the plan timing rule provided in 
section 402(f)(1) and Sec. 1.402(f)-1 applies to section 403(b) 
contracts.
    (4) Mandatory withholding upon certain eligible rollover 
distributions from contracts. If a distributee of an eligible rollover 
distribution from a section 403(b) contract does not elect to have the 
eligible rollover distribution paid directly to an eligible retirement 
plan in a direct rollover, the eligible rollover distribution is subject 
to 20-percent income tax withholding imposed under section 3405(c). See 
section 3405(c) and Sec. 31.3405(c)-1 of this chapter

[[Page 494]]

for provisions regarding the withholding requirements relating to 
eligible rollover distributions.
    (5) Automatic rollover for certain mandatory distributions under 
section 401(a)(31). In accordance with section 403(b)(10), a section 
403(b) plan is required to comply with section 401(a)(31) (including 
automatic rollover for certain mandatory distributions) in the same 
manner as a qualified plan.
    (c) Special rules. See section 402(g)(2)(C) for special rules to 
determine the tax treatment of a distribution of excess deferrals, and 
see Sec. 1.401(m)-1(e)(3)(v) for the tax treatment of corrective 
distributions of after-tax employee contributions and matching 
contributions to comply with section 401(m). See sections 402(l) and 
403(b)(2) for a special rule regarding distributions for certain retired 
public safety officers made from a governmental plan for the direct 
payment of certain premiums.
    (d) Amounts taxable under section 72(p)(1). In accordance with 
section 72(p), the amount of any loan from a section 403(b) contract to 
a participant or beneficiary (including any pledge or assignment treated 
as a loan under section 72(p)(1)(B)) is treated as having been received 
as a distribution from the contract under section 72(p)(1), except to 
the extent set forth in section 72(p)(2) (relating to loans that do not 
exceed a maximum amount and that are repayable in accordance with 
certain terms) and Sec. 1.72(p)-1. See generally Sec. 1.72(p)-1. Thus, 
except to the extent a loan satisfies section 72(p)(2), any amount 
loaned from a section 403(b) contract to a participant or beneficiary 
(including any pledge or assignment treated as a loan under section 
72(p)(1)(B)) is includible in the gross income of the participant or 
beneficiary for the taxable year in which the loan is made. A deemed 
distribution is not an actual distribution for purposes of Sec. 
1.403(b)-6, as provided at Sec. 1.72(p)-1, Q&A-12 and Q&A-13. (Further, 
see section 408(b)(1) of title I of ERISA concerning the effect of 
noncompliance with title I loan requirements for plans that are subject 
to title I of ERISA.)
    (e) Special rules relating to distributions from a designated Roth 
account. If an amount is distributed from a designated Roth account 
under a section 403(b) plan, the amount, if any, that is includible in 
gross income and the amount, if any, that may be rolled over to another 
section 403(b) plan is determined under Sec. 1.402A-1. Thus, the 
designated Roth account is treated as a separate contract for purposes 
of section 72. For example, the rules of section 72(b) must be applied 
separately to annuity payments with respect to a designated Roth account 
under a section 403(b) plan and separately to annuity payments with 
respect to amounts attributable to any other contributions to the 
section 403(b) plan.
    (f) Aggregation of contracts. In accordance with section 403(b)(5), 
the rules of this section are applied as if all annuity contracts for 
the employee by the employer are treated as a single contract.
    (g) Certain rules relating to employment taxes. With respect to 
contributions under the Federal Insurance Contributions Act (FICA) under 
Chapter 21, see section 3121(a)(5)(D) for a special rule relating to 
section 403(b) contracts. With respect to income tax withholding on 
distributions from section 403(b) contracts, see section 3405 generally. 
However, see section 3401 for income tax withholding applicable to 
annuity contracts or custodial accounts that are not section 403(b) 
contracts or for cases in which an annuity contract or custodial account 
ceases to be a section 403(b) contract. See also Sec. 1.72(p)-1, Q&A-
15, and Sec. 35.3405(c)-1, Q&A-11 of this chapter, for special rules 
relating to income tax withholding for loans made from certain employer 
plans, including section 403(b) contracts.

[T.D. 9340, 72 FR 41144, July 26, 2007, as amended by 75 FR 65566, Oct. 
26, 2010]



Sec. 1.403(b)-8  Funding.

    (a) Investments. Section 403(b) and Sec. 1.403(b)-3(a) only apply 
to amounts held in an annuity contract (as defined in Sec. 1.403(b)-2), 
including a custodial account that is treated as an annuity contract 
under paragraph (d) of this section, or a retirement income account that 
is treated as an annuity contract under Sec. 1.403(b)-9.
    (b) Contributions to the plan. Contributions to a section 403(b) 
plan must be

[[Page 495]]

transferred to the insurance company issuing the annuity contract (or 
the entity holding assets of any custodial or retirement income account 
that is treated as an annuity contract) within a period that is not 
longer than is reasonable for the proper administration of the plan. For 
purposes of this requirement, the plan may provide for section 403(b) 
elective deferrals for a participant under the plan to be transferred to 
the annuity contract within a specified period after the date the 
amounts would otherwise have been paid to the participant. For example, 
the plan could provide for section 403(b) elective deferrals under the 
plan to be contributed within 15 business days following the month in 
which these amounts would otherwise have been paid to the participant.
    (c) Annuity contracts--(1) Generally. As defined in Sec. 1.403(b)-
2, and except as otherwise permitted under this section, an annuity 
contract means a contract that is issued by an insurance company 
qualified to issue annuities in a State and that includes payment in the 
form of an annuity. This paragraph (c) sets forth additional rules 
regarding annuity contracts.
    (2) Certain insurance contracts. Neither a life insurance contract, 
as defined in section 7702, an endowment contract, a health or accident 
insurance contract, nor a property, casualty, or liability insurance 
contract meets the definition of an annuity contract. See Sec. 
1.401(f)-4(e). If a contract issued by an insurance company qualified to 
issue annuities in a State provides death benefits as part of the 
contract, then that coverage is permitted, assuming that those death 
benefits do not cause the contract to fail to satisfy any requirement 
applicable to section 403(b) contracts, for example, assuming that those 
benefits satisfy the incidental benefit requirement of Sec. 1.401-
1(b)(1)(i), as required by Sec. 1.403(b)-6(g).
    (3) Special rule for certain contracts. This paragraph (c)(3) 
applies in the case of a contract issued under a State section 403(b) 
plan established on or before May 17, 1982, or for an employee who 
becomes covered for the first time under the plan after May 17, 1982, 
unless the Commissioner had before that date issued any written 
communication (either to the employer or financial institution) to the 
effect that the arrangement under which the contract was issued did not 
meet the requirements of section 403(b). The requirement that the 
contract be issued by an insurance company qualified to issue annuities 
in a State does not apply to a contract described in the preceding 
sentence if one of the following two conditions is satisfied and that 
condition has been satisfied continuously since May 17, 1982--
    (i) Benefits under the contract are provided from a separately 
funded retirement reserve that is subject to supervision of the State 
insurance department; or
    (ii) Benefits under the contract are provided from a fund that is 
separate from the fund used to provide statutory benefits payable under 
a state retirement system and that is part of a State teachers 
retirement system (including a state university retirement system) to 
purchase benefits that are unrelated to the basic benefits provided 
under the retirement system, and the death benefit provided under the 
contract does not at any time exceed the larger of the reserve or the 
contribution made for the employee.
    (d) Custodial accounts--(1) Treatment as a section 403(b) contract. 
Under section 403(b)(7), a custodial account is treated as an annuity 
contract for purposes of Sec. Sec. 1.403(b)-1 through 1.403(b)-7, this 
section and Sec. Sec. 1.403(b)-9 through 1.403(b)-11. See section 
403(b)(7)(B) for special rules regarding the tax treatment of custodial 
accounts and section 4973(c) for an excise tax that applies to excess 
contributions to a custodial account.
    (2) Custodial account defined. A custodial account means a plan, or 
a separate account under a plan, in which an amount attributable to 
section 403(b) contributions (or amounts rolled over to a section 403(b) 
contract, as described in Sec. 1.403(b)-10(d)) is held by a bank or a 
person who satisfies the conditions in section 401(f)(2), if--
    (i) All of the amounts held in the account are invested in stock of 
a regulated investment company (as defined in section 851(a) relating to 
mutual funds);

[[Page 496]]

    (ii) The requirements of Sec. 1.403(b)-6(c) (imposing restrictions 
on distributions with respect to a custodial account) are satisfied with 
respect to the amounts held in the account;
    (iii) The assets held in the account cannot be used for, or diverted 
to, purposes other than for the exclusive benefit of plan participants 
or their beneficiaries (for which purpose, assets are treated as 
diverted to the employer if the employer borrows assets from the 
account); and
    (iv) The account is not part of a retirement income account.
    (3) Effect of definition. The requirement in paragraph (d)(2)(i) of 
this section is not satisfied if the account includes any assets other 
than stock of a regulated investment company.
    (4) Treatment of custodial account. A custodial account is treated 
as a section 401 qualified plan solely for purposes of subchapter F of 
subtitle A and subtitle F of the Internal Revenue Code with respect to 
amounts received by it (and income from investment thereof). This 
treatment only applies to a custodial account that constitutes a section 
403(b) contract under Sec. Sec. 1.403(b)-1 through 1.403(b)-7, this 
section and Sec. Sec. 1.403(b)-9 through 1.403(b)-11 or that would 
constitute a section 403(b) contract under Sec. Sec. 1.403(b)-1 through 
1.403(b)-7, this section and Sec. Sec. 1.403(b)-9 through 1.403(b)-11 
if the amounts held in the account were to satisfy the nonforfeitability 
requirement of Sec. 1.403(b)-3(a)(2).
    (e) Retirement income accounts. See Sec. 1.403(b)-9 for special 
rules under which a retirement income account for employees of a church-
related organization is treated as a section 403(b) contract for 
purposes of Sec. Sec. 1.403(b)-1 through 1.403(b)-7, this section and 
Sec. Sec. 1.403(b)-9 through 1.403(b)-11.
    (f) Combining assets. To the extent permitted by the Commissioner in 
revenue rulings, notices, or other guidance published in the Internal 
Revenue Bulletin (see Sec. 601.601(d)(2)(ii)(b) of this chapter), trust 
assets held under a custodial account and trust assets held under a 
retirement income account, as described in Sec. 1.403(b)-9(a)(6), may 
be invested in a group trust with trust assets held under a qualified 
plan or individual retirement plan. For this purpose, a trust includes a 
custodial account that is treated as a trust under section 401(f).

[T.D. 9340, 72 FR 41144, July 26, 2007]



Sec. 1.403(b)-9  Special rules for church plans.

    (a) Retirement income accounts--(1) Treatment as a section 403(b) 
contract. Under section 403(b)(9), a retirement income account for 
employees of a church-related organization (as defined in Sec. 
1.403(b)-2) is treated as an annuity contract for purposes of Sec. Sec. 
1.403(b)-1 through 1.403(b)-8, this section, Sec. 1.403(b)-10 and Sec. 
1.403(b)-11.
    (2) Retirement income account defined--(i) In general. A retirement 
income account means a defined contribution program established or 
maintained by a church-related organization under which--
    (A) There is separate accounting for the retirement income account's 
interest in the underlying assets (namely, there must be sufficient 
separate accounting in order for it to be possible at all times to 
determine the retirement income account's interest in the underlying 
assets and to distinguish that interest from any interest that is not 
part of the retirement income account);
    (B) Investment performance is based on gains and losses on those 
assets; and
    (C) The assets held in the account cannot be used for, or diverted 
to, purposes other than for the exclusive benefit of plan participants 
or their beneficiaries (and for this purpose, assets are treated as 
diverted to the employer if there is a loan or other extension of credit 
from assets in the account to the employer).
    (ii) Plan required. A retirement income account must be maintained 
pursuant to a program which is a plan (as defined in Sec. 1.403(b)-
3(b)(3)) and the plan document must state (or otherwise evidence in a 
similarly clear manner) the intent to constitute a retirement income 
account.
    (3) Ownership or use constitutes distribution. Any asset of a 
retirement income account that is owned or used by a participant or 
beneficiary is treated as having been distributed to that participant or 
beneficiary. See Sec. Sec. 1.403(b)-6

[[Page 497]]

and 1.403(b)-7 for rules relating to distributions.
    (4) Coordination of retirement income account with custodial account 
rules. A retirement income account that is treated as an annuity 
contract is not a custodial account (as defined in Sec. 1.403(b)-
8(d)(2)), even if it is invested solely in stock of a regulated 
investment company.
    (5) Life annuities. A retirement income account may distribute 
benefits in a form that includes a life annuity only if--
    (i) The amount of the distribution form has an actuarial present 
value, at the annuity starting date, equal to the participant's or 
beneficiary's accumulated benefit, based on reasonable actuarial 
assumptions, including regarding interest and mortality; and
    (ii) The plan sponsor guarantees benefits in the event that a 
payment is due that exceeds the participant's or beneficiary's 
accumulated benefit.
    (6) Combining retirement income account assets with other assets. 
For purposes of Sec. 1.403(b)-8(f) relating to combining assets, 
retirement income account assets held in trust (including a custodial 
account that is treated as a trust under section 401(f)) are subject to 
the same rules regarding combining of assets as custodial account 
assets. In addition, retirement income account assets are permitted to 
be commingled in a common fund with amounts devoted exclusively to 
church purposes (such as a fund from which unfunded pension payments are 
made to former employees of the church). However, unless otherwise 
permitted by the Commissioner, no assets of the plan sponsor, other than 
retirement income account assets, may be combined with custodial account 
assets or any other assets permitted to be combined under Sec. 
1.403(b)-8(f). This paragraph (a)(6) is subject to any additional rules 
issued by the Commissioner in revenue rulings, notices, or other 
guidance published in the Internal Revenue Bulletin (see Sec. 
601.601(d)(2)(ii)(b) of this chapter).
    (7) Trust treated as tax exempt. A trust (including a custodial 
account that is treated as a trust under section 401(f)) that includes 
no assets other than assets of a retirement income account is treated as 
an organization that is exempt from taxation under section 501(a).
    (b) No compensation limitation up to $10,000. See section 415(c)(7) 
for special rules regarding certain annual additions not exceeding 
$10,000.
    (c) Special deduction rule for self-employed ministers. See section 
404(a)(10) for a special rule regarding the deductibility of a 
contribution made by a self-employed minister.

[T.D. 9340, 72 FR 41144, July 26, 2007]



Sec. 1.403(b)-10  Miscellaneous provisions.

    (a) Plan terminations and frozen plans--(1) In general. An employer 
is permitted to amend its section 403(b) plan to eliminate future 
contributions for existing participants or to limit participation to 
existing participants and employees (to the extent consistent with Sec. 
1.403(b)-5). A section 403(b) plan is permitted to contain provisions 
that provide for plan termination and that allow accumulated benefits to 
be distributed on termination. However, in the case of a section 403(b) 
contract that is subject to the distribution restrictions in Sec. 
1.403(b)-6(c) or (d) (relating to custodial accounts and section 403(b) 
elective deferrals), termination of the plan and the distribution of 
accumulated benefits is permitted only if the employer (taking into 
account all entities that are treated as the same employer under section 
414(b), (c), (m), or (o) on the date of the termination) does not make 
contributions to any section 403(b) contract that is not part of the 
plan during the period beginning on the date of plan termination and 
ending 12 months after distribution of all assets from the terminated 
plan. However, if at all times during the period beginning 12 months 
before the termination and ending 12 months after distribution of all 
assets from the terminated plan, fewer than 2 percent of the employees 
who were eligible under the section 403(b) plan as of the date of plan 
termination are eligible under the alternative section 403(b) contract, 
the alternative section 403(b) contract is disregarded. To the extent a 
contract fails to satisfy the nonforfeitability requirement of Sec. 
1.403(b)-3(a)(2) at the date of plan termination, the contact is not, 
and cannot later become, a section

[[Page 498]]

403(b) contract. In order for a section 403(b) plan to be considered 
terminated, all accumulated benefits under the plan must be distributed 
to all participants and beneficiaries as soon as administratively 
practicable after termination of the plan. For this purpose, delivery of 
a fully paid individual insurance annuity contract is treated as a 
distribution. The mere provision for, and making of, distributions to 
participants or beneficiaries upon plan termination does not cause a 
contract to cease to be a section 403(b) contract. See Sec. 1.403(b)-7 
for rules regarding the tax treatment of distributions, including Sec. 
1.403(b)-7(b)(1) under which an eligible rollover distribution is not 
included in gross income if paid in a direct rollover to an eligible 
retirement plan or if transferred to an eligible retirement plan within 
60 days.
    (2) Employers that cease to be eligible employers. An employer that 
ceases to be an eligible employer may no longer contribute to a section 
403(b) contract for any subsequent period, and the contract will fail to 
satisfy Sec. 1.403(b)-3(a) if any further contributions are made with 
respect to a period after the employer ceases to be an eligible 
employer.
    (b) Contract exchanges and plan-to-plan transfers--(1) Contract 
exchanges and transfers--(i) General rule. If the conditions in 
paragraph (b)(2) of this section are met, a section 403(b) contract held 
under a section 403(b) plan is permitted to be exchanged for another 
section 403(b) contract held under that section 403(b) plan. Further, if 
the conditions in paragraph (b)(3) of this section are met, a section 
403(b) plan is permitted to provide for the transfer of its assets 
(including any assets held in a custodial account or retirement income 
account that are treated as section 403(b) contracts) to another section 
403(b) plan. In addition, if the conditions in paragraph (b)(4) of this 
section (relating to permissive service credit and repayments under 
section 415) are met, a section 403(b) plan is permitted to provide for 
the transfer of its assets to a qualified plan under section 401(a). 
However, neither a qualified plan nor an eligible governmental plan 
under section 457(b) may transfer assets to a section 403(b) plan, and a 
section 403(b) plan may not accept such a transfer. In addition, a 
section 403(b) contract may not be exchanged for an annuity contract 
that is not a section 403(b) contract. Neither a plan-to-plan transfer 
nor a contract exchange permitted under this paragraph (b) is treated as 
a distribution for purposes of the distribution restrictions at Sec. 
1.403(b)-6. Therefore, such a transfer or exchange may be made before 
severance from employment or another distribution event. Further, no 
amount is includible in gross income by reason of such a transfer or 
exchange.
    (ii) ERISA rules. See Sec. 1.414(l)-1 for other rules that are 
applicable to section 403(b) plans that are subject to section 208 of 
the Employee Retirement Income Security Act of 1974 (88 Stat. 829, 865).
    (2) Requirements for contract exchange within the same plan--(i) 
General rule. A section 403(b) contract of a participant or beneficiary 
may be exchanged under paragraph (b)(1) of this section for another 
section 403(b) contract of that participant or beneficiary under the 
same section 403(b) plan if each of the following conditions are met:
    (A) The plan under which the contract is issued provides for the 
exchange.
    (B) The participant or beneficiary has an accumulated benefit 
immediately after the exchange that is at least equal to the accumulated 
benefit of that participant or beneficiary immediately before the 
exchange (taking into account the accumulated benefit of that 
participant or beneficiary under both section 403(b) contracts 
immediately before the exchange).
    (C) The other contract is subject to distribution restrictions with 
respect to the participant that are not less stringent than those 
imposed on the contract being exchanged, and the employer enters into an 
agreement with the issuer of the other contract under which the employer 
and the issuer will from time to time in the future provide each other 
with the following information:
    (1) Information necessary for the resulting contract, or any other 
contract to which contributions have been made by the employer, to 
satisfy section

[[Page 499]]

403(b), including information concerning the participant's employment 
and information that takes into account other section 403(b) contracts 
or qualified employer plans (such as whether a severance from employment 
has occurred for purposes of the distribution restrictions in Sec. 
1.403(b)-6 and whether the hardship withdrawal rules of Sec. 1.403(b)-
6(d)(2) are satisfied).
    (2) Information necessary for the resulting contract, or any other 
contract to which contributions have been made by the employer, to 
satisfy other tax requirements (such as whether a plan loan satisfies 
the conditions in section 72(p)(2) so that the loan is not a deemed 
distribution under section 72(p)(1)).
    (ii) Accumulated benefit. The condition in paragraph (b)(2)(i)(B) of 
this section is satisfied if the exchange would satisfy section 
414(l)(1) if the exchange were a transfer of assets.
    (iii) Authority for future guidance. Subject to such conditions as 
the Commissioner determines to be appropriate, the Commissioner may 
issue rules of general applicability, in revenue rulings, notices, or 
other guidance published in the Internal Revenue Bulletin (see Sec. 
601.601(d)(2)(ii)(b) of this chapter), permitting an exchange of one 
section 403(b) contract for another section 403(b) contract for an 
exchange that does not satisfy paragraph (b)(2)(i)(C) of this section. 
Any such rules must require the resulting contract to set forth 
procedures that the Commissioner determines are reasonably designed to 
ensure compliance with those requirements of section 403(b) or other tax 
provisions that depend on either information concerning the 
participant's employment or information that takes into account other 
section 403(b) contracts or other employer plans (such as whether a 
severance from employment has occurred for purposes of the distribution 
restrictions in Sec. 1.403(b)-6, whether the hardship withdrawal rules 
of Sec. 1.403(b)-6(d)(2) are satisfied, and whether a plan loan 
constitutes a deemed distribution under section 72(p)).
    (3) Requirements for plan-to-plan transfers--(i) In general. A plan-
to-plan transfer under paragraph (b)(1) of this section from a section 
403(b) plan to another section 403(b) plan is permitted if each of the 
following conditions are met--
    (A) In the case of a transfer for a participant, the participant is 
an employee or former employee of the employer (or the business of the 
employer) for the receiving plan.
    (B) In the case of a transfer for a beneficiary of a deceased 
participant, the participant was an employee or former employee of the 
employer (or business of the employer) for the receiving plan.
    (C) The transferor plan provides for transfers.
    (D) The receiving plan provides for the receipt of transfers.
    (E) The participant or beneficiary whose assets are being 
transferred has an accumulated benefit immediately after the transfer 
that is at least equal to the accumulated benefit of that participant or 
beneficiary immediately before the transfer.
    (F) The receiving plan provides that, to the extent any amount 
transferred is subject to any distribution restrictions under Sec. 
1.403(b)-6, the receiving plan imposes restrictions on distributions to 
the participant or beneficiary whose assets are being transferred that 
are not less stringent than those imposed on the transferor plan.
    (G) If a plan-to-plan transfer does not constitute a complete 
transfer of the participant's or beneficiary's interest in the section 
403(b) plan, the transferee plan treats the amount transferred as a 
continuation of a pro rata portion of the participant's or beneficiary's 
interest in the section 403(b) plan (for example, a pro rata portion of 
the participant's or beneficiary's interest in any after-tax employee 
contributions).
    (ii) Accumulated benefit. The condition in paragraph (b)(3)(i)(D) of 
this section is satisfied if the transfer would satisfy section 
414(l)(1).
    (4) Purchases of permissive service credit by contract-to-plan 
transfers from a section 403(b) contract to a qualified plan--(i) 
General rule. If the conditions in paragraph (b)(4)(ii) of this section 
are met, a section 403(b) plan may provide for the transfer of assets 
held in the plan to a qualified defined benefit plan that is a 
governmental plan (as defined in section 414(d)).

[[Page 500]]

    (ii) Conditions for plan-to-plan transfers. A transfer may be made 
under this paragraph (b)(4) only if the transfer is either--
    (A) For the purchase of permissive service credit (as defined in 
section 415(n)(3)(A)) under the receiving defined benefit plan; or
    (B) A repayment to which section 415 does not apply by reason of 
section 415(k)(3).
    (c) Qualified domestic relations orders. In accordance with the 
second sentence of section 414(p)(9), any distribution from an annuity 
contract under section 403(b) (including a distribution from a custodial 
account or retirement income account that is treated as a section 403(b) 
contract) pursuant to a qualified domestic relations order is treated in 
the same manner as a distribution from a plan to which section 
401(a)(13) applies. Thus, for example, a section 403(b) plan does not 
fail to satisfy the distribution restrictions set forth in Sec. 
1.403(b)-6(b), (c), or (d) merely as a result of distribution made 
pursuant to a qualified domestic relations order under section 414(p), 
so that such a distribution is permitted without regard to whether the 
employee from whose contract the distribution is made has had a 
severance from employment or another event permitting a distribution to 
be made under section 403(b). In the case of a plan that is subject to 
title I of ERISA, see also section 206(d)(3) of ERISA under which the 
prohibition against assignment or alienation of plan benefits under 
section 206(d)(1) of ERISA does not apply to an order that is determined 
to be a qualified domestic relations order.
    (d) Rollovers to a section 403(b) contract--(1) General rule. A 
section 403(b) contract may accept a contribution that is an eligible 
rollover distribution (as defined in section 402(c)(4)) made from 
another eligible retirement plan (as defined in section 402(c)(8)(B)). 
Any amount contributed to a section 403(b) contract as an eligible 
rollover distribution is not taken into account for purposes of the 
limits in Sec. 1.403(b)-4, but, except as otherwise specifically 
provided (for example, at Sec. 1.403(b)-6(i)), is otherwise treated in 
the same manner as an amount held under a section 403(b) contract for 
purposes of Sec. Sec. 1.403(b)-3 through 1.403(b)-9 and this section.
    (2) Special rules relating to after-tax employee contributions and 
designated Roth contributions. A section 403(b) plan that receives an 
eligible rollover distribution that includes after-tax employee 
contributions or designated Roth contributions is required to obtain 
information regarding the employee's section 72 basis in the amount 
rolled over. A section 403(b) plan is permitted to receive an eligible 
rollover distribution that includes designated Roth contributions only 
if the plan permits employees to make elective deferrals that are 
designated Roth contributions.
    (e) Deemed IRAs. See regulations under section 408(q) for special 
rules relating to deemed IRAs.
    (f) Defined benefit plans--(1) Defined benefit plans generally. 
Except for a TEFRA church defined benefit plan as defined in paragraph 
(f)(2) of this section, section 403(b) does not apply to any 
contributions or accrual under a defined benefit plan.
    (2) TEFRA church defined benefit plans. See section 251(e)(5) of the 
Tax Equity and Fiscal Responsibility Act of 1982, Public Law 97-248, for 
a provision permitting certain arrangements established by a church-
related organization and in effect on September 3, 1982 (a TEFRA church 
defined benefit plan) to be treated as section 403(b) contract even 
though it is a defined benefit arrangement. In accordance with section 
403(b)(1), for purposes of applying section 415 to a TEFRA church 
defined benefit plan, the accruals under the plan are limited to the 
maximum amount permitted under section 415(c) when expressed as an 
annual addition, and, for this purpose, the rules at Sec. 1.402(b)-
1(a)(2) for determining the present value of an accrual under a 
nonqualified defined benefit plan also apply for purposes of converting 
the accrual under a TEFRA church defined benefit plan to an annual 
addition. See section 415(b) for additional limits applicable to TEFRA 
church defined benefit plans.
    (g) Other rules relating to section 501(c)(3) organizations. See 
section 501(c)(3) and regulations thereunder for

[[Page 501]]

the substantive standards for tax-exemption under that section, 
including the requirement that no part of the organization's net 
earnings inure to the benefit of any private shareholder or individual. 
See also sections 4941 (self dealing), 4945 (taxable expenditures), and 
4958 (excess benefit transactions), and the regulations thereunder, for 
rules relating to excise taxes imposed on certain transactions involving 
organizations described in section 501(c)(3).

[T.D. 9340, 72 FR 41144, July 26, 2007, as amended by 75 FR 65566, Oct. 
26, 2010]



Sec. 1.403(b)-11  Applicable dates.

    (a) General rule. Except as otherwise provided in this section, 
Sec. Sec. 1.403(b)-1 through 1.403(b)-10 apply for taxable years 
beginning after December 31, 2008.
    (b) Collective bargaining agreements. In the case of a section 
403(b) plan maintained pursuant to one or more collective bargaining 
agreements that have been ratified and in effect on July 26, 2007, 
Sec. Sec. 1.403(b)-1 through 1.403(b)-10 do not apply before the 
earlier of--
    (1) The date on which the last of the collective bargaining 
agreements terminates (determined without regard to any extension 
thereof after July 26, 2007); or
    (2) July 26, 2010.
    (c) Church conventions; retirement income account. (1) In the case 
of a section 403(b) plan maintained by a church-related organization for 
which the authority to amend the plan is held by a church convention 
(within the meaning of section 414(e)), Sec. Sec. 1.403(b)-1 through 
1.403(b)-10 do not apply before the first day of the first plan year 
that begins after December 31, 2009.
    (2) In the case of a loan or other extension of credit to the 
employer that was entered into under a retirement income account before 
July 26, 2007, the plan does not fail to satisfy Sec. 1.403(b)-
9(a)(2)(i)(C) on account of the loan or other extension of credit if the 
plan takes reasonable steps to eliminate the loan or other extension of 
credit to the employer before the applicable date for Sec. 1.403(b)-
9(a)(2) or as promptly as practical thereafter (including taking steps 
after July 26, 2007 and before the applicable date).
    (d) Special rules for plans that exclude certain types of employees 
from elective deferrals. (1) If, on July 26, 2007, a plan excludes any 
of the following categories of employees, then the plan does not fail to 
satisfy Sec. 1.403(b)-5(b) as a result of that exclusion before the 
first day of the first taxable year that begins after December 31, 2009:
    (i) Employees who make a one-time election to participate in a 
governmental plan described in section 414(d) that is not a section 
403(b) plan.
    (ii) Professors who are providing services on a temporary basis to 
another educational organization (as defined under section 
170(b)(1)(A)(ii)) for up to one year and for whom section 403(b) 
contributions are being made at a rate no greater than the rate each 
such professor would receive under the section 403(b) plan of the 
original educational organization.
    (iii) Employees who are affiliated with a religious order and who 
have taken a vow of poverty where the religious order provides for the 
support of such employees in their retirement from eligibility to make 
elective deferrals.
    (2) If, on July 26, 2007, a plan excludes employees who are covered 
by a collective bargaining agreement from eligibility to make elective 
deferrals, the plan does not fail to satisfy Sec. 1.403(b)-5(b) 
(relating to universal availability) as a result of that exclusion 
before the later of--
    (i) The first day of the first taxable year that begins after 
December 31, 2008; or
    (ii) The earlier of--
    (A) The date on which the related collective bargaining agreement 
terminates (determined without regard to any extension thereof after 
July 26, 2007); or
    (B) July 26, 2010.
    (3) In the case of a governmental plan (as defined in section 
414(d)) for which the authority to amend the plan is held by a 
legislative body that meets in legislative session, the plan does not 
fail to satisfy Sec. 1.403(b)-5(b) as a result of any exclusion in 
paragraph (d)(1)(i), (d)(1)(ii),(d)(1)(iii), or (d)(2) of this section 
before the earlier of --
    (i) The close of the first regular legislative session of the 
legislative body

[[Page 502]]

with the authority to amend the plan that begins on or after January 1, 
2009; or
    (ii) January 1, 2011.
    (e) Special rules for plans that permit in-service distributions. 
(1) Section 1.403(b)-6(b) does not apply to a contract issued by an 
insurance company before January 1, 2009.
    (2) Any amendment to comply with the requirements of Sec. 1.403(b)-
6 (disregarding paragraph (e)(1) of this section) that is adopted before 
January 1, 2009, or such later date as may be permitted under guidance 
issued by the Commissioner in revenue rulings, notices, or other 
guidance published in the Internal Revenue Bulletin (see Sec. 
601.601(d)(2)(ii)(b) of this chapter), does not violate section 204(g) 
of the Employee Retirement Income Security Act of 1974 to the extent the 
amendment eliminates or reduces a right to receive benefit distributions 
during employment.
    (f) Special rule for life insurance contracts. Section 1.403(b)-
8(c)(2) does not apply to a contract issued before September 24, 2007.
    (g) Special rule for contracts received in an exchange. Section 
1.403(b)-10(b)(2) does not apply to a contract received in an exchange 
that occurred on or before September 24, 2007 if the exchange (including 
the contract received in the exchange) satisfies such rules as the 
Commissioner has prescribed in guidance of general applicability at the 
time of the exchange.
    (h) Special rule for coordination with regulations under section 
415. Section 1.403(b)-3(b)(4)(ii) is applicable for taxable years 
beginning on or after July 1, 2007.
    (i) Special rule for coordination with regulations under section 
402A. Sections 1.403(b)-3(c), 1.403(b)-7(e), and 1.403(b)-10(d)(2) are 
applicable with respect to taxable years beginning on or after January 
1, 2007.

[T.D. 9340, 72 FR 41144, July 26, 2007; 72 FR 54352, Sept. 25, 2007]



Sec. 1.403(c)-1  Taxability of beneficiary under a nonqualified 
annuity.

    (a) Taxability of vested interest in premiums. If after August 1, 
1969, an employer (whether or not exempt under section 501(a)) pays 
premiums for an annuity contract for the benefit of an employee, the 
amount of such premiums shall be included as compensation in the gross 
income of the employee for the taxable year during which such premiums 
are paid, but only to the extent that the employees's rights in such 
premiums are substantially vested (as defined in Sec. 1.83-3(b)) at the 
time such premiums are paid. The preceding sentence shall not apply to 
contracts referred to in the transitional rule of paragraph (d) (1), 
(ii), or (iii) of this section, or to premiums subject to Sec. 
1.403(a)-1(a) or excludible under Sec. 1.403(b)-3. If any employer has 
purchased annuity contracts and transfered them to a trust (other than 
one described in section 401(a)) that is to provide annuity contracts or 
benefits for his employees, the amounts so paid shall be treated as 
contributions to a trust described in section 402(b). For the rules 
relating to the taxation of the cost of life insurance protection when 
rights in a life insurance contract are substantially nonvested, see 
Sec. 1.83-1(a)(2).
    (b) Taxability of employee when rights under annuity contract change 
from nonvested to vested--(1) In general. If, during a taxable year of 
an employee ending after August 1, 1969, the rights of such employee 
under an annuity contract purchased for him by an employer (whether or 
not exempt under section 501(a) or 521(a)) become substantially vested, 
the value of the annuity contract on the date of such change shall be 
included in the employee's gross income for such year, to the extent 
provided in paragraph (b)(2) of this section. The preceding sentence 
shall not apply, however, to an annuiity contract purchased and held as 
part of a plan which met at the time of such purchase, and continues to 
meet, the requirements of section 404(a)(2) or an annuity contract 
referred to in paragraph (d) (ii) or (iii) of this section. For purposes 
of this section, the value of an annuity contract on the date the 
employee's rights become substantially vested means the cash surrender 
value of such contract on such date.
    (2) Extent to which value of annuity contract is includible in 
employee's gross income. For purposes of paragraph (b)(1)

[[Page 503]]

of this section, the only amount includible in the gross income of the 
employee is that the portion of the value of the contract on the date of 
the change that is attributable to premiums which were paid by the 
employer after August 1, 1969, and which were not excludible from the 
employer's gross income under Sec. 1.403(b)-3. However, the includible 
portion does not include--
    (i) The value attributable to a premium paid on the date of such 
change, and
    (ii) The value attributable to premiums described in the 
transitional rule of paragraph (d)(1) (ii) or (iii) of this section.

See Sec. 1.403(b)-3(c) for the treatment of an amount otherwise 
includible in gross income under section 403(c) as an employer 
contribution for purposes of the exclusion under section 403(b).
    (3) Partial vesting. If, during any taxable year of an employee, 
only part of his beneficial interest in an annuity contract becomes 
substantially vested, then only the corresponding part of the value of 
the annuity contract on the date of such change is includible in the 
employee's gross income for such taxable year. In such a case, it is 
first necessary to compute, under the rules in paragraphs (b)(1) and (2) 
of this section but without regard to any exclusion allowable under 
Sec. 1.403(b)-3, the amount which would be includible in the employee's 
gross income for the taxable year if his entire beneficial interest in 
the annuity contract had changed to a substantially vested interest 
during such year. The amount that is includible under this (3) (without 
regard to the section 403(b) exclusion) is equal to the amount 
determined under the preceding sentence multiplied by the percent of the 
employee's beneficial interest which became substantially vested during 
the taxable year.
    (c) Amounts paid or made available under an annuity contract. The 
amounts paid or made available to the employee under an annuity contract 
subject to this section shall be included in the gross income of the 
employee for the taxable year in which paid or made available, as 
provided in section 72 (relating to annuities). Such amounts may be 
taken into account in computations under sections 1301 through 1305 
(relating to income averaging). For rules relating to the treatment of 
employer contributions as part of the consideration paid by the 
employee, see section 72(f). See also section 101(b)(2)(D) for rules 
relating to the treatment of the limited exclusion provided thereunder 
as part of the consideration paid by the employee.
    (d) Taxability of beneficiary under a nonqualified annuity on or 
before August 1, 1969. (1) Except as provided in section 402(d) 
(relating to taxable years beginning before Janaury 1, 1977), if an 
employer purchases an annuity contract and if the amounts paid for the 
contract.
    (i) On or before August 1, 1969, or
    (ii) After such date, if pursuant to a binding written contract (as 
defined in Sec. 1.83-8(b)(2)) entered into before April 22, 1969, or
    (iii) After August 1, 1969, pursuant to a written plan in which the 
employee participated on April 22, 1969 and under which the obligation 
of the employer is essentially the same as under a binding written 
contract, are not subject to paragraph (a) of Sec. 1.403(a)-1 or 
paragraph (a) of Sec. 1.403-1, the amount of such contribution shall, 
to the extent it is not excludible under paragraph (b) of Sec. 
1.403(b)-1, be included in the income of the employee for the taxable 
year during which such contribution is made if, at at the time the 
contribution is made, the employee's rights under the annuity contract 
are nonforfeitable, except for failure to pay future premiums. If the 
annuity contract was purchased by an employer which is not exempt from 
tax under section 501(a) or section 521(a), and if the employee's rights 
under the annuity contract in such a case were forfeitable at the time 
the employer's contribution was made for the annuity contract, even 
though they become nonforfeitable later the amount of such contribution 
is not required to be included in the income of the employee at the time 
his rights under the contract become nonforfeitable. On the other hand, 
if the annuity contract is purchased by an employer which is exempt from 
tax under section 501(a) or section 521(a), all or part of the value of 
the contract may be includible in the employee's

[[Page 504]]

gross income at the time his rights under the contract become 
nonforfeitable (see section 403(d) prior to the repeal thereof by the 
Tax Reform Act of 1969 and the regulations thereunder). As to what 
constitutes nonforfeitable rights of an employee, see Sec. 1.402(b)-
1(d)(2). The amounts received by or made available to the employee under 
the annuity contract shall be included in the gross income of the 
employee for the taxable year in which received or made available, as 
provided in section 72 (relating to annuities). For taxable years 
beginning before Janaury 1, 1964, sections 72(e)(3) (relating to the 
treatment of certain lump sums), as in effect before such date, shall 
not apply to such amounts. For taxable years beginning after December 
31, 1963, such amounts may be taken into account in computations under 
sections 1301 through 1305 (relating to income averaging). For rules 
relating to the treatment of employer contributions as part of the 
consideration paid by the employee, see section 72(f). See also section 
101(b)(2)(D) for rules relating to the treatment of the limited 
exclusion provided thereunder as part of the consideration paid by the 
employee.
    (2) If an employer has purchased annuity contracts and transferred 
them to a trust, or if an employer has made contributions to a trust for 
the purpose of providing annuity contracts for his employees as provided 
in section 402(d) (see paragraph (a) of Sec. 1.402(D)-1, the amount so 
paid or contributed is not required to be included in the income of the 
employee, but any amount received by or made available to the employee 
under the annuity contract shall be includible in the gross income of 
the employee for the taxable year in which received or made available, 
as provided in section 72 (relating to annuities). For taxable years 
beginning before January 1, 1964, section 72(e)(3) (relating to the 
treatment of certain lump sums), as in effect before such date, shall 
not apply to any amount received by or made available to the employee 
under the annuity contract. For taxable years beginning after December 
31, 1963, amounts received by or made available to the employee under 
the annuity contract may be taken into account in computations under 
sections 1301 through 1305 (relating to income averaging). In such case 
the amount paid or contributed by the employer shall not constitute 
consideration paid by the employee for such annuity contract in 
determining the amount of annuity payments required to be included in 
his gross income under section 72 unless the employee has paid income 
tax for any taxable year beginning before January 1, 1949, with respect 
to such payment or contribution by the employer for such year and such 
tax is not credited or refunded to the employee. In the event such tax 
has been paid and not creditid or refunded the amount paid or 
contributed by the employer for such year shall constitute consideration 
paid by the employee for the annuity contract in determining the amount 
of the annuity required to be included in the income of the employee 
under section 72.
    (3) For taxable years beginning before January 1, 1958, the 
provisions contained in section 403(c) prior to the amendment made 
thereto by the Tax Reform Act of 1969 were included in section 403(b) of 
the Internal Revenue Code of 1954. Therefore, the regulations contained 
in this paragraph shall, for such taxable years, be considered as the 
regulations under section 403(b) as in effect for such taxable years. 
For the rules with respect to contributions paid after August 1, 1969, 
see paragraphs (a), (b), and (c) of this section.

(Secs. 83 and 7805 of the Internal Revenue Code of 1954 (83 Stat. 588; 
68A Stat. 917; 26 U.S.C. 83 and 7805))

[T.D. 7554, 43 FR 31924, July 24, 1978, as amended by T.D. 9340, 72 FR 
41159, July 26, 2007]



Sec. 1.404(a)-1  Contributions of an employer to an employees' trust 
or annuity plan and compensation under a deferred payment plan; 

general rule.

    (a)(1) Section 404(a) prescribes limitations upon deductions for 
amounts contributed by an employer under a pension, annuity, stock 
bonus, or profit-sharing plan, or under any plan of deferred 
compensation. It is immaterial whether the plan covers present employees 
only, or present and former employees, or only former employees.

[[Page 505]]

Section 404(a) also governs the deductibility of unfunded pensions and 
death benefits paid directly to former employees or their beneficiaries 
(see Sec. 1.404(a)-12). For taxable years beginning after 1962, certain 
self-employed individuals may be covered by pension, annuity, or profit-
sharing plans. For the rules relating to the deduction of contributions 
on behalf of such individuals, see paragraph (a)(2) of Sec. 1.404(a)-8 
and Sec. 1.404(e)-1.
    (2) Section 404(a) does not apply to a plan which does not defer the 
receipt of compensation. Furthermore, section 404(a) does not apply to 
deductions for contributions under a plan which is solely a dismissal 
wage or unemployment benefit plan, or a sickness, accident, 
hospitalization, medical expense, recreation, welfare, or similar 
benefit plan, or a combination thereof. For example, if under a plan an 
employer contributes 5 percent of each employee's compensation per month 
to a fund out of which employees who are laid off will be paid benefits 
for temporary periods, but employees who are not laid off have no rights 
to the funds, such a plan is an unemployment benefit plan, and the 
deductibility of the contributions to it is determined under section 
162. As to the deductibility of such contributions, see Sec. 1.162-9.
    (3) If, however, the contributions to a pension, profit-sharing, 
stock bonus, or other plan of deferred compensation can be used to 
provide any of the benefits referred to in subparagraph (2) of this 
paragraph, then, except as provided in section 404(c), section 404(a) 
applies to the entire contribution to the plan. Thus, if in the example 
described in subparagraph (2) of this paragraph, the employer's 
contribution on behalf of each employee is set up as a separate account, 
and if any amount which remains in an employee's account at the time of 
retirement is paid to him at such time, the deductibility of the 
contributions to the plan is determined under section 404(a). For the 
regulations for determining whether the benefits referred to in 
subparagraph (2) of this paragraph can be included in a qualified 
pension or profit-sharing plan, see Sec. 1.401-1(b).
    (4) As to inclusion of full-time life insurance salesmen within the 
class of persons considered to be employees, see section 7701(a)(20).
    (b) In order to be deductible under section 404(a), contributions 
must be expenses which would be deductible under section 162 (relating 
to trade or business expenses) or 212 (relating to expenses for 
production of income) if it were not for the provision in section 404(a) 
that they are deductible, if at all, only under section 404(a). 
Contributions may therefore be deducted under section 404(a) only to the 
extent that they are ordinary and necessary expenses during the taxable 
year in carrying on the trade or business or for the production of 
income and are compensation for personal services actually rendered. In 
no case is a deduction allowable under section 404(a) for the amount of 
any contribution for the benefit of an employee in excess of the amount 
which, together with other deductions allowed for compensation for such 
employee's services, constitutes a reasonable allowance for compensation 
for the services actually rendered. What constitutes a reasonable 
allowance depends upon the facts in the particular case. Among the 
elements to be considered in determining this are the personal services 
actually rendered in prior years as well as the current year and all 
compensation and contributions paid to or for such employee in prior 
years as well as in the current year. Thus, a contribution which is in 
the nature of additional compensation for services performed in prior 
years may be deductible, even if the total of such contributions and 
other compensation for the current year would be in excess of reasonable 
compensation for services performed in the current year, provided that 
such total plus all compensation and contributions paid to or for such 
employee in prior years represents a reasonable allowance for all 
services rendered by the employee by the end of the current year. A 
contribution under a plan which is primarily for the benefit of 
shareholders of the employer is not deductible. Such a contribution may 
constitute a dividend within the meaning of section 316. See also 
Sec. Sec. 1.162-6 and 1.162-8. In addition to the limitations referred 
to above, deductions under section 404(a) are also subject to further 
conditions

[[Page 506]]

and limitations particularly provided therein.
    (c) Deductions under section 404(a) are generally allowable only for 
the year in which the contribution or compensation is paid, regardless 
of the fact that the taxpayer may make his returns on the accrual method 
of accounting. Exceptions are made in the case of overpayments as 
provided in paragraphs (1), (3), and (7) of section 404(a), and, as 
provided by section 404(a)(6), in the case of payments made by a 
taxpayer on the accrual method of accounting not later than the time 
prescribed by law for filing the return for the taxable year of accrual 
(including extensions thereof). This latter provision is intended to 
permit a taxpayer on the accrual method to deduct such accrued 
contribution or compensation in the year of accrual, provided payment is 
actually made not later than the time prescribed by law for filing the 
return for the taxable year of accrual (including extensions thereof), 
but this provision is not applicable unless, during the taxable year on 
account of which the contribution is made, the taxpayer incurs a 
liability to make the contribution, the amount of which is accruable 
under section 461 for such taxable year. See section 461 and the 
regulations thereunder. There is another exception in the case of 
certain taxpayers who are required to make additional contributions as a 
result of the Act of June 15, 1955 (Public Law 74, 84th Cong., 69 Stat. 
134), and the regulations thereunder.

[T.D. 6500, 25 FR 11682, Nov. 26, 1960, as amended by T.D. 6676, 28 FR 
10144, Sept. 17, 1963]



Sec. 1.404(a)-1T  Questions and answers relating to deductibility of 
deferred compensation and deferred benefits for employees. (Temporary)

    Q-1: How does the amendment of section 404(b) by the Tax Reform Act 
of 1984 affect the deduction of contributions or compensation under 
section 404(a)?
    A-1: As amended by the Tax Reform Act of 1984, section 404(b) 
clarifies that section 404(a) shall govern the deduction of 
contributions paid and compensation paid or incurred by the employer 
under a plan, or method or arrangement, deferring the receipt of 
compensation or providing for deferred benefits to employees, their 
spouses, or their dependents. See section 404(b) and Sec. 1.404(b)-1T. 
Section 404 (a) and (d) requires that such a contribution or 
compensation be paid or incurred for purposes of section 162 or 212 and 
satisfy the requirements for deductibility under either of those 
sections. However, notwithstanding the above, section 404 does not apply 
to contributions paid or accrued with respect to a ``welfare benefit 
fund'' (as defined in section 419(e)) after July 18, 1984, in taxable 
years of employers (and payors) ending after that date. Also, section 
463 shall govern the deduction of vacation pay by a taxpayer that has 
elected the application of such section. For rules relating to the 
deduction of contributions paid or accured with respect to a welfare 
benefit fund, see section 419, Sec. 1.419-1T and Sec. 1.419A-2T. For 
rules relating to the deduction of vacation pay for which an election is 
made under section 463, see Sec. 301.9100-16T of this chapter and Sec. 
1.463-1T.

[T.D. 8073, 51 FR 4320, Feb. 4, 1986, as amended by T.D. 8435, 57 FR 
43896, Sept. 23, 1992]



Sec. 1.404(a)-2  Information to be furnished by employer claiming 
deductions; taxable years ending before December 31, 1971.

    (a) For the first taxable year for which a deduction from gross 
income is claimed under section 404(a) (1), (2), (3), or (7), the 
employer must file the following information (unless such information 
has been previously filed in accordance with the regulations under 
section 23(p) of the Internal Revenue Code of 1939) for each plan 
involved to establish that it meets the requirements of section 401(a) 
or 404(a)(2), and that deductions claimed do not exceed the amount 
allowable under paragraphs (1), (2), (3), and (7) of section 404(a), as 
the case may be:
    (1) Verified copies of all the instruments constituting or 
evidencing the plan, including trust indentures, group annuity 
contracts, specimen copy of each type of individual contract, and 
specimen copy of formal announcement and comprehensive detailed 
description to employees, with all amendments to any such instruments.

[[Page 507]]

    (2) A statement describing the plan which identifies it and which 
sets forth the name or names of the employers, the effective date of the 
plan and of any amendments thereto, the method of distribution or of 
disbursing benefits (whether by trustee, insurance company, or 
otherwise), the dates when the instruments or amendments were executed, 
the date of formal announcement and the dates when comprehensive 
detailed description of the plan and of each amendment thereto were made 
available to employees generally, the dates when the plan and when the 
trust or the contract evidencing the plan and of any amendments thereto 
were put into effect so that contributions thereunder were irrevocable 
and a summary of the provisions and rules relating to--
    (i) Employee eligibility requirements for participation in the plan,
    (ii) Employee contributions,
    (iii) Employer contributions,
    (iv) The basis or formula for determining the amount of each type of 
benefit and the requirements for obtaining such benefits and the vesting 
conditions,
    (v) The medium of funding (e. g., self-insured, unit purchase group 
annuity contract, individual level annual premium retirement endowment 
insurance contracts, etc.) and, if not wholly insured, the medium of 
contributions and the kind of investments, and
    (vi) The discontinuance or modification of the plan and 
distributions or benefit payments upon liquidation or termination.
    (3) A tabulation in columnar form showing the information specified 
below with respect to each of the 25 highest paid employees covered by 
the plan in the taxable year, listed in order of their nondeferred 
compensation (where there are several plans of deferred compensation, 
the information for each of the plans may be shown on a single 
tabulation without repetition of the information common to the several 
plans):
    (i) Name.
    (ii) Whether an officer.
    (iii) Percentage of each class of stock owned directly or indirectly 
by the employee or members of his family.
    (iv) Whether the principal duties consist in supervising the work of 
other employees.
    (v) Year of birth.
    (vi) Length of service for employer to the close of the year.
    (vii) Total nondeferred compensation paid or accrued during the 
taxable year with a breakdown of such compensation into the following 
components:
    (A) Basic compensation and overtime pay,
    (B) Other direct payments, such as bonuses and commissions,
    (C) Compensation paid other than in cash, such as goods, services, 
insurance not directly related to the benefits or provided from funds 
under the plan, etc.
    (viii) Amount allocated during the year for the benefit of the 
employee or his beneficiary (including any insurance provided thereby or 
directly related thereto), less the employee's contributions during the 
year, under each other plan of deferred compensation.
    (ix) Amount allocated during the year for the benefit of the 
employee or his beneficiary (including any insurance provided thereby or 
directly related thereto), less the employee's contributions during the 
year, under the plan. If a profit-sharing or stock bonus plan, also a 
breakdown of such amounts into the following components:
    (A) Amounts originally allocated in the year, and
    (B) Amounts reallocated in the year.
    (x) Amounts of employee contributions during the year under the 
plan,
    (xi) If a pension or annuity plan,
    (A) The retirement age and date and the form of the retirement 
benefit,
    (B) The annual rate or amount of the retirement benefit, and
    (C) The aggregate of all of the employee's contributions under the 
plan,

all based, in the case of an employee who is not on retirement benefit 
under the plan, upon the assumption of his continued employment at his 
current rate of compensation until his normal retirement age (or the end 
of the current year if later) and retirement on such date with the 
normal form of retirement benefit under the plan.
    (4) The following totals:

[[Page 508]]

    (i) Total nondeferred compensation paid or accrued during the 
taxable year for all employees covered under the plan and also for all 
employees of the employer.
    (ii) Total amount allocated during the year for the benefit of 
employees, former or retired employees, or their beneficiaries 
(including any insurance provided thereby or directly related thereto), 
less employee contributions during the year under the plan and, if a 
profit-sharing or stock bonus plan, also a breakdown of such total into 
the following components:
    (A) Amount originally allocated in the year, and
    (B) Amount reallocated in the year.
    (5) A schedule showing the total number of employees as of the close 
of the year for each of the following groups, based on reasonable 
estimates:
    (i) All employees ineligible for coverage under the plan because of 
requirements as to employment classification, specifying the reasons 
applicable to the group (as, for example, temporary, seasonal, part 
time, hourly pay basis, etc.).
    (ii) All employees ineligible for coverage under the plan because of 
requirements as to length of service and not included in subdivision (i) 
of this subparagraph.
    (iii) All employees ineligible for coverage under the plan because 
of requirements as to minimum age and not included in subdivision (i) or 
(ii) of this subparagraph.
    (iv) All employees ineligible for coverage under the plan solely 
because of requirements as to minimum rate of compensation.
    (v) All employees ineligible for coverage under the plan other than 
those employees included in subdivision (i), (ii), (iii), or (iv) of 
this subparagraph, specifying the reason applicable to the group.
    (vi) All employees ineligible for coverage under the plan for any 
reasons, which should be the sum of subdivisions (i) to (v), inclusive, 
of this subparagraph.
    (vii) All employees eligible for coverage but not covered under the 
plan.
    (viii) All employees covered under the plan.
    (ix) All employees of the employer, which should be the sum of 
subdivisions (vi), (vii), and (viii) of this subparagraph.

If it is claimed that the requirements of section 401(a)(3)(A) are 
satisfied, also the data and computations necessary to show that such 
requirements are satisfied.
    (6) In the case of a trust, a detailed balance sheet and a detailed 
statement of receipts and disbursements during the year; in the case of 
a nontrusteed annuity plan, a detailed statement of the names of the 
insurers, the contributions paid by the employer and by the employees, 
and a statement as to the amounts and kinds of premium refunds or 
similar credits made available and the disposition of such credits in 
the year.
    (7) If a pension or annuity plan, a detailed description of all the 
methods, factors, and assumptions used in determining costs and in 
adjusting the costs for actual experience under the plan (including any 
loadings, contingency reserves, or special factors and the basis of any 
insured costs or liabilities involved therein) explaining their source 
and application in sufficient detail to permit ready analysis and 
verification thereof, and, in the case of a trust, a detailed 
description of the basis used in valuing the investments held.
    (8) A statement of the applicable limitations under section 404(a) 
(1), (2), (3), or (7) and an explanation of the method of determining 
such limitations, a summary of the data, and a statement of computations 
necessary to determine the allowable deductions for the taxable year. 
Also, in the case of a pension or annuity plan, a summary of the costs 
or liabilities and adjustments for the year under the plan based on the 
application of the methods, factors, and assumptions used under the 
plan, in sufficient detail to permit ready verification of the 
reasonableness thereof.
    (9) A statement of the contributions paid under the plan for the 
taxable year showing the date and amount of each payment. Also, a 
summary of the deductions claimed for the taxable year for the plan with 
a breakdown of

[[Page 509]]

the deductions claimed into the following components:
    (i) For contributions paid in the taxable year before giving effect 
to the provisions of paragraph (7) of section 404(a).
    (ii) For contributions paid in prior taxable years beginning after 
December 31, 1941, in accordance with the carryover provisions of 
paragraphs (1) and (3) of section 404(a), before giving effect to the 
provisions of paragraph (7) thereof, and in accordance with the 
carryover provisions of section 404(d).
    (iii) Any reductions or increases in the deductions in accordance 
with the provisions of paragraph (7) of section 404(a). However, if the 
information in this subdivision is filed prior to the filing of the 
information required by subparagraph (8) of this paragraph, then, in 
determining the limit of deduction under paragraph (7) of section 
404(a), the applicable percentage of the compensation otherwise paid or 
accrued during the year may be used.
    (b) For taxable years subsequent to the year for which all of the 
applicable information under paragraph (a) of this section (or 
corresponding provisions of prior regulations) has been filed, 
information is to be filed only to the following extent:
    (1) If there is any change in the plan, instruments, methods, 
factors, or assumptions upon which the data and information specified in 
paragraph (a) (1), (2), or (7) of this section are based, a detailed 
statement explaining the change and its effect is to be filed only for 
the taxable year in which the change is put into effect. However, if 
there is no such change, unless otherwise requested by the district 
director, merely a statement that there is no such change is to be 
filed.
    (2) The information specified in paragraph (a)(3) of this section 
which has been filed for a taxable year, unless otherwise requested by 
the district director and so long as the plan and the method and basis 
of allocations are not changed, is to be filed for subsequent years only 
to the extent of showing in the tabulation such information with respect 
to employees who, at any time in the taxable year, own, directly or 
indirectly, more than 5 percent of the voting stock, considering stock 
so owned by an individual's spouse or minor lineal descendant as owned 
by the individual for this purpose.
    (3) The information specified in paragraph (a) (4), (5), (6), (8), 
and (9) of this section.

In the case of corporate employers, the information required to be 
submitted by this paragraph shall, except as otherwise provided by the 
Commissioner, be filed on Form 2950 for taxable years ending on or after 
December 31, 1961. In the case of other employers, the information 
required to be submitted by this paragraph shall, except as otherwise 
provided by the Commissioner, be filed on Form 2950 for taxable years 
ending on or after December 31, 1962.
    (c) If a deduction is claimed under section 404(a)(5) for the 
taxable year, the taxpayer shall furnish such information as is 
necessary to show that the deduction is not allowable under the other 
paragraphs of section 404(a), that the amount paid is an ordinary and 
necessary expense or an expense for the production of income, and that 
the employees' rights to, or derived from, such employer's contribution 
or such compensation were nonforfeitable at the time the contribution or 
compensation was paid. In the case of corporate employers, the 
information required to be submitted by this paragraph shall, except as 
otherwise provided by the Commissioner, be filed on Form 2950 for 
taxable years ending on or after December 31, 1961. In the case of other 
employers, the information required to be submitted by this paragraph 
shall, except as otherwise provided by the Commissioner, be filed on 
Form 2950 for taxable years ending on or after December 31, 1962.
    (d) For the purpose of the information required by this section, 
contributions paid in a taxable year shall include those deemed to be so 
paid in accordance with the provisions of section 404(a)(6) and shall 
exclude those deemed to be paid in the prior taxable year in accordance 
with such provisions. As used in this section, ``taxable year'' refers 
to the taxable year of the employer and, unless otherwise requested by 
the district director, a ``year'' which is not specified as a ``taxable 
year'' may be taken as the taxable year of the employer or as the

[[Page 510]]

plan, trust, valuation, or group contract year with respect to which 
deductions are being claimed provided the same rule is followed 
consistently so that there is no gap or overlap in the information 
furnished for each item. In any case the date or period to which each 
item of information furnished relates should be clearly shown. All the 
information required by this section should be filed with the tax return 
for the taxable year in which the deduction is claimed, except that, 
unless sooner requested by the district director, such information, 
other than that specified in paragraph (a)(4)(i) and (9) of this 
section, may be filed within 12 months after the close of the taxable 
year provided there is filed with the tax return a statement that the 
information cannot reasonably be filed therewith, setting forth the 
reasons therefor.
    (e) In any case all the information and data required by this 
section must be filed in the office of the district director in which 
the employer files his tax returns and must be filed independently of 
any information and data otherwise submitted in connection with a 
determination of the qualification of the trust or plan under section 
401(a). The district director may, in addition, require any further 
information that he considers necessary to determine allowable 
deductions under section 404 or qualification under section 401. For 
taxable years ending on or before December 31, 1961, the district 
director may waive the filing of such information required by this 
section which he finds unnecessary in a particular case. For taxable 
years ending after December 31, 1961, the Commissioner may waive the 
filing of such information.
    (f) Records substantiating all data and information required by this 
section to be filed must be kept at all times available for inspection 
by internal revenue officers at the main office or place of business of 
the employer.
    (g) In the case of a plan which covers employees, some or all of 
whom are self-employed individuals and with respect to which a deduction 
is claimed under section 404(a) (1), (2), (3), or (7), paragraphs (a) 
and (b) of this section, and the provision of paragraph (d) of this 
section relating to the time for filing the information required by this 
section, shall not apply, but in lieu of the information required to be 
submitted by paragraphs (a) and (b) of this section, the employer shall, 
with the return for the taxable year in which the deduction is claimed, 
submit the information required by the form provided by the Internal 
Revenue Service for such purpose.
    (h) When a custodial account forms a part of a plan for which a 
deduction is claimed under section 404(a) (1), (2), (3), or (7), the 
information which under this section is to be submitted with respect to 
a qualified trust must be submitted with respect to such custodial 
account. Thus, for purposes of this section--
    (1) The term ``trust'' includes custodial account,
    (2) The term ``trustee'' includes custodian, and
    (3) The term ``trust indenture'' includes custodial agreement.
    (i) Except as provided under Sec. 1.503(d)-1(a) and Sec. 601.201 
of this chapter (Statement of Procedural Rules) in the case of a request 
for the determination of qualification of a trust under section 401 and 
exemption under section 501, paragraphs (a) through (h) of this section 
shall not apply for taxable years ending on or after December 31, 1971. 
For information to be furnished for taxable years ending on or after 
December 31, 1971, see Sec. 1.404(a)-2A.

[T.D. 6500, 25 FR 11683, Nov. 26, 1960, as amended by T.D. 6599, 27 FR 
4475, May 10, 1962; T.D. 6676, 28 FR 10144, Sept. 17, 1963; T.D. 7165, 
37 FR 5025, Mar. 9, 1972; T.D. 7168, 37 FR 5491, Mar. 16, 1972]



Sec. 1.404(a)-2A  Information to be furnished by employer; taxable 
years ending on or after December 31, 1971, and before December 31, 1975.

    (a) In general. For any taxable year ending on or after December 31, 
1971, any employer who maintains a pension, annuity, stock bonus, 
profit-sharing, or other funded plan of deferred compensation shall file 
the forms prescribed by this section. An employer (including a self-
employed individual) maintaining such a plan shall furnish such 
information as is required by the forms and the instructions relating 
thereto. The forms shall be filed in the

[[Page 511]]

manner and at the time prescribed under paragraph (c) of this section. 
See Sec. 1.404(a)-2 with respect to information to be furnished for 
taxable years ending before December 31, 1971. For purposes of this 
section, in the case of a plan of several employers described in Sec. 
1.401-1(d), each employer shall be deemed to be maintaining a separate 
plan corresponding to the plan of which the trust is a part. For 
information required to be furnished with respect to a funded deferred 
compensation plan maintained by an employer who is exempt from tax under 
section 501(a), see Sec. 1.6033-2(a)(2)(ii)(i).
    (b) Forms. The forms prescribed by this section are:
    (1) Form 4848, generally relating to information concerning the 
qualification of the plan, and deductions for contributions made on 
behalf of employees or self-employed individuals,
    (2) Form 4849, generally relating to the financial position of the 
trust, fund, or custodial or fiduciary account which is a part of the 
plan, and
    (3) For any taxable year ending on or after December 31, 1971, and 
before December 31, 1972, Forms 2950 and 2950SE, relating to the 
identification of plans to which an employer has made a contribution and 
information with respect to a deduction for a contribution made on 
behalf of a self-employed individual, respectively.
    (c) Filing requirements. (1) Form 4848 shall be filed by the 
employer for each taxable year during which he maintains a pension, 
annuity, stock bonus, profit-sharing, or other funded plan of deferred 
compensation. Such form shall be filed on or before the 15th day of the 
5th month following the close of the employer's taxable year. For rules 
relating to the extension of time for filing, see section 6081 and the 
regulations thereunder and the instructions for Form 4848.
    (2) Form 4849 shall be filed by the employer as an attachment to 
Form 4848 for each taxable year during which he maintains a pension, 
annuity, stock bonus, profit-sharing, or other funded plan of deferred 
compensation unless the employer (i) has been notified in writing that 
Form 4849 will be filed by the fiduciary for such plan as an attachment 
to Form 990-P or (ii) is not required to file Form 4849 under the 
instructions relating thereto.
    (3) For any taxable year ending on or after December 31, 1971, and 
before December 31, 1972, Form 2950 shall be filed with the employer's 
tax return for any such taxable year during which a pension, annuity, 
stock bonus, profit-sharing, or other funded plan of deferred 
compensation is maintained.
    (4) For any taxable year ending on or after December 31, 1971, and 
before December 31, 1972, Form 2950SE shall be filed by each self-
employed individual with his income tax return for any such taxable year 
in which he claims a deduction for contributions made on his behalf.
    (d) Additional information. In addition to the information otherwise 
required to be furnished by this section, the district director may 
require any further information that he considers necessary to determine 
allowable deductions under section 404 or qualification under section 
401.
    (e) Records. Records substantiating all data and information 
required by this section to be filed must be kept at all times available 
for inspection by internal revenue officers at the main office or place 
of business of the employer.

[T.D. 7165, 37 FR 5025, Mar. 9, 1972, as amended by T.D. 7223, 37 FR 
24748, Nov. 21, 1972; T.D. 7551, 43 FR 29292, July 7, 1978]



Sec. 1.404(a)-3  Contributions of an employer to or under an employees' 
pension trust or annuity plan that meets the requirements of 

section 401(a); application of section 404(a)(1).

    (a) If contributions are paid by an employer to or under a pension 
trust or annuity plan for employees and the general conditions and 
limitations applicable to deductions for such contributions are 
satisfied (see Sec. 1.404(a)-1), the contributions are deductible under 
section 404(a) (1) or (2) if the further conditions provided therein are 
also satisfied. As used in this section, a ``pension trust'' means a 
trust forming part of a pension plan and an ``annuity plan'' means a 
pension plan under which retirement benefits are provided under annuity 
or insurance contracts

[[Page 512]]

without a trust. This section is also applicable to contributions to a 
foreign situs pension trust which could qualify for exemption under 
section 501(a) except that it is not created or organized and maintained 
in the United States. For the meaning of ``pension plan'' as used in 
this section, see paragraph (b)(1)(i) of Sec. 1.401-1. Where disability 
pensions, insurance, or survivorship benefits incidental and directly 
related to the retirement benefits under a pension or annuity plan are 
provided for the employees or their beneficiaries by contributions under 
the plan, deductions on account of such incidental benefits are also 
covered under section 404(a) (1) or (2). See paragraph (b)(2) of Sec. 
1.72-16 as to taxability to employees of cost of incidental life 
insurance protection. Similarly, where medical benefits described in 
section 401(h) as defined in paragraph (a) of Sec. 1.401-14 are 
provided for retired employees, their spouses, or their dependents under 
the plan, deductions on account of such subordinate benefits are also 
covered under section 404(a) (1) or (2). In order to be deductible under 
section 404(a)(1), contributions to a pension trust must be paid in a 
taxable year of the employer which ends with or within a year of the 
trust for which it is exempt under section 501(a). Contributions paid in 
such a taxable year of the employer may be carried over and deducted in 
a succeeding taxable year of the employer in accordance with section 
404(a)(1)(D), whether or not such succeeding taxable year ends with or 
within a taxable year of the trust for which it is exempt under section 
501(a). See Sec. 1.404(a)-7 for rules relating to the limitation on the 
amount deductible in such a succeeding taxable year of the employer. See 
Sec. 1.404(a)-8 as to conditions for deductions under section 404(a)(2) 
in the case of an annuity plan. In either case, the deductions are also 
subject to further limitations provided in section 404(a)(1). The 
limitations provided in section 404(a)(1) are, with an exception 
provided for certain years under subparagraph (A) thereof (see Sec. 
1.404(a)-4), based on the actuarial costs of the plan.
    (b) In determining costs for the purpose of limitations under 
section 404(a)(1), the effects of expected mortality and interest must 
be discounted and the effects of expected withdrawals, changes in 
compensation, retirements at various ages, and other pertinent factors 
may be discounted or otherwise reasonably recognized. A properly 
weighted retirement age based on adequate analyses of representative 
experience may be used as an assumed retirement age. Different basic 
assumptions or rates may be used for different classes of risks or 
different groups where justified by conditions or required by contract. 
In no event shall costs for the purpose of section 404(a)(1) exceed 
costs based on assumptions and methods which are reasonable in view of 
the provisions and coverage of the plan, the funding medium, reasonable 
expectations as to the effects of mortality and interest, reasonable and 
adequate regard for other factors such as withdrawal and deferred 
retirement (whether or not discounted) which can be expected to reduce 
costs materially, reasonable expenses of operation, and all other 
relevant conditions and circumstances. In any case, in determining the 
costs and limitations, an adjustment shall be made on account of any 
experience more favorable than that assumed in the basis of limitations 
for prior years. Unless such adjustments are consistently made every 
year by reducing the limitations otherwise determined by any decrease in 
liability or cost arising from experience in the next preceding taxable 
year which was more favorable than the assumptions on which the costs 
and limitations were based, the adjustment shall be made by some other 
method approved by the Commissioner.
    (c) The amount of a contribution to a pension or annuity plan that 
is deductible under section 404(a) (1) or (2) depends upon the methods, 
factors, and assumptions which are used to compute the costs of the plan 
and the limitation of section 404(a)(1) which is applied. Since the 
amount that is deductible for one taxable year may affect the amount 
that is deductible for other taxable years, the methods, factors, and 
assumptions used in determining costs and the method of determining the 
limitation which have been used for determining the deduction for a 
taxable year for which the return has

[[Page 513]]

been filed shall not be changed for such taxable year, except when the 
Commissioner determines that the methods, factors, assumptions, or 
limitations were not proper, or except when a change is necessitated by 
reason of the use of different methods, factors, assumptions, or 
limitations for another taxable year. However, different methods, 
factors, and assumptions, or a different method of determining the 
limitation, if they are proper, may be used in determining the deduction 
for a subsequent taxable year.
    (d) Any expenses incurred by the employer in connection with the 
plan, such as trustee's and actuary's fees, which are not provided for 
by contributions under the plan are deductible by the employer under 
section 162 (relating to trade or business expenses), or 212 (relating 
to expenses for production of income) to the extent that they are 
ordinary and necessary.
    (e) In case deductions are allowable under section 404(a)(3), as 
well as under section 404(a) (1) or (2), the limitations under section 
404(a) (1) and (3) are determined and applied without giving effect to 
the provisions of section 404(a)(7) but the amounts allowable as 
deductions are subject to the further limitations provided in section 
404(a)(7). See Sec. 1.404(a)-13.
    (f)(1) Amounts contributed by an employer under the plan for the 
funding of medical benefits described in section 401(h) as defined in 
paragraph (a) of Sec. 1.401-14 must satisfy the general requirements 
which are applicable to deductions allowable under section 404 and which 
are set forth in Sec. 1.404(a)-1 including, for example, the 
requirements described in paragraph (b) of such section. Accordingly, 
such amounts must constitute an ordinary and necessary expense relating 
to either the trade or business or the production of income and must 
not, when added to all other compensation paid by the employer to the 
employee on whose behalf such a contribution is made, constitute more 
than reasonable compensation. However, in determining the amount which 
is deductible with respect to contributions to provide retirement 
benefits under the plan, amounts contributed for the funding of medical 
benefits described in section 401(h) shall not be taken into 
consideration.
    (2) The amounts deductible with respect to employer contributions to 
fund medical benefits described in section 401(h) shall not exceed the 
total cost of providing such benefits. The total cost of providing such 
benefits shall be determined in accordance with any generally accepted 
actuarial method which is reasonable in view of the provisions and 
coverage of the plan, the funding medium, and other applicable 
considerations. The amount deductible for any taxable year with respect 
to such cost shall not exceed the greater of--
    (i) An amount determined by distributing the remaining unfunded 
costs of past and current service credits as a level amount, or as a 
level percentage of compensation, over the remaining future service of 
each employee, or
    (ii) 10 percent of the cost which would be required to completely 
fund or purchase such medical benefits.

In determining the amount deductible, an employer must apply either 
subdivision (i) of this subparagraph for all employees or subdivision 
(ii) of this subparagraph for all employees. If contributions paid by an 
employer in a taxable year to fund such medical benefits under a pension 
or annuity plan exceed the limitations of this subparagraph but 
otherwise satisfy the conditions for deduction under section 404, then 
the excess contributions are carried over and are deductible in 
succeeding taxable years of the employer which end with or within 
taxable years of the trust for which it is exempt under section 501(a) 
in order of time to the extent of the difference between the amount paid 
and deductible in each succeeding year and the limitation applicable to 
such year under this subparagraph. For purposes of subdivision (i) of 
this subparagraph, if the remaining future service of an employee is one 
year or less, it shall be treated as one year.

[T.D. 6500, 25 FR 11685, Nov. 26, 1960, as amended by T.D. 6722, 29 FR 
5073, Apr. 14, 1964; T.D. 7165, 37 FR 5025, Mar. 9, 1972]

[[Page 514]]



Sec. 1.404(a)-4  Pension and annuity plans; limitations under section 
404(a)(1)(A).

    (a) Subject to the applicable general conditions and limitations 
(see Sec. 1.404(a)-3), the initial limitation under section 
404(a)(1)(A) is 5 percent of the compensation otherwise paid or accrued 
during the taxable year to all employees under the pension or annuity 
plan. This initial 5-percent limitation applies to the first taxable 
year for which a deduction is allowed for contributions to or under such 
a plan and also applies to any subsequent year (other than one described 
in paragraph (d) of this section) for which the 5-percent figure is not 
reduced as provided in this section. For years to which the initial 5-
percent limitation applies, no adjustment on account of prior experience 
is required. If the contributions do not exceed the initial 5-percent 
limitation in the first taxable year to which this limitation applies, 
the taxpayer need not submit actuarial data for such year.
    (b) For the first taxable year following the first year to which the 
initial 5-percent limitation applies, and for every fifth year 
thereafter, or more frequently where preferable to the taxpayer, the 
taxpayer shall submit with his return an actuarial certification of the 
amount reasonably necessary to provide the remaining unfunded cost of 
past and current service credits of all employees under the plan with a 
statement explaining all the methods, factors, and assumptions used in 
determining such amount. This amount may be determined as the sum of (1) 
the unfunded past service cost as of the beginning of the year, and (2) 
the normal cost for the year. Such costs shall be determined by methods, 
factors, and assumptions appropriate as a basis of limitations under 
section 404(a)(1)(C). Whenever requested by the district director, a 
similar certification and statement shall be submitted for the year or 
years specified in such request. The district director will make 
periodical examinations of such data at not less than 5-year intervals. 
Based upon such examinations the Commissioner will reduce the limitation 
under section 404(a)(1)(A) below the 5-percent limitation for the years 
with respect to which he finds that the 5-percent limitation exceeds the 
amount reasonably necessary to provide the remaining unfunded cost of 
past and current service credits of all employees under the plan. Where 
the limitation is so reduced, the reduced limitation shall apply until 
the Commissioner finds that a subsequent actuarial valuation shows a 
change to be necessary. Such subsequent valuation may be made by the 
taxpayer at any time and submitted to the district director with a 
request for a change in the limitation. See, however, paragraph (d) of 
this section with respect to taxable years to which the limitation under 
section 404(a)(1)(A) does not apply.
    (c) For the purpose of limitations under section 404(a)(1)(A), 
``compensation otherwise paid or accrued'' means all of the compensation 
paid or accrued except that for which a deduction is allowable under a 
plan that qualifies under section 401(a), including a plan that 
qualifies under section 404(a)(2). Where two or more pension or annuity 
plans cover the same employee, under section 404(a)(1)(A) the deductions 
with respect to each such plan are subject to the limitations applicable 
to the particular plan and the total deductions for all such plans are 
also subject to the limitations which would be applicable thereto if 
they constituted a single plan. Where, because of the particular 
provisions applicable to a large class of employees under a plan, the 
costs with respect to such employees are nominal in comparison with 
their compensation, after the first year to which the initial 5-percent 
limitation applies, deductions under section 404(a)(1)(A) are subject to 
limitations determined by considering the plan applicable to such class 
as if it were a separate plan. Deductions are allowable to the extent of 
the applicable limitations under section 404(a)(1)(A) even where these 
are greater than the applicable limitations under section 404(a)(1)(B) 
or section 404(a)(1)(C).
    (d) The limitation under section 404(a)(1)(A) shall not be used for 
purposes of determining the amount deductible for a taxable year of the 
employer which ends with or within a taxable year of the pension trust 
during which it is not exempt under section

[[Page 515]]

501(a), or, in the case of an annuity plan, during which it does not 
meet the requirements of section 404(a)(2), or which ends after the 
trust or plan has terminated. See Sec. 1.404(a)-7 for rules relating to 
the limitation which is applicable for purposes of determining the 
amount deductible for such a taxable year of the employer.

[T.D. 6500, 25 FR 11685, Nov. 26, 1960, as amended by T.D. 6534, 26 FR 
515, Jan. 20, 1961]



Sec. 1.404(a)-5  Pension and annuity plans; limitations under section 
404(a)(1)(B).

    (a) Subject to the applicable general conditions and limitations 
(see Sec. 1.404(a)-3), under section 404(a)(1)(B), deductions may be 
allowed to the extent of limitations based on costs determined by 
distributing the remaining unfunded cost of the past and current service 
credits with respect to all employees covered under the trust or plan as 
a level amount or level percentage of compensation over the remaining 
service of each such employee except that, as to any three individuals 
with respect to whom more than 50 percent of such remaining unfunded 
cost attributable to such individuals shall be distributed evenly over a 
period of at least five taxable years. See, however, paragraph (e) of 
this section with respect to taxable years to which the limitation under 
section 404(a)(1)(B) does not apply.
    (b) The statutory limitation for any taxable year under section 
404(a)(1)(B) is any excess of the amount of the costs described in 
paragraph (a) of this section for the year over the amount allowable as 
a deduction under section 404(a)(1)(A).
    (c) For this purpose, such excess, adjusted for prior experience, 
may be computed for each year as follows, all determinations being made 
as of the beginning of the year:
    (1) Determine the value of all benefits expected to be paid, after 
the beginning of the year for all employees, any former employees, and 
any other beneficiaries, then covered under the plan.
    (2) If employees contribute under the plan, determine the value of 
all contributions expected to be made after the beginning of the year by 
employees then covered under the plan.
    (3) Determine the value of all funds of the plan as of the beginning 
of the year.
    (4) Determine the amount remaining to be distributed as a level 
amount or as a level percentage of compensation over the remaining 
future service of each employee by subtracting from subparagraph (1) of 
this paragraph the sum of subparagraphs (2) and (3) of this paragraph.
    (5) Determine the value of all compensation expected to be paid 
after the beginning of the year to all employees then covered under the 
plan.
    (6) Determine an accrual rate for each employee by dividing 
subparagraph (5) of this paragraph into subparagraph (4) of this 
paragraph.
    (7) Compute the excess under section 404(a)(1)(B) for the year by 
multiplying the compensation paid to all employees covered under the 
plan during the year by any excess of subparagraph (6) of this paragraph 
over 5 percent. In general, where this method is used, the limitation 
under section 404(a)(1)(B) will be equal to the excess so computed 
without further adjustment on account of prior favorable experience, 
provided all the factors and assumptions used are reasonable in view of 
all applicable considerations (see Sec. 1.404(a)-3) and provided 
subparagraph (5) of this paragraph is not less than five times the 
annual rate of compensation in effect at the beginning of the year.
    (d) Instead of determining the excess deductible under section 
404(a)(1)(B) by the method shown in paragraph (c), such excess may be 
based upon cost determined by some other method which is reasonable and 
appropriate under the circumstances. Thus, such excess may be based on 
the amounts necessary with respect to each individual covered employee 
to provide the remaining unfunded cost of all his benefits under the 
plan distributed as a level amount over the period remaining until the 
normal commencement of his retirement benefits, in accordance with other 
generally accepted actuarial methods which are reasonable and 
appropriate in view of the provisions of the plan, the funding medium, 
and other applicable considerations.

[[Page 516]]

    (e) The limitation under section 404(a)(1)(B) shall not be used for 
purposes of determining the amount deductible for a taxable year of the 
employer which ends with or within a taxable year of the pension trust 
during which it is not exempt under section 501(a), or, in the case of 
an annuity plan, during which it does not meet the requirements of 
section 404(a)(2), or which ends after the trust or plan has terminated. 
See Sec. 1.404(a)-7 for rules relating to the limitation which is 
applicable for purposes of determining the amount deductible for such a 
taxable year of the employer.

[T.D. 6500, 25 FR 11686, Nov. 26, 1960, as amended by T.D. 6534, 26 FR 
515, Jan. 20, 1961]



Sec. 1.404(a)-6  Pension and annuity plans; limitations under section 
404(a)(1)(C).

    (a) Application to a taxable year of the employer which ends with or 
within a taxable year of the pension trust or annuity plan for which it 
is exempt under section 501(a) or meets the requirements of section 
404(a)(2). (1) The rules in this paragraph are applicable with respect 
to the limitation under section 404(a)(1)(C) for taxable years of the 
employer which end with or within a taxable year of the pension trust 
for which it is exempt under section 501(a), or, in the case of an 
annuity plan, during which it meets the requirements of section 
404(a)(2). See paragraph (b) of this section for rules relating to the 
limitation under section 404(a)(1)(C) for other taxable years of the 
employer.
    (2) Subject to the applicable general conditions and limitations 
(see Sec. 1.404(a)-3), in lieu of amounts deductible under the 
limitations of section 404(a)(1)(A) and section 404(a)(1)- (B), 
deductions may be allowed under section 404(a)(1)(C) to the extent of 
limitations based on normal and past service or supplementary costs of 
providing benefits under the plan. ``Normal cost'' for any year is the 
amount actuarially determined which would be required as a contribution 
by the employer in such year to maintain the plan if the plan had been 
in effect from the beginning of service of each then included employee 
and if such costs for prior years had been paid and all assumptions as 
to interest, mortality, time of payment, etc., had been fulfilled. Past 
service or supplementary cost at any time is the amount actuarially 
determined which would be required at such time to meet all the future 
benefits provided under the plan which would not be met by future normal 
costs and employee contributions with respect to the employees covered 
under the plan at such time.
    (3) The limitation under section 404(a)(1)(C) for any taxable year 
to which this paragraph applies is the sum of normal cost for the year 
plus an amount not in excess of one-tenth of the past service or 
supplementary cost as of the date the past service or supplementary 
credits are provided under the plan. For this purpose, the normal cost 
may be determined by any generally accepted actuarial method and may be 
expressed either as (i) the aggregate of level amounts with respect to 
each employee covered under the plan, (ii) a level percentage of payroll 
with respect to each employee covered under the plan, or (iii) the 
aggregate of the single premium or unit costs for the unit credits 
accruing during the year with respect to each employee covered under the 
plan, provided, in any case, that the method is reasonable in view of 
the provisions and coverage of the plan, the funding medium, and other 
applicable considerations. The limitation may include one-tenth of the 
past service or supplementary cost as of the date the provisions 
resulting in such cost were put into effect, but it is subject to 
adjustments for prior favorable experience. See Sec. 1.404(a)-3. In any 
case, past service or supplementary costs shall not be included in the 
limitation for any year in which the amount required to fund fully or to 
purchase such past service or supplementary credits has been deducted, 
since no deduction is allowable for any amount (other than the normal 
cost) which is paid in after such credits are fully funded or purchased.
    (b) Application to a taxable year of the employer which does not end 
with or within a taxable year of the pension trust or annuity plan for 
which it is exempt under section 501(a) or meets the requirements of 
section 404(a)(2). (1) The rules in this paragraph are applicable with 
respect to the limitation under section

[[Page 517]]

404(a)(1)(C) for taxable years of the employer which end with or within 
a taxable year of the pension trust during which it is not exempt under 
section 501(a), or, in the case of an annuity plan, during which it does 
not meet the requirements of section 404(a)(2), or which end after the 
trust or plan has terminated. Since contributions paid in such taxable 
years of the employer are not deductible under section 404(a) (1) or (2) 
(except as provided in section 404(a)(6)), the limitation under section 
404(a)(1)(C) for such taxable years relates only to the amount of any 
excess contributions that may be carried over to such taxable years 
under section 404(a)(1)(D).
    (2) Subject to the applicable general conditions and limitations 
(see Sec. 1.404(a)-3), deductions may be allowed under section 
404(a)(1)(C) for taxable years of the employer to which this paragraph 
applies to the extent of limitations based on past service or 
supplementary costs of providing benefits under the plan. For definition 
of the ``past service or supplementary cost at any time'', see paragraph 
(a)(2) of this section.
    (3) The limitation under section 404(a)(1)(C) for any taxable year 
to which this paragraph applies is an amount not in excess of one-tenth 
of the past service or supplementary cost as of the date the past 
service or supplementary credits are provided under the plan. The 
limitation under section 404(a)(1)(C) is subject, however, to 
adjustments for prior favorable experience. In any case, no amounts are 
deductible under section 404(a)(1)(C) for any year to which this 
paragraph applies if the amount required to fund fully or to purchase 
the past service or supplementary credits has been deducted in prior 
taxable years of the employer.

[T.D. 6534, 26 FR 515, Jan. 20, 1961]



Sec. 1.404(a)-7  Pension and annuity plans; contributions in excess of 
limitations under section 404(a)(1); application of section 404(a)(1)(D).

    When contributions paid by an employer in a taxable year to or under 
a pension or annuity plan exceed the limitations applicable under 
section 404(a)(1) but otherwise satisfy the conditions for deduction 
under section 404(a) (1) or (2), then in accordance with section 
404(a)(1)(D), the excess contributions are carried over and are 
deductible in succeeding taxable years of the employer in order of time 
pursuant to the following rules:
    (a) In the case of a succeeding taxable year of the employer which 
ends with or within a taxable year of the pension trust during which it 
is not exempt under section 501(a), or, in the case of an annuity plan, 
during which it meets the requirements of section 404(a)(2), such excess 
contributions are deductible to the extent of the difference between the 
amount paid and deductible in such succeeding taxable year and the 
limitation applicable to such year under section 404(a)(1) (A), (B), or 
(C).
    (b) In the case of a succeeding taxable year of the employer which 
ends with or within a taxable year of the pension trust during which it 
is not exempt under section 501(a), or, in the case of an annuity plan, 
during which it does not meet the requirements of section 404(a)(2), or 
which ends after the trust or plan has terminated, such excess 
contributions are deductible to the extent of the limitation applicable 
to such year under section 404(a)(1)(C) (see paragraph (b) of Sec. 
1.404(a)-6).

The provisions of section 404(a)(1)(D) are to be applied before giving 
effect to the provisions of section 404(a)(7) for any year. The 
carryover provisions of section 404(a)(1)(D), before effect has been 
given to section 404(a)(7), may be illustrated by the following example 
for a plan put into effect in a taxable year ending December 31, 1954:

                    Taxable Year Ending Dec. 31, 1954
Amount of contributions paid in year........................    $100,000
Limitation applicable to year...............................      60,000
Amount deductible for year..................................      60,000
                                                             -----------
   Excess carried over to succeeding years..................      40,000
                                                             ===========
 
                    Taxable Year Ending Dec. 31, 1955
 
Amount of contributions paid in year........................     $25,000
Carried over from previous years............................      40,000
                                                             -----------
   Total deductible subject to limitation...................      65,000
Limitation applicable to year...............................      50,000
Amount deductible for year..................................      50,000
                                                             -----------
   Excess carried over to succeeding years..................      15,000
                                                             ===========
 
                    Taxable Year Ending Dec. 31, 1956
 
Amount of contributions paid in year........................     $10,000

[[Page 518]]

 
Carried over from previous years............................      15,000
                                                             -----------
   Total deductible subject to limitation...................      25,000
Limitation applicable to year...............................      45,000
Amount deductible for year..................................      25,000
                                                             -----------
   Excess carried over to succeeding years..................        None
 



Sec. 1.404(a)-8  Contributions of an employer under an employees' 
annuity plan which meets the requirements of section 401(a); application 

of section 404(a)(2).

    (a) If contributions are paid by an employer under an annuity plan 
for employees and the general conditions and limitations applicable to 
deductions for such contributions are satisfied (see Sec. 1.404(a)-1), 
the contributions are deductible under section 404(a)(2) if the further 
conditions provided therein are satisfied. For the meaning of ``annuity 
plan'' as used here, see Sec. 1.404(a)-3. In order that contributions 
by the employer may be deducted under section 404(a)(2), all of the 
following conditions must be satisfied:
    (1) The contributions must be paid toward the purchase of retirement 
annuities (or for disability, severance, insurance, survivorship 
benefits incidental and directly related to such annuities, or medical 
benefits described in section 401(h) as defined in paragraph (a) of 
Sec. 1.404(h)-1) under an annuity plan for the exclusive benefit of the 
employer's employees or their beneficiaries.
    (2) The contributions must be paid in a taxable year of the employer 
which ends with or within a year of the plan for which it meets the 
applicable requirements set forth in section 401(a) (3), (4), (5), (6), 
(7), (8), (11), (12), (13), (14), (15), (16), and (19). In the case of a 
plan which covers a self-employed individual, the contributions must be 
paid in a taxable year of the employer which ends with or within a year 
of the plan for which it also meets the requrements of section 401(a), 
(9), (10), (17), and (18) and of section 401(d) (other than paragraph 
(1)). In the case of a plan which covers a shareholder-employee within 
the meaning of section 1379(d), the contributions must be paid in a 
taxable year of the employer which ends with or within a year of the 
plan for which it also meets the requirements of section 401(a) (17) and 
(18). See section 401(a) and the regulations thereunder for the 
requirements and the applicable effective dates of the respective 
paragraphs set forth in section 401(a). Any contributions of an employer 
which are paid in a taxable year of the employer ending with or within a 
year of the plan for which it meets the applicable requirements of 
section 401 may be carried over and deducted in a succeeding taxable 
year of the employer in accordance with section 404(a)(1)(D), whether or 
not such succeeding taxable year ends with or within a taxable year of 
the plan for which it meets the requirements set out in section 401 (a) 
and (d). See section 401(b) and the regulations thereunder for special 
rules allowing certain plan amendments to be given retroactive effect. 
See section 404(a)(6) for a special rule for determining the time when a 
contribution is deemed to have been made.
    (3) There must be a definite written arrangement between the 
employer and the insurer that refunds of premiums, if any, shall be 
applied within the taxable year of the employer in which received or 
within the next succeeding taxable year toward the purchase of 
retirement annuities (or for disability, severance, insurance, 
survivorship benefits incidental and directly related to such annuities, 
or medical benefits described in section 401(h) as defined in paragraph 
(a) of Sec. 1.401(h)-1 under the plan. For the purpose of this 
condition, ``refunds of premiums'' means payments by the insurer on 
account of credits such as dividends, experience rating credits, or 
surrender or cancellation credits. The arrangement may be in the form of 
contract provisions or written directions of the employer or partly in 
one form and partly in another. This condition will be considered 
satisfied where--
    (i) All credits are applied regularly, as they are determined, 
toward the premiums next due under the contracts before any further 
employer contributions are so applied, and
    (ii) Under the arrangement,
    (A) No refund of premiums may be made during continuance of the plan 
unless applied as aforesaid, and

[[Page 519]]

    (B) If refunds of premiums may be made after discontinuance or 
termination, whichever is applicable, of the plan on account of 
surrenders or cancellations before all retirement annuities provided 
under the plan with respect to service before its discontinuance or 
termination have been purchased, such refunds will be applied in the 
taxable year of the employer in which received, or in the next 
succeeding taxable year, to purchase retirement annuities for employees 
by a procedure which does not contravene the conditions of section 
401(a)(4). If the plan also includes medical benefits described in 
section 401(h) as defined in paragraph (a) of Sec. 1.401(h)-1, any 
refund of premiums attributable to such benefits must, in accordance 
with these rules, be applied toward the purchase of medical benefits 
described in section 401(h).
    (4) Any amounts described in subparagraph (3) of this paragraph 
which are attributable to contributions on behalf of a self-employed 
individual must be applied toward the purchase of retirement benefits. 
Amounts which are so applied are not contributions and thus are not 
taken into consideration in determining--
    (i) The amount deductible with respect to contributions on his 
behalf, nor
    (ii) In the case of an owner-employee, the maximum amount of 
contributions that may be made on his behalf.
    (b) Where the above conditions are satisfied, the amounts deductible 
under section 404(a)(2) are governed by the limitations provided in 
section 404(a)(1). See Sec. Sec. 1.404(a)-3 to 1.404(a)-7, inclusive.

(Sec. 411 Internal Revenue Code of 1954 (88 Stat. 901; 26 U.S.C. 411))

[T.D. 7501, 42 FR 42321, Aug. 23, 1977]



Sec. 1.404(a)(8)-1T  Deductions for plan contributions on behalf of 
self-employed individuals. (Temporary)

    Q: How does the amendment to section 404(a)(8)(D), made by section 
713(d)(6) of the Tax Reform Act of 1984 (TRA of 1984), affect section 
404(a)(8)(C)?
    A: In applying the rules of section 404(a)(8)(C), the Service will 
treat the amendment to section 404(a)(8)(D) as also having been made to 
section 404(a)(8)(C), pending enactment of technical corrections to TRA 
of 1984. The effect of treating the amendment as having also been made 
to section 404(a)(8)(C) is to increase the amount of contributions on 
behalf of a self-employed individual that will be treated as satisfying 
section 162 or 212. Generally, therefore, a contribution on behalf of a 
self-employed individual is treated as satisfying section 162 or 212 if 
it is not in excess of the individual's earned income for the year, 
determined without regard to the deduction allowed by section 404 for 
the self-employed individual's contribution.

[T.D. 8073, 51 FR 4321, Feb. 4, 1986]



Sec. 1.404(a)-9  Contributions of an employer to an employees' 
profit-sharing or stock bonus trust that meets the requirements of 

section 401(a); application of section 404(a)(3)(A).

    (a) If contributions are paid by an employer to a profit-sharing or 
stock bonus trust for employees and the general conditions and 
limitations applicable to deductions for such contributions are 
satisfied (see Sec. 1.404(a)-1), the contributions are deductible under 
section 404(a)(3)(A) if the further conditions provided therein are also 
satisfied. In order to be deductible under the first, second, or third 
sentence of section 404(a)(3)(A), the contributions must be paid (or 
deemed to have been paid under section 404(a)(6)) in a taxable year of 
the employer which ends with or within a taxable year of the trust for 
which it is exempt under section 501(a) and the trust must not be 
designed to provide retirement benefits for which the contributions can 
be determined actuarially. Excess contributions paid in such a taxable 
year of the employer may be carried over and deducted in a succeeding 
taxable year of the employer in accordance with the third sentence of 
section 404(a)(3)(A), whether or not such succeeding taxable year ends 
with or within a taxable year of the trust for which it is exempt under 
section 501(a). This section is also applicable to contributions to a 
foreign situs profit-sharing or stock bonus trust which could qualify 
for exemption under section 501(a) except

[[Page 520]]

that it is not created or organized and maintained in the United States.
    (b) The amount of deductions under section 404(a)(3)(A) for any 
taxable year is subject to limitations based on the compensation 
otherwise paid or accrued by the employer during such taxable year to 
employees who are beneficiaries under the plan. For purposes of 
computing this limitation, the following rules are applicable:
    (1) In the case of a taxable year of the employer which ends with or 
within a taxable year of the trust for which it is exempt under section 
501(a), the limitation shall be based on the compensation otherwise paid 
or accrued by the employer during such taxable year of the employer to 
the employees who, in such taxable year of the employer, are 
beneficiaries of the trust funds accumulated under the plan.
    (2) In the case of a taxable year of the employer which ends with or 
within a taxable year of the trust during which it is not exempt under 
section 501(a), or which ends after the trust has terminated, the 
limitation shall be based on the compensation otherwise paid or accrued 
by the employer during such taxable year of the employer to the 
employees who, at any time during the one-year period ending on the last 
day of the last calendar month during which the trust was exempt under 
section 501(a), were beneficiaries of the trust funds accumulated under 
the plan.

For purposes of this paragraph, ``compensation otherwise paid or 
accrued'' means all of the compensation paid or accrued except that for 
which a deduction is allowable under a plan that qualifies under section 
401(a), including a plan that qualifies under section 404(a)(2). The 
limitations under section 404(a)(3)(A) apply to the total amount 
deductible for contributions to the trust regardless of the manner in 
which the funds of the trust are invested, applied, or distributed, and 
no other deduction is allowable on account of any benefits provided by 
contributions to the trust or by the funds thereof. Where contributions 
are paid to two or more profit-sharing or stock bonus trusts satisfying 
the conditions for deduction under section 404(a)(3)(A), such trusts are 
considered as a single trust in applying these limitations.
    (c) The primary limitation on deductions for a taxable year is 15 
percent of the compensation otherwise paid or accrued by the employer 
during such taxable year to the employees who are beneficiaries under 
the plan. See paragraph (b) of this section for rules for determining 
who are the beneficiaries under the plan.
    (d) In order that the deductions may average 15 percent of 
compensation otherwise paid or accrued over a period of years, where 
contributions in some taxable year are less than the primary limitation 
but contributions in some succeeding taxable year exceed the primary 
limitation, deductions in each succeeding year are subject to a 
secondary limitation instead of to the primary limitation. The secondary 
limitation for any year is equal to the lesser of (1) twice the primary 
limitation for the year, or (2) any excess of (i) the aggregate of the 
primary limitations for the year and for all prior years over (ii) the 
aggregate of the deductions allowed or allowable under the limitations 
provided in section 404(a)(3)(A) for all prior years. Since 
contributions paid into a profit-sharing or stock bonus trust are 
deductible under section 404(a)(3)(A) only if they are paid (or deemed 
to have been paid under section 404(a)(6)) in a taxable year of the 
employer which ends with or within a taxable year of the trust for which 
it is exempt under section 501(a), the secondary limitation described in 
this paragraph is not applicable with respect to determining amounts 
deductible for a taxable year of the employer which ends with or within 
a taxable year of the trust during which it is not exempt under section 
501(a), or which ends after the trust has terminated. See paragraph (e) 
of this section for rules relating to amounts which are deductible in 
such a taxable year.
    (e) In any case when the contributions in a taxable year exceed the 
amount allowable as a deduction for the year under section 404(a)(3)(A), 
the excess is deductible in succeeding taxable years, in order of time, 
in accordance with the following limitations:
    (1) If the succeeding taxable year ends with or within a taxable 
year of

[[Page 521]]

the trust for which it is exempt under section 501(a), such excess is 
deductible in any such succeeding taxable year in which the 
contributions are less than the primary limitation for that year; but 
the total deduction for such succeeding taxable year cannot exceed the 
lesser of (i) the primary limitation for such year, or (ii) the sum of 
the contributions in such year and the excess contributions not deducted 
under the limitations of section 404(a)(3)(A) for prior years.
    (2) If the succeeding taxable year ends with or within a taxable 
year of the trust during which it is not exempt under section 501(a), or 
if such succeeding taxable year ends after the trust has terminated, the 
total deduction for such succeeding taxable year cannot exceed the 
lesser of (i) the primary limitation for such succeeding taxable year, 
or (ii) the excess contributions not deducted under the limitations of 
section 404(a)(3)(A) for prior years.

In no case, however, are excess contributions deductible in a succeeding 
taxable year if such contributions were not paid (or deemed to have been 
paid under section 404(a)(6)) in a taxable year of the employer which 
ends with or within a taxable year of the trust for which it is exempt 
under section 501(a).
    (f) In case deductions are allowable under section 404(a) (1) or 
(2), as well as under section 404(a)(3)(A), the limitations under 
section 404(a) (1) and (3)(A) are determined and applied without giving 
effect to the provisions of section 404(a)(7), but the amounts allowable 
as deductions are subject to the further limitations provided in section 
404(a)(7). See Sec. 1.404(a)-13.
    (g) The provisions of section 404(a)(3)(A) before giving effect to 
section 404(a)(7), may be illustrated as follows:

  Illustration of Provisions of Section 404(a)(3)(A) for a Plan Put Into Effect in the Taxable (Calendar) Year
   1954, Before Giving Effect to Section 404(a)(7) (All Figures Represent Thousands of Dollars and All Taxable
  (Calendar) Years Are Years Which End With or Within a Taxable Year of the Trust For Which it is Exempt Under
                                                 Section 501(a))
----------------------------------------------------------------------------------------------------------------
                                                                         Taxable (calendar) years
                                                         -------------------------------------------------------
                                                           1954    1955    1956    1957    1958    1959    1960
----------------------------------------------------------------------------------------------------------------
1. Amount of contributions:
  (i) In taxable year...................................     $65     $10     $15    $100     $70     $40     $30
  (ii) Carried over from prior taxable years............       0       8       0       0       4       5       3
2. Primary limitation applicable to year:
  15 percent of covered compensation in year \1\........      57      54      51      48      45      42      39
3. Secondary limitation applicable to year:
  (i) Twice primary limitation..........................  ......  ......  ......      96      90      84
                                                         =======================================================
  (ii) (a) Aggregate primary limitations (see item 2)...  ......  ......  ......     210     255     297
    (b) Aggregate prior deductions (see item 4 (iii))...  ......  ......  ......      90     186     255
    (c) Excess of (a) over (b)..........................  ......  ......  ......     120      69      42
  (iii) Lesser of (i) or (ii)...........................  ......  ......  ......      96      69      42
                                                         =======================================================
4. Amount deductible for year on account of:
  (i) Contributions in year.............................      57      10      15      96      69      40      30
  (ii) Contributions carried over.......................       0       8       0       0       0       2       3
                                                         -------------------------------------------------------
  (iii) Total...........................................      57      18      15      96      69      42      33
5. Excess contributions carried over to succeeding             8       0       0       4       5       3      0
 years..................................................
----------------------------------------------------------------------------------------------------------------
\1\ Compensation otherwise paid or accrued during the year to the employees who are beneficiaries of trust funds
  accumulated under the plan in the year.


[T.D. 6500, 25 FR 11687, Nov. 26, 1960, as amended by T.D. 6534, 26 FR 
516, Jan. 20, 1961]

[[Page 522]]



Sec. 1.404(a)-10  Profit-sharing plan of an affiliated group; 
application of section 404(a)(3)(B).

    (a) Section 404(a)(3)(B) allows a corporation a deduction to the 
extent provided in paragraphs (b) and (c) of this section for a 
contribution which it makes for another corporation to a profit-sharing 
plan or a stock bonus plan under which contributions are determined by 
reference to profits, provided the following tests are met:
    (1) The corporation for which the contribution is made and the 
contributing corporation are members of an affiliated group of 
corporations as defined in section 1504, relating to the filing of 
consolidated returns, and both such corporations participate in the 
plan. However, it is immaterial whether all the members of such group 
participate in the plan.
    (2) The corporation for which the contribution is made is required 
under the plan to make the contribution, but such corporation is 
prevented from making such contribution because it has neither current 
nor accumulated earnings or profits, or because its current and 
accumulated earnings or profits are insufficient to make the required 
contribution. To the extent that such a corporation has any current or 
accumulated earnings or profits, it is not considered to be prevented 
from making its required contribution to the plan.
    (3) The contribution is made out of the current or accumulated 
earnings or profits of the contributing corporation.
    (b) The amount that is deductible under section 404(a)(3)(B) is 
determined by applying the rules of section 404(a)(3)(A) and Sec. 
1.404(a)-9 as if the contribution were made by the corporation for which 
it is made. For example, the primary limitation described in paragraph 
(e) of Sec. 1.404(a)-9 is determined by reference to the compensation 
otherwise paid or accrued to the employees of the corporation for which 
the contribution is made, and the secondary limitation described in 
paragraph (d) of Sec. 1.404(a)-9 and the contribution carryover 
described in paragraph (c) of Sec. 1.404(a)-9 are determined by 
reference to the prior contributions and deductions of such corporation. 
The contributing corporation may deduct the amount so determined subject 
to the limitations contained in paragraph (c) of this section. The 
contributing corporation shall not treat such amount as a contribution 
made by it in applying the rules of section 404(a)(3)(A) and Sec. 
1.404(a)-9 either for the taxable year for which the contribution is 
made or for succeeding taxable years. The corporation for which the 
contribution is made shall treat the contribution as having been made by 
it in applying the rules of section 404(a)(3)(A) and Sec. 1.404(a)-9 
for succeeding taxable years.
    (c) The allowance of the deduction under section 404(a)(3)(B) does 
not depend upon whether the affiliated group does or does not file a 
consolidated return. If a consolidated return is filed, it is immaterial 
which of the participating corporations makes the contribution and takes 
the deduction or how the contribution or the deduction is allocated 
among them. However, if a consolidated return is not filed, the 
contribution which is deductible under section 404(a)(3)(B) by each 
contributing corporation shall be limited to that portion of its total 
current and accumulated earnings or profits (adjusted for its 
contribution deductible without regard to section 404(a)(3)(B)) which 
the prevented contribution bears to the total current and accumulated 
earnings or profits of all the participating members of the group having 
such earnings or profits (adjusted for all contributions deductible 
without regard to section 404(a)(3)(B)). For the purpose of this 
section, current earnings or profits shall be computed as of the close 
of the taxable year without diminution by reason of any dividends during 
the taxable year, and accumulated earnings or profits shall be computed 
as of the beginning of the taxable year.
    (d) The application of section 404(a)(3)(B) may be illustrated by 
the following example in which the affiliated group does not file a 
consolidated return:

--------------------------------------------------------------------------------------------------------------------------------------------------------
                       (1)                           (2)         (3)         (4)        (5)      (6)      (7)       (8)       (9)      (10)       (11)
--------------------------------------------------------------------------------------------------------------------------------------------------------
A...............................................  ($10,000)  ($140,000)  ($150,000)   $200,000  \1/5\    $6,000

[[Page 523]]

 
B...............................................    (5,000)     105,000     100,000    300,000    \3/     9,000    $9,000   $91,000    6/326x  $1,674.85
                                                                                                  10\
                                                  .........  ..........  ..........  .........  .....  ........  ........  ........    91,000
C...............................................     75,000     175,000     250,000    500,000  \1/2\    15,000    15,000   235,000    6/326x   4,325.15
                                                  .........  ..........  ..........  .........  .....  ........  ........  ........   235,000
--------------------------------------------------------------------------------------------------------------------------------------------------------
  Total.........................................     60,000     140,000     200,000  1,000,000  .....    30,000    24,000   326,000  ........   6,000.00
--------------------------------------------------------------------------------------------------------------------------------------------------------
Column:
(1) Member.
(2) Earnings and profits of the taxable year.
(3) Accumulated earnings and profits at beginning of taxable year.
(4) Total current and accumulated earnings and profits (column 2 plus column 3).
(5) Compensation of participating employees.
(6) Contribution formula: 50 percent of consolidated earnings and profits, allocated among participating member in proportion of covered payroll of each
  to covered payroll of consolidated group.
(7) Individual contribution had it not been prevented.
(8) Individual contribution made by each employer for its own employees.
(9) Balance of accumulated earnings and profits (column 4 minus column 8).
(10) Proportion of make-up contribution.
(11) Make-up contribution.


[T.D. 6500, 25 FR 11688, Nov. 26, 1960]



Sec. 1.404(a)-11  Trusts created or organized outside the United States; 
application of section 404(a)(4).

    In order that a trust may constitute a qualified trust under section 
401(a) and be exempt under section 501(a), it must be created or 
organized in the United States and maintained at all times as a domestic 
trust. See paragraph (a) of Sec. 1.401-1. Paragraph (4) of section 
404(a) provides, however, that an employer which is a resident, a 
corporation, or other entity of the United States, making contributions 
to a foreign stock bonus, pension, or profit-sharing trust, shall be 
allowed deductions for such contributions, under the applicable 
conditions and within the prescribed limits of section 404(a), if such 
foreign trust would qualify for exemption under section 501(a) except 
for the fact that it is a trust created, organized, or maintained 
outside the United States. Moreover, if a nonresident alien individual, 
foreign corporation, or other entity is engaged in trade or business 
within the United States and makes contributions to a foreign stock 
bonus, pension, or profit-sharing trust, which would qualify under 
section 401(a) and be exempt under section 501(a) except that it is 
created, organized, or maintained outside the United States, such 
contributions are deductible subject to the conditions and limitations 
of section 404(a) and to the extent allowed by section 873 or 882(c).

[T.D. 6500, 25 FR 11689, Nov. 26, 1960]



Sec. 1.404(a)-12  Contributions of an employer under a plan that does 
not meet the requirements of section 401(a); application of section 

404(a)(5).

    (a) In general. Section 404(a)(5) covers all cases for which 
deductions are allowable under section 404(a) (for contributions paid by 
an employer under a stock bonus, pension, profit sharing, or annuity 
plan or for any compensation paid on account of any employee under a 
plan deferring the receipt of such compensation) but not allowable under 
paragraph (1), (2), (3), (4), or (7) of such section. For the rules with 
respect to the taxability of an employee when rights under a nonexempt 
trust become substantially vested, see section 402(b) and the 
regulations thereunder.
    (b) Contributions made after August 1, 1969--(1) In general. A 
deduction is allowable for a contribution paid after August 1, 1969, 
under section 404(a)(5) only in the taxable year of the employer in 
which or with which ends the taxable year of an employee in which an 
amount attributable to such contribution is includible in his gross 
income as compensation, and then only to the extent allowable under 
section 404(a). See Sec. 1.404(a)-1. For example, if an employer A 
contributes $1,000 to the account of its employee E for its taxable 
(calendar) year 1977, but the amount in the account attributable to that 
contribution is not includible in E's gross income until his taxable 
(calendar) year 1980 (at which time the includible amount is $1,150), 
A's deduction for that contribution is $1,000 in

[[Page 524]]

1980 (if allowable under section 404(a)). For purposes of this (1), a 
contribution is considered to be so includible where the employee or his 
beneficiary excludes it from his gross income under section 101(b) or 
subchapter N. To the extent that property of the employer is transferred 
in connection with such a contribution, such transfer will constitute a 
disposition of such property by the employer upon which gain or loss is 
recognized, except as provided in section 1032 and the regulations 
thereunder. The amount of gain or loss recognized from such disposition 
shall be the difference between the value of such property used to 
measure the deduction allowable under this section and the employer's 
adjusted basis in such property.
    (2) Special rule for unfunded pensions and certain death benefits. 
If unfunded pensions are paid directly to former employees, such 
payments are includible in their gross income when paid, and 
accordingly, such amounts are deductible under section 404(a)(5) when 
paid. Similarly, if amounts are paid as a death benefit to the 
beneficiaries of an employee (for example, by continuing his salary for 
a reasonable period), and if such amounts meet the requirements of 
section 162 or 212, such amounts are deductible under section 404(a)(5) 
in any case when they are not includible under the other paragraphs of 
section 404(a).
    (3) Separate accounts for funded plans with more than one employee. 
In the case of a funded plan under which more than one employee 
participates, no deduction is allowable under section 404(a)(5) for any 
contribution unless separate accounts are maintained for each employee. 
The requirement of separate accounts does not require that a separate 
trust be maintained for each employee. However, a separate account must 
be maintained for each employee to which employer contributions under 
the plan are allocated, along with any income earned thereon. In 
addition, such accounts must be sufficiently separate and independent to 
qualify as separate shares under section 663(c). Nothing shall preclude 
a trust which loses its exemption under section 501(a) from setting up 
such acounts and meeting the separate account requirement of section 
404(a)(5) with respect to the taxable years in which such accounts are 
set up and maintained.
    (c) Contributions paid on or before August 1, 1969. No deduction is 
allowable under section 404(a)(5) for any contribution paid on or before 
August 1, 1969, by an employer under a stock bonus, pension, profit-
sharing, or annuity plan, or for any compensation paid on account of any 
employee under plan deferring the receipt of such compensation, except 
in the year when paid, and then only to the extent allowable under 
section 404(a). See Sec. 1.404(a)-1. If payments are made under such a 
plan and the amounts are not deductible under the other paragraphs of 
section 404(a), they are deductible under section 404(a)(5) to the 
extent that the rights of individual employees to, or derived from, such 
employer's contribution or such compensation are nonforfeitable at the 
time the contribution or compensation is paid. If unfunded pensions are 
paid directly to former employees, their rights to such payments are 
nonforfeitable, and accordingly, such amounts are deductible under 
section 404(a)(5) when paid. Similarly, if amounts are paid as a death 
benefit to the beneficiaries of an employee (for example, by continuing 
his salary for a reasonable period), and if such amounts meet the 
requirements of section 162 or 212, such amounts are deductible under 
section 404(a)(5) in any case where they are not deductible under the 
other paragraphs of section 404(a). As to what constitutes 
nonforfeitable rights of an employee in other cases, see Sec. 1.402(b)-
1(d)(2). If an amount is accrued but not paid during the taxable year, 
no deduction is allowable for such amount for such year. If an amount is 
paid during the taxable year to a trust or under a plan and the 
employee's rights to such amount are forfeitable at the time the amount 
is paid, no deduction is allowable for such amount for any taxable year.

(Secs. 83 and 7805 of the Internal Revenue Code of 1954 (83 Stat. 588; 
68A Stat. 917; 26 U.S.C. 83 and 7805))

[T.D. 7554, 43 FR 31926, July 24, 1978]

[[Page 525]]



Sec. 1.404(a)-13  Contributions of an employer where deductions are 
allowable under section 404(a) (1) or (2) and also under section 

404(a)(3); application of section 404(a)(7).

    (a) Where deductions are allowable under section 404(a) (1) or (2) 
on account of contributions under a pension or annuity plan and 
deductions are also allowable under section 404(a)(3) for the same 
taxable year on account of contributions to a profit-sharing or stock 
bonus trust, the total deductions under these sections are subject to 
the provisions of section 404(a)(7) unless no employee who is a 
beneficiary under the trusts or plans for which deductions are allowable 
under section 404(a) (1) or (2) is also a beneficiary under the trusts 
for which deductions are allowable under section 404(a)(3). The 
provisions of section 404(a)(7) apply only to deductions for overlapping 
trusts or plans, i.e., for all trusts or plans for which deductions are 
allowable under section 404(a) (1), (2), or (3) except (1) any trust or 
plan for which deductions are allowable under section 404(a) (1) or (2) 
and which does not cover any employee who is also covered under a trust 
for which deductions are allowable under section 404(a) (3), and (2) any 
trust for which deductions are allowable under section 404(a)(3) and 
which does not cover any employee who is also covered under a trust or 
plan for which deductions are allowable under section 404(a) (1) or (2). 
The limitations under section 404(a)(7) for any taxable year of the 
employer are based on the compensation otherwise paid or accrued during 
the year by the employer to all employees who, in such year, are 
beneficiaries of the funds accumulated under one or more of the 
overlapping trusts or plans. For purposes of the preceding sentence, if 
the taxable year of the employer with respect to which the limitation is 
being computed ends with or within a taxable year of any of the 
overlapping trusts or plans during which any such trust is not exempt 
under section 501(a) or, in the case of a plan, during which it does not 
meet the requirements of section 404(a)(2), or if such taxable year of 
the employer ends after any such trust or plan has terminated, then, 
with respect to such trust or plan, those employees, and only those 
employees, who, at any time during the one-year period ending on the 
last day of the last calendar month during which the trust was exempt 
under section 501(a), or the plan met the requirements of section 
404(a)(2), were beneficiaries of the funds accumulated under such trust 
or plan shall be considered the beneficiaries of such trust or plan in 
the taxable year of the employer with respect to which the limitation is 
being computed. For purposes of this paragraph, ``compensation otherwise 
paid or accrued'' means all of the compensation paid or accrued except 
that for which a deduction is allowable under a plan that qualifies 
under section 401(a), including a plan that qualifies under section 
404(a)(2).
    (b) Under section 404(a)(7), any excess of the total amount 
otherwise deductible for the taxable year under section 404(a) (1), (2), 
or (3) as contributions to overlapping trusts or plans over 25 percent 
of the compensation otherwise paid or accrued during the year to all the 
employees who are beneficiaries under such trusts or plans, is not 
deductible for such year but is deductible for succeeding taxable years, 
in order of time, so that the total deduction for contributions to such 
trusts or plans for a succeeding taxable year is equal to the lesser 
of--
    (1) 30 percent of the compensation otherwise paid or accrued during 
the taxable year to all the employees who are beneficiaries under such 
trusts or plans in the year, or
    (2) The sum of (i) the smaller of (a) 25 percent of the compensation 
otherwise paid or accrued during the taxable year to all employees who 
are beneficiaries under such trusts or plans in the year, or (b) the 
total of the amounts otherwise deductible under section 404(a) (1), (2), 
or (3) for the year for such trusts or plans and (ii) any carryover to 
the year from prior years under section 404(a)(7), i.e., any excess 
otherwise deductible under section 404(a) (1), (2), or (3), but not 
deducted for a prior taxable year because of the limitations under 
section 404(a)(7).
    (c) The limitations under section 404(a)(7) are determined and 
applied after all the limitations, deductions otherwise allowable, and 
carryovers under section 404(a) (1), (2), and (3) have

[[Page 526]]

been determined and applied, and, in particular, after effect has been 
given to the carryover provision in section 404(a)(1)(D) and in the 
second and third sentences of section 404(a)(3)(A). Where the 
limitations under section 404(a)(7) reduce the total amount deductible, 
the excess deductible in succeeding years is treated as a carryover 
which is distinct from, and additional to, any excess contributions 
carried over and deductible in succeeding years under the provisions in 
section 404(a)(1)(D) or in the third sentence of section 404(a)(3)(A). 
The application of the provisions of section 404(a)(7) and the treatment 
of carryovers for a case where the taxable years are calendar years and 
the overlapping trusts or plans consist of a pension trust and a profit-
sharing trust put into effect in 1954 and covering the same employees 
may be illustrated as follows:

  Illustration of Application of Provisions of Section 404(a)(7) and of
   Treatment of Carryovers for Overlapping Pension and Profit-Sharing
   Trusts Put Into Effect in 1954 and Covering the Same Employees (All
 Figures Represent Thousands of Dollars and all Taxable (Calendar) Years
of the Employer are Years Which End With or Within A Taxable Year of the
           Trust for Which it is Exempt Under Section 501(a))
------------------------------------------------------------------------
                                            Taxable calendar years
                                     -----------------------------------
                                        1954     1955     1956     1957
------------------------------------------------------------------------
   before giving effect to section
              404(a)(7)
Pension trust contributions and
 limitations, deductions, and
 carryovers under section 404(a)(1):
  1. Contributions paid in year.....     $215      $85     $140      $60
  2. Contributions carried over from        0        5        0       20
   prior years......................
                                     -----------------------------------
  3. Total deductible for year            215       90      140       80
   subject to limitation............
  4. Limitation applicable to year..      210      175      120       85
  5. Amount deductible for year.....      210       90      120       80
                                     -----------------------------------
  6. Contributions carried over to          5        0       20        0
   succeeding years.................
                                     ===================================
Profit-sharing trust contributions
 and limitations, deductions, and
 carryovers under section 404(a)(3):
  7. Contributions paid in year.....      200      125      105       65
  8. Contributions carried over from        0       35       10        0
   prior years......................
                                     -----------------------------------
  9. Total deductible for year            200      160      115       65
   subject to limitation............
  10. Limitation applicable to year.      165      150      135  \1\ 110
  11. Amount deductible for year....      165      150      115       65
                                     -----------------------------------
  12. Contributions carried over to        35       10        0        0
   succeeding years.................
                                     ===================================
  application of section 404(a)(7)
Totals for pension and profit-
 sharing trust:
  13. Amount deductible for year
   under section 404(a)(7):
    (1) 30 percent of compensation     (\3\ )      300      270      180
     covered in year \2\............
    (2) (i) (a) 25 percent of             275      250      225      150
     compensation covered in year
     \2\............................
      (b) Total amount otherwise          375      240      235      145
       deductible for year: item 5
       plus item 11.................
                                     ===================================
      (c) Smaller of (a) or (b).....      275      240      225      145
    (ii) Carryover from prior years         0      100       40       10
     under section 404(a)(7)........
                                     -----------------------------------
    (iii) Sum of (i)(c) and (ii)....      275      340      265      155
    (3) Amount deductible: Lesser of      275      300      265      155
     (1) or (2)(iii)................
14. Carryover to succeeding years         100       40       10        0
 under section 404(a)(7): item
 13(2)(ii) plus item 3(2)(i)(b)
 minus item 13(3)...................
------------------------------------------------------------------------
\1\ Includes carryover of 20 from 1956.
\2\ Compensation otherwise paid or accrued during the year to the
  employees who are beneficiaries under the trusts in the year.
\3\ 30 percent limitation not applicable to first year of plan.


[T.D. 6500, 25 FR 11689, Nov. 26, 1960, as amended by T.D. 6534, 26 FR 
517, Jan. 20, 1961]

[[Page 527]]



Sec. 1.404(a)-14  Special rules in connection with the Employee 
Retirement Income Security Act of 1974.

    (a) Purpose of this section. This section provides rules for 
determining the deductible limit under section 404(a)(1)(A) of the 
Internal Revenue Code of 1954 for defined benefit plans.
    (b) Definitions. For purposes of this section--
    (1) Section 404(a). The term ``old section 404(a)'' means section 
404(a) as in effect on September 1, 1974. Any reference to section 404 
without the designation ``old'' is a reference to section 404 as amended 
by the Employee Retirement Income Security Act of 1974.
    (2) Ten-year amortization base. The term ``10-year amortization 
base'' means either the past service and other supplementary pension and 
annuity credits described in section 404(a)(1)(A)(iii) or any base 
established in accordance with paragraph (g) of this section. A plan may 
have several 10-year amortization bases to reflect different plan 
amendments, changes in actuarial assumptions, changes in funding method, 
and experience gains and losses of previous years.
    (3) Limit adjustment. The term ``limit adjustment'' with respect to 
any 10-year amortization base is the lesser of--
    (i) The level annual amount necessary to amortize the base over 10 
years using the valuation rate, or
    (ii) The unamortized balance of the base,

in each case using absolute values (solely for the purpose of 
determining which is the lesser). To compute the level amortization 
amount, the base may be divided by the present value of an annuity of 
one dollar, obtained from standard annuity tables on the basis of a 
given interest rate (the valuation rate) and a known period (the 
amortization period).
    (4) Absolute value. The term ``absolute value'' for any number is 
the value of that number, treating negative numbers as if they were 
positive numbers. For example, the absolute value of 5 is 5 and the 
absolute value of minus 3 is 3. On the other hand, the true value of 
minus 3 is minus 3. This term is relevant to the computation of the 
limit adjustment described in paragraph (b)(3) and the remaining 
amortization period of combined bases described in paragraph (i)(3) of 
this section.
    (5) Valuation rate. The term ``valuation rate'' means the assumed 
interest rate used to value plan liabilities.
    (c) Use of plan in determining deductible limit for employer's 
taxable year. Although the deductible limit applies for an employer's 
taxable year, the deductible limit is determined on the basis of a plan 
year. If the employer's taxable year coincides with the plan year, the 
deductible limit for the taxable year is the deductible limit for the 
plan year that coincides with that year. If the employer's taxable year 
does not coincide with the plan year, the deductible limit under section 
404(a)(1)(A) (i), (ii), or (iii) for a given taxable year of the 
employer is one of the following alternatives:
    (1) The deductible limit determined for the plan year commencing 
within the taxable year.
    (2) The deductible limit determined for the plan year ending within 
the taxable year, or
    (3) A weighted average of alternatives (1) and (2). Such an average 
may be based, for example, upon the number of months of each plan year 
falling within the taxable year.

The employer must use the same alternative for each taxable year unless 
consent to change is obtained from the Commissioner under section 446 
(e).
    (d) Computation of deductible limit for a plan year--(1) General 
rules. The computation of the deductible limit for a plan year is based 
on the funding methods, actuarial assumptions, and benefit structure 
used for purposes of section 412, determined without regard to section 
412(g) (relating to the alternative minimum funding standard), for the 
plan year. The method of valuing assets for purposes of section 404 must 
be the same method of valuing assets used for purposes of section 412.
    (2) Special adjustments of computations under section 412. To apply 
the rules of this section (i.e., rules regarding the computation of 
normal cost with aggregate type funding methods, unfunded liabilities, 
and the full funding limitation described in paragraph (k) of the 
section, where applicable) with

[[Page 528]]

respect to a given plan year in computing deductible limits under 
section 404 (a)(1)(A), the following adjustments must be made:
    (i) There must be excluded from the total assets of the plan the 
amount of any plan contribution for a plan year for which the plan was 
qualified under section 401(a), 403(a) or 405(a) that has not been 
previously deducted, even though that amount may have been credited to 
the funding standard account under section 412(b)(3). In the case of a 
plan using a spread gain funding method which maintains an unfunded 
liability (e.g., the frozen initial liability method, but not the 
aggregate method), the amount described in the preceding sentence must 
be included in the unfunded liability of the plan.
    (ii) There must be included in the total assets of the plan for a 
plan year the amount of any plan contribution that has been deducted 
with respect to a prior plan year, even though that amount is considered 
under section 412 to be contributed in a plan year subsequent to that 
prior plan year. In the case of a plan using a spread gain funding 
method which does not maintain an unfunded liability, the amount 
described in the preceding sentence must be excluded from the unfunded 
liability of the plan.

The special adjustments described in paragraph (d)(2) (i) and (ii) of 
this section apply on a year-by-year basis for purposes of section 
404(a)(1)(A) only. Thus, the adjustments have no effect on the 
computation of the minimum funding requirement under section 412.
    (e) Special computation rules under section 404(a)(1)(A)(i)--(1) In 
general. For purposes of determining the deductible limit under section 
404(a)(1)(A)(i), the deductible limit with respect to a plan year is the 
sum of--
    (i) The amount required to satisfy the minimum funding standard of 
section 412(a) (determined without regard to section 412(g)) for the 
plan year and
    (ii) An amount equal to the includible employer contributions. The 
term ``includible employer contributions'' means employer contributions 
which were required by section 412 for the plan year immediately 
preceding such plan year, and which were not deductible under section 
404(a) for the prior taxable year of the employer solely because they 
were not contributed during the prior taxable year (determine with 
regard to section 404(a)(6)).
    (2) Rule for an employer using alternative minimum funding standard 
account and computing its deduction under section 404(a)(1)(A)(i). This 
paragraph (e)(2) applies if the minimum funding requirements for the 
plan are determined under the alternative minimum funding standard 
described in section 412(g) for both the current plan year and the 
immediately preceding plan year. In that case, the deductible limit 
under section 404(a)(1)(A)(i) (regarding the minimum funding requirement 
of section 412) for the current year is the sum of the amount determined 
under the rules of paragraph (e)(1) of this section.
    (i) Plus the charge under section 412(b)(2)(D), and
    (ii) Less the credit under section 412(b)(3)(D),

that would be required if in the current plan year the use of the 
alternative method were discontinued.
    (f) Special computation rules under section 404(a)(1)(A) (ii) and 
(iii)--(1) In general. Subject to the full funding limitation described 
in paragraph (k) of this section, the deductible limit under section 
404(a)(1)(A)(ii) and (iii) is the normal cost of the plan (determined in 
accordance with paragraph (d) of this section).
    (2) Adjustments in calculating limit under section 404 
(a)(1)(A)(iii). In calculating the deductible limit under section 
404(a)(1)(A)(iii), the normal cost of the plan is--
    (i) Decreased by the limit adjustments to any unamortized bases 
required by paragraph (g) of this section, for example, bases that are 
due to a net experience gain, a change in actuarial assumptions, a 
change in funding method, or a plan provision or amendment which 
decreases the accrued liability of the plan, and
    (ii) Increased by the limit adjustments of any unamortized 10-year 
amortization bases required by paragraph (g) or (j) of this section, for 
example, bases that are due to a net experience loss, a change in 
actuarial assumptions, a change in funding method, or a

[[Page 529]]

plan provision or amendment which increases the accrued liability.
    (3) Timing for computations and interest adjustments under section 
404(a)(1)(A) (ii) and (iii). Regardless of the actual time when 
contributions are made to a plan, in computing the deductible limit 
under section 404(a)(1)(A) (ii) and (iii) the normal cost and limit 
adjustments shall be computed as of the date when contributions are 
assumed to be made (``the computation date'') and adjusted for interest 
at the valuation rate from the computation date to the earlier of--
    (i) The last day of the plan year used to compute the deductible 
limit for the taxable year, or
    (ii) The last day of that taxable year. For additional provisions 
relating to the timing of computations and interest adjustments, see 
paragraph (h)(6) of this section (relating to the timing of computations 
and interest adjustments in the maintenance of 10-year amortization 
bases). For taxable years beginning before April 22, 1981, computations 
under the preceding sentence may, as an alternative, be based on prior 
published positions of the Internal Revenue Service under section 
404(a).
    (4) Special limit under section 404(a)(1)(A)(ii). If the deduction 
for the plan year is determined solely on the basis of section 
404(a)(1)(A)(ii) (that is, without regard to clauses (i) or (iii)), the 
special limitation contained in section 404(a)(1)(A)(ii), regarding the 
unfunded cost with respect to any three individuals, applies, 
notwithstanding the rules contained in paragraphs (d)(2) and (f)(1) of 
this section.
    (g) Establishment of a 10-year amortization base--(1) Experience 
gains and losses. In the case of a plan valued by the use of a funding 
method which is an immediate gain type of funding method (and therefore 
separately amortizes rather than includes experience gains and losses as 
a part of the normal cost of the plan), a 10-year amortization base must 
be established in any plan year equal to the net experience gain or loss 
required under section 412 to be determined with respect to that plan 
year. The base is to be maintained in accordance with paragraph (h) of 
this section. Such a base must not be established if the deductible 
limit is determined by use of a funding method which is a spread gain 
type of funding method (under which experience gains and losses are 
spread over future periods as a part of the plan's normal cost). 
Examples of the immediate gain type of funding method are the unit 
credit method, entry age normal cost method, and the individual level 
premium cost method. Examples of the spread gain type of funding method 
are the aggregate cost method, frozen initial liability cost method, and 
the attained age normal cost method.
    (2) Change in actuarial assumptions. (i) If the creation of an 
amortization base is required under the rules of section 412(b) 
(2)(B)(v) or (3)(B)(iii) (as applied to the funding method used by the 
plan), a 10-year amortization base must be established at the time of a 
change in actuarial assumptions used to value plan liabilities. The 
amount of the base is the difference between the accrued liability 
calculated on the basis of the new assumptions and the accrued liability 
calculated on the basis of the old assumptions. Both computations of 
accrued liability are made as of the date of the change in assumptions.
    (ii) A plan using a funding method of the spread gain type does not 
directly determine an accrued liability. If a plan using such a method 
is required under section 412(b) (2)(B)(v) or (3)(B)(iii) to create an 
amortization base, it must establish a base as described in paragraph 
(g)(2)(i) of this section for a change in actuarial assumptions by 
determining an accrued liability on the basis of another funding method 
(of the immediate gain type) that does determine an accrued liability. 
(The aggregate method is an example of a funding method that is not 
required under section 412(b) (2)(B)(v) or (3)(B)(iii) to create an 
amortization base.) The funding method chosen to determine the accrued 
liability of the plan in these cases must be the same method used to 
establish all other 10-year amortization bases maintained by the plan, 
if any. These bases must be maintained in accordance with paragraph (h) 
of this section.
    (3) Past service or supplemental credits. A 10-year base must be 
established when a plan is established or amended, if the creation of an 
amortizable base

[[Page 530]]

is required under the rules of section 412(b)(2)(B) (ii) or (iii), or 
(b)(3)(B)(i) (as applied to the funding method used by the plan). The 
amount of the base is the accrued liability arising from, or the 
decrease in accrued liability resulting from, the establishment or 
amendment of the plan. The base must be maintained in accordance with 
paragraph (h) of this section.
    (4) Change in funding method. If a change in funding method results 
in an increase or decrease in an unfunded liability required to be 
amortized under section 412, a 10-year base must be established equal to 
the increase or decrease in unfunded liability resulting from the change 
in funding method. The base must be maintained in accordance with 
paragraph (h) of this section.
    (h) Maintenance of 10-year amortization base--(1) In general. Each 
time a 10-year amortization base is established, whether by a change in 
funding method, by plan amendment, by change in actuarial assumptions, 
or by experience gains and losses, the base must, except as provided in 
paragraph (i) of this section, be separately maintained in order to 
determine when the unamortized amount of the base is zero. The sum of 
the unamortized balances of all of the 10-year bases must equal the 
plan's unfunded liability with the adjustments described in paragraph 
(d) of this section, if applicable. When the unamortized amount of a 
base is zero, the deductible limit is no longer adjusted to reflect the 
amortization of the base.
    (2) First year's base. See either paragraph (g) or paragraph (i) of 
this section for rules applicable with respect to the first year of a 
base.
    (3) Succeeding year's base. For any plan year after the first year 
of a base, the unamortized amount of the base is equal to--
    (i) The unamortized amount of the base as of the valuation date in 
the prior plan year, plus
    (ii) Interest at the valuation rate from the valuation date in the 
prior plan year to the valuation date in the current plan year on the 
amount described in subdivision (i), minus
    (iii) The contribution described in paragraph (h)(4) of this section 
with respect to the base for the prior plan year.

The valuation date is the date as of which plan liabilities are valued 
under section 412(c)(9). If such a valuation is performed less often 
than annually for purposes of section 412, bases must be adjusted for 
purposes of section 404 each year as of the date on which a section 412 
valuation would be performed were it required on an annual basis. See 
paragraph (b)(3) of this section for the definition of valuation rate.
    (4) Contribution allocation with respect to each base. A portion of 
the total contribution for the prior plan year is allocated to each 
base. Generally, this portion equals the product of--
    (i) The total contribution described in paragraph (h)(6) of this 
section with respect to all bases, and
    (ii) The ratio of the amount described in paragraph (b)(3)(i) of 
this section with respect to the base to the sum (using true rather than 
absolute values) of such amounts with respect to all remaining bases.

However, if the result of this computation with respect to a particular 
base exceeds the amount necessary to amortize such base fully, the 
smaller amount shall be deemed the contribution made with respect to 
such base. The unallocated excess with respect to a now fully amortized 
base shall be allocated among the other bases as indicated above.
    (5) Other allocation methods. The Commissioner may authorize the use 
of methods other than the method described in paragraph (h)(4) of this 
section for allocating contributions to bases.
    (6) Total contribution for all bases. The contribution with respect 
to all bases for the prior plan year (see paragraph (h)(3)(iii) of this 
section) is the difference between--
    (i) The sum of (A) the total deduction (including a carryover 
deduction) for the prior year, (B) interest on the actual contributions 
for the prior year (whether or not deductible) at the valuation rate for 
the period between the dates as of which the contributions are credited 
under section 412 and the valuation date in the current plan year, and 
(C) interest on the carryover described in section 404(a)(1)(D) that is

[[Page 531]]

available at the beginning of the prior taxable year at the valuation 
rate for the period between the current and prior valuation dates, and
    (ii) The normal cost for the prior plan year and interest on it at 
the valuation rate from the date as of which the normal cost is 
calculated to the current valuation date.
    (7) Effect of failure to contribute normal cost plus interest on 
unamortized amounts. The failure to make a contribution at least equal 
to the sum of the normal cost plus interest on the unamortized amounts 
has the following effects under the preceding rules of this section--
    (i) It does not create a new base.
    (ii) It results in an increase in the unamortized amount of each 
base and consequently extends the time before the base is fully 
amortized.
    (iii) The limit adjustment for any base is not increased (in 
absolute terms) even if the unamortized amount computed under paragraph 
(h) of this section exceeds the initial 10-year amortization base. Thus, 
if the total unamortized amount of the plan's bases at the beginning of 
the plan year is $100,000 (which is also the unfunded liability of the 
plan), and a required $50,000 normal cost contribution is not made for 
the plan year, the following effects occur. The total unamortized 
balance of the plan's bases increases by the $50,000 normal cost for the 
year (adjusted for interest), plus interest on the $100,000 balance of 
the bases; and, because of that increase, it will take a longer period 
to amortize the remaining balance of the bases. (The annual amortization 
amount does not change.)
    (8) Required adjustment to a 10-year base limit adjustment if 
valuation rate changed. If there is a change in the valuation rate, the 
limit adjustment for all unamortized 10-year amortization bases must be 
changed, in addition to establishing a new base as provided in paragraph 
(g)(2) of this section. The new limit adjustment for any base is the 
level amount necessary to amortize the unamortized amount of the base 
over the remaining amortization period using the new valuation rate. The 
remaining amortization period of the base is the number of years at the 
end of which the unamortized amount of the base would be zero if the 
contribution made with respect to that base equaled the limit adjustment 
each year. This calculation of the remaining period is made on the basis 
of the valuation rate used before the change. Both the remaining 
amortization period and the revised limit adjustment may be determined 
through the use of standard annuity tables. The remaining period may be 
computed in terms of fractional years, or it may be rounded off to a 
full year. The unamortized amount of the base as of the valuation date 
and the remaining amortization period of that base shall not be changed 
by any change in the valuation rate.
    (i) Combining bases--(1) General method. For purposes of section 404 
only, and not for purposes of section 412, different 10-year 
amortization bases may be combined into a single 10-year amortization 
base if such single base satisfies all of the requirements of paragraph 
(i) (2), (3), and (4) of this section at the time of the combining of 
the different bases.
    (2) Unamortized amount. The unamortized amount of the single base 
equals the sum, as of the date the combination is made, of the 
unamortized amount of the bases being combined (treating negative bases 
as having negative unamortized amounts).
    (3) Remaining amortization period. The remaining amortization period 
of the single base is equal to (i) the sum of the separate products of 
(A) the unamortized amount of each of these bases (using absolute 
values) and (B) its remaining amortization period, divided by (ii) the 
sum of the unamortized amounts of each of the bases (using absolute 
values). For purposes of this paragraph (i)(3), the remaining 
amortization period of each base being combined is that number of years 
at the end of which the unamortized amount of the base would be zero if 
the contribution made with respect to that base equaled the limit 
adjustment of that base in each year. This number may be determined 
through the use of standard annuity tables. The remaining amortization 
period described in this paragraph may be computed in terms of 
fractional years, or it may be rounded off to a whole year.

[[Page 532]]

    (4) Limit adjustment. The limit adjustment for the single base is 
the level amount necessary to amortize the unamortized amount of the 
combined base over the remaining amortization period described in 
paragraph (i)(3) of this section, using the valuation rate. This amount 
may be determined through the use of standard annuity tables.
    (5) Fresh start alternative. In lieu of combining different 10-year 
amortization bases, a plan may replace all existing bases with one new 
10-year amortization base equal to the unfunded liability of the plan as 
of the time the new base is being established. This unfunded liability 
must be determined in accordance with the general rules of paragraphs 
(d) and (f) of this section. The unamortized amount of the base and the 
limit adjustment for the base will be determined as though the base were 
newly established.
    (j) Initial 10-year amortization base for existing plan--(1) In 
general. In the case of a plan in existence before the effective date of 
section 404(a), the 10-year amortization base on the effective date of 
section 404(a) is the sum of all 10 percent bases existing immediately 
before section 404(a) became effective for the plan, determined under 
the rules of old section 404(a).
    (2) Limit adjustment. The limit adjustment for the initial base is 
the lesser of the unamortized amount of such base or the sum of the 
amounts determined under paragraph (b)(3) of this section using the 
original balances of the remaining bases (under old section 404(a) 
rules) as the amount to be amortized.
    (3) Unamortized amount. The employer may choose either to establish 
a single initial base reflecting both all prior 10-percent bases and the 
experience gain or loss for the immediately preceding actuarial period, 
or to establish a separate base for the prior 10-percent bases and 
another for the experience gain or loss for the immediately preceding 
period. If the initial 10-year amortization base reflects the net 
experience gain or loss from the immediately preceding actuarial period, 
the unamortized amount of the initial base shall equal the total 
unfunded liability on the effective date of section 404(a) determined in 
accordance with the general rules of paragraphs (d) and (f) of this 
section. If, however, a separate base will be used to reflect that gain 
or loss, the unamortized amount of the initial base shall equal such 
unfunded liability on the effective date of section 404(a), reduced by 
the net experience loss or increased by the net experience gain for the 
immediately preceding actuarial period. In this case, a separate 10-year 
amortization base must be established on the effective date equal to the 
net experience gain or loss. Thus, if the effective date unfunded 
liability is $100,000 and an experience loss of $15,000 is recognized on 
that date, and if the loss is to be treated as a separate base, the 
unamortized balances of the two bases would be $85,000 and $15,000. If 
the unfunded liability were the same $100,000, but a gain of $15,000 
instead of a loss were recognized on that date, the unamortized balances 
of the two bases would be $115,000 and a credit base of $15,000. In both 
cases, if only one 10-year base is to be established on the effective 
date, its unamortized balance would be $100,000 (the unfunded liability 
of the plan). See paragraphs (d) and (f) for rules for determining the 
unfunded liability of the plan.
    (k) Effect of full funding limit on 10-year-amortization bases. The 
amount deductible under section 404(a)(1)(A) (i), (ii), or (iii) for a 
plan year may not exceed the full funding limitation for that year. See 
section 412 and paragraphs (d), (e), and (f) of this section for rules 
to be used in the computation of the full funding limitation. If the 
total deductible contribution (including carryover) for a plan year 
equals or exceeds the full funding limitation for the year, all 10-year 
amortization bases maintained by the plan will be considered fully 
amortized, and the deductible limit for subsequent plan years will not 
be adjusted to reflect the amortization of these bases.
    (l) Transitional rules--(1) Plan years beginning before April 22, 
1981. In determining the deductible limit for plan years beginning 
before April 22, 1981, a contribution will be deductible under section 
404(a)(1)(A) if the computation of the deductible limit is based on an 
interpretation of section 404(a)(1)(A) that is reasonable when 
considered with prior published positions of the

[[Page 533]]

Internal Revenue Service. A computation of the deductible limit may 
satisfy the preceding sentence even if it does not satisfy the rules 
contained in paragraphs (c) through (i) of this section.
    (2) Transitional approaches. The deductible limit determined for the 
first plan year with respect to which a plan applies the rules contained 
in paragraphs (c) through (i) of this section must be computed using one 
of the following approaches--
    (i) The plan (whether or not in existence before the effective date 
of section 404(a)) may apply the rules of paragraph (j) for establishing 
the initial base for an existing plan, treating 10-year bases (if any) 
as 10 percent bases in adding bases.
    (ii) The plan may apply the fresh start alternative for combining 
bases under paragraph (i)(5).
    (iii) The plan may retroactively establish 10-year amortization 
bases for years with respect to which section 404(a)(1)(A) and the rules 
of this section would have applied but for the transition rule contained 
in paragraph (l)(1) of this section. Contributions actually deducted are 
used in retroactively establishing and maintaining these bases under 
paragraph (h). However, a deduction already taken shall not be 
recomputed because of the retroactive establishment of a base.
    (m) Effective date of section 404(a). In the case of a plan which 
was in existence on January 1, 1974, section 404(a) generally applies 
for contributions on account of taxable years of an employer ending with 
or within plan years beginning after December 31, 1974. In the case of a 
plan not in existence on January 1, 1974, section 404(a) generally 
applies for contributions on account of taxable years of an employer 
ending with or within plan years beginning after September 4, 1974. See 
Sec. 1.410(a)-2(c) for rules concerning the time of plan existence. See 
also Sec. 1.410(a)-2(d), which provides that a plan in existence on 
January 1, 1974, may elect to have certain provisions, including the 
amendments to section 404(a) contained in section 1013 of the Employee 
Retirement Income Security Act of 1974, apply to a plan year beginning 
after September 2, 1974, and before the otherwise applicable effective 
date contained in that section.

[T.D. 7760, 46 FR 6914, Jan. 22, 1981; 46 FR 15685, Mar. 9, 1981]



Sec. 1.404(b)-1  Method of contribution, etc., having the effect of a 
plan; effect of section 404(b).

    Section 404(a) is not confined to formal stock bonus, pension, 
profit- sharing, and annuity plans, or deferred compensation plans, but 
it includes any method of contributions or compensation having the 
effect of a stock bonus, pension, profit-sharing, or annuity plan, or 
similar plan deferring the receipt of compensation. Thus, where a 
corporation pays pensions to a retired employee or employees or to their 
beneficiaries in such amounts as may be determined from time to time by 
the board of directors or responsible officers of the company, or where 
a corporation is under an obligation, whether funded or unfunded, to pay 
a pension or other deferred compensation to an employee or his 
beneficiaries, there is a method having the effect of a plan deferring 
the receipt of compensation for which deductions are governed by section 
404(a). If an employer on the accrual basis defers paying any 
compensation to an employee until a later year or years under an 
arrangement having the effect of a stock bonus, pension, profit-sharing, 
or annuity plan, or similar plan deferring the receipt of compensation, 
he shall not be allowed a deduction until the year in which the 
compensation is paid. This provision is not intended to cover the case 
where an employer on the accrual basis defers payment of compensation 
after the year of accrual merely because of inability to pay such 
compensation in the year of accrual, as, for example, where the funds of 
the company are not sufficient to enable payment of the compensation 
without jeopardizing the solvency of the company, or where the liability 
accrues in the earlier year, but the amount payable cannot be exactly 
determined until the later year.

[T.D. 6500, 25 FR 11690, Nov. 26, 1960]

[[Page 534]]



Sec. 1.404(b)-1T  Method or arrangement of contributions, etc., 
deferring the receipt of compensation or providing for deferred 

benefits. (Temporary)

    Q-1: As amended by the Tax Reform Act of 1984, what does section 
404(b) of the Internal Revenue Code provide?
    A-1: As amended, section 404(b) clarifies that any plan, or method 
or arrangement, deferring the receipt of compensation or providing for 
deferred benefits (other than compensation) is to be treated as a plan 
deferring the receipt of compensation for purposes of section 404 (a) 
and (d). Accordingly, section 404 (a) and (d) (in the case of employees 
and nonemployees; respectively) shall govern the deduction of 
contributions paid or compensation paid or incurred with respect to such 
a plan, or method or arrangement. Section 404 (a) and (d) requires that 
such a contribution or compensation be paid or incurred for purposes of 
section 162 or 212 and satisfy the requirements for deductibility under 
either of those sections. Thus, for example, under section 404 (a)(5) 
and (b), if otherwise deductible under section 162 or 212, a 
contribution paid or incurred with respect to a nonqualified plan, or 
method or arragement, providing for deferred benefits is deductible in 
the taxable year of the employer in which or with which ends the taxable 
year of the employee in which the amount attributable to the 
contribution is includible in the gross income of the employee (without 
regard to any applicable exclusion under Chapter 1, Subtitle A, of the 
Internal Revenue Code). Section 404 (a) and (d) applies to all 
compensation and benefit plans, or methods or arrangements, however 
denominated, which defer the receipt of any amount of compensation or 
benefit, including fees or other payments. Thus, a limited partnership 
(using the accrual method of accounting) may not accrue deductions for a 
fee owed to an unrelated person (using the cash method of accounting) 
who performs services for the partnership until the partnership taxable 
year in which or with which ends the taxable year of the service 
provider in which the fee is included in income. However, 
notwithstanding the above, section 404 does not apply to contributions 
paid or accrued with respect to a ``welfare benefit fund'' (as defined 
in section 419(e)) after July 18, 1984, in taxable years of employers 
(and payors) ending after that date. Also, section 463 shall govern the 
deduction of vacation pay by a taxpayer that has elected the application 
of such section. For rules relating to the deduction of contributions 
paid or accrued with respect to a welfare benefit fund, see section 419, 
Sec. 1.419-1T and Sec. 1.419A-2T. For rules relating to the deduction 
of vacation pay for which an election is made under section 463, see 
Sec. 301.9100-16T of this chapter and Sec. 1.463-1T.
    Q-2: When does a plan, or method or arrangement, defer the receipt 
of compensation or benefits for purposes of section 404 (a), (b), and 
(d)?
    A-2: (a) For purposes of section 404 (a), (b), and (d), a plan, or 
method or arrangement, defers the receipt of compensation or benefits to 
the extent it is one under which an employee receives compensation or 
benefits more than a brief period of time after the end of the 
employer's taxable year in which the services creating the right to such 
compensation or benefits are performed. The determination of whether a 
plan, or method or arrangement, defers the receipts of compensation or 
benefits is made separately with respect to each employee and each 
amount of compensation or benefit. Compensation or benefits received by 
an employee's spouse or dependent or any other person, but taxable to 
the employee, are treated as received by the employee for purposes of 
section 404. An employee is determined to receive compensation or 
benefits within or beyond a brief period of time after the end of the 
employer's taxable year under the rules provided in this Q&A. For the 
treatment of expenses with respect to transactions between related 
taxpayers, see section 267.
    (b)(1) A plan, or method or arrangement, shall be presumed to be one 
deferring the receipt of compensation for more than a brief period of 
time after the end of an employer's taxable year to the extent that 
compensation is received after the 15th day of the 3rd calendar month 
after the end of the employer's taxable year in which the related 
services are rendered (``the 2\1/2\

[[Page 535]]

month period''). Thus, for example, salary under an employment contract 
or a bonus under a year-end bonus declaration is presumed to be paid 
under a plan, or method or arrangement, deferring the receipt of 
compensation, to the extent that the salary or bonus is received beyond 
the applicable 2\1/2\ month period. Further, salary or a year-end bonus 
received beyond the applicable 2\1/2\ month period by one employee shall 
be presumed to constitute payment under a plan, or method or 
arrangement, deferring the receipt of compensation for such employee 
even though salary or bonus payments to all other employees are not 
similarly treated because they are received within the 2\1/2\ month 
period. Benefits are ``deferred benefits'' if, assuming the benefits 
were cash compensation, such benefits would be considered deferred 
compensation. Thus, a plan, or method or arrangement, shall be presumed 
to be one providing for deferred benefits to the extent benefits for 
services are received by an employee after the 2\1/2\ month period 
following the end of the employer's taxable year in which the related 
services are rendered.
    (2) The taxpayer may rebut the presumption established under the 
previous subparagraph with respect to an amount of compensation or 
benefits only by setting forth facts and circumstances the preponderance 
of which demonstrates that it was impracticable, either administratively 
or economically, to avoid the deferral of the receipt by an employee of 
the amount of compensation or benefits beyond the applicable 2\1/2\ 
month period and that, as of the end of the employer's taxable year such 
impracticability was unforeseeable. For example, the presumption may be 
rebutted with respect to an amount of compensation to the extent that 
receipt of such amount is deferred beyond the applicable 2\1/2\ month 
period (i) either because the funds of the employer were not sufficient 
to make the payment within the 2\1/2\ month period without jeopardizing 
the solvency of the employer or because it was not reasonably possible 
to determine within the 2\1/2\ month period whether payment of such 
amount was to be made, and (ii) the circumstance causing the deferral 
described in (i) was unforeseeable as of the close of the employer's 
taxable year. Thus, the presumption with respect to the receipt of an 
amount of compensation or benefit is not rebutted to the extent it was 
foreseeable, as of the end of the employer's taxable year, that the 
amount would be received after the applicable 2\1/2\ month period. For 
example, if, as of the end of the employer's taxable year, it is 
foreseeable that calculation of a year-end bonus to be paid to an 
employee under a given formula will not be completed and thus the bonus 
will not be received (and is in fact not received) by the end of the 
applicable 2\1/2\ month period, the presumption that the bonus is 
deferred compensation is not rebutted.
    (c) A plan, or method or arrangement, shall not be considered as 
deferring the receipt of compensation or benefits for more than a brief 
period of time after the end of the employer's taxable year to the 
extent that compensation or benefits are received by the employee on or 
before the end of the applicable 2\1/2\ month period. Thus, for example, 
salary under an employment contract or a bonus under a year-end bonus 
declaration is not considered paid under a plan, or method or 
arrangement, deferring the receipt of compensation to the extent that 
such salary or bonus is received by the employee on or before the end of 
the applicable 2\1/2\ month period.
    (d) Solely for purposes of applying the rules of paragraphs (b) and 
(c) of this Q&A, in the case of an employer's taxable year ending on or 
after July 18, 1984, and on or before March 21, 1986, compensation or 
benefits that relate to services rendered in such taxable year shall be 
deemed to have been received within the applicable 2\1/2\ month period 
if such receipt actually occurs after such 2\1/2\ month period but on or 
before March 21, 1986.
    Q-3: When does section 404(b), as amended by the Tax Reform Act of 
1984, become effective?
    A-3: With the exceptions discussed below, section 404(b), as 
amended, and the rules under Q&A-2 are effective with respect to amounts 
paid or incurred after July 18, 1984, in taxable years of employers (and 
payors) ending after that date. In the case of an extended vacation pay 
plan maintained

[[Page 536]]

pursuant to a collective bargaining agreement (a) between employee 
representatives and one or more employers, and (b) in effect on June 22, 
1984, section 404(b) is not effective before the date on which such 
collective bargaining agreement terminates (determined without regard to 
any extension thereof agreed to after June 22, 1984). For purposes of 
the preceding sentence, any plan amendment made pursuant to a collective 
bargaining agreement relating to the plan which amends the plan solely 
to conform to any requirement added under section 512 of the Tax Reform 
Act of 1984 shall not be treated as a termination of such collective 
bargaining agreement. For purposes of this section, an ``extended 
vacation pay plan'' is one under which covered employees gradually over 
a specified period of years earn the right to additional vacation 
benefits, no part of which, under the terms of the plan, can be taken 
until the end of the specified period.

[T.D. 8073, 51 FR 4321, Feb. 4, 1986; 51 FR 7262, Mar. 3, 1986; 51 FR 
11303, Apr. 2, 1986, as amended by T.D. 8435, 57 FR 43896, Sept. 23, 
1992]



Sec. 1.404(c)-1  Certain negotiated plans; effect of section 404(c).

    (a) Section 404(a) does not apply to deductions for contributions 
paid by an employer under a negotiated plan which meets the following 
conditions:
    (1) The contributions under the plan are held in trust for the 
purpose of paying, either from principal or income or both, for the 
benefit of employees and their families, at least medical or hospital 
care, and pensions on retirement or death of employees; and
    (2) Such plan was established before January 1, 1954, as a result of 
an agreement between employee representatives and the Government of the 
United States during a period of Government operation, under seizure 
powers, of a major part of the productive facilities of the industry in 
which such employer is engaged.


If these conditions are met, such contributions shall be deductible 
under section 162, to the extent that they constitute ordinary and 
necessary business expenses.
    (b) The term ``as a result of an agreement'' is intended primarily 
to cover a trust established under the terms of an agreement referred to 
in paragraph (a)(2) of this section. It will also include a trust 
established under a plan of an employer, or group of employers, who are 
in competition with the employers whose facilities were seized by reason 
of producing the same commodity, and who would therefore be expected to 
establish such a trust as a reasonable measure to maintain a sound 
position in the labor market producing the commodity. Thus, for example, 
if a trust was established under such an agreement in the bituminous 
coal industry, a similar trust established about the same time in the 
anthracite coal industry would be covered by this provision.
    (c) If any such trust becomes qualified for exemption under section 
501(a), the deductibility of contributions by an employer to such trust 
on or after the date of such qualification would no longer be governed 
by section 404(c), even though the trust may later lose its exemption 
under section 501(a).

[T.D. 6500, 25 FR 11690, Nov. 26, 1960]



Sec. 1.404(d)-1T  Questions and answers relating to deductibility of 
deferred compensation and deferred benefits for independent contractors. 

(Temporary)

    Q-1: How does the amendment of section 404(b) by the Tax Reform Act 
of 1984 affect the deduction of contributions or compensation under 
section 404(d)?
    A-1: As amended by the Tax Reform Act of 1984, section 404(b) 
clarifies that section 404(d) shall govern the deduction of 
contributions paid and compensation paid or incurred by a payor under a 
plan, or method or arrangement, deferring the receipt of compensation or 
providing for deferred benefits for service providers with respect to 
which there is no employer-employee relationship. In such a case, 
section 404 (a) and (b) and the regulations thereunder apply as if the 
person providing the services were the employee and the person to whom 
the services are provided were the employer. Section 404(a) requires 
that such a contribution or compensation be paid or

[[Page 537]]

incurred for purposes of section 162 or 212 and satisfy the requirements 
for deductibility under either of those sections. However, 
notwithstanding the above, section 404 does not apply to contributions 
paid or accrued with respect to a ``welfare benefit fund'' (as defined 
in section 419(e)) after June 18, 1984, in taxable years of employers 
(and payors) ending after that date. Also, section 463 shall govern the 
deduction of vacation pay by a taxpayer that has elected under such 
section. For rules relating to the deduction of contributions paid or 
accrued with respect to a welfare benefit fund, see section 419, Sec. 
1.419-1T and Sec. 1.419A-2T. For rules relating to the deduction of 
vacation pay for which an election is made under section 463, see Sec. 
301.9100-16T of this chapter and Sec. 1.463-1T.

[T.D. 8073, 51 FR 4322, Feb. 4, 1986, as amended by T.D. 8435, 57 FR 
43896, Sept. 23, 1992]



Sec. 1.404(e)-1  Contributions on behalf of a self-employed individual 
to or under a pension, annuity, or profit-sharing plan meeting the 

requirements of section 401; application of section 404(a) (8), (9), 
and (10) and section 404 (e) and (f).

    (a) In general. (1) The Self-Employed Individuals Tax Retirement Act 
of 1962 (76 Stat. 809) permits certain self-employed individuals to be 
treated as employees for purposes of pension, annuity, and profit-
sharing plans included in paragraph (1), (2), or (3) of section 404(a). 
Therefore, for taxable years of an employer beginning after December 31, 
1962, employer contributions to qualified plans on behalf of self-
employed individuals are deductible under section 404 subject to the 
limitations of paragraphs (b) and (c) of this section.
    (2) In the case of contributions to qualified plans on behalf of 
self-employed individuals, the amount deductible differs from the amount 
allowed as a deduction. In general, the amount deductible is 10 percent 
of the earned income derived by the self-employed individual from the 
trade or business with respect to which the plan is established, or 
$2,500, whichever is the lesser. This is the amount referred to in 
section 401 when reference is made to the amounts which may be deducted 
under section 404 or the amount of contributions deductible under 
section 404. Thus, this is the amount taken into consideration in 
determining whether contributions under the plan are discriminatory. The 
amount allowed as a deduction with respect to contributions on behalf of 
a self-employed individual is one-half of the amount deductible. The 
amount allowed as a deduction is relevant only for purposes of 
determining the amount an employer may deduct from gross income.
    (b) Determination of the amount deductible. (1) If a plan covers 
employees, some of whom are self-employed individuals, the determination 
of the amount deductible is made on the basis of independent 
consideration of the common-law employees and of the self-employed 
individuals. See subparagraphs (2) and (3) of this paragraph. For 
purposes of determining the amount deductible with respect to 
contributions on behalf of a self-employed individual, such 
contributions shall be considered to satisfy the conditions of section 
162 (relating to trade or business expenses) or 212 (relating to 
expenses for the production of income), but only to the extent that such 
contributions do not exceed the earned income of such individual derived 
from the trade or business with respect to which the plan is 
established. However, the portion of such contribution, if any, 
attributable to the purchase of life, accident, health, or other 
insurance protection shall be considered payment of a personal expense 
which does not satisfy the requirements of section 162 or 212. See 
paragraph (f) of this section. For the additional rules applicable where 
contributions are made by more than one employer on behalf of a self-
employed individual, see paragraph (d) of this section.
    (2) If contributions are made to a plan included in section 404(a) 
(1), (2), or (3) on behalf of employees, some of whom are self-employed 
individuals, the amount deductible with respect to contributions on 
behalf of the common-law employees covered under the plan shall be 
determined as if such employees were the only employees for whom 
contributions and benefits are provided under the plan. Accordingly, for 
purposes of such determination, the percentage of compensation 
limitations of

[[Page 538]]

section 404(a) (1), (3), and (7) are applicable only with respect to the 
compensation otherwise paid or accrued during the taxable year by the 
employer to the common-law employees. Similarly, the costs referred to 
in section 404(a)(1) (B) and (C) shall be the costs of funding the 
benefits of the common-law employees. Also, the provisions of section 
404(a)(1)(D), (3), and (7), relating to certain carryover deductions, 
shall be applicable only to amounts contributed, or to the amounts 
deductible, on behalf of such employees.
    (3) If contributions are made to a plan included in section 404(a) 
(1), (2), or (3) on behalf of individuals some or all of whom are self-
employed individuals, the amount deductible in any taxable year with 
respect to contributions on behalf of such individuals shall be 
determined as follows:
    (i) The provisions of section 404(a) (1), (2), (3), and (7) shall be 
applied as if such individuals were the only participants for whom 
contributions and benefits are provided under the plan. Thus, the costs 
referred to in such provisions shall be the costs of funding the 
benefits of the self-employed individuals. If such costs are less than 
an amount equal to the amount determined under subdivision (iii) of this 
subparagraph, the maximum amount deductible with respect to such 
individuals shall be the costs of their benefits.
    (ii) The provisions of section 404(a)(1)(D), the second and third 
sentences of section 404(a)(3)(A), and the second sentence of section 
404(a)(7), relating to certain carryover deductions, are not applicable 
to contributions on behalf of self-employed individuals. Contributions 
on behalf of self-employed individuals are deductible, if at all, only 
in the taxable year in which the contribution is paid or deemed paid 
under section 404(a)(6).
    (iii) The amount deductible for the taxable year of the employer 
with respect to contributions on behalf of a self-employed individual 
shall not exceed the lesser of $2,500 or 10 percent of the earned income 
derived by such individual for such taxable year from the trade or 
business with respect to which the plan is established.
    (iv) If a self-employed individual receives in any taxable year 
earned income with respect to which deductions are allowable to two or 
more employers, the aggregate amounts deductible shall not exceed the 
lesser of $2,500 or 10 percent of such earned income. See paragraph (d) 
of this section.
    (c) Special limitation on the amount allowed as a deduction for 
self-employed individuals. The amount allowed as a deduction under 
section 404(a) (1), (2), (3), and (7) in any taxable year with respect 
to contributions made on behalf of a self-employed individual shall be 
an amount equal to one-half of the amount deductible with respect to 
such contributions under paragraph (b)(3) of this section. However, for 
purposes of section 401, the amount which may be deducted, or the amount 
deductible, under section 404 with respect to contributions made on 
behalf of self-employed individuals shall be determined without regard 
to the special limitation of this paragraph.
    (d) Rules applicable where contributions are made by more than one 
employer on behalf of a self-employed individual. (1) Under paragraph 
(b)(3)(iv) of this section, if a self-employed individual receives in 
any taxable year earned income with respect to which deductions are 
allowable to two or more employers, the aggregate amounts deductible 
shall not exceed the lesser of $2,500 or 10 percent of such earned 
income. This limitation does not apply to contributions made under a 
plan on behalf of an employee who is not self-employed in the trade or 
business with respect to which the plan is established, even though such 
employee may be covered as a self-employed individual under a plan or 
plans established by other trades or businesses.
    (2) In any case in which the application of subparagraph (1) of this 
paragraph reduces the amount otherwise deductible, the amount deductible 
by each employer shall be that amount which bears the same ratio to the 
aggregate amount deductible with respect to all trades or businesses (as 
determined in subparagraph (1) of this paragraph) as the earned income 
derived from that employer bears to the aggregate of the earned income 
derived from all of the trades or businesses

[[Page 539]]

with respect to which plans are established. The amount allowed as a 
deduction to each employer is one-half of the amount determined (in 
accordance with the preceding sentence) to be deductible by such 
employer.
    (e) Partner's distributive share of contributions and deductions. 
For purposes of sections 702(a)(8) and 704, a partner's distributive 
share of contributions on behalf of self-employed individuals under a 
qualified pension, annuity, or profit-sharing plan is the contribution 
made on his behalf, and his distributive share of deductions allowed the 
partnership under section 404 for contributions on behalf of self-
employed individuals is that portion of the deduction which is 
attributable to contributions made on his behalf under the plan. The 
contribution on behalf of a partner and the deduction with respect 
thereto must be accounted for separately by such partner, for his 
taxable year with or within which the partnership's taxable year ends, 
as an item described in section 702(a)(8).
    (f) Contributions allocable to insurance protection. For purposes of 
determining the amount deductible with respect to contributions on 
behalf of a self-employed individual, amounts allocable to the purchase 
of life, accident, health, or other insurance protection shall not be 
taken into account. Such amounts are neither deductible nor considered 
as contributions for purposes of determining the maximum amount of 
contributions that may be made on behalf of an owner-employee. The 
amount of a contribution allocable to insurance shall be an amount equal 
to a reasonable net premium cost, as determined by the Commissioner, for 
such amount of insurance for the appropriate period. See paragraph 
(b)(5) of Sec. 1.72-16.
    (g) Rules applicable to loans. For purposes of section 404, any 
amount paid, directly or indirectly, by an owner-employee in repayment 
of any loan which under section 72(m)(4)(B) was treated as an amount 
received from a qualified trust or plan shall be treated as a 
contribution to such trust or under such plan on behalf of such owner-
employee.
    (h) Definitions. For purposes of section 404 and the regulations 
thereunder--
    (1) The term ``employee'' includes an employee as defined in section 
401(c)(1) and paragraph (b) of Sec. 1.401-10, and the term ``employer'' 
means the person treated as the employer of such individual under 
section 401(c)(4);
    (2) The term ``owner-employee'' means an owner-employee as defined 
in section 401(c)(3) and paragraph (d) of Sec. 1.401-10;
    (3) The term ``earned income'' means earned income as defined in 
section 401(c)(2) and paragraph (c) of Sec. 1.401-10; and
    (4) The term ``compensation'' when used with respect to an 
individual who is an employee described in subparagraph (1) of this 
paragraph shall be considered to be a reference to the earned income of 
such individual derived from the trade or business with respect to which 
the plan is established.
    (i) Years to which this section applies. This section applies to 
taxable years of employers beginning before January 1, 1974. For taxable 
years beginning after December 31, 1973, see Sec. 1.404(e)-1A.

[T.D. 6673, 28 FR 10145, Sept. 17, 1963; as amended by T.D. 7636, 44 FR 
47056, Aug. 10, 1979]



Sec. 1.404(e)-1A  Contributions on behalf of a self-employed individual 
to or under a qualified pension, annuity, or profit-sharing plan.

    (a) In general. This section provides rules relating to employer 
contributions to qualified plans on behalf of self-employed individuals 
described in subsections (a) (8) and (9), (e), and (f) of section 404. 
Unless otherwise specifically provided, this section applies to taxable 
years of an employer beginning after December 31, 1973. See section 
1.404(e)-1 for rules relating to plans for self-employed individuals for 
taxable years beginning before January 1, 1974. Paragraph (b) of this 
section provides general rules of deductibility, paragraph (c) provides 
rules relating to defined contribution plans, paragraph (d) provides 
rules relating to defined benefit plans, paragraph (e) provides rules 
relating to combinations of plans, paragraph (f) provides rules for 
partnerships, paragraph (g) provides rules for insurance, paragraph (h) 
provides

[[Page 540]]

rules for loans, and paragraph (i) provides definitions.
    (b) Determination of the amount deductible. (1) If a defined 
contribution plan covers employees, some of whom are self-employed 
individuals, the determination of the amount deductible is made on the 
basis of independent consideration of the common-law employees and of 
the self-employed individuals. See subparagraphs (2) and (3) of this 
paragraph. For purposes of determining the amount deductible with 
respect to contributions on behalf of a self-employed individual, such 
contributions shall be considered to satisfy the conditions of section 
162 (relating to trade or business expenses) or 212 (relating to 
expenses for the production of income), but only to the extent that such 
contributions do not exceed the earned income of such individual derived 
from the trade or business with respect to which the plan is 
established. However, the portion of such contribution, if any, 
attributable to the purchase of life, accident, health, or other 
insurance protection shall be considered payment of a personal expense 
which does not satisfy the requirements of section 162 or 212. See 
paragraph (g) of this section.
    (2)(i) If contributions are made on behalf of employees, some of 
whom are self-employed individuals, to a defined contribution plan 
described in section 414(i) and included in section 404(a) (1), (2), or 
(3), the amount deductible with respect to contributions on behalf of 
the common-law employees covered under the plan shall be determined as 
if such employees were the only employees for whom contributions and 
benefits are provided under the plan. Accordingly, for purposes of such 
determination, the percentage of compensation limitations of section 
404(a) (3) and (7) are applicable only with respect to the compensation 
otherwise paid or accrued during the taxable year by the employer with 
respect to the common-law employees. Similarly, the costs referred to in 
section 404(a)(1) (A) and (B) shall be the costs of funding the benefits 
of the common-law employees. Also, the provisions of section 
404(a)(1)(D), (3), and (7), relating to certain carryover deductions, 
shall be applicable only to amounts contributed or to the amounts 
deductible on behalf of such employees.
    (ii) The amount deductible, by reason of contributions on behalf of 
employees to a defined benefit plan, shall be determined without regard 
to the self-employed or common law status of each employee.
    (3)(i) If contributions are made on behalf of individuals, some or 
all of whom are self-employed individuals, to a defined contribution 
plan described in section 414(i) and included in section 404(a) (1), 
(2), or (3), the amount deductible in any taxable year with respect to 
contributions on behalf of such individuals shall be determined as 
follows:
    (A) The provisions of section 404(a) (1), (2), (3), and (7) shall be 
applied as if such individuals were the only participants for whom 
contributions and benefits are provided under the plan. Thus, the costs 
referred to in such provisions shall be the costs of funding the 
benefits of the self-employed individuals. If such costs are less than 
an amount equal to the amount determined under paragraph (c) of this 
section, the maximum amount deductible with respect to such individuals 
shall be the cost of their benefits.
    (B) The provisions of section 404(a) (1), (D), the third sentence of 
section 404(a) (3), (A), and the second sentence of section 404(a)(7), 
relating to certain carryover deductions are applicable to contributions 
on behalf of self-employed individuals made in taxable years of an 
employer beginning after December 31, 1975.
    (C) For any employer taxable year in applying the 15 percent limit 
on deductible contributions set forth section in 404(a)(3) and the 25 
percent limit in section 404(a)(7) for any taxable year of the employer, 
the amount deductible under section 404(e)(4) and paragraph (c)(4) of 
this section (relating to the minimum deduction of $750 or 100 percent 
of earned income) shall be substituted for such limits with respect to 
the self-employed individuals on whose behalf contributions are 
deductible under section 404(e)(4) for the taxable year of the employer. 
In addition, although the limitations of section 415 are applicable to 
the plan for plan years beginning after December 31,

[[Page 541]]

1975, the defined contribution compensation limitation described in 
section 415(c)(1)(B) shall not be less than the amount deductible under 
section 404(e)(4) and paragraph (c)(4) of this section with respect to 
any self-employed individual for the taxable year of the employer wnding 
with or within the limitation year. The special rule in the second 
sentence of paragraph (3)(A) of section 404(a) is not applicable in 
determining the amounts deductible on behalf of self-employed 
individuals.
    (ii) The limitations of this subparagraph are not applicable to a 
defined benefit plan for self-employed individuals.
    (c) Defined contribution plans. (1) Under section 404(e)(1) in the 
case of a defined contribution plan, as defined in section 414(i), the 
amount deductible for the taxable year of the employer with respect to 
contributions on behalf of a self-employed individual shall not exceed 
the lesser of $7,500 or 15 percent of the earned income derived by such 
individual for such taxable year from the trade or business with respect 
to which the plan is established.
    (2) Under section 404(e)(2)(A) if a self-employed individual 
receives in any taxable year earned income with respect to which 
deductions are allowable to two or more employers under two or more 
defined contribution plans the aggregate amounts deductible shall not 
exceed the lesser of $7,500 or 15 percent of such earned income. This 
limitation does not apply to contributions made under a plan on behalf 
of an employee who is not self-employed in the trade or business with 
respect to which the plan is established.
    (3) Under section 404(e)(2)(B) in any case in which the applicable 
limitation of subparagraph (2) of this paragraph reduces the amount 
otherwise deductible with respect to contributions on behalf of any 
employee within the meaning of section 401(c)(1), the amount deductible 
by each employer for such employee shall be that amount which bears the 
same ratio to the aggregate amount deductible for such employee with 
respect to all trades or businesses (as determined in subparagraph (1) 
of this paragraph) as his earned income derived from the employer bears 
to the aggregate of his earned income derived from all of the trades or 
businesses with respect to which plans are established.
    Under section 404(e)(4), notwithstanding the provisions of 
subparagraphs (1) and (2) of this paragraph, the limitations on the 
amount deductible for the taxable year of the employer with respect to 
contributions on behalf of a self-employed individual shall not be less 
than the lesser of $750 or 100 percent of the earned income derived by 
such individual for such taxable year from the trade or business with 
respect to which the plan is established. If such individual receives in 
any taxable year earned income with respect to which deductions are 
allowable to two or more employers, 100 percent of such earned income 
shall be taken into account for purposes of the limitations determined 
under this subparagraph. This subparagraph does not apply to any taxable 
year beginning after December 31, 1975, to any employee whose adjusted 
gross income for that taxable year is greater than $15,000. In applying 
the preceding sentence, the adjusted gross income of an employee for a 
taxable year is determined separately for each individual, without 
regard to any community property laws, and without regard to the 
deduction allowable under section 404(a).
    (d) Defined benefit plans. In the case of a defined benefit plan, as 
defined in section 401(j), the special limitations provided by section 
404(e) and paragraph (c) of this section do not apply. See section 
401(j) for requirements applicable to defined benefit plans.
    (e) Combination of plans. For special rules applied if a self-
employed individual in any taxable year is a paraticipant in both a 
defined benefit plan and a defined contribution plan, see section 401(j) 
and the regulations thereunder.
    (f) Partner's distributive share of contributions and deductions. 
(1) For purposes of sections 702(a)(8) and 704 in the case of a defined 
contribution plan, a partner's distributive share of contributions on 
behalf of self-employed individuals under such a plan is the 
contribution made on his behalf, and his distributive share of 
deductions allowed the partnership under section 404 for contributions 
on behalf of a self-

[[Page 542]]

employed individual is that portion of the deduction which is 
attributable to contributions made on his behalf under the plan. The 
contribution on behalf of a partner and the deduction with respect 
thereto must be accounted for separately by such partner, for his 
taxable year with or within which the partnership's taxable year ends, 
as an item described in section 702(a)(8).
    (2) In the case of a defined benefit plan, a partner's distributive 
share of contributions on behalf of self-employed individuals and his 
distributive share of deductions allowed the partnership under section 
404 for such contributions is determined in the same manner as his 
distributive share of partnership taxable income. See section 704, 
relating to the determination of the distributive share and the 
regulations thereunder.
    (g) Contributions allocable to insurance protection. Under Section 
404(e)(3), for purposes of determining the amount deductible with 
respect to contributions on behalf of a self-employed individual, 
amounts allocable to the purchase of life, accident, health, or other 
insurance protection shall not be taken into account. Such amounts are 
neither deductible nor considered as contributions for purposes of 
determining the maximum amount of contributions that may be made on 
behalf of an owner-employee. The amount of a contribution allocable to 
insurance shall be an amount equal to a reasonable net premium cost, as 
determined by the Commissioner, for such amount of insurance for the 
appropriate period. See paragraph (b)(5) of Sec. 1.72-16.
    (h) Rules applicable to loans. Under section 404(f), for purposes of 
section 404, any amount paid, directly or indirectly, by an owner-
employee in repayment of any loan which under section 72(m)(4)(B) was 
treated as an amount recieved from a qualified trust or plan shall be 
treated as a contribution to such trust or under such plan on behalf of 
such owner-employee.
    (i) Definitions. Under section 404(a)(8), for purposes of section 
404 and the regulations thereunder--
    (1) The term ``employee'' includes an employee as defined in section 
401(c)(1) and the term ``employer'' means the person treated as the 
employer of such individual under section 401(c)(4);
    (2) The term ``owner-employee'' means an owner-employee as defined 
in section 401(c)(3);
    (3) The term ``earned income'' means earned income as defined in 
section 401(c)(2); and
    (4) The term ``compensation'' when used with respect to an 
individual who is an employee described in subparagraph (1) of this 
paragraph shall be considered to be a reference to the earned income of 
such individual derived from the trade or business with respect to which 
the plan is established.

[T.D. 7636, 44 FR 47056, Aug. 10, 1979]



Sec. 1.404(g)-1  Deduction of employer liability payments.

    (a) General rule. Employer liability payments shall be treated as 
contributions to a stock bonus, pension, profit-sharing, or annuity plan 
to which section 404 applies. Such payments that satisfy the limitations 
of this section shall be deductible under section 404 when paid without 
regard to any other limitations in section 404.
    (b) Employer liability payments. For purposes of this section, 
employer liability payments mean:
    (1) Any payment to the Pension Benefit Guaranty Corporation (PBGC) 
for termination or withdrawal liability imposed under section 4062 
(without regard to section 4062(b)(2)), 4063, or 4064 of the Employee 
Retirement Insurance Security Act of 1974 (ERISA). Any bond or escrow 
payment furnished under section 4063 of ERISA shall not be considered as 
a payment of liability until applied against the liability of the 
employer.
    (2) Any payment to a non-multiemployer plan pursuant to a commitment 
to the PBGC made in accordance with PBGC Determination of Plan 
Sufficiency and Termination of Sufficient Plans. See PBGC regulations, 
29 CFR 2617.13(b) for rules concerning these commitments. Such payments 
shall not exceed an amount necessary to provide for, and used to fund, 
the benefits guaranteed under section 4022 of ERISA.
    (3) Any payment to a multiemployer plan for withdrawal liability 
imposed

[[Page 543]]

under part 1 of subtitle E of title IV of ERISA. Any bond or escrow 
payment furnished under such part shall not be considered as a payment 
of liability until applied against the liability of the employer.
    (c) Limitations, etc.--(1) Permissible expenses. A payment shall be 
deductible under section 404(g) and this section only if the payment 
satisfies the conditions of section 162 or section 212. Payments made by 
an entity which is liable for such payments because it is a member of a 
commonly controlled group of corporations, or trades or businesses, 
within the meaning of section 414 (b) or (c), shall not fail to satisfy 
such conditions merely because the entity did not directly employ 
participants in the plan with respect to which the liability payments 
were made.
    (2) Qualified plan. A payment shall be deductible under section 
404(g) and this section only if the payment is made in a taxable year of 
the employer ending within or with a taxable year of the trust for which 
the trust is exempt under section 501(a). For purposes of this 
paragraph, the payment timing rules of section 404(a)(6) shall apply.
    (3) Full funding limitation. (i) If the employer liability payment 
is to a plan, the total amount deductible for such payment and for other 
plan contributions may not exceed an amount equal to the full funding 
limitation as defined in section 412(c)(7) for the taxable year with 
respect to which the contributions are deemed made under section 404.
    (ii) If the total contributions to the plan for the taxable year 
including the employer liability payment exceed the amount equal to this 
full funding limitation, the employer liability payment shall be 
deductible first.
    (iii) Any amount paid in a taxable year in excess of the amount 
deductible in such year under the full funding limitation shall be 
treated as a liability payment and be deductible in the succeeding 
taxable years in order of time to the extent of the difference between 
the employer liability payments made in each succeeding year and the 
maximum amount deductible for such year under the full funding 
limitation.
    (4) Maximum deduction allowable under section 404. The amount 
deductible under section 404 is limited to the higher of the maximum 
amount deductible by the employer under section 404(a) or the amount 
otherwise deductible under section 404(g). If the contributions are to a 
plan to which more than one employer contributes, this limit shall apply 
to each employer separately rather than all employers in the aggregate. 
Thus, each employer may deduct the greater of its allocable share of the 
deduction determined under sections 404(a) and 413(b)(7) or 413(c)(6) or 
its allocable share of the amount deductible under section 404(g). 
However, pursuant to the rule in subdivision (ii) of subparagraph (3), 
in determining each employer's allocable share under section 404(a), the 
total amount deductible under section 404(a) by all employers shall not 
exceed the difference between the full funding limitation and the total 
amount deductible by all employers under section 404(g).
    (5) Example. The provisions of this paragraph may be illustrated by 
the following example:

    Example. In the 1983 taxable year, Employer A makes a withdrawal 
liability payment of $700,000 to multiemployer Plan X to which Employer 
A and Employer B are required to contribute. Employer A's allocable 
share of the deduction allowable under sections 404(a) and 413(b)(7) in 
the 1983 taxable year is $600,000. Employer B's allocable share of the 
deduction allowable under section 404(a) and 413(b)(7) in the 1983 
taxable year is $400,000.
    The full funding limitation for the 1983 taxable year is $1,000,000. 
Based on paragraph (c)(4) of this section, Employer A may deduct 
$700,000, the amount of the withdrawal liability payment. However, the 
deduction of Employer B is limited to $300,000, the difference between 
the full funding limitation and the amount deductible under section 
404(g).

    (d) Effective date etc.--(1) General rule. This section is effective 
for employer payments made after September 25, 1980.
    (2) Transitional rule. For employer payments made before September 
26, 1980, for purposes of section 404, any amount paid by an employer 
under section 4062, 4063, or 4064 of the Employee Retirement Income 
Security Act of 1974 shall be treated as a contribution to which section 
404 applies by such

[[Page 544]]

employer to or under a stock bonus, pension, profit-sharing, or annuity 
plan.

[T.D. 8085, 51 FR 16297, May 2, 1986]



Sec. 1.404(k)-1T  Questions and answers relating to the deductibility 
of certain dividend distributions. (Temporary)

    Q-1: What does section 404(k) provide?
    A-1: Section 404(k) allows a corporation a deduction for dividends 
actually paid in accordance with section 404(k)(2) with respect to stock 
of such corporation held by an employee stock ownership plan (as defined 
in section 4975(e)(7)) maintained by the corporation (or by any other 
corporation that is a member of a ``controlled group of corporations'' 
within the meaning of section 409(l)(4) that includes the corporation), 
but only if such dividends may be immediately distributed under the 
terms of the plan and all of the applicable qualification and 
distribution rules. The deduction is allowed under section 404(k) for 
the taxable year of the corporation during which the dividends are 
received by the participants.
    Q-2: Is the deductibility of dividends paid to plan participants 
under section 404(k) affected by a plan provision which permits 
participants to elect to receive or not receive payment of dividends?
    A-2: No. Dividends actually paid in cash to plan participants in 
accordance with section 404(k) are deductible under section 404(k) 
despite such an election provision.
    Q-3: Are dividends paid in cash directly to plan participants by the 
corporation and dividends paid to the plan and then distributed in cash 
to plan participants under section 404(k) treated as distributions under 
the plan holding stock to which the dividends relate for purposes of 
sections 72, 401 and 402?
    A-3: Generally, yes. However, a deductible dividend under section 
404(k) is treated for purposes of section 72 as paid under a contract 
separate from any other contract that is part of the plan. Thus, a 
deductible dividend is treated as a plan distribution and as paid under 
a separate contract providing only for payment of deductible dividends. 
Therefore, a deductible dividend under section 404(k) is a taxable plan 
distribution even though an employee has unrecovered employee 
contributions or basis in the plan.

[T.D. 8073, 51 FR 4322, Feb. 4, 1986]



Sec. 1.404(k)-3  Disallowance of deduction for reacquisition payments.

    Q-1: Are payments to reacquire stock held by an ESOP applicable 
dividends that are deductible under section 404(k)(1)?
    A-1: (a) Payments to reacquire stock held by an ESOP, including 
reacquisition payments that are used to make benefit distributions to 
participants or beneficiaries, are not deductible under section 404(k) 
because--
    (1) Those payments do not constitute applicable dividends under 
section 404(k)(2); and
    (2) The treatment of those payments as applicable dividends would 
constitute, in substance, an avoidance or evasion of taxation within the 
meaning of section 404(k)(5).
    (b) See also Sec. 1.162(k)-1 concerning the disallowance of 
deductions for amounts paid or incurred by a corporation in connection 
with the reacquisition of its stock from an ESOP.
    Q-2: What is the effective date of this section?
    A-2: This section applies with respect to payments to reacquire 
stock that are made on or after August 30, 2006.

[T.D. 9282, 71 FR 51474, Aug. 30, 2006]



Sec. 1.405-1  Qualified bond purchase plans.

    (a) Introduction. Section 405 relates to the requirements for 
qualification of, and the tax treatment of funds contributed to, 
retirement plans of an employer for the benefit of his employees which 
are funded through the purchase of United States retirement plan bonds. 
Such bonds may be purchased under a qualified bond purchase plan 
described in section 405(a) and paragraph (b) of this section. The 
qualified bond purchase plan is an alternative method of providing some 
of the deferred compensation benefits provided by plans described in 
section 401. In addition, retirement bonds may be purchased under a 
qualified pension or profit-sharing plan described in section

[[Page 545]]

401. A qualified bond purchase plan or a qualified pension or profit-
sharing plan under which retirement bonds are purchased may cover only 
common-law employees, self-employed individuals, or both. A qualified 
bond purchase plan may be established after December 31, 1962, and 
retirement bonds may be purchased by a qualified pension or profit-
sharing plan after December 31, 1962. For the terms and conditions of 
the retirement bonds, see section 405(b) and Treasury Department 
Circular, Public Debt Series--No. 1-63.
    (b) Qualified bond purchase plans. (1) A qualified bond purchase 
plan is a definite written program and arrangement which is communicated 
to the employees and established and maintained by an employer solely to 
purchase for and distribute to his employees or their beneficiaries 
retirement bonds. These bonds must be purchased in the name of the 
employee on whose behalf the contributions are made. The plan must be a 
permanent plan which meets the requirements of section 401(a) (3), (4), 
(5), (6), (7), (8), (16), and (19), and, if applicable, the requirements 
of section 401(a) (9) and (10) and of section 401(d) (other than 
paragraphs (1), (5)(B), (8), (16), and (19)). The rules set forth in the 
regulations relating to those provisions shall be applicable to 
qualified bond purchase plans.
    (2) A qualified bond purchase plan must provide that an employee's 
right to the proceeds of a bond purchased in his name are nonforfeitable 
and will in no event inure to the benefit of the employer or be 
reallocated in any manner.
    (c) Benefits under a qualified bond purchase plan. (1) Except as 
provided in subparagraph (2) of this paragraph, a qualified bond 
purchase plan must conform to the definition of a pension plan in 
paragraph (b)(1)(i) of Sec. 1.401-1, or the definition of a profit-
sharing plan in paragraph (b)(1)(ii) of Sec. 1.401-1. For example, if 
the qualified bond purchase plan is a profit-sharing plan, the plan must 
include the definite allocation formula described in paragraph 
(b)(1)(ii) of Sec. 1.401-1. In addition, if such a profit-sharing plan 
covers any owner-employee, the plan must also include the definite 
contribution formula described in section 401(d)(2)(B).
    (2)(i) Under a qualified bond purchase plan, the bonds may be 
distributed to the employees at any time, and the plan need not prohibit 
the distribution or redemption of the bonds until the retirement of the 
employee. Accordingly, even though a qualified bond purchase plan is 
designed as a pension plan, it need not provide systematically for the 
payment of definitely determinable benefits. However, provisions for 
distribution must apply in a nondiscriminatory manner.
    (ii) A qualified bond purchase plan which is designed as a pension 
plan may not contain a formula for contributions or benefits which might 
require the reallocation of amounts to an employee's credit or which 
might provide for the reversion of any amounts to the employer.
    (d) Contributions under a qualified bond purchase plan. (1) The 
retirement bonds will be issued in the denominations of $50, $100, $500, 
and $1,000. Therefore, the contribution otherwise called for under the 
plan may not coincide with an amount that can be invested in retirement 
bonds. Accordingly, the plan must provide that the contributions on 
behalf of an individual employee for any year shall be rounded to the 
nearest multiple of $50.
    (2) Since the employee's rights to any bonds purchased for him under 
a qualified bond purchase plan must be nonforfeitable, a qualified bond 
purchase plan must, in order to conform to the requirements of section 
401(a)(4) with respect to the early termination of the plan, restrict 
the contributions on behalf of any employee to the amount which could be 
allocated to him under paragraph (c) of Sec. 1.401-4.
    (e) Definitions. For purposes of this section and Sec. Sec. 1.405-2 
and 1.405-3--
    (1) The term ``employee'' includes an employee as defined in section 
401(c)(1) and paragraph (b) of Sec. 1.401-10, and the term ``employer'' 
means the person treated as the employer of such individual under 
section 401(c)(4);
    (2) The term ``owner-employee'' means an owner-employee as defined 
in section 401(c)(3) and paragraph (d) of Sec. 1.401-10;
    (3) The term ``earned income'' means earned income as defined in 
section

[[Page 546]]

401(c)(2) and paragraph (c) of Sec. 1.401-10; and
    (4) The term ``retirement bond'' means a United States Retirement 
Plan Bond, as described in section 405(b) and Treasury Department 
Circular, Public Debt Series--No. 1-63.

[T.D. 6675, 28 FR 10131, Sept. 17, 1963, as amended by T.D. 7748, 46 FR 
1697, Jan. 7, 1981]



Sec. 1.405-2  Deduction of contributions to qualified bond purchase 
plans.

    (a) In general. An employer shall be allowed a deduction for 
contributions paid to or under a qualified bond purchase plan in the 
same manner and to the same extent as if such contributions were made to 
a trust described in section 401(a) which is exempt from tax under 
section 501(a). A deduction will be allowed only for the taxable year in 
which the contributions are paid, or treated as paid, except as provided 
by section 404(a) (1), (3), and (7). For purposes of the deduction, a 
contribution is paid at the time the application for the bond is made 
and the full purchase price paid.
    (b) Rules for applying section 404. If a qualified bond purchase 
plan is designed as a pension plan as defined in paragraph (b)(1)(i) of 
Sec. 1.401-1, the limitations of section 404 applicable to qualified 
pension trusts shall apply. See Sec. Sec. 1.404(a)-3 through 1.404(a)-
7. Similarly, if a qualified bond purchase plan is designed as a profit-
sharing plan as defined in paragraph (b)(1)(ii) of Sec. 1.401-1, the 
limitations of section 404 applicable to qualified profit-sharing trusts 
shall apply. See Sec. Sec. 1.404(a)-9 and 1.404(a)-10. In addition, if 
a qualified bond purchase plan designed as a pension plan covers some or 
all of the employees who are covered by a qualified profit-sharing plan 
established and maintained by the same employer, or if a qualified bond 
purchase plan which is designed as a profit-sharing plan covers some or 
all the employees who are also covered by a qualified pension or annuity 
plan established and maintained by the same employer, section 404(a)(7) 
is applicable. See Sec. 1.404(a)-(13). Furthermore, if a qualified bond 
purchase plan covers employees some or all of whom are employees within 
the meaning of section 401(c)(1), the provisions of section 404(a) (8), 
(9), and (10) and 404(e) shall also apply.
    (c) Accrual method taxpayers. In the case of a taxpayer using the 
accrual method of accounting, a contribution to a qualified bond 
purchase plan will be deemed paid on the last day of the year of accrual 
if--
    (1) During the taxable year of accrual the taxpayer incurs a 
liability to make the contribution, the amount of which is accruable 
under section 461 for such taxable year, and
    (2) Payment is in fact made no later than the time prescribed by the 
law for filing the return for the taxable year of accrual (including 
extensions thereof).

[T.D. 6675, 28 FR 10131, Sept. 17, 1963]



Sec. 1.405-3  Taxation of retirement bonds.

    (a) In general. (1) As in the case of employer contributions under a 
qualified pension, annuity, profit-sharing, or stock bonus plan, 
employer contributions on behalf of his common-law employees under a 
qualified bond purchase plan are not includible in the gross income of 
the employees when made, and employer contributions on behalf of self-
employed individuals are deductible as provided in section 405(c) and 
Sec. 1.405-2. Further, an employee or his beneficiary does not realize 
gross income upon the receipt of a retirement bond pursuant to a 
qualified bond purchase plan or from a trust described in section 401(a) 
which is exempt from tax under section 501(a). Upon redemption of such a 
bond, ordinary income will be realized to the extent the proceeds 
thereof exceed the basis (determined in accordance with paragraph (b) of 
this section) of the bond. The proceeds of a retirement bond are not 
entitled to the special tax treatment of section 72(n) and Sec. 1.72-
18.
    (2) In the event a retirement bond is surrendered for partial 
redemption and reissuance of the remainder, the person surrendering the 
bond shall be taxable on the proceeds received to the extent such 
proceeds exceed the basis in the portion redeemed. In such case, the 
basis shall be determined (in accordance with paragraph (b) of this 
section) as if the portion redeemed and the portion reissued had been 
issued as separate bonds.

[[Page 547]]

    (3) In the event a retirement bond is redeemed after the death of 
the registered owner, the amount taxable (as determined in accordance 
with subparagraph (1) of this paragraph) is income in respect of a 
decedent under section 691.
    (4) The provisions of section 402(a)(2) are not applicable to a 
retirement bond. In general, section 402(a)(2) provides for capital 
gains treatment of certain distributions from a qualified trust which 
constitute the total distributions payable with respect to any employee. 
The proceeds of a retirement bond received upon redemption will not be 
entitled to such capital gain treatment even though the bond is received 
as a part of, or as the whole of, such a total distribution. Nor will 
such a bond be taken into consideration in determining whether the 
distribution represents the total amount payable by the trust with 
respect to an employee. Thus, a distribution by a qualified trust may 
constitute a total distribution payable with respect to an employee for 
purposes of section 402(a)(2) even though the trust retains retirement 
bonds registered in the name of such employee.
    (b) Basis. (1) This paragraph is applicable in determining the basis 
of any retirement bond distributed pursuant to a qualified bond purchase 
plan or distributed by a trust qualifying under section 401. In the case 
of such a bond purchased for an individual at the time he is a common-
law employee, the basis is that portion of the purchase price 
attributable to employee contributions. In the case of such a bond 
purchased for an individual at the time he is a self-employed 
individual, the basis shall be determined under subparagraph (3) of this 
paragraph.
    (2) At the time a retirement bond is purchased, there shall be 
indicated on the application for the retirement bond whether the 
individual for whom the retirement bond is purchased is a common-law 
employee or a self-employed individual, and in the case of common-law 
employees the amount of the purchase price, if any, attributable to the 
employee's contribution. The answers to these questions will appear on 
the retirement bond, and when the retirement bond is purchased for a 
common-law employee, the basis for the retirement bond is presumed to be 
the amount of the purchase price which the retirement bond indicates was 
contributed by the employee.
    (3)(i) Except as provided in subdivision (ii) of this subparagraph, 
for purposes of determining the basis of retirement bonds purchased for 
an individual while he was a self-employed individual, all such bonds 
redeemed during a taxable year shall be considered in the aggregate as a 
single retirement bond. The basis of such retirement bonds shall be the 
difference between the aggregate of their face amounts and the lesser 
of:
    (A)1 One-half the aggregate of their face amounts, or
    (B) The aggregate of the unused amounts allowed as a deduction at 
the end of the taxable year (as determined in subparagraph (4) of this 
paragraph).
    (ii) The basis of a retirement bond purchased for a self-employed 
individual which is redeemed after his death is the amount determined by 
multiplying the face amount of such retirement bond by a fraction--
    (A) The numerator of which is the aggregate of the face amounts of 
all the bonds registered in the individual's name at his death which 
were purchased while he was a self-employed individual reduced by the 
aggregate of the unused amounts allowed as a deduction at his death (as 
determined in subparagraph (4) of this paragraph), and
    (B) The denominator of which is the aggregate of the face amounts of 
all such bonds.
    (4)(i) In the case of retirement bonds purchased under a qualified 
bond purchase plan, the aggregate of the unused amounts allowed as a 
deduction at the end of any taxable year shall be an amount equal to the 
total of the amounts allowable for such taxable year, and the amounts 
allowed in all prior taxable years, as a deduction under section 405(c) 
for contributions used to purchase retirement bonds for the registered 
owner while he was a self-employed individual, reduced by an amount 
equal to the portion of the face amounts of such retirement bonds 
redeemed in prior taxable years which

[[Page 548]]

were included in the registered owner's gross income.
    (ii) In the case of retirement bonds purchased by a trust described 
in section 401(a) and exempt under section 501(a), there shall be 
allocated to the retirement bond the deduction under section 404 
attributable to the contributions used to purchase the retirement bond. 
The amount so allocated shall be treated in the same manner as the 
deduction allowed under section 405(c) for purposes of computing the 
unused amounts allowed as a deduction under subdivision (i) of this 
subparagraph. Further, the amount so allocated shall not be included in 
the investment in the contract for purposes of section 72 in determining 
the portion of the other assets distributed by the trust included in 
gross income.
    (5) The application of the rule of subparagraphs (3) and (4) of this 
paragraph may be illustrated by the following examples:

    Example 1. B, a self-employed individual, adopts a qualified bond 
purchase plan in 1963. During 1963 the plan purchased $2,000 worth of 
retirement bonds in his name. As a result of overestimating his income 
for 1963, only $400 was allowed B as a deduction pursuant to section 
405(c). In 1964, prior to B's retirement in June of that year, the plan 
purchased a $500 retirement bond in B's name for which a deduction was 
allowable pursuant to section 405(c) in the amount of $250. B redeemed a 
retirement bond with a face amount of $500 in September of 1964 and 
another with a face amount of $500 in October of 1964. Of the proceeds 
received in 1964 from the redemption of the bonds, $1,000 plus interest, 
B shall exclude from his gross income $500 (face amount of the 
retirement bonds, $1,000, less $500, one-half of the face amount, the 
latter being less than the aggregate of the unused amounts allowed as a 
deduction, $250 allowable for the taxable year in which the bonds were 
redeemed plus $400, the unused amounts allowed in prior taxable years, 
or $650). The aggregate of the unused amounts allowed as a deduction 
shall be reduced by the amount so excluded ($650-$500=$150). During the 
following year, B redeems another retirement bond with a face amount of 
$500. Of the proceeds received from the redemption of such retirement 
bond, $500 plus interest, B shall exclude from his gross income $350 
(face amount of the retirement bonds, $500, less $150, the aggregate of 
the unused amounts allowed as a deduction, the latter being less than 
one-half of the face amount of the bond, $250). The aggregate of the 
unused amounts allowed as a deduction is reduced to zero ($150-$150=0). 
Upon redemption of the remaining retirement bonds registered in B's 
name, B shall exclude from his gross income with respect to such 
proceeds an amount equal to the face amounts of the bonds redeemed.
    Example 2. C, a self-employed individual, participated in a 
qualified bond purchase plan during the years 1963 through 1966. The 
plan purchased in his name retirement bonds in the aggregate of $10,000. 
C deducted $4,000 from his gross income for the four years ($1,000 for 
each year) with respect to the purchase of such retirement bonds. C 
retired in December of 1966 and during the following year redeemed one 
retirement bond with a face amount of $1,000. C excluded from his gross 
income $500 of the proceeds of the bond. C died without redeeming any of 
the remaining retirement bonds registered in his name. The basis of each 
remaining retirement bond shall be determined by multiplying the face 
amount of each retirement bond by $5,500/$9,000. The numerator is the 
aggregate of the face amounts registered in C's name (as a self-employed 
individual) at his death, $9,000, reduced by the aggregate of the unused 
amounts allowed as a deduction at his death, $3,500 (amounts allowed as 
a deduction under section 405(c), $4,000, reduced by the portion of the 
face amount of the retirement bond redeemed by C which was included in 
C's gross income, $500), or $5,500. The denominator is the face amount 
of the retirement bonds registered in his name as a self-employed 
individual at his death, $9,000.

[T.D. 6675, 28 FR 10131, Sept. 17, 1963]



Sec. 1.406-1  Treatment of certain employees of foreign subsidiaries 
as employees of the domestic corporation.

    (a) Scope--(1) General rule. For purposes of applying the rules in 
part 1 of subchapter D of chapter 1 of subtitle A of the Code and the 
regulations thereunder with respect to a pension, profit-sharing, or 
stock bonus plan described in section 401(a), an annuity plan described 
in section 403(a), or a bond purchase plan described in section 405(a), 
of a domestic corporation, an individual who is a citizen of the United 
States and who is an employee of a foreign subsidiary (as defined in 
section 3121(1)(8) and the regulations thereunder) of such domestic 
corporation shall be treated as an employee of such domestic corporation 
if the requirements of paragraph (b) of this section are satisfied.
    (2) Cross-references. For rules relating to nondiscrimination 
requirements and

[[Page 549]]

the determination of compensation, see paragraph (c) of this section. 
For rules under which termination of the status of an individual as an 
employe of the domestic corporation in certain instances will not be 
considered as separation from service for certain purposes, see 
paragraph (d) of this section. For rules regarding deductibility of 
contribution, see paragraph (e) of this section. For rules regarding 
treatment of such individual as an employee of the domestic corporation 
under related provisions, see paragraph (f) of this section.
    (b) Application of this section--(1) Requirements. This section 
shall apply and the employee of the foreign subsidiary shall be treated 
as an employee of domestic corporation for the purposes set forth in 
paragraph (a)(1) of this section only if each of the following 
requirements is satisfied:
    (i) The domestic corporation must have entered into an agreement 
under section 3121(l) to provide social security coverage which applies 
to the foreign subsidiary of which such individual is an employee and 
which has not been terminated under section 3121(l)(3) or (4).
    (ii) The plan, referred to in paragraph (a)(1) of this section, must 
expressly provide for contributions or benefits for individuals who are 
citizens of the United States and who are employees of one or more of 
its foreign subsidiaries to which an agreement entered into by such 
domestic corporation under section 3121(l) applies. The plan must apply 
to all of the foreign subsidiaries to which such agreement applies.
    (iii) Contributions under a funded plan of deferred compensation 
(whether or not a plan described in section 401(a), 403(a), or 405(a)) 
must not be provided by any other person with respect to the 
remuneration paid to such individual by the foreign subsidiary.
    (2) Supplementary rules. Subparagraph (l)(ii) of this paragraph does 
not modify the requirements for qualification of a plan described in 
section 401(a), 403(a), or 405(a) and the regulations thereunder. It is 
not necessary that the plan provide benefits or contributions for all 
United States citizens who are employees of such foreign subsidiaries. 
If the plan is amended to cover individuals who are employees by reason 
of paragraph (a)(1) of this section, the plan will not qualify unless it 
meets the coverage requirements of section 410(b)(1) (section 401(a)(3), 
as in effect on September 1, 1974, for plan years to which section 410 
does not apply; see Sec. 1.410(a)-2 for the effective dates of section 
401) and the nondiscrimination requirements of section 401(a)(4). In 
addition, the administrative rules contained in Sec. 1.401(a)-3(e) 
(relating to the determination of the contributions or benefits provided 
by the employer under the Social Security Act) will also apply for 
purposes of determining whether the plan meets the requirements of 
section 401. For purposes of subparagraph (1)(iii) of this paragraph, 
contributions will not be considered as provided under a funded plan 
merely because the foreign subsidiary is required under the laws of the 
foreign jurisdiction to pay social insurance taxes or to make similar 
payments with respect to the wages paid to the employee.
    (c) Special rules--(1) Nondiscrimination requirements. For purposes 
of applying sections 401(a)(4) and 410(b)(1)(B) (section 401(a)(3)(B), 
as in effect on September 1, 1974, for plan years to which section 410 
does not apply) and the regulations thereunder (relating to 
nondiscrimination concerning benefits and contributions and coverage of 
employees) with respect to an employee of the foreign subsidiary who is 
treated as an employee of the domestic corporation under paragraph 
(a)(1) of this section--
    (i) If the employee is an officer, shareholder, or (with respect to 
plan years to which section 410 does not apply) person whose principal 
duties consist in supervising the work of other employees of the foreign 
subsidiary of the domestic corporation, he shall be treated as having 
such capacity with respect to the domestic corporation; and
    (ii) The determination as to whether the employee is a highly 
compensated employee shall be made by comparing his total compensation 
(determined under subparagraph (2) of this paragraph) with the 
compensation of all the employees of the domestic corporation (including 
individuals treated as employees of the domestic corporation

[[Page 550]]

pursuant to section 406 and this section).
    (2) Determination of compensation. For purposes of applying section 
401(a)(5) and the regulations thereunder, relating to classifications 
that will not be considered discriminatory, with respect to an employee 
of the foreign subsidiary who is treated as an employee of the domestic 
corporation under paragraph (a)(1) of this section--
    (i) The total compensation of the employee shall be the remuneration 
of the employee from the foreign subsidiary (including any allowances 
that are paid to the employee because of his employment in a foreign 
country) which would constitute his total compensation if his services 
had been performed for the domestic corporation;
    (ii) The basic or regular rate of compensation of the employee shall 
be determined for the employee in the same manner as it is determined 
under section 401 for other employees of the domestic corporation; and
    (iii) The amount paid by the domestic corporation which is 
equivalent to the tax imposed with respect to the employee by section 
3101 (relating to the tax on employees under the Federal Insurance 
Contributions Act) shall be treated as having been paid by the employee 
and shall be included in his compensation.
    (d) Termination of status as deemed employee not to be treated as 
separation from service for purposes of capital gain provisions and 
limitation of tax. For purposes of applying the rules, relating to the 
treatment of certain distributions which are made after an employee's 
separation from service, set forth in section 72(n) as in effect on 
September 1, 1974 (with respect to taxable years ending after December 
31, 1969, and to which section 402(e) does not apply), and in sections 
402(a)(2) and (e) and 403(a)(2) with respect to distributions or 
payments made after December 31, 1973, and in taxable years beginning 
after December 31, 1973) with respect to an employee of a foreign 
subsidiary who is treated as an employee of a domestic corporation under 
paragraph (a)(1) of this section, the employee shall not be considered 
as separated from the service of the domestic corporation solely by 
reason of the occurrence of any one or more of the following events:
    (1) The termination, under the provisions of section 3121(l), of the 
agreement entered into by the domestic corporation under that section 
which covers the employment of the employee;
    (2) The employee's becoming an employee of another foreign 
subsidiary of the domestic corporation with respect to which such 
agreement does not apply,
    (3) The employee's ceasing to be an employee of the foreign 
subsidiary by reason of which employment he was treated as an employee 
of such domestic corporation, if he becomes an employee of another 
corporation controlled by such domestic corporation; or
    (4) The termination of the provision of the plan described in 
paragraph (b)(1)(ii) of this section, for coverage of United States 
citizens who are employees of foreign subsidiaries covered by an 
agreement under section 3121(l).

For purposes of subparagraph (3) of this paragraph, a corporation is 
considered to be controlled by a domestic corporation if such domestic 
corporation owns directly or indirectly more than 50 percent of the 
voting stock of the corporation.
    (e) Deductibility of contributions--(1) In general. For purposes of 
applying sections 404 and 405(c) with respect to the deduction for 
contributions made to or under a pension, profit-sharing, or stock bonus 
plan described in section 401(a), an annuity plan described in section 
403(a), or a bond purchase plan described in section 405(a), by a 
domestic corporation, or by another corporation which is entitled to 
deduct its contributions under section 404(a)(3)(B), on behalf of an 
employee of a foreign subsidiary treated as an employee of the domestic 
corporation under paragraph (a)(1) of this section--
    (i) Except as provided in subdivision (ii) of this subparagraph, no 
deduction shall be allowed to such domestic corporation or to any other 
corporation which would otherwise be entitled to deduct its 
contributions on behalf of such employee under one of such sections;

[[Page 551]]

    (ii) There shall be allowed as a deduction from the gross income of 
the foreign subsidiary which is effectively connected with the conduct 
of a trade or business within the United States (within the meaning of 
section 882 and the regulations thereunder) an amount which is allocable 
and apportionable to such gross income under the rules of Sec. 1.861-8 
and which in no event may exceed the amount which (but for subdivision 
(i) of this subparagraph) would be deductible under section 404 or 
section 405(c) by the domestic corporation if the individual were an 
employee of the domestic corporation and if his compensation were paid 
by the domestic corporation; and
    (iii) Any reference to compensation shall be considered to be a 
reference to the total compensation of such individual (determined by 
applying paragraph (c)(2) of this section).
    (2) Year of deduction. Any amount deductible by the foreign 
subsidiary under section 406(d) and this paragraph shall be deductible 
for its taxable year with or within which ends the taxable year of the 
domestic corporation for which the contribution was made.
    (3) Special rules. Whether contributions to a plan on behalf of an 
employee of the foreign subsidiary who is treated as an employee of the 
domestic corporation under paragraph (a)(1) of this section, or whether 
forfeitures with regard to such employee, will require an inclusion in 
the income of the domestic corporation or an adjustment in the basis of 
its stock in the foreign subsidiary, shall be determined in accordance 
with the rules of general application of subtitle A of chapter 1 of the 
Code (relating to income taxes). For example, an unreimbursed 
contribution by the domestic corporation to a plan which meets the 
requirements of section 401(a) will be treated, to the extent each 
employee's rights to the contribution are nonforfeitable, as a 
contribution of capital to the foreign subsidiary to the extent that 
such contributions are made on behalf of the employees of such 
subsidiary.
    (f) Treatment as an employee of the domestic corporation under 
related provisions. An individual who is treated as an employee of a 
domestic corporation under paragraph (a)(1) of this section shall also 
be treated as an employee of such domestic corporation, with respect to 
the plan having the provision described in paragraph (b)(1)(ii) of this 
section, for purposes of applying section 72(d) (relating to employees' 
annuities), section 72(f) (relating to special rules for computing 
employees' contributions), section 101(b) (relating to employees' death 
benefits), section 2039 (relating to annuities), and section 2517 
(relating to certain annuities under qualified plans) and the 
regulations thereunder.
    (g) Nonexempt trust. If the plan of the domestic corporation is a 
qualified plan described under section 401(a), the fact that a trust 
which forms a part of such plan is not exempt from tax under section 
501(a) shall not affect the treatment of an employee of a foreign 
subsidiary as an employee of a domestic corporation under section 406(a) 
and paragraph (a)(1) of this section.

(Sec. 411 Internal Revenue Code of 1954 (88 Stat. 901; 26 U.S.C. 411))

[T.D. 7501, 42 FR 42321, Aug. 23, 1978]



Sec. 1.407-1  Treatment of certain employees of domestic subsidiaries 
engaged in business outside the United States as employees of the 

domestic parent corporation.

    (a) Scope--(1) General rule. For purposes of applying the rules in 
part 1 of subchapter D of chapter 1 of subtitle A of the Code and the 
regulations thereunder with respect to a pension, profit-sharing, or 
stock bonus plan described in section 401(a), an annuity plan described 
in section 403(a), or a bond purchase plan described in section 405(a), 
of a domestic parent corporation (as defined in paragraph (b)(3)(ii) of 
this section), an individual who is a citizen of the United States and 
who is an employee of a domestic subsidiary (as defined in paragraph 
(b)(3)(i) of this section) of such domestic parent corporation shall be 
treated as an employee of such domestic parent corporation if the 
requirements of paragraph (b) of this section are satisfied.
    (2) Cross-references. For rules relating to nondiscrimination 
requirements and the determination of compensation, see paragraph (c) of 
this section. For rules under which termination of the status of an 
individual as an employee of the

[[Page 552]]

domestic parent corporation in certain instances will not be considered 
as separation from service for certain purposes, see paragraph (d) of 
this section. For rules regarding deductibility of contributions, see 
paragraph (e) of this section. For rules regarding treatment of such 
individual as an employee of the domestic parent corporation under 
related provisions, see paragraph (f) of this section.
    (b) Application of this section--(1) Requirements. This section 
shall apply and the employee of the domestic subsidiary shall be treated 
as an employee of the domestic parent corporation for the purposes set 
forth in paragraph (a)(1) of this section only if each of the following 
requirements is satisfied:
    (i) The plan, referred to in paragraph (a)(1) of this section, must 
expressly provide for contributions of benefits for individuals who are 
citizens of the United States and who are employees of one or more of 
the domestic subsidiaries of the domestic parent corporation. The plan 
must apply to every domestic subsidiary.
    (ii) Contributions under a funded plan of deferred compensation 
(whether or not a plan described in section 401(a), 403(a), or 405(a)) 
must not be provided by any other person with respect to the 
remuneration paid to such individual by the domestic subsidiary.
    (2) Supplementary rules. Subparagraph (1)(i) of this paragraph does 
not modify the requirements for qualification of a plan described in 
section 401(a), 403(a), or 405(a) and the regulations thereunder. It is 
not necessary that the plan provide benefits or contributions for all 
United States citizens who are employees of such domestic subsidiaries. 
It the plan is amended to cover individuals who are employees by reason 
of paragraph (a)(1) of this section, the plan will not qualify unless it 
meets the coverage requirements of section 410(b)(1) (section 401(a)(3), 
as in effect on September 1, 1974, for plan years to which section 410 
does not apply; see Sec. 1.410 (a)-2 for the effective dates of section 
401) and the nondiscrimination requirements of section 410(a)(4). The 
administrative rules contained in Sec. 1.401 (a)-3(e) (relating to the 
determination of the contributions or benefits provided by the employer 
under the Social Security Act) will also apply for purposes of 
determining whether the plan meets the requirements of section 401. For 
purposes of subparagraph (1)(ii) of this paragraph, contributions will 
not be considered as provided under a funded plan merely because the 
domestic subsidiary employer pays the tax imposed by section 3111 
(relating to tax on employers under the Federal Insurance Contributions 
Act) with respect to such employee or is required under the laws of a 
foreign jurisdiction to pay social insurance taxes or to make similar 
payments with respect to the wages paid to the employee.
    (3) Definitions--(i) Domestic subsidiary. For purposes of this 
section, a corporation shall be treated as a domestic subsidiary for any 
taxable year only if each of the following requirements is satisfied:
    (A) It is a domestic corporation 80 percent or more of the 
outstanding voting stock of which is owned by another domestic 
corporation;
    (B) 95 percent of more of its gross income for the three-year period 
immediately preceding the close of its taxable year which ends on or 
before the close of the taxable year of such other domestic corporation 
(or for such part of such period during which it was in existence) was 
derived from sources without the United States, determined pursuant to 
sections 861 through 864 and the regulations thereunder; and
    (C) 90 percent or more of its gross income for such period (or such 
part) was derived from the active conduct of a trade or business.

If for the period (or part thereof) referred to in (B) and (C) of this 
subdivision such corporation has no gross income, the provisions of (B) 
and (C) shall be treated as satisfied if it is reasonable to anticipate 
that, with respect to the first taxable year thereafter for which such 
corporation has gross income, such provisions will be satisfied.
    (ii) Domestic parent corporation. The domestic parent corporation of 
any domestic subsidiary is the domestic corporation which owns 80 
percent or more of the outstanding voting stock of such domestic 
subsidiary.
    (c) Special rules--(1) Nondiscrimination requirements. For purposes 
of applying

[[Page 553]]

sections 401(a)(4) and 410(b)(1)(B) (section 401(a)(3)(B), as in effect 
on Septemeber 1, 1974, for plan years to which section 410 does not 
apply) and the regulation thereunder (relating to nondiscrimination 
concerning benefits and contributions and coverage of employees) with 
respect to an employee of the domestic subsidiary who is treated as an 
employee of the domestic parent corporation under paragraph (a)(1) of 
this section--
    (i) If the employee is an officer, shareholder, or (with respect to 
plan years to which section 410 does not apply) a person whose principal 
duties consist in supervising the work of other employees of the 
domestic subsidiary of the domestic parent corporation, he shall be 
treated as having such capacity with respect to the domestic parent 
corporation; and
    (ii) The determination as to whether the employee is a highly 
compensated employee shall be made by comparing his total compensation 
determined under subparagraph (2) of this paragraph with the 
compensation of all the employees of the domestic parent corporation 
(including individuals treated as employees of the domestic parent 
corporation pursuant to section 407 and this section).
    (2) Determination of compensation. For purposes of applying section 
401(a) (5) and the regulations thereunder, relating to classifications 
that will not be considered discriminatory, with respect to an employee 
of the domestic subsidiary who is treated as an employee of the domestic 
parent corporation under paragraph (a)(1) of this section--
    (i) The total compensation of the employee shall be the remuneration 
of the employee from the domestic subsidiary (including any allowances 
that are paid to the employee because of his employment in a foreign 
country) which would constitute his total compensation if his services 
had been performed for such domestic parent corporation; and
    (ii) The basic or regular rate of compensation of the employee shall 
be determined for the employee in the same manner as it is determined 
under section 401 for other employees of the domestic parent 
corporation.
    (d) Termination of status as deemed employee not to be treated as 
separation from service for purposes of captial gain provisions and 
limitation of tax. For purposes of applying the rules, relating to 
treatment of certain distributions which are made after an employee's 
separation from service, set forth in section 72(n) as in effect on 
September 1, 1974 (with respect to taxable years ending after December 
31, 1969, and to which section 402(e) does not apply), and in sections 
402 (a)(2) and (e) and 403(a)(2) (with respect to distributions or 
payments made after December 31, 1973, and in taxable years beginning 
after December 31, 1973) with respect to an employee of a domestic 
subsidiary who is treated as an employee of a domestic parent 
corporation under paragraph (a)(1) of this section, the employee shall 
not be considered as separated from the service of the domestic parent 
corporation solely by reason of the occurrence of any one or more of the 
following events:
    (1) The fact that the corporation of which such individual is an 
employee ceases, for any taxable year, to be a domestic subsidiary 
within the mean of paragraph (b)(3)(i) of this section;
    (2) The employee' ceasing to be an employee of the domestic 
subsidiary of such domestic parent corporation, if he becomes an 
employee of another corporation controlled by such domestic parent 
corporation; or
    (3) The termination of the provision of the plan described in 
paragraph (b)(1)(i) of this section, requiring coverage of the United 
States citizens who are employees of domestic subsidiaries of the 
domestic parent corporation.

For purposes of subparagraph (2) of this paragraph, a corporation is 
considered to be controlled by a domestic parent corporation if the 
domestic parent corporation owns directly or indirectly more than 50 
percent of the voting stock of the corporation.
    (e) Deductibility of contributions--(1) In general. For purposes of 
applying sections 404 and 405(c) with respect to the deduction for 
contributions made to or under a pension, profit-sharing, or stock bonus 
plan described in section 401(a), and annuity plan described in section 
403(a), or a bond purchase plan

[[Page 554]]

described in section 405(a), by a domestic parent corporation, or by 
another corporation which is entitled to deduct its contributions under 
section 404(a)(3)(B), on behalf of an employee of a domestic subsidiary 
treated as an employee of the domestic parent corporation under 
paragraph (a)(1) of this section--
    (i) Except as provided in subdivision (ii) of this subparagraph, no 
deduction shall be allowed to the domestic parent corporation which 
would otherwise be entitled to deduct its contributions on behalf of 
such employee under one of such sections;
    (ii) There shall be allowed as a deduction to the domestic 
subsidiary of which such individual is an employee an amount equal to 
the amount which (but for subdivision (i) of this subparagraph) would be 
deductible under section 404 or section 405(c) by the domestic parent 
corporation if the individual were an employee of the domestic parent 
corporation and if his compensation were paid by the domestic 
corporation; and
    (iii) Any reference to compensation shall be considered to be a 
reference to the total compensation of such individual determined by 
applying paragraph (c)(2) of this section).
    (2) Year of deduction. Any amount deductible by the domestic 
subsidiary under section 407(d) and this paragraph shall be deductible 
for its taxable year with or within which ends the taxable year of the 
domestic parent corporation for which the contribution was made.
    (3) Special rules. Whether contributions to a plan on behalf of an 
employee of the domestic subsidiary who is treated as an employee of the 
domestic parent corporation under paragraph (a)(1) of this section, or 
whether forfeitures with regard to such employee, will require an 
inclusion in the income of the domestic parent corporation or an 
adjustment in the basis of its stock in the domestic subsidiary, shall 
be determined in accordance with the rules of general application of 
subtitle A of chapter 1 of the Code (relating to income taxes). For an 
example, and unreimbursed contribution by the domestic parent 
corporation to a plan which meets the requirements of section 401(a) 
will be treated, to the extent each employee's rights to the 
contribution are nonforfeitable, as a contribution of capital to the 
domestic subsidiary to the extent that such contributions are made on 
behalf of the employees of such subsidiary.
    (f) Treatment as an employee of the domestic parent corporation 
under related provisions. An individual who is treated as an employee of 
a domestic parent corporation under paragraph (a)(1) of this section 
shall also be treated as an employee of such domestic corporation, with 
respect to the plan having the provision described in paragraph 
(b)(1)(i) of this section, for purposes of applying section 72(d) 
(relating to special rules for computing employees' contributions), 
section 72(f) (relating to special rules for computing employees' 
contributions), section 101(b) (relating to employees' section 101(b) 
(relating to employees' death benefits), section 2039 (relating to 
annuities), and section 2517 (relating to certain annuities under 
qualified plans) and the regulations thereunder.
    (g) Nonexempt trust. If the plan of the domestic parent corporation 
is a qualified plan described under section 401(a), the fact that a 
trust which forms a part of such plan is not exempt from tax under 
section 501(a) shall not affect the treatment of an employee of a 
domestic subsidiary as an employee of a domestic parent corporation 
under section 407(a) and paragraph (a)(1) of this section.

(Sec. 411 Internal Revenue Code of 1954 (88 Stat. 901; 26 U.S.C. 411))

[T.D. 7501, 42 FR 42323, Aug. 23, 1977]



Sec. 1.408-1  General rules.

    (a) In general. Section 408 prescribes rules relating to individual 
retirement accounts and individual retirement annuities. In addition to 
the rules set forth in Sec. Sec. 1.408-2 and 1.408-3, relating 
respectively to individual retirement accounts and individual retirement 
annuities, the rules set forth in this section shall also apply.
    (b) Exemption from tax. The individual retirement account or 
individual retirement annuity is exempt from all taxes under subtitle A 
of the Code other than the taxes imposed under

[[Page 555]]

section 511, relating to tax on unrelated business income of charitable, 
etc., organizations.
    (c) Sanctions--(1) Excess contributions. If an individual retirement 
account or individual retirement annuity accepts and retains excess 
contributions, the individual on whose behalf the account is established 
or who is the owner of the annuity will be subject to the excise tax 
imposed by section 4973.
    (2) Prohibited transactions by owner or beneficiary of individual 
retirement account--(i) Under section 408(e)(2), if, during any taxable 
year of the individual for whose benefit any individual retirement 
account is established, that individual or the individual's beneficiary 
engages in any transaction prohibited by section 4975 with respect to 
such account, such account ceases to be an individual retirement account 
as of the first day of such taxable year. In any case in which any 
individual retirement account ceases to be an individual retirement 
account by reason of the preceding sentence as of the first day of any 
taxable year, section 408(d)(1) applies as if there were a distribution 
on such first day in an amount equal to the fair market value (on such 
first day) of all assets in the account (on such first day). The 
preceding sentence applies even though part of the fair market value of 
the individual retirement account as of the first day of the taxable 
year is attributable to excess contributions which may be returned tax-
free under section 408(d)(4) or 408(d)(5).
    (ii) If the trust with which the individual engages in any 
transaction described in subdivision (i) of this subparagraph is 
established by an employer or employee association under section 408(c), 
only the employee who engages in the prohibited transaction is subject 
to disqualification of his separate account.
    (3) Prohibited transaction by person other than owner or beneficiary 
of account. If any person other than the individual on whose behalf an 
individual retirement account is established or the individual's 
beneficiary engages in any transaction prohibited by section 4975 with 
respect to such account, such person shall be subject to the taxes 
imposed by section 4975.
    (4) Pledging account as security. Under section 408(e)(4), if, 
during any taxable year of the individual for whose benefit an 
individual retirement account is established, that individual uses the 
account or any portion thereof as security for a loan, the portion so 
used is treated as distributed to that individual.
    (5) Borrowing on annuity contract. Under section 408(e)(3), if 
during any taxable year the owner of an individual retirement annuity 
borrows any money under or by use of such contract, the contract ceases 
to be an individual retirement annuity as of the first day of such 
taxable year. See Sec. 1.408-3(c).
    (6) Premature distributions. If a distribution (whether a deemed 
distribution or an actual distribution) is made from an individual 
retirement account, or individual retirement annuity, to the individual 
for whose benefit the account was established, or who is the owner of 
the annuity, before the individual attains age 59\1/2\ (unless the 
individual has become disabled within the meaning of section 72(m)(7)), 
the tax under Chapter 1 of the Code for the taxable year in which such 
distribution is received is increased under section 408(f)(1) or (f)(2). 
The increase equals 10 percent of the amount of the distribution which 
is includible in gross income for the taxable year. Except in the case 
of the credits allowable under section 31, 39, or 42, no credit can be 
used to offset the increased tax described in this subparagraph. See, 
however, Sec. 1.408-4(c)(3).
    (d) Limitation on contributions and benefits. An individual 
retirement account or individual retirement annuity is subject to the 
limitation on contributions and benefits imposed by section 415 for 
years beginning after December 31, 1975.
    (e) Community property laws. Section 408 shall be applied without 
regard to any community property laws.

[T.D. 7714, 45 FR 52790, Aug. 8, 1980]



Sec. 1.408-2  Individual retirement accounts.

    (a) In general. An individual retirement account must be a trust or 
a custodial account (see paragraph (d) of

[[Page 556]]

this section). It must satisfy the requirements of paragraph (b) of this 
section in order to qualify as an individual retirement account. It may 
be established and maintained by an individual, by an employer for the 
benefit of his employees (see paragraph (c) of this section), or by an 
employee association for the benefit of its members (see paragraph (c) 
of this section).
    (b) Requirements. An individual retirement account must be a trust 
created or organized in the United States (as defined in section 
7701(a)(9)) for the exclusive benefit of an individual or his 
beneficiaries. Such trust must be maintained at all times as a domestic 
trust in the United States. The instrument creating the trust must be in 
writing and the following requirements must be satisfied.
    (1) Amount of acceptable contributions. Except in the case of a 
contribution to a simplified employee pension described in section 
408(k) and a rollover contribution described in section 408(d)(3), 
402(a)(5), 402(a)(7), 403(a)(4), 403(b)(8) or 409(b)(3)(C), the trust 
instrument must provide that contributions may not be accepted by the 
trustee for the taxable year in excess of $1,500 on behalf of any 
individual for whom the trust is maintained. An individual retirement 
account maintained as a simplified employee pension may provide for the 
receipt of up to $7,500 for a calendar year.
    (2) Trustee. (i) The trustee must be a bank (as defined in section 
408(n) and the regulations thereunder) or another person who 
demonstrates, in the manner described in paragraph (e) of this section, 
to the satisfaction of the Commissioner, that the manner in which the 
trust will be administered will be consistent with the requirements of 
section 408 and this section.
    (ii) Section 11.408(a)(2)-1 of the Temporary Income Tax Regulations 
under the Employee Retirement Income Security Act of 1974 is superseded 
by this subparagraph (2).
    (3) Life insurance contracts. No part of the trust funds may be 
invested in life insurance contracts. An individual retirement account 
may invest in annuity contracts which provide, in the case of death 
prior to the time distributions commence, for a payment equal to the sum 
of the premiums paid or, if greater, the cash value of the contract.
    (4) Nonforfeitability. The interest of any individual on whose 
behalf the trust is maintained in the balance of his account must be 
nonforfeitable.
    (5) Prohibition against commingling. (i) The assets of the trust 
must not be commingled with other property except in a common trust fund 
or common investment fund.
    (ii) For purposes of this subparagraph, the term ``common investment 
fund'' means a group trust created for the purpose of providing a 
satisfactory diversification or investments or a reduction of 
administrative expenses for the individual participating trusts, and 
which group trust satisfies the requirements of section 408(c) (except 
that it need not be established by an employer or an association of 
employees) and the requirements of section 401(a) in the case of a group 
trust in which one of the individual participating trusts is an 
employees' trust described in section 401(a) which is exempt from tax 
under section 501(a).
    (iii) For purposes of this subparagraph, the term ``individual 
participating trust'' means an employees' trust described in section 
401(a) which is exempt from tax under section 501(a) or a trust which 
satisfies the requirements of section 408(a) provided that in the case 
of such an employees' trust, such trust would be permitted to 
participate in such a group trust if all the other individual 
participating trusts were employees' trusts described in section 401(a) 
which are exempt from tax under section 501(a).
    (6) Distribution of interest. (i) The trust instrument must provide 
that the entire interest of the individual for whose benefit the trust 
is maintained must be distributed to him in accordance with paragraph 
(b)(6)(ii) or (iii) of this section.
    (ii) Unless the provisions of paragraph (b)(6)(iii) of this section 
apply, the entire interest of the individual must be actually 
distributed to him not later than the close of his taxable year in which 
he attains age 70\1/2\.
    (iii) In lieu of distributing the individual's entire interest as 
provided in paragraph (b)(6)(ii) of this section, the

[[Page 557]]

interest may be distributed commencing not later than the taxable year 
described in such paragraph (b)(6)(ii). In such case, the trust must 
expressly provide that the entire interest of the individual will be 
distributed to the individual and the individual's beneficiaries, in a 
manner which satisfies the requirements of paragraph (b)(6)(v) of this 
section, over any of the following periods (or any combination 
thereof)--
    (A) The life of the individual,
    (B) The lives of the individual and spouse,
    (C) A period certain not extending beyond the life expectancy of the 
individual, or
    (D) A period certain not extending beyond the joint life and last 
survivor expectancy of the individual and spouse.
    (iv) The life expectancy of the individual or the joint life and 
last survivor expectancy of the individual and spouse cannot exceed the 
period computed by use of the expected return multiples in Sec. 1.72-9, 
or, in the case of payments under a contract issued by an insurance 
company, the period computed by use of the mortality tables of such 
company.
    (v) If an individual's entire interest is to be distributed over a 
period described in paragraph (b)(6)(iii) of this section, beginning in 
the year the individual attains 70\1/2\ the amount to be distributed 
each year must be not less than the lesser of the balance of the 
individual's entire interest or an amount equal to the quotient obtained 
by dividing the entire interest of the individual in the trust at the 
beginning of such year (including amounts not in the individual 
retirement account at the beginning of the year because they have been 
withdrawn for the purpose of making a rollover contribution to another 
individual retirement plan) by the life expectancy of the individual (or 
the joint life and last survivor expectancy of the individual and spouse 
(whichever is applicable)), determined in either case as of the date the 
individual attains age 70 in accordance with paragraph (b)(6)(iv) of 
this section, reduced by one for each taxable year commencing after the 
individual's attainment of age 70\1/2\. An annuity or endowment contract 
issued by an insurance company which provides for non-increasing 
payments over one of the periods described in paragraph (b)(6)(iii) of 
this section beginning not later than the close of the taxable year in 
which the individual attains age 70\1/2\ satisfies this provision. 
However, no distribution need be made in any year, or a lesser amount 
may be distributed, if beginning with the year the individual attains 
age 70\1/2\ the aggregate amounts distributed by the end of any year are 
at least equal to the aggregate of the minimum amounts required by this 
subdivision to have been distributed by the end of such year.
    (vi) If an individual's entire interest is distributed in the form 
of an annuity contract, then the requirements of section 408(a)(6) are 
satisfied if the distribution of such contract takes place before the 
close of the taxable year described in subdivision (ii) of this 
subparagraph, and if the individual's interest will be paid over a 
period described in subdivision (iii) of this subparagraph and at a rate 
which satisfies the requirements of subdivision (v) of this 
subparagraph.
    (vii) In determining whether paragraph (b)(6)(v) of this section is 
satisfied, all individual retirement plans maintained for an 
individual's benefit (except those under which he is a beneficiary 
described in section 408(a)(7)) at the close of the taxable year in 
which he reaches age 70\1/2\ must be aggregated. Thus, the total 
payments which such individual receives in any taxable year must be at 
least equal to the amount he would have been required to receive had all 
the plans been one plan at the close of the taxable year in which he 
attained age 70\1/2\.
    (7) Distribution upon death. (i) The trust instrument must provide 
that if the individual for whose benefit the trust is maintained dies 
before the entire interest in the trust has been distributed to him, or 
if distribution has been commenced as provided in paragraph (b)(6) of 
this section to the surviving spouse and such spouse dies before the 
entire interest has been distributed to such spouse, the entire interest 
(or the remaining part of such interest if distribution thereof has 
commenced) must, within 5 years after

[[Page 558]]

the individual's death (or the death of the surviving spouse) be 
distributed or applied to the purchase of an immediate annuity for this 
beneficiary or beneficiaries (or the beneficiary or beneficiaries of the 
surviving spouse) which will be payable for the life of such beneficiary 
or beneficiaries (or for a term certain not extending beyond the life 
expectancy of such beneficiary or beneficiaries) and which annuity 
contract will be immediately distributed to such beneficiary or 
beneficiaries. A contract described in the preceding sentence is not 
includible in gross income upon distribution. Section 1.408-4(e) 
provides rules applicable to the taxation of such contracts. The first 
sentence of this paragraph (b)(7) shall have no application if 
distributions over a term certain commenced before the death of the 
individual for whose benefit the trust was maintained and the term 
certain is for a period permitted under paragraph (b)(6)(iii) (C) or (D) 
of this section.
    (ii) Each such beneficiary (or beneficiary of a surviving spouse) 
may elect to treat the entire interest in the trust (or the remaining 
part of such interest if distribution thereof has commenced) as an 
account subject to the distribution requirements of section 408(a)(6) 
and paragraph (b)(6) of this section instead of those of section 
408(a)(7) and paragraph (b)(7) of this section. Such an election will be 
deemed to have been made if such beneficiary treats the account in 
accordance with the requirements of section 408(a)(6) and paragraph 
(b)(6) of this section. An election will be considered to have been made 
by such beneficiary if either of the following occurs: (A) any amounts 
in the account (including any amounts that have been rolled over, in 
accordance with the requirements of section 408(d)(3)(A)(i), into an 
individual retirement account, individual retirement annuity, or 
retirement bond for the benefit of such individual) have not been 
distributed within the appropriate time period required by section 
408(a)(7) and paragraph (b)(7) of this section; or (B) any additional 
amounts are contributed to the account (or to the account, annuity, or 
bond to which the beneficiary has rolled such amounts over, as described 
in (1) above) which are subject, or deemed to be subject, to the 
distribution requirements of section 408(a)(6) and paragraph (b)(6) of 
this section.
    (8) Definition of beneficiaries. The term ``beneficiaries'' on whose 
behalf an individual retirement account is established includes (except 
where the context indicates otherwise) the estate of the individual, 
dependents of the individual, and any person designated by the 
individual to share in the benefits of the account after the death of 
the individual.
    (c) Accounts established by employers and certain association of 
employees--(1) In general. A trust created or organized in the United 
States (as defined in section 7701(a)(9)) by an employer for the 
exclusive benefit of his employees or their beneficiaries, or by an 
association of employees for the exclusive benefit of its members or 
their beneficiaries, is treated as an individual retirement account if 
the requirements of paragraphs (c)(2) and (c)(3) of this section are 
satisfied under the written governing instrument creating the trust. A 
trust described in the preceding sentence is for the exclusive benefit 
of employees or members even though it may maintain an account for 
former employees or members and employees who are temporarily on leave.
    (2) General requirements. The trust must satisfy the requirements of 
paragraphs (b) (1) through (7) of this section.
    (3) Special requirement. There must be a separate accounting for the 
interest of each employee or member.
    (4) Definitions--(i) Separate accounting. For purposes of paragraph 
(c)(3) of this section, the term ``separate accounting'' means that 
separate records must be maintained with respect to the interest of each 
individual for whose benefit the trust is maintained. The assets of the 
trust may be held in a common trust fund, common investment fund, or 
common fund for the account of all individuals who have an interest in 
the trust.
    (ii) Employee association. For purposes of this paragraph and 
section 408(c), the term ``employee association'' means any organization 
composed of two or more employees, including but

[[Page 559]]

not limited to, an employee association described in section 501(c)(4). 
Such association may include employees within the meaning of section 
401(c)(1). There must be, however, some nexus between the employees 
(e.g., employees of same employer, employees in the same industry, etc.) 
in order to qualify as an employee association described in this 
subdivision (ii).
    (d) Custodial accounts. For purposes of this section and section 
408(a), a custodial account is treated as a trust described in section 
408(a) if such account satisfies the requirements of section 408(a) 
except that it is not a trust and if the assets of such account are held 
by a bank (as defined in section 401(d)(1) and the regulations 
thereunder) or such other person who satisfies the requirements of 
paragraph (b)(2)(ii) of this section. For purposes of this chapter, in 
the case of a custodial account treated as a trust by reason of the 
preceding sentence, the custodian of such account will be treated as the 
trustee thereof.
    (e)(1) In general. The trustee of a trust described in paragraph (b) 
of this section may be a person other than a bank if the person 
demonstrates to the satisfaction of the Commissioner that the manner in 
which the person will administer trusts will be consistent with the 
requirements of section 408. The person must demonstrate by written 
application that the requirements of paragraph (e)(2) to (e)(6) of this 
section will be met. The written application must be sent to address 
prescribed by the Commissioner in revenue rulings, notices, and other 
guidance published in the Internal Revenue Bulletin (see Sec. 
601.601(d)(2)(ii)(b) of this chapter). For procedural and administrative 
rules, see paragraph (e)(7) of this section.
    (2) Fiduciary ability. The applicant must demonstrate in detail its 
ability to act within the accepted rules of fiduciary conduct. Such 
demonstration must include the following elements of proof:
    (i) Continuity. (A) The applicant must assure the uninterrupted 
performance of its fiduciary duties nonwithstanding the death or change 
of its owners. Thus, for example, there must be sufficient diversity in 
the ownership of the applicant to ensure that the death or change of its 
owners will not interrupt the conduct of its business. Therefore, the 
applicant cannot be an individual.
    (B) Sufficient diversity in the ownership of an incorporated 
applicant is demonstrated in the following circumstances:
    (1) Individuals each of whom owns more than 20 percent of the voting 
stock in the applicant own, in the aggregate, no more than 50 percent of 
such stock;
    (2) The applicant has issued securities registered under section 12 
(b) of the Securities Exchange Act of 1934 (15 U.S.C. 78l (b)) or 
required to be registered under section 12(g) (1) of that Act (15 U.S.C. 
78l (g)(1)); or
    (3) The applicant has a parent corporation within the meaning of 
section 1563 (a) (1) that has issued securities registered under section 
12 (b) of the Securities Exchange Act of 1934 (15 U.S.C. 78l (b)) or 
required to be registered under Section 12 (g) (1) of that Act (15 
U.S.C. 78l (g)(1)).
    (C) Sufficient diversity in the ownership of an applicant that is a 
partnership means that--
    (1) Individuals each of whom owns more than 20 percent of the 
profits interest in the partnership own, in the aggregate, no more than 
50 percent of such profits interest, and
    (2) Individuals each of whom owns more than 20 percent of the 
capital interest in the partnership own, in the aggregate, no more than 
50 percent of such capital interest.
    (D) For purposes of this subdivision, the ownership of stock and of 
capital and profits interests shall be determined in accordance with the 
rules for constructive ownership of stock provided in section 1563 (e) 
and (f) (2). For this purpose, the rules for constructive ownership of 
stock provided in section 1563(e) and (f) (2) shall apply to a capital 
or profits interest in a partnership as if it were a stock interest.
    (ii) Established location. The applicant must have an established 
place of business in the United States where it is accessible during 
every business day.
    (iii) Fiduciary experience. The applicant must have fiduciary 
experience or expertise sufficient to ensure that it

[[Page 560]]

will be able to perform its fiduciary duties. Evidence of fiduciary 
experience must include proof that a significant part of the business of 
the applicant consists of exercising fiduciary powers similar to those 
it will exercise if its application is approved. Evidence of fiduciary 
expertise must include proof that the applicant employs personnel 
experienced in the administration of fiduciary powers similar to those 
the applicant will exercise if its application is approved.
    (iv) Fiduciary responsibility. The applicant must assure compliance 
with the rules of fiduciary conduct set out in paragraph (e)(5) of this 
section.
    (v) Financial responsibility. The applicant must exhibit a high 
degree of solvency commensurate with the obligations imposed by this 
paragraph. Among the factors to be taken into account are the 
applicant's net worth, its liquidity, and its ability to pay its debts 
as they come due.
    (3) Capacity to account. The applicant must demonstrate in detail 
its experience and competence with respect to accounting for the 
interests of a large number of individuals (including calculating and 
allocating income earned and paying out distributions to payees). 
Examples of accounting for the interests of a large number of 
individuals include accounting for the interests of a large number of 
shareholders in a regulated investment company and accounting for the 
interests of a large number of variable annuity contract holders.
    (4) Fitness to handle funds--(i) In general. The applicant must 
demonstrate in detail its experience and competence with respect to 
other activities normally associated with the handling of retirement 
funds.
    (ii) Examples. Examples of activities normally associated with the 
handling of retirement funds include:
    (A) To Receive, issue receipts for, and safely keep securities;
    (B) To collect income;
    (C) To execute such ownership certificates, to keep such records, 
make such returns, and render such statements as are required for 
Federal tax purposes;
    (D) To give proper notification regarding all collections;
    (E) To collect matured or called principal and properly report all 
such collections;
    (F) To exchange temporary for definitive securities;
    (G) To give proper notification of calls, subscription rights, 
defaults in principal or interest, and the formation of protective 
committees;
    (H) To buy, sell, receive, or deliver securities on specific 
directions.
    (5) Rules of fiduciary conduct. The applicant must demonstrate that 
under applicable regulatory requirements, corporate or other governing 
instruments, or its established operating procedures:
    (i) Administration of fiduciary powers. (A)(1) The owners or 
directors of the applicant will be responsible for the proper exercise 
of fiduciary powers by the applicant. Thus, all matters pertinent 
thereto, including the determination of policies, the investment and 
disposition of property held in a fiduciary capacity, and the direction 
and review of the actions of all employees utilized by the applicant in 
the exercise of its fiduciary powers, will be the responsibility of the 
owners or directors. In discharging this responsibility, the owners or 
directors may assign to designated employees, by action duly recorded, 
the administration of such of the applicant's fiduciary powers as may be 
proper to assign.
    (2) A written record will be made of the acceptance and of the 
relinquishment or closing out of all fiduciary accounts, and of the 
assets held for each account.
    (3) If the applicant has the authority or the responsibility to 
render any investment advice with regard to the assets held in or for 
each fiduciary account, the advisability of retaining or disposing of 
the assets will be determined at least once during each period of 12 
months.
    (B) All employees taking part in the performance of the applicant's 
fiduciary duties will be adequately bonded. Nothing in this subdivision 
(i)(B) shall require any person to be bonded in contravention of section 
412(d) of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 
1112(d)).
    (C) The applicant will employ or retain legal counsel who will be 
readily

[[Page 561]]

available to pass upon fiduciary matters and to advise the applicant.
    (D) In order to segregate the performance of its fiduciary duties 
from other business activities, the applicant will maintain a separate 
trust division under the immediate supervision of an individual 
designated for that purpose. The trust division may utilize the 
personnel and facilities of other divisions of the applicant, and other 
divisions of the applicant may utilize the personnel and facilities of 
the trust division, as long as the separate identity of the trust 
division is preserved.
    (ii) Adequacy of net worth--(A) Initial net worth requirement. In 
the case of applications received after January 5, 1995, no initial 
application will be accepted by the Commissioner unless the applicant 
has a net worth of not less than $250,000 (determined as of the end of 
the most recent taxable year). Thereafter, the applicant must satisfy 
the adequacy of net worth requirements of paragraph (e)(5)(ii)(B) and 
(C) of this section.
    (B) No fiduciary account will be accepted by the applicant unless 
the applicant's net worth (determined as of the end of the most recent 
taxable year) exceeds the greater of--
    (1) $100,000, or
    (2) Four percent (or, in the case of a passive trustee described in 
paragraph (e)(6)(i)(A) of this section, two percent) of the value of all 
of the assets held by the applicant in fiduciary accounts (determined as 
of the most recent valuation date).
    (C) The applicant will take whatever lawful steps are necessary 
(including the relinquishment of fiduciary accounts) to ensure that its 
net worth (determined as of the close of each taxable year) exceeds the 
greater of--
    (1) $50,000, or
    (2) Two percent (or, in the case of a passive trustee described in 
paragraph (e)(6)(i)(A) of this section, one percent) of the value of all 
of the assets held by the applicant in fiduciary accounts (determined as 
of the most recent valuation date).
    (D) Assets held by members of SIPC--(1) For purposes of satisfying 
the adequacy-of-net-worth requirement of this paragraph, a special rule 
is provided for nonbank trustees that are members of the Securities 
Investor Protection Corporation (SIPC) created under the Securities 
Investor Protection Act of 1970 (SIPA)(15 U.S.C. 78aaa et seq., as 
amended). The amount that the net worth of a nonbank trustee that is a 
member of SIPC must exceed is reduced by two percent for purposes of 
paragraph (e)(5)(ii)(B)(2), and one percent for purposes of paragraph 
(e)(5)(ii)(C)(2), of the value of assets (determined on an account-by-
account basis) held for the benefit of customers (as defined in 15 
U.S.C. 78fff-2(e)(4)) in fiduciary accounts by the nonbank trustee to 
the extent of the portion of each account that does not exceed the 
dollar limit on advances described in 15 U.S.C. 78fff-3(a), as amended, 
that would apply to the assets in that account in the event of a 
liquidation proceeding under the SIPA.
    (2) The provisions of this special rule for assets held in fiduciary 
accounts by members of SIPC are illustrated in the following example.

    Example: (a) Trustee X is a broker-dealer and is a member of the 
Securities Investment Protection Corporation. Trustee X also has been 
approved as a nonbank trustee for individual retirement accounts (IRAs) 
by the Commissioner but not as a passive nonbank trustee. Trustee X is 
the trustee for four IRAs. The total assets of each IRA (for which 
Trustee X is the trustee) as of the most recent valuation date before 
the last day of Trustee X's taxable year ending in 1995 are as follows: 
the total assets for IRA-1 is $3,000,000 (all of which is invested in 
securities); the value of the total assets for IRA-2 is $500,000 
($200,000 of which is cash and $300,000 of which is invested in 
securities), the value of the total assets for IRA-3 is $400,000 (all of 
which is invested in securities); and the value of the total assets of 
IRA-4 is $200,000 (all of which is cash). The value of all assets held 
in fiduciary accounts, as defined in Sec. 1.408-2(e)(6)(viii)(A), is 
$4,100,000.
    (b) The dollar limit on advances described in 15 U.S.C. Sec. 78fff-
3(a) that would apply to the assets in each account in the event of a 
liquidation proceeding under the Securities Investor Protection Act of 
1970 in effect as of the last day of Trustee X's taxable year ending in 
1995 is $500,000 per account (no more than $100,000 of which is 
permitted to be cash). Thus, the dollar limit that would apply to IRA-1 
is $500,000; the dollar limit for IRA-2 is $400,000 ($100,000 of the 
cash and the $300,000 of the value of the securities); the dollar limit 
for IRA-3 is $400,000 (the full value of the account because the value 
of the

[[Page 562]]

account is less than $500,000 and no portion of the account is cash); 
and the dollar limit for IRA-4 is $100,000 (the entire account is cash 
and the dollar limit per account for cash is $100,000). The aggregate 
dollar limits of the four IRAs is $1,400,000.
    (c) For 1996, the amount determined under Sec. 1.408-2(e)(5)(ii)(B) 
is determined as follows for Trustee X: (1) four percent of $4,100,000 
equals $164,000; (2) two percent of $1,400,000 equals $28,000; and (3) 
$164,000 minus $28,000 equals $136,000. Thus, because $136,000 exceeds 
$100,000, the minimum net worth necessary for Trustee X to accept new 
accounts for 1996 is $136,000.
    (d) For 1996, the amount determined under Sec. 1.408-2(e)(5)(ii)(C) 
for Trustee X is determined as follows: (1) two percent of $4,100,000 
equals $82,000; (2) one percent of $1,400,000 equals $14,000; and (3) 
$82,000 minus $14,000 equals $68,000. Thus, because $68,000 exceeds 
$50,000, the minimum net worth necessary for Trustee X to avoid a 
mandatory relinquishment of accounts for 1996 is $68,000.

    (E) The applicant will determine the value of the assets held by it 
in trust at least once in each calendar year and no more than 18 months 
after the preceding valuation. The assets will be valued at their fair 
market value, except that the assets of an employee pension benefit plan 
to which section 103(b)(3)(A) of the Employee Retirement Income Security 
Act of 1974 (29 U.S.C. 1023(b)(3)(A)) applies will be considered to have 
the value stated in the most recent annual report of the plan.
    (iii) Audits. (A) At least once during each period of 12 months, the 
applicant will cause detailed audits of the fiduciary books and records 
to be made by a qualified public accountant. At that time, the applicant 
will ascertain whether the fiduciary accounts have been administered in 
accordance with law, this paragraph, and sound fiduciary principles. The 
audits shall be conducted in accordance with generally accepted auditing 
standards, and shall involve whatever tests of the fiduciary books and 
records of the applicant are considered necessary by the qualified 
public accountant.
    (B) In the case of an applicant which is regulated, supervised, and 
subject to periodic examination by a State or Federal agency, such 
applicant may adopt an adequate continuous audit system in lieu of the 
periodic audits required by paragraph (e)(5)(iii)(A) of this section.
    (C) A report of the audits and examinations required under this 
subdivision, together with the action taken thereon, will be noted in 
the fiduciary records of the applicant.
    (iv) Funds awaiting investment or distribution. Funds held in a 
fiduciary capacity by the applicant awaiting investment or distribution 
will not be held uninvested or undistributed any longer than is 
reasonable for the proper management of the account.
    (v) Custody of investments. (A) Except for investments pooled in a 
common investment fund in accordance with the provisions of paragraph 
(e)(5)(vi) of this section and for investments of accounts established 
under section 408(q) on or after August 1, 2003, the investments of each 
account will not be commingled with any other property.
    (B) Assets of accounts requiring safekeeping will be deposited in an 
adequate vault. A permanent record will be kept of assets deposited in 
or withdrawn from the vault.
    (vi) Common investment funds. The assets of an account may be pooled 
in a common investment fund (as defined in paragraph (e)(5)(viii)(C) of 
this section) if the applicant is authorized under applicable law to 
administer a common investment fund and if pooling the assets in a 
common investment fund is not in contravention of the plan documents or 
applicable law. The common investment fund must be administered as 
follows:
    (A) Each common investment fund must be established and maintained 
in accordance with a written agreement, containing appropriate 
provisions as to the manner in which the fund is to be operated, 
including provisions relating to the investment powers and a general 
statement of the investment policy of the applicant with respect to the 
fund; the allocation of income, profits and losses; the terms and 
conditions governing the admission or withdrawal of participations in 
the funds; the auditing of accounts of the applicant with respect to the 
fund; the basis and method of valuing assets held by the fund, setting 
forth specific criteria for each type of asset; the minimum frequency 
for valuation of assets of the fund; the period following each such

[[Page 563]]

valuation date during which the valuation may be made (which period in 
usual circumstances may not exceed 10 business days); the basis upon 
which the fund may be terminated; and such other matters as may be 
necessary to define clearly the rights of participants in the fund. A 
copy of the agreement must be available at the principal office of the 
applicant for inspection during all business hours, and upon request a 
copy of the agreement must be furnished to the employer, the plan 
administrator, any participant or beneficiary of an account, or the 
individual for whose benefit the account is established or that 
individual's beneficiary.
    (B) All participations in the common investment fund must be on the 
basis of a proportionate interest in all of the investments.
    (C) Not less frequently than once during each period of 3 months the 
applicant must determine the value of the assets in the fund as of the 
date set for the valuation of assets. No participation may be admitted 
to or withdrawn from the fund except (1) on the basis of such valuation 
and (2) as of such valuation date. No participation may be admitted to 
or withdrawn from the fund unless a written request for or notice of 
intention of taking such action has been entered on or before the 
valuation date in the fiduciary records of the applicant. No request or 
notice may be canceled or countermanded after the valuation date.
    (D)(1) The applicant must at least once during each period of 12 
months cause an adequate audit to be made of the common investment fund 
by a qualified public accountant.
    (2) The applicant must at least once during each period of 12 months 
prepare a financial report of the fund which, based upon the above 
audit, must contain a list of investments in the fund showing the cost 
and current value of each investment; a statement for the period since 
the previous report showing purchases, with cost; sales, with profit or 
loss; any other investment changes; income and disbursements; and an 
appropriate notation as to any investments in default.
    (3) The applicant must transmit and certify the accuracy of the 
financial report to the administrator of each plan participating in the 
common investment fund within 120 days after the end of the plan year.
    (E) When participations are withdrawn from a common investment fund, 
distributions may be made in cash or ratably in kind, or partly in cash 
and partly in kind: Provided, That all distributions as of any one 
valuation date must be made on the same basis.
    (F) If for any reason an investment is withdrawn in kind from a 
common investment fund for the benefit of all participants in the fund 
at the time of such withdrawal and such investment is not distributed 
ratably in kind, it must be segregated and administered or realized upon 
for the benefit ratably of all participants in the common investment 
fund at the time of withdrawal.
    (vii) Books and records. (A) The applicant must keep its fiduciary 
records separate and distinct from other records. All fiduciary records 
must be so kept and retained for as long as the contents thereof may 
become material in the administration of any internal revenue law. The 
fiduciary records must contain full information relative to each 
account.
    (B) The applicant must keep an adequate record of all pending 
litigation to which it is a party in connection with the exercise of 
fiduciary powers.
    (viii) Definitions. For purposes of this paragraph (e)(5), and 
paragraph (e)(2)(v), and paragraph (e)(7) of this section--
    (A) The term ``account'' or ``fiduciary account'' means a trust 
described in section 401(a) (including a custodial account described in 
section 401(f)), a custodial account described in section 403(b)(7), or 
an individual retirement account described in section 408(a) (including 
a custodial account described in section 408(h)).
    (B) The term ``plan administrator'' means an administrator as 
defined in Sec. 1.414(g)-1.
    (C) The term ``common investment fund'' means a trust that satisfies 
the following requirements:
    (1) The trust consists of all or part of the assets of several 
accounts that have been established with the applicant, and

[[Page 564]]

    (2) The trust is described in section 401(a) and is exempt from tax 
under section 501(a), or is a trust that is created for the purpose of 
providing a satisfactory diversification of investments or a reduction 
of administrative expenses for the participating accounts and that 
satisfies the requirements of section 408(c).
    (D) The term ``fiduciary records'' means all matters which are 
written, transcribed, recorded, received or otherwise come into the 
possession of the applicant and are necessary to preserve information 
concerning the acts and events relevant to the fiduciary activities of 
the applicant.
    (E) The term ``qualified public accountant'' means a qualified 
public accountant, as defined in section 103(a)(3)(D) of the Employee 
Retirement Income Security Act of 1974, 29 U.S.C. 1023(a)(3)(D), who is 
independent of the applicant.
    (F) The term ``net worth'' means the amount of the applicant's 
assets less the amount of its liabilities, as determined in accordance 
with generally accepted accounting principles.
    (6) Special rules--(i) Passive trustee. (A) An applicant that 
undertakes to act only as a passive trustee may be relieved of one or 
more of the requirements of this paragraph upon clear and convincing 
proof that such requirements are not germane, under all the facts and 
circumstances, to the manner in which the applicant will administer any 
trust. A trustee is a passive trustee only if under the written trust 
instrument the trustee has no discretion to direct the investment of the 
trust funds or any other aspect of the business administration of the 
trust, but is merely authorized to acquire and hold particular 
investments specified by the trust instrument. Thus, for example, in the 
case of an applicant that undertakes merely to acquire and hold the 
stock of regulated investment companies, the requirements of paragraph 
(e)(5)(i)(A)(3) in its place, and (i)(D), and (vi) of this section shall 
not apply and no negative inference shall be drawn from the applicant's 
failure to demonstrate its experience of competence with respect to the 
activities described in paragraph (e)(4)(ii)(E) to (H) of this section.
    (B) The notice of approval issued to an applicant that is approved 
by reason of this subdivision shall state that the applicant is 
authorized to act only as a passive trustee.
    (ii) Federal or State regulation. Evidence that an applicant is 
subject to Federal or State regulation with respect to one or more 
relevant factors shall be given weight in proportion to the extent that 
such regulatory standards are consonant with the requirements of section 
401. Such evidence may be submitted in addition to, or in lieu of, the 
specific proofs required by this paragraph.
    (iii) Savings account. (A) An applicant will be approved to act as 
trustee under this subdivision if the following requirements are 
satisfied:
    (1) The applicant is a credit union, industrial loan company, or 
other financial institution designated by the Commissioner;
    (2) The investment of the trust assets will be solely in deposits in 
the applicant;
    (3) Deposits in the applicant are insured (up to the dollar limit 
prescribed by applicable law) by an agency or instrumentality of the 
United States, or by an organization established under a special statute 
the business of which is limited to insuring deposits in financial 
institutions and providing related services.
    (B) Any applicant that satisfies the requirements of this 
subdivision is hereby approved, and (notwithstanding subparagraph (2) of 
this paragraph) is not required to submit a written application. This 
approval takes effect on the first day after December 22, 1976, on which 
the applicant satisfies the requirements of this subdivision, and 
continues in effect for so long as the applicant continues to satisfy 
those requirements.
    (C) If deposits are insured, but not in the manner provided in 
paragraph (e)(6)(iii)(A)(3) of this section, the applicant must submit 
an application. The application, notwithstanding subparagraph (2) of 
this paragraph, will be limited to a complete description of the 
insurance of applicant's deposits. The applicant will be approved if the 
Commissioner approves of the applicant's insurance.

[[Page 565]]

    (iv) Notification of Commissioner. The applicant must notify the 
Commissioner in writing of any change that affects the continuing 
accuracy of any representation made in the application required by this 
paragraph, whether the change occurs before or after the applicant 
receives a notice of approval. The notification must be addressed to 
address prescribed by the Commissioner in revenue rulings, notices, and 
other guidance published in the Internal Revenue Bulletin (see Sec. 
601.601(d)(2)(ii)(b) of this chapter.
    (v) Substitution of trustee. No applicant will be approved unless 
the applicant undertakes to act as trustee only under trust instruments 
which contain a provision to the effect that the grantor is to 
substitute another trustee upon notification by the Commissioner that 
such substitution is required because the applicant has failed to comply 
with the requirements of this paragraph or is not keeping such records, 
or making such returns, or rendering such statements as are required by 
forms or regulations.
    (7) Procedure and administration--(i) Notice of approval. If the 
applicant is approved, a written notice of approval will be issued to 
the applicant. The notice of approval will state the day on which it 
becomes effective, and (except as otherwise provided therein) will 
remain effective until revoked. This paragraph does not authorize the 
applicant to accept any fiduciary account before such notice of approval 
becomes effective.
    (ii) Notice of disapproval. If the applicant is not approved, a 
written notice will be furnished to the applicant containing a statement 
of the reasons why the applicant has not been approved.
    (iii) Copy to be furnished. The applicant must not accept a 
fiduciary account until after the plan administrator or the person for 
whose benefit the account is to be established is furnished with a copy 
of the written notice of approval issued to the applicant. This 
provision is effective six months after April 20, 1979 for new accounts 
accepted thereafter. For accounts accepted before that date, the 
administrator must be notified before the later of the effective date of 
this provision or six months after acceptance of the account.
    (iv) Grounds for revocation. The notice of approval issued to an 
applicant will be revoked if the Commissioner determines that the 
applicant is unwilling or unable to administer fiduciary accounts in a 
manner consistent with the requirements of this paragraph. Generally, 
the notice will not be revoked unless the Commissioner determines that 
the applicant has knowingly, willfully, or repeatedly failed to 
administer fiduciary accounts in a manner consistent with the 
requirements of this paragraph, or has administered a fiduciary account 
in a grossly negligent manner.
    (v) Procedures for revocation. The notice of approval issued to an 
applicant may be revoked in accordance with the following procedures:
    (A) If the Commissioner proposes to revoke the notice of approval 
issued to an applicant, the Commissioner will advise the applicant in 
writing of the proposed revocation and of the reasons therefor.
    (B) Within 60 days after the receipt of such written advice, the 
applicant may protest the proposed revocation by submitting a written 
statement of facts, law, and arguments opposing such revocation to 
address prescribed by the Commissioner in revenue rulings, notices, and 
other guidance published in the Internal Revenue Bulletin (see Sec. 
601.601(d)(2)(ii)(b) of this chapter. In addition, the applicant may 
request a conference in the National Office.
    (C) If the applicant consents to the proposed revocation, either 
before or after a National Office conference, or if the applicant fails 
to file a timely protest, the Commissioner will revoke the notice of 
approval that was issued to the applicant.
    (D) If, after considering the applicant's protest and any 
information developed in conference, the Commissioner determines that 
the applicant is unwilling or unable to administer fiduciary accounts in 
a manner consistent with the requirements of this paragraph, the 
Commissioner will revoke the notice of approval that was issued to the 
applicant and will furnish the applicant with a written statement of

[[Page 566]]

findings on which the revocation is based.
    (E) If at any time the Commissioner determines that immediate action 
is necessary to protect the interest of the Internal Revenue Service or 
of any fiduciary account, the notice of approval issued to the applicant 
will be suspended at once, pending a final decision to be based on the 
applicant's protest and any information developed in conference.
    (8) Special rules for governmental units--(i) In general. A 
governmental unit that seeks to qualify as a nonbank trustee of a deemed 
IRA that is part of its qualified employer plan must demonstrate to the 
satisfaction of the Commissioner that it is able to administer the trust 
in a manner that is consistent with the requirements of section 408. The 
demonstration must be made by written application to the Commissioner. 
Notwithstanding the requirement of paragraph (e)(1) of this section that 
a person must demonstrate by written application that the requirements 
of paragraphs (e)(2) through (e)(6) of this section will be met in order 
to qualify as a nonbank trustee, a governmental unit that maintains a 
plan qualified under section 401(a), 403(a), 403(b) or 457 need not 
demonstrate that all of these requirements will be met with respect to 
any individual retirement accounts maintained by that governmental unit 
pursuant to section 408(q). For example, a governmental unit need not 
demonstrate that it satisfies the net worth requirements of paragraph 
(e)(3)(ii) of this section if it demonstrates instead that it possesses 
taxing authority under applicable law. The Commissioner, in his 
discretion, may exempt a governmental unit from certain other 
requirements upon a showing that the governmental unit is able to 
administer the deemed IRAs in the best interest of the participants. 
Moreover, in determining whether a governmental unit satisfies the other 
requirements of paragraphs (e)(2) through (e)(6) of this section, the 
Commissioner may apply the requirements in a manner that is consistent 
with the applicant's status as a governmental unit.
    (ii) Governmental unit. For purposes of this special rule, the term 
governmental unit means a state, political subdivision of a state, and 
any agency or instrumentality of a state or political subdivision of a 
state.
    (iii) Additional rules. The Commissioner may in revenue rulings, 
notices, or other guidance of general applicability provide additional 
rules for governmental units seeking approval as nonbank trustees.
    (iv) Effective/applicability date. This section is applicable for 
written applications made on or after June 18, 2007. The rules in this 
section also may be relied on for applications submitted on or after 
August 1, 2003 (or such earlier application as the Commissioner deems 
appropriate) and before June 18, 2007.

[T.D. 7714, 45 FR 52791, Aug. 8, 1980, as amended by T.D. 8635, 60 FR 
65549, Dec. 20, 1995; 61 FR 11307, Mar. 20, 1996; T.D. 9142, 69 FR 
43739, July 22, 2004; T.D. 9331, 72 FR 33388, June 18, 2007]



Sec. 1.408-3  Individual retirement annuities.

    (a) In general. An individual retirement annuity is an annuity 
contract or endowment contract (described in paragraph (e)(1) of this 
section) issued by an insurance company which is qualified to do 
business under the law of the jurisdiction in which the contract is sold 
and which satisfies the requirements of paragraph (b) of this section. A 
participation certificate in a group contract issued by an insurance 
company described in this paragraph will be treated as an individual 
retirement annuity if the contract satisfies the requirements of 
paragraph (b) of this section; the certificate of participation sets 
forth the requirements of paragraphs (1) through (5) of section 408 (b); 
the contract provides for a separate accounting of the benefit allocable 
to each participant-owner; and the group contract is for the exclusive 
benefit of the participant owners and their beneficiaries. For purposes 
of this title, a participant-owner of a group contract described in this 
paragraph shall be treated as the owner of an individual retirement 
annuity. A contract will not be treated as other than an individual 
retirement annuity merely because it provides for waiver of premium on 
disability. An individual retirement annuity contract which satisfies 
the

[[Page 567]]

requirements of section 408 (b) need not be purchased under a trust if 
the requirements of paragraph (b) of this section are satisfied. An 
individual retirement endowment contract may not be held under a trust 
which satisfies the requirements of section 408 (a). Distribution of the 
contract is not a taxable event. Distributions under the contract are 
includible in gross income in accordance with the provisions of Sec. 
1.408-4 (e).
    (b) Requirements--(1) Transferability. The annuity or the endowment 
contract must not be transferable by the owner. An annuity or endowment 
contract is transferable if the owner can transfer any portion of his 
interest in the contract to any person other than the issuer thereof. 
Accordingly, such a contract is transferable if the owner can sell, 
assign, discount, or pledge as collateral for a loan or as security for 
the performance of an obligation or for any other purpose his interest 
in the contract to any person other than the issuer thereof. On the 
other hand, a contract is not to be considered transferable merely 
because the contract contains: a provision permitting the individual to 
designate a beneficiary to receive the proceeds in the event of his 
death, a provision permitting the individual to elect a joint and 
survivor annuity, or other similar provisions.
    (2) Annual premium. Except in the case of a contribution to a 
simplified employee pension described in section 408 (k), the annual 
premium on behalf of any individual for the annuity or the endowment 
contract cannot exceed $1,500. Any refund of premiums must be applied 
before the close of the calendar year following the year of the refund 
toward the payment of future premiums or the purchase of additional 
benefits.
    (3) Distribution. The entire interest of the owner must be 
distributed to him in the same manner and over the same period as 
described in Sec. 1.408-2 (b) (6).
    (4) Distribution upon death. If the owner dies before the entire 
interest has been distributed to him, or if distribution has commenced 
to the surviving spouse, the remaining interest must be distributed in 
the same manner, over the same period, and to the same beneficiaries as 
described in Sec. 1.408-2 (b) (7).
    (5) Nonforfeitability. The entire interest of the owner in the 
annuity or endowment contract must be nonforfeitable.
    (6) Flexible premium. [Reserved]
    (c) Disqualification. If during any taxable year the owner of an 
annuity borrows any money under the annuity or endowment contract or by 
use of such contract (including, but not limited to, pledging the 
contract as security for any loan), such contract will cease to be an 
individual retirement annuity as of the first day of such taxable year, 
and will not be an individual retirement annuity at any time thereafter. 
If an annuity or endowment contract which constitutes an individual 
retirement annuity is disqualified as a result of the preceding 
sentence, an amount equal to the fair market value of the contract as of 
the first day of the taxable year of the owner in which such contract is 
disqualified is deemed to be distributed to the owner. Such owner shall 
include in gross income for such year an amount equal to the fair market 
value of such contract as of such first day. The preceding sentence 
applies even though part of the fair market value of the individual 
retirement annuity as of the first day of the taxable year is 
attributable to excess contributions which may be returned tax-free 
under section 408(d)(4) or 408(d)(5).
    (d) Premature distribution tax on deemed distribution. If the 
individual has not attained age 59\1/2\ before the beginning of the year 
in which the disqualification described in paragraph (c) of this section 
occurs, see section 408(f)(2) for additional tax on premature 
distributions.
    (e) Endowment contracts--(1) Additional requirement for endowment 
contracts. No contract providing life insurance protection issued by a 
company described in paragraph (a) of this section shall be treated as 
an endowment contract for purposes of this section if--
    (i) Such contract matures later than the taxable year in which the 
individual in whose name the contract is purchased attains the age of 
70\1/2\;

[[Page 568]]

    (ii) Such contract is not for the exclusive benefit of such 
individual or his beneficiaries;
    (iii) Premiums under the contract may increase over the term of the 
contract;
    (iv) When all premiums are paid when due, the case value of such 
contract at maturity is less than the death benefit payable under the 
contract at any time before maturity;
    (v) The death benefit does not, at some time before maturity, exceed 
the greater of the cash value or the sum of premiums paid under the 
contract;
    (vi) Such contract does not provide for a cash value;
    (vii) Such contract provides that the life insurance element of such 
contract may increase over the term of such contract, unless such 
increase is merely because such contract provides for the purchase of 
additional benefits;
    (viii) Such contract provides insurance other than life insurance 
and waiver of premiums upon disability; or
    (ix) Such contract is issued after November 6, 1978.
    (2) Treatment of proceeds under endowment contract upon death of 
individual. In the case of the payment of a death benefit under an 
endowment contract upon the death of the individual in whose name the 
contract is purchased, the portion of such payment which is equal to the 
cash value immediately before the death of such individual is not 
excludable from gross income under section 101(a) and is treated as a 
distribution from an individual retirement annuity. The remaining 
portion, if any, of such payment constitutes current life insurance 
protection and is excludable under section 101(a). If a death benefit is 
paid under an endowment contract at a date or dates later than the death 
of the individual, section 101(d) is applicable only to the portion of 
the benefit which is attributable to the amount excludable under section 
101(a).

[T.D. 7714, 45 FR 52792, Aug. 8, 1980]



Sec. 1.408-4  Treatment of distributions from individual retirement 
arrangements.

    (a) General rule--(1) Inclusion in income. Except as otherwise 
provided in this section, any amount actually paid or distributed or 
deemed paid or distributed from an individual retirement account or 
individual retirement annuity shall be included in the gross income of 
the payee or distributee for the taxable year in which the payment or 
distribution is received.
    (2) Zero basis. Notwithstanding section 1015(d) or any other 
provision of the Code, the basis (or investment in the contract) of any 
person in such an account or annuity is zero. For purposes of this 
section, an assignment of an individual's rights under an individual 
retirement account or an individual retirement annuity shall, except as 
provided in Sec. 1.408-4(g) (relating to transfer incident to divorce), 
be deemed a distribution to such individual from such account or annuity 
of the amount assigned.
    (b) Rollover contribution--(1) To individual retirement arrangement. 
Paragraph (a)(1) of this section shall not apply to any amount paid or 
distributed from an individual retirement account or individual 
retirement annuity to the individual for whose benefit the account was 
established or who is the owner of the annuity if the entire amount 
received (including the same amount of money and any other property) is 
paid into an individual retirement account, annuity (other than an 
endowment contract), or bond created for the benefit of such individual 
not later than the 60th day after the day on which he receives the 
payment or distribution.
    (2) To qualified plan. Paragraph (a)(1) of this section does not 
apply to any amount paid or distributed from an individual retirement 
account or individual retirement annuity to the individual for whose 
benefit the account was established or who is the owner of the annuity 
if--
    (i) No amount in the account or no part of the value of the annuity 
is attributable to any source other than a rollover contribution from an 
employees' trust described in section 401(a) which is exempt from tax 
under section 501(a) or a rollover contribution from an annuity plan 
described in section 403(a) and the earnings on such sums, and
    (ii) The entire amount received (including the same amount of money 
and

[[Page 569]]

any other property) represents the entire amount in the account and is 
paid into another such trust or plan (for the benefit of such 
individual) not later than the 60th day after the day on which the 
payment or distribution is received.

This subparagraph does not apply if any portion of the rollover 
contribution described in paragraph (b)(2)(i) of this section is 
attributable to an employees' trust forming part of a plan or an annuity 
under which the individual was an employee within the meaning of section 
401(c)(1) at the time contributions were made on his behalf under the 
plan.
    (3) To section 403(b) contract. [Reserved]
    (4) Frequency limitation. (i) For taxable years beginning on or 
before December 31, 1977, paragraph (b)(1) of this section does not 
apply to any amount received by an individual from an individual 
retirement account, annuity or bond if at any time during the 3-year 
period ending on the day of receipt, the individual received any other 
amount from an individual retirement account, annuity or bond which was 
not includible in his gross income because of the application of 
paragraph (b)(1) of this section.
    (ii) [Reserved]
    (c) Excess contributions returned before due date of return--(1) 
Excess contribution. The rules in this paragraph (c) apply for purposes 
of determining net income attributable to IRA contributions made before 
January 1, 2004, and returned pursuant to section 408(d)(4). The rules 
in Sec. 1.408-11 apply for purposes of determining net income 
attributable to IRA contributions made on or after January 1, 2004, and 
returned pursuant to section 408(d)(4). For purposes of this paragraph, 
excess contributions are the excess of the amounts contributed to an 
individual retirement account or paid for an individual retirement 
annuity during the taxable year over the amount allowable as a deduction 
under section 219 or 220 for the taxable year.
    (2) General rule. (i) Paragraph (a)(1) of this section does not 
apply to the distribution of any excess contribution paid during a 
taxable year to an account or annuity if: the distribution is received 
on or before the date prescribed by law (including extensions) for 
filing the individual's return for such taxable year; no deduction is 
allowed under section 219 or section 220 with respect to the excess 
contribution; and the distribution is accompanied by the amount of net 
income attributable to the excess contribution as of the date of the 
distribution as determined under subdivision (ii).
    (ii) The amount of net income attributable to the excess 
contributions is an amount which bears the same ratio to the net income 
earned by the account during the computation period as the excess 
contribution bears to the sum of the balance of the account as of the 
first day of the taxable year in which the excess contribution is made 
and the total contribution made for such taxable year. For purposes of 
this paragraph, the term ``computation period'' means the period 
beginning on the first day of the taxable year in which the excess 
contribution is made and ending on the date of the distribution from the 
account.
    (iii) For purposes of paragraph (c)(2)(ii), the net income earned by 
the account during the computation period is the fair market value of 
the balance of the account immediately after the distribution increased 
by the amount of distributions from the account during the computation 
period, and reduced (but not below zero) by the sum of: (A) the fair 
market value of the balance of the account as of the first day of the 
taxable year in which the excess contribution is made and (B) the 
contributions to the account made during the computation period.
    (3) Time of inclusion. (i) For taxable years beginning before 
January 1, 1977, the amount of net income determined under subparagraph 
(2) is includible in the gross income of the individual for the taxable 
year in which it is received. The amount of net income thus distributed 
is subject to the tax imposed by section 408(f)(1) for the year 
includible in gross income.
    (ii) [Reserved]
    (4) Example. The provisions of this paragraph may be illustrated by 
the following example:

    Example. On January 1, 1975, A, age 55, who is a calendar-year 
taxpayer, contributes

[[Page 570]]

$1,500 to an individual retirement account established for his benefit. 
For 1975, A is entitled to a deduction of $1,400 under section 219. For 
1975, A does not claim as deductions any other items listed in section 
62. A's gross income for 1975 is $9,334. On April 1, 1976, $107 is 
distributed to A from his individual retirement account. As of such 
date, the balance of the account is $1,498 [$1,605 - $107]. There were 
no other distributions from the account as of such date. The net amount 
of income earned by the account is $105 [$1,498 + $107 - (0 + $1,500)]. 
The net income attributable to the excess contribution is $7. 
[$105x($100/$1,500)]. A's adjusted gross income for 1975 is his gross 
income for 1975 ($9,334) reduced by the amount allowable to A as a 
deduction under section 219 ($1,400), or $7,934. A will include the $7 
of the $107 distributed on April 1, 1976, in his gross income for 1976. 
Further, A will pay an additional income tax of $.70 for 1976 under 
section 408(f)(1).

    (d) Deemed distribution--(1) General rule. In any case in which an 
individual retirement account ceases to be an individual retirement 
account by reason of the application of section 408(e)(2), paragraph 
(a)(1) of this section shall apply as if there were a distribution on 
the first day of the taxable year in which such account ceases to be an 
individual retirement account of an amount equal to the fair market 
value on such day of all of the assets in the account on such day. In 
the case of a deemed distribution from an individual retirement annuity, 
see Sec. 1.408-3(d).
    (2) Using account as security. In any case in which an individual 
for whose benefit an individual retirement account is established uses, 
directly or indirectly, all or any portion of the account as security 
for a loan, paragraph (a)(1) of this section shall apply as if there 
were distributed on the first day of the taxable year in which the loan 
was made an amount equal to that portion of the account used as security 
for such loan.
    (e) Distribution of annuity contracts. Paragraph (a)(1) of this 
section does not apply to any annuity contract which is distributed from 
an individual retirement account and which satisfies the requirements of 
paragraphs (b) (1), (3), (4) and (5) of section 408. Amounts distributed 
under such contracts will be taxable to the distributee under section 
72. For purposes of applying section 72 to a distribution from such a 
contract, the investment in such contract is zero.
    (f) Treatment of assets distributed from an individual retirement 
account for the purchase of an endowment contract. Under section 
408(e)(5), if all, or any portion, of the assets of an individual 
retirement account are used to purchase an endowment contract described 
in Sec. 1.408-3(e) for the benefit of the individual for whose benefit 
the account is established--
    (1) The excess, if any, of the total amount of assets used to 
purchase such contract over the portion of the assets attributable to 
life insurance protection shall be treated as a rollover contribution 
described in section 408(d)(3), and
    (2) The portion of the assets attributable to life insurance 
protection shall be treated as a distribution described in paragraph 
(a)(91) of this section, except that the provisions of section 408(f) 
shall not apply to such amount.
    (g) Transfer incident to divorce--(1) General rule. The transfer of 
an individual's interest, in whole or in part, in an individual 
retirement account, individual retirement annuity, or a retirement bond, 
to his former spouse under a valid divorce decree or a written 
instrument incident to such divorce shall not be considered to be a 
distribution from such an account or annuity to such individual or his 
former spouse; nor shall it be considered a taxable transfer by such 
individual to his former spouse notwithstanding any other provision of 
Subtitle A of the Code.
    (2) Spousal account. The interest described in this paragraph (g) 
which is transferred to the former spouse shall be treated as an 
individual retirement account of such spouse if the interest is an 
individual retirement account; an individual retirement annuity of such 
spouse if such interest is an individual retirement annuity; and a 
retirement bond of such spouse if such interest is a retirement bond.

[T.D. 7714, 45 FR 52793, Aug. 8, 1980, as amended by T.D. 9056, 68 FR 
23588, May 5, 2003]

[[Page 571]]



Sec. 1.408-5  Annual reports by trustees or issuers.

    (a) In general. The trustee of an individual retirement account or 
the issuer of an individual retirement annuity shall make annual 
calendar year reports concerning the status of the account or annuity. 
The report shall contain the information required in paragraph (b) and 
be furnished or filed in the manner and time specified in paragraph (c).
    (b) Information required to be included in the annual reports. The 
annual calendar year report shall contain the following information for 
transactions occurring during the calendar year--
    (1) The amount of contributions;
    (2) The amount of distributions;
    (3) In the case of an endowment contract, the amount of the premium 
paid allocable to the cost of life insurance;
    (4) The name and address of the trustee or issuer; and
    (5) Such other information as the Commissioner may require.
    (c) Manner and time for filing. (1) The annual report shall be 
furnished to the individual on whose behalf the account is established 
or in whose name the annuity is purchased (or the beneficiary of the 
individual or owner). The report shall be furnished on or before the 
30th day of June following the calendar year for which the report is 
required.
    (2) The Commissioner may require the annual report to be filed with 
the Service at the time the Commissioner specifies.
    (d) Penalties. Section 6693 prescribes penalties for failure to file 
the annual report.
    (e) Effective date. This section shall apply to reports for calendar 
years after 1978.
    (f) Reports for years prior to 1979. For years prior to 1979, a 
trustee or issuer shall make reports in the time and manner as the 
Commissioner requires.

[T.D. 7714, 45 FR 52795, Aug. 8, 1980]



Sec. 1.408-6  Disclosure statements for individual retirement 
arrangements.

    (a) In general--(1) General rule. Trustees and issuers of individual 
retirement accounts and annuities are, under the authority of section 
408(i), required to provide disclosure statements. This section sets 
forth these requirements.
    (2) [Reserved]
    (b)-(c) [Reserved]
    (d) Requirements. (1)-(3) [Reserved]
    (4) Disclosure statements--(i) Under the authority contained in 
section 408(i), a disclosure statement shall be furnished in accordance 
with the provisions of this subparagraph by the trustee of an individual 
retirement account described in section 408(a) or the issuer of an 
individual retirement annuity described in section 408(b) or of an 
endowment contract described in section 408(b) to the individual 
(hereinafter referred to as the ``benefited individual'') for whom such 
an account, annuity, or contract is, or is to be, established.
    (ii)(A)(1) The trustee or issuer shall furnish, or cause to be 
furnished, to the benefited individual, a disclosure statement 
satisfying the requirements of subdivisions (iii) through (viii) of this 
subparagraph, as applicable, and a copy of the governing instrument to 
be used in establishing the account, annuity, or endowment contract. The 
copy of such governing instrument need not be filled in with financial 
and other data pertaining to the benefited individual; however, such 
copy must be complete in all other respects. The disclosure statement 
and copy of the governing instrument must be received by the benefited 
individual at least seven days preceding the earlier of the date of 
establishment or purchase of the account, annuity, or endowment 
contract. A disclosure statement or copy of the governing instrument 
required by this subparagraph may be received by the benefited 
individual less than seven days preceding, but no later than, the 
earlier of the date of establishment or purchase, if the benefited 
individual is permitted to revoke the account, annuity, or endowment 
contract pursuant to a procedure which satisfies the requirements of 
subdivision (ii)(A)(2) of this subparagraph.
    (2) A procedure for revocation satisfies the requirements of this 
subdivision (ii)(A)(2) of this subparagraph if the benefited individual 
is permitted to revoke the account, or endowment contract by mailing or 
delivering, at his option, a notice of revocation on or before a day not 
less than seven days

[[Page 572]]

after the earlier of the date of establishment or purchase and, upon 
revocation, is entitled to a return of the entire amount of the 
consideration paid by him for the account, annuity, or endowment 
contract without adjustment for such items as sales commissions, 
administrative expenses or fluctuation in market value. The procedure 
may require that the notice be in writing or that it be oral, or it may 
require both a written and an oral notice. If an oral notice is required 
or permitted, the procedure must permit it to be delivered by telephone 
call during normal business hours. If a written notice is required or 
permitted, the procedure must provide that, if mailed, it shall be 
deemed mailed on the date of the postmark (or if sent by certified or 
registered mail, the date of certification or registration) if it is 
deposited in the mail in the United States in an envelope, or other 
appropriate wrapper, first class postage prepaid, properly addressed.
    (B) If after a disclosure statement has been furnished, or caused to 
be furnished, to the benefited individual pursuant to paragraph 
(d)(4)(ii)(A) of this section and--
    (1) On or before the earlier of the date of establishment or 
purchase, or
    (2) On or before the last day on which the benefited individual is 
permitted to revoke the account, annuity, or endowment contract (if the 
benefited individual has a right to revoke the account, annuity, or 
endowment contract pursuant to the rules of subdivision (ii)(A) of this 
subparagraph).

there becomes effective a material adverse change in the information set 
forth in such disclosure statement or a material change in the governing 
instrument to be used in establishing the account, annuity, or contract, 
the trustee or issuer shall furnish, or cause to be furnished, to the 
benefited individual such amendments to any previously furnished 
disclosure statement or governing instrument as may be necessary to 
adequately inform the benefited individual of such change. The trustee 
or issuer shall be treated as satisfying this subdivision (ii)(B) of 
this subparagraph only if material required to be furnished by this 
subdivision is received by the benefited individual at least seven days 
preceding the earlier of the date of establishment or purchase of the 
account, annuity, or endowment contract or if the benefited individual 
is permitted to revoke the account, annuity, or endowment contract on or 
before a date not less than seven days after the date on which such 
material is received, pursuant to a procedure for revocation otherwise 
satisfying the provisions of subdivision (ii)(A)(2) of this 
subparagraph.
    (C) If the governing instrument is amended after the account, 
annuity, or endowment contract is no longer subject to revocation 
pursuant to subdivision (ii)(A) or (B) of this subparagraph, the trustee 
or issuer shall not later than the 30th day after the later of the date 
on which the amendment is adopted or becomes effective, deliver or mail 
to the last known address of the benefited individual a copy of such 
amendment and, if such amendment affects a matter described in 
subdivisions (iii) through (viii) of this subparagraph, a disclosure 
statement with respect to such matter meeting the requirements of 
subdivision (iv) of this subparagraph.
    (D) For purposes of subdivision (ii) (A) and (B) of this 
subparagraph, if a disclosure statement, governing instrument, or an 
amendment to either, is mailed to the benefited individual, it shall be 
deemed (in the absence of evidence to the contrary) to be received by 
the benefited individual seven days after the date of mailing.
    (E) In the case of a trust described in section 408(c) (relating to 
certain retirement savings arrangements for employees or members of 
associations of employees), the following special rules shall be 
applied:
    (1) For purposes of this subparagraph, references to the benefited 
individual's account, annuity, or endowment contract shall refer to the 
benefited individual's interest in such trust, and
    (2) The provisions of subdivision (ii) of this subparagraph shall be 
applied by substituting ``the date on which the benefited individual's 
interest in such trust commences'' for ``the earlier of the date of 
establishment or purchase'' wherever it appear therein.
    Thus, for example, if an employer establishes a trust described in 
section 408(c) for the benefit of employees, and

[[Page 573]]

the trustee furnishes an employee with a disclosure statement and a copy 
of the governing instrument (as required by this subparagraph) on the 
date such employee's interest in the trust commences, such employee must 
be given a right to revoke such interest within a period of at least 
seven days. If any contribution has been made within such period 
(whether by the employee or by the employer), the full amount of such 
contribution must be paid to such employee pursuant to subdivision 
(ii)(A)(2) of this subparagraph.
    (iii) The disclosure statement required by this subparagraph shall 
set forth in nontechnical language the following matters as such matters 
relate to the account, annuity, or endowment contract (as the case may 
be);
    (A) Concise explanations of--
    (1) The statutory requirements prescribed in section 408(a) 
(relating to an individual retirement account) or section 408(b) 
(relating to an individual retirement annuity and an endowment 
contract), and any additional requirements (whether or not required by 
law) that pertain to the particular retirement savings arrangement.
    (2) The income tax consequences of establishing an account, annuity, 
or endowment contract (as the case may be) which meets the requirements 
of section 408(a) relating to an individual retirement account) or 
section 408(b) (relating to an individual retirement annuity and an 
endowment contract), including the deductibility of contributions to, 
the tax treatment of distributions (other than premature distributions) 
from, the availability of income tax free rollovers to and from, and the 
tax status of such account, annuity, or endowment contract.
    (3) The limitations and restrictions on the deduction for retirement 
savings under section 219, including the ineligibility of certain 
individuals who are active participants in a plan described in section 
219(b)(2)(A) or for whom amounts are contributed under a contract 
described in section 219(b)(2)(B) to make deductible contributions to an 
account or for an annuity or endowment contract.
    (4) The circumstances under which the benefited individual may 
revoke the account, annuity, or endowment contract, and the procedure 
therefor (including the name, address, and telephone number of the 
person designated to receive notice of such revocation). Such 
explanation shall be prominently displayed at the beginning of the 
disclosure statement.
    (B) Statements to the effect that--
    (1) If the benefited individual or his beneficiary engages in a 
prohibited transaction, described in section 4975(c) with respect to an 
individual retirement account, the account will lose its exemption from 
tax by reason of section 408(e)(2)(A), and the benefited individual must 
include in gross income, for the taxable year during which the benefited 
individual or his beneficiary engages in the prohibited transaction the 
fair market value of the account.
    (2) If the owner of an individual retirement annuity or endowment 
contract described in section 408(b) borrows any money under, or by use 
of, such annuity or endowment contract, then, under section 408(e)(3), 
such annuity or endowment contract loses its section 408(b) 
classification, and the owner must include in gross income, for the 
taxable year during which the owner borrows any money under, or by use 
of, such annuity or endowment contract, the fair market value of the 
annuity or endowment contract.
    (3) If a benefited individual uses all or any portion of an 
individual retirement account as security for a loan, then, under 
section 408(e)(4), the portion so used is treated as distributed to such 
individual and the benefited individual must include such distribution 
in gross income for the taxable year during which he so uses such 
account.
    (4) An additional tax of 10 percent is imposed by section 408(f) on 
distributions (including amounts deemed distributed as the result of a 
prohibited loan or use as security for a loan) made before the benefited 
individual has attained age 59\1/2\, unless such distribution is made on 
account of death or disability, or unless a rollover contribution is 
made with such distribution.
    (5) Sections 2039(e) (relating to exemption from estate tax of 
annuities under certain trusts and plans) and 2517 (relating to 
exemption from gift tax of specified transfers of certain annuities 
under qualified plans) apply (including

[[Page 574]]

the manner in which such sections apply) to the account, annuity, or 
endowment contract.
    (6) Section 402(a)(2) and (e) (relating to tax on lump sum 
distributions) is not applicable to distributions from an account, 
annuity, or endowment contract.
    (7) A minimum distribution is required under section 408(a) (6) or 
(7) and 408(b) (3) or (4) (including a brief explanation of the amount 
of minimum distribution) and that if the amount distributed from an 
account, annuity, or endowment contract during the taxable year of the 
payee is less than the minimum required during such year, an excise tax, 
which shall be paid by the payee, is imposed under section 4974, in an 
amount equal to 50 percent of the excess of the minimum required to be 
distributed over the amount actually distributed during the year.
    (8) An excise tax is imposed under section 4973 on excess 
contributions (including a brief explanation of an excess contribution).
    (9) The benefited individual must file Form 5329 (Return for 
Individual Retirement Savings Arrangement) with the Internal Revenue for 
each taxable year during which the account, annuity, or endowment 
contract is maintained.
    (10) The account or contract has or has not (as the case may be) 
been approved as to form for use as an account, annuity, or endowment 
contract by the Internal Revenue Service. For purposes of this 
subdivision, if a favorable opinion or determination letter with respect 
to the form of a prototype trust, custodial account, annuity, or 
endowment contract has been issued by the Internal Revenue Service, or 
the instrument which establishes an individual retirement trust account 
or an individual retirement custodial account utilizes the precise 
language of a form currently provided by the Internal Revenue Service 
(including any additional language permitted by such form), such account 
or contract may be treated as approved as to form.
    (11) The Internal Revenue Service approval is a determination only 
as to the form of the account, annuity, or endowment contract, and does 
not represent a determination of the merits of such account, annuity, or 
endowment contract.
    (12) The proceeds from the account, annuity or endowment contract 
may be used by the benefited individual as a rollover contribution to 
another account or annuity or retirement bond in accordance with the 
provisions of section 408(d)(3).
    (13) In the case of an endowment contract described in section 
408(b), no deduction is allowed under section 219 for that portion of 
the amounts paid under the contract for the taxable year properly 
allocable to the cost of life insurance.
    (14) If applicable, in the event that the benefited individual 
revokes the account, annuity, or endowment contract, pursuant to the 
procedure described in the disclosure statement (see subdivision (A)(4) 
of this subdivision (iii)), the benefited individual is entitled to a 
return of the entire amount of the consideration paid by him for the 
account, annuity, or endowment contract without adjustment for such 
items as sales commissions, administrative expenses or fluctuation in 
market value.
    (15) Further information can be obtained from any district office of 
the Internal Revenue Service.
    To the extent that information on the matters described in 
subdivisions (iii) (A) and (B) of this subparagraph is provided in a 
publication of the Internal Revenue Service relating to individual 
retirement savings arrangements, such publication may be furnished by 
the trustee or issuer in lieu of providing information relating to such 
matters in a disclosure statement.
    (C) The financial disclosure required by paragraph (d)(4) (v), (vi), 
and (vii) of this section.
    (iv) In the case of an amendment to the terms of an account, 
annuity, or endowment contract described in paragraph (d)(4)(i) of this 
section, the disclosure statement required by this subparagraph need not 
repeat material contained in the statement furnished pursuant to 
paragraph (d)(4)(iii) of this section, but it must set forth in 
nontechnical language those matters described in paragraph (d)(4)(iii) 
of this section which are affected by such amendment.

[[Page 575]]

    (v) With respect to an account, annuity, or endowment contract 
described in paragraph (d)(4)(i) of this section (other than an account 
or annuity which is to receive only a rollover contribution described in 
paragraph (d)(4)(vi) of this section and to which no deductible 
contributions will be made), the disclosure statement must set forth in 
cases where either an amount is guaranteed over period of time (such as 
in the case of a nonparticipating endowment or annuity contract), or a 
projection of growth of the value of the account, annuity, or endowment 
contract can reasonably be made (such as in the case of a participating 
endowment or annuity contract (other than a variable annuity) or 
passbook savings account), the following:
    (A) To the extent that an amount is guaranteed,
    (1) The amount, determined without regard to any portion of a 
contribution which is not deductible, that would be guaranteed to be 
available to the benefited individual if (i) level annual contributions 
in the amount of $1,000 were to be made on the first day of each year, 
and (ii) the benefited individual were to withdraw in a single sum the 
entire amount of such account, annuity, or endowment contract at the end 
of each of the first five years during which contributions are to be 
made, at the end of the year in which the benefited individual attains 
the ages of 60, 65, and 70, and at the end of any other year during 
which the increase of the guaranteed available amount is less than the 
increase of the guaranteed available amount during any preceding year 
for any reason other than decrease of cessation of contributions, and
    (2) A statement that the amount described in subdivision (v)(A)(1) 
of this subparagraph is guaranteed, and the period for which guaranteed;
    (B) To the extent a projection of growth of the value of the 
account, annuity, or endowment contract can reasonably be made but the 
amounts are not guaranteed.
    (1) The amount, determined without regard to any portion of a 
contribution which is not deductible, and upon the basis of an earnings 
rate no greater than, and terms no different from, those currently in 
effect, that would be available to the benefited individual if (i) level 
annual contributions in the amount of $1,000 were to be made on the 
first day of each year, and (ii) the benefited individual were to 
withdraw in a single sum the entire amount of such account, annuity, or 
endowment contract at the end of each of the first five years during 
which contributions are to be made, at the end of each of the years in 
which the benefited individual attains the ages of 60, 65, and 70, and 
at the end of any other year during which the increase of the available 
amount is less than the increase of the available amount during any 
preceding year for any reason other than decrease or cessation of 
contributions, and
    (2) A statement that the amount described in paragraph 
(d)(4)(v)(B)(1) of this section is a projection and is not guaranteed 
and a statement of the earnings rate and terms on the basis of which the 
projection is made;
    (C) The portion of each $1,000 contribution attributable to the cost 
of life insurance, which would not be deductible, for each year during 
which contributions are to be made; and
    (D) The sales commission (including any commission attributable to 
the sale of life insurance), if any, to be charged in each year, 
expressed as a percentage of gross annual contributions (including any 
portion attributable to the cost of life insurance) to be made for each 
year.
    (vi) With respect to an account or annuity described in paragraph 
(d)(4)(i) of this section to which a rollover contribution described in 
section 402(a)(5)(A), 403(a)(4)(A), 408(d)(3)(A) or 409(b)(3)(C) will be 
made, the disclosure statement must set forth, in cases where an amount 
is guaranteed over a period of time (such as in the case of a non-
participating annuity contract, or a projection of growth of the value 
of the account or annuity can reasonably be made (such as in the case of 
a participating annuity contract (other than a variable annuity) or a 
passbook savings account), the following:
    (A) To the extent guaranteed,
    (1) The amount that would be guaranteed to be available to the 
benefited

[[Page 576]]

individual if (i) Such a rollover contribution in the amount of $1,000 
were to be made on the first day of the year, (ii) No other contribution 
were to be made, and (iii) The benefited individual were to withdraw in 
a single sum the entire amount of such account or annuity at the end of 
each of the first five years after the contribution is made, at the end 
of the year in which the benefited individual attains the ages of 60, 
65, and 70, and at the end of any other year during which the increase 
of the guaranteed available amount is less than the increase of the 
guaranteed available amount during any preceding year, and
    (2) A statement that the amount described in paragraph (d)(vi)(A)(1) 
of this section is guaranteed;
    (B) To the extent that a projection of growth of the value of the 
account or annuity can reasonably be made but the amounts are not 
guaranteed,
    (1) The amount, determined upon the basis of an earnings rate no 
greater than, and terms no different from, those currently in effect, 
that would be available to the benefited individual if (i) such a 
rollover contribution in the amount of $1,000 were to be made on the 
first day of the year, (ii) no other contribution were to be made, and 
(iii) the benefited individual were to withdraw in a single sum the 
entire amount of such account or annuity at the end of each of the first 
five years after the contribution is made, at the end of each of the 
years in which the benefited individual attains the ages 60, 65, 70, and 
at the end of any other year during which the increase of the available 
amount is less than the increase of the available amount during any 
preceding year, and
    (2) A statement that the amount described in paragraph 
(d)(4)(vi)(B)(1) of this section is a projection and is not guaranteed 
and a statement of the earnings rate and terms on the basis of which the 
projection is made; and
    (C) The sales commission, if any, to be charged in each year, 
expressed as a percentage of the assumed $1,000 contribution.
    (vii) With respect to an account, annuity, or endowment contract 
described in paragraph (d)(4)(i) of this section, in all cases not 
subject to paragraph (d)(4) (v) or (vi) of this section (such as in the 
case of a mutual fund or variable annuity), the disclosure statement 
must set forth information described in subdivisions (A) through (C) of 
this subdivisions (vii) based (as applicable with respect to the type or 
types of contributions to be received by the account, annuity, or 
endowment contract) upon the assumption of (1) level annual 
contributions of $1,000 on the first day of each year, (2) a rollover 
contribution of $1,000 on the first day of the year and no other 
contributions, or (3) a rollover contribution of $1,000 on the first day 
of the year plus level annual contributions of $1,000 on the first day 
of each year.
    (A) A description (in nontechnical language) with respect to the 
benefited individual's interest in the account, annuity, or endowment 
contract, of:
    (1) Each type of charge, and the amount thereof, which may be made 
against a contribution,
    (2) The method for computing and allocating annual earnings, and
    (3) Each charge (other than those described in complying with 
paragraph (d)(4)(vii)(A)(1) of this section) which may be applied to 
such interest in determining the net amount of money available to the 
benefited individual and the method of computing each such charge;
    (B) A statement that growth in value of the account, annuity, or 
endowment contract is neither guaranteed nor projected; and
    (C) The portion of each $1,000 contribution attributable to the cost 
of life insurance, which would not be deductible, for every year during 
which contributions are to be made.
    (viii) A disclosure statement, or an amendment thereto, furnished 
pursuant to the provisions of this subparagraph may contain information 
in addition to that required by paragraph (d)(4)(iii) through (vii) of 
this section. However, such disclosure statement will not be considered 
to comply with the provisions of this subparagraph if the substance of 
such additional material or the form in which it is presented causes 
such disclosure statement to be false or misleading with respect to the 
information required to be disclosed by this paragraph.

[[Page 577]]

    (ix) The provisions of section 6693, relating to failure to provide 
reports on individual retirement accounts or annuities, shall apply to 
any trustee or issuer who fails to furnish, or cause to be furnished, a 
disclosure statement, a copy of the governing instrument, or an 
amendment to either, as required by this paragraph.
    (x) This section shall be effective for disclosure statements and 
copies of governing instruments mailed, or delivered without mailing, 
after February 14, 1977.
    (xi) This section does not reflect the amendments made by section 
1501 of the Tax Reform Act of 1976 (90 Stat. 1734) relating to 
retirement savings for certain married individuals.

[T.D. 7714, 45 FR 52795, Aug. 8, 1980; 45 FR 56802, Aug. 26, 1980]



Sec. 1.408-7  Reports on distributions from individual retirement 
plans.

    (a) Requirement of report. The trustee of an individual retirement 
account or the issuer of an individual retirement annuity who makes a 
distribution during any calendar year to an individual from such account 
or under such annuity shall make a report on Form W-2P (in the case of 
distributions that are not total distributions) or Form 1099R (in the 
case of total distributions), and their related transmittal forms, for 
such year. The return must show the name and address of the person to 
whom the distribution was made, the aggregate amount of such 
distribution, and such other information as is required by the forms.
    (b) Amount subject to this section. The amounts subject to reporting 
under paragraph (a) include all amounts distributed or made available to 
which section 408(d) applies.
    (c) Time and place for filing. The report required under this 
section for any calendar year shall be filed after the close of that 
year and on or before February 28 of the following year with the 
appropriate Internal Revenue Service Center.
    (d) Statement to recipients. (1) Each trustee or issuer required to 
file Form 1099R or Form W-2P under this section shall furnish to the 
person whose identifying number is (or should be) shown on the forms a 
copy of the form.
    (2) Each statement required by this paragraph to be furnished to 
recipients shall be furnished to such person after November 30 of the 
year of the distribution and on or before January 31 of the following 
year. However, for a distribution after December 31, 2008, the February 
15 due date under section 6045 applies to the statement if the statement 
is furnished in a consolidated reporting statement under section 6045. 
See Sec. Sec. 1.6045-1(k)(3), 1.6045-2(d)(2), 1.6045-3(e)(2), 1.6045-
4(m)(3), and 1.6045-5(a)(3)(ii).
    (e) Effective date. This section is effective for calendar years 
beginning after December 31, 1977.

[T.D. 7714, 45 FR 52798, Aug. 8, 1980, as amended by T.D. 9504, 75 FR 
64084, Oct. 18, 2010]



Sec. 1.408-8  Distribution requirements for individual retirement plans.

    The following questions and answers relate to the distribution rules 
for IRAs provided in sections 408(a)(6) and 408(b)(3).
    Q-1. Is an IRA subject to the distribution rules provided in section 
401(a)(9) for qualified plans?
    A-1. (a) Yes, an IRA is subject to the required minimum distribution 
rules provided in section 401(a)(9). In order to satisfy section 
401(a)(9) for purposes of determining required minimum distributions for 
calendar years beginning on or after January 1, 2003, the rules of 
Sec. Sec. 1.401(a)(9)-1 through 1.401(a)(9)-9 and 1.401(a)(9)-6 for 
defined contribution plans must be applied, except as otherwise provided 
in this section. For example, whether the 5-year rule or the life 
expectancy rule applies to distributions after death occurring before 
the IRA owner's required beginning date is determined in accordance with 
Sec. 1.401(a)(9)-3 and the rules of Sec. 1.401(a)(9)-4 apply for 
purposes of determining an IRA owner's designated beneficiary. 
Similarly, the amount of the minimum distribution required for each 
calendar year from an individual account is determined in accordance 
with Sec. 1.401(a)(9)-5. For purposes of this section, the term IRA 
means an individual retirement account or annuity described in section 
408(a) or (b). The IRA owner is the individual for whom

[[Page 578]]

an IRA is originally established by contributions for the benefit of 
that individual and that individual's beneficiaries.
    (b) For purposes of applying the required minimum distribution rules 
in Sec. Sec. 1.401(a)(9)-1 through 1.401(a)(9)-9 and 1.401(a)(9)-6 for 
qualified plans, the IRA trustee, custodian, or issuer is treated as the 
plan administrator, and the IRA owner is substituted for the employee.
    (c) See A-14 and A-15 of Sec. 1.408A-6 for rules under section 
401(a)(9) that apply to a Roth IRA.
    Q-2. Are IRAs that receive employer contributions under a simplified 
employee pension (defined in section 408(k)) or a SIMPLE IRA (defined in 
section 408(p)) treated as IRAs for purposes of section 401(a)(9)?
    A-2. Yes, IRAs that receive employer contributions under a 
simplified employee pension (defined in section 408(k)) or a SIMPLE plan 
(defined in section 408(p)) are treated as IRAs, rather than employer 
plans, for purposes of section 401(a)(9) and are, therefore, subject to 
the distribution rules in this section.
    Q-3. In the case of distributions from an IRA, what does the term 
required beginning date mean?
    A-3. In the case of distributions from an IRA, the term required 
beginning date means April 1 of the calendar year following the calendar 
year in which the individual attains age 70\1/2\.
    Q-4. What portion of a distribution from an IRA is not eligible for 
rollover because the amount is a required minimum distribution?
    A-4. The portion of a distribution that is a required minimum 
distribution from an IRA and thus not eligible for rollover is 
determined in the same manner as provided in A-7 of Sec. 1.402(c)-2 for 
distributions from qualified plans. For example, if a minimum 
distribution is required under section 401(a)(9) for a calendar year, an 
amount distributed during a calendar year from an IRA is treated as a 
required minimum distribution under section 401(a)(9) to the extent that 
the total required minimum distribution for the year under section 
401(a)(9) for that IRA has not been satisfied. This requirement may be 
satisfied by a distribution from the IRA or, as permitted under A-9 of 
this section, from another IRA.
    Q-5. May an individual's surviving spouse elect to treat such 
spouse's entire interest as a beneficiary in an individual's IRA upon 
the death of the individual (or the remaining part of such interest if 
distribution to the spouse has commenced) as the spouse's own account?
    A-5. (a) The surviving spouse of an individual may elect, in the 
manner described in paragraph (b) of this A-5, to treat the spouse's 
entire interest as a beneficiary in an individual's IRA (or the 
remaining part of such interest if distribution thereof has commenced to 
the spouse) as the spouse's own IRA. This election is permitted to be 
made at any time after the individual's date of death. In order to make 
this election, the spouse must be the sole beneficiary of the IRA and 
have an unlimited right to withdraw amounts from the IRA. If a trust is 
named as beneficiary of the IRA, this requirement is not satisfied even 
if the spouse is the sole beneficiary of the trust. If the surviving 
spouse makes the election, the required minimum distribution for the 
calendar year of the election and each subsequent calendar year is 
determined under section 401(a)(9)(A) with the spouse as IRA owner and 
not section 401(a)(9)(B) with the surviving spouse as the deceased IRA 
owner's beneficiary. However, if the election is made in the calendar 
year containing the IRA owner's death, the spouse is not required to 
take a required minimum distribution as the IRA owner for that calendar 
year. Instead, the spouse is required to take a required minimum 
distribution for that year, determined with respect to the deceased IRA 
owner under the rules of A-4(a) of Sec. 1.401(a)(9)-5, to the extent 
such a distribution was not made to the IRA owner before death.
    (b) The election described in paragraph (a) of this A-5 is made by 
the surviving spouse redesignating the account as an account in the name 
of the surviving spouse as IRA owner rather than as beneficiary. 
Alternatively, a surviving spouse eligible to make the election is 
deemed to have made the election if, at any time, either of the 
following occurs--

[[Page 579]]

    (1) Any amount in the IRA that would be required to be distributed 
to the surviving spouse as beneficiary under section 401(a)(9)(B) is not 
distributed within the time period required under section 401(a)(9)(B); 
or
    (2) Any additional amount is contributed to the IRA which is 
subject, or deemed to be subject, to the lifetime distribution 
requirements of section 401(a)(9)(A).
    (c) The result of an election described in paragraph (b) of this A-5 
is that the surviving spouse shall then be considered the IRA owner for 
whose benefit the trust is maintained for all purposes under the 
Internal Revenue Code (e.g., section 72(t)).
    Q-6. How is the benefit determined for purposes of calculating the 
required minimum distribution from an IRA?
    A-6. For purposes of determining the minimum distribution required 
to be made from an IRA in any calendar year, the account balance of the 
IRA as of December 31 of the calendar year immediately preceding the 
calendar year for which distributions are required to be made is 
substituted in A-3 of Sec. 1.401(a)(9)-5 for the account balance of the 
employee. Except as provided in A-7 and A-8 of this section, no 
adjustments are made for contributions or distributions after that date.
    Q-7. What rules apply in the case of a rollover to an IRA of an 
amount distributed by a qualified plan or another IRA?
    A-7. If the surviving spouse of an employee rolls over a 
distribution from a qualified plan, such surviving spouse may elect to 
treat the IRA as the spouse's own IRA in accordance with the provisions 
in A-5 of this section. In the event of any other rollover to an IRA of 
an amount distributed by a qualified plan or another IRA, the rules in 
Sec. 1.401(a)(9)-7 will apply for purposes of determining the account 
balance for the receiving IRA and the required minimum distribution from 
the receiving IRA. However, because the value of the account balance is 
determined as of December 31 of the year preceding the year for which 
the required minimum distribution is being determined and not as of a 
valuation date in the preceding year, the account balance of the 
receiving IRA is only adjusted if the amount is not received in the 
calendar year in which the amount rolled over is distributed. In that 
case, for purposes of determining the required minimum distribution for 
the calendar year in which such amount is actually received, the account 
balance of the receiving IRA as of December 31 of the preceding year 
must be adjusted by the amount received in accordance with A-2 of Sec. 
1.401(a)(9)-7.
    Q-8. What rules apply in the case of a transfer (including a 
recharacterization) from one IRA to another?
    A-8. (a) General rule. In the case of a trustee-to-trustee transfer 
from one IRA to another IRA that is not a distribution and rollover, the 
transfer is not treated as a distribution by the transferor IRA for 
purposes of section 401(a)(9). Accordingly, the minimum distribution 
requirement with respect to the transferor IRA must still be satisfied. 
Except as provided in paragraph (b) of this A-8 for recharacterizations, 
after the transfer the employee's account balance and the required 
minimum distribution under the transferee IRA are determined in the same 
manner as an account balance and required minimum distribution are 
determined under an IRA receiving a rollover contribution under A-7 of 
this section.
    (b) Recharacterizations. If an amount is contributed to a Roth IRA 
that is a conversion contribution or failed conversion contribution and 
that amount (plus net income allocable to that amount) is transferred to 
another IRA (transferee IRA) in a subsequent year as a recharacterized 
contribution, the recharacterized contribution (plus allocable net 
income) must be added to the December 31 account balance of the 
transferee IRA for the year in which the conversion or failed conversion 
occurred.
    Q-9. Is the required minimum distribution from one IRA of an owner 
permitted to be distributed from another IRA in order to satisfy section 
401(a)(9)?
    A-9. Yes, the required minimum distribution must be calculated 
separately for each IRA. The separately calculated amounts may then be 
totaled and the total distribution taken from any one or more of the 
individual's IRAs under the rules set forth in

[[Page 580]]

this A-9. Generally, only amounts in IRAs that an individual holds as 
the IRA owner may be aggregated. However, amounts in IRAs that an 
individual holds as a beneficiary of the same decedent and which are 
being distributed under the life expectancy rule in section 
401(a)(9)(B)(iii) or (iv) may be aggregated, but such amounts may not be 
aggregated with amounts held in IRAs that the individual holds as the 
IRA owner or as the beneficiary of another decedent. Distributions from 
section 403(b) contracts or accounts will not satisfy the distribution 
requirements from IRAs, nor will distributions from IRAs satisfy the 
distribution requirements from section 403(b) contracts or accounts. 
Distributions from Roth IRAs (defined in section 408A) will not satisfy 
the distribution requirements applicable to IRAs or section 403(b) 
accounts or contracts and distributions from IRAs or section 403(b) 
contracts or accounts will not satisfy the distribution requirements 
from Roth IRAs.
    Q-10. Is any reporting required by the trustee, custodian, or issuer 
of an IRA with respect to the minimum amount that is required to be 
distributed from that IRA?
    A-10. Yes, the trustee, custodian, or issuer of an IRA is required 
to report information with respect to the minimum amount required to be 
distributed from the IRA for each calendar year to individuals or 
entities, at the time, and in the manner, prescribed by the Commissioner 
in revenue rulings, notices, and other guidance published in the 
Internal Revenue Bulletin (see Sec. 601.601(d)(2)(ii)(b) of this 
chapter) as well as the applicable Federal tax forms and accompanying 
instructions.
    Q-11. Which amounts distributed from an IRA are taken into account 
in determining whether section 401(a)(9) is satisfied?
    A-11. (a) General rule. Except as provided in paragraph (b) of this 
A-11, all amounts distributed from an IRA are taken into account in 
determining whether section 401(a)(9) is satisfied, regardless of 
whether the amount is includible in income.
    (b) Amounts not taken into account. The following amounts are not 
taken into account in determining whether the required minimum amount 
with respect to an IRA for a calendar year has been distributed--
    (1) Contributions returned pursuant to section 408(d)(4), together 
with the income allocable to these contributions;
    (2) Contributions returned pursuant to section 408(d)(5);
    (3) Corrective distributions of excess simplified employee pension 
contributions under section 408(k)(6)(C), together with the income 
allocable to these distributions; and
    (4) Similar items designated by the Commissioner in revenue rulings, 
notices, and other guidance published in the Internal Revenue Bulletin. 
See Sec. 601.601(d)(2)(ii)(b) of this chapter.

[T.D. 8987, 67 FR 19024, Apr. 17, 2002, as amended by T.D. 9130, 69 FR 
33293, June 15, 2004]



Sec. 1.408-11  Net income calculation for returned or recharacterized 
IRA contributions.

    (a) Net income calculation for returned IRA contributions--(1) 
General rule. For purposes of returned contributions under section 
408(d)(4), the net income attributable to a contribution made to an IRA 
is determined by allocating to the contribution a pro rata portion of 
the earnings on the assets in the IRA during the period the IRA held the 
contribution. This attributable net income is calculated by using the 
following formula:
[GRAPHIC] [TIFF OMITTED] TR05MY03.002

    (2) Special rule. If an IRA is established with a contribution and 
no other contributions, distributions or transfers are made to or from 
that IRA, then

[[Page 581]]

the subsequent distribution of the entire account balance of the IRA 
pursuant to section 408(d)(4) will satisfy the requirement of that 
Internal Revenue Code section that the return of a contribution be 
accompanied by the amount of net income attributable to the 
contribution.
    (b) Definitions. For purposes of this section the following 
definitions apply:
    (1) Adjusted opening balance. The term adjusted opening balance 
means the fair market value of the IRA at the beginning of the 
computation period plus the amount of any contributions or transfers 
(including the contribution that is distributed as a returned 
contribution pursuant to section 408(d)(4) and recharacterizations of 
contributions pursuant to section 408A(d)(6)) made to the IRA during the 
computation period.
    (2) Adjusted closing balance. The term adjusted closing balance 
means the fair market value of the IRA at the end of the computation 
period plus the amount of any distributions or transfers (including 
recharacterizations of contributions pursuant to section 408A(d)(6)) 
made from the IRA during the computation period.
    (3) Computation period. The term computation period means the period 
beginning immediately prior to the time that the contribution being 
returned was made to the IRA and ending immediately prior to the removal 
of the contribution. If more than one contribution was made as a regular 
contribution and is being returned from the IRA, the computation period 
begins immediately prior to the time the first contribution being 
returned was contributed.
    (4) Regular contribution. The term regular contribution means an IRA 
contribution made by the IRA owner that is neither a trustee-to-trustee 
transfer from another IRA nor a rollover from another IRA or retirement 
plan.
    (c) Additional rules. (1) When an IRA asset is not normally valued 
on a daily basis, the fair market value of the asset at the beginning of 
the computation period is deemed to be the most recent, regularly 
determined, fair market value of the asset, determined as of a date that 
coincides with or precedes the first day of the computation period. In 
addition, solely for purposes of this section, notwithstanding A-3 of 
Sec. 1.408A-5, recharacterized contributions are taken into account for 
the period they are actually held in a particular IRA.
    (2) In the case of an IRA that has received more than one regular 
contribution for a particular taxable year, the last regular 
contribution made to the IRA for the year is deemed to be the 
contribution that is distributed as a returned contribution under 
section 408(d)(4), up to the amount of the contribution identified by 
the IRA owner as the amount distributed as a returned contribution.
    (3) In the case of an individual who owns multiple IRAs, the net 
income calculation is performed only on the IRA containing the 
contribution being returned, and that IRA is the IRA that must 
distribute the contribution.
    (d) Examples. The following examples illustrate the net income 
calculation under section 408(d)(4) and this section:

    Example 1. (i) On May 1, 2004, when her IRA is worth $4,800, 
Taxpayer A makes a $1,600 regular contribution to her IRA. Taxpayer A 
requests that $400 of the May 1, 2004, contribution be returned to her 
pursuant to section 408(d)(4). Pursuant to this request, on February 1, 
2005, when the IRA is worth $7,600, the IRA trustee distributes to 
Taxpayer A the $400 plus attributable net income. During this time, no 
other contributions have been made to the IRA and no distributions have 
been made.
    (ii) The adjusted opening balance is $6,400 [$4,800 + $1,600] and 
the adjusted closing balance is $7,600. Thus, the net income 
attributable to the $400 May 1, 2004, contribution is $75 [$400 x 
($7,600-$6,400) / $6,400]. Therefore, the total to be distributed on 
February 1, 2005, pursuant to Sec. 408(d)(4) is $475.
    Example 2. (i) Beginning in January 2004, Taxpayer B contributes 
$300 on the 15th of each month to an IRA for 2004, resulting in an 
excess regular contribution of $600 for that year. Taxpayer B requests 
that the $600 excess regular contribution be returned to her pursuant to 
section 408(d)(4). Pursuant to this request, on March 1, 2005, when the 
IRA is worth $16,000, the IRA trustee distributes to Taxpayer B the $600 
plus attributable net income. The excess regular contributions to be 
returned are deemed to be the last two made in 2004: the $300 December 
15 contribution and the $300 November 15 contribution. On November 15 
the IRA was worth $11,000 immediately prior to the contribution. No 
distributions or transfers have been made

[[Page 582]]

from the IRA and no contributions or transfers, other than the monthly 
contributions (including $300 in January and February 2005), have been 
made.
    (ii) As of the beginning of the computation period (November 15), 
the adjusted opening balance is $12,200 [$11,000 + $300 + $300 + $300 + 
$300] and the adjusted closing balance is $16,000. Thus, the net income 
attributable to the excess regular contributions is $187 [$600 x 
($16,000 - $12,200) / $12,200]. Therefore, the total to be distributed 
as returned contributions on March 1, 2005, to correct the excess 
regular contribution is $787 [$600 + $187].

[T.D. 9056, 68 FR 23588, May 5, 2003]



Sec. 1.408(q)-1  Deemed IRAs in qualified employer plans.

    (a) In general. Under section 408(q), a qualified employer plan may 
permit employees to make voluntary employee contributions to a separate 
account or annuity established under the plan. If the requirements of 
section 408(q) and this section are met, such account or annuity is 
treated in the same manner as an individual retirement plan under 
section 408 or 408A (and contributions to such an account or annuity are 
treated as contributions to an individual retirement plan and not to the 
qualified employer plan). The account or annuity is referred to as a 
deemed IRA.
    (b) Types of IRAs. If the account or annuity meets the requirements 
applicable to traditional IRAs under section 408, the account or annuity 
is deemed to be a traditional IRA, and if the account or annuity meets 
the requirements applicable to Roth IRAs under section 408A, the account 
or annuity is deemed to be a Roth IRA. Simplified employee pensions 
(SEPs) under section 408(k) and SIMPLE IRAs under section 408(p) may not 
be used as deemed IRAs.
    (c) Separate entities. Except as provided in paragraphs (d) and (g) 
of this section, the qualified employer plan and the deemed IRA are 
treated as separate entities under the Internal Revenue Code and are 
subject to the separate rules applicable to qualified employer plans and 
IRAs, respectively. Issues regarding eligibility, participation, 
disclosure, nondiscrimination, contributions, distributions, 
investments, and plan administration are generally to be resolved under 
the separate rules (if any) applicable to each entity under the Internal 
Revenue Code.
    (d) Exceptions. The following exceptions to treatment of a deemed 
IRA and the qualified employer plan as separate entities apply:
    (1) The plan document of the qualified employer plan must contain 
the deemed IRA provisions and a deemed IRA must be in effect at the time 
the deemed IRA contributions are accepted. Notwithstanding the preceding 
sentence, employers that provided deemed IRAs for plan years beginning 
before January 1, 2004, (but after December 31, 2002) are not required 
to have such provisions in their plan documents before the end of such 
plan years.
    (2) The requirements of section 408(a)(5) regarding commingling of 
assets do not apply to deemed IRAs. Accordingly, the assets of a deemed 
IRA may be commingled for investment purposes with those of the 
qualified employer plan. However, the restrictions on the commingling of 
plan and IRA assets with other assets apply to the assets of the 
qualified employer plan and the deemed IRA.
    (e) Application of distribution rules. (1) Rules applicable to 
distributions from qualified employer plans under the Internal Revenue 
Code and regulations do not apply to distributions from deemed IRAs. 
Instead, the rules applicable to distributions from IRAs apply to 
distributions from deemed IRAs. Also, any restrictions that a trustee, 
custodian, or insurance company is permitted to impose on distributions 
from traditional and Roth IRAs may be imposed on distributions from 
deemed IRAs (for example, early withdrawal penalties on annuities).
    (2) The required minimum distribution rules of section 401(a)(9) 
must be met separately with respect to the qualified employer plan and 
the deemed IRA. The determination of whether a qualified employer plan 
satisfies the required minimum distribution rules of section 401(a)(9) 
is made without regard to whether a participant satisfies the required 
minimum distribution requirements with respect to the deemed IRA that is 
established under such plan.

[[Page 583]]

    (f) Additional rules--(1) Trustee. The trustee or custodian of an 
individual retirement account must be a bank, as required by section 
408(a)(2), or, if the trustee is not a bank, as defined in section 
408(n), the trustee must have received approval from the Commissioner to 
serve as a nonbank trustee or nonbank custodian pursuant to Sec. 1.408-
2(e). For further guidance regarding governmental units serving as 
nonbank trustees of deemed IRAs established under section 408(q), see 
Sec. 1.408-2T(e)(8).
    (2) Trusts. (i) General rule. Deemed IRAs that are individual 
retirement accounts may be held in separate individual trusts, a single 
trust separate from a trust maintained by the qualified employer plan, 
or in a single trust that includes the qualified employer plan. A deemed 
IRA trust must be created or organized in the United States for the 
exclusive benefit of the participants. If deemed IRAs are held in a 
single trust that includes the qualified employer plan, the trustee must 
maintain a separate account for each deemed IRA. In addition, the 
written governing instrument creating the trust must satisfy the 
requirements of section 408(a) (1), (2), (3), (4), and (6).
    (ii) Application of section 408(a)(3). If deemed IRAs are held in a 
single trust that includes the qualified employer plan, section 
408(a)(3) is treated as satisfied if no part of the separate accounts of 
any of the deemed IRAs is invested in life insurance contracts, 
regardless of whether the separate account for the qualified employer 
plan invests in life insurance contracts.
    (iii) Separate accounts for traditional and Roth deemed IRAs. The 
rules of section 408A(b) and the regulations thereunder, requiring each 
Roth IRA to be clearly designated as a Roth IRA, will not fail to be 
satisfied solely because Roth deemed IRAs and traditional deemed IRAs 
are held in a single trust, provided that the trustee maintains separate 
accounts for the Roth deemed IRAs and traditional deemed IRAs of each 
participant, and each of those accounts is clearly designated as such.
    (3) Annuity contracts. Deemed IRAs that are individual retirement 
annuities may be held under a single annuity contract or under separate 
annuity contracts. However, the contract must be separate from any 
annuity contract or annuity contracts of the qualified employer plan. In 
addition, the contract must satisfy the requirements of section 408(b) 
and there must be separate accounting for the interest of each 
participant in those cases where the individual retirement annuities are 
held under a single annuity contract.
    (4) Deductibility. The deductibility of voluntary employee 
contributions to a traditional deemed IRA is determined in the same 
manner as if they were made to any other traditional IRA. Thus, for 
example, taxpayers with compensation that exceeds the limits imposed by 
section 219(g) may not be able to make contributions to deemed IRAs, or 
the deductibility of such contributions may be limited in accordance 
with sections 408 and 219(g). However, section 219(f)(5), regarding the 
taxable year in which amounts paid by an employer to an individual 
retirement plan are includible in the employee's income, is not 
applicable to deemed IRAs.
    (5) Rollovers and transfers. The same rules apply to rollovers and 
transfers to and from deemed IRAs as apply to rollovers and transfers to 
and from other IRAs. Thus, for example, the plan may provide that an 
employee may request and receive a distribution of his or her deemed IRA 
account balance and may roll it over to an eligible retirement plan in 
accordance with section 408(d)(3), regardless of whether that employee 
may receive a distribution of any other plan benefits.
    (6) Nondiscrimination. The availability of a deemed IRA is not a 
benefit, right or feature of the qualified employer plan under Sec. 
1.401(a)(4)-4.
    (7) IRA assets and benefits not taken into account in determining 
benefits under or funding of qualified employer plan. Neither the assets 
held in the deemed IRA portion of the qualified employer plan, nor any 
benefits attributable thereto, shall be taken into account for purposes 
of:
    (i) Determining the benefits of employees and their beneficiaries 
under the plan (within the meaning of section 401(a)(2)); or
    (ii) Determining the plan's assets or liabilities for purposes of 
section 404 or 412.

[[Page 584]]

    (g) Disqualifying defects--(1) Single trust. If the qualified 
employer plan fails to satisfy the qualification requirements applicable 
to it, either in form or operation, any deemed IRA that is an individual 
retirement account and that is included as part of the trust of that 
qualified employer plan does not satisfy section 408(q). Accordingly, 
any account maintained under such a plan as a deemed IRA ceases to be a 
deemed IRA at the time of the disqualifying event. In addition, the 
deemed IRA also ceases to satisfy the requirements of sections 408(a) 
and 408A. Also, if any one of the deemed IRAs fails to satisfy the 
applicable requirements of sections 408 or 408A, and the assets of that 
deemed IRA are included as part of the trust of the qualified employer 
plan, section 408(q) does not apply and the plan will fail to satisfy 
the plan's qualification requirements.
    (2) Separate trusts and annuities. If the qualified employer plan 
fails to satisfy its qualification requirements, either in form or 
operation, but the assets of a deemed IRA are held in a separate trust 
(or where a deemed IRA is an individual retirement annuity), then the 
deemed IRA does not automatically fail to satisfy the applicable 
requirements of section 408 or 408A. Instead, its status as an IRA will 
be determined by considering whether the account or the annuity 
satisfies the applicable requirements of sections 408 and 408A 
(including, in the case of individual retirement accounts, the 
prohibition against the commingling of assets under section 408(a)(5)). 
Also, if a deemed IRA fails to satisfy the requirements of a qualified 
IRA and the assets of the deemed IRA are held in a separate trust (or 
where the deemed IRA is an individual retirement annuity), the qualified 
employer plan will not fail the qualification requirements applicable to 
it under the Code solely because of the failure of the deemed IRA.
    (h) Definitions. The following definitions apply for purposes of 
this section:
    (1) Qualified employer plan. A qualified employer plan is a plan 
described in section 401(a), an annuity plan described in section 
403(a), a section 403(b) plan, or a governmental plan under section 
457(b).
    (2) Voluntary employee contribution. A voluntary employee 
contribution is any contribution (other than a mandatory contribution 
within the meaning of section 411(c)(2)(C)) which is made by an 
individual as an employee under a qualified employer plan that allows 
employees to elect to make contributions to deemed IRAs and with respect 
to which the individual has designated the contribution as a 
contribution to which section 408(q) applies.
    (3) Employee. An employee includes any individual who is an employee 
under the rules applicable to the qualified employer plan under which 
the deemed IRA is established.
    (i) Effective date. This section applies to accounts or annuities 
established under section 408(q) on or after August 1, 2003.

[T.D. 9142, 69 FR 43739, July 22, 2004]



Sec. 1.408A-0  Roth IRAs; table of contents.

    This table of contents lists the regulations relating to Roth IRAs 
under section 408A of the Internal Revenue Code as follows:

Sec. 1.408A-1 Roth IRAs in general.
Sec. 1.408A-2 Establishing Roth IRAs.
Sec. 1.408A-3 Contributions to Roth IRAs.
Sec. 1.408A-4 Converting amounts to Roth IRAs.
Sec. 1.408A-5 Recharacterized contributions.
Sec. 1.408A-6 Distributions.
Sec. 1.408A-7 Reporting.
Sec. 1.408A-8 Definitions.
Sec. 1.408A-9 Effective date.

[T.D. 8816, 64 FR 5601, Feb. 4, 1999]



Sec. 1.408A-1  Roth IRAs in general.

    This section sets forth the following questions and answers that 
discuss the background and general features of Roth IRAs:
    Q-1. What is a Roth IRA?
    A-1. (a) A Roth IRA is a new type of individual retirement plan that 
individuals can use, beginning in 1998. Roth IRAs are described in 
section 408A, which was added by the Taxpayer Relief Act of 1997 (TRA 
97), Public Law 105-34 (111 Stat. 788).
    (b) Roth IRAs are treated like traditional IRAs except where the 
Internal Revenue Code specifies different treatment. For example, 
aggregate contributions (other than by a conversion

[[Page 585]]

or other rollover) to all an individual's Roth IRAs are not permitted to 
exceed $2,000 for a taxable year. Further, income earned on funds held 
in a Roth IRA is generally not taxable. Similarly, the rules of section 
408(e), such as the loss of exemption of the account where the owner 
engages in a prohibited transaction, apply to Roth IRAs in the same 
manner as to traditional IRAs.
    Q-2. What are the significant differences between traditional IRAs 
and Roth IRAs?
    A-2. There are several significant differences between traditional 
IRAs and Roth IRAs under the Internal Revenue Code. For example, 
eligibility to contribute to a Roth IRA is subject to special modified 
AGI (adjusted gross income) limits; contributions to a Roth IRA are 
never deductible; qualified distributions from a Roth IRA are not 
includible in gross income; the required minimum distribution rules 
under section 408(a)(6) and (b)(3) (which generally incorporate the 
provisions of section 401(a)(9)) do not apply to a Roth IRA during the 
lifetime of the owner; and contributions to a Roth IRA can be made after 
the owner has attained age 70\1/2\.

[T.D. 8816, 64 FR 5601, Feb. 4, 1999]



Sec. 1.408A-2  Establishing Roth IRAs.

    This section sets forth the following questions and answers that 
provide rules applicable to establishing Roth IRAs:
    Q-1. Who can establish a Roth IRA?
    A-1. Except as provided in A-3 of this section, only an individual 
can establish a Roth IRA. In addition, in order to be eligible to 
contribute to a Roth IRA for a particular year, an individual must 
satisfy certain compensation requirements and adjusted gross income 
limits (see Sec. 1.408A-3 A-3).
    Q-2. How is a Roth IRA established?
    A-2. A Roth IRA can be established with any bank, insurance company, 
or other person authorized in accordance with Sec. 1.408-2(e) to serve 
as a trustee with respect to IRAs. The document establishing the Roth 
IRA must clearly designate the IRA as a Roth IRA, and this designation 
cannot be changed at a later date. Thus, an IRA that is designated as a 
Roth IRA cannot later be treated as a traditional IRA. However, see 
Sec. 1.408A-4 A-1(b)(3) for certain rules for converting a traditional 
IRA to a Roth IRA with the same trustee by redesignating the traditional 
IRA as a Roth IRA, and see Sec. 1.408A-5 for rules for recharacterizing 
certain IRA contributions.
    Q-3. Can an employer or an association of employees establish a Roth 
IRA to hold contributions of employees or members?
    A-3. Yes. Pursuant to section 408(c), an employer or an association 
of employees can establish a trust to hold contributions of employees or 
members made under a Roth IRA. Each employee's or member's account in 
the trust is treated as a separate Roth IRA that is subject to the 
generally applicable Roth IRA rules. The employer or association of 
employees may do certain acts otherwise required by an individual, for 
example, establishing and designating a trust as a Roth IRA.
    Q-4. What is the effect of a surviving spouse of a Roth IRA owner 
treating an IRA as his or her own?
    A-4. If the surviving spouse of a Roth IRA owner treats a Roth IRA 
as his or her own as of a date, the Roth IRA is treated from that date 
forward as though it were established for the benefit of the surviving 
spouse and not the original Roth IRA owner. Thus, for example, the 
surviving spouse is treated as the Roth IRA owner for purposes of 
applying the minimum distribution requirements under section 408(a)(6) 
and (b)(3). Similarly, the surviving spouse is treated as the Roth IRA 
owner rather than a beneficiary for purposes of determining the amount 
of any distribution from the Roth IRA that is includible in gross income 
and whether the distribution is subject to the 10-percent additional tax 
under section 72(t).

[T.D. 8816, 64 FR 5601, Feb. 4, 1999]



Sec. 1.408A-3  Contributions to Roth IRAs.

    This section sets forth the following questions and answers that 
provide rules regarding contributions to Roth IRAs:
    Q-1. What types of contributions are permitted to be made to a Roth 
IRA?
    A-1. There are two types of contributions that are permitted to be 
made to

[[Page 586]]

a Roth IRA: regular contributions and qualified rollover contributions 
(including conversion contributions). The term regular contributions 
means contributions other than qualified rollover contributions.
    Q-2. When are contributions permitted to be made to a Roth IRA?
    A-2. (a) The provisions of section 408A are effective for taxable 
years beginning on or after January 1, 1998. Thus, the first taxable 
year for which contributions are permitted to be made to a Roth IRA by 
an individual is the individual's taxable year beginning in 1998.
    (b) Regular contributions for a particular taxable year must 
generally be contributed by the due date (not including extensions) for 
filing a Federal income tax return for that taxable year. (See Sec. 
1.408A-5 regarding recharacterization of certain contributions.)
    Q-3. What is the maximum aggregate amount of regular contributions 
an individual is eligible to contribute to a Roth IRA for a taxable 
year?
    A-3. (a) The maximum aggregate amount that an individual is eligible 
to contribute to all his or her Roth IRAs as a regular contribution for 
a taxable year is the same as the maximum for traditional IRAs: $2,000 
or, if less, that individual's compensation for the year.
    (b) For Roth IRAs, the maximum amount described in paragraph (a) of 
this A-3 is phased out between certain levels of modified AGI. For an 
individual who is not married, the dollar amount is phased out ratably 
between modified AGI of $95,000 and $110,000; for a married individual 
filing a joint return, between modified AGI of $150,000 and $160,000; 
and for a married individual filing separately, between modified AGI of 
$0 and $10,000. For this purpose, a married individual who has lived 
apart from his or her spouse for the entire taxable year and who files 
separately is treated as not married. Under section 408A(c)(3)(A), in 
applying the phase-out, the maximum amount is rounded up to the next 
higher multiple of $10 and is not reduced below $200 until completely 
phased out.
    (c) If an individual makes regular contributions to both traditional 
IRAs and Roth IRAs for a taxable year, the maximum limit for the Roth 
IRA is the lesser of--
    (1) The amount described in paragraph (a) of this A-3 reduced by the 
amount contributed to traditional IRAs for the taxable year; and
    (2) The amount described in paragraph (b) of this A-3. Employer 
contributions, including elective deferrals, made under a SEP or SIMPLE 
IRA Plan on behalf of an individual (including a self-employed 
individual) do not reduce the amount of the individual's maximum regular 
contribution.
    (d) The rules in this A-3 are illustrated by the following examples:

    Example 1. In 1998, unmarried, calendar-year taxpayer B, age 60, has 
modified AGI of $40,000 and compensation of $5,000. For 1998, B can 
contribute a maximum of $2,000 to a traditional IRA, a Roth IRA or a 
combination of traditional and Roth IRAs.
    Example 2. The facts are the same as in Example 1. However, assume 
that B violates the maximum regular contribution limit by contributing 
$2,000 to a traditional IRA and $2,000 to a Roth IRA for 1998. The 
$2,000 to B's Roth IRA would be an excess contribution to B's Roth IRA 
for 1998 because an individual's contributions are applied first to a 
traditional IRA, then to a Roth IRA.
    Example 3. The facts are the same as in Example 1, except that B's 
compensation is $900. The maximum amount B can contribute to either a 
traditional IRA or a Roth (or a combination of the two) for 1998 is 
$900.
    Example 4. In 1998, unmarried, calendar-year taxpayer C, age 60, has 
modified AGI of $100,000 and compensation of $5,000. For 1998, C 
contributes $800 to a traditional IRA and $1,200 to a Roth IRA. Because 
C's $1,200 Roth IRA contribution does not exceed the phased-out maximum 
Roth IRA contribution of $1,340 and because C's total IRA contributions 
do not exceed $2,000, C's Roth IRA contribution does not exceed the 
maximum permissible contribution.

    Q-4. How is compensation defined for purposes of the Roth IRA 
contribution limit?
    A-4. For purposes of the contribution limit described in A-3 of this 
section, an individual's compensation is the same as that used to 
determine the maximum contribution an individual can make to a 
traditional IRA. This amount is defined in section 219(f)(1) to include 
wages, commissions, professional fees, tips, and other amounts received 
for personal services, as well as

[[Page 587]]

taxable alimony and separate maintenance payments received under a 
decree of divorce or separate maintenance. Compensation also includes 
earned income as defined in section 401(c)(2), but does not include any 
amount received as a pension or annuity or as deferred compensation. In 
addition, under section 219(c), a married individual filing a joint 
return is permitted to make an IRA contribution by treating his or her 
spouse's higher compensation as his or her own, but only to the extent 
that the spouse's compensation is not being used for purposes of the 
spouse making a contribution to a Roth IRA or a deductible contribution 
to a traditional IRA.
    Q-5. What is the significance of modified AGI and how is it 
determined?
    A-5. Modified AGI is used for purposes of the phase-out rules 
described in A-3 of this section and for purposes of the $100,000 
modified AGI limitation described in Sec. 1.408A-4 A-2(a) (relating to 
eligibility for conversion). As defined in section 408A(c)(3)(C)(i), 
modified AGI is the same as adjusted gross income under section 
219(g)(3)(A) (used to determine the amount of deductible contributions 
that can be made to a traditional IRA by an individual who is an active 
participant in an employer-sponsored retirement plan), except that any 
conversion is disregarded in determining modified AGI. For example, the 
deduction for contributions to an IRA is not taken into account for 
purposes of determining adjusted gross income under section 219 and thus 
does not apply in determining modified AGI for Roth IRA purposes.
    Q-6. Is a required minimum distribution from an IRA for a year 
included in income for purposes of determining modified AGI?
    A-6. (a) Yes. For taxable years beginning before January 1, 2005, 
any required minimum distribution from an IRA under section 408(a)(6) 
and (b)(3) (which generally incorporate the provisions of section 
401(a)(9)) is included in income for purposes of determining modified 
AGI.
    (b) For taxable years beginning after December 31, 2004, and solely 
for purposes of the $100,000 limitation applicable to conversions, 
modified AGI does not include any required minimum distributions from an 
IRA under section 408(a)(6) and (b)(3).
    Q-7. Does an excise tax apply if an individual exceeds the aggregate 
regular contribution limits for Roth IRAs?
    A-7. Yes. Section 4973 imposes an annual 6-percent excise tax on 
aggregate amounts contributed to Roth IRAs that exceed the maximum 
contribution limits described in A-3 of this section. Any contribution 
that is distributed, together with net income, from a Roth IRA on or 
before the tax return due date (plus extensions) for the taxable year of 
the contribution is treated as not contributed. Net income described in 
the previous sentence is includible in gross income for the taxable year 
in which the contribution is made. Aggregate excess contributions that 
are not distributed from a Roth IRA on or before the tax return due date 
(with extensions) for the taxable year of the contributions are reduced 
as a deemed Roth IRA contribution for each subsequent taxable year to 
the extent that the Roth IRA owner does not actually make regular IRA 
contributions for such years. Section 4973 applies separately to an 
individual's Roth IRAs and other types of IRAs.

[T.D. 8816, 64 FR 5601, Feb. 4, 1999]



Sec. 1.408A-4  Converting amounts to Roth IRAs.

    This section sets forth the following questions and answers that 
provide rules applicable to Roth IRA conversions:
    Q-1. Can an individual convert an amount in his or her traditional 
IRA to a Roth IRA?
    A-1. (a) Yes. An amount in a traditional IRA may be converted to an 
amount in a Roth IRA if two requirements are satisfied. First, the IRA 
owner must satisfy the modified AGI limitation described in A-2(a) of 
this section and, if married, the joint filing requirement described in 
A-2(b) of this section. Second, the amount contributed to the Roth IRA 
must satisfy the definition of a qualified rollover contribution in 
section 408A(e) (i.e., it must satisfy the requirements for a rollover 
contribution as defined in section 408(d)(3), except that the one-
rollover-per-year limitation in section 408(d)(3)(B) does not apply).

[[Page 588]]

    (b) An amount can be converted by any of three methods--
    (1) An amount distributed from a traditional IRA is contributed 
(rolled over) to a Roth IRA within the 60-day period described in 
section 408(d)(3)(A)(i);
    (2) An amount in a traditional IRA is transferred in a trustee-to-
trustee transfer from the trustee of the traditional IRA to the trustee 
of the Roth IRA; or
    (3) An amount in a traditional IRA is transferred to a Roth IRA 
maintained by the same trustee. For purposes of sections 408 and 408A, 
redesignating a traditional IRA as a Roth IRA is treated as a transfer 
of the entire account balance from a traditional IRA to a Roth IRA.
    (c) Any converted amount is treated as a distribution from the 
traditional IRA and a qualified rollover contribution to the Roth IRA 
for purposes of section 408 and section 408A, even if the conversion is 
accomplished by means of a trustee-to-trustee transfer or a transfer 
between IRAs of the same trustee.
    (d) A transaction that is treated as a failed conversion under Sec. 
1.408A-5 A-9(a)(1) is not a conversion.
    Q-2. What are the modified AGI limitation and joint filing 
requirements for conversions?
    A-2. (a) An individual with modified AGI in excess of $100,000 for a 
taxable year is not permitted to convert an amount to a Roth IRA during 
that taxable year. This $100,000 limitation applies to the taxable year 
that the funds are paid from the traditional IRA, rather than the year 
they are contributed to the Roth IRA.
    (b) If the individual is married, he or she is permitted to convert 
an amount to a Roth IRA during a taxable year only if the individual and 
the individual's spouse file a joint return for the taxable year that 
the funds are paid from the traditional IRA. In this case, the modified 
AGI subject to the $100,000 limit is the modified AGI derived from the 
joint return using the couple's combined income. The only exception to 
this joint filing requirement is for an individual who has lived apart 
from his or her spouse for the entire taxable year. If the married 
individual has lived apart from his or her spouse for the entire taxable 
year, then such individual can treat himself or herself as not married 
for purposes of this paragraph, file a separate return and be subject to 
the $100,000 limit on his or her separate modified AGI. In all other 
cases, a married individual filing a separate return is not permitted to 
convert an amount to a Roth IRA, regardless of the individual's modified 
AGI.
    Q-3. Is a remedy available to an individual who makes a failed 
conversion?
    A-3. (a) Yes. See Sec. 1.408A-5 for rules permitting a failed 
conversion amount to be recharacterized as a contribution to a 
traditional IRA. If the requirements in Sec. 1.408A-5 are satisfied, 
the failed conversion amount will be treated as having been contributed 
to the traditional IRA and not to the Roth IRA.
    (b) If the contribution is not recharacterized in accordance with 
Sec. 1.408A-5, the contribution will be treated as a regular 
contribution to the Roth IRA and, thus, an excess contribution subject 
to the excise tax under section 4973 to the extent that it exceeds the 
individual's regular contribution limit. This is the result regardless 
of which of the three methods described in A-1(b) of this section 
applies to this transaction. Additionally, the distribution from the 
traditional IRA will not be eligible for the 4-year spread and will be 
subject to the additional tax under section 72(t) (unless an exception 
under that section applies).
    Q-4. Do any special rules apply to a conversion of an amount in an 
individual's SEP IRA or SIMPLE IRA to a Roth IRA?
    A-4. (a) An amount in an individual's SEP IRA can be converted to a 
Roth IRA on the same terms as an amount in any other traditional IRA.
    (b) An amount in an individual's SIMPLE IRA can be converted to a 
Roth IRA on the same terms as a conversion from a traditional IRA, 
except that an amount distributed from a SIMPLE IRA during the 2-year 
period described in section 72(t)(6), which begins on the date that the 
individual first participated in any SIMPLE IRA Plan maintained by the 
individual's employer, cannot be converted to a Roth IRA. Pursuant to 
section

[[Page 589]]

408(d)(3)(G), a distribution of an amount from an individual's SIMPLE 
IRA during this 2-year period is not eligible to be rolled over into an 
IRA that is not a SIMPLE IRA and thus cannot be a qualified rollover 
contribution. This 2-year period of section 408(d)(3)(G) applies 
separately to the contributions of each of an individual's employers 
maintaining a SIMPLE IRA Plan.
    (c) Once an amount in a SEP IRA or SIMPLE IRA has been converted to 
a Roth IRA, it is treated as a contribution to a Roth IRA for all 
purposes. Future contributions under the SEP or under the SIMPLE IRA 
Plan may not be made to the Roth IRA.
    Q-5. Can amounts in other kinds of retirement plans be converted to 
a Roth IRA?
    A-5. No. Only amounts in another IRA can be converted to a Roth IRA. 
For example, amounts in a qualified plan or annuity plan described in 
section 401(a) or 403(a) cannot be converted directly to a Roth IRA. 
Also, amounts held in an annuity contract or account described in 
section 403(b) cannot be converted directly to a Roth IRA.
    Q-6. Can an individual who has attained at least age 70\1/2\ by the 
end of a calendar year convert an amount distributed from a traditional 
IRA during that year to a Roth IRA before receiving his or her required 
minimum distribution with respect to the traditional IRA for the year of 
the conversion?
    A-6. (a) No. In order to be eligible for a conversion, an amount 
first must be eligible to be rolled over. Section 408(d)(3) prohibits 
the rollover of a required minimum distribution. If a minimum 
distribution is required for a year with respect to an IRA, the first 
dollars distributed during that year are treated as consisting of the 
required minimum distribution until an amount equal to the required 
minimum distribution for that year has been distributed.
    (b) As provided in A-1(c) of this section, any amount converted is 
treated as a distribution from a traditional IRA and a rollover 
contribution to a Roth IRA and not as a trustee-to-trustee transfer for 
purposes of section 408 and section 408A. Thus, in a year for which a 
minimum distribution is required (including the calendar year in which 
the individual attains age 70\1/2\), an individual may not convert the 
assets of an IRA (or any portion of those assets) to a Roth IRA to the 
extent that the required minimum distribution for the traditional IRA 
for the year has not been distributed.
    (c) If a required minimum distribution is contributed to a Roth IRA, 
it is treated as having been distributed, subject to the normal rules 
under section 408(d)(1) and (2), and then contributed as a regular 
contribution to a Roth IRA. The amount of the required minimum 
distribution is not a conversion contribution.
    Q-7. What are the tax consequences when an amount is converted to a 
Roth IRA?
    A-7. (a) Any amount that is converted to a Roth IRA is includible in 
gross income as a distribution according to the rules of section 
408(d)(1) and (2) for the taxable year in which the amount is 
distributed or transferred from the traditional IRA. Thus, any portion 
of the distribution or transfer that is treated as a return of basis 
under section 408(d)(1) and (2) is not includible in gross income as a 
result of the conversion.
    (b) The 10-percent additional tax under section 72(t) generally does 
not apply to the taxable conversion amount. But see Sec. 1.408A-6 A-5 
for circumstances under which the taxable conversion amount would be 
subject to the additional tax under section 72(t).
    (c) Pursuant to section 408A(e), a conversion is not treated as a 
rollover for purposes of the one-rollover-per-year rule of section 
408(d)(3)(B).
    Q-8. Is there an exception to the income-inclusion rule described in 
A-7 of this section for 1998 conversions?
    A-8. Yes. In the case of a distribution (including a trustee-to-
trustee transfer) from a traditional IRA on or before December 31, 1998, 
that is converted to a Roth IRA, instead of having the entire taxable 
conversion amount includible in income in 1998, an individual includes 
in gross income for 1998 only one quarter of that amount and one quarter 
of that amount for each of the next 3 years. This 4-year spread also 
applies

[[Page 590]]

if the conversion amount was distributed in 1998 and contributed to the 
Roth IRA within the 60-day period described in section 408(d)(3)(A)(i), 
but after December 31, 1998. However, see Sec. 1.408A-6 A-6 for special 
rules requiring acceleration of inclusion if an amount subject to the 4-
year spread is distributed from the Roth IRA before 2001.
    Q-9. Is the taxable conversion amount included in income for all 
purposes?
    A-9. Except as provided below, any taxable conversion amount 
includible in gross income for a year as a result of the conversion 
(regardless of whether the individual is using a 4-year spread) is 
included in income for all purposes. Thus, for example, it is counted 
for purposes of determining the taxable portion of social security 
payments under section 86 and for purposes of determining the phase-out 
of the $25,000 exemption under section 469(i) relating to the 
disallowance of passive activity losses from rental real estate 
activities. However, as provided in Sec. 1.408A-3 A-5, the taxable 
conversion amount (and any resulting change in other elements of 
adjusted gross income) is disregarded for purposes of determining 
modified AGI for section 408A.
    Q-10. Can an individual who makes a 1998 conversion elect not to 
have the 4-year spread apply and instead have the full taxable 
conversion amount includible in gross income for 1998?
    A-10. Yes. Instead of having the taxable conversion amount for a 
1998 conversion included over 4 years as provided under A-8 of this 
section, an individual can elect to include the full taxable conversion 
amount in income for 1998. The election is made on Form 8606 and cannot 
be made or changed after the due date (including extensions) for filing 
the 1998 Federal income tax return.
    Q-11. What happens when an individual who is using the 4-year spread 
dies, files separately, or divorces before the full taxable conversion 
amount has been included in gross income?
    A-11. (a) If an individual who is using the 4-year spread described 
in A-8 of this section dies before the full taxable conversion amount 
has been included in gross income, then the remainder must be included 
in the individual's gross income for the taxable year that includes the 
date of death.
    (b) However, if the sole beneficiary of all the decedent's Roth IRAs 
is the decedent's spouse, then the spouse can elect to continue the 4-
year spread. Thus, the spouse can elect to include in gross income the 
same amount that the decedent would have included in each of the 
remaining years of the 4-year period. Where the spouse makes such an 
election, the amount includible under the 4-year spread for the taxable 
year that includes the date of the decedent's death remains includible 
in the decedent's gross income and is reported on the decedent's final 
Federal income tax return. The election is made on either Form 8606 or 
Form 1040, in accordance with the instructions to the applicable form, 
for the taxable year that includes the decedent's date of death and 
cannot be changed after the due date (including extensions) for filing 
the Federal income tax return for the spouse's taxable year that 
includes the decedent's date of death.
    (c) If a Roth IRA owner who is using the 4-year spread and who was 
married in 1998 subsequently files separately or divorces before the 
full taxable conversion amount has been included in gross income, the 
remainder of the taxable conversion amount must be included in the Roth 
IRA owner's gross income over the remaining years in the 4-year period 
(unless accelerated because of distribution or death).
    Q-12. Can an individual convert a traditional IRA to a Roth IRA if 
he or she is receiving substantially equal periodic payments within the 
meaning of section 72(t)(2)(A)(iv) from that traditional IRA?
    A-12. Yes. Not only is the conversion amount itself not subject to 
the early distribution tax under section 72(t), but the conversion 
amount is also not treated as a distribution for purposes of determining 
whether a modification within the meaning of section 72(t)(4)(A) has 
occurred. Distributions from the Roth IRA that are part of the original 
series of substantially equal periodic payments will be nonqualified 
distributions from the Roth IRA until they meet the requirements for 
being a qualified distribution, described in

[[Page 591]]

Sec. 1.408A-6 A-1(b). The additional 10-percent tax under section 72(t) 
will not apply to the extent that these nonqualified distributions are 
part of a series of substantially equal periodic payments. Nevertheless, 
to the extent that such distributions are allocable to a 1998 conversion 
contribution with respect to which the 4-year spread for the resultant 
income inclusion applies (see A-8 of this section) and are received 
during 1998, 1999, or 2000, the special acceleration rules of Sec. 
1.408A-6 A-6 apply. However, if the original series of substantially 
equal periodic payments does not continue to be distributed in 
substantially equal periodic payments from the Roth IRA after the 
conversion, the series of payments will have been modified and, if this 
modification occurs within 5 years of the first payment or prior to the 
individual becoming disabled or attaining age 59\1/2\, the taxpayer will 
be subject to the recapture tax of section 72(t)(4)(A).
    Q-13. Can a 1997 distribution from a traditional IRA be converted to 
a Roth IRA in 1998?
    A-13. No. An amount distributed from a traditional IRA in 1997 that 
is contributed to a Roth IRA in 1998 would not be a conversion 
contribution. See A-3 of this section regarding the remedy for a failed 
conversion.
    Q-14. What is the amount that is treated as a distribution, for 
purposes of determining income inclusion, when a conversion involves an 
annuity contract?
    A-14. (a) In general--(1) Distribution of Fair Market Value Upon 
Conversion. Notwithstanding Sec. 1.408-4(e), when part or all of a 
traditional IRA that is an individual retirement annuity described in 
section 408(b) is converted to a Roth IRA, for purposes of determining 
the amount includible in gross income as a distribution under Sec. 
1.408A-4, A-7, the amount that is treated as distributed is the fair 
market value of the annuity contract on the date the annuity contract is 
converted. Similarly, when a traditional IRA that is an individual 
retirement account described in section 408(a) holds an annuity contract 
as an account asset and the traditional IRA is converted to a Roth IRA, 
for purposes of determining the amount includible in gross income as a 
distribution under Sec. 1.408A-4, A-7, the amount that is treated as 
distributed with respect to the annuity contract is the fair market 
value of the annuity contract on the date that the annuity contract is 
distributed or treated as distributed from the traditional IRA. The 
rules in this A-14 also apply to conversions from SIMPLE IRAs.
    (2) Annuity contract surrendered. Paragraph (a)(1) of this paragraph 
A-14 does not apply to a conversion of a traditional IRA to the extent 
the conversion is accomplished by the complete surrender of an annuity 
contract for its cash value and the reinvestment of the cash proceeds in 
a Roth IRA, but only if the surrender extinguishes all benefits and 
other characteristics of the contract. In such a case, the cash from the 
surrendered contract is the amount reinvested in the Roth IRA.
    (3) Definitions. The definitions set forth in Sec. 1.408A-8 apply 
for purposes of this paragraph A-14.
    (b) Determination of fair market value--(1) Overview--(i) Use of 
alternative methods. This paragraph (b) sets forth methods which may be 
used to determine the fair market value of an individual retirement 
annuity for purposes of paragraph (a)(1) of this paragraph A-14. 
However, if, because of the unusual nature of the contract, the value 
determined under one of these methods does not reflect the full value of 
the contract, that method may not be used.
    (ii) Additional guidance. Additional guidance regarding the fair 
market value of an individual retirement annuity, including formulas to 
be used for determining fair market value, may be issued by the 
Commissioner in revenue rulings, notices, or other guidance published in 
the Internal Revenue Bulletin (see Sec. 601.601(d)(2)(ii)(b)).
    (2) Gift tax method--(i) Cost of contract or comparable contract. If 
with respect to an annuity, there is a comparable contract issued by the 
company which sold the annuity, the fair market value of the annuity may 
be established by the price of the comparable contract. If the 
conversion occurs soon after the annuity was sold, the comparable 
contract may be the annuity itself, and thus, the fair market value of 
the annuity may be established through the sale of the particular 
contract by the

[[Page 592]]

company (that is, the actual premiums paid for such contract).
    (ii) Use of reserves where no comparable contract available. If with 
respect to an annuity, there is no comparable contract available in 
order to make the comparison described in paragraph (b)(2)(i) of this 
paragraph A-14, the fair market value may be established through an 
approximation that is based on the interpolated terminal reserve at the 
date of the conversion, plus the proportionate part of the gross premium 
last paid before the date of the conversion which covers the period 
extending beyond that date.
    (3) Accumulation method. As an alternative to the gift tax method 
described in paragraph (b)(2) of this paragraph A-14, this paragraph 
(b)(3) provides a method that may be used for an annuity contract which 
has not been annuitized. The fair market value of such an annuity 
contract is permitted to be determined using the methodology provided in 
Sec. 1.401(a)(9)-6, A-12, with the following modifications:
    (i) All front-end loads and other non-recurring charges assessed in 
the twelve months immediately preceding the conversion must be added to 
the account value.
    (ii) Future distributions are not to be assumed in the determination 
of the actuarial present value of additional benefits.
    (iii) The exclusions provided under Sec. 1.401(a)(9)-6, A-12(c)(1) 
and (c)(2), are not to be taken into account.
    (c) Effective/applicability date. The provisions of this paragraph 
A-14 are applicable to any conversion in which an annuity contract is 
distributed or treated as distributed from a traditional IRA on or after 
August 19, 2005. However, for annuity contracts distributed or treated 
as distributed from a traditional IRA on or before December 31, 2008, 
taxpayers may instead apply the valuation methods in Sec. 1.408A-4T (as 
it appeared in the April 1, 2008, edition of 26 CFR part 1) and Revenue 
Procedure 2006-13 (2006-1 CB 315) (See Sec. 601.601(d)(2)(ii)(b)).

[T.D. 8816, 64 FR 5603, Feb. 4, 1999, as amended by T.D. 9220, 70 FR 
48871, Aug. 22, 2005; T.D. 9418, 73 FR 43862, July 29, 2008]



Sec. 1.408A-5  Recharacterized contributions.

    This section sets forth the following questions and answers that 
provide rules regarding recharacterizing IRA contributions:
    Q-1. Can an IRA owner recharacterize certain contributions (i.e., 
treat a contribution made to one type of IRA as made to a different type 
of IRA) for a taxable year?
    A-1. (a) Yes. In accordance with section 408A(d)(6), except as 
otherwise provided in this section, if an individual makes a 
contribution to an IRA (the FIRST IRA) for a taxable year and then 
transfers the contribution (or a portion of the contribution) in a 
trustee-to-trustee transfer from the trustee of the FIRST IRA to the 
trustee of another IRA (the SECOND IRA), the individual can elect to 
treat the contribution as having been made to the SECOND IRA, instead of 
to the FIRST IRA, for Federal tax purposes. A transfer between the FIRST 
IRA and the SECOND IRA will not fail to be a trustee-to-trustee transfer 
merely because both IRAs are maintained by the same trustee. For 
purposes of section 408A(d)(6), redesignating the FIRST IRA as the 
SECOND IRA will be treated as a transfer of the entire account balance 
from the FIRST IRA to the SECOND IRA.
    (b) This recharacterization election can be made only if the 
trustee-to-trustee transfer from the FIRST IRA to the SECOND IRA is made 
on or before the due date (including extensions) for filing the 
individual's Federal income tax return for the taxable year for which 
the contribution was made to the FIRST IRA. For purposes of this 
section, a conversion that is accomplished through a rollover of a 
distribution from a traditional IRA in a taxable year that, 60 days 
after the distribution (as described in section 408(d)(3)(A)(i)), is 
contributed to a Roth IRA in the next taxable year is treated as a 
contribution for the earlier taxable year.
    Q-2. What is the proper treatment of the net income attributable to 
the amount of a contribution that is being recharacterized?
    A-2. (a) The net income attributable to the amount of a contribution 
that is

[[Page 593]]

being recharacterized must be transferred to the SECOND IRA along with 
the contribution.
    (b) If the amount of the contribution being recharacterized was 
contributed to a separate IRA and no distributions or additional 
contributions have been made from or to that IRA at any time, then the 
contribution is recharacterized by the trustee of the FIRST IRA 
transferring the entire account balance of the FIRST IRA to the trustee 
of the SECOND IRA. In this case, the net income (or loss) attributable 
to the contribution being recharacterized is the difference between the 
amount of the original contribution and the amount transferred.
    (c)(1) If paragraph (b) of this A-2 does not apply, then, for 
purposes of determining net income attributable to IRA contributions, 
the net income attributable to the amount of a contribution is 
determined by allocating to the contribution a pro rata portion of the 
earnings on the assets in the IRA during the period the IRA held the 
contribution. This attributable net income is calculated by using the 
following formula:
[GRAPHIC] [TIFF OMITTED] TR05MY03.003

    (2) For purposes of this paragraph (c), the following definitions 
apply:
    (i) The term adjusted opening balance means the fair market value of 
the IRA at the beginning of the computation period plus the amount of 
any contributions or transfers (including the contribution that is being 
recharacterized pursuant to section 408A(d)(6) and any other 
recharacterizations) made to the IRA during the computation period.
    (ii) The term adjusted closing balance means the fair market value 
of the IRA at the end of the computation period plus the amount of any 
distributions or transfers (including contributions returned pursuant to 
section 408(d)(4) and recharacterizations of contributions pursuant to 
section 408A(d)(6)) made from the IRA during the computation period.
    (iii) The term computation period means the period beginning 
immediately prior to the time the particular contribution being 
recharacterized is made to the IRA and ending immediately prior to the 
recharacterizing transfer of the contribution. If a series of regular 
contributions was made to the IRA, and consecutive contributions in that 
series are being recharacterized, the computation period begins 
immediately prior to the time the first of the regular contributions 
being recharacterized was made.
    (3) When an IRA asset is not normally valued on a daily basis, the 
fair market value of the asset at the beginning of the computation 
period is deemed to be the most recent, regularly determined, fair 
market value of the asset, determined as of a date that coincides with 
or precedes the first day of the computation period. In addition, solely 
for purposes of this paragraph (c), notwithstanding A-3 of this section, 
recharacterized contributions are taken into account for the period they 
are actually held in a particular IRA.
    (4) In the case of an individual with multiple IRAs, the net income 
calculation is performed only on the IRA containing the particular 
contribution to be recharacterized, and that IRA is the IRA from which 
the recharacterizing transfer must be made.
    (5) In the case of multiple contributions made to an IRA for a 
particular year that are eligible for recharacterization, the IRA owner 
can choose (by date and by dollar amount, not by specific assets 
acquired with those dollars) which contribution, or portion thereof, is 
to be recharacterized.
    (6) The following examples illustrate the net income calculation 
under section 408A(d)(6) and this paragraph:

    Example 1. (i) On March 1, 2004, when her Roth IRA is worth $80,000, 
Taxpayer A makes a $160,000 conversion contribution to the Roth IRA. 
Subsequently, Taxpayer A discovers that she was ineligible to make a

[[Page 594]]

Roth conversion contribution in 2004 and so she requests that the 
$160,000 be recharacterized to a traditional IRA pursuant to section 
408A(d)(6). Pursuant to this request, on March 1, 2005, when the IRA is 
worth $225,000, the Roth IRA trustee transfers to a traditional IRA the 
$160,000 plus allocable net income. No other contributions have been 
made to the Roth IRA and no distributions have been made.
    (ii) The adjusted opening balance is $240,000 [$80,000 + $160,000] 
and the adjusted closing balance is $225,000. Thus the net income 
allocable to the $160,000 is - $10,000 [$160,000 x ($225,000 - $240,000) 
/ $240,000]. Therefore, in order to recharacterize the March 1, 2004, 
$160,000 conversion contribution on March 1, 2005, the Roth IRA trustee 
must transfer from Taxpayer A's Roth IRA to her traditional IRA $150,000 
[$160,000 - $10,000].
    Example 2. (i) On April 1, 2004, when her traditional IRA is worth 
$100,000, Taxpayer B converts the entire amount, consisting of 100 
shares of stock in ABC Corp. and 100 shares of stock in XYZ Corp., by 
transferring the shares to a Roth IRA. At the time of the conversion, 
the 100 shares of stock in ABC Corp. are worth $50,000 and the 100 
shares of stock in XYZ Corp. are also worth $50,000. Taxpayer B decides 
that she would like to recharacterize the ABC Corp. shares back to a 
traditional IRA. However, B may choose only by dollar amount the 
contribution or portion thereof that is to be recharacterized. On the 
date of transfer, November 1, 2004, the 100 shares of stock in ABC Corp. 
are worth $40,000 and the 100 shares of stock in XYZ Corp. are worth 
$70,000. No other contributions have been made to the Roth IRA and no 
distributions have been made.
    (ii) If B requests that $50,000 (which was the value of the ABC 
Corp. shares at the time of conversion) be recharacterized, the net 
income allocable to the $50,000 is $5,000 [$50,000 x ($110,000 - 
$100,000) / $100,000]. Therefore, in order to recharacterize $50,000 of 
the April 1, 2004, conversion contribution on November 1, 2004, the Roth 
IRA trustee must transfer from Taxpayer B's Roth IRA to a traditional 
IRA assets with a value of $55,000 [$50,000 + $5,000].
    (iii) If, on the other hand, B requests that $40,000 (which was the 
value of the ABC Corp. shares on November 1) be recharacterized, the net 
income allocable to the $40,000 is $4,000 [$40,000 x ($110,000 - 
$100,000) / $100,000]. Therefore, in order to recharacterize $40,000 of 
the April 1, 2004, conversion contribution on November 1, 2004, the Roth 
IRA trustee must transfer from Taxpayer B's Roth IRA to a traditional 
IRA assets with a value of $44,000 [$40,000 + $4,000].
    (iv) Regardless of the amount of the contribution recharacterized, 
the determination of that amount (or of the net income allocable 
thereto) is not affected by whether the recharacterization is 
accomplished by the transfer of shares of ABC Corp. or of shares of XYZ 
Corp.

    (7) This paragraph (c) applies for purposes of determining net 
income attributable to IRA contributions, made on or after January 1, 
2004. For purposes of determining net income attributable to IRA 
contributions made before January 1, 2004, see paragraph (c) of this A-2 
of Sec. 1.408A-5 (as it appeared in the April 1, 2003, edition of 26 
CFR part 1).
    Q-3. What is the effect of recharacterizing a contribution made to 
the FIRST IRA as a contribution made to the SECOND IRA?
    A-3. The contribution that is being recharacterized as a 
contribution to the SECOND IRA is treated as having been originally 
contributed to the SECOND IRA on the same date and (in the case of a 
regular contribution) for the same taxable year that the contribution 
was made to the FIRST IRA. Thus, for example, no deduction would be 
allowed for a contribution to the FIRST IRA, and any net income 
transferred with the recharacterized contribution is treated as earned 
in the SECOND IRA, and not the FIRST IRA.
    Q-4. Can an amount contributed to an IRA in a tax-free transfer be 
recharacterized under A-1 of this section?
    A-4. No. If an amount is contributed to the FIRST IRA in a tax-free 
transfer, the amount cannot be recharacterized as a contribution to the 
SECOND IRA under A-1 of this section. However, if an amount is 
erroneously rolled over or transferred from a traditional IRA to a 
SIMPLE IRA, the contribution can subsequently be recharacterized as a 
contribution to another traditional IRA.
    Q-5. Can an amount contributed by an employer under a SIMPLE IRA 
Plan or a SEP be recharacterized under A-1 of this section?
    A-5. No. Employer contributions (including elective deferrals) under 
a SIMPLE IRA Plan or a SEP cannot be recharacterized as contributions to 
another IRA under A-1 of this section. However, an amount converted from 
a SEP IRA or SIMPLE IRA to a Roth IRA may be recharacterized under A-1 
of this section as a contribution to a

[[Page 595]]

SEP IRA or SIMPLE IRA, including the original SEP IRA or SIMPLE IRA.
    Q-6. How does a taxpayer make the election to recharacterize a 
contribution to an IRA for a taxable year?
    A-6. (a) An individual makes the election described in this section 
by notifying, on or before the date of the transfer, both the trustee of 
the FIRST IRA and the trustee of the SECOND IRA, that the individual has 
elected to treat the contribution as having been made to the SECOND IRA, 
instead of the FIRST IRA, for Federal tax purposes. The notification of 
the election must include the following information: the type and amount 
of the contribution to the FIRST IRA that is to be recharacterized; the 
date on which the contribution was made to the FIRST IRA and the year 
for which it was made; a direction to the trustee of the FIRST IRA to 
transfer, in a trustee-to-trustee transfer, the amount of the 
contribution and net income allocable to the contribution to the trustee 
of the SECOND IRA; and the name of the trustee of the FIRST IRA and the 
trustee of the SECOND IRA and any additional information needed to make 
the transfer.
    (b) The election and the trustee-to-trustee transfer must occur on 
or before the due date (including extensions) for filing the 
individual's Federal income tax return for the taxable year for which 
the recharacterized contribution was made to the FIRST IRA, and the 
election cannot be revoked after the transfer. An individual who makes 
this election must report the recharacterization, and must treat the 
contribution as having been made to the SECOND IRA, instead of the FIRST 
IRA, on the individual's Federal income tax return for the taxable year 
described in the preceding sentence in accordance with the applicable 
Federal tax forms and instructions.
    (c) The election to recharacterize a contribution described in this 
A-6 may be made on behalf of a deceased IRA owner by his or her 
executor, administrator, or other person responsible for filing the 
final Federal income tax return of the decedent under section 
6012(b)(1).
    Q-7. If an amount is initially contributed to an IRA for a taxable 
year, then is moved (with net income attributable to the contribution) 
in a tax-free transfer to another IRA (the FIRST IRA for purposes of A-1 
of this section), can the tax-free transfer be disregarded, so that the 
initial contribution that is transferred from the FIRST IRA to the 
SECOND IRA is treated as a recharacterization of that initial 
contribution?
    A-7. Yes. In applying section 408A(d)(6), tax-free transfers between 
IRAs are disregarded. Thus, if a contribution to an IRA for a year is 
followed by one or more tax-free transfers between IRAs prior to the 
recharacterization, then for purposes of section 408A(d)(6), the 
contribution is treated as if it remained in the initial IRA. 
Consequently, an individual may elect to recharacterize an initial 
contribution made to the initial IRA that was involved in a series of 
tax-free transfers by making a trustee-to-trustee transfer from the last 
IRA in the series to the SECOND IRA. In this case the contribution to 
the SECOND IRA is treated as made on the same date (and for the same 
taxable year) as the date the contribution being recharacterized was 
made to the initial IRA.
    Q-8. If a contribution is recharacterized, is the recharacterization 
treated as a rollover for purposes of the one-rollover-per-year 
limitation of section 408(d)(3)(B)?
    A-8. No, recharacterizing a contribution under A-1 of this section 
is never treated as a rollover for purposes of the one-rollover-per-year 
limitation of section 408(d)(3)(B), even if the contribution would have 
been treated as a rollover contribution by the SECOND IRA if it had been 
made directly to the SECOND IRA, rather than as a result of a 
recharacterization of a contribution to the FIRST IRA.
    Q-9. If an IRA owner converts an amount from a traditional IRA to a 
Roth IRA and then transfers that amount back to a traditional IRA in a 
recharacterization, may the IRA owner subsequently reconvert that amount 
from the traditional IRA to a Roth IRA?
    A-9. (a)(1) Except as otherwise provided in paragraph (b) of this A-
9, an IRA owner who converts an amount from a traditional IRA to a Roth 
IRA

[[Page 596]]

during any taxable year and then transfers that amount back to a 
traditional IRA by means of a recharacterization may not reconvert that 
amount from the traditional IRA to a Roth IRA before the beginning of 
the taxable year following the taxable year in which the amount was 
converted to a Roth IRA or, if later, the end of the 30-day period 
beginning on the day on which the IRA owner transfers the amount from 
the Roth IRA back to a traditional IRA by means of a recharacterization 
(regardless of whether the recharacterization occurs during the taxable 
year in which the amount was converted to a Roth IRA or the following 
taxable year). Thus, any attempted reconversion of an amount prior to 
the time permitted under this paragraph (a)(1) is a failed conversion of 
that amount. However, see Sec. 1.408A-4 A-3 for a remedy available to 
an individual who makes a failed conversion.
    (2) For purposes of paragraph (a)(1) of this A-9, a failed 
conversion of an amount resulting from a failure to satisfy the 
requirements of Sec. 1.408A-4 A-1(a) is treated as a conversion in 
determining whether an IRA owner has previously converted that amount.
    (b)(1) An IRA owner who converts an amount from a traditional IRA to 
a Roth IRA during taxable year 1998 and then transfers that amount back 
to a traditional IRA by means of a recharacterization may reconvert that 
amount once (but no more than once) on or after November 1, 1998 and on 
or before December 31, 1998; the IRA owner may also reconvert that 
amount once (but no more than once) during 1999. The rule set forth in 
the preceding sentence applies without regard to whether the IRA owner's 
initial conversion or recharacterization of the amount occurred before, 
on, or after November 1, 1998. An IRA owner who converts an amount from 
a traditional IRA to a Roth IRA during taxable year 1999 that has not 
been converted previously and then transfers that amount back to a 
traditional IRA by means of a recharacterization may reconvert that 
amount once (but no more than once) on or before December 31, 1999. For 
purposes of this paragraph (b)(1), a failed conversion of an amount 
resulting from a failure to satisfy the requirements of Sec. 1.408A-4 
A-1(a) is not treated as a conversion in determining whether an IRA 
owner has previously converted that amount.
    (2) A reconversion by an IRA owner during 1998 or 1999 for which the 
IRA owner is not eligible under paragraph (b)(1) of this A-9 will be 
deemed an excess reconversion (rather than a failed conversion) and will 
not change the IRA owner's taxable conversion amount. Instead, the 
excess reconversion and the last preceding recharacterization will not 
be taken into account for purposes of determining the IRA owner's 
taxable conversion amount, and the IRA owner's taxable conversion amount 
will be based on the last reconversion that was not an excess 
reconversion (unless, after the excess reconversion, the amount is 
transferred back to a traditional IRA by means of a recharacterization). 
An excess reconversion will otherwise be treated as a valid 
reconversion.
    (3) For purposes of this paragraph (b), any reconversion that an IRA 
owner made before November 1, 1998 will not be treated as an excess 
reconversion and will not be taken into account in determining whether 
any later reconversion is an excess reconversion.
    (c) In determining the portion of any amount held in a Roth IRA or a 
traditional IRA that an IRA owner may not reconvert under this A-9, any 
amount previously converted (or reconverted) is adjusted for subsequent 
net income thereon.
    Q-10. Are there examples to illustrate the rules in this section?
    A-10. The rules in this section are illustrated by the following 
examples:

    Example 1. In 1998, Individual C converts the entire amount in his 
traditional IRA to a Roth IRA. Individual C thereafter determines that 
his modified AGI for 1998 exceeded $100,000 so that he was ineligible to 
have made a conversion in that year. Accordingly, prior to the due date 
(plus extensions) for filing the individual's Federal income tax return 
for 1998, he decides to recharacterize the conversion contribution. He 
instructs the trustee of the Roth IRA (FIRST IRA) to transfer in a 
trustee-to-trustee transfer the amount of the contribution, plus net 
income, to the trustee of a new traditional IRA (SECOND IRA). The 
individual notifies the trustee of the FIRST IRA and the trustee of the 
SECOND IRA that he is recharacterizing his

[[Page 597]]

IRA contribution (and provides the other information described in A-6 of 
this section). On the individual's Federal income tax return for 1998, 
he treats the original amount of the conversion as having been 
contributed to the SECOND IRA and not the Roth IRA. As a result, for 
Federal tax purposes, the contribution is treated as having been made to 
the SECOND IRA and not to the Roth IRA. The result would be the same if 
the conversion amount had been transferred in a tax-free transfer to 
another Roth IRA prior to the recharacterization.
    Example 2. In 1998, an individual makes a $2,000 regular 
contribution for 1998 to his traditional IRA (FIRST IRA). Prior to the 
due date (plus extensions) for filing the individual's Federal income 
tax return for 1998, he decides that he would prefer to contribute to a 
Roth IRA instead. The individual instructs the trustee of the FIRST IRA 
to transfer in a trustee-to-trustee transfer the amount of the 
contribution, plus attributable net income, to the trustee of a Roth IRA 
(SECOND IRA). The individual notifies the trustee of the FIRST IRA and 
the trustee of the SECOND IRA that he is recharacterizing his $2,000 
contribution for 1998 (and provides the other information described in 
A-6 of this section). On the individual's Federal income tax return for 
1998, he treats the $2,000 as having been contributed to the Roth IRA 
for 1998 and not to the traditional IRA. As a result, for Federal tax 
purposes, the contribution is treated as having been made to the Roth 
IRA for 1998 and not to the traditional IRA. The result would be the 
same if the conversion amount had been transferred in a tax-free 
transfer to another traditional IRA prior to the recharacterization.
    Example 3. The facts are the same as in Example 2, except that the 
$2,000 regular contribution is initially made to a Roth IRA and the 
recharacterizing transfer is made to a traditional IRA. On the 
individual's Federal income tax return for 1998, he treats the $2,000 as 
having been contributed to the traditional IRA for 1998 and not the Roth 
IRA. As a result, for Federal tax purposes, the contribution is treated 
as having been made to the traditional IRA for 1998 and not the Roth 
IRA. The result would be the same if the contribution had been 
transferred in a tax-free transfer to another Roth IRA prior to the 
recharacterization, except that the only Roth IRA trustee the individual 
must notify is the one actually making the recharacterization transfer.
    Example 4. In 1998, an individual receives a distribution from 
traditional IRA 1 and contributes the entire amount to traditional IRA 2 
in a rollover contribution described in section 408(d)(3). In this case, 
the individual cannot elect to recharacterize the contribution by 
transferring the contribution amount, plus net income, to a Roth IRA, 
because an amount contributed to an IRA in a tax-free transfer cannot be 
recharacterized. However, the individual may convert (other than by 
recharacterization) the amount in traditional IRA 2 to a Roth IRA at any 
time, provided the requirements of Sec. 1.408A-4 A-1 are satisfied.

[T.D. 8816, 64 FR 5605, Feb. 4, 1999, as amended by T.D. 9056, 68 FR 
23589, May 5, 2003]



Sec. 1.408A-6  Distributions.

    This section sets forth the following questions and answers that 
provide rules regarding distributions from Roth IRAs:
    Q-1. How are distributions from Roth IRAs taxed?
    A-1. (a) The taxability of a distribution from a Roth IRA generally 
depends on whether or not the distribution is a qualified distribution. 
This A-1 provides rules for qualified distributions and certain other 
nontaxable distributions. A-4 of this section provides rules for the 
taxability of distributions that are not qualified distributions.
    (b) A distribution from a Roth IRA is not includible in the owner's 
gross income if it is a qualified distribution or to the extent that it 
is a return of the owner's contributions to the Roth IRA (determined in 
accordance with A-8 of this section). A qualified distribution is one 
that is both--
    (1) Made after a 5-taxable-year period (defined in A-2 of this 
section); and
    (2) Made on or after the date on which the owner attains age 59\1/
2\, made to a beneficiary or the estate of the owner on or after the 
date of the owner's death, attributable to the owner's being disabled 
within the meaning of section 72(m)(7), or to which section 72(t)(2)(F) 
applies (exception for first-time home purchase).
    (c) An amount distributed from a Roth IRA will not be included in 
gross income to the extent it is rolled over to another Roth IRA on a 
tax-free basis under the rules of sections 408(d)(3) and 408A(e).
    (d) Contributions that are returned to the Roth IRA owner in 
accordance with section 408(d)(4) (corrective distributions) are not 
includible in gross income, but any net income required to be 
distributed under section 408(d)(4) together with the contributions is 
includible in gross income for the taxable year in which the 
contributions were made.

[[Page 598]]

    Q-2. When does the 5-taxable-year period described in A-1 of this 
section (relating to qualified distributions) begin and end?
    A-2. The 5-taxable-year period described in A-1 of this section 
begins on the first day of the individual's taxable year for which the 
first regular contribution is made to any Roth IRA of the individual or, 
if earlier, the first day of the individual's taxable year in which the 
first conversion contribution is made to any Roth IRA of the individual. 
The 5-taxable-year period ends on the last day of the individual's fifth 
consecutive taxable year beginning with the taxable year described in 
the preceding sentence. For example, if an individual whose taxable year 
is the calendar year makes a first-time regular Roth IRA contribution 
any time between January 1, 1998, and April 15, 1999, for 1998, the 5-
taxable-year period begins on January 1, 1998. Thus, each Roth IRA owner 
has only one 5-taxable-year period described in A-1 of this section for 
all the Roth IRAs of which he or she is the owner. Further, because of 
the requirement of the 5-taxable-year period, no qualified distributions 
can occur before taxable years beginning in 2003. For purposes of this 
A-2, the amount of any contribution distributed as a corrective 
distribution under A-1(d) of this section is treated as if it was never 
contributed.
    Q-3. If a distribution is made to an individual who is the sole 
beneficiary of his or her deceased spouse's Roth IRA and the individual 
is treating the Roth IRA as his or her own, can the distribution be a 
qualified distribution based on being made to a beneficiary on or after 
the owner's death?
    A-3. No. If a distribution is made to an individual who is the sole 
beneficiary of his or her deceased spouse's Roth IRA and the individual 
is treating the Roth IRA as his or her own, then, in accordance with 
Sec. 1.408A-2 A-4, the distribution is treated as coming from the 
individual's own Roth IRA and not the deceased spouse's Roth IRA. 
Therefore, for purposes of determining whether the distribution is a 
qualified distribution, it is not treated as made to a beneficiary on or 
after the owner's death.
    Q-4. How is a distribution from a Roth IRA taxed if it is not a 
qualified distribution?
    A-4. A distribution that is not a qualified distribution, and is 
neither contributed to another Roth IRA in a qualified rollover 
contribution nor constitutes a corrective distribution, is includible in 
the owner's gross income to the extent that the amount of the 
distribution, when added to the amount of all prior distributions from 
the owner's Roth IRAs (whether or not they were qualified distributions) 
and reduced by the amount of those prior distributions previously 
includible in gross income, exceeds the owner's contributions to all his 
or her Roth IRAs. For purposes of this A-4, any amount distributed as a 
corrective distribution is treated as if it was never contributed.
    Q-5. Will the additional tax under 72(t) apply to the amount of a 
distribution that is not a qualified distribution?
    A-5. (a) The 10-percent additional tax under section 72(t) will 
apply (unless the distribution is excepted under section 72(t)) to any 
distribution from a Roth IRA includible in gross income.
    (b) The 10-percent additional tax under section 72(t) also applies 
to a nonqualified distribution, even if it is not then includible in 
gross income, to the extent it is allocable to a conversion 
contribution, if the distribution is made within the 5-taxable-year 
period beginning with the first day of the individual's taxable year in 
which the conversion contribution was made. The 5-taxable-year period 
ends on the last day of the individual's fifth consecutive taxable year 
beginning with the taxable year described in the preceding sentence. For 
purposes of applying the tax, only the amount of the conversion 
contribution includible in gross income as a result of the conversion is 
taken into account. The exceptions under section 72(t) also apply to 
such a distribution.
    (c) The 5-taxable-year period described in this A-5 for purposes of 
determining whether section 72(t) applies to a distribution allocable to 
a conversion contribution is separately determined for each conversion 
contribution, and need not be the same as the 5-taxable-year period used 
for purposes

[[Page 599]]

of determining whether a distribution is a qualified distribution under 
A-1(b) of this section. For example, if a calendar-year taxpayer who 
received a distribution from a traditional IRA on December 31, 1998, 
makes a conversion contribution by contributing the distributed amount 
to a Roth IRA on February 25, 1999 in a qualifying rollover contribution 
and makes a regular contribution for 1998 on the same date, the 5-
taxable-year period for purposes of this A-5 begins on January 1, 1999, 
while the 5-taxable-year period for purposes of A-1(b) of this section 
begins on January 1, 1998.
    Q-6. Is there a special rule for taxing distributions allocable to a 
1998 conversion?
    A-6. Yes. In the case of a distribution from a Roth IRA in 1998, 
1999 or 2000 of amounts allocable to a 1998 conversion with respect to 
which the 4-year spread for the resultant income inclusion applies (see 
Sec. 1.408A-4 A-8), any income deferred as a result of the election to 
years after the year of the distribution is accelerated so that it is 
includible in gross income in the year of the distribution up to the 
amount of the distribution allocable to the 1998 conversion (determined 
under A-8 of this section). This amount is in addition to the amount 
otherwise includible in the owner's gross income for that taxable year 
as a result of the conversion. However, this rule will not require the 
inclusion of any amount to the extent it exceeds the total amount of 
income required to be included over the 4-year period. The acceleration 
of income inclusion described in this A-6 applies in the case of a 
surviving spouse who elects to continue the 4-year spread in accordance 
with Sec. 1.408A-4 A-11(b).
    Q-7. Is the 5-taxable-year period described in A-1 of this section 
redetermined when a Roth IRA owner dies?
    A-7. (a) No. The beginning of the 5-taxable-year period described in 
A-1 of this section is not redetermined when the Roth IRA owner dies. 
Thus, in determining the 5-taxable-year period, the period the Roth IRA 
is held in the name of a beneficiary, or in the name of a surviving 
spouse who treats the decedent's Roth IRA as his or her own, includes 
the period it was held by the decedent.
    (b) The 5-taxable-year period for a Roth IRA held by an individual 
as a beneficiary of a deceased Roth IRA owner is determined 
independently of the 5-taxable-year period for the beneficiary's own 
Roth IRA. However, if a surviving spouse treats the Roth IRA as his or 
her own, the 5-taxable-year period with respect to any of the surviving 
spouse's Roth IRAs (including the one that the surviving spouse treats 
as his or her own) ends at the earlier of the end of either the 5-
taxable-year period for the decedent or the 5-taxable-year period 
applicable to the spouse's own Roth IRAs.
    Q-8. How is it determined whether an amount distributed from a Roth 
IRA is allocated to regular contributions, conversion contributions, or 
earnings?
    A-8. (a) Any amount distributed from an individual's Roth IRA is 
treated as made in the following order (determined as of the end of a 
taxable year and exhausting each category before moving to the following 
category)--
    (1) From regular contributions;
    (2) From conversion contributions, on a first-in-first-out basis; 
and
    (3) From earnings.
    (b) To the extent a distribution is treated as made from a 
particular conversion contribution, it is treated as made first from the 
portion, if any, that was includible in gross income as a result of the 
conversion.
    Q-9. Are there special rules for determining the source of 
distributions under A-8 of this section?
    A-9. Yes. For purposes of determining the source of distributions, 
the following rules apply:
    (a) All distributions from all an individual's Roth IRAs made during 
a taxable year are aggregated.
    (b) All regular contributions made for the same taxable year to all 
the individual's Roth IRAs are aggregated and added to the undistributed 
total regular contributions for prior taxable years. Regular 
contributions for a taxable year include contributions made in the 
following taxable year that are identified as made for the taxable year 
in accordance with Sec. 1.408A-3 A-2. For example, a regular 
contribution made in 1999 for 1998 is aggregated with the contributions 
made in 1998 for 1998.

[[Page 600]]

    (c) All conversion contributions received during the same taxable 
year by all the individual's Roth IRAs are aggregated. Notwithstanding 
the preceding sentence, all conversion contributions made by an 
individual during 1999 that were distributed from a traditional IRA in 
1998 and with respect to which the 4-year spread applies are treated for 
purposes of A-8(b) of this section as contributed to the individual's 
Roth IRAs prior to any other conversion contributions made by the 
individual during 1999.
    (d) A distribution from an individual's Roth IRA that is rolled over 
to another Roth IRA of the individual in accordance with section 408A(e) 
is disregarded for purposes of determining the amount of both 
contributions and distributions.
    (e) Any amount distributed as a corrective distribution (including 
net income), as described in A-1(d) of this section, is disregarded in 
determining the amount of contributions, earnings, and distributions.
    (f) If an individual recharacterizes a contribution made to a 
traditional IRA (FIRST IRA) by transferring the contribution to a Roth 
IRA (SECOND IRA) in accordance with Sec. 1.408A-5, then, pursuant to 
Sec. 1.408A-5 A-3, the contribution to the Roth IRA is taken into 
account for the same taxable year for which it would have been taken 
into account if the contribution had originally been made to the Roth 
IRA and had never been contributed to the traditional IRA. Thus, the 
contribution to the Roth IRA is treated as contributed to the Roth IRA 
on the same date and for the same taxable year that the contribution was 
made to the traditional IRA.
    (g) If an individual recharacterizes a regular or conversion 
contribution made to a Roth IRA (FIRST IRA) by transferring the 
contribution to a traditional IRA (SECOND IRA) in accordance with Sec. 
1.408A-5, then pursuant to Sec. 1.408A-5 A-3, the contribution to the 
Roth IRA and the recharacterizing transfer are disregarded in 
determining the amount of both contributions and distributions for the 
taxable year with respect to which the original contribution was made to 
the Roth IRA.
    (h) Pursuant to Sec. 1.408A-5 A-3, the effect of income or loss 
(determined in accordance with Sec. 1.408A-5 A-2) occurring after the 
contribution to the FIRST IRA is disregarded in determining the amounts 
described in paragraphs (f) and (g) of this A-9. Thus, for purposes of 
paragraphs (f) and (g), the amount of the contribution is determined 
based on the original contribution.
    Q-10. Are there examples to illustrate the ordering rules described 
in A-8 and A-9 of this section?
    A-10. Yes. The following examples illustrate these ordering rules:

    Example 1. In 1998, individual B converts $80,000 in his traditional 
IRA to a Roth IRA. B has a basis of $20,000 in the conversion amount and 
so must include the remaining $60,000 in gross income. He decides to 
spread the $60,000 income by including $15,000 in each of the 4 years 
1998-2001, under the rules of Sec. 1.408A-4 A-8. B also makes a regular 
contribution of $2,000 in 1998. If a distribution of $2,000 is made to B 
anytime in 1998, it will be treated as made entirely from the regular 
contributions, so there will be no Federal income tax consequences as a 
result of the distribution.
    Example 2. The facts are the same as in Example 1, except that the 
distribution made in 1998 is $5,000. The distribution is treated as made 
from $2,000 of regular contributions and $3,000 of conversion 
contributions that were includible in gross income. As a result, B must 
include $18,000 in gross income for 1998: $3,000 as a result of the 
acceleration of amounts that otherwise would have been included in later 
years under the 4-year-spread rule and $15,000 includible under the 
regular 4-year-spread rule. In addition, because the $3,000 is allocable 
to a conversion made within the previous 5 taxable years, the 10-percent 
additional tax under section 72(t) would apply to this $3,000 
distribution for 1998, unless an exception applies. Under the 4-year-
spread rule, B would now include in gross income $15,000 for 1999 and 
2000, but only $12,000 for 2001, because of the accelerated inclusion of 
the $3,000 distribution.
    Example 3. The facts are the same as in Example 1, except that B 
makes an additional $2,000 regular contribution in 1999 and he does not 
take a distribution in 1998. In 1999, the entire balance in the account, 
$90,000 ($84,000 of contributions and $6,000 of earnings), is 
distributed to B. The distribution is treated as made from $4,000 of 
regular contributions, $60,000 of conversion contributions that were 
includible in gross income, $20,000 of conversion contributions that 
were not includible in gross income, and $6,000 of earnings. Because a 
distribution has been

[[Page 601]]

made within the 4-year-spread period, B must accelerate the income 
inclusion under the 4-year-spread rule and must include in gross income 
the $45,000 remaining under the 4-year-spread rule in addition to the 
$6,000 of earnings. Because $60,000 of the distribution is allocable to 
a conversion made within the previous 5 taxable years, it is subject to 
the 10-percent additional tax under section 72(t) as if it were 
includible in gross income for 1999, unless an exception applies. The 
$6,000 allocable to earnings would be subject to the tax under section 
72(t), unless an exception applies. Under the 4-year-spread rule, no 
amount would be includible in gross income for 2000 or 2001 because the 
entire amount of the conversion that was includible in gross income has 
already been included.
    Example 4. The facts are the same as in Example 1, except that B 
also makes a $2,000 regular contribution in each year 1999 through 2002 
and he does not take a distribution in 1998. A distribution of $85,000 
is made to B in 2002. The distribution is treated as made from the 
$10,000 of regular contributions (the total regular contributions made 
in the years 1998-2002), $60,000 of conversion contributions that were 
includible in gross income, and $15,000 of conversion contributions that 
were not includible in gross income. As a result, no amount of the 
distribution is includible in gross income; however, because the 
distribution is allocable to a conversion made within the previous 5 
years, the $60,000 is subject to the 10-percent additional tax under 
section 72(t) as if it were includible in gross income for 2002, unless 
an exception applies.
    Example 5. The facts are the same as in Example 4, except no 
distribution occurs in 2002. In 2003, the entire balance in the account, 
$170,000 ($90,000 of contributions and $80,000 of earnings), is 
distributed to B. The distribution is treated as made from $10,000 of 
regular contributions, $60,000 of conversion contributions that were 
includible in gross income, $20,000 of conversion contributions that 
were not includible in gross income, and $80,000 of earnings. As a 
result, for 2003, B must include in gross income the $80,000 allocable 
to earnings, unless the distribution is a qualified distribution; and if 
it is not a qualified distribution, the $80,000 would be subject to the 
10-percent additional tax under section 72(t), unless an exception 
applies.
    Example 6. Individual C converts $20,000 to a Roth IRA in 1998 and 
$15,000 (in which amount C had a basis of $2,000) to another Roth IRA in 
1999. No other contributions are made. In 2003, a $30,000 distribution, 
that is not a qualified distribution, is made to C. The distribution is 
treated as made from $20,000 of the 1998 conversion contribution and 
$10,000 of the 1999 conversion contribution that was includible in gross 
income. As a result, for 2003, no amount is includible in gross income; 
however, because $10,000 is allocable to a conversion contribution made 
within the previous 5 taxable years, that amount is subject to the 10-
percent additional tax under section 72(t) as if the amount were 
includible in gross income for 2003, unless an exception applies. The 
result would be the same whichever of C's Roth IRAs made the 
distribution.
    Example 7. The facts are the same as in Example 6, except that the 
distribution is a qualified distribution. The result is the same as in 
Example 6, except that no amount would be subject to the 10-percent 
additional tax under section 72(t), because, to be a qualified 
distribution, the distribution must be made on or after the date on 
which the owner attains age 59\1/2\, made to a beneficiary or the estate 
of the owner on or after the date of the owner's death, attributable to 
the owner's being disabled within the meaning of section 72(m)(7), or to 
which section 72(t)(2)(F) applies (exception for a first-time home 
purchase). Under section 72(t)(2), each of these conditions is also an 
exception to the tax under section 72(t).
    Example 8. Individual D makes a $2,000 regular contribution to a 
traditional IRA on January 1, 1999, for 1998. On April 15, 1999, when 
the $2,000 has increased to $2,500, D recharacterizes the contribution 
by transferring the $2,500 to a Roth IRA (pursuant to Sec. 1.408A-5 A-
1). In this case, D's regular contribution to the Roth IRA for 1998 is 
$2,000. The $500 of earnings is not treated as a contribution to the 
Roth IRA. The results would be the same if the $2,000 had decreased to 
$1,500 prior to the recharacterization.
    Example 9. In December 1998, individual E receives a distribution 
from his traditional IRA of $300,000 and in January 1999 he contributes 
the $300,000 to a Roth IRA as a conversion contribution. In April 1999, 
when the $300,000 has increased to $350,000, E recharacterizes the 
conversion contribution by transferring the $350,000 to a traditional 
IRA. In this case, E's conversion contribution for 1998 is $0, because 
the $300,000 conversion contribution and the earnings of $50,000 are 
disregarded. The results would be the same if the $300,000 had decreased 
to $250,000 prior to the recharacterization. Further, since the 
conversion is disregarded, the $300,000 is not includible in gross 
income in 1998.

    Q-11. If the owner of a Roth IRA dies prior to the end of the 5-
taxable-year period described in A-1 of this section (relating to 
qualified distributions) or prior to the end of the 5-taxable-year 
period described in A-5 of this section (relating to conversions), how 
are different types of contributions in the Roth IRA allocated to 
multiple beneficiaries?
    A-11. Each type of contribution is allocated to each beneficiary on 
a pro-

[[Page 602]]

rata basis. Thus, for example, if a Roth IRA owner dies in 1999, when 
the Roth IRA contains a regular contribution of $2,000, a conversion 
contribution of $6,000 and earnings of $1,000, and the owner leaves his 
Roth IRA equally to four children, each child will receive one quarter 
of each type of contribution. Pursuant to the ordering rules in A-8 of 
this section, an immediate distribution of $2,000 to one of the children 
will be deemed to consist of $500 of regular contributions and $1,500 of 
conversion contributions. A beneficiary's inherited Roth IRA may not be 
aggregated with any other Roth IRA maintained by such beneficiary 
(except for other Roth IRAs the beneficiary inherited from the same 
decedent), unless the beneficiary, as the spouse of the decedent and 
sole beneficiary of the Roth IRA, elects to treat the Roth IRA as his or 
her own (see A-7 and A-14 of this section).
    Q-12. How do the withholding rules under section 3405 apply to Roth 
IRAs?
    A-12. Distributions from a Roth IRA are distributions from an 
individual retirement plan for purposes of section 3405 and thus are 
designated distributions unless one of the exceptions in section 
3405(e)(1) applies. Pursuant to section 3405(a) and (b), nonperiodic 
distributions from a Roth IRA are subject to 10-percent withholding by 
the payor and periodic payments are subject to withholding as if the 
payments were wages. However, an individual can elect to have no amount 
withheld in accordance with section 3405(a)(2) and (b)(2).
    Q-13. Do the withholding rules under section 3405 apply to 
conversions?
    A-13. Yes. A conversion by any method described in Sec. 1.408A-4 A-
1 is considered a designated distribution subject to section 3405. 
However, a conversion occurring in 1998 by means of a trustee-to-trustee 
transfer of an amount from a traditional IRA to a Roth IRA established 
with the same or a different trustee is not required to be treated as a 
designated distribution for purposes of section 3405. Consequently, no 
withholding is required with respect to such a conversion (without 
regard to whether or not the individual elected to have no withholding).
    Q-14. What minimum distribution rules apply to a Roth IRA?
    A-14. (a) No minimum distributions are required to be made from a 
Roth IRA under section 408(a)(6) and (b)(3) (which generally incorporate 
the provisions of section 401(a)(9)) while the owner is alive. The post-
death minimum distribution rules under section 401(a)(9)(B) that apply 
to traditional IRAs, with the exception of the at-least-as-rapidly rule 
described in section 401(a)(9)(B)(i), also apply to Roth IRAs.
    (b) The minimum distribution rules apply to the Roth IRA as though 
the Roth IRA owner died before his or her required beginning date. Thus, 
generally, the entire interest in the Roth IRA must be distributed by 
the end of the fifth calendar year after the year of the owner's death 
unless the interest is payable to a designated beneficiary over a period 
not greater than that beneficiary's life expectancy and distribution 
commences before the end of the calendar year following the year of 
death. If the sole beneficiary is the decedent's spouse, such spouse may 
delay distributions until the decedent would have attained age 70\1/2\ 
or may treat the Roth IRA as his or her own.
    (c) Distributions to a beneficiary that are not qualified 
distributions will be includible in the beneficiary's gross income 
according to the rules in A-4 of this section.
    Q-15. Does section 401(a)(9) apply separately to Roth IRAs and 
individual retirement plans that are not Roth IRAs?
    A-15. Yes. An individual required to receive minimum distributions 
from his or her own traditional or SIMPLE IRA cannot choose to take the 
amount of the minimum distributions from any Roth IRA. Similarly, an 
individual required to receive minimum distributions from a Roth IRA 
cannot choose to take the amount of the minimum distributions from a 
traditional or SIMPLE IRA. In addition, an individual required to 
receive minimum distributions as a beneficiary under a Roth IRA can only 
satisfy the minimum distributions for one Roth IRA by distributing from 
another Roth IRA if the Roth IRAs were inherited from the same decedent.

[[Page 603]]

    Q-16. How is the basis of property distributed from a Roth IRA 
determined for purposes of a subsequent disposition?
    A-16. The basis of property distributed from a Roth IRA is its fair 
market value (FMV) on the date of distribution, whether or not the 
distribution is a qualified distribution. Thus, for example, if a 
distribution consists of a share of stock in XYZ Corp. with an FMV of 
$40.00 on the date of distribution, for purposes of determining gain or 
loss on the subsequent sale of the share of XYZ Corp. stock, it has a 
basis of $40.00.
    Q-17. What is the effect of distributing an amount from a Roth IRA 
and contributing it to another type of retirement plan other than a Roth 
IRA?
    A-17. Any amount distributed from a Roth IRA and contributed to 
another type of retirement plan (other than a Roth IRA) is treated as a 
distribution from the Roth IRA that is neither a rollover contribution 
for purposes of section 408(d)(3) nor a qualified rollover contribution 
within the meaning of section 408A(e) to the other type of retirement 
plan. This treatment also applies to any amount transferred from a Roth 
IRA to any other type of retirement plan unless the transfer is a 
recharacterization described in Sec. 1.408A-5.
    Q-18. Can an amount be transferred directly from an education IRA to 
a Roth IRA (or distributed from an education IRA and rolled over to a 
Roth IRA)?
    A-18. No amount may be transferred directly from an education IRA to 
a Roth IRA. A transfer of funds (or distribution and rollover) from an 
education IRA to a Roth IRA constitutes a distribution from the 
education IRA and a regular contribution to the Roth IRA (rather than a 
qualified rollover contribution to the Roth IRA).
    Q-19. What are the Federal income tax consequences of a Roth IRA 
owner transferring his or her Roth IRA to another individual by gift?
    A-19. A Roth IRA owner's transfer of his or her Roth IRA to another 
individual by gift constitutes an assignment of the owner's rights under 
the Roth IRA. At the time of the gift, the assets of the Roth IRA are 
deemed to be distributed to the owner and, accordingly, are treated as 
no longer held in a Roth IRA. In the case of any such gift of a Roth IRA 
made prior to October 1, 1998, if the entire interest in the Roth IRA is 
reconveyed to the Roth IRA owner prior to January 1, 1999, the Internal 
Revenue Service will treat the gift and reconveyance as never having 
occurred for estate tax, gift tax, and generation-skipping tax purposes 
and for purposes of this A-19.

[T.D. 8816, 64 FR 5607, Feb. 4, 1999]



Sec. 1.408A-7  Reporting.

    This section sets forth the following questions and answers that 
relate to the reporting requirements applicable to Roth IRAs:
    Q-1. What reporting requirements apply to Roth IRAs?
    A-1. Generally, the reporting requirements applicable to IRAs other 
than Roth IRAs also apply to Roth IRAs, except that, pursuant to section 
408A(d)(3)(D), the trustee of a Roth IRA must include on Forms 1099-R 
and 5498 additional information as described in the instructions 
thereto. Any conversion of amounts from an IRA other than a Roth IRA to 
a Roth IRA is treated as a distribution for which a Form 1099-R must be 
filed by the trustee maintaining the non-Roth IRA. In addition, the 
owner of such IRAs must report the conversion by completing Form 8606. 
In the case of a recharacterization described in Sec. 1.408A-5 A-1, IRA 
owners must report such transactions in the manner prescribed in the 
instructions to the applicable Federal tax forms.
    Q-2. Can a trustee rely on reasonable representations of a Roth IRA 
contributor or distributee for purposes of fulfilling reporting 
obligations?
    A-2. A trustee maintaining a Roth IRA is permitted to rely on 
reasonable representations of a Roth IRA contributor or distributee for 
purposes of fulfilling reporting obligations.

[T.D. 8816, 64 FR 5610, Feb. 4, 1999]



Sec. 1.408A-8  Definitions.

    This section sets forth the following question and answer that 
provides definitions of terms used in the provisions of Sec. Sec. 
1.408A-1 through 1.408A-7 and this section:

[[Page 604]]

    Q-1. Are there any special definitions that govern in applying the 
provisions of Sec. Sec. 1.408A-1 through 1.408A-7 and this section?
    A-1. Yes, the following definitions govern in applying the 
provisions of Sec. Sec. 1.408A-1 through 1.408A-7 and this section. 
Unless the context indicates otherwise, the use of a particular term 
excludes the use of the other terms.
    (a) Different types of IRAs--(1) IRA. Sections 408(a) and (b), 
respectively, describe an individual retirement account and an 
individual retirement annuity. The term IRA means an IRA described in 
either section 408(a) or (b), including each IRA described in paragraphs 
(a)(2) through (5) of this A-1. However, the term IRA does not include 
an education IRA described in section 530.
    (2) Traditional IRA. The term traditional IRA means an individual 
retirement account or individual retirement annuity described in section 
408(a) or (b), respectively. This term includes a SEP IRA but does not 
include a SIMPLE IRA or a Roth IRA.
    (3) SEP IRA. Section 408(k) describes a simplified employee pension 
(SEP) as an employer-sponsored plan under which an employer can make 
contributions to IRAs established for its employees. The term SEP IRA 
means an IRA that receives contributions made under a SEP. The term SEP 
includes a salary reduction SEP (SARSEP) described in section 408(k)(6).
    (4) SIMPLE IRA. Section 408(p) describes a SIMPLE IRA Plan as an 
employer-sponsored plan under which an employer can make contributions 
to SIMPLE IRAs established for its employees. The term SIMPLE IRA means 
an IRA to which the only contributions that can be made are 
contributions under a SIMPLE IRA Plan or rollovers or transfers from 
another SIMPLE IRA.
    (5) Roth IRA. The term Roth IRA means an IRA that meets the 
requirements of section 408A.
    (b) Other defined terms or phrases--(1) 4-year spread. The term 4-
year spread is described in Sec. 1.408A-4 A-8.
    (2) Conversion. The term conversion means a transaction satisfying 
the requirements of Sec. 1.408A-4 A-1.
    (3) Conversion amount or conversion contribution. The term 
conversion amount or conversion contribution is the amount of a 
distribution and contribution with respect to which a conversion 
described in Sec. 1.408A-4 A-1 is made.
    (4) Failed conversion. The term failed conversion means a 
transaction in which an individual contributes to a Roth IRA an amount 
transferred or distributed from a traditional IRA or Simple IRA 
(including a transfer by redesignation) in a transaction that does not 
constitute a conversion under Sec. 1.408A-4 A-1.
    (5) Modified AGI. The term modified AGI is defined in Sec. 1.408A-3 
A-5.
    (6) Recharacterization. The term recharacterization means a 
transaction described in Sec. 1.408A-5 A-1.
    (7) Recharacterized amount or recharacterized contribution.The term 
recharacterized amount or recharacterized contribution means an amount 
or contribution treated as contributed to an IRA other than the one to 
which it was originally contributed pursuant to a recharacterization 
described in Sec. 1.408A-5 A-1.
    (8) Taxable conversion amount. The term taxable conversion amount 
means the portion of a conversion amount includible in income on account 
of a conversion, determined under the rules of section 408(d)(1) and 
(2).
    (9) Tax-free transfer. The term tax-free transfer means a tax-free 
rollover described in section 402(c), 402(e)(6), 403(a)(4), 403(a)(5), 
403(b)(8), 403(b)(10) or 408(d)(3), or a tax-free trustee-to-trustee 
transfer.
    (10) Treat an IRA as his or her own. The phrase treat an IRA as his 
or her own means to treat an IRA for which a surviving spouse is the 
sole beneficiary as his or her own IRA after the death of the IRA owner 
in accordance with the terms of the IRA instrument or in the manner 
provided in the regulations under section 408(a)(6) or (b)(3).
    (11) Trustee. The term trustee includes a custodian or issuer (in 
the case of an annuity) of an IRA (except where the context clearly 
indicates otherwise).

[T.D. 8816, 64 FR 5610, Feb. 4, 1999]

[[Page 605]]



Sec. 1.408A-9  Effective date.

    This section contains the following question and answer providing 
the effective date of Sec. Sec. 1.408A-1 through 1.408A-8:
    Q-1. To what taxable years do Sec. Sec. 1.408A-1 through 1.408A-8 
apply?
    A-1 Sections 1.408A-1 through 1.408A-8 apply to taxable years 
beginning on or after January 1, 1998.

[T.D. 8816, 64 FR 5611, Feb. 4, 1999]



Sec. 1.408A-10  Coordination between designated Roth accounts and 
Roth IRAs.

    Q-1. Can an eligible rollover distribution, within the meaning of 
section 402(c)(4), from a designated Roth account, as defined in A-1 of 
Sec. 1.402A-1, be rolled over to a Roth IRA?
    A-1. Yes. An eligible rollover distribution, within the meaning of 
section 402(c)(4), from a designated Roth account may be rolled over to 
a Roth IRA. For purposes of this section, a designated Roth account 
means a designated Roth account as defined in A-1 of Sec. 1.402A-1.
    Q-2. Can an eligible rollover distribution from a designated Roth 
account be rolled over to a Roth IRA even if the distributee is not 
otherwise eligible to make regular or conversion contributions to a Roth 
IRA?
    A-2. Yes. An individual may establish a Roth IRA and roll over an 
eligible rollover distribution from a designated Roth account to that 
Roth IRA even if such individual is not eligible to make regular 
contributions or conversion contributions (as described in section 
408A(c)(2) and (d)(3), respectively) because of the modified adjusted 
gross income limits in section 408A(b)(3).
    Q-3. For purposes of the ordering rules on distributions from Roth 
IRAs, what portion of a distribution from a rollover contribution from a 
designated Roth account is treated as contributions?
    A-3. (a) Under section 408A(d)(4), distributions from Roth IRAs are 
deemed to consist first of regular contributions, then of conversion 
contributions, and finally, of earnings. For purposes of section 
408A(d)(4), the amount of a rollover contribution that is treated as a 
regular contribution is the portion of the distribution that is treated 
as investment in the contract under A-6 of Sec. 1.402A-1, and the 
remainder of the rollover contribution is treated as earnings. Thus, the 
entire amount of any qualified distribution from a designated Roth 
account that is rolled over into a Roth IRA is treated as a regular 
contribution to the Roth IRA. Accordingly, a subsequent distribution 
from the Roth IRA in the amount of that rollover contribution is not 
includible in gross income under the rules of A-8 of Sec. 1.408A-6.
    (b) If the entire account balance of a designated Roth account is 
distributed to an employee and only a portion of the distribution is 
rolled over to a Roth IRA within the 60-day period described in section 
402(c)(3), and at the time of the distribution, the investment in the 
contract exceeds the balance in the designated Roth account, the portion 
of investment in the contract that exceeds the amount used to determine 
the taxable amount of the distribution is treated as a regular 
contribution for purposes of section 408A(d)(4).
    Q-4. In the case of a rollover from a designated Roth account to a 
Roth IRA, when does the 5-taxable-year period (described in section 
408A(d)(2)(B) and A-1 of Sec. 1.408A-6) for determining qualified 
distributions from a Roth IRA begin?
    A-4. (a) The 5-taxable-year period for determining a qualified 
distribution from a Roth IRA (described in section 408A(d)(2)(B) and A-1 
of Sec. 1.408A-6) begins with the earlier of the taxable year described 
in A-2 of Sec. 1.408A-6 or the taxable year in which a rollover 
contribution from a designated Roth account is made to a Roth IRA. The 
5-taxable-year period described in this A-4 and the 5-taxable-year 
period of participation described in A-4 of Sec. 1.402A-1 are 
determined independently.
    (b) The following examples illustrate the application of this A-4:

    Example 1. Employee D began making designated Roth contributions 
under his employer's 401(k) plan in 2006. Employee D, who is over age 
59\1/2\, takes a distribution from D's designated Roth account in 2008, 
prior to the end of the 5-taxable-year period of participation used to 
determine qualified distributions from a designated Roth account. The

[[Page 606]]

distribution is an eligible rollover distribution and D rolls it over in 
accordance with sections 402(c) and 402A(c)(3) to D's Roth IRA, which 
was established in 2003. Any subsequent distribution from the Roth IRA 
of the amount rolled in, plus earnings thereon, would not be includible 
in gross income (because it would be a qualified distribution within the 
meaning of section 408A(d)(2)).
    Example 2. The facts are the same as in Example 1, except that the 
Roth IRA is D's first Roth IRA and is established with the rollover in 
2008, which is the only contribution made to the Roth IRA. If a 
distribution is made from the Roth IRA prior to the end of the 5-
taxable-year period used to determine qualified distributions from a 
Roth IRA (which begins in 2008, the year of the rollover which 
established the Roth IRA) the distribution would not be a qualified 
distribution within the meaning of section 408A(d)(2), and any amount of 
the distribution that exceeded the portion of the rollover contribution 
that consisted of investment in the contract is includible in D's gross 
income.
    Example 3. The facts are the same as in Example 2, except that the 
distribution from the designated Roth account and the rollover to the 
Roth IRA occur in 2011 (after the end of the 5-taxable-year period of 
participation used to determine qualified distributions from a 
designated Roth account). If a distribution is made from the Roth IRA 
prior to the expiration of the 5-taxable-year period used to determine 
qualified distributions from a Roth IRA, the distribution would not be a 
qualified distribution within the meaning of section 408A(d)(2), and any 
amount of the distribution that exceeded the amount rolled in is 
includible in D's gross income.

    Q-5. Can amounts distributed from a Roth IRA be rolled over to a 
designated Roth account as defined in A-1 of Sec. 1.402A-1?
    A-5. No. Amounts distributed from a Roth IRA may be rolled over or 
transferred only to another Roth IRA and are not permitted to be rolled 
over to a designated Roth account under a section 401(a) or section 
403(b) plan. The same rule applies even if all the amounts in the Roth 
IRA are attributable to a rollover distribution from a designated Roth 
account in a plan.
    Q-6. When is this Sec. 1.408A-10 applicable?
    A-6. The rules of this Sec. 1.408A-10 apply for taxable years 
beginning on or after January 1, 2006.

[T.D. 9324, 72 FR 21115, Apr. 30, 2007]



Sec. 1.409-1  Retirement bonds.

    (a) In general. Section 409 authorizes the issuance of bonds under 
the Second Liberty Bond Act the purchase price of which would be 
deductible under section 219. Section 409 also prescribes the tax 
treatment of such bonds. See paragraph (b) of this section.
    (b) Income tax treatment of bonds--(1) General rule. Except as 
provided in paragraph (b)(2) of this section, the entire proceeds upon 
redemption of a retirement bond described in section 409(a) shall be 
included in the gross income of the taxpayer entitled to such proceeds. 
If a bond has not been tendered for redemption by the registered owner 
before the close of the taxable year in which he attains age 70\1/2\, he 
must include in his gross income for such taxable year the amount of the 
proceeds he would have received if the bond had been redeemed at age 
70\1/2\. The provisions of sections 72 and 1232 do not apply to a 
retirement bond.
    (2) Exceptions. (i) If a retirement bond is redeemed within 12 
months after the issue date, the proceeds are excluded from gross income 
if no deduction is allowed under section 219 on account of the purchase 
of such bond. For definition of issue date, see 31 CFR 346.1(c).
    (ii) If a retirement bond is redeemed after the close of the taxable 
year in which the registered owner attains age 70\1/2\ the proceeds from 
the redemption of the bond are excludable from the gross income of the 
registered owner or his beneficiary to the extent that such proceeds 
were includible in the gross income of the registered owner for such 
taxable year.
    (iii) If a retirement bond is surrendered for reissuance in the same 
or lesser face amount, the difference between current redemption value 
of the bond surrendered for reissuance and the current surrender value 
of the bond reissued is includible in the gross income of the registered 
owner.
    (3) Basis. The basis of a retirement bond is zero.
    (c) Rollover. The first sentence of paragraph (b)(1) of this section 
shall not apply in any case in which a retirement bond is redeemed by 
the registered owner before the close of the taxable year in which he 
attains the age of 70\1/2\ if he transfers the entire

[[Page 607]]

amount of the proceeds of such redemption to--
    (1) An individual retirement account described in section 408(a) or 
an individual retirement annuity described in section 408(b) (other than 
an endowment contract described in Sec. 1.408-3(e)), or
    (2) An employees' trust which is described in section 401(a) which 
is exempt from tax under section 501(a), or an annuity plan described in 
section 403(a), for the benefit of the registered owner, on or before 
the 60th day after the day on which he received the proceeds of such 
redemption. This subparagraph shall not apply in the case of a transfer 
to a trust or plan described in (c)(2) of this section unless no part of 
the purchase price of the retirement bond redeemed is attributable to 
any source other than a rollover contribution from such an employees' 
trust or annuity plan (other than an annuity plan or employees' trust 
forming part of a plan under which the individual was an employee within 
the meaning of section 401(c)(1) at the time contributions were made on 
his behalf under the plan).
    (d) Additional tax--(1) Early redemption. Except as provided in 
paragraph (d)(2) of this section, under section 409(c) if a retirement 
bond is redeemed by the registered owner before he attains age 59\1/2\, 
his tax under chapter 1 of the Code is increased by an amount equal to 
10 percent of the proceeds of the redemption includible in his gross 
income for the taxable year. Except in the case of the credits allowable 
under sections 31, 39, or 42, no credit can be used to offset the tax 
described in the preceding sentence.
    (2) Limitations. Paragraph (d)(1) of this section shall not apply 
if--
    (i) During the taxable year of the registered owner in which a 
retirement bond is redeemed, the registered owner becomes disabled 
within the meaning of section 72(m)(7), or
    (ii) A retirement bond is tendered for redemption in accordance with 
paragraph (b)(2)(i) of this section.

[T.D. 7714, 45 FR 52799, Aug. 8, 1980]



Sec. 1.409A-0  Table of contents.

    This section lists captions contained in Sec. Sec. 1.409A-1, 
1.409A-2, 1.409A-3, 1.409A-4, 1.409A-5 and 1.409A-6.

    Sec. 1.409A-1 Definitions and covered plans.
(a) Nonqualified deferred compensation plan.
(1) In general.
(2) Qualified employer plans.
(3) Certain foreign plans.
(i) Participation addressed by treaty.
(ii) Participation by nonresident aliens, certain resident aliens, and 
bona fide residents of possessions.
(iii) Participation by U.S. citizens and lawful permanent residents.
(iv) Plans subject to a totalization agreement and similar plans.
(v) Broad-based foreign retirement plan.
(4) Section 457 plans.
(5) Certain welfare benefits.
(b) Deferral of compensation
(1) In general.
(2) Earnings.
(3) Compensation payable pursuant to the service recipient's customary 
payment timing arrangement.
(4) Short-term deferrals.
(i) In general.
(ii) Certain delayed payments.
(iii) Examples.
(5) Stock options, stock appreciation rights, and other equity-based 
compensation.
(i) Stock rights.
(A) Nonstatutory stock options not providing for the deferral of 
compensation.
(B) Stock appreciation rights not providing for the deferral of 
compensation.
(C) Stock rights that may provide for the deferral of compensation.
(D) Feature for the deferral of compensation.
(E) Rights to dividends.
(ii) Statutory stock options.
(iii) Service recipient stock.
(A) In general.
(B) American depositary receipts.
(C) Mutual company units.
(D) Other entities.
(E) Eligible issuer of service recipient stock.
(1) In general.
(2) Investment vehicles.

[[Page 608]]

(3) Corporate structures established or transactions undertaken for 
purposes of avoiding coverage under section 409A.
(4) Substitutions and assumptions by reason of a corporate transaction.
(iv) Determination of the fair market value of service recipient stock.
(A) Stock readily tradable on an established securities market.
(B) Stock not readily tradable on an established securities market.
(1) In general.
(2) Presumption of reasonableness.
(3) Use of alternative methods.
(v) Modifications, extensions, substitutions, and assumptions of stock 
rights.
(A) Treatment of modified and extended stock rights.
(B) Modification in general.
(C) Extensions.
(1) In general.
(2) Certain extensions before April 10, 2007.
(3) Examples.
(D) Substitutions and assumptions of stock rights by reason of a 
corporate transaction.
(E) Acceleration of date when exercisable.
(F) Discretionary added benefits.
(G) Change in underlying stock increasing value.
(H) Change in the number of shares purchasable.
(I) Rescission of changes.
(J) Successive modifications and extensions.
    (K) Modifications and extensions in effect on October 23, 2004.
(vi) Meaning and use of certain terms.
(A) Option.
(B) Date of grant of option.
(C) Stock.
(D) Exercise price.
(E) Exercise.
(F) Transfer.
(G) Readily tradable.
(H) Application to stock appreciation rights.
(6) Restricted property, section 402(b) trusts, and section 403(c) 
annuities.
(i) In general.
(ii) Promises to transfer property.
(7) Arrangements between partnerships and partners. [Reserved]
(8) Certain foreign plans.
(i) Plans with respect to compensation covered by treaty or other 
international agreement.
(ii) Plans with respect to certain other compensation.
(iii) Tax equalization agreements.
(iv) Certain limited deferrals of a nonresident alien.
(v) Additional foreign plans.
(vi) Earnings.
(9) Separation pay plans.
(i) In general.
(ii) Collectively bargained separation pay plans.
(iii) Separation pay due to involuntary separation from service or 
participation in a window program.
(iv) Foreign separation pay plans.
(v) Reimbursements and certain other separation payments.
(A) In general.
(B) Medical benefits.
(C) In-kind benefits and direct service recipient payments.
(D) Limited payments.
(E) Limited period of time.
(vi) Window programs--definition.
(10) Certain indemnification and liability insurance plans.
(11) Legal settlements.
(12) Certain educational benefits.
(c) Plan.
(1) In general.
(2) Plan aggregation rules.
(i) In general.
(ii) Dual status.
(3) Establishment of plan.
(i) In general.
(ii) Initial deferral election provisions.
(iii) Subsequent deferral election provisions.
(iv) Payment accelerations.
(v) Six-month delay for specified employees.
(vi) Plan amendments.
(vii) Transition rule for written plan requirement.
(viii) Plan aggregation rules.
(d) Substantial risk of forfeiture.
(1) In general.
(2) Stock rights.
(3) Enforcement of forfeiture condition.
(i) In general.
(ii) Examples.
(e) Performance-based compensation.
(1) In general.
(2) Payments based upon subjective performance criteria.
(3) Equity-based compensation.

[[Page 609]]

(f) Service provider.
(1) In general.
(2) Independent contractors.
(i) In general.
(ii) Related person.
(iii) Significant services.
(iv) Management services.
(v) Services provided to related persons.
(g) Service recipient.
(h) Separation from service.
(1) Employees.
(i) In general.
(ii) Termination of employment.
(2) Independent contractors.
(i) In general.
(ii) Special rule.
(3) Definition of service recipient and employer.
(4) Asset purchase transactions.
(5) Dual status.
(6) Collectively bargained plans covering multiple employers.
(i) Specified employee.
(1) In general.
(2) Definition of compensation.
(3) Specified employee identification date.
(4) Specified employee effective date.
(5) Alternative methods of satisfying the six-month delay rule.
(6) Corporate transactions.
(i) Mergers and acquisitions of public service recipients.
(ii) Mergers and acquisitions of nonpublic service recipients.
(iii) Spinoffs.
(iv) Public offerings and other corporate transactions.
(v) Alternative methods of compliance.
(7) Nonresident alien employees.
(8) Elections affecting the identification of specified employees.
(j) Nonresident alien.
(k) Established securities market.
(l) Stock right.
(m) Separation pay plan.
(n) Involuntary separation from service.
(1) In general.
(2) Separations from service for good reason.
(i) In general.
(ii) Safe harbor.
(3) Special rule for certain collectively bargained plans.
(o) Earnings.
(p) In-kind benefits.
(q) Application of definitions and rules.
    Sec. 1.409A-2 Deferral elections.
(a) Initial elections as to the time and form of payment.
(1) In general.
(2) Service recipient elections.
(3) General rule.
(4) Initial deferral election with respect to short-term deferrals.
(5) Initial deferral election with respect to certain forfeitable 
rights.
(6) Initial deferral election with respect to fiscal year compensation.
(7) First year of eligibility.
(i) In general.
(ii) Eligibility to participate.
(iii) Application to excess benefit plans.
(8) Initial deferral election with respect to performance-based 
compensation.
(9) Nonqualified deferred compensation plans linked to qualified 
employer plans or certain other arrangements.
    (10) Changes in elections under a cafeteria plan.
(11) Initial deferral election with respect to certain separation pay.
(12) Initial deferral election with respect to certain commissions.
(i) Sales commission compensation.
(ii) Investment commission compensation.
(iii) Commission compensation and related persons.
(13) Initial deferral election with respect to compensation paid for 
final payroll period.
(i) In general.
(ii) Transition rule.
(14) Elections to annualize recurring part-year compensation.
(15) USERRA rights.
(b) Subsequent changes in time and form of payment.
(1) In general.
(2) Definition of payments for purposes of subsequent changes in the 
time and form of payment.
(i) In general.
(ii) Life annuities.
(A) In general.
(B) Certain features disregarded.
(C) Subsidized joint and survivor annuities.
(D) Actuarial assumptions and methods.
(iii) Installment payments.
(iv) Transition rule.

[[Page 610]]

    (3) Beneficiaries.
(4) Domestic relations orders.
(5) Coordination with prohibition against acceleration of payments.
(6) Application to multiple payment events.
(7) Delay of payments under certain circumstances.
(i) Payments subject to section 162(m).
(ii) Payments that would violate Federal securities laws or other 
applicable law.
(iii) Other events and conditions.
(8) USERRA rights.
(9) Examples.
(c) Special rules for certain resident aliens.
    Sec. 1.409A-3 Permissible payments
(a) In general.
(b) Designation of payment upon a permissible payment event.
(c) Designation of alternative specified dates or payment schedules 
based upon date of permissible event.
(d) When a payment is treated as made upon the designated payment date.
(e) Designation of time and form of payment with respect to earnings.
(f) Substitutions.
(g) Disputed payments and refusals to pay.
(h) Special rule for certain resident aliens.
(i) Definitions and special rules.
(1) Specified time or fixed schedule.
(i) In general.
(ii) Payment schedules with formula and fixed limitations.
(A) Individual limitations.
(B) Limitations on aggregate payments to all participants in 
substantially identical plans.
(iii) Payment schedules determined by timing of payments received by the 
service recipient.
(iv) Reimbursement or in-kind benefit plans.
(A) General rule.
(B) Medical reimbursement arrangements.
(v) Tax gross-up payments.
(vi) Examples.
(2) Separation from service--required delay in payment to a specified 
employee pursuant to a separation from service.
(i) In general.
(ii) Application of payment rules to delayed payments.
(3) Unforeseeable emergency.
(i) Definition.
(ii) Amount of payment permitted upon an unforeseeable emergency.
(iii) Payments due to an unforeseeable emergency.
(4) Disability.
(i) In general.
(ii) Limited plan definition of disability.
(iii) Determination of disability.
(5) Change in the ownership or effective control of a corporation, or a 
change in the ownership of a substantial portion of the assets of a 
corporation.
(i) In general.
(ii) Identification of relevant corporation.
(A) In general.
(B) Majority shareholder.
(C) Example.
(iii) Attribution of stock ownership.
(iv) Special rules for certain delayed payments pursuant to a change in 
control event.
(A) Certain transaction-based compensation.
(B) Certain nonvested compensation.
(v) Change in the ownership of a corporation.
(A) In general.
(B) Persons acting as a group.
(vi) Change in the effective control of a corporation.
(A) In general.
(B) Multiple change in control events.
(C) Acquisition of additional control.
(D) Persons acting as a group.
(vii) Change in the ownership of a substantial portion of a 
corporation's assets.
(A) In general.
(B) Transfers to a related person.
(C) Persons acting as a group.
(6) Certain back-to-back arrangements.
(i) In general.
(ii) Example.
(j) Prohibition on acceleration of payments.
(1) In general.
(2) Application to multiple payment events.
(3) Beneficiaries.
(4) Exceptions.
(i) In general.
(ii) Domestic relations order.
(iii) Conflicts of interest.
(A) Compliance with ethics agreements with the Federal government.

[[Page 611]]

(B) Compliance with ethics laws or conflicts of interest laws.
(iv) Section 457 plans.
(v) Limited cashouts.
(vi) Payment of employment taxes.
(vii) Payment upon income inclusion under section 409A.
(viii) Cancellation of deferrals following an unforeseeable emergency or 
hardship distribution.
(ix) Plan terminations and liquidations.
(x) Certain distributions to avoid a nonallocation year under section 
409(p).
(xi) Payment of state, local, or foreign taxes.
(xii) Cancellation of deferral elections due to disability.
(xiii) Certain offsets.
(xiv) Bona fide disputes as to a right to a payment.
(5) Nonqualified deferred compensation plans linked to qualified 
employer plans or certain other arrangements.
(6) Changes in elections under a cafeteria plan.
    Sec. 1.409A-4 Calculation of income inclusion [Reserved]
    Sec. 1.409A-5 Funding [Reserved]
    Sec. 1.409A-6 Application of section 409A and effective dates.
(a) Statutory application and effective dates
(1) Application to amounts deferred.
(i) In general.
(ii) Collectively bargained plans.
(2) Identification of date of deferral for statutory effective date 
purposes.
(3) Calculation of amount of compensation deferred for statutory 
effective date purposes.
(i) Nonaccount balance plans.
(ii) Account balance plans.
(iii) Equity-based compensation plans.
(iv) Earnings.
(v) Definition of plan.
(4) Material modifications.
(i) In general.
(ii) Adoptions of new plans.
(iii) Suspension or termination of a plan.
(iv) Changes to investment measures--account balance plans.
(v) Stock rights.
(vi) Rescission of modifications.
(vii) Definition of plan.
(b) Regulatory applicability date.

[T.D. 9321, 72 FR 19276, Apr. 17, 2007]



Sec. 1.409A-1  Definitions and covered plans.

    (a) Nonqualified deferred compensation plan--(1) In general. Except 
as otherwise provided in this paragraph (a), the term nonqualified 
deferred compensation plan means any plan (within the meaning of 
paragraph (c) of this section) that provides for the deferral of 
compensation (within the meaning of paragraph (b) of this section). 
Whether a plan provides for the deferral of compensation generally is 
determined at the time the service provider obtains a legally binding 
right to the compensation under the plan, and is not affected by any 
retroactive change to the plan to characterize the right as one that 
does not provide for the deferral of compensation. For example, amounts 
deferred under a nonqualified deferred compensation plan do not become 
an excluded death benefit if the plan is amended so that the amounts are 
payable only upon the death of the service provider. If a principal 
purpose of a plan is to achieve a result with respect to a deferral of 
compensation that is inconsistent with the purposes of section 409A, the 
Commissioner may treat the plan as a nonqualified deferred compensation 
plan for purposes of section 409A and the regulations thereunder.
    (2) Qualified employer plans. The term nonqualified deferred 
compensation plan does not include a qualified employer plan. The term 
qualified employer plan means any of the following plans:
    (i) Any plan described in section 401(a) and a trust exempt from tax 
under section 501(a) or that is described in section 402(d).
    (ii) Any annuity plan described in section 403(a).
    (iii) Any annuity contract described in section 403(b).
    (iv) Any simplified employee pension (within the meaning of section 
408(k)).
    (v) Any simple retirement account (within the meaning of section 
408(p)).
    (vi) Any plan under which an active participant makes deductible 
contributions to a trust described in section 501(c)(18).

[[Page 612]]

    (vii) Any eligible deferred compensation plan (within the meaning of 
section 457(b)).
    (viii) Any plan described in section 415(m).
    (ix) Any plan described in Sec. 1022(i)(2) of the Employee 
Retirement Income Security Act of 1974, Public Law 93-406 (88 Stat. 829, 
942) (Sept. 2, 1974) (ERISA).
    (3) Certain foreign plans--(i) Participation addressed by treaty. 
With respect to an individual for a taxable year, the term nonqualified 
deferred compensation plan does not include any scheme, trust, 
arrangement, or plan maintained with respect to such individual, to the 
extent contributions made by or on behalf of such individual to such 
scheme, trust, arrangement, or plan, or credited allocations, accrued 
benefits, earnings, or other amounts constituting income, of such 
individual under such scheme, trust, arrangement, or plan, are 
excludable by such individual for Federal income tax purposes pursuant 
to any bilateral income tax convention, or other bilateral or 
multilateral agreement, to which the United States is a party.
    (ii) Participation by nonresident aliens, certain resident aliens, 
and bona fide residents of possessions. With respect to an alien 
individual for a taxable year during which such individual is a 
nonresident alien, a resident alien classified as a resident alien 
solely under section 7701(b)(1)(A)(ii) (and not section 
7701(b)(1)(A)(i)), or a bona fide resident of a possession (within the 
meaning of section 937(a)), the term nonqualified deferred compensation 
plan does not include any broad-based foreign retirement plan (within 
the meaning of paragraph (a)(3)(v) of this section).
    (iii) Participation by U.S. citizens and lawful permanent residents. 
With respect to an individual for a given taxable year during which such 
individual is a U.S. citizen or a resident alien classified as a 
resident alien under section 7701(b)(1)(A)(i), other than an individual 
who is also a bona fide resident of a possession (within the meaning of 
section 937(a)), the term nonqualified deferred compensation plan does 
not include a broad-based foreign retirement plan (within the meaning of 
paragraph (a)(3)(v) of this section), but only with respect to a plan, 
or a portion of a plan where such portion may be distinguished, 
providing for nonelective deferrals of modified foreign earned income, 
and earnings with respect to such nonelective deferrals, and only to the 
extent that the amounts deferred under all such plans of the service 
recipient, or all portions of such plans, in which the service provider 
participates in such taxable year, do not exceed the applicable limits 
under section 415(b) (applied to nonaccount balance plans as defined in 
paragraph (c)(2)(i)(C) of this section) and section 415(c) (applied to 
account balance plans as defined in paragraph (c)(2)(i)(A) of this 
section) that would be applicable if such plans were plans subject to 
section 415 and the modified foreign earned income of such individual 
were treated as compensation for purposes of applying section 415(b) and 
(c). For purposes of this paragraph (a)(3)(iii), the term modified 
foreign earned income means foreign earned income as defined in section 
911(b)(1) without regard to section 911(b)(1)(B)(iv) and without regard 
to the requirement that the income be attributable to services performed 
during the period described in section 911(d)(1)(A) or (B). The 
provisions of this paragraph (a)(3)(iii) do not apply to any individual 
with respect to any taxable year in which the individual is 
simultaneously eligible to participate in a broad-based foreign 
retirement plan and a qualified employer plan described in paragraph 
(a)(2) of this section. For purposes of this paragraph (a)(3)(iii), an 
individual is eligible to participate in a qualified employer plan if 
under the terms of the plan and without further amendment or action by 
the plan sponsor, the individual is eligible to make or receive 
contributions or accrue benefits under the plan (regardless of whether 
the individual has elected to participate in the plan).
    (iv) Plans subject to a totalization agreement and similar plans. 
The term nonqualified deferred compensation plan does not include any 
social security system of a jurisdiction to the extent that benefits 
provided under or contributions made to the system are subject to an 
agreement entered into pursuant to section 233 of the Social Security 
Act (42 U.S.C. 433) with any foreign

[[Page 613]]

jurisdiction. In addition, the term nonqualified deferred compensation 
plan does not include a social security system of a foreign jurisdiction 
to the extent that benefits are provided under or contributions are made 
to a government-mandated plan as part of that foreign jurisdiction's 
social security system.
    (v) Broad-based foreign retirement plan. The term broad-based 
foreign retirement plan means a scheme, trust, arrangement, or plan 
(regardless of whether sponsored by a U.S. person) that is written and 
that, in the case of an employer-maintained plan, satisfies the 
following conditions:
    (A) The plan is nondiscriminatory insofar as the employees who, 
under the terms of the plan (alone or in combination with other 
comparable plans) and without further amendment or action by the 
employer, are eligible to make or receive contributions or accrue 
benefits under the plan other than earnings (regardless of whether the 
employee has elected to participate in the plan), are a wide range of 
employees, substantially all of whom are nonresident aliens, resident 
aliens classified as resident aliens solely under section 
7701(b)(1)(A)(ii) (and not section 7701(b)(1)(A)(i)), or bona fide 
residents of a possession (within the meaning of section 937(a)), 
including rank and file employees.
    (B) The plan (alone or in combination with other comparable plans) 
actually provides significant benefits for a substantial majority of 
such covered employees.
    (C) The benefits actually provided under the plan to such covered 
employees are nondiscriminatory.
    (D) The plan contains provisions or is the subject of tax law 
provisions or other legal restrictions that generally discourage 
employees from using plan benefits for purposes other than retirement or 
restrict access to plan benefits before separation from service, 
including (but not limited to), restricting in-service distributions 
except in events similar to an unforeseeable emergency (as defined in 
Sec. 1.409A-3(i)(3)(i)) or hardship (as defined for purposes of section 
401(k)(2)(B)(i)(IV)), or for educational purposes or the purchase of a 
primary residence.
    (4) Section 457 plans. A nonqualified deferred compensation plan 
under section 457(f) may constitute a nonqualified deferred compensation 
plan for purposes of this paragraph (a). The rules of section 409A apply 
to nonqualified deferred compensation plans separately and in addition 
to any requirements applicable to such plans under section 457(f). In 
addition, nonelective deferred compensation of non-employees described 
in section 457(e)(12) and a grandfathered plan or arrangement described 
in Sec. 1.457-2(k)(4) may constitute a nonqualified deferred 
compensation plan for purposes of this paragraph (a). The term 
nonqualified deferred compensation plan does not include a length of 
service award to a bona fide volunteer under section 457(e)(11)(A)(ii). 
For purposes of the application of section 409A to a plan to which 
section 457 applies, a payment under the plan generally means the 
provision of cash or property to the service provider, provided that for 
purposes of the application of the short-term deferral rule set forth in 
paragraph (b)(4) of this section, the inclusion in income of an amount 
under section 457(f) is treated as a payment of the amount.
    (5) Certain welfare benefits. The term nonqualified deferred 
compensation plan does not include a plan, or a portion of a plan, to 
the extent that the plan provides bona fide vacation leave, sick leave, 
compensatory time, disability pay, or death benefits. For these 
purposes, the terms ``disability pay'' and ``death benefits'' have the 
same meanings as provided in Sec. 31.3121(v)(2)-1(b)(4)(iv)(C) of this 
chapter, provided that for purposes of this paragraph, such disability 
pay and death benefits may be provided through insurance and the 
lifetime benefits payable under the plan are not treated as including 
the value of any taxable term life insurance coverage or taxable 
disability insurance coverage provided under the plan. The term 
nonqualified deferred compensation plan also does not include any Archer 
Medical Savings Account as described in section 220, any Health Savings 
Account as described in section 223, or any other medical reimbursement 
arrangement, including a health reimbursement arrangement,

[[Page 614]]

that satisfies the requirements of section 105 and section 106 such that 
the benefits or reimbursements provided under such arrangement are not 
includible in income.
    (b) Deferral of compensation--(1) In general. Except as otherwise 
provided in paragraphs (b)(3) through (b)(12) of this section, a plan 
provides for the deferral of compensation if, under the terms of the 
plan and the relevant facts and circumstances, the service provider has 
a legally binding right during a taxable year to compensation that, 
pursuant to the terms of the plan, is or may be payable to (or on behalf 
of) the service provider in a later taxable year. Such compensation is 
deferred compensation for purposes of section 409A, this section and 
Sec. Sec. 1.409A-2 through 1.409A-6. A legally binding right to an 
amount that will be excluded from income when and if received does not 
constitute a deferral of compensation, unless the service provider has 
received the right in exchange for, or has the right to exchange the 
right for, an amount that will be includible in income (other than due 
to participation in a cafeteria plan described in section 125). A 
service provider does not have a legally binding right to compensation 
to the extent that compensation may be reduced unilaterally or 
eliminated by the service recipient or other person after the services 
creating the right to the compensation have been performed. However, if 
the facts and circumstances indicate that the discretion to reduce or 
eliminate the compensation is available or exercisable only upon a 
condition, or the discretion to reduce or eliminate the compensation 
lacks substantive significance, a service provider will be considered to 
have a legally binding right to the compensation. Whether the discretion 
to reduce or eliminate the compensation lacks substantive significance 
depends on all the relevant facts and circumstances. However, where the 
service provider to whom the compensation may be paid has effective 
control of the person retaining the discretion to reduce or eliminate 
the compensation, or has effective control over any portion of the 
compensation of the person retaining the discretion to reduce or 
eliminate the compensation, or is a member of the family (as defined in 
section 267(c)(4) applied as if the family of an individual includes the 
spouse of any member of the family) of the person retaining the 
discretion to reduce or eliminate the compensation, the discretion to 
reduce or eliminate the compensation will not be treated as having 
substantive significance. For this purpose, compensation is not 
considered subject to unilateral reduction or elimination merely because 
it may be reduced or eliminated by operation of the objective terms of 
the plan, such as the application of a nondiscretionary, objective 
provision creating a substantial risk of forfeiture. Similarly, a 
service provider does not fail to have a legally binding right to 
compensation merely because the amount of compensation is determined 
under a formula that provides for benefits to be offset by benefits 
provided under another plan (including a plan that is qualified under 
section 401(a)), or because benefits are reduced due to actual or 
notional investment losses, or, in a final average pay plan, subsequent 
decreases in compensation.
    (2) Earnings. References to the deferral of compensation or deferred 
compensation include references to earnings. When the right to earnings 
is specified under the terms of the plan, the legally binding right to 
earnings arises at the time of the deferral of the compensation to which 
the earnings relate. A plan may provide that the time and form of 
payment of earnings is treated separately from the time and form of 
payment of the underlying compensation, so that, provided that the rules 
of section 409A are otherwise met, a plan may provide that earnings will 
be paid at a separate time or in a separate form from the payment of the 
underlying compensation. For the application of the deferral election 
rules to current payments of earnings and dividend equivalents, see 
Sec. 1.409A-3(e).
    (3) Compensation payable pursuant to the service recipient's 
customary payment timing arrangement. A deferral of compensation does 
not occur solely because compensation is paid after the last day of the 
service provider's taxable year pursuant to the timing arrangement

[[Page 615]]

under which the service recipient normally compensates service providers 
for services performed during a payroll period described in section 
3401(b), or with respect to a non-employee service provider, a period 
not longer than the payroll period described in section 3401(b) or if no 
such payroll period exists, a period not longer than the earlier of the 
normal timing arrangement under which the service provider normally 
compensates non-employee service providers or 30 days after the end of 
the service provider's taxable year.
    (4) Short-term deferrals--(i) In general. A deferral of compensation 
does not occur under a plan with respect to any payment (as defined in 
Sec. 1.409A-2(b)(2)) that is not a deferred payment, provided that the 
service provider actually or constructively receives such payment on or 
before the last day of the applicable 2\1/2\ month period. The following 
rules apply for purposes of this paragraph (b)(4)(i):
    (A) The applicable 2\1/2\ month period is the period ending on the 
later of the 15th day of the third month following the end of the 
service provider's first taxable year in which the right to the payment 
is no longer subject to a substantial risk of forfeiture or the 15th day 
of the third month following the end of the service recipient's first 
taxable year in which the right to the payment is no longer subject to a 
substantial risk of forfeiture.
    (B) A payment is treated as actually or constructively received if 
the payment is includible in income, including if the payment is 
includible in income under section 83, the economic benefit doctrine, 
section 402(b), or section 457(f).
    (C) A right to a payment that is never subject to a substantial risk 
of forfeiture is considered to be no longer subject to a substantial 
risk of forfeiture on the first date the service provider has a legally 
binding right to the payment.
    (D) A payment is a deferred payment if it is made pursuant to a 
provision of a plan that provides for the payment to be made or 
completed on or after any date, or upon or after the occurrence of any 
event, that will or may occur later than the end of the applicable 2\1/
2\ month period, such as a separation from service, death, disability, 
change in control event, specified time or schedule of payment, or 
unforeseeable emergency, regardless of whether an amount is actually 
paid as a result of the occurrence of such a payment date or event 
during the applicable 2\1/2\ month period. If a plan provides that the 
service provider or service recipient may make an election under the 
plan (including an election under Sec. 1.409A-2(a)(4)) of a different 
payment date, schedule, or event, such right is disregarded for this 
purpose. In such cases, whether a plan provides for a deferred payment 
is determined based on the payment date, schedule, or event that would 
apply if no such election were made, except that if the plan would not 
provide for a deferred payment absent such an election, and the service 
provider or service recipient makes such an election, whether the plan 
provides for a deferred payment is determined based upon the payment 
date, schedule, or event that the service provider or service recipient 
in fact elected.
    (E) A stock right provides for a deferred payment if such right 
includes any provision pursuant to which the holder of the stock right 
will or may have the right to exercise the stock right after the 
applicable 2\1/2\ month period.
    (F) This paragraph (b)(4)(i) is applied separately to each payment 
(as defined in Sec. 1.409A-2(b)(2)) required to be made under a plan.
    (G) If a plan provides for a deferred payment with respect to part 
of a payment (for example a life annuity or a series of installment 
amounts treated as a single payment), the plan provides for a deferred 
payment with respect to the entire payment.
    (ii) Certain delayed payments. A payment that otherwise qualifies as 
a short-term deferral under paragraph (b)(4)(i) of this section but is 
made after the applicable 2\1/2\ month period may continue to qualify as 
a short-term deferral if the taxpayer establishes that it was 
administratively impracticable to make the payment by the end of the 
applicable 2\1/2\ month period and, as of the date upon which the 
legally binding right to the compensation arose, such impracticability 
was

[[Page 616]]

unforeseeable, or the taxpayer establishes that making the payment by 
the end of the applicable 2\1/2\ month period would have jeopardized the 
ability of the service recipient to continue as a going concern, and 
provided further that the payment is made as soon as administratively 
practicable or as soon as the payment would no longer have such effect. 
For purposes of this paragraph (b)(4)(ii), an action or failure to act 
of the service provider or a person under the service provider's 
control, such as a failure to provide necessary information or 
documentation, is not an unforeseeable event. In addition, a payment 
that otherwise qualifies as a short-term deferral under paragraph 
(b)(4)(i) of this section but is made after the applicable 2\1/2\ month 
period may continue to qualify as a short-term deferral if the taxpayer 
establishes that the service recipient reasonably anticipated that the 
service recipient's deduction with respect to such payment otherwise 
would not be permitted by application of section 162(m), and, as of the 
date the legally binding right to the payment arose, a reasonable person 
would not have anticipated the application of section 162(m) at the time 
of the payment, and provided further that the payment is made as soon as 
reasonably practicable following the first date on which the service 
recipient anticipates or reasonably should anticipate that, if the 
payment were made on such date, the service recipient's deduction with 
respect to such payment would no longer be restricted due to the 
application of section 162(m). For additional rules applicable to 
certain transaction-based compensation, see Sec. 1.409A-3(i)(5)(iv)(A).
    (iii) Examples. The following examples illustrate the provisions of 
this paragraph (b)(4). In these examples, except as otherwise noted, 
each employee and each employer has a calendar year taxable year and 
each employee is an individual who is employed by the specified 
employer.

    Example 1. On November 1, 2008, Employer Z awards a bonus to 
Employee A such that Employee A has a legally binding right to the 
payment as of November 1, 2008, that is not subject to a substantial 
risk of forfeiture. The bonus plan does not provide for a payment date 
or a deferred payment. The bonus plan will not be considered to have 
provided for a deferral of compensation if the bonus is paid or made 
available to Employee A on or before March 15, 2009.
    Example 2. Employer Y has a taxable year ending August 31. On 
November 1, 2008, Employer Y awards a bonus to Employee B so that 
Employee B has a legally binding right to the payment as of November 1, 
2008, that is not subject to a substantial risk of forfeiture. The bonus 
plan does not provide for a payment date or a deferred payment. The 
bonus plan will not be considered to have provided for a deferral of 
compensation if the bonus is paid or made available to Employee B on or 
before November 15, 2009.
    Example 3. On November 1, 2008, Employer X awards a bonus to 
Employee C such that Employee C has a legally binding right to the 
payment as of November 1, 2008. Under the bonus plan, Employee C will 
forfeit the bonus unless Employee C continues performing services 
through December 31, 2010. The right to the payment is subject to a 
substantial risk of forfeiture through December 31, 2010. Employee C has 
the right to make a written election not later than December 31, 2009, 
to receive the bonus on or after December 31, 2015, but Employee C does 
not make such election. The bonus plan does not provide for a default 
payment date or a deferred payment in the absence of an election by 
Employee C. The bonus plan will not be considered to have provided for a 
deferral of compensation if the bonus is paid or made available to 
Employee C on or before March 15, 2011.
    Example 4. On November 1, 2008, Employer W awards a bonus to 
Employee D such that Employee D has a legally binding right to the 
payment as of November 1, 2008. Under the bonus plan, the bonus will be 
determined based on services performed during the period from January 1, 
2009 through December 31, 2010. The bonus is scheduled to be paid as a 
lump sum payment on February 15, 2011. Under the bonus plan, Employee D 
will forfeit the bonus unless Employee D continues performing services 
through the scheduled payment date (February 15, 2011). Provided that at 
all times before the scheduled payment date Employee D is required to 
continue to perform services to retain the right to the bonus, and the 
bonus is paid on or before March 15, 2012, the bonus plan will not be 
considered to have provided for a deferral of compensation.
    Example 5. On November 1, 2008, Employer V awards a bonus to 
Employee E such that Employee E has a legally binding right to the 
payment as of November 1, 2008. Under the bonus plan, Employee E will 
forfeit the bonus unless Employee E continues performing services 
through December 31, 2010. Under the bonus plan, the bonus is scheduled 
to be paid as a lump sum payment on July 1, 2011. By specifying a 
payment date after the applicable 2\1/2\ month period, the bonus plan

[[Page 617]]

provides for a deferred payment. The bonus plan provides for a deferral 
of compensation, and will not qualify as a short-term deferral 
regardless of whether the bonus is paid or made available on or before 
March 15, 2011 (and generally any payment before June 1, 2011 would 
constitute an impermissible acceleration of a payment).
    Example 6. On November 1, 2008, Employer U awards a bonus to 
Employee F such that Employee F has a legally binding right to the 
payment as of November 1, 2008, that is not subject to a substantial 
risk of forfeiture. The bonus plan provides for a lump sum payment upon 
Employee F's separation from service. Because the separation from 
service is an event that may occur after the applicable 2\1/2\ month 
period, the bonus plan provides for a deferred payment and therefore 
provides for a deferral of compensation. Accordingly, the bonus plan 
will not qualify as a short-term deferral regardless of whether Employee 
F separates from service and the bonus is paid or made available on or 
before March 15, 2009.
    Example 7. On November 1, 2008, Employer T grants Employee G a 
legally binding right to the payment of a life annuity with the first 
annuity payment on November 1, 2013, provided that Employee G continues 
performing services for Employer T continuously through November 1, 
2013. Because the life annuity is treated as a single payment, and 
because all payments of the life annuity may not occur during the 
applicable 2\1/2\ month period, the plan provides for a deferred payment 
and none of the amounts payable under the annuity will qualify as a 
short-term deferral, so that section 409A applies to all amounts that 
are payable under the plan.
    Example 8. On November 1, 2008, Employer S grants Employee H a stock 
right providing for an exercise price less than the fair market value of 
the underlying stock on November 1, 2008. The stock right is subject to 
a substantial risk of forfeiture requiring services through November 1, 
2010. The stock right becomes exercisable when the substantial risk of 
forfeiture lapses and expires on November 1, 2013. Employee H continues 
providing services through November 1, 2010, at which time the 
substantial risk of forfeiture lapses. The stock right provides for a 
deferred payment and will not qualify as a short-term deferral 
regardless of whether Employee H exercises the stock right on or before 
March 15, 2011.

    (5) Stock options, stock appreciation rights, and other equity-based 
compensation--(i) Stock rights--(A) Nonstatutory stock options not 
providing for the deferral of compensation. An option to purchase 
service recipient stock does not provide for a deferral of compensation 
if--
    (1) The exercise price may never be less than the fair market value 
of the underlying stock (disregarding lapse restrictions as defined in 
Sec. 1.83-3(i)) on the date the option is granted and the number of 
shares subject to the option is fixed on the original date of grant of 
the option;
    (2) The transfer or exercise of the option is subject to taxation 
under section 83 and Sec. 1.83-7; and
    (3) The option does not include any feature for the deferral of 
compensation other than the deferral of recognition of income until the 
later of the following:
    (i) The exercise or disposition of the option under Sec. 1.83-7.
    (ii) The time the stock acquired pursuant to the exercise of the 
option first becomes substantially vested (as defined in Sec. 1.83-
3(b)).
    (B) Stock appreciation rights not providing for the deferral of 
compensation. A right to compensation based on the appreciation in value 
of a specified number of shares of service recipient stock occurring 
between the date of grant and the date of exercise of such right (a 
stock appreciation right) does not provide for a deferral of 
compensation if--
    (1) Compensation payable under the stock appreciation right cannot 
be greater than the excess of the fair market value of the stock 
(disregarding lapse restrictions as defined in Sec. 1.83-3(i)) on the 
date the stock appreciation right is exercised over an amount specified 
on the date of grant of the stock appreciation right (the stock 
appreciation right exercise price), with respect to a number of shares 
fixed on or before the date of grant of the right;
    (2) The stock appreciation right exercise price may never be less 
than the fair market value of the underlying stock (disregarding lapse 
restrictions as defined in Sec. 1.83-3(i)) on the date the right is 
granted; and
    (3) The stock appreciation right does not include any feature for 
the deferral of compensation other than the deferral of recognition of 
income until the exercise of the stock appreciation right.
    (C) Stock rights that may provide for the deferral of compensation. 
An option

[[Page 618]]

to purchase stock other than service recipient stock, or a stock 
appreciation right with respect to stock other than service recipient 
stock, generally will provide for the deferral of compensation within 
the meaning of this paragraph (b). If under the terms of an option to 
purchase service recipient stock (other than an incentive stock option 
described in section 422 or a stock option granted under an employee 
stock purchase plan described in section 423), the exercise price is or 
could become less than the fair market value of the stock (disregarding 
lapse restrictions as defined in Sec. 1.83-3(i)) on the date of grant, 
the grant of the option generally will provide for the deferral of 
compensation within the meaning of this paragraph (b). If under the 
terms of a stock appreciation right with respect to service recipient 
stock, the compensation payable under the stock appreciation right is or 
could be any amount greater than, with respect to a predetermined number 
of shares, the excess of the fair market value of the stock 
(disregarding lapse restrictions as defined in Sec. 1.83-3(i)) on the 
date the stock appreciation right is exercised over the fair market 
value of the stock (disregarding lapse restrictions as defined in Sec. 
1.83-3(i)) on the date of grant of the stock appreciation right, the 
grant of the stock appreciation right generally will provide for a 
deferral of compensation within the meaning of this paragraph (b).
    (D) Feature for the deferral of compensation. To the extent a stock 
right provides a right other than the right to receive cash or stock on 
the date of exercise and such additional right would otherwise allow 
compensation to be deferred beyond the date of exercise, the entire 
arrangement (including the underlying stock right) provides for the 
deferral of compensation. For purposes of this paragraph (b)(5)(i), 
neither the right to receive substantially nonvested stock (as defined 
in Sec. 1.83-3(b)) upon the exercise of a stock right, nor the right to 
pay the exercise price with previously acquired shares, constitutes a 
feature for the deferral of compensation.
    (E) Rights to dividends. For purposes of this paragraph (b)(5)(i), 
the right, directly or indirectly contingent upon the exercise of a 
stock right, to receive an amount equal to all or part of the dividends 
or other distributions (other than stock dividends described in 
paragraph (b)(5)(v)(H) of this section) declared and paid on the number 
of shares underlying the stock right between the date of grant and the 
date of exercise of the stock right constitutes an offset to the 
exercise price of the stock option or an increase in the amount payable 
under the stock appreciation right (generally causing such stock right 
to be subject to section 409A). A plan providing a right to dividends or 
other distributions declared and paid on the number of shares underlying 
a stock right, the payment of which is not contingent upon, or otherwise 
payable on, the exercise of the stock right, may provide for a deferral 
of compensation, but the existence of the right to receive such an 
amount will not be treated as a reduction to the exercise price of (or 
an increase to the compensation payable under) the stock right. Thus, a 
right to such dividends or distributions that is not contingent, 
directly or indirectly, upon the exercise of a stock right will not 
cause the related stock right to fail to satisfy the requirements of the 
exclusion from the definition of a deferral of compensation provided in 
paragraphs (b)(5)(i)(A) and (B) of this section.
    (ii) Statutory stock options. The grant of an incentive stock option 
as described in section 422, or the grant of an option under an employee 
stock purchase plan described in section 423 (including the grant of an 
option with an exercise price discounted in accordance with section 
423(b)(6) and the accompanying regulations), does not constitute a 
deferral of compensation. However, the exclusion for statutory stock 
options under this paragraph (b)(5)(ii) does not apply to a 
modification, extension, or renewal of a statutory option that is 
treated as the grant of a new option that is not a statutory option. See 
Sec. 1.424-1(e). In such event, the option is treated for purposes of 
this paragraph (b) as if it had been a nonstatutory stock option from 
the date of the original grant. Accordingly, if such modification, 
extension, or renewal of the stock option would have

[[Page 619]]

been treated as the grant of a new option or as causing the option to 
have had a deferral feature from the date of grant under paragraph 
(b)(5)(v) of this section, the modification, extension, or renewal of 
the stock option is treated as the grant of a new option or as causing 
the option to have had a deferral feature from the date of grant for 
purposes of this paragraph (b)(5).
    (iii) Service recipient stock--(A) In general. Except as otherwise 
provided in paragraphs (b)(5)(iii)(B), (C), and (D) of this section, the 
term service recipient stock means a class of stock that, as of the date 
of grant, is common stock for purposes of section 305 and the 
regulations thereunder of a corporation that is an eligible issuer of 
service recipient stock (as defined in paragraph (b)(5)(iii)(E) of this 
section). Notwithstanding the foregoing, the term service recipient 
stock does not include a class of stock that has any preference as to 
distributions other than distributions of service recipient stock and 
distributions in liquidation of the issuer. The term service recipient 
stock also does not include any stock that is subject to a mandatory 
repurchase obligation (other than a right of first refusal), or a put or 
call right that is not a lapse restriction as defined in Sec. 1.83-
3(i), if the stock price under such right or obligation is based on a 
measure other than the fair market value (disregarding lapse 
restrictions as defined in Sec. 1.83-3(i)) of the equity interest in 
the corporation represented by the stock.
    (B) American depositary receipts. An American depositary receipt or 
American depositary share may constitute service recipient stock, to the 
extent that the stock traded on a foreign securities market to which the 
American depositary receipt or American depositary share relates 
qualifies as service recipient stock.
    (C) Mutual company units. Mutual company units may constitute 
service recipient stock. For this purpose, the term mutual company unit 
means a fixed percentage of the overall value of a non-stock mutual 
company or association. For purposes of determining the value of the 
mutual company unit, the unit may be valued in accordance with the rules 
set forth in paragraph (b)(5)(iv)(B) of this section governing valuation 
of service recipient stock the shares of which are not traded on an 
established securities market, applied as if the mutual company were a 
stock corporation with one class of common stock and the number of 
shares of such stock determined according to such fixed percentage. For 
example, an appreciation right based on the appreciation of 10 mutual 
company units, where each unit is defined as one percent of the overall 
value of the mutual company, would be valued as if the appreciation 
right were based upon 10 shares of a corporation, with 100 shares of 
common stock (and no other class of stock), the shares of which are not 
readily tradable on an established securities market.
    (D) Other entities. An interest in an entity other than a 
corporation or non-stock mutual company or association may constitute 
service recipient stock to the extent designated by the Commissioner in 
revenue procedures, notices, or other guidance published in the Internal 
Revenue Bulletin (see Sec. 601.601(d)(2) of this chapter).
    (E) Eligible issuer of service recipient stock--(1) In general. The 
term eligible issuer of service recipient stock means only the 
corporation for which the service provider provides direct services on 
the date of grant of the stock right (if the entity receiving such 
services is a corporation), and any corporation in a chain of 
corporations or other entities in which each corporation or other entity 
has a controlling interest in another corporation or other entity in the 
chain, ending with the corporation or other entity that has a 
controlling interest in the corporation or other entity for which the 
service provider provides direct services on the date of grant of the 
stock right. For this purpose, the term controlling interest has the 
same meaning as provided in Sec. 1.414(c)-2(b)(2)(i), provided that the 
language ``at least 50 percent'' is used instead of ``at least 80 
percent'' each place it appears in Sec. 1.414(c)-2(b)(2)(i). In 
addition, where the use of such stock with respect to the grant of a 
stock right to such service provider is based upon legitimate business 
criteria, the term controlling interest has the same meaning as provided 
in

[[Page 620]]

Sec. 1.414(c)-2(b)(2)(i), provided that the language ``at least 20 
percent'' is used instead of ``at least 80 percent'' each place it 
appears in Sec. 1.414(c)-2(b)(2)(i). For purposes of determining 
ownership of an interest in an organization, the rules of Sec. Sec. 
1.414(c)-3 and 1.414(c)-4 apply. The determination of whether a grant is 
based on legitimate business criteria is based on the facts and 
circumstances, focusing primarily on whether there is a sufficient nexus 
between the service provider and the issuer of the stock right so that 
the grant serves a legitimate non-tax business purpose other than simply 
providing compensation to the service provider that is excluded from the 
requirements of section 409A. For example, stock of a corporation that 
owns an interest in a joint venture involving an operating business, 
used with respect to stock rights granted to service providers of the 
joint venture who are former service providers of such corporation, 
generally will constitute use of service recipient stock based upon 
legitimate business criteria, and therefore could constitute service 
recipient stock with respect to such service providers if the 
corporation owns at least 20 percent of the joint venture and the other 
requirements of this paragraph (b)(5)(iii) are met. Similarly, the 
legitimate business criteria requirement generally would be met if the 
corporate venturer issued such a right to an employee of the joint 
venture who it reasonably expected would in the future become an 
employee of the corporate venturer. However, where a service provider 
has no real nexus with a corporate venturer, such as generally happens 
when the corporate venturer is a passive investor in the service 
recipient joint venture, a stock right issued to that employee on the 
investor corporation's stock generally would not be based upon 
legitimate business criteria. Similarly, where a corporation holds only 
a minority interest in an entity that in turn holds a minority interest 
in the entity for which the service provider performs services, such 
that the corporation holds only an insubstantial indirect interest in 
the entity receiving the services, legitimate business criteria 
generally would not exist for issuing a stock right on the corporation's 
stock to the service provider.
    (2) Investment vehicles. Notwithstanding the provisions of paragraph 
(b)(5)(iii)(E)(1) of this section, except as to a service provider 
providing services directly to such corporation, for purposes of this 
paragraph (b)(5), an eligible issuer of service recipient stock does not 
include any corporation whose primary purpose is to serve as an 
investment vehicle with respect to the corporation's minority ownership 
interests in entities other than the service recipient.
    (3) Corporate structures established or transactions undertaken for 
purposes of avoiding coverage under section 409A. Notwithstanding the 
provisions of paragraph (b)(5)(iii)(E)(1) of this section, an eligible 
issuer of service recipient stock does not include any corporation 
within a group of entities treated as a single service recipient if a 
purpose of the establishment of the structure of the ownership, or a 
purpose of a significant transaction between or among two or more 
entities comprising a single service recipient, is to provide deferred 
compensation not subject to the application of section 409A. If an 
entity becomes a member of a group of corporations or other entities 
treated as a single service recipient, and the primary source of income 
or value of such entity arises from the provision of management services 
to other members of the service recipient group, it is presumed that 
such structure was established for purposes of avoiding the application 
of section 409A if any stock rights are issued with respect to such 
entity.
    (4) Substitutions and assumptions by reason of a corporate 
transaction. If the requirements of paragraph (b)(5)(v)(D) of this 
section are met such that the substitution of a new stock right pursuant 
to a corporate transaction for an outstanding stock right, or the 
assumption of an outstanding stock right pursuant to a corporate 
transaction, would not be treated as the grant of a new stock right or a 
change in the form of payment for purposes of this section and 
Sec. Sec. 1.409A-2 through 1.409A-6, the stock underlying the stock 
right that replaced the stock right that is substituted or assumed will 
be treated

[[Page 621]]

as service recipient stock for purposes of applying this paragraph 
(b)(5) to the replacement stock rights if such underlying stock 
otherwise satisfies the requirements of paragraph (b)(5)(iii)(A) of this 
section. For example, if by reason of a spinoff transaction (under which 
the stock of a subsidiary corporation is distributed to the stockholders 
of a distributing corporation), a stock option to purchase distributing 
corporation stock is replaced with a stock option to purchase 
distributing corporation stock and a stock option to purchase the spun 
off subsidiary corporation's stock (each otherwise satisfying the 
requirements of paragraph (b)(5)(iii)(A) of this section), and where 
such substitution is not treated as a modification of the original stock 
option pursuant to paragraph (b)(5)(v)(D) of this section, both the 
distributing corporation stock and the subsidiary corporation stock are 
treated as service recipient stock for purposes of applying this 
paragraph (b)(5) to the replacement stock options.
    (iv) Determination of the fair market value of service recipient 
stock--(A) Stock readily tradable on an established securities market. 
For purposes of paragraph (b)(5)(i) of this section, in the case of 
service recipient stock that is readily tradable on an established 
securities market, the fair market value of the stock may be determined 
based upon the last sale before or the first sale after the grant, the 
closing price on the trading day before or the trading day of the grant, 
the arithmetic mean of the high and low prices on the trading day before 
or the trading day of the grant, or any other reasonable method using 
actual transactions in such stock as reported by such market. The 
determination of fair market value also may be determined using an 
average selling price during a specified period that is within 30 days 
before or 30 days after the applicable valuation date, provided that the 
program under which the stock right is granted, including a program with 
a single participant, must irrevocably specify the commitment to grant 
the stock right with an exercise price set using such an average selling 
price before the beginning of the specified period. For this purpose, 
the term average selling price refers to the arithmetic mean of such 
selling prices on all trading days during the specified period, or the 
average of such prices over the specified period weighted based on the 
volume of trading of such stock on each trading day during such 
specified period. To satisfy this requirement, the service recipient 
must designate the recipient of the stock right, the number and class of 
shares of stock that are subject to the stock right, and the method for 
determining the exercise price including the period over which the 
averaging will occur, before the beginning of the specified averaging 
period. Notwithstanding the forgoing provisions of this paragraph 
(b)(5)(iv)(A), where applicable foreign law requires that a compensatory 
stock right be priced based upon a specific price averaging method and 
period, a stock right granted in accordance with such applicable foreign 
law will be treated as meeting the requirements of this paragraph 
(b)(5)(iv)(A), provided that the averaging period does not exceed 30 
days.
    (B) Stock not readily tradable on an established securities market--
(1) In general. For purposes of paragraph (b)(5)(i) of this section, in 
the case of service recipient stock that is not readily tradable on an 
established securities market, the fair market value of the stock as of 
a valuation date means a value determined by the reasonable application 
of a reasonable valuation method. The determination whether a valuation 
method is reasonable, or whether an application of a valuation method is 
reasonable, is made based on the facts and circumstances as of the 
valuation date. Factors to be considered under a reasonable valuation 
method include, as applicable, the value of tangible and intangible 
assets of the corporation, the present value of anticipated future cash-
flows of the corporation, the market value of stock or equity interests 
in similar corporations and other entities engaged in trades or 
businesses substantially similar to those engaged in by the corporation 
the stock of which is to be valued, the value of which can be readily 
determined through nondiscretionary, objective means (such as through 
trading prices on an established securities market or an amount paid in 
an arm's

[[Page 622]]

length private transaction), recent arm's length transactions involving 
the sale or transfer of such stock or equity interests, and other 
relevant factors such as control premiums or discounts for lack of 
marketability and whether the valuation method is used for other 
purposes that have a material economic effect on the service recipient, 
its stockholders, or its creditors. The use of a valuation method is not 
reasonable if such valuation method does not take into consideration in 
applying its methodology all available information material to the value 
of the corporation. Similarly, the use of a value previously calculated 
under a valuation method is not reasonable as of a later date if such 
calculation fails to reflect information available after the date of the 
calculation that may materially affect the value of the corporation (for 
example, the resolution of material litigation or the issuance of a 
patent) or the value was calculated with respect to a date that is more 
than 12 months earlier than the date for which the valuation is being 
used. The service recipient's consistent use of a valuation method to 
determine the value of its stock or assets for other purposes, including 
for purposes unrelated to compensation of service providers, is also a 
factor supporting the reasonableness of such valuation method.
    (2) Presumption of reasonableness. For purposes of this paragraph 
(b)(5)(iv)(B), the use of any of the following methods of valuation is 
presumed to result in a reasonable valuation, provided that the 
Commissioner may rebut such a presumption upon a showing that either the 
valuation method or the application of such method was grossly 
unreasonable:
    (i) A valuation of a class of stock determined by an independent 
appraisal that meets the requirements of section 401(a)(28)(C) and the 
regulations as of a date that is no more than 12 months before the 
relevant transaction to which the valuation is applied (for example, the 
date of grant of a stock option).
    (ii) A valuation based upon a formula that, if used as part of a 
nonlapse restriction (as defined in Sec. 1.83-3(h)) with respect to the 
stock, would be considered to be the fair market value of the stock 
pursuant to Sec. 1.83-5, provided that such stock is valued in the same 
manner for purposes of any transfer of any shares of such class of stock 
(or any substantially similar class of stock) to the issuer or any 
person that owns stock possessing more than 10 percent of the total 
combined voting power of all classes of stock of the issuer (applying 
the stock attribution rules of Sec. 1.424-1(d)), other than an arm's 
length transaction involving the sale of all or substantially all of the 
outstanding stock of the issuer, and such valuation method is used 
consistently for all such purposes, and provided further that this 
paragraph (b)(5)(iv)(B)(2)(ii) does not apply with respect to stock 
subject to a stock right payable in stock, where the stock acquired 
pursuant to the exercise of the stock right is transferable other than 
through the operation of a nonlapse restriction.
    (iii) A valuation, made reasonably and in good faith and evidenced 
by a written report that takes into account the relevant factors 
described in paragraph (b)(5)(iv)(B)(1) of this section, of illiquid 
stock of a start-up corporation. For this purpose, illiquid stock of a 
start-up corporation means service recipient stock of a corporation that 
has no material trade or business that it or any predecessor to it has 
conducted for a period of 10 years or more and has no class of equity 
securities that are traded on an established securities market (as 
defined in paragraph (k) of this section), where such stock is not 
subject to any put, call, or other right or obligation of the service 
recipient or other person to purchase such stock (other than a right of 
first refusal upon an offer to purchase by a third party that is 
unrelated to the service recipient or service provider and other than a 
right or obligation that constitutes a lapse restriction as defined in 
Sec. 1.83-3(i)), and provided that this paragraph (b)(5)(iv)(B)(2)(iii) 
does not apply to the valuation of any stock if the service recipient or 
service provider may reasonably anticipate, as of the time the valuation 
is applied, that the service recipient will undergo a change in control 
event as described in Sec. 1.409A-3(i)(5)(v) or Sec. 1.409A-
3(i)(5)(vii) within the 90 days following the action to

[[Page 623]]

which the valuation is applied, or make a public offering of securities 
within the 180 days following the action to which the valuation is 
applied. For purposes of this paragraph (b)(5)(iv)(B)(2)(iii), a 
valuation will not be treated as made reasonably and in good faith 
unless the valuation is performed by a person or persons that the 
corporation reasonably determines is qualified to perform such a 
valuation based on the person's or persons'' significant knowledge, 
experience, education, or training. Generally, a person will be 
qualified to perform such a valuation if a reasonable individual, upon 
being apprised of such knowledge, experience, education, and training, 
would reasonably rely on the advice of such person with respect to 
valuation in deciding whether to accept an offer to purchase or sell the 
stock being valued. For this purpose, significant experience generally 
means at least five years of relevant experience in business valuation 
or appraisal, financial accounting, investment banking, private equity, 
secured lending, or other comparable experience in the line of business 
or industry in which the service recipient operates.
    (3) Use of alternative methods. For purposes of this paragraph 
(b)(5), a different valuation method may be used for each separate 
action for which a valuation is relevant, provided that a single 
valuation method is used for each separate action and, once used, may 
not retroactively be altered. For example, one valuation method may be 
used to establish the exercise price of a stock option, and a different 
valuation method may be used to determine the value at the date of the 
repurchase of stock pursuant to a put or call right. However, once an 
exercise price or amount to be paid has been established, the exercise 
price or amount to be paid may not be changed through the retroactive 
use of another valuation method. In addition, notwithstanding the 
foregoing, where after the date of grant, but before the date of 
exercise or transfer, of the stock right, the service recipient stock to 
which the stock right relates becomes readily tradable on an established 
securities market, the service recipient must use the valuation method 
set forth in paragraph (b)(5)(iv)(A) of this section for purposes of 
determining the payment at the date of exercise or the purchase of the 
stock, as applicable.
    (v) Modifications, extensions, substitutions, and assumptions of 
stock rights--(A) Treatment of modified and extended stock rights. A 
modification of the terms of a stock right within the meaning of 
paragraph (b)(5)(v)(B) of this section is considered to be the grant of 
a new stock right. The new stock right may or may not constitute a 
deferral of compensation under paragraph (b)(5)(i) of this section, 
determined at the date of grant of the new stock right. If there is an 
extension of a stock right (within the meaning of paragraph (b)(5)(v)(C) 
of this section), the stock right is treated as having had an additional 
deferral feature from the original date of grant of the stock right, and 
therefore will be treated as a plan providing for the deferral of 
compensation from the original grant date for purposes of this paragraph 
(b).
    (B) Modification in general. Except as otherwise provided in 
paragraph (b)(5)(v) of this section, the term modification means any 
change in the terms of the stock right (or change in the terms of the 
plan pursuant to which the stock right was granted or in the terms of 
any other agreement governing the stock right) that may provide the 
holder of the stock right with a direct or indirect reduction in the 
exercise price of the stock right regardless of whether the holder in 
fact benefits from the change in terms. A change in the terms of the 
stock right shortening the period during which the stock right is 
exercisable is not a modification. It is not a modification to add a 
feature providing the ability to tender previously acquired stock for 
the stock purchasable under the stock right, or to withhold or have 
withheld shares of stock to facilitate the payment of the exercise price 
or the employment taxes or required withholding taxes resulting from the 
exercise of the stock right. In addition, it is not a modification for 
the grantor to exercise discretion specifically reserved under a stock 
right with respect to the transferability of the stock right.

[[Page 624]]

    (C) Extensions--(1) In general. An extension of a stock right refers 
to the provision to the holder of an additional period of time within 
which to exercise the stock right beyond the time originally prescribed 
under the terms of the stock right, the conversion or exchange of a 
stock right for a legally binding right to compensation in a future 
taxable year, or the addition of any feature for the deferral of 
compensation not permitted in paragraph (b)(5)(i)(A)(3) of this section 
(in the case of a stock option) or not permitted in paragraph 
(b)(5)(i)(B)(3) of this section (in the case of a stock appreciation 
right) to the terms of the stock right, other than at a time when the 
exercise price of the stock right equals or exceeds the fair market 
value of the service recipient stock that could be purchased (in the 
case of an option) or the fair market value of the service recipient 
stock used to determine the payment to the service provider (in the case 
of a stock appreciation right), and includes a renewal of such right 
that has such effect. It is not an extension if the exercise period of a 
stock right is extended to a date no later than the earlier of the 
latest date upon which the stock right could have expired by its 
original terms under any circumstances or the 10th anniversary of the 
original date of grant of the stock right. If the exercise period of a 
stock right is extended at a time when the exercise price of the stock 
right equals or exceeds the fair market value of the service recipient 
stock that could be purchased (in the case of an option) or the fair 
market value of the service recipient stock used to determine the 
payment to the service provider (in the case of a stock appreciation 
right), it is not an extension of the original stock right. Instead, in 
such a case, the original stock right is treated as modified rather than 
extended and a new stock right is treated as having been granted for 
purposes of this section. In addition, it is not an extension of a stock 
right if the expiration of the stock right is tolled while the holder 
cannot exercise the stock right because such an exercise would violate 
an applicable Federal, state, local, or foreign law, or would jeopardize 
the ability of the service recipient to continue as a going concern, 
provided that the period during which the stock right may be exercised 
is not extended more than 30 days after the exercise of the stock right 
first would no longer violate an applicable Federal, state, local, and 
foreign laws or would first no longer jeopardize the ability of the 
service recipient to continue as a going concern. For this purpose, a 
provision of foreign law shall be considered applicable only to foreign 
earned income (as defined under section 911(b)(1) without regard to 
section 911(b)(1)(B)(iv) and without regard to the requirement that the 
income be attributable to services performed during the period described 
in section 911(d)(1)(A) or (B)) from sources within the foreign country 
that promulgated such law.
    (2) Certain extensions before April 10, 2007. An extension of a 
stock right before April 10, 2007 solely in order to provide the holder 
of such stock right an additional period of time beyond the time 
originally prescribed under the terms of such stock right within which 
to exercise the stock right is disregarded for purposes of applying the 
rules contained in paragraph (b)(5)(v)(C)(1) of this section. For 
purposes of applying the rules contained in paragraph (b)(5)(v)(C)(1) of 
this section on and after April 10, 2007, such a stock right is treated 
as having specified at the date of grant the time within which to 
exercise such stock right that was prescribed under the terms of such 
stock right in effect on April 10, 2007. Nothing in this paragraph 
(b)(5)(v)(C)(2) affects any other action treated as the extension of a 
stock right, including the addition of a deferral feature.
    (3) Examples. The following examples illustrate the provisions of 
this paragraph (b)(5)(v)(C). In the examples, each employee is an 
individual employed by the specified employer, and each employee and 
each employer has a calendar year taxable year.

    Example 1. On July 1, 2009, Employer Z grants Employee A a 
nonstatutory stock option that does not provide for the deferral of 
compensation in accordance with paragraph (b)(5)(i)(A) of this section. 
The terms of the nonstatutory stock option provide that the exercise 
period of the stock option expires on the earlier of July 1, 2019, or 3 
months after

[[Page 625]]

Employee A's separation from service. On July 1, 2011, Employee A 
separates from service. On the same day, Employee A and Employer Z 
change the exercise period of the option so that it expires on July 1, 
2013. Because the exercise period of the stock right is not extended 
beyond July 1, 2019, the change is not an extension for purposes of this 
paragraph (b)(5)(v)(C).
    Example 2. The facts are the same as in Example 1 except that 
Employee A separates from service on July 1, 2018, and on the same day, 
Employee A and Employer Z change the exercise period of the option so 
that it expires on July 1, 2020. As of July 1, 2018, the fair market 
value of the underlying stock exceeds the exercise price. Because the 
exercise period of the stock right is extended beyond July 1, 2019, the 
change is an extension for purposes of this paragraph (b)(5)(v)(C).
    Example 3. The facts are the same as in Example 2 except that as of 
July 1, 2018, the fair market value of the underlying stock is less than 
the exercise price of the option. Because the exercise period of the 
stock right is extended at a time when the fair market value of the 
underlying stock is less than the exercise price, the change is not an 
extension for purposes of this paragraph (b)(5)(v)(C) and the change is 
treated as a modification of the option, resulting in the extension of 
the exercise period being treated as the grant of a new option on July 
1, 2018.
    Example 4. On July 1, 2009, Employer Y grants to Employee B a stock 
appreciation right with respect to 200 shares of Employer Y common stock 
that does not provide for the deferral of compensation in accordance 
with paragraph (b)(5)(i)(B) of this section. Upon exercise of the stock 
appreciation right, Employee B is entitled to receive the excess of the 
fair market value of a share of Employer Y common stock on the date of 
exercise over $100 (the fair market value of a share of Employer Y 
common stock on July 1, 2009), multiplied by the number of shares with 
respect to which Employee B is exercising the right. The exercise period 
of the right expires on the earlier of July 1, 2019, or 3 months after 
Employee B separates from service. Employee B cannot exercise the stock 
appreciation right with respect to more than 100 shares unless Employee 
B continues to be employed by Employer Y through June 30, 2014. On July 
1, 2011, when the fair market value of a share of Employer Y common 
stock is $200, Employee B and Employer Y amend the stock appreciation 
right to provide that the right will be exercisable only during calendar 
year 2018, except that before January 1, 2017, Employee B may elect to 
designate calendar year 2023 or any subsequent calendar year before 2033 
as the year in which the right will be exercisable. The amendment 
constitutes an extension of the stock appreciation right under paragraph 
(b)(5)(v)(C)(1) of this section. Under paragraph (b)(5)(v)(A) of this 
section, the stock appreciation right is treated as having had an 
additional deferral feature from the original date of grant (July 1, 
2009) of the right, and therefore is treated as a plan providing for the 
deferral of compensation from that date. During the period from July 1, 
2009, through June 30, 2011, the provisions of the stock appreciation 
right relating to the time and form of payment did not satisfy the 
requirements of Sec. 1.409A-3(a). Therefore, the stock appreciation 
right provides for a deferral of compensation that does not comply with 
section 409A.

    (D) Substitutions and assumptions of stock rights by reason of a 
corporate transaction. If the requirements of Sec. 1.424-1 (without 
regard to the requirement described in Sec. 1.424-1(a)(2) that an 
eligible corporation be the employer of the optionee) would be met if 
the stock right were a statutory option, the substitution of a new stock 
right pursuant to a corporate transaction (as defined in Sec. 1.424-
1(a)(3)) for an outstanding stock right or the assumption of an 
outstanding stock right pursuant to a corporate transaction will not be 
treated as the grant of a new stock right or a change in the form of 
payment for purposes of this section and Sec. Sec. 1.409A-2 through 
1.409A-6. For purposes of the preceding sentence, the requirement of 
Sec. 1.424-1(a)(5)(iii) will be deemed to be satisfied if the ratio of 
the exercise price to the fair market value of the shares subject to the 
stock right immediately after the substitution or assumption is not 
greater than the ratio of the exercise price to the fair market value of 
the shares subject to the stock right immediately before the 
substitution or assumption. In the case of a transaction described in 
section 355 in which the stock of the distributing corporation and the 
stock distributed in the transaction are both readily tradable on an 
established securities market immediately after the transaction, for 
purposes of this paragraph (b)(5)(v), the requirements of Sec. 1.424-
1(a)(5) related to the fair market value of the stock may be satisfied 
by--
    (1) Using the last sale before or the first sale after the specified 
date as of which such valuation is being made, the closing price on the 
last trading day before or the trading day of a specified date, the 
arithmetic mean of the high and low prices on the last trading

[[Page 626]]

day before or the trading day of such specified date, or any other 
reasonable method using actual transactions in such stock as reported by 
such market on a specified date, for the stock of the distributing 
corporation and the stock distributed in the transaction, provided the 
specified date is designated before such specified date, and such 
specified date is not more than 60 days after the transaction;
    (2) Using the arithmetic mean of such market prices on trading days 
during a specified period designated before the beginning of such 
specified period, where such specified period is not longer than 30 days 
and ends no later than 60 days after the transaction; or
    (3) Using an average of such prices during such prespecified period 
weighted based on the volume of trading of such stock on each trading 
day during such prespecified period.
    (E) Acceleration of date when exercisable. Although with respect to 
a stock right not immediately exercisable in full, a change in the terms 
of the right solely to accelerate or delay, within the original term of 
the stock right, the time at which the stock right (or any portion of 
such stock right) may be exercised is not a modification for purposes of 
this section, with respect to a stock right subject to section 409A, 
such an acceleration may constitute an impermissible acceleration of a 
payment date under Sec. 1.409A-3(j) or a subsequent deferral under 
Sec. 1.409A-2(b).
    (F) Discretionary added benefits. If a change to a stock right 
provides, either by its terms or in substance, that the holder may 
receive an additional benefit under the stock right at the future 
discretion of the grantor, and the addition of such benefit would 
constitute a modification or extension, then the addition of such 
discretion is a modification or extension at the time that the stock 
right is changed to provide such discretion.
    (G) Change in underlying stock increasing value. A change in the 
terms of the stock subject to a stock right that increases the value of 
the stock is a modification of such stock right, except to the extent 
that a new stock right is substituted for such stock right by reason of 
the change in the terms of the stock in accordance with paragraph 
(b)(5)(v)(D) of this section.
    (H) Change in the number of shares purchasable. If a stock right is 
amended solely to increase the number of shares subject to the stock 
right, the increase is not considered a modification of the stock right 
but is treated as the grant of a new additional stock right to which the 
additional shares are subject. Notwithstanding the previous sentence, if 
the exercise price and number of shares subject to a stock right are 
proportionally adjusted to reflect a stock split (including a reverse 
stock split) or stock dividend, and the only effect of the stock split 
or stock dividend is to increase (or decrease) on a pro rata basis the 
number of shares owned by each shareholder of the class of stock subject 
to the stock right, then there is no modification of the stock right if 
it is proportionally adjusted to reflect the stock split or stock 
dividend and the aggregate exercise price of the stock right is not less 
than the aggregate exercise price before the stock split or stock 
dividend.
    (I) Rescission of changes. A change to the terms of a stock right 
(or change in the terms of the plan pursuant to which the stock right 
was granted or in the terms of any other agreement governing the right) 
is not considered a modification or extension of the stock right to the 
extent the change in the terms of the stock right is rescinded by the 
earlier of the date the stock right is exercised or the last day of the 
service provider's taxable year during which such change occurred. Thus, 
for example, if the terms of a stock right granted to an individual 
employee with a calendar year taxable year are changed on March 1 in a 
manner that would result in an extension of the stock right, and the 
change is rescinded on November 1 of the same year, and the stock right 
is not exercised before the change is rescinded, the stock right is not 
considered extended under this paragraph (b)(5)(v).
    (J) Successive modifications and extensions. The rules of this 
paragraph (b)(5)(v) apply as well to successive modifications and 
extensions.
    (K) Modifications and extensions in effect on October 23, 2004. For 
purposes of the application of section 409A and

[[Page 627]]

these regulations to a stock right, if a legally binding right to a 
modification or extension of such stock right existed on October 23, 
2004, such modification or extension is disregarded, and the stock right 
is treated as if granted with the terms and conditions in effect on 
October 23, 2004.
    (vi) Meaning and use of certain terms--(A) Option. The term option 
means the right or privilege of an individual to purchase stock from a 
corporation by virtue of an offer of the corporation continuing for a 
stated period of time, whether or not irrevocable, to sell such stock at 
a price determined under paragraph (b)(5)(vi)(D) of this section, such 
individual being under no obligation to purchase. While no particular 
form of words is necessary, the option must express an offer to sell at 
the option price, the maximum number of shares purchasable under the 
option, and the period of time during which the offer remains open. The 
term option includes a warrant that meets the requirements of this 
paragraph (b)(5)(vi)(A). An option may be granted as part of or in 
conjunction with an employee stock purchase plan or subscription 
contract. An option must be in writing (in paper or electronic form) 
provided that such writing is adequate to establish an option right or 
privilege that is enforceable under applicable law.
    (B) Date of grant of option. (1) The language the date of grant of 
the option, and similar phrases, refer to the date when the granting 
corporation completes the corporate action necessary to create the 
legally binding right constituting the option. A corporate action 
creating the legally binding right constituting the option is not 
considered complete until the date on which the maximum number of shares 
that can be purchased under the option and the minimum exercise price 
are fixed or determinable, and the class of underlying stock and the 
identity of the service provider is designated. Ordinarily, if the 
corporate action provides for an immediate offer of stock for sale to a 
service provider, or provides for a particular date on which such offer 
is to be made, the date of the granting of the option is the date of 
such corporate action if the offer is to be made immediately, or the 
date provided as the date of the offer, as the case may be. However, an 
unreasonable delay in the giving of notice of such offer to the service 
provider will be taken into account as indicating that the corporation 
provided that the offer was to be made at the subsequent date on which 
such notice is given.
    (2) If the corporation imposes a condition on the granting of an 
option (as distinguished from a condition governing the exercise of the 
option), such condition generally will be given effect in accordance 
with the intent of the corporation. However, if the grant of an option 
is subject to approval by stockholders, the date of grant of the option 
will be determined as if the option had not been subject to such 
approval. A condition that does not require corporate action, such as 
the approval of, or registration with, some regulatory or government 
agency, for example, a stock exchange or the Securities and Exchange 
Commission, is ordinarily considered a condition upon the exercise of 
the option unless the corporate action clearly indicates that the option 
is not to be granted until such condition has been satisfied.
    (3) In general, a condition imposed upon the exercise of an option 
will not operate to make ineffective the granting of the option. For 
example, on June 1, 2008, Corporation A grants to X, an employee, an 
option to purchase 5,000 shares of the corporation's common stock, 
exercisable by X on or after June 1, 2009, provided X is employed by the 
corporation on June 1, 2009, and provided that A's profits during the 
fiscal year preceding the year of exercise exceed $200,000. Such an 
option is granted to X on June 1, 2008, and will be treated as 
outstanding as of such date.
    (C) Stock. The term stock means capital stock of any class, 
including voting or nonvoting common or preferred stock. Except as 
otherwise provided, the term stock includes both treasury stock and 
stock of original issue. Special classes of stock authorized to be 
issued to and held by employees are within the scope of the term stock 
for this purpose, provided such stock otherwise possesses the rights and 
characteristics of capital stock.

[[Page 628]]

    (D) Exercise price. The term exercise price means the consideration 
in cash or property that, pursuant to the terms of the option, is the 
price at which the stock subject to the option is purchased. The term 
exercise price does not include any amounts paid as interest under a 
deferred payment plan or treated as interest.
    (E) Exercise. The term exercise, when used in reference to an 
option, means the act of acceptance by the holder of the option of the 
offer to sell contained in the option. In general, the time of exercise 
is the time when there is a sale or a contract to sell between the 
corporation and the individual. A promise to pay the exercise price does 
not constitute an exercise of the option unless the holder of the option 
is subject to personal liability on such promise. An agreement or 
undertaking by the service provider to make payments under a stock 
purchase plan does not constitute the exercise of an option to the 
extent the payments made remain subject to withdrawal by or refund to 
the service provider.
    (F) Transfer. The term transfer, when used in reference to the 
transfer to an individual of a share of stock pursuant to the exercise 
of an option, means the transfer of ownership of such share, or the 
transfer of substantially all the rights of ownership. Such transfer 
must, within a reasonable time, be evidenced on the books of the 
corporation. A transfer may occur even if a share of stock is subject to 
a substantial risk of forfeiture or is not otherwise transferable 
immediately after the date of exercise. A transfer does not fail to 
occur merely because, under the terms of the arrangement, the individual 
may not dispose of the share for a specified period of time, or the 
share is subject to a right of first refusal or a right to acquire the 
share at the share's fair market value at the time of the sale.
    (G) Readily tradable. For purposes of this section and Sec. Sec. 
1.409A-2 through 1.409A-6, stock is treated as readily tradable if it is 
regularly quoted by brokers or dealers making a market in such stock.
    (H) Application to stock appreciation rights. For purposes of this 
section and Sec. Sec. 1.409A-2 through 1.409A-6, the definitions 
provided in paragraphs (b)(5)(vi)(A) through (G) of this section may be 
applied by analogy to the issuance of, exercise of, or payment upon the 
exercise of, a stock appreciation right.
    (6) Restricted property, section 402(b) trusts, and section 403(c) 
annuities--(i) In general. If a service provider receives property from, 
or pursuant to, a plan maintained by a service recipient, there is no 
deferral of compensation merely because the value of the property is not 
includible in income by reason of the property being substantially 
nonvested (as defined in Sec. 1.83-3(b)), or is includible in income 
solely due to a valid election under section 83(b). For purposes of this 
paragraph (b)(6)(i), a transfer of property includes the transfer of a 
beneficial interest in a trust or annuity plan, or a transfer to or from 
a trust or under an annuity plan, to the extent such a transfer is 
subject to section 83, section 402(b) or section 403(c). In addition, 
for purposes of this paragraph (b), a right to compensation income that 
will be required to be included in income under section 402(b)(4)(A) is 
not a deferral of compensation.
    (ii) Promises to transfer property. A plan under which a service 
provider obtains a legally binding right to receive property in a future 
taxable year where the property will be substantially vested (as defined 
in Sec. 1.83-3(b)) at the time of transfer of the property may provide 
for the deferral of compensation and, accordingly, may constitute a 
nonqualified deferred compensation plan. A legally binding right to 
receive property in a future taxable year where the property will be 
substantially nonvested (as defined in Sec. 1.83-3(b)) at the time of 
transfer of the property will not provide for the deferral of 
compensation and, accordingly, will not constitute a nonqualified 
deferred compensation plan unless offered in conjunction with another 
legally binding right that constitutes a deferral of compensation.
    (7) Arrangements between partnerships and partners. [Reserved]
    (8) Certain foreign plans--(i) Plans with respect to compensation 
covered by treaty or other international agreement. A plan in which a 
service provider participates

[[Page 629]]

does not provide for a deferral of compensation for purposes of this 
paragraph (b) to the extent that the compensation under the plan would 
have been excluded from gross income for Federal income tax purposes 
under the provisions of any bilateral income tax convention or other 
bilateral or multilateral agreement to which the United States is a 
party if the compensation had been paid to the service provider at the 
time that the legally binding right to the compensation first arose or, 
if later, the time that the legally binding right was no longer subject 
to a substantial risk of forfeiture.
    (ii) Plans with respect to certain other compensation. A plan in 
which a service provider participates does not provide for a deferral of 
compensation for purposes of this paragraph (b) to the extent that 
compensation under the plan would not have been includible in gross 
income for Federal tax purposes if it had been paid to the service 
provider at the time that the legally binding right to the compensation 
first arose or, if later, the time that the legally binding right was no 
longer subject to a substantial risk of forfeiture, due to one of the 
following:
    (A) The service provider was a nonresident alien at such time and 
the compensation would not have been includible in gross income under 
section 872.
    (B) The service provider was a qualified individual (as defined in 
section 911(d)(1)) at such time, the compensation would have been 
foreign earned income within the meaning of section 911(b)(1) (without 
regard to section 911(b)(1)(B)(iv)) if paid at such time, and the amount 
of such compensation was equal to or less than the excess (if any) of 
the maximum exclusion amount under section 911(b)(2)(D) for such taxable 
year over the amount of foreign earned income actually excluded from 
gross income by such qualified individual for such taxable year under 
section 911(a)(1).
    (C) The compensation would have been excludible from gross income 
under section 893.
    (D) The compensation would have been excludible from gross income 
under section 931 or section 933.
    (iii) Tax equalization agreements. A tax equalization agreement does 
not provide for a deferral of compensation if payments made under such 
tax equalization agreement are made no later than the end of the second 
taxable year of the service provider beginning after the taxable year of 
the service provider in which the service provider's U.S. Federal income 
tax return is required to be filed (including any extensions) for the 
year to which the compensation subject to the tax equalization payment 
relates, or, if later, the second taxable year of the service provider 
beginning after the latest such taxable year in which the service 
provider's foreign tax return or payment is required to be filed or made 
for the year to which the compensation subject to the tax equalization 
payment relates. Where such payments arise due to an audit, litigation 
or similar proceeding, the right to the payments will not be treated as 
resulting in a deferral of compensation if the payments are scheduled 
and made in accordance with the provisions of Sec. 1.409A-3(i)(1)(v) 
(timing of tax gross-up payments). For purposes of this paragraph 
(b)(8)(iii), the term tax equalization agreement refers to an agreement, 
method, program, or other arrangement that provides payments intended to 
compensate the service provider for some or all of the excess of the 
taxes actually imposed by a foreign jurisdiction on the compensation 
paid by the service recipient to the service provider over the taxes 
that would be imposed if the compensation were subject solely to United 
States Federal, state, and local income tax, or some or all of the 
excess of the United States Federal, state, and local income tax 
actually imposed on the compensation paid by the service to the service 
provider over the taxes that would be imposed if the compensation were 
subject solely to taxes in the foreign jurisdiction, provided that the 
payment made under such agreement, method, program, or other arrangement 
may not exceed such excess and the amount necessary to compensate for 
the additional taxes on the amount paid under the agreement, method, 
program, or other arrangement.

[[Page 630]]

    (iv) Certain limited deferrals of a nonresident alien. With respect 
to a nonresident alien, a foreign plan does not provide for a deferral 
of compensation if the amounts deferred under the foreign plan based 
upon services performed by the nonresident alien in the United States 
(including amounts deferred based upon service credits or compensation 
received due to services performed in the United States) do not exceed 
the applicable dollar amount under section 402(g)(1)(B) for the taxable 
year. If the amounts deferred under the foreign plan based upon the 
services performed by the nonresident alien in the United States exceed 
the applicable dollar amount, an amount of such deferrals equal to such 
amount is treated as not deferred under a nonqualified deferred 
compensation plan. For purposes of this paragraph (b)(8)(iv), the term 
foreign plan means a plan that, together with all substantially similar 
plans, is maintained by a service recipient for a substantial number of 
participants, substantially all of whom are nonresident aliens or 
resident aliens classified as resident aliens solely under section 
7701(b)(1)(A)(ii) (and not section 7701(b)(1)(A)(i)).
    (v) Additional foreign plans. A plan in which a service provider 
participates does not provide for a deferral of compensation for 
purposes of this paragraph (b) to the extent designated by the 
Commissioner in revenue procedures, notices, or other guidance published 
in the Internal Revenue Bulletin (see Sec. 601.601(d)(2) of this 
chapter).
    (vi) Earnings. Earnings on compensation excluded from the definition 
of deferral of compensation pursuant to this paragraph (b)(8) are also 
not treated as a deferral of compensation.
    (9) Separation pay plans--(i) In general. A plan that otherwise 
provides for a deferral of compensation under this paragraph (b) does 
not fail to provide a deferral of compensation merely because the right 
to payment of the compensation is conditioned upon a separation from 
service. However, paragraphs (b)(9)(ii), (iii), (iv), and (v) of this 
section provide rules concerning the extent to which certain separation 
pay plans do not provide for the deferral of compensation. The 
exceptions contained in paragraphs (b)(9)(ii), (iii), (iv), and (v) of 
this section may be used in combination, such that compensation under a 
plan that would be excepted under one of those paragraphs may be treated 
as excepted under another of those paragraphs, so that other 
compensation under a plan may be treated as excepted under the first of 
such paragraphs. Notwithstanding any other provision of this paragraph 
(b)(9), any payment or benefit, or entitlement to a payment or benefit, 
that acts as a substitute for, or replacement of, amounts deferred by 
the service recipient under a separate nonqualified deferred 
compensation plan constitutes a payment or a deferral of compensation 
under the separate nonqualified deferred compensation plan, and does not 
constitute a payment or deferral of compensation under a separation pay 
plan. If a service provider receives a payment at separation from 
service and also has a legally binding right to an amount of deferred 
compensation that would be forfeited upon the separation from service, 
whether the payment acts as an acceleration of vesting and substitute 
payment for the amount of deferred compensation forfeited, or whether 
the deferred compensation is treated as forfeited and the amount paid is 
treated as a separate payment of current compensation, is determined 
based on the facts and circumstances, provided that, where the 
separation from service is voluntary, it is presumed that the payment 
results from an acceleration of vesting followed by a payment of the 
deferred compensation that is subject to section 409A. Accordingly, any 
change in the payment schedule to accelerate or defer the payments would 
be subject to the rules of section 409A. The presumption that a right to 
a payment is not a new right, but is instead a right substituted for a 
pre-existing forfeited right, may be rebutted by demonstrating that the 
service provider would have obtained the right to the payment regardless 
of the forfeiture of the nonvested right. A factor indicating that the 
service provider would have obtained a right to a payment regardless of 
the forfeiture of the nonvested right is that the amount to which the 
service provider obtains a right is materially less than an amount

[[Page 631]]

equal to the present value of the forfeited amount multiplied by a 
fraction, the numerator of which is the period of service the service 
provider actually completed, and the denominator of which is the full 
period of service the service provider would have been required to 
complete to receive the full amount of the payment. For example, where a 
service provider is entitled to a future payment only if the service 
provider completes three years of service and at the time of termination 
the service provider has completed one year of service, the presumption 
could be rebutted if the payment to the service provider is materially 
less than the present value of one-third of the nonvested amount. 
Another such factor is that the payment to the service provider is of a 
type customarily made to service providers who separate from service 
with the service recipient and do not forfeit nonvested rights to 
deferred compensation (for example, a payment of accrued but unused 
leave or a payment for a release of actual or potential claims).
    (ii) Collectively bargained separation pay plans. A separation pay 
plan does not provide for a deferral of compensation to the extent the 
plan is a collectively bargained separation pay plan that provides for 
separation pay only upon an involuntary separation from service or 
pursuant to a window program. Only the portion of the separation pay 
plan attributable to employees covered by a bona fide collective 
bargaining agreement is considered to be provided under a collectively 
bargained separation pay plan. A collectively bargained separation pay 
plan is a separation pay plan that meets the following conditions:
    (A) The separation pay plan is contained within an agreement that 
the Secretary of Labor determines to be a collective bargaining 
agreement.
    (B) The separation pay provided by the collective bargaining 
agreement was the subject of arm's length negotiations between employee 
representatives and one or more employers, and the agreement between 
employee representatives and one or more employers satisfies section 
7701(a)(46).
    (C) The circumstances surrounding the agreement evidence good faith 
bargaining between adverse parties over the separation pay to be 
provided under the agreement.
    (iii) Separation pay due to involuntary separation from service or 
participation in a window program. A separation pay plan that is not 
described in paragraph (b)(9)(ii) of this section and that provides for 
separation pay only upon an involuntary separation from service (as 
defined in paragraph (n) of this section) or pursuant to a window 
program does not provide for a deferral of compensation to the extent 
that the separation pay, or portion of the separation pay, provided 
under the plan meets the following requirements:
    (A) The separation pay (other than amounts described in paragraphs 
(b)(9)(iv) and (v) of this section) does not exceed two times the lesser 
of--
    (1) The sum of the service provider's annualized compensation based 
upon the annual rate of pay for services provided to the service 
recipient for the taxable year of the service provider preceding the 
taxable year of the service provider in which the service provider has a 
separation from service with such service recipient (adjusted for any 
increase during that year that was expected to continue indefinitely if 
the service provider had not separated from service); or
    (2) The maximum amount that may be taken into account under a 
qualified plan pursuant to section 401(a)(17) for the year in which the 
service provider has a separation from service.
    (B) The plan provides that the separation pay described in paragraph 
(b)(9)(iii)(A) of this section must be paid no later than the last day 
of the second taxable year of the service provider following the taxable 
year of the service provider in which occurs the separation from 
service.
    (iv) Foreign separation pay plans. A separation pay plan (including 
a plan providing payments upon a voluntary separation from service) does 
not provide for deferred compensation to the extent the plan provides 
for amounts of separation pay required to be provided under the 
applicable law of a foreign jurisdiction. For this purpose, a provision 
of foreign law shall be considered applicable only to foreign earned 
income (as defined under section 911(b)(1)

[[Page 632]]

without regard to section 911(b)(1)(B)(iv) and without regard to the 
requirement that the income be attributable to services performed during 
the period described in section 911(d)(1)(A) or (B)) from sources within 
the foreign country that promulgated such law.
    (v) Reimbursements and certain other separation payments--(A) In 
general. To the extent a separation pay plan (including a plan providing 
payments upon a voluntary separation from service) entitles a service 
provider to payment by the service recipient of reimbursements that are 
not otherwise excludible from gross income for expenses that the service 
provider could otherwise deduct under section 162 or section 167 as 
business expenses incurred in connection with the performance of 
services (ignoring any applicable limitation based on adjusted gross 
income), or of reasonable outplacement expenses and reasonable moving 
expenses actually incurred by the service provider and directly related 
to the termination of services for the service recipient, such plan does 
not provide for a deferral of compensation to the extent such rights 
apply during a limited period of time (regardless of whether such rights 
extend beyond the limited period of time). For purposes of this 
paragraph (b)(9)(v)(A), the reimbursement of reasonable moving expenses 
includes the reimbursement of all or part of any loss the service 
provider actually incurs due to the sale of a primary residence in 
connection with a separation from service.
    (B) Medical benefits. To the extent a separation pay plan (including 
a plan providing payments due to a voluntary separation from service) 
entitles a service provider to reimbursement by the service recipient of 
payments of medical expenses incurred and paid by the service provider 
but not reimbursed by a person other than the service recipient and 
allowable as a deduction under section 213 (disregarding the requirement 
of section 213(a) that the deduction is available only to the extent 
that such expenses exceed 7.5 percent of adjusted gross income), such 
plan does not provide for a deferral of compensation to the extent such 
rights apply during the period of time during which the service provider 
would be entitled (or would, but for such plan, be entitled) to 
continuation coverage under a group health plan of the service recipient 
under section 4980B (COBRA) if the service provider elected such 
coverage and paid the applicable premiums.
    (C) In-kind benefits and direct service recipient payments. A 
service provider's entitlement to in-kind benefits from the service 
recipient, or a payment by the service recipient directly to the person 
providing the goods or services to the service provider, is treated as 
not providing for a deferral of compensation for purposes of this 
paragraph (b), if a right to reimbursement by the service recipient for 
a payment for such benefits, goods, or services by the service provider 
would not be treated as providing for a deferral of compensation under 
this paragraph (b)(9)(v).
    (D) Limited payments. If not otherwise excluded, a taxpayer may 
treat a right or rights under a separation pay plan to a payment or 
payments as not providing for a deferral of compensation to the extent 
such payments in the aggregate do not exceed the applicable dollar 
amount under section 402(g)(1)(B) for the year of the separation from 
service.
    (E) Limited period of time. For purposes of paragraphs (b)(9)(v)(A) 
and (C) of this section, a limited period of time in which expenses may 
be incurred, or in which in-kind benefits may be provided by the service 
recipient or a third party that the service recipient will pay, does not 
include periods beyond the last day of the second taxable year of the 
service provider following the taxable year of the service provider in 
which the separation from service occurred, provided that the period 
during which the reimbursements for such expenses must be paid may not 
extend beyond the third taxable year of the service provider following 
the taxable year of the service provider in which the separation from 
service occurred.
    (vi) Window programs--definition. The term window program refers to 
a program established by a service recipient in connection with an 
impending separation from service to provide separation pay, where such 
program is made

[[Page 633]]

available by the service recipient for a limited period of time (no 
longer than 12 months) to service providers who separate from service 
during that period or to service providers who separate from service 
during that period under specified circumstances. A program will not be 
considered a window program if a service recipient establishes a pattern 
of repeatedly providing for similar separation pay in similar situations 
for substantially consecutive, limited periods of time. Whether the 
recurrence of these programs constitutes a pattern is determined based 
on the facts and circumstances. Although no one factor is determinative, 
relevant factors include whether the benefits are on account of a 
specific business event or condition, the degree to which the separation 
pay relates to the event or condition, and whether the event or 
condition is temporary or discrete or is a permanent aspect of the 
employer's business.
    (10) Certain indemnification and liability insurance plans. A plan 
in which a service provider participates does not provide for a deferral 
of compensation for purposes of this paragraph (b) to the extent that 
the plan provides (to the extent permissible under applicable law), for 
the indemnification of, or the purchase of an insurance policy providing 
for payments of, all or part of the expenses incurred or damages paid or 
payable by a service provider with respect to a bona fide claim against 
the service provider or service recipient, including amounts paid or 
payable by the service provider upon the settlement of a bona fide claim 
against the service provider or service recipient, where such claim is 
based on actions or failures to act by the service provider in his or 
her capacity as a service provider of the service recipient.
    (11) Legal settlements. An agreement to which a service provider is 
a party does not provide for a deferral of compensation for purposes of 
this paragraph (b) to the extent that the agreement provides for amounts 
paid as settlements or awards resolving bona fide legal claims based on 
wrongful termination, employment discrimination, the Fair Labor 
Standards Act, or worker's compensation statutes, including claims under 
applicable Federal, state, local, or foreign laws, or for reimbursements 
or payments of reasonable attorneys fees or other reasonable expenses 
incurred by the service provider related to such bona fide legal claims, 
regardless of whether such settlements, awards, or reimbursement or 
payment of expenses pursuant to such claims are treated as compensation 
or wages for Federal tax purposes. Whether the execution of a waiver of 
any or all of such types of claims indicates that the amounts are paid 
as an award or settlement of an actual bona fide claim for damages under 
applicable law is determined based on the facts and circumstances. This 
paragraph (b)(11) does not apply to any deferred amounts that did not 
arise as a result of an actual bona fide claim for damages under 
applicable law, such as amounts that would have been deferred or paid 
regardless of the existence of such claim, even if such amounts are paid 
or modified as part of a settlement or award resolving an actual bona 
fide claim. For this purpose, a provision of foreign law shall be 
considered applicable only to foreign earned income (as defined under 
section 911(b)(1) without regard to section 911(b)(1)(B)(iv) and without 
regard to the requirement that the income be attributable to services 
performed during the period described in section 911(d)(1)(A) or (B)) 
from sources within the foreign country that promulgated such law.
    (12) Certain educational benefits. A plan in which a service 
provider participates does not provide for a deferral of compensation to 
the extent the plan provides for taxable educational benefits. For 
purposes of this paragraph (b)(12), the term educational benefits refers 
solely to benefits provided to a service provider, consisting solely of 
educational assistance for the education of the service provider, as 
defined in section 127(c) and the accompanying regulations, and does not 
refer to any benefits provided for the education of any other person, 
including any spouse, child, or other family member of the service 
provider.
    (c) Plan--(1) In general. The term plan includes any agreement, 
method, program, or other arrangement, including an agreement, method, 
program, or other arrangement that applies to one

[[Page 634]]

person or individual. A plan may be adopted unilaterally by the service 
recipient or may be negotiated or agreed to by the service recipient and 
one or more service providers or service provider representatives. An 
agreement, method, program, or other arrangement may constitute a plan 
regardless of whether it is an employee benefit plan under section 3(3) 
of ERISA, as amended (29 U.S.C. 1002(3)). The requirements of section 
409A are applied as if a separate plan or plans is maintained for each 
service provider. For purposes of determining the terms of a plan, 
general provisions of the plan that purport to nullify noncompliant plan 
terms, or to supply any specific plan terms required by this section, 
Sec. 1.409A-2 or Sec. 1.409A-3, are disregarded.
    (2) Plan aggregation rules--(i) In general. Except as otherwise 
provided, the following rules apply with respect to the application of 
this section and Sec. Sec. 1.409A-2 through 1.409A-6 to deferrals of 
compensation with respect to a service provider:
    (A) All deferrals of compensation at the election of that service 
provider under all plans of the service recipient that are account 
balance plans, except to the extent that the plan is described in 
paragraph (c)(2)(i)(D), (E), (F), (G), or (H) of this section, are 
treated as deferred under a single plan. For purposes of this paragraph, 
the term account balance plan means--
    (1) An agreement, method, program, or other arrangement that is an 
account balance plan as defined in Sec. 31.3121(v)(2)-1(c)(1)(ii)(A) of 
this chapter, including mandatorily bifurcating the agreement, method, 
program, or other arrangement in accordance with the rules provided in 
Sec. 31.3121(v)-1(c)(1)(iii)(B) of this chapter; or
    (2) An agreement, method, program, or other arrangement that would 
be described in paragraph (c)(2)(i)(A)(1) of this section if the service 
provider were an employee.
    (B) All deferrals of compensation other than at the election of that 
service provider, including deferrals reflecting matching by the service 
recipient with respect to amounts a service provider elects to defer, 
under all plans of the service recipient that are account balance plans, 
except to the extent the plan is described in paragraph (c)(2)(i)(D), 
(E), (F), (G), or (H) of this section, are treated as deferred under a 
single plan. For purposes of this paragraph (c)(2)(i)(B), the term 
``account balance plan'' has the same meaning as provided in paragraph 
(c)(2)(i)(A) of this section.
    (C) All deferrals of compensation with respect to that service 
provider under all plans of the service recipient that are nonaccount 
balance plans, except to the extent such plan is described in paragraph 
(c)(2)(i)(D), (E), (F), (G), or (H) of this section, are treated as 
deferred under a single plan. For purposes of this paragraph 
(c)(2)(i)(C), the term nonaccount balance plan means--
    (1) An agreement, method, program, or other arrangement that is a 
nonaccount balance plan as defined in Sec. 31.3121(v)(2)-1(c)(2)(i) of 
this chapter, including mandatorily bifurcating the agreement, method, 
program, or other arrangement in accordance with the rules provided in 
Sec. 31.3121(v)-1(c)(1)(iii)(B) of this chapter; or
    (2) An agreement, method, program, or other arrangement that would 
be described in paragraph (c)(2)(i)(C)(1) of this section if the service 
provider were an employee.
    (D) All deferrals of compensation with respect to that service 
provider under all separation pay plans (as defined in paragraph (m) of 
this section) of the service recipient to the extent an amount deferred 
under the plans is not described in paragraph (c)(2)(i)(E) of this 
section and is payable solely upon an involuntary separation from 
service within the meaning of paragraph (n) of this section or as a 
result of participation in a window program, are treated as deferred 
under a single plan.
    (E) All deferrals of compensation with respect to that service 
provider under all plans of the service recipient to the extent such 
amounts deferred consist of rights to in-kind benefits or reimbursements 
of expenses, such as membership fees, or expenses related to aircraft or 
vehicle usage, to the extent that the right to the in-kind benefit or 
reimbursement, separately or in the aggregate, does not constitute a

[[Page 635]]

substantial portion of either the overall compensation earned by the 
service provider for performing services for the service recipient or 
the overall compensation received due to a separation from service, are 
treated as deferred under a single plan.
    (F) All deferrals of compensation with respect to that service 
provider under all plans of the service recipient to the extent that the 
taxation of such compensation is governed by Sec. 1.61-22 or Sec. 
1.7872-15 (split-dollar life insurance arrangements), or the taxation of 
such compensation would be governed by Sec. 1.61-22 or Sec. 1.7872-15 
but for the operation of Sec. 1.61-22(j) (effective date provisions), 
are treated as deferred under a single plan.
    (G) All deferrals of compensation with respect to that service 
provider under all agreements, methods, programs, or other arrangements 
of the service recipient to the extent the deferrals under the 
agreements, methods, programs, or other arrangements are deferrals of 
amounts that would be treated as modified foreign earned income (meaning 
foreign earned income as defined under section 911(b)(1) without regard 
to section 911(b)(1)(B)(iv) and without regard to the requirement that 
the income be attributable to services performed during the period 
described in section 911(d)(1)(A) or (B)) if paid to the service 
provider at the time the amount is first deferred, and provided further 
that substantially all the participants in such agreements, methods, 
programs, or other arrangements and any substantially similar 
agreements, methods, programs, or other arrangements are nonresident 
aliens and that the service provider does not participate in a 
substantially identical agreement, method, program, or other arrangement 
that does not meet the requirements of this paragraph (c)(2)(i)(G) (a 
domestic arrangement), are treated as deferred under a single plan.
    (H) All deferrals of compensation with respect to that service 
provider under all plans of the service recipient to the extent such 
plans are stock rights (as defined in paragraph (l) of this section) 
subject to section 409A, are treated as deferred under a single plan.
    (I) All deferrals of compensation with respect to that service 
provider under all plans of the service recipient to the extent such 
plans are not described in paragraph (c)(2)(i)(A), (B), (C), (D), (E), 
(F), (G), or (H) of this section are treated as deferred under a single 
plan.
    (ii) Dual status. Agreements, methods, programs, and other 
arrangements in which a service provider participates are not aggregated 
with other agreements, methods, programs, and other arrangements to the 
extent the service provider participates in one set of agreements, 
methods, programs, and other arrangements due to status as an employee 
of the service recipient (employee arrangements) and another set of 
agreements, methods, programs, and other arrangements due to status as 
an independent contractor of the service recipient (independent 
contractor arrangements). For example, where a service provider deferred 
amounts under an independent contractor arrangement while providing 
services as an independent contractor, and then becomes eligible for and 
defers amounts under a separate employee arrangement after being hired 
as an employee, the two arrangements will not be aggregated for purposes 
of this paragraph (c)(2). Where an employee also is a member of the 
board of directors of the service recipient (or a similar position with 
respect to a non-corporate service recipient), the arrangements under 
which the employee participates as a director (director arrangements) 
are not aggregated with employee arrangements, provided that the 
director arrangements are substantially similar to arrangements provided 
to service providers providing services only as directors (or similar 
positions with respect to non-corporate service recipients). For 
example, an employee director who participates in an employee 
arrangement and a director arrangement generally may treat the two 
arrangements as separate plans, provided that the director arrangement 
is substantially similar to arrangements providing benefits to non-
employee directors. To the extent a plan in which an employee director 
participates is not substantially similar to arrangements

[[Page 636]]

in which non-employee directors participate, such plan is treated as an 
employee plan for purposes of this paragraph (c)(2). Director plans and 
independent contractor plans are aggregated for purposes of this 
paragraph (c)(2).
    (3) Establishment of plan--(i) In general. A plan does not satisfy 
the requirements of section 409A and this section and Sec. Sec. 1.409A-
2 through 1.409A-3 and Sec. Sec. 1.409A-5 through 1.409A-6, unless the 
plan is established and maintained by a service recipient in accordance 
with the requirements of this section, Sec. Sec. 1.409A-2 through 
1.409A-3 and Sec. Sec. 1.409A-5 through 1.409A-6. For purposes of this 
paragraph (c)(3), a plan is established on the latest of the date on 
which it is adopted, the date on which it is effective, and the date on 
which the material terms of the plan are set forth in writing. The 
material terms of the plan may be set forth in writing in one or more 
documents. For purposes of this paragraph (c)(3)(i), a plan will be 
deemed to be set forth in writing if it is set forth in any other form 
that is approved by the Commissioner. The material terms of the plan 
include the amount (or the method or formula for determining the amount) 
of deferred compensation to be provided under the plan and the time and 
form of payment. Notwithstanding the foregoing, a plan will be deemed to 
be established as of the date the participant obtains a legally binding 
right to a deferral of compensation, provided that the plan is otherwise 
established under the rules of this paragraph (c)(3)(i) by the end of 
the taxable year of the service provider in which the legally binding 
right arises, or with respect to an amount not payable in the year 
immediately following the taxable year of the service provider in which 
the legally binding right arises (the subsequent year), the 15th day of 
the third month of the subsequent year.
    (ii) Initial deferral election provisions. If a plan provides a 
service provider or a service recipient with an initial deferral 
election, the plan satisfies the requirements of this paragraph (c)(3) 
if the plan sets forth in writing, on or before the date the applicable 
election is required to be irrevocable to satisfy the requirements of 
Sec. 1.409A-2(a), the conditions under which such election may be made.
    (iii) Subsequent deferral election provisions. If a plan permits a 
subsequent deferral election described in Sec. 1.409A-2(b), the plan 
satisfies the requirements of this paragraph (c)(3) if the plan sets 
forth in writing, on or before the date the election is required to be 
irrevocable to meet the requirements of Sec. 1.409A-2(b), the 
conditions under which such election may be made.
    (iv) Payment accelerations. Except as explicitly provided in Sec. 
1.409A-3, a plan is not required to set forth in writing the conditions 
under which a payment may be accelerated if such acceleration is 
permitted under Sec. 1.409A-3(j)(4).
    (v) Six-month delay for specified employees. A plan must provide 
that distributions to a specified employee may not be made before the 
date that is six months after the date of separation from service or, if 
earlier, the date of death (the six-month delay rule). The six-month 
delay rule, required for payments due to the separation from service of 
a specified employee, must be written in the plan. A plan does not fail 
to be established and maintained merely because it does not contain the 
six-month delay rule when the service provider who has a right to 
compensation deferred under such plan is not a specified employee. 
However, such provision must be set forth in writing on or before the 
date such service provider first becomes a specified employee. In 
general, this means the provision must be set forth in writing on or 
before the specified employee effective date (as defined in paragraph 
(i)(3) of this section) for the first list of specified employees that 
includes such service provider.
    (vi) Plan amendments. In the case of an amendment that increases the 
amount deferred under a nonqualified deferred compensation plan, the 
plan is not considered established with respect to the additional amount 
deferred until the plan, as amended, is established in accordance with 
paragraph (c)(3)(i) of this section.
    (vii) Transition rule for written plan requirement. For purposes of 
this paragraph (c)(3), a legally enforceable unwritten plan that was 
adopted and effective before December 31, 2007, is

[[Page 637]]

treated as established under this section as of the later of the date on 
which it was adopted or became effective, provided that the material 
terms of the plan are set forth in writing on or before December 31, 
2007.
    (viii) Plan aggregation rules. The plan aggregation rules of 
paragraph (c)(2)(i) of this section do not apply to the written plan 
requirements of this paragraph (c)(3). Accordingly, deferrals of 
compensation under an agreement, method, program, or other arrangement 
that fails to meet the requirements of section 409A solely due to a 
failure to meet the written plan requirements of this paragraph (c)(3) 
are not aggregated with deferrals of compensation under other 
agreements, methods, programs, or other arrangements that meet such 
requirements.
    (d) Substantial risk of forfeiture--(1) In general. Compensation is 
subject to a substantial risk of forfeiture if entitlement to the amount 
is conditioned on the performance of substantial future services by any 
person or the occurrence of a condition related to a purpose of the 
compensation, and the possibility of forfeiture is substantial. For 
purposes of this paragraph (d), a condition related to a purpose of the 
compensation must relate to the service provider's performance for the 
service recipient or the service recipient's business activities or 
organizational goals (for example, the attainment of a prescribed level 
of earnings or equity value or completion of an initial public 
offering). For purposes of this paragraph (d), if a service provider's 
entitlement to the amount is conditioned on the occurrence of the 
service provider's involuntary separation from service without cause, 
the right is subject to a substantial risk of forfeiture if the 
possibility of forfeiture is substantial. An amount is not subject to a 
substantial risk of forfeiture merely because the right to the amount is 
conditioned, directly or indirectly, upon the refraining from the 
performance of services. Except as provided with respect to certain 
transaction-based compensation under Sec. 1.409A-3(i)(5)(iv), the 
addition of any risk of forfeiture after the legally binding right to 
the compensation arises, or any extension of a period during which 
compensation is subject to a risk of forfeiture, is disregarded for 
purposes of determining whether such compensation is subject to a 
substantial risk of forfeiture. An amount will not be considered subject 
to a substantial risk of forfeiture beyond the date or time at which the 
recipient otherwise could have elected to receive the amount of 
compensation, unless the present value of the amount subject to a 
substantial risk of forfeiture (disregarding, in determining the present 
value, the risk of forfeiture) is materially greater than the present 
value of the amount the recipient otherwise could have elected to 
receive absent such risk of forfeiture. For this purpose, compensation 
that the service provider would receive for continuing to perform 
services regardless of whether the service provider elected to receive 
the amount that is subject to a substantial risk of forfeiture is not 
taken into account in determining whether the present value of the right 
to the amount subject to a substantial risk of forfeiture is materially 
greater than the amount the recipient otherwise could have elected to 
receive absent such risk of forfeiture. For example, a salary deferral 
generally may not be made subject to a substantial risk of forfeiture. 
But, for example, where a bonus plan provides an election between a cash 
payment or restricted stock units with a present value that is 
materially greater (disregarding the risk of forfeiture) than the 
present value of such cash payment and that will be forfeited absent 
continued services for a period of years, the right to the restricted 
stock units generally will be treated as subject to a substantial risk 
of forfeiture.
    (2) Stock rights. A stock right is not subject to a substantial risk 
of forfeiture at the earlier of the first date the holder may exercise 
the stock right and receive cash or property that is substantially 
vested (as defined in Sec. 1.83-3(b)) or the first date that the stock 
right is not subject to a forfeiture condition that would constitute a 
substantial risk of forfeiture. Accordingly, a stock option that the 
service provider may exercise immediately and receive substantially 
vested stock is

[[Page 638]]

not subject to a substantial risk of forfeiture, even if the stock 
option automatically terminates upon the service provider's separation 
from service.
    (3) Enforcement of forfeiture condition--(i) In general. In 
determining whether the possibility of forfeiture is substantial in the 
case of rights to compensation granted by a service recipient to a 
service provider that owns a significant amount of the total combined 
voting power or value of all classes of equity of the service recipient 
(where the service provider's ownership is determined with application 
of the attribution rules under section 318 if the service recipient is a 
corporation, or if the service recipient is an entity that is not a 
corporation, with application by analogy of the attribution rules under 
section 318), all relevant facts and circumstances will be taken into 
account in determining whether the probability of the service recipient 
enforcing such condition is substantial, including--
    (A) The service provider's relationship to other equity holders and 
the extent of their control, potential control and possible loss of 
control of the service recipient;
    (B) The position of the service provider in the service recipient 
and the extent to which the service provider is subordinate to other 
service providers;
    (C) The service provider's relationship to the officers and 
directors of the service recipient (or similar positions with respect to 
a noncorporate service recipient);
    (D) The person or persons who must approve the service provider's 
discharge; and
    (E) Past actions of the service recipient in enforcing the 
restrictions.
    (ii) Examples. The following examples illustrate the rules of 
paragraph (d)(3)(i) of this section:

    Example 1. A service provider would be considered as having deferred 
compensation subject to a substantial risk of forfeiture, but for the 
fact that the service provider owns 20 percent of the single class of 
stock in the transferor corporation. If the remaining 80 percent of the 
class of stock is owned by an unrelated individual (or members of such 
an individual's family) so that the possibility of the corporation 
enforcing a restriction on such rights is substantial, then such rights 
are subject to a substantial risk of forfeiture.
    Example 2. A service provider would be considered as having deferred 
compensation subject to a substantial risk of forfeiture, but for the 
fact that the service provider, who is president of the corporation, 
also owns 4 percent of the voting power of all the stock of a 
corporation. If the remaining stock is so diversely held by the public 
that the president, in effect, controls the corporation, then the 
possibility of the corporation enforcing a restriction on the right to 
deferred compensation of the president is not substantial, and such 
rights are not subject to a substantial risk of forfeiture.

    (e) Performance-based compensation--(1) In general. The term 
performance-based compensation means compensation the amount of which, 
or the entitlement to which, is contingent on the satisfaction of 
preestablished organizational or individual performance criteria 
relating to a performance period of at least 12 consecutive months. 
Organizational or individual performance criteria are considered 
preestablished if established in writing by not later than 90 days after 
the commencement of the period of service to which the criteria relates, 
provided that the outcome is substantially uncertain at the time the 
criteria are established. Performance-based compensation may include 
payments based on performance criteria that are not approved by a 
compensation committee of the board of directors (or similar entity in 
the case of a non-corporate service recipient) or by the stockholders or 
members of the service recipient. Performance-based compensation does 
not include any amount or portion of any amount that will be paid either 
regardless of performance, or based upon a level of performance that is 
substantially certain to be met at the time the criteria is established. 
In addition, except as provided in paragraph (e)(3) of this section, 
compensation is not performance-based compensation merely because the 
amount of such compensation is determined by reference to the value of 
the service recipient or the stock of the service recipient. Where a 
portion of an amount of compensation would qualify as performance-based 
compensation if the portion were the sole amount available under the 
plan, that portion of the award will not fail to qualify as performance-
based compensation if that

[[Page 639]]

portion is designated separately or otherwise separately identifiable 
under the terms of the plan, and the amount of each portion is 
determined independently of the other. Compensation may be performance-
based compensation where the amount will be paid regardless of 
satisfaction of the performance criteria due to the service provider's 
death, disability, or a change in control event (as defined in Sec. 
1.409A-3(i)(5)(i)), provided that a payment made under such 
circumstances without regard to the satisfaction of the performance 
criteria will not constitute performance-based compensation. For 
purposes of this paragraph (e)(1), a disability refers to any medically 
determinable physical or mental impairment resulting in the service 
provider's inability to perform the duties of his or her position or any 
substantially similar position, where such impairment can be expected to 
result in death or can be expected to last for a continuous period of 
not less than six months.
    (2) Payments based upon subjective performance criteria. The term 
performance-based compensation includes payments based upon subjective 
performance criteria, provided that--
    (i) The subjective performance criteria are bona fide and relate to 
the performance of the participant service provider, a group of service 
providers that includes the participant service provider, or a business 
unit for which the participant service provider provides services (which 
may include the entire organization); and
    (ii) The determination that any subjective performance criteria have 
been met is not made by the participant service provider or a family 
member of the participant service provider (as defined in section 
267(c)(4) applied as if the family of an individual includes the spouse 
of any member of the family), or a person under the effective control of 
the participant service provider or such a family member, and no amount 
of the compensation of the person making such determination is 
effectively controlled in whole or in part by the service provider or 
such a family member.
    (3) Equity-based compensation. Compensation is performance-based 
compensation if it is based solely on an increase in the value of the 
service recipient, or a share of stock in the service recipient, after 
the date of a grant or award. However, compensation payable for a 
service period that is equal to the value of a predetermined number of 
shares of stock, and is variable only to the extent that the value of 
such shares appreciates or depreciates, generally will not be 
performance-based compensation. Notwithstanding the foregoing, the 
attainment of a prescribed value for the service recipient (or a portion 
thereof), or a share of stock in the service recipient, may be used as a 
preestablished organizational criterion for purposes of providing 
performance-based compensation, provided that the other requirements of 
paragraph (e)(1) of this section are satisfied. In addition, an award of 
equity-based compensation may constitute performance-based compensation 
if entitlement to the compensation is subject to a condition that would 
cause the award to otherwise qualify as performance-based compensation, 
such as a performance-based vesting condition. A provision that allows a 
service provider to defer compensation that would be realized upon the 
exercise of a stock right generally constitutes an additional deferral 
feature for purposes of the definition of a deferral of compensation 
under paragraph (b)(5) of this section.
    (f) Service provider--(1) In general. The term service provider 
includes an individual, corporation, subchapter S corporation, 
partnership, personal service corporation (as defined in section 
269A(b)(1)), noncorporate entity that would be a personal service 
corporation if it were a corporation, qualified personal service 
corporation (as defined in section 448(d)(2)), and noncorporate entity 
that would be a qualified personal service corporation if it were a 
corporation, for any taxable year in which such individual, corporation, 
subchapter S corporation, partnership, or other entity accounts for 
gross income from the performance of services under the cash receipts 
and disbursements method of accounting. The term service provider 
generally includes a person who has separated from service (a former 
service provider).

[[Page 640]]

    (2) Independent contractors--(i) In general. Except as otherwise 
provided in paragraph (f)(2)(iv) of this section, section 409A does not 
apply to an amount deferred under a plan between a service provider and 
service recipient with respect to a particular trade or business in 
which the service provider participates, including earnings credited to 
such deferred amount, if during the service provider's taxable year in 
which the service provider obtains a legally binding right to the 
payment of the amount deferred each of the following applies:
    (A) The service provider is actively engaged in the trade or 
business of providing services, other than as an employee or as a member 
of the board of directors of a corporation (or similar position with 
respect to an entity that is not a corporation).
    (B) The service provider provides significant services to two or 
more service recipients to which the service provider is not related and 
that are not related to one another (as defined in paragraph (f)(2)(ii) 
of this section).
    (C) The service provider is not related to the service recipient, 
applying the definition of related person contained in paragraph 
(f)(2)(ii) of this section subject to the modification that the language 
``20 percent'' is not used instead of ``50 percent'' each place ``50 
percent'' appears in sections 267(b) and 707(b)(1).
    (ii) Related person. For purposes of this paragraph (f)(2), a person 
is related to another person if the persons bear a relationship to each 
other that is specified in section 267(b) or 707(b)(1), subject to the 
modifications that the language ``20 percent'' is used instead of ``50 
percent'' each place it appears in sections 267(b) and 707(b)(1), and 
section 267(c)(4) is applied as if the family of an individual includes 
the spouse of any member of the family; or the persons are engaged in 
trades or businesses under common control (within the meaning of section 
52(a) and (b)). In addition, an individual is related to an entity if 
the individual is an officer of an entity that is a corporation, or 
holds a position substantially similar to an officer of a corporation 
with an entity that is not a corporation.
    (iii) Significant services. Whether a service provider is providing 
significant services depends on the facts and circumstances of each 
case. However, for purposes of paragraph (f)(2)(i) of this section, a 
service provider who provides services to two or more service recipients 
to which the service provider is not related and that are not related to 
one another is deemed to be providing significant services to two or 
more of such service recipients for a given taxable year, if the 
revenues generated from the services provided to any service recipient 
or group of related service recipients during such taxable year do not 
exceed 70 percent of the total revenue generated by the service provider 
from the trade or business of providing such services. In addition, in 
the case of a service provider who has been providing services in a 
trade or business for a period of not less than three consecutive years, 
for purposes of paragraph (f)(2)(i) of this section, a service provider 
who provides services to two or more service recipients to which the 
service provider is not related and that are not related to one another 
is deemed to be providing significant services to two or more of such 
service recipients for a given taxable year if in each of the prior 
three taxable years the revenues generated from the services provided to 
any service recipient or group of related service recipients during such 
prior taxable years did not exceed 70 percent of the total revenue 
generated by the service provider from the trade or business of 
providing such services and, at the time an amount is deferred, the 
service provider does not know or have reason to anticipate that the 
revenues generated from the services provided to any service recipient 
or group of related service recipients during the current year will 
exceed 70 percent of the total revenue generated by the service provider 
from the trade or business of providing such services.
    (iv) Management services. This paragraph (f)(2) does not apply to a 
service provider to the extent the service provider provides management 
services to a service recipient. For purposes of this paragraph 
(f)(2)(iv), the term management services means services that involve the 
actual or de facto direction

[[Page 641]]

or control of the financial or operational aspects of a trade or 
business of the service recipient, or investment management or advisory 
services provided to a service recipient whose primary trade or business 
includes the investment of financial assets (including investments in 
real estate), such as a hedge fund or a real estate investment trust.
    (v) Services provided to related persons. Section 409A does not 
apply to an amount deferred under a plan that is a bona fide agreement, 
method, program, or other arrangement between a service provider and a 
related service recipient arising in the ordinary course of a particular 
trade or business in which the service provider is engaged to the extent 
that--
    (A) The service provider provides services to the service recipient 
as an independent contractor;
    (B) During the service provider's taxable year in which the amount 
is deferred, the service provider qualifies for the safe harbor provided 
in paragraph (f)(2)(iii) of this section with respect to such trade or 
business; and
    (C) Such agreement, method, program, or other arrangement and the 
practices thereunder (including billing and collection practices), are 
substantially similar to the agreements, methods, programs, or other 
arrangements and practices applicable to one or more unrelated service 
recipients to whom the service provider provides substantial services 
and that produce a majority of the total revenue that the service 
provider earns from the trade or business of providing such services 
during the taxable year.
    (g) Service recipient. Except as otherwise specifically provided in 
these regulations, the term service recipient means the person for whom 
the services are performed and with respect to whom the legally binding 
right to compensation arises, and all persons with whom such person 
would be considered a single employer under section 414(b) (employees of 
controlled group of corporations), and all persons with whom such person 
would be considered a single employer under section 414(c) (employees of 
partnerships, proprietorships, etc., under common control). For example, 
if the service provider is an employee, the service recipient generally 
is the employer (including all persons treated as a single employer 
under section 414(b) or (c)). Notwithstanding the foregoing, section 
409A applies to a plan that provides for the deferral of compensation, 
even if the payment of the compensation is not made by the person for 
whom services are performed.
    (h) Separation from service--(1) Employees--(i) In general. An 
employee separates from service with the employer if the employee dies, 
retires, or otherwise has a termination of employment with the employer. 
However, for purposes of this paragraph (h)(1), the employment 
relationship is treated as continuing intact while the individual is on 
military leave, sick leave, or other bona fide leave of absence if the 
period of such leave does not exceed six months, or if longer, so long 
as the individual retains a right to reemployment with the service 
recipient under an applicable statute or by contract. For purposes of 
this paragraph (h)(1), a leave of absence constitutes a bona fide leave 
of absence only if there is a reasonable expectation that the employee 
will return to perform services for the employer. If the period of leave 
exceeds six months and the individual does not retain a right to 
reemployment under an applicable statute or by contract, the employment 
relationship is deemed to terminate on the first date immediately 
following such six-month period. Notwithstanding the foregoing, where a 
leave of absence is due to any medically determinable physical or mental 
impairment that can be expected to result in death or can be expected to 
last for a continuous period of not less than six months, where such 
impairment causes the employee to be unable to perform the duties of his 
or her position of employment or any substantially similar position of 
employment, a 29-month period of absence may be substituted for such 
six-month period.
    (ii) Termination of employment. Whether a termination of employment 
has occurred is determined based on whether the facts and circumstances 
indicate that the employer and employee reasonably anticipated that no 
further services would be performed after a

[[Page 642]]

certain date or that the level of bona fide services the employee would 
perform after such date (whether as an employee or as an independent 
contractor) would permanently decrease to no more than 20 percent of the 
average level of bona fide services performed (whether as an employee or 
an independent contractor) over the immediately preceding 36-month 
period (or the full period of services to the employer if the employee 
has been providing services to the employer less than 36 months). Facts 
and circumstances to be considered in making this determination include, 
but are not limited to, whether the employee continues to be treated as 
an employee for other purposes (such as continuation of salary and 
participation in employee benefit programs), whether similarly situated 
service providers have been treated consistently, and whether the 
employee is permitted, and realistically available, to perform services 
for other service recipients in the same line of business. An employee 
is presumed to have separated from service where the level of bona fide 
services performed decreases to a level equal to 20 percent or less of 
the average level of services performed by the employee during the 
immediately preceding 36-month period. An employee will be presumed not 
to have separated from service where the level of bona fide services 
performed continues at a level that is 50 percent or more of the average 
level of service performed by the employee during the immediately 
preceding 36-month period. No presumption applies to a decrease in the 
level of bona fide services performed to a level that is more than 20 
percent and less than 50 percent of the average level of bona fide 
services performed during the immediately preceding 36-month period. The 
presumption is rebuttable by demonstrating that the employer and the 
employee reasonably anticipated that as of a certain date the level of 
bona fide services would be reduced permanently to a level less than or 
equal to 20 percent of the average level of bona fide services provided 
during the immediately preceding 36-month period or full period of 
services provided to the employer if the employee has been providing 
services to the service recipient for a period of less than 36 months 
(or that the level of bona fide services would not be so reduced). For 
example, an employee may demonstrate that the employer and employee 
reasonably anticipated that the employee would cease providing services, 
but that, after the original cessation of services, business 
circumstances such as termination of the employee's replacement caused 
the employee to return to employment. Although the employee's return to 
employment may cause the employee to be presumed to have continued in 
employment because the employee is providing services at a rate equal to 
the rate at which the employee was providing services before the 
termination of employment, the facts and circumstances in this case 
would demonstrate that at the time the employee originally ceased to 
provide services, the employee and the service recipient reasonably 
anticipated that the employee would not provide services in the future. 
Notwithstanding the foregoing provisions of this paragraph (h)(1)(ii), a 
plan may treat another level of reasonably anticipated permanent 
reduction in the level of bona fide services as a separation from 
service, provided that the level of reduction required must be 
designated in writing as a specific percentage, and the reasonably 
anticipated reduced level of bona fide services must be greater than 20 
percent but less that 50 percent of the average level of bona fide 
services provided in the immediately preceding 36 months. The plan must 
specify the definition of separation from service on or before the date 
on which a separation from service is designated as a time of payment of 
the applicable amount deferred, and once designated, any change to the 
definition of separation from service with respect to such amount 
deferred will be subject to the rules regarding subsequent deferrals and 
the acceleration of payments. For purposes of this paragraph (h)(1)(ii), 
for periods during which an employee is on a paid bona fide leave of 
absence (as defined in paragraph (h)(1)(i) of this section) and has not 
otherwise terminated employment pursuant to paragraph (h)(1)(i) of this 
section, the employee is treated as providing bona fide services

[[Page 643]]

at a level equal to the level of services that the employee would have 
been required to perform to receive the compensation paid with respect 
to such leave of absence. Periods during which an employee is on an 
unpaid bona fide leave of absence (as defined in paragraph (h)(1)(i) of 
this section) and has not otherwise terminated employment pursuant to 
paragraph (h)(1)(i) of this section, are disregarded for purposes of 
this paragraph (h)(1)(ii) (including for purposes of determining the 
applicable 36-month (or shorter) period).
    (2) Independent contractors--(i) In general. An independent 
contractor is considered to have a separation from service with the 
service recipient upon the expiration of the contract (or in the case of 
more than one contract, all contracts) under which services are 
performed for the service recipient if the expiration constitutes a 
good-faith and complete termination of the contractual relationship. An 
expiration does not constitute a good faith and complete termination of 
the contractual relationship if the service recipient anticipates a 
renewal of a contractual relationship or the independent contractor 
becoming an employee. For this purpose, a service recipient is 
considered to anticipate the renewal of the contractual relationship 
with an independent contractor if it intends to contract again for the 
services provided under the expired contract, and neither the service 
recipient nor the independent contractor has eliminated the independent 
contractor as a possible provider of services under any such new 
contract. Further, a service recipient is considered to intend to 
contract again for the services provided under an expired contract if 
the service recipient's doing so is conditioned only upon incurring a 
need for the services, the availability of funds, or both.
    (ii) Special rule. Notwithstanding paragraph (h)(2)(i) of this 
section, a plan is considered to satisfy the requirement described in 
Sec. 1.409A-3(a)(1) with respect to an amount payable upon a separation 
from service if, with respect to amounts payable to a service provider 
who is an independent contractor, the plan provides that--
    (A) No amount will be paid to the service provider before a date at 
least 12 months after the day on which the contract expires under which 
the service provider performs services for the service recipient (or, in 
the case of more than one contract, all such contracts expire); and
    (B) No amount payable to the service provider on that date will be 
paid to the service provider if, after the expiration of the contract 
(or contracts) and before that date, the service provider performs 
services for the service recipient as an independent contractor or an 
employee.
    (3) Definition of service recipient and employer. For purposes of 
this paragraph (h), the term service recipient or employer means the 
service recipient as defined in paragraph (g) of this section, provided 
that in applying section 1563(a)(1), (2), and (3) for purposes of 
determining a controlled group of corporations under section 414(b), the 
language ``at least 50 percent'' is used instead of ``at least 80 
percent'' each place it appears in section 1563(a)(1), (2), and (3), and 
in applying Sec. 1.414(c)-2 for purposes of determining trades or 
businesses (whether or not incorporated) that are under common control 
for purposes of section 414(c), ``at least 50 percent'' is used instead 
of ``at least 80 percent'' each place it appears in Sec. 1.414(c)-2. A 
plan may provide with respect to a deferral of compensation under the 
plan that in applying sections 1563(a)(1), (2), and (3) for purposes of 
determining a controlled group of corporations under section 414(b), 
another defined percentage greater than 50 percent, but not greater than 
80 percent, is used instead of ``at least 80 percent'' at each place it 
appears in sections 1563(a)(1), (2), and (3), and in applying Sec. 
1.414(c)-2 for purposes of determining trades or businesses (whether or 
not incorporated) that are under common control for purposes of section 
414(c), another defined percentage greater than 50 percent, but not 
greater than 80 percent, is used instead of ``at least 80 percent'' at 
each place it appears in Sec. 1.414(c)-2. In addition, where the use of 
such definition of service recipient for purposes of determining a 
separation from service is based upon legitimate business criteria, the 
plan may provide that for purposes of a deferral of compensation under 
the plan

[[Page 644]]

that in applying sections 1563(a)(1), (2), and (3) for purposes of 
determining a controlled group of corporations under section 414(b), the 
language ``at least 20 percent'' or another defined percentage not less 
than 20 percent but not greater than 50 percent is used instead of ``at 
least 80 percent'' at each place it appears in sections 1563(a)(1), (2), 
and (3), and in applying Sec. 1.414(c)-2 for purposes of determining 
trades or businesses (whether or not incorporated) that are under common 
control for purposes of section 414(c), the language ``at least 20 
percent'' or another defined percentage not less than 20 percent but not 
greater than 50 percent is used instead of ``at least 80 percent'' at 
each place it appears in Sec. 1.414(c)-2. Where a definition of service 
recipient or employer other than the definition provided in the first 
sentence of this paragraph (h)(3) (the 50 percent standard) is used, the 
plan must designate in writing the alternate definition no later than 
the last date at which the time and form of payment of the applicable 
amount deferred must be elected in accordance with Sec. 1.409A-2(a), 
and any change in the definition for such amounts deferred will 
constitute a change in the time and form of payment subject to the rules 
governing subsequent deferral elections under Sec. 1.409A-2(b) and the 
acceleration of payments under Sec. 1.409A-3(j).
    (4) Asset purchase transactions. Where as part of a sale or other 
disposition of assets by one service recipient (seller) to an unrelated 
service recipient (buyer), a service provider of the seller would 
otherwise experience a separation from service with the seller, the 
seller and the buyer may retain the discretion to specify, and may 
specify, whether a service provider providing services to the seller 
immediately before the asset purchase transaction and providing services 
to the buyer after and in connection with the asset purchase transaction 
has experienced a separation from service for purposes of this paragraph 
(h), provided that the asset purchase transaction results from bona 
fide, arm's length negotiations, all service providers providing 
services to the seller immediately before the asset purchase transaction 
and providing services to the buyer after and in connection with the 
asset purchase transaction are treated consistently (regardless of 
position at the seller) for purposes of applying the provisions of any 
nonqualified deferred compensation plan, and such treatment is specified 
in writing no later than the closing date of the asset purchase 
transaction. For purposes of this paragraph (h)(4), references to a sale 
or other disposition of assets, or an asset purchase transaction, refer 
only to a transfer of substantial assets, such as a plant or division or 
substantially all the assets of a trade or business. For purposes of 
this paragraph (h)(4), whether a service recipient is related to another 
service recipient is determined under the rules provided in paragraph 
(f)(2)(ii) of this section.
    (5) Dual status. If a service provider provides services both as an 
employee of a service recipient and as an independent contractor of a 
service recipient, the service provider must separate from service both 
as an employee and as an independent contractor to be treated as having 
separated from service. If a service provider ceases providing services 
as an independent contractor and begins providing services as an 
employee, or ceases providing services as an employee and begins 
providing services as an independent contractor, the service provider 
will not be considered to have a separation from service until the 
service provider has ceased providing services in both capacities. 
Notwithstanding the foregoing, if a service provider provides services 
both as an employee of a service recipient and a member of the board of 
directors of a corporate service recipient (or an analogous position 
with respect to a non-corporate service recipient), the services 
provided as a director are not taken into account in determining whether 
the service provider has a separation from service as an employee for 
purposes of a nonqualified deferred compensation plan in which the 
service provider participates as an employee that is not aggregated with 
any plan in which the service provider participates as a director under 
paragraph (c)(2)(ii) of this section. In addition, if a service provider 
provides services both as an employee of a service recipient and a 
member of the

[[Page 645]]

board of directors of a corporate service recipient (or an analogous 
position with respect to a non-corporate service recipient), the 
services provided as an employee are not taken into account in 
determining whether the service provider has a separation from service 
as a director for purposes of a nonqualified deferred compensation plan 
in which the service provider participates as a director that is not 
aggregated with any plan in which the service provider participates as 
an employee under paragraph (c)(2)(ii) of this section.
    (6) Collectively bargained plans covering multiple employers. 
Notwithstanding the foregoing provisions of this paragraph (h), to the 
extent a plan is established pursuant to a bona fide collective 
bargaining agreement covering services performed by employees for 
multiple employers, such plan may define a separation from service in a 
reasonable manner that treats the employee as not having separated from 
service during periods in which the employee is not providing services 
but is available to perform services covered by the collective 
bargaining agreement for one or more employers, provided that the 
definition also provides that the employee must be deemed to have 
separated from service at a specified date not later than the end of any 
period of at least 12 consecutive months during which the employee has 
not provided any services covered by the collective bargaining agreement 
to any participating employer. This paragraph (h)(6) applies only if the 
definition of separation from service provided by the collective 
bargaining agreement was the subject of arm's length negotiations 
between employee representatives and two or more employers, the 
agreement between employee representatives and such employers satisfies 
section 7701(a)(46), and the circumstances surrounding the agreement 
evidence good faith bargaining between adverse parties over such 
definition.
    (i) Specified employee--(1) In general. The term specified employee 
means a service provider who, as of the date of the service provider's 
separation from service, is a key employee of a service recipient any 
stock of which is publicly traded on an established securities market or 
otherwise. For purposes of this paragraph (i)(1), a service provider is 
a key employee if the service provider meets the requirements of section 
416(i)(1)(A)(i), (ii), or (iii) (applied in accordance with the 
regulations thereunder and disregarding section 416(i)(5)) at any time 
during the 12-month period ending on a specified employee identification 
date. If a service provider is a key employee as of a specified employee 
identification date, the service provider is treated as a key employee 
for purposes of this paragraph (i) for the entire 12-month period 
beginning on the specified employee effective date.
    (2) Definition of compensation. For purposes of identifying a 
specified employee by applying the requirements of section 
416(i)(1)(A)(i), (ii), and (iii), the definition of compensation under 
Sec. 1.415(c)-2(a) is used, applied as if the service recipient were 
not using any safe harbor provided in Sec. 1.415(c)-2(d), were not 
using any of the elective special timing rules provided in Sec. 
1.415(c)-2(e), and were not using any of the elective special rules 
provided in Sec. 1.415(c)-2(g). Notwithstanding the foregoing, a 
service recipient may elect to use any available definition of 
compensation under section 415 and the regulations thereunder in 
accordance with the election requirements set forth in paragraph (i)(8) 
of this section, including any available safe harbor and any available 
election under the timing rules or special rules, provided that the 
definition is applied consistently to all employees of the service 
recipient for purposes of identifying specified employees. A service 
recipient may elect to use such an alternative definition regardless of 
whether another definition of compensation is being used for purposes of 
a qualified plan sponsored by the service recipient. However, once a 
list of specified employees has become effective, the service recipient 
cannot change the definition of compensation for purposes of identifying 
specified employees for the period with respect to which such list is 
effective.
    (3) Specified employee identification date. Unless another date is 
designated in accordance with the requirements of this paragraph (i)(3) 
and paragraph (i)(8) of this section, the specified employee 
identification date is December

[[Page 646]]

31. A service recipient may designate in accordance with the 
requirements of paragraph (i)(8) of this section any other date as the 
specified employee identification date, provided that a service 
recipient must use the same specified employee identification date with 
respect to all nonqualified deferred compensation plans, and any change 
to the specified employee identification date may not be effective for a 
period of at least 12 months. The service recipient may designate a 
specified employee identification date in each plan or in a separate 
document applicable to all plans, provided that the service recipient 
will not be treated as having designated a specified employee 
identification date before the designation is legally binding on the 
service recipient and all affected service providers. Any designation of 
a specified employee identification date made on or before December 31, 
2007, may be applied to any separation from service occurring on or 
after January 1, 2005, unless and until subsequently changed pursuant to 
this paragraph (i)(3).
    (4) Specified employee effective date. Unless another date is 
designated in accordance with the requirements of this paragraph (i)(4) 
and paragraph (i)(8) of this section, the specified employee effective 
date is the first day of the fourth month following the specified 
employee identification date. A service recipient may designate in 
accordance with the requirements of paragraph (i)(8) of this section any 
date following the specified employee identification date as the 
specified employee effective date, provided that such date may not be 
later than the first day of the fourth month following the specified 
employee identification date, and provided further that a service 
recipient must use the same specified employee effective date with 
respect to all nonqualified deferred compensation plans, and any change 
to the specified employee effective date may not be effective for a 
period of at least 12 months. The service recipient may designate a 
specified employee effective date through inclusion in each plan 
document or through a separate document applicable to all plans, 
provided that the service recipient will not be treated as having 
designated a specified employee effective date on any date before the 
designation is legally binding on the service recipient and all affected 
service providers. Any designation of a specified employee effective 
date made on or before December 31, 2007, may be applied to any 
separation from service occurring on or after January 1, 2005, unless 
and until subsequently changed pursuant to this paragraph (i)(4).
    (5) Alternative methods of satisfying the six-month delay rule. A 
plan may provide, in accordance with the requirements of paragraph 
(i)(8) of this section, for an alternative method to identify service 
providers who will be subject to the six-month delay rule provided in 
section 409A(a)(2)(B)(i), provided that the alternative method is 
reasonably designed to include all specified employees (determined 
without respect to any available service recipient elections), the 
alternative method is an objectively determinable standard providing no 
direct or indirect election to any service provider regarding its 
application, and the alternative method results in either all service 
providers or no more than 200 service providers being identified in the 
class as of any date. Use of such an alternative method will not be 
treated as a change in the time and form of payment for purposes of 
Sec. 1.409A-2(b) (the subsequent deferral rules), even if the service 
provider is not a specified employee when the payment is delayed.
    (6) Corporate transactions--(i) Mergers and acquisitions of public 
service recipients. If as a result of a corporate transaction, two or 
more separate service recipients, more than one of which has stock 
outstanding that is publicly traded on an established securities market 
or otherwise immediately before the transaction, become one service 
recipient, any stock of which is publicly traded on an established 
securities market or otherwise immediately after the transaction 
(resulting public service recipient), the resulting public service 
recipient's next specified employee identification date and specified 
employee effective date following the corporate transaction are the 
specified employee identification date and specified employee effective 
date that

[[Page 647]]

the acquiring service recipient would have been required to use absent 
such transaction. For this purpose, in the case of a corporate merger, 
the acquiring service recipient is the service recipient that included 
the surviving corporation in such merger, in the case of an acquisition 
by a corporation of the stock of another corporation, the acquiring 
service recipient is the service recipient that included the corporation 
that acquired such stock, and in all other cases, the surviving service 
recipient is determined on the basis of all of the facts and 
circumstances. For the period between the transaction and the next 
specified employee effective date, the list of specified employees of 
the resulting public service recipient is determined by combining the 
lists of specified employees of all service recipients participating in 
the transaction that were in effect at the date of the corporate 
transaction, ranking such specified employees in order of the amount of 
compensation used to determine each specified employee's status as a 
specified employee, and treating the top 50 of such specified employees, 
plus any employees described in section 416(i)(1)(ii) or section 
416(i)(1)(iii) and the regulations thereunder (relating to 1-percent and 
5-percent owners) who are not included in such top 50 specified 
employees, as specified employees for the period between the corporate 
transaction and the next specified employee effective date. 
Alternatively, the resulting service recipient may elect in accordance 
with the requirements of paragraph (i)(8) of this section to use any 
reasonable method to determine the specified employees of the resulting 
service recipient, including the use of an alternative method of 
compliance described in paragraph (i)(5) of this section, provided that 
such method is adopted no later than 90 days after the corporate 
transaction and applied prospectively from the date the method is 
adopted.
    (ii) Mergers and acquisitions of nonpublic service recipients. If as 
part of a corporate transaction a service recipient that does not have 
outstanding stock that is publicly traded on an established securities 
market or otherwise immediately before the transaction (initial private 
service recipient), and a service recipient with stock outstanding that 
is publicly traded on an established securities market or otherwise 
immediately before the transaction (initial public service recipient), 
become a single service recipient having stock that is publicly traded 
on an established securities market or otherwise immediately after the 
transaction (resulting public service recipient), the resulting public 
service recipient's next specified employee identification date and 
specified employee effective date following the corporate transaction 
are the specified employee identification date and specified employee 
effective date that the initial public service recipient would have been 
required to use absent such transaction. For the period after the date 
of the corporate transaction and before the next specified employee 
effective date, the specified employees of the initial public service 
recipient immediately before the transaction continue to be the 
specified employees of the resulting public service recipient, and no 
service providers of the initial private service recipient are required 
to be treated as specified employees.
    (iii) Spinoffs. If as part of a corporate transaction, a service 
recipient with stock outstanding that is publicly traded on an 
established securities market or otherwise immediately before the 
transaction (initial public service recipient), becomes two or more 
separate service recipients, each with stock outstanding that is 
publicly traded on an established securities market or otherwise 
immediately after the transaction (post-transaction public service 
recipients), the next specified employee identification date of each of 
the post-transaction public service recipients is the specified employee 
identification date that the initial public service recipient would have 
been required to use absent such transaction. For the period after the 
date of the corporate transaction and before the next specified employee 
effective date, the specified employees of the initial public service 
recipient immediately before the transaction continue to be the 
specified employees of the post-transaction public service recipients.

[[Page 648]]

    (iv) Public offerings and other corporate transactions. If as part 
of an initial public offering or corporate transaction not described in 
paragraph (i)(6)(ii) or (iii) of this section, a service recipient with 
no outstanding stock that is publicly traded on an established 
securities market or otherwise immediately before such offering or other 
transaction (initial private service recipient), becomes one or more 
service recipients with stock outstanding that is publicly traded on an 
established securities market or otherwise immediately after such 
offering or other transaction (post-transaction public service 
recipient), each post-transaction public service recipient has a 
specified employee identification date of December 31 and a specified 
employee effective date of April 1, effective retroactively to the 
December 31 and April 1 next preceding the offering or other transaction 
for purposes of identifying the specified employees between the 
corporation transaction and the next December 31. Alternatively, a post-
transaction public service recipient may elect in accordance with the 
requirements of paragraph (i)(8) of this section, a specified employee 
identification date and specified employee effective date on or before 
the date of the offering or other transaction. If a public service 
recipient makes such an election, for the period after the offering or 
other transaction and before the next specified employee effective date, 
the specified employees of the post-transaction public service recipient 
consist of the service providers that at the time of the offering or 
other transaction would have been classified as specified employees of 
the initial private service recipient, had the initial private service 
recipient elected the same specified employee identification date and 
specified employee effective date as selected by the post-transaction 
public service recipient, and had such initial private service recipient 
had stock publicly traded on an established securities market or 
otherwise as of the specified employee identification date preceding the 
transaction.
    (v) Alternative methods of compliance. For purposes of this 
paragraph (i)(6), references to specified employees as of a corporate 
transaction or offering include any specified employees identified 
through the use of an alternative method described in paragraph (i)(5) 
of this section, where the use of such alternative method was 
established and effective at the time of the corporate transaction or 
offering.
    (7) Nonresident alien employees. For purposes of determining whether 
an employee meets the requirements of section 416(i)(1)(A)(i), (ii), or 
(iii) (applied in accordance with the regulations thereunder and 
disregarding section 416(i)(5)), and therefore is a key employee, the 
incorporation of the rules of Sec. 1.415(c)-2(g)(5) regarding the 
definition of compensation applies. Accordingly, the rule of Sec. 
1.415(c)-2(g)(5)(i), generally requiring the treatment as compensation 
of certain compensation excludible from an employee's gross income due 
to the location of the services or the identity of the employer, 
applies. In addition, a service recipient may elect in accordance with 
paragraph (i)(8) of this section to apply the rule of Sec. 1.415(c)-
2(g)(5)(ii) to not treat as compensation certain compensation excludible 
from an employee's gross income on account of the location of the 
services or the identity of the employer that is not effectively 
connected with the conduct of a trade or business within the United 
States. A service recipient may elect to apply the rule of Sec. 1.415-
2(g)(5)(ii) regardless of whether the service recipient has elected to 
apply the rule to a qualified plan sponsored by the service recipient; 
however, once a list of specified employees has become effective, any 
election of the rule for that period may not be changed. Notwithstanding 
the foregoing, any election of the rule made before January 1, 2008, may 
be effective with respect to any specified employee identification date 
on or before December 31, 2007.
    (8) Elections affecting the identification of specified employees. 
The elections described in paragraphs (i)(2) through (7) of this section 
are effective only as of the date that all necessary corporate action 
has been taken to make such elections binding for purposes of all 
affected nonqualified deferred compensation plans in which the service 
providers of the service recipient that would become a specified 
employee due

[[Page 649]]

to the application of such election participate. Where a taxpayer 
attempts to make an election under paragraph (i)(2), (3), (4), (5), (6), 
or (7) of this section but such election is not binding on all the 
affected nonqualified deferred compensation plans and applied 
consistently to all such service providers, the election is not 
effective and the rule under paragraph (i)(2), (3), (4), (5), (6), or 
(7) of this section, as applicable, that would apply absent an election 
is applicable for identifying specified employees.
    (j) Nonresident alien. (1) Except as provided in paragraph (j)(2) of 
this section, the term nonresident alien means an individual who is--
    (i) A nonresident alien within the meaning of section 7701(b)(1)(B); 
or
    (ii) A dual resident taxpayer within the meaning of Sec. 
301.7701(b)-7(a)(1) of this chapter with respect to any taxable year in 
which such individual is treated as a nonresident alien for purposes of 
computing the individual's U.S. income tax liability.
    (2) The term nonresident alien does not include--
    (i) A nonresident alien with respect to whom an election is in 
effect for the taxable year under section 6013(g) to be treated as a 
resident of the United States;
    (ii) A former citizen or long-term resident (within the meaning of 
section 877(e)(2)) who expatriated after June 3, 2004, and has not 
complied with the requirements of section 7701(n); or
    (iii) An individual who is treated as a citizen or resident of the 
United States for the taxable year under section 877(g).
    (k) Established securities market. The term established securities 
market means an established securities market within the meaning of 
Sec. 1.897-1(m).
    (l) Stock right. The term stock right means a stock option (other 
than an incentive stock option described in section 422 or an option 
granted pursuant to an employee stock purchase plan described in section 
423) or a stock appreciation right.
    (m) Separation pay plan. The term separation pay plan means any plan 
that provides separation pay or, where a plan provides both amounts that 
are separation pay and that are not separation pay, that portion of the 
plan that provides separation pay. The term separation pay means any 
deferral of compensation (before the application of the exclusions from 
the definition of a deferral of compensation set forth in paragraph 
(b)(9) of this section) that will not be paid under any circumstances 
unless the service provider has had a separation from service, whether 
voluntary or involuntary, including payments in the form of 
reimbursements of expenses incurred, and the provision of in-kind 
benefits. A deferral of compensation that the service provider may 
receive without a separation from service does not become separation pay 
merely because the service provider elects to receive or receives the 
payment after or upon a separation from service. A deferral of 
compensation does not fail to be separation pay merely because the 
payment is conditioned upon the execution of a release of claims, 
noncompetition or nondisclosure provisions, or other similar 
requirements. Notwithstanding the foregoing, any amount, or entitlement 
to any amount, that acts as a substitute for, or replacement of, amounts 
deferred by the service recipient under a nonqualified deferred 
compensation plan constitutes a payment of compensation or deferral of 
compensation under such nonqualified deferred compensation plan.
    (n) Involuntary separation from service--(1) In general. An 
involuntary separation from service means a separation from service due 
to the independent exercise of the unilateral authority of the service 
recipient to terminate the service provider's services, other than due 
to the service provider's implicit or explicit request, where the 
service provider was willing and able to continue performing services. 
An involuntary separation from service may include the service 
recipient's failure to renew a contract at the time such contract 
expires, provided that the service provider was willing and able to 
execute a new contract providing terms and conditions substantially 
similar to those in the expiring contract and to continue providing such 
services. The determination of whether a separation from service is 
involuntary is based on all the facts and circumstances. Any

[[Page 650]]

characterization of the separation from service as voluntary or 
involuntary by the service provider and the service recipient in the 
documentation of the separation from service is presumed to properly 
characterize the nature of the separation from service. However, the 
presumption may be rebutted where the facts and circumstances indicate 
otherwise. For example, if a separation from service is designated as a 
voluntary separation from service or resignation, but the facts and 
circumstances indicate that absent such voluntary separation from 
service the service recipient would have terminated the service 
provider's services, and that the service provider had knowledge that 
the service provider would be so terminated, the separation from service 
is involuntary.
    (2) Separations from service for good reason--(i) In general. 
Notwithstanding paragraph (n)(1) of this section, a service provider's 
voluntary separation from service will be treated for purposes of this 
section and Sec. Sec. 1.409A-2 through 1.409A-6 as an involuntary 
separation from service if the separation from service occurs under 
certain limited bona fide conditions, where the avoidance of the 
requirements of section 409A is not a purpose of the inclusion of these 
conditions in the plan or of the actions by the service recipient in 
connection with the satisfaction of these conditions, and a voluntary 
separation from service under such conditions effectively constitutes an 
involuntary separation from service. Generally such conditions will be 
prespecified under an agreement to provide compensation upon a 
separation from service for good reason. Such a good reason (or a 
similar condition) must be defined to require actions taken by the 
service recipient resulting in a material negative change to the service 
provider in the service relationship, such as the duties to be 
performed, the conditions under which such duties are to be performed, 
or the compensation to be received for performing such services. Other 
factors taken into account in determining whether a separation from 
service for good reason effectively constitutes an involuntary 
separation from service include the extent to which the payments upon a 
separation from service for good reason are in the same amount and are 
to be made at the same time and in the same form as payments available 
upon an actual involuntary separation from service, and whether the 
service provider is required to give the service recipient notice of the 
existence of the condition that would result in treatment as a 
separation from service for good reason and a reasonable opportunity to 
remedy the condition.
    (ii) Safe harbor. For purposes of this section and Sec. Sec. 
1.409A-2 through 1.409A-6, if a plan provides that a voluntary 
separation from service will be treated as an involuntary separation 
from service if the separation from service occurs under certain express 
conditions, a separation from service satisfying the conditions set 
forth in the plan will be treated as an involuntary separation from the 
service if the necessary conditions (or set of conditions) require the 
following:
    (A) The separation from service must occur during a pre-determined 
limited period of time not to exceed two years following the initial 
existence of one or more of the following conditions arising without the 
consent of the service provider:
    (1) A material diminution in the service provider's base 
compensation.
    (2) A material diminution in the service provider's authority, 
duties, or responsibilities.
    (3) A material diminution in the authority, duties, or 
responsibilities of the supervisor to whom the service provider is 
required to report, including a requirement that a service provider 
report to a corporate officer or employee instead of reporting directly 
to the board of directors of a corporation (or similar governing body 
with respect to an entity other than a corporation).
    (4) A material diminution in the budget over which the service 
provider retains authority.
    (5) A material change in the geographic location at which the 
service provider must perform the services.
    (6) Any other action or inaction that constitutes a material breach 
by the service recipient of the agreement under which the service 
provider provides services.

[[Page 651]]

    (B) The amount, time, and form of payment upon the separation from 
service must be substantially identical to the amount, time and form of 
payment payable due to an actual involuntary separation from service, to 
the extent such a right exists.
    (C) The service provider must be required to provide notice to the 
service recipient of the existence of the condition described in 
paragraph (n)(2)(ii)(A) of this section within a period not to exceed 90 
days of the initial existence of the condition, upon the notice of which 
the service recipient must be provided a period of at least 30 days 
during which it may remedy the condition and not be required to pay the 
amount.
    (3) Special rule for certain collectively bargained plans. 
Notwithstanding the foregoing, for purposes of this paragraph (n), to 
the extent a plan is subject to a bona fide collective bargaining 
agreement covering services performed for multiple employers under which 
an employee must separate from service with all such employers in order 
to receive a payment, such plan may use any reasonable definition of 
involuntary separation from service, provided that such definition is 
consistent with any definition of a separation from service adopted 
under paragraph (h)(6) of this section, and provided further that the 
definition of an involuntary separation from service provided by the 
collective bargaining agreement was the subject of arm's length 
negotiations between employee representatives and two or more employers, 
the agreement between employee representatives and such employers 
satisfies section 7701(a)(46), and the circumstances surrounding the 
agreement evidence good faith bargaining between adverse parties over 
such definition.
    (o) Earnings. Whether a deferred amount constitutes earnings on an 
amount deferred, or actual or notional income attributable to an amount 
deferred, is determined under the principles defining income 
attributable to the amount taken into account under Sec. 31.3121(v)(2)-
1(d)(2) of this chapter. Accordingly, with respect to an account balance 
plan, earnings on an amount deferred generally include an amount 
credited on behalf of a service provider under the terms of the plan 
that reflects a rate of return that does not exceed either the rate of 
return on a predetermined actual investment or, if the income does not 
reflect the rate of return on a predetermined actual investment, a 
reasonable rate of interest. With respect to nonaccount balance plans, 
earnings on an amount deferred generally include an increase, due solely 
to the passage of time, in the present value of the future payments to 
which the service provider has obtained a legally binding right, the 
present value of which constituted the amount deferred (determined as of 
the date such amount was deferred), but only if the amount deferred was 
determined using reasonable actuarial assumptions and methods. A right 
to earnings on an amount deferred generally is treated as a right to a 
deferral of compensation for purposes of this section and Sec. Sec. 
1.409A-2 through 1.409A-6. However, for purposes of any provision of 
this section and Sec. Sec. 1.409A-2 through 1.409A-6 referring to 
earnings on deferred compensation (or similar terms), the use of an 
unreasonable rate of return, or unreasonable actuarial assumptions and 
methods, generally will result in the treatment of some or all of such a 
right to deferred compensation as a right only to deferred compensation, 
and not a right to earnings on deferred compensation, so that the 
provision will not be applicable. With respect to plans that are neither 
account balance plans nor nonaccount balance plans, these rules apply by 
analogy.
    (p) In-kind benefits. The term in-kind benefits refers to services 
provided to or on behalf of a service provider, such as financial 
planning services, or tangible personal or real property made available 
for use by or on behalf of the service provider, such as the use of an 
aircraft or vehicle, and does not refer to a transfer of property within 
the meaning of section 83 and the regulations thereunder, or a promise 
to transfer, or an option to purchase or receive, property in the 
future.
    (q) Application of definitions and rules. The definitions and rules 
set forth in paragraphs (a) through (p) of this section apply for 
purposes of section 409A,

[[Page 652]]

this section, and Sec. Sec. 1.409A-2 through 1.409A-6.

[T.D. 9321, 72 FR 19276, Apr. 17, 2007; 72 FR 41620, July 31, 2007]



Sec. 1.409A-2  Deferral elections.

    (a) Initial elections as to the time and form of payment--(1) In 
general. A plan that is, or constitutes part of, a nonqualified deferred 
compensation plan meets the requirements of section 409A(a)(4)(B) only 
if under the terms of the plan, compensation for services performed 
during a service provider's taxable year (the service year) may be 
deferred at the service provider's election only if the election to 
defer such compensation is made and becomes irrevocable not later than 
the latest date permitted in this paragraph (a). An election will not be 
considered to be revocable merely because the service provider or 
service recipient may make an election to change the time and form of 
payment pursuant to paragraph (b) of this section, or the service 
recipient may accelerate the time of payment pursuant to Sec. 1.409A-
3(j)(4) (exceptions to prohibition on accelerated payments). Whether a 
plan provides a service provider an opportunity to elect the time or 
form of payment of compensation is determined based upon all the facts 
and circumstances surrounding the determination of the time and form of 
payment of the compensation. For purposes of this section, an election 
to defer includes an election as to the time of the payment, an election 
as to the form of the payment or an election as to both the time and the 
form of the payment, but does not include an election as to the medium 
of payment (for example, an election between a payment of cash or a 
payment of property). Except as otherwise expressly provided in this 
section, an election will not be considered made until such election 
becomes irrevocable under the terms of the applicable plan. Accordingly, 
a plan may provide that an election to defer may be changed at any time 
before the last permissible date for making such an election. Where a 
plan provides the service provider a right to make an initial deferral 
election, and further provides that the election remains in effect until 
terminated or modified by the service provider, the election will be 
treated as made as of the date such election becomes irrevocable as to 
compensation for services performed during the relevant service year. 
For example, where a plan provides that a service provider's election to 
defer a set percentage will remain in effect until changed or revoked, 
but that as of each December 31 the election becomes irrevocable with 
respect to salary payable in connection with services performed in the 
immediately following year, the initial deferral election with respect 
to salary payable with respect to services performed in the immediately 
following year will be deemed to have been made as of the December 31 
upon which the election became irrevocable. For purposes of this 
paragraph (a), the reference to a service period or a performance period 
refers to the period of service for which the right to the compensation 
arises, and may include periods before the grant of a legally binding 
right to the compensation. For example, where a service recipient grants 
a bonus based upon services performed in the calendar year 2010, but 
retains the discretion to rescind the bonus until 2011 such that the 
promise of the bonus is not a legally binding right, the period of 
service or performance period to which the compensation relates is the 
calendar year 2010.
    (2) Service recipient elections. A plan that provides for a deferral 
of compensation for services performed during a service provider's 
taxable year that does not provide the service provider with an 
opportunity to elect the time or form of payment of such compensation 
must designate the time and form of payment by no later than the later 
of the time the service provider first has a legally binding right to 
the compensation or, if later, the time the service provider would be 
required under this section to make such an election if the service 
provider were provided such an election. Such designation is treated as 
an initial deferral election for purposes of this section. Where a plan 
permits a service recipient to exercise discretion to disregard a 
service provider election as to the time or form of a payment, any 
service provider election that is subject to such discretion will be 
treated

[[Page 653]]

as revocable so long as such discretion may be exercised.
    (3) General rule. A plan that is, or constitutes part of, a 
nonqualified deferred compensation plan meets the requirements of 
section 409A(a)(4)(B) if under the terms of the plan, compensation for 
services performed during a service provider's taxable year (the service 
year) may be deferred at the service provider's election only if the 
election to defer such compensation is made not later than the close of 
the service provider's taxable year next preceding the service year.
    (4) Initial deferral election with respect to short-term deferrals. 
If a service provider has a legally binding right to a payment of 
compensation in a subsequent taxable year that, absent a deferral 
election, would be treated as a short-term deferral within the meaning 
of Sec. 1.409A-1(b)(4), an election to defer such compensation may be 
made in accordance with the requirements of paragraph (b) of this 
section, applied as if the amount were a deferral of compensation and 
the scheduled payment date for the amount were the date the substantial 
risk of forfeiture lapses. Notwithstanding the requirements of paragraph 
(b) of this section, such a deferral election may provide that the 
deferred amounts will be payable upon a change in control event (as 
defined in Sec. 1.409A-3(i)(5)) without regard to the five-year 
additional deferral requirement in paragraph (b) of this section.
    (5) Initial deferral election with respect to certain forfeitable 
rights. If a service provider has a legally binding right to a payment 
in a subsequent year that is subject to a condition requiring the 
service provider to continue to provide services for a period of at 
least 12 months from the date the service provider obtains the legally 
binding right to avoid forfeiture of the payment, an election to defer 
such compensation may be made on or before the 30th day after the 
service provider obtains the legally binding right to the compensation, 
provided that the election is made at least 12 months in advance of the 
earliest date at which the forfeiture condition could lapse. For 
purposes of this paragraph (a)(5), a condition will not be treated as 
failing to require the service provider to continue to provide services 
for a period of at least 12 months from the date the service provider 
obtains the legally binding right merely because the condition 
immediately lapses upon the death or disability (as defined in Sec. 
1.409A-3(i)(4)) of the service provider, or upon a change in control 
event (as defined in Sec. 1.409A-3(i)(5)), provided that if death, 
disability, or a change in control event occurs and the condition lapses 
before the end of such 12-month period, a deferral election may be given 
effect only if the deferral election is permitted under this section 
without regard to this paragraph (a)(5).
    (6) Initial deferral election with respect to fiscal year 
compensation. In the case of a service recipient with a taxable year 
that is not the same as the taxable year of the service provider, a plan 
may provide that fiscal year compensation may be deferred at the service 
provider's election if the election to defer such compensation is made 
not later than the close of the service recipient's taxable year 
immediately preceding the first taxable year of the service recipient in 
which any services are performed for which such compensation is payable. 
For purposes of this paragraph (a)(6), the term fiscal year compensation 
means compensation relating to a period of service coextensive with one 
or more consecutive taxable years of the service recipient, of which no 
amount is paid or payable during the service recipient's taxable year or 
years constituting the period of service. For example, fiscal year 
compensation generally would include a bonus to an individual employee 
with a calendar year taxable year that is based on a service period 
consisting of the service recipient's two consecutive taxable years 
ending September 30, 2011, where the amount will be paid after the end 
of the second of such taxable years, but would not include either a 
bonus based on a service period consisting of one or more calendar years 
or salary that would otherwise be paid during such taxable years of the 
service recipient.
    (7) First year of eligibility--(i) In general. In the case of the 
first year in which a service provider becomes eligible to participate 
in a plan, the service provider may make an initial deferral election 
within 30 days after the date

[[Page 654]]

the service provider becomes eligible to participate in such plan, with 
respect to compensation paid for services to be performed after the 
election. In the case of a plan that does not provide for service 
provider elections with respect to the time or form of a payment, the 
time and form of the payment must be specified on or before the date 
that is 30 days after the date the service provider first becomes 
eligible to participate in such plan. For compensation that is earned 
based upon a specified performance period (for example, an annual 
bonus), where a deferral election is made in the first year of 
eligibility but after the beginning of the performance period, the 
election must apply only to the compensation paid for services performed 
after the election. For this purpose, an election will be deemed to 
apply to compensation paid for services performed after the election if 
the election applies to no more than an amount equal to the total amount 
of the compensation for the performance period multiplied by the ratio 
of the number of days remaining in the performance period after the 
election over the total number of days in the performance period.
    (ii) Eligibility to participate. For purposes of this paragraph 
(a)(7), a service provider is eligible to participate in a plan at any 
time during which, under the plan's terms and without further amendment 
or action by the service recipient, the service provider is eligible to 
accrue an amount of deferred compensation under the plan other than 
earnings on amounts previously deferred, even if the service provider 
has elected not to accrue (or has not elected to accrue) an amount of 
deferred compensation. Where a service provider has been paid all 
amounts deferred under a plan, and on and before the date of the last 
payment was not eligible to continue (or to elect to continue) to 
participate in the plan for periods after the last payment (other than 
through an election of a different time and form of payment with respect 
to the amounts paid), the service provider may be treated as initially 
eligible to participate in a plan as of the first date following such 
payment that the service provider becomes eligible to accrue an 
additional amount of deferred compensation. Where a service provider has 
ceased being eligible to participate in a plan (other than the accrual 
of earnings), regardless of whether all amounts deferred under the plan 
have been paid, and subsequently becomes eligible to participate in the 
plan again, the service provider may be treated as being initially 
eligible to participate in the plan if the service provider had not been 
eligible to participate in the plan (other than the accrual of earnings) 
at any time during the 24-month period ending on the date the service 
provider again becomes eligible to participate in the plan.
    (iii) Application to excess benefit plans. For purposes of this 
paragraph (a)(7), a service provider is treated as initially eligible to 
participate in an excess benefit plan as of the first day of the service 
provider's taxable year immediately following the first year the service 
provider accrues a benefit under the excess benefit plan; and any 
election made within 30 days following such date is treated as applying 
to benefits accrued under such plan for services performed before the 
election. For purposes of this paragraph (a)(7), the term excess benefit 
plan means all nonqualified deferred compensation plans in which a 
service provider participates, to the extent such plans do not provide 
for an election between current compensation (including a short-term 
deferral) and deferred compensation and solely provide deferred 
compensation equal to the excess of the benefits the service provider 
would have accrued under a qualified employer plan (as defined in Sec. 
1.409A-1(a)(2)) in which the service provider also participates, in the 
absence of one or more of the limits incorporated into the plan to 
reflect one or more of the limits on contributions or benefits 
applicable to the qualified employer plan under the Internal Revenue 
Code, over the benefits the service provider actually accrues under the 
qualified employer plan. For purposes of this paragraph (a)(7), once a 
service provider has accrued a benefit or deferred compensation under a 
plan in any year, the service provider will not become eligible for an 
initial deferral election based upon an accrual or deferral under an 
excess benefit plan in a subsequent year, even if the benefit

[[Page 655]]

or deferred compensation accrued in a previous year is forfeited or 
eliminated.
    (8) Initial deferral election with respect to performance-based 
compensation. In the case of any performance-based compensation (as 
defined in Sec. 1.409A-1(e)), an initial deferral election may be made 
with respect to such performance-based compensation on or before the 
date that is six months before the end of the performance period, 
provided that the service provider performs services continuously from 
the later of the beginning of the performance period or the date the 
performance criteria are established through the date an election is 
made under this paragraph (a)(8), and provided further that in no event 
may an election to defer performance-based compensation be made after 
such compensation has become readily ascertainable. For purposes of this 
paragraph (a)(8), if the performance-based compensation is a specified 
or calculable amount, the compensation is readily ascertainable if and 
when the amount is first substantially certain to be paid. If the 
performance-based compensation is not a specified or calculable amount 
because, for example, the amount may vary based upon the level of 
performance, the compensation, or any portion of the compensation, is 
readily ascertainable when the amount is first both calculable and 
substantially certain to be paid. For this purpose, the performance-
based compensation is bifurcated between the portion that is readily 
ascertainable and the amount that is not readily ascertainable. 
Accordingly, in general any minimum amount that is both calculable and 
substantially certain to be paid will be treated as readily 
ascertainable.
    (9) Nonqualified deferred compensation plans linked to qualified 
employer plans or certain other arrangements. If a nonqualified deferred 
compensation plan provides that the amount deferred under the plan is 
determined under the formula for determining benefits under a qualified 
employer plan (as defined in Sec. 1.409A-1(a)(2)) or a broad-based 
foreign retirement plan (as defined in Sec. 1.409A-1(a)(3)(v)) 
maintained by the service recipient but applied without regard to one or 
more limitations applicable to the qualified employer plan under the 
Internal Revenue Code or to the broad-based foreign retirement plan 
under other applicable law, or that the amount deferred under the 
nonqualified deferred compensation plan is determined as an amount 
offset by some or all of the benefits provided under the qualified 
employer plan or the broad-based foreign retirement plan, an increase in 
amounts deferred under the nonqualified deferred compensation plan that 
results directly from the operation of the qualified employer plan or 
broad-based foreign retirement plan (other than service provider actions 
described in paragraphs (a)(9)(iii) and (iv) of this section) including 
changes in benefit limitations applicable to the qualified employer plan 
or the broad-based foreign retirement plan under the Internal Revenue 
Code or other applicable law does not constitute a deferral election 
under the nonqualified deferred compensation plan, provided that such 
operation does not otherwise result in a change in the time or form of a 
payment under the nonqualified deferred compensation plan, and provided 
further that such change in the amounts deferred under the nonqualified 
deferred compensation plan does not exceed that change in the amounts 
deferred under the qualified employer plan or the broad-based foreign 
retirement plan, as applicable. In addition, with respect to such a 
nonqualified deferred compensation plan, the following actions or 
failures to act will not constitute a deferral election under the 
nonqualified deferred compensation plan even if in accordance with the 
terms of the nonqualified deferred compensation plan, the actions or 
inactions result in an increase in the amounts deferred under the plan, 
provided that such actions or inactions do not otherwise affect the time 
or form of payment under the nonqualified deferred compensation plan and 
provided further that with respect to actions or inactions described in 
paragraphs (a)(9)(i) or (ii), the change in the amount deferred under 
the nonqualified deferred compensation plan does not exceed the change 
in the amounts deferred under the qualified employer plan or the broad-
based foreign retirement plan, as applicable:

[[Page 656]]

    (i) A service provider's action or inaction under the qualified 
employer plan or broad-based foreign retirement plan with respect to 
whether to elect to receive a subsidized benefit or an ancillary benefit 
under the qualified employer plan or broad-based foreign retirement 
plan.
    (ii) The amendment of a qualified employer plan or broad-based 
foreign retirement plan to add or remove a subsidized benefit or an 
ancillary benefit, or to freeze or limit future accruals of benefits 
under the qualified plan or freeze or limit future accruals of benefits 
or reduce existing benefits under the broad-based foreign retirement 
plan.
    (iii) A service provider's action or inaction under a qualified 
employer plan with respect to elective deferrals and other employee pre-
tax contributions subject to the contribution restrictions under section 
401(a)(30) or section 402(g), including an adjustment to a deferral 
election under such qualified employer plan, provided that for any given 
taxable year, the service provider's action or inaction does not result 
in an increase in the amounts deferred under all nonqualified deferred 
compensation plans in which the service provider participates (other 
than amounts described in paragraph (a)(9)(iv) of this section) in 
excess of the limit with respect to elective deferrals under section 
402(g)(1)(A), (B), and (C) in effect for the taxable year in which such 
action or inaction occurs.
    (iv) A service provider's action or inaction under a qualified 
employer plan with respect to elective deferrals and other employee pre-
tax contributions subject to the contribution restrictions under section 
401(a)(30) or section 402(g), and after-tax contributions by the service 
provider to a qualified employer plan that provides for such 
contributions, that affects the amounts that are credited under one or 
more nonqualified deferred compensation plans as matching amounts or 
other similar amounts contingent on such elective deferrals, employee 
pre-tax contributions, or after-tax contributions, provided that the 
total of such matching or contingent amounts, as applicable, never 
exceeds 100 percent of the matching or contingent amounts that would be 
provided under the qualified employer plan absent any plan-based 
restrictions that reflect limits on qualified plan contributions under 
the Internal Revenue Code.
    (10) Changes in elections under a cafeteria plan. A change in an 
election under a cafeteria plan does not constitute a deferral election 
with respect to an amount deferred under a nonqualified deferred 
compensation plan to the extent that the change in the amount deferred 
under the nonqualified deferred compensation plan results solely from 
the application of the change in amount eligible to be treated as 
compensation under the terms of the nonqualified deferred compensation 
plan resulting from the election change under the cafeteria plan, to a 
benefit formula under the nonqualified deferred compensation plan based 
upon the service provider's eligible compensation, and only to the 
extent that such change applies in the same manner as any other increase 
or decrease in compensation would apply to such benefit formula.
    (11) Initial deferral election with respect to certain separation 
pay. In the case of separation pay (as defined in Sec. 1.409A-1(m)), 
where such separation pay is the subject of bona fide, arm's length 
negotiations at the time of the separation from service, an initial 
deferral election may be made at any time up to the time the service 
provider obtains a legally binding right to the payment. This paragraph 
(a)(11) does not apply to any separation pay to which the service 
provider obtained a legally binding right before the negotiations at the 
time of the separation from service, including a right to a payment 
subject to a condition such as that the service provider separate from 
service other than for cause. In the case of separation pay due to 
participation in a window program (as defined in Sec. 1.409A-
1(b)(9)(vi)), an initial deferral election may be made at any time 
before the time the election to participate in the window program 
becomes irrevocable.
    (12) Initial deferral election with respect to certain commissions--
(i) Sales commission compensation. For purposes of this paragraph (a), a 
service provider earning sales commission compensation is treated as 
providing the services to

[[Page 657]]

which such compensation relates only in the service provider's taxable 
year in which the customer remits payment to the service recipient or, 
if applied consistently to all similarly situated service providers, the 
service provider's taxable year in which the sale occurs. For purposes 
of this paragraph (a)(12), the term sales commission compensation means 
compensation or portions of compensation earned by a service provider if 
a substantial portion of the services provided by such service provider 
to a service recipient consist of the direct sale of a product or 
service to an unrelated customer, the compensation paid by the service 
recipient to the service provider consists of either a portion of the 
purchase price for the product or service or an amount substantially all 
of which is calculated by reference to the volume of sales, and payment 
of the compensation is either contingent upon the service recipient 
receiving payment from an unrelated customer for the product or services 
or, if applied consistently to all similarly situated service providers, 
is contingent upon the closing of the sales transaction and such other 
requirements as may be specified by the service recipient before the 
closing of the sales transaction. For this purpose, a customer is 
treated as an unrelated customer only if the customer is not related to 
either the service provider or the service recipient. A person is 
treated as related to another person if the person would be treated as 
related to the other person under Sec. 1.409A-1(f)(2)(ii) or the person 
would be treated as providing management services to the other person 
under Sec. 1.409A-1(f)(2)(iv).
    (ii) Investment commission compensation. For purposes of this 
paragraph (a), a service provider earning investment commission 
compensation is treated as providing the services to which such 
compensation relates over the 12 months preceding the date as of which 
the overall value of the assets or asset accounts is determined for 
purposes of the calculation of the investment commission compensation. 
For purposes of this paragraph (a)(12), the term investment commission 
compensation means the compensation or the portion of compensation 
earned by a service provider if a substantial portion of the services 
provided by such service provider to a service recipient to which such 
compensation relates consists of sales of financial products or other 
direct customer services to an unrelated customer with respect to 
customer assets or customer asset accounts, the customer retains the 
right to terminate the customer relationship and may move or liquidate 
the assets or asset accounts without undue delay (which may be subject 
to a reasonable notice period), such compensation consists of a portion 
of the value of the overall assets or asset account balance, an amount 
substantially all of which is calculated by reference to the increase in 
the value of the overall assets or account balance during a specified 
period, or both, and the value of the overall assets or account balance 
and investment commission compensation is determined at least annually. 
For this purpose, a customer is treated as an unrelated customer only if 
the customer is not related to either the service provider or the 
service recipient. A person is treated as related to another person if 
the person would be treated as related to the other person under Sec. 
1.409A-1(f)(2)(ii) or the person would be treated as providing 
management services to the other person under Sec. 1.409A-1(f)(2)(iv).
    (iii) Commission compensation and related persons. The rules of 
paragraphs (a)(12)(i) and (ii) of this section apply to sales commission 
compensation and investment commission compensation involving a related 
customer, provided that substantial sales from which commission 
compensation arises are made, or substantial services from which 
commission compensation arises are provided, to unrelated customers by 
the service recipient, the sales and service arrangement and the 
commission arrangement with respect to the related customer are bona 
fide, arise from the service recipient's ordinary course of business, 
and are substantially the same, both in terms and in practice, as the 
terms and practices applicable to unrelated customers (as defined in 
such paragraphs) to which individually or in the aggregate substantial 
sales are made or substantial services provided by the service 
recipient.

[[Page 658]]

    (13) Initial deferral election with respect to compensation paid for 
final payroll period--(i) In general. Unless a plan provides otherwise, 
compensation payable after the last day of the service provider's 
taxable year solely for services performed during the final payroll 
period described in section 3401(b) containing the last day of the 
service provider's taxable year or, with respect to a non-employee 
service provider, a period not longer than the payroll period described 
in section 3401(b), where such amount is payable pursuant to the timing 
arrangement under which the service recipient normally compensates 
service providers for services performed during a payroll period 
described in section 3401(b), or with respect to a non-employee service 
provider, a period not longer than the payroll period described in 
section 3401(b), is treated as compensation for services performed in 
the subsequent taxable year in which the payment is made. The preceding 
sentence does not apply to any compensation paid during such period for 
services performed during any period other than such final payroll 
period, such as a payment of an annual bonus. Any amendment of a plan 
after December 31, 2007, to add a provision providing for a differing 
treatment of such compensation may not be effective for 12 months from 
the date the amendment is executed and enacted.
    (ii) Transition rule. For purposes of this paragraph (a)(13), a plan 
that was adopted and effective before December 31, 2007, whether written 
or unwritten, will be treated as designating such compensation for 
services performed in the taxable year in which the payroll period ends, 
unless otherwise set forth in writing before December 31, 2007.
    (14) Elections to annualize recurring part-year compensation. In the 
case of a service provider receiving recurring part-year compensation, 
an election to defer all or a portion of the recurring part-year 
compensation to be earned during a particular service period is 
considered to meet the requirements of this paragraph (a) if the 
election is made before the services for which the recurring part-year 
compensation is paid begin, and the election does not defer payment of 
any of the recurring part-year compensation to a date beyond the last 
day of the 13th month following the first date of the service period. 
For purposes of this paragraph (a)(14), the term recurring part-year 
compensation means compensation paid for services rendered in a position 
that the service recipient and service provider reasonably anticipate 
will continue on similar terms and conditions in subsequent years, and 
will require services to be provided during successive service periods 
each of which comprises less than 12 months (for example, a teacher 
providing services during a school year comprised of 10 consecutive 
months), and each of which periods begins in one taxable year of the 
service provider and ends in the next such taxable year. The rules of 
this paragraph (a)(14) apply to a particular amount of compensation only 
once, so that an amount deferred under this rule may not again be 
treated as recurring part-year compensation for purposes of this 
paragraph and subject to a second deferral election under this paragraph 
(a)(14).
    (15) USERRA rights. The requirements of this paragraph (a) are 
deemed satisfied to the extent an initial deferral election is provided 
to satisfy the requirements of the Uniformed Service Employment and 
Reemployment Rights Act of 1994, as amended, 38 U.S.C. 4301-4334.
    (b) Subsequent changes in time and form of payment--(1) In general. 
A plan that permits under a subsequent election a delay in a payment or 
a change in the form of payment (a subsequent deferral election), 
including a subsequent deferral election made by a service provider or a 
service recipient, satisfies the requirements of section 409A(a)(4)(C) 
only if the conditions of this paragraph (b) are met. For purposes of 
this paragraph (b), except as otherwise expressly provided in this 
section, a subsequent deferral election is not considered made until 
such election becomes irrevocable under the terms of the plan. 
Accordingly, a plan may provide that a subsequent deferral election may 
be changed at any time before the last permissible date for making such 
a subsequent deferral election. Where a plan permits a subsequent 
deferral election, the requirements of this paragraph are satisfied

[[Page 659]]

only if the following conditions are met:
    (i) The plan requires that such election not take effect until at 
least 12 months after the date on which the election is made.
    (ii) In the case of an election related to a payment not described 
in Sec. 1.409A-3(a)(2) (payment on account of disability), Sec. 
1.409A-3(a)(3) (payment on account of death), or Sec. 1.409A-3(a)(6) 
(payment on account of the occurrence of an unforeseeable emergency), 
the plan requires that the payment with respect to which such election 
is made be deferred for a period of not less than five years from the 
date such payment would otherwise have been paid (or in the case of a 
life annuity or installment payments treated as a single payment, five 
years from the date the first amount was scheduled to be paid).
    (iii) The plan requires that any election related to a payment 
described in Sec. 1.409A-3(a)(4) (payment at a specified time or 
pursuant to a fixed schedule) be made not less than 12 months before the 
date the payment is scheduled to be paid (or in the case of a life 
annuity or installment payments treated as a single payment, 12 months 
before the date the first amount was scheduled to be paid).
    (2) Definition of payments for purposes of subsequent changes in the 
time or form of payment--(i) In general. Except as provided in 
paragraphs (b)(2)(ii) and (iii) of this section, the term payment refers 
to each separately identified amount to which a service provider is 
entitled to payment under a plan on a determinable date, and includes 
amounts applied for the benefit of the service provider. An amount is 
separately identified only if the amount may be objectively determined 
under a nondiscretionary formula. For example, an amount identified as 
10 percent of the account balance as of a specified payment date would 
be a separately identified amount. A payment includes the provision of 
any taxable benefit, including payment in cash or in kind. In addition, 
a payment includes, but is not limited to, the transfer, cancellation, 
or reduction of an amount of deferred compensation in exchange for 
benefits under a welfare benefit plan, a fringe benefit excludible under 
section 119 or section 132, or any other benefit that is excludible from 
gross income. For additional rules relating to the application of this 
paragraph (b) to amounts payable at a fixed time or pursuant to a fixed 
schedule, see Sec. 1.409A-3(i)(1).
    (ii) Life annuities--(A) In general. The entitlement to a life 
annuity is treated as the entitlement to a single payment. Accordingly, 
an election to delay payment of a life annuity, or to change the form of 
payment of a life annuity, must be made at least 12 months before the 
scheduled commencement of the life annuity, and must defer the payment 
for a period of not less than five years from the originally scheduled 
commencement of the life annuity. For purposes of Sec. 1.409A-1, this 
section, and Sec. Sec. 1.409A-3 through 1.409A-6, the term life annuity 
means a series of substantially equal periodic payments, payable not 
less frequently than annually, for the life (or life expectancy) of the 
service provider, or a series of substantially equal periodic payments, 
payable not less frequently than annually, for the life (or life 
expectancy) of the service provider, followed upon the death or end of 
the life expectancy of the service provider by a series of substantially 
equal periodic payments, payable not less frequently than annually, for 
the life (or life expectancy) of the service provider's designated 
beneficiary (if any). Notwithstanding the foregoing, a schedule of 
payments does not fail to be an annuity solely because such plan 
provides for an immediate payment of the actuarial present value of all 
remaining annuity payments if the actuarial present value of the 
remaining annuity payments falls below a predetermined amount, and the 
immediate payment of such amount does not constitute an accelerated 
payment for purposes of Sec. 1.409A-3(j), provided that such feature, 
including the predetermined amount, is established by no later than the 
time and form of payment is otherwise required to be established, and 
provided further that any change in such feature, including the 
predetermined amount, is a change in the time and form of payment. A 
change in designated beneficiary before any annuity payment has been 
made under the plan is not a change in the

[[Page 660]]

time or form of payment. A change in the form of a payment before any 
annuity payment has been made under the plan, from one type of life 
annuity to another type of life annuity with the same scheduled date for 
the first annuity payment, is not considered a change in the time and 
form of a payment, provided that the annuities are actuarially 
equivalent applying reasonable actuarial methods and assumptions. For 
purposes of this paragraph (b)(2)(ii), a requirement that a service 
provider obtain the consent of a spouse or other potential recipient of 
a survivor annuity to change a beneficiary or form of payment is 
disregarded, so that any annuity form that the service recipient could 
elect to receive with such consent is considered currently available.
    (B) Certain features disregarded. Notwithstanding the foregoing 
provisions of this paragraph (b)(2)(ii), the following features are 
disregarded for purposes of determining whether a payment form is a life 
annuity within the meaning of this paragraph (b)(2)(ii), but are not 
disregarded for purposes of determining whether a life annuity is the 
actuarial equivalent of another life annuity except as otherwise 
provided in this paragraph (b)(2)(ii):
    (1) Term certain features under which annuity payments continue for 
the longer of the life of the annuitant or a fixed period of time.
    (2) Pop-up features under which payments increase upon the death of 
the beneficiary or another event that eliminates the right to a survivor 
annuity.
    (3) Cash refund features under which payment is provided upon the 
death of the last annuitant in an amount that is not greater than the 
excess of the present value of the annuity at the annuity starting date 
over the total of payments before the death of the last annuitant.
    (4) Features under which an annuity form of payment provides higher 
periodic payments before the expected commencement of benefits under the 
Social Security Act (42 U.S.C. ch. 7) or the Railroad Retirement Act (45 
U.S.C. 231 et seq.) and lower periodic payments after such expected 
commencement date, so that the combined periodic payments under the 
arrangement and the Social Security Act or the Railroad Retirement Act, 
as applicable, are approximately level before and after such expected 
commencement date (Social Security or Railroad Retirement leveling 
features).
    (5) Features providing for an increase in the annuity payment in a 
manner described in Sec. 1.401(a)(9)-6, Q&A-14(a)(1) or (2) (eligible 
cost-of-living adjustments).
    (C) Subsidized joint and survivor annuities. For purposes of this 
paragraph (b)(2)(ii), a joint and survivor annuity will not fail to be 
treated as actuarially equivalent to a single life annuity due solely to 
the value of a subsidized survivor annuity benefit, provided that the 
annual lifetime annuity benefit available to the service provider under 
the joint and survivor annuity is not greater than the annual lifetime 
annuity benefit available to the service provider under the single life 
annuity alternative, and provided that the annual survivor annuity 
benefit is not greater than the annual lifetime annuity benefit 
available to the service provider under the joint and survivor annuity.
    (D) Actuarial assumptions and methods. For purposes of this 
paragraph (b)(2)(ii), at any given time the same actuarial assumptions 
and methods must be used in valuing each annuity payment option, in 
determining whether the payments are actuarially equivalent and such 
assumptions must be reasonable. This requirement applies over the entire 
term of the service provider's participation in the plan, such that the 
annuity payment must be actuarially equivalent at all times for the 
annuity payment options to be treated as one time and form of payment. 
There is no requirement that the same actuarial methods and assumptions 
be used over the term of a service provider's participation in a plan. 
Accordingly, a plan may change the actuarial assumptions and methods 
used to determine the life annuity payments provided that all of the 
actuarial assumptions and methods are reasonable.
    (iii) Installment payments. The entitlement to a series of 
installment payments that is not a life annuity is treated as the 
entitlement to a single payment, unless the plan provides at

[[Page 661]]

all times with respect to the amount deferred that the right to the 
series of installment payments is to be treated as a right to a series 
of separate payments. For purposes of Sec. 1.409A-1, this section, and 
Sec. Sec. 1.409A-3 through 1.409A-6, a series of installment payments 
refers to an entitlement to the payment of a series of substantially 
equal periodic amounts to be paid over a predetermined period of years, 
except to the extent any increase (or decrease) in the amount reflects 
reasonable earnings (or losses) through the date the amount is paid. For 
this purpose, a series of installment payments over a predetermined 
period and a series of installment payments over a shorter or longer 
period, or a series of installment payments over the same predetermined 
period but with a different commencement date, are different times and 
forms of payment. Accordingly, a change in the predetermined period or 
the commencement date is a change in the time and form of payment. 
Notwithstanding the foregoing, a schedule of payments does not fail to 
be an installment payment solely because such plan provides for an 
immediate payment of all remaining installments if the present value of 
the deferred amount to be paid in the remaining installment payments 
falls below a predetermined amount, and the immediate payment of such 
amount does not constitute an accelerated payment for purposes of Sec. 
1.409A-3(j), provided that such feature including the predetermined 
amount is established by no later than the time and form of payment is 
otherwise required to be established, and provided further that any 
change in such feature including the predetermined amount is a change in 
the time and form of payment.
    (iv) Transition rule. For purposes of this section, a plan that was 
adopted and effective before December 31, 2007, whether written or 
unwritten, that fails to make a designation as to whether the 
entitlement to a series of payments is to be treated as an entitlement 
to a series of separate payments under paragraph (b)(2)(iii) of this 
section, may make such designation on or before December 31, 2007, 
provided such designation is set forth in writing on or before December 
31, 2007.
    (3) Beneficiaries. The rules of this paragraph (b) governing changes 
in the time and form of payment apply to elections by beneficiaries with 
respect to the time and form of payment, as well as elections by service 
providers or service recipients with respect to the time and form of 
payment to beneficiaries. An election to change the identity of a 
beneficiary does not constitute a change in the time and form of payment 
merely because the election changes the identity of the recipient of the 
payment, if the time and form of the payment is not otherwise changed. 
In addition, an election to change the identity of a beneficiary before 
the initial payment of a life annuity does not constitute a change in 
the time and form of payment if the change in the time of payments stems 
solely from the different life expectancy of the new beneficiary, such 
as in the case of a joint and survivor annuity.
    (4) Domestic relations orders. The rules of this paragraph (b) 
governing changes in the time and form of payment do not apply to 
elections by individuals other than a service provider, with respect to 
payments to a person other than the service provider, to the extent such 
elections are reflected in, or made in accordance with, the terms of a 
domestic relations order (as defined in section 414(p)(1)(B)).
    (5) Coordination with prohibition against acceleration of payments. 
For purposes of applying the prohibition against the acceleration of 
payments in Sec. 1.409A-3(j), the definition of payment is the same as 
the definition in paragraph (b)(2) of this section. Accordingly, a 
change in the form of a payment that results in a more rapid schedule 
for payments generally will not constitute an acceleration of a payment, 
if the change in the form of payment is made in compliance with the 
subsequent deferral rules. For example, a change in form from a 10-year 
installment payment treated as a single payment to a lump-sum payment 
would not constitute an acceleration if the change in the form of the 
payment is made in compliance with the requirements of paragraph (b)(1) 
of this section, generally meaning that the election to change to a 
lump-sum payment

[[Page 662]]

must be made at least 12 months before the installment payments were 
scheduled to commence and the lump-sum payment could not be made until 
at least five years after the date the installment payments were 
scheduled to commence. See Sec. 1.409A-3(j)(4)(i) with respect to 
situations in which the failure to accelerate a payment or the 
modification of a plan term relating to certain accelerated payments 
will not be subject to the rules of this paragraph (b).
    (6) Application to multiple payment events. In the case of a plan 
that permits a payment upon each of a number of potential permissible 
payment events, such as the earlier of a fixed date or separation from 
service, the requirements of paragraph (b)(1) of this section are 
applied separately to each payment (as defined in paragraph (b)(2) of 
this section) due upon each payment event. Notwithstanding the 
foregoing, the addition or deletion of a permissible payment event to a 
plan under which amounts were previously deferred is subject to the 
rules of this paragraph (b) where the addition or deletion of the 
permissible payment event may result in a change in the time or form of 
payment of the amount deferred. For application of the rules governing 
accelerations of payments to the addition of a permissible payment event 
to amounts deferred, see Sec. 1.409A-3(j).
    (7) Delay of payments under certain circumstances. A payment may be 
delayed to a date after the designated payment date under any of the 
circumstances described in this paragraph (b)(7), and the provision will 
not fail to meet the requirements of establishing a permissible payment 
event and the delay in the payment will not constitute a subsequent 
deferral election, so long as the service recipient treats all payments 
to similarly situated service providers on a reasonably consistent 
basis.
    (i) Payments subject to section 162(m). A payment may be delayed to 
the extent that the service recipient reasonably anticipates that if the 
payment were made as scheduled, the service recipient's deduction with 
respect to such payment would not be permitted due to the application of 
section 162(m), provided that the payment is made either during the 
service provider's first taxable year in which the service recipient 
reasonably anticipates, or should reasonably anticipate, that if the 
payment is made during such year, the deduction of such payment will not 
be barred by application of section 162(m) or during the period 
beginning with the date of the service provider's separation from 
service and ending on the later of the last day of the taxable year of 
the service recipient in which the service provider separates from 
service or the 15th day of the third month following the service 
provider's separation from service, and provided further that where any 
scheduled payment to a specific service provider in a service 
recipient's taxable year is delayed in accordance with this paragraph, 
the delay in payment will be treated as a subsequent deferral election 
unless all scheduled payments to that service provider that could be 
delayed in accordance with this paragraph are also delayed. Where the 
payment is delayed to a date on or after the service provider's 
separation from service, the payment will be considered a payment upon a 
separation from service for purposes of the rules under Sec. 1.409A-
3(i)(2) (payments to specified employees upon a separation from service) 
and, in the case of a specified employee, the date that is six months 
after a service provider's separation from service is substituted for 
any reference to a service provider's separation from service in the 
first sentence of this paragraph. No election may be provided to the 
service provider with respect to the timing of the payment under this 
paragraph (b)(7)(i).
    (ii) Payments that would violate Federal securities laws or other 
applicable law. A payment may be delayed where the service recipient 
reasonably anticipates that the making of the payment will violate 
Federal securities laws or other applicable law; provided that the 
payment is made at the earliest date at which the service recipient 
reasonably anticipates that the making of the payment will not cause 
such violation. The making of a payment that would cause inclusion in 
gross income or the application of any penalty provision or other 
provision of the Internal Revenue

[[Page 663]]

Code is not treated as a violation of applicable law.
    (iii) Other events and conditions. A service recipient may delay a 
payment upon such other events and conditions as the Commissioner may 
prescribe in generally applicable guidance published in the Internal 
Revenue Bulletin (see Sec. 601.601(d)(2) of this chapter). For 
additional rules applicable to certain delayed payments pursuant to a 
change in control event, see Sec. 1.409A-3(i)(5)(iv). For additional 
rules applicable to amounts payable because of an unforeseeable 
emergency, see Sec. 1.409A-3(i)(3).
    (8) USERRA rights. The requirements of this paragraph (b) are deemed 
met to the extent an election to change the time or form of a payment of 
deferred compensation is provided to satisfy the requirements of the 
Uniformed Services Employment and Reemployment Rights Act of 1994, as 
amended, 38 U.S.C. 4301-4344.
    (9) Examples. The following examples illustrate the application of 
the provisions of this section. For purposes of these examples, each 
employee is an individual with a calendar year taxable year, and is 
employed by the specified employer:

    Example 1. Initial election to defer salary. Employer ZZ sponsors a 
plan under which Employee A may elect to defer a percentage of Employee 
A's salary. Employee A has participated in the plan in prior years. To 
satisfy the requirements of this section with respect to salary earned 
in calendar year 2008, if Employee A elects to defer any amount of such 
salary, the deferral election (including an election as to the time and 
form of payment) must be made no later than December 31, 2007.
    Example 2. Designation of time and form of payment where an initial 
deferral election is not provided. Employer YY has a taxable year ending 
September 30. On July 1, 2008, Employer YY enters into a legally binding 
obligation to pay Employee B a $10,000 bonus. The amount is not subject 
to a substantial risk of forfeiture and does not qualify as performance-
based compensation as described in Sec. 1.409A-1(e). Employer YY does 
not provide Employee B an election as to the time and form of payment. 
Unless the amount is to be paid in accordance with the short-term 
deferral rule of Sec. 1.409A-1(b)(4), Employer YY must specify the time 
and form of payment on or before July 1, 2008, to satisfy the 
requirements of this section.
    Example 3. Initial election to defer bonus payable based on services 
during calendar year. Employer XX has a taxable year ending September 
30. Employee C participates in a bonus plan under which Employee C is 
entitled to a bonus for services performed during the calendar year 
that, absent an election by Employee C, will be paid on March 15 of the 
following year. The amount is not subject to a substantial risk of 
forfeiture and does not qualify as performance-based compensation as 
described in Sec. 1.409A-1(e). If Employee C elects to defer the 
payment of the bonus with respect to services rendered during calendar 
year 2008, Employee C must elect the time and form of payment not later 
than December 31, 2007, to satisfy the requirements of this section.
    Example 4. Initial election to defer bonus payable based on services 
during fiscal year other than calendar year. Employer WW has a taxable 
year ending September 30. Employee D participates in a bonus plan under 
which Employee D is entitled to a bonus for services performed during 
Employer WW's fiscal year that, absent an election by Employee D, will 
be paid on December 15 of the calendar year in which the fiscal year 
ends. The amount is not subject to a substantial risk of forfeiture and 
does not qualify as performance-based compensation as described in Sec. 
1.409A-1(e). The amount qualifies as fiscal year compensation. If 
Employee D elects to defer the payment of the amount related to the 
fiscal year ending September 30, 2009, to satisfy the requirements of 
this section Employee D must elect the time and form of payment not 
later than September 30, 2008.
    Example 5. Initial election to defer bonus payable only if service 
provider completes at least 12 months of services after the election. 
Employer VV has a calendar year taxable year. On March 1, 2008, Employer 
VV grants Employee E a $10,000 bonus, payable on March 1, 2010 (with 
reasonable interest), provided that Employee E continues performing 
services as an employee of Employer VV through March 1, 2010. The amount 
does not qualify as performance-based compensation as described in Sec. 
1.409A-1(e), and Employee E already participates in another account 
balance nonqualified deferred compensation plan. Employee E may make an 
initial deferral election on or before March 31, 2008 (within 30 days 
after obtaining a legally binding right), because at least 12 months of 
additional services are required after the date of election for the risk 
of forfeiture to lapse.
    Example 6. Initial election to defer bonus that would otherwise 
constitute a short-term deferral. The same facts as Example 5, except 
that Employee E does not make an initial deferral election on or before 
March 31, 2008. Because the right to the compensation would not be 
treated as a deferral of compensation pursuant to Sec. 1.409A-1(b)(4) 
absent a deferral election (because the arrangement would be treated as 
a short-term deferral), Employee

[[Page 664]]

E may make an initial deferral election provided that the election may 
not become effective for 12 months and must defer the payment at least 5 
years from March 1, 2010 (the first date the payment could become 
substantially vested). Accordingly, Employee E may make an election 
before March 1, 2009, provided that the election defers the payment to a 
date on or after March 1, 2015 (other than a payment due to death, 
disability, unforeseeable emergency, or a change in control event).
    Example 7. Initial election to defer sales commissions. Employer UU 
has a calendar year taxable year. As part of Employee F's services for 
Employer UU, Employee F sells refrigerators to customers unrelated to 
Employee F or Employer UU. Under the employment arrangement, Employee F 
is entitled to 10% of the sales price of any refrigerator Employee F 
sells, payable only upon the receipt of payment from the customer who 
purchased the refrigerator. For purposes of the initial deferral rule, 
Employee F is treated as performing the services related to each 
refrigerator sale in the calendar year in which each customer pays for 
the refrigerator.
    Example 8. Initial election to defer renewal sales commissions. The 
same facts as Example 7, except that Employee F also sells warranties 
related to the refrigerators sold. Under the warranty arrangement, 
refrigerator warranty customers are entitled in a future year to extend 
the warranty for an additional cost to be paid at the time of the 
extension. Under Employee F's arrangement with Employer UU, Employee F 
is entitled to 10% of the amount paid for an extension of any warranty, 
payable upon the receipt of payment from the customer extending the 
warranty. For purposes of the initial deferral election rule, Employee F 
is treated as performing the services related to the amount paid for the 
extension of the warranty in the taxable year in which the customer pays 
for the warranty extension.
    Example 9. Initial election to defer investment commissions. 
Employer TT is in the trade or business of managing financial assets for 
customer accounts. Customers who deposit funds in an account with 
Employer TT are entitled to remove the account balance of such account 
upon 60 days notice to Employer TT. Employee G sells financial products 
and provides continuing customer service to certain unrelated customers 
involving the deposit and maintenance of funds in customer accounts 
managed by Employer TT. Under the employment arrangement, Employee G is 
entitled to a set percentage of the aggregate value of the assets held 
in the accounts of customers to whom Employee G sold financial products 
and provides customer service. Under the arrangement, the aggregate 
value of the assets held in the accounts is determined as of June 30 of 
each year, and unless Employee G elects to defer the payment, the amount 
is payable to Employee G in a lump sum on December 31 of the year in 
which the valuation is made. Employee G has no control over the 
valuation of the assets held in the accounts, or the calculation of the 
amount due Employee G. For purposes of the initial deferral rule, 
Employee G is treated as providing the services to which a payment 
relates during the July 1 through June 30 period ending on the June 30 
date as of which the assets held in the account are valued.
    Example 10. Initial election to defer part-year compensation. 
Employee H provides services as a teacher to Employer SS, a school 
system. The period of services routinely begins on the second Monday of 
August of one year and ends on the first Friday of June of the 
subsequent year. Employer SS provides an election to Employee H to 
receive the compensation for the period of services ratably over the 
period beginning on the second Monday of August of one year and ending 
on the last day of August of the subsequent year. Because the 
compensation constitutes recurring part-year compensation, as defined in 
paragraph (a)(14) of this section, and because the schedule will provide 
that all of the recurring part-year compensation is paid no later than 
September 30 of the subsequent year, Employee H will be deemed to have 
made a timely deferral election with respect to such recurring part-year 
compensation if Employee H elects before the first day of the service 
period to have the recurring part-year compensation paid under such 
schedule.
    Example 11. Initial election to defer negotiated separation pay. 
Employer RR decides to terminate Employee J's employment involuntarily. 
As part of the process of terminating Employee J, Employer RR enters 
into bona fide, arm's length negotiations with respect to the terms of 
Employee J's termination of employment. As part of the process, Employer 
RR offers Employee J an amount that is in addition to any amounts to 
which Employee J is otherwise entitled, payable either as a lump sum 
payment at the end of 3 years or in 3 annual payments starting at the 
date of termination of employment. The election of the time and form of 
payment by Employee J may be made at any time before Employee J accepts 
the offer and obtains a legally binding right to the additional amount. 
The election may not apply to any amount to which Employee J already had 
a legally binding right.
    Example 12. Election of time and form of payments under a window 
program. Employer QQ establishes a window program, as defined in Sec. 
1.409A-1(b)(9)(vi). Individuals who elect to terminate employment under 
the window program are entitled to receive an amount equal to 2 weeks 
pay multiplied by every year of service with Employer QQ. The 
individuals participating in the window program

[[Page 665]]

may elect to receive the payment as either a lump sum payment payable on 
the first day of the month after making the election to participate in 
the window program, or as a payment of 3 equal annual installments on 
each January 1 of the first 3 years following the election to 
participate in the window program. Employee K is eligible to participate 
in the window program. Employee K will be treated as making a timely 
deferral election if the election as to the time and form of payment is 
made on or before the date Employee K's election to participate in the 
window program becomes irrevocable.
    Example 13. Initial election to defer salary earned during final 
payroll period beginning in one calendar year and ending in the 
subsequent calendar year. Employer PP pays the salary of its employees, 
including Employee L, on a bi-weekly basis. One bi-weekly payroll period 
runs from December 24, 2008, through January 6, 2009, with a scheduled 
payment date of January 13, 2009. Employer PP sponsors, and Employee L 
participates in, a nonqualified deferred compensation plan under which 
Employee L may defer a specified percentage of his annual salary. The 
plan does not specify that any salary compensation paid for the payroll 
period in which falls January 1 is to be treated as compensation for 
services performed during the year preceding the year in which falls 
that January 1. For purposes of applying the initial deferral election 
rules, Employee L is deemed to have performed the services for the 
payroll period December 24, 2008, through January 6, 2009, during the 
calendar year 2009.
    Example 14. Application of deferral election rules and anti-
acceleration rules to a nonqualified deferred compensation plan linked 
to a qualified plan. Employee M participates in a qualified retirement 
plan that is a defined benefit plan that offers a subsidized early 
retirement benefit to employees who have attained age 55 and completed 
30 years of service. Employee M, who has attained age 55 and completed 
30 years of service, also participates in a nonqualified deferred 
compensation plan, under which the benefit payable is calculated under a 
formula, with that benefit then reduced by any benefit that Employee M 
has accrued under the qualified retirement plan. In 2008, Employee M 
fails to elect the subsidized early retirement benefit under the 
qualified retirement plan, with the effect that the amounts payable 
under the nonqualified deferred compensation plan are increased by an 
amount equal to the reduction in the benefit payable under the qualified 
plan. In 2009, Employer NN amends the qualified retirement plan to 
increase benefits under the plan, resulting in a decrease in the amounts 
payable under the nonqualified deferred compensation plan equal to the 
increase in the benefit payable under the qualified plan. Neither of 
these actions constitutes a deferral election or an acceleration of a 
payment under the nonqualified deferred compensation plan.
    Example 15. Subsequent deferral election. Employee N participates in 
a nonqualified deferred compensation plan. Employee N elects to be paid 
in a lump sum payment at the earlier of age 65 or separation from 
service. Employee N anticipates that he will work after age 65, and 
wishes to defer payment to a later date. Provided that Employee N 
continues in employment and makes the election by his 64th birthday, 
Employee N may elect to receive a lump sum payment at the earlier of age 
70 or separation from service.
    Example 16. Subsequent deferral election rule--change in form of 
payment from lump sum payment to life annuity. Employee P participates 
in a nonqualified deferred compensation plan. Employee P elects to be 
paid in a lump sum payment at age 65. Employee P wishes to change the 
payment form to a life annuity. Provided that Employee P makes the 
election on or before his 64th birthday, Employee P may elect to receive 
a life annuity commencing at age 70.
    Example 17. Subsequent deferral election rule--change in form of 
payment from life annuity to lump sum payment. Employee Q participates 
in a nonqualified deferred compensation plan. Employee Q elects to be 
paid in a life annuity at age 65. Employee Q wishes to change the 
payment form to a lump sum payment. Provided that Employee Q makes the 
election on or before his 64th birthday, Employee Q may elect to receive 
a lump sum payment at age 70.
    Example 18. Subsequent deferral election rule--installment payments 
designated as separate payments. Employee R, whose taxable year is the 
calendar year, participates in a nonqualified deferred compensation plan 
that provides for payment in a series of 5 equal annual amounts, each 
designated as a separate payment. The first payment is scheduled to be 
made on January 1, 2010. Provided that Employee R makes the election on 
or before January 1, 2009, Employee R may elect for the first payment 
scheduled to be made on January 1, 2010, to be made on January 1, 2015. 
If Employee R makes that election, but does not elect to defer the 
remaining payments, the remaining payments continue to be due upon 
January 1 of the 4 consecutive calendar years commencing on January 1, 
2011.
    Example 19. Subsequent deferral election rule--change in form of 
payment from installment payments not designated as separate payments to 
lump sum payment. Employee S participates in a nonqualified deferred 
compensation plan that provides for payment in a series of 5 equal 
annual amounts that are not designated as a series of 5 separate 
payments. The first amount is scheduled to be paid on January 1, 2010. 
Employee S wishes to receive the entire amount equal to the sum of all 5 
of the amounts to be paid as a

[[Page 666]]

lump sum payment. Provided that Employee S makes the election on or 
before January 1, 2009, Employee S may elect to receive a lump sum 
payment on or after January 1, 2015.
    Example 20. Subsequent deferral election rule--change in form of 
payment from installment payments designated as separate payments to 
lump sum payment. Employee T participates in a nonqualified deferred 
compensation plan that provides for payment in a series of 5 equal 
annual amounts each of which is designated as a separate payment. The 
first amount is scheduled to be paid on January 1, 2010. Employee T 
wishes to receive the entire amount equal to the sum of all 5 of the 
amounts in a single lump sum payment. Provided that Employee T makes the 
election on or before January 1, 2009, Employee T may elect to receive a 
lump sum payment on or after January 1, 2019.
    Example 21. Subsequent deferral election rule--change in form of 
payment from one life annuity form to another life annuity form. 
Employee U participates in a nonqualified deferred compensation plan 
that permits Employee U to elect before Employee U's separation from 
service whether to be paid in the form of a single life annuity 
beginning on the first day of the month following Employee U's 
separation from service, or an annuity beginning on the first day of the 
month following Employee U's separation from service under which annuity 
payments continue for Employee U's lifetime but not less than 10 years. 
The two types of annuities are actuarially equivalent at all times 
applying reasonable actuarial methods and assumptions. For purposes of 
this section, the two types of annuities are treated as a single form of 
payment. Accordingly, the election provided under the plan is not 
treated as providing a subsequent deferral election or accelerated 
payment, and an election by Employee U under the plan between the two 
annuity options made before the first scheduled payment date for an 
annuity payment is not treated as a subsequent deferral election or an 
acceleration of a payment.
    Example 22. Subsequent deferral election rule--change in time of 
payment from payment at specified age to payment at later of specified 
age or separation from service. Employee V participates in a 
nonqualified deferred compensation plan that provides for a lump sum 
payment at age 65. Employee V wishes to modify the plan so that the 
deferred amount will be payable upon the later of Employee V's 
attainment of a specified age or separation from service. Provided that 
Employee V makes such election on or before his 64th birthday, Employee 
V may modify the plan so Employee V will receive a lump sum payment upon 
the later of age 70 or separation from service.
    Example 23. Subsequent deferral election rule--change in time of 
payment from payment at separation from service to payment at later of 
separation from service or specified age. Employee W participates in a 
nonqualified deferred compensation plan that provides for a lump sum 
payment at separation from service. Employee W wishes to make the 
payment payable upon the later of separation from service or a 
predetermined age. Provided that Employee W makes such election on or 
before the date 1 year before a separation from service, Employee W may 
elect to receive a lump sum payment upon the later of the date 5 years 
following a separation from service or at a specified age.
    Example 24. Subsequent deferral election rule--change in time of 
payment from payment at separation from service to payment at a change 
in control event. Employee X participates in a nonqualified deferred 
compensation plan that provides for a lump sum payment at separation 
from service. Employee X wishes to change the payment provision such 
that the payment is payable upon a change in control event. A change in 
the distribution provision to provide for a payment only upon a change 
in control event will violate the rules governing payment provisions, 
because the change could result in an acceleration if the change in 
control event occurs before Employee X separates from service, or a 
subsequent deferral if the change in control does not occur until after 
Employee X separates from service. However, provided that Employee X 
makes such election on or before the date 1 year before a separation 
from service, Employee X may elect to receive a payment upon the later 
of a change in control event or 5 years following a separation from 
service.

    (c) Special rules for certain resident aliens. For the first taxable 
year of an individual in which such individual is a resident alien, a 
nonqualified deferred compensation plan is deemed to meet the 
requirements of paragraph (a) of this section if, with respect to 
compensation payable for services performed during that first taxable 
year or with respect to compensation the right to which is subject to a 
substantial risk of forfeiture as of the first day of that first taxable 
year, an initial deferral election is made by the end of such first 
taxable year, provided that the initial deferral election may not apply 
to amounts that have already been paid or made available to the service 
provider before the election is made. For any year after the first 
taxable year in which an individual is classified as a resident alien, 
this paragraph (c) does not apply, provided that a taxable year may 
again be treated as

[[Page 667]]

the first taxable year in which an individual is classified as a 
resident alien if such individual is classified as a resident alien in 
that taxable year and has not been classified as a resident alien for 
the three consecutive taxable years immediately preceding that taxable 
year.

[T.D. 9321, 72 FR 19276, Apr. 17, 2007; 72 FR 41621, July 31, 2007]



Sec. 1.409A-3  Permissible payments.

    (a) In general. The requirements of section 409A(a)(2)(A) are met 
only if the plan provides that an amount of deferred compensation under 
the plan may be paid only upon an event or at a time set forth in this 
paragraph (a):
    (1) The service provider's separation from service (as defined in 
Sec. 1.409A-1(h) and in accordance with paragraph (i)(2) of this 
section).
    (2) The service provider becoming disabled (in accordance with 
paragraph (i)(4) of this section).
    (3) The service provider's death.
    (4) A time or a fixed schedule specified under the plan (in 
accordance with paragraph (i)(1) of this section).
    (5) A change in the ownership or effective control of the 
corporation, or in the ownership of a substantial portion of the assets 
of the corporation (in accordance with paragraph (i)(5) of this 
section).
    (6) The occurrence of an unforeseeable emergency (in accordance with 
paragraph (i)(3) of this section).
    (b) Designation of payment upon a permissible payment event. Except 
as otherwise specified in this section, a plan provides for the payment 
upon an event described in paragraph (a)(1), (2), (3), (5), or (6) of 
this section if the plan provides the date of the event is the payment 
date, or specifies another payment date that is objectively determinable 
and nondiscretionary at the time the event occurs. A plan may also 
provide that a payment upon an event described in paragraph (a)(1), (2), 
(3), (5), or (6) of this section is to be made in accordance with a 
schedule that is objectively determinable and nondiscretionary based on 
the date the event occurs and that would qualify as a fixed schedule 
under paragraph (i)(1) of this section if the payment event were instead 
a fixed date, provided that the schedule must be fixed at the time the 
permissible payment event is designated. In addition, a plan may provide 
that a payment, including a payment that is part of a schedule, is to be 
made during a designated taxable year of the service provider that is 
objectively determinable and nondiscretionary at the time the payment 
event occurs such as, for example, a schedule of three substantially 
equal payments payable during the first three taxable years following 
the taxable year in which a separation from service occurs. A plan may 
also provide that a payment, including a payment that is part of a 
schedule, is to be made during a designated period objectively 
determinable and nondiscretionary at the time the payment event occurs, 
but only if the designated period both begins and ends within one 
taxable year of the service provider or the designated period is not 
more than 90 days and the service provider does not have a right to 
designate the taxable year of the payment (other than an election that 
complies with the subsequent deferral election rules of Sec. 1.409A-
2(b)). Where a plan provides for a period of more than one day following 
a payment event during which a payment may be made, such as within 90 
days following the date of the event, the payment date for purposes of 
the subsequent deferral rules under Sec. 1.409A-2(b) is treated as the 
first possible date upon which a payment could be made under the terms 
of the plan. A plan may provide for payment upon the earliest or latest 
of more than one event or time, provided that each event or time is 
described in paragraphs (a)(1) through (6) of this section. For examples 
illustrating the provisions of this paragraph, see paragraph (i)(1)(vi) 
of this section.
    (c) Designation of alternative specified dates or payment schedules 
based upon date of permissible event. Except as otherwise provided in 
this paragraph (c), for an amount of deferred compensation under a plan, 
the plan may designate only one time and form of payment upon the 
occurrence of each event described in paragraph (a)(1), (2),

[[Page 668]]

(3), (5), or (6) of this section. For example, a plan does not satisfy 
the requirements of this paragraph (c) if it provides for one payment 
date or schedule of payments if a specified event occurs on a Monday, 
but another payment date or schedule of payments if the event occurs on 
any other day of the week. However, a plan that provides for a payment 
upon an event described in paragraph (a)(2), (3), (5), or (6) of this 
section may allow for an alternative payment schedule if the event 
occurs on or before one (but not more than one) specified date, provided 
that the addition or deletion of such a different time and form of 
payment applicable to an existing deferral is subject to Sec. 1.409A-
2(b) (subsequent deferral elections) and paragraph (j) of this section 
(accelerated payments). For example, a plan may provide that a service 
provider will receive a lump sum payment of the service provider's 
entire benefit under the plan on the first day of the month following a 
change in control event that occurs before the service provider attains 
age 55, but will receive 5 substantially equal annual payments 
commencing on the first day of the month following a change in control 
event that occurs on or after the service provider attains age 55. In 
the case of a plan that provides that a payment upon an event described 
in paragraph (a)(1) of this section (a payment upon a separation from 
service), a different time and form of payment may be designated with 
respect to a separation from service under each of the following 
conditions, provided that the addition or deletion of such a different 
time and form of payment applicable to an existing deferral is subject 
to Sec. 1.409A-2(b) and paragraph (j) of this section:
    (1) A separation from service during a limited period of time not to 
exceed two years following a change in control event (as defined in 
paragraph (i)(5) of this section).
    (2) A separation from service before or after a specified date (for 
example, the attainment of a specified age), or a separation from 
service before or after a combination of a specified date, such as 
attaining a specified age, and a specified period of service determined 
under a predetermined, nondiscretionary, objective formula or pursuant 
to the method for crediting service under a qualified plan sponsored by 
the service recipient.
    (3) A separation from service not described in paragraphs (c)(1) or 
(c)(2) of this section.
    (d) When a payment is treated as made upon the designated payment 
date. Except as otherwise specified in this section, a payment is 
treated as made upon the date specified under the plan (including a date 
specified under paragraph (a)(4) of this section) if the payment is made 
at such date or a later date within the same taxable year of the service 
provider or, if later, by the 15th day of the third calendar month 
following the date specified under the plan and the service provider is 
not permitted, directly or indirectly, to designate the taxable year of 
the payment. In addition, a payment is treated as made upon the date 
specified under the plan (including a date specified under paragraph 
(a)(4) of this section) and is not treated as an accelerated payment if 
the payment is made no earlier than 30 days before the designated 
payment date and the service provider is not permitted, directly or 
indirectly to designate the taxable year of the payment. For purposes of 
this paragraph, if the date specified is only a designated taxable year 
of the service provider, or a period of time during such a taxable year, 
the date specified under the plan is treated as the first day of such 
taxable year or the first day of the period of time during such taxable 
year, as applicable. The payment with respect to a stock right generally 
occurs upon the exercise of the stock right, so that where a stock right 
designates a fixed exercise date, the stock right will be deemed to have 
been paid at such date if the exercise and payment occur on such date or 
a later date within the same taxable year of the service provider or, if 
later, by the 15th day of the third calendar month following the 
exercise date specified under the plan. If calculation of the amount of 
the payment is not administratively practicable due to events beyond the 
control of the service provider (or service provider's beneficiary), the 
payment will be treated as made upon the date specified under the

[[Page 669]]

plan if the payment is made during the first taxable year of the service 
provider in which the calculation of the amount of the payment is 
administratively practicable. For purposes of this paragraph, the 
inability of a service recipient to calculate the amount or timing of a 
payment due to a failure of a service provider (or service provider's 
beneficiary) to provide reasonably available information necessary to 
make such calculation does not constitute an event beyond the control of 
the service provider. Similarly, if the making of the payment at the 
date specified under the plan would jeopardize the ability of the 
service recipient to continue as a going concern, the payment will be 
treated as made upon the date specified under the plan if the payment is 
made during the first taxable year of the service provider in which the 
making of the payment would not have such effect.
    (e) Designation of time and form of payment with respect to 
earnings. A nonqualified deferred compensation plan that provides for 
actual or notional earnings to be credited on amounts of deferred 
compensation may specify, in accordance with the requirements of Sec. 
1.409A-2(a) (initial deferral elections), that such earnings are treated 
separately from the right to the other amounts deferred under the plan 
for purposes of designating the time and form of payments under such 
plan, provided that to satisfy the requirements of this paragraph (e), 
actual or notional earnings must be credited at least annually. For 
these purposes, a right to dividend equivalents may be treated 
analogously to a right to actual or notional earnings on an amount of 
deferred compensation. For purposes of this paragraph (e), the term 
dividend equivalents means the right to an amount equal to all or a 
specified portion of dividends declared and paid, if any, on a specified 
number of shares of stock.
    (f) Substitutions. Except as otherwise provided under these 
regulations, the payment of an amount as a substitute for a payment of 
deferred compensation will be treated as a payment of the deferred 
compensation. A forfeiture or voluntary relinquishment of an amount of 
deferred compensation will not be treated as a payment of the 
compensation, but there is no forfeiture or voluntary relinquishment for 
this purpose if an amount is paid, or a legally binding right to a 
payment is created, that acts as a substitute for the forfeited or 
voluntarily relinquished amount. Whether a payment or a right to a 
payment acts as a substitute for a payment of deferred compensation is 
determined based on all the facts and circumstances. However, where the 
payment of an amount results in an actual or potential reduction of, or 
current or future offset to, an amount of deferred compensation, or if 
the service provider receives a loan the repayment of which is secured 
by or may be accomplished through an offset of or a reduction in an 
amount deferred under a nonqualified deferred compensation plan, the 
payment or loan is a substitute for the deferred compensation. In 
addition, where a service provider's right to deferred compensation is 
made subject to anticipation, alienation, sale, transfer, assignment, 
pledge, encumbrance, attachment, or garnishment by creditors of the 
service provider or the service provider's beneficiary, the deferred 
compensation is treated as having been paid. For the treatment of 
certain offsets, see paragraph (j)(4)(xiii) of this section. Even where 
there is no explicit reduction or offset, the payment of an amount or 
creation of a new right to a payment proximate to the purported 
forfeiture or voluntary relinquishment of a right to deferred 
compensation is presumed to be a substitute for the deferred 
compensation. The presumption is rebuttable by a showing that the 
compensation paid would have been received regardless of the forfeiture 
or voluntary relinquishment of the right to deferred compensation. 
Factors indicating that a payment would have been received regardless of 
such forfeiture or voluntarily relinquishment include that the amount 
paid is materially less than the forfeited or relinquished amount, or 
consists of a type of payment customarily made in the ordinary course of 
business of the service recipient to service providers who do not 
forfeit or relinquish deferred compensation (for example, a payment of 
accrued but unused leave or a payment

[[Page 670]]

for a release of actual or potential claims). See Sec. 1.409A-
1(b)(9)(i) with respect to certain separation pay plans.
    (g) Disputed payments and refusals to pay. If a service recipient 
fails to make a payment in whole or in part as of the date specified 
under a plan, either intentionally or unintentionally, other than with 
the express or implied consent of the service provider, the payment will 
be treated as made upon the date specified under the plan if the service 
provider accepts the portion (if any) of the payment that the service 
recipient is willing to make (unless such acceptance will result in a 
relinquishment of the claim to all or part of the remaining amount), 
makes prompt and reasonable, good faith efforts to collect the remaining 
portion of the payment, and any further payment (including payment of a 
lesser amount that satisfies the obligation to make the payment) is made 
no later than the end of the first taxable year of the service provider 
in which the service recipient and the service provider enter into a 
legally binding settlement of such dispute, the service recipient 
concedes that the amount is payable, or the service recipient is 
required to make such payment pursuant to a final and nonappealable 
judgment or other binding decision. For purposes of this paragraph (g), 
efforts to collect the payment will be presumed not to be prompt, 
reasonable, good faith efforts, unless the service provider provides 
notice to the service recipient within 90 days of the latest date upon 
which the payment could have been timely made in accordance with the 
terms of the plan and these regulations, and unless, if not paid, the 
service provider takes further enforcement measures within 180 days 
after such latest date. For purposes of this paragraph (g), a service 
recipient is not treated as having failed to make a payment where 
pursuant to the terms of the plan the service provider is required to 
request payment, or otherwise provide information or take any other 
action, and the service provider has failed to take such action. In 
addition, for purposes of this paragraph (g), the service provider is 
deemed to have requested that a payment not be made, rather than the 
service recipient having failed to make such payment, where the service 
recipient's decision to refuse to make the payment is made by the 
service provider or a member of the service provider's family (as 
defined in section 267(c)(4) applied as if the family of an individual 
includes the spouse of any member of the family), or any person or group 
of persons over whom the service provider or service provider's family 
member has effective control, or any person any portion of whose 
compensation is controlled the service provider or service provider's 
family member.
    (h) Special rule for certain resident aliens. An agreement, method, 
program, or other arrangement that is, or constitutes part of, a 
nonqualified deferred compensation plan is deemed to meet the 
requirements of this section with respect to any amount payable in the 
first taxable year of the service provider in which a service provider 
is a resident alien, and with respect to any amount payable in a 
subsequent taxable year if no later than the last day of the first 
taxable year of the service provider in which the service provider is a 
resident alien, the plan is amended as necessary so that the times and 
forms of payment of amounts payable in a subsequent year comply with the 
provisions of this section. For any year after the first taxable year of 
an individual in which the individual is a resident alien, this 
paragraph (h) does not apply, provided that a taxable year may again be 
treated as the first taxable year in which an individual is a resident 
alien if such individual has not been a resident alien for at least 
three consecutive taxable years immediately preceding the taxable year 
in which the service provider is again a resident alien.
    (i) Definitions and special rules--(1) Specified time or fixed 
schedule--(i) In general. Amounts are payable at a specified time or 
pursuant to a fixed schedule if objectively determinable amounts are 
payable at a date or dates that are nondiscretionary and objectively 
determinable at the time the amount is deferred. An amount is 
objectively determinable for this purpose if the amount is specifically 
identified or if the amount may be determined at the time payment is due 
pursuant to

[[Page 671]]

an objective, nondiscretionary formula specified at the time the amount 
is deferred (for example, 50 percent of a specified account balance). 
Except as otherwise provided in paragraph (i)(1) of this section, an 
amount is not objectively determinable if the amount of the payment is 
based all or in part upon the occurrence of an event, including the 
consummation of a transaction by, or a payment of an amount to, a 
service recipient. If an amount is payable in a service provider's 
taxable year (or pursuant to a fixed schedule of taxable years of the 
service provider) that is designated at the time the amount is deferred 
and that is objectively determinable, the amount is treated as payable 
at a specified time (or pursuant to a fixed schedule), provided that for 
purposes of the application of the subsequent deferral rules contained 
in Sec. 1.409A-2(b), the specified time or fixed schedule of payments 
is deemed to refer to the first day of the relevant taxable year or 
years. A specified time or fixed schedule also includes the designation 
at the time the amount is deferred of a defined period or periods within 
the service provider's taxable year or taxable years that are 
objectively determinable, provided that no such defined period may begin 
within one taxable year and end within another taxable year, and 
provided further that for purposes of the application of the subsequent 
deferral rules contained in Sec. 1.409A-2(b), the specified time or 
fixed schedule of payments is deemed to refer to the first day of the 
relevant period in which the payment will be made. A plan may provide 
that a payment upon the lapse of a substantial risk of forfeiture is to 
be made in accordance with a fixed schedule that is objectively 
determinable based on the date the substantial risk of forfeiture lapses 
(disregarding any discretionary acceleration of the lapse of the 
substantial risk of forfeiture), provided that the schedule must be 
fixed on the date the time and form of payment are designated, and any 
change in the fixed schedule will constitute a change in the time and 
form of payment. For example, a plan that provides for a bonus payment 
subject to the condition that the service provider complete three years 
of service, and subject to the further condition that such requirement 
of continued services will lapse upon the occurrence of an initial 
public offering, which condition if applied alone would constitute a 
substantial risk of forfeiture, may provide that a service provider is 
entitled to substantially equal payments on each of the first three 
anniversaries of the date the substantial risk of forfeiture lapses (the 
earlier of three years of service or the date of an initial public 
offering).
    (ii) Payment schedules with formula and fixed limitations--(A) 
Individual limitations. A schedule of payments does not fail to be a 
fixed schedule of payments where the amount of a payment or payments 
that may be paid at a specified time or during a specified period is 
limited by an objective nondiscretionary formula or a specified amount 
that is not under the effective control of the service provider and is 
not subject to the exercise of discretion by the service recipient, 
where such limitation is established on or before the date the time and 
form of payment is otherwise required to be set under these regulations, 
and the plan specifies the time and form of any payment that will be 
made or completed after its original payment date due to the application 
of the limitation. A change in the limitation or a change in the time 
and form of any payment that exceeds the limitation is subject to the 
requirements of Sec. 1.409A-2(b) (subsequent deferral elections) and 
paragraph (j) of this section (accelerated payments). For purposes of 
this paragraph, a plan provision that reduces a schedule of periodic 
payments on a dollar-for-dollar basis by the amount of Social Security 
payments received or receivable may be treated as a nondiscretionary, 
objective formula limitation, if such reduction does not otherwise 
affect the time of payment of the deferred compensation (other than a 
forfeiture due to the reduction), including changes based on the service 
provider's eligibility or elections related to Social Security benefits. 
Similarly, a plan provision that reduces a schedule of periodic payments 
on a dollar-for-dollar basis by the amount of bona fide disability pay 
(within the meaning

[[Page 672]]

of Sec. 1.409A-1(a)(5)) received or receivable may be treated as a 
nondiscretionary, objective formula limitation, if the disability 
payments are made pursuant to a plan sponsored by the service recipient 
that covers a substantial number of service providers and was 
established before the service provider became disabled, and if such 
reduction does not otherwise affect the time of payment of the deferred 
compensation (other than a forfeiture due to the reduction). Whether an 
amendment to, or other change in the benefit payable under, such bona 
fide disability plan results in an acceleration of a payment for 
purposes of paragraph (j) of this section or a subsequent election to 
delay the time or change the form of payment for purposes of Sec. 
1.409A-2(b) is determined based on all of the relevant facts and 
circumstances.
    (B) Limitations on aggregate payments to all participants in 
substantially identical plans. A schedule of payments does not fail to 
be a fixed schedule of payments where the amount of the aggregate 
payments that will be made during a specified period of time to all 
participants in substantially identical plans is limited by an objective 
nondiscretionary formula or specified amount that is not under the 
effective control of the service provider and is not subject to the 
exercise of discretion by the service recipient, where the limit is 
established on or before the date the time and form of payment of the 
amount deferred is otherwise required to be set under these regulations, 
the method of allocating payments among the participants where there is 
an overall limitation on the aggregate amount that may be paid to a 
group of service providers during a specified period is an objective 
nondiscretionary allocation method that is not under the effective 
control of the service provider and is not subject to the exercise of 
discretion by the service recipient, the method is established on or 
before the date the time and form of payment of the amount deferred is 
otherwise required to be set, and the plan specifies the time and form 
of any payment of any amount that will be paid after its original 
payment date due to the application of the limitation. A change in the 
limitation or a change in the time and form of payment of any payment 
that is not otherwise made at the scheduled payment date due to 
application of the formula limitation is subject to the requirements of 
Sec. 1.409A-2(b) (subsequent deferral elections) and paragraph (j) of 
this section (accelerated payments).
    (iii) Payment schedules determined by timing of payments received by 
the service recipient. A payment schedule determined by reference to the 
timing of payments received by the service recipient (not including 
payments from one entity to another entity where both entities are 
treated as part of a single service recipient), meets the requirements 
of a specified date or fixed schedule of payments if the following 
conditions are met:
    (A) The payments due to the service recipient arise from bona fide 
and routine transactions in the ordinary course of business of the 
service recipient.
    (B) The service provider does not have effective control of the 
service recipient, the person from whom such amounts are due, or the 
collection of any of the amounts due to the service recipient.
    (C) The payment schedule provides an objective, nondiscretionary 
method of identification of the payments to the service recipient from 
which the amount of the payment from the service recipient to the 
service provider is determined.
    (D) The payment schedule provides an objective, nondiscretionary 
schedule under which the payments will be made to the service provider.
    (E) The payments to the service recipient from which the amount of 
the payments from service recipient to the service provider are 
determined result from sales of a type that the service recipient is in 
the trade or business of making and makes frequently, and either all 
such sales by the service recipient are taken into account for purposes 
of determining the payment to the service provider, or there is a 
legitimate, non-tax business reason for identifying the specific sales 
taken into account.

[[Page 673]]

    (iv) Reimbursement or in-kind benefit plans--(A) General rule. A 
plan that provides for reimbursements of expenses incurred by a service 
provider, or in-kind benefits, meets the requirements of a specified 
date or fixed schedule of payments with respect to such reimbursements 
or benefits if the following conditions are met:
    (1) The plan provides an objectively determinable nondiscretionary 
definition of the expenses eligible for reimbursement or of the in-kind 
benefits to be provided.
    (2) The plan provides for the reimbursement of expenses incurred or 
for the provision of the in-kind benefits during an objectively and 
specifically prescribed period (including the lifetime of the service 
provider).
    (3) The plan provides that the amount of expenses eligible for 
reimbursement, or in-kind benefits provided, during a service provider's 
taxable year may not affect the expenses eligible for reimbursement, or 
in-kind benefits to be provided, in any other taxable year.
    (4) The reimbursement of an eligible expense is made on or before 
the last day of the service provider's taxable year following the 
taxable year in which the expense was incurred.
    (5) The right to reimbursement or in-kind benefits is not subject to 
liquidation or exchange for another benefit.
    (B) Medical reimbursement arrangements. Notwithstanding the 
foregoing, an arrangement providing for the reimbursement of expenses 
referred to in section 105(b) will not be deemed to fail to meet the 
requirements of paragraph (i)(1)(iv)(A)(3) of this section solely 
because the arrangement provides for a limit on the amount of expenses 
that may be reimbursed under such arrangement over some or all of the 
period in which the reimbursement arrangement remains in effect.
    (v) Tax gross-up payments. A plan providing a right to a tax gross-
up payment will be treated as providing for payment at a specified time 
or on a fixed schedule of payments if the plan provides that payment 
will be made, and the payment is made, by the end of the service 
provider's taxable year next following the service provider's taxable 
year in which the service provider remits the related taxes. For 
purposes of this paragraph (i)(1)(v), the term tax gross-up payment 
refers to a payment to reimburse the service provider in an amount equal 
to all or a designated portion of the Federal, state, local, or foreign 
taxes imposed upon the service provider as a result of compensation paid 
or made available to the service provider by the service recipient, 
including the amount of additional taxes imposed upon the service 
provider due to the service recipient's payment of the initial taxes on 
such compensation. In addition, a right to the reimbursement of expenses 
incurred due to a tax audit or litigation addressing the existence or 
amount of a tax liability, whether Federal, state, local, or foreign, 
satisfies the requirement of a fixed time and form of payment if the 
right to the reimbursement provides that payment will be made, and the 
payment is made, by the end of the service provider's taxable year 
following the service provider's taxable year in which the taxes that 
are the subject of the audit or litigation are remitted to the taxing 
authority, or where as a result of such audit or litigation no taxes are 
remitted, the end of the service provider's taxable year following the 
service provider's taxable year in which the audit is completed or there 
is a final and nonappealable settlement or other resolution of the 
litigation. Nothing in this paragraph (i)(1)(v) otherwise alters the 
application of section 409A to the underlying compensation arrangement 
or other arrangement that results in the taxes subject to the right to 
the tax gross-up payment.
    (vi) Examples. The following examples (in which each employee is an 
individual whose taxable year is the calendar year) illustrate the 
principles of paragraphs (a), (b), (c), (d), and (i)(1) of this section:

    Example 1. Employee A provides services as an employee of Employer 
Z, but is not a specified employee. Employee A participates in a 
nonqualified deferred compensation plan providing for a lump sum payment 
payable on or before December 31 of the calendar year in which Employee 
A separates from service. The plan provides for a payment upon a 
separation from service in compliance with this section.

[[Page 674]]

    Example 2. Employee B provides services as an employee of Employer 
Y, but is not a specified employee. Employee B participates in a 
nonqualified deferred compensation plan providing for a lump sum payment 
payable on or before the 90th day immediately following the date upon 
which Employee B separates from service. Employer Y retains the sole 
discretion to determine when during the 90-day period the payment will 
be made. Although the plan does not specify a period during one calendar 
year in which the payment will be made, the plan provides for a payment 
upon a separation from service in compliance with this section because 
the period over which the payment may be made is not longer than 90 
days.
    Example 3. Employee C provides services as an employee of Employer 
X, but is not a specified employee. Employee C participates in a 
nonqualified deferred compensation plan providing for a lump sum payment 
payable on or before the 180th day following the date upon which 
Employee C separates from service. Employer X retains the sole 
discretion to determine when during the 180-day period the payment will 
be made. Because the plan does not specify a period during one calendar 
year in which the payment will be made, and because the period over 
which the payment may be made is longer than 90 days, the plan does not 
provide for a payment upon a separation from service that complies with 
this section.
    Example 4. Employee D provides services as an employee of Employer 
W, but is not a specified employee. Employee D participates in a 
nonqualified deferred compensation plan providing for 10 installment 
payments payable on the first 10 anniversaries of the date Employee D 
separates from service, provided that no installment payment in any year 
may be more than 1% of Employer W's net income for the previous calendar 
year, and provided further that the excess over such limit that would 
otherwise be payable but is not paid due to application of the limit 
will become payable as of the first installment payment date at which 
time such amount, in combination with any installment payment otherwise 
due Employee D, does not exceed 1% of Employer W's net income for the 
previous calendar year. Provided that Employee D does not retain 
effective control of the calculation of Employer W's net income or the 
amount that Employee D will not be paid due to application of the limit, 
the plan provides for a schedule of payments upon a separation from 
service that complies with this section.
    Example 5. Employee E and Employee F provide services as employees 
of Employer V, but neither is a specified employee. Employee E and 
Employee F both participate in substantially identical nonqualified 
deferred compensation plans providing for 10 installment payments 
payable on the first 10 anniversaries of the date the respective 
employee separates from service, provided that the total amount of 
installment payments in any year may not be more than 1% of Employer V's 
net income for the previous year, that where any payments are not made 
due to application of the limit the determination of the amount not paid 
to a particular employee will be made by applying the overall limit 
proportionately based upon the installment payment due the employee that 
year, and that the excess over such limit that would otherwise be 
payable but is not paid due to application of the limit will become 
payable as of the first installment payment date at which time such 
amount, in combination with any installment payments otherwise due the 
participants, does not exceed 1% of Employer V's net income for the 
previous calendar year. Provided that neither Employee E nor Employee F 
retains effective control of the calculation of Employer V's net income 
or the amount that the respective employee will not be paid due to 
application of the limit, the plan provides for a schedule of payments 
upon a separation from service that complies with this section.
    Example 6. Employee G provides services as an employee of Employer 
U, but is not a specified employee. As a bona fide part of this 
employment relationship, Employee G provides professional services to 
clients of Employer U as part of the bona fide, ordinary course of 
Employer U's trade or business. Under an arrangement between Employee G 
and Employer U, Employer U agrees to pay Employee G upon Employee G's 
separation from service an amount equal to 5% of any amount collected 
from Company T, a client of Employer U for which Employee G performed 
services during his employment with Employer U, during the 36 months 
following Employee G's separation from service. Under the arrangement, 
the amounts due to Employee G based upon payments received by Employer U 
during any calendar year are payable to Employee G on April 1 of the 
subsequent calendar year. Provided that Employee G does not have 
effective control of Employer U, Company T, or the collection of any 
amounts due Employer Y from Company T, the arrangement provides for a 
schedule of payments upon a separation from service that complies with 
this section.
    Example 7. Employee H provides services as an employee of Employer 
S, but is not a specified employee. Under a plan sponsored by Employer 
S, Employee H has a legally binding right upon a separation from service 
to the reimbursement of country club dues paid in the calendar year of 
the separation from service and each of the next 3 calendar years 
following the separation from service in an amount not to exceed $30,000 
in any calendar year, provided that the amount of

[[Page 675]]

dues paid in any calendar year that are eligible for reimbursement 
equals only the amount actually expended during such calendar year, and 
the maximum amount available for reimbursement in any calendar year will 
not be increased or decreased to reflect the amount expended or 
reimbursed in a prior or subsequent calendar year. The plan further 
provides that any reimbursement must be paid to Employee H by December 
31 of the calendar year following the year in which Employee H pays the 
country club dues. The reimbursement plan provides for a schedule of 
payments upon a separation from service that complies with this section.
    Example 8. Employee J provides services as an employee of Employer 
Q, but is not a specified employee. Under a plan sponsored by Employer 
Q, Employee J has a legally binding right upon a separation from service 
to the reimbursement of country club dues paid during the calendar year 
in which the separation from service occurs and the next 3 calendar 
years in a total amount not to exceed $90,000. The plan further provides 
that any reimbursement must be paid to Employee J by December 31 of the 
calendar year following the year in which Employee J pays the country 
club dues. Because the reimbursement of a payment of country club dues 
in one calendar year may affect the amount of country club dues 
available for reimbursement in another calendar year, the plan does not 
provide for a schedule of payments upon a separation from service that 
complies with this section.

    (2) Separation from service--required delay in payment to a 
specified employee pursuant to a separation from service--(i) In 
general. In the case of any service provider who is a specified employee 
(as defined in Sec. 1.409A-1(i)) as of the date of a separation from 
service, the requirements of paragraph (a)(1) of this section permitting 
a payment upon a separation from service are satisfied only if payments 
may not be made before the date that is six months after the date of 
separation from service (or, if earlier than the end of the six-month 
period, the date of death of the specified employee). For this purpose, 
a service provider who is not a specified employee as of the date of a 
separation from service will not be treated as subject to this 
requirement even if the service provider would have become a specified 
employee if the service provider had continued to provide services 
through the next specified employee effective date. Similarly, a service 
provider who is treated as a specified employee as of the date of a 
separation from service will be subject to this requirement even if the 
service provider would not have been treated as a specified employee 
after the next specified employee effective date had the specified 
employee continued providing services through the next specified 
employee effective date. Notwithstanding the foregoing, this paragraph 
(i)(2)(i) does not apply to a payment made under the circumstances 
described in paragraph (j)(4)(ii) (domestic relations order), 
(j)(4)(iii) (conflicts of interest), or (j)(4)(vi) (payment of 
employment taxes) of this section.
    (ii) Application of payment rules to delayed payments. The required 
delay in payment is met if payments to which a specified employee would 
otherwise be entitled during the first six months following the date of 
separation from service are accumulated and paid on the first day of the 
seventh month following the date of separation from service, or if each 
payment to which a specified employee is otherwise entitled upon a 
separation from service is delayed by six months. A service recipient 
may retain discretion to choose which method will be implemented, 
provided that no direct or indirect election as to the method may be 
provided to the service provider. For an affected specified employee, a 
date upon which the plan or the service recipient designates that the 
payment will be made after the six-month delay is treated as a fixed 
payment date for purposes of paragraph (d) of this section once the 
separation from service has occurred.
    (3) Unforeseeable emergency--(i) Definition. For purposes of 
Sec. Sec. 1.409A-1 and 1.409A-2, this section, and Sec. Sec. 1.409A-4 
through 1.409A-6, an unforeseeable emergency is a severe financial 
hardship to the service provider resulting from an illness or accident 
of the service provider, the service provider's spouse, the service 
provider's beneficiary, or the service provider's dependent (as defined 
in section 152, without regard to section 152(b)(1), (b)(2), and 
(d)(1)(B)); loss of the service provider's property due to casualty 
(including the need to rebuild a home following damage to a home not 
otherwise covered by insurance, for example, not as a result of a

[[Page 676]]

natural disaster); or other similar extraordinary and unforeseeable 
circumstances arising as a result of events beyond the control of the 
service provider. For example, the imminent foreclosure of or eviction 
from the service provider's primary residence may constitute an 
unforeseeable emergency. In addition, the need to pay for medical 
expenses, including non-refundable deductibles, as well as for the costs 
of prescription drug medication, may constitute an unforeseeable 
emergency. Finally, the need to pay for the funeral expenses of a 
spouse, a beneficiary, or a dependent (as defined in section 152, 
without regard to section 152(b)(1), (b)(2), and (d)(1)(B)) may also 
constitute an unforeseeable emergency. Except as otherwise provided in 
this paragraph (i)(3)(i), the purchase of a home and the payment of 
college tuition are not unforeseeable emergencies. Whether a service 
provider is faced with an unforeseeable emergency permitting a 
distribution under this paragraph (i)(3)(i) is to be determined based on 
the relevant facts and circumstances of each case, but, in any case, a 
distribution on account of unforeseeable emergency may not be made to 
the extent that such emergency is or may be relieved through 
reimbursement or compensation from insurance or otherwise, by 
liquidation of the service provider's assets, to the extent the 
liquidation of such assets would not cause severe financial hardship, or 
by cessation of deferrals under the plan. A plan may provide for a 
payment upon a specific type or types of unforeseeable emergency, 
without providing for payment upon all unforeseeable emergencies, 
provided that any event upon which a payment may be made qualifies as an 
unforeseeable emergency.
    (ii) Amount of payment permitted upon an unforeseeable emergency. 
Distributions because of an unforeseeable emergency must be limited to 
the amount reasonably necessary to satisfy the emergency need (which may 
include amounts necessary to pay any Federal, state, local, or foreign 
income taxes or penalties reasonably anticipated to result from the 
distribution). Determinations of amounts reasonably necessary to satisfy 
the emergency need must take into account any additional compensation 
that is available if the plan provides for cancellation of a deferral 
election upon a payment due to an unforeseeable emergency. See paragraph 
(j)(4)(viii) of this section. However, the determination of amounts 
reasonably necessary to satisfy the emergency need is not required to 
take into account any additional compensation that is available from a 
qualified employer plan as defined in Sec. 1.409A-1(a)(2) (including 
any amount available by obtaining a loan under the plan), or that due to 
the unforeseeable emergency is available under another nonqualified 
deferred compensation plan (including a plan that would provide for 
deferred compensation except due to the application of the effective 
date provisions under Sec. 1.409A-6). The payment may be made from any 
plan in which the service provider participates that provides for 
payment upon an unforeseeable emergency, provided that the plan under 
which the payment was made must be designated at the time of payment.
    (iii) Payments due to an unforeseeable emergency. A service provider 
may retain discretion with respect to whether to apply for a payment 
upon an unforeseeable emergency, and a service recipient may retain 
discretion with respect to whether to make a payment available under the 
plan due to an unforeseeable emergency. A service provider who has 
experienced an unforeseeable emergency will not be treated as making a 
subsequent deferral election under Sec. 1.409A-2(b) (subsequent 
deferral election rules) if the service provider does not apply for or 
elect to receive a payment available under the plan. A service recipient 
will not be treated as making a subsequent deferral election under Sec. 
1.409A-2(b) (subsequent deferral election rules) if the service 
recipient exercises its discretion not to make a payment otherwise 
available due to an unforeseeable emergency.
    (4) Disability--(i) In general. For purposes of Sec. Sec. 1.409A-1 
and 1.409A-2, this section, and Sec. Sec. 1.409A-4 through 1.409A-6, 
except as otherwise specifically provided, a service provider is 
considered disabled if the service provider meets one of the following 
requirements:

[[Page 677]]

    (A) The service provider is unable to engage in any substantial 
gainful activity by reason of any medically determinable physical or 
mental impairment that can be expected to result in death or can be 
expected to last for a continuous period of not less than 12 months.
    (B) The service provider is, by reason of any medically determinable 
physical or mental impairment that can be expected to result in death or 
can be expected to last for a continuous period of not less than 12 
months, receiving income replacement benefits for a period of not less 
than three months under an accident and health plan covering employees 
of the service provider's employer.
    (ii) Limited plan definition of disability. A plan may provide for a 
payment upon any disability, and need not provide for a payment upon all 
disabilities, provided that any disability upon which a payment may be 
made under the plan complies with the provisions of this paragraph 
(i)(4).
    (iii) Determination of disability. A plan may provide that a service 
provider will be deemed disabled if determined to be totally disabled by 
the Social Security Administration or Railroad Retirement Board. A plan 
may also provide that a service provider will be deemed disabled if 
determined to be disabled in accordance with a disability insurance 
program, provided that the definition of disability applied under such 
disability insurance program complies with the requirements of this 
paragraph (i)(4).
    (5) Change in the ownership or effective control of a corporation, 
or a change in the ownership of a substantial portion of the assets of a 
corporation--(i) In general. Pursuant to section 409A(a)(2)(A)(v), a 
plan may permit a payment upon the occurrence of a change in the 
ownership of the corporation (as defined in paragraph (i)(5)(v) of this 
section), a change in effective control of the corporation (as defined 
in paragraph (i)(5)(vi) of this section), or a change in the ownership 
of a substantial portion of the assets of the corporation (as defined in 
paragraph (i)(5)(vii) of this section) (collectively referred to as a 
change in control event). To qualify as a change in control event, the 
occurrence of the event must be objectively determinable and any 
requirement that any other person or group, such as a plan administrator 
or compensation committee, certify the occurrence of a change in control 
event must be strictly ministerial and not involve any discretionary 
authority. The plan may provide for a payment on a particular type or 
types of change in control events, and need not provide for a payment on 
all such events, provided that each event upon which a payment is 
provided qualifies as a change in control event. For rules regarding the 
ability of the service recipient to terminate the plan and pay amounts 
of deferred compensation upon a change in control event, see paragraph 
(j)(4)(ix)(B) of this section.
    (ii) Identification of relevant corporation--(A) In general. To 
constitute a change in control event with respect to the service 
provider, the change in control event must relate to--
    (1) The corporation for whom the service provider is performing 
services at the time of the change in control event;
    (2) The corporation that is liable for the payment of the deferred 
compensation (or all corporations liable for the payment if more than 
one corporation is liable) but only if either the deferred compensation 
is attributable to the performance of service by the service provider 
for such corporation (or corporations) or there is a bona fide business 
purpose for such corporation or corporations to be liable for such 
payment and, in either case, no significant purpose of making such 
corporation or corporations liable for such payment is the avoidance of 
Federal income tax; or
    (3) A corporation that is a majority shareholder of a corporation 
identified in paragraph (i)(5)(ii)(A)(1) or (2) of this section, or any 
corporation in a chain of corporations in which each corporation is a 
majority shareholder of another corporation in the chain, ending in a 
corporation identified in paragraph (i)(5)(ii)(A)(1) or (2) of this 
section.
    (B) Majority shareholder. For purposes of this paragraph (i)(5)(ii), 
a majority shareholder is a shareholder owning more than 50 percent of 
the total fair

[[Page 678]]

market value and total voting power of such corporation.
    (C) Example. The following example illustrates the rules of this 
paragraph (i)(5)(ii):

    Example. Corporation A is a majority shareholder of Corporation B, 
which is a majority shareholder of Corporation C. A change in ownership 
of Corporation B constitutes a change in control event to service 
providers performing services for Corporation B or Corporation C, and to 
service providers for which Corporation B or Corporation C is solely 
liable for payments under the plan (for example, former employees), but 
is not a change in control event as to Corporation A or any other 
corporation of which Corporation A is a majority shareholder unless the 
sale constitutes a change in the ownership of a substantial portion of 
Corporation A's assets (see paragraph (i)(5)(vii) of this section).

    (iii) Attribution of stock ownership. For purposes of paragraph 
(i)(5) of this section, section 318(a) applies to determine stock 
ownership. Stock underlying a vested option is considered owned by the 
individual who holds the vested option (and the stock underlying an 
unvested option is not considered owned by the individual who holds the 
unvested option). For purposes of the preceding sentence, however, if a 
vested option is exercisable for stock that is not substantially vested 
(as defined by Sec. 1.83-3(b) and (j)), the stock underlying the option 
is not treated as owned by the individual who holds the option.
    (iv) Special rules for certain delayed payments pursuant to a change 
in control event--(A) Certain transaction-based compensation. Payments 
of compensation related to a change in control event described in 
paragraph (i)(5)(v) of this section (change in the ownership of a 
corporation) or paragraph (i)(5)(vii) of this section (change in the 
ownership of a substantial portion of a corporation's assets), that 
occur because a service recipient purchases its stock held by the 
service provider or because the service recipient or a third party 
purchases a stock right held by a service provider, or that are 
calculated by reference to the value of stock of the service recipient 
(collectively, transaction-based compensation), may be treated as paid 
at a designated date or pursuant to a payment schedule that complies 
with the requirements of section 409A if the transaction-based 
compensation is paid on the same schedule and under the same terms and 
conditions as apply to payments to shareholders generally with respect 
to stock of the service recipient pursuant to a change in control event 
described in paragraph (i)(5)(v) of this section (change in the 
ownership of a corporation) or as apply to payments to the service 
recipient pursuant to a change in control event described in paragraph 
(i)(5)(vii) of this section (change in the ownership of a substantial 
portion of a corporation's assets), and to the extent that the 
transaction-based compensation is paid not later than five years after 
the change in control event, the payment of such compensation will not 
violate the initial or subsequent deferral election rules set out in 
Sec. 1.409A-2(a) and (b) solely as a result of such transaction-based 
compensation being paid pursuant to such schedule and terms and 
conditions. If before and in connection with a change in control event 
described in paragraph (i)(5)(v) or (i)(5)(vii) of this section, 
transaction-based compensation that would otherwise be payable as a 
result of such event is made subject to a condition on payment that 
constitutes a substantial risk of forfeiture (as defined in Sec. 
1.409A-1(d), without regard to the provisions of that section under 
which additions or extensions of forfeiture conditions are disregarded) 
and the transaction-based compensation is payable under the same terms 
and conditions as apply to payments made to shareholders generally with 
respect to stock of the service recipient pursuant to a change in 
control event described in paragraph (i)(5)(v) of this section or to 
payments to the service recipient pursuant to a change in control event 
described in paragraph (i)(5)(vii) of this section, for purposes of 
determining whether such transaction-based compensation is a short-term 
deferral the requirements of Sec. 1.409A-1(b)(4) are applied as if the 
legally binding right to such transaction-based compensation arose on 
the date that it became subject to such substantial risk of forfeiture.
    (B) Certain nonvested compensation. Notwithstanding the provisions 
of Sec. 1.409A-1(d) (definition of a substantial

[[Page 679]]

risk of forfeiture) that disregard the extension or modification of a 
condition for purposes of determining whether a condition on payment 
constitutes a substantial risk of forfeiture, a condition that is a 
substantial risk of forfeiture that otherwise would lapse as a result of 
a change in control event described in paragraph (i)(5)(v) or 
(i)(5)(vii) of this section may be extended or modified before and in 
connection with such event to provide for a condition on payment that 
will not lapse as a result of such change in control event, and such 
extended or modified condition will be treated as continuing to subject 
the amount to a substantial risk of forfeiture, provided that the 
transaction constituting the change in control event is a bona fide 
arm's length transaction between the service recipient or its 
shareholders and one or more parties who are unrelated to the service 
recipient and service provider (applying the rules of Sec. 1.409A-
1(f)(2)(ii)) and the modified or extended condition to which the payment 
is subject would otherwise be treated as a substantial risk of 
forfeiture under Sec. 1.409A-1(d) (without regard to the provisions 
disregarding additions or extensions of forfeiture conditions). In such 
a case, the continued application of a fixed schedule of payments based 
upon the lapse of the substantial risk of forfeiture, so that payments 
commence upon the lapse of the modified or extended condition on 
payment, will not be treated as a change in the fixed schedule of 
payments for purposes of Sec. 1.409A-2(b) (subsequent deferral 
elections) or paragraph (j) of this section (prohibition on the 
acceleration of payments).
    (v) Change in the ownership of a corporation--(A) In general. Except 
as provided in paragraph (i)(5)(vi)(C) of this section, a change in the 
ownership of a corporation occurs on the date that any one person, or 
more than one person acting as a group (as defined in paragraph 
(i)(5)(v)(B) of this section), acquires ownership of stock of the 
corporation that, together with stock held by such person or group, 
constitutes more than 50 percent of the total fair market value or total 
voting power of the stock of such corporation. A nonqualified deferred 
compensation plan may provide that amounts payable upon a change in the 
ownership of a corporation will be paid only if the conditions in the 
preceding sentence are satisfied but substituting a percentage specified 
in the plan that is higher than 50 percent for the words ``50 percent'' 
in the preceding sentence, but only if the provision is set forth in the 
plan no later than the date by which the time and form of payment must 
be established under Sec. 1.409A-2. However, if any one person, or more 
than one person acting as a group, is considered to own more than 50 
percent of the total fair market value or total voting power of the 
stock of a corporation (or such higher percentage specified in 
accordance with the preceding sentence), the acquisition of additional 
stock by the same person or persons is not considered to cause a change 
in the ownership of the corporation (or to cause a change in the 
effective control of the corporation (within the meaning of paragraph 
(i)(5)(vi) of this section)). An increase in the percentage of stock 
owned by any one person, or persons acting as a group, as a result of a 
transaction in which the corporation acquires its stock in exchange for 
property will be treated as an acquisition of stock for purposes of this 
section. This section applies only when there is a transfer of stock of 
a corporation (or issuance of stock of a corporation) and stock in such 
corporation remains outstanding after the transaction (see paragraph 
(i)(5)(vii) of this section for rules regarding the transfer of assets 
of a corporation). See Sec. 1.280G-1, Q&A-27(d), Example 1, Example 2, 
Example 5, and Example 6.
    (B) Persons acting as a group. For purposes of paragraph 
(i)(5)(v)(A) of this section, persons will not be considered to be 
acting as a group solely because they purchase or own stock of the same 
corporation at the same time, or as a result of the same public 
offering. However, persons will be considered to be acting as a group if 
they are owners of a corporation that enters into a merger, 
consolidation, purchase or acquisition of stock, or similar business 
transaction with the corporation. If a person, including an entity, owns 
stock in both corporations that enter into a

[[Page 680]]

merger, consolidation, purchase or acquisition of stock, or similar 
transaction, such shareholder is considered to be acting as a group with 
other shareholders only with respect to the ownership in that 
corporation before the transaction giving rise to the change and not 
with respect to the ownership interest in the other corporation. See 
Sec. 1.280G-1, Q&A-27(d), Example 3 and Example 4.
    (vi) Change in the effective control of a corporation--(A) In 
general. Notwithstanding that a corporation has not undergone a change 
in ownership under paragraph (i)(5)(v) of this section, a change in the 
effective control of the corporation occurs only on either of the 
following dates:
    (1) The date any one person, or more than one person acting as a 
group (as determined under paragraph (i)(5)(v)(B) of this section), 
acquires (or has acquired during the 12-month period ending on the date 
of the most recent acquisition by such person or persons) ownership of 
stock of the corporation possessing 30 percent or more of the total 
voting power of the stock of such corporation. A nonqualified deferred 
compensation plan may provide that amounts payable upon an effective 
change in control of a corporation will be paid only if the conditions 
in the preceding sentence are satisfied but substituting a percentage 
specified in the plan that is higher than 30 percent for the word ``30 
percent'' in the preceding sentence, but only if the percentage is set 
forth in the plan no later than the date by which the time and form of 
payment must be established under Sec. 1.409A-2).
    (2) The date a majority of members of the corporation's board of 
directors is replaced during any 12-month period by directors whose 
appointment or election is not endorsed by a majority of the members of 
the corporation's board of directors before the date of the appointment 
or election, provided that for purposes of this paragraph (i)(5)(vi)(A) 
the term corporation refers solely to the relevant corporation 
identified in paragraph (i)(5)(ii) of this section for which no other 
corporation is a majority shareholder for purposes of that paragraph. 
For example, if Corporation A is a publicly held corporation with no 
majority shareholder, and Corporation A is the majority shareholder of 
Corporation B, which is the majority shareholder of Corporation C, the 
term corporation for purposes of this paragraph (i)(5)(vi)(A)(2) would 
refer solely to Corporation A. A nonqualified deferred compensation plan 
may provide that amounts payable upon a change in the effective control 
of a corporation will be paid only if the conditions in the first 
sentence of this paragraph are satisfied substituting a portion of the 
members of the corporation's board of directors that is higher than the 
words ``a majority of the members of the corporation's board of 
directors'' in the first sentence of this paragraph, but only if the 
higher portion is set forth in the plan no later than the date by which 
the time and form of payment must be established under Sec. 1.409A-
2(a)).
    (B) Multiple change in control events. A change in effective control 
may occur in a transaction in which one of the two corporations involved 
in the transaction has a change in control event under paragraph 
(i)(5)(v) or (i)(5)(vii) of this section. Thus, for example, assume 
Corporation P transfers more than 40 percent of the total gross fair 
market value of its assets to Corporation O in exchange for 35 percent 
of O's stock. P has undergone a change in ownership of a substantial 
portion of its assets under paragraph (i)(5)(vii) of this section and O 
has a change in effective control under this paragraph (i)(5)(vi).
    (C) Acquisition of additional control. If any one person, or more 
than one person acting as a group, is considered to effectively control 
a corporation (within the meaning of this paragraph (i)(5)(vi)), the 
acquisition of additional control of the corporation by the same person 
or persons is not considered to cause a change in the effective control 
of the corporation (or to cause a change in the ownership of the 
corporation within the meaning of paragraph (i)(5)(v) of this section).
    (D) Persons acting as a group. Persons will not be considered to be 
acting as a group solely because they purchase or own stock of the same 
corporation at the same time, or as a result of the same public 
offering. However, persons will be considered to be acting as a

[[Page 681]]

group if they are owners of a corporation that enters into a merger, 
consolidation, purchase or acquisition of stock, or similar business 
transaction with the corporation. If a person, including an entity, owns 
stock in both corporations that enter into a merger, consolidation, 
purchase or acquisition of stock, or similar transaction, such 
shareholder is considered to be acting as a group with other 
shareholders in a corporation only with respect to the ownership in that 
corporation before the transaction giving rise to the change and not 
with respect to the ownership interest in the other corporation. See 
Sec. 1.280G-1, Q&A-27(d), Example 4.
    (vii) Change in the ownership of a substantial portion of a 
corporation's assets--(A) In general. A change in the ownership of a 
substantial portion of a corporation's assets occurs on the date that 
any one person, or more than one person acting as a group (as determined 
in paragraph (i)(5)(v)(B) of this section), acquires (or has acquired 
during the 12-month period ending on the date of the most recent 
acquisition by such person or persons) assets from the corporation that 
have a total gross fair market value equal to or more than 40 percent of 
the total gross fair market value of all of the assets of the 
corporation immediately before such acquisition or acquisitions (or such 
higher amount specified by the plan no later than the date by which the 
time and form of payment must be established under Sec. 1.409A-2). For 
this purpose, gross fair market value means the value of the assets of 
the corporation, or the value of the assets being disposed of, 
determined without regard to any liabilities associated with such 
assets.
    (B) Transfers to a related person--(1) There is no change in control 
event under this paragraph (i)(5)(vii) when there is a transfer to an 
entity that is controlled by the shareholders of the transferring 
corporation immediately after the transfer, as provided in this 
paragraph (i)(5)(vii)(B). A transfer of assets by a corporation is not 
treated as a change in the ownership of such assets if the assets are 
transferred to--
    (i) A shareholder of the corporation (immediately before the asset 
transfer) in exchange for or with respect to its stock;
    (ii) An entity, 50 percent or more of the total value or voting 
power of which is owned, directly or indirectly, by the corporation;
    (iii) A person, or more than one person acting as a group, that 
owns, directly or indirectly, 50 percent or more of the total value or 
voting power of all the outstanding stock of the corporation; or
    (iv) An entity, at least 50 percent of the total value or voting 
power of which is owned, directly or indirectly, by a person described 
in paragraph (i)(5)(vii)(B)(1)(iii) of this section.
    (2) For purposes of this paragraph (i)(5)(vii)(B) and except as 
otherwise provided in this paragraph (i), a person's status is 
determined immediately after the transfer of the assets. For example, a 
transfer to a corporation in which the transferor corporation has no 
ownership interest before the transaction, but that is a majority-owned 
subsidiary of the transferor corporation after the transaction is not 
treated as a change in the ownership of the assets of the transferor 
corporation.
    (C) Persons acting as a group. Persons will not be considered to be 
acting as a group solely because they purchase assets of the same 
corporation at the same time. However, persons will be considered to be 
acting as a group if they are owners of a corporation that enters into a 
merger, consolidation, purchase or acquisition of assets, or similar 
business transaction with the corporation. If a person, including an 
entity shareholder, owns stock in both corporations that enter into a 
merger, consolidation, purchase or acquisition of assets, or similar 
transaction, such shareholder is considered to be acting as a group with 
other shareholders in a corporation only to the extent of the ownership 
in that corporation before the transaction giving rise to the change and 
not with respect to the ownership interest in the other corporation. See 
Sec. 1.280G-1, Q&A-27(d), Example 4.
    (6) Certain back-to-back arrangements--(i) In general. This 
paragraph (i)(6) applies where a service provider is

[[Page 682]]

providing services to a service recipient (the intermediate service 
recipient), who in turn is providing services to another service 
recipient (the ultimate service recipient), the services provided by the 
service provider to the intermediate service recipient are closely 
related to the services provided by the intermediate service recipient 
to the ultimate service recipient, there is a nonqualified deferred 
compensation plan providing for payments by the ultimate service 
recipient to the intermediate service recipient (the ultimate service 
recipient plan), there is a nonqualified deferred compensation plan or 
other agreement, method, program, or other arrangement providing for 
payments of compensation by the intermediate service recipient to the 
service provider (the intermediate service recipient plan), and the 
intermediate service recipient plan provides for a payment upon the 
occurrence of an event described in paragraph (a)(1), (2), (3), (5), or 
(6) of this section. In such a case, notwithstanding the generally 
applicable limits on payments in paragraph (a) of this section, the 
ultimate service recipient plan may provide for a payment to the 
intermediate service recipient upon the occurrence of a payment event 
under the intermediate service recipient plan described in paragraph 
(a)(1), (2), (3), (5), or (6) of this section if the time and form of 
payment is defined as the same time and form of payment provided under 
the intermediate service recipient plan, the amount of the payment under 
the ultimate service recipient plan does not exceed the amount of the 
payment under the intermediate service recipient plan, and the ultimate 
service recipient plan and the intermediate service recipient plan 
otherwise satisfy the requirements of section 409A (regardless of 
whether such plan is subject to section 409A).
    (ii) Example. The provisions of paragraph (i)(6)(i) of this section 
are illustrated by the following example:

    Example. Company B (intermediate service recipient) provides 
services to Company C (ultimate service recipient). Employee A (service 
provider) provides services to Company B that are closely related to the 
services Company B provides to Company C. Pursuant to a nonqualified 
deferred compensation plan meeting the requirements of section 409A, 
Employee A is entitled to a payment of deferred compensation upon a 
separation from service with Company B (the intermediate service 
recipient plan). Under an arrangement between Company B and Company C 
(the ultimate service recipient plan), Company C agrees to pay an amount 
of deferred compensation to Company B upon Employee A's separation from 
service with Company B, in accordance with the time, form and amount of 
payment provided in the intermediate service recipient plan. Provided 
that the intermediate service recipient plan and the ultimate service 
recipient plan otherwise comply with the requirements of section 409A 
(regardless of whether such arrangements are subject to section 409A), 
Company C's payment to Company B of the amount due under the ultimate 
service recipient plan upon the separation from service of Employee A 
from Company B may constitute a permissible payment event for purposes 
of paragraph (a) of this section.

    (j) Prohibition on acceleration of payments--(1) In general. Except 
as provided in paragraph (j)(4) of this section, a nonqualified deferred 
compensation plan may not permit the acceleration of the time or 
schedule of any payment or amount scheduled to be paid pursuant to the 
terms of the plan, and no such accelerated payment may be made whether 
or not provided for under the terms of such plan. For purposes of 
determining whether a payment of deferred compensation has been made, 
the rules of paragraph (f) of this section (substituted payments) apply. 
For purposes of this paragraph (j), an impermissible acceleration does 
not occur if payment is made in accordance with plan provisions or an 
election as to the time and form of payment in effect at the time of 
initial deferral (or added in accordance with the rules applicable to 
subsequent deferral elections under Sec. 1.409A-2(b)) pursuant to which 
payment is required to be made on an accelerated schedule as a result of 
an intervening event that is an event described in paragraph (a)(1), 
(2), (3), (5), or (6) of this section. For example, a plan may provide 
that a participant will receive six installment payments commencing at 
separation from service, and also provide that if the participant dies 
after such payments commence but before all payments have been made, all 
remaining amounts will be paid in a lump sum

[[Page 683]]

payment. Additionally, it is not an acceleration of the time or schedule 
of payment of a deferral of compensation if a service recipient waives 
or accelerates the satisfaction of a condition constituting a 
substantial risk of forfeiture applicable to such deferral of 
compensation, provided that the requirements of section 409A (including 
the requirement that the payment be made upon a permissible payment 
event) are otherwise satisfied with respect to such deferral of 
compensation. For example, if a nonqualified deferred compensation plan 
provides for a lump sum payment of the vested benefit upon separation 
from service, and the benefit vests under the plan only after 10 years 
of service, it is not a violation of the requirements of section 409A if 
the service recipient reduces the vesting requirement to five years of 
service, even if a service provider becomes vested as a result and 
receives a payment in connection with a separation from service before 
the service provider would have completed 10 years of service. However, 
if the plan in this example had provided for a payment at a fixed date, 
rather than at separation from service, the date of payment could not be 
accelerated due to the accelerated vesting. For the definition of a 
payment for purposes of this paragraph (j), see Sec. 1.409A-2(b)(5) 
(coordination of the subsequent deferral election rules with the 
prohibition on acceleration of payments). For other permissible 
payments, see Sec. 1.409A-2(b)(2)(iii) (certain immediate payments of 
remaining installments) and paragraph (d) of this section (certain 
payments made no more than 30 days before the designated payment date).
    (2) Application to multiple payment events. Generally, the addition 
of a permissible payment event, the deletion of a permissible payment 
event, or the substitution of one permissible payment event for another 
permissible payment event, results in an acceleration of a payment if 
the addition, deletion, or substitution could result in the payment 
being made at an earlier date than such payment would have been made 
absent such addition, deletion, or substitution. Notwithstanding the 
previous sentence, the addition of death, disability (as defined in 
paragraph (i)(4) of this section), or an unforeseeable emergency (as 
defined in paragraph (i)(3) of this section), as a potentially earlier 
alternative payment event to an amount previously deferred will not be 
treated as resulting in an acceleration of a payment, even if such 
addition results in the payment being paid at an earlier time than such 
payment would have been made absent the addition of the payment event. 
However, the addition of such a payment event as a potentially later 
alternative payment event generally is subject to the rules governing 
changes in the time and form of payment (see Sec. 1.409A-2(b)).
    (3) Beneficiaries. The rules of this paragraph (j) apply to 
elections by beneficiaries with respect to the time and form of payment, 
as well as elections by service providers or service recipients with 
respect to the time and form of payment to beneficiaries. An election to 
change the identity of a beneficiary does not constitute an acceleration 
of a payment merely because the election changes the identity of the 
recipient of the payment, if the time and form of the payment is not 
otherwise changed. In addition, an election before the commencement of a 
life annuity to change the identity of a beneficiary does not constitute 
an acceleration of a payment if the change in the time of payments stems 
solely from the different life expectancy of the new beneficiary, such 
as in the case of a joint and survivor annuity, and does not change the 
commencement date of the life annuity.
    (4) Exceptions--(i) In general. Except as otherwise expressly 
provided, a plan may provide for the acceleration of a payment in 
accordance with paragraphs (j)(4)(ii) through (xiv) of this section, or 
may provide a service recipient discretion to accelerate payments in 
accordance with the provisions of paragraphs (j)(4)(ii) through (xiv) of 
this section. A plan may not provide a service provider discretion with 
respect to whether a payment will be accelerated, and a service 
recipient may not provide a service provider a direct or indirect 
election as to whether the service recipient's discretion to accelerate 
a payment will be exercised, even if such acceleration would be 
permitted under paragraphs (j)(4)(ii)

[[Page 684]]

through (xiv) of this section. Whether a service recipient has provided 
a service provider an election as to whether the service recipient's 
discretion to accelerate a payment will be exercised is determined based 
on all the facts and circumstances, including whether similarly situated 
service providers have been treated differently. Except as otherwise 
provided in paragraphs (j)(4)(ii) through (xiv) of this section, the 
plan need not set forth the exception in writing, and provided all other 
requirements of this section are met, the making of such a payment or 
the addition of a plan term permitting the making of such a payment will 
not constitute the acceleration of a payment, and the failure to make 
such a payment or the deletion or modification of a plan term permitting 
the making of such a payment will not be subject to the rules regarding 
a change in the time and form of payment under Sec. 1.409A-2(b).
    (ii) Domestic relations order. A plan may provide for acceleration 
of the time or schedule of a payment under the plan to an individual 
other than the service provider, or a payment under such plan may be 
made to an individual other than the service provider, to the extent 
necessary to fulfill a domestic relations order (as defined in section 
414(p)(1)(B)).
    (iii) Conflicts of interest--(A) Compliance with ethics agreements 
with the Federal government. A plan may provide for acceleration of the 
time or schedule of a payment under the plan, or a payment may be made 
under a plan, to the extent necessary for any Federal officer or 
employee in the executive branch to comply with an ethics agreement with 
the Federal government.
    (B) Compliance with ethics laws or conflicts of interest laws. A 
plan may provide for acceleration of the time or schedule of a payment 
under the plan, or a payment may be made under a plan, to the extent 
reasonably necessary to avoid the violation of an applicable Federal, 
state, local, or foreign ethics law or conflicts of interest law 
(including where such payment is reasonably necessary to permit the 
service provider to participate in activities in the normal course of 
his or her position in which the service provider would otherwise not be 
able to participate under an applicable rule). A payment is reasonably 
necessary to avoid the violation of a Federal, state, local, or foreign 
ethics law or conflicts of interest law if the payment is a necessary 
part of a course of action that results in compliance with a Federal, 
state, local, or foreign ethics law or conflicts of interest law that 
would be violated absent such course of action, regardless of whether 
other actions would also result in compliance with the Federal, state, 
local, or foreign ethics law or conflicts of interest law. For this 
purpose, a provision of foreign law is considered applicable only to 
foreign earned income (as defined under section 911(b)(1) without regard 
to section 911(b)(1)(B)(iv) and without regard to the requirement that 
the income be attributable to services performed during the period 
described in section 911(d)(1)(A) or (B)) from sources within the 
foreign country that promulgated such law.
    (iv) Section 457 plans. A plan subject to section 457(f) may provide 
for an acceleration of the time or schedule of a payment to a service 
provider, or a payment may be made under such a plan, to pay Federal, 
state, local, and foreign income taxes due upon a vesting event, 
provided that the amount of such payment is not more than an amount 
equal to the Federal, state, local, and foreign income tax withholding 
that would have been remitted by the employer if there had been a 
payment of wages equal to the income includible by the service provider 
under section 457(f) at the time of the vesting.
    (v) Limited cashouts. A plan may require or provide a service 
recipient discretion to require (or be amended to require or to provide 
a service recipient discretion to require), a mandatory lump sum payment 
of amounts deferred under the plan that do not exceed a specified 
amount, provided that such plan term or amendment is executed and 
effective, and any required exercise of service recipient discretion is 
evidenced in writing, no later than the date of such payment, and 
provided that--
    (A) The payment results in the termination and liquidation of the 
entirety of the service provider's interest

[[Page 685]]

under the plan, including all agreements, methods, programs, or other 
arrangements with respect to which deferrals of compensation are treated 
as having been deferred under a single nonqualified deferred 
compensation plan under Sec. 1.409A-1(c)(2); and
    (B) The payment is not greater than the applicable dollar amount 
under section 402(g)(1)(B).
    (vi) Payment of employment taxes. A plan may provide for the 
acceleration of the time or schedule of a payment, or a payment may be 
made under the plan, to pay the Federal Insurance Contributions Act 
(FICA) tax imposed under section 3101, section 3121(a), and section 
3121(v)(2), or the Railroad Retirement Act tax imposed under section 
3201, section 3211, section 3231(e)(1), and section 3231(e)(8), where 
applicable, on compensation deferred under the plan (the FICA or RRTA 
amount). Additionally, a plan may provide for the acceleration of the 
time or schedule of a payment, or a payment may be made under the plan, 
to pay the income tax at source on wages imposed under section 3401 or 
the corresponding withholding provisions of applicable state, local, or 
foreign tax laws as a result of the payment of the FICA or RRTA amount, 
and to pay the additional income tax at source on wages attributable to 
the pyramiding section 3401 wages and taxes. However, the total payment 
under this acceleration provision must not exceed the aggregate of the 
FICA or RRTA amount, and the income tax withholding related to such FICA 
or RRTA amount.
    (vii) Payment upon income inclusion under section 409A. A plan may 
provide for the acceleration of the time or schedule of a payment, or a 
payment under such plan may be made, at any time the plan fails to meet 
the requirements of section 409A and these regulations. Such payment may 
not exceed the amount required to be included in income as a result of 
the failure to comply with the requirements of section 409A and these 
regulations.
    (viii) Cancellation of deferrals following an unforeseeable 
emergency or hardship distribution. A plan may provide for a 
cancellation of a service provider's deferral election, or such a 
cancellation may be made, due to an unforeseeable emergency or a 
hardship distribution pursuant to Sec. 1.401(k)-1(d)(3). The deferral 
election must be cancelled, not merely postponed or otherwise delayed. 
Accordingly, any later deferral election will be subject to the 
provisions governing initial deferral elections. See Sec. 1.409A-2(a).
    (ix) Plan terminations and liquidations. A plan may provide for the 
acceleration of the time and form of a payment, or a payment under such 
plan may be made, where the acceleration of the payment is made pursuant 
to a termination and liquidation of the plan in accordance with one of 
the following:
    (A) The service recipient's termination and liquidation of the plan 
within 12 months of a corporate dissolution taxed under section 331, or 
with the approval of a bankruptcy court pursuant to 11 U.S.C. Sec. 
503(b)(1)(A), provided that the amounts deferred under the plan are 
included in the participants' gross incomes in the latest of the 
following years (or, if earlier, the taxable year in which the amount is 
actually or constructively received).
    (1) The calendar year in which the plan termination and liquidation 
occurs.
    (2) The first calendar year in which the amount is no longer subject 
to a substantial risk of forfeiture.
    (3) The first calendar year in which the payment is administratively 
practicable.
    (B) The service recipient's termination and liquidation of the plan 
pursuant to irrevocable action taken by the service recipient within the 
30 days preceding or the 12 months following a change in control event 
(as defined in paragraph (i)(5) of this section), provided that this 
paragraph will only apply to a payment under a plan if all agreements, 
methods, programs, and other arrangements sponsored by the service 
recipient immediately after the time of the change in control event with 
respect to which deferrals of compensation are treated as having been 
deferred under a single plan under Sec. 1.409A-1(c)(2) are terminated 
and liquidated with respect to each participant that experienced the 
change in control event, so that under the terms

[[Page 686]]

of the termination and liquidation all such participants are required to 
receive all amounts of compensation deferred under the terminated 
agreements, methods, programs, and other arrangements within 12 months 
of the date the service recipient irrevocably takes all necessary action 
to terminate and liquidate the agreements, methods, programs, and other 
arrangements. Solely for purposes of this paragraph (j)(4)(ix)(B), the 
applicable service recipient with the discretion to liquidate and 
terminate the agreements, methods, programs, and other arrangements is 
the service recipient that is primarily liable immediately after the 
transaction for the payment of the deferred compensation.
    (C) The service recipient's termination and liquidation of the plan, 
provided that--
    (1) The termination and liquidation does not occur proximate to a 
downturn in the financial health of the service recipient;
    (2) The service recipient terminates and liquidates all agreements, 
methods, programs, and other arrangements sponsored by the service 
recipient that would be aggregated with any terminated and liquidated 
agreements, methods, programs, and other arrangements under Sec. 
1.409A-1(c) if the same service provider had deferrals of compensation 
under all of the agreements, methods, programs, and other arrangements 
that are terminated and liquidated;
    (3) No payments in liquidation of the plan are made within 12 months 
of the date the service recipient takes all necessary action to 
irrevocably terminate and liquidate the plan other than payments that 
would be payable under the terms of the plan if the action to terminate 
and liquidate the plan had not occurred;
    (4) All payments are made within 24 months of the date the service 
recipient takes all necessary action to irrevocably terminate and 
liquidate the plan; and
    (5) The service recipient does not adopt a new plan that would be 
aggregated with any terminated and liquidated plan under Sec. 1.409A-
1(c) if the same service provider participated in both plans, at any 
time within three years following the date the service recipient takes 
all necessary action to irrevocably terminate and liquidate the plan.
    (D) Such other events and conditions as the Commissioner may 
prescribe in generally applicable guidance published in the Internal 
Revenue Bulletin (see Sec. 601.601(d)(2) of this chapter).
    (x) Certain distributions to avoid a nonallocation year under 
section 409(p). A plan may provide for an acceleration of the time and 
form of a payment, or a payment may be made under such plan, to prevent 
the occurrence of a nonallocation year (within the meaning of section 
409(p)(3)) in the plan year of an employee stock ownership plan next 
following the plan year in which such payment is made, provided that the 
amount distributed may not exceed 125 percent of the minimum amount of 
distribution necessary to avoid the occurrence of a nonallocation year. 
Solely for purposes of determining permissible distributions under this 
paragraph (j)(4)(x), synthetic equity (within the meaning of section 
409(p)(6)(C) and Sec. 1.409(p)-1(f)) granted during the plan year of 
the employee stock ownership plan in which such payment is made is 
disregarded for purposes of determining whether the subsequent plan year 
would result in a nonallocation year.
    (xi) Payment of state, local, or foreign taxes. A plan may provide 
for an acceleration of the time and form of a payment, or a payment may 
be made under such plan, to reflect payment of state, local, or foreign 
tax obligations arising from participation in the plan that apply to an 
amount deferred under the plan before the amount is paid or made 
available to the participant (the state, local, or foreign tax amount). 
Such payment may not exceed the amount of such taxes due as a result of 
participation in the plan. Such payment may be made by distributions to 
the participant in the form of withholding pursuant to provisions of 
applicable state, local, or foreign law or by distribution directly to 
the participant. Additionally, an arrangement may provide for the 
acceleration of the time or schedule of payment, or a payment may be 
made under such arrangement, to pay the income tax at source on wages 
imposed under section 3401 as

[[Page 687]]

a result of such payment and to pay the additional income tax at source 
on wages imposed under section 3401 attributable to such additional 
section 3401 wages and taxes. However, the total payment under this 
acceleration provision must not exceed the aggregate of the state, 
local, and foreign tax amount, and the income tax withholding related to 
such state, local, and foreign tax amount.
    (xii) Cancellation of deferral elections due to disability. A plan 
may provide for a cancellation of a service provider's deferral 
election, or a cancellation of such election may be made, where such 
cancellation occurs by the later of the end of the taxable year of the 
service provider or the 15th day of the third month following the date 
the service provider incurs a disability. For purposes of this 
paragraph, a disability refers to any medically determinable physical or 
mental impairment resulting in the service provider's inability to 
perform the duties of his or her position or any substantially similar 
position, where such impairment can be expected to result in death or 
can be expected to last for a continuous period of not less than six 
months.
    (xiii) Certain offsets. A plan may provide for the acceleration of 
the time or schedule of a payment, or a payment may be made under such 
plan, as satisfaction of a debt of the service provider to the service 
recipient, where such debt is incurred in the ordinary course of the 
service relationship between the service recipient and the service 
provider, the entire amount of reduction in any of the service 
recipient's taxable years does not exceed $5,000, and the reduction is 
made at the same time and in the same amount as the debt otherwise would 
have been due and collected from the service provider.
    (xiv) Bona fide disputes as to a right to a payment. A plan may 
provide for the acceleration of the time or schedule of one or more 
payments, or a payment may be made under such plan, where such payments 
occur as part of a settlement between the service provider and the 
service recipient of an arm's length, bona fide dispute as to the 
service provider's right to the deferred amount. Discretion to 
accelerate payments, other than due to an arm's length settlement of a 
bona fide dispute as to the service provider's right to the deferred 
amount, is not permitted under this paragraph (j)(4)(xiv). Whether a 
payment qualifies for the exception under this paragraph is based on all 
relevant facts and circumstances. A payment will be presumed not to meet 
this exception unless the payment is subject to a substantial reduction 
in the value of the payment made in relation to the amount that would 
have been payable had there been no dispute as to the service provider's 
right to the payment. For this purpose, a reduction that is less than 25 
percent of the present value of the deferred amount in dispute generally 
is not a substantial reduction. In addition, a payment will be presumed 
not to meet this exception if the payment is made proximate to a 
downturn in the financial health of the service recipient.
    (5) Nonqualified deferred compensation plans linked to qualified 
employer plans or certain other arrangements. If a nonqualified deferred 
compensation plan provides that the amount deferred under the plan is 
the amount determined under the formula determining benefits under a 
qualified employer plan (as defined in Sec. 1.409A-1(a)(2)), or a 
broad-based foreign retirement plan (as defined in Sec. 1.409A-
1(a)(3)(v)) maintained by the service recipient but applied without 
regard to one or more limitations applicable to the qualified employer 
plan under the Internal Revenue Code or to the broad-based foreign 
retirement plan under other applicable law, or that the amount deferred 
under the nonqualified deferred compensation plan is determined as an 
amount offset by some or all of the benefits provided under the 
qualified employer plan or broad-based foreign retirement plan, a 
decrease in amounts deferred under the nonqualified deferred 
compensation plan that results directly from the operation of the 
qualified employer plan or broad-based foreign retirement plan (other 
than service provider actions described in paragraphs (j)(5)(iii) and 
(iv) of this section) including changes in benefit limitations 
applicable to the qualified employer plan or the broad-based foreign 
retirement plan under

[[Page 688]]

the Internal Revenue Code or other applicable law does not constitute an 
acceleration of a payment under the nonqualified deferred compensation 
plan, provided that such operation does not otherwise result in a change 
in the time or form of a payment under the nonqualified deferred 
compensation plan, and provided further that the change in the amounts 
deferred under the nonqualified deferred compensation plan does not 
exceed such change in the amounts deferred under the qualified employer 
plan or the broad-based foreign retirement plan, as applicable. In 
addition, with respect to such a nonqualified deferred compensation 
plan, the following actions or failures to act will not constitute an 
acceleration of a payment under the nonqualified deferred compensation 
plan even if in accordance with the terms of the nonqualified deferred 
compensation plan, the actions or inactions result in a decrease in the 
amounts deferred under the plan, provided that such actions or inactions 
do not otherwise affect the time or form of payment under the 
nonqualified deferred compensation plan, and provided further that with 
respect to actions or inactions described in paragraphs (j)(5)(i) and 
(ii) of this section, the change in the amount deferred under the 
nonqualified deferred compensation plan does not exceed the change in 
the amounts deferred under the qualified employer plan or the broad-
based foreign retirement plan, as applicable:
    (i) A service provider's action or inaction under the qualified 
employer plan or broad-based foreign retirement plan with respect to 
whether to elect to receive a subsidized benefit or an ancillary benefit 
under the qualified employer plan or broad-based foreign retirement 
plan.
    (ii) The amendment of a qualified employer plan or broad-based 
foreign retirement plan to increase benefits provided under such plan, 
or to add or remove a subsidized benefit or an ancillary benefit.
    (iii) A service provider's action or inaction under a qualified 
employer plan with respect to elective deferrals and other employee pre-
tax contributions subject to the contribution restrictions under section 
401(a)(30) or section 402(g), including an adjustment to a deferral 
election under such qualified employer plan, provided that for any given 
taxable year, the service provider's action or inaction does not result 
in a decrease in the amounts deferred under all nonqualified deferred 
compensation plans in which the service provider participates (other 
than amounts described in paragraph (j)(5)(iv) of this section) in 
excess of the limit with respect to elective deferrals under section 
402(g)(1)(A), (B), and (C) in effect for the taxable year in which such 
action or inaction occurs.
    (iv) A service provider's action or inaction under a qualified 
employer plan with respect to elective deferrals and other employee pre-
tax contributions subject to the contributions restrictions under 
section 401(a)(30) or section 402(g), and after-tax contributions by the 
service provider to a qualified employer plan that provides for such 
contributions, that affects the amounts that are credited under one or 
more nonqualified deferred compensation plans as matching amounts or 
other similar amounts contingent on such elective deferrals, pre-tax 
contributions, or after-tax contributions, provided that the total of 
such matching or contingent amounts, as applicable, never exceeds 100 
percent of the matching or contingent amounts that would be provided 
under the qualified employer plan absent any plan-based restrictions 
that reflect limits on qualified plan contributions under the Internal 
Revenue Code.
    (6) Changes in elections under a cafeteria plan. A change in an 
election under a cafeteria plan (as defined in section 125(d)) does not 
result in an accelerated payment of an amount deferred under a 
nonqualified deferred compensation plan to the extent that the change in 
the amount deferred under the nonqualified deferred compensation plan 
results solely from the application of the change in amount eligible to 
be treated as compensation under the terms of the nonqualified deferred 
compensation plan resulting from the election change under the cafeteria 
plan, to a benefit formula under the nonqualified deferred compensation 
plan based upon the service provider's eligible compensation, and only 
to the

[[Page 689]]

extent that such change applies in the same manner as any other increase 
or decrease in compensation would apply to such benefit formula.

[T.D. 9321, 72 FR 19276, Apr. 17, 2007; 72 FR 41622, July 31, 2007]



Sec. 1.409A-4  Calculation of income inclusion. [Reserved]



Sec. 1.409A-5  Funding. [Reserved]



Sec. 1.409A-6  Application of section 409A and effective dates.

    (a) Statutory application and effective dates--(1) Application to 
amounts deferred--(i) In general. Except as otherwise provided in this 
section, section 409A applies with respect to amounts deferred in 
taxable years beginning after December 31, 2004, and with respect to 
amounts deferred in taxable years beginning before January 1, 2005, if 
the plan under which the deferral is made is materially modified after 
October 3, 2004. For amounts deferred in taxable years beginning before 
January 1, 2005, under a plan that is materially modified after October 
3, 2004, whether the plan complies with the requirements of section 409A 
and these regulations is determined by reference to the terms of the 
plan in effect as of, and any actions taken under the plan on or after, 
the date of the material modification. Section 409A is applicable with 
respect to earnings on amounts deferred only to the extent that section 
409A is applicable with respect to the amounts deferred. Accordingly, 
section 409A does not apply with respect to earnings on amounts deferred 
before January 1, 2005, unless section 409A applies with respect to the 
amounts deferred. For this purpose, a right to earnings that is subject 
to a substantial risk of forfeiture (as defined in Sec. 1.83-3(c)) or a 
requirement to perform further services, on an amount deferred that is 
not subject to a substantial risk of forfeiture (as defined in Sec. 
1.83-3(c)) or a requirement to perform further services, is not treated 
as earnings on the amount deferred, but a separate right to 
compensation. Except as otherwise provided in applicable guidance (see 
Sec. 601.601(d)(2) of this chapter), the provisions of Sec. Sec. 
1.409A-1 through 1.409A-5 and this section provide the exclusive means 
of identifying agreements, methods, programs, or other arrangements 
subject to section 409A, and the exclusive means of satisfying the 
requirements of section 409A with respect to such agreements, methods, 
programs, or other arrangements.
    (ii) Collectively bargained plans. Section 409A does not apply with 
respect to amounts deferred under a plan maintained pursuant to one or 
more bona fide collective bargaining agreements in effect on October 3, 
2004, for the period ending on the earlier of the date on which the last 
of such collective bargaining agreements terminates (determined without 
regard to any extension thereof after October 3, 2004) or December 31, 
2009.
    (2) Identification of date of deferral for statutory effective date 
purposes. For purposes of determining whether section 409A is applicable 
with respect to an amount, the amount is considered deferred before 
January 1, 2005, if before January 1, 2005, the service provider had a 
legally binding right to be paid the amount, and the right to the amount 
was earned and vested. For purposes of this paragraph (a)(2), a right to 
an amount was earned and vested only if the amount was not subject to a 
substantial risk of forfeiture (as defined in Sec. 1.83-3(c)) or a 
requirement to perform further services. Amounts to which the service 
provider did not have a legally binding right before January 1, 2005 
(for example, because the service recipient retained discretion to 
reduce the amount), will not be considered deferred before January 1, 
2005. In addition, amounts to which the service provider had a legally 
binding right before January 1, 2005, but the right to which was subject 
to a substantial risk of forfeiture or a requirement to perform further 
services after December 31, 2004, are not considered deferred before 
January 1, 2005, for purposes of the effective date. Notwithstanding the 
foregoing, an amount to which the service provider had a legally binding 
right before January 1, 2005, but for which the service provider was 
required to continue performing services to retain the right only 
through the completion of the payroll period (as defined in Sec. 
1.409A-1(b)(3)) that includes December 31, 2004,

[[Page 690]]

is not treated as subject to a requirement to perform further services 
(or a substantial risk of forfeiture) for purposes of the effective 
date. For purposes of this paragraph (a)(2), a stock option, stock 
appreciation right, or similar compensation that on or before December 
31, 2004, was immediately exercisable for cash or substantially vested 
property (as defined in Sec. 1.83-3(b)) is treated as earned and 
vested, regardless of whether the right would terminate if the service 
provider ceased providing services for the service recipient.
    (3) Calculation of amount of compensation deferred for statutory 
effective date purposes--(i) Nonaccount balance plans. The amount of 
compensation deferred before January 1, 2005, under a nonqualified 
deferred compensation plan that is a nonaccount balance plan (as defined 
in Sec. 1.409A-1(c)(2)(i)(C)), equals the present value of the amount 
to which the service provider would have been entitled under the plan if 
the service provider voluntarily terminated services without cause on 
December 31, 2004, and received a payment of the benefits available from 
the plan on the earliest possible date allowed under the plan to receive 
a payment of benefits following the termination of services, and 
received the benefits in the form with the maximum value.
    Notwithstanding the foregoing, for any subsequent taxable year of 
the service provider, the grandfathered amount may increase to equal the 
present value of the benefit the service provider actually becomes 
entitled to, in the form and at the time actually paid, determined under 
the terms of the plan (including applicable limits under the Internal 
Revenue Code), as in effect on October 3, 2004, without regard to any 
further services rendered by the service provider after December 31, 
2004, or any other events affecting the amount of or the entitlement to 
benefits (other than a participant election with respect to the time or 
form of an available benefit). For purposes of calculating the present 
value of a benefit under this paragraph (a)(3)(i), reasonable actuarial 
assumptions and methods must be used. Whether assumptions and methods 
are reasonable for this purpose is determined as of each date the 
benefit is valued for purposes of determining the grandfathered benefit, 
provided that any reasonable actuarial assumptions and methods that were 
used by the service recipient with respect to such benefit as of 
December 31, 2004, will continue to be treated as reasonable assumptions 
and methods for purposes of calculating the grandfathered benefit.
    Actuarial assumptions and methods will be presumed reasonable if 
they are the same as those used to value benefits under a qualified plan 
sponsored by the service recipient the benefits under which are part of 
the benefit formula under, or otherwise impact the amount of benefits 
under, the nonaccount balance nonqualified deferred compensation plan.
    (ii) Account balance plans. The amount of compensation deferred 
before January 1, 2005, under a nonqualified deferred compensation plan 
that is an account balance plan (as defined in Sec. 1.409A-
1(c)(2)(i)(A)), equals the portion of the service provider's account 
balance as of December 31, 2004, the right to which was earned and 
vested (as defined in paragraph (a)(2) of this section) as of December 
31, 2004, plus any future contributions to the account, the right to 
which was earned and vested (as defined in paragraph (a)(2) of this 
section) as of December 31, 2004, to the extent such contributions are 
actually made.
    (iii) Equity-based compensation plans. For purposes of determining 
the amounts deferred before January 1, 2005, under an equity-based 
compensation plan, the rules of paragraph (a)(3)(ii) of this section 
governing account balance plans are applied except that the account 
balance is deemed to be the amount of the payment available to the 
service provider on December 31, 2004 (or that would be available to the 
service provider if the right were immediately exercisable) the right to 
which is earned and vested (as defined in paragraph (a)(2) of this 
section) as of December 31, 2004. For this purpose, the payment 
available to the service provider excludes any exercise price or other 
amount that must be paid by the service provider.
    (iv) Earnings. Earnings on amounts deferred under a plan before 
January 1,

[[Page 691]]

2005, include only income (whether actual or notional) attributable to 
the amounts deferred under a plan as of December 31, 2004, or to such 
income. For example, notional interest earned under the plan on amounts 
deferred in an account balance plan as of December 31, 2004, generally 
will be treated as earnings on amounts deferred under the plan before 
January 1, 2005. Similarly, an increase in the amount of payment 
available pursuant to a stock option, stock appreciation right, or other 
equity-based compensation above the amount of payment available as of 
December 31, 2004, due to appreciation in the underlying stock after 
December 31, 2004, or accrual of other earnings such as dividends, is 
treated as earnings on the amount deferred. In the case of a nonaccount 
balance plan, earnings include the increase, due solely to the passage 
of time, in the present value of the future payments to which the 
service provider has obtained a legally binding right, the present value 
of which constituted the amounts deferred under the plan before January 
1, 2005. Thus, for each year, there will be an increase (determined 
using the same interest rate used to determine the amounts deferred 
under the plan before January 1, 2005) resulting from the shortening of 
the discount period before the future payments are made, plus, if 
applicable, an increase in the present value resulting from the service 
provider's survivorship during the year. However, an increase in the 
potential benefits under a nonaccount balance plan due to, for example, 
an application of an increase in compensation after December 31, 2004, 
to a final average pay plan or subsequent eligibility for an early 
retirement subsidy, does not constitute earnings on the amounts deferred 
under the plan before January 1, 2005.
    (v) Definition of plan. For purposes of paragraphs (a)(1), (2), and 
(3) of this section, the term ``plan'' has the meaning provided in Sec. 
1.409A-1(c), except that the plan aggregation rules do not apply for 
purposes of the actuarial assumptions and methods used in paragraph 
(a)(3)(i) of this section. Accordingly, different reasonable actuarial 
assumptions and methods may be used to calculate the amounts deferred by 
a service provider in two different agreements, methods, programs, or 
other arrangements each of which constitutes a nonaccount balance plan.
    (4) Material modifications--(i) In general. Except as otherwise 
provided, a modification of a plan is a material modification if a 
benefit or right existing as of October 3, 2004, is materially enhanced 
or a new material benefit or right is added, and such material 
enhancement or addition affects amounts earned and vested before January 
1, 2005. Such material benefit enhancement or addition is a material 
modification whether it occurs pursuant to an amendment or to the 
service recipient's exercise of discretion under the terms of the plan. 
For example, an amendment to a plan to add a provision that payments of 
deferred amounts earned and vested before January 1, 2005, may be 
allowed upon request if service providers are required to forfeit 20 
percent of the amount of the payment (a haircut) would be a material 
modification to the plan. Similarly, a material modification would occur 
if a service recipient exercised discretion to accelerate vesting of a 
benefit under the plan to a date on or before December 31, 2004. 
However, it is not a material modification for a service recipient to 
exercise discretion over the time and manner of payment of a benefit to 
the extent such discretion is provided under the terms of the plan as of 
October 3, 2004. It is not a material modification for a service 
provider to exercise a right permitted under the plan as in effect on 
October 3, 2004. The amendment of a plan to bring the plan into 
compliance with the provisions of section 409A will not be treated as a 
material modification. However, a plan amendment or the exercise of 
discretion under the terms of the plan that materially enhances an 
existing benefit or right or adds a new material benefit or right will 
be considered a material modification even if the enhanced or added 
benefit would be permitted under section 409A. For example, the addition 
of a right to a payment upon an unforeseeable emergency of an amount 
earned and vested before January 1, 2005, would be considered a material 
modification. The reduction of an existing benefit is not a material

[[Page 692]]

modification. For example, the removal of a haircut provision generally 
would not constitute a material modification. The following 
modifications also are not material modifications for purposes of this 
paragraph (a)(4)(i):
    (A) The establishment of or contributions to a trust or other 
arrangement from which benefits under the plan are to be paid is not a 
material modification of the plan, provided that the contribution to the 
trust or other arrangement would not otherwise cause an amount to be 
includible in the service provider's gross income.
    (B) The modification of a provision requiring the immediate 
cancellation of a current deferral election, to require the cancellation 
of deferrals for the same length of time beginning with the first date 
at which the application of such cancellation would not violate section 
409A (for example, the first date of the service provider's first 
taxable year following the cancellation).
    (C) Compliance with a domestic relations order (as defined in Sec. 
1.409A-3(j)(4)(ii)) with respect to payments to an individual other than 
the service provider, or an amendment to a plan to require compliance 
with a domestic relations order with respect to payments to an 
individual other than the service provider.
    (D) The modification of a plan providing a life annuity form of 
payment to permit an election between the existing life annuity form of 
payment and other forms of annuity payments that would be treated as a 
single form of payment with the existing life annuity form of payment 
under Sec. 1.409A-2(b)(2)(ii).
    (E) The modification of a grandfathered plan to add a limited 
cashout feature consistent with Sec. 1.409A-3(j)(4)(v) (exception to 
prohibition on accelerated payments).
    (ii) Adoptions of new plans. It is presumed that the adoption of a 
new plan or the grant of an additional benefit under an existing plan 
after October 3, 2004, and before January 1, 2005, constitutes a 
material modification of a plan. However, the presumption may be 
rebutted by demonstrating that the adoption of the plan or grant of the 
additional benefit was consistent with the service recipient's 
historical compensation practices. For example, the presumption that the 
grant of a discounted stock option on November 1, 2004, is a material 
modification of a plan may be rebutted by demonstrating that the grant 
was consistent with the historic practice of granting substantially 
similar discounted stock options (both as to terms and amounts) each 
November for a significant number of years. Notwithstanding paragraph 
(a)(4)(i) of this section and this paragraph (a)(4)(ii), the grant of an 
additional benefit under an existing plan that consists of a deferral of 
additional compensation not otherwise provided under the plan as of 
October 3, 2004, will be treated as a material modification of the plan 
only as to the additional deferral of compensation, if the plan 
explicitly identifies the additional deferral of compensation and 
provides that the additional deferral of compensation is subject to 
section 409A. Accordingly, amendments to conform a plan to the 
requirements of section 409A with respect to deferrals under a plan 
occurring after December 31, 2004, will not constitute a material 
modification of the plan with respect to amounts deferred that are 
earned and vested on or before December 31, 2004, provided that there is 
no concurrent material modification with respect to the amount of, or 
rights to, amounts deferred that were earned and vested on or before 
December 31, 2004. Similarly, a grant of an additional benefit under a 
new plan adopted after October 3, 2004, and before January 1, 2005, will 
not be treated as a material modification of an existing plan to the 
extent that the new plan explicitly identifies additional deferrals of 
compensation and provides that the additional deferrals of compensation 
are subject to section 409A.
    (iii) Suspension or termination of a plan. A cessation of deferrals 
under, or termination of, a plan, pursuant to the provisions of such 
plan, is not a material modification. Amending a plan to provide 
participants an election whether to terminate participation in a plan 
generally constitutes a material modification of the plan.
    (iv) Changes to investment measures--account balance plans. With 
respect to an account balance plan (as defined in

[[Page 693]]

Sec. 1.409A-1(c)(2)(i)(A)), it is not a material modification to change 
a notional investment measure to, or to add to an existing investment 
measure, an investment measure that qualifies as a predetermined actual 
investment within the meaning of Sec. 31.3121(v)(2)-1(d)(2) of this 
chapter or, for any given taxable year, reflects a reasonable rate of 
interest (determined in accordance with Sec. 31.3121(v)(2)-
1(d)(2)(i)(C) of this chapter).
    (v) Stock rights. The modification, extension, or renewal of a stock 
right will not constitute a material modification of the stock right, if 
the modification, extension, or renewal would not be treated as the 
grant of a new stock right under Sec. 1.409A-1(b)(5)(v)(A), and would 
not result in the stock right being treated as having had a deferral 
feature from the date of grant pursuant to Sec. 1.409A-1(b)(5)(v)(C).
    (vi) Rescission of modifications. Any modification to the terms of a 
plan that would inadvertently result in treatment as a material 
modification under this section is not considered a material 
modification of the plan to the extent the modification in the terms of 
the plan is rescinded by the earlier of a date before the right is 
exercised (if the change grants a discretionary right) or the last day 
of the taxable year of the service provider during which such change 
occurred. Thus, for example, if a service recipient modifies the terms 
of a plan on March 1 to allow an individual employee to elect a new 
change in the time or form of payment without realizing that such a 
change constituted a material modification that would subject the plan 
to the requirements of section 409A, and the modification is rescinded 
on November 1, then if no change in the time or form of payment has been 
made pursuant to the modification before November 1, the plan is not 
considered materially modified under this section.
    (vii) Definition of plan. For purposes of this paragraph (a)(4), the 
term ``plan'' has the same meaning provided in Sec. 1.409A-1(c), except 
that the plan aggregation rules of Sec. 1.409A-1(c)(2) do not apply.
    (b) Regulatory applicability date. Sec. 1.409A-1, Sec. 1.409A-2, 
Sec. 1.409A-3 and this section are applicable for taxable years 
beginning on or after January 1, 2008.

[T.D. 9321, 72 FR 19276, Apr. 17, 2007; 72 FR 41623, July 31, 2007; 73 
FR 54945, Sept. 24, 2008; 73 FR 58438, Oct. 7, 2008]



Sec. 1.409(p)-1  Prohibited allocation of securities in an S corporation.

    (a) Organization of this section and definition--(1) Organization of 
this section. Section 409(p) applies if a nonallocation year occurs in 
an ESOP that holds shares of stock of an S corporation that are employer 
securities. Paragraph (b) of this section sets forth the general rule 
under section 409(p)(1) and (2) prohibiting any accrual or allocation to 
a disqualified person in a nonallocation year. Paragraph (c) of this 
section sets forth rules under section 409(p)(3), (5), and (7) for 
determining whether a year is a nonallocation year, generally based on 
whether disqualified persons own at least 50 percent of the shares of 
the S corporation, either taking into account only the outstanding 
shares of the S corporation (including shares held by the ESOP) or 
taking into account both the outstanding shares and synthetic equity of 
the S corporation. Paragraphs (d), (e), and (f) of this section contain 
definitions of disqualified person under section 409(p)(4) and (5), 
deemed-owned ESOP shares under section 409(p)(4)(C), and synthetic 
equity under section 409(p)(6)(C). Paragraph (g) of this section 
contains a standard for determining when the principal purpose of the 
ownership structure of an S corporation constitutes an avoidance or 
evasion of section 409(p).
    (2) Definitions. The following definitions apply for purposes of 
section 409(p) and this section, as well as for purposes of section 
4979A, which imposes an excise tax on certain events.
    (i) Deemed-owned ESOP shares has the meaning set forth in paragraph 
(e) of this section.
    (ii) Disqualified person has the meaning set forth in paragraph (d) 
of this section.
    (iii) Employer has the meaning set forth in Sec. 1.410(b)-9.
    (iv) Employer securities means employer securities within the 
meaning of section 409(l).

[[Page 694]]

    (v) ESOP means an employee stock ownership plan within the meaning 
of section 4975(e)(7).
    (vi) Prohibited allocation has the meaning set forth in paragraph 
(b)(2) of this section.
    (vii) S corporation means S corporation within the meaning of 
section 1361.
    (viii) Synthetic equity has the meaning set forth in paragraph (f) 
of this section.
    (b) Prohibited allocation in a nonallocation year--(1) General rule. 
Section 409(p)(1) provides that an ESOP holding employer securities 
consisting of stock in an S corporation must provide that no portion of 
the assets of the plan attributable to (or allocable in lieu of) such 
employer securities may, during a nonallocation year, accrue under the 
ESOP, or be allocated directly or indirectly under any plan of the 
employer (including the ESOP) meeting the requirements of section 
401(a), for the benefit of any disqualified person.
    (2) Additional rules--(i) Prohibited allocation definition. For 
purposes of section 409(p) and this section, a prohibited allocation 
means an impermissible accrual or an impermissible allocation. Whether 
there is impermissible accrual is determined under paragraph (b)(2)(ii) 
of this section and whether there is an impermissible allocation is 
determined under paragraph (b)(2)(iii) of this section. The amount of 
the prohibited allocation is equal to the sum of the amount of the 
impermissible accrual plus the amount of the impermissible allocation.
    (ii) Impermissible accrual. There is an impermissible accrual to the 
extent that employer securities consisting of stock in an S corporation 
owned by the ESOP and any assets attributable thereto are held under the 
ESOP for the benefit of a disqualified person during a nonallocation 
year. For this purpose, assets attributable to stock in an S corporation 
owned by an ESOP include any distributions, within the meaning of 
section 1368, made on S corporation stock held in a disqualified 
person's account in the ESOP (including earnings thereon), plus any 
proceeds from the sale of S corporation securities held for a 
disqualified person's account in the ESOP (including any earnings 
thereon). Thus, in the event of a nonallocation year, all S corporation 
shares and all other ESOP assets attributable to S corporation stock, 
including distributions, sales proceeds, and earnings on either 
distributions or proceeds, held for the account of such disqualified 
person in the ESOP during that year are an impermissible accrual for the 
benefit of that person, whether attributable to contributions in the 
current year or in prior years.
    (iii) Impermissible allocation. An impermissible allocation occurs 
during a nonallocation year to the extent that a contribution or other 
annual addition (within the meaning of section 415(c)(2)) is made with 
respect to the account of a disqualified person, or the disqualified 
person otherwise accrues additional benefits, directly or indirectly 
under the ESOP or any other plan of the employer qualified under section 
401(a) (including a release and allocation of assets from a suspense 
account, as described at Sec. 54.4975-11(c) and (d) of this chapter) 
that, for the nonallocation year, would have been added to the account 
of the disqualified person under the ESOP and invested in employer 
securities consisting of stock in an S corporation owned by the ESOP but 
for a provision in the ESOP that precludes such addition to the account 
of the disqualified person, and investment in employer securities during 
a nonallocation year.
    (iv) Effects of prohibited allocation--(A) Deemed distribution. If a 
plan year is a nonallocation year, the amount of any prohibited 
allocation in the account of a disqualified person as of the first day 
of the plan year, as determined under this paragraph (b)(2), is treated 
as distributed from the ESOP (or other plan of the employer) to the 
disqualified person on the first day of the plan year. In the case of an 
impermissible accrual or impermissible allocation that is not in the 
account of the disqualified person as of the first day of the plan year, 
the amount of the prohibited allocation, as determined under this 
paragraph (b)(2), is treated as distributed on the date of the 
prohibited allocation. Thus, the fair market value of assets in the 
disqualified person's account that constitutes an impermissible accrual 
or allocation is included

[[Page 695]]

in gross income (to the extent in excess of any investment in the 
contract allocable to such amount) and is subject to any additional 
income tax that applies under section 72(t). A deemed distribution under 
this paragraph (b)(2)(iv)(A) is not an actual distribution from the 
ESOP. Thus, the amount of the prohibited allocation is not an eligible 
rollover distribution under section 402(c). However, for purposes of 
applying sections 72 and 402 with respect to any subsequent distribution 
from the ESOP, the amount that the disqualified person previously took 
into account as income as a result of the deemed distribution is treated 
as investment in the contract.
    (B) Other effects. If there is a prohibited allocation, then the 
plan fails to satisfy the requirements of section 4975(e)(7) and ceases 
to be an ESOP. In such a case, the exemption from the excise tax on 
prohibited transactions for loans to leveraged ESOPs contained in 
section 4975(d)(3) would cease to apply to any loan (with the result 
that the employer would owe an excise tax with respect to the previously 
exempt loan). As a result of these failures, the plan would lose the 
prohibited transaction exemption for loans to an ESOP under section 
4975(d)(3) of the Code and section 408(b)(3) of title I of the Employee 
Retirement Income Security Act of 1974, as amended (ERISA). Finally, a 
plan that does not operate in accordance with its terms to reflect 
section 409(p) fails to satisfy the qualification requirements of 
section 401(a), which would cause the corporation's S election to 
terminate under section 1362. See also section 4979A(a) which imposes an 
excise tax in certain events, including a prohibited allocation under 
section 409(p).
    (C) Example. The rules of this paragraph (b)(2)(iv) are illustrated 
by the following example:

    Example. (i) Facts. Corporation M, an S corporation under section 
1361, establishes Plan P as an ESOP in 2006, with a calendar plan year. 
Plan P is a qualified plan that includes terms providing that a 
prohibited allocation will not occur during a nonallocation year in 
accordance with section 409(p). On December 31, 2006, all of the 1,000 
outstanding shares of stock of Corporation M, with a fair market value 
of $30 per share, are contributed to Plan P and allocated among accounts 
established within Plan P for the benefit of Corporation M's three 
employees, individuals A, B, and C, based on their compensation for 
2006. As a result, on December 31, 2006, participant A's account 
includes 800 of the shares ($24,000); participant B's account includes 
140 of the shares ($4,200); and participant C's account includes the 
remaining 60 shares ($1,800). The plan year 2006 is a nonallocation 
year, participants A and B are disqualified persons on December 31, 
2006, and a prohibited allocation occurs for A and B on December 31, 
2006.
    (ii) Conclusion. On December 31, 2006, participants A and B each 
have a deemed distribution as a result of the prohibited allocation, 
resulting in income of $24,000 for participant A and $4,200 for 
participant B. Corporation M owes an excise tax under section 4979A, 
based on an amount involved of $28,200. Plan P ceases to be an ESOP on 
the date of the prohibited allocation (December 31, 2006) and also fails 
to satisfy the qualification requirements of section 401(a) on that date 
due to the failure to comply with the provisions requiring compliance 
with section 409(p). As a result of having an ineligible shareholder 
under section 1361(b)(1)(B), Corporation M ceases to be an S corporation 
under section 1361 on December 31, 2006.

    (v) Prevention of prohibited allocation--(A) Transfer of account to 
non-ESOP. An ESOP may prevent a nonallocation year or a prohibited 
allocation during a nonallocation year by providing for assets 
(including S corporation securities) allocated to the account of a 
disqualified person (or a person reasonably expected to become a 
disqualified person absent a transfer described in this paragraph 
(b)(2)(v)(A)) to be transferred into a separate portion of the plan that 
is not an ESOP, as described in Sec. 54.4975-11(a)(5) of this chapter, 
or to another plan of the employer that satisfies the requirements of 
section 401(a) and that is not an ESOP. Any such transfer must be 
effectuated by an affirmative action taken no later than the date of the 
transfer, and all subsequent actions (including benefit statements) 
generally must be consistent with the transfer having occurred on that 
date. In the event of such a transfer involving S corporation 
securities, the recipient plan is subject to tax on unrelated business 
taxable income under section 512.
    (B) Relief from nondiscrimination requirement. Pursuant to this 
paragraph (b)(2)(v)(B), if a transfer described in paragraph 
(b)(2)(v)(A) of this section is

[[Page 696]]

made from an ESOP to a separate portion of the plan or to another 
qualified plan of the employer that is not an ESOP, then both the ESOP 
and the plan or portion of a plan that is not an ESOP do not fail to 
satisfy the requirements of Sec. 1.401(a)(4)-4 merely because of the 
transfer. Further, subsequent to the transfer, that plan will not fail 
to satisfy the requirements of Sec. 1.401(a)(4)-4 merely because of the 
benefits, rights, and features with respect to the transferred benefits 
if those benefits, rights, and features would satisfy the requirements 
of Sec. 1.401(a)(4)-4 if the mandatory disaggregation rule for ESOPs at 
Sec. 1.410(b)-7(c)(2) did not apply.
    (c) Nonallocation year. A year is a nonallocation year if it is 
described in the general definition in paragraph (c)(1) of this section 
or if the special rule of paragraph (c)(3) of this section applies.
    (1) General definition. For purposes of section 409(p) and this 
section, a nonallocation year means a plan year of an ESOP during which, 
at any time, the ESOP holds any employer securities that are shares of 
an S corporation and either--
    (i) Disqualified persons own at least 50 percent of the number of 
outstanding shares of stock in the S corporation (including deemed-owned 
ESOP shares); or
    (ii) Disqualified persons own at least 50 percent of the sum of:
    (A) The outstanding shares of stock in the S corporation (including 
deemed-owned ESOP shares); and
    (B) The shares of synthetic equity in the S corporation owned by 
disqualified persons.
    (2) Attribution rules. For purposes of this paragraph (c), the rules 
of section 318(a) apply to determine ownership of shares in the S 
corporation (including deemed-owned ESOP shares) and synthetic equity. 
However, for this purpose, section 318(a)(4) (relating to options to 
acquire stock) is disregarded and, in applying section 318(a)(1), the 
members of an individual's family include members of the individual's 
family under paragraph (d)(2) of this section. In addition, an 
individual is treated as owning deemed-owned ESOP shares of that 
individual notwithstanding the employee trust exception in section 
318(a)(2)(B)(i). If the attribution rules in paragraph (f)(1) of this 
section apply, then the rules of paragraph (f)(1) of this section are 
applied before (and in addition to) the rules of this paragraph (c)(2).
    (3) Special rule for avoidance or evasion. (i) Any ownership 
structure described in paragraph (g)(3) of this section results in a 
nonallocation year. In addition, each individual referred to in 
paragraph (g)(3) of this section is treated as a disqualified person and 
the individual's interest in the separate entity described in paragraph 
(g)(3) of this section is treated as synthetic equity.
    (ii) Pursuant to section 409(p)(7)(B), the Commissioner, in revenue 
rulings, notices, and other guidance published in the Internal Revenue 
Bulletin (see Sec. 601.601(d)(2)(ii)(b) of this chapter), may provide 
that a nonallocation year occurs in any case in which the principal 
purpose of the ownership structure of an S corporation constitutes an 
avoidance or evasion of section 409(p). For any year that is a 
nonallocation year under this paragraph (c)(3), the Commissioner may 
treat any person as a disqualified person. See paragraph (g) of this 
section for guidance regarding when the principal purpose of an 
ownership structure of an S corporation involving synthetic equity 
constitutes an avoidance or evasion of section 409(p).
    (4) Special rule for certain stock rights. (i) For purposes of 
paragraph (c)(1) of this section, a person is treated as owning stock if 
the person has an exercisable right to acquire the stock, the stock is 
both issued and outstanding, and the stock is held by persons other than 
the ESOP, the S corporation, or a related entity (as defined in 
paragraph (f)(3) of this section).
    (ii) This paragraph (c)(4) applies only if treating persons as 
owning the shares described in paragraph (c)(4)(i) of this section 
results in a nonallocation year. This paragraph (c)(4) does not apply to 
a right to acquire stock of an S corporation held by a shareholder that 
is subject to Federal income tax that, under Sec. 1.1361-
1(l)(2)(iii)(A) or (l)(4)(iii)(C), would not be taken into account in 
determining if an S corporation has a second class of stock, provided 
that a principal purpose of the right is not the avoidance or evasion of

[[Page 697]]

section 409(p). Under the last sentence of paragraph (f)(2)(i) of this 
section, this paragraph (c)(4)(ii) does not apply for purposes of 
determining ownership of deemed-owned ESOP shares or whether an interest 
constitutes synthetic equity.
    (5) Application with respect to shares treated as owned by more than 
one person. For purposes of applying paragraph (c)(1) of this section, 
if, by application of the rules of paragraph (c)(2), (c)(4), or (f)(1) 
of this section, any share is treated as owned by more than one person, 
then that share is counted as a single share and that share is treated 
as owned by disqualified persons if any of the owners is a disqualified 
person.
    (6) Effect of nonallocation year. See paragraph (b) of this section 
for a prohibition applicable during a nonallocation year. See also 
section 4979A for an excise tax applicable in certain cases, including 
section 4979A(a)(3) and (4) which applies during a nonallocation year 
(whether or not there is a prohibited allocation during the year).
    (d) Disqualified persons. A person is a disqualified person if the 
person is described in paragraph (d)(1), (d)(2), or (d)(3) of this 
section.
    (1) General definition. For purposes of section 409(p) and this 
section, a disqualified person means any person for whom--
    (i) The number of such person's deemed-owned ESOP shares of the S 
corporation is at least 10 percent of the number of the deemed-owned 
ESOP shares of the S corporation;
    (ii) The aggregate number of such person's deemed-owned ESOP shares 
and synthetic equity shares of the S corporation is at least 10 percent 
of the sum of--
    (A) The total number of deemed-owned ESOP shares of the S 
corporation; and
    (B) The person's synthetic equity shares of the S corporation;
    (iii) The aggregate number of the S corporation's deemed-owned ESOP 
shares of such person and of the members of such person's family is at 
least 20 percent of the number of deemed-owned ESOP shares of the S 
corporation; or
    (iv) The aggregate number of the S corporation's deemed-owned ESOP 
shares and synthetic equity shares of such person and of the members of 
such person's family is at least 20 percent of the sum of--
    (A) The total number of deemed-owned ESOP shares of the S 
corporation; and
    (B) The synthetic equity shares of the S corporation owned by such 
person and the members of such person's family.
    (2) Treatment of family members; definition--(i) Rule. Each member 
of the family of any person who is a disqualified person under paragraph 
(d)(1)(iii) or (iv) of this section and who owns any deemed-owned ESOP 
shares or synthetic equity shares is a disqualified person.
    (ii) General definition. For purposes of section 409(p) and this 
section, member of the family means, with respect to an individual--
    (A) The spouse of the individual;
    (B) An ancestor or lineal descendant of the individual or the 
individual's spouse;
    (C) A brother or sister of the individual or of the individual's 
spouse and any lineal descendant of the brother or sister; and
    (D) The spouse of any individual described in paragraph 
(d)(2)(ii)(B) or (C) of this section.
    (iii) Spouse. A spouse of an individual who is legally separated 
from such individual under a decree of divorce or separate maintenance 
is not treated as such individual's spouse under paragraph (d)(2)(ii) of 
this section.
    (3) Special rule for certain nonallocation years. See paragraph 
(c)(3) of this section (relating to avoidance or evasion of section 
409(p)) for special rules under which certain persons are treated as 
disqualified persons.
    (4) Example. The rules of this paragraph (d) are illustrated by the 
following examples:

    Example 1. (i) Facts. An S corporation has 800 outstanding shares, 
of which 100 are owned by individual O and 700 are held in an employee 
stock ownership plan (ESOP) during 2006, including 200 shares held in 
the ESOP account of O, 65 shares held in the ESOP account of participant 
P, 65 shares held in the ESOP account of participant Q who is P's 
spouse, and 14 shares held in the ESOP account of R, who is the daughter 
of P

[[Page 698]]

and Q. There are no unallocated suspense account shares in the ESOP. The 
S corporation has no synthetic equity.
    (ii) Conclusion. Under paragraph (d)(1)(i) of this section, O is a 
disqualified person during 2006 because O's account in the ESOP holds at 
least 10% of the shares owned by the ESOP (200 is 28.6% of 700). During 
2006, neither P, Q, nor R is a disqualified person under paragraph 
(d)(1)(i) of this section, because each of their accounts holds less 
than 10% of the shares owned by the ESOP. However, each of P, Q, and R 
is a disqualified person under paragraph (d)(1)(iii) of this section 
because P and members of P's family own at least 20% of the deemed-owned 
ESOP shares (144 (the sum of 65, 65 and 14) is 20.6% of 700). As a 
result, disqualified persons own at least 50% of the outstanding shares 
of the S corporation during 2006 (O's 100 directly owned shares, O's 200 
deemed-owned shares, P's 65 deemed-owned shares, Q's 65 deemed-owned 
shares, and R's 14 deemed-owned shares are 55.5% of 800).
    Example 2. (i) Facts. An S corporation has shares that are owned by 
an ESOP and various individuals. Individuals S and T are married and 
have a son, U. Individuals V and W are married and have a daughter, X. 
Individuals U and X are married. Individual V has a brother Y. Their 
percentages of the deemed-owned ESOP shares of the S corporation are as 
follows: T has 6%; U has 7%; and V has 8%. Neither S, W, X, nor Y has 
any deemed-owned ESOP shares and the S corporation has no synthetic 
equity. However, individual S and individual Y each own directly a 
number of shares of the outstanding shares of the S corporation.
    (ii) Conclusion. In this example, individual U is a disqualified 
person under paragraph (d)(1) of this section (because U's family 
consists of S, T, U, V, W, and X, and, in the aggregate, those persons 
own more than 20% of the deemed-owned ESOP shares) and individual X is 
also a disqualified person under paragraph (d)(1) of this section 
(because T's family consists of S, T, U, V, W, and X, and, in the 
aggregate, those persons own more than 20% of the deemed-owned ESOP 
shares). Further, individuals T and V are each a disqualified person 
under paragraph (d)(2) of this section because each is a member of a 
family that includes one or more disqualified persons and each has 
deemed-owned ESOP shares. However, individuals S, W, and Y are not 
disqualified persons under this paragraph (d). For example, S does not 
own more than 10% of the deemed-owned ESOP shares, and S's family, which 
consists of S, T, U, and X, owns, in the aggregate, only 13% of the 
deemed-owned ESOP shares (X's parents are not members of S's family 
because the family members of a person do not include the parents-in-law 
of the person's descendants). Further, note that, for purposes of 
determining whether the ESOP has a nonallocation year under paragraph 
(c) of this section, the shares directly owned by S and Y would be taken 
into account as shares owned by disqualified persons under the 
attribution rules in paragraph (c)(2) of this section.

    (e) Deemed-owned ESOP shares. For purposes of section 409(p) and 
this section, a person is treated as owning his or her deemed-owned ESOP 
shares. Deemed-owned ESOP shares owned by a person mean, with respect to 
any person--
    (1) Any shares of stock in the S corporation constituting employer 
securities that are allocated to such person's account under the ESOP; 
and
    (2) Such person's share of the stock in the S corporation that is 
held by the ESOP but is not allocated to the account of any participant 
or beneficiary (with such person's share to be determined in the same 
proportion as the shares released and allocated from a suspense account, 
as described at Sec. 54.4975-11(c) and (d) of the Excise Tax 
Regulations, under the ESOP for the most recently ended plan year for 
which there were shares released and allocated from a suspense account, 
or if there has been no such prior release and allocation from a 
suspense account, then determined in proportion to a reasonable estimate 
of the shares that would be released and allocated in the first year of 
a loan repayment).
    (f) Synthetic equity and rights to acquire stock of the S 
corporation--(1) Ownership of synthetic equity. For purposes of section 
409(p) and this section, synthetic equity means the rights described in 
paragraph (f)(2) of this section. Synthetic equity is treated as owned 
by the person that has any of the rights specified in paragraph (f)(2) 
of the section. In addition, the attribution rules as set forth in 
paragraph (c)(2) of this section apply for purposes of attributing 
ownership of synthetic equity.
    (2) Synthetic equity--(i) Rights to acquire stock of the S 
corporation--(A) General rule. Synthetic equity includes any stock 
option, warrant, restricted stock, deferred issuance stock right, stock 
appreciation right payable in stock, or similar interest or right that 
gives the holder the right to acquire or receive stock of the S 
corporation in the future. Rights to acquire stock in an S

[[Page 699]]

corporation with respect to stock that is, at all times during the 
period when such rights are effective, both issued and outstanding, and 
held by a person other than the ESOP, the S corporation, or a related 
entity are not synthetic equity but only if that person is subject to 
federal income taxes. (See also paragraph (c)(4) of this section.)
    (B) Exception for certain rights of first refusal. A right of first 
refusal to acquire stock held by an ESOP is not treated as a right to 
acquire stock of an S corporation under this paragraph if the right to 
acquire stock would not be taken into account under Sec. 1.1361-
1(l)(2)(iii)(A) in determining if an S corporation has a second class of 
stock and the price at which the stock is acquired under the right of 
first refusal is not less than the price determined under section 
409(h). See Sec. 54.4975-11(d)(5) of the Excise Tax Regulations. The 
right of first refusal must also comply with the requirements of Sec. 
54.4975-7(b)(9) of the Excise Tax Regulations. This paragraph 
(f)(2)(i)(B) does not apply if, based on the facts and circumstances, 
the Commissioner finds that the right to acquire stock held by the ESOP 
constitutes an avoidance or an evasion of section 409(p). See also 
section 408(d) of ERISA, under which the exemption provided by section 
408(e) of ERISA (and the related exemption at section 4975(d)(13) of the 
Code) does not apply to an owner-employee, including an employee or 
officer of an S corporation who is a 5 percent owner.
    (ii) Special rule for certain stock rights. Synthetic equity also 
includes a right to a future payment (payable in cash or any other form 
other than stock of the S corporation) from an S corporation that is 
based on the value of the stock of the S corporation, such as 
appreciation in such value. Thus, for example, synthetic equity includes 
a stock appreciation right with respect to stock of an S corporation 
that is payable in cash or a phantom stock unit with respect to stock of 
an S corporation that is payable in cash.
    (iii) Rights to acquire interests in or assets of an S corporation 
or a related entity. Synthetic equity includes a right to acquire stock 
or other similar interests in a related entity to the extent of the S 
corporation's ownership. Synthetic equity also includes a right to 
acquire assets of an S corporation or a related entity other than either 
rights to acquire goods, services, or property at fair market value in 
the ordinary course of business or fringe benefits excluded from gross 
income under section 132.
    (iv) Special rule for nonqualified deferred compensation. (A) 
Synthetic equity also includes any of the following with respect to an S 
corporation or a related entity: any remuneration to which section 
404(a)(5) applies; remuneration for which a deduction would be permitted 
under section 404(a)(5) if separate accounts were maintained; any right 
to receive property, as defined in Sec. 1.83-3(e) of the Income Tax 
Regulations (including a payment to a trust described in section 402(b) 
or to an annuity described in section 403(c)) in a future year for the 
performance of services; any transfer of property in connection with the 
performance of services to which section 83 applies to the extent that 
the property is not substantially vested within the meaning of Sec. 
1.83-3(i) by the end of the plan year in which transferred; and a split-
dollar life insurance arrangement under Sec. 1.61-22(b) entered into in 
connection with the performance of services (other than one under which, 
at all times, the only economic benefit that will be provided under the 
arrangement is current life insurance protection as described in Sec. 
1.61-22(d)(3)). Synthetic equity also includes any other remuneration 
for services under a plan, method, or arrangement deferring the receipt 
of compensation to a date that is after the 15th day of the 3rd calendar 
month after the end of the entity's taxable year in which the related 
services are rendered. However, synthetic equity does not include 
benefits under a plan that is an eligible retirement plan within the 
meaning of section 402(c)(8)(B).
    (B) For purposes of applying paragraph (f)(2)(iv)(A) of this section 
with respect to an ESOP, synthetic equity does not include any interest 
described in such paragraph (f)(2)(iv)(A) of this section to the extent 
that--

[[Page 700]]

    (1) The interest is nonqualified deferred compensation (within the 
meaning of section 3121(v)(2)) that was outstanding on December 17, 
2004;
    (2) The interest is an amount that was taken into account (within 
the meaning of Sec. 31.3121(v)(2)-1(d) of this chapter) prior to 
January 1, 2005, for purposes of taxation under chapter 21 of the 
Internal Revenue Code (or income attributable thereto); and
    (3) The interest was held before the first date on which the ESOP 
acquires any employer securities.
    (v) No overlap among shares of deemed-owned ESOP shares or synthetic 
equity. Synthetic equity under this paragraph (f)(2) does not include 
shares that are deemed-owned ESOP shares (or any rights with respect to 
deemed-owned ESOP shares to the extent such rights are specifically 
provided under section 409(h)). In addition, synthetic equity under a 
specific subparagraph of this paragraph (f)(2) does not include anything 
that is synthetic equity under a preceding provision of paragraph 
(f)(2)(i), (ii), (iii), or (iv) of this section.
    (3) Related entity. For purposes of this paragraph (f), related 
entity means any entity in which the S corporation holds an interest and 
which is a partnership, a trust, an eligible entity that is disregarded 
as an entity that is separate from its owner under Sec. 301.7701-3 of 
this chapter, or a qualified subchapter S subsidiary under section 
1361(b)(3).
    (4) Number of synthetic shares--(i) Synthetic equity determined by 
reference to S corporation shares. In the case of synthetic equity that 
is determined by reference to shares of stock of the S corporation, the 
person who is entitled to the synthetic equity is treated as owning the 
number of shares of stock deliverable pursuant to such synthetic equity. 
In the case of synthetic equity that is determined by reference to 
shares of stock of the S corporation, but for which payment is made in 
cash or other property (besides stock of the S corporation), the number 
of shares of synthetic equity treated as owned is equal to the number of 
shares of stock having a fair market value equal to the cash or other 
property (disregarding lapse restrictions as described in Sec. 1.83-
3(i)). Where such synthetic equity is a right to purchase or receive S 
corporation shares, the corresponding number of shares of synthetic 
equity is determined without regard to lapse restrictions as described 
in Sec. 1.83-3(i) or to any amount required to be paid in exchange for 
the shares. Thus, for example, if a corporation grants an employee of an 
S corporation an option to purchase 100 shares of the corporation's 
stock, exercisable in the future only after the satisfaction of certain 
performance conditions, the employee is the deemed owner of 100 
synthetic equity shares of the corporation as of the date the option is 
granted. If the same employee were granted 100 shares of restricted S 
corporation stock (or restricted stock units), subject to forfeiture 
until the satisfaction of performance or service conditions, the 
employee would likewise be the deemed owner of 100 synthetic equity 
shares from the grant date. However, if the same employee were granted a 
stock appreciation right with regard to 100 shares of S corporation 
stock (whether payable in stock or in cash), the number of synthetic 
equity shares the employee is deemed to own equals the number of shares 
having a value equal to the appreciation at the time of measurement 
(determined without regard to lapse restrictions).
    (ii) Synthetic equity determined by reference to shares in a related 
entity. In the case of synthetic equity that is determined by reference 
to shares of stock (or similar interests) in a related entity, the 
person who is entitled to the synthetic equity is treated as owning 
shares of stock of the S corporation with the same aggregate value as 
the number of shares of stock (or similar interests) of the related 
entity (with such value determined without regard to any lapse 
restriction as defined at Sec. 1.83-3(i)).
    (iii) Other synthetic equity--(A) General rule. In the case of any 
synthetic equity to which neither paragraph (f)(4)(i) of this section 
nor paragraph (f)(4)(ii) of this section apply, the person who is 
entitled to the synthetic equity is treated as owning on any date a 
number of shares of stock in the S corporation equal to the present 
value (on that date) of the synthetic equity (with such value determined 
without regard to any lapse restriction as defined at

[[Page 701]]

Sec. 1.83-3(i)) divided by the fair market value of a share of the S 
corporation's stock as of that date.
    (B) Use of annual or more frequent determination dates. A year is a 
nonallocation year if the thresholds in paragraph (c) of this section 
are met at any time during that year. However, for purposes of this 
paragraph (f)(4)(iii), an ESOP may provide that the number of shares of 
S corporation stock treated as owned by a person who is entitled to 
synthetic equity to which this paragraph (f)(4)(iii) applies is 
determined annually (or more frequently), as of the first day of the 
ESOP's plan year or as of any other reasonable determination date or 
dates during a plan year. If the ESOP so provides, the number of shares 
of synthetic equity to which this paragraph (f)(4)(iii) applies that are 
treated as owned by that person for any period from a given 
determination date through the date immediately preceding the next 
following determination date is the number of shares treated as owned on 
the given determination date.
    (C) Use of triennial recalculations. (1) Although an ESOP must have 
a determination date that is no less frequent than annually, if the 
terms of the ESOP so provide, then the number of shares of synthetic 
equity with respect to grants of synthetic equity to which this 
paragraph (f)(4)(iii) applies may be fixed for a specified period from a 
determination date identified under the ESOP through the day before a 
determination date that is not later than the third anniversary of the 
identified determination date. Thus, the ESOP must provide for the 
number of shares of synthetic equity to which this paragraph (f)(4)(iii) 
applies to be re-determined not less frequently than every three years, 
based on the S corporation share value on a determination date that is 
not later than the third anniversary of the identified determination 
date and the aggregate present value of the synthetic equity to which 
this paragraph (f)(4)(iii) applies (including all grants made during the 
three-year period) on that determination date.
    (2) However, additional accruals, allocations, or grants (to which 
this paragraph (f)(4)(iii) applies) that are made during such three-year 
period are taken into account on each determination date during that 
period, based on the number of synthetic equity shares resulting from 
the additional accrual, allocation, or grant (determined as of the 
determination date on or next following the date of the accrual, 
allocation, or grant). See Example 3 of paragraph (h) of this section 
for an example illustrating this paragraph (f)(4)(iii)(C).
    (3) If, as permitted under this paragraph (f)(4)(iii)(C), an ESOP 
provides for the number of shares of synthetic equity to be fixed for a 
specified period from a determination date to a subsequent determination 
date, then that subsequent determination date can be changed to a new 
determination date, subject to the following conditions:
    (i) The change in the subsequent determination date must be 
effectuated through a plan amendment adopted before the new 
determination date;
    (ii) The new determination date must be earlier than the prior 
determination date (that is, the new determination date must be earlier 
than the determination date applicable in the absence of the plan 
amendment);
    (iii) The conditions in paragraph (f)(4)(iii)(C)(2) of this section 
must be satisfied measured from the new determination date; and
    (iv) Except to the extent permitted by the Commissioner in revenue 
rulings, notices, or other guidance published in the Internal Revenue 
Bulletin (see Sec. 601.601(d)(2)(ii)(b) of this chapter), the change 
must be adopted in connection with either a change in the plan year of 
the ESOP or a merger, consolidation, or transfer of plan assets of the 
ESOP under section 414(l) (and the new determination date must 
consistent with that plan year change or section 414(l) event).
    (4) Conditions for application of rules. This paragraph 
(f)(4)(iii)(C) only applies with respect to grants of synthetic equity 
to which this paragraph (f)(4)(iii) applies. In addition, paragraph 
(f)(4)(iii)(C) of this section applies only if the fair market value of 
a share of the S corporation securities on any determination date is not 
unrepresentative of the value of the S corporation securities throughout 
the rest of the plan year and only if the terms of

[[Page 702]]

the ESOP include provisions conforming to paragraph (f)(4)(iii)(C)(1) of 
this section which are consistently used by the ESOP for all persons. In 
addition, paragraph (f)(4)(iii)(C)(1) of this section applies only if 
the terms of the ESOP include provisions conforming to paragraphs 
(f)(4)(iii)(C)(1) of this section which are consistently used by the 
ESOP for all persons.
    (iv) Adjustment of number of synthetic equity shares where ESOP owns 
less than 100 percent of S corporation. The number of synthetic shares 
otherwise determined under this paragraph (f)(4) is decreased ratably to 
the extent that shares of the S corporation are owned by a person who is 
not an ESOP and who is subject to Federal income taxes. For example, if 
an S corporation has 200 outstanding shares, of which individual A owns 
50 shares and the ESOP owns the other 150 shares, and individual B would 
be treated under this paragraph (f)(4) as owning 100 synthetic equity 
shares of the S corporation but for this paragraph (f)(4)(iv), then, 
under the rule of this paragraph (f)(4)(iv), the number of synthetic 
shares treated as owned by B under this paragraph (f)(4) is decreased 
from 100 to 75 (because the ESOP only owns 75 percent of the outstanding 
stock of the S corporation, rather than 100 percent).
    (v) Special rule for shares with greater voting power than ESOP 
shares. Notwithstanding any other provision of this paragraph (f)(4), if 
a synthetic equity right includes (directly or indirectly) a right to 
purchase or receive shares of S corporation stock that have per-share 
voting rights greater than the per-share voting rights of one or more 
shares of S corporation stock held by the ESOP, then the number of 
shares of deemed owned synthetic equity attributable to such right is 
not less than the number of shares that would have the same voting 
rights if the shares had the same per-share voting rights as shares held 
by the ESOP with the least voting rights. For example, if shares of S 
corporation stock held by the ESOP have one voting right per share, then 
an individual who holds an option to purchase one share with 100 voting 
rights is treated as owning 100 shares of synthetic equity.
    (g) Avoidance or evasion of section 409(p) involving synthetic 
equity--(1) General rule. Paragraph (g)(2) of this section sets forth a 
standard for determining whether the principal purpose of the ownership 
structure of an S corporation involving synthetic equity constitutes an 
avoidance or evasion of section 409(p). Paragraph (g)(3) of this section 
identifies certain specific ownership structures that constitute an 
avoidance or evasion of section 409(p). See also paragraph (c)(3) of 
this section for a rule under which the ownership structures in 
paragraph (g)(3) of this section result in a nonallocation year for 
purposes of section 409(p).
    (2) Standard for determining when there is an avoidance or evasion 
of section 409(p) involving synthetic equity. For purposes of section 
409(p) and this section, whether the principal purpose of the ownership 
structure of an S corporation involving synthetic equity constitutes an 
avoidance or evasion of section 409(p) is determined by taking into 
account all the surrounding facts and circumstances, including all 
features of the ownership of the S corporation's outstanding stock and 
related obligations (including synthetic equity), any shareholders who 
are taxable entities, and the cash distributions made to shareholders, 
to determine whether, to the extent of the ESOP's stock ownership, the 
ESOP receives the economic benefits of ownership in the S corporation 
that occur during the period that stock of the S corporation is owned by 
the ESOP. Among the factors indicating that the ESOP receives those 
economic benefits include shareholder voting rights, the right to 
receive distributions made to shareholders, and the right to benefit 
from the profits earned by the S corporation, including the extent to 
which actual distributions of profits are made from the S corporation to 
the ESOP and the extent to which the ESOP's ownership interest in 
undistributed profits and future profits is subject to dilution as a 
result of synthetic equity. For example, the ESOP's ownership interest 
is not subject to dilution if the total amount of synthetic equity is a 
relatively small portion of the total number of shares and deemed-owned 
shares of the S corporation.

[[Page 703]]

    (3) Specific transactions that constitute an avoidance or evasion of 
section 409(p) involving segregated profits. Taking into account the 
standard in paragraph (g)(2) of this section, the principal purpose of 
the ownership structure of an S corporation constitutes an avoidance or 
evasion of section 409(p) in any case in which--
    (i) The profits of the S corporation generated by the business 
activities of a specific individual or individuals are not provided to 
the ESOP, but are instead substantially accumulated and held for the 
benefit of the individual or individuals on a tax-deferred basis within 
an entity related to the S corporation, such as a partnership, trust, or 
corporation (such as in a subsidiary that is a disregarded entity), or 
any other method that has the same effect of segregating profits for the 
benefit of such individual or individuals (such as nonqualified deferred 
compensation described in paragraph (f)(2)(iv) of this section);
    (ii) The individual or individuals for whom profits are segregated 
have rights to acquire 50 percent or more of those profits directly or 
indirectly (for example, by purchase of the subsidiary); and
    (iii) A nonallocation year would occur if this section were 
separately applied with respect to either the separate entity or 
whatever method has the effect of segregating profits of the individual 
or individuals, treating such entity as a separate S corporation owned 
by an ESOP (or in the case of any other method of segregation of profits 
by treating those profits as the only assets of a separate S corporation 
owned by an ESOP).
    (h) Examples. The rules of this section are illustrated by the 
following examples:

    Example 1. Relating to determination of disqualified persons and 
nonallocation year if there is no synthetic equity. (i) Facts. 
Corporation X is a calendar year S corporation that maintains an ESOP. X 
has a single class of common stock, of which there are a total of 1,200 
shares outstanding. X has no synthetic equity. In 2006, individual A, 
who is not an employee of X (and is not related to any employee of X), 
owns 100 shares directly, B, who is an employee of X, owns 100 shares 
directly, and the remaining 1,000 shares are owned by an ESOP maintained 
by X for its employees. The ESOP's 1,000 shares are allocated to the 
accounts of individuals who are employees of X (none of whom are 
related), as set forth in columns 1 and 2 in the following table:

----------------------------------------------------------------------------------------------------------------
                                                 2                    3                          4
                                       -------------------------------------------------------------------------
            1 Shareholders               Deemed-owned ESOP
                                          shares (total of    Percentage deemed-        Disqualified person
                                               1,000)         owned ESOP shares
----------------------------------------------------------------------------------------------------------------
B.....................................                  330                   33  Yes.
C.....................................                  145                 14.5  Yes.
D.....................................                   75                  7.5  No.
E.....................................                   30                    3  No.
F.....................................                   20                    2  No.
Other participants....................              \1\ 400                (\2\)  No.
----------------------------------------------------------------------------------------------------------------
\1\ None exceed 10 shares.
\2\ 1% or less.

    (ii) Conclusion with respect to disqualified persons. As shown in 
column 4 in the table contained in paragraph (i) of Example 1, 
individuals B and C are disqualified persons for 2006 under paragraph 
(d)(1) of this section because each owns at least 10% of X's deemed-
owned ESOP shares. However, the synthetic equity shares owned by any 
person do not affect the calculation for any other person's ownership of 
shares.
    (iii) Conclusion with respect to nonallocation year. 2006 is not a 
nonallocation year under section 409(p) because disqualified persons do 
not own at least 50% of X's outstanding shares (the 100 shares owned 
directly by B, B's 330 deemed-owned ESOP shares, plus C's 145 deemed-
owned ESOP shares equal only 47.9% of the 1,200 outstanding shares of 
X).
    Example 2. Relating to determination of disqualified persons and 
nonallocation year if there is synthetic equity. (i) Facts. The facts 
are the same as in Example 1, except that, as shown in column 4 of the 
table in this Example 2, individuals E and F have options to acquire 110 
and 130 shares, respectively, of the common stock of X from X:

[[Page 704]]



--------------------------------------------------------------------------------------------------------------------------------------------------------
                                           2 Deemed-owned
                                             ESOP shares    3 Percentage      4 Options    5 Shareholder percentage of
              1 Shareholder                   (total of     deemed-owned        (240)         deemed-owned ESOP plus          6 Disqualified person
                                               1,000)        ESOP shares                     synthetic equity shares
--------------------------------------------------------------------------------------------------------------------------------------------------------
B........................................             330              33  ..............  ...........................  Yes (col. 3).
C........................................             145            14.5  ..............  ...........................  Yes (col. 3).
D........................................              75             7.5  ..............  ...........................  No.
E........................................              30               3             110  11.1% ([30+ 91.7] divided    Yes (col. 5).
                                                                                            by 1,091.7).
F........................................              20               2             130  11.6% ([20 +108.3] divided   Yes (col. 5).
                                                                                            by 1,108.3).
Other participants.......................         \1\ 400           (\2\)  ..............  ...........................  No.
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ None exceeds 10 shares.
\2\ 1% or less.

    (ii) Conclusion with respect to disqualified persons. Individual E's 
synthetic equity shares are counted in determining whether E is a 
disqualified person for 2006, and individual F's synthetic equity shares 
are counted in determining whether F is a disqualified person for 2006. 
Applying the rule of paragraph (f)(4)(iv) of this section, E's option to 
acquire 110 shares of the S corporation converts under paragraph 
(f)(4)(iv) of this section, into 91.7 shares of synthetic equity (110 
times the ratio of the 1,000 deemed-owned ESOP shares to the sum of the 
1,000 deemed-owned ESOP shares plus the 200 shares held outside the ESOP 
by A and B). Similarly, F's option to acquire 130 shares of the S 
corporation converts into 108.3 shares of synthetic equity (130 times 
the ratio of the 1,000 deemed-owned ESOP shares to the sum of the 1,000 
deemed-owned ESOP shares plus the 200 shares held outside the ESOP by A 
and B). However, the synthetic equity shares owned by any person do not 
affect the calculation for any other person's ownership of shares. 
Accordingly, as shown in column 6 in the table contained in paragraph 
(i) of Example 2, individuals B, C, E, and F are disqualified persons 
for 2006.
    (iii) Conclusion with respect to nonallocation year. The 100 shares 
owned directly by B, B's 330 deemed-owned ESOP shares, C's 145 deemed-
owned ESOP shares, E's 30 deemed-owned ESOP shares, E's 91.7 synthetic 
equity shares, F's 20 deemed-owned ESOP shares, plus F's 108.3 synthetic 
equity shares total 825, which equals 58.9% of 1,400, which is the sum 
of the 1,200 outstanding shares of X and the 200 shares of synthetic 
equity shares of X held by disqualified persons. Thus, 2006 is a 
nonallocation year for X's ESOP under section 409(p) because 
disqualified persons own at least 50% of the total shares of outstanding 
stock of X and the total synthetic equity shares of X held by 
disqualified persons. In addition, independent of the preceding 
conclusion, 2006 would be a nonallocation year because disqualified 
persons own at least 50% of X's outstanding shares because the 100 
shares owned directly by B, B's 330 deemed-owned ESOP shares, C's 145 
deemed-owned ESOP shares, E's 30 deemed-owned ESOP shares, plus F's 20 
deemed-owned ESOP shares equal 52.1% of the 1,200 outstanding shares of 
X.
    Example 3. Relating to determination of number of shares of 
synthetic equity. (i) Facts. Corporation Y is a calendar year S 
corporation that maintains an ESOP. Y has a single class of common 
stock, of which there are a total of 1,000 shares outstanding, all of 
which are owned by the ESOP. Y has no synthetic equity, except for four 
grants of nonqualified deferred compensation that are made to an 
individual during the period from 2005 through 2011, as set forth in 
column 2 in the following table. The ESOP provides for the special rules 
in paragraph (f)(4)(iii) of this section to determine the number of 
shares of synthetic equity owned by that individual with a determination 
date of January 1 and the triennial rule redetermining value, as shown 
in columns 4 and 5:

----------------------------------------------------------------------------------------------------------------
             1                          2                          3                     4               5
----------------------------------------------------------------------------------------------------------------
                                                                                                     Aggregate
                                                                                   New shares of     number of
                                 Present value of                                    synthetic       synthetic
    Determination date        nonqualified deferred          Share value on          equity on     equity shares
                                 compensation on           determination date      determination        on
                                determination date                                     date        determination
                                                                                                       date
----------------------------------------------------------------------------------------------------------------
January 1, 2005...........  A grant is made on         $10 per share............             100             100
                             January 1, 2005, with a
                             present value of $1,000.
                             An additional grant of
                             nonqualified deferred
                             compensation with a
                             present value of $775 is
                             made on March 1, 2005.

[[Page 705]]

 
January 1, 2006...........  An additional grant is     $8 per share.............             200             300
                             made on December 31,
                             2005, which has a
                             present value of $800 on
                             January 1, 2006. The
                             March 1, 2005, grant has
                             a present value on
                             January 1, 2006, of $800.
January 1, 2007...........  No new grants made.......  $12 per share............  ..............             300
January 1, 2008...........  An additional grant is     $15 per share............             200             450
                             made on December 31,
                             2007, which has a
                             present value of $3,000
                             on January 1, 2008. The
                             grants made during 2005
                             through 2007 have an
                             aggregate present value
                             on January 1, 2008, of
                             $3,750.
January 1, 2009...........  No new grants are made...  $11 per share............  ..............             450
January 1, 2010...........  No new grants are made...  $22 per share............  ..............             450
January 1, 2011...........  No new grants are made.    $20 per share............  ..............             380
                             The grants made during
                             2005 through 2008 have
                             an aggregate present
                             value on January 1,
                             2011, of $7,600.
----------------------------------------------------------------------------------------------------------------

    (ii) Conclusion. The grant made on January 1, 2005, is treated as 
100 shares until the determination date in 2008. The grant made on March 
1, 2005, is not taken into account until the 2006 determination date and 
its present value on that date, along with the then present value of the 
grant made on December 31, 2005, is treated as a number of shares that 
are based on the $8 per share value on the 2006 determination date, with 
the resulting number of shares continuing to apply until the 
determination date in 2008. On the January 1, 2008, determination date, 
the grant made on the preceding day is taken into account at its present 
value of $3,000 on January 1, 2008 and the $15 per share value on that 
date with the resulting number of shares (200) continuing to apply until 
the next determination date. In addition, on the January 1, 2008, 
determination date, the number of shares determined under other grants 
made between January 1, 2005 and December 31, 2007, must be revalued. 
Accordingly, the aggregate value of all nonqualified deferred 
compensation granted during that period is determined to be $3750 on 
January 1, 2008, and the corresponding number of shares of synthetic 
equity based on the $15 per share value is determined to be 250 shares 
on the 2008 determination date, with the resulting aggregate number of 
shares (450) continuing to apply until the determination date in 2011. 
On the January 1, 2011, determination date, the aggregate value of all 
nonqualified deferred compensation is determined to be $7,600 and the 
corresponding number of shares of synthetic equity based on the $20 per 
share value on the 2011 determination date is determined to be 380 
shares (with the resulting number of shares continuing to apply until 
the day before the determination date in 2014, assuming no further 
grants are made).

    (i) Effective dates--(1) Statutory effective date. (i) Except as 
otherwise provided in paragraph (i)(1)(ii) of this section, section 
409(p) applies for plan years ending after March 14, 2001.
    (ii) If an ESOP holding stock in an S corporation was established on 
or before March 14, 2001, and the election under section 1362(a) with 
respect to that S corporation was in effect on March 14, 2001, section 
409(p) applies for plan years beginning on or after January 1, 2005.
    (2) Regulatory effective date. This section applies for plan years 
beginning on or after January 1, 2006. For plan years beginning before 
January 1, 2006, Sec. 1.409(p)-1T (as it appeared in the April 1, 2005, 
edition of 26 CFR part 1) applies.

[T.D. 9302, 71 FR 76137, Dec. 20, 2006]



Sec. 1.409(p)-1T  Prohibited allocations of securities in an S 
corporation (temporary).

    (a) Organization of this section. Section 409(p) applies if a 
nonallocation year occurs in an employee stock ownership plan (ESOP), as 
defined in section 4975(e)(7), that holds shares of stock of an S 
corporation, as defined in section 1361, that are employer securities as 
defined in section 409(l). Paragraph (b) of this section sets forth the 
general rule under section 409(p)(1) and (2) prohibiting any accrual or 
allocation to a disqualified person in a nonallocation year. Paragraph 
(c) of this

[[Page 706]]

section sets forth rules under section 409(p)(3), (5), and (7) for 
determining whether a year is a nonallocation year, generally based on 
whether disqualified persons own at least 50 percent of the shares of 
the S corporation, either taking into account only the outstanding 
shares of the S corporation (including shares held by the ESOP) or 
taking into account both the outstanding shares and synthetic equity of 
the S corporation. Paragraphs (d), (e), and (f) of this section contain 
definitions of disqualified person under section 409(p)(4) and (5), 
deemed-owned ESOP shares under section 409(p)(4)(C), and synthetic 
equity under section 409(p)(6)(C). Paragraph (g) of this section 
contains a standard for determining when the principal purpose of the 
ownership structure of an S corporation constitutes an avoidance or 
evasion of section 409(p). The definitions used in section 409(p) and 
this section are also applicable for purposes of section 4979A, which 
imposes an excise tax on certain events, including a nonallocation year 
under section 409(p).
    (b) Prohibited allocation in a nonallocation year--(1) General rule. 
An ESOP holding employer securities consisting of stock in an S 
corporation must provide that no portion of the assets of the plan 
attributable to (or allocable in lieu of) such employer securities may, 
during a nonallocation year, accrue under the ESOP, or be allocated 
directly or indirectly under any plan of the employer (including the 
ESOP) meeting the requirements of section 401(a), for the benefit of any 
disqualified person (a prohibited allocation).
    (2) Additional rules--(i) Prohibited allocation definition. For 
purposes of section 409(p)(2)(A) and paragraph (b)(1) of this section, 
there is a prohibited allocation (i.e., assets accrue or are allocated 
as prohibited under paragraph (b)(1) of this section) if there is either 
an impermissible accrual as defined in paragraph (b)(2)(ii) of this 
section or an impermissible allocation as defined in paragraph 
(b)(2)(iii) of this section. The amount of the prohibited allocation is 
equal to the sum of the impermissible accrual plus the amount of the 
impermissible allocation (if any).
    (ii) Impermissible accrual. There is an impermissible accrual to the 
extent (and only to the extent) that employer securities consisting of 
stock in an S corporation owned by the ESOP and any assets attributable 
thereto are held under the ESOP for the benefit of a disqualified person 
during a nonallocation year. For this purpose, assets attributable to S 
corporation securities include any distributions, within the meaning of 
section 1368, made on S corporation stock held in a disqualified 
person's account in the ESOP (including earnings thereon), plus any 
proceeds from the sale of S corporation securities held for a 
disqualified person's account in the ESOP (including any earnings 
thereon). Thus, for example, in the event of a nonallocation year, all S 
corporation shares and all other ESOP assets attributable to S 
corporation stock, including distributions, sales proceeds, and earnings 
on either the distribution or proceeds, held for the account of such 
disqualified person in the ESOP during that year are an impermissible 
accrual for the benefit of that person, whether attributable to 
contributions in the current year or in prior years.
    (iii) Impermissible allocation. An impermissible allocation means 
any allocation for a disqualified person directly or indirectly under 
any plan of the employer qualified under section 401(a) that occurs 
during a nonallocation year to the extent that a contribution or other 
annual addition is made, or the disqualified person otherwise accrues 
additional benefits, under the ESOP or any other plan of the employer 
qualified under section 401(a) (including a release and allocation of 
assets from a suspense account, as described at Sec. 54.4975-11(c) and 
(d) of this chapter) that, for the nonallocation year, would otherwise 
have been added to the account of the disqualified person under the ESOP 
and invested in employer securities consisting of stock in an S 
corporation owned by the ESOP but for a provision in the ESOP to comply 
with section 409(p).
    (iv) Effects of prohibited allocation--(A) Deemed distribution. If 
there is a prohibited allocation, the amount of the prohibited 
allocation, as determined under this paragraph (b)(2), is

[[Page 707]]

treated as distributed from the ESOP (or other plan of the employer) to 
the disqualified person on the first day of the plan year on which there 
is an impermissible accrual or on the date of the allocation in the case 
of an additional impermissible accrual or impermissible allocation 
during the plan year but after the first day of the plan year. Thus, the 
fair market value of assets in the disqualified person's account that 
constitutes an impermissible accrual or allocation is included in gross 
income (to the extent in excess of any investment in the contract 
allocable to such amount) and is subject to any additional income tax 
that applies under section 72(t). A deemed distribution under this 
paragraph (b)(2)(iv)(A) is not an actual distribution from the ESOP. 
Thus, the amount of the prohibited allocation is not an eligible 
rollover distribution under section 402(c). However, for purposes of 
applying sections 72 and 402 with respect to any subsequent distribution 
from the ESOP, the amount that the disqualified person previously took 
into account as income as a result of the deemed distribution is treated 
as an investment in the contract.
    (B) Other effects. If there is a prohibited allocation, then the 
plan fails to satisfy the requirements of section 4975(e)(7) and ceases 
to be an ESOP. In such a case, the exemption from the excise tax on 
prohibited transactions for loans to leveraged ESOPs contained in 
section 4975(d)(3) would cease to apply to any loan (with the result 
that the employer would owe an excise tax with respect to the previously 
exempt loan) and, further, the exception in section 512(e)(3) would not 
apply to the plan (with the result that the plan may owe income tax as a 
result of unrelated business taxable income under section 512 with 
respect to S corporation stock held by the plan). See also section 
4979A(a) which imposes an excise tax in certain events, including a 
prohibited allocation under section 409(p).
    (v) Prevention of prohibited allocation--(A) Transfer of account to 
non-ESOP. An ESOP may prevent a nonallocation year or a prohibited 
allocation during a nonallocation year by permitting assets (including S 
corporation securities) allocated to the account of a disqualified 
person (or a person reasonably expected to become a disqualified person 
absent a transfer described in this paragraph (b)(2)(v)(A)) to be 
transferred into a separate portion of the plan that is not an ESOP, as 
described in Sec. 54.4975-11(a)(5) of this chapter, or to another plan 
of the employer that satisfies the requirements of section 401(a) (and 
that is not an ESOP). In the event of such a transfer involving S 
corporation securities, the recipient plan is subject to tax on 
unrelated business taxable income under section 512.
    (B) Relief from nondiscrimination requirement. Pursuant to this 
paragraph (b)(2)(v)(B), if a transfer described in paragraph 
(b)(2)(v)(A) of this section is made from an ESOP to a separate portion 
of the plan or to another qualified plan of the employer that is not an 
ESOP, then both the ESOP and the plan or portion of a plan that is not 
an ESOP will not fail to satisfy the requirements of Sec. 1.401(a)(4)-4 
merely because of the transfer. Further, subsequent to the transfer, 
that plan will not fail to satisfy the requirements of Sec. 
1.401(a)(4)-4 merely because of the benefits, rights, or features with 
respect to the transferred benefits if those benefits, rights, or 
features would satisfy the requirements of Sec. 1.401(a)(4)-4 if the 
mandatory disaggregation rule for ESOPs at Sec. 1.410(b)-7(c)(2) did 
not apply.
    (c) Nonallocation year--(1) Definition generally. For purposes of 
section 409(p) and this section, a nonallocation year means a plan year 
of an ESOP during which, at any time, the ESOP holds any employer 
securities that are shares of an S corporation and either--
    (i) Disqualified persons own at least 50 percent of the number of 
outstanding shares of stock in the S corporation (including deemed-owned 
ESOP shares); or
    (ii) Disqualified persons own at least 50 percent of the sum of:
    (A) The outstanding shares of stock in the S corporation (including 
deemed-owned ESOP shares), plus
    (B) The shares of synthetic equity in the S corporation owned by 
disqualified persons.
    (2) Attribution rules. For purposes of this paragraph (c), the rules 
of section 318(a) apply to determine ownership of

[[Page 708]]

shares in the S corporation (including deemed-owned ESOP shares) and 
synthetic equity. However, for this purpose, section 318(a)(4) (relating 
to options to acquire stock) is disregarded and, in applying section 
318(a)(1), the members of an individual's family include members of the 
individual's family under paragraph (d)(2) of this section. In addition, 
an individual is treated as owning deemed-owned ESOP shares of that 
individual notwithstanding the employee trust exception in section 
318(a)(2)(B)(i). If the attribution rules in paragraph (f)(1) of this 
section apply, then the rules of paragraph (f)(1) of this section are 
applied before the rules of this paragraph (c)(2).
    (3) Special rule for avoidance or evasion. (i) The ownership 
structures described in paragraph (g)(3) of this section result in a 
nonallocation year. In addition, under the ownership structures 
described in paragraph (g)(3) of this section, the individual referred 
to in paragraph (g)(3) of this section is treated as a disqualified 
person and that person's interest in the separate entity is treated as 
synthetic equity.
    (ii) Under section 409(p)(7)(B), the Commissioner, in revenue 
rulings, notices, and other guidance published in the Internal Revenue 
Bulletin (see Sec. 601.601(d)(2)(ii)(b) of this chapter), may provide 
that a nonallocation year occurs in any case in which the principal 
purpose of the ownership structure of an S corporation constitutes an 
avoidance or evasion of section 409(p). For any year that is a 
nonallocation year under this paragraph (c)(3), the Commissioner may 
treat any person as a disqualified person. See paragraph (g) of this 
section for guidance regarding when the principal purpose of an 
ownership structure of an S corporation involving synthetic equity 
constitutes an avoidance or evasion of section 409(p).
    (4) Special rule for certain stock rights. (i) For purposes of 
paragraph (c)(1) of this section, a person is treated as owning stock 
that the person has a right to acquire if, at all times during the 
period when such right is effective, the stock that the person has the 
right to acquire is both issued and outstanding and is held by persons 
other than the ESOP, the S corporation, or a related entity (as defined 
in paragraph (f)(3) of this section).
    (ii) This paragraph (c)(4) applies only if treating persons as 
owning the shares described in paragraph (c)(4)(i) of this section 
results in a nonallocation year. This paragraph (c)(4) does not apply to 
a right to acquire stock of an S corporation held by a shareholder 
subject to Federal income tax that, under Sec. 1.1361-1(l)(2)(iii) or 
(l)(4)(iii)(C), would not be taken into account in determining if an S 
corporation has a second class of stock provided that a principal 
purpose of the right is not the avoidance or evasion of section 409(p). 
Under the last sentence of paragraph (f)(2)(i) of this section, this 
paragraph (c)(4)(ii) does not apply for purposes of determining 
ownership of deemed-owned ESOP shares or whether an interest constitutes 
synthetic equity.
    (5) Application with respect to shares treated as owned by more than 
one person. For purposes of applying paragraph (c)(1) of this section, 
if, by application of the rules of paragraph (c)(2), (c)(4), or (f)(1) 
of this section, any share is treated as owned by more than one person, 
then that share is counted as a single share and that share is treated 
as owned by disqualified persons if any of the owners is a disqualified 
person.
    (6) Effect of nonallocation year. See paragraph (b) of this section 
for a prohibition applicable during a nonallocation year. See also 
section 4979A for an excise tax applicable in certain cases, including 
section 4979A(a)(3) and (4) which applies during a nonallocation year 
(whether or not there is a prohibited allocation during the year).
    (d) Disqualified persons--(1) General definition. For purposes of 
section 409(p) and this section, a disqualified person means any person 
for whom--
    (i) The number of such person's deemed-owned ESOP shares of the S 
corporation is at least 10 percent of the number of the deemed-owned 
ESOP shares of the S corporation;
    (ii) The aggregate number of such person's deemed-owned ESOP shares 
and synthetic equity shares of the S corporation is at least 10 percent 
of the sum of:
    (A) The total number of deemed-owned ESOP shares; and

[[Page 709]]

    (B) The person's synthetic equity shares of the S corporation;
    (iii) The aggregate number of the S corporation's deemed-owned ESOP 
shares of such person and of the members of such person's family is at 
least 20 percent of the number of deemed-owned ESOP shares of the S 
corporation; or
    (iv) The aggregate number of the S corporation's deemed-owned ESOP 
shares and synthetic equity shares of such person and of the members of 
such person's family is at least 20 percent of the sum of:
    (A) The total number of deemed-owned ESOP shares, and
    (B) The synthetic equity shares of the S corporation owned by such 
person and the members of such person's family.
    (2) Treatment of family members; definition--(i) Rule. Each member 
of the family of any person who is a disqualified person under paragraph 
(d)(1) (iii) or (iv) of this section is a disqualified person.
    (ii) General definition. For purposes of section 409(p) and this 
section, member of the family means, with respect to an individual--
    (A) The spouse of the individual;
    (B) An ancestor or lineal descendant of the individual or the 
individual's spouse;
    (C) A brother or sister of the individual or of the individual's 
spouse and any lineal descendant of the brother or sister; and
    (D) The spouse of any individual described in paragraph (d)(2)(ii) 
(B) or (C) of this section.
    (iii) Spouse. A spouse of an individual who is legally separated 
from such individual under a decree of divorce or separate maintenance 
is not treated as such individual's spouse under paragraph (d)(2)(ii)(A) 
of this section.
    (3) Special rule for certain nonallocation years. See paragraph 
(c)(3) of this section (relating to avoidance or evasion of section 
409(p)) for special rules permitting certain persons to be treated as 
disqualified persons in certain nonallocation years.
    (4) Example. The rules of this paragraph (d) are illustrated by the 
following example:

    Example. (i) Facts. An S corporation has 800 outstanding shares of 
which 100 are owned by individual O and 700 are held in an employee 
stock ownership plan (ESOP) during 2005, including 200 shares held in 
the ESOP account of O, 65 shares held in the ESOP account of participant 
P, and 40 shares held in the ESOP account of participant Q who is P's 
spouse. The S corporation has no synthetic equity.
    (ii) Conclusion. O is a disqualified person during 2005 because O's 
account in the ESOP holds at least 10 percent of the shares owned by the 
ESOP (200 is 28.6 percent of 700). In addition, P is a disqualified 
person during 2005 because, under paragraph (d)(2) of this section, P is 
treated as owning the shares held by Q and P's total deemed-owned shares 
are thus at least 10 percent of the shares owned by the plan (65 plus 40 
is more than 10 percent of 700). In addition, Q is a disqualified person 
as a result of the rules in paragraph (d)(2) of this section. As a 
result, disqualified persons own at least 50 percent of the outstanding 
shares of the S corporation during 2005 (O's 100 directly owned shares, 
O's 200 deemed-owned shares, P's 65 deemed-owned shares, plus Q's 40 
deemed owned shares are 50.6 percent of 800).

    (e) Deemed-owned ESOP shares. For purposes of section 409(p) and 
this section, a person is treated as owning his or her deemed-owned ESOP 
shares.
    Deemed-owned ESOP shares mean, with respect to any person--
    (1) Any shares of stock in the S corporation constituting employer 
securities that are allocated to such person's account under the ESOP; 
and
    (2) Such person's share of the stock in the S corporation that is 
held by the ESOP but is not allocated to the account of any participant 
or beneficiary (with such person's share to be determined in the same 
proportion as the shares released and allocated from a suspense account, 
as described at Sec. 54.4975-11(c) and (d) of this chapter, under the 
ESOP for the most recently ended plan year for which there were shares 
released and allocated from a suspense account, or if there has been no 
such prior release and allocation from a suspense account, then 
determined in proportion to a reasonable estimate of the shares that 
would be released and allocated in the first year of loan repayment).
    (f) Synthetic equity--(1) Ownership of synthetic equity. For 
purposes of section 409(p) and this section, synthetic equity is treated 
as owned by a person in

[[Page 710]]

the same manner as stock is treated as owned by a person, directly or 
under the rules of section 318(a)(2) and (3). Synthetic equity means the 
rights described in paragraph (f)(2) of this section.
    (2) Synthetic equity--(i) Rights to acquire stock of the S 
corporation. Synthetic equity includes any stock option, warrant, 
restricted stock, deferred issuance stock right, stock appreciation 
right payable in stock, or similar interest or right that gives the 
holder the right to acquire or receive stock of the S corporation in the 
future. Rights to acquire stock in an S corporation with respect to 
stock that is, at all times during the period when such rights are 
effective, both issued and outstanding and held by persons (who are 
subject to federal income taxes) other than the ESOP, the S corporation, 
or a related entity are not synthetic equity (but see paragraph (c)(4) 
of this section).
    (ii) Special rule for certain stock rights. Synthetic equity also 
includes a right to a future payment (payable in cash or any other form 
other than stock of the S corporation) from an S corporation that is 
based on the value of the stock of the S corporation, such as 
appreciation in such value. Thus, synthetic equity includes a stock 
appreciation right with respect to stock of an S corporation that is 
payable in cash or a phantom stock unit with respect to stock of an S 
corporation that is payable in cash.
    (iii) Rights to acquire interests in or assets of an S corporation 
or a related entity. Synthetic equity includes a right to acquire stock 
or other similar interests in a related entity to the extent of the S 
corporation's ownership. Synthetic equity also includes a right to 
acquire assets of an S corporation or a related entity other than either 
rights to acquire goods, services, or property at fair market value in 
the ordinary course of business or fringe benefits excluded from gross 
income under section 132.
    (iv) Special rule for nonqualified deferred compensation. (A) 
Synthetic equity also includes any of the following with respect to an S 
corporation or a related entity: any remuneration to which section 
404(a)(5) applies; remuneration for which a deduction would be permitted 
under section 404(a)(5) if separate accounts were maintained; any right 
to receive property to which section 83 applies (including a payment to 
a trust described in section 402(b) or to an annuity described in 
section 403(c)) in a future year for the performance of services; any 
transfer of property (to which section 83 applies) in connection with 
the performance of services to the extent that the property is not 
substantially vested within the meaning of Sec. 1.83-3(i) by the end of 
the plan year in which transferred; and a split-dollar life insurance 
arrangement under Sec. 1.61-22(b) entered into in connection with the 
performance of services (other than one under which, at all times, the 
only economic benefit that will be provided under the arrangement is 
current life insurance protection as described in Sec. 1.61-22(d)(3)). 
Synthetic equity also includes any other remuneration for services under 
a plan, or method or arrangement, deferring the receipt of compensation 
to a date that is after the 15th day of the 3rd calendar month after the 
end of the entity's taxable year in which the related services are 
rendered. However, synthetic equity does not include benefits under a 
plan that is an eligible retirement plan within the meaning of section 
402(c)(8)(B).
    (B) For purposes of applying paragraph (f)(2)(iv)(A) of this section 
with respect to an ESOP, synthetic equity does not include any interest 
described in such paragraph (f)(2)(iv)(A) of this section to the extent 
that--
    (1) The interest is nonqualified deferred compensation (within the 
meaning of section 3121(v)(2)) that was outstanding on December 17, 
2004;
    (2) The interest is an amount that was taken into account (within 
the meaning of Sec. 31.3121(v)(2)-1(d) of this chapter) prior to 
January 1, 2005, for purposes of taxation under chapter 21 of the 
Internal Revenue Code (or income attributable thereto); and
    (3) The interest was held before the first date on which the ESOP 
acquires any employer securities.
    (v) No overlap among shares of deemed-owned ESOP shares or synthetic 
equity. Synthetic equity under this paragraph

[[Page 711]]

(f)(2) does not include shares that are deemed-owned ESOP shares (or any 
rights with respect to deemed-owned ESOP shares to the extent such 
rights are specifically permitted under section 409(h)). In addition, 
synthetic equity under a specific subparagraph of this paragraph (f)(2) 
does not include anything that is synthetic equity under paragraph 
(f)(2)(i), (ii), (iii) or (iv) of this section.
    (3) Related entity. For purposes of this paragraph (f), related 
entity means any entity in which the S corporation holds an interest and 
which is a partnership, a trust, an eligible entity that is disregarded 
as an entity that is separate from its owner under Sec. 301.7701-3 of 
this chapter, or a Qualified Subchapter S Subsidiary under section 
1361(b)(3).
    (4) Number of synthetic shares--(i) Synthetic equity determined by 
reference to S corporation shares. In the case of synthetic equity that 
is determined by reference to shares of stock of the S corporation, the 
person who is entitled to the synthetic equity is treated as owning the 
number of shares of stock deliverable pursuant to such synthetic equity. 
In the case of synthetic equity that is determined by reference to 
shares of stock of the S corporation, but for which payment is made in 
cash or other property (besides stock of the S corporation), the number 
of shares of synthetic equity treated as owned is equal to the number of 
shares of stock having a fair market value equal to the cash or other 
property (disregarding lapse restrictions as described in Sec. 1.83-
3(i)). Where such synthetic equity is a right to purchase or receive S 
corporation shares, the corresponding number of shares of synthetic 
equity is determined without regard to lapse restrictions as described 
in Sec. 1.83-3(i) or to any amount required to be paid in exchange for 
the shares. Thus, for example, if a corporation grants an employee of an 
S corporation an option to purchase 100 shares of the corporation's 
stock, exercisable in the future only after the satisfaction of certain 
performance conditions, the employee is the deemed owner of 100 
synthetic equity shares of the corporation as of the date the option is 
granted. If the same employee were granted 100 shares of restricted S 
corporation stock (or restricted stock units), subject to forfeiture 
until the satisfaction of performance or service conditions, the 
employee would likewise be the deemed owner of 100 synthetic equity 
shares from the grant date. However, if the same employee were granted a 
stock appreciation right with regard to 100 shares of S corporation 
stock (whether payable in stock or in cash), the number of synthetic 
equity shares the employee is deemed to own equals the number of shares 
having a value equal to the appreciation at the time of measurement 
(determined without regard to lapse restrictions).
    (ii) Synthetic equity determined by reference to shares in a related 
entity. In the case of synthetic equity that is determined by reference 
to shares of stock (or similar interests) in a related entity, the 
person who is entitled to the synthetic equity is treated as owning 
shares of stock of the S corporation with the same aggregate value as 
the number of shares of stock (or similar interests) of the related 
entity (with such value determined without regard to any lapse 
restriction as defined at Sec. 1.83-3(i)).
    (iii) Other synthetic equity--(A) General rule. In the case of any 
synthetic equity to which neither paragraph (f)(4)(i) nor paragraph 
(f)(4)(ii) of this section apply, the person who is entitled to the 
synthetic equity is treated as owning on any date a number of shares of 
stock in the S corporation equal to the present value (on that date) of 
the synthetic equity (with such value determined without regard to any 
lapse restriction as defined at Sec. 1.83-3(i)) divided by the fair 
market value of a share of the S corporation's stock as of that date.
    (B) Special rules--(1) Use of annual or more frequent determination 
dates. For purposes of this paragraph (f)(4)(iii), while the 
determination of whether there is a nonallocation year depends on day-
by-day determinations under paragraph (c) of this section, the number of 
shares of S corporation stock treated as owned by a person who is 
entitled to synthetic equity to which this paragraph (f)(4)(iii) applies 
is permitted to be determined only annually (or more frequently), as of 
the first day of the ESOP's plan year or as of any other

[[Page 712]]

reasonable determination date or dates during a plan year. If the ESOP 
so provides, the number of shares of synthetic equity to which this 
paragraph (f)(4)(iii) applies that are treated as owned by that person 
for any period from a given determination date through the date 
immediately preceding the next following determination date is the 
number of shares treated as owned on the given determination date.
    (2) Use of triannual recalculations. In addition, if the terms of 
the ESOP so provide, then the number of shares of synthetic equity with 
respect to grants of synthetic equity to which this paragraph 
(f)(4)(iii) applies may be fixed for a specified period from a 
determination date identified under the ESOP through a date that is not 
later than the day before the determination date that is on or 
immediately preceding the third anniversary of the identified 
determination date. Additional accruals, allocations, or grants (to 
which this paragraph (f)(4)(iii) applies) that are made during such 
three-year period are taken into account on each determination date 
during that period, based on the number of synthetic equity shares 
resulting from the additional accrual, allocation, or grant (determined 
as of the determination date on or next following the date of the 
accrual, allocation, or grant). However, the ESOP must provide for the 
number of shares of synthetic equity to which this paragraph (f)(4)(iii) 
applies to be re-determined not less frequently than every three years, 
based on the S corporation share value on a determination date that is 
not later than the third anniversary of the identified determination 
date and the aggregate present value of the synthetic equity to which 
this paragraph (f)(4)(iii) applies (including all grants made during the 
three-year period) on that determination date. See Example 3 of 
paragraph (h) of this section for an example illustrating this paragraph 
(f)(4)(iii)(B)(2).
    (3) Conditions for application of rules. Paragraph (f)(4)(iii)(B) of 
this section only applies with respect to grants of synthetic equity to 
which this paragraph (f)(4)(iii) applies. In addition, paragraph 
(f)(4)(iii)(B)(1) of this section applies only if the fair market value 
of a share of the S corporation securities on any determination date is 
not unrepresentative of the value of the S corporation securities 
throughout the rest of the plan year and only if the terms of the ESOP 
include provisions conforming to paragraph (f)(4)(iii)(B)(1) of this 
section which are consistently used by the ESOP for all persons. In 
addition, paragraph (f)(4)(iii)(B)(2) of this section applies only if 
the terms of the ESOP include provisions conforming to paragraphs 
(f)(4)(iii)(B)(1) and (2) of this section which are consistently used by 
the ESOP for all persons.
    (iv) Adjustment of number of synthetic equity shares where ESOP owns 
less than 100% of S corporation. Under this paragraph (f)(4)(iv), the 
number of synthetic shares otherwise determined under this paragraph 
(f)(4) is decreased ratably to the extent that shares of the S 
corporation are owned by a person who is not an ESOP (and who is subject 
to Federal income taxes). For example, if an S corporation has 200 
outstanding shares, of which individual A owns 50 shares and the ESOP 
owns the other 150 shares, and individual B would be treated under this 
paragraph (f)(4) as owning 200 synthetic equity shares of the S 
corporation but for this paragraph (f)(4)(iv), then, under the rule of 
this paragraph (f)(4)(iv), the number of synthetic shares treated as 
owned by B under this paragraph (f)(4) is decreased from 200 to 150 
(because the ESOP only owns 75% of the outstanding stock of the S 
corporation, rather than 100%).
    (v) Special rule for shares with greater voting power than ESOP 
shares. Notwithstanding any other provision of this paragraph (f)(4), if 
a synthetic equity right includes (directly or indirectly) a right to 
purchase or receive shares of S corporation stock that have per-share 
voting rights greater than the per-share voting rights of one or more 
shares of S corporation stock held by the ESOP, then the number of 
shares of deemed owned synthetic equity attributable to such right is 
not less than the number of shares that would have the same voting 
rights if the shares had the same per-share voting rights as shares held 
by the ESOP

[[Page 713]]

with the least voting rights. For example, if shares of S corporation 
stock held by the ESOP have one voting right per share, then an 
individual who holds an option to purchase one share with 100 voting 
rights is treated as owning 100 shares of synthetic equity.
    (g) Avoidance or evasion of section 409(p) involving synthetic 
equity--(1) General rule. Paragraph (g)(2) of this section sets forth a 
standard for determining whether the principal purpose of the ownership 
structure of an S corporation involving synthetic equity constitutes an 
avoidance or evasion of section 409(p). Paragraph (g)(3) of this section 
identifies certain specific ownership structures that constitute an 
avoidance or evasion of section 409(p). See also paragraph (c)(3) of 
this section for a rule under which the ownership structures in 
paragraph (g)(3) result in a nonallocation year for purposes of section 
409(p).
    (2) Standard for determining when there is an avoidance or evasion 
of section 409(p) involving synthetic equity--For purposes of section 
409(p) and this section, whether the principal purpose of the ownership 
structure of an S corporation involving synthetic equity constitutes an 
avoidance or evasion of section 409(p) is determined by taking into 
account all the surrounding facts and circumstances, including all 
features of the ownership of the S corporation's outstanding stock and 
related obligations (including synthetic equity), any shareholders who 
are taxable entities, and the cash distributions made to shareholders, 
to determine whether, to the extent of the ESOP's stock ownership, the 
ESOP receives the economic benefits of ownership in the S corporation 
that occur during the period that stock of the S corporation is owned by 
the ESOP. Among the factors indicating that the ESOP receives these 
economic benefits include shareholder voting rights, the right to 
receive distributions made to shareholders, and the right to benefit 
from the profits earned by the S corporation, including the extent to 
which actual distributions of profits are made from the S corporation to 
the ESOP and the extent to which the ESOP's ownership interest in 
undistributed profits and future profits is subject to dilution as a 
result of synthetic equity, for example, the ESOP's ownership interest 
is not subject to dilution if the total amount of synthetic equity is a 
relatively small portion of the total number of shares and deemed-owned 
shares of the S corporation.
    (3) Specific transactions that constitute an avoidance or evasion of 
section 409(p) involving segregated profits. Taking into account the 
standard in paragraph (g)(2) of this section, the principal purpose of 
the ownership structure of an S corporation constitutes an avoidance or 
evasion of section 409(p) in any case in which--
    (i) The profits of the S corporation generated by the business 
activities of a specific individual or individuals are not provided to 
the ESOP, but are instead substantially accumulated and held for the 
benefit of that individual or individuals on a tax-deferred basis within 
an entity related to the S corporation, such as a partnership, trust, or 
corporation (such as in a subsidiary that is a disregarded entity), or 
any other method that has the same effect of segregating profits for the 
benefit of such individual or individuals (such as nonqualified deferred 
compensation described in paragraph (f)(2)(iv) of this section);
    (ii) The individual or individuals for whom profits are segregated 
have rights to acquire 50 percent or more of those profits directly or 
indirectly (for example, by purchase of the subsidiary); and
    (iii) A nonallocation year would occur if this section were 
separately applied with respect to either the separate entity or 
whatever method has the effect of segregating profits of the individual 
or individuals, treating such entity as a separate S corporation owned 
by an ESOP (or in the case of any other method of segregation of profits 
by treating those profits as the only assets of a separate S corporation 
owned by an ESOP).
    (h) Examples. The rules of this section are illustrated by the 
following examples:

    Example 1. Relating to determination of disqualified persons and 
nonallocation year if there is no synthetic equity. (i) Facts. 
Corporation X is a calendar year S corporation that maintains an ESOP. X 
has a single class of

[[Page 714]]

common stock, of which there are a total of 1,200 shares outstanding. X 
has no synthetic equity. In 2006, individual A, who is not an employee 
of X (and is not related to any employee of X), owns 100 shares 
directly, individual B owns 100 shares directly, and the remaining 1,000 
shares are owned by an ESOP maintained by X for its employees. The 
ESOP's 1,000 shares are allocated to the accounts of individuals who are 
employees of X (none of whom are related), as set forth in columns 1 and 
2 in the following table:

----------------------------------------------------------------------------------------------------------------
                                          2 Deemed-owned ESOP      3 Percentage deemed-    4 Disqualified person
            1 Shareholders              shares (total of 1,000)      owned ESOP shares
----------------------------------------------------------------------------------------------------------------
B....................................  330.....................  33......................  Yes.
C....................................  145.....................  14.5....................  Yes.
D....................................  75......................  7.5.....................  No.
E....................................  30......................  3.......................  No.
F....................................  20......................  2.......................  No.
Other participants...................  400 (none exceed 10       1 or less...............  No.
                                        shares).
----------------------------------------------------------------------------------------------------------------

    (ii) Conclusion with respect to disqualified persons. As shown in 
column 4 in the table above, individuals B and C are disqualified 
persons for 2006 under paragraph (d)(1) of this section because each 
owns at least 10% of X's deemed-owned ESOP shares.
    (iii) Conclusion with respect to nonallocation year. However, 2006 
is not a nonallocation year under section 409(p) because disqualified 
persons do not own at least 50% of X's outstanding shares (the 100 
shares owned directly by B, B's 330 deemed-owned ESOP shares, plus C's 
145 deemed-owned ESOP shares equal only 47.9% of the 1,200 outstanding 
shares of X).
    Example 2. Relating to determination of disqualified persons and 
nonallocation year if there is synthetic equity. (i) Facts. The facts 
are the same as in Example 1, except that, as shown in column 4 of the 
table in this example 2, individuals E and F have options to acquire 110 
and 130 shares, respectively, of the common stock of X from X:

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                             5 Shareholder
                                        2 Deemed-owned ESOP      3 Percentage deemed-      4 Options     percentage of deemed-
           1 Shareholders             shares (total of 1,000)     owned ESOP shares          (240)          owned ESOP plus       6 Disqualified person
                                                                                                        synthetic equity shares
--------------------------------------------------------------------------------------------------------------------------------------------------------
B...................................  330....................  33.....................  ..............  .......................  Yes (col. 3).
C...................................  145....................  14.5...................  ..............  .......................  Yes (col. 3).
D...................................  75.....................  7.5....................  ..............  .......................  No.
E...................................  30.....................  3......................             110  11.1% ([30 + 91.7]       Yes (col. 5).
                                                                                                         divided by 1,091.7).
F...................................  20.....................  2......................             130  11.6% ([20 + 108.3]      Yes (col. 5).
                                                                                                         divided by 1,108.3).
Other participants..................  400 (none exceeds 10     1 or less..............  ..............  .......................  No.
                                       shares).
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (ii) Conclusion with respect to disqualified persons. Applying the 
rule of paragraph (f)(4)(iv) of this section, E's option to acquire 110 
shares of the S corporation converts into 91.7 shares of synthetic 
equity (110 times the ratio of the 1,000 deemed-owned ESOP shares to the 
sum of the 1,000 deemed-owned ESOP shares plus the 200 shares held 
outside the ESOP by A and B). Similarly, F's option to acquire 130 
shares of the S corporation converts into 108.3 shares of synthetic 
equity (130 times the ratio of the 1,000 deemed-owned ESOP shares to the 
sum of the 1,000 deemed-owned ESOP shares plus the 200 shares held 
outside the ESOP by A and B). Accordingly, as shown in column 6 in the 
table above, individual E's synthetic equity shares are counted in 
determining whether E is a disqualified person for 2006, and individual 
F's synthetic equity shares are counted in determining whether F is a 
disqualified person for 2006, but the synthetic equity shares owned by 
any person do not affect the calculation for any other person's 
ownership of shares. Accordingly, individuals B, C, E, and F are 
disqualified persons for 2006.
    (iii) Conclusion with respect to nonallocation year. The 100 shares 
owned directly by B, B's 330 deemed-owned ESOP shares, C's 145 deemed-
owned ESOP shares, E's 30 deemed-owned ESOP shares, E's 91.7 synthetic 
equity shares, F's 20 deemed-owned ESOP shares, plus F's 108.3 synthetic 
equity shares total 825, which equals 58.9% of 1,400, which is the sum 
of the 1,200 outstanding shares of X and the 200 shares of synthetic 
equity shares of X held by disqualified persons. Thus, 2006 is a

[[Page 715]]

nonallocation year for X's ESOP under section 409(p) because 
disqualified persons own at least 50% of the total shares of outstanding 
stock of X and the total synthetic equity shares of X held by 
disqualified persons. In addition, independent of the preceding 
conclusion, 2006 would be a nonallocation year because disqualified 
persons own at least 50% of X's outstanding shares because the 100 
shares owned directly by B, B's 330 deemed-owned ESOP shares, C's 145 
deemed-owned ESOP shares, E's 30 deemed-owned ESOP shares, plus F's 20 
deemed-owned ESOP shares equal 52.1% of the 1,200 outstanding shares of 
X.
    Example 3. Relating to determination of number of shares of 
synthetic equity. (i) Facts. Corporation Y is a calendar year S 
corporation that maintains an ESOP. Y has a single class of common 
stock, of which there are a total of 1,000 shares outstanding, all of 
which are owned by the ESOP. Y has no synthetic equity, except for four 
grants of nonqualified deferred compensation that are made to an 
individual during the period from 2005 through 2011, as set forth in 
column 2 in the following table, and the ESOP uses the special rules in 
paragraph (f)(4)(iii) of this section to determine the number of shares 
of synthetic equity owned by that individual, as shown in columns 4 and 
5:

----------------------------------------------------------------------------------------------------------------
                                                                                                    5 Aggregate
                                                                                   4 New shares      number of
                                      2 Present value of                           of synthetic      synthetic
       1 Determination date         nonqualified deferred     3 Share value on       equity on     equity shares
                                        compenstion on       determination date    determination        on
                                      determination date                               date        determination
                                                                                                       date
----------------------------------------------------------------------------------------------------------------
January 1, 2005...................  A grant is made on     $10 per share........             100             100
                                     January 1, 2005 with
                                     a present value of
                                     $1,000. An
                                     additional grant of
                                     nonqualified
                                     deferred
                                     compensation with a
                                     present value of
                                     $775 is made on
                                     March 1, 2005.
January 1, 2006...................  An additional grant    $8 per share.........             200             300
                                     is made on December
                                     31, 2005 which has a
                                     present value of
                                     $800 on January 1,
                                     2006. The March 1,
                                     2005 grant has a
                                     present value on
                                     January 1, 2006 of
                                     $800.
January 1, 2007...................  No new grants made...  $12 per share........  ..............             300
January 1, 2008...................  An additional grant    $15 per share........             200             450
                                     is made on December
                                     31, 2007 which has a
                                     present value of
                                     $3,000 on January 1,
                                     2008. The grants
                                     made during 2005
                                     through 2007 have an
                                     aggregate present
                                     value on January 1,
                                     2008 of $3,750.
January 1, 2009...................  No new grants are      $11 per share........  ..............             450
                                     made.
January 1, 2010...................  No new grants are      $22 per share........  ..............             450
                                     made.
January 1, 2011...................  No new grants are      $20 per share........  ..............             380
                                     made. The grants
                                     made during 2005
                                     through 2008 have an
                                     aggregate present
                                     value on January 1,
                                     2011 of $7,600.
----------------------------------------------------------------------------------------------------------------

    (ii) Conclusion. The grant made on January 1, 2005, is treated as 
100 shares until the determination date in 2008. The grant made on March 
1, 2005, is not taken into account until the 2006 determination date and 
its present value on that date, along with the then present value of the 
grant made on the preceding day, is treated as a number of shares that 
are based on the $8 per share value on the 2006 determination date, with 
the resulting number of shares continuing to apply until the 
determination date in 2008. On the January 1, 2008, determination date, 
the grant made on the preceding day is taken into account at its present 
value of $3,000 on January 1, 2008 and the $15 per share value on that 
date with the resulting number of shares (200) continuing to apply until 
the next determination date. In addition, on the January 1, 2008, 
determination date, the number of shares determined under other grants 
made between January 1, 2005 and December 31, 2007, must be revalued. 
Accordingly, the aggregate value of all nonqualified deferred 
compensation granted during that period is determined to be $3750 on 
January 1, 2008, and the corresponding number of shares of synthetic 
equity based on the $15 per share value is determined to be 250 shares 
on the 2008 determination date, with the resulting aggregate number of 
shares (450) continuing to apply until the determination date in 2011. 
On the January 1, 2011, determination date, the aggregate value of all 
nonqualified deferred compensation is determined to be $7,600 and the 
corresponding number of shares of synthetic equity based on the $20 per 
share value on the 2011 determination date is determined to be 380 
shares

[[Page 716]]

(with the resulting number of shares continuing to apply until the 
determination date in 2014, assuming no further grants are made).

    (i) Effective dates--(1) Statutory effective date. (i) Except as 
otherwise provided in paragraph (i)(1)(ii) of this section, section 
409(p) applies for plan years ending after March 14, 2001.
    (ii) If an ESOP holding stock in an S corporation was established on 
or before March 14, 2001, and the election under section 1362(a) with 
respect to that S corporation was in effect on March 14, 2001, section 
409(p) applies for plan years beginning on or after January 1, 2005.
    (2) Regulation effective date--(i) General effective date. Except as 
otherwise provided in paragraph (i)(2)(ii) of this section, this section 
applies for plan years beginning on or after January 1, 2005.
    (ii) Rules for plan years beginning before January 1, 2005. (A) 
Except as provided in this paragraph (i)(2)(ii), Sec. 1.409(p)-1T as in 
effect prior to December 17, 2004 (see Sec. 1.409(p)-1T in 26 CFR part 
1 revised as of April 1, 2004) applies for plan years ending after 
October 20, 2003, and beginning before January 1, 2005.
    (B) Paragraphs (c)(3) and (g) of this section apply for plan years 
ending on or after December 31, 2004, but do not apply with respect to 
an interest held in a qualified subchapter S subsidiary (QSUB) of an S 
corporation or another entity to which paragraph (g)(3) of this section 
applies before March 15, 2004 if:
    (1) All interests in the entity held by individuals who would be 
disqualified persons under paragraph (g)(3) of this section or under 
guidance issued by the Commissioner before March 15, 2004 are 
distributed to those individuals as compensation on or before March 15, 
2004; and
    (2) No such individual has been a participant in the ESOP of the S 
corporation at any time after October 20, 2003 and before March 15, 
2004.
    (C) Paragraph (f)(2)(iv)(B) of this section (providing that 
synthetic equity does not include certain preexisting nonqualified 
deferred compensation) applies for plan years ending before January 1, 
2005.
    (D) Paragraph (f)(4)(iv) of this section (permitting an adjustment 
of the number of synthetic equity shares where an ESOP owns less than 
100% of an S corporation) applies for plan years ending before January 
1, 2005.
    (E) In no event does this paragraph (i)(2)(ii) apply for any plan 
year ending before January 1, 2005, for an ESOP holding stock in an S 
corporation that was established on or before March 14, 2001, if the 
election under section 1362(a) with respect to that S Corporation was in 
effect on March 14, 2001.
    (iii) Transition rules. (A) Assets held in the account of a 
disqualified person as of the last day of the first plan year beginning 
before January 1, 2005, will not be treated as an impermissible accrual 
with respect to that disqualified person under paragraph (b)(2)(ii) of 
this section for the first plan year beginning on or after January 1, 
2005, to the extent those assets are not held in that person's account 
on or after July 1, 2005. Thus, for example, to the extent the assets 
allocated to the account of a disqualified person as of the last day of 
the first plan year beginning before January 1, 2005, are transferred to 
a non-ESOP portion of the plan as described in paragraph (b)(2)(v)(A) of 
this section before July 1, 2005, those assets will not be treated as an 
impermissible accrual under paragraph (b)(2)(ii) of this section for the 
period from the first day of the first plan year beginning on or after 
January 1, 2005 through June 30, 2005. However, see section 4979A(a)(3), 
(a)(4), and (e)(2)(C) for excise tax provisions that apply to all 
deemed-owned shares during the first nonallocation year for the ESOP.
    (B) An individual is not treated as a disqualified person during the 
period from the first day of the first plan year beginning on or after 
January 1, 2005 through June 30, 2005 if that person would not be a 
disqualified person during that period under the modified rules of this 
paragraph (i)(2)(iii)(B) as of any date during that same period. 
Further, solely for the purpose of determining whether the first plan 
year beginning on or after January 1, 2005 is a nonallocation year under 
section 409(p) and this section, if that plan year would not have been a 
nonallocation year under the modified rules of

[[Page 717]]

this paragraph (i)(2)(iii)(B), then synthetic equity that is not owned 
by a person on July 1, 2005 is disregarded during the period from the 
first day of the first plan year beginning on or after January 1, 2005 
through June 30, 2005. For purposes of this paragraph (i)(2)(iii)(B), 
the modified rules of this paragraph (i)(2)(iii)(B) are the rules in 
Sec. 1.409(p)-1T as in effect prior to December 17, 2004 (see Sec. 
1.409(p)-1T in 26 CFR Part 1 revised as of April 1, 2004), modified to 
exclude from the definition of synthetic equity any stock option, stock 
appreciation right (payable in cash or stock), or similar rights with 
respect to shares of the S corporation or a related entity where the 
facts and circumstances indicate that there is no reasonable likelihood 
that the holder of the right will receive the shares (or equivalent 
value). For this purpose, there is no reasonable likelihood that the 
holder of the right will receive the shares (or equivalent value) in any 
case in which the option is based on an exercise price that is more than 
200% of the fair market value of the shares on the date of grant or the 
right (in the case of a stock appreciation right or similar right to 
acquire shares of the S corporation or a related entity) is payable only 
if the appreciation exceeds 100% of the fair market value of the shares 
on the date of grant.
    (C) For the period from the first day of the first plan year 
beginning on or after January 1, 2005 through June 30, 2005, there is no 
nonallocation year under this section if there would be no nonallocation 
year under this section during that period if this section were applied 
without regard to paragraph (f)(4)(v) of this section (relating to 
voting rights).
    (D) This paragraph (iii) does not apply to an ESOP for which the 
first plan year beginning on or after January 1, 2005 begins after June 
30, 2005.

[T.D. 9164, 69 FR 75460, Dec. 17, 2004; 70 FR 11121, Mar. 8, 2005]



Sec. 1.410(a)-1  Minimum participation standards; general rules.

    (a) In general. A plan is not a qualified plan (and a trust forming 
a part of such plan is not a qualified trust) unless the plan 
satisfies--
    (1) The minimum age and service requirements of section 410(a)(1) 
and Sec. 1.410(a)-3,
    (2) The maximum age requirements of section 410(a)(2) and Sec. 
1.410(a)-4, and
    (3) The minimum coverage requirements of section 410(b)(1) and Sec. 
1.410(b)-1.
    (b) Organization of regulations relating to minimum participation 
standards--(1) General rules. This section prescribes general rules 
relating to the minimum participation standards provided by Section 410.
    (2) Effective dates. Section 1.410(a)-2 provides rules under section 
1017 of the Employee Retirement Income Security Act of 1974 relating to 
effective dates under section 410.
    (3) Age and service conditions. Section 1.410(a)-3 provides rules 
under section 410(a)(1) relating to minimum age and service conditions.
    (4) Maximum age and time of participation. Section 1.410(a)-4 
provides rules under section 410(a) (2) and (4) relating to maximum age 
and time of participation.
    (5) Year of service; breaks in service. For rules relating to years 
of service and breaks in service, see 29 CFR Part 2530 (Department of 
Labor regulations relating to minimum standards for employee pension 
benefit plans). See Sec. 1.410(a)-5 for rules under section 
410(a)(3)(B) relating to seasonal industries and for certain rules under 
section 410(a)(5) relating to breaks in service.
    (6) Breaks in service. Section 1.410(a)-6 provides special rules 
under section 1017(f) of the Employee Retirement Income Security Act of 
1974 relating to amendment of break in service rules.
    (7) Elapsed time. Section 1.410 (a)-7 provides rules under sections 
410 and 411 relating to the elapsed time method of crediting years of 
service.
    (8) Coverage. Section 1.410(b)-1 provides rules relating to the 
minimum coverage requirements provided by section 410(b)(1).
    (9) Church election. Section 1.410(d)-1 provides rules relating to 
the election by a church to have participation, vesting, funding, etc., 
provisions apply.
    (c) Application of participation standards to certain plans--(1) 
General rule. Except as provided in subparagraph (2)

[[Page 718]]

of this paragraph, section 410 does not apply to--
    (i) A governmental plan (within the meaning of section 414(d) and 
the regulations thereunder),
    (ii) A church plan (within the meaning of section 414(e) and the 
regulations thereunder) which has not made the election provided by 
section 410(d) and the regulations thereunder,
    (iii) A plan which has not provided for employer contributions at 
any time after September 2, 1974, and
    (iv) A plan established and maintained by a society, order, or 
association described in section 501(c) (8) or (9), if no part of the 
contributions to or under such plan are made by employers of 
participants in such plan.
    (2) Participation requirements. A plan described in subparagraph (1) 
of this paragraph shall, for purposes of section 401(a), be treated as 
meeting the requirements of section 410 if such plan meets the coverage 
requirements resulting from the application of section 401(a)(3) as in 
effect on September 1, 1974. Such coverage requirements include the 
rules in Sec. 1.410(b)-1(d) (special rules relating to minimum coverage 
requirements), that interpret statutory provisions substantially 
identical to section 401(a)(3) as in effect on September 1, 1974. In 
applying the rules of that paragraph (d) to plans described in this 
paragraph (c) employees whose principal duties consist in supervising 
the work of other employees shall be treated as officers, shareholders, 
and highly compensated employees.
    (d) Supersession. Section 11.410(a)-1 through 11.410(d)-1 inclusive, 
of the Temporary Income Tax Regulation under the Employee Retirement 
Income Security Act of 1974 are superseded by this section and 
Sec. Sec. 1.410(a)-2 through 1.410(d)-1.

(Sec. 410 (88 Stat. 898; 26 U.S.C. 410))

[T.D. 7508, 42 FR 47193, Sept. 20, 1977, as amended by T.D. 7703, 45 FR 
40980, June 17, 1980; T.D. 7735, 45 FR 74722, Nov. 12, 1980]



Sec. 1.410(a)-2  Effective dates.

    (a) Plans not in existence on January 1, 1974. Under section 1017(a) 
of the Employee Retirement Income Security Act of 1974, in the case of a 
plan which was not in existence on January 1, 1974, section 410 and the 
regulations thereunder apply for plan years beginning after September 2, 
1974. See paragraph (c) of this section for time plan is considered in 
existence.
    (b) Plans in existence on January 1, 1974. Under section 1017(b) of 
the Employee Retirement Income Security Act of 1974, in the case of a 
plan which was in existence on January 1, 1974, section 410 and the 
regulations thereunder apply for plan years beginning after December 31, 
1975. See paragraph (c) of this section for time plan is considered to 
be in existence.
    (c) Time of plan existence--(1) General rule. For purposes of this 
section, a plan is considered to be in existence on a particular day 
if--
    (i) The plan on or before that day was reduced to writing and 
adopted by the employer (including, in the case of a corporate employer, 
formal approval by the employer's board of directors and, if required, 
shareholder), even though no amounts had been contributed under the plan 
as of such day, and
    (ii) The plan was not terminated on or before that day.
    (2) Collectively bargained plan. Notwithstanding subparagraph (1) of 
this paragraph, a plan described in section 413(a), relating to a plan 
maintained pursuant to a collective bargaining agreement, is considered 
to be in existence on a particular day if--
    (i) On or before that day there is a legally enforceable agreement 
to establish such a plan signed by the employer, and
    (ii) The employer contributions to be made to the plan are set forth 
in the agreement.
    (3) Special rule. If a plan is considered to be in existence on 
January 1, 1974, under subparagraph (1) of this paragraph, any other 
plan with which such existing plan is merged or consolidated shall also 
be considered to be in existence on such date.
    (d) Certain existing plans may elect new provisions--(1) In general. 
The plan administrator (as defined in section 414(g)) of a plan that was 
in existence on January 1, 1974, may elect to have the provisions of the 
Code relating to participation, vesting, funding, and form of benefit 
(as in effect from time to time) apply to a plan year selected by the 
plan year selected by the plan

[[Page 719]]

administrator which begins after September 2, 1974, but before the 
otherwise applicable effective dates determined under section 1017 (b) 
or (c), 1021, or 1024 of the Employee Retirement Income Security Act of 
1974, and to all subsequent plan years. The provisions referred to are 
the amendments to the Code made by sections 1011, 1012, 1013, 1015, 
1016(a) (1) through (11) and (13) through (27), 1021, and 1022(b) of the 
Employee Retirement Income Security Act of 1974.
    (2) Election is irrevocable. Any election made under this paragraph, 
once made shall be irrevocable.
    (3) Procedure and time for making election. An election under this 
paragraph shall be made by attaching a statement to either the annual 
return required under section 6058(a) (or an amended return) with 
respect to the plan which is filed for the first plan year for which the 
election is effective or to a written request for a determination letter 
relating to the qualification of the plan under section 401(a), 403(a), 
or 405(a) of the Code and, if trusteed, the exempt status under section 
501(a) of the Code of a trust consituting a part of the plan. If the 
election is made with a written request for a determination letter, the 
election may be conditioned upon issuance of a favorable determination 
letter and will become irrevocable upon issuance of such letter. The 
statement shall indicate that the election is made under section 1017(d) 
of the Employee Retirement Income Security Act of 1974 and the first 
plan year for which the election is effective.
    (e) Examples. The rules of this section are illustrated by the 
following examples:

    Example 1. A plan is adopted on January 2, 1974, effective as of 
Janurary 1, 1974. The plan is not considered to have been in existence 
on Janurary 1, 1974.
    Example 2. A plan was in existence on January 1, 1974, and was 
amended on November 1, 1974, to increase benefits. The fact that the 
plan was amended is not relevant and the amended plan is considered to 
be in existence on January 1, 1974.
    Example 3. (i) A subsidiary business corporation is a member of a 
controlled group of corporations within the meaning of IRC section 
1563(a). On November 1, 1974, the plan of the parent corporation is 
amended to provide coverage for employees of the subsidiary corporation. 
This amendment of the parent corporation's plan does not affect the 
effective date of section 410 with respect to the parent corporation's 
plan. No distinction is made for this purpose between employees of the 
parent corporation and employees of the subsidiary corporation.
    (ii) If the subsidiary adopted a separate plan on November 1, 1974, 
under paragraph (a) of this section, section 410 would apply to that 
plan for its first plan year beginning after September 2, 1974. However, 
the adoption of a different plan by the subsidiary would not affect the 
time section 410 applies to the plan of the parent corporation. If, 
instead of adopting its own separate plan, the subsidiary merely 
executed an adoption agreement under the terms of the parent plan 
providing that a subsidiary, upon the execution of an adoption 
agreement, will become part of the parent plan, the effective date of 
section 410 with respect to such plan will not be affected by the 
adoption of the plan by the subsidiary.

(Sec. 410 (88 Stat. 898; 26 U.S.C. 410))

[T.D. 7508, 42 FR 47194, Sept. 20, 1977]



Sec. 1.410(a)-3  Minimum age and service conditions.

    (a) General rule. Except as provided by paragraph (b) or (c) of this 
section, a plan is not a qualified plan (and a trust forming a part of 
such plan is not a qualified trust) if the plan requires, as a condition 
of participation in the plan, that an employee complete a period of 
service with the employer or employers maintaining the plan extending 
beyond the later of--
    (1) Age 25. The date on which the employee attains the age of 25; or
    (2) One year of service. The date on which the employee completes 1 
year of service.
    (b) Special rule for plan with 3-year 100 percent vesting. A plan 
which provides that after not more than 3 years of service each 
participant's right to his accrued benefit under the plan is completely 
nonforfeitable (within the meaning of section 411 and the regulations 
thereunder) at the time such benefit accrues satisfies the requirements 
of paragraph (a) of this section if the period of service required by 
the plan as a condition of participation does not extend beyond the 
later of--
    (1) Age 25. The date on which the employee attains the age of 25; or
    (2) Three years of service. The date on which the employee completes 
3 years of service.

[[Page 720]]

    (c) Special rule for employees of certain educational institutions. 
A plan maintained exclusively for employees of an educational 
institution (as defined in section 170(b)(1)(A)(ii)) by an employer 
exempt from tax under section 501(a) which provides that after 1 year of 
service each participant's right to his accrued benefit under the plan 
is completely nonforfeitable (within the meaning of section 411 and the 
regulations thereunder) at the time such benefit accrues satisfies the 
requirements of paragraph (a) of this section if the period of service 
required by the plan as a condition of participation does not extend 
beyond the later of--
    (1) Age 30. The date on which the employee attains the age of 30; or
    (2) One year of service. The date on which the employee completes 1 
year of service.
    (d) Other conditions. Section 410(a), Sec. 1.410(a)-4, and this 
section relate solely to age and service conditions and do not preclude 
a plan from establishing conditions, other than conditions relating to 
age or service, which must be satisfied by plan participants. For 
example, such provisions would not preclude a qualified plan from 
requiring, as a condition of participation, that an employee be employed 
within a specified job classification. See section 410(b) and the 
regulations thereunder for rules with respect to coverage of employees 
under qualified plans.
    (e) Age and service requirements--(1) General rule. For purposes of 
applying the rules of this section, plan provisons may be treated as 
imposing age or service requirements even though the provisions do not 
specifically refer to age or service. Plan provisions which have the 
effect of requiring an age or service requirement with the employer or 
employers maintaing the plan will be treated as if they imposed an age 
or service requirement. In general, a plan under which an employee 
cannot participate unless he retires will impose an age and service 
requirement. However, a plan may provide benefits which supplement 
benefits provided for employees covered under a pension plan, as defined 
in section 3(2) of the Employee Retirement Income Security Act of 1974, 
satisfying the requirements of section 410(a)(1) without violating the 
age and service rules.
    (2) Examples. The rules of this paragraph are illustrated by the 
following examples:

    Example 1. Corporation A is divided into two divisions. In order to 
work in division 2 an employee must first have been employed in division 
1 for 5 years. A plan provision which required division 2 employment for 
participation will be treated as a service requirement because such a 
provision has the effect of requiring 5 years of service.
    Example 2. Plan B requires as a condition of participation that each 
employee have had a driver's license for 15 years or more. This 
provision will be treated as an age requirement because such a provision 
has the effect of requiring an employee to attain a specified age.
    Example 3. A plan which requires 1 year of service as a condition of 
participation also excludes a part-time or seasonal employee if his 
customary employment is for not more than 20 hours per week or 5 months 
in any plan year. The plan does not qualify because the provision could 
result in the exclusion by reason of a minimum service requirement of an 
employee who has completed a year of service. The plan would not qualify 
even though after excluding all such employees, the plan satisfied the 
coverage requirements of section 410(b).
    Example 4. Employer A establishes a plan which covers employees 
after they retire and does not cover current employees unless they 
retire. Any employee who works past age 60 is treated as retired. The 
plan fails to satisfy the requirements of section 410(a) because the 
plan imposes a minimum age and service requirement in excess of that 
allowed by this section.
    Example 5. Employer B establishes plan X, which provides that 
employees covered by qualified plan Y will receive benefits 
supplementing their benefits under plan Y to take into account cost of 
living increases after retirement. Plan X is not treated as imposing an 
age of service requirement.
    Example 6. Employer C establishes a qualified plan satisfying the 
minimum age and service requirements. At a later time, entry into the 
plan is frozen so that employees not covered at that time cannot 
participate in the plan. The limitation on new participants is not 
treated as imposing a minimum age and service requirement.

(Sec. 410 (88 Stat. 898; 26 U.S.C. 410))

[T.D. 7508, 42 FR 47194, Sept. 20, 1977]



Sec. 1.410(a)-3T  Minimum age and service conditions (temporary).

    (a) [Reserved]

[[Page 721]]

    (b) Special rule for plan with 2-year 100 percent vesting. A plan 
which provides that after not more than 2 years of service each 
participant's right to his or her accrued benefit under the plan is 
completely nonforeitable (within the meaning of section 411 and the 
regulations thereunder) at the time such benefit accrues satisfies the 
requirements of paragraph (a) of this section if the period of service 
required by the plan as a condition of participation does not extend 
beyond the later of--
    (1) [Reserved]
    (2) Two years of service. The date on which the employee completes 2 
years of service. For employees not described in Sec. 1.411(a)-
3T(e)(1), which describes employees with one hour of service in any plan 
year beginning after December 31, 1988, or later in the case of certain 
collectively bargained plans, the preceding sentence shall be applied by 
substituting ``3 years of service'' for ``2 years of service''.

[T.D. 8170, 53 FR 239, Jan. 6, 1988]



Sec. 1.410(a)-4  Maximum age conditions and time of participation.

    (a) Maximum age conditions--(1) General rule. A plan is not a 
qualified plan (and a trust forming a part of such plan is not a 
qualified trust) if the plan excludes from participation (on the basis 
of age) an employee who has attained an age specified by the plan 
unless--
    (i) The plan is a defined benefit plan or a target benefit plan, and
    (ii) The employee begins employment with the employer after the 
employee has attained an age specified by the plan, which age is not 
more than 5 years before normal retirement age (within the meaning of 
section 411(a)(8) and Sec. 1.411(a)-7.

For purposes of this paragraph, a target benefit plan is a defined 
contribution plan under which the amount of employer contributions 
allocated to each participant is determined under a plan formula which 
does not allow employer discretion and on the basis of the amount 
necessary to provide a target benefit specified by the plan for such 
participant. Such target benefit must be the type of benefit which is 
provided by a defined benefit plan and the targeted benefit must not 
discriminate in favor of employees who are officers, shareholders, or 
highly compensated. For purposes of this paragraph, in the determination 
of the time an employee begins employment, any such time which is 
included in a period of service which may be disregarded under the break 
in service rules need not be taken into account.
    (2) Examples. The rules provided by this paragraph are illustrated 
by the following examples:

    Example 1. A defined benefit plan provides that an employee will 
become a participant upon completion of 3 years of service if at such 
time the employee is less than age 60. The normal retirement age under 
the plan is age 65. The plan also provides full and immediate vesting 
for each of the plan's participants. Under the plan, an employee hired 
at age 58 would be denied participation on account of service for the 
first 3 years and on account of maximum age for the remaining years even 
though the employee was hired more than 5 years prior to the normal 
retirement date. The plan therefore does not satisfy section 410(a)(2).
    Example 2. A defined benefit plan provides a normal retirement age 
of the later of age 65 or completion of 10 years of service. Because no 
employee could ever be hired within 5 years of his normal retirement 
age, the plan could not exclude employees for being over a specified 
age.
    Example 3. Prior to the effective date of section 410, a defined 
benefit plan with a normal retirement age of 65 contained a maximum age 
55 requirement for participation. Because of the maximum age 
requirement, and employee hired at age 58 was excluded from the plan. 
This employee is age 61 at the time that section 410 first applies to 
the plan. The employee cannot be excluded from participation because of 
age. The exclusion under section 410(a)(2) is not applicable in this 
instance because the employee's age at the time of hire, 58, was not 
within 5 years of the normal retirement age specified in the plan.
    Example 4. Employee A was hired at age 50 and participated in a 
defined benefit plan until separating from service at age 55 with 5 
years of service and with no vested benefit. At age 61, employee A was 
rehired within 5 years of the normal retirement age of 65 after he 
incurred 6 consecutive breaks in service. Because A's consecutive number 
of 1-year breaks (6) exceeds his years of service prior to such breaks 
(5), his service before the breaks may be disregarded. Consequently, A's 
initial employment date falling within such period may be disregarded 
and the plan could exclude A on account of his age because his 
employment commenced within 5 years of normal retirement age.


[[Page 722]]


    (b) Time of participation--(1) General rule. A plan is not a 
qualified plan (and a trust forming a part of such plan is not a 
qualified trust) unless under the plan any employee who has satisfied 
the applicable minimum age and service requirements specified in Sec. 
1.410(a)-3, and who is otherwise entitled to participate in the plan, 
commences participation in the plan no later than the earlier of--
    (i) The first day of the first plan year beginning after the date on 
which such employee first satisfied such requirements, or
    (ii) The date 6 months after the date on which he first satisfied 
such requirements,


unless such employee was separated from service and has not returned 
before the date referred to in subdivision (i) or (ii), whichever is 
applicable. If such separated employee returns to service after either 
of such dates without incurring a 1-year break in service, the employee 
must commence participation immediately upon his return. In the case of 
a plan using the elapsed time method described in Sec. 1.410(a)-7, such 
an employee who has a period of absence commencing before the date 
referred to in subdivision (i) or (ii) (whichever is applicable) must 
commence participation as of such applicable date no later than the date 
such absence ended. However, if an employee's prior service is 
disregarded on account of the plan's break-in-service rules then, for 
purposes of this subparagraph, such service is also disregarded for 
purposes of determining the date on which such employee first satisfied 
the minimum age and service requirements.
    (2) Examples. The rules provided by this paragraph are illustrated 
by the following examples:

    Example 1. A calendar year plan provides that an employee may enter 
the plan only on the first semi-annual entry date, January 1 or July 1, 
after he has satisfied the applicable minimum age and service 
requirements specified in section 410(a)(1). The plan satisfies the 
requirements of this paragraph because an employee is eligible to 
participate no later than the earlier of (1) the first day of the first 
plan year beginning after he satisfied the applicable minimum age and 
service requirements, or (2) the date 6 months after he satisfied such 
requirements.
    Example 2. A plan provides that an employee is not eligible to 
participate until the first day of the first plan year beginning after 
he has satisfied the minimum age and service requirements of section 
410(a)(1). In this case, an employee who satisfies the ``6 month'' rule 
described in subparagraph (1) of this paragraph will not be eligible to 
participate in the plan. Therefore, the plan does not satisfy the 
requirements of this paragraph.
    Example 3. A calendar year plan provides that an employee may enter 
the plan only on the first semi-annual entry date, January 1 or July 1, 
after he has satisfied the applicable minimum age and service 
requirements specified in section 410(a)(1). Employee A after 10 years 
of service separated from service in 1976 with a vested benefit. On 
February 1, 1990, A returns to employment covered by the plan. Assuming 
A completes a year of service after his return, A must participate 
immediately on his return, February 1. A's prior service cannot be 
disregarded, because he had a vested benefit when he separated from 
service. Therefore, the plan may not postpone his participation until 
July 1.
    Example 4. Assume the same facts as in example (3). The plan has the 
break-in-service rule described in section 410(a)(5)(D) and Sec. 
1.410(a)-5(c)(4). Employee B, after he had 5 years of service but no 
vested benefit incurs 5 consecutive 1-year breaks. Because B's prior 
service can be disregarded, the plan may postpone B's participation in 
the plan under the rule described in section 410(a)(4) and this 
paragraph.

(Sec. 410 (88 Stat. 898; 26 U.S.C. 410))

[T.D. 7508, 42 FR 47195, Sept. 20, 1977, as amended by T.D. 7703, 45 FR 
40980, June 17, 1980]



Sec. 1.410(a)-5  Year of service; break in service.

    (a) Year of service. For the rules relating to years of service 
under subparagraphs (A), (C), and (D) of section 410(a)(3), see 
regulations prescribed by the Secretary of Labor under 29 CFR Part 2530, 
relating to minimum standards for employee pension benefit plans.
    Rules relating to a general rule for a year of service, hours of 
service, and maritime industries apply for purposes of section 410(a) 
and the regulations thereunder.
    (b) Seasonal industries. For rules which relate to seasonal 
industries under section 410(a)(3)(B), see regulations prescribed by the 
Secretary of Labor under 29 CFR Part 2530, relating to minimum standards 
for employee pension benefits plans.

[[Page 723]]

    (c) Breaks in service--(1) General rule. This paragraph provides 
rules with respect to breaks in service under section 410(a)(5). Except 
as provided in subparagraphs (2), (3), (4), and (5) of this paragraph, 
all of an employee's years of service with the employer or employers 
maintaining a plan are taken into account in computing his period of 
service under the plan for purposes of section 410(a)(1) and Sec. 
1.410(a)-3.
    (2) Employees under 3-year 100 percent vesting schedule--( i) 
General rule. In the case of an employee who incurs a 1-year break in 
service under a plan which provides that after not more than 3 years of 
service, each participant's right to his accrued benefit under the plan 
is completely nonforfeitable (within the meaning of section 411 and the 
regulations thereunder) at the time such benefit accrues, the employee's 
service before the break in service is not required to be taken into 
account after the break in service in determining the employee's years 
of service under section 410(a)(1) and Sec. 1.410(a)-3 if such employee 
has not satisfied such service requirement.
    (ii) Example. The rules of this subparagraph are illustrated by the 
following example.

    Example. A qualified plan computing service by the actual counting 
of hours provides full and immediate vesting. The plan can not require 
as a condition of participation that an employee complete 3 consecutive 
years of service with the employer because the requirement as to 
consecutive years is not permitted under section 410(a) (5). However, 
such a plan can require 3 years without a break in service, i.e., 3 
years with no intervening years in which the employee fails to complete 
more than 500 hours of service. Under a plan containing such a 
participation requirement, the following example illustrates when 
employees whould become eligible to participate.

------------------------------------------------------------------------
                                            Hours of service completed
                                        --------------------------------
                  Year                    Employee   Employee   Employee
                                             A          B          C
------------------------------------------------------------------------
1......................................      1,000      1,000      1,000
2......................................      1,000      1,000        500
3......................................      1,000        700      1,000
4......................................      1,000      1,000        700
5......................................      1,000      1,000      1,000
6......................................      1,000      1,000      1,000
------------------------------------------------------------------------
Note. Employee A will have satisfied the plan's service requirement at
  the end of year 3. Employee B at the end of year 4, and Employee C at
  the end of year 6.


    (3) One-year break in service--(i) In general. In computing the 
period of service of an employee who has incurred a 1-year break in 
service, for purposes of section 410(a)(1) and Sec. 1.410(a)-3, a plan 
may disregard the employee's service before the break until the employee 
completes a year of service after such break in service.
    (ii) Examples. The rules provided by this subparagraph are 
illustrated by the following examples.

    Example 1. Employee A completes a year of service under a plan 
computing service by the actual counting of hours for the 12-month 
period ending December 31, 1980, and incurs a 1-year break in service 
for the 12-month period ending December 31, 1981. The plan does not 
contain the provisions permitted by section 410(a)(5)(B) (relating to 3-
year 100 percent vesting) and section 410(a)(5)(D) (relating to 
nonvested participants). Thereafter, he does not complete a year of 
service. As of January 1, 1982, in computing his period of service under 
the plan his service prior to December 31, 1981, is not required to be 
taken into account for purposes of section 410(a)(1) and Sec. 1.410 
(a)-3.
    Example 2. The employee in example (1) completes a year of service 
for the 12-month period ending December 31, 1982. Prior to December 31, 
1982, in computing the employee's period of service as of any date 
occurring in 1982, the employee's service before December 31, 1981, is 
not required to be taken into account for purposes of section 410(a)(1) 
and Sec. 11.410(a)-3. Because the employee completed a year of service 
for the 12-month period ending December 31, 1982, however, his period of 
service is redetermined as of January 1, 1982. Upon completion of a year 
of service for 1982, the employee's period of service, determined as of 
any date occurring in 1982, includes service prior to December 31, 1981.

    (4) Nonvested participants--(i) General rule. In the case of a 
participant in a plan who does not have any nonforfeitable right under 
the plan to his employer-derived accrued benefit and who incurs a 1-year 
break in service, for purposes of section 410(a)(1) and Sec. 1.410.(a)-
3 the plan may disregard his years of service prior to such break if the 
number of his consecutive 1-year breaks in service equals or exceeds his 
aggregate number of years of service prior to such break. In the case of 
a plan using the elapsed time method described in Department of Labor 
regulations, the plan may disregard such years of service prior to such 
break if the period of severance is at least 1

[[Page 724]]

year and the period of severance equals or exceeds the prior period of 
service, whether or not consecutive, completed before such period of 
severance. The plan may in computing such aggregate number of years of 
service prior to such break disregard any years of service which could 
have been disregarded under this subparagraph by reason of any prior 
break in service.
    (ii) Examples. The rules of this subparagraph are illustrated by the 
following example:

    Example. In 1980, A, who was hired at age 35, separates from the 
service of X Corporation after completing 4 years of service. At this 
time A had no vested benefits. In 1985, after incurring 5 consecutive 
one-year breaks in service, A was reemployed. Under section 
410(a)(5)(D), A's 4 years of service may be disregarded because they are 
exceeded by the number of years of consecutive one-year breaks (5) after 
such service.

    (d) Special continuity rule for certain plans. For special rules for 
computing years of service in the case of a plan maintained by more than 
one employer, see regulations prescribed by the Secretary of Labor under 
29 CFR Part 2530, relating to minimum standards for employee pension 
benefit plans.

(Sec. 410 (88 Stat. 898; 26 U.S.C. 410))

[T.D. 7508, 42 FR 47196, Sept. 20, 1977; T.D. 7508, 42 FR 57123, Nov. 1, 
1977, as amended by T.D. 7703, 45 FR 40980, June 17, 1980]



Sec. 1.410(a)-6  Amendment of break in service rules; Transition period.

    (a) In general. Under section 1017(f) (1) of the Employee retirement 
Income Security Act of 1974, a plan is not a qualified plan (and a trust 
forming a part of such plan is not a qualified trust) if the rules of 
the plan relating to breaks in service are amended, and--
    (1) Such amendment is effective after January 1, 1974, and before 
the date on which section 410 becomes applicable to the plan, and
    (2) Under such amendment, any employee's participation in the plan 
commences at any date later than the later of--
    (i) The date on which his participation would commence under the 
break in service rules of section 410(a)(5), or
    (ii) The earliest date on which his participation would commence 
under the plan as in effect on or after January 1, 1974.
    (b) Break in service rules. For purposes of paragraph (a), the term 
``break in service rules'' means the rules provided by a plan relating 
to circumstances under which a period of an employee's service or plan 
participation is disregarded for purposes of determining his rights to 
participate in the plan, if under such rules such service is disregarded 
by reason of the employee's failure to complete a required period of 
service within a specified period of time.

(Sec. 410 (88 Stat. 898; 26 U.S.C. 410))

[T.D. 7508, 42 FR 47197, Sept. 20, 1977; 43 FR 2721, Jan. 19, 1978]



Sec. 1.410(a)-7  Elapsed time.

    (a) In general--(1) Introduction to elapsed time method of crediting 
service. (i) 29 CFR 2530.200b-2 sets forth the general method of 
crediting service for an employee. The general method is based upon the 
actual counting of hours of service during the applicable 12-
consecutive-month computation period. The equivalencies set forth in 29 
CFR 2530.200b-3 are also methods for crediting hours of service during 
computation periods. Under the general method and the equivalencies an 
employee receives a year's credit (in units of years of service or years 
of participation) for a computation period during which the employee is 
credited with a specified number of hours of service. In general, an 
employee's statutory entitlement with respect to eligibility to 
participate, vesting and benefit accrual is determined by totalling the 
number of years' credit to which an employee is entitled.
    (ii) Under the alternative method set forth in this section, by 
contrast, an employee's statutory entitlement with respect to 
eligibility to participate, vesting and benefit accrual is not based 
upon the actual completion of a specified number of hours of service 
during a 12-consecutive-month period. Instead, such entitlement is 
determined generally with reference to the total period of time which 
elapses while the employee is employed (i.e., while the employment 
relationship exists) with

[[Page 725]]

the employer or employers maintaining the plan. The alternative method 
set forth in this section is designed to enable a plan to lessen the 
administrative burdens associated with the maintenance of records of an 
employee's hours of service by permitting each employee to be credited 
with his or her total period of service with the employer or employers 
maintaining the plan, irrespective of the actual hours of service 
completed in any 12-consecutive-month period.
    (2) Overview of the operation of the elapsed time method. (i) Under 
the elapsed time method of crediting service, a plan is generally 
required to take into account the period of time which elapses while the 
employee is employed (i.e., while the employment relationship exists) 
with the employer or employers maintaining the plan, regardless of the 
actual number of hours he or she completes during such period. Under 
this alternative method of crediting service, an employee's service is 
required to be taken into account for purposes of eligibility to 
participate and vesting as of the date he or she first performs an hour 
of service within the meaning of 29 CFR 2530.200b-2 (a) (1) for the 
employer or employers maintaining the plan. Service is required to be 
taken into account for the period of time from the date the employee 
first performs such an hour of service until the date he or she severs 
from service with the employer or employers maintaining the plan.
    (ii) The date the employee severs from service is the earlier of the 
date the employee quits, is discharged, retires or dies, or the first 
anniversary of the date the employee is absent from service for any 
other reason (e.g., disability, vacation, leave of absence, layoff, 
etc.). Thus, for example, if an employee quits, the severance from 
service date is the date the employee quits. On the other hand, if an 
employee is granted a leave of absence (and if no intervening event 
occurs), the severance from service date will occur one year after the 
date the employee was first absent on leave, and this one year of 
absence is required to be taken into account as service for the employer 
or employers maintaining the plan. Because the severance from service 
date occurs on the earlier of two possible dates (i.e., quit, discharge, 
retirement or death or the first anniversary of an absence from service 
for any other reason), a quit, discharge, retirement or death within the 
year after the beginning of an absence for any other reason results in 
an immediate severance from service. Thus, for example, if an employee 
dies at the end of a four-week absence resulting from illness, the 
severance from service date is the date of death, rather than the first 
anniversary date of the first day of absence for illness.
    (iii) In addition, for purposes of eligibility to participate and 
vesting under the elapsed time method of crediting service, an employee 
who has severed from service by reason of a quit, discharge or 
retirement may be entitled to have a period of time of 12 months or less 
taken into account by the employer or employers maintaining the plan if 
the employee returns to service within a certain period of time and 
performs an hour of service within the meaning of 29 CFR 2530.200b-2 (a) 
(1). In general, the period of time during which the employee must 
return to service begins on the date the employee severs from service as 
a result of a quit, discharge or retirement and ends on the first 
anniversary of such date. However, if the employee is absent for any 
other reason (e.g., layoff) and then quits, is discharged or retires, 
the period of time during which the employee may return and receive 
credit begins on the severance from service date and ends one year after 
the first day of absence (e.g., first day of layoff). As a result of the 
operation of these rules, a severance from service (e.g., a quit), or an 
absence (e.g., layoff) followed by a severance from service, never 
results in a period of time of more than one year being required to be 
taken into account after an employee severs from service or is absent 
from service.
    (iv) For purposes of benefit accrual under the elapsed time method 
of crediting service, an employee is entitled to have his or her service 
taken into account from the date he or she begins to participate in the 
plan until the severance from service date. Periods of severance under 
any circumstances are

[[Page 726]]

not required to be taken into account. For example, a participant who is 
discharged on December 14, 1980 and rehired on October 14, 1981 is not 
required to be credited with the 10 month period of severance for 
benefit accrual purposes.
    (3) Overview of certain concepts relating to the elapsed time 
method--(i) In general. The rules with respect to the elapsed time 
method of crediting service are based on certain concepts which are 
defined in paragraph (b) of this section. These concepts are applied in 
the substantive rules contained in paragraphs (c), (d), (e), (f) and (g) 
of this section. The purpose of this subparagraph is to summarize these 
concepts.
    (ii) Employment commencement date. (A) A concept which is necessary 
in order to credit service accurately under any service crediting method 
is the establishment of a starting point for crediting service. The 
employment commencement date, which is the date on which an employee 
first performs an hour of service within the meaning of 29 CFR 
2530.200b-2 (a) (1) for the employer or employers maintaining the plan, 
is used to establish the date upon which an employee must begin to 
receive credit for certain purposes (e.g., eligibility to participate 
and vesting).
    (B) In order to credit accurately an employee's total service with 
an employer or employers maintaining the plan, a plan also may provide 
for an ``adjusted'' employment commencement date (i.e., a recalculation 
of the employment commencement date to reflect noncreditable periods of 
severance) or a reemployment commencement date as defined in paragraph 
(b) (3) of this section. Fundamentally, all three concepts rely upon the 
performance of an hour of service to provide a starting point for 
crediting service. One purpose of these three concepts is to enable 
plans to satisfy the requirements of this section in a variety of ways.
    (C) The fundamental rule with respect to these concepts is that any 
plan provision is permissible so long as it satisfies the minimum 
standards. Thus, for example, although the rules of this section provide 
that credit must begin on the employment commencement date, a plan is 
permitted to ``adjust'' the employment commencement date to reflect 
periods of time for which service is not required to be credited. 
Similarly, a plan may wish to credit service under the elapsed time 
method as discrete periods of service and provide for a reemployment 
commencement date. Certain plans may wish to provide for both concepts, 
although it is not a requirement of this section that plans so provide.
    (iii) Severance from service date. Another fundamental concept of 
the elapsed time method of crediting service is the severance from 
service date, which is defined as the earlier of the date on which an 
employee quits, retires, is discharged or dies, or the first anniversary 
of the first date of absence for any other reason. One purpose of the 
severance from service date is to provide the endpoint for crediting 
service under the elapsed time method. As a general proposition, service 
is credited from the employment commencement date (i.e., the starting 
point) until the severance from service date (i.e., the endpoint). A 
complementary purpose of the severance from service date is to establish 
the starting point for measuring a period of severance from service in 
order to determine a ``break in service'' (see paragraph (a)(3)(v) of 
this section). A third purpose of such date is to establish the starting 
point for measuring the period of time which may be required to be taken 
into account under the service spanning rules (see paragraph (a)(3)(vi) 
of this section).
    (iv) Period of service. A third elapsed time concept is the use of 
the ``period of service'' rather than the ``year of service'' in 
determining service to be taken into account for purposes of eligibility 
to participate, vesting and benefit accrual. For purposes of eligibility 
to participate and vesting, the period of service runs from the 
employment commencement date or reemployment commencement date until the 
severance from service date. For purposes of benefit accrual, a period 
of service runs from the date that a participant commences participation 
under the plan until the severance from service date. Because the 
endpoint of the period of service is marked by the severance

[[Page 727]]

from service date, an employee is credited with the period of time which 
runs during any absence from service (other than for reason of a quit, 
retirement, discharge or death) which is 12 months or less. Thus, for 
example, a three week absence for vacation is taken into account as part 
of a period of service and does not trigger a severance from service 
date.
    (v) Period of severance. A period of severance begins on the 
severance from service date and ends when an employee returns to service 
with the employer or employers maintaining the plan. The purpose of the 
period of severance is to apply the statutory ``break in service'' rules 
to an elapsed time method of crediting service.
    (vi) Service spanning. Under the elapsed time method of crediting 
service, a plan is required to credit periods of service and, under the 
service spanning rules, certain periods of severance of 12 months or 
less for purposes of eligibility to participate and vesting. Under the 
first service spanning rule, if an employee severs from service as a 
result of quit, discharge or retirement and then returns to service 
within 12 months, the period of severance is required to be taken into 
account. Also, a situation may arise in which an employee is absent from 
service for any reason other than quit, discharge, retirement or death 
and during the absence a quit, discharge or retirement occurs. The 
second service spanning rule provides in that set of circumstances that 
a plan is required to take into account the period of time between the 
severance from service date (i.e., the date of quit, discharge or 
retirement) and the first anniversary of the date on which the employee 
was first absent, if the employee returns to service on or before such 
first anniversary date.
    (4) Organization and applicability. (i) The substantive rules for 
crediting service under the elapsed time method with respect to 
eligibility to participate are contained in paragraph (c), the rules 
with respect to vesting are contained in subparagraph (d), and the rules 
with respect to benefit accrual are contained in paragraph (e). The 
format of the rules is designed to enable a plan to use the elapsed time 
method of crediting service either for all purposes or for any one or 
combination of purposes under sections 410 and 411. Thus, for example, a 
plan may credit service for eligibility to participate purposes by the 
use of the general method of crediting service set forth in 29 CFR 
2530.200b-2 or by the use of any of the equivalences set forth in 29 CFR 
2530.200b-3, while the plan may credit service for vesting and benefit 
accrual purposes by the use of the elapsed time method of crediting 
service.
    (ii) A plan using the elapsed time method of crediting service for 
one or more classifications of employees covered under the plan may use 
the general method of crediting service set forth in 29 CFR 2530.200b-2 
or any of the equivalencies set forth in 29 CFR 2530.200b-3 for other 
classifications of employees, provided that such classifications are 
reasonable and are consistently applied. Thus, for example, a plan may 
provide that part-time employees are credited under the general method 
of crediting service set forth in 29 CFR 2530.200b-2 and full-time 
employees are credited under the elapsed time method. A classification, 
however, will not be deemed to be reasonable or consistently applied if 
such classification is designed with an intent to preclude an employee 
or employees from attaining his or her statutory entitlement with 
respect to eligibility to participate, vesting or benefit accrual. For 
example, a classification applied so that any full-time employee 
credited with less than 1,000 hours of service during a given 12-
consecutive-month period would be considered part-time and subject to 
the general method of crediting service rather than the elapsed time 
method would not be reasonable.
    (iii) Notwithstanding paragraph (a) (4) (i) and (ii) of this 
section, the use of the elapsed time method for some purposes or the use 
of the elapsed time method for some employees may, under certain 
circumstances, result in discrimination prohibited under section 
401(a)(4), even though the use of the elapsed time method for such 
purposes, and for such employees, is permitted under this section.
    (5) More than one employer plans. For special rules for computing 
years of

[[Page 728]]

service in the case of a plan maintained by more than one employer, see 
29 CFR Part 2530 (Department of Labor regulations relating to minimum 
standards for employee pension benefit plans).
    (b) Definitions--(1) Employment commencement date. For purposes of 
this section, the term ``employment commencement date'' shall mean the 
date on which the employee first performs an hour of service within the 
meaning of 29 CFR 2530.200b-2 (a)(1) for the employer or employers 
maintaining the plan.
    (2) Severance from service date. For purposes of this section, a 
``severance from service'' shall occur on the earlier of--
    (i) The date on which an employee quits, retires, is discharged or 
dies; or
    (ii) The first anniversary of the first date of a period in which an 
employee remains absent from service (with or without pay) with the 
employer or employers maintaining the plan for any reason other than 
quit, retirement, discharge or death, such as vacation, holiday, 
sickness, disability, leave of absence or layoff.
    (3) Reemployment commencement date. For purposes of this section, 
the term ``reemployment commencement date'' shall mean the first date, 
following a period of severance from service which is not required to be 
taken into account under the service spanning rules in paragraphs 
(c)(2)(iii) and (d)(1)(iii) of this section, on which the employee 
performs an hour of service within the meaning of 29 CFR 2530.200b-
2(a)(1) for the employer or employers maintaining the plan.
    (4) Participation commencement date. For purposes of this section, 
the term ``participation commencement date'' shall mean the date a 
participant first commences participation under the plan.
    (5) Period of severance. For purposes of this section, the term 
``period of severance'' shall mean the period of time commencing on the 
severance from service date and ending on the date on which the employee 
again performs an hour of service within the meaning of 29 CFR 
2530.200b-2(a)(1) for an employer or employers maintaining the plan.
    (6) Period of service--(i) General rule. For purposes of this 
section, the term ``period of service'' shall mean a period of service 
commencing on the employee's employment commencement date or 
reemployment commencement date, whichever is applicable, and ending on 
the severance from service date.
    (ii) Aggregation rule. Unless a plan provides in some manner for an 
``adjusted'' employment commencement date or similar method of 
consolidating periods of service, periods of service shall be aggregated 
unless such periods may be disregarded under section 410(a)(5) or 
411(a)(4).
    (iii) Other federal law. Nothing in this section shall be construed 
to alter, amend, modify, invalidate, impair or supersede any law of the 
United States or any rule or regulation issued under such law. Thus, for 
example, nothing in this section shall be construed as denying an 
employee credit for a ``period of service'' if credit is required by a 
separate federal law. Furthermore, the nature and extent of such credit 
shall be determined under such law.
    (c) Eligibility to participate--(1) General rule. For purposes of 
section 410(a)(1)(A), a plan generally may not require as a condition of 
participation in the plan that an employee complete a period of service 
with the employer or employers maintaining the plan extending beyond the 
later of--
    (i) The date on which the employee attains the age of 25; or
    (ii) The date on which the employee completes a one-year period of 
service. See the regulations under section 410(a) (relating to 
eligibility to participate).
    (2) Determination of one-year period of service. (i) For purposes of 
determining the date on which an employee satisfies the service 
requirement for initial eligibility to participate under the plan, a 
plan using the elapsed time method of crediting service shall provide 
that an employee who completes the 1-year period of service requirement 
on the first anniversary of his employment commencement date satisfies 
the minimum service requirement as of such date. In the case of an 
employee who fails to complete a one-

[[Page 729]]

year period of service on the first anniversary of his employment 
commencement date, a plan which does not contain a provision permitted 
by section 410(a)(5)(D) (rule of parity) shall provide for the 
aggregation of periods of service so that a one-year period of service 
shall be completed as of the date the employee completes 12 months of 
service (30 days are deemed to be a month in the case of the aggregation 
of fractional months) or 365 days of service.
    (ii) For purposes of section 410(a)(1)(B)(i), a ``3-year period of 
service'' shall be deemed to be ``3 years of service.''
    (iii) Service spanning rules. In determining a 1-year period of 
service for purposes of initial eligibility to participate and a period 
of service for purposes of retention of eligibility to participate, in 
addition to taking into account an employee's period of service, a plan 
shall take into account the following periods of severance--
    (A) If an employee severs from service by reason of a quit, 
discharge or retirement and the employee then performs an hour of 
service within the meaning of 29 CFR 2530.200b-2(a)(1) within 12 months 
of the severance from service date, the plan is required to take into 
account the period of severance; and
    (B) Notwithstanding paragraph (c)(2)(iii)(A) of this section, if an 
employee severs from service by reason of a quit, discharge or 
retirement during an absence from service of 12 months or less for any 
reason other than a quit, discharge, retirement or death, and then 
performs an hour of service within the meaning of 29 CFR 2530.200b-
2(a)(1) within 12 months of the date on which the employee was first 
absent from service, the plan is required to take into account the 
period of severance.
    (iv) For purposes of determining an employee's retention of 
eligibility to participate in the plan, a plan shall take into account 
an employee's entire period of service unless certain periods of service 
may be disregarded under section 410(a)(5) of the Code.
    (v) Example. Employee W, age 31, completed 6 months of service and 
was laid off. After 2 months of layoff, W quit. Five months later, W 
returned to service. For purposes of eligibility to participate, W was 
required to be credited with 13 months of service (8 months of service 
and 5 months of severance). If, on the other hand, W had not returned to 
service within the first 10 months of severance (i.e., within 12 months 
after the first day of layoff), W would be required to be credited with 
only 8 months of service.
    (3) Entry date requirements--(i) General rule. For purposes of 
section 410(a)(4), it is necessary for a plan to provide that any 
employee who has satisfied the minimum age and service requirements, and 
who is otherwise entitled to participate in the plan, commences 
participation in the plan no later than the earlier of--
    (A) The first day of the first plan year beginning after the date on 
which such employee satisfied such requirements, or
    (B) The date six months after the date on which he satisfied such 
requirements, unless such employee was separated from service before the 
date referred to in subdivision (i) (A) or (B), whichever is applicable. 
See the regulations under section 410(a) (relating to eligibility to 
participate).
    (ii) Separation from service--(A) Definition. For purposes of this 
section, the term ``separated from service'' includes a severance from 
service or an absence from service for any reason other than a quit, 
discharge, retirement or death, regardless of the duration of such 
absence. Accordingly, if an employee is laid off for a period of six 
weeks, the employee shall be deemed to be ``separated from service'' 
during such period for purposes of the entry date requirements.
    (B) Application. A period of severance which is taken into account 
under the service spanning rules in paragraph (c)(2)(iii) of this 
section or an absence of 12 months or less may result in an employee 
satisfying the plan's minimum service requirement during such period of 
time. In addition, once an employee satisfies the plan's minimum service 
requirement, either before or during such period of time, such period of 
time may contain an entry date applicable to such employee. In the case

[[Page 730]]

of an employee whose period of severance is taken into account and such 
period contains an entry date applicable to the employee, he or she 
shall be made a participant in the plan (if otherwise eligible) no later 
than the date on which he or she ended the period of severance. In the 
case of an employee whose period of absence contains an entry date 
applicable to such employee, he or she, no later than the date such 
absence ended, shall be made a participant in the plan (if otherwise 
eligible) as of the first applicable entry date which occurred during 
such absence from service.
    (iii) Examples. For purposes of the following examples, assume that 
the plan provides for a minimum age requirement of 25 and a minimum 
service requirement of one year, and provides for semi-annual entry 
dates.
    (A) Employee A, age 35, worked for 10 months in a job classification 
covered under the plan, became disabled for nine consecutive months and 
then returned to service. During the period of absence, A completed a 1-
year period of service and passed a semi-annual entry date after 
satisfying the minimum service requirement. Accordingly, the plan is 
required to make A a participant no later than his return to service 
effective as of the applicable entry date.
    (B) Employee B, after satisfying the minimum age and service 
requirements, quit work before the next semi-annual entry date, and then 
returned to service before incurring a 1-year period of severance, but 
after such semi-annual entry date. Employee B is entitled to become a 
participant immediately upon his return to service effective as of the 
date of his return.
    (4) Break in service. For purposes of applying the break in service 
rules under section 410(a)(5) (B) and (C), the term ``1-year period of 
severance'' shall be substituted for the term ``1-year break in 
service''. A 1-year period of severance shall be determined on the basis 
of a 12-consecutive-month period beginning on the severance from service 
date and ending on the first anniversary of such date, provided that the 
employee during such 12-consecutive-month period does not perform an 
hour of service within the meaning of 29 CFR 2530.200b-2(a)(1) for the 
employer or employers maintaining the plan.
    (5) One-year hold-out--(i) General rule. (A) For purposes of section 
410(a)(5)(C), in determining the period of service of an employee who 
has incurred a 1-year period of severance, a plan may disregard the 
employee's period of service before such period of severance until the 
employee completes a 1-year period of service after such period of 
severance.
    (B) Example. Assume that a plan provides for a minimum service 
requirement of 1-year and provides for semi-annual entry dates, but does 
not contain the provisions permitted by section 410(a)(5)(D) (relating 
to the rule of parity). Employee G, age 40, completed a seven-month 
period of service, quit and then returned to service 15 months later, 
thereby incurring a 1-year period of severance. After working four 
months, G was laid off for nine months and then returned to work again. 
Although the plan may hold employee G out from participation in the plan 
until the completion of a 1-year period of service after the 1-year (or 
greater) period of severance, once the 1-year hold-out is completed, the 
plan is required to provide the employee with such statutory entitlement 
as arose during the 1-year hold-out. Accordingly, employee G satisfied 
the 1-year hold-out requirement as of the eighth month of layoff, and G 
is entitled to become a participant in the plan immediately upon his 
return to service after the nine-month layoff effective as of the first 
applicable entry date occurring after the date on which he satisfied the 
1-year of service requirement (i.e., the first applicable entry date 
after the first month of layoff). See the regulations under section 410 
(a) (relating to eligibility to participate).
    (6) Rule of parity--(i) General rule. For purposes of section 
410(a)(5)(D), in the case of a participant who does not have any 
nonforfeitable right under the plan to his accrued benefit derived from 
employer contributions and who incurs a 1-year period of severance, a 
plan, in determining an employee's period of service for purposes of 
section 410(a)(1), may disregard his period of service if his latest 
period of severance equals or exceeds his prior periods of service,

[[Page 731]]

whether or not consecutive, completed before such period of severance. 
See the regulations under section 410(a) (relating to eligibility to 
participate).
    (ii) In determining whether a completely nonvested employee's 
service may be disregarded under the rule of parity, a plan is not 
permitted to apply the rule until the employee incurs a 1-year period of 
severance. Accordingly, a plan may not disregard a period of service of 
less than one year until an employee has incurred a period of severance 
of at least one year.
    (iii) Example. Assume that a plan provides for a minimum service 
requirement of one year and provides for the rule of parity. An employee 
works for three months, quits and then is rehired 10 months later. Such 
employee is entitled to receive 13 months of credit for purposes of 
eligibility to participate and vesting (see the service spanning rules). 
Although the period of severance exceeded the period of service, the 
three months of service may not be disregarded because no 1-year period 
of severance occurred.
    (d) Vesting--(1) General rule. (i) For purposes of section 
411(a)(2), relating to vesting in accrued benefits derived from employer 
contributions, a plan which determines service to be taken in account on 
the basis of elapsed time shall provide that an employee is credited 
with a number of years of service equal to at least the number of whole 
years of the employee's period of service, whether or not such periods 
of service were completed consecutively.
    (ii) In order to determine the number of whole years of an 
employee's period of service, a plan shall provide that non-successive 
periods of service must be aggregated and that less than whole year 
periods of service (whether or not consecutive) must be aggregated on 
the basis that 12 months of service (30 days are deemed to be a month in 
the case of the aggregation of fractional months) or 365 days of service 
equal a whole year of service.
    (iii) Service spanning rules. In determining a participant's period 
of service for vesting purposes, a plan shall take into account the 
following periods of severance--
    (A) If an employee severs from service by reason of a quit, 
discharge or retirement and the employee then performs an hour of 
service within the meaning of 29 CFR 2530.200b-2(a)(1) within 12 months 
of the severance from service date, the plan is required to take into 
account the period of severance; and
    (B) Nothwithstanding paragraph (d)(1)(iii)(A) of this section, if an 
employee severs from service by reason of a quit, discharge or 
retirement during an absence from service of 12 months or less for any 
reason other than a quit, discharge, retirement or death, and then 
performs an hour of service within the meaning of 29 CFR 2530.200b-
2(a)(1) within 12 months of the date on which the employee was first 
absent from service, the plan is required to take into account the 
period of severance.
    (iv) For purposes of determining an employee's nonforfeitable 
percentage of accrued benefits derived from employer contributions, a 
plan, after calculating an employee's period of service in the manner 
prescribed in this paragraph, may disregard any remaining less than 
whole year, 12-month or 365-day period of service. Thus, for example, if 
a plan provides for the statutory five to fifteen year graded vesting, 
an employee with a period (or periods) of service which yield 5 whole 
year periods of service and an additional 321-day period of service is 
twenty-five percent vested in his or her employer-derived accrued 
benefits (based solely on the 5 whole year periods of service).
    (2) Service which may be disregarded. (i) For purposes of section 
411(a)(4), in determining the nonforfeitable percentage of an employee's 
right to his or her accrued benefits derived from employer 
contributions, all of an employee's period or periods of service with an 
employer or employers maintaining the plan shall be taken into account 
unless such service may be disregarded under paragraph (d)(2)(ii) of 
this section.
    (ii) For purposes of paragraph (d)(2)(i) of this section, the 
following periods of service may be disregarded--
    (A) The period of service completed by an employee before the date 
on which he attains age 22;
    (B) In the case of a plan which requires mandatory employee 
contributions, the period of service which falls

[[Page 732]]

within the period of time to which a particular employee contribution 
relates, if the employee had the opportunity to make a contribution for 
such period of time and failed to do so;
    (C) The period of service during any period for which the employer 
did not maintain the plan or a predecessor plan;
    (D) The period of service which is not required to be taken into 
account by reason of a period of severance which constitutes a break in 
service within the meaning of paragraph (d)(4) of this section;
    (E) The period of service completed by an employee prior to January 
1, 1971, unless the employee completes a period of service of at least 3 
years at any time after December 31, 1970; and
    (F) The period of service completed before the first plan year for 
which this section applies to the plan, if such service would have been 
disregarded under the plan rules relating to breaks in service in effect 
at that time. See the regulations under section 411(a) (relating to 
vesting).
    (3) Seasonal industry. [Reserved]
    (4) Break in service. For purposes of applying the break in service 
rules, the term ``1-year period of severance'' shall be substituted for 
the term ``1-year break in service''. A 1-year period of severance shall 
be a 12-consecutive-month period beginning on the severance from service 
date and ending on the first anniversary of such date, provided that the 
employee during such 12-consecutive-month period fails to perform an 
hour of service within the meaning of 29 CFR 2530.200b-2(a)(1) for an 
employer or employers maintaining the plan.
    (5) One-year hold-out. For purposes of section 411(a)(6)(B), in 
determining the nonforfeitable percentage of the right to accrued 
benefits derived from employer contributions of an employee who has 
incurred a 1-year period of severance, the period of service completed 
before such period of severance is not required to be taken into account 
until the employee has completed a 1-year period of service after his 
return to service. See the regulations under section 411(a) (relating to 
vesting).
    (6) Vesting in pre-break accruals. For purposes of section 
411(a)(6)(C), a ``1-year period of severance'' shall be deemed to 
constitute a ``1-year break in service.'' See the regulations under 
section 411(a) (relating to vesting).
    (7) Rule of partity--(i) General rule. For purposes of section 
411(a)(6)(D), in the case of an employee who is a nonvested participant 
in employer-derived benefits at the time he incurs a 1-year period of 
severance, the period of service completed by such participant before 
such period of severance is not required to be taken into account for 
purposes of determining the vested percentage of his or her right to 
employer-derived benefits if at such time the consecutive period of 
severance equals or exceeds his prior periods of service, whether or not 
consecutive, completed before such period of severance. See the 
regulations under section 411(a) (relating to vesting).
    (e) Benefit accrual. (1) For purposes of section 411(b), a plan may 
provide that a participant's service with an employer or employers 
maintaining the plan shall be determined on the basis of the 
participant's total period of service beginning on the participation 
commencement date and ending on the severance from service date.
    (2) Under section 411(b)(3)(A), a defined benefit pension plan may 
determine an employee's service for purposes of benefit accrual on any 
basis which is reasonable and consistent and which takes into account 
all service during the employee's participation in the plan which is 
included in a period of service required to be taken into account under 
section 410(a)(5) (relating to service which must be taken into account 
for purposes of determining an employee's eligibility to participate). A 
plan which provides for the determination of an employee's service with 
an employer or employers maintaining the plan on the basis permitted 
under paragraph (e)(1) of this section will be deemed to meet the 
requirements of section 411(b)(3)(A), provided that the plan meets the 
requirements of 29 CFR 2530.204-3, relating to plans which determine an 
employee's service for purposes of benefit accrual on a basis other than 
computation periods. Specifically, under 29 CFR 2530.204-3, it must be 
possible to prove that, despite the fact that benefit accrual under

[[Page 733]]

such a plan is not based on computation periods, the plan's provisions 
meet at least one of the three benefit accrual rules of section 
411(b)(1) under all circumstances. Further, 29 CFR 2530.204-3 prohibits 
such a plan from disregarding service under section 411(b)(3)(C) (which 
would otherwise permit a plan to disregard service performed by an 
employee during a computation period in which the employee is credited 
with less than 1,000 hours). See the regulations under section 411(b) 
(relating to benefit accrual).
    (f) Transfers between methods of crediting service--(1) Single plan. 
A plan may provide that an employee's service for purposes of 
eligibility to participate, vesting or benefit accrual shall be 
determined on the basis of computation periods under the general method 
set forth in 29 CFR 2530.200b-2 for certain classes of employees but 
under the alternative method permitted under this section for other 
classes of employees if the plan provides as follows--
    (i) In the case of an employee who transfers from a class of 
employees whose service is determined on the basis of computation 
periods to a class of employees whose service is determined on the 
alternative basis permitted under this section, the employee shall 
receive credit for a period of service consisting of--
    (A) A number of years equal to the number of years of service 
credited to the employee before the computation period during which the 
transfer occurs; and
    (B) The greater of (1) the period of service that would be credited 
to the employee under the elapsed time method for his service during the 
entire computation period in which the transfer occurs or (2) the 
service taken into account under the computation periods method as of 
the date of the transfer.
    In addition, the employee shall receive credit for service 
subsequent to the transfer commencing on the day after the last day of 
the computation period in which the transfer occurs.
    (ii) In the case of an employee who transfers from a class of 
employees whose service is determined on the alternative basis permitted 
under this section to a class of employees whose service is determined 
on the basis of computation periods--
    (A) The employee shall receive credit, as of the date of the 
transfer, for a number of years of service equal to the number of 1-year 
periods of service credited to the employee as of the date of the 
transfer, and
    (B) The employee shall receive credit, in the computation period 
which includes the date of the transfer, for a number of hours of 
service determined by applying one of the equivalencies set forth in 29 
CFR 2530.200b-3 (e) (1) to any fractional part of a year credited to the 
employee under this section as of the date of the transfer. Such 
equivalency shall be set forth in the plan and shall apply to all 
similarly situated employees.
    (2) More than one plan. In the case of an employee who transfers 
from a plan using either the general method of determining service on 
the basis of computation periods set forth in 29 CFR 2530.200b-2 or the 
method of determining service permitted under this section to a plan 
using the other method of determining service, all service required to 
be credited under the plan to which the employee transfers shall be 
determined by applying the rules of paragraph (f)(1) of this section.
    (g) Amendments to change method of crediting service. A plan may be 
amended to change the method of crediting service for any purpose or for 
any class of employees between the general method set forth in 29 CFR 
2530.200-2 and the method permitted under this section, if such 
amendment contains provisions under which each employee with respect to 
whom the method of crediting service is changed is treated in the same 
manner as an employee who transfers from one class of employees to 
another under paragraph (f)(1) of this section.
    (h) Transitional rule. For plans in existence on [insert the date of 
the publication of this document], the provisions of paragraph (f) of 
this section are effective for plan years beginning after December 31, 
1983.

[T.D. 7703, 45 FR 40980, June 17, 1980]

[[Page 734]]



Sec. 1.410(a)-8  Five consecutive 1-year breaks in service, 
transitional rules under the Retirement Equity Act of 1984.

    Sections 410(a)(5)(D) and 411(a)(6)(D), as amended by the Retirement 
Equity Act of 1984 (REA 1984), permit a plan to disregard years of 
service that were disregarded under the plan provisions satisfying those 
sections (as in effect on August 22, 1984) as of the day before the REA 
amendments apply to the plan. Under section 302(a) of REA 1984, the new 
break-in-service rules generally apply to plan years beginning after 
December 31, 1984. Thus, for example, assume a plan has a calendar plan 
year and disregarded years of service as permitted by sections 
410(a)(5)(D) and 411(a)(6)(D) as in effect on August 22, 1984. An 
employee completed two years of service in 1981 and 1982, and then 
incurred two consecutive 1-year breaks in service in 1983 and 1984. The 
plans may disregard the prior years of service even though the employee 
did not incur five consecutive 1-year breaks in service. On the other 
hand, assume the employee completed three consecutive years of service 
beginning in 1980, and incurred two 1-year breaks in service in 1983 and 
1984. Because, as of December 31, 1984, the years of service credited 
before 1983 could not be disregarded, whether the plan may subsequently 
disregard those years of service would be governed by the rules enacted 
by REA 1984.

[T.D. 8219, 53 FR 31851, Aug. 22, 1988; 53 FR 48534, Dec. 1, 1988]



Sec. 1.410(a)-8T  Year of service; break in service (temporary).

    (a)-(b) [Reserved]
    (c) Breaks in service. (1) [Reserved]
    (2) Employees under 2-year 100 percent vesting schedule--(i) General 
rule. In the case of an employee who incurs a 1-year break in service 
under a plan which provides that after not more than 2 years of service 
each participant's right to his accrued benefit under the plan is 
completely nonforfeitable (within the meaning of section 411 and the 
regulations thereunder) at the time such benefit accrues, the employee's 
service before the break in service is not required to be taken into 
account after the break in service in determining the employee's years 
of service under section 410(a)(1) and Sec. 1.410(a)-3 if such employee 
has not satisfied such service requirement.
    (ii) Example. The rules of this subparagraph are illustrated by the 
following example:

    Example. A qualified plan computing service by the actual counting 
of hours provides full and immediate vesting. The plan can not require 
as a condition of participation that an employee complete 2 consecutive 
years of service with the employer because the requirement as to 
consecutive years is not permitted under section 410(a)(5). However, 
such a plan can require 2 years without a break in service, i.e., 2 
years with no intervening years in which the employee fails to complete 
more than 500 hours of service. Under a plan containing such a 
participation requirement, the following example illustrates when 
employees would become eligible to participate.

------------------------------------------------------------------------
                                          Hours of service completed
                Year                 -----------------------------------
                                      Employee A  Employee B  Employee C
------------------------------------------------------------------------
1...................................       1,000       1,000       1,000
2...................................       1,000         700         500
3...................................       1,000       1,000       1,000
4...................................       1,000       1,000         700
5...................................       1,000       1,000       1,000
------------------------------------------------------------------------

    Note: Employee A will have satisfied the plan's service requirement 
at the end of year 2, Employee B at the end of year 3, and Employee C at 
the end of year 5.

    (3) One-year break in service--
    (i) [Reserved]
    (ii) Examples. The rules provided by this subparagraph are 
illustrated by the following examples:

    Example 1. Employee A completes a year of service under a plan 
computing service by the actual counting of hours for the 12-month 
period ending December 31, 1989, and incurs a 1-year break in service 
for the 12-month period ending December 31, 1990. The plan does not 
contain the provisions permitted by section 410(a)(5)(B) (relating to 2-
year 100 percent vesting) and section 410(a)(5)(D) (relating to 
nonvested participants). Thereafter, he does not complete a year of 
service. As of January 1, 1991, in computing his period of service under 
the plan his service prior to December 31, 1990, is not required to be 
taken into account for purposes of section 410(a)(1) and Sec. 1.410(a)-
3.

[T.D. 8170, 53 FR 239, Jan. 6, 1988]

[[Page 735]]



Sec. 1.410(a)-9  Maternity and paternity absence.

    (a) Elapsed time--(1) Rule. For purposes of applying the rules of 
Sec. 1.410(a)-7 (relating to the elapsed time method of crediting 
service) to absences described in sections 410(a)(5)(E) and 411(a)(6)(E) 
(relating to maternity or paternity absence), the severance from service 
date of an employee who is absent from service beyond the first 
anniversary of the first day of absence by reason of a maternity or 
paternity absence described in section 410(a)(5)(E)(i) or 
411(a)(6)(E)(i) is the second anniversary of the first day of such 
absence. The period between the first and second anniversaries of the 
first day of absence from work is neither a period of service nor a 
period of severance. This rule applies to maternity and paternity 
absences beginning on or after the first day of the first plan year in 
which the plan is required to credit service under sections 410(a)(5)(E) 
and 411(a)(6)(E).

    (2) Example. The rules of this section are illustrated by the 
following example:

    Assume an individual works until June 30, 1986; is first absent from 
employment on July 1, 1986, on account of maternity or paternity 
absence; and on July 1, 1989, performs an hour of service. The period of 
service must include the period from employment commencement date until 
June 30, 1987 (one year after the date of separation for any reason 
other than a quit, discharge, retirement, or death). The period from 
July 1, 1987, to June 30, 1988, is neither a period of service nor a 
period of severance. The period of severance would be from July 1, 1988, 
to June 30, 1989.

    (b) Other methods. This paragraph provides a safe harbor for plans 
that compute years of service under the hours of service methods or 
permitted equivalencies. Such a plan will be treated as satisfying the 
requirements of sections 410(a)(5)(E) and 411(a)(6)(E) if the plan 
increases the minimum period of consecutive 1-year breaks required to 
disregard any service (or deprive any employee of any right) by one. 
Thus, a plan will satisfy sections 410(a)(5)(E) and 411(a)(6)(E) without 
having to compute service for maternity or paternity and sections 
410(a)(5)(D) and 411 (a)(4)(D) and (a)(6)(C), by increasing the period 
of consecutive breaks-in-service from 5 to 6.

[T.D. 8219, 53 FR 31852, Aug. 22, 1988; 53 FR 48534, Dec. 1, 1988]



Sec. 1.410(a)-9T  Elapsed time (temporary).

    (a)-(b) [Reserved]
    (c) Eligibility to participate.
    (1) [Reserved]
    (2) Determination of one-year period of service.
    (i) [Reserved]
    (ii) For purposes of section 410(a)(1)(B)(i), a ``2-year period of 
service'' shall be deemed to be ``2 years of service.''
    (d) Vesting--(1) General rule.
    (i)-(iii) [Reserved]
    (iv) For purposes of determining an employee's nonforfeitable 
percentage of accrued benefits derived from employer contributions, a 
plan, after calculating an employee's period of service in the manner 
prescribed in this paragraph, may disregard any remaining less than 
whole year, 12-month or 365-day period of service. Thus, for example, if 
a plan provides for the statutory three to seven year graded vesting, an 
employee with a period (or periods) of service which yields 3 whole year 
periods of service and an additional 321-day period of service is twenty 
percent vested in his or her employer-derived accrued benefits (based 
solely on the 3 whole year periods of service).

[T.D. 8170, 53 FR 239, Jan. 6, 1988]



Sec. 1.410(b)-0  Table of contents.

    This section contains a listing of the major headings of Sec. Sec. 
1.410(b)-1 through 1.410(b)-10.

      Sec. 1.410(b)-1 Minimum coverage requirements (before 1994).

(a) In general.
(b) Coverage tests.
    (1) Percentage test.
    (2) Classification test.
(c) Exclusion of certain employees.
    (1) Bargaining unit.
    (2) Air pilots.
    (3) Nonresident aliens.
(d) Special rules.
    (1) Highly compensated.
    (2) Discrimination.
    (3) Multiple plans.
    (4) Profit-sharing plans.

[[Page 736]]

    (5) Certain classifications.
    (6) Integration with Social Security Act.
    (7) Different age and service requirements.
    (i) Application.
    (ii) General rule.
    (8) Certain controlled groups.
    (9) Transitional rule.
(e) Example.

      Sec. 1.410(b)-2 Minimum coverage requirements (after 1993).

(a) In general.
(b) Requirements with respect to employees.
    (1) In general.
    (2) Ratio percentage test.
    (i) In general.
    (ii) Examples.
    (3) Average benefit test.
    (4) Certain tax credit employee stock ownership plans.
    (5) Employers with no nonhighly compensated employees.
    (6) Plans benefiting no highly compensated employees.
    (7) Plans benefiting collectively bargained employees.
(c) Requirements with respect to former employees.
    (1) Former employees tested separately.
    (2) Testing former employees.
(d) Nonelective contributions under section 403(b) plans.
(e) Certain governmental and church plans.
(f) Certain acquisitions or dispositions.
(g) Additional rules.

  Sec. 1.410(b)-3 Employees and former employees who benefit under a 
                                  plan.

(a) Employees benefiting under a plan.
    (1) In general.
    (2) Exceptions to allocation or accrual requirement.
    (i) Section 401(k) and 401(m) plans.
    (ii) Section 415 limits.
    (iii) Certain employees treated as benefiting.
    (iv) Section 412(i) plans.
    (3) Examples.
(b) Former employees benefiting under a plan.
    (1) In general.
    (2) Examples.

         Sec. 1.410(b)-4 Nondiscriminatory classification test.

(a) In general.
(b) Reasonable classification established by the employer.
(c) Nondiscriminatory classification.
    (1) General rule.
    (2) Safe harbor.
    (3) Facts and circumstances.
    (i) General rule.
    (ii) Factual determination.
    (4) Definitions.
    (i) Safe harbor percentage.
    (ii) Unsafe harbor percentage.
    (iii) Nonhighly compensated employee concentration percentage.
    (iv) Table.
    (5) Examples.

            Sec. 1.410(b)-5 Average benefit percentage test.

(a) General rule.
(b) Determination of average benefit percentage.
(c) Determination of actual benefit percentage.
(d) Determination of employee benefit percentages.
    (1) Overview.
    (2) Employee contributions and employee-provided benefits 
disregarded.
    (3) Plans and plan years taken into account.
    (i) Testing group.
    (ii) Testing period.
    (4) Contributions or benefits basis.
    (5) Determination of employee benefit percentage.
    (i) General rule.
    (ii) Plans with differing plan years.
    (iii) Options and consistency requirements.
    (6) Permitted disparity.
    (i) In general.
    (ii) Plans which may not use permitted disparity.
    (7) Requirements for certain plans providing early retirement 
benefits.
    (i) General rule.
    (ii) Exception.
(e) Additional optional rules.
    (1) Overview.
    (2) Determination of employee benefit percentages as the sum of 
separately determined rates.
    (i) In general.
    (ii) Exception from consistency requirement.
    (iii) Permitted inconsistencies.
    (3) Determination of employee benefit percentages without regard to 
plans of another type.
    (i) General rule.
    (ii) Restriction on use of separate testing group determination 
method.
    (iii) Treatment of permitted disparity.
    (iv) Example.
    (4) Simplified method for determining employee benefit percentages 
for certain defined benefit plans.
    (i) In general.
    (ii) Simplified method.
    (5) Three-year averaging period.
    (6) Alternative methods of determining compensation.
(f) Special rule for certain collectively bargained plans.

                 Sec. 1.410(b)-6 Excludable employees.

(a) Employees.
    (1) In general.

[[Page 737]]

    (2) Rules of application.
(b) Minimum age and service exclusions.
    (1) In general.
    (2) Multiple age and service conditions.
    (3) Plans benefiting certain otherwise excludable employees.
    (i) In general.
    (ii) Testing portion of plan benefiting otherwise excludable 
employees.
    (4) Examples.
(c) Certain nonresident aliens.
    (1) General rule.
    (2) Special treaty rule.
(d) Collectively bargained employees.
    (1) General rule.
    (2) Definition of collectively bargained employee.
    (1) In general.
    (ii) Special rules for certain employees in multiemployer plans.
    (iii) Covered by a collective bargaining agreement.
    (iv) Examples.
(e) Employees of qualified separate lines of business.
(f) Certain terminating employees.
    (1) In general.
    (2) Hours of service.
    (3) Examples.
(g) Employees of certain governmental or tax-exempt entities.
    (1) Plans covered.
    (2) Employees of governmental entities.
    (3) Employees of tax-exempt entities.
(h) Former employees.
    (1) In general.
    (2) Employees terminated before a specified date.
    (3) Previously excludable employees.
    (i) Former employees treated as employees.

      Sec. 1.410(b)-7 Definition of plan and rules governing plan 
                     disaggregation and aggregation.

(a) In general.
(b) Separate asset pools are separate plans.
(c) Mandatory disaggregation of certain plans.
    (1) Section 401(k) and section 401(m) plans.
    (2) ESOPs and non-ESOPs.
    (3) Plans benefiting otherwise excludable employees.
    (4) Plans benefiting certain disaggregation populations of 
employees.
    (i) In general.
    (ii) Definition of disaggregation population.
    (5) Additional rules for plans benefiting employees of more than one 
qualified separate line of business.
(d) Permissive aggregation for ratio percentage and nondiscriminatory 
          classification tests.
    (1) In general.
    (2) Rules of disaggregation.
    (3) Duplicative aggregation.
    (4) Special rule for plans benefiting employees of a qualified 
separate line of business.
    (5) Same plan year requirement.
(e) Determination of plans in testing group for average benefit 
          percentage test.
    (1) In general.
    (2) Example.
(f) Section 403(b) plans.

                   Sec. 1.410(b)-8 Additional rules.

(a) Testing methods.
    (1) In general.
    (2) Daily testing option.
    (3) Quarterly testing option.
    (4) Annual testing option.
    (5) Example.
(b) Family member aggregation rule.

                      Sec. 1.410(b)-9 Definitions.

    Collectively bargained employee.
    Defined benefit plan.
    Defined contribution plan.
    Employee.
    Employer.
    ESOP.
    Former employee.
    Highly compensated employee.
    Highly compensated former employee.
    Multiemployer plan.
    Noncollectively bargained employee.
    Nonhighly compensated employee.
    Nonhighly compensated former employee.
    Plan year.
    Plan year compensation.
    Professional employee.
    Ratio percentage.
    Section 401(k) plan.
    Section 401(l) plan.
    Section 401(m) plan.

         Sec. 1.410(b)-10 Effective dates and transition rules.

(a) Statutory effective dates.
    (1) In general.
    (2) Special statutory effective date for collective bargaining 
agreements.
    (i) In general.
    (ii) Example.
    (iii) Plan maintained pursuant to a collective bargaining agreement.
(b) Regulatory effective dates.
    (1) In general.
    (2) Plans of tax-exempt organizations.
(c) Compliance during transition period.
(d) Effective date for governmental plans.

[T.D. 8363, 56 FR 47641, Sept. 19, 1991; 57 FR 10954, Mar. 31, 1992, as 
amended by T.D. 8487, 58 FR 46838, Sept. 3, 1993; T.D. 8548, 59 FR 
32914, June 27, 1994; T.D. 9275, 71 FR 41359, July 21, 2006]

[[Page 738]]



Sec. 1.410(b)-1  Minimum coverage requirements (before 1994).

    (a) In general. A plan is not a qualified plan (and a trust forming 
a part of the plan is not a qualified trust) unless the plan satisfies 
section 410(b)(1). For plan years prior to the applicable effective date 
set forth in Sec. 1.410(b)-10, a plan satisfies section 410(b)(1) if it 
satisfies the requirements of paragraph (b)(1) or (b)(2) of this 
section. See also Sec. 1.410(b)-2 for plan years beginning on or after 
the applicable effective date set forth in Sec. 1.410(b)-10.
    (b) Coverage tests--(1) Percentage test. A plan satisfies the 
requirements of this subparagraph if it benefits--
    (i) Seventy percent or more of all employees, or
    (ii) Eighty percent or more of all employees who are eligible to 
benefit under the plan if 70 percent or more of all the employees are 
eligible to benefit under the plan,

excluding in each case employees who have not satisfied the minimum age 
and service requirements (if any) prescribed by the plan, as of the date 
coverage is tested, as a condition of participation and employees 
permitted to be excluded under paragraph (c) of this section. The 
percentage requirements of this subparagraph refer to a percentage of 
active employees, including employees temporarily on leave, such as 
those in the Armed Forces of the United States, if such employees are 
eligible under the plan.
    (2) Classification test. A plan satisfies the requirements of 
section 410(b)(1) and this subparagraph if it benefits such employees as 
qualify under a classification of employees set up by the employer, 
which classification is found by the Internal Revenue Service not to be 
discriminatory in favor of employees who are officers, shareholders, or 
highly compensated. For purposes of this subparagraph, except as 
provided by paragraph (c) of this section, all active employees 
(including employees who do not satisfy the minimum age or service 
requirements of the plan) are taken into account.
    (c) Exclusion of certain employees. Under section 410(b)(2), for 
purposes of section 410(b)(1) and paragraph (b) of this section, there 
shall be excluded from consideration employees described in 
subparagraphs (1), (2), and (3) of this paragraph.
    (1) Bargaining unit. Under section 410(b)(2)(A) and this paragraph, 
there may be excluded from consideration employees not included in the 
plan who are included in a unit of employees covered by an agreement 
which the Secretary of Labor finds to be a collective bargaining 
agreement between employee representatives and one or more employers, if 
the Internal Revenue Service finds that retirement benefits were the 
subject of good faith bargaining between such employee representatives 
and such employer or employers. For purposes of determining whether such 
bargaining occurred, it is not material that such employees are not 
covered by another plan or that the plan was not considered in such 
bargaining.
    (2) Air pilots. Under section 410(b)(2)(B) and this paragraph there 
may be excluded from consideration, in the case of a plan established or 
maintained pursuant to an agreement which the Secretary of Labor finds 
to be a collective bargaining agreement between air pilots represented 
in accordance with title II of the Railway Labor Act and one or more 
employers all employees not covered by such agreement. Section 
410(b)(2)(B) and this subparagraph do not apply to a plan if the plan 
provides contributions or benefits for employees whose principal duties 
are not customarily performed aboard aircraft in flight.
    (3) Nonresident aliens. Under section 410(b)(2)(C) and this 
paragraph, there may be excluded from consideration employees who are 
nonresident aliens and who receive no earned income (within the meaning 
of section 911(b) and the regulations thereunder) from the employer 
which constitutes income from sources within the United States (within 
the meaning of section 861(a)(3) and the regulations thereunder).
    (d) Special rules--(1) Highly compensated. The classification of an 
employee as highly compensated for purposes of section 410(b)(1)(B) and 
Sec. 1.410(b)-1(b)(2) is made on the basis of the facts and 
circumstances of each case, taking into account the level of the 
employee's compensation and the

[[Page 739]]

level of compensation paid by the employer to other employees, whether 
or not covered by the plan. Average compensation levels determined on a 
local, regional, or national basis, are not relevant for this purpose. 
Further, the classification of an employee as highly compensated is not 
made solely on the basis of the number or percentage of employees whose 
compensation exceeds, or is exceeded by, the employee's.
    (2) Discrimination. The determination as to whether a plan 
discriminates in favor of employees who are officers, shareholders, or 
highly compensated is made on the basis of the facts and circumstances 
of each case, allowing a reasonable difference between the ratio of such 
employees benefited by the plan to all such employees of the employer 
and the ratio of the employees (other than officers, shareholders, or 
highly compensated) of the employer benefited by the plan to all 
employees (other than officers, shareholders, or highly compensated). A 
showing that a specified percentage of employees covered by a plan are 
not officers, shareholders, or highly compensated, is not in itself 
sufficient to establish that the plan does not discriminate in favor of 
employees who are officers, shareholders, or highly compensated.
    (3) Multiple plans--(i) An employer may designate two or more plans 
as constituting a single plan which is intended to qualify for purposes 
of section 410(b)(1) and this section, in which case all plans so 
designated shall be considered as a single plan in determining whether 
the requirements of such section are satisfied by each of the separate 
plans. A determination that the combination of plans so designated does 
not satisfy such requirements does not preclude a determination that one 
or more of such plans, considered separately, satisfies such 
requirements.
    (ii) Notwithstanding subdivision (i) of this subparagraph, a plan 
which is subject to the limitations of section 401(a)(17) of the Code or 
section 301(d)(3) of the Tax Reduction Act of 1975 cannot be considered 
with any other plan which covers any employee covered by such plan.
    (4) Profit-sharing plans. Employees under a profit-sharing plan who 
receive the amounts allocated to their accounts before the expiration of 
a period of time or the occurrence of a contingency specified in the 
plan shall not be considered covered by the plan. Thus, in case a plan 
permits employees to receive immediately the amounts allocated to their 
accounts, or to have such amounts paid to a profit-sharing plan for 
them, the employees who receive the shares immediately shall not be 
considered covered by the plan.
    (5) Certain classifications. See section 401(a)(5) and the 
regulations thereunder for rules relating to classifications of 
employees which are not considered to be discriminatory per se for 
purposes of section 410(b)(1)(B) and Sec. 1.410(b)-1(b)(2).
    (6) Integration with Social Security Act. See section 401(a)(5) and 
the regulations thereunder for rules relating to integration of plans 
with the Social Security Act.
    (7) Different age and service requirements--(i) Application. The 
rules of this subparagraph (7) apply to a plan which must satisfy the 
minimum age and service requirements of section 410(a)(1)(A) in order to 
be a qualified plan. Accordingly, the rules are inapplicable to plans 
described in section 410(c)(1) (see Sec. 1.410(a)-1(c)(1)); plans 
satisfying the alternative minimum age and service requirements of 
section 410(a)(1)(B) but not satisfying the requirements of section 
410(a)(1)(A); and plans which provide contributions or benefits for 
employees, some or all of whom are owner-employees (see section 
401(a)(10)).
    (ii) General rules. A provision for different age and service 
requirements for present and future employees either upon establishment 
or subsequent amendment is not, of itself, discriminatory under section 
410(b)(1)(B) even though present employees who are officers, 
shareholders, or highly compensated cannot meet the age and service 
requirements for future employees at the time the plan is established or 
amended and even though present participants who are officers, 
shareholders, or highly compensated would not have satisfied the age and 
service requirements for future employees at the time they became 
participants in

[[Page 740]]

the plan. Furthermore, prohibited discrimination will be deemed not to 
arise in operation, solely because of such different requirements, when 
future employees are added to the employer's work force.
    (8) Certain controlled groups. In applying the percentage test and 
classification test described in paragraph (b) (1) and (2) of this 
section for a year, all the employees of corporations or trades and 
businesses whose employees are treated as employed by a single employer 
by reason of section 414 (b) or (c) must be taken into account. The 
preceding sentence shall apply for a plan year if, on 1 day in each 
quarter of such plan year, such corporations are members of a controlled 
group of corporations (within the meaning of section 414(b)) of such 
trades or businesses are under common control (within the meaning of 
section 414(c)).
    (9) Transitional rule. In the case of a cash and deferred profit-
sharing plan, in existence on June 27, 1974, the requirements of 
paragraph (b)(2) of this section are satisfied if over one-half of the 
participants in the plan are among the lowest paid two-thirds of all 
eligible employees. This subparagraph shall not apply after December 31, 
1977.
    (e) Example. The rules provided by this section are illustrated by 
the following example:

    Example. An employer established a non-contributory defined benefit 
plan covering all employees of its ABC Division who are hired prior to 
age 60 and who are at least 25 years old. The normal retirement age 
under the plan is age 65. The employer has 100 employees including 20 
employees who are under age 25 and 10 employees who were hired over age 
60. The plan does not cover 15 employees who are over age 25 and were 
hired before age 60 because they are not in the ABC Division. Of these 
15 excluded employees, 3 have less than 1 year of service. In addition, 
12 of the 55 employees covered have less than one year of service. The 
plan can be shown not to satisfy the requirements of IRC section 
410(b)(1)(A) as follows:

(i) Number of employees........................................      100
(ii) Number of employees excluded on account of minimum age and       20
 service.......................................................
(iii) (i)-(ii).................................................       80
(iv) Number of employees who must be covered if plan is to            56
 satisfy IRC section 410(b)(1)(A), 70% of (iii)................
(v) Number of employees actually covered.......................       55
 


Because the number of employees covered is less than the number of 
employees who must be covered, the plan does not satisfy the percentage 
coverage requirements of IRC section 410(b)(1)(A).

(Sec. 410 (88 Stat. 898; 26 U.S.C. 410))

[T.D. 7508, 42 FR 47197, Sept. 20, 1977, as amended by T.D. 7735, 45 FR 
74722, Nov. 12, 1980; T.D. 8363, 56 FR 47643, Sept. 19, 1991; T.D. 8487, 
58 FR 46839, Sept. 3, 1993]



Sec. 1.410(b)-2  Minimum coverage requirements (after 1993).

    (a) In general. A plan is a qualified plan for a plan year only if 
the plan satisfies section 410(b) for the plan year. A plan satisfies 
section 410(b) for a plan year if and only if it satisfies paragraph (b) 
of this section with respect to employees for the plan year and 
paragraph (c) of this section with respect to former employees for the 
plan year. The rules in paragraphs (a), (b), and (c) of this section 
apply to all plans as a condition of qualification, including plans 
under which no employee is able to accrue any additional benefits (for 
example, frozen plans). Paragraphs (d), (e), and (f) of this section 
provide special rules for nonelective section 403(b) plans subject to 
section 403(b)(12)(A)(i), for governmental and church plans subject to 
section 410(c), and for certain acquisitions or dispositions, 
respectively. See Sec. 1.410(b)-7 for rules for determining the 
``plan'' subject to section 410(b).
    (b) Requirements with respect to employees--(1) In general. A plan 
satisfies this paragraph (b) for a plan year if and only if it satisfies 
at least one of the tests in paragraphs (b)(2) through (b)(7) of this 
section for the plan year.
    (2) Ratio percentage test--(i) In general. A plan satisfies this 
paragraph (b)(2) for a plan year if and only if the plan's ratio 
percentage for the plan year is at least 70 percent. This test 
incorporates both the percentage test of section 410(b)(1)(A) and the 
ratio test of section 410(b)(1)(B). See Sec. 1.410(b)-9 for the 
definition of ratio percentage.
    (ii) Examples. The following examples illustrate the ratio 
percentage test of this paragraph (b)(2).

    Example 1. For a plan year, Plan A benefits 70 percent of an 
employer's nonhighly compensated employees and 100 percent of the 
employer's highly compensated employees. The plan's ratio percentage for 
the year is 70

[[Page 741]]

percent (70 percent/100 percent), and thus the plan satisfies the ratio 
percentage test.
    Example 2. For a plan year, Plan B benefits 40 percent of the 
employer's nonhighly compensated employees and 60 percent of the 
employer's highly compensated employees. Plan B fails to satisfy the 
ratio percentage test because the plan's ratio percentage is only 66.67 
percent (40 percent/60 percent).

    (3) Average benefit test. A plan satisfies this paragraph (b)(3) for 
a plan year if and only if the plan satisfies both the nondiscriminatory 
classification test of Sec. 1.410(b)-4 and the average benefit 
percentage test of Sec. 1.410(b)-5 for the plan year.
    (4) Certain tax credit employee stock ownership plans. A plan 
satisfies this paragraph (b)(4) for a plan year if and only if the 
plan--
    (i) Is a tax credit employee stock ownership plan (as defined in 
section 409(a)),
    (ii) Is the only plan of the employer that is intended to qualify 
under section 401(a), and
    (iii) Is a plan that satisfies the rule set forth in section 
410(b)(6)(D).
    This paragraph (b)(4) is available only for plan years for which the 
tax credit employee stock ownership plan receives contributions for 
which the employer is allowed a tax credit under section 41 (as in 
effect prior to its repeal by the Tax Reform Act of 1986) or section 
48(n) (as in effect prior to its amendment by the Tax Reform Act of 
1984). The requirement of this paragraph (b)(4) that the plan be the 
only plan of the employer that is intended to qualify under section 
401(a) is not satisfied if the employer has only one plan, but that plan 
is treated as two or more separate plans under the mandatory 
disaggregation rules of Sec. 1.410(b)-7(c).
    (5) Employers with no nonhighly compensated employees. A plan 
satisfies this paragraph (b)(5) for a plan year if and only if the plan 
is maintained by an employer that has no nonhighly compensated employees 
at any time during the plan year.
    (6) Plans benefiting no highly compensated employees. A plan 
satisfies this paragraph (b)(6) for a plan year if and only if the plan 
benefits no highly compensated employees for the plan year.
    (7) Plans benefiting collectively bargained employees. A plan that 
benefits solely collectively bargained employees for a plan year 
satisfies this paragraph (b)(7) for the plan year. If a plan (within the 
meaning of Sec. 1.410(b)-7(b)) benefits both collectively bargained 
employees and noncollectively bargained employees for a plan year, Sec. 
1.410(b)-7(c)(4) provides that the portion of the plan that benefits 
collectively bargained employees is treated as a separate plan from the 
portion of the plan that benefits noncollectively bargained employees. 
Thus, the mandatorily disaggregated portion of the plan that benefits 
the collectively bargained employees automatically satisfies this 
paragraph (b)(7) for the plan year and hence section 410(b). See Sec. 
1.410(b)-9 for the definitions of collectively bargained employee and 
noncollectively bargained employee.
    (c) Requirements with respect to former employees--(1) Former 
employees tested separately. Former employees are tested separately from 
employees for purposes of section 410(b). Thus, former employees are 
disregarded in applying the ratio percentage test, the nondiscriminatory 
classification test, and the average benefit percentage test with 
respect to the coverage of employees under a plan, and employees are 
disregarded in applying this section with respect to the coverage of 
former employees under a plan.
    (2) Testing former employees. A plan satisfies section 410(b) with 
respect to former employees if and only if, under all of the relevant 
facts and circumstances (including the group of nonexcludable former 
employees not benefiting under the plan), the group of former employees 
benefiting under the plan does not discriminate significantly in favor 
of highly compensated former employees.
    (d) Nonelective contributions under section 403(b) plans. For plan 
years beginning on or after January 1, 1989, a plan subject to section 
403(b)(12)(A)(i) with respect to nonelective contributions (i.e., 
contributions not made pursuant to a salary reduction agreement) is 
treated as a plan subject to the requirements of this section. For this 
purpose, a plan described in the preceding sentence must satisfy the 
requirements of this section without regard to section 410(c) and 
paragraph (e)

[[Page 742]]

of this section. For plan years beginning before the effective date set 
forth in Sec. 1.410(b)-10(d), any plan described in section 
410(c)(1)(A) (regarding governmental plans) satisfies the requirements 
of this section.
    (e) Certain governmental and church plans. The requirements of 
section 410(b) do not apply to a plan described in section 410(c)(1) 
(other than a plan subject to section 403(b)(12)(A)(i) or a plan with 
respect to which an election has been made under section 410(d)). Such a 
plan must satisfy section 401(a)(3) as in effect on September 1, 1974. 
For this purpose, a plan that satisfies section 410(b) (without regard 
to this paragraph (e)) is treated as satisfying section 401(a)(3) as in 
effect on September 1, 1974. For plan years beginning before the 
effective date set forth in Sec. 1.410(b)-10(d), any plan described in 
section 410(c)(1)(A) (regarding governmental plans) satisfies the 
requirements of this section and is thus treated as satisfying the 
requirements of section 401(a)(3) as in effect on September 1, 1974. See 
Sec. 1.410(b)-10(b)(2) for a special rule for plans of tax-exempt 
organizations.
    (f) Certain acquisitions or dispositions. Section 410(b)(6)(C) 
(relating to certain acquisitions or dispositions) provides a special 
rule whereby a plan may be treated as satisfying section 410(b) for a 
limited period of time after an acquisition or disposition if it 
satisfies section 410(b) (without regard to the special rule) 
immediately before the acquisition or disposition and there is no 
significant change in the plan or in the coverage of the plan other than 
the acquisition or disposition. For purposes of section 410(b)(6)(C) and 
this paragraph (f), the terms ``acquisition'' and ``disposition'' refer 
to an asset or stock acquisition, merger, or other similar transaction 
involving a change in employer of the employees of a trade or business.
    (g) Additional rules. The Commissioner may, in revenue rulings, 
notices, and other guidance of general applicability, provide any 
additional rules that may be necessary or appropriate in applying the 
minimum coverage requirements of section 410(b), including (without 
limitation) additional rules limiting or expanding the methods in Sec. 
1.410(b)-5(d) and (e) for determining employee benefit percentages.

[T.D. 8363, 56 FR 47643, Sept. 19, 1991; 57 FR 10817, Mar. 31, 1992, as 
amended by T.D. 8487, 58 FR 46839, Sept. 3, 1993; T.D. 8548, 59 FR 
32914, June 27, 1994]



Sec. 1.410(b)-3  Employees and former employees who benefit under a plan.

    (a) Employees benefiting under a plan--(1) In general. Except as 
provided in paragraph (a)(2) of this section, an employee is treated as 
benefiting under a plan for a plan year if and only if for that plan 
year, in the case of a defined contribution plan, the employer receives 
an allocation taken into account under Sec. 1.401(a)(4)-2(c)(2)(ii), or 
in the case of a defined benefit plan, the employee has an increase in a 
benefit accrued or treated as an accrued benefit under section 
411(d)(6).
    (2) Exceptions to allocation or accrual requirement--(i) Section 
401(k) and 401(m) plans. Notwithstanding paragraph (a)(1) of this 
section, an employee is treated as benefiting under a section 401(k) 
plan for a plan year if and only if the employee is an eligible employee 
as defined in Sec. 1.401(k)-6 under the plan. Similarly, an employee is 
treated as benefiting under a section 401(m) plan for a plan year if and 
only if the employee is an eligible employee as defined in Sec. 
1.401(m)-5 under the plan for the plan year.
    (ii) Section 415 limits--(A) General rule for defined benefit plans. 
In determining whether an employee is treated as benefiting under a 
defined benefit plan for a plan year, plan provisions that implement the 
limits of section 415 are disregarded. Any plan provision that provides 
for increases in an employee's accrued benefit under the plan due solely 
to adjustments under section 415(d)(1), additional years of 
participation or service under section 415(b)(5), or changes in the 
defined contribution fraction under section 415(e) is also disregarded, 
but only if such provision applies uniformly to all employees in the 
plan.
    (B) Defined benefit plans taking section 415 limits into account 
under section 401(a)(4) testing. Paragraph (a)(2)(ii)(A) of this section 
does not apply in the case of a defined benefit plan that uses the 
option in Sec. 1.401(a)(4)-3(d)(2)(ii)(B)

[[Page 743]]

to take into account plan provisions implementing the provisions of 
section 415 in determining accrual rates under the section 401(a)(4) 
general test.
    (C) Defined contribution plans. A defined contribution plan is 
permitted to apply the rule in the first sentence of paragraph 
(a)(2)(ii)(A) of this section in determining whether an employee is 
treated as benefiting under the plan, provided it applies the rule on a 
consistent basis for all employees in the plan.
    (iii) Certain employees treated as benefiting--(A) In general. An 
employee is treated as benefiting under a plan for a plan year if the 
employee satisfies all of the applicable conditions for accruing a 
benefit or receiving an allocation for the plan year but fails to have 
an increase in accrued benefit or to receive an allocation solely 
because of one or more of the conditions set forth in paragraphs 
(a)(2)(iii) (B) through (F) of this section.
    (B) Certain plan limits. The employee's benefit would otherwise 
exceed a limit that is applicable on a uniform basis to all employees in 
the plan. Thus, for example, if the formula under a defined benefit plan 
takes into account only the first 30 years of service for accrual 
purposes, an employee who has completed more than 30 years of service is 
still treated as benefiting under the plan.
    (C) Benefits previously accrued. The benefit previously accrued by 
the employee is greater than the benefit that would be determined under 
the plan if the benefit previously accrued were disregarded. This could 
happen, for example, when the plan is applying the wear-away formula of 
Sec. 1.401(a)(4)-13(c)(4)(ii) and the employee's frozen accrued benefit 
exceeds the benefit determined under the current formula.
    (D) Benefit offset arrangements. The plan offsets the employee's 
current benefit accrual under an offset arrangement described in Sec. 
1.401(a)(4)-3(f)(9) (without regard to whether the offset is 
attributable to pre-participation service or past service).
    (E) Target benefit plans. In the case of a target benefit plan that 
satisfies the nondiscriminatory amount requirement of Sec. 1.401(a)(4)-
1(b)(2) by satisfying the safe harbor in Sec. 1.401(a)(4)-8(b)(3), the 
employee's theoretical reserve is greater than or equal to the actuarial 
present value of the fractional rule benefit.
    (F) Post-normal retirement age adjustments. The employee has 
attained normal retirement age under a defined benefit plan and fails to 
accrue a benefit because of the provisions of section 411(b)(1)(H)(iii) 
regarding adjustments for delayed retirement.
    (iv) Section 412(i) plans--(A) General rule. Notwithstanding 
paragraph (a)(1) of this section, an employee is treated as benefiting 
under an insurance contract plan within the meaning of section 412(i) 
for a plan year if and only if a premium is paid on behalf of the 
employee for the plan year.
    (B) Exceptions. Notwithstanding paragraph (a)(2)(iv)(A) of this 
section, an employee is treated as benefiting under an insurance 
contract plan within the meaning of section 412(i) for a plan year if 
the sole reason that a premium is not paid on behalf of the employee is 
one of the reasons described in paragraph (a)(2)(iii) of this section. 
In addition, an employee is treated as benefiting under an insurance 
contract plan, within the meaning of section 412(i), that is a defined 
benefit plan if a premium is not paid on behalf of the employee solely 
because the insurance contracts that have previously been purchased on 
behalf of the employee guarantee to provide for the employee's projected 
normal retirement benefit without regard to future premium payments.
    (3) Examples. The following examples illustrate the determination of 
whether an employee is benefiting under a plan for purposes of section 
410(b).

    Example 1. An employer has 35 employees who are eligible under a 
defined benefit plan. The plan requires 1,000 hours of service to accrue 
a benefit. Only 30 employees satisfy the 1,000-hour requirement and 
accrue a benefit. The five employees who do not satisfy the 1,000-hour 
requirement during the plan year are taken into account in testing the 
plan under section 410(b) but are treated as not benefiting under the 
plan.
    Example 2. An employer maintains a section 401(k) plan. Only 
employees who are at least age 21 and who complete one year of service 
are eligible employees under the plan within the meaning of Sec. 
1.401(k)-6. Under the rule of paragraph (a)(2)(i) of this section, only 
employees who have satisfied these age

[[Page 744]]

and service conditions are treated as benefiting under the plan.
    Example 3. The facts are the same as in Example 2, except that the 
employer also maintains a section 401(m) plan that provides matching 
contributions contingent on elective contributions under the section 
401(k) plan. The matching contributions are contingent on employment on 
the last day of the plan year. Under Sec. 1.401(m)-5, because matching 
contributions are contingent on employment on the last day of the plan 
year, not all employees who are eligible employees under the section 
401(k) plan are eligible employees under the section 401(m) plan. Thus, 
employees who have satisfied the age and service conditions but who do 
not receive a matching contribution because they are not employed on the 
last day of the plan year are treated as not benefiting under the 
section 401(m) portion of the plan.

    (b) Former employees benefiting under a plan--(1) In general. A 
former employee is treated as benefiting for a plan year if and only if 
the plan provides an allocation or benefit increase described in 
paragraph (a)(1) of this section to the former employee for the plan 
year. Thus, for example, a former employee benefits under a defined 
benefit plan for a plan year if the plan is amended to provide an ad hoc 
cost-of-living adjustment in the former employee's benefits. In 
contrast, because an increase in benefits payable under a plan pursuant 
to an automatic cost-of-living provision adopted and effective before 
the beginning of the plan year is previously accrued, a former employee 
is not treated as benefiting in a subsequent plan year merely because 
the former employee receives an increase pursuant to such an automatic 
cost-of-living provision. Any accrual or allocation for an individual 
during the plan year that arises from the individual's status as an 
employee is treated as an accrual or allocation of an employee. 
Similarly, any accrual or allocation for an individual during the plan 
year that arises from the individual's status as a former employee is 
treated as an accrual or allocation of a former employee. It is possible 
for an individual to accrue a benefit both as an employee and as a 
former employee in a given plan year. During the plan year in which an 
individual ceases performing services for the employer, the individual 
is treated as an employee in applying section 410(b) with respect to 
employees and is treated as a former employee in applying section 410(b) 
with respect to former employees.
    (2) Examples. The following examples illustrate the determination of 
whether a former employee benefits under a plan for purposes of section 
410(b).

    Example 1. Employer A amends its defined benefit plan in the 1995 
plan year to provide an ad hoc cost-of-living increase of 5 percent for 
all retirees. Former employees who receive this increase are treated as 
benefiting under the plan for the 1995 plan year.
    Example 2. Employer B maintains a defined benefit plan with a 
calendar plan year. In the 1995 plan year, Employer B amends the plan to 
provide that an employee who has reached early retirement age under the 
plan and who retires before July 31 of the 1995 plan year will receive 
an unreduced benefit, even though the employee has not yet reached 
normal retirement age. This early retirement window benefit is provided 
to employees based on their status as employees. Thus, although 
individuals who take advantage of the benefit become former employees, 
the window benefit is treated as provided to employees and is not 
treated as a benefit for former employees.
    Example 3. The facts are the same as Example 2, except that on 
September 1, 1995, Employer B also amends the defined benefit plan to 
provide an ad hoc cost-of-living increase effective for all former 
employees. An individual who ceases performing services for the employer 
before July 31, 1995, under the early retirement window, and then 
receives the ad hoc cost-of-living increase, is treated as benefiting 
for the 1995 plan year both as an employee with respect to the early 
retirement window, and as a former employee with respect to the ad hoc 
COLA.

[T.D. 8363, 56 FR 47644, Sept. 19, 1991; 57 FR 10954, Mar. 31, 1992, as 
amended by T.D. 8487, 58 FR 46839, Sept. 3, 1993; T.D. 9169, 69 FR 
78153, 78154, Dec. 29, 2004]



Sec. 1.410(b)-4  Nondiscriminatory classification test.

    (a) In general. A plan satisfies the nondiscriminatory 
classification test of this section for a plan year if and only if, for 
the plan year, the plan benefits the employees who qualify under a 
classification established by the employer in accordance with paragraph 
(b) of this section, and the classification of employees is 
nondiscriminatory under paragraph (c) of this section.
    (b) Reasonable classification established by the employer. A 
classification is established by the employer in accordance with this 
paragraph (b) if and only

[[Page 745]]

if, based on all the facts and circumstances, the classification is 
reasonable and is established under objective business criteria that 
identify the category of employees who benefit under the plan. 
Reasonable classifications generally include specified job categories, 
nature of compensation (i.e., salaried or hourly), geographic location, 
and similar bona fide business criteria. An enumeration of employees by 
name or other specific criteria having substantially the same effect as 
an enumeration by name is not considered a reasonable classification.
    (c) Nondiscriminatory classification--(1) General rule. A 
classification is nondiscriminatory under this paragraph (c) for a plan 
year if and only if the group of employees included in the 
classification benefiting under the plan satisfies the requirements of 
either paragraph (c)(2) or (c)(3) of this section for the plan year.
    (2) Safe harbor. A plan satisfies the requirement of this paragraph 
(c)(2) for a plan year if and only if the plan's ratio percentage is 
greater than or equal to the employer's safe harbor percentage, as 
defined in paragraph (c)(4)(i) of this section. See Sec. 1.410(b)-9 for 
the definition of a plan's ratio percentage.
    (3) Facts and circumstances--(i) General rule. A plan satisfies the 
requirements of this paragraph (c)(3) if and only if--
    (A) The plan's ratio percentage is greater than or equal to the 
unsafe harbor percentage, as defined in paragraph (c)(4)(ii) of this 
section, and
    (B) The classification satisfies the factual determination of 
paragraph (c)(3)(ii) of this section.
    (ii) Factual determination. A classification satisfies this 
paragraph (c)(3)(ii) if and only if, based on all the relevant facts and 
circumstances, the Commissioner finds that the classification is 
nondiscriminatory. No one particular fact is determinative. Included 
among the facts and circumstances relevant in determining whether a 
classification is nondiscriminatory are the following--
    (A) The underlying business reason for the classification. The 
greater the business reason for the classification, the more likely the 
classification is to be nondiscriminatory. Reducing the employer's cost 
of providing retirement benefits is not a relevant business reason.
    (B) The percentage of the employer's employees benefiting under the 
plan. The higher the percentage, the more likely the classification is 
to be nondiscriminatory.
    (C) Whether the number of employees benefiting under the plan in 
each salary range is representative of the number of employees in each 
salary range of the employer's workforce. In general, the more 
representative the percentages of employees benefiting under the plan in 
each salary range, the more likely the classification is to be 
nondiscriminatory.
    (D) The difference between the plan's ratio percentage and the 
employer's safe harbor percentage. The smaller the difference, the more 
likely the classification is to be nondiscriminatory.
    (E) The extent to which the plan's average benefit percentage 
(determined under Sec. 1.410(b)-5) exceeds 70 percent.
    (4) Definitions--(i) Safe harbor percentage. The safe harbor 
percentage of an employer is 50 percent, reduced by \3/4\ of a 
percentage point for each whole percentage point by which the nonhighly 
compensated employee concentration percentage exceeds 60 percent. See 
paragraph (c)(4)(iv) for a table that illustrates the safe harbor 
percentage and unsafe harbor percentage.
    (ii) Unsafe harbor percentage. The unsafe harbor percentage of an 
employer is 40 percent, reduced by \3/4\ of a percentage point for each 
whole percentage point by which the nonhighly compensated employee 
concentration percentage exceeds 60 percent. However, in no case is the 
unsafe harbor percentage less than 20 percent.
    (iii) Nonhighly compensated employee concentration percentage. The 
nonhighly compensated employee concentration percentage of an employer 
is the percentage of all the employees of the employer who are nonhighly 
compensated employees. Employees who are excludable employees for 
purposes of the average benefit test are not taken into account.
    (iv) Table. The following table sets forth the safe harbor and 
unsafe harbor

[[Page 746]]

percentages at each nonhighly compensated employee concentration 
percentage:

------------------------------------------------------------------------
  Nonhighly compensated
 employee concentration   Safe harbor percentage       Unsafe harbor
       percentage                                       percentage
------------------------------------------------------------------------
              0-60                    50.00                   40.00
                61                    49.25                   39.25
                62                    48.50                   38.50
                63                    47.75                   37.75
                64                    47.00                   37.00
                65                    46.25                   36.25
                66                    45.50                   35.50
                67                    44.75                   34.75
                68                    44.00                   34.00
                69                    43.25                   33.25
                70                    42.50                   32.50
                71                    41.75                   31.75
                72                    41.00                   31.00
                73                    40.25                   30.25
                74                    39.50                   29.50
                75                    38.75                   28.75
                76                    38.00                   28.00
                77                    37.25                   27.25
                78                    36.50                   26.50
                79                    35.75                   25.75
                80                    35.00                   25.00
                81                    34.25                   24.25
                82                    33.50                   23.50
                83                    32.75                   22.75
                84                    32.00                   22.00
                85                    31.25                   21.25
                86                    30.50                   20.50
                87                    29.75                   20.00
                88                    29.00                   20.00
                89                    28.25                   20.00
                90                    27.50                   20.00
                91                    26.75                   20.00
                92                    26.00                   20.00
                93                    25.25                   20.00
                94                    24.50                   20.00
                95                    23.75                   20.00
                96                    23.00                   20.00
                97                    22.25                   20.00
                98                    21.50                   20.00
                99                    20.75                   20.00
------------------------------------------------------------------------

    (5) Examples. The following examples illustrate the rules in this 
paragraph (c).

    Example 1. Employer A has 200 nonexcludable employees, of whom 120 
are nonhighly compensated employees and 80 are highly compensated 
employees. Employer A maintains a plan that benefits 60 nonhighly 
compensated employees and 72 highly compensated employees. Thus, the 
plan's ratio percentage is 55.56 percent ([60/120]/[72/80]=50%/
90%=0.5556), which is below the percentage necessary to satisfy the 
ratio percentage test of Sec. 1.410(b)-2(b)(2). The employer's 
nonhighly compensated employee concentration percentage is 60 percent 
(120/200); thus, Employer A's safe harbor percentage is 50 percent and 
its unsafe harbor percentage is 40 percent. Because the plan's ratio 
percentage is greater than the safe harbor percentage, the plan's 
classification satisfies the safe harbor of paragraph (c)(2) of this 
section.
    Example 2. The facts are the same as in Example 1, except that the 
plan benefits only 40 nonhighly compensated employees. The plan's ratio 
percentage is thus 37.03 percent ([40/120]/[72/80]=33.33%/90%=0.3703). 
Under these facts, the plan's classification is below the unsafe harbor 
percentage and is thus considered discriminatory.
    Example 3. The facts are the same as in Example 1, except that the 
plan benefits 45 nonhighly compensated employees. The plan's ratio 
percentage is thus 41.67 percent ([45/120]/[72/80]=37.50%/90%=0.4167), 
above the unsafe harbor percentage (40 percent) and below the safe 
harbor percentage (50 percent). The Commissioner may determine that the 
classification is nondiscriminatory after considering all the relevant 
facts and circumstances.
    Example 4. Employer B has 10,000 nonexcludable employees, of whom 
9,600 are nonhighly compensated employees and 400 are highly compensated 
employees. Employer B maintains a plan that benefits 600 nonhighly 
compensated employees and 100 highly compensated employees. Thus, the 
plan's ratio percentage is 25.00 percent ([600/9,600]/[100/400]=6.25%/
25%=0.2500), which is below the percentage necessary to satisfy the 
ratio percentage test of Sec. 1.410(b)-2(b)(2). Employer B's nonhighly 
compensated employee concentration percentage is 96 percent (9,600/
10,000); thus, Employer B's safe harbor percentage is 23 percent, and 
its unsafe harbor percentage is 20 percent. Because the plan's ratio 
percentage (25.00 percent) is greater than the safe harbor percentage 
(23.00 percent), the plan's classification satisfies the safe harbor of 
paragraph (c)(2) of this section.
    Example 5. The facts are the same as in Example 4, except that the 
plan benefits only 400 nonhighly compensated employees. The plan's ratio 
percentage is thus 16.67 percent ([400/9,600]/[100/400]=4.17%/
25%=0.1667). The plan's ratio percentage is below the unsafe harbor 
percentage and thus the classification is considered discriminatory.
    Example 6. The facts are the same as in Example 4, except that the 
plan benefits 500 nonhighly compensated employees. The plan's ratio 
percentage is thus 20.83 percent ([500/9,600]/[100/400]=5.21%/
25%=0.2083), above the unsafe harbor percentage (20 percent) and below 
the safe harbor percentage (23 percent). The Commissioner may determine 
that the classification is nondiscriminatory after considering all the 
facts and circumstances.

[T.D. 8363, 56 FR 47645, Sept. 19, 1991; 57 FR 10954, Mar. 31, 1992]

[[Page 747]]



Sec. 1.410(b)-5  Average benefit percentage test.

    (a) General rule. A plan satisfies the average benefit percentage 
test of this section for a plan year if and only if the average benefit 
percentage of the plan for the plan year is at least 70 percent. A plan 
is deemed to satisfy this requirement if it satisfies paragraph (f) of 
this section for the plan year.
    (b) Determination of average benefit percentage. The average benefit 
percentage of a plan for a plan year is the percentage determined by 
dividing the actual benefit percentage of the nonhighly compensated 
employees in plans in the testing group for the testing period that 
includes the plan year by the actual benefit percentage of the highly 
compensated employees in plans in the testing group for that testing 
period. See paragraph (d)(3)(ii) of this section for the definition of 
testing period.
    (c) Determination of actual benefit percentage. The actual benefit 
percentage of a group of employees for a testing period is the average 
of the employee benefit percentages, calculated separately with respect 
to each of the employees in the group for the testing period. All 
nonexcludable employees of the employer are taken into account for this 
purpose, even if they are not benefiting under any plan that is taken 
into account.
    (d) Determination of employee benefit percentages--(1) Overview. 
This paragraph (d) provides rules for determining employee benefit 
percentages. See paragraph (e) of this section for alternative methods 
for determining employee benefit percentages.
    (2) Employee contributions and employee-provided benefits 
disregarded. Only employer-provided contributions and benefits are taken 
into account in determining employee benefit percentages. Therefore, 
employee contributions (including both employee contributions allocated 
to separate accounts and employee contributions not allocated to 
separate accounts), and benefits derived from such contributions, are 
not taken into account in determining employee benefit percentages.
    (3) Plans and plan years taken into account--(i) Testing group. All 
plans included in the testing group under Sec. 1.410(b)-7(e)(1), and 
only those plans, are taken into account in determining an employee's 
employee benefit percentage.
    (ii) Testing period. An employee's employee benefit percentage is 
determined on the basis of plan years ending with or within the same 
calendar year. These plan years are referred to in this section as the 
relevant plan years or, in the aggregate, as the testing period.
    (4) Contributions or benefits basis. Employee benefit percentages 
may be determined on either a contributions or a benefits basis. 
Employee benefit percentages for any testing period must be determined 
on the same basis (contributions or benefits) for all plans in the 
testing group.
    (5) Determination of employee benefit percentage--(i) General rule. 
The employee benefit percentage for an employee for a testing period is 
the rate that would be determined for that employee for purposes of 
applying the general test for nondiscrimination in Sec. Sec. 
1.401(a)(4)-2, 1.401(a)(4)-3, 1.401(a)(4)-8 or 1.401(a)(4)-9, if all the 
plans in the testing group were aggregated for purposes of section 
410(b). Thus, if employee benefit percentages are determined on a 
contributions basis, each employee's employee benefit percentage is the 
aggregate normal allocation rate that would be determined for the 
employee under Sec. 1.401(a)(4)-9(b)(2)(ii)(A) (if the plans in the 
testing group include both defined benefit and defined contribution 
plans), the allocation rate that would be determined for the employee 
under Sec. 1.401(a)(4)-2(c)(2) (if the plans in the testing group 
include only defined contribution plans), or the equivalent normal 
allocation rate that would be determined for the employee under Sec. 
1.401(a)(4)-8(c)(2) (if the plans in the testing group include only 
defined benefit plans). Similarly, if employee benefit percentages are 
determined on a benefits basis, each employee's employee benefit 
percentage is the aggregate normal accrual rate that would be determined 
for the employee under Sec. 1.401(a)(4)-9(b)(2)(ii)(B), the normal 
accrual rate that would be determined for the employee under Sec. 
1.401(a)(4)-3(d), or the equivalent accrual rate that would be 
determined for the employee under Sec. 1.401(a)(4)-8(b)(2),

[[Page 748]]

depending on whether the plans in the testing group include both defined 
benefit and defined contribution plans, only defined benefit plans, or 
only defined contribution plans.
    (ii) Plans with differing plan years. If not all the plans in the 
testing group share the same plan year, Sec. 1.410(b)-7(d)(5) would 
ordinarily prohibit them from being aggregated for purposes of section 
410(b). In such a case, employee benefit percentages are determined by 
applying the rules of paragraph (d)(5)(i) of this section separately to 
each subset of plans in the testing group that share the same plan year 
(or the same accrual computation period) and aggregating the results for 
all plans in the testing group. Thus, an employee's employee benefit 
percentage is determined as the sum of these separate employee benefit 
percentages that are determined consistently for all the plans in the 
testing group (except for differences attributable solely to the 
differences in plan years).
    (iii) Options and consistency requirements. In determining employee 
benefit percentages under this paragraph (d)(5), any optional or 
alternative methods or rules available for determining rates in 
Sec. Sec. 1.401(a)(4)-2, 1.401(a)(4)-3, 1.401(a)(4)-8, or 1.401(a)(4)-
9, whichever is applicable, may be applied. Thus, for example, employee 
benefit percentages may generally be calculated using any of the 
alternative methods of determining average annual compensation or plan 
year compensation under Sec. 1.401(a)(4)-12, and using any underlying 
definition of compensation that satisfies section 414(s). Except as 
otherwise specifically permitted, the determination of employee benefit 
percentages must be made on a consistent basis for all employees and for 
all plans in the testing group as required by Sec. Sec. 1.401(a)(4)-
2(c)(2)(vi), 1.401(a)(4)-3(d)(2)(i), 1.401(a)(4)-8(b)(2)(iv), 
1.401(a)(4)-8(c)(2)(iv) or 1.401(a)(4)-9(b)(2)(iv).
    (6) Permitted disparity--(i) In general. Permitted disparity may be 
imputed in determining employee benefit percentages as provided in 
Sec. Sec. 1.401(a)(4)-2, 1.401(a)(4)-3, 1.401(a)(4)-8, or 1.401(a)(4)-
9, whichever is applicable. When separate employee benefit percentages 
are determined for individual plans under paragraph (e)(2) of this 
section (or for subsets of plans that have the same plan year as 
described in paragraph (d)(5)(ii) of this section), permitted disparity 
may be imputed for an employee only in one individual plan (or subset of 
plans) and may not be imputed for the same employee in another 
individual plan (or subset of plans). However, if the same average 
annual compensation or plan year compensation is used to determine 
employee benefit percentages in more than one plan, the employee's 
employee benefit percentages for those plans may be summed prior to 
imputing permitted disparity.
    (ii) Plans which may not use permitted disparity. Permitted 
disparity may be reflected in the determination of rates only to the 
extent that the plans for which rates are being determined are plans for 
which the permitted disparity of section 401(l) is available. Thus, for 
example, if a section 401(k) plan is included in the testing group and 
permitted disparity is imputed under Sec. 1.401(a)(4)-2(c)(iv), then 
employee benefit percentages are determined by first calculating an 
adjusted allocation rate (within the meaning of Sec. 1.401(a)(4)-
7(b)(1)) without regard to the amount of allocations under the section 
401(k) plan and adding to it the allocation rate for the section 401(k) 
plan. See Sec. 1.401(l)-1(a)(4) for a list of types of plans for which 
permitted disparity is not available.
    (7) Requirements for certain plans providing early retirement 
benefits--(i) General rule. If any defined benefit plan in the testing 
group provides for early retirement benefits in addition to normal 
retirement benefits to any highly compensated employee, and the average 
actuarial reduction for any one of these benefits commencing in the five 
years prior to the plan's normal retirement age is less than four 
percent per year, then the aggregate most valuable allocation rate, 
equivalent most valuable allocation rate, aggregate most valuable 
accrual rate, or most valuable accrual rate must be substituted for the 
related normal rates in paragraph (d)(5) of this section.

[[Page 749]]

    (ii) Exception. Paragraph (d)(7)(i) of this section does not apply 
if early retirement benefits with average actuarial reductions described 
in that paragraph are currently available, within the meaning of Sec. 
1.401(a)(4)-4(b), under plans in the testing group to a percentage of 
nonhighly compensated employees that is at least 70 percent of the 
percentage of highly compensated employees to whom these benefits are 
currently available.
    (e) Additional optional rules--(1) Overview. This paragraph (e) 
contains various alternative methods for determining employee benefit 
percentages for a testing period.
    (2) Determination of employee benefit percentages as the sum of 
separately determined rates--(i) In general. Employee benefit 
percentages may be determined as the sum of separately determined 
employee benefit percentages for each of the plans in the testing group 
that are aggregated under paragraphs (d)(5) (i) or (ii) of this section, 
provided that these employee benefit percentages are determined on a 
consistent basis for all of these plans pursuant to paragraph 
(d)(5)(iii) of this section.
    (ii) Exception from consistency requirement. The consistency 
requirement of paragraph (e)(2)(i) of this section is not violated 
merely because employee benefit percentages are not determined in a 
consistent manner for all of the plans in the testing group and the 
inconsistencies in determination of rates among plans are described in 
paragraph (e)(2)(iii) of this section. The exception in this paragraph 
(e)(2)(ii) applies only if it is reasonable to believe that the 
inconsistencies do not result in an average benefit percentage that is 
significantly higher than the average benefit percentage that would be 
determined had employee benefit percentages been determined on a 
consistent basis pursuant to paragraph (d)(5)(iii) of this section.
    (iii) Permitted inconsistencies. The following inconsistencies 
between plans are permitted under this paragraph (e)(2)--
    (A) Use of different underlying definitions of section 414(s) 
compensation in the determination of rates;
    (B) Use of different definitions of average annual compensation;
    (C) Use of different testing ages;
    (D) Use of different fresh-start dates;
    (E) Use of different actuarial assumptions for normalization; or
    (F) Disregard of actuarial increases after normal retirement age and 
QPSA charges without regard to any requirement for uniformity in the 
actuarial increases or QPSA charges.
    (3) Determination of employee benefit percentages without regard to 
plans of another type--(i) General rule. Employee benefit percentages 
may be determined under plans of one type (i.e., defined benefit plans 
or defined contribution plans) by treating all plans of the other type 
(i.e., defined contribution plans or defined benefit plans, 
respectively) as if they were not part of the testing group, using the 
method provided in this paragraph (e)(3). If this method is used to 
determine whether a defined contribution plan satisfies the average 
benefit percentage test, employee benefit percentages under all defined 
contribution plans in the testing group must be determined on a 
contributions basis, and benefits under any defined benefit plans may 
not be included in the employee benefit percentage. Similarly, if this 
method is used to determine whether a defined benefit plan satisfies the 
average benefit percentage test, employee benefit percentages under all 
defined benefit plans in the testing group must be determined on a 
benefits basis, and allocations under any defined contribution plans may 
not be included in the employee benefit percentage.
    (ii) Restriction on use of separate testing group determination 
method. A plan does not satisfy the average benefit percentage test 
using the method provided in this paragraph (e)(3) unless each of the 
plans in the testing group of the other type (i.e., defined benefit plan 
or defined contribution plan) than the plan being tested satisfies the 
average benefit test of Sec. 1.410(b)-2(b)(3) using the method in this 
paragraph (e)(3) or satisfies the ratio percentage test of Sec. 
1.410(b)-2(b)(2).
    (iii) Treatment of permitted disparity. Although under the general 
rule of this paragraph (e)(3) plans of another type are disregarded in 
determining employee benefit percentages, the permitted disparity used 
by those plans

[[Page 750]]

(including any permitted disparity that is used by those plans to 
satisfy Sec. 1.401(a)(4)-1(b)(2)) is nonetheless taken into account in 
determining the extent to which permitted disparity may be used in 
determining employee benefit percentages.
    (iv) Example. The following example illustrates the rules of this 
paragraph (e)(3):

    Example. Employer A maintains two defined benefit plans, neither of 
which covers a group of employees that satisfies the ratio percentage 
test of Sec. 1.410(b)-2(b)(2), and a profit-sharing plan and a section 
401(k) plan, each of which benefits a group of employees that satisfies 
the ratio percentage test of Sec. 1.410(b)-2(b)(2). The defined benefit 
plans will satisfy the average benefit percentage test if the actual 
benefit percentage of all nonexcludable nonhighly compensated employees, 
computed on a benefits basis without regard to contributions under the 
profit-sharing plan or the section 401(k) plan, is at least 70 percent 
of the actual benefit percentage of all nonexcludable highly compensated 
employees, computed on a benefits basis without regard to contributions 
under the profit-sharing plan or the section 401(k) plan.

    (4) Simplified method for determining employee benefit percentages 
for certain defined benefit plans--(i) In general. An employee's 
employee benefit percentage with respect to a plan may be determined 
under the simplified method of paragraph (e)(4)(ii) of this section, 
provided the following conditions are satisfied:
    (A) The only plans included in the testing group are defined benefit 
plans, and employee benefit percentages under these plans are determined 
on a benefits basis.
    (B) Employee benefit percentages under the plans in the testing 
group are not required to be determined by taking into account early 
retirement benefits under paragraph (d)(7) of this section.
    (C) The plan is a safe harbor defined benefit plan described in 
Sec. 1.401(a)(4)-3(b).
    (ii) Simplified method--(A) Section 401(l) plans. Under the 
simplified method of this paragraph (e)(4)(ii), an employee's employee 
benefit percentage with respect to a section 401(l) plan described in 
Sec. 1.401(a)(4)-3(b)(3) (i.e., a unit credit plan) may be deemed equal 
to the employee's excess benefit percentage or gross benefit percentage 
(as defined in Sec. 1.401(l)-1(c) (14) or (18), respectively), 
whichever is applicable under the plan's benefit formula in the plan 
year. In the case of a section 401(l) plan described in Sec. 
1.401(a)(4)-3(b)(4) (i.e., a fractional accrual plan), an employee's 
employee benefit percentage with respect to that plan may be deemed 
equal to the rate at which the excess or gross benefit, whichever is 
applicable, accrues for the employee in the plan year, taking into 
account the plan's benefit formula and the employee's projected service 
at normal retirement age. The use of this simplified method will be 
treated as an imputation of permitted disparity. See paragraph (d)(6) of 
this section for a restriction on multiple use of permitted disparity.
    (B) Other plans. Under the simplified method of this paragraph 
(e)(4)(ii), an employee's employee benefit percentage with respect to a 
plan described in Sec. 1.401(a)(4)-3(b)(3) that is not a section 401(l) 
plan and that is not imputing permitted disparity may be deemed equal to 
the employee's benefit rate in the plan year under the plan's benefit 
formula. In the case of a plan described in Sec. 1.401(a)(4)-3(b)(4) 
that is not a section 401(l) plan and that is not imputing permitted 
disparity, an employee's employee benefit percentage with respect to 
that plan may be deemed equal to the rate at which the benefit accrues 
for the employee in the plan year, taking into account the plan's 
benefit formula and an employee's projected service at normal retirement 
age.
    (5) Three-year averaging period. An employee's employee benefit 
percentage may be determined for a testing period as the average of the 
employee's employee benefit percentages determined separately for the 
testing period and for the immediately preceding one or two testing 
periods (referred to in this section as an averaging period). Employee 
benefit percentages of a particular employee that are averaged together 
within an averaging period must be determined on a consistent basis for 
all testing periods within the averaging period.
    (6) Alternative methods of determining compensation. Employee 
benefit percentages may be determined on the

[[Page 751]]

basis of any definition of compensation that satisfies Sec. 1.414(s)-
1(d) (without regard to whether the definition satisfies Sec. 1.414(s)-
1(d)(3)), provided that the same definition is used for all employees 
and it is reasonable to believe that the definition does not result in 
an average benefit percentage that is significantly higher than the 
average benefit percentage that would be determined had employee benefit 
percentages been determined using a definition of compensation that also 
satisfies Sec. 1.414(s)-1(d)(3).
    (f) Special rule for certain collectively bargained plans. A plan 
(as determined without regard to the mandatory disaggregation rule of 
Sec. 1.410(b)-7(c)(5)) that benefits both collectively bargained 
employees and noncollectively bargained employees is deemed to satisfy 
the average benefit percentage test of this section if--
    (1) The provisions of the plan applicable to each employee in the 
plan are identical to the provisions of the plan applicable to every 
other employee in the plan, including the plan benefit or allocation 
formula, any optional forms of benefit, any ancillary benefit, and any 
other right or feature under the plan, and
    (2) The plan would satisfy the ratio percentage test of Sec. 
1.410(b)-2(b)(2), if Sec. Sec. 1.410(b)-6(d) and 1.410(b)-7(c)(5) (the 
excludable employee and mandatory disaggregation rules for collectively 
bargained and noncollectively bargained employees) did not apply.

[T.D. 8363, 56 FR 47646, Sept. 19, 1991; 57 FR 10817, 10954, Mar. 31, 
1992, as amended by T.D. 8487, 58 FR 46840, Sept. 3, 1993]



Sec. 1.410(b)-6  Excludable employees.

    (a) Employees--(1) In general. For purposes of applying section 
410(b) with respect to employees, all employees of the employer, other 
than the excludable employees described in paragraphs (b) through (i) of 
this section, are taken into account. Excludable employees are not taken 
into account with respect to a plan even if they are benefiting under 
the plan, except as otherwise provided in paragraph (b) of this section.
    (2) Rules of application. Except as specifically provided otherwise, 
excludable employees are determined separately with respect to each plan 
for purposes of testing that plan under section 410(b). Thus, in 
determining whether a particular plan satisfies the ratio percentage 
test of Sec. 1.410(b)-2(b)(2), paragraphs (b) through (i) of this 
section are applied solely with reference to that plan. Similarly, in 
determining whether two or more plans that are permissively aggregated 
and treated as a single plan under Sec. 1.410(b)-7(d) satisfy the ratio 
percentage test of Sec. 1.410(b)-2(b)(2), paragraphs (b) through (i) of 
this section are applied solely with reference to the deemed single 
plan. In determining whether a plan satisfies the average benefit 
percentage test of Sec. 1.410(b)-5, the rules of this section are 
applied by treating all plans in the testing group as a single plan.
    (b) Minimum age and service exclusions--(1) In general. If a plan 
applies minimum age and service eligibility conditions permissible under 
section 410(a)(1) and excludes all employees who do not meet those 
conditions from benefiting under the plan, then all employees who fail 
to satisfy those conditions are excludable employees with respect to 
that plan. An employee is treated as meeting the age and service 
requirements on the date that any employee with the same age and service 
(including service permitted to be taken into account for purposes of 
nondiscrimination testing under Sec. 1.401(a)(4)-11(d)(3)) would be 
eligible to commence participation in the plan, as provided in section 
410(b)(4)(C).
    (2) Multiple age and service conditions. If a plan, including a plan 
for which an employer chooses the treatment under paragraph (b)(3) of 
this section, has two or more different sets of minimum age and service 
eligibility conditions, those employees who fail to satisfy all of the 
different sets of age and service conditions are excludable employees 
with respect to the plan. Except as provided in paragraph (b)(3) of this 
section, an employee who satisfies any one of the different sets of 
conditions is not an excludable employee with respect to the plan. 
Differences in the manner in which service is credited (e.g., hours of 
service calculated in accordance with 29 CFR 2530.200b-2 for hourly 
employees

[[Page 752]]

and elapsed time calculated in accordance with Sec. 1.410(a)-7 for 
salaried employees) for purposes of applying a service condition are not 
taken into account in determining whether multiple age and service 
eligibility conditions exist.
    (3) Plans benefiting certain otherwise excludable employees--(i) In 
general. An employer may treat a plan benefiting otherwise excludable 
employees as two separate plans, one for the otherwise excludable 
employees and one for the other employees benefiting under the plan. See 
Sec. 1.410(b)-7(c)(3) regarding permissive disaggregation of plans 
benefiting otherwise excludable employees. The effect of this rule is 
that employees who would be excludable under paragraph (b)(1) of this 
section (applied without regard to section 410(a)(1)(B)) but for the 
fact that the plan does not apply the greatest permissible minimum age 
and service conditions may be treated as excludable employees with 
respect to the plan. This treatment is available only if the plan 
satisfies section 410(b) and Sec. 1.410(b)-2 with respect to these 
otherwise excludable employees in the manner described in paragraph 
(b)(3)(ii) of this section.
    (ii) Testing portion of plan benefiting otherwise excludable 
employees. In determining whether the plan that benefits employees who 
would otherwise be excludable under paragraph (b)(1) of this section 
(applied without regard to section 410(a)(1)(B)) satisfies section 
410(b) and Sec. 1.410(b)-2, employees who have satisfied the greatest 
permissible minimum age and service conditions with respect to the plan 
are excludable employees. In addition, if the plan being tested applies 
minimum age and service conditions and those conditions are less than 
the maximum permissible minimum age and service conditions, employees 
who have not satisfied the lower minimum age and service conditions 
actually provided for in the plan are excludable employees. Thus, for 
example, if the plan requires attainment of age 18 and 3 months of 
service, employees who have not attained age 18 or 3 months of service 
with the employer are excludable employees.
    (4) Examples. The following examples illustrate the minimum age and 
service condition rules of this paragraph (b). In each example, the 
employer is not treated as operating qualified separate lines of 
business under section 414(r).

    Example 1. An employer maintains Plan A for hourly employees and 
Plan B for salaried employees. Plan A has no minimum age or service 
condition. Plan B has no minimum age condition and requires 1 year of 
service. The employer treats Plans A and B as a single plan for purposes 
of section 410(b). Because Plan A imposes no minimum age or service 
condition, all employees of the employer automatically satisfy the 
minimum age and service conditions of Plan A. Therefore, no employees 
are excludable under this paragraph (b) in testing Plans A and B for 
purposes of section 410(b).
    Example 2. An employer maintains three plans. Plan C benefits 
employees in Division C who satisfy the plan's minimum age and service 
condition of age 21 and 1 year of service. Plan D benefits employees in 
Division D who satisfy the plan's minimum age and service condition of 
age 18 and 1 year of service. Plan E benefits employees in Division E 
who satisfy the plan's minimum age and service condition of age 21 and 6 
months of service. The employer treats Plans D and E as a single plan 
for purposes of section 410(b). In testing Plan C under the ratio 
percentage test or the nondiscriminatory classification test of section 
410(b), employees who are not at least age 21 or who do not have at 
least 1 year of service are excludable employees under paragraph (b)(1) 
of this section. In testing Plans D and E, employees who do not satisfy 
the age and service requirements of either of the two plans are 
excludable employees under paragraph (b)(2) of this section. Thus, an 
employee is excludable with respect to Plans D and E only if the 
employee is not at least age 18 with at least 1 year of service or is 
not at least age 21 with at least 6 months of service. Thus, an employee 
who is 19 years old and has 11 months of service is excludable. 
Similarly, an employee who is 17 years old and has performed 2 years of 
service is also excludable.
    Example 3. An employer maintains three plans. Plan F benefits all 
employees in Division F (the plan does not apply any minimum age or 
service condition). Plan G benefits employees in Division G who satisfy 
the plan's minimum age and service condition of age 18 and 1 year of 
service. Plan H benefits employees in Division H who satisfy the plan's 
minimum age and service condition of age 21 and 6 months of service. In 
testing the employer's plans under the average benefit percentage test 
provided in Sec. 1.410(b)-5, Plans F, G, and H are treated as a single 
plan and, as such, use the lowest minimum age and service condition 
under the rule of paragraph (b)(2) of this section. Therefore, because 
Plan

[[Page 753]]

F does not apply any minimum age or service condition, no employee is 
excludable under this paragraph (b).
    Example 4. An employer maintains Plan J, which does not apply any 
minimum age or service conditions. Plan J benefits all employees in 
Division 1 but does not benefit employees in Division 2. Although Plan J 
has no minimum age or service condition, the employer wants to exclude 
employees whose age and service is below the permissible minimums 
provided in section 410(b)(1)(A). The employer has 110 employees who 
either do not have 1 year of service or are not at least age 21. Of 
these 110 employees, 10 are highly compensated employees and 100 are 
nonhighly compensated employees. Five of these highly compensated 
employees, or 50 percent, work in Division 1 and thus benefit under Plan 
J. Thirty-five of these nonhighly compensated employees, or 35 percent, 
work in Division 1 and thus benefit under Plan J. Plan J satisfies the 
ratio percentage test of section 410(b) with respect to employees who do 
not satisfy the greatest permissible minimum age and service requirement 
because the ratio percentage of that group of employees is 70 percent. 
Thus, in determining whether or not Plan J satisfies section 410(b), the 
110 employees may be treated as excludable employees in accordance with 
paragraph (b)(3)(i) of this section.

    (c) Certain nonresident aliens--(1) General rule. An employee who is 
a nonresident alien (within the meaning of section 7701(b)(1)(B)) and 
who receives no earned income (within the meaning of section 911(d)(2)) 
from the employer that constitutes income from sources within the United 
States (within the meaning of section 861(a)(3)) is treated as an 
excludable employee.
    (2) Special treaty rule. In addition, an employee who is a 
nonresident alien (within the meaning of section 7701(b)(1)(B)) and who 
does receive earned income (within the meaning of section 911(d)(2)) 
from the employer that constitutes income from sources within the United 
States (within the meaning of section 861(a)(3)) is permitted to be 
excluded, if all of the employee's earned income from the employer from 
sources within the United States is exempt from United States income tax 
under an applicable income tax convention. This paragraph (c)(2) applies 
only if all employees described in the preceding sentence are so 
excluded.
    (d) Collectively bargained employees--(1) General rule. A 
collectively bargained employee is an excludable employee with respect 
to a plan that benefits solely noncollectively bargained employees. If a 
plan (within the meaning of Sec. 1.410(b)-7(b)) benefits both 
collectively bargained employees and noncollectively bargained employees 
for a plan year, Sec. 1.410(b)-7(c)(4) provides that the portion of the 
plan that benefits the collectively bargained employees is treated as a 
separate plan from the portion of the plan that benefits the 
noncollectively bargained employees. Thus, a collectively bargained 
employee is always an excludable employee with respect to the 
mandatorily disaggregated portion of any plan that benefits 
noncollectively bargained employees.
    (2) Definition of collectively bargained employee--(i) In general. A 
collectively bargained employee is an employee who is included in a unit 
of employees covered by an agreement that the Secretary of Labor finds 
to be a collective bargaining agreement between employee representatives 
and one or more employers, provided that there is evidence that 
retirement benefits were the subject of good faith bargaining between 
employee representatives and the employer or employers. An employee is a 
collectively bargained employee regardless of whether the employee 
benefits under any plan of the employer. See section 7701(a)(46) and 
Sec. 301.7701-17T of this chapter for additional requirements 
applicable to the collective bargaining agreement. An employee who 
performs hours of service during the plan year as both a collectively 
bargained employee and a noncollectively bargained employee is treated 
as a collectively bargained employee with respect to the hours of 
service performed as a collectively bargained employee and a 
noncollectively bargained employee with respect to the hours of service 
performed as a noncollectively bargained employee. See Sec. 1.410(b)-
7(c) for disaggregation rules for plans benefiting collectively 
bargained and noncollectively bargained employees.
    (ii) Special rules for certain employees in multiemployer plans--(A) 
In general. For purposes of this paragraph (d), in testing the 
disaggregated portion of a

[[Page 754]]

multiemployer plan benefiting noncollectively bargained employees, a 
noncollectively bargained employee who benefits under the plan may be 
treated as a collectively bargained employee with respect to all of the 
employee's hours of service under the rules of paragraphs (d)(2)(ii) (B) 
through (E) of this section, if the employee is or was a member of a 
unit of employees covered by a collective bargaining agreement and that 
agreement or a successor agreement provides for the employee to benefit 
under the plan in the current plan year. For this purpose, provisions of 
a participation agreement or similar document are taken into account in 
determining whether a collective bargaining agreement provides for an 
employee to benefit under a multiemployer plan.
    (B) Employees who were collectively bargained employees during a 
portion of the current plan year. An employee described in paragraph 
(d)(2)(ii)(A) of this section who performs services for one or more 
employers that are parties to the collective bargaining agreement, for 
the plan, or for the employee representative both as a collectively 
bargained employee and as a noncollectively bargained employee during a 
plan year may be treated as a collectively bargained employee for the 
plan year, provided that at least half of the employee's hours of 
service during the plan year are performed as a collectively bargained 
employee.
    (C) Employees who were collectively bargained employees during the 
collective bargaining agreement. An employee described in paragraph 
(d)(2)(ii)(A) of this section who was a collectively bargained employee 
with respect to all of the employee's hours of service during a plan 
year (including employees who are treated as collectively bargained 
employees with respect to all of their hours of service during a plan 
year under paragraph (d)(2)(ii) (B) or (E) of this section) may be 
treated as a collectively bargained employee with respect to all of the 
employee's hours of service for the duration of the collective 
bargaining agreement applicable for such plan year or, if later, until 
the end of the following plan year. For this purpose, a collective 
bargaining agreement is applicable for a plan year if it provided for 
the employee to benefit in the plan and was effective for any portion of 
that plan year. This paragraph (d)(2)(ii)(C) does not apply unless the 
terms of the plan providing for benefit accruals treat the employee in a 
manner that is generally no more favorable than similarly-situated 
employees who are collectively bargained employees.
    (D) Employees who previously were collectively bargained employees. 
An employee who was treated as a collectively bargained employee 
pursuant to paragraph (d)(2)(ii)(C) of this section may be treated as a 
collectively bargained employee with respect to all of the employee's 
hours of service after the end of the period described in paragraph 
(d)(2)(ii)(C) of this section, provided that the employee is performing 
services for one or more employers that are parties to the collective 
bargaining agreement, for the plan, or for the employee representative. 
This paragraph (d)(2)(ii)(D) does not apply unless the terms of the plan 
providing for benefit accruals treat the employee in a manner that is 
generally no more favorable than similarly-situated employees who are 
collectively bargained employees, and no more than five percent of the 
employees covered under the multiemployer plan are noncollectively 
bargained employees (determined without regard to this paragraph 
(d)(2)(ii)(D)). In determining whether more than five percent of the 
employees covered under the multiemployer plan are noncollectively 
bargained employees, those employees who are described in paragraphs 
(d)(2)(ii) (B) and (C) of this section are treated as collectively 
bargained employees.
    (E) Transition rule. For a plan year beginning before the applicable 
effective date of these regulations as set forth in Sec. 1.410(b)-10 
(b) or (d), any employee described in paragraph (d)(2)(ii)(A) of this 
section may be treated as a collectively bargained employee with respect 
to all of the employee's hours of service for that plan year.
    (F) Consistency requirement. The rules in paragraphs (d)(2) (i) and 
(ii) of this section must be applied to all employees on a reasonable 
and consistent basis for the plan year.

[[Page 755]]

    (iii) Covered by a collective bargaining agreement--(A) General 
rule. For purposes of paragraph (d)(2)(i) of this section, an employee 
is included in a unit of employees covered by a collective bargaining 
agreement if and only if the employee is represented by a bona fide 
employee representative that is a party to the collective bargaining 
agreement under which the plan is maintained. Thus, for example, an 
employee of either a plan or the employee representative that is a party 
to the collective bargaining agreement under which the plan is 
maintained is not included in a unit of employees covered by the 
collective bargaining agreement under which the plan is maintained 
merely because the employee is covered under the plan pursuant to an 
agreement entered into by the plan or employee representative on behalf 
of the employee (other than in the capacity of an employee 
representative with respect to the employee). This is the case even if 
all of such employees benefiting under the plan constitute only a de 
minimis percentage of the total employees benefiting under the plan.
    (B) Plans covering professional employees--(1) In general. An 
employee is not considered included in a unit of employees covered by a 
collective bargaining agreement for a plan year for purposes of 
paragraph (d)(2)(iii)(A) of this section if, for the plan year, more 
than 2 percent of the employees who are covered pursuant to the 
agreement are professionals. This rule applies to all employees under 
the agreement, nonprofessionals as well as professionals. Thus, no 
employees covered by such an agreement are excludable employees with 
respect to employees who are not covered by a collective bargaining 
agreement.
    (2) Multiple collective bargaining agreements. This paragraph 
(d)(2)(iii)(B) is applied separately with respect to each collective 
bargaining agreement. Thus, for example, if a plan benefits two groups 
of employees, one included in a unit of employees covered by collective 
bargaining agreement X, more than 2 percent of whom are professionals, 
and another included in a unit of employees covered by collective 
bargaining agreement Y, none of whom are professionals, the group 
covered by agreement X is not considered covered by a collective 
bargaining agreement and the group covered by agreement Y is considered 
covered by a collective bargaining agreement.
    (3) Application of minimum coverage tests. If a plan covers more 
than 2 percent professional employees, no employees in the plan are 
treated as covered by a collective bargaining agreement. A plan that 
covers more than 2 percent professional employees must satisfy section 
410(b) without regard to section 413(b) and the special rule in Sec. 
1.410(b)-2(b)(7) of this section (regarding collectively bargained 
plans). In such cases, all nonexcludable employees must be taken into 
account. For this purpose, employees included in other collective 
bargaining units are excludable employees. However, the employees who 
are not covered by a collective bargaining agreement and the employees 
who are covered by an agreement that has more than 2 percent 
professionals are not excludable employees.
    (iv) Examples. The following examples illustrate the collective 
bargaining unit rules of this section.

    Example 1. An employer has 700 collectively bargained employees 
(none of whom is a professional employee) and 300 noncollectively 
bargained employees (200 of whom are highly compensated employees). For 
purposes of applying the ratio percentage test of Sec. 1.410(b)-2(b)(2) 
to Plan X, which benefits only the 300 noncollectively bargained 
employees, the 700 collectively bargained employees are treated as 
excludable employees pursuant to paragraph (d) of this section.
    Example 2. (i) An employer has 1,500 employees in the following 
categories:

------------------------------------------------------------------------
                                  Noncollectively  Collectively
                                     bargained       bargained    Total
                                     employees       employees
------------------------------------------------------------------------
Highly compensated employees....            100             100      200
Nonhighly compensated employees.            900             400    1,300
                                 ---------------------------------------
      Total.....................          1,000             500    1,500
------------------------------------------------------------------------

    The employer maintains Plan Y, which benefits 1,100 employees, 
including all of the noncollectively bargained employees (except for 100 
nonhighly compensated employees who are noncollectively bargained 
employees), and 200 of the collectively bargained

[[Page 756]]

employees (including the 100 highly compensated employees who are 
collectively bargained employees). There are no professional employees 
covered by the collective bargaining agreement. In accordance with Sec. 
1.410(b)-7(c)(4), the employer must apply the ratio percentage test of 
Sec. 1.410(b)-2(b)(2) to Plan Y as if the plan were two separate plans, 
one benefiting the noncollectively bargained employees and the other 
benefiting the collectively bargained employees.
    (ii) In testing the portion of Plan Y that benefits the 
noncollectively bargained employees, the collectively bargained 
employees are excludable employees. That portion's ratio percentage is 
88.89 percent ([800/900] /[100/100] = 88.89%/100% =0.8889), and thus it 
satisfies the ratio percentage test. The portion of Plan Y that benefits 
collectively bargained employees automatically satisfies section 410(b) 
under the special rule in Sec. 1.410(b)-2(b)(7).

    (e) Employees of qualified separate lines of business. If an 
employer is treated as operating qualified separate lines of business 
for purposes of section 410(b) in accordance with Sec. 1.414(r)-1 (b), 
in testing a plan that benefits employees of one qualified separate line 
of business, the employees of the other qualified separate lines of 
business of the employer are treated as excludable employees. The rule 
in this paragraph (e) does not apply for purposes of satisfying the 
nondiscriminatory classification requirement of section 410(b)(5)(B). 
See Sec. Sec. 1.414(r)-1(c)(2) and 1.414(r)-8 (separate application of 
section 410(b) to the employees of a qualified separate line of 
business). In addition, the rule in this paragraph (e) does not apply to 
a plan that is tested under the special rule for employer-wide plans in 
Sec. 1.414(r)-1(c) (2) (ii) for a plan year.
    (f) Certain terminating employees--(1) In general. An employee may 
be treated as an excludable employee for a plan year with respect to a 
particular plan if--
    (i) The employee does not benefit under the plan for the plan year,
    (ii) The employee is eligible to participate in the plan,
    (iii) The plan has a minimum period of service requirement or a 
requirement that an employee be employed on the last day of the plan 
year (last-day requirement) in order for an employee to accrue a benefit 
or receive an allocation for the plan year,
    (iv) The employee fails to accrue a benefit or receive an allocation 
under the plan solely because of the failure to satisfy the minimum 
period of service or last-day requirement,
    (v) The employee terminates employment during the plan year with no 
more than 500 hours of service, and the employee is not an employee as 
of the last day of the plan year (for purposes of this paragraph 
(f)(1)(v), a plan that uses the elapsed time method of determining years 
of service may use either 91 consecutive calendar days or 3 consecutive 
calendar months instead of 500 hours of service, provided it uses the 
same convention for all employees during a plan year), and
    (vi) If this paragraph (f) is applied with respect to any employee 
with respect to a plan for a plan year, it is applied with respect to 
all employees with respect to the plan for the plan year.
    (2) Hours of service. For purposes of this paragraph (f), the term 
``hours of service'' has the same meaning as provided for such term by 
29 CFR 2530.200b-2 under the general method of crediting service for the 
employee. If one of the equivalencies set forth in 29 CFR 2530.200b-3 is 
used for crediting service under the plan, the 500-hour requirement must 
be adjusted accordingly.
    (3) Examples. The following examples illustrate the provision of 
this paragraph (f).

    Example 1. An employer has 35 employees who are eligible to 
participate under a defined contribution plan. The plan provides that an 
employee will not receive an allocation of contributions for a plan year 
unless the employee is employed by the employer on the last day of the 
plan year. Only 30 employees are employed by the employer on the last 
day of the plan year. Two of the five employees who terminated 
employment before the last day of the plan year had 500 or fewer hours 
of service during the plan year, and the remaining three had more than 
500 hours of service during the year. Of the five employees who were no 
longer employed on the last day of the plan year, the two with 500 hours 
of service or less during the plan year are treated as excludable 
employees for purposes of section 410(b), and the remaining three who 
had over 500 hours of service during the plan year are taken into 
account in testing the plan under section 410(b) but are treated as not 
benefiting under the plan.

[[Page 757]]

    Example 2. An employer has 30 employees who are eligible to 
participate under a defined contribution plan. The plan requires 1,000 
hours of service to receive an allocation of contributions or 
forfeitures. Ten employees do not receive an allocation because of their 
failure to complete 1,000 hours of service. Three of the 10 employees 
who failed to satisfy the minimum service requirement completed 500 or 
fewer hours of service and terminated their employment. Two of the 
employees completed more than 500, but fewer than 1,000 hours of service 
and terminated their employment. The remaining five employees did not 
terminate employment. Under the rule in paragraph (f) of this section, 
the three terminated employees who completed 500 or fewer hours of 
service are treated as excludable employees for the portion of the plan 
year they are employed. The other seven employees who do not receive an 
allocation are taken into account in testing the plan under section 
410(b) but are treated as not benefiting under the plan.
    Example 3. An employer maintains two plans, Plan A for salaried 
employees and Plan B for hourly employees. Of the 100 salaried 
employees, two do not receive an allocation under Plan A for the plan 
year because they terminate employment before completing 500 hours of 
service. Of the 300 hourly employees, 50 do not receive an allocation 
under Plan B for the plan year because they terminate employment before 
completing 500 hours. In applying section 410(b) to Plan A, the two 
employees who did not receive an allocation under Plan A are excludable 
employees, but the 50 who did not receive an allocation under Plan B are 
not excludable employees, because they were not eligible to participate 
under Plan A.

    (g) Employees of certain governmental or tax-exempt entities--(1) 
Plans covered. For purposes of testing either a section 401(k) plan, or 
a section 401(m) plan that is provided under the same general 
arrangement as a section 401(k) plan, an employer may treat as 
excludable those employees described in paragraphs (g)(2) and (3) of 
this section.
    (2) Employees of governmental entities. Employees of governmental 
entities who are precluded from being eligible employees under a section 
401(k) plan by reason of section 401(k)(4)(B)(ii) may be treated as 
excludable employees if more than 95 percent of the employees of the 
employer who are not precluded from being eligible employees by reason 
of section 401(k)(4)(B)(ii) benefit under the plan for the year.
    (3) Employees of tax-exempt entities. Employees of an organization 
described in section 403(b)(1)(A)(i) who are eligible to make salary 
reduction contributions under section 403(b) may be treated as 
excludable with respect to a section 401(k) plan, or a section 401(m) 
plan that is provided under the same general arrangement as a section 
401(k) plan, if--
    (i) No employee of an organization described in section 
403(b)(1)(A)(i) is eligible to participate in such section 401(k) plan 
or section 401(m) plan; and
    (ii) At least 95 percent of the employees who are neither employees 
of an organization described in section 403(b)(1)(A)(i) nor employees of 
a governmental entity who are precluded from being eligible employees 
under a section 401(k) plan by reason of section 401(k)(4)(B)(ii) are 
eligible to participate in such section 401(k) plan or section 401(m) 
plan.
    (h) Former employees--(1) In general. For purposes of applying 
section 410(b) with respect to former employees, all former employees of 
the employer are taken into account, except that the employer may treat 
a former employee described in paragraph (h)(2) or (h)(3) of this 
section as an excludable former employee. If either (or both) of the 
former employee exclusion rules under paragraphs (h)(2) and (h)(3) of 
this section is applied, it must be applied to all former employees for 
the plan year on a consistent basis.
    (2) Employees terminated before a specified date. The employer may 
treat a former employee as excludable if--
    (i) The former employee became a former employee either prior to 
January 1, 1984, or prior to the tenth calendar year preceding the 
calendar year in which the current plan year begins, and
    (ii) The former employee became a former employee in a calendar year 
that precedes the earliest calendar year in which any former employee 
who benefits under the plan in the current plan year became a former 
employee.
    (3) Previously excludable employees. The employer may treat a former 
employee as excludable if the former employee was an excludable employee 
(or would have been an excludable employee if these regulations had been 
in effect) under the rules of paragraphs (b)

[[Page 758]]

through (g) of this section during the plan year in which the former 
employee became a former employee. If the employer treats a former 
employee as excludable pursuant to this paragraph (h)(3), the former 
employee is not taken into account with respect to a plan even if the 
former employee is benefiting under the plan.
    (i) Former employees treated as employees. An employer may treat as 
excludable employees all formerly nonhighly compensated employees who 
are treated as employees of the employer under Sec. 1.410(b)-9 solely 
because they have increases in accrued benefits under a defined benefit 
plan that are based on ongoing service or compensation credits 
(including imputed service or compensation) after they cease to perform 
services for the employer.

[T.D. 8363, 56 FR 47652, Sept. 19, 1991, as amended by T.D. 8376, 56 FR 
63433, Dec. 4, 1991; T.D. 8363, 57 FR 10817, Mar. 31, 1992; T.D. 8487, 
58 FR 46842, Sept. 3, 1993; T.D. 8487, 59 FR 16984, Apr. 11, 1994; T.D. 
8548, 59 FR 32914, June 27, 1994; T.D. 9275, 71 FR 41359, July 21, 2006]



Sec. 1.410(b)-7  Definition of plan and rules governing plan 
disaggregation and aggregation.

    (a) In general. This section provides a definition of ``plan.'' 
First, this section sets forth a definition of plan within the meaning 
of section 401(a) or 403(a). Then certain mandatory disaggregation and 
permissive aggregation rules are applied. The result is the definition 
of plan that applies for purposes of sections 410(b) and 401(a)(4). 
Thus, in general, the term ``plan'' as used in this section initially 
refers to a plan described in section 414(l) and to an annuity plan 
described in section 403(a), and the term ``plan'' as used in other 
sections under these regulations means the plan determined after 
application of this section. Paragraph (b) of this section provides that 
each single plan under section 414(l) is treated as a single plan for 
purposes of section 410(b). Paragraph (c) of this section describes the 
rules for certain plans that must be treated as comprising two or more 
separate plans, each of which is a single plan subject to section 
410(b). Paragraph (d) of this section provides a rule permitting an 
employer to aggregate certain separate plans to form a single plan for 
purposes of section 410(b). Paragraph (e) of this section provides rules 
for determining the testing group of plans taken into account in 
determining whether a plan satisfies the average benefit percentage test 
of Sec. 1.410(b)-5.
    (b) Separate asset pools are separate plans. Each single plan within 
the meaning of section 414(l) is a separate plan for purposes of section 
410(b). See Sec. 1.414(l)-1(b). For example, if only a portion of the 
assets under a defined benefit plan is available, on an ongoing basis, 
to provide the benefits of certain employees, and the remaining assets 
are available only in certain limited cases to provide such benefits 
(but are available in all cases for the benefit of other employees), 
there are two separate plans. Similarly, the defined contribution 
portion of a plan described in section 414(k) is a separate plan from 
the defined benefit portion of that same plan. A single plan under 
section 414(l) is a single plan for purposes of section 410(b), even 
though the plan comprises separate written documents and separate 
trusts, each of which receives a separate determination letter from the 
Internal Revenue Service. A defined contribution plan does not comprise 
separate plans merely because it includes more than one trust, or merely 
because it provides for separate accounts and permits employees to 
direct the investment of the amounts allocated to their accounts. 
Further, a plan does not comprise separate plans merely because assets 
are separately invested in individual insurance or annuity contracts for 
employees.
    (c) Mandatory disaggregation of certain plans--(1) Section 401(k) 
and 401(m) plans. The portion of a plan that is a section 401(k) plan 
and the portion that is not a section 401(k) plan are treated as 
separate plans for purposes of section 410(b). Similarly, the portion of 
a plan that is a section 401(m) plan and the portion that is not a 
section 401(m) plan are treated as separate plans for purposes of 
section 410(b). Thus, a plan that consists of elective contributions 
under a section 401(k) plan, employee and matching contributions under a 
section 401(m) plan, and contributions other than elective, employee, or

[[Page 759]]

matching contributions is treated as three separate plans for purposes 
of section 410(b). In addition, the portion of a plan that consists of 
contributions described in Sec. 1.401(k)-2(a)(5) (i.e., contributions 
that fail to satisfy the allocation or compensation requirements 
applicable to elective contributions and are therefore required to be 
tested separately) and the portion of the plan that does not consist of 
such contributions are treated as separate plans for purposes of section 
410(b). Similarly, the portion of a plan that consists of contributions 
described in Sec. 1.410(m)-1(b)(4)(ii) (i.e., matching contributions 
that fail to satisfy the allocation and other requirements applicable to 
matching contributions and are therefore required to be tested 
separately) and the portion of the plan that does not consist of such 
contributions are treated as separate plans for purposes of section 
410(b).
    (2) ESOPs and non-ESOPs. The portion of a plan that is an ESOP and 
the portion of the plan that is not an ESOP are treated as separate 
plans for purposes of section 410(b), except as otherwise permitted 
under Sec. 54.4975-11(e) of this Chapter.
    (3) Plans benefiting otherwise excludable employees. If an employer 
applies section 410(b) separately to the portion of a plan that benefits 
only employees who satisfy age and service conditions under the plan 
that are lower than the greatest minimum age and service conditions 
permissible under section 410(a), the plan is treated as comprising 
separate plans, one benefiting the employees who have satisfied the 
lower minimum age and service conditions but not the greatest minimum 
age and service conditions permitted under section 410(a) and one 
benefiting employees who have satisfied the greatest minimum age and 
service conditions permitted under section 410(a). See Sec. 410(b)-
6(b)(3)(ii) for rules about testing otherwise excludable employees.
    (4) Plans benefiting certain disaggregation populations of 
employees--(i) In general--(A) Single plan must be treated as separate 
plans. If a plan (i.e., a single plan within the meaning of section 
414(l)) benefits employees of more than one disaggregation population, 
the plan must be disaggregated and treated as separate plans, each 
separate plan consisting of the portion of the plan benefiting the 
employees of each disaggregation population. See paragraph (c)(4)(ii) of 
this section for the definition of disaggregation population.
    (B) Benefit accruals or allocations attributable to current status. 
Except as otherwise provided in paragraph (c)(4)(i)(C) of this section, 
in applying the rule of paragraph (c)(4)(i)(A) of this section, the 
portion of the plan benefiting employees of a disaggregation population 
consists of all benefits accrued by, or all allocations made to, 
employees while they were members of the disaggregation population.
    (C) Exceptions for certain benefit accruals--(1) Attribution of 
benefits to first disaggregation population. If employees benefiting 
under a plan change from one disaggregation population to a second 
disaggregation population, benefits they accrue while members of the 
second disaggregation population that are attributable to years of 
service previously credited while the employees were members of the 
first disaggregation population may be treated as provided to them in 
their status as members of the first disaggregation population and thus 
included in the portion of the plan benefiting employees of the first 
disaggregation population. This special treatment is available only if 
it is applied on a consistent basis, if it does not result in 
significant discrimination in favor of highly compensated employees, and 
if the plan provision providing the additional benefits applies on the 
same terms to all similarly-situated employees. For example, if all 
formerly collectively bargained employees accrue additional benefits 
under a plan after becoming noncollectively bargained employees, then 
those benefit increases may be treated as included in the portion of the 
plan benefiting collectively bargained employees if they are 
attributable to years of service credited while the employees were 
collectively bargained (e.g., where the additional benefits result from 
compensation increases that occur while the employees are 
noncollectively bargained or from plan amendments affecting

[[Page 760]]

benefits earned while collectively bargained that are adopted while the 
employees are noncollectively bargained) and if such treatment does not 
result in significant discrimination in favor of highly compensated 
employees.
    (2) Attribution of benefits to current disaggregation population. If 
employees benefiting under a plan change from one disaggregation 
population to another disaggregation population, benefits they accrue 
while members of the first disaggregation population may be treated as 
provided to them in their current status and thus included in the 
portion of the plan benefiting employees of the disaggregation 
population of which they are currently members. This special treatment 
is available only if it is applied on a consistent basis and if it does 
not result in significant discrimination in favor of highly compensated 
employees.
    (D) Change in disaggregation populations--(1) Reasonable treatment. 
If, in previous years, the configuration of a plan's disaggregation 
populations differed from their configuration for the current year, for 
purposes of the benefits accrued by, or allocations made to, an employee 
for those years, the employee's status as a member of a current 
disaggregation population for those years must be determined on a 
reasonable basis. A different configuration occurs, for example, if 
disaggregation populations exist for the first time, such as when an 
employer is first treated as operating qualified separate lines of 
business, or if the existing disaggregation populations change, such as 
when an employer redesignates its qualified separate lines of business.
    (2) Example. The following example illustrates the application of 
this paragraph (c)(4)(i)(D).

    Example. (a) Employer X operates Divisions M and N, which are 
treated as qualified separate lines of business for the first time in 
1998. Thus, the disaggregation populations of employees of Division M 
and employees of Division N exist for the first time. Since 1981 
Employer X has maintained a defined benefit plan, Plan P, for employees 
of Division M. Plan P provides a normal retirement benefit of one 
percent of average annual compensation for each year of service up to 
25. Employee A has worked for Division M since 1981 and has never worked 
for Division N. Employee B has worked for Division N since 1989 and 
worked for Division M from 1981 to 1988. Employee C has worked in the 
headquarters of Employer X since 1981. For the period 1981 to 1988 
Employee C was credited with years of service under Plan P.
    (b) For purposes of the benefits accrued by Employee A under Plan P 
during years 1981 through 1997, Employee A is reasonably treated as 
having been a member of the Division M disaggregation population for 
those years. For purposes of the benefits accrued by Employee B under 
Plan P during years 1981 through 1988, Employee B is reasonably treated 
as having been a member of the Division M disaggregation population for 
1981 through 1988 and as having changed to the Division N disaggregation 
population for 1989 through 1997. For purposes of the benefits accrued 
by Employee C under Plan P during years 1981 through 1988, Employee C is 
reasonably treated as having been a member of the Division M 
disaggregation population for those years. Moreover, any benefit 
accruals for Employee B and Employee C in years after 1988, that result 
from increases in average annual compensation after 1988 and that are 
attributable to years of service credited for 1981 through 1988, may be 
treated as provided to Employee B and Employee C in their status as 
members of the Division M disaggregation population if the requirements 
of paragraph (c)(4)(i)(C)(1) of this section are otherwise met.

    (ii) Definition of disaggregation population--(A) Plan benefiting 
employees of qualified separate lines of business. If an employer is 
treated as operating qualified separate lines of business for purposes 
of section 410(b) in accordance with Sec. 1.414(r)-1(b), and a plan 
benefits employees of more than one qualified separate line of business, 
the employees of each qualified separate line of business are separate 
disaggregation populations. In this case, the portion of the plan 
benefiting the employees of each qualified separate line of business is 
treated as a separate plan maintained by that qualified separate line of 
business. However, employees of different qualified separate lines of 
business who are benefiting under a plan that is tested under the 
special rule for employer-wide plans in Sec. 1.414(r)-1(c)(2)(ii) for a 
plan year are not separate disaggregation populations merely because 
they are employees of different qualified separate lines of business.
    (B) Plan benefiting collectively bargained employees. If a plan 
benefits both collectively bargained employees and noncollectively 
bargained employees,

[[Page 761]]

the collectively bargained employees are one disaggregation population 
and the noncollectively bargained employees are another disaggregation 
population. If the population of collectively bargained employees 
includes employees covered under different collective bargaining 
agreements, the population of employees covered under each collective 
bargaining agreement is also a separate disaggregation population.
    (C) Plan maintained by more than one employer. If a plan benefits 
employees of more than one employer, the employees of each employer are 
separate disaggregation populations. In this case, the portion of the 
plan benefiting the employees of each employer is treated as a separate 
plan maintained by that employer, which must satisfy section 410(b) by 
reference only to that employer's employees. However, for purposes of 
this paragraph (c)(4)(ii)(C), if the plan of one employer (or, in the 
case of a plan maintained by more than one employer, the plan provisions 
applicable to the employees of one employer) treats compensation or 
service with another employer as compensation or service with the first 
employer, then the current accruals attributable to that compensation or 
service are treated as provided to an employee of the first employer 
under the plan of the first employer (or the portion of a plan 
maintained by more than one employer benefiting employees of the first 
employer), and the provisions of paragraph (c)(4)(i)(C) of this section 
do not apply to those accruals. Thus, for example, if Plan A maintained 
by Employer X imputes service or compensation for an employee of 
Employer Y, then Plan A is not treated as benefiting the employees of 
more than one employer merely because of this imputation.
    (5) Additional rule for plans benefiting employees of more than one 
qualified separate line of business. If a plan benefiting employees of 
more than one qualified separate line of business satisfies the 
reasonable classification requirement of Sec. 1.410(b)-4(b) before the 
application of paragraph (c)(4) of this section, then any portion of the 
plan that is treated as a separate plan as a result of the application 
of paragraphs (c)(4)(i)(A) and (ii)(A) of this section is deemed to 
satisfy that requirement.
    (d) Permissive aggregation for ratio percentage and 
nondiscriminatory classification tests--(1) In general. Except as 
provided in paragraphs (d)(2) and (d)(3) of this section, for purposes 
of applying the ratio percentage test of Sec. 1.410(b)-2(b)(2) or the 
nondiscriminatory classification test of Sec. 1.410(b)-4, an employer 
may designate two or more separate plans (determined after application 
of paragraph (b) of this section) as a single plan. If an employer 
treats two or more separate plans as a single plan under this paragraph, 
the plans must be treated as a single plan for all purposes under 
sections 401(a)(4) and 410(b).
    (2) Rules of disaggregation. An employer may not aggregate portions 
of a plan that are disaggregated under the rules of paragraph (c) of 
this section. Similarly, an employer may not aggregate two or more 
separate plans that would be disaggregated under the rules of paragraph 
(c) of this section if they were portions of the same plan. In addition, 
an employer may not aggregate an ESOP with another ESOP, except as 
permitted under Sec. 54.4975-11(e) of this Chapter.
    (3) Duplicative aggregation. A plan may not be combined with two or 
more plans to form more than one single plan. Thus, for example, an 
employer that maintains plans A, B, and C may not aggregate plans A and 
B and plans A and C to form two single plans. However, the employer may 
apply the permissive aggregation rules of this paragraph (d) to form any 
one (and only one) of the following combinations: plan ABC, plans AB and 
C, plans AC and B, or plans A and BC.
    (4) Special rule for plans benefiting employees of a qualified 
separate line of business. For purposes of paragraph (d)(1) of this 
section, an employer that is treated as operating qualified separate 
lines of business for purposes of section 410(b) in accordance with 
Sec. 1.414(r)-1(b) is permitted to aggregate the portions of two or 
more plans that benefit employees of the same qualified separate line of 
business (regardless of whether the employer elects to aggregate the 
portions of the same plans that benefit employees of the other

[[Page 762]]

qualified separate lines of business of the employer), provided that 
none of the plans is tested under the special rule for employer-wide 
plans in Sec. 1.414(r)-1 (c)(2)(ii). Thus, the employer is permitted to 
apply paragraph (d)(1) of this section with respect to two or more 
separate plans determined after the application of paragraphs (b) and 
(c)(4) of this section, but may not aggregate a plan that is tested 
under the special rule for employer-wide plans in Sec. 1.414(r)-
1(c)(2)(ii) for a plan year with any portion of a plan that does not 
rely on that special rule for the plan year. In all other respects, the 
provisions of this paragraph (d) regarding permissive aggregation apply, 
including (but not limited to) the disaggregation rules under paragraph 
(d)(2) of this section (including the mandatory disaggregation rule of 
paragraph (c)(4) of this section), and the prohibition on duplicative 
aggregation under paragraph (d)(3) of this section. This paragraph 
(d)(4) applies only in the case of an employer that is treated as 
operating qualified separate lines of business for purposes of section 
410(b) in accordance with Sec. 1.414(r)-1(b). See Sec. Sec. l.414(r)-
1(c)(2) and 1.414(r)-8 (separate application of section 410(b) to the 
employees of a qualified separate line of business).
    (5) Same plan year requirement. Two or more plans may not be 
aggregated and treated as a single plan under this paragraph (d) unless 
they have the same plan year.
    (e) Determination of plans in testing group for average benefit 
percentage test--(1) In general. For purposes of applying the average 
benefit percentage test of Sec. 1.410(b)-5 with respect to a plan, all 
plans in the testing group must be taken into account. For this purpose, 
the plans in the testing group are the plan being tested and all other 
plans of the employer that could be permissively aggregated with that 
plan under paragraph (d) of this section. Whether two or more plans 
could be permissively aggregated under paragraph (d) of this section is 
determined (i) without regard to the rule in paragraph (d)(4) of this 
section that portions of two or more plans benefiting employees of the 
same line of business may not be aggregated if any of the plans is 
tested under the special rule for employer-wide plans in Sec. 1.414(r)-
1(c)(2)(ii), (ii) without regard to paragraph (d)(5) of this section, 
and (iii) by applying paragraph (d)(2) of this section without regard to 
paragraphs (c)(1) and (c)(2) of this section.
    (2) Examples. The following example illustrates the rules of this 
paragraph (e).

    Example 1. Employer X is treated as operating two qualified separate 
lines of business for purposes of section 410(b) in accordance with 
section 414(r), QSLOB1 and QSLOB2. Employer X must apply the rules in 
Sec. 1.414(r)-8 to determine whether its plans satisfy section 410(b) 
on a qualified-separate-line-of-business basis. Employer X maintains the 
following plans:
    (a) Plan A, the portion of Employer X' s employer-wide section 
401(k) plan that benefits all noncollectively bargained employees of 
QSLOB1,
    (b) Plan B, the portion of Employer X' s employer-wide section 
401(k) plan that benefits all noncollectively bargained employees of 
QSLOB2,
    (c) Plan C, a defined benefit plan that benefits all hourly 
noncollectively bargained employees of QSLOB1,
    (d) Plan D, a defined benefit plan that benefits all collectively 
bargained employees of QSLOB1,
    (e) Plan E, an ESOP that benefits all noncollectively bargained 
employees of QSLOB1,
    (f) Plan F, a profit-sharing plan that benefits all salaried 
noncollectively bargained employees of QSLOB1.


Assume that Plan F does not satisfy the ratio percentage test of Sec. 
1.410(b)-2(b)(2) on a qualified-separate-line-of-business basis, but 
does satisfy the nondiscriminatory classification test of Sec. 
1.410(b)-4 on both an employer-wide and a qualified-separate-line-of-
business basis. Therefore, to satisfy section 410(b), Plan F must 
satisfy the average benefit percentage test of Sec. 1.410(b)-5 on a 
qualifiedseparatelineofbu5ine55 basis. The plans in the testing group 
used to determine whether Plan F satisfies the average benefit 
percentage test of Sec. 1.4 10(b)-5 are Plans A, C, E, and F.
    Example 2. The facts are the same as in Example 1, except that 
Employer X applies the special rule for employer-wide plans in Sec. 
1.414(r)-1(c)(2)(ii) to its employer-wide section 401(k) plan. To 
satisfy section 410(b), Plan F must satisfy the average benefit 
percentage test of Sec. 1.4 10(b)-5. Since paragraph (c)(4) of this 
section no longer applies to Plans A and B, they are treated as a single 
plan (Plan AB). The plans in the testing group used to determine whether 
Plan F satisfies the average benefit percentage test of

[[Page 763]]

Sec. 1.4 10(b)-5 are therefore Plans A, B, C, E, and F. However, the 
employees of QSLOB 2 continue to be excludable employees for purposes of 
determining whether Plan F satisfies the average benefit percentage 
test. See Sec. 1.410(b)-6(e).

    (f) Section 403(b) plans. In determining whether a plan satisfies 
section 410(b), a plan subject to section 403(b)(12)(A)(i) is 
disregarded. However, in determining whether a plan subject to section 
403(b)(12)(A)(i) satisfied section 410(b), plans that are not subject to 
section 403(b)(12)(A)(i) may be taken into account.

[T.D. 8363, 56 FR 47655, Sept. 19, 1991, as amended by T.D. 8376, 56 FR 
63433, Dec. 4, 1991; T.D. 8363, 57 FR 10819, 10954, Mar. 31, 1992; T.D. 
8487, 58 FR 46843, Sept. 3, 1993; T.D. 8548, 59 FR 32914, June 27, 1994; 
T.D. 9169, 69 FR 78153, Dec. 29, 2004]



Sec. 1.410(b)-8  Additional rules.

    (a) Testing methods--(1) In general. A plan must satisfy section 
410(b) for a plan year using one of the testing options in paragraphs 
(a)(2) through (a)(4) of this section. Whichever testing option is used 
for the plan year must also be used for purposes of applying section 
401(a)(4) to the plan for the plan year. The annual testing option in 
paragraph (a)(4) of this section must be used in applying section 410(b) 
to a section 401(k) plan or a section 401(m) plan, and in applying the 
average benefit percentage test of Sec. 1.410(b)-5. For purposes of 
this paragraph (a), the plan provisions and other relevant facts as of 
the last day of the plan year regarding which employees benefit under 
the plan for the plan year are applied to the employees taken into 
account under the testing option used for the plan year. For this 
purpose, amendments retroactively correcting a plan in accordance with 
Sec. 1.401(a)(4)-11(g) are taken into account as plan provisions in 
effect as of the last day of the plan year.
    (2) Daily testing option. A plan satisfies section 410(b) for a plan 
year if it satisfies Sec. 1.410(b)-2 on each day of the plan year, 
taking into account only those employees (or former employees) who are 
employees (or former employees) on that day.
    (3) Quarterly testing option. A plan is deemed to satisfy section 
410(b) for a plan year if the plan satisfies Sec. 1.410(b)-2 on at 
least one day in each quarter of the plan year, taking into account for 
each of those days only those employees (or former employees) who are 
employees (or former employees) on that day. The preceding sentence does 
not apply if the plan's eligibility rules or benefit formula operate to 
cause the four quarterly testing days selected by the employer not to be 
reasonably representative of the coverage of the plan over the entire 
plan year.
    (4) Annual testing option. A plan satisfies section 410(b) for a 
plan year if it satisfies Sec. 1.410(b)-2 as of the last day of the 
plan year, taking into account all employees (or former employees) who 
were employees (or former employees) on any day during the plan year.
    (5) Example. The following example illustrates this paragraph (a).

    Example. Plan A is a defined contribution plan that is not a section 
401(k) plan or a section 401(m) plan, and that conditions allocations on 
an employee's employment on the last day of the plan year. Plan A is 
being tested for the 1995 calendar plan year using the daily testing 
option in paragraph (a)(2) of this section. In testing the plan for 
compliance with section 410(b) on March 11, 1995, Employee X is taken 
into account because he was an employee on that day and was not an 
excludable employee with respect to Plan A on that day. Employee X was a 
participant in Plan A on March 11, 1995, was employed on December 31, 
1995, and received an allocation under Plan A for the 1995 plan year. 
Under these facts, Employee X is treated as benefiting under Plan A on 
March 11, 1995, even though Employee X had not satisfied all of the 
conditions for receiving an allocation on that day, because Employee X 
satisfied all of those conditions as of the last day of the plan year.

    (b) Family member aggregation rule. For purposes of section 410(b), 
and in accordance with section 414(q)(6), a highly compensated employee 
who is a 5-percent owner or one of the ten most highly compensated 
employees and any family member (or members) of such a highly 
compensated employee who is also an employee of the employer are to be 
treated as a single highly compensated employee. If any member of that 
group is benefiting under a plan, the deemed single employee is treated 
as benefiting under the plan. If no member of that group is benefiting

[[Page 764]]

under a plan, the deemed single employee is treated as not benefiting 
under the plan.

[T.D. 8363, 56 FR 47656, Sept. 19, 1991]



Sec. 1.410(b)-9  Definitions.

    In applying this section and Sec. Sec. 1.410(b)-2 through 1.410(b)-
10, the definitions in this section govern unless otherwise provided.
    Collectively bargained employee. Collectively bargained employee 
means a collectively bargained employee within the meaning of Sec. 
1.410(b)-6(d)(2).
    Defined benefit plan. Defined benefit plan means a defined benefit 
plan within the meaning of section 414(j). The portion of a plan 
described in section 414(k) that does not consist of separate accounts 
is treated as a defined benefit plan.
    Defined contribution plan. Defined contribution plan means a defined 
contribution plan within the meaning of section 414(i). The portion of a 
plan described in section 414(k) that consists of separate accounts is 
treated as a defined contribution plan.
    Employee. Employee means an individual who performs services for the 
employer who is either a common law employee of the employer, a self-
employed individual who is treated as an employee pursuant to section 
401(c)(1), or a leased employee (not excluded under section 414(n)(5)) 
who is treated as an employee of the employer-recipient under section 
414(n)(2) or 414(o)(2). Individuals that an employer treats as employees 
under section 414(n) pursuant to the requirements of section 414(o) are 
considered to be leased employees for purposes of this rule. In 
addition, an individual must be treated as an employee with respect to 
allocations under a defined contribution plan taken into account under 
Sec. 1.401(a)(4)-2(c)(ii) and with respect to increases in accrued 
benefits (within the meaning of 411(a)(7)) under a defined benefit plan 
that are based on ongoing service or compensation (including imputed 
service or compensation) credits.
    Employer. Employer means the employer maintaining the plan and those 
employers required to be aggregated with the employer under sections 
414(b), (c), (m), or (o). An individual who owns the entire interest of 
an unincorporated trade or business is treated as an employer. Also, a 
partnership is treated as the employer of each partner and each employee 
of the partnership.
    ESOP. ESOP or employee stock ownership plan means an employee stock 
ownership plan within the meaning of section 4975(e)(7) or a tax credit 
employee stock ownership plan within the meaning of section 409(a).
    Former employee. Former employee means an individual who was, but 
has ceased to be, an employee of the employer (i.e., the individual has 
ceased performing services as an employee for the employer). An 
individual is treated as a former employee beginning on the day after 
the day on which the individual ceases performing services as an 
employee for the employer. Thus, an individual who ceases performing 
services as an employee for an employer during a plan year is both an 
employee and a former employee for the plan year. Notwithstanding the 
foregoing, an individual is an employee (and not a former employee) to 
the extent that the individual is treated as an employee with respect to 
the plan for the plan year under the definition of employee in this 
section.
    Highly compensated employee. Highly compensated employee means an 
employee who is a highly compensated employee within the meaning of 
section 414(q) or a former employee treated as an employee under the 
definition of employee in this section who is a highly compensated 
former employee within the meaning of section 414(q).
    Highly compensated former employee. Highly compensated former 
employee means a former employee who is a highly compensated former 
employee within the meaning of section 414(q).
    Multiemployer plan. Multiemployer plan means a multiemployer plan 
within the meaning of section 414(f).
    Noncollectively bargained employee. Noncollectively bargained 
employee means an employee who is not a collectively bargained employee.
    Nonhighly compensated employee. Nonhighly compensated employee means 
an employee who is not a highly compensated employee.
    Nonhighly compensated former employee. Nonhighly compensated former

[[Page 765]]

employee means a former employee who is not a highly compensated former 
employee.
    Plan year. Plan year means the plan year of the plan as defined in 
the written plan document. In the absence of a specifically designated 
plan year, the plan year is deemed to be the calendar year.
    Plan year compensation. Plan year compensation means plan year 
compensation within the meaning of Sec. 1.401(a)(4)-12.
    Professional employee. Professional employee means any highly 
compensated employee who, on any day of the plan year, performs 
professional services for the employer as an actuary, architect, 
attorney, chiropodist, chiropractor, dentist, executive, investment 
banker, medical doctor, optometrist, osteopath, podiatrist, 
psychologist, certified or other public accountant, stockbroker, or 
veterinarian, or in any other professional capacity determined by the 
Commissioner in a notice or other document of general applicability to 
constitute the performance of services as a professional.
    Ratio percentage. With respect to a plan for a plan year, a plan's 
ratio percentage means the percentage (rounded to the nearest hundredth 
of a percentage point) determined by dividing the percentage of the 
nonhighly compensated employees who benefit under the plan by the 
percentage of the highly compensated employees who benefit under the 
plan. The percentage of the nonhighly compensated employees who benefit 
under the plan is determined by dividing the number of nonhighly 
compensated employees benefiting under the plan by the total number of 
nonhighly compensated employees of the employer. The percentage of the 
highly compensated employees who benefit under the plan is determined by 
dividing the number of highly compensated employees benefiting under the 
plan by the total number of highly compensated employees of the 
employer.
    Section 401(k) plan. Section 401(k) plan means a plan consisting of 
elective contributions described in Sec. 1.40(k)-1(g)(3) under a 
qualified cash or deferred arrangement described in Sec. 1.401(k)-
1(a)(4)(i). Thus, a section 401(k) plan does not include a plan (or 
portion of a plan) that consists of contributions under a nonqualified 
cash or deferred arrangement, or qualified nonelective or qualified 
matching contributions treated as elective contributions under Sec. 
1.401(k)-1(a)(6).
    Section 401( l) plan. Section 401( l) plan means a plan that--
    (1) Provides for a disparity in employer-provided benefits or 
contributions that satisfies section 401(l) in form, and
    (2) Relies on one of the safe harbors of Sec. 1.401(a)(4)-2(b)(2), 
1.401(a)(4)-3(b), 1.401(a)(4)-8(b)(3), or 1.401(a)(4)-8(c)(3)(iii)(B) to 
satisfy section 401(a)(4).
    Section 401(m) plan. Section 401(m) plan means a plan consisting of 
employee contributions described in Sec. 1.401(m)-1(f)(6) or matching 
contributions described in Sec. 1.40(m)-1(f)(12), or both. Thus, a 
section 401(m) plan does not include a plan (or portion of a plan) that 
consists of elective contributions or qualified nonelective 
contributions treated as matching contributions under Sec. 1.401(m)-
1(b)(5).

[T.D. 8363, 56 FR 47657, Sept. 19, 1991; 57 FR 10817, 10954, Mar. 31, 
1992, as amended by T.D. 8487, 58 FR 46843, Sept. 3, 1993; T.D. 9169, 69 
FR 78153, Dec. 29, 2004]

    Editorial Note: By T.D. 9169, 69 FR 78153, Dec. 29, 2004, the 
Internal Revenue Service published a document in the Federal Register, 
attempting to amend Sec. 1.410(b)-9 by removing ``1.401(k)-1(g)(3) and 
1.401(m)-1(f)(12)'' and inserting ``1.401(k)-6 and 1.401(m)-1(f)(12)''. 
However, because of inaccurate language, this amendment could not be 
incorporated.



Sec. 1.410(b)-10  Effective dates and transition rules.

    (a) Statutory effective dates--(1) In general. Except as set forth 
in paragraph (a)(2) of this section, the minimum coverage rules of 
section 410(b) as amended by section 1112 of the Tax Reform Act of 1986 
apply to plan years beginning on or after January 1, 1989.
    (2) Special statutory effective date for collective bargaining 
agreements--(i) In general. As provided for by section 1112(e)(2) of the 
Tax Reform Act of 1986, in the case of a plan maintained pursuant to one 
or more collective bargaining agreements between employee 
representatives and one or more employers ratified before March 1, 1986,

[[Page 766]]

the minimum coverage rules of section 410(b) as amended by section 1112 
of the Tax Reform Act of 1986 do not apply to employees covered by any 
such agreement in plan years beginning before the earlier of--
    (A) January 1, 1991; or
    (B) The later of January 1, 1989, or the date on which the last of 
such collective bargaining agreements terminates (determined without 
regard to any extension thereof after February 28, 1986). For purposes 
of this paragraph (a)(2), any extension or renegotiation of a collective 
bargaining agreement, which extension or renegotiation is ratified after 
February 28, 1986, is to be disregarded in determining the date on which 
the agreement terminates.
    (ii) Example. The following example illustrates this paragraph 
(a)(2).

    Example. Employer A maintains Plan 1 pursuant to a collective 
bargaining agreement. Plan 1 covers 100 of Employer A's noncollectively 
bargained employees and 900 of Employer A's collectively bargained 
employees. Employer A also maintains Plan 2, which covers Employer A's 
other 400 noncollectively bargained employees. The collective bargaining 
agreement under which Plan 1 is maintained was entered into on January 
1, 1986, and expires December 31, 1992. Because Plan 1 is a plan 
maintained pursuant to a collective bargaining agreement, section 410(b) 
applies to the first plan year beginning on or after January 1, 1991. In 
applying section 410(b) to Plan 2, the 100 noncollectively bargained 
employees in Plan 1 must be taken into account. The deferred effective 
date for plans maintained pursuant to a collective bargaining agreement 
is not applicable in determining how section 410(b) is applied to a plan 
that is not maintained pursuant to a collective bargaining agreement.

    (iii) Plan maintained pursuant to a collective bargaining agreement. 
For purposes of this paragraph (a)(2), a plan is maintained pursuant to 
one or more collective bargaining agreements between employee 
representatives and one or more employers, if one or more of the 
agreements were ratified before March 1, 1986. Only plans maintained 
pursuant to agreements that the Secretary of Labor finds to be 
collective bargaining agreements and that satisfy section 7701(a)(46) 
are eligible for the deferred effective date under this paragraph 
(a)(2). A plan will not be treated as a plan maintained pursuant to one 
or more collective bargaining agreements eligible for the deferred 
effective date under this paragraph (a)(2) unless the plan would be a 
plan maintained pursuant to one or more collective bargaining agreements 
under the principles applied under section 1017(c) of the Employee 
Retirement Income Security Act of 1974. See H.R. Rep. No. 1280, 93rd 
Cong. 2d Sess. 266 (1974).
    (b) Regulatory effective dates--(1) In general. Except as otherwise 
provided in this section, Sec. Sec. 1.410(b)-2 through 1.410(b)-9 apply 
to plan years beginning on or after January 1, 1994.
    (2) Plans of tax-exempt organizations. In the case of plans 
maintained by organizations exempt from income taxation under section 
501(a), including plans subject to section 403(b)(12)(A)(i) (nonelective 
plans), Sec. Sec. 1.410(b)-2 through 1.410(b)-9 apply to plan years 
beginning on or after January 1, 1996, to the extent such plans are 
subject to section 410(b).
    (c) Compliance during transition period. For plan years beginning 
before the effective date of these regulations, as set forth in 
paragraph (b) of this section, and on or after the statutory effective 
date as set forth in paragraph (a) of this section, a plan must be 
operated in accordance with a reasonable, good faith interpretation of 
section 410(b). Whether a plan is operated in accordance with a 
reasonable, good faith interpretation of section 410(b) will generally 
be determined based on all of the relevant facts and circumstances, 
including the extent to which an employer has resolved unclear issues in 
its favor. If a plan's classification has been determined by the 
Commissioner to be nondiscriminatory and there have been no significant 
changes in or omissions of a material fact, the classification will be 
treated as nondiscriminatory for the relevant plan year. A plan will be 
deemed to be operated in accordance with a reasonable, good faith 
interpretation of section 410(b) if it is operated in accordance with 
the terms of Sec. Sec. 1.410(b)-2 through 1.410(b)-9.
    (d) Effective date for governmental plans. In the case of 
governmental plans described in section 414(d), including plans subject 
to section 403(b)(12)(A)(i) (nonelective plans) Sec. 1.410(b)-2 through 
Sec. 1.410(b)-10 apply to

[[Page 767]]

plan years beginning on or after January 1, 1996, or 90 days after the 
opening of the first legislative session beginning on or after January 
1, 1996, of the governing body with authority to amend the plan, if that 
body does not meet continuously. Such plans are deemed to satisfy 
section 410(b) (and in the case of such plans that are not subject to 
section 403(b)(12)(A)(i), section 401(a)(3) as in effect on September 1, 
1974) for plan years before that effective date. For purposes of this 
section, the governing body with authority to amend the plan is the 
legislature, board, commission, council, or other governing body with 
authority to amend the plan. See Sec. 1.410(b)-2(d) and (e).
    (e) Effective date for provisions relating to exclusion of employees 
of certain tax-exempt entities. The provisions in Sec. 1.410(b)-6(g) 
apply to plan years beginning after December 31, 1996. For plan years to 
which Sec. 1.410(b)-6 applies that begin before January 1, 1997, Sec. 
1.410(b)-6(g) (as it appeared in the April 1, 2005 edition of 26 CFR 
part 1) applies.

[T.D. 8487, 58 FR 46844, Sept. 3, 1993, as amended by T.D. 9275, 71 FR 
41359, July 21, 2006]



Sec. 1.410(d)-1  Election by church to have participation, vesting, 
funding, etc. provisions apply.

    (a) In general. If a church or convention or association of churches 
which maintains any church plan, as defined in section 414(e), makes an 
election under this section, certain provisions of the Code and title I 
of the Employee Retirement Income Security Act of 1974 (the ``Act'') 
shall apply to such church plan as if such plan were not a church plan. 
The provisions of the Code referred to are section 410 (relating to 
minimum participation standards), section 411 (relating to minimum 
vesting standards), section 412 (relating to minimum funding standards), 
section 4975 (relating to prohibited transactions), and paragraphs (11), 
(12), (13), (14), (15), and (19) of section 401(a) (relating to joint 
and survivor annuities, mergers and consolidations, assignment or 
alienation of benefits, time of benefit commencement, certain social 
security increases, and withdrawals of employee contributions, 
respectively).
    (b) Election is irrevocable. An election under this section with 
respect to any church plan shall be binding with respect to such plan 
and, once made, shall be irrevocable.
    (c) Procedure for making election--(1) Time of election. An election 
under this section may be made for plan years for which the provisions 
of section 410(d) of the Code apply to the church plan. By reason of 
section 1017(b) of the Act section 410(d) does not apply to a plan in 
existence on January 1, 1974, for plan years beginning before January 1, 
1976. Section 1017(d) of the Act permits a plan administrator to elect 
to have certain provisions of the Code (including section 410(d)) apply 
to a plan before the otherwise applicable effective dates of such 
provisions. See Sec. 1.410(a)-2(d). Therefore, for a plan in existence 
on Janurary 1, 1974, an election under section 410(d) of the Code may be 
made for a plan year beginning before January 1, 1976, only if an 
election has been made under section 1017(d) of the Act with respect to 
that plan year.
    (2) By whom election is to be made. The election provided by this 
section may be made only by the plan administrator of the church plan.
    (3) Manner of making election. The plan administrator may elect to 
have the provisions of the Code described in paragraph (a) of this 
section apply to the church plan as it is were not a church plan by 
attaching the statement described in subparagraph (5) of this paragraph 
to either (i) the annual return required under section 6058(a) (or an 
amended return) with respect to the plan which is filed for the first 
plan year for which the election is effective or (ii) a written request 
for a determination letter relating to the qualification of the plan 
under section 401(a), 403(a), or 405(a) of the Code and if trusteed, the 
exempt status under section 501(a) of the Code of a trust constituting a 
part of the plan.
    (4) Conditional election. If an election is made with a written 
request for a determination letter, the election may be conditioned upon 
issuance of a favorable determination letter and will become irrevocable 
upon issuance of such letter.
    (5) Statement. The statement described in subparagraph (3) of this

[[Page 768]]

paragraph shall indicate (i) that the election is made under section 
410(d) of the Code and (ii) the first plan year for which it is 
effective.

(Sec. 410 (88 Stat. 898; 26 U.S.C. 410))

[T.D. 7508, 42 FR 47198, Sept. 20, 1977]



Sec. 1.411(a)-1  Minimum vesting standards; general rules.

    (a) In general. A plan is not a qualified plan (and a trust forming 
a part of such plan is not a qualified trust) unless--
    (1) The plan provides that an employee's right to his normal 
retirement benefit (see Sec. 1.411(a)-7(c)) is nonforfeitable (see 
Sec. 1.411(a)-4) upon and after the attainment of normal retirement age 
(see Sec. 1.411(a)-7(b)),
    (2) The plan provides that an employee's rights in his accrued 
benefit derived from his own contributions (see Sec. 1.411(c)-1) are 
nonforfeitable at all times, and
    (3) The plan satisfies the requirements of--
    (A) Section 411(a)(2) and Sec. 1.411(a)-3 (relating to vesting in 
accrued benefit derived from employer contributions), and
    (B) In the case of a defined benefit plan, section 411(b)(1) and 
Sec. 1.411(b)-1 (relating to accrued benefit).
    (b) Organization of regulations relating to minimum vesting 
standards--(1) General rules. This section prescribes general rules 
relating to the minimum vesting standards provided by section 411.
    (2) Effective dates. Section 1.411(a)-2 provides rules under section 
1017 of the Employee Retirement Income Security Act of 1974 relating to 
effective dates under section 411.
    (3) Employer contributions. Section 1.411(a)-3 provides rules under 
section 411(a)(2) relating to vesting in employer-derived accrued 
benefits.
    (4) Certain forfeitures. Section 1.411(a)-4 provides rules under 
section 411(a)(3) relating to certain permitted forfeitures, 
suspensions, etc. under qualified plans.
    (5) Nonforfeitable percentage. Section 1.411(a)-5 provides rules 
under section 411(a)(4) relating to service included in the 
determination of an employee's nonforfeitable percentage under section 
411(a)(2) and Sec. 1.411(a)-3.
    (6) Years of service; break in service. Section 1.411(a)-6 provides 
rules under section 411(a) (5) and (6) of the Internal Revenue Code of 
1954 relating to years of service and breaks in service. Rules 
prescribed by the Secretary of Labor, relating to years of service and 
breaks in service under part 2 of subtitle B of title I of the Employee 
Retirement Income Security Act of 1974 are provided under 29 CFR Part 
2530 (Department of Labor regulations relating to minimum standards for 
employee pension benefit plans).
    (7) Definitions and special rules. Section 1.411(a)-7 provides 
definitions and special rules under section 411(a) (7), (8), and (9), 
for purposes of section 411 and the regulations thereunder.
    (8) Changes in vesting schedule. Section 1.411(a)-8 provides rules 
under section 411(a)(10) relating to changes in the vesting schedule of 
a plan.
    (9) Breaks in service. Section 1.411(a)-9 provides special rules 
relating to breaks in service.
    (10) Accrued benefits. See Sec. 1.411(b)-1 for rules under section 
411(b) relating to accrued benefit requirements under defined benefit 
plans.
    (11) Allocation of accrued benefits. See Sec. 1.411(c)-1 for rules 
under section 411(c) relating to allocation of accrued benefits between 
employer and employee contributions.
    (12) Discrimination, etc. See Sec. 1.411(d)-1 for rules relating to 
the coordination of section 411 with section 401(a)(4) (relating to 
discrimination) and other rules under section 411(d).
    (c) Application of standards to certain plans--(1) General rule. 
Except as provided in subparagraph (2) of this paragraph, section 411 
does not apply to--
    (i) A governmental plan (within the meaning of section 414(d) and 
the regulations thereunder),
    (ii) A church plan (within the meaning of section 414(e) and the 
regulations thereunder) which has not made the election provided by 
section 410(d) and the regulations thereunder,
    (iii) A plan which has not provided for employer contributions at 
any time after September 2, 1974, and
    (iv) A plan established and maintained by a society, order, or 
association described in section 501(c) (8) or (9), if no part of the 
contributions to or

[[Page 769]]

under such plan are made by employers of participants in such plan.
    (2) Vesting requirements. A plan described in subparagraph (1) of 
this paragraph shall, for purposes of section 401(a), be treated as 
meeting the requirements of section 411 if such plan meets the vesting 
requirements resulting from the application of section 401(a)(4) and 
section 401(a)(7) as in effect on September 1, 1974.
    (d) Supersession. Sections 11.411(a)-1 through 11.411(d)-3, 
inclusive, of the Temporary Income Tax Regulations under the Employee 
Retirement Income Security Act of 1974 are superseded by this section 
and Sec. Sec. 1.411(a)-2 through 1.411(d)-3.

(Sec. 411 (88 Stat. 901; 26 U.S.C. 411))

[T.D. 7501, 42 FR 42324, Aug. 23, 1977]



Sec. 1.411(a)-2  Effective dates.

    (a) Plan not in existence on January 1, 1974. Under section 1017(a) 
of the Employee Retirement Income Security Act of 1974, in the case of a 
plan which was not in existence on January 1, 1974, section 411 and the 
regulations thereunder apply for plan years beginning after September 2, 
1974. See paragraph (c) of this section for time plan is considered in 
existence.
    (b) Plans in existence on January 1, 1974. Under section 1017(b) of 
the Employee Retirement Income Security Act of 1974, in the case of a 
plan which was in existence on January 1, 1974, section 411 and the 
regulations thereunder apply for plan years beginning after December 31, 
1975. See paragraph (c) of this section for time plan is considered to 
be in existence.
    (c) Time of plan existence--(1) General rule. For purposes of this 
section, a plan is considered to be in existence on a particular day 
if--
    (i) The plan on or before that day was reduced to writing and 
adopted by the employer (including, in the case of a corporate employer, 
formal approval by the employer's board of directors and, if required, 
shareholders), even though no amounts had been contributed under the 
plan as of such day, and
    (ii) The plan was not terminated on or before that day.

For example, if a plan was adopted on January 2, 1974, effective as of 
January 1, 1974, the plan is not considered to have been in existence on 
January 1, 1974, because it was not both adopted and in writing on 
January 1, 1974.
    (2) Collectively-bargained plan. Notwithstanding paragraph (c) (1) 
of this section, a plan described in section 413 (a), relating to a plan 
maintained pursuant to a collective-bargaining agreement, is considered 
to be in existence on a particular day if--
    (i) On or before that day there is a legally enforceable agreement 
to establish such a plan signed by the employer, and
    (ii) The employer contributions to be made to the plan are set forth 
in the agreement.
    (3) Special rule. If a plan is considered to be in existence under 
subparagraph (1) of this paragraph, any other plan with which such 
existing plan is merged or consolidated shall also be considered to be 
in existence on such date.
    (d) Existing plans under collective-bargaining agreements. For a 
special effective date rule for certain plans maintained pursuant to a 
collective bargaining agreement, see section 1017(c)(1) of the Employee 
Retirement Income Security Act of 1974 (88 Stat. 932).
    (e) Certain existing plans may elect new provisions. The plan 
administrator may elect to have the provisions of the Code relating to 
participation, vesting, funding, and form of benefit apply to a selected 
plan year. See Sec. 1.410(a)-2(d) for rules relating to such an 
election.
    (f) Application of rules. The requirements of section 411 do not 
apply to employees who separate from service with the employer prior to 
the first plan year to which such requirements apply and who never 
return to service with the employer in a plan year to which section 411 
applies.

(Sec. 411 (88 Stat. 901; 26 U.S.C. 411))

[T.D. 7501, 42 FR 42325, Aug. 23, 1977]



Sec. 1.411(a)-3  Vesting in employer-derived benefits.

    (a) In general--(1) Alternative requirements. A plan is not a 
qualified plan (and a trust forming a part of such plan is not a 
qualified trust) unless the plan satisfies the requirements of section

[[Page 770]]

411(a)(2) and this section. A plan satisfies the requirements of this 
section if is satisfies the requirements of paragraph (b), (c), or (d) 
of this section.
    (2) Composite arrangements. A plan will not be considered to satisfy 
the requirements of paragraph (b), (c), or (d) of this section unless it 
satisfies all requirements of a particular one of such paragraphs with 
respect to all of an employee's years of service. A plan which, for 
example, satisfies the requirements of paragraph (b) (but not (c) or 
(d)) for an employee's first 9 years of service and satisfies the 
requirements of paragraph (c) (but not (b)) for all of his remaining 
years of service, does not satisfy the requirements of this section. A 
plan is not precluded from satisfying the requirement of one such 
paragraph with respect to one group of employees and another such 
paragraph with respect to another group provided that the groups are not 
so structured as to evade the requirements of this paragraph. For 
example, if plan A provides that employees who commence participation 
before age 30 are subject to the ``rule of 45'' vesting schedule and 
employees who commence participation after age 30 are subject to the 
full vesting after 10 years schedule, plan A would be so structured as 
to evade the requirements of this paragraph.
    (3) Plan amendments. A plan which satisfies the requirements of a 
particular one of such paragraphs for each of an employee's years of 
service and which is amended so that, as amended, it satisfies the 
requirements of another such paragraph for all such years of service, 
satisfies the requirements of this section even though, as amended, it 
does not satisfy the requirements of the paragraph which were satisfied 
prior to the amendment. See Sec. 1.411(a)-8 for rules relating to 
employee election where the vesting schedule is amended.
    (b) 10-year vesting. A plan satisfies the requirements of section 
411(a)(2) (A) and this paragraph if an employee who has completed 10 
years of service has a nonforfeitable right to 100 percent of his 
accrued benefit derived from employer contributions.
    (c) 5- to 15-year vesting. A plan satisfies the requirements of 
section 411(a)(2) (B) and this paragraph if an employee who has 
completed at least 5 years of service has a nonforfeitable right to a 
percentage of his accrued benefit derived from employer contribution 
which percentage is not less than the nonforfeitable percentage 
determined under the following table:

------------------------------------------------------------------------
                                                          Nonforfeitable
               Completed years of service                   percentage
------------------------------------------------------------------------
5.......................................................             25
6.......................................................             30
7.......................................................             35
8.......................................................             40
9.......................................................             45
10......................................................             50
11......................................................             60
12......................................................             70
13......................................................             80
14......................................................             90
15 or more..............................................            100
------------------------------------------------------------------------

    (d) Rule of 45. A plan satisfies the requirements of section 
411(a)(2)(C) and this paragraph if an employee is entitled to the 
greater of the two percentages determined under paragraph (d) (1) or (2) 
of this section.
    (1) Age and service test. An employee who is not separated from the 
service, who has completed at least 5 years of service, and with respect 
to whom the sum of his age and years of service equals of exceeds 45, 
has a nonforfeit- able right to a percentage of his accrued benefit 
derived from employer contributions which is not less than the 
nonforfeitable percentage corresponding to his number of completed years 
of service to the sum of his age and completed years of service 
(whichever percentage is the lesser) determined under the following 
table:

------------------------------------------------------------------------
                                       Sum of age and     Nonforfeitable
    Completed years of service             service          percentage
------------------------------------------------------------------------
5.................................  45 or 46............             50
6.................................  47 or 48............             60
7.................................  49 or 50............             70
8.................................  51 or 52............             80
9.................................  53 or 54............             90
10 or more........................  55 or more..........            100
------------------------------------------------------------------------

    (2) Service test. An employee who has completed at least 10 years of 
service has a nonforfeitable right to a percentage of his accrued 
benefit derived from employer contributions determined under the 
following table:

[[Page 771]]



------------------------------------------------------------------------
                                                          Nonforfeitable
               Completed years of service                   percentage
------------------------------------------------------------------------
10......................................................             50
11......................................................             60
12......................................................             70
13......................................................             80
14......................................................             90
15......................................................            100
------------------------------------------------------------------------

    (3) Computation of age. For purposes of subparagraph (1) of this 
paragraph, the age of an employee is his age on his last birthday.
    (e) Examples. The rules provided by this section are illustrated by 
the following examples:

    Example 1. Plan B provides that each employee's rights to his 
employer-derived accrued benefit are nonforfeitable as follows:

------------------------------------------------------------------------
                                                          Nonforfeitable
               Completed years of service                   percentage
------------------------------------------------------------------------
2 or less...............................................              0
3.......................................................             30
4.......................................................             35
5.......................................................             40
6.......................................................             45
7.......................................................             50
8.......................................................             55
9.......................................................             60
10......................................................             65
11......................................................             70
12......................................................             75
13......................................................             80
14......................................................             85
15......................................................            100
------------------------------------------------------------------------


Plan B does not satisfy the requirements of paragraph (c) of this 
section (relating to 5-15-year vesting) because the nonforfeitable 
percentage provided by the plan after completion of 14 years of service 
(85 percent) is less than the percentage required by paragraph (c) of 
this section at that time (90 percent). The fact that the nonforfeitable 
percentage provided by the plan for years prior to the 13th year of 
service is greater than the percentage required under paragraph (c) of 
this section is immaterial. The plan fails to satisfy the requirements 
of paragraph (c) of this section even if it is demonstrated that the 
value of the vesting provided by the plan to the employee is at least 
equal to the value of the vesting rate required by that paragraph.
    Example 2. Plan C provides for plan participation after the 
completion of 1 year of service. The plan provides that each employee's 
rights to his employer-derived accrued benefit are 100 percent 
nonforfeitable after 10 years of plan participation rather than service. 
The plan does not satisfy the requirements of paragraph (b) of this 
section because, under the plan, an employee obtains a 100 percent 
nonforfeitable right to his employer-derived accrued benefit only after 
completion of more than 10 years of service.
    Example 3. Plan D provides that each employee's rights to his 
employer-derived accrued benefit are nonforfeitable in accordance with 
the following schedule:

------------------------------------------------------------------------
                                                          Nonforfeitable
               Completed years of service                   percentage
------------------------------------------------------------------------
0-9.....................................................              0
10......................................................             50
11......................................................             60
12......................................................             70
13......................................................             80
14......................................................             90
15......................................................            100
------------------------------------------------------------------------


The plan does not satisfy the requirements of paragraph (b) of this 
section after the 9th year of service. It does not satisfy the 
requirements of paragraph (c) of this section for years prior to the 
10th year of service. It does not satisfy the requirements of paragraph 
(d)(1) of this section for any year of service prior to the 10th year. 
The plan does not satisfy the requirements of this section because it 
does not satisfy the requirements of a particular one of the three 
paragraphs for each of an employee's years of service.
    Example 4. Plan G provides that each employee's rights to his 
employer-derived accrued benefit are 100 percent nonforfeitable upon 
completion of 5 years of service. The plan satisfies the requirements of 
paragraphs (b), (c), and (d) of this section and, because it satisfies 
the requirements of at least one of such paragraphs for all of an 
employee's years of service, it satisfies the requirements of this 
section.

(Sec. 411 (88 Stat. 901; 26 U.S.C. 411))

[T.D. 7501, 42 FR 42325, Aug. 23, 1977]



Sec. 1.411(a)-3T  Vesting in employer-derived benefits (temporary).

    (a) In general--(1) [Reserved]
    (2) Composite arrangements. A plan will not be considered to satisfy 
the requirements of paragraph (b), (c), or (d) of this section unless it 
satisfies all requirements of a particular one of such paragraphs with 
respect to all of an employee's years of service. A plan which, for 
example, satisfies the requirements of paragraph (b) (but not (c) or 
(d)) for an employee's first 4 years of service and satisfies the 
requirements of paragraph (c) (but not (b)) for all of his remaining 
years of service does not satisfy the requirements of this section. A 
plan is not precluded from satisfying the requirements of one such 
paragraph with respect to one group of employees and

[[Page 772]]

another such paragraph with respect to another group provided that the 
groups are not so structured as to evade the requirements of this 
paragraph.
    (b) 5-year vesting. A plan satisfies the requirements of section 
411(a)(2)(A) and this paragraph if an employee who has completed 5 years 
of service has a nonforfeitable right to 100 percent of his or her 
accrued benefits derived from employer contributions.
    (c) 3- to 7-year vesting. A plan satisfies the requirements of 
section 411(a)(2)(B) and this paragraph if an employee who has completed 
at least 3 years of service has a nonforfeitable right to a percentage 
of his accrued benefit derived from employer contributions, which 
percentage is not less than the nonforfeitable percentage determined 
under the following table:

------------------------------------------------------------------------
                                                          Nonforfeitable
               Completed years of service                   percentage
------------------------------------------------------------------------
3.......................................................             20
4.......................................................             40
5.......................................................             60
6.......................................................             80
7 or more...............................................            100
------------------------------------------------------------------------

    (d) Multiemployer plans. A plan satisfies the requirements of 
section 411(a)(2)(C) and this paragraph if--
    (1) The plan is a multiemployer plan (within the meaning of section 
414(f)), and
    (2) Under the plan--
    (i) An employee who is covered pursuant to a collective bargaining 
agreement described in section 414(f)(1)(B) has a nonforfeitable right 
to 100 percent of the employee's accrued benefit derived from employer 
contributions not later than upon completion of 10 years of service, and
    (ii) The requirements of paragraph (b) or (c) of this section are 
met with respect to employees who are not covered pursuant to a 
collective bargaining agreement described in section 414(f)(1)(B).
    (iii) For purposes of this provision, an employee is not covered 
pursuant to a collective bargaining agreement unless the employee is 
represented by a bona fide employee representative that is a party to 
the collective bargaining agreement pursuant to which the multiemployer 
plan is maintained. Thus, for example, an employee of either the 
multiemployer plan or the employee representative is not covered 
pursuant to the collective bargaining agreement under which the plan is 
maintained even if the employee is covered pursuant to an agreement 
entered into by the multiemployer plan or employee representative on 
behalf of the employee and even if all such employees covered under the 
plan constitute only a de minimis percentage of the total employees 
covered under the plan.
    (e) Effective date. (1) The provisions of this section apply to all 
employees who have one hour of service in any plan year beginning 
after--
    (i) December 31, 1988, or
    (ii) In the case of a plan maintained pursuant to one or more 
collective bargaining agreements between employee representatives and 
one or more employers ratified before March 1, 1986, for employees 
covered by any such agreement, the earlier of--
    (A) The later of--
    (1) January 1, 1989, or
    (2) The date on which the last of such collective bargaining 
agreements terminates (determined without regard to any extension 
thereof after February 28, 1986), or
    (B) January 1, 1991.
    (2) For employees not described in paragraph (e)(1), above, the 
regulations in effect prior to January 1, 1989, shall be applied to 
determine the requirements of this section.
    (f) Examples. The rules provided by this section are illustrated by 
the following examples:

    Example 1. Plan B provides that each employee's rights to his 
employer-derived accrued benefit are nonforfeitable as follows:

------------------------------------------------------------------------
                                                          Nonforfeitable
               Completed years of service                   percentage
------------------------------------------------------------------------
1.......................................................              0
2.......................................................             10
3.......................................................             25
4.......................................................             45
5.......................................................             65
6.......................................................             75
7.......................................................            100
------------------------------------------------------------------------

    Plan B does not satisfy the requirements of paragraph (c) of this 
section (relating to 3- to 7-year vesting) because the nonforfeitable 
percentage provided by the plan after completion of 6 years of service 
(75 percent) is

[[Page 773]]

less than the percentage required by paragraph (c) of this section at 
that time (80 percent). The fact that the nonforfeitable percentage 
provided by the plan for years prior to the 6th year of service is 
greater than the percentage required under paragraph (c) of this section 
is immaterial. The plan fails to satisfy the requirements of paragraph 
(c) of this section even if it is demonstrated that the value of the 
vesting provided by the plan to the employees is at least equal to the 
value of the vesting rate required by this paragraph.
    Example 2. Plan C provides for plan participation after the 
completion of 1 year of service. The plan provides that each employee's 
rights to his employer-derived accrued benefits are 100 percent 
nonforfeitable after 5 years of plan participation rather than service. 
The plan does not satisfy the requirements of paragraph (b) of this 
section because, under the plan, an employee obtains a 100 percent 
nonforfeitable right to his or her employer-derived accrued benefit only 
after completion of more than 5 years of service.
    Example 3. Plan D provides that each employee's rights to his 
employer-derived accrued benefits are nonforfeitable in accordance with 
the following schedule:

------------------------------------------------------------------------
                                                          Nonforfeitable
               Completed years of service                   percentage
------------------------------------------------------------------------
0 to 4..................................................              0
5.......................................................             60
6.......................................................             80
7.......................................................            100
------------------------------------------------------------------------

    The plan does not satisfy the requirements of paragraph (b) of this 
section after the 4th year of service. It does not satisfy the 
requirements of paragraph (c) of this section for years prior to the 5th 
year of service. The plan does not satisfy the requirements of this 
section because it does not satisfy the requirements of a particular one 
of the two paragraphs for each of an employee's years of service.
    Example 4. Plan G provides that each employee's rights to his 
employer-derived accrued benefit are 100 percent nonforfeitable upon 
completion of 3 years of service. The plan satisfies the requirements of 
paragraphs (b) and (c) of this section and, because it satisfies the 
requirements of at least one of such paragraphs for all of an employee's 
years of service, it satisfies the requirements of this section.

[T.D. 8170, 53 FR 240, Jan. 6, 1988]



Sec. 1.411(a)-4  Forfeitures, suspensions, etc.

    (a) Nonforfeitability. Certain rights in an accrued benefit must be 
nonforfeitable to satisfy the requirements of section 411(a). This 
section defines the term ``nonforfeitable'' for purposes of these 
requirements. For purposes of section 411 and the regulations 
thereunder, a right to an accrued benefit is considered to be 
nonforfeitable at a particular time if, at that time and thereafter, it 
is an unconditional right. Except as provided by paragraph (b) of this 
section, a right which, at a particular time, is conditioned under the 
plan upon a subsequent event, subsequent performance, or subsequent 
forbearance which will cause the loss of such right is a forfeitable 
right at that time. Certain adjustments to plan benefits such as 
adjustments in excess of reasonable actuarial reductions, can result in 
rights being forfeitable. Rights which are conditioned upon a 
sufficiency of plan assets in the event of a termination or partial 
termination are considered to be forfeitable because of such condition. 
However, a plan does not violate the nonforfeitability requirements 
merely because in the event of a termination an employee does not have 
any recourse toward satisfaction of his nonforfeitable benefits from 
other than the plan assets or the Pension Benefit Guaranty Corporation. 
Furthermore, nonforfeitable rights are not considered to be forfeitable 
by reason of the fact that they may be reduced to take into account 
benefits which are provided under the Social Security Act or under any 
other Federal or State law and which are taken into account in 
determining plan benefits. To the extent that rights are not required to 
be nonforfeitable to satisfy the minimum vesting standards, or the 
nondiscrimination requirements of section 401(a)(4), they may be 
forfeited without regard to the limitations on forfeitability required 
by this section. The right of an employee to repurchase his accrued 
benefit for example under section 411(a)(3)(D), is an example of a right 
which is required to satisfy such standards. Accordingly, such a right 
is subject to the limitations on forfeitability. Rights which are 
required to be prospectively nonforfeitable under the vesting standards 
are nonforfeitable and may not be forfeited until it is determined that 
such rights are, in fact, in excess of the vesting standards. Thus, 
employees have a right to vest in the accrued benefits if they continue 
in

[[Page 774]]

employment of employers maintaining the plan unless a forfeitable event 
recognized by section 411 occurs. For example, if a plan covered 
employees in Division A of Corporation X under a plan utilizing a 10-
year 100 percent vesting schedule, the plan could not forfeit employees' 
rights on account of their moving to service in Division B of 
Corporation X prior to completion of 10 years of service even though 
employees are not vested at that time.
    (b) Special rules. For purposes of paragraph (a) of this section a 
right is not treated as forfeitable--
    (1) Death--(i) General rule. In the case of a participant's right to 
his employer-derived accrued benefit, merely because such accrued 
benefit is forfeitable by the participant to the extent it has not been 
paid or distributed to him prior to his death. This subparagraph shall 
not apply to a benefit which must be paid to a survivor in order to 
satisfy the requirements of section 401(a)(11).
    (ii) Employee contributions. A participant's right in his accrued 
benefit derived from his own contributions must be nonforfeitable at all 
times. Such a right is not treated as forfeitable merely because, after 
commencement of annuity or pension payments in a benefit form provided 
under the plan, the participant dies without receiving payments equal in 
amount to his nonforfeitable accrued benefit derived from his 
contributions determined at the time of commencement.
    (2) Suspension of benefits upon reemployment of retiree. In the case 
of certain suspensions of benefits under section 411(a)(3)(B), see 
regulations prescribed by the Secretary of Labor under 29 CFR Part 2530 
(Department of Labor regulations relating to minimum standards for 
employee pension benefit plans).
    (3) Retroactive plan amendment. In the case of a participant's right 
to his employer-derived accrued benefit, merely because such benefit is 
subject to reduction to the extent provided by a plan amendment 
described in section 412(c)(8) and the regulations thereunder, which 
amendment is given retroactive effect in accordance with such section.
    (4) Other forfeiture rules--(i) Withdrawal of mandatory 
contributions. For rules allowing forfeitures on account of the 
withdrawal of mandatory contributions, see Sec. 1.411(a)-7(d) (2) and 
(3).
    (ii) Additional requirements. For additional requirements relating 
to nonforfeitability of benefits in the event of a withdrawal by the 
employee, see section 401(a)(19) and Sec. 1.401(a)-19.
    (5) Multiemployer plan. In the case of a multiemployer plan 
described in section 414(f), merely because an employee's accrued 
benefit which results from service with an employer before such employer 
was required to contribute to the plan is forfeitable on account of the 
cessation of contributions by the employer of the employee. This 
subparagraph shall not apply to an employee's accrued benefit with 
respect to an employer which accrued under a plan maintained by that 
employer prior to the adoption by that employer of the multiemployer 
plan.
    (6) Lost beneficiary; escheat. In the case of a benefit which is 
payable, merely because the benefit is forfeitable on account of the 
inability to find the participant or beneficiary to whom payment is due, 
provided that the plan provides for reinstatement of the benefit if a 
claim is made by the participant or beneficiary for the forfeited 
benefit. In addition, a benefit which is lost by reason of escheat under 
applicable state law is not treated as a forfeiture.
    (7) Certain matching contributions. A matching contribution (within 
the meaning of section 401(m)(4)(A) and Sec. 1.401(m)-1(a)(2)) is not 
treated as forfeitable even if under the plan it may be forfeited under 
Sec. 1.401(m)-2(b)(1) because the contribution to which it relates is 
treated as an excess contribution (within the meaning of Sec. Sec. 
1.401(k)-2(b)(2)(ii) and 1.401(k)-6), excess deferral (within the 
meaning of Sec. 1.402(g)-1(e)(1)(iii)), excess aggregate contribution 
(within the meaning of Sec. 1.401(m)-5), or a default elective 
contribution (within the meaning of Sec. 1.414(w)-1(e)) that is 
withdrawn in accordance with the requirements of Sec. 1.414(w)-1(c).
    (c) Examples. The rules of this section are illustrated by the 
following examples:


[[Page 775]]


    Example 1. Corporation A's plan provides that an employee is fully 
vested in his employer-derived accrued benefit after completion of 5 
years of service. The plan also provides that, if an employee works for 
a competitor he forfeits his rights in the plan. Such provision could 
result in the forfeiture of an employee's rights which are required to 
be nonforfeitable under section 411 and therefore the plan would not 
satisfy the requirements of section 411. If the plan limited the 
forfeiture to employees who completed less than 10 years of service, the 
plan would not fail to satisfy the requirements of section 411 because 
the forfeitures under this provision are limited to rights which are in 
excess of the minimum required to be nonforfeitable under section 
411(a)(2)(A).
    Example 2. Plan B provides that if an employee does not apply for 
benefits within 5 years after the attainment of normal retirement age, 
the employee loses his plan benefits. Such a plan provision could result 
in forfeiture of an employee's rights which are required to be 
nonforfeitable under section 411 and, therefore, the plan would not 
satisfy the requirements of section 411.

(Sec. 411 (88 Stat. 901; 26 U.S.C. 411))

[T.D. 7501, 42 FR 42326, Aug. 23, 1977, as amended by T.D. 8357, 56 FR 
40549, Aug. 15, 1991; T.D. 9169, 69 FR 78153, Dec. 29, 2004; T.D. 9219, 
70 FR 47126, Aug. 12, 2005; T.D. 9447, 74 FR 8211, Feb. 24, 2009]

    Editorial Note: By T.D. 9169, 69 FR 78153, Dec. 29, 2004, Sec. 
1.411(a)-(b)(7) was amended by removing the reference to Sec. 1.401(k)-
1(f)(2) and (g)(7). However, the reference does not appear in the 
paragraph.



Sec. 1.411(a)-4T  Forfeitures, suspensions, etc. (temporary).

    (a) Nonforfeitability. Certain rights in an accrued benefit must be 
nonforfeitable to satisfy the requirements of section 411(a). This 
section defines the term ``nonforfeitable'' for purposes of these 
requirements. For purposes of section 411 and the regulations 
thereunder, a right to an accrued benefit is considered to be 
nonforfeitable at a particular time if, at that time and thereafter, it 
is an unconditional right. Except as provided by paragraph (b) of this 
section, a right which, at a particular time, is conditioned under the 
plan upon a subsequent event, subsequent performance, or subsequent 
forbearance which will cause the loss of such right is a forfeitable 
right at that time. Certain adjustments to plan benefits, such as 
adjustments in excess of reasonable actuarial reductions, can result in 
rights being forfeitable. Rights which are conditioned upon a 
sufficiency of plan assets in the event of a termination or partial 
termination are considered to be forfeitable because of such condition. 
However, a plan does not violate the nonforfeitability requirements 
merely because in the event of a termination an employee does not have 
any recourse toward satisfaction of his nonforfeitable benefits from 
other than the plan assets, the Pension Benefit Guaranty Corporation, or 
a trust established and maintained pursuant to sections 4041(c)(3)(B) 
(ii) or (iii) and section 4049 of ERISA with respect to the plan. 
Furthermore, nonforfeitable rights are not considered to be forfeitable 
by reason of the fact that they may be reduced as allowed under sections 
401(a)(5) and 401(l). To the extent that rights are not required to be 
nonforfeitable to satisfy the minimum vesting standards, or the 
nondiscrimination requirements of section 401(a)(4), they may be 
forfeited without regard to the limitations on forfeitability required 
by this section. The right of an employee to repurchase his accrued 
benefit for example under section 411(a)(3)(D), is an example of a right 
which is required to satisfy such standards. Accordingly, such a right 
is subject to the limitations on forfeitability. Rights which are 
required to be prospectively nonforfeitable under the vesting standards 
are nonforfeitable and may not be forfeited until it is determined that 
such rights are, in fact, in excess of the vesting standards. Thus, 
employees have a right to vest in the accrued benefits if they continue 
in employment of employers maintaining the plan unless a forfeitable 
event recognized by section 411 occurs. For example, if a plan covered 
employees in Division A of Corporation X under a plan utilizing a 5-year 
100 percent vesting schedule, the plan could not forfeit employees' 
rights on account of their moving to service in Division B of 
Corporation X prior to completion of 5 years of service even though 
employees are not vested at that time.
    (b) [Reserved]
    (c) Examples. The rules of this section ae illustrated by the 
following examples:


[[Page 776]]


    Example 1. Corporation A's plan provides that an employee is fully 
vested in his employer-derived accrued benefit after completion of 3 
years of service. The plan also provides that if the employee works for 
a competitor he forfeits his rights in the plan. Such provision could 
result in the forfeiture of an employee's rights which are required to 
be nonforfeitable under section 411 and therefore the plan would not 
satisfy the requirements of section 411. If the plan limited the 
forfeiture to employees who completed less than 5 years of service, the 
plan would not fail to satisfy the requirements of section 411 because 
the forfeitures under this provision are limited to rights which are in 
excess of the minimum required to be nonforfeitable under section 
411(a)(2)(A).

[T.D. 8170, 53 FR 241, Jan. 6, 1988]



Sec. 1.411(a)-5  Service included in determination of nonforfeitable 
percentage.

    (a) In general. Under section 411(a)(4), for purposes of determining 
the nonforfeitable percentage of an employee's right to his employer-
derived accrued benefit under section 411(a)(2) and Sec. 1.411(a)-3, 
all of an employee's years of service with an employer or employers 
maintaining the plan shall be taken into account except that years of 
service described in paragraph (b) of this section may be disregarded.
    (b) Certain service. For purposes of paragraph (a) of this section, 
the following years of service may be disregarded:
    (1) Service before age 22. (i) In the case of a plan which satisfies 
the requirements of section 411(a)(2) (A) or (B) (relating to 10-year 
vesting and 5-15-year vesting, respectively), a year of service 
completed by an employee before he attains age 22.
    (ii) In the case of a plan which does not satisfy the requirements 
of section 411(a)(2) (A) or (B), a year of service completed by an 
employee before he attains age 22 if the employee is not a participant 
(for purposes of section 410) in the plan at any time during such year.
    (iii) For purposes of this subparagraph in the case of a plan 
utilizing computation periods, service during a computation period 
described in section 411(a)(5)(A) within which the employee attains age 
22 may not be disregarded. In the case of a plan utilizing the elapsed 
time method described in Sec. 1.410(a)-7, service on or after the date 
on which the employee attains age 22 may not be disregarded.
    (2) Contributory plans. In the case of a plan utilizing computation 
periods, a year of service completed by an employee under a plan which 
requires mandatory contributions (within the meaning of section 
411(c)(2)(C) and Sec. 1.411(c)-1(c)(4)) to be made by the employee for 
such year, if the employee does not participate for such year solely 
because of his failure to make all mandatory contributions to the plan 
for such year. If the employee contributes any part of the mandatory 
contributions for the year, such year may not be excluded by reason of 
this subparagraph. In the case of a plan utilizing the elapsed time 
method described in Sec. 1.410(a)-7, the service which may be 
disregarded is the period with respect to which the mandatory 
contribution is not made.
    (3) Plan not maintained--(i) In general. An employee's years of 
service with an employer during any period for which the employer did 
not maintain the plan or a predecessor plan may be disregarded for 
purposes of section 411(a)(2). Paragraph (b)(3)(ii) of this section 
provides rules regarding the period prior to the adoption of a plan. 
Paragraph (b)(3)(iii) of this section provides rules regarding the 
period after the termination of a plan. Paragraph (b)(3)(iv) of this 
section provides rules regarding employers who have certain 
relationships with other employers maintaining the plan.
    (ii) Period prior to adoption. The period for which a plan is not 
maintained by an employer includes the period before the plan was 
established. For purposes of this subdivision, a plan is established on 
the first day of the plan year in which the plan is adopted even though 
the plan is adopted after such first day. Except as provided in 
paragraph (b)(3)(iv) of this section if an employer adopts a plan which 
has previously been established by another employer or group of 
employers, the plan is not maintained by the adopting employer prior to 
the first day of the plan year in which the plan is adopted by the 
adopting employer. In the case

[[Page 777]]

of a transfer of assets or liabilities (including a merger or 
consolidation) involving two plans maintained by a single employer, the 
successor (or transferee) plan is treated as if it was established at 
the same time as the date of the establishment of the earliest component 
plan. In the case of a plan merger, consolidation, or transfer of plan 
assets or liabilities involving plans of two or more employers, the 
successor plan is treated as if it were established on each of the 
separate dates on which such component plan was established for the 
employees of each employer. Thus, for example, if employer A establishes 
a plan January 1, 1970, and employer B establishes a plan January 1, 
1980, and the plans were subsequently merged, then the merged plan would 
be treated as if it were in existence on January 1, 1970, with respect 
to A's employees and as if it were in existence on January 1, 1980, with 
respect to B's employees.
    (iii) Period after termination or withdrawal. The period for which a 
plan is not maintained by an employer includes the period after the plan 
is terminated. For purposes of this section, a plan is terminated at the 
date there is a termination of the plan within the meaning of section 
411(d)(3)(A) and the regulations thereunder. Notwithstanding the 
preceding sentence, if contributions to or under a plan are made after 
termination, the plan is treated as being maintained until such 
contributions cease, whether or not accruals are made after such 
termination. If, after termination of a plan in circumstances under 
which the employer may be liable to the Pension Benefit Guaranty 
Corporation under section 4062 of the Act, employer contributions are 
made to or under the plan to fund benefits accrued at the time of 
termination, such contributions shall, for purposes of this paragraph, 
be deemed to be payments in satisfaction of employer liability to such 
Corporation rather than contributions to or under the plan. In the case 
of a plan maintained by more than one employer, the period for which the 
plan is not maintained by the withdrawing employer includes the period 
after the withdrawal from the plan.
    (iv) Certain employers. For purposes of this subparagraph--
    (A) Predecessor employers. Service with a predecessor employer who 
maintained the plan of the current employer is treated as service with 
such current employer (see section 414(a)(1) and the regulations 
thereunder), and certain service with a predecessor employer who did not 
maintain the plan of the current employer is treated as service with the 
current employer (see section 414(a)(2) and the regulations thereunder).
    (B) Related employers. Service with an employer is treated as 
service for certain related employers for the period during which the 
employers are related. These related employers include members of a 
controlled group of corporations (within the meaning of section 1563(a), 
determined without regard to subsections (a)(4) and (e)(3) (C) thereof) 
and trades or businesses (whether or not incorporated) which are under 
common control (see section 414 (b) and (c) and 29 CFR Part 2530, 
Department of Labor regulations relating to minimum standards for 
employee pension benefits plans).
    (C) Plan maintained by more than one employer. Service with an 
employer who maintains a plan is treated as service for each other 
employer who maintains that plan for the period during which the 
employers are maintaining the plan (see section 413 (b)(4) and (c)(3) 
and 29 CFR Part 2530, Department of Labor regulations relating to 
minimum standards for employee pension benefit plans).
    (v) Predecessor plan--(A) General rule. In the case of an employee 
who was covered by a predecessor plan, the time the successor of such 
plan is maintained for such employee includes the time the predecessor 
plan was maintained if, as of the later of the time the predecessor plan 
is terminated or the successor plan is established, the employee's years 
of service under the predecessor plan are not equalled or exceeded by 
the aggregate number of consecutive 1-year breaks in service occuring 
after such years of service. Years of service and breaks in service, 
without regard to whether the employee has nonforfeitable rights under 
the predecessor plan, are determined

[[Page 778]]

under section 411(a) (5) and (6) except that years between the 
termination date of the predecessor plan and the date of establishment 
of the successor plan do not count as years of service.
    (B) Definition of predecessor plan. For purposes of this section, 
if--
    (1) An employer establishes a retirement plan (within the meaning of 
section 7476(d)) qualified under subchapter D of chapter 1 of the Code 
within the 5-year period immediately preceding or following the date 
another such plan terminates, and
    (2) The other plan is terminated during a plan year to which this 
section applies.

The terminated plan is a predecessor plan with respect to such other 
plan.
    (C) Example. The rules provided by this subparagraph are illustrated 
by the following example:

    Example. (1) Employer X's qualified plan A terminated on January 1, 
1977, Employer X established qualified plan B on January 1, 1981. Under 
paragraph (b)(3)(v)(B) of this section, plan A is a predecessor plan 
with respect to plan B because plan B is established within the 5-year 
period immediately following the date plan A terminated.
    (2) Employee C was not covered by the A plan. Under the general rule 
in subdivision (v)(A) of this subparagraph, plan B is not maintained 
until January 1, 1981, with respect to Employee C.
    (3) Employee D was covered by the A plan. On December 31, 1976, D 
had 4 years of service. D had 4 consecutive 1-year breaks in service 
because, during the years between the termination of plan A and the 
establishment of plan B, he did not have more than 500 hours of service 
in any applicable computation period. Because D's consecutive 1-year 
breaks (4) equal his years of service prior to his breaks (4), plan B is 
not maintained until January 1, 1981, with respect to employee D.
    (4) Employee E was covered by the A plan. On December 31, 1975, E 
had 6 years of service. E had a 1-year break in service in 1976. E also 
had 4 consecutive 1-year breaks in service for the period between plan 
A's termination and plan B's establishment. Because E's years of service 
(6) are not less than his consecutive 1-year breaks (5), plan B is 
maintained for E as of the establishment date of plan A.

    (4) Break in service. A year of service which is not required to be 
taken into account by reason of a break in service (within the meaning 
of section 411(a)(6) and Sec. 1.411(a)-6)).
    (5) Service before January 1, 1971. A year of service completed by 
an employee prior to January 1, 1971, unless the employee completes at 
least 3 years of service at any time after December 31, 1970. For 
purposes of determining if an employee completes 3 years of service, 
whether or not consecutive, the exceptions of section 411(a)(4) are not 
applicable. For the meaning of the term ``year of service'', see 
regulations prescribed by the Secretary of Labor under 29 CFR Part 2530, 
relating to minimum standards for employee pension benefit plans.
    (6) Service before effective date. A year of service completed 
before the first plan year for which this section applies to the plan, 
if such service would have been disregarded under the plan rules 
relating to breaks in service (whether or not such rules are so 
designated in the plan) as such rules were in effect from time to time 
under the plan. For this purpose, plan rules which result in the loss of 
prior vesting or benefit accruals of an employee, or which deny an 
employee eligibility to participate, by reason of separation or failure 
to complete a required period of service within a specified priod of 
time (e.g., 300 hours in one year) will be considered break in service 
rules See Sec. 1.411(a)-9 for requirements relating to certain 
amendments to the break in service rules of a plan.
    (i) [Reserved]
    (ii) Examples. The rules of this subparagraph are illustrated by the 
following examples:

    Example 1. The A plan in 1971 provides for immediate participation 
and vesting at normal retirement age. Employees accrue a unit benefit 
based on their compensation in each year. The plan provides that if an 
employee is not employed on the last day of the calendar year, he loses 
all accrued benefits. The requirement of employment on the last day of 
the year is a break in service rule because employees can lose benefits 
by reason of their separation. Accordingly, in the case of employees who 
separate and do not return by the close of the year, service which is 
completed prior to separation may be disregarded.
    Example 2. The B plan in 1971 excludes from plan participation 
employees who work less than 1,200 hours per year. Because years of less 
than 1,200 hours are not taken into account under the B plan for 
eligibility to participate, such years are excluded under rules

[[Page 779]]

relating to breaks in service. Therefore, the years can be disregarded 
under this subparagraph.
    Example 3. The C plan in 1971 provides for immediate participation 
and provides accruals and vesting credit for 1,200 hours or more in a 
given year. The plan provides that if a participant works less than 300 
hours in a given year, he loses all prior vesting and benefit credits. 
The 300 hour rule is a break in service rule because the failure to 
complete 300 hours results in the loss of vesting and prior service 
credit. The 1,200 hour requirement is not a break in service rule 
because even though employees do not increase vesting or accrue benefits 
for service between 300 and 1,200 hours, they cannot lose prior vesting 
or benefits for such service. Accordingly, the C plan can disregard 
completed years only on account of less than 300 hours of service by an 
employee.

    (c) Special continuity rule for certain plans. For special rules for 
computing years of service in the case of a plan maintained by more than 
one employer, see 29 CFR Part 2530 (Department of Labor regulations 
relating to minimum standards for employee pension benefit plans).

(Sec. 411 (88 Stat. 901, 26 U.S.C. 411))

[T.D. 7501, 42 FR 42327, Aug. 23, 1977, as amended by T.D. 7703, 45 FR 
40985, June 17, 1980]



Sec. 1.411(a)-6  Year of service; hours of service; breaks in service.

    (a) Year of service. Under section 411 (a)(5)(A), for purposes of 
the regulations thereunder, the term ``year of service'' is defined in 
regulations prescribed by the Secretary of Labor under section 
203(b)(2)(A) of the Employee Retirement Income Security Act of 1974. For 
special rules applicable to seasonal industries and maritime industries, 
see regulations prescribed by the Secretary of Labor under subparagraphs 
(C) and (D) of section 203(b)(2) of the Employee Retirement Income 
Security Act of 1974.
    (b) Hours of service. Under section 411(a)(5)(B), for purposes of 
the regulations thereunder, the term ``hours of service'' has the 
meaning provided by section 410(a)(3)(C). See regulations prescribed by 
the Secretary of Labor under 29 CFR Part 2530, relating to minimum 
standards for employee pension benefit plans.
    (c) Breaks in service. Under section 411(a)(6), for purposes of 
Sec. 1.411(a)-5(b)(4) and of this paragraph--
    (1) In general--(i) Year of service after 1-year break in service. 
In the case of any employee who has incurred a 1-year break in service, 
years of service completed before such break are not required to be 
taken into account until the employee has completed one year of service 
after his return to service.
    (ii) Defined contribution plan. In the case of a participant in a 
defined contribution plan or in an insured defined benefit plan (which 
plan satisfies the requirements of section 411 (b)(1)(F) and Sec. 
1.411(b)-1) who has incurred a 1-year break in service, years of service 
completed after such break are not required to be taken into account for 
purposes of determining the nonforfeitable percentage of the 
participant's right to employer-derived benefits which accrued before 
such break. This subdivision does not permit years of service completed 
before a 1-year break in service to be disregarded in determining the 
nonforfeitable percentage of a participant's right to employer-derived 
benefits which accrue after such break.
    (iii) Nonvested participants. In the case of an employee who is a 
nonvested participant in employer-derived benefits at the time he incurs 
a 1-year break in service, years of service completed by such 
participant before such break are not required to be taken into account 
for purposes of determining the nonforfeitable percentage of his right 
to employer-derived benefits if at such time the number of consecutive 
1-year breaks in service included in his most recent break in service 
equals or exceeds the aggregate number of his years of service, whether 
or not consecutive, completed before such break. In the case of a plan 
utilizing the elapsed time method described in Sec. 1.410(a)-7, the 
condition in the preceding sentence shall be satisfied if the period of 
severance is at least one year and the consecutive period of severance 
equals or exceeds his prior period of service, whether or not 
consecutive, completed before such period of severance. In computing the 
aggregate number of years of service prior to such break, years of 
service which could

[[Page 780]]

have been disregarded under this subdivision by reason of any prior 
break in service may be disregarded.
    (2) One-year break in service defined. The term ``1-year break in 
service'' means a calendar year, plan year, or other 12-consecutive 
month period designated by a plan (and not prohibited under regulations 
prescribed by the Secretary of Labor) during which the participant has 
not completed more than 500 hours of service. In the case of a plan 
utilizing the elapsed time method, the term ``1-year break in service'' 
means a 12-consecutive month period beginning on the severance from 
service date or any anniversary thereof and ending on the next 
succeeding anniversary of such date; provided, however, that the 
employee during such 12-consecutive-month period does not complete any 
hours of service within the meaning of 29 CFR Part 2530.200b-2(a) for 
the employer or employers maintaining the plan. See regulations 
prescribed by the Secretary of Labor under 29 CFR Part 2530, relating to 
minimum standards for employee pension benefit plans.
    (d) Examples. The rules provided by this section are illustrated by 
the following examples:

    Example 1. (i) X Corporation maintains a defined contribution plan 
to which section 411 applies. The plan uses the calendar year as the 
vesting computation period. In 1980, Employee A, who was hired at age 
35, separates from the service of X Corporation after completing 4 years 
of service. At the time of his separation, Employee A had a 
nonforfeitable right to 25 percent of his employer-derived accrued 
benefit which was not distributed. In 1985, after incurring 5 
consecutive one-year breaks in service. Employee A is re-employed by X 
Corporation and becomes an active participant in the plan. The plan 
provides that, for 1985 and all subsequent years, Employee A's previous 
years of service will not be taken into account for purposes of 
computing the nonforfeitable percentage of his employer-derived accrued 
benefit, solely because of his break in service.
    (ii) The plan fails to satisfy section 411. Section 411(a)(6)(B) 
would permit the plan to disregard Employee A's prior service for 
purposes of computing his nonforfeitable percentage in 1985 only, but 
such service must be taken into account in subsequent years unless there 
is another break in service. Under section 411(a)(6)(C), the plan is not 
required to take Employee A's post-break service into account for 
purposes of computing his nonforfeitable right to his prebreak employer-
derived accrued benefits. This provision, however, would not permit the 
plan to disregard pre-break service in determining his nonforfeitable 
right to his benefit accrued after the break. The exception provided by 
section 411(a)(6)(D) does not apply in the case of a participant who has 
any nonforfeitable right to his accrued benefit derived from employer 
contributions.
    Example 2. (i) X Corporation maintains a qualified plan to which 
sections 410 and 411 (relating to minimum participation standards and 
minimum vesting standards, respectively) apply. The plan permits 
participation upon completion of a year of service and provides that 
100% of an employee's employer-derived accrued benefit vests after 10 
years of service. The plan uses the calendar year as the vesting 
computation period. The plan provides that an employee who completes at 
least 1,000 hours of service in a 12-month period is credited with a 
year of service for participation and vesting purposes. The plan also 
provides that an employee who does not complete more than 500 hours of 
service in that 12-month period incurs a one-year break in service. The 
plan includes the rule described in section 411 (a)(6)(D) for 
participation and vesting purposes. Under this rule, an employee's years 
of service prior to a break in service may be disregarded under certain 
circumstances if he has no vested right to any employer-derived benefit 
under the plan. The plan does not contain the rule described in section 
411(a)(6)(B) (relating to the requirement of one year of service after a 
one-year break in service).
    (ii) Employee A commences employment with the X Corporation on 
January 1, 1977. Employee A's employment history for 1977 through 1989 
is as follows:

------------------------------------------------------------------------
                                                               Hours of
                  Year ending December 31                      service
                                                              completed
------------------------------------------------------------------------
1977.......................................................        1,000
1978.......................................................          800
1979.......................................................        1,000
1980.......................................................          400
1981.......................................................        1,000
1982.......................................................            0
1983.......................................................          400
1984.......................................................        1,000
1985.......................................................            0
1986.......................................................            0
1987.......................................................          500
1988.......................................................          200
1989.......................................................        1,000
------------------------------------------------------------------------


Employee A's status as a participant during this period is determined as 
follows:
    1978: Employee A was a plan participant on January 1, 1978, because 
he completed a year of service (1,000 hours) in 1977. He did not 
complete a year of service in 1978 because he completed fewer than 1,000 
hours in that year. Because he completed more than 500

[[Page 781]]

hours of service in 1978, however, Employee A did not incur a one-year 
break in service that year.
    1979: Employee A completes a year of service in 1979. Because he did 
not incur a one-year break in service in 1978, the plan may not 
disregard his 1977 service for purposes of determining his years of 
service as of January 1, 1979.
    1980: Employee A incurs a one-year break in service in 1980.
    1981: Because Employee A had completed 2 years of service prior to 
1981 and had incurred one 1-year break in service prior to 1981, under 
section 411(a)(6)(D), the plan may not disregard his pre-1980 service in 
1981. Employee A completes a year of service in 1981.
    1982: Employee A incurs a one-year break in service in 1982.
    1983: Employee A incurs a one-year break in service in 1983. As of 
the end of 1983, he has completed 3 years of service and has incurred 2 
consecutive one-year breaks in service.
    1984: Employee A completes a year of service in 1984. Under section 
411(a)(6)(D), his pre-1982 service may not be disregarded in 1984 
because, as of the beginning of 1984, his pre-1984 years of service (3) 
exceed his consecutive one-year breaks in service (2).
    1984-1988: Employee A incurs 4 consecutive one-year breaks in 
service during the years 1985 through 1988.
    1989: Employee A's pre-1989 service is disregarded in 1989 and all 
subsequent plan years because his years of service as of January 1, 
1989, equal the number of consecutive one-year breaks he has incurred as 
of that date. Therefore, as of the beginning of 1989, Employee A is not 
a plan participant. Employee A completes a year of service in 1989. 
(Although section 411(a)(6)(D) does not prohibit the plan provision 
under which Employee A's pre-1989 service is disregarded, that section 
does not require such a provision in a qualified plan.)

(Sec. 411 (88 Stat. 901; 26 U.S.C. 411))

[T.D. 7501, 42 FR 42329, Aug. 23, 1977, as amended by T.D. 7703, 45 FR 
40985, June 17, 1980]



Sec. 1.411(a)-7  Definitions and special rules.

    (a) Accrued benefit. For purposes of section 411 and the regulations 
thereunder, the term ``accrued benefit'' means--
    (1) Defined benefit plan. In the case of a defined benefit plan--
    (i) If the plan provides an accrued benefit in the form of an annual 
benefit commencing at normal retirement age, such accrued benefit, or
    (ii) If the plan does not provide an accured benefit in the form 
described in subdivision (i) of this subparagraph, an annual benefit 
commencing at normal retirement age which is the actuarial equivalent 
(determined under section 411(c)(3) and Sec. 1.411(c)-(5) of the 
accrued benefit determined under the plan. In general, the term 
``accrued benefits'' refers only to pension or retirement benefits. 
Consequently, accrued benefits do not include ancillary benefits not 
directly related to retirement benefits such as payment of medical 
expenses (or insurance premiums for such expenses), disability benefits 
not in excess of the qualified disability benefit (see section 411(a)(9) 
and paragraph (c)(3) of this section), life insurance benefits payable 
as a lump sum, incidental death benefits, current life insurance 
protection, or medical benefits described in section 401(h). For 
purposes of this paragraph a subsidized early retirement benefit which 
is provided by a plan is not taken into account, except to the extent of 
determining the normal retirement benefit under the plan (see section 
411(a)(9) and paragraph (c) of this section). The accrued benefit 
includes any optional settlement at normal retirement age under 
actuarial assumptions no less favorable than those which would be 
applied if the employee were terminating his employment at normal 
retirement age. The accrued benefit does not include any subsidized 
value in a joint and survivor annuity to the extent that the annual 
benefit of the joint and survivor annuity does not exceed the annual 
benefit of a single life annuity.
    (2) Defined contribution plan. In the case of a defined contribution 
plan, the balance of the employee's account held under the plan.
    (b) Normal retirement age--(1) General rule. For the purposes of 
section 411 and the regulations thereunder, the term ``normal retirement 
age'' means the earlier of--
    (i) The time specified by a plan at which a plan participant attains 
normal retirement age, or
    (ii) The later of--
    (A) The time the plan participant attains age 65, or

[[Page 782]]

    (B) The 10th anniversary of the date the plan participant commences 
participation in the plan.

If a plan, or the employer sponsoring the plan, imposes a requirement 
that an employee retire upon reaching a certain age, the normal 
retirement age may not exceed that mandatory retirement age. The 
preceding sentence will apply if the employer consistently enforces a 
mandatory retirement age rule, whether or not set forth in the plan or 
any related document. For purposes of subdivision (i) of this 
subparagraph, if an age is not specified by a plan as the normal 
retirement age then the normal retirement age under the plan is the 
earliest age beyond which the participant's benefits under the plan are 
not greater solely on account of his age or service. For purposes of 
paragraph (b)(1)(ii)(B) of this section, participation commences on the 
first day of the first year in which the participant commenced his 
participation in the plan, except that years which may be disregarded 
under section 410(a)(5)(D) may be disregarded in determining when 
participation commenced.
    (2) Examples. The provisions of this paragraph are illustrated by 
the following examples:

    Example 1. Plan A defines normal retirement age as age 65. Under the 
plan, benefits payable to participants who retire at or after age 60 are 
not reduced on account of early retirement. For purposes of section 411 
and the vesting regulations, normal retirement age under Plan A is age 
65 (determined under subparagraph (1)(i) of this paragraph). This is 
true even if in operation all participants retire at age 60.
    Example 2. Plan B does not specify any age as the normal retirement 
age. Under the plan, participants who have attained age 55 are entitled 
to benefits commencing upon retirement but the benefits of participants 
who retire before attaining age 70 are subject to reduction on account 
of early retirement. For purposes of section 411 and the vesting 
regulations the normal retirement age under Plan B is the later of (i) 
age 65, or (ii) the 10th anniversary of the date a plan participant 
commences participation in the plan (assuming such date is prior to age 
70).
    Example 3. The facts are the same as in example (2). Employee X 
first became a participant in Plan B on January 1, 1980 at age 53. His 
participation continued until December 31, 1980, when he separated from 
the service with no vested benefits. After incurring 5 consecutive 1-
year breaks in service, Employee X again becomes an employee and a plan 
participant on January 1, 1986, at age 59. For purposes of section 411, 
Employee X's normal retirement age under Plan B is age 69, the 10th 
anniversary of the date on which his year of plan participation 
commenced. His participation in 1980 may be disregarded under the last 
sentence of paragraph (b)(1) of this section.

    (c) Normal retirement benefit--(1) In general. For purposes of 
section 411 and the regulations thereunder, the term ``normal retirement 
benefit'' means the periodic benefit under the plan commencing upon 
early retirement (if any) or at normal retirement age, whichever benefit 
is greater.
    (2) Periodic benefit. For purposes of subparagraph (1) of this 
paragraph--
    (i) In the case of a plan under which a benefit is payable as an 
annuity in the same form upon early retirement and at normal retirement 
age, the greater benefit is determined by comparing the amount of such 
annuity payments.
    (ii) In the case of a plan under which an annuity benefit payable 
upon early retirement is not in the same form as an annuity benefit 
payable at normal retirement age, the greater benefit is determined by 
converting the annuity benefit payable upon early retirement age into 
the same form of annuity benefit as is payable at normal retirement age 
and by comparing the amount of the converted early retirement benefit 
payment with the amount of the normal retirement benefit payment.
    (iii) In the case of a plan which is integrated with the Social 
Security Act or any other Federal or State law, the periodic benefit 
payable upon and after early retirement age is adjusted for any 
increases in such benefits occurring on or after early retirement age 
which are taken into account under the plan. See however, section 
401(a)(15) and the regulations thereunder.
    (3) Benefits included. For purposes of this paragraph, the normal 
retirement benefit under a plan shall be determined without regard to 
ancillary benefits not directly related to retirement benefits such as 
medical benefits or disability benefits not in excess of the qualified 
disability benefit; see section 411(a)(7) and paragraph (a)(1) of this 
section. For this purpose, a qualified

[[Page 783]]

disability benefit is a disability benefit which is not in excess of the 
amount of the benefit which would be payable to the participant if he 
separated from service at normal retirement age.
    (4) Early retirement benefit; social security supplement. (i) For 
purposes of this paragraph, the early retirement benefit under a plan 
shall be determined without regard to any social security supplement.
    (ii) For purposes of this subparagraph, a social security supplement 
is a benefit for plan participants which--
    (A) Commences before the age and terminates before the age when 
participants are entitled to old-age insurance benefits, unreduced on 
account of age, under title II of the Social Security Act, as amended 
(see section 202 (a) and (g) of such Act), and
    (B) Does not exceed such old-age insurance benefit.
    (5) Special limitation. If a defined benefit plan bases its normal 
retirement benefits on employee compensation, the compensation must 
reflect the compensation which would have been paid for a full year of 
participation within the meaning of section 411(b)(3). If an employee 
works less than a full year of participation, the compensation used to 
determine benefits under the plan for such year of participation must be 
multiplied by the ratio of the number of hours for a complete year of 
participation to the number of hours worked in such year. A plan whose 
benefit formula is computed on a computation base which cannot decrease 
is not required to adjust employee compensation in the manner described 
in the previous sentence. Thus, for example, if a plan provided a 
benefit based on an employee's compensation for his highest five 
consecutive years or a separate benefit for each year of participation 
based on the employee's compensation for such year the plan would not 
have to so adjust compensation. However, if a plan provided a benefit 
based on an employee's compensation for the employee's last five years 
or the five highest consecutive years out of the last 10 years, the 
compensation, would have to be so adjusted. For special rules for 
applying the limitations on proration of a year of participation for 
benefit accrual, see regulations prescribed by the Secretary of Labor 
under 29 CFR Part 2530, relating to minimum standards for employee 
pension benefit plans.
    (6) Examples. The provisions of this paragraph are illustrated by 
the following examples:

    Example 1. Plan A provides for a benefit equal to 1% of high 5 years 
compensation for each year of service and a normal retirement age of 65. 
The plan also provides for a full unreduced accrued benefit without any 
actuarial reduction for any employee at age 55 with 30 years of service. 
Even though the actuarial value of the early retirement benefit could 
exceed the value of the benefit at the normal retirement age, the normal 
retirement benefit would not include the greater value of the early 
retirement benefit because actuarial subsidies are ignored.
    Example 2. Plan B provides the following benefits: (1) at normal 
retirement age 65, $300/mo. for life and (2) at early retirement age 60, 
$400/mo. for life. The normal retirement benefit is $400/mo., the 
greater of the benefit payable at normal retirement age ($300) or early 
retirement ($400).
    Example 3. Assume the same facts as example (2) except that the 
early retirement benefit of $400 is reduced to $300 upon attainment of 
age 65. If each employee's social security benefit at age 65 is not less 
than $100, the $100 would be considered to be a social security 
supplement and would therefore be ignored. Consequently, the normal 
retirement benefit would be $300.
    Example 4. Plan C provides a benefit at normal retirement age equal 
to 1% per year of service, multiplied by the participant's compensation 
averaged over the 5 years immediately prior to retirement. An early 
retirement benefit is provided upon attainment of age 60 equal to the 
benefit accrued to date of early retirement reduced by 4 percent for 
each year by which the early retirement date precedes the normal 
retirement age of 65. Employee A was hired at age 30, participated 
immediately, and retired at age 65. Employee A's annual compensation was 
$50,000 between ages 55-60 and was reduced to $33,000 after age 60. The 
following table indicates the amount of annual benefit that would have 
been provided by the plan formula if the employee retired at or after 
age 60:

------------------------------------------------------------------------
                                  Final    Percent
             Age                 average   accrued  Reduction    Annual
                               computated  benefit              benefit
------------------------------------------------------------------------
                                   (1)--     (2)--     (3)--       (4)--
------------------------------------------------------------------------
60...........................    $50,000        30      0.80    *$12,000
61...........................     46,600        31       .84      12,135
62...........................     43,200        32       .88      12,165
63...........................     39,800        33       .92      12,083
64...........................     36,400        34       .96      11,881

[[Page 784]]

 
65...........................     33,000        35      1.00      11,550
Note. Col. (1) times col. (2) times col. (3) equals col. (4).


The normal retirement benefit is the greater of the benefit payable at 
normal retirement age or the early retirment benefit. Employee A's 
normal retirement benefit is $12,165, the greatest annual benefit 
Employee A would be entitled to.

    (d) Rules relating to certain distributions and cash-outs of accrued 
benefits--(1) In general. This paragraph sets forth vesting rules 
applicable to certain distributions from qualified plans and their 
related trusts (other than class year plans). Subparagraphs (2) and (3) 
set forth the exceptions to nonforfeitability on account of withdrawal 
of mandatory contributions provided by section 411(a)(3)(D). When a plan 
utilizes these exceptions with respect to a given participant's accrued 
benefit, such accrued benefit is not subject to the cash-out rules or 
vesting rules of subparagraphs (4) or (5), respectively. Section 411 
prescribes certain requirements with respect to accrued benefits under a 
qualified plan. These requirements would generally not be satisfied if 
the plan disregarded service in computing accrued benefits even though 
amounts were distributed on account of such service. Subparagraph (4) of 
this paragraph sets forth rules under section 411(a)(7)(B) which allow a 
plan to make distributions and compute accrued benefits without regard 
to the accrued benefit attributable to the distribution. When a defined 
contribution plan utilizes this exception with respect to an accrued 
benefit, the plan is not required to satisfy the rules of subparagraph 
(5) of this paragraph. Subparagraph (5) of this paragraph sets forth a 
vesting requirement applicable to certain distributions from defined 
contribution plans. Subparagraph (6) sets forth other rules which 
pertain to the distribution rules of this paragraph.
    (2) Withdrawal of mandatory contribution--(i) General rule. In the 
case of a participant's right to his employer-derived accrued benefit, a 
right is not treated as forfeitable merely because all or a portion of 
such benefit may be forfeited on account of the withdrawal by the 
participant of any amount attributable to his accrued benefit derived 
from his mandatory contributions (within the meaning of section 
411(c)(2)(C) and Sec. 1.411(c)-1) before he has become a 50 percent 
vested participant (within the meaning of Sec. 1.401(a)-19(b)(2)). For 
purposes of determining the vested percentage, the plan may disregard 
service after the withdrawal. For example, assume that a plan utilizes 
1000 hours for computing years of service and that for the computation 
period employee A had 1000 hours of service. If A was 40 percent vested 
at the beginning of the period but only had 800 hours at the time of the 
withdrawal, the plan could treat A as only 40 percent vested because 
service after the withdrawal can be disregarded. On the other hand, if A 
had 1000 hours at the time of the withdrawal, he must receive a year of 
service for the computation period, even though service is not taken 
into account until the end of such period.
    (ii) Plan repayment provision. (A) Subdivision (i) of this 
subparagraph shall not apply unless, at the time the amount described in 
such subdivision is withdrawn by the participant, the plan provides the 
employee with a right to restoration of his employer-derived accrued 
benefit to the extent forfeited in accordance with such subdivision upon 
repayment to the plan of the full amount of the withdrawal.
    (B) In the case of a defined benefit plan (as defined in section 
414(j)) the restoration of the employee's employer-derived accrued 
benefit may be conditioned upon repayment of interest on the full amount 
of the distribution. Such interest shall be computed on the amount of 
the distribution from the date of such distribution to the date of 
repayment, compounded annually from the date of distribution, at the 
rate determined under section 411(c)(2)(C) in effect on the date of 
repayment. A plan may provide for repayment of interest which is less 
than the amount determined under the preceding sentence.
    (C) In the case of both defined benefit plans and defined 
contribution plans, the plan repayment provision described

[[Page 785]]

in this subparagraph may provide that the employee must repay the full 
amount of the distribution in order to have the forfeited benefit 
restored. The plan provision may not require that such repayment be made 
sooner than the time described in paragraph (d)(2)(ii)(D) of this 
section.
    (D)(1) If a distribution is on account of separation from service, 
the time for repayment may not end before the earlier of--
    (i) 5 years after the first day the employee is subsequently 
employed, or
    (ii) The close of the first period of consecutive 1-year breaks in 
service commencing after the distribution.

If the distribution occurs for any other reason, the time for repayment 
may not end earlier than 5 years after the date of distribution. 
Nevertheless, a plan provision may provide for a longer period in which 
the employee may repay. For example, a plan could allow repayments to be 
made at any time before normal retirement age.
    (2) In the case of a plan utilizing the elapsed time method, 
described in Sec. 1.410(a)-7, the minimum time for repayment shall be 
determined as in paragraph (d)(2)(ii)(D)(1) of this section except as 
provided in this subdivision. The 5 consecutive 1-year break periods 
shall be determined by substituting the term ``1-year period of 
severance'' for the term ``1-year break in service''. Also, the 
repayment period both commences and closes in a manner determined by the 
Commissioner that is consistent with the rules in Sec. 1.410(a)-7 and 
the substitution in section 411(a)(6) (C) and (D) of a 5-year break-in-
service rule for the former 1-year break-in-service rule.
    (E) A defined benefit plan using the break-in-service rule described 
in section 410(a)(5)(D) or a defined contribution plan using the break-
in-service rule described in section 411(a)(6)(C) for determining 
employees' accrued benefits is not required to provide for repayment by 
an employee whose accrued benefit is disregarded by reason of a plan 
provision using these rules.
    (iii) Computation of benefit. In the case of a defined contribution 
plan, the employer-derived accrued benefit required to be restored by 
this subparagraph shall not be less than the amount in the account 
balance of the employee which was forfeited, unadjusted by any 
subsequent gains or losses.
    (iv) Delayed forfeiture. A defined contribution plan may, in lieu of 
the forfeiture and restoration described in this subparagraph, provide 
that the forfeiture does not occur until the expiration of the time for 
repayment described in subdivision (ii) of this subparagraph provided 
that the conditions of this subparagraph are satisfied.
    (3) Withdrawal of mandatory contributions; accruals before September 
2, 1974--(i) General rule. In the case of a participant's right to the 
portion of the employer-derived benefit which accrued prior to September 
2, 1974, a right is not treated as forfeitable merely because all or 
part of such portion may be forfeited on account of the withdrawal by 
the participant of an amount attributable to his benefit derived from 
mandatory contributions (within the meaning of section 411(c)(2)(C) and 
Sec. 1.411(c)-1(c)(4)) made by the participant before September 2, 
1974, if the amount so subject to forfeiture is no more than 
proportional to such amounts withdrawn. This subparagraph shall not 
apply to any plan to which any mandatory contribution (within the 
meaning of section 411(c)(2)(C) and Sec. 1.411(c)-1(c)(4)) is made 
after September 2, 1974.
    (ii) Defined contribution plan. In the case of a defined 
contribution plan, the portion of a participant's employer-derived 
benefit which accrued prior to September 2, 1974, shall be determined on 
the basis of a separate accounting between benefits accruing before and 
after such date. Gains, losses, withdrawals, forfeitures, and other 
credits or charges must be separately allocated to such benefits. Any 
allocation made on a reasonable and consistent basis prior to September 
1, 1977, shall satisfy the requirements of this subdivision.
    (iii) Defined benefit plan. In the case of a defined benefit plan, 
the portion of a participant's employer-derived benefit which accrued 
prior to September 2, 1974, shall be determined in a manner consistent 
with the determination of an accrued benefit under section 411(b)(1)(D) 
(see Sec. 1.411(b)-1(c)). Any

[[Page 786]]

method of determining such accrued benefit which the Commissioner finds 
to be reasonable shall satisfy the requirements of this subdivision.
    (4) Certain cash-outs of accrued benefits--(i) Involuntary cash-
outs. For purposes of determining an employee's right to an accrued 
benefit derived from employer contributions under a plan, the plan may 
disregard service performed by the employee with respect to which--
    (A) The employee receives a distribution of the present value of his 
entire nonforfeitable benefit at the time of the distribution;
    (B) The requirements of section 411(a)(11) are satisfied at the time 
of the distribution;
    (C) The distribution is made due to the termination of the 
employee's participation in the plan; and
    (D) The plan has a repayment provision which satisfies the 
requirements of paragraph (d)(4)(iv) of this section in effect at the 
time of the distribution.
    (ii) Voluntary cash-outs. For purposes of determining an employee's 
accrued benefit derived from employer contributions under a plan, the 
plan may disregard service performed by the employee with respect to 
which--
    (A) The employee receives a distribution of the present value of his 
nonforfeitable benefit attributable to such service at the time of such 
distribution,
    (B) The employee voluntarily elects to receive such distribution,
    (C) The distribution is made on termination of the employee's 
participation in the plan, and
    (D) The plan has a repayment provision in effect at the time of the 
distribution which satisfies the requirements of subdivision (iv) of 
this subparagraph.

A distribution shall be deemed to be made on termination of 
participation in the plan if it is made not later than the close of the 
second plan year following the plan year in which such termination 
occurs. For purposes of determining the nonforfeitable benefit, the plan 
may disregard service after the distribution as illustrated in 
subparagraph (2)(i) of this subparagraph.
    (iii) Disregard of service. Service of an employee permitted to be 
disregarded under subdivision (i) or (ii) of the subparagraph is not 
required to be taken into account in computing the employee's accrued 
benefit under the plan. In the case of a voluntary distribution 
described in subdivision (ii) of this subparagraph which is less than 
the present value of the employee's total nonforfeitable benefit 
immediately prior to the distribution, the accrued benefit not required 
to be taken into account is such total accrued benefit multiplied by a 
fraction, the numerator of which is the amount of the distribution and 
the denominator of which is the present value of his total 
nonforfeitable benefit immediately prior to such distribution. For 
example, A who is 50 percent vested in an account balance of $1,000 
receives a voluntary distribution of $250. The accrued benefit which can 
be disregarded equals $1,000 times $250/$500, or $500. However, such 
service may not by reason of this paragraph be disregarded for purposes 
of determining an employee's years of service under sections 410(a)(3) 
and 411(a)(4).
    (iv) Plan repayment provision. (A) A plan repayment provision 
satisfies the requirements of this subdivision if, under the provision, 
the accrued benefit of an employee that is disregarded by a plan under 
this subparagraph is restored upon repayment to the plan by the employee 
of the full amount of the distribution. An accrued benefit is not 
restored unless all of the optional forms of benefit and subsidies 
relating to such benefit are also restored. A plan is not required to 
provide for repayment of an accrued benefit unless the employee--
    (1) Received a distribution that is in a plan year to which section 
411 applies (see Sec. 1.411(a)-2), which distribution is less than the 
amount of his accrued benefit determined under the same optional form of 
benefit as the distribution was made, and
    (2) Resumes employment covered under the plan.
    (B) Example. Plan A provides a single sum distribution equal to the 
present value of the normal form of the accrued benefit payable at 
normal retirement age which is a single life annuity. Plan A also 
provides a subsidized joint and survivor annuity and a subsidized

[[Page 787]]

early retirement annuity benefit. A participant who is fully vested and 
receives a single sum distribution equal to the present value of the 
single life annuity normal retirement benefit is not required to be 
provided the right under the plan to repay the distribution upon 
subsequent reemployment even though the participant received a 
distribution that did not reflect the value of the subsidy in the joint 
and survivor annuity or the value of the early retirement annuity 
subsidy. This is true whether or not the participant had satisfied at 
the time of the distribution all of the conditions necessary to receive 
the subsidies. However, if a participant does not receive his total 
accrued benefit in the optional form of benefit under which his benefit 
was distributed, the plan must provide for repayment. If the employee 
repays the distribution in accordance with section 411(a)(7), the plan 
must restore the employee's accrued benefit which would include the 
right to receive the subsidized joint and survivor annuity and the 
subsidized early retirement annuity benefit.
    (C) A plan may impose the same conditions on repayments for the 
restoration of employer-derived accrued benefits that are allowed as 
conditions for restoration of employer-derived accrued benefits upon 
repayment of mandatory contributions under paragraphs (d)(2)(ii) (B), 
(C), (D) and (E) of this section.
    (v) In the case of a defined contribution plan, the employer-derived 
accrued benefit required to be restored by this subparagraph shall not 
be less than the amount in the account balance of the employee, both the 
amount distributed and the amount forfeited, unadjusted by any 
subsequent gains or losses. Thus, for example, if an employee received a 
distribution of $250 when he was 25 percent vested in an account balance 
of $1,000, upon repayment of $250 the account balance may not be less 
than $1,000 even if, because of plan losses, the account balance, if not 
distributed, would have been reduced to $500.
    (vi) For purposes of paragraph (d)(4)(i) of this section, a 
distribution shall be deemed to be made due to the termination of an 
employee's participation in the plan if it is made no later than the 
close of the second plan year following the plan year in which such 
termination occurs, or if such distribution would have been made under 
the plan by the close of such second plan year but for the fact that the 
present value of the nonforfeitable accrued benefit then exceeded the 
cash-out limit in effect under Sec. 1.411(a)-11(c)(3)(ii). For purposes 
of determining the entire nonforfeitable benefit, the plan may disregard 
service after the distribution, as illustrated in paragraph (d)(2)(i) of 
this section.
    (vii) Effective date. Paragraphs (d)(4)(i) and (vi) of this section 
apply to distributions made on or after March 22, 1999. However, an 
employer is permitted to apply paragraphs (d)(4)(i) and (vi) of this 
section to plan years beginning on or after August 6, 1997. Otherwise, 
for distributions prior to March 22, 1999, Sec. Sec. 1.411(a)-7 and 
1.411(a)-7T, in effect prior to October 17, 2000 (as contained in 26 CFR 
part 1, revised as of April 1, 2000) apply.
    (5) Vesting requirement for defined contribution plans--(i) 
Application. The requirements of this subparagraph apply to a defined 
contribution plan which makes distributions to employees from their 
accounts attributable to employer contributions at a time when--
    (A) Employees are less than 100 percent vested in such accounts, and
    (B) Under the plan, employees can increase their percentage of 
vesting in such accounts after the distributions.
    (ii) Requirements. In order for a plan, to which this subparagraph 
applies, to satisfy the vesting requirements of section 411, account 
balances under the plan (with respect to which percentage vesting can 
increase) must be computed in a manner which satisfies either 
subdivision (iii) (A) or (B) of this subparagraph.
    (iii) Permissible methods. A plan many provide for either of the 
following methods, but not both, for computing account balances with 
respect to which percentage vesting can increase and from which 
distributions are made:
    (A)(1) A separate account is established for the employee's interest 
in the plan as of the time of the distribution, and

[[Page 788]]

    (2) At any relevant time the employee's vested portion of the 
separate account is not less than an amount (``X'') determined by the 
formula: X=P(AB+(RxD))-(RxD). For purposes of applying the formula: P is 
the vested percentage at the relevant time; AB is the account balance at 
the relevant time; D is the amount of the distribution; R is the ratio 
of the account balance at the relevant time to the account balance after 
distribution; and the relevant time is the time at which, under the 
plan, the vested percentage in the account cannot increase.

A plan is not required to provide for separate accounts provided that 
account balances are maintained under a method that has the same effect 
as under this subdivision.
    (B) At any relevant time the employee's vested portion is not less 
than an amount (``X'') determined by the formula: X=P(AB+D)-D. For 
purposes of applying the formula, the terms have the same meaning as 
under subdivision (iii)(A)(2) of this subparagraph.
    (C) An application of the methods described in subdivisions (iii) 
(A) and (B) of this subparagraph is illustrated by the following 
examples:

    Example 1. The X defined contribution plan uses the method described 
in subdivision (iii)(A) of this subparagraph for computing account 
balances and the break in service rule described in section 411(a)(6)(C) 
(service after a 1-year break does not increase the vesting percentage 
in account balances accrued prior to the break). The plan distributes 
$250 to A when A's account balance prior to the distribution equals 
$1,000 and he is 25 percent vested. At the time of the distribution, A 
has not incurred a 1-year break so that his vesting percentage can 
increase. Six years later, when A is 60 percent vested, he incurs a 1-
year break so that his vesting percentage cannot increase. At this time 
his separate account balance equals $1,500. R=$1,500/$750 or 2. A's 
separate account must equal 60 percent ($1,500+(2x$250))-(2x$250) or 60 
percent ($1,500+$500)-$500, or $1,200-$500 equals $700.
    Example 2. The Y defined contribution plan uses the method descirbed 
in subdivision (iii)(B) of this subparagraph for computing account 
balances and the break in service rule described in section 
411(a)(6)(C). The plan distributes $250 to B when B's account balance 
prior to the distribution equals $1,000 and he is 25 percent vested. At 
the time of the distribution, B has not incurred a 1-year break so that 
his vesting percentage can increase. Six years later, when A is 60 
percent vested, he incurs a 1-year break so that his vesting percentage 
cannot increase. At this time his account balance equals $1,500. B's 
separate account must equal 60 percent ($1,500+$250)-$250, 60% of 
$1,750-$250 equals $800.

    (6) Other rules--(i) Distributions on separation or other event. 
None of the rules of this paragraph preclude distributions to employees 
upon separation from service or any other event recognized by the plan 
for commencing distributions. Such a distribution must, of course, 
satisfy the applicable qualification requirements pertaining to such 
distributions. For example, a profitsharing plan could pay the vested 
portion of an account balance to an employee when he separated from 
service, but in order to satisfy section 411 the plan might not be able 
to forfeit the nonvested account balance until the employee has a 1-year 
break in service. Similarly, the fact that a plan cannot disregard an 
accrued benefit attributable to service for which an employee has 
received a distribution because the plan does not satisfy the cash-out 
requirements of subparagraph (4) of this paragraph does not mean that 
the employee's accrued benefit (computed by taking into account such 
service) cannot be offset by the accrued benefit attributable to the 
distribution.
    (ii) Joint and survivor requirements. See Sec. 1.401(a)-11(a)(2) 
(relating to joint and survivor annuities) for special rules applicable 
to certain distributions described in this paragraph.
    (iii) Plan repayments. (A) Under subparagraphs (2) and (4) of this 
paragraph, a plan may be required to restore accrued benefits in the 
event of repayment by an employee.
    (B) For purposes of applying the limitations of section 415 (c) and 
(e), in the case of a defined contribution plan, the repayment by the 
employee and the restoration by the employer shall not be treated as 
annual additions.
    (C) In the case of a defined contribution plan, the permissible 
sources for restoration of the accrued benefit are: income or gain to 
the plan, forfeitures, or employer contributions. Notwithstanding the 
provisions of Sec. 1.401-1(b)(1)(ii), contributions may be made for 
such an accrued benefit by a profit-

[[Page 789]]

sharing plan even though there are no profits. In order for such a plan 
to be qualified, account balances (accrued benefits) generally must 
correspond to assets in the plan. Accordingly, there cannot be an 
unfunded account balance. However, an account balance will not be deemed 
to be unfunded in the case of a restoration if assets for the restored 
benefit are provided by the end of the plan year following the plan year 
in which the repayment occurs.

(Sec. 411 (88 Stat. 901; 26 U.S.C. 411))

[T.D. 7501, 42 FR 42329, Aug. 23, 1977, as amended by T.D. 8038, 50 FR 
29374, July 19, 1985; T.D. 8219, 53 FR 31852, Aug. 22, 1988; 53 FR 
48534, Dec. 1, 1988; T.D. 8794, 63 FR 70337, Dec. 21, 1998; T.D. 8891, 
65 FR 44681, July 19, 2000]



Sec. 1.411(a)-8  Changes in vesting schedule.

    (a) Requirement of prior schedule. Under section 411(a)(10)(A), for 
plan years for which section 411 applies, a plan will be treated as not 
meeting the minimum vesting standards of section 411(a)(2) if the plan 
does not satisfy the requirements of this paragraph. If the vesting 
schedule of a plan is amended, then as of the date such amendment is 
adopted, the plan satisfies the requirements of this paragraph if, under 
the plan as amended, in the case of an employee who is a participant 
on--
    (1) The date the amendment is adopted, or
    (2) The date the amendment is effective, if later.

The nonforfeitable percentage (determined as of such date) of such 
employee's right to his employer-derived accrued benefit is not less 
than his percentage computed under the plan without regard to such 
amendment.
    (b) Election of former schedule--(1) In general. Under section 411 
(a)(10)(B), for plan years for which section 411 applies, if the vesting 
schedule of a plan is amended, the plan will not be treated as meeting 
the minimum vesting standards of section 411 (a)(2) unless the plan as 
amended, provides that each participant whose nonforfeitable percentage 
of his accrued benefit derived from employer contributions is determined 
under such schedule, and who has completed at least 5 years of service 
with the employer, may elect, during the election period, to have the 
nonforfeitable percentage of his accrued benefit derived from employer 
contributions determined without regard to such amendment. 
Notwithstanding the preceding sentence, no election need be provided for 
any participant whose nonforfeitable percentage under the plan, as 
amended, at any time cannot be less than such percentage determined 
without regard to such amendment.
    (2) Election period. For purposes of subparagraph (1) of this 
paragraph, the election period under the plan must begin no later than 
the date the plan amendment is adopted and end no earlier than the 
latest of the following dates:
    (i) The date which is 60 days after the day the plan amendment is 
adopted,
    (ii) The date which is 60 days after the day the plan amendment 
becomes effective, or
    (iii) The date which is 60 days after the day the participant is 
issued written notice of the plan amendment by the employer or plan 
administrator.
    (3) Service requirement. For purposes of subparagraph (1) of this 
paragraph, a participant shall be considered to have completed 5 years 
of service if such participant has completed 5 years of service, whether 
or not consecutive, without regard to the exceptions of section 
411(a)(4) prior to the expiration of the election period described in 
subparagraph (2) of this paragraph. For the meaning of the term ``year 
of service'', see regulations prescribed by the Secretary of Labor under 
29 CFR Part 2530, relating to minimum standards for employee pension 
benefit plans.
    (4) Election only by participant. The election described in 
subparagraph (1) of this paragraph is available only to an individual 
who is a participant in the plan at the time such election is made.
    (5) Election may be irrevocable. A plan, as amended, shall not fail 
to meet the minimum vesting standards of section 411(a)(2) by reason of 
section 411(a)(10)(B) merely because such plan provides that the 
election described in subparagraph (1) of this paragraph is irrevocable.
    (6) Relationship with section 411(a)(2). The election described in 
subparagraph

[[Page 790]]

(1) of this paragraph is available for a vesting schedule which does not 
satisfy the requirements of section 411(a)(2) only if under such 
schedule all participants have a 50 percent nonforfeitable right after 
10 years of service, and a 100 percent nonforfeitable right after 15 
years of service, in their employer-derived accrued benefit. If the 
vesting schedule provides less vesting than the percentages required by 
the preceding sentence, the plan can be amended to provide for such 
vesting.
    (c) Special rules--(1) Amendment of vesting schedule. For purposes 
of this section, an amendment of a vesting schedule is each plan 
amendment which directly or indirectly affects the computation of the 
nonforfeitable percentage of employees' rights to employer-derived 
accrued benefits. Consequently, such an amendment, for example, includes 
each change in the plan which affects either the plan's computation of 
years of service or of vesting percentages for years of service.
    (2) Aggregation of amendments. All plan amendments which are: (i) 
amendments of a vesting schedule within the meaning of subparagraph (1) 
of this paragraph and (ii) adopted and effective at the same time, shall 
be deemed to be a single amendment for purposes of applying the rules in 
paragraphs (a) and (b) of this section.
    (3) Relationship with section 411(d)(6). For additional requirements 
relating to section 411(d)(6), see Sec. 1.411(d)-3(a)(3).

(Sec. 411 (88 Stat. 901; 26 U.S.C. 411))

[T.D. 7501, 42 FR 42333, Aug. 23, 1977, as amended by T.D. 9280, 71 FR 
45383, Aug. 9, 2006]



Sec. 1.411(a)-8T  Changes in vesting schedule (temporary).

    (a) [Reserved]
    (b) Election of former schedule--(1) In general. Under section 
411(a)(10)(B), for plan years for which section 411 applies, if the 
vesting schedule of a plan is amended, the plan will not be treated as 
meeting the minimum vesting standards of section 411(a)(2) unless the 
plan as amended provides that each participant whose nonforfeitable 
percentage of his accrued benefit derived from employer contributions is 
determined under such schedule, and who has completed at least 3 years 
of service with the employer, may elect, during the election period, to 
have the nonforfeitable percentage of his accrued benefit derived from 
employer contributions determined without regard to such amendment. 
Notwithstanding the preceding sentence, no election need be provided for 
any participant whose nonforfeitable percentage under the plan, as 
amended, at any time cannot be less than such percentage determined 
without regard to such amendment. For employees not described in Sec. 
1.411(a)-3T(e)(1), this section shall be applied by substituting ``5 
years of service'' for ``3 years of service'' where such language 
appears.
    (2) Election period. For purposes of subparagraph (1) of this 
paragraph, the election period under the plan must begin no later than 
the date the plan amendment is adopted and end no earlier than the 
latest of the following dates:
    (i) The date which is 60 days after the day the plan amendment is 
adopted,
    (ii) The date which is 60 days after the day the plan amendment 
becomes effective, or
    (iii) The date which is 60 days after the day the participant is 
issued written notice of the plan amendment by the employer or plan 
administrator.
    (3) Service requirement. For purposes of subparagraph (1) of this 
paragraph, a participant shall be considered to have completed 3 years 
of service if such participant has completed 3 years of service, whether 
or not consecutive, without regard to the exceptions of section 
411(a)(4) prior to the expiration of the election period described in 
subparagraph (2) of this paragraph. For the meaning of the term ``year 
of service'', see regulations prescribed by the Secretary of Labor under 
29 CFR Part 2530, relating to minimum standards for employee pension 
benefit plans.

[T.D. 8170, 53 FR 241, Jan. 6, 1988]



Sec. 1.411(a)-9  Amendment of break in service rules; transitional 
period.

    (a) In general. Under section 1017(f)(2) of the Employee Retirement 
Income Security Act of 1974, a plan is not a qualified plan (and a trust 
forming a part of such plan is not a qualified

[[Page 791]]

trust) if the rules of the plan relating to breaks in service are 
amended, and--
    (1) Such amendment is effective after January 1, 1974, and before 
the effective date of section 411, and
    (2) Under such amendment, the nonforfeitable percentage of any 
employee's right to his employer-derived accrued benefit is less than 
the lesser of the nonforfeitable percentage of such employee's right to 
such benefit--
    (i) Under the break in service rules provided by section 411(a)(6) 
and Sec. 1.411(a)-6(c), or
    (ii) The greatest such percentage under the plan as in effect on or 
after January 1, 1974 (provided the break in service rules of the plan 
were not in violation of any law or rule of law on January 1, 1974).
    (b) Break in service rules. For purposes of paragraph (a), the term 
``break in service rules'' means the rules provided by a plan relating 
to circumstances under which a period of an employee's service or plan 
participation is disregarded, for purposes of determining the extent to 
which his rights to his accrued benefit under the plan are 
unconditional, if under such rules such service is disregarded by reason 
of the employee's failure to complete a required period of service 
within a specified period of time. For this purpose, plan rules which 
result in the loss of prior vesting or benefit accruals of an employee, 
or which deny an employee eligibility to participate, by reason of 
separation or failure to complete a required period of service within a 
specified period of time (e.g., 300 hours in one year) will be 
considered break in service rules. For purposes of section 411(b)(3), 
service described under the plan's break in service rules, as in effect 
before the effective date of section 411, need not be counted.

(Sec. 411 (88 Stat. 901; 26 U.S.C. 411))

[T.D. 7501, 42 FR 42333, Aug. 23, 1977]



Sec. 1.411(a)-11  Restriction and valuation of distributions.

    (a) Scope--(1) In general. Section 411(a)(11) restricts the ability 
of a plan to distribute any portion of a participant's accrued benefit 
without the participant's consent. Section 411(a)(11) also restricts the 
ability of defined benefit plans to distribute any portion of a 
participant's accrued benefit in optional forms of benefit without 
complying with specified valuation rules for determining the amount of 
the distribution. If the consent requirements or the valuation rules of 
this section are not satisfied, the plan fails to satisfy the 
requirements of section 411(a).
    (2) Accrued benefit. For purposes of this section, an accrued 
benefit is valued taking into consideration the particular optional form 
in which the benefit is to be distributed. The value of an accrued 
benefit is the present value of the benefit in the distribution form 
determined under the plan. For example, a plan that provides a 
subsidized early retirement annuity benefit may specify that the 
optional single sum distribution form of benefit available at early 
retirement age is the present value of the subsidized early retirement 
annuity benefit. In this case, the subsidized early retirement annuity 
benefit must be used to apply the valuation requirements of this section 
and the resulting amount of the single sum distribution. However, if a 
plan that provides a subsidized early retirement annuity benefit 
specifies that the single sum distribution benefit available at early 
retirement age is the present value of the normal retirement annuity 
benefit, then the normal retirement annuity benefit is used to apply the 
valuation requirements of this section and the resulting amount of the 
single sum distribution available at early retirement age.
    (b) General consent rules. A plan must satisfy the participant 
consent requirement with respect to the distribution of a participant's 
nonforfeitable accrued benefit with a present value in excess of the 
cash-out limit in effect under paragraph (c)(3)(ii) of this section. See 
paragraphs (c) (3) and (4) for situations where no consent is required.
    (c) Consent, etc. requirements--(1) General rule. If an accrued 
benefit is immediately distributable, section 411(a)(11) permits plans 
to provide for the distribution of any portion of a participant's 
nonforfeitable accrued benefits only if the applicable consent 
requirements are satisfied.

[[Page 792]]

    (2) Consent. (i) No consent is valid unless the participant has 
received a general description of the material features of the optional 
forms of benefit available under the plan. In addition, so long as a 
benefit is immediately distributable, a participant must be informed of 
the right, if any, to defer receipt of the distribution. Furthermore, 
consent is not valid if a significant detriment is imposed under the 
plan on any participant who does not consent to a distribution. Whether 
or not a significant detriment is imposed shall be determined by the 
Commissioner by examining the particular facts and circumstances.
    (ii) Consent of the participant to the distribution must not be made 
before the participant receives the notice of his or her rights 
specified in this paragraph (c)(2) and must not be made more than 90 
days before the date the distribution commences.
    (iii) A plan must provide a participant with notice of the rights 
specified in this paragraph (c)(2) at a time that satisfies either 
paragraph (c)(2)(iii)(A) or (B) of this section:
    (A) This paragraph (c)(2)(iii)(A) is satisfied if the plan provides 
a participant with notice of the rights specified in this paragraph 
(c)(2) no less than 30 days and no more than 90 days before the date the 
distribution commences. However, if the participant, after having 
received this notice, affirmatively elects a distribution, a plan will 
not fail to satisfy the consent requirement of section 411(a)(11) merely 
because the distribution commences less than 30 days after the notice 
was provided to the participant, provided the plan administrator clearly 
indicates to the participant that the participant has a right to at 
least 30 days to consider whether to consent to the distribution.
    (B) This paragraph (c)(2)(iii)(B) is satisfied if the plan--
    (1) Provides the participant with notice of the rights specified in 
this paragraph (c)(2);
    (2) Provides the participant with a summary of the notice within the 
time period described in paragraph (c)(2)(iii)(A) of this section; and
    (3) If the participant so requests after receiving the summary 
described in paragraph (c)(2)(iii)(B)(2) of this section, provides the 
notice to the participant without charge and no less than 30 days before 
the date the distribution commences, subject to the rules for the 
participant's waiver of that 30-day period. The summary described in 
paragraph (c)(2)(iii)(B)(2) of this section must advise the participant 
of the right, if any, to defer receipt of the distribution, must set 
forth a summary of the distribution options under the plan, must refer 
the participant to the most recent version of the notice (and, in the 
case of a notice provided in any document containing information in 
addition to the notice, must identify that document and must provide a 
reasonable indication of where the notice may be found in that document, 
such as by index reference or by section heading), and must advise the 
participant that, upon request, a copy of the notice will be provided 
without charge.
    (iv) For purposes of satisfying the requirements of this paragraph 
(c)(2), the plan administrator may substitute the annuity starting date, 
within the meaning of Sec. 1.401(a)-20, Q&A-10, for the date the 
distribution commences.
    (v) See Sec. 1.401(a)-20, Q&A-24 for a special rule applicable to 
consents to plan loans.
    (3) Cash-out limit. (i) Written consent of the participant is 
required before the commencement of the distribution of any portion of 
an accrued benefit if the present value of the nonforfeitable total 
accrued benefit is greater than the cash-out limit in effect under 
paragraph (c)(3)(ii) of this section on the date the distribution 
commences. The consent requirements are deemed satisfied if such value 
does not exceed the cash-out limit, and the plan may distribute such 
portion to the participant as a single sum. Present value for this 
purpose must be determined in the same manner as under section 417(e); 
see Sec. 1.417(e)-1(d).
    (ii) The cash-out limit in effect for a date is the amount described 
in section 411(a)(11)(A) for the plan year that includes that date. The 
cash-out limit in effect for dates in plan years beginning on or after 
August 6, 1997, is $5,000. The cash-out limit in effect for dates in 
plan years beginning before August 6, 1997, is $3,500.

[[Page 793]]

    (iii) Effective date. Paragraphs (c)(3)(i) and (ii) of this section 
apply to distributions made on or after October 17, 2000. However, an 
employer is permitted to apply the $5,000 cash-out limit described in 
paragraph (c)(3)(ii) of this section to plan years beginning on or after 
August 6, 1997. Otherwise, for distributions prior to October 17, 2000, 
Sec. Sec. 1.411(a)-11 and 1.411(a)-11T in effect prior to October 17, 
2000 (as contained in 26 CFR Part 1 revised as of April 1, 2000) apply.
    (4) Immediately distributable. Participant consent is required for 
any distribution while it is immediately distributable, i.e., prior to 
the later of the time a participant has attained normal retirement age 
(as defined in section 411(a)(8)) or age 62. Once a distribution is no 
longer immediately distributable, a plan may distribute the benefit in 
the form of a QJSA in the case of a benefit subject to section 417 or in 
the normal form in other cases without consent.
    (5) Death of participant. The consent requirements of section 
411(a)(11) do not apply after the death of the participant.
    (6) QDROs. The consent requirements of section 411(a)(11) do not 
apply to payments to an alternate payee, defined in section 414(p)(8), 
except as provided in a qualified domestic relations order pursuant to 
section 414(p).
    (7) Section 401(a)(9), etc. The consent requirements of section 
411(a)(11) do not apply to the extent that a distribution is required to 
satisfy the requirements of section 401(a)(9) or 415. See section 
401(a)(9) and the regulations thereunder and Sec. 1.401(a)-20 Q&A 23 
for guidance on these requirements. Notwithstanding any provision to the 
contrary in section 401(a)(14) or Sec. 1.401(a)-14, a plan may not 
distribute a participant's nonforfeitable accrued benefit with a present 
value in excess of the cash-out limit in effect under paragraph 
(c)(3)(ii) of this section while the benefit is immediately 
distributable unless the participant consents to such distribution. The 
failure of a participant to consent is deemed to be an election to defer 
commencement of payment of the benefit for purposes of section 
401(a)(14) and Sec. 1.401(a)-14.
    (8) Delegation to Commissioner. The Commissioner, in revenue 
rulings, notices, and other guidance published in the Internal Revenue 
Bulletin, may modify, or provide additional guidance with respect to, 
the notice and consent requirements of this section. See Sec. 
601.601(d)(2)(ii)(b) of this chapter.
    (d) Distribution valuation requirements. In determining the present 
value of any distribution of any accrued benefit from a defined benefit 
plan, the plan must take into account specified valuation rules. For 
this purpose, the valuation rules are the same valuation rules for 
valuing distributions as set forth in section 417(e); see Sec. 
1.417(e)-1(d). This paragraph (d) applies both before and after the 
participant's death regardless of whether the accrued benefit is 
immediately distributable. This paragraph also applies whether or not 
the participant's consent is required under paragraphs (b) and (c) of 
this section.
    (e) Special rules--(1) Plan termination. The requirements of this 
section apply before, on and after a plan termination. If a defined 
contribution plan terminates and the plan does not offer an annuity 
option (purchased from a commercial provider), then the plan may 
distribute a participant's accrued benefit without the participant's 
consent. The preceding sentence does not apply if the employer, or any 
entity within the same controlled group as the employer, maintains 
another defined contribution plan, other than an employee stock 
ownership plan (as defined in section 4975(e)(7)). In such a case, the 
participant's accrued benefit may be transferred without the 
participant's consent to the other plan if the participant does not 
consent to an immediate distribution from the terminating plan. See 
section 411(d)(6) and the regulations thereunder for other rules 
applicable to transferee plans and plan terminations.
    (2) ESOP dividends. The requirements of this section do not apply to 
any distribution of dividends to which section 404(k) applies.
    (3) Other rules. See Sec. 1.401(a)-20 Q&As 14, 17 and 24 for other 
rules that apply to the section 411(a)(11) requirements.
    (f) Medium for notice and consent--(1) Notice. The notice of a 
participant's rights described in paragraph (c)(2) of

[[Page 794]]

this section or the summary of that notice described in paragraph 
(c)(2)(iii)(B)(2) of this section must be provided on a written paper 
document. However, see Sec. 1.401(a)-21 of this chapter for rules 
permitting the use of electronic media to provide applicable notices to 
recipients with respect to retirement plans.
    (2) Consent. The consent described in paragraphs (c)(2) and (3) of 
this section must be given on a written paper document. However, see 
Sec. 1.401(a)-21 of this chapter for rules permitting the use of 
electronic media to make participant elections with respect to 
retirement plans.

[T.D. 8219, 53 FR 31853, Aug. 22, 1988; 53 FR 48534, Dec. 1, 1988, as 
amended by T.D. 8620, 60 FR 49221, Sept. 22, 1995; T.D. 8796, 63 FR 
70011, Dec. 18, 1998; T.D. 8794, 63 FR 70338, Dec. 21, 1998; T.D. 8873, 
65 FR 6006, Feb. 8, 2000; T.D. 8891, 65 FR 44681, 44682, July 19, 2000; 
T.D. 9294, 71 FR 61887, Oct. 20, 2006]



Sec. 1.411(a)(13)-1  Statutory hybrid plans.

    (a) In general. This section sets forth certain rules that apply to 
statutory hybrid plans under section 411(a)(13). Paragraph (b) of this 
section describes special rules for certain statutory hybrid plans that 
determine benefits under a lump sum-based benefit formula. Paragraph (c) 
of this section describes the vesting requirement for statutory hybrid 
plans. Paragraphs (d) and (e) of this section contain definitions and 
effective/applicability dates, respectively.
    (b) Calculation of benefit by reference to hypothetical account 
balance or accumulated percentage--(1) Payment of a current balance or 
current value under a lump sum-based benefit formula. Pursuant to 
section 411(a)(13)(A), a statutory hybrid plan that determines any 
portion of a participant's benefits under a lump sum-based benefit 
formula is not treated as failing to meet the following requirements 
solely because, with respect to benefits determined under that formula, 
the present value of those benefits is, under the terms of the plan, 
equal to the then-current balance of the hypothetical account maintained 
for the participant or to the then-current value of the accumulated 
percentage of the participant's final average compensation under that 
formula--
    (i) Section 411(a)(2); or
    (ii) With respect to the participant's accrued benefit derived from 
employer contributions, section 411(a)(11), 411(c), or 417(e).
    (2) Requirements that lump sum-based benefit formula must satisfy to 
obtain relief. [Reserved]
    (3) Alternative forms of distribution under a lump sum-based benefit 
formula. [Reserved]
    (4) Rules of application. [Reserved]
    (c) Three-year vesting requirement--(1) In general. Pursuant to 
section 411(a)(13)(B), if any portion of the participant's accrued 
benefit under a defined benefit plan is determined under a statutory 
hybrid benefit formula, the plan is treated as failing to satisfy the 
requirements of section 411(a)(2) unless the plan provides that the 
participant has a nonforfeitable right to 100 percent of the 
participant's accrued benefit if the participant has three or more years 
of service. Thus, this 3-year vesting requirement applies with respect 
to the entire accrued benefit of a participant under a defined benefit 
plan even if only a portion of the participant's accrued benefit under 
the plan is determined under a statutory hybrid benefit formula. 
Similarly, if the participant's accrued benefit under a defined benefit 
plan is, under the plan's terms, the larger of two (or more) benefit 
amounts, where each amount is determined under a different benefit 
formula (including a benefit determined pursuant to an offset among 
formulas within the plan or a benefit determined as the greater of a 
protected benefit under section 411(d)(6) and another benefit amount) 
and at least one of those formulas is a statutory hybrid benefit 
formula, the participant's entire accrued benefit under the defined 
benefit plan is subject to the 3-year vesting rule of section 
411(a)(13)(B) and this paragraph (c). The rule described in the 
preceding sentence applies even if the larger benefit is ultimately the 
benefit determined under a formula that is not a statutory hybrid 
benefit formula.
    (2) Examples. The provisions of this paragraph (c) are illustrated 
by the following examples:


[[Page 795]]


    Example 1. Employer M sponsors Plan X, a defined benefit plan under 
which each participant's accrued benefit is equal to the sum of the 
benefit provided under two benefit formulas. The first benefit formula 
is a statutory hybrid benefit formula, and the second formula is not. 
Because a portion of each participant's accrued benefit provided under 
Plan X is determined under a statutory hybrid benefit formula, the 3-
year vesting requirement described in paragraph (c)(1) of this section 
applies to each participant's entire accrued benefit provided under Plan 
X.
    Example 2. The facts are the same as in Example 1, except that the 
benefit formulas described in Example 1 only apply to participants for 
service performed in Division A of Employer M and a different benefit 
formula applies to participants for service performed in Division B of 
Employer M. Pursuant to the terms of Plan X, the accrued benefit of a 
participant attributable to service performed in Division B is based on 
a benefit formula that is not a statutory hybrid benefit formula. 
Therefore, the 3-year vesting requirement described in paragraph (c)(1) 
of this section does not apply to a participant with an accrued benefit 
under Plan X if the participant's benefit is solely attributable to 
service performed in Division B.
    Example 3. Employer N sponsors defined benefit Plan Y, an 
independent plan that provides benefits based solely on a lump sum-based 
benefit formula, and defined benefit Plan Z, which provides benefits 
based on a formula which is not a statutory hybrid benefit formula, but 
which is a floor plan that provides for the benefits payable to a 
participant under Plan Z to be reduced by the amount of the vested 
accrued benefit payable under Plan Y. The formula under Plan Y is a 
statutory hybrid benefit formula. Accordingly, Plan Y is subject to the 
3-year vesting requirement described in paragraph (c)(1) of this 
section. The formula provided under Plan Z, even taking into account the 
offset for vested accrued benefits under Plan Y, is not a statutory 
hybrid benefit formula. Therefore, Plan Z is not subject to the 3-year 
vesting requirement in paragraph (c)(1) of this section.

    (d) Definitions--(1) In general. The definitions in this paragraph 
(d) apply for purposes of this section.
    (2) Accumulated benefit. A participant's accumulated benefit at any 
date means the participant's benefit, as expressed under the terms of 
the plan, accrued to that date. For this purpose, if a participant's 
benefit is expressed under the terms of the plan as the current balance 
of a hypothetical account or the current value of an accumulated 
percentage of the participant's final average compensation, the 
participant's accumulated benefit is expressed in that manner regardless 
of how the plan defines the participant's accrued benefit. Thus, for 
example, the accumulated benefit of a participant may be expressed under 
the terms of the plan as either the current balance of a hypothetical 
account or the current value of an accumulated percentage of the 
participant's final average compensation, even if the plan defines the 
participant's accrued benefit as an annuity beginning at normal 
retirement age that is actuarially equivalent to that balance or value.
    (3) Lump sum-based benefit formula--(i) In general. A lump sum-based 
benefit formula means a benefit formula used to determine all or any 
part of a participant's accumulated benefit under a defined benefit plan 
under which the accumulated benefit provided under the formula is 
expressed as the current balance of a hypothetical account maintained 
for the participant or as the current value of an accumulated percentage 
of the participant's final average compensation. A benefit formula is 
expressed as the current balance of a hypothetical account maintained 
for the participant if it is expressed as a current single-sum dollar 
amount. Whether a benefit formula is a lump sum-based benefit formula is 
determined based on how the accumulated benefit of a participant is 
expressed under the terms of the plan, and does not depend on whether 
the plan provides an optional form of benefit in the form of a single-
sum payment.
    (ii) Exception for employee contributions. For purposes of the 
definition of a lump sum-based benefit formula in paragraph (d)(3)(i) of 
this section, the benefit properly attributable to after-tax employee 
contributions, rollover contributions from eligible retirement plans 
under section 402(c)(8), and other similar employee contributions (such 
as repayments of distributions pursuant to section 411(a)(7)(C) and 
employee contributions that are pickup contributions pursuant to section 
414(h)(2)) is disregarded. However, a benefit is not properly 
attributable to contributions described in this paragraph (d)(3)(ii) if

[[Page 796]]

the contributions are credited with interest at a rate that exceeds a 
reasonable rate of interest or if the conversion factors used to 
calculate such benefit are not actuarially reasonable. See section 
411(c) for an example of a calculation of a benefit that is properly 
attributable to employee contributions.
    (4) Statutory hybrid benefit formula--(i) In general. A statutory 
hybrid benefit formula means a benefit formula that is either a lump 
sum-based benefit formula or a formula that is not a lump sum-based 
benefit formula but that has an effect similar to a lump sum-based 
benefit formula.
    (ii) Effect similar to a lump sum-based benefit formula--(A) In 
general. Except as provided in paragraphs (d)(4)(ii)(B) through (D) of 
this section, a benefit formula under a defined benefit plan that is not 
a lump sum-based benefit formula has an effect similar to a lump sum-
based benefit formula if the formula provides that a participant's 
accumulated benefit is expressed as a benefit that includes the right to 
adjustments (including a formula that provides for indexed benefits 
under Sec. 1.411(b)(5)-1(b)(2)) for a future period and the total 
dollar amount of those adjustments is reasonably expected to be smaller 
for the participant than for a similarly situated, younger individual 
(within the meaning of Sec. 1.411(b)(5)-1(b)(5)) who is or could be a 
participant in the plan. A benefit formula that does not include 
adjustments for any future period is treated as a formula with an effect 
similar to a lump sum-based benefit formula if the formula would be 
described in the preceding sentence except for the fact that the 
adjustments are provided pursuant to a pattern of repeated plan 
amendments. See Sec. 1.411(d)-4, A-1(c)(1).
    (B) Exception for post-retirement benefit adjustments. Post-annuity 
starting date adjustments in the amount payable to a participant (such 
as cost-of-living increases) are disregarded in determining whether a 
benefit formula under a defined benefit plan has an effect similar to a 
lump sum-based benefit formula.
    (C) Exception for certain variable annuity benefit formulas. If the 
assumed interest rate used for purposes of the adjustment of amounts 
payable to a participant under a variable annuity benefit formula is 5 
percent or higher, then the variable annuity benefit formula is not 
treated as being reasonably expected to provide a smaller total dollar 
amount of future adjustments for the participant than for a similarly 
situated, younger individual who is or could be a participant in the 
plan, and thus such a variable annuity benefit formula does not have an 
effect similar to a lump sum-based benefit formula.
    (D) Exception for employee contributions. Benefits that are 
disregarded under paragraph (d)(3)(ii) of this section (benefits 
properly attributable to certain employee contributions) are also 
disregarded for purposes of determining whether a benefit formula has an 
effect similar to a lump sum-based benefit formula.
    (5) Statutory hybrid plan. A statutory hybrid plan means a defined 
benefit plan that contains a statutory hybrid benefit formula.
    (6) Variable annuity benefit formula. A variable annuity benefit 
formula means any benefit formula under a defined benefit plan which 
provides that the amount payable is periodically adjusted by reference 
to the difference between the rate of return on plan assets (or 
specified market indices) and a specified assumed interest rate.
    (e) Effective/applicability date--(1) Statutory effective/
applicability date--(i) In general. Except as provided in paragraphs 
(e)(1)(ii) and (e)(1)(iii) of this section, section 411(a)(13) applies 
for periods beginning on or after June 29, 2005.
    (ii) Calculation of benefits. Section 411(a)(13)(A) applies to 
distributions made after August 17, 2006.
    (iii) Vesting--(A) Plans in existence on June 29, 2005--(1) General 
rule. In the case of a plan that is in existence on June 29, 2005 
(regardless of whether the plan is a statutory hybrid plan on that 
date), section 411(a)(13)(B) applies to plan years that begin on or 
after January 1, 2008.
    (2) Exception for plan sponsor election. See Sec. 1.411(b)(5)-
1(f)(1)(iii)(A)(2) for a special election for early application of 
section 411(a)(13)(B).
    (B) Plans not in existence on June 29, 2005. In the case of a plan 
not in existence on June 29, 2005, section

[[Page 797]]

411(a)(13)(B) applies to plan years that end on or after June 29, 2005.
    (C) Collectively bargained plans. Notwithstanding paragraphs 
(e)(1)(iii)(A) and (B) of this section, in the case of a collectively 
bargained plan maintained pursuant to one or more collective bargaining 
agreements between employee representatives and one or more employers 
ratified on or before August 17, 2006, the requirements of section 
411(a)(13)(B) do not apply to plan years that begin before the earlier 
of--
    (1) The later of--
    (i) The date on which the last of those collective bargaining 
agreements terminates (determined without regard to any extension 
thereof on or after August 17, 2006); or
    (ii) January 1, 2008; or
    (2) January 1, 2010.
    (D) Treatment of plans with both collectively bargained and non-
collectively bargained employees. In the case of a plan with respect to 
which a collective bargaining agreement applies to some, but not all, of 
the plan participants, the plan is considered a collectively bargained 
plan for purposes of paragraph (e)(1)(iii)(C) of this section if it is 
considered a collectively bargained plan under the rules of Sec. 1.436-
1(a)(5)(ii)(B).
    (E) Hour of service required. Section 411(a)(13)(B) does not apply 
to a participant who does not have an hour of service after section 
411(a)(13)(B) would otherwise apply to the participant under the rules 
of paragraph (e)(1)(iii)(A), (B), or (C) of this section.
    (2) Effective/applicability date of regulations--(i) In general. 
Except as provided in paragraph (e)(2)(ii) of this section, this section 
applies to plan years that begin on or after January 1, 2011. For the 
periods after the statutory effective date set forth in paragraph (e)(1) 
of this section and before the regulatory effective date set forth in 
the preceding sentence, the relief of section 411(a)(13)(A) applies and 
the 3-year vesting requirement of section 411(a)(13)(B) must be 
satisfied. During these periods, a plan is permitted to rely on the 
provisions of this section for purposes of applying the relief of 
section 411(a)(13)(A) and satisfying the requirements of section 
411(a)(13)(B).
    (ii) Special effective date. [Reserved]
    (iii) Hour of service required. A benefit formula is not treated as 
having an effect similar to a lump sum-based benefit formula under 
paragraph (d)(4)(ii) of this section with respect to a participant who 
does not have an hour of service after the regulatory effective date set 
forth in paragraph (e)(2)(i) of this section.

[T.D. 9505, 75 FR 64135, Oct. 19, 2010, as amended by 76 FR 4244, Jan. 
25, 2011]



Sec. 1.411(b)-1  Accrued benefit requirements.

    (a) Accrued benefit requirements--(1) In general. Under section 
411(b), for plan years beginning after the applicable effective date of 
section 411, rules are provided for the determination of the accrued 
benefit to which a participant is entitled under a plan. Under a defined 
contribution plan, a participant's accrued benefit is the balance to the 
credit of the participant's account. Under a defined benefit plan, a 
participant's accrued benefit is his accrued benefit determined under 
the plan. A defined benefit plan is not a qualified plan unless the 
method provided by the plan for determining accrued benefits satisfies 
at least one of the alternative methods (described in paragraph (b) of 
this section) for determining accrued benefits with respect to all 
active participants under the plan. A defined benefit plan may provide 
that accrued benefits for participants are determined under more than 
one plan formula. In such a case, the accrued benefits under all such 
formulas must be aggregated in order to determine whether or not the 
accrued benefits under the plan for participants satisfy one of the 
alternative methods. A plan may satisfy different methods with respect 
to different classifications of employees, or separately satisfy one 
method with respect to the accrued benefits for each such 
classification, provided that such classifications are not so structured 
as to evade the accrued benefit requirements of section 411(b) and this 
section. (For example, if a plan provides that employees who commence 
participation at or before age 40 accrue benefits in a manner which 
satisfies the 133\1/3\ percent method of determining accrued benefits 
and employees who commence participation after age 40

[[Page 798]]

accrue benefits in a manner which satisfies the 3 percent method of 
determining accrued benefits, the plan would be so structured as to 
evade the requirements of section 411(b).) A defined benefit plan does 
not satisfy the requirements of section 411(b) and this section merely 
because the accrued benefit is defined as the ``reserve under the 
plan''. Special rules are provided for the first two years of service by 
a participant, certain insured defined benefit plans, and certain 
reductions in accrued benefits due to increasing age or service. In 
addition, a special rule is provided with respect to accruals for 
service before the effective date of section 411.
    (2) Cross references--(i) 3 percent method. For rules relating to 
the 3 percent method of determining accrued benefits, see paragraph 
(b)(1) of this section.
    (ii) 133\1/3\ percent method. For rules relating to the 133\1/3\ 
percent method of determining accrued benefits, see paragraph (b)(2) of 
this section.
    (iii) Fractional method. For rules relating to the fractional method 
of determining accrued benefits, see paragraph (b)(3) of this section.
    (iv) Accruals before effective date. For rules relating to accruals 
for service before the effective date of section 411, see paragraph (c) 
of this section.
    (v) First 2 years of service. For special rules relating to 
determination of accrued benefit for first 2 continuous years of 
service, see paragraph (d)(1) of this section.
    (vi) Certain insured plans. For special rules relating to 
determination of accrued benefit under a defined benefit plan funded 
exclusively by insurance contracts, see paragraph (d)(2) of this 
section.
    (vii) Accruals decreased by increasing age or service. For special 
rules relating to prohibition of decrease in accrued benefit on account 
of increasing age or service, see paragraph (d)(3) of this section.
    (viii) Separate accounting. For rules relating to requirements for 
separate accounting, see paragraph (e) of this section.
    (ix) Year of participation. For definition of ``year of 
participation'', see paragraph (f) of this section.
    (b) Defined benefit plans. A defined benefit plan satisfies the 
requirements of section 411(b)(1) and this paragrah for a plan year to 
which section 411 and this section apply if it satisfies the 
requirements of subparagraph (1), (2), or (3) of this paragraph for such 
year.
    (1) 3 percent method--(i) General rule. A defined benefit plan 
satisfies the requirements of this paragraph for a plan year if, as of 
the close of the plan year, the accrued benefit to which each 
participant is entitled, computed as if the participant separated from 
the service as of the close of such plan year, is not less than 3 
percent of the 3 percent method benefit, multiplied by the number of 
years (not in excess of 33\1/3\) of his participation in the plan 
including years after his normal retirement age. For purposes of this 
subparagraph, the ``3 percent method benefit'' is the normal retirement 
benefit to which the participant would be entitled if he commenced 
participation at the earliest possible entry age for any individual who 
is or could be a participant under the plan and if he served 
continuously until the earlier of age 65 or the normal retirement age 
under the plan.
    (ii) Special rules--(A) Compensation. In the case of a plan 
providing a retirement benefit based upon compensation during any 
period, the normal retirement benefit to which a participant would be 
entitled is determined as if he continued to earn annually the average 
rate of compensation which he earned during consecutive years of 
service, not in excess of 10, for which his compensation was the 
highest. For purposes of this subdivision (A), the number of consecutive 
years of service used in computing average compensation shall be the 
number of years of service specified under the plan (not in excess of 
10) for computing normal retirement benefits.
    (B) Social security, etc. For purposes of this subparagraph, for any 
plan year, social security benefits and all relevant factors used to 
compute benefits, e.g., consumer price index, are treated as remaining 
constant as of the beginning of the current plan year for all subsequent 
plan years.

[[Page 799]]

    (C) Computation in certain cases. In the case of any plan to which 
the provisions of section 411(b)(1)(D) and paragraph (c) of this section 
are applicable, for any plan year the accrued benefit of any participant 
shall not be less than the accrued benefit otherwise determined under 
this subparagraph, reduced by the excess of the accrued benefit 
determined under this subparagraph as of the first day of the first plan 
year to which section 411 applies over the accrued benefit determined 
under section 411(b)(1)(D) and paragraph (c) of this section and 
increased by the amount determined under paragraph (c)(2)(v) of this 
section.
    (iii) Examples. The application of this subparagraph is illustrated 
by the following examples.

    Example 1. The M Corporation's defined benefit benefit plan provides 
an annual retirement benefit commencing at age 65 or $4 per month for 
each year of participation. As a condition of participation, the plan 
requires that an employee have attained age 25. The normal retirement 
age specified under the plan is age 65. The plan provides for no limit 
on the number of years of credited service. A, age 40, is a participant 
in the M Corporation's plan.
    A has completed 12 years of participation in the plan of the M 
Corporation as of the close of the plan year. Under subdivision (i) of 
this subparagraph, the normal retirement benefit commencing at age 65 to 
which a participant would be entitled if he commenced participation at 
the earliest possible entry age (25) under the plan and served 
continuously until normal retirement age (65) is an annual benefit of 
$1,920 [40x(12x$4)]. Under paragraph (b)(1)(i) of this section, the plan 
does not satisfy the requirements of this subparagraph unless A has 
accrued an annual benefit of at least $691 [0.03x($1,920x12)] as of the 
close of the plan year. Under the M Corporation plan, A is entitled to 
an accrued benefit of $576 [(12x12)x$4] as of the close of the plan 
year. Thus, with respect to A, the accrued benefit provided under the M 
Corporation plan does not satisfy the requirements of this subparagraph.
    Example 2. Assume the same facts as in example (1) except that the M 
Corporation's plan provides that only the first 30 years of 
participation are taken into account. Under subdivision (i) of this 
subparagraph, the normal retirement benefit commencing at age 65 to 
which a participant would be entitled if he commenced participation at 
the earliest possible entry age under the plan (25) and served 
continuously until normal retirement age (65) is an annual benefit of 
$1.440 [30x$48]. Under paragraph (b)(1)(i) of this section, the plan 
does not satisfy the requirements of this subparagraph unless A has 
accrued an annual benefit of at least $518 [0.03x($1,440x12)] as of the 
close of the plan year. Under the M Corporation plan, A is entitled to 
an accrued benefit of $576 [(12x$48]. Thus, with respect to A, the 
accrued benefit provided under the M Corporation plan satisfies the 
requirements of this subparagraph.
    Example 3. The N Corporation's defined benefit plan provides an 
annual retirement benefit commencing at age 65 of 50 percent of average 
compensation for the highest 3 consecutive years of compensation for an 
employee with 25 years of participation. A participant who separates 
from service before age 65 is entitled to 2 percent of average 
compensation for the highest 3 consecutive years of compensation for 
each year of participation not in excess of 25. The plan has no minimum 
age or service requirement for participation. The normal retirement age 
specified under the plan is age 65. On December 31, 1990, B, age 40, is 
a participant in the N Corporation's plan. B began employment with the N 
Corporation and became a participant in the N Corporation's plan on 
January 1, 1980. Under this subparagraph, the normal retirement benefit 
to which a participant would be entitled if he commenced participation 
at the earliest possible entry age (0) under the plan and served 
continuously until normal retirement age (65) is 50 percent of average 
compensation for the highest 3 consecutive years of compensation per 
year commencing at age 65. Under this subparagraph, B must have accrued 
an annual benefit of at least 16.5 percent of his highest 3 consecutive 
years of compensation per year commencing at age 65 [0.03x50 percent of 
average compensation for the highest 3 consecutive years of 
compensationx11] as of the close of the plan year. Under the N 
Corporation plan, B has accrued an annual benefit of 22 percent of 
average compensation for his highest 3 consecutive years of compensation 
per year commencing at age 65. Thus, with respect to B, the accrued 
benefit under the N Corporation plan satisfies the requirements of this 
subparagraph.
    Example 4. The P Corporation's defined benefit plan provides an 
annual retirement benefit commencing at age 65 of 50 percent of average 
compensation for the 3 consecutive years of compensation from the P 
Corporation next preceding normal retirement age. The plan has no 
minimum age or service requirement for participation. The normal 
retirement age under the plan is age 65. On December 31, 1990, C, age 
55, separates from service with the P Corporation. C began employment 
with the P Corporation and became a participant in the P Corporation's 
plan on January 1, 1980. As of December 31, 1990. C's average 
compensation for the 3 consecutive years preceding his separation from 
service is $15,000. Under this subparagraph,

[[Page 800]]

the normal retirement benefit to which a participant would be entitled 
if he commenced participation at the earliest possible entry age (0) 
under the plan and served continuously until normal retirement age (65) 
is an annual benefit of 50 percent of average compensation for the 3 
consecutive years of compensation from the P Corporation next preceding 
normal retirement age commencing at age 65. C must have accrued an 
annual benefit of at least $2,475 commencing at age 65 
[0.03x(0.050x$15,000)x11] as of his separation from the service with the 
P Corporation in order for the P Corporation's plan to satisfy the 
requirements of this subparagraph with respect to C.
    Example 5. On December 31, 1985, the R Corporation's defined benefit 
plan provided an annual retirement benefit commencing at age 65 of $100 
for each year of participation, not to exceed 30. As a condition of 
participation, the plan requires that an employee have attained age 25. 
The normal retirement age specified under the plan is age 65. The 
appropriate computation period is the calendar year. On January 1, 1986, 
the plan is amended to provide an annual retirement benefit commencing 
at age 65 of $200 for each year of participation (before and after the 
amendment), not to exceed 30. B, age 40, is a participant in the R 
Corporation's plan. B has completed 15 years of participation in the 
plan of the R Corporation as of December 31, 1990. Under paragraph 
(b)(1)(i) of this section, the normal retirement benefit commencing at 
age 65 to which a participant would be entitled if he commenced 
participation at the earliest possible entry age (25) under the plan and 
served continuously until normal retirement age (65) is an annual 
benefit of $6,000 [30x200]. Under subdivision (i) of this subparagraph, 
the plan does not satisfy the requirements of this subparagraph unless B 
has accrued an annual benefit of at least $2,700 [0.03x$6,000x15] as of 
December 31, 1990. Under the R Corporation plan, B is entitled to an 
accrued benefit of $3,000 [$200x15] as of December 31, 1990. Thus, with 
respect to B, the accrued benefit provided under the R Corporation plan 
satisfies the requirements of this subparagraph.
    Example 6. On December 31, 1995, the J Corporation's defined benefit 
plan provided an annual retirement benefit commencing at age 65 of 
$4,800 after 30 years of participation. The normal retirement age 
specified under the plan is age 65. The appropriate computation period 
is the calendar year. On January 1, 1996, the plan is amended to provide 
an annual retirement benefit commencing at age 65 of $6,000. A, age 40, 
is a participant in the J Corporation's plan since its adoption on 
January 1, 1986. Under paragraph (b)(1)(i) of this section, on December 
31, 1995, the normal retirement benefit commencing at age 5 to which a 
participant would be entitled if he commenced participation at the 
earliest possible entry age (0) under the plan and served continuously 
until normal retirement age (65) is an annual benefit of $4,800. Under 
paragraph (b)(1)(i) of this section, on January 1, 1996, the normal 
retirement benefit commencing at age 65 to which a participant would be 
entitled if he commenced participation at the earliest possible entry 
age (0) under the plan and served continuously until normal retirement 
age (65) is an annual benefit of $6,000. Under subdivision (i) of this 
subparagraph, the plan does not satisfy the requirements of this 
subparagraph unless A has an accrued benefit on December 31, 1995 of at 
least $1,440 [$4,800x0.02x10] and an accrued benefit on January 1, 1996 
of at least $1,800 [$6,000x0.03x10].
    Example 7. The X Company's defined benefit plan provides an annual 
retirement benefit commencing at age 65 of $4 per month for each year of 
participation (not to exceed 30). As a condition of participation, the 
plan requires that an employee have attained age 25. The normal 
retirement age specified under the plan is age 65. D, age 68, is a 
participant in the X Company's plan. D has completed 20 years of 
participation in the X Company plan as of the close of the plan year. 
Under paragraph (b)(1)(i) of this section, the normal retirement benefit 
commencing at age 65 to which a participant would be entitled if he 
commenced participation at the earliest possible entry age (25) under 
the plan and served continuously until normal retirement age (65) is an 
annual benefit, commencing at age 65, of $1,440 [30x$48]. Under 
paragraph (b)(1)(i) of this section, the plan does not satisfy the 
requirements of this subparagraph unless D has accrued an annual 
benefit, commencing at age 65, of $864 [0.03x$1,440x20] as of the close 
of the plan year. Under the X Company plan, D has accrued an annual 
benefit, commencing at age 65, of $960 [20x$48]. Thus, with respect to D 
the accrued benefit provided under the X Company plan satisfies the 
requirements of this subparagraph.
    Example 8. Assume the same facts as in example (7) except that for 
purposes of determining accrued benefits under the plan the X Company's 
plan disregards all years of participation after normal retirement age. 
Under paragraph (b)(1)(i) of this section, the normal retirement benefit 
commencing at age 65 to which a participant would be entitled if he 
commenced participation at the earliest possible entry age (25) under 
the plan and served continuously until normal retirement age (65) is an 
annual benefit of $1,440 [30x$48]. Under paragraph (b)(1)(i) of this 
section the plan does not satisfy the requirements of this subparagraph 
unless D has accrued an annual benefit, commencing at age 65, of $864 
[0.03x$1,440x20] as of the close of the plan year. Under the X Company's 
plan D has accrued an annual benefit

[[Page 801]]

commencing at age 65, of $816 [17x$48]. Thus, with respect to D, the 
accrued benefit provided under the X Company plan does not satisfy the 
requirements of this subparagraph.

    (2) 133\1/3\ percent rule--(i) General rule. A defined benefit plan 
satisfies the requirements of this subparagraph for a particular plan 
year if--
    (A) Under the plan the accrued benefit payable at the normal 
retirement age (determined under the plan) is equal to the normal 
retirement benefit (determined under the plan), and
    (B) The annual rate at which any individual who is or could be a 
participant can accrue the retirement benefits payable at normal 
retirement age under the plan for any later plan year cannot be more 
than 133\1/3\ percent of the annual rate at which he can accrue benefits 
for any plan year beginning on or after such particular plan year and 
before such later plan year.
    (ii) Special rules. For purposes of this subparagraph--
    (A) Plan amendments. Any amendment to the plan which is in effect 
for the current plan year shall be treated as if it were in effect for 
all other plan years.
    (B) Change in accrual rate. Any change in an accrual rate which 
change does not apply to any individual who is of could be a participant 
in the plan year is disregarded. Thus, for example, if for its plan year 
beginning January 1, 1980, a defined benefit plan provides an accrued 
benefit in plan year 1980 of 2 percent of a participant's average 
compensation for his highest 3 years of compensation for each year of 
service and provides that in plan year 1981 the accrued benefit will be 
3 percent of such average compensation, the plan will not be treated as 
failing to satisfy the requirements of this subparagraph for plan year 
1980 because in plan year 1980 the change in the accrual rate does not 
apply to any individual who is or could be a participant in plan year 
1980. However, if, for example, a defined benefit plan provided for an 
accrued benefit of 1 percent of a participant's average compensation for 
his highest 3 years of compensation for each of the first 10 years of 
service and 1.5 percent of such average compensations for each year of 
service thereafter, the plan will be treated as failing to satisfy the 
requirements of this subparagraph for the plan year even though no 
participant is actually accruing at the 1.5 percent rate because an 
individual who could be a participant and who had over 10 years of 
service would accrue at the 1.5 percent rate, which rate exceeds 133\1/
3\ percent of the 1 percent rate.
    (C) Early retirement benefits. The fact that certain benefits under 
the plan may be payable to certain participants before normal retirement 
age is disregarded. Thus, the requirements of subdivision (i) of this 
subparagraph must be satisfied without regard to any benefit payable 
prior to the normal retirement benefit (such as an early retirement 
benefit which is not the normal retirement benefit (see Sec. 1.411(a)-
7(c).
    (D) Social security, etc. For purposes of this paragraph, for any 
plan year, social security benefits and all relevant factors used to 
compute benefits, e.g., consumer price index, are treated as remaining 
constant as of the beginning of the current plan year for all subsequent 
plan years.
    (E) Postponed retirement. A plan shall not be treated as failing to 
satisfy the requirements of this subparagraph for a plan year merely 
because no benefits under the plan accrue to a participant who continues 
service with the employer after such participant has attained normal 
retirement age.
    (F) Computation of benefit. A plan shall not satisfy the 
requirements of this subparagraph if the base for the computation of 
retirement benefits changes solely by reason of an increase in the 
number of years of participation. Thus, for example, a plan will not 
satisfy the requirements of this subparagraph if it provides a benefit, 
commencing at normal retirement age, of the sum of (1) 1 percent of 
average compensation for a participant's first 3 years of participation 
multiplied by his first 10 years of participation (or, if less than 10 
his total years of participation) and (2) 1 percent of average 
compensation for a participant's 3 highest years of participation 
multiplied by each year of participation subsequent to the 10th year.

[[Page 802]]

    (iii) Examples. The application of this subparagraph is illustrated 
by the following examples:

    Example 1. On January 1, 1980, the R Corporation's defined benefit 
plan provides for an annual benefit (commencing at age 65) of a 
percentage of a participant's average compensation for the period of 5 
consecutive years of participation for which his compensation is the 
highest. The percentage is 2 percent for each of the first 20 years of 
participation and 1 percent per year thereafter. The appropriate 
computation period is the calendar year. The R Corporation's plan 
satisfies the requirements of this subparagraph because the 133\1/3\ 
percent rule does not restrict subsequent accrual rate decreases.
    Example 2. On January 1, 1980, the J Corporation's defined benefit 
plan provides for an annual benefit (commencing at age 65) of a 
percentage of a participant's average compensation for the period of his 
final 5 consecutive years of participation. The percentage is 1 percent 
for each of the first 5 years of participation; 1\1/3\ percent for each 
of the next 5 years of participation; and 1\7/9\ percent for each year 
thereafter. The appropriate computation period is the calendar year. 
Even though no single accrual rate under the J Corporation's plan 
exceeds 133\1/3\ percent of the immediately preceding accrual rate, the 
J Corporation's plan does not satisfy the requirements of this 
subparagraph because the rate of accrual for all years of participation 
in excess of 10 (1\7/9\ percent) exceeds 133\1/3\ percent of the rate of 
accrual for any of the first 5 years of participation (1 percent).
    Example 3. On January 1, 1980, the C Corporation's defined benefit 
plan provides for an annual benefit (commencing at age 65) of a 
percentage of a participant's average compensation for the period of 3 
consecutive years of participation for which his compensation is the 
highest. The percentage is 2 percent for each of the first 5 years of 
participation; 1 percent for each of the next 5 years of participation; 
and 1\1/2\ percent for each year thereafter. The appropriate computation 
period is the calendar year. Even though the average rate of accrual 
under the C Corporation's plan is not less rapidly than ratably, the C 
Corporation's plan does not satisfy the requirements of this 
subparagraph because the rate of accrual for all years of participation 
in excess of 10 (1\1/2\ percent) for any employee who is actually 
accruing benefits or who could accrue benefits exceeds 133\1/3\ percent 
of the rate of accrual for the sixth through tenth years of 
participation, respectively (1 percent).

    (3) Fractional rule--(i) In general. A defined benefit plan 
satisfies the requirements of this paragraph if the accrued benefit to 
which any participant is entitled is not less than the fractional rule 
benefit multiplied by a fraction (not exceeding 1)--
    (A) The numerator of which is his total number of years of 
participation in the plan, and
    (B) The denominator of which is the total number of years he would 
have participated in the plan if he separated from the service at the 
normal retirement age under the plan.
    (ii) Special rules. For purposes of this subparagraph--
    (A) Fractional rule benefit. The ``fractional rule benefit'' is the 
annual benefit commencing at the normal retirement age under the plan to 
which a participant would be entitled if he continued to earn annually 
until such normal retirement age the same rate of compensation upon 
which his normal retirement benefit would be computed. Such rate of 
compensation shall be computed on the basis of compensation taken into 
account under the plan (but taking into account average compensation for 
no more than the 10 years of service immediately preceding the 
determination). For purposes of this subdivision (A), the normal 
retirement benefit shall be determined as if the participant had 
attained normal retirement age on the date any such determination is 
made.
    (B) Social security, etc. For purposes of this subparagraph, for any 
plan year, social security benefits and all relevant factors used to 
compute benefits, e.g., consumer price index, are treated as remaining 
constant as of the beginning of the current plan year for all subsequent 
plan years.
    (C) Postponed retirement. A plan shall not be treated as failing to 
satisfy the requirements of this subparagraph merely because no benefits 
under the plan accrue to a participant who continues service with the 
employer after such participant has attained normal retirement age under 
the plan.
    (D) Computation in certain cases. In the case of any plan to which 
the provisions of section 411(b)(1)(D) and paragraph (c) of this section 
are applicable, for any plan year the accrued benefit of any participant 
shall not be less than

[[Page 803]]

the accrued benefit otherwise determined under this subparagraph, 
reduced by the excess of the accrued benefit determined under this 
subparagraph as of the first day of the first plan year to which section 
411 applies over the accrued benefit determined under section 
411(b)(1)(D) and paragraph (c) of this section and increased by the 
amount determined under paragraph (c)(2)(v) of this section.
    (iii) Examples. The application of this subparagraph is illustrated 
by the following examples:

    Example 1. The R Corporation's defined benefit plan provides an 
annual retirement benefit commencing at age 65 of 30 percent of a 
participant's average compensation for his highest 3 consecutive years 
of participation. If a participant separates from service prior to 
normal retirement age, the R Corporation's plan provides a benefit equal 
to an amount which bears the same ratio to 30 percent of such average 
compensation as the participant's actual number of years of 
participation in the plan bears to the number of years the participant 
would have participated in the plan had he separated from service at age 
65. The plan further provides that normal retirement age is age 65. A, 
age 55, is a participant in the R Corporation's plan for the current 
year, and A has 15 years of participation in the R Corporation's plan. 
As of the current year, A's average compensation for his highest 3 years 
of compensation is $20,000. The R Corporation's plan satisfies the 
requirements of this subparagraph because if A separates from the 
service in the current year he will be entitled to an annual benefit of 
$3,600 commencing at age 65 [0.3x$20,000x15/25].
    Example 2. The J Corporation's defined benefit plan provides a 
normal retirement benefit of 1 percent per year of a participant's 
average compensation from the employer. In the case of a participant who 
separates from service prior to normal retirement age (65), the plan 
provides that the annual benefit is an amount which is equal to 1 
percent of such compensation multiplied by the number of years of plan 
participation actually completed by the participant. The plan year of 
the J Corporation's plan is the calendar year. B, age 55, is a 
participant in the J Corporation's plan for the current year. B became a 
participant in the J Corporation's plan on January 1, 1980. As of 
December 31, 1990, B's compensation history is as follows:

------------------------------------------------------------------------
                          Year                             Compensation
------------------------------------------------------------------------
1980...................................................          $17,000
1981...................................................           18,000
1982...................................................           20,000
1983...................................................           20,000
1984...................................................           21,000
1985...................................................           22,000
1986...................................................           23,000
1987...................................................           25,000
1988...................................................           26,000
1989...................................................           29,000
1990...................................................           32,000
------------------------------------------------------------------------

    If B separates from service on December 31, 1990, he would be 
entitled to an annual benefit of $2,530 commencing at age 65. Because 
the J Corporation's plan does not limit the number of years of 
compensation to be taken into account in determining the normal 
retirement benefit, B's rate of compensation for purposes of determining 
his normal retirement benefit is $23,600 [$18,000 + $20,000 + $20,000 + 
$21,000 + $22,000 + $23,000 + $25,000 + $26,000 + $29,000 + $32,000]/10.
    Under this subparagraph, B's accrued benefit under the J 
Corporation's plan as of December 31, 1990 must be not less than $2,561 
per year commencing at age 65 [0.01 x ($17,000 + $18,000 + $20,000 + 
$20,000 + $21,000 + $22,000 + $23,000 + $25,000 + $26,000 + $29,000 + 
$32,000 + ($23,600 x 10)) x 11/21]. Thus, the J Corporation's plan would 
not satisfy the requirements of this subparagraph.

    (c) Accruals for service before effective date--(1) General rule. 
For a plan year to which section 411 applies, a defined benefit plan 
does not satisfy the requirements of section 411(b)(1) and this section 
unless, under the plan, the accrued benefit of each participant for plan 
years beginning before section 411 applies is not less than the greater 
of--
    (i) Such participant's accrued benefit (as of the day before section 
411 applies) determined under the plan as in effect from time to time 
prior to September 2, 1974 (without regard to any amendment adopted 
after such date), or
    (ii) One-half of the accrued benefit that would be determined with 
respect to the participant as of the day before section 411 applies if 
the participant's accrued benefit were computed for such prior plan 
years under a method which satisfies the requirements of section 
411(b)(1) (A), (B), or (C) and paragraph (b) (1), (2), or (3) of this 
section. See 29 CFR Part 2530, Department of Labor regulations relating 
to minimum standards for employee pension benefit plans, for time 
participation deemed to begin.
    (2) Special rules--(i) A plan shall not be deemed to fail to satisfy 
the requirements of section 411(b) and this section

[[Page 804]]

merely because the method for computing the accrued benefit of a 
participant for years of participation prior to the first plan year for 
which section 411 is effective with respect to the plan is not the same 
method for computing the accrued benefit of a participant for years of 
participation subsequent to such plan year.
    (ii) For purposes of paragraph (c)(1)(ii) of this section, section 
411(b)(1)(A) and paragraph (b)(1) of this section shall be applied as if 
the participant separated from service with the employer on the day 
before the first day of the first plan year to which section 411 
applies.
    (iii) For purposes of paragraph (c)(1)(ii) of this section, section 
411(b)(1)(B) and paragraph (b)(2) of this section shall be applied in 
the following manner:
    (A) Except as provided in (c)(2)(iii)(B) of this section, section 
411(b)(1)(B) and paragraph (b)(2) of this section shall be applied as if 
the participant separated from service with the employer on the day 
before the first day of the first plan year to which section 411 
applies.
    (B) In the case that the plan does not satisfy the requirements of 
section 411(b)(1)(B) and paragraph (b)(2) of this section at any time 
prior to the day specified in (c)(2)(iii)(A) of this section, the plan 
shall be deemed revised to the extent necessary to satisfy the 
requirements of section 411(b)(1)(B) and paragraph (b)(2) of this 
section for all plan years beginning before the applicable effective 
date of section 411 and this section. For purposes of the preceding 
sentence, a plan shall not be deemed revised to the extent necessary to 
satisfy the requirements of section 411(b)(1)(B) and paragraph (b)(2) of 
this section for a plan year if the benefit a participant would receive 
if he were employed until normal retirement age is reduced by such 
revision or if the revised rate of accrual with respect to such accrued 
benefit does not otherwise satisfy the requirements of section 
411(b)(1)(B) and paragraph (b)(2) of this section.
    (iv) For purposes of paragraph (c)(1)(ii) of this section, section 
411(b)(1)(C) and paragraph (b)(3) of this section shall be applied as if 
the participant separated from service on the day before the first day 
of the first plan year to which section 411 applies.
    (v) The excess of the accrued benefit payable at normal retirement 
age of any participant determined under section 411(b)(1) (A), (B), or 
(C) (without regard to section 411(b)(1)(D)), and paragraph (b)(1), (2), 
or (3) of this section (without regard to this paragraph) as of the day 
before the first day of the first plan year to which section 411 and 
this section applies over the accrued benefit determined under paragraph 
(c)(1) of this section shall be accrued in accordance with the 
provisions of the plan as in effect after the applicable effective date 
of section 411, as if the plan had been initially adopted on such 
effective date.
    (d) Special rules--(1) First 2 years of service. Notwithstanding 
paragraphs (1), (2), and (3) of paragraph (b) of this section, under 
section 411(b)(1)(E) and this subparagraph, a plan shall not be treated 
as failing to satisfy the requirements of paragraph (b) of this section 
solely because the accrual of benefits under the plan does not become 
effective until the employee has completed 2 continuous years of 
service. For purposes of this subparagraph, continuous years of service 
are years of service (within the meaning of section 410(a)(3)(A)) which 
are not separated by a break in service (within the meaning of section 
410(a)(5)). For years of service beginning after such 2 years of 
service, the accrued benefit of an employee shall not be less than that 
to which the employee would be entitled if section 411(b)(1)(E) and this 
subparagraph did not apply. Thus, for example, a plan which otherwise 
satisfies the requirements of paragraph (b)(2) of this section provides 
for a rate of accrual of 1 percent of average compensation for the 
highest 3 years of compensation beginning with the third year of service 
of a participant shall not be treated as satisfying paragraph (b)(2) of 
this section because as of the time the employee completes 3 continuous 
years of service there is no accrual during the first 2 years of 
service. In addition, a plan which otherwise satisfies the requirements 
of paragraph (b)(1) of this section and which requires that an employee 
must attain age 25 and complete 1 year of service prior to becoming a

[[Page 805]]

participant will not satisfy the requirements of paragraph (b)(1) of 
this section if an employee who completes 2 years of service prior to 
attaining age 25 does not begin accruals immediately upon commencement 
of participation in the plan. For rules relating to years of service, 
see 29 CFR part 2530, Department of Labor regulations relating to 
minimum standards for employee pension benefit plans.
    (2) Certain insured defined benefit plans. Notwithstanding 
paragraphs (b) (1), (2), and (3) of this section, a defined benefit plan 
satisfies the requirements of paragraph (b) of this section if such plan 
is funded exclusively by the purchase of contracts from a life insurance 
company and such contracts satisfy the requirements of sections 412(i) 
(2) and (3) and the regulations thereunder. The preceding sentence is 
applicable only if an employee's accrued benefit as of any applicable 
date is not less than the cash surrender value such employee's insurance 
contracts would have on such applicable date if the requirements of 
section 412(i) (4), (5), and (6) and the regulations thereunder were 
satisfied.
    (3) Accrued benefit may not decrease on account of increasing age or 
service. Notwithstanding paragraphs (b) (1), (2), and (3) of this 
section and paragraphs (d) (1) and (2) of this section, a defined 
benefit plan shall be treated as not satisfying the requirements of 
paragraphs (b) and (d) of this section if the participant's accrued 
benefit is reduced on account of any increase in his age or years of 
service. The preceding sentence shall not apply to social security 
supplements described in Sec. 1.411(a)-7(c)(4).
    (e) Separate accounting. A plan satisfies the requirements of this 
paragraph if the requirements of paragraph (e) (1) or (2) of this 
paragraph are met.
    (1) Defined benefit plan. In the case of a defined benefit plan, the 
requirements of this paragraph are satisfied if the plan requires 
separate accounting for the portion of each employee's accrued benefit 
derived from any voluntary employee contributions permitted under the 
plan. For purposes of this subparagraph the term ``voluntary employee 
contributions'' means all employee contributions which are not mandatory 
contributions within the meaning of section 411(c)(2)(C) and the 
regulations thereunder. See Sec. 1.411(c)-1(b)(1) for rules requiring 
the determination of such an accrued benefit by the use of a separate 
account.
    (2) Defined contribution plan. In the case of a defined contribution 
plan, the requirements of this paragraph are not satisfied unless the 
plan requires separate accounting for each employee's accrued benefit. 
If a plan utilizes the break in service rule of section 411(a)(6)(C), an 
employee could have different percentages of vesting between pre-break 
and post-break accrued benefits. In such a case, the requirements of 
this paragraph are not satisfied unless the plan computes accrued 
benefits in a manner which takes into account different percentages. A 
plan which provides separate accounts for pre-break and post-break 
accrued benefits will be deemed to compute benefits in a reasonable 
manner.
    (f) Year of participation--(1) In general. This paragraph is 
inapplicable to a defined contribution plan. For purposes of determining 
an employee's accrued benefit, a ``year of participation'' is a period 
of service determined under regulations prescribed by the Secretary of 
Labor in 29 CFR Part 2530, relating to minimum standards for employee 
pension benefit plans.
    (2) Additional rule relating to year of participation. A trust shall 
not constitute a qualified trust if the plan of which such trust is a 
part provides for the crediting of a year of participation, or part 
thereof, and such credit results in the discrimination prohibited by 
section 401(a)(4).
    (g) Additional illustrations. The application of this section may be 
illustrated by the following example:

    Example. (i) The S Corporation established a defined benefit plan on 
January 1, 1980. The plan provides a minimum age for participation of 
age 25. The normal retirement age under the plan is age 65. The 
appropriate computation periods are the calendar year. The plan provides 
an annual benefit, commencing at age 65, equal to $96 per year of 
service for the first 25 years of service, and $48 per year of service 
for each additional year of service.
    (ii) The plan of the S Corporation does not satisfy the requirements 
of section

[[Page 806]]

411(b)(1)(A) and paragraph (b)(1) of this section because the accrued 
benefit under the plan at some point will be less than the accrued 
benefit required under section 411(b)(1)(A) and paragraph (b)(1) of this 
section (i.e., 3 percent x normal retirement benefit x years of 
participation).
    (iii) The plan of the S Corporation does satisfy the requirements of 
section 411(b)(1)(B) and paragraph (b)(2) of this section because the 
rate of benefit accrual is equal in each of the first 25 years of 
service and the rate decreases thereafter.
    (iv) The plan of the S Corporation does satisfy the requirements of 
section 411(b)(1)(C) and paragraph (b)(3) of this section because the 
accrued benefit under the plan will equal or exceed the normal 
retirement benefit multiplied by the fraction described in paragraph 
(b)(3)(i) of this section.

(Sec. 411 (88 Stat. 901; 26 U.S.C. 411))

[T.D. 7501, 42 FR 42334, Aug. 23, 1977]



Sec. 1.411(b)(5)-1  Reduction in rate of benefit accrual under a 
defined benefit plan.

    (a) In general--(1) Organization of regulation. This section sets 
forth certain rules for determining whether a reduction occurs in the 
rate of benefit accrual under a defined benefit plan because of the 
attainment of any age for purposes of section 411(b)(1)(H)(i). Paragraph 
(b) of this section describes safe harbors for certain plan designs 
(including statutory hybrid plans) that are deemed to satisfy the age 
discrimination rules under section 411(b)(1)(H). Paragraph (c) of this 
section describes rules relating to statutory hybrid plan conversion 
amendments. Paragraph (d) of this section describes rules restricting 
interest credits (or equivalent amounts) under a statutory hybrid plan 
to a market rate of return. Paragraph (e) of this section contains 
additional rules related to market rates of return. Paragraph (f) of 
this section contains effective/applicability dates.
    (2) Definitions. The definitions of accumulated benefit, lump sum-
based benefit formula, statutory hybrid benefit formula, statutory 
hybrid plan, and variable annuity benefit formula in Sec. 1.411(a)(13)-
1(d) apply for purposes of this section.
    (b) Safe harbors for certain plan designs--(1) Accumulated benefit 
testing--(i) In general. Pursuant to section 411(b)(5)(A), and subject 
to paragraph (b)(1)(ii) of this section, a plan is not treated as 
failing to meet the requirements of section 411(b)(1)(H)(i) with respect 
to an individual who is or could be a participant if, as of any date, 
the accumulated benefit of the individual would not be less than the 
accumulated benefit of any similarly situated, younger individual who is 
or could be a participant. Thus, this test involves a comparison of the 
accumulated benefit of an individual who is or could be a participant in 
the plan with the accumulated benefit of each similarly situated, 
younger individual who is or could be a participant in the plan. See 
paragraph (b)(5) of this section for rules regarding whether a younger 
individual who is or could be a participant is similarly situated to a 
participant. The comparison described in this paragraph (b)(1)(i) is 
based on any one of the following benefit measures, each of which is 
referred to as a safe-harbor formula measure:
    (A) The annuity payable at normal retirement age (or current age, if 
later) if the accumulated benefit of the participant under the terms of 
the plan is an annuity payable at normal retirement age (or current age, 
if later).
    (B) The current balance of a hypothetical account maintained for the 
participant if the accumulated benefit of the participant under the 
terms of the plan is a balance of a hypothetical account.
    (C) The current value of an accumulated percentage of the 
participant's final average compensation if the accumulated benefit of 
the participant under the terms of the plan is an accumulated percentage 
of final average compensation.
    (ii) Benefit formulas for comparison--(A) In general. Except as 
provided in paragraphs (b)(1)(ii)(B), (C), and (D) of this section, the 
safe harbor provided by section 411(b)(5)(A) and paragraph (b)(1)(i) of 
this section is available with respect to an individual only if the 
individual's accumulated benefit under the plan is expressed in terms of 
only one safe-harbor formula measure and no similarly situated, younger 
individual who is or could be a participant has an accumulated benefit 
that is expressed in terms of any measure other than that same safe-
harbor formula measure. Thus, for example, if a plan

[[Page 807]]

provides that the accumulated benefit of participants who are age 55 or 
over is expressed under the terms of the plan as a life annuity payable 
at normal retirement age (or current age, if later) as described in 
paragraph (b)(1)(i)(A) of this section and the plan provides that the 
accumulated benefit of participants who are younger than age 55 is 
expressed as the current balance of a hypothetical account as described 
in paragraph (b)(1)(i)(B) of this section, then the safe harbor 
described in section 411(b)(5)(A) and paragraph (b)(1)(i) of this 
section does not apply to individuals who are or could be participants 
who are age 55 or over.
    (B) Sum-of benefit formulas. If a plan provides that a participant's 
accumulated benefit is expressed as the sum of benefits determined in 
terms of two or more benefit formulas, each of which is expressed in 
terms of a different safe-harbor formula measure, then the plan is 
deemed to satisfy paragraph (b)(1)(i) of this section with respect to an 
individual who is or could be a participant, provided that the plan 
satisfies the comparison described in paragraph (b)(1)(i) of this 
section separately for benefits determined in terms of each safe-harbor 
formula measure and no accumulated benefit of a similarly situated, 
younger individual who is or could be a participant is expressed other 
than as--
    (1) The sum of benefits under two or more benefit formulas, each of 
which is expressed in terms of one of those same safe-harbor formula 
measures as is used for the participant's ``sum-of'' benefit;
    (2) The greater of benefits under two or more benefit formulas, each 
of which is expressed in terms of any one of those same safe-harbor 
formula measures;
    (3) The choice of benefits under two or more benefit formulas, each 
of which is expressed in terms of any one of those same safe-harbor 
formula measures; or
    (4) A benefit that is determined in terms of only one of those same 
safe-harbor formula measures.
    (C) Greater-of benefit formulas. If a plan provides that a 
participant's accumulated benefit is expressed as the greater of 
benefits under two or more benefit formulas, each of which is determined 
in terms of a different safe-harbor formula measure, then the plan is 
deemed to satisfy paragraph (b)(1)(i) of this section with respect to an 
individual who is or could be a participant, provided that the plan 
satisfies the comparison described in paragraph (b)(1)(i) of this 
section separately for benefits determined in terms of each safe-harbor 
formula measure and no accumulated benefit of a similarly situated, 
younger individual who is or could be a participant is expressed other 
than as--
    (1) The greater of benefits determined under two or more benefit 
formulas, each of which is expressed in terms of one of those same safe-
harbor formula measures as is used for the participant's ``greater-of'' 
benefit;
    (2) The choice of benefits determined under two or more benefit 
formulas, each of which is expressed in terms of one of those same safe-
harbor formula measures; or
    (3) A benefit that is determined in terms of only one of those same 
safe-harbor formula measures.
    (D) Choice-of benefit formulas. If a plan provides that a 
participant's accumulated benefit is determined pursuant to a choice by 
the participant between benefits determined in terms of two or more 
different safe-harbor formula measures, then the plan is deemed to 
satisfy paragraph (b)(1)(i) of this section with respect to an 
individual who is or could be a participant, provided that the plan 
satisfies the comparison described in paragraph (b)(1)(i) of this 
section separately for benefits determined in terms of each safe-harbor 
formula measure and no accumulated benefit of a similarly situated, 
younger individual who is or could be a participant is expressed other 
than as--
    (1) The choice of benefits determined under two or more benefit 
formulas, each of which is expressed in terms of one of those same safe-
harbor formula measures as is used for the participant's ``choice-of'' 
benefit; or
    (2) A benefit that is determined in terms of only one of those same 
safe-harbor formula measures.
    (iii) Disregard of certain subsidized benefits. For purposes of 
paragraph (b)(1)(i) of this section, any subsidized portion

[[Page 808]]

of any early retirement benefit that is included in a participant's 
accumulated benefit is disregarded. For this purpose, the subsidized 
portion of an early retirement benefit is the retirement-type subsidy 
within the meaning of Sec. 1.411(d)-3(g)(6) that is contingent on a 
participant's severance from employment and commencement of benefits 
before normal retirement age.
    (iv) Examples. The provisions of this paragraph (b)(1) are 
illustrated by the following examples:

    Example 1. (i) Facts relating to formulas described in paragraph 
(b)(1)(i)(A) of this section. Employer X maintains a defined benefit 
plan that provides a straight life annuity payable commencing at normal 
retirement age (which is age 65) equal to 1 percent of the participant's 
highest 3 consecutive years' compensation times years of service and 
provides for suspension of benefits as permitted under section 
411(a)(3)(B). In the case of a participant whose service continues after 
normal retirement age, the amount payable is the greater of (i) the 
benefit payable at normal retirement age, and for each year thereafter, 
actuarially increased to account for delayed commencement, and (ii) the 
retirement benefit determined under the formula at the date the 
employee's service ceases (calculated by including years of service and 
increases in compensation after normal retirement age).
    (ii) Conclusion. Under these facts, the plan formula is a formula 
described in paragraph (b)(1)(i)(A) of this section. The formula is not 
a statutory hybrid benefit formula merely because the plan formula 
includes a benefit that is based on the participant's benefit at normal 
retirement age (and each year thereafter) that is actuarially increased 
for commencement after attainment of normal retirement age. In addition, 
the plan formula would satisfy the comparison under paragraph (b)(1)(i) 
of this section for each individual who is or could be a participant 
because, as of any date (including any date after normal retirement 
age), the accumulated benefit of the individual would not be less than 
the accumulated benefit of any similarly situated, younger individual 
who is or could be a participant.
    Example 2. (i) Facts relating to formulas described in paragraph 
(b)(1)(i)(B) of this section. Employer Y maintains a defined benefit 
plan that expresses each participant's accumulated benefit as the 
balance of a hypothetical account. Under the formula, the hypothetical 
account balance of each participant is credited monthly with interest at 
a specified rate and the hypothetical account balance of each employee 
who is a participant is also credited with a pay credit under the plan 
equal to 7 percent of the participant's compensation for the month.
    (ii) Conclusion. The plan formula is a lump sum-based benefit 
formula described in paragraph (b)(1)(i)(B) of this section and the 
formula would satisfy the comparison under paragraph (b)(1)(i) of this 
section for each individual who is or could be a participant because, as 
of any date, the hypothetical account balance of the individual would 
not be less than the hypothetical account balance of any similarly 
situated, younger individual who is or could be a participant.
    Example 3. (i) Facts where plan suspends interest credits after 
normal retirement age. The facts are the same as in Example 2 except 
that the plan provides for suspension of benefits as permitted under 
section 411(a)(3)(B). Pursuant to the plan's suspension of benefits 
provision, the plan provides for interest credits to cease during 
service after normal retirement age or for the amount of the interest 
credits during this service to be reduced to reflect principal credits 
credited.
    (ii) Conclusion. The plan does not satisfy the safe harbor in 
paragraph (b)(1)(i) of this section. Applying the rule of paragraph 
(b)(1)(i) of this section, the plan formula would fail to satisfy the 
safe harbor comparison under paragraph (b)(1)(i) of this section with 
respect to an individual whose benefits have been suspended because, as 
of any date after attainment of normal retirement age, the hypothetical 
account balance of this individual would be less than the hypothetical 
account balance of one or more similarly situated individuals who have 
not attained normal retirement age.
    Example 4. (i) Facts providing greater-of benefits as described in 
paragraph (b)(1)(ii)(C) of this section. Employer Z sponsors a defined 
benefit plan that provides an accumulated benefit expressed as a 
straight life annuity commencing at the plan's normal retirement age 
(age 65), based on a percentage of average annual compensation times the 
participant's years of service. On November 2, 2011, the plan is amended 
effective as of January 1, 2012, to provide participants who have 
attained age 55 by January 1, 2012, with a benefit that is the greater 
of the benefit under the average annual compensation formula and a 
benefit that is based on the balance of a hypothetical account, which 
provides for annual pay credits of a specified percentage of the 
participant's compensation and annual interest credits based on the 
third segment rate.
    (ii) Conclusion where plan provides greater-of benefits to older 
participants. The plan satisfies the safe harbor of paragraph (b)(1)(i) 
of this section with respect to all individuals who are or could be 
participants. Pursuant to the rules of paragraph (b)(1)(ii)(C) of this 
section, the plan satisfies the safe harbor with respect to individuals 
who have attained age 55 by January 1, 2012, because (A)

[[Page 809]]

with respect to the benefit described in paragraph (b)(1)(i)(A) of this 
section (the benefit based on average annual compensation, disregarding 
the benefit based on the balance of a hypothetical account), the 
accumulated benefit for any individual who is or could be a participant 
and who is at least age 55 on January 1, 2012, would in no event be less 
than the accumulated benefit for a similarly situated, younger 
individual who is or could be participant and who has not yet attained 
age 55 by January 1, 2012, (B) with respect to the benefit described in 
paragraph (b)(1)(i)(B) of this section (the benefit based on the balance 
of a hypothetical account, disregarding the benefit based on average 
annual compensation), the accumulated benefit for any individual who is 
or could be a participant and who is at least age 55 on January 1, 2012, 
would in no event be less than the accumulated benefit for a similarly 
situated, younger individual who is or could be a participant and who 
has not yet attained age 55 by January 1, 2012, and (C) the benefit of 
any individual who is or could be a participant who has not yet attained 
age 55 by January 1, 2012, is only expressed as an annuity payable at 
normal retirement age as described in paragraph (b)(1)(i)(A) of this 
section, and this safe-harbor formula measure applies also to 
participants who have attained age 55 by January 1, 2012. Furthermore, 
the plan satisfies the safe harbor with respect to individuals who have 
not yet attained age 55 by January 1, 2012, because the benefit of these 
individuals satisfies the general rule of paragraph (b)(1)(ii)(A) of 
this section.
    (iii) Conclusion where plan provides greater-of benefits only to 
younger participants. If, instead of the facts in paragraph (i) of this 
Example 4, the plan had been amended to provide only participants who 
have not yet attained age 55 by January 1, 2012, with a benefit that is 
the greater of the benefit under the average annual compensation formula 
and a benefit that is based on the balance of a hypothetical account, 
then the safe harbor would not be satisfied with respect to individuals 
who have attained age 55 by January 1, 2012. Under paragraph 
(b)(1)(ii)(A) of this section, except as provided in paragraphs 
(b)(1)(ii)(B), (C), and (D) of this section, the safe harbor of 
paragraph (b)(1)(i) of this section is available only with respect to 
individuals over age 55, whose benefit is expressed in terms of only one 
safe-harbor formula measure, if no similarly situated, younger 
individual has an accumulated benefit that is expressed in terms of any 
measure other than that same safe-harbor formula measure. This is not 
the case under these facts. The greater-of rule of paragraph 
(b)(1)(ii)(C) of this section would not apply to individuals who have 
attained age 55 because the accumulated benefits of these individuals is 
not equal to the greater of benefits under two or more benefit formulas.
    Example 5. (i) Facts where plan provides choice-of benefits to older 
participants. The facts are the same as in paragraph (i) of Example 4, 
except that for service after December 31, 2011, the amendment permits 
participants who have attained age 55 by January 1, 2012, to choose 
between benefits under the average annual compensation benefit formula 
or benefits under the hypothetical account balance formula (but, if a 
participant chooses the hypothetical account balance formula, his or her 
benefit under the plan is in no event to be less than the benefit 
determined under the average annual compensation benefit formula for 
service before January 1, 2012), while other participants receive 
benefits solely under the hypothetical account balance formula (but 
individuals who are participants on December 31, 2011, are in no event 
to receive less than the benefit determined under the average annual 
compensation benefit formula for service before January 1, 2012).
    (ii) Conclusion where plan provides choice to older participants. 
The plan satisfies the safe harbor with respect to all individuals who 
are or could be participants. Pursuant to the rule of paragraph 
(b)(1)(ii)(D) of this section, the plan satisfies the safe harbor of 
paragraph (b)(1)(i) of this section with respect to individuals who have 
attained age 55 by January 1, 2012, and, pursuant to the rule of 
paragraph (b)(1)(ii)(A), the plan satisfies the safe harbor with respect 
to individuals who have not yet attained 55 by January 1, 2012.
    (iii) Conclusion where plan provides choice-of benefits to older 
workers and greater-of benefits to younger participants. If, in addition 
to the facts in paragraph (i) of this Example 5, the plan were also to 
provide participants who had not yet attained age 55 by January 1, 2012, 
the greater of the benefits under the average annual compensation 
benefit formula or the benefits under the hypothetical account balance 
formula, then pursuant to the rules of paragraph (b)(1)(ii)(A) and (D) 
of this section, the safe harbor would not be satisfied with respect to 
participants who have attained age 55 by January 1, 2012.

    (2) Indexed benefits--(i) In general. Except as provided in 
paragraph (b)(2)(iii) of this section, pursuant to section 411(b)(5)(E) 
and this paragraph (b)(2)(i), a defined benefit plan is not treated as 
failing to meet the requirements of section 411(b)(1)(H) with respect to 
a participant solely because a benefit formula (other than a lump sum-
based benefit formula) under the plan provides for the periodic 
adjustment of the participant's accrued benefit under the plan by means 
of the application of a recognized index or methodology. For purpose of 
the preceding sentence, a

[[Page 810]]

rate that does not exceed a market rate of return, as defined in 
paragraph (d) of this section, is deemed to be a recognized index or 
methodology. However, such a plan must satisfy the qualification 
requirements otherwise applicable to statutory hybrid plans, including 
the requirements of Sec. 1.411(a)(13)-1(c) (relating to minimum vesting 
standards) and paragraph (c) of this section (relating to plan 
conversion amendments).
    (ii) Similarly situated participant test. Paragraph (b)(2)(i) of 
this section does not apply unless the aggregate adjustments made to a 
participant's accrued benefit under the plan (determined as a percentage 
of the unadjusted accrued benefit) in a period would not be less than 
the aggregate adjustments for any similarly situated, younger 
participant. This test requires a comparison, for each period, of the 
aggregate adjustments for each individual who is or could be a 
participant in the plan for the period with the aggregate adjustments of 
each other similarly situated, younger individual who is or could be a 
participant in the plan for that period. See paragraph (b)(5) of this 
section for rules regarding whether each younger individual who is or 
could be a participant is similarly situated to a participant.
    (iii) Protection against loss--(A) In general. Paragraph (b)(2)(i) 
of this section does not apply unless the plan satisfies section 
411(b)(5)(E)(ii) and paragraph (d)(2) of this section (relating to 
preservation of capital).
    (B) Exception for variable annuity benefit formulas. The requirement 
to satisfy section 411(b)(5)(B)(i)(II), as set forth in paragraph (d)(2) 
of this section, as well as section 411(b)(5)(E)(ii), as set forth in 
this paragraph (b)(2)(iii), does not apply in the case of a benefit 
provided under a variable annuity benefit formula as defined in Sec. 
1.411(a)(13)-1(d)(6).
    (3) Certain offsets permitted. A plan is not treated as failing to 
meet the requirements of section 411(b)(1)(H) solely because the plan 
provides offsets against benefits under the plan to the extent the 
offsets are allowable in applying the requirements of section 401(a) and 
the applicable requirements of the Employee Retirement Income Security 
Act of 1974, Public Law 93-406 (88 Stat. 829 (1974)), and the Age 
Discrimination in Employment Act of 1967, Public Law 90-202 (81 Stat. 
602 (1967)).
    (4) Permitted disparities in plan contributions or benefits. A plan 
is not treated as failing to meet the requirements of section 
411(b)(1)(H) solely because the plan provides a disparity in 
contributions or benefits with respect to which the requirements of 
section 401(l) are met.
    (5) Definition of similarly situated. For purposes of paragraphs 
(b)(1) and (b)(2) of this section, an individual is similarly situated 
to another individual if the individual is identical to that other 
individual in every respect that is relevant in determining a 
participant's benefit under the plan (including period of service, 
compensation, position, date of hire, work history, and any other 
respect) except for age. In determining whether an individual is 
similarly situated to another individual, any characteristic that is 
relevant for determining benefits under the plan and that is based 
directly or indirectly on age is disregarded. For example, if a 
particular benefit formula applies to a participant on account of the 
participant's age, an individual to whom the benefit formula does not 
apply and who is identical to the participant in all other respects is 
similarly situated to the participant. By contrast, an individual is not 
similarly situated to a participant if a different benefit formula 
applies to the individual and the application of the different formula 
is not based directly or indirectly on age.
    (c) Special rules for plan conversion amendments--(1) In general. 
Pursuant to section 411(b)(5)(B)(ii), (iii), and (iv), if there is a 
conversion amendment within the meaning of paragraph (c)(4) of this 
section with respect to a defined benefit plan, then the plan is treated 
as failing to meet the requirements of section 411(b)(1)(H) unless the 
plan, after the amendment, satisfies the requirements of paragraph 
(c)(2) of this section.
    (2) Separate calculation of post-conversion benefit--(i) In general. 
A statutory hybrid plan satisfies the requirements of this paragraph 
(c)(2) if the plan provides that, in the case of an individual

[[Page 811]]

who was a participant in the plan immediately before the date of 
adoption of the conversion amendment, the participant's benefit at any 
subsequent annuity starting date is not less than the sum of--
    (A) The participant's section 411(d)(6) protected benefit (as 
defined in Sec. 1.411(d)-3(g)(14)) with respect to service before the 
effective date of the conversion amendment, determined under the terms 
of the plan as in effect immediately before the effective date of the 
conversion amendment; and
    (B) The participant's section 411(d)(6) protected benefit with 
respect to service on and after the effective date of the conversion 
amendment, determined under the terms of the plan as in effect after the 
effective date of the conversion amendment.
    (ii) Rules of application. For purposes of this paragraph (c)(2), 
except as provided in paragraph (c)(3) of this section, the benefits 
under paragraphs (c)(2)(i)(A) and (c)(2)(i)(B) of this section must each 
be determined in the same manner as if they were provided under separate 
plans that are independent of each other (for example, without any 
benefit offsets), and, except to the extent permitted under Sec. 
1.411(d)-3 or Sec. 1.411(d)-4 (or other applicable law), each optional 
form of payment provided under the terms of the plan with respect to a 
participant's section 411(d)(6) protected benefit as in effect before 
the conversion amendment must be available thereafter to the extent of 
the plan's benefits for service prior to the effective date of the 
conversion amendment.
    (3) Establishment of opening hypothetical account balance or opening 
accumulated percentage--(i) In general. Provided that the requirements 
of paragraph (c)(3)(ii) or (c)(3)(iii) of this section are satisfied, a 
statutory hybrid plan under which an opening hypothetical account 
balance or opening accumulated percentage of the participant's final 
average compensation is established as of the effective date of the 
conversion amendment does not fail to satisfy the requirements of 
paragraph (c)(2) of this section merely because benefits attributable to 
that opening hypothetical account balance or opening accumulated 
percentage (that is, benefits that are not described in paragraph 
(c)(2)(i)(B) of this section) are substituted for benefits described in 
paragraph (c)(2)(i)(A) of this section.
    (ii) Comparison of benefits at annuity starting date--(A) Testing 
requirement. The requirements of this paragraph (c)(3)(ii) are satisfied 
with respect to an optional form of benefit payable at an annuity 
starting date only if the plan provides that the amount of the benefit 
payable in that optional form under the lump sum-based benefit formula 
that is attributable to the opening hypothetical account balance or 
opening accumulated percentage as described in paragraph (c)(3)(i) of 
this section is not less than the benefit under the comparable optional 
form of benefit under paragraph (c)(2)(i)(A) of this section. To satisfy 
this requirement, if the benefit under the optional form attributable to 
the opening hypothetical account balance or opening accumulated 
percentage is less than the benefit under the comparable optional form 
of benefit described in paragraph (c)(2)(i)(A) of this section, then the 
benefit attributable to the opening hypothetical account balance or 
opening accumulated percentage must be increased to the extent necessary 
to provide the minimum benefit described in this paragraph (c)(3)(ii). 
Thus, if a plan is using the option under this paragraph (c)(3)(ii) to 
satisfy paragraph (c)(2) of this section with respect to a participant, 
the participant must receive a benefit equal to not less than the sum 
of--
    (1) The benefit described in paragraph (c)(2)(i)(B) of this section; 
and
    (2) The greater of--
    (i) The benefit attributable to the opening hypothetical account 
balance or attributable to the opening accumulated percentage of the 
participant's final average compensation as described in this paragraph 
(c)(3)(ii); or
    (ii) The benefit described in paragraph (c)(2)(i)(A) of this 
section.
    (B) Comparable optional form of benefit. If there was an optional 
form of benefit within the same generalized optional form of benefit 
(within the meaning of Sec. 1.411(d)-3(g)(8)) that would have been 
available to the participant at that annuity starting date under the

[[Page 812]]

terms of the plan as in effect immediately before the effective date of 
the conversion amendment, then that optional form of benefit is the 
comparable optional form of benefit.
    (C) Special rule for new post-conversion optional forms of benefit. 
If an optional form of benefit is available on the annuity starting date 
with respect to the benefit attributable to the opening hypothetical 
account balance or opening accumulated percentage, but no optional form 
within the same generalized optional form of benefit (within the meaning 
of Sec. 1.411(d)-3(g)(8)) was available at that annuity starting date 
under the terms of the plan as in effect immediately prior to the 
effective date of the conversion amendment, then, for purposes of this 
paragraph (c)(3)(ii), the plan is treated as if such an optional form of 
benefit were available immediately prior to the effective date of the 
conversion amendment for purposes of this paragraph (c)(3)(ii). Thus, 
for example, if a single-sum optional form of payment is not available 
under the plan terms applicable to the accrued benefit described in 
paragraph (c)(2)(i)(A) of this section, but a single-sum optional form 
of payment is available with respect to the benefit attributable to the 
opening hypothetical account balance or opening accumulated percentage 
as of the annuity starting date, then, for purposes of this paragraph 
(c)(3)(ii), the plan is treated as if a single sum (which satisfies the 
requirements of section 417(e)(3)) were available under the terms of the 
plan as in effect immediately prior to the effective date of the 
conversion amendment.
    (iii) Comparison of benefits at effective date of conversion 
amendment. [Reserved]
    (4) Conversion amendment--(i) In general. An amendment is a 
conversion amendment that is subject to the requirements of this 
paragraph (c) with respect to a participant if--
    (A) The amendment reduces or eliminates the benefits that, but for 
the amendment, the participant would have accrued after the effective 
date of the amendment under a benefit formula that is not a statutory 
hybrid benefit formula (and under which the participant was accruing 
benefits prior to the amendment); and
    (B) After the effective date of the amendment, all or a portion of 
the participant's benefit accruals under the plan are determined under a 
statutory hybrid benefit formula.
    (ii) Rules of application--(A) In general. Paragraphs (c)(4)(iii), 
(iv), and (v) of this section describe special rules that treat certain 
arrangements as conversion amendments. The rules described in those 
paragraphs apply both separately and in combination. Thus, for example, 
in an acquisition described in Sec. 1.410(b)-2(f), if the buyer adopts 
an amendment under which a participant's benefits under the seller's 
plan that is not a statutory hybrid plan are coordinated with a separate 
plan of the buyer that is a statutory hybrid plan, such as through an 
offset of the participant's benefit under the buyer's plan by the 
participant's benefit under the seller's plan, the seller and buyer are 
treated as a single employer under paragraph (c)(4)(iv) of this section 
and they are treated as having adopted a conversion amendment under 
paragraph (c)(4)(iii) of this section. However, pursuant to paragraph 
(c)(4)(iii) of this section, if there is no coordination between the two 
plans, there is no conversion amendment.
    (B) Covered amendments. Only amendments that eliminate or reduce 
accrued benefits described in section 411(a)(7), or a retirement-type 
subsidy described in section 411(d)(6)(B)(i), that would otherwise 
accrue as a result of future service are treated as amendments described 
in paragraph (c)(4)(i)(A) of this section.
    (C) Operation of plan terms treated as covered amendment. If, under 
the terms of a plan, a change in the conditions of a participant's 
employment results in a reduction of the participant's benefits that 
would have accrued in the future under a benefit formula that is not a 
statutory hybrid benefit formula, the plan is treated for purposes of 
this paragraph (c)(4) as if such plan terms constitute an amendment that 
reduces the participant's benefits that would have accrued after the 
effective date of the change under a benefit formula that is not a 
statutory hybrid benefit

[[Page 813]]

formula. Thus, for example, if a participant transfers from an operating 
division that is covered by a non-statutory hybrid benefit formula to an 
operating division that is covered by a statutory hybrid benefit 
formula, there has been a conversion amendment and the effective date of 
the conversion amendment is the date of the transfer. For purposes of 
applying the effective date rule of paragraph (f)(1)(ii) of this 
section, the date that the relevant plan terms were adopted is treated 
as the adoption date of the amendment.
    (iii) Multiple plans. An employer is treated as having adopted a 
conversion amendment if the employer adopts an amendment under which a 
participant's benefits under a plan that is not a statutory hybrid plan 
are coordinated with a separate plan that is a statutory hybrid plan, 
such as through a reduction (offset) of the benefit under the plan that 
is not a statutory hybrid plan.
    (iv) Multiple employers. If the employer of an employee changes as a 
result of a transaction described in Sec. 1.410(b)-2(f), then the two 
employers are treated as a single employer for purposes of this 
paragraph (c)(4).
    (v) Multiple amendments--(A) In general--(1) General rule. For 
purposes of this paragraph (c)(4), a conversion amendment includes 
multiple amendments that result in a conversion amendment even if the 
amendments are not conversion amendments individually. For example, an 
employer is treated as having adopted a conversion amendment if the 
employer first adopts an amendment described in paragraph (c)(4)(i)(A) 
of this section and, at a later date, adopts an amendment that adds a 
benefit under a statutory hybrid benefit formula as described in 
paragraph (c)(4)(i)(B) of this section, if they are consolidated under 
paragraph (c)(4)(v)(A)(2) of this section.
    (2) Delay between plan amendments. In determining whether a 
conversion amendment has been adopted, an amendment to provide a benefit 
under a statutory hybrid benefit formula is consolidated with a prior 
amendment to reduce non-statutory hybrid benefit formula benefits if the 
amendment providing benefits under a statutory hybrid benefit formula is 
adopted within three years after adoption of the amendment reducing non-
statutory hybrid benefit formula benefits. Thus, the later adoption of 
the statutory hybrid benefit formula will cause the earlier amendment to 
be treated as part of a conversion amendment. In the case of an 
amendment to provide a benefit under a statutory hybrid benefit formula 
that is adopted more than three years after adoption of an amendment to 
reduce benefits under a non-statutory hybrid benefit formula, there is a 
presumption that the amendments are not consolidated unless the facts 
and circumstances indicate that adoption of the amendment to provide a 
benefit under a statutory hybrid benefit formula was intended at the 
time of reduction in the non-statutory hybrid benefit formula.
    (B) Multiple conversion amendments. If an employer adopts multiple 
amendments reducing benefits described in paragraph (c)(4)(i)(A) of this 
section, each amendment is treated as a separate conversion amendment, 
provided that paragraph (c)(4)(i)(B) of this section is applicable at 
the time of the amendment (taking into account the rules of this 
paragraph (c)(4)).
    (vi) Effective date of a conversion amendment. The effective date of 
a conversion amendment is, with respect to a participant, the date as of 
which the reduction of the participant's benefits described in paragraph 
(c)(4)(i)(A) of this section occurs. In accordance with section 
411(d)(6), the date of a reduction of those benefits cannot be earlier 
than the date of adoption of the conversion amendment.
    (5) Examples. The following examples illustrate the application of 
this paragraph (c):

    Example 1. (i) Facts where plan does not establish opening 
hypothetical account balance for participants and participant elects 
life annuity at normal retirement age. Employer N sponsors Plan E, a 
defined benefit plan that provides an accumulated benefit, payable as a 
straight life annuity commencing at age 65 (which is Plan E's normal 
retirement age), based on a percentage of highest average compensation 
times the participant's years of service. Plan E permits any participant 
who has had a severance from employment to elect payment in the 
following optional forms of benefit (with spousal consent if 
applicable), with any payment not made in a

[[Page 814]]

straight life annuity converted to an equivalent form based on 
reasonable actuarial assumptions: A straight life annuity; and a 50 
percent, 75 percent, or 100 percent joint and survivor annuity. The 
payment of benefits may commence at any time after attainment of age 55, 
with an actuarial reduction if the commencement is before normal 
retirement age. In addition, the plan offers a single-sum payment after 
attainment of age 55 equal to the present value of the normal retirement 
benefit using the applicable interest rate and mortality table under 
section 417(e)(3) in effect under the terms of the plan on the annuity 
starting date.
    (ii) Facts relating to the conversion amendment. On January 1, 2012, 
Plan E is amended to eliminate future accruals under the highest average 
compensation benefit formula and to base future benefit accruals under a 
hypothetical account balance formula. For service on or after January 1, 
2012, each participant's hypothetical account balance is credited 
monthly with a pay credit equal to a specified percentage of the 
participant's compensation during the month and also with interest based 
on the third segment rate described in section 430(h)(2)(C)(iii). With 
respect to benefits under the hypothetical account balance attributable 
to service on and after January 1, 2012, a participant is permitted to 
elect (with spousal consent if applicable) payment in the same 
generalized optional forms of benefit (even though different actuarial 
factors apply) as under the terms of the plan in effect before January 
1, 2012, and also as a single-sum distribution. The plan provides for 
the benefit attributable to service before January 1, 2012, to be 
determined under the terms of the plan as in effect immediately before 
the effective date of the amendment, and the benefit attributable to 
service on and after January 1, 2012, to be determined separately, under 
the terms of the plan as in effect after the effective date of the 
amendment, with neither benefit offsetting the other in any manner. 
Thus, each participant's benefit is equal to the sum of the benefit 
attributable to service before January 1, 2012 (to be determined under 
the terms of the plan as in effect immediately before the effective date 
of the amendment), plus the benefit attributable to the participant's 
hypothetical account balance.
    (iii) Facts relating to an affected participant. Participant A is 
age 62 on January 1, 2012. On December 31, 2011, A's benefit for years 
of service before January 1, 2012, payable as a straight life annuity 
commencing at A's normal retirement age (age 65), which is January 1, 
2015, is $1,000 per month. On January 1, 2015, when Participant A has a 
severance from employment, the then-current hypothetical account 
balance, with pay credits and interest from January 1, 2012, to January 
1, 2015, is $11,000. Using the conversion factors applicable under the 
plan on January 1, 2015, that balance is equivalent to a straight life 
annuity of $100 per month commencing on January 1, 2015. This benefit is 
in addition to the benefit attributable to service before January 1, 
2012. Participant A elects (with spousal consent) a straight life 
annuity of $1,100 per month commencing January 1, 2015.
    (iv) Conclusion. Participant A's benefit satisfies the requirements 
of paragraph (c) of this section because Participant A's benefit is not 
less than the sum of Participant A's section 411(d)(6) protected benefit 
(as defined in Sec. 1.411(d)-3(g)(14)) with respect to service before 
the effective date of the conversion amendment, determined under the 
terms of the plan as in effect immediately before the effective date of 
the amendment, and Participant A's section 411(d)(6) protected benefit 
with respect to service on and after the effective date of the 
conversion amendment, determined under the terms of the plan as in 
effect after the effective date of the amendment.
    Example 2. (i) Facts involving plan's establishment of opening 
hypothetical account balance and payment of pre-conversion accumulated 
benefit in life annuity at normal retirement age. Except as indicated in 
this Example 2, the facts are the same as the facts under paragraph (i) 
of Example 1.
    (ii) Facts relating to the conversion amendment. On January 1, 2012, 
Plan E is amended to eliminate future accruals under the highest average 
compensation benefit formula and to provide future benefit accruals 
under a hypothetical account balance formula. An opening hypothetical 
account balance is established for each participant, and, under the 
plan's terms, that balance is equal to the present value of the 
participant's accumulated benefit on December 31, 2011 (payable as a 
straight life annuity at normal retirement age or immediately, if 
later), using the applicable interest rate and applicable mortality 
table under section 417(e)(3) on January 1, 2012. Under Plan E, the 
account based on this opening hypothetical account balance is maintained 
as a separate account from the account for accruals on or after January 
1, 2012. The hypothetical account balance maintained for each 
participant for accruals on or after January 1, 2012, is credited 
monthly with a pay credit equal to a specified percentage of the 
participant's compensation during the month. A participant's 
hypothetical account balance (including both of the separate accounts) 
is credited monthly with interest based on the third segment rate 
described in section 430(h)(2)(C)(iii).
    (iii) Facts relating to optional forms of benefit. Following 
severance from employment and attainment of age 55, a participant is 
permitted to elect (with spousal consent, if applicable) payment in the 
same generalized

[[Page 815]]

optional forms of benefit as under the plan in effect prior to January 
1, 2012, with the amount payable calculated based on the hypothetical 
account balance on the annuity starting date and the applicable interest 
rate and applicable mortality table on the annuity starting date. The 
single-sum distribution is equal to the hypothetical account balance.
    (iv) Facts relating to conversion protection. The plan provides 
that, as of a participant's annuity starting date, the plan will 
determine whether the benefit attributable to the opening hypothetical 
account balance payable in the particular optional form of benefit 
selected is equal to or greater than the benefit accrued under the plan 
through the date of conversion and payable in the same generalized 
optional form of benefit with the same annuity starting date. If the 
benefit attributable to the opening hypothetical account balance is 
equal to or greater than the pre-conversion benefit, the plan provides 
that such benefit is paid in lieu of the pre-conversion benefit, 
together with the benefit attributable to post-conversion pay-based 
principal credits. If the benefit attributable to the opening 
hypothetical account balance is less than the pre-conversion benefit, 
the plan provides that such benefit is increased sufficiently to provide 
the pre-conversion benefit, together with the benefit attributable to 
post-conversion pay-based principal credits.
    (v) Facts relating to an affected participant. On January 1, 2012, 
the opening hypothetical account balance established for Participant A 
is $80,000, which is the present value of Participant A's straight life 
annuity of $1,000 per month commencing at January 1, 2015, using the 
applicable interest rate and applicable mortality table under section 
417(e)(3) in effect on January 1, 2012. On January 1, 2012, the 
applicable interest rate for Participant A is equivalent to a level rate 
of 5.5 percent. Thereafter, Participant A's hypothetical account balance 
for subsequent accruals is credited monthly with a pay credit equal to a 
specified percentage of the participant's compensation during the month. 
In addition, Participant A's hypothetical account balance (including 
both of the separate accounts) is credited monthly with interest based 
on the third segment rate described in section 430(h)(2)(C)(iii).
    (vi) Facts relating to calculation of the participant's benefit. 
Participant A has a severance from employment on January 1, 2015 at age 
65, and elects (with spousal consent) a straight life annuity commencing 
January 1, 2015. On January 1, 2015, the opening hypothetical account 
balance, with interest credits from January 1, 2012, to January 1, 2015, 
has become $95,000, which, using the conversion factors under the plan 
on January 1, 2015, is equivalent to a straight life annuity of $1,005 
per month commencing on January 1, 2015 (which is greater than the 
$1,000 a month payable at age 65 under the terms of the plan in effect 
before January 1, 2012). This benefit is in addition to the benefit 
determined using the hypothetical account balance for service after 
January 1, 2012.
    (vii) Conclusion. The benefit satisfies the requirements of 
paragraph (c)(3)(ii)(A) of this section with respect to Participant A 
because A's benefit is not less than the sum of (A) the greater of 
Participant A's benefits attributable to the opening hypothetical 
account balance and A's section 411(d)(6) protected benefit (as defined 
in Sec. 1.411(d)-3(g)(14)) with respect to service before the effective 
date of the conversion amendment, determined under the terms of the plan 
as in effect immediately before the effective date of the amendment, and 
(B) Participant A's section 411(d)(6) protected benefit with respect to 
service on and after the effective date of the conversion amendment, 
determined under the terms of the plan as in effect after the effective 
date of the amendment.
    Example 3. (i) Facts involving a subsequent decrease in interest 
rates. The facts are the same as in Example 2, except that, because of a 
decrease in bond rates after January 1, 2012, and before January 1, 
2015, the rate of interest credited in that period averages less than 
5.5 percent, and, on January 1, 2015, the effective applicable interest 
rate under section 417(e)(3) under the plan's terms is 4.7 percent. As a 
result, Participant A's opening hypothetical account balance plus 
attributable interest credits has increased to only $87,000 on January 
1, 2015, and, using the conversion factors under the plan on January 1, 
2015, is equivalent to a straight life annuity commencing on January 1, 
2015, of $775 per month. Under the terms of Plan E, the benefit 
attributable to A's opening hypothetical account balance is increased so 
that A's straight life annuity commencing on January 1, 2015, is $1,000 
per month. This benefit is in addition to the benefit attributable to 
the hypothetical account balance for service after January 1, 2012.
    (ii) Conclusion. The benefit satisfies the requirements of paragraph 
(c)(3)(ii)(A) of this section with respect to Participant A because A's 
benefit is not less than the sum of--
    (A) The greater of A's benefits attributable to the opening 
hypothetical account balance and A's section 411(d)(6) protected benefit 
(as defined in Sec. 1.411(d)-3(g)(14)) with respect to service before 
the effective date of the conversion amendment, determined under the 
terms of the plan as in effect immediately before the effective date of 
the amendment; and
    (B) A's section 411(d)(6) protected benefit with respect to service 
on and after the effective date of the conversion amendment, determined 
under the terms of the plan as in

[[Page 816]]

effect after the effective date of the amendment.
    Example 4. (i) Facts involving payment of a subsidized early 
retirement benefit. The facts are the same as in Example 2, except that 
under the terms of Plan E on December 31, 2011, a participant who 
retires before age 65 and after age 55 with 30 years of service has only 
a 3 percent per year actuarial reduction. Participant A has a severance 
from employment on January 1, 2013, when A is age 63 and has 30 years of 
service. On January 1, 2013, A's opening hypothetical account balance, 
with interest from January 1, 2012, to January 1, 2013, has become 
$86,000, which, using the conversion factors under the plan (as amended) 
on January 1, 2013, is equivalent to a straight life annuity commencing 
on January 1, 2013, of $850 per month.
    (ii) Facts relating to calculation of the participant's benefit. 
Under the terms of Plan E on December 31, 2011, Participant A is 
entitled to a straight life annuity commencing on January 1, 2013, equal 
to at least $940 per month ($1,000 reduced by 3 percent for each of the 
2 years that A's benefits commence before normal retirement age). Under 
the terms of Plan E, the benefit attributable to A's opening account 
balance is increased so that A is entitled to a straight life annuity of 
$940 per month commencing on January 1, 2015. This benefit is in 
addition to the benefit determined using the hypothetical account 
balance for service after January 1, 2012.
    (iii) Conclusion. The benefit satisfies the requirements of 
paragraph (c)(3)(ii)(A) of this section with respect to Participant A 
because A's benefit is not less than the sum of--
    (A) The greater of Participant A's benefits attributable to the 
opening hypothetical account balance (increased by attributable interest 
credits) and A's section 411(d)(6) protected benefit (as defined in 
Sec. 1.411(d)-3(g)(14)) with respect to service before the effective 
date of the conversion amendment, determined under the terms of the plan 
as in effect immediately before the effective date of the amendment; and
    (B) Participant A's section 411(d)(6) protected benefit with respect 
to service on and after the effective date of the conversion amendment, 
determined under the terms of the plan as in effect after the effective 
date of the amendment.
    Example 5. (i) Facts involving addition of a single-sum payment 
option. The facts are the same as in Example 2, except that, before 
January 1, 2012, Plan E did not offer payment in a single-sum 
distribution for amounts in excess of $5,000. Plan E, as amended on 
January 1, 2012, offers payment in any of the available annuity 
distribution forms commencing at any time following severance from 
employment as were provided under Plan E before January 1, 2012. In 
addition, Plan E, as amended on January 1, 2012, offers payment in the 
form of a single sum attributable to service before January 1, 2012, 
which is the greater of the opening hypothetical account balance 
(increased by attributable interest credits) or a single-sum 
distribution of the straight life annuity payable at age 65 using the 
same actuarial factors as are used for mandatory cashouts for amounts 
equal to $5,000 or less under the terms of the plan on December 31, 
2011. Participant B is age 40 on January 1, 2012, and B's opening 
hypothetical account balance (increased by attributable interest 
credits) is $33,000 (which is the present value, using the conversion 
factors under the plan (as amended) on January 1, 2012, of Participant 
B's straight life annuity of $1,000 per month commencing at January 1, 
2037, which is when B will be age 65). Participant B has a severance 
from employment on January 1, 2015, and elects (with spousal consent) an 
immediate single-sum distribution. Participant B's opening hypothetical 
account balance (increased by attributable interest) on January 1, 2015, 
is $45,000. The present value, on January 1, 2015, of Participant B's 
benefit of $1,000 per month, commencing immediately using the actuarial 
factors for mandatory cashouts under the terms of the plan on December 
31, 2011, would result in a single-sum payment of $44,750. Participant B 
is paid a single-sum distribution equal to the sum of $45,000 plus an 
amount equal to B's January 1, 2015, hypothetical account balance for 
benefit accruals for service after January 1, 2012.
    (ii) Conclusion. Because, under Plan E, Participant B is entitled to 
the sum of--
    (A) The greater of the $45,000 opening hypothetical account balance 
(increased by attributable interest credits) and $44,750 (present value 
of the benefit with respect to service prior to January 1, 2012, using 
the actuarial factors for mandatory cashout distributions under the 
terms of the plan on December 31, 2011); and
    (B) An amount equal to B's hypothetical account balance for benefit 
accruals for service after January 1, 2012, the benefit satisfies the 
requirements of paragraph (c)(3)(ii)(A) of this section with respect to 
Participant B. If Participant B's hypothetical account balance under 
Plan E was instead less than $44,750 on January 1, 2015, Participant B 
would be entitled to a single-sum payment equal to the sum of $44,750 
and an amount equal to B's hypothetical account balance for benefit 
accruals for service after January 1, 2012.
    Example 6. (i) Facts involving addition of new annuity optional form 
of benefit. The facts are the same as in Example 2, except that, after 
December 31, 2011, and before January 1, 2015, Plan E is amended to 
offer payment in a 5-, 10-, or 15-year term certain and life annuity, 
using the same actuarial assumptions

[[Page 817]]

that apply for other optional forms of distribution. When Participant A 
has a severance from employment on January 1, 2015, A elects (with 
spousal consent) a 5-year term certain and life annuity commencing 
immediately equal to $935 per month. Application of the same actuarial 
assumptions to Participant A's benefit of $1,000 per month (under Plan E 
as in effect on December 31, 2011), commencing immediately on January 1, 
2015, would result in a 5-year term certain and life annuity commencing 
immediately equal to $955 per month. Under the terms of Plan E, the 
benefit attributable to A's opening account balance is increased so 
that, using the conversion factors under the plan (as amended) on 
January 1, 2015, A's opening hypothetical account balance (increased by 
attributable interest credits) produces a 5-year term certain and life 
annuity commencing immediately equal to $955 per month commencing on 
January 1, 2015. This benefit is in addition to the benefit determined 
using the January 1, 2015, hypothetical account balance for service 
after January 1, 2012.
    (ii) Conclusion. This benefit satisfies the requirements of 
paragraph (c)(3)(ii)(A) of this section with respect to Participant A.
    Example 7. (i) Facts involving addition of distribution option 
before age 55. The facts are the same as in Example 5, except that 
Participant B (age 43) elects (with spousal consent) a straight life 
annuity commencing immediately on January 1, 2015. Under Plan E, the 
straight life annuity attributable to Participant B's opening 
hypothetical account balance at age 43 is $221 per month. Application of 
the same actuarial assumptions to Participant B's benefit of $1,000 per 
month commencing at age 65 (under Plan E as in effect on December 31, 
2011) would result in a straight life annuity commencing immediately on 
January 1, 2015, equal to $219 per month.
    (ii) Conclusion. Because, under its terms, Plan E provides that 
Participant B is entitled to an amount not less than the present value 
(using the same actuarial assumptions as apply on January 1, 2015, in 
converting the $45,000 hypothetical account balance attributable to the 
opening hypothetical account balance to the $221 straight life annuity) 
of Participant B's straight life annuity of $1,000 per month commencing 
at age 65, and the $221 straight life annuity is in addition to the 
benefit accruals for service after January 1, 2012, payment of the $221 
monthly annuity would satisfy the requirements of paragraph 
(c)(3)(ii)(A) of this section with respect to Participant B.

    (d) Market rate of return--(1) In general--(i) Basic test. Subject 
to the rules of paragraph (e) of this section, a statutory hybrid plan 
satisfies the requirements of section 411(b)(1)(H) and this paragraph 
(d) only if, for any plan year, the interest crediting rate with respect 
to benefits determined under a statutory hybrid benefit formula is not 
greater than a market rate of return.
    (ii) Definitions relating to market rate of return--(A) Interest 
credit. Subject to other rules in this paragraph (d), an interest credit 
for purposes of this paragraph (d) and section 411(b)(5)(B) means the 
following adjustments to a participant's accumulated benefit under a 
statutory hybrid benefit formula, to the extent not conditioned on 
current service and not made on account of imputed service (as defined 
in Sec. 1.401(a)(4)-11(d)(3)(ii)(B))--
    (1) Any increase or decrease for a period, under the terms of the 
plan at the beginning of the period, that is calculated by applying a 
rate of interest or rate of return (including a rate of increase or 
decrease under an index) to the participant's accumulated benefit (or a 
portion thereof) as of the beginning of the period; and
    (2) Any other increase for a period, under the terms of the plan at 
the beginning of the period.
    (B) Treatment of plan amendments. An increase to a participant's 
accumulated benefit is not treated as an interest credit to the extent 
the increase is made as a result of a plan amendment providing for a 
one-time adjustment to the participant's accumulated benefit. However, a 
pattern of repeated plan amendments each of which provides for a one-
time adjustment to a participant's accumulated benefit will cause such 
adjustments to be treated as provided on a permanent basis under the 
terms of the plan. See Sec. 1.411(d)-4, A-1(c)(1).
    (C) Interest crediting rate. Except as otherwise provided in this 
paragraph (d), the interest crediting rate, or effective rate of return, 
for a period with respect to a participant equals the total amount of 
interest credits for the period divided by the participant's accumulated 
benefit at the beginning of the period.
    (D) Principal credit. For purposes of this paragraph (d), a 
principal credit means any increase to a participant's accumulated 
benefit under a statutory hybrid benefit formula that is not an interest 
credit. Thus, for example, a

[[Page 818]]

principal credit includes an increase to a participant's accumulated 
benefit to the extent the increase is conditioned on current service or 
made on account of imputed service. As a result, a principal credit 
includes an increase to the value of an accumulated percentage of the 
participant's final average compensation. For indexed benefits described 
in paragraph (b)(2) of this section, a principal credit includes an 
increase to the participant's accrued benefit other than an increase 
provided by indexing. In addition, pursuant to the rule in paragraph 
(d)(1)(ii)(B) of this section, a principal credit generally includes an 
increase to a participant's accumulated benefit to the extent the 
increase is made as a result of a plan amendment providing for a one-
time adjustment to the participant's accumulated benefit. As a result, a 
principal credit includes an opening hypothetical account balance or 
opening accumulated percentage of the participant's final average 
compensation, as described in paragraph (c)(3) of this section.
    (iii) Market rate of return for single rates. Except as otherwise 
provided in this paragraph (d)(1), an interest crediting rate is not in 
excess of a market rate of return only if the plan terms provide that 
the interest credit for each plan year is determined using one of the 
following specified interest crediting rates:
    (A) The interest rate on long-term investment grade corporate bonds 
(as described in paragraph (d)(3) of this section).
    (B) An interest rate that, under paragraph (d)(4) of this section, 
is deemed to be not in excess of the interest rate described in 
paragraph (d)(3) of this section.
    (C) A rate of return that, under paragraph (d)(5) of this section, 
is not in excess of a market rate of return.
    (iv) Timing and other rules related to interest crediting rate--(A) 
In general. A plan that provides interest credits must specify how the 
plan determines interest credits and must specify how and when interest 
credits are credited. The plan must specify the method for determining 
interest credits in accordance with the requirements of paragraph 
(d)(1)(iv)(B) of this section, the frequency of interest crediting in 
accordance with the requirements of paragraph (d)(1)(iv)(C) of this 
section, and the treatment of interest credits on distributed amounts, 
as well as other debits and credits during the period, in accordance 
with the rules of paragraph (d)(1)(iv)(D) of this section. See paragraph 
(e) of this section for additional rules that apply to changes in the 
interest crediting rate.
    (B) Methods to determine interest credits. A plan that is using any 
specified interest crediting rate can determine interest credits for 
each current interest crediting period based on the effective periodic 
interest crediting rate that applies over the period. Alternatively, a 
plan that is using one of the interest crediting rates described in 
paragraph (d)(3) or (d)(4) of this section can determine interest 
credits for a stability period based on the interest crediting rate for 
a specified lookback month with respect to that stability period. For 
purposes of the preceding sentence, the stability period and lookback 
month must satisfy the rules for selecting the stability period and 
lookback month under Sec. 1.417(e)-1(d)(4), although the interest 
crediting rate can be any one of the rates in paragraph (d)(3) or (d)(4) 
of this section and the stability period and lookback month need not be 
the same as those used under the plan for purposes of section 417(e)(3).
    (C) Frequency of interest crediting. Interest credits under a plan 
must be provided on an annual or more frequent periodic basis and 
interest credits for each interest crediting period must be credited as 
of the end of the period. If a plan provides for the crediting of 
interest more frequently than annually (for example, daily, monthly or 
quarterly) based on one of the annual interest rates described in 
paragraph (d)(3) or (d)(4) of this section, then the plan generally 
provides an above market rate of return unless each periodic interest 
credit is determined using an interest crediting rate that is no greater 
than a pro rata portion of the applicable annual interest crediting 
rate. However, a plan that credits interest daily based on one of the 
annual interest rates described in paragraph (d)(3) or (d)(4) of this 
section is not treated as

[[Page 819]]

providing an above market rate of return merely because the plan 
determines each daily interest credit using a daily interest crediting 
rate that is \1/360\ of the applicable annual interest crediting rate. 
In addition, interest credits determined, under the terms of a plan, 
based on one of the annual interest rates described in paragraph (d)(3) 
or (d)(4) of this section are not treated as creating an effective rate 
of return that is in excess of a market rate of return merely because an 
otherwise permissible interest crediting rate for a plan year is 
compounded more frequently than annually. Thus, for example, if a plan's 
terms provide for interest to be credited monthly and for the interest 
crediting rate to be equal to the interest rate on long-term investment 
grade corporate bonds (as described in paragraph (d)(3) of this section) 
and the applicable annual rate on these bonds for the plan year is 6 
percent, then the accumulated benefit at the beginning of each month 
could be increased as a result of interest credits by as much as 0.5 
percent per month during the plan year without resulting in an interest 
crediting rate that is in excess of a market rate of return.
    (D) Debits and credits during the interest crediting period. 
[Reserved]
    (v) Lesser rates. An interest crediting rate is not in excess of a 
market rate of return if the rate can never be in excess of a particular 
rate that is described in paragraph (d)(1)(iii) of this section. Thus, 
for example, an interest crediting rate that always equals the rate 
described in paragraph (d)(3) of this section minus 200 basis points is 
not in excess of a market rate of return because it can never be in 
excess of the rate described in paragraph (d)(3) of this section. 
Similarly, an interest crediting rate that always equals the lesser of 
the yield on 30-year Treasury bonds and a fixed 6 percent interest rate 
is not in excess of a market rate of return because it can never be in 
excess of the yield on 30-year Treasury bonds.
    (vi) Greater-of rates. If a statutory hybrid plan determines an 
interest credit by applying the greater of 2 or more different rates to 
the accumulated benefit, the effective interest crediting rate is not in 
excess of a market rate of return only if each of the different rates 
would separately satisfy the requirements of this paragraph (d) and the 
requirements of paragraph (d)(6) of this section are also satisfied.
    (vii) Blended rates. A statutory hybrid plan does not provide an 
effective interest crediting rate that is in excess of a market rate of 
return merely because the plan determines an interest credit by applying 
different rates to different predetermined portions of the accumulated 
benefit, provided each rate would separately satisfy the requirements of 
this paragraph (d) if the rate applied to the entire accumulated 
benefit.
    (2) Preservation of capital requirement--(i) General rule. A 
statutory hybrid plan satisfies the requirements of section 411(b)(1)(H) 
only if the plan provides that the participant's benefit under the 
statutory hybrid benefit formula determined as of the participant's 
annuity starting date is no less than the benefit based on the sum of 
all principal credits (as described in paragraph (d)(1)(ii)(D) of this 
section) credited under the plan to the participant as of that date 
(including principal credits that were credited before the applicable 
statutory effective date of paragraph (f)(1) of this section).
    (ii) Application to multiple annuity starting dates. [Reserved]
    (iii) Exception for variable annuity benefit formulas. See paragraph 
(b)(2)(iii)(B) of this section for an exception to this paragraph 
(d)(2).
    (3) Long-term investment grade corporate bonds. For purposes of this 
paragraph (d), the rate of interest on long-term investment grade 
corporate bonds means the third segment rate described in section 
417(e)(3)(D) or 430(h)(2)(C)(iii) (determined with or without regard to 
the transition rules of section 417(e)(3)(D)(ii) or 430(h)(2)(G)). 
However, for plan years beginning prior to January 1, 2008, the rate of 
interest on long-term investment grade corporate bonds means the rate 
described in section 412(b)(5)(B)(ii)(II) prior to amendment by the 
Pension Protection Act of 2006, Public Law 109-280 (120 Stat. 780) (PPA 
'06).
    (4) Safe harbor rates of interest--(i) In general. This paragraph 
(d)(4) identifies interest rates that are deemed to be

[[Page 820]]

not in excess of the interest rate described in paragraph (d)(3) of this 
section. The Commissioner may, in guidance of general applicability, 
specify additional interest crediting rates that are deemed to be not in 
excess of the rate described in paragraph (d)(3) of this section. See 
Sec. 601.601(d)(2)(ii)(b).
    (ii) Rates based on bonds with margins--(A) In general. An interest 
crediting rate is deemed to be not in excess of the interest rate 
described in paragraph (d)(3) of this section if the rate is equal to 
the sum of any of the following rates of interest for bonds and the 
associated margin for that interest rate:

------------------------------------------------------------------------
       Interest rate bond index                 Associated margin
------------------------------------------------------------------------
The discount rate on 3-month Treasury   175 basis points.
 Bills.
The discount rate on 12-month or        150 basis points.
 shorter Treasury Bills.
The yield on 1-year Treasury Constant   100 basis points.
 Maturities.
The yield on 3-year or shorter          50 basis points.
 Treasury bonds.
The yield on 7-year or shorter          25 basis points.
 Treasury bonds.
The yield on 30-year or shorter         0 basis points.
 Treasury bonds.
The first segment rate................  0 basis points.
The second segment rate...............  0 basis points.
------------------------------------------------------------------------

    (B) Rule of application. For purposes of this paragraph (d)(4), the 
first and second segment rates mean the first and second segment rates 
described in section 417(e)(3)(D) or 430(h)(2)(C), determined with or 
without regard to the transition rules of section 417(e)(3)(D)(ii) or 
430(h)(2)(G).
    (iii) Eligible cost-of-living indices. An interest crediting rate is 
deemed to be not in excess of the interest rate described in paragraph 
(d)(3) of this section if the rate is adjusted no less frequently than 
annually and is equal to the rate of increase with respect to an 
eligible cost-of-living index described in Sec. 1.401(a)(9)-6, A-14(b), 
except that, for purposes of this paragraph (d)(4)(iii), the eligible 
cost-of-living index described in Sec. 1.401(a)(9)-6, A-14(b)(2) is 
increased by 300 basis points.
    (iv) Fixed rate of interest. [Reserved]
    (5) Other rates of return--(i) General rule. This paragraph (d)(5) 
sets forth additional methods for determining an interest crediting rate 
that is not in excess of a market rate of return.
    (ii) Actual rate of return on plan assets. In the case of indexed 
benefits described in paragraph (b)(2) of this section, an interest 
crediting rate equal to the actual rate of return on the aggregate 
assets of the plan, including both positive returns and negative 
returns, is not in excess of a market rate of return if the plan's 
assets are diversified so as to minimize the volatility of returns. This 
requirement that plan assets be diversified so as to minimize the 
volatility of returns does not require greater diversification than is 
required under section 404(a)(1)(C) of title I of the Employee 
Retirement Income Security Act of 1974, Public Law 93-406 (88 Stat. 829 
(1974)) with respect to defined benefit pension plans.
    (iii) Annuity contract rates. The rate of return on the annuity 
contract for the employee issued by an insurance company licensed under 
the laws of a State is not in excess of a market rate of return. 
However, this paragraph (d)(5)(iii) does not apply if the Commissioner 
determines that the annuity contract has been structured to provide an 
interest crediting rate that is in excess of a market rate of return.
    (iv) Rate of return on certain RICs. [Reserved]
    (6) Combinations of rates of return--(i) In general. A plan that 
determines interest credits based, in whole or in part, on the greater 
of two or more different interest crediting rates provides an effective 
interest crediting rate in excess of a market rate of return unless the 
combination of rates is described in paragraph (d)(6)(ii), (d)(6)(iii), 
(e)(3)(iii), or (e)(4) of this section. However, a plan is not treated 
as providing the greater of two or more interest crediting rates merely 
because the plan satisfies the requirements of paragraph (d)(2) of this 
section. In addition, a plan is not treated as providing the greater of 
two or more interest crediting rates merely because a rate of return 
described in paragraph

[[Page 821]]

(d)(5)(iii) of this section is itself based on the greater of two or 
more rates.
    (ii) Annual or more frequent floor applied to bond-based rates. 
[Reserved]
    (iii) Cumulative floor applied to equity-based or bond-based rates. 
[Reserved]
    (e) Other rules regarding market rates of return--(1) In general. 
This paragraph (e) sets forth additional rules regarding the application 
of the market rate of return requirement with respect to benefits 
determined under a statutory hybrid benefit formula.
    (2) Plan termination. [Reserved]
    (3) Rules relating to section 411(d)(6)--(i) General rule. The right 
to interest credits in the future that are not conditioned on future 
service constitutes a section 411(d)(6) protected benefit (as defined in 
Sec. 1.411(d)-3(g)(14)). Thus, to the extent that benefits have accrued 
under the terms of a statutory hybrid plan that entitle the participant 
to future interest credits, an amendment to the plan to change the 
interest crediting rate must satisfy section 411(d)(6) if the revised 
rate under any circumstances could result in interest credits that are 
smaller as of any date after the applicable amendment date (within the 
meaning of Sec. 1.411(d)-3(g)(4)) than the interest credits that would 
be provided without regard to the amendment. For additional rules, see 
Sec. 1.411(d)-3(b). Paragraphs (e)(3)(ii) and (e)(3)(iii) of this 
section set forth special rules that apply regarding the interaction of 
section 411(d)(6) and changes to a plan's interest crediting rate. The 
Commissioner may, in guidance of general applicability, prescribe 
additional rules regarding the interaction of section 411(d)(6) and 
section 411(b)(5), including changes to a plan's interest crediting 
rate. See Sec. 601.601(d)(2)(ii)(b).
    (ii) Adoption of long-term investment grade corporate bond rate. For 
purposes of applying section 411(d)(6) and this paragraph (e) to an 
amendment to change to the interest crediting rate described in 
paragraph (d)(3) of this section, a plan is not treated as providing 
interest credits that are smaller as of any date after the applicable 
amendment date than the interest credits that would be provided using an 
interest crediting rate described in paragraph (d)(4) of this section 
merely because the plan credits interest after the applicable amendment 
date using the interest crediting rate described in paragraph (d)(3) of 
this section, provided--
    (A) The amendment only applies to interest credits to be credited 
after the effective date of the amendment;
    (B) The effective date of the amendment is at least 30 days after 
adoption of the amendment; and
    (C) On the effective date of the amendment, the new interest 
crediting rate is not lower than the interest crediting rate that would 
have applied in the absence of the amendment.
    (iii) Coordination of section 411(d)(6) and market rate of return 
limitation. [Reserved]
    (4) Actuarial increases after normal retirement age. [Reserved]
    (f) Effective/applicability date--(1) Statutory effective/
applicability dates--(i) In general. Except as provided in paragraph 
(f)(1)(iii) of this section, section 411(b)(5) applies for periods 
beginning on or after June 29, 2005.
    (ii) Conversion amendments. The requirements of section 
411(b)(5)(B)(ii), 411(b)(5)(B)(iii), and 411(b)(5)(B)(iv) apply to a 
conversion amendment (as defined in paragraph (c)(4) of this section) 
that both is adopted on or after June 29, 2005, and takes effect on or 
after June 29, 2005.
    (iii) Market rate of return--(A) Plans in existence on June 29, 
2005--(1) In general. In the case of a plan that was in existence on 
June 29, 2005 (regardless of whether the plan was a statutory hybrid 
plan on that date), section 411(b)(5)(B)(i) applies to plan years that 
begin on or after January 1, 2008.
    (2) Exception for plan sponsor election. Notwithstanding paragraph 
(f)(1)(iii)(A)(1) of this section, a plan sponsor of a plan that was in 
existence on June 29, 2005 (regardless of whether the plan was a 
statutory hybrid plan on that date) may elect to have the requirements 
of section 411(a)(13)(B) and section 411(b)(5)(B)(i) apply for any 
period on or after June 29, 2005, and before the first plan year 
beginning after December 31, 2007. In accordance with section 1107 of 
the PPA '06, an employer is permitted to adopt an amendment to make this 
election as late as the last day of the first plan year that

[[Page 822]]

begins on or after January 1, 2009 (January 1, 2011, in the case of a 
governmental plan as defined in section 414(d)) if the plan operates in 
accordance with the election.
    (B) Plans not in existence on June 29, 2005. In the case of a plan 
not in existence on June 29, 2005, section 411(b)(5)(B)(i) applies to 
the plan on and after the later of June 29, 2005, and the date the plan 
becomes a statutory hybrid plan.
    (iv) Collectively bargained plans--(A) In general. Notwithstanding 
paragraph (f)(1)(iii) of this section, in the case of a collectively 
bargained plan maintained pursuant to one or more collective bargaining 
agreements between employee representatives and one or more employers 
ratified on or before August 17, 2006, the requirements of section 
411(b)(5)(B)(i) do not apply to plan years that begin before the earlier 
of--
    (1) The later of--
    (i) The date on which the last of those collective bargaining 
agreements terminates (determined without regard to any extension 
thereof on or after August 17, 2006); or
    (ii) January 1, 2008; or
    (2) January 1, 2010.
    (B) Treatment of plans with both collectively bargained and non-
collectively bargained employees. In the case of a plan with respect to 
which a collective bargaining agreement applies to some, but not all, of 
the plan participants, the plan is considered a collectively bargained 
plan for purposes of this paragraph (f)(1)(iv) if it is considered a 
collectively bargained plan under the rules of Sec. 1.436-
1(a)(5)(ii)(B).
    (2) Effective/applicability date of regulations--(i) In general--(A) 
General effective date. Except as provided in paragraph (f)(2)(i)(B) of 
this section, this section applies to plan years that begin on or after 
January 1, 2011.
    (B) Special effective date. Paragraphs (d)(1)(iii), (d)(1)(vi), and 
(d)(6)(i) of this section apply to plan years that begin on or after 
January 1, 2012.
    (ii) Conversion amendments. With respect to a conversion amendment 
(within the meaning of paragraph (c)(4) of this section), where the 
effective date of the conversion amendment (as defined in paragraph 
(c)(4)(vi) of this section) is on or after the statutory effective date 
set forth in paragraph (f)(1)(ii) of this section, the requirements of 
paragraph (c)(2) of this section apply only to a participant who has an 
hour of service on or after the regulatory effective date set forth in 
paragraph (f)(2)(i) of this section.
    (iii) Reliance before regulatory effective date. For the periods 
after the statutory effective date set forth in paragraph (f)(1) of this 
section and before the regulatory effective date set forth in paragraph 
(f)(2)(i) of this section, the safe harbor and other relief of section 
411(b)(5) apply and the market rate of return and other requirements of 
section 411(b)(5) must be satisfied. During these periods, a plan is 
permitted to rely on the provisions of this section for purposes of 
applying the relief and satisfying the requirements of section 
411(b)(5).

[T.D. 9505, 75 FR 64137, Oct. 19, 2010, as amended by T.D. 9505, Dec. 
28, 2010]



Sec. 1.411(c)-1  Allocation of accrued benefits between employer 
and employee contributions.

    (a) Accrued benefit derived from employer contributions. For 
purposes of section 411 and the regulations thereunder, under section 
411(c)(1), an employee's accrued benefit derived from employer 
contributions under a plan as of any applicable date is the excess, if 
any, of--
    (1) The total accrued benefit under the plan provided for the 
employee as of such date, over
    (2) The accrued benefit provided for the employee, derived from 
contributions made by the employee under the plan as of such date.
    For computation of accrued benefit derived from employee 
contributions to a defined contribution plan or from voluntary employee 
contributions to a defined benefit plan, see paragraph (b) of this 
section. For computation of accrued benefit derived from mandatory 
employee contributions to a defined benefit plan, see paragraph (c) of 
this section.
    (b) Accrued benefit derived from employee contribution to defined 
contribution plan, etc. For purposes of section 411 and the regulations 
thereunder, under section 411(c)(2)(A) the accrued

[[Page 823]]

benefit derived from employee contributions to a defined contribution 
plan is determined under paragraph (b) (1) or (2) of this section, 
whichever applies. Under section 411(d)(5), the accrued benefit derived 
from voluntary employee contributions to a defined benefit plan is 
determined under paragraph (b)(1) of this section.
    (1) Separate accounts maintained. If a separate account is 
maintained with respect to an employee's contributions and all income, 
expenses, gains, and losses attributable thereto, the accrued benefit 
determined under this subparagraph as of any applicable date is the 
balance of such account as of such date.
    (2) Separate accounts not maintained. If a separate account is not 
maintained with respect to an employee's contributions and the income, 
expenses, gains, and losses attributable thereto, the accrued benefit 
determined under this subparagraph is the employee's total accrued 
benefit determined under the plan multiplied by a fraction--
    (i) The numerator of which is the total amount of the employee's 
contributions under the plan less withdrawals, and
    (ii) The denominator of which is the sum of (A) the amount described 
in paragraph (b)(2)(i) of this section, and (B) the total contributions 
made under the plan by the employer on behalf of the employee less 
withdrawals.

For purposes of this subparagraph, contributions include all amounts 
which are contributed to the plan even if such amounts are used to 
provide ancillary benefits, such as incidental life insurance, health 
insurance, or death benefits, and withdrawals include only amounts 
distributed to the employee and do not reflect the cost of any death 
benefits under the plan.
    (c) Accrued benefit derived from mandatory employee contributions to 
a defined benefit plan--(1) General rule. In the case of a defined 
benefit plan (as defined in section 414(j)) the accrued benefit derived 
from contributions made by an employee under the plan as of any 
applicable date is an annual benefit, in the form of a single life 
annuity (without ancillary benefits) commencing at normal retirement 
age, equal to the amount of the employee's accumulated contributions 
(determined under paragraph (c)(3) of this section) multiplied by the 
appropriate conversion factor (determined under paragraph (c)(2) of this 
section). Paragraph (e) of this section provides rules for actuarial 
adjustments where the benefit is to be determined in a form other than 
the form described in this paragraph.
    (2) Appropriate conversion factor. For purposes of this paragraph, 
the term ``appropriate conversion factor'' means the factor necessary to 
convert an amount equal to the accumulated contributions to a single 
life annuity (without ancillary benefits) commencing at normal 
retirement age and shall be 10 percent for a normal retirement age of 65 
years. For other normal retirement ages the appropriate conversion 
factor shall be the factor as determined by the Commissioner.
    (3) Accumulated contributions. For purposes of section 411(c) and 
this section, the term ``accumulated contributions'' means the total 
of--
    (i) All mandatory contributions made by the employee (determined 
under paragraph (c)(4) of this section),
    (ii) Interest (if any) on such contributions, computed at the rate 
provided by the plan to the end of the last plan year to which section 
411(a)(2) does not apply (by reason of the applicable effective date), 
and
    (iii) Interest on the sum of the amounts determined under paragraphs 
(c)(3)(i) and (ii) of this section compounded annually at the rate of 5 
percent per annum from the beginning of the first plan year to which 
section 411(a)(2) applies (by reason of the applicable effective date) 
to the date on which the employee would attain normal retirement age.

For example, if under section 1017 of the Employee Retirement Income 
Security Act of 1974, section 411(a)(2) of the Code applies for plan 
years beginning after December 31, 1975, and for plan years beginning 
before 1975, the plan provided for 3 percent interest on employee 
contributions, an employee's accumulated contributions would be computed 
by crediting interest at the rate provided by the plan (3 percent) for 
plan years beginning before 1976 and by crediting interest at the rate 
of 5

[[Page 824]]

percent (or another rate prescribed under section 411(c)(2)(D)) 
thereafter. Section 1017 of the Employee Retirement Income Security Act 
of 1974 and Sec. 1.411(a)-2 provide the effective dates for the 
application of section 411(a)(2).
    (4) Mandatory contributions. For purposes of section 411(c) and this 
section the term ``mandatory contributions'' means amounts contributed 
to the plan by the employee which are required as a condition of his 
employment, as a condition of his participation in the plan, or as a 
condition of obtaining benefits (or additional benefits) under the plan 
attributable to employer contributions. For example, if the benefit 
derived from employer contributions depends upon a specified level of 
employee contributions, employee contributions up to that level would be 
treated as mandatory contributions. Mandatory contributions, otherwise 
satisfying the requirements of this subparagraph, include amounts 
contributed to the plan which are used to provide ancillary benefits 
such as incidental life insurance, health insurance, or death benefits.
    (d) Limitation on accrued benefit. The accrued benefit derived from 
mandatory employee contributions under a defined benefit plan 
(determined under paragraph (c) of this section) shall not exceed the 
greater of--
    (1) The accrued benefit of the employee under the plan, or
    (2) The accrued benefit derived from employee contributions 
determined without regard to any interest under section 411(c)(2)(C) 
(ii) and (iii) and under paragraphs (c)(3) (ii) and (iii) of this 
section.
    (e) Actuarial adjustments for defined benefit plans--(1) Accrued 
benefit. In the case of a defined benefit plan (as defined in section 
414(j)) if an employee's accrued benefit is to be determined as an 
amount other than an annual benefit commencing at normal retirement age, 
such benefit (determined under section 411(c)(1) and paragraph (a) of 
this section) shall be the actuarial equivalent of such benefit, as 
determined by the Commissioner.
    (2) Accrued benefit derived from employee contributions. In the case 
of a defined benefit plan (as defined in section 414(j) if the accrued 
benefit derived from mandatory contributions made by an employee is to 
be determined with respect to a benefit other than an annual benefit in 
the form of a single life annuity (without ancillary benefits) 
commencing at normal retirement age, such benefit shall be the actuarial 
equivalent of such benefit (determined under section 411(c)(2)(B) and 
paragraph (c) of this section) as determined by the Commissioner.
    (f) Suspension of benefits, etc.--(1) Suspensions. No adjustment to 
an accrued benefit is required on account of any suspension of benefits 
if such suspension is permitted under section 203(a)(3)(B) of the 
Employee Retirement Income Security Act of 1974 (88 Stat. 855) (Code 
section 411(a)(3)(B)).
    (2) Employment after retirement. No actuarial adjustment to an 
accrued benefit is required on account of employment after normal 
retirement age. For example, if a plan with a normal retirement age of 
65 provides a benefit of $400 a month payable at age 65 the same $400 
benefit (with no upward adjustment) could be paid to an employee who 
retires at age 68.

(Sec. 411 (88 Stat. 901; 26 U.S.C. 411))

[T.D. 7501, 42 FR 42338, Aug. 23, 1977]



Sec. 1.411(d)-1  Coordination of vesting and discrimination 
requirements. [Reserved]



Sec. 1.411(d)-2  Termination or partial termination; discontinuance of 
contributions.

    (a) General rule--(1) Required nonforfeitability. A plan is not a 
qualified plan (and a trust forming a part of such plan is not a 
qualified trust) unless the plan provides that--
    (i) Upon the termination or partial termination of the plan, or
    (ii) In addition, in the case of a plan to which section 412 
(relating to minimum funding standards) does not apply, upon the 
complete discontinuance of contributions under the plan,

the rights of each affected employee to benefits accrued to the date of 
such termination or partial termination (or, in the case of a plan to 
which section 412 does not apply, discontinuance), to the extent funded, 
or the rights of each employee to the amounts credited to

[[Page 825]]

his account at such time, are nonforfeitable (within the meaning of 
Sec. 1.411(a)-4.
    (2) Required allocation. (i) A plan is not a qualified plan (and a 
trust forming a part of such plan is not a qualified trust) unless the 
plan provides for the allocation of any previously unallocated funds to 
the employes covered by the plan upon the termination or partial 
termination of the plan (or, in the case of a plan to which section 412 
does not apply, upon the complete discontinuance of contributions under 
the plan). Such provision may be incorporated in the plan at its 
inception or by an amendment made prior to the termination or partial 
termination of the plan for the discontinuance of contributions 
thereunder. In the case of a defined contribution plan under which 
unallocated forfeitures are held in a suspense account in order to 
satisfy the requirements of section 415, this subdivision shall not 
require such plan to provide for allocations from the suspense account 
to the extent that such allocations would result in annual additions to 
participants' accounts in excess of amounts permitted under section 415 
for the year for which such allocations would be made.
    (ii) Any provision for the allocation of unallocated funds which is 
found by the Secretary of Labor or the Pension Benefit Guaranty 
Corporation (whichever is appropriate) to satisfy the requirements of 
section 4044 or section 403(d)(1) of the Employee Retirement Income 
Security Act of 1974 is acceptable if it specifies the method to be used 
and does not conflict with the provisions of section 401(a)(4) of the 
Internal Revenue Code of 1954 and the regulations thereunder. Any 
allocation of funds required by paragraph (1), (2), (3), or (4)(A) of 
section 4044(a) of such Act shall be deemed not to result in 
discrimination prohibited by section 401(a)(4) of the Code (see, 
however, paragraph (e) of this section). Notwithstanding the preceding 
sentence, in the case of a plan which establishes subclasses or 
categories pursuant to section 4044(b)(6) of such Act, the allocation of 
funds by the use of such subclasses or categories shall not be deemed 
not to result in discrimination prohibited by the Code. The allocation 
of unallocated funds may be in cash or in the form of other benefits 
provided under the plan. However, the allocation of the funds 
contributed by the employer among the employees need not necessarily 
benefit all the employees covered by the plan.
    (iii) Paragraphs (a)(2) (i) and (ii) of this section do not require 
the allocation of amounts to the account of any employee if such amounts 
are not required to be used to satisfy the liabilities with respect to 
employees and their beneficiaries under the plan (see section 
401(a)(2)).
    (b) Partial termination--(1) General rule. Whether or not a partial 
termination of a qualified plan occurs (and the time of such event) 
shall be determined by the Commissioner with regard to all the facts and 
circumstances in a particular case. Such facts and circumstances 
include: the exclusion, by reason of a plan amendment or severance by 
the employer, of a group of employees who have previously been covered 
by the plan; and plan amendments which adversely affect the rights of 
employees to vest in benefits under the plan.
    (2) Special rule. If a defined benefit plan ceases or decreases 
future benefit accruals under the plan, a partial termination shall be 
deemed to occur if, as a result of such cessation or decrease, a 
potential reversion to the employer, or employers, maintaining the plan 
(determined as of the date such cessation or decrease is adopted) is 
created or increased. If no such reversion is created or increased, a 
partial termination shall be deemed not to occur by reason of such 
cessation or decrease. However, the Commissioner may determine that a 
partial termination of such a plan occurs pursuant to subparagraph (1) 
of this paragraph for reasons other than such cessation or decrease.
    (3) Effect of partial termination. If a termination of a qualified 
plan occurs, the provisions of section 411(d)(3) apply only to the part 
of the plan that is terminated.
    (c) Termination--(1) Application. This paragraph applies to a plan 
other than a plan described in section 411(e)(1) (relating to 
governmental, certain church plans, etc.).

[[Page 826]]

    (2) Plans subject to termination insurance. For purposes of this 
section, a plan to which title IV of the Employee Retirement Income 
Security Act of 1974 applies is considered terminated on a particular 
date if, as of that date--
    (i) The plan is voluntarily terminated by the plan administrator 
under section 4041 of the Employee Retirement Income Security Act of 
1974, or
    (ii) The Pension Benefit Guaranty Corporation terminates the plan 
under section 4042 of the Employee Retirement Income Security Act of 
1974.

For purposes of this subparagraph, the particular date of termination 
shall be the date of termination determined under section 4048 of such 
Act.
    (3) Other plans. In the case of a plan not described in paragraph 
(c)(2) of this section, a plan is considered terminated on a particular 
date if, as of that date, the plan is voluntarily terminated by the 
employer, or employers, maintaining the plan.
    (d) Complete discontinuance--(1) General rule. For purposes of this 
section, a complete discontiuance of contributions under the plan is 
contrasted with a suspension of contributions under the plan which is 
merely a temporary cessation of contributions by the employer. A 
complete discontinuance of contributions may occur although some amounts 
are contributed by the employer under the plan if such amounts are not 
substantial enough to reflect the intent on the part of the employer to 
continue to maintain the plan. The determination of whether a complete 
discontinuance of contributions under the plan has occurred will be made 
with regard to all the facts and circumstances in the particular case, 
and without regard to the amount of any contributions made under the 
plan by employees. Among the factors to be considered in determining 
whether a suspension constitutes a discontinuance are:
    (i) Whether the employer may merely be calling an actual 
discontinuance of contributions a suspension of such contributions in 
order to avoid the requirement of full vesting as in the case of a 
discontinuance, or for any other reason;
    (ii) Whether contributions are recurring and substantial; and
    (iii) Whether there is any reasonable probability that the lack of 
contributions will continue indefinitely.
    (2) Time of discontinuance. In any case in which a suspension of a 
profit-sharing plan maintained by a single employer is considered a 
discontinuance, the discontinuance becomes effective not later than the 
last day of the taxable year of the employer following the last taxable 
year of such employer for which a substantial contribution was made 
under the profit-sharing plan. In the case of a profit-sharing plan 
maintained by more than one employer, the discontinuance becomes 
effective not later than the last day of the plan year following the 
plan year within which any employer made a substantial contribution 
under the plan.
    (e) Contributions or benefits which remain forfeitable. Under 
section 411 (d) (2) and (3), section 411(a) and this section do not 
apply to plan benefits which may not be provided for designated 
employees in the event of early termination of the plan under provisions 
of the plan adopted pursuant to regulations prescribed by the Secretary 
or his delegate to preclude the discrimination prohibited by section 
401(a)(4). Accordingly, in such a case, plan benefits may be required to 
be reallocated without regard to this section. See Sec. 1.401-4(c).

(Sec. 411 (88 Stat. 901; 26 U.S.C. 411))

[T.D. 7501, 42 FR 42339, Aug. 23, 1977]



Sec. 1.411(d)-3  Section 411(d)(6) protected benefits.

    (a) Protection of accrued benefits--(1) General rule. Under section 
411(d)(6)(A), a plan is not a qualified plan (and a trust forming a part 
of such plan is not a qualified trust) if a plan amendment decreases the 
accrued benefit of any plan participant, except as provided in section 
412(d)(2) (section 412(c)(8) for plan years beginning before January 1, 
2008), section 4281 of the Employee Retirement Income Security Act of 
1974 as amended (ERISA), or other applicable law (see, for example, 
sections 418D and 418E of the Internal Revenue Code, and section 1107 of 
the Pension Protection Act of 2006, Public Law 109-280 (120 Stat. 780, 
1063)). For purposes of this

[[Page 827]]

section, a plan amendment includes any changes to the terms of a plan, 
including changes resulting from a merger, consolidation, or transfer 
(as defined in section 414(l)) or a plan termination. The protection of 
section 411(d)(6) applies to a participant's entire accrued benefit 
under the plan as of the applicable amendment date, without regard to 
whether the entire accrued benefit was accrued before a participant's 
severance from employment or whether any portion was the result of an 
increase in the accrued benefit of the participant pursuant to a plan 
amendment adopted after the participant's severance from employment.
    (2) Plan provisions taken into account--(i) Direct or indirect 
reduction in accrued benefit. For purposes of determining whether a 
participant's accrued benefit is decreased, all of the amendments to the 
provisions of a plan affecting, directly or indirectly, the computation 
of accrued benefits are taken into account. Plan provisions indirectly 
affecting the computation of accrued benefits include, for example, 
provisions relating to years of service and compensation.
    (ii) Amendments effective with the same applicable amendment date. 
In determining whether a reduction in a participant's accrued benefit 
has occurred, all plan amendments with the same applicable amendment 
date are treated as one amendment. Thus, if two amendments have the same 
applicable amendment date and one amendment, standing alone, increases 
participants' accrued benefits and the other amendment, standing alone, 
decreases participants' accrued benefits, the amendments are treated as 
one amendment and will only violate section 411(d)(6) if, for any 
participant, the net effect is to decrease participants' accrued benefit 
as of that applicable amendment date.
    (iii) Multiple amendments--(A) General rule. A plan amendment 
violates the requirements of section 411(d)(6) if it is one of a series 
of plan amendments that, when taken together, have the effect of 
reducing or eliminating a section 411(d)(6) protected benefit in a 
manner that would be prohibited by section 411(d)(6) if accomplished 
through a single amendment.
    (B) Determination of the time period for combining plan amendments. 
For purposes of applying the rule in paragraph (a)(2)(iii)(A) of this 
section, generally only plan amendments adopted within a 3-year period 
are taken into account.
    (3) Application of section 411(a) nonforfeitability provisions with 
respect to section 411(d)(6) protected benefits--(i) In general. The 
rules of this paragraph (a) apply to a plan amendment that decreases a 
participant's accrued benefits, or otherwise places greater restrictions 
or conditions on a participant's rights to section 411(d)(6) protected 
benefits, even if the amendment merely adds a restriction or condition 
that is permitted under the vesting rules in section 411(a)(3) through 
(11). However, such an amendment does not violate section 411(d)(6) to 
the extent it applies with respect to benefits that accrue after the 
applicable amendment date. See section 411(a)(10) and Sec. 1.411(a)-8 
for additional rules relating to changes in a plan's vesting schedule.
    (ii) Exception for changes in a plan's vesting computation period. 
Notwithstanding paragraph (a)(3)(i) of this section, a plan amendment 
that satisfies the applicable requirements under 29 CFR 2530.203-2(c) 
(rules relating to vesting computation periods) does not fail to satisfy 
the requirements of section 411(d)(6) merely because the plan amendment 
changes the plan's vesting computation period.
    (4) Examples. The following examples illustrate the application of 
this paragraph (a):

    Example 1. (i) Facts. Plan A provides an annual benefit of 2% of 
career average pay times years of service commencing at normal 
retirement age (age 65). Plan A is amended on November 1, 2006, 
effective as of January 1, 2007, to provide for an annual benefit of 
1.3% of final pay times years of service, with final pay computed as the 
average of a participant's highest 3 consecutive years of compensation. 
As of January 1, 2007, Participant M has 16 years of service, M's career 
average pay is $37,500, and the average of M's highest 3 consecutive 
years of compensation is $67,308. Thus, Participant M's accrued benefit 
as of the applicable amendment date is increased from $12,000 per year 
at normal retirement age (2% times $37,500 times 16 years of service) to 
$14,000 per year at normal retirement age (1.3% times $67,308 times 16 
years of service). As of January 1, 2007, Participant N has 6 years of 
service, N's career

[[Page 828]]

average pay is $50,000, and the average of N's highest 3 consecutive 
years of compensation is $51,282. Participant N's accrued benefit as of 
the applicable amendment date is decreased from $6,000 per year at 
normal retirement age (2% times $50,000 times 6 years of service) to 
$4,000 per year at normal retirement age (1.3% times $51,282 times 6 
years of service).
    (ii) Conclusion. While the plan amendment increases the accrued 
benefit of Participant M, the plan amendment fails to satisfy the 
requirements of section 411(d)(6)(A) because the amendment decreases the 
accrued benefit of Participant N below the level of the accrued benefit 
of Participant N immediately before the applicable amendment date.
    Example 2. (i) Facts. The facts are the same as Example 1, except 
that Plan A includes a provision under which Participant N's accrued 
benefit cannot be less than what it was immediately before the 
applicable amendment date (so that Participant N's accrued benefit could 
not be less than $6,000 per year at normal retirement age).
    (ii) Conclusion. The amendment does not violate the requirements of 
section 411(d)(6)(A) with respect to Participant M (whose accrued 
benefit has been increased) or with respect to Participant N (although 
Participant N would not accrue any benefits until the point in time at 
which the new formula amount would exceed the amount payable under the 
minimum provision, approximately 3 years after the amendment becomes 
effective).

    Example 3. (i) Facts. Employer N maintains Plan C, a qualified 
defined benefit plan under which an employee becomes a participant upon 
completion of 1 year of service and is vested in 100% of the employer-
derived accrued benefit upon completion of 5 years of service. Plan C 
provides that a former employee's years of service prior to a break in 
service will be reinstated upon completion of 1 year of service after 
being rehired. Plan C has participants who have fewer than 5 years of 
service and who are accordingly 0% vested in their employer-derived 
accrued benefits. On December 31, 2007, effective January 1, 2008, Plan 
C is amended, in accordance with section 411(a)(6)(D), to provide that 
any nonvested participant who has at least 5 consecutive 1-year breaks 
in service and whose number of consecutive 1-year breaks in service 
exceeds his or her number of years of service before the breaks will 
have his or her pre-break service disregarded in determining vesting 
under the plan.
    (ii) Conclusion. Under paragraph (a)(3) of this section, the plan 
amendment does not satisfy the requirements of this paragraph (a), and 
thus violates section 411(d)(6), because the amendment places greater 
restrictions or conditions on the rights to section 411(d)(6) protected 
benefits, as of January 1, 2008, for participants who have fewer than 5 
years of service, by restricting the ability of those participants to 
receive further vesting protections on benefits accrued as of that date.
    Example 4. (i) Facts. (A) Employer O sponsors Plan D, a qualified 
profit sharing plan under which each employee has a nonforfeitable right 
to a percentage of his or her employer-derived accrued benefit based on 
the following table:

------------------------------------------------------------------------
        Completed years of service            Nonforfeitable percentage
------------------------------------------------------------------------
Fewer than 3..............................  0
3.........................................  20
4.........................................  40
5.........................................  60
6.........................................  80
7.........................................  100
------------------------------------------------------------------------

    (B) In January 2006, Employer O acquires Company X, which maintains 
Plan E, a qualified profit sharing plan under which each employee who 
has completed 5 years of service has a nonforfeitable right to 100% of 
the employer-derived accrued benefit. In 2007, Plan E is merged into 
Plan D. On the effective date for the merger, Plan D is amended to 
provide that the vesting schedule for participants of Plan E is the 7-
year graded vesting schedule of Plan D. In accordance with section 
411(a)(10)(A), the plan amendment provides that any participant of Plan 
E who had completed 5 years of service prior to the amendment is fully 
vested. In addition, as required under section 411(a)(10)(B), the 
amendment provides that any participant in Plan E who has at least 3 
years of service prior to the amendment is permitted to make an 
irrevocable election to have the vesting of his or her nonforfeitable 
right to the employer-derived accrued benefit determined under either 
the 5-year cliff vesting schedule or the 7-year graded vesting schedule. 
Participant G, who has an account balance of $10,000 on the applicable 
amendment date, is a participant in Plan E with 2 years of service as of 
the applicable amendment date. As of the date of the merger, Participant 
G's nonforfeitable right to G's employer-derived accrued benefit is 0% 
under both the 7-year graded vesting schedule of Plan D and the 5-year 
cliff vesting schedule of Plan E.
    (ii) Conclusion. Under paragraph (a)(3) of this section, the plan 
amendment does not satisfy the requirements of this paragraph (a) and 
violates section 411(d)(6), because the amendment places greater 
restrictions or conditions on the rights to section 411(d)(6) protected 
benefits with respect to G and any participant who has fewer than 5 
years of service and who elected (or was made subject to) the new 
vesting schedule. A method of avoiding a section 411 (d)(6) violation 
with

[[Page 829]]

respect to account balances attributable to benefits accrued as of the 
applicable amendment date and earnings thereon would be for Plan D to 
provide for the vested percentage of G and each other participant in 
Plan E to be no less than the greater of the vesting percentages under 
the two vesting schedules (for example, for G and each other participant 
in Plan E to be 20% vested upon completion of 3 years of service, 40% 
vested upon completion of 4 years of service, and fully vested upon 
completion of 5 years of service) for those account balances and 
earnings.

    (b) Protection of section 411(d)(6)(B) protected benefits--(1) 
General rule--(i) Prohibition against plan amendments eliminating or 
reducing section 411(d)(6)(B) protected benefits. Except as provided in 
this section, a plan is treated as decreasing an accrued benefit if it 
is amended to eliminate or reduce a section 411(d)(6)(B) protected 
benefit as defined in paragraph (g)(15) of this section. This paragraph 
(b)(1) applies to participants who satisfy (either before or after the 
plan amendment) the preamendment conditions for a section 411(d)(6)(B) 
protected benefit.
    (ii) Contingent benefits. The rules of paragraph (b)(1)(i) of this 
section apply to participants who satisfy (either before or after the 
plan amendment) the preamendment conditions for the section 411(d)(6)(B) 
protected benefit even if the condition on which the eligibility for the 
section 411(d)(6)(B) protected benefit depends is an unpredictable 
contingent event (e.g., a plant shutdown).
    (iii) Application of general rules in paragraph (a) of this section 
to section 411(d)(6)(B) protected benefits. For purposes of determining 
whether a participant's section 411(d)(6)(B) protected benefit is 
eliminated or reduced, the rules of paragraph (a) of this section apply 
to section 411(d)(6)(B) protected benefits in the same manner as they 
apply to accrued benefits described in section 411(d)(6)(A). As an 
example of the application of paragraph (a)(2)(ii) of this section to 
section 411(d)(6)(B) protected benefits, if there are two amendments 
with the same applicable amendment date and one amendment increases 
accrued benefits and the other amendment decreases the early retirement 
factors that are used to determine the early retirement annuity, the 
amendments are treated as one amendment and only violate section 
411(d)(6) if, after the two amendments, the net dollar amount of any 
early retirement annuity with respect to the accrued benefit of any 
participant as of the applicable amendment date is lower than it would 
have been without the two amendments. As an example of the application 
of paragraph (a)(2)(iii) of this section to section 411(d)(6)(B) 
protected benefits, a series of amendments made within a 3-year period 
that, when taken together, have the effect of reducing or eliminating 
early retirement benefits or retirement-type subsidies in a manner that 
adversely affects the rights of any participant in a more than de 
minimis manner violates section 411(d)(6)(B) even if each amendment 
would be permissible pursuant to paragraphs (c), (d), or (f) of this 
section.
    (2) Permissible elimination of section 411(d)(6)(B) protected 
benefits--(i) In general. A plan is permitted to be amended to eliminate 
a section 411(d)(6)(B) protected benefit if the elimination is in 
accordance with this section or Sec. 1.411(d)-4.
    (ii) Increases in payment amounts do not eliminate an optional form 
of benefit. An amendment is not treated as eliminating an optional form 
of benefit or eliminating or reducing an early retirement benefit or 
retirement-type subsidy under the plan, if, effective after the plan 
amendment, there is another optional form of benefit available to the 
participant under the plan that is of inherently equal or greater value 
(within the meaning of Sec. 1.401(a)(4)-4(d)(4)(i)(A)). Thus, for 
example, a change in the method of calculating a joint and survivor 
annuity from using a 90% adjustment factor on account of the 
survivorship payment at particular ages for a participant and a spouse 
to using a 91% adjustment factor at the same ages is not treated as an 
elimination of an optional form of benefit. Similarly, a plan that 
offers a subsidized qualified joint and survivor annuity option for 
married participants under which the amount payable during the 
participant's lifetime is not less than the amount payable under the 
plan's straight life annuity is permitted to be amended to eliminate the

[[Page 830]]

straight life annuity option for married participants.
    (3) Permissible elimination of benefits that are not section 
411(d)(6) protected benefits--(i) In general. Section 411(d)(6) does not 
provide protection for benefits that are ancillary benefits, other 
rights and features, or any other benefits that are not described in 
section 411(d)(6). See Sec. 1.411(d)-4, Q&A-1(d). However, a plan may 
not be amended to recharacterize a retirement-type benefit as an 
ancillary benefit. Thus, for example, a plan amendment to recharacterize 
any portion of an early retirement subsidy as a social security 
supplement that is an ancillary benefit violates section 411(d)(6).
    (ii) No protection for future benefit accruals. Section 411(d)(6) 
only protects benefits that accrue before the applicable amendment date. 
Thus, a plan is permitted to be amended to eliminate or reduce an early 
retirement benefit, a retirement-type subsidy, or an optional form of 
benefit with respect to benefits that accrue after the applicable 
amendment date without violating section 411(d)(6). However, section 
4980F(e) of the Internal Revenue Code and section 204(h) of ERISA 
require notice of an amendment to an applicable pension plan that either 
provides for a significant reduction in the rate of future benefit 
accrual or that eliminates or significantly reduces an early retirement 
benefit or a retirement-type subsidy. See Sec. 54.4980F-1 of this 
chapter generally, and see Sec. 54.4980F-1, Q&A-7(b) and Q&A-8(c) of 
this chapter, with respect to the circumstances under which such notice 
is required for a reduction in an early retirement benefit or 
retirement-type subsidy.
    (4) Examples. The following examples illustrate the application of 
this paragraph (b):

    Example 1. (i) Facts involving amendments to an early retirement 
subsidy. Plan A provides an annual benefit of 2% of career average pay 
times years of service commencing at normal retirement age (age 65). 
Plan A is amended on November 1, 2006, effective as of January 1, 2007, 
to provide for an annual benefit of 1.3% of final pay times years of 
service, with final pay computed as the average of a participant's 
highest 3 consecutive years of compensation. Participant M is age 50, M 
has 16 years of service, M's career average pay is $37,500, and the 
average of M's highest 3 consecutive years of compensation is $67,308. 
Thus, M's accrued benefit as of the effective date of the amendment is 
increased from $12,000 per year at normal retirement age (2% times 
$37,500 times 16 years of service) to $14,000 per year at normal 
retirement age (1.3% times $67,308 times 16 years of service). (These 
facts are similar to the facts in Example 1 in paragraph (a)(4) of this 
section.) Before the amendment, Plan A permitted a former employee to 
commence distribution of benefits as early as age 55 and, for a 
participant with at least 15 years of service, actuarially reduced the 
amount payable in the form of a straight life annuity commencing before 
normal retirement age by 3% per year from age 60 to age 65 and by 7% per 
year from age 55 through age 59. Thus, before the amendment, the amount 
of M's early retirement benefit that would be payable for commencement 
at age 55 was $6,000 per year ($12,000 per year minus 3% for 5 years and 
minus 7% for 5 more years). The amendment also alters the actuarial 
reduction factor so that, for a participant with at least 15 years of 
service, the amount payable in a straight life annuity commencing before 
normal retirement age is reduced by 6% per year. As a result, the amount 
of M's early retirement benefit at age 55 becomes $5,600 per year after 
the amendment ($14,000 minus 6% for 10 years).
    (ii) Conclusion. The straight life annuity payable under Plan A at 
age 55 is an optional form of benefit that includes an early retirement 
subsidy. The plan amendment fails to satisfy the requirements of section 
411(d)(6)(B) because the amendment decreases the optional form of 
benefit payable to Participant M below the level that Participant M was 
entitled to receive immediately before the effective date of the 
amendment. If instead Plan A had included a provision under which M's 
straight life annuity payable at any age could be not be less than what 
it was immediately before the amendment (so that M's straight life 
annuity payable at age 55 could not be less than $6,000 per year), then 
the amendment would not fail to satisfy the requirements of section 
411(d)(6)(B) with respect to M's straight life annuity payable at age 55 
(although the straight life annuity payable to M at age 55 would not 
increase until the point in time at which the new formula amount with 
the new actuarial reduction factors exceeds the amount payable under the 
minimum provision, approximately 14 months after the amendment becomes 
effective).
    Example 2. (i) Facts involving plant shutdown benefits. Plan B 
permits participants who have a severance from employment before normal 
retirement age (age 65) to commence distributions at any time after age 
55 with

[[Page 831]]

the amount payable to be actuarially reduced using reasonable actuarial 
assumptions regarding interest and mortality specified in the plan, but 
provides that the annual reduction for any participant who has at least 
20 years of service and who has a severance from employment after age 55 
is only 3% per year (which is a smaller reduction than would apply under 
reasonable actuarial reductions). Plan B also provides 2 plant shutdown 
benefits to participants who have a severance of employment as a result 
of a plant shutdown. First, the favorable 3% per year actuarial 
reduction applies for commencement of benefits after age 55 and before 
age 65 for any participant who has at least 10 years of service and who 
has a severance from employment as a result of a plant shutdown. Second, 
all participants who have at least 20 years of service and who have a 
severance from employment after age 55 (and before normal retirement age 
at age 65) as a result of a plant shutdown will receive supplemental 
payments. Under the supplemental payments, an additional amount equal to 
the participant's estimated old-age insurance benefit under the Social 
Security Act is payable until age 65. The supplemental payments are not 
a QSUPP, as defined in Sec. 1.401(a)(4)-12, because the plan's terms do 
not state that the supplement is treated as an early retirement benefit 
that is protected under section 411(d)(6).
    (ii) Conclusion with respect to plant shutdown benefits. The 
benefits payable with the 3% annual reduction are retirement-type 
benefits. The excess of the actuarial present value of the early 
retirement benefit using the 3% annual reduction over the actuarial 
present value of the normal retirement benefit is a retirement-type 
subsidy and the right to receive payments of the benefit at age 55 is an 
early retirement benefit. These conclusions apply not only with respect 
to the rights that apply to participants who have at least 20 years of 
service, but also to participants with at least 10 years of service who 
have a severance from employment as a result of a plant shutdown. Thus, 
the right to receive benefits based on a 3% annual reduction for 
participants with at least 10 years of service at the time of a plant 
shutdown is an early retirement benefit that provides a retirement-type 
subsidy and is a section 411(d)(6)(B) protected benefit (even though no 
plant shutdown has occurred). Therefore, a plan amendment cannot 
eliminate this benefit with respect to benefits accrued before the 
applicable amendment date, even before the occurrence of the plant 
shutdown. Because the plan provides that the supplemental payments 
cannot exceed the OASDI benefit under the Social Security Act, the 
supplemental payments constitute a social security supplement (but not a 
QSUPP as defined in Sec. 1.401(a)(4)-12), which is an ancillary benefit 
that is not a section 411(d)(6)(B) protected benefit and accordingly is 
not taken into account in determining whether a prohibited reduction has 
occurred.

    Example 3. (i) Facts. Plan C, a multiemployer defined benefit plan 
in which participation is limited to electricians in the construction 
industry, provides that a participant may elect to commence 
distributions only if the participant is not currently employed by a 
participating employer and provides that, if the participant has a 
specified number of years of service and attains a specified age, the 
distribution is without any actuarial reduction for commencement before 
normal retirement age. Since the plan's inception, Plan C has provided 
for suspension of pension benefits during periods of disqualifying 
employment (ERISA section 203(a)(3)(B) service). Before 2007, the plan 
defined disqualifying employment to include any job as an electrician in 
the particular industry and geographic location to which Plan C applies. 
This definition of disqualifying employment did not cover a job as an 
electrician supervisor. In 2005, Participant E, having rendered the 
specified number of years of service and attained the specified age to 
retire with a fully subsidized early retirement benefit, retires from 
E's job as an electrician with Employer Y and starts a position with 
Employer Z as an electrician supervisor. Employer Z is not a 
participating employer in Plan C but is an employer in the same industry 
and geographic location as Employer Y. When E left service with Employer 
Y, E's position as an electrician supervisor was not disqualifying 
employment for purposes of Plan C's suspension of pension benefit 
provision, and E elected to commence benefit payments in 2005. In 2006, 
effective January 1, 2007, Plan C is amended to expand the definition of 
disqualifying employment to include any job (including supervisory 
positions) as an electrician in the same industry and geographic 
location to which Plan C applies. The plan's definition of disqualifying 
employment satisfies the requirements of section 411(a)(3)(B). On 
January 1, 2007, E's pension benefits are suspended because of E's 
disqualifying employment as an electrician supervisor.
    (ii) Conclusion. Under paragraphs (a)(3) and (b)(1) of this section, 
the 2007 plan amendment violates section 411(d)(6), because the 
amendment places greater restrictions or conditions on a participant's 
rights to section 411(d)(6) protected benefits to the extent it applies 
with respect to benefits that accrued before January 1, 2007. The result 
would be the same even if the amendment did not apply to former 
employees and instead applied only to participants who were actively 
employed at the time of the applicable amendment.


[[Page 832]]


    (c) Permissible elimination of optional forms of benefit that are 
redundant--(1) General rule. Except as otherwise provided in paragraph 
(c)(5) of this section, a plan is permitted to be amended to eliminate 
an optional form of benefit for a participant with respect to benefits 
accrued before the applicable amendment date if--
    (i) The optional form of benefit is redundant with respect to a 
retained optional form of benefit, within the meaning of paragraph 
(c)(2) of this section;
    (ii) The plan amendment is not applicable with respect to an 
optional form of benefit with an annuity commencement date that is 
earlier than the number of days in the maximum QJSA explanation period 
(as defined in paragraph (g)(9) of this section) after the date the 
amendment is adopted; and
    (iii) The requirements of paragraph (e) of this section are 
satisfied in any case in which either:
    (A) The retained optional form of benefit for the participant does 
not commence on the same annuity commencement date as the optional form 
of benefit that is being eliminated; or
    (B) As of the date the amendment is adopted, the actuarial present 
value of the retained optional form of benefit for the participant is 
less than the actuarial present value of the optional form of benefit 
that is being eliminated.
    (2) Similar types of optional forms of benefit are redundant--(i) 
General rule. An optional form of benefit is redundant with respect to a 
retained optional form of benefit if, after the amendment becomes 
applicable--
    (A) There is a retained optional form of benefit available to the 
participant that is in the same family of optional forms of benefit, 
within the meaning of paragraphs (c)(3) and (4) of this section, as the 
optional form of benefit being eliminated; and
    (B) The participant's rights with respect to the retained optional 
form of benefit are not subject to materially greater restrictions (such 
as conditions relating to eligibility, restrictions on a participant's 
ability to designate the person who is entitled to benefits following 
the participant's death, or restrictions on a participant's right to 
receive an in-kind distribution) than applied to the optional form of 
benefit being eliminated.
    (ii) Special rule for core options. An optional form of benefit that 
is a core option as defined in paragraph (g)(5) of this section may not 
be eliminated as a redundant benefit under the rules of this paragraph 
(c) unless the retained optional form of benefit and the eliminated core 
option are identical except for differences described in paragraph 
(c)(3)(ii) of this section. Thus, for example, a particular 10-year term 
certain and life annuity may not be eliminated by plan amendment unless 
the retained optional form of benefit is another 10-year term certain 
and life annuity.
    (3) Family of optional forms of benefit--(i) In general. Paragraph 
(c)(4) of this section describes certain families of optional forms of 
benefits. Not every optional form of benefit that is offered under a 
plan necessarily fits within a family of optional forms of benefit as 
described in paragraph (c)(4) of this section. Each optional form of 
benefit that is not included in any particular family of optional forms 
of benefit listed in paragraph (c)(4) of this section is in a separate 
family of optional forms of benefit with other optional forms of benefit 
that would be identical to that optional form of benefit but for 
differences that are disregarded under paragraph (c)(3)(ii) of this 
section.
    (ii) Certain differences among optional forms of benefit--(A) 
Differences in actuarial factors and annuity starting dates. The 
determination of whether two optional forms of benefit are within a 
family of optional forms of benefit is made without regard to actuarial 
factors or annuity starting dates. Thus, any optional forms of benefit 
that are part of the same generalized optional form (within the meaning 
of paragraph (g)(8) of this section) are in the same family of optional 
forms of benefit. For example, if a plan has a single-sum distribution 
option for some participants that is calculated using a 5% interest rate 
and a specific mortality table (but no less than the minimum present 
value as determined under section 417(e)) and another single-sum 
distribution option for other participants that

[[Page 833]]

is calculated using the applicable interest rate as defined in section 
417(e)(3)(A)(ii)(II) and the applicable mortality table as defined in 
section 417(e)(3)(A)(ii)(I), both single-sum distribution options are 
part of the same generalized optional form and thus in the same family 
of optional forms of benefit under the rules of paragraph (c)(3)(i) of 
this section. However, differences in actuarial factors and annuity 
starting dates are taken into account for purposes of the requirements 
in paragraph (e)(3) of this section.
    (B) Differences in pop-up provisions and cash refund features for 
joint and contingent options. The determination of whether two optional 
forms of benefit are within a family of optional forms of benefit 
relating to joint and contingent families (as described in paragraph 
(c)(4)(i) and (ii) of this section) is made without regard to the 
following features--
    (1) Pop-up provisions (under which payments increase upon the death 
of the beneficiary or another event that causes the beneficiary not to 
be entitled to a survivor annuity);
    (2) Cash refund features (under which payment is provided upon the 
death of the last annuitant in an amount that is not greater than the 
excess of the present value of the annuity at the annuity starting date 
over the total of payments before the death of the last annuitant); or
    (3) Term-certain provisions for optional forms of benefit within a 
joint and contingent family.
    (C) Differences in social security leveling features, refund of 
employee contributions features, and retroactive annuity starting date 
features. The determination of whether 2 optional forms of benefit are 
within a family of optional forms of benefit is made without regard to 
social security leveling features, refund of employee contributions 
features, or retroactive annuity starting date features. But see 
paragraph (c)(5) of this section for special rules relating to social 
security leveling, refund of employee contributions, and retroactive 
annuity starting date features in optional forms of benefit.
    (4) List of families. The following are families of optional forms 
of benefit for purposes of this paragraph (c):
    (i) Joint and contingent options with continuation percentages of 
50% to 100%. An optional form of benefit is within the 50% or more joint 
and contingent family if it provides a life annuity to the participant 
and a survivor annuity to an individual that is at least 50% and no more 
than 100% of the annuity payable during the joint lives of the 
participant and the participant's survivor.
    (ii) Joint and contingent options with continuation percentages less 
than 50%. An optional form of benefit is within the less than 50% joint 
and contingent family if it provides a life annuity to the participant 
and a survivor annuity to an individual that is less than 50% of the 
annuity payable during the joint lives of the participant and the 
participant's survivor.
    (iii) Term certain and life annuity options with a term of 10 years 
or less. An optional form of benefit is within the 10 years or less term 
certain and life family if it is a life annuity with a guarantee that 
payments will continue to the participant's beneficiary for the 
remainder of a fixed period that is 10 years or less if the participant 
dies before the end of the fixed period.
    (iv) Term certain and life annuity options with a term longer than 
10 years. An optional form of benefit is within the longer than 10 years 
term certain and life family if it is a life annuity with a guarantee 
that payments will continue to the participant's beneficiary for the 
remainder of a fixed period that is in excess of 10 years if the 
participant dies before the end of the fixed period.
    (v) Level installment payment options over a period of 10 years or 
less. An optional form of benefit is within the 10 years or less 
installment family if it provides for substantially level payments to 
the participant for a fixed period of at least 2 years and not in excess 
of 10 years with a guarantee that payments will continue to the 
participant's beneficiary for the remainder of the fixed period if the 
participant dies before the end of the fixed period.
    (vi) Level installment payment options over a period of more than 10 
years. An optional form of benefit is within the more than 10 years 
installment family if it provides for substantially level payments to 
the participant for a fixed

[[Page 834]]

period that is in excess of 10 years with a guarantee that payments will 
continue to the participant's beneficiary for the remainder of the fixed 
period if the participant dies before the end of the fixed period.
    (5) Special rules for certain features included in optional forms of 
benefit. For purposes of applying this paragraph (c), to the extent an 
optional form of benefit that is being eliminated includes either a 
social security leveling feature or a refund of employee contributions 
feature, the retained optional form of benefit must also include that 
feature, and, to the extent that the optional form of benefit that is 
being eliminated does not include a social security leveling feature or 
a refund of employee contributions feature, the retained optional form 
of benefit must not include that feature. For purposes of applying this 
paragraph (c), to the extent an optional form of benefit that is being 
eliminated does not include a retroactive annuity starting date feature, 
the retained optional form of benefit must not include the feature.
    (6) Separate application of redundancy rules for bifurcated 
benefits. If a plan permits the participant to make different 
distribution elections with respect to two or more separate portions of 
the participant's benefit, the rules of this paragraph (c) are permitted 
to be applied separately to each such portion of the participant's 
benefit as if that portion were the participant's entire benefit. Thus, 
for example, if one set of distribution elections applies to a portion 
of the participant's accrued benefit and another set of distribution 
elections applies to the other portion of the participant's accrued 
benefit, then with respect to one portion of the participant's benefit, 
the determination of whether any optional form of benefit is within a 
family of optional forms of benefit is permitted to be made disregarding 
elections that apply to the other portion of the participant's benefit. 
Similarly, if a participant can elect to receive any portion of the 
accrued benefit in a single sum and the remainder pursuant to a set of 
distribution elections, the rules of this paragraph (c) are permitted to 
be applied separately to the set of distribution elections that apply to 
the portion of the participant's accrued benefit that is not payable in 
a single sum (for example, for the portion of a participant's benefit 
that is not paid in a single sum, the determination of whether any 
optional form of benefit is within a family of optional forms of benefit 
is permitted to be made disregarding the fact that the other portion of 
the participant's benefit is paid in a single sum).
    (d) Permissible elimination of noncore optional forms of benefit 
where core options are offered--(1) General rule. Except as otherwise 
provided in paragraph (d)(2) of this section, a plan is permitted to be 
amended to eliminate an optional form of benefit for a participant with 
respect to benefits accrued before the applicable amendment date if--
    (i) After the amendment becomes applicable, each of the core options 
described in paragraph (g)(5) of this section is available to the 
participant with respect to benefits accrued before and after the 
amendment;
    (ii) The plan amendment is not applicable with respect to an 
optional form of benefit with an annuity commencement date that is 
earlier than 4 years after the date the amendment is adopted; and
    (iii) The requirements of paragraph (e) of this section are 
satisfied in any case in which either:
    (A) One or more of the core options are not available commencing on 
the same annuity commencement date as the optional form of benefit that 
is being eliminated; or
    (B) As of the date the amendment is adopted, the actuarial present 
value of the benefit payable under any core option with the same annuity 
commencement date is less than the actuarial present value of benefits 
payable under the optional form of benefit that is being eliminated.
    (2) Special rules--(i) Treatment of certain features included in 
optional forms of benefit. For purposes of applying this paragraph (d), 
to the extent an optional form of benefit that is being eliminated 
includes either a social security leveling feature or a refund of 
employee contributions feature, at least one of the core options must 
also be available with that feature, and, to

[[Page 835]]

the extent that the optional form of benefit that is being eliminated 
does not include a social security leveling feature or a refund of 
employee contributions feature, each of the core options must be 
available without that feature. For purposes of applying this paragraph 
(d), to the extent an optional form of benefit that is being eliminated 
does not include a retroactive annuity starting date feature, each of 
the core options must be available without that feature.
    (ii) Eliminating the most valuable option for a participant with a 
short life expectancy. For purposes of applying this paragraph (d), if 
the most valuable option for a participant with a short life expectancy 
(as defined in paragraph (g)(5)(iii) of this section) is eliminated, 
then, after the plan amendment, an optional form of benefit that is 
identical, except for differences described in paragraph (c)(3)(ii) of 
this section, must be available to the participant. However, such a plan 
amendment cannot eliminate a refund of employee contributions feature 
from the most valuable option for a participant with a short life 
expectancy.
    (iii) Single-sum distributions. A plan amendment is not treated as 
satisfying this paragraph (d) if it eliminates an optional form of 
benefit that includes a single-sum distribution that applies with 
respect to at least 25% of the participant's accrued benefit as of the 
date the optional form of benefit is eliminated. But see Sec. 1.411(d)-
4, Q&A-2(b)(2)(v), relating to involuntary single-sum distributions for 
benefits with a present value not in excess of the maximum dollar amount 
in section 411(a)(11).
    (iv) Application of multiple amendment rule to core option rule. 
Notwithstanding paragraph (a)(2)(iii)(B) of this section, if a plan is 
amended to eliminate an optional form of benefit using the core options 
rule in this paragraph (d), then the employer must wait 3 years after 
the first annuity commencement date for which the optional form of 
benefit is no longer available before making any changes to the core 
options offered under the plan (other than a change that is not treated 
as an elimination under paragraph (b)(2)(ii) of this section). Thus, for 
example, if a plan amendment eliminates an optional form of benefit for 
a participant using the core options rule under this paragraph (d), with 
an adoption date of January 1, 2006 and an effective date of January 1, 
2010, the plan would not be permitted to be amended to make changes to 
the core options offered under the plan (and the core options would 
continue to apply with respect to the participant's accrued benefit) 
until January 1, 2013.
    (v) Special rule for joint and contingent annuity core option. If a 
plan offers joint and contingent annuities under which a participant is 
entitled to a life annuity with a survivor annuity for the individual 
designated by the participant (including a non-spousal contingent 
annuitant) with continuation percentage options of both 50% and 100% 
(after adjustments permitted under paragraph (g)(5)(ii) of this section 
to comply with applicable law), the plan is permitted to treat both of 
these options as core options for purposes of this paragraph (d), in 
lieu of a 75% joint and contingent annuity. Thus, such a plan is 
permitted to use the rules of this paragraph (d) if the plan satisfies 
all of the requirements of this paragraph (d) (taking into account the 
modification rule in paragraph (g)(5)(ii) of this section) other than 
the requirement of offering a 75% joint and contingent annuity as 
described in paragraph (g)(5)(i)(B) of this section.
    (e) Permissible plan amendments under paragraphs (c) and (d) 
eliminating or reducing section 411(d)(6)(B) protected benefits that are 
burdensome and of de minimis value--(1) In general. A plan amendment 
that, pursuant to paragraph (c)(1)(iii) or (d)(1)(iii) of this section, 
is required to satisfy this paragraph (e) satisfies this paragraph (e) 
if--
    (i) The amendment eliminates section 411(d)(6)(B) protected benefits 
that create significant burdens or complexities for the plan and its 
participants as described in paragraph (e)(2) of this section; and
    (ii) The amendment does not adversely affect the rights of any 
participant in a more than de minimis manner as described in paragraph 
(e)(3) of this section.
    (2) Plan amendments eliminating section 411(d)(6)(B) protected 
benefits that

[[Page 836]]

create significant burdens and complexities--(i) Facts and circumstances 
analysis--(A) In general. The determination of whether a plan amendment 
eliminates section 411(d)(6)(B) protected benefits that create 
significant burdens or complexities for the plan and its participants is 
based on facts and circumstances.
    (B) Early retirement benefits. In the case of an amendment that 
eliminates an early retirement benefit, relevant factors include whether 
the annuity starting dates under the plan considered in the aggregate 
are burdensome or complex (e.g., the number of categories of early 
retirement benefits, whether the terms and conditions applicable to the 
plan's early retirement benefits are difficult to summarize in a manner 
that is concise and readily understandable to the average plan 
participant, and whether those different early retirement benefits were 
added to the plan as a result of a plan merger, transfer, or 
consolidation), and whether the effect of the plan amendment is to 
reduce the number of categories of early retirement benefits.
    (C) Retirement-type subsidies and actuarial factors. In the case of 
a plan amendment eliminating a retirement-type subsidy or changing the 
actuarial factors used to determine optional forms of benefit, relevant 
factors include whether the actuarial factors used for determining 
optional forms of benefit available under the plan considered in the 
aggregate are burdensome or complex (e.g., the number of different 
retirement-type subsidies and other actuarial factors available under 
the plan, whether the terms and conditions applicable to the plan's 
retirement-type subsidies are difficult to summarize in a manner that is 
concise and readily understandable to the average plan participant, 
whether the plan is eliminating one or more generalized optional forms, 
whether the plan is replacing a complex optional form of benefit that 
contains a retirement-type subsidy with a simpler form, and whether the 
different retirement-type subsidies and other actuarial factors were 
added to the plan as a result of a plan merger, transfer, or 
consolidation), and whether the effect of the plan amendment is to 
reduce the number of categories of retirement-type subsidies or other 
actuarial factors.
    (D) Example. The following example illustrates the application of 
this paragraph (e)(2)(i):

    Example. (i) Facts. Plan A is a defined benefit plan under which 
employees may select a distribution in the form of a straight life 
annuity, a straight life annuity with cost-of-living increases, a 50% 
qualified joint and survivor annuity with a pop-up provision, or a 10-
year term certain and life annuity. On January 15, 2007, Plan A is 
amended, effective June 1, 2007, to eliminate the 50% qualified joint 
and survivor annuity with a pop-up provision as described in paragraph 
(c)(3)(ii)(B)(1) of this section and replace it with a 50% qualified 
joint and survivor annuity without the pop-up provision (and using the 
same actuarial factor).
    (ii) Conclusion. Plan A satisfies the requirements of paragraph 
(e)(2)(i)(B) of this section because, based on the relevant facts and 
circumstances (e.g., the amendment replaces a complex optional form of 
benefit with a simpler form), the amendment eliminates section 
411(d)(6)(B) protected benefits that create significant burdens and 
complexities. Accordingly, the plan amendment is permitted to eliminate 
the pop-up provision, provided that the plan amendment satisfies all the 
other applicable requirements in paragraph (c) or (d) of this section. 
For example, the plan amendment must not eliminate the most valuable 
option for a participant with a short life expectancy (as defined in 
paragraph (g)(5)(iii) of this section) and the plan amendment must not 
adversely affect the rights of any participant in a more than de minimis 
manner, taking into account the actuarial factors for the joint and 
survivor annuity with the pop-up provision and the joint and survivor 
annuity without the pop-up provision, as described in paragraph (e)(3) 
of this section.

    (ii) Presumptions for certain amendments--(A) Presumption for 
amendments eliminating certain annuity starting dates. If the annuity 
starting dates under the plan considered in the aggregate are burdensome 
or complex, then elimination of any one of the annuity starting dates is 
presumed to eliminate section 411(d)(6)(B) protected benefits that 
create significant burdens or complexities for the plan and its 
participants. However, if the effect of a plan amendment with respect to 
a set of optional forms of benefit is merely to substitute one set of 
annuity starting dates for another set of annuity starting dates, 
without any reduction in the number of different annuity starting

[[Page 837]]

dates, then the plan amendment does not satisfy the requirements of this 
paragraph (e)(2).
    (B) Presumption for amendments changing certain actuarial factors. 
If the actuarial factors used for determining benefit distributions 
available under a generalized optional form considered in the aggregate 
are burdensome or complex, then replacing some of the actuarial factors 
for the generalized optional form is presumed to eliminate section 
411(d)(6)(B) protected benefits that create significant burdens or 
complexities for the plan and its participants. However, if the effect 
is merely to substitute one set of actuarial factors for another set of 
actuarial factors, without any reduction in the number of different 
actuarial factors or the complexity of those factors, then the plan 
amendment does not satisfy the requirements of this paragraph (e)(2) 
unless the change of actuarial factors is merely to replace one or more 
of the plan's actuarial factors for determining optional forms of 
benefit with new actuarial factors that are more accurate (e.g., 
reflecting more recent mortality experience or more recent market rates 
of interest).
    (iii) Restrictions against creating burdens or complexities. See 
paragraphs (a)(2)(iii) and (b)(1)(iii) of this section for general rules 
applicable to multiple amendments. In accordance with these rules, a 
plan amendment does not eliminate a section 411(d)(6)(B) protected 
benefit that creates burdens and complexities for a plan and its 
participants if, less than 3 years earlier, a plan was previously 
amended to add another retirement-type subsidy in order to facilitate 
the elimination of the original retirement-type subsidy, even if the 
elimination of the other subsidy would not adversely affect the rights 
of any plan participant in a more than de minimis manner as provided in 
paragraph (e)(3) of this section.
    (3) Elimination of early retirement benefits or retirement-type 
subsidies that are de minimis--(i) Rules for retained optional forms of 
benefit under paragraph (c) of this section. For purposes of paragraph 
(c) of this section, the elimination of an optional form of benefit does 
not adversely affect the rights of any participant in a more than de 
minimis manner if--
    (A) The retained optional form of benefit described in paragraph (c) 
of this section has substantially the same annuity commencement date as 
the optional form of benefit that is being eliminated, as described in 
paragraph (e)(4) of this section; and
    (B) Either the actuarial present value of the benefit payable in the 
optional form of benefit that is being eliminated does not exceed the 
actuarial present value of the benefit payable in the retained optional 
form of benefit by more than a de minimis amount, as described in 
paragraph (e)(5) of this section, or the amendment satisfies the 
requirements of paragraph (e)(6) of this section relating to a delayed 
effective date.
    (ii) Rules for core options under paragraph (d) of this section. For 
purposes of paragraph (d) of this section, the elimination of an 
optional form of benefit does not adversely affect the rights of any 
participant in a more than de minimis manner if, with respect to each of 
the core options--
    (A) The core option is available after the amendment with 
substantially the same annuity commencement date as the optional form of 
benefit that is being eliminated, as described in paragraph (e)(4) of 
this section; and
    (B) Either the actuarial present value of the benefit payable in the 
optional form of benefit that is being eliminated does not exceed the 
actuarial present value of the benefit payable under the core option by 
more than a de minimis amount, as described in paragraph (e)(5) of this 
section, or the amendment satisfies the requirements of paragraph (e)(6) 
of this section.
    (4) Definition of substantially the same annuity starting dates. For 
purposes of applying paragraphs (e)(3)(i)(A) and (ii)(A) of this 
section, annuity starting dates are considered substantially the same if 
they are within 6 months of each other.
    (5) Definition of de minimis difference in actuarial present value. 
For purposes of applying paragraph (e)(3)(i)(B) and (ii)(B) of this 
section, a difference in actuarial present value between the optional 
form of benefit being eliminated

[[Page 838]]

and the retained optional form of benefit or core option is not more 
than a de minimis amount if, as of the date the amendment is adopted, 
the difference between the actuarial present value of the eliminated 
optional form of benefit and the actuarial present value of the retained 
optional form of benefit or core option is not more than the greater 
of--
    (i) 2% of the present value of the retirement-type subsidy (if any) 
under the eliminated optional form of benefit prior to the amendment; or
    (ii) 1% of the greater of the participant's compensation (as defined 
in section 415(c)(3)) for the prior plan year or the participant's 
average compensation for his or her high 3 years (within the meaning of 
section 415(b)(1)(B) and (b)(3)).
    (6) Delayed effective date--(i) General rule. For purposes of 
applying paragraph (e)(3)(i)(B) and (ii)(B) of this section, an 
amendment that eliminates an optional form of benefit satisfies the 
requirements of this paragraph (e)(6) if the elimination of the optional 
form of benefit is not applicable to any annuity commencement date 
before the end of the expected transition period for that optional form 
of benefit.
    (ii) Determination of expected transition period--(A) General rule. 
The expected transition period for a plan amendment eliminating an 
optional form of benefit is the period that begins when the amendment is 
adopted and ends when it is reasonable to expect, with respect to a 
section 411(d)(6)(B) protected benefit (i.e., not taking into account 
benefits that accrue in the future), that the form being eliminated 
would be subsumed by another optional form of benefit after taking into 
account expected future benefit accruals.
    (B) Determination of expected transition period using conservative 
actuarial assumptions. The expected transition period for a plan 
amendment eliminating an optional form of benefit must be determined in 
accordance with actuarial assumptions that are reasonable at the time of 
the amendment and that are conservative (i.e., reasonable actuarial 
assumptions that are likely to result in the longest period of time 
until the eliminated optional form of benefit would be subsumed). For 
this purpose, actuarial assumptions are not treated as conservative 
unless they include assumptions that a participant's compensation will 
not increase and that future benefit accruals will not exceed accruals 
in recent periods.
    (C) Effect of subsequent amendments reducing future benefit accruals 
on the expected transition period. If, during the expected transition 
period for a plan amendment eliminating an optional form of benefit, the 
plan is subsequently amended to reduce the rate of future benefit 
accrual (or otherwise to lengthen the expected transition period), thus 
that subsequent plan amendment must provide that the elimination of the 
optional form of benefit is void or must provide for the effective date 
for elimination of the optional form of benefit to be further extended 
to a new expected transition period that satisfies this paragraph (e)(6) 
taking into account the subsequent amendment.
    (iii) Applicability of the delayed effective date rule limited to 
employees who continue to accrue benefits through the end of expected 
transition period. An amendment eliminating an optional form of benefit 
under this paragraph (e)(6) must be limited to participants who continue 
to accrue benefits under the plan through the end of the expected 
transition period. Thus, for example, the plan amendment may not apply 
to any participant who has a severance from employment during the 
expected transition period.
    (iv) Special rule for section 204(h) notice. See Sec. 54.4980F-
1(b), Q&A-8(c) of this chapter for a special rule relating to this 
paragraph (e)(6).
    (f) Utilization test--(1) General rule. A plan is permitted to be 
amended to eliminate all of the optional forms of benefit that comprise 
a generalized optional form (as defined in paragraph (g)(8) of this 
section) for a participant with respect to benefits accrued before the 
applicable amendment date if--
    (i) None of the optional forms of benefit being eliminated is a core 
option, within the meaning of paragraph (g)(5) of this section;
    (ii) The plan amendment is not applicable with respect to an 
optional form

[[Page 839]]

of benefit with an annuity commencement date that is earlier than the 
number of days in the maximum Qualified Joint and Survivor Annuity 
explanation period (as defined in paragraph (g)(9) of this section) 
after the date the amendment is adopted;
    (iii) During the look-back period--
    (A) The generalized optional form has been available to at least the 
applicable number of participants who are taken into account under 
paragraph (f)(3) and (4) of this section; and
    (B) No participant has elected any optional form of benefit that is 
part of the generalized optional form with an annuity commencement date 
that is within the look-back period.
    (2) Look-back period--(i) In general. For purposes of this paragraph 
(f), the look-back period is the period that includes--
    (A) The portion of the plan year in which such plan amendment is 
adopted that precedes the date of adoption (the pre-adoption period); 
and
    (B) The 2 plan years immediately preceding the pre-adoption period.
    (ii) Special look-back period rules--(A) 12-month plan year. In the 
look-back period, at least 1 of the plan years must be a 12-month plan 
year.
    (B) Permitted 3-month exclusion in the pre-adoption period. A plan 
is permitted to exclude from the look-back period the calendar month in 
which the amendment is adopted and the preceding 1 or 2 calendar months 
to the extent those preceding months are contained within the pre-
adoption period.
    (C) Permission to extend the look-back period. In order to have a 
look-back period that satisfies the minimum applicable number of 
participants requirement in paragraph (f)(1)(iii)(A) of this section, 
the look-back period described in paragraph (f)(2)(i)(B) of this section 
is permitted to be expanded, so as to include the 3, 4, or 5 plan years 
immediately preceding the plan year in which the amendment is adopted. 
Thus, in determining the look-back period, a plan is permitted to 
substitute the 3, 4, or 5 plan years immediately preceding the pre-
adoption period for the 2 plan years described in paragraph (f)(2)(i)(B) 
of this section. However, if a plan does not satisfy the minimum 
applicable number of participants requirement of paragraph 
(f)(1)(iii)(A) of this section using the pre-adoption period and the 
immediately preceding 5 plan years, the plan is not permitted to be 
amended in accordance with the utilization test in this paragraph (f).
    (3) Participants taken into account. A participant is taken into 
account for purposes of this paragraph (f) only if the participant was 
eligible to elect to commence payment of an optional form of benefit 
that is part of the generalized optional form being eliminated with an 
annuity commencement date that is within the look-back period. However, 
a participant is not taken into account if the participant--
    (i) Did not elect any optional form of benefit with an annuity 
commencement date that was within the look-back period;
    (ii) Elected an optional form of benefit that included a single-sum 
distribution that applied with respect to at least 25% of the 
participant's accrued benefit;
    (iii) Elected an optional form of benefit that was only available 
during a limited period of time and that contained a retirement-type 
subsidy where the subsidy that is part of the generalized optional form 
being eliminated was not extended to any optional form of benefit with 
the same annuity commencement date; or
    (iv) Elected an optional form of benefit with an annuity 
commencement date that was more than 10 years before normal retirement 
age.
    (4) Determining the applicable number of participants. For purposes 
of applying the rules in this paragraph (f), the applicable number of 
participants is 50 participants. However, notwithstanding paragraph 
(f)(3)(ii) of this section, a plan is permitted to take into account any 
participant who elected an optional form of benefit that included a 
single-sum distribution that applied with respect to at least 25% of the 
participant's accrued benefit, but only if the applicable number of 
participants is increased to 1,000 participants.
    (5) Default elections. For purposes of this paragraph (f), an 
election includes the payment of an optional form of benefit that 
applies in the absence of an affirmative election.

[[Page 840]]

    (g) Definitions and use of terms. The definitions in this paragraph 
(g) apply for purposes of this section.
    (1) Actuarial present value. The term actuarial present value means 
actuarial present value (within the meaning of Sec. 1.401(a)(4)-12) 
determined using reasonable actuarial assumptions.
    (2) Ancillary benefit. The term ancillary benefit means--
    (i) A social security supplement under a defined benefit plan (other 
than a QSUPP as defined in Sec. 1.401(a)(4)-12);
    (ii) A benefit payable under a defined benefit plan in the event of 
disability (to the extent that the benefit exceeds the benefit otherwise 
payable), but only if the total benefit payable in the event of 
disability does not exceed the maximum qualified disability benefit, as 
defined in section 411(a)(9);
    (iii) A life insurance benefit;
    (iv) A medical benefit described in section 401(h);
    (v) A death benefit under a defined benefit plan other than a death 
benefit which is a part of an optional form of benefit; or
    (vi) A plant shutdown benefit or other similar benefit in a defined 
benefit plan that does not continue past retirement age and does not 
affect the payment of the accrued benefit, but only to the extent that 
such plant shutdown benefit, or other similar benefit (if any), is 
permitted in a qualified pension plan (see Sec. 1.401-1(b)(1)(i)).
    (3) Annuity commencement date. The term annuity commencement date 
generally means the annuity starting date, except that, in the case of a 
retroactive annuity starting date under section 417(a)(7), annuity 
commencement date means the date of the first payment of benefits 
pursuant to a participant election of a retroactive annuity starting 
date, as defined in Sec. 1.417(e)-1(b)(3)(iv).
    (4) Applicable amendment date. The term applicable amendment date, 
with respect to a plan amendment, means the later of the effective date 
of the amendment or the date the amendment is adopted.
    (5) Core options--(i) General rule. With respect to a plan, the term 
core options means--
    (A) A straight life annuity generalized optional form under which 
the participant is entitled to a level life annuity with no benefit 
payable after the participant's death;
    (B) A 75% joint and contingent annuity generalized optional form 
under which the participant is entitled to a life annuity with a 
survivor annuity for any individual designated by the participant 
(including a non-spousal contingent annuitant) that is 75% of the amount 
payable during the participant's life (but see paragraph (d)(2)(v) of 
this section for a special rule relating to the joint and contingent 
annuity core option);
    (C) A 10-year term certain and life annuity generalized optional 
form under which the participant is entitled to a life annuity with a 
guarantee that payments will continue to any person designated by the 
participant for the remainder of a fixed period of 10 years if the 
participant dies before the end of the 10-year period; and
    (D) The most valuable option for a participant with a short life 
expectancy (as defined in paragraph (g)(5)(iii) of this section).
    (ii) Modification of core options to satisfy other requirements. An 
annuity does not fail to be a core option (e.g., a joint and contingent 
annuity described in paragraph (g)(5)(i)(B) of this section or a 10-year 
term certain and life annuity described in paragraph (g)(5)(i)(C) of 
this section) as a result of differences to comply with applicable law, 
such as limitations on death benefits to comply with the incidental 
benefit requirement of Sec. 1.401-1(b)(1)(i) or on account of the 
spousal consent rules of section 417.
    (iii) Most valuable option for a participant with a short life 
expectancy--(A) General definition. Except as provided in paragraph 
(g)(5)(iii)(B) of this section, most valuable option for a participant 
with a short life expectancy means, for an annuity starting date, the 
optional form of benefit that is reasonably expected to result in 
payments that have the largest actuarial present value in the case of a 
participant who dies shortly after the annuity starting date, taking 
into account both payments due to the participant prior to the 
participant's death and any payments due after the participant's death. 
For this purpose, a plan is permitted to assume

[[Page 841]]

that the spouse of the participant is the same age as the participant. 
In addition, a plan is permitted to assume that the optional form of 
benefit that is the most valuable option for a participant with a short 
life expectancy when the participant is age 70\1/2\ also is the most 
valuable option for a participant with a short life expectancy at all 
older ages, and that the most valuable option for a participant with a 
short life expectancy at age 55 is the most valuable option for a 
participant with a short life expectancy at all younger ages.
    (B) Safe harbor hierarchy--(1) A plan is permitted to treat a 
single-sum distribution option with an actuarial present value that is 
not less than the actuarial present value of any optional form of 
benefit eliminated by the plan amendment as the most valuable option for 
a participant with a short life expectancy for all of a participant's 
annuity starting dates if such single-sum distribution option is 
available at all such dates, without regard to whether the option was 
available before the plan amendment.
    (2) If the plan before the amendment does not offer a single-sum 
distribution option as described in paragraph (g)(5)(iii)(B)(1) of this 
section, a plan is permitted to treat a joint and contingent annuity 
with a continuation percentage that is at least 75% and that is at least 
as great as the highest continuation percentage available before the 
amendment as the most valuable option for a participant with a short 
life expectancy for all of a participant's annuity starting dates if 
such joint and contingent annuity is available at all such dates, 
without regard to whether the option was available before the plan 
amendment.
    (3) If the plan before the amendment offers neither a single-sum 
distribution option as described in paragraph (g)(5)(iii)(B)(1) of this 
section nor a joint and contingent annuity with a continuation 
percentage as described in paragraph (g)(5)(iii)(B)(2) of this section, 
a plan is permitted to treat a term certain and life annuity with a term 
certain period no less than 15 years as the most valuable option for a 
participant with a short life expectancy for each annuity starting date 
if such 15-year term certain and life annuity is available at all 
annuity starting dates, without regard to whether the option was 
available before the plan amendment.
    (6) Definitions of types of section 411(d)(6)(B) protected 
benefits--(i) Early retirement benefit. The term early retirement 
benefit means the right, under the terms of a plan, to commence 
distribution of a retirement-type benefit at a particular date after 
severance from employment with the employer and before normal retirement 
age. Different early retirement benefits result from differences in 
terms relating to timing.
    (ii) Optional form of benefit--(A) In general. The term optional 
form of benefit means a distribution alternative (including the normal 
form of benefit) that is available under the plan with respect to an 
accrued benefit or a distribution alternative with respect to a 
retirement-type benefit. Different optional forms of benefit exist if a 
distribution alternative is not payable on substantially the same terms 
as another distribution alternative. The relevant terms include all 
terms affecting the value of the optional form, such as the method of 
benefit calculation and the actuarial factors or assumptions used to 
determine the amount distributed. Thus, for example, different optional 
forms of benefit may result from differences in terms relating to the 
payment schedule, timing, commencement, medium of distribution (e.g., in 
cash or in kind), election rights, differences in eligibility 
requirements, or the portion of the benefit to which the distribution 
alternative applies. Likewise, differences in the normal retirement ages 
of employees or in the form in which the accrued benefit of employees is 
payable at normal retirement age under a plan are taken into account in 
determining whether a distribution alternative constitutes one or more 
optional forms of benefit.
    (B) Death benefits. If a death benefit is payable after the annuity 
starting date for a specific optional form of benefit and the same death 
benefit would not be provided if another optional form of benefit were 
elected by a participant, then that death benefit is part of the 
specific optional form of

[[Page 842]]

benefit and is thus protected under section 411(d)(6). A death benefit 
is not treated as part of a specific optional form of benefit merely 
because the same benefit is not provided to a participant who has 
received his or her entire accrued benefit prior to death. For example, 
a $5,000 death benefit that is payable to all participants except any 
participant who has received his or her accrued benefit in a single-sum 
distribution is not part of a specific optional form of benefit.
    (iii) Retirement-type benefit. The term retirement-type benefit 
means--
    (A) The payment of a distribution alternative with respect to an 
accrued benefit; or
    (B) The payment of any other benefit under a defined benefit plan 
(including a QSUPP as defined in Sec. 1.401(a)(4)-12) that is permitted 
to be in a qualified pension plan, continues after retirement, and is 
not an ancillary benefit.
    (iv) Retirement-type subsidy. The term retirement-type subsidy means 
the excess, if any, of the actuarial present value of a retirement-type 
benefit over the actuarial present value of the accrued benefit 
commencing at normal retirement age or at actual commencement date, if 
later, with both such actuarial present values determined as of the date 
the retirement-type benefit commences. Examples of retirement-type 
subsidies include a subsidized early retirement benefit and a subsidized 
qualified joint and survivor annuity.
    (v) Subsidized early retirement benefit or early retirement subsidy. 
The terms subsidized early retirement benefit or early retirement 
subsidy mean the right, under the terms of a plan, to commence 
distribution of a retirement-type benefit at a particular date after 
severance from employment with the employer and before normal retirement 
age where the actuarial present value of the optional forms of benefit 
available to the participant under the plan at that annuity starting 
date exceeds the actuarial present value of the accrued benefit 
commencing at normal retirement age (with such actuarial present values 
determined as of the annuity starting date). Thus, an early retirement 
subsidy is an early retirement benefit that provides a retirement-type 
subsidy.
    (7) Eliminate; elimination; reduce; reduction. The terms eliminate 
or elimination when used in connection with a section 411(d)(6)(B) 
protected benefit mean to eliminate or the elimination of an optional 
form of benefit or an early retirement benefit and to reduce or a 
reduction in a retirement-type subsidy. The terms reduce or reduction 
when used in connection with a retirement-type subsidy mean to reduce or 
a reduction in the amount of the subsidy. For purposes of this section, 
an elimination includes a reduction and a reduction includes an 
elimination.
    (8) Generalized optional form. The term generalized optional form 
means a group of optional forms of benefit that are identical except for 
differences due to the actuarial factors that are used to determine the 
amount of the distributions under those optional forms of benefit and 
the annuity starting dates.
    (9) Maximum QJSA explanation period. The term maximum QJSA 
explanation period means the maximum number of days before an annuity 
starting date for a qualified joint and survivor annuity for which a 
written explanation relating to the qualified joint and survivor annuity 
would satisfy the timing requirements of section 417(a)(3) and Sec. 
1.417(e)-1(b)(3)(ii).
    (10) Other right and feature. The term other right or feature has 
the meaning set forth at Sec. 1.401(a)(4)-4(e)(3)(ii).
    (11) Refund of employee contributions feature. The term refund of 
employee contributions features means a feature with respect to an 
optional form of benefit that provides for employee contributions and 
interest thereon to be paid in a single sum at the annuity starting date 
with the remainder to be paid in another form beginning on that date.
    (12) Retirement; retirement age. For purposes of this section, the 
date of retirement means the annuity starting date. Thus, retirement age 
means a participant's age at the annuity starting date.
    (13) Retroactive annuity starting date feature. The term retroactive 
annuity starting date feature means a feature with respect to an 
optional form of

[[Page 843]]

benefit under which the annuity starting date for the distribution 
occurs on or before the date the written explanation required by section 
417(a)(3) is provided to the participant.
    (14) Section 411(d)(6) protected benefit. The term section 411(d)(6) 
protected benefit means the accrued benefit of a participant as of the 
applicable amendment date described in section 411(d)(6)(A) and any 
section 411(d)(6)(B) protected benefit.
    (15) Section 411(d)(6)(B) protected benefit. The term section 
411(d)(6)(B) protected benefit means the portion of an early retirement 
benefit, a retirement-type subsidy, or an optional form of benefit 
attributable to benefits accrued before the applicable amendment date.
    (16) Social security leveling feature. The term social security 
leveling feature means a feature with respect to an optional form of 
benefit commencing prior to a participant's expected commencement of 
social security benefits that provides for a temporary period of higher 
payments which is designed to result in an approximately level amount of 
income when the participant's estimated old age benefits from Social 
Security are taken into account.
    (h) Examples. The following examples illustrate the application of 
paragraphs (c) through (g) of this section:

    Example 1. (i) Facts involving elimination of optional forms of 
benefit as redundant. Plan C is a defined benefit plan under which 
employees may elect to commence distributions at any time after the 
later of termination of employment or attainment of age 55. At each 
potential annuity commencement date, Plan C permits employees to select, 
with spousal consent where required, a straight life annuity or any of a 
number of actuarially equivalent alternative forms of payment, including 
a straight life annuity with cost-of-living increases and a joint and 
contingent annuity with the participant having the right to select any 
beneficiary and any continuation percentage from 1% to 100%, subject to 
modification to the extent necessary to satisfy the requirements of the 
incidental benefit requirement of Sec. 1.401-1(b)(1)(i). The amount of 
any alternative payment is determined as the actuarial equivalent of the 
straight life annuity payable at the same age using reasonable actuarial 
assumptions. On June 2, 2006, Plan C is amended to delete all 
continuation percentages for joint and contingent options other than 
25%, 50%, 75%, or 100%, effective with respect to annuity commencement 
dates that are on or after January 1, 2007.
    (ii) Conclusion--(A) Categorization of family members under the 
redundancy rule. The optional forms of benefit described in paragraph 
(i) of this Example 1 are members of 4 families: a straight life 
annuity; a straight life annuity with cost-of-living increases; joint 
and contingent options with continuation percentages of less than 50%; 
and joint and contingent options with continuation percentages of 50% or 
more. The amendment does not affect either of the first 2 families, but 
affects the 2 families relating to joint and contingent options.
    (B) Conclusion for elimination of optional forms of benefit as 
redundant. The amendment satisfies the requirements of paragraph (c) of 
this section. First, the eliminated optional forms of benefit are 
redundant with respect to the retained optional forms of benefit because 
each eliminated joint and contingent annuity option with a continuation 
percentage of less than 50% is redundant with respect to the 25% 
continuation option and each eliminated joint and contingent annuity 
option with a continuation percentage of 50% or higher is redundant with 
respect to any one of the retained 50%, 75%, or 100% continuation 
options. In addition, to the extent that the optional form of benefit 
that is being eliminated does not include a social security leveling 
feature, return of employee contribution feature, or retroactive annuity 
starting date feature, the retained optional form of benefit does not 
include that feature. Second, the amendment is not effective with 
respect to annuity commencement dates before September 1, 2006, as 
required under paragraph (c)(1)(ii) of this section. Third, the plan 
amendment does not eliminate any available core option, including the 
most valuable option for a participant with a short life expectancy, 
treating a joint and contingent annuity with a 100% continuation 
percentage as this optional form of benefit pursuant to paragraph 
(g)(5)(iii)(B)(2) of this section. Finally, the amendment need not 
satisfy the requirements of paragraph (e) of this section because the 
retained optional forms of benefit are available on the same annuity 
commencement dates and have the same actuarial present value as the 
optional forms of benefit that are being eliminated.
    Example 2. (i) Facts involving elimination of optional forms of 
benefit as redundant if additional restrictions are imposed. The facts 
are the same as Example 1, except that the plan amendment also restricts 
the class of beneficiaries that may be elected under the 4 retained 
joint and contingent annuities to the employee's spouse.
    (ii) Conclusion. The amendment fails to satisfy the requirements of 
paragraph (c)(2)(i)(B) of this section because the retained joint and 
contingent annuities have

[[Page 844]]

materially greater restrictions on the beneficiary designation than did 
the eliminated joint and contingent annuities. Thus, the joint and 
contingent annuities being eliminated are not redundant with respect to 
the retained joint and contingent annuities. In addition, the amendment 
fails to satisfy the requirements of the core option rules in paragraph 
(d) of this section because the amendment fails to be limited to annuity 
commencement dates that are at least 4 years after the date the 
amendment is adopted, the amendment fails to include the core option in 
paragraph (g)(5)(i)(B) of this section because the participant does not 
have the right to designate any beneficiary, and the amendment fails to 
include the core option described in paragraph (g)(5)(i)(C) of this 
section because the plan does not provide a 10-year term certain and 
life annuity.
    Example 3. (i) Facts involving elimination of a social security 
leveling feature and a period certain annuity as redundant. Plan D is a 
defined benefit plan under which participants may elect to commence 
distributions in the following actuarially equivalent forms, with 
spousal consent if applicable: a straight life annuity; a 50%, 75%, or 
100% joint and contingent annuity; a 5-year, 10-year, or a 15-year term 
certain and life annuity; and an installment refund annuity (i.e., an 
optional form of benefit that provides a period certain, the duration of 
which is based on the participant's age), with the participant having 
the right to select any beneficiary. In addition, each annuity offered 
under the plan, if payable to a participant who is less than age 65, is 
available both with and without a social security leveling feature. The 
social security leveling feature provides for an assumed commencement of 
social security benefits at any age selected by the participant between 
age 62 and 65. Plan D is amended on June 2, 2006, effective as of 
January 1, 2007, to eliminate the installment refund form of benefit and 
to restrict the social security leveling feature to an assumed social 
security commencement age of 65.
    (ii) Conclusion. The amendment satisfies the requirements of 
paragraph (c) of this section. First, the installment refund annuity 
option is redundant with respect to the 15-year certain and life annuity 
(except for advanced ages where, because of shorter life expectancies, 
the installment refund annuity option is redundant with respect to the 
5-year certain and life annuity and also redundant with respect to the 
10-year certain and life annuity). Second, with respect to restricting 
the social security leveling feature to an assumed social security 
commencement age of 65, under paragraph (c)(3)(ii)(C) of this section, 
straight life annuities with social security leveling features that have 
different social security commencement ages are treated as members of 
the same family as straight life annuities without social security 
leveling features. To the extent an optional form of benefit that is 
being eliminated includes a social security leveling feature, the 
retained optional form of benefit must also include that feature, but it 
is permitted to have a different assumed age for commencement of social 
security benefits. Third, to the extent that the optional form of 
benefit that is being eliminated does not include a social security 
leveling feature, a return of employee contribution feature, or 
retroactive annuity starting date feature, the retained optional form of 
benefit must not include that feature. Fourth, the plan amendment does 
not eliminate any available core option, including the most valuable 
option for a participant with a short life expectancy, treating a joint 
and contingent annuity with a 100% continuation percentage as this 
optional form of benefit pursuant to paragraph (g)(5)(iii)(B)(2) of this 
section. Fifth, the amendment is not effective with respect to annuity 
commencement dates before September 1, 2006, as required under paragraph 
(c)(1)(ii) of this section. The amendment need not satisfy the 
requirements of paragraph (e) of this section because the retained 
optional forms of benefit are available on the same annuity commencement 
dates and have the same actuarial present value as the optional forms of 
benefit that are being eliminated.
    Example 4. (i) Facts involving elimination of noncore options. 
Employer N sponsors Plan E, a defined benefit plan that permits every 
participant to elect payment in the following actuarially equivalent 
optional forms of benefit (Plan E's uniformly available options), with 
spousal consent if applicable: a straight life annuity; a 50%, 75%, or 
100% joint and contingent annuity with no restrictions on designation of 
beneficiaries; and a 5-, 10-, or 15-year term certain and life annuity. 
In addition, each can be elected in conjunction with a social security 
leveling feature, with the participant permitted to select a social 
security commencement age from age 62 to age 67. None of Plan E's 
uniformly available options include a single-sum distribution. The plan 
has been in existence for over 30 years, during which time Employer N 
has acquired a large number of other businesses, including merging over 
20 defined benefit plans of acquired entities into Plan E. Many of the 
merged plans offered optional forms of benefit that were not among Plan 
E's uniformly available options, including some plans funded through 
insurance products, often offering all of the insurance annuities that 
the insurance carrier offers, and with some of the merged plans offering 
single-sum distributions. In particular, under the XYZ acquisition that 
occurred in 1990, the XYZ acquired plan offered a single-sum 
distribution option that was frozen at the time of the acquisition. On

[[Page 845]]

April 1, 2006, each single-sum distribution option applies to less than 
25% of the XYZ participants' accrued benefits. Employer N has generally, 
but not uniformly, followed the practice of limiting the optional forms 
of benefit for an acquired unit to an employee's service before the date 
of the merger, and has uniformly followed this practice with respect to 
each of the early retirement subsidies in the acquired unit's plan. As a 
result, as of April 1, 2007, Plan E includes a large number of 
generalized optional forms which are not members of families of optional 
forms of benefit identified in paragraph (c)(4) of this section, but 
there are no participants who are entitled to any early retirement 
subsidies because any subsidies have been subsumed by the actuarially 
reduced accrued benefit. Plan E is amended in April of 2007 to eliminate 
all of the optional forms of benefit that Plan E offers other than Plan 
E's uniformly available options, except that the amendment does not 
eliminate any single-sum distribution option except with respect to XYZ 
participants and permits any commencement date that was permitted under 
Plan E before the amendment. Plan E also eliminates the single-sum 
distribution option for XYZ participants. Further, each of Plan E's 
uniformly available options has an actuarial present value that is not 
less than the actuarial present value of any optional form of benefit 
offered before the amendment. The amendment is effective with respect to 
annuity commencement dates that are on or after May 1, 2011.
    (ii) Conclusion. The amendment satisfies the requirements of 
paragraph (d) of this section. First, Plan E, as amended, does not 
eliminate any single-sum distribution option as provided in paragraph 
(d)(2)(iii) of this section except for single-sum distribution options 
that apply to less than 25% of a plan participant's accrued benefit as 
of the date the option is eliminated (May 1, 2011). Second, Plan E, as 
amended, includes each of the core options as defined in paragraph 
(g)(5) of this section, including offering the most valuable option for 
a participant with a short life expectancy (treating the 100% joint and 
contingent annuity as this benefit, under paragraph (g)(5)(iii)(B)(2) of 
this section). The 100% joint and contingent annuity option (and not the 
grandfathered single-sum distribution option) is the most valuable 
option for a participant with a short life expectancy because the 
grandfathered single-sum distribution option is not available with 
respect to a participant's entire accrued benefit. In addition, as 
required under paragraph (d)(2) of this section, to the extent an 
optional form of benefit that is being eliminated includes either a 
social security leveling feature or a refund of employee contributions 
feature, at least one of the core options is available with that feature 
and, to the extent that the optional form of benefit that is being 
eliminated does not include a social security leveling feature or a 
refund of employee contributions feature, each of the core options is 
available without that feature. Third, the amendment is not effective 
with respect to annuity commencement dates that are less than 4 years 
after the date the amendment is adopted. Finally, the amendment need not 
satisfy the requirements of paragraph (e) of this section because the 
retained optional forms of benefit are available on the same annuity 
commencement date and have the same actuarial present value as the 
optional forms of benefit that are being eliminated. The conclusion that 
the amendment satisfies the requirements of paragraph (d) of this 
section assumes that no amendments are made to change the core options 
before May 1, 2014.
    Example 5. (i) Facts involving reductions in actuarial present 
value. (A) Plan F is a defined benefit plan providing an accrued benefit 
of 1% of the average of a participant's highest 3 consecutive years' pay 
times years of service, payable as a straight life annuity beginning at 
the normal retirement age at age 65. Plan F permits employees to elect 
to commence actuarially reduced distributions at any time after the 
later of termination of employment or attainment of age 55. At each 
potential annuity commencement date, Plan F permits employees to select, 
with spousal consent, either a straight life annuity, a joint and 
contingent annuity with the participant having the right to select any 
beneficiary and a continuation percentage of 50%, 66 2/3%, 75%, or 100%, 
or a 10-year certain and life annuity with the participant having the 
right to select any beneficiary, subject to modification to the extent 
necessary to satisfy the requirements of the incidental benefit 
requirement of Sec. 1.401-1(b)(1)(i). The amount of any joint and 
contingent annuity and the 10-year certain and life annuity is 
determined as the actuarial equivalent of the straight life annuity 
payable at the same age using reasonable actuarial assumptions. The plan 
covers employees at 4 divisions, one of which, Division X, was acquired 
on January 1, 1999. The plan provides for distributions before normal 
retirement age to be actuarially reduced, but, if a participant retires 
after attainment of age 55 and completion of 10 years of service, the 
applicable early retirement reduction factor is 3% per year for the 
years between age 65 and 62 and 6% per year for the ages from 62 to 55 
for all employees at any division, except for employees who were in 
Division X on January 1, 1999, for whom the early retirement reduction 
factor for retirement after age 55 and 10 years of service is 5% for 
each year before age 65. On June 2, 2006, effective January 1, 2007, 
Plan F is amended to change the early retirement reduction factors for 
all employees of Division X to be the same as for other employees, 
effective with respect to annuity

[[Page 846]]

commencement dates that are on or after January 1, 2008, but only with 
respect to participants who are employees on or after January 1, 2008 
and only if Plan F continues accruals at the current rate through 
January 1, 2008 (or the effective date of the change in reduction 
factors is delayed to reflect the change in the accrual rate). For 
purposes of this Example 5, it is assumed that an actuarially equivalent 
early retirement factor would have a reduction shown in column 4 of the 
following table, which compares the reduction factors for Division X 
before and after the amendment:

----------------------------------------------------------------------------------------------------------------
                                                                              Actuarially
            Age (1)                 Old division X      New factor (as a   equivalent factor    Column 3 minus
                                  factor (as a %) (2)        %) (3)          (as a %) (4)        column 2 (5)
----------------------------------------------------------------------------------------------------------------
65.............................                    NA                 NA                  NA                  NA
64.............................                    95                 97                91.1                  +2
63.............................                    90                 94                83.2                  +4
62.............................                    85                 91                76.1                  +5
61.............................                    80                 85                69.8                  +5
60.............................                    75                 79                64.1                  +4
59.............................                    70                 73                59.0                  +3
58.............................                    65                 67                54.3                  +2
57.............................                    60                 61                50.1                  +1
56.............................                    55                 55                46.3                   0
55.............................                    50                 49                42.8                  -1
----------------------------------------------------------------------------------------------------------------

    (B) On January 1, 2007, the employee with the largest number of 
years of service is Employee E, who is age 54 and has 20 years of 
service. For 2006, Employee E's compensation is $80,000 and E's highest 
3 consecutive years of pay on January 1, 2007 is $75,000. Employee E's 
accrued benefit as of the January 1, 2007 effective date of the 
amendment is a life annuity of $15,000 per year at normal retirement age 
(1% times $75,000 times 20 years of service) and E's early retirement 
benefit commencing at age 55 has a present value of $91,397 as of 
January 1, 2007. It is assumed for purposes of this example that the 
longest expected transition period for any active employee does not 
exceed 5 months (20 years and 5 months, times 1% times 49% exceeds 20 
years times 1% times 50%). Finally, it is assumed for purposes of this 
example that the amendment reduces optional forms of benefit which are 
burdensome or complex.
    (ii) Conclusion concerning application of section 411(d)(6)(B). The 
amendment reducing the early retirement factors has the effect of 
eliminating the existing optional forms of benefit (where the amount of 
the benefit is based on preamendment early retirement factors in any 
case where the new factors result in a smaller amount payable) and 
adding new optional forms of benefit (where the amount of benefit is 
based on the different early retirement factors). Accordingly, the 
elimination must satisfy the requirements of paragraph (c) or (d) of 
this section if the amount payable at any date is less than would have 
been payable under the plan before the amendment.
    (iii) Conclusion concerning application of redundancy rules. The 
amendment satisfies the requirements of paragraph (c)(1)(i) and (ii) of 
this section (see paragraphs (iv) through (vi) of this Example 5 below 
for the requirements of paragraph (c)(1)(iii) of this section). First, 
with respect to each eliminated optional form of benefit (i.e., with 
respect to each optional form of benefit with the Old Division X 
Factor), after the amendment there is a retained optional form of 
benefit that is in the same family of optional forms of benefit (i.e., 
the optional form of benefit with the New Factor). Second, the amendment 
is not effective with respect to annuity commencement dates that are 
less than the time period required under paragraph (c)(1)(ii) of this 
section. Third, to the extent that the plan amendment eliminates the 
most valuable option for a participant with a short life expectancy, the 
retained optional form of benefit is identical except for differences in 
actuarial factors.
    (iv) Conclusion concerning application of the requirements under 
paragraph (e) of this section. The plan amendment must satisfy the 
requirements of paragraph (e) of this section because, as of the 
December 2, 2006 adoption date, the actuarial present value of the early 
retirement subsidy is less than the actuarial present value of the early 
retirement subsidy being eliminated. The plan amendment satisfies the 
requirements under paragraph (e)(1)(i) and (2) of this section because 
the amendment eliminates optional forms of benefit that create 
significant burdens or complexities for the plan and its participants. 
See below for the de minimis requirement under paragraph (e)(1)(ii) and 
(3) of this section.
    (v) Conclusion concerning application of de minimis rules under 
paragraph (e)(5) of this section. In order to satisfy the requirements 
under paragraph (e)(1)(ii) and (3) of this section, the amendment must 
satisfy the requirements of either paragraph (e)(5) or paragraph (e)(6) 
of this section. The amendment

[[Page 847]]

does not satisfy the requirements of paragraph (e)(5) of this section 
because the reduction in the actuarial present value is more than a de 
minimis amount under paragraph (e)(5) of this section. For example, for 
Employee E, the amount of the joint and contingent annuity payable at 
age 55 is reduced from $7,500 (50% of $15,000) to $7,350 (49% of 
$15,000) and the reduction in present value as a result of the amendment 
is $1,828 ($91,397--$89,569). In this case, the retirement-type subsidy 
at age 55 is the excess of the present value of the 50% early retirement 
benefit over the present value of the deferred payment of the accrued 
benefit, or $13,921 ($97,269--$83,348) and the present value at age 54 
of the retirement-type subsidy is $13,081. The reduction in present 
value is more than the greater of 2% of the present value of the 
retirement-type subsidy and 1% of E's compensation because the reduction 
in present value exceeds $800 (the greater of $262, which is 2% of the 
present value of the retirement-type subsidy for the benefit being 
eliminated, and $800, which is 1% of E's compensation of $80,000).
    (vi) Conclusion involving application of de minimis rules under 
paragraph (e)(6) of this section relating to expected transition period. 
The amendment satisfies the requirements of paragraph (e)(6) of this 
section and, thus, satisfies the requirements of paragraph (c) of this 
section, including the requirement in paragraph (c)(1)(iii) of this 
section that paragraph (e) of this section be satisfied. First, as 
assumed under the facts above, the amendment reduces optional forms of 
benefit that are burdensome or complex. Second, the plan amendment is 
not effective for annuity commencement dates before January 1, 2008, and 
that date is not earlier than the longest expected transition period for 
any participant in Plan F on the date of the amendment. Third, the 
amendment does not apply to any participant who has a severance from 
employment during the transition period. If, however, a later plan 
amendment reduces accruals under Plan F, the initial plan amendment will 
no longer satisfy the requirements of paragraph (e)(6) of this section 
(and must be voided) unless, as part of the later amendment, the 
expected transition period is extended to reflect the reduction in 
accruals under Plan F.
    Example 6. (i) Facts involving elimination of noncore options using 
utilization test--(A) In general. Plan G is a calendar year defined 
benefit plan under which participants may elect to commence 
distributions after termination of employment in the following 
actuarially equivalent forms, with spousal consent, if applicable: a 
straight life annuity; a 50%, 75%, or 100% joint and contingent annuity; 
or a 5-year, 10-year, or a 15-year term certain and life annuity. A 
participant is permitted to elect a single-sum distribution if the 
present value of the participant's nonforfeitable accrued benefit is not 
greater than $5,000. The annuities offered under the plan are generally 
available both with and without a social security leveling feature. The 
social security leveling feature provides for an assumed commencement of 
social security benefits at any age selected by the participant between 
the ages of 62 and 67. Under Plan G, the normal retirement age is 
defined as age 65.
    (B) Utilization test. In 2007, the plan sponsor of Plan G, after 
reviewing participants' benefit elections, determines that, during the 
period from January 1, 2005, through June 30, 2007, no participant has 
elected a 5-year term certain and life annuity with a social security 
leveling option. During that period, Plan G has made the 5-year term 
certain and life annuity with a social security leveling option 
available to 142 participants who were at least age 55 and who elected 
optional forms of benefit with an annuity commencement dates during that 
period. In addition, during that period, 20 of the 142 participants 
elected a single-sum distribution and there was no retirement-type 
subsidy available for a limited period of time. Plan G, in accordance 
with paragraph (f)(1) of this section, is amended on September 15, 2007, 
effective as of January 1, 2008, to eliminate all 5-year term certain 
and life annuities with a social security leveling option for all 
annuity commencement dates on or after January 1, 2008.
    (ii) Conclusion. The amendment satisfies the requirements of 
paragraph (f) of this section. First, the 5-year term certain and life 
annuity with a social security leveling option is not a core option as 
defined in paragraph (g)(5) of this section. Second, the plan amendment 
is not applicable with respect to an optional form of benefit with an 
annuity commencement date that is earlier than the number of days in the 
maximum QJSA explanation period after the date the amendment is adopted. 
Third, the 5-year term certain and life annuity with a social security 
leveling option has been available to at least 50 participants who are 
taken into account for purposes of paragraph (f) of this section during 
the look-back period. Fourth, during the look-back period, no 
participant elected any optional form that is part of the generalized 
optional form being eliminated (for example, the 5-year term and life 
annuity with a social security leveling option).

    (i) [Reserved]
    (j) Effective dates--(1) General effective date. Except as otherwise 
provided in this paragraph (j), the rules of this section apply to 
amendments adopted on or after August 12, 2005.
    (2) Effective date for rules relating to contingent event benefits. 
Paragraph (b)(1)(ii) of this section applies to

[[Page 848]]

amendments adopted after December 31, 2005.
    (3) Effective dates for rules relating to section 411(a) 
nonforfeitability provisions--(i) Application of suspension of benefit 
rules to section 411(d)(6) protected benefits. With respect to a plan 
amendment that places greater restrictions or conditions on a 
participant's rights to section 411(d)(6) protected benefits by adding 
or modifying a plan provision relating to suspension of benefit payments 
during a period of employment or reemployment, the rules provided in 
paragraph (a)(3) of this section apply to periods beginning on or after 
June 7, 2004.
    (ii) Application of section 411(a) nonforfeitability provisions to 
section 411(d)(6) protected benefits. With respect to a plan amendment 
that places greater restrictions or conditions on a participant's rights 
to section 411(d)(6) protected benefits other than a plan amendment 
described in paragraph (j)(3)(i) of this section, the rules provided in 
paragraph (a)(3) of this section apply to plan amendments adopted after 
August 9, 2006.
    (4) Effective date for change to redundancy rule regarding 
bifurcation of benefits. The rules provided in paragraph (c)(6) of this 
section are applicable for amendments adopted after August 9, 2006.
    (5) Effective date for rules relating to utilization test. The rules 
provided in paragraph (f) of this section are applicable for amendments 
adopted after December 31, 2006.

[T.D. 9219, 70 FR 47116, Aug. 12, 2005, as amended by T.D. 9280, 71 FR 
45383, Aug. 9, 2006; 71 FR 55108, Sept. 21, 2006; T.D. 9472, 74 FR 
61276, Nov. 24, 2009]



Sec. 1.411(d)-4  Section 411(d)(6) protected benefits.

    Q-1: What are ``section 411(d)(6) protected benefits''?
    A-1: (a) In general. The term ``section 411(d)(6) protected 
benefit'' includes any benefit that is described in one or more of the 
following categories--
    (1) Benefits described in section 411(d)(6)(A),
    (2) Early retirement benefits (as defined in Sec. 1.411(d)-
3(g)(6)(i)) and retirement-type subsidies (as defined in Sec. 1.411(d)-
3(g)(6)(iv)), and
    (3) Optional forms of benefit described in section 411(d)(6)(B)(ii).

Such benefits, to the extent they have accrued, are subject to the 
protection of section 411(d)(6) and, where applicable, the definitely 
determinable requirement of section 401(a) (including section 
401(a)(25)) and cannot, therefore, be reduced, eliminated, or made 
subject to employer discretion except to the extent permitted by 
regulations.
    (b) Optional forms of benefit--(1) In general. The term optional 
form of benefit has the same meaning as in Sec. 1.411(d)-3(g)(6)(ii). 
Under this definition, different optional forms of benefit exist if a 
distribution alternative is not payable on substantially the same terms 
as another distribution alternative. Thus, for example, different 
optional forms of benefit may result from differences in terms relating 
to the payment schedule, timing, commencement, medium of distribution 
(e.g., in cash or in kind), election rights, differences in eligibility 
requirements, or the portion of the benefit to which the distribution 
alternative applies.
    (2) Examples. The following examples illustrate the meaning of the 
term ``optional form of benefit.'' Other issues, such as the requirement 
that the optional forms satisfy section 401(a)(4), are not addressed in 
these examples and no inferences are intended with respect to such 
requirements. Assume that the distribution forms, including those not 
described in these examples, provided under the plan in each of the 
following examples are identical in all respects not described.

    Example 1. A plan permits each participant to receive his benefit 
under the plan as a single sum distribution; a level monthly 
distribution schedule over 15 years; a single life annuity; a joint and 
50 percent survivor annuity; a joint and 75 percent survivor annuity; a 
joint and 50 percent survivor annuity with a benefit increase for the 
participant if the beneficiary dies before a specified date; and joint 
and 50 percent survivor annuity with a 10 year certain feature. Each of 
these benefit distribution options is an optional form of benefit 
(without regard to whether the values of these options are actuarially 
equivalent).
    Example 2. A plan permits each participant who is employed by 
division A to receive his benefit in a single sum distribution payable 
upon termination from employment and each participant who is employed by 
division

[[Page 849]]

B in a single sum distribution payable upon termination from employment 
on or after the attainment of age 50. This plan provides two single sum 
optional forms of benefit.
    Example 3. A plan permits each participant to receive his benefit in 
a single life annuity that commences in the month after the 
participant's termination from employment or in a single life annuity 
that commences upon the completion of five consecutive one year breaks 
in service. These are two optional forms of benefit.
    Example 4. A profit-sharing plan permits each participant who is 
employed by division A to receive an in-service distribution upon the 
satisfaction of objective criteria set forth in the plan designed to 
determine whether the participant has a heavy and immediate financial 
need, and each participant who is employed by division B to receive an 
in-service distribution upon the satisfaction of objective criteria set 
forth in the plan designed to determine whether the participant has a 
heavy and immediate financial need attributable to extraordinary medical 
expenses. These in-service distribution options are two optional forms 
of benefits.
    Example 5. A profit-sharing plan permits each participant who is 
employed by division A to receive an in-service distribution up to 
$5,000 and each participant who is employed by division B to receive an 
in-service distribution of up to his total benefit. These in-service 
distribution options differ as to the portion of the accrued benefit 
that may be distributed in a particular form and are, therefore, two 
optional forms of benefit.
    Example 6. A profit-sharing plan provides for a single sum 
distribution on termination of employment. The plan is amended in 1991 
to eliminate the single sum optional form of benefit with respect to 
benefits accrued after the date of amendment. This single sum optional 
form of benefit continues to be a single optional form of benefit 
although, over time, the percentage of various employees' accrued 
benefits that are potentially payable under this single sum may vary 
because the form is only available with respect to benefits accrued up 
to and including the date of the amendment.
    Example 7. A profit-sharing plan permits each participant to receive 
a single sum distribution of his benefit in cash or in the form of a 
specified class of employer stock. This plan provides two single sum 
distribution optinal forms of benefit.
    Example 8. A stock bonus plan permits each participant to receive a 
single sum distribution of his benefit in cash or in the form of the 
property in which such participant's benefit was invested prior to the 
distribution. This plan's single sum distribution option provides two 
optional forms of benefit.
    Example 9. A defined benefit plan provides for an early retirement 
benefit payable upon termination of employment after attainment of age 
55 and either after ten years of service or, if earlier, upon plan 
termination to employees of Division A and provides for an identical 
early retirement benefit payable on the same terms with the exception of 
payment on plan termination to employees of Division B. The plan 
provides for two optional forms of benefit.
    Example 10. A profit-sharing plan provides for loans secured by an 
employee's account balance. In the event of default on such a loan, 
there is an execution on such account balances. Such execution is a 
distribution of the employee's accrued benefits under the plan. A 
distribution of an accrued benefit contingent on default under a plan 
loan secured by such accrued benefits is an optional form of benefit 
under the plan.

    (c) Plan terms--(1) General rule. Generally, benefits described in 
section 411(d)(6)(A), early retirement benefits, retirement-type 
subsidies, and optional forms of benefit are section 411(d)(6) protected 
benefits only if they are provided under the terms of a plan. However, 
if an employer establishes a pattern of repeated plan amendments 
providing for similar benefits in similar situations for substantially 
consecutive, limited periods of time, such benefits will be treated as 
provided under the terms of the plan, without regard to the limited 
periods of time, to the extent necessary to carry out the purposes of 
section 411(d)(6) and, where applicable, the definitely determinable 
requirement of section 401(a), including section 401(a)(25). A pattern 
of repeated plan amendments providing that a particular optional form of 
benefit is available to certain named employees for a limited period of 
time is within the scope of this rule and may result in such optional 
form of benefit being treated as provided under the terms of the plan to 
all employees covered under the plan without regard to the limited 
period of time and the limited group of named employees.
    (2) Effective date. The provisions of paragraph (c)(1)of this Q&A-1 
are effective as of July 11, 1988. Thus, patterns or repeated plan 
amendments adopted and effective before July 11, 1988 will be 
disregarded in determining whether such amendments have created an 
ongoing optional form of benefit under the plan.
    (d) Benefits that are not section 411(d)(6) protected benefits. The 
following benefits are examples of items

[[Page 850]]

that are not section 411(d)(6) protected benefits:
    (1) Ancillary life insurance protection;
    (2) Accident or health insurance benefits;
    (3) Social security supplements described in section 411(a)(9), 
except qualified social security supplements as defined in Sec. 
1.401(a)(4)-12;
    (4) The availability of loans (other than the distribution of an 
employee's accrued benefit upon default under a loan);
    (5) The right to make after-tax employee contributions or elective 
deferrals described in section 402(g)(3);
    (6) The right to direct investments;
    (7) The right to a particular form of investment (e.g., investment 
in employer stock or securities or investment in certain types of 
securities, commercial paper, or other investment media);
    (8) The allocation dates for contributions, forfeitures, and 
earnings, the time for making contributions (but not the conditions for 
receiving an allocation of contributions or forfeitures for a plan year 
after such conditions have been satisfied), and the valuation dates for 
account balances;
    (9) Administrative procedures for distributing benefits, such as 
provisions relating to the particular dates on which notices are given 
and by which elections must be made; and
    (10) Rights that derive from administrative and operational 
provisions, such as mechanical procedures for allocating investment 
experience among accounts in defined contribution plans.
    Q-2: To what extent may section 411(d)(6) protected benefits under a 
plan be reduced or eliminated?
    A-2:
    (a) Reduction or elimination of section 411(d)(6) protected 
benefits--(1) In general. A plan is not permitted to be amended to 
eliminate or reduce a section 411(d)(6) protected benefit that has 
already accrued, except as provided in Sec. 1.411(d)-3 or this section. 
This is generally the case even if such elimination or reduction is 
contingent upon the employee's consent. However, a plan may be amended 
to eliminate or reduce section 411(d)(6) protected benefits with respect 
to benefits not yet accrued as of the later of the amendment's adoption 
date or effective date without violating section 411(d)(6).
    (2) Selection of optional forms of benefit--(i) General rule. A plan 
may treat a participant as receiving his entire nonforfeitable accrued 
benefit under the plan if the participant receives his benefit in an 
optional form of benefit in an amount determined under the plan that is 
at least the actuarial equivalent of the employee's nonforfeitable 
accrued benefit payable at normal retirement age under the plan. This is 
true even though the participant could have elected to receive an 
optional form of benefit with a greater actuarial value than the value 
of the optional form received, such as an optional form including 
retirement-type subsidies, and without regard to whether such other, 
more valuable optional form could have commenced immediately or could 
have become available only upon the employee's future satisfaction of 
specified eligibility conditions.
    (ii) Election of an optional form. Except as provided in paragraph 
(a)(2)(iii) of this Q&A-2, a plan does not violate section 411(d)(6) 
merely because an employee's election to receive a portion of his 
nonforfeitable accrued benefit in one optional form of benefit precludes 
the employee from receiving that portion of his benefit in another 
optional form of benefit. Such employee retains all 411(d)(6) protected 
rights with respect to the entire portion of such employee's 
nonforfeitable accrued benefit for which no distribution election was 
made. For purposes of this rule, an elective transfer of an otherwise 
distributable benefit is treated as the selection of an optional form of 
benefit. See Q&A-3 of this section.
    (iii) Buy-back rule. Notwithstanding paragraph (a)(2)(ii) of this 
Q&A-2, an employee who received a distribution of his nonforfeitable 
benefit from a plan that is required to provide a repayment opportunity 
to such employee if he returns to service within the applicable period 
pursuant to the requirements of section 411(a)(7) and who, upon 
subsequent reemployment, repays the full amount of such distribution in 
accordance with section 411(a)(7)(C) must be reinstated in the full 
array of section 411(d)(6) protected benefits that

[[Page 851]]

existed with respect to such benefit prior to distribution.
    (iv) Examples. The rules in this paragraph (a)(2) can be illustrated 
by the following examples:

    Example 1. Defined benefit plan X provides, among its optional forms 
of benefit, for a subsidized early retirement benefit payable in the 
form of an annuity and available to employees who terminate from 
employment on or after their 55th birthdays. In addition plan X provides 
for a single sum distribution available on termination from employment 
or termination of the plan. The single sum distribution is determined on 
the basis of the present value of the accrued normal retirement benefit 
and does not take the early retirement subsidy into account. Plan X is 
terminated December 31, 1991. Employees U, age 47, V, age 55, and W, age 
47, all continue in the service of the employer. Employees X, age 47, Y, 
age 55 and Z, age 47, terminate from employment with the employer during 
1991. Employees U and V elect to take the single sum optional form of 
distribution at the time of plan termination. Employees X and Y elect to 
take the single sum distribution on termination from employment with the 
employer. The elimination of the subsidized early retirement benefit 
with respect to employees U, V, X and Y does not result in a violation 
of section 411(d)(6). This is the result even though employees U and X 
had not yet satisfied the conditions for the subsidized early retirement 
benefit. Because employees W and Z have not selected an optional form of 
benefit, they continue to have a 411(d)(6) protected right to the full 
array of section 411(d)(6) protected benefits provided under the plan, 
including the single sum distribution form and the subsidized early 
retirement benefit.
    Example 2. A partially vested employee receives a single sum 
distribution of the present value of his entire nonforfeitable benefit 
on account of separation from service under a defined benefit plan 
providing for a repayment provision. Upon reemployment with the employer 
such employee makes repayment in the required amount in accordance with 
section 411(a)(7). Such employee may, upon subsequent termination of 
employment, elect to take such repaid benefits in any optional form 
provided under the plan as of the time of the employee's initial 
separation from service. If the plan was amended prior to such 
repayment, to eliminate the single sum optional form of benefit with 
respect to benefits accrued after the date of the amendment, such 
participant has a 411(d)(6) protected right to take distribution of the 
repaid benefit in the form of a single sum distribution.

    (3) Certain transactions--(i) Plan mergers and benefit transfers. 
The prohibition against the reduction or elimination of section 
411(d)(6) protected benefits already accrued applies to plan mergers, 
spinoffs, transfers, and transactions amending or having the effect of 
amending a plan or plans to transfer plan benefits. Thus, for example, 
if plan A, a profit-sharing plan that provides for distribution of plan 
benefits in annual installments over ten or twenty years, is merged with 
plan B, a profit-sharing plan that provides for distribution of plan 
benefits in annual installments over life expectancy at time of 
retirement, the merged plan must retain the ten or twenty year 
installment option for participants with respect to benefits already 
accrued under plan A as of the merger and the installments over life 
expectancy for participants with benefits already accrued under plan B. 
Similarly, for example, if an employee's benefit under a defined 
contribution plan is transferred to another defined contribution plan 
(whether or not of the same employer), the optional forms of benefit 
available with respect to the employee's benefit accrued under the 
transferor plan may not be eliminated or reduced except as otherwise 
permitted under this regulation. See Q&A-3 of this section with respect 
to the transfer of benefits between and among defined benefit and 
defined contribution plans.
    (ii) Annuity contracts--(A) General rule. The right of a participant 
to receive a benefit in the form of cash payments from the plan and the 
right of a participant to receive that benefit in the form of the 
distribution of an annuity contract that provides for cash payments that 
are identical in all respects to the cash payments from the plan except 
with respect to the source of the payments are not separate optional 
forms of benefit. Therefore, for example, if a plan includes an optional 
form of benefit under which benefits are distributed in the medium of an 
annuity contract that provides for cash payments, that optional form of 
benefit may be modified by a plan amendment that substitutes cash 
payments from the plan for the annuity contract, where those cash 
payments from the plan are identical to the cash payments payable from 
the annuity contract in all respects except with respect to the

[[Page 852]]

source of the payments. The protection provided by section 411(d)(6) may 
not be avoided by the use of annuity contracts. Thus, section 411(d)(6) 
protected benefits already accrued may not be eliminated or reduced 
merely because a plan uses annuity contracts to provide such benefits, 
without regard to whether the plan, a participant, or a beneficiary of a 
participant holds the contract or whether such annuity contracts are 
purchased as a result of the termination of the plan. However, to the 
extent that an annuity contract constitutes payment of benefits in a 
particular optional form elected by the participant, the plan does not 
violate section 411(d)(6) merely because it provides that other optional 
forms are no longer available with respect to such participant. See 
paragraph (a)(2) of this Q&A-2.
    (B) Examples. The provisions of this paragraph (a)(3)(ii) can be 
illustrated by the following examples:

    Example 1. A profit-sharing plan that is being terminated satisfies 
section 411(d)(6) only if the plan makes available to participants 
annuity contracts that provide for all section 411(d)(6) protected 
benefits under the plan that may not otherwise be reduced or eliminated 
pursuant to this Q&A-2. Thus, if such a plan provided for a single sum 
distribution upon attainment of early retirement age, and a provision 
for payment in the form of 10 equal annual installments, the plan would 
satisfy section 411(d)(6) only if the participants had the opportunity 
to elect to have their benefits provided under an annuity contract that 
provided for the same single sum distribution upon the attainment of the 
participant's early retirement age and the same 10 year installment 
optional form of benefit.
    Example 2. A defined benefit plan permits each participant who 
separates from service on or after age 62 to receive a qualified joint 
and survivor annuity or a single life annuity commencing 45 days after 
termination from employment. For a participant who separates from 
service before age 62, payments under these optional forms of benefit 
commence 45 days after the participant's 62nd birthday. Under the plan, 
a participant is to elect among these optional forms of benefit during 
the 90-day period preceding the annuity starting date. However, during 
such period, a participant may defer both benefit commencement and the 
election of a particular benefit form to any later date, subject to 
section 401(a)(9). In January 1990, the employer decides to terminate 
the plan as of July 1, 1990. The plan will fail to satisfy section 
411(d)(6) unless the optional forms of benefit provided under the plan 
are preserved under the annuity contract purchased on plan termination. 
Thus, such annuity contract must provide a participant the same optional 
benefit commencement rights that the plan provided. In addition, such 
contract must provide the same election rights with respect to such 
benefit options. This is the case even if, for example, in conjunction 
with the termination, the employer amended the plan to permit 
participants to elect a qualified joint and survivor annuity, single 
life annuity, or single sum distribution commencing on July 1, 1990.

    (4) Benefits payable to a spouse or beneficiary. Section 411(d)(6) 
protected benefits may not be eliminated merely because they are payable 
with respect to a spouse or other beneficiary.
    (b) Section 411(d)(6) protected benefits that may be eliminated or 
reduced only as permitted by the Commissioner--(1) In general. The 
Commissioner may, consistent with the provisions of this section, 
provide for the elimination or reduction of section 411(d)(6) protected 
benefits that have already accrued only to the extent that such 
elimination or reduction does not result in the loss to plan 
participants of either a valuable right or an employer-subsidized 
optional form of benefit where a similar optional form of benefit with a 
comparable subsidy is not provided or to the extent such elimination or 
reduction is necessary to permit compliance with other requirements of 
section 401(a) (e.g., sections 401(a)(4), 401(a)(9) and 415). The 
Commissioner may exercise this authority only through the publication of 
revenue rulings, notices, and other documents of general applicability.
    (2) Section 411(d)(6) protected benefits that may be eliminated or 
reduced. The elimination or reduction of certain section 411(d)(6) 
protected benefits that have already accrued in the following situations 
does not violate section 411(d)(6). The rules with respect to 
permissible eliminations and reductions provided in this paragraph 
(b)(2) generally are effective January 30, 1986; however, the rules of 
paragraphs (b)(2)(iii) (A) and (B) and (b)(2)(viii) of this Q&A-2 are 
effective for plan amendments that are adopted and effective on or after 
September 6, 2000. These exceptions create no inference

[[Page 853]]

with respect to whether any other applicable requirements are satisfied 
(for example, requirements imposed by section 401(a)(9) and section 
401(a)(14)).
    (i) Change in statutory requirement. A plan may be amended to 
eliminate or reduce a section 411(d)(6) protected benefit if the 
following three requirements are met: the amendment constitutes timely 
compliance with a change in law affecting plan qualification; there is 
an exercise of section 7805(b) relief by the Commissioner; and the 
elimination or reduction is made only to the extent necessary to enable 
the plan to continue to satisfy the requirements for qualified plans. In 
general, the elimination or reduction of a section 411(d)(6) protected 
benefit will not be treated as necessary if it is possible through other 
modifications to the plan (e.g., by expanding the availability of an 
optional form of benefit to additional employees) to satisfy the 
applicable qualification requirement.
    (ii) Joint and survivor annuity. A plan that provides a range of 
three or more actuarially equivalent joint and survivor annuity options 
may be amended to eliminate any of such options, other than the options 
with the largest and smallest optional survivor payment percentages, 
even if the effect of such amendment is to change which of the options 
is the qualified joint and survivor annuity under section 417. Thus, for 
example, if a money purchase pension plan provides three joint and 
survivor annuity options with survivor payments of 50%, 75% and 100%, 
respectively, that are uniform with respect to age and are actuarially 
equivalent, then the employer may eliminate the option with the 75% 
survivor payment, even if this option had been the qualified joint and 
survivor annuity under the plan.
    (iii) In-kind distributions--(A) In-kind distributions payable under 
defined contribution plans in the form of marketable securities other 
than employer securities. If a defined contribution plan includes an 
optional form of benefit under which benefits are distributed in the 
form of marketable securities, other than securities of the employer, 
that optional form of benefit may be modified by a plan amendment that 
substitutes cash for the marketable securities as the medium of 
distribution. For purposes of this paragraph (b)(2)(iii)(A) and 
paragraph (b)(2)(iii)(B) of this Q&A-2, the term marketable securities 
means marketable securities as defined in section 731(c)(2), and the 
term securities of the employer means securities of the employer as 
defined in section 402(e)(4)(E)(ii).
    (B) Amendments to defined contribution plans to specify medium of 
distribution. If a defined contribution plan includes an optional form 
of benefit under which benefits are distributable to a participant in a 
medium other than cash, the plan may be amended to limit the types of 
property in which distributions may be made to the participant to the 
types of property specified in the amendment. For this purpose, the 
types of property specified in the amendment must include all types of 
property (other than marketable securities that are not securities of 
the employer) that are allocated to the participant's account on the 
effective date of the amendment and in which the participant would be 
able to receive a distribution immediately before the effective date of 
the amendment if a distributable event occurred. In addition, a plan 
amendment may provide that the participant's right to receive a 
distribution in the form of specified types of property is limited to 
the property allocated to the participant's account at the time of 
distribution that consists of property of those specified types.
    (C) In-kind distributions after plan termination. If a plan includes 
an optional form of benefit under which benefits are distributed in 
specified property, that optional form of benefit may be modified for 
distributions after plan termination by substituting cash for the 
specified property as the medium of distribution to the extent that, on 
plan termination, an employee has the opportunity to receive the 
optional form of benefit in the form of the specified property. This 
exception is not available, however, if the employer that maintains the 
terminating plan also maintains another plan that provides an optional 
form of benefit under which benefits are distributed in the specified 
property.

[[Page 854]]

    (D) Examples. The following examples illustrate the application of 
this paragraph (b)(2)(iii):

    Example 1. (i) An employer maintains a profit-sharing plan under 
which participants may direct the investment of their accounts. One 
investment option available to participants is a fund invested in common 
stock of the employer. The plan provides that the participant has the 
right to a distribution in the form of cash upon termination of 
employment. In addition, the plan provides that, to the extent a 
participant's account is invested in the employer stock fund, the 
participant may receive an in-kind distribution of employer stock upon 
termination of employment. On October 18, 2000, the plan is amended, 
effective on January 1, 2001, to remove the fund invested in employer 
common stock as an investment option under the plan and to provide for 
the stock held in the fund to be sold. The amendment permits 
participants to elect how the sale proceeds are to be reallocated among 
the remaining investment options, and provides for amounts not so 
reallocated as of January 1, 2001, to be allocated to a specified 
investment option.
    (ii) The plan does not fail to satisfy section 411(d)(6) solely on 
account of the plan amendment relating to the elimination of the 
employer stock investment option, which is not a section 411(d)(6) 
protected benefit. See paragraph (d)(7) of Q&A-1 of this section. 
Moreover, because the plan did not provide for distributions of employer 
securities except to the extent participants' accounts were invested in 
the employer stock fund, the plan is not required operationally to offer 
distributions of employer securities following the amendment. In 
addition, the plan would not fail to satisfy section 411(d)(6) on 
account of a further plan amendment, effective after the plan has ceased 
to provide for an employer stock fund investment option (and 
participants' accounts have ceased to be invested in employer 
securities), to eliminate the right to a distribution in the form of 
employer stock. See paragraph (b)(2)(iii)(B) of this Q&A-2.
    Example 2. (i) An employer maintains a profit-sharing plan under 
which a participant, upon termination of employment, may elect to 
receive benefits in a single-sum distribution either in cash or in kind. 
The plan's investments are limited to a fund invested in employer stock, 
a fund invested in XYZ mutual funds (which are marketable securities), 
and a fund invested in shares of PQR limited partnership (which are not 
marketable securities).
    (ii) The following alternative plan amendments would not cause the 
plan to fail to satisfy section 411(d)(6):
    (A) A plan amendment that limits non-cash distributions to a 
participant on termination of employment to a distribution of employer 
stock and shares of PQR limited partnership. See paragraph 
(b)(2)(iii)(A) of this Q&A-2.
    (B) A plan amendment that limits non-cash distributions to a 
participant on termination of employment to a distribution of employer 
stock and shares of PQR limited partnership, and that also provides that 
only participants with employer stock allocated to their accounts as of 
the effective date of the amendment have the right to distributions in 
the form of employer stock, and that only participants with shares of 
PQR limited partnership allocated to their accounts as of the effective 
date of the amendment have the right to distributions in the form of 
shares of PQR limited partnership. To comply with the plan amendment, 
the plan administrator retains a list of participants with employer 
stock allocated to their accounts as of the effective date of the 
amendment, and a list of participants with shares of PQR limited 
partnership allocated to their accounts as of the effective date of the 
amendment. See paragraphs (b)(2)(iii) (A) and (B) of this Q&A-2.
    (C) A plan amendment that limits non-cash distributions to a 
participant on termination of employment to a distribution of employer 
stock and shares of PQR limited partnership to the extent that those 
assets are allocated to the participant's account at the time of the 
distribution. See paragraphs (b)(2)(iii) (A) and (B) of this Q&A-2.
    (D) A plan amendment that limits non-cash distributions to a 
participant on termination of employment to a distribution of employer 
stock and shares of PQR limited partnership, and that provides that only 
participants with employer stock allocated to their accounts as of the 
effective date of the amendment have the right to distributions in the 
form of employer stock, and that only participants with shares of PQR 
limited partnership allocated to their accounts as of the effective date 
of the amendment have the right to distributions in the form of shares 
of PQR limited partnership, and that further provides that the 
distribution of that stock or those shares is available only to the 
extent that those assets are allocated to those participants' accounts 
at the time of the distribution. To comply with the plan amendment, the 
plan administrator retains a list of participants with employer stock 
allocated to their accounts as of the effective date of the amendment, 
and a list of participants with shares of PQR limited partnership 
allocated to their accounts as of the effective date of the amendment. 
See paragraphs (b)(2)(iii) (A) and (B) of this Q&A-2.
    Example 3. (i) An employer maintains a stock bonus plan under which 
a participant, upon termination of employment, may elect to receive 
benefits in a single-sum distribution in employer stock. This is the 
only plan

[[Page 855]]

maintained by the employer under which distributions in employer stock 
are available. The employer decides to terminate the stock bonus plan.
    (ii) If the plan makes available a single-sum distribution in 
employer stock on plan termination, the plan will not fail to satisfy 
section 411(d)(6) solely because the optional form of benefit providing 
a single-sum distribution in employer stock on termination of employment 
is modified to provide that such distribution is available only in cash. 
See paragraph (b)(2)(iii)(C) of this Q&A-2.

    (iv) Coordination with diversification requirement. A tax credit 
employee stock ownership plan (as defined in section 409(a)) or an 
employee stock ownership plan (as defined in section 4975(e)(7)) may be 
amended to provide that a distribution is not available in employer 
securities to the extent that an employee elects to diversify benefits 
pursuant to section 401(a)(28).
    (v) Involuntary distributions. A plan may be amended to provide for 
the involuntary distribution of an employee's benefit to the extent such 
involuntary distribution is permitted under sections 411(a)(11) and 
417(e). Thus, for example, an involuntary distribution provision may be 
amended to require that an employee who terminates from employment with 
the employer receive a single sum distribution in the event that the 
present value of the employee's benefit is not more than $3,500, by 
substituting the cash-out limit in effect under Sec. 1.411(a)-
11(c)(3)(ii) for $3,500, without violating section 411(d)(6). In 
addition, for example, the employer may amend the plan to reduce the 
involuntary distribution threshold from the cash-out limit in effect 
under Sec. 1.411(a)-11(c)(3)(ii) to any lower amount and to eliminate 
the involuntary single sum option for employees with benefits between 
the cash-out limit in effect under Sec. 1.411(a)-11(c)(3)(ii) and such 
lower amount without violating section 411(d)(6). This rule does not 
permit a plan provision permitting employer discretion with respect to 
optional forms of benefit for employees the present value of whose 
benefit is less than the cash-out limit in effect under Sec. 1.411(a)-
11(c)(3)(ii).
    (vi) Distribution exception for certain profit-sharing plans--(A) In 
general. If a defined contribution plan that is not subject to section 
412 and does not provide for an annuity option is terminated, the plan 
may be amended to provide for the distribution of a participant's 
accrued benefit upon termination in a single sum optional form without 
the participant's consent. The preceding sentence does not apply if the 
employer maintains any other defined contribution plan (other than an 
employee stock ownership plan as defined in section 4975(e)(7)).
    (B) Examples. The provisions of this paragraph (b)(2)(vi) can be 
illustrated by the following examples:

    Example 1. Employer X maintains a defined contribution plan that is 
not subject to section 412. The plan provides for distribution in the 
form of equal installments over five years or equal installments over 
twenty years. X maintains no other defined contribution plans. X 
terminates its defined contribution plan after amending the plan to 
provide for the distribution of all participants' accrued benefits in 
the form of single sum distributions, without obtaining participant 
consent. Pursuant to the rule in this paragraph (b)(2)(iv), this 
amendment does not violate the requirements of section 411(d)(6).
    Example 2. Corporations X and Y are members of controlled group 
employer XY. Both X and Y maintain defined contribution plans. X's plan, 
which is not subject to section 412, covers only employees working for 
X. Y's plan, which is subject to section 412, covers only employees 
working for Y. X terminates its defined contribution plan. Because 
employer XY maintains another defined contribution plan, plan X may not 
provide for the distribution of participants' accrued benefits upon 
termination without a participants' consent.

    (vii) Distribution of benefits on default of loans. Notwithstanding 
that the distribution of benefits arising from an execution on an 
account balance used to secure a loan on which there has been a default 
is an optional form of benefit, a plan may be amended to eliminate or 
change a provision for loans, even if such loans would be secured by an 
employee's account balance.
    (viii) Provisions for transfer of benefits between and among defined 
contribution plans and defined benefit plans. A plan may be amended to 
eliminate provisions permitting the transfer of benefits between and 
among defined contribution plans and defined benefit plans.

[[Page 856]]

    (ix) De minimis change in the timing of an optional form of benefit. 
A plan may be amended to modify an optional form of benefit by changing 
the timing of the availability of such optional form if, after the 
change, the optional form is available at a time that is within two 
months of the time such optional form was available before the 
amendment. To the extent the optional form of benefit is available prior 
to termination of employment, six months may be substituted for two 
months in the prior sentence. Thus, for example, a plan that makes in-
service distributions available to employees once every month may be 
amended to make such in-service distributions available only once every 
six months. This exception to section 411(d)(6) relates only to the 
timing of the availability of the optional form of benefit. Other 
aspects of an optional form of benefit may not be modified and the value 
of such optional form may not be reduced merely because of an amendment 
permitted by this exception.
    (x) Amendment of hardship distribution standards. A qualified cash 
or deferred arrangement that permits hardship distributions under Sec. 
1.401(k)-1(d)(3) may be amended to specify or modify nondiscriminatory 
and objective standards for determining the existence of an immediate 
and heavy financial need, the amount necessary to meet the need, or 
other conditions relating to eligibility to receive a hardship 
distribution. For example, a plan will not be treated as violating 
section 411(d)(6) merely because it is amended to specify or modify the 
resources an employee must exhaust to qualify for a hardship 
distribution or to require employees to provide additional statements or 
representations to establish the existence of a hardship. A qualified 
cash or deferred arrangement may also be amended to eliminate hardship 
distributions. The provisions of this paragraph also apply to profit-
sharing or stock bonus plans that permit hardship distributions, whether 
or not the hardship distributions are limited to those described in 
Sec. 1.401(k)-1(d)(3).
    (xi) Section 415 benefit limitations. Accrued benefits under a plan 
as of the first day of the first limitation year beginning after 
December 31, 1986, that exceed the benefit limitations under section 415 
(b) or (e), effective on the first day of the plan's first limitation 
year beginning after December 31, 1986, because of a change in the terms 
and conditions of the plan made after May 5, 1986, or the establishment 
of a plan after that date, may be reduced to the level permitted under 
section 415 (b) or (e).
    (xii) Prohibited payment option under single-employer defined 
benefit plan of plan sponsor in bankruptcy. A single-employer plan that 
is covered under section 4021 of the Employee Retirement Income Security 
Act of 1974, Public Law 93-406 (88 Stat. 829 (1974)), as amended 
(ERISA), may be amended, effective for a plan amendment that is both 
adopted and effective after November 8, 2012, to eliminate an optional 
form of benefit that includes a prohibited payment described in section 
436(d)(5), provided that the following conditions are satisfied on the 
applicable amendment date (as defined in Sec. 1.411(d)-3(g)(4)):
    (A) The enrolled actuary of the plan has certified that the plan's 
adjusted funding target attainment percentage (as defined in section 
436(j)(2)) for the plan year that contains the applicable amendment date 
is less than 100 percent.
    (B) The plan is not permitted to pay any prohibited payment, due to 
application of the requirements of section 436(d)(2) of the Internal 
Revenue Code and section 206(g)(3)(B) of ERISA, because the plan sponsor 
is a debtor in a bankruptcy case (that is, a case under title 11, United 
States Code, or under similar Federal or State law).
    (C) The court overseeing the bankruptcy case has issued an order, 
after notice to the affected parties (as defined in section 4001(a)(21) 
of ERISA) and a hearing, within the meaning of 11 U.S.C. 102(1), finding 
that the adoption of the amendment eliminating that optional form of 
benefit is necessary to avoid a distress termination of the plan 
pursuant to section 4041(c) of ERISA or an involuntary termination of 
the plan pursuant to section 4042 of ERISA before the plan sponsor 
emerges from bankruptcy (or before the bankruptcy case is otherwise 
completed).

[[Page 857]]

    (D) The Pension Benefit Guaranty Corporation has issued a 
determination that--
    (1) The adoption of the amendment eliminating that optional form of 
benefit is necessary to avoid a distress or involuntary termination of 
the plan before the plan sponsor emerges from bankruptcy (or before the 
bankruptcy case is otherwise completed); and
    (2) The plan is not sufficient for guaranteed benefits within the 
meaning of section 4041(d)(2) of ERISA.
    (c) Multiple amendments--(1) General rule. A plan amendment violates 
the requirements of section 411(d)(6) if it is one of a series of plan 
amendments that, when taken together, have the effect of reducing or 
eliminating a section 411(d)(6) protected benefit in a manner that would 
be prohibited by section 411(d)(6) if accomplished through a single 
amendment.
    (2) Determination of time period for combining plan amendments. For 
purposes of paragraph (c)(1) of this Q&A-2, generally only plan 
amendments adopted within a 3-year period are taken into account. But 
see Q&A-1(c)(1) of this section for rules relating to repeated plan 
amendments.
    (d) ESOP and stock bonus plan exception--(1) In general. Subject to 
the limitations in paragraph (d)(2) of this Q&A-2, a tax credit employee 
stock ownership plan (as defined in section 409(a)) or an employee stock 
ownership plan (as defined in section 4975(e)(7)) will not be treated as 
violating the requirements of section 411(d)(6) merely because of any of 
the circumstances described in paragraphs (d)(1)(i) through (d)(1)(iv) 
of this Q&A-2. In addition, a stock bonus plan that is not an employee 
stock ownership plan will not be treated as violating the requirements 
of section 411(d)(6) merely because of any of the circumstances 
described in paragraphs (d)(1)(ii) and (d)(1)(iv) of this Q&A-2.
    (i) Single sum or installment optional forms of benefit. The 
employer eliminates, or retains the discretion to eliminate, with 
respect to all participants, a single sum optional form or installment 
optional form with respect to benefits that are subject to section 
409(h)(1)(B), provided such elimination or retention of discretion is 
consistent with the distribution and payment requirements otherwise 
applicable to such plans (e.g., those required by section 409).
    (ii) Employer becomes substantially employee-owned or is an S 
corporation. The employer eliminates, or retains the discretion to 
eliminate, with respect to all participants, optional forms of benefit 
by substituting cash distributions for distributions in the form of 
employer stock with respect to benefits subject to section 409(h) in the 
circumstances described in paragraph (d)(1)(ii)(A) or (B) of this Q&A-2, 
but only if the employer otherwise meets the requirements of section 
409(h)(2)--
    (A) The employer becomes substantially employee-owned; or
    (B) For taxable years of the employer beginning after December 31, 
1997, the employer is an S corporation as defined in section 1361.
    (iii) Employer securities become readily tradable. The employer 
eliminates, or retains the discretion to eliminate, with respect to all 
participants, in cases in which the employer securities become readily 
tradable, optional forms of benefit by substituting distributions in the 
form of employer securities for distributions in cash with respect to 
benefits that are subject to section 409(h).
    (iv) Employer securities cease to be readily tradable or certain 
sales. The employer eliminates, or retains the discretion to eliminate, 
with respect to all participants, optional forms of benefit by 
substituting cash distributions for distributions in the form of 
employer stock with respect to benefits that are subject to section 
409(h) in the following circumstances:
    (A) The employer stock ceases to be readily tradable;
    (B) The employer stock continues to be readily tradable but there is 
a sale of substantially all of the stock of the employer or a sale of 
substantially all of the assets of a trade or business of the employer 
and, in either situation, the purchasing employer continues to maintain 
the plan.

In the situation described in paragraph (d)(1)(iv)(B) of this Q&A-2, the 
employer may also substitute distributions in the purchasing employer's 
stock for distributions in the form of

[[Page 858]]

employer stock of the predecessor employer.
    (2) Limitations on ESOP and stock bonus plan exceptions--(i) 
Nondiscrimination requirement. Plan amendments and the retention and 
exercise of discretion permitted under the exceptions in paragraph 
(d)(1) must meet the nondiscrimination requirements of section 
401(a)(4).
    (ii) ESOP investment requirement. Except as provided in paragraph 
(d)(2)(iii) of this Q&A-2, benefits provided by employee stock ownership 
plans will not be eligible for the exceptions in paragraph (d)(1) of 
this Q&A-2 unless the benefits have been held in a tax credit employee 
stock ownership plan (as defined in section 409 (a)) or an employee 
stock ownership plan (as defined in section 4975 (e)(7)) subject to 
section 409 (h) for the five-year period prior to the exercise of 
employer discretion or any amendment affecting such benefits and 
permitted under paragraph (d)(1) of this Q&A-2. For purposes of the 
preceding sentence, if benefits held under an employee stock ownership 
plan are transferred to a plan that is an employee stock ownership plan 
at the time of transfer, then the consecutive periods under the 
transferor and transferee employee stock ownership plans may be 
aggregated for purposes of meeting the five-year requirement. If the 
benefits are held in an employee stock ownership plan throughout the 
entire period of their existence, and such total period of existence is 
less than five years, then such lesser period may be substituted for the 
five year requirement.
    (3) Effective date. The provisions of this paragraph (d) are 
effective beginning with the first day of the first plan year commencing 
on or after January 1, 1989. Prior to this effective date the reduction 
or elimination of a section 411(d)(6) protected benefit by a tax credit 
employee stock ownership plan (as defined in section 409(a)) or an 
employee stock ownership plan (as defined in section 4975(e)(7)) will 
not be treated as violating the requirements of section 411(d)(6) if 
such reduction or elimination reflects a reasonable interpretation of 
the statutory language of section 411(d)(6)(C).
    (4) Additional exceptions and requirements. The Commissioner may, in 
revenue rulings, notices or other documents of general applicability, 
prescribe such additional rules and exceptions, consistent with the 
purposes of this section, as may be necessary or appropriate.
    (e) Permitted plan amendments affecting alternative forms of payment 
under defined contribution plans--(1) General rule. A defined 
contribution plan does not violate the requirements of section 411(d)(6) 
merely because the plan is amended to eliminate or restrict the ability 
of a participant to receive payment of accrued benefits under a 
particular optional form of benefit for distributions with annuity 
starting dates after the date the amendment is adopted if, after the 
plan amendment is effective with respect to the participant, the 
alternative forms of payment available to the participant include 
payment in a single-sum distribution form that is otherwise identical to 
the optional form of benefit that is being eliminated or restricted.
    (2) Otherwise identical single-sum distribution. For purposes of 
this paragraph (e), a single-sum distribution form is otherwise 
identical to an optional form of benefit that is eliminated or 
restricted pursuant to paragraph (e)(1) of this Q&A-2 only if the 
single-sum distribution form is identical in all respects to the 
eliminated or restricted optional form of benefit (or would be identical 
except that it provides greater rights to the participant) except with 
respect to the timing of payments after commencement. For example, a 
single-sum distribution form is not otherwise identical to a specified 
installment form of benefit if the single-sum distribution form is not 
available for distribution on the date on which the installment form 
would have been available for commencement, is not available in the same 
medium of distribution as the installment form, or imposes any condition 
of eligibility that did not apply to the installment form. However, an 
otherwise identical distribution form need not retain rights or features 
of the optional form of benefit that is eliminated or restricted to the 
extent that those

[[Page 859]]

rights or features would not be protected from elimination or 
restriction under section 411(d)(6) or this section.
    (3) Example. The following example illustrates the application of 
this paragraph (e):

    Example. (i) P is a participant in Plan M, a qualified profit-
sharing plan with a calendar plan year that is invested in mutual funds. 
The distribution forms available to P under Plan M include a 
distribution of P's vested account balance under Plan M in the form of 
distribution of various annuity contract forms (including a single life 
annuity and a joint and survivor annuity). The annuity payments under 
the annuity contract forms begin as of the first day of the month 
following P's severance from employment (or as of the first day of any 
subsequent month, subject to the requirements of section 401(a)(9)). P 
has not previously elected payment of benefits in the form of a life 
annuity, and Plan M is not a direct or indirect transferee of any plan 
that is a defined benefit plan or a defined contribution plan that is 
subject to section 412. Distributions on the death of a participant are 
made in accordance with plan provisions that comply with section 
401(a)(11)(B)(iii)(I). On September 2, 2005, Plan M is amended so that, 
effective for payments that begin on or after November 1, 2005, P is no 
longer entitled to any distribution in the form of the distribution of 
an annuity contract. However, after the amendment is effective, P is 
entitled to receive a single-sum cash distribution of P's vested account 
balance under Plan M payable as of the first day of the month following 
P's severance from employment (or as of the first day of any subsequent 
month, subject to the requirements of section 401(a)(9)).
    (ii) Plan M does not violate the requirements of section 411(d)(6) 
(or section 401(a)(11)) merely because, as of November 1, 2005, the plan 
amendment has eliminated P's option to receive a distribution in any of 
the various annuity contract forms previously available.

    (4) Effective date. This paragraph (e) is applicable on January 25, 
2005.
    Q-3 Does the transfer of benefits between and among defined benefit 
plans and defined contribution plans (or similar transactions) violate 
the requirements of section 411(d)(6)?
    A-3 (a) Transfers and similar transactions--(1) General rule. 
Section 411(d)(6) protected benefits may not be eliminated by reason of 
transfer or any transaction amending or having the effect of amending a 
plan or plans to transfer benefits. Thus, for example, except as 
otherwise provided in this section, an employer who maintains a money 
purchase pension plan that provides for a single sum optional form of 
benefit may not establish another plan that does not provide for this 
optional form of benefit and transfer participants' account balances to 
such new plan.
    (2) Defined benefit feature and separate account feature. The 
defined benefit feature of an employee's benefit under a defined benefit 
plan and the separate account feature of an employee's benefit under a 
defined contribution plan are section 411(d)(6) protected benefits. 
Thus, for example, the elimination of the defined benefit feature of an 
employee's benefit under a defined benefit plan, through transfer of 
benefits from a defined benefit plan to a defined contribution plan or 
plans, will violate section 411(d)(6).
    (3) Waiver prohibition. In general, except as provided in paragraph 
(b) of this Q&A-3, a participant may not elect to waive section 
411(d)(6) protected benefits. Thus, for example, the elimination of the 
defined benefit feature of a participant's benefit under a defined 
benefit plan by reason of a transfer of such benefits to a defined 
contribution plan pursuant to a participant election, at a time when the 
benefit is not distributable to the participant, violates section 
411(d)(6).
    (4) Direct rollovers. A direct rollover described in Q&A-3 of Sec. 
1.401(a)(31)-1 that is paid to a qualified plan is not a transfer of 
assets and liabilities that must satisfy the requirements of section 
414(l), and is not a transfer of benefits for purposes of applying the 
requirements under section 411(d)(6) and paragraph (a)(1) of this Q&A-3. 
Therefore, for example, if such a direct rollover is made to another 
qualified plan, the receiving plan is not required to provide, with 
respect to amounts paid to it in a direct rollover, the same optional 
forms of benefit that were provided under the plan that made the direct 
rollover. See Sec. 1.401(a)(31)-1, Q&A-14.
    (b) Elective transfers of benefits between defined contribution 
plans--(1) General rule. A transfer of a participant's entire benefit 
between qualified defined contribution plans (other than any direct 
rollover described in Q&A-3 of

[[Page 860]]

Sec. 1.401(a)(31)-1) that results in the elimination or reduction of 
section 411(d)(6) protected benefits does not violate section 411(d)(6) 
if the following requirements are met--
    (i) Voluntary election. The plan from which the benefits are 
transferred must provide that the transfer is conditioned upon a 
voluntary, fully-informed election by the participant to transfer the 
participant's entire benefit to the other qualified defined contribution 
plan. As an alternative to the transfer, the participant must be offered 
the opportunity to retain the participant's section 411(d)(6) protected 
benefits under the plan (or, if the plan is terminating, to receive any 
optional form of benefit for which the participant is eligible under the 
plan as required by section 411(d)(6)).
    (ii) Types of plans to which transfers may be made. To the extent 
the benefits are transferred from a money purchase pension plan, the 
transferee plan must be a money purchase pension plan. To the extent the 
benefits being transferred are part of a qualified cash or deferred 
arrangement under section 401(k), the benefits must be transferred to a 
qualified cash or deferred arrangement under section 401(k). To the 
extent the benefits being transferred are part of an employee stock 
ownership plan as defined in section 4975(e)(7), the benefits must be 
transferred to another employee stock ownership plan. Benefits 
transferred from a profit-sharing plan other than from a qualified cash 
or deferred arrangement, or from a stock bonus plan other than an 
employee stock ownership plan, may be transferred to any type of defined 
contribution plan.
    (iii) Circumstances under which transfers may be made. The transfer 
must be made either in connection with an asset or stock acquisition, 
merger, or other similar transaction involving a change in employer of 
the employees of a trade or business (i.e., an acquisition or 
disposition within the meaning of Sec. 1.410(b)-2(f)) or in connection 
with the participant's change in employment status to an employment 
status with respect to which the participant is not entitled to 
additional allocations under the transferor plan.
    (2) Applicable qualification requirements. A transfer described in 
this paragraph (b) is a transfer of assets or liabilities within the 
meaning of section 414(l)(1) and, thus, must satisfy the requirements of 
section 414(l). In addition, this paragraph (b) only provides relief 
under section 411(d)(6); a transfer described in this paragraph must 
satisfy all other applicable qualification requirements. Thus, for 
example, if the survivor annuity requirements of sections 401(a)(11) and 
417 apply to the plan from which the benefits are transferred, as 
described in this paragraph (b), but do not otherwise apply to the 
receiving plan, the requirements of sections 401(a)(11) and 417 must be 
met with respect to the transferred benefits under the receiving plan. 
In addition, the vesting provisions under the receiving plan must 
satisfy the requirements of section 411(a)(10) with respect to the 
amounts transferred.
    (3) Status of elective transfer as other right or feature. A right 
to a transfer of benefits from a plan pursuant to the elective transfer 
rules of this paragraph (b) is an other right or feature within the 
meaning of Sec. 1.401(a)(4)-4(e)(3), the availability of which is 
subject to the nondiscrimination requirements of section 401(a)(4) and 
Sec. 1.401(a)(4)-4. However, for purposes of applying the rules of 
Sec. 1.401(a)(4)-4, the following conditions are to be disregarded in 
determining the employees to whom the other right or feature is 
available--
    (i) A condition restricting the availability of the transfer to 
benefits of participants who are transferred to a different employer in 
connection with a specified asset or stock disposition, merger, or other 
similar transaction involving a change in employer of the employees of a 
trade or business (i.e., a disposition within the meaning of Sec. 
1.410(b)-2(f)), or in connection with any such disposition, merger, or 
other similar transaction.
    (ii) A condition restricting the availability of the transfer to 
benefits of participants who have a change in employment status to an 
employment status with respect to which the participant is not entitled 
to additional allocations under the transferor plan.

[[Page 861]]

    (c) Elective transfers of certain distributable benefits between 
qualified plans--(1) In general. A transfer of a participant's benefits 
between qualified plans that results in the elimination or reduction of 
section 411(d)(6) protected benefits does not violate section 411(d)(6) 
if--
    (i) The transfer occurs at a time at which the participant's 
benefits are distributable (within the meaning of paragraph (c)(3) of 
this Q&A-3);
    (ii) For a transfer that occurs on or after January 1, 2002, the 
transfer occurs at a time at which the participant is not eligible to 
receive an immediate distribution of the participant's entire 
nonforfeitable accrued benefit in a single-sum distribution that would 
consist entirely of an eligible rollover distribution within the meaning 
of section 401(a)(31)(C);
    (iii) The voluntary election requirements of paragraph (b)(1)(i) of 
this Q&A-3 are met;
    (iv) The participant is fully vested in the transferred benefit in 
the transferee plan;
    (v) In the case of a transfer from a defined contribution plan to a 
defined benefit plan, the defined benefit plan provides a minimum 
benefit, for each participant whose benefits are transferred, equal to 
the benefit, expressed as an annuity payable at normal retirement age, 
that is derived solely on the basis of the amount transferred with 
respect to such participant; and
    (vi) The amount of the benefit transferred, together with the amount 
of any contemporaneous section 401(a)(31) direct rollover to the 
transferee plan, equals the entire nonforfeitable accrued benefit under 
the transferor plan of the participant whose benefit is being 
transferred, calculated to be at least the greater of the single-sum 
distribution provided for under the plan for which the participant is 
eligible (if any) or the present value of the participant's accrued 
benefit payable at normal retirement age (calculated by using interest 
and mortality assumptions that satisfy the requirements of section 
417(e) and subject to the limitations imposed by section 415).
    (2) Treatment of transfer--(i) In general. A transfer of benefits 
pursuant to this paragraph (c) generally is treated as a distribution 
for purposes of section 401(a). For example, the transfer is subject to 
the cash-out rules of section 411(a)(7), the early termination 
requirements of section 411(d)(2), and the survivor annuity requirements 
of sections 401(a)(11) and 417. A transfer pursuant to the elective 
transfer rules of this paragraph (c) is not treated as a distribution 
for purposes of the minimum distribution requirements of section 
401(a)(9).
    (ii) Status of elective transfer as optional form of benefit. A 
right to a transfer of benefits from a plan pursuant to the elective 
transfer rules of this paragraph (c) is an optional form of benefit 
under section 411(d)(6), the availability of which is subject to the 
nondiscrimination requirements of section 401(a)(4) and Sec. 
1.401(a)(4)-4.
    (3) Distributable benefits. For purposes of paragraph (c)(1)(i) of 
this Q&A-3, a participant's benefits are distributable on a particular 
date if, on that date, the participant is eligible, under the terms of 
the plan from which the benefits are transferred, to receive an 
immediate distribution of these benefits (e.g., in the form of an 
immediately commencing annuity) from that plan under provisions of the 
plan not inconsistent with section 401(a).
    (d) Effective date. This Q&A-3 is applicable for transfers made on 
or after September 6, 2000.
    Q-4: May a plan provide that the employer may, through the exercise 
of discretion, deny a participant a section 411(d)(6) protected benefit 
for which the participant is otherwise eligible?
    A-4: (a) In general. Except as provided in paragraph (d) of Q&A-2 of 
this section with respect to certain employee stock ownership plans, a 
plan that permits the employer, either directly or indirectly, through 
the exercise of discretion, to deny a participant a section 411(d)(6) 
protected benefit provided under the plan for which the participant is 
otherwise eligible (but for the employer's exercise of discretion) 
violates the requirements of section 411(d)(6). A plan provision that 
makes a section 411(d)(6) protected benefit available only to those 
employees as the employer may designate is within the scope of this 
prohibition. Thus, for example, a plan provision under which

[[Page 862]]

only employees who are designated by the employer are eligible to 
receive a subsidized early retirement benefit constitutes an 
impermissible provision under section 411(d)(6). In addition, a pension 
plan that permits employer discretion to deny the availability of a 
section 411(d)(6) protected benefit violates the definitely determinable 
requirement of section 401(a), including section 401(a)(25). See Sec. 
1.401-1(b)(1)(i). This is the result even if the plan specifically 
limits the employer's discretion to choosing among section 411(d)(6) 
protected benefits, including optional forms of benefit, that are 
actuarially equivalent. In addition, the provisions of sections 
411(a)(11) and 417(e) that allow a plan to make involuntary 
distributions of certain amounts are not excepted from this limitation 
on employer discretion. Thus, for example, a plan may not permit 
employer discretion with respect to whether benefits will be distributed 
involuntarily in the event that the present value of the employee's 
benefit is not more than the cash-out limit in effect under Sec. 
1.411(a)-11(c)(3)(ii) within the meaning of sections 411(a)(11) and 
417(e). (An exception is provided for such provisions with respect to 
the nondiscrimination requirements of section 401(a)(4). See Sec. 
1.401(a)(4)-4(b)(2)(ii)(C).)
    (b) Exception for administrative discretion. A plan may permit 
limited discretion with respect to the ministerial or mechanical 
administration of the plan, including the application of objective plan 
criteria specifically set forth in the plan. Such plan provisions do not 
violate the requirements of section 411(d)(6) or the definitely 
determinable requirement of section 401(a), including section 
401(a)(25). For example, these requirements are not violated by the 
following provisions that permit limited administrative discretion:
    (1) Commencement of benefit payments as soon as administratively 
feasible after a stated date or event;
    (2) Employer authority to determine whether objective criteria 
specified in the plan (e.g., objective criteria designed to identify 
those employees with a heavy and immediate financial need or objective 
criteria designed to determine whether an employee has a permanent and 
total disability) have been satisfied; and
    (3) Employer authority to determine, pursuant to specific guidelines 
set forth in the plan, whether the participant or spouse is dead or 
cannot be located.
    Q-5: When will the exercise of discretion by some person or persons, 
other than the employer, be treated as employer discretion?
    A-5: For purposes of applying the rules of this section and Sec. 
1.401(a)-4, the term ``employer'' includes plan administrator, 
fiduciary, trustee, actuary, independent third party, and other persons. 
Thus, if a plan permits any person, other than the participant (and 
other than the participant's spouse), the discretion to deny or limit 
the availability of a section 411(d)(6) protected benefit for which the 
employee is otherwise eligible under the plan (but for the exercise of 
such discretion), such plan violates the requirements of sections 
401(a), including section 411(d)(6) and, where applicable, the 
definitely determinable requirement of section 401(a), including section 
401(a)(25).
    Q-6: May a plan condition the availability of a section 411(d)(6) 
protected benefit on the satisfaction of objective conditions that are 
specifically set forth in the plan?
    A-6: (a) Certain objective conditions permissible--(1) In general. 
The availability of a section 411(d)(6) protected benefit may be limited 
to employees who satisfy certain objective conditions provided the 
conditions are ascertainable, clearly set forth in the plan and not 
subject to the employer's discretion except to the extent reasonably 
necessary to determine whether the objective conditions have been met. 
Also, the availability of the section 411(d)(6) protected benefit must 
meet the nondiscrimination requirements of section 401(a)(4). See Sec. 
1.401(a)-4.
    (2) Examples of permissible conditions. The following examples 
illustrate of permissible objective conditions: a plan may deny a single 
sum distribution form to employees for whom life insurance is not 
available at standard rates as defined under the terms of the plan at 
the time the single sum distribution would otherwise be payable; a plan

[[Page 863]]

may provide that a single sum distribution is available only if the 
employee is in extreme financial need as defined under the terms of the 
plan at the time the single sum distribution would otherwise be payable; 
a plan my condition the availability of a single sum distribution on the 
execution of a covenant not to compete, provided that objective 
conditions with respect to the terms of such covenant and the employees 
and circumstances requiring execution of such covenant are set forth in 
the plan.
    (b) Conditions based on factors within employer's discretion 
generally impermissible. A plan may not limit the availability of 
section 411(d)(6) protected benefits permitted under the plan on 
objective conditions that are within the employer's discretion. For 
example, the availability of section 411(d)(6) protected benefits in a 
plan may not be conditioned on a determination with respect to the level 
of the plan's funded status, because the amount of plan funding is 
within the employer's discretion. However, for example, although 
conditions based on the plan's funded status are impermissible, a plan 
may limit the availability of a section 411(d)(6) protected benefit 
(e.g., a single sum distribution) in an objective manner, such as the 
following:
    (1) Single sum distributions of $25,000 and less are available 
without limit; and
    (2) Single sum distributions in excess of $25,000 are available for 
a year only to the extent that the total amount of such single sum 
distributions for the year is not greater than $5,000,000; and
    (3) An objective and nondiscriminatory method for determining which 
particular single sum distributions will not be available during a year 
in order for the $5,000,000 limit to be satisfied is set forth in the 
plan.
    Q-7: May a plan be amended to add employer discretion or conditions 
restricting the availability of a section 411(d)(6) protected benefit?
    A-7: No. The addition of employer discretion or objective conditions 
with respect to a section 411(d)(6) protected benefit that has already 
accrued violates section 411(d)(6). Also, the addition of conditions 
(whether or not objective) or any change to existing conditions with 
respect to section 411(d)(6) protected benefits that results in any 
further restriction violates section 411(d)(6). However, the addition of 
objective conditions to a section 411(d)(6) protected benefit may be 
made with respect to benefits accrued after the later of the adoption or 
effective date of the amendment. In addition, objective conditions may 
be imposed on section 411(d)(6) protected benefits accrued as of the 
date of an amendment where permitted under the transitional rules of 
Sec. 1.401(a)-4 Q&A-5 and Q&A-8 of this section. Finally, objective 
conditions may be imposed on section 411(d)(6) protected benefits to the 
extent permitted by the permissible benefit cutback provisions of Q&A-2 
of this section.
    Q-8: If a plan contains an impermissible employer discretion 
provision with respect to a section 411(d)(6) protected benefit, what 
acceptable alternative exist for amending the plan without violating the 
requirements of section 411(d)(6)?
    A-8: (a) In general. The following rules apply for purposes of 
making necessary amendments to existing plans (as defined in Q&A-9 of 
this section) that contain discretion provisions with respect to the 
availability of section 411(d)(6) protected benefits that violate the 
requirements of section 401(a), including sections 401(a)(25) and 
411(d)(6), and this section. These transitional rules are provided under 
the authority of section 411(d)(6) and section 7805(b).
    (b) Transitional alternatives. If the availability of an optional 
forms of benefit, early or late retirement benefit, or retirement-type 
subsidy under an existing plan is conditioned on the exercise of 
employer discretion, the plan must be amended either to eliminate the 
optional form of benefit, early or late retirement benefit, or 
retirement-type subsidy to make such benefit available to all 
participants without limitation, or to apply objective and 
nondiscriminatory conditions to the availability of the optional form of 
benefit, early or later retirement benefit, or retirement-type subsidy. 
See paragraph (d) of this Q&A-8 for rules limiting the period during 
which section 411(d)(6) protected benefits may be

[[Page 864]]

eliminated or reduced under this paragraph.
    (c) Compliance and amendment date provisions--(1) Operational 
compliance requirement. On or before the applicable effective date for 
the plan (as determined under Q&A-9 of this section), the plan sponsor 
must select one of the alternatives permitted under paragraph (b) of the 
Q&A-8 with respect to each affected section 411(d)(6) protected benefit 
and the plan must be operated in accordance with this selection. This is 
an operational requirement and does not require a plan amendment prior 
to the period set forth in paragraph (c)(2) of this Q&A-8. There are no 
special reporting requirements under the Code or this section with 
respect to this selection.
    (2) Deferred amendment date. If paragraph (c)(1) of this Q&A-8 is 
satisfied, a plan amendment conforming the plan to the particular 
alternative selected under paragraph (b) of this Q&A-8 must be adopted 
within the time period permitted for amending plans in order to meet the 
requirements of section 410(b) as amended by TRA '86. The plan amendment 
to conform the plan to these regulations may be made at an earlier date. 
Such conforming amendment must be consistent with the sponsor's 
selection as reflected by plan practice during the period from the 
effective date to the date the amendment is adopted. Thus, for example, 
if any existing calendar year noncollectively bargained defined benefit 
plan has a single sum distribution option that is subject to employer 
discretion as of August 1, 1986, and such employer makes one or more 
single sum distributions available on or after January 1, 1989 and 
before the effective date by which plan amendment is required pursuant 
to this section, then such employer may not adopt a plan amendment 
eliminating the single sum distribution, but rather must adopt an 
amendment eliminating the discretion provision. Any objective conditions 
that are adopted as part of such amendment must not be inconsistent with 
the plan practice for the applicable period prior to the amendment. A 
conforming amendment under this paragraph (c)(2) must be made with 
respect to each section 411(d)(6) protected benefit for which such 
amendment is required and must be retroactive to the applicable 
effective date.
    (d) Limitation on transitional alternatives. The transitional 
alternatives permitting the elimination or reduction of section 
411(d)(6) protected benefits are only permissible until the applicable 
effective date for the plan (see Q&A-9 of this section). After the 
applicable effective date, any amendment (other than one permitted under 
paragraph (c)(2) of this Q&A-8) that eliminates or reduces a section 
411(d)(6) protected benefit or imposes new objective conditions on the 
availability of such benefit will fail to qualify for the exception to 
section 411(d)(6) provided in this Q&A-8. This is the case without 
regard to whether the section 411(d)(6) protected benefit is subject to 
employer discretion.
    Q-9: What are the applicable effective date rules for purposes of 
this section?
    A-9: (a) General effective date. Except as otherwise provided in 
this section, the provisions of this section are effective January 30, 
1986.
    (b) New plans--(1) In general. Unless otherwise provided in 
paragraph (b)(2) of this Q&A-9, plans that are either adopted or made 
effective on or after August 1, 1986, are ``new plans''. With respect to 
such new plans, this section is effective August 1, 1986. This effective 
date is applicable to such plans whether or not they are collectively 
bargained.
    (2) Exception with respect to certain new plans. Plans that are new 
plans as defined in paragraph (b)(1) of this Q&A-9 under which the 
availability of a section 411(d)(6) protected benefit is subject to 
employer discretion; and that receive a favorable determination letter 
that covered such plan provisions with respect to an application 
submitted prior to July 11, 1988, will be treated as existing plans with 
respect to such section 411(d)(6) protected benefit for purposes of the 
transitional rules of this section. Thus, such plans are eligible for 
the compliance and amendment alternatives set forth in the transitional 
rule in Q&A-8 of this section.
    (c) Existing plans--(1) In general. Plans, including plans that are 
adoptions of master or prototype plans,

[[Page 865]]

that are both adopted and in effect prior to August 1, 1986, are 
``existing plans'' for purposes of this section. In addition, a plan 
that is established after July 31, 1986, but before January 1, 1989, as 
an initial adoption of a master or prototype plan for which a favorable 
opinion letter was issued by the Service after July 18, 1985 and before 
January 1, 1989, will be deemed to be an existing plan for purposes of 
this section. See sections 4.01 and 4.02 of Rev. Proc. 84-23, 1984-1 
C.B. 457, 459, for the definitions of master prototype plans. However, 
if such plan ceases to be covered under an opinion letter of the type 
described above, as a result of amendment of the plan or adoption of a 
new plan, prior to the first day of the first plan year beginning on or 
after January 1, 1989, then the effective date for such plan will be 
determined as though the plan were a new plan initially adopted as of 
the date of such amendment or adoption of a new plan. Finally, new plans 
described in paragraph (b)(2) of this Q&A-9 are treated as existing 
plans with respect to certain section 411(d)(6) protected benefits. 
Subject to the limitations in paragraph (c) of this Q&A-9, the effective 
dates set forth in paragraphs (c)(2), (c)(3), and (c)(4) of this Q&A-9 
apply to these existing plans for purposes of this section:
    (2) Existing noncollectively bargained plans. With respect to 
existing plans other than collectively bargained plans this section is 
effective for the first day of the first plan year commencing on or 
after January 1, 1989.
    (3) Existing collectively bargained plans. With respect to existing 
collectively bargained plans this section is effective for the later of 
the first day of the first plan year commencing on or after January 1, 
1989, or the first day of the first plan year that the requirements of 
section 410(b) as amended by TRA '86 apply to such plan.
    (4) Existing master and prototype plans. With respect to existing 
plans that are adoptions of master or prototype plans the effective date 
will be the first day of the first plan year commencing on or after 
January 1, 1989.
    (d) Delayed effective date not applicable to new alternatives or 
conditions--(1) In general. The delayed effective dates in paragraphs 
(c)(2) and (c)(3) of this Q&A-9 for existing plans are only applicable 
with respect to a section 411(d)(6) protected benefit if both the 
section 411(d)(6) protected benefit and the condition providing employer 
discretion as to the availability of such benefit are both adopted and 
in effect prior to August 1, 1986. If the preceding sentence is not 
satisfied with respect to a particular section 411(d)(6) protected 
benefit, this section is effective with respect to such section 
411(d)(6) protected benefit as if the plan were a new plan.
    (2) Addition of discretion on or after January 30, 1986. The delayed 
effective dates in paragraphs (c)(2) and (c)(3) of this Q&A-9 are not 
available with respect to any section 411(d)(6) protected benefit if the 
section 411(d)(6) protected benefit was provided for in the plan prior 
to January 30, 1986, and the availability of such benefit was made 
subject to the exercise of employer discretion on or after January 30, 
1986. If the conditions set forth in this paragraph are not satisfied 
with respect to a particular section 411(d)(6) protected benefit, this 
section is effective with respect to such section 411(d)(6) protected 
benefit as if the plan were a new plan. A limited exception is provided 
with respect to existing plans that provided a particular section 
411(d)(6) protected benefit prior to January 30, 1986, and then amended 
the plan after January 30, 1986, and before August 1, 1986, to add a 
provision for employer discretion with respect to the availability of 
such benefit. Such plans are required to have been amended retroactively 
by December 31, 1987, to remove such provision for employer discretion, 
and, if the benefit made subject to such discretion was subsequently 
eliminated, the plan is required to have been further amended, by the 
same date, to retroactively reinstate the benefit.
    (3) Exception for certain amendments covered by a favorable 
determination letter. If an amendment adding a section 411(d)(6) 
protected benefit subject to employer discretion was adopted or made 
effective after August 1, 1986, and the plan receives a favorable 
determination letter covering such provision with respect to an 
application for such letter made prior to July 11, 1988,

[[Page 866]]

then the effective date for purposes of amending such provision under 
the transitional rules is the applicable effective date determined under 
the rules with respect to existing plans.
    (e) Transitional rule effective date. The transitional rule provided 
in Q&A-8 of this section is effective January 30, 1986.
    Q-10: If a plan provides for an age 70\1/2\ distribution option that 
commences prior to retirement from employment with the employer 
maintaining the plan, to what extent may the plan be amended to 
eliminate this distribution option?
    A-10: (a) In general. The right to commence benefit distributions in 
a particular form and at a particular time prior to retirement from 
employment with the employer maintaining the plan is a separate optional 
form of benefit within the meaning of section 411(d)(6)(B) and Q&A-1 of 
this section, even if the plan provision creating this right was 
included in the plan solely to comply with section 401(a)(9), as in 
effect for years before January 1, 1997. Therefore, except as otherwise 
provided in paragraph (b) of this Q&A-10 or any other Q&A in this 
section, a plan amendment violates section 411(d)(6) if it eliminates an 
age 70\1/2\ distribution option (within the meaning of paragraph (c) of 
this Q&A-10) to the extent that it applies to benefits accrued as of the 
later of the adoption date or effective date of the amendment.
    (b) Permitted elimination of age 70\1/2\ distribution option. An 
amendment of a plan will not violate the requirements of section 
411(d)(6) merely because the amendment eliminates an age 70\1/2\ 
distribution option to the extent that the option provides for 
distribution to an employee prior to retirement from employment with the 
employer maintaining the plan, provided that--
    (1) The amendment eliminating this optional form of benefit applies 
only to benefits with respect to employees who attain age 70\1/2\ in or 
after a calendar year, specified in the amendment, that begins after the 
later of--
    (i) December 31, 1998; or
    (ii) The adoption date of the amendment;
    (2) The plan does not, except to the extent required by section 
401(a)(9), preclude an employee who retires after the calendar year in 
which the employee attains age 70\1/2\ from receiving benefits in any of 
the same optional forms of benefit (except for the difference in the 
timing of the commencement of payments) that would have been available 
had the employee retired in the calendar year in which the employee 
attained age 70\1/2\; and
    (3) The amendment is adopted no later than--
    (i) The last day of the remedial amendment period that applies to 
the plan for changes under the Small Business Job Protection Act of 1996 
(110 Stat. 1755); or
    (ii) Solely in the case of a plan maintained pursuant to one or more 
collective bargaining agreements between employee representatives and 
one or more employers ratified before September 3, 1998, the last day of 
the twelfth month beginning after the date on which the last of such 
collective bargaining agreements terminates (determined without regard 
to any extension thereof on or after September 3, 1998), if later than 
the date described in paragraph (b)(3)(i) of this Q&A-10. For purposes 
of this paragraph (b)(3)(ii), the rules of Sec. 1.410(b)-10(a)(2) apply 
for purposes of determining whether a plan is maintained pursuant to one 
or more collective bargaining agreements, except that September 3, 1998 
is substituted for March 1, 1986, as the date before which the 
collective bargaining agreements must be ratified.
    (c) Age 70\1/2\ distribution option. For purposes of this Q&A-10, an 
age 70\1/2\ distribution option is an optional form of benefit under 
which benefits payable in a particular distribution form (including any 
modifications that may be elected after benefit commencement) commence 
at a time during the period that begins on or after January 1 of the 
calendar year in which an employee attains age 70\1/2\ and ends April 1 
of the immediately following calendar year.
    (d) Examples. The provisions of this Q&A-10 are illustrated by the 
following examples:

    Example 1. Plan A, a defined benefit plan, provides each participant 
with a qualified joint and survivor annuity (QJSA) that is available at 
any time after the later of age 65 or retirement. However, in accordance 
with

[[Page 867]]

section 401(a)(9) as in effect prior to January 1, 1997, Plan A provides 
that if an employee does not retire by the end of the calendar year in 
which the employee attains age 70\1/2\, then the QJSA commences on the 
following April 1. On October 1, 1998, Plan A is amended to provide 
that, for an employee who is not a 5-percent owner and who attains age 
70\1/2\ after 1998, benefits may not commence before the employee 
retires but must commence no later than the April 1 following the later 
of the calendar year in which the employee retires or the calendar year 
in which the employee attains age 70\1/2\. This amendment satisfies this 
Q&A-10 and does not violate section 411(d)(6).
    Example 2. Plan B, a money purchase pension plan, provides each 
participant with a choice of a QJSA or a single sum distribution 
commencing at any time after the later of age 65 or retirement. In 
addition, in accordance with section 401(a)(9) as in effect prior to 
January 1, 1997, Plan B provides that benefits will commence in the form 
of a QJSA on April 1 following the calendar year in which the employee 
attains age 70\1/2\, except that, with spousal consent, a participant 
may elect to receive annual installment payments equal to the minimum 
amount necessary to satisfy section 401(a)(9) (calculated in accordance 
with a method specified in the plan) until retirement, at which time a 
participant may choose between a QJSA and a single sum distribution 
(with spousal consent). On June 30, 1998, Plan B is amended to provide 
that, for an employee who is not a 5-percent owner and who attains age 
70\1/2\ after 1998, benefits may not commence prior to retirement but 
benefits must commence no later than April 1 after the later of the 
calendar year in which the employee retires or the calendar year in 
which the employee attains age 70\1/2\. The amendment further provides 
that the option described above to receive annual installment payments 
prior to retirement will not be available under the plan to an employee 
who is not a 5-percent owner and who attains age 70\1/2\ after 1998. 
This amendment satisfies this Q&A-10 and does not violate section 
411(d)(6).
    Example 3. Plan C, a profit-sharing plan, contains two distribution 
provisions. Under the first provision, in any year after an employee 
attains age 59\1/2\, the employee may elect a distribution of any 
specified amount not exceeding the balance of the employee's account. In 
addition, the plan provides a section 401(a)(9) override provision under 
which, if, during any year following the year that the employee attains 
age 70\1/2\, the employee does not elect an amount at least equal to the 
minimum amount necessary to satisfy section 401(a)(9) (calculated in 
accordance with a method specified in the plan), Plan C will distribute 
the difference by December 31 of that year (or for the year the employee 
attains age 70\1/2\, by April 1 of the following year). On December 31, 
1996, Plan C is amended to provide that, for an employee other than an 
employee who is a 5-percent owner in the year the employee attains age 
70\1/2\, in applying the section 401(a)(9) override provision, the later 
of the year of retirement or year of attainment of age 70\1/2\, is 
substituted for the year of attainment of age 70\1/2\. After the 
amendment, Plan C still permits each employee to elect to receive the 
same amount as was available before the amendment. Because this 
amendment does not eliminate an optional form of benefit, the amendment 
does not violate section 411(d)(6). Accordingly, the amendment is not 
required to satisfy the conditions of paragraph (b) of this Q&A-10.

    (e) Effective date. This Q&A-10 applies to amendments adopted and 
effective after June 5, 1998.
    Q-11: To what extent may a plan amendment that is made pursuant to 
the Taxpayer Relief Act of 1997 (TRA '97) (Public Law 105-34, 111 Stat. 
788), reduce or eliminate section 411(d)(6) protected benefits?
    A-11: A plan amendment does not violate the requirements of section 
411(d)(6) merely because the plan amendment reduces or eliminates 
section 411(d)(6) protected benefits as of the effective date of the 
plan amendment, provided that--
    (a) The plan amendment is made pursuant to an amendment made by 
title XV, or subtitle H of title X, of TRA '97; and
    (b) The plan amendment is adopted no later than the last day of any 
remedial amendment period that applies to the plan pursuant to 
Sec. Sec. 1.401(b)-1 and 1.401(b)-1T for changes under TRA '97.
    Q-12. Is there a transition period during which a plan is permitted 
to eliminate a right to in-service distributions in connection with an 
amendment to ensure that the plan's normal retirement age satisfies the 
requirements of Sec. 1.401(a)-1(b)(2)?
    A-12. (a) In general. A plan amendment that changes the normal 
retirement age under the plan to a later normal retirement age pursuant 
to Sec. 1.401(a)-1(b)(2) does not violate section 411(d)(6) merely 
because it eliminates a right to an in-service distribution prior to the 
amended normal retirement age. However, this paragraph does not provide 
relief from any other applicable requirements; for example, this relief

[[Page 868]]

does not permit the amendment to violate section 411(a)(9) (requiring 
that the normal retirement benefit not be less than the greater of any 
early retirement benefit payable under the plan or the benefit under the 
plan commencing at normal retirement age), section 411(a)(10) (if the 
amendment changes the plan's vesting rules), section 411(d)(6) (other 
than elimination of the right to an in-service distribution prior to the 
amended normal retirement age), or section 4980F (relating to an 
amendment that reduces the rate of future benefit accrual). This 
paragraph only applies to a plan amendment that is adopted after May 22, 
2007 and on or before the last day of the applicable remedial amendment 
period under Sec. 1.401(b)-1 with respect to the requirements of Sec. 
1.401(a)-1(b)(2) and (3).
    (b) Example. The following example illustrates the application of 
this section:

    (i) Facts. (A) Plan A is a defined benefit plan intended to be 
qualified under section 401(a). Plan A is maintained by a calendar year 
taxpayer and has a normal retirement age that is age 45. For employees 
who cease employment before normal retirement age with a vested benefit, 
Plan A permits benefits to commence at any date after the attainment of 
normal retirement age through attainment of age 70\1/2\ and provides for 
benefits to be actuarially increased to the extent they commence after 
normal retirement age. For employees who continue employment after 
attainment of normal retirement age, Plan A provides for benefits to 
continue to accrue and permits benefits to commence at any time, with an 
actuarial increase in benefits to apply to the extent benefits do not 
commence after normal retirement age. Age 45 is an age that is earlier 
than the earliest age that is reasonably representative of the typical 
retirement age for the industry in which the covered workforce is 
employed.
    (B) On February 18, 2008, Plan A is amended, effective May 22, 2007, 
to change its normal retirement age to the later of age 65 or the fifth 
anniversary of participation in the plan. The amendment provides full 
vesting for any participating employee who is employed on May 21, 2007, 
and who terminates employment on or after attaining age 45. The 
amendment provides employees who cease employment before the revised 
normal retirement age and who are entitled to a vested benefit with the 
right to be able to commence benefits at any date from age 45 to age 
70\1/2\. The plan amendment also revises the plan's benefit accrual 
formula so that the benefit for prior service (payable commencing at the 
revised normal retirement age or any other age after age 45) is not less 
than would have applied under the plan's formula before the amendment 
(also payable commencing at the corresponding dates), based on the 
benefit accrued on May 21, 2007, and provides for service thereafter to 
have the same rate of future benefit accrual. Thus, for any participant 
employed on May 21, 2007, with respect to benefits accrued for service 
after May 21, 2007, the amount payable under the plan (as amended) at 
any benefit commencement date after age 45 is the same amount that would 
have been payable at that benefit commencement date under the plan prior 
to amendment. The plan amendment also eliminates the right to an in-
service distribution between age 45 and the revised normal retirement 
age. Plan A has been operated since May 22, 2007, in conformity with the 
amendment adopted on February 18, 2008.
    (ii) Conclusion. The plan amendment does not violate section 
411(d)(6). Although the amendment eliminates the right to commence 
benefits in-service between age 45 and the revised normal retirement 
age, the amendment is made before the last day of the remedial amendment 
period applicable to the plan under Sec. 1.401(b)-1 with respect to the 
requirements of Sec. 1.401(a)-1(b)(2) and (3), and therefore the 
amendment is permitted under paragraph (a) of this A-12. Further, the 
amendment does not result in a reduction in any benefit for service 
after May 22, 2007.
    Thus, the amendment does not result in a reduction in any benefit 
for future service, and advance notice of a significant reduction in the 
rate of future benefit accrual is not required under section 4980F.

[53 FR 26058, July 11, 1988]

    Editorial Note: For Federal Register citations affecting Sec. 
1.411(d)-4, see the List of CFR Sections Affected, which appears in the 
Finding Aids section of the printed volume and at www.fdsys.gov.



Sec. 1.411(d)-5  Class year plans; plan years beginning after 
October 22, 1986.

    (a) Plan years beginning prior to 1989. (1) The requirements of 
section 411(a)(2) shall be treated as satisfied in the case of a class-
year plan if such plan provides that 100 percent of each employee's 
right to or derived from the contributions of the employer on the 
employee's behalf with respect to any plan year is nonforfeitable not 
later than when such participant was performing services for the 
employer as of the close of each of 5 plan years (whether or not 
consecutive) after the

[[Page 869]]

plan year for which the contributions were made.
    (2) For purposes of paragraph (a)(1) of this section if--
    (i) Any contributions are made on behalf of a participant with 
respect to any plan year, and
    (ii) Before such participant meets the requirements of paragraph 
(a)(1) of this section, such participant was not performing services for 
the employer as of the close of each of any 5 consecutive plan years 
after such plan year, then the plan may provide that the participant 
forfeits any right to or derived from the contributions made with 
respect to such plan year.
    (3) This paragraph (a) applies to contributions made for plan years 
beginning after October 22, 1986.
    (b) Plan years beginning after 1988. (1) The special class year 
vesting rule in section 411(d)(4) was repealed by section 1113(b) of the 
Tax Reform Act of 1986 (1986 Act). The repeal is generally effective for 
plan years beginning after December 31, 1988. See section 1111(e) of the 
1986 Act for a special effective date rule applicable to certain plans 
maintained pursuant to collective bargaining agreements.
    (2)(i) This subparagraph (2) provides a special rule for class year 
plans that were in compliance with section 411(d)(4) immediately before 
the first plan year beginning after section 411(d)(4) is repealed. These 
plans are not required to retroactively compute years of service under 
the general section 411(a)(2) rules. Instead, a participant must receive 
a year of service for each such prior plan year if the employee was 
performing services on the last day of such year. Similarly, if the 
participant was not performing services on the last day of such years, 
the participant will be treated as if a one-year break-in-service 
occurred for such plan year. This subdivision (i) applies to plan years 
to which this section applies.
    (ii) In the case of a plan year to which Sec. 1.411(d)-3 applied, a 
class year plan must compute years of service and breaks in service in a 
manner consistent with the rules in this paragraph (b)(2)(i), giving 
appropriate regard to the statutory changes made to section 411(d)(4).

[T.D. 8219, 53 FR 31854, Aug. 22, 1988; 53 FR 48534, Dec. 1, 1988]



Sec. 1.412(b)-2  Amortization of experience gains in connection with 
certain group deferred annuity contracts.

    (a) Experience gain treatment. Dividends, rate credits, and credits 
for forfeitures arising in a plan described in paragraph (b) of this 
section are experience gains described in section 412(b)(3)(B)(ii) 
(relating to the amortization of experience gains).
    (b) Plan. A plan is described in this paragraph (b) if--
    (1) The plan is funded solely through a group deferred annuity 
contract,
    (2) The annual single premium required under the contract for the 
purchase of the benefits accruing during the plan year is treated as the 
normal cost of the plan for that year, and
    (3) The amount necessary to pay in equal annual installments, over 
the appropriate amortization period, an amount equal to the single 
premium necessary to provide all past service benefits not initially 
funded, together with interest thereon, is treated as the annual 
amortization amount determined under section 412(b)(2)(B) (i), (ii) or 
(iii).
    (c) Effective date. This section applies for the first plan year to 
which section 412 applies that begins after May 22, 1981.

[T.D. 7764, 46 FR 6923, Jan. 22, 1981]



Sec. 1.412(b)-5  Election of the alternative amortization method of 
funding.

    (a) Alternative amortization method in general. Section 1013(d) of 
the Employee Retirement Income Security Act of 1974 provides an 
alternative method which may be used by certain multiemployer plans (as 
defined in section 414(f)) which were in existence on January 1, 1974, 
for funding certain unfunded past service liability. The multiemployer 
plans which may elect to use this alternative method are those plans (1) 
under which, on January 1, 1974, contributions were based on a 
percentage of pay, (2) which use actuarial assumptions with respect to 
pay that are reasonably related to past and projected experience, and 
(3) which use

[[Page 870]]

rates of interest that are determined on the basis of reasonable 
acturial assumptions. The unfunded past service liability to which this 
method applies is that amount existing as of the date 12 months after 
the date on which section 412 first applies to the plan. The alternative 
method allows the plan to fund this liability over a period of 40 plan 
years by charging the funding standard account with an equal annual 
percentage of the aggregate pay of all participants in the plan instead 
of the level dollar charges required under section 412(b)(2)(B). 
Paragraphs (b), (c), (d) and (e) of this section contain procedural 
rules for electing this alternative method.
    (b) Election procedure. To elect the alternative amortization 
method, a multiemployer plan must attach a statement to the annual 
report required under section 6058(a) for the plan year for which the 
election is made, stating that the alternative method for funding 
unfunded past service liability is being adopted. Advance approval from 
the Internal Revenue Service is not required. The alternative method 
must be adopted on or before the last day prescribed for filing the 
annual report corresponding to the last plan year beginning before 
January 1, 1982.
    (c) Charges to which the alternative amortization method is 
applicable. Once elected, the alternative amortization method is 
applicable to the unfunded past service liability existing as of the 
date 12 months after the date on which section 412 first applies to the 
plan. This results in charges to the funding standard account which are 
in lieu of--
    (1) Charges required under clause (i) of section 412(b)(2)(B), and
    (2) Charges required under clause (iii) of section 412(b)(2)(B) if 
the plan amendments referred to in such clause result in a net increase 
in the unfunded past service liability existing as of the date 12 months 
after the date on which section 412 first applies to the plan. Such 
charges generally will arise only with respect to plan amendments 
adopted in the first plan year to which section 412 applies.


If the election is made on an annual report corresponding to a plan year 
after the first plan year to which section 412 applies, recomputation of 
the contributions due in the prior years (to which section 412 applied) 
will be necessary.
    (d) Limitation. The sum of the charges described in this paragraph 
may not be less than the interest on the unfunded past service 
liabilities described in section 412(b)(2)(B) (i) and (iii), determined 
as of the date 12 months after the date on which section 412 first 
applies to the plan.
    (e) Reporting requirements. Each annual report required by section 
6058(a) and periodic report of the actuary required by section 6059 must 
include all additional information relevant to the use of the 
alternative amortization method as may be required by the applicable 
forms and the instructions for such forms.

[T.D. 7702, 45 FR 40113, June 13, 1980]



Sec. 1.412(c)(1)-1  Determinations to be made under funding method--
terms defined.

    (a) Actuarial cost method and funding method. Section 3 (31) of the 
Employee Retirement Income Security Act of 1974 (``ERISA'') provides 
certain acceptable (and unacceptable) actuarial cost methods which may 
(or may not) be used by employee plans. The term ``funding method'' when 
used in section 412 has the same meaning as the term ``actuarial cost 
method'' in section 3 (31) of ERISA. For shortfall method for certain 
collectively bargained plans, see Sec. 1.412(c)(1)-2; for principles 
applicable to funding methods in general, see regulations under section 
412(c)(3).
    (b) Computations included in funding method. The funding method of a 
plan includes not only the overall funding method used by the plan but 
also each specific method of computation used in applying the overall 
method. However, the choice of which actuarial assumptions are 
appropriate to the overall method or to the specific method of 
computation is not a part of the funding method. For example, the 
decision to use or not to use a mortality factor in the funding method 
of a plan is not a part of such funding method. Similarly, the specific 
mortality rate determined to be applicable to a particular plan year is 
not part of the funding

[[Page 871]]

method. See section 412(c)(5) for the requirement of approval to change 
the funding method used by a plan.

[T.D. 7733, 45 FR 75202, Nov. 14, 1980]



Sec. 1.412(c)(1)-2  Shortfall method.

    (a) In general--(1) Shortfall method. The shortfall method is a 
funding method that adapts a plan's underlying funding method for 
purposes of section 412. As such, the use of the shortfall method is 
subject to section 412(c)(3). A plan described in paragraph (a)(2) of 
this section may elect to determine the charges to the funding standard 
account required by section 412(b) under the shortfall method. These 
charges are computed on the basis of an estimated number of units of 
service or production (for which a certain amount per unit is to be 
charged). The difference between the net amount charged under this 
method and the net amount that otherwise would have been charged under 
section 412 for the same period is a shortfall loss (gain) and is to be 
amortized over certain subsequent plan years.
    (2) Eligibility for use of shortfall. No plan may use the shortfall 
method unless--
    (i) The plan is a collectively bargained plan described in section 
413(a), and
    (ii) Contributions to the plan are made at a rate specified under 
the terms of a legally binding agreement applicable to the plan.

For purposes of this section, a plan maintained by a labor organization 
which is exempt from tax under section 501(c)(5) is treated as a 
collectively bargained plan and the governing rules of the organization 
(such as its constitution, bylaws, or other document that can be altered 
only through action of a convention of the organization) are treated as 
a collectively bargained agreement.
    (b) Computation and effect of net shortfall charge--(1) In general. 
The ``net shortfall charge'' to the funding standard account under the 
shortfall method is the product of (i) the estimated unit charge 
described in paragraph (c) of this section that applies for a particular 
plan year, multiplied by (ii) the actual number of base units (for 
example, units of service or production) which occurred during that plan 
year. When the shortfall method is used, the net shortfall charge is a 
substitute for the specific charges and credits to the funding standard 
account described in section 412 (b)(2) and (3)(B).
    (2) Example. Paragraph (b)(1) of this section may be illustrated by 
the following example:

    Example. A pension plan uses the calendar year as the plan year and 
the shortfall method. Its estimated unit charge applicable to 1980 is 80 
cents per hour of covered employment. During 1980, there were 125,000 
hours of covered employment. The net shortfall charge for the plan year 
is $100,000 (i.e., 125,000x$.80), regardless of the amount which would 
be charged and credited to the funding standard account under section 
412 (b)(2) and (3)(B) had the shortfall method not applied. The funding 
standard account for 1980 will be separately credited for the amount 
considered contributed for the plan year under section 412 (b)(3)(A). 
The other items which may be credited, if applicable, are a waived 
funding deficiency and the alternative minimum funding standard credit 
adjustment under section 412(b)(3)(C) and (D) because these items are 
not credits under section 412(b)(3)(B).

    (3) Plans with more than one contract, contribution rate, employer, 
or benefit level--(i) General rule. A single plan with more than one 
contract, contribution rate, employer, or benefit level may compute a 
separate net shortfall charge for each contract, contribution rate, each 
employer, or each benefit level. The sum of these charges is the plan's 
total net shortfall charge. under Sec. 1.412(c)(1)-1(b), the use of 
separate computations would be a specific method of computation used in 
applying the overall funding method. See also paragraph (f)(5) of this 
section.
    (ii) Single valuation. Only one actuarial valuation shall be made 
for the single plan on each actuarial valuation date.
    (iii) Reasonableness test. The specific method of computation of the 
net shortfall charge must be reasonable, determined in the light of the 
facts and circumstances.
    (c) Estimated unit charge. The estimated unit charge is the annual 
computation charge described in paragraph

[[Page 872]]

(d) of this section divided by the estimated base units of service or 
production described in paragraph (e) of this section.
    (d) Annual computation charge. The annual computation charge for a 
plan year is the sum of the following amounts:
    (1) The net charges and credits which, but for using the shortfall 
method, would be made under section 412 (b)(2) and (b)(3)(B).
    (2) The amount described in paragraph (g)(3) of this section, if 
applicable, for amortization of shortfall gain or loss.
    (e) Estimated base units--(1) In general. The estimated base units 
are the expected units of service or production for a plan year (hours, 
days, tons, dollars of compensation, etc.), determined as of the base 
unit estimation date for that plan year under paragraph (f) of this 
section. This estimate must be based on the past experience of the plan 
and the reasonable expectations of the plan for the plan year. The 
specific type of unit used must be described in the statement of funding 
method for the plan year. (See paragraph (i)(3) of this section for 
reporting requirements.)
    (2) Reasonable expectations. The reasonableness of expectations used 
under paragraph (e)(1) of this section is determined under the facts and 
circumstances of the plan for each plan year as of the relevant base 
unit estimation date. Expectations will be considered unreasonable if, 
for example, they do not reflect a consistent and substantial decline or 
growth in actual base units that has occurred over the course of recent 
years and that is likely to continue beyond the base unit estimation 
date. This determination of reasonableness is independent of 
determinations made under section 412(c)(3) of the reasonableness of 
actuarial assumptions.
    (f) Base unit estimation date--(1) In general. The base unit 
estimation date for the current plan year is determined under this 
paragraph (f). This date shall be an actuarial valuation date no earlier 
than the last actuarial valuation date occurring at least one year 
before the earliest date any current collectively bargained agreement in 
existence during the plan year came into effect.
    (2) Four-month rule. For purposes of this paragraph (f), a current 
collectively bargained agreement is one in effect during at least four 
months of the current plan year.
    (3) Effective date of agreement. For purposes of this paragraph (f), 
a collectively bargained agreement shall be deemed to have come into 
effect on the effective date of the agreement containing the currently 
effective provision for contributions to the plan or the benefits 
provided under the plan.
    (4) Long-term contract rule. The effective date of a collectively 
bargained agreement shall be deemed not to occur prior to the first day 
of the third plan year preceding the current year.
    (5) Special rule for plans computing separate net shortfall charge. 
A plan that computes a separate net shortfall charge for each contract, 
contribution rate, employer, or benefit level under paragraph (b)(3) of 
this section shall determine the base unit estimation date for each 
separate charge without regard to any collectively bargained agreement 
that does not relate to that contract, contribution rate, employer, or 
benefit level. If a collective bargaining agreement requiring 
contributions by a certain employer, or prescribing a certain benefit 
level, is in effect on December 31, 1980, the preceding sentence shall 
not apply to the computation of a separate net shortfall charge for that 
employer or benefit level until the earlier of--
    (i) The first plan year beginning after the date on which expires 
the collective bargaining agreement requiring contributions by that 
employer (or the last collective bargaining agreement relating to that 
benefit level), or
    (ii) The first plan year beginning after December 31, 1983.
    (6) Example. The rules contained in paragraph (f) of this section 
are illustrated by the following table. In the table, ``V'' signifies 
actuarial valuation date (January 1 in each case shown); ``B'' signifies 
beginning of a contract; and ``E'' signifies end of a contract. The 
table shows the resulting earliest base unit estimation date with 
respect to the following assumed items:

[[Page 873]]



                                Computation of Earliest Base Unit Estimation Date
----------------------------------------------------------------------------------------------------------------
                                                        Plan year (calendar year basis)
           Example           -----------------------------------------------------------------------------------
                               1973   1974   1975   1976   1977   1978   1979   1980   1981   1982   1983   1984
----------------------------------------------------------------------------------------------------------------
Plan A......................      V  .....  .....      V  .....  .....      V  .....  .....      V
  Contract 1................  .....  .....    E/B  .....  .....    E/B  .....    E/B  .....  .....  .....    E/B
  Base unit estimation date   .....  .....  .....   1973   1973   1973   1976   1976   1979   1979   1979   1979
   \1\......................
----------------------------------------------------------------------------------------------------------------
Plan B......................      V  .....  .....      V  .....  .....      V  .....  .....      V
  Contract 2................    \2\    \2\    \2\     B*  .....    E/B  .....  .....  .....   E/B*
  Contract 3................    E/B  .....  .....    E/B  .....  .....    E/B  .....  .....    E/B
  Base unit estimation date   .....  .....  .....   1973   1973   1973   1976   1976   1976   1976   1979   1979
   \1\......................
----------------------------------------------------------------------------------------------------------------
Plan C......................      V      V      V      V      V      V      V      V      V      V      V      V
  Contract 4................  .....  .....    E/B  .....  .....   E/B*  .....  .....  .....   E/B*
  Contract 5................  .....  .....    E/B  .....  .....   E/B*  .....  .....  .....  .....   E/B*
  Base unit estimation date   .....  .....  .....   1974   1974   1977   1977   1977   1977   1978   1979   1981
   \1\......................
----------------------------------------------------------------------------------------------------------------
\1\ The base unit estimation date may be on or any time after the actuarial valuation date in the year indicated
  on this line.
\2\ No contract.
* Denotes that a prior contract ends and a new contract begins prior to the fifth month of a plan year.

    (g) Amortization of shortfall gain or loss--(1) Definition. The 
shortfall gain for a plan is the excess for the plan year of--
    (i) The net shortfall charge computed under paragraph (b) of this 
section over
    (ii) The annual computation charge described in paragraph (d) of 
this section.

The shortfall loss for a plan is the excess for the plan year of the 
annual computation charge over the net shortfall charge.
    (2) Shortfall amortization period--(i) First year. The plan year in 
which the amortization of a shortfall gain or loss must begin is the 
earlier of two years: the fifth plan year following the plan year in 
which the shortfall gain or loss arose, or the first plan year beginning 
after the latest scheduled expiration date of a collectively bargained 
agreement in effect with respect to the plan during the plan year in 
which the shortfall gain or loss arose. For purposes of this 
subparagraph, a contract expiring on the last day of a plan year shall 
be deemed to be renewed on such last day for the same period of years as 
the contract that succeeds the expiring contract.
    (ii) Last year. The plan year in which the amortization of a 
shortfall gain or loss must end is the 15th plan year following the plan 
year in which the shortfall gain or loss arose. For a multiemployer plan 
described in section 414(f), the amortization must end with the 20th 
plan year instead of the 15th.
    (3) Annual amortization amount. The shortfall gain or loss must be 
amortized in equal annual installments. The total amount to be amortized 
must be adjusted for interest at the rate used for determining the 
plan's normal cost.
    (4) Shortfall gain or loss under spread gain type of funding 
method--(i) In general. A spread gain type of funding method spreads 
experience gains and losses over future periods as part of a plan's 
normal cost. (Examples of spread gain types of funding methods are the 
aggregate cost method, the frozen initial liability method, and the 
attained age normal method.) However, a shortfall gain or loss is not an 
experience gain or loss. Therefore, a plan using a spread gain type of 
funding method together with the shortfall method must amortize 
shortfall gains and losses and otherwise meet the requirements of 
paragraph (g) of this section.
    (ii) Asset adjustment for aggregate method. A plan using the 
shortfall method with the aggregate cost method of funding must adjust 
its plan assets for a shortfall gain or loss in calculating normal cost. 
The unamortized portion of any shortfall gain is subtracted from plan 
assets. The unamortized portion of any shortfall loss is added to plan 
assets.
    (5) Reconciliation of shortfall gain or loss with funding standard 
account. At the beginning of each year, the actual unfunded liability 
under the method used by the plan must equal the outstanding balance of 
all amortization bases, including bases for shortfall

[[Page 874]]

gains and losses, less the credit balance under the funding standard 
account at the end of the prior year.
    (6) Example. This paragraph is illustrated by the following 
examples:

    Example 1. A multiemployer plan described in section 414 (f) is 
maintained with the calendar year as the plan year and uses the 
shortfall method. The plan uses the frozen initial liability funding 
method. A five percent interest assumption is used by the plan, with 
payments computed as of the first day of each plan year for all items. 
The expiration dates of contracts in effect during plan years 1976, 
1977, and 1978 are such that the amortization of gains or losses for 
each year must begin in the fifth following plan year. The assumed plan 
costs and estimated base units for selected years, and the computations 
under this section which follow from such assumptions are shown in the 
following table. In the table, ``*'' denotes an assumed item. The 
remaining figures have been calculated on the basis of these 
assumptions.

   (A) Computation of Net Shortfall Charge and Shortfall Gain or Loss
------------------------------------------------------------------------
            Plan year                  1976         1977         1978
------------------------------------------------------------------------
1. Normal cost*..................     $100,000     $100,000     $100,000
2. Amortization of unfunded             50,000       50,000       50,000
 liability*......................
                                  --------------------------------------
3. Total annual computation           $150,000     $150,000     $150,000
 charges.........................
4. Estimated base units*.........      100,000      100,000      100,000
5. Estimated unit charge (line 3/        $1.50        $1.50        $1.50
 line 4).........................
6. Actual units during year*.....       80,000       90,000      110,000
7. Net shortfall charge for year       120,000      135,000      165,000
 (line 5xline 6).................
8. Shortfall (gain) or loss (line       30,000       15,000    ($15,000)
 3-line 7).......................
------------------------------------------------------------------------


                     (B) Annual Amortization Amount
9. Year of shortfall gain or loss         1976         1977         1978
10. First year of amortization...         1981         1982         1983
11. Last year of amortization....         1996         1997         1998
12. (Gain) or loss adjusted for        $38,288      $19,144    ($19,144)
 interest to year amortization
 begins (1-1-76 to 1-1-81, etc.).
13. Annual amortization (16             $3,364       $1,682     ($1,682)
 years)..........................
 


 (C) Computation of Net Shortfall Charges for Selected Years (Including
                         Shortfall Amortization)
------------------------------------------------------------------------
            Plan year                  1981         1982         1983
------------------------------------------------------------------------
14. Normal cost*.................     $120,000     $125,000     $130,000
15. Amortization of unfunded            50,000       50,000       50,000
 liability*......................
16. Shortfall amortization (see
 line 13) from:
    1976.........................        3,364        3,364        3,364
    1977.........................  ...........        1,682        1,682
    1978.........................  ...........  ...........      (1,682)
                                  --------------------------------------
17. Total annual computation           173,364      180,046      183,364
 charges.........................
18. Estimated base units*........      110,000      110,000      110,000
19. Estimated unit charge (line          1.576        1.637        1.667
 17/line 18).....................
20. Actual units during year*....      105,000      110,000      105,000
21. Net shortfall charge for year      165,480      180,070      175,035
 (line 19xline 20)...............
22. Shortfall (gain) loss (line          7,884         (24)        8,329
 17-line 21).....................
------------------------------------------------------------------------

    The amounts in line 22 will be amortized beginning 1986, 1987, and 
1988, respectively. The $24 gain in 1982 results from rounding the 
estimated unit charge.
    Example 2. Assume the facts in Example 1. Also assume that the plan 
uses the frozen initial liability funding method, that the unfunded 
liability as of January 1, 1976 (corresponding to a 40-year charge of 
$50,000 due at the beginning of the year) is $900,850, and that actual 
contributions at the rate of $1.75 per unit are paid at mid-year in 
1976.

    (A) Computation of the Unfunded Liability as of December 31, 1976
1. Unfunded liability as of 1/1/76.........................     $900,850
2. Normal cost (that used in the calculation of the total        100,000
 annual computation charges)...............................
3. Interest at 5% due on items 1 and 2.....................       50,043
4. Contribution with interest: $1.75x80,000x1.025 (actual        143,500
 contribution rate times acutal base units times interest
 adjustment from mid-year).................................
                                                            ------------
5. Unfunded liability as of 12/31/76: item 1+item 2+item 3 -     907,393
 item 4....................................................
 


 (B) Computation of the Outstanding Balance of the Bases as of December
                                31, 1976
1. Original base: ($900,850-$50,000)x1.05..................     $893,393
2. Shortfall loss $30,000x1.05.............................       31,500
                                                            ------------
3. Total...................................................      924,893
 


[[Page 875]]


      (C) Computation of the Credit Balance as of December 31, 1976
1. Net shortfall charge (Sec. 1.412 (c) (1)-2 (b))            $126,000
 adjusted for interest: $120,000x1.05......................
2. Actual contributions with interest......................      143,500
                                                            ------------
3. Credit balance as of 12/31/76: item 2-item 1............       17,500
 

                   (D) Reconciliation of computations

    As of January 1, 1977, the unfunded liability ($907,393) equals the 
outstanding balance of the bases minus the credit balance ($924,893-
$17,500=$907,393).

    (h) Amortization of experience gain or loss--(1) General rule. In 
the case of a plan using an immediate gain type of funding method, an 
experience gain or loss shall be amortized pursuant to section 412 
(b)(2)(B)(iv) or (b)(3)(B)(ii). (Examples of the immediate gain type of 
funding method are the unit credit method, the entry age normal cost 
method, and the individual level premium cost method.) For purposes of 
this section, a shortfall gain or loss is not an experience gain or 
loss. The amount of the experience gain or loss must be adjusted for 
interest at the rate used for determining the plan's normal cost.
    (2) Experience amortization period under shortfall method--(i) First 
year. The plan year in which the amortization of an experience gain or 
loss must begin in the case of a plan using the shortfall method is the 
earlier of two years: the fifth plan year following the plan year in 
which the experience gain or loss arose, or the first plan year 
beginning after the last scheduled expiration date of a contract in 
effect during the plan year in which the experience gain or loss arose. 
For purposes of this subparagraph a contract expiring on the last day of 
the plan year shall be deemed to be renewed on such last day for the 
same period of years as the contract that succeeds the expiring 
contract.
    (ii) Last year. The plan year in which the amortization of an 
experience gain or loss must end in the case of a plan using the 
shortfall method is the 15th plan year following the plan year in which 
the experience gain or loss arose. For a multi-employer plan described 
in section 414 (f), the amortization must end with the 20th plan year 
instead of the 15th.
    (3) Use of annual computation charge in determining experience gain 
or loss. In the case of a plan using an immediate gain type of funding 
method, an experience gain or loss is the difference between the 
expected unfunded liability and the actual unfunded liability under the 
plan. The expected unfunded liability as of the end of a plan year 
equals the actual unfunded liability as of the beginning of the year 
plus normal cost, minus contributions, all adjusted for interest. If the 
plan adopts the shortfall method, the expected unfunded liability is 
computed by using the normal cost applicable for the plan year in 
determining the annual computation charge under paragraph (d) of this 
section. The same normal cost is used in computing the unfunded 
liability under the frozen initial liability funding method.
    (4) Example. This paragraph is illustrated by the following example:

    Example. Assume the facts in Example 2 from paragraph (g) (6) of 
this section, except that the entry age normal funding method is used. 
Also assume that as of December 31, 1976, the actual unfunded liability 
is $900,000.

             (A) Computation of Expected Unfunded Liability
1. Actual unfunded liability as of 1-1-76..................     $900,850
2. Normal cost portion of annual computation charge as of 1-     100,000
 1-76......................................................
3. Interest at 5% due on items 1 and 2.....................       50,043
4. Contribution received with interest: $1.75 x 80,000 x         143,500
 1.025 (actual contribution rate times actual base units
 times interest adjustment at mid-year)....................
                                                            ------------
5. Expected unfunded liability as of 12-31-76 (item 1 +          907,393
 item 2 + item 3 - item 4).................................
 


                     (B) Computation of Gain or Loss
1. Expected unfunded liability as of 12-31-76..............     $907,393
2. Actual unfunded liability as of 12-31-76................      900,000
                                                            ------------
3. Gain (or loss) (item 1 - item 2)........................        7,393
 


    (i) Election procedure--(1) In general. To elect the shortfall 
method, a collectively bargained plan must attach a statement to the 
annual report required under section 6058 (a) for the first plan year to 
which it is applied. The statement shall state that the shortfall method 
is adopted, beginning with the plan year covered by such report. Advance 
approval from the Internal Revenue Service is not required if the 
shortfall method is first adopted on or before the later of--

[[Page 876]]

    (i) The first plan year to which section 412 applies or
    (ii) The last plan year commencing before December 31, 1981.

However, approval must be received pursuant to section 412(c)(5) prior 
to the adoption of the shortfall method at a later time, or the 
discontinuance of such method, once adopted.
    (2) Use of specific computation method. A specific method of 
computation under the shortfall method is described in paragraph (b)(3) 
of this section, regarding the treatment of more than one contract, 
employer, or benefit level under the plan. This specific method may be 
adopted with respect to any plan year to which the shortfall method 
applies. Approval from the Commissioner must be received under section 
412(c)(5) prior to the adoption of this specific computation method for 
a plan year subsequent to the first plan year to which the shortfall 
method applies, or prior to the discontinuance of a specific computation 
method, once adopted.
    (3) Reporting requirements. Each annual report required by section 
6058(a) and periodic report of the actuary required by section 6059 must 
include all additional information relevant to the use of the shortfall 
method as may be required by the applicable forms and the instructions 
for such forms.
    (j) Transitional rule. In lieu of paragraphs (g)(2) and (h)(2) of 
this section relating to the amortization period for shortfall and 
experience gains and losses, for gains and losses arising in plan years 
beginning before January 1, 1981, a plan may rely on the prior published 
position of the Internal Revenue Service with respect to the 
amortization period for shortfall and experience gains and losses.
    (k) Supersession. This section and Sec. 1.412 (c) (1)-1 supersede 
Sec. Sec. 11.412 (c) (1)-1 and (c) (1)-2 of the Temporary Income Tax 
Regulations Under the Employee Retirement Income Security Act of 1974.

(Secs. 412, 7805, Internal Revenue Code of 1954 (88 Stat. 914 and 68A 
Stat. 917; (26 U.S.C. 412 and 7805)), and sec. 3 (31) of the Employee 
Retirement Income Security Act of 1974 (88 Stat. 837; (29 U.S.C. 1002)))

[T.D. 7733, 45 FR 75202, Nov. 14, 1980]



Sec. 1.412(c)(1)-3  Applying the minimum funding requirements to 
restored plans.

    (a) In general--(1) Restoration method. The restoration method is a 
funding method that adapts the underlying funding method of section 412 
in the case of certain plans that are or have been terminated and are 
later restored by the Pension Benefit Guaranty Corporation (PBGC). The 
normal operation of the funding standard account, and all other 
provisions of section 412 and the regulations thereunder, are unchanged 
except as provided in this Sec. 1.412(c)(1)-3. Under the restoration 
method, the PBGC shall determine a restoration payment schedule, 
extending over no more than 30 years, that replaces all charges and 
credits to the funding standard account attributable to pre-restoration 
amortization bases. The restoration payment schedule is determined on 
the basis of an actuarial valuation of the accrued liability of the plan 
on the initial post-restoration valuation date less the actuarial value 
of the plan assets on that date. The initial post-restoration valuation 
date is the date of the valuation that falls in the first plan year 
beginning on or after the date of the restoration order.
    (2) Applicability of restoration method. A plan must use the 
restoration method if, and only if--
    (i) The plan is being or has been terminated pursuant to section 
4041(c) or section 4042 of the Employee Retirement Income Security Act 
of 1974 (ERISA); and
    (ii) The plan has been restored by the PBGC pursuant to its 
authority under section 4047 of ERISA.
    (b) Computation and effect of the initial restoration amortization 
base--(1) In general. The initial restoration amortization base is 
determined under the underlying funding method used by the plan. When 
the plan uses a spread gain funding method that does not maintain an 
unfunded liability, the plan must change either to an immediate gain 
method that directly calculates an accrued liability or to a spread gain 
method that maintains an unfunded liability. A plan may adopt any cost 
method that satisfies this requirement and that is acceptable under 
section 412

[[Page 877]]

and the regulations thereunder, provided that the plan administrator 
follows the procedures established by the Commissioner for changes in 
funding methods. The initial restoration amortization base is determined 
using the valuation for the plan year in which the initial post-
restoration valuation date falls. The initial restoration amortization 
base equals the accrued liability with respect to plan benefit 
liabilities returned by the PBGC less the value of the plan assets 
returned by the PBGC. The initial restoration amortization base replaces 
all prior amortization bases including those under section 412(b)(2) 
(B), (C), and (D) and under section 412(b)(3)(B). Any base resulting 
from a change in funding method, including a change required under this 
paragraph, is treated as a prior amortization base within the meaning of 
this paragraph (b). Any accumulated funding deficiency or credit balance 
in the funding standard account is set equal to zero when the initial 
restoration amortization base is established.
    (2) Example. The following example illustrates the provisions of 
this paragraph (b):

    Example. A pension plan uses the calendar year as its plan year, 
makes its annual periodic valuation as of January 1, and uses the unit 
credit actuarial cost method for funding purposes. The plan is in the 
process of being terminated. By order of the PBGC the plan is restored 
as of July 1, 1991. The initial post-restoration valuation date is 
January 1, 1992, and a restoration payment schedule order is issued on 
October 31, 1992. If, as of January 1, 1992, the accrued liability of 
the plan is $1,000,000 and the value of the plan assets is $200,000, the 
initial restoration amortization base is $800,000.

    (c) Establishment of a restoration payment schedule--(1) 
Certification requirement. When the PBGC establishes a restoration 
payment schedule, the Executive Director of the PBGC must certify to the 
PBGC's Board of Directors, and to the Internal Revenue Service, that the 
PBGC has reviewed the funding of the plan, the financial condition of 
the plan sponsor and its controlled group members, the payments required 
under the restoration payment schedule (taking into account the 
availability of deferrals authorized under paragraph (c)(4) of this 
section), and any other factor that the PBGC deems relevant, and, based 
on that review, determines that it is in the best interests of 
participants and beneficiaries of the plan and the pension insurance 
program that the restored plan not be reterminated.
    (2) Requirements for restoration payment schedule--(i) Amortization 
of base over period of no more than 30 years. The restoration payment 
schedule must be prescribed in an order requiring the employer to make 
stated contributions to the plan sufficient to amortize the initial 
restoration amortization base over a period extending not more than 30 
years after the initial post-restoration valuation date (the restoration 
payment period). Payments included in the restoration payment schedule 
order are charged to the funding standard account of the plan at the end 
of each plan year in accordance with paragraph (d) of this section. The 
restoration payment schedule must provide for total charges that are 
sufficient to amortize the entire amount of the initial restoration 
amortization base by the end of the restoration payment period. The 
scheduled charges need not be in level amounts, but the present value of 
the prescribed charges on the initial post-restoration valuation date, 
computed with interest at the valuation rate, must equal the initial 
restoration amortization base.
    (ii) Minimum annual charge. The restoration payment schedule must 
prescribe annual charges that are sufficient to prevent the outstanding 
balance of the initial restoration amortization base from exceeding 
whichever of the following amounts is applicable--
    (A) During the first 10 plan years on the restoration payment 
schedule, the amount of the initial restoration amortization base on the 
date the base was established; or
    (B) During plan years 11 through 20 on the restoration payment 
schedule, the maximum permitted outstanding balance of the initial 
restoration amortization base at the end of the tenth plan year, as 
calculated under paragraph (c)(2)(iii) of this section; or

[[Page 878]]

    (C) During plan years 21 through the end of the restoration payment 
schedule, the maximum permitted outstanding balance of the initial 
restoration amortization base at the end of the twentieth plan year, as 
calculated under paragraph (c)(2)(iii) of this section.
    (iii) Interim amortization requirements. The restoration payment 
schedule must provide for sufficient periodic charges so that the 
outstanding balance of the initial restoration amortization base at the 
end of the tenth plan year and at the end of the twentieth plan year of 
the restoration payment period will not be larger than the outstanding 
balance that would have remained at the end of the tenth plan year and 
at the end of the twentieth plan year, respectively, if the initial 
restoration amortization base had been amortized in level annual amounts 
over the restoration payment period at the valuation rate.
    (3) Amendments to the restoration payment schedule. The order 
establishing the restoration payment schedule may be amended by the PBGC 
from time to time with respect to any remaining payments, provided that 
no amendment may extend the restoration payment period beyond 30 years 
from the initial post-restoration valuation date, and provided further 
that the restoration payment schedule, as amended, satisfies the 
requirements of paragraph (c)(2) of this section.
    (4) Deferral of minimum scheduled annual payment amounts--(i) 
Authority to grant deferral. Not later than 2\1/2\ months following the 
end of the plan year, the PBGC may grant a deferral of the charges 
required in the restoration payment schedule for that plan year if the 
requirements in paragraph (c)(4)(ii) of this section are satisfied. The 
PBGC may require the plan sponsor and its controlled group members to 
provide security to the plan as a condition to granting a deferral.
    (ii) Determination of business hardship. Before granting a deferral 
under this paragraph (c)(4), the PBGC must make a determination that the 
granting of the deferral is in the best interests of plan participants 
and the plan termination insurance system, and that the plan sponsor and 
its controlled group members are unable to make the scheduled 
restoration payments without experiencing temporary substantial business 
hardship. In making these determinations, the factors the PBGC shall 
consider, include, but are not limited to, the following--
    (A) Whether the plan sponsor and its controlled group members are 
operating at an economic loss;
    (B) Whether there is substantial unemployment or underemployment in 
the trades or businesses of the plan sponsor and its controlled group 
members;
    (C) Whether the sales and profits of the industry or industries are 
depressed or declining; and
    (D) Whether it is reasonable to expect that the plan termination 
insurance system will suffer a greater loss if the plan is terminated 
than if it is continued as a restored plan.
    (iii) Amount of deferral. The amount of the deferral for any 
particular plan year may not exceed the lesser of the amount that would 
have been required to be contributed under the restoration payment 
schedule for that year or interest at the valuation rate on the 
outstanding balance of the initial restoration amortization base for 
that year. An amortization payment for a deferral granted for a prior 
plan year may not be deferred. No deferral may extend the overall 
restoration payment period beyond 30 years.
    (iv) Modification of payment schedule. The restoration payment 
schedule must be adjusted to reflect any deferral granted for a plan 
year in the manner prescribed in this paragraph (c). The charge 
otherwise specified in the schedule is reduced by the amount of any 
deferral. The charges under the restoration payment schedule for the 
subsequent plan years are increased by the amounts in paragraph 
(c)(4)(v) of this section.
    (v) Amortization of deferred amount. The amount of any deferral 
granted by the PBGC for any plan year must be amortized in level amounts 
over five years or such shorter period as may be prescribed by the PBGC, 
at the valuation rate, beginning with the plan year following the year 
of the deferral.
    (vi) Number of deferrals permitted. The PBGC may not grant more than 
five

[[Page 879]]

deferrals of the minimum scheduled payments as required by this section 
during the restoration payment period and no more than three of these 
deferrals may be granted during the first ten years of that period.
    (vii) Deferrals override minimum annual charges and interim 
amortization requirements. In determining the minimum annual charge 
under paragraph (c)(2)(ii) of this section and in applying the interim 
amortization requirements of paragraph (c)(2)(iii) of this section, the 
unamortized balances of any deferrals granted by the PBGC under this 
paragraph shall be added to the outstanding balance of the initial 
restoration amortization base otherwise allowable.
    (d) Charging the scheduled restoration payments to the funding 
standard account. In addition to any other charges and credits 
prescribed in the normal operation of the funding standard account under 
section 412, the amount of each payment specified in the restoration 
payment schedule shall be charged against the funding standard account 
of the plan for the plan year to which that payment is attributed in the 
restoration payment schedule. To the extent that the restoration payment 
schedule provides for payments before the end of the plan year, the 
annual charge to the funding standard account attributable to the 
restoration payment schedule is equal to the sum of the periodic 
payments for the plan year accumulated with interest at the valuation 
rate to the last day of the plan year.
    (e) Changes in actuarial assumptions or methods. The plan 
administrator must notify the PBGC of any changes in the actuarial 
assumptions or methods used by the plan. Upon notification of any such 
change, the PBGC may make any changes to the restoration payment 
schedule that it deems appropriate.
    (f) Change to restoration method. A plan that has been restored must 
use the restoration method until the initial restoration amortization 
base has been fully amortized. The use of this method does not require 
prior approval from the Commissioner. A plan using the restoration 
method must compute the charges to the funding standard account to 
amortize the initial restoration amortization base in accordance with 
the order of the PBGC and in accordance with this section.
    (g) Deficit reduction contribution--(1) Calculation of deficit 
reduction contribution. For any plan using the restoration method, the 
deficit reduction contribution under section 412(l)(2) is equal to the 
sum of--
    (i) The unfunded section 412(l) restoration liability amount; plus
    (ii) The unfunded new liability amount.
    (2) Unfunded section 412(l) restoration liability amount. The 
unfunded section 412(l) restoration liability amount is the amount 
necessary to amortize fully the unfunded section 412(l) restoration 
liability in installments, as prescribed by the PBGC, over not more than 
30 years. The annual amount need not be level, but at all times the 
present value of the future amortization charges prescribed under the 
restoration payment schedule, at the current liability interest rate, 
must equal the outstanding balance of the unfunded section 412(l) 
restoration liability and the schedule must provide that at the end of 
no more than 30 years the entire amount of the unfunded section 412(l) 
restoration liability base will have been fully amortized. The schedule 
prescribed for amortization of the unfunded section 412(l) restoration 
liability must comply with the requirements imposed in paragraph (c) of 
this section on the restoration payment schedule, except as provided in 
paragraph (g)(7) of this section and except that the maximum permitted 
outstanding balance of the unfunded section 412(l) restoration liability 
at the end of the tenth plan year must not be greater than the 
outstanding balance of the section 412(l) restoration liability that 
would have remained at the end of the tenth plan year if the unfunded 
section 412(l) restoration liability had been amortized in level amounts 
over the restoration payment period at the actual current liability 
interest rate for each year, increased by the current liability interest 
rate differential as defined under paragraph (g)(7) of this section. The 
unfunded section 412(l) restoration liability amount for the tenth plan 
year otherwise prescribed under the restoration payment schedule is 
increased by any

[[Page 880]]

outstanding current liability interest rate differential. By issuing an 
appropriate order, the PBGC may permit the outstanding current liability 
interest rate differential to be amortized over the tenth through the 
fourteenth plan years. If the PBGC permits the amortization of the 
outstanding current liability interest rate differential, then the 
unfunded section 412(l) restoration liability amount for each year to 
which an amortization payment is attributed under the order shall be 
increased by such payment. The outstanding balance otherwise required by 
paragraph (g)(2) of this section is increased by the outstanding 
balance, if any, of the base resulting from the amortization of the 
current liability interest rate differential. The PBGC may amend the 
amortization schedule for the unfunded section 412(l) restoration 
liability subject to the limits on amendments to the amortization 
schedule prescribed for the initial restoration amortization base.
    (3) Establishment of unfunded section 412(l) restoration liability. 
In the plan year in which the initial post-restoration valuation date 
falls, the unfunded section 412(l) restoration liability is equal to the 
unfunded current liability of the plan.
    (4) Unfunded new liability amount. In the case of a plan using the 
restoration method, the unfunded new liability amount is the applicable 
percentage, as defined in section 412(l)(4)(C), of the unfunded new 
liability determined under paragraph (g)(5) of this section.
    (5) Unfunded new liability. The unfunded new liability of a plan 
using the restoration method is the excess, if any, of the unfunded 
current liability of the plan, within the meaning of section 
412(l)(8)(A) for the plan year (determined without taking into account 
any unpredictable contingent event benefits, even if the event has 
occurred) over the outstanding balance of the unfunded section 412(l) 
restoration liability determined under paragraph (g)(3) of this section.
    (6) Offset of amortization charges. The amounts charged to the 
funding standard account pursuant to the restoration payment schedule in 
order to amortize the initial restoration base, as described in 
paragraph (d) of this section, must be offset against the deficit 
reduction contribution in paragraph (g)(1) of this section along with 
any other applicable amounts provided in section 412(l)(1)(A)(ii).
    (7) Interest rate differential. During the first 10 plan years after 
the initial post-restoration valuation date, the restoration payment 
schedule must prescribe an unfunded section 412(l) restoration liability 
amount for each plan year that is sufficient to prevent the outstanding 
balance of the unfunded section 412(l) restoration liability from 
exceeding the initial amount of the unfunded section 412(l) restoration 
liability increased by the current liability interest rate differential. 
The current liability interest rate differential at any point during the 
first ten years of the restoration payment period is the excess, if any, 
of the outstanding balance of the unfunded section 412(l) restoration 
liability determined using the actual current liability interest rate 
for each year, taking into account the charges described in paragraph 
(d) of this section, over the outstanding balance of the unfunded 
section 412(l) restoration liability determined using the lowest, for 
each year, of the initial current liability interest rate, the current 
liability interest rate for the computation year, and the valuation 
interest rate, taking into account the charges described in paragraph 
(d) of this section.
    (h) Election of the alternative minimum funding standard. A plan 
using the restoration method may not elect the alternative minimum 
funding standard under section 412(g).
    (i) Funding review by the PBGC. The PBGC must review the funding of 
any plan using the restoration method at least once in each plan year. 
As a result of a funding review, the PBGC may amend the restoration 
payment schedule as provided in paragraph (c)(3) of this section. As 
part of the funding review, the Executive Director of the PBGC must 
certify to the PBGC's Board of Directors, and to the Internal Revenue 
Service, that the PBGC has reviewed the funding of the plan, the 
financial condition of the plan sponsor and its controlled group 
members, the

[[Page 881]]

payments required under the restoration payment schedule (taking into 
account the availability of deferrals authorized under paragraph (c)(4) 
of this section), and any other factor that the PBGC deems relevant, 
and, based on that review, determines that it is in the best interests 
of participants and beneficiaries of the plan and the pension insurance 
program that the restored plan not be reterminated.

[T.D. 8494, 58 FR 54491, Oct. 22, 1993]



Sec. 1.412(c)(1)-3T  Applying the minimum funding requirements to 
restored plans (temporary).

    (a) In general--(1) Restoration method. The restoration method is a 
funding method that adapts the underlying funding method of section 412 
in the case of certain plans that are or have been terminated and are 
later restored by the Pension Benefit Guaranty Corporation. The normal 
operation of the funding standard account, and all other provisions of 
section 412 and the regulations thereunder, are unchanged except as 
provided in this Sec. 1.412(c)(1)-3T. Under the restoration method, the 
Pension Benefit Guaranty Corporation shall determine a restoration 
payment schedule, extending over no more than 30 years, that replaces 
all charges and credits to the funding standard account attributable to 
pre-restoration amortization bases. The restoration payment schedule is 
determined on the basis of an actuarial valuation of the accrued 
liability of the plan on the initial post-restoration valuation date 
less the actuarial value of the plan assets on that date. The initial 
post-restoration valuation date is the date of the first valuation that 
falls in the first plan year beginning on or after the later of October 
23, 1990, or the date of the restoration order.
    (2) Applicability of restoration method. A plan must use the 
restoration method if, and only if:
    (i) The plan is being or has been terminated pursuant to section 
4041(c) or section 4042 of the Employee Retirement Income Security Act 
of 1974 (ERISA), and
    (ii) The plan has been restored by the Pension Benefit Guaranty 
Corporation pursuant to its authority under section 4047 of ERISA.
    (b) Computation and effect of the initial restoration amortization 
base--(1) In general. The initial restoration amortization base is 
determined under the underlying funding method used by the plan. When 
the plan uses a spread gain funding method that does not maintain an 
unfunded liability, the plan must change either to an immediate gain 
method that directly calculates an accrued liability or to a spread gain 
method that maintains an unfunded liability. A plan may adopt any cost 
method that satisfies this requirement and that is acceptable under 
section 412 and the regulations thereunder, provided that the plan 
follows the procedures established by the Commissioner for changes in 
funding methods. The initial restoration amortization base is determined 
using the valuation for the plan year in which the initial post-
restoration valuation date falls. The initial restoration amortization 
base equals the accrued liability with respect to plan benefit 
liabilities returned by the Pension Benefit Guaranty Corporation less 
the value of the plan assets returned by the Pension Benefit Guaranty 
Corporation. The initial restoration amortization base replaces all 
prior amortization bases including those under subparagraphs (B), (C), 
and (D) of section 412(b)(2) and under subparagraph (B) of section 
412(b)(3). Any base resulting from a change in funding method is treated 
as a prior amortization base within the meaning of this paragraph (b). 
Any accumulated funding deficiency or credit balance in the funding 
standard account is set equal to zero when the initial restoration 
amortization base is established.
    (2) Example. A pension plan uses the calendar year as its plan year, 
makes its annual periodic valuation as of January 1, and uses the unit 
credit actuarial cost method for funding purposes. The plan is in the 
process of being terminated. By order of the Pension Benefit Guaranty 
Corporation the plan is restored as of July 1, 1991, and a restoration 
payment schedule order issued on October 31, 1992. The initial post-
restoration valuation date is January l, 1993. If, as of that date, the 
accrued liability of the plan is $1,000,000 and the value of the plan 
assets is $200,000, the

[[Page 882]]

initial restoration amortization base is $800,000.
    (c) Establishment of a restoration payment schedule--(1) 
Certification requirement. When the PBGC establishes a restoration 
payment schedule, the Executive Director of the PBGC must certify to the 
Corporation's Board of Directors, and to the Internal Revenue Service, 
that the Corporation has reviewed the funding of the plan, the financial 
condition of the plan sponsor and its controlled group members, the 
payments required under the restoration payment schedule (taking into 
account the availability of deferrals authorized under paragraph (c)(4) 
of this section), and any other factor that the Corporation deems 
relevant, and, based on that review, determines that it is in the best 
interests of participants and beneficiaries of the plan and the pension 
insurance program that the restored plan not be reterminated.
    (2) Requirements for restoration payment schedule--(i) Amortization 
of base over period of no more than 30 years. The restoration payment 
schedule must be prescribed in an order requiring the employer to make 
stated contributions to the plan sufficient to amortize the initial 
restoration amortization base over a period extending not more than 30 
years after the initial post-restoration valuation date (the restoration 
payment period). The restoration payment schedule must be sufficient to 
amortize the entire amount of the initial restoration amortization base 
by the end of the restoration payment period. The scheduled charges need 
not be in level amounts, but the present value of the prescribed charges 
on the initial post-restoration valuation date, computed with interest 
at the valuation rate, must equal the initial restoration amortization 
base.
    (ii) Minimum annual charge. The restoration payment schedule must 
require annual charges that are sufficient to prevent the outstanding 
balance of the initial restoration amortization base from exceeding 
whichever of the following amounts is applicable:
    (A) During the first 10 plan years on the restoration payment 
schedule, the amount of the initial restoration amortization base on the 
date the base was established, or
    (B) During plan years 11 through 20 on the restoration payment 
schedule, the maximum permitted outstanding balance of the initial 
restoration amortization base at the end of the tenth plan year, as 
calculated under paragraph (c)(2)(iii) below, or
    (C) During plan years 21 through the end of the restoration payment 
schedule, the maximum permitted outstanding balance of the initial 
restoration amortization base at the end of the twentieth plan year, as 
calculated under paragraph (c)(2)(iii) below.
    (iii) Interim amortization requirements. The restoration payment 
schedule must provide for sufficient periodic charges so that the 
outstanding balance of the initial restoration amortization base at the 
end of the tenth plan year and at the end of the twentieth plan year of 
the restoration payment period will not be larger than the outstanding 
balance that would have remained at the end of the tenth plan year and 
at the end of the twentieth plan year, respectively, if the initial 
restoration amortization base had been amortized in level amounts over 
the restoration payment period at the valuation rate.
    (3) Amendments to the restoration payment schedule. The order 
establishing the restoration payment schedule may be amended by the 
Pension Benefit Guaranty Corporation from time to time with respect to 
any remaining payments, provided that no amendment may extend the 
restoration payment period beyond 30 years from the initial post-
restoration valuation date, and provided further that the restoration 
payment schedule, as amended, satisfies the requirements of paragraph 
(c)(2) of this section.
    (4) Deferral of minimum scheduled annual payment amounts--(i) 
Authority to grant deferral. Not later than 2\1/2\ months following the 
end of the plan year, the Pension Benefit Guaranty Corporation may grant 
a deferral of the charges required in the restoration payment schedule 
for that plan year if the requirements in paragraph (c)(4)(ii) of this 
section are satisfied. The Pension Benefit Guaranty Corporation may 
require the plan sponsor and its controlled group members to provide

[[Page 883]]

security to the plan as a condition to granting a deferral.
    (ii) Determination of business hardship. Before granting a deferral 
under this paragraph (c)(4), the Pension Benefit Guaranty Corporation 
must make a determination that the granting of the deferral is in the 
best interests of plan participants and the plan termination insurance 
system, and that the plan sponsor and its controlled group members are 
unable to make the scheduled restoration payments without experiencing 
temporary substantial business hardship. In making these determinations, 
the factors the Pension Benefit Guaranty Corporation shall consider, 
include, but are not limited to, the following:
    (A) Whether the plan sponsor and its controlled group members are 
operating at an economic loss,
    (B) Whether there is substantial unemployment or underemployment in 
the trades or businesses of the plan sponsor and its controlled group 
members,
    (C) Whether the sales and profits of the industry or industries are 
depressed or declining, and
    (D) Whether it is reasonable to expect that the plan termination 
insurance system will suffer a greater loss if the plan is terminated 
than if it is continued as a restored plan.
    (iii) Amount of deferral. The amount of the deferral for any 
particular plan year may not exceed the lesser of the amount that would 
have been required to be contributed under the restoration payment 
schedule for that year or interest on the outstanding balance of the 
initial restoration amortization base for that year. An amortization 
payment for a deferral granted for a prior plan year may not be 
deferred. No deferral may extend the overall restoration payment period 
beyond 30 years.
    (iv) Modification of payment schedule. The restoration payment 
schedule must be adjusted to reflect any deferral granted for a plan 
year in the manner prescribed in this paragraph (c). The charge 
otherwise specified in the schedule is reduced by the amount of any 
deferral. The charges under the restoration payment schedule for the 
subsequent plan years are increased by the amounts in paragraph 
(c)(4)(v) of this section.
    (v) Amortization of deferred amount. The amount of any deferral 
granted by the Pension Benefit Guaranty Corporation for any plan year 
must be amortized in level amounts over five years or such shorter 
period as may be prescribed by the Pension Benefit Guaranty Corporation, 
at the valuation rate, beginning with the plan year following the year 
of the deferral.
    (vi) Number of deferrals permitted. The Pension Benefit Guaranty 
Corporation may not grant more than five deferrals of the minimum 
scheduled payments as required by this section during the restoration 
payment period and no more than three of these deferrals may be granted 
during the first ten years of that period.
    (d) Charging the scheduled restoration charges to the funding 
standard account. In addition to any other charges and credits 
prescribed in the normal operation of the funding standard account under 
section 412, the amount of each charge specified in the restoration 
payment schedule shall be charged against the funding standard account 
of the plan for the plan year to which that payment is attributed in the 
restoration payment schedule.
    (e) Changes in actuarial assumptions. If changes in actuarial 
assumptions increase or decrease the charges that would be required to 
amortize the outstanding balance of the initial restoration amortization 
base over the remaining years of the restoration payment schedule, the 
plan must notify the Pension Benefit Guaranty Corporation of the changes 
so that it may make appropriate changes to the restoration payment 
schedule.
    (f) Change to restoration method. A plan that has been restored must 
use the restoration method until the initial restoration amortization 
base has been fully amortized. The use of this method does not require 
prior approval from the Commissioner. A plan using the restoration 
method must compute the charges and credits to the initial restoration 
amortization base in accordance with the order of the Pension Benefit 
Guaranty Corporation and in accordance with this section.

[[Page 884]]

    (g) Deficit reduction contribution--(1) Calculation of deficit 
reduction contribution. For any plan using the restoration method, the 
deficit reduction contribution under section 412(l)(2) is equal to the 
sum of--
    (i) The unfunded section 412(l) restoration liability amount, plus
    (ii) The unfunded new liability amount.
    (2) Unfunded section 412(l) restoration liability amount. The 
unfunded section 412(l) restoration liability amount is the amount 
necessary to amortize fully the unfunded section 412(l) restoration 
liability in installments, as prescribed by the Pension Benefit Guaranty 
Corporation, over not more than 30 years. The annual amount need not be 
level, but at all times the present value of the future amortization 
charges under the restoration payment schedule, at the current liability 
interest rate, must equal the outstanding balance of the unfunded 
section 412(l) restoration liability and the schedule must provide that 
at the end of no more than 30 years the entire amount of the unfunded 
section 412(l) restoration liability base will have been fully 
amortized. The schedule prescribed for amortization of the unfunded 
section 412(l) restoration liability must comply with the requirements 
imposed in paragraph (c) of this section on the restoration payment 
schedule, except as provided in paragraph (g)(7) of this section and 
except that the maximum permitted outstanding balance of the unfunded 
section 412(l) restoration liability at the end of the tenth plan year 
must not be greater than the outstanding balance of the section 412(l) 
restoration liability that would have remained at the end of the tenth 
plan year if the unfunded section 412(l) restoration liability had been 
amortized in level amounts over the restoration payment period at the 
current liability interest rate, increased by the current liability 
interest rate differential as defined under paragraph (g)(7) of this 
section. The Pension Benefit Guaranty Corporation may amend the 
amortization schedule for the unfunded section 412(l) restoration 
liability subject to the limits on amendments to the amortization 
schedule prescribed for the initial restoration amortization base.
    (3) Establishment of unfunded section 412(l) restoration liability. 
In the plan year in which the initial post-restoration valuation date 
falls, the unfunded section 412(l) restoration liability is equal to the 
unfunded current liability of the plan.
    (4) Unfunded new liability amount. In the case of a plan using the 
restoration method, the unfunded new liability amount is the applicable 
percentage, as defined in section 412(l)(4)(C), of the unfunded new 
liability determined under paragraph (g)(5) of this section.
    (5) Unfunded new liability. The unfunded new liability of a plan 
using the restoration method is the unfunded current liability of the 
plan for the plan year less the outstanding balance of the unfunded 
section 412(l) restoration liability determined under paragraph (g)(3) 
of this section and less any unpredictable contingent event benefit 
liabilities (without regard to whether or not the event has occurred).
    (6) Offset of amortization charges. The charges specified in the 
restoration payment schedule to amortize the initial restoration 
amortization base, must be offset against the deficit reduction 
contribution in paragraph (g)(1) of this section along with any other 
applicab1e amounts provided in section 412 (l)(1)(A)(ii).
    (7) Interest rate differential. During the first 10 plan years after 
the initial post-restoration valuation date, the unfunded section 412(l) 
restoration liability amount for the plan as determined for purposes of 
this section must be sufficient to prevent the outstanding balance of 
the unfunded section 412(l) restoration liability from exceeding the 
initial amount of the unfunded section 412(l) restoration liability 
increased by the current liability interest rate differential. The 
current liability interest rate differential at any point during the 
first ten years of the restoration payment period is the excess if any 
of the accumulated interest on the unfunded section 412(l) restoration 
liability computed at the current liability interest rate over the 
accumulated interest on the unfunded section 412(l) restoration 
liability computed at the least of the valuation rate, the current 
liability interest rate and current liability interest rate for

[[Page 885]]

the plan year in which the initial post restoration valuation date 
falls. The current liability interest rate differential is charged to 
the funding standard account at the end of the tenth plan year, but the 
Pension Benefit Guaranty Corporation may, as part of the restoration 
payment schedule order, or a modification to that order, direct that the 
charging of this amount must be spread over not more than 5 years, 
beginning with the eleventh plan year.
    (h) Election of the alternative minimum funding standard. A plan 
using the restoration method may not elect the alternative minimum 
funding standard under section 412(g).
    (i) Funding review by the Pension Benefit Guaranty Corporation. The 
Pension Benefit Guaranty Corporation must review the funding of any plan 
using the restoration method at least once in each plan year. As a 
result of a funding review, the Pension Benefit Guaranty Corporation may 
amend the restoration payment schedule as provided in paragraph (c)(3) 
of this section. As part of the funding review, the Executive Director 
of the PBGC must certify to the Corporation's Board of Directors, and to 
the Internal Revenue Service, that the Corporation has reviewed the 
funding of the plan, the financial condition of the plan sponsor and its 
controlled group members, the payments required under the restoration 
payment schedule (taking into account the availability of deferrals 
authorized under paragraph (c)(4) of this section), and any other factor 
that the Corporation deems relevant, and, based on that review, 
determines that it is in the best interests of participants and 
beneficiaries of the plan and the pension insurance program that the 
restored plan not be reterminated.

[T.D. 8317, 55 FR 42707, Oct. 23, 1990; 56 FR 19038, Apr. 25, 1991]



Sec. 1.412(c)(2)-1  Valuation of plan assets; reasonable actuarial 
valuation methods.

    (a) Introduction--(1) In general. This section prescribes rules for 
valuing plan assets under an actuarial valuation method which satisfies 
the requirements of section 412(c)(2)(A). An actuarial valuation method 
is a funding method within the meaning of section 412(c)(3) and the 
regulations thereunder. Therefore, certain changes affecting the 
actuarial valuation method are identified in this section as changes in 
a plan's funding method.
    (2) Exception for certain bonds, etc. The rules of this section do 
not apply to bonds or other evidences of indebtedness for which the 
election described in section 412(c)(2)(B) has been made, nor are such 
assets counted in applying paragraphs (b) or (c) of this section. Also, 
an election under section 412(c)(2)(B) is not a change in funding method 
within the meaning of section 412(c)(5).
    (3) Money purchase pension plan. A money purchase pension plan must 
value assets for the purpose of satisfying the requirements of section 
412(c)(2)(A) solely on the basis of their fair market value (under 
paragraph (c) of this section).
    (4) Defined benefit plans. (i) To satisfy the requirements of 
section 412(c)(2)(A), an actuarial method valuing assets of a defined 
benefit plan must meet the requirements of paragraph (b) of this 
section.
    (ii) In general, the purpose of paragraph (b) of this section is to 
permit use of reasonble actuarial valuation methods designed to mitigate 
short-run changes in the fair market value of plan assets. The funding 
of plan benefits and the charges and credits to the funding standard 
account required by section 412 are generally based upon the assumption 
that the defined benefit plan will be continued by the employer. Thus, 
short-run changes in the value of plan assets presumably will offset one 
another in the long term. Accordingly, in the determination of the 
amount required to be contributed under section 412 it is generally not 
necessary to recognize fully each change in fair market value of the 
assets in the period in which it occurs.
    (iii) The asset valuation rules contained in paragraph (b) produce a 
``smoothing'' effect. Thus, investment performance, including 
appreciation or depreciation in the market value of the assets occurring 
in each plan year, may be recognized gradually over several plan years. 
This ``smoothing'' is in addition to the ``smoothing'' effect which 
results, for example, from amortizing

[[Page 886]]

experience losses and gains over 15 or 20 years under section 412(b)(2 
(B)(iv) and (3)(B)(ii).
    (b) Asset valuation method requirements--(1) Consistent basis. (i) 
The actuarial asset valuation method must be applied on a consistent 
basis. Any change in meeting the requirements of this paragraph (b) is a 
change in funding method subject to section 412(c)(5).
    (ii) A method may satisfy the consistency requirement even though 
computations are based only on the period elapsed since the adoption of 
the method or on asset values occurring during that period.
    (2) Statement of plan's method. The method of determining the 
actuarial value (but not fair market value) of the assets must be 
specified in the plan's actuarial report (required under section 6059). 
The method must be described in sufficient detail so that another 
actuary employing the method described would arrive at a reasonably 
similar result. Whether a deviation from the stated actuarial valuation 
method is a change in funding method is to be determined in accordance 
with section 412(c)(5) and the regulations thereunder. A deviation to 
include a type of asset not previously held by the plan would not be a 
change in funding method.
    (3) Consistent valuation dates. The same day or days (such as the 
first or the last day of a plan year) must be used for all purposes to 
value the plan's assets for each plan year, or portion of plan year, for 
which a valuation is made. For purposes of this section, each such day 
is a valuation date. A change in the day or days used is a change in 
funding method.
    (4) Reflect fair market value. The valuation method must take into 
account fair market value by making use of the--
    (i) Fair market value (determined under paragraph (c) of this 
section), or
    (ii) Average value (determined under paragraph (b)(7) of this 
section) of the plan's assets as of the applicable asset valuation date. 
This is done either directly in the computation of their actuarial value 
or indirectly in the computation of upper or lower limits placed on that 
value.
    (5) Results above and below fair market or average value. A method 
will not satisfy the requirements of this paragraph (b) if it is 
designed to produce a result which will be consistently above or below 
the values described in paragraph (b)(4) (i) and (ii). However, a method 
designed to produce a result which consistently falls between fair 
market value and average value will satisfy this requirement. See 
Example 5 in paragraph (b)(9) of this section for an illustration of a 
method described in the preceding sentence.
    (6) Corridor limits. (i) Regardless of how the method reflects fair 
market value under paragraph (b)(4), the method must result in an 
actuarial value of the plan's assets which is not less than a minimum 
amount and not more than a maximum amount. The minimum amount is the 
lesser of 80 percent of the current fair market value of plan assets as 
of the applicable asset valuation date or 85 percent of the average 
value (as described in subparagraph (7)) of plan assets as of that date. 
The maximum amount is the greater of 120 percent of the current fair 
market value of plan assets as of the applicable asset valuation date or 
115 percent of the average value of plan assets as of that date.
    (ii) Under a plan's method, a preliminary computation of the 
expected actuarial value may fall outside the prescribed corridor. A 
method meets the requirements of paragraph (b)(6)(i) of this section is 
such a case only by adjusting the expected actuarial value to the 
nearest corridor limit applicable under the method. A plan may use an 
actuarial valuation method with a narrower corridor than the general 
corridor required under paragraph (b)(6)(i). The adjustment to the 
nearest corridor limit of such a method for purposes of this subdivision 
(ii) would be determined by the narrower corridor stated in the 
description of the plan's method.
    (7) Average value. the average value of plan assets is computed by--
    (i) Determining the fair market value of plan assets at least 
annually,
    (ii) Adding the current fair market value of the assets (as of the 
applicable valuation date) and their adjusted values (as described in 
paragraph (b)(8) of this section) for a stated period not to

[[Page 887]]

exceed the five most recent plan years (including the current year), and
    (iii) Dividing this sum by the number of values (including the 
current fair market value) considered in computing the sum described in 
subdivision (ii).
    (8) Adjusted value. (i) the adjusted value of plan assets for a 
prior valuation date is their fair market value on that date with 
certain positive and negative adjustments. These adjustments reflect 
changes that occur between the prior asset valuation date and the 
current valuation date. However, no adjustment is made for increases or 
decreases in the total value of plan assets that result from the 
purchase, sale, or exchange of plan assets or from the receipt of 
payment on a debt obligation held by the plan.
    (ii) In determining the adjusted value of plan assets for a prior 
valuation date, there is added to the fair market value of the plan 
assets of that date the sum of all additions to the plan assets since 
that date, excluding appreciation in the fair market value of the 
assets. The additions would include, for example, any contribution to 
the plan; any interest or dividend paid to the plan; and any asset not 
taken into account in a prior valuation of assets, but taken into 
account for the current year, in computing the fair market value of plan 
assets under paragraph (c) of this section.
    (iii) In determining the adjusted value of plan assets for a prior 
valuation date, there is subtracted from the fair market value of the 
plan assets on that date the sum of all reductions in plan assets since 
that date, excluding depreciation in the fair market value of the 
assets. The reductions would include, for example, any benefit paid from 
plan assets; any expense paid from plan assets; and any asset taken into 
account in a prior valuation of assets but not taken into account for 
the current year, in computing the fair market value of plan assets 
under paragraph (c) of this section.
    (9) Examples. This paragraph (b) may be illustrated by the following 
examples. In each example, assume that the pension plan uses a 
consistent actuarial method of valuing its assets within the meaning of 
paragraph (b)(1), (2), and (3) of this section.

    Example 1. Plan A considers the value of its assets to be initial 
cost, increased by an assumed rate of growth of X percent annually. 
Under the circumstances, the X-percent factor used by the plan is a 
reasonable assumption. Thus, this method is not designed to produce 
results consistently above or below fair market value as prohibited by 
paragraph (b)(5) of this section. Also, the method requires that the 
actuarial value be adjusted as required to fall within the corridor 
under paragraph (b) (6) and (7) of this section. Therefore, the method 
reflects fair market value as required by paragraph (b)(4) of this 
section.
    Example 2. Plan B computes the actuarial value of its assets as 
follows: It determines the fair market value of the plan assets. Then 
the fair market value is adjusted to the extent necessary to make the 
actuarial value fall within a ``5 percent'' corridor. This corridor is 
plus or minus 5 percent of the following amount: the fair market value 
of the assets at the beginning of the valuation period plus an assumed 
annual growth of 4 percent with adjustments for contributions and 
benefit payments during the period. This method reflects fair market 
value in a manner prescribed by paragraph (b)(4) of this section. If the 
4 percent factor used by the plan is a reasonable assumption, this 
method is not designed to produce results consistently above or below 
fair market value, and thus it satisfies paragraph (b)(5). However, this 
method is unacceptable because in some instances it may result in an 
actuarial value outside the corridor described in paragraph (b)(6) of 
this section. This method would be permitted if a second corridor were 
imposed which would adjust the value of the total plan assets to the 
corridor limits as required by paragraph (b)(6).
    Example 3. Plan C values its assets by multiplying their fair market 
value by an index number. The use of the index results in the 
hypothetical average value that plan assets present on the valuation 
date would have had if they had been held during the current and four 
preceding years, and had appreciated or depreciated at the actual yield 
rates including appreciation and depreciation experienced by the plan 
during that period. However, the method requires an adjustment to the 
extent necessary to bring the resulting actuarial value of the assets 
inside the corridor described in the statement of the plan's actuarial 
valuation method. In this case, the stated corridor is 90 to 110 percent 
of fair market value, a corridor narrower than that described in 
paragraph (b)(7) of this section. This method is permitted.
    Example 4. Plan D values its assets by multiplying their fair market 
value by 95 percent. Although the method reflects fair market value and 
the results of this method will always be within the required corridor, 
it is

[[Page 888]]

not acceptable because it will consistently result in a value less than 
fair market value.
    Example 5. Plan E values its assets by using a five-year average 
method with appropriate adjustments for the period. Under the particular 
method used by Plan E, assets are not valued below 80 percent of fair 
market value or above 100 percent of fair market value. If the average 
produces a value that exceeds 100 percent of fair market value, the 
excess between 100 and 120 percent is recorded in a ``value reserve 
account.'' In years after one in which the average exceeds 100 percent 
of fair market value, amounts are subtracted from this account and 
added, to the extent necessary, to raise the value produced by the 
average for that year to 100 percent of fair market value. This method 
is permitted because it reflects fair market value under paragraph 
(b)(4) of this section by appropriately computing an average value, it 
satisfies paragraph (b)(5) by producing a result that falls consistently 
between fair market value and average value, and it properly reflects 
the corridor described in paragraph (b)(7).
    Example 6. All assets of Plan F are invested in a trust fund and the 
plan year is the calendar year. The actuarial value is determined by 
averaging fair market value over 4 years. An actuarial valuation is 
performed as of December 31, 1988.
    (i) The average value as of December 31, 1988, is computed as 
follows:

----------------------------------------------------------------------------------------------------------------
                                             1986        1986        1987        1987        1988        1988
----------------------------------------------------------------------------------------------------------------
Fair market value: Jan. 1...............  ..........    $150,000  ..........    $196,500  ..........    $238,000
  Contributions.........................     $65,000  ..........     $62,000  ..........     $66,000
  Benefit payments......................    (22,000)  ..........    (24,000)  ..........    (25,000)
  Expenses..............................     (6,500)  ..........     (7,000)  ..........     (7,500)
  Interest and dividends................       8,000      44,500       7,500      38,500       7,000     240,500
Net realized gains (losses).............  ..........     (2,000)  ..........       6,000  ..........     (8,000)
Balancing item \1\......................  ..........       4,000  ..........     (3,000)  ..........    (42,000)
                                         -----------------------------------------------------------------------
Fair market value: Dec. 31..............  ..........     196,500  ..........     238,000  ..........    228,000
----------------------------------------------------------------------------------------------------------------
\1\ This equals the increase (decrease) in unrealized appreciation.


----------------------------------------------------------------------------------------------------------------
                 Adjusted values                       1985            1986            1987            1988
----------------------------------------------------------------------------------------------------------------
Fair market value: Dec. 31......................        $150,000        $196,500        $238,000        $228,000
Net adjustments:
  1988..........................................          40,500          40,500          40,500
  1987..........................................          38,500          38,500
  1986..........................................          44,500
                                                 ---------------------------------------------------------------
   Total........................................         273,500         275,500         278,500         228,000
                                                 ===============================================================
Average value: 1988=$273,500 + $275,500 + $278,500 + $228,000 / 4=$263,875
----------------------------------------------------------------------------------------------------------------

    (ii) Plan F properly determines an average value under paragraph 
(b)(7) of this section for use as an actuarial value. Therefore, the 
valuation method meets the requirements of this section.
    Example 7. Plan G computes the actuarial value of the plan assets as 
follows: The current fair market value of the plan assets is averaged 
with the most recent prior adjusted actuarial value. This average value 
is adjusted up or down toward the current fair market value by 20 
percent of the difference between it and the current fair market value 
of the assets. This value is further adjusted to the extent necessary to 
fall within the corridor described in the statement of the plan's 
actuarial valuation method. The lower end of the corridor is the lesser 
of 80 percent of the fair market value of the plan assets or 85 percent 
of the average value of the plan assets. The higher end of the corridor 
is the greater of 120 percent of the fair market value of plan assets or 
115 percent of the average value of plan assets. Average value for 
purposes of the corridor is determined under paragraph (b)(7) of this 
section. Assuming the numerical data of Example 6, the application of 
the corridor is as follows. The actuarial asset value as of December 31, 
1988, must not be less than $182,400 (80 percent of current fair market 
value, $228,000) nor greater than $303,456 (115 percent of average 
value, 263,875). This method is permitted because it reflects fair 
market value in a manner permitted by paragraph (b)(4) of this section, 
it produces an actuarial value which is neither consistently above nor 
consistently below fair market or average value to satisfy paragraph 
(b)(5), and it is appropriately limited by the corridor described in 
paragraph (b)(6).

    (c) Fair market value of assets--(1) General rules. Except as 
otherwise provided in this paragraph (c), the fair market value of a 
plan's assets for purposes of this section is the price at which the 
property would change hands between

[[Page 889]]

a willing buyer and a willing seller, neither being under any compulsion 
to buy or sell and both having reasonable knowledge of relevant facts.
    (d) Methods for taking into account the fair market value of certain 
agreements. [Reserved]
    (e) Effective date and transition rules--(1) Effective date. This 
section applies to plan years to which section 412, or section 302 of 
the Employee Retirement Income Security Act of 1974, applies.
    (2) Special rule for certain plan years. For plan years beginning 
prior to November 12, 1980, the amounts required to be determined under 
section 412 may be computed on the basis of any reasonable actuarial 
method of asset valuation which takes into account the fair market value 
of the plan's assets, even if the method does not meet all of the 
requirements of paragraphs (a) through (c) of this section.
    (3) Plan years beginning on or after November 12, 1980. Paragraphs 
(a) through (c) of this section apply beginning with the first valuation 
of plan assets made for a plan year to which section 412 applies that 
begins on or after November 12, 1980. The statement of the plan's 
actuarial asset valuation method required by paragraph (b)(2) of this 
section must be included with the plan's actuarial report for that year, 
in addition to any subsequent reports.
    (4) Effect of change of asset valuation method. A plan which is 
required to change its asset valuation method to comply with paragraphs 
(a) through (c) of this section must make the change no later than the 
time when the plan is first required to comply with this section under 
paragraph (e)(3). A method of adjustment must be used to take account of 
any difference in the actuarial value of the plan's assets based on the 
old and new valuation methods. The plan may use either--
    (i) A method of adjustment described in paragraph (e)(5) or (e)(6) 
of this section without prior approval by the Commissioner, or
    (ii) Any other method of adjustment if the Commissioner gives prior 
approval under section 412(c)(5).
    (5) Retroactive recomputation method. (i) Under this method of 
adjustment, the plan recomputes the balance of the funding standard 
account as of the beginning of the first plan year for which it uses its 
new asset valuation method to comply with paragraphs (a) through (c) of 
this section. This new balance is recomputed by retroactively applying 
the plan's new method as of the first day of the first plan year to 
which section 412 applies.
    (ii) Beginning with the first plan year for which it uses its new 
method, the plan computes the normal cost and amortization charges and 
credits to the funding standard account based on the retroactive 
application of its new method as of the first day of the first plan year 
to which section 412 applies.
    (iii) If the recomputed aggregate charges exceed the recomputed 
aggregate credits to the funding standard account as of the end of the 
first plan year for which the plan uses its new method, an additional 
contribution to the plan may be necessary to avoid an accumulated 
funding deficiency in that year. The use of the retroactive 
recomputation method may also result in an accumulated funding 
deficiency for years prior to that first year. In such cases, the rules 
of section 412(c)(10), relating to the time when certain contributions 
are deemed to have been made, apply.
    (6) Prospective gain or loss adjustment method. (i) Under this 
method of adjustment the plan values its assets under its new method no 
later than the valuation date for the first plan year beginning after 
[the publication date of this section]
    (ii) Regardless of the type of funding method used by a plan, the 
difference in the value of the assets under the old and the new asset 
valuation methods may be treated as arising from an experience loss or 
gain; or alternatively it may be treated as arising from a change in 
actuarial assumptions.
    (iii) The treatment of this difference as an experience gain or loss 
or as a change in actuarial assumptions must be consistent with the 
treatment of such gains, losses, or changes under the funding method 
used by the plan. Thus, if a plan uses a spread gain type funding method 
other than the aggregate cost method, the difference in the value of 
assets under the old and the new asset valuation methods may be either 
amortized or spread over future

[[Page 890]]

periods as a part of normal cost. Examples of this type of funding 
method are the frozen initial liability cost method and the attained age 
normal cost method. With an aggregate method, the difference in the 
value of assets under the old and the new asset valuation methods must 
be spread over future periods as a part of normal cost.

(Secs. 412(c)(2) and 7805 of the Internal Revenue Code of 1954 (88 Stat. 
916 and 68A Stat. 917; 26 U.S.C. 412(c)(2) and 7805))

[T.D. 7734, 45 FR 74718, Nov. 12, 1980]



Sec. 1.412(c)(3)-1  Reasonable funding methods.

    (a) Introduction--(1) In general. This section prescribes rules for 
determining whether or not, in the case of an ongoing plan, a funding 
method is reasonable for purposes of section 412(c)(3). A method is 
unreasonable only if it is found to be inconsistent with a rule 
prescribed in this section. The term ``reasonable funding method'' under 
this section has the same meaning as the term ``acceptable actuarial 
cost method'' under section 3(31) of the Employee Retirement Income 
Security Act of 1974 (ERISA).
    (2) Computations included in method. See Sec. 1.412(c)(1)-1(b) for 
a discussion of matters that are, and are not, included in the funding 
method of a plan.
    (3) Plans using shortfall. The shortfall method is a method of 
determining charges to the funding standard account by adapting the 
underlying funding method of certain collectively bargained plans in the 
manner described in Sec. 1.412(c)(1)-2. As such, the shortfall method 
is a funding method. The underlying method of a plan that uses the 
shortfall method must be a reasonable funding method under this section. 
The rules contained in this section, relating to cost under a reasonable 
funding method, apply in the shortfall method to the annual computation 
charge under Sec. 1.412(c)(1)-2(d).
    (4) Scope of funding method. Except for the shortfall method, a 
reasonable funding method is applied to the computation of--
    (i) The normal cost of a plan for a plan year; and, if applicable,
    (ii) The bases established under section 412(b)(2)(B), (C), and (D), 
and (3) (B) (``amortizable bases'').
    (b) General rules for reasonable funding methods--(1) Basic funding 
formula. At any time, except as provided by the Commissioner, the 
present value of future benefits under a reasonable funding method must 
equal the sum of the following amounts:
    (i) The present value of normal costs (taking into account future 
mandatory employee contributions, within the meaning of section 
411(c)(2)(C), in the case of a contributory plan) over the future 
working lifetime of participants;
    (ii) The sum of the unamortized portions of amortizable bases, if 
any, treating credit bases under section 412(b)(3)(B) as negative 
numbers; and
    (iii) The plan assets, decreased by a credit balance (and increased 
by a debit balance) in the funding standard account under section 
412(b).
    (2) Normal cost. Normal cost under a reasonable funding method must 
be expressed as--
    (i) A level dollar amount, or a level percentage of pay, that is 
computed from year to year on either an individual basis or an aggregate 
basis; or
    (ii) An amount equal to the present value of benefits accruing under 
the method for a particular plan year.
    (3) Application to shortfall. Paragraph (b)(2) will not fail to be 
satisfied merely because an amount described in (i) or (ii) is expressed 
as permitted under the shortfall method.
    (c) Additional requirements--(1) Inclusion of all liabilities. Under 
a reasonable funding method, all liabilities of the plan for benefits, 
whether vested or not, must be taken into account.
    (2) Production of experience gains and losses. If each actuarial 
assumption is exactly realized under a reasonable funding method, no 
experience gains or losses are produced.
    (3) Plan population--(i) In general. Under a reasonable funding 
method, the plan population must include three classes of individuals: 
participants currently employed in the service of the employer; former 
participants who either terminated service with the employer, or 
retired, under the plan; and all other individuals currently entitled to 
benefits under the plan. See Sec. 1.412(c)(3)-1(d)(2) for rules 
concerning anticipated future participants.

[[Page 891]]

    (ii) Limited exclusion for certain recent participants. Under a 
reasonable funding method, certain individuals may be excluded from the 
first class of individuals described in paragraph (c)(3)(i) of this 
section unless otherwise provided by the Commissioner. The excludable 
individuals are participants who would be excluded from participation by 
the minimum age or service requirement of section 410 but who, under the 
terms of the plan, participate immediately upon entering the service of 
the employer.
    (iii) Special exclusion for ``rule of parity'' cases. Under a 
reasonable funding method, certain individuals may be excluded from the 
second class of individuals described in paragraph (c)(3)(i) of this 
section. The excludable individuals are those former participants who 
have terminated service with the employer without vested benefits and 
whose service might be taken into account in future years because the 
``rule of parity'' of section 411(a)(6)(D) does not permit that service 
to be disregarded. However if the plan's experience as to separated 
employees' returning to service has been such that the exclusion 
described in this subparagraph would be unreasonable, the exclusion 
would no longer apply.
    (4) Use of salary scale--(i) General acceptability. The use of a 
salary scale assumption is not inappropriate merely because of the 
funding method with which it is used. Therefore, in determining whether 
actuarial assumptions are reasonable, a salary scale will not be 
considered to be prohibited merely because a particular funding method 
is being used.
    (ii) Projection to appropriate salary. Under a reasonable funding 
method, salary scales reflected in projected benefits must be the 
expected salary on which benefits would be based under the plan at the 
age when the receipt of benefits is expected to begin.
    (5) Treatment of allocable items. Under a reasonable funding method 
that allocates assets to individual participants to determine costs, the 
allocation of assets among participants must be reasonable. An initial 
allocation of assets among participants will be considered reasonable 
only if it is in proportion to related liabilities. However, the 
Commissioner may determine, based on the facts and circumstances, that 
it is unreasonable to continue to allocate assets on this basis beyond 
the initial year. Under a reasonable funding method that allocates 
liabilities among different elements of past and future service, the 
allocation of liabilities must be reasonable.
    (d) Prohibited considerations under a reasonable funding method--(1) 
Anticipated benefit changes--(i) In general. Except as otherwise 
provided by the Commissioner, a reasonable funding method does not 
anticipate changes in plan benefits that become effective, whether or 
not retroactively, in a future plan year or that become effective after 
the first day of, but during, a current plan year.
    (ii) Exception for collectively bargained plans. A collectively 
bargained plan described in section 413(a) may on a consistent basis 
anticipate benefit increases scheduled to take effect during the term of 
the collective-bargaining agreement applicable to the plan. A plan's 
treatment of benefit increases scheduled in a collective bargaining 
agreement is part of its funding method. Accordingly, a change in a 
plan's treatment of such benefit increases (for example, ignoring 
anticipated increases after taking them into account) is a change of 
funding method.
    (2) Anticipated future participants. A reasonable funding method 
must not anticipate the affiliation with the plan of future participants 
not employed in the service of the employer on the plan valuation date. 
However, a reasonable funding method may anticipate the affiliation with 
the plan of current employees who have not satisfied the participation 
requirements of the plan.
    (e) Special rules for certain funding methods--(1) Applicability of 
special rules. Paragraph (e) of this section applies to a funding method 
that determines normal cost under paragraph (b)(2)(ii) of this section.
    (2) Use of salary scale. For rules relating to use of a salary scale 
assumption, see paragraph (c)(4) of this section.
    (3) Allocation of liabilities. In determining a plan's normal cost 
and accrued liability for a particular plan year, the projected benefits 
of the plan must be allocated between past years and future years. 
Except in the case of

[[Page 892]]

a career average pay plan, this allocation must be in proportion to the 
applicable rates of benefit accrual under the plan. Thus, the allocation 
to past years is effected by multiplying the projected benefit by a 
fraction. The numerator of the fraction is the participant's credited 
years of service. The denominator is the participant's total credited 
years of service at the anticipated benefit commencement date. 
Adjustments are made to account for changes in the rate of benefit 
accrual. An allocation based on compensation is not permitted. In the 
case of a career average pay plan, an allocation between past and future 
service benefits must be reasonable.
    (f) Treatment of ancillary benefit costs--(1) General rule. Under a 
reasonable funding method, except as otherwise provided by this 
paragraph (f), ancillary benefit costs must be computed by using the 
same method used to compute retirement benefit costs under a plan.
    (2) Ancillary benefit defined. For purposes of this paragraph an 
ancillary benefit is a benefit that is paid as a result of a specified 
event which--
    (i) Occurs not later than a participant's separation from service, 
and
    (ii) Was detrimental to the participant's health.


Thus, for example, benefits payable if a participant dies or becomes 
disabled prior to separation from service are ancillary benefits because 
the events giving rise to the benefits are detrimental to the 
participant's health. However, an early retirement benefit, a social 
security supplement (as defined in Sec. 1.411(a)-7(c)(4)(ii)), and the 
vesting of plan benefits (even if more rapid than is required by section 
411) are not ancillary benefits because those benefits do not result 
from an event which is detrimental to the participant's health.
    (3) Exception for certain insurance contracts. Under a reasonable 
funding method, regardless of the method used to compute retirement 
benefit costs, the cost of an ancillary benefit may equal the premium 
paid for that benefit under an insurance contract if--
    (i) The ancillary benefit is provided under the contract, and
    (ii) The benefit is guaranteed under the contract.
    (4) Exception for 1-year term funding and other approved methods. 
[Reserved]
    (5) Section 401(h) benefits. Section 412 does not apply to benefits 
that are described in section 401(h) and for which a separate account is 
maintained.
    (g) Examples. The principles of this section are illustrated by the 
following examples:

    Example 1. Assume that a plan, using funding method A, is in its 
first year. No contributions have been made to the plan, other than a 
nominal contribution to establish a corpus for the plan's trust. There 
is no past service liability, and the normal cost is a constant 
percentage of an annually determined amount. The constant percentage is 
99 percent, and the annually determined amount is the excess of the 
present value of future benefits over plan assets. The present value of 
future benefits is $10,000. Under paragraph (b)(1) of this section, the 
present value of future benefits must equal the present value of future 
normal costs plus plan assets. (No amortizable bases exist, nor are 
there credit or debit balances.) Under method A, the present value of 
future normal costs would equal the sum of a series of annually 
decreasing amounts. Because of the constant percentage factor, the 
present value of future normal costs over the years can never equal 
$10,000, the present value of future benefits. In effect, then, assets 
under method A can never equal the present value of future benefits if 
all assumptions are exactly realized. Therefore, method A is not a 
reasonable funding method.
    Example 2. Assume that a plan, using funding method B, determines 
normal cost by computing the present value of benefits expected to be 
accrued under the plan by the end of 10 years after the valuation date 
and adding to this the present value of benefits expected to be paid 
within these 10 years. Plan assets are subtracted from the sum of the 
two present value amounts. The difference then is divided by the present 
value of salaries projected over the 10 years. Under paragraph (c)(1) of 
this section, all liabilities of a plan must be taken into account. 
Because method B takes into account only benefits paid or accrued by the 
end of 10 years, it is not a reasonable funding method.
    Example 3. Assume that a plan, using funding method C, determines 
normal cost as a constant percentage of compensation. (This percentage 
is determined as follows: The excess of projected benefits over accrued 
benefits is computed. Then the present value of this excess is divided 
by the present value of future salaries.) However, the accrued liability 
is computed each year as the present value of accrued benefits. (This 
computation

[[Page 893]]

does not reflect normal cost as a constant percentage of compensation. 
Thus, normal cost under the plan does not link accrued liabilities under 
the plan for consecutive years as would be the case, for example, under 
a unit credit cost method.) In determining gains and losses, method C 
compares the actual unfunded liability (the accrued liability less 
assets) with the expected unfunded liability (the sum of the actual 
unfunded liability in the previous year and the normal cost for the 
previous year less the contribution made for the previous year, all 
adjusted for interest). Under paragraph (c)(2) of this section, if 
actuarial assumptions are exactly realized, experience gains and losses 
must not be produced. Under method C, the use of a constant percentage 
in computing normal cost (and the expected unfunded liability) coupled 
with the manner of computing the accrued liability (and the actual 
unfunded liability) generally produces gains in the earlier years and 
losses in the later years if each actuarial assumption is exactly 
realized. Therefore, method C is not a reasonable funding method.
    Example 4. Assume that a plan, using funding method D, bases 
benefits on final average pay. Under method D, the past service 
liability on any date equals the present value of the accrued benefit on 
that date based on compensation as of that date. The normal cost for any 
year equals the present value of a certain amount. That amount is the 
excess of the projected accrued benefit as of the end of the year over 
the actual accrued benefit at the beginning of the year. Accrued 
benefits, projected as of the end of a year, reflect a 1-year salary 
projection. Under paragraph (c)(4) of this section, salary scales 
reflected in projected benefits must project salaries to the salary on 
which benefits would be based under the plan at the age when the receipt 
of benefits under the plan is expected to begin. Because the plan is not 
a career average pay plan and compensation is projected only 1 year, 
method D is not a reasonable funding method. (Under paragraph (c)(4) of 
this section, the use of a salary scale assumption could be required 
with a unit credit method if, without the use of a salary scale, 
assumptions in the aggregate are unreasonable.)
    Example 5. Assume that a plan, using method E, a unit credit funding 
method, calculates a participant's accrued benefit according to the 
following formula: 2 percent of final salary for the first 10 years of 
service and 1 percent of final salary for the years of service in excess 
of 10. Under the plan, no employee may be credited with more than 25 
years of service. The actuarial assumptions for the valuation include a 
salary scale of 5 percent per year. For a participant at age 40 with 15 
years of service, a current salary of $20,000 and a normal retirement 
age of 65, the accrued liability for the retirement benefit is the 
present value of an annuity of $16,932 per year, commencing at age 65. 
The $16,932 is calculated as follows:
[GRAPHIC] [TIFF OMITTED] TC14NO91.161


(3.3864 is 1.05 raised to the 25th power; the 25th power reflects the 
difference between normal retirement age and attained age (65-40).)
    Salary under this method is projected to the age when the receipt of 
benefits is expected to begin. Therefore, method E meets the requirement 
of paragraph (c)(4) of this section. Also, the allocation of benefits 
under method E between past and future years of service meets the 
requirements of paragraph (e)(3) of this section.
    Example 6. Assume that a plan that has two participants and that 
previously used the unit credit cost method wishes to change the funding 
method at the beginning of the plan year to funding method F, a 
modification of the aggregate cost method. The modification involves 
determining normal cost for each of the two participants under the plan. 
Therefore, it requires an allocation of assets to each participant for 
valuation purposes. The actuary proposes to allocate the assets on hand 
at the beginning of the plan year of the change in funding method in 
proportion to the accrued liabilities calculated under the unit credit 
cost method. The relevant results of the calculations are shown below:

------------------------------------------------------------------------
                                                    Employees
                                                ----------------  Totals
                                                    M       N
------------------------------------------------------------------------
Accrued Liabilities (unit credit method):
  Dollar amount................................   15,670    906   16,576
  Per cent of total............................    94.53   5.47   100.00
Assets:
  Dollar amount................................    7,835    453    8,288
  per cent of total............................    94.53   5.47   100.00
------------------------------------------------------------------------

    The proposed allocation in proportion to the accrued liabilities 
under the unit credit cost method satisfies the requirements of 
paragraph (c)(5) of this section at the beginning of the first plan year 
for which the new method is used.
    Example 7. The facts are the same as in Example 6. However, the 
actuary proposes to

[[Page 894]]

allocate all the assets to employee M, the older employee. Method F, 
under these facts, is not an acceptable funding method because the 
allocation is not in proportion to related liabilities as required under 
paragraph (c)(5) of this section.

[T.D. 7746, 45 FR 86430, Dec. 31, 1980]



Sec. 1.412(c)(3)-2  Effective dates and transitional rules relating to 
reasonable funding methods.

    (a) Introduction. This section prescribes effective dates for rules 
relating to reasonable funding methods, under section 412(c)(3) and 
Sec. 1.412(c)(3)-1. Also, this section sets forth rules concerning 
adjustments to a plan's funding standard account that are necessitated 
by a change in funding method, and a provision setting forth procedural 
requirements for use of an optional phase-in of required changes.
    (b) Effective date--(1) General rule. Except as otherwise provided 
by subparagraph (2) of this paragraph, Sec. 1.412(c)(3)-1 applies to 
any valuation of a plan's liabilities (within the meaning of section 
412(c)(9)) as of a date after April 30, 1981.
    (2) Exception. If a collective bargaining agreement which determines 
contributions to a plan is in effect on April 30, 1981, then Sec. 
1.412(c)(3)-1 applies to any valuation of that plan's liabilities as of 
a date after the earlier of the date on which the last such collective 
bargaining agreement expires or April 30, 1984.
    (3) Transitional rule. The reasonableness of a funding method used 
in making a valuation of a plan's liability as of a date before the 
effective date determined under subparagraph (1) or (2) of this 
paragraph is determined on the basis of such published guidance as was 
available on the date as of which the valuation was made.
    (c) Change of funding method without approval--(1) In general. A 
plan that is required to change its funding method to comply with Sec. 
1.412(c)(3)-1 is not required to submit the change of funding method for 
approval as otherwise required by section 412(c)(5). However, this 
change must be described on Form 5500, Schedule B for the plan year with 
respect to which the change is first effective.
    (2) Amortization base. An amortization base must be established in 
the plan year of the change in method equal to the change in the 
unfunded liability due to the change (where both unfunded liabilities 
are based on the same actuarial assumptions). Such a base must be 
amortized over 30 years in determining the charges or credits to the 
funding standard account, unless the Commissioner upon application 
permits amortization over a shorter period.
    (d) Phase-in of additional funding required by new method--(1) In 
general. A plan that is required to change its funding method to comply 
with Sec. 1.412(c)(3)-1 may elect to charge and credit the funding 
standard account as provided in this paragraph. An election under this 
paragraph shall be irrevocable.
    (2) Credit in year of change. In the plan year of the change in 
method the funding standard account may be credited with an amount not 
in excess of 0.8 multiplied by the excess (if any) of--
    (i) The normal cost under the new method plus the amortization 
charge (or minus the amortization credit) computed as described in Sec. 
1.412(c)(3)-2(c)(2), over
    (ii) The normal cost under the prior method, for the plan year of 
the change in method.
    (3) Credits in the next three years. In the three years following 
the year of the change the funding standard account may be credited with 
an amount not in excess of 0.6, 0.4, and 0.2 respectively in the first, 
second, and third years, multiplied by either of the following amounts, 
computed as of the last day of the year of credit--
    (i) The excess described in Sec. 1.412(c)(3)-2(d)(2) multiplied by 
a fraction (not greater than 1), the numerator of which is the number of 
participants in the year of the credit and the denominator of which is 
the number of participants in the year of the change, or, at the option 
of the plan,
    (ii) The excess (if any) in the year of credit of--
    (A) The net charge to the funding standard account based on the new 
method, over
    (B) The net charge to the funding standing account based on the 
prior method.

[[Page 895]]

    (4) Computational rules. For purposes of the calculation described 
in Sec. 1.412(c)(3)-2(d)(3)(ii), the net charge is the excess of 
charges under section 412(b)(2) (A) and (B) over the credits under 
section 412(b)(3)(B) (including the charge or credit described in Sec. 
1.412(c)(3)-2(c)) which would be required using the actuarial 
assumptions and plan benefit structure in effect on the last day of the 
plan year of change.
    (5) Fifteen-year amortization of credits. The funding standard 
account shall be charged with 15-year amortization of each credit 
described in Sec. 1.412(c)(3)-2(d) (2) and (3) beginning in the year 
following each such credit.
    (6) Manner of election. An election under this paragraph shall be 
made by the claiming of the credits described in Sec. 1.412(c)(3)-2(d) 
(2) and (3) on Schedule B to Form 5500 and by filing such other 
information as may be required by the Commissioner.
    (e) Effect on shortfall method. The charges and credits described in 
this section apply in the shortfall method to the annual computation 
charge described in Sec. 1.412(c)(1)-2(d). The amounts described in 
Sec. 1.412(c)(3)-2(d) shall be determined before the application of the 
shortfall method.

(Sec. 3(31) of the Employee Retirement Income Security Act of 1974 (88 
Stat. 837; 29 U.S.C. 1002) and sec. 7805 of the Internal Revenue Code of 
1954 (68A Stat. 917; 26 U.S.C. 7805))

[T.D. 7746, 45 FR 86432, Dec. 31, 1980]



Sec. 1.412(i)-1  Certain insurance contract plans.

    (a) In general. Under section 412(h)(2) of the Internal Revenue Code 
of 1954, as added by section 1013(a) of the Employee Retirement Income 
Security Act of 1974 (88 Stat. 914) (hereinafter referred to as ``the 
Act''), an insurance contract plan described in section 412(i) for a 
plan year is not subject to the minimum funding requirements of section 
412 for that plan year. Consequently, if an individual or group 
insurance contract plan satisfies all of the requirements of paragraph 
(b)(2) or (c)(2) of this section, whichever are applicable, for the plan 
year, the plan is not subject to the requirements of section 412 for 
that plan year. The effective date for section 412 of the Code is 
determined under section 1017 of the Act. In general, in the case of a 
plan which was not in existence on January 1, 1974, this section applies 
for plan years beginning after September 2, 1974, and in the case of a 
plan in existence on January 1, 1974, to plan years beginning after 
December 31, 1975.
    (b) Individual insurance contract plans. (1) An individual insurance 
contract plan is described in section 412(i) during a plan year if the 
plan satisfies the requirements of paragraph (b)(2) of this section for 
the plan year.
    (2) The requirements of this paragraph are:
    (i) The plan must be funded exclusively by the purchase from an 
insurance company or companies (licensed under the law of a State or the 
District of Columbia to do business with the plan) of individual annuity 
or individual insurance contracts, or a combination thereof. The 
purchase may be made either directly by the employer or through the use 
of a custodial account or trust. A plan shall not be considered to be 
funded otherwise than exclusively by the purchase of individual annuity 
or individual insurance contracts merely because the employer makes a 
payment necessary to comply with the provisions of section 411(c)(2) 
(relating to accrued benefit from employee contributions).
    (ii) The individual annuity or individual insurance contracts issued 
under the plan must provide for level annual, or more frequent, premium 
payments to be paid under the plan for the period commencing with the 
date each individual participating in the plan became a participant and 
ending not later than the normal retirement age for that individual or, 
if earlier, the date the individual ceases his participation in the 
plan. Premium payments may be considered to be level even though items 
such as experience gains and dividends are applied against premiums. In 
the case of an increase in benefits, the contracts must provide for 
level annual payments with respect to such increase to be paid for the 
period commencing at the time the increase becomes effective. If payment 
commences on the first payment date under the contract occurring after 
the

[[Page 896]]

date an individual becomes a participant or after the effective date of 
an increase in benefits, the requirements of this subdivision will be 
satisfied even though payment does not commence on the date on which the 
individual's participation commenced or on the effective date of the 
benefit increase, whichever is applicable. If an individual accrues 
benefits after his normal retirement age, the requirements of this 
subdivision are satisfied if payment is made at the time such benefits 
accrue. If the provisions required by this subdivision are set forth in 
a separate agreement with the issuer of the individual contracts, they 
need not be included in the individual contracts.
    (iii) The benefits provided by the plan for each individual 
participant must be equal to the benefits provided under his individual 
contracts at his normal retirement age under the plan provisions.
    (iv) The benefits provided by the plan for each individual 
participant must be guaranteed by the life insurance company, described 
in paragraph (b)(2)(i) of this section, issuing the individual contracts 
to the extent premiums have been paid.
    (v) Except as provided in the following sentence, all premiums 
payable for the plan year, and for all prior plan years, under the 
insurance or annuity contracts must have been paid before lapse. If the 
lapse has occurred during the plan year, the requirements of this 
subdivision will be considered to have been met if reinstatement of the 
insurance policy, under which the individual insurance contracts are 
issued, occurs during the year of the lapse and before distribution is 
made or benefits commence to any participant whose benefits are reduced 
because of the lapse.
    (vi) No rights under the individual contracts may have been subject 
to a security interest at any time during the plan year. This 
subdivision shall not apply to contracts which have been distributed to 
participants if the security interest is created after the date of 
distribution.
    (vii) No policy loans, including loans to individual participants, 
on any of the individual contracts may be outstanding at any time during 
the plan year. This subdivision shall not apply to contracts which have 
been distributed to participants if the loan is made after the date of 
distribution. An application of funds by the issuer to pay premiums due 
under the contracts shall be deemed not to be a policy loan if the 
amount of the funds so applied, and interest thereon, is repaid during 
the plan year in which the funds are applied and before distribution is 
made or benefits commence to any participant whose benefits are reduced 
because of such application.
    (c) Group insurance contract plans. (1) A group insurance contract 
plan is described in section 412(i) during a plan year if the plan 
satisfies the requirements of subparagraph (2) for the plan year.
    (2) The requirements of this subparagraph are:
    (i) The plan must be funded exclusively by the purchase from an 
insurance company or companies, described in paragraph (b)(2)(i) of this 
section, of group annuity or group insurance contracts, or a combination 
thereof. The purchase may be made either directly by the employer or 
through the use of a custodial account or trust. A plan shall not be 
considered to be funded otherwise than exclusively by the purchase of 
group annuity or group insurance contracts merely because the employer 
makes a payment necessary to comply with the provisions of section 411 
(c)(2) (relating to accrued benefit derived from employee 
contributions).
    (ii) In the case of a plan funded by a group insurance contract or a 
group annuity contract the requirements of paragraph (b)(2)(ii) of this 
section must be satisfied by the group contract issued under the plan. 
Thus, for example, each individual participant's benefits under the 
group contract must be provided for by level annual, or more frequent, 
payments equivalent to the payments required to satisfy such paragraph. 
The requirements of this subdivision will not be satisfied if benefits 
for any individual are not provided for by level payments made on his 
behalf under the group contract.
    (iii) The group annuity or group insurance contract must satisfy the 
requirements of clauses (iii), (iv), (v), (vi), and (vii) of paragraph 
(b)(2). Thus,

[[Page 897]]

for example, each participant's benefits provided by the plan must be 
equal to his benefits provided under the group contract at his normal 
retirement age.
    (iv)(A) If the plan is funded by a group annuity contract, the value 
of the benefits guaranteed by the insurance company issuing the contract 
under the plan with respect to each participant under the contract must 
not be less than the value of such benefits which the cash surrender 
value would provide for that participant under any individual annuity 
contract plan satisfying the requirements of paragraph (b) and approved 
for sale in the State where the principal office of the plan is located.
    (B) If the plan is funded by a group insurance contract, the value 
of the benefits guaranteed by the insurance company issuing the contract 
under the plan with respect to each participate under the contract must 
not be less than the value of such benefits which the cash surrender 
value would provide for that participant under any individual insurance 
contract plan satisfying the requirements of paragraph (b) and approved 
for sale in the State where the principal office of the plan is located.
    (v) Under the group annuity or group insurance contract, premiums or 
other consideration received by the insurance company (and, if a 
custodial account or trust is used, the custodian or trustee thereof) 
must be allocated to purchase individual benefits for participants under 
the plan. A plan which maintains unallocated funds in an auxiliary trust 
fund or which provides that an insurance company will maintain 
unallocated funds in a separate account, such as a group deposit 
administration contract, does not satisfy the requirements of this 
subdivision.
    (d) Combination of plans. A plan which is funded by a combination of 
individual contracts and a group contract shall be treated as a plan 
described in section 412 (i) for the plan year if the combination, in 
the aggregate, satisfies the requirements of this section for the plan 
year.

[T.D. 7746, 45 FR 47676, July 16, 1980; 45 FR 50563, July 30, 1980]



Sec. 1.412(l)(7)-1  Mortality tables used to determine current 
liability.

    (a) In general. The mortality tables set forth in paragraph (d) of 
this section are to be used in determining current liability under 
section 412(l)(7) for participants and beneficiaries (other than 
disabled participants) for plan years beginning in 2007. For plan years 
beginning on or after January 1, 2008, the mortality tables described in 
section 430(h)(3)(A) are to be used in determining current liability 
under section 412(l)(7) for participants and beneficiaries (other than 
disabled participants).
    (b) Separate tables for annuitants and nonannuitants. The separate 
tables for annuitants and nonannuitants are used unless the plan applies 
the optional combined table pursuant to paragraph (c) of this section. 
If these separate tables are used, the nonannuitant mortality table is 
applied to determine the probability of survival for a nonannuitant for 
the period before the nonannuitant is projected to commence receiving 
benefits. The annuitant mortality table is applied to determine the 
present value of benefits for each annuitant, and for each nonannuitant 
for the period after which the nonannuitant is projected to commence 
receiving benefits. For purposes of this section, an annuitant means a 
plan participant who has commenced receiving benefits and a nonannuitant 
means a plan participant who has not yet commenced receiving benefits 
(e.g., an active employee or a terminated vested participant). Thus, for 
example, with respect to a 45-year-old active participant who is 
projected to commence receiving an annuity at age 55, current liability 
would be determined using the nonannuitant mortality table for the 
period before the participant attains age 55 (i.e., so that the 
probability of an active male participant living from age 45 to the age 
of 55 for the table that applies in plan years beginning in 2007 is 
98.59%) and the annuitant mortality table for the period ages 55 and 
above. Similarly, if a 45-year-old terminated vested participant is 
projected to commence an annuity at age 65, current liability would be 
determined using the nonannuitant mortality table for the period before 
the participant attains

[[Page 898]]

age 65 and the annuitant mortality table for ages 65 and above. For 
purposes of this section, a participant whose benefit has partially 
commenced is treated as an annuitant with respect to the portion of the 
benefit which has commenced and a nonannuitant with respect to the 
balance of the benefit.
    (c) Optional combined tables. As an alternative to the separate 
tables specified for annuitants and nonannuitants as described in 
paragraph (b) of this section, the optional combined table, which 
applies the same mortality rates to both annuitants and nonannuitants, 
can be used.
    (d) Mortality tables for 2007. As set forth in paragraph (a) of this 
section, the following tables are to be used for determining current 
liability for plan years beginning during 2007 in accordance with the 
rules of this section.

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                               Male                                           Female
                                                         -----------------------------------------------------------------------------------------------
                           Age                             Nonannuitant      Annuitant       Optional      Nonannuitant      Annuitant       Optional
                                                               table           table      combined table       table           table      combined table
--------------------------------------------------------------------------------------------------------------------------------------------------------
1.......................................................        0.000408        0.000408        0.000408        0.000366        0.000366        0.000366
2.......................................................        0.000276        0.000276        0.000276        0.000239        0.000239        0.000239
3.......................................................        0.000229        0.000229        0.000229        0.000178        0.000178        0.000178
4.......................................................        0.000178        0.000178        0.000178        0.000133        0.000133        0.000133
5.......................................................        0.000163        0.000163        0.000163        0.000121        0.000121        0.000121
6.......................................................        0.000156        0.000156        0.000156        0.000113        0.000113        0.000113
7.......................................................        0.000150        0.000150        0.000150        0.000106        0.000106        0.000106
8.......................................................        0.000138        0.000138        0.000138        0.000094        0.000094        0.000094
9.......................................................        0.000134        0.000134        0.000134        0.000090        0.000090        0.000090
10......................................................        0.000136        0.000136        0.000136        0.000090        0.000090        0.000090
11......................................................        0.000140        0.000140        0.000140        0.000092        0.000092        0.000092
12......................................................        0.000146        0.000146        0.000146        0.000095        0.000095        0.000095
13......................................................        0.000154        0.000154        0.000154        0.000099        0.000099        0.000099
14......................................................        0.000167        0.000167        0.000167        0.000109        0.000109        0.000109
15......................................................        0.000176        0.000176        0.000176        0.000119        0.000119        0.000119
16......................................................        0.000186        0.000186        0.000186        0.000127        0.000127        0.000127
17......................................................        0.000197        0.000197        0.000197        0.000135        0.000135        0.000135
18......................................................        0.000207        0.000207        0.000207        0.000138        0.000138        0.000138
19......................................................        0.000217        0.000217        0.000217        0.000136        0.000136        0.000136
20......................................................        0.000226        0.000226        0.000226        0.000134        0.000134        0.000134
21......................................................        0.000239        0.000239        0.000239        0.000132        0.000132        0.000132
22......................................................        0.000251        0.000251        0.000251        0.000133        0.000133        0.000133
23......................................................        0.000267        0.000267        0.000267        0.000138        0.000138        0.000138
24......................................................        0.000282        0.000282        0.000282        0.000144        0.000144        0.000144
25......................................................        0.000301        0.000301        0.000301        0.000152        0.000152        0.000152
26......................................................        0.000331        0.000331        0.000331        0.000164        0.000164        0.000164
27......................................................        0.000342        0.000342        0.000342        0.000171        0.000171        0.000171
28......................................................        0.000352        0.000352        0.000352        0.000180        0.000180        0.000180
29......................................................        0.000369        0.000369        0.000369        0.000190        0.000190        0.000190
30......................................................        0.000398        0.000398        0.000398        0.000212        0.000212        0.000212
31......................................................        0.000447        0.000447        0.000447        0.000257        0.000257        0.000257
32......................................................        0.000503        0.000503        0.000503        0.000293        0.000293        0.000293
33......................................................        0.000565        0.000565        0.000565        0.000323        0.000323        0.000323
34......................................................        0.000629        0.000629        0.000629        0.000349        0.000349        0.000349
35......................................................        0.000692        0.000692        0.000692        0.000372        0.000372        0.000372
36......................................................        0.000753        0.000753        0.000753        0.000394        0.000394        0.000394
37......................................................        0.000810        0.000810        0.000810        0.000415        0.000415        0.000415
38......................................................        0.000844        0.000844        0.000844        0.000439        0.000439        0.000439
39......................................................        0.000875        0.000875        0.000875        0.000465        0.000465        0.000465
40......................................................        0.000904        0.000904        0.000904        0.000506        0.000506        0.000506
41......................................................        0.000936        0.000963        0.000936        0.000555        0.000555        0.000555
42......................................................        0.000974        0.001081        0.000975        0.000611        0.000611        0.000611
43......................................................        0.001018        0.001258        0.001021        0.000672        0.000672        0.000672
44......................................................        0.001071        0.001493        0.001079        0.000738        0.000738        0.000738
45......................................................        0.001131        0.001788        0.001146        0.000788        0.000791        0.000788
46......................................................        0.001185        0.002142        0.001211        0.000839        0.000896        0.000840
47......................................................        0.001244        0.002554        0.001286        0.000889        0.001054        0.000893
48......................................................        0.001304        0.003026        0.001366        0.000962        0.001265        0.000972
49......................................................        0.001368        0.003557        0.001457        0.001039        0.001528        0.001059
50......................................................        0.001434        0.004146        0.001557        0.001149        0.001844        0.001184
51......................................................        0.001500        0.004226        0.001636        0.001272        0.001962        0.001312
52......................................................        0.001570        0.004254        0.001754        0.001442        0.002173        0.001496
53......................................................        0.001681        0.004312        0.001932        0.001637        0.002445        0.001714
54......................................................        0.001803        0.004369        0.002134        0.001861        0.002771        0.001969
55......................................................        0.001986        0.004514        0.002508        0.002117        0.003155        0.002314
56......................................................        0.002217        0.004749        0.003020        0.002414        0.003608        0.002755
57......................................................        0.002488        0.005069        0.003464        0.002696        0.004088        0.003170

[[Page 899]]

 
58......................................................        0.002803        0.005501        0.003990        0.002947        0.004588        0.003583
59......................................................        0.003095        0.005972        0.004529        0.003223        0.005156        0.004066
60......................................................        0.003421        0.006539        0.005177        0.003521        0.005780        0.004640
61......................................................        0.003860        0.007284        0.006030        0.003838        0.006450        0.005354
62......................................................        0.004244        0.008024        0.006929        0.004170        0.007168        0.006148
63......................................................        0.004746        0.008989        0.008099        0.004513        0.007932        0.007084
64......................................................        0.005154        0.009947        0.009159        0.004862        0.008758        0.007996
65......................................................        0.005553        0.011015        0.010377        0.005213        0.009662        0.009018
66......................................................        0.006073        0.012379        0.011951        0.005559        0.010640        0.010192
67......................................................        0.006447        0.013705        0.013349        0.005896        0.011690        0.011323
68......................................................        0.006650        0.014940        0.014641        0.006220        0.012838        0.012522
69......................................................        0.006974        0.016504        0.016231        0.006528        0.014126        0.013843
70......................................................        0.007115        0.017971        0.017689        0.006818        0.015607        0.015309
71......................................................        0.008002        0.019884        0.019606        0.007450        0.017078        0.016784
72......................................................        0.009777        0.022078        0.021822        0.008714        0.018995        0.018716
73......................................................        0.012439        0.024592        0.024371        0.010610        0.020819        0.020577
74......................................................        0.015988        0.027435        0.027256        0.013139        0.023074        0.022872
75......................................................        0.020425        0.031057        0.030919        0.016299        0.025117        0.024967
76......................................................        0.025749        0.034615        0.034523        0.020092        0.027673        0.027570
77......................................................        0.031961        0.039054        0.038999        0.024516        0.030911        0.030846
78......................................................        0.039059        0.044018        0.043992        0.029573        0.034074        0.034043
79......................................................        0.047046        0.049617        0.049610        0.035261        0.037618        0.037610
80......................................................        0.055919        0.055919        0.055919        0.041582        0.041582        0.041582
81......................................................        0.063476        0.063476        0.063476        0.046024        0.046024        0.046024
82......................................................        0.071926        0.071926        0.071926        0.051021        0.051021        0.051021
83......................................................        0.080176        0.080176        0.080176        0.056651        0.056651        0.056651
84......................................................        0.090433        0.090433        0.090433        0.063006        0.063006        0.063006
85......................................................        0.100383        0.100383        0.100383        0.071188        0.071188        0.071188
86......................................................        0.111295        0.111295        0.111295        0.080522        0.080522        0.080522
87......................................................        0.125051        0.125051        0.125051        0.091080        0.091080        0.091080
88......................................................        0.140385        0.140385        0.140385        0.101448        0.101448        0.101448
89......................................................        0.155142        0.155142        0.155142        0.114246        0.114246        0.114246
90......................................................        0.173400        0.173400        0.173400        0.126258        0.126258        0.126258
91......................................................        0.188868        0.188868        0.188868        0.138648        0.138648        0.138648
92......................................................        0.207683        0.207683        0.207683        0.151126        0.151126        0.151126
93......................................................        0.224037        0.224037        0.224037        0.165722        0.165722        0.165722
94......................................................        0.240367        0.240367        0.240367        0.177747        0.177747        0.177747
95......................................................        0.260098        0.260098        0.260098        0.189133        0.189133        0.189133
96......................................................        0.276058        0.276058        0.276058        0.199703        0.199703        0.199703
97......................................................        0.291564        0.291564        0.291564        0.212246        0.212246        0.212246
98......................................................        0.310910        0.310910        0.310910        0.220832        0.220832        0.220832
99......................................................        0.325614        0.325614        0.325614        0.228169        0.228169        0.228169
100.....................................................        0.339763        0.339763        0.339763        0.234164        0.234164        0.234164
101.....................................................        0.358628        0.358628        0.358628        0.244834        0.244834        0.244834
102.....................................................        0.371685        0.371685        0.371685        0.254498        0.254498        0.254498
103.....................................................        0.383040        0.383040        0.383040        0.266044        0.266044        0.266044
104.....................................................        0.392003        0.392003        0.392003        0.279055        0.279055        0.279055
105.....................................................        0.397886        0.397886        0.397886        0.293116        0.293116        0.293116
106.....................................................        0.400000        0.400000        0.400000        0.307811        0.307811        0.307811
107.....................................................        0.400000        0.400000        0.400000        0.322725        0.322725        0.322725
108.....................................................        0.400000        0.400000        0.400000        0.337441        0.337441        0.337441
109.....................................................        0.400000        0.400000        0.400000        0.351544        0.351544        0.351544
110.....................................................        0.400000        0.400000        0.400000        0.364617        0.364617        0.364617
111.....................................................        0.400000        0.400000        0.400000        0.376246        0.376246        0.376246
112.....................................................        0.400000        0.400000        0.400000        0.386015        0.386015        0.386015
113.....................................................        0.400000        0.400000        0.400000        0.393507        0.393507        0.393507
114.....................................................        0.400000        0.400000        0.400000        0.398308        0.398308        0.398308
115.....................................................        0.400000        0.400000        0.400000        0.400000        0.400000        0.400000
116.....................................................        0.400000        0.400000        0.400000        0.400000        0.400000        0.400000
117.....................................................        0.400000        0.400000        0.400000        0.400000        0.400000        0.400000
118.....................................................        0.400000        0.400000        0.400000        0.400000        0.400000        0.400000
119.....................................................        0.400000        0.400000        0.400000        0.400000        0.400000        0.400000
120.....................................................        1.000000        1.000000        1.000000        1.000000        1.000000        1.000000
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 900]]

    (e) Effective date. This section applies for plan years beginning on 
or after January 1, 2007.

[T.D. 9310, 72 FR 4958, Feb. 2, 2007]



Sec. 1.413-1  Special rules for collectively bargained plans.

    (a) Application of section 413(b) to certain collectively bargained 
plans--(1) In general. Section 413(b) sets forth special rules 
applicable to certain pension, profit-sharing, and stock bonus plans 
(and each trust which is a part of such a plan), hereinafter referred to 
as ``section 413(b) plans'', described in paragraph (a)(2) of this 
section. Notwithstanding any other provision of the Code, a section 
413(b) plan is subject to the special rules of section 413(b) (1) 
through (8) and paragraphs (b) through (i) of this section.
    (2) Requirements. Section 413(b) applies to a plan (and each trust 
which is a part of such plan) if the plan is a single plan which is 
maintained pursuant to one or more agreements which the Secretary of 
Labor finds to be a collective bargaining agreement between employee 
representatives and one or more employers. A plan which provides 
benefits for employees of more than one employer is considered a single 
plan subject to the requirements of section 413(b) and this section if 
the plan is considered a single plan for purposes of applying section 
414(l) (see Sec. 1.414(l)-1(b)(1)). For purposes of determining whether 
one or more plans (or agreements) are a single plan, under sections 
413(a) and 414(l), it is irrelevant that there are in form two or more 
separate plans (or agreements). For example, a single plan will be 
considered to exist where agreements are entered into separately by a 
national labor organization (or one or more local units of such 
organization), on one hand, and individual employers, on the other hand, 
if the plan is considered a single plan for purposes of applying section 
414(l).
    (3) Additional rules and effective dates. (i) If a plan is a section 
413(b) plan at a relevant time, the rules of section 413(b) and this 
section apply, and the rules of section 413(c) and Sec. 1.413-2 do not 
apply to the plan.
    (ii) The qualification of a section 413(b) plan, at any relevant 
time, under section 401(a), 403(a), or 405(a), as modified by sections 
413(b) and this section, is determined with respect to all employers 
maintaining the plan. Consequently, the failure by one employer 
maintaining the plan (or by the plan itself) to satisfy an applicable 
qualification requirement will result in the disqualification of the 
plan for all employers maintaining the plan.
    (iii) Except as otherwise provided, section 413 (a) and (b) and this 
section apply to a plan for plan years beginning after December 31, 
1953.
    (b) Participation. Section 410 and the regulations thereunder shall 
be applied as if all employees of each of the employers who are parties 
to the collective-bargaining agreement and all such employees who are 
subject to the same benefit computation formula under the plan were 
employed by a single employer.
    (c) Discrimination, etc.--(1) General rule. Section 401(a)(4) 
(relating to prohibited discrimination) and section 411(d)(3) (relating 
to vesting required on termination, partial termination, or 
discontinuance of contributions) shall be applied as if all the 
participants in the plan, who are subject to the same benefit 
computation formula and who are employed by employers who are parties to 
the collective bargaining agreement, are employed by a single employer.
    (2) Application of discrimination rules. Under section 401(a)(4) and 
the regulations thereunder a plan is not qualified unless the 
contributions or benefits provided under the plan do not discriminate in 
favor of officers, shareholders or highly compensated employees 
(hereinafter referred to collectively as ``the prohibited group''). The 
presence or absence of such discrimination under a plan to which this 
section applies at any time shall not be determined on an employer-by-
employer basis, but rather by testing separately each group of employees 
who are subject to the same benefit computation formula to determine if 
there is discrimination within such group. Consequently, discrimination 
in contributions or benefits among two or more different groups or among 
employees in different groups covered by the plan may be present without 
causing the plan to be disqualified. However, the

[[Page 901]]

presence of prohibited discrimination within one such group will result 
in the disqualification of the plan for all groups. Section 401(a)(4) 
and the regulations thereunder provide rules relating to the 
determination of which employees are members of the prohibited group and 
to the determination of discrimination in contributions or benefits 
which are applicable to a plan to which this section applies. The 
determination of whether or not an individual employee is a highly 
compensated employee shall be based on the relationship of the 
compensation of the employee to the compensation of all the other 
employees of all employers who are maintaining the plan and have 
employees covered under the same benefit computation formula, whether or 
not such other employees are covered by the plan or are covered under 
the same benefit computation formula, rather than to the compensation of 
all the other employees of the employer of such individual employee.
    (3) Application of termination, etc. rules. Section 411(d)(3) and 
the regulations thereunder (relating to vesting required in the case of 
a termination, partial termination, or complete discontinuance of 
contributions) apply to a plan subject to the provisions of this 
section. The requirements of section 411(d)(3) shall be applied as if 
all participants in the plan who are subject to the same benefit 
computation formula and who are employed by employers who are parties to 
the collective bargaining agreement are employed by a single employer. 
The determination of whether or not there is a termination, partial 
termination, or complete discontinuance of contributions shall be made 
separately for each such group of participants who are treated as 
employed by a single employer. Consequently, if there are two or more 
groups of participants, a termination, partial termination, or complete 
discontinuance can take place under a plan with respect to one group of 
participants but not with respect to another such group of participants 
or for the entire plan. See Sec. 1.411(d)-2 for rules prescribed under 
section 411(d)(3).
    (4) Effective dates and transitional rules. (i) Section 413(b)(2) 
and this paragraph apply to a plan for plan years beginning after 
December 31, 1953.
    (ii) In applying the rules of this paragraph to a plan for plan 
years to which section 411 does not apply, section 401(a)(7) (as in 
effect on September 1, 1974) shall be substituted for section 411(d)(3). 
See Sec. 1.401-6 for rules prescribed under section 401(a)(7) as in 
effect on September 1, 1974. See Sec. 1.411(a)-2 for the effective 
dates of section 411.
    (5) Examples. The provisions of this paragraph are illustrated by 
the following examples:

    Example 1. Plan A is a defined benefit plan subject to the 
provisions of this section and covers two groups of participants, local 
unions 1 and 2. Each local union has negotiated its own bargaining 
agreement with employers X, Y, and Z to provide its own benefit 
computation formula. The following table indicates the composition of 
the plan A participants:

------------------------------------------------------------------------
                                 Employer   Employer   Employer
                                    X          Y          Z       Total
------------------------------------------------------------------------
Local union 1.................         20         10         70      100
Local union 2.................         30         70        100      200
------------------------------------------------------------------------


Under the rules of subparagraph (2) of this paragraph, the determination 
of whether contributions or benefits provided under the plan 
discriminate in favor of the prohibited group is made by applying the 
rules of section 401(a)(4) separately to participants who are members of 
local union 1 and local union 2. Thus, plan A will satisfy the 
qualification requirements of section 401(a)(4) if, within local union 1 
and local union 2, respectively, plan benefits do not discriminate in 
favor of participants who are prohibited group employees within local 
union 1 and local union 2. Under the rules of subparagraph (2) of this 
paragraph, the determination under section 401(a)(4) of whether or not 
any individual employee, included within the 300 participants in plan A, 
is a highly compensated employee is based on the relationship of the 
compensation of such individual employee to the compensation of all the 
employees of Employers X, Y, and Z, whether or not such employees are 
participants in plan A. Thus, if there are 20 participants who are 
prohibited group employees within the 100 participants of local union 1, 
discrimination is determined by comparing the benefits of the 20 
prohibited group participants to the benefits of the other 80 
participants within local union 1. The same comparison would have to be 
made for the local union 2 participants between the prohibited group 
participants and the other participants in local union 2. Discrimination 
in benefits, if any, between the participants in local union 1 and local 
union 2,

[[Page 902]]

or among the employees of X, Y, or Z, would not affect the qualification 
of plan A under section 401(a)(4).
    Example 2. Assume the same facts as in example (1). Employer X 
withdraws from the plan. Under subparagraph (3) of this paragraph, 
whether or not as a result of the withdrawal there is a partial 
termination under section 411(d)(3) is to be determined by applying the 
requirements of such section separately to the local union 1 and local 
union 2 participants. See Sec. 1.411(d)-2 for the requirements relating 
to partial terminations. The application of such requirements raises the 
following possibilities with respect to the plan: (1) A partial 
termination as to local union 1, (2) a partial termination as to local 
union 2, (3) a partial termination as to both local unions 1 and 2, or 
(4) no partial termination for either local union.
    Example 3. Assume the same facts as in example (1). Plan A is 
amended to cease future benefit accruals under the plan for local union 
1 participants. Under subparagraph (3) of the paragraph, whether or not 
as a result of the cessation there is a partial termination under 
section 411(d)(3) is to be determined by applying the requirements of 
such section separately to the local union 1 and local union 2 
participants.
    Example 4. Plan A is a defined benefit plan that provides for two 
normal retirement benefits, X and 2X. A participant receives benefit X 
if the collective bargaining agreement covering his employment provides 
for a contribution rate, M. If such agreement provides for a 
contribution rate of N, the participant receives benefit 2X. Benefit X 
and benefit 2X constitute separate benefit computation formulas.
    Example 5. Plan B is a defined benefit plan that provides for a 
normal retirement benefit, X. Benefit X is provided for all plan 
participants even though there are two collective bargaining agreements 
providing for different contribution rates, M and N. Plan B has a single 
benefit computation formula, even though there are two contribution 
rates.

    (d) Exclusive benefit. Under section 401(a), a plan is not qualified 
unless the plan is for the exclusive benefit of the employees (and their 
beneficiaries) of the employer establishing and maintaining the plan. 
Other qualification requirements under section 401(a) require the 
application of the exclusive benefit rule (for example, section 
401(a)(2), which precludes diversion of plan assets). For purposes of 
applying the requirements of section 401(a) in determining whether a 
plan subject to this section is, with respect to each employer 
establishing and maintaining the plan, for the exclusive benefit of its 
employees (and their beneficiaries), all of the employees participating 
in the plan shall be treated as employees of each such employer. Thus, 
for example, contributions by employer A to a plan subject to this 
section could be allocated to employees of other employers maintaining 
the plan without violating the requirements of section 401(a)(2), 
because all the employees participating in the plan are deemed to be 
employees of A.
    (e) Vesting. Section 411 (other than section 411(d)(3) relating to 
termination or partial termination; discontinuance of contributions) and 
the regulations thereunder shall be applied as if all employers who have 
been parties to the collective-bargaining agreement constituted a single 
employer. The application of any rules with respect to breaks in service 
under section 411 shall be made under regulations prescribed by the 
Secretary of Labor. Thus, for example, all the hours which an employee 
worked for each employer in a collectively-bargained plan would be 
aggregated in computing the employee's hours of service under the plan. 
See also 29 CFR Part 2530 (Department of Labor regulations relating to 
minimum standards for employee pension benefit plans.)
    (f)-(h) [Reserved]
    (i) Employees of labor unions--(1) General rule. For purposes of 
section 413(b) and this section, employees of employee representatives 
shall be treated as employees of an employer establishing and 
maintaining a plan to which section 413(b) and this section apply if, 
with respect to the employees of such representatives, the plan 
satisfies the nondiscrimination requirements of section 401(a)(4) 
(determined without regard to section 413(b)(2)) and the minimum 
participation and coverage requirements of section 410 (determined 
without regard to section 413(b)(1)). For purposes of the preceding 
sentence, the plan and any affiliated employee health or welfare plan 
shall be deemed to be an employee representative. If employees of 
employee representatives, the plan, or an affiliated employee health or 
welfare plan are covered by the plan and are not treated as employees of 
an employer

[[Page 903]]

establishing and maintaining the plan under the provisions of this 
paragraph, the plan fails to satisfy the qualification requirements of 
section 401(a). In addition, in order for such a plan to be qualified, 
the plan must satisfy the requirements of section 413(b) (1) and (2), 
relating to participation and discrimination, respectively; see 
paragraphs (b) and (c) of this section. For purposes of this paragraph, 
an affiliated health or welfare plan is a health or welfare plan that is 
maintained under the same collective bargaining agreement or agreements, 
and that covers the same membership.
    (2) Effective dates and transitional rules. (i) Section 413(b)(8) 
and this paragraph apply to a plan for plan years beginning after 
December 31, 1953.
    (ii) In applying the rules of this paragraph to a plan for plan 
years to which section 410 does not apply, section 401(a)(3) (as in 
effect on September 1, 1974) shall be substituted for section 410. See 
Sec. 1.401-3 for rules prescribed under section 401(a)(3) as in effect 
on September 1, 1974. See Sec. 1.410(a)-2 for the effective dates of 
section 410.
    (3) Examples. The provisions of this paragraph are illustrated by 
the following examples:

    Example 1. Plan A is a defined benefit plan, maintained pursuant to 
a collective bargaining agreement between employers, X, Y, and Z and 
labor union, L, which covers members of L employed by X, Y, and Z. In 
1978, plan A is amended to cover, under the same benefit formula, all 
five employees of L who have satisfied the minimum age and service 
requirements of the plans (age 25 and 1 year of service). Assume that 
plan A is subject to section 413(b) and satisfies the requirements of 
section 413(b) (1) and (2). Assume further that with respect to 
employees of L, plan A (i) satisfies the nondiscrimination requirements 
of section 401(a)(4), (ii) meets the minimum participation requirements 
of section 410(a), and (iii) meets the minimum coverage requirements of 
section 410(b)(1)(A). Under the rules of subparagraph (1) of this 
paragraph, because such requirements are all satisfied, the employees of 
L are treated as employees of an employer establishing and maintaining 
plan A.
    Example 2. Assume the same facts as example (1), except that plan A 
is amended to cover only one of the five employees of L, none of whom is 
covered by any other plan. Assume further that, under plan A, L does not 
satisfy the minimum percentage coverage requirement of section 
410(b)(1)(A) with respect to employees of L. Assume further that the 
compensation of the one L employee who is covered by the plan is such 
that he is highly compensated relative to the four employees of L not 
covered by the plan. Consequently, L does not satisfy the minimum 
coverage requirements of section 410(b)(1)(B), with respect to employees 
of L. Under the rules of subparagraph (1) of this paragraph, the 
employees of L cannot be treated as employees of an employer 
establishing and maintaining the A plan because such coverage 
requirements are not satisfied by L. Consequently, the A plan fails to 
satisfy the qualification requirements of section 401(a).

(Sec. 411 (88 Stat. 901; 26 U.S.C. 411))

[T.D. 7501, 42 FR 42340, Aug. 23, 1977, as amended by 42 FR 47198, Sept. 
20, 1977; T.D. 7654, 44 FR 65063, Nov. 9, 1979]



Sec. 1.413-2  Special rules for plans maintained by more than one 
employer.

    (a) Application of section 413(c)--(1) In general. Section 413(c) 
describes certain plans (and each trust which is a part of any such 
plan) hereinafter referred to as ``section 413(c) plans.'' A plan (and 
each trust which is a part of such plan) is deemed to be a section 
413(c) plan if it is described in subparagraph (2) of this paragraph. 
Notwithstanding any other provision of the code (not specifically in 
conflict with the special rules hereinafter mentioned), a section 413(c) 
plan is subject to the special rules of section 413(c) (1) through (6) 
and paragraphs (b) through (g) of this section.
    (2) Section 413(c) plan. A plan (and each trust which is a part of 
such plan) is a section 413(c) plan if--
    (i) The plan is a single plan, within the meaning of section 413(a) 
and Sec. 1.413-1(a)(2), and
    (ii) The plan is maintained by more than one employer.

For purposes of subdivision (ii) of this subparagraph, the number of 
employers maintaining the plan is determined by treating any employers 
described in section 414(b) (relating to a controlled group of 
corporations) or any employers described in section 414(c) (relating to 
trades or businesses under common control), whichever is applicable, as 
if such employers are a single employer. See Sec. 1.411(a)-5(b)(3) for 
rules relating to the time when an employer maintains a plan. A master 
or prototype plan is not a section 413(c) plan unless

[[Page 904]]

such a plan is described in this subparagraph. Similarly, the mere fact 
that a plan, or plans, utilizes a common trust fund or otherwise pools 
plan assets for investment purposes does not, by itself, result in a 
particular plan being treated as a section 413(c) plan.
    (3) Additional rules. (i) If a plan is a collectively bargained plan 
described in Sec. 1.413-1(a), the rules of section 413(c) and this 
section do not apply, and the rules of section 413(b) and Sec. 1.413-1 
do apply to the plan.
    (ii) The special rules of section 413(b)(1) and Sec. 1.413-1(b) 
relating to the application of section 410, other than the rules of 
section 410(a), do not apply to a section 413(c) plan. Thus, for 
example, the minimum coverage requirements of section 410(b) are 
generally applied to a section 413(c) plan on an employer-by-employer 
basis, taking into account the generally applicable rules such as 
section 401(a)(5) and section 414 (b) and (c).
    (iii) The special rules of section 413(b)(2) and Sec. 1.413-1(c) 
(relating to (A) section 401(a)(4) and prohibited discrimination, and 
(B) 411(d)(3) and vesting required on termination, partial termination, 
or discontinuance of contributions) do not apply to a section 413(c) 
plan. Thus, for example, the determination of whether or not there is a 
termination, within the meaning of section 411(d)(3), of a section 
413(c) plan is made solely by reference to the rules of sections 
411(d)(3) and 413(c)(3).
    (iv) The qualification of a section 413(c) plan, at any relevant 
time, under section 401(a), 403(a) or 405(a), as modified by section 
413(c) and this section, is determined with respect to all employers 
maintaining the section 413(c) plan. Consequently, the failure by one 
employer maintaining the plan (or by the plan itself) to satisfy an 
applicable qualification requirement will result in the disqualification 
of the section 413(c) plan for all employers maintaining the plan.
    (4) Effective dates. Except as otherwise provided, section 413(c) 
and this section apply to a plan for plan years beginning after December 
31, 1953.
    (b) Participation. Section 410(a) and the regulations thereunder 
shall be applied as if all employees of each of the employers who 
maintain the plan were employed by a single employer.
    (c) Exclusive benefit. In the case of a plan subject to this 
section, the exclusive benefit requirements of section 401(a) shall be 
applied to the plan in the same manner as under section 413(b)(3) and 
Sec. 1.413-1(d).
    (d) Vesting. Section 411 and the regulations thereunder shall be 
applied as if all employers who maintain the plan constituted a single 
employer. The application of any rules with respect to breaks in service 
under section 411 shall be made under regulations prescribed by the 
Secretary of Labor. Thus, for example, all the hours which an employee 
worked for each employer maintaining the plan would be aggregated in 
computing the employee's hours of service under the plan. See also 29 
CFR Part 2530 (Department of Labor regulations relating to minimum 
standards for employee pension benefit plans).

(Sec. 411 (88 Stat. 901; 26 U.S.C. 411))

[T.D. 7501, 42 FR 42340, Aug. 23, 1977, as amended by 42 FR 47198, Sept. 
20, 1977; T.D. 7654, 44 FR 65065, Nov. 9, 1979]



Sec. 1.414(b)-1  Controlled group of corporations.

    (a) Defintion of controlled group of corporations. For purposes of 
this section, the term ``controlled group of corporations'' has the same 
meaning as is assigned to the term in section 1563(a) and the 
regulations thereunder, except that (1) the term ``controlled group of 
corporations'' shall not include an ``insurance group'' described in 
section 1563(a)(4), and (2) section 1563(e)(3)(C) (relating to stock 
owned by certain employees' trusts) shall not apply. For purposes of 
this section, the term ``members of a controlled group'' means two or 
more corporations connected through stock ownership described in section 
1563(a) (1), (2), or (3), whether or not such corporations are 
``component members of a controlled group'' within the meaning of 
section 1563(b). Two or more corporations are members of a controlled 
group at any time such corporations meet the requirements of section 
1563(a) (as modified by this paragraph). For purposes of this section, 
if a corporation is a member of more than one controlled group

[[Page 905]]

of corporations, such corporation shall be treated as a member of each 
controlled group.
    (b) Single plan adopted by two or more members. If two or more 
members of a controlled group of corporations adopt a single plan for a 
plan year, then the minimum funding standard provided in section 412, 
the tax imposed by section 4971, and the applicable limitations provided 
by section 404(a) shall be determined as if such members were a single 
employer. In such a case, the amount of such items and the allocable 
portion attributable to each member shall be determined in the manner 
provided in regulations under sections 412, 4971, and 404(a).
    (c) Cross reference. For rules relating to the application of 
sections 401, 408(k), 410, 411, 415, and 416 with respect to two or more 
trades or businesses which are under common control, see section 414(c) 
and the regulations thereunder.

[T.D. 8179, 53 FR 6605, Mar. 2, 1988]



Sec. 1.414(c)-1  Commonly controlled trades or businesses.

    For purposes of applying the provisions of sections 401 (relating to 
qualified pension, profit-sharing, and stock bonus plans), 408(k) 
(relating to simplified employee pensions), 410 (relating to minimum 
participation standards), 411 (relating to minimum vesting standards), 
415 (relating to limitations on benefits and contributions under 
qualified plans), and 416 (relating to top-heavy plans), all employees 
of two or more trades or businesses under common control within the 
meaning of Sec. 1.414(c)-2 for any period shall be treated as employed 
by a single employer. See sections 401, 408(k), 410, 411, 415, and 416 
and the regulations thereunder for rules relating to employees of trades 
or businesses which are under common control. See Sec. 1.414(c)-5 for 
effective date.

[T.D. 8179, 53 FR 6606, Mar. 2, 1988]



Sec. 1.414(c)-2  Two or more trades or businesses under common control.

    (a) In general. For purposes of this section, the term ``two or more 
trades or businesses under common control'' means any group of trades or 
businesses which is either a ``parent-subsidiary group of trades or 
businesses under common control'' as defined in paragraph (b) of this 
section, a ``brother-sister group of trades or businesses under common 
control'' as defined in paragraph (c) of this section, or a ``combined 
group of trades or businesses under common control'' as defined in 
paragraph (d) of this section. For purposes of this section and 
Sec. Sec. 1.414(c)-3 and 1.414(c)-4, the term ``organization'' means a 
sole proprietorship, a partnership (as defined in section 7701(a)(2)), a 
trust, an estate, or a corporation.
    (b) Parent-subsidiary group of trades or businesses under common 
control--(1) In general. The term ``parent-subsidiary group of trades or 
businesses under common control'' means one or more chains of 
organizations conducting trades or businesses connected through 
ownership of a controlling interest with a common parent organization 
if--
    (i) A controlling interest in each of the organizations, except the 
common parent organization, is owned (directly and with the application 
of Sec. 1.414(c)-4(b)(1), relating to options) by one or more of the 
other organizations; and
    (ii) The common parent organization owns (directly and with the 
application of Sec. 1.414(c)-4(b)(1), relating to options) a 
controlling interest in at least one of the other organizations, 
excluding, in computing such controlling interest, any direct ownership 
interest by such other organizations.
    (2) Controlling interest defined--(i) Controlling interest. For 
purposes of paragraphs (b) and (c) of this section, the phrase 
``controlling interest'' means:
    (A) In the case of an organization which is a corporation, ownership 
of stock possessing at least 80 percent of total combined voting power 
of all classes of stock entitled to vote of such corporation or at least 
80 percent of the total value of shares of all classes of stock of such 
corporation;
    (B) In the case of an organization which is a trust or estate, 
ownership of an actuarial interest of at least 80 percent of such trust 
or estate;
    (C) In the case of an organization which is a partnership, ownership 
of at

[[Page 906]]

least 80 percent of the profits interest or capital interest of such 
partnership; and
    (D) In the case of an organization which is a sole proprietorship, 
ownership of such sole proprietorship.
    (ii) Actuarial interest. For purposes of this section, the actuarial 
interest of each beneficiary of trust or estate shall be determined by 
assuming the maximum exercise of discretion by the fiduciary in favor of 
such beneficiary. The factors and methods prescribed in Sec. 20.2031-7 
or, for certain prior periods, Sec. 20.2031-7A (Estate Tax Regulations) 
for use in ascertaining the value of an interest in property for estate 
tax purposes shall be used for purposes of this subdivision in 
determining a beneficiary's actuarial interest.
    (c) Brother-sister group of trades or businesses under common 
control--(1) In general. The term ``brother-sister group of trades or 
businesses under common control'' means two or more organizations 
conducting trades or businesses if (i) the same five or fewer persons 
who are individuals, estates, or trusts own (directly and with the 
application of Sec. 1.414(c)-4) a controlling interest in each 
organization, and (ii) taking into account the ownership of each such 
person only to the extent such ownership is identical with respect to 
each such organization, such persons are in effective control of each 
organization. The five or fewer persons whose ownership is considered 
for purposes of the controlling interest requirement for each 
organization must be the same persons whose ownership is considered for 
purposes of the effective control requirement.
    (2) Effective control defined. For purposes of this paragraph, 
persons are in ``effective control'' of an organization if--
    (i) In the case of an organization which is a corporation, such 
persons own stock possessing more than 50 percent of the total combined 
voting power of all classes of stock entitled to vote or more than 50 
percent of the total value of shares of all classes of stock of such 
corporation;
    (ii) In the case of an organization which is a trust or estate, such 
persons own an aggregate actuarial interest of more than 50 percent of 
such trust or estate;
    (iii) In the case of an organization which is a partnership, such 
persons own an aggregate of more than 50 percent of the profits interest 
or capital interest of such partnership; and
    (iv) In the case of an organization which is a sole proprietorship, 
one of such persons owns such sole proprietorship.
    (d) Combined group of trades or businesses under common control. The 
term ``combined group of trades or businesses under common control'' 
means any group of three or more organizations, if (1) each such 
organization is a member of either a parent-subsidiary group of trades 
or businesses under common control or a brother-sister group of trades 
or businesses under common control, and (2) at least one such 
organization is the common parent organization of a parent-subsidiary 
group of trades or businesses under common control and is also a member 
of a brother-sister group of trades or businesses under common control.
    (e) Examples. The definitions of parent-subsidiary group of trades 
or businesses under common control, brother-sister group of trades or 
businesses under common control, and combined group of trades or 
businesses under common control may be illustrated by the following 
examples.

    Example 1. (a) The ABC partnership owns stock possessing 80 percent 
of the total combined voting power of all classes of stock entitled to 
voting of S corporation. ABC partnership is the common parent of a 
parent-subsidiary group of trades or businesses under common control 
consisting of the ABC partnership and S Corporation.
    (b) Assume the same facts as in (a) and assume further that S owns 
80 percent of the profits interest in the DEF Partnership. The ABC 
Partnership is the common parent of a parent-subsidiary group of trades 
or businesses under common control consisting of the ABC Partnership, S 
Corporation, and the DEF Partnership. The result would be the same if 
the ABC Partnership, rather than S, owned 80 percent of the profits 
interest in the DEF Partnership.
    Example 2. L Corporation owns 80 percent of the only class of stock 
of T Corporation, and T, in turn, owns 40 percent of the capital 
interest in the GHI Partnership. L also owns 80 percent of the only 
class of stock of N Corporation and N, in turn, owns 40 percent of the 
capital interest in the GHI Partnership.

[[Page 907]]

L is the common parent of a parent-subsidiary group of trades or 
businesses under common control consisting of L Corporation, T 
Corporation, N Corporation, and the GHI Partnership.
    Example 3. ABC Partnership owns 75 percent of the only class of 
stock of X and Y Corporations; X owns all the remaining stock of Y, and 
Y owns all the remaining stock of X. Since interorganization ownership 
is excluded (that is, treated as not outstanding) for purposes of 
determining whether ABC owns a controlling interest of at least one of 
the other organizations, ABC is treated as the owner of stock possessing 
100 percent of the voting power and value of all classes of stock of X 
and of Y for purposes of paragraph (b)(1)(ii) of this section. 
Therefore, ABC is the common parent of a parent-subsidiary group of 
trades or businesses under common control consisting of the ABC 
Partnership, X Corporation, and Y Corporation.
    Example 4. Unrelated individuals A, B, C, D, E, and F own an 
interest in sole proprietorship A, a capital interest in the GHI 
Partnership, and stock of corporations M, W, X, Y, and Z (each of which 
has only one class of stock outstanding) in the following proportions:

                                                                      Organizations
--------------------------------------------------------------------------------------------------------------------------------------------------------
                      Individuals                             A            GHI            M             W             X             Y             Z
--------------------------------------------------------------------------------------------------------------------------------------------------------
A.....................................................     100%           50%          100%           60%           40%           20%           60%
B.....................................................       --           40%            --           15%           40%           50%           30%
C.....................................................       --            --            --            --           10%           10%           10%
D.....................................................       --            --            --           25%            --           20%            --
E.....................................................       --           10%            --            --           10%            --            --
                                                       -------------------------------------------------------------------------------------------------
                                                           100%          100%          100%          100%          100%          100%          100%
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Under these facts the following four brother-sister groups of trades 
or businesses under common control exist: GHI, X and Z; X, Y and Z; W 
and Y; A and M. In the case of GHI, X, and Z, for example, A and B 
together have effective control of each organization because their 
combined identical ownership of GHI, X and Z is greater than 50%. (A's 
identical ownership of GHI, X and Z is 40% because A owns at least a 40% 
interest in each organization. B's identical ownership of GHI, X and Z 
is 30% because B owns at least a 30% interest in each organization.) A 
and B (the persons whose ownership is considered for purposes of the 
effective control requirement) together own a controlling interest in 
each organization because they own at least 80% of the capital interest 
of partnership GHI and at least 80% of the total combined voting power 
of corporations X and Z. Therefore, GHI, X and Z comprise a brother-
sister group of trades or businesses under common control. Y is not a 
member of this group because neither the effective control requirement 
nor the 80% controlling interest requirement are met. (The effective 
control requirement is not met because A's and B's combined identical 
ownership in GHI, X, Y and Z (20% for A and 30% for B) does not exceed 
50%. The 80% controlling interest test is not met because A and B 
together only own 70% of the total combined voting power of the stock of 
Y.) A and M are not members of this group because B owns no interest in 
either organization and A's ownership of GHI, X and Z, considered alone, 
is less than 80%.
    Example 5. The outstanding stock of corporations U and V, which have 
only one class of stock outstanding, is owned by the following unrelated 
individuals:

                              Corporations
------------------------------------------------------------------------
                                                  U              V
                Individuals                -----------------------------
                                              (percent)      (percent)
------------------------------------------------------------------------
A.........................................       12             12
B.........................................       12             12
C.........................................       12             12
D.........................................       12             12
E.........................................       13             13
F.........................................       13             13
G.........................................       13             13
H.........................................       13             13
                                           -----------------------------
                                                100            100
------------------------------------------------------------------------


Any group of five of the shareholders will own more than 50 percent of 
the stock in each corporation, in identical holdings. However, U and V 
are not members of a brother-sister group of trades or businesses under 
common control because at least 80 percent of the stock of each 
corporation is not owned by the same five or fewer persons.
    Example 6. A, an individual, owns a controlling interest in ABC 
Partnership and DEF Partnership. ABC, in turn, owns a controlling 
interest in X Corporation. Since ABC, DEF, and X are each members of 
either a parent-subsidiary group or a brother-sister group of trades or 
businesses under common control, and ABC is the common parent of a 
parent-subsidiary group of trades or businesses under common control 
consisting of

[[Page 908]]

ABC and X, and also a member of a brother-sister group of trades or 
businesses under common control consisting of ABC and DEF, ABC 
Partnership, DEF Partnership, and X Corporation are members of the same 
combined group of trades or businesses under common control.

[T.D. 8179, 53 FR 6606, Mar. 2, 1988, as amended by T.D. 8540, 59 FR 
30102, June 10, 1994]



Sec. 1.414(c)-3  Exclusion of certain interests or stock in determining 
control.

    (a) In general. For purposes of Sec. 1.414(c)-2 (b)(2)(i) and 
(c)(2), the term ``interest'' and the term ``stock'' do not include an 
interest which is treated as not outstanding under paragraph (b) of this 
section in the case of a parent-subsidiary group of trades or businesses 
under common control or under paragraph (c) of this section in the case 
of a brother-sister group of trades or businesses under common control. 
In addition, the term ``stock'' does not include treasury stock or 
nonvoting stock which is limited and preferred as to dividends. For 
definitions of certain terms used in this section, see paragraph (d) of 
this section.
    (b) Parent-subsidiary group of trades or businesses under common 
control--(1) In general. If an organization (hereinafter in this section 
referred to as ``parent organization'') owns (within the meaning of 
paragraph (b)(2) of this section)--
    (i) In the case of a corporation, 50 percent or more of the total 
combined voting power of all classes of stock entitled to vote or 50 
percent or more of the total value of shares of all classes of stock of 
such corporation.
    (ii) In the case of a trust or an estate, an actuarial interest 
(within the meaning of Sec. 1.414(c)-2(b)(2)(ii)) of 50 percent or more 
of such trust or estate, and
    (iii) In the case of a partnership, 50 percent or more of the 
profits or capital interest of such partnership, then for purposes of 
determining whether the parent organization or such other organization 
(hereinafter in this section referred to as ``subsidiary organization'') 
is a member of a parent-subsidiary group of trades or businesses under 
common control, an interest in such subsidiary organization excluded 
under paragraph (b) (3), (4), (5), or (6) of this section shall be 
treated as not outstanding.
    (2) Ownership. For purposes of paragraph (b)(1) of this section, a 
parent organization shall be considered to own an interest in or stock 
of another organization which it owns directly or indirectly with the 
application of Sec. 1.414(c)-4(b)(1) and--
    (i) In the case of a parent organization which is a partnership, a 
trust, or an estate, with the application of paragraphs (b) (2), (3), 
and (4) of Sec. 1.414(c)-4, and
    (ii) In the case of a parent organization which is a corporation, 
with the application of Sec. 1.414(c)-4(b)(4).
    (3) Plan of deferred compensation. An interest which is an interest 
in or stock of the subsidiary organization held by a trust which is part 
of a plan of deferred compensation (within the meaning of section 
406(a)(3) and the regulations thereunder) for the benefit of the 
employees of the parent organization or the subsidiary organization 
shall be excluded.
    (4) Principal owners, officers, etc. An interest which is an 
interest in or stock of the subsidiary organization owned (directly and 
with the application of Sec. 1.414(c)-4) by an individual who is a 
principal owner, officer, partner, or fiduciary of the parent 
organization shall be excluded.
    (5) Employees. An interest which is an interest in or stock of the 
subsidiary organization owned (directly and with the application of 
Sec. 1.414(c)-4) by an employee of the subsidiary organization shall be 
excluded if such interest or such stock is subject to conditions which 
substantially restrict or limit the employee's right (or if the employee 
constructively owns such interest or such stock, the direct or record 
owner's right) to dispose of such interest or such stock and which run 
in favor of the parent or subsidiary organization.
    (6) Controlled exempt organization. An interest which is an interest 
in or stock of the subsidiary organization shall be excluded if owned 
(directly and with the application of Sec. 1.414(c)-4) by an 
organization (other than the parent organization):
    (i) To which section 501 (relating to certain educational and 
charitable organizations which are exempt from tax) applies, and

[[Page 909]]

    (ii) Which is controlled directly or indirectly (within the meaning 
of paragraph (d)(7) of this section) by the parent organization or 
subsidiary organization, by an individual, estate, or trust that is a 
principal owner of the parent organization, by an officer, partner, or 
fiduciary of the parent organization, or by any combination thereof.
    (c) Brother-sister group of trades or businesses under common 
control--(1) In general. If five or fewer persons (hereinafter in this 
section referred to as ``common owners'') who are individuals, estates, 
or trusts own (directly and with the application of Sec. 1.414(c)-4)--
    (i) In the case of a corporation, 50 percent or more of the total 
combined voting power of all classes of stock entitled to vote or 50 
percent or more of the total value of shares of all classes of stock or 
such corporation,
    (ii) In the case of a trust or an estate, an actuarial interest 
(within the meaning of Sec. 1.414(c)-2(b)(2)(ii)) of 50 percent or more 
of such trust or estate, and
    (iii) In the case of a partnership, 50 percent or more of the 
profits or capital interest of such partnership, then for purposes of 
determining whether such organization is a member of a brother-sister 
group of trades or businesses under common control, an interest in such 
organization excluded under paragraph (c) (2), (3), or (4) of this 
section shall be treated as not outstanding.
    (2) Exempt employees' trust. An interest which is an interest in or 
stock of such organization held by an employees' trust described in 
section 401(a) which is exempt from tax under section 501(a) shall be 
excluded if such trust is for the benefit of the employees of such 
organization.
    (3) Employees. An interest which is an interest in or stock of such 
organization owned (directly and with the application of Sec. 1.414(c)-
4) by an employee of such organization shall be excluded if such 
interest or stock is subject to conditions which run in favor of a 
common owner of such organization or in favor of such organization and 
which substantially restrict or limit the employee's right (or if the 
employee constructively owns such interest or stock, the direct or 
record owner's right) to dispose of such interest or stock.
    (4) Controlled exempt organization. An interest which is an interest 
in or stock of such organization shall be excluded if owned (directly 
and with the application of Sec. 1.414(c)-4) by an organization:
    (i) To which section 501(c)(3) (relating to certain educational and 
charitable organizations which are exempt from tax) applies, and
    (ii) Which is controlled directly or indirectly (within the meaning 
of paragraph (d)(7) of this section) by such organization, by an 
individual, estate, or trust that is a principal owner of such 
organization, by an officer, partner, or fiduciary of such organization, 
or by any combination thereof.
    (d) Definitions--(1) Employee. For purposes of this section, the 
term ``employee'' has the same meaning such term is given in section 
3306(i) of the Code (relating to definitions for purposes of the Federal 
Unemployment Tax Act).
    (2) Principal owner. For purposes of this section, the term 
``principal owner'' means a person who owns (directly and with the 
application of Sec. 1.414(c)-4)--
    (i) In the case of a corporation, 5 percent or more of the total 
combined voting power of all classes of stock entitled to vote in such 
corporation or 5 percent of more of the total value of shares of all 
classes of stock of such corporation;
    (ii) In the case of a trust or estate, an actuarial interest of 5 
percent or more of such trust or estate; or
    (iii) In the case of a partnership, 5 percent or more of the profits 
or capital interest of such partnership.
    (3) Officer. For purposes of this section, the term ``officer'' 
includes the president, vice-presidents, general manager, treasurer, 
secretary, and comptroller of a corporation, and any other person who 
performs duties corresponding to those normally performed by persons 
occupying such positions.
    (4) Partner. For purposes of this section, the term ``partner'' 
means any person defined in section 7701(a)(2) (relating to definitions 
of partner).

[[Page 910]]

    (5) Fiduciary. For purposes of this section and Sec. 1.414(c)-4, 
the term ``fiduciary'' has the same meaning as such term is given in 
section 7701(a)(6) and the regulations thereunder.
    (6) Substantial conditions. (i) In general. For purposes of this 
section, an interest in or stock of an organization is subject to 
conditions which substantially restrict or limit the right to dispose of 
such interest or stock and which run in favor of another person if the 
condition extends directly or indirectly to such person preferential 
rights with respect to the acquisition of the direct owner's (or the 
record owner's) interest or stock. For a condition to be in favor of 
another person it is not necessary that such person be extended a 
discriminatory concession with respect to price. A right of first 
refusal with respect to an interest or stock in favor of another person 
is a condition which substantially restricts or limits the direct or 
record owner's right of disposition which runs in favor of such person. 
Further, any legally enforceable condition which prohibits the direct or 
record owner from disposing of his or her interest or stock without the 
consent of another person will be considered to be a substantial 
limitation running in favor of such person.
    (ii) Special rule. For purposes of paragraph (c)(3) of this section 
only, if a condition which restricts or limits an employee's right (or 
direct or record owner's right) to dispose of his or her interest or 
stock also applies to the interest or stock in such organization held by 
a common owner pursuant to a bonafide reciprocal purchase arrangement, 
such condition shall not be treated as a substantial limitation or 
restriction. An example of a reciprocal purchase arrangement is an 
agreement whereby a common owner and the employee are given a right of 
first refusal with respect to stock of the employer corporation owned by 
the other party. If, however, the agreement also provides that the 
common owner has the right to purchase the stock of the employer 
corporation owned by the employee in the event the corporation should 
discharge the employee for reasonable cause, the purchase arrangement 
would not be reciprocal within the meaning of this subdivision.
    (7) Control. For purposes of paragraphs (b)(6) and (c)(4) of this 
section, the term ``control'' means control in fact. The determination 
of whether there exists control in fact will depend upon all of the 
facts and circumstances of each case, without regard to whether such 
control is legally enforceable and irrespective of the method by which 
such control is exercised or exercisable.
    (e) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. ABC Partnership owns 70 percent of the capital interest 
and of the profits interest in the DEF Partnership. The remaining 
capital interest and profits interest in DEF is owned as follows: 4 
percent by A (a general partner in ABC), and 26 percent by D (a limited 
partner in ABC). ABC satisfies the 50-percent capital interest or 
profits interest ownership requirement of paragraph (b)(1)(iii) of this 
section with respect to DEF. Since A and D are partners of ABC, under 
paragraph (b)(4) of this section the capital and profits interests in 
DEF owned by A and D are treated as not outstanding for purposes of 
determining whether ABC and DEF are members of a parent-subsidiary group 
of trades or businesses under common control under Sec. 1.414 (c)-2(b). 
Thus, ABC is considered to own 100 percent (70/70) of the capital 
interest and profits interest in DEF. Accordingly, ABC and DEF are 
members of a parent-subsidiary group of trades or businesses under 
common control.
    Example 2. Assume the same facts as in example (1) and assume 
further that A owns 15 shares of the 100 shares of the only class of 
stock of S Corporation and DEF Partner-ship owns 75 shares of such 
stock. ABC satisfies the 50 percent stock requirement of paragraph 
(b)(1)(i) of this section with respect to S since ABC is considered as 
owning 52.5 percent (70 percentx75 percent) of the S stock with the 
application of Sec. 1.414 (c)-4(b)(2). Since A is a partner of ABC, the 
S stock owned by A is treated as not outstanding for purposes of 
determining whether S is a member of a parent-subsidiary group of trades 
or businesses under common control. Thus, DEF Partnership is considered 
to own stock possessing 88.2 percent (75/85) of the voting power and 
value of the S stock. Accordingly, ABC Partnership, DEF Partnership, and 
S Corporation are members of a parent-subsidiary group of trades or 
businesses under common control.
    Example 3. ABC Partnership owns 60 percent of the only class of 
stock of Corporation Y. D, the president of Y, owns the remaining 40 
percent of the stock of Y. D has agreed that if she offers her stock in 
Y for sale she

[[Page 911]]

will first offer the stock to ABC at a price equal to the fair market 
value of the stock on the first date the stock is offered for sale. 
Since D is an employee of Y within the meaning of section 3306(i) of the 
Code and her stock in Y is subject to a condition which substantially 
restricts or limits her right to dispose of such stock and runs in favor 
of ABC Partnership, under paragraph (b)(5) of this section such stock is 
treated as not outstanding for purposes of determining whether ABC and Y 
are members of a parent-subsidiary group of trades or businesses under 
common control. Thus, ABC Partnership is considered to own stock 
possessing 100 percent of the voting power and value of the stock of Y. 
Accordingly, ABC Partnership and Y Corporation are members of a parent-
subsidiary group of trades or businesses under common control. The 
result would be the same if D's husband, instead of D, owned directly 
the 40 percent stock interest in Y and such stock was subject to a right 
of first refusal running in favor of ABC Partnership.

    (f) Exception--(1) In general. If an interest in an organization 
(including stock of a corporation) is owned by a person directly or with 
the application of the rules of paragraph (b) of Sec. 1.414 (c)-4 and 
such ownership results in the membership of that organization in a group 
of two or more trades or businesses under common control for any period, 
then the interest will not be treated as an excluded interest under 
paragraph (b) or (c) of this section if the result of applying such 
provisions is that the organization is not a member of a group of two or 
more trades or businesses under common control for the period.
    (2) Example. The provisions of this paragraph may be illustrated by 
the following example:

    Example. Corporation P owns directly 50 of the 100 shares of the 
only class of stock of corporation S. A, an officer of P, owns directly 
30 shares of S stock which P has an option to acquire. If, under 
paragraph (b)(4) of this section, the 30 shares owned directly by A are 
treated as not outstanding, P would be treated as owning stock 
possessing only 71 percent (50/70) of the total voting power and value 
of S stock, and S should not be a member of a parent-subsidiary group of 
trades or businesses under common control. However, because the 30 
shares owned by A that P has an option to purchase are considered as 
owned by P under paragraph (b)(2) of this section, and that ownership 
plus P's direct ownership of 50 shares result in S's membership in a 
parent-subsidiary group of trades or businesses under common control for 
1985, the provisions of this paragraph apply. Therefore, A's stock is 
not treated as an excluded interest and S is a member of a parent-
subsidiary group consisting of P and S.

[T.D. 8179, 53 FR 6607, Mar. 2, 1988; 53 FR 8302, Mar. 14, 1988]



Sec. 1.414(c)-4  Rules for determining ownership.

    (a) In general. In determining the ownership of an interest in an 
organization for purposes of Sec. 1.414(c)-2 and Sec. 1.414(c)-3, the 
constructive ownership rules of paragraph (b) of this section shall 
apply, subject to the operating rules contained in paragraph (c). For 
purposes of this section the term ``interest'' means: in the case of a 
corporation, stock; in the case of a trust or estate, an actuarial 
interest; in the case of a partnership, an interest in the profits or 
capital; and in the case of a sole proprietorship, the proprietorship.
    (b) Constructive ownership--(1) Options. If a person has an option 
to acquire any outstanding interest in an organization, such interest 
shall be considered as owned by such person. For this purpose, an option 
to acquire an option, and each one of a series of such options shall be 
considered as an option to acquire such interest.
    (2) Attribution from partnerships--(i) General. An interest owned, 
directly or indirectly, by or for a partnership shall be considered as 
owned by any partner having an interest of 5 percent or more in either 
the profits or capital of the partnership in proportion to such 
partner's interest in the profits or capital, whichever such proportion 
is greater.
    (ii) Example. The provisions of paragraph (b)(2)(i) of this section 
may be illustrated by the following example:

    Example. A, B, and C, unrelated individuals, are partners in the ABC 
Partnership. The partners' interest in the capital and profits of ABC 
are as follows:

                              (In percent)
------------------------------------------------------------------------
                  Partner                      Capital        Profits
------------------------------------------------------------------------
A.........................................       36             25
B.........................................       60             71
C.........................................        4              4
------------------------------------------------------------------------

    The ABC Partnership owns the entire outstanding stock (100 shares) 
of X Corporation. Under paragraph (b)(2)(i) of this section, A is 
considered to own the stock of X owned by

[[Page 912]]

the partnership in proportion to his interest in capital (36 percent) or 
profits (25 percent), whichever such proportion is greater. Therefore, A 
is considered to own 36 shares of X stock. Since B has a greater 
interest in the profits of the partnership than in the capital, B is 
considered to own X stock in proportion to his interest in such profits. 
Therefore, B is considered to own 71 shares of X stock. Since C does not 
have an interest of 5 percent or more in either the capital or profits 
of ABC, he is not considered to own any shares of X stock.

    (3) Attribution from estates and trusts--(i) In general. An interest 
in an organization (hereinafter called an ``organization interest'') 
owned, directly or indirectly, by or for an estate or trust shall be 
considered as owned by any beneficiary of such estate or trust who has 
an actuarial interest of 5 percent or more in such organization 
interest, to the extent of such actuarial interest. For purposes of this 
subparagraph, the actuarial interest of each beneficiary shall be 
determined by assuming the maximum exercise of discretion by the 
fiduciary in favor of such beneficiary and the maximum use of the 
organization interest to satisfy the beneficiary's rights. A beneficiary 
of an estate or trust who cannot under any circumstances receive any 
part of an organization interest held by the estate or trust, including 
the proceeds from the disposition thereof, or the income therefrom, does 
not have an actuarial interest in such organization interest. Thus, 
where stock owned by a decedent's estate has been specifically 
bequeathed to certain beneficiaries and the remainder of the estate has 
been specifically bequeathed to other beneficiaries, the stock is 
attributable only to the beneficiaries to whom it is specifically 
bequeathed. Similarly a remainderman of a trust who cannot under any 
circumstances receive any interest in the stock of a corporation which 
is a part of the corpus of the trust (including any accumulated income 
therefrom or the proceeds from a disposition thereof) does not have an 
actuarial interest in such stock. However, an income beneficiary of a 
trust does have an actuarial interest in stock if he has any right to 
the income from such stock even though under the terms of the trust 
instrument such stock can never be distributed to him. The factors and 
methods prescribed in Sec. 20.2031-7 or, for certain prior periods, 
Sec. 20.2031-7A (Estate Tax Regulations) for use in ascertaining the 
value of an interest in property for estate tax purposes shall be used 
for purposes of this subdivision in determining a beneficiary's 
actuarial interest in an organization interest owned directly or 
indirectly by or for an estate or trust.
    (ii) Special rules for estates. (A) For purposes of this paragraph 
(b)(3) with respect to an estate, property of a decedent shall be 
considered as owned by his or her estate if such property is subject to 
administration by the executor or administrator for the purposes of 
paying claims against the estate and expenses of administration 
notwithstanding that, under local law, legal title to such property 
vests in the decedent's heirs, legatees or devisees immediately upon 
death.
    (B) For purposes of this paragraph (b)(3) with respect to an estate, 
the term ``beneficiary'' includes any person entitled to receive 
property of a decedent pursuant to a will or pursuant to laws of descent 
and distribution.
    (C) For purposes of this paragraph (b)(3) with respect to an estate, 
a person shall no longer be considered a beneficiary of an estate when 
all the property to which he or she is entitled has been received by him 
or her, when he or she no longer has a claim against the estate arising 
out of having been a beneficiary, and when there is only a remote 
possibility that it will be necessary for the estate to seek the return 
of property from him or her or to seek payment from him or her by 
contribution or otherwise to satisfy claims against the estate or 
expenses of administration.
    (iii) Grantor trusts, etc. An interest owned, directly or 
indirectly, by or for any portion of a trust of which a person is 
considered the owner under subpart E, part I, subchapter J of the Code 
(relating to grantors and others treated as substantial owners) is 
considered as owned by such person.
    (4) Attribution from corporations--(i) General. An interest owned, 
directly or indirectly, by or for a corporation shall be considered as 
owned by any person who owns (directly and, in the case of a parent-
subsidiary group of trades or

[[Page 913]]

businesses under common control, with the application of paragraph 
(b)(1) of this section, or in the case of a brother-sister group of 
trades or business under common control, with the application of this 
section), 5 percent or more in value of the stock in that proportion 
which the value of the stock which such person so owns bears to the 
total value of all the stock in such corporation.
    (ii) Example. The provisions of paragraph (b)(4)(i) of this section 
may be illustrated by the following example:

    Example. B, an individual, owns 60 of the 100 shares of the only 
class of outstanding stock of corporation P. C, an individual, owns 4 
shares of the P stock, and corporation X owns 36 shares of the P stock. 
Corporation P owns, directly and indirectly, 50 shares of the stock of 
corporation S. Under this subparagraph, B is considered to own 30 shares 
of the S stock (60/100x50), and X is considered to own 18 shares of S 
stock (36/100x50). Since C does not own 5 percent or more in the value 
of P stock, he is not considered as owning any of the S stock owned by 
P. If in this example, C's wife had owned directly 1 share of the P 
stock, C and his wife would each be considered as owning 5 shares of the 
P stock, and therefore C and his wife would be considered as owning 2.5 
shares of the S stock (5/100x50).

    (5) Spouse--(i) General rule. Except as provided in paragraph 
(b)(5)(ii) of this section, an individual shall be considered to own an 
interest owned, directly or indirectly, by or for his or her spouse, 
other than a spouse who is legally separated from the individual under a 
decree of divorce, whether interlocutory or final, or a decree of 
separate maintenance.
    (ii) Exception. An individual shall not be considered to own an 
interest in an organization owned, directly or indirectly, by or for his 
or her spouse on any day of a taxable year of such organization, 
provided that each of the following conditions are satisfied with 
respect to such taxable year:
    (A) Such individual does not, at any time during such taxable year, 
own directly any interest in such organization;
    (B) Such individual is not a member of the board of directors, a 
fiduciary, or an employee of such organization and does not participate 
in the management of such organization at any time during such taxable 
year;
    (C) Not more than 50 percent of such organization's gross income for 
such taxable year was derived from royalties, rents, dividends, 
interest, and annuities; and
    (D) Such interest in such organization is not, at any time during 
such taxable year, subject to conditions which substantially restrict or 
limit the spouse's right to dispose of such interest and which run in 
favor of the individual or the individual's children who have not 
attained the age of 21 years. The principles of Sec. 1.414(c)-
3(d)(6)(i) shall apply in determining whether a condition is a condition 
described in the preceding sentence.
    (iii) Definitions. For purposes of paragraph (b)(5)(ii)(C) of this 
section, the gross income of an organization shall be determined under 
section 61 and the regulations thereunder. The terms ``interest'', 
``royalties'', ``rents'', ``dividends'', and ``annuities'' shall have 
the same meaning such terms are given for purposes of section 1244(c) 
and Sec. 1.1244(c)-1(e)(1).
    (6) Children, grandchildren, parents, and grandparents--(i) Children 
and parents. An individual shall be considered to own an interest owned, 
directly or indirectly, by or for the individual's children who have not 
attained the age of 21 years, and if the individual has not attained the 
age of 21 years, an interest owned, directly or indirectly, by or for 
the individual's parents.
    (ii) Children, grandchildren, parents, and grandparents. If an 
individual is in effective control (within the meaning of Sec. 
1.414(c)-2(c)(2)), directly and with the application of the rules of 
this paragraph without regard to this subdivision, of an organization, 
then such individual shall be considered to own an interest in such 
organization owned, directly or indirectly, by or for the individual's 
parents, grandparents, grandchildren, and children who have attained the 
age of 21 years.
    (iii) Adopted children. For purposes of this section, a legally 
adopted child of an individual shall be treated as a child of such 
individual.
    (iv) Example. The provisions of this subparagraph (6) may be 
illustrated by the following example:


[[Page 914]]


    Example: (A) Facts. Individual F owns directly 40 percent of the 
profits interest of the DEF Partnership. His son, M, 20 years of age, 
owns directly 30 percent of the profits interest of DEF, and his son, A, 
30 years of age, owns directly 20 percent of the profits interest of 
DEF. The 10 percent remaining of the profits interest and 100 percent of 
the capital interest of DEF is owned by an unrelated person.
    (B) F's ownership. F owns 40 percent of the profits interest in DEF 
directly and is considered to own the 30 percent profits interest owned 
directly by M. Since, for purposes of the effective control test 
contained in paragraph (b)(6)(ii) of this section, F is treated as 
owning 70 percent of the profits interest of DEF, F is also considered 
as owning the 20 percent profits interest of DEF owned by his adult son, 
A. Accordingly, F is considered as owning a total of 90 percent of the 
profits interest in DEF.
    (C) M's ownership. Minor son, M. owns 30 percent of the profits 
interest in DEF directly, and is considered to own the 40 percent 
profits interest owned directly by his father, F. However, M is not 
considered to own the 20 percent profits interest of DEF owned directly 
by his brother, A, and constructively by F, because an interest 
constructively owned by F by reason of family attribution is not 
considered as owned by him for purposes of making another member of his 
family the constructive owner of such interest. (See paragraph (c)(2) of 
this section.) Accordingly, M is considered as owning a total of 70 
percent of the profits interest of the DEF Partnership.
    (D) A's ownership. Adult son, A, owns 20 percent of the profits 
interest in DEF directly. Since, for purposes of determining whether A 
effectively controls DEF under paragraph (b)(6)(ii) of this section, A 
is treated as owning only the percentage of profits interest he owns 
directly, he does not satisfy the condition precedent for the 
attribution of the DEF profits interest from his father. Accordingly, A 
is considered as owning only the 20 percent profits interest in DEF 
which he owns directly.

    (c) Operating rules--(1) In general. Except as provided in paragraph 
(c)(2) of this section, an interest constructively owned by a person by 
reason of the application of paragraph (b) (1), (2), (3), (4), (5), or 
(6) of this section shall, for the purposes of applying such paragraph, 
be treated as actually owned by such person.
    (2) Members of family. An interest constructively owned by an 
individual by reason of the application of paragraph (b) (5) or (6) of 
this section shall not be treated as owned by such individual for 
purposes of again applying such subparagraphs in order to make another 
the constructive owner of such interest.
    (3) Precedence of option attribution. For purposes of this section, 
if an interest may be considered as owned under paragraph (b)(1) of this 
section (relating to option attribution) and under any other 
subparagraph of paragraph (b) of this section, such interest shall be 
considered as owned by such person under paragraph (b)(1) of this 
section.
    (4) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. A, 30 years of age, has a 90 percent interest in the 
capital and profits of DEF Partnership. DEF owns all the outstanding 
stock of corporation X and X owns 60 shares of the 100 outstanding 
shares of corporation Y. Under paragraph (c)(1) of this section, the 60 
shares of Y constructively owned by DEF by reason of paragraph (b)(4) of 
this section are treated as actually owned by DEF for purposes of 
applying paragraph (b)(2) of this section. Therefore, A is considered as 
owning 54 shares of the Y stock (90 percent of 60 shares).
    Example 2. Assume the same facts as in example (1). Assume further 
that B, who is 20 years of age and the brother of A, directly owns 40 
shares of Y stock. Although the stock of Y owned by B is considered as 
owned by C (the father of A and B) under paragraph (b)(6)(i) of this 
section, under paragraph (c)(2) of this section such stock may not be 
treated as owned by C for purposes of applying paragraph (b)(6)(ii) of 
this section in order to make A the constructive owner of such stock.
    Example 3. Assume the same facts as in example (2), and further 
assume that C has an option to acquire the 40 shares of Y stock owned by 
his son, B. The rule contained in paragraph (c)(2) of this section does 
not prevent the reattribution of such 40 shares to A because, under 
paragraph (c)(3) of this section, C is considered as owning the 40 
shares by reason of option attribution and not by reason of family 
attribution. Therefore, since A is in effective control of Y under 
paragraph (b)(6)(ii) of this section, the 40 shares of Y stock 
constructively owned by C are reattributed to A. A is considered as 
owning a total of 94 shares of Y stock.

[T.D. 8179, 53 FR 6609, Mar. 2, 1988; 53 FR 8302, Mar. 14, 1988, as 
amended by T.D. 8540, 59 FR 30102, June 10, 1994]

[[Page 915]]



Sec. 1.414(c)-5  Certain tax-exempt organizations.

    (a) Application. This section applies to an organization that is 
exempt from tax under section 501(a). The rules of this section only 
apply for purposes of determining when entities are treated as the same 
employer for purposes of section 414(b), (c), (m), and (o) (including 
the sections referred to in section 414(b), (c), (m), (o), and (t)), and 
are in addition to the rules otherwise applicable under section 414(b), 
(c), (m), and (o) for determining when entities are treated as the same 
employer. Except to the extent set forth in paragraphs (d), (e), and (f) 
of this section, this section does not apply to any church, as defined 
in section 3121(w)(3)(A), or any qualified church-controlled 
organization, as defined in section 3121(w)(3)(B).
    (b) General rule. In the case of an organization that is exempt from 
tax under section 501(a) (an exempt organization) whose employees 
participate in a plan, the employer with respect to that plan includes 
the exempt organization whose employees participate in the plan and any 
other organization that is under common control with that exempt 
organization. For this purpose, common control exists between an exempt 
organization and another organization if at least 80 percent of the 
directors or trustees of one organization are either representatives of, 
or directly or indirectly controlled by, the other organization. A 
trustee or director is treated as a representative of another exempt 
organization if he or she also is a trustee, director, agent, or 
employee of the other exempt organization. A trustee or director is 
controlled by another organization if the other organization has the 
general power to remove such trustee or director and designate a new 
trustee or director. Whether a person has the power to remove or 
designate a trustee or director is based on facts and circumstances. To 
illustrate the rules of this paragraph (b), if exempt organization A has 
the power to appoint at least 80 percent of the trustees of exempt 
organization B (which is the owner of the outstanding shares of 
corporation C, which is not an exempt organization) and to control at 
least 80 percent of the directors of exempt organization D, then, under 
this paragraph (b) and Sec. 1.414(b)-1, entities A, B, C, and D are 
treated as the same employer with respect to any plan maintained by A, 
B, C, or D for purposes of the sections referenced in section 414(b), 
(c), (m), (o), and (t).
    (c) Permissive aggregation with entities having a common exempt 
purpose--(1) General rule. For purposes of this section, exempt 
organizations that maintain a plan to which section 414(c) applies that 
covers one or more employees from each organization may treat themselves 
as under common control for purposes of section 414(c) (and, thus, as a 
single employer for all purposes for which section 414(c) applies) if 
each of the organizations regularly coordinates their day-to-day exempt 
activities. For example, an entity that provides a type of emergency 
relief within one geographic region and another exempt organization that 
provides that type of emergency relief within another geographic region 
may treat themselves as under common control if they have a single plan 
covering employees of both entities and regularly coordinate their day-
to-day exempt activities. Similarly, a hospital that is an exempt 
organization and another exempt organization with which it coordinates 
the delivery of medical services or medical research may treat 
themselves as under common control if there is a single plan covering 
employees of the hospital and employees of the other exempt organization 
and the coordination is a regular part of their day-to-day exempt 
activities.
    (2) Authority to permit aggregation. (i) For determining when 
entities are treated as the same employer under section 414(b), (c), 
(m), and (o), the Commissioner may issue rules of general applicability, 
in revenue rulings, notices, or other guidance published in the Internal 
Revenue Bulletin (see Sec. 601.601(d)(2)(ii)(b) of this chapter), 
permitting other types of combinations of entities that include exempt 
organizations to elect to be treated as under common control for one or 
more specified purposes if:
    (A) There are substantial business reasons for maintaining each 
entity in a separate trust, corporation, or other form; and

[[Page 916]]

    (B) Such treatment would be consistent with the anti-abuse standards 
in paragraph (f) of this section.
    (ii) For example, this authority might be exercised in any situation 
in which the organizations are so integrated in their operations as to 
effectively constitute a single coordinated employer for purposes of 
section 414(b), (c), (m), and (o), including common employee benefit 
plans.
    (d) Permissive disaggregation between qualified church controlled 
organizations and other entities. In the case of a church plan (as 
defined in section 414(e)) to which contributions are made by more than 
one common law entity, any employer may apply paragraphs (b) and (c) of 
this section to those entities that are not a church (as defined in 
section 403(b)(12)(B) and Sec. 1.403(b)-2) separately from those 
entities that are churches. For example, in the case of a group of 
entities consisting of a church (as defined in section 3121(w)(3)(A)), a 
secondary school (that is treated as a church under Sec. 1.403(b)-2), 
and several nursing homes each of which receives more than 25 percent of 
its support from fees paid by residents (so that none of them is a 
qualified church-controlled organization under Sec. 1.403(b)-2 and 
section 3121(w)(3)(B)), the nursing homes may treat themselves as being 
under common control with each other, but not as being under common 
control with the church and the school, even though the nursing homes 
would be under common control with the school and the church under 
paragraph (b) of this section.
    (e) Application to certain church entities under section 3121(w)(3). 
[Reserved]
    (f) Anti-abuse rule. In any case in which the Commissioner 
determines that the structure of one or more exempt organizations (which 
may include an exempt organization and an entity that is not exempt from 
income tax) or the positions taken by those organizations has the effect 
of avoiding or evading any requirements imposed under section 401(a), 
403(b), or 457(b), or any applicable section (as defined in section 
414(t)), or any other provision for which section 414(c) applies, the 
Commissioner may treat an entity as under common control with the exempt 
organization.
    (g) Examples. The provisions of this section are illustrated by the 
following examples:

    Example 1. (i) Facts. Organization A is a tax-exempt organization 
under section 501(c)(3) which owns 80% or more of the total value of all 
classes of stock of corporation B, which is a for profit organization.
    (ii) Conclusion. Under paragraph (a) of this section, this section 
does not alter the rules of section 414(b) and (c), so that organization 
A and corporation B are under common control under Sec. 1.414(c)-2(b).
    Example 2. (i) Facts. Organization M is a hospital which is a tax-
exempt organization under section 501(c)(3) and organization N is a 
medical clinic which is also a tax-exempt organization under section 
501(c)(3). N is located in a city and M is located in a nearby suburb. 
There is a history of regular coordination of day-to-day activities 
between M and N, including periodic transfers of staff, coordination of 
staff training, common sources of income, and coordination of budget and 
operational goals. A single section 403(b) plan covers professional and 
staff employees of both the hospital and the medical clinic. While a 
number of members of the board of directors of M are also on the board 
of directors of N, there is less than 80% overlap in board membership. 
Both organizations have approximately the same percentage of employees 
who are highly compensated and have appropriate business reasons for 
being maintained in separate entities.
    (ii) Conclusion. M and N are not under common control under this 
section, but, under paragraph (c) of this section, may chose to treat 
themselves as under common control, assuming both of them act in a 
manner that is consistent with that choice for purposes of Sec. 
1.403(b)-5(a), sections 401(a), 403(b), and 457(b), and any other 
applicable section (as defined in section 414(t)), or any other 
provision for which section 414(c) applies.
    Example 3. (i) Facts. Organizations O and P are each tax-exempt 
organizations under section 501(c)(3). Each organization maintains a 
qualified plan for its employees, but one of the plans would not satisfy 
section 410(b) (or section 401(a)(4)) if the organizations were under 
common control. The two organizations are closely related and, while the 
organizations have several trustees in common, the common trustees 
constitute fewer than 80 percent of the trustees of either organization. 
Organization O has the power to remove any of the trustees of P and to 
select the slate of replacement nominees.
    (ii) Conclusion. Under these facts, pursuant to paragraphs (b) and 
(f) of this section, the Commissioner treats the entities as under 
common control.


[[Page 917]]


    (h) Applicable date. This section applies for plan years beginning 
after December 31, 2008.

[T.D. 9340, FR 41158, July 26, 2007; 72 FR 54352, Sept. 25, 2007]



Sec. 1.414(c)-6  Effective date.

    (a) General rule. Except as provided in paragraph (b), (c), (e), or 
(f) of this section, the provisions of Sec. 1.414(b)-1 and Sec. Sec. 
1.414(c)-1 through 1.414 (c)-4 shall apply for plan years beginning 
after September 2, 1974.
    (b) Existing plans. In the case of a plan in existence on January 1, 
1974, unless paragraph (c) of this section applies, the provisions of 
``Sec. 1.414 (b)-1 and Sec. Sec. 1.414(c)-1 through 1.414(c)-4 shall 
apply for plan years beginning after December 31, 1975. For definition 
of the term ``existing plan'', see Sec. 1.410(a)-2(c).
    (c) Existing plans electing new provisions. In the case of a plan in 
existence on January 1, 1974, for which the plan administrator makes an 
election under Sec. 1.410 (a)-2(d), the provisions of Sec. 1.414(b)-1 
and Sec. Sec. 1.414 (c)-1 through 1.414(c)-4 shall apply to the plan 
years elected under Sec. 1.410 (a)-2 (d).
    (d) Application. For purposes of the Employee Retirement Income 
Security Act of 1974, the provisions of Sec. 1.414(b)-1 and Sec. Sec. 
1.414(c)-1 through 1.414(c)-4 do not apply for any period of time before 
the plan years described in paragraph (a), (b), or (c) of this section, 
whichever is applicable.
    (e) Special rule. Notwithstanding paragraph (a), (b), or (c) of this 
section, Sec. 1.414(c)-3 (f) is effective April 1, 1988.
    (f) Transitional rule--(1) In general. The amendments made by T.D. 
8179 apply to the plan years or period described in paragraphs (a), (b), 
or (c) of this section, whichever is applicable.
    (2) Exception. In the case of a plan year or period beginning before 
March 2, 1988, if an organization--
    (i) Is a member of a brother-sister group of trades or businesses 
under common control under Sec. 11.414(c)-2(c), as in effect before 
removal by T.D. 8179 (``old group''), for such plan year or period, and
    (ii) Is not such a member for such plan year or period because of 
the amendments made by such Treasury decision,

such member (whether or not a corporation) nevertheless will be treated 
as a member of such old group for purposes of section 414(c) for that 
plan year or period to the extent provided in Sec. 1.1563-1 (d)(2). 
Also, such member will be treated as a member of an old group for all 
purposes of the Code for such plan year or period if all the 
organizations (whether or not corporations) that are members of the old 
group meet all the requirements of Sec. 1.1563-1(d)(3) with respect to 
such plan year or period.

[T.D. 8179, 53 FR 6611, Mar. 2, 1988. Redesignated by T.D. 9340, 72 FR 
41158, July 26, 2007]



Sec. 1.414(e)-1  Definition of church plan.

    (a) General rule. For the purposes of part I of subchapter D of 
chapter 1 of the Code and the regulations thereunder, the term ``church 
plan'' means a plan established and at all times maintained for its 
employees by a church or by a convention or association of churches 
(hereinafter included within the term ``church'') which is exempt from 
tax under section 501(a), provided that such plan meets the requirements 
of paragraphs (b) and (if applicable) (c) of this section. If at any 
time during its existence a plan is not a church plan because of a 
failure to meet the requirements set forth in this section, it cannot 
thereafter become a church plan.
    (b) Unrelated businesses--(1) In general. A plan is not a church 
plan unless it is established and maintained primarily for the benefit 
of employees (or their beneficiaries) who are not employed in connection 
with one or more unrelated trades or businesses (within the meaning of 
section 513).
    (2) Establishment or maintenance of a plan primarily for persons not 
employed in connection with one or more unrelated trades or businesses. 
(i) (A) A plan, other than a plan in existence on September 2, 1974, is 
established primarily for the benefit of employees (or their 
beneficiaries) who are not employed in connection with one or more 
unrelated trades or businesses if on the date the plan is established 
the number of employees employed in connection with the unrelated trades 
or businesses eligible to participate in the plan is less than 50 
percent of the total number of

[[Page 918]]

employees of the church eligible to participate in the plan.
    (B) A plan in existence on September 2, 1974, is to be considered 
established as a plan primarily for the benefit of employees (or their 
beneficiaries) who are not employed in connection with one or more 
unrelated trades or businesses if it meets the requirements of both 
paragraphs (b)(2)(ii) (A) and (B) (if applicable) in either of its first 
2 plan years ending after September 2, 1974.
    (ii) For plan years ending after September 2, 1974, a plan will be 
considered maintained primarily for the benefit of employees of a church 
who are not employed in connection with one or more unrelated trades or 
businesses if in 4 out of 5 of its most recently completed plan years--
    (A) Less than 50 percent of the persons participating in the plan 
(at any time during the plan year) consist of and in the same year
    (B) Less than 50 percent of the total compensation paid by the 
employer during the plan year (if benefits or contributions are a 
function of compensation) to employees participating in the plan is paid 
to,

employees employed in connection with an unrelated trade or business. 
The determination that the plan is not a church plan will apply to the 
second year (within a 5 year period) for which the plan fails to meet 
paragraph (b)(2)(ii) (A) or (B) (if applicable) and to all plan years 
thereafter unless, taking into consideration all of the facts and 
circumstances as described in paragraph (b)(2)(iii) of this section, the 
plan is still considered to be a church plan. A plan that has not 
completed 5 plan years ending after September 2, 1974, shall be 
considered maintained primarily for the benefit of employees not 
employed in connection with an unrelated trade or business unless it 
fails to meet paragraphs (b)(2)(ii) (A) and (B) in at least 2 such plan 
years.
    (iii) Even though a plan does not meet the provisions of paragraph 
(b)(2)(ii) of this section, it nonetheless will be considered maintained 
primarily for the benefit of employees who are not employed in 
connection with one or more unrelated trades or businesses if the church 
maintaining the plan can demonstrate that based on all of the facts and 
circumstances such is the case. Among the facts and circumstances to be 
considered in evaluating each case are:
    (A) The margin by which the plan fails to meet the provisions of 
paragraph (b)(2)(ii) of this section, and
    (B) Whether the failure to meet such provisions was due to a 
reasonable mistake as to what constituted an unrelated trade or business 
or whether a particular person or group of persons were employed in 
connection with one or more unrelated trades or businesses.
    (iv) For purposes of this section, an employee will be considered 
eligible to participate in a plan if such employee is a participant in 
the plan or could be a participant in the plan upon making mandatory 
employee contributions to the plan.
    (3) Employment in connection with one or more unrelated trades or 
businesses. An employee is employed in connection with one or more 
unrelated trades or businesses of a church if a majority of such 
employee's duties and responsibilities in the employ of the church are 
directly or indirectly related to the carrying on of such trades or 
businesses. Although an employee's duties and responsibilities may be 
insignificant with respect to any one unrelated trade or business, such 
employee will nonetheless be considered as employed in connection with 
one or more unrelated trades or businesses if such employee's duties and 
responsibilities with respect to all of the unrelated trades or 
businesses of the church represent a majority of the total of such 
person's duties and responsibilities in the employ of the church.
    (c) Plans of two or more employers. The term ``church plan'' does 
not include a plan which, during the plan year, is maintained by two or 
more employers unless--
    (1) Each of the employers is a church that is exempt from tax under 
section 501(a), and
    (2) With respect to the employees of each employer, the plan meets 
the provisions of paragraph (b)(2)(ii) of this section or would be 
determined to be a church plan based on all the facts and circumstances 
described in paragraph (b)(2)(iii) of this section.

[[Page 919]]


Thus, if with respect to a single employer the plan fails to meet any 
provision of this paragraph, the entire plan ceases to be a church plan 
unless that employer ceases maintaining the plan for all plan years 
beginning after the plan year in which it receives a final notification 
from the Internal Revenue Service that it does not meet the provisions 
of this paragraph. If the employer does cease maintaining the plan in 
accordance with this paragraph, the fact that the employer formerly did 
maintain the plan will not prevent the plan from being a church plan for 
prior years.
    (d) Special rule. (1) Notwithstanding paragraph (c)(1) of this 
section, a plan maintained by a church and one or more agencies of such 
church for the employees of such church and of such agency or agencies, 
that is in existence on January 1, 1974, shall be treated as a church 
plan for plan years ending after September 2, 1974, and beginning before 
January 1, 1983, provided that the plan is described in paragraph (c) of 
this section without regard to paragraph (c)(1) of this section, and the 
plan is not maintained by an agency which did not maintain the plan on 
January 1, 1974.
    (2) For the purposes of section 414(e) and this section, an agency 
of a church means an organization which is exempt from tax under section 
501 and which is either controlled by, or associated with, a church. For 
example, an organization, a majority of whose officers or directors are 
appointed by a church's governing board or by officials of a church, is 
controlled by a church within the meaning of this paragraph. An 
organization is associated with a church if it shares common religious 
bonds and convictions with that church.
    (e) Religious orders and religious organizations. For the purpose of 
this section the term ``church'' includes a religious order or a 
religious organization if such order or organization (1) is an integral 
part of a church, and (2) is engaged in carrying out the functions of a 
church, whether as a civil law corporation or otherwise.
    (f) Separately incorporated fiduciaries. A plan which otherwise 
meets the provisions of this section shall not lose its status as a 
church plan because of the fact that it is administered by a separately 
incorporated fiduciary such as a pension board or a bank.
    (g) Cross reference. (1) For rules relating to treatment of church 
plans, see section 410(c), 411(e), 412(h), 4975(g), and the regulations 
thereunder.
    (2) For rules relating to church plan elections, see section 410(d) 
and the regulations thereunder.

[T.D. 7688, 45 FR 20797, Mar. 31, 1980]



Sec. 1.414(f)-1  Definition of multiemployer plan.

    (a) General rule. For purposes of part I of subchapter D of chapter 
1 of the Code and the regulations thereunder, a plan is a multiemployer 
plan for a plan year if all of the following requirements are satisfied:
    (1) Number of contributing employers. More than one employer is 
required by the plan instrument or other agreement to contribute (or to 
have contributions made on its behalf) to the plan for the plan year.
    (2) Collective bargaining agreement. The plan is maintained for the 
plan year pursuant to one or more collective bargaining agreements 
between employee representatives and more than one employer.
    (3) Amount of contributions. Except as provided by paragraph (c) of 
this section (relating to the special rule for contributions exceeding 
50 percent), the amount of contributions made under the plan for the 
plan year by or on behalf of each employer is less than 50 percent of 
the total amount of contributions made under the plan for such plan year 
by or on behalf of all employers.
    (4) Benefits. The plan provides that the amount of benefits payable 
with respect to each employee participating in the plan is determined 
without regard to whether or not his employer continues as a member of 
the plan. If benefits accrued as a result of the participant's service 
with his employer during a period before such employer was a member of 
the plan, this requirement does not apply to the amount of those 
benefits, except that this requirement does apply to the amount of those 
benefits (i) which are accrued benefits derived from employee 
contributions, or

[[Page 920]]

(ii) which are accrued under a plan maintained by an employer prior to 
the time such employer became a member of the plan to which the 
requirements of this paragraph (a) are applied.
    (5) Other requirements. The plan satisfies such other requirements 
as the Secretary of Labor by regulations prescribes under the authority 
of section 414(f)(1)(E) of the Code and section 3(37) of the Employee 
Retirement Income Security Act of 1974 (Pub. L. 93-406, 88 Stat. 839). 
See 29 CFR 2510.3-37.
    (b) Special rules--(1) Amount of contributions. For purposes of 
paragraphs (a)(3) and (c) of this section, the amount of contributions 
made under the plan for the plan year by or on behalf of each employer 
shall be the sum of such contributions made on or before the last day of 
the plan year. For purposes of determining whether contributions are 
made on or before the last day of the plan year, the rule of section 
412(c)(10) and the regulations thereunder (relating to the treatment of 
certain contributions made after the last day of the plan year as made 
on such last day) shall apply.
    (2) Benefits. (i) For purposes of paragraph (a)(4) of this section, 
certain benefit amounts are treated as accrued as a result of the 
participant's service with an employer during a period before such 
employer was a member of the plan. The amount of such a benefit so 
treated is the difference (if any) between two calculated amounts. The 
first calculated amount is the participant's total accrued benefit 
calculated under the plan as of the date the employer ceased to be a 
member of the plan. The second calculated amount is the participant's 
accrued benefit calculated without regard to his service with such 
employer during the period before such employer was a member of the 
plan. However, under a special limitation, this difference may not 
exceed the benefit a participant accrued from service before his 
employer became a member of the plan. For purposes of this limitation, 
this benefit is the benefit accrued as of the date the employer ceases 
to be a member of the plan. An employer shall be deemed to be a member 
of the plan in a plan year if the employer is required by the plan 
instrument or other agreement to contribute (or to have contributions 
made on its behalf) to the plan for such plan year or if an employee of 
the employer accrues a benefit, on account of service with the employer 
during such plan year, under the plan for that plan year.
    (ii) The provisions of paragraphs (a)(4) and (b)(2)(i) of this 
section are illustrated by the following example:

    Example. On January 1, 1976, employer W became a member of the 
noncontributory XYZ pension plan which uses the calendar year as the 
plan year. W did not maintain any plan prior to that date. The plan 
provided for benefits of $4 per month per year of service (including 
service with W before January 1, 1976). On January 1, 1980, following 
adoption of a new collective bargaining agreement, the benefits were 
increased to $12 per month per year of service for all years of service 
(including service with W before January 1, 1976). On January 1, 1991, W 
ceased to be a member of the plan.
    A, an employee of W, had 15 years of service before January 1, 1976, 
4 years of service between January 1, 1976, and December 31, 1979, and 
11 years of service between January 1, 1980, and December 31, 1990. On 
December 31, 1990, A's accrued benefit was $360 per month ($12 per 
monthx30). On January 1, 1991, the portion of A's accrued benefit 
retained and the portion forfeited under the terms of the XYZ pension 
plan were determined as follows:

----------------------------------------------------------------------------------------------------------------
                                                               Monthly accrued benefit   Monthly accrued benefit
                            Years                                     retained                  forfeited
----------------------------------------------------------------------------------------------------------------
Before Jan. 1, 1976.........................................  ........................         $12x15 years=$180
Jan. 1, 1976 to Dec. 31, 1979...............................            $4x4 years=$16            $8x4 years=$32
Jan. 1, 1980 to Dec. 31, 1990...............................         $12x11 years=$132
                                                             ---------------------------------------------------
  Total.....................................................                      $148                      $212
----------------------------------------------------------------------------------------------------------------

    The XYZ plan does not satisfy the requirements of paragraphs (a)(4) 
and (b)(2)(i) of this section because no benefit can be forfeited with 
respect to service after W began participating in the plan. Thus, the 
maximum accrued benefit that may be forfeited is $180 per month (the 
accrued benefit with respect to A's service prior to January 1, 1976).

[[Page 921]]

Therefore, in order for the plan to meet the requirements of paragraphs 
(a)(4) and (b)(2)(i) of this section, the plan must provide for A's 
accrued benefit after W ceased to be a member of the plan to be at least 
$180 per month ($360 per month total accrued benefit less $180 per month 
benefit accrued for service prior to W's membership in the plan).

    (iii) For purposes of paragraphs (a)(4) and (b)(2) of this section, 
if an employer for a period employs two or more individuals who, solely 
by reason of their employment, are participants in the plan and who do 
not belong to the same collective bargaining unit, the dates on which 
the employer became and ceased to be a member of the plan shall be 
determined separately on a class basis for individuals who belong to 
separate collective bargaining units, as separate classes, and for 
individuals who do not belong to a collective bargaining unit, as a 
further single separate class. Thus, such dates shall be determined with 
respect to individuals as a class who belong to the same collective 
bargaining unit (or who do not belong to a collective bargaining unit) 
without consideration of the employment by the employer of, or the 
participation in the plan by, other individuals (who do not belong to 
such collective bargaining unit and who may belong to another collective 
bargaining unit) or whether the employer is a member of the plan with 
respect to such other individuals. In no event, however, may service not 
attributable to service with a particular collective bargaining unit be 
disregarded under paragaphs (a)(4) and (b)(2) of this section merely 
because the employer ceases to maintain the plan with respect to such 
unit. Thus, for example, paragraphs (a)(4) and (b)(2) of this section do 
not permit the disregard of a period of service of an individual 
belonging to a collective bargaining unit prior to the time the employer 
became a member of the plan with respect to such unit to the extent 
that, during such period of service, the individual belonged to another 
collective bargaining unit with respect to which the employer was a 
member of the plan.
    (3) Controlled groups. For purposes of section 414(f) and this 
section, all corporations which are members of a controlled group of 
corporations (within the meaning of section 1563(a) and the regulations 
thereunder, but determined without regard to section 1563(e)(3)(C) and 
the regulations thereunder) are deemed to be one employer.
    (c) Contributions exceeding 50 percent. If a plan was a 
multiemployer plan as defined in this section for any plan year 
(including plan years ending prior to September 3, 1974), ``75 percent'' 
shall be substituted for ``50 percent'' in applying paragraph (a)(3) of 
this section for subsequent plan years until the first plan year 
following a plan year in which the amount contributed by or on behalf of 
one employer is 75 percent or more of the total amount of contributions 
made under the plan for that plan year by or on behalf of all of the 
employers making contributions. In such case ``75 percent'' shall not 
again be substituted for ``50 percent'' until the plan has met the 
requirements of paragraph (a) of this section (determined without regard 
to this paragraph) for one plan year.
    (d) Examples. The application of this section is illustrated by the 
following examples. For purposes of these examples, assume that the plan 
meets the requirements of paragraphs (a) (1), (2), (4), and (5) of this 
section for each plan year.

    Example 1. On January 1, 1970, U, V, and W, three employers none of 
which is a member of a controlled group of corporations with any of the 
other two employers, establish a plan with a plan year corresponding to 
the calendar year. U, V, and W each contribute less than one-half of the 
total contributions made under the plan for each of the years 1970, 
1971, and 1972. For the years 1973, 1974, and 1975, U contributes 70 
percent and V and W each contribute 15 percent of the total 
contributions made under the plan for each year. The plan is a 
multiemployer plan under section 414(f) and this section for 1975 
because no employer has contributed 75 percent or more of the total 
amount contributed for each of the plan years subsequent to 1972.
    Example 2. (i) First plan year. On January 1, 1975, X, Y, and Z, 
three employers none of which is a member of a controlled group of 
corporations with any of the other two employers, establish a plan with 
a plan year corresponding to the calendar year. X, Y, and Z each 
contribute less than one-half of the total contributions made under the 
plan for 1975. The plan is a multiemployer plan for 1975 because it 
meets the 50 percent contribution requirement of paragraph (a)(3) of 
this section.

[[Page 922]]

    (ii) Second plan year. For the second plan year, 1976, X contributes 
70 percent and Y and Z each contribute 15 percent of the total 
contributions made under the plan. The plan is a multiemployer plan for 
1976 because it was a multiemployer plan for the preceding plan year and 
satisfies the 75 percent contribution requirement of paragraph (c) of 
this section.
    (iii) Third plan year. For the third plan year, 1977, X contributes 
80 percent and Y and Z each contribute 10 percent of the total 
contributions made under the plan. The plan is not a multiemployer plan 
for 1977 because it fails to satisfy the 75 percent contribution 
requirement of paragraph (c) of this section.
    (iv) Fourth plan year. For the fourth plan year, 1978, Y contributes 
60 percent and X and Z each contribute 20 percent of the total 
contributions made under the plan. The 75 percent contribution 
requirement of paragraph (c) of this section does not apply. The plan is 
not a multiemployer plan for 1978 because it fails to satisfy the 50 
percent contribution requirement of paragraph (a)(3) of this section.
    (v) Fifth plan year. For the fifth plan year, 1979, X, Y, and Z each 
contribute less than one-half of the total contributions made under the 
plan. The 75 percent contribution requirement of paragraph (c) of this 
section does not apply. The plan is a multiemployer plan for 1979 
because it again meets the 50 percent contribution requirement of 
paragraph (a)(3) of this section.
    (vi) Sixth plan year. For the sixth plan year, 1980, the plan will 
continue to be a multiemployer plan, provided that no employer 
contributes 75 percent or more of the total amount of contributions made 
under the plan for the plan year.

    (e) Retention of records. (1) For plan years ending prior to 
September 3, 1974, a plan may be required to furnish proof that it met 
the requirements of section 414(f) and this section for each plan year 
ending prior to that date to the extent necessary to show the 
applicability of the 75 percent test provided in paragraph (c) of this 
section.
    (2) For plan years ending after September 2, 1974, a plan may be 
required to furnish proof that it met the requirements of section 414(f) 
and this section for 6 immediately preceding plan years.

(Secs. 414(f) and 7805 of the Internal Revenue Code of 1954 (88 Stat. 
927, 26 U.S.C. 414(f); 68A Stat. 917; 26 U.S.C. 7805))

[T.D. 7552, 43 FR 29940, July 12, 1978]



Sec. 1.414(g)-1  Definition of plan administrator.

    (a) In general. For purposes of part I of subchapter D of chapter 1 
of the Code and the regulations thereunder, if the instrument under 
which the plan is operated for a plan year specifically designates a 
person or a group of persons as plan administrator, the person or group 
of persons collectively is the plan administrator for the plan year. The 
instrument may specifically designate a plan administrator--
    (1) By name,
    (2) By reference to the person or group of persons holding a named 
position or positions,
    (3) By reference to a procedure established under the terms of the 
instrument pursuant to which a plan administrator is designated, or
    (4) By reference to the person or group of persons charged with 
specific responsibilities of plan administrator. Consistent with the 
provisions of section 405 (c) (1) of the Employee Retirement Income 
Security Act of 1974 (29 U.S.C. 1105 (c) (1)), a plan may provide for 
the allocation of specific responsibilities of plan administrator among 
named persons and for named persons to designate others to carry out 
such responsibilities. A person or group of persons may be designated as 
plan administrator in accordance with the rules of this paragraph even 
though the person or group of persons does not carry the specific title 
``plan administrator''. In the absence of a person or group of persons 
designated as the plan administrator (individually, collectively, or by 
designation of different specific administrative responsibilities), the 
plan administrator for the plan year is the person or group of persons 
specified in paragraph (b) of this section.
    (b) Plan administrator not specifically designated. If no person or 
group of persons is specifically designated as the plan administrator 
for a plan year by the instrument under which the plan is operated, the 
plan administrator for such year is the person or group of persons 
determined under the following rules:
    (1) Single employer. In the case of a plan maintained by a single 
employer, the employer is the plan administrator.

[[Page 923]]

If the employer is a corporation, the corporation is the plan 
administrator. However, the corporation's board of directors may 
authorize a person or group of persons to fulfill responsibilities of 
the corporation as plan administrator. In the absence of such 
authorization, any corporate officer authorized under law, corporate by-
laws, or resolution of the board of directors to act on behalf of the 
corporation with respect to contracts of a value equivalent to the fair 
market value of the assets of the plan shall be presumed to have 
authority to fulfill responsibilities of the corporation as plan 
administrator. For purposes of this paragraph (b) (1), ``employer'' 
means the ``employer'' as defined in section 3 (5) of the Employee 
Retirement Income Security Act of 1974 (29 U.S.C. 1003 (5)).
    (2) Employee organization. In the case of a plan maintained by an 
employee organization, the employee organization is the plan 
administrator.
    (3) Group representing the parties. In the case of a plan maintained 
by two or more employers, or jointly by one or more employers and one or 
more employee organizations, the association, committee, joint board of 
trustees, or other similar group of representatives of the parties who 
maintain the plan, as the case may be, is the plan administrator. For 
purposes of this subparagraph (3), a plan shall be considered maintained 
by two or more employers or jointly by one or more employers and one or 
more employee organizations only if none of the parties has the express 
power, under the terms of the instrument under which the plan is 
operated, to terminate the plan unilaterally.
    (4) Person in control of assets. In any case where a plan 
administrator may not be determined by application of paragraphs (a) and 
(b), (1), (2), and (3) of this section, the plan administrator is the 
person or persons actually responsible, whether or not under the terms 
of the plan, for the control, disposition, or management of the cash or 
property received by or contributed to the plan, irrespective of whether 
such control, disposition, or management is exercised directly by such 
person or persons or indirectly through an agent or trustee designated 
by such person or persons.

(Secs. 414(g) and 7805 of the Internal Revenue Code of 1954 (88 Stat. 
927, 68A Stat 917; 26 U.S.C. 414(g), 7805))

[T.D. 7618, 44 FR 27657, May 11, 1979]



Sec. 1.414(l)-1  Mergers and consolidations of plans or transfers of 
plan assets.

    (a) In general--(1) Scope of the regulations. Sections 401(a)(12) 
and 414(l) apply only to plans to which section 411 applies without 
regard to section 411(e)(2). Thus, for example, these sections do not 
apply to a governmental plan within the meaning of section 414(d); a 
church plan, within the meaning of section 414(e), for which there has 
not been made the election under section 410(d) to have the 
participation, vesting, funding, etc. requirements apply; or a plan 
which at no time after September 2, 1974, provided for employer 
contributions.
    (2) General rule. Under section 414(l),
    (i) A trust which forms a part of a plan will not constitute a 
qualified trust under section 401, and
    (ii) A plan will not be treated as being qualified under section 403 
(a) and 405 (a), unless, in the case of a merger or consolidation (as 
defined in paragraph (b)(2) of this section), or a transfer of assets or 
liabilities (as defined in paragraph (b)(3) of this section), the 
following condition is satisfied. This condition requires that each 
participant receive benefits on a termination basis (as defined in 
paragraph (b)(5) of this section) from the plan immediately after the 
merger, consolidation or transfer which are equal to or greater than the 
benefits the participant would receive on a termination basis 
immediately before the merger, consolidation, or transfer.
    (b) Definitions. For purposes of this section:
    (1) Single plan. A plan is a ``single plan'' if and only if, on an 
ongoing basis, all of the plan assets are available to pay benefits to 
employees who are covered by the plan and their beneficiaries. For 
purposes of the preceding sentence, all the assets of a plan will not 
fail to be available to provide all the benefits of a plan merely 
because the plan is funded in part or in whole with allocated insurance 
instruments.

[[Page 924]]

A plan will not fail to be a single plan merely because of the 
following:
    (i) The plan has several distinct benefit structures which apply 
either to the same or different participants,
    (ii) The plan has several plan documents,
    (iii) Several employers, whether or not affiliated, contribute to 
the plan,
    (iv) The assets of the plan are invested in several trusts or 
annuity contracts, or
    (v) Separate accounting is maintained for purposes of cost 
allocation but not for purposes of providing benefits under the plan.

However, more than one plan will exist if a portion of the plan assets 
is not available to pay some of the benefits. This will be so even if 
each plan has the same benefit structure or plan document, or if all or 
part of the assets are invested in one trust with separate accounting 
with respect to each plan.
    (2) Merger or consolidation. The terms ``merger'' or 
``consolidation'' means the combining of two or more plans into a single 
plan. A merger or consolidation will not occur merely because one or 
more corporations undergo a reorganization (whether or not taxable). 
Furthermore, a merger or consolidation will not occur if two plans are 
not combined into a single plan, such as by using one trust which limits 
the availability of assets of one plan to provide benefits to 
participants and beneficiaries of only that plan.
    (3) Transfer of assets or liabilities. A ``transfer of assets or 
liabilities'' occurs when there is a diminution of assets or liabilities 
with respect to one plan and the acquisition of these assets or the 
assumption of these liabilities by another plan. For example, the 
shifting of assets or liabilities pursuant to a reciprocity agreement 
between two plans in which one plan assumes liabilities of another plan 
is a transfer of assets or liabilities. However, the shifting of assets 
between several funding media used for a single plan (such as between 
trusts, between annuity contracts, or between trusts and annuity 
contracts) is not a transfer of assets or liabilities.
    (4) Spinoff. The term ``spinoff'' means the splitting of a single 
plan into two or more plans.
    (5) Benefits on a termination basis. (i) The term ``benefits on a 
termination basis'' means the benefits that would be provided 
exclusively by the plan assets pursuant to section 4044 of the Employee 
Retirement Income Security Act of 1974 (``ERISA'') and the regulations 
thereunder if the plan terminated. Thus, the term does not include 
benefits that are guaranteed by the Pension Benefit Guaranty 
Corporation, but not provided by the plan assets.
    (ii) For purposes of determining the benefits on a termination 
basis, the allocation of assets to various priority categories under 
section 4044 of ERISA must be made on the basis of reasonable actuarial 
assumptions. The assumptions used by the Pension Benefit Guaranty 
Corporation as of the date of the merger or spinoff are deemed 
reasonable for this purpose.
    (iii) If a change in the benefit structure of a plan in conjunction 
with a merger, consolidation, or transfer of assets or liabilities 
alters the benefits on a termination basis, the change should be 
designated, at the time the merger, consolidation, or transfer occurs, 
to be effective either immediately before or immediately after that 
occurrence. In the event that no designation is made, the change in the 
benefit structure will be deemed to occur immediately after the merger, 
consolidation, or transfer of assets or liabilities.
    (6) Lower funded plan. (i) The term ``lower funded plan'' generally 
means the plan which, immediately prior to the merger, would have its 
assets exhausted in a higher priority category than the other plan.
    (ii) Where two plans, immediately prior to the merger, would have 
their assets exhausted in the same priority category of section 4044 of 
ERISA in the event of termination, the lower funded plan is the one in 
which the assets would satisfy a lesser proportion of the liability 
allocated to that priority category.
    (7) Priority category. The term ``priority category'' means the 
category of benefits described in each paragraph of section 4044(a) of 
ERISA. References to higher or highest priority categories refer to 
those priority categories which receive the first allocation of asserts,

[[Page 925]]

i.e. the lowest paragraph numbers in section 4044(a).
    (8) Separate accounting of assets. The term ``separate accounting of 
assets'' means the maintenance of an asset account with respect to a 
given group of participants which is:
    (i) Credited with contributions made to the plan on behalf of the 
participants and with its allocable share of investment income, if any, 
and
    (ii) Charged with benefits paid to the participants, and with its 
allocable share of investment losses or expenses.
    (9) Present value of accrued benefit. For purposes of this section, 
the present value of an accrued benefit must be determined on the basis 
of reasonable actuarial assumptions. For this purpose, the assumptions 
used by the Pension Benefit Guaranty Corporation as of the date of the 
merger or spinoff are deemed reasonable.
    (10) Valuation of plan assets. In determining the value of a plan's 
assets, the standards set forth in regulations prescribed by the Pension 
Benefit Guaranty Corporation (29 CFR Part 2611) shall be applied.
    (11) Date of merger or spinoff. The actual date of a merger or 
spinoff shall be determined on the basis of the facts and circumstances 
of the particular situation. For purposes of this determination, the 
following factors, none of which is necessarily controlling, are 
relevant:
    (i) The date on which the affected employees stop accruing benefits 
under one plan and begin coverage and benefit accruals under another 
plan.
    (ii) The date as of which the amount of assets to be eventually 
transferred is calculated.
    (iii) If the merger or spinoff agreement provides that interest is 
to accrue from a certain date to the date of actual transfer, the date 
from which such interest will accrue.
    (c) Application of section 414(l)--(1) Two or more plans. (i) 
Section 414(l) does not apply unless more than a single plan is 
involved. It also does not apply unless at least a single plan assumes 
liabilities from another plan or obtains assets from another plan (as in 
a merger or spinoff). For purposes of section 414(l), a transfer of 
assets or liabilities will not be deemed to occur merely because a 
defined contribution plan is amended to become a defined benefit plan. 
This rule will apply even if, under the facts and circumstances of a 
particular case, a termination of the defined contribution plan will be 
considered to have occurred for purposes of other provisions of the 
Code.
    (ii) The requirements of this subparagraph may be illustrated as 
follows:

    Example. After acquiring Corporation B, Corporation A amends 
Corporation B's defined benefit plan (Plan B) to provide the same 
benefits as Corporation A's defined benefit plan (Plan A). The assets of 
Plan B are transferred to the trust containing the assets of Plan A in 
such a manner that the assets of each plan: (1) are separately accounted 
for, and (2) are not available to pay benefits of the other plan. 
Because of condition (2) there are still two plans and, therefore, a 
merger did not occur. As a result, section 414(l) does not apply. If at 
some later date Corporation A were to sell Corporation B and transfer 
the assets of Plan B that were separately accounted for to another trust 
or to an annuity contract solely for the purpose of providing Plan B's 
benefits, this transfer would also not involve section 414(l). This is 
so because Plan B was a separate plan before the entire transaction and 
because no plan assumed liabilities or obtained assets from another 
plan. If, on the other hand, Corporation A merged Plan A and Plan B at 
the time of the acquisition of Corporation B by deleting condition (2) 
above, then section 414(l) would apply both to the merger of Plan A and 
Plan B and to the spinoff of Plan B from the merged plan. The spinoff 
would have to satisfy the requirements of paragraph (n) of this section, 
even if the assets attributable to Plan A and Plan B were separately 
accounted for in order to allocate funding costs.

    (2) Multiemployer plans. Except to the extent provided by 
regulations of the Pension Benefit Guaranty Corporation, section 114(l) 
does not apply to any transaction to the extent that participants either 
before or after that transaction are covered under a multiemployer plan 
within the meaning of section 414(f). Until these regulations are 
issued, section 414(l) does not apply to any of the following 
situations:
    (i) A multiemployer plan is split into two or more plans, one or 
more of which are not multiemployer plans, or (ii) A single employer 
plan is merged into a multiemployer plan.

Therefore, if some (but not all) of the participants in a single 
employer plan

[[Page 926]]

become participants in a multiemployer plan under an agreement in which 
the multiemployer plan assumes all the liabilities of the single 
employer plan with respect to these participants and in which some or 
all of the assets of the single employer plan are transferred to the 
multiemployer plan, section 414(l) applies, but only with respect to the 
participants in the single employer plan who did not transfer to the 
multiemployer plan.
    (d) Merger of defined contribution plans. In the case of a merger of 
two or more defined contribution plans, the requirements of section 
414(l) will be satisfied if all of the following conditions are met:
    (1) The sum of the account balances in each plan equals the fair 
market value (determined as of the date of the merger) of the entire 
plan assets.
    (2) The assets of each plan are combined to form the assets of the 
plan as merged.
    (3) Immediately after the merger, each participant in the plan as 
merged has an account balance equal to the sum of the account balances 
the participant had in the plans immediately prior to merger.
    (e) Merger of defined benefit plans--(1) General rule. Section 
414(l) compares the benefits on a termination basis before and after the 
merger. If the sum of the assets of all plans is not less than the sum 
of the present values of the accrued benefit (whether or not vested) of 
all plans, the requirements of section 414(l) will be satisfied merely 
by combining the assets and preserving each participant's accrued 
benefits. This is so because all the accrued benefits of the plan as 
merged are provided on a termination basis by the plan as merged. 
However, if the sum of the assets of all plans is less than the sum of 
the present values of the accrued benefits (whether or not vested) in 
all plans, the accrued benefits in the plan as merged are not provided 
on a termination basis.
    (2) Special schedule of benefits. Generally, for some participants, 
the benefits provided on a termination basis for the plan as merged 
would be different from the benefits provided on a termination basis in 
the plans prior to merger if the assets were merely combined and if each 
participant retained his accrued benefit. Some participants would, 
therefore, receive greater benefits on a termination basis as a result 
of the merger and some other participants would receive smaller 
benefits. Accordingly, the requirements of section 414(l) would not be 
satisfied unless the distribution on termination were modified in some 
manner to prevent any participant from receiving smaller benefits on a 
termination basis as a result of the merger. This is accomplished 
through modifying the application of section 4044 of ERISA by inserting 
a special schedule of benefits.
    (f) Operational rules for the special schedule. The application of 
section 4044 of ERISA as modified by the schedule of benefits is 
accomplished by the following steps:
    (1) Section 4044 is applied in the plan as merged through the 
priority categories fully satisfied by the assets of the lower funded 
plan immediately prior to the merger.
    (2) The assets in the plan as merged are then allocated to the next 
priority category as a percentage of the value of the benefits that 
would otherwise be allocated to that priority category. That percentage 
is the ratio of (i) the assets allocated to the first priority category 
not fully satisfied by the lower funded plan immediately prior to the 
merger to (ii) the assets that would have been allocated had that 
priority category been fully satisfied.
    (3) A schedule of benefits is formed listing participants and 
scheduled accrued benefits. The scheduled accrued benefit is the excess 
of the benefits provided on a termination basis with respect to any 
participant from the plans immediately prior to the merger, over the 
benefits provided on a termination basis in subparagraphs (1) and (2) of 
this paragraph immediately after the merger. After allocating the assets 
in accordance with subparagraph (2) of this paragraph, the assets are 
allocated to the schedule of benefits as follows:
    (i) First the assets are allocated to the scheduled benefits to the 
extent that the participant would have benefits provided in subparagraph 
(4) of this paragraph if there were no scheduled benefits.

[[Page 927]]

    (ii) Then the assets are allocated to the scheduled benefits to the 
extent that the participant would have benefits provided pursuant to 
subparagraph (5) of this paragraph if there were no scheduled benefits.

These assets should be allocated first to those scheduled benefits that 
are in the highest priority category under section 4044.
    (4) The assets are then allocated to those benefits in the priority 
category described in subparagraph (2) of this paragraph with respect to 
which assets were not allocated. This allocation is made to the extent 
that these benefits are not associated with benefits in the schedule.
    (5) Finally, the assets are allocated in accordance with section 
4044 with respect to priority categories lower than the priority 
category described in subparagraph (4) of this paragraph. This 
allocation is made to the extent that these benefits are not associated 
with benefits in the schedule.
    (g) Successive mergers--(1) In general. In the case of a current 
merger of a defined benefit plan with another defined benefit plan which 
as a result of a previous merger has a special schedule, the rules of 
paragraphs (e) and (f) of this section apply as if the schedule were 
considered a category described in section 4044 of ERISA. Thus, a second 
schedule may be formed as a result of the current merger. The second 
schedule will be inserted in the priority category of section 4044 
described in paragraph (f)(2) of this section as of the date of the 
current merger. This priority category may be higher, lower, or within 
the schedule of benefits existing on account of a previous merger. If 
this priority schedule is inserted within a schedule of benefits, a new 
single schedule of benefits replacing the old schedule of benefits would 
in effect be created.
    (2) Allocation of assets. Assets in the new schedule of benefits are 
allocated as follows:
    (i) First to the benefits remaining in the old schedule to the 
extent that there are assets immediately prior to the second merger to 
satisfy the original benefits,
    (ii) Then to the benefits provided on a termination basis from the 
plans immediately prior to the second merger to the extent that they are 
not provided before the schedule after the second merger or in 
subdivision (i) of this subparagraph,
    (iii) Then to benefits remaining in the original schedule not 
included in subdivision (i) of this subparagraph.
    (h) De minimis rule for merger of defined benefit plan--(1) In 
general. In the case of a merger of a defined benefit plan (``smaller 
plan'') whose liabilities (i.e., the present value of accrued benefits, 
whether or not vested) are less than 3 percent of the assets of another 
defined benefit plan (``larger plan'') as of at least one day in the 
larger plan's plan year in which the merger of the two plans occurs, 
section 414(l) will be deemed to be satisfied if the following condition 
is met. The condition requires that a special schedule of benefits 
(consisting of all the benefits that would be provided by the smaller 
plan on a termination basis just prior to the merger) be payable in a 
priority category higher than the highest priority category in section 
4044 of ERISA. Assets will be allocated to that schedule in accordance 
with the allocation of assets to scheduled benefits in paragraph (f)(3) 
of this section.
    (2) Application to a series of mergers. In the case of a series of 
such mergers in a given plan year of the larger plan, the rule described 
in subparagraph (1) of this paragraph will apply only if the sum of the 
liabilities (whether or not vested) assumed by the larger plan are less 
than 3 percent of the assets of the larger plan as of at least one day 
in the plan year of the larger plan in which the mergers occurred.
    (3) Application to a merger occurring over more than one plan year. 
In the case of a merger of a smaller plan or a portion thereof with a 
larger plan designed to occur in steps over more than one plan year of 
the larger plan, the entire transaction will be deemed to occur in the 
plan year of the larger plan which contains the first of these steps.
    (4) Liabilities of the smaller plan. For purposes of subparagraphs 
(2) and (3) of this paragraph, mergers satisfying paragraphs (e), (f) or 
(g) of this section will be ignored in determining the sum of the 
liabilities assumed by the larger plan.

[[Page 928]]

    (i) Data maintenance--(1) Alternative to the special schedule. In 
the case of a merger which would require the creation of a special 
schedule in order to satisfy section 414(l), the schedule need not be 
created at the time of the merger if data sufficient to create the 
schedule is maintained. The schedule would only have to be created in 
the event of a subsequent plan termination or a subsequent spinoff. In 
that case the schedule must be determined as of the date of the merger.
    (2) Required data. The data that must be maintained depends on the 
plan, and care should be taken to ensure that all necessary data is 
maintained. Furthermore, in order to take advantage of the data 
maintenance alternative provided in this paragraph, an enrolled actuary 
must certify to the plan administrator that each element of data 
necessary to determine the schedule as of the date of the merger is 
maintained. This certification must be based either upon the enrolled 
actuary's independent examination of the data, or upon his reliance, 
which under the circumstances of the particular situation must be 
reasonable, upon a written statement of the plan administrator 
concerning what data is actually being maintained.
    (j) Five year rule--(1) Limitation on the required use of the 
special schedule. A plan will not fail to satisfy the requirements of 
section 414(l) merely because the effects of the special schedule 
created pursuant to paragraphs (e)(2) or (h) of this section are ignored 
5 years after the date of a merger. Furthermore, the date maintained 
pursuant to paragraph (i) of this section need not be maintained for 
more than 5 years after the merger, if the plan does not have a spinoff 
or a termination within 5 years.
    (2) Illustration. If Plans A and B merge to form Plan AB and if Plan 
AB merges with Plan C 3 years later to form Plan ABC and if Plan ABC 
terminates 4 years later, the data relating to the merger of Plans A and 
B need not be maintained for more than 5 years after the merger of Plans 
A and B. In addition, after 5 years have elapsed after the merger of 
Plans A and B, the effect of any special schedule created by the merger 
of Plans A and B on the schedule created by the merger of Plans AB and C 
may be ignored in determining the later schedule.
    (k) Examples. The provisions of paragraphs (e) through (j) of this 
section may be illustrated by the following examples:

    Example 1. Plan A, whose assets are $220,000, is to be merged with 
Plan B, whose assets are $200,000. Plan A has three employees. Plan B 
has two employees. If Plans A and B were to terminate just prior to the 
merger, the benefits provided on a termination basis would be as 
follows:

[[Page 929]]



                                                                                             Plan A
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                     (1)--Annual accrued benefits       (2)--Present value of accrued         (3)--Fair     (4)--Benefits on a termination basis
                                                                  ---------------------------------                benefits                 market value  --------------------------------------
                                                                                                   ---------------------------------------    of assets
            Priority category of section 4044 of ERISA                                                                                      allocated to
                                                                      EE1        EE2        EE3         EE1          EE2          EE3         priority         EE1          EE2          EE3
                                                                                                                                              category
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
3................................................................    $10,000  .........  .........     $120,000  ...........  ...........        $120,000      $10,000
4................................................................      2,000     $4,000  .........       24,000      $44,000  ...........          68,000        2,000       $4,000
5................................................................  .........      3,000     $4,000  ...........       33,000      $40,000          32,000  ...........    \1\ 1,315   \2\ $1,753
6................................................................  .........  .........      1,000  ...........  ...........       10,000
                                                                  ------------------------------------------------------------------------------------------------------------------------------
   Total.........................................................  .........  .........  .........  ...........  ...........  ...........         220,000       12,000        5,315       1,753
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ $3,000x$32,000/$73,000 i.e. accrued benefit x assets available for priority category 5--Total present value of accrued benefits in category 5.
\2\ $4,000x$32,000/$73,000.


                                                                                             Plan B
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                  (1)--Annual accrued benefits        (2)--Present value of accrued benefits     (3)--Fair      (4)--Benefits on a termination
                                                            -----------------------------------------------------------------------------------    market                   basis
                                                                                                                                                  value of  ------------------------------------
         Priority category of section 4044 of ERISA                                                                                                assets
                                                             EE1  EE2  EE3      EE4         EE5     EE1  EE2  EE3      EE4            EE5        allocated
                                                                                                                                                to priority  EE1  EE2  EE3      EE4        EE5
                                                                                                                                                  category
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
3..........................................................  ...  ...  ...      $15,000  .........  ...  ...  ...     $195,000  ..............     $195,000  ...  ...  ...      $15,000
4..........................................................  ...  ...  ...  ...........     $5,000  ...  ...  ...  ...........         $50,000        5,000  ...  ...  ...  ...........      \1\
                                                                                                                                                                                            $500
5..........................................................  ...  ...  ...  ...........      8,000  ...  ...  ...  ...........          80,000
                                                            ------------------------------------------------------------------------------------------------------------------------------------
Total......................................................  ...  ...  ...  ...........  .........  ...  ...  ...  ...........  ..............      200,000  ...  ...  ...       15,000     500
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ $5,000/$5,000x$50,000.


[[Page 930]]

    Because Plan B's assets are exhausted in a higher priority category 
than Plan A's assets, Plan B is the lower funded plan. A schedule will, 
therefore, be inserted in Priority Category 4 of the plan as merged 
after providing 10% of the benefits provided in category 4, i.e. the 
ratio of $5,000 assets in Plan B allocated to category 4 to the $50,000 
liability in category 4. The schedule would be constructed as follows:

----------------------------------------------------------------------------------------------------------------
                                                   (2)--Benefits
                                   (1)--Benefits   provided from    (3)--10% of    (4)--Benefits
                                       on a          priority        benefits        provided      (5)--Schedule
               EE                   termination     categories      provided in       before        of benefits
                                   basis before     higher than      priority     schedule (2) +     (1) - (4)
                                      merger        Category 4      Category 4          (3)
----------------------------------------------------------------------------------------------------------------
1...............................         $12,000         $10,000            $200         $10,200          $1,800
2...............................           5,315  ..............             400             400           4,915
3...............................           1,753  ..............  ..............  ..............           1,753
4...............................          15,000          15,000  ..............          15,000
5...............................             500  ..............             500             500
----------------------------------------------------------------------------------------------------------------

    Example 2. The facts are the same as in Example 1. The plan, 
however, terminates one year later. Furthermore, no employee has accrued 
additional benefits during the year except that the $2,000 benefit for 
EE 1, that was originally in category 4 is now in category 3. 
The assets would be allocated to the priority categories to the extent 
that there are assets to cover the following benefits.

----------------------------------------------------------------------------------------------------------------
                 Priority termination category                     EE1       EE2       EE3       EE4       EE5
----------------------------------------------------------------------------------------------------------------
3.............................................................   $12,000  ........  ........   $15,000
10% of 4......................................................  ........      $400  ........  ........      $500
Schedule of benefits included in balance of Category 4........  ........     3,600
Schedule of benefits included in Category 5...................  ........     1,315    $1,753
Schedule of benefits included in Category 6...................
Balance of Category 4 not included in schedule................  ........  ........  ........  ........     4,500
Balance of Category 5 not included in schedule................  ........     1,685     2,247  ........     8,000
Balance of Category 6 not included in schedule................  ........  ........     1,000
----------------------------------------------------------------------------------------------------------------

    (l) Merger of defined benefit and defined contribution plan. In the 
case of a merger of a defined benefit plan with a defined contribution 
plan, one of the plans before the merger should be converted into the 
other type of plan (i.e., the defined benefit converted into a defined 
contribution or the defined contribution converted into a defined 
benefit) and either paragraph (d) or paragraphs (e) through (j) of this 
section, whichever is appropriate, should be applied.
    (m) Spinoff of a defined contribution plan. In the case of a spinoff 
of a defined contribution plan, the requirements of section 414(l) will 
be satisfied if after the spinoff--
    (1) The sum of the account balances for each of the participants in 
the resulting plans equals the account balance of the participant in the 
plan before the spinoff, and
    (2) The assets in each of the plans immediately after the spinoff 
equals the sum of the account balances for all participants in that 
plan.
    (n) Spinoff of a defined benefit plan--(1) General rule. In the case 
of a spinoff of a defined benefit plan, the requirements of section 
414(l) will be satisfied if--
    (i) All of the accrued benefits of each participant are allocated to 
only one of the spun off plans, and
    (ii) The value of the assets allocated to each of the spun off plans 
is not less than the sum of the present value of the benefits on a 
termination basis in the plan before the spin off for all participants 
in that spun off plan.
    (2) De minimis rule. In the case of a spin off the requirements of 
section 414(l) will be deemed to be satisfied if the value of the assets 
spun off--
    (i) Equals the present value of the accrued benefits spun off 
(whether or not vested), and
    (ii) In conjunction with other assets spun off during the plan year 
in which the spinoff occurs in accordance with this subparagraph, is 
less than 3 percent of the assets as of at least one day in that year.


[[Page 931]]



Spinoffs occurring in previous or subsequent plan years are ignored if 
they are not part of a single spinoff designed to occur in steps over 
more than one plan year.
    (3) Special temporary rule. In the case of a defined benefit plan 
maintained for different groups of employees, which is a single plan (as 
defined in paragraph (b)(l) of this section) and under which there has 
been separate accounting of assets for each group, a spinoff of the plan 
on or before July 1, 1978, into a separate plan for each group will be 
deemed to satisfy section 414 (l) if--
    (i) All the liabilities with respect to each group of employees are 
allocated to a separate plan for that group of employees, and
    (ii) The assets that are separately accounted for with respect to 
each group of employees are allocated to the separate plan for that 
group of employees.

For purposes of this subparagraph, a separate accounting of assets will 
not be considered to have occurred to the extent that the assets 
allocated to each single plan are determined by an historical re-
creation of benefits, contributions, investment gains, etc.
    (o) Transfers of assets or liabilities. Any transfer of assets or 
liabilities will for purposes of section 414 (l) be considered as a 
combination of separate mergers and spinoffs using the rules of 
paragraphs (d), (e) through (j), (l), (m), or (n) of this section, 
whichever is appropriate. Thus, for example, if in accordance with the 
transfer of one or more employees, a block of assets and liabilities are 
transferred from Plan A to Plan B, each of which is a defined benefit 
plan, the transaction will be considered as a spinoff from Plan A and a 
merger of one of the spinoff plans with Plan B. The spinoff and merger 
described in the previous sentence would be subject to the requirements 
of paragraphs (n) and (e) through (j) of this section respectively.

[T.D. 7638, 44 FR 48195, Aug. 17, 1979]



Sec. 1.414(q)-1  Highly compensated employee.

    Q&A-1--Q&A-8: [Reserved]. See Sec. 1.414(q)-1T, Q&A-1 through Q&A-8 
for further guidance.
    Q-9: How is the top-paid group determined?
    A-9: (a) [Reserved]. See Sec. 1.414(q)-1T, Q&A-9(a) for further 
guidance.
    (b) Number of employees in the top-paid group--(1) Exclusions. The 
number of employees who are in the top-paid group for a year is equal to 
20 percent of the total number of active employees of the employer for 
such year. However, solely for purposes of determining the total number 
of active employees in the top-paid group for a year, the employees 
described in Sec. 1.414(q)-1T, A-9(b)(1) (i), (ii) and (iii)(B) are 
disregarded. Paragraph (g) of this A-9 provides rules for determining 
those employees who are excluded for purposes of applying section 
414(r)(2)(A), relating to the 50-employee requirement applicable to a 
qualified separate line of business.
    (i)-(iii) [Reserved]. See Sec. 1.414(q)-1T, Q&A-9(b)(1) (i) through 
(iii) for further guidance.
    (2) Alternative exclusion provisions--(i)-(ii) [Reserved]. See Sec. 
1.414(q)-1T, Q&A-9(b)(2) (i) and (ii) for further guidance.
    (iii) Method of election. The elections in this paragraph (b)(2) 
must be provided for in all plans of the employer and must be uniform 
and consistent with respect to all situations in which the section 
414(q) definition is applicable to the employer. Thus, with respect to 
all plan years beginning in the same calendar year, the employer must 
apply the test uniformly for purposes of determining its top-paid group 
with respect to all its qualified plans and employee benefit plans. If 
either election is changed during the determination year, no 
recalculation of the look-back year based on the new election is 
required, provided the change in election does not result in 
discrimination in operation.
    (c)-(f) [Reserved]. See Sec. 1.414(q)-1T, Q&A-9 (c) through (f) for 
further guidance.
    (g) Excluded employees under section 414(r)(2)(A)--(1) In general. 
This paragraph (g) provides the rules for determining which employees 
are excluded employees for purposes of applying section 414(r)(2)(A), 
relating to the 50-employee requirement applicable to a qualified 
separate line of business.

[[Page 932]]

    (2) Excluded employees--(i) Age and service exclusion. All employees 
are excluded who are described in Sec. 1.414(q)-1T, A-9(b)(1)(i) 
(relating to exclusions based on age or service). For this purpose, the 
rules in Sec. 1.414(q)-1T, A-9 (e) and (f) (relating respectively to 
the 17\1/2\-hour rule and the 6-month rule) apply. However, the election 
in Sec. 1.414(q)-1T, A-9(b)(2)(i) (permitting the employer to elect 
reduced minimum age or service requirements) does not apply.
    (ii) Nonresident alien exclusion. All employees are excluded who are 
described in Sec. 1.414(q)-1T, A-9(b)(1)(ii) (relating to the exclusion 
of nonresident aliens with no U.S.- source income from the employer).
    (iii) Inclusion of employees covered under a collective bargaining 
agreement. All employees are included who are described in Sec. 
1.414(q)-1T, A-9(b)(1)(iii)(A) (relating to employees covered under a 
collective bargaining agreement) and who are not otherwise described in 
paragraph (g)(2) (i) or (ii) of this A-9. For this purpose, the 
exclusion in Sec. 1.414(q)-1T, A- 9(b)(1)(iii)(B) and the related 
election in Sec. 1.414(q)-1T, A- 9(b)(2)(ii) do not apply.
    (3) Applicable period. The determination of which employees are 
excluded employees is made on the basis of the testing year specified in 
the regulations under section 414(r) and not on the basis of the 
determination year or the look-back year under section 414(q).
    (h) Effective date. The provisions of this A-9 apply to plan years 
and testing years beginning on or after January 1, 1994.
    Q&A-10 through Q&A-15: [Reserved]. See Sec. 1.414(q)-1T, Q&A-10 
through Q&A-15 for further guidance.

[T.D. 8548, 59 FR 32915, June 27, 1994]



Sec. 1.414(q)-1T  Highly compensated employee (temporary).

    The following questions and answers relate to the definition of 
``highly compensated employee'' provided in section 414(q). The 
definitions and rules provided in these questions and answers are 
provided solely for purposes of determining the group of highly 
compensated employees.

                           Table of contents.

Q&A-1 General applicability of section 414(q).
Q&A-2 Definition of highly compensated employees.
Q&A-3 Definition of highly compensated active employees.
Q&A-4 Definition of highly compensated former employees.
Q&A-5 Definition of separation year.
Q&A-6 Definition of employer.
Q&A-7 Definition of employee.
Q&A-8 Definition of 5-percent owner.
Q&A-9 Definition of top-paid group.
Q&A-10 Definition of officer and rules on inclusion of officers in 
          highly compensated group.
Q&A-11 Rules with respect to family aggregation.
Q&A-12 Definition of family member.
Q&A-13 Definition of compensation.
Q&A-14 Rules with respect to the relevant determination periods.
Q&A-15 Transition rule applicable to plan years beginning in 1987 and 
          1988 for certain employers that have plans that must comply 
          with the provisions of section 401(k)(3) or 401(m)(2).

    Q-1: To what employee benefit plans and statutory provisions is the 
definition of highly compensated employee contained in section 414(q) 
applicable?
    A-1: (a) In general. This definition is applicable to statutory 
provisions that incorporate the definition by reference.
    (b) Qualified retirement plans--(1) In general. Generally, this 
definition is incorporated in many of the nondiscrimination requirements 
applicable to pension, profit-sharing, and stock bonus plans qualified 
under section 401(a). See, e.g., the nondiscrimination provisions of 
sections 401(a) (4) and (5), 401(k)(3), 401(l), 401(m), 406(b), 407(b), 
408(k), 410(b) and 411(d)(1). The definition is also incorporated by 
certain other provisions with respect to such plans, including the 
aggregation rules of section 414(m) and section 4975 (tax on prohibited 
transactions).
    (2) Not applicable where not incorporated by reference. This 
definition is not applicable to qualified plan provisions that do not 
incorporate it. See, e.g., section 415 (limitations on contributions and 
benefits), with the exception of section 415(c)(3)(C) and 415(c)(6) 
(special rules for permanent and total disability and employee stock 
ownership plans respectively).

[[Page 933]]

    (c) Other employee benefit plans or arrangements. This definition is 
incorporated by various sections relating to employee benefit 
provisions. See, e.g., section 89 (certain other employee benefit 
plans), section 106 (accident and health plans), 117(d) (qualified 
tuition reduction), section 125 (cafeteria plans), section 129 
(dependent care assistance programs), section 132 (certain fringe 
benefits), section 274 (certain entertainment, etc. expenses), section 
423(b) (employee stock purchase plan provisions), section 501(c) (17) 
and (18) (certain exempt trusts providing benefits to employees), and 
section 505 (certain exempt organizations or trusts providing benefits 
to individuals). See the respective sections for the applicable 
effective dates.
    (d) ERISA. This definition is not determinative with respect to any 
provisions of title I of the Employee Retirement Income Security Act of 
1974 (ERISA), unless it is explicitly incorporated by reference (e.g., 
section 408(b)(1)(B)).
    Q-2: Who is a highly compensated employee?
    A-2: The group of employees (including former employees) who are 
highly compensated employees consists of both highly compensated active 
employees (see A-3 of this Sec. 1.414(q)-1T) and highly compensated 
former employees (see A-4 of this Sec. 1.414(q)-1T). In many 
circumstances, highly compensated active employees and highly 
compensated former employees are considered separately in applying the 
provisions for which the definition of highly compensated employees in 
section 414(q) is applicable. Specific rules with respect to the 
treatment of highly compensated active employees and highly compensated 
former employees will be provided in the regulations with respect to the 
sections to which the definition of highly compensated employees is 
applicable.
    Q-3: Who is a highly compensated active employee?
    A-3: (a) General rule. For purposes of the year for which the 
determination is being made (the determination year), a highly 
compensated active employee is any employee who, with respect to the 
employer, performs services during the determination year and is 
described in any one or more of the following groups applicable with 
respect to the look-back year calculation and/or determination year 
calculation for such determination year. See A-14 for rules relating to 
the periods for which the look-back year calculation and determination 
year calculation are to be made.
    (1) Look-back year calculation.
    (i) 5-percent owner. The employee is a 5-percent owner at any time 
during the look-back year (i.e., generally, the 12-month period 
immediately preceding the determination year; see A-14. (See A-8 of this 
Sec. 1.414(q)-1T.)
    (ii) Compensation above $75,000. The employee receives compensation 
in excess of $75,000 during the look-back year.
    (iii) Compensation above $50,000 and top-paid group. The employee 
receives compensation in excess of $50,000 during the look-back year and 
is a member of the top-paid group for the look-back year. (See A-9 of 
this Sec. 1.414(q)-1T.)
    (iv) Officer. The employee is an ``includible officer'' during the 
look-back year. (See A-10 of this Sec. 1.414(q)-1T.)
    (2) Determination year calculation.
    (i) 5-percent owner. The employee is a 5-percent owner at any time 
during the determination year. (See A-8 of this Sec. 1.414(q)-1T.)
    (ii) Top-100 employees. The employee is both (A) described in 
paragraph (a)(1)(i), (ii) and/or (iv) of this A-3, when such paragraphs 
are modified to substitute the determination year for the look-back 
year, and (B) one of the 100 employees who receive the most compensation 
from the employer during the determination year.
    (b) Rounding and tie-breaking rules. In making the look-back year 
and determination year calculations for a determination year, it may be 
necessary for an employer to adopt a rule for rounding calculations 
(e.g., in determining the number of employees in the top-paid group). In 
addition, it may be necessary to adopt a rule breaking ties among two or 
more employees (e.g., in identifying those particular employees who are 
in the top-paid group or who are among the 100 most highly compensated 
employees). In such cases, the employer may adopt any rounding or tie-
breaking rules it desires, so long as

[[Page 934]]

such rules are reasonable, nondiscriminatory, and uniformly and 
consistently applied.
    (c) Adjustments to dollar thresholds--(1) Indexing of dollar 
thresholds. The dollar amounts in paragraph (a)(1) (i) and (ii) of this 
A-3 are indexed at the same time and in the same manner as the section 
415(b)(1)(A) dollar limitation for defined benefit plans.
    (2) Applicable dollar threshold. The applicable dollar amount for a 
particular determination year or look-back year is the dollar amount for 
the calendar year in which such determination year or look-back year 
begins. Thus, the dollar amount for purposes of determining the highly 
compensated active employees for a particular look-back year is based on 
the calendar year in which such look-back year begins, not the calendar 
year in which such look-back year ends or in which the determination 
year with respect to such look-back year begins.
    (d) Employees described in more than one group. An individual who is 
a highly compensated active employee for a determination year, by reason 
of being described in one group in paragraph (a) of this A-3, under 
either the look-back year calculation or the determination year 
calculation, is not disregarded in determining whether another 
individual is a highly compensated active employee by reason of being 
described in another group under paragraph (a). For example, an 
individual who is a highly compensated active employee for a 
determination year, by reason of being a 5-percent owner during such 
year, who receives compensation in excess of $50,000 during both the 
look-back year and the determination year, is taken into account in 
determining the group of employees who are highly compensated active 
employees for such determination year by reason of receiving more than 
$50,000, and being in the top-paid group under either or both the look-
back year calculation or determination year calculation for such 
determination year.
    (e) Examples. The following examples, in which the determination 
year and look-back year are the calendar year, are illustrative of the 
rules in paragraph (a) of this A-3. For purposes of these examples, the 
threshold dollar amounts in paragraph (a)(1) (ii) and (iii) of this A-3 
are not increased pursuant to paragraph (c) of this A-3.

    Example 1. Employee A, who is not at any time a 5-percent owner, an 
officer, or a member of the top-100 within the meaning of paragraph 
(a)(1) (i), or (iv), or (a)(2) (i) or (ii), but who was a member of the 
top-paid group for each year, is included in or excluded from the highly 
compensated groups as specified below for the following years:

------------------------------------------------------------------------
     Year         Compensation       Status              Comments
------------------------------------------------------------------------
1986..........   $45,000         N/A...........  Although prior to
                                                  414(q) effective date,
                                                  1986 constitutes the
                                                  look-back year for
                                                  purposes of
                                                  determining the highly
                                                  compensated group for
                                                  the 1987 determination
                                                  year.
1987..........    80,000         Excl..........  Excluded because A was
                                                  not an employee
                                                  described in paragraph
                                                  (a)(1) (ii) or (iii)
                                                  of this A-3 for the
                                                  look-back year (1986).
1988..........    80,000         Incl..........  Included because A was
                                                  an employee described
                                                  in paragraph (a)(1)
                                                  (ii) or (iii) of this
                                                  A-3 for the look-back
                                                  year (1987).
1989..........    45,000         Incl..........  Included because A was
                                                  an employee described
                                                  in paragraph (a)(1)
                                                  (ii) or (iii) of this
                                                  A-3 for the look-back
                                                  year (1988).
1990..........    45,000         Excl..........  Excluded because A was
                                                  not an employee
                                                  described in paragraph
                                                  (a)(1) (ii) or (iii)
                                                  of this A-3 for the
                                                  look-back year (1989).
------------------------------------------------------------------------

    Example 2. Assuming the same facts as those given in Example 1, 
except that A is a member of the top-100 employees within the meaning of 
paragraph (a)(2)(ii) of this A-3 for the 1987 year and 1990 year, the 
results are as follows:

------------------------------------------------------------------------
     Year         Compensation       Status              Comments
------------------------------------------------------------------------
1986..........   $45,000         N/A...........  Although prior to
                                                  414(q) effective date,
                                                  1986 constitutes the
                                                  look-back year for
                                                  purposes of
                                                  determining the highly
                                                  compensated group for
                                                  the 1987 determination
                                                  year.
1987..........    80,000         Incl..........  Included because A was
                                                  an employee described
                                                  in paragraph
                                                  (a)(1)(ii) or (iii) of
                                                  this A-3 for the
                                                  determination year
                                                  (1987) and was
                                                  described in paragraph
                                                  (a)(2)(ii) of this A-3
                                                  in that year.

[[Page 935]]

 
1988..........    80,000         Incl..........  Included because A was
                                                  an employee described
                                                  in paragraph
                                                  (a)(1)(ii) or (iii) of
                                                  this A-3 for the look-
                                                  back year (1987).
1989..........    45,000         Incl..........  Included because A was
                                                  an employee described
                                                  in paragraph
                                                  (a)(1)(ii) or (iii) of
                                                  this A-3 for the look-
                                                  back year (1988).
1990..........    45,000         Excl..........  Excluded even though in
                                                  top-100 employees
                                                  during 1990
                                                  determination year
                                                  because A was not an
                                                  employee described in
                                                  paragraph (a)(1)(ii)
                                                  or (iii) of this A-3
                                                  for the look-back year
                                                  (1989) or for the
                                                  determination year
                                                  (1990).
------------------------------------------------------------------------

    A-4: Who is a highly compensated former employee?
    Q-4: (a) General rule. Except to the extent provided in paragraph 
(d) of this A-4, a highly compensated former employee for a 
determination year is any former employee who, with respect to the 
employer, had a separation year (as defined in A-5 of this Sec. 
1.414(q)-1T) prior to the determination year and was a highly 
compensated active employee as defined in A-3 of this Sec. 1.414(q)-1T 
for either such employee's separation year or any determination year 
ending on or after the employee's 55th birthday. Thus, for example, an 
employee who is a highly compensated active employee for such employee's 
separation year, by reason of receiving over $75,000 during the look-
back year, is a highly compensated former employee for determination 
years after such employee's separation year.
    (b) Special rule for employees who perform no services for the 
employer in the determination year. For purposes of this rule, employees 
who perform no services for an employer during a determination year are 
treated as former employees. Thus, for example, an employee who 
performed no services for the employer during a determination year, by 
reason of a leave of absence during such year, is treated as a former 
employee for such year.
    (c) Dollar amounts for pre-1987 determination years. For 
determination years beginning before January 1, 1987, the dollar amounts 
in paragraph (a)(1)(B) and (C) of A-2 of this Sec. 1.414(q)-1T are 
$75,000 and $50,000 respectively.
    (d) Special rule for employees who separated from service before 
January 1, 1987--(1) Election of special rule. Employers may elect to 
apply paragraph (d)(2) of this A-4 in lieu of paragraph (a) of this A-4 
in determining whether former employees who separated from service prior 
to January 1, 1987, are highly compensated former employees. If this 
election is made with respect to any qualified plan, it must be provided 
for in the plan. If the employer makes this election with respect to any 
employee benefit plan, such election must be used uniformly for all 
purposes for which the section 414(q) definition is applicable. The 
election, once made, cannot be changed without the consent of the 
Commissioner.
    (2) Special definition of highly compensated former employee. A 
highly compensated former employee includes any former employee who 
separated from service with the employer prior to January 1, 1987, and 
was described in any one or more of the following groups during either 
the employee's separation year (or the year preceding such separation 
year) or any year ending on or after such individual's 55th birthday (or 
the last year ending before such employee's 55th birthday):
    (i) 5-percent owner. The employee was a 5-percent owner of the 
employer at any time during the year.
    (ii) Compensation amount. The employee received compensation is 
excess of $50,000 during the year.
    The determinations provided for in this paragraph (b)(2) may be made 
on the basis of the calendar year, the plan year, or any other twelve 
month period selected by the employer and applied on a reasonable and 
consistent basis.
    (e) Rules with respect to former employees--(1) In general. For 
specific provisions with respect to the treatment of former employees 
and of highly compensated former employees, refer to the rules with 
respect to which the section 414(q) definition of highly compensated 
employee is applicable.
    (2) Former employees excluded in determining top-paid group, top-100 
employees and includible officers. Former employees are not included in 
the top-paid group, the group of the top-100 employees, or the group of 
includible officers for purposes of applying section 414(q)

[[Page 936]]

to active employees. In addition, former employees are not counted as 
employees for purposes of determining the number of employees in the 
top-paid group.
    Q-5: What is a separation year for purposes of section 414(q)?
    A-5: (a) Separation year--(1) In general. The separation year 
generally is the determination year during which the employee separates 
from service with the employer. For purposes of this rule, an employee 
who performs no services for the employer during a determination year 
will be treated as having separated from service with the employer in 
the year in which such employee last performed services for the 
employer. Thus, for example, an employee who performs no services for 
the employer by reason of being on a leave of absence throughout the 
determination year is considered to have separated from service with the 
employer in the year in which such employee last performed services 
prior to beginning the leave of absence.
    (2) Deemed separation. An employee who performs services for the 
employer during a determination year may be deemed to have separated 
from service with the employer during such year pursuant to the rules in 
paragraph (a)(3) of this A-5. Such deemed separation year is relevant 
for purposes of determining whether such employee is a highly 
compensated former employee after such employee actually separates from 
service, not for purposes of identifying such employee as either an 
active or former employee. Because employees to whom the provisions of 
paragraph (a)(2) of this A-5 apply are still performing services for the 
employer during the determination year, they are treated as active 
employees. Thus, for example, an employee who has a deemed separation 
year in 1989, a year during which he was a highly compensated employee, 
who continues to work for the employer until he retires from employment 
in 1995, is an active employee of the employer until 1995 and is either 
highly compensated or not highly compensated for any determination year 
during such period based on the rules with respect to highly compensated 
active employees. For determination years after the year of such 
employee's retirement, such employee is a highly compensated former 
employee because such employee was a highly compensated active employee 
for the deemed separation year.
    (3) Deemed separation year. An employee will be deemed to have a 
separation year if, in a determination year prior to attainment of age 
55, the employee receives compensation in an amount less than 50% of the 
employee's average annual compensation for the three consecutive 
calendar years preceding such determination year during which the 
employee received the greatest amount of compensation from the employer 
(or the total period of the employee's service with the employer, if 
less).
    (4) Leave of absence. The deemed separation rules contained in 
paragraph (a)(2) and (3) of this A-5 apply without regard to whether the 
reduction in compensation occurs on account of a leave of absence.
    (b) Deemed resumption of employment. An employee who is treated as 
having a deemed separation year by reason of the provisions of paragraph 
(a) of this A-5 will not be treated as a highly compensated former 
employee (by reason of such deemed separation year) after such employee 
actually separates from service with the employer if, after such deemed 
separation year, and before the year of actual separation, such 
employee's services for and compensation from the employer for a 
determination year increase significantly so that such employee is 
treated as having a deemed resumption of employment. The determination 
of whether an employee who has incurred a deemed separation year has an 
increase in services and compensation sufficient to result in a deemed 
resumption of employment will be made on the basis of all the 
surrounding facts and circumstances pertaining to each individual case. 
At a minimum, there must be an increase in compensation from the 
employer to the extent that such compensation would not result in a 
deemed separation year under the tests in paragraph (a)(2) of this A-5 
using the same three-year period taken into account in such paragraph.

[[Page 937]]

    (c) Examples. Paragraphs (a) and (b) of this A-5 are illustrated by 
the following examples based on calendar years. For purposes of these 
examples the threshold dollar amounts in A-5(a) of this Sec. 1.414(q)-
1T have not been increased pursuant to A-5(b) of this Sec. 1.414(q)-1T.

    Example 1. Assume that in 1990 A is a highly compensated employee of 
X by reason of having earned more than $75,000 during the 1989 look-back 
year. In 1987, 1988 and 1989, A's years of greatest compensation 
received from X, A received $76,000, $80,000 and $79,000 respectively. 
In February of 1990, A received $30,000 in compensation. Because A's 
compensation during the 1990 determination year is less than 50% of A's 
average annual compensation from X during A's high three prior 
determination years, A is deemed to have a separation year during the 
1990 determination year pursuant to the provisions of paragraph (a) of 
this A-5. Since A is a highly compensated employee for X in 1990, A's 
deemed separation year, A will be treated as a highly compensated former 
employee after A actually separates from service with the employer 
unless A experiences a deemed resumption of employment within the 
meaning of paragraph (b) of this A-5.
    Example 2. Assume that in 1990 A is a highly compensated employee by 
reason of having been an officer (with annual compensation in excess of 
the section 415(c)(1)(A) dollar limitation) during the 1989 look-back 
year. A's compensation from X during 1990 is $37,000. A's average 
compensation from X for the three-year period ending with or within 
January, 1990, was $60,000. A's compensation during the 1990 
determination year is not less than 50% of the compensation earned 
during the test period. Therefore, A is not deemed to have a separation 
year under paragraph (a)(2)(i) of this A-5.
    Example 3. Assume that in 1990 C is 35 and a highly compensated 
employee of Z for the reasons given in Example 1 with the same 
compensation set forth in that example. During 1990, C leaves C's 40 
hour a week position as director of the actuarial division of Z and 
starts working as an actuary for the same division, producing actuarial 
reports approximately 15 to 20 hours a week, approximately half of these 
hours at home. C contemplates returning to full-time employment with Z 
when C's child enters school. During the 1990 determination year, C's 
compensation is less than 50% of C's compensation during her high three 
preceding determination years. Therefore, C has a deemed separation year 
during the 1990 determination year. In 1991 C commences working 32 hours 
a week for X at X's place of business and receives compensation in an 
amount equal to 80 percent of her average annual compensation during her 
high three prior determination years. The C's increased compensation, 
considered in conjunction with the reasons for the reduction in service, 
the nature and extent of the services performed before and after the 
reduction in services, and the lack of proximity of C's age to age 55 at 
the time of the reduction are sufficient to establish that C has a 
deemed resumption of employment within the meaning of paragraph (b) of 
this A-5. Therefore, when C separates from service with the employer, C 
will not be treated as a highly compensated former employee by reason of 
C's deemed separation year in 1990.

    Q-6: Who is the employer?
    A-6: (a) Aggregation of certain entities. The employer is the entity 
employing the employees and includes all other entities aggregated with 
such employing entity under the aggregation requirements of section 
414(b), (c), (m) and (o). Thus, the following entities must be taken 
into account as a single employer for purposes of determining the 
employees who are ``highly compensated employees'' within the meaning of 
section 414(q):
    (1) All corporations that are members of a controlled group of 
corporations (as defined in section 414(b)) that includes the employing 
entity.
    (2) All trades or businesses (whether or not incorporated) that are 
under common control (as defined in section 414(c)) which group includes 
the employing entity.
    (3) All organizations (whether or not incorporated) that are members 
of an affiliated service group (as defined in section 414(m)) that 
includes the employing entity.
    (4) Any other entities required to be aggregated with the employing 
entity pursuant to section 414(o) and the regulations thereunder.
    (b) Priority of aggregation provisions. The aggregation requirements 
of paragraph (a) of this A-6 and of A-7(b) of this section with respect 
to leased employees are applied before the application of any of the 
other provisions of section 414(q) and this section.
    (c) Line of business rules. The section 414(r) rules with respect to 
separate lines of business are not applicable in determining the group 
of highly compensated employees.
    Q-7: Who is an employee for purposes of section 414(q)?

[[Page 938]]

    A-7: (a) General rule. Except as provided in paragraph (b) of this 
A-7, the term ``employee'' for purposes of section 414(q) refers to 
individuals who perform services for the employer and are either common-
law employees of the employer or self-employed individuals who are 
treated as employees pursuant to section 401(c)(1). This rule with 
respect to the inclusion of certain self-employed individuals in the 
group of highly compensated employees is applicable whether or not such 
individuals are eligible to participate in the plan or benefit 
arrangement being tested.
    (b) Leased employees--(1) In general. The term ``employee'' includes 
a leased employee who is treated as an employee of the recipient 
pursuant to the provisions of section 414(n)(2) or 414(o)(2). Employees 
that an employer treats as leased employees under section 414(n), 
pursuant to the requirements of section 414(o), are considered to be 
leased employees for purposes of this rule.
    (2) Safe-harbor exception. For purposes of qualified retirement 
plans, if an employee who would be a leased employee within the meaning 
of section 414(n)(2) is covered in a safe-harbor plan described in 
section 414(n)(5) (a qualified money purchase pension plan maintained by 
the leasing organization), and not otherwise covered under a qualified 
retirement plan of the employer, then such employee is excluded from the 
term ``employee'' unless the employer elects to include such employee 
pursuant to the provisions of paragraph (4) of this paragraph (b).
    (3) Other employee benefit plans. The exception in paragraph (b)(2) 
of this A-7 is not applicable to the determination of the highly 
compensated employee group for purposes of the sections enumerated in 
section 414(n)(3)(C). Thus, for example, a leased employee covered by a 
safe-harbor plan is considered to be an employee in applying the 
nondiscrimination provisions of section 89 to statutory benefit plans. 
Consequently, an employer with leased employees covered in a safe-harbor 
plan may have 2 groups of highly compensated employees, one with respect 
to its retirement plans and another with respect to its statutory 
benefit plans.
    (4) Election with respect to leased employee exclusion. An employer 
may elect to include the employees excepted under the provisions of 
paragraph (b)(2) of this A-7 in determining the highly compensated group 
with respect to an employer's retirement plans. Thus, for example, by 
electing to forego the exception in paragraph (b)(2) of this A-7, an 
employer may achieve more uniform highly compensated employee groups for 
purposes of its retirement plans and welfare benefit plans. The election 
to include such employees must be made on a reasonable and consistent 
basis and must be provided for in the plan.
    Q-8: Who is a 5-percent owner of the employer?
    A-8: An employee is a 5-percent owner of the employer for a 
particular year if, at any time during such year, such employee is a 5-
percent owner as defined in section 416(i)(B)(i) and Sec. 1.416-1 A T-
17&18. Thus, if the employer is a corporation, a 5-percent owner is any 
employee who owns (or is considered as owning within the meaning of 
section 318) more than 5 percent of the value of the outstanding stock 
of the corporation or stock possessing more than 5 percent of the total 
combined voting power of all stock of the corporation. If the employer 
is not a corporation, a 5-percent owner is any employee who owns more 
than 5 percent of the capital or profits interest in the employer. The 
rules of subsections (b), (c), and (m) of section 414 do not apply for 
purposes of determining who is a 5-percent owner. Thus, for example, an 
individual who is a 5-percent owner of a subsidiary corporation that is 
part of a controlled group of corporations within the meaning of section 
414(b) is treated as a 5-percent owner for purposes of these rules.
    Q-9: How is the ``top-paid group'' determined?
    A-9: (a) General rule. An employee is in the top-paid group of 
employees for a particular year if such employee is in the group 
consisting of the top 20 percent of the employer's employees when ranked 
on the basis of compensation received from the employer during such 
year. The identification of the

[[Page 939]]

particular employees who are in the top-paid group for a year involves a 
two-step procedure:
    (1) The determination of the number of employees that corresponds to 
20 percent of the employer's employees, and
    (2) The identification of the particular employees who are among the 
number of employees who receive the most compensation during this year.

Employees who perform no services for the employer during a year are not 
included in making either of these determinations for such year.
    (b) Number of employees in the top-paid group--(1) Exclusions. 
[Reserved]. See Sec. 1.414(q)-1, Q&A-9(b)(1) for further information.
    (i) Age and service exclusion. The following employees are excluded 
on the basis of age or service absent an election by the employer 
pursuant to the rules in paragraph (b)(2) of this A-9:
    (A) Employees who have not completed 6 months of service by the end 
of such year. For purposes of this paragraph (A), an employee's service 
in the immediately preceding year is added to service in the current 
year in determining whether the exclusion is applicable with respect to 
a particular employee in the current year. For example, given a plan 
with a calendar determination year, if employee A commences work August 
1, 1989, and terminates employment May 31, 1990, A may be excluded under 
this paragraph (b)(1)(i)(A) in 1989 because A completed only 5 months of 
service by December 31, 1989. However, A cannot be excluded pursuant to 
this rule in 1990 because A has completed 10 months of service, for 
purposes of this rule, by the end of 1990.
    (B) Employees who normally work less than 17\1/2\ hours per week as 
defined in paragraph (d) of this A-9 for such year.
    (C) Employees who normally work during less than 6 months during any 
year as defined in paragraph (e) of this A-9 for such year.
    (D) Employees who have not had their 21st birthdays by the end of 
such year.
    (ii) Nonresident alien exclusion. Employees who are nonresident 
aliens and who receive no earned income (within the meaning of section 
911(d)(2)) from the employer that constitutes income from sources within 
the United States (within the meaning of section 861(a)(3)) are 
excluded.
    (iii) Collective bargaining exclusion--(A) In general. Except as 
provided in paragraph (B) of this paragraph (b)(1)(iii), employees who 
are included in a unit of employees covered by an agreement that the 
Secretary of Labor finds to be a collective bargaining agreement between 
employee representatives and the employer, which agreement satisfies 
section 7701(a)(46) and Sec. 301.7701-17T (Temporary), are included in 
determining the number of employees in the top-paid group.
    (B) Percentage exclusion provision. If 90 percent or more of the 
employees of the employer are covered under collective bargaining 
agreements that the Secretary of Labor finds to be collective bargaining 
agreements between employee representatives and the employer, which 
agreements satisfy section 7701(a)(46) and Sec. 301.7701-17T 
(Temporary), and the plan being tested covers only employees who are not 
covered under such agreements, then the employees who are covered under 
such collective bargaining agreements are not counted in determining the 
number of noncollective bargaining employees who will be included in the 
top-paid group for purposes of testing such plan. In addition, such 
employees are not included in the top-paid group for such purposes. 
Thus, if the conditions of this paragraph (b)(1)(iii)(B) are satisfied, 
a separate calculation is required to determine the number and identity 
of noncollective bargaining employees who will be highly compensated 
employees by reason of receiving over $50,000 and being in the top-paid 
group of employees for purposes of testing those plans that cover only 
noncollective bargaining employees.
    (2) Alternative exclusion provisions--(i) Age and service exclusion 
election. An employer may elect, on a consistent and uniform basis, to 
modify the permissible exclusions set forth in paragraph (b)(1)(i) (A), 
(B), (C), and (D) of this A-9 by substituting any shorter period of 
service or lower age than that specified in such paragraph. These 
exclusions may be modified to substitute a zero service or age 
requirement.

[[Page 940]]

    (ii) Election not to apply percentage exclusion provision. An 
employer may elect not to exclude employees under the rules in paragraph 
(b)(1)(iii)(B) of this A-9.
    (iii) Method of election. [Reserved]. See Sec. 1.414(q)-1, Q&A-
9(b)(2)(iii) for further information.
    (c) Identification of top-paid group members. With the exception of 
the paragraph (b)(1)(iii) of this A-9 exclusion for certain employees 
covered by collective bargaining agreements, the exclusions in paragraph 
(b)(1) of this A-9 are not applicable for purposes of identifying the 
particular employees in the top-paid group. Thus, for example, even if 
an employee who normally works for less than 17\1/2\ hours is excluded 
in determining the number of employees in the top-paid group such 
employee may be a member of the top-paid group. Similarly, if during a 
determination year, employee A receives over $75,000 and is one of the 
top-100 employees ranked by compensation, then employee A is a highly 
compensated active employee for such determination year. This is true 
even though employee A has worked less than six months and thus may be 
excluded in determining the number of persons in the top-paid group for 
the determination year.
    (d) Example. Paragraphs (b) and (c) of this A-9 are illustrated by 
the following example:

    Example. Employer X has 200 active employees during the 1989 
determination year, 100 of whom normally work less than 17\1/2\ hours 
per week during such year and 80 of whom normally work less than 15 
hours per week during such year. X elects to exclude all employees who 
normally work less than 15 hours per week in determining the number of 
employees in the top-paid group. Thus, X excludes 80 employees in 
determining the number of employees in the top-paid group. X's top-paid 
group for the 1989 determination year consists of 20% of 120 or 24 
employees. All 200 of X's employees must then be ranked in order by 
compensation received during the year, and the 24 employees X paid the 
greatest amount of compensation during the year are top-paid employees 
with respect to X for the 1989 determination year.

    (e) 17\1/2\ hour rule--(1) In general. The determination of whether 
an employee normally works less than 17\1/2\ hours per week is made 
independently for each year based on the rules in paragraph (e)(2) and 
(3) of this A-9. In making this determination, weeks during which the 
employee did not work for the employer are not considered. Thus, for 
example, if an employee normally works twenty hours a week for twenty-
five weeks during the fall and winter school quarters, 10 hours a week 
for the 12 week spring quarter, and does not work for the employer 
during the three-month summer quarter, such employee is treated as 
normally working more than 17\1/2\ hours per week under the rule of this 
paragraph (e).
    (2) Deemed above 17\1/2\. An employee who works 17\1/2\ hours a week 
or more, for more than fifty percent of the total weeks worked by such 
employee during the year, is deemed to normally work more than 17\1/2\ 
hours a week for purposes of this rule.
    (3) Deemed below 17\1/2\. An employee who works less than 17\1/2\ 
hours a week for fifty percent or more of the total weeks worked by such 
employee during the year is deemed to normally work less than 17\1/2\ 
hours a week for purposes of this rule.
    (4) Application. The determination provided for in paragraph (e)(1), 
(2), and (3) of this A-9 may be made separately with respect to each 
employee, or on the basis of groups of employees who fall within 
particular job categories as established by the employer on a reasonable 
basis. For example, under the rule of this paragraph (e)(4) an employer 
may exclude all office cleaning personnel if, for the year in question, 
the employees performing this function normally work less than 17\1/2\ 
hours a week. This is true even though one or more employees within this 
group normally work in excess of 17\1/2\ hours. The election to make 
this determination on the basis of individuals or groups is operational 
and does not require a plan provision.
    (5) Application based on groups. (i) Groups of employees who perform 
the same job are not required to be considered as one category for 
purposes of the rule in paragraph (e)(4) of this A-9. Thus, for example, 
an employer supermarket may determine its highly compensated employees 
by excluding part-time grocery checkers if such personnel normally work 
less than 17\1/2\

[[Page 941]]

hours a week while continuing to include full-time personnel performing 
this function. In general, 80 percent of the positions within a 
particular job category must be filled by employees who normally work 
less than 17\1/2\ hours a week before any employees may be excluded 
under this rule on the basis of their membership in that job category.
    (ii) Alternatively, an employer may exclude employees who are 
members of a particular job category if the median number of hours of 
service credited to employees in that category during a determination or 
look-back year is 500 or less.
    (f) 6-month rule--(1) In general. The determination of whether 
employees normally work during not more than 6 months in any year is 
made on the basis of the facts and circumstances of the particular 
employer as evidenced by the employer's customary experience in the 
years preceding the determination year. An employee who works on one day 
during a month is deemed to have worked during that month.
    (2) Application of prior year experience. In making the 
determination under this paragraph (f), the experience for years 
immediately preceding the determination year will generally be weighed 
more heavily than that of earlier years. However, this emphasis on more 
recent years is not appropriate if the data for a particular year 
reflects unusual circumstances. For example, if fishermen working for 
employer X worked 9 months in 1987 and 1988, 8 months in 1989, and then, 
because of abnormal ice conditions, worked only 5 months in 1990, such 
fishermen could not be excluded under this rule in 1990. Furthermore, 
the data with respect to 1990 would not be weighed more heavily in 
making a determination with respect to subsequent years.
    (3) Individual or group basis. This determination may be made 
separately with respect to each employee or on the basis of groups of 
employees who fall within particular job categories in the manner set 
forth in paragraph (e)(4) of this A-8.
    Q-10. For purposes of determining the group of highly compensated 
employees, which employees are officers and which officers must be 
included in the highly compensated group?
    A-10: (a) In general. Subject to the limitations set forth in 
paragraph (b) of this A-10 and the top-100 employee rule set forth in A-
2, an employee is an includible officer for purposes of this section and 
is a member of the group of highly compensated employees if such 
employee is an officer of the employer (within the meaning of section 
416(i) and Sec. 1.416-1 A-T 13 & A-T 15) at any time during the 
determination year or look-back year and receives compensation during 
such year that is greater than 150 percent of the dollar limitation in 
effect under section 415(c)(1)(A) for the calendar year in which the 
determination or look-back year begins. In addition, an officer who does 
not meet the 415(c)(1)(A) dollar limitation requirement may be an 
includible officer based on the minimum inclusion rules set forth in 
paragraph (c) of this A-10.
    (b) Maximum limitation--(1) In general. Nor more than 50 employees 
(or, if lesser, the greater of 3 employees or 10 percent of the 
employees without regard to any exclusions) shall be treated as officers 
for purposes of this provision in determining the group of highly 
compensated employees for any determination year or look-back year.
    (2) Total number of employees. The total number of employees for 
purposes of the limitation in this paragraph (b) is the number of 
employees the employer has during the particular determination year or 
look-back year. For purposes of this A-10, employees include only those 
individuals who perform services for the employer during the 
determination or look-back year. The exclusions applicable for purposes 
of determining the number of employees in the top-paid group are not 
applicable for purposes of the limitations in this paragraph (b).
    (3) Inclusion ranking. If the number of the employer's officers who 
satisfy paragraph (a) of this A-10 during either the determination year 
or the look-back year exceeds the limitation under this paragraph (b), 
then the officers who will be considered as includible officers for 
purposes of this rule are those who receive the greatest compensation 
from the employer during such determination or look-back year.

[[Page 942]]

The definition of compensation in A-13 is to be used for this purpose.
    (c) Minimum inclusion rule. This paragraph (c) is applicable when no 
officer of the employer satisfies the compensation requirements of 
paragraph (a) of this A-10 during either a determination year or look-
back year. In such case, the highest paid officer of the employer for 
such year is treated as a highly compensated employee by reason of being 
an officer, without regard to the amount of compensation paid to such 
officer in relation to the section 415(c)(1)(A) dollar amount for the 
year. This is true whether or not such employee is also a highly 
compensated employee on any other basis. Thus, for example, if no 
officer of employer X meets the compensation requirements of paragraph 
(a) of this A-10 during the 1989 look-back year, and employee A is both 
the highest paid officer during such year and a 5-percent owner, 
employee A is treated as an includible officer satisfying the minimum 
inclusion rules of this paragraph.
    (d) Separate application. The maximum and minimum officer inclusion 
rules of paragraphs (b) and (c) of this A-10 apply separately with 
respect to the determination year calculation and the look-back year 
calculation. Thus, for example, if no officer of employer X receives 
compensation above the threshold amount in paragraph (a) of this A-10 
during either the determination year or look-back year, application of 
the minimum inclusion rule would result in the officer of employer X who 
received the greatest compensation during the look-back year being 
treated as a highly compensated employee and, in addition, the officer 
of employer X who receives the most compensation during the 
determination year would be included in the highly compensated group if 
such officer is also in the top-100 employees of employer X for such 
year. Thus, two officers may be treated as highly compensated active 
employees for a determination year by reason of the provisions of the 
minimum inclusion rule.
    Q-11: To what extent must family members who are employed by the 
same employer be aggregated for purposes of section 414(q)?
    A-11: (a) Family aggregation--(1) In general. Aggregation is 
required with respect to an employee who is, during a particular 
determination year or look-back year, a family member (as defined in A-
12) of either (i) a 5-percent owner who is an active or former employee 
or (ii) a highly compensated employee who is one of the ten most highly 
compensated employees ranked on the basis of compensation paid by the 
employer during such year.
    (2) Aggregation of contributions or benefits. As prescribed in 
regulations under the provisions to which section 414(q) is applicable, 
a family member and a 5-percent owner or top-10 highly compensated 
employee aggregated under this rule are generally treated as a single 
employee receiving an amount of compensation and a plan contribution or 
benefit that is based on the compensation, contributions, and benefits 
of such family member and 5-percent owner or top-10 highly compensated 
employee.
    (b) Exclusion status irrelevant. Family members are subject to this 
aggregation rule whether or not they fall within the categories of 
employees that may be excluded for purposes of determining the number of 
employees in the top-paid group and whether or not they are highly 
compensated employees when considered separately.
    (c) Order of determination--(1) Determination of highly compensated 
employees. The determination of which employees are highly compensated 
employees and which highly compensated employees are among the ten most 
highly compensated employees in making the look-back year calculation or 
the determination year calculation for a determination year will be made 
prior to the application of the rules in paragraph (a) of this A-11.
    (2) Determination of top-paid group and top-100 employees. The 
determination of the number and identity of employees in the top-paid 
group under the look-back year calculation or the determination year 
calculation for a determination year and the identity of individuals in 
the top-100 employees under the determination year calculation for a 
determination year is made prior to application of the rules in 
paragraph (a) of this A-11.

[[Page 943]]

    (d) Determination period. The rules under paragraph (a) of this A-11 
apply separately to the determination year and the look-back year. Thus, 
assuming there are no 5-percent owners, if employees A, B, C, D, E, F, 
G, H, I and J are the top 10 highly compensated employees in the 1988 
look-back year, and employees F, G, H, I, J, K, L, M, N and O are the 
top 10 highly compensated employees in the 1989 determination year, then 
family aggregation would be required with respect to all fifteen of such 
employees (i.e. employees A, B, C, D, E, F, G, H, I, J, K, L, M, N, and 
O).
    Q-12: Which individuals are family members for purposes of the 
aggregation rules in section 414(a)(6)(A) and A-11?
    A-12: (a) Definition of family member. Individuals who are family 
members for purposes of these provisions include, with respect to any 
employee or former employee, such employee's or former employee's spouse 
and lineal ascendants or descendants and the spouses of such lineal 
ascendants and descendants. In determining whether an individual is a 
family member with respect to an employee or former employee, legal 
adoptions shall be taken into account.
    (b) Test period. If an individual is a family member with respect to 
an employee or former employee on any day during the year, such 
individual is treated as a family member for the entire year. Thus, for 
example, if an individual is a family member with respect to an employee 
on the first day of a year, such individual continues to be a family 
member with respect to such employee throughout the year even though 
their relationship changes as a result of death or divorce.
    Q-13: How is ``compensation'' determined for purposes of determining 
the group of ``highly compensated employees.''
    A-13: (a) In general. For purposes of section 414(q), the term 
``compensation'' means compensation within the meaning of section 
415(c)(3) without regard to sections 125, 402(a)(8), and 402(h)(1)(B) 
and, in the case of employer contributions made pursuant to a salary 
reduction agreement, without regard to section 403(b). Thus, 
compensation includes elective or salary reduction contributions to a 
cafeteria plan, cash or deferred arrangement or tax-sheltered annuity.
    (b) Determination period. For purposes of determining the group of 
highly compensated employees, compensation must be calculated on the 
basis of the applicable period for the determination year and look-back 
year respectively.
    (c) Compensation taken into account. Only compensation received by 
an employee during the determination year or during the look-back year 
is considered in determining whether such employee is a highly 
compensated active employee under either the look-back year calculation 
or determination year calculation for such determination year. Thus, 
compensation is not annualized for purposes of determining an employee's 
compensation in the determination year or the look-back year in applying 
the rules of paragraph (a) of this A-13.
    Q-14: What periods must be used for determining who is a highly 
compensated employee for a determination year?
    A-14: (a) Determination year and look-back year--(1) In general. For 
purposes of determining the group of highly compensated employees for a 
determination year, the determination year calculation is made on the 
basis of the applicable year of the plan or other entity for which a 
determination is being made and the look-back year calculation is made 
on the basis of the twelve month period immediately preceding such year. 
Thus, in testing plans X and Y of an employer, if plan X has a calendar 
year plan year and plan Y has a July 1 to June 30 plan year, the 
determination year calculation and look-back year calculation for plan X 
must be made on the basis of the calendar year. Similarly, the 
determination year calculation and look-back year calculation for plan Y 
must be made on the basis of the July 1 to June 30 year.
    (2) Applicable year. For purposes of this A-14, the applicable year 
is the plan year of the qualified plan or other employee benefit 
arrangement to which the definition of highly compensated employees is 
applicable as defined in the written plan document or

[[Page 944]]

otherwise identified in regulations pursuant to sections to which the 
definition of highly compensated employees is applicable. To the extent 
that the definition of highly compensated employees is applicable to 
entities of other arrangements that do not have an otherwise identified 
plan year, then either the calendar year of the employer's fiscal year 
may be treated as the plan year.
    (3) Look-back year. The look-back year is never less than a twelve 
month period.
    (b) Calendar year calculation election--(1) In general. An employer 
may elect to make the look-back year calculation for a determination 
year on the basis of the calendar year ending with or within the 
applicable determination year (or, in the case of a determination year 
that is shorter than twelve months, the calendar year ending with or 
within the twelve-month period ending with the end of the applicable 
determination year). In such case, the employer must make the 
determination year calculation for the determination year on the basis 
of the period (if any) by which the applicable determination year 
extends beyond such calendar year (i.e., the lag period). If the 
applicable year for which the determination is being made is the 
calendar year, the employer still may elect to make the calendar year 
calculation election under this A-14(b). In such case, the look-back 
year calculation is made on the basis of the calendar year determination 
year and, because there is no lag period, a separate determination year 
calculation under A-3(a)(2) of this Sec. 1.414(q)-1 is not required.
    (2) Lag period calculation. In making the determination year 
calculation under A-3(a)(2) of this Sec. 1.414(q)-1 on the basis of the 
lag period, the dollar amounts applicable under A-3(a)(1) (B) and (C) of 
this Sec. 1.414(q)-1 are to be adjusted by multiplying such dollar 
amounts by a fraction, the numerator of which is the number of calendar 
months that are included in the lag period and the denominator of which 
is twelve.
    (3) Determination of active employees. An employee will be 
considered an active employee for purposes of a determination year for 
which the calendar year calculation election is in effect so long as 
such employee performs services for the employer during the applicable 
year for which the determination is being made. This is the case even if 
such employee does not perform services for the employer during the lag-
period for such determination year.
    (4) Election requirement. If the employer elects to make the 
calendar year calculation election with respect to one plan, entity, or 
arrangement, such election must apply with respect to all plans, 
entities, and arrangements of the employer. In addition, such election 
must be provided for in the plan.
    (c) Change in applicable years. Where there is a change in the 
applicable year for which a determination is being made with respect to 
a plan entity, or other arrangement that is not subject to the calendar 
year calculation election, the look-back year calculation for the short 
applicable year is to be made on the basis of the twelve month period 
preceding the short applicable year (i.e., generally, the old applicable 
year) and the determination year calculation for the short applicable 
year is to be made on the basis of the short applicable year. In 
addition, the dollar amounts under A-3(a)(1) (B) and (C) are to be 
adjusted for such determination year calculation as if the short 
applicable year were a lag period under paragraph (b)(2) of this A-14.
    (d) Example. The following examples illustrates the rules of this A-
14:

    Example 1. Employer X has a single plan (Plan A) with an April 1 to 
March 31 plan year. Employer X makes no election to use the calendar 
year for the determination period. Therefore, in determining the group 
of highly compensated employees for the April 1, 1989 to March 31, 1990 
plan year, the determination year is the plan year ending March 31, 1990 
and the look-back year is the plan year ending March 31, 1989.
    Example 2. Assume the same facts given above. With respect to the 
plan year beginning in 1990, employer X elects to use the calendar year 
for the determination period. Therefore, in determining the group of 
highly compensated employees for the April 1, 1990 to March 31, 1991 
plan year, the lag-period determination year is the period from January 
1, 1991, through March 31, 1991, and the applicable look-back year is 
the 1990 calendar year.

[[Page 945]]

    Example 3. Employer Y has a single plan (Plan B) with a calendar 
plan year. With respect to the plan year beginning in 1990, employer Y 
elects to make the look-back year calculation for the 1990 determination 
year on the basis of the calendar year ending with or within the 1990 
determination year. Because employer Y's determination year is the 1990 
calendar year there is no lag period and employer Y determines the group 
of highly compensated employees for purposes of the 1990 calendar plan 
year on the basis of such plan year alone.

    Q-15: Is there any transition rule in determining the group of 
highly compensated employees for 1987 and 1988?
    A-15: (a) In general. Solely for purposes of section 401(k)(3) and 
(m)(2) and solely for twelve-month plan years beginning in 1987 and 
1988, an eligible employer may elect to define the group of highly 
compensated employees as the group consisting of 5-percent owners of the 
employer at any time during the plan year and employees who receive 
compensation in excess of $50,000 during the plan year. This rule would 
apply in lieu of the look-back year calculation and determination year 
calculation otherwise applicable under A-3(a) of this Sec. 1.44(q)-1. 
In addition, an eligible employer may elect to make the determinations 
permitted under this transition rule on the basis of the calendar year 
ending in the plan year and the period by which such plan year extends 
beyond such calendar year, in accordance with the rules of A-14(b), in 
lieu of making the determinations under this transition rule on the 
basis of the plan year for which the determinations are being made.
    (b) Eligible employers. An employer is an eligible employer under 
this A-15 if such employer satisfies both of the following requirements:
    (1) The employer does not maintain any top-heavy plan within the 
meaning of section 416 at any time during 1987 and 1988; and
    (2) Under each plan of the employer to which section 401(k)(3) or 
401(m)(2) is applicable, the group of eligible employees that comprises 
the highest 25% of eligible employees ranked on the basis of 
compensation includes at least one employee whose compensation is 
$50,000 or below. This requirement must be met separately with respect 
to each such plan of the employer.
    (c) Uniformity requirement. An eligible employer may not make the 
election under paragraph (a) of this A-15 unless the election applies to 
all of the plans maintained by the employer to which section 401(k)(3) 
or 401(m)(2) applies.
    (d) Election requirements. This election is operational and does not 
require a plan provision.

[T.D. 8173, 53 FR 4967, Feb. 19, 1988, as amended by T.D. 8334, 56 FR 
3977, Feb. 1, 1991; T.D. 8548, 59 FR 32916, June 27, 1994]



Sec. 1.414(r)-0  Table of contents.

    (a) In general. Sections 1.414(r)-1 through 1.414(r)-11 provide 
rules for determining whether an employer is treated as operating 
qualified separate lines of business under section 414(r) of the 
Internal Revenue Code of 1986 as added to the Code by section 1115(a) of 
the Tax Reform Act of 1986 (Pub. L. No. 99-514), as well as rules for 
applying the requirements of sections 410(b), 401(a)(26), and 129(d)(8) 
separately with respect to the employees of each qualified separate line 
of business of an employer. Paragraph (b) of this section contains a 
listing of the headings of Sec. Sec. 1.414(r)-1 through 1.414(r)-11. 
Paragraph (c) of this section provides a flowchart showing how the major 
provisions of Sec. Sec. 1.414(r)-1 through 1.414(r)-6 are applied.
    (b) Table of contents. The following is a listing of the headings of 
Sec. Sec. 1.414(r)-1 through 1.414(r)-11.

Sec. 1.414(r)-1 Requirements applicable to qualified separate lines of 
                                business.

(a) In general.
(b) Conditions under which an employer is treated as operating qualified 
          separate lines of business.
    (1) In general.
    (2) Qualified separate line of business.
    (i) In general.
    (ii) Line of business.
    (iii) Separate line of business.
    (iv) Qualified separate line of business.
    (A) In general.
    (B) Fifty-employee requirement.
    (C) Notice requirement.
    (D) Requirement of administrative scrutiny.
    (3) Determining the employees of a qualified separate line of 
business.
(c) Separate application of certain Code requirements to employees of a 
          qualified separate line of business.
    (1) In general.
    (2) Separate application of section 410(b).

[[Page 946]]

    (i) General rule.
    (ii) Special rule for employer-wide plans.
    (3) Separate application of section 401(a)(26).
    (i) General rule.
    (ii) Special rule for employer-wide plans.
    (4) Separate application of section 129(d)(8). [Reserved]
    (5) Separate application of other Code requirements.
(d) Application of requirements.
    (1) In general.
    (2) Interpretation.
    (3) Separate operating units.
    (4) Certain mergers and acquisitions.
    (5) Governmental and tax-exempt employers.
    (i) General rule.
    (ii) Additional rules. [Reserved]
    (6) Testing year basis of application.
    (i) Section 414(r).
    (ii) Sections 410(b), 401(a)(26), and 129(d)(8).
    (7) Averaging rules.
    (8) Definitions.
    (9) Effective dates.
    (i) General rule.
    (ii) Reasonable compliance.
    (A) In general.
    (B) Determination of reasonable compliance.
    (C) Effect on other plans.
(e) Additional rules.

                   Sec. 1.414(r)-2 Line of business.

(a) General rule.
(b) Employer determination of its lines of business.
    (1) In general.
    (2) Property and services provided to customers.
    (i) In general.
    (ii) Timing of provision of property or services.
    (3) Employer designation.
    (i) In general.
    (ii) Ability to combine unrelated types of property or services in a 
single line of business.
    (iii) Ability to separate related types of property or services into 
two or more lines of business.
    (iv) Affiliated service groups.
(c) Examples.
    (1) In general.
    (2) Examples illustrating employer designation.
    (3) Examples illustrating property and services provided to 
customers.

               Sec. 1.414(r)-3 Separate line of business.

(a) General rule.
(b) Separate organization and operation.
    (1) In general.
    (2) Separate organizational unit.
    (3) Separate financial accountability.
    (4) Separate employee workforce.
    (5) Separate management.
(c) Supplementary rules.
    (1) In general.
    (2) Determination of separate employee workforce.
    (3) Determination of separate management.
    (4) Employees taken into account.
    (5) Services taken into account.
    (i) Provision of services to a separate line of business.
    (ii) Period for which services are provided.
    (iii) Optional rule for employees who change status.
    (A) In general.
    (B) Change in employee's status.
    (6) Examples of the separate employee workforce requirement.
    (7) Examples of the separate management requirement.
(d) Optional rule for vertically integrated lines of business.
    (1) In general.
    (2) Requirements.
    (3) Optional rule.
    (i) Treatment of employees.
    (ii) Purposes for which optional rule applies.
    (4) Examples.

Sec. 1.414(r)-4 Qualified separate line of business--fifty-employee and 
                          notice requirements.

(a) In general.
(b) Fifty-employee requirement.
(c) Notice requirement.
    (1) General rule.
    (2) Effect of notice.

  Sec. 1.414(r)-5 Qualified separate line of business--administrative 
                   scrutiny requirement--safe harbors.

(a) In general.
(b) Statutory safe harbor.
    (1) General rule.
    (2) Highly compensated employee percentage ratio.
    (3) Employees taken into account.
    (4) Ten-percent exception.
    (5) Determination based on preceding testing year.
    (6) Examples.
(c) Safe harbor for separate lines of business in different industries.
    (1) In general.
    (2) Optional rule for foreign operations.
    (3) Establishment of industry categories.
    (4) Examples.
(d) Safe harbor for separate lines of business that are acquired through 
          certain mergers and acquisitions.
    (1) General rule.
    (2) Employees taken into account.
    (3) Transition period.
    (4) Examples.
(e) Safe harbor for separate lines of business reported as industry 
          segments.

[[Page 947]]

    (1) In general.
    (2) Reported as an industry segment in conformity with Form 10-K or 
Form 20-F.
    (3) Timely filing of Form 10-K or 20-F.
    (4) Examples.
(f) Safe harbor for separate lines of business that provide same average 
          benefits as other separate lines of business.
    (1) General rule.
    (2) Separate lines of business benefiting disproportionate number of 
nonhighly compensated employees.
    (i) Applicability of safe harbor.
    (ii) Requirement.
    (3) Separate lines of business benefiting disproportionate number of 
highly compensated employees.
    (i) Applicability of safe harbor.
    (ii) Requirement.
    (4) Employees taken into account.
    (5) Example.
(g) Safe harbor for separate lines of business that provide minimum or 
          maximum benefits.
    (1) In general.
    (2) Minimum benefit required.
    (i) Applicability.
    (ii) Requirement.
    (iii) Defined benefit minimum.
    (A) In general.
    (B) Normal form and equivalent benefits.
    (C) Compensation definition.
    (D) Average compensation requirement.
    (E) Special rules.
    (iv) Defined contribution minimum.
    (A) In general.
    (B) Modified allocation definition for averaging.
    (3) Maximum benefit permitted.
    (i) Applicability.
    (ii) Requirement.
    (iii) Defined benefit maximum.
    (A) In general.
    (B) Determination of defined benefit maximum.
    (C) Adjustment for different compensation definitions.
    (D) Adjustment for certain subsidies.
    (iv) Defined contribution maximum.
    (4) Duplication of benefits or contributions.
    (i) Plans of the same type.
    (ii) Plans of different types.
    (iii) Special rule for floor-offset arrangements.
    (5) Certain contingency provisions ignored.
    (6) Employees taken into account.

  Sec. 1.414(r)-6 Qualified separate line of business--administrative 
            scrutiny requirement--individual determinations.

(a) In general.
(b) Authority to establish procedures.

    Sec. 1.414(r)-7 Determination of the employees of an employer's 
                  qualified separate lines of business.

(a) Introduction.
    (1) In general.
    (2) Purposes for which this section applies.
(b) Assignment procedure.
    (1) In general.
    (2) Assignment for the first testing day.
    (3) Assignment of new employees for subsequent testing days.
    (4) Special rule for employers using annual option under section 
410(b).
(c) Assignment and allocation of residual shared employees.
    (1) In general.
    (2) Dominant line of business method of allocation.
    (i) In general.
    (ii) Dominant line of business.
    (iii) Employee assignment percentage.
    (A) Determination of percentage.
    (B) Employees taken into account.
    (iv) Option to apply reduced percentage.
    (v) Examples.
    (3) Pro-rata method of allocation.
    (i) In general.
    (ii) Allocation procedure.
    (iii) Examples.
    (4) HCE percentage ratio method of allocation.
    (i) In general.
    (ii) Highly compensated employee percentage assignment ratio.
    (iii) Allocation procedure.
    (5) Small group method.
    (i) In general.
    (ii) Size of group.
    (iii) Composition of qualified separate line of business.
    (iv) Reasonable allocation.

        Sec. 1.414(r)-8 Separate application of section 410(b).

(a) General rule.
(b) Rules of separate application.
    (1) In general.
    (2) Satisfaction of section 410(b)(5)(B) on an employer-wide basis.
    (i) General rule.
    (ii) Application of facts and circumstances requirements under 
nondiscriminatory classification test.
    (iii) Modification of unsafe harbor percentage for plans satisfying 
ratio percentage test at 90 percent level.
    (A) General Rule.
    (B) Facts and circumstances alternative.
    (3) Satisfaction of section 410(b) on a qualified-separate-line-of-
business basis.
    (4) Examples.
(c) Coordination of section 401(a)(4) with section 410(b).
    (1) General rule.
    (2) Examples.
(d) Supplementary rules.

[[Page 948]]

    (1) In general.
    (2) Definition of plan.
    (3) Employees of a qualified separate line of business.
    (4) Consequences of failure.

      Sec. 1.414(r)-9 Separate application of section 401(a)(26).

(a) General rule.
(b) Requirements applicable to a plan.
(c) Supplementary rules.
    (1) In general.
    (2) Definition of plan.
    (3) Employees of a qualified separate line of business.
    (4) Consequences of failure.

 Sec. 1.414(r)-10 Separate application of section 129(d)(8). [Reserved]

            Sec. 1.414(r)-11 Definitions and special rules.

(a) In general.
(b) Definitions.
    (1) In general.
    (2) Substantial-service employee.
    (3) Top-paid employee.
    (4) Residual shared employee.
    (5) Testing year.
    (6) Testing day.
    (7) First testing day.
    (8) Section 401(a)(26) testing day.
(c) Averaging rules.
    (1) In general.
    (2) Specified provisions.
    (3) Averaging of large fluctuations not permitted.
    (4) Consistency requirements.

    (c) Flowchart. The following is a flowchart showing how the major 
provisions of Sec. Sec. 1.414(r)-1 through 1.414(r)-6 are applied.

[[Page 949]]

[GRAPHIC] [TIFF OMITTED] TC05OC91.015


[T.D. 8376, 56 FR 63434, Dec. 4, 1991, as amended by T.D. 8548, 59 FR 
32916, June 27, 1994]



Sec. 1.414(r)-1  Requirements applicable to qualified separate lines 
of business.

    (a) In general. Section 414(r) prescribes the conditions under which 
an employer is treated as operating qualified separate lines of 
business. If an employer is treated as operating qualified separate 
lines of business under section 414(r), certain requirements

[[Page 950]]

under the Code may be applied separately with respect to the employees 
of each qualified separate line of business. These requirements are 
limited to the minimum coverage requirements of section 410(b) 
(including the nondiscrimination requirements of section 401(a)(4)), the 
minimum participation requirements of section 401(a)(26), and the 55-
percent average benefits test of section 129(d)(8). This section 
provides the exclusive rules for determining whether an employer is 
treated as operating qualified separate lines of business under section 
414(r), as well as rules for applying the requirements of sections 
410(b), 401(a)(26), and 129(d)(8) separately with respect to the 
employees of a qualified separate line of business.
    (b) Conditions under which an employer is treated as operating 
qualified separate lines of business--(1) In general. An employer is 
treated as operating qualified separate lines of business under section 
414(r) only if all property and services provided by the employer to its 
customers are provided exclusively by qualified separate lines of 
business. Thus, once an employer has determined its qualified separate 
lines of business under paragraph (b)(2) of this section, no portion of 
the employer may remain that is not included in a qualified separate 
line of business. In addition, once the employer has determined the 
employees of its qualified separate lines of business under paragraph 
(b)(3) of this section, every employee must be treated as an employee of 
a qualified separate line of business, and no employee may be treated as 
an employee of more than one qualified separate line of business.
    (2) Qualified separate line of business--(i) In general. A qualified 
separate line of business is a portion of the employer that is a line of 
business within the meaning of paragraph (b)(2)(ii) of this section, 
that is also a separate line of business within the meaning of paragraph 
(b)(2)(iii) of this section, and, finally, that satisfies the 
requirements of section 414(r)(2) in accordance with paragraph 
(b)(2)(iv) of this section.
    (ii) Line of business. A line of business is a portion of an 
employer that is identified by the property or services it provides to 
customers of the employer. For this purpose, the employer is permitted 
to determine the lines of business it operates by designating the 
property and services that each of its lines of business provides to 
customers of the employer. Rules for determining an employer's lines of 
business are provided in Sec. 1.414(r)-2.
    (iii) Separate line of business. A separate line of business is a 
line of business that is organized and operated separately from the 
remainder of the employer. The determination of whether a line of 
business is organized and operated separately from the remainder of the 
employer is made on the basis of objective criteria. These criteria 
generally require that the line of business be organized into one or 
more separate organizational units (e.g., corporations, partnerships, or 
divisions), that the line of business constitute one or more distinct 
profit centers within the employer, and that no more than a moderate 
overlap exist between the employee workforce and management employed by 
the line of business and those employed by the remainder of the 
employer. Rules for determining whether a line of business is organized 
and operated separately from the remainder of the employer and thus 
constitutes a separate line of business are provided in Sec. 1.414(r)-
3. These rules include an optional rule for vertically integrated lines 
of business.
    (iv) Qualified separate line of business--(A) In general. A 
qualified separate line of business must satisfy the three statutory 
requirements in section 414(r)(2). A separate line of business that 
satisfies these three statutory requirements in accordance with 
paragraphs (b)(2)(iv)(B) through (b)(2)(iv)(D) of this section 
constitutes a qualified separate line of business.
    (B) Fifty-employee requirement. Under section 414(r)(2)(A), a 
separate line of business must have at least 50 employees. Rules for 
determining whether this requirement is satisfied are provided in Sec. 
1.414(r)-4(b).
    (C) Notice requirement. Under section 414(r)(2)(B), the employer 
must notify the Secretary that it treats itself as operating qualified 
separate lines of business under section 414(r) for purposes of applying 
the requirements of section 410(b), 401(a)(26), or 129(d)(8)

[[Page 951]]

separately with respect to the employees of the separate line of 
business. Rules and procedures for complying with this requirement are 
provided in Sec. 1.414(r)-4(c).
    (D) Requirement of administrative scrutiny. Under section 
414(r)(2)(C), a separate line of business must pass administrative 
scrutiny. A separate line of business may satisfy this requirement in 
one of two ways. First, a separate line of business that satisfies any 
of the safe harbors in Sec. 1.414(r)-5 satisfies the requirement of 
administrative scrutiny. These safe harbors implement the statutory safe 
harbor of section 414(r)(3) as well as the guidelines prescribed under 
section 414(r)(2)(C). Second, a separate line of business that does not 
satisfy any of the safe harbors in Sec. 1.414(r)-5 nonetheless 
satisfies the requirement of administrative scrutiny if the employer 
requests and receives an individual determination from the Commissioner 
that the separate line of business satisfies the requirement of 
administrative scrutiny. Rules and procedures applicable to requesting 
and receiving an individual determination are provided in Sec. 
1.414(r)-6. A separate line of business is permitted to satisfy the 
requirement of administrative scrutiny in any manner permitted under 
this paragraph (b)(2)(iv)(D), regardless of how any other separate line 
of business of the employer satisfies the requirement.
    (3) Determining the employees of a qualified separate line of 
business. In order to apply certain provisions under these regulations, 
it is necessary to determine the employees of a qualified separate line 
of business. For these purposes, the employees of a qualified separate 
line of business consist of all employees who are substantial-service 
employees with respect to the qualified separate line of business, and 
all other employees who are assigned to the qualified separate line of 
business. Rules for making these determinations are provided in Sec. 
1.414(r)-7. These rules apply solely for the purposes specified in these 
regulations (see Sec. 1.414(r)-7(a)(2) for a comprehensive listing of 
these purposes). These rules do not apply for any other purpose (e.g., 
the determination under Sec. 1.414(r)-3 of whether a line of business 
is organized and operated separately from the remainder of the 
employer).
    (c) Separate application of certain Code requirements to employees 
of a qualified separate line of business--(1) In general. If an employer 
is treated as operating qualified separate lines of business under 
section 414(r) in accordance with paragraph (b) of this section, the 
requirements of sections 410(b), 401(a)(26), and 129(d)(8) may be 
applied separately with respect to the employees of each qualified 
separate line of business. Paragraphs (c)(2) through (c)(4) of this 
section provide for the separate application of these requirements. In 
general, the requirements of a Code section are applied separately with 
respect to the employees of a qualified separate line of business by 
treating those employees as if they were the only employees of the 
employer. Paragraph (c)(5) of this section prescribes the limited 
conditions under which other Code requirements may be applied separately 
with respect to the employees of a qualified separate line of business.
    (2) Separate application of section 410(b)--(i) General rule. Except 
as provided in paragraph (c)(2)(ii) of this section, an employer is 
permitted to apply the requirements of section 410(b) separately with 
respect to the employees of each qualified separate line of business 
operated by the employer only if the employer does so with respect to 
all its plans, all its employees, and all its qualified separate lines 
of business. For this purpose, the requirements of section 410(b) 
encompass the requirements of section 401(a)(4) (including, but not 
limited to, the permitted disparity rules of section 401(l), the actual 
deferral percentage test of section 401(k)(3) and the actual 
contribution percentage test of section 401(m)(2)). Rules for applying 
section 410(b) separately with respect to the employees of a qualified 
separate line of business are provided in Sec. 1.414(r)-8. An employer 
may apply the rules of section 414(r) for purposes of section 410(b) 
even if it does not apply the rules of section 414(r) for purposes of 
section 401(a)(26).
    (ii) Special rule for employer-wide plans. Notwithstanding paragraph 
(c)(2)(i) of this section, an employer that is treated as operating 
qualified

[[Page 952]]

separate lines of business for purposes of section 410(b) in accordance 
with paragraph (b) of this section may apply the requirements of section 
410(b) on an employer-wide rather than a qualified-separate-line-of-
business basis with respect to any plan (within the meaning of Sec. 
1.414(r)-8(d)(2), but without regard to the mandatory disaggregation 
rule of Sec. 1.410(b)-7(c)(4) for portions of a plan that benefit 
employees of different qualified separate lines of business) that 
benefits a group of employees that satisfies the percentage test of 
section 410(b)(1)(A) (i.e., benefits at least 70 percent of the 
employer's nonexcludable nonhighly compensated employees). If section 
401(a)(4) requires that a group of employees under the plan described in 
the preceding sentence satisfy section 410(b) for purposes of satisfying 
section 401(a)(4), the percentage test of section 410(b)(1)(A) must be 
satisfied by each such group of employees. See Sec. 1.414(r)-8(c). The 
rules of this paragraph (c)(2)(ii) are illustrated by the following 
example.

    Example. Employer A maintains a single profit-sharing plan, Plan W, 
and three pension plans, Plans X, Y and Z, each benefiting employees of 
a different one of Employer A's three qualified separate lines of 
business. Contributions to the profit-sharing plan are made pursuant to 
a cash or deferred arrangement in which all employees of Employer A are 
eligible to participate. Assume that, as a result, Plan W satisfies the 
requirements to be tested under this paragraph (c)(2)(ii). None of the 
pension plans benefits more than 70 percent of the nonexcludable 
nonhighly compensated employees of Employer A. Employer A is treated as 
operating qualified separate lines of business for purposes of applying 
section 410(b) to its qualified plans. The requirements of sections 
410(b) and 401(a)(4) must therefore be applied to Plans X, Y and Z 
separately with respect to the employees of each of the three qualified 
separate line of business operated by Employer A. Since Plan W benefits 
at least 70 percent of the nonexcludable nonhighly compensated employees 
of Employer A, however, the requirements of sections 410(b) and 
401(a)(4) (including section 401(k)) may be applied to Plan W on an 
employer-wide basis.

    (3) Separate application of section 401(a)(26)--(i) General rule. 
Except as provided in paragraph (c)(3)(ii) of this section, an employer 
is permitted to apply the requirements of section 401(a)(26) separately 
with respect to the employees of each qualified separate line of 
business operated by the employer only if the employer does so with 
respect to all its plans, all its employees, and all its qualified 
separate lines of business. Rules for applying the requirements of 
section 401(a)(26) separately with respect to the employees of a 
qualified separate line of business are provided in Sec. 1.414(r)-9. An 
employer may apply the rules of section 414(r) for purposes of section 
401(a)(26) even if it does not apply the rules of section 414(r) for 
purposes of section 410(b).
    (ii) Special rule for employer-wide plans. Notwithstanding the first 
sentence of paragraph (c)(3)(i) of this section, an employer that is 
treated as operating qualified separate lines of business in accordance 
with paragraph (b) of this section for purposes of both sections 410(b) 
and 401(a)(26) may apply the requirements of section 401(a)(26) on an 
employer-wide rather than a qualified-separate-line-of-business basis 
with respect to any plan (within the meaning of Sec. 1.414(r)-9(c)(2), 
but without regard to the mandatory disaggregation rule of Sec. 
1.401(a)(26)-2(d)(1)(iv) for portions of a plan that benefit employees 
of different qualified separate lines of business), but only if the 
special rule for employer-wide plans in paragraph (c)(2)(ii) of this 
section is applied to the same plan for the same plan year.
    (4) Separate application of section 129(d)(8). [Reserved]
    (5) Separate application of other Code requirements. Under no 
circumstance may the requirements of any section of the Code (other than 
a section described in paragraphs (c)(2) through (c)(4) of this section) 
be applied separately with respect to the employees of a qualified 
separate line of business unless the section specifically cross-
references, or is specifically cross-referenced by, section 414(r). The 
Code sections whose requirements may not be applied separately with 
respect to the employees of a qualified separate line of business 
include, but are not limited to, sections 79(d)(3), 105(h), 117(d)(3), 
120(c)(2), 125(g)(3), 127(b)(2), 129(d)(3), 132, 195, 401(a)(3) (as in 
effect on September 1, 1974), 414(q)(4),

[[Page 953]]

501(c)(17)(A)(ii), 501(c)(17)(B)(iii), 501(c)(18)(B), and 505(b)(1)(A).
    (d) Application of requirements--(1) In general. The requirements of 
paragraphs (b) and (c) of this section must be applied in accordance 
with the rules in this paragraph (d).
    (2) Interpretation. The provisions of this section and of Sec. Sec. 
1.414(r)-2 through 1.414(r)-11 are to be interpreted in a reasonable 
manner consistent with the purpose of section 414(r) to recognize an 
employer's operation of qualified separate lines of business for bona 
fide business reasons and not for reasons of evading the requirements of 
any section of the Code, including sections 410(b), 401(a)(26), and 
129(d)(8). See section 414(r)(1) and (r)(7). Thus, for example, an 
employer is not permitted to apply these regulations in a manner that 
may literally comply with the other provisions of this section and of 
Sec. Sec. 1.414(r)-2 through 1.414(r)-11, but that does not reflect the 
employer's operation of qualified separate lines of business for bona 
fide business reasons.
    (3) Separate operating units. No additional requirements beyond 
those provided in these regulations apply to a separate operating unit. 
Thus, a separate operating unit that satisfies the requirements of 
paragraph (b)(2) of this section is deemed to satisfy the geographic 
separation requirement of section 414(r)(7) and accordingly is treated 
as a qualified separate line of business for all purposes under this 
section, including the separate application of section 401(a)(26).
    (4) Certain mergers and acquisitions. A portion of an employer that 
is acquired in a transaction described in section 410(b)(6)(C) and Sec. 
1.410(b)-2(f) (i.e., an asset or stock acquisition, merger, or other 
similar transaction involving a change in the employer of the employees 
of a trade or business) is deemed to satisfy the requirements to be a 
qualified separate line of business, other than the 50-employee 
requirement and the notice requirement of pararaphs (b)(2)(iv)(R) and 
(b)(2)(iv)(C) of this section, respectively. In addition, the acquired 
employees are not taken into account, and the property and services 
provided by the acquired portion to customers of the employer are 
disregarded, for purposes of determining whether the employer's 
remaining lines of business satisfy the requirements of Sec. Sec. 
1.414(r)-3 through 1.414(r)-6. The rules in this paragraph (d)(4) apply 
only for those testing years with first testing days that fall within 
the transition period described in section 410(b)(6)(C). For this 
purpose, the transition period described in section 410(b)(6)(C) lasts 
only for so long as the conditions in that section are satisfied. For 
the definition of ``first testing day,'' see Sec. 1.414(r)-11(b)(7). 
See Sec. 1.414(r)-5(d)(4), Example 1, for an example of the application 
of the rule in this paragraph (d)(4). See also Sec. 1.414(r)-5(d) for 
an administrative scrutiny safe harbor applicable to certain separate 
lines of business acquired in a transaction described in this section.
    (5) Governmental and tax-exempt employers--(i) General rule. Except 
as provided in paragraph (d)(5)(ii) of this section, the rules of this 
section are applicable in determining whether section 401(a)(26) is 
satisfied by a plan maintained by an employer that is exempt from tax 
under Subtitle A of the Internal Revenue Code (including a governmental 
plan within the meaning of section 414(d)). Similarly, except as 
provided in paragraph (d)(5)(ii) of this section, the rules of this 
section are applicable in determining whether section 410(b) is 
satisfied by a plan that is subject to section 410(b) (including by 
virtue of Sec. 1410(b)-2(e)) and is maintained by an employer that is 
exempt from tax under Subtitle A of the Internal Revenue Code (including 
a governmental plan within the meaning of section 414(d)).
    (ii) Additional rules. [Reserved]
    (6) Testing year basis of application--(i) Section 414(r). Whether 
an employer is treated as operating qualified separate lines of business 
under section 414(r) in accordance with paragraph (b) of this section is 
determined on a year-by-year basis with respect to the testing year. It 
is therefore possible for an employer to satisfy paragraph (b) of this 
section for one testing year and to fail to satisfy it for another 
testing year. It is also possible for an employer to satisfy paragraph 
(b) of this section for two testing years but to have designated its 
lines of business differently in each of those two testing years. In 
determining

[[Page 954]]

whether an employer satisfies paragraph (b) of this section for a 
testing year, the requirements of that paragraph are applied solely with 
respect to the testing year. Thus, all property and services provided by 
the employer to its customers during the testing year must be provided 
exclusively by portions of the employer that for the testing year 
constitute qualified separate lines of business. Furthermore, each 
employee of the employer must respectively be treated as an employee of 
one and only one of those qualified separate lines of business for all 
purposes with respect to the testing year.
    (ii) Sections 410(b), 401(a)(26), and 129(d)(8). For purposes of 
paragraph (c) of this section, relating to the separate application of 
sections 410(b), 401(a)(26), and 129(d)(8) to the employees of a 
qualified separate line of business, the determination whether an 
employer operates qualified separate lines of business in accordance 
with paragraph (b) of this section for a testing year generally applies 
for all plan years beginning in the testing year. Rules for the separate 
application of sections 410(b), 401(a)(26), and 129(d)(8) are 
respectively provided in Sec. Sec. 1.414(r)-8, 1.414(r)-9, and 
1.414(r)-10.
    (7) Averaging rules. The employer is permitted to apply certain 
provisions of these regulations on the basis of a consecutive-year 
average (not to exceed five consecutive years) under the averaging rules 
of Sec. 1.414(r)-11(c).
    (8) Definitions. In applying the provisions of this section and of 
Sec. Sec. 1.414(r)-2 through 1.414(r)-11, the definitions in Sec. Sec. 
1.414(r)-11(b) and 1.410(b)-9 govern, unless otherwise provided.
    (9) Effective--(i) General rule. The provisions of this section and 
of Sec. Sec. 1.414(r)-2 through 1.414(r)-11 apply to plan years and 
testing years beginning on or after January 1, 1994 (or January 1, 1996, 
in the case of plans maintained by organizations exempt from income 
taxation under section 501(a), including plans subject to section 
403(b)(12)(A)(i) (nonelective plans)).
    (ii) Reasonable compliance--(A) In general. With respect to plan 
years beginning before the date on which the Commissioner begins issuing 
determinations under section 414(r)(2)(C), and on or after the first day 
of the first plan year to which section 414(r) applies under section 
1112(a) of the Tax Reform Act of 1986, an employer is treated as 
operating qualified separate lines of business if the employer 
reasonably determines that it meets the requirements of section 414(r) 
(other than the requirement of administrative scrutiny under section 
414(r)(2)(C)).
    (B) Determination of reasonable compliance. Whether an employer 
reasonably determines that it meets the requirements of section 414(r) 
generally will be determined on the basis of all relevant facts and 
circumstances, including the extent to which the employer has resolved 
unclear issues in its favor. For the period described in paragraph 
(d)(9)(ii)(A) of this section, the Internal Revenue Service will 
consider the employer's compliance with the terms of these final 
regulations (other than the requirement of administrative scrutiny under 
paragraph (b)(2)(iv)(D) of this section) to constitute a reasonable 
determination that the employer meets the requirements of section 414(r) 
(other than the requirement of administrative scrutiny under section 
414(r)(2)(C)).
    (C) Effect on other plans. If an employer sponsors a plan that has a 
plan year beginning within the period decribed in paragraph 
(d)(9)(ii)(A) of this section, the employer's reasonable determination 
of its qualified separate lines of business for the testing year in 
which that plan year begins, and the allocation of employees to those 
qualified separate lines of business, must also be used for purposes of 
applying Sec. 1.414(r)-8 and Sec. 1.414(r)-9 for plan years that begin 
in that testing year but after the end of the period described in 
paragraph (d)(9)(ii)(A) of this section.
    (e) Additional rules. The Commissioner may, in revenue rulings, 
notices, and other guidance of general applicability, provide any 
additional rules that may be necessary or appropriate in applying the 
qualified separate line of business requirements of section 414(r). 
These additional rules may include, for example, new safe harbors in 
Sec. 1.414(r)-5.

[T.D. 8376, 56 FR 63437, Dec. 4, 1991, as amended by T.D. 8548, 59 FR 
32916, June 27, 1994]

[[Page 955]]



Sec. 1.414(r)-2  Line of business.

    (a) General rule. A line of business is a portion of an employer 
that is identified by the property or services it provides to customers 
of the employer. For this purpose, an employer is permitted to determine 
its lines of business by designating the property or services that each 
of its lines of business provides to customers of the employer. 
Paragraph (b) of this section explains how an employer determines its 
lines of business for a testing year. Paragraph (c) of this section 
provides examples illustrating the application of this section.
    (b) Employer determination of its lines of business--(1) In general. 
An employer determines its lines of business for a testing year first by 
identifying all the property and services it provides to its customers 
during the testing year, and then by designating which portion of the 
property and services is provided by each of its lines of business.
    (2) Property and services provided to customers--(i) In general. 
Property, whether real or personal, tangible or intangible, is provided 
by an employer to a customer if the employer provides the property to or 
on behalf of the customer for consideration. Similarly, services are 
provided by an employer to a customer if the employer renders the 
services to or on behalf of the customer for consideration. An 
individual item of property or service is taken into account under this 
paragraph (b)(2) only if the employer provides the item to a person 
other than the employer in the ordinary course of a trade or business 
conducted by the employer and the person to whom the employer provides 
the item is acting in the capacity of a customer of the employer. A type 
of tangible property is deemed to be provided to customers of the 
employer for purposes of this section if, with respect to a business 
that produces or manufactures that type of tangible property, the 
employer satisfies the special rule in Sec. 1.414(r)-3(d)(2)(iii)(B) 
for vertically integrated businesses.
    (ii) Timing of provision of property or services. Generally an 
employer determines its lines of business on the basis of the property 
and services it provides to its customers for consideration during the 
testing year. However, it is not necessary both that property or 
services actually be provided, and that consideration for the property 
or services actually be paid, during the current testing year. For an 
employer to be considered to provide property or services to customers 
for consideration during a testing year under this paragraph (b)(2), it 
is sufficient that the property or services actually be provided to 
customers during the testing year, the consideration actually be paid 
during the testing year, or the employer actually incur significant 
costs during the testing year associated with the provision of the 
property or services to a specified customer or specified customers.
    (3) Employer designation--(i) In general. Once the employer has 
identified all the property and services it provides to its customers 
during the testing year under paragraph (b)(2) of this section, the 
employer determines its lines of business for the testing year by 
designating which portion of those property and services is provided by 
each of its lines of business. For this purpose, the employer must 
apportion all the property and services identified under paragraph 
(b)(2) of this section among its lines of business. An employer 
generally is not required to designate its lines of business for the 
testing year in the same manner as it designates its lines of business 
for any other testing year.
    (ii) Ability to combine unrelated types of property or services in a 
single line of business. For purposes of this paragraph (b)(3), there is 
no requirement that a line of business provide only one type of property 
or service, or only related types of property or services. Nor is there 
any requirement that a line of business provide solely property or 
solely services. Thus, the employer is permitted to combine in a single 
line of business dissimilar types of property or services that are 
otherwise unrelated to one another.
    (iii) Ability to separate related types of property or services into 
two or more lines of business. For purposes of this paragraph (b)(3), 
there is no requirement that all property or services of related types 
or the same type be provided by a single line of business. Thus, the 
employer is permitted to designate two or

[[Page 956]]

more lines of business that provide related types of property or 
services, or the same type of property or service. An employer might 
designate two or more lines of business that provide property or 
services of related types or the same type, for example, where the lines 
of business manufacture, prepare, or provide the property or services in 
different geographic areas (e.g., in different regions of the country or 
the world), or at different levels in the chain of commercial 
distribution (e.g., wholesale versus retail), or in different types of 
transactions (e.g, sale versus lease), or for different types of 
customers (e. g., governmental versus private), or subject to different 
legal constraints (e. g., regulated versus unregulated), or if the lines 
of business have developed differently (e.g., one line of business was 
acquired while another line of business developed internally). 
Notwithstanding the foregoing, an employer is not permitted to designate 
two or more lines of business that provide property or services of 
related types or the same type, if the employer's designation is 
unreasonable. An employer's designation would be unreasonable, for 
example, if the designation separated two types of property or services 
in different lines of business, but the employer did not provide those 
types of property or services separately from one another to its 
customers. Similarly, an employer's designation would be unreasonable if 
it separated two types of property or services in different lines of 
business, but the provision of one type of property or service was 
merely ancillary or incidental to, or regularly associated with, the 
provision of the other type of property or service. See generally Sec. 
1.414(r)-1(d)(2) (requiring an employer's operation of qualified 
separate lines of business to be for bona fide business reasons).
    (iv) Affiliated service groups. An employer is not permitted to 
designate its lines of business in a manner that results in separating 
employees of an affiliated service group (within the meaning of section 
414(m)) from other employees of the employer. See section 414(r)(8).
    (c) Examples--(1) In general. Paragraphs (c)(2) and (c)(3) of this 
section provide examples that illustrate the application of this 
section.
    (2) Examples illustrating employer designation. The following 
examples illustrate the application of paragraph (b)(3) of this section 
relating to an employer's designation of the property or services 
provided to customers by each of its lines of business.

    Example 1. Employer A is a domestic conglomerate engaged in the 
manufacture and sale of consumer food and beverage products and the 
provision of data processing services to private industry. Employer A 
provides no other property or services to its customers. Pursuant to 
paragraph (b)(3) of this section, Employer A apportions all the property 
and services it provides to its customers among three lines of business, 
one providing all its consumer food products, a second providing all its 
consumer beverage products, and a third providing all its data 
processing services. Employer A has three lines of business for purposes 
of this section.
    Example 2. The facts are the same as in Example 1, except that 
Employer A determines that neither the consumer food products line of 
business nor the consumer beverage products line of business would 
satisfy the separateness criteria of Sec. 1.414(r)-3 for recognition as 
a separate line of business. Accordingly, pursuant to paragraph (b)(3) 
of this section, Employer A apportions all the property and services it 
provides to its customers between only two lines of business, one 
providing all its consumer food and beverage products, and a second 
providing all its data processing services. Employer A has two lines of 
business for purposes of this section.
    Example 3. The facts are the same as in Example 2, except that 
Employer A also owns and operates a regional commuter airline, a 
professional basketball team, a pharmaceutical manufacturer, and a 
leather tanning company. Pursuant to paragraph (b)(3) of this section, 
Employer A apportions all the property and services it provides to its 
customers among three lines of business, one providing all its consumer 
food and beverage products, a second providing all its data processing 
services, and a third providing all the other property and services 
provided to customers through Employer A's regional commuter airline, 
professional basketball team, pharmaceutical manufacturer, and leather 
tanning company. Even though the third line of business includes 
dissimilar types of property and services that are otherwise unrelated 
to one another, paragraph (b)(3)(ii) of this section permits Employer A 
to combine these property and services in a single line of business. 
Employer A has three lines of business for purposes of this section.
    Example 4. The facts are the same as in Example 2, except that 
Employer A has recently

[[Page 957]]

acquired Corporation L, whose only product is a well-known brand of 
gourmet ice cream. Although Employer A manufactures and sells other ice 
cream products, it does not manufacture or market the newly acquired 
brand of gourmet ice cream except through Corporation L. Pursuant to 
paragraph (b)(3) of this section, Employer A apportions all the property 
and services it provides to its customers among three lines of business, 
one providing only the newly acquired brand of gourmet ice cream, a 
second providing all its other consumer food and beverage products 
(including the other ice cream products manufactured and sold by 
Employer A) and a third providing all its data processing services. Even 
though the gourmet ice cream line of business provides the same type of 
property as the consumer food and beverage line of business (i.e., ice 
cream), paragraph (b)(3)(iii) of this section permits Employer A to 
separate its ice cream products between two different lines of business. 
Employer A has three lines of business for purposes of this section.
    Example 5. The facts are the same as in Example 2, except that 
Employer A operates the data processing services portion of its business 
in two separate subsidiaries, one serving customers in the eastern half 
of the United States and the other serving customers in the western half 
of the United States. Pursuant to paragraph (b)(3) of this section, 
Employer A apportions all the property and services it provides to its 
customers among three lines of business, one providing all its consumer 
food and beverage products, a second providing data processing services 
to customers in the eastern half of the United States, and a third 
providing data processing services to customers in the western half of 
the United States. Even though the second and third lines of business 
provide the same type of service (i.e., data processing services), 
paragraph (b)(3)(iii) of this section permits Employer A to separate its 
data processing services into two lines of business. Employer A has 
three lines of business for purposes of this section.
    Example 6. Employer B is a diversified engineering firm offering 
civil, chemical, and aeronautical engineering services to government and 
private industry. Employer B provides no other property or services to 
its customers. Employer B operates the aeronautical engineering services 
portion of its business as two separate divisions, one serving federal 
government customers and the other serving customers in private 
industry. Pursuant to paragraph (b)(3) of this section, Employer B 
apportions all the property and services it provides to its customers 
among four lines of business, one providing all its civil engineering 
services, a second providing all its chemical engineering services, a 
third providing aeronautical engineering services to federal government 
customers, and a fourth providing aeronautical engineering services to 
customers in private industry. Even though the third and fourth lines of 
business include the same type of service (i.e., aeronautical 
engineering services), paragraph (b)(3)(iii) of this section permits 
Employer B to separate its aeronautical engineering services into two 
lines of business. Employer B has four lines of business for purposes of 
this section.
    Example 7. Among its other business activities, Employer C 
manufacturers industrial diesel generators. At no additional cost to its 
buyers, Employer C warrants the proper functioning of its diesel 
generators for a one-year period following sale. Pursuant to its 
warranty, Employer C provides labor and parts to repair or replace any 
components that malfunction within the one-year warranty period. Because 
Employer C does not provide the industrial diesel generators, on the one 
hand, and the warranty repair services and replacement parts, on the 
other hand, separately from one another to its customers, under 
paragraph (b)(3)(iii) of this section it would be unreasonable for 
Employer C to separate these property and services in different lines of 
business.
    Example 8. Among its other business activities, Employer D leases 
office photocopying equipment. Employer D also provides photo-copying 
supplies and repair services to its lessees for a separate charge. 
Employer D generally does not provide such supplies and repair services 
to persons other than its lessees. Lessees of Employer D's equipment are 
permitted to use photo-copying supplies and repair services from 
suppliers other than Employer D. Because the provision of the photo-
copying supplies and repair services are merely ancillary or incidental 
to the provision of the leased photo-copiers, under paragraph 
(b)(3)(iii) of this section it would be unreasonable for Employer D to 
separate these property and services in different lines of business.
    Example 9. Employer E operates a medical clinic. The employees of 
the clinic include physicians, nurses, and laboratory technicians, all 
of whom participate in providing medical and related services to 
patients of the clinic. Under paragraph (b)(3)(iii) of this section, it 
would be unreasonable for Employer E to separate the services of the 
physicians, nurses, and laboratory technicians in different lines of 
business.
    Example 10. Employer F is a law firm. The employees of the firm 
include lawyers, paralegals, and secretaries, all of whom participate in 
rendering legal and related services to clients of the firm. Under 
paragraph (b)(3)(iii) of this section, it would be unreasonable for 
Employer F to separate the services of the lawyers, paralegals, and 
secretaries in different lines of business.
    Example 11. Employer G is a management consulting firm. The 
employees of the firm

[[Page 958]]

include management consultants, secretaries, and other support staff 
personnel, all of whom participate in rendering management consulting 
and related services to clients of the firm. Under paragraph (b)(3)(iii) 
of this section, it would be unreasonable for Employer G to separate the 
services of the management consultants, secretaries, and other support 
staff personnel in different lines of business.

    (3) Examples illustrating property and services provided to 
customers. The following examples illustrate the application of 
paragraph (b)(2) of this section relating to property and services 
provided to customers of the employer.

    Example 1. Employer H operates several dairy farms and dairy product 
processing plants. The dairy farms provide part of their output of milk 
and milk by-products to Employer H's dairy product processing plants and 
also sell part to retail distributors unrelated to Employer H. The dairy 
farms' provision of milk and milk by-products to Employer H's dairy 
product processing plants does not constitute the provision of property 
or services to customers of Employer H because the milk and milk by-
products are not provided to a person other than employer H. However, 
the dairy farms' provision of milk and milk by-products to independent 
retail distributors does constitute the provision of property or 
services to customers of Employer H under paragraph (b)(2) of this 
section.
    Example 2. The facts are the same as in Example 1, except that the 
dairy farms provide their entire output of milk and milk by-products to 
Employer H's dairy product processing plants. The dairy farms' provision 
of milk and milk by-products to the dairy product processing plants 
generally does not constitute the provision of property or services to 
customers of Employer H because the milk and milk by-products are not 
provided to a person other than Employer H. However, paragraph (b)(2)(i) 
of this section provides a special rule for vertically integrated 
businesses that satisfy Sec. 1.414(r)-3(d)(2)(iii)(B). If Sec. 
1.414(r)-3(d)(2)(iii)(B) is satisfied, then, under the special rule of 
paragraph (b)(2)(i) of this section, the milk and milk by-products are 
deemed to be provided to customers of Employer H.
    Example 3. Among its other business activities, Employer J 
manufactures automobiles. Employer J operates a cafeteria at one of its 
automobile manufacturing facilities. The cafeteria is intended primarily 
for use by employees of Employer J, but nonemployees are not prohibited 
from using the cafeteria. The cafeteria charges the same prices to 
employees and non-employees. Under paragraph (b)(2) of this section, the 
provision of cafeteria services to employees of Employer J does not 
constitute the provision of property or services to customers of 
Employer J, because the cafeteria services are provided to the employees 
in their capacity as employees of Employer J and not as customers of 
Employer J.
    Example 4. Employer K sells books and periodicals to members of the 
public and provides telecommunications services to private industry. 
Employer K periodically acquires and disposes of businesses in both 
asset and stock transactions. In addition, for its own investment 
purposes, Employer K acquires and disposes of corporate and other 
securities. Under paragraph (b)(2) of this section, the sale by Employer 
K of businesses and investment securities does not constitute the 
provision of property or services to customers of Employer K, because 
the sales are not made in the ordinary course of a trade or business 
conducted by Employer K. However, the sale of published materials and 
the provision of telecommunications services to persons unrelated to 
Employer K does constitute the provision of property or services to 
customers of Employer K.
    Example 5. Employer L is active in the financial services industry. 
Subsidiary 1 of Employer L is a brokerage firm that is regulated as a 
broker-dealer under applicable federal and state law. In its capacity as 
a dealer, Subsidiary 1 holds in its own inventory securities of 
unrelated corporations and regularly sells these securities to unrelated 
persons. Under paragraph (b)(2) of this section, the sale by Subsidiary 
1 of the securities to unrelated persons constitutes the provision of 
property or services to customers of Employer L, because the sales are 
made in the ordinary course of Subsidiary 1's trade or business as a 
broker-dealer.
    Example 6. The facts are the same as in Example 5. Subsidiary 2 of 
Employer L is an insurance company that is regulated under applicable 
state insurance laws. In managing its investments, Subsidiary 2 
regularly makes use of the brokerage services of Subsidiary 1 (which 
Subsidiary 1 regularly provides to unrelated persons as well). Under 
paragraph (b)(2) of this section, Subsidiary 1's provision of brokerage 
services to Subsidiary 2 does not constitute the provision of property 
or services to customers of Employer L, because the brokerage services 
are not provided to a person other than Employer L. However, Subsidiary 
1's provision of brokerage services to unrelated persons does constitute 
the provision of property or services to customers of Employer L.
    Example 7. Employer M is a shipbuilder. In a testing year, Employer 
M enters into a contract with a customer to construct a new cargo ship 
for delivery two years later. Employer M incurs significant costs 
designing and planning for the production of the new ship during the 
testing year, but receives no payments from the customer during that

[[Page 959]]

year. Under paragraph (b)(2) of this section, Employer M is treated as 
providing the cargo ship to the customer during the testing year.
    Example 8. The facts are the same as in Example 7, except that, 
pursuant to a request from the customer, Employer M also incurred 
significant costs developing a prototype and submitting a bid on the new 
cargo ship in the prior testing year, and that these costs were not 
reimbursed by the customer. Under paragraph (b)(2) of this section, 
Employer M is also treated as providing the cargo ship to the customer 
in the prior testing year.

[T.D. 8376, 56 FR 63439, Dec. 4, 1991, as amended by T.D. 8548, 59 FR 
32917, June 27, 1994]



Sec. 1.414(r)-3  Separate line of business.

    (a) General rule. A separate line of business is a line of business 
(as determined under Sec. 1.414(r)-2) that is organized and operated 
separately from the remainder of the employer. Paragraph (b) of this 
section sets forth the rules for determining whether a line of business 
is organized and operated separately from the remainder of the employer. 
Paragraph (c) of this section provides certain supplementary rules 
necessary to apply the requirements of paragraph (b) of this section, as 
well as examples illustrating the application of those requirements. 
Paragraph (d) of this section provides an optional rule for lines of 
business that are vertically integrated.
    (b) Separate organization and operation--(1) In general. A line of 
business is organized and operated separately from the remainder of the 
employer for a testing year only if it satisfies all the requirements of 
paragraphs (b)(2) through (b)(5) of this section for the testing year.
    (2) Separate organizational unit. The line of business must be 
formally organized as a separate organizational unit or group of 
separate organizational units within the employer. For this purpose, an 
organizational unit is a corporation, partnership, division, or other 
unit having a similar degree of organizational formality. This 
requirement must be satisfied on every day of the testing year.
    (3) Separate financial accountability. The line of business must be 
a separate profit center or group of separate profit centers within the 
employer. This requirement must be satisfied on every day of the testing 
year. In addition, the employer must maintain books and records that 
provide separate revenue and expense information that is used for 
internal planning and control with respect to each profit center 
comprising the line of business.
    (4) Separate employee workforce. The line of business must have its 
own separate employee workforce. A line of business has its own separate 
workforce only if at least 90 percent of the employees who provide 
services to the line of business, and who are not substantial-service 
employees with respect to any other line of business, are substantial-
service employees with respect to the line of business. See paragraph 
(c)(2) of this section to determine how the percentage in the preceding 
sentence is calculated for the testing year.
    (5) Separate management. The line of business must have its own 
separate management. A line of business has its own separate management 
only if at least 80 percent of the employees who are top-paid employees 
with respect to the line of business are substantial-service employees 
with respect to the line of business. See paragraph (c)(3) of this 
section to determine how the percentage in the preceding sentence is 
calculated for the testing year.
    (c) Supplementary rules--(1) In general. This paragraph (c) provides 
certain supplementary rules necessary to apply the requirements of 
paragraph (b) of this section, as well as examples illustrating the 
application of those requirements.
    (2) Determination of separate employee workforce. The percentage in 
paragraph (b)(4) of this section is the fraction (expressed as a 
percentage)--
    (i) The numerator of which is the number of substantial-service 
employees with respect to the line of business within the meaning of 
Sec. 1.414(r)-11(b)(2); and
    (ii) The denominator of which is the total number of employees who 
provide services to the line of business within the meaning of paragraph 
(c)(5) of this section and who are not substantial-service employees 
with respect to any other line of business.
    (3) Determination of separate management. The percentage in 
paragraph

[[Page 960]]

(b)(5) of this section is the fraction (expressed as a percentage)--
    (i) The numerator of which is the number of employees who are both 
top-paid employees and substantial-service employees with respect to the 
line of business within the meaning of Sec. 1.414(r)-11(b)(3) and (2), 
respectively; and
    (ii) The denominator of which is the total number of top-paid 
employees with respect to the line of business within the meaning of 
Sec. 1.414(r)-11(b)(3).
    (4) Employees taken into account. For purposes of applying this 
paragraph (c), only employees who are employees on the first testing day 
are taken into account. For this purpose, there are no excludable 
employees except nonresident aliens described in section 410(b)(3)(C). 
Consequently, all other employees who are employees on the first testing 
day are taken into account, including collectively bargained employees. 
For the definition of first testing day, see Sec. 1.414(r)-11(b)(7).
    (5) Services taken into account--(i) Provision of services to a line 
of business. An employee provides services to a line of business if more 
than a negligible portion of the employee's services contributes to 
providing the property or services provided by the line of business to 
customers of the employer. All of the services of each employee who 
provides services to the employer contribute, whether directly or 
indirectly, to the provision of property or services to customers of the 
employer, and therefore each employee who provides services to the 
employer must be treated as providing more than a negligible portion of 
the employee's services to one or more lines of business operated by the 
employer.
    (ii) Period for which services are provided. Only services performed 
by an employee during the testing year that contribute to providing the 
property or services provided by a line of business to customers are 
taken into account. An employee's services during the testing year are 
considered to contribute to providing the property or services provided 
by a line of business to customers of the employer if--
    (A) The employee's services during the testing year contribute to 
providing such property or services to customers of the employer during 
the testing year; or
    (B) It is reasonably anticipated that the employee's services during 
the testing year will contribute to providing such property and services 
to customers of the employer after the close of the testing year.
    (iii) Optional rule for employees who change status--(A) In general. 
Solely for purposes of the separateness rules of this section and the 
assignment rules of Sec. 1.414(r)-7, if an employee changes status as 
described in paragraph (c)(5)(iii)(B) of this section, an employer may, 
for up to three consecutive testing years after the base year (within 
the meaning of paragraph (c)(5)(iii)(B) (1) or (2) of this section), 
treat the employee as providing the same level of service to its lines 
of business as the employee provided in the base year.
    (B) Change in employee's status. An employee changes status as 
described in this paragraph (c)(5)(iii)(B) if--
    (1) For a testing year (the base year), the employee was a 
substantial-service employee with respect to a qualified separate line 
of business of the employer (prior line of business) and, for the 
immediately succeeding testing year, the employee is not a substantial-
service employee with respect to that prior line of business; or
    (2) For a testing year (the base year), the employee was a residual 
shared employee and, for the immediately succeeding testing year, the 
employee is a substantial-service employee with respect to a qualified 
separate line of business.
    (6) Examples of the separate employee workforce requirement. The 
following examples illustrate the application of the separate employee 
workforce requirement in paragraph (b)(4) of this section and the 
supplementary rules of this paragraph (c). Unless otherwise specified, 
it is assumed that the employees and their services described in these 
examples are taken into account under paragraphs (c) (4) and (5) of this 
section for the testing year and that the employer does not use the 
option under Sec. 1.414(r)-11(b)(2) to treat employees who provide less 
than 75 percent of their services to a line of business as

[[Page 961]]

substantial-service employees with respect to the line of business.

    Example 1. Employer A operates three lines of business as determined 
under Sec. 1.414(r)-2. One of Employer A's lines of business 
manufactures and sells tires and other automotive products. Employee M 
is a tire press operator in Employer A's tire factory. Employee N is the 
manager of the tire factory. Under these facts, the services of 
Employees M and N contribute to providing tires to customers of Employer 
A. Both employees therefore provide services to Employer A's tire and 
automotive products line of business within the meaning of paragraph 
(c)(5) of this section.
    Example 2. The facts are the same as in Example 1. In addition, none 
of the services of Employees M and N that contribute to providing 
property or services to customers contribute to providing any property 
or service other than tires to customers of Employer A. Under these 
facts, Employees M and N provide at least 75 percent of their respective 
services to Employer A's tire and automotive products line of business. 
Therefore Employees M and N are substantial-service employees with 
respect to Employer A's tire and automotive products line of business 
within the meaning of Sec. 1.414(r)-11(b)(2), and do not provide any 
services within the meaning of paragraph (c)(5) of this section to any 
of Employer A's other lines of business. Moreover, because Employees M 
and N provide at least 75 percent of their services to Employer A's tire 
and automotive products line of business and are substantial-service 
employees with respect to that line, they are disregarded in applying 
paragraph (b)(4) of this section to any other line of business, even if 
they provide services to the other line.
    Example 3. The facts are the same as in Example 2. Employer A's 
second line of business manufactures and sells construction machinery, 
and Employer A's third line of business manufactures and sells 
agricultural equipment. As part of these lines of business, Employer A 
operates a construction machinery factory and an agricultural equipment 
factory on the same site as the tire factory described in Example 2. 
Employer A's facilities at the site include a health clinic and a 
fitness center that serve the employees of the construction machinery 
factory, the agricultural equipment factory, and the tire factory. 
Employee O is a nurse in the health clinic, and Employee P is a fitness 
instructor in the fitness center. Both employees therefore provide 
services within the meaning of paragraph (c)(5) of this section to 
Employer A's tire and automotive products line of business, construction 
machinery line of business, and agricultural equipment line of business. 
In addition, under these facts, Employer A determines that approximately 
33 percent of the services of Employees O and P are provided to each of 
Employer A's three lines of business. As a result, neither Employee O or 
P provide at least 75 percent of their respective services to any of 
Employer A's lines of business. Therefore, Employees O and P are not 
substantial-service employees with respect to any of Employer A's three 
lines of business within the meaning of Sec. 1.414(r)-11(b)(2).
    Example 4. The facts are the same as in Example 3. Employee Q is the 
president and chief executive officer of Employer A and is responsible 
for reviewing the performance of all Employer A's lines of business. 
Under these facts, the services of Employee Q contributes to providing 
property and services to customers of each of Employer A's three lines 
of business. Employee Q therefore provides services to each of these 
three lines of business. Employer A determines that Employee Q provides 
the following percentages of his services to Employer A's three lines of 
business: tire and automotive products--40 percent; construction 
machinery--40 percent, and agricultural equipment--20 percent. Employee 
Q does not provide at least 75 percent of his services to any of 
Employer A's lines of business. Therefore, Employee Q is not a 
substantial-service employee with respect to any of Employer A's three 
lines of business within the meaning of Sec. 1.414(r)-11(b)(2).
    Example 5. The facts are the same as in Example 4, except that 
Employer A also owns 75 percent of Corporation X. Corporation X is not 
treated as part of Employer A within the meaning of Sec. 1.410(b)-9. 
Employee R is an accountant in the accounting department of Employer A. 
Employee R devotes all of his time to maintaining the accounting books 
and records of the tire and automotive products line of business of 
Employer A and the accounting books and records of Corporation X. 
Employer A determines that Employee R provides 40 percent of his 
services directly to the tire and automotive products line of business. 
Employer A also determines that Employee R provides the following 
percentages of the remainder of Employee R's services (i.e., his 
provision of services of maintaining the accounting books and records of 
Corporation X) indirectly to Employer A's three lines of business by 
virtue of the services he provides to Corporation X: tire and automotive 
products--25 percent; construction machinery--20 percent, and 
agricultural equipment--15 percent. Therefore, Employee R provides 65 
percent of his services to the tire and automotive products line of 
business of Employer A (i.e., 40 percent directly and 25 percent 
indirectly). Under the definition of substantial-service employee in 
Sec. 1.414(r)-11(b)(2), Employer A may treat Employee R as a 
substantial-service employee with respect to the tire and automotive 
products line of business because Employee R provides at least 50 
percent of his services to that

[[Page 962]]

line. In that case, Employee R would be disregarded in applying 
paragraph (b)(4) of this section to the construction machinery and 
agricultural equipment lines of business.
    Example 6. The facts are the same as in Example 5. Employee S is a 
lawyer in the legal department located at the headquarters who devotes 
all her time to product liability suits filed against the construction 
machinery line of business. Under these facts, the services of Employee 
S contribute to providing property and services to customers of Employer 
A in the construction machinery line of business, and therefore Employee 
S provides services to that line of business. Because Employee S's 
services do not contribute to providing property or services in any 
other of Employer A's lines of business within the meaning of paragraph 
(c)(5) of this section, Employee S provides more than 75 percent of her 
services to the construction machinery line of business and therefore is 
a substantial-service employee with respect to Employer A's construction 
machinery line of business within the meaning of Sec. 1.414(r)-
11(b)(2).
    Example 7. The facts are the same as in Example 6. Employer A also 
maintains a separate facility that houses a centralized procurement, 
marketing, and billing operation for all of its lines of business. None 
of the procurement, marketing, or billing employees specializes in any 
particular line of business. Under these facts, the services of the 
procurement, marketing, and billing employees contribute to providing 
property and services to customers of Employer A in each of Employer A's 
three lines of business. Employer A determines that each of the 
procurement, marketing, and billing employees provides approximately an 
equal proportion of their services to each of Employer A's three lines 
of business. These employees therefore provide services to all of 
Employer A's lines of business within the meaning of paragraph (c)(5) of 
this section. However, none of them provides at least 75 percent of his 
services to any line of business. Therefore, these employees are not 
substantial-service employees with respect to any of Employer A's three 
lines of business within the meaning of Sec. 1.414(r)-11(b)(2).
    Example 8. The facts are the same as in Example 7. Employee T works 
for the construction machinery line of business. During the testing 
year, he is temporarily detailed to the agricultural equipment line of 
business. His temporary detail lasts for one week, after which he 
returns to his regular duties with the construction machinery line of 
business. Under these facts, Employee T does not provide more than a 
negligible portion of his services during the testing year to the 
agricultural equipment line of business. Accordingly, Employee T does 
not provide services to the agricultural equipment line of business 
within the meaning of paragraph (c)(5) of this section. In addition, 
because Employee T provides at least 75 percent of his services to the 
construction machinery line of business, Employee T is a substantial-
service employee with respect to Employer A's agricultural equipment 
line of business within the meaning of Sec. 1.414(r)-11(b)(2).
    Example 9. The facts are the same as in Example 8, except that, 
during the testing year but before the first testing day, Employee T 
retires from employment with Employer A. Under paragraph (c)(5)(ii) of 
this section, Employee T is not taken into account in determining 
whether Employer A's construction machinery line of business has its own 
separate employee workforce within the meaning of paragraph (b)(4) of 
this section.
    Example 10. Employer B is a multinational controlled group of 
corporations that engages in the exploration, production, refining, and 
marketing of petrochemical products. Employer B operates two lines of 
business as determined under Sec. 1.414(r)-2. The first line of 
business (the ``exploration, production, and refining line of 
business'') provides lubricating oil, gasoline, and other petrochemical 
products to wholesale customers of Employer B as well as to the second 
line of business. The wholesale customers of Employer B include 
independent jobbers, independent franchisees that operate retail filling 
stations under Employer B's trademark and tradename, as well as chemical 
and plastics manufacturers. The second line of business (the ``retail 
marketing line of business'') provides lubricating oil and gasoline 
products to retail customers of Employer B through filling stations 
owned and operated by Employer B. Employee U is an attendant at a 
filling station owned and operated by Employer B. Employee U performs no 
other services for Employer B, Under these facts, Employee U provides at 
least 75 percent of his services to Employer B's retail marketing line 
of business and therefore is a substantial-service employee with respect 
to that line of business within the meaning of Sec. 1.414(r)-11(b)(2), 
and does not provide any services within the meaning of paragraph (c)(5) 
of this section to any of Employer B's other lines of business.
    Example 11. The facts are the same as in Example 10. Employer B 
operates a refinery that produces lubricating oil, gasoline, and other 
petrochemical products. Employee V is an operating engineer at the 
refinery who is involved at a stage in the refining process before 
lubricating oil and gasoline products have been separated from other 
types of petrochemical products. Employee V performs no other services 
for Employer B. Under these facts, Employee V's services contribute to 
providing property and services to customers of Employer B in both the 
exploration, production, and refining line of business and the retail 
marketing line of business. Employee V therefore provides services

[[Page 963]]

to both lines of business within the meaning of paragraph (c)(5) of this 
section. See paragraph (d) of this section, however, for an optional 
rule for vertically integrated lines of business.
    Example 12. The facts are the same as in Example 11. Employee W is a 
petroleum engineer who conducts geological studies of potential future 
drilling sites. Although Employee W's services during the testing year 
will not contribute to providing lubricating oil, gasoline, and other 
petrochemical products to customers of Employer B during the testing 
year, it is reasonably anticipated (in accordance with paragraph 
(c)(5)(ii)(B) of this section) that her services during the testing year 
will contribute to providing such products to customers of Employer B 
after the close of the testing year. Under these facts, Employee W 
provides her services to both of Employer B's lines of business within 
the meaning of paragraph (c)(5) of this section.

    (7) Examples of the separate management requirement. The following 
examples illustrate the application of the separate management 
requirement in paragraph (b)(5) of this section and the supplementary 
rules of this paragraph (c). Unless otherwise specified, it is assumed 
that employees who provide services to a line of business are not 
substantial-service employees with respect to any other line of business 
and that, in determining the top-paid employees with respect to a line 
of business, the employer is using the option under Sec. 1.414(r)-
11(b)(3) to disregard all employees who provide less than 25 percent of 
their services to that line of business.

    Example 1. (a) Employer C operates three lines of business as 
determined under Sec. 1.414(r)-2. One of its lines of business is the 
operation of a chain of athletic equipment and apparel stores. Of 
Employer C's total workforce, 12,000 employees provide more than a 
negligible amount of the services they provide to Employer C to the 
athletic equipment and apparel stores line of business, within the 
meaning of paragraph (c)(5) of this section. Of the 1,200 employees who 
constitute the top ten percent by compensation of those 12,000 
employees, 930 are substantial-service employees with respect to that 
line of business. Because 930 is 77.5 percent of 1,200, less than 80 
percent of the top-paid employees with respect to the line of business 
are substantial-service employees with respect to that line of business. 
Therefore, Employer C's athletic equipment and apparel stores line of 
business does not have its own separate management under paragraph 
(b)(5) of this section.
    (b) Assume that, in determining the top-paid employees with respect 
to the athletic equipment and apparel stores line of business, Employer 
C chooses to disregard all employees who provide less than 25 percent of 
their services to the line of business as permitted under the definition 
in Sec. 1.414(r)-11(b)(3). Of the 12,000 employees who provide more 
than a negligible amount of their services to the athletic equipment and 
apparel stores line of business, 10,000 provide at least 25 percent of 
their services to that line. Of the 1,000 employees who constitute the 
top ten percent by compensation of those 10,000 employees, 930 are 
substantial-service employees with respect to the athletic equipment and 
apparel stores line of business. Because 930 is 93 percent of 1,000, at 
least 80 percent of the top-paid employees with respect to the line of 
business are substantial-service employees with respect to that line of 
business. Therefore, Employer C's athletic equipment and apparel stores 
line of business has its own separate management and satisfies the 
requirement of paragraph (b)(5) of this section.
    Example 2. The facts are the same as in Example 1. Employee X is a 
vice president of the accounting department located at the headquarters, 
who devotes all of his time supervising the staff of Employer C's 
accounting department. Employer C determines that 10 percent of Employee 
X's services contribute to providing property and services to customers 
of Employer C's athletic equipment and apparel stores line of business 
and 45 percent of Employee X's services contribute to providing property 
and services to customers to each of Employer C's other two lines of 
business. Because Employee X does not provide at least 25 percent of his 
services to Employer C's athletic equipment and apparel stores line of 
business, Employee X is not one of the 10,000 employees described in 
Example 1 and therefore cannot be a top-paid employee within the meaning 
of Sec. 1.414(r)-11(b)(3) with respect to the athletic equipment and 
apparel stores line of business. Therefore, Employee X is not taken into 
account in determining whether the athletic equipment and apparel stores 
line of business satisfies the separate management requirement of 
paragraph (b)(5) of this section.
    Example 3. The facts are the same as in Example 2 except that 
Employee X provides 60 percent of his services to Employer C's second 
line of business, an athletic equipment factory, and 30 percent of his 
service to Employer C's third line of business, a fast-food chain. 
Because Employee X provides at least 50 percent of his services to the 
athletic equipment factory line of business, Employer C chooses to treat 
him as a substantial- service employee with respect to that line of 
business, as permitted under

[[Page 964]]

Sec. 1.414(r)-11(b)(2). Thus, Employee X is taken into account as a 
substantial-service employee with respect to the athletic equipment 
factory line of business and is disregarded in applying the separate 
workforce and separate management requirements under paragraphs (b) (4) 
and (5) to the fast-food chain line of business.
    Example 4. Employer D operates four lines of business as determined 
under Sec. 1.414(r)-2. One of its lines of business is a machine tool 
shop. Sixty of Employer D's employees provide at least 25 percent of 
their services to the machine tool shop line of business. Of the six 
employees who constitute the top 10 percent by compensation of those 60 
employees, four are substantial-service employees with respect to the 
line of business. Because four is 67 percent of six, 80 percent of the 
top-paid employees with respect to the machine tool shop line of 
business are not substantial-service employees with respect to that line 
of business. Therefore the machine tool shop line of business does not 
satisfy the separate management requirement of paragraph (b)(5) of this 
section.
    Example 5. The facts are the same as in Example 4, except that, in 
addition, another of Employer D's lines of business is an automotive 
repair shop, and 80 of Employer D's employees provide at least 25 
percent of their services to that line of business. Employer D combines 
the machine shop line of business with the automotive repair shop line 
of business and treats them as a single line of business. As a result, 
Employer D has three lines of business as determined under Sec. 
1.414(r)-2. Assume that 150 of Employer D's employees provide more than 
25 percent of their services to the machine tool shop/automotive repair 
shop line of business within the meaning of paragraph (c)(5) of this 
section. Of the 15 employees who constitute the top 10 percent by 
compensation of these 150 employees, 12 are substantial-service 
employees with respect to that line of business. Because 12 is 80 
percent of 15, at least 80 percent of the top-paid employees with 
respect to the machine tool shop/automotive repair shop line of business 
are substantial-service employees with respect to that line of business. 
Therefore, the machine tool shop/automotive repair shop line of business 
satisfies the separate management requirement of paragraph (b)(5) of 
this section.

    (d) Optional rule for vertically integrated lines of business--(1) 
In general. If two lines of business satisfy the requirements of this 
paragraph (d) with respect to a type of property or service for a 
testing year, the employer is permitted to apply the optional rule in 
this paragraph (d) for the testing year.
    (2) Requirements. Two lines of business satisfy the requirements of 
this paragraph (d) with respect to a type of property or service only 
if--
    (i) One of the lines of business (the upstream line of business) 
provides a type of property or service to the other line of business 
(the downstream line of business);
    (ii) The downstream line of business either--
    (A) Uses, consumes, or substantially modifies the property or 
service in the course of itself providing property or services to 
customers of the employer; or
    (B) Provides the same property or service to customers of the 
employer at a different level in the chain of commercial distribution 
from the upstream line of business (e.g., retail versus wholesale); and
    (iii) The upstream line of business either--
    (A) Provides the same type of property or service to customers of 
the employer, and at least 25 percent of the total number of units of 
the same type of property or service provided by the upstream line of 
business to all persons (including customers of the employer, the 
downstream line of business, and all other lines of business of the 
employer) are provided to customers of the employer by the upstream line 
of business, when measured on a uniform basis; or
    (B) Provides to the downstream line of business property consisting 
primarily of a type of tangible property (i.e., goods, not services) 
that it produces or manufactures, and some entities outside the 
employer's controlled group that are engaged in a similar business as 
the upstream line of business provide the same type of tangible property 
to unrelated customers (i.e., customers outside those entities' 
respective controlled groups).
    (3) Optional rule--(i) Treatment of employees. For purposes of 
determining the lines of business to which an employee provides services 
under paragraph (c)(5) of this section, an employee is not treated as 
providing services to the downstream line of business if--
    (A) The employee is considered to provide services to the downstream 
line of business under paragraph (c)(5) of this section (applied without 
regard

[[Page 965]]

to the optional rule in this paragraph (d)); and
    (B) The employee is so considered solely because the employee's 
services contribute to providing the property or service from the 
upstream line of business to the downstream line of business.
    (ii) Purposes for which optional rule applies. If an employee 
applies the optional rule in this paragraph (d), the treatment specified 
in paragraphs (d)(3)(i) (A) and (B) of this section applies for all the 
following purposes and only for the following purposes--
    (A) The separate employee workforce and separate management 
requirements of paragraphs (b)(4) and (b)(5) of this section;
    (B) The 50-employee requirement of Sec. 1.414(r)-4(b); and
    (C) The determination of the employees of a qualified separate line 
of business under Sec. 1.414(r)-7.
    (4) Examples. The following examples illustrate the application of 
the optional rule in this paragraph (d).

    Example 1. Employer E operates two lines of business as determined 
under Sec. 1.414(r)-2, one engaged in upholstery textile manufacturing 
and the other in furniture manufacturing. During the testing year, the 
upholstery textile line of business provides its entire output of 
upholstery textiles to the furniture line of business. The furniture 
line of business uses the upholstery textiles in the manufacture of 
upholstered furniture for sale to customers of Employer E. The furniture 
line of business thus substantially modifies the upholstery textiles 
provided to it by the upholstery textile line of business in providing 
upholstered furniture products to customers of Employer E. In addition, 
although the upholstery textile line of business does not provide 
upholstery textiles to customers of Employer E, some entities engaged in 
upholstery textile manufacturing provide upholstery textiles to 
customers outside their controlled groups. Under these facts, Employer 
E's two lines of business satisfy the requirements of this paragraph (d) 
with respect to upholstery textiles for the testing year.
    Example 2. Employer B is a multinational controlled group of 
corporations that engages in the exploration, production, refining, and 
marketing of petrochemical products. See Example 10 under paragraph 
(c)(7) of this section. Employer B operates two lines of business as 
determined under Sec. 1.414(r)-(2). The first line of business (``the 
exploration, production, and refining line of business'') provides 
lubricating oil, gasoline, and other petrochemical products to wholesale 
customers of Employee B as well as the second line of business. The 
wholesale customers of Employee B include independent jobbers, 
independent franchisees that operate retail filling stations under 
Employee B's trademark and tradename, as well as chemical and plastics 
manufacturers. The second line of business (the ``retail marketing line 
of business'') provides lubricating oil and gasoline products to retail 
customers of Employee B through filing stations owned and operated by 
Employee B. During the testing year, the exploration, production and 
refining line of business provides 25,000 gallons of lubricating oil, 
100,000 gallons of unleaded and 150,000 gallons of leaded gasoline to 
the retail marketing line of business, and 75,000 gallons of lubricating 
oil, 500,000 gallons of unleaded gasoline and 15,000 gallons of leaded 
gasoline to wholesale customers of Employer B. Thus, the exploration, 
production, and refining line of business provides 75 percent of its 
output of lubricating oil during the testing year to wholesale customers 
of Employer B. In addition, because unleaded and leaded gasoline is the 
same type of property (i.e., gasoline), the exploration, production, and 
refining line of business provides 67 percent of its output of gasoline 
products during the testing year to wholesale customers of Employer B. 
Furthermore, the retail line of business provides lubricating oil and 
gasoline products to customers of Employer B at different levels in the 
chain of commercial distribution than the exploration, production, and 
refining line of business. Under these facts, Employer B's two lines of 
business satisfy the requirements of this paragraph (d) with respect to 
both lubricating oil and gasoline products for the testing year.
    Example 3. The facts are the same as in Example 2. Employer B 
operates a refinery that produces lubricating oil, gasoline, and other 
petrochemical products. Employee V is an operating engineer at the 
refinery who is involved at a stage in the refining process before 
lubricating oil and gasoline products have been separated from other 
types of petrochemical products. Employee V performs no other services 
for Employer B. Absent application of the optional rule in this 
paragraph (d), Employee V would be considered to provide services to 
both of Employer B's lines of business. See Example 11 under paragraph 
(c)(7) of this section. However, because Employee V's services to the 
retail marketing line of business contribute solely to providing 
lubricating oil and gasoline products from the exploration, production, 
and refining line of business to the retail marketing line of business, 
under the optional rule in paragraph (d)(3)(i) of this section Employee 
V is not treated as providing services to the retail marketing line of 
business.
    Example 4. The facts are the same as in Example 3. Employee W is a 
petroleum engineer

[[Page 966]]

who conducts geological studies of potential future drilling sites. 
Employee W performs no other services for Employer B. Absent application 
of the optional rule in this paragraph (d), Employee W would be 
considered to provide services to both of Employer B's lines of 
business. See Example 12 under paragraph (c)(7) of this Section. 
However, because Employee W's services to the retail marketing line of 
business contribute solely to providing lubricating oil and gasoline 
products from the exploration, production, and refining line of business 
to the retail marketing line of business, under the optional rule in 
paragraph (d)(3)(i) of this section Employee W is not treated as 
providing services to the retail marketing line of business.
    Example 5. The facts are the same as in Example 4. Employee Y is a 
vice president in Employer B's home office. As part of his senior 
management responsibilities, Employee Y helps to set the rate of 
production at Employer B's refineries in the United States and also 
helps to set the price charged at the pump at the retail filling 
stations owned and operated by Employer B in this country. Absent 
application of the optional rule in this paragraph (d), Employee X would 
be considered to provide services to both of Employer B's lines of 
business within the meaning of paragraph (c)(5) of this section for 
purposes of satisfying the separate workforce requirement of paragraph 
(b)(4) of this section. Because Employee X helps to set the price 
charged at the pump by Employer B's retail marketing line of business, 
Employee X's services to the retail marketing line of business are not 
limited to contributing solely to providing lubricating oil and gasoline 
products from the exploration, production, and refining line of business 
to the retail marketing line of business, as required under paragraph 
(d)(3)(i)(B) of this section. Accordingly, even though Employer B's two 
lines of business satisfy the requirements of this paragraph (d) with 
respect to both lubricating oil and gasoline products for the testing 
year, and even though Employer B applies the optional rule in this 
paragraph (d), Employee X is still considered to provide services to 
both of Employer B's lines of business.

[T.D. 8376, 56 FR 63442, Dec. 4, 1991, as amended by T.D. 8548, 59 FR 
32917, June 27, 1994]



Sec. 1.414(r)-4  Qualified separate line of business--fifty-employee 
and notice requirements.

    (a) In general. This section sets forth the rules for determining 
whether a separate line of business (as determined under Sec. 1.414(r)-
3) satisfies the 50-employee and notice requirements of Sec. 1.414(r-
1(b)(2)(iv) (B) and (C), respectively.
    (b) Fifty-employee requirement. A separate line of business 
satisfies the 50-employee requirement of Sec. 1.414(r)-1(b)(2)(iv)(B) 
for a testing year only if on each day of the testing year there are at 
least 50 employees who provide services to the separate line of business 
for the testing year and do not provide services to any other separate 
line of business of the employer for the testing year within the meaning 
of Sec. 1.414(r)-3(c)(5). For this purpose, all employees of the 
employer are taken into account (including collectively bargained 
employees), except employees described in Sec. 1.414(q)-1, Q&A-
9(g)(i.e., the same employees, subject to certain modifications, who are 
excluded in determining the number of employees in the top-paid group 
under section 414(q)(4)).
    (c) Notice requirement--(1) General rule. A separate line of 
business satisfies the notice requirement of Sec. 1.414(r)-
1(b)(2)(iv)(C) for a testing year only if the employer notifies the 
Secretary that it treats itself as operating qualified separate lines of 
business for the testing year in accordance with Sec. 1.414(r)-1(b). 
The employer's notice for the testing year must specify each of the 
qualified separate lines of business operated by the employer and the 
section or sections of the Code to be applied on a qualified-separate-
line-of-business basis. See Sec. 1.414(r)-1(c). The employer's notice 
must take the form, must be filed at the time and the place, and must 
contain any additional information prescribed by the Commissioner in 
revenue procedures, notices, or other guidance of general applicability. 
No other notice, whether actual or constructive, satisfies the 
requirement of this paragraph (c).
    (2) Effect of notice. Once an employer has provided the notice 
prescribed in this paragraph (c) for a testing year, and the time for 
filing the notice for the testing year has expired without its being 
modified, withdrawn, or revoked, the employer is deemed to have 
irrevocably elected to apply the requirements of the section or sections 
of the Code specified in the notice separately with respect to the 
employees of each qualified separate line of business

[[Page 967]]

specified in the notice for all plan years that begin in the testing 
year. The Commissioner may, in revenue procedures, notices, or other 
guidance of general applicability, provide for exceptions to the rule in 
this paragraph (c)(2) as well as for the effect that will be given to 
the employer's notice for purposes of any future testing year.

[T.D. 8376, 56 FR 63446, Dec. 4, 1991, as amended by T.D. 8548, 59 FR 
32919, June 27, 1994]



Sec. 1.414(r)-5  Qualified separate line of business--administrative 
scrutiny requirement--safe harbors.

    (a) In general. A separate line of business (as determined under 
Sec. 1.414(r)-3 satisfies the administrative scrutiny requirement of 
Sec. 1.414(r)-1(b)(2)(iv)(D) for a testing year if the separate line of 
business satisfies any of the safe harbors in paragraphs (b) through (g) 
of this section for the testing year. The safe harbor in paragraph (b) 
of this section implements the statutory safe harbor of section 
414(r)(3). The safe harbors in paragraphs (c) through (g) of this 
section constitute the guidelines provided for under section 
414(r)(2)(C). A separate line of business that does not satisfy any of 
the safe harbors in this section nonetheless satisfies the requirement 
of administrative scrutiny if the employer requests and receives an 
individual determination from the Commissioner under Sec. 1.414(r)-6 
that the separate line of business satisfies the requirement of 
administrative scrutiny.
    (b) Statutory safe harbor--(1) General rule. A separate line of 
business satisfies the safe harbor in this paragraph (b) for the testing 
year only if the highly compensated employee percentage ratio of the 
separate line of business is--
    (i) At least 50 percent; and
    (ii) Non more than 200 percent.
    (2) Highly compensated employee percentage ratio. For purposes of 
this paragraph (b), the highly compensated employee percentage ratio of 
a separate line of business is the fraction (expressed as a percentage), 
the numerator of which is the percentage of the employees of the 
separate line of business who are highly compensated employees, and the 
denominator of which is the percentage of all employees of the employer 
who are highly compensated employees.
    (3) Employees taken into account. For purposes of this paragraph 
(b), the employees taken into account are the same employees who are 
taken into account for purposes of applying section 410(b) with respect 
to the first testing day. For this purpose, employees described in 
section 410 (b)(3) and (b)(4) are excluded. However, section 410(b)(4) 
is applied with reference to the lowest minimum age requirement 
applicable under any plan of the employer, and with reference to the 
lowest service requirement applicable under any plan of the employer, as 
if all the plans were a single plan under Sec. 1.410(b)-6(b)(2). The 
employees of the separate line of business are determined by applying 
Sec. 1.414(r)-7 to the employees taken into account under this 
paragraph (b)(3). An employee is treated as a highly compensated 
employee for purposes of this paragraph (b) if the employee is treated 
as a highly compensated employee for purposes of applying section 410(b) 
with respect to the first testing day. For the definition of ``first 
testing day,'' see Sec. 1.414(r)-11(b)(7).
    (4) Ten-percent exception. A separate line of business is deemed to 
satisfy paragraph (b)(1)(i) of this section for the testing year if at 
least 10 percent of all highly compensated employees of the employer 
provide services to the separate line of business during the testing 
year and do not provide services to any other separate line of business 
of the employer during the testing year within the meaning of Sec. 
1.414(r)-3(c)(5).
    (5) Determination based on preceding testing year. A separate line 
of business that satisfied this safe harbor for the immediately 
preceding testing year (without taking into account the special rule in 
this paragraph (b)(5)) is deemed to satisfy the safe harbor for the 
current testing year. The preceding sentence applies to a separate line 
of business only if the employer designated the same line of business in 
the immediately preceding testing year as in the current testing year 
and either--
    (i) The highly compensated employee percentage ratio of the separate 
line of business for the current testing year

[[Page 968]]

does not deviate by more than 10 percent (not 10 percentage points) from 
the highly compensated employee percentage ratio of the separate line of 
business for the immediately preceding testing year; or
    (ii) No more than five percent of the employees of the separate line 
of business for the current testing year were employees of a different 
separate line of business for the immediately preceding testing year, 
and no more than five percent of the employees of the separate line of 
business for the immediately preceding testing year are employees of a 
different separate line of business for the current testing year.
    (6) Examples. The following examples illustrate the application of 
the safe harbor in this paragraph (b).

    Example 1. (i) Employer A operates three separate lines of business 
as determined under Sec. 1.414(r)-3, that respectively consist of a 
railroad, an insurance company, and a newspaper. Employer A employs a 
total of 400 employees, 100 of whom are highly compensated employees. 
Thus, the percentage of all employees of Employer A who are highly 
compensated employees in 25 percent. After applying Sec. 1.414(r)-7, 
the distribution of highly and nonhighly compensated employees among 
Employer A's separate lines of business is as follows:

----------------------------------------------------------------------------------------------------------------
                                                               Employer-                 Insurance
                                                                  wide       Railroad     company     Newspaper
----------------------------------------------------------------------------------------------------------------
Number of Employees.........................................          400          100          150          150
Number of HCEs..............................................          100           20           50           30
Number of Non-HCEs..........................................          300           80          100          120
HCE Percentage..............................................          25%          20%          33%          20%
                                                                (100/400)     (20/100)     (50/150)     (30/150)
HCE Percentage Ratio........................................          N/A          80%         133%          80%
                                                              ...........    (20%/25%)    (33%/25%)    (20%/25%)
----------------------------------------------------------------------------------------------------------------

    (ii) Because the highly compensated employee percentage ratio of 
each separate line of business is at least 50 percent and no more than 
200 percent, each of Employer A's separate lines of business satisfies 
the requirements of the safe harbor in this paragraph (b).
    Example 2. (i) Employer B operates three separate lines of business 
as determined under Sec. 1.414(r)-3, that respectively consist of a 
dairy products manufacturer, a candy manufacturer, and a chain of 
housewares stores. Employer B employs a total of 1,000 employees, 100 of 
whom are highly compensated employees. Thus, the percentage of all 
employees of Employer B who are highly compensated employees is 10 
percent. After applying Sec. 1.414(r)-7, the distribution of highly and 
nonhighly compensated employees among Employer B's separate lines of 
business is as follows:

----------------------------------------------------------------------------------------------------------------
                                                               Employer-      Dairy                   Housewares
                                                                  wide       products      Candy        stores
----------------------------------------------------------------------------------------------------------------
Number of Employees.........................................        1,000          200          500          300
Number of HCEs..............................................          100            5           50           45
Number of Non-HCEs..........................................          900          195          450          255
HCE Percentage..............................................          10%         2.5%          10%          15%
                                                              (100/1,000)      (5/200)     (50/500)     (45/300)
HCE Percentage Ratio........................................          N/A          25%         100%         150%
                                                              ...........   (2.5%/10%)    (10%/10%)    (15%/10%)
----------------------------------------------------------------------------------------------------------------

    (ii) Because the highly compensated employee percentage ratio for 
the dairy products line of business is less than 50 percent, it does not 
satisfy the requirements of the statutory safe harbor in this paragraph 
(b). However, because Employer B's other two separate lines of business 
(candy manufacturing and housewares stores) each has a highly 
compensated employee percentage ratio that is no less than 50 percent 
and no greater than 200 percent, they each satisfy the statutory safe 
harbor in this paragraph (b).
    Example 3. (i) The facts are the same as in Example 2, except that 
Employer B operates only two separate lines of business as determined 
under Sec. 1.414(r)-3, one consisting of the dairy products 
manufacturer and the candy manufacturer, and the other consisting of the 
chain of housewares stores. After applying Sec. 1.414(r)-7, the 
distribution of highly and nonhighly compensated employees among

[[Page 969]]

Employer B's separate lines of business is as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                    Candy/Dairy     Housewares
                                                                   Employer-Wide     Products         Stores
----------------------------------------------------------------------------------------------------------------
Number of Employees.............................................           1,000             700             300
Number of HCEs..................................................             100              55              45
Number of Non-HCEs..............................................             900             645             255
HCE Percentage..................................................             10%            7.9%             15%
                                                                     (100/1,000)        (55/700)        (45/300)
HCE Percentage Ratio............................................             N/A             79%            150%
                                                                  ..............      (7.9%/10%)       (15%/10%)
----------------------------------------------------------------------------------------------------------------

    (ii) Because the highly compensated employee percentage ratio for 
both of Employer B's separate lines of business is at least 50 percent 
and no more than 200 percent, they each satisfy the requirements of the 
statutory safe harbor in this paragraph (b).

    (c) Safe harbor for separate lines of business in different 
industries--(1) In general. A separate line of business satisfies the 
safe harbor in this paragraph (c) for the testing year if it is in a 
different industry or industries from every other separate line of 
business of the employer. For this purpose, a separate line of business 
is in a different industry or industries from every other separate line 
of business of the employer only if--
    (i) The property or services provided to customers of the employer 
by the separate line of business (as designated by the employer for the 
testing year under Sec. 1.414(r)-2) fall exclusively within one or more 
industry categories established by the Commissioner for purposes of this 
paragraph (c); and
    (ii) None of the property or services provided to customers of the 
employer by any of the employer's other separate lines of business (as 
designated by the employer for the testing year under Sec. 1.414(r)-2) 
falls within the same industry category or categories.
    (2) Optional rule for foreign operations. For purposes of satisfying 
this paragraph (c), an employer is permitted to disregard any property 
or services provided to customers of the employer during the testing 
year by a foreign corporation or foreign partnership (as defined in 
section 7701(a)(5)), to the extent that income from the provision of the 
property or services is not effectively connected with the conduct of 
the trade or business within the United States within the meaning of 
section 864(c). Thus, for example, an employer is permitted to take into 
account only property and services provided to customers of the employer 
by its domestic subsidiaries and property and services provided by its 
foreign subsidiaries that generate income effectively connected with the 
conduct of a trade or business within the United States in determining 
whether the property or services provided to customers of the employer 
by a separate line of business fall exclusively within one or more 
industry categories and also whether the property or services provided 
by any other separate line of business fall within the same industry 
category or categories.
    (3) Establishment of industry categories. The Commissioner shall, by 
revenue procedure or other guidance of general applicability, establish 
industry categories for purposes of this paragraph (c).
    (4) Examples. The following examples illustrate the application of 
the safe harbor in this paragraph (c). For purposes of these examples, 
it is assumed that, pursuant to paragraph (c)(3) of this section, the 
Commissioner has established the following industry categories (among 
others): transportation equipment and services; banking, insurance, and 
finance; machinery and electronics; and entertainment, sports, and 
hotels.

    Example 1. Among its other business activities, Employer C operates 
a commercial airline that constitutes a separate line of business under 
Sec. 1.414(r)-3. In addition, no other separate line of business of 
Employer C provides to customers of Employer C any property or services 
in the transportation equipment and services industry category. Under 
these facts, the separate line of business described in this example 
satisfies the safe harbor in this paragraph (c).

[[Page 970]]

    Example 2. The facts are the same as in Example 1, except that 
Employer C also operates a trucking company that constitutes another 
separate line of business of Employer C under Sec. 1.414(r)-3. Because 
the commercial airline and the trucking company both provide to 
customers of Employer C services in the transportation equipment and 
services industry category, neither separate line of business satisfies 
the safe harbor in this paragraph (c).
    Example 3. Among its other business activities, Employer D operates 
a commercial bank and luxury hotel that together constitute a single 
separate line of business under Sec. 1.414(r)-3. No other separate line 
of business of employer D provides to customers of Employer D property 
or services in either the banking, insurance, or financial industry 
category, or the entertainment, sports, or hotel industry category. 
Under these facts, the separate line of business described in this 
example satisfies the safe harbor in this paragraph (c).
    Example 4. The facts are the same as in Example 3, except that 
Employer D also manufactures computers in the United States and abroad. 
Employer D apportions its computer operations by designating these 
operations between two separate lines of business, one consisting of its 
domestic operations located in the United States and the second 
consisting of its foreign operations by a foreign subsidiary. Because 
both lines of business provide property and services in the machinery 
and electronics industry category to customers of Employer D, neither 
separate line of business would satisfy the safe harbor in this 
paragraph (c). However, pursuant to the optional rule in paragraph 
(c)(2) of his section, Employer D disregards the property and services 
provided by its foreign computer subsidiary. As a result, no other 
separate line of business of Employer D provides to customers of 
Employer D any property or services in the machinery and electronics 
industry category. Under these facts, Employer D's domestic computer 
operations separate line of business satisfies the safe harbor in this 
paragraph (c).

    (d) Safe harbor for separate lines of business that are acquired 
through certain mergers and acquisitions--(1) General rule. A portion of 
the employer that is acquired through a transaction described in section 
410(b)(6)(C) and Sec. 1.410(b)-2(f) (i.e., an asset or stock 
acquisition, merger, or other similar transaction involving a change in 
the employer of the employees of a trade or business) (the ``acquired 
line of business'') satisfies the safe harbor in this paragraph (d) for 
each testing year in the transition period provided in paragraph (d)(3) 
of this section if each of the following requirements is satisfied--
    (i) For each testing year within the transition period the employer 
designates the acquired line of business as a line of business within 
the meaning of Sec. 1.414(r)-2;
    (ii) On the first testing day in each testing year in the transition 
period:
    (A) The acquired line of business constitutes a separate line of 
business within the meaning of Sec. 1.414(r)-3 (taking into account 
Sec. 1.414(r)-1(d)(4));
    (B) No more than 10 percent of the employees who are substantial-
service employees with respect to the acquired line of business were 
substantial-service employees with respect to a different separate line 
of business for the immediately preceding testing year; and
    (C) No more than 10 percent of the employees who were substantial-
service employees with respect to the acquired line of business for the 
immediately preceding testing year are substantial-service employees 
with respect to a different separate line of business in the respective 
testing year.
    (iii) If the transaction described in paragraph (d)(1) of this 
section occurs after the first testing day in a testing year, the 
determinations required by paragraphs (d)(1)(ii) (B) and (C) of this 
section with respect to that testing year are made as of the date of the 
transaction.
    (2) Employees taken into account. For purposes of this paragraph 
(d), the employees taken into account are the same employees who are 
taken into account for purposes of applying section 410(b) with respect 
to the first testing day. For this purpose, employees described in 
section 410(b)(3) and (b)(4) are excluded. However, section 410(b)(4) is 
applied with reference to the lowest minimum age requirement, and with 
reference to the lowest service requirement applicable under any plan of 
the employer that benefits employees of the separate line of business, 
as if all the plans were a single plan under Sec. 1.410(b)-6(b)(2). The 
employees of the separate line of business are determined by applying 
Sec. 1.414(r)-7 to the employees taken into account under this 
paragraph (d)(2). 0

[[Page 971]]

    (3) Transition period. The transition period for purposes of this 
safe harbor is the period that begins with the first testing year 
beginning after the date that the transaction described in paragraph 
(d)(1) of this section occurs. The employer is permitted, but not 
required, to extend the transition period to include one, two, or three 
of the testing years immediately succeeding that first testing year.
    (4) Examples. The following examples illustrate the application of 
the safe harbor in this paragraph (d).

    Example 1. Employer E is treated as operating three qualified 
separate lines of business pursuant to Sec. 1.414(r)-1(b). In 1996, 
Employer E acquires a company that employs 4,000 employees who 
manufacture and sell pharmaceutical supplies, and designates that 
portion as a line of business under Sec. 1.414(r)-2. Under Sec. 
1.414(r)-1(d)(4), the pharmaceutical supplies line of business is deemed 
to satisfy the requirements to be a qualified separate line of business 
(other than the 50-employee and notice requirements) for testing year 
1996. In addition, the determination of whether Employer E's remaining 
three lines of business constitute qualified separate lines of business 
for testing year 1996 is made without taking into account the acquired 
employees and by disregarding the property and services provided to 
customers of Employer E by the pharmaceutical supplies line of business.
    Example 2. The facts are the same as in Example 1 except that, by 
the first testing day in 1997 (Transition Year 1), there are 300 
additional substantial-service employees with respect to the 
pharmaceutical supplies line of business, increasing the total number to 
4,300. Of those 300 employees, 250 were substantial-service employees 
with respect to a different separate line of business for testing year 
1996 and 50 are new hires. Assume that, on the first testing day in 
Transition Year 1, the pharmaceutical supplies line of business 
satisfies the requirements of Sec. 1.414(r)-3 (taking into account 
Sec. 1.414(r)-1(d)(4)) and therefore constitutes a separate line of 
business. Because 250 is 6 percent of 4,300, no more than ten percent of 
the employees who are substantial-service employees with respect to the 
pharmaceutical supplies line of business were substantial- service 
employees with respect to a different separate line of business for the 
immediately preceding testing year. The 50 newly hired employees are 
disregarded in making this determination. Under these facts, the 
pharmaceutical supplies separate line of business satisfies the safe 
harbor in this paragraph (d) for Transition Year 1.
    Example 3. The facts are the same as in Example 2, except that, 
before the first day of the next testing year (``Transition Year 2''), 
Employer E permanently transfers 200 of the 4,300 employees who were 
substantial-service employees with respect to the pharmaceutical line of 
business on the first testing day in Transition Year 1 to a different 
line of business and does not hire any additional employees for the 
pharmaceutical supplies line of business. Therefore, by the first 
testing day in Transition Year 2, the number of employees who are 
substantial-service employees with respect to the pharmaceutical line of 
business of Employer E has decreased from 4,300 to 4,100. Assume that, 
on that first testing day in Transition Year 2, the pharmaceutical 
supplies line of business constitutes a separate line of business within 
the meaning of Sec. 1.414(r)-3. Because 200 is approximately 5 percent 
of 4,300, no more than 10 percent of the employees who were substantial-
service employees of the pharmaceutical line of business for Transition 
Year 1 are not substantial-service employees of the pharmaceutical line 
of business in Transition Year 2. Under these facts, the pharmaceutical 
supplies separate line of business continues to satisfy the safe harbor 
in this paragraph (d) for Transition Year 2.

    (e) Safe harbor for separate lines of business reported as industry 
segments--(1) In general. A separate line of business satisfies the safe 
harbor in this paragraph (e) for the testing year if, for the employer's 
fiscal year ending latest in the testing year, the separate line of 
business is reported as one or more industry segments on its annual 
report required to be filed in conformity with either--
    (i) Form 10-K, annual Report Pursuant to Section 13 or 15(d) of the 
Securities Exchange Act of 1934 (``Form 10-K''); or
    (ii) Form 20-F, Annual Report Pursuant to Section 13(a) or 15(d) of 
the Securities Exchange Act of 1934 with Item 18 financials (``Form 20-
F''), and the employer timely files either the Form 10-K or Form 20-F 
with the Securities and Exchange Commission (``SEC'').
    (2) Reported as an industry segment in conformity with Form 10-K or 
Form 20-F. For purposes of this paragraph (e), a separate line of 
business is reported as one or more industry segments in conformity with 
either Form 10-K or Form 20-F only if--
    (i) The separate line of business consists of one or more industry 
segments within the meaning of paragraphs 10(a),

[[Page 972]]

11(b), and 12 through 14 of the Statement of Financial Accounting 
Standards No. 14, Financial Reporting for Segments of a Business 
Enterprise (``FAS 14''); and
    (ii) The property or services provided to customers of the employer 
by the separate line of business (as designated by the employer for the 
testing year under Sec. 1.414(r)-2) is identical to the property or 
services provided to customers of the employer by the industry segment 
or segments (as determined under paragraphs 10(a), 11(b), and 12 through 
14 of FAS 14).
    (3) Timely filing of Form 10-K or Form 20-F. For purposes of this 
paragraph (e), a Form 10-K of Form 20-F is timely filed with the SEC if 
it is filed within the required period as provided under 17 CFR 240.12b-
25(b)(2)(ii). Therefore, the required period for timely filing of the 
Form 10-K is the 90-day period after the end of the fiscal year covered 
by the annual report (including the 15-day extension), and the required 
period for timely filing of the Form 20-F is the 6-month period after 
the end of the fiscal year covered by the annual report (including the 
15-day extension).
    (4) Examples. The following examples illustrate the application of 
the safe harbor in this paragraph (e).

    Example 1. Among its other business activities, Employer F operates 
a bearing manufacturing firm that constitutes a separate line of 
business under Sec. 1.414(r)-3. Employer F is required to file an 
annual Form 10-K with the SEC. On its timely filed Form 10-K, Employer F 
reports its bearing manufacturing operations as an industry segment in 
accordance of FAS 14 (as determined under paragraphs 10(a), 11(b), and 
12 through 14 of FAS 14). The group of bearing products provided by the 
separate line of business (as designated by Employer F under Sec. 
1.414(r)-2) is identical to the group of bearing products provided by 
the industry segment (as determined under paragraphs 10(a), 11(b), and 
12 through 14 of FAS 14). Under these facts, the separate line of 
business described in this example satisfies the safe harbor in this 
paragraph (e).
    Example 2. The facts are the same as in Example 1, except that 
Employer F has apportioned its bearing manufacturing operations between 
two separate lines of business as determined under Sec. 1.414(r)-3, one 
engaged in the manufacture of bearings for use in the automotive 
industry, and a second engaged in the manufacture of bearings for use in 
the aerospace industry. Because neither separate line of business 
provides a group of property or services to customers of Employer F that 
is identical to the group of bearing products provided by the industry 
segment reported on Employer F's annual Form 10-K, neither separate line 
of business described in this example satisfies the safe harbor in this 
paragraph (e).

    (f) Safe harbor for separate lines of business that provide the same 
average benefits as other separate lines of business--(1) General rule. 
A separate line of business satisfies the safe harbor in this paragraph 
(f) for the testing year only if the level of benefits provided to 
employees of the separate line of business satisfies paragraph (f)(2) or 
(f)(3) of this section, whichever is applicable.
    (2) Separate lines of business with a disproportionate number of 
nonhighly compensated employees--(i) Applicability of safe harbor. This 
paragraph (f)(2) applies to a separate line of business that for the 
testing year has a highly compensated employee percentage ratio of less 
than 50 percent (as determined under paragraph (b)(2) of this section).
    (ii) Requirement. A separate line of business satisfies this 
paragraph (f)(2) only if the actual benefit percentage of the group of 
nonhighly compensated employees of the separate line of business for the 
testing period that ends with or within the testing year is at least as 
great as the actual benefit percentage of the group of all other 
nonhighly compensated employees of the employer for the same testing 
period. See Sec. 1.410 (b)-5(c) and (d)(3)(ii) for the definitions of 
actual benefit percentage and testing period, respectively. In 
determining actual benefit percentages for purposes of this paragraph 
(f)(2)(ii), the special rule in Sec. 1.410(b)-5(e)(3) (permitting an 
employer to determine employee benefit percentages separately for 
defined contribution and defined benefit plans) may not be used.
    (3) Separate lines of business with a disproportionate number of 
highly compensated employees--(i) Applicability of safe harbor. This 
paragraph (f)(3) applies to a separate line of business that for the 
testing year has a highly compensated employee percentage ratio of more 
than 200 percent (as determined under paragraph (b)(2) of this section).
    (ii) Requirement. A separate line of business satisfies this 
paragraph (f)(3) only if the actual benefit percentage of

[[Page 973]]

the group of highly compensated employees of the separate line of 
business for the testing period that ends with or within the testing 
year is no greater than the actual benefit percentage of the group of 
all other highly compensated employees of the employer for the same 
testing period. See Sec. 1.410 (b)-5(c) and (d)(3)(ii) for the 
definitions of actual benefit percentage and testing period, 
respectively. In determining actual benefit percentages for purposes of 
this paragraph (f)(3)(ii), the special rule in Sec. 1.410(b)-5(e)(3) 
(permitting an employer to determine employee benefit percentages 
separately for defined contribution and defined benefit plans) may not 
be used.
    (4) Employees taken into account. An employee of a separate line of 
business (as determined under Sec. 1.414(r)-7 is taken into account for 
a testing period for purposes of this paragraph (f) only if the employee 
is an employee of the separate line of business on the first testing 
day, and would not be an excludable employee for purposes of applying 
the average benefit percentage test of Sec. 1.410(b)-5 to a plan for a 
plan year included in that testing period. In determining whether an 
employee is an excludable employee for purposes of the average benefit 
percentage test, the employer is assumed not to be operating qualified 
separate lines of business under Sec. 1.414(r)-1(b). An employee is 
treated as a highly compensated employee for purposes of this paragraph 
(f) if the employee is treated as a highly compensated employee for 
purposes of applying section 410(b) on the first testing day. See Sec. 
1.414(r)-11(b)(7) for the definition of ``first testing day''.
    (5) Example. The rules of this paragraph (f) are illustrated by the 
following example.

    Example. (i) Employer G is treated as operating two separate lines 
of business, Line 1 and Line 2, in accordance with Sec. 1.414(r)-1(b). 
Employer G maintains three qualified plans. Plan A is a calendar-year 
profit-sharing plan that benefits all employees of Employer G. Plan B is 
a defined benefit plan with a plan year ending March 31 that benefits 
all employees of Line 1. Plan C is a defined benefit plan with a plan 
year ending November 30 that benefits all employees of Line 2.
    (ii) In 1995, Line 1 has a highly compensated employee percentage 
ratio of 25 percent. Employer G's first testing day is March 31. After 
applying the rules of Sec. 1.414(r)-7, the nonhighly compensated 
employees of Line 1 and Line 2 on March 31, 1995, are N1-N80 and N81-
N100, respectively. N1 is an excludable employee under Sec. 1.410(b)-6 
for purposes of the average benefit percentage test during the testing 
period that includes the plan years of Plans A, B, and C that end in 
1995 (the ``1995 testing period''), and would therefore not be taken 
into account in determining whether any of those plans satisfied the 
average benefit percentage test of Sec. 1.410(b)-5 for plan years 
included in that testing period, because N1 does not satisfy the minimum 
age and service conditions under any plan of the employer. All other 
employees of Line 1 and Line 2 on March 31, 1995 are nonexcludable 
employees for purposes of the average benefit percentage test during the 
1995 testing period.
    (iii) In order for Line 1 to satisfy the requirements of this 
paragraph (f) for 1995, the actual benefit percentage of N2-N80 for the 
1995 testing period under Plans A, B and C must be at least as great as 
the actual benefit percentage of N81-N100 for the same testing period 
under the same plans. N1 is not taken into account because N1 is an 
excludable employees for purposes of the average benefit percentage test 
for the 1995 testing period. Any other employees who were taken into 
account for purposes of the average benefit percentage test for the 1995 
testing period are excluded because they are not employees of Line 1 or 
Line 2 on March 31, 1995.

    (g) Safe harbor for separate lines of business that provide minimum 
or maximum benefits--(1) In general. A separate line of business 
satisfied the safe harbor in this paragraph (g) for the testing only if 
the level of benefits provided to employees of the separate line of 
business satisfies paragraph (g)(2) or (g)(3) of this section, whichever 
is applicable. For this purpose, the level of benefits is determined 
with respect to all qualified plans of the employer that benefit 
employees of the separate line of business for plan years that begin in 
the testing year.
    (2) Minimum benefit required--(i) Applicability. This paragraph 
(g)(2) applies to a separate line of business that for the test year has 
a highly compensated employee percentage ratio of less than 50 percent 
(as determined under paragraph (b)(2) of this section).
    (ii) Requirement. A separate line of business satisfies this 
paragraph (g)(2) only if one of the following requirements is 
satisfied--
    (A) At least 80 percent of all nonhighly compensated employees of 
the

[[Page 974]]

separate line of business either accrue a benefit for the plan year that 
equals or exceeds the defined benefit minimum in paragraph (g)(2)(iii) 
of this section, receive all allocation for the plan year that equal or 
exceeds the defined contribution minimum in paragraph (g)(2)(iv) of this 
section, or accrue a benefit and receive an allocation that together 
equal or exceed the combined plan minimum in paragraph (g)(4) of this 
section. The defined benefit minimum must be provided in a defined plan, 
and the defined contribution minimum must be provided in a defined 
contribution plan.
    (B) The separate line of business would satisfy the requirements of 
paragraph (g)(2)(ii)(A) of this section if the 80 percent threshold were 
reduced to 60 percent, and the average of the accrual rates or 
allocation rates of all nonhighly compensated employees in the separate 
line of business equals or exceeds the minimum amount described for each 
individual employee in paragraph (g)(2)(ii)(A) of this section.
    (iii) Defined benefit minimum--(A) In general. The defined benefit 
minimum for a plan year is the employer-derived accrual that would 
result in a normal accrual rate for the plan year equal to 0.75 percent 
of compensation. For purposes of this paragraph (g)(2)(iii), the normal 
accrual rate is the percentage (not less than 0) determined by 
subtracting the employee's normalized accrued benefit as of the end of 
the prior plan year (expressed as a percentage of average annual 
compensation as of the end of the prior plan year) from the employee's 
normalized accrued benefit as of the end of the plan year (expressed as 
a percentage of average annual compensation as of the end of the plan 
year).
    (B) Normal form and equivalent benefits. The benefit that is tested 
for purposes of this paragraph (g)(2)(iii) is the accrued retirement 
benefit commencing at normal retirement age. If the normal form of 
benefit for a plan being tested is other than a straight life annuity 
beginning at a normal retirement age of 65, the benefit must be 
normalized (within the meaning of Sec. 1.401(a)(4)-12) to a straight 
life annuity commencing at age 65. No adjustment is permitted for early 
retirement benefits or for any ancillary benefit, including disability 
benefits.
    (C) Compensation definition. The underlying definition of 
compensation used for purposes of determining accrual rates under this 
paragraph (g)(2)(iii) must be a definition of compensation that 
automatically satisfies section 414(s) without a test for 
nondiscrimination (see Sec. 1.414(s)-1(c)).
    (D) Average compensation requirement. For purposes of determining 
accrual rates, compensation must be average annual compensation within 
the meaning of Sec. 1.401(a)(4)-3(e)(2) determined using a five-year 
averaging period. The compensation history to be taken into account are 
all years beginning with the first year in which the employee benefits 
under the plan, and ending with the last plan year in which the employee 
participates in the plan. However, a plan may disregard in a reasonable 
and consistent manner: years before the effective date of these 
regulations as set forth in Sec. 1.414(r)-1(d)(9)(i), years more than 
10 years preceding the current plan year, and years for which the 
employer does not use this paragraph (g)(2) to satisfy this safe harbor 
with respect to the separate line of business. If a plan provides a 
defined benefit minimum that uses three consecutive years (in lieu of 
five) for calculating average annual compensation, the 0.75 percent 
annual accrual in paragraph (g)(2)(iii)(A) of this section is multiplied 
by 93.3 percent, resulting in a normal accrual rate equal to 0.70 
percent. If a plan provides a defined benefit minimum that uses more 
than five consecutive years for calculating average annual compensation 
or the plan is an accumulation plan as defined in Sec. 1.401(a)(4)-12, 
the 0.75 percent annual accrual rate in paragraph (g)(2)(iii)(A) of this 
section is multiplied by 133.3 percent, resulting in a normal accrual 
rate equal to 1.0 percent.
    (E) Special rules. The special rules of Sec. 1.401(a)(4)-3(f) apply 
for purposes of determining whether a benefit accrual satisfies the 
minimum benefit requirement. For example, benefits may be determined on 
other than a plan year basis as permitted by Sec. 1.401(a)(4)-3(f)(6). 
A plan described in section 412(i)

[[Page 975]]

may be used to provide the defined benefit minimum described in this 
paragraph (g)(2). In such case, the rules in Sec. 1.416-1, M-17, apply 
to such a plan. For purposes of this paragraph (g)(2)(iii) an employee 
is treated as accruing a benefit equal to the minimum benefit in 
paragraph (g)(2)(iii)(A) of this section if the reason that the employee 
does not accrue such a benefit is either--
    (1) The application of a plan provision that applies uniformly to 
all employees in the plan and limits the service used for purposes of 
benefit accrual to a specified maximum no less than 25 years, or
    (2) The employee has attained normal retirement age and fails to 
accrue a benefit solely because of the provisions of section 
411(b)(1)(H)(iii) regarding adjustments for delayed retirement.
    (iv) Defined contribution minimum--(A) In general. The defined 
contribution minimum for a plan year is an allocation that results in an 
allocation rate for the plan year (within the meaning of Sec. 
1.401(a)(4)-2(c)) equal to three percent of an employee's plan year 
compensation. Plan year compensation must be based on a definition of 
compensation that automatically satisfies section 414(s) without a test 
for nondiscrimination (see Sec. 1.414(s)-1(c)). For this purpose, 
allocations that are taken into account to do not include matching 
contributions described in Sec. 1.401(m)-1(a)(2), elective 
contributions described in Sec. 1.401(k)-6, any adjustment in 
allocation rates permitted under section 401(l) or imputed disparity 
under Sec. 1.401(a)(4)-7.
    (B) Modified allocation definition for averaging. For purposes of 
determining whether the average allocation rates for all nonhighly 
compensated employees of the separate line of business satisfy the 
minimum benefit requirement in paragraph (g)(2)(ii)(B) of this section, 
matching contributions described in Sec. 1.401(m)-1(a)(2) are treated 
as employer allocations.
    (3) Maximum benefit permitted--( i) Applicability. This paragraph 
(g)(3) applies to a separate line of business that for the testing year 
has a highly compensated employee percentage ratio that exceeds 200 
percent (as determined under paragraph (b)(2) of this section).
    (ii) Requirement. A separate line of business satisfies this 
paragraph (g)(3) only if one of the following requirements is 
satisfied--
    (A) No highly compensated employee of the separate line of business 
accrues a benefit for the plan year that results in an accrual rate that 
exceeds the defined benefit maximum in paragraph (g)(3)(iii) of this 
section, receives an allocation that exceeds the defined contribution 
maximum in paragraph (g)(3)(iv) of this section, or accrues a benefit 
and receives an allocation that together exceed the combined plan 
maximum in paragraph (g)(4) of this section. All benefits provided by 
qualified defined benefit plans are subject to the defined benefit 
maximum, and all benefits provided by qualified defined contribution 
plans are subject to the defined contribution maximum.
    (B) The average of the accrual rates or allocation rates of all 
highly compensated employees of the separate line of business is no more 
than 80 percent of the maximum amount described for any individual 
employee in paragraph (g)(3)(ii)(A) of this section.
    (iii) Defined benefit maximum--(A) In general. The defined benefit 
maximum is the employer-derived accrued benefit that would result from 
calculating a normal accrual rate equal to 2.5 percent of compensation.
    (B) Determination of defined benefit maximum. The accrual rate used 
for the defined benefit maximum is determined in the same manner as the 
normal accrual rate used for the defined benefit minimum is determined 
under paragraph (g)(2)(iii) of this section, except as provided below. 
Thus, a defined benefit plan may provide, in addition to the defined 
benefit maximum, any benefit the value of which is not taken into 
account under paragraph (g)(2)(iii) of this section. For example, a plan 
may provide qualified disability benefits described in section 411(a)(9) 
or ancillary benefits described in Sec. 1.401(a)(4)-4(e)(2).
    (C) Adjustment for different compensation definitions. If a plan 
subject to the defined benefit maximum determines accrual rates by using 
three consecutive years (in lieu of five) for purposes

[[Page 976]]

of determining average annual compensation, the 2.5 percent annual 
accrual rate in paragraph (g)(3)(iii)(B) of this section is multiplied 
by 93.3 percent, resulting in a maximum accrual rate equal to 2.33 
percent. Compensation may be less inclusive than the compensation 
described in paragraph (g)(2)(iii)(C) of this section. However, no 
adjustment is made to the maximum normal accrual rate because of the use 
of a definition of compensation that is less inclusive than the 
compensation described in paragraph (g)(2)(iii)(C) of this section. In 
addition, no adjustment is made to the maximum normal accrual rate 
because the plan uses more than five consecutive years for calculating 
average annual compensation or the plan is an accumulation plan as 
defined in Sec. 1.401(a)(4)-12.
    (D) Adjustment for certain subsidies. If the plan provides 
subsidized optional forms of benefit, the accrual rate for purposes of 
this paragraph (g)(3) must be determined by taking those subsidies into 
account. An optional form of benefit is considered subsidized if the 
normalized optional form of benefit is larger than the normalized normal 
retirement benefit under the plan. In the case of a plan with subsidized 
optional forms, the determination of accrual rate for the plan year 
under paragraph (g)(2)(iii)(A) of this section is the percentage (not 
less than 0) determined by subtracting the largest of the sums of the 
employee's normalized QJSAs and QSUPPs determined for each age under 
Sec. 1.401(a)(4)-3(d)(1)(ii) as of the end of the prior plan year 
(expressed as a percentage of average annual compensation as of the end 
of the prior plan year) from the largest of the sums of the employee's 
normalized QJSAs and QSUPPs determined for each age under Sec. 
1.401(a)(4)-3(d)(1)(ii) as of the end of the plan year (expressed as a 
percentage of average annual compensation as of the end of the plan 
year).
    (iv) Defined contribution maximum. The defined contribution maximum 
is an allocation that results in an allocation rate for the plan year 
(within the meaning of Sec. 1.401(a)(4)-2(c)) equal to 10 percent of an 
employee's plan year compensation. Compensation may be less inclusive 
than the compensation described in paragraph (g)(2)(iv)(A) of this 
section. However, no adjustment is made to the defined contribution 
maximum because of the use of a definition of compensation that is less 
inclusive than the compensation described in paragraph (g)(2)(iv)(A) of 
this section. For this purpose, allocations that are taken into account 
do not include elective contributions described in Sec. 1.401(k)-6, any 
adjustment in allocation rates permitted under section 401(l) or imputed 
disparity under Sec. 1.401(a)(4)-7 but do include employer matching 
contributions under Sec. 1.401(m)-1(f)(12).
    (4) Duplication of benefits or contributions--(i) Plans of the same 
type. In the case of an employee who benefits under more than one 
defined benefit plan, the defined benefit minimum required or the 
defined benefit maximum permitted under this paragraph (g) is determined 
by reference to the employee's aggregate employer-provided benefit under 
all qualified defined benefit plans of the employer. In the case of an 
employee who benefits under more than one defined contribution plan, the 
defined contribution minimum required or the defined contribution 
maximum permitted under this paragraph (g) is determined by reference to 
the employee's aggregate employer-provided allocations under all 
qualified defined contribution plans of the employer.
    (ii) Plans of different types. In the case of an employee who 
benefits under both a defined benefit plan and a defined contribution 
plan, a percentage of the minimum benefit required or the maximum 
benefit permitted under this paragraph (g) may be provided in each type 
of plan as long as the combined percentage equals at least 100 percent 
in the case of the minimum benefit required and does not exceed 100 
percent in the case of the maximum benefit permitted. Thus, for example, 
if a highly compensated employee benefits under both types of plans and 
accrues an aggregate adjusted normal accrual rate equal to 1.25 percent 
of average annual compensation under all defined benefit plans of the 
employer (i.e, 50 percent of the defined benefit maximum described in 
paragraph (g)(3)(iii)

[[Page 977]]

of this section), in order to comply with the maximum benefit safe 
harbor, the employee may not receive an aggregate allocation under all 
defined contribution plans of the employer in excess of five percent of 
plan year compensation (i.e., 50 percent of the defined contribution 
maximum described in paragraph (g)(3)(iv) of this section).
    (iii) Special rule for floor-offset arrangements. In the case of a 
floor-offset arrangement (as described in Sec. 1.401(a)(4)-8(d)), the 
minimum or maximum benefit rules are applied to each plan as if the 
other plan did not exist. Thus, the defined benefit plan must provide at 
least 100 percent of the defined benefit minimum (or no more than 100 
percent of the defined benefit maximum) based on the gross benefit prior 
to offset, and the defined contribution plan must provide at least 100 
percent of the defined contribution minimum (or no more than 100 percent 
of the defined contribution maximum).
    (5) Certain contingency provisions ignored. For purposes of this 
paragraph (g), an employee's accrual or allocation rate is determined 
without regard to any minimum benefit or any maximum benefit limitation 
that is applicable to the employee only if the separate line of business 
fails otherwise to satisfy the requirement of administrative scrutiny.
    (6) Employees taken into account. For purposes of this paragraph 
(g), an employee is taken into account if the employee is taken into 
account for purposes of applying section 410(b) with respect to any 
testing day for the testing year. For this purpose, employees described 
in section 410 (b)(3) and (b)(4) are excluded. However, section 
410(b)(4) is applied with reference to the lowest minimum age 
requirement applicable, and with reference to the lowest service 
requirement applicable under any plan of the employer that benefits 
employees of the separate line of business, as if all the plans were a 
single plan under Sec. 1.410(b)-6(b)(2). For purposes of the minimum 
benefit requirement of paragraph (g)(2) of this section, section 
410(b)(4) may be applied with reference to the lowest minimum age 
requirement, and with reference to the lowest minimum service 
requirement, applicable under any plan of the employer that benefits 
highly compensated employees of the separate line of business, as if all 
the plans were a single plan under Sec. 1.410(b)-6(b)(2), or, if no 
plan of the employer benefits highly compensated employees of the 
separate line of business, with reference to the greatest age and 
service requirements permitted under section 410(a)(1)(A). The employees 
of the separate line of business are determined by applying Sec. 
1.414(r)-7 to the employees taken into account under this paragraph 
(g)(6). An employee is treated as a highly compensated employee for 
purposes of this paragraph (g) if the employee is treated as a highly 
compensated employee for purposes of applying section 410(b) on any 
testing day for the testing year. For the definition of ``testing day,'' 
see Sec. 1.414(r)-11(b)(6).

[T.D. 8376, 56 FR 63446, Dec. 4, 1991, as amended by T.D. 8548, 59 FR 
32919, June 27, 1994; T.D. 9169, 69 FR 78153, Dec. 29, 2004]



Sec. 1.414(r)-6  Qualified separate line of business--administrative 
scrutiny requirement--individual determinations.

    (a) In general. A separate line of business (as determined under 
Sec. 1.414(r)-3) that does not satisfy any of the safe harbors in Sec. 
1.414(r)-5 for a testing year nonetheless satisfies the administrative 
scrutiny requirement of Sec. 1.414(r)-1(b)(2)(iv)(D) if the employer 
requests and receives from the Commissioner an individual determination 
under this section that the separate line of business satisfies the 
requirement of administrative scrutiny for the testing year. This 
section implements the individual determinations provided for under 
section 414(r)(2)(C). The Commissioner shall issue such an individual 
determination only when it is consistent with the purpose of section 
414(r), taking into account the nondiscrimination requirements of 
sections 401(a)(4) and 410(b). Paragraph (b) of this section authorizes 
the Commissioner to establish procedures for requesting and granting 
individual determinations.
    (b) Authority to establish procedures. The Commissioner may, in 
revenue rulings and procedures, notices, and other guidance, published 
in the Internal Revenue Bulletin (see

[[Page 978]]

Sec. 601.601(d)(2)(ii)(b) of this chapter), provide any additional 
guidance that may be necessary or appropriate for requesting and 
granting individual determinations under this section. For example, such 
guidance may specify the circumstances in which an employer may request 
an individual determination and factors to be taken into account in 
deciding whether to grant a favorable individual determination. In 
addition, such guidance may describe situations that automatically fail 
the administrative scrutiny requirement.

[T.D. 8376, 56 FR 63452, Dec. 4, 1991, as amended by T.D. 8548, 59 FR 
32920, June 27, 1994]



Sec. 1.414(r)-7  Determination of the employees of an employer's 
qualified separate lines of business.

    (a) Introduction--(1) In general. This section provides the rules 
for determining the employees of each qualified separate line of 
business operated by an employer. Paragraph (a)(2) of this section lists 
the specific provisions of the regulations for which these rules apply. 
Paragraph (b) of this section provides the procedure for assigning the 
employees of the employer among the qualified separate lines of business 
of the employer and for determining the day or days on which such 
assignments must be made. Under this procedure, each employee (i.e., a 
substantial-service employee or a residual shared employee as defined in 
Sec. 1.414(r)-11(b)(2) and (4)) is assigned to a single qualified 
separate line of business in a consistent manner for all purposes listed 
in paragraph (a)(2) of this section with respect to the testing year and 
plan years beginning within the testing year. Paragraph (c) of this 
section provides methods for allocating residual shared employees among 
qualified separate lines of business.
    (2) Purposes for which this section applies. This section applies 
solely for purposes of determining whether--
    (i) A separate line of business satisfies the statutory safe harbor 
of Sec. 1.414(r)-5(b) for a testing year (see Sec. 1.414(r)-5(b)(3) 
for the employees taken into account for this purpose);
    (ii) A separate line of business satisfies the merger and 
acquisition safe harbor of Sec. 1.414(r)-5(d) for a testing year (see 
Sec. 1.414(r)-5(d)(2) for the employees taken into account for this 
purpose);
    (iii) A separate line of business satisfies the average benefits 
safe harbor of Sec. 414(r)-5(f) for a testing year (see Sec. 414(r)-
5(f)(4) for the employees taken into account for this purpose);
    (iv) A separate line of business satisfies the minimum or maximum 
benefits safe harbor of Sec. 414(r)-5(g) for a testing year (see Sec. 
1.414(r)-5(g)(6) for the employees taken into account for this purpose);
    (v) A plan of the employer satisfies sections 410(b) and 401(a)(4) 
for a plan year (see Sec. 414(r)-8(d)(3) for the employees taken into 
account for this purpose); or
    (vi) A plan of the employer satisfies section 401(a)(26) for a plan 
year (see Sec. 414(r)-9(c)(3) for the employees taken into account for 
this purpose).
    (b) Assignment procedure--(1) In general. To apply the provisions 
listed in paragraph (a)(2) of this section with respect to a testing 
year or plan year, as the case may be, each of the employees taken into 
account under that provision must be assigned to a qualified separate 
line of business of the employer on one or more testing days (or section 
401(a)(26) testing days) during the year. The first day for which this 
assignment procedure is required for a testing year is the first testing 
day. See Sec. 414(r)-11(b)(6), (7) and (8) (definitions of ``testing 
day'', ``first testing day'' and ``section 401(a)(26) testing day''). 
Section Sec. 414(r)-8 may require that the assignment procedure be 
repeated for testing days that fall after the first testing day 
(including testing days that fall after the close of the testing year in 
a plan year that begins in the testing year). Accordingly, new employees 
may be taken into account for the first time on these later testing days 
who were not taken into account on the first testing day. Section Sec. 
414(r)-9 may have the same effect with respect to section 401(a)(26) 
testing days that fall after the first testing day.
    (2) Assignment for the first testing day. The employees taken into 
account under a provision described in paragraph (a)(2) of this section 
with respect to the first testing day for a testing

[[Page 979]]

year are assigned among the employer's qualified separate lines of 
business by applying the following procedure to each of those 
employees--
    (i) An employee who is a substantial-service employee with respect 
to a qualified separate line of business within the meaning of Sec. 
414(r)-11(b)(2) must be assigned to that qualified separate line of 
business;
    (ii) An employee who is a residual shared employee within the 
meaning of Sec. 414(r)-11(b)(4) must be assigned to a qualified 
separate line of business under paragraph (c) of this section.

Each employee assigned to a qualified separate line of business under 
paragraph (b)(2)(i) of this section or this paragraph (b)(2)(ii) remains 
assigned to the same qualified separate line of business for all 
purposes with respect to the testing year listed in paragraph (a)(2) of 
this section and for all plan years beginning in that testing year. Once 
an employee is assigned to a qualified separate line of business with 
respect to a particular testing day or section 401(a)(26) testing day, 
that employee remains assigned to that qualified separate line of 
business after the employee terminates employment. However, after the 
employee terminates employment, that employee will in most cases not be 
taken into account with respect to a subsequent testing day or section 
401(a)(26) testing day for purposes of applying one or more of the 
provisions in paragraph (a)(2) of this section.
    (3) Assignment of new employees for subsequent testing days. After 
the first testing day for the testing year, the employees taken into 
account under a provision described in paragraph (a)(2) of this section 
with respect to a subsequent testing day (or a section 401(a)(26) 
testing day) for the testing year may include one or more employees who 
previously have not been assigned to a qualified separate line of 
business for any purpose listed in paragraph (a)(2) of this section with 
respect to the testing year. An employee may not previously have been 
assigned to a qualified separate line of business for any purpose with 
respect to the testing year if, for example, the employee has just been 
hired or has just become a nonexcludable employee. Previously unassigned 
employees are assigned among the employer's qualified separate lines of 
business by applying the procedure in paragraph (b)(2) of this section 
to those employees. In determining whether an employee who is not 
employed by the employer during the testing year is a substantial-
service or a residual shared employee with respect to a qualified 
separate line of business, Sec. 414(r)-3(c)(5) is applied with 
reference to services performed by the employee during a period in the 
immediately succeeding testing year that are reasonably representative 
of the employee's services for the employer.
    (4) Special rule for employers using annual option under section 
410(b). Notwithstanding the fact that paragraphs (b)(1) through (b)(3) 
of this section generally only require employees to be assigned on 
testing days beginning with the first testing day, if a plan is tested 
under section 410(b) using the annual option of Sec. 410(b)-8(a)(4) 
(including for purposes of the average benefit percentage test), 
employees must be assigned on every day of the plan year of that plan 
for purposes of this paragraph (b). Thus, all employees who provide 
services at any time during the plan year of a plan that is tested using 
the annual option of Sec. 1.410(b)-8(a)(4) must be assigned to a line 
of business even if they terminate employment before the first testing 
day within the meaning of Sec. 414(r)-11(b)(7) of the testing year in 
which the plan year begins.
    (c) Assignment and allocation of residual shared employees--(1) In 
general. All residual shared employees must be allocated among an 
employer's qualified separate lines of business under one of the 
allocation methods provided in paragraphs (c)(2) through (5) of this 
section. An employer is permitted to select which method of allocation 
to apply for the testing year to residual shared employees. However, the 
same allocation method must be used for all of the employer's residual 
shared employees and for all purposes listed in paragraph (a)(2) of this 
section with respect to the testing year.
    (2) Dominant line of business method of allocation--(i) In general. 
Under the method of allocation in this paragraph (c)(2), all residual 
shared employees are allocated to the employer's dominant

[[Page 980]]

line of business. This method does not apply unless the employer has a 
dominant line of business within the meaning of paragraph (c)(2)(ii) or 
(c)(2)(iv) of this section. If an employer has more than one dominant 
line of business under this paragraph (c), the employer must select 
which qualified separate lines of business is its dominant line of 
business.
    (ii) Dominant line of business. An employer's dominant line of 
business is that qualified separate line of business that has an 
employee assignment percentage of at least 50 percent.
    (iii) Employee assignment percentage--(A) Determination of 
percentage. The employee assignment percentage of a qualified separate 
line of business is the fraction (expressed as a percentage)--
    (1) The numerator of which is the number of substantial-service 
employees with respect to the qualified separate line of business who 
are assigned to that line of business under paragraph (b) of this 
section; and
    (2) The denominator of which is the total number of substantial-
service employees who are assigned to all qualified separate lines of 
business of the employer under paragraph (b) of this section.
    (B) Employees taken into account. The employee assignment percentage 
is calculated solely with respect to employees who are taken into 
account for purposes of satisfying section 410(b) with respect to the 
first testing day. Therefore, this percentage is calculated only once 
for all purposes with respect to a testing year. The employees described 
in section 410(b)(3) and (4) are excluded. However, section 410(b)(4) is 
applied with reference to the lowest minimum age requirement applicable 
under any plan of the employer, and with reference to the lowest service 
requirement applicable under any plan of the employer, as if all the 
plans were a single plan under Sec. 1.410(b)-6(b)(2).
    (iv) Option to apply reduced percentage. An employer is permitted to 
determine whether it has a dominant line of business by substituting 25 
percent for 50 percent in paragraph (c)(2)(ii) of this section. This 
option is available for a testing year only if the qualified separate 
line of business satisfies one of the following requirements:
    (A) The qualified separate line of business accounts for at least 60 
percent of the employer's gross revenues for the employer's latest 
fiscal year ending in the testing year.
    (B) The employee assignment percentage of the qualified separate 
line of business would be at least 60 percent if collectively bargained 
employees were taken into account.
    (C) Each qualified separate line of business of the employer 
satisfies the statutory safe harbor of Sec. 1.414(r)-5(b), the average 
benefits safe harbor of Sec. 1.414(r)-5(f), or the minimum or maximum 
benefits safe harbor of Sec. 1.414(r)-5(g). Whether a qualified 
separate line of business satisfies one of these safe harbors is 
determined after the application of this section, including the 
assignment of all residual shared employees under this paragraph (c)(2).
    (D) The employee assignment percentage of the qualified separate 
line of business is at least twice the employee assignment percentages 
of each of the employer's other qualified separate lines of business.
    (v) Examples. The following examples illustrate the application of 
the method of allocation in this paragraph (c)(2).

    Example 1. (i) Employer A operates four qualified separate lines of 
business as determined under Sec. 1.414(r)-1(b) for the testing year, 
consisting of a software developer, a health food products supplier, a 
real estate developer, and a ski equipment manufacturer. In applying 
this section for the first testing day with respect to the testing year, 
Employer A determines that it has a total of 21,000 employees, of whom 
10,000 are substantial-service employees not excludable under section 
410(b)(3) or (b)(4). Pursuant to paragraph (b) of this section, these 
10,000 employees are assigned among Employer A's qualified separate 
lines of business as follows:

----------------------------------------------------------------------------------------------------------------
                                                                Software                                 Ski
                                                               developer   Health food  Real estate   equipment
----------------------------------------------------------------------------------------------------------------
Substantial-Service Employees...............................        2,500        1,000        2,500        4,000
Percentage Assigned to QSLOB................................          25%          10%          25%          40%
----------------------------------------------------------------------------------------------------------------


[[Page 981]]

    (ii) Under these facts, Employer A is not permitted to apply the 
method of allocation in paragraph (c)(2)(ii) of this section, because 
none of its qualified separate lines of business satisfies the 50 
percent requirement in paragraph (c)(3)(ii) of this section.
    Example 2. The facts are the same as in Example 1, except that, 
after allocating all residual shared employees to the ski equipment line 
of business, the software, ski equipment and health food supplier lines 
of business each would satisfy the statutory safe harbor of Sec. 
1.414(r)-5(b), and that the real estate development line of business 
would satisfy the minimum or maximum benefits safe harbor of Sec. 
1.414(r)-5(g). Under these facts, Employer A is permitted to apply the 
method of allocation in this paragraph (c)(2) to allocate all its 
residual shared employees to the ski equipment line of business, because 
the employee assignment percentage of the ski equipment line of business 
exceeds 25 percent and each qualified separate line of business 
satisfies either the statutory safe harbor of Sec. 1.414(r)-5(b) or the 
minimum or maximum benefits safe harbor of Sec. 1.414(r)-5(g).
    Example 3. (i) The facts are the same as in Example 1, except that, 
Employer A chooses not to satisfy the minimum or maximum benefits safe 
harbor of Sec. 1.414(r)-5(g). Instead, Employer A combines the real 
estate developer and ski equipment manufacturer into a single line of 
business. As a result, Employer A has three qualified separate lines of 
business as determined under Sec. 1.414(r)-1(b). Assume that no 
residual shared employee becomes a substantial-service employee as a 
result of the new combination. Employer A's substantial-service 
employees are assigned among Employer A's qualified separate lines of 
business as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                                    Real estate/
                                                                          Software     Health food       ski
                                                                          developer                   equipment
----------------------------------------------------------------------------------------------------------------
Substantial-Service Employees.........................................         2,500         1,000         6,500
Percentage Assigned to QSLOB..........................................           25%           10%           65%
----------------------------------------------------------------------------------------------------------------

    (ii) Under these facts, Employer A is permitted to apply the method 
of allocation in this paragraph (c)(2) to allocate all its residual 
shared employees to the combined real estate development and ski 
equipment manufacturing line of business, because more than 50 percent 
of Employer A's substantial-service employees that are taken into 
account for the first testing day are assigned to that qualified 
separate line of business.
    Example 4. (i) The facts are the same as in Example 1, except that, 
of the remaining 11,000 employees of Employer A, 10,000 employees are 
substantial-service employees who are collectively bargained employees. 
Pursuant to paragraph (b) of this section, the 10,000 substantial-
service employees and the 10,000 substantial-service employees who are 
collectively bargained employees are assigned among Employer A's 
qualified separate lines of business as follows:

----------------------------------------------------------------------------------------------------------------
                                                            Software                                     Ski
                                                            developer    Health food   Real estate    equipment
----------------------------------------------------------------------------------------------------------------
Substantial-Service Employees...........................         2,500         1,000         2,500         4,000
Percentage of total substantial-service employees                  25%           10%           25%           40%
 assigned to QSLOB......................................
Substantial-Service Employees (including collectively            2,500         1,000         2,500        14,000
 bargained employees)...................................
Percentage of total employees (including collectively            12.5%            5%         12.5%           70%
 bargained employees) assigned to QSLOB.................
----------------------------------------------------------------------------------------------------------------

    (ii) Thus, the ski equipment line of business satisfies the 25-
percent threshold in paragraph (c)(2)(iv) of this section. In addition, 
the ski equipment's percentage of substantial-service employees is at 
least 60 percent when taking into account substantial-service employees 
who are collectively bargained employees and therefore satisfies the 
requirement under paragraph (c)(2)(iv)(B) of this section. Under these 
facts, Employer A is permitted to apply the method of allocation in this 
paragraph (c)(2) to allocate all its residual shared employees to the 
ski equipment line of business.

    (3) Pro-rata method of allocation--(i) In general. Under the method 
of allocation in this paragraph (c)(3), all residual shared employees 
are allocated among an employer's qualified separate lines of business 
in proportion to the employee assignment percentage of each qualified 
separate line of business, as determined under paragraph (c)(2)(iii) of 
this section.

[[Page 982]]

    (ii) Allocation procedure. The procedure for allocating residual 
shared employees under the method in this paragraph (c)(3) is as 
follows--
    (A) The number of highly compensated residual shared employees who 
are allocated to each qualified separate line of business is equal to 
the product determined by multiplying the total number of highly 
compensated residual shared employees of the employer by the employee 
assignment percentage determined with respect to the qualified separate 
line of business under paragraph (c)(3)(i) of this section;
    (B) The number of nonhighly compensated residual shared employees 
who are allocated to each qualified separate line of business is equal 
to the product determined by multiplying the total number of nonhighly 
compensated residual shared employees of the employer by the employee 
assignment percentage determined with respect to the qualified separate 
line of business under paragraph (c)(3)(i) of this section;
    (C) For purposes of this procedure, the employer is permitted to 
determine which highly compensated residual shares employees and which 
nonhighly compensated residual shared employees are allocated to each 
qualified separate line of business, provided that the required number 
of highly and nonhighly compensated residual shared employees are 
allocated to each qualified separate line of business.
    (iii) Examples. The following example illustrates the application of 
the method of allocation in this paragraph (c)(4).

    Example 1. The facts that are the same as in Example 1 under 
paragraph (c)(2)(v) of this section except that there are no additional 
residual shared employees after the first testing day. Of Employer A's 
1,000 residual shared employees, 800 are highly compensated employees 
and 200 are nonhighly compensated employees. Employer A applies the pro-
rata method of allocation in this paragraph (c)(3). Under these facts, 
the 1,000 residual shared employees are allocated among Employer A's 
qualified separate lines of business as follows:

----------------------------------------------------------------------------------------------------------------
                                                     Software
                                                     developer      Health food     Real estate    Ski equipment
----------------------------------------------------------------------------------------------------------------
Substantial-Service Employees...................           2,500           1,000           2,500           4,000
Percentage Assigned to QSLOB (``employee                     25%             10%             25%             40%
 assignment percentage'').......................
Residual Shared HCEs............................             200              80             200             320
Allocated to QSLOB..............................       (25%X800)       (10%X800)       (25%X800)       (40%X200)
Residual Shared NHCEs...........................              50              20              50              80
Allocated to QSLOB..............................       (25%X200)       (10%X200)       (25%X200)       (40%X200)
----------------------------------------------------------------------------------------------------------------

    (4) HCE percentage ratio method of allocation--(i) In general. Under 
the method of allocation in this paragraph (c)(4), all residual shared 
employees are allocated among an employer's qualified separate lines of 
business according to the highly compensated employee percentage 
assignment ratio of each qualified separate line of business.
    (ii) Highly compensated employee percentage assignment ratio. For 
purposes of this paragraph (c)(4), the highly compensated employee 
percentage assignment ratio of a qualified separate line of business is 
the fraction expressed as a percentage)--
    (A) The numerator of which is the percentage of all employees who 
have previously been assigned to the qualified separate line of business 
under this section with respect to the testing year who are highly 
compensated employees; and
    (B) The denominator of which is the percentage of all employees who 
have previously been assigned to any qualified separate line of business 
under this section with respect to the testing year who are highly 
compensated employees.

Thus, the highly compensated employee percentage assignment ratio of 
each of the employer's qualified separate lines of business is 
recalculated each time a residual shared employee is allocated to a 
qualified separate line of business under this paragraph (c)(5).
    (iii) Allocation procedure. The procedure for allocating all 
residual shared

[[Page 983]]

employees under the method in this paragraph (c)(4) is as follows--
    (A) If there are any qualified separate lines of business with a 
highly compensated employee percentage assignment ratio of less than 50 
percent (as determined immediately before the employee is allocated to a 
qualified separate line of business), the highly compensated residual 
shared employee must be allocated to one of these qualified separate 
lines of business;
    (B) If there are any qualified separate lines of business with a 
highly compensated employee percentage assignment ratio of greater than 
200 percent (as determined immediately before the employee is allocated 
to a qualified separate line of business), the nonhighly compensated 
residual shared employee must be allocated to one of these qualified 
separate lines of business;
    (C) If there are no qualified separate lines of business with a 
highly compensated employee percentage assignment ratio less than 50 
percent, a highly compensated residual shared employee may be allocated 
to any qualified separate line of business with a highly compensated 
employee percentage assignment ratio of no more than 200 percent, 
provided that the employee's allocation to the qualified separate line 
of business does not cause its highly compensated employee percentage 
assignment ratio to exceed 200 percent (as determined immediately after 
the employee is allocated to the qualified separate line of business);
    (D) If there are no qualified separate lines of business with a 
highly compensated employee percentage assignment ratio greater than 200 
percent, a nonhighly compensated residual shared employee may be 
allocated to any qualified separate line of business with a highly 
compensated employee percentage assignment ratio of no less than 50 
percent, provided that the employee's allocation to the qualified 
separate line of business does not cause its highly compensated employee 
percentage assignment ratio to fall below 50 percent (as determined 
immediately after the employee is allocated to the qualified separate 
line of business);
    (E) For purposes of this procedure, the employer is permitted to 
determine which highly compensated residual shared employees and which 
nonhighly compensated residual shared employees are allocated to each 
qualified separate line of business, provided that the requirements of 
this paragraph (c)(4)(iii) are satisfied.
    (5) Small group method--(i) In general. Under the method of 
allocation provided for in this paragraph (c)(5), each residual shared 
employee is allocated to a qualified separate line of business chosen by 
the employer. This method does not apply unless all of the requirements 
of paragraphs (c)(5)(ii), (iii), and (iv) of this section are satisfied.
    (ii) Size of group. The total number of the employer's residual 
shared employees allocated under this paragraph (c) must not exceed 
three percent of all of the employer's employees. For this purpose, the 
employer's employees include only those employees taken into account 
under paragraph (c)(2)(iii)(B) of this section.
    (iii) Composition of qualified separate line of business. The 
qualified separate line of business to which the residual shared 
employee is allocated must have an employee assignment percentage under 
paragraph (c)(2)(iii) of this section of at least ten percent. In 
addition, the qualified separate line of business to which the residual 
shared employee is allocated must satisfy the statutory safe harbor 
under Sec. 1.414(r)-5(b) after the employee is so allocated.
    (iv) Reasonable allocation. The allocation of residual shared 
employees under the small group method provided for in this paragraph 
(c)(5) must be reasonable. Reasonable allocations generally include 
allocations that are based on the level of services that the residual 
shared employees provide to the employer's qualified separate lines of 
business, the similar treatment of similarly situated residual shared 
employees, and other bona fide business criteria; in contrast, an 
allocation that is designed to maximize benefits for select employees is 
not considered a reasonable allocation. For example, allocation of all 
residual shared employees who work in the same department, or at the 
same location, to the same qualified separate line of business would be 
an indication of reasonableness. However, allocation of a group of

[[Page 984]]

similarly situated residual shared employees to a qualified separate 
line of business for which they provide minimal services might not be 
considered reasonable. In addition, the allocation of the professional 
employees of a department to one qualified separate line of business and 
the allocation of the support staff of the same department to a 
different qualified separate line of business would not be reasonable.

[T.D. 8376, 56 FR 63453, Dec. 4, 1991, as amended by T.D. 8548, 59 FR 
32920, June 27, 1994]



Sec. 1.414(r)-8  Separate application of section 410(b).

    (a) General rule. If an employer is treated as operating qualified 
separate lines of business for purposes of section 410(b) in accordance 
with Sec. 1.414(r)-1(b) for a testing year, the requirements of section 
410(b) must be applied in accordance with this section separately with 
respect to the employees of each qualified separate line of business for 
purposes of testing all plans of the employer for plan years that begin 
in the testing year (other than a plan tested under the special rule for 
employer-wide plans in Sec. 1.414(r)-(c)(2)(ii) for such a plan year). 
Conversely, if an employer is not treated as operating qualified 
separate lines of business for purposes of section 410(b) in accordance 
with Sec. 1.414(r)-1(b) for a testing year, the requirements of section 
410(b) must be applied on an employer-wide basis for purposes of testing 
all plans of the employer for plan years that begin in the testing year. 
See Sec. 1.414(r)-1(c)(2) and (d)(6). Paragraph (b) of this section 
explains how the requirements of section 410(b) are applied separately 
with respect to the employees of a qualified separate line of business 
for purposes of testing a plan. Paragraph (c) of this section explains 
the coordination between sections 410(b) and 401(a)(4). Paragraph (d) of 
this section provides certain supplementary rules necessary for the 
application of this section.
    (b) Rules of separate application--(1) In general. If the 
requirements of section 410(b) are applied separately with respect to 
the employees of each qualified separate line of business operated by 
the employer for a testing year, a plan (other than a plan that is 
tested under the special rule for employer-wide plans in Sec. 1.414(r)-
1(c)(2)(ii) for a plan year) satisfies the requirements of section 
410(b) only if--
    (i) The plan satisfies section 410(b)(5)(B) of an employer-wide 
basis; and
    (ii) The plan satisfies section 410(b) on a qualified-separate-line-
of-business basis.
    (2) Satisfaction of section 410(b)(5)(B) on an employer-wide basis--
(i) General rule. Section 410(b)(5)(B) provides that a plan is not 
permitted to be tested separately with respect to the employees of a 
qualified separate line of business unless the plan benefits a 
classification of employees found by the Secretary to be 
nondiscriminatory. A plan satisfies this requirement only if the plan 
satisfies either the ratio percentage test of Sec. 1.410(b)-2(b)(2) or 
the nondiscriminatory classification test of Sec. 1.410(b)-4 (without 
regard to the average benefit percentage test of Sec. 1.410(b)-5), 
taking into account the other applicable provisions of Sec. Sec. 
1.410(b)-1 through 1.410(b)-10. For this purpose, the nonexcludable 
employees of the employer taken into account in testing the plan under 
section 410(b) are determined under Sec. 1.410(b)-6, without regard to 
the exclusion in Sec. 1.410(b)-6(e) for employees of other qualified 
separate lines of business of the employer. Thus, in testing a plan 
separately with respect to the employees of one qualified separate line 
of business under this paragraph (b)(2), the otherwise nonexcludable 
employees of the employer's other qualified separate lines of business 
are not treated as excludable employees. However, under the definition 
of ``plan'' in paragraph (d)(2) of this section, these employees are not 
treated as benefiting under the plan for purposes of applying this 
paragraph (b)(2).
    (ii) Application of facts and circumstances requirements under 
nondiscriminatory classification test. The fact that an employer has 
satisfied the qualified-separate-line-of-business requirements in 
Sec. Sec. 1.414(r)-1 through 1.414(r)-7 is taken into account in 
determining whether a classification of employees benefiting under a 
plan that falls between the safe and unsafe harbors satisfies Sec. 
1.410(b)-4(c)(3) (facts and circumstances requirements). Except

[[Page 985]]

in unusual circumstances, this fact will be determinative.
    (iii) Modification of unsafe harbor percentage for plans satisfying 
ratio percentage test at 90 percent level--(A) General rule. If a plan 
benefits a group of employees for a plan year that would satisfy the 
ratio percentage test of Sec. 1.410(b)-2(b)(2) on a qualified-separate-
line-of-business basis under paragraph (b)(3) of this section if the 
percentage in Sec. 1.410(b)-2(b)(2) were increased to 90 percent, the 
unsafe harbor percentage in Sec. 1.410(b)-4(c)(4)(ii) for the plan is 
reduced by five percentage points (not five percent) for the plan year 
and is applied without regard to the requirement that the unsafe harbor 
percentage not be less than 20 percent. Thus, if the requirements of 
this paragraph (b)(2)(iii)(A) are satisfied, the unsafe harbor 
percentage in Sec. 1.410(b)-4(c)(4)(ii) is treated as 35 percent, 
reduced by \3/4\ of a percentage point for each whole percentage point 
by which the nonhighly compensated employee concentration percentage 
exceeds 60 percent.
    (B) Facts and circumstances alternative. If a plan satisfies the 
requirements of paragraph (b)(2)(iii)(A) of this section, but has a 
ratio percentage on an employer-wide basis that falls below the unsafe 
harbor percentage determined under paragraph (b)(2)(iii)(A) of this 
section, the plan nonetheless is deemed to satisfy section 410(b)(5)(B) 
on an employer-wide basis if the Commissioner determines that, on the 
basis of all of the relevant facts and circumstances, the plan benefits 
such employees as qualify under a classification of employees that does 
not discriminate in favor of highly compensated employees.
    (3) Satisfaction of section 410(b) on a qualified-separate-line-of-
business basis. A plan satisfies section 410(b) on a qualified-separate-
line-of-business basis only if the plan satisfies either the ratio 
percentage test of Sec. 1.410(b)-2(b)(2) or the average benefit test of 
Sec. 1.410(b)-2(b)(3) (including the nondiscriminatory classification 
test of Sec. 1.410(b)-4 and the average benefit percentage test of 
Sec. 1.410(b)-5), taking into account the other applicable provisions 
of Sec. Sec. 1.410(b)-1 through 1.410(b)-10. For this purpose, the non-
excludable employees of the employer taken into account in testing the 
plan under section 40(b) are determined under Sec. 1.410(b)-6, taking 
into account the exclusion in Sec. 1.410(b)-6(e) for employees of other 
qualified separate lines of business of the employer. Thus, in testing a 
plan separately with respect to the employees of one qualified separate 
line of business under this paragraph (b)(3), all employees of the 
employer's other qualified separate lines of business are treated as 
excludable employees.
    (4) Examples. The following examples illustrate the application of 
this paragraph (b).

    Example 1. (i) Employer A is treated as operating qualified separate 
lines of business for purposes of section 410(b) in accordance with 
Sec. 1.414(r)-1(b) for the 1994 testing year with respect to all of its 
plans. Employer A operates two qualified separate lines of business as 
determined under Sec. 1.414(r)-1(b)(2), Line 1 and Line 2. Employer A 
maintains only two plans, Plan X which benefits solely employees of Line 
1, and Plan Y which benefits solely employees of Line 2. In testing Plan 
X under section 410(b) with respect to the first testing day for the 
plan year of Plan X beginning in the 1994 testing year, it is determined 
that Employer A has 2,100 nonexcludable employees, of whom 100 are 
highly compensated employees and 2,000 are nonhighly compensated 
employees. After applying Sec. 1.414(r)-7 to these employees, 50 of the 
highly compensated employees and 100 of the nonhighly compensated 
employees are treated as employees of Line 2, and the remaining 50 
highly compensated employees and the remaining 1,900 nonhighly 
compensated employees are treated as employees of Line 1.
    (ii) All of the highly compensated employees and 1,300 of the 
nonhighly compensated employees who are treated as employees of Line 1 
benefit under Plan X. Thus, on an employer-wide basis, Plan X benefits 
50 percent of all Employer A's highly compensated employees (50 out of 
100) and 65 percent of all Employer A's nonhighly compensated employees 
(1,300 out of 2,000). Plan X consequently has a ratio percentage 
determined on an employer-wide basis of 130 percent (65%/50%), see Sec. 
1.410(b)-9, and could satisfy section 410(b) under the ratio percentage 
test of Sec. 1.410(b)-2(b)(2) if that section were applied on an 
employer-wide basis without regard to the provisions of this paragraph 
(b). Under paragraph (a) of this section, however, the requirements of 
section 410(b) must be applied separately with respect to the employees 
of each qualified separate line of business operated by Employer A for 
all plans of Employer A for plan years that begin in the 1994 testing 
year. This rule does

[[Page 986]]

not apply to plans tested under the special rule for employer-wide plans 
in Sec. 1.414(r)-1(c)(2)(ii). Plan X benefits only 65 percent of the 
nonhighly compensated employees of Employer A, however, and therefore 
cannot satisfy the 70 percent requirement necessary to be tested under 
that rule. As a result, for the plan year of Plan X beginning in the 
1994 testing year, Plan X is not permitted to satisfy section 410(b) on 
an employer-wide basis and, instead, is only permitted to satisfy 
section 410(b) separately with respect to the employees of each 
qualified separate line of business operated by Employer A, in 
accordance with paragraphs (b)(2) and (b)(3) of this section.
    Example 2. The facts are the same as in Example 1. All of the 50 
highly compensated employees treated as employees of Line 2 benefit 
under Plan Y, and 80 of the 100 nonhighly compensated employees treated 
as employees of Line 2 benefit under Plan Y. Thus, Plan Y benefits 50 
percent of all Employer A's highly compensated employees (50 out of 100) 
and only 4 percent of all Employer A's nonhighly compensated employees 
(80 out of 2,000). Thus, while Plan Y has a ratio percentage of 80 
percent (80%/100%) on a qualified-separate-line-of-business basis, it 
has a ratio percentage of only 8 percent (4%/50%) on an employer-wide 
basis. See Sec. 1.410(b)-9. Under Sec. 1.410(b)-4(c)(4)(iii), the 
nonhighly compensated employee concentration percentage is 2,000/2,100 
or 95 percent. Because 8 percent is less than 20 percent (the unsafe 
harbor percentage applicable to Employer A under Sec. 1.410(b)-
4(c)(4)(ii)), Plan Y does not satisfy the nondiscriminatory 
classification test of Sec. 1.410(b)-4 on an employer-wide basis. Nor 
does Plan Y satisfy the ratio percentage test of Sec. 1.410(b)-2(b)(2) 
on an employer-wide basis, since 8 percent is less than 70 percent. 
Under these facts, Plan Y does not satisfy section 410(b)(5)(B) on an 
employer-wide basis in accordance with paragraph (b)(2) of this section 
for the plan year of Plan Y beginning in the 1994 testing year, and 
therefore fails to satisfy section 410(b) for that year. This is true 
even though Plan Y satisfies section 410(b) on a qualified-separate-
line-of-business basis in accordance with paragraph (b)(3) of this 
section.
    Example 3. The facts are the same as in Example 2, except that all 
of the employees treated as employees of Line 2 benefit under Plan Y. 
Thus, Plan Y benefits 50 percent of all of Employer A's highly 
compensated employees (50 out of 100) and 5 percent of all of Employer 
A's nonhighly compensated employees (100 out of 2,000). Plan Y therefore 
has a ratio percentage of 100 percent (100%/100%) on a qualified-
separate-line-of-business basis and a ratio percentage of 10 percent 
(5%/50%) on an employer-wide basis. Because Plan Y has a ratio 
percentage of at least 90 percent on a qualified-separate-line-of-
business basis, a reduced unsafe harbor percentage applies to Plan Y 
under paragraph (b)(2)(iii)(A) of this section. The reduced unsafe 
harbor percentage applicable to Plan Y is 8.75 percent because Employer 
A's nonhighly compensated employee concentration percentage is 95 
percent. Plan Y's employer-wide ratio percentage of 10 percent therefore 
exceeds the unsafe harbor percentage. Plan Y thus satisfies section 
410(b)(5)(B) on an employer-wide basis in accordance with paragraph 
(b)(2) of this section for the plan year of Plan Y beginning in the 1994 
testing year. Plan Y also satisfies section 410(b) on a qualified-
separate-line-of-business basis in accordance with paragraph (b)(3) of 
this section.
    Example 4. The facts are the same as in Example 3, except that 
Employer A's total nonexcludable nonhighly compensated employees are 
2,500 (rather than 2,000), of whom 100 are treated as employees of Line 
2 and of whom 90 benefit under Plan Y. Plan Y has a ratio percentage of 
90 percent (90%/100%) on a qualified-separate-line-of-business basis, 
and Employer A's nonhighly compensated employee concentration percentage 
is 2,500/2,600 or 96 percent. Thus, the reduced unsafe harbor percentage 
applicable to Plan Y under paragraph (b)(2)(iii)(A) of this section is 8 
percent. Plan Y benefits 50 percent of all of Employer A's highly 
compensated employees (50 out of 100) and 3.6 percent of all of Employer 
A's nonhighly compensated employees (90 out of 2,500). Plan Y therefore 
has a ratio percentage of only 7.2 percent (3.6%/50%) on an employer-
wide basis, which falls below the reduced unsafe harbor percentage of 8 
percent. Nonetheless, under paragraph (b)(2)(iii)(B) of this section, 
Plan Y will be deemed to satisfy section 410(b)(5)(B) on an employer-
wide basis if the Commissioner determines that, on the basis of all of 
the relevant facts and circumstances, the plan benefits such employees 
as qualify under a classification of employees that does not 
discriminate in favor of highly compensated employees.
    Example 5. (i) The facts are the same as in Example 1, except that 
Plan X benefits only 950 of the employees of Line 1. Assume Plan X 
satisfies the reasonable classification requirement of Sec. 1.410(b)-
4(b) on an employer-wide basis. Plan X benefits 50 percent of all 
Employer A's highly compensated employees (50 out 100) and 47.5 percent 
of all Employer A's nonhighly compensated employees (950 out of 2,000). 
Plan X consequently has a ratio percentage determined on an employer-
wide basis of 95 percent (47.5%/50%), see Sec. 1.410(b)-9, and thus 
satisfies section 410(b)(5)(B) on an employer-wide basis.
    (ii) Plan X has a ratio percentage determined on a qualified-
separate-line-of-business basis of 50 percent (50% / 100%). Because 50 
percent is less than 70 percent, Plan X must satisfy the 
nondiscriminatory classification test of Sec. 1.410(b)-4 and the 
average

[[Page 987]]

benefit percentage test of Sec. 1.410(b)-5 on a qualified-separate-
line-of-business basis in order to satisfy the other requirements of 
section 410(b). Plan X satisfies the nondiscriminatory classification 
requirement of Sec. 1.410(b)-4(c) on a qualified-separate-line-of-
business because its ratio percentage determined on a qualified-
separate-line-of-business basis is more than 22.25 percent, the safe 
harbor percentage applicable to Line 1 under Sec. 1.410(b)-4(c)(4)(i). 
Because Plan X satisfies the reasonable classification requirement of 
Sec. 1.410(b)-4(b) on an employer-wide basis, it is also deemed to 
satisfy this requirement on a qualified-separate-line-of-business basis. 
See Sec. 1.410(b)-7(c)(5). In determining whether Plan X satisfies the 
average benefit percentage test of Sec. 1.410(b)-5, only Plan X and 
only employees of Line 1 are taken into account. See Sec. Sec. 
1.410(b)-6(e) and 1.410(b)-7(e).
    Example 6. The facts are the same as in Example 2, except that, 
prior to the 1994 testing year, Employer A merges Plan X and Plan Y so 
that they form a single plan within the meaning of section 414(l). Under 
the definition of ``plan'' in paragraph (d)(2) of this section, however, 
the portion of the newly merged plan that benefits employees of Line 2 
(former Plan Y) is still treated as a separate plan from the portion of 
the newly merged plan that benefits employees of Line 1 (former Plan X). 
The portion of the newly merged plan that benefits employees of Line 2 
(former Plan Y) fails to satisfy section 410(b) for the reasons stated 
in Example 2. Under these facts, because the portion of the newly merged 
plan that benefits employees of Line 2 fails to satisfy section 410(b), 
the entire newly merged plan fails to satisfy section 410(b) for the 
plan year of the newly merged plan that begins in the 1994 testing year. 
See paragraph (d)(5) of this section.

    (c) Coordination of section 401(a)(4) with section 410(b)--(1) 
General rule. For purposes of these regulations, the requirements of 
section 410(b) encompass the requirements of section 401(a)(4) 
(including, but not limited to, the permitted disparity rules of section 
401(l), the actual deferral percentage test of section 401(k)(3), and 
the actual contribution percentage test of section 401(m)(2)). 
Therefore, if the requirements of section 410(b) are applied separately 
with respect to the employees of each qualified separate line of 
business of an employer for purposes of testing one or more plans of the 
employer for plan years that begin in a testing year, the requirements 
of section 401(a)(4) must also be applied separately with respect to the 
employees of the same qualified separate lines of business for purposes 
of testing the same plans for the same plan years. Furthermore, if 
section 401(a)(4) requires that a group of employees under the plan 
satisfy section 410(b) for purposes of satisfying section 401(a)(4), 
section 410(b) must be applied for this purpose in the same manner 
provided in paragraph (b) of this section. See, for example, Sec. Sec. 
1.401(a)(4)-2(c)(1) and 1.401(a)(4)-3(c)(1) (requiring each rate group 
of employees under a plan to satisfy section 410(b)), Sec. 1.401(a)(4)-
4(b) (requiring the group of employees to whom each benefit, right, or 
feature is currently available under a plan to satisfy section 410(b)), 
and Sec. 1.401(a)(4)-9(c)(1) (requiring the group of employees included 
in each component plan into which a plan is restructured to satisfy 
section 410(b)). Thus, the group of employees must satisfy section 
410(b)(5)(B) on an employer-wide basis in accordance with paragraph 
(b)(2) of this section and also must satisfy section 410(b) on a 
qualified-separate-line-of-business basis in accordance with paragraph 
(b)(3) of this section, in both cases as if the group of employees were 
the only employees benefiting under the plan.
    (2) Examples. The following examples illustrate the application of 
the rule in this paragraph (c).

    Example 1. Employer B is treated as operating qualified separate 
lines of business for purposes of section 410(b) in accordance with 
Sec. 1.414(r)-1(b) for the 1993 testing year. Employer B operates two 
qualified separate lines of business as determined under Sec. 1.414(r)-
1(b)(2), Line 1 and Line 2. Employer B maintains Plan Z, which benefits 
employees in both Line 1 and Line 2. Under the definition of ``plan'' in 
paragraph (d)(2) of this section, the portion of Plan Z that benefits 
employees of Line 1 is treated as a separate plan from the portion of 
Plan Z that benefits employees of Line 2. Under this paragraph (c), this 
result applies for purposes of both section 410(b) and section 
401(a)(4).
    Example 2. The facts are the same as in Example 1, except that Plan 
Z benefits solely employees of Line 1. In testing Plan Z under section 
401(a)(4) for the plan year of Plan Z beginning in the 1993 testing 
year, Employer B restructures Plan Z into several component plans 
(within the meaning of Sec. 1.401(a)(4)-9(c)). Under Sec. 1.401(a)(4)-
9(c)(1), each of these component plans is required to satisfy section 
410(b). This paragraph (c) requires that each of the component plans be

[[Page 988]]

tested separately with respect to the employees of each qualified 
separate line of business operated by Employer B. This testing must be 
done in accordance with paragraph (b) of this section. Consequently, 
each component plan must satisfy section 410(b)(5)(B) on an employer-
wide basis in accordance with paragraph (b)(2) of this section and must 
also satisfy section 410(b) on a qualified-separate-line-of-business 
basis in accordance with paragraph (b)(3) of this section.
    Example 3. The facts are the same as in Example 1, except that Plan 
Z is a profit-sharing plan, and contributions to Plan Z are made 
pursuant to cash or deferred arrangement in which all employees of 
Employer B are eligible to participate. Assume that, as a result, Plan Z 
satisfies the requirements to be tested under the special rule for 
employer-wide plans in Sec. 1.414(r)-1(c)(2)(ii). Under these facts, 
the requirements of sections 410(b), 401(a)(4) and 401(k), including the 
actual deferral percentage test of section 401(k)(3) and Sec. 1.401(k)-
1(b), would generally be required to be applied separately to the 
portions of Plan Z that benefit the employees of Line 1 and Line 2, 
respectively. However, if Plan Z is tested under the special rule in 
Sec. 1.414(r)-1(c)(2)(ii), these requirements must be applied on an 
employer-wide basis.

    (d) Supplementary rules--(1) In general. This paragraph (d) provides 
certain supplementary rules necessary for the application of this 
section.
    (2) Definition of plan. For purposes of this section, the term plan 
means a plan within the meaning of Sec. 1.410(b)-7(a) and (b), after 
application of the mandatory disaggregation rules of Sec. 1.410(b)-7(c) 
(including the mandatory disaggregation rule for portions of a plan that 
benefit employees of different qualified separate lines of business) and 
the permissive aggregation rules of Sec. 1.410(b)-7(d). Thus, for 
purposes of this section, the portion of a plan that benefits employees 
of one qualified separate line of business is treated as a separate plan 
from the other portions of the same plan that benefit employees of other 
qualified separate lines of business of the employer, unless the plan is 
tested under the special rule for employer-wide plans in Sec. 1.414(r)-
1(c)(2)(ii) for the plan year.
    (3) Employees of a qualified separate line of business. For purposes 
of applying paragraph (b) of this section with respect to a testing day, 
the employees of each qualified separate line of business of the 
employer are determined by applying Sec. 1.414(r)-7 to the employees of 
the employer otherwise taken into account under section 410(b) for the 
testing day. For purposes of applying paragraph (c) of this section with 
respect to a testing day, the employees of each qualified separate line 
of business of the employer are determined by applying Sec. 1.414(r)-7 
to the employees of the employer otherwise taken into account under 
section 410(a)(4) for the testing day. For the definition of testing 
day, see Sec. 1.414(r)-11(b)(6).
    (4) Consequences of failure. If a plan fails to satisfy either 
paragraph (b)(2), (b)(3), or (c)(1) of this section, the plan (and any 
plan of which it constitutes a portion) fails to satisfy section 401(a). 
However, this failure alone does not cause the employer to fail to be 
treated as operating qualified separate lines of business in accordance 
with Sec. 1.414(r)-1(b), unless the employer is relying on benefits 
provided under the plan to satisfy the minimum benefit portion of the 
safe harbor in Sec. 1.414(r)-5(g)(2) with respect to at least one of 
its qualified separate lines of business.

[T.D. 8376, 56 FR 63457, Dec. 4, 1991, as amended by T.D. 8376, 57 FR 
52591, Nov. 4, 1992; T.D. 8548, 59 FR 32921, June 27, 1994]



Sec. 1.414(r)-9  Separate application of section 401(a)(26).

    (a) General rule. If an employer is treated as operating qualified 
separate lines of business for purposes of section 401(a)(26) in 
accordance with Sec. 1.414(r)-1(b) for a testing year, the requirements 
of section 401(a)(26) must be applied separately with respect to the 
employees of each qualified separate line of business for purposes of 
testing all plans of the employer for plan years that begin in the 
testing year (other than a plan tested under the special rule for 
employer-wide plans in Sec. 1.414(r)-1(c)(3)(ii) for such a plan year). 
Conversely, if an employer is not treated as operating qualified 
separate lines of business for purposes of section 401(a)(26) in 
accordance with Sec. 1.414(r)-1(b) for a testing year, the requirements 
of section 401(a)(26) must be applied on an employer-wide basis for 
purposes of testing all plans of the employer for plan years that begin 
in the

[[Page 989]]

testing years. See Sec. 1414(r)-1(c)(3) and (d)(6). Paragraph (b) of 
this section explains how the requirements of section 401(a)(26) are 
applied separately with respect to the employees of a qualified separate 
line of business for purposes of testing a plan. Paragraph (c) of this 
section provides certain supplementary rules necessary for the 
application of this section.
    (b) Requirements applicable to a plan. If the requirements of 
section 401(a)(26) are applied separately with respect to the employees 
of a qualified separate line of business for a testing year, a plan 
(other than a plan that is tested under the special rule for employer-
wide plans in Sec. 1.414(r)-1(c)(3)(ii) for a plan year) satisfies 
section 401(a)(26) only if it satisfies the requirements of Sec. Sec. 
1.401(a)(26)-1 through 1.401(a)(26)-9 on a qualified-separate-line-of-
business basis. For this purpose, the nonexcludable employees of the 
employer taken into account in testing the plan under section 401(a)(26) 
are determined under Sec. 1.401(a)(26)-6(b), taking into account the 
exclusion in Sec. 1.401(a)(26)-6(b)(8) for employees of other qualified 
separate lines of business of the employer. Thus, in testing a plan 
separately with respect to the employees of one qualified separate line 
of business under this paragraph (b), all employees of the employer's 
other qualified separate lines of business are treated as excludable 
employees.
    (c) Supplementary rules--(1) In general. This paragraph (c) provides 
certain supplementary rules necessary for the application of this 
section.
    (2) Definition of plan. For purposes of this section, the term plan 
mean a plan within the meaning of Sec. 1.401(a)(26)-2(c) and (d), 
including the mandatory disaggregation rule of Sec. 1.401(a)(26)-
2(d)(6) for portions of a plan that benefit employees of different 
qualified separate lines of business. Thus, for purposes of this 
section, the portion of a plan that benefits employees of one qualified 
separate line of business is treated as a separate plan from the other 
portions of the same plan that benefit employees of other qualified 
separate lines of business of the employer, unless the plan is tested 
under the special rule for employer-wide plans in Sec. 1.414(r)-
1(c)(3)(ii) for the plan year.
    (3) Employees of a qualified separate line of business. For purposes 
of applying paragraph (b)(2) of this section with respect to a section 
401(a)(26) testing day, the employees of each qualified separate line of 
business of the employer are determined by applying Sec. 1.414(r)-7 to 
the employees of the employer otherwise taken into account under section 
401(a)(26) for the section 401(a)(26) testing day. For the definition of 
section 401(a)(26) testing day, see Sec. 1.414(r)-11(b)(8).
    (4) Consequences of failure. If a plan fails to satisfy paragraph 
(b)(2) of this section, the plan (and any plan of which it constitutes a 
portion) fails to satisfy section 401(a). However, this failure alone 
would not cause the employer to fail to be treated as operating 
qualified separate lines of business in accordance with Sec. 1.414(r)-
1(b), unless the employer is relying on benefits provided under the plan 
to satisfy the minimum benefit portion of the safe harbor in Sec. 
1.414(r)-5(g)(2) with respect to at least one of its qualified separate 
lines of business.

[T.D. 8376, 56 FR 63459, Dec. 4, 1991]



Sec. 1.414(r)-10  Separate application of section 129(d)(8). [Reserved]



Sec. 1.414(r)-11  Definitions and special rules.

    (a) In general. This section contains certain definitions and 
special rules applicable under these regulations. Paragraph (b) of this 
section provides certain definitions that apply for purposes of these 
regulations. Paragraph (c) of this section provides averaging rules 
under which certain provisions of these regulations may be applied on 
the basis of a two-year or a three-year average.
    (b) Definitions--(1) In general. In applying the provisions of this 
section and of Sec. Sec. 1.414(r)-1 through 1.414(r)-10, unless 
otherwise provided, the definitions in this paragraph (b) govern in 
addition to the definitions in Sec. 1.410(b)-9.

[[Page 990]]

    (2) Substantial-service employee. An employee is a substantial-
service employee with respect to a line of business for a testing year 
if at least 75 percent of the employee's services are provided to that 
line of business for that testing year within the meaning of Sec. 
1.414(r)-3(c)(5). In addition, if an employee provides at least 50% and 
less than 75% of the employee's services to a line of business for the 
testing year within the meaning of Sec. 1.414(r)-3(c)(5), the employer 
may treat that employee as a substantial-service employee with respect 
to that line of business provided the employee is so treated for all 
purposes of these regulations. The employer may choose such treatment 
separately with respect to each employee.
    (3) Top-paid employee. Generally, an employee is a top-paid employee 
with respect to a line of business for a testing year if the employee is 
among the top 10 percent by compensation of those employees who provide 
services to that line of business for that testing year within the 
meaning of Sec. 1.414(r)-3(c)(5) and who are not substantial-service 
employees within the meaning of paragraph (b)(2) of this section with 
respect to any other line of business. In addition, in determining the 
group of top-paid employees, the employer may choose to disregard all 
employees who provide less than 25 percent of their services to the line 
of business. For purposes of this paragraph (b)(3), an employee's 
compensation is the compensation used to determine the employee's status 
as a highly or nonhighly compensated employee under section 414(q) for 
purposes of applying section 410(b) with respect to the first testing 
day. For this purpose, only compensation received during the 
determination year (within the meaning of Sec. 1.414(q)-1T, Q&A-13) is 
taken into account. See Sec. 1.414(r)-3(c)(7) for examples of the 
determination of top-paid employee.
    (4) Residual shared employee. An employee is a residual shared 
employee for a testing year if the employee is not a substantial-service 
employee with respect to any line of business for the testing year.
    (5) Testing year. The term testing year means the calendar year.
    (6) Testing day. The term testing day means any day on which Sec. 
1.410(b)-8(a)(1) requires any plan (within the meaning of Sec. 
1.414(r)-8(d)(2)) of the employer actually to satisfy section 410(b) 
with respect to plan year that begins in the testing year. Thus, if a 
plan is required to satisfy section 410(b) on one day within each 
quarter of the plan year under the quarterly testing option of Sec. 
1.410(b)-8(a)(3), each of those four days is a testing day. Similarly, 
if a plan is required to satisfy section 410(b) on every day of the plan 
year under the daily testing option of Sec. 1.410(b)-8(a)(2), every day 
of the plan year is a testing day.
    (7) First testing day. The term first testing day means the testing 
day that occurs earliest in time of all the testing days under all plans 
of the employer with respect to the testing year. If a plan is tested 
under the annual testing option of Sec. 1.410(b)-8(a)(4) (other than 
for purposes of the average benefit percentage test of Sec. 1.410(b)-5) 
for a plan year that begins in a testing year, then, solely for purposes 
of determining the first testing day in a testing year, the employer may 
treat any day in the plan year as a testing day, provided that the 
coverage of each plan of the employer on the day selected is reasonably 
representative of the coverage of the plan over the entire plan year. 
The first testing day with respect to a testing year must fall within 
that testing year.
    (8) Section 401(a)(26) testing day. The term section 401(a)(26) 
testing day means any day on which Sec. 1.401(a)(26)-7(a) or (b) 
requires any plan of the employer actually to satisfy section 401(a)(26) 
with respect to a plan year that begins in the testing year. In no event 
may a section 401(a)(26) testing day with respect to a testing year fall 
before the first testing day for that testing year. For purposes of this 
paragraph (b)(8), the term plan has the same meaning as in Sec. 
1.414(r-9(c)(2).
    (c) Averaging rules--(1) In general. The provisions specified in 
this paragraph (c) are permitted to be applied based on the average of 
the percentages for the current testing year and the consecutive testing 
years (not to exceed four consecutive testing years) immediately 
preceding the current testing year.

[[Page 991]]

    (2) Specified provisions. The provisions specified in this paragraph 
(c) are--
    (i) The 90-percent separate employee workforce requirement of Sec. 
1.414(r)-3(b)(4);
    (ii) The 80-percent separate management requirement of Sec. 
1.414(r)-3(b)(5);
    (iii) The 25-percent provision-to-customers requirement of Sec. 
1.414(r)-3(d)(2)(iii);
    (iv) The minimum and maximum highly compensated employee percentage 
ratios under the statutory safe harbor of Sec. 1.414(r)-5(b)(1)(i) and 
(ii) (50 percent and 200 percent, respectively), but not the 10-percent 
exception in Sec. 1.414(r)-5(b)(4);
    (v) The employee assignment percentage applied for purposes of the 
dominant line of business method of allocating residual shared employees 
under Sec. 1.414(r)-7(c)(2) and the pro-rata method for allocating 
residual shared employees under Sec. 1.414(r)-7(c)(3).
    (3) Averaging of large fluctuations not permitted. A provision is 
not permitted to be applied based on an average determined under this 
paragraph (c) if the percentage for any testing year taken into account 
in calculating the average falls below a mimimum percentage, or exceeds 
a maximum percentage, by more than 10 percent (not 10 percentage points) 
of the respective minimum or maximum percentage. Thus, for example, the 
statutory safe harbor of Sec. 1.414(r)-5(b) is not permitted to be 
applied based on an average determined under this paragraph (c) if the 
percentage for any testing year taken into account in calculating the 
average falls below 45 percent (which is 10 percent below the 50-percent 
minimum) or exceeds 220 percent (which is 10 percent above the 200-
percent maximum).
    (4) Consistency requirements. A provision is permitted to be applied 
on an averaging basis under this paragraph (c) regardless of how any 
other provision is applied, except in the case of the separate employee 
workforce and separate management requirements of Sec. 1.414(r)-3(b)(4) 
and (5), which each must be applied on the same basis as the other. A 
provision is also permitted to be applied on an averaging basis under 
this paragraph (c) for a testing year, regardless of how the provision 
is applied for any other testing year. However, once a provision is 
applied on an averaging basis under this paragraph (c) for a testing 
year, it must be applied on the same basis to all the employer's lines 
of business to which the provision is applied for the testing year. The 
percentage for a preceding testing year may be taken into account under 
this paragraph (c) only if--
    (i) The employer calculates the percentage for the preceding testing 
year in the same manner as the employer calculates the percentage for 
the current testing year;
    (ii) The employer is treated as operating qualified separate lines 
of business in accordance with Sec. 1.414(r)-1(b) for the preceding 
testing year; and
    (iii) The employer designated the same lines of business in the 
preceding testing year as in the current testing year.

[T.D. 8376, 56 FR 63460, Dec. 4, 1991, as amended by T.D. 8548, 59 FR 
32922, June 27, 1994]



Sec. 1.414(s)-1  Definition of compensation.

    (a) Introduction--(1) In general. Section 414(s) and this section 
provide rules for defining compensation for purposes of applying any 
provision that specifically refers to section 414(s) or this section. 
For example, section 414(s) is referred to in many of the 
nondiscrimination provisions applicable to pension, profit-sharing, and 
stock bonus plans qualified under section 401(a). In accordance with 
section 414(s)(1), this section defines compensation as compensation 
within the meaning of section 415(c)(3). It also implements the election 
provided in section 414(s)(2) to treat certain deferrals as compensation 
and exercises the authority granted to the Secretary in section 
414(s)(3) to prescribe alternative nondiscriminatory definitions of 
compensation.
    (2) Limitations on scope of section 414(s). Section 414(s) and this 
section do not apply unless a provision specifically refers to section 
414(s) or this section. For example, even though a definition of 
compensation permitted under section 414(s) must be used in determining 
whether the contributions or

[[Page 992]]

benefits under a pension, profit-sharing, or stock bonus plan satisfy a 
certain applicable provision (such as section 401(a)(4)), except as 
otherwise specified, the plan is not required to use a definition of 
compensation that satisfies section 414(s) in calculating the amount of 
contributions or benefits actually provided under the plan.
    (3) Overview. Paragraph (b) of this section provides rules of 
general application that govern a definition of compensation that 
satisfies section 414(s). Paragraph (c) of this section contains 
specific definitions of compensation that satisfy section 414(s) without 
satisfying any additional nondiscrimination requirement under section 
414(s). Paragraph (d) of this section provides rules permitting the use 
of alternative definitions of compensation that satisfy section 414(s) 
as long as the nondiscrimination requirement and other requirements 
described in paragraph (d) of this section are satisfied. Paragraph (e) 
and (f) of this section provide special rules permitting the use of rate 
of compensation, or prior-employer compensation or imputed compensation, 
rather than actual compensation, under a definition of compensation that 
satisfies section 414(s). Paragraph (g) of this section provides other 
special rules, including a special rule for determining the compensation 
of a self-employed individual under an alternate definition of 
compensation. Paragraph (h) of this section provides definitions for 
certain terms used in this section.
    (b) Rules of general application--(1) Use of a definition. Any 
definition of compensation that satisfies section 414(s) may be used 
when a provision explicitly refers to section 414(s) unless the 
reference or this section specifically indicates otherwise.
    (2) Consistency rule--(i) General rule. A definition of compensation 
selected by an employer for use in satisfying an applicable provision 
must be used consistently to define the compensation of all employees 
taken into account in satisfying the requirements of the applicable 
provision for the determination period. For example, although any 
definition of compensation that satisfies section 414(s) may be used for 
section 401(a)(4) purposes, the same definition of compensation 
generally must be used consistently to define the compensation of all 
employees taken into account in determining whether a plan satisfies 
section 401(a)(4). Furthermore, a different definition of compensation 
that satisfies section 414(s) is permitted to be used to determine 
whether another plan maintained by the same employer separately 
satisfies the requirements of section 401(a)(4). Although a definition 
of compensation must be used consistently, an employer may change its 
definition of compensation for a subsequent determination period with 
respect to the applicable provision. Rules provided under any applicable 
provision may modify the consistency requirements of this paragraph 
(b)(2).
    (ii) Scope of consistency rule. Compensation will not fail to be 
defined consistently for a group of employees merely because some 
employees do not receive one or more of the types of compensation 
included in the definition. For example, a definition of compensation 
that includes salary, regular or scheduled pay, overtime, and specified 
types of bonuses will not fail to define compensation consistently 
merely because only salaried employees receive salary and these 
specified types of bonuses and only hourly employees receive regular or 
scheduled pay and overtime.
    (3) Self-employed individuals. Notwithstanding paragraph (b)(1) of 
this section, self-employed individuals' compensation can only be 
determined under paragraph (c)(2) of this section (with or without the 
modification permitted by paragraph (c)(4) of this section or a 
modification permitted by paragraph (c)(5) of this section) or by using 
an equivalent alternative compensation amount determined in accordance 
with paragraph (g)(1) of this section. These limitations on self-
employed individuals do not affect their common-law employees. Thus, the 
compensation of common-law employees of a partnership or sole 
proprietorship may be defined using an alternative definition, provided 
the definition otherwise satisfies paragraph (c)(3), (d), (e), or (f) of 
this section. If an alternative definition of compensation under 
paragraph (c)(3), (d), (e), or

[[Page 993]]

(f) of this section is used for other employees to satisfy an applicable 
provision, the consistency requirement is only met if paragraph (g) of 
this section is used for the self-employed individuals.
    (c) Specific definitions of compensation that satisfy section 
414(s)--(1) General rules. The definitions of compensation provided in 
paragraphs (c)(2) and (c)(3) of this section satisfy section 414(s) and 
need not satisfy any additional requirements under section 414(s). 
Paragraph (c)(2) of this section describes definitions of compensation 
within the meaning of section 415(c)(3). Paragraph (c)(3) of this 
section provides a safe harbor alternative definition that excludes 
certain additional items of compensation. Paragraph (c)(4) of this 
section permits any definition provided in paragraph (c)(2) or (c)(3) of 
this section to include certain types of elective contributions and 
deferred compensation. Paragraph (c)(5) of this section permits certain 
modifications to a definition otherwise provided under this paragraph 
(c).
    (2) Compensation within the meaning of section 415(c)(3). A 
definition of compensation that includes all compensation within the 
meaning of section 415(c)(3) and excludes all other compensation 
satisfies section 414(s). Sections 1.415(c)-2(b) and (c) provide rules 
for determining items of compensation included in and excluded from 
compensation within the meaning of section 415(c)(3). In addition, 
section 414(s) is satisfied by the safe harbor definitions provided in 
Sec. 1.415(c)-2(d)(2), (d)(3) and (d)(4) and any additional definitions 
of compensation prescribed by the Commissioner under the authority 
provided in Sec. 1.415(c)-2(d)(1) that are treated as satisfying 
section 415(c)(3).
    (3) Safe harbor alternative definition. Under the safe harbor 
alternative definition in this paragraph (c)(3), compensation is 
compensation as defined in paragraph (c)(2) of this section, reduced by 
all of the following items (even if includible in gross income): 
reimbursements or other expense allowances, fringe benefits (cash and 
noncash), moving expenses, deferred compensation, and welfare benefits.
    (4) Inclusion of certain deferrals in compensation. Any definition 
of compensation provided in paragraph (c)(2) or (c)(3) of this section 
satisfies section 414(s) even though it is modified to include all of 
the following types of elective contributions and all of the following 
types of deferred compensation--
    (i) Elective contributions that are made by the employer on behalf 
of its employees that are not includible in gross income under section 
125, section 402(e)(3), section 402(h), and section 403(b);
    (ii) Compensation deferred under an eligible deferred compensation 
plan within the meaning of section 457(b) (deferred compensation plans 
of state and local governments and tax-exempt organizations); and
    (iii) Employee contributions (under governmental plans) described in 
section 414(h)(2) that are picked up by the employing unit and thus are 
treated as employer contributions.
    (5) Exclusions applicable solely to highly compensated employees. 
Any definition of compensation that satisfies paragraph (c)(2) or (c)(3) 
of this section, with or without the modification permitted by paragraph 
(c)(4) of this section, may be modified to exclude any portion of the 
compensation of some or all of the employer's highly compensated 
employees (including, for example, any one or more of the types of 
elective contributions or deferred compensation described in paragraph 
(c)(4) of this section).
    (d) Alternative definitions of compensation that satisfy section 
414(s)--(1) General rule. In addition to the definitions provided in 
paragraph (c) of this section, any definition of compensation satisfies 
section 414(s) with respect to employees (other than self-employed 
individuals treated as employees under section 401(c)(1)) if the 
definition of compensation does not by design favor highly compensated 
employees, is reasonable within the meaning of paragraph (d)(2) of this 
section, and satisfies the nondiscrimination requirement in paragraph 
(d)(3) of this section.
    (2) Reasonable definition of compensation--(i) General rule. An 
alternative definition of compensation under this paragraph (d) is 
reasonable under section 414(s) if it is a definition of compensation 
provided in paragraph (c) of

[[Page 994]]

this section, modified to exclude all or any portion of one or more of 
the types of compensation described in paragraph (d)(2)(ii) of this 
section. See paragraph (e) of this section, however, for special rules 
that permit definitions of compensation based on employees' rates of 
compensation and paragraph (f) of this section for special rules that 
permit definitions of compensation that include prior-employer 
compensation or imputed compensation.
    (ii) Items that may be excluded. A reasonable definition of 
compensation is permitted to exclude, on a consistent basis, all or any 
portion of irregular or additional compensation, including (but not 
limited to) one or more of the following: Any type of additional 
compensation for employees working outside their regularly scheduled 
tour of duty (such as overtime pay, premiums for shift differential, and 
call-in premiums), bonuses, or any one or more of the types of 
compensation excluded under the safe harbor alternative definition in 
paragraph (c)(3) of this section. Whether a type of compensation is 
irregular or additional is determined based on all the relevant facts 
and circumstances. A reasonable definition is also permitted to include, 
on a consistent basis, all or any portion of the types of elective 
contributions or deferred compensation described in paragraph (c)(4) of 
this section and, thus, need not include all those types of elective 
contributions or deferred compensation as otherwise required under 
paragraph (c)(4) of this section.
    (iii) Limits on the amount excluded from compensation. A definition 
of compensation is not reasonable if it provides that each employee's 
compensation is a specified portion of the employee's compensation 
measured for the otherwise applicable determination period under another 
definition. For example, a definition of compensation that specifically 
limits each employee's compensation for a determination period to 95 
percent of the employee's compensation using a definition provided in 
paragraph (c) of this section is not reasonable. Similarly, a definition 
of compensation that limits each employee's compensation used to satisfy 
an applicable provision with a 12-month determination period to 
compensation under a definition provided in paragraph (c) of this 
section for one month is not a reasonable definition of compensation. 
However, a definition of compensation is not unreasonable merely because 
it excludes all compensation in excess of a specified dollar amount.
    (3) Nondiscrimination requirement--(i) In general. An alternative 
definition of compensation under this paragraph (d) is nondiscriminatory 
under section 414(s) for a determination period if the average 
percentage of total compensation included under the alternative 
definition of compensation for an employer's highly compensated 
employees, as a group for the determination period does not exceed by 
more than a de minimis amount the average percentage of total 
compensation included under the alternative definition for the 
employer's nonhighly compensated employees as a group.
    (ii) Total compensation--(A) General rule. For purposes of this 
paragraph (d)(3), total compensation must be determined using a 
definition of compensation provided in paragraph (c)(2) of this section, 
either with or without the modification permitted by paragraph (c)(4) of 
this section. Thus, total compensation does not include prior-employer 
compensation or imputed compensation described in paragraph (f)(1) of 
this section (including imputed compensation for a period during which 
an employee performs services for another employer). Total compensation 
taken into account for each employee (including, if added, the elective 
contributions and deferred compensation described in paragraph (c)(4) of 
this section) may not exceed the annual compensation limit of section 
401(a)(17).
    (B) Alternative definitions with exclusions applicable solely to 
highly compensated employees. If an alternative definition of 
compensation contains a provision that excludes amounts from 
compensation and, as described in paragraph (c)(5) of this section, the 
provision only applies in defining the compensation of some highly 
compensated employees, then, for purposes of this paragraph (d)(3), the 
total compensation of any highly compensated

[[Page 995]]

employee subject to the provision must be reduced by any amount excluded 
from the employee's compensation as a result of the provision. However, 
if the provision applies consistently in defining the compensation of 
all highly compensated employees, this adjustment to total compensation 
is not required.
    (iii) Employees taken into account--(A) General rule. In applying 
the requirement of this paragraph (d)(3), the employees taken into 
account are the same employees taken into account in satisfying the 
requirements of the applicable provision for the determination period. 
For example, in determining whether a plan satisfies section 401(a)(4), 
an alternative definition must satisfy this paragraph (d)(3) taking into 
account all employees who benefit under the plan for the plan year 
(within the meaning of Sec. 1.410(b)-3(a)). If an employer is using the 
same alternative definition of compensation to determine whether more 
than one separate plan satisfies section 401(a)(4), the employer is 
permitted to take into account all the employees who benefit under all 
of those plans for the plan year in determining whether the alternative 
definition of compensation being used satisfies this paragraph (d)(3).
    (B) Exclusion of self-employed individuals. In applying the 
requirement of this paragraph (d)(3), self-employed individuals are 
disregarded.
    (C) Certain employees disregarded. If an employee's total 
compensation for the determination period, determined under paragraph 
(d)(3)(ii) and (d)(3)(vi)(B) of this section, is zero, the employee is 
disregarded in determining whether the nondiscrimination requirement of 
paragraph (d)(3) of this section is satisfied for that determination 
period. For example, an employee who does not receive any actual 
compensation during a determination period because the employee is on 
unpaid leave of absence for the entire period, but who is credited with 
imputed compensation described in paragraph (f)(1) of this section, is 
disregarded in determining whether the nondiscrimination requirement of 
this paragraph (d)(3) is satisfied for that determination period.
    (iv) Calculation of average percentages--(A) General rule. To 
determine the average percentages described in paragraph (d)(3)(i) of 
this section, an individual compensation percentage must be calculated 
for each employee in a group, and then the average of the separately 
calculated compensation percentages for each employee in the group must 
be determined. The individual compensation percentage for an employee is 
calculated by dividing the amount of the employee's compensation that is 
included under the alternative definition by the amount of the 
employee's total compensation.
    (B) Other reasonable methods. Notwithstanding paragraph 
(d)(3)(iv)(A) of this section, any other reasonable method is permitted 
to be used to determine the average percentages described in paragraph 
(d)(3)(i) of this section for either or both of the groups (i.e., highly 
compensated employees and nonhighly compensated employees), provided 
that the method cannot reasonably be expected to create a significant 
variance from the average percentage for that group determined using the 
individual-percentage method provided in paragraph (d)(3)(iv)(A) of this 
section. The same method is not required to be used for calculating the 
two average percentages. For example, to determine the average 
percentage for nonhighly compensated employees as a group, an employer 
may calculate an aggregate compensation percentage by dividing the 
aggregate amount of compensation of nonhighly compensated employees that 
are included under the alternative definition by the aggregate amount of 
total compensation of nonhighly compensated employees, provided the 
resulting percentage is not reasonably expected to vary significantly 
from the average percentage produced using the individual-percentage 
method provided in paragraph (d)(3)(iv)(A) of this section because of 
the extra weight given employees with higher compensation.
    (v) Facts and circumstances determination. The determination of 
whether the average percentage of total compensation included for the 
employer's highly compensated employees as a group for a determination 
period exceeds by more than a de minimis amount the

[[Page 996]]

average percentage of total compensation included for the employer's 
nonhighly compensated employees as a group is based on all the relevant 
facts and circumstances. The differences between the percentages for 
prior determination periods may be considered in determining whether the 
amount of the difference between the percentages is more than de 
minimis. In addition, an isolated instance of a more than de minimis 
difference between the compensation percentages that is due to an 
extraordinary unforeseeable event (such as overtime payments to 
employees of a public utility due to a major hurricane) will be 
disregarded if the amount of the difference in prior determination 
periods was de minimis.
    (vi) Special rules for definitions of compensation based on rate of 
compensation or that include prior-employer or imputed compensation--(A) 
Special rule for determining compensation included under an alternative 
definition. If an alternative definition uses rate of compensation or 
includes prior-employer compensation or imputed compensation, the amount 
of each employee's compensation for a determination period that is 
treated as included under the alternative definition for purposes of 
determining the average percentages for the nondiscrimination 
requirement (i.e. the amount used in the numerator) must not be more 
than 100 percent of the employee's total compensation for that period, 
determined under paragraph (d)(3)(ii) and (d)(3)(vi)(B) of this section. 
This limit on the amount of compensation treated as included under the 
alternative definition applies even if the amount of compensation 
actually credited to the employee for the determination period under the 
definition and, thus, used as compensation within the meaning of section 
414(s), exceeds the employee's total compensation for the period.
    (B) Special rule for determining total compensation. If an 
alternative definition uses rate of compensation or includes prior-
employer compensation or imputed compensation, each employee's total 
compensation for purposes of determining the average percentages for the 
nondiscrimination requirement (i.e. the amount used in the denominator) 
must include all the types of elective contributions and deferred 
compensation described in paragraph (c)(4) of this section.
    (e) Rate of compensation--(1) General rule. A definition of 
compensation satisfies section 414(s) as a reasonable definition of 
compensation even though it defines the amount of each employee's basic 
or regular compensation using the employee's basic or regular rate of 
compensation rather than using the employee's actual basic or regular 
compensation from the employer if the definition satisfies the 
requirements specified in paragraph (e)(3) of this section and otherwise 
satisfies the requirements of paragraph (d) of this section, including 
the nondiscrimination test in paragraph (d)(3) of this section. For this 
purpose, the employee's rate of compensation must be determined using an 
hourly pay scale, weekly salary, or similar unit of basic or regular 
compensation applicable to the employee. A definition will not fail to 
satisfy the requirements of this paragraph (e) merely because it defines 
compensation as including each employee's basic or regular compensation, 
the amount of which is determined using each employee's basic or regular 
rate of compensation, plus actual amounts of irregular or additional 
compensation, such as overtime or bonuses. In addition, a definition of 
compensation will not fail to satisfy section 414(s) merely because it 
defines compensation for each employee as the greater of the employee's 
actual compensation, the amount of which is determined using a 
definition that would otherwise satisfy paragraph (c) or (d)(2) of this 
section, or the employee's basic or regular compensation, the amount of 
which is determined using the employee's basic or regular rate of 
compensation.
    (2) Not applicable to certain contributions. This paragraph (e) does 
not apply to a definition of compensation used in determining whether 
elective deferrals (as defined in section 402(g)(3)), matching 
contributions (as defined in section 401(m)(4)), or employee 
contributions subject to section 401(m) satisfy any applicable 
provision. Thus, for example, a definition of compensation that defines 
compensation based on each employee's basic or regular rate of 
compensation may not be used to

[[Page 997]]

measure compensation for purposes of determining if a qualified cash or 
deferred arrangement satisfies the actual deferral percentage test in 
section 401(k)(3).
    (3) Requirements for definitions of compensation based on rate of 
compensation--(i) Benefit determination. The definition of compensation 
must actually be used to calculate the benefits, contributions, or other 
amounts, that are subject to the applicable provision. For example, a 
definition of compensation that defines compensation based on each 
employee's basic or regular rate of compensation may not be used to 
determine whether a plan satisfies section 401(a)(4) unless the 
benefits, contributions, or other amounts for each employee in the plan 
are determined using that definition of compensation.
    (ii) Period for determining compensation. The amount of each 
employee's basic or regular compensation for the determination period 
must be determined using the employee's basic or regular rate of 
compensation as of a designated date in the determination period. For 
example, if the determination period is a calendar year, this 
requirement would be satisfied if the amount of each employee's basic or 
regular compensation for the calendar year is determined using the 
employee's basic or regular rate of compensation as of January 1 of the 
calendar year. Alternatively, the amount of each employee's basic or 
regular compensation for a determination period can be the sum of the 
amounts separately determined for shorter specified periods (e.g., weeks 
or months) within the determination period provided the amount of each 
employee's basic or regular compensation for each specified period is 
determined using the employee's basic or regular rate of compensation as 
of a designated date within the specified period.
    (iii) Dates for determining rate of compensation. One or more dates 
may be used to determine employees' rates of compensation for a 
determination period or specified period provided that, if the same date 
is not used for all employees, the dates selected are designed to 
determine the rates of compensation for that period on a consistent 
basis for all employees taken into account for the determination period. 
For example, if annual compensation increases are provided to different 
groups of employees on different dates during the year, it would be 
consistent to choose a different date for each group in order to include 
the annual increase in the employees' rates of compensation for the 
determination period. In addition, the date or dates selected, by 
themselves, must not cause the portion of total compensation included to 
vary significantly among employees.
    (iv) Periods without compensation or with reduced compensation. An 
employee's compensation may generally only be determined using the 
employee's rate of compensation for employment periods during which the 
employer actually compensates the employee. However, if an employee 
terminates employment or otherwise stops performing services (such as 
for a leave of absence, layoff or similar event) either without 
compensation or with reduced compensation during a determination period, 
the employer may continue to credit the employee with compensation based 
on the employee's rate of compensation for a period of up to 31 days 
after the event, but not beyond the end of the determination period. 
Paragraph (f) of this section contains special rules for crediting 
imputed compensation for periods extending beyond 31 days during which 
an employee is not compensated or an employee's compensation is reduced. 
See also the definition of Section 414(s) compensation in Sec. 
1.401(a)(4)-12 that, for purposes of satisfying section 401(a)(4), 
permits adjustments to compensation to reflect the equivalent of full-
time compensation to the extent necessary to satisfy the requirements of 
29 CFR 2530.204-2(d) (regarding double proration of service and 
compensation).
    (f) Prior-employer compensation and imputed compensation--(1) 
General rule. Solely for purposes of determining whether a defined 
benefit plan, as defined in Sec. 1.410(b)-9, satisfies section 
401(a)(4) or 410(b), an alternative definition that includes prior-
employer compensation or imputed compensation satisfies section 414(s) 
as a reasonable alternative definition if the definition satisfies the 
requirements specified in

[[Page 998]]

paragraphs (f) (2) and (3) of this section. For this purpose, prior-
employer compensation is compensation from an employer other than the 
employer (determined at the time that the compensation is paid) 
maintaining the plan that is credited for periods prior to the 
employee's employment with the employer maintaining the plan and during 
which the employee performed services for the other employer. For this 
purpose, imputed compensation is compensation credited for periods after 
an employee has commenced or recommenced participation in a plan while 
the employee is not compensated by the employer maintaining the plan or 
is compensated at a reduced rate by that employer because the employee 
is not performing services as an employee for the employer (including a 
period in which the employee performs services for another employer, 
e.g., a joint venture) or because the employee has a reduced work 
schedule.
    (2) Requirements for definitions of compensation crediting prior-
employer compensation or imputed compensation--(i) General requirement. 
The definition must otherwise be described in paragraph (c) of this 
section or must otherwise satisfy the requirements of paragraph (d) or 
(e) of this section for alternative definitions of compensation, 
including the nondiscrimination requirement in paragraph (d)(3) of this 
section.
    (ii) Benefit determination. A definition of compensation that 
credits prior-employer compensation or imputed compensation must 
actually be used to calculate the benefits under the plan. For example, 
the definition may not be used to determine whether a defined benefit 
plan satisfies section 401(a)(4) unless the benefits for each employee 
in the plan are determined using that definition of compensation.
    (iii) Provision applied to all similarly-situated employees. A 
provision in a plan's definition of compensation crediting prior-
employer compensation or imputed compensation must apply on the same 
terms to all similarly-situated employees in the plan. The criteria for 
determining whether employees are similarly situated for this purpose 
are the same as the criteria for determining whether a plan provision 
crediting pre-participation or imputed service satisfies the 
requirements of Sec. 1.401(a)(4)-11(d)(3)(iii)(A).
    (iv) Legitimate business purpose. There must be a legitimate 
business purpose, based on all of the relevant facts and circumstances, 
for crediting prior-employer compensation or imputed compensation to an 
employee for the period being credited. The standard for determining 
whether crediting prior-employer compensation or imputed compensation 
satisfies this requirement is the same as the standard for determining 
whether crediting pre-participation or imputed service under a plan 
satisfies the requirements of Sec. 1.401(a)(4)-11(d)(3)(iii)(B) and 
whether crediting imputed service satisfies the additional requirements 
of Sec. 1.401(a)(4)-11(d)(3)(iv)(A). However, if the legitimate 
business reason for crediting imputed compensation relates to the 
services the employee is performing for another employer and the reason 
satisfies the standard in Sec. 1.401(a)(4)-11(d)(3)(iii)(B), the 
additional requirements of Sec. 1.401(a)(4)-11(d)(3)(iv)(A) are deemed 
to be satisfied. For example, if an employee becomes employed by another 
employer as a result of a merger, acquisition or similar transaction 
with the other employer and imputed compensation is credited to the 
employee while the employee is performing services for the other 
employer, the crediting of imputed compensation to the employee 
satisfies the standard in Sec. 1.401(a)(4)-11(d)(3)(iii)(B). Thus, 
under that example, crediting the imputed compensation to the employee 
is deemed to satisfy the additional requirements of Sec. 1.401(a)(4)-
11(d)(3)(iv)(A), even if the employee is not performing those services 
under an arrangement that provides an ongoing business benefit to the 
employer maintaining the plan.
    (v) No significant discrimination. Based on all of the relevant 
facts and circumstances, crediting prior-employer compensation or 
imputed compensation must not by design or in operation discriminate 
significantly in favor of highly compensated employees. The standard for 
determining whether crediting prior-employer compensation or imputed 
compensation satisfies this requirement is the same as the standard

[[Page 999]]

for determining whether crediting pre-participation or imputed service 
satisfies the requirement in Sec. 1.401(a)(4)-11(d)(3)(iii)(C) and 
whether crediting imputed service satisfies the additional requirement 
of Sec. 1.401(a)(4)-11(d)(3)(iv)(B).
    (3) Reasonable method--(i) General rule. Any reasonable method may 
be used to determine the amount of prior-employer compensation or 
imputed compensation provided that the requirements of paragraph (f)(3) 
(ii) or (iii) of this section are satisfied, whichever is applicable.
    (ii) Requirements for prior-employer compensation. Prior-employer 
compensation credited to an employee for a period that an employee is 
performing services for another employer must be compensation for the 
employee from the other employer (or be based on the employee's basic or 
regular rate of compensation from the other employer) for that period. 
In addition, prior employer compensation credited to an employee must 
not exceed the amount of compensation from the other employer that would 
have been included under the definition of compensation in effect for 
that period for compensation from the employer maintaining the plan. 
Reasonable assumptions may be made in determining the amount of 
compensation received from another employer for a period that would have 
been included under the definition of compensation in effect for that 
period for compensation from the employer maintaining the plan.
    (iii) Requirements for imputed compensation--(A) General rule. The 
amount of imputed compensation credited to an employee during any 
period, when combined with the amount of any actual compensation being 
included, must not exceed an amount that, based on all of the relevant 
facts and circumstances, is reasonably representative of the amount of 
compensation that the employee would have received and that would have 
been included under the definition of compensation in effect for the 
period if the employee had continued to perform services for the 
employer during that period at the same level as the employee was 
performing before the employee stopped performing services or changed to 
a reduced work schedule. The relevant facts and circumstances include 
the compensation that the employee was receiving immediately before the 
employee stopped performing services or changed to a reduced work 
schedule, and, if applicable, the rate of compensation in effect while 
the employee is not performing services or has a reduced work schedule 
that is applicable to the employee's specific job grade immediately 
before the change occurred.
    (B) Imputed compensation from another employer. Imputed compensation 
credited for a period that an employee is performing services for 
another employer is deemed to satisfy paragraph (f)(3)(iii)(A) of this 
section if the amount of compensation credited satisfies the 
requirements of paragraph (f)(3)(ii) of this section for prior-employer 
compensation. Thus, for example, the amount of imputed compensation 
credited to an employee for a period that the employee is performing 
services for another employer is deemed to satisfy paragraph 
(f)(3)(iii)(A) of this section if the amount credited is compensation 
for the employee from the other employer (or is based on the employee's 
basic or regular rate of compensation from the other employer) for that 
period, and the amount credited does not exceed the compensation from 
the other employer that would be included for the employee under the 
definition of compensation in effect for that period for compensation 
from the employer maintaining the plan.
    (4) Special nondiscrimination rule for safe harbor definitions. If a 
definition of compensation crediting prior-employer or imputed 
compensation is otherwise described in paragraph (c) of this section, 
and the prior-employer compensation or imputed compensation credited 
satisfies the requirements of paragraphs (f) (1), (2), and (3) of this 
section, then the definition is deemed to satisfy paragraph (d) of this 
section (i.e., it is deemed to be nondiscriminatory).
    (g) Special rules--(1) Self-employed individuals--(i) General rule. 
If an alternative definition of compensation under paragraph (c)(3), 
(d), (e), or (f) of this section is used to satisfy an applicable 
provision, an equivalent alternative compensation amount must be

[[Page 1000]]

determined for any self-employed individual who is in the group of 
employees for whom paragraph (b) of this section requires a single 
definition of compensation to be used. This equivalent alternative 
compensation amount is determined by multiplying the self-employed 
individual's total earned income (as defined in section 401 (c)(2)) for 
the determination period by the percentage of total compensation (as 
defined in paragraph (d)(3)(ii) of this section) included under the 
alternative definition for the employer's nonhighly compensated common-
law employees as a group (determined in a manner consistent with the 
rules in paragraph (d)(3)(iii) of this section and, if applicable, 
paragraph (d)(3)(vi) of this section). Thus, for purposes of this 
determination, highly compensated common-law employees must be 
disregarded. This equivalent alternative compensation amount will be 
treated as the self-employed individual's compensation under the 
alternative definition of compensation for the determination period.
    (ii) Inclusion of elective contributions. If the alternative 
definition of compensation includes any types of elective contributions 
described in paragraph (c)(4) of this section, the self-employed 
individual's earned income for this determination must be increased by 
the amount of elective contributions made by the employer on behalf of 
the self-employed individual, and the definition of total compensation 
for this determination must include all the types of elective 
contributions described in paragraph (c)(4) of this section made by the 
employees (other than highly compensated employees.
    (iii) Reductions in equivalent alternative compensation amount 
applicable only to highly compensated employees. An alternative 
definition of compensation may provide that compensation under the 
alternative definition for some or all self-employed individuals who are 
highly compensated employees is a specified portion of, rather than 
equal to, the equivalent compensation amount determined under paragraph 
(g)(1)(i).
    (2) Leased employees. [Reserved]
    (h) Definitions. The following definitions apply for purposes of 
this section:
    (1) Applicable provision. Applicable provision means a provision 
that specifically refers to section 414(s) or this section.
    (2) Determination period. Determination period means a period during 
which the amount of compensation is measured for use in determining 
whether the requirements of an applicable provision are satisfied. If no 
period is provided under the applicable provision for measuring 
compensation, the determination period is the period for which the 
applicable provision must be satisfied. The applicable provision may 
provide additional rules concerning the determination period to be used 
for satisfying the nondiscrimination requirement in paragraph (d) of 
this section.
    (3) Employee. Employee means employee within the meaning of Sec. 
1.410(b)-9.
    (4) Highly compensated employee. Highly compensated employee means 
highly compensated employee within the meaning of Sec. 1.410(b)-9.
    (5) Nonhighly compensated employee. Nonhighly compensated employee 
means nonhighly compensated employee within the meaning of Sec. 
1.410(b)-9.
    (6) Self-employed individual. Self-employed individual means self-
employed individual within the meaning of section 401(c)(1).
    (i) Additional rules. The Commissioner may in revenue rulings, 
notices, and other guidance of general applicability provide additional 
rules for defining compensation within the meaning of section 414(s), 
including additional definitions of compensation that satisfy section 
414(s).
    (j) Effective date and transition rules--(1) Statutory effective 
date. Section 414(s) applies to years beginning on or after January 1, 
1987.
    (2) Regulatory effective date--(i) In general. Except as otherwise 
provided in paragraph (j)(2)(ii) of this section, Sec. 1.414(s)-1 (a) 
through (i) apply to years beginning on or after January 1, 1994.
    (ii) Plans of tax-exempt organizations. In the case of a plan 
maintained by an organization that is exempt from income taxation 
pursuant to section 501(a), including plans subject to section 
403(b)(12)(A)(i) (nonelective plans),

[[Page 1001]]

Sec. 1.414(s)-1 (a) through (i) apply to plan years beginning on or 
after January 1, 1996.
    (3) Compliance during transition period. For plan years beginning 
before the effective date of these regulations, as set forth in 
paragraph (j)(2) of this section, and on or after the statutory 
effective date as set forth in paragraph (j)(1) of this section, a plan 
must be operated in accordance with a reasonable, good faith 
interpretation of section 414(s). Whether a plan is operated in 
accordance with a reasonable, good faith interpretation of section 
414(s) will generally be determined based on all relevant facts and 
circumstances, including the extent to which an employer has resolved 
unclear issues in its favor. A plan will be deemed to be operated in 
accordance with a reasonable, good faith interpretation of section 
414(s)(1) and (2) if it is operated in accordance with the terms of 
Sec. 1.414(s)-1 (a) through (i). For years beginning on or after the 
statutory effective date and before the effective date of these 
regulations, a definition of compensation is also deemed to satisfy 
section 414(s) as an alternative method of determining compensation 
under section 414(s)(3) if the definition satisfies the requirements of 
Sec. 1.414(s)-1 (a) through (i) or if the definition satisfies the 
prior regulation provisions of Sec. 1.414(s)-1T. (See Sec. 1.414(s)-1T 
as contained in the CFR edition revised as of April 1, 1991.) In 
addition, for those transition years, a definition of compensation is 
deemed to satisfy section 414(s) as an alternative method of determining 
compensation under section 414(s)(3) if, based on all the relevant facts 
and circumstances in effect for the year, use of the definition does not 
cause discrimination in favor of highly compensated employees.

[T.D. 8361, 56 FR 47662, Sept. 19, 1991; 57 FR 10815, 10953, Mar. 31, 
1992, as amended by T.D. 8488, 58 FR 47063, Sept. 7, 1993; T.D. 9319, 72 
FR 16894, Apr. 5, 2007]



Sec. 1.414(v)-1  Catch-up contributions.

    (a) Catch-up contributions--(1) General rule. An applicable employer 
plan shall not be treated as failing to meet any requirement of the 
Internal Revenue Code solely because the plan permits a catch-up 
eligible participant to make catch-up contributions in accordance with 
section 414(v) and this section. With respect to an applicable employer 
plan, catch-up contributions are elective deferrals made by a catch-up 
eligible participant that exceed any of the applicable limits set forth 
in paragraph (b) of this section and that are treated under the 
applicable employer plan as catch-up contributions, but only to the 
extent they do not exceed the catch-up contribution limit described in 
paragraph (c) of this section (determined in accordance with the special 
rules for employers that maintain multiple applicable employer plans in 
paragraph (f) of this section, if applicable). To the extent provided 
under paragraph (d) of this section, catch-up contributions are 
disregarded for purposes of various statutory limits. In addition, 
unless otherwise provided in paragraph (e) of this section, all catch-up 
eligible participants of the employer must be provided the opportunity 
to make catch-up contributions in order for an applicable employer plan 
to comply with the universal availability requirement of section 
414(v)(4). The definitions in paragraph (g) of this section apply for 
purposes of this section and Sec. 1.402(g)-2.
    (2) Treatment as elective deferrals. Except as specifically provided 
in this section, elective deferrals treated as catch-up contributions 
remain subject to statutory and regulatory rules otherwise applicable to 
elective deferrals. For example, catch-up contributions under an 
applicable employer plan that is a section 401(k) plan are subject to 
the distribution and vesting restrictions of section 401(k)(2)(B) and 
(C). In addition, the plan is permitted to provide a single election for 
catch-up eligible participants, with the determination of whether 
elective deferrals are catch-up contributions being made under the terms 
of the plan.
    (3) Coordination with section 457(b)(3). In the case of an 
applicable employer plan that is a section 457 eligible governmental 
plan, the catch-up contributions permitted under this section shall not 
apply to a catch-up eligible participant for any taxable year for which 
a higher limitation applies to such participant under section 457(b)(3). 
For additional guidance, see regulations under section 457.

[[Page 1002]]

    (b) Elective deferrals that exceed an applicable limit--(1) 
Applicable limits. An applicable limit for purposes of determining 
catch-up contributions for a catch-up eligible participant is any of the 
following:
    (i) Statutory limit. A statutory limit is a limit on elective 
deferrals or annual additions permitted to be made (without regard to 
section 414(v) and this section) with respect to an employee for a year 
provided in section 401(a)(30), 402(h), 403(b), 408, 415(c), or 
457(b)(2) (without regard to section 457(b)(3)), as applicable.
    (ii) Employer-provided limit. An employer-provided limit is any 
limit on the elective deferrals an employee is permitted to make 
(without regard to section 414(v) and this section) that is contained in 
the terms of the plan, but which is not required under the Internal 
Revenue Code. Thus, for example, if, in accordance with the terms of the 
plan, highly compensated employees are limited to a deferral percentage 
of 10% of compensation, this limit is an employer-provided limit that is 
an applicable limit with respect to the highly compensated employees.
    (iii) Actual deferral percentage (ADP) limit. In the case of a 
section 401(k) plan that would fail the ADP test of section 401(k)(3) if 
it did not correct under section 401(k)(8), the ADP limit is the highest 
amount of elective deferrals that can be retained in the plan by any 
highly compensated employee under the rules of section 401(k)(8)(C) 
(without regard to paragraph (d)(2)(iii) of this section). In the case 
of a simplified employee pension (SEP) with a salary reduction 
arrangement (within the meaning of section 408(k)(6)) that would fail 
the requirements of section 408(k)(6)(A)(iii) if it did not correct in 
accordance with section 408(k)(6)(C), the ADP limit is the highest 
amount of elective deferrals that can be made by any highly compensated 
employee under the rules of section 408(k)(6) (without regard to 
paragraph (d)(2)(iii) of this section).
    (2) Contributions in excess of applicable limit--(i) Plan year 
limits--(A) General rule. Except as provided in paragraph (b)(2)(ii) of 
this section, the amount of elective deferrals in excess of an 
applicable limit is determined as of the end of the plan year by 
comparing the total elective deferrals for the plan year with the 
applicable limit for the plan year. In addition, except as provided in 
paragraph (b)(2)(i)(B) of this section, in the case of a plan that 
provides for separate employer-provided limits on elective deferrals for 
separate portions of plan compensation within the plan year, the 
applicable limit for the plan year is the sum of the dollar amounts of 
the limits for the separate portions. For example, if a plan sets a 
deferral percentage limit for each payroll period, the applicable limit 
for the plan year is the sum of the dollar amounts of the limits for the 
payroll periods.
    (B) Alternative method for determining employer-provided limit--(1) 
General rule. If the plan limits elective deferrals for separate 
portions of the plan year, then, solely for purposes of determining the 
amount that is in excess of an employer-provided limit, the plan is 
permitted to provide that the applicable limit for the plan year is the 
product of the employee's plan year compensation and the time-weighted 
average of the deferral percentage limits, rather than determining the 
employer-provided limit as the sum of the limits for the separate 
portions of the year. Thus, for example, if, in accordance with the 
terms of the plan, highly compensated employees are limited to 8% of 
compensation during the first half of the plan year and 10% of 
compensation for the second half of the plan year, the plan is permitted 
to provide that the applicable limit for a highly compensated employee 
is 9% of the employee's plan year compensation.
    (2) Alternative definition of compensation permitted. A plan using 
the alternative method in this paragraph (b)(2)(i)(B) is permitted to 
provide that the applicable limit for the plan year is determined as the 
product of the catch-up eligible participant's compensation used for 
purposes of the ADP test and the time-weighted average of the deferral 
percentage limits. The alternative calculation in this paragraph 
(b)(2)(i)(B)(2) is available regardless of whether the deferral 
percentage limits change during the plan year.
    (ii) Other year limit. In the case of an applicable limit that is 
applied on the basis of a year other than the plan year

[[Page 1003]]

(e.g., the calendar-year limit on elective deferrals under section 
401(a)(30)), the determination of whether elective deferrals are in 
excess of the applicable limit is made on the basis of such other year.
    (c) Catch-up contribution limit--(1) General rule. Elective 
deferrals with respect to a catch-up eligible participant in excess of 
an applicable limit under paragraph (b) of this section are treated as 
catch-up contributions under this section as of a date within a taxable 
year only to the extent that such elective deferrals do not exceed the 
catch-up contribution limit described in paragraphs (c)(1) and (2) of 
this section, reduced by elective deferrals previously treated as catch-
up contributions for the taxable year, determined in accordance with 
paragraph (c)(3) of this section. The catch-up contribution limit for a 
taxable year is generally the applicable dollar catch-up limit for such 
taxable year, as set forth in paragraph (c)(2) of this section. However, 
an elective deferral is not treated as a catch-up contribution to the 
extent that the elective deferral, when added to all other elective 
deferrals for the taxable year under any applicable employer plan of the 
employer, exceeds the participant's compensation (determined in 
accordance with section 415(c)(3)) for the taxable year. See also 
paragraph (f) of this section for special rules for employees who 
participate in more than one applicable employer plan maintained by the 
employer.
    (2) Applicable dollar catch-up limit--(i) In general. The applicable 
dollar catch-up limit for an applicable employer plan, other than a plan 
described in section 401(k)(11) or 408(p), is determined under the 
following table:

------------------------------------------------------------------------
                                                            Applicable
             For taxable years beginning in                dollar catch-
                                                             up limit
------------------------------------------------------------------------
2002....................................................          $1,000
2003....................................................           2,000
2004....................................................           3,000
2005....................................................           4,000
2006....................................................           5,000
------------------------------------------------------------------------

    (ii) SIMPLE plans. The applicable dollar catch-up limit for a SIMPLE 
401(k) plan described in section 401(k)(11) or a SIMPLE IRA plan as 
described in section 408(p) is determined under the following table:

------------------------------------------------------------------------
                                                            Applicable
             For taxable years beginning in                dollar catch-
                                                             up limit
------------------------------------------------------------------------
2002....................................................           $ 500
2003....................................................           1,000
2004....................................................           1,500
2005....................................................           2,000
2006....................................................           2,500
------------------------------------------------------------------------

    (iii) Cost of living adjustments. For taxable years beginning after 
2006, the applicable dollar catch-up limit is the applicable dollar 
catch-up limit for 2006 described in paragraph (c)(2)(i) or (ii) of this 
section increased at the same time and in the same manner as adjustments 
under section 415(d), except that the base period shall be the calendar 
quarter beginning July 1, 2005, and any increase that is not a multiple 
of $500 shall be rounded to the next lower multiple of $500.
    (3) Timing rules. For purposes of determining the maximum amount of 
permitted catch-up contributions for a catch-up eligible participant, 
the determination of whether an elective deferral is a catch-up 
contribution is made as of the last day of the plan year (or in the case 
of section 415, as of the last day of the limitation year), except that, 
with respect to elective deferrals in excess of an applicable limit that 
is tested on the basis of the taxable year or calendar year (e.g., the 
section 401(a)(30) limit on elective deferrals), the determination of 
whether such elective deferrals are treated as catch-up contributions is 
made at the time they are deferred.
    (d) Treatment of catch-up contributions--(1) Contributions not taken 
into account for certain limits. Catch-up contributions are not taken 
into account in applying the limits of section 401(a)(30), 402(h), 
403(b), 408, 415(c), or 457(b)(2) (determined without regard to section 
457(b)(3)) to other contributions or benefits under an applicable 
employer plan or any other plan of the employer.
    (2) Contributions not taken into account in application of ADP 
test--(i) Calculation of ADR. Elective deferrals that are treated as 
catch-up contributions pursuant to paragraph (c) of this section with 
respect to a section 401(k) plan because they exceed a statutory or 
employer-provided limit described in

[[Page 1004]]

paragraph (b)(1)(i) or (ii) of this section, respectively, are 
subtracted from the catch-up eligible participant's elective deferrals 
for the plan year for purposes of determining the actual deferral ratio 
(ADR) (as defined in regulations under section 401(k)) of a catch-up 
eligible participant. Similarly, elective deferrals that are treated as 
catch-up contributions pursuant to paragraph (c) of this section with 
respect to a SEP because they exceed a statutory or employer-provided 
limit described in paragraph (b)(1)(i) or (ii) of this section, 
respectively, are subtracted from the catch-up eligible participant's 
elective deferrals for the plan year for purposes of determining the 
deferral percentage under section 408(k)(6)(D) of a catch-up eligible 
participant.
    (ii) Adjustment of elective deferrals for correction purposes. For 
purposes of the correction of excess contributions in accordance with 
section 401(k)(8)(C), elective deferrals under the plan treated as 
catch-up contributions for the plan year and not taken into account in 
the ADP test under paragraph (d)(2)(i) of this section are subtracted 
from the catch-up eligible participant's elective deferrals under the 
plan for the plan year.
    (iii) Excess contributions treated as catch-up contributions. A 
section 401(k) plan that satisfies the ADP test of section 401(k)(3) 
through correction under section 401(k)(8) must retain any elective 
deferrals that are treated as catch-up contributions pursuant to 
paragraph (c) of this section because they exceed the ADP limit in 
paragraph (b)(1)(iii) of this section. In addition, a section 401(k) 
plan is not treated as failing to satisfy section 401(k)(8) merely 
because elective deferrals described in the preceding sentence are not 
distributed or recharacterized as employee contributions. Similarly, a 
SEP is not treated as failing to satisfy section 408(k)(6)(A)(iii) 
merely because catch-up contributions are not treated as excess 
contributions with respect to a catch-up eligible participant under the 
rules of section 408(k)(6)(C). Notwithstanding the fact that elective 
deferrals described in this paragraph (d)(2)(iii) are not distributed, 
such elective deferrals are still considered to be excess contributions 
under section 401(k)(8), and accordingly, matching contributions with 
respect to such elective deferrals are permitted to be forfeited under 
the rules of section 411(a)(3)(G).
    (3) Contributions not taken into account for other nondiscrimination 
purposes--(i) Application for top-heavy. Catch-up contributions with 
respect to the current plan year are not taken into account for purposes 
of section 416. However, catch-up contributions for prior years are 
taken into account for purposes of section 416. Thus, catch-up 
contributions for prior years are included in the account balances that 
are used in determining whether the plan is top-heavy under section 
416(g).
    (ii) Application for section 410(b). Catch-up contributions with 
respect to the current plan year are not taken into account for purposes 
of section 410(b). Thus, catch-up contributions are not taken into 
account in determining the average benefit percentage under Sec. 
1.410(b)-5 for the year if benefit percentages are determined based on 
current year contributions. However, catch-up contributions for prior 
years are taken into account for purposes of section 410(b). Thus, 
catch-up contributions for prior years would be included in the account 
balances that are used in determining the average benefit percentage if 
allocations for prior years are taken into account.
    (4) Availability of catch-up contributions. An applicable employer 
plan does not violate Sec. 1.401(a)(4)-4 merely because the group of 
employees for whom catch-up contributions are currently available (i.e., 
the catch-up eligible participants) is not a group of employees that 
would satisfy section 410(b) (without regard to Sec. 1.410(b)-5). In 
addition, a catch-up eligible participant is not treated as having a 
right to a different rate of allocation of matching contributions merely 
because an otherwise nondiscriminatory schedule of matching rates is 
applied to elective deferrals that include catch-up contributions. The 
rules in this paragraph (d)(4) also apply for purposes of satisfying the 
requirements of section 403(b)(12).
    (e) Universal availability requirement--(1) General rule--(i) 
Effective opportunity. An applicable employer plan

[[Page 1005]]

that offers catch-up contributions and that is otherwise subject to 
section 401(a)(4) (including a plan that is subject to section 401(a)(4) 
pursuant to section 403(b)(12)) will not satisfy the requirements of 
section 401(a)(4) unless all catch-up eligible participants who 
participate under any applicable employer plan maintained by the 
employer are provided with an effective opportunity to make the same 
dollar amount of catch-up contributions. A plan fails to provide an 
effective opportunity to make catch-up contributions if it has an 
applicable limit (e.g., an employer-provided limit) that applies to a 
catch-up eligible participant and does not permit the participant to 
make elective deferrals in excess of that limit. An applicable employer 
plan does not fail to satisfy the universal availability requirement of 
this paragraph (e) solely because an employer-provided limit does not 
apply to all employees or different limits apply to different groups of 
employees under paragraph (b)(2)(i) of this section. However, a plan may 
not provide lower employer-provided limits for catch-up eligible 
participants.
    (ii) Certain practices permitted--(A) Proration of limit. An 
applicable employer plan does not fail to satisfy the universal 
availability requirement of this paragraph (e) merely because the plan 
allows participants to defer an amount equal to a specified percentage 
of compensation for each payroll period and for each payroll period 
permits each catch-up eligible participant to defer a pro-rata share of 
the applicable dollar catch-up limit in addition to that amount.
    (B) Cash availability. An applicable employer plan does not fail to 
satisfy the universal availability requirement of this paragraph (e) 
merely because it restricts the elective deferrals of any employee 
(including a catch-up eligible participant) to amounts available after 
other withholding from the employee's pay (e.g., after deduction of all 
applicable income and employment taxes). For this purpose, an employer 
limit of 75% of compensation or higher will be treated as limiting 
employees to amounts available after other withholdings.
    (2) Certain employees disregarded. An applicable employer plan does 
not fail to satisfy the universal availability requirement of this 
paragraph (e) merely because employees described in section 410(b)(3) 
(e.g., collectively bargained employees) are not provided the 
opportunity to make catch-up contributions.
    (3) Exception for certain plans. An applicable employer plan does 
not fail to satisfy the universal availability requirement of this 
paragraph (e) merely because another applicable employer plan that is a 
section 457 eligible governmental plan does not provide for catch-up 
contributions to the extent set forth in section 414(v)(6)(C) and 
paragraph (a)(3) of this section.
    (4) Exception for section 410(b)(6)(C)(ii) period. If an applicable 
employer plan satisfies the universal availability requirement of this 
paragraph (e) before an acquisition or disposition described in Sec. 
1.410(b)-2(f) and would fail to satisfy the universal availability 
requirement of this paragraph (e) merely because of such event, then the 
applicable employer plan shall continue to be treated as satisfying this 
paragraph (e) through the end of the period determined under section 
410(b)(6)(C)(ii).
    (f) Special rules for an employer that sponsors multiple plans--(1) 
General rule. For purposes of paragraph (c) of this section, all 
applicable employer plans, other than section 457 eligible governmental 
plans, maintained by the same employer are treated as one plan and all 
section 457 eligible governmental plans maintained by the same employer 
are treated as one plan. Thus, the total amount of catch-up 
contributions under all applicable employer plans of an employer (other 
than section 457 eligible governmental plans) is limited to the 
applicable dollar catch-up limit for the taxable year, and the total 
amount of catch-up contributions for all section 457 eligible 
governmental plans of an employer is limited to the applicable dollar 
catch-up limit for the taxable year.
    (2) Coordination of employer-provided limits. An applicable employer 
plan is permitted to allow a catch-up eligible participant to defer 
amounts in excess of an employer-provided limit under that plan without 
regard to whether

[[Page 1006]]

elective deferrals made by the participant have been treated as catch-up 
contributions for the taxable year under another applicable employer 
plan aggregated with such plan under this paragraph (f). However, to the 
extent elective deferrals under another plan maintained by the employer 
have already been treated as catch-up contributions during the taxable 
year, the elective deferrals under the plan may be treated as catch-up 
contributions only up to the amount remaining under the catch-up limit 
for the year. Any other elective deferrals that exceed the employer-
provided limit may not be treated as catch-up contributions and must 
satisfy the otherwise applicable nondiscrimination rules. For example, 
the right to make contributions in excess of the employer-provided limit 
is another right or feature which must satisfy Sec. 1.401(a)(4)-4 to 
the extent that the contributions are not catch-up contributions. Also, 
contributions in excess of the employer provided limit are taken into 
account under the ADP test to the extent they are not catch-up 
contributions.
    (3) Allocation rules. If a catch-up eligible participant makes 
additional elective deferrals in excess of an applicable limit under 
paragraph (b)(1) of this section under more than one applicable employer 
plan that is aggregated under the rules of this paragraph (f), the 
applicable employer plan under which elective deferrals in excess of an 
applicable limit are treated as catch-up contributions is permitted to 
be determined in any manner that is not inconsistent with the manner in 
which such amounts were actually deferred under the plan.
    (g) Definitions--(1) Applicable employer plan. The term applicable 
employer plan means a section 401(k) plan, a SIMPLE IRA plan as defined 
in section 408(p), a simplified employee pension plan as defined in 
section 408(k) (SEP), a plan or contract that satisfies the requirements 
of section 403(b), or a section 457 eligible governmental plan.
    (2) Elective deferral. The term elective deferral means an elective 
deferral within the meaning of section 402(g)(3) or any contribution to 
a section 457 eligible governmental plan.
    (3) Catch-up eligible participant. An employee is a catch-up 
eligible participant for a taxable year if--
    (i) The employee is eligible to make elective deferrals under an 
applicable employer plan (without regard to section 414(v) or this 
section); and
    (ii) The employee's 50th or higher birthday would occur before the 
end of the employee's taxable year.
    (4) Other definitions. (i) The terms employer, employee, section 
401(k) plan, and highly compensated employee have the meanings provided 
in Sec. 1.410(b)-9.
    (ii) The term section 457 eligible governmental plan means an 
eligible deferred compensation plan described in section 457(b) that is 
established and maintained by an eligible employer described in section 
457(e)(1)(A).
    (h) Examples. The following examples illustrate the application of 
this section. For purposes of these examples, the limit under section 
401(a)(30) is $15,000 and the applicable dollar catch-up limit is $5,000 
and, except as specifically provided, the plan year is the calendar 
year. In addition, it is assumed that the participant's elective 
deferrals under all plans of the employer do not exceed the 
participant's section 415(c)(3) compensation, that the taxable year of 
the participant is the calendar year and that any correction pursuant to 
section 401(k)(8) is made through distribution of excess contributions. 
The examples are as follows:

    Example 1. (i) Participant A is eligible to make elective deferrals 
under a section 401(k) plan, Plan P. Plan P does not limit elective 
deferrals except as necessary to comply with sections 401(a)(30) and 
415. In 2006, Participant A is 55 years old. Plan P also provides that a 
catch-up eligible participant is permitted to defer amounts in excess of 
the section 401(a)(30) limit up to the applicable dollar catch-up limit 
for the year. Participant A defers $18,000 during 2006.
    (ii) Participant A's elective deferrals in excess of the section 
401(a)(30) limit ($3,000) do not exceed the applicable dollar catch-up 
limit for 2006 ($5,000). Under paragraph (a)(1) of this section, the 
$3,000 is a catch-up contribution and, pursuant to paragraph (d)(2)(i) 
of this section, it is not taken into account in determining Participant 
A's ADR for purposes of section 401(k)(3).
    Example 2. (i) Participants B and C, who are highly compensated 
employees each earning $120,000, are eligible to make elective

[[Page 1007]]

deferrals under a section 401(k) plan, Plan Q. Plan Q limits elective 
deferrals as necessary to comply with section 401(a)(30) and 415, and 
also provides that no highly compensated employee may make an elective 
deferral at a rate that exceeds 10% of compensation. However, Plan Q 
also provides that a catch-up eligible participant is permitted to defer 
amounts in excess of 10% during the plan year up to the applicable 
dollar catch-up limit for the year. In 2006, Participants B and C are 
both 55 years old and, pursuant to the catch-up provision in Plan Q, 
both elect to defer 10% of compensation plus a pro-rata portion of the 
$5,000 applicable dollar catch-up limit for 2006. Participant B 
continues this election in effect for the entire year, for a total 
elective contribution for the year of $17,000. However, in July 2006, 
after deferring $8,500, Participant C discontinues making elective 
deferrals.
    (ii) Once Participant B's elective deferrals for the year exceed the 
section 401(a)(30) limit ($15,000), subsequent elective deferrals are 
treated as catch-up contributions as they are deferred, provided that 
such elective deferrals do not exceed the catch-up contribution limit 
for the taxable year. Since the $2,000 in elective deferrals made after 
Participant B reaches the section 402(g) limit for the calendar year 
does not exceed the applicable dollar catch-up limit for 2006, the 
entire $2,000 is treated as a catch-up contribution.
    (iii) As of the last day of the plan year, Participant B has 
exceeded the employer-provided limit of 10% (10% of $120,000 or $12,000 
for Participant B) by an additional $3,000. Since the additional $3,000 
in elective deferrals does not exceed the $5,000 applicable dollar 
catch-up limit for 2006, reduced by the $2,000 in elective deferrals 
previously treated as catch-up contributions, the entire $3,000 of 
elective deferrals is treated as a catch-up contribution.
    (iv) In determining Participant B's ADR, the $5,000 of catch-up 
contributions are subtracted from Participant B's elective deferrals for 
the plan year under paragraph (d)(2)(i) of this section. Accordingly, 
Participant B's ADR is 10% ($12,000/$120,000). In addition, for purposes 
of applying the rules of section 401(k)(8), Participant B is treated as 
having elective deferrals of $12,000.
    (v) Participant C's elective deferrals for the year do not exceed an 
applicable limit for the plan year. Accordingly, Participant C's $8,500 
of elective deferrals must be taken into account in determining 
Participant C's ADR for purposes of section 401(k)(3).
    Example 3. (i) The facts are the same as in Example 2, except that 
Plan Q is amended to change the maximum permitted deferral percentage 
for highly compensated employees to 7%, effective for deferrals after 
April 1, 2006. Participant B, who has earned $40,000 in the first 3 
months of the year and has been deferring at a rate of 10% of 
compensation plus a pro-rata portion of the $5,000 applicable dollar 
catch-up limit for 2006, reduces the 10% of pay deferral rate to 7% for 
the remaining 9 months of the year (while continuing to defer a pro-rata 
portion of the $5,000 applicable dollar catch-up limit for 2006). During 
those 9 months, Participant B earns $80,000. Thus, Participant B's total 
elective deferrals for the year are $14,600 ($4,000 for the first 3 
months of the year plus $5,600 for the last 9 months of the year plus an 
additional $5,000 throughout the year).
    (ii) The employer-provided limit for Participant B for the plan year 
is $9,600 ($4,000 for the first 3 months of the year, plus $5,600 for 
the last 9 months of the year). Accordingly, Participant B's elective 
deferrals for the year that are in excess of the employer-provided limit 
are $5,000 (the excess of $14,600 over $9,600), which does not exceed 
the applicable dollar catch-up limit of $5,000.
    (iii) Alternatively, Plan Q may provide that the employer-provided 
limit is determined as the time-weighted average of the different 
deferral percentage limits over the course of the year. In this case, 
the time-weighted average limit is 7.75% for all participants, and the 
applicable limit for Participant B is 7.75% of $120,000, or $9,300. 
Accordingly, Participant B's elective deferrals for the year that are in 
excess of the employer-provided limit are $5,300 (the excess of $14,600 
over $9,300). Since the amount of Participant B's elective deferrals in 
excess of the employer-provided limit ($5,300) exceeds the applicable 
dollar catch-up limit for the taxable year, only $5,000 of Participant 
B's elective deferrals may be treated as catch-up contributions. In 
determining Participant B's actual deferral ratio, the $5,000 of catch-
up contributions are subtracted from Participant B's elective deferrals 
for the plan year under paragraph (d)(2)(i) of this section. 
Accordingly, Participant B's actual deferral ratio is 8% ($9,600/
$120,000). In addition, for purposes of applying the rules of section 
401(k)(8), Participant B is treated as having elective deferrals of 
$9,600.
    Example 4. (i) The facts are the same as in Example 1. In addition 
to Participant A, Participant D is a highly compensated employee who is 
eligible to make elective deferrals under Plan P. During 2006, 
Participant D, who is 60 years old, elects to defer $14,000.
    (ii) The ADP test is run for Plan P (after excluding the $3,000 in 
catch-up contributions from Participant A's elective deferrals), but 
Plan P needs to take corrective action in order to pass the ADP test. 
After applying the rules of section 401(k)(8)(C) to allocate the total 
excess contributions determined under section 401(k)(8)(B), the maximum 
deferrals which may be retained by any highly compensated employee in 
Plan P is $12,500.

[[Page 1008]]

    (iii) Pursuant to paragraph (b)(1)(iii) of this section, the ADP 
limit under Plan P of $12,500 is an applicable limit. Accordingly, 
$1,500 of Participant D's elective deferrals exceed the applicable 
limit. Similarly, $2,500 of Participant A's elective deferrals (other 
than the $3,000 of elective deferrals treated as catch-up contributions 
because they exceed the section 401(a)(30) limit) exceed the applicable 
limit.
    (iv) The $1,500 of Participant D's elective deferrals that exceed 
the applicable limit are less than the applicable dollar catch-up limit 
and are treated as catch-up contributions. Pursuant to paragraph 
(d)(2)(iii) of this section, Plan P must retain Participant D's $1,500 
in elective deferrals and Plan P is not treated as failing to satisfy 
section 401(k)(8) merely because the elective deferrals are not 
distributed to Participant D.
    (v) The $2,500 of Participant A's elective deferrals that exceed the 
applicable limit are greater than the portion of the applicable dollar 
catch-up limit ($2,000) that remains after treating the $3,000 of 
elective deferrals in excess of the section 401(a)(30) limit as catch-up 
contributions. Accordingly, $2,000 of Participant A's elective deferrals 
are treated as catch-up contributions. Pursuant to paragraph (d)(2)(iii) 
of this section, Plan P must retain Participant A's $2,000 in elective 
deferrals and Plan P is not treated as failing to satisfy section 
401(k)(8) merely because the elective deferrals are not distributed to 
Participant A. However, $500 of Participant A's elective deferrals 
cannot be treated as catch-up contributions and must be distributed to 
Participant A in order to satisfy section 401(k)(8).
    Example 5. (i) Participant E is a highly compensated employee who is 
a catch-up eligible participant under a section 401(k) plan, Plan R, 
with a plan year ending October 31, 2006. Plan R does not limit elective 
deferrals except as necessary to comply with section 401(a)(30) and 
section 415. Plan R permits all catch-up eligible participants to defer 
an additional amount equal to the applicable dollar catch-up limit for 
the year ($5,000) in excess of the section 401(a)(30) limit. Participant 
E did not exceed the section 401(a)(30) limit in 2005 and did not exceed 
the ADP limit for the plan year ending October 31, 2005. Participant E 
made $3,200 of deferrals in the period November 1, 2005 through December 
31, 2005 and an additional $16,000 of deferrals in the first 10 months 
of 2006, for a total of $19,200 in elective deferrals for the plan year.
    (ii) Once Participant E's elective deferrals for the calendar year 
2006 exceed $15,000, subsequent elective deferrals are treated as catch-
up contributions at the time they are deferred, provided that such 
elective deferrals do not exceed the applicable dollar catch-up limit 
for the taxable year. Since the $1,000 in elective deferrals made after 
Participant E reaches the section 402(g) limit for the calendar year 
does not exceed the applicable dollar catch-up limit for 2006, the 
entire $1,000 is a catch-up contribution. Pursuant to paragraph 
(d)(2)(i) of this section, $1,000 is subtracted from Participant E's 
$19,200 in elective deferrals for the plan year ending October 31, 2006 
in determining Participant E's ADR for that plan year.
    (iii) The ADP test is run for Plan R (after excluding the $1,000 in 
elective deferrals in excess of the section 401(a)(30) limit), but Plan 
R needs to take corrective action in order to pass the ADP test. After 
applying the rules of section 401(k)(8)(C) to allocate the total excess 
contributions determined under section 401(k)(8)(C), the maximum 
deferrals that may be retained by any highly compensated employee under 
Plan R for the plan year ending October 31, 2006 (the ADP limit) is 
$14,800.
    (iv) Under paragraph (d)(2)(ii) of this section, elective deferrals 
that exceed the section 401(a)(30) limit under Plan R are also 
subtracted from Participant E's elective deferrals under Plan R for 
purposes of applying the rules of section 401(k)(8). Accordingly, for 
purposes of correcting the failed ADP test, Participant E is treated as 
having contributed $18,200 of elective deferrals in Plan R. The amount 
of elective deferrals that would have to be distributed to Participant E 
in order to satisfy section 401(k)(8)(C) is $3,400 ($18,200 minus 
$14,800), which is less than the excess of the applicable dollar catch-
up limit ($5,000) over the elective deferrals previously treated as 
catch-up contributions under Plan R for the taxable year ($1,000). Under 
paragraph (d)(2)(iii) of this section, Plan R must retain Participant 
E's $3,400 in elective deferrals and is not treated as failing to 
satisfy section 401(k)(8) merely because the elective deferrals are not 
distributed to Participant E.
    (v) Even though Participant E's elective deferrals for the calendar 
year 2006 have exceeded the section 401(a)(30) limit, Participant E can 
continue to make elective deferrals during the last 2 months of the 
calendar year, since Participant E's catch-up contributions for the 
taxable year are not taken into account in applying the section 
401(a)(30) limit for 2006. Thus, Participant E can make an additional 
contribution of $3,400 ($15,000 minus ($16,000 minus $4,400)) without 
exceeding the section 401(a)(30) for the calendar year and without 
regard to any additional catch-up contributions. In addition, 
Participant E may make additional catch-up contributions of $600 (the 
$5,000 applicable dollar catch-up limit for 2006, reduced by the $4,400 
($1,000 plus $3,400) of elective deferrals previously treated as catch-
up contributions during the taxable year). The $600 of catch-up 
contributions will not be taken into account in the ADP test for the 
plan year ending October 31, 2007.

[[Page 1009]]

    Example 6. (i) The facts are the same as in Example 5, except that 
Participant E exceeded the section 401(a)(30) limit for 2005 by $1,300 
prior to October 31, 2005, and made $600 of elective deferrals in the 
period November 1, 2005, through December 31, 2005 (which were catch-up 
contributions for 2005). Thus, Participant E made $16,600 of elective 
deferrals for the plan year ending October 31, 2006.
    (ii) Once Participant E's elective deferrals for the calendar year 
2006 exceed $15,000, subsequent elective deferrals are treated as catch-
up contributions as they are deferred, provided that such elective 
deferrals do not exceed the applicable dollar catch-up limit for the 
taxable year. Since the $1,000 in elective deferrals made after 
Participant E reaches the section 402(g) limit for calendar year 2006 
does not exceed the applicable dollar catch-up limit for 2006, the 
entire $1,000 is a catch-up contribution. Pursuant to paragraph 
(d)(2)(i) of this section, $1,000 is subtracted from Participant E's 
elective deferrals in determining Participant E's ADR for the plan year 
ending October 31, 2006. In addition, the $600 of catch-up contributions 
from the period November 1, 2005 to December 31, 2005 are subtracted 
from Participant E's elective deferrals in determining Participant E's 
ADR. Thus, the total elective deferrals taken into account in 
determining Participant E's ADR for the plan year ending October 31, 
2006, is $15,000 ($16,600 in elective deferrals for the current plan 
year, less $1,600 in catch-up contributions).
    (iii) The ADP test is run for Plan R (after excluding the $1,600 in 
elective deferrals in excess of the section 401(a)(30) limit), but Plan 
R needs to take corrective action in order to pass the ADP test. After 
applying the rules of section 401(k)(8)(C) to allocate the total excess 
contributions determined under section 401(k)(8)(C), the maximum 
deferrals that may be retained by any highly compensated employee under 
Plan R (the ADP limit) is $14,800.
    (iv) Under paragraph (d)(2)(ii) of this section, elective deferrals 
that exceed the section 401(a)(30) limit under Plan R are also 
subtracted from Participant E's elective deferrals under Plan R for 
purposes of applying the rules of section 401(k)(8). Accordingly, for 
purposes of correcting the failed ADP test, Participant E is treated as 
having contributed $15,000 of elective deferrals in Plan R. The amount 
of elective deferrals that would have to be distributed to Participant E 
in order to satisfy section 401(k)(8)(C) is $200 ($15,000 minus 
$14,800), which is less than the excess of the applicable dollar catch-
up limit ($5,000) over the elective deferrals previously treated as 
catch-up contributions under Plan R for the taxable year ($1,000). Under 
paragraph (d)(2)(iii) of this section, Plan R must retain Participant 
E's $200 in elective deferrals and is not treated as failing to satisfy 
section 401(k)(8) merely because the elective deferrals are not 
distributed to Participant E.
    (v) Even though Participant E's elective deferrals for calendar year 
2006 have exceeded the section 401(a)(30) limit, Participant E can 
continue to make elective deferrals during the last 2 months of the 
calendar year, since Participant E's catch-up contributions for the 
taxable year are not taken into account in applying the section 
401(a)(30) limit for 2006. Thus Participant E can make an additional 
contribution of $200 ($15,000 minus ($16,000 minus $1,200)) without 
exceeding the section 401(a)(30) for the calendar year and without 
regard to any additional catch-up contributions. In addition, 
Participant E may make additional catch-up contributions of $3,800 (the 
$5,000 applicable dollar catch-up limit for 2006, reduced by the $1,200 
($1,000 plus $200) of elective deferrals previously treated as catch-up 
contributions during the taxable year). The $3,800 of catch-up 
contributions will not be taken into account in the ADP test for the 
plan year ending October 31, 2007.
    Example 7. (i) Participant F, who is 58 years old, is a highly 
compensated employee who earns $100,000 per year. Participant F 
participates in a section 401(k) plan, Plan S, for the first 6 months of 
the year and then transfers to another section 401(k) plan, Plan T, 
sponsored by the same employer, for the second 6 months of the year. 
Plan S limits highly compensated employees' elective deferrals to 6% of 
compensation for the period of participation, but permits catch-up 
eligible participants to defer amounts in excess of 6% during the plan 
year, up to the applicable dollar catch-up limit for the year. Plan T 
limits highly compensated employees' elective deferrals to 8% of 
compensation for the period of participation, but permits catch-up 
eligible participants to defer amounts in excess of 8% during the plan 
year, up to the applicable dollar catch-up limit for the year. 
Participant F earned $50,000 in the first 6 months of the year and 
deferred $6,000 under Plan S. Participant F also deferred $6,500 under 
Plan T.
    (ii) As of the last day of the plan year, Participant F has $3,000 
in elective deferrals under Plan S that exceed the employer-provided 
limit of $3,000. Under Plan T, Participant F has $2,500 in elective 
deferrals that exceed the employer-provided limit of $4,000. The total 
amount of elective deferrals in excess of employer-provided limits, 
$5,500, exceeds the applicable dollar catch-up limit by $500. 
Accordingly, $500 of the elective deferrals in excess of the employer-
provided limits are not catch-up contributions and are treated as 
regular elective deferrals (and are taken into account in the ADP test). 
The determination of which elective deferrals in excess of an applicable 
limit are treated as catch-up contributions is permitted to be made in 
any manner that is not inconsistent

[[Page 1010]]

with the manner in which such amounts were actually deferred under Plan 
S and Plan T.
    Example 8. (i) Employer X sponsors Plan P, which provides for 
matching contributions equal to 50% of elective deferrals that do not 
exceed 10% of compensation. Elective deferrals for highly compensated 
employees are limited, on a payroll-by-payroll basis, to 10% of 
compensation. Employer X pays employees on a monthly basis. Plan P also 
provides that elective contributions are limited in accordance with 
section 401(a)(30) and other applicable statutory limits. Plan P also 
provides for catch-up contributions. Under Plan P, for purposes of 
calculating the amount to be treated as catch-up contributions (and to 
be excluded from the ADP test), amounts in excess of the 10% limit for 
highly compensated employees are determined at the end of the plan year 
based on compensation used for purposes of ADP testing (testing 
compensation), a definition of compensation that is different from the 
definition used under the plan for purposes of calculating elective 
deferrals and matching contributions during the plan year (deferral 
compensation).
    (ii) Participant A, a highly compensated employee, is a catch-up 
eligible participant under Plan P with deferral compensation of $10,000 
per monthly payroll period. Participant A defers 10% per payroll period 
for the first 10 months of the year, and is allocated a matching 
contribution each payroll period of $500. In addition, Participant A 
defers an additional $4,000 during the first 10 months of the year. 
Participant A then reduces deferrals during the last 2 months of the 
year to 5% of compensation. Participant A is allocated a matching 
contribution of $250 for each of the last 2 months of the plan year. For 
the plan year, Participant A has $15,000 in elective deferrals and 
$5,500 in matching contributions.
    (iii) A's testing compensation is $118,000. At the end of the plan 
year, based on 10% of testing compensation, or $11,800, Plan P 
determines that A has $3,200 in deferrals that exceed the 10% employer 
provided limit. Plan P excludes $3,200 from ADP testing and calculates 
A's ADR as $11,800 divided by $118,000, or 10%. Although A has not been 
allocated a matching contribution equal to 50% of $11,800, because Plan 
P provides that matching contributions are calculated based on elective 
deferrals during a payroll period as a percentage of deferral 
compensation, Plan P is not required to allocate an additional $400 of 
matching contributions to A.

    (i) Effective date--(1) Statutory effective date. Section 414(v) 
applies to contributions in taxable years beginning on or after January 
1, 2002.
    (2) Regulatory effective date. Paragraphs (a) through (h) of this 
section apply to contributions in taxable years beginning on or after 
January 1, 2004.

[T.D. 9072, 68 FR 40515, July 8, 2003]



Sec. 1.414(w)-1  Permissible withdrawals from eligible automatic 
contribution arrangements.

    (a) Overview. Section 414(w) provides rules under which certain 
employees are permitted to elect to make a withdrawal of default 
elective contributions from an eligible automatic contribution 
arrangement. This section sets forth the rules applicable to permissible 
withdrawals from an eligible automatic contribution arrangement within 
the meaning of section 414(w). Paragraph (b) of this section defines an 
eligible automatic contribution arrangement. Paragraph (c) of this 
section describes a permissible withdrawal and addresses which employees 
are eligible to elect a withdrawal, the timing of the withdrawal 
election, and the amount of the withdrawal. Paragraph (d) of this 
section describes the tax and other consequences of the withdrawal. 
Paragraph (e) of this section includes the definitions applicable to 
this section.
    (b) Eligible automatic contribution arrangement--(1) In general. An 
eligible automatic contribution arrangement is an automatic contribution 
arrangement under an applicable employer plan that is intended to be an 
eligible automatic contribution arrangement for the plan year and that 
satisfies the uniformity requirement under paragraph (b)(2) of this 
section, and the notice requirement under paragraph (b)(3) of this 
section. An eligible automatic contribution arrangement need not cover 
all employees who are eligible to elect to have contributions made on 
their behalf under the applicable employer plan.
    (2) Uniformity requirement--(i) In general. An eligible automatic 
contribution arrangement must provide that the default elective 
contribution is a uniform percentage of compensation.
    (ii) Exception to uniform percentage requirement. An arrangement 
does not violate the uniformity requirement of paragraph (b)(2)(i) of 
this section merely because the percentage varies in a manner that is 
permitted under Sec. 1.401(k)-3(j)(2)(iii), except that the

[[Page 1011]]

rule of Sec. 1.401(k)-3(j)(2)(iii)(B) is applied without regard to 
whether the arrangement is intended to be a qualified automatic 
contribution arrangement.
    (iii) Rules of application. For purposes of this paragraph (b)(2), 
all automatic contribution arrangements that are intended to be eligible 
automatic contribution arrangements within a plan (or within the 
disaggregated plan under Sec. 1.410(b)-7, in the case of a plan subject 
to section 410(b)) are aggregated. Thus, for example, if a single plan 
within the meaning of section 414(l) covering employees in two separate 
divisions has two different automatic contribution arrangements that are 
intended to be eligible automatic contributions arrangements, the two 
automatic contribution arrangements can constitute eligible automatic 
contribution arrangements only if the default elective contributions 
under the arrangements are the same percentage of compensation. However, 
if the different automatic contribution arrangements cover employees in 
portions of the plan that are mandatorily disaggregated under the rules 
of section 410(b), then there is no requirement to aggregate those 
automatic contribution arrangements under the uniformity requirements of 
this paragraph (b)(2).
    (3) Notice requirement--(i) General rule. The notice requirement of 
this paragraph (b)(3) is satisfied for a plan year if each covered 
employee is given notice of the employee's rights and obligations under 
the arrangement. The notice must be sufficiently accurate and 
comprehensive to apprise the employee of such rights and obligations, 
and be written in a manner calculated to be understood by the average 
employee to whom the arrangement applies. The notice must be in writing; 
however, see Sec. 1.401(a)-21 for rules permitting the use of 
electronic media to provide applicable notices.
    (ii) Content requirement. The notice must include the provisions 
found in Sec. 1.401(k)-3(d)(2)(ii) to the extent those provisions apply 
to the arrangement. A notice is not considered sufficiently accurate and 
comprehensive unless the notice accurately describes--
    (A) The level of the default elective contributions which will be 
made on the employee's behalf if the employee does not make an 
affirmative election;
    (B) The employee's rights to elect not to have default elective 
contributions made to the plan on his or her behalf or to have a 
different percentage of compensation or different amount of contribution 
made to the plan on his or her behalf;
    (C) How contributions made under the arrangement will be invested in 
the absence of any investment election by the employee; and
    (D) The employee's rights to make a permissible withdrawal, if 
applicable, and the procedures to elect such a withdrawal.
    (iii) Timing--(A) General rule. The timing requirement of this 
paragraph (b)(3)(iii) is satisfied if the notice is provided within a 
reasonable period before the beginning of each plan year or, in the plan 
year the employee is first eligible to make a cash or deferred election 
(or first becomes covered under the automatic contribution arrangement 
as a result of a change in employment status), within a reasonable 
period before the employee becomes a covered employee. In addition, a 
notice satisfies the timing requirements of paragraph (b)(3) of this 
section only if it is provided sufficiently early so that the employee 
has a reasonable period of time after receipt of the notice in order to 
make the election described under paragraph (e)(2)(i) or (e)(2)(ii) of 
this section.
    (B) Deemed satisfaction of timing requirement. The timing 
requirement of this paragraph (b)(3)(iii) is satisfied if at least 30 
days (and no more than 90 days) before the beginning of each plan year, 
the notice is given to each employee covered under the automatic 
contribution arrangement for the plan year. In the case of an employee 
who does not receive the notice within the period described in the 
previous sentence because the employee becomes eligible to make a cash 
or deferred election (or becomes covered under the automatic 
contribution arrangement as a result of a change in employment status) 
after the 90th day before the beginning of the plan year, the timing 
requirement is deemed to be satisfied if the notice is provided no more 
than 90

[[Page 1012]]

days before the employee becomes eligible to make a cash or deferred 
election (or becomes covered under the automatic contribution 
arrangement as a result of a change in employment status), and no later 
than the date that affords the employee a reasonable period of time 
after receipt of the notice to make the election described under 
paragraph (e)(2)(i) or (e)(2)(ii) of this section. If it is not 
practicable for the notice to be provided on or before the date 
specified in the plan that an employee becomes eligible to make a cash 
or deferred election, the notice will nonetheless be treated as provided 
timely if it is provided as soon as practicable after that date and the 
employee is permitted to elect to defer from all types of compensation 
that may be deferred under the plan earned beginning on that date.
    (c) Permissible withdrawal--(1) In general. If the plan so provides, 
any employee who has default elective contributions made under the 
eligible automatic contribution arrangement may elect to make a 
withdrawal of such contributions (and earnings attributable thereto) in 
accordance with the requirements of this paragraph (c). An applicable 
employer plan that includes an eligible automatic contribution 
arrangement will not fail to satisfy the prohibition on in-service 
withdrawals under section 401(k)(2)(B), 403(b)(7), 403(b)(11), or 
457(d)(1) merely because it permits withdrawals that satisfy the timing 
requirement of paragraph (c)(2) of this section and the amount 
requirement of paragraph (c)(3) of this section.
    (2) Timing--(i) Last date to make election. A covered employee's 
election to withdraw default elective contributions must be made no 
later than 90 days after the date of the first default elective 
contribution under the eligible automatic contribution arrangement and 
must be effective no later than the date set forth in paragraph 
(c)(2)(iii) of this section. A plan is permitted to set an earlier 
deadline for making this election, but if a plan provides that a covered 
employee may withdraw default elective contributions, then the election 
period for the covered employee must be at least 30 days.
    (ii) Determination of date of first default elective contribution. 
For purposes of this paragraph (c)(2), the date of the first default 
elective contribution is the date that the compensation that is subject 
to the cash or deferred election would otherwise have been included in 
gross income.
    (iii) Latest effective date of the election. The effective date of 
an election described in this paragraph (c)(2) cannot be after the 
earlier of--
    (A) The pay date for the second payroll period that begins after the 
date the election is made; and
    (B) The first pay date that occurs at least 30 days after the 
election is made.
    (iv) Special rules--(A) Treatment of periods without default 
elective contributions. For purposes of determining the date of the 
first default elective contribution under the eligible automatic 
contribution arrangement, a plan is permitted to treat an employee who 
for an entire plan year did not have default elective contributions made 
under the eligible automatic contribution arrangement as if the employee 
had not had such contributions for any prior plan year as well.
    (B) Treatment relating to aggregation of arrangements. The 
determination of whether an election is made no later than 90 days after 
the date of the first default elective contribution under the eligible 
automatic contribution arrangement must take into account any other 
eligible automatic contribution arrangement that is required to be 
aggregated with the eligible automatic contribution arrangement under 
the rules of paragraph (b)(2)(iii) of this section.
    (3) Amount and timing of distributions--(i) In general. A 
distribution satisfies the requirement of this paragraph (c)(3) if the 
distribution is equal to the amount of default elective contributions 
made under the eligible automatic contribution arrangement through the 
effective date of the election described in paragraph (c)(2) of this 
section (adjusted for allocable gains and losses to the date of 
distribution). If default elective contributions are separately 
accounted for in the participant's account, the amount of the 
distribution will be the total amount in that account. However, if 
default

[[Page 1013]]

elective contributions are not separately accounted for under the plan, 
the amount of the allocable gains and losses will be determined under 
rules similar to those provided under Sec. 1.401(k)-2(b)(2)(iv) for the 
distribution of excess contributions.
    (ii) Fees. The distribution amount as determined under this 
paragraph (c)(3) may be reduced by any generally applicable fees. 
However, the plan may not charge a higher fee for a distribution under 
section 414(w) than would apply to any other distributions of cash.
    (iii) Date of distribution. The distribution must be made in 
accordance with the plan's ordinary timing procedures for processing 
distributions and making distributions.
    (d) Consequences of the withdrawal--(1) Income tax consequences--(i) 
Year of inclusion. The amount of the withdrawal is includible in the 
eligible employee's gross income for the taxable year in which the 
distribution is made. However, any portion of the distribution 
consisting of designated Roth contributions is not included in an 
employee's gross income a second time. The portion of the withdrawal 
that is treated as an investment in the contract is determined without 
regard to any plan contributions other than those distributed as a 
withdrawal of default elective contributions.
    (ii) No additional tax on early distributions from qualified 
retirement plans. The withdrawal is not subject to the additional tax 
under section 72(t).
    (iii) Reporting. The amount of the withdrawal is reported on Form 
1099-R, ``Distributions From Pensions, Annuities, Retirement or Profit-
Sharing Plans, IRAs, Insurance Contracts, etc.,'' as described in the 
applicable instructions.
    (iv) Disregarded for purposes of section 402(g). The amount of the 
withdrawal is not taken into account in determining the limitation on 
elective deferrals under section 402(g).
    (2) Forfeiture of matching contributions. In the case of any 
withdrawal made under paragraph (c) of this section, employer matching 
contributions with respect to the amount withdrawn that have been 
allocated to the participant's account (adjusted for allocable gains and 
losses) must be forfeited. A plan is permitted to provide that employer 
matching contributions will not be made with respect to any withdrawal 
made under paragraph (c) of this section if the withdrawal has been made 
prior to the date as of which the match would otherwise be allocated.
    (3) Consent rules. A withdrawal made under paragraph (c) of this 
section may be made without regard to any notice or consent otherwise 
required under section 401(a)(11) or 417.
    (e) Definitions. Unless indicated otherwise, the following 
definitions apply for purposes of section 414(w) and this section.
    (1) Applicable employer plan. An applicable employer plan means a 
plan that--
    (i) Is qualified under section 401(a);
    (ii) Satisfies the requirements of section 403(b);
    (iii) Is a section 457(b) eligible governmental plan described in 
Sec. 1.457-2(f);
    (iv) Is a simplified employee pension the terms of which provide for 
a salary reduction arrangement described in section 408(k)(6); or
    (v) Is a SIMPLE described in section 408(p).
    (2) Automatic contribution arrangement. An automatic contribution 
arrangement means an arrangement that provides for a cash or deferred 
election and which specifies that, in the absence of a covered 
employee's affirmative election, a default election applies under which 
the employee is treated as having elected to have default elective 
contributions made on his or her behalf under the plan. The default 
election begins to apply with respect to an eligible employee no earlier 
than a reasonable period of time after receipt of the notice describing 
the automatic contribution arrangement. This default election ceases to 
apply with respect to an eligible employee for periods of time with 
respect to which the employee has an affirmative election that is 
currently in effect to--
    (i) Not have any default elective contributions made on his or her 
behalf; or
    (ii) Have contributions made in a different amount or percentage of 
compensation.
    (3) Covered employee. Covered employee means an employee who is 
covered under the automatic contribution

[[Page 1014]]

arrangement, determined under the terms of the plan. A plan must provide 
whether an employee who makes an affirmative election remains a covered 
employee. If a plan provides that an employee who makes an affirmative 
election described in paragraph (e)(2)(i) or (e)(2)(ii) of this section 
remains a covered employee, then the employee must continue to receive 
the notice described in paragraph (b)(3) of this section and the plan 
may be eligible for the excise tax relief with respect to excess amounts 
distributed within 6 months after the end of the plan year under section 
4979(f)(1). Such an employee will also have the default election reapply 
if the plan provides that the employee's prior affirmative election no 
longer remains in effect and the employee does not make a new 
affirmative election.
    (4) Default elective contributions. Default elective contributions 
means the contributions that are made at a specified level or amount 
under an automatic contribution arrangement in the absence of a covered 
employee's affirmative election that are--
    (i) Contributions described in section 402(g)(3); or
    (ii) Contributions made to an eligible governmental plan within the 
meaning of Sec. 1.457-2(f) that would be elective contributions if they 
were made under a qualified plan.
    (f) Effective/applicability date--(1) Statutory effective date. 
Section 414(w) applies to plan years beginning on or after January 1, 
2008.
    (2) Regulatory effective date. This section applies to plan years 
beginning on or after January 1, 2010. For plan years that begin in 
2008, a plan must operate in accordance with a good faith interpretation 
of section 414(w). For this purpose, a plan that operates in accordance 
with this section will be treated as operating in accordance with a good 
faith interpretation of section 414(w).

[T.D. 9447, 74 FR 8212, Feb. 24, 2009]



Sec. 1.415(a)-1  General rules with respect to limitations on benefits 
and contributions under qualified plans.

    (a) Trusts. Under sections 415 and 401(a)(16), a trust that forms 
part of a pension, profit-sharing, or stock bonus plan will not be 
qualified under section 401(a) if any of the following conditions 
exists:
    (1) In the case of a defined benefit plan, the annual benefit with 
respect to any participant for any limitation year exceeds the 
limitations of section 415(b) and Sec. 1.415(b)-1.
    (2) In the case of a defined contribution plan, the annual additions 
credited with respect to any participant for any limitation year exceed 
the limitations of section 415(c) and Sec. 1.415(c)-1.
    (3) The trust has been disqualified under section 415(g) and Sec. 
1.415(g)-1 for any year.
    (b) Certain annuities and accounts--(1) In general. Under section 
415, an employee annuity plan described in section 403(a), an annuity 
contract described in section 403(b), or a simplified employee pension 
described in section 408(k) will not be considered to be described in 
the otherwise applicable section if any of the following conditions 
exists:
    (i) The annual benefit under a defined benefit plan with respect to 
any participant for any limitation year exceeds the limitations of 
section 415(b) and Sec. 1.415(b)-1.
    (ii) The contributions and other additions credited under a defined 
contribution plan with respect to any participant for any limitation 
year exceed the limitations of section 415(c) and Sec. 1.415(c)-1.
    (iii) The employee annuity plan, annuity contract, or simplified 
employee pension has been disqualified under section 415(g) and Sec. 
1.415(g)-1 for any year.
    (2) Special rule for section 403(b) annuity contracts. If the 
contributions and other additions under an annuity contract that 
otherwise satisfies the requirements of section 403(b) exceed the 
limitations of section 415(c) and Sec. 1.415(c)-1 with respect to any 
participant for any limitation year (regardless of whether the annuity 
contract is a defined contribution plan or a defined benefit plan), then 
the portion of the contract that includes such excess annual addition 
fails to be a section 403(b) annuity contract, and the remaining portion 
of the contract is a section 403(b) annuity contract. However, the 
status of the remaining portion of the contract as a section 403(b) 
annuity

[[Page 1015]]

contract is not retained unless, for the year of the excess and each 
year thereafter, the issuer of the contract maintains separate accounts 
for each such portion. In addition, if the benefit under an annuity 
contract that is a defined benefit plan and that otherwise satisfies the 
requirements of section 403(b) exceeds the limitations of section 415(b) 
and Sec. 1.415(b)-1 with respect to any participant for any limitation 
year, then the contract fails to be a section 403(b) annuity contract.
    (3) Section 403(b) annuity contract. For purposes of section 415 and 
regulations promulgated under section 415, the term section 403(b) 
annuity contract includes arrangements that are treated as annuity 
contracts for purposes of section 403(b). Thus, such term includes 
custodial accounts described in section 403(b)(7) and retirement income 
accounts described in section 403(b)(9).
    (c) Regulations--(1) In general. This section provides general rules 
regarding the application of section 415. For further rules regarding 
the application of section 415, see--
    (i) Section 1.415(b)-1 (for general rules regarding the limits 
applicable to defined benefit plans);
    (ii) Section 1.415(b)-2 (for special rules for defined benefit plans 
where a participant has multiple annuity starting dates);
    (iii) Section 1.415(c)-1 (for general rules regarding the limits 
applicable to defined contribution plans);
    (iv) Section 1.415(c)-2 (for rules regarding the definition of 
compensation for purposes of section 415);
    (v) Section 1.415(d)-1 (for rules regarding cost-of-living 
adjustments to the various limits of section 415);
    (vi) Section 1.415(f)-1 (for rules for aggregating plans for 
purposes of section 415);
    (vii) Section 1.415(g)-1 (for rules regarding disqualification of 
plans that fail to satisfy the requirements of section 415); and
    (viii) Section 1.415(j)-1 (for rules regarding limitation years).
    (2) Cross references to special rules for section 403(b) annuity 
contracts. For special rules relating to section 403(b) annuity 
contracts, see--
    (i) Section 1.415(c)-2(g)(1) and (3) (relating to the definition of 
compensation for section 403(b) annuity contracts);
    (ii) Section 1.415(f)-1(f) (relating to rules for section 403(b) 
annuity contracts for purposes of aggregating plans);
    (iii) Section 1.415(g)-1(b)(3)(iv)(C) (regarding disqualification of 
a section 403(b) annuity contract aggregated with a qualified defined 
contribution plan if the aggregated plans exceed the limitations of 
section 415(c));
    (iv) Section 1.415(g)-1(c) (relating to the plan year for section 
403(b) annuity contracts); and
    (v) Section 1.415(j)-1(e) (relating to the limitation year for 
section 403(b) annuity contracts).
    (3) Cross references to special rules for governmental plans. For 
special rules relating to governmental plans, see--
    (i) Paragraph (f)(4) of this section (regarding permissive service 
credits);
    (ii) Paragraph (g)(2) of this section (providing a delayed effective 
date for governmental plans);
    (iii) Section 1.415(b)-1(a)(6)(i) (providing an exception from the 
compensation-based limit of section 415(b)(1)(B) for governmental 
plans);
    (iv) Section 1.415(b)-1(a)(7)(ii) (regarding a special limitation 
for certain governmental plans making an election during 1990);
    (v) Section 1.415(b)-1(b)(4) (regarding qualified governmental 
excess benefit arrangements);
    (vi) Section 1.415(b)-1(d)(3) and (4) (regarding age adjustments to 
the dollar limit of section 415(b)(1)(A) for employees of police and 
fire departments and members of the Armed Forces of the United States, 
and for survivor and disability benefits);
    (vii) Section 1.415(b)-1(g)(3) (regarding adjustments to applicable 
limitations for years of participation, and adjustments to applicable 
limitations for years of service for survivor and disability benefits 
under governmental plans);
    (viii) Section 1.415(c)-1(b)(2)(ii) and (3)(iii) (regarding amounts 
not treated as annual additions under governmental plans); and
    (ix) Section 1.415(c)-2(e)(5) (providing an alternative rule for 
inclusion of compensation after a severance from employment for 
governmental plans).

[[Page 1016]]

    (4) Cross references to special rules for multiemployer plans. For 
special rules relating to multiemployer plans as defined in section 
414(f), see--
    (i) Paragraph (e) of this section (regarding benefits or 
contributions taken into account where a plan is maintained by more than 
one employer);
    (ii) Paragraph (f)(5)(ii) of this section (providing a special 
definition of severance from employment for multiemployer plans);
    (iii) Section 1.415(b)-1(a)(6)(ii) (providing an exception from the 
compensation-based limit for multiemployer plans);
    (iv) Section 1.415(b)-1(f)(3) (regarding the application of the 
minimum $10,000 limitation on benefits in the case of a multiemployer 
plan);
    (v) Section 1.415(f)-1(g) (providing special rules for aggregating 
multiemployer plans with other plans); and
    (vi) Section 1.415(g)-1(b)(3)(ii) (regarding plan disqualification 
rules where a multiemployer plan is aggregated with a plan that is not a 
multiemployer plan and the aggregated plans exceed the limitations of 
section 415).
    (5) Cross references to special rules for plans that are not subject 
to the requirements of section 411. For special rules relating to plans 
that are not subject to the requirements of section 411, see--
    (i) Paragraph (d)(1) of this section and Sec. 1.415(b)-1(a)(7)(iii) 
(providing that the rule limiting accruals to the section 415(b) limits 
does not apply to plans that are not subject to the requirements of 
section 411); and
    (ii) Section 1.415(b)-1(b)(2)(iii) (providing rules for applying the 
section 411(c) factors in determining the annual benefit attributable to 
employee contributions for plans that are not subject to the 
requirements of section 411).
    (6) Cross references to special rules for plans maintained by 
churches. For special rules relating to plans maintained by churches as 
defined in section 3121(w)(3)(A), see Sec. Sec. 1.415(b)-1(a)(6)(iv) 
and 1.415(b)-1(a)(7)(iv) (providing an exception from the compensation-
based limit for participants who have never been a highly compensated 
employee of the church).
    (d) Plan provisions--(1) In general. Although no specific plan 
provision is required under section 415 in order for a plan to establish 
or maintain its qualification, the plan provisions must preclude the 
possibility that any distribution under a defined benefit plan or annual 
addition under a defined contribution plan will exceed the limitations 
of section 415. In addition, a defined benefit plan that is subject to 
the requirements of section 411 must preclude the possibility that any 
accrual under the plan will exceed the limitations of section 415. A 
defined benefit plan may include provisions that automatically freeze or 
reduce the rate of benefit accrual (or limit the benefit payable in the 
case of a plan that is not subject to the requirements of section 411), 
and a defined contribution plan may include provisions that 
automatically limit the annual addition to a level necessary to prevent 
the limitations of section 415 from being exceeded with respect to any 
participant. For rules relating to this type of plan provision and the 
definitely determinable benefit requirement for pension plans, see Sec. 
1.401(a)-1(b)(1)(iii). Because Sec. 1.401(a)-1(b)(1)(iii) requires that 
the operation of such a provision preclude discretion by the employer, 
if two defined benefit plans that are aggregated under the rules of 
section 415(f) would otherwise provide for aggregate benefits that might 
exceed the limits of section 415(b), the plan provisions must specify 
(without involving employer discretion) how benefits will be limited to 
prevent a violation of section 415(b).
    (2) Special rule for profit-sharing and stock bonus plans. A 
provision of a profit-sharing or stock bonus plan that automatically 
freezes or reduces the amount of annual additions to ensure that the 
limitations of section 415 will not be exceeded must comply with the 
requirement set forth in Sec. 1.401-1(b)(1)(ii) or (iii) (as 
applicable) that such plans provide a definite predetermined formula for 
allocating the contributions made to the plan among the participants. If 
the operation of a provision that automatically freezes or reduces the 
amount of annual additions to ensure that the limitations of section 415 
are not exceeded does not involve discretionary action on the part

[[Page 1017]]

of the employer, the definite predetermined allocation formula 
requirement is not violated by the provision. If the operation of such a 
provision involves discretionary action on the part of the employer, the 
definite predetermined allocation formula requirement is violated. For 
example, if two profit-sharing plans of one employer otherwise provide 
for aggregate contributions which may exceed the limits of section 
415(c), the plan provisions must specify (without involving employer 
discretion) under which plan contributions and allocations will be 
reduced to prevent an excess annual addition and how the reduction will 
occur.
    (3) Incorporation by reference--(i) In general. A plan is permitted 
to incorporate by reference the limitations of section 415, and will not 
fail to meet the definitely determinable benefit requirement or the 
definite predetermined allocation formula requirement, whichever applies 
to the plan, merely because it incorporates the limits of section 415 by 
reference.
    (ii) Section 415 can be applied in more than one manner, but a 
statutory or regulatory default rule exists. Where a provision of 
section 415 is permitted to be applied in more than one manner but is to 
be applied in a specified manner in the absence of contrary plan 
provisions (in other words, a default rule exists), if a plan 
incorporates the limitations of section 415 by reference with respect to 
that provision of section 415 and does not specifically vary from the 
default rule, then the default rule applies. With respect to a provision 
of section 415 for which a default rule exists, if the limitations of 
section 415 are to be applied in a manner other than using the default 
rule, the plan must specify the manner in which the limitation is to be 
applied in addition to generally incorporating the limitations of 
section 415 by reference. For example, if a plan generally incorporates 
the limitations of section 415 by reference and does not restrict the 
accrued benefits to which the amendments to section 415(b)(2)(E) made by 
the Uruguay Round Agreements Act of 1994, Public Law 103-465 (108 Stat. 
4809) (GATT), apply (as permitted by Q&A-12 of Rev. Rul. 98-1 (1998-1 CB 
249) (see Sec. 601.601(d)(2) of this chapter), which reflects the 
amendments to section 767 of GATT made by section 1449 of the Small 
Business Job Protection Act of 1996, Public Law 104-188 (110 Stat. 
1755)), then the amendments to section 415(b)(2)(E) made by GATT apply 
to all benefits under the plan.
    (iii) Section 415 can be applied in more than one manner with no 
statutory or regulatory default. If a limitation of section 415 may be 
applied in more than one manner, and if there is no governing principle 
pursuant to which that limitation is applied in the absence of contrary 
plan provisions, then the plan must specify the manner in which the 
limitation is to be applied in addition to generally incorporating the 
limitations of section 415 by reference. For example, if an employer 
maintains two profit-sharing plans, and if any participant participates 
in more than one such plan, then both plans must specify (in a 
consistent manner) under which of the employer's two profit-sharing 
plans annual additions must be reduced if aggregate annual additions 
would otherwise exceed the limitations of section 415(c).
    (iv) Former requirements. A plan is not permitted to incorporate by 
reference formerly applicable requirements of section 415 that are no 
longer in force (such as the limits of former section 415(e)).
    (v) Cost-of-living adjustments--(A) In general. A plan is permitted 
to incorporate by reference the annual adjustments to the limitations of 
section 415 that are made pursuant to section 415(d). See Sec. 
1.415(d)-1 for additional rules relating to cost-of-living adjustments 
under section 415(d).
    (B) Cost-of-living adjustments not included in accrued benefit until 
effective. Notwithstanding that a plan incorporates the increases to the 
applicable limits under section 415(d) by reference, the accrued benefit 
of a participant for purposes of section 411 and any amount payable to a 
participant for purposes of Sec. 1.415(b)-1(a)(1) are not permitted to 
reflect increases pursuant to the annual increase under section 415(d) 
of the dollar limitation described in section 415(b)(1)(A) or the 
compensation limit described in section 415(b)(1)(B) for any period 
before the annual increase becomes effective. See

[[Page 1018]]

Sec. 1.415(d)-1(a)(3) for rules relating to when the annual adjustments 
to the dollar and compensation limitations are effective. A plan 
amendment does not violate the requirements of section 411(d)(6) merely 
because it eliminates the incorporation by reference of the increases 
under section 415(d) with respect to increases that have not yet 
occurred.
    (C) Application of increase in defined benefit dollar limit to 
participants who have incurred a severance from employment or commenced 
receiving benefits. If a plan incorporates by reference the annual 
adjustments to the limitations of section 415 pursuant to this paragraph 
(d)(3)(v), the plan will be treated as applying the section 415(d) cost-
of-living adjustments to the maximum extent permitted under the safe 
harbor described in Sec. 1.415(d)-1(a)(5), except to the extent 
provided in this paragraph (d)(3)(v)(C). Thus, such a plan is not 
subject to the requirements of Sec. 1.415(b)-1(b)(1)(iii) (providing 
special rules for determining the annual benefit of an employee in the 
case of multiple annuity starting dates) with respect to benefit 
increases that result solely from an increase in the section 415(b) 
limits pursuant to section 415(d). If a plan incorporates by reference 
the annual adjustments to the limitations of section 415 pursuant to 
this paragraph (d)(3)(v), the annual increase under section 415(d) of 
the dollar limitation described in section 415(b)(1)(A) does not apply 
with respect to a participant if the increase is effective after the 
participant's severance from employment with the employer maintaining 
the plan (or, if earlier, after the annuity starting date in the case of 
a participant who has commenced receiving benefits), unless the plan 
specifies that this annual increase applies. Similarly, if a plan 
incorporates by reference the annual adjustments to the limitations of 
section 415 pursuant to this paragraph (d)(3)(v), the annual increase 
under section 415(d) of the compensation-based limitation described in 
section 415(b)(1)(B) does not apply with respect to a participant for 
increases that are effective after the participant's severance from 
employment with the employer maintaining the plan (or, if earlier, after 
the annuity starting date in the case of a participant who has commenced 
receiving benefits), unless the plan specifies that this annual increase 
applies.
    (D) Treatment of cost-of-living adjustments for funding and 
deduction purposes. In general, the annual increase under section 415(d) 
of the dollar limitation described in section 415(b)(1)(A) and the 
compensation limitation described in section 415(b)(1)(B) is treated as 
a plan amendment, regardless of whether the plan reflects the increase 
automatically through operation of plan provisions in accordance with 
this paragraph (d)(3)(v) or the plan is amended to reflect the increase 
(pursuant to Sec. 1.415(d)-1(a)(5)). However, where a plan reflects the 
annual increase under section 415(d) of the dollar limitation described 
in section 415(b)(1)(A) or the compensation limitation described in 
section 415(b)(1)(B) automatically through operation of plan provisions 
pursuant to this paragraph (d)(3)(v), the funding method for the plan is 
permitted to provide for this annual increase to be treated as an 
experience loss for purposes of applying sections 404, 412, and 431.
    (e) Rules for plans maintained by more than one employer. Except as 
provided in Sec. 1.415(f)-1(g)(2)(i) (regarding aggregation of 
multiemployer plans with plans other than multiemployer plans), for 
purposes of applying the limitations of section 415 with respect to a 
participant in a plan maintained by more than one employer, benefits and 
contributions attributable to such participant from all of the employers 
maintaining the plan must be taken into account. Furthermore, in 
applying the limitations of section 415 with respect to a participant in 
such a plan, the total compensation received by the participant from all 
of the employers maintaining the plan is taken into account under the 
plan, unless the plan specifies otherwise.
    (f) Special rules--(1) Affiliated employers. Pursuant to section 
414(b) and Sec. 1.414(b)-1, all employees of all corporations that are 
members of a controlled group of corporations (within the meaning of 
section 1563(a), as modified by section 1563(f)(5), and determined 
without regard to section 1563(a)(4) and (e)(3)(C)) are treated as

[[Page 1019]]

employed by a single employer for purposes of section 415. Similarly, 
pursuant to section 414(c) and regulations promulgated under section 
414(c), all employees of trades or businesses that are under common 
control are treated as employed by a single employer. Thus, any defined 
benefit plan or defined contribution plan maintained by any member of a 
controlled group of corporations (within the meaning of section 414(b)) 
or by any trade or business (whether or not incorporated) that is part 
of a group of trades or businesses that are under common control (within 
the meaning of section 414(c)) is deemed maintained by all such members 
or such trades or businesses. Pursuant to section 415(h), for purposes 
of section 415, sections 414(b) and 414(c) are applied by using the 
phrase ``more than 50 percent'' instead of the phrase ``at least 80 
percent'' each place the latter phrase appears in section 1563(a)(1) and 
in the regulations under section 414(c) (except for purposes of 
determining whether two or more organizations are a brother-sister group 
of trades or businesses under common control under the rules in Sec. 
1.414(c)-2(c)).
    (2) Affiliated service groups. Any defined benefit plan or defined 
contribution plan maintained by any member of an affiliated service 
group (within the meaning of section 414(m)) is deemed maintained by all 
members of that affiliated service group.
    (3) Leased employees--(i) In general. Pursuant to section 414(n), 
except as provided in paragraph (f)(3)(ii) of this section, with respect 
to any person (referred to as the recipient) for whom a leased employee 
(within the meaning of section 414(n)(2)) performs services, the leased 
employee is treated as an employee of the recipient, but contributions 
or benefits provided by the leasing organization that are attributable 
to services performed for the recipient are treated as provided under a 
plan maintained by the recipient.
    (ii) Exception for leased employees covered by safe harbor plans. 
Pursuant to section 414(n)(5), the rule of paragraph (f)(3)(i) of this 
section does not apply to a leased employee with respect to services 
performed for a recipient if--
    (A) The leased employee is covered by a plan that is maintained by 
the leasing organization and that meets the requirements of section 
414(n)(5)(B); and
    (B) Leased employees (determined without regard to this paragraph 
(f)(3)(ii)) do not constitute more than 20 percent of the recipient's 
nonhighly compensated workforce.
    (4) Permissive service credit under governmental plans. See section 
415(n) for rules regarding the application of the limitations of 
sections 415(b) and (c) where a participant makes contributions 
(including a transfer described in section 403(b)(13) or section 
457(e)(17)) to a defined benefit governmental plan to purchase 
permissive service credit under the plan.
    (5) Definition of severance from employment--(i) General rule. For 
purposes of this section and Sec. Sec. 1.415(b)-1, 1.415(b)-2, 
1.415(c)-1, 1.415(c)-2, 1.415(d)-1, 1.415(f)-1, 1.415(g)-1, and 
1.415(j)-1, whether an employee has a severance from employment with the 
employer that maintains a plan is determined in the same manner as under 
Sec. 1.401(k)-1(d)(2) except that, for purposes of determining the 
employer of an employee, the modifications provided under section 415(h) 
(described in paragraph (f)(1) of this section) to the employer 
aggregation rules apply. Thus, an employee has a severance from 
employment when the employee ceases to be an employee of the employer 
maintaining the plan, and an employee does not have a severance from 
employment if, in connection with a change of employment, the employee's 
new employer maintains such plan with respect to the employee. The 
determination of whether an employee ceases to be an employee of the 
employer maintaining the plan is based on all of the relevant facts and 
circumstances.
    (ii) Multiemployer plans. A participant in a multiemployer plan 
(within the meaning of section 414(f)) is not treated as having incurred 
a severance from employment with the employer maintaining the 
multiemployer plan for purposes of this section and Sec. Sec. 1.415(b)-
1, 1.415(b)-2, 1.415(c)-1, 1.415(c)-2, 1.415(d)-1, 1.415(f)-1, 1.415(g)-
1, and 1.415(j)-1 if the participant continues to

[[Page 1020]]

be an employee of another employer maintaining the multiemployer plan.
    (6) Qualified domestic relations orders. A benefit provided to an 
alternate payee (as defined in section 414(p)(8)) of a participant 
pursuant to a qualified domestic relations order (as defined in section 
414(p)(1)(A)) is treated as if it were provided to the participant for 
purposes of applying the limitations of section 415. See Sec. 1.401(a)-
13(g)(4)(iv).
    (7) Effect on other requirements. Except as provided in Sec. 
1.417(e)-1(d)(1), the application of section 415 does not relieve a plan 
from the obligation to satisfy other applicable qualification 
requirements. Accordingly, the terms of the plan must provide for the 
plan to satisfy section 415 as well as all other applicable 
requirements. For example, if a defined benefit plan has a normal 
retirement age of 62, and if a participant's benefit remains unchanged 
between the ages of 62 and 65 because of the application of the section 
415(b)(1)(A) dollar limit, the plan satisfies the requirements of 
section 411 only if the plan either commences distribution of the 
participant's benefit at normal retirement age (without regard to 
severance from employment) or provides for a suspension of benefits at 
normal retirement age that satisfies the requirements of section 
411(a)(3)(B) and 29 CFR 2530.203-3. Similarly, if the increase to a 
participant's benefit under a defined benefit plan in a year after the 
participant has attained normal retirement age is less than the 
actuarial increase to the participant's previously accrued benefit 
because of the application of the section 415(b)(1)(B) compensation 
limitation (which is not adjusted for commencement after age 65), the 
plan satisfies the requirements of section 411 only if the plan either 
commences distribution of the participant's benefit at normal retirement 
age (without regard to severance from employment) or provides for a 
suspension of benefits at normal retirement age that satisfies the 
requirements of section 411(a)(3)(B) and 29 CFR 2530.203-3.
    (g) Effective date--(1) General rule. Except as otherwise provided, 
this section and Sec. Sec. 1.415(b)-1, 1.415(c)-1, 1.415(c)-2, 
1.415(d)-1, 1.415(f)-1, 1.415(g)-1, and 1.415(j)-1 apply to limitation 
years beginning on or after July 1, 2007.
    (2) Governmental plans. In the case of a governmental plan as 
defined in section 414(d), this section and Sec. Sec. 1.415(b)-1, 
1.415(c)-1, 1.415(c)-2, 1.415(d)-1, 1.415(f)-1, 1.415(g)-1, and 
1.415(j)-1 apply to limitation years that begin more than 90 days after 
the close of the first regular legislative session of the legislative 
body with authority to amend the plan that begins on or after July 1, 
2007. A governmental plan is permitted to apply the provisions of this 
section and Sec. Sec. 1.415(b)-1, 1.415(c)-1, 1.415(c)-2, 1.415(d)-1, 
1.415(f)-1, 1.415(g)-1, and 1.415(j)-1 to limitation years beginning on 
or after July 1, 2007, provided the plan applies all the applicable 
provisions of this section and Sec. Sec. 1.415(b)-1, 1.415(c)-1, 
1.415(c)-2, 1.415(d)-1, 1.415(f)-1, 1.415(g)-1, and 1.415(j)-1 for such 
limitation years.
    (3) Option to apply regulations earlier. A plan may apply the rules 
in Sec. 1.415(c)-2(e) regarding post-severance compensation payments 
for limitation years prior to the effective date described in paragraphs 
(g)(1) and (2) of this section. This early application affects the rules 
relating to the definition of compensation in Sec. 1.401(k)-1(e)(8) and 
Sec. 1.457-4(d).
    (4) Grandfather rule for preexisting benefits. A defined benefit 
plan is considered to satisfy the limitations of section 415(b) for a 
participant with respect to benefits accrued or payable under the plan 
as of the end of the limitation year that is immediately prior to the 
effective date of final regulations under this section and Sec. Sec. 
1.415(b)-1, 1.415(c)-1, 1.415(c)-2, 1.415(d)-1, 1.415(f)-1, 1.415(g)-1, 
and 1.415(j)-1 (as provided under paragraph (g)(1) or (2) of this 
section) pursuant to plan provisions (including plan provisions relating 
to the plan's limitation year) that were both adopted and in effect 
before April 5, 2007, but only if such plan provisions meet the 
applicable requirements of statutory provisions, regulations, and other 
published guidance relating to section 415 in effect immediately before 
the effective date of final regulations under this section and 
Sec. Sec. 1.415(b)-1, 1.415(c)-1, 1.415(c)-2, 1.415(d)-1, 1.415(f)-1, 
1.415(g)-1, and 1.415(j)-1 (as provided under paragraph

[[Page 1021]]

(g)(1) or (2) of this section). Plan provisions will not be treated as 
failing to satisfy these requirements merely because the plan has not 
been amended to reflect changes to section 415(b) made by the Pension 
Funding Equity Act of 2004, Public Law 108-218 (118 Stat. 596), and the 
Pension Protection Act of 2006, Public Law 109-280 (120 Stat. 780). In 
addition, plan provisions will not be treated as failing to satisfy 
these requirements merely because the plan's definition of compensation 
for a limitation year that is used for purposes of applying the 
limitations of section 415(b)(1)(B) reflects compensation for a plan 
year that is in excess of the limitation under section 401(a)(17) that 
applies to that plan year. If benefits under a plan are accrued after 
the applicable effective date under paragraph (g)(1) or (2) of this 
section, then the sum of the benefits grandfathered under the first 
sentence of this paragraph (g)(4) and benefits accrued after the 
applicable effective date must satisfy the requirements of section 415, 
taking into account the requirements of this section and Sec. Sec. 
1.415(b)-1, 1.415(c)-1, 1.415(c)-2, 1.415(d)-1, 1.415(f)-1, 1.415(g)-1, 
and 1.415(j)-1.

[T.D. 9319, 72 FR 16895, Apr. 5, 2007]



Sec. 1.415(b)-1  Limitations for defined benefit plans.

    (a) General rules--(1) Maximum limitations. Except as otherwise 
provided under this section, a defined benefit plan fails to satisfy the 
requirements of section 415(a) for a limitation year if, during the 
limitation year, either the annual benefit (as defined in paragraph 
(b)(1)(i) of this section) accrued by a participant (whether or not the 
benefit is vested) or the annual benefit payable to a participant at any 
time under the plan exceeds the lesser of--
    (i) $160,000 (as adjusted pursuant to section 415(d), Sec. 
1.415(d)-1(a), and this section); or
    (ii) 100 percent of the participant's average compensation for the 
period of the participant's high-3 years of service (as adjusted 
pursuant to section 415(d), Sec. 1.415(d)-1(a), and this section).
    (2) Defined benefit plan. For purposes of section 415 and 
regulations promulgated under section 415, a defined benefit plan is any 
plan, contract, or account to which section 415 applies pursuant to 
Sec. 1.415(a)-1(a) or (b) (or any portion thereof) that is not a 
defined contribution plan within the meaning of Sec. 1.415(c)-1(a)(2). 
In addition, a section 403(b) annuity contract that is not described in 
section 414(i) is treated as a defined benefit plan for purposes of 
section 415 and regulations promulgated under section 415.
    (3) Plan provisions. As required in Sec. 1.415(a)-1(d)(1), in order 
to satisfy the limitations on benefits under this section, the plan 
provisions (including the provisions of any annuity) must preclude the 
possibility that any annual benefit exceeding these limitations will be 
accrued (except as provided in paragraph (a)(7)(iii) of this section), 
distributed, or otherwise payable in any optional form of benefit 
(including the normal form of benefit) at any time (from the plan, from 
an annuity contract that will make distributions to the participant on 
behalf of the plan, or from an annuity contract that has been 
distributed under the plan). Thus, for example, a plan that is subject 
to the requirements of section 411 will fail to satisfy the limitations 
of this section if the plan does not contain terms that preclude the 
possibility that any annual benefit exceeding these limitations will be 
accrued or payable in any optional form of benefit (including the normal 
form of benefit) at any time, even though no participant has actually 
accrued a benefit in excess of these limitations.
    (4) Adjustments to dollar limitation for commencement before age 62 
or after age 65. The age-adjusted section 415(b)(1)(A) dollar limit 
computed pursuant to paragraph (d) or (e) of this section is used in 
place of the dollar limitation described in section 415(b)(1)(A) and 
paragraph (a)(1)(i) of this section in the case of a benefit with an 
annuity starting date that occurs before the participant attains age 62 
or after the participant attains age 65.
    (5) Average compensation for period of high-3 years of service--(i) 
In general. Except as otherwise provided in this paragraph (a)(5), for 
purposes of applying the limitation on benefits described in this 
section, the period of a participant's high-3 years of service is the 
period of 3 consecutive calendar years

[[Page 1022]]

(taking into account the rule in paragraph (a)(5)(iii) of this section) 
during which the employee had the greatest aggregate compensation (as 
defined in Sec. 1.415(c)-2) from the employer, and the average 
compensation for the period of a participant's high-3 years of service 
is determined by dividing the aggregate compensation for this period by 
3. For purposes of this paragraph (a)(5), in determining a participant's 
high-3 years of service, the plan may use any 12-month period to 
determine a year of service instead of the calendar year, provided that 
it is uniformly and consistently applied in a manner that is specified 
under the terms of the plan. As provided under Sec. 1.415(c)-2(f), 
because a plan is not permitted to base benefits on compensation in 
excess of the limitation under section 401(a)(17), a plan's definition 
of compensation for a year that is used for purposes of applying the 
limitations of section 415 is not permitted to reflect compensation for 
a year that is in excess of the limitation under section 401(a)(17) that 
applies to that year. See Sec. Sec. 1.401(a)(17)-1(a)(3)(i) and 
1.401(a)(17)-1(b)(3)(ii) for rules regarding the effective date of 
increases in the section 401(a)(17) compensation limitation for a plan 
year and for a 12-month period other than the plan year.
    (ii) Short periods of service. For a participant who is employed 
with an employer for less than 3 consecutive years, the period of the 
participant's high-3 years of service is the actual number of 
consecutive years of service (including fractions of years, but not less 
than one year). In such a case, the limitation of section 415(b)(1)(B) 
of 100 percent of the participant's average compensation for the period 
of the participant's high-3 years of service is computed by dividing the 
participant's compensation during the participant's longest consecutive 
period of service by the number of years in that period (including 
fractions of years, but not less than one year). The rule in paragraph 
(a)(5)(iii) of this section is used for purposes of determining a 
participant's consecutive years of service.
    (iii) Break in service. In the case of a participant who has had a 
severance from employment with an employer that maintains the plan and 
who is subsequently rehired by the employer, the period of the 
participant's high-3 years of service is calculated by excluding all 
years for which the participant performs no services for and receives no 
compensation from the employer maintaining the plan (referred to as the 
break period), and by treating the year of service immediately prior to 
and the year of service immediately after the break period as if such 
years of service were consecutive. See Sec. 1.415(d)-1(a)(2)(iii) for a 
special rule for determining a rehired participant's section 
415(b)(1)(B) compensation limit in the case of a plan that adjusts the 
compensation limit for limitation years after the limitation year in 
which the participant incurs a severance from employment.
    (iv) Examples. For purposes of these examples, except as otherwise 
stated, the plan year and the limitation year are the calendar year, and 
the plan uses the calendar year for purposes of determining the period 
of high-3 years of service. In addition, except as otherwise stated, it 
is assumed that the plan's normal retirement age is 65, and all 
participants discussed in these examples have at least ten years of 
service with the employer and at least ten years of participation in the 
plan at issue. It is also assumed that none of the plans in the examples 
are governmental plans. The following examples illustrate the rules of 
this paragraph (a)(5):

    Example 1. (i) Facts. Plan A, which was established on January 1, 
2008, covers Participant M, who was hired on January 1, 1990. 
Participant M's compensation (as defined in Sec. 1.415(c)-2) from the 
employer maintaining the plan is $140,000 each year for 1990 through 
1992, is $120,000 each year for 1993 through 2007, and is $165,000 for 
2008 and 2009. Assume that for Plan A's 2008 and 2009 limitation years, 
the section 415(b)(1)(A) age-adjusted dollar limit for M is $185,000 and 
$190,000, respectively, prior to the reduction of the age-adjusted 
dollar limit pursuant to paragraph (g)(1) of this section (which 
requires a reduction in the dollar limit if a participant has less than 
10 years of participation in the plan).
    (ii) Conclusion. As of the end of the 2008 limitation year, the 
period of M's high-3 consecutive years of service runs from January 1, 
1990, through December 31, 1992, and M's average compensation for this 
period is $140,000. Thus, the limitation under section

[[Page 1023]]

415(b)(1)(B) for the 2008 limitation year is $140,000. As of the end of 
the 2009 limitation year, the period of M's high-3 consecutive years of 
service runs from January 1, 2007, through December 31, 2009, and M's 
average compensation for this period is $150,000. Thus, the limitation 
under section 415(b)(1)(B) for the 2009 limitation year is $150,000.
    Example 2 (i) Facts. Participant N is a participant in Plan B. N's 
compensation for 2008, 2009, and 2010 is $300,000 for each year. N's 
average compensation for the period of N's high-3 years of service 
(determined before the application of section 401(a)(17)) is $300,000, 
based on N's compensation for 2008, 2009, and 2010. For all years before 
2008, Participant N's compensation was less than the then-applicable 
section 401(a)(17) limit. On January 1, 2011, N commences receiving 
benefits from Plan B at the age of 75, 10 years after attaining N's 
normal retirement age under Plan B, when the age-adjusted section 
415(b)(1)(A) dollar limit for benefits commencing at that age is 
$293,453.
    (ii) Conclusion. Pursuant to Sec. 1.415(c)-2(f) and section 
401(a)(17), Plan B is not permitted to provide for a definition of 
compensation that includes compensation for a year that is in excess of 
the limitation under section 401(a)(17) that applies to that year. 
Accordingly, the limitation under section 415(b)(1)(B) based on N's 
average compensation for the period of N's high three years of service 
must not reflect compensation for a year that is in excess of the 
limitation under section 401(a)(17) that applies to that year. Thus, if 
the limitation under section 401(a)(17) for years beginning in 2008, 
2009, and 2010 is $230,000, $235,000, and $240,000, respectively, then 
the limitation under section 415(b)(1)(B) based on N's average 
compensation for the period of N's high three years of service is 
$235,000.
    Example 3. (i) Facts. The facts are the same as in Example 2, except 
that N commences receiving benefits from Plan B on January 1, 2008, at 
the age of 75, 10 years after attaining N's normal retirement age under 
Plan B. In addition, N's period of high three years of service is from 
January 1, 2003, through December 31, 2005, and N's average compensation 
for this period is $300,000. The section 401(a)(17) limits for 2003, 
2004 and 2005 are $200,000, $205,000, and $210,000, respectively. As of 
December 31, 2007, pursuant to plan provisions adopted and in effect on 
January 1, 2007, N's accrued benefit under Plan B, payable in the form 
of a straight life annuity, actuarially adjusted to reflect commencement 
10 years after normal retirement age, is $300,000. Plan B has not been 
amended during 2007, and that as of December 31, 2007, Plan B satisfied 
all of the requirements of section 415(b) with respect to N's accrued 
benefit, pursuant to statutory provisions, regulations, and other 
published guidance in effect immediately before the limitation year 
beginning on January 1, 2008.
    (ii) Conclusion. Under Sec. 1.415(a)-1(g)(4), Plan B is considered 
to satisfy the section 415(b)(1)(B) compensation limit with respect to 
N's benefit payable at age 75 of $300,000 (which N accrued prior to 
January 1, 2008), for limitation years beginning after December 31, 
2007. This is because Sec. 1.415(a)-1(g)(4) provides that plan 
provisions will not be treated as failing to satisfy the requirements of 
section 415(b)(1)(B) merely because the plan's definition of 
compensation that is used for purposes of applying the limitations of 
section 415(b)(1)(B) reflects compensation in excess of the section 
401(a)(17) limitation for limitation years beginning before January 1, 
2008. N, however, cannot accrue any additional benefits under Plan B for 
limitation years beginning after December 31, 2007, until N's section 
415(b)(1)(B) compensation limit, as limited by Sec. 1.415(c)-2(f) and 
section 401(a)(17), increases above $300,000.
    Example 4. (i) Facts. Participant O participates in Plan C, 
maintained by Employer X. Plan C does not adjust a participant's section 
415(b)(1)(B) compensation limit for limitation years after the 
limitation year in which the participant incurs a severance from 
employment. Prior to separating from employment with X in 2010, O's 
average compensation for O's period of high-3 years of service is 
$50,000, based on O's compensation for 2007, 2008, and 2009, which was 
$50,000 for each year. O's compensation for 2010 was $45,000. O's 
compensation is $0 for 2011. In 2012, O is rehired by X and resumes 
participation in Plan C. O's compensation in 2012 is $45,000, and is 
$70,000 in 2013.
    (ii) Conclusion. As of the end of the 2013 limitation year, O's 
average compensation for O's period of high-3 years of service is 
$53,333, based on O's compensation in 2010, 2012, and 2013. See 
paragraph (a)(5)(iii) of this section.
    Example 5. (i) Facts. The facts are the same as in Example 4, except 
that, in accordance with Sec. 1.415(a)-1(d)(3)(v), Plan C incorporates 
by reference section 415(d) adjustments to a participant's section 
415(b)(1)(B) compensation limit for limitation years after the 
limitation year in which the participant incurs a severance from 
employment. Assume that the annual adjustment factor described in Sec. 
1.415(d)-1(a)(2)(ii) for 2011 through 2013 is 1.03 for each year. Thus, 
disregarding O's rehire by X, O's average compensation for O's period of 
high-3 years of service for the 2013 limitation year is equal to $54,636 
($50,000 * 1.03 * 1.03 * 1.03).
    (ii) Conclusion. Under Sec. 1.415(d)-1(a)(2)(iii), O's average 
compensation for O's period of high-3 years of service for the 2013 
limitation year is $54,636.

    (6) Exceptions from compensation limit. The limit under paragraph 
(a)(1)(ii) of

[[Page 1024]]

this section (100 percent of the participant's average compensation for 
the participant's high-3 years of service) does not apply to--
    (i) A governmental plan (as defined in section 414(d));
    (ii) A multiemployer plan (as defined in section 414(f));
    (iii) A collectively bargained plan that is described in section 
415(b)(7); or
    (iv) A participant in a plan maintained by an organization described 
in section 3121(w)(3)(A) who has never been a highly compensated 
employee (within the meaning of section 414(q)) of the organization.
    (7) Special rules--(i) Total benefits not in excess of $10,000. See 
section 415(b)(4) and paragraph (f) of this section for an exception 
from the limits of section 415(b)(1) and paragraph (a)(1) of this 
section with respect to retirement benefits that do not exceed $10,000 
for the limitation year.
    (ii) Governmental plans electing during 1990. For a special 
limitation applicable to certain governmental plans electing the 
application of this rule during the first plan year beginning after 
December 31, 1989, see section 415(b)(10).
    (iii) Defined benefit plans not subject to the requirements of 
section 411. In the case of a defined benefit plan that is not subject 
to the requirements of section 411, the limitations described in this 
paragraph (a) are not required to be applied to the annual benefit 
accrued by a participant before the benefit is payable. However, such a 
defined benefit plan is subject to the limitations described in this 
paragraph (a) with respect to the annual benefit payable to a 
participant at any time under the plan.
    (iv) Application of compensation limitation exception to a church 
employee who becomes a highly compensated employee--(A) In general. If a 
participant who was described in paragraph (a)(6)(iv) of this section 
for a prior limitation year later becomes a highly compensated employee 
(within the meaning of section 414(q)) of the organization that 
maintains the defined benefit plan, the plan is not treated as failing 
to satisfy the compensation-based limitation described in paragraph 
(a)(1)(ii) of this section with respect to the participant if the 
requirements of paragraph (a)(7)(iv)(B) of this section are satisfied 
with respect to the participant.
    (B) Limitation on accruals. The requirements of this paragraph 
(a)(7)(iv)(B) are satisfied with respect to a participant if no plan 
amendments increasing the participant's benefits are adopted during the 
limitation year in which the participant first becomes a highly 
compensated employee (within the meaning of section 414(q)) of the 
organization that maintains the plan, and there is no increase in the 
participant's accrued benefit derived from employer contributions 
(including increases as a result of increased compensation or service) 
in subsequent limitation years.
    (b) Annual benefit--(1) In general--(i) Definition of annual 
benefit--(A) Straight life annuities. For purposes of this section and 
Sec. 1.415(b)-2, the term annual benefit means a benefit that is 
payable in the form of a straight life annuity. A straight life annuity 
means an annuity payable in equal installments for the life of the 
participant that terminates upon the participant's death. Examples of 
benefits that are not in the form of a straight life annuity include an 
annuity with a post-retirement death benefit and an annuity providing a 
guaranteed number of payments. If a benefit is payable in the form of a 
straight life annuity, no adjustment is made to the benefit to account 
for differences in the timing of payments during a year (for example, no 
adjustment is made on account of the annuity being payable in annual or 
monthly installments).
    (B) Other benefit forms. With respect to a benefit payable in a form 
other than a straight life annuity, the annual benefit is determined as 
the straight life annuity payable on the first day of each month that is 
actuarially equivalent to the benefit payable in such other form, 
determined under the rules of paragraph (c) of this section.
    (ii) Rules for determination of annual benefit. The annual benefit 
does not include the annual benefit attributable to either employee 
contributions or rollover contributions (as described in sections 
401(a)(31), 402(c)(1), 403(a)(4),

[[Page 1025]]

403(b)(8), 408(d)(3), and 457(e)(16)), determined pursuant to the rules 
of paragraph (b)(2) of this section. The treatment of transferred 
benefits is determined under the rules of paragraph (b)(3) of this 
section. Paragraph (b)(4) of this section discusses the treatment of 
qualified governmental excess benefit arrangements.
    (iii) Determination of annual benefit in the case of multiple 
annuity starting dates--(A) General rule. If a participant has or will 
have distributions commencing at more than one annuity starting date, 
then the limitations of section 415 must be satisfied as of each of the 
annuity starting dates, taking into account the benefits that have been 
or will be provided at all of the annuity starting dates. This will 
happen, for example, where benefit distributions to a participant have 
previously commenced under a plan that is aggregated for purposes of 
section 415 with a plan under which the participant receives current 
accruals. In determining the annual benefit for such a participant as of 
a particular annuity starting date, the plan must actuarially adjust the 
past and future distributions with respect to the benefits that 
commenced at the other annuity starting dates. For limitation years to 
which Sec. 1.415(b)-2 applies, these adjustments must be made using the 
rules of Sec. 1.415(b)-2. For purposes of this paragraph (b)(1)(iii) 
and Sec. 1.415(b)-2, the determination of whether a new annuity 
starting date has occurred is made without regard to the rule of Sec. 
1.401(a)-20, Q&A-10(d) (under which the commencement of certain 
distributions may not give rise to a new annuity starting date).
    (B) Scope of multiple annuity starting date rules. The rules 
provided in this paragraph (b)(1)(iii) and Sec. 1.415(b)-2 apply for 
purposes of determining the annual benefit of a participant where a new 
distribution election is effective during the current limitation year 
with respect to a distribution that previously commenced. The rules of 
this paragraph (b)(1)(iii) and Sec. 1.415(b)-2 also apply for 
determining the annual benefit of a participant for purposes of applying 
the limitations of section 415(b) and this section where benefit 
payments are increased as a result of plan terms or a plan amendment 
applying a cost-of-living adjustment or similar benefit increase, unless 
the increase is described in paragraph (b)(1)(iii)(C) of this section.
    (C) Safe harbors for certain benefit increases. An increase to 
benefit payments as a result of plan terms or a plan amendment applying 
a cost-of-living adjustment or similar benefit increase is described in 
this paragraph (b)(1)(iii)(C) if the increase--
    (1) Has previously been accounted for as part of the annual benefit 
under the rules of paragraph (c) of this section;
    (2) Is not required to be accounted for as part of the annual 
benefit, pursuant to the exception for certain automatic benefit 
increase features under paragraph (c)(5) of this section;
    (3) Is pursuant to a plan provision that automatically incorporates 
section 415(d) cost-of-living adjustments under Sec. 1.415(a)-
1(d)(3)(v); or
    (4) Complies with one of the safe harbors described in Sec. 
1.415(d)-1(a)(5) or (6) (providing safe harbors for annual and other 
periodic adjustments to distributions).
    (2) Determination of annual benefit attributable to employee 
contributions and rollover contributions--(i) In general. If employee 
contributions (other than contributions described in paragraph 
(b)(2)(ii) of this section) or rollover contributions are made to the 
plan, the annual benefit attributable to these contributions is 
determined as provided in this paragraph (b)(2).
    (ii) Certain employee contributions disregarded. For purposes of 
this paragraph (b)(2), the following are not treated as employee 
contributions:
    (A) Contributions that are picked up by a governmental employer as 
provided under section 414(h)(2).
    (B) Repayment of any loan made to a participant from the plan.
    (C) Repayment of a previously distributed amount as described in 
section 411(a)(7)(B) in accordance with section 411(a)(7)(C).
    (D) Repayment of a withdrawal of employee contributions as provided 
under section 411(a)(3)(D).
    (E) Repayments that would have been described in paragraph 
(b)(2)(ii)(C) or (b)(2)(ii)(D) of this section except

[[Page 1026]]

that the plan does not restrict the timing of repayments to the maximum 
extent permitted by section 411(a).
    (iii) Annual benefit attributable to mandatory employee 
contributions. In the case of mandatory employee contributions as 
defined in section 411(c)(2)(C) and Sec. 1.411(c)-1(c)(4) (or 
contributions that would be mandatory employee contributions if section 
411 applied to the plan), the annual benefit attributable to those 
contributions is determined by applying the factors applicable to 
mandatory employee contributions as described in section 411(c)(2)(B) 
and (C) and regulations promulgated under section 411 to those 
contributions to determine the amount of a straight life annuity 
commencing at the annuity starting date, regardless of whether the 
requirements of sections 411 and 417 apply to that plan. For purposes of 
applying such factors to a plan that is not subject to the requirements 
of section 411, the applicable effective date of section 411(a)(2) 
(which is used under Sec. 1.411(c)-1(c)(3) to determine the beginning 
date from which statutorily specified interest must be credited to 
mandatory employee contributions) must be determined as if section 411 
applied to the plan, and in determining the annual benefit that is 
actuarially equivalent to these accumulated contributions, the plan must 
determine the interest rate that would have been required under section 
417(e)(3) as if section 417 applied to the plan. See Sec. 1.415(c)-
1(a)(2)(ii)(B) and (b)(3) for rules regarding treatment of mandatory 
employee contributions to a defined benefit plan as annual additions 
under a defined contribution plan.
    (iv) Voluntary employee contributions. If voluntary employee 
contributions are made to the plan, the portion of the plan to which 
voluntary employee contributions are made is treated as a defined 
contribution plan pursuant to section 414(k) and, accordingly, is a 
defined contribution plan pursuant to Sec. 1.415(c)-1(a)(2)(i). 
Accordingly, the portion of a plan to which voluntary employee 
contributions are made is not a defined benefit plan within the meaning 
of paragraph (a)(2) of this section and is not taken into account in 
determining the annual benefit under the portion of the plan that is a 
defined benefit plan.
    (v) Annual benefit attributable to rollover contributions. The 
annual benefit attributable to rollover contributions from an eligible 
retirement plan, as defined in section 402(c)(8)(B) (for example, a 
contribution received pursuant to a direct rollover under section 
401(a)(31)(A)), is determined in the same manner as the annual benefit 
attributable to mandatory employee contributions if the plan provides 
for a benefit derived from the rollover contribution (other than a 
benefit derived from a separate account to be maintained with respect to 
the rollover contribution and actual earnings and losses thereon). Thus, 
in the case of rollover contributions from a defined contribution plan 
to a defined benefit plan to provide an annuity distribution, the annual 
benefit attributable to those rollover contributions for purposes of 
section 415(b) is determined by applying the rules of section 411(c) as 
described in paragraph (b)(2)(iii) of this section, regardless of the 
assumptions used to compute the annuity distribution under the plan and 
regardless of whether the plan is subject to the requirements of 
sections 411 and 417. Accordingly, in such a case, if the plan uses more 
favorable factors than those specified in section 411(c) to determine 
the amount of annuity payments arising from rollover contributions, the 
annual benefit under the plan would reflect the excess of those annuity 
payments over the amounts that would be payable using the factors 
specified in section 411(c). See Sec. 1.415(c)-1(b)(3)(i) for rules 
excluding rollover contributions maintained in a separate account that 
is treated as a defined contribution plan pursuant to section 414(k) 
from annual additions to a defined contribution plan.
    (3) Treatment of transferred benefits--(i) In general--(A) Treatment 
of transferor plan if transferred benefits are aggregated with 
transferor plan. Except as provided in paragraph (b)(3)(ii) of this 
section, when there has been a transfer of benefits from one defined 
benefit plan to another plan, to the extent the benefits transferred to 
the transferee plan are otherwise required to be taken into account 
pursuant to section 415(f)

[[Page 1027]]

and Sec. 1.415(f)-1 in determining whether the transferor plan 
satisfies the limitations of section 415(b) for a limitation year, the 
transferred benefits are not treated as being provided under the 
transferor plan. This will occur, for example, if the employer 
sponsoring the transferor plan and the employer sponsoring the 
transferee plan are in the same controlled group within the meaning of 
section 414(b).
    (B) Treatment of transferor plan if transferred benefits are not 
aggregated with transferor plan. Except as provided in paragraph 
(b)(3)(ii) of this section, when there has been a transfer of benefits 
from one defined benefit plan to another plan, to the extent the 
benefits transferred to the transferee plan are not otherwise required 
to be taken into account pursuant to section 415(f) and Sec. 1.415(f)-1 
in determining whether the transferor plan satisfies the limitations of 
section 415(b) for a limitation year, the transferred benefits are 
treated by the transferor plan as if such benefits were provided under 
annuities purchased to provide benefits under a plan that must be 
aggregated with the transferor plan and that terminated immediately 
prior to the transfer with sufficient assets to pay all benefit 
liabilities under the plan, in accordance with the rules of paragraph 
(b)(5)(i) of this section. This will occur, for example, in the case of 
a transfer of benefits between defined benefit plans maintained by 
employers that are not required to be aggregated under sections 414(b) 
and (c) (as modified by section 415(h)) or sections 414(m).
    (C) Treatment of transferee plan. Except as provided in paragraph 
(b)(3)(ii) of this section, where there has been a transfer of benefits 
from one defined benefit plan to another defined benefit plan, the 
transferee plan must take into account the transferred benefits in 
determining whether it satisfies the limitations of section 415(b).
    (ii) Elective transfer of distributable benefit. Where, as described 
in Sec. 1.411(d)-4, Q&A-3(c) (permitting certain elective transfers of 
distributable benefits), a distributable benefit is transferred to a 
defined benefit plan from either a defined contribution plan or a 
defined benefit plan, the amount transferred is treated as a benefit 
paid from the transferor plan, and the annual benefit provided by the 
transferee defined benefit plan does not include the annual benefit 
attributable to the amount transferred (determined as if the transferred 
amount were a rollover contribution subject to the rules of paragraph 
(b)(2)(v) of this section). The rule in the preceding sentence applies 
regardless of whether the requirements of section 411 apply to the plan 
and, in the case of a transfer from a defined contribution plan that is 
not subject to the requirements of section 411 (such as a governmental 
plan) to a defined benefit plan, the rule applies even if the 
participant's benefits are not distributable from the defined 
contribution plan at the time of the transfer.
    (4) Treatment of qualified governmental excess benefit arrangements. 
Pursuant to section 415(m), in determining whether a governmental plan 
(as defined in section 414(d)) meets the requirements of this section, 
the annual benefit does not include benefits provided under a qualified 
governmental excess benefit arrangement, as defined in section 
415(m)(3). Thus, the limitation of section 415(b) does not apply to 
benefits to the extent the benefits are provided under a qualified 
governmental excess benefit arrangement.
    (5) Treatment of benefits provided under a terminated plan--(i) 
Terminated plan with sufficient assets. If a defined benefit plan is 
terminated with sufficient assets for the payment of the benefit 
liabilities of all plan participants and a participant in the plan has 
not yet commenced benefits under the plan, for purposes of satisfying 
section 415(b) with respect to the participant, all other defined 
benefit plans maintained by the employer that maintained the terminated 
plan are required to take into account the benefits provided pursuant to 
the annuities purchased to provide benefits under the terminated plan at 
each possible annuity starting date. In such a case, see paragraph 
(b)(1)(iii) of this section for rules regarding the determination of a 
participant's annual benefit if the participant commences receiving 
benefits under the terminated plan.
    (ii) Terminated plan with insufficient assets. If a defined benefit 
plan is terminated and there are not sufficient

[[Page 1028]]

assets for the payment of the benefit liabilities of all plan 
participants, for purposes of satisfying section 415(b) with respect to 
a participant, all other defined benefit plans maintained by the 
employer that maintained the terminated plan are required to take into 
account the benefits that are actually provided to the participant under 
the terminated plan. For example, in the case of a plan that is subject 
to title IV of the Employee Retirement Income Security Act of 1974 (88 
Stat. 829), Public Law 93-406 (ERISA), and that terminates with 
insufficient assets for the payment of the benefit liabilities of all 
plan participants, all other defined benefit plans maintained by the 
employer that maintained the terminating plan must take into account 
benefits that are paid by the Pension Benefit Guaranty Corporation. In 
such a case, see paragraph (b)(1)(iii) of this section for rules 
regarding the determination of a participant's annual benefit if the 
participant commences receiving benefits under the terminated plan.
    (iii) Other guidance. The Commissioner may provide guidance 
regarding the rules applicable to terminated plans (and plans that are 
deemed to have been terminated pursuant to paragraph (b)(3)(i)(B) of 
this section) in revenue rulings, notices, and other guidance published 
in the Internal Revenue Bulletin. See Sec. 601.601(d) of this chapter.
    (c) Adjustment to form of benefit for forms other than a straight 
life annuity--(1) In general. This paragraph (c) provides rules for 
adjusting a form of benefit other than a straight life annuity to an 
actuarially equivalent straight life annuity beginning at the same time 
for purposes of determining the annual benefit described in paragraph 
(b) of this section. Paragraph (c)(2) of this section describes how to 
adjust a benefit paid in a form to which section 417(e)(3) does not 
apply. Paragraph (c)(3) of this section describes how to adjust a 
benefit paid in a form to which section 417(e)(3) applies. Paragraph 
(c)(4) of this section describes benefit forms for which no adjustment 
is required. Paragraph (c)(5) of this section provides an exception from 
the requirements of this paragraph (c) with respect to certain automatic 
benefit increase features. Paragraph (c)(6) of this section sets forth 
examples illustrating the application of this paragraph (c). The 
Commissioner may, in revenue rulings, notices, or other guidance 
published in the Internal Revenue Bulletin set forth simplified methods 
for adjusting a form of benefit other than a straight life annuity to an 
actuarially equivalent straight life annuity beginning at the same time 
for purposes of determining the annual benefit described in paragraph 
(b) of this section. See Sec. 601.601(d)(2) of this chapter.
    (2) Benefits paid in a form to which section 417(e)(3) does not 
apply. For a benefit paid in a form to which section 417(e)(3) does not 
apply, the actuarially equivalent straight life annuity benefit is the 
greater of--
    (i) The annual amount of the straight life annuity (if any) payable 
to the participant under the plan commencing at the same annuity 
starting date as the form of benefit payable to the participant; or
    (ii) The annual amount of the straight life annuity commencing at 
the same annuity starting date that has the same actuarial present value 
as the form of benefit payable to the participant, computed using a 5 
percent interest assumption and the applicable mortality table described 
in Sec. 1.417(e)-1(d)(2) for that annuity starting date.
    (3) Benefits paid in a form to which section 417(e)(3) applies--(i) 
In general. Except as otherwise provided in this paragraph (c)(3), for a 
benefit paid in a form to which section 417(e)(3) applies, the 
actuarially equivalent straight life annuity benefit is the greatest of:
    (A) The annual amount of the straight life annuity commencing at the 
annuity starting date that has the same actuarial present value as the 
particular form of benefit payable, computed using the interest rate and 
mortality table, or tabular factor, specified in the plan for actuarial 
equivalence;
    (B) The annual amount of the straight life annuity commencing at the 
annuity starting date that has the same actuarial present value as the 
particular form of benefit payable, computed using a 5.5 percent 
interest

[[Page 1029]]

assumption and the applicable mortality table for the distribution under 
Sec. 1.417(e)-1(d)(2); or
    (C) The annual amount of the straight life annuity commencing at the 
annuity starting date that has the same actuarial present value as the 
particular form of benefit payable (computed using the applicable 
interest rate for the distribution under Sec. 1.417(e)-1(d)(3) and the 
applicable mortality table for the distribution under Sec. 1.417(e)-
1(d)(2)), divided by 1.05.
    (ii) Special rule for distributions in plan years beginning in 2004 
and 2005. For a distribution to which section 417(e)(3) applies and 
which has an annuity starting date occurring in plan years beginning in 
2004 or 2005, except as provided in section 101(d)(3) of the Pension 
Funding Equity Act of 2004, Public Law 108-218 (118 Stat. 596), the 
actuarially equivalent straight life annuity benefit is the greater of--
    (A) The annual amount of the straight life annuity commencing at the 
annuity starting date that has the same actuarial present value as the 
particular form of benefit payable, computed using the interest rate and 
mortality table, or tabular factor, specified in the plan for actuarial 
equivalence; or
    (B) The annual amount of the straight life annuity commencing at the 
annuity starting date that has the same actuarial present value as the 
particular form of benefit payable, computed using a 5.5 percent 
interest assumption and the applicable mortality table for the 
distribution under Sec. 1.417(e)-1(d)(2).
    (4) Certain benefit forms for which no adjustment is required--(i) 
In general. For purposes of the adjustments described in this paragraph 
(c), the following benefits are not taken into account:
    (A) Survivor benefits payable to a surviving spouse under a 
qualified joint and survivor annuity (as defined in section 417(b)) to 
the extent that such benefits would not be payable if the participant's 
benefit were not paid in the form of a qualified joint and survivor 
annuity.
    (B) Ancillary benefits that are not directly related to retirement 
benefits, such as preretirement disability benefits not in excess of the 
qualified disability benefit, preretirement incidental death benefits 
(including a qualified preretirement survivor annuity), and post-
retirement medical benefits.
    (ii) Rules of application--(A) Social security supplements. Although 
a social security supplement described in section 411(a)(9) and Sec. 
1.411(a)-7(c)(4) may be an ancillary benefit, it is included in 
determining the annual benefit because it is payable upon retirement and 
therefore is directly related to retirement income benefits.
    (B) Qualified joint and survivor annuities combined with other 
distributions. If benefits are paid partly in the form of a qualified 
joint and survivor annuity (QJSA) and partly in some other form (such as 
a single-sum distribution), the rule of paragraph (c)(4)(i)(A) of this 
section (under which survivor benefits are not included in determining 
the annual benefit) applies to the survivor annuity payments under the 
portion of the benefit that is paid in the form of a QJSA.
    (5) Exception for certain automatic benefit increase features--(i) 
General rule. Notwithstanding paragraph (b)(1)(i)(B) of this section, no 
adjustment is required to a benefit that is paid in a form that is not a 
straight life annuity to take into account the inclusion in that form of 
an automatic benefit increase feature, as described in paragraph 
(c)(5)(ii) of this section, if:
    (A) The benefit is paid in a form to which section 417(e)(3) does 
not apply.
    (B) The plan satisfies the requirements of paragraph (c)(5)(iii) of 
this section.
    (ii) Definition of automatic benefit increase feature. An automatic 
benefit increase feature is included in a form of benefit if that form 
provides for automatic, periodic increases to the benefits paid in that 
form, such as a form of benefit that automatically increases the benefit 
paid under that form annually according to a specified percentage or 
objective index, or a form of benefit that automatically increases the 
benefit paid in that form to share favorable investment returns on plan 
assets.
    (iii) Requirements. A plan satisfies the requirements of this 
paragraph

[[Page 1030]]

(c)(5)(iii) with respect to a form of benefit that includes an automatic 
benefit increase feature if the form of benefit without regard to the 
automatic benefit increase feature satisfies the requirements of section 
415(b) and this section, and the plan provides that in no event will the 
amount payable to the participant under the form of benefit in any 
limitation year be greater than the section 415(b) limit applicable at 
the annuity starting date (which is the lesser of the age-adjusted 
section 415(b)(1)(A) dollar limit described in paragraph (a)(1)(i) of 
this section or the section 415(b)(1)(B) compensation limit described in 
paragraph (a)(1)(ii) of this section), as increased in subsequent years 
pursuant to section 415(d) and Sec. 1.415(d)-1. If the form of benefit 
without regard to the automatic benefit increase feature is not a 
straight life annuity, then the preceding sentence is applied by 
reducing the section 415(b) limit applicable at the annuity starting 
date to an actuarially equivalent amount (determined using the 
assumptions specified in paragraph (c)(2)(ii) of this section) that 
takes into account the death benefits under the form of benefit (other 
than the survivor portion of a QJSA).
    (6) Examples. The following examples illustrate the provisions of 
this paragraph (c). For purposes of these examples, except as otherwise 
stated, actuarial equivalence under the plan is determined using a 5 
percent interest assumption and the mortality table that applies under 
section 417(e)(3) as of January 1, 2003. It is assumed for purposes of 
these examples that the interest rate that applies under section 
417(e)(3) and Sec. 1.417(e)-1(d)(3) for relevant time periods is 5.25 
percent and that the mortality table that applies under section 
417(e)(3) and Sec. 1.417(e)-1(d)(2) for relevant time periods is the 
mortality table that applies under section 417(e)(3) as of January 1, 
2003. In addition, it is assumed that all participants discussed in 
these examples have at least ten years of service with the employer and 
at least ten years of participation in the plan at issue, all payments 
other than a payment of a single sum are made monthly, on the first day 
of each calendar month, and each plan's normal retirement age is 65. The 
examples are as follows:

    Example 1. (i) Facts. Plan A provides a single-sum distribution 
determined as the actuarial present value of the straight life annuity 
payable at the actual retirement date. Plan A provides that a 
participant's single sum is determined as the greater of the present 
value determined using the otherwise applicable actuarial assumptions of 
the plan and the present value determined using the applicable interest 
rate and the applicable mortality table for the distribution under 
section 417(e)(3). In accordance with Sec. 1.417(e)-1(d)(1), Plan A 
also provides that the single sum is not less than the actuarial present 
value of the accrued benefit payable at normal retirement age, 
determined using the applicable interest rate and the applicable 
mortality table under section 417(e)(3) and Sec. 1.417(e)-1(d). 
Participant M retires at age 65 with a benefit under the plan formula 
(and before the application of section 415) of $152,619 and elects to 
receive a distribution in the form of a single sum. Under the plan and 
before the application of section 415, the amount of the single sum is 
$1,800,002 (which is based on the 5 percent interest rate and applicable 
mortality table as of January 1, 2003, since that present value is 
greater than the present value that would have been determined using the 
applicable interest rate (5.25 percent) and the applicable mortality 
table (the January 1, 2003, table) for the distribution under section 
417(e)(3)).
    (ii) Conclusion. For purposes of this section, the annual benefit is 
the greatest of the annual amount of the actuarially equivalent straight 
life annuity commencing at the same age (determined using the plan's 
actuarial factors), the annual amount of the actuarially equivalent 
straight life annuity commencing at the same age (determined using a 5.5 
percent interest assumption and the applicable mortality table for the 
distribution under Sec. 1.417(e)-1(d)(2)), and the annual amount of the 
actuarially equivalent straight life annuity commencing at the same age 
(determined using the applicable interest rate and applicable mortality 
table for the distribution under Sec. Sec. 1.417(e)-1(d)(2) and (d)(3)) 
divided by 1.05. Based on the factors used in the plan to determine the 
actuarially equivalent lump sum (in this case, an interest rate of 5 
percent and the applicable mortality table as of January 1, 2003), 
$1,800,002 payable as a single sum is actuarially equivalent to an 
immediate straight life annuity at age 65 of $152,619. A single sum 
payment of $1,800,002 is actuarially equivalent to an immediate straight 
life annuity at age 65 of $159,105, using a 5.5 percent interest 
assumption and the applicable mortality table under Sec. 1.417(e)-
1(d)(2). Based on the applicable interest rate and the applicable 
mortality table for the distribution under

[[Page 1031]]

Sec. Sec. 1.417(e)-1(d)(2) and (d)(3), $1,800,002 payable as a single 
sum is actuarially equivalent to an immediate straight life annuity at 
age 65 of $155,853. $148,432 is the result when this annual amount is 
divided by 1.05. With respect to the single-sum distribution, M's annual 
benefit for purposes of section 415(b) is equal to the greatest of the 
three resulting amounts ($152,619, $159,105, and $148,432), or $159,105.
    Example 2. (i) Facts. The facts are the same as in Example 1, except 
that Participant M elects to receive his benefit in the form of a 10-
year certain and life annuity. Applying the plan's actuarial equivalence 
factors, the benefit payable in this form is $146,100.
    (ii) Conclusion. Since the form of benefit elected by M is a form of 
benefit to which section 417(e)(3) does not apply, the annual benefit 
for purposes of this section is the greater of the annual amount of the 
plan's straight life annuity commencing at the same age or the annual 
amount of the actuarially equivalent straight life annuity commencing at 
the same age, determined using a 5 percent interest rate and the 
applicable mortality table described in Sec. 1.417(e)-1(d)(2) for that 
annuity starting date. In this case, the straight life annuity payable 
under the plan commencing at the same age is $152,619. Because the 
plan's factors for actuarial equivalence in this case are the same 
standardized actuarial factors required to be applied to determine the 
actuarially equivalent straight life annuity, the actuarially equivalent 
straight life annuity using the required standardized factors is also 
$152,619. With respect to the 10-year certain and life annuity 
distribution, M's annual benefit is equal to the greater of the two 
resulting amounts ($152,619 and $152,619), or $152,619.
    Example 3. (i) Facts. The facts are the same as in Example 1. 
Participant M retires at age 62 with a benefit under the plan (before 
the application of section 415) of $100,000 (after application of the 
plan's early retirement factors) and a Social Security supplement of 
$10,000 per year payable until age 65. N chooses to receive the accrued 
benefit in the form of a straight life annuity. The Plan has no 
provisions under which the actuarial value of the Social Security 
supplement can be paid as a level annuity for life.
    (ii) Conclusion. Because the form of benefit elected by M is a form 
of benefit to which section 417(e)(3) does not apply and because the 
plan does not provide for a straight life annuity beginning at age 62, 
the annual benefit for purposes of this section is the annual amount of 
the straight life annuity commencing at age 62 that is actuarially 
equivalent to the distribution stream of $110,000 for three years and 
$100,000 thereafter, where actuarial equivalence is determined using a 5 
percent interest rate and the applicable mortality table described in 
Sec. 1.417(e)-1(d)(2) for the annuity starting date. In this case, the 
actuarially equivalent straight life annuity is $102,180. Accordingly, 
with respect to this distribution stream, N's annual benefit is equal to 
$102,180. The results are the same without regard to whether the Social 
Security supplement is a QSUPP (as defined in Sec. 1.401(a)(4)-12).
    Example 4. (i) Facts. Plan B is a defined benefit plan that provides 
a benefit equal to 100 percent of a participant's average compensation 
for the period of the participant's high-3 years of service, payable as 
a straight life annuity. For a married participant who does not elect 
another form of benefit, the benefit is payable in the form of a joint 
and 100 percent survivor annuity benefit that is a QJSA within the 
meaning of section 417 and that is reduced from the straight life 
annuity. For purposes of determining the amount of this QJSA, the plan 
provides that the reduction is only half of the reduction that would 
normally apply under the actuarial assumptions specified in the plan for 
determining actuarial equivalence of optional forms. The plan also 
provides that a married participant can elect to receive the plan 
benefits as a straight life annuity, or in the form of a single sum 
distribution that is the actuarial equivalent of the joint and 100 
percent survivor annuity determined using the applicable interest rate 
and the applicable mortality table under section 417(e)(3) and Sec. 
1.417(e)-1(d). Participant O elects, with spousal consent, a single-sum 
distribution.
    (ii) Conclusion. The special rule that disregards the value of the 
survivor portion of a QJSA set forth in paragraph (c)(4)(i) of this 
section only applies to a benefit that is payable in the form of a 
qualified joint and survivor annuity. Any other form of benefit must be 
adjusted to a straight life annuity in accordance with paragraph (c)(1) 
of this section. Accordingly, because the benefit payable under the plan 
in the form of a single-sum distribution is actuarially equivalent to a 
straight life annuity that is greater than 100 percent of a 
participant's average compensation for the period of the participant's 
high-3 years of service, the limitation of section 415(b)(1)(B) has been 
exceeded.
    Example 5. (i) Facts. Plan C is a defined benefit plan that provides 
an option to receive the benefit in the form of a joint and 100 percent 
survivor annuity with a 10-year certain feature, where the survivor 
beneficiary is the participant's spouse.
    (ii) Conclusion. Since this form of benefit is not subject to 
section 417(e)(3), for a participant at age 65, the annual benefit with 
respect to the joint and 100 percent survivor annuity with a 10-year 
certain feature is determined for purposes of this section as the 
greater of the annual amount of the straight life annuity payable to the 
participant under the plan at age 65 (if any), or the annual

[[Page 1032]]

amount of the straight life annuity commencing at age 65 that has the 
same actuarial present value as the joint and 100 percent survivor 
annuity with a 10-year certain feature (but excluding the survivor 
annuity payments pursuant to paragraph (c)(4)(i)(A) of this section), 
computing using a 5 percent interest assumption and the applicable 
mortality table described in Sec. 1.417(e)-1(d)(2) for the annuity 
starting date. This latter amount is equal to the product of the annual 
payments under this optional form of benefit and the factor that 
provides for actuarial equivalence between a straight life annuity and a 
10-year certain and life annuity (with no annuity for the survivor) 
computed using a 5 percent interest rate and the applicable mortality 
table described in Sec. 1.417(e)-1(d)(2) for the annuity starting date.
    Example 6. (i) Facts. Plan E provides a benefit at age 65 of a 
straight life annuity equal to the lesser of 90 percent of the 
participant's average compensation for the period of the participant's 
high-3 years of service and $148,500. Upon retirement at age 65, the 
optional forms of benefit available to a participant include payment of 
a QJSA with annual payments equal to 50 percent of the annual payments 
under the straight life annuity, along with a single-sum distribution 
that is actuarially equivalent (determined as the greater of the single 
sum calculated using a 5 percent interest assumption and the section 
417(e)(3)(A)(ii)(I) mortality table in effect on January 1, 2003, and 
the single sum calculated using the section 417(e)(3)(A)(ii)(II) 
applicable interest rate and the section 417(e)(3)(A)(ii)(I) applicable 
mortality table for the distribution) to 50 percent of the annual 
payments under the straight life annuity. Participant Q retires at age 
65. Q's average compensation for the period of Q's high-3 years of 
service is $100,000. Q elects to receive a distribution in the optional 
form of benefit described above, under which the annual payments under 
the QJSA are $45,000 and the single-sum distribution is equal to 
$530,734. Q's spouse is 3 years younger than Q.
    (ii) Determination of annual benefit. Q's annual benefit under Plan 
E for purposes of section 415(b) is determined as the sum of the annual 
benefit attributable to the QJSA portion of the distribution and the 
annual benefit attributable to the single-sum portion of the 
distribution.
    (iii) Annual benefit attributable to QJSA portion. Because survivor 
benefits are not taken into account in determining the annual benefit 
attributable to the QJSA portion of the distribution, the annual benefit 
attributable to the QJSA portion of the distribution is determined as if 
that distribution were a straight life annuity of $45,000 per year 
commencing at age 65. Thus, no form adjustment is needed to determine 
the annual benefit attributable to the QJSA portion of the distribution, 
and the annual benefit attributable to the QJSA portion of the benefit 
is $45,000.
    (iv) Annual benefit attributable to single sum portion. The annual 
benefit attributable to the single sum portion of the distribution is 
determined as the greatest of the annual amount of the actuarially 
equivalent straight life annuity commencing at the same age (determined 
using the plan's actuarial factors), the annual amount of the 
actuarially equivalent straight life annuity commencing at the same age 
(determined using a 5.5 percent interest assumption and the applicable 
mortality table under Sec. 1.417(e)-1(d)(2) for the distribution), and 
the annual amount of the actuarially equivalent straight life annuity 
commencing at the same age (determined using the applicable interest 
rate and applicable mortality table under section 417(e)(3) and 
Sec. Sec. 1.417(e)-1(d)(2) and (d)(3) for the distribution) divided by 
1.05. With respect to the single-sum distribution, the annual amount of 
the actuarially equivalent straight life annuity commencing at the same 
age determined using the plan's actuarial factors is equal to $45,000. 
The annual amount of the actuarially equivalent straight life annuity 
commencing at the same age determined using a 5.5 percent interest 
assumption and the applicable mortality table under Sec. 1.417(e)-
1(d)(2) for the distribution is $46,912. The actuarially equivalent 
straight life annuity commencing at the same age determined using the 
applicable interest rate and the applicable mortality table under 
section 417(e)(3) and Sec. Sec. 1.417(e)-1(d)(2) and (d)(3) for the 
distribution is equal to $45,954. This amount divided by 1.05 is equal 
to $43,766. Thus, the annual benefit attributable to the single sum 
portion of the benefit is $46,912.
    (v) Conclusion. Q's annual benefit under the optional form of 
benefit for purposes of section 415(b) is equal to the sum of the annual 
benefit attributable to the QJSA portion of the distribution and the 
annual benefit attributable to the single sum portion of the 
distribution, or $91,912. Because Q's average compensation for the 
period of Q's high-3 years of service is $100,000, the distribution 
satisfies the compensation limit of section 415(b)(1)(B).
    Example 7. (i) Facts. Plan D is a defined benefit plan with a normal 
retirement age of 65. The normal retirement benefit under Plan D (and 
the only life annuity available under Plan D) is a life annuity with a 
fixed increase of 2 percent per year. The increase applies to the 
benefit provided in the prior year and is thus compounded. The plan 
provides that the benefit is limited to the lesser of 84 percent of the 
participant's average compensation for the period of the participant's 
high-3 years of service or 84 percent of the age-adjusted section 
415(b)(1)(A) dollar limit (which is assumed to be $180,000 at age

[[Page 1033]]

65). Plan D does not incorporate the section 415(d) cost-of-living 
adjustments to the section 415(b) limits for limitation years following 
the limitation year in which a participant incurs a severance from 
employment. Participant P retires at age 65, at which time P's average 
compensation for the period of P's high-3 years of service is $165,000. 
Under Plan D, P commences receiving benefits in the form of a life 
annuity of $138,600 with a fixed increase of 2 percent per year.
    (ii) Conclusion. Because Plan D does not provide for a straight life 
annuity and the form of benefit is not subject to section 417(e)(3), P's 
annual benefit for purposes of section 415(b) is the annual amount of 
the straight life annuity, commencing at age 65, that is actuarially 
equivalent to the distribution stream of $138,600 with a fixed increase 
of 2 percent per year, where actuarial equivalence is determined using a 
5 percent interest rate and the applicable mortality table for the 
distribution under section 417(e)(3) and Sec. 1.417(e)-1(d)(2). In 
order to satisfy the requirements of section 415 and this section, this 
annual benefit must not exceed 100 percent of the average compensation 
for the period of the participant's high-3 years of service, or 
$165,000. Using a 5 percent interest rate and the section 417(e)(3) 
applicable mortality table for the distribution, the actuarially 
equivalent straight life annuity is $165,453, which exceeds $165,000. 
Accordingly, the plan fails to satisfy the compensation-based limitation 
of section 415(b)(1)(B).
    Example 8. (i) Facts. The facts are the same as in Example 7, except 
that Plan D incorporates by reference the section 415(d) cost-of-living 
adjustments to the section 415(b) limits as described in Sec. 1.415(a)-
1(d)(3)(v) and Plan D provides that the benefit is limited to the 
applicable section 415(b) limit. Under Plan D, P commences receiving 
benefits at age 65 in the form of a life annuity of $138,221 with a 
fixed increase of 2 percent per year.
    (ii) Conclusion. Because Plan D does not provide for a straight life 
annuity and the form of benefit is not subject to section 417(e)(3), P's 
annual benefit for purposes of section 415(b) is the annual amount of 
the straight life annuity, commencing at age 65, that is actuarially 
equivalent to the distribution stream of $138,221 with a fixed increase 
of 2 percent per year, where actuarial equivalence is determined using a 
5 percent interest rate and the applicable mortality table for P's 
annuity starting date under section 417(e)(3) and Sec. 1.417(e)-
1(d)(2). In order to satisfy the requirements of section 415(b) and this 
section, this annual benefit must not exceed 100 percent of P's average 
compensation for the period of P's high-3 years of service, or $165,000. 
Using a 5 percent interest rate and the section 417(e)(3) applicable 
mortality table for the distribution, the actuarially equivalent 
straight life annuity is $165,000, which does not exceed $165,000. 
Accordingly, the plan satisfies the compensation-based limitation of 
section 415(b)(1)(B).
    (iii) Section 415(d) adjustments. In addition to the fixed 2 percent 
per year automatic increase, P's benefit will be increased in limitation 
years following the limitation year in which P retires in accordance 
with the plan provisions that incorporate by reference the section 
415(d) cost-of-living adjustments to the section 415(b) limits (or, if 
Plan D did not incorporate by reference the section 415(d) adjustments, 
P's benefit may be increased pursuant to plan amendments that comply 
with the safe harbors provided in Sec. 1.415(d)-1(a)(5) or (6)), and 
such increases will not cause P's benefit to violate the requirements of 
section 415(b). For example, if in a later limitation year the 
applicable section 415(b) limit is increased by 3 percent pursuant to 
section 415(d) and Sec. 1.415(d)-1, P's benefit payable under Plan D 
will be increased by both the fixed automatic 2 percent per year 
increase and by the 3 percent section 415(d) cost-of-living adjustment. 
The effect of the combined increases may result in P's benefits for a 
year exceeding the then applicable dollar limit under section 415(b), 
but the plan will not violate section 415(b).
    Example 9. (i) Facts. The facts are the same as in Example 7, except 
that the plan provides that benefits are limited to the lesser of 100 
percent of the participant's average compensation for the period of the 
participant's high-3 years of service or 100 percent of the age-adjusted 
section 415(b)(1)(A) dollar limit. Assume that P retires at age 65 with 
a benefit in the form of a life annuity of $165,000 per year with a 
fixed increase of 2 percent per year. Additionally, assume that Plan D 
incorporates by reference the section 415(d) cost-of-living adjustments 
to the section 415(b) limits as described in Sec. 1.415(a)-1(d)(3)(v) 
and the plan provides pursuant to paragraph (c)(5) of this section that 
in no event will a benefit payable from the plan, as increased by the 
fixed increase of 2 percent per year, be greater than the section 415(b) 
limit applicable as of the annuity starting date for the benefit 
(increased pursuant to the rules of section 415(d) and Sec. 1.415(d)-
1).
    (ii) Conclusion. The benefit payable to P at age 65 is not required 
to be adjusted to take into account the fixed increase of 2 percent per 
year. This is because the benefit payable to P satisfies the 
requirements of section 415(b) without regard to the fixed increase of 2 
percent per year, and pursuant to paragraph (c)(5) of this section, the 
plan provides that the benefit payable to P, as increased by the fixed 
increase of 2 percent per year, will never be greater than the section 
415(b) limit applicable as of P's annuity starting date (increased in 
subsequent limitation years pursuant to the rules of section 415(d) and 
Sec. 1.415(d)-1).

[[Page 1034]]

    (iii) Section 415(d) adjustments. In addition to the fixed 2 percent 
per year automatic increase, P's benefit will be increased in limitation 
years following the limitation year in which P retires in accordance 
with the plan provisions that incorporate by reference the section 
415(d) cost-of-living adjustments to the section 415(b) limits (or, if 
Plan D did not incorporate by reference the section 415(d) adjustments, 
P's benefit may be increased pursuant to plan amendments that comply 
with the safe harbors provided in Sec. 1.415(d)-1(a)(5) or (6)), and 
such increases will not cause P's benefit to violate the requirements of 
section 415(b). However, pursuant to paragraph (c)(5)(iii) of this 
section, P's benefit during any limitation year, as increased by the 2 
percent per year automatic increase feature and any plan provisions that 
incorporate by reference the section 415(d) cost-of-living adjustments 
or any plan amendments that increase P's benefits, cannot exceed the 
then applicable section 415(b) limit (as increased pursuant to section 
415(d) and Sec. 1.415(d)-1).
    Example 10. (i) Facts. Employer T maintains a defined benefit plan. 
Under the terms of the plan, all benefits in pay status (other than 
single sum payments) are adjusted upwards or downwards annually 
depending on an annual comparison of actual return on plan assets and an 
assumed interest rate of 4 percent. Thus, the plan does not offer a 
straight life annuity form of benefit, and the plan must determine for 
purposes of applying the section 415(b) limits the actuarially 
equivalent straight life annuity for benefits provided under the plan.
    (ii) Conclusion. Benefits under the plan are paid in a form to which 
section 417(e)(3) does not apply. In determining the actuarially 
equivalent straight life annuity of benefits that are subject to the 
annual investment performance adjustment, the plan must assume a 5 
percent return on plan assets. See paragraph (c)(2) of this section. 
Therefore, in determining the actuarially equivalent straight life 
annuity, the plan must assume that the form of benefit payable under the 
plan will be an annuity that increases annually by a factor equal to 
1.05 divided by 1.04. This increasing annuity is then converted to an 
actuarially equivalent straight life annuity under paragraph (c)(2) of 
this section using a 5 percent interest rate and the applicable 
mortality table described in Sec. 1.417(e)-1(d)(2) for the relevant 
annuity starting date.
    Example 11. (i) Facts. R is a participant in a defined benefit plan 
maintained by R's employer. Under the terms of the plan, R must make 
contributions to the plan in a stated amount to accrue benefits derived 
from employer contributions.
    (ii) Conclusion. R's contributions are mandatory employee 
contributions within the meaning of section 411(c)(2)(C) and, thus, the 
annual benefit attributable to these contributions is not taken into 
account for purposes of testing the annual benefit derived from employer 
contributions against the applicable limitation on benefits. However, 
these contributions are treated as contributions to a defined 
contribution plan maintained by R's employer for purposes of section 
415(c). See Sec. 1.415(c)-1(a)(2)(ii)(B). Accordingly, with respect to 
the current limitation year, the limitation on benefits (as described in 
paragraph (a)(1) of this section) is applicable to the annual benefit 
attributable to employer contributions to the defined benefit plan, and 
the limitation on contributions and other additions (as described in 
Sec. 1.415(c)-1) is applicable to the portion of the plan treated as a 
defined contribution plan, which consists of R's mandatory 
contributions. These same limitations would also apply if, instead of 
providing for mandatory employee contributions, the plan permitted 
voluntary employee contributions, because the portion of the plan 
attributable to voluntary employee contributions and earnings thereon is 
treated as a defined contribution plan maintained by the employer 
pursuant to section 414(k), and thus is not subject to the limitations 
of section 415(b).
    Example 12. (i) Facts. V is a participant in a defined benefit plan 
maintained by V's employer. Under the terms of the plan, V must make 
contributions to the plan in a stated amount to accrue benefits derived 
from employer contributions. V's contributions are mandatory employee 
contributions within the meaning of section 411(c)(2)(C). Thus, the 
annual benefit attributable to these contributions is not taken into 
account for purposes of testing the annual benefit derived from employer 
contributions against the applicable limitation on benefits. V 
terminates employment and receives a distribution from the plan that 
includes V's mandatory employee contributions. Subsequently, V resumes 
employment with the employer maintaining the plan. V recommences 
participation in the plan and repays the prior distribution from the 
plan (including the portion of the distribution that included V's prior 
mandatory employee contributions to the plan) with reasonable interest.
    (ii) Conclusion. In determining V's annual benefit under the plan 
for purposes of applying the limitations of section 415(b), no portion 
of V's repayment of the prior distribution is treated as employee 
contributions. See paragraphs (b)(2)(ii)(C), (D) and (E) of this 
section. However, V's annual benefit under the plan is determined by 
excluding the portion of the annual benefit attributable to V's employee 
contributions to the plan made both prior to the first distribution and 
during V's subsequent recommencement of plan participation.

    (d) Adjustment to section 415(b)(1)(A) dollar limit for commencement 
before age

[[Page 1035]]

62--(1) General rule--(i) Calculation using statutory factors. For a 
distribution with an annuity starting date that occurs before the 
participant attains the age of 62, the age-adjusted section 415(b)(1)(A) 
dollar limit generally is determined as the actuarial equivalent of the 
annual amount of a straight life annuity commencing at the annuity 
starting date that has the same actuarial present value as a deferred 
straight life annuity commencing at age 62, where annual payments under 
the straight life annuity commencing at age 62 are equal to the dollar 
limitation of section 415(b)(1)(A) (as adjusted pursuant to section 
415(d) and Sec. 1.415(d)-1 for the limitation year), and where the 
actuarially equivalent straight life annuity is computed using a 5 
percent interest rate and the applicable mortality table under Sec. 
1.417(e)-1(d)(2) that is effective for that annuity starting date (and 
expressing the participant's age based on completed calendar months as 
of the annuity starting date). However, if the plan has an immediately 
commencing straight life annuity payable both at age 62 and the age of 
benefit commencement, then the age-adjusted section 415(b)(1)(A) dollar 
limit is equal to the lesser of--
    (A) The limit as otherwise determined under this paragraph 
(d)(1)(i); and
    (B) The amount determined under paragraph (d)(1)(ii) of this 
section.
    (ii) Calculation using plan factors. The amount determined under 
this paragraph (d)(1)(ii) is equal to the section 415(b)(1)(A) dollar 
limit (as adjusted pursuant to section 415(d) and Sec. 1.415(d)-1 for 
the limitation year) multiplied by the ratio of the annual amount of the 
immediately commencing straight life annuity under the plan to the 
annual amount of the straight life annuity under the plan commencing at 
age 62, with both annual amounts determined without applying the rules 
of section 415.
    (2) Mortality adjustments--(i) In general. For purposes of 
determining the actuarially equivalent amount described in paragraph 
(d)(1)(i) of this section, to the extent that a forfeiture does not 
occur upon the participant's death before the annuity starting date, no 
adjustment is made to reflect the probability of the participant's death 
between the annuity starting date and the participant's attainment of 
age 62, unless the plan provides for such an adjustment. To the extent 
that a forfeiture occurs upon the participant's death before the annuity 
starting date, an adjustment must be made to reflect the probability of 
the participant's death between the annuity starting date and the 
participant's attainment of age 62.
    (ii) No forfeiture deemed to occur where qualified preretirement 
survivor annuity payable. For purposes of paragraphs (d)(2)(i) and 
(e)(2)(i) of this section, a plan is permitted to treat no forfeiture as 
occurring upon a participant's death if the plan does not charge 
participants for providing a qualified preretirement survivor annuity 
(QPSA) (as defined in section 417(c)) on the participant's death, but 
only if the plan applies this treatment both for adjustments before age 
62 and adjustments after age 65. Thus, in such a case, the plan is 
permitted to provide that, in computing the adjusted dollar limitation 
under section 415(b)(1)(A), no adjustment is made to reflect the 
probability of a participant's death after the annuity starting date and 
before age 62 or after age 65 and before the annuity starting date.
    (3) Exception for certain participants of certain governmental 
plans. Pursuant to section 415(b)(2)(G) and (H), no age adjustment is 
made to the dollar limit for commencement before age 62 for any 
qualified participant. For this purpose, a qualified participant is a 
participant in a defined benefit plan that is maintained by a state, 
Indian tribal government (as defined in section 7701(a)(40)), or any 
political subdivision of a state or Indian tribal government with 
respect to whom the service taken into account in determining the amount 
of the benefit under the defined benefit plan includes at least 15 years 
of service of the participant--
    (i) As a full-time employee of any police department or fire 
department that is organized and operated by the state, Indian tribal 
government, or political subdivision maintaining such defined benefit 
plan to provide police protection, firefighting services, or emergency 
medical services for any

[[Page 1036]]

area within the jurisdiction of such state, Indian tribal government, or 
political subdivision; or
    (ii) As a member of the Armed Forces of the United States.
    (4) Exception for survivor and disability benefits under 
governmental plans. Pursuant to section 415(b)(2)(I), no age adjustment 
is made to the dollar limit for commencement before age 62 for a 
distribution from a governmental plan (as defined in section 414(d)) on 
account of the participant's becoming disabled by reason of personal 
injuries or sickness, or as a result of the death of the participant.
    (5) Special rule for commercial airline pilots. Pursuant to section 
415(b)(9), no age adjustment is made to the dollar limit for early 
commencement on or after age 60 for a participant if--
    (i) The participant is a commercial airline pilot;
    (ii) The participant separates from service upon or after attaining 
age 60; and
    (iii) As of the time of the participant's retirement, regulations 
prescribed by the Federal Aviation Administration require an individual 
to separate from service as a commercial airline pilot after attaining 
any age occurring on or after age 60 and before age 62.
    (6) No decrease in age-adjusted section 415(b)(1)(A) dollar limit on 
account of age or service. Notwithstanding any other provision of this 
paragraph (d), the age-adjusted section 415(b)(1)(A) dollar limit 
applicable to a participant does not decrease on account of an increase 
in age or the performance of additional service.
    (7) Examples. The following examples illustrate the application of 
this paragraph (d). For purposes of these examples, it is assumed that 
the dollar limitation under section 415(b)(1)(A) for all relevant years 
is $180,000, that the normal form of benefit under the plan is a 
straight life annuity payable beginning at age 65, and that all payments 
other than a payment of a single sum are made monthly, on the first day 
of each calendar month. The examples are as follows:

    Example 1. (i) Plan A provides that early retirement benefits are 
determined by reducing the accrued benefit by 4 percent for each year 
that the early retirement age is less than age 65. Participant M retires 
at age 60 with exactly 30 years of service with a benefit (prior to the 
application of section 415) in the form of a straight life annuity of 
$100,000 payable at age 65, and is permitted to elect to commence 
benefits at any time between M's retirement and M's attainment of age 
65. For example, M can elect to commence benefits at age 60 in the 
amount of $80,000, can wait until age 62 and commence benefits in the 
amount of $88,000, or can wait until age 65 and commence benefits in the 
amount of $100,000. Plan A provides a QPSA to all married participants 
without charge. Plan A provides (consistent with paragraph (d)(2)(ii) of 
this section) that, for purposes of adjusting the dollar limitation 
under section 415(b)(1)(A) for commencement before age 62 or after age 
65, no forfeiture is treated as occurring upon a participant's death 
before retirement and, therefore, in computing the adjusted dollar 
limitation under section 415(b)(1)(A), no adjustment is made to reflect 
the probability of a participant's death after the annuity starting date 
and before age 62 or after age 65 and before the annuity starting date.
    (ii) The age-adjusted section 415(b)(1)(A) dollar limit that applies 
for commencement of M's benefit at age 60 is the lesser of the section 
415(b)(1)(A) dollar limit multiplied by the ratio of the annuity payable 
at age 60 to the annuity payable at age 62, or the straight life annuity 
payable at age 60 that is actuarially equivalent, using 5 percent 
interest and the applicable mortality table effective for that annuity 
starting date under section 417(e)(3)(A)(ii)(I) and Sec. 1.417(e)-
1(d)(2), to the deferred annuity payable at age 62 of $180,000 per year. 
In this case, the age-adjusted section 415(b)(1)(A) dollar limit at age 
60 is $156,229 (the lesser of $163,636 ($180,000* $80,000/$88,000) and 
$156,229 (the straight life annuity at age 60 that is actuarially 
equivalent to a deferred annuity of $180,000 commencing at age 62, 
determined using 5 percent interest and the applicable mortality table, 
without a mortality decrement for the period between 60 and 62)).
    Example 2. (i) The facts are the same as in Example 1, except that 
participant M elects to retire at age 60, 6 months, and 21 days.
    (ii) Under paragraph (d)(1)(i) of this section, M is treated as age 
60 and 6 months (or, age 60.5). Absent the rule provided in paragraph 
(d)(6) of this section, the age-adjusted section 415(b)(1)(A) dollar 
limit that applies for commencement of M's benefit at age 60.5 is the 
lesser of the section 415(b)(1)(A) dollar limit multiplied by the ratio 
of the annuity payable at age 60.5 to the annuity payable at age 62, or 
the straight life annuity payable at age 60.5 that is actuarially 
equivalent, using 5 percent interest and the applicable mortality table 
for that annuity starting date under section 417(e)(3)(A)(ii)(I) and

[[Page 1037]]

Sec. 1.417(e)-1(d)(2), to the deferred annuity payable at age 62 of 
$180,000 per year. The age-adjusted section 415(b)(1)(A) dollar limit at 
age 60.5 is $161,769 (the lesser of $167,727 ($180,000* $82,000/$88,000) 
and $161,769 (the straight life annuity at age 60.5 that is actuarially 
equivalent to a deferred annuity of $180,000 commencing at age 62, 
determined using 5 percent interest and the applicable mortality table, 
without a mortality decrement for the period between 60.5 and 62).
    Example 3. (i) The facts are the same as in Example 1, except the 
plan provides that, if a participant has 30 or more years of service, no 
reduction applies for benefits commencing at age 62 and later.
    (ii) Absent the rule provided in paragraph (d)(6) of this section, 
the age-adjusted section 415(b)(1)(A) dollar limit that applies for 
commencement of M's benefit at age 60 is the lesser of the section 
415(b)(1)(A) dollar limit multiplied by the ratio of the annuity payable 
at age 60 to the annuity payable at age 62, or the straight life annuity 
payable at age 60 that is actuarially equivalent, using 5 percent 
interest and the applicable mortality table for that annuity starting 
date under section 417(e)(3)(A)(ii)(I) and Sec. 1.417(e)-1(d)(2), to 
the deferred annuity payable at age 62 of $180,000 per year. In this 
case, because M has 30 years of service and would be eligible for the 
unreduced early retirement benefit at age 62, the age-adjusted section 
415(b)(1)(A) dollar limit at age 60 would be $144,000 (the lesser of 
$144,000 ($180,000* $80,000/$100,000) and $156,229 (the straight life 
annuity at age 60 that is actuarially equivalent to a deferred annuity 
of $180,000 commencing at age 62, determined using 5 percent interest 
and the applicable mortality table, without a mortality decrement for 
the period between 60 and 62)).
    (iii) However, at age 59\11/12\ with 29\11/12\ years of service, the 
age-adjusted section 415(b)(1)(A) dollar limit for M is $155,311 (the 
lesser of $162,955 ($180,000* $79,667/$88,000) and $155,311 (the 
straight life annuity at age 59\11/12\ that is actuarially equivalent to 
a deferred annuity of $180,000 commencing at age 62, determined using 5 
percent interest and the applicable mortality table, without a mortality 
decrement for the period between 59 and 62)). Thus, after applying the 
rule provided in paragraph (d)(6) of this section, the age-adjusted 
section 415(b)(1)(A) dollar limit that applies for commencement of M's 
benefit at age 60 is $155,311.
    Example 4. (i) The facts are the same as in Example 1, except that 
the plan provides that, if a participant has 30 or more years of 
service, then no reduction is made in early retirement benefits if the 
early retirement age is at least age 62 and, in the case of an early 
retirement age before age 62, the early retirement benefit is determined 
by reducing the accrued benefit by 4 percent for each year that the 
early retirement age is less than age 62.
    (ii) The age-adjusted section 415(b)(1)(A) dollar limit that applies 
for commencement of M's benefit at age 60 is the lesser of the section 
415(b)(1)(A) dollar limit multiplied by the ratio of the annuity payable 
at age 60 to the annuity payable at age 62, or the straight life annuity 
payable at age 60 that is actuarially equivalent, using 5 percent 
interest and the applicable mortality table for that annuity starting 
date under section 417(e)(3)(A)(ii)(I) and Sec. 1.417(e)-1(d)(2), to 
the deferred annuity payable at age 62 of $180,000 per year. In this 
case, because M has 30 years of service and would be eligible for the 
unreduced early retirement benefit at age 62, the age-adjusted section 
415(b)(1)(A) dollar limit at age 60 is $156,229 (the lesser of $165,600 
($180,000* $92,000/$100,000) and $156,229 (the straight life annuity at 
age 60 that is actuarially equivalent to a deferred annuity of $180,000 
commencing at age 62, determined using 5 percent interest and the 
applicable mortality table, without a mortality decrement for the period 
between 60 and 62)).
    Example 5. (i) The facts are the same as in Example 1, except that 
Participant M chooses to receive benefits in the form of a 10-year 
certain and life annuity under which payments are 97 percent of the 
periodic payments that would be made under the immediately commencing 
straight life annuity. Annual payments to M are 97 percent of $80,000, 
or $77,600. Additionally, M's average compensation for the period of M's 
high-3 years of service is $120,000. As in Example 1, the age-adjusted 
section 415(b)(1)(A) dollar limit at age 60 is $156,229.
    (ii) In the case of a form of benefit to which section 417(e)(3) 
does not apply, the annual benefit for purposes of this section is the 
greater of the annual amount of the plan's straight life annuity 
commencing at the same age or the annual amount of the actuarially 
equivalent straight life annuity commencing at the same age, determined 
using a 5 percent interest rate and the applicable mortality table for 
that annuity starting date under section 417(e)(3)(A)(ii)(I) and Sec. 
1.417(e)-1(d)(2). In this case, the straight life annuity payable under 
the plan commencing at the same age is $80,000. The annual amount of the 
straight life annuity that is actuarially equivalent to the $77,600 
benefit payable as a 10-year certain and life annuity is determined by 
applying the required standardized factors (a 5 percent interest 
assumption and the applicable mortality under section 
417(e)(3)(A)(ii)(I) and Sec. 1.417(e)-1(d)(2), and is $79,416. With 
respect to the 10-year certain and life annuity commencing at age 62, 
M's annual benefit is equal to the greater of the two resulting amounts 
($80,000 and $79,416), or $80,000. Because M's annual benefit is less 
than the age-adjusted section 415(b)(1)(A) dollar limit and is less than 
the

[[Page 1038]]

section 415(b)(1)(B) compensation limit, M's benefit satisfies section 
415.
    Example 6. (i) Participant O is a full-time civilian employee of the 
Harbor Police Division of the State of X Port Authority. The Harbor 
Police Division provides police protection services. O performs clerical 
services for the Harbor Police Division. O is a participant in the 
defined benefit plan that is maintained by the State of X with respect 
to whom the years of service taken into account in determining the 
amount of the benefit under the plan includes 10 years of service 
working for the Harbor Police Division and 5 years of service as a 
member of the Armed Forces of the United States.
    (ii) For a distribution with an annuity starting date that occurs 
before O attains the age of 62, there is no age adjustment to the 
section 415(b)(1)(A) dollar limit.
    Example 7. (i) Participant R is a full-time employee of the 
Emergency Medical Service Department of County Y (which is not a part of 
a police or fire department) who performs services as a driver of an 
ambulance. R is a participant in the defined benefit plan that is 
maintained by County Y with respect to whom the years of service taken 
into account in determining the amount of the benefit under the plan 
includes 15 years of service working for County Y. R does not have 
service credit for time in the Armed Forces of the United States.
    (ii) The age adjustments to the limitations of section 415(b)(1)(A) 
pursuant to section 415(b)(2)(C) and (D) will apply if R commences 
receiving a distribution at an age to which either of those adjustments 
applies.

    (e) Adjustment to section 415(b)(1)(A) dollar limit for commencement 
after age 65--(1) General rule--(i) Calculation using statutory factors. 
For a distribution with an annuity starting date that occurs after the 
participant attains the age of 65, the age-adjusted section 415(b)(1)(A) 
dollar limit generally is determined as the actuarial equivalent of the 
annual amount of a straight life annuity commencing at the annuity 
starting date that has the same actuarial present value as a straight 
life annuity commencing at age 65, where annual payments under the 
straight life annuity commencing at age 65 are equal to the dollar 
limitation of section 415(b)(1)(A) (as adjusted pursuant to section 
415(d) and Sec. 1.415(d)-1 for the limitation year), and where the 
actuarially equivalent straight life annuity is computed using a 5 
percent interest rate and the applicable mortality table under Sec. 
1.417(e)-1(d)(2) that is effective for that annuity starting date (and 
expressing the participant's age based on completed calendar months as 
of the annuity starting date). However, if the plan has an immediately 
commencing straight life annuity payable as of the annuity starting date 
and an immediately commencing straight life annuity payable at age 65, 
then the age-adjusted section 415(b)(1)(A) dollar limit is equal to the 
lesser of--
    (A) The limit as otherwise determined under this paragraph 
(e)(1)(i); and
    (B) The amount determined under paragraph (e)(1)(ii) of this 
section.
    (ii) Calculation using plan factors. The amount determined under 
this paragraph (e)(1)(ii) is equal to the section 415(b)(1)(A) dollar 
limit (as adjusted pursuant to section 415(d) and Sec. 1.415(d)-1 for 
the limitation year) multiplied by the adjustment ratio described in 
paragrap. (e)(2)(i) of this section.
    (2) Adjustment ratio--(i) General rule. For purposes of applying the 
rule of paragraph (e)(1)(ii) of this section, the adjustment ratio is 
equal to the ratio of the annual amount of the adjusted immediately 
commencing straight life annuity under the plan described in paragraph 
(e)(2)(ii) of this section to the adjusted age 65 straight life annuity 
described in paragraph (e)(2)(iii) of this section.
    (ii) Adjusted immediately commencing straight life annuity. The 
adjusted immediately commencing straight life annuity that is used for 
purposes of paragraph (e)(2)(i) of this section is the annual amount of 
the immediately commencing straight life annuity payable to the 
participant, computed disregarding the participant's accruals after age 
65 but including actuarial adjustments even if those actuarial 
adjustments are applied to offset accruals. For this purpose, the annual 
amount of the immediately commencing straight life annuity is determined 
without applying the rules of section 415.
    (iii) Adjusted age 65 straight life annuity. The adjusted age 65 
straight life annuity that is used for purposes of paragraph (e)(2)(i) 
of this section is the annual amount of the straight life annuity that 
would be payable under the plan to a hypothetical participant who

[[Page 1039]]

is 65 years old and has the same accrued benefit (with no actuarial 
increases for commencement after age 65) as the participant receiving 
the distribution (determined disregarding the participant's accruals 
after age 65 and without applying the rules of section 415).
    (3) Mortality adjustments--(i) In general. For purposes of 
determining the actuarially equivalent amount described in paragraph 
(e)(1)(i) of this section, to the extent that a forfeiture does not 
occur upon the participant's death before the annuity starting date, no 
adjustment is made to reflect the probability of the participant's death 
between the participant's attainment of age 65 and the annuity starting 
date. To the extent that a forfeiture occurs upon the participant's 
death before the annuity starting date, an adjustment must be made to 
reflect the probability of the participant's death between the 
participant's attainment of age 65 and the annuity starting date.
    (ii) No forfeiture deemed to occur where QPSA payable. See paragraph 
(d)(2)(ii) of this section for a rule deeming no forfeiture to occur if 
the plan does not charge participants for providing a QPSA on the 
participant's death.
    (4) Examples. The following examples illustrate the application of 
this paragraph (e):

    Example 1. (i) Plan A provides that monthly benefits payable upon 
commencement after normal retirement age (which is age 65) are increased 
by 0.5 percent for each month of delay in commencement after attainment 
of normal retirement age. Plan A provides a QPSA to all married 
participants without charge. Plan A provides (consistent with paragraph 
(d)(2)(ii) of this section) that, for purposes of adjusting the dollar 
limitation under section 415(b)(1)(A) for commencement before age 62 or 
after age 65, no adjustment is made to reflect the probability of a 
participant's death between the annuity starting date and the 
participant's attainment of age 62 or between the age of 65 and the 
annuity starting date. The normal form of benefit under Plan A is a 
straight life annuity commencing at age 65. Plan A does not provide 
additional benefit accruals once a participant is credited with 30 years 
of service. Participant M was credited with 30 years of service under 
Plan A when M attained age 65. M retires at age 70 on January 1, 2008, 
with a benefit (prior to the application of section 415) that is payable 
monthly in the form of a straight life annuity of $195,000, which 
reflects the actuarial increase of 30 percent applied to the accrued 
benefit of $150,000. It is assumed that all payments under Plan A, other 
than a payment of a single sum, are made monthly, on the first day of 
each calendar month. It is also assumed that the dollar limit in 2008 is 
$185,000.
    (ii) The age-adjusted section 415(b)(1)(A) dollar limit at age 70 is 
the lesser of the section 415(b)(1)(A) dollar limit multiplied by the 
ratio of the adjusted immediately commencing straight life annuity 
payable at age 70 (computed disregarding the rules of section 415 and 
accruals after age 65, but including actuarial adjustments) to the 
adjusted age 65 straight life annuity (computed disregarding the rules 
of section 415 and any accruals after age 65), or the straight life 
annuity payable at age 70 that is actuarially equivalent, using 5 
percent interest and the applicable mortality table for that annuity 
starting date under section 417(e)(3)(A)(ii)(I) and Sec. 1.417(e)-
1(d)(2), to the straight life annuity payable at age 65, where annual 
payments under the straight life annuity payable at age 65 are equal to 
the dollar limitation of section 415(b)(1)(A). In this case, the age-
adjusted section 415(b)(1)(A) dollar limit at age 70 is $240,500 (the 
lesser of $240,500 ($185,000* $195,000/$150,000) and $271,444 (the 
straight life annuity at age 70 that is actuarially equivalent to an 
annuity of $185,000 commencing at age 65, determined using 5 percent 
interest and the applicable mortality table, without a mortality 
decrement for the period between 65 and 70)).
    Example 2. (i) The facts are the same as in Example 1, except that 
Plan A does not limit benefit accruals to 30 years of credited service, 
and thus M accrues benefits between ages 65 and 70.
    (ii) Since M's accruals after attaining age 65 are disregarded for 
purposes of determining the age-adjusted section 415(b)(1)(A) dollar 
limit applicable to M at age 70, the result is the same as in Example 1.
    Example 3. (i) The facts are the same as in Example 1, except that 
Plan A does not limit benefit accruals to 30 years of credited service. 
However, benefit accruals after an employee has reached normal 
retirement age (age 65), are offset by the actuarial increase that the 
plan provides for commencement of benefits after normal retirement age.
    (ii) The result is the same as in Example 1, even if the actuarial 
increases for post-age 65 benefit commencement provided under Plan A do 
or do not fully offset M's benefit accruals after attaining age 65. This 
is because benefit accruals after age 65 are disregarded for purposes of 
determining the age-adjusted section 415(b)(1)(A) dollar limit 
applicable to M after age 65.

    (f) Total annual payments not in excess of $10,000--(1) In general. 
Pursuant to section 415(b)(4), the annual benefit

[[Page 1040]]

(without regard to the age at which benefits commence) payable with 
respect to a participant under any defined benefit plan is not 
considered to exceed the limitations on benefits described in section 
415(b)(1) and in paragraph (a)(1) of this section if--
    (i) The benefits (other than benefits not taken into account in the 
computation of the annual benefit under the rules of paragraph (b) or 
(c) of this section) payable with respect to the participant under the 
plan and all other defined benefit plans of the employer do not in the 
aggregate exceed $10,000 (as adjusted under paragraph (g) of this 
section) for the limitation year, or for any prior limitation year; and
    (ii) The employer (or a predecessor employer) has not at any time 
maintained a defined contribution plan in which the participant 
participated.
    (2) Computation of benefits for purposes of applying the $10,000 
amount. For purposes of paragraph (f)(1)(i) of this section, the 
benefits payable with respect to the participant under a plan for a 
limitation year reflect all amounts payable under the plan for the 
limitation year (other than benefits not taken into account in the 
computation of the annual benefit under the rules of paragraph (b) or 
(c) of this section), and are not adjusted for form of benefit or 
commencement date.
    (3) Special rule with respect to participants in multiemployer 
plans. The special $10,000 exception set forth in paragraph (f)(1) of 
this section applies to a participant in a multiemployer plan described 
in section 414(f) without regard to whether that participant ever 
participated in one or more other plans maintained by an employer who 
also maintains the multiemployer plan, provided that none of such other 
plans were maintained as a result of collective bargaining involving the 
same employee representative as the multiemployer plan.
    (4) Special rule with respect to employee contributions. 
Notwithstanding Sec. Sec. 1.415(c)-1(a)(2)(ii)(B) and 1.415(c)-1(b)(3), 
mandatory employee contributions under a defined benefit plan described 
in paragraph (b)(2)(iii) of this section are not considered a separate 
defined contribution plan maintained by the employer for purposes of 
paragraph (f)(1)(ii) of this section. Thus, the special dollar 
limitation provided for in this paragraph (f) applies to a contributory 
defined benefit plan.
    Similarly, for purposes of this paragraph (f), an individual medical 
account under section 401(h) or an account for postretirement medical 
benefits established pursuant to section 419A(d)(1) is not considered a 
separate defined contribution plan maintained by the employer.
    (5) Examples. The application of this paragraph (f) may be 
illustrated by the following examples. For purposes of these examples, 
it is assumed that each participant has 10 years of participation in the 
plan and service with the employer. The examples are as follows:

    Example 1. (i) B is a participant in a defined benefit plan 
maintained by X Corporation, which provides for a benefit payable in the 
form of a straight life annuity beginning at age 65. B's average 
compensation for the period of B's high-3 years of service is $6,000. 
The plan does not provide for mandatory employee contributions, and at 
no time has B been a participant in a defined contribution plan 
maintained by X. With respect to the current limitation year, B's 
benefit under the plan (before the application of section 415) is 
$9,500.
    (ii) Because annual payments under B's benefit do not exceed 
$10,000, and because B has at no time participated in a defined 
contribution plan maintained by X, the benefits payable under the plan 
are not considered to exceed the limitation on benefits otherwise 
applicable to B ($6,000).
    (iii) This result would remain the same even if, under the terms of 
the plan, B's benefit of $9,500 were payable at age 60, or if the plan 
provided for mandatory employee contributions.
    Example 2. (i) The facts are the same as in Example 1, except that 
the plan provides for a benefit payable in the form of a life annuity 
with a 10-year certain feature with annual payments of $9,500. Assume 
that, after the adjustment described in paragraph (c) of this section, 
B's actuarially equivalent straight life annuity (which is the annual 
benefit used for demonstrating compliance with section 415) for the 
current limitation year is $10,400.
    (ii) For purposes of applying the special rule provided in this 
paragraph for total benefits not in excess of $10,000, there is no 
adjustment required if the retirement benefit payable under the plan is 
not in the form of a straight life annuity. Therefore, because B's 
retirement benefit does not exceed $10,000, B may receive the full 
$9,500 benefit

[[Page 1041]]

without the otherwise applicable benefit limitations of this section 
being exceeded.
    Example 3. (i) The facts are the same as in Example 1, except that 
the plan provides for a benefit payable in the form of a single sum and 
the amount of the single sum that is the actuarial equivalent of the 
straight life annuity payable to B ($9,500 annually), determined in 
accordance with the rules of section 417(e)(3) and Sec. 1.417(e)-1(d), 
is $95,000.
    (ii) Because the amount payable to B for the limitation year would 
exceed $10,000, the rule of this paragraph (f) does not provide an 
exception from the generally applicable limits of section 415(b)(1) for 
the single-sum distribution. Thus, the otherwise applicable limits apply 
to the single-sum distribution, and a single-sum distribution of $95,000 
would not satisfy the requirements of section 415(b). Limiting the 
single-sum distribution to $60,000 (the present value of the annuity 
that complies with the compensation-based limitation of section 
415(b)(1)(B)) in order to satisfy section 415 would be an impermissible 
forfeiture under the requirements of section 411(a). Accordingly, the 
plan should not provide for a single-sum distribution in these 
circumstances.

    (g) Special rule for participation or service of less than 10 
years--(1) Proration of dollar limit based on years of participation--
(i) In general. Pursuant to section 415(b)(5)(A), where a participant 
has less than 10 years of participation in the plan, the dollar limit 
described in paragraph (a)(1)(i) of this section (as adjusted pursuant 
to section 415(d), Sec. 1.415(d)-1, and paragraphs (d) and (e) of this 
section) is reduced by multiplying the otherwise applicable limitation 
by a fraction--
    (A) The numerator of which is the number of years of participation 
in the plan (or 1, if greater); and
    (B) The denominator of which is 10.
    (ii) Years of participation. The following rules apply for purposes 
of determining a participant's years of participation for purposes of 
this paragraph (g)(1)--
    (A) A participant is credited with a year of participation (computed 
to fractional parts of a year) for each accrual computation period for 
which the participant is credited with at least the number of hours of 
service (or period of service if the elapsed time method is used for 
benefit accrual purposes) required under the terms of the plan in order 
to accrue a benefit for the accrual computation period, and the 
participant is included as a plan participant under the eligibility 
provisions of the plan for at least one day of the accrual computation 
period. If these two conditions are met, the portion of a year of 
participation credited to the participant is equal to the amount of 
benefit accrual service credited to the participant for such accrual 
computation period. For example, if under the terms of a plan, a 
participant receives \1/10\ of a year of benefit accrual service for an 
accrual computation period for each 200 hours of service, and the 
participant is credited with 1,000 hours of service for the period, the 
participant is credited with \1/2\ a year of participation for purposes 
of section 415(b)(5)(A) and this paragraph (g)(1).
    (B) A participant who is permanently and totally disabled within the 
meaning of section 415(c)(3)(C)(i) for an accrual computation period is 
credited with a year of participation with respect to that period for 
purposes of section 415(b)(5)(A) and this paragraph (g)(1).
    (C) For a participant to receive a year of participation (or part 
thereof) for an accrual computation period for purposes of section 
415(b)(5)(A) and this paragraph (g)(1), the plan must be established no 
later than the last day of such accrual computation period.
    (D) No more than one year of participation may be credited for any 
12-month period for purposes of section 415(b)(5)(A) and this paragraph 
(g)(1).
    (2) Proration of compensation limit and special rule for total 
annual payments less than $10,000 based on years of service--(i) In 
general. Pursuant to section 415(b)(5)(B), where a participant has less 
than 10 years of service with the employer, the compensation limit 
described in paragraph (a)(1)(ii) of this section and the $10,000 amount 
under the special rule for small annual payments under paragraph (f) of 
this section are reduced by multiplying the otherwise applicable 
limitation by a fraction--
    (A) The numerator of which is the number of years of service with 
the employer (or 1, if greater); and
    (B) The denominator of which is 10.
    (ii) Years of service--(A) In general. For purposes of applying this 
paragraph (g)(2), years of service must be

[[Page 1042]]

determined on a reasonable and consistent basis. A plan is considered to 
be determining years of service on a reasonable and consistent basis for 
this purpose if, subject to the limits of paragraph (g)(2)(ii)(B) of 
this section, a participant is credited with a year of service (computed 
to fractional parts of a year) for each accrual computation period for 
which the participant is credited with at least the number of hours of 
service (or period of service if the elapsed time method is used for 
benefit accrual purposes) required under the terms of the plan in order 
to accrue a benefit for the accrual computation period.
    (B) Rules of application. No more than one year of service may be 
credited for any 12-month period for purposes of section 415(b)(5)(B). 
In addition, only the participant's service with the employer or a 
predecessor employer (as defined in Sec. 1.415(f)-1(c)) may be taken 
into account in determining the participant's years of service for this 
purpose. Thus, if an employer does not maintain a former employer's 
plan, a participant's service with the former employer may be taken into 
account in determining the participant's years of service for purposes 
of this paragraph (g)(2) only if the former employer is a predecessor 
employer with respect to the employer pursuant to Sec. 1.415(f)-1(c)(2) 
(which defines predecessor employer to include, under certain 
circumstances, a former entity that antedates the employer).
    (C) Period of disability. Notwithstanding the rules of paragraph 
(g)(2)(ii)(B) of this section, a plan is permitted to provide that a 
participant who is permanently and totally disabled within the meaning 
of section 415(c)(3)(C)(i) for an accrual computation period is credited 
with service with respect to that period for purposes of section 
415(b)(5)(B).
    (3) Exception for survivor and disability benefits under 
governmental plans. The requirements of this paragraph (g) (regarding 
participation or service of less than 10 years) do not apply to a 
distribution from a governmental plan (as defined in section 414(d)) on 
account of the participant's becoming disabled by reason of personal 
injuries or sickness, or as a result of the death of the participant.
    (4) Examples. The provisions of this paragraph (g) may be 
illustrated by the following examples:

    Example 1. (i) C begins employment with Employer A on January 1, 
2005, at the age of 58. Employer A maintains only a noncontributory 
defined benefit plan which provides for a straight life annuity 
beginning at age 65 and uses the calendar year for the limitation and 
plan year. Employer A has never maintained a defined contribution plan. 
C becomes a participant in Employer A's plan on January 1, 2006, and 
works through December 31, 2011, when C is age 65. C begins to receive 
benefits under the plan in 2012. C's average compensation for the period 
of C's high-3 years of service is $40,000. Furthermore, under the terms 
of Employer A's plan, for purposes of computing C's nonforfeitable 
percentage in C's accrued benefit derived from employer contributions, C 
has only 7 years of service with Employer A (2005-2011).
    (ii) Because C has only 7 years of service with Employer A at the 
time he begins to receive benefits under the plan, the maximum 
permissible annual benefit payable with respect to C is $28,000 ($40,000 
multiplied by 7/10).
    Example 2. (i) The facts are the same as in Example 1, except that 
C's average compensation for the period of his high-3 years of service 
is $8,000.
    (ii) Because C has only 7 years of service with Employer A at the 
time he begins to receive benefits, the maximum benefit payable with 
respect to C would be reduced to $5,600 ($8,000 multiplied by 7/10). 
However, the special rule for total benefits not in excess of $10,000, 
provided in paragraph (f) of this section, is applicable in this case. 
Accordingly, C may receive an annual benefit of $7,000 ($10,000 
multiplied by 7/10) without the benefit limitations of this section 
being exceeded.
    Example 3. (i) Employer B maintains a defined benefit plan. Benefits 
under the plan are computed based on months of service rather than years 
of service. Accordingly, for purposes of applying the reduction based on 
years of service less than 10 to the limitations under section 415(b), 
the plan provides that the otherwise applicable limitation is multiplied 
by a fraction, the numerator of which is the number of completed months 
of service with the employer (but not less than 12 months), and the 
denominator of which is 120. The plan further provides that months of 
service are computed in the same manner for this purpose as for purposes 
of computing plan benefits.
    (ii) The manner in which the plan applies the reduction based on 
years of service less than 10 to the limitations under section

[[Page 1043]]

415(b) is consistent with the requirements of this paragraph (g).
    Example 4. (i) G begins employment with Employer D on January 1, 
2003, at the age of 58. Employer D maintains a noncontributory defined 
benefit plan which provides for a straight life annuity beginning at age 
65 and uses the calendar year for the limitation and plan year. G 
becomes a participant in Employer D's plan on January 1, 2004, and works 
through December 31, 2009, when G is age 65. G performs sufficient 
service to be credited with a year of service under the plan for each 
year during 2003 through 2009 (although G is not credited with a year of 
service for 2003 because G is not yet a plan participant). G begins to 
receive benefits under the plan during 2010. The plan's accrual 
computation period is the plan year. The plan provides that, for 
purposes of applying the rules of section 415(b)(5)(B), a participant is 
credited with a year of service (computed to fractional parts of a year) 
for each plan year for which the participant is credited with sufficient 
service to accrue a benefit for the plan year. G's average compensation 
for the period of G's high-3 years of service is $200,000. It is assumed 
for purposes of this example that the dollar limitation of section 
415(b)(1)(A) for limitation years ending in 2010 is $195,000.
    (ii) G has 7 years of service and 6 years of participation in the 
plan at the time G begins to receive benefits under the plan. 
Accordingly, the limitation under section 415(b)(1)(B) based on G's 
average compensation for the period of G's high-3 years of service that 
applies pursuant to the adjustment required under section 415(b)(5)(B) 
is $140,000 ($200,000 multiplied by 7/10), and the dollar limitation 
under section 415(b)(1)(A) that applies to G pursuant to the adjustment 
required under section 415(b)(5)(A) is $117,000 ($195,000 multiplied by 
6/10).

    (h) Retirement Protection Act of 1994 transition rules. For special 
rules affecting the actuarial adjustment for form of benefit under 
paragraph (c) of this section and the adjustment to the dollar limit for 
early or late commencement under paragraphs (d) and (e) of this section 
for certain plans adopted and in effect before December 8, 1994, see 
section 767(d)(3)(A) of the Uruguay Round Agreements Act of 1994, Public 
Law 103-465 (108 Stat. 4809) as amended by section 1449(a) of the Small 
Business Job Protection Act of 1996, Public Law 104-188 (110 Stat. 
1755). The Commissioner may provide guidance regarding these special 
rules in revenue rulings, notices, and other guidance published in the 
Internal Revenue Bulletin. See Sec. 601.601(d) of this chapter.

[T.D. 9319, 72 FR 16899, Apr. 5, 2007; 72 FR 28854, May 23, 2007]



Sec. 1.415(b)-2  Multiple annuity starting dates. [Reserved]



Sec. 1.415(c)-1  Limitations for defined contribution plans.

    (a) General rules--(1) Maximum limitations. Under section 415(c) and 
this section, to satisfy the provisions of section 415(a) for any 
limitation year, except as provided by paragraph (a)(3) of this section, 
the annual additions (as defined in paragraph (b) of this section) 
credited to the account of a participant in a defined contribution plan 
for the limitation year must not exceed the lesser of--
    (i) $40,000 (adjusted pursuant to section 415(d) and Sec. 1.415(d)-
1(b)); or
    (ii) 100 percent of the participant's compensation (as defined in 
Sec. 1.415(c)-2) for the limitation year.
    (2) Defined contribution plan--(i) Definition. For purposes of 
section 415 and regulations promulgated under section 415, the term 
defined contribution plan means a defined contribution plan within the 
meaning of section 414(i) (including the portion of a plan treated as a 
defined contribution plan under the rules of section 414(k)) that is--
    (A) A plan described in section 401(a) which includes a trust which 
is exempt from tax under section 501(a);
    (B) An annuity plan described in section 403(a); or
    (C) A simplified employee pension described in section 408(k).
    (ii) Additional plans treated as defined contribution plans--(A) In 
general. Contributions to the types of arrangements described in 
paragraphs (a)(2)(ii)(B) through (D) of this section are treated as 
contributions to defined contribution plans for purposes of section 415 
and regulations promulgated under section 415.
    (B) Employee contributions to a defined benefit plan. Mandatory 
employee contributions (as defined in section 411(c)(2)(C) and Sec. 
1.411(c)-1(c)(4), regardless of whether the plan is subject to the 
requirements of section 411) to a defined benefit plan are treated as 
contributions to a defined contribution

[[Page 1044]]

plan. For this purpose, contributions that are picked up by the employer 
as described in section 414(h)(2) are not considered employee 
contributions.
    (C) Individual medical benefit accounts under section 401(h). 
Pursuant to section 415(l)(1), contributions allocated to any individual 
medical benefit account which is part of a pension or annuity plan 
established pursuant to section 401(h) are treated as contributions to a 
defined contribution plan.
    (D) Post-retirement medical accounts for key employees. Pursuant to 
section 419A(d)(2), amounts attributable to medical benefits allocated 
to an account established for a key employee (any employee who, at any 
time during the plan year or any preceding plan year, is or was a key 
employee as defined in section 416(i)) pursuant to section 419A(d)(1) 
are treated as contributions to a defined contribution plan.
    (iii) Section 403(b) annuity contracts. Annual additions under an 
annuity contract described in section 403(b) are treated as annual 
additions under a defined contribution plan for purposes of this 
section.
    (3) Alternative contribution limitations--(i) Church plans. For 
alternative contribution limitations relating to church plans, see 
paragraph (d) of this section.
    (ii) Special rules for medical benefits. For additional rules 
relating to certain medical benefits, see paragraph (e) of this section.
    (iii) Employee stock ownership plans. For additional rules relating 
to employee stock ownership plans, see paragraph (f) of this section.
    (b) Annual additions--(1) In general--(i) General definition. The 
term annual addition means, for purposes of this section, the sum, 
credited to a participant's account for any limitation year, of--
    (A) Employer contributions;
    (B) Employee contributions; and
    (C) Forfeitures.
    (ii) Certain excess amounts treated as annual additions. 
Contributions do not fail to be annual additions merely because they are 
excess contributions (as described in section 401(k)(8)(B)) or excess 
aggregate contributions (as described in section 401(m)(6)(B)), or 
merely because excess contributions or excess aggregate contributions 
are corrected through distribution.
    (iii) Direct transfers. The direct transfer of a benefit or employee 
contributions from a qualified plan to a defined contribution plan does 
not give rise to an annual addition.
    (iv) Reinvested employee stock ownership plan dividends. The 
reinvestment of dividends on employer securities under an employee stock 
ownership plan pursuant to section 404(k)(2)(A)(iii)(II) does not give 
rise to an annual addition.
    (2) Employer contributions--(i) Amounts treated as an annual 
addition. For purposes of paragraph (b)(1)(i)(A) of this section, the 
term annual addition includes employer contributions credited to the 
participant's account for the limitation year and other allocations 
described in paragraph (b)(4) of this section that are made during the 
limitation year. See paragraph (b)(6) of this section for timing rules 
applicable to annual additions with respect to employer contributions.
    (ii) Amounts not treated as annual additions--(A) Certain 
restorations of accrued benefits. The restoration of an employee's 
accrued benefit by the employer in accordance with section 411(a)(3)(D) 
or section 411(a)(7)(C) or resulting from the repayment of cashouts (as 
described in section 415(k)(3)) under a governmental plan (as defined in 
section 414(d)) is not considered an annual addition for the limitation 
year in which the restoration occurs. This treatment of a restoration of 
an employee's accrued benefit as not giving rise to an annual addition 
applies regardless of whether the plan restricts the timing of 
repayments to the maximum extent allowed by section 411(a).
    (B) Catch-up contributions. A catch-up contribution made in 
accordance with section 414(v) and Sec. 1.414(v)-1 does not give rise 
to an annual addition.
    (C) Restorative payments. A restorative payment that is allocated to 
a participant's account does not give rise to an annual addition for any 
limitation year. For this purpose, restorative payments are payments 
made to restore losses to a plan resulting from actions by a fiduciary 
for which there is reasonable risk of liability for breach of a

[[Page 1045]]

fiduciary duty under title I of the Employee Retirement Income Security 
Act of 1974 (88 Stat. 829), Public Law 93-406 (ERISA) or under other 
applicable federal or state law, where plan participants who are 
similarly situated are treated similarly with respect to the payments. 
Generally, payments to a defined contribution plan are restorative 
payments only if the payments are made in order to restore some or all 
of the plan's losses due to an action (or a failure to act) that creates 
a reasonable risk of liability for such a breach of fiduciary duty 
(other than a breach of fiduciary duty arising from failure to remit 
contributions to the plan). This includes payments to a plan made 
pursuant to a Department of Labor order, the Department of Labor's 
Voluntary Fiduciary Correction Program, or a court-approved settlement, 
to restore losses to a qualified defined contribution plan on account of 
the breach of fiduciary duty (other than a breach of fiduciary duty 
arising from failure to remit contributions to the plan). Payments made 
to a plan to make up for losses due merely to market fluctuations and 
other payments that are not made on account of a reasonable risk of 
liability for breach of a fiduciary duty under title I of ERISA are not 
restorative payments and generally constitute contributions that give 
rise to annual additions under paragraph (b)(4) of this section.
    (D) Excess deferrals. Excess deferrals that are distributed in 
accordance with Sec. 1.402(g)-1(e)(2) or (3) do not give rise to annual 
additions.
    (3) Employee contributions. For purposes of paragraph (b)(1)(i)(B) 
of this section, the term annual addition includes mandatory employee 
contributions (as defined in section 411(c)(2)(C) and regulations 
promulgated under section 411) as well as voluntary employee 
contributions. The term annual addition does not include--
    (i) Rollover contributions (as described in sections 401(a)(31), 
402(c)(1), 403(a)(4), 403(b)(8), 408(d)(3), and 457(e)(16));
    (ii) Repayments of loans made to a participant from the plan;
    (iii) Repayments of amounts described in section 411(a)(7)(B) (in 
accordance with section 411(a)(7)(C)) and section 411(a)(3)(D) or 
repayment of contributions to a governmental plan (as defined in section 
414(d)) as described in section 415(k)(3);
    (iv) Repayments that would have been described in paragraph 
(b)(3)(iii) of this section except that the plan does not restrict the 
timing of repayments to the maximum extent permitted by section 411(a); 
or
    (v) Employee contributions to a qualified cost of living arrangement 
within the meaning of section 415(k)(2)(B).
    (4) Transactions with plan. The Commissioner may in an appropriate 
case, considering all of the facts and circumstances, treat transactions 
between the plan and the employer, transactions between the plan and the 
employee, or certain allocations to participants' accounts as giving 
rise to annual additions. Further, where an employee or employer 
transfers assets to a plan in exchange for consideration that is less 
than the fair market value of the assets transferred to the plan, there 
is an annual addition in the amount of the difference between the value 
of the assets transferred and the consideration. A transaction described 
in this paragraph (b)(4) may constitute a prohibited transaction with 
the meaning of section 4975(c)(1).
    (5) Contributions other than cash. For purposes of this paragraph 
(b), a contribution by the employer or employee of property rather than 
cash is considered to be a contribution in an amount equal to the fair 
market value of the property on the date the contribution is made. For 
this purpose, the fair market value is the price at which the property 
would change hands between a willing buyer and a willing seller, neither 
being under any compulsion to buy or to sell and both having reasonable 
knowledge of relevant facts. In addition, a contribution described in 
this paragraph (b)(5) may constitute a prohibited transaction within the 
meaning of section 4975(c)(1).
    (6) Timing rules--(i) In general--(A) Date of allocation. For 
purposes of this paragraph (b), an annual addition is credited to the 
account of a participant for a particular limitation year if it is 
allocated to the participant's account under the terms of the plan as of 
any

[[Page 1046]]

date within that limitation year. Similarly, an annual addition that is 
made pursuant to a corrective amendment that complies with the 
requirements of Sec. 1.401(a)(4)-11(g) is credited to the account of a 
participant for a particular limitation year if it is allocated to the 
participant's account under the terms of the corrective amendment as of 
any date within that limitation year. However, if the allocation of an 
annual addition is dependent upon the satisfaction of a condition (such 
as continued employment or the occurrence of an event) that has not been 
satisfied by the date as of which the annual addition is allocated under 
the terms of the plan, then the annual addition is considered allocated 
for purposes of this paragraph (b) as of the date the condition is 
satisfied.
    (B) Date of employer contributions. For purposes of this paragraph 
(b), employer contributions are not treated as credited to a 
participant's account for a particular limitation year unless the 
contributions are actually made to the plan no later than 30 days after 
the end of the period described in section 404(a)(6) applicable to the 
taxable year with or within which the particular limitation year ends. 
If, however, contributions are made by an employer exempt from Federal 
income tax (including a governmental employer), the contributions must 
be made to the plan no later than the 15th day of the tenth calendar 
month following the end of the calendar year or fiscal year (as 
applicable, depending on the basis on which the employer keeps its 
books) with or within which the particular limitation year ends. If 
contributions are made to a plan after the end of the period during 
which contributions can be made and treated as credited to a 
participant's account for a particular limitation year, allocations 
attributable to those contributions are treated as credited to the 
participant's account for the limitation year during which those 
contributions are made.
    (C) Date of employee contributions. For purposes of this paragraph 
(b), employee contributions, whether voluntary or mandatory, are not 
treated as credited to a participant's account for a particular 
limitation year unless the contributions are actually made to the plan 
no later than 30 days after the close of that limitation year.
    (D) Date for forfeitures. A forfeiture is treated as an annual 
addition for the limitation year that contains the date as of which it 
is allocated to a participant's account as a forfeiture.
    (E) Treatment of elective contributions as plan assets. The extent 
to which elective contributions constitute plan assets for purposes of 
the prohibited transaction provisions of section 4975 and title I of 
ERISA, is determined in accordance with regulations and rulings issued 
by the Department of Labor. See 29 CFR 2510.3-102.
    (ii) Special timing rules--(A) Corrective contributions. For 
purposes of this section, if, in a particular limitation year, an 
employer allocates an amount to a participant's account because of an 
erroneous forfeiture in a prior limitation year, or because of an 
erroneous failure to allocate amounts in a prior limitation year, the 
corrective allocation will not be considered an annual addition with 
respect to the participant for that particular limitation year, but will 
be considered an annual addition for the prior limitation year to which 
it relates. An example of a situation in which an employer contribution 
might occur under the circumstances described in the preceding sentence 
is a retroactive crediting of service for an employee under 29 CFR 
2530.200b-2(a)(3) in accordance with an award of back pay. For purposes 
of this paragraph (b)(6)(ii), if the amount so contributed in the 
particular limitation year takes into account actual investment gains 
attributable to the period subsequent to the year to which the 
contribution relates, the portion of the total contribution that 
consists of such gains is not considered as an annual addition for any 
limitation year.
    (B) Contributions for accumulated funding deficiencies and 
previously waived contributions--(1) Accumulated funding deficiency. In 
the case of a defined contribution plan to which the rules of section 
412 apply, a contribution made to reduce an accumulated funding 
deficiency will be treated as if it were timely made for purposes of 
determining the limitation year in which the annual additions arising 
from the contribution are made, but only if the

[[Page 1047]]

contribution is allocated to those participants who would have received 
an annual addition if the contribution had been timely made.
    (2) Previously waived contributions. In the case of a defined 
contribution plan to which the rules of section 412 apply and for which 
there has been a waiver of the minimum funding standard in a prior 
limitation year in accordance with section 412(d), that portion of an 
employer contribution in a subsequent limitation year which, if not for 
the waiver, would have otherwise been required in the prior limitation 
year under section 412(a) will be treated as if it were timely made 
(without regard to the funding waiver) for purposes of determining the 
limitation year in which the annual additions arising from the 
contribution are made, but only if the contribution is allocated to 
those participants who would have received an annual addition if the 
contribution had been timely made (without regard to the funding 
waiver).
    (3) Interest. For purposes of determining the amount of the annual 
addition under paragraphs (b)(6)(ii)(B)(1) and (2) of this section, a 
reasonable amount of interest paid by the employer is disregarded. 
However, any interest paid by the employer that is in excess of a 
reasonable amount, as determined by the Commissioner, is taken into 
account as an annual addition for the limitation year during which the 
contribution is made.
    (C) Simplified employee pensions. For purposes of this paragraph 
(b), amounts contributed to a simplified employee pension described in 
section 408(k) are treated as allocated to the individual's account as 
of the last day of the limitation year ending with or within the taxable 
year for which the contribution is made.
    (D) Treatment of certain contributions made pursuant to veterans' 
reemployment rights. If, in a particular limitation year, an employer 
contributes an amount to an employee's account with respect to a prior 
limitation year and such contribution is required by reason of such 
employee's rights under chapter 43 of title 38, United States Code, 
resulting from qualified military service, as specified in section 
414(u)(1), then such contribution is not considered an annual addition 
with respect to the employee for that particular limitation year in 
which the contribution is made, but, in accordance with section 
414(u)(1)(B), is considered an annual addition for the limitation year 
to which the contribution relates.
    (c) Examples. The following examples illustrate the rules of 
paragraphs (a) and (b) of this section:

    Example 1. (i) P is a participant in a qualified profit-sharing plan 
maintained by his employer, ABC Corporation. The limitation year for the 
plan is the calendar year. P's compensation (as defined in Sec. 
1.415(c)-2) for the current limitation year is $30,000.
    (ii) Because the compensation limitation described in section 
415(c)(1)(B) applicable to P for the current limitation year is lower 
than the dollar limitation described in section 415(c)(1)(A), the 
maximum annual addition which can be allocated to P's account for the 
current limitation year is $30,000 (100 percent of $30,000).
    Example 2. (i) The facts are the same as in Example 1, except that 
P's compensation for the current limitation year is $140,000.
    (ii) The maximum amount of annual additions that may be allocated to 
P's account in the current limitation year is the lesser of $140,000 
(100 percent of P's compensation) or the dollar limitation of section 
415(c)(1)(A) as in effect as of January 1 of the calendar year in which 
the current limitation year ends. If, for example, the dollar limitation 
of section 415(c)(1)(A) in effect as of January 1 of the calendar year 
in which the current limitation year ends is $45,000, then the maximum 
annual addition that can be allocated to P's account for the current 
limitation year is $45,000.
    Example 3. (i) Employer N maintains a qualified profit-sharing plan 
that uses the calendar year as its plan year and its limitation year. 
N's taxable year is a fiscal year beginning June 1 and ending May 31. 
Under the terms of the profit-sharing plan maintained by N, employer 
contributions are made to the plan two months after the close of N's 
taxable year and are allocated as of the last day of the plan year 
ending within the taxable year (and are not dependent on the 
satisfaction of a condition). Thus, employer contributions for the 2008 
calendar year limitation year are made on July 31, 2009 (the date that 
is two months after the close of N's taxable year ending May 31, 2009) 
and are allocated as of December 31, 2008.
    (ii) Because the employer contributions are actually made to the 
plan no later than 30 days after the end of the period described in 
section 404(a)(6) with respect to N's taxable year ending May 31, 2009, 
the contributions will be considered annual additions for the 2008 
calendar year limitation year.

[[Page 1048]]

    Example 4. (i) The facts are the same as in Example 3, except that 
the plan year for the profit-sharing plan maintained by N is the 12-
month period beginning on February 1 and ending on January 31. The 
limitation year continues to be the calendar year. Under the terms of 
the plan, an employer contribution which is made to the plan on July 31, 
2009, is allocated to participants' accounts as of January 31, 2009.
    (ii) Because the last day of the plan year is in the 2009 calendar 
year limitation year, and because, under the terms of the plan, employer 
contributions are allocated to participants' accounts as of the last day 
of the plan year, the contributions are considered annual additions for 
the 2009 calendar year limitation year.
    Example 5. (i) XYZ Corporation maintains a profit-sharing plan to 
which a participant may make voluntary employee contributions for any 
year not to exceed 10 percent of the participant's compensation for the 
year. The plan permits a participant to make retroactive make-up 
contributions for any year for which the participant contributed less 
than 10 percent of compensation. XYZ uses the calendar year as the plan 
year and the limitation year. Under the terms of the plan, voluntary 
employee contributions are credited to a participant's account for a 
particular limitation year if such contributions are allocated to the 
participant's account as of any date within that limitation year. 
Participant A's compensation is as follows--

------------------------------------------------------------------------
                     Limitation year                       Compensation
------------------------------------------------------------------------
2008....................................................         $30,000
2009....................................................         $32,000
2010....................................................         $34,000
2011....................................................         $36,000
------------------------------------------------------------------------

    (ii) Participant A makes no voluntary employee contributions during 
limitation years 2008, 2009, and 2010. On October 1, 2011, participant A 
makes a voluntary employee contribution of $13,200 (10 percent of A's 
aggregate compensation for limitation years 2008, 2009, 2010, and 2011 
of $132,000). Under the terms of the plan, $3,000 of this 2011 
contribution is allocated to A's account as of limitation year 2008; 
$3,200 is allocated to A's account of limitation year 2009; $3,400 is 
allocated to A's account as of limitation year 2010, and $3,600 is 
allocated to A's account as of limitation year 2011.
    (iii) Under the rule set forth in paragraph (b)(6)(i)(C) of this 
section, employee contributions will not be considered credited to a 
participant's account for a particular limitation year for section 415 
purposes unless the contributions are actually made to the plan no later 
than 30 days after the close of that limitation year. Thus, A's 
voluntary employee contribution of $13,200 made on October 1, 2011, 
would be considered as credited to A's account only for the 2011 
calendar year limitation year, notwithstanding the plan provisions.

    (d) Special rules relating to church plans--(1) Alternative 
contribution limitation--(i) In general. Pursuant to section 
415(c)(7)(A), notwithstanding the general rule of paragraph (a)(1) of 
this section, additions for a section 403(b) annuity contract for a year 
with respect to a participant who is an employee of a church or a 
convention or association of churches, including an organization 
described in section 414(e)(3)(B)(ii), when expressed as an annual 
addition to such participant's account, are treated as not exceeding the 
limitation of paragraph (a)(1) of this section if such annual additions 
for the year are not in excess of $10,000.
    (ii) $40,000 aggregate limitation. With respect to any participant, 
the total amount of annual additions that are in excess of the 
limitation of paragraph (a)(1) of this section but, pursuant to the rule 
of paragraph (d)(1)(i) of this section, are treated as not exceeding 
that limitation (taking into account the rule of paragraph (d)(3) of 
this section) cannot exceed $40,000. Thus, the aggregate of annual 
additions for all limitation years that would exceed the limitation of 
this section but for this paragraph (d)(1) is limited to $40,000.
    (2) Years of service taken into account for duly ordained, 
commissioned, or licensed ministers or lay employees. For purposes of 
this paragraph (d)--
    (i) All years of service by an individual as an employee of a 
church, or a convention or association of churches, including an 
organization described in section 414(e)(3)(B)(ii), are considered as 
years of service for one employer; and
    (ii) All amounts contributed for annuity contracts by each such 
church (or convention or association of churches) during such years for 
the employee are considered to have been contributed by one employer.
    (3) Foreign missionaries. Pursuant to section 415(c)(7)(C), in the 
case of any individual described in paragraph (d)(1) of this section 
performing any services for the church outside the United States during 
the limitation year, additions for an annuity contract under section 
403(b) for any year are not treated as exceeding the limitation of

[[Page 1049]]

paragraph (a)(1) of this section if such annual additions for the year 
do not exceed $3,000. The preceding sentence shall not apply with 
respect to any taxable year to any individual whose adjusted gross 
income for such taxable year (determined separately and without regard 
to community property law) exceeds $17,000.
    (4) Church, convention or association of churches. For purposes of 
this paragraph (d), the terms ``church'' and ``convention or association 
of churches'' have the same meaning as when used in section 414(e).
    (5) Examples. The following examples illustrate the rules of this 
paragraph (d):

    Example 1. (i) E is an employee of ABC Church earning $7,000 during 
each calendar year. E participates in a section 403(b) annuity contract 
maintained by ABC Church beginning in the year 2008. E's taxable year is 
the calendar year, and the limitation year for the plan coincides with 
the calendar year. ABC Church contributes $10,000 to be allocated to E's 
account under the plan for the year 2008.
    (ii) Under paragraph (d)(1) of this section, this allocation is 
treated as not violating the limits established in paragraph (a)(1) of 
this section because it does not exceed $10,000. Moreover, since an 
annual addition of $10,000 would otherwise exceed the limitation of 
paragraph (a)(1) of this section by $3,000, $3,000 is counted toward the 
aggregate limitation specified in paragraph (d)(1)(ii) of this section 
for year 2008. Accordingly, ABC Church may make such allocations for 13 
years (for example, for years 2008 through 2020) without exceeding the 
aggregate limitation of $40,000 specified in paragraph (d) of this 
section. For the fourteenth year, ABC Church could allocate only $8,000 
to E's account (the sum of the $7,000 limitation computed under 
paragraph (a)(1)(ii) of this section and the remaining $1,000 of the 
$40,000 aggregate limitation under paragraph (d)(1)(ii) of this section 
on annual additions in excess of the limits under paragraph (a)(1) of 
this section).
    Example 2. (i) F is an employee of XYZ Church and F's taxable year 
is the calendar year. F earns $2,000 during each calendar year for 
services he provides to XYZ Church, all of which are performed outside 
the United States during each calendar year. F participates in a section 
403(b) annuity contract maintained by ABC Church beginning in the year 
2008. The limitation year for the plan coincides with the calendar year. 
ABC Church contributes $10,000 to be allocated to F's account under the 
plan for the year 2008. F's adjusted gross income for each taxable year 
(determined separately and without regard to community property law) 
does not exceed $17,000.
    (ii) Under paragraph (d)(1) of this section, this allocation is 
treated as not violating the limits established in paragraph (a)(1) of 
this section because it does not exceed $10,000. Moreover, since an 
annual addition of $10,000 would otherwise exceed the limitation of 
paragraph (a)(1) of this section by $7,000 (the excess of $10,000 over 
the greater of the $2,000 compensation limitation under section 
415(c)(1)(B) or the $3,000 section 415(c)(7)(C) amount), XYZ Church may 
make such allocations for 5 years (for example, for years 2008 through 
2012) without exceeding the aggregate limitation of $40,000 specified in 
paragraph (d) of this section. In year 2013, XYZ church may contribute 
$8,000 to be allocated to F's account under the plan (the sum of the 
$3,000 limitation computed under paragraph (d)(3) of this section and 
the remaining $5,000 of the $40,000 aggregate limitation under paragraph 
(d)(1)(ii) of this section on annual additions in excess of the limits 
under paragraph (a)(1) of this section). For years after 2013, pursuant 
to paragraph (d)(3) of this section, XYZ Church could allocate $3,000 
per year to F's account.

    (e) Special rules for medical benefits. The limit under paragraph 
(a)(1)(ii) of this section (100 percent of the participant's 
compensation for the limitation year) does not apply to--
    (1) An individual medical benefit account (as defined in section 
415(l)); or
    (2) A post-retirement medical benefits account for a key employee 
(as defined in section 419A(d)(1)).
    (f) Special rules for employee stock ownership plans--(1) In 
general. Special rules apply to employee stock ownership plans, as 
provided in paragraphs (f)(2) through (f)(4) of this section.
    (2) Determination of annual additions for leveraged employee stock 
ownership plans--(i) In general. Except as provided in this paragraph 
(f) of this section, in the case of an employee stock ownership plan to 
which an exempt loan as described in Sec. 54.4975-7(b) of this chapter 
has been made, the amount of employer contributions that is considered 
an annual addition for the limitation year is calculated with respect to 
employer contributions of both principal and interest used to repay that 
exempt loan for the limitation year.
    (ii) Employer stock that has decreased in value. A plan may provide 
that, in lieu of computing annual additions in accordance with paragraph 
(f)(2)(i) of

[[Page 1050]]

this section, annual additions with respect to a loan repayment 
described in paragraph (f)(2)(i) of this section are determined as the 
fair market value of shares released from the suspense account on 
account of the repayment and allocated to participants for the 
limitation year if that amount is less than the amount determined in 
accordance with paragraph (f)(2)(i) of this section.
    (3) Exclusions from annual additions for certain employee stock 
ownership plans that allocate to a broad range of participants--(i) 
General rule. Pursuant to section 415(c)(6), in the case of an employee 
stock ownership plan (as described in section 4975(e)(7)) that meets the 
requirements of paragraph (f)(3)(ii) of this section for a limitation 
year, the limitations imposed by this section do not apply to--
    (A) Forfeitures of employer securities (within the meaning of 
section 409(l)) under such an employee stock ownership plan if such 
securities were acquired with the proceeds of a loan (as described in 
section 404(a)(9)(A)); or
    (B) Employer contributions to such an employee stock ownership plan 
which are deductible under section 404(a)(9)(B) and charged against the 
participant's account.
    (ii) Employee stock ownership plans to which the special exclusion 
applies. An employee stock ownership plan meets the requirements of this 
paragraph (f)(3)(ii) for a limitation year if no more than one-third of 
the employer contributions for the limitation year that are deductible 
under section 404(a)(9) are allocated to highly compensated employees 
(within the meaning of section 414(q)).
    (4) Gratuitous transfers under section 664(g)(1). The amount of any 
qualified gratuitous transfer (as defined in section 664(g)(1)) 
allocated to a participant for any limitation year is not taken into 
account in determining whether any other annual addition exceeds the 
limitations imposed by this section, but only if the amount of the 
qualified gratuitous transfer does not exceed the limitations imposed by 
section 415.

[T.D. 9319, 72 FR 16911, Apr. 5, 2007]



Sec. 1.415(c)-2  Compensation.

    (a) General definition. Except as otherwise provided in this 
section, compensation from the employer within the meaning of section 
415(c)(3), which is used for purposes of section 415 and regulations 
promulgated under section 415, means all items of remuneration described 
in paragraph (b) of this section, but excludes the items of remuneration 
described in paragraph (c) of this section. Paragraph (d) of this 
section provides safe harbor definitions of compensation that are 
permitted to be provided in a plan in lieu of the generally applicable 
definition of compensation. Paragraph (e) of this section provides 
timing rules relating to compensation. Paragraph (f) of this section 
provides rules regarding the application of the rules of section 
401(a)(17) to the definition of compensation for purposes of section 
415. Paragraph (g) of this section provides special rules relating to 
the determination of compensation, including rules for determining 
compensation for a section 403(b) annuity contract, rules for 
determining the compensation of employees of controlled groups or 
affiliated service groups, rules for disabled employees, rules relating 
to foreign compensation, rules regarding deemed section 125 
compensation, rules for employees in qualified military service, and 
rules relating to back pay.
    (b) Items includible as compensation. For purposes of applying the 
limitations of section 415, except as otherwise provided in this 
section, the term compensation means remuneration for services of the 
following types--
    (1) The employee's wages, salaries, fees for professional services, 
and other amounts received (without regard to whether or not an amount 
is paid in cash) for personal services actually rendered in the course 
of employment with the employer maintaining the plan, to the extent that 
the amounts are includible in gross income (or to the extent amounts 
would have been received and includible in gross income but for an 
election under section 125(a), 132(f)(4), 402(e)(3), 402(h)(1)(B), 
402(k), or 457(b)). These amounts include, but are not limited to, 
commissions paid to salespersons, compensation for services on the basis 
of a percentage of profits, commissions on insurance premiums,

[[Page 1051]]

tips, bonuses, fringe benefits, and reimbursements or other expense 
allowances under a nonaccountable plan as described in Sec. 1.62-2(c).
    (2) In the case of an employee who is an employee within the meaning 
of section 401(c)(1) and regulations promulgated under section 
401(c)(1), the employee's earned income (as described in section 
401(c)(2) and regulations promulgated under section 401(c)(2)), plus 
amounts deferred at the election of the employee that would be 
includible in gross income but for the rules of section 402(e)(3), 
402(h)(1)(B), 402(k), or 457(b).
    (3) Amounts described in section 104(a)(3), 105(a), or 105(h), but 
only to the extent that these amounts are includible in the gross income 
of the employee.
    (4) Amounts paid or reimbursed by the employer for moving expenses 
incurred by an employee, but only to the extent that at the time of the 
payment it is reasonable to believe that these amounts are not 
deductible by the employee under section 217.
    (5) The value of a nonstatutory option (which is an option other 
than a statutory option as defined in Sec. 1.421-1(b)) granted to an 
employee by the employer, but only to the extent that the value of the 
option is includible in the gross income of the employee for the taxable 
year in which granted.
    (6) The amount includible in the gross income of an employee upon 
making the election described in section 83(b).
    (7) Amounts that are includible in the gross income of an employee 
under the rules of section 409A or section 457(f)(1)(A) or because the 
amounts are constructively received by the employee.
    (c) Items not includible as compensation. The term compensation does 
not include--
    (1) Contributions (other than elective contributions described in 
section 402(e)(3), section 408(k)(6), section 408(p)(2)(A)(i), or 
section 457(b)) made by the employer to a plan of deferred compensation 
(including a simplified employee pension described in section 408(k) or 
a simple retirement account described in section 408(p), and whether or 
not qualified) to the extent that the contributions are not includible 
in the gross income of the employee for the taxable year in which 
contributed. In addition, any distributions from a plan of deferred 
compensation (whether or not qualified) are not considered as 
compensation for section 415 purposes, regardless of whether such 
amounts are includible in the gross income of the employee when 
distributed. However, if the plan so provides, any amounts received by 
an employee pursuant to a nonqualified unfunded deferred compensation 
plan are permitted to be considered as compensation for section 415 
purposes in the year the amounts are actually received, but only to the 
extent such amounts are includible in the employee's gross income.
    (2) Amounts realized from the exercise of a nonstatutory option 
(which is an option other than a statutory option as defined in Sec. 
1.421-1(b)), or when restricted stock or other property held by an 
employee either becomes freely transferable or is no longer subject to a 
substantial risk of forfeiture (see section 83 and regulations 
promulgated under section 83).
    (3) Amounts realized from the sale, exchange, or other disposition 
of stock acquired under a statutory stock option (as defined in Sec. 
1.421-1(b)).
    (4) Other amounts that receive special tax benefits, such as 
premiums for group-term life insurance (but only to the extent that the 
premiums are not includible in the gross income of the employee and are 
not salary reduction amounts that are described in section 125).
    (5) Other items of remuneration that are similar to any of the items 
listed in paragraphs (c)(1) through (c)(4) of this section.
    (d) Safe harbor rules with respect to plan's definition of 
compensation--(1) In general. Paragraphs (d)(2) through (4) of this 
section contain safe harbor definitions of compensation that are 
automatically considered to satisfy section 415(c)(3) if specified in 
the plan. The Commissioner may, in revenue rulings, notices, and other 
guidance of general applicability published in the Internal Revenue 
Bulletin (see Sec. 601.601(d)(2) of this chapter), provide additional 
definitions of compensation that are treated as satisfying section 
415(c)(3).

[[Page 1052]]

    (2) Simplified compensation. The safe harbor definition of 
compensation under this paragraph (d)(2) includes only those items 
specified in paragraph (b)(1) or (2) of this section and excludes all 
those items listed in paragraph (c) of this section.
    (3) Section 3401(a) wages. The safe harbor definition of 
compensation under this paragraph (d)(3) includes wages within the 
meaning of section 3401(a) (for purposes of income tax withholding at 
the source), plus amounts that would be included in wages but for an 
election under section 125(a), 132(f)(4), 402(e)(3), 402(h)(1)(B), 
402(k), or 457(b). However, any rules that limit the remuneration 
included in wages based on the nature or location of the employment or 
the services performed (such as the exception for agricultural labor in 
section 3401(a)(2)) are disregarded for this purpose.
    (4) Information required to be reported under sections 6041, 6051 
and 6052. The safe harbor definition of compensation under this 
paragraph (d)(4) includes amounts that are compensation under the safe 
harbor definition of paragraph (d)(3) of this section, plus all other 
payments of compensation to an employee by his employer (in the course 
of the employer's trade or business) for which the employer is required 
to furnish the employee a written statement under sections 6041(d), 
6051(a)(3), and 6052. See Sec. Sec. 1.6041-1(a), 1.6041-2(a)(1), 
1.6052-1, and 1.6052-2, and also see Sec. 31.6051-1(a)(1)(i)(C) of this 
chapter. This safe harbor definition of compensation may be modified to 
exclude amounts paid or reimbursed by the employer for moving expenses 
incurred by an employee, but only to the extent that, at the time of the 
payment, it is reasonable to believe that these amounts are deductible 
by the employee under section 217.
    (e) Timing rules--(1) In general--(i) Payment during the limitation 
year. Except as otherwise provided in this paragraph (e), in order to be 
taken into account for a limitation year, compensation within the 
meaning of section 415(c)(3) must be actually paid or made available to 
an employee (or, if earlier, includible in the gross income of the 
employee) within the limitation year. For this purpose, compensation is 
treated as paid on a date if it is actually paid on that date or it 
would have been paid on that date but for an election under section 125, 
132(f)(4), 401(k), 403(b), 408(k), 408(p)(2)(A)(i), or 457(b).
    (ii) Payment prior to severance from employment. Except as otherwise 
provided in this paragraph (e), in order to be taken into account for a 
limitation year, compensation within the meaning of section 415(c)(3) 
must be paid or treated as paid to the employee (in accordance with the 
rules of paragraph (e)(1)(i) of this section) prior to the employee's 
severance from employment with the employer maintaining the plan. See 
Sec. 1.415(a)-1(f)(5) for the definition of severance from employment.
    (2) Certain minor timing differences. Notwithstanding the provisions 
of paragraph (e)(1)(i) of this section, a plan may provide that 
compensation for a limitation year includes amounts earned during that 
limitation year but not paid during that limitation year solely because 
of the timing of pay periods and pay dates if--
    (i) These amounts are paid during the first few weeks of the next 
limitation year;
    (ii) The amounts are included on a uniform and consistent basis with 
respect to all similarly situated employees; and
    (iii) No compensation is included in more than one limitation year.
    (3) Compensation paid after severance from employment--(i) In 
general. Any compensation described in paragraph (e)(3)(ii) of this 
section does not fail to be compensation (within the meaning of section 
415(c)(3)) pursuant to the rule of paragraph (e)(1)(ii) of this section 
merely because it is paid after the employee's severance from employment 
with the employer maintaining the plan, provided the compensation is 
paid by the later of 2\1/2\ months after severance from employment with 
the employer maintaining the plan or the end of the limitation year that 
includes the date of severance from employment with the employer 
maintaining the plan. In addition, the plan may provide that amounts 
described in paragraph (e)(3)(iii) of this section are included in 
compensation (within the meaning of section 415(c)(3)) if--
    (A) Those amounts are paid by the later of 2\1/2\ months after 
severance

[[Page 1053]]

from employment with the employer maintaining the plan or the end of the 
limitation year that includes the date of severance from employment with 
the employer maintaining the plan; and
    (B) Those amounts would have been included in the definition of 
compensation if they were paid prior to the employee's severance from 
employment with the employer maintaining the plan.
    (ii) Regular pay after severance from employment. An amount is 
described in this paragraph (e)(3)(ii) if--
    (A) The payment is regular compensation for services during the 
employee's regular working hours, or compensation for services outside 
the employee's regular working hours (such as overtime or shift 
differential), commissions, bonuses, or other similar payments; and
    (B) The payment would have been paid to the employee prior to a 
severance from employment if the employee had continued in employment 
with the employer.
    (iii) Leave cashouts and deferred compensation. An amount is 
described in this paragraph (e)(3)(iii) if the amount is either--
    (A) Payment for unused accrued bona fide sick, vacation, or other 
leave, but only if the employee would have been able to use the leave if 
employment had continued; or
    (B) Received by an employee pursuant to a nonqualified unfunded 
deferred compensation plan, but only if the payment would have been paid 
to the employee at the same time if the employee had continued in 
employment with the employer and only to the extent that the payment is 
includible in the employee's gross income.
    (iv) Other post-severance payments. Any payment that is not 
described in paragraph (e)(3)(ii) or (iii) of this section is not 
considered compensation under paragraph (e)(3)(i) of this section if 
paid after severance from employment with the employer maintaining the 
plan, even if it is paid within the time period described in paragraph 
(e)(3)(i) of this section. Thus, compensation does not include severance 
pay, or parachute payments within the meaning of section 280G(b)(2), if 
they are paid after severance from employment with the employer 
maintaining the plan, and does not include post-severance payments under 
a nonqualified unfunded deferred compensation plan unless the payments 
would have been paid at that time without regard to the severance from 
employment.
    (4) Salary continuation payments for military service and disabled 
participants. The rule of paragraph (e)(1)(ii) of this section does not 
apply to payments to an individual who does not currently perform 
services for the employer by reason of qualified military service (as 
that term is used in section 414(u)(1)) to the extent those payments do 
not exceed the amounts the individual would have received if the 
individual had continued to perform services for the employer rather 
than entering qualified military service, but only if the plan so 
provides. In addition, the rule of paragraph (e)(1)(ii) of this section 
does not apply to compensation paid to a participant who is permanently 
and totally disabled (as defined in section 22(e)(3)) if the conditions 
set forth in paragraph (g)(4)(ii)(A) of this section are satisfied 
(applied by substituting a continuation of compensation for the 
continuation of contributions), but only if the plan so provides.
    (5) Special rule for governmental plans. For purposes of applying 
the rules of paragraph (e)(3) of this section, a governmental plan (as 
defined in section 414(d)) may provide for the substitution of the 
calendar year in which the severance from employment with the employer 
maintaining the plan occurs for the limitation year in which the 
severance from employment with the employer maintaining the plan occurs.
    (6) Examples. The provisions of this paragraph (e) are illustrated 
by the following examples:

    Example 1. (i) Facts. Participant A was a common law employee of 
Employer X, performing services as a script writer for Employer X from 
January 1, 2005 to December 31, 2005. Pursuant to a collective 
bargaining agreement, Employer X, Employer Y and Employer Z maintain and 
contribute to Plan T, a multiemployer plan (as defined in section 
414(f)) in which Participant A participates. Under the collective 
bargaining agreement, Participant A is entitled to residual payments 
whenever television shows that

[[Page 1054]]

Participant A wrote are re-used commercially (These residual payments 
constitute compensation described in paragraph (b) of this section and 
do not constitute compensation described in paragraph (c) of this 
section.). In the year 2008, Participant A receives residual payments 
from Employer X for television programs using the scripts that 
Participant A wrote in the year 2005 that were rebroadcast in the year 
2008. In the years 2006, 2007, and 2008, Participant A was a common law 
employee of Employer Y, and did not perform any services for Employer X.
    (ii) Conclusion. The residual payments received from Employer X by 
Participant A in the year 2008 are compensation for purposes of section 
415(c)(3). The payments are not treated as made after severance from 
employment because Plan T is a multiemployer plan (as defined in section 
414(f)) and Participant A continues to be employed by an employer 
maintaining Plan T.
    Example 2. (i) Facts. The facts are the same as in Example 1, except 
that Participant A: ceased employment with Employer Y in the year 2006; 
subsequently moved away from the area in which A formerly worked; 
performs no services as an employee for any employer; and commenced 
receiving distributions under Plan T in March, 2006.
    (ii) Conclusion. Based on the facts and circumstances, A has ceased 
employment with any employer maintaining Plan T. Pursuant to paragraph 
(e)(1)(ii) of this section, compensation must be paid prior to an 
employee's severance from employment with the employer maintaining the 
plan. Accordingly, the residual payments received by Participant A in 
the year 2008 are not compensation for purposes of section 415(c)(3).

    (f) Interaction with section 401(a)(17). Because a plan may not base 
allocations (in the case of a defined contribution plan) or benefits (in 
the case of a defined benefit plan) on compensation in excess of the 
limitation under section 401(a)(17), a plan's definition of compensation 
for a year that is used for purposes of applying the limitations of 
section 415 is not permitted to reflect compensation for a year that is 
in excess of the limitation under section 401(a)(17) that applies to 
that year. See Sec. Sec. 1.401(a)(17)-1(a)(3)(i) and 1.401(a)(17)-
1(b)(3)(ii) for rules regarding the effective date of increases in the 
section 401(a)(17) compensation limitation for a plan year and for a 12-
month period other than the plan year.
    (g) Special rules--(1) Compensation for section 403(b) annuity 
contract. In the case of an annuity contract described in section 
403(b), the term participant's compensation means the participant's 
includible compensation determined under section 403(b)(3). Accordingly, 
the rules for determining a participant's compensation pursuant to 
section 415(c)(3) (other than section 415(c)(3)(E)) and this section do 
not apply to a section 403(b) annuity contract.
    (2) Employees of controlled groups of corporations, etc. In the case 
of an employee of two or more corporations which are members of a 
controlled group of corporations (as defined in section 414(b) as 
modified by section 415(h)), the term compensation for such employee 
includes compensation from all employers that are members of the group, 
regardless of whether the employee's particular employer has a qualified 
plan. This special rule is also applicable to an employee of two or more 
trades or businesses (whether or not incorporated) that are under common 
control (as defined in section 414(c) as modified by section 415(h)), to 
an employee of two or more members of an affiliated service group as 
defined in section 414(m), and to an employee of two or more members of 
any group of employers who must be aggregated and treated as one 
employer pursuant to section 414(o).
    (3) Aggregation of section 403(b) annuity with qualified plan of 
controlled employer. If a section 403(b) annuity contract is aggregated 
with a qualified plan of a controlled employer in accordance with Sec. 
1.415(f)-1(f)(2), then, in applying the limitations of section 415(c) in 
connection with the aggregation of the section 403(b) annuity with a 
qualified plan, the total compensation from both employers is permitted 
to be taken into account.
    (4) Permanent and total disability of defined contribution plan 
participant--(i) In general. Pursuant to section 415(c)(3)(C), if the 
conditions set forth in paragraph (g)(4)(ii) of this section are 
satisfied, then, in the case of a participant in any defined 
contribution plan who is permanently and totally disabled (as defined in 
section 22(e)(3)), the participant's compensation means the compensation 
the participant would have received for the year if the participant was 
paid at the rate of compensation paid immediately before

[[Page 1055]]

becoming permanently and totally disabled, if such compensation is 
greater than the participant's compensation determined without regard to 
this paragraph (g)(4).
    (ii) Conditions for deemed disability compensation. The rule of 
paragraph (g)(4)(i) of this section applies only if the following 
conditions are satisfied--
    (A) Either the participant is not a highly compensated employee (as 
defined in section 414(q)) immediately before becoming disabled, or the 
plan provides for the continuation of contributions on behalf of all 
participants who are permanently and totally disabled for a fixed or 
determinable period;
    (B) The plan provides that the rule of this paragraph (g)(4) 
(treating certain amounts as compensation for a disabled participant) 
applies with respect to the participant; and
    (C) Contributions made with respect to amounts treated as 
compensation under this paragraph (g)(4) are nonforfeitable when made.
    (5) Foreign compensation, etc.--(i) In general. Amounts paid to an 
individual as compensation for services do not fail to be treated as 
compensation under paragraphs (b)(1) and (2) of this section (and are 
not excluded from the definition of compensation pursuant to paragraph 
(c)(4) of this section) merely because those amounts are not includible 
in the individual's gross income on account of the location of the 
services. Similarly, compensation for services do not fail to be treated 
as compensation under paragraphs (b)(1) and (2) of this section (and are 
not excluded from the definition of compensation pursuant to paragraph 
(c)(4) of this section) merely because those amounts are paid by an 
employer with respect to which all compensation paid to the participant 
by such employer is excluded from gross income. Thus, for example, the 
determination of whether an amount is treated as compensation under 
paragraph (b)(1) or (2) of this section is made without regard to the 
exclusions from gross income under sections 872, 893, 894, 911, 931, and 
933.
    (ii) Exclusion of non-participant compensation by the plan. With 
respect to a nonresident alien who is not a participant in a plan, the 
plan may provide that the compensation described in paragraph (g)(5)(i) 
of this section is not treated as compensation for purposes of 
paragraphs (b)(1) and (b)(2) of this section to the extent the 
compensation is excludable from gross income and is not effectively 
connected with the conduct of a trade or business within the United 
States, but only if the plan applies this rule uniformly to all such 
employees. For purposes of this paragraph (g)(5)(ii), nonresident alien 
has the same meaning as in section 7701(b)(1)(B).
    (6) Deemed section 125 compensation--(i) General rule. A plan is 
permitted to provide that deemed section 125 compensation (as defined in 
paragraph (g)(6)(ii) of this section) is compensation within the meaning 
of section 415(c)(3), but only if the plan applies this rule uniformly 
to all employees with respect to whom amounts subject to section 125 are 
included in compensation.
    (ii) Definition of deemed section 125 compensation. Deemed section 
125 compensation is an amount that is excludable from the income of the 
participant under section 106 that is not available to the participant 
in cash in lieu of group health coverage under a section 125 arrangement 
solely because that participant is not able to certify that the 
participant has other health coverage. Under this definition, amounts 
are deemed section 125 compensation only if the employer does not 
otherwise request or collect information regarding the participant's 
other health coverage as part of the enrollment process for the health 
plan.
    (7) Employees in qualified military service. See section 414(u)(7) 
for special rules regarding compensation of employees who are in 
qualified military service within the meaning of section 414(u)(5).
    (8) Back pay. Payments awarded by an administrative agency or court 
or pursuant to a bona fide agreement by an employer to compensate an 
employee for lost wages are compensation within the meaning of section 
415(c)(3) for the limitation year to which the back pay relates, but 
only to the extent such payments represent wages

[[Page 1056]]

and compensation that would otherwise be included in compensation under 
this section.

[T.D. 9319, 72 FR 16916, Apr. 5, 2007]



Sec. 1.415(d)-1  Cost-of-living adjustments.

    (a) Defined benefit plans--(1) Dollar limitation--(i) Determination 
of adjusted limit. Under section 415(d)(1)(A), the dollar limitation 
described in section 415(b)(1)(A) applicable to defined benefit plans is 
adjusted annually to take into account increases in the cost of living. 
The adjustment of the dollar limitation is made by multiplying the 
adjustment factor for the year, as described in paragraph (a)(1)(ii)(A) 
of this section, by $160,000, and rounding the result in accordance with 
paragraph (a)(1)(iii) of this section. The adjusted dollar limitation is 
prescribed by the Commissioner and published in the Internal Revenue 
Bulletin. See Sec. 601.601(d)(2) of this chapter.
    (ii) Determination of adjustment factor--(A) Adjustment factor. The 
adjustment factor for a calendar year is equal to a fraction, the 
numerator of which is the value of the applicable index for the calendar 
quarter ending September 30 of the preceding calendar year, and the 
denominator of which is the value of such index for the base period. The 
applicable index is determined consistent with the procedures used to 
adjust benefit amounts under section 215(i)(2)(A) of the Social Security 
Act, Public Law 92-336 (86 Stat. 406), as amended. If, however, the 
value of that fraction is less than one for a calendar year, then the 
adjustment factor for the calendar year is equal to one.
    (B) Base period. For the purpose of adjusting the dollar limitation 
pursuant to paragraph (a)(1)(ii)(A) of this section, the base period is 
the calendar quarter beginning July 1, 2001.
    (iii) Rounding. Any increase in the $160,000 amount specified in 
section 415(b)(1)(A) which is not a multiple of $5,000 is rounded to the 
next lowest multiple of $5,000.
    (2) Average compensation for high-3 years of service limitation--(i) 
Determination of adjusted limit. Under section 415(d)(1)(B), with regard 
to participants who have had a severance from employment with the 
employer maintaining the plan, the compensation limitation described in 
section 415(b)(1)(B) is permitted to be adjusted annually to take into 
account increases in the cost of living. For any limitation year 
beginning after the severance occurs, the adjustment of the compensation 
limitation is made by multiplying the annual adjustment factor (as 
defined in paragraph (a)(2)(ii) of this section) by the compensation 
limitation applicable to the participant in the prior limitation year. 
The annual adjustment factor is prescribed by the Commissioner and 
published in the Internal Revenue Bulletin. See Sec. 601.601(d)(2) of 
this chapter.
    (ii) Annual adjustment factor. The annual adjustment factor for a 
calendar year is equal to a fraction, the numerator of which is the 
value of the applicable index for the calendar quarter ending September 
30 of the preceding calendar year, and the denominator of which is the 
value of such index for the calendar quarter ending September 30 of the 
calendar year prior to that preceding calendar year. The applicable 
index is determined consistent with the procedures used to adjust 
benefit amounts under section 215(i)(2)(A) of the Social Security Act. 
If the value of the fraction described in the first sentence of this 
paragraph (a)(2)(ii) is less than one for a calendar year, then the 
adjustment factor for the calendar year is equal to one. In such a case, 
the annual adjustment factor for future calendar years will be 
determined in accordance with revenue rulings, notices, or other 
published guidance prescribed by the Commissioner and published in the 
Internal Revenue Bulletin. See Sec. 601.601(d)(2) of this chapter.
    (iii) Special rule for rehired employees. If, after having a 
severance from employment with the employer maintaining the plan, an 
employee is rehired by the employer maintaining the plan, the employee's 
compensation limit under section 415(b)(1)(B) is the greater of--
    (A) 100 percent of the participant's average compensation for the 
period of the participant's high-3 years of service, as determined prior 
to the employee's severance from employment with the employer 
maintaining the plan, as adjusted pursuant to paragraph (a)(2)(i) of 
this section (if the plan so provides); or

[[Page 1057]]

    (B) 100 percent of the participant's average compensation for the 
period of the participant's high-3 years of service, with the period of 
the participant's high-3 years of service determined pursuant to Sec. 
1.415(b)-1(a)(5)(iii).
    (3) Effective date of adjustment. The adjusted dollar limitation 
applicable to defined benefit plans and the adjusted compensation limit 
applicable to a participant are effective as of January 1 of each 
calendar year and apply with respect to limitation years ending with or 
within that calendar year. However, benefit payments (and, in the case 
of plans that are subject to the requirements of section 411, accrued 
benefits for a limitation year) cannot exceed the currently applicable 
dollar limitation or compensation limitation (as in effect before the 
January 1 adjustment) prior to January 1. Thus, where there is an 
increase in the limitation under section 415(b)(1), any increase in a 
participant's benefits associated with the limitation increase is 
permitted to occur as of a date no earlier than January 1 of the 
calendar year for which the increase in the limitation is effective, and 
can only be applied for payments due on or after January 1 of such 
calendar year. For example, assume that a participant in a defined 
benefit plan is currently receiving a benefit in the form of a straight 
life annuity, payable monthly, in an amount equal to the section 
415(b)(1)(A) dollar limit, and the defined benefit plan has a limitation 
year that runs from July 1 to June 30. If the plan is amended to reflect 
the section 415(d) increase to the section 415(b)(1)(A) dollar limit 
that is effective as of January 1, 2009, the associated increase in the 
participant's monthly benefit payments is only effective for payments 
due on or after January 1, 2009, and the participant's benefit cannot be 
increased to reflect the section 415(d) increase that is effective 
January 1, 2009, with respect to any monthly payment due prior to 
January 1, 2009.
    (4) Application of adjusted figure--(i) In general. If the dollar 
limitation of section 415(b)(1)(A) or the compensation limitation of 
section 415(b)(1)(B) is adjusted pursuant to section 415(d) for a 
limitation year, the adjustment is applied as provided in this paragraph 
(a)(4).
    (ii) Application of adjusted limitations to benefits that have not 
commenced. An adjustment to the dollar limitation of section 
415(b)(1)(A) is permitted to be applied to a participant who has not 
commenced benefits before the date on which the adjustment is effective. 
Annual adjustments to the compensation limit of section 415(b)(1)(B) as 
described in paragraph (a)(2) of this section are permitted to be made 
for all limitation years that begin after the participant's severance 
from employment, and apply to distributions that commence after the 
effective dates of such adjustments. However, no adjustment to the 
compensation limit of section 415(b)(1)(B) is made for any limitation 
year that begins on or before the date of the participant's severance 
from employment with the employer maintaining the plan.
    (iii) Application of adjusted dollar limitation to remaining 
payments under benefits that have commenced. With respect to a 
distribution of accrued benefits that commenced before the date on which 
an adjustment to the section 415(b)(1)(A) dollar limitation is 
effective, a plan is permitted to apply the adjusted limitations to that 
distribution, but only to the extent that benefits have not been paid. 
Thus, for example, a plan cannot provide that the adjusted dollar 
limitation applies to a participant who has previously received the 
entire plan benefit in a single-sum distribution. However, a plan can 
provide for an increase in benefits to a participant who accrues 
additional benefits under the plan that could have been accrued without 
regard to the adjustment of the dollar limitation (including benefits 
that accrue as a result of a plan amendment) on or after the effective 
date of the adjusted limitation.
    (iv) Manner of adjustment for benefits that have commenced. If a 
plan is amended to increase benefits payable under the plan in 
accordance with paragraphs (a)(5) or (a)(6) of this section (or the plan 
is treated as applying paragraph (a)(5) of this section because the plan 
incorporates the section 415(d) cost-of-living adjustments automatically 
by reference pursuant to

[[Page 1058]]

Sec. 1.415(a)-1(d)(3)(v)), or if benefits payable under the plan are 
increased pursuant to a form of benefit that is described in Sec. 
1.415(b)-1(c)(5), then the distribution as increased will be treated as 
continuing to satisfy the requirements of section 415(b). If benefits 
payable under a plan are increased in a manner other than as described 
in the preceding sentence, the plan must satisfy the requirements of 
Sec. 1.415(b)-1(b)(1)(iii), treating the commencement of the additional 
benefit as the commencement of a new distribution that gives rise to a 
new annuity starting date.
    (5) Safe harbor for annual adjustments to distributions. An 
amendment to a plan to incorporate adjustments to the section 415(b) 
limits that increases a distribution that has previously commenced is 
described in this paragraph (a)(5) if--
    (i) The employee has received one or more distributions that satisfy 
the requirements of section 415(b) before the date the adjustment to the 
applicable limits is effective (as determined under paragraph (a)(3) of 
this section);
    (ii) The increased distribution is solely as a result of the 
amendment of the plan to reflect the adjustment to the applicable limits 
pursuant to section 415(d); and
    (iii) The amounts payable to the employee on and after the effective 
date of the adjustment (as determined under paragraph (a)(3) of this 
section) are not greater than the amounts that would otherwise be 
payable without regard to the adjustment, multiplied by a fraction 
determined for the limitation year, the numerator of which is the 
limitation under section 415(b) (which is the lesser of the applicable 
dollar limitation under section 415(b)(1)(A), as adjusted for age at 
commencement, and the applicable compensation-based limitation under 
section 415(b)(1)(B)) in effect with respect to the distribution taking 
into account the section 415(d) adjustment, and the denominator of which 
is the limitation under section 415(b) in effect for the distribution 
immediately before the adjustment.
    (6) Safe harbor for periodic adjustments to distributions--(i) 
General rule. An amendment to a plan that increases a distribution that 
has previously commenced is made using the safe harbor methodology of 
this paragraph (a)(6) if--
    (A) The employee has received one or more distributions that satisfy 
the requirements of section 415(b) before the date on which the increase 
is effective; and
    (B) The amounts payable to the employee on and after the effective 
date of the increase are not greater than the amounts that would 
otherwise be payable without regard to the increase, multiplied by the 
cumulative adjustment fraction.
    (ii) Cumulative adjustment fraction. The cumulative adjustment 
fraction for purposes of this paragraph (a)(6) is equal to the product 
of all of the fractions described in paragraph (a)(5)(iii) of this 
section that would have applied after benefits commence if the plan had 
been amended each year to incorporate the section 415(d) adjustments to 
the applicable section 415(b) limits and had otherwise satisfied the 
safe harbor methodology described in paragraph (a)(5) of this section. 
For purposes of the preceding sentence, if for the limitation year for 
which the increase to the section 415(b)(1)(A) dollar limitation 
pursuant to section 611(a)(1)(A) of the Economic Growth and Tax Relief 
Reconciliation Act of 2001 (115 Stat. 38), Public Law 107-16 (EGTRRA), 
is first effective (generally, the first limitation year beginning after 
December 31, 2001), the section 415(b)(1)(A) dollar limit applicable to 
a participant is less than the section 415(b)(1)(B) compensation limit 
for the participant, then the fraction described in paragraph 
(a)(5)(iii) of this section for that limitation year is 1.0.
    (7) Examples. The following examples illustrate the application of 
this paragraph (a):

    Example 1. (i) X is a participant in a qualified defined benefit 
plan maintained by X's employer. The plan has a calendar year limitation 
year. Under the terms of the plan, X is entitled to a benefit consisting 
of a straight life annuity equal to 100 percent of X's average 
compensation for the period of X's high-3 years of service. X's average 
compensation for the period of X's high-3 years of service is $50,000. X 
incurs a severance from employment with the employer maintaining the 
plan on October 3, 2007, at age 65 with a nonforfeitable right to the 
accrued

[[Page 1059]]

benefit after more than 10 years of participation in the plan. X begins 
to receive annual benefit payments (payable monthly) of $50,000, 
commencing on November 1, 2007. The dollar limitation for the 2007 
limitation year (as adjusted pursuant to section 415(d)) is $180,000. 
Assume that the dollar limitation for the 2008 limitation year (as 
adjusted pursuant to section 415(d)) is $185,000 and the annual 
adjustment factor for adjusting the compensation limitation of section 
415(b)(1)(B) for the 2008 limitation year is 1.0334. Effective January 
1, 2008, the plan is amended to incorporate these adjustments to the 
dollar and compensation limitations, and accordingly, X's annual benefit 
payment is increased, effective for payments due on or after January 1, 
2008. Prior to the plan amendment incorporating the application of the 
adjusted dollar and compensation limitations, X has received one or more 
distributions that satisfy the requirements of section 415(b). In 
addition, the adjustment to X's annual benefit payments is solely on 
account of the plan amendment incorporating the adjusted limitations.
    (ii) For the limitation year beginning January 1, 2008, the dollar 
limit applicable to X under section 415(b)(1)(A) is $185,000, and the 
compensation limit applicable to X under section 415(b)(1)(B) is $51,670 
($50,000 multiplied by the annual adjustment factor of 1.0334). 
Accordingly, the adjustment to X's benefit satisfies the safe harbor for 
cost-of-living adjustments under paragraph (a)(5) of this section if, 
after the adjustment, X's benefit payable in the 2008 limitation year is 
no greater than $50,000 multiplied by $51,670 (X's section 415(b) 
limitation for 2008)/$50,000 (X's section 415(b) limitation for 2007).
    Example 2. (i) The facts are the same as in Example 1, except that 
X's average compensation for the period of X's high-3 consecutive years 
of service is $200,000. Consequently, X's annual benefit payments 
commencing on November 1, 2007, are limited to $180,000.
    (ii) For the limitation year beginning January 1, 2008, the dollar 
limit applicable to X under section 415(b)(1)(A) is $185,000, and the 
compensation limit applicable to X under section 415(b)(1)(B) is 
$206,680 ($200,000 multiplied by the annual adjustment factor of 
1.0334). Accordingly, the adjustment to X's benefit satisfies the safe 
harbor for cost-of-living adjustments under paragraph (a)(5) of this 
section if, after the adjustment, X's benefit payable in 2008 is no 
greater than $180,000 multiplied by $185,000 (X's section 415(b) 
limitation for 2008)/$180,000 (X's section 415(b) limitation for 2007).
    Example 3. (i) X is a participant in Plan T, a qualified defined 
benefit plan maintained by X's employer. In the year 2008, X receives a 
single-sum distribution of X's entire accrued benefit under the plan. At 
the time that X receives the single-sum distribution, X's accrued 
benefit under Plan T is limited by the section 415(b)(1)(A) age-adjusted 
dollar limit. X accrues no further benefits under Plan T after X 
receives the single-sum distribution. In the 2009 limitation year, 
pursuant to section 415(d) and Sec. 1.415(d)-1, the section 
415(b)(1)(A) dollar limit is increased.
    (ii) In the 2009 limitation year, Plan T may not provide additional 
benefits to X on account of the increase in the section 415(b)(1)(A) 
dollar limit pursuant to section 415(d) and Sec. 1.415(d)-1.
    Example 4. (i) X is a participant in Plan T, a qualified defined 
benefit plan maintained by X's employer, Employer S. Plan T has a 
calendar limitation year. In 2008, X incurs a severance from employment 
with Employer S and X commences receiving distributions from Plan T in 
the form of a single life annuity in an annual amount of $30,000. At the 
time that X commences receiving distributions from Plan T, X's accrued 
benefit under Plan T is limited by the section 415(b)(1)(B) compensation 
limit. In 2009, the annual adjustment factor described in paragraph 
(a)(2) of this section (which is the factor for adjusting the 
compensation limit described in section 415(b)(1)(B)) is 1.03. Employer 
S amends Plan T, effective as of January 1, 2009, to increase the annual 
benefit of all participants who, prior to January 1, 2009, incurred a 
severance from employment with Employer S and who have commenced 
receiving benefits from Plan T by a factor of 1.015. Assume that for 
limitation years prior to 2009, X's distributions from Plan T satisfy 
the requirements of section 415(b).
    (ii) The increase in X's annual benefit pursuant to the amendment 
effective January 1, 2009, is within the safe harbor described in 
paragraph (a)(6) of this section. This is because the amount payable to 
X under Plan T for the 2009 limitation year and limitation years 
thereafter (as increased by the amendment effective January 1, 2009) is 
not greater than the product of the amount payable to X under Plan T for 
such limitation years (as determined without regard to the amendment 
increasing X's benefit effective January 1, 2009) and the cumulative 
adjustment fraction (which, in X's case, is 1.03). Thus, X's annual 
benefit, as increased by the amendment, is not determined pursuant to 
the rules of Sec. 1.415(b)-1(b)(1)(iii).
    Example 5. (i) Participant P participated in Plan A, maintained by 
Employer M, for more than 10 years. Plan A uses a calendar year 
limitation year and Plan A automatically adjusts a participant's section 
415(b)(1)(B) compensation limit for limitation years after the 
limitation year in which the participant incurs a severance from 
employment as described in Sec. 1.415(a)-1(d)(3)(v). Prior to 
separating from employment with M in 2010, P's average compensation for 
P's period of high-3 years while a participant in Plan A is $50,000, 
based on P's compensation for 2007, 2008, and 2009, which was $50,000 
for each

[[Page 1060]]

year. P's compensation for year 2010 was $45,000. In year 2012, P is 
rehired by M and resumes participation in Plan A. P's compensation in 
year 2012 is $45,000, and is $70,000 in year 2013. Assume that the 
annual adjustment factor described in Sec. 1.415(d)-1(a)(2)(ii) for the 
limitation years 2011 through 2013 is 1.03 for each year. Thus, 
disregarding P's rehire by M, P's average compensation for P's period of 
high-3 years while a participant in Plan A for the 2013 limitation year 
would be equal to $54,636 (or 1.03 * 1.03 * 1.03 * $50,000). See Sec. 
1.415(b)-1(a)(5)(iii).
    (ii) Under Sec. 1.415(d)-1(a)(2)(iii), P's average compensation for 
P's period of high-3 years while a participant in Plan A for the 2013 
limitation year is $54,636.

    (b) Defined contribution plans--(1) In general. Under section 
415(d)(1)(C), the dollar limitation described in section 415(c)(1)(A) is 
adjusted annually to take into account increases in the cost of living. 
The adjusted dollar limitation is prescribed by the Commissioner and 
published in the Internal Revenue Bulletin. See Sec. 601.601(d)(2) of 
this chapter.
    (2) Determination of adjusted limit--(i) Base period. The base 
period taken into account for purposes of adjusting the dollar 
limitation pursuant to paragraph (b)(2)(ii) of this section is the 
calendar quarter beginning July 1, 2001.
    (ii) Method of adjustment--(A) In general. The dollar limitation is 
adjusted with respect to a calendar year based on the increase in the 
applicable index for the calendar quarter ending September 30 of the 
preceding calendar year over such index for the base period. Adjustment 
procedures similar to the procedures used to adjust benefit amounts 
under section 215(i)(2)(A) of the Social Security Act will be used.
    (B) Rounding. Any increase in the $40,000 amount specified in 
section 415(c)(1)(A) which is not a multiple of $1,000 shall be rounded 
to the next lowest multiple of $1,000.
    (iii) Effective date of adjustment. The adjusted dollar limitation 
applicable to defined contribution plans is effective as of January 1 of 
each calendar year and applies with respect to limitation years ending 
with or within that calendar year. Annual additions for a limitation 
year cannot exceed the currently applicable dollar limitation (as in 
effect before the January 1 adjustment) prior to January 1. However, 
after a January 1 adjustment is made, annual additions for the entire 
limitation year are permitted to reflect the dollar limitation as 
adjusted on January 1.
    (c) Application of rounding rules to other cost-of-living 
adjustments. Pursuant to section 415(d)(4)(A), the $5,000 rounding 
methodology of paragraph (a)(1)(iii) of this section is used for 
purposes of any provision of chapter 1 of subtitle A of the Internal 
Revenue Code that provides for adjustments in accordance with section 
415(d), except to the extent provided by that provision. Thus, the 
$5,000 rounding methodology of paragraph (a)(1)(iii) of this section is 
used for purposes of--
    (1) Determining the level of compensation specified in section 
414(q)(1)(B) that is used to determine whether an employee is a highly 
compensated employee;
    (2) Calculating the amounts used pursuant to section 409(o)(1)(C) to 
determine the maximum period over which distributions from an employee 
stock ownership plan may be made without participant consent; and
    (3) Determining the levels of compensation specified in Sec. 1.61-
21(f)(5)(i) and (iii) used in determining whether an employee is a 
control employee of a nongovernmental employer for purposes of the 
commuting valuation rule of Sec. 1.61-21(f).
    (d) Implementation of cost-of-living adjustments. A plan is 
permitted to be amended to reflect any of the adjustments described in 
this section at any time after those limitations become applicable. 
Alternatively, a plan is permitted to incorporate by reference any of 
the adjustments described in this section in accordance with the rules 
of Sec. 1.415(a)-1(d)(3)(v). Because the accrued benefit of a 
participant can reflect increases in the applicable limitations only 
after those increases become effective, a pattern of repeated plan 
amendments increasing annual benefits to reflect the increases in the 
section 415(b) limitations pursuant to section 415(d) does not result in 
any protection under section 411(d)(6) for future increases to reflect 
increases in the section 415(b) limitations pursuant to Sec. 1.411(d)-
4, Q&A-1(c)(1). Thus, a plan does not violate the requirements of 
section 411(d)(6) merely because the plan has been amended annually for 
a

[[Page 1061]]

number of years to increase annual benefits to reflect the increases in 
the section 415(b) limitations pursuant to section 415(d) and 
subsequently is not amended to reflect later increases in the section 
415(b) limitations.

[T.D. 9319, 72 FR 16919, Apr. 5, 2007]



Sec. 1.415(f)-1  Aggregating plans.

    (a) In general. Except as provided in paragraph (g) of this section 
(regarding multiemployer plans), and taking into account the rules of 
paragraph (b)(2) (regarding the break-up of affiliated employers and 
affiliated service groups), paragraph (c) (regarding predecessor 
employers), and paragraph (d)(1) (regarding nonduplication rules) of 
this section, section 415(f) and this section require that for purposes 
of applying the limitations of sections 415(b) and (c) applicable to a 
participant for a particular limitation year--
    (1) All defined benefit plans (without regard to whether a plan has 
been terminated) ever maintained by the employer (or a predecessor 
employer within the meaning of paragraphs (c)(1) and (c)(2) of this 
section) under which the participant has accrued a benefit are treated 
as one defined benefit plan;
    (2) All defined contribution plans (without regard to whether a plan 
has been terminated) ever maintained by the employer (or a predecessor 
employer within the meaning of paragraphs (c)(1) and (c)(2) of this 
section) under which the participant receives annual additions are 
treated as one defined contribution plan; and
    (3) All section 403(b) annuity contracts purchased by an employer 
(including plans purchased through salary reduction contributions) for 
the participant are treated as one section 403(b) annuity contract.
    (b) Affiliated employers, affiliated service groups, and leased 
employees--(1) General rule. See Sec. 1.415(a)-1(f)(1) and (2) for 
rules regarding aggregation of employers in the case of affiliated 
employers and affiliated service groups. See Sec. 1.415(a)-1(f)(3) for 
rules regarding the treatment of leased employees.
    (2) Special rule in the case of the break-up of an affiliated 
employer or an affiliated service group--(i) In general. A formerly 
affiliated plan of an employer is taken into account for purposes of 
applying paragraph (a) of this section to the employer, but the formerly 
affiliated plan is treated as if it had terminated immediately prior to 
the cessation of affiliation with sufficient assets to pay benefit 
liabilities under the plan, and had purchased annuities to provide plan 
benefits. See Sec. 1.415(b)-1(b)(5)(i) for rules determining annual 
benefits under a terminated defined benefit plan under which annuities 
are purchased to provide plan benefits.
    (ii) Definitions. For purposes of this paragraph (b)(2), a formerly 
affiliated plan of an employer is a plan that, immediately prior to the 
cessation of affiliation, was actually maintained by one or more of the 
entities that constitute the employer (as determined under the employer 
affiliation rules described in Sec. 1.415(a)-1(f)(1) and (2)), and 
immediately after the cessation of affiliation, is not actually 
maintained by any of the entities that constitute the employer (as 
determined under the employer affiliation rules described in Sec. 
1.415(a)-1(f)(1) and (2)). For purposes of this paragraph (b)(2), a 
cessation of affiliation means the event that causes an entity to no 
longer be aggregated with one or more other entities as a single 
employer under the employer affiliation rules described in Sec. 
1.415(a)-1(f)(1) and (2) (such as the sale of a subsidiary outside a 
controlled group), or that causes a plan to not actually be maintained 
by any of the entities that constitute the employer under the employer 
affiliation rules of Sec. 1.415(a)-1(f)(1) and (2) (such as a transfer 
of plan sponsorship outside of a controlled group).
    (c) Predecessor employer--(1) Where plan is maintained by successor. 
For purposes of section 415 and regulations promulgated under section 
415, a former employer is a predecessor employer with respect to a 
participant in a plan maintained by an employer if the employer 
maintains a plan under which the participant had accrued a benefit while 
performing services for the former employer (for example, the employer 
assumed sponsorship of the former employer's plan, or the employer's 
plan received a transfer of benefits from the former employer's plan), 
but only if that benefit is provided under the plan maintained by the 
employer.

[[Page 1062]]

In such a case, in applying the limitations of section 415 to a 
participant in a plan maintained by the employer, paragraph (a) of this 
section requires the plan to take into account benefits provided to the 
participant under plans that are maintained by the predecessor employer 
and that are not maintained by the employer. For this purpose, the 
formerly affiliated plan rules in paragraph (b)(2) of this section apply 
as if the employer and predecessor employer constituted a single 
employer under the rules described in Sec. 1.415(a)-1(f)(1) and (2) 
immediately prior to the cessation of affiliation (and as if they 
constituted two, unrelated employers under the rules described in Sec. 
1.415(a)-1(f)(1) and (2) immediately after the cessation of affiliation) 
and cessation of affiliation was the event that gives rise to the 
predecessor employer relationship, such as a transfer of benefits or 
plan sponsorship.
    (2) Where plan is not maintained by successor. With respect to an 
employer of a participant, a former entity that antedates the employer 
is a predecessor employer with respect to the participant if, under the 
facts and circumstances, the employer constitutes a continuation of all 
or a portion of the trade or business of the former entity. This will 
occur, for example, where formation of the employer constitutes a mere 
formal or technical change in the employment relationship and continuity 
otherwise exists in the substance and administration of the business 
operations of the former entity and the employer.
    (d) Special rules--(1) Nonduplication. In applying the limitations 
of section 415 to a plan maintained by an employer, if the plan is 
aggregated with another plan pursuant to the aggregation rules of 
paragraph (a) of this section, a participant's benefits are not counted 
more than once in determining the participant's aggregate annual benefit 
or annual additions. For example, if a defined benefit plan is treated 
as if it terminated immediately prior to a cessation of affiliation 
under paragraph (b)(2) of this section, the plans maintained by the 
employer (as determined after the cessation of affiliation) that 
actually maintains the plan do not double count the annual benefit 
provided under the plan by aggregating under paragraph (a) of this 
section both the participant's annual benefit provided under the plan 
and the participant's annual benefit under the plan as a formerly 
affiliated plan (which is a plan that the employers formerly affiliated 
with the employer must take into account as a terminated plan under the 
rules of paragraph (b)(2) of this section). Instead, the plans 
maintained by the employer include the annual benefit provided to the 
participant under the actual plan that the employer maintains. 
Similarly, if a defined benefit plan maintained by an employer (the 
transferee plan) receives a transfer of benefits from a defined benefit 
plan maintained by a predecessor employer (the transferor plan) and the 
transfer is described in Sec. 1.415(b)-1(b)(3)(i)(B) (which requires 
the transferred benefits to be treated by the transferor plan as if the 
benefits were provided under a plan that must be aggregated with the 
transferor plan that terminated immediately prior to the transfer), the 
transferee plan does not double count the transferred benefits under 
paragraph (a) of this section by taking into account both the actual 
benefit provided under the transferee plan and the benefit provided 
under the deemed terminated plan that the predecessor employer is 
treated as maintaining (and that otherwise would have to be taken into 
account by the transferee plan under the predecessor employer 
aggregation rules of paragraph (a) of this section). Instead, the 
transferee plan takes into account the transferred benefits that are 
actually provided under the transferee plan (see Sec. 1.415(b)-
1(b)(3)(i)(C)) and, pursuant to paragraph (c)(1) of this section, any 
nontransferred benefits provided under plans maintained by the 
predecessor employer with respect to a participant whose benefits have 
been transferred to the transferee plan.
    (2) Determination of years of participation for multiple plans. If 
two or more defined benefit plans are aggregated under section 415(f) 
and this section for a particular limitation year, in applying the 
reduction for participation of

[[Page 1063]]

less than ten years (as described in section 415(b)(5)(A)) to the dollar 
limitation under section 415(b)(1)(A), time periods that are counted as 
years of participation under any of the plans are counted in computing 
the limitation of the aggregated plans under this section.
    (3) Determination of years of service for multiple plans. If two or 
more defined benefit plans are aggregated under section 415(f) and this 
section for a particular limitation year, in applying the reduction for 
service of less than ten years (as described in section 415(b)(5)(B)) to 
the compensation limitation under section 415(b)(1)(B), time periods 
that are counted as years of service under any of the plans are counted 
in computing the limitation of the aggregated plans under this section.
    (e) Previously unaggregated plans--(1) In general. This paragraph 
(e) provides rules for those situations in which two or more existing 
plans, which previously were not required to be aggregated pursuant to 
section 415(f) and this section, are aggregated during a particular 
limitation year and, as a result, the limitations of section 415(b) or 
(c) are exceeded for that limitation year. Paragraph (e)(2) of this 
section provides rules for defined contribution plans that are first 
required to be aggregated pursuant to section 415(f) and this section in 
a plan year. Paragraph (e)(3) of this section provides rules for defined 
benefit plans that are first required to be aggregated pursuant to 
section 415(f) and this section, and for defined benefit plans under 
which a participant's benefit is frozen following aggregation.
    (2) Defined contribution plans. Two or more defined contribution 
plans that are not required to be aggregated pursuant to section 415(f) 
and this section as of the first day of a limitation year do not fail to 
satisfy the requirements of section 415 with respect to a participant 
for the limitation year merely because they are aggregated later in that 
limitation year, provided that no annual additions are credited to the 
participant's account after the date on which the plans are required to 
be aggregated.
    (3) Defined benefit plans--(i) First year of aggregation. Two or 
more defined benefit plans that are not required to be aggregated 
pursuant to section 415(f) and this section as of the first day of a 
limitation year do not fail to satisfy the requirements of section 415 
for the limitation year merely because they are aggregated later in that 
limitation year, provided that no plan amendments increasing benefits 
with respect to the participant under either plan are made after the 
occurrence of the event causing the plan to be aggregated.
    (ii) All years of aggregation in which accrued benefits are frozen. 
Two or more defined benefit plans that are required to be aggregated 
pursuant to section 415(f) and this section during a limitation year 
subsequent to the limitation year during which the plans were first 
aggregated do not fail to satisfy the requirements of section 415 with 
respect to a participant for the limitation year merely because they are 
aggregated if there have been no increases in the participant's accrued 
benefit derived from employer contributions (including increases as a 
result of increased compensation or service) under any of the plans 
within the period during which the plans have been aggregated.
    (f) Section 403(b) annuity contracts--(1) In general. In the case of 
a section 403(b) annuity contract, except as provided in paragraph 
(f)(2) of this section, the participant on whose behalf the annuity 
contract is purchased is considered for purposes of section 415 to have 
exclusive control of the annuity contract. Accordingly, except as 
provided in paragraph (f)(2) of this section, the participant, and not 
the participant's employer who purchased the section 403(b) annuity 
contract, is deemed to maintain the annuity contract, and such a section 
403(b) annuity contract is not aggregated with a qualified plan that is 
maintained by the participant's employer.
    (2) Special rules under which the employer is deemed to maintain the 
annuity contract--(i) In general. Where a participant on whose behalf a 
section 403(b) annuity contract is purchased is in control of any 
employer for a limitation year as defined in paragraph (f)(2)(ii) of 
this section (regardless of whether the employer controlled by

[[Page 1064]]

the participant is the employer maintaining the section 403(b) annuity 
contract), the annuity contract for the benefit of the participant is 
treated as a defined contribution plan maintained by both the controlled 
employer and the participant for that limitation year. Accordingly, 
where a participant on whose behalf a section 403(b) annuity contract is 
purchased is in control of any employer for a limitation year, the 
section 403(b) annuity contract is aggregated with all other defined 
contribution plans maintained by that employer. In addition, in such a 
case, the section 403(b) annuity contract is aggregated with all other 
defined contribution plans maintained by the employee or any other 
employer that is controlled by the employee. Thus, for example, if a 
doctor is employed by a non-profit hospital to which section 501(c)(3) 
applies and which provides him with a section 403(b) annuity contract, 
and the doctor also maintains a private practice as a shareholder owning 
more than 50 percent of a professional corporation, then any qualified 
defined contribution plan of the professional corporation must be 
aggregated with the section 403(b) annuity contract for purposes of 
applying the limitations of section 415(c) and Sec. 1.415(c)-1. For 
purposes of this paragraph (f)(2), it is immaterial whether the section 
403(b) annuity contract is purchased as a result of a salary reduction 
agreement between the employer and the participant.
    (ii) Determination of when a participant is in control of an 
employer. For purposes of paragraph (f)(2)(i) of this section, a 
participant is in control of an employer for a limitation year if, 
pursuant to Sec. 1.415(a)-1(f)(1) and (2), a plan maintained by that 
employer would have to be aggregated with a plan maintained by an 
employer that is 100 percent owned by the participant. Thus, for 
example, if a participant owns 60 percent of the common stock of a 
corporation, the participant is considered to be in control of that 
employer for purposes of applying paragraph (f)(2)(i) of this section.
    (3) Aggregation of section 403(b) annuity with qualified plan of 
controlled employer. If a section 403(b) annuity contract is aggregated 
with a qualified plan of a controlled employer in accordance with 
paragraph (f)(2) of this section, the plans must satisfy the limitations 
of section 415(c) both separately and on an aggregate basis. In applying 
separately the limitations of section 415 to the qualified plan and to 
the section 403(b) annuity contract, compensation from the controlled 
employer may not be aggregated with compensation from the employer 
purchasing the section 403(b) annuity contract (that is, without regard 
to Sec. 1.415(c)-2(g)(3)).
    (g) Multiemployer plans--(1) Multiemployer plan aggregated with 
another multiemployer plan. Pursuant to section 415(f)(3)(B), 
multiemployer plans, as defined in section 414(f), are not aggregated 
with other multiemployer plans for purposes of applying the limits of 
section 415.
    (2) Multiemployer plan aggregated with other plan--(i) Aggregation 
only for benefits provided by the employer. Notwithstanding the rule of 
Sec. 1.415(a)-1(e), a multiemployer plan, as defined in section 414(f), 
is permitted to provide that only the benefits under that multiemployer 
plan that are provided by an employer are aggregated with benefits under 
plans maintained by that employer that are not multiemployer plans. If 
the multiemployer plan so provides, then, where an employer maintains 
both a plan which is not a multiemployer plan and a multiemployer plan, 
only the benefits under the multiemployer plan that are provided by the 
employer are aggregated with benefits under the employer's plans other 
than multiemployer plans (in lieu of including benefits provided by all 
employers under the multiemployer plan pursuant to the generally 
applicable rule of Sec. 1.415(a)-1(e)).
    (ii) Exception from aggregation for purposes of applying section 
415(b)(1)(B) compensation limit. Pursuant to section 415(f)(3)(A), a 
multiemployer plan, as defined in section 414(f), is not aggregated with 
any other plan that is not a multiemployer plan for purposes of applying 
the compensation limit of section 415(b)(1)(B) and Sec. 1.415(b)-
1(a)(1)(ii).
    (h) Special rules for aggregating certain plans, etc. If a plan, 
annuity contract or arrangement is subject to a special limitation in 
addition to, or instead of,

[[Page 1065]]

the regular limitations described in section 415(b) or (c), and is 
aggregated under this section with a plan which is subject only to the 
regular section 415(b) or (c) limitations, the following rules apply:
    (1) Each plan, annuity contract or arrangement which is subject to a 
special limitation must meet its own applicable limitation and each plan 
subject to the regular limitations of section 415 must meet its 
applicable limitation.
    (2) The limitation for the aggregated plans is the larger of the 
applicable limitations for the separate plans.
    (i) [Reserved]
    (j) Examples. The following examples illustrate the rules of this 
section. Except to the extent otherwise stated in an example, each 
entity is not and has never been affiliated with another entity under 
the employer affiliation rules of Sec. 1.415(a)-1(f)(1) and (2), each 
entity has never maintained a qualified plan (other than the plans 
specifically mentioned in the example), and the limitation year for each 
qualified plan is the calendar year.

    Example 1. (i) Facts. M was formerly an employee of ABC Corporation 
and is currently an employee of XYZ Corporation. ABC maintains a 
qualified defined benefit plan (Plan ABC) and a qualified defined 
contribution plan in which M participates and XYZ maintains a qualified 
defined benefit plan (Plan XYZ) and a qualified defined contribution 
plan in which M participates. ABC Corporation owns 60 percent of XYZ 
Corporation.
    (ii) Treatment as a single employer. ABC Corporation and XYZ 
Corporation are members of a controlled group of corporations within the 
meaning of section 414(b) as modified by section 415(h). Because ABC 
Corporation and XYZ Corporation are members of a controlled group of 
corporations within the meaning of section 414(b) as modified by section 
415(h), M is treated as being employed by a single employer under Sec. 
1.415(a)-1(f)(1).
    (iii) Plan aggregation. Under paragraph (a)(1) of this section, the 
sum of M's annual benefit under Plan ABC and M's annual benefit under 
Plan XYZ is not permitted to exceed the limitations of section 415(b) 
and Sec. 1.415(b)-1; and, under paragraph (a)(2) of this section, the 
sum of the annual additions to M's account under the defined 
contribution plans maintained by ABC and XYZ may not exceed the 
limitations of section 415(c) and Sec. 1.415(c)-1. For purposes of 
determining the limitations of section 415(b) and Sec. 1.415(b)-1 for 
the aggregated plans, a year of service for either employer is 
considered as a year of service for purposes of Sec. 1.415(b)-1(g)(2) 
(phase-in rules for the compensation limit) and a year of participation 
under either plan is considered as a year of participation for purposes 
of Sec. 1.415(b)-1(g)(1) (phase-in rules for the dollar limit).
    Example 2. (i) Facts. The facts are the same as in Example 1, except 
that ABC Corporation and XYZ Corporation do not maintain defined 
contribution plans. In addition, Participant O was formerly an employee 
of ABC Corporation and is currently an employee of XYZ Corporation. 
Participant O has an accrued benefit under the ABC Plan, but Participant 
O has no accrued benefit under the XYZ Plan. Effective January 1, 2010, 
ABC Corporation sells all of its shares of stock of XYZ Corporation to 
an unaffiliated entity, LMN Corporation (the 2010 stock sale). After the 
2010 stock sale, XYZ Corporation continues to maintain Plan XYZ. LMN 
Corporation maintains a qualified defined benefit plan (Plan LMN). After 
the 2010 stock sale, M begins to accrue benefits under Plan LMN, but O 
does not participate in Plan LMN.
    (ii) Affiliated employer status of the corporations. Immediately 
after the 2010 stock sale, ABC Corporation and XYZ Corporation are no 
longer members of a controlled group of corporations under section 
414(b) (as modified by section 414(h)) and accordingly are no longer 
treated as a single employer under the employer affiliation rules of 
Sec. 1.415(a)-1(f)(1). Immediately after the 2010 stock sale, LMN 
Corporation and XYZ Corporation are members of a controlled group of 
corporations under section 414(b) (as modified by section 414(h)) and 
accordingly are treated as a single employer under the employer 
affiliation rules of Sec. 1.415(a)-1(f)(1).
    (iii) Treatment of plans maintained by ABC Corporation after the 
2010 stock sale. Under Sec. 1.415(a)-1(f)(1), any plan maintained by 
any member of a controlled group of corporations is deemed maintained by 
all members of the controlled group, and paragraph (a)(1) of this 
section requires that, for purposes of applying the limitations of 
section 415(b), all defined benefit plans ever maintained by an employer 
(as determined under the affiliation rules of Sec. 1.415(a)-1(f)(1) and 
(2)) are treated as one defined benefit plan. Therefore, defined benefit 
plans maintained by ABC Corporation must take into account the annual 
benefit of a participant provided under Plan XYZ in applying the 
limitations of section 415(b) to the participant because Plan XYZ is a 
plan that had once been maintained by ABC Corporation. However, 
beginning with the 2010 limitation year, the aggregation of the annual 
benefit accrued by a participant under Plan XYZ for purposes of testing 
defined benefit plans maintained by ABC Corporation is limited to the 
annual benefit accrued by the participant under Plan XYZ immediately 
prior to the 2010 stock sale. This is because paragraph (b)(2)(i)

[[Page 1066]]

of this section provides that a formerly affiliated plan of an employer 
is treated as if it had terminated immediately prior to the cessation of 
affiliation with sufficient assets to pay benefit liabilities under the 
plan, and had purchased annuities to provide plan benefits. The 2010 
stock sale is a cessation of affiliation under paragraph (b)(2)(ii) of 
this section because this event caused XYZ Corporation to no longer be 
affiliated with ABC Corporation under the employer affiliation rules of 
Sec. 1.415(a)-1(f)(1) and (2). Immediately after the 2010 stock sale, 
Plan XYZ is a formerly affiliated plan with respect to ABC Corporation 
under paragraph (b)(2)(ii) of this section because immediately prior to 
the cessation of affiliation, Plan XYZ was actually maintained by XYZ 
Corporation (which together with ABC Corporation constituted a single 
employer under the employer affiliation rules of Sec. 1.415(a)-1(f)(1) 
and (2)), and immediately after the cessation of affiliation, Plan XYZ 
is not actually maintained by ABC Corporation or any other entity 
affiliated with it.
    (iv) Application of rules to Participants M and O with respect to 
plans maintained by ABC Corporation after the 2010 stock sale. In 
applying the limitations of section 415(b) to Participant M for the 2010 
limitation year and later limitation years, Plan ABC must take into 
account the annual benefit provided under Plan ABC to Participant M and 
the annual benefit provided under Plan XYZ to Participant M, but 
treating Plan XYZ as if it had terminated immediately prior to the 2010 
stock sale with sufficient assets to pay benefit liabilities under the 
plan, and had purchased annuities to provide plan benefits. The 
aggregation of Plan XYZ with Plan ABC is irrelevant for purposes of 
Participant O because Participant O does not have any accrued benefit 
under Plan XYZ (as determined prior to the 2010 stock sale).
    (v) Treatment of plans maintained by LMN Corporation and XYZ 
Corporation after the 2010 stock sale. Under Sec. 1.415(a)-1(f)(1) and 
paragraph (a)(1) of this section, when applying the limitations of 
section 415(b) to a participant under Plans LMN and XYZ for the 2010 
limitation year and later years, the annual benefit provided to the 
participant under Plans LMN, XYZ and ABC must be aggregated. Benefits 
under Plan ABC must be included in this aggregation because XYZ 
Corporation is deemed to have once maintained Plan ABC pursuant to Sec. 
1.415(a)-1(f)(1), and since LMN Corporation and XYZ Corporation 
constitute a single employer under Sec. 1.415(a)-1(f)(1), paragraph 
(a)(1) of this section requires the aggregation of all defined benefit 
plans ever maintained by LMN Corporation and XYZ Corporation. However, 
in performing this aggregation, a participant's annual benefit under 
Plan ABC is limited to the annual benefit accrued by the participant 
immediately prior to the 2010 stock sale. This is because, pursuant to 
paragraph (b)(2)(i) of this section, Plan ABC is a formerly affiliated 
plan of LMN Corporation and XYZ Corporation.
    (vi) Application of rules to Participants M and O with respect to 
plans maintained by LMN Corporation and XYZ Corporation after the 2010 
stock sale. In applying the limitation of section 415(b) to Participant 
M for the 2010 limitation year and later limitation years, Plan LMN and 
Plan XYZ must take into account the annual benefit provided under Plans 
LMN and XYZ to Participant M and the annual benefit provided under Plan 
ABC to Participant M as if Plan ABC had terminated immediately prior to 
the 2010 stock sale with sufficient assets to pay benefit liabilities 
under the plan, and had purchased annuities to provide plan benefits. 
Participant O does not have an accrued benefit under Plan LMN or Plan 
XYZ, so the aggregation of Plan ABC with Plans LMN and XYZ is currently 
irrelevant with respect to Participant O. However, if Participant O were 
to ever participate in Plans LMN or XYZ after the 2010 stock sale, 
Participant O's annual benefit under Plan ABC (determined as if Plan ABC 
terminated immediately prior to the 2010 stock sale) would have to be 
aggregated with any annual benefit that Participant O accrues under Plan 
LMN or Plan XYZ.
    (vii) Application of nonduplication rule. In applying paragraph 
(a)(1) of this section to plans maintained by ABC Corporation after 2010 
stock sale, plans maintained by ABC Corporation do not take into account 
the deemed termination of Plan ABC since ABC Corporation maintains Plan 
ABC after the cessation of affiliation. Similarly, in applying paragraph 
(a)(1) of this section to plans maintained by LMN Corporation and XYZ 
Corporation after the 2010 stock sale, plans maintained by LMN 
Corporation and XYZ Corporation do not take into account the deemed 
termination of Plan XYZ since XYZ Corporation maintains Plan XYZ after 
the cessation of affiliation. See paragraph (d)(1) of this section.
    Example 3. (i) Facts. The facts are the same as in Example 2, except 
that on January 1, 2009, Plan ABC transfers Participant M's benefit to 
Plan XYZ.
    (ii) Treatment of plans maintained by ABC Corporation. Pursuant to 
Sec. 1.415(b)-1(b)(3)(i)(A), M's benefit that is transferred from Plan 
ABC to Plan XYZ is not treated as being provided under Plan ABC for the 
limitation year in which the transfer occurs (2009). This is because M's 
transferred benefit is otherwise required to be taken into account by 
Plan ABC for the 2009 limitation year since Plan XYZ must be aggregated 
with Plan ABC pursuant to paragraph (a)(1) of this section. This result 
does not change for the 2010 limitation year and later limitation years, 
where pursuant to paragraph

[[Page 1067]]

(b)(2)(i) of this section, Plan XYZ becomes a formerly affiliated plan 
with respect to ABC Corporation due to the 2010 stock sale. Under 
paragraph (b)(2)(i) of this section, Plan XYZ (the formerly affiliated 
plan) is treated from the perspective of plans maintained by ABC 
Corporation (Plan ABC) as if Plan XYZ terminated immediately prior to 
the 2010 stock sale with sufficient assets to pay benefit liabilities 
under the plan, and had purchased annuities to provide plan benefits. 
However, the pre-2010 stock sale benefits of Plan XYZ include the 
January 1, 2009, transfer of Participant M's benefit. Thus, in the 2010 
limitation year, M's transferred benefit is still otherwise required to 
be taken into account by Plan ABC on account of the aggregation of Plan 
XYZ with Plan ABC pursuant to paragraph (a)(1) of this section, and 
therefore the transferred benefit is not treated as being provided by 
Plan ABC.
    (iii) Treatment of plans maintained by LMN Corporation and XYZ 
Corporation. Pursuant to Sec. 1.415(b)-1(b)(3)(i)(C), Participant M's 
benefit that is transferred to Plan XYZ from Plan ABC must be treated as 
provided under Plan XYZ for purposes of applying the limitations of 
section 415 to Plan XYZ with respect to Participant M for the limitation 
year in which the transfer occurs and later years. This result does not 
change on account of the 2010 stock sale. When applying the limitation 
of section 415 to Plans LMN and XYZ for the 2010 limitation year and 
later years, Plans LMN and XYZ must aggregate the annual benefit 
provided to a participant under each plan along with the participant's 
benefit under Plan ABC pursuant to Sec. 1.415(a)-1(f)(1) and paragraph 
(a)(1) of this section. However, under paragraph (b)(2)(i) of this 
section, for the 2010 limitation year and later years, this aggregation 
of M's Plan ABC benefit only includes the annual benefit attributable to 
a participant's accrued benefit under Plan ABC immediately prior to the 
2010 stock sale, which (due to the 2009 transfer) is zero.
    Example 4. (i) Facts. The facts are the same as in Example 2, except 
that on January 1, 2011, Plan ABC transfers Participant M's benefit to 
Plan XYZ.
    (ii) Treatment of plans maintained by ABC Corporation for the 2011 
limitation year and later years. Pursuant to Sec. 1.415(b)-
1(b)(3)(i)(B), M's benefit that is transferred from Plan ABC to Plan XYZ 
during the 2011 limitation year is treated by Plan ABC for the 2011 
limitation year and later years as if the transferred benefit were 
provided under a plan that must be aggregated with Plan ABC that 
terminated immediately prior to the transfer with sufficient assets to 
pay benefit liabilities under the plan, and had purchased annuities to 
provide plan benefits. This is because M's transferred benefit is not 
otherwise required to be taken into account by Plan ABC for the 2011 
limitation year and later years pursuant to paragraphs (a)(1) and 
(b)(2)(i) of this section. While Plan ABC must take into account 
Participant M's annual benefit under Plan XYZ under paragraph (a)(1) of 
this section, Participant M's annual benefit for this purpose is limited 
under paragraph (b)(2)(i) of this section to M's accrued benefit under 
Plan XYZ immediately prior to the 2010 stock sale, and Participant M's 
pre-2010 stock sale accrued benefit under Plan XYZ excludes the 2011 
transfer.
    (iii) Treatment of plans maintained by LMN Corporation and XYZ 
Corporation for the 2011 limitation year and later years. Pursuant to 
Sec. 1.415(b)-1(b)(3)(i)(C), Participant M's benefit that is 
transferred to Plan XYZ from Plan ABC must be treated as provided under 
Plan XYZ for purposes of applying the limitations of section 415 to Plan 
XYZ with respect to Participant M for the limitation year in which the 
transfer occurs and later years. In applying the limitations of section 
415(b) to Plans LMN and XYZ with respect to Participant M for the 2010 
limitation year and later years, the annual benefit of Participant M 
under Plans ABC, LMN, and XYZ must be aggregated pursuant to Sec. 
1.415(a)-1(f)(1) and paragraph (a)(1) of this section, but for this 
purpose, Participant M's benefit under Plan ABC is treated as if it were 
provided under a plan that terminated immediately prior to the cessation 
of affiliation of ABC Corporation and XYZ Corporation with sufficient 
assets to pay benefit liabilities under the plan, and had purchased an 
annuity to provide Participant M's benefits. (See paragraph (b)(2)(i) of 
this section and Example 2.) In applying the limitations of section 
415(b) to Plans LMN and XYZ with respect to Participant M for the 2011 
limitation year and later years, the annual benefit of Participant M 
under Plans ABC, LMN, and XYZ still must be aggregated pursuant to Sec. 
1.415(a)-1(f)(1) and paragraph (a)(1) of this section. However, 
beginning with the 2011 limitation year, ABC Corporation is a 
predecessor employer with respect to LMN Corporation and XYZ Corporation 
with respect to Participant M on account of the transfer of benefits 
from Plan ABC to Plan XYZ, pursuant to paragraph (c)(1) of this section. 
Therefore, Plans LMN and XYZ must take into account benefits that 
Participant M accrued under Plan ABC after the January 1, 2010, 
cessation of affiliation of ABC Corporation and XYZ Corporation that 
were not transferred to Plan XYZ on January 1, 2011, pursuant to 
paragraphs (c)(1) and (d)(1) of this section. Since all of Participant 
M's benefit in Plan ABC is transferred to Plan XYZ on January 1, 2011, 
Participant M's annual benefit from Plan ABC for purposes of aggregating 
Plan ABC with Plans LMN and XYZ is zero.
    Example 5. (i) Facts. The facts are the same as in Example 2, except 
that instead of the 2010 stock sale, XYZ Corporation sells some of its 
operating assets to LMN Corporation

[[Page 1068]]

(and, under the facts and circumstances, the sale does not result in XYZ 
Corporation constituting a predecessor employer of LMN Corporation under 
the rules of paragraph (c)(2) of this section), and in connection with 
the asset sale, LMN Corporation assumes sponsorship of Plan XYZ in place 
of XYZ Corporation, effective January 1, 2010.
    (ii) Treatment of plans maintained by ABC Corporation and XYZ 
Corporation. Pursuant to paragraph (a)(1) of this section, all defined 
benefit plans ever maintained by ABC Corporation and XYZ Corporation 
must be aggregated as a single defined benefit plan for purposes of 
applying the limitations of section 415(b). However, for purposes of 
determining the annual benefit under Plan XYZ for the 2010 limitation 
year and later years, the aggregation of a participant's benefit under 
Plan XYZ is limited to the participant's annual benefit accrued 
immediately prior to the January 1, 2010, transfer of sponsorship of 
Plan XYZ. This is because paragraph (b)(2)(i) of this section provides 
that a formerly affiliated plan of an employer is treated as if it were 
a plan that terminated immediately prior to the cessation of affiliation 
with sufficient assets to pay benefit liabilities under the plan, and 
had purchased annuities to provide plan benefits. The January 1, 2010, 
transfer of sponsorship of Plan XYZ is a cessation of affiliation under 
paragraph (b)(2)(ii) of this section because this event causes Plan XYZ 
to no longer actually be maintained by either ABC Corporation or XYZ 
Corporation. Effective immediately after the January 1, 2010, transfer 
of sponsorship, Plan XYZ is a formerly affiliated plan with respect to 
ABC Corporation and XYZ Corporation under paragraph (b)(2)(ii) of this 
section because immediately prior to the cessation of affiliation, Plan 
XYZ was actually maintained by XYZ Corporation, and immediately after 
the cessation of affiliation, Plan XYZ is not actually maintained by 
either XYZ Corporation or ABC Corporation. Therefore, in applying the 
limitation of section 415(b) to Participant M for the 2010 limitation 
year and later limitation years, Plan ABC must take into account the 
annual benefit provided under Plan ABC to Participant M and the annual 
benefit provided under Plan XYZ to Participant M as if Plan XYZ had 
terminated immediately prior to the 2010 stock sale with sufficient 
assets to pay benefit liabilities under the plan, and had purchased 
annuities to provide plan benefits. The aggregation of Plan XYZ with 
Plan ABC is irrelevant for purposes of Participant O because Participant 
O does not have any accrued benefit under Plan XYZ (as determined prior 
to the 2010 transfer of sponsorship).
    (iii) Treatment of plans maintained by LMN Corporation. Under 
paragraph (a)(1) of this section, all defined benefit plans ever 
maintained by LMN Corporation or a predecessor employer must be 
aggregated as a single plan for purposes of applying the limitations of 
section 415(b). ABC Corporation and XYZ Corporation constitute a 
predecessor employer pursuant to paragraph (c)(1) of this section with 
respect to the participants who participate in Plan XYZ on the date of 
the transfer of sponsorship of Plan XYZ (the transferred participants) 
from XYZ Corporation to LMN Corporation, such as Participant M. This is 
because, effective with the January 1, 2010, transfer of sponsorship, 
LMN Corporation maintains a plan (Plan XYZ) under which the participants 
accrued a benefit while performing services for XYZ Corporation (which 
is in turn affiliated with ABC Corporation under Sec. 1.415(a)-1(f)(1)) 
and such benefits are provided under a plan maintained by LMN 
Corporation. Therefore, for the 2010 limitation year and later years, 
the annual benefit under Plan ABC of the transferred participants (such 
as Participant M) must be aggregated with the annual benefit provided to 
such participants under Plans XYZ and LMN for purposes of determining 
whether Plan LMN or Plan XYZ satisfies the limitations of section 
415(b). However, the aggregation of the transferred participants' Plan 
ABC annual benefits is limited to the annual benefit accrued under Plan 
ABC immediately prior to January 1, 2010, transfer of sponsorship. This 
is because, pursuant to paragraph (c)(1) of this section, Plan ABC is 
treated from the perspective of plans maintained by LMN Corporation as 
if Plan ABC had terminated immediately prior to the transfer of 
sponsorship of Plan ABC to LMN Corporation with sufficient assets to pay 
benefit liabilities under the plan, and had purchased annuities to 
provide plan benefits. ABC Corporation and XYZ Corporation do not 
constitute a predecessor employer with respect to Participant O. Thus, 
if Participant O is a participant in Plan LMN or becomes a participant 
in Plan XYZ after the 2010 transfer of sponsorship, neither plan 
aggregates Participant O's Plan ABC benefits for purposes of satisfying 
section 415(b). In applying paragraph (a)(1) of this section to a 
participant, plans maintained by LMN Corporation do not double count the 
participant's annual benefit. See paragraph (d)(1) of this section. 
Thus, such plans do not aggregate the annual benefit provided under Plan 
XYZ with the annual benefit from the deemed termination of Plan XYZ that 
LMN Corporation's predecessor employer (which is ABC and XYZ 
Corporations) must take into account in applying paragraph (a)(1) of 
this section, and instead consider the annual benefit actually provided 
under Plan XYZ.
    Example 6. (i) Facts. N is employed by a hospital which purchases an 
annuity contract described in section 403(b) on N's behalf for the 
current limitation year. N is in control of the hospital within the 
meaning of section 414(b) or (c), as modified by section

[[Page 1069]]

415(h). The hospital also maintains a qualified defined contribution 
plan during the current limitation year in which N participates.
    (ii) Conclusion. Under section 415(k)(4), the hospital, as well as 
N, is considered to maintain the annuity contract. Accordingly, for N 
the sum of the annual additions under the qualified defined contribution 
plan and the annuity contract must satisfy the limitations of section 
415(c) and Sec. 1.415(c)-1.
    Example 7. (i) Facts. The facts are the same as in Example 6, except 
that instead of being in control of the hospital, N is the 100 percent 
owner of a professional corporation P, which maintains a qualified 
defined contribution plan in which N participates.
    (ii) Conclusion. Under section 415(k)(4), the professional 
corporation, as well as N, is considered to maintain the annuity 
contract. Accordingly, the sum of the annual additions under the 
qualified defined contribution plan maintained by professional 
corporation P and the annuity contract must satisfy the limitations of 
section 415(c) and Sec. 1.415(c)-1. See Sec. 1.415(g)-
1(b)(3)(iv)(C)(2) for an example of the treatment of a contribution to a 
section 403(b) annuity contract that exceeds the limits of section 
415(c) by reason of the aggregation required by this section.
    Example 8. (i) Facts. J is an employee of two corporations, N and M, 
each of which has employed J for more than 10 years. N and M are not 
required to be aggregated pursuant to section 415(f) and this section. 
Each corporation has a qualified defined benefit plan in which J has 
participated for more than 10 years. Each plan provides a benefit which 
is equal to 75 percent of a participant's average compensation for the 
period of the participant's high-3 years of service and is payable in 
the form of a straight life annuity beginning at age 65. J's average 
compensation for the period of his high-3 years of service from each 
corporation is $160,000. In July 2008, N Corporation becomes a wholly 
owned subsidiary of M Corporation.
    (ii) Plan aggregation analysis. As a result of the acquisition of N 
Corporation by M Corporation, J is treated as being employed by a single 
employer under section 414(b). Therefore, because section 415(f)(1)(A) 
requires that all defined benefit plans of an employer be treated as one 
defined benefit plan, the two plans must be aggregated for purposes of 
applying the limitations of section 415. However, under paragraph 
(e)(3)(i) of this section, since the plans were not aggregated as of the 
first day of the 2008 limitation year (January 1, 2008), they will not 
be considered aggregated until the limitation year beginning January 1, 
2009, provided that no plan amendment increasing benefits with respect 
to participant J is made after the acquisition of N by M.
    (iii) Application to Participant J. J has a total benefit under the 
two plans of $240,000, which, as a result of the plan aggregation, is in 
excess of the section 415(b) limit. However, under paragraph (e)(3)(ii) 
of this section, the limitations of section 415(b) and Sec. 1.415(b)-1 
applicable to J may be exceeded in this situation without plan 
disqualification so long as J's accrued benefit derived from employer 
contributions is not increased (that is, J's accrued benefit does not 
increase on account of increased compensation, service, participation, 
or other accruals) during the period within which the limitations are 
being exceeded.
    Example 9. (i) Facts. A, age 30, owns all of the stock of X 
Corporation and also owns 10 percent of the stock of Z Corporation. F, 
A's father, directly owns 75 percent of the stock of Z Corporation. Both 
corporations have qualified defined contribution plans in which A 
participates. A's compensation (within the meaning of Sec. 1.415(c)-2) 
for 2008 is $20,000 from Z Corporation and $150,000 from X Corporation. 
During the period January 1, 2008 through June 30, 2008, annual 
additions of $20,000 are credited to A's account under the plan of Z 
Corporation, while annual additions of $40,000 are credited to A's 
account under the plan of X Corporation. In both instances, the amount 
of annual additions represent the maximum allowable under section 415(c) 
and Sec. 1.415(c)-1. On July 15, 2008, F dies, and A inherits all of 
F's stock in Z in 2008.
    (ii) Conclusion. As of July 15, 2008, A is considered to be in 
control of X and Z Corporations, and the two plans must be aggregated 
for purposes of applying the limitations of section 415. However, even 
though A's total annual additions for 2008 are $60,000, the limitations 
of section 415(c) and Sec. 1.415(c)-1 are not violated for 2008, 
provided no annual additions are credited to A's accounts after July 15, 
2008 (the date that A is first in control of Z) for the remainder of the 
2008 limitation year.
    Example 10. (i) Facts. P is a key employee of employer XYZ who 
participates in a qualified defined contribution plan (Plan X). P is 
also provided post-retirement medical benefits, and XYZ has taken into 
account a reserve for those benefits under section 419A(c)(2). In the 
2008 limitation year, P's compensation is $30,000 and P's annual 
additions under Plan X are $5,000. Pursuant to section 419A(d), a 
separate account is maintained for P, and that account is credited with 
an allocation of $32,000 for the 2008 limitation year. It is assumed 
that the section 415(c)(1)(A) dollar limit for 2008 is $46,000.
    (ii) Separate testing analysis. Under paragraph (h)(1) of this 
section, Plan X and the individual medical account must separately 
satisfy the requirements of section 415(c), taking into account any 
special limit applicable to that arrangement. In this case, the 
contributions to Plan X separately satisfy the limitations of section 
415(c). While the individual medical account is treated as a

[[Page 1070]]

defined contribution plan subject to the rules of section 415(c), it is 
not subject to the 100 percent of compensation limit of section 
415(c)(1)(B), so the contributions to that account satisfy the 
limitations of section 415(c).
    (iii) Aggregation analysis. The sum of the annual additions under 
Plan X and the amounts contributed to the separate account on P's behalf 
must satisfy the requirements of section 415(c). Under paragraph (h)(2) 
of this section, the limit applicable to the aggregated plan is equal to 
the greater of the limits applicable to the separate plans. In this 
case, the limit applicable to the medical account is $46,000 (which is 
greater than the limit of $30,000 applicable to the qualified plan), so 
the limit that applies to the aggregated plan is $46,000, and the 
aggregated plan satisfies the requirements of section 415.

[T.D. 9319, 72 FR 16922, Apr. 5, 2007; 72 FR 28854, May 23, 2007]



Sec. 1.415(g)-1  Disqualification of plans and trusts.

    (a) Disqualification of plans--(1) In general. Under section 415(g) 
and this section, with respect to a particular limitation year, a plan 
(and the trust forming part of the plan) is disqualified in accordance 
with the rules provided in paragraph (b) of this section, if the 
conditions described in paragraph (a)(2) or (a)(3) of this section 
apply. For purposes of this paragraph (a), the determination of whether 
a plan or a group of aggregated plans exceeds the limitations imposed by 
section 415 for a particular limitation year is, except as otherwise 
provided, made by taking into account the aggregation of plan rules 
provided in section 415(f) and Sec. 1.414(f)-1.
    (2) Defined contribution plans. A plan is disqualified in accordance 
with the rules provided in paragraph (b) of this section if annual 
additions (as defined in Sec. 1.415(c)-1(b)) with respect to the 
account of any participant in a defined contribution plan maintained by 
the employer exceed the limitations of section 415(c) and Sec. 
1.415(c)-1.
    (3) Defined benefit plans. A plan is disqualified in accordance with 
the rules provided in paragraph (b) of this section if the annual 
benefit (as defined in Sec. 1.415(b)-1(b)(1)) of a participant in a 
defined benefit plan maintained by the employer exceeds the limitations 
of section 415(b) and Sec. 1.415(b)-1.
    (b) Rules for disqualification of plans and trusts--(1) In general. 
If any plan (including a trust which forms part of such plan) is 
disqualified for a particular limitation year under the rules set forth 
in this paragraph (b), then the disqualification is effective as of the 
first day of the first plan year containing any portion of the 
particular limitation year.
    (2) Single plan. In the case of a single qualified defined benefit 
plan (determined without regard to section 415(f) and Sec. 1.415(f)-1) 
maintained by the employer that provides an annual benefit (as defined 
in Sec. 1.415(b)-1(b)(1)) in excess of the limitations of section 
415(b) and Sec. 1.415(b)-1 for any particular limitation year, such 
plan is disqualified in that limitation year. Similarly, if the employer 
only maintains a single defined contribution plan (determined without 
regard to section 415(f) and Sec. 1.415(f)-1) under which annual 
additions (as defined in Sec. 1.415(c)-1(b)) allocated to the account 
of any participant exceed the limitations of section 415(c) and Sec. 
1.415(c)-1 for any particular limitation year, such plan is also 
disqualified in that limitation year.
    (3) Multiple plans--(i) In general. If the limitations of section 
415(b) and Sec. 1.415(b)-1, or section 415(c) and Sec. 1.415(c)-1, are 
exceeded for a particular limitation year with respect to any 
participant solely because of the application of the aggregation rules 
of section 415(f)(1) and Sec. 1.415(f)-1 (taking into account the rules 
of Sec. 1.415(a)-1(f)), then one or more of the plans is disqualified 
in accordance with the ordering rules set forth in paragraph (b)(3)(ii) 
of this section, applied in accordance with the rules of application set 
forth in paragraph (b)(3)(iii) of this section, subject to the special 
rules set forth in paragraph (b)(3)(iv) of this section, until, without 
regard to annual benefits or annual additions under the disqualified 
plan or plans, the remaining plans satisfy the applicable limitations of 
section 415.
    (ii) Ordering rules--(A) Disqualification of ongoing plans other 
than multiemployer plans. If there are two or more plans that have not 
been terminated at any time including the last day of the particular 
limitation year, and if one

[[Page 1071]]

or more of those plans is a multiemployer plan described in section 
414(f), then one or more of the plans (as needed to satisfy the 
limitations of section 415) that has not been terminated and is not a 
multiemployer plan is disqualified in that limitation year. For purposes 
of the preceding sentence, the determination of whether a plan is a 
multiemployer plan described in section 414(f) is made as of the last 
day of the particular limitation year.
    (B) Disqualification of ongoing multiemployer plans. If, after the 
application of paragraph (b)(3)(ii)(A) of this section, there are two or 
more plans and one or more of the plans has been terminated at any time 
including the last day of the particular limitation year, then one or 
more of the plans (as needed to satisfy the applicable limitations of 
section 415) that has not been so terminated (regardless of whether the 
plan is a multiemployer plan described in section 414(f)) is 
disqualified in that limitation year.
    (iii) Rules of application--(A) Employer elects which plan is 
disqualified. If there are two or more plans of an employer within a 
group of plans one or more of which is to be disqualified pursuant to 
paragraph (b)(3)(ii)(A) or (B) of this section, then the employer may 
elect, in a manner determined by the Commissioner, which plan or plans 
are disqualified. If those two or more plans are involved because of the 
application of Sec. 1.415(a)-1(f), the employers involved may elect, in 
a manner determined by the Commissioner, which plan or plans are 
disqualified. However, the election described in the preceding sentence 
is not effective unless made by all of those employers.
    (B) Commissioner determines which plan is disqualified. If the 
election described in paragraph (b)(3)(iii)(A) of this section is not 
made with respect to the two plans described in paragraph (b)(3)(iii)(A) 
of this section, then the Commissioner, taking into account all of the 
facts and circumstances, has the discretion to determine the plan that 
is disqualified in the particular limitation year. In making this 
determination, some of the factors that will be taken into account 
include, but are not limited to, the number of participants in each 
plan, the amount of benefits provided on an overall basis by each plan, 
and the extent to which benefits are distributed or retained in each 
plan.
    (iv) Special rules--(A) Simplified employee pensions. If there are 
two or more plans one or more of which is to be disqualified pursuant to 
paragraph (b)(3)(ii)(A) or (B) of this section, and if one of the plans 
is a simplified employee pension (as defined in section 408(k)), then 
the simplified employee pension is not disqualified until all of the 
other plans have been disqualified. However, if one of the plans has 
been terminated, then the simplified employee pension is disqualified 
before the terminated plan. For purposes of this paragraph 
(b)(3)(iv)(A), the disqualification of a simplified employee pension 
means that the simplified employee pension is no longer described under 
section 408(k).
    (B) Aggregating medical accounts with defined contribution plans. In 
the event that aggregating a medical account described in Sec. 
1.415(c)-1(a)(2)(ii)(C) or (D) and a defined contribution plan other 
than such a medical account causes the limitations of section 415(c) and 
Sec. 1.415(c)-1 applicable to a participant to be exceeded for a 
particular limitation year, the defined contribution plan other than the 
medical account is disqualified for the limitation year.
    (C) Aggregating section 403(b) annuity contract and qualified 
defined contribution plan--(1) In general. In the event that aggregating 
a section 403(b) annuity contract and a qualified defined contribution 
plan under the provisions of section 415(f)(1)(B) causes the limitations 
of section 415(c) and Sec. 1.415(c)-1 applicable to a participant under 
the aggregated defined contribution plans to be exceeded for a 
particular limitation year, the excess of the contributions to the 
annuity contract plus the annual additions to the qualified plan over 
such limitations is attributed to the annuity contract and therefore 
includable in the gross income of the participant for the taxable year 
with or within which that limitation year ends. See Sec. 1.415(a)-
1(b)(2) for rules regarding the treatment of a contribution to a section 
403(b) annuity contract that exceeds the limitations of section 415.

[[Page 1072]]

    (2) Example. The following example illustrates the application of 
this paragraph (b)(3)(iv)(C). It is assumed for purposes of this example 
that the dollar limitation under section 415(c)(1)(A) that applies for 
all relevant limitation years is $45,000. The example is as follows:

    Example. (i) N is employed by a hospital which purchases an annuity 
contract described in section 403(b) on N's behalf for the current 
limitation year. N is also the 100 percent owner of a professional 
corporation P that maintains a qualified defined contribution plan 
during the current limitation year in which N participates. (The facts 
of this example are the same as in Sec. 1.415(f)-1(j) Example 7.) N's 
compensation (within the meaning of Sec. 1.415(c)-2) from the hospital 
for the current limitation year is $150,000. For the current limitation 
year, the hospital contributes $30,000 for the section 403(b) annuity 
contract on N's behalf, which is within the limitations applicable to N 
under the annuity contract (specifically, the limit under the annuity 
contract is $45,000)). Professional corporation P also contributes 
$20,000 to the qualified defined contribution plan on N's behalf for the 
current limitation year (which represents the only annual additions 
allocated to N's account under the plan for such year), which is within 
the $45,000 limitation of section 415(c)(1) applicable to N under the 
plan.
    (ii) Under section 415(k)(4), the professional corporation, as well 
as N, is considered to maintain the annuity contract. Accordingly, the 
sum of the annual additions under the qualified defined contribution 
plan maintained by professional corporation P and the annuity contract 
must satisfy the limitations of section 415(c) and Sec. 1.415(c)-1.
    (iii) Because the total aggregate contributions ($50,000) exceed the 
section 415(c) limitation applicable to N ($45,000), $5,000 of the 
$30,000 contributed to the section 403(b) annuity contract is considered 
an excess contribution and therefore currently includable in N's gross 
income. The contract continues to be a section 403(b) annuity contract 
only if, for the current limitation year and all years thereafter, the 
issuer of the contract maintains separate accounts for each portion 
attributable to such excess contributions. See Sec. Sec. 1.415(a)-
1(b)(2).

    (c) Plan year for certain annuity contracts and individual 
retirement plans. For purposes of this section, unless the plan under 
which the annuity contract or individual retirement plan is provided 
specifies that a different twelve-month period is considered to be the 
plan year--
    (1) An annuity contract described in section 403(b) is considered to 
have a plan year coinciding with the taxable year of the individual on 
whose behalf the contract has been purchased; and
    (2) A simplified employee pension described in section 408(k) is 
considered to have a plan year coinciding with the year under the plan 
that is used pursuant to section 408(k)(7)(C).

[T.D. 9319, 72 FR 16927, Apr. 5, 2007]



Sec. 1.415(j)-1  Limitation year.

    (a) In general. Unless the terms of a plan provide otherwise, the 
limitation year, with respect to any qualified plan maintained by the 
employer, is the calendar year.
    (b) Alternative limitation year election. The terms of a plan may 
provide for the use of any other consecutive twelve month period as the 
limitation year. This includes a fiscal year with an annual period 
varying from 52 to 53 weeks, so long as the fiscal year satisfies the 
requirements of section 441(f). A plan may only provide for one 
limitation year regardless of the number or identity of the employers 
maintaining the plan.
    (c) Multiple limitation years--(1) In general. Where an employer 
maintains more than one qualified plan, those plans may provide for 
different limitation years. The rule described in this paragraph (c) 
also applies to a controlled group of employers (within the meaning of 
section 414(b) or (c), as modified by section 415(h)). If the plans of 
an employer (or a controlled group of employers whose plans are 
aggregated) have different limitation years, section 415 is applied in 
accordance with the rule of paragraphs (c)(2) and (3) of this section.
    (2) Testing rule for defined contribution plans. If a participant is 
credited with annual additions in only one defined contribution plan, in 
determining whether the requirements of section 415(c) are satisfied, 
only the limitation year applicable to that plan is considered. However, 
if a participant is credited with annual additions in more than one 
defined contribution plan, each such plan satisfies the requirements of 
section 415(c) only if the limitations of section 415(c) are satisfied

[[Page 1073]]

with respect to amounts that are annual additions for the limitation 
year with respect to the participant under the plan, plus amounts 
credited to the participant's account under all other plans required to 
be aggregated with the plan pursuant to section 415(f) and Sec. 
1.415(f)-1 that would have been considered annual additions for the 
limitation year under the plan if they had been credited under the plan 
rather than an aggregated plan.
    (3) Testing rule for defined benefit plans. If a participant has 
participated in only one defined benefit plan, in determining whether 
the requirements of section 415(b) are satisfied, only the limitation 
year applicable to that plan is considered. However, if a participant 
has participated in more than one defined benefit plan, a plan satisfies 
the requirements of section 415(b) only if the annual benefit under all 
plans required to be aggregated pursuant to section 415(f) and Sec. 
1.415(f)-1 for the limitation year of that plan with respect to the 
participant satisfy the applicable limitations of section 415(b). Thus, 
for example, the dollar limitation of section 415(b)(1)(A) applicable to 
the limitation year for each plan must be applied to annual benefits 
under all aggregated plans to determine whether the plan satisfies the 
requirements of section 415(b).
    (d) Change of limitation year--(1) In general. Once established, the 
limitation year may be changed only by amending the plan. Any change in 
the limitation year must be a change to a 12-month period commencing 
with any day within the current limitation year. For purposes of this 
section, the limitations of section 415 are to be applied in the normal 
manner to the new limitation year.
    (2) Application to short limitation period. Where there is a change 
of limitation year, the limitations of section 415 are to be separately 
applied to a limitation period which begins with the first day of the 
current limitation year and which ends on the day before the first day 
of the first limitation year for which the change is effective. In the 
case of a defined contribution plan, the dollar limitation with respect 
to this limitation period is determined by multiplying the applicable 
dollar limitation for the calendar year in which the limitation period 
ends by a fraction, the numerator of which is the number of months 
(including any fractional parts of a month) in the limitation period, 
and the denominator of which is 12. In the case of a defined benefit 
plan, no adjustment is made to the section 415(b) limitations to reflect 
a short limitation period.
    (3) Deemed change of limitation year. If a defined contribution plan 
is terminated effective as of a date other than the last day of the 
plan's limitation year, the plan is treated for purposes of this section 
as if the plan was amended to change its limitation year. Thus, the 
rules of this paragraph (d) apply to the terminating plan's final 
limitation year.
    (e) Limitation year for individuals on whose behalf section 403(b) 
annuity contracts have been purchased. The limitation year of an 
individual on whose behalf a section 403(b) annuity contract has been 
purchased by an employer is determined in the following manner.
    (1) If the individual is not in control of any employer (within the 
meaning of Sec. 1.415(f)-1(f)(2)(ii)), the limitation year is the 
calendar year. However, the individual may elect to change the 
limitation year to another twelve-month period. To do this, the 
individual must attach a statement to his or her income tax return filed 
for the taxable year in which the change is made. Any change in the 
limitation year must comply with the rules set forth in paragraph (d) of 
this section.
    (2) If the individual is in control of an employer (within the 
meaning of Sec. 1.415(f)-1(f)(2)(ii)), the limitation year is the 
limitation year of that employer.
    (f) Limitation year for individuals on whose behalf individual 
retirement plans are maintained. The limitation year of an individual on 
whose behalf an individual retirement plan (within the meaning of 
section 7701(a)(37)) is maintained is determined in the manner described 
in paragraph (e) of this section.
    (g) Examples. The following examples illustrate the application of 
this section:

    Example 1. (i) Participant M is employed by both Employer A and 
Employer B, each of which maintains a qualified defined contribution 
plan. M participates in both of

[[Page 1074]]

these plans. The limitation year for Employer A's plan is January 1 
through December 31, and the limitation year for Employer B's plan is 
April 1 through March 31. Employer A and Employer B are both 
corporations, and Corporation X owns 100 percent of the stock of 
Employer A and Employer B.
    (ii) The two plans in which M participates are required under 
section 415(f) to be aggregated for purposes of applying the limitations 
of section 415(c) to annual additions made with respect to M. Thus, for 
example, for the limitation year of Employer A's plan that begins 
January 1, 2008, annual additions with respect to M that are subject to 
the limitations of section 415(c) include both amounts that are annual 
additions with respect to M under Employer A's plan for the period 
beginning January 1, 2008, and ending December 31, 2008, and amounts 
contributed to Employer B's plan with respect to M that would have been 
considered annual additions for the period beginning January 1, 2008, 
and ending December 31, 2008, under Employer A's plan if those amounts 
had instead been contributed to Employer A's plan.
    Example 2. In 2008, an employer with a qualified defined 
contribution plan using the calendar year as the limitation year elects 
to change the limitation year to a period beginning July 1 and ending 
June 30. Because of this change, the plan must satisfy the limitations 
of section 415(c) for the limitation period beginning January 1, 2008, 
and ending June 30, 2008. In applying the limitations of section 415(c) 
to this limitation period, the amount of compensation taken into account 
may only include compensation for this period. Furthermore, the dollar 
limitation for this period is the otherwise applicable dollar limitation 
for calendar year 2008, multiplied by 6/12.

[T.D. 9319, 72 FR 16928, Apr. 5, 2007]



Sec. 1.416-1  Questions and answers on top-heavy plans.

    The following questions and answers relate to special rules for top-
heavy plans under section 416 of the Internal Revenue Code of 1954, as 
added by section 240 of the Tax Equity and Fiscal Responsibility Act of 
1982 (Pub. L. 97-248) (TEFRA), and amended by sections 524 and 713(f) of 
the Tax Reform Act of 1984 (Pub. L. 98-369):

                            Table of Contents

G--General Provisions
T--Top-Heaviness Determinations
V--Vesting Rules for Top-Heavy Plans
M--Minimum Benefits Under Top-Heavy Plans

                          G. General Provisions

    G-1 Q. What requirement plans are subject to the top-heavy rules 
added to the Code by the Tax Equity and Fiscal Responsibility Act and 
amended by the Tax Reform Act of 1984?
    A. All stock bonus, pension, or profit-sharing plans intended to 
qualify under section 401(a), annuity contracts described in section 
403(a), and simplified employee pensions described in section 408(k) are 
subject to the new top-heavy rules added to the Code by the Tax Equity 
and Fiscal Responsibility Act and amended by the Tax Reform Act 
(``TRA'') of 1984.
    G-2 Q. Is a multiple employer plan subject to the top-heavy 
requirements of section 416?
    A. A multiple employer plan is subject to the requirements of 
section 416, but only with respect to each individual employer. Thus, if 
twelve employers contribute to a multiple employer plan and the accrued 
benefits for the key employees of one employer exceed 60 percent of the 
accrued benefits of all employees for such employer, the plan is top-
heavy with respect to that employer. A failure by the multiple employer 
plan to satisfy section 416 with respect to the employees of such 
employer means that all employers are maintaining a plan that is not a 
qualified plan.
    G-3 Q. As of what date must plan amendments to comply with top-heavy 
rules be effective?
    A. Amendments required to comply with the top-heavy rules must be 
effective as of the first day of the first plan year which begins after 
1983. See Sec. 1.401(b)-1 for the date by which such amendments must be 
adopted.

                     T. Top-Heaviness Determinations

    T-1 Q. What factors must be considered in determining whether a plan 
is top-heavy?
    A. (a) In order to determine whether a plan is top-heavy for a plan 
year, it is necessary to determine which employers will be treated as a 
single employer for purposes of section 416; what the determination date 
is for the plan year; which employees are or formerly were key 
employees; which former employees have not performed any service

[[Page 1075]]

for the employer maintaining the plan at any time during the five-year 
period ending on the determination date; which plans of such employers 
are required or permitted to be aggregated to determine top-heavy 
status; and the present value of the accrued benefits (including 
distributions made during the plan year containing the determination 
date and the four preceding plan years) of key employees, former key 
employees, and non-key employees.
    (b) All employers that are aggregated under section 414 (b), (c), 
and (m) must be taken into account as a single employer for the plan 
year in question, and those employees in all plans maintained by the 
employers that are aggregated must be categorized as key employees, as 
former key employees, or as non-key employees. See Question and Answer 
T-12 for the determination of which employees are or were key employees. 
All plans maintained by the employers in which a key employee 
participates, and certain other plans, must then be aggregated (the 
required aggregation group). See Question and Answer T-6 for rules 
concerning required aggregation. Other plans may in some cases be 
aggregated with the required aggregation group. See Question and Answer 
T-7 for rules concerning such permissive aggregation.
    (c) Once aggregated, all plans that are required to be aggregated 
will either be top-heavy or not top-heavy, depending upon whether the 
aggregation group is top-heavy. A plan or aggregation group will be 
considered top-heavy if the sum of the present value of the accrued 
benefits for key employees is more than 60 percent of the sum of the 
present value of accrued benefits of all employees.
    (d) Except as otherwise stated, for purposes of section 416(g), an 
employee is an individual currently or formerly employed by an employer. 
Former key employees are non-key employees and are excluded entirely 
from the calculation to determine top-heaviness. In all cases, the 
present value of accrued benefits includes distributions made during the 
plan year containing the determination date and the preceding four plan 
years. See Questions and Answers T-24 and T-25 for rules concerning the 
account balances and present value of accrued benefits. For plan years 
beginning after December 31, 1984, the accrued benefit of an employee 
who has not performed any sevice for the employer maintaining the plan 
at any time during the five-year period ending on the determination date 
is excluded from the calculation to determine top-heaviness. However, if 
an employee performs no services for five years and then performs 
sevices, such employee's total accrued benefit is included in the 
calculation for top-heaviness.
    T-2 Q. To what extent are multiemployer plans and multiple employer 
plans to which an employer makes contributions on behalf of its 
employees treated as plans of that employer for top-heavy purposes?
    A. Multiemployer plans described in section 414(f) and multiple 
employer plans described in section 413(c) to which an employer makes 
contributions on behalf of its employees are treated as plans of that 
employer to the extent that benefits under the plan are provided to 
employees of the employer because of service with that employer.
    T-3 Q. Must a collectively-bargained plan be aggregated with other 
plans of the employer to determine whether some or all of the employer's 
plans are top-heavy?
    A. A collectively-bargained plan that includes a key employee of an 
employer must be included in the required aggregation group for that 
employer. See Question and Answer T-6 for rules concerning required 
aggregation. A collectively-bargained plan that does not include a key 
employee may be included in a permissive aggregation group. See Question 
and Answer T-7 for rules concerning permissive aggregation. However, the 
special rules in section 416 (b), (c), or (d) applicable to top-heavy 
plans do not apply with respect to any employee included in a unit of 
employees covered by an agreement which the Secretary of Labor finds to 
be a collective-bargaining agreement between employee representatives 
and one or more employers if there is evidence that retirement benefits 
were the subject of good faith bargaining between such employee 
representatives

[[Page 1076]]

and such employer or employers. In determining whether there is a 
collective-bargaining agreement between employee representatives and one 
or more employers, the additional condition of section 7701(a)(46) must 
be satisfied after March 31, 1984.
    T-4 Q. How is a terminated plan treated for purposes of the top-
heavy rules?
    A. A terminated plan is treated like any other plan for purposes of 
the top-heavy rules. For purposes of section 416, a terminated plan is 
one that has been formally terminated, has ceased crediting service for 
benefit accruals and vesting, and has been or is distributing all plan 
assets to participants or their beneficiaries as soon as 
administratively feasible. Such a plan must be aggregated with other 
plans of the employer if it was maintained within the last five years 
ending on the determination date for the plan year in question and 
would, but for the fact that it terminated, be part of a required 
aggregation group for such plan year. Distributions which have taken 
place within the five years ending on the determination date must be 
accounted for in accordance with section 416(g)(3). No additional 
vesting, benefit accruals or contributions must be provided for 
participants in a terminated plan.
    T-5 Q. How are frozen plans treated for purposes of the top-heavy 
rules?
    A. For purposes of section 416, a frozen plan is one in which 
benefit accruals have ceased but all assets have not been distributed to 
participants or their beneficiaries. Such plans are treated, for 
purposes of the top-heavy rules, as any non-frozen plan. That is, such 
plans must provide minimum contributions or benefit accruals, limit the 
amount of compensation which can be taken into account in providing 
benefits, and provide top-heavy vesting. A frozen defined contribution 
plan may not be required to provide additional contributions because of 
the rule in section 416(c)(2)(B).
    T-6 Q. What is a required aggregation group?
    A. For purposes of determining whether the plans of an employer are 
top-heavy for a particular plan year, the required aggregation group 
includes each plan of the employer in which a key employee participates 
in the plan year containing the determination date, or any of the four 
preceding plan years. In addition, each other plan of the employer 
which, during this period, enables any plan in which a key employee 
participates to meet the requirements of section 401(a)(4) or 410 is 
part of the required aggregation group. This concept may be illustrated 
by the following examples:

    Example 1. An employer maintains two plans. Key employees 
participate in one plan, but not in the other. If the plan containing 
key employees independently satisfies the coverage and non-
discrimination rules of sections 410 and 401(a)(4), it may be tested 
independently to determine whether it is top-heavy. Also, the plan not 
covering key employees would not be part of a required aggregation group 
and would not need to be tested to determine whether it is top-heavy. 
However, if the plan containing key employees satisfies the coverage 
requirements of section 410(b) or the non-discrimination requirements of 
section 401(a)(4) only when it is considered together with the other 
plan in accordance with Sec. 1.410(b)-1(d)(3), the plan not covering 
key employees would be part of the required aggregation group.
    Example 2. A sole proprietor terminated a Keogh plan in 1981. In 
1982, the sole proprietor incorporated and established a corporate plan 
with a calendar-year plan year. For purposes of determining whether the 
corporate plan is top-heavy for its 1984 plan year, the terminated Keogh 
plan and the corporate plan would be part of a required aggregation 
group. The sole proprietor and the corporation would be treated as a 
single employer under section 414(c). Under Question and Answer T-4, the 
terminated plan would be aggregated with the corporate plan because it 
was maintained within the five-year period ending on the determination 
date for the 1984 plan year and because, but for the fact that it 
terminated, it would be aggregated with the corporate plan because it 
covered a key employee.

    T-7 Q. What is a permissive aggregation group?
    A. A permissive aggregation group consists of plans of the employer 
that are required to be aggregated, plus one or more plans of the 
employer that are not part of a required aggregation group but that 
satisfy the requirements of sections 401(a)(4) and 410 when considered 
together with the required aggregation group. This concept may

[[Page 1077]]

be illustrated by the following examples:

    Example 1. (a) An employer maintains two plans:
    1. Plan A covers key employees and independently satisfies the 
requirements of sections 410 and 401(a)(4).
    2. Plan B covers no key employees. It also independently satisfies 
the requirements of sections 410 and 401(a)(4).
    (b) As indicated in Question and Answer T-6, Plan B is not required 
to be aggregated with Plan A. Further, if Plan B provided contributions 
or benefits that were not at least comparable to the contributions or 
benefits provided under Plan A, then Plan B could not be permissively 
aggregated with Plan A because the contributions and benefits would 
discriminate if the two plans were considered as a unit. However, if the 
benefits or contributions under Plan B were comparable to those under 
Plan A, the two plans would be permitted to be aggregated to determine 
whether or not the group consisting of both plans is top-heavy. If Plan 
A and Plan B are permitted to be aggregated, and if the permissive 
aggregation group is not top-heavy, then neither Plan A nor Plan B would 
be considered top-heavy.
    Example 2. (a) Employer W maintains two plans.
    1. Plan C covers salaried employees and independently satisfies the 
requirements of sections 410 and 401(a)(4).
    2. Plan D covers employees who are included in a unit of employees 
covered by an agreement which the Secretary of Labor has found to be a 
collective-bargaining agreement between employee representatives and the 
employer and retirement benefits were bargained for between employee 
representatives and the employer.
    (b) The fact that Plan D is a collectively-bargained plan does not 
necessarily mean that it may be permissively aggregated with Plan C. In 
order to be permissively aggregated with Plan C, Plan D must provide 
contributions or benefits with respect to service with Employer W that 
are at least comparable to the contributions or benefits provided under 
Plan C.

    T-8 Q. May an employer permissively aggregate multiemployer plans, 
multiple employer plans and simplified employee pension plans to which 
the employer contributes with a plan covering key employees or a 
required aggregated group?
    A. Yes. Multiemployer plans, multiple employer plans and simplified 
employee pensions to which an employer makes contributions may be 
permissively aggregated with a plan covering key employees or with a 
required aggregation group if the contributions or benefits provided 
under the multiemployer plan, multiple employer plan or simplified 
employee pension by the employer are comparable to the contributions or 
benefits provided under the plan covering key employees or the plans in 
the required aggregation group. In making this determination, only the 
employer's contribution to the simplified employee pension may be used.
    T-9 Q. What plans will be treated as top-heavy if they are part of a 
required aggregation group that is top-heavy?
    A. In the case of plans that are required to be aggregated, each 
plan in the required aggregation group will be top-heavy if the group is 
top-heavy. No plan in the required aggregation group will be top-heavy 
if the group is not top-heavy.
    T-10 Q. If a required aggregation group is top-heavy, and one plan 
of the group satisfies the requirements of sections 416 (b), (c), and 
(d), may other plans in the group include provisions which do not 
satisfy sections 416 (b), (c) and (d)?
    A. No. Each plan in a required aggregation group is top-heavy if the 
group is top-heavy. Thus, each plan must contain provisions satisfying 
the requirements of sections 416 (b) and (d). If all the plans are 
defined contribution plans, only one plan need satisfy the requirements 
of section 416(c)(2) with respect to any non-key employee who 
participates in more than one of the plans. If all the plans are defined 
benefit plans, only one plan need satisfy the requirements of section 
416(c)(1) with respect to any non-key employee who participates in more 
than one of the plans. However, in the case of non-key employees who do 
not participate in more than one plan, each plan must separately provide 
the applicable minimum contribution or benefit with respect to each such 
employee. See Question and Answer M-12 in the case of employees who are 
covered under both a defined benefit and a defined contribution plan.
    T-11 Q. What plans will be treated as top-heavy if a permissive 
aggregation group is top-heavy?
    A. If a permissive aggregation group is top-heavy, only those plans 
that are

[[Page 1078]]

part of the required aggregation group will be subject to the 
requirements of section 416 (b), (c) and (d). Plans that are not part of 
the required aggregation group will not be subject to these 
requirements. Thus, if an employer wishes to demonstrate that the plans 
maintained by the employer are not top-heavy, the employer need consider 
only the required aggregation group. If, after considering the required 
aggregation group, it is determined that the plans are not top-heavy, 
the requirements of section 416 (b), (c) and (d) will not apply to any 
of the plans. If, on the other hand, the plans required to be aggregated 
are top-heavy, the employer may wish to determine whether there are any 
plans that may be permissively aggregated to demonstrate that the plans 
are not top-heavy. Assuming that there are plans that are eligible for 
permissive aggregation, the employer may take these plans into 
consideration. If, after taking such plans into consideration, the net 
result is that the entire group is not top-heavy, the top-heavy 
requirements do not apply to any plan in the group.
    T-12 Q. For purposes of determining whether a plan is top-heavy for 
a plan year, who is a key employee?
    A. Under section 416(i)(1), a key employee is any employee 
(including any deceased employee) who at any time during the plan year 
containing the determination date for the plan year in question or the 
four preceding plan years (including plan years before 1984) is:
    1. An officer of the employer having annual compensation from the 
employer for a plan year greater than 150 percent of the dollar 
limitation in effect under section 415(c)(1)(A) for the calendar year in 
which such plan year ends (see Questions and Answers T-13, T-14, and T-
15),
    2. One of the ten employees having annual compensation from the 
employer for a plan year greater than the dollar limitation in effect 
under section 415(c)(1)(A) for the calendar year in which such plan year 
ends and owning (or considered as owning within the meaning of section 
318) both more than a \1/2\ percent interest and the largest interests 
in the employer (see Question and Answer T-19),
    3. A 5-percent owner of the employer, or
    4. A 1-percent owner of the employer having annual compensation from 
the employer for a plan year more than $150,000 (see Questions and 
Answers T-16 and T-21).
    An individual may be considered a key employee in a plan year for 
more than one reason. For example, an individual may be both an officer 
and one of the ten largest owners. However, in testing whether a plan or 
group is top-heavy, an individual's accrued benefit is counted only 
once. The terms key employee, former key employee, and non-key employee 
include the beneficiaries of such individuals. This Question and Answer 
is illustrated by the following examples:

    Example 1. An employer maintains a calendar-year plan. An individual 
who was an employee of the employer and a 5-percent owner of the 
employer in 1986 was neither an employee nor an owner in 1987 or 
thereafter. Even though the individual is no longer an employee or owner 
of the employer, the individual would be treated as a key employee for 
purposes of determining whether the plan is top-heavy for each plan year 
through the 1991 plan year. However, for purposes of determining whether 
the plan is top-heavy for the 1992 plan year and for subsequent plan 
years, the individual would be treated as a former key employee.
    Example 2. The facts are the same as in example (1), except that the 
individual died in early 1987 and his total benefit under the plan was 
distributed to his beneficiary in 1987. Such distribution would be 
treated as the accrued benefit of the individual for each year through 
the 1991 plan year. However, such individual would be treated as a 
former key employee for purposes of determining whether the plan is top-
heavy for the 1992 plan year and for subsequent plan years. The 
conclusions are not affected by whether the beneficiary of the 
individual is a non-key employee or a key employee of the employer.

    T-13 Q. For purposes of defining a key employee, who is an officer?
    A. Whether an individual is an officer shall be determined upon the 
basis of all the facts, including, for example, the source of his 
authority, the term for which elected or appointed, and the nature and 
extent of his duties. Generally, the term officer means an 
administrative executive who is in regular and continued service. The 
term officer implies continuity of service

[[Page 1079]]

and excludes those employed for a special and single transaction. An 
employee who merely has the title of an officer but not the authority of 
an officer is not considered an officer for purposes of the key employee 
test. Similarly, an employee who does not have the title of an officer 
but has the authority of an officer is an officer for purposes of the 
key employee test. In the case of one or more employers treated as a 
single employer under sections 414(b), (c), or (m), whether or not an 
individual is an officer shall be determined based upon his 
responsibilities with respect to the employer or employers for which he 
is directly employed, and not with respect to the controlled group of 
corporations, employers under common control or affiliated service 
group. A partner of a partnership will not be treated as an officer for 
purposes of the key employee test merely because he owns a capital or 
profits interest in the partnership, exercises his voting rights as a 
partner, and may, for limited purposes, be authorized and does in fact 
act as an agent of the partnership.
    T-14 Q. For purposes of determining whether a plan is top-heavy for 
a plan year, how many officers must be taken into account?
    A. There is no minimum number of officers that must be taken into 
account. Only individuals who are in fact officers within the meaning of 
Question and Answer T-13 must be considered. For example, a corporation 
with only one officer and two employees would have only one officer for 
purposes of section 416(i)(1)(A)(i). After aggregating all employees 
(including leased employees within the meaning of section 414(n)) of 
employers required to be aggregated under section 414(b), (c) or (m), 
there is a maximum limit to the number of officers that are to be taken 
into account as officers for the entire group of employers that are so 
aggregated. The number of employees an employer (including all employers 
required to be aggregated under section 414(b), (c), or (m)) has for the 
plan year containing the determination date is the greatest number of 
employees it had during that plan year or any of the four preceding plan 
years. For purposes of this Question and Answer, employees include only 
those individuals who perform services for the employer during a plan 
year. If the number of employees (including part-time employees) of all 
the employers aggregated under section 414(b), (c) or (m) is less than 
30 employees, no more than three individuals shall be treated as key 
employees for the plan year containing the determination date by reason 
of being officers. If the number of employees of all organizations 
aggregated under section 414(b), (c) or (m) is greater than 30 but less 
than 500, no more than 10% of the number of employees will be treated as 
key employees by reason of being officers. (If 10% of the number of 
employees is not an integer, the maximum number of individuals to be 
treated as key employees by reason of being officers shall be increased 
to the next integer). If the number of employees of employers aggregated 
under section 414 (b), (c) and (m) exceeds 500, no more than 50 
employees are to be considered as key employees by reason of being 
officers. This limited number of officers is comprised of the individual 
officers, selected from the group of all individuals who were officers 
in the plan year containing the determination date or any one of the 
four preceding plan years, who had annual plan year compensation (in the 
officer year) in excess of 150 percent of the dollar limitation in 
effect under section 415(c)(1)(A) for the calendar year in which the 
plan year ends and who had the largest annual plan-year compensation in 
that five-year period. (The definition of compensation contained in 
Question and Answer T-21 is to be used for this purpose.) In determining 
the officers of an employer, an employee who is an officer shall be 
counted as an officer for key employee purposes without regard to 
whether the employee is a key employee for any other reason. However, in 
testing whether the plan(s) is top-heavy, an individual's present value 
of accrued benefits is counted only once.

    Example. A company is testing to see if its plan is top-heavy for 
the 1985 plan year. In each year from 1980 through 1984 it has more than 
500 employees. Assume that (1) because of rapid turnover among officers, 
the individuals who are officers each year are different from the 
individuals who are officers in any preceding year, and (2) the annual 
plan year

[[Page 1080]]

compensation of each officer exceeds 150 percent of the dollar 
limitation in effect under section 415(c)(1)(A) for the calendar year in 
which the plan year ends. Under the limitations, only a total of 50 
individuals would be considered to be key employees by virtue of being 
officers in testing for top-heaviness for the 1985 plan year. Further, 
the 50 individuals considered as key employees under this test would be 
determined by selecting the 50 out of 250 individuals (50 different 
officers each year) who had the highest annual plan-year compensation 
during the 1980-1984 period (while officers).

    T-15 Q. For purposes of section 416, do organizations other than 
corporations have officers?
    A. Yes. For purposes of the top-heavy rules, sole proprietorships, 
partnerships, associations, trusts, and labor organizations may have 
officers. This rule is effective for purposes of determining whether a 
plan is top-heavy for plan years which begin after February 28, 1985.
    T-16 Q. Who is a 1-percent owner of the employer?
    A. (a) If the employer is a corporation, a 1-percent owner is any 
employee who owns (or is considered as owning within the meaning of 
section 318) more than 1 percent of the value of the outstanding stock 
of the corporation or stock possessing more than 1 percent of the total 
combined voting power of all stock of the corporation. If the employer 
is not a corporation, a 1-percent owner is any employee who owns more 
than 1 percent of the capital or profits interest in the employer. The 
rules of subsections (b), (c), and (m) of section 414 do not apply for 
purposes of determining who is a 1-percent owner.
    (b) For purposes of determining who is a 1-percent owner, 5-percent 
owner, or top-ten owner, value means fair market value taking into 
account all facts and circumstances.
    T-17 Q. Who is a 5-percent owner of the employer?
    A. If the employer is a corporation, a 5-percent owner is any 
employee who owns (or is considered as owning within the meaning of 
section 318) more than 5 percent of the value of the outstanding stock 
of the corporation or stock possessing more than 5 percent of the total 
combined voting power of all stock of the corporation. If the employer 
is not a corporation, a 5-percent owner is any employee who owns more 
than 5 percent of the capital or profits interest in the employer. The 
rules of subsections (b), (c), and (m) of section 414 do not apply for 
purposes of determining who is a 5-percent owner.
    T-18 Q. How do the rules of section 318 apply for purposes of 
determining ownership in an entity other than a corporation?
    A. For purposes of determining ownership is an entity other than a 
corporation, the rules of section 318 apply in a manner similar to the 
way in which they apply for purposes of determining ownership in a 
corporation. For non-corporate interests, capital or profits interest 
must be substituted for stock.
    T-19 Q. Which employees will be considered one of the top ten 
owners?
    A. (a) For purposes of determining whether a plan is top-heavy for a 
plan year, the top ten owners are the ten employees who (1) own (or are 
considered as owning within the meaning of section 318) during the plan 
year containing the determination date or any of the four preceding plan 
years both more than a \1/2\ percent ownership interest in value and the 
largest percentage ownership interests in value of any of the employers 
required to be aggregated under section 414(b), (c), or (m), and (2) 
have during the plan year of ownership annual plan year compensation 
from the employer more than the limitation in effect under section 
415(c)(1)(A) for the calendar year in which such plan year ends. The 
five years for which the test is made will be referred to as the 
``testing period.'' An employee whose annual plan year compensation 
exceeds the section 415(c)(1)(A) limit in effect for the calendar year 
in which a plan year in the testing period ends who has an ownership 
interest greater than \1/2\ percent in that plan year is considered to 
be one of the top ten owners unless at least ten other employees own a 
greater interest in the employer during any year of the testing period 
and have annual plan year compensation during such plan year of 
ownership greater than the section 415(c)(1)(A) limit in effect for the 
calendar year in which such plan year ends. Ownership each plan

[[Page 1081]]

year is determined on the basis of percentage of ownership interest in 
total ownership value and not dollar amounts. Thus, an employee whose 
stock interest is valued at 15 percent of the total stock value of a 
corporation in year one that was worth $15,000 is ranked higher than an 
employee whose stock interest is valued at 5 percent of the total stock 
value of the same corporation in year three which is now worth $50,000.
    (b) If an employee's ownership interest changes during a plan year, 
his ownership interest for the year is the largest interest owned at any 
time during the year. If two employees have the same ownership interest 
in the employer during the testing period, the employee having the 
largest annual compensation from the employer for the plan year during 
any part of which that ownership interest existed shall be treated as 
having a larger interest. Thus, if 25 employees each own 4 percent in 
value of the employer during the testing period, the 10 employees with 
the largest single plan year compensation during this period will be 
considered the top ten owners. For purposes of this Question and Answer, 
compensation has the meaning set forth in Question and Answer T-21. This 
Question and Answer is illustrated by the following examples:

    Example 1. Corporation K maintains a calendar year defined 
contribution plan. On January 1, 1986, Corporation K has five owners who 
owned the following value percentages of K stock: A=50%, B=20%, C=15%, 
D=10%, and E=5%. On June 30, 1987, the five owners of Corporation K sold 
all of their shares of stock. The new owners and their respective 
ownership percentages were: F=40%, G=30%, H=10%, I=10%, and J=10%. 
Assume that, for 1986, A, B, C, D, and E had annual compensation from 
Corporation K greater than the section 415(c)(1)(A) limit and that, for 
1987, F, G, H, I, and J also had compensation from Corporation K greater 
than the section 415(c)(1)(A) limit. For purposes of determining whether 
the plan is top-heavy for the 1991 plan year, the top ten owners will 
include A, B, C, D, E, F, G, H, I, and J because no 10 individuals 
during the testing period, 1986-1990, had a greater ownership interest 
than these individuals.
    Example 2. Assume the same facts in Example 1, except that on June 
1, 1988, F, G, H, I, and J sold their interests to new owners, K, L, M, 
N, and O. K, L, M, N, and O owned, respectively, 30%, 30%, 30%, 5% and 
5% of the value of the shares of X. Assume also that for 1988 K, L, M, 
N, and O earned more than the section 415(c)(1)(A) limitation. For 
purposes of determining whether the plan is top-heavy for the 1991 plan 
year, the top ten owners will include: A, B, F, K, G, L, M, and C 
because these eight individuals owned the highest value percentages of 
the Corporation K stock. Since D, H, I, and J owned equal 10% interests 
in value, the two employees of this group who had the largest annual 
plan year compensation during the plan years of their ownership will be 
the last 2 top ten owners.

    T-20 Q. For purposes of determining whether an employee is a key 
employee under section 416(i)(1)(A), what aggregation rules apply?
    A. In the case of ownership percentages, each employer that would 
otherwise be aggregated under section 414 (b), (c) and (m) is treated as 
a separate employer. (See section 416(i)(1)(C).) However, for purposes 
of determining whether an individual has compensation of $150,000, or 
whether an individual is a key employee by reason of being an officer or 
a top ten owner, compensation from each entity required to be aggregated 
under sections 414 (b), (c) and (m) is taken into account. These rules 
may be illustrated by the following example:

    Example. An individual owns two percent of the value of a 
professional corporation, which in turn owns a \1/10\th of 1 percent 
interest in a partnership. The entities must be aggregated in accordance 
with section 414(m). The individual performs services for the 
professional corporation and for the partnership. The individual 
receives compensation of $125,000 from the professional corporation and 
$26,000 from the partnership. The individual is considered to be a key 
employee with respect to the employer that comprises both the 
professional corporation and the partnership because he has a two 
percent interest in the professional corporation and because his 
combined compensation from both the professional corporation and the 
partnership is more than $150,000.

    T-21. Q. For purposes of testing whether an individual has 
compensation of more than $150,000, what definition of compensation must 
be used?
    A. The definition of compensation to be used is the definition in 
Sec. 1.415(c)-2, however, compensation must be determined for a plan 
year, not a limitation year. Alternatively, compensation that would be 
stated on an employee's Form

[[Page 1082]]

W-2, ``Wage and Tax Statement,'' for the calendar year that ends with or 
within the plan year may be used, although amounts that would have been 
stated on the employee's Form W-2 but for an election under section 125, 
132(f)(4), 401(k), 403(b), 408(k), 408(p)(2)(A)(i), or 457(b) must be 
included. A plan must use the same definition of compensation for all 
top-heavy plan purposes for which the definition in this Q and A must be 
used.
    T-22 Q. In the case of an employer who maintains a single plan, when 
must the determination whether the plan is top-heavy be made?
    A. Whether a plan is top-heavy for a particular plan year is 
determined as of the determination date for such plan year. The 
determination date with respect to a plan year is defined in section 
416(g)(4)(C) as (1) the last day of the preceding plan year, or (2) in 
the case of the first plan year, the last day of such plan year. 
Distributions made and the present value of accrued benefits are 
generally determined as of the determination date. (See Questions and 
Answers T-24 and T-25 for more specific rules.)
    T-23 Q. In the case of an aggregation group, when must the 
determination whether the group is top-heavy be made?
    A. When two or more plans constitute an aggregation group in 
accordance with section 416(g)(2), the following procedures are used to 
determine whether the plans are top-heavy for a particular plan year. 
First, the present value of the accrued benefits (including 
distributions for key employees and all employees) is determined 
separately for each plan as of each plan's determination date. The plans 
are then aggregated by adding together the results for each plan as of 
the determination dates for such plans that fall within the same 
calendar year. The combined results will indicate whether or not the 
plans so aggregated are top-heavy. These rules may be illustrated by the 
following example:

    Example. An employer maintains Plan A and Plan B, each containing a 
key employee. Plan A's plan year commences July 1 and ends June 30. Plan 
B's plan year is the calendar year. For Plan A's plan year commencing 
July 1, 1984, the determination date is June 30, 1984. For Plan B's plan 
year in 1985, the determination date is December 31, 1984. These plans 
are required to be aggregated. For each of these plans as of their 
respective determination dates, the present value of the accrued 
benefits for key employees and all employees are separately determined. 
The two determination dates, June 30, 1984, and December 31, 1984, fall 
within the same calendar year. Accordingly, the present values of 
accrued benefits as of each of these determination dates are combined 
for purposes of determining whether the group is top-heavy. If, after 
combining the two present values, the total results show that the group 
is top-heavy, Plan A will be top-heavy for the plan year commencing July 
1, 1984, and Plan B will be top-heavy for the 1985 calendar year.

    T-24 Q. How is the present value of an accrued benefit determined in 
a defined contribution plan?
    A. The present value of accrued benefits as of the determination 
date for any individual is the sum of (a) the account balance as of the 
most recent valuation date occurring within a 12-month period ending on 
the determination date, and (b) an adjustment for contributions due as 
of the determination date. In the case of a plan not subject to the 
minimum funding requirements of section 412, the adjustment in (b) is 
generally the amount of any contributions actually made after the 
valuation date but on or before the determination date. However, in the 
first plan year of the plan, the adjustment in (b) should also reflect 
the amount of any contributions made after the determination date that 
are allocated as of a date in that first plan year. In the case of a 
plan that is subject to the minimum funding requirements, the account 
balance in (a) should include contributions that would be allocated as 
of a date not later than the determination date, even though those 
amounts are not yet required to be contributed. Thus, the account 
balance will include contributions waived in prior years as reflected in 
the adjusted account balance and contributions not paid that resulted in 
a funding deficiency. The adjusted account balance is described in Rev. 
Rul. 78-223, 1978-1 C.B. 125. Also, the adjustment in (b) should reflect 
the amount of any contribution actually made (or due to be

[[Page 1083]]

made) after the valuation date but before the expiration of the extended 
payment period in section 412(c)(10).
    T-25. Q. How is the present value of an accrued benefit determined 
in a defined benefit plan?
    A. The present value of an accrued benefit as of a determination 
date must be determined as of the most recent valuation date which is 
within a 12-month period ending on the determination date. In the first 
plan year of a plan, the accrued benefit for a current employee must be 
determined either (i) as if the individual terminated service as of the 
determination date or (ii) as if the individual terminated service as of 
the valuation date, but taking into account the estimated accrued 
benefit as of the determination date. For the second plan year of a 
plan, the accrued benefit taken into account for a current participant 
must not be less than the accrued benefit taken into account for the 
first plan year unless the difference is attributable to using an 
estimate of the accrued benefit as of the determination date for the 
first plan year and using the actual accrued benefit as of the 
determination date for the second plan year. For any other plan year, 
the accrued benefit for a current employee must be determined as if the 
individual terminated service as of such valuation date. For this 
purpose, the valuation date must be the same valuation date for 
computing plan costs for minimum funding, regardless of whether a 
valuation is performed that year.
    T-26. Q. What actuarial assumptions are used for determining the 
present value of accrued benefits for defined benefit plans?
    A. (a) There are no specific prescribed actuarial assumptions that 
must be used for determining the present value of accrued benefits. The 
assumptions used must be reasonable and need not relate to the actual 
plan and investment experience. The assumptions need not be the same as 
those used for minimum funding purposes or for purposes of determining 
the actuarial equivalence of optional benefits under the plan. The 
accrued benefit for each current employee is computed as if the employee 
voluntarily terminated service as of the valuation date. The present 
value must be computed using an interest and a post-retirement mortality 
assumption. Pre-retirement mortality and future increases in cost of 
living (but not in the maximum dollar amount permitted by section 415) 
may also be assumed. However, assumptions as to future withdrawals or 
future salary increases may not be used. In the case of a plan providing 
a qualified joint and survivor annuity within the meaning of section 
401(a)(11) as a normal form of benefit, for purposes of determining the 
present value of the accrued benefit, the spouse of the participant may 
be assumed to be the same age as the participant.
    (b) Except in the case where the plan provides for a nonproportional 
subsidy, the present value should reflect a benefit payable commencing 
at normal retirement age (or attained age, if later). Thus, benefits not 
relating to retirement benefits, such as pre-retirement death and 
disability benefits and post-retirement medical benefits, must not be 
taken into account. Further, subsidized early retirement benefits and 
subsidized benefit options must not be taken into account unless they 
are nonproportional subsidies. See Question and Answer

T-27.
    (c) Where the plan provides for a nonproportional subsidy, the 
benefit should be assumed to commence at the age at which the benefit is 
most valuable. In the case of two or more defined benefit plans which 
are being tested for determining whether an aggregation group is top-
heavy, the actuarial assumptions used for all plans within the group 
must be the same. Any assumptions which reflect a reasonable mortality 
experience and an interest rate not less than five percent or greater 
than six percent will be considered as reasonable. Plans, however, are 
not required to use an interest rate in this range.
    T-27 Q. In determining the present value of accrued benefits in a 
defined benefit plan, what standards are applied toward determining 
whether a subsidy is nonproportional?
    A. A subsidy is nonproportional unless the subsidy applies to a 
group of employees that would independently satisfy the requirements of 
section

[[Page 1084]]

410(b). If two or more plans are considered as a unit for comparability 
purposes under Sec. 1.410(b)-1(d)(3), subsidies may be necessary in 
both plans or else the subsidy may be nonproportional. Thus, for 
example, in the case of a plan which provides an early retirement 
benefit after age 55 and 20 years of service equal to the normal 
retirement benefit without actuarial reduction and if the employees who 
may conceivably reach age 55 with 20 years of service would, as a group, 
satisfy the requirements of section 410(b), that subidy is proportional. 
However, in contrast, consider a plan that provides an early retirement 
benefit that is the actuarial equivalent of the normal retirement 
benefit. In determining the early retirement benefit, the plan imposes 
the section 415 limits only on the early retirement benefit (not on the 
normal retirement benefit before applying the early retirement reduction 
factors). In such a plan, a participant with a normal retirement benefit 
(before limitation by section 415) in excess of the section 415 limits 
will receive a subsidized early retirement benefit, whereas a 
participant with a lower normal retirement benefit will not. Thus, such 
a benefit would be a nonproportional subsidy if the group of individuals 
who are limited by the limitations under section 415 do not, by 
themselves, constitute a cross section of employees that could satisfy 
section 410(b).
    T-28 Q. For purposes of determining the present value of accrued 
benefits in either a defined benefit or defined contribution plan, are 
the accrued benefits attributable to employee contributions considered 
to be part of the accrued benefits?
    A. The accrued benefits attributable to employee contributions are 
considered to be part of the accrued benefits without regard to whether 
such contributions are mandatory or voluntary. However, the amounts 
attributable to deductible employee contributions (as defined in section 
72(o)(5)(A)) are not considered to be part of the accrued benefits.
    T-29 Q. How are plans described in section 401(k) treated for 
purposes of the top-heavy rules?
    A. No special top-heavy rules are provided for plans described in 
section 401(k), except a transitional rule. For plan years beginning 
after December 31, 1984, amounts which an employee elects to defer are 
treated as employer contributions for purposes of determining minimum 
required contributions under section 416(c)(2). However, for plan years 
beginning prior to January 1, 1985, amounts which an employee elects to 
have contributed to a plan described in section 401(k) are not treated 
as employer contributions for these purposes. A plan described in 
section 401(k) which is top-heavy must provide minimum contributions by 
the employer and limit the amount of compensation which can be taken 
into account in providing benefits under the plan.
    T-30 Q. What distributions are added to the present value of accrued 
benefits in determining whether a plan is top-heavy for a particular 
plan year?
    A. Under section 416(g)(3)(A), distributions made within the plan 
year that includes the determination date and within the four preceding 
plan years are added to the present value of accrued benefits of key 
employees and non-key employees in testing for top-heaviness. However, 
in the case of distributions made after the valuation date and prior to 
the determination date, such distributions are not included as 
distributions in section 416(g)(3)(A) to the extent that such 
distributions are included in the present value of the accrued benefits 
as of the valuation date. In the case of the distribution of an annuity 
contract, the amount of such distribution is deemed to be the current 
actuarial value of the contract, determined on the date of the 
distribution. Certain distributions that are rolled over by the employee 
are not included as distributions. See Question and Answer T-32. A 
distribution will not fail to be considered in determining the present 
value of accrued benefits merely because it was made before the 
effective date of section 416. For purposes of this question and answer, 
distributions mean all distributions made by a plan, including all 
distributions of employee contributions made during and before the plan 
year.

[[Page 1085]]

    T-31 Q. Are benefits paid on account of death treated as 
distributions for purposes of section 416(g)(3)?
    A. Benefits paid on account of death are treated as distributions 
for purposes of section 416(g)(3) to the extent such benefits do not 
exceed the present value of accrued benefits existing immediately prior 
to death; benefits paid on account of death are not treated as 
distributions for purposes of section 416(g)(3) to the extent such 
benefits exceed the present value of accrued benefits existing 
immediately prior to death. The distribution from a defined contribution 
plan (including the cash value of life insurance policies) of a 
participant's account balance on account of death will be treated as a 
distribution for purposes of section 416(g)(3).
    T-32 Q. How are rollovers and plan-to-plan transfers treated in 
testing whether a plan is top-heavy?
    A. The rules for handling rollovers and transfers depend upon 
whether they are unrelated (both initiated by the employee and made from 
a plan maintained by one employer to a plan maintained by another 
employer) or related (a rollover or transfer either not initiated by the 
employee or made to a plan maintained by the same employer). Generally, 
a rollover or transfer made incident to a merger or consolidation of two 
or more plans or the division of a single plan into two or more plans 
will not be treated as being initiated by the employee. The fact that 
the employer initiated the distribution does not mean that the rollover 
was not initiated by the employee. For purposes of determining whether 
two employers are to be treated as the same employer, all employers 
aggregated under section 414(b), (c) or (m) are treated as the same 
employer. In the case of unrelated rollovers and transfers, (1) the plan 
making the distribution or transfer is to count the distribution as a 
distribution under section 416(g)(3), and (2) the plan accepting the 
rollover or transfer is not to consider the rollover or transfer as part 
of the accrued benefit if such rollover or transfer was accepted after 
December 31, 1983, but is to consider it as part of the accrued benefit 
if such rollover or transfer was accepted prior to January 1, 1984. In 
the case of related rollovers and transfers, the plan making the 
distribution or transfer is not to count the distribution or transfer 
under section 416(g)(3) and the plan accepting the rollover or transfer 
counts the rollover or transfer in the present value of the accrued 
benefits. Rules for related rollovers and transfers do not depend on 
whether the rollover or transfer was accepted prior to January 1, 1984.
    T-33 Q. How are the aggregate defined benefit and defined 
contribution limits under section 415(e) affected by the top-heavy 
rules?
    A. Section 416(h) modifies the aggregate limits in section 415(e) 
for super top-heavy plans and for top-heavy plans that are not super 
top-heavy but do not provide for an additional minimum contribution or 
benefit. A plan is a super top-heavy plan if the present value of 
accrued benefits for key employees exceeds 90% of the present value of 
the accrued benefits for all employees. In the case of a top-heavy 
aggregation group, the test is applied to all plans in the group as a 
whole. These present values are computed using the same rules as are 
used for determining whether the plan is top-heavy. In the case of a 
super top-heavy plan, in computing the denominators of the defined 
benefit and defined contribution fractions under section 415(e), a 
factor of 1.0 is used instead of 1.25 for all employees. In the case of 
a top-heavy plan that is not super top-heavy, the same rule applies 
unless each non-key employee who is entitled to a minimum contribution 
or benefit receives an additional minimum contribution or benefit. In 
the case of a defined benefit plan, the additional minimum benefit is 
one percentage point (up to a maximum of ten percentage points) for each 
year of service described in Question and Answer M-2 of the 
participant's average compensation for the years described in Question 
and Answer M-2. In the case of a defined contribution plan, the 
additional minimum contribution is one percent of the participant's 
compensation. If a plan does not provide the applicable additional one 
percent minimum or if a plan is super top-heavy, the factor of 1.25 may 
be used for an individual only if there

[[Page 1086]]

are both no further accruals for that individual under any defined 
benefit plan and no further annual additions for that individual under 
any defined contribution plan until the combined fraction satisfies the 
rules of section

415(e) using the 1.0 factor for that individual. The rules contained in 
this Question and Answer apply for each limitation year that contains 
any portion of a plan year for which the plan is top-heavy. This 
Question and Answer may be illustrated by the following example:

    Example. A Corporation maintains a profit-sharing plan and a defined 
benefit plan, and these plans constitute a required aggregation group. 
Both plans use the calendar year for the plan year and the limitation 
year under section 415. The plans were determined to be top-heavy for 
plan year 1986. The plans use the 1.25 factor under section 415(e), and 
non-key employees covered by both the profit-sharing and the defined 
benefit plan accrue, under the defined benefit plan, 3% of compensation 
for each year of service (up to a maximum of 30%). The plans become 
super top-heavy for the 1990 plan year. In order to satisfy section 415, 
no further accruals and no further annual additions may take place for 
any employee covered by both plans until the combined defined benefit-
defined contribution fraction for such employee is less than 1.0, using 
the 1.0 factor in place of 1.25.

    T-34 Q. May plans be permissively aggregated to avoid being super 
top-heavy?
    A. Yes, plans may be permissively aggregated to avoid being super 
top-heavy.
    T-35 Q. What provisions must be contained in a plan to comply with 
the top-heavy requirements?
    A. Section 401(a)(10)(B) provides that a plan will qualify only if 
it contains provisions which will take effect if the plan becomes top-
heavy and which meet the requirements of section 416. See Questions and 
Answers T-39 and T-40 for rules on what provisions must be included. 
Under section 401(a)(10)(B)(ii), regulations may waive this requirement 
for some plans. See Question and Answer T-38 for a description of plans 
that need not include such provisions.
    T-36 Q. For an employer who has no employee who has participated or 
is eligible to participate in both a defined benefit and defined 
contribution plan (or a simplified employee pension, ``SEP'') of that 
employer, what provisions must be in the plan(s) to comply with the top-
heavy requirements?
    A. (a) If the defined benefit plan has no participants who are or 
could be participants in a defined contribution plan of the employer (or 
vice versa), the defined benefit plan (or defined contribution plan) 
need not include provisions describing the defined benefit or defined 
contribution fractions for purposes of section 415 and, thus, the plan 
need not contain provisions to determine whether the plan is super top-
heavy or to change any plan provisions if the plan becomes super top-
heavy. Furthermore, if the plan contains a single benefit structure that 
satisfies the requirements of section 416 (b), (c), and (d) for each 
plan year without regard to whether the plan is top-heavy for such year, 
the plan need not include separate provisions to determine whether the 
plan is top-heavy or that apply if the plan is top-heavy. If the plan's 
single benefit structure does not assure that section 416 (b), (c), and 
(d) will be satisfied in all cases, then the plan must include three 
types of provisions.
    (b) First, the plan must contain provisions describing how to 
determine whether the plan is top-heavy. These provisions must include 
(1) the criteria for determining which employees are key employees (or 
non-key employees), (2) in the case of a defined benefit plan, the 
actuarial assumptions and benefits considered to determine the present 
value of accrued benefits, (3) a description of how the top-heavy ratio 
is computed, (4) a description of what plans (or types of plans) will be 
aggregated in testing whether the plan is top-heavy, and (5) a 
definition of the determination date and the valuation date applicable 
to the determination date. These determinations must be based on 
standards that are uniformly and consistently applied and that satisfy 
the rules set forth in section 416 and these Questions and Answers. The 
provisions in (1) and (3) above may be incorporated in the plan by 
reference to the applicable sections of the Internal Revenue Code 
without adversely affecting the qualification of the plan. However, the 
plan must state the definition of

[[Page 1087]]

compensation for purposes of determining who is a key employee.
    (c) Second, the plan must specifically contain the following 
provisions that will become effective if the plan becomes top-heavy: 
vesting that satisfies the minimum vesting requirements of section 
416(b), benefits that will not be less than the minimum benefits set 
forth in section 416(c), and the compensation limitation described in 
section 416(d). The compensation limitation described in section 416(d) 
may be incorporated by reference. If a plan always meets the 
requirements of either section 416(b), (c) or (d), the plan need not 
include additional provisions to meet any such requirements.
    (d) Third, the plan must include provisions insuring that any change 
in the plan's benefit structure (including vesting schedules) resulting 
from a change in the plan's top-heavy status will not violate section 
411(a)(10). Thus, if a plan ceases being top-heavy, certain restrictions 
apply with respect to the change in the applicable vesting schedule.
    T-37 Q. For an employer who maintains or has maintained both a 
defined benefit and a defined contribution plan (or a simplified 
employee pension, ``SEP'') and some participants do or could participate 
in both types of plan, what provisions must be in the plans to comply 
with the top-heavy requirements?
    A. If an employer maintains (or has maintained) both a defined 
benefit plan and a defined contribution plan (or SEP), and the plans 
have or could have participants who participate in both types of plans, 
then the plans must contain more provisions than those described in 
Question and Answer T-36. First, the plans may exclude rules to 
determine whether the plan is top-heavy (or to apply when the plan is 
top-heavy) only if both plans contain a single benefit structure that 
satisfies sections 416 (b), (c), and (d) without regard to whether the 
plans are top-heavy. Second, unless the plans always satisfy the 
requirements of section 415(e) using the 1.0 factor in the defined 
benefit and defined contribution fractions as described in section 
416(h)(i), the plans must include provisions similar to those in 
Question and Answer T-36 (for top-heavy) to determine whether the plan 
is super top-heavy and to satisfy section 416(h) if it is.
    T-38 Q. Are any plans exempted from including top-heavy provisions?
    A. Section 401(a)(10)(B) exempts governmental plans (as defined in 
section 414(d)) from the top-heavy requirements and provides that 
regulations may exempt certain plans from including the top-heavy 
provisions. A plan need not include any top-heavy provisions if the 
plan: (1) is not top-heavy, and (2) covers only employees who are 
included in a unit of employees covered by a collective-bargaining 
agreement (if retirement benefits were the subject of good faith 
bargaining) or employees of employee representatives. The requirement 
set forth in section 7701(a)(46) must be met before an agreement will be 
considered a collective-bargaining agreement after March 31, 1984.
    T-39 Q. Must ratios be computed each year to determine whether a 
plan is top-heavy?
    A. No. In order to administer the plan, the plan administrator must 
know whether the plan is top-heavy. However, precise top-heavy ratios 
need not be computed every year. If, on examination, the Internal 
Revenue Service requests a demonstration as to whether the plan is top-
heavy (or super top-heavy; see Question and Answer T-33) the employer 
must demonstrate to the Service's satisfaction that the plan is not 
operating in violation of section 401(a)(10)(B). For purposes of any 
demonstration, the employer may use computations that are not precisely 
in accordance with this section but which mathematically prove that the 
plan is not top-heavy. For example, if the employer determined the 
present value of accrued benefits for key employees in a simplified 
manner which overstated that value, determined the present value for 
non-key employees in a simplified manner which understated that value, 
and the ratio of the key employee present value divided by the sum of 
the present values was less than 60 percent, the plan would not be 
considered top-heavy. This would be a sufficient demonstration because 
the simplified fraction could be shown to be greater than the exact 
fraction and,

[[Page 1088]]

thus, the exact fraction must also be less than 60 percent.
    Several methods that may be used to simplify the determinations are 
indicated below.
    (1) If the top-heavy ratio, computed considering all the key 
employees and only some of the non-key employees, is less than 60 
percent, then it is not necessary to accumulate employee data on the 
remaining non-key employees. Inclusion of additional non-key employees 
would only further decrease the ratio.
    (2) If the number of key employees is known but the identity of the 
key employees is not known (i.e. if the only key employees are officers 
and the limit on officers is applicable), the numerator may be 
determined by using a hypothetical ``worst case'' basis. Thus, in the 
case of a defined benefit plan, if the numerator of the top-heavy ratio 
were determined assuming each key employee's present value of accrued 
benefits were equal to the maximum section 415 benefits at the age that 
would maximize such present value, that assumption would only overstate 
the present value of accrued benefits for key employees. Thus, if that 
ratio is less than 60 percent, the plan is not top-heavy and accurate 
data on the key employees need not be collected.
    (3) If the employer has available present value of accrued benefit 
computations for key and non-key employees in a defined benefit plan, 
and these values differ from those that would be produced under Question 
and Answer T-25 only by inclusion of a withdrawal assumption, the 
present value for the key employees (but not the non-key employees) may 
be adjusted to a ``worst case'' value by dividing by the lowest possible 
probability of not withdrawing from plan participation before normal 
retirement age. If the top-heavy ratio based on this inflated key 
employee value is less than 60 percent, the present value need not be 
recomputed without the withdrawal assumption. The methods set forth in 
this answer may also be used to determine whether a plan is super top-
heavy by inserting ``90%'' for ``60%'' in the appropriate places.
    T-40 Q. Will a plan fail to qualify if it provides that the $200,000 
maximum amount of annual compensation taken into account under section 
416(d) for any plan year that the plan is top-heavy may be automatically 
increased in accordance with regulations under section 416?
    A. No.
    T-41 Q. If a plan provides benefits based on compensation in excess 
of $200,000 and the plan becomes top-heavy, must any accrued benefits 
attributable to this excess compensation be eliminated?
    A. No. For any year that a plan is top-heavy, section 416(d) 
provides that compensation in excess of $200,000 must not be taken into 
account. However, a top-heavy plan may continue to provide for any 
benefits attributable to compensation in excess of $200,000 to the 
extent such benefits were accrued before the plan was top-heavy. 
Furthermore, section 411(d)(6) will be violated if any individual's pre-
top-heavy benefit is reduced by either (1) a plan amendment adding the 
$200,000 restriction, or (2) an automatic change in the plan benefits 
structure imposing the $200,000 restriction due to the plan's becoming 
top-heavy.
    T-42 Q. Under a top-heavy defined benefit plan, are the requirements 
of section 416(d) satisfied if the annual compensation of an employee 
taken into account to determine plan benefits is limited to the amount 
currently described in section 416(d) for years during which the plan is 
top-heavy but higher compensation is taken into account for years before 
the plan became top-heavy?
    A. No. For the top-heavy plan to meet the requrements of section 
416(d), compensation for all years, including years before the plan 
became top-heavy, that is taken into account to determine plan benefits 
must not exceed the amount currently described in section 416(d). 
However, if the accrued benefit as of the end of the last plan year 
before the plan became top-heavy (ignoring any plan amendments after 
that date) is greater than the accrued benefit determined by limiting 
compensation in accordance with section 416(d), that higher accrued 
benefit as of the end of the last plan year before the plan became top-
heavy must not be reduced. Providing such higher accrued

[[Page 1089]]

benefit will not cause the plan to violate section 416(d).
    T-43 Q. What happens to an individual who has ceased employment 
before a plan becomes top-heavy?
    A. If an individual has ceased employment before a plan becomes top-
heavy, such individual would not be required to receive any additional 
benefit accruals, contributions, or vesting, unless the individual 
returned to employment with the employer. See Questions and Answers V-3, 
M-4, and M-10. In addition, if the individual is receiving benefits 
based on annual compensation greater than $200,000, such benefits cannot 
be decreased.

                  V. Vesting Rules for Top-Heavy Plans

    V-1 Q. What vesting must be provided under a top-heavy plan?
    A. Under section 416(b), the accrued benefits attributable to 
employer contributions must be nonforfeitable in accordance with one of 
two statutory standards. Either such accrued benefits must be 
nonforfeitable after 3 years of service or the nonforfeitable portion of 
accrued benefits must be at least 20 percent after 2 years of service, 
40 percent after 3 years of service, 60 percent after 4 years of 
service, 80 percent after 5 years of service, and 100 percent after 6 
years of service. The accrued benefits attributable to employer 
contributions has the same meaning as under section 411(c) of the Code. 
As under section 411(a), the accrued benefits attributable to employee 
contributions must be nonforfeitable at all times.
    V-2 Q. What service must be counted in determining vesting 
requirements?
    A. All service required to be counted under section 411(a) must be 
counted for these purposes. All service permitted to be disregarded 
under section 411(a)(4) may similarly be disregarded under the schedules 
of section 416(b).
    V-3 Q. What benefits must be subject to the minimum vesting schedule 
of section 416(b)?
    A. All accrued benefits within the meaning of section 411(a)(7) must 
be subject to the minimum vesting schedule. These accrued benefits 
include benefits accrued before the effective date of section 416 and 
benefits accrued before a plan becomes top-heavy. However, when a plan 
becomes top-heavy, the accrued benefits of any employee who does not 
have an hour of service after the plan becomes top-heavy are not 
required to be subject to the minimum vesting schedule. Accrued benefits 
which have been forfeited before a plan becomes top-heavy need not vest 
when a plan becomes top-heavy.
    V-4 Q. May a top-heavy plan provide a minimum eligibility 
requirement of the later of age 21 or the completion of 3 years of 
service and provide that all benefits are nonforfeitable when accrued?
    A. Yes. For plan years which begin after December 31, 1984, a top-
heavy plan may provide a minimum eligibility requirement of the later of 
age 21, or the completion of 3 years of service, and provide that all 
benefits are nonforfeitable when accrued. For plan years which begin 
before January 1, 1985, ``25'' may be substituted for ``21'' in the 
preceding sentence.
    V-5 Q. What does nonforfeitable mean?
    A. In general, nonforfeitable has the same meaning as in section 
411(a). However, the minimum benefits required under section 416 (to the 
extent required to be nonforfeitable under section 416(b)) may not be 
forfeited under section 411(a)(3) (B) or (D). Thus, if benefits are 
suspended (ceased) during a period of reemployment, the benefit payable 
upon the subsequent resumption of payments must be actuarially increased 
to reflect the nonpayment of benefits during such period of re-
employment.
    V-6 Q. Will a class-year plan automatically satisfy the minimum 
vesting requirements in section 416(b) if it provides that contributions 
with respect to any plan year become nonforfeitable no later than the 
end of the third plan year following the plan year for which the 
contribution was made?
    A. No. Although this vesting schedule is similar to the 3-year 
minimum vesting schedule permitted by section 416(b)(1)(A), it does not 
satisfy that minimum. The 3-year vesting schedule in section 
416(b)(1)(A) requires that, after completion of 3 years of service, the 
entire accrued benefit of a participant be nonforfeitable. Under the 
class-year vesting schedule described above,

[[Page 1090]]

a portion of a participant's accrued benefit (that portion attributable 
to contributions for the prior 3 years) is forfeitable regardless of the 
participant's years of service.
    V-7 Q. When a top-heavy plan ceases to be a top-heavy, may the 
vesting schedule be altered to a vesting schedule permitted without 
regard to section 416?
    A. When a top-heavy plan ceases to be top-heavy, the vesting 
schedule may be changed to one that would otherwise be permitted. 
However, in changing the vesting schedule, the rules described in 
section 411(a)(10) apply. Thus, the nonforfeitable percentage of the 
accrued benefit before the plan ceased to be top-heavy must not be 
reduced; also, any employee with five or more years of service must be 
given the option of remaining under the prior (i.e., top-heavy) vesting 
schedule.

                M. Minimum Benefits under Top-heavy Plans

    M-1 Q. Which employees must receive minimum contributions or 
benefits in a top-heavy plan?
    A. Generally, every non-key employee who is a participant in a top-
heavy plan must receive minimum contributions or benefits under such 
plan. However, see Questions and Answers M-4 and M-10 for certain 
exceptions. Different minimums apply for defined benefit and defined 
contribution plans.
    M-2 Q. What is the defined benefit minimum?
    A. (a) The defined benefit minimum requires that the accrued benefit 
at any point in time must equal at least the product of (i) an 
employee's average annual compensation for the period of consecutive 
years (not exceeding five) when the employee had the highest aggregate 
compensation from the employer and (ii) the lesser of 2% per year of 
service with the employer or 20%.
    (b) For purposes of the defined benefit minimum, years of service 
with the employer are generally determined under the rules of section 
411(a) (4), (5) and (6). However, a plan may disregard any year of 
service if the plan was not top-heavy for any plan year ending during 
such year of service, or if the year of service was completed in a plan 
year beginning before January 1, 1984.
    (c) In determining the average annual compensation for a period of 
consecutive years during which the employee had the largest aggregate 
compensation, years for which the employee did not earn a year of 
service under the rules of section 411(a) (4), (5), and (6) are to be 
disregarded. Thus, if an employee has received compensation from the 
employer during years one two, and three, and for each of these years 
the employee earned a year of service, then the employee's average 
annual compensation is determined by dividing the employee's aggregate 
compensation for these three years by three. If the employee fails to 
earn a year of service in the next year, but does earn a year of service 
in the fifth year, the employee's average annual compensation is 
calculated by dividing the employee's aggregate compensation for years 
one, two, three, and five by four. The compensation required to be taken 
into account is the compensation described in Question and Answer T-21. 
In addition, compensation received for years ending in plan years 
beginning before January 1, 1984, and compensation received for years 
beginning after the close of the last plan year in which the plan is 
top-heavy may be disregarded.
    (d) The defined benefit minimum is expressed as a life annuity (with 
no ancillary benefits) commencing at normal retirement age. Thus, if 
post-retirement death benefits are also provided, the 2% minimum annuity 
benefit may be adjusted. (See Question and Answer M-3.) The 2% minimum 
annuity benefit may not be adjusted due to the provision of pre-
retirement ancillary benefits. Normal retirement age has the same 
meaning as under section 411(a)(8).
    (e) Any accruals of employer-derived benefits, whether or not 
attributable to years for which the plan is top-heavy, may be used to 
satisfy the defined benefit minimums. Thus, if a non-key employee had 
already accrued a benefit of 20 percent of final average pay at the time 
the plan became top-heavy, no additional minimum accruals are required 
(although the accrued benefit

[[Page 1091]]

would increase as final average pay increased). Accrued benefits 
attributable to employee contributions must be ignored. Accrued benefits 
attributable to employer and employee contributions have the same 
meaning as under section 411(c).
    M-3 Q. What defined benefit minimum must be received if an employee 
receives a benefit in a form other than a single life annuity or a 
benefit other than at normal retirement age?
    A. If the form of benefit is other than a single life annuity, the 
employee must receive an amount that is the actuarial equivalent of the 
minimum single life annuity benefit. If the benefit commences at a date 
other than at normal retirement age, the employee must receive at least 
an amount that is the acturial equivalent of the minimum single life 
annuity benefit commencing at normal retirement age. Thus, the employee 
may receive a lower benefit if the benefit commences before the normal 
retirement age and the employee must receive a higher benefit if the 
benefit commences after the normal retirement age. No specific actuarial 
assumptions are mandated providing different actuarial equivalents. 
However, the assumptions must be reasonable.
    M-4 Q. Which employees must accrue a minimum benefit in a top-heavy 
defined benefit plan?
    A. Each non-key employee who is a participant in a top-heavy defined 
benefit plan and who has at least one thousand hours of service (or 
equivalent service as determined under Department of Labor regulations, 
29 CFR 2530.200b-3) for an accrual computation period must accrue a 
minimum benefit in a top-heavy defined benefit plan for that accrual 
computation period. If the accrual computation period does not coincide 
with the plan year, a minimum benefit must be provided, if required, for 
both accrual periods within the top-heavy plan year. For a top-heavy 
plan that does not base accruals on accrual computation periods, minimum 
benefits must be credited for all periods of service required to be 
credited for benefit accrual. (See Sec. 1.410(a)-7). A non-key employee 
may not fail to accrue a minimum benefit merely because the employee was 
not employed on a specified date. Similarly, a non-key employee may not 
fail to accrue a minimum benefit because either (1) an employee is 
excluded from participation (or accrues no benefit) merely because the 
employee's compensation is less than a stated amount, or (2) the 
employee is excluded from participation (or accrues no benefit) merely 
because of a failure to make mandatory employee contributions.
    M-5 Q. Would the defined benefit minimum be satisfied if the plan 
provides a normal retirement benefit equal to the greater of the plan's 
projected formula or the projected minimum benefit and if benefits 
accrue in accordance with the fractional rule described in section 
411(b)(1)(C)?
    A. No. The fact that this fractional rule would not satisfy the 
defined benefit minimum may be illustrated by the following example. 
Consider a non-key employee, age 25, entering a top-heavy plan in which 
the projected minimum for the employee is greater than the projected 
benefit under the normal formula. Under the fractional rule, the 
employee's accrued benefit ten years later at age 35 would be 5% (20% 
x(10/40)). Under section 416, the employee's minimum accrued benefit 
after ten years of service must be at least 20%. Thus, because the 5% 
benefit is less than the 20% benefit required under section 416, such 
benefit would not satisfy the required minimum.
    M-6 Q. What benefit must an employer provide in a top-heavy defined 
benefit employee pay-all plan?
    A. The defined benefit minimum in an employee pay-all top-heavy plan 
is the same as that for a plan which has employer contributions. That 
is, the employer must provide the benefits specified in Question and 
Answer M-2.
    M-7 Q. What is the defined contribution minimum?
    A. The sum of the contributions and forfeitures allocated to the 
account of any non-key employee who is a participant in a top-heavy 
defined contribution plan must equal at least 3% of such employee's 
compensation (see Question and Answer T-21 for the definition of 
compensation) for that plan year or for the calendar year ending within 
the plan year. However, a lower minimum is permissible where the

[[Page 1092]]

largest contribution made or required to be made for key employees is 
less than 3%. The preceding sentence does not apply to any plan required 
to be included in an aggregation group if such plan enables a defined 
benefit plan required to be included in such group to meet the 
requirements of section 401(a)(4) or 410. The contribution made or 
required to be made on behalf of any key employee is equal to the ratio 
of the sum of the contributions made or required to be made and 
forfeitures allocated for such key employee divided by the compensation 
(not in excess of $200,000) for such key employee. Thus, the defined 
contribution minimum that must be provided for any non-key employee for 
a top-heavy plan year is the largest percentage of compensation (not in 
excess of $200,000) provided on behalf of any key employee for that plan 
year (if the largest percentage of compensation provided on behalf of 
any key employee for that plan year is less than 3%).
    M-8 Q. If an employer maintains two top-heavy defined contribution 
plans, must both plans provide the defined contribution minimum for each 
non-key employee who is a participant in both plans?
    A. No. If one of the plans provides the defined contribution minimum 
for each non-key employee who participates in both plans, the other plan 
need not provide an additional contribution for such employees. However, 
the other plan must provide the vesting required by section 416(b) and 
must limit compensation (based on all compensation from all aggregated 
employers) in providing benefits as required by section 416(d).
    M-9 Q. In the case of the waiver of minimum funding standards of 
section 412(d), how does section 416 treat the defined contribution 
minimum?
    A. For purposes of determining the contribution that is required to 
be made on behalf of a key employee, a waiver of the minimum funding 
requirements is disregarded. Thus, if a defined contribution plan 
receives a waiver of the minimum funding requirement, and if the minimum 
contribution required under the plan without regard to the waiver 
exceeds 3%, the exception described in Question and Answer M-7 does not 
apply even though no key employee receives a contribution in excess of 
3% and even though the amount required to be contributed on behalf of 
the key employee has been waived. Also, a waiver of the minimum funding 
requirements will not alter the requirements of section 416. Thus, in 
the case of the top-heavy defined contribution plan in which the non-key 
employee must receive an allocation, a waiver of the minimum funding 
requirements may eliminate a funding violation and such waiver will 
preclude a violation under section 416 even though the required 
contribution is not made. However, the adjusted account balance (as 
described in Rev. Rul. 78-223, 1978-1 C.B. 125) of the non-key employees 
must reflect the required minimum contribution even though such 
contribution was not made.
    M-10 Q. Which employees must receive the defined contribution 
minimum?
    A. Those non-key employees who are participants in a top-heavy 
defined contribution plan who have not separated from service by the end 
of the plan year must receive the defined contribution minimum. Non-key 
employees who have become participants but who subsequently fail to 
complete 1,000 hours of service (or the equivalent) for an accrual 
computation period must receive the defined contribution minimum. A non-
key employee may not fail to receive a defined contribution minimum 
because either (1) the employee is excluded from participation (or 
accrues no benefit) merely because the employee's compensation is less 
than a stated amount, or (2) the employee is excluded from participation 
(or accrues no benefit) merely because of a failure to make mandatory 
employee contributions or, in the case of a cash or deferred 
arrangement, elective contributions.
    M-11 Q. May either the defined benefit minimum or the defined 
contribution minimum be integrated with social security?
    A. No.
    M-12 Q. What minimum contribution or benefit must be received by a 
non-key employee who participates in a top-heavy plan?

[[Page 1093]]

    A. In the case of an employer maintaining only one plan, if such 
plan is a defined benefit plan, each non-key employee covered by that 
plan must receive the defined benefit minimum. If such plan is a defined 
contribution plan (including a target benefit plan), each non-key 
employee covered by the plan must receive the defined contribution 
minimum. In the case of an employer who maintains more than one plan, 
employees covered under only the defined benefit plan must receive the 
defined benefit minimum. Employees covered under only the defined 
contribution plan must receive the defined contribution minimum. In the 
case of employees covered under both defined benefit and defined 
contribution plans, the rules are more complicated. Section 416(f) 
precludes, in the case of employees covered under both defined benefit 
and defined contribution plans, either required duplication or 
inappropriate omission. Therefore, such employees need not receive both 
the defined benefit and the defined contribution minimums.
    There are four safe harbor rules a plan may use in determining which 
minimum must be provided to a non-key employee who is covered by both 
defined benefit and defined contribution plans. Since the defined 
benefit minimums are generally more valuable, if each employee covered 
under both a top-heavy defined benefit plan and a top-heavy defined 
contribution plan receives the defined benefit minimum, the defined 
benefit and defined contribution minimums will be satisfied. Another 
approach that may be used is a floor offset approach (see Rev. Rul. 76-
259, 1976-2 C.B. 111) under which the defined benefit minimum is 
provided in the defined benefit plan and is offset by the benefits 
provided under the defined contribution plan. Another approach that may 
be used in the case of employees covered under both defined benefit and 
defined contribution plans is to prove, using a comparability analysis 
(see Rev. Rul. 81-202, 1981-2 C.B. 93) that the plans are providing 
benefits at least equal to the defined benefit minimum. Finally, in 
order to preclude the cost of providing the defined benefit minimum 
alone, the complexity of a floor offset plan and the annual fluctuation 
of a comparability analysis, a safe haven minimum defined contribution 
is being provided. If the contributions and forfeitures under the 
defined contribution plan equal 5% of compensation for each plan year 
the plan is top-heavy, such minimum will be presumed to satisfy the 
section 416 minimums.
    M-13 Q. An employer maintains a defined benefit plan and a profit-
sharing plan. Both plans are top-heavy and are members of a required 
aggregation group. In order to meet the minimum contribution/minimum 
benefit requirements, the employer decides to contribute 5% of 
compensation to the profit-sharing plan. What happens if for a 
particular plan year there are no profits out of which to make 
contributions to the profit-sharing plan?
    A. In this particular situation, in order to satisfy the 
requirements of section 416(c), the employer must provide the defined 
contribution minimum, 5% of compensation. This rule is an exception to 
the general rule that an employer cannot make a contribution to a 
profit-sharing plan if there are no profits. Alternatively, the employer 
may provide the defined benefit minimum for this year.
    M-14 Q. What minimum contribution or benefit must be received by a 
non-key employee when he is covered under both a defined benefit plan 
and defined contribution plan (both of which are top-heavy) of an 
employer and the employer desires to use a factor of 1.25 in computing 
the denominators of the defined benefit and defined contribution 
fractions under section 415(e)?
    A. In this particular situation, the employer may use one of the 
four rules set forth in Question and Answer M-12, subject to the 
following modifications. The defined benefit minimum must be increased 
by one percentage point (up to a maximum of ten percentage points) for 
each year of service described in Question and Answer M-2 of the 
participant's average compensation for the years described in Question 
and Answer M-2. The defined contribution minimum is increased to 7\1/2\ 
percent of compensation. If the floor offset or comparability analysis 
approach is used, the defined benefit minimum must be increased by one 
percentage

[[Page 1094]]

point (up to a maximum of ten percentage points) for each year of 
service described in Question and Answer M-2 of the participant's 
average compensation for the years described in Question and Answer M-2.
    M-15 Q. May an employer use a different method each year to meet the 
requirements of Question and Answer M-12 or Question and Answer M-14 
without amending the plans each year?
    A. No. An employer must set forth in the plan document the method he 
will use to meet the requirements of Question and Answer M-12 or M-14, 
as the case may be. If an employer desires to change the method, the 
plan document must be amended.
    M-16 Q. Will target benefit plans be treated as defined benefit or 
defined contribution plans for purposes of the top-heavy rules?
    A. Target benefit plans will be treated as defined contribution 
plans for purposes of the top-heavy rules.
    M-17 Q. Can a plan described in section 412(i) (funded exclusively 
by level premium insurance contracts) also satisfy the minimum benefit 
requirements of section 416?
    A. The accrued benefits provided for a non-key employee under most 
level premium insurance contracts might not provide a benefit satisfying 
the defined benefit minimum because of the lower cash values in early 
years under most level premium insurance contracts, and because such 
contracts normally provide for level premiums until normal retirement 
age. However, a plan will not be considered to violate the requirements 
of section 412(i) merely because it funds certain benefits through 
either an auxiliary fund or deferred annuity contracts, if the following 
conditions are met:
    (1) The targeted benefit at normal retirement age under the level 
premium insurance contract is determined, taking into account the 
defined benefit minimum that would be required assuming the current top-
heavy (or non top-heavy) status of the plan continues until normal 
retirement age; and
    (2) The benefits provided by the auxiliary fund or deferred annuity 
contracts do not exceed the excess of the defined benefit minimum 
benefits over the benefits provided by the level premium insurance 
contract.
    If the above conditions are satisfied, then the plan is still exempt 
from the minimum funding requirements under section 412 and may still 
utilize the special accrued benefit rule in section 411(b)(1)(F) subject 
to the following modifications: Although the portion of the plan funded 
by the level premium annuity contract is exempt from the minimum funding 
requirements, the portion funded by an auxiliary fund is subject to 
those requirements. (Thus, a funding standard account must be maintained 
and a Schedule B must be filed with the annual report). The accrued 
benefit for any participant may be determined using the rule in section 
411(b)(1)(F) but must not be less than the defined benefit minimum.
    M-18 Q. May qualified nonelective contributions described in section 
401(m)(4)(C) be treated as employer contributions for purposes of the 
minimum contribution or benefit requirement of section 416?
    A. Yes. This is the case even if the qualified nonelective 
contributions are taken into account under the actual deferral 
percentage test of Sec. 1.401(k)-1(b)(2) or under the actual 
contribution percentage test of Sec. 1.401(m)-1(b).
    M-19 Q. May matching contributions described in section 40l(m)(4)(A) 
be treated as employer contributions for purposes of the minimum 
contribution or benefit requirement of section 416?
    A. Matching contributions allocated to key employees are treated as 
employer contributions for purposes of determining the minimum 
contribution or benefit under section 416. However, if a plan uses 
contributions allocated to employees other than key employees on the 
basis of employee contributions or elective contributions to satisfy the 
minimum contribution requirement, these contributions are not treated as 
matching contributions for purposes of applying the requirements of 
sections 401(k) and 401(m) for plan years beginning after December 31, 
1988. Thus these contributions must meet the nondiscrimination 
requirements of section 401(a)(4) without regard to section 401(m). See 
Sec. 1.401(m)-1(f)(12)(iii).
    M-20 Q. May elective contributions be treated as employer 
contributions

[[Page 1095]]

for purposes of satisfying the minimum contribution or benefit 
requirement of section 416(c)(2)?
    A. Elective contributions on behalf of key employees are taken into 
account in determining the minimum required contribution under section 
416(c)(2). However, elective contributions on behalf of employees other 
than key employees may not be treated as employer contributions for 
purposes of the minimum contribution or benefit requirement of section 
416. See section 401(k)(4)(C) and the regulations thereunder. This 
Question and Answer is effective for plan years beginning after December 
31, 1988.

[T.D. 7997, 49 FR 50646, Dec. 31, 1984, as amended by T.D. 8357, 56 FR 
40550, Aug. 15, 1991; T.D. 9319, 72 FR 16929, Apr. 5, 2007]



Sec. 1.417(a)(3)-1  Required explanation of qualified joint and 
survivor annuity and qualified preretirement survivor annuity.

    (a) Written explanation requirement--(1) General rule. A plan meets 
the survivor annuity requirements of section 401(a)(11) only if the plan 
meets the requirements of section 417(a)(3) and this section regarding 
the written explanation required to be provided a participant with 
respect to a QJSA or a QPSA. A written explanation required to be 
provided to a participant with respect to either a QJSA or a QPSA under 
section 417(a)(3) and this section is referred to in this section as a 
section 417(a)(3) explanation. See Sec. 1.401(a)-20, Q&A-37, for 
exceptions to the written explanation requirement in the case of a fully 
subsidized QPSA or QJSA, and Sec. 1.401(a)-20, Q&A-38, for the 
definition of a fully subsidized QPSA or QJSA.
    (2) Time for providing section 417(a)(3) explanation--(i) QJSA 
explanation. See Sec. 1.417(e)-1(b)(3)(ii) for rules governing the 
timing of the QJSA explanation.
    (ii) QPSA explanation. See Sec. 1.401(a)-20, Q&A-35, for rules 
governing the timing of the QPSA explanation.
    (3) Required method for providing section 417(a)(3) explanation. A 
section 417(a)(3) explanation must be a written explanation. First class 
mail to the last known address of the participant is an acceptable 
delivery method for a section 417(a)(3) explanation. Likewise, hand 
delivery is acceptable. However, the posting of the explanation is not 
considered provision of the section 417(a)(3) explanation. But see Sec. 
1.401(a)-21 of this chapter for rules permitting the use of electronic 
media to provide applicable notices to recipients with respect to 
retirement plans.
    (4) Understandability. A section 417(a)(3) explanation must be 
written in a manner calculated to be understood by the average 
participant.
    (b) Required content of section 417(a)(3) explanation--(1) Content 
of QPSA explanation. The QPSA explanation must contain a general 
description of the QPSA, the circumstances under which it will be paid 
if elected, the availability of the election of the QPSA, and, except as 
provided in paragraph (d)(3) of this section, a description of the 
financial effect of the election of the QPSA on the participant's 
benefits (i.e., an estimate of the reduction to the participant's 
estimated normal retirement benefit that would result from an election 
of the QPSA).
    (2) Content of QJSA explanation. The QJSA explanation must satisfy 
either paragraph (c) or paragraph (d) of this section. Under paragraph 
(c) of this section, the QJSA explanation must contain certain specific 
information relating to the benefits available under the plan to the 
particular participant. Alternatively, under paragraph (d) of this 
section, the QJSA explanation can contain generally applicable 
information in lieu of specific participant information, provided that 
the participant has the right to request additional information 
regarding the participant's benefits under the plan.
    (c) Participant-specific information required to be provided--(1) In 
general. A QJSA explanation satisfies this paragraph (c) if it provides 
the following information with respect to each of the optional forms of 
benefit presently available to the participant (i.e., optional forms of 
benefit for which the QJSA explanation applies that have an annuity 
starting date after the providing of the QJSA explanation and optional 
forms of benefit with retroactive annuity starting dates that are 
available with payments commencing at that same time)--

[[Page 1096]]

    (i) A description of the optional form of benefit;
    (ii) A description of the eligibility conditions for the optional 
form of benefit;
    (iii) A description of the financial effect of electing the optional 
form of benefit (i.e., the amounts and timing of payments to the 
participant under the form of benefit during the participant's lifetime, 
and the amounts and timing of payments after the death of the 
participant);
    (iv) In the case of a defined benefit plan, a description of the 
relative value of the optional form of benefit compared to the value of 
the QJSA, in the manner described in paragraph (c)(2) of this section; 
and
    (v) A description of any other material features of the optional 
form of benefit.
    (2) Requirement for numerical comparison of relative values--(i) In 
general. The description of the relative value of an optional form of 
benefit compared to the value of the QJSA under paragraph (c)(1)(iv) of 
this section must be expressed to the participant in a manner that 
provides a meaningful comparison of the relative economic values of the 
two forms of benefit without the participant having to make calculations 
using interest or mortality assumptions. Thus, in performing the 
calculations necessary to make this comparison, the benefits under one 
or both optional forms of benefit must be converted, taking into account 
the time value of money and life expectancies, so that the values of 
both optional forms of benefit are expressed in the same form. For 
example, such a comparison may be expressed to the participant using any 
of the following techniques--
    (A) Expressing the actuarial present value of the optional form of 
benefit as a percentage or factor of the actuarial present value of the 
QJSA;
    (B) Stating the amount of the annuity that is the actuarial 
equivalent of the optional form of benefit and that is payable at the 
same time and under the same conditions as the QJSA; or
    (C) Stating the actuarial present value of both the optional form of 
benefit and the QJSA.
    (ii) Use of one form for both married and unmarried individuals--(A) 
In general. Under the rules of this paragraph (c)(2)(ii), in lieu of 
providing different QJSA explanations for married and unmarried 
individuals, the plan may provide a QJSA explanation to an individual 
that does not vary based on the participant's marital status. Except as 
specifically provided in this section, any reference in this section to 
comparing the relative value of an optional form of benefit to the value 
of the QJSA may be satisfied using the substitution permitted under 
paragraph (c)(2)(ii)(B) or (C) of this section.
    (B) Substitution of single life annuity for married individual. For 
a married participant, in lieu of comparing the value of each optional 
form of benefit presently available to the participant to the value of 
the QJSA, the plan can compare the value of each optional form of 
benefit (including the QJSA) to the value of a QJSA for an unmarried 
participant (i.e., a single life annuity), but only if that same single 
life annuity is available to that married participant.
    (C) Substitution of joint and survivor annuity for unmarried 
individual. For an unmarried participant, in lieu of comparing the value 
of each optional form of benefit presently available to the participant 
to the value of the QJSA for that individual (which is a single life 
annuity), the plan can compare the value of each optional form of 
benefit (including the single life annuity) to the value of the joint 
and survivor annuity that is the QJSA for a married participant, but 
only if that same joint and survivor annuity is available to that 
unmarried participant.
    (iii) Simplified presentations permitted--(A) Grouping of certain 
optional forms. Two or more optional forms of benefit that have 
approximately the same value may be grouped for purposes of a required 
numerical comparison described in this paragraph (c)(2). For this 
purpose, two or more optional forms of benefit have approximately the 
same value if none of those optional forms of benefit vary in relative 
value in comparison to the value of the QJSA by more than 5 percentage 
points when the relative value comparison is made by expressing the 
actuarial

[[Page 1097]]

present value of each of those optional forms of benefit as a percentage 
of the actuarial present value of the QJSA. For such a group of optional 
forms of benefit, the requirement relating to disclosing the relative 
value of each optional form of benefit compared to the value of the QJSA 
can be satisfied by disclosing the relative value of any one of the 
optional forms in the group compared to the value of the QJSA, and 
disclosing that the other optional forms of benefit in the group are of 
approximately the same value. If a single-sum distribution is included 
in such a group of optional forms of benefit, the single-sum 
distribution must be the distribution form that is used for purposes of 
this comparison.
    (B) Representative relative value for grouped optional forms. If, in 
accordance with paragraph (c)(2)(iii)(A) of this section, two or more 
optional forms of benefits are grouped, the relative values for all of 
the optional forms of benefit in the group can be stated using a 
representative relative value as the approximate relative value for the 
entire group. For this purpose, a representative relative value is any 
relative value that is not less than the relative value of the member of 
the group of optional forms of benefit with the lowest relative value 
and is not greater than the relative value of the member of that group 
with the highest relative value when measured on a consistent basis. For 
example, if three grouped optional forms have relative values of 87.5 
percent, 89 percent, and 91 percent of the value of the QJSA, all three 
optional forms can be treated as having a relative value of 
approximately 90 percent of the value of the QJSA. As required under 
paragraph (c)(2)(iii)(A) of this section, if a single-sum distribution 
is included in the group of optional forms of benefit, the 90 percent 
relative factor of the value of the QJSA must be disclosed as the 
approximate relative value of the single sum, and the other forms can be 
described as having the same approximate value as the single sum.
    (C) Special rule for optional forms of benefit that are close in 
value to the QJSA. The relative value of all optional forms of benefit 
that have an actuarial present value that is at least 95% of the 
actuarial present value of the QJSA and no greater than 105% of the 
actuarial present value of the QJSA is permitted to be described by 
stating that those optional forms of benefit are approximately equal in 
value to the QJSA, or that all of those forms of benefit and the QJSA 
are approximately equal in value.
    (iv) Actuarial assumptions used to determine relative values. For 
the purpose of providing a numerical comparison of the value of an 
optional form of benefit to the value of the immediately commencing QJSA 
under this paragraph (c)(2), the following rules apply--
    (A) If an optional form of benefit is subject to the requirements of 
section 417(e)(3) and Sec. 1.417(e)-1(d), any comparison of the value 
of the optional form of benefit to the value of the QJSA must be made 
using the applicable mortality table and the applicable interest rate as 
defined in Sec. 1.417(e)-1(d)(2) and (3) (or, at the option of the 
plan, another reasonable interest rate and reasonable mortality table 
used under the plan to calculate the amount payable under the optional 
form of benefit); and
    (B) All other optional forms of benefit payable to the participant 
must be compared with the QJSA using a single set of interest and 
mortality assumptions that are reasonable and that are applied uniformly 
with respect to all such optional forms payable to the participant 
(regardless of whether those assumptions are actually used under the 
plan for purposes of determining benefit payments). For this purpose, 
the reasonableness of interest and mortality assumptions is determined 
without regard to the circumstances of the individual participant. In 
addition, the applicable mortality table and the applicable interest 
rate as defined in Sec. 1.417(e)-1(d)(2) and (3) are considered 
reasonable actuarial assumptions for this purpose and thus are permitted 
(but not required) to be used.
    (v) Required disclosure of assumptions--(A) Explanation of concept 
of relative value. The notice must provide an explanation of the concept 
of relative value, communicating that the relative value comparison is 
intended to allow the participant to compare the total value of 
distributions paid in different

[[Page 1098]]

forms, that the relative value comparison is made by converting the 
value of the optional forms of benefit presently available to a common 
form (such as the QJSA or a single-sum distribution), and that this 
conversion uses interest and life expectancy assumptions. The 
explanation of relative value must include a general statement that all 
comparisons provided are based on average life expectancies, and that 
the relative value of payments ultimately made under an annuity optional 
form of benefit will depend on actual longevity.
    (B) Disclosure of assumptions. A required numerical comparison of 
the value of the optional form of benefit to the value of the QJSA under 
this paragraph (c)(2) is required to include a disclosure of the 
interest rate that is used to develop the comparison. If all optional 
forms of benefit are permitted to be grouped under paragraph 
(c)(2)(iii)(A) of this section, then the requirement of this paragraph 
(c)(2)(v)(B) does not apply for any optional form of benefit not subject 
to the requirements of section 417(e)(3) and Sec. 1.417(e)-1(d)(3).
    (C) Offer to provide actuarial assumptions. If the plan does not 
disclose the actuarial assumptions used to calculate the numerical 
comparison required under paragraph (c)(2) of this section, then, the 
notice must be accompanied by a statement that includes an offer to 
provide, upon the participant's request, the actuarial assumptions used 
to calculate the relative value of optional forms of benefit under the 
plan.
    (3) Permitted estimates of financial effect and relative value--(i) 
General rule. For purposes of providing a description of the financial 
effect of the distribution forms available to a participant as required 
under paragraph (c)(1)(iii) of this section, and for purposes of 
providing a description of the relative value of an optional form of 
benefit compared to the value of the QJSA for a participant as required 
under paragraph (c)(1)(iv) of this section, the plan is permitted to 
provide reasonable estimates (e.g., estimates based on data as of an 
earlier date than the annuity starting date, a reasonable assumption for 
the age of the participant's spouse, or, in the case of a defined 
contribution plan, reasonable estimates of amounts that would be payable 
under a purchased annuity contract), including reasonable estimates of 
the applicable interest rate under section 417(e)(3).
    (ii) Right to more precise calculation. If a QJSA notice uses a 
reasonable estimate under paragraph (c)(3)(i) of this section, the QJSA 
explanation must identify the estimate and explain that the plan will, 
upon the request of the participant, provide a more precise calculation 
and the plan must provide the participant with a more precise 
calculation if so requested. Thus, for example, if a plan provides an 
estimate of the amount of the QJSA that is based on a reasonable 
assumption concerning the age of the participant's spouse, the 
participant can request a calculation that takes into account the actual 
age of the spouse, as provided by the participant.
    (iii) Revision of prior information. If a more precise calculation 
described in paragraph (c)(3)(ii) of this section materially changes the 
relative value of an optional form compared to the value of the QJSA, 
the revised relative value of that optional form must be disclosed, 
regardless of whether the financial effect of selecting the optional 
form is affected by the more precise calculation. For example, if a 
participant provides a plan with the age of the participant's spouse and 
that information materially changes the relative value of an optional 
form of benefit (such as a single sum) compared to the value of the 
QJSA, then the revised relative value of the optional form of benefit 
and the value of the QJSA must be disclosed, regardless of whether the 
amount of the payment under that optional form of benefit is affected by 
the more precise calculation.
    (4) Special rules for disclosure of financial effect for defined 
contribution plans. For a written explanation provided by a defined 
contribution plan, a description of financial effect required by 
paragraph (c)(1)(iii) of this section with respect to an annuity form of 
benefit must include a statement that the annuity will be provided by 
purchasing an annuity contract from an insurance company with the 
participant's account balance under the plan. If the description of the 
financial effect of the

[[Page 1099]]

optional form of benefit is provided using estimates rather than by 
assuring that an insurer is able to provide the amount disclosed to the 
participant, the written explanation must also disclose this fact.
    (5) Simplified presentations of financial effect and relative value 
to enhance clarity for participants--(i) In general. This paragraph 
(c)(5) permits certain simplified presentations of financial effect and 
relative value of optional forms of benefit to permit more useful 
presentations of information to be provided to participants in certain 
cases in which a plan offers a range of optional forms of benefit. 
Paragraph (c)(5)(ii) of this section permits simplified presentations of 
financial effect and relative value for a plan that offers a significant 
number of substantially similar optional forms of benefit. Paragraph 
(c)(5)(iii) of this section permits simplified presentations of 
financial effect and relative value for a plan that permits the 
participant to make separate benefit elections with respect to parts of 
a benefit.
    (ii) Disclosure for plans offering a significant number of 
substantially similar optional forms of benefit--(A) In general. If a 
plan offers a significant number of substantially similar optional forms 
of benefit within the meaning of paragraph (c)(5)(ii)(B) of this section 
and disclosing the financial effect and relative value of each such 
optional form of benefit would provide a level of detail that could be 
overwhelming rather than helpful to participants, then the financial 
effect and relative value of those optional forms of benefit can be 
disclosed by disclosing the relative value and financial effect of a 
representative range of examples of those optional forms of benefit as 
described in paragraph (c)(5)(ii)(C) of this section if the requirements 
of paragraph (c)(5)(ii)(D) of this section (relating to additional 
information available upon request) are satisfied.
    (B) Substantially similar optional forms of benefit. For purposes of 
this paragraph (c)(5)(ii), optional forms of benefit are substantially 
similar if those optional forms of benefit are identical except for a 
particular feature or features (with associated adjustment factors) and 
the feature or features vary linearly. For example, if a plan offers 
joint and survivor annuity options with survivor payments available in 
every whole number percentage between 50% and 100%, those joint and 
survivor annuity options are substantially similar optional forms of 
benefit. Similarly, if a participant is entitled under the plan to 
receive a particular form of benefit with an annuity starting date that 
is the first day of any month beginning three years before commencement 
of a distribution and ending on the date of commencement of the 
distribution, those forms of benefit are substantially similar optional 
forms of benefit.
    (C) Representative range of examples. A range of examples with 
respect to substantially similar optional forms of benefit as permitted 
under this paragraph (c)(5) is representative only if it includes 
examples illustrating the financial effect and relative value of the 
optional forms of benefit that reflect each varying feature at both 
extremes of its linear range, plus at least one example illustrating the 
financial effect and relative value of the optional forms of benefit 
that reflects each varying feature at an intermediate point. However, if 
one intermediate example is insufficient to illustrate the pattern of 
variation in relative value with respect to a varying feature, examples 
sufficient to illustrate such pattern must be provided. Thus, for 
example, if a plan offers joint and survivor annuity options with 
survivor payments available in every whole number percentage between 50% 
and 100%, and if all such optional forms of benefit would be permitted 
to be disclosed as approximately equal in value as described in 
paragraph (c)(5)(ii)(B) of this section, the plan could satisfy the 
requirement to disclose the financial effect and relative value of a 
representative range of examples of those optional forms of benefit by 
disclosing the financial effect and relative value with respect to the 
joint and 50% survivor annuity, the joint and 75% survivor annuity, and 
the joint and 100% survivor annuity.
    (D) Requirement to provide information with respect to other 
optional forms of benefit upon request. If a QJSA explanation discloses 
the financial effect

[[Page 1100]]

and relative value of substantially similar optional forms of benefit by 
disclosing the financial effect and relative value of a representative 
range of examples in accordance with this paragraph (c)(5)(ii), the QJSA 
explanation must explain that the plan will, upon the request of the 
participant, disclose the financial effect and relative value of any 
particular optional form of benefit from among the substantially similar 
optional forms of benefit and the plan must provide the participant with 
the financial effect and relative value of any such optional form of 
benefit if the participant so requests.
    (iii) Separate presentations permitted for elections that apply to 
parts of a benefit. If the plan permits the participant to make separate 
benefit elections with respect to two or more portions of the 
participant's benefit, the description of the financial effect and 
relative values of optional forms of benefit can be made separately for 
each such portion of the benefit, rather than for each optional form of 
benefit (i.e., each combination of possible elections).
    (d) Substitution of generally applicable information for participant 
information in the section 417(a)(3) explanation--(1) Forms of benefit 
available. In lieu of providing the information required under 
paragraphs (c)(1)(i) through (v) of this section for each optional form 
of benefit presently available to the participant as described in 
paragraph (c) of this section, the QJSA explanation may contain the 
information required under paragraphs (c)(1)(i) through (v) of this 
section for the QJSA and each other optional form of benefit generally 
available under the plan, along with a reference to where a participant 
may readily obtain the information required under paragraphs (c)(1)(i) 
through (v) of this section for any other optional forms of benefit that 
are presently available to the participant.
    (2) Financial effect and comparison of relative values--(i) General 
rule. In lieu of providing a statement of the financial effect of 
electing an optional form of benefit as required under paragraph 
(c)(1)(iii) of this section, or a comparison of relative values as 
required under paragraph (c)(1)(iv) of this section, based on the actual 
age and benefit of the participant, the QJSA explanation is permitted to 
include a chart (or other comparable device) showing the financial 
effect and relative value of optional forms of benefit in a series of 
examples specifying the amount of the optional form of benefit payable 
to a hypothetical participant at a representative range of ages and the 
comparison of relative values at those same representative ages. Each 
example in this chart must show the financial effect of electing the 
optional form of benefit pursuant to the rules of paragraph (c)(1)(iii) 
of this section, and a comparison of the relative value of the optional 
form of benefit to the value of the QJSA pursuant to the rules of 
paragraph (c)(2) of this section, using reasonable assumptions for the 
age of the hypothetical participant's spouse and any other variables 
that affect the financial effect, or relative value, of the optional 
form of benefit. The requirement to show the financial effect of 
electing an optional form can be satisfied through the use of other 
methods (e.g., expressing the amount of the optional form as a 
percentage or a factor of the amount payable under the normal form of 
benefit), provided that the method provides sufficient information so 
that a participant can determine the amount of benefits payable in the 
optional form. The chart (or other comparable device) must be 
accompanied by the disclosures described in paragraph (c)(2)(v) of this 
section explaining the concept of relative value and disclosing certain 
interest assumptions. In addition, the chart (or other comparable 
device) must be accompanied by a general statement describing the effect 
of significant variations between the assumed ages or other variables on 
the financial effect of electing the optional form of benefit and the 
comparison of the relative value of the optional form of benefit to the 
value of the QJSA.
    (ii) Actual benefit must be disclosed. The generalized notice 
described in this paragraph (d)(2) will satisfy the requirements of 
paragraph (b)(2) of this section only if the notice includes either the 
amount payable to the participant under the normal form of benefit or 
the amount payable to the participant under the normal form of benefit

[[Page 1101]]

adjusted for immediate commencement. For this purpose, the normal form 
of benefit is the form under which payments due to the participant under 
the plan are expressed under the plan, prior to adjustments for form of 
benefit. For example, assuming that a plan's benefit accrual formula is 
expressed as a straight life annuity, the generalized notice must 
provide the amount of either the straight life annuity commencing at 
normal retirement age or the straight life annuity commencing 
immediately. Reasonable estimates of the type described in paragraph 
(c)(3)(i) of this section may be used to determine the amount payable to 
the participant under the normal form of benefit for purposes of this 
paragraph (d)(2)(ii) if the requirements of paragraphs (c)(3)(ii) and 
(iii) of this section are satisfied with respect to those estimates.
    (iii) Ability to request additional information. The generalized 
notice described in this paragraph (d)(2) must be accompanied by a 
statement that includes an offer to provide, upon the participant's 
request, a statement of financial effect and a comparison of relative 
values that is specific to the participant for any presently available 
optional form of benefit, and a description of how a participant may 
obtain this additional information.
    (3) Financial effect of QPSA election. In lieu of providing a 
specific description of the financial effect of the QPSA election, the 
QPSA explanation may provide a general description of the financial 
effect of the election. Thus, for example, the description can be in the 
form of a chart showing the reduction to a hypothetical participant's 
normal retirement benefit at a representative range of participant ages 
as a result of the QPSA election (using a reasonable assumption for the 
age of the hypothetical participant's spouse relative to the age of the 
hypothetical participant). In addition, this chart must be accompanied 
by a statement that includes an offer to provide, upon the participant's 
request, an estimate of the reduction to the participant's estimated 
normal retirement benefit, and a description of how a participant may 
obtain this additional information.
    (4) Additional information required to be furnished at the 
participant's request--The generalized notice described in paragraph 
(d)(2) of this section must be accompanied by a statement that includes 
an offer to provide, upon the participant's request, information 
described in this paragraph (d)(4)(i) and (ii), and a description of how 
a participant may obtain this additional information.
    (i) Explanation of QJSA. If, as permitted under paragraphs (d)(1) 
and (2) of this section, the content of a QJSA explanation does not 
include all the items described in paragraph (c) of this section, then, 
upon a participant's request for any of the information required under 
paragraphs (c)(1)(i) through (v) of this section for one or more 
presently available optional forms (including a request for all optional 
forms presently available to the participant), the plan must furnish the 
information required under paragraphs (c)(1)(i) through (v) of this 
section with respect to those optional forms. Thus, with respect to 
those optional forms of benefit, the participant must receive a QJSA 
explanation specific to the participant that is based on the 
participant's actual age and benefit. In addition, the plan must comply 
with paragraph (c)(3)(iii) of this section. Further, if as permitted 
under paragraph (c)(2)(v)(B) of this section, the plan does not disclose 
the actuarial assumptions used to calculate the numerical comparison 
required under paragraph (c)(2) of this section, then, upon request, the 
plan must provide the actuarial assumptions used to calculate the 
relative value of optional forms of benefit under the plan.
    (ii) Explanation of QPSA. If, as permitted under paragraph (d)(3) of 
this section, the content of a QPSA explanation does not include all the 
items described in paragraph (b)(1) of this section, then, upon a 
participant's request, the plan must furnish an estimate of the 
reduction to the participant's estimated normal retirement benefit that 
would result from a QPSA election.

[[Page 1102]]

    (5) Use of participant-specific information in generalized notice. A 
QJSA explanation does not fail to satisfy the requirements of this 
paragraph (d) merely because it contains an item of participant-specific 
information in place of the corresponding generally applicable 
information.
    (e) Examples. The following examples illustrate the application of 
this section. Solely for purposes of these examples, the applicable 
interest rate that applies to any distribution that is subject to the 
rules of section 417(e)(3) is assumed to be 52\1/2\ percent, and the 
applicable mortality table under section 417(e)(3) and Sec. 1.417(e)-
1(d)(2) is assumed to be the table that applies as of January 1, 2003. 
In addition, solely for purposes of these examples, assume that a plan 
which determines actuarial equivalence using 6 percent interest and the 
applicable mortality table under section 417(e)(3) and Sec. 1.417(e)-
1(d)(2) that applies as of January 1, 1995, is using reasonable 
actuarial assumptions. The examples are as follows:

    Example 1. (i) Participant M participates in Plan A, a qualified 
defined benefit plan. Under Plan A, the QJSA is a joint and 100 percent 
survivor annuity, which is actuarially equivalent to the single life 
annuity determined using 6 percent interest and the section 417(e)(3) 
applicable mortality table that applies as of January 1, 1995. On 
October 1, 2004, M will terminate employment at age 55. When M 
terminates employment, M will be eligible to elect an unreduced early 
retirement benefit, payable as either a single life annuity or the QJSA. 
M will also be eligible to elect a single-sum distribution equal to the 
actuarial present value of the single life annuity payable at normal 
retirement age (age 65), determined using the applicable mortality table 
and the applicable interest rate under section 417(e)(3).
    (ii) Consistent with paragraph (c) of this section, Participant M is 
provided with a QJSA explanation that describes the single life annuity, 
the QJSA, and single-sum distribution options under the plan, and any 
eligibility conditions associated with these options. Participant M is 
married when the explanation is provided. The explanation indicates 
that, if Participant M commenced benefits at age 55 and had a spouse age 
55, the monthly benefit under an immediately commencing single life 
annuity is $3,000, the monthly benefit under the QJSA is estimated to be 
89.96 percent of the monthly benefit under the immediately commencing 
single life annuity or $2,699, and the single sum is estimated to be 
74.7645 times the monthly benefit under the immediately commencing 
single life annuity or $224,293.
    (iii) The QJSA explanation indicates that the single life annuity 
and the QJSA are of approximately the same value, but that the single-
sum option is equivalent in value to a monthly benefit under the QJSA of 
$1,215. (This amount is 45 percent of the value of the QJSA at age 55 
($1,215 divided by 89.96 percent of $3,000 equals 45 percent).) The 
explanation states that the relative value comparison converts the value 
of the single life annuity and the single-sum options to the value of 
each if paid in the form of the QJSA and that this conversion uses 
interest and life expectancy assumptions. The explanation specifies that 
the calculations relating to the single-sum distribution were prepared 
using 5.5 percent interest and average life expectancy, that the other 
calculations were prepared using a 6 percent interest rate and that the 
relative value of actual annuity payments for an individual can vary 
depending on how long the individual and spouse live. The explanation 
notes that the calculation of the QJSA assumed that the spouse was age 
55, that the amount of the QJSA will depend on the actual age of the 
spouse (for example, annuity payments will be significantly lower if the 
spouse is significantly younger than the participant), and that the 
amount of the single-sum payment will depend on the interest rates that 
apply when the participant actually takes a distribution. The 
explanation also includes an offer to provide a more precise calculation 
to the participant taking into account the spouse's actual age.
    (iv) In accordance with paragraph (c)(3)(ii) of this section, 
Participant M requests a more precise calculation of the financial 
effect of choosing a QJSA taking into account that Participant M's 
spouse is 50 years of age. Using the actual age of Participant M's 
spouse, Plan A determines that the monthly payments under the QJSA are 
87.62 percent of the monthly payments under the single life annuity, or 
$2,628.60 per month, and provides this information to M. Plan A is not 
required to provide an updated calculation of the relative value of the 
single sum because the value of single sum continues to be 45 percent of 
the value of the QJSA.
    Example 2. (i) The facts are the same as in Example 1, except that 
the comparison of the relative values of optional forms of benefit to 
the value of the QJSA is not expressed as a percentage of the actuarial 
present value of the QJSA, but instead is expressed by disclosing the 
actuarial present values of the optional forms and the QJSA. In 
addition, the Plan uses the applicable interest rate and the applicable 
mortality table under section 417(e)(3) for all comparison purposes.
    (ii) Accordingly, the QJSA explanation indicates that the QJSA has 
an actuarial

[[Page 1103]]

present value of $498,089, while the single-sum payment has an actuarial 
present value of $224,293 (i.e. the amount of the single sum is 
$224,293) and that the single life annuity is approximately equal in 
value to the QJSA. The explanation states that the relative value 
comparison converts the value of single life annuity and the QJSA into 
an amount payable in the form of the single-sum option (even though a 
single-sum distribution in that amount is not available under the plan) 
and that this conversion uses interest and life expectancy assumptions. 
The explanation specifies that the calculations were prepared using 5.5 
percent interest and average life expectancy, and that the relative 
value of actual annuity payments for an individual can vary depending on 
how long the individual and spouse live. The explanation notes that the 
calculation of the QJSA assumed that the spouse was age 55, that the 
amount of the QJSA will depend on the actual age of the spouse (for 
example, annuity payments will be significantly lower if the spouse is 
significantly younger than the participant), and that the amount of the 
single-sum payment will depend on the interest rates that apply when the 
participant actually takes a distribution. The explanation also includes 
an offer to provide a more precise calculation to the participant taking 
into account the spouse's actual age.
    Example 3. (i) The facts are the same as in Example 1, except that, 
in lieu of providing information specific to Participant M in the QJSA 
notice as set forth in paragraph (c) of this section, Plan A satisfies 
the QJSA explanation requirement in accordance with paragraph (d)(2) of 
this section by providing M with a statement that M's monthly benefit 
under an immediately commencing single life annuity (which is the normal 
form of benefit under Plan A, adjusted for immediate commencement) is 
$3,000, along with the following chart. The chart shows the financial 
effect of electing each optional form of benefit for a hypothetical 
participant with a $1,000 benefit and a spouse who is the same age as 
the participant. Instead of showing the relative value of these optional 
forms of benefit compared to the value of the QJSA, the chart shows the 
relative value of these optional forms of benefit compared to the value 
of the single life annuity. Separate charts are provided for ages 55, 
60, and 65 as follows:

                           Age 55 Commencement
------------------------------------------------------------------------
                                       Amount of
                                   distribution per
          Optional form                $1,000 of        Relative value
                                   immediate single
                                     life annuity
------------------------------------------------------------------------
Life Annuity....................  $1,000 per month..  n/a.
QJSA (Joint and 100 percent       $900 per month      Approximately the
 survivor annuity).                ($900 per month     same value as the
                                   for survivor        Life Annuity.
                                   annuity).
Lump sum........................  $74,764...........  Approximately 45
                                                       percent of the
                                                       value of the Life
                                                       Annuity.
------------------------------------------------------------------------


                           Age 60 Commencement
------------------------------------------------------------------------
                                       Amount of
                                   distribution per
          Optional form                $1,000 of        Relative value
                                   immediate single
                                     life annuity
------------------------------------------------------------------------
Life Annuity....................  $1,000 per month..  n/a.
QJSA (Joint and 100 percent       $878 per month      Approximately the
 survivor annuity).                ($878 per month     same value as the
                                   for survivor        Life Annuity.
                                   annuity).
Lump sum........................  $99,792...........  Approximately 66
                                                       percent of the
                                                       value of the Life
                                                       Annuity.
------------------------------------------------------------------------


                           Age 65 Commencement
------------------------------------------------------------------------
                                       Amount of
                                   distribution per
          Optional form                $1,000 of        Relative value
                                   immediate single
                                     life annuity
------------------------------------------------------------------------
Life Annuity....................  $1,000 per month..  n/a.
QJSA (Joint and 100 percent       $852 per month      Approximately the
 survivor annuity).                ($852 per month     same value as the
                                   for survivor        Life Annuity.
                                   annuity).
Lump sum........................  $135,759..........  Approximately the
                                                       same value as the
                                                       Life Annuity.
------------------------------------------------------------------------

    (ii) In accordance with paragraph (d)(4)(i) of this section, when 
Participant M requests specific information regarding the amounts 
payable under the QJSA, the joint and 100 percent survivor annuity, and 
the single-sum distribution and provides the age of M's spouse, Plan A 
determines that M's QJSA is $2,628.60 per month and the single-sum 
distribution is $224,293. The actuarial present value of the QJSA 
(determined using the 5.5

[[Page 1104]]

percent interest and the section 417(e)(3) applicable mortality table) 
is $498,896 and the actuarial present value of the single life annuity 
is $497,876. Accordingly, the specific information discloses that the 
single-sum distribution has a value that is 45 percent of the value of 
the single life annuity available to M on October 1, 2004. In accordance 
with paragraph (c)(2)(iii)(C) of this section, the QJSA notice provides 
that the QJSA is of approximately the same value as the single life 
annuity.
    Example 4. (i) The facts are the same as in Example 1, except that 
under Plan A, the single-sum distribution is determined as the actuarial 
present value of the immediately commencing single life annuity. In 
addition, Plan A provides a joint and 75 percent survivor annuity that 
is reduced from the single life annuity and that is the QJSA under Plan 
A. For purposes of determining the amount of the QJSA, if the 
participant is married the reduction is only half of the reduction that 
would normally apply under the actuarial assumptions specified in Plan A 
for determining actuarial equivalence of optional forms.
    (ii) In lieu of providing information specific to Participant M in 
the QJSA notice as set forth in paragraph (c) of this section, Plan A 
satisfies the QJSA explanation requirement in accordance with paragraph 
(d)(2) of this section by providing M with a statement that M's monthly 
benefit under an immediately commencing single life annuity (which is 
the normal form of benefit under Plan A, adjusted for immediate 
commencement) is $3,000, along with the following chart showing the 
financial effect and the relative value of the optional forms of benefit 
compared to the QJSA for a hypothetical participant with a $1,000 
benefit and a spouse who is three years younger than the participant. 
For each optional form generally available under the plan, the chart 
shows the financial effect and the relative value, using the grouping 
rules of paragraph (c)(2)(iii) of this section. Separate charts are 
provided for ages 55, 60, and 65, as follows:

                           Age 55 Commencement
------------------------------------------------------------------------
                                       Amount of
                                   distribution per
          Optional form                $1,000 of        Relative value
                                   immediate single
                                     life annuity
------------------------------------------------------------------------
Life Annuity....................  $1,000 per month..  Approximately the
                                                       same value as the
                                                       QJSA.
QJSA (joint and 75 percent        $956 per month      n/a.
 survivor annuity for a            ($717 per month
 participant who is married).      for survivor
                                   annuity).
Joint and 100 percent survivor    $886 per month      Approximately the
 annuity.                          ($886 per month     same value as the
                                   for survivor        QJSA.
                                   annuity).
Lump sum........................  $165,959..........  Approximately the
                                                       same value as the
                                                       QJSA.
------------------------------------------------------------------------


                           Age 60 Commencement
------------------------------------------------------------------------
                                       Amount of
                                   distribution per
          Optional form                $1,000 of        Relative value
                                   immediate single
                                     life annuity
------------------------------------------------------------------------
Life Annuity....................  $1,000 per month..  Approximately 94
                                                       percent of the
                                                       value of the
                                                       QJSA.
QJSA (joint and 75 percent        $945 per month      n/a.
 survivor annuity for a            ($709 per month
 participant who is married).      for survivor
                                   annuity).
Joint and 100 percent survivor    $859 per month      Approximately 94
 annuity.                          ($859 per month     percent of the
                                   for survivor        value of the
                                   annuity).           QJSA.
Lump sum........................  $151,691..........  Approximately the
                                                       same value as the
                                                       QJSA.
------------------------------------------------------------------------


                           Age 65 Commencement
------------------------------------------------------------------------
                                       Amount of
                                   distribution per
          Optional form                $1,000 of        Relative value
                                   immediate single
                                     life annuity
------------------------------------------------------------------------
Life Annuity....................  $1,000 per month..  Approximately 93
                                                       percent of the
                                                       value of the
                                                       QJSA.
QJSA (joint and 75 percent        $932 per month      n/a.
 survivor annuity for a            ($699 per month
 participant who is married).      for survivor
                                   annuity).
Joint and 100 percent survivor    $828 per month      Approximately 93
 annuity.                          ($828 per month     percent of the
                                   for survivor        value of the
                                   annuity).           QJSA.
Lump sum........................  $135,759..........  Approximately 93
                                                       percent of the
                                                       value of the
                                                       QJSA.
------------------------------------------------------------------------


[[Page 1105]]

    (iii) The chart disclosing the financial effect and relative value 
of the optional forms specifies that the calculations were prepared 
assuming that the spouse is three years younger than the participant, 
that the calculations relating to the single-sum distribution were 
prepared using 5.5 percent interest and average life expectancy, that 
the other calculations were prepared using a 6 percent interest rate, 
and that the relative value of actual payments for an individual can 
vary depending on how long the individual and spouse live. The 
explanation states that the relative value comparison converts the 
single life annuity, the joint and 100 percent survivor annuity, and the 
single-sum options to value of each if paid in the form of the QJSA and 
that this conversion uses interest and life expectancy assumptions. The 
explanation notes that the calculation of the QJSA depends on the actual 
age of the spouse (for example, annuity payments will be significantly 
lower if the spouse is significantly younger than the participant), and 
that the amount of the single-sum payment will depend on the interest 
rates that apply when the participant actually takes a distribution. The 
explanation also includes an offer to provide a calculation specific to 
the participant upon request, and an offer to provide mortality tables 
used in preparing calculations upon request.
    (iv) In accordance with paragraph (d)(4)(i) of this section, 
Participant M requests specific information regarding the amounts 
payable under the QJSA, the joint and 100 percent survivor annuity, and 
the single sum.
    (v) Based on the information about the age of Participant M's 
spouse, Plan A determines that M's QJSA is $2,856.30 per month, the 
joint and 100 percent survivor annuity is $2,628.60 per month, and the 
single sum is $497,876. The actuarial present value of the QJSA 
(determined using the 5.5 percent interest and the section 417(e)(3) 
applicable mortality table, the actuarial assumptions required under 
section 417) is $525,091. Accordingly, the value of the single-sum 
distribution available to M on October 1, 2004, is 94.8 percent of the 
actuarial present value of the QJSA. In addition, the actuarial present 
value of the life annuity and the 100 percent joint and survivor annuity 
are 95.0 percent of the actuarial present value of the QJSA.
    (vi) Plan A provides M with a QJSA explanation that incorporates 
these more precise calculations of the financial effect and relative 
value of the optional forms for which M requested information.

    (f) Effective date--(1) General effective date for QJSA 
explanations--(i) In general. Except as otherwise provided in this 
paragraph (f), this section applies to a QJSA explanation with respect 
to any distribution with an annuity starting date that is on or after 
February 1, 2006.
    (ii) Reasonable, good faith transition rule. Except with respect to 
any portion of a QJSA explanation that is subject to the earlier 
effective date rule of paragraph (f)(2) of this section, a reasonable, 
good faith effort to comply with these regulations will be deemed to 
satisfy the requirements of these regulations for QJSA explanations 
provided before January 1, 2007, with respect to distributions with 
annuity starting dates that are on or after February 1, 2006. For this 
purpose, a reasonable, good faith effort to comply with these 
regulations includes substantial compliance with Sec. 1.417(a)(3)-1 as 
it appeared in 26 CFR part 1 revised April 1, 2004.
    (2) Special effective date for certain QJSA explanations--(i) 
Application to QJSA explanations with respect to certain optional forms 
that are less valuable than the QJSA. This section also applies to a 
QJSA explanation with respect to any distribution with an annuity 
starting date that is on or after October 1, 2004, and before February 
1, 2006, if the actuarial present value of any optional form of benefit 
that is subject to the requirements of section 417(e)(3) is less than 
the actuarial present value (as determined under Sec. 1.417(e)-1(d)) of 
the QJSA. For purposes of this paragraph (f)(2)(i), the actuarial 
present value of an optional form is treated as not less than the 
actuarial present value of the QJSA if--
    (A) Using the applicable interest rate and applicable mortality 
table under Sec. 1.417(e)-1(d)(2) and (3), the actuarial present value 
of that optional form is not less than the actuarial present value of 
the QJSA for an unmarried participant; and
    (B) Using reasonable actuarial assumptions, the actuarial present 
value of the QJSA for an unmarried participant is not less than the 
actuarial present value of the QJSA for a married participant.
    (ii) Requirement to disclose differences in value for certain 
optional forms. A QJSA explanation with respect to any distribution with 
an annuity starting date that is on or after October 1, 2004,

[[Page 1106]]

and before February 1, 2006, is only required to be provided under this 
section with respect to--
    (A) An optional form of benefit that is subject to the requirements 
of section 417(e)(3) and that has an actuarial present value that is 
less than the actuarial present value of the QJSA (as described in 
paragraph (f)(2)(i) of this section); and
    (B) The QJSA (determined without application of paragraph (c)(2)(ii) 
of this section).
    (iii) Application to QJSA explanations with respect to optional 
forms that are approximately equal in value to the QJSA. Paragraph 
(c)(2)(iii)(C) of this section, relating to disclosures of optional 
forms of benefit that are permitted to be described as approximately 
equal in value to the QJSA, is not applicable to a QJSA explanation 
provided before January 1, 2007. However, Sec. 1.417(a)(3)-
1(c)(2)(iii)(C), as it appeared in 26 CFR part 1 revised April 1, 2004, 
applies to a QJSA explanation with respect to any distribution with an 
annuity starting date that is on or after October 1, 2004, and that is 
provided before January 1, 2007.
    (3) Annuity starting date. For purposes of paragraphs (f)(1) and (2) 
of this section, in the case of a retroactive annuity starting date 
under section 417(a)(7), as described in Sec. 1.417(e)-1(b)(3)(vi), the 
date of commencement of the actual payments based on the retroactive 
annuity starting date is substituted for the annuity starting date.
    (4) Effective date for QPSA explanations. This section applies to 
any QPSA explanation provided on or after July 1, 2004.

[T.D. 9099, 68 FR 70144, Dec. 17, 2003, as amended by T.D. 9256, 71 FR 
14802, Mar. 24, 2006; 71 FR 26688, May 8, 2006; T.D. 9294, 71 FR 61888, 
Oct. 20, 2006]



Sec. 1.417(e)-1  Restrictions and valuations of distributions from 
plans subject to sections 401(a)(11) and 417.

    (a) Scope--(1) In general. A plan does not satisfy the requirements 
of sections 401(a)(11) and 417 unless it satisfies the consent 
requirements, the determination of present value requirements and the 
other requirements set forth in this section. See section 401(a)(11) and 
Sec. 1.401(a)-20 for other rules regarding the survivor annuity 
requirements.
    (2) Additional requirements. See Sec. 1.411(a)-11 for other rules 
applicable to the consent requirements.
    (3) Accrued benefit. The definition of ``accrued benefit'' in Sec. 
1.411(a)-11 applies when that term is used in this section.
    (b) Consent, etc. requirements--(1) General rule. Generally plans 
may not commence the distribution of any portion of a participant's 
accrued benefit in any form unless the applicable consent requirements 
are satisfied. No consent of the participant or spouse is needed for 
distribution of a QJSA or QPSA after the benefit is no longer 
immediately distributable (after the participant attains (or would have 
attained if not dead) the later of normal retirement age (as defined in 
section 411(a)(8)) or age 62). No consent of the spouse is needed for 
distribution of a QJSA at any time. After the participant's death, a 
benefit may be paid to a nonspouse beneficiary without the beneficiary's 
consent. A distribution cannot be made at any time in a form other than 
a QJSA unless such QJSA has been waived by the participant and such 
waiver has been consented to by the spouse. A QJSA is an annuity that 
commences immediately. Thus, for example, a plan may not offer a 
participant separating from service at age 45 a choice only between a 
single sum distribution at separation of service and a joint and 
survivor annuity that satisfies all the requirements of a QJSA except 
that it commences at normal retirement age rather than immediately. To 
satisfy this section, the plan must also offer a QJSA (i.e., an annuity 
that satisfies all the requirements for a QJSA including the requirement 
that it commences immediately).
    (2) Consent. (i) Written consent of the participant and, if the 
participant is married at the annuity starting date and the benefit is 
to be paid in a form other than a QJSA, the participant's spouse (or, if 
either the participant or the spouse has died, the survivor) is required 
before the commencement of the distribution of any part of an accrued 
benefit if the present value of the

[[Page 1107]]

nonforfeitable benefit is greater than the cash-out limit in effect 
under Sec. 1.411(a)-11(c)(3)(ii). No consent is valid unless the 
participant has received a general description of the material features, 
and an explanation of the relative values of, the optional forms of 
benefit available under the plan in a manner which would satisfy the 
notice requirements of section 417(a)(3). See Sec. 1.417(a)(3)-1. No 
consent is required before the annuity starting date if the present 
value of the nonforfeitable benefit is not more than the cash-out limit 
in effect under Sec. 1.411(a)-11(c)(3)(ii). After the annuity starting 
date, consent is required for the immediate distribution of the present 
value of the accrued benefit being distributed in any form, including a 
qualified joint and survivor annuity or a qualified preretirement 
survivor annuity, regardless of the amount of such present value.
    (ii) In determining the present value of any nonforfeitable accrued 
benefit, a defined benefit plan is limited by the interest rate 
restriction as set forth in paragraph (d) of this section.
    (iii) Paragraph (b)(2)(i) of this section applies to distributions 
made on or after October 17, 2000. For distributions prior to October 
17, 2000, Sec. 1.417(e)-1(b)(2)(i) in effect prior to October 17, 2000 
(as contained in 26 CFR part 1 revised as of April 1, 2000) applies.
    (3) Time of consent. (i) Written consent of the participant and the 
participant's spouse to the distribution must be made not more than 90 
days before the annuity starting date, and, except as otherwise provided 
in paragraphs (b)(3)(iii) and (b)(3)(iv) of this section, no later than 
the annuity starting date.
    (ii) A plan must provide participants with the written explanation 
of the QJSA required by section 417(a)(3) no less than 30 days and no 
more than 90 days before the annuity starting date, except as provided 
in paragraph (b)(3)(iv) of this section regarding retroactive annuity 
starting dates. However, if the participant, after having received the 
written explanation of the QJSA, affirmatively elects a form of 
distribution and the spouse consents to that form of distribution (if 
necessary), a plan will not fail to satisfy the requirements of section 
417(a) merely because the written explanation was provided to the 
participant less than 30 days before the annuity starting date, provided 
that the following conditions are met:
    (A) The plan administrator provides information to the participant 
clearly indicating that (in accordance with the first sentence of this 
paragraph (b)(3)(ii)) the participant has a right to at least 30 days to 
consider whether to waive the QJSA and consent to a form of distribution 
other than a QJSA.
    (B) The participant is permitted to revoke an affirmative 
distribution election at least until the annuity starting date, or, if 
later, at any time prior to the expiration of the 7-day period that 
begins the day after the explanation of the QJSA is provided to the 
participant.
    (C) The annuity starting date is after the date that the explanation 
of the QJSA is provided to the participant.
    (D) Distribution in accordance with the affirmative election does 
not commence before the expiration of the 7-day period that begins the 
day after the explanation of the QJSA is provided to the participant.
    (iii) The plan may permit the annuity starting date to be before the 
date that any affirmative distribution election is made by the 
participant (and before the date that distribution is permitted to 
commence under paragraph (b)(3)(ii)(D) of this section), provided that, 
except as otherwise provided in paragraph (b)(3)(vii) of this section 
regarding administrative delay, distributions commence not more than 90 
days after the explanation of the QJSA is provided.
    (iv) Retroactive annuity starting dates. (A) Notwithstanding the 
requirements of paragraphs (b)(3)(i) and (ii) of this section, pursuant 
to section 417(a)(7), a defined benefit plan is permitted to provide 
benefits based on a retroactive annuity starting date if the 
requirements described in paragraph (b)(3)(v) of this section are 
satisfied. A defined benefit plan is not required to provide for 
retroactive annuity starting dates. If a plan does provide for a 
retroactive annuity starting date, it may impose

[[Page 1108]]

conditions on the availability of a retroactive annuity starting date in 
addition to those imposed by paragraph (b)(3)(v) of this section, 
provided that imposition of those additional conditions does not violate 
any of the rules applicable to qualified plans. For example, a plan that 
includes a single sum payment as a benefit option may limit the election 
of a retroactive annuity starting date to those participants who do not 
elect the single sum payment. A defined contribution plan is not 
permitted to have a retroactive annuity starting date.
    (B) For purposes of this section, a ``retroactive annuity starting 
date'' is an annuity starting date affirmatively elected by a 
participant that occurs on or before the date the written explanation 
required by section 417(a)(3) is provided to the participant. In order 
for a plan to treat a participant as having elected a retroactive 
annuity starting date, future periodic payments with respect to a 
participant who elects a retroactive annuity starting date must be the 
same as the future periodic payments, if any, that would have been paid 
with respect to the participant had payments actually commenced on the 
retroactive annuity starting date. The participant must receive a make-
up payment to reflect any missed payment or payments for the period from 
the retroactive annuity starting date to the date of the actual make-up 
payment (with an appropriate adjustment for interest from the date the 
missed payment or payments would have been made to the date of the 
actual make-up payment). Thus, the benefit determined as of the 
retroactive annuity starting date must satisfy the requirements of 
sections 417(e)(3), if applicable, and section 415 with the applicable 
interest rate and applicable mortality table determined as of that date. 
Similarly, a participant is not permitted to elect a retroactive annuity 
starting date that precedes the date upon which the participant could 
have otherwise started receiving benefits (e.g., in the case of an 
ongoing plan, the earlier of the participant's termination of employment 
or the participant's normal retirement age) under the terms of the plan 
in effect as of the retroactive annuity starting date. A plan does not 
fail to treat a participant as having elected a retroactive annuity 
starting date as described in this paragraph (b)(3)(iv)(B) merely 
because the distributions are adjusted to the extent necessary to 
satisfy the requirements of paragraph (b)(3)(v)(B) and (C) of this 
section relating to sections 415 and 417(e)(3).
    (C) If the participant's spouse as of the retroactive annuity 
starting date would not be the participant's spouse determined as if the 
date distributions commence was the participant's annuity starting date, 
consent of that former spouse is not needed to waive the QJSA with 
respect to the retroactive annuity starting date, unless otherwise 
provided under a qualified domestic relations order (as defined in 
section 414(p)).
    (D) A distribution payable pursuant to a retroactive annuity 
starting date election is treated as excepted from the present value 
requirements of paragraph (d) of this section under paragraph (d)(6) of 
this section if the distribution form would have been described in 
paragraph (d)(6) of this section had the distribution actually commenced 
on the retroactive annuity starting date. Similarly, annuity payments 
that otherwise satisfy the requirements of a QJSA under section 417(b) 
will not fail to be treated as a QJSA for purposes of section 
415(b)(2)(B) merely because a retroactive annuity starting date is 
elected and a make-up payment is made. Also, for purposes of section 
72(t)(2)(A)(iv), a distribution that would otherwise be one of a series 
of substantially equal periodic payments will be treated as one of a 
series of substantially equal periodic payments notwithstanding the 
distribution of a make-up payment provided for in paragraph 
(b)(3)(iv)(B) of this section.
    (E) The following example illustrates the application of paragraph 
(b)(3)(iv)(D) of this section:

    Example. Under the terms of a defined benefit plan, participant A is 
entitled to a QJSA with a monthly payment of $1,500 beginning as of his 
annuity starting date. Due to administrative error, the QJSA explanation 
is provided to A after the annuity starting date. After receiving the 
QJSA explanation A elects a retroactive annuity starting date.

[[Page 1109]]

Pursuant to this election, A begins to receive a monthly payment of 
$1,500 and also receives a make-up payment of $10,000. Under these 
circumstances the monthly payments may be treated as a QJSA for purposes 
of section 415(b)(2)(B). In addition, the monthly payments of $1,500 and 
the make-up payment of $10,000 may be treated as part of as series of 
substantially equal periodic payments for purpose of section 
72(t)(2)(A)(iv).

    (v) Requirements applicable to retroactive annuity starting dates. A 
distribution is permitted to have a retroactive annuity starting date 
with respect to a participant's benefit only if the following 
requirements are met:
    (A) The participant's spouse (including an alternate payee who is 
treated as the spouse under a qualified domestic relations order (QDRO), 
as defined in section 414(p)), determined as if the date distributions 
commence were the participant's annuity starting date, consents to the 
distribution in a manner that would satisfy the requirements of section 
417(a)(2). The spousal consent requirement of this paragraph 
(b)(3)(v)(A) is satisfied if such spouse consents to the distribution 
under paragraph (b)(2)(i) of this section. The spousal consent 
requirement of this paragraph (b)(3)(v)(A) does not apply if the amount 
of such spouse's survivor annuity payments under the retroactive annuity 
starting date election is no less than the amount that the survivor 
payments to such spouse would have been under an optional form of 
benefit that would satisfy the requirements to be a QJSA under section 
417(b) and that has an annuity starting date after the date that the 
explanation was provided.
    (B) The distribution (including appropriate interest adjustments) 
provided based on the retroactive annuity starting date would satisfy 
the requirements of section 415 if the date the distribution commences 
is substituted for the annuity starting date for all purposes, including 
for purposes of determining the applicable interest rate and the 
applicable mortality table. However, in the case of a form of benefit 
that would have been excepted from the present value requirements of 
paragraph (d) of this section under paragraph (d)(6) of this section if 
the distribution had actually commenced on the retroactive annuity 
starting date, the requirement to apply section 415 as of the date 
distribution commences set forth in this paragraph (b)(3)(v)(B) does not 
apply if the date distribution commences is twelve months or less from 
the retroactive annuity starting date.
    (C) In the case of a form of benefit that would have been subject to 
section 417(e)(3) and paragraph (d) of this section if distributions had 
commenced as of the retroactive annuity starting date, the distribution 
is no less than the benefit produced by applying the applicable interest 
rate and the applicable mortality table determined as of the date the 
distribution commences to the annuity form that corresponds to the 
annuity form that was used to determine the benefit amount as of the 
retroactive annuity starting date. Thus, for example, if a distribution 
paid pursuant to an election of a retroactive annuity starting date is a 
single-sum distribution that is based on the present value of the 
straight life annuity payable at normal retirement age, then the amount 
of the distribution must be no less than the present value of the 
annuity payable at normal retirement age, determined as of the 
distribution date using the applicable mortality table and applicable 
interest rate that apply as of the distribution date. Likewise, if a 
distribution paid pursuant to an election of a retroactive annuity 
starting date is a single-sum distribution that is based on the present 
value of the early retirement annuity payable as of the retroactive 
annuity starting date, then the amount of the distribution must be no 
less than the present value of the early retirement annuity payable as 
of the distribution date, determined as of the distribution date using 
the applicable mortality table and applicable interest rate that apply 
as of the distribution date.
    (vi) Timing of notice and consent requirements in the case of 
retroactive annuity starting dates. In the case of a retroactive annuity 
starting date, the date of the first actual payment of benefits based on 
the retroactive annuity starting date is substituted for the annuity 
starting date for purposes of satisfying the timing requirements for

[[Page 1110]]

giving consent and providing an explanation of the QJSA provided in 
paragraphs (b)(3)(i) and (ii) of this section, except that the 
substitution does not apply for purposes of paragraph (b)(3)(iii) of 
this section. Thus, the written explanation required by section 
417(a)(3)(A) must generally be provided no less than 30 days and no more 
than 90 days before the date of the first payment of benefits and the 
election to receive the distribution must be made after the written 
explanation is provided and on or before the date of the first payment. 
Similarly, the written explanation may also be provided less than 30 
days prior to the first payment of benefits if the requirements of 
paragraph (b)(3)(ii) of this section would be satisfied if the date of 
the first payment is substituted for the annuity starting date.
    (vii) Administrative delay. A plan will not fail to satisfy the 90-
day timing requirements of paragraphs (b)(3)(iii) and (vi) of this 
section merely because, due solely to administrative delay, a 
distribution commences more than 90 days after the written explanation 
of the QJSA is provided to the participant.
    (viii) The following example illustrates the provisions of this 
paragraph (b)(3):

    Example. Employee E, a married participant in a defined benefit plan 
who has terminated employment, is provided with the explanation of the 
QJSA on November 28.
    Employee E elects (with spousal consent) on December 2 to waive the 
QJSA and receive an immediate distribution in the form of a single life 
annuity. The plan may permit Employee E to receive payments with an 
annuity starting date of December 1, provided that the first payment is 
made no earlier than December 6 and the participant does not revoke the 
election before that date. The plan can make the remaining monthly 
payments on the first day of each month thereafter in accordance with 
its regular payment schedule.

    (ix) The additional rules of this paragraph (b)(3) concerning the 
notice and consent requirements of section 417 apply to distributions on 
or after September 22, 1995. For distributions before September 22, 
1995, the additional rules concerning the notice and consent 
requirements of section 417 in Sec. 1.417(e)-1(b)(3) in effect prior to 
September 22, 1995 (see Sec. 1.417(e)-1 (b)(3) in 26 CFR Part 1 revised 
as of April 1, 1995) apply.
    (4) Delegation to Commissioner. The Commissioner, in revenue 
rulings, notices, and other guidance published in the Internal Revenue 
Bulletin, may modify, or provide additional guidance with respect to, 
the notice and consent requirements of this section. See Sec. 
601.601(d)(2)(ii)(b) of this chapter.
    (c) Permitted distributions. A plan may not require that a 
participant or surviving spouse begin to receive benefits without 
satisfying paragraph (b) of this section while such benefits are 
immediately distributable, (see paragraph (b)(1) of this section). Once 
benefits are no longer immediately distributable, all benefits that the 
plan requires to begin must be provided in the form of a QJSA and QPSA 
unless the applicable written explanation, election and consent 
requirements of section 417 are satisfied.
    (d) Present value requirement--(1) General rule. A defined benefit 
plan must provide that the present value of any accrued benefit and the 
amount (subject to sections 411(c)(3) and 415) of any distribution, 
including a single sum, must not be less than the amount calculated 
using the applicable interest rate described in paragraph (d)(3) of this 
section (determined for the month described in paragraph (d)(4) of this 
section) and the applicable mortality table described in paragraph 
(d)(2) of this section. The present value of any optional form of 
benefit cannot be less than the present value of the normal retirement 
benefit determined in accordance with the preceding sentence. The same 
rules used for the plan under this paragraph (d) must also be used to 
compute the present value of the benefit for purposes of determining 
whether consent for a distribution is required under paragraph (b) of 
this section.
    (2) Applicable mortality table. The applicable mortality table is 
the mortality table based on the prevailing commissioners' standard 
table (described in section 807(d)(5)(A)) used to determine reserves for 
group annuity contracts issued on the date as of which present value is 
being determined (without regard to any other subparagraph of section 
807(d)(5)), that

[[Page 1111]]

is prescribed by the Commissioner in revenue rulings, notices, or other 
guidance published in the Internal Revenue Bulletin (see Sec. 
601.601(d)(2)(ii)(b) of this chapter). The Commissioner may prescribe 
rules that apply in the case of a change to the prevailing 
commissioners' standard table (described in section 807(d)(5)(A)) used 
to determine reserves for group annuity contracts, in revenue rulings, 
notices, or other guidance published in the Internal Revenue Bulletin 
(see Sec. 601.601(d)(2)(ii)(b) of this chapter).
    (3) Applicable interest rate--(i) General rule. The applicable 
interest rate for a month is the annual interest rate on 30-year 
Treasury securities as specified by the Commissioner for that month in 
revenue rulings, notices or other guidance published in the Internal 
Revenue Bulletin (see Sec. 601.601(d)(2)(ii)(b) of this chapter).
    (ii) Example. This example illustrates the rules of this paragraph 
(d)(3):

    Example. Plan A is a calendar year plan. For its 1995 plan year, 
Plan A provides that the applicable mortality table is the table 
described in Rev. Rul. 95-6 (1995-1 C.B. 80), and that the applicable 
interest rate is the annual interest rate on 30-year Treasury securities 
as specified by the Commissioner for the first full calendar month 
preceding the calendar month that contains the annuity starting date. 
Participant P is age 65 in January 1995, which is the month that 
contains P's annuity starting date. P has an accrued benefit payable 
monthly of $1,000 and has elected to receive a distribution in the form 
of a single sum in January 1995. The annual interest rate on 30-year 
Treasury securities as published by the Commissioner for December 1994 
is 7.87 percent. To satisfy the requirements of section 417(e)(3) and 
this paragraph (d), the single sum received by P may not be less than 
$111,351.

    (4) Time for determining interest rate--(i) General rule. Except as 
provided in paragraph (d)(4)(iv) or (v) of this section, the applicable 
interest rate to be used for a distribution is the rate determined under 
paragraph (d)(3) of this section for the applicable lookback month. The 
applicable lookback month for a distribution is the lookback month (as 
described in paragraph (d)(4)(iii) of this section) for the month (or 
other longer stability period described in paragraph (d)(4)(ii) of this 
section) that contains the annuity starting date for the distribution. 
The time and method for determining the applicable interest rate for 
each participant's distribution must be determined in a consistent 
manner that is applied uniformly to all participants in the plan.
    (ii) Stability period. A plan must specify the period for which the 
applicable interest rate remains constant. This stability period may be 
one calendar month, one plan quarter, one calendar quarter, one plan 
year, or one calendar year.
    (iii) Lookback month. A plan must specify the lookback month that is 
used to determine the applicable interest rate. The lookback month may 
be the first, second, third, fourth, or fifth full calendar month 
preceding the first day of the stability period.
    (iv) Permitted average interest rate. A plan may apply the rules of 
paragraph (d)(4)(i) of this section by substituting a permitted average 
interest rate with respect to the plan's stability period for the rate 
determined under paragraph (d)(3) of this section for the applicable 
lookback month for the stability period. For this purpose, a permitted 
average interest rate with respect to a stability period is an interest 
rate that is computed by averaging the applicable interest rates 
determined under paragraph (d)(3) of this section for two or more 
consecutive months from among the first, second, third, fourth, and 
fifth calendar months preceding the first day of the stability period. 
For this paragraph (d)(4)(iv) to apply, a plan must specify the manner 
in which the permitted average interest rate is computed.
    (v) Additional determination dates. The Commissioner may prescribe, 
in revenue rulings, notices or other guidance published in the Internal 
Revenue Bulletin (see Sec. 601.601(d)(2)(ii)(b)), other times that a 
plan may provide for determining the applicable interest rate.
    (vi) Example. This example illustrates the rules of this paragraph 
(d)(4):

    Example. Employer X maintains Plan A, a calendar year plan. Employer 
X wishes to amend Plan A so that the applicable interest rate will 
remain fixed for each plan quarter, and so that the applicable interest 
rate for distributions made during each plan quarter can be determined 
approximately 80 days before the beginning of the plan quarter. To 
comply with the provisions of this paragraph

[[Page 1112]]

(d)(4), Plan A is amended to provide that the applicable interest rate 
is the annual interest rate on 30-year Treasury securities as specified 
by the Commissioner for the fourth calendar month preceding the first 
day of the plan quarter during which the annuity starting date occurs.

    (5) Use of alternative interest rate and mortality table. If a plan 
provides for use of an interest rate or mortality table other than the 
applicable interest rate or the applicable mortality table, the plan 
must provide that a participant's benefit must be at least as great as 
the benefit produced by using the applicable interest rate and the 
applicable mortality table. For example, if a plan provides for use of 
an interest rate of 7% and the UP-1984 Mortality Table (see Sec. 
1.401(a)(4)-12, Standard mortality table) in calculating single-sum 
distributions, the plan must provide that any single-sum distribution is 
calculated as the greater of the single-sum benefit calculated using 7% 
and the UP-1984 Mortality Table and the single-sum benefit calculated 
using the applicable interest rate and the applicable mortality table.
    (6) Exceptions. This paragraph (d) (other than the provisions 
relating to section 411(d)(6) requirements in paragraph (d)(10) of this 
section) does not apply to the amount of a distribution paid in the form 
of an annual benefit that--
    (i) Does not decrease during the life of the participant, or, in the 
case of a QPSA, the life of the participant's spouse; or
    (ii) Decreases during the life of the participant merely because 
of--
    (A) The death of the survivor annuitant (but only if the reduction 
is to a level not below 50% of the annual benefit payable before the 
death of the survivor annuitant); or
    (B) The cessation or reduction of Social Security supplements or 
qualified disability benefits (as defined in section 411(a)(9)).
    (7) Defined contribution plans. Because the accrued benefit under a 
defined contribution plan equals the account balance, a defined 
contribution plan is not subject to the requirements of this paragraph 
(d), even though it is subject to section 401(a)(11).
    (8) Effective date--(i) In general. This paragraph (d) is effective 
for distributions with annuity starting dates in plan years beginning 
after December 31, 1994.
    (ii) Optional delayed effective date of Retirement Protection Act of 
1994 (RPA '94)(108 Stat. 5012) rules for plans adopted and in effect 
before December 8, 1994. For a plan adopted and in effect before 
December 8, 1994, the application of the rules relating to the 
applicable mortality table and applicable interest rate under paragraphs 
(d)(2) through (4) of this section is delayed to the extent provided in 
this paragraph (d)(8)(ii), if the plan provisions in effect on December 
7, 1994, met the requirements of section 417(e)(3) and Sec. 1.417(e)-
1(d) as in effect on December 7, 1994 (as contained in 26 CFR part 1 
revised April 1, 1995). In the case of a distribution from such a plan 
with an annuity starting date that precedes the optional delayed 
effective date described in paragraph (d)(8)(iv) of this section, and 
that precedes the first day of the first plan year beginning after 
December 31, 1999, the rules of paragraph (d)(9) of this section (which 
generally apply to distributions with annuity starting dates in plan 
years beginning before January 1, 1995) apply in lieu of the rules of 
paragraphs (d)(2) through (4) of this section. The interest rate under 
the rules of paragraph (d)(9) of this section is determined under the 
provisions of the plan as in effect on December 7, 1994, reflecting the 
interest rate or rates published by the Pension Benefit Guaranty 
Corporation (PBGC) and the provisions of the plan for determining the 
date on which the interest rate is fixed. The above described interest 
rate or rates published by the PBGC are those determined by the PBGC 
(for the date determined under those plan provisions) pursuant to the 
methodology under the regulations of the PBGC for determining the 
present value of a lump sum distribution on plan termination under 29 
CFR part 2619 that were in effect on September 1, 1993 (as contained in 
29 CFR part 2619 revised July 1, 1994).
    (iii) Optional accelerated effective date of RPA '94 rules. This 
paragraph (d) is also effective for a distribution with an annuity 
starting date after December 7, 1994, during a plan year beginning 
before January 1, 1995, if the employer

[[Page 1113]]

elects, on or before the annuity starting date, to make the rules of 
this paragraph (d) effective with respect to the plan as of the optional 
accelerated effective date described in paragraph (d)(8)(iv) of this 
section. An employer is treated as making this election by making the 
plan amendments described in paragraph (d)(8)(iv) of this section.
    (iv) Determination of delayed or accelerated effective date by plan 
amendment adopting RPA '94 rules. The optional delayed effective date of 
paragraph (d)(8)(ii) of this section, or the optional accelerated 
effective date of paragraph (d)(8)(iii) of this section, whichever is 
applicable, is the date plan amendments applying both the applicable 
mortality table of paragraph (d)(2) of this section and the applicable 
interest rate of paragraph (d)(3) of this section are adopted or, if 
later, are made effective.
    (9) Plan years beginning before January 1, 1995--(i) Interest rate. 
(A) For distributions made in plan years beginning after December 31, 
1986, and before January 1, 1995, the following interest rate described 
in paragraph (d)(9)(i)(A)(1) or (2) of this section, whichever applies, 
is substituted for the applicable interest rate for purposes of this 
section--
    (1) The rate or rates that would be used by the PBGC for a trusteed 
single-employer plan to value the participant's (or beneficiary's) 
vested benefit (PBGC interest rate) if the present value of such benefit 
does not exceed $25,000; or
    (2) 120 percent of the PBGC interest rate, as determined in 
accordance with paragraph (d)(9)(i)(A)(1) of this section, if such 
present value exceeds $25,000. In no event shall the present value 
determined by use of 120 percent of the PBGC interest rate result in a 
present value less than $25,000.
    (B) The PBGC interest rate may be a series of interest rates for any 
given date. For example, the PBGC interest rate for immediate annuities 
for November 1994 is 6%, and the PBGC interest rates for the deferral 
period for that month are as follows: 5.25% for the first 7 years of the 
deferral period, 4% for the following 8 years of the deferral period, 
and 4% for the remainder of the deferral period. For November 1994, 120 
percent of the PBGC interest rate is 7.2% (1.2 times 6%) for an 
immediate annuity, 6.3% (1.2 times 5.25%) for the first 7 years of the 
deferral period, 4.8% (1.2 times 4%) for the following 8 years of the 
deferral period, and 4.8% (1.2 times 4%) for the remainder of the 
deferral period. The PBGC interest rates are the interest rates that 
would be used (as of the date of the distribution) by the PBGC for 
purposes of determining the present value of that benefit upon 
termination of an insufficient trusteed single employer plan. Except as 
otherwise provided by the Commissioner, the PBGC interest rates are 
determined by PBGC regulations. See subpart B of 29 CFR part 4044 for 
the applicable PBGC rates.
    (ii) Time for determining interest rate. (A) Except as provided in 
paragraph (d)(9)(ii)(B) of this section, the PBGC interest rate or rates 
are determined on either the annuity starting date or the first day of 
the plan year that contains the annuity starting date. The plan must 
provide which date is applicable.
    (B) The plan may provide for the use of any other time for 
determining the PBGC interest rate or rates provided that such time is 
not more than 120 days before the annuity starting date if such time is 
determined in a consistent manner and is applied uniformly to all 
participants.
    (C) The Commissioner may, in revenue rulings, notices or other 
guidance published in the Internal Revenue Bulletin (see Sec. 
601.601(d)(2)(ii)(b), prescribe other times for determining the PBGC 
interest rate or rates.
    (iii) No applicable mortality table. In the case of a distribution 
to which this paragraph (d)(9) applies, the rules of this paragraph (d) 
are applied without regard to the applicable mortality table described 
in paragraph (d)(2) of this section.
    (10) Relationship with section 411(d)(6)--(i) In general. A plan 
amendment that changes the interest rate, the time for determining the 
interest rate, or the mortality assumptions used for the purposes 
described in paragraph (d)(1) of this section is subject to section 
411(d)(6). But see Sec. 1.411(d)-4,

[[Page 1114]]

Q&A-2(b)(2)(v) (regarding plan amendments relating to involuntary 
distributions). In addition, a plan amendment that changes the interest 
rate or the mortality assumptions used for the purposes described in 
paragraph (d)(1) of this section merely to eliminate use of the interest 
rate described in paragraph (d)(3) or paragraph (d)(9) of this section, 
or the applicable mortality table, with respect to a distribution form 
described in paragraph (d)(6) of this section, for distributions with 
annuity starting dates occurring after a specified date that is after 
the amendment is adopted, does not violate the requirements of section 
411(d)(6) if the amendment is adopted on or before the last day of the 
last plan year ending before January 1, 2000.
    (ii) Section 411(d)(6) relief for change in time for determining 
interest rate. Notwithstanding the general rule of paragraph (d)(10)(i) 
of this section, if a plan amendment changes the time for determining 
the applicable interest rate (including an indirect change as a result 
of a change in plan year), the amendment will not be treated as reducing 
accrued benefits in violation of section 411(d)(6) merely on account of 
this change if the conditions of this paragraph (d)(10)(ii) are 
satisfied. If the plan amendment is effective on or after the adoption 
date, any distribution for which the annuity starting date occurs in the 
one-year period commencing at the time the amendment is effective must 
be determined using the interest rate provided under the plan determined 
at either the date for determining the interest rate before the 
amendment or the date for determining the interest rate after the 
amendment, whichever results in the larger distribution. If the plan 
amendment is adopted retroactively (that is, the amendment is effective 
prior to the adoption date), the plan must use the interest rate 
determination date resulting in the larger distribution for the period 
beginning with the effective date and ending one year after the adoption 
date.
    (iii) Section 411(d)(6) relief for plan amendments pursuant to 
changes to section 417 made by RPA '94 providing for statutory interest 
rate determination date. Notwithstanding the general rule of paragraph 
(d)(10)(i) of this section, except as provided in paragraph 
(d)(10)(vi)(B) of this section, a participant's accrued benefit is not 
considered to be reduced in violation of section 411(d)(6) merely 
because of a plan amendment that changes any interest rate or mortality 
assumption used to calculate the present value of a participant's 
benefit under the plan, if the following conditions are satisfied--
    (A) The amendment replaces the PBGC interest rate (or an interest 
rate or rates based on the PBGC interest rate) as the interest rate used 
under the plan in determining the present value of a participant's 
benefit under this paragraph (d); and
    (B) After the amendment is effective, the present value of a 
participant's benefit under the plan cannot be less than the amount 
calculated using the applicable mortality table and the applicable 
interest rate for the first full calendar month preceding the calendar 
month that contains the annuity starting date.
    (iv) Section 411(d)(6) relief for plan amendments pursuant to 
changes to section 417 made by RPA '94 providing for prior determination 
date or up to two months earlier. Notwithstanding the general rule of 
paragraph (d)(10)(i) of this section, except as provided in paragraph 
(d)(10)(vi)(B) of this section, a participant's accrued benefit is not 
considered to be reduced in violation of section 411(d)(6) merely 
because of a plan amendment that changes any interest rate or mortality 
assumption used to calculate the present value of a participant's 
benefit under the plan, if the following conditions are satisfied--
    (A) The amendment replaces the PBGC interest rate (or an interest 
rate or rates based on the PBGC interest rate) as the interest rate used 
under the plan in determining the present value of a participant's 
benefit under this paragraph (d); and
    (B) After the amendment is effective, the present value of a 
participant's benefit under the plan cannot be less than the amount 
calculated using the applicable mortality table and the applicable 
interest rate, but only if the applicable interest rate is the annual

[[Page 1115]]

interest rate on 30-year Treasury securities for the calendar month that 
contains the date as of which the PBGC interest rate (or an interest 
rate or rates based on the PBGC interest rate) was determined 
immediately before the amendment, or for one of the two calendar months 
immediately preceding such month.
    (v) Section 411(d)(6) relief for plan amendments pursuant to changes 
to section 417 made by RPA '94 providing for other interest rate 
determination date. Notwithstanding the general rule of paragraph 
(d)(10)(i) of this section, except as provided in paragraph 
(d)(10)(vi)(B) of this section, a participant's accrued benefit is not 
considered to be reduced in violation of section 411(d)(6) merely 
because of a plan amendment that changes any interest rate or mortality 
assumption used to calculate the present value of a participant's 
benefit under the plan, if the following conditions are satisfied--
    (A) The amendment replaces the PBGC interest rate (or an interest 
rate or rates based on the PBGC interest rate) as the interest rate used 
under the plan in determining the present value of a participant's 
benefit under this paragraph (d);
    (B) After the amendment is effective, the present value of a 
participant's benefit under the plan cannot be less than the amount 
calculated using the applicable mortality table and the applicable 
interest rate; and
    (C) The plan amendment satisfies either the condition of paragraph 
(d)(10)(ii) of this section (determined using the interest rate provided 
under the terms of the plan after the effective date of the amendment) 
or the special early transition interest rate rule of paragraph 
(d)(10)(vi)(C) of this section.
    (vi) Special rules--(A) Provision of temporary additional benefits. 
A plan amendment described in paragraph (d)(10)(iii), (iv), or (v) of 
this section is not considered to reduce a participant's accrued benefit 
in violation of section 411(d)(6) even if the plan amendment provides 
for temporary additional benefits to accommodate a more gradual 
transition from the plan's old interest rate to the new rules.
    (B) Replacement of non-PBGC interest rate. The section 411(d)(6) 
relief provided in paragraphs (d)(10)(iii) through (v) of this section 
does not apply to a plan amendment that replaces an interest rate other 
than the PBGC interest rate (or an interest rate or rates based on the 
PBGC interest rate) as an interest rate used under the plan in 
determining the present value of a participant's benefit under this 
paragraph (d). Thus, the accrued benefit determined using that interest 
rate and the associated mortality table is protected under section 
411(d)(6). For purposes of this paragraph (d), an interest rate is based 
on the PBGC interest rate if the interest rate is defined as a specified 
percentage of the PBGC interest rate, the PBGC interest rate minus a 
specified number of basis points, or an average of such interest rates 
over a specified period.
    (C) Special early transition interest rate rule for paragraph 
(d)(10)(v). A plan amendment satisfies the special rule of this 
paragraph (d)(10)(vi)(C) if any distribution for which the annuity 
starting date occurs in the one-year period commencing at the time the 
plan amendment is effective is determined using whichever of the 
following two interest rates results in the larger distribution--
    (1) The interest rate as provided under the terms of the plan after 
the effective date of the amendment, but determined at a date that is 
either one month or two months (as specified in the plan) before the 
date for determining the interest rate used under the terms of the plan 
before the amendment; or
    (2) The interest rate as provided under the terms of the plan after 
the effective date of the amendment, determined at the date for 
determining the interest rate after the amendment.
    (vii) Examples. The provisions of this paragraph (d)(10) are 
illustrated by the following examples:

    Example 1. On December 31, 1994, Plan A provided that all single-sum 
distributions were to be calculated using the UP-1984 Mortality Table 
and 100% of the PBGC interest rate for the date of distribution. On 
January 4, 1995, and effective on February 1, 1995, Plan A was amended 
to provide that all single-sum distributions are calculated using

[[Page 1116]]

the applicable mortality table and the annual interest rate on 30-year 
Treasury securities for the first full calendar month preceding the 
calendar month that contains the annuity starting date. Pursuant to 
paragraph (d)(10)(iii) of this section, this amendment of Plan A is not 
considered to reduce the accrued benefit of any participant in violation 
of section 411(d)(6).
    Example 2. On December 31, 1994, Plan B provided that all single-sum 
distributions were to be calculated using the UP-1984 Mortality Table 
and an interest rate equal to the lesser of 100% of the PBGC interest 
rate for the date of distribution, or 6%. On January 4, 1995, and 
effective on February 1, 1995, Plan B was amended to provide that all 
single-sum distributions are calculated using the applicable mortality 
table and the annual interest rate on 30-year Treasury securities for 
the second full calendar month preceding the calendar month that 
contains the annuity starting date. Pursuant to paragraph (d)(10)(iv) of 
this section, this amendment of Plan B is not considered to reduce the 
accrued benefit of any participant in violation of section 411(d)(6) 
merely because of the replacement of the PBGC interest rate. However, 
under paragraph (d)(10)(vi)(B) of this section, the section 411(d)(6) 
relief provided in paragraphs (d)(10)(iii) through (v) of this section 
does not apply to a plan amendment that replaces an interest rate other 
than the PBGC interest rate (or a rate based on the PBGC interest rate). 
Therefore, pursuant to paragraph (d)(10)(vi)(B) of this section, to 
satisfy the requirements of section 411(d)(6), the plan must provide 
that the single-sum distribution payable to any participant must be no 
less than the single-sum distribution calculated using the UP-1984 
Mortality Table and an interest rate of 6%, based on the participant's 
benefits under the plan accrued through January 31, 1995, and based on 
the participant's age at the annuity starting date.
    Example 3. On December 31, 1994, Plan C, a calendar year plan, 
provided that all single sum distributions were to be calculated using 
the UP-1984 Mortality Table and an interest rate equal to the PBGC 
interest rate for January 1 of the plan year. On March 1, 1995, and 
effective on July 1, 1995, Plan C was amended to provide that all 
single-sum distributions are calculated using the applicable mortality 
table and the annual interest rate on 30-year Treasury securities for 
August of the year before the plan year that contains the annuity 
starting date. The plan amendment provides that each distribution with 
an annuity starting date after June 30, 1995, and before July 1, 1996, 
is calculated using the 30-year Treasury rate for August of the year 
before the plan year that contains the annuity starting date, or the 30-
year Treasury rate for January of the plan year that contains the 
annuity starting date, whichever produces the larger benefit. Pursuant 
to paragraph (d)(10)(v) of this section, the amendment of Plan C is not 
considered to have reduced the accrued benefit of any participant in 
violation of section 411(d)(6).
    Example 4. (a) Employer X maintains Plan D, a calendar year plan. As 
of December 7, 1994, Plan D provided for single-sum distributions to be 
calculated using the PBGC interest rate as of the annuity starting date 
for distributions not greater than $25,000, and 120% of that interest 
rate (but not an interest rate producing a present value less than 
$25,000) for distributions over $25,000. Employer X wishes to delay the 
effective date of the RPA '94 rules for a year, and to provide for an 
extended transition from the use of the PBGC interest rate to the new 
applicable interest rate under section 417(e)(3). On December 1, 1995, 
and effective on January 1, 1996, Employer X amends Plan D to provide 
that single-sum distributions are determined as the sum of--
    (i) The single-sum distribution calculated based on the applicable 
mortality table and the annual interest rate on 30-year Treasury 
securities for the first full calendar month preceding the calendar 
month that contains the annuity starting date; and
    (ii) A transition amount.
    (b) The amendment provides that the transition amount for 
distributions in the years 1996-99 is a transition percentage of the 
excess, if any, of the amount that the single-sum distribution would 
have been under the plan provisions in effect prior to this amendment 
over the amount of the single sum described in paragraph (a)(i) of this 
Example 4. The transition percentages are 80% for 1996, decreasing to 
60% for 1997, 40% for 1998 and 20% for 1999. The amendment also provides 
that the transition amount is zero for plan years beginning on or after 
the year 2000. Pursuant to paragraphs (d)(10)(iii) and (vi)(A) of this 
section, the amendment of Plan D is not considered to have reduced the 
accrued benefit of any participant in violation of section 411(d)(6).
    Example 5. On December 31, 1994, Plan E, a calendar year plan, 
provided that all single-sum distributions were to be calculated using 
the UP-1984 Mortality Table and an interest rate equal to the PBGC 
interest rate for January 1 of the plan year. On March 1, 1995, and 
effective on July 1, 1995, Plan E was amended to provide that all 
single-sum distributions are calculated using the applicable mortality 
table and the annual interest rate on 30-year Treasury securities for 
August of the year before the plan year that contains the annuity 
starting date. The plan amendment provides that each distribution with 
an annuity starting date after June 30, 1995, and before July 1, 1996, 
is calculated using the 30-year Treasury rate for August of the year 
before the plan year that contains the annuity starting date, or the 30-
year

[[Page 1117]]

Treasury rate for November of the plan year preceding the plan year that 
contains the annuity starting date, whichever produces the larger 
benefit. Pursuant to paragraphs (d)(10)(v) and (vi)(C) of this section, 
the amendment of Plan E is not considered to have reduced the accrued 
benefit of any participant in violation of section 411(d)(6).

    (e) Special rules for annuity contracts--(1) General rule. Any 
annuity contract purchased by a plan subject to section 401(a)(11) and 
distributed to or owned by a participant must provide that benefits 
under the contract are provided in accordance with the applicable 
consent, present value, and other requirements of sections 401(a)(11) 
and 417 applicable to the plan.
    (2) [Reserved]
    (f) Effective dates--(1) Annuity contracts. (i) Paragraph (e) of 
this section does not apply to contracts distributed to or owned by a 
participant prior to September 17, 1985, unless additional contributions 
are made under the plan by the employer with respect to such contracts.
    (ii) In the case of a contract owned by the employer or distributed 
to or owned by a participant prior to the first plan year beginning 
after December 31, 1988, paragraph (e) of this section shall be 
satisfied if the annuity contracts described therein satisfy the 
requirements in Sec. Sec. 1.401(a)-11T and 1.417(e)-1T. The preceding 
sentence shall not apply if additional contributions are made under the 
plan by the employer with respect to such contracts on or after the 
beginning of the first plan year beginning after December 31, 1988.
    (2) Interest rates. (i) A plan that uses the PBGC immediate interest 
rate as required by Sec. 1.417(e)-1T(e) for distributions commencing in 
plan years beginning before January 1, 1987, shall be deemed to satisfy 
paragraph (d) of this section for such years.
    (ii) For a special exception to the requirements of section 
411(d)(6) for certain plan amendments that incorporate applicable 
interest rates, see section 1139(d)(2) of the Tax Reform Act of 1986.
    (3) Other effective dates and transitional rules. (i) Except as 
otherwise provided, a plan will be treated as satisfying sections 
401(a)(11) and 417 for plan years beginning before the first plan year 
that the requirements of section 410(b) as amended by TRA 86 apply to 
such plan, if the plan satisfied the requirements in Sec. Sec. 
1.401(a)-11T and 1.417(e)-1T.
    (ii) See Sec. 1.401(a)-20 for other effective dates and 
transitional rules that apply to plans subject to sections 401(a)(11) 
and 417.

[T.D. 8219, 53 FR 31854, Aug. 22, 1988; 53 FR 48534, Dec. 1, 1988, as 
amended by T.D. 8591, 60 FR 17219, Apr. 5, 1995; T.D. 8620, 60 FR 49221, 
Sept. 22, 1995; T.D. 8768, 63 FR 16898, Apr. 7, 1998; T.D. 8796, 63 FR 
70011, Dec. 18, 1998; T.D. 8794, 63 FR 70338, Dec. 21, 1998; T.D. 8891, 
65 FR 44681, 44682, July 19, 2000; T.D. 9076, 68 FR 41909, July 16, 
2003; T.D. 9099, 68 FR 70149, Dec. 17, 2003]



Sec. 1.417(e)-1T  Restrictions and valuations of distributions from 
plans subject to sections 401(a)(11) and 417. (Temporary)

    (a) [Reserved]
    (b) Consent, etc. requirements--(1) General rule. [Reserved]
    (2) Consent. [Reserved]
    (c) [Reserved]
    (d) For rules regarding the present value of a participant's accrued 
benefit and related matters, see Sec. 1.417(e)-1(d).

[T.D. 8591, 60 FR 17219, Apr. 5, 1995, as amended by T.D. 8620, 60 FR 
49221, Sept. 22, 1995; T.D. 8768, 63 FR 16902, Apr. 7, 1998; T.D. 8796, 
63 FR 70012, Dec. 18, 1998]



Sec. 1.419-1T  Treatment of welfare benefit funds. (Temporary)

    Q-1: What does section 419 of the Internal Revenue Code provide?
    A-1: Section 419 prescribes limitations upon deductions for 
contributions paid or accrued with respect to a welfare benefit fund. 
Under section 419 (a) and (b), an employer's contributions to a welfare 
benefit fund are not deductible under section 162 (relating to trade or 
business expenses) or section 212 (relating to expenses for production 
of income) but, if the requirements of section 162 or 212 are otherwise 
met, are deductible under section 419 for the taxable year of the 
employer in which paid to the extent of the welfare benefit fund's 
qualified cost (within the meaning of section 419(c)(1)) for the taxable 
year of the fund that relates to such taxable year of the employer. 
Under section 419(g), section 419 and this section shall also apply to 
the deduction by a taxpayer of contributions

[[Page 1118]]

with respect to a fund that would be a welfare benefit fund but for the 
fact that there is no employer-employee relationship between the person 
providing the services and the person for whom the services are 
provided. Contributions paid to a welfare benefit fund after section 419 
becomes effective with respect to such contributions are deemed to 
relate, first, to amounts accrued and deducted (but not paid) by the 
employer with respect to such fund before section 419 becomes effective 
with respect to such contributions and thus shall not be treated as 
satisfying the payment requirement of section 419. See paragraph (b) of 
Q&A-5 for special deduction limits applicable to employer contributions 
to welfare benefit funds with excess reserves.
    Q-2: When do the deduction rules of section 419, as enacted by the 
Tax Reform Act of 1984, become effective?
    A-2: (a) Section 419 generally applies to contributions paid or 
accrued with respect to a welfare benefit fund after December 31, 1985, 
in taxable years of employers ending after that date. See Q&A-9 of this 
regulation for special rules relating to the deduction limit for the 
first taxable year of a fiscal year employer ending after December 31, 
1985.
    (b) In the case of a welfare benefit fund which is part of a plan 
maintained pursuant to one or more collective bargaining agreements (1) 
between employee representatives and one or more employers, and (2) that 
are in effect on July 1, 1985 (or ratified on or before such date), 
sections 419 shall not apply to contributions paid or accrued in taxable 
years beginning before the termination of the last of the collective 
bargaining agreements pursuant to which the plan is maintained 
(determined without regard to any extension thereof agreed to after July 
1, 1985). For purposes of the preceding sentence, any plan amendment 
made pursuant to a collective bargaining agreement relating to the plan 
which amends the plan solely to conform to any requirement added under 
section 511 of the Tax Reform Act of 1984 (i.e., requirements under 
sections 419, 419A, 512(a)(3)(E), and 4976) shall not be treated as a 
termination of such collective bargaining agreement. See Sec. 1.419A-2T 
for special rules relating to the application of section 419 to 
collectively bargained welfare benefit funds.
    (c) Notwithstanding paragraphs (a) and (b), section 419 applies to 
any contribution of a facility to a welfare benefit fund (or other 
contribution, such as cash, which is used to acquire, construct, or 
improve such a facility) after June 22, 1984, unless such facility is 
placed in service by the fund before January 1, 1987, and either (1) is 
acquired or improved by the fund (or contributed to the fund) pursuant 
to a binding contract in effect on June 22, 1984, and at all times 
thereafter, or (2) the construction of which was begun by or for the 
welfare benefit fund before June 22, 1984. See Q&A-11 of this regulation 
for special rules relating to the application of section 419 to the 
contribution of a facility to a welfare benefit fund (and to the 
contribution of other amounts, such as cash, used to acquire, construct, 
or improve such a facility) before section 419 generally becomes 
effective with respect to contributions to the fund.
    Q-3. What is a ``welfare benefit fund'' under section 419?
    A-3. (a) A ``welfare benefit fund'' is any fund which is part of a 
plan, or method or arrangement, of an employer and through which the 
employer provides welfare benefits to employees or their beneficiaries. 
For purposes of this section, the term ``welfare benefit'' includes any 
benefit other than a benefit with respect to which the employer's 
deduction is governed by section 83(h), section 404 (determined without 
regard to section 404(b)(2)), section 404A, or section 463.
    (b) Under section 419(e)(3) (A) and (B), the term ``fund'' includes 
any organization described in section 501(c) (7), (9), (17) or (20), and 
any trust, corporation, or other organization not exempt from tax 
imposed by chapter 1, subtitle A, of the Internal Revenue Code. Thus, a 
taxable trust or taxable corporation that is maintained for the purpose 
of providing welfare benefits to an employer's employees is a ``welfare 
benefit fund.''
    (c) Section 419(e)(3)(C) also provides that the term ``fund'' 
includes, to the

[[Page 1119]]

extent provided in regulations, any account held for an employer by any 
person. Pending the issuance of further guidance, only the following 
accounts, and arrangements that effectively constitute accounts, as 
described below, are ``funds'' within section 419(e)(3)(C).
    A retired lives reserve or a premium stabilization reserve 
maintained by an insurance company is a ``fund,'' or part of a ``fund,'' 
if it is maintained for a particular employer and the employer has the 
right to have any amount in the reserve applied against its future 
years' benefit costs or insurance premiums. Also, if an employer makes a 
payment to an insurance company under an ``administrative services 
only'' arrangement with respect to which the life insurance company 
maintains a separate account to provide benefits, then the arrangement 
would be considered to be a ``fund.'' Finally, an insurance or premium 
arrangement between an employer and an insurance company is a ``fund'' 
if, under the arrangement, the employer has a right to a refund, credit, 
or additional benefits (including upon termination of the arrangement) 
based on the benefit or claims experience, administrative cost 
experience, or investment experience attributable to such employer. 
However, an arrangement with an insurance company is not a ``fund'' 
under the previous sentence merely because the employer's premium for a 
renewal year reflects the employer's own experience for an earlier year 
if the arrangement is both cancellable by the insurance company and 
cancellable by the employer as of the end of any policy year and, upon 
cancellation by either of the parties, neither of the parties can 
receive a refund or additional amounts or benefits and neither of the 
parties can incur a residual liability beyond the end of the policy year 
(other than, in the case of the insurer, to provide benefits with 
respect to claims incurred before cancellation). The determination 
whether either of the parties can receive a refund or additional amounts 
or benefits or can incur a residual liability upon cancellation of an 
arrangement will be made by examining both the contractual rights and 
obligations of the parties under the arrangement and the actual practice 
of the insurance company (and other insurance companies) with respect to 
other employers upon cancellation of similar arrangements. Similarly, a 
disability income policy does not constitute a ``fund'' under the 
preceding provisions merely because, under the policy, an employer pays 
an annual premium so that employees who became disabled in such year may 
receive benefit payments for the duration of the disability.
    Q-4: For purposes of determining the section 419 limit on the 
employer's deduction for contributions to the fund for a taxable year of 
the employer, which taxable year of the welfare benefit fund is related 
to the taxable year of the employer?
    A-4: The amount of an employer's deduction for contributions to a 
welfare benefit fund for a taxable year of the employer is limited to 
the ``qualified cost'' of the welfare benefit fund for the taxable year 
of the fund that is related to such taxable year of the employer. The 
taxable year of the welfare benefit fund that ends with or within the 
taxable year of the employer is the taxable year of the fund that is 
related to the taxable year of the employer. Thus, for example, if an 
employer has a calendar taxable year and it makes contributions to a 
fund having a taxable year ending June 30, the ``qualified cost'' of the 
fund for the taxable year of the fund ending on June 30, 1986, applies 
to limit the employer's deduction for contributions to the fund in the 
employer's 1986 taxable year. In the case of employer contributions paid 
directly to an account or arrangement with an insurance company that is 
treated as a welfare benefit fund for the purposes of section 419, the 
policy year will be treated as the taxable year of the fund. See Q&A-7 
of this regulation for special section 419 rules relating to the 
coordination of taxable years for the taxable year of the employer in 
which a welfare benefit fund is established and for the next following 
taxable year of the employer.
    Q-5: What is the ``qualified cost'' of a welfare benefit fund for a 
taxable year under section 419?
    A-5: (a) Under section 419(c), the ``qualified cost'' of a welfare 
benefit fund for a taxable year of the fund is

[[Page 1120]]

the sum of: (1) The ``qualified direct cost'' of such fund for such 
taxable year of the fund, and (2) the amount that may be added to the 
qualified asset account for such taxable year of the fund to the extent 
that such addition does not result in a total amount of such account as 
of the end of such taxable year of the fund that exceeds the applicable 
account limit under section 419A(c). However, in calculating the 
qualified cost of a welfare benefit fund for a taxable year of the fund, 
this sum is reduced by the fund's ``after-tax income'' (as defined in 
section 419(c)(4)) for such taxable year of the fund. Also, the 
qualified cost of a welfare benefit fund is reduced further under the 
provisions of paragraph (b) of this Q&A.
    (b)(1) Pursuant to section 419A(i), notwithstanding section 419 and 
Sec. 1.419-1T, contributions to a welfare benefit fund during any 
taxable year of the employer beginning after December 31, 1985, shall 
not be deductible for such taxable year to the extent that such 
contributions result in the total amount in the fund as of the end of 
the last taxable year of the fund ending with or within such taxable 
year of the employer exceeding the account limit applicable to such 
taxable year of the fund (as adjusted under section 419A(f)(7)). Solely 
for purposes of this subparagraph, (i) contributions paid to a welfare 
benefit fund during the taxable year of the employer but after the end 
of the last taxable year of the fund that relates to such taxable year 
of the employer, and (ii) contributions accrued with respect to a 
welfare benefit fund during the taxable year of the employer or during 
any prior taxable year of the employer (but not actually paid to such 
fund on or before the end of a taxable year of the employer) and 
deducted by the employer for such or any prior taxable year of the 
employer, shall be treated as an amount in the fund as of the end of the 
last taxable year of the fund that relates to the taxable year of the 
employer. Contributions that are not deductible under this subparagraph 
are in excess of the qualified cost of the welfare benefit fund for the 
taxable year of the fund that relates to the taxable year of the 
employer and thus are treated as contributed to the fund on the first 
day of the employer's next taxable year.
    (2) Paragraph (b)(1) of this section shall not apply to 
contributions with respect to a collectively bargained welfare benefit 
fund within the meaning of Sec. 1.419A-2T. In addition, paragraph 
(b)(1) of this section shall not apply to any taxable year of an 
employer beginning after the end of the earlier of the following taxable 
years: (i) the first taxable year of the employer beginning after 
December 31, 1985, for which the employer's deduction limit under 
section 419 (after the application of paragraph (b)(1) of this section) 
is at least equal to the qualified direct cost of the fund for the 
taxable year (or years) of the fund that relates to such first taxable 
year of the employer, or (ii) the first taxable year of the employer 
beginning after December 31, 1985, with or within which ends the first 
taxable year of the fund with respect to which the total amount in the 
fund as of the end of such taxable year of the fund does not exceed the 
account limit for such taxable year of the fund (as adjusted under 
section 419A(f)(7)).
    (3) For example, assume an employer with a taxable year ending June 
30 and a welfare benefit fund with a taxable year ending January 31. 
During its taxable year ending June 30, 1987, and on or before January 
31, 1987, the employer contributes $250,000 to the fund, and during the 
remaining portion of its taxable year ending June 30, 1987, the employer 
contributes $200,000. The qualified direct cost of the fund for its 
taxable year ending January 31, 1987, is $500,000, the account limit 
applicable to such taxable year (after the adjustment under section 
419A(f)(7)) is $750,000, and the total amount in the fund as of January 
31, 1987, is $800,000. Before the application of this paragraph, the 
employer may deduct the entire $450,000 contribution for its taxable 
year ending June 30, 1987. However, under this paragraph, the excess of 
(i) the sum of the total amount in the fund as of January 31, 1987 
($800,000), and employer contributions to the fund after January 31, 
1987, and on or before June 30, 1987 ($200,000), over (ii) the account 
limit applicable to the fund for its taxable year ending January 31, 
1987 ($750,000), is $250,000.

[[Page 1121]]

Thus, under this paragraph, only $200,000 of the $450,000 contribution 
the employer made during its taxable year ending June 30, 1987, is 
deductible for such taxable year. If the excess were $450,000 or 
greater, no portion of the $450,000 contribution would be deductible by 
the employer for its taxable year ending June 30, 1987. Such 
nondeductible contributions are in excess of the fund's qualified cost 
for the taxable year related to the employer's taxable year and thus are 
deemed to be contributed on the first day of the employer's next taxable 
year.
    (c) See Q&A-7 of this regulation for special rules relating to the 
calculation of the qualified cost of a welfare benefit fund for an 
Initial Fund Year and an Overlap Fund Year (as defined in Q&A-7). See 
Q&A-11 of this regulation for special rules relating to the application 
of section 419 to the contribution to a welfare benefit fund of a 
facility (and to the contribution of other amounts, such as cash, used 
to acquire, construct, or improve a facility) before section 419 
generally becomes effective with respect to contributions to the fund. 
See Sec. 1.419A-2T for special rules relating to certain collectively 
bargained welfare benefit funds.
    Q-6: What is the ``qualified direct cost'' of a welfare benefit fund 
under section 419(c)(3)?
    A-6: (a) Under section 419(c)(3), the ``qualified direct cost'' of a 
welfare benefit fund for any taxable year of the fund is the aggregate 
amount which would have been allowable as a deduction to the employer 
for benefits provided by such fund during such year (including insurance 
coverage for such year) if (1) such benefits were provided directly by 
the employer and (2) the employer used the cash receipts and 
disbursements method of accounting and had the same taxable year as the 
fund. In this regard, a benefit is treated as provided when such benefit 
would be includible in the gross income of the employee if provided 
directly by the employer (or would be so includible but for a provision 
of chapter 1, subtitle A, of the Internal Revenue Code excluding it from 
gross income). Thus, for example, if a calendar year welfare benefit 
fund pays an insurance company in July 1986 the full premium for 
coverage of its current employees under a term health insurance policy 
for the twelve month period ending June 30, 1987, the insurance coverage 
will be treated as provided by the fund over such twelve month period. 
Accordingly, only the portion of the premium for coverage during 1986 
will be treated as a ``qualified direct cost'' of the fund for 1986; the 
remaining portion of the premium will be treated as a ``qualified direct 
cost'' of the fund for 1987. The ``qualified direct cost'' for a taxable 
year of the fund includes the administrative expenses incurred by the 
welfare benefit fund in delivering the benefits for such year.
    (b) If, in a taxable year of a welfare benefit fund, the fund holds 
an asset with a useful life extending substantially beyond the end of 
the taxable year (e.g., buildings, vehicles, tangible assets, and 
licenses) and, for such taxable year of the fund, the asset is used in 
the provision of welfare benefits to employees, the ``qualified direct 
cost'' of the fund for such taxable year of the fund includes the amount 
that would have been allowable to the employer as a deduction under the 
applicable Code provisions (e.g., sections 168 and 179) with respect to 
the portion of the asset used in the provision of welfare benefits for 
such year if the employer had acquired and placed in service the asset 
at the same time the fund received and placed in service the asset, and 
the employer had the same taxable year as the fund. This rule applies 
regardless of whether the fund received the asset through a contribution 
of the asset by the employer or through an acquisition or the 
construction by the fund of the asset. For example, assume that in 1986 
a calendar year employer contributes recovery property under section 
168(c) to a welfare benefit fund with a calendar taxable year to be used 
in the provision of welfare benefits. The employer will be treated as 
having sold the property in such year and thus will recognize gain to 
the extent that the fair market value of the property exceeds the 
employer's adjusted basis in the property. In this regard, see section 
1239(d). Also, the employer will be treated as having made a 
contribution to the fund in such year equal to the

[[Page 1122]]

fair market value of the property. Finally, the qualified direct cost of 
the welfare benefit fund for 1986 will include the amount that the 
employer could have deducted in 1986 with respect to the portion of the 
property used in the provision of welfare benefits if the employer had 
acquired the property in 1986 and had placed the property in service 
when the fund actually placed the property in service. Similarly, for 
example, assume that in 1986 a welfare bendfit fund purchases and places 
in service a facility to be used in the provision of welfare benefits. 
The qualified direct cost of the fund for 1986 will include the amount 
that the employer could have deducted with respect to such facility if 
the employer had purchased and placed in service the facility at the 
same time that the fund purchased and placed in service the facility.
    (c) The qualified direct cost of a welfare benefit fund does not 
include expenditures by the fund that would not have been deductible if 
they had been made directly by the employer. For example, a fund's 
purchase of land in a year for an employee recreational facility will 
not be treated as a qualified direct cost because, if made directly by 
the employer, the purchase would not have been deductible under section 
263. See also sections 264 and 274.
    (d) Notwithstanding the preceding paragraphs, the qualified direct 
cost of a welfare benefit fund with respect to that portion of a child 
care facility used in the provision of welfare benefits for a year will 
include the amount that would have been allowable to the employer as a 
deduction for the year under a straight-line depreciation schedule for a 
period of 60 months beginning with the month in which the facility is 
placed in service under rules similar to those provided for section 188 
property under Sec. 1.188-1(a). For purposes of this section, a ``child 
care facility'' is tangible property of a character subject to 
depreciation that is located in the United States and specifically used 
as an integral part of a ``qualified child care center facility'' within 
the meaning of Sec. 1.188-1(d)(4).
    (e) See Q&A-7 of this regulation for special section 419 rules 
relating to the calculation of the qualified direct cost of a welfare 
benefit fund for an Initial Fund Year and an Overlap Fund Year (as 
defined in Q&A-7). See Q&A-11 of this regulation for special rules 
relating to the contribution to a welfare benefit fund of a facility 
(and to the contribution of other amounts, such as cash, used to 
acquire, construct, or improve a facility) before section 419 generally 
becomes effective with respect to contributions to the fund.
    Q-7: What special rules apply for purposes of determining the 
section 419 limit on the employer's deduction for contributions to a 
welfare benefit fund for the taxable year of the employer in which the 
fund is established and for the next following taxable year of the 
employer?
    A-7: (a) If the taxable year of a welfare benefit fund is the same 
as the taxable year of the employer, there are no special rules that 
apply for purposes of determining the section 419 limit on an employer's 
deduction for contributions to the fund for either the taxable year of 
the employer in which the fund is established or the next following 
taxable year of the employer. However, if the taxable year of a welfare 
benefit fund is different from the taxable year of the employer, the 
general section 419 rules are modified by the special rules set forth 
below for purposes of determining the section 419 deduction limit for 
the taxable year of the employer in which a fund is established and for 
the next following taxable year of the employer.
    (b) If a welfare benefit fund is established after December 31, 
1985, during a taxable year of an employer and either (i) the first 
taxable year of the fund ends after the close of such taxable year of 
the employer, or (ii) the first taxable year of the fund is six months 
or less and ends before the close of such taxable year of the employer 
and the second taxable year of the fund begins before and ends after the 
close of such taxable year of the employer, the taxable year of the fund 
that contains the closing day of such taxable year of the employer will 
be treated as an ``Overlap Fund Year.'' For purposes of determining the 
limit on the employer's deduction for contributions to a welfare benefit 
fund for the taxable year of the

[[Page 1123]]

employer in which the fund was established, the period between the 
beginning of the fund's Overlap Fund Year and the end of the employer's 
taxable year in which the Overlap Fund Year began will be treated as a 
taxable year of the fund (``Initial Fund Year'').
    (c) The qualified cost of a welfare benefit fund for its Initial 
Fund Year will be equal to the qualified direct cost of the fund for 
such Initial Fund Year. The qualified cost of a fund for its Overlap 
Fund Year will be determined under the general rules of Q&A-5 of this 
regulation and section 419(c), with the exception that such qualfied 
cost will be reduced by the employer contributions made during the 
Initial Fund Year and deductible by the employer for the taxable year of 
the employer in which the Overlap Fund Year of the fund begins.
    (d) Assume that an employer with a calendar taxable year establishes 
on July 1, 1986, a welfare benefit fund with a taxable year ending on 
June 30. The fund's first taxable year from July 1, 1986, to June 30, 
1987, is an Overlap Fund Year. The employer contributes $1,000 to the 
fund during its taxable year ending December 31, 1986 (i.e., during the 
period between July 1, 1986, and December 31, 1986, which is also the 
Initial Fund Year) and another $1,500 to the fund during its taxable 
year ending December 31, 1987. Assume further that the qualified direct 
cost of the fund for the Initial Fund Year is $900 and that the 
qualified cost for the Overlap Fund Year is $2,500 (prior to the 
reduction required by paragraph (c) of this Q&A). Under the special 
rules of paragraphs (b) and (c), the employer may deduct $900 for its 
taxable year ending on December 31, 1986, and $1,600 for its taxable 
year ending on December 31, 1987. If the qualified direct cost of the 
fund for the Initial Fund Year had been $1,050 and the qualified cost 
for the Overlap Fund Year had been $2,500 (prior to the reduction 
required by paragraph (c) of this Q&A), the employer's deduction for its 
taxable year ending December 31, 1986, would have been $1,000 and its 
deduction for its taxable year ending December 31, 1987, would have been 
$1,500.
    (e) Assume that an employer with a calendar taxable year establishes 
on March 1, 1986, a welfare benefit fund with a taxable year ending June 
30. Thus, the fund has a short first taxable year ending June 30, 1986, 
an Overlap Fund Year from July 1, 1986, until June 30, 1987, and an 
ongoing June 30 taxable year. The employer contributes $1,750 to the 
fund during the employer's taxable year ending December 31, 1986--$750 
during the short first taxable year of the fund and $1,000 during the 
Initial Fund Year (i.e., the period between July 1, 1986, and December 
31, 1986)--and $1,500 to the fund during its taxable year ending 
December 31, 1987. Assume that the qualified cost of the fund for the 
short first taxable year of the fund is $800, the qualified direct cost 
for the Initial Fund Year is $900, and the qualified cost for the 
Overlap Fund Year is $2,500 (prior to the reduction required by 
paragraph (c) of this Q&A). Under the special rules of paragraphs (b) 
and (c), the employer may deduct $1,700 for its taxable year ending 
December 31, 1986, and $1,550 for its taxable year ending December 31, 
1987.
    Q-8: How does section 419 treat an employer's contribution with 
respect to a welfare benefit fund in excess of the applicable deduction 
limit for a taxable year of the employer?
    A-8: (a) If an employer makes contributions to a welfare benefit 
fund in a taxable year of the employer and such contributions (when 
combined with prior contributions that are deemed under the rule of this 
Q&A and section 419(d) to have been made in such taxable year) exceed 
the section 419 deduction limit for such taxable year of the employer, 
the excess amounts are deemed to be contributed to the fund on the first 
day of the next taxable year of the employer. Such deemed contributions 
are combined with amounts actually contributed by the employer to the 
fund during the next taxable year and may be deductible for such year, 
subject to the otherwise applicable section 419 deduction limit for such 
year.
    (b) Contributions to a welfare benefit fund on or before December 
31, 1985, that were not deductible by the employer for any taxable year 
of the employer ending on or before December 31, 1985, or for the first 
taxable year of the employer ending after December 31,

[[Page 1124]]

1985, as pre-1986 contributions (see Q&A-9 of this regulation) are 
deemed to be contributed to the fund on January 1, 1986, However, see 
Q&A-11 of this regulation for special rules relating to the contribution 
to a welfare benefit fund of amounts (such as cash) used to acquire, 
construct, or improve a facility before section 419 generally becomes 
effective with respect to contributions to the fund. Generally, such 
contributions (to the extent that they were made after June 22, 1984 and 
on or before December 31, 1985) are treated as nondeductible pre-1986 
contributions and are deemed to be contributed in the form of a facility 
at the same time as when the facility is placed in service by the fund.
    Q-9: How does an employer with a fiscal taxable year calculate its 
deduction limit for contributions with respect to a welfare benefit fund 
for the first taxable year of the employer ending after December 31, 
1985?
    A-9: (a) If the first taxable year of an employer ending after 
December 31, 1985 (or, if applicable under paragraph (b) of Q&A-2 of 
this section, the first taxable year of an employer beginning after 
termination of the last of the collective bargaining agreements pursuant 
to which the fund is maintained) is a fiscal year, the employer's 
deduction for such taxable year for contributions to a welfare benefit 
fund that is not a collectively bargained welfare benefit fund under 
Sec. 1.419A-2T is limited to the greater of the following two amounts: 
(1) The contributions paid to the fund during such first taxable year up 
to the qualified cost of the welfare benefit fund for the taxable year 
of the fund that relates to such taxable year of the employer, and (2) 
the contributions paid to the fund during the 1985 portion of such first 
taxable year of the employer (``the pre-1986 contributions'') to the 
extent that such pre-1986 contributions are deductible under the rules 
governing the deduction of such contributions before section 419 
generally becomes effective (including the rules set forth in Q&A-10 of 
this regulation, modified for purposes of this Q&A-9 by substituting 
``December 31, 1986'' for ``December 31, 1985'' in paragraph (c)). See 
Q&A-11 of this regulation for special rules relating to the contribution 
to a welfare benefit fund of a facility (and to the contribution of 
other amounts, such as cash, used to acquire, construct, or improve such 
a facility) before section 419 generally becomes effective with respect 
to contributions to such fund.
    (b) For example, assume that an employer with a taxable year ending 
June 30, contributes to a welfare benefit fund with a taxable year 
ending January 31. This employer contributes $1,000 to the fund between 
July 1, 1985, and December 31, 1985, and an additional $500 to the fund 
between January 1, 1986, and June 30, 1986. Assume further that the 
qualified direct cost of the fund for the taxable year of the fund 
ending January 31, 1986, is $500 and that the qualified cost for such 
taxable year is $800. Under the deduction rule set forth above, the 
employer's deduction for its taxable year ending June 30, 1986, is the 
greater of two amounts: (1) The contributions made during such full 
taxable year ($1,500) up to the qualifed cost of the fund with respect 
to such taxable year ($800), and (2) the pre-1986 contributions ($1,000) 
to the extent that such pre-1986 contributions are deductible under the 
pre-section 419 rules. In determining the extent to which the pre-1986 
contributions are deductible under the pre-section 419 rules, the rules 
contained in Q&A-10 apply as though December 31, 1985, in paragraph (c) 
were December 31, 1986. Assuming that only $875 is deductible under the 
pre-section 419 rules, because $875 is greater than $800, this employer 
may deduct $875 for its first taxable year ending after December 31, 
1985. This full $875 deduction for 1985 is deemed to consist entirely of 
pre-1986 contributions.
    Q-10: How do the rules of sections 263, 446(b), 461(a), and 461(h) 
apply in determining whether contributions with respect to a welfare 
benefit fund are deductible for a taxable year?
    A-10: (a) Both before and after the effective date of section 419 
(see Q&A-2 of this regulation), an employer is allowed a deduction for 
taxable year for contributions paid or accrued with respect to a 
``welfare benefit fund'' (as defined in Q&A-3 of this regulation and 
section 419(e)) only to the extent that

[[Page 1125]]

such contributions satisfy the requirements of section 162 or 212. These 
requirements must be satisfied after the effective date of section 419 
because 419 requires that (among other requirements) contributions to a 
welfare benefit fund satisfy the requirements of section 162 or 212.
    (b) Except as provided in paragraphs (c) and (d), in determinig the 
extent to which contributions paid or accrued with respect to welfare 
benefit fund satisfy the requirements of section 162 or 212 for a 
taxable year (both before and after section 419 generally becomes 
effective with respect to such contributions), the rules of sections 
263, 446(b), 461(a) (including the rules that relate to the creation of 
an asset with a useful life extending substantially beyond the close of 
the taxable year), and 461(h) (to the extent that such section is 
effective with respect to such contributions) are are generally 
applicable.
    (c) Notwithstanding paragraph (b), under the authority of section 
7805(b), the rules of sections 263, 446(b), and 461(a) shall not be 
applied in determining the extent to which an employer's contribution 
with respect to a welfare benefit fund is deductible under section 162 
or 212 with respect to any taxable year of the employer ending on or 
before December 31, 1985, to the extent that, for such taxable year, (1) 
the contribution was made pursuant to a bona fide collective bargaining 
agreement requiring fixed and determinable contributions to a 
collectively bargained welfare benefit fund (as defined in Sec. 1.419A-
2T), or (2) the contribution was not in excess of the amount deductible 
under the principles of Revenue Rulings 69-382, 1969-2 C.B. 28; 69-478, 
1969-2 C.B. 29; and 73-599, 1973-2 C.B. 40, modified as appropriate for 
benefits for active employees.
    (d) Notwithstanding paragraph (b), in determining the extent to 
which contributions paid or accrued with respect to a welfare benefit 
fund are deductible under section 419, the rules of sections 263, 
446(b), and 461(a) will be treated as having been satisfied to the 
extent that such contributions satisfy the otherwise applicable rules of 
section 419. Thus, for example, contributions to a welfare benefit fund 
will not fail to be deductible under section 419 merely because they 
create an asset with a useful life extending substantially beyoud the 
close of the taxable year if such contributions satisfy the otherwise 
applicable requirements of section 419.
    (e) In determining the extent to which contributions with respect to 
a welfare benefit fund satisfy the requirements of section 461(h) for 
any taxable year for which section 461(h) is effective, pursuant to the 
authority under section 461(h)(2), economic performance occurs as 
contributions to the welfare benefit fund are made. Solely for purposes 
of section 461(h), in the case of an employer's taxable year ending on 
or after July 18, 1984, and on or before March 21, 1986, contributions 
made to the welfare benefit fund after the end of such taxable year and 
on or before March 21, 1986 shall be deemed to have been made on the 
last day of such taxable year.
    Q-11: What special section 419 rules apply to the payment or accrual 
with respect to a welfare benefit fund of a facility (and the payment or 
accrual of other amounts, such as cash, used to acquire, construct, or 
improve such a facility)?
    A-11: (a)(1) In the case of an employer's payment or accrual with 
respect to a welfare benefit fund after June 22, 1984, and on or before 
December 31, 1985 (or, if applicable under paragraph (b) of Q&A-2 of 
this regulation, before section 419 generally becomes effective with 
respect to contributions to such fund), of a facility, the rules of 
section 419, Sec. 1.419-1T, and Sec. 1.419A-2T generally apply to 
determine the extent to which such contribution is deductible by the 
employer for its taxable year of contribution. For this purpose, 
however, the facility is to be treated as the only contribution made to 
the fund and the qualified cost of the fund for the taxable year of the 
fund in which the facility was contributed is to be equal to the 
qualified direct cost directly attributable to the facility (as 
determined under Q&A-6 of this regulation). Also, for this purpose, the 
welfare benefit fund to which the facility was contributed may not be 
aggregated with any other fund. For purposes of this Q&A, ``facility'' 
means any tangible

[[Page 1126]]

asset with a useful life extending substantially beyond the end of the 
taxable year (e.g., vehicles, buildings) and any intangible asset (e.g., 
licenses) related to a tangible asset, whether or not such asset is used 
in the provision of welfare benefits. See, however, paragraph (c) of 
Q&A-2 of this regulation for a binding contract exception.
    (2) For example, assume that an employer and a welfare benefit fund 
each has a calendar taxable year and that, during 1985, the employer 
contributes to the fund $200,000 in cash and a facility with a fair 
market value of $100,000. Such facility is used in the provision of 
welfare benefits under the fund. The employer is treated as having sold 
the facility in such year and thus will recognize gain to the extent 
that the fair market value of the facility exceeds the employer's 
adjusted basis in the facility. In this regard, see section 1239(d). The 
extent to which the facility contribution is deductible by the employer 
for its 1985 taxable year is determined as though it were the only 
contribution made by the employer to the fund during such year and the 
qualified cost of the fund for the taxable year of the fund in which the 
contribution was made (i.e., the 1985 taxable year) were equal to the 
amount that would have been allowable to the employer as a deduction for 
such year under the applicable Code provisions with respect to the 
portion of the facility used in the provision of welfare benefits for 
such year if the employer had placed in service the facility at the time 
the fund placed in service the facility and if the employer had the same 
taxable year as the fund. If, under these assumptions, the employer 
would have been allowed a $10,000 deduction with respect to the facility 
for the 1985 taxable year, the fund's qualified cost for its 1985 
taxable year would be only $10,000. Thus, only $10,000 of the $100,000 
facility contribution would be deductible by the employer for its 1985 
taxable year (i.e., the taxable year of the employer with or within 
which the applicable taxable year of the fund ends). However, in 
determining the extent to which the $200,000 in cash is deductible by 
the employer for its 1985 taxable year, the $100,000 facility is not to 
be disregarded. Thus, if under the applicable pre-section 419 rules the 
employer is allowed for 1985 a total deduction of only $175,000, the 
employer would be permitted a deduction for 1985 of $175,000 ($10,000 
with respect to the facility and $165,000 of the cash contribution). The 
nondeductible portion of the cash contribution is to be treated as 
contributed to the fund on the first day of the next taxable year of the 
employer. If under the applicable pre-section 419 rules the employer 
were allowed a total deduction of $300,000 for 1985, the employer would 
be permitted a deduction for 1985 of only $210,000 ($10,000 with respect 
to the facility and the full $200,000 cash contribution).
    (3) For example, assume that an employer has a June 30 taxable year 
and maintains a welfare benefit fund with a taxable year ending January 
31. During the 1985 portion of its taxable year ending June 30, 1986, 
the employer contributes $50,000 in cash and a facility with a fair 
market value of $100,000; and during the 1986 portion of such taxable 
year, the employer contributes another $75,000 in cash to the fund. The 
facility is used in the provision of welfare benefits under the fund. 
Under the rules of Q&A-9 of this regulation, the employer's deduction 
for its June 30, 1986, taxable year is limited to the greater of the 
following two amounts: (i) The contributions paid to the fund during 
such taxable year ($225,000) up to the qualified cost of the fund for 
the taxable year of the fund ending January 31, 1986, and (ii) the 
contributions paid to the fund during the 1985 portion of the employer's 
taxable year ending June 30, 1986 (``the pre-1986 contributions'') 
($150,000) to the extent that such pre-1986 contributions are deductible 
under the rules governing the deduction of such contributions before 
section 419 is generally effective with respect to the fund. For 
purposes of this rule, the contribution of the facility on or before 
December 31, 1985, is to be treated as a pre-1986 contribution and the 
rules of section 419 and this Q&A are to be treated as rules governing 
the deduction of such contribution before section 419 generally becomes 
effective with respect to the fund. Thus, in determining the extent to 
which the facility is deductible as a pre-1986 contribution

[[Page 1127]]

under the rules before section 419 generally becomes effective, the 
facility is treated as the only contribution to the welfare benefit fund 
and the qualified cost of such fund for the taxable year of the fund in 
which the facility was contributed is the amount that would have been 
allowable to the employer as a deduction with respect to the portion of 
the facility used in the provision of welfare benefits if the employer 
had placed in service the facility at the same time that the fund placed 
in service the facility and the employer's taxable year ended on January 
31, 1986.
    (b)(1) The preceding rules shall also apply for purposes of 
determining when and the extent to which an employer may deduct 
contributions or other items and amounts after June 22, 1984 and on or 
before December 31, 1985 (or, if applicable under paragraph (b) of Q&A-2 
of this regulation, before section 419 generally becomes effective with 
respect to contributions to the fund) that are not facilities (e.g., 
cash contributions) to a welfare benefit fund that are used by the fund 
to acquire, construct, or improve a facility. The most recent non-
facility contributions made to a welfare benefit fund before the 
facility in question is placed in service by the fund (up to the fair 
market value of the facility at such time) are to be treated as used by 
the fund for the acquisition, construction, or improvement (as the case 
may be) of such facility. To the extent that contributions before such a 
facility is placed in service are not at least equal to the value of the 
facility at such time, contributions after such date (up to the value of 
the facility at the time it is placed in service) are treated as used 
for acquisition, construction, or improvement of the facility. Such non-
facility contributions, to the extent that they were made after June 22, 
1984, and on or before December 31, 1985 (or, if applicable under 
paragraph (b) of Q&A-2 of this regulation, before section 419 generally 
becomes effective with respect to contributions to the fund), are not 
deductible by the employer as non-facility contributions for any year. 
Instead, the employer is permitted a deduction with respect to such 
contributions only under the rules of this Q&A as though the employer 
had contributed a facility to the fund at the same time that the fund 
placed in service the facility in question and, at such time, the 
facility had a fair market value equal to the total of such non-facility 
contributions.
    (2) For example, assume that an employer and a welfare benefit fund 
each has a calendar taxable year and during 1985 the fund acquired and 
placed in service a facility with a fair market value of $100,000 to be 
used in the provision of welfare benefits. Further, during July 1984 the 
employer contributed $150,000 in cash to the fund and, during the 
portion of 1985, before the facility was placed in service by the fund, 
the employer contributed another $75,000 in cash to the fund; during the 
remaining portion of 1985, the employer contributed $125,000 in cash. 
The facility is used in the provision of welfare benefits under the 
fund. Because $25,000 of the employer's 1984 contribution is treated 
under this rule as used for the acquisition of a facility, such $25,000 
is not deductible by the employer for 1984. For purposes of determining 
the employer's deduction for 1985, the employer will be treated as 
having contributed $125,000 in cash and a facility with a fair market 
value of $100,000. The employer's deduction for its 1985 taxable year 
will be determined under the rules relating to the contribution of a 
facility after June 22, 1984, and on or before December 31, 1985.
    (3) For example, assume that an employer and a welfare benefit fund 
each has a calendar taxable year and during 1986 the fund placed in 
service a facility with a fair market value of $100,000 to be used in 
the provision of welfare benefits. During 1985, the employer contributed 
$125,000 in cash to the fund. During the portion of 1986 before the 
facility was placed in service, the employer contributed $60,000 in 
cash, and during the remaining portion of 1986, the employer contributed 
another $75,000 in cash. The facility is used in the provision of 
welfare benefits under the fund. Because $40,000 of its 1985 cash 
contribution is treated under this rule as used for the acquisition of 
the facility, such $40,000 is not deductible by the employer for 1985. 
For purposes of determining the employer's deduction for 1986, the 
employer will be

[[Page 1128]]

treated as though it had contributed a $40,000 facility to the fund at 
the time the fund placed the facility in service.
    (c) For purposes of calculating the ``existing excess reserve 
amount'' under Q&A-1 of Sec. 1.419A-1T and the ``existing reserves for 
post-retirement medical or life insurance benefits'' under Q&A-4 of 
Sec. 1.512(a)-5T (but not the exempt function income under Q&A-3 of 
Sec. 1.512(a)-5T), the amount set aside as of any applicable date is to 
be reduced to the extent that contributions originally included in such 
amount are subsequently treated under this Q&A as used for the 
acquisition, construction, or improvement of an asset excluded from the 
calculation of the total amount set aside under paragraph (b) of Sec. 
1.512(a)-5T (or would be so treated under this Q&A if it applied to such 
asset). The reduction required under this paragraph applies for purposes 
of calculating the ``existing excess reserve amount'' and the ``existing 
reserves for post-retirement medical or life insurance benefits'' for 
all taxable years of the welfare benefit fund.

[T.D. 8073, 51 FR 4323, Feb. 4, 1986; 51 FR 7262, Mar. 3, 1986; 51 FR 
11303, Apr. 2, 1986]



Sec. 1.419A-1T  Qualified asset account limitation of additions to 
account. (Temporary)

    Q-1: What does the transition rule under section 419A(f)(7) provide?
    A-1: Section 419A(f)(7) provides that, in the case of a welfare 
benefit fund that was in existence on July 18, 1984, the account limit 
(as determined under section 419A(c)) for each of the first four taxable 
years of the fund that relate to taxable years of the employer ending 
after December 31, 1985 (or, if applicable under paragraph (b) of Q&A-2 
of Sec. 1.419-1T, taxable years of the employer beginning after the 
termination of the last of the collective bargaining agreements pursuant 
to which the plan is maintained) shall be increased by the following 
percentages of the ``existing excess reserve amount'':

 
                                                                 Percent
 
First taxable year............................................        80
Second taxable year...........................................        60
Third taxable year............................................        40
Fourth taxable year...........................................        20
 

    For purposes of this section, the ``existing excess reserve amount'' 
for any taxable year of a fund is the excess of (a) the assets actually 
set aside for purposes described in section 419A(a) at the close of the 
first taxable year of the fund ending after July 18, 1984 (calculated in 
the manner set forth in Q&A-3 of Sec. 1.512(a)-3T, and adjusted under 
paragraph (c) of Q&A-11 of Sec. 1.419-1T), reduced by employer 
contributions to the fund before the close of such first taxable year to 
the extent that such contributions are not deductible for the taxable 
year of the employer with or within which such taxable year of the fund 
ends and for any prior taxable year of the employer, over (b) the 
account limit which would have applied to the taxable year of the fund 
for which the excess is being computed (without regard to this 
transition rule). A welfare benefit fund is treated as in existence on 
July 18, 1984, for purposes of this transition rule only if amounts were 
actually set aside in such fund on such date to provide welfare benefits 
enumerated under section 419A.

[T.D. 8073, 51 FR 4329, Feb. 4, 1986, as amended at 51 FR 11303, Apr. 2, 
1986]



Sec. 1.419A-2T  Qualified asset account limitation for collectively 
bargained funds. (Temporary)

    Q-1: What account limits apply to welfare benefit funds that are 
maintained pursuant to a collective bargaining agreement?
    A-1: Contributions to a welfare benefit fund maintained pursuant to 
one or more collective bargaining agreements and the reserves of such a 
fund generally are subject to the rules of sections 419, 419A, and 512. 
However, neither contributions to nor reserves of such a collectively 
bargained welfare benefit fund shall be treated as exceeding the 
otherwise applicable limits of section 419(b), 419A(b), or 512(a)(3)(E) 
until the earlier of: (i) The date on which the last of the collective 
bargaining agreements relating to the fund in effect on, or ratified on 
or before, the date of issuance of final regulations concerning such 
limits for collectively bargained welfare benefit funds terminates 
(determined without regard to any extension thereof agreed

[[Page 1129]]

to after the date of issuance of such final regulations), or (ii) the 
date 3 years after the issuance of such final regulations.
    Q-2: What is a welfare benefit fund maintained pursuant to a 
collective bargaining agreement for purposes of Q&A-1?
    A-2: (1) For purposes of Q&A-1, a collectively bargained welfare 
benefit fund is a welfare benefit fund that is maintained pursuant to an 
agreement which the Secretary of Labor determines to be a collective 
bargaining agreement and which meets the requirements of the Secretary 
of the Treasury as set forth in paragraph 2 below.
    (2) Notwithstanding a determination by the Secretary of Labor that 
an agreement is a collective bargaining agreement, a welfare benefit 
fund is considered to be maintained pursuant to a collective bargaining 
agreement only if the benefits provided through the fund were the 
subject of arms-length negotiations between employee representatives and 
one or more employers, and if such agreement between employee 
representatives and one or more employers satisfies section 7701(a)(46) 
of the Code. Moreover, the circumstances surrounding a collective 
bargaining agreement must evidence good faith bargaining between adverse 
parties over the welfare benefits to be provided through the fund. 
Finally, a welfare benefit fund is not considered to be maintained 
pursuant to a collective bargaining agreement unless at least 50 percent 
of the employees eligible to receive benefits under the fund are covered 
by the collective bargaining agreement.
    (3) In the case of a collectively bargained welfare benefit fund, 
only the portion of the fund (as determined under allocation rules to be 
provided by the Commissioner) attributable to employees covered by a 
collective bargaining agreement, and from which benefits for such 
employees are provided, is considered to be maintained pursuant to a 
collective bargaining agreement.
    (4) Notwithstanding the preceding paragraphs and pending the 
issuance of regulations setting account limits for collectively 
bargained welfare benefit funds, a welfare benefit fund will not be 
treated as a collectively bargained welfare benefit fund for purposes of 
Q&A-1 if and when, after July 1, 1985, the number of employees who are 
not covered by a collective bargaining agreement and are eligible to 
receive benefits under the fund increases by reason of an amendment, 
merger, or other action of the employer or the fund. In addition, 
pending the issuance of such regulations, for purposes of applying the 
50 percent test of paragraph (2) to a welfare benefit fund that is not 
in existence on July 1, 1985, ``90 percent'' shall be substituted for 
``50 percent''.

[T.D. 8034, 50 FR 27428, July 3, 1985]



Sec. 1.419A(f)(6)-1  Exception for 10 or more employer plan.

    (a) Requirements--(1) In general. Sections 419 and 419A do not apply 
in the case of a welfare benefit fund that is part of a 10 or more 
employer plan described in section 419A(f)(6). A plan is a 10 or more 
employer plan described in section 419A(f)(6) only if it is a single 
plan--
    (i) To which more than one employer contributes;
    (ii) To which no employer normally contributes more than 10 percent 
of the total contributions contributed under the plan by all employers;
    (iii) That does not maintain an experience-rating arrangement with 
respect to any individual employer; and
    (iv) That satisfies the requirements of paragraph (a)(2) of this 
section.
    (2) Compliance information. A plan satisfies the requirements of 
this paragraph (a)(2) if the plan is maintained pursuant to a written 
document that requires the plan administrator to maintain records 
sufficient for the Commissioner or any participating employer to readily 
verify that the plan satisfies the requirements of section 419A(f)(6) 
and this section and that provides the Commissioner and each 
participating employer (or a person acting on the participating 
employer's behalf) with the right, upon written request to the plan 
administrator, to inspect and copy all such records. See Sec. 1.414(g)-
1 for the definition of plan administrator.

[[Page 1130]]

    (3) Application of rules--(i) In general. The requirements described 
in paragraph (a)(1) and (2) of this section must be satisfied both in 
form and in operation.
    (ii) Arrangement is considered in its entirety. The determination of 
whether a plan is a 10 or more employer plan described in section 
419A(f)(6) is based on the totality of the arrangement and all related 
facts and circumstances, including any related insurance contracts. 
Accordingly, all agreements and understandings (including promotional 
materials and policy illustrations) and the terms of any insurance 
contract will be taken into account in determining whether the 
requirements are satisfied in form and in operation.
    (b) Experience-rating arrangements--(1) General rule. A plan 
maintains an experience-rating arrangement with respect to an individual 
employer and thus does not satisfy the requirement of paragraph 
(a)(1)(iii) of this section if, with respect to that employer, there is 
any period for which the relationship of contributions under the plan to 
the benefits or other amounts payable under the plan (the cost of 
coverage) is or can be expected to be based, in whole or in part, on the 
benefits experience or overall experience (or a proxy for either type of 
experience) of that employer or one or more employees of that employer. 
For purposes of this paragraph (b)(1), an employer's contributions 
include all contributions made by or on behalf of the employer or the 
employer's employees. See paragraph (d) of this section for the 
definitions of benefits experience, overall experience, and benefits or 
other amounts payable. The rules of this paragraph (b) apply under all 
circumstances, including employer withdrawals and plan terminations.
    (2) Adjustment of contributions. An example of a plan that maintains 
an experience-rating arrangement with respect to an individual employer 
is a plan that entitles an employer to (or for which the employer can 
expect) a reduction in future contributions if that employer's overall 
experience is positive. Similarly, a plan maintains an experience-rating 
arrangement with respect to an individual employer where an employer can 
expect its future contributions to be increased if the employer's 
overall experience is negative. A plan also maintains an experience-
rating arrangement with respect to an individual employer where an 
employer is entitled to receive (or can expect to receive) a rebate of 
all or a portion of its contributions if that employer's overall 
experience is positive or, conversely, where an employer is liable to 
make additional contributions if its overall experience is negative.
    (3) Adjustment of benefits. An example of a plan that maintains an 
experience-rating arrangement with respect to an individual employer is 
a plan under which benefits for an employer's employees are (or can be 
expected to be) increased if that employer's overall experience is 
positive or, conversely, under which benefits are (or can be expected to 
be) decreased if that employer's overall experience is negative. A plan 
also maintains an experience-rating arrangement with respect to an 
individual employer if benefits for an employer's employees are limited 
by reference, directly or indirectly, to the overall experience of the 
employer (rather than having all the plan assets available to provide 
the benefits).
    (4) Special rules--(i) Treatment of insurance contracts--(A) In 
general. For purposes of this section, insurance contracts under the 
arrangement will be treated as assets of the fund. Accordingly, the 
value of the insurance contracts (including non-guaranteed elements) is 
included in the value of the fund, and amounts paid between the fund and 
the insurance company are disregarded, except to the extent they 
generate gains or losses as described in paragraph (b)(4)(i)(C) of this 
section.
    (B) Payments to and from an insurance company. Payments from a 
participating employer or its employees to an insurance company pursuant 
to insurance contracts under the arrangement will be treated as 
contributions made to the fund, and amounts paid under the arrangement 
from an insurance company will be treated as payments from the fund.
    (C) Gains and losses from insurance contracts. As of any date, if 
the sum of the benefits paid by the insurer and the

[[Page 1131]]

value of the insurance contract (including non-guaranteed elements) is 
greater than the cumulative premiums paid to the insurer, the excess is 
treated as a gain to the fund. As of any date, if the cumulative 
premiums paid to the insurer are greater than the sum of the benefits 
paid by the insurer and the value of the insurance contract (including 
non-guaranteed elements), the excess is treated as a loss to the fund.
    (ii) Treatment of flexible contribution arrangements. Solely for 
purposes of determining the cost of coverage under a plan, if 
contributions for any period can vary with respect to a benefit package, 
the Commissioner may treat the employer as contributing the minimum 
amount that would maintain the coverage for that period.
    (iii) Experience rating by group of employers or group of employees. 
A plan will not be treated as maintaining an experience-rating 
arrangement with respect to an individual employer merely because the 
cost of coverage under the plan with respect to the employer is based, 
in whole or in part, on the benefits experience or the overall 
experience (or a proxy for either type of experience) of a rating group, 
provided that no employer normally contributes more than 10 percent of 
all contributions with respect to that rating group. For this purpose, a 
rating group means a group of participating employers that includes the 
employer or a group of employees covered under the plan that includes 
one or more employees of the employer.
    (iv) Family members, etc. For purposes of this section, 
contributions with respect to an employee include contributions with 
respect to any other person (e.g., a family member) who may be covered 
by reason of the employee's coverage under the plan and amounts provided 
with respect to an employee include amounts provided with respect to 
such a person.
    (v) Leased employees. In the case of an employer that is the 
recipient of services performed by a leased employee described in 
section 414(n)(2) who participates in the plan, the leased employee is 
treated as an employee of the recipient and contributions made by the 
leasing organization attributable to service performed with the 
recipient are treated as made by the recipient.
    (c) Characteristics indicating a plan is not a 10 or more employer 
plan--(1) In general. The presence of any of the characteristics 
described in paragraphs (c)(2) through (c)(6) of this section generally 
indicates that the plan is not a 10 or more employer plan described in 
section 419A(f)(6). Accordingly, unless established to the satisfaction 
of the Commissioner that the plan satisfies the requirements of section 
419A(f)(6) and this section, a plan having any of the following 
characteristics is not a 10 or more employer plan described in section 
419A(f)(6). A plan's lack of all the following characteristics does not 
create any inference that the plan is a 10 or more employer plan 
described in section 419A(f)(6).
    (2) Allocation of plan assets. Assets of the plan or fund are 
allocated to a specific employer or employers through separate 
accounting of contributions and expenditures for individual employers, 
or otherwise.
    (3) Differential pricing. The amount charged under the plan is not 
the same for all the participating employers, and those differences are 
not merely reflective of differences in current risk or rating factors 
that are commonly taken into account in manual rates used by insurers 
(such as current age, gender, geographic locale, number of covered 
dependents, and benefit terms) for the particular benefit or benefits 
being provided.
    (4) No fixed welfare benefit package. The plan does not provide for 
fixed welfare benefits for a fixed coverage period for a fixed cost, 
within the meaning of paragraph (d)(5) of this section.
    (5) Unreasonably high cost. The plan provides for fixed welfare 
benefits for a fixed coverage period for a fixed cost, but that cost is 
unreasonably high for the covered risk for the plan as a whole.
    (6) Nonstandard benefit triggers. Benefits or other amounts payable 
can be paid, distributed, transferred, or otherwise provided from a fund 
that is part of the plan by reason of any event other than the illness, 
personal injury, or death of an employee or family member, or the 
employee's involuntary separation from employment. Thus, for

[[Page 1132]]

example, a plan exhibits this characteristic if the plan provides for 
the payment of benefits or the distribution of an insurance contract to 
an employer's employees on the occasion of the employer's withdrawal 
from the plan. A plan will not be treated as having the characteristic 
described in this paragraph merely because, upon cessation of 
participation in the plan, an employee is provided with the right to 
convert coverage under a group life insurance contract to coverage under 
an individual life insurance contract without demonstrating evidence of 
insurability, but only if there is no additional economic value 
associated with the conversion right.
    (d) Definitions. For purposes of this section:
    (1) Benefits or other amounts payable. The term benefits or other 
amounts payable includes all amounts that are payable or distributable 
(or that will be otherwise provided) directly or indirectly to 
employers, to employees or their beneficiaries, or to another fund as a 
result of a spinoff or transfer, and without regard to whether payable 
or distributable as welfare benefits, cash, dividends, rebates of 
contributions, property, promises to pay, or otherwise.
    (2) Benefits experience. The benefits experience of an employer (or 
of an employee or a group of employers or employees) means the benefits 
and other amounts incurred, paid, or distributed (or otherwise provided) 
directly or indirectly, including to another fund as a result of a 
spinoff or transfer, with respect to the employer (or employee or group 
of employers or employees), and without regard to whether provided as 
welfare benefits, cash, dividends, credits, rebates of contributions, 
property, promises to pay, or otherwise.
    (3) Overall experience--(i) Employer's overall experience. The term 
overall experience means, with respect to an employer (or group of 
employers), the balance that would have accumulated in a welfare benefit 
fund if that employer (or those employers) were the only employer (or 
employers) providing welfare benefits under the plan. Thus, the overall 
experience is credited with the sum of the contributions under the plan 
with respect to that employer (or group of employers), less the benefits 
and other amounts paid or distributed (or otherwise provided) with 
respect to that employer (or group of employers) or the employees of 
that employer (or group of employers), and adjusted for gain or loss 
from insurance contracts (as described in paragraph (b)(4)(i) of this 
section), investment return, and expenses. Overall experience as of any 
date may be either a positive or a negative number.
    (ii) Employee's overall experience. The term overall experience 
means, with respect to an employee (or group of employees, whether or 
not employed by the same employer), the balance that would have 
accumulated in a welfare benefit fund if the employee (or group of 
employees) were the only employee (or employees) being provided welfare 
benefits under the plan. Thus, the overall experience is credited with 
the sum of the contributions under the plan with respect to that 
employee (or group of employees), less the benefits and other amounts 
paid or distributed (or otherwise provided) with respect to that 
employee (or group of employees), and adjusted for gain or loss from 
insurance contracts (as described in paragraph (b)(4)(i) of this 
section), investment return, and expenses. Overall experience as of any 
date may be either a positive or a negative number.
    (4) Employer. The term employer means the employer whose employees 
are participating in the plan and those employers required to be 
aggregated with the employer under section 414(b), (c), or (m).
    (5) Fixed welfare benefit package--(i) In general. A plan provides 
for fixed welfare benefits for a fixed coverage period for a fixed cost, 
if it--
    (A) Defines one or more welfare benefits, each of which has a fixed 
amount that does not depend on the amount or type of assets held by the 
fund;
    (B) Specifies fixed contributions to provide for those welfare 
benefits; and
    (C) Specifies a coverage period during which the plan agrees to 
provide specified welfare benefits, subject to the payment of the 
specified contributions by the employer.
    (ii) Treatment of actuarial gains or losses. A plan will not be 
treated as failing to provide for fixed welfare benefits

[[Page 1133]]

for a fixed coverage period for a fixed cost merely because the plan 
does not pay the promised benefits (or requires all participating 
employers to make proportionate additional contributions based on the 
fund's shortfall) when there are insufficient assets under the plan to 
pay the promised benefits. Similarly, a plan will not be treated as 
failing to provide for fixed welfare benefits for a fixed coverage 
period for a fixed cost merely because the plan provides a period of 
extended coverage after the end of the coverage period with respect to 
employees of all participating employers at no cost to the employers (or 
provides a proportionate refund of contributions to all participating 
employers) because of the plan-wide favorable actuarial experience 
during the coverage period.
    (e) Maintenance of records. The plan administrator of a plan that is 
intended to be a 10 or more employer plan described in section 
419A(f)(6) shall maintain permanent records and other documentary 
evidence sufficient to substantiate that the plan satisfies the 
requirements of section 419A(f)(6) and this section. (See Sec. 
1.414(g)-1 for the definition of plan administrator.)
    (f) Examples. The provisions of paragraph (c) of this section and 
the provisions of section 419A(f)(6) and this section relating to 
experience-rating arrangements may be illustrated by the following 
examples. Unless stated otherwise, it should be assumed that any life 
insurance contract described in an example is non-participating and has 
no value other than the value of the policy's current life insurance 
protection plus its cash value, and that no employer normally 
contributes more than 10 percent of the total contributions contributed 
under the plan by all employers. Paragraph (ii) of each example applies 
the characteristics listed in paragraph (c) of this section to the facts 
described in that example. Paragraphs (iii) and (iv) of each example 
analyze the facts described in the example to determine whether the plan 
maintains experience-rating arrangements with respect to individual 
employers. Paragraphs (iii) and (iv) of each example illustrate only the 
meaning of experience-rating arrangements. No inference should be drawn 
from these examples about whether these plans are otherwise described in 
section 419A(f)(6) or about the applicability or nonapplicability of any 
other Internal Revenue Code provision that may limit or deny the 
deduction of contributions to the arrangements. Further, no inference 
should be drawn from the examples concerning the tax treatment of 
employees as a result of the employer contributions or the provision of 
the benefits. The examples are as follows:

    Example 1. (i) An arrangement provides welfare benefits to employees 
of participating employers. Each year a participating employer is 
required to contribute an amount equal to the claims and other expenses 
expected with respect to that employer for the year (based on current 
age, gender, geographic locale, number of participating employees, 
benefit terms, and other risk or rating factors commonly taken into 
account in manual rates used by insurers for the benefits being 
provided), multiplied by the ratio of actual claims with respect to that 
employer for the previous year over the expected claims with respect to 
that employer for the previous year.
    (ii) This arrangement exhibits at least one of the characteristics 
listed in paragraph (c) of this section generally indicating that an 
arrangement is not a 10 or more employer plan described in section 
419A(f)(6). Differential pricing exists under this arrangement because 
the amount charged under the plan is not the same for all the 
participating employers, and those differences are not merely reflective 
of differences in current risk or rating factors that are commonly taken 
into account in manual rates used by insurers for the particular benefit 
or benefits being provided.
    (iii) This arrangement does not satisfy the requirements of section 
419A(f)(6) and this section because, at a minimum, the requirement of 
paragraph (a)(1)(iii) of this section is not satisfied. Under the 
arrangement, an employer's cost of coverage for each year is based, in 
part, on that employer's benefits experience (i.e., the benefits and 
other amounts provided in the past with respect to one or more employees 
of that employer). Accordingly, pursuant to paragraph (b)(1) of this 
section, the arrangement maintains experience-rating arrangements with 
respect to individual employers.
    Example 2. (i) The facts are the same as in Example 1, except that 
the amount charged to an employer each year is equal to claims and other 
expenses expected with respect to that employer for the year (determined 
the same as in Example 1), multiplied by the ratio of actual claims for 
the previous year

[[Page 1134]]

(determined on a plan-wide basis) over the expected claims for the 
previous year (determined on a plan-wide basis).
    (ii) Based on the limited facts described above, this arrangement 
exhibits none of the characteristics listed in paragraph (c) of this 
section generally indicating that an arrangement is not a 10 or more 
employer plan described in section 419A(f)(6). Unlike the arrangement 
discussed in Example 1, there is no differential pricing under the 
arrangement because the only differences in the amounts charged to the 
employers are solely reflective of differences in current risk or rating 
factors that are commonly taken into account in manual rates used by 
insurers for the particular benefit or benefits being provided.
    (iii) Nothing in the facts described in this Example 2 indicates 
that the arrangement maintains experience-rating arrangements prohibited 
under section 419A(f)(6) and this section. An employer's cost of 
coverage under the arrangement is based, in part, on the benefits 
experience of that employer (as well as of all the other participating 
employers). However, pursuant to paragraph (b)(4)(iii) of this section, 
the arrangement will not be treated as maintaining experience-rating 
arrangements with respect to the individual employers merely because the 
employers' cost of coverage is based on the benefits experience of a 
group of employees eligible under the plan, provided no employer 
normally contributes more than 10 percent of all contributions with 
respect to the rating group that includes the employees of an individual 
employer. Under the arrangement described in this Example 2, the rating 
group includes all the participating employers (or all of their 
employees), and no employer normally contributes more than 10 percent of 
the contributions made under the arrangement by all the employers. 
Accordingly, absent other facts, the arrangement will not be treated as 
maintaining experience-rating arrangements with respect to individual 
employers.
    Example 3. (i) Arrangement A provides welfare benefits to employees 
of participating employers. Each year an employer is required to 
contribute an amount equal to the claims and other expenses expected 
with respect to that employer for the year (based on current risk or 
rating factors commonly taken into account in manual rates used by 
insurers for the benefits being provided), adjusted based on the 
employer's notional account. An employer's notional account is 
determined as follows. The account is credited with the sum of the 
employer's contributions previously paid under the plan less the benefit 
claims for that employer's employees. The notional account is further 
increased by a fixed five percent investment return (regardless of the 
actual investment return earned on the funds). If an employer's notional 
account is positive, the employer's contributions are reduced by a 
specified percentage of the notional account. If an employer's notional 
account is negative, the employer's contributions are increased by a 
specified percentage of the notional account.
    (ii) Arrangement A exhibits at least two of the characteristics 
listed in paragraph (c) of this section generally indicating that an 
arrangement is not a 10 or more employer plan described in section 
419A(f)(6). First, assets under the plan are allocated to specific 
employers. Second, differential pricing exists because the amount 
charged under the plan is not the same for all the participating 
employers, and those differences are not merely reflective of 
differences in current risk or rating factors that are commonly taken 
into account in manual rates used by insurers for the particular benefit 
or benefits being provided.
    (iii) Arrangement A does not satisfy the requirements of section 
419A(f)(6) and this section because, at a minimum, the requirement of 
paragraph (a)(1)(iii) of this section is not satisfied. Under the 
arrangement, a participating employer's cost of coverage for each year 
is based on a proxy for that employer's overall experience. An 
employer's overall experience, as that term is defined in paragraph 
(d)(3) of this section, includes the balance that would have accumulated 
in the fund if that employer's employees were the only employees being 
provided benefits under the plan. Under that definition, the overall 
experience is credited with the sum of the contributions paid under the 
plan by or on behalf of that employer less the benefits or other amounts 
provided to with respect to that employer's employees, and adjusted for 
gain or loss from insurance contracts, expenses, and investment return. 
Under the formula used by the arrangement in this example to determine 
employer contributions, expenses are disregarded and a fixed investment 
return of five percent is used instead of actual investment return. The 
disregard of expenses and substitution of the fixed investment return 
for the actual investment return merely results in an employer's 
notional account that is a proxy for the overall experience of that 
employer. Accordingly, the arrangement maintains experience-rating 
arrangements with respect to individual employers.
    Example 4. (i) Under Arrangement B, death benefits are provided for 
eligible employees of each participating employer. Individual level 
premium whole life insurance policies are purchased to provide the death 
benefits. Each policy has a face amount equal to the death benefit 
payable with respect to the individual employee. Each year, a 
participating employer is charged an amount equal to the level premiums 
payable with respect to the employees of that employer. One 
participating employer, F, has an employee, P,

[[Page 1135]]

whose coverage under the arrangement commenced at the beginning of 2000, 
when P was age 50. P is covered under the arrangement for $1 million of 
death benefits, and a life insurance policy with a face amount of $1 
million has been purchased on P's life. The level annual premium on the 
policy is $23,000. At the beginning of 2005, when P is age 55, the 
$23,000 premium amount has been paid for five years and the policy, 
which continues to have a face amount of $1 million, has a cash value of 
$92,000. Another employer, G, has an employee, R, who is also 55 years 
old at the beginning of 2005 and is covered under Arrangement B for $1 
million, for which a level premium life insurance policy with a face 
amount of $1 million has been purchased. However, R did not become 
covered under Arrangement B until the beginning of 2005. Because R's 
coverage began at age 55, the level annual premium charged for the 
policy on R's life is $30,000, or $7,000 more than the premiums payable 
on the policy in effect on P's life. Employer F is charged $23,000 and 
employer G is charged $30,000 for the death benefit for employees P and 
R, respectively. Assume that employees P and R are the only covered 
employees of their respective employers and that they are identical with 
respect to current risk and rating factors that are commonly taken into 
account in manual rates used by insurers for death benefits.
    (ii) Arrangement B exhibits at least three of the characteristics 
listed in paragraph (c) of this section generally indicating that an 
arrangement is not a 10 or more employer plan described in section 
419A(f)(6). First, assets of the plan are effectively allocated to 
specific employers. Second, there is differential pricing under the 
arrangement. That is, the amount charged under the plan during the year 
for a specific amount of death benefit coverage is not the same for all 
the employers (employer F is charged $23,000 each year for $1 million of 
death benefit coverage while employer G is charged $30,000 each year for 
the same coverage), and the difference is not merely reflective of 
differences in current risk or rating factors that are commonly taken 
into account in manual rates used by insurers for the death benefit 
being provided. (The differences in amounts charged are attributable to 
differences in issue age and not to differences in current risk or 
rating factors, as employees P and R are the same age). Third, during 
the early years of the arrangement, the amounts charged are unreasonably 
high for the covered risk for the plan as a whole.
    (iii) Arrangement B does not satisfy the requirements of section 
419A(f)(6) and this section because, at a minimum, the requirement of 
paragraph (a)(1)(iii) of this section is not satisfied. Arrangement B 
maintains experience-rating arrangements with respect to individual 
employers because the cost of coverage for each year for any employer 
participating in the arrangement is based on a proxy for the overall 
experience of that employer. Under Arrangement B, employer F's cost of 
coverage for 2005 is $23,000 for $1 million of coverage. The $92,000 
cash value at the beginning of 2005 in the policy insuring P's life is a 
proxy for employer F's overall experience. (The $92,000 is essentially 
the balance that would have accumulated in the fund if employer F were 
the only employer providing welfare benefits under Arrangement B.) 
Further, the $23,000 charged to F for the $1 million of coverage in 2005 
is based on the $92,000 since, in the absence of the $92,000, employer F 
would have been charged $30,000 for P's $1 million death benefit 
coverage. (Note that the conclusion that the $92,000 balance is the 
basis for the lower premium charged to employer F is consistent with the 
fact that a $92,000 balance, if converted to a life annuity using the 
same actuarial assumptions as were used to calculate the cash value 
amount, would be sufficient to provide for annual annuity payments of 
$7,000 for the life of P--an amount equal to the $7,000 difference from 
the premium charged in 2005 to employer G for the $1 million of coverage 
on employee R's life.) Thus, F's cost of coverage for 2005 is based on a 
proxy for F's overall experience. Accordingly, Arrangement B maintains 
an experience-rating arrangement with respect to employer F.
    (iv) Arrangement B also maintains an experience-rating arrangement 
with respect to employer G because it can be expected that each year G 
will be charged $30,000 for the $1 million of coverage on R's life. Each 
year, G's cost of coverage will reflect G's prior contributions and 
allocable earnings, so that G's cost of coverage will be based on a 
proxy for G's overall experience. Accordingly, Arrangement B maintains 
an experience-rating arrangement with respect to employer G. Similarly, 
Arrangement B maintains an experience-rating arrangement with respect to 
each other participating employer. Accordingly, Arrangement B maintains 
experience-rating arrangements with respect to individual employers. 
This would also be the result if Arrangement B maintained an experience-
rating arrangement with respect to only one individual employer.
    Example 5. (i) The facts are the same as in Example 4 except that 
the death benefits are provided under 10-year level term life insurance 
policies. One participating employer, H, has an employee, M, whose 
coverage under the arrangement commenced at the beginning of 2000, when 
M was age 35. M is covered under the arrangement for $1 million of death 
benefits, and a 10-year level term life insurance policy with a face 
amount of $1 million has been purchased on M's life. The level annual 
premium on the policy for the first 10 years is $700. At the beginning 
of 2007, when M is age 42, the $700 premium amount

[[Page 1136]]

has been paid for seven years. Another employer, J, has an employee, N, 
who is also 42 years old at the beginning of 2007 and is covered under 
the arrangement for $1 million, for which a 10-year level term life 
insurance policy with a face amount of $1 million has been purchased. 
However, N did not become covered under the arrangement until the 
beginning of 2007. Because N's coverage began at age 42, the 10-year 
level term premium charged for the policy on N's life is $1,100, or $400 
more than the premiums then payable on the policy in effect on M's life. 
Neither the policy on employee M nor the policy on employee N has any 
cash value at any point during its term. Assume that employees M and N 
are the only covered employees of their respective employers and that 
they are identical with respect to any current risk and rating factors 
that are commonly taken into account in manual rates used by insurers 
for the death benefit being provided.
    (ii) Based on the facts described in this Example 5, this 
arrangement exhibits at least two of the characteristics listed in 
paragraph (c) of this section generally indicating that an arrangement 
is not a 10 or more employer plan described in section 419A(f)(6). 
First, for the same reasons as described in paragraph (ii) of Example 4, 
there is differential pricing under the arrangement. Second, assets of 
the plan are effectively allocated to specific employers. This is the 
case even though the insurance policies used by employers H and J have 
no accessible cash value.
    (iii) The facts described in this Example 5 indicate that the 
arrangement does not satisfy the requirements of section 419A(f)(6) and 
this section because, at a minimum, the requirement of paragraph 
(a)(1)(iii) of this section is not satisfied. This arrangement maintains 
experience-rating arrangements with respect to individual employers 
because the cost of coverage for each year for any employer 
participating in the arrangement is based on a proxy for the overall 
experience of that employer. Under this arrangement employer H's cost of 
coverage in 2007 is $700 for $1 million of coverage. Although the policy 
insuring M's life has no cash value accessible to employer H, the 
accumulation of the excesses of the amounts paid by employer H on behalf 
of employee M over each year's underlying mortality and expense charges 
for providing life insurance coverage to employee M provide economic 
value to employer H (i.e., the ability to purchase future coverage on 
M's life at a premium that is less than the underlying mortality and 
expense charges as those underlying charges increase with M's increasing 
age). Thus, H's cost of coverage for 2007 is based on a proxy for H's 
overall experience. Accordingly, this arrangement maintains an 
experience-rating arrangement with respect to employer H.
    (iv) This arrangement also maintains an experience-rating 
arrangement with respect to employer J because it can be expected that 
for each of the next nine years J will be charged $1,100 for the $1 
million of coverage on N's life. Each year, J's cost of coverage will 
reflect J's prior contributions, so that J's cost of coverage will be 
based on a proxy for J's overall experience. Accordingly, this 
arrangement maintains an experience-rating arrangement with respect to 
employer J. Similarly, this arrangement maintains an experiencing-rating 
arrangement with respect to each other participating employer. 
Accordingly, this arrangement maintains experience-rating arrangements 
with respect to individual employers. This would also be the result if 
this arrangement maintained an experience-rating arrangement with 
respect to only one individual employer.
    Example 6. (i) Under Arrangement C, death benefits are provided for 
eligible employees of each participating employer. Flexible premium 
universal life insurance policies are purchased to provide the death 
benefits. Each policy has a face amount equal to the death benefit 
payable with respect to the individual employee. Each participating 
employer can make any contributions to the arrangement provided that the 
amount paid for each employee is at least the amount needed to prevent 
the lapse of the policy. The amount needed to prevent the lapse of the 
universal life insurance policy is the excess, if any, of the mortality 
and expense charges for the year over the policy balance. All 
contributions made by an employer are paid as premiums to the universal 
life insurance policies purchased on the lives of the covered employees 
of that employer. Participating employers S and V each have a 50-year-
old employee covered under Arrangement C for death benefits of $1 
million, which is the face amount of the respective universal life 
insurance policies on the lives of the employees. In the first year of 
coverage employer S makes a contribution of $23,000 (the amount of a 
level premium) while employer V contributes only $6,000, which is the 
amount of the mortality and expense charges for the first year. At the 
beginning of year two, the balance in employer S's policy (including 
earnings) is $18,000, but the balance in V's policy is zero. Although S 
is not required to contribute anything in the second year of coverage, S 
contributes an additional $15,000 in the second year. Employer V 
contributes $7,000 in the second year.
    (ii) Arrangement C exhibits at least two of the characteristics 
listed in paragraph (c) of this section generally indicating that an 
arrangement is not a 10 or more employer plan described in section 
419A(f)(6). First, assets of the plan are effectively allocated to 
specific employers. Second, the arrangement does not provide for fixed 
welfare benefits for a fixed coverage period for a fixed cost.

[[Page 1137]]

    (iii) Arrangement C does not satisfy the requirements of section 
419A(f)(6) and this section because, at a minimum, the requirement of 
paragraph (a)(1)(iii) of this section is not satisfied. Arrangement C 
maintains experience-rating arrangements with respect to individual 
employers because the cost of coverage of an employer participating in 
the arrangement is based on a proxy for the overall experience of that 
employer. Pursuant to paragraph (b)(4)(ii) of this section (concerning 
treatment of flexible contribution arrangements), solely for purposes of 
determining an employer's cost of coverage, the Commissioner may treat 
an employer as contributing the minimum amount needed to maintain the 
coverage. Applying this treatment, H's cost of coverage for the first 
year of coverage under Arrangement C is $6,000 for $1 million of death 
benefit coverage, but for the second year it is zero for the same amount 
of coverage because that is the minimum amount needed to keep the 
insurance policy from lapsing. Employer H's overall experience at the 
beginning of the second year of coverage is $18,000, because that is the 
balance that would have accumulated in the fund if H were the only 
employer providing benefits under Arrangement C. (The special rule of 
paragraph (b)(4)(ii) of this section only applies to determine cost of 
coverage; it does not apply in determining overall experience.) The 
$18,000 balance in the policy insuring the life of employer H's employee 
is a proxy for H's overall experience. Employer H can choose not to make 
any contributions in the second year of coverage due to the $18,000 
policy balance. Thus, H's cost of coverage for the second year is based 
on a proxy for H's overall experience. Accordingly, Arrangement C 
maintains an experience-rating arrangement with respect to employer H.
    (iv) Arrangement C also maintains an experience-rating arrangement 
with respect to employer J because in each year J can contribute more 
than the amount needed to prevent a lapse of the policy on the life of 
its employee and can expect that its cost of coverage for subsequent 
years will reflect its prior contributions and allocable earnings. 
Accordingly, Arrangement C maintains an experience-rating arrangement 
with respect to employer J.
    Example 7. (i) Arrangement D provides death benefits for eligible 
employees of each participating employer. Each employer can choose to 
provide a death benefit of either one, two, or three times the annual 
compensation of the covered employees. Under Arrangement D, the death 
benefit is payable only if the employee dies while employed by the 
employer. If an employee terminates employment with the employer or if 
the employer withdraws from the arrangement, the death benefit is no 
longer payable, no refund or other credit is payable to the employer or 
to the employees, and no policy or other property is transferrable to 
the employer or the employees. Furthermore, the employees are not 
provided with any right under Arrangement D to coverage under any other 
arrangement, nor with any right to purchase or to convert to an 
individual insurance policy, other than any conversion rights the 
employees may have in accordance with state law (and which provide no 
additional economic benefit). Arrangement D determines the amount 
required to be contributed by each employer for each month of coverage 
by aggregating the amount required to be contributed for each covered 
employee of the employer. The amount required to be contributed for each 
covered employee is determined by multiplying the amount of the death 
benefit coverage (in thousands) for the employee by five-year age 
bracket rates in a table specified by the plan, which is used uniformly 
for all covered employees of all participating employers. The rates in 
the specified table do not exceed the rates set forth in Table I of 
Sec. 1.79-3(d)(2), and differences in the rates in the table are merely 
reflective of differences in mortality risk for the various age 
brackets. The rates in the table are not based in whole or in part on 
the experience of the employers participating in Arrangement D. 
Arrangement D uses the amount contributed by each employer to purchase 
one-year term insurance coverage on the lives of the covered employees 
with a face amount equal to the death benefit provided by the plan. No 
employer is entitled to any rebates or refunds provided under the 
insurance contract.
    (ii) Arrangement D does not exhibit any of the characteristics 
listed in paragraph (c) of this section generally indicating that an 
arrangement is not a 10 or more employer plan described in section 
419A(f)(6). Under Arrangement D, assets are not allocated to a specific 
employer or employers. Differences in the amounts charged to the 
employers are solely reflective of differences in risk or rating factors 
that are commonly taken into account in manual rates used by insurers 
for the particular benefit or benefits being provided. The arrangement 
provides for fixed welfare benefits for a fixed coverage period for a 
fixed cost, within the meaning of paragraph (d)(5) of this section. The 
cost charged under the arrangement is not unreasonably high for the 
covered risk of the plan as a whole. Finally, benefits and other amounts 
payable can be paid, distributed, transferred, or otherwise made 
available only by reason of the death of the employee, so that there is 
no nonstandard benefit trigger under the arrangement.
    (iii) Nothing in the facts of this Example 7 indicates that 
Arrangement D fails to satisfy the requirements of section 419A(f)(6) or 
this section by reason of maintaining experience-rating arrangements 
with respect to individual employers. Based solely on the facts

[[Page 1138]]

described above, Arrangement D does not maintain an experience rating-
arrangement with respect to any individual employer because for each 
participating employer there is no period for which the employer's cost 
of coverage under the arrangement is based, in whole or in part, on 
either the benefits experience or the overall experience (or a proxy for 
either type of experience) of that employer or its employees.
    Example 8. (i) The facts are the same as in Example 7, except that 
under the arrangement, any refund or rebate provided under that year's 
insurance contract is allocated among all the employers participating in 
the arrangement in proportion to their contributions, and is used to 
reduce the employers' contributions for the next year.
    (ii) This arrangement exhibits at least one of the characteristics 
listed in paragraph (c) of this section generally indicating that an 
arrangement is not a 10 or more employer plan described in section 
419A(f)(6). The arrangement includes nonstandard benefit triggers 
because amounts are made available to an employer by reason of the 
insurer providing a refund or rebate to the plan, an event that is other 
than the illness, personal injury, or death of an employee or family 
member, or an employee's involuntary separation from employment.
    (iii) Based on the limited and specific facts described in this 
Example 8, an employer participating in this arrangement should be able 
to establish to the satisfaction of the Commissioner that the plan does 
not maintain experience-rating arrangements with respect to individual 
employers. A participating employer's cost of coverage is the 
relationship of its contributions to the death benefit coverage or other 
amounts payable with respect to that employer, including the employer's 
portion of the insurance company rebate and refund amounts. The rebate 
and refund amounts are allocated to an employer based on that employer's 
contribution for the prior year. However, even though an employer's 
overall experience includes its past contributions, contributions alone 
are not a proxy for an employer's overall experience under the 
particular facts described in this Example 8. As a result, a 
participating employer's cost of coverage under the arrangement for each 
year (or any other period) is not based on that employer's benefits 
experience or its overall experience (or a proxy for either type of 
experience), except as follows: If the total of the insurance company 
refund or rebate amounts is a proxy for the overall experience of all 
participating employers, a participating employer's cost of coverage 
will be based in part on that employer's overall experience (or a proxy 
therefor) by reason of that employer's overall experience being a 
portion of the overall experience of all participating employers. Under 
the special rule of paragraph (b)(2)(iii) of this section, however, that 
fact alone will not cause the arrangement to be treated as maintaining 
an experience-rating arrangement with respect to an individual employer 
because no employer normally contributes more than 10 percent of the 
total contributions under the plan by all employers (the rating group). 
Accordingly, the arrangement will not be treated as maintaining 
experience-rating arrangements with respect to individual employers.
    Example 9. (i) Arrangement E provides medical benefits for covered 
employees of 90 participating employers. The level of medical benefits 
is determined by a schedule set forth in the trust document and does not 
vary by employer. Other than any rights an employee may have to COBRA 
continuation coverage, the medical benefits cease when an employee 
terminates employment with the employer. If an employer withdraws from 
the arrangement, there is no refund of any contributions and there is no 
transfer of anything of value to employees of the withdrawing employer, 
to the withdrawing employer, or to another plan or arrangement 
maintained by the withdrawing employer. Arrangement E determines the 
amount required to be contributed by each employer for each year of 
coverage, and the aggregate amounts charged are not unreasonably high 
for the covered risk for the plan as a whole. To determine the amount to 
be contributed for each employer, Arrangement E classifies an employer 
based on the employer's location. These geographic areas are not changed 
once established under the arrangement. The amount charged for the 
coverage under the arrangement to the employers in a geographic area is 
determined from a rate-setting manual based on the benefit package and 
geographic area, and differences in the rates in the manual are merely 
reflective of current differences in those risk or rating factors. The 
rates in the rate-setting manual are not based in whole or in part on 
the experience of the employers participating in Arrangement E.
    (ii) Arrangement E does not exhibit any of the characteristics 
listed in paragraph (c) of this section generally indicating that an 
arrangement is not a 10 or more employer plan described in section 
419A(f)(6). Although the amounts charged under the arrangement to an 
employer in one geographic area can be expected to differ from those 
charged to an employer in another geographic area, the differences are 
merely reflective of differences in current risk or rating factors that 
are commonly taken into account in manual rates used by insurers for 
medical benefits.
    (iii) Nothing in the facts of this Example 9 indicates that 
Arrangement E fails to satisfy the requirements of section 419A(f)(6) or 
this section by reason of maintaining experience-rating arrangements 
with respect to individual employers. Based solely on the facts

[[Page 1139]]

described above, Arrangement E does not maintain an experience rating-
arrangement with respect to any individual employer because for each 
participating employer there is no period for which the employer's cost 
of coverage under the arrangement is based, in whole or in part, on 
either the benefits experience or the overall experience (or a proxy for 
either type of experience) of that employer or its employees.
    Example 10. (i) The facts are the same as in Example 9, except that 
the amount charged for the coverage under the arrangement to the 
employers in a geographic area is initially determined from a rate-
setting manual based on the benefit package and then adjusted to reflect 
the claims experience of the employers in that classification as a 
whole. The arrangement does not have any geographic area classification 
for which one of the employers in the classification normally 
contributes more than 10 percent of the contributions made by all the 
employers in that classification.
    (ii) This arrangement exhibits at least one of the characteristics 
listed in paragraph (c) of this section generally indicating that an 
arrangement is not a 10 or more employer plan described in section 
419A(f)(6). There is differential pricing under the arrangement because 
the amounts charged to an employer in one geographic area can be 
expected to differ from those charged to an employer in another 
geographic area, and the differences are not merely reflective of 
current risk or rating factors that are commonly taken into account in 
manual rates used by insurers for medical benefits.
    (iii) Based on the facts described in this Example 10, an employer 
participating in this arrangement should be able to establish to the 
satisfaction of the Commissioner that the plan does not maintain 
experience-rating arrangements with respect to individual employers even 
though there is differential pricing. Although an employer's cost of 
coverage for each year is based, in part, on its benefits experience (as 
well as the benefits experience of the other employers in its geographic 
area), that does not result in experience-rating arrangements with 
respect to any individual employer because the employers in each 
geographic area are a rating group and no employer normally contributes 
more than 10 percent of the contributions made by all the employers in 
its rating group. (See paragraph (b)(4)(iii) of this section.)
    Example 11. (i) The facts of Arrangement F are the same as those 
described in Example 10, except that K, an employer in one of 
Arrangement F's geographic areas, normally contributes more than 10 
percent of the contributions made by the employers in that geographic 
area.
    (ii) For the same reasons as described in Example 10, Arrangement F 
results in differential pricing.
    (iii) Arrangement F does not satisfy the requirements of section 
419A(f)(6) and this section because, at a minimum, the requirement of 
paragraph (a)(1)(iii) of this section is not satisfied. An employer's 
cost of coverage for each year is based, in part, on its benefits 
experience (as well as the benefits experience of the other employers in 
its geographic area) and the special rule for experience-rating by a 
rating group does not apply to Arrangement F because employer K normally 
contributes more than 10 percent of the contributions made by the 
employers in its rating group. Accordingly, Arrangement F maintains 
experience-rating arrangements with respect to individual employers.
    Example 12. (i) The facts of Arrangement G are the same as those 
described in Example 10, except for the way that the arrangement 
classifies the employers. Under Arrangement G, the experience of each 
employer for the prior year is reviewed and then the employer is 
assigned to one of three classifications (low cost, intermediate cost, 
or high cost) based on the ratio of actual claims with respect to that 
employer to expected claims with respect to that employer. No employer 
in any classification normally contributes more than 10 percent of the 
contributions of all employers in that classification.
    (ii) For the same reasons as described in Example 10, Arrangement G 
results in differential pricing.
    (iii) Arrangement G does not satisfy the requirements of section 
419A(f)(6) and this section because, at a minimum, the requirement of 
paragraph (a)(1)(iii) of this section is not satisfied. The special rule 
in paragraph (b)(4)(iii) of this section for rating groups can prevent a 
plan from being treated as maintaining experience-rating arrangements 
with respect to individual employers if the mere use of a rating group 
is the only reason a plan would be so treated. Under Arrangement G, 
however, an employer's cost of coverage for each year is based on the 
employer's benefits experience in two ways: the employer's benefits 
experience is part of the benefits experience of a rating group that is 
otherwise permitted under the special rule of paragraph (b)(4)(iii) of 
this section, and the employer's benefits experience is considered 
annually in redetermining the rating group to which the employer is 
assigned. Accordingly, Arrangement G maintains experience-rating 
arrangements with respect to individual employers.
    Example 13. (i) Arrangement H provides a death benefit equal to a 
multiple of one, two, or three times compensation as elected by the 
participating employer for all of its covered employees. Universal life 
insurance contracts are purchased on the lives of the covered employees. 
The face amount of each

[[Page 1140]]

contract is the amount of the death benefit payable upon the death of 
the covered employee. Under the arrangement, each employer is charged 
annually an amount equal to 200 percent of the mortality and expense 
charges under the contracts for that year covering the lives of the 
covered employees of that employer. Arrangement H pays the amount 
charged each employer to the insurance company. Thus, the insurance 
company receives an amount equal to 200 percent of the mortality and 
expense charges under the policies. The excess amounts charged and paid 
to the insurance company increase the policy value of the universal life 
insurance contracts. When an employer ceases to participate in 
Arrangement H, the insurance policies are distributed to each of the 
covered employees of the withdrawing employer.
    (ii) Arrangement H exhibits at least three of the characteristics 
listed in paragraph (c) of this section generally indicating that an 
arrangement is not a 10 or more employer plan described in section 
419A(f)(6). First, assets are effectively allocated to specific 
employers. Second, because the amount of the withdrawal benefit (i.e., 
the value of the life insurance policies to be distributed) is unknown, 
the arrangement does not provide for fixed welfare benefits for a fixed 
coverage period for a fixed cost. Finally, Arrangement H includes 
nonstandard benefit triggers because amounts can be distributed under 
the arrangement for a reason other than the illness, personal injury, or 
death of an employee or family member, or an employee's involuntary 
separation from employment.
    (iii) Arrangement H does not satisfy the requirements of section 
419A(f)(6) and this section because, at a minimum, the requirement of 
paragraph (a)(1)(iii) of this section is not satisfied. Pursuant to 
paragraph (b)(1) of this section, the prohibition against maintaining 
experience-rating arrangements applies under all circumstances, 
including employer withdrawals. Arrangement H maintains experience-
rating arrangements with respect to individual employers because the 
cost of coverage for a participating employer is based on a proxy for 
the overall experience of that employer. Under Arrangement H, the 
contributions of a participating employer are fixed. The benefits or 
other amounts payable with respect to an employer include the value of 
the life insurance policies that are distributable to the employees of 
that employer upon the withdrawal of that employer from the plan. Thus, 
the cost of coverage for any period of an employer's participation in 
Arrangement H is the relationship between the fixed contributions for 
that period and the variable benefits payable under the arrangement. The 
value of those variable benefits depends on the value of the policies 
that would be distributed if the employer were to withdraw at the end of 
the period. (Each year the insurance policies to be distributed to the 
employees in the event of the employer's withdrawal will increase in 
value due to the premium amounts paid on the policy in excess of current 
mortality and expense charges.) For reasons similar to those discussed 
above in Example 6, the aggregate value of the life insurance policies 
on the lives of an employer's employees is a proxy for that employer's 
overall experience. Thus, a participating's employer's cost of coverage 
for any period is based on a proxy for the overall experience of that 
employer. Accordingly, Arrangement H maintains experience-rating 
arrangements with respect to individual employers.
    (iv) The result would be the same if, rather than distributing the 
policies, Arrangement H distributed cash amounts equal to the cash 
values of the policies. The result would also be the same if the 
distribution of policies or cash values is triggered by employees 
terminating their employment rather than by employers ceasing to 
participate in the arrangement.
    Example 14. (i)(1) The facts of Arrangement J are the same as those 
described in Example 13 for Arrangement H, except that--
    (A) Arrangement J purchases a special term insurance policy on the 
life of each covered employee with a face amount equal to the death 
benefit payable upon the death of the covered employee; and
    (B) there is no benefit distributable upon an employer's withdrawal.
    (2) The special term policy includes a rider that extends the term 
protection for a period of time beyond the term provided on the policy's 
face. The length of the extended term is not guaranteed, but is based on 
the excess of premiums over mortality and expense charges during the 
period of original term protection, increased by any investment return 
credited to the policies.
    (ii) Arrangement J exhibits two of the characteristics listed in 
paragraph (c) of this section generally indicating that an arrangement 
is not a 10 or more employer plan described in section 419A(f)(6). 
First, assets of the plan are effectively allocated to specific 
employers. Second, the plan does not provide for fixed welfare benefits 
for a fixed coverage period for a fixed cost because the coverage period 
is not fixed.
    (iii) Arrangement J does not satisfy the requirements of section 
419A(f)(6) and this section because, at a minimum, the requirement of 
paragraph (a)(1)(iii) of this section is not satisfied. Arrangement J 
maintains experience-rating arrangements with respect to individual 
employers because the cost of coverage for a participating employer is 
based on a proxy for the overall experience of that employer. Under 
Arrangement J, the contributions of a participating employer are fixed. 
The benefits or other amounts payable with respect to an employer are 
the one-

[[Page 1141]]

, two-, or three-times-compensation death benefit for each employee of 
the employer for the current year, plus the extended term protection 
coverage for future years. Thus, for any period extending to or beyond 
the end of the original term of one or more of the policies on the lives 
of an employer's employees, the employer's cost of coverage is the 
relationship between the fixed contributions for that period and the 
variable benefits payable under the arrangement. The value of those 
variable benefits depends on the aggregate value of the policies 
insuring the employer's employees (i.e., the total of the premiums paid 
on the policies by Arrangement J to the insurance company, reduced by 
the mortality and expense charges that were needed to provide the 
original term protection, and increased by any investment return 
credited to the policies). The aggregate value of the policies insuring 
an employer's employees is, at any time, a proxy for the employer's 
overall experience. Thus, a participating employer's cost of coverage 
for any period described above is based on a proxy for the overall 
experience of that employer. Accordingly, Arrangement J maintains 
experience-rating arrangements with respect to individual employers.
    Example 15. (i) Arrangement K provides a death benefit to employees 
of participating employers equal to a specified multiple of 
compensation. Under the arrangement, a flexible-premium universal life 
insurance policy is purchased on the life of each covered employee in 
the amount of that employee's death benefit. Each policy has a face 
amount equal to the employee's death benefit under the arrangement. Each 
participating employer is charged annually with the aggregate amount (if 
any) needed to maintain the policies covering the lives of its 
employees. However, each employer is permitted to make additional 
contributions to the arrangement and, upon doing so, the additional 
contributions are paid to the insurance company and allocated to one or 
more contracts covering the lives of the employer's employees. In the 
event that any policy covering the life of an employee would lapse in 
the absence of new contributions from that employee's employer, and if 
at the same time there are policies covering the lives of other 
employees of the employer that have cash values in excess of the amounts 
needed to prevent their lapse, the employer has the option of reducing 
its otherwise-required contribution by amounts withdrawn from those 
other policies.
    (ii) Arrangement K exhibits at least two of the characteristics 
listed in paragraph (c) of this section generally indicating that an 
arrangement is not a 10 or more employer plan described in section 
419A(f)(6). First, assets of the plan are allocated to specific 
employers. Second, because the plan allows an employer to choose to 
contribute an amount that is different than that contributed by another 
employer for the same benefit, the amount charged under the plan is not 
the same for all participating employers (and the differences in the 
amounts are not merely reflective of differences in current risk or 
rating factors that are commonly taken into account in manual rates used 
by insurers for the particular benefit or benefits being provided), 
resulting in differential pricing.
    (iii) Arrangement K does not satisfy the requirements of section 
419A(f)(6) and this section because, at a minimum, the requirement of 
paragraph (a)(1)(iii) of this section is not satisfied. Arrangement K 
maintains experience-rating arrangements with respect to individual 
employers because the cost of coverage for any employer participating in 
the arrangement is based on a proxy for the overall experience of that 
employer. Under Arrangement K the benefits with respect to an employer 
for any year are a fixed amount. For purposes of determining the 
employer's cost of coverage for that year, the Commissioner may treat 
the employer's contribution under the special rule of paragraph 
(b)(4)(ii) of this section (concerning treatment of flexible 
contribution/arrangements) as being the minimum contribution amount 
needed to maintain the universal life policies with respect to that 
employer for the death benefit coverage for that year. Because the 
employer has the option to prevent the lapse of one policy by having 
amounts withdrawn from other policies, that minimum contribution amount 
will be based in part on the aggregate value of the policies on the 
lives of that employer's employees. That aggregate value is a proxy for 
the employer's overall experience. Accordingly, Arrangement K maintains 
experience-rating arrangements with respect to individual employers.

    (g) Effective date--(1) In general. Except as set forth in paragraph 
(g)(2) of this section, this section applies to contributions paid or 
incurred in taxable years of an employer beginning on or after July 11, 
2002.
    (2) Compliance information and recordkeeping. Paragraphs (a)(1)(iv), 
(a)(2), and (e) of this section apply for taxable years of a welfare 
benefit fund beginning after July 17, 2003.

[T.D. 9079, 68 FR 42259, July 17, 2003]



Sec. 1.420-1  Significant reduction in retiree health coverage during 
the cost maintenance period.

    (a) In general. Notwithstanding section 420(c)(3)(A), the minimum 
cost requirements of section 420(c)(3) are not

[[Page 1142]]

met if the employer significantly reduces retiree health coverage during 
the cost maintenance period.
    (b) Significant reduction--(1) In general. An employer significantly 
reduces retiree health coverage during the cost maintenance period if, 
for any taxable year beginning on or after January 1, 2002, that is 
included in the cost maintenance period, either--
    (i) The employer-initiated reduction percentage for that taxable 
year exceeds 10 percent; or
    (ii) The sum of the employer-initiated reduction percentages for 
that taxable year and all prior taxable years during the cost 
maintenance period exceeds 20 percent.
    (2) Employer-initiated reduction percentage. The employer-initiated 
reduction percentage for any taxable year is the fraction B/A, expressed 
as a percentage, where:

A = The total number of individuals (retired employees plus their 
          spouses plus their dependents) receiving coverage for 
          applicable health benefits as of the day before the first day 
          of the taxable year.
B = The total number of individuals included in A whose coverage for 
          applicable health benefits ended during the taxable year by 
          reason of employer action.

    (3) Special rules for taxable years beginning before January 1, 
2002. The following rules apply for purposes of computing the amount in 
paragraph (b)(1)(ii) of this section if any portion of the cost 
maintenance period precedes the first day of the first taxable year 
beginning on or after January 1, 2002--
    (i) Aggregation of taxable years. The portion of the cost 
maintenance period that precedes the first day of the first taxable year 
beginning on or after January 1, 2002 (the initial period) is treated as 
a single taxable year and the employer-initiated reduction percentage 
for the initial period is computed as set forth in paragraph (b)(2) of 
this section, except that the words ``initial period'' apply instead of 
``taxable year.''
    (ii) Loss of coverage. If coverage for applicable health benefits 
for an individual ends by reason of employer action at any time during 
the initial period, an employer may treat that coverage as not having 
ended if the employer restores coverage for applicable health benefits 
to that individual by the end of the initial period.
    (4) Employer action--(i) General rule. For purposes of paragraph 
(b)(2) of this section, an individual's coverage for applicable health 
benefits ends during a taxable year by reason of employer action, if on 
any day within the taxable year, the individual's eligibility for 
applicable health benefits ends as a result of a plan amendment or any 
other action of the employer (e.g., the sale of all or part of the 
employer's business) that, in conjunction with the plan terms, has the 
effect of ending the individual's eligibility. An employer action is 
taken into account for this purpose regardless of when the employer 
action actually occurs (e.g., the date the plan amendment is executed), 
except that employer actions occurring before the later of December 18, 
1999, and the date that is 5 years before the start of the cost 
maintenance period are disregarded.
    (ii) Special rule. Notwithstanding paragraph (b)(4)(i) of this 
section, coverage for an individual will not be treated as having ended 
by reason of employer action merely because such coverage ends under the 
terms of the plan if those terms were adopted contemporaneously with the 
provision under which the individual became eligible for retiree health 
coverage. This paragraph (b)(4)(ii) does not apply with respect to plan 
terms adopted contemporaneously with a plan amendment that restores 
coverage for applicable health benefits before the end of the initial 
period in accordance with paragraph (b)(3)(ii) of this section.
    (iii) Sale transactions. If a purchaser provides coverage for 
retiree health benefits to one or more individuals whose coverage ends 
by reason of a sale of all or part of the employer's business, the 
employer may treat the coverage of those individuals as not having ended 
by reason of employer action. In such a case, for the remainder of the 
year of the sale and future taxable years of the cost maintenance 
period--
    (A) For purposes of computing the applicable employer cost under 
section 420(c)(3), those individuals are treated as individuals to whom 
coverage for applicable health benefits was provided

[[Page 1143]]

(for as long as the purchaser provides retiree health coverage to them), 
and any amounts expended by the purchaser of the business to provide for 
health benefits for those individuals are treated as paid by the 
employer;
    (B) For purposes of determining whether a subsequent termination of 
coverage is by reason of employer action under this paragraph (b)(4), 
the purchaser is treated as the employer. However, the special rule in 
paragraph (b)(4)(ii) of this section applies only to the extent that any 
terms of the plan maintained by the purchaser that have the effect of 
ending retiree health coverage for an individual are the same as terms 
of the plan maintained by the employer that were adopted 
contemporaneously with the provision under which the individual became 
eligible for retiree health coverage under the plan maintained by the 
employer.
    (c) Definitions. The following definitions apply for purposes of 
this section:
    (1) Applicable health benefits. Applicable health benefits means 
applicable health benefits as defined in section 420(e)(1)(C).
    (2) Cost maintenance period. Cost maintenance period means the cost 
maintenance period as defined in section 420(c)(3)(D).
    (3) Sale. A sale of all or part of an employer's business means a 
sale or other transfer in connection with which the employees of a trade 
or business of the employer become employees of another person. In the 
case of such a transfer, the term purchaser means a transferee of the 
trade or business.
    (d) Examples. The following examples illustrate the application of 
this section:

    Example 1. (i) Employer W maintains a defined benefit pension plan 
that includes a 401(h) account and permits qualified transfers that 
satisfy section 420. The number of individuals receiving coverage for 
applicable health benefits as of the day before the first day of Year 1 
is 100. In Year 1, Employer W makes a qualified transfer under section 
420. There is no change in the number of individuals receiving health 
benefits during Year 1. As of the last day of Year 2, applicable health 
benefits are provided to 99 individuals, because 2 individuals became 
eligible for coverage due to retirement and 3 individuals died in Year 
2. During Year 3, Employer W amends its health plan to eliminate 
coverage for 5 individuals, 1 new retiree becomes eligible for coverage 
and an additional 3 individuals are no longer covered due to their own 
decision to drop coverage. Thus, as of the last day of Year 3, 
applicable health benefits are provided to 92 individuals. During Year 
4, Employer W amends its health plan to eliminate coverage under its 
health plan for 8 more individuals, so that as of the last day of Year 
4, applicable health benefits are provided to 84 individuals. During 
Year 5, Employer W amends its health plan to eliminate coverage for 8 
more individuals.
    (ii) There is no significant reduction in retiree health coverage in 
either Year 1 or Year 2, because there is no reduction in health 
coverage as a result of employer action in those years.
    (iii) There is no significant reduction in Year 3. The number of 
individuals whose health coverage ended during Year 3 by reason of 
employer action (amendment of the plan) is 5. Since the number of 
individuals receiving coverage for applicable health benefits as of the 
last day of Year 2 is 99, the employer-initiated reduction percentage 
for Year 3 is 5.05 percent (5/99), which is less than the 10 percent 
annual limit.
    (iv) There is no significant reduction in Year 4. The number of 
individuals whose health coverage ended during Year 4 by reason of 
employer action is 8. Since the number of individuals receiving coverage 
for applicable health benefits as of the last day of Year 3 is 92, the 
employer-initiated reduction percentage for Year 4 is 8.70 percent (8/
92), which is less than the 10 percent annual limit. The sum of the 
employer-initiated reduction percentages for Year 3 and Year 4 is 13.75 
percent, which is less than the 20 percent cumulative limit.
    (v) In Year 5, there is a significant reduction under paragraph 
(b)(1)(ii) of this section. The number of individuals whose health 
coverage ended during Year 5 by reason of employer action (amendment of 
the plan) is 8. Since the number of individuals receiving coverage for 
applicable health benefits as of the last day of Year 4 is 84, the 
employer-initiated reduction percentage for Year 5 is 9.52 percent (8/
84), which is less than the 10 percent annual limit. However, the sum of 
the employer-initiated reduction percentages for Year 3, Year 4, and 
Year 5 is 5.05 percent + 8.70 percent + 9.52 percent = 23.27 percent, 
which exceeds the 20 percent cumulative limit.
    Example 2. (i) Employer X, a calendar year taxpayer, maintains a 
defined benefit pension plan that includes a 401(h) account and permits 
qualified transfers that satisfy section 420. X also provides lifetime 
health benefits to employees who retire from Division A as a result of a 
plant shutdown, no health benefits to employees who retire from Division 
B, and lifetime health benefits to all employees who retire from 
Division C. In 2000, X amends its health plan to provide

[[Page 1144]]

coverage for employees who retire from Division B as a result of a plant 
shutdown, but only for the 2-year period coinciding with their severance 
pay. Also in 2000, X amends the health plan to provide that employees 
who retire from Division A as a result of a plant shutdown receive 
health coverage only for the 2-year period coinciding with their 
severance pay. A plant shutdown that affects Division A and Division B 
employees occurs in 2000. The number of individuals receiving coverage 
for applicable health benefits as of the last day of 2001 is 200. In 
2002, Employer X makes a qualified transfer under section 420. As of the 
last day of 2002, applicable health benefits are provided to 170 
individuals, because the 2-year period of benefits ends for 10 employees 
who retired from Division A and 20 employees who retired from Division B 
as a result of the plant shutdown that occurred in 2000.
    (ii) There is no significant reduction in retiree health coverage in 
2002. Coverage for the 10 retirees from Division A who lose coverage as 
a result of the end of the 2-year period is treated as having ended by 
reason of employer action, because coverage for those Division A 
retirees ended by reason of a plan amendment made after December 17, 
1999. However, the terms of the health plan that limit coverage for 
employees who retired from Division B as a result of the 2000 plant 
shutdown (to the 2-year period) were adopted contemporaneously with the 
provision under which those employees became eligible for retiree 
coverage under the health plan. Accordingly, under the rule provided in 
paragraph (b)(4)(ii) of this section, coverage for those 20 retirees 
from Division B is not treated as having ended by reason of employer 
action. Thus, the number of individuals whose health benefits ended by 
reason of employer action in 2002 is 10. Since the number of individuals 
receiving coverage for applicable health benefits as of the last day of 
2001 is 200, the employer-initiated reduction percentage for 2002 is 5 
percent (10/200), which is less than the 10 percent annual limit.

    (e) Regulatory effective date. This section is applicable to 
transfers of excess pension assets occurring on or after December 18, 
1999.

[T.D. 8948, 66 FR 32900, June 19, 2001]

                          Certain Stock Options



Sec. 1.421-1  Meaning and use of certain terms.

    (a) Option. (1) For purposes of this section and Sec. Sec. 1.421-2 
through 1.424-1, the term ``option'' means the right or privilege of an 
individual to purchase stock from a corporation by virtue of an offer of 
the corporation continuing for a stated period of time, whether or not 
irrevocable, to sell such stock at a price determined under paragraph 
(e) of this section, such individual being under no obligation to 
purchase. The individual who has such right or privilege is referred to 
as the optionee and the corporation offering to sell stock under such an 
arrangement is referred to as the optionor. While no particular form of 
words is necessary, the option must express, among other things, an 
offer to sell at the option price, the maximum number of shares 
purchasable under the option, and the period of time during which the 
offer remains open. The term option includes a warrant that meets the 
requirements of this paragraph (a)(1).
    (2) An option may be granted as part of or in conjunction with an 
employee stock purchase plan or subscription contract. See section 423.
    (3) An option must be in writing (in paper or electronic form), 
provided that such writing is adequate to establish an option right or 
privilege that is enforceable under applicable law.
    (b) Statutory options. (1) The term statutory option, for purposes 
of this section and Sec. Sec. 1.421-2 through 1.424-1, means an 
incentive stock option, as defined in Sec. 1.422-2(a), or an option 
granted under an employee stock purchase plan, as defined in Sec. 
1.423-2.
    (2) An option qualifies as a statutory option only if the option is 
not transferable (other than by will or by the laws of descent and 
distribution) by the individual to whom the option was granted, and is 
exercisable, during the lifetime of such individual, only by such 
individual. See Sec. Sec. 1.422-2(a)(2)(v) and 1.423-2(j). Accordingly, 
an option which is transferable or transferred by the individual to whom 
the option is granted during such individual's lifetime, or is 
exercisable during such individual's lifetime by another person, is not 
a statutory option. However, if the option or the plan under which the 
option was granted contains a provision permitting the individual to 
designate the person who may exercise the option after such individual's 
death,

[[Page 1145]]

neither such provision, nor a designation pursuant to such provision, 
disqualifies the option as a statutory option. A pledge of the stock 
purchasable under an option as security for a loan that is used to pay 
the option price does not cause the option to violate the 
nontransferability requirements of this paragraph (b). Also, the 
transfer of an option to a trust does not disqualify the option as a 
statutory option if, under section 671 and applicable State law, the 
individual is considered the sole beneficial owner of the option while 
it is held in the trust. If an option is transferred incident to divorce 
(within the meaning of section 1041) or pursuant to a domestic relations 
order, the option does not qualify as a statutory option as of the day 
of such transfer. For the treatment of nonstatutory options, see Sec. 
1.83-7.
    (3)(i) The determination of whether an option is a statutory option 
is made as of the date such option is granted. An option which is a 
statutory option when granted does not lose its character as such an 
option by reason of subsequent events, and an option which is not a 
statutory option when granted does not become such an option by reason 
of subsequent events. See, however, paragraph (e) of Sec. 1.424-1, 
relating to modification, extension, or renewal of an option. For rules 
concerning options that are not statutory options, see Sec. 1.83-7.
    (ii) The application of this subparagraph may be illustrated by the 
following examples:

    Example 1. X Corporation is a subsidiary of S Corporation which, in 
turn, is a subsidiary of P Corporation. On June 1, 2004, P grants to an 
employee of P a statutory option to purchase a share of stock of X. On 
January 1, 2005, S sells a portion of the X stock which it owns to an 
unrelated corporation and, as of that date, X ceases to be a subsidiary 
of S. Because X was a subsidiary of P on the date of the grant of the 
statutory option, the option does not fail to be a statutory option even 
though X ceases to be a subsidiary of P.
    Example 2. Assume P grants an option to an employee under the same 
facts as in example (1) above, except that on June 1, 2004, X is not a 
subsidiary of either S or P. Such option is not a statutory option on 
June 1, 2004. On January 1, 2005, S purchases from an unrelated 
corporation a sufficient number of shares of X stock to make X, as of 
that date, a subsidiary of S. Because X was not a subsidiary of S or P 
on the date of the grant of the option, the option is not a statutory 
option even though X later becomes a subsidiary of P. See Sec. Sec. 
1.422-2(a)(2) and 1.423-2(b).

    (c) Time and date of granting option. (1) For purposes of this 
section and Sec. Sec. 1.421-2 through 1.424-1, the language ``the date 
of the granting of the option'' and ``the time such option is granted,'' 
and similar phrases refer to the date or time when the granting 
corporation completes the corporate action constituting an offer of 
stock for sale to an individual under the terms and conditions of a 
statutory option. Except as set forth in Sec. 1.423-2(h)(2), a 
corporate action constituting an offer of stock for sale is not 
considered complete until the date on which the maximum number of shares 
that can be purchased under the option and the minimum option price are 
fixed or determinable.
    (2) If the corporation imposes conditions on the granting of an 
option (as distinguished from conditions governing the exercise of the 
option), such conditions shall be given effect in accordance with the 
intent of the corporation. However, under section 424(i), if the grant 
of an option is subject to approval by stockholders, the date of grant 
of the option shall be determined as if the option had not been subject 
to such approval. A condition which does not require corporate action, 
such as the approval of, or registration with, some regulatory or 
governmental agency, for example, a stock exchange or the Securities and 
Exchange Commission, is ordinarily considered a condition upon the 
exercise of the option unless the corporate action clearly indicates 
that the option is not to be granted until such condition is satisfied. 
If an option is granted to an individual upon the condition that such 
individual will become an employee of the corporation granting the 
option or of a related corporation, such option is not granted prior to 
the date the individual becomes such an employee.
    (3) In general, conditions imposed upon the exercise of an option 
will not operate to make ineffective the granting of the option. For 
example, on June 1, 2004, the A Corporation grants to X, an employee, an 
option to purchase 5,000 shares of the corporation's stock,

[[Page 1146]]

exercisable by X on or after June 1, 2005, provided he is employed by 
the corporation on June 1, 2005, and provided that A's profits during 
the fiscal year preceding the year of exercise exceed $200,000. Such an 
option is granted to X on June 1, 2004, and will be treated as 
outstanding as of such date.
    (d) Stock and voting stock. (1) For purposes of this section and 
Sec. Sec. 1.421-2 through 1.424-1, the term stock means capital stock 
of any class, including voting or nonvoting common or preferred stock. 
Except as otherwise provided, the term includes both treasury stock and 
stock of original issue. Special classes of stock authorized to be 
issued to and held by employees are within the scope of the term stock 
as used in such sections, provided such stock otherwise possesses the 
rights and characteristics of capital stock.
    (2) For purposes of determining what constitutes voting stock in 
ascertaining whether a plan has been approved by stockholders under 
Sec. 1.422-2(b) or 1.423-2(c) or whether the limitations pertaining to 
voting power contained in Sec. Sec. 1.422-2(f) and 1.423-2(d) have been 
met, stock which does not have voting rights until the happening of an 
event, such as the default in the payment of dividends on preferred 
stock, is not voting stock until the happening of the specified event. 
Generally, stock which does not possess a general voting power, and may 
vote only on particular questions, is not voting stock. However, if such 
stock is entitled to vote on whether a stock option plan may be adopted, 
it is voting stock.
    (3) In general, for purposes of this section and Sec. Sec. 1.421-2 
through 1.424-1, ownership interests other than capital stock are 
considered stock.
    (e) Option price. (1) For purposes of this section and Sec. Sec. 
1.421-2 through 1.424-1, the term option price, price paid under the 
option, or exercise price means the consideration in cash or property 
which, pursuant to the terms of the option, is the price at which the 
stock subject to the option is purchased. The term option price does not 
include any amounts paid as interest under a deferred payment 
arrangement or treated as interest.
    (2) Any reasonable valuation method may be used to determine 
whether, at the time the option is granted, the option price satisfies 
the pricing requirements of sections 422(b)(4), 422(c)(5), 422(c)(7), 
and 423(b)(6) with respect to the stock subject to the option. Such 
methods include, for example, the valuation method described in Sec. 
20.2031-2 of this chapter (Estate Tax Regulations).
    (f) Exercise. For purposes of this section and Sec. Sec. 1.421-2 
through 1,424-1, the term ``exercise'', when used in reference to an 
option, means the act of acceptance by the optionee of the offer to sell 
contained in the option. In general, the time of exercise is the time 
when there is a sale or a contract to sell between the corporation and 
the individual. A promise to pay the option price does not constitute an 
exercise of the option unless the optionee is subject to personal 
liability on such promise. An agreement or undertaking by the employee 
to make payments under a stock purchase plan does not constitute the 
exercise of an option to the extent the payments made remain subject to 
withdrawal by or refund to the employee.
    (g) Transfer. For purposes of this section and Sec. Sec. 1.421-2 
through 1.424-1, the term ``transfer'', when used in reference to the 
transfer to an individual of a share of stock pursuant to his exercise 
of a statutory option, means the transfer of ownership of such share, or 
the transfer of substantially all the rights of ownership. Such transfer 
must, within a reasonable time, be evidenced on the books of the 
corporation. For purposes of section 422, a transfer may occur even if a 
share of stock is subject to a substantial risk of forfeiture or is not 
otherwise transferable immediately after the date of exercise. See Sec. 
1.422-1(b)(3) Example 2. A transfer does not fail to occur merely 
because, under the terms of the arrangement, the individual may not 
dispose of the share for a specified period of time, or the share is 
subject to a right of first refusal or a right to reacquire the share at 
the share's fair market value at the time of sale.
    (h) Employment relationship. (1) An option is a statutory option 
only if, at the time the option is granted, the optionee is an employee 
of the corporation granting the option, or a related corporation of such 
corporation. If the

[[Page 1147]]

option has been assumed or a new option has been substituted in its 
place under Sec. 1.424-1(a), the optionee must, at the time of such 
substitution or assumption, be an employee (or a former employee within 
the 3-month period following termination of the employment relationship) 
of the corporation so substituting or assuming the option, or a related 
corporation of such corporation. The determination of whether the 
optionee is an employee at the time the option is granted (or at the 
time of the substitution or assumption under Sec. 1.424-1(a)) is made 
in accordance with section 3401(c) and the regulations thereunder. As to 
the granting of an option conditioned upon employment, see paragraph 
(c)(2) of this section. A statutory option must be granted for a reason 
connected with the individual's employment by the corporation or by its 
related corporation.
    (2) In addition, Sec. 1.421-2(a) is applicable to the transfer of a 
share pursuant to the exercise of the statutory option only if the 
optionee is, at all times during the period beginning with the date of 
the granting of such option and ending on the day 3 months before the 
date of such exercise, an employee of either the corporation granting 
such option, a related corporation of such corporation, or a corporation 
(or a related corporation of such corporation) substituting or assuming 
a stock option in a transaction to which Sec. 1.424-1(a) applies. For 
purposes of the preceding sentence, the employment relationship is 
treated as continuing intact while the individual is on military leave, 
sick leave, or other bona fide leave of absence (such as temporary 
employment by the Government) if the period of such leave does not 
exceed 3 months, or if longer, so long as the individual's right to 
reemployment with the corporation granting the option (or a related 
corporation of such corporation) or a corporation (or a related 
corporation of such corporation) substituting or assuming a stock option 
in a transaction to which Sec. 1.424-1(a) applies, is provided either 
by statute or by contract. If the period of leave exceeds 3 months and 
the individual's right to reemployment is not provided either by statute 
or by contract, the employment relationship is deemed to terminate on 
the first day immediately following such three-month period. Thus, if 
the option is not exercised before such deemed termination of 
employment, Sec. 1.421-2(a) applies to the transfer of a share pursuant 
to an exercise of the option only if the exercise occurs within 3 months 
from the date the employment relationship is deemed terminated.
    (3) For purposes of determining whether an individual meets the 
requirements of this paragraph, the term ``employer corporation'', as 
used in section 424 (e) and (f), shall be read as ``grantor 
corporation'' or ``corporation issuing or assuming a stock option in a 
transaction to which section 424(a) is applicable'', as the case may be. 
For purposes of the employment requirement, a corporation employing an 
optionee is considered a related corporation if it was a parent or 
subsidiary of the corporation granting the option or substituting or 
assuming the option during the entire portion of the requisite period of 
employment during which it was the employer of such optionee.
    (4) The application of this paragraph may be illustrated by the 
following examples:

    Example 1. On June 1, 2004, X Corporation granted a statutory option 
to A, an employee of X Corporation, to purchase a share of X stock. On 
February 1, 2005, X sold the plant where A was employed to M 
Corporation, an unrelated corporation, and A was employed by M. If A 
exercises his statutory option on June 1, 2005, section 421 is not 
applicable to such exercise, because on June 1, 2005, A is not employed 
by the corporation which granted the option or by a related corporation 
of such corporation, nor was he employed by any of such corporations 
within 3 months before June 1, 2005.
    Example 2. Assume the facts to be the same as in example (1), except 
that when A was employed by M Corporation, the option to purchase X 
stock was terminated and was replaced by an option to buy M stock in 
such circumstances that M Corporation is treated as a corporation 
substituting an option under section 424(a). If A exercises the option 
to purchase the share of M stock on June 1, 2005, section 421 is 
applicable to the transfer of the M stock because, at all times during 
the period beginning with the date of grant of the X option and ending 
with the date of exercise of the M option, A was an employee of the 
corporation granting the option or

[[Page 1148]]

substituting or assuming the option under Sec. 1.424-1(a).
    Example 3. E is an employee of P Corporation. On June 1, 2004, P 
grants E a statutory option to purchase a share of P stock. On June 1, 
2005, P acquires 100 percent of the stock of S Corporation; on such date 
S becomes a subsidiary of P. On July 1, 2005, E ceases to be employed by 
P and becomes employed by S. On October 10, 2005, while still employed 
by S, E exercises his option to buy P stock. Since E was at all times 
during the requisite period of employment an employee of either P, the 
corporation granting the option, or S, a subsidiary of the grantor 
during the period in which such corporation was E's employer, section 
421 is applicable to the exercise of the option.
    Example 4. Assume the same facts as in example (3) except assume 
that at the time E became an employee of S Corporation, S assumed E's 
option to purchase P stock under section 424(a). Section 421 is 
applicable to E's exercise of his option to buy P stock.
    Example 5. M Corporation grants a statutory option to E, an employee 
of such corporation. E is an officer in a reserve Air Force unit. E goes 
on military leave with his unit for 3 weeks. Regardless of whether E is 
an employee of M within the meaning of section 3401(c) and the 
regulations thereunder during such 3-week period, E's employment 
relationship with M is treated as uninterrupted during the period of E's 
military leave.
    Example 6. Assume the same facts as in example (5) and assume 
further that E's active duty status is extended indefinitely, but that E 
has a right to reemployment with M or a related corporation on the 
termination of any military duty E may be required to serve. E exercises 
his M option while on active military duty. Irrespective of whether E is 
an employee of M or a related corporation within the meaning of section 
3401(c) and the regulations thereunder at the time of such exercise or 
within 3 months before such exercise, section 421 applies to such 
exercise.
    Example 7. X Corporation grants an incentive option to A, an 
employee of X Corporation, whose employment contract provides that in 
the event of illness, A's right to reemployment with X, or a related 
corporation of X, will continue for 1 year after the time A becomes 
unable to perform his duties for X. A falls ill for 90 days. For 
purposes of section 422(a)(2), A's employment relationship with X will 
be treated as uninterrupted during the 90-day period. If A's incapacity 
extends beyond 90 days, then, for purposes of section 422(a)(2), A's 
employment relationship with X will be treated as continuing 
uninterrupted until A's reemployment rights terminate. Under section 
422(a)(2), A has 3 months in which to exercise an incentive option after 
his employment relationship with X (and related corporations) is deemed 
terminated.

    (i) Additional definitions. (1) Corporation. For purposes of this 
section and Sec. Sec. 1.421-2 through 1.424-1, the term corporation has 
the meaning prescribed by section 7701(a)(3) and Sec. 301.7701-2(b) of 
this chapter. For example, a corporation for purposes of the preceding 
sentence includes an S corporation (as defined in section 1361), a 
foreign corporation (as defined in section 7701(a)(5)), and a limited 
liability company that is treated as a corporation for all Federal tax 
purposes.
    (2) Parent corporation and subsidiary corporation. For the 
definition of the terms parent corporation (and parent) and subsidiary 
corporation (and subsidiary), for purposes of this section and 
Sec. Sec. 1.421-2 through 1.424-1, see Sec. 1.424-1(f)(i) and (ii), 
respectively. Related corporation as used in this section and in 
Sec. Sec. 1.421-2 through 1.424-1 means either a parent corporation or 
subsidiary corporation.
    (j) Effective/applicability date--(1) In general. Except for 
paragraph (c)(1) of this section, the regulations under this section are 
effective on August 3, 2004. Paragraph (c)(1) of this section is 
effective on November 17, 2009. Paragraph (c)(1) of this section applies 
to statutory options granted on or after January 1, 2010.
    (2) Reliance and transition period. For statutory options granted on 
or before June 9, 2003, taxpayers may rely on the 1984 proposed 
regulations LR-279-81 (49 FR 4504), the 2003 proposed regulations REG-
122917-02 (68 FR 34344), or this section until the earlier of January 1, 
2006, or the first regularly scheduled stockholders meeting of the 
granting corporation occurring 6 months after August 3, 2004. For 
statutory options granted after June 9, 2003, and before the earlier of 
January 1, 2006, or the first regularly scheduled stockholders meeting 
of the granting corporation occurring at least 6 months after August 3, 
2004, taxpayers may rely on either REG-122917-02 or this section. 
Taxpayers may not rely on LR-279-81 or REG-122917-02 after December 31, 
2005. Reliance on LR-279-81, REG-122917-02, or this section must be in 
its entirety, and all statutory options

[[Page 1149]]

granted during the reliance period must be treated consistently.

[T.D. 6887, 31 FR 8787, June 24, 1966, as amended by T.D. 6975, 33 FR 
14779, Oct. 3, 1968; T.D. 7554, 43 FR 31927, July 24, 1978. Redesignated 
and amended by T.D. 9144, 69 FR 46406, Aug. 3, 2004; 69 FR 61310, Oct. 
18, 2004; 69 FR 70551, Dec. 7, 2004; T.D. 9471, 74 FR 59077, Nov. 17, 
2009]



Sec. 1.421-2  General rules.

    (a) Effect of qualifying transfer. (1) If a share of stock is 
transferred to an individual pursuant to the individual's exercise of a 
statutory option, and if the requirements of Sec. 1.422-1(a) (relating 
to incentive stock options) or Sec. 1.423-1(a) (relating to employee 
stock purchase plans) whichever is applicable, are met, then--
    (i) No income results under section 83 at the time of the transfer 
of such share to the individual upon the exercise of the option with 
respect to such share;
    (ii) No deduction under sections 83(h) or 162 or the regulations 
thereunder (relating to trade or business expenses) is allowable at any 
time with respect to the share so transferred; and
    (iii) No amount other than the price paid under the option is 
considered as received by the employer corporation, a related 
corporation of such corporation, or a corporation substituting or 
assuming a stock option in a transaction to which Sec. 1.424-1(a) 
(relating to corporate reorganizations, liquidations, etc.) applies, for 
the share so transferred.
    (2) For the purpose of this paragraph, each share of stock 
transferred pursuant to a statutory option is treated separately. For 
example, if an individual, while employed by a corporation granting him 
a statutory option, exercises the option with respect to part of the 
stock covered by the option, and if such individual exercises the 
balance of the option more than three months after leaving such 
employment, the application of section 421 to the stock obtained upon 
the earlier exercise of the option is not affected by the fact that the 
income taxes of the employer and the individual with respect to the 
stock obtained upon the later exercise of the option are not determined 
under section 421.
    (b) Effect of disqualifying disposition. (1)(i) The disposition (as 
defined in Sec. 1.424-1(c)) of a share of stock acquired by the 
exercise of a statutory option before the expiration of the applicable 
holding periods as determined under Sec. 1.422-1(a) or 1.423-1(a) is a 
disqualifying disposition and makes paragraph (a) of this section 
inapplicable to the transfer of such share. See section 83(a) to 
determine the amount includible on a disqualifying disposition. The 
income attributable to such transfer (determined without reduction for 
any brokerage fees or other costs paid in connection with the 
disposition) is treated by the individual as compensation income 
received in the taxable year in which such disqualifying disposition 
occurs. A deduction attributable to such transfer is allowable, to the 
extent otherwise allowable under section 162, for the taxable year in 
which such disqualifying disposition occurs to the employer corporation, 
or a related corporation of such corporation, or a corporation 
substituting or assuming an option in a transaction to which Sec. 
1.424-1(a) applies. Additionally, the amount allowed as a deduction must 
be determined as if the requirements of section 83(h) and Sec. 1.83-
6(a) apply. No amount is treated as income, and no amount is allowed as 
a deduction, for any taxable year other than the taxable year in which 
the disqualifying disposition occurs. If the amount realized on the 
disposition exceeds (or is less than) the sum of the amount paid for the 
share and the amount of compensation income recognized as a result of 
such disposition, the extent to which the difference is treated as gain 
(or loss) is determined under the rules of section 302 or 1001, as 
applicable.
    (ii) The following examples illustrate the principles of this 
paragraph (b):

    Example 1. On June 1, 2006, X Corporation grants an incentive stock 
option to A, an employee of X, entitling A to purchase 100 shares of X 
stock at $10 per share. On August 1, 2006, A exercises the option when 
the fair market value of X stock is $20 per share, and 100 shares of X 
stock are transferred to A on that date. On December 15, 2007, A sells 
the stock for $20 per share. Because A disposed of the stock before June 
2, 2008, A did not satisfy the holding period requirements of Sec. 
1.422-1(a). Under paragraph (b)(1)(i) of this section, A therefore made 
a disqualifying

[[Page 1150]]

disposition of the stock. Thus, paragraph (a) of this section is 
inapplicable to the transfer of the shares, and A must include the 
compensation income attributable to the transfer of the shares in gross 
income in the year of the disqualifying disposition. The amount of 
compensation income A must include in income is $1,000 ($2,000, the fair 
market value of X stock on transfer less $1,000, the exercise price per 
share). If the requirements of Sec. 83(h) and Sec. 1.83-6(a) are 
satisfied and otherwise allowable under section162, X is allowed a 
deduction of $1,000 for its taxable year in which the disqualifying 
disposition occurs.
    Example 2. Y Corporation grants an incentive stock option for 100 
shares of its stock to E, an employee of Y. The option has an exercise 
price of $10 per share. E exercises the option and is transferred the 
shares when the fair market value of a share of Y stock is $30. Before 
the applicable holding periods are met, Y redeems the shares for $70 per 
share. Because the holding period requirements of Sec. 1.422-1(a) are 
not met, the redemption of the shares is a disqualifying disposition of 
the shares. Under paragraph (b)(1)(i) of this section, A made a 
disqualifying disposition of the stock. Thus, paragraph (a) of this 
section is inapplicable to the transfer of the shares, and E must 
include the compensation income attributable to the transfer of the 
shares in gross income in the year of the disqualifying disposition. The 
amount of compensation income that E must include in income is $2,000 
($3,000, the fair market value of Y stock on transfer, less $1,000, the 
exercise price paid by E). The character of the additional gain that is 
includible in E's income as a result of the redemption is determined 
under the rules of section 302. If the requirements of Sec. 83(h) and 
Sec. 1.83-6(a) are satisfied and otherwise allowable under section 162, 
Y is allowed a deduction for the taxable year in which the disqualifying 
disposition occurs for the compensation income of $2,000. Y is not 
allowed a deduction for the additional gain includible in E's income as 
a result of the redemption.

    (2) If an optionee transfers stock acquired through the optionee's 
exercise of a statutory option prior to the expiration of the applicable 
holding periods, paragraph (a) of this section continues to apply to the 
transfer of the stock pursuant to the exercise of the option if such 
transfer is not a disposition of the stock as defined in Sec. 1.424-
1(c) (for example, a transfer from a decedent to the decedent's estate 
or a transfer by bequest or inheritance). Similarly, a subsequent 
transfer by the executor, administrator, heir, or legatee is not a 
disqualifying disposition by the decedent. If a statutory option is 
exercised by the estate of the optionee or by a person who acquired the 
option by bequest or inheritance or by reason of the death of such 
optionee, see paragraph (c) of this section. If a statutory option is 
exercised by the individual to whom the option was granted and the 
individual dies before the expiration of the holding periods, see 
paragraph (d) of this section.
    (3) For special rules relating to the disqualifying disposition of a 
share of stock acquired by exercise of an incentive stock option, see 
Sec. Sec. 1.422-5(b)(2) and 1.424-1(c)(3).
    (c) Exercise by estate. (1) If a statutory option is exercised by 
the estate of the individual to whom the option was granted (or by any 
person who acquired such option by bequest or inheritance or by reason 
of the death of such individual), paragraph (a) of this section applies 
to the transfer of stock pursuant to such exercise in the same manner as 
if the option had been exercised by the deceased optionee. Consequently, 
neither the estate nor such person is required to include any amount in 
gross income as a result of a transfer of stock pursuant to the exercise 
of the option. Paragraph (a) of this section applies even if the 
executor, administrator, or such person disposes of the stock so 
acquired before the expiration of the applicable holding periods as 
determined under Sec. 1.422-1(a) or 1.423-1(a). This special rule does 
not affect the applicability of section 423(c), relating to the estate's 
or other qualifying person's recognition of compensation income, or 
section 1222, relating to what constitutes a short-term and long-term 
capital gain or loss. Paragraph (a) of this section also applies even if 
the executor, administrator, or such person does not exercise the option 
within three months after the death of the individual or is not employed 
as described in Sec. 1.421-1(h), either when the option is exercised or 
at any time. However, paragraph (a) of this section does not apply to a 
transfer of shares pursuant to an exercise of the option by the estate 
or by such person unless the individual met the employment requirements 
described in Sec. 1.421-1(h) either at the time of the individual's 
death or within three

[[Page 1151]]

months before such time (or, if applicable, within the period described 
in Sec. 1.422-1(a)(3)). Additionally, paragraph (a) of this section 
does not apply if the option is exercised by a person other than the 
executor or administrator, or other than a person who acquired the 
option by bequest or inheritance or by reason of the death of such 
deceased individual. For example, if the option is sold by the estate, 
paragraph (a) of this section does not apply to the transfer of stock 
pursuant to an exercise of the option by the buyer, but if the option is 
distributed by the administrator to an heir as part of the estate, 
paragraph (a) of this section applies to the transfer of stock pursuant 
to an exercise of the option by such heir.
    (2) Any transfer by the estate, whether a sale, a distribution of 
assets, or otherwise, of the stock acquired by its exercise of the 
option under this paragraph is a disposition of the stock for purposes 
of section 423(c). Therefore, if section 423(c) is applicable, the 
estate must include an amount as compensation in its gross income. 
Similarly, if section 423(c) is applicable in case of an exercise of the 
option under this paragraph by a person who acquired the option by 
bequest or inheritance or by reason of the death of the individual to 
whom the option was granted, there must be included in the gross income 
of such person an amount as compensation, either when such person 
disposes of the stock, or when he dies owning the stock.
    (3)(i) If, under section 423(c) an amount is required to be included 
in the gross income of the estate or of such person, the estate or such 
person shall be allowed a deduction as a result of the inclusion of the 
value of the option in the estate of the individual to whom the option 
was granted. Such deduction shall be computed under section 691(c) by 
treating the option as an item of gross income in respect of a decedent 
under section 691 and by treating the amount required to be included in 
gross income under section 423(c) as an amount included in gross income 
under section 691 in respect of such item of gross income. No such 
deduction shall be allowable with respect to any amount other than an 
amount includible under section 423(c). For the rules relating to the 
computation of a deduction under section 691(c), see Sec. 1.691(c)-1.
    (ii) The application of subdivision (i) may be illustrated by the 
following example:

    Example. On June 1, 2004, E was granted an option under an employee 
stock purchase plan to purchase for $85 one share of the stock of his 
employer. On such day, the fair market value of such stock was $100 per 
share. E died on February 1, 2006, without having exercised such option. 
The option was, however, exercisable by his estate, and for purposes of 
the estate tax was valued at $30. On March 1, 2006, the estate exercised 
the option, and on March 15, 2006, sold for $150 the share of stock so 
acquired. For its taxable year including March 15, 2006, the estate is 
required by sections 421(c)(1)(B) and 423(c) to include in its gross 
income as compensation the amount of $15. During such taxable year, no 
amounts of income were properly paid, credited, or distributable to the 
beneficiaries of the estate. However, under section 421(c)(2), the 
estate is entitled to a deduction determined in the following manner. 
E's estate includes no other items of income in respect of a decedent 
referred to in section 691(a), and no deductions referred to in section 
691(b), so that the value for estate tax purposes of the option, $30, is 
also the net value of all items of income in respect of the decedent. 
The estate tax attributable to the inclusion of the option in the estate 
of E is $10. Since $15, the amount includible in gross income by reason 
of sections 421(c)(1)(B) and 423(c), is less than the value for estate 
tax purposes of the option, only \15/30\ of the estate tax attributable 
to the inclusion of the option in the estate is deductible; that is, 
\15/30\ of $10, or $5. No deduction under section 421(c)(2) is allowable 
with respect to any capital gain.

    (4)(i)(a) In the case of the death of an optionee, the basis of any 
share of stock acquired by the exercise of an option under this 
paragraph, determined under section 1011, shall be increased by an 
amount equal to the portion of the basis of the option attributable to 
such share. For example, if a statutory option to acquire 10 shares of 
stock has a basis of $100, the basis of one share acquired by a partial 
exercise of the option, determined under section 1011, would be 
increased by 1/10th of $100, or $10. The option acquires a basis, 
determined under section 1014(a), only if the transfer of the share 
pursuant to the exercise of such option qualifies for the

[[Page 1152]]

special tax treatment provided by section 421(a). To the extent the 
option is so exercised, in whole or in part, it will acquire a basis 
equal to its fair market value at the date of the employee's death or, 
if an election is made under section 2032, its value at its applicable 
valuation date. In certain cases, the basis of the share is subject to 
the adjustments provided by (b) and (c) of this subdivision, but such 
adjustments are only applicable in the case of an option which is 
subject to section 423(c).
    (b) If the amount which would have been includible in gross income 
under section 423(c) had the employee exercised the option on the date 
of his death and held the share at the time of his death exceeds the 
amount which is includible in gross income under such section, the basis 
of the share, determined under (a) of this subdivision, shall be reduced 
by such excess. For example, if $15 would have been includible in the 
gross income of the employee had he exercised the option and held such 
share at the time of his death, and only $10 is includible under section 
423(c), the basis of the share, determined under (a) of this 
subdivision, would be reduced by $5. For purposes of determining the 
amount which would have been includible in gross income under section 
423(c), if the employee had exercised the option and held such share at 
the time of his death, the amount which would have been paid for the 
share shall be computed as if the option had been exercised on the date 
the employee died.
    (c) If the amount includible in gross income under section 423(c) 
exceeds the portion of the basis of the option attributable to the 
share, the basis of the share, determined under (a) of this subdivision, 
shall be increased by such excess. Thus, if $15 is includible in gross 
income under such section, and the basis of the option with respect to 
the share is $10, the basis of the share, determined under (a) of this 
subdivision, will be increased by $5.
    (ii) If a statutory option is not exercised by the estate of the 
individual to whom the option was granted, or by the person who acquired 
such option by bequest or inheritance or by reason of the death of such 
individual, the option shall be considered to be property which 
constitutes a right to receive an item of income in respect of a 
decedent to which the rules of sections 691 and 1014(c) apply.
    (iii) The application of this subparagraph may be illustrated by the 
following examples:

    Example 1. On June 1, 2005, the X Corporation granted to E, an 
employee, an option under its employee stock purchase plan to purchase a 
share of X Corporation stock for $85. The fair market value of X 
Corporation stock on such date was $100 per share. On June 1, 2006, E 
died. The fair market value of X Corporation stock on such date exceeded 
$100 per share and the fair market value of the option on the applicable 
valuation date was $35. On August 1, 2006, the estate of E exercised the 
option and sold the share of X Corporation stock at a time when the fair 
market value of the share was $120. The basis of the share is $120 (the 
$85 paid for the stock plus the $35 basis of the option). When the share 
is sold for $120, the estate is required to include $15 in its gross 
income as compensation. Since $15 would have been includible in E's 
gross income if he had exercised the option and held such share at the 
time of his death, paragraph (c)(4)(i)(b) of this section does not 
apply. Moreover, since the $15 includible in the gross income of the 
estate does not exceed the basis of the option ($35), paragraph 
(c)(4)(i)(c) of this section does not apply. Since the basis of the 
stock and the sale price are the same, no gain or loss is realized by 
the estate on the disposition of the share.
    Example 2. Assume the same facts as in Example 1, except that the 
fair market value of the share of stock at the time of its sale was $90. 
The basis of the share, determined under paragraph (c)(4)(i)(a) of this 
section, is $120 (the $85 paid for the stock plus the $35 basis of the 
option). When the share is sold for $90, the estate is required to 
include $5 in its gross income as compensation. If the employee had 
exercised the option and held the share at the time of his death, $15 
would have been includible in gross income as compensation for the 
taxable year ending with his death. Since such amount exceeds by $10 the 
amount which the estate is required to include in its gross income, 
paragraph (c)(4)(i)(b) of this section applies, and the basis of the 
share ($120), determined under paragraph (c)(4)(i)(a) of this section is 
reduced by $10. Accordingly, the basis is $110, and a capital loss of 
$20 is realized on the disposition of the share.
    Example 3. Assume the same facts as in Example 1, except that the 
fair market value of the option on the applicable valuation date was $5, 
and that the fair market value of X Corporation stock on the date the 
employee died did not exceed $100. The basis of the

[[Page 1153]]

share, determined under paragraph (c)(4)(i)(a) of this section, is $90 
(the $85 paid for the stock plus the $5 basis of the option). When the 
share is sold for $120, the estate is required to include $15 in its 
gross income as compensation. Since such amount exceeds by $10 the basis 
of the option, paragraph (c)(4)(i)(c) of this section applies, and the 
basis of the share ($90), determined under paragraph (c)(4)(i)(b) of 
this section, is increased by $10. Accordingly, the basis is $100 and a 
capital gain of $20 is realized on the disposition of the share.
    Example 4. Assume the same facts as in Example 1, except that on 
June 1, 2006, the date the employee died, the fair market value of X 
Corporation stock was $98, and that on June 1, 2007, the alternate 
valuation date, the fair market value of the stock had declined 
substantially, and the fair market value of the option was $5. On August 
1, 2007, the estate of E exercised the option and sold the share when 
its fair market value was $92. The basis of the share, determined under 
paragraph (c)(4)(i)(a) of this section, is $90 (the $85 paid for the 
stock plus the $5 basis of the option). When the share is sold for $92, 
the estate is required to include $7 in its gross income as 
compensation. Since $13 would have been includible in E's gross income 
if he had exercised the option and held such share at the time of his 
death, paragraph (c)(4)(i)(b) of this section applies, and the basis of 
the share ($90), determined under paragraph (c)(4)(i)(a) of this 
section, is reduced by $6 to $84. Furthermore, since the $7 that the 
estate is required to include in its gross income when the share is sold 
for $92 exceeds by $2 the basis of the option, paragraph (c)(4)(i)(c) of 
this section applies, and the basis of the share ($84), determined under 
paragraph (c)(4)(i)(a) of this section and paragraph (c)(4)(i)(b) of 
this section, is increased by $2. Accordingly, the basis is $86 and a 
capital gain of $6 is realized on the disposition of the share.

    (d) Option exercised by the individual to whom the option was 
granted if the individual dies before expiration of the applicable 
holding periods. If a statutory option is exercised by the individual to 
whom the option was granted and such individual dies before the 
expiration of the applicable holding periods as determined under Sec. 
1.422-1(a) or 1.423-1(a), paragraph (a) of this section does not become 
inapplicable if the executor or administrator of the estate of such 
individual, or any person who acquired such stock by bequest or 
inheritance or by reason of the death of such individual, disposes of 
such stock before the expiration of such applicable holding periods. 
This rule does not affect the applicability of section 423(c), relating 
to the individual's recognition of compensation income, or section 1222, 
relating to what constitutes a short-term and long-term capital gain or 
loss.
    (e) Incorporation by reference. Any requirement that an option 
expressly contain or state a prescribed limitation or term will be 
considered met if such limitation or term is set forth in a statutory 
option plan and is incorporated by reference by the option. Thus, if a 
statutory option plan expressly provides that no option granted 
thereunder shall be exercisable after five years from the date of grant, 
and if an option granted thereunder expressly provides that the option 
is granted subject to the terms and limitations of such plan, the option 
will be regarded as being, by its terms, not exercisable after the 
expiration of 5 years from the date such option is granted.
    (f) Effective date--(1) In general. These regulations are effective 
on August 3, 2004.
    (2) Reliance and transition period. For statutory options granted on 
or before June 9, 2003, taxpayers may rely on the 1984 proposed 
regulations LR-279-81 (49 FR 4504), the 2003 proposed regulations REG-
122917-02 (68 FR 34344), or this section until the earlier of January 1, 
2006, or the first regularly scheduled stockholders meeting of the 
granting corporation occurring 6 months after August 3, 2004. For 
statutory options granted after June 9, 2003, and before the earlier of 
January 1, 2006, or the first regularly scheduled stockholders meeting 
of the granting corporation occurring at least 6 months after August 3, 
2004, taxpayers may rely on either REG-122917-02 or this section. 
Taxpayers may not rely on LR-279-81 or REG-122917-02 after December 31, 
2005. Reliance on LR-279-81, REG-122917-02, or this section must be in 
its entirety, and all statutory options granted during the reliance 
period must be treated consistently.

[T.D. 6887, 31 FR 8789, June 24, 1966. Redesignated and amended by T.D. 
9144, 69 FR 46406, Aug. 3, 2004; 69 FR 61310, Oct. 18, 2004; 69 FR 
70551, Dec. 7, 2004]

[[Page 1154]]



Sec. 1.422-1  Incentive stock options; general rules.

    (a) Applicability of section 421(a). (1)(i) Section 1.421-2(a) 
applies to the transfer of a share of stock to an individual pursuant to 
the individual's exercise of an incentive stock option if the following 
conditions are satisfied--
    (A) The individual makes no disposition of such share before the 
later of the expiration of the 2-year period from the date of grant of 
the option pursuant to which such share was transferred, or the 
expiration of the 1-year period from the date of transfer of such share 
to the individual; and
    (B) At all times during the period beginning on the date of grant of 
the option and ending on the day 3 months before the date of exercise, 
the individual was an employee of either the corporation granting the 
option, a related corporation of such corporation, or a corporation (or 
a related corporation of such corporation) substituting or assuming a 
stock option in a transaction to which Sec. 1.424-1(a) applies.
    (ii) For rules relating to the disposition of shares of stock 
acquired pursuant to the exercise of a statutory option, see Sec. 
1.424-1(c). For rules relating to the requisite employment relationship, 
see Sec. 1.421-1(h).
    (2)(i) The holding period requirement of section 422(a)(1), 
described in paragraph (a)(1)(i)(A) of this section, does not apply to 
the transfer of shares by an insolvent individual described in this 
paragraph (a)(2). If an insolvent individual holds a share of stock 
acquired pursuant to the individual's exercise of an incentive stock 
option, and if such share is transferred to a trustee, receiver, or 
other similar fiduciary in any proceeding under the Bankruptcy Act or 
any other similar insolvency proceeding, neither such transfer, nor any 
other transfer of such share for the benefit of the individual's 
creditors in such proceeding is a disposition of such share for purposes 
of this paragraph (a). For purposes of this paragraph (a)(2), an 
individual is insolvent only if the individual's liabilities exceed the 
individual's assets or the individual is unable to satisfy the 
individual's liabilities as they become due. See section 422(c)(3).
    (ii) A transfer by the trustee or other fiduciary that is not 
treated as a disposition for purposes of this paragraph (a) may be a 
sale or exchange for purposes of recognizing capital gain or loss with 
respect to the share transferred. For example, if the trustee transfers 
the share to a creditor in an insolvency proceeding, capital gain or 
loss must be recognized by the insolvent individual to the extent of the 
difference between the amount realized from such transfer and the 
adjusted basis of such share.
    (iii) If any transfer by the trustee or other fiduciary (other than 
a transfer back to the insolvent individual) is not for the exclusive 
benefit of the creditors in an insolvency proceeding, then whether such 
transfer is a disposition of the share by the individual for purposes of 
this paragraph (a) is determined under Sec. 1.424-1(c). Similarly, if 
the trustee or other fiduciary transfers the share back to the insolvent 
individual, any subsequent transfer of the share by such individual 
which is not made in respect of the insolvency proceeding may be a 
disposition of the share for purposes of this paragraph (a).
    (3) If the employee exercising an option ceased employment because 
of permanent and total disability, within the meaning of section 
22(e)(3), 1 year is used instead of 3 months in the employment period 
requirement of paragraph (a)(1)(i)(B) of this section.
    (b) Failure to satisfy holding period requirements--(1) General 
rule. For general rules concerning a disqualifying disposition of a 
share of stock acquired pursuant to the exercise of an incentive stock 
option, see Sec. 1.421-2(b)(1).
    (2)(i) Special rule. If an individual makes a disqualifying 
disposition of a share of stock acquired by the exercise of an incentive 
stock option, and if such disposition is a sale or exchange with respect 
to which a loss (if sustained) would be recognized to the individual, 
then, under this paragraph (b)(2)(i), the amount includible (determined 
without reduction for brokerage fees or other costs paid in connection 
with the disposition) in the gross income of such individual, and 
deductible from the income of the employer corporation (or a related 
corporation of such corporation, or of a corporation

[[Page 1155]]

substituting or assuming the option in a transaction to which Sec. 
1.424-1(a) applies) as compensation attributable to the exercise of such 
option, shall not exceed the excess (if any) of the amount realized on 
such sale or exchange over the adjusted basis of such share. Subject to 
the special rule provided by this paragraph (b)(2)(i), the amount of 
compensation attributable to the exercise of the option is determined 
under section 83(a); see Sec. 1.421-2(b)(1)(i).
    (ii) Limitation to special rule. The special rule described in 
paragraph (b)(2)(i) of this section does not apply if the disposition is 
a sale or exchange with respect to which a loss (if sustained) would not 
be recognized by the individual. Thus, for example, if a disqualifying 
disposition is a sale described in section 1091 (relating to loss from 
wash sales of stock or securities), a gift (or any other transaction 
which is not at arm's length), or a sale described in section 267(a)(1) 
(relating to sales between related persons), the special rule described 
in paragraph (b)(2)(i) of this section does not apply because a loss 
sustained in any such transaction would not be recognized.
    (3) Examples. The following examples illustrate the principles of 
this paragraph (b):

    Example 1. Disqualifying disposition of vested stock. On June 1, 
2006, X Corporation grants an incentive stock option to A, an employee 
of X Corporation, entitling A to purchase one share of X Corporation 
stock. On August 1, 2006, A exercises the option, and the share of X 
Corporation stock is transferred to A on that date. The option price is 
$100 (the fair market value of a share of X Corporation stock on June 1, 
2006), and the fair market value of a share of X Corporation stock on 
August 1, 2006 (the date of transfer) is $200. The share transferred to 
A is transferable and not subject to a substantial risk of forfeiture. A 
makes a disqualifying disposition by selling the share on June 1, 2007, 
for $250. The amount of compensation attributable to A's exercise is 
$100 (the difference between the fair market value of the share at the 
date of transfer, $200, and the amount paid for the share, $100). 
Because the amount realized ($250) is greater than the value of the 
share at transfer ($200), paragraph (b)(2)(i) of this section does not 
apply and thus does not affect the amount includible as compensation in 
A's gross income and deductible by X. A must include in gross income for 
the taxable year in which the sale occurred $100 as compensation and $50 
as capital gain ($250, the amount realized from the sale, less A's basis 
of $200 (the $100 paid for the share plus the $100 increase in basis 
resulting from the inclusion of that amount in A's gross income as 
compensation attributable to the exercise of the option)). If the 
requirements of section 83(h) and Sec. 1.83-6(a) are satisfied and the 
deduction is otherwise allowable under section 162, for its taxable year 
in which the disqualifying disposition occurs, X Corporation is allowed 
a deduction of $100 for compensation attributable to A's exercise of the 
incentive stock option.
    Example 2.@Disqualifying disposition of unvested stock. Assume the 
same facts as in Example 1, except that the share of X Corporation stock 
received by A is subject to a substantial risk of forfeiture and not 
transferable for a period of six months after such exercise. Assume 
further that the fair market value of X Corporation stock is $225 on 
February 1, 2007, the date on which the six-month restriction lapses. 
Because section 83 does not apply for ordinary income tax purposes on 
the date of exercise, A cannot make an effective section 83(b) election 
at that time (although such an election is permissible for alternative 
minimum tax purposes). Additionally, at the time of the disposition, 
section 422 and Sec. 1.422-1(a) no longer apply, and thus, section 
83(a) is used to measure the consequences of the disposition, and the 
holding period for capital gain purposes begins on the vesting date, six 
months after exercise. The amount of compensation attributable to A's 
exercise of the option and disqualifying disposition of the share is 
$125 (the difference between the fair market value of the share on the 
date that the restriction lapsed, $225, and the amount paid for the 
share, $100). Because the amount realized ($225) is greater than the 
value of the share at transfer ($200), paragraph (b)(2)(i) of this 
section does not apply and thus does not affect the amount includible as 
compensation in A's gross income and deductible by X. A must include 
$125 of compensation income and $25 of capital gain in gross income for 
the taxable year in which the disposition occurs ($250, the amount 
realized from the sale, less A's basis of $225 (the $100 paid for the 
share plus the $125 increase in basis resulting from the inclusion of 
that amount of compensation in A's gross income)). If the requirements 
of section 83(h) and Sec. 1.83-6(a) are satisfied and the deduction is 
otherwise allowable under section 162, for its taxable year in which the 
disqualifying disposition occurs, X Corporation is allowed a deduction 
of $125 for the compensation attributable to A's exercise of the option.
    Example 3. (i) Disqualifying disposition and application of special 
rule. Assume the same facts as in Example 1, except that A sells the 
share for $150 to M.

[[Page 1156]]

    (ii) If the sale to M is a disposition that meets the requirements 
of paragraph (b)(2)(i) of this section, instead of $100 which otherwise 
would have been includible as compensation under Sec. 1.83-7, under 
paragraph (b)(2)(i) of this section, A must include only $50 (the excess 
of the amount realized on such sale, $150, over the adjusted basis of 
the share, $100) in gross income as compensation attributable to the 
exercise of the incentive stock option. Because A's basis for the share 
is $150 (the $100 which A paid for the share, plus the $50 increase in 
basis resulting from the inclusion of that amount in A's gross income as 
compensation attributable to the exercise of the option), A realizes no 
capital gain or loss as a result of the sale. If the requirements of 
section 83(h) and Sec. 1.83-6(a) are satisfied and the deduction is 
otherwise allowable under section 162, for its taxable year in which the 
disqualifying disposition occurs, X Corporation is allowed a deduction 
of $50 for the compensation attributable to A's exercise of the option 
and disqualifying disposition of the share.
    (iii) Assume the same facts as in paragraph (i) of this Example 3, 
except that 10 days after the sale to M, A purchases substantially 
identical stock. Because under section 1091(a) a loss (if it were 
sustained on the sale) would not be recognized on the sale, under 
paragraph (b)(2)(ii) of this section, the special rule described in 
paragraph (b)(2)(i) of this section does not apply. A must include $100 
(the difference between the fair market value of the share on the date 
of transfer, $200, and the amount paid for the share, $100) in gross 
income as compensation attributable to the exercise of the option for 
the taxable year in which the disqualifying disposition occurred. A 
recognizes no capital gain or loss on the transaction. If the 
requirements of section 83(h) and Sec. 1.83-6(a) are satisfied and the 
deduction is otherwise allowable under section 162, for its taxable year 
in which the disqualifying disposition occurs X Corporation is allowed a 
$100 deduction for compensation attributable to A's exercise of the 
option and disqualifying disposition of the share.
    (iv) Assume the same facts as in paragraph (ii) of this Example 3, 
except that A sells the share for $50. Under paragraph (b)(2)(i) of this 
section, A is not required to include any amount in gross income as 
compensation attributable to the exercise of the option. A is allowed a 
capital loss of $50 (the difference between the amount realized on the 
sale, $50, and the adjusted basis of the share, $100). X Corporation is 
not allowed any deduction attributable to A's exercise of the option and 
disqualifying disposition of the share.

    (c) Failure to satisfy employment requirement. Section 1.421-2(a) 
does not apply to the transfer of a share of stock pursuant to the 
exercise of an incentive stock option if the employment requirement, as 
determined under paragraph (a)(1)(i)(B) of this section, is not met at 
the time of the exercise of such option. Consequently, the effects of 
such a transfer are determined under the rules of Sec. 1.83-7. For 
rules relating to the employment relationship, see Sec. 1.421-1(h).

[T.D. 9144, 69 FR 46411, Aug. 3, 2004; 69 FR 61310, Oct. 18, 2004; 69 FR 
70551, Dec. 7, 2004]



Sec. 1.422-2  Incentive stock options defined.

    (a) Incentive stock option defined--(1) In general. The term 
incentive stock option means an option that meets the requirements of 
paragraph (a)(2) of this section on the date of grant. An incentive 
stock option is also subject to the $100,000 limitation described in 
Sec. 1.422-4. An incentive stock option may contain a number of 
permissible provisions that do not affect the status of the option as an 
incentive stock option. See Sec. 1.422-5 for rules relating to 
permissible provisions of an incentive stock option.
    (2) Option requirements. To qualify as an incentive stock option 
under this section, an option must be granted to an individual in 
connection with the individual's employment by the corporation granting 
such option (or by a related corporation as defined in Sec. 1.421-
1(i)(2)), and granted only for stock of any of such corporations. In 
addition, the option must meet all of the following requirements--
    (i) It must be granted pursuant to a plan that meets the 
requirements described in paragraph (b) of this section;
    (ii) It must be granted within 10 years from the date of the 
adoption of the plan or the date such plan is approved by the 
stockholders, whichever is earlier (see paragraph (c) of this section);
    (iii) It must not be exercisable after the expiration of 10 years 
from the date of grant (see paragraph (d) of this section);
    (iv) It must provide that the option price per share is not less 
than the fair market value of the share on the date of grant (see 
paragraph (e) of this section);
    (v) By its terms, it must not be transferrable by the individual to

[[Page 1157]]

whom the option is granted other than by will or the laws of descent and 
distribution, and must be exercisable, during such individual's 
lifetime, only by such individual (see Sec. Sec. 1.421-1(b)(2) and 
1.421-2(c)); and
    (vi) Except as provided in paragraph (f) of this section, it must be 
granted to an individual who, at the time the option is granted, does 
not own stock possessing more than 10 percent of the total combined 
voting power of all classes of stock of the corporation employing such 
individual or of any related corporation of such corporation.
    (3) Amendment of option terms. Except as otherwise provided in Sec. 
1.424-1, the amendment of the terms of an incentive stock option may 
cause it to cease to be an option described in this section. If the 
terms of an option that has lost its status as an incentive stock option 
are subsequently changed with the intent to re-qualify the option as an 
incentive stock option, such change results in the grant of a new option 
on the date of the change. See Sec. 1.424-1(e).
    (4) Terms provide option not an incentive stock option. If the terms 
of an option, when granted, provide that it will not be treated as an 
incentive stock option, such option is not treated as an incentive stock 
option.
    (b) Option plan--(1) In general. An incentive stock option must be 
granted pursuant to a plan that meets the requirements of this paragraph 
(b). The authority to grant other stock options or other stock-based 
awards pursuant to the plan, where the exercise of such other options or 
awards does not affect the exercise of incentive stock options granted 
pursuant to the plan, does not disqualify such incentive stock options. 
The plan must be in writing or electronic form, provided that such 
writing or electronic form is adequate to establish the terms of the 
plan. See Sec. 1.422-5 for rules relating to permissible provisions of 
an incentive stock option.
    (2) Stockholder approval. (i) The plan required by this paragraph 
(b) must be approved by the stockholders of the corporation granting the 
incentive stock option within 12 months before or after the date such 
plan is adopted. Ordinarily, a plan is adopted when it is approved by 
the granting corporation's board of directors, and the date of the 
board's action is the reference point for determining whether 
stockholder approval occurs within the applicable 24-month period. 
However, if the board's action is subject to a condition (such as 
stockholder approval) or the happening of a particular event, the plan 
is adopted on the date the condition is met or the event occurs, unless 
the board's resolution fixes the date of approval as the date of the 
board's action.
    (ii) For purposes of paragraph (b)(2)(i) of this section, the 
stockholder approval must comply with the rules described in Sec. 
1.422-3.
    (iii) The provisions relating to the maximum aggregate number of 
shares to be issued under the plan (described in paragraph (b)(3) of 
this section) and the employees (or class or classes of employees) 
eligible to receive options under the plan (described in paragraph 
(b)(4) of this section) are the only provisions of a stock option plan 
that, if changed, must be re-approved by stockholders for purposes of 
section 422(b)(1). Any increase in the maximum aggregate number of 
shares that may be issued under the plan (other than an increase merely 
reflecting a change in the number of outstanding shares, such as a stock 
dividend or stock split), or change in the designation of the employees 
(or class or classes of employees) eligible to receive options under the 
plan is considered the adoption of a new plan requiring stockholder 
approval within the prescribed 24-month period. In addition, a change in 
the granting corporation or the stock available for purchase or award 
under the plan is considered the adoption of a new plan requiring new 
stockholder approval within the prescribed 24-month period. Any other 
changes in the terms of an incentive stock option plan are not 
considered the adoption of a new plan and, thus, do not require 
stockholder approval.
    (3) Maximum aggregate number of shares. (i) The plan required by 
this paragraph (b) must designate the maximum aggregate number of shares 
that may be issued under the plan through incentive stock options. If 
nonstatutory options or other stock-based awards may be granted, the 
plan may

[[Page 1158]]

separately designate terms for each type of option or other stock-based 
awards and designate the maximum number of shares that may be issued 
under such option or other stock-based awards. Unless otherwise 
specified, all terms of the plan apply to all options and other stock-
based awards that may be granted under the plan.
    (ii) A plan that merely provides that the number of shares that may 
be issued as incentive stock options under such plan may not exceed a 
stated percentage of the shares outstanding at the time of each offering 
or grant under such plan does not satisfy the requirement that the plan 
state the maximum aggregate number of shares that may be issued under 
the plan. However, the maximum aggregate number of shares that may be 
issued under the plan may be stated in terms of a percentage of the 
authorized, issued, or outstanding shares at the date of the adoption of 
the plan. The plan may specify that the maximum aggregate number of 
shares available for grants under the plan may increase annually by a 
specified percentage of the authorized, issued, or outstanding shares at 
the date of the adoption of the plan. A plan which provides that the 
maximum aggregate number of shares that may be issued as incentive stock 
options under the plan may change based on any other specified 
circumstances satisfies the requirements of this paragraph (b)(3) only 
if the stockholders approve an immediately determinable maximum 
aggregate number of shares that may be issued under the plan in any 
event.
    (iii) It is permissible for the plan to provide that, shares 
purchasable under the plan may be supplied to the plan through 
acquisitions of stock on the open market; shares purchased under the 
plan and forfeited back to the plan; shares surrendered in payment of 
the exercise price of an option; shares withheld for payment of 
applicable employment taxes and/or withholding obligations resulting 
from the exercise of an option.
    (iv) If there is more than one plan under which incentive stock 
options may be granted and stockholders of the granting corporation 
merely approve a maximum aggregate number of shares that are available 
for issuance under such plans, the stockholder approval requirements 
described in paragraph (b)(2) of this section are not satisfied. A 
separate maximum aggregate number of shares available for issuance 
pursuant to incentive stock options must be approved for each plan.
    (4) Designation of employees. The plan described in this paragraph 
(b), as adopted and approved, must indicate the employees (or class or 
classes of employees) eligible to receive the options or other stock-
based awards to be granted under the plan. This requirement is satisfied 
by a general designation of the employees (or the class or classes of 
employees) eligible to receive options or other stock-based awards under 
the plan. Designations such as ``key employees of the grantor 
corporation''; ``all salaried employees of the grantor corporation and 
its subsidiaries, including subsidiaries which become such after 
adoption of the plan;'' or ``all employees of the corporation'' meet 
this requirement. This requirement is considered satisfied even though 
the board of directors, another group, or an individual is given the 
authority to select the particular employees who are to receive options 
or other stock-based awards from a described class and to determine the 
number of shares to be optioned or granted to each such employee. If 
individuals other than employees may be granted options or other stock-
based awards under the plan, the plan must separately designate the 
employees or classes of employees eligible to receive incentive stock 
options.
    (5) Conflicting option terms. An option on stock available for 
purchase or grant under the plan is treated as having been granted 
pursuant to a plan even if the terms of the option conflict with the 
terms of the plan, unless such option is granted to an employee who is 
ineligible to receive options under the plan, options have been granted 
on stock in excess of the aggregate number of shares which may be issued 
under the plan, or the option provides otherwise.
    (6) The following examples illustrate the principles of this 
paragraph (b):

    Example 1. Stockholder approval. (i) S Corporation is a subsidiary 
of P Corporation, a

[[Page 1159]]

publicly traded corporation. On January 1, 2006, S adopts a plan under 
which incentive stock options for S stock are granted to S employees.
    (ii) To meet the requirements of paragraph (b)(2) of this section, 
the plan must be approved by the stockholders of S (in this case, P) 
within 12 months before or after January 1, 2006.
    (iii) Assume the same facts as in paragraph (i) of this Example 1, 
except that the plan was adopted on January 1, 2010. Assume further that 
the plan was approved by the stockholders of S (in this case, P) on 
March 1, 2010. On January 1, 2012, S changes the plan to provide that 
incentive stock options for P stock will be granted to S employees under 
the plan. Because there is a change in the stock available for grant 
under the plan, the change is considered the adoption of a new plan that 
must be approved by the stockholder of S (in this case, P) within 12 
months before or after January 1, 2012.
    Example 2. Stockholder approval. (i) Assume the same facts as in 
paragraph (i) of Example 1, except that on March 15, 2007, P completely 
disposes of its interest in S. Thereafter, S continues to grant options 
for S stock to S employees under the plan.
    (ii) The new S options are granted under a plan that meets the 
stockholder approval requirements of paragraph (b)(2) of this section 
without regard to whether S seeks approval of the plan from the 
stockholders of S after P disposes of its interest in S.
    (iii) Assume the same facts as in paragraph (i) of this Example 2, 
except that under the plan as adopted on January 1, 2006, only options 
for P stock are granted to S employees. Assume further that after P 
disposes of its interest in S, S changes the plan to provide for the 
grant of options for S stock to S employees. Because there is a change 
in the stock available for purchase or grant under the plan, under 
paragraph (b)(2)(iii) of this section, the stockholders of S must 
approve the plan within 12 months before or after the change to the plan 
to meet the stockholder approval requirements of paragraph (b) of this 
section.
    Example 3. Stockholder approval. (i) Corporation X maintains a plan 
under which incentive stock options may be granted to all eligible 
employees. Corporation Y does not maintain an incentive stock option 
plan. On May 15, 2006, Corporation X and Corporation Y consolidate under 
state law to form one corporation. The new corporation will be named 
Corporation Y. The consolidation agreement describes the Corporation X 
plan, including the maximum aggregate number of shares available for 
issuance pursuant to incentive stock options after the consolidation and 
the employees eligible to receive options under the plan. Additionally, 
the consolidation agreement states that the plan will be continued by 
Corporation Y after the consolidation and incentive stock options will 
be issued by Corporation Y. The consolidation agreement is unanimously 
approved by the shareholders of Corporations X and Y on May 1, 2006. 
Corporation Y assumes the plan formerly maintained by Corporation X and 
continues to grant options under the plan to all eligible employees.
    (ii) Because there is a change in the granting corporation (from 
Corporation X to Corporation Y), under paragraph (b)(2)(iii) of this 
section, Corporation Y is considered to have adopted a new plan. Because 
the plan is fully described in the consolidation agreement, including 
the maximum aggregate number of shares available for issuance pursuant 
to incentive stock options and employees eligible to receive options 
under the plan, the approval of the consolidation agreement by the 
shareholders constitutes approval of the plan. Thus, the shareholder 
approval of the consolidation agreement satisfies the shareholder 
approval requirements of paragraph (b)(2) of this section, and the plan 
is considered to be adopted by Corporation Y and approved by its 
shareholders on May 1, 2006.
    Example 4. Maximum aggregate number of shares. X Corporation 
maintains a plan under which statutory options and nonstatutory options 
may be granted. The plan designates the number of shares that may be 
used for incentive stock options. Because the maximum aggregate number 
of shares that will be used for incentive stock options is designated in 
the plan, the requirements of paragraph (b)(3) of this section are 
satisfied.
    Example 5. Maximum aggregate number of shares. Y Corporation adopts 
an incentive stock option plan on November 1, 2006. On that date, there 
are two million outstanding shares of Y Corporation stock. The plan 
provides that the maximum aggregate number of shares that may be issued 
under the plan may not exceed 15% of the outstanding number of shares of 
Y Corporation on November 1, 2006. Because the maximum aggregate number 
of shares that may be issued under the plan is designated in the plan, 
the requirements of paragraph (b)(3) of this section are met.
    Example 6. Maximum aggregate number of shares. (i) B Corporation 
adopts an incentive stock option plan on March 15, 2005. The plan 
provides that the maximum aggregate number of shares available for 
issuance under the plan is 50,000, increased on each anniversary date of 
the adoption of the plan by 5 percent of the then-outstanding shares.
    (ii) Because the maximum aggregate number of shares is not 
designated under the plan, the requirements of paragraph (b)(3) of this 
section are not met.
    (iii) Assume the same facts as in paragraph (i) of this Example 6, 
except that the plan provides that the maximum aggregate number of 
shares available under the plan is the

[[Page 1160]]

lesser of (a) 50,000 shares, increased each anniversary date of the 
adoption of the plan by 5 percent of the then-outstanding shares, or (b) 
200,000 shares. Because the maximum aggregate number of shares that may 
be issued under the plan is designated as the lesser of one of two 
numbers, one of which provides an immediately determinable maximum 
aggregate number of shares that may be issued under the plan in any 
event, the requirements of paragraph (b)(3) of this section are met.

    (c) Duration of option grants under the plan. An incentive stock 
option must be granted within 10 years from the date that the plan under 
which it is granted is adopted or the date such plan is approved by the 
stockholders, whichever is earlier. To grant incentive stock options 
after the expiration of the 10-year period, a new plan must be adopted 
and approved.
    (d) Period for exercising options. An incentive stock option, by its 
terms, must not be exercisable after the expiration of 10 years from the 
date such option is granted, or 5 years from the date such option is 
granted to an employee described in paragraph (f) of this section. An 
option that does not contain such a provision when granted is not an 
incentive stock option.
    (e) Option price. (1) Except as provided by paragraph (e)(2) of this 
section, the option price of an incentive stock option must not be less 
than the fair market value of the stock subject to the option at the 
time the option is granted. The option price may be determined in any 
reasonable manner, including the valuation methods permitted under Sec. 
20.2031-2 of this chapter, so long as the minimum price possible under 
the terms of the option is not less than the fair market value of the 
stock on the date of grant. For general rules relating to the option 
price, see Sec. 1.421-1(e). For rules relating to the determination of 
when an option is granted, see Sec. 1.421-1(c).
    (2)(i) If a share of stock is transferred to an individual pursuant 
to the exercise of an option which fails to qualify as an incentive 
stock option merely because there was a failure of an attempt, made in 
good faith, to meet the option price requirements of paragraph (e)(1) of 
this section, the requirements of such paragraph are considered to have 
been met. Whether there was a good-faith attempt to set the option price 
at not less than the fair market value of the stock subject to the 
option at the time the option was granted depends on the relevant facts 
and circumstances.
    (ii) For publicly held stock that is actively traded on an 
established market at the time the option is granted, determining the 
fair market value of such stock by the appropriate method described in 
Sec. 20.2031-2 of this chapter establishes that a good-faith attempt to 
meet the option price requirements of this paragraph (e) was made.
    (iii) For non-publicly traded stock, if it is demonstrated, for 
example, that the fair market value of the stock at the date of grant 
was based upon an average of the fair market values as of such date set 
forth in the opinions of completely independent and well-qualified 
experts, such a demonstration generally establishes that there was a 
good-faith attempt to meet the option price requirements of this 
paragraph (e). The optionee's status as a majority or minority 
stockholder may be taken into consideration.
    (iv) Regardless of whether the stock offered under an option is 
publicly traded, a good-faith attempt to meet the option price 
requirements of this paragraph (e) is not demonstrated unless the fair 
market value of the stock on the date of grant is determined with regard 
to nonlapse restrictions (as defined in Sec. 1.83-3(h)) and without 
regard to lapse restrictions (as defined in Sec. 1.83-3(i)).
    (v) Amounts treated as interest and amounts paid as interest under a 
deferred payment arrangement are not includible as part of the option 
price. See Sec. 1.421-1(e)(1). An attempt to set the option price at 
not less than fair market value is not regarded as made in good faith 
where an adjustment of the option price to reflect amounts treated as 
interest results in the option price being lower than the fair market 
value on which the option price was based.
    (3) Notwithstanding that the option price requirements of paragraphs 
(e)(1) and (2) of this section are satisfied by an option granted to an 
employee whose stock ownership exceeds the limitation provided by 
paragraph (f) of

[[Page 1161]]

this section, such option is not an incentive stock option when granted 
unless it also complies with paragraph (f) of this section. If the 
option, when granted, does not comply with the requirements described in 
paragraph (f) of this section, such option can never become an incentive 
stock option, even if the employee's stock ownership does not exceed the 
limitation of paragraph (f) of this section when such option is 
exercised.
    (f) Options granted to certain stockholders. (1) If, immediately 
before an option is granted, an individual owns (or is treated as 
owning) stock possessing more than 10 percent of the total combined 
voting power of all classes of stock of the corporation employing the 
optionee or of any related corporation of such corporation, then an 
option granted to such individual cannot qualify as an incentive stock 
option unless the option price is at least 110 percent of the stock's 
fair market value on the date of grant and such option by its terms is 
not exercisable after the expiration of 5 years from the date of grant. 
For purposes of determining the minimum option price for purposes of 
this paragraph (f), the rules described in paragraph (e)(2) of this 
section, relating to the good-faith determination of the option price, 
do not apply.
    (2) For purposes of determining the stock ownership of the optionee, 
the stock attribution rules of Sec. 1.424-1(d) apply. Stock that the 
optionee may purchase under outstanding options is not treated as stock 
owned by the individual. The determination of the percentage of the 
total combined voting power of all classes of stock of the employer 
corporation (or of its related corporations) that is owned by the 
optionee is made with respect to each such corporation in the related 
group by comparing the voting power of the shares owned (or treated as 
owned) by the optionee to the aggregate voting power of all shares of 
each such corporation actually issued and outstanding immediately before 
the grant of the option to the optionee. The aggregate voting power of 
all shares actually issued and outstanding immediately before the grant 
of the option does not include the voting power of treasury shares or 
shares authorized for issue under outstanding options held by the 
individual or any other person.
    (3) Examples. The rules of this paragraph (f) are illustrated by the 
following examples:

    Example 1. (i) E, an employee of M Corporation, owns 15,000 shares 
of M Corporation common stock, which is the only class of stock 
outstanding. M has 100,000 shares of its common stock outstanding. On 
January 1, 2005, when the fair market value of M stock is $100, E is 
granted an option with an option price of $100 and an exercise period of 
10 years from the date of grant.
    (ii) Because E owns stock possessing more than 10 percent of the 
total combined voting power of all classes of M Corporation stock, M 
cannot grant an incentive stock option to E unless the option is granted 
at an option price of at least 110 percent of the fair market value of 
the stock subject to the option and the option, by its terms, expires no 
later than 5 years from its date of grant. The option granted to E fails 
to meet the option-price and term requirements described in paragraph 
(f)(1) of this section and, thus, the option is not an incentive stock 
option.
    (iii) Assume the same facts as in paragraph (i) of this Example 1, 
except that E's father and brother each owns 7,500 shares of M 
Corporation stock, and E owns no M stock in E's own name. Because under 
the attribution rules of Sec. 1.424-1(d), E is treated as owning stock 
held by E's parents and siblings, M cannot grant an incentive stock 
option to E unless the option price is at least 110 percent of the fair 
market value of the stock subject to the option, and the option, by its 
terms, expires no later than 5 years from the date of grant.
    Example 2. Assume the same facts as in paragraph (i) of this Example 
1. Assume further that M is a subsidiary of P Corporation. Regardless of 
whether E owns any P stock and the number of P shares outstanding, if P 
Corporation grants an option to E which purports to be an incentive 
stock option, but which fails to meet the 110-percent-option-price and 
5-year-term requirements, the option is not an incentive stock option 
because E owns more than 10 percent of the total combined voting power 
of all classes of stock of a related corporation of P Corporation (i.e., 
M Corporation). An individual who owns (or is treated as owning) stock 
in excess of the ownership specified in paragraph (f)(1) of this 
section, in any corporation in a group of corporations consisting of the 
employer corporation and its related corporations, cannot be granted an 
incentive stock option by any corporation in the group unless such 
option meets the 110-percent-option-price and 5-

[[Page 1162]]

year-term requirements of paragraph (f)(1) of this section.
    Example 3. (i) F is an employee of R Corporation. R has only one 
class of stock, of which 100,000 shares are issued and outstanding. F 
owns no stock in R Corporation or any related corporation of R 
Corporation. On January 1, 2005, R grants a 10-year incentive stock 
option to F to purchase 50,000 shares of R stock at $3 per share, the 
fair market value of R stock on the date of grant of the option. On 
April 1, 2005, F exercises half of the January option and receives 
25,000 shares of R stock that previously were not outstanding. On July 
1, 2005, R grants a second 50,000 share option to F which purports to be 
an incentive stock option. The terms of the July option are identical to 
the terms of the January option, except that the option price is $3.25 
per share, which is the fair market value of R stock on the date of 
grant of the July option.
    (ii) Because F does not own more than 10% of the total combined 
voting power of all classes of stock of R Corporation or any related 
corporation on the date of the grant of the January option and the 
pricing requirements of paragraph (e) of this section are satisfied on 
the date of grant of such option, the unexercised portion of the January 
option remains an incentive stock option regardless of the changes in 
F's percentage of stock ownership in R after the date of grant. However, 
the July option is not an incentive stock option because, on the date 
that it is granted, F owns 20 percent (25,000 shares owned by F divided 
by 125,000 shares of R stock issued and outstanding) of the total 
combined voting power of all classes of R Corporation stock and, thus 
the pricing requirements of paragraph (f)(1) of this section are not 
met.
    (iii) Assume the same facts as in paragraph (i) of this Example 3 
except that the partial exercise of the January incentive stock option 
on April 1, 2003, is for only 10,000 shares. Under these circumstances, 
the July option is an incentive stock option, because, on the date of 
grant of the July option, F does not own more than 10 percent of the 
total combined voting power (10,000 shares owned by F divided by 110,000 
shares of R issued and outstanding) of all classes of R Corporation 
stock.

[T.D. 9144, 69 FR 46412, Aug. 3, 2004; T.D. 9471, 74 FR 59077, Nov. 17, 
2009]



Sec. 1.422-3  Stockholder approval of incentive stock option plans.

    This section addresses the stockholder approval of incentive stock 
option plans required by section 422(b)(1) of the Internal Revenue Code. 
(Section 422 was added to the Code as section 422A by section 251 of the 
Economic Recovery Tax Act of 1981, and was redesignated as section 422 
by section 11801 of the Omnibus Budget Reconciliation Act of 1990.) The 
approval of stockholders must comply with all applicable provisions of 
the corporate charter, bylaws, and applicable State law prescribing the 
method and degree of stockholder approval required for the issuance of 
corporate stock or options. If the applicable State law does not 
prescribe a method and degree of stockholder approval in such cases an 
incentive stock option plan must be approved:
    (a) By a majority of the votes cast at a duly held stockholders' 
meeting at which a quorum representing a majority of all outstanding 
voting stock is, either in person or by proxy, present and voting on the 
plan; or
    (b) By a method and in a degree that would be treated as adequate 
under applicable State law in the case of an action requiring 
stockholder approval (i.e., an action on which stockholders would be 
entitled to vote if the action were taken at a duly held stockholders' 
meeting).

[T.D. 8374, 56 FR 61160, Dec. 2, 1991. Redesignated by T.D. 9144, 69 FR 
46415, Aug. 3, 2004]



Sec. 1.422-4  $100,000 limitation for incentive stock options.

    (a) $100,000 per year limitation--(1) General rule. An option that 
otherwise qualifies as an incentive stock option nevertheless fails to 
be an incentive stock option to the extent that the $100,000 limitation 
described in paragraph (a)(2) of this section is exceeded.
    (2) $100,000 per year limitation. To the extent that the aggregate 
fair market value of stock with respect to which an incentive stock 
option (determined without regard to this section) is exercisable for 
the first time by any individual during any calendar year (under all 
plans of the employer corporation and related corporations) exceeds 
$100,000, such option is treated as a nonstatutory option. See Sec. 
1.83-7 for rules applicable to nonstatutory options.
    (b) Application. To determine whether the limitation described in 
paragraph (a)(2) of this section has been exceeded, the following rules 
apply:

[[Page 1163]]

    (1) An option that does not meet the requirements of Sec. 1.422-2 
when granted (including an option which, when granted, contains terms 
providing that it will not be treated as an incentive stock option) is 
disregarded. See Sec. 1.422-2(a)(4).
    (2) The fair market value of stock is determined as of the date of 
grant of the option for such stock.
    (3) Except as otherwise provided in paragraph (b)(4) of this 
section, options are taken into account in the order in which they are 
granted.
    (4) For purposes of this section, an option is considered to be 
first exercisable during a calendar year if the option will become 
exercisable at any time during the year assuming that any condition on 
the optionee's ability to exercise the option related to the performance 
of services is satisfied. If the optionee's ability to exercise the 
option in the year is subject to an acceleration provision, then the 
option is considered first exercisable in the calendar year in which the 
acceleration provision is triggered. After an acceleration provision is 
triggered, the options subject to such provision are then taken into 
account in accordance with paragraph (b)(3) of this section for purposes 
of applying the limitation described in paragraph (a)(2) of this section 
to all options first exercisable during a calendar year. However, 
because an acceleration provision is not taken into account prior to its 
triggering, an incentive stock option that becomes exercisable for the 
first time during a calendar year by operation of such a provision does 
not affect the application of the $100,000 limitation with respect to 
any option (or portion thereof) exercised prior to such acceleration. 
For purposes of this paragraph (b)(4), an acceleration provision 
includes, for example, a provision that accelerates the exercisability 
of an option on a change in ownership or control or a provision that 
conditions exercisability on the attainment of a performance goal. See 
paragraph (d), Example 4 of this section.
    (5)(i) An option (or portion thereof) is disregarded if, prior to 
the calendar year during which it would otherwise have become 
exercisable for the first time, the option (or portion thereof) is 
modified and thereafter ceases to be an incentive stock option described 
in Sec. 1.422-2, is canceled, or is transferred in violation of Sec. 
1.421-1(b)(2).
    (ii) If an option (or portion thereof) is modified, canceled, or 
transferred at any other time, such option (or portion thereof) is 
treated as outstanding according to its original terms until the end of 
the calendar year during which it would otherwise have become 
exercisable for the first time.
    (6) A disqualifying disposition has no effect on the determination 
of whether an option exceeds the $100,000 limitation.
    (c) Bifurcation--(1) Options. The application of the rules described 
in paragraph (b) of this section may result in an option being treated, 
in part, as an incentive stock option and, in part, as a nonstatutory 
option. See Sec. 1.83-7 for the treatment of nonstatutory options.
    (2) Stock. A corporation may issue a separate certificate for 
incentive option stock or designate such stock as incentive stock option 
stock in the corporation's transfer records or plan records. In such a 
case, the issuance of separate certificates or designation in the 
corporation's transfer records or plan records is not a modification 
under Sec. 1.424-1(e). In the absence of such an issuance or 
designation, shares are treated as first purchased under an incentive 
stock option to the extent of the $100,000 limitation, and the excess 
shares are treated as purchased under a nonstatutory option. See Sec. 
1.83-7 for the treatment of nonstatutory options.
    (d) Examples. The following examples illustrate the principles of 
this section. In each of the following examples E is an employee of X 
Corporation. The examples are as follows:

    Example 1. General rule. Effective January 1, 2004, X Corporation 
adopts a plan under which incentive stock options may be granted to its 
employees. On January 1, 2004, and each succeeding January 1 through 
January 1, 2013, E is granted immediately exercisable options for X 
Corporation stock with a fair market value of $100,000 determined on the 
date of grant. The options qualify as incentive stock options 
(determined without regard to this section). On January 1, 2014, E 
exercises all of the options. Because the $100,000 limitation has not 
been exceeded during any calendar year, all of the options are treated 
as incentive stock options.

[[Page 1164]]

    Example 2. Order of grant. X Corporation is a parent corporation of 
Y Corporation, which is a parent corporation of Z Corporation. Each 
corporation has adopted its own separate plan, under which an employee 
of any member of the corporate group may be granted options for stock of 
any member of the group. On January 1, 2004, X Corporation grants E an 
incentive stock option (determined without regard to this section) for 
stock of Y Corporation with a fair market value of $100,000 on the date 
of grant. On December 31, 2004, Y Corporation grants E an incentive 
stock option (determined without regard to this section) for stock of Z 
Corporation with a fair market value of $75,000 as of the date of grant. 
Both of the options are immediately exercisable. For purposes of this 
section, options are taken into account in the order in which granted 
using the fair market value of stock as of the date on the option is 
granted. During calendar year 2004, the aggregate fair market value of 
stock with respect to which E's options are exercisable for the first 
time exceeds $100,000. Therefore, the option for Y Corporation stock is 
treated as an incentive stock option, and the option for Z Corporation 
stock is treated as a nonstatutory option.
    Example 3. Acceleration provision. (i) In 2004, X Corporation grants 
E three incentive stock options (determined without regard to this 
section) to acquire stock with an aggregate fair market value of 
$150,000 on the date of grant. The dates of grant, the fair market value 
of the stock (as of the applicable date of grant) with respect to which 
the options are exercisable, and the years in which the options are 
first exercisable (without regard to acceleration provisions) are as 
follows:

------------------------------------------------------------------------
                                                Fair market
                                Date of grant     value of      First
                                                   stock     exercisable
------------------------------------------------------------------------
Option 1.....................  April 1, 2004..      $60,000         2004
Option 2.....................  May 1, 2004....       50,000         2006
Option 3.....................  June 1, 2004...       40,000         2004
------------------------------------------------------------------------

    (ii) In July of 2004, a change in control of X Corporation occurs, 
and, under the terms of its option plan, all outstanding options become 
immediately exercisable. Under the rules of this section, Option 1 is 
treated as an incentive stock option in its entirety; Option 2 exceeds 
the $100,000 aggregate fair market value limitation for calendar year 
2004 by $10,000 (Option 1's $60,000 + Option 2's $50,000 = $110,000) and 
is, therefore, bifurcated into an incentive stock option for stock with 
a fair market value of $40,000 as of the date of grant and a 
nonstatutory option for stock with a fair market value of $10,000 as of 
the date of grant. Option 3 is treated as a nonstatutory option in its 
entirety.
    Example 4. Exercise of option and acceleration provision. (i) In 
2004, X Corporation grants E three incentive stock options (determined 
without regard to this section) to acquire stock with an aggregate fair 
market value of $120,000 on the date of grant. The dates of grant, the 
fair market value of the stock (as of the applicable date of grant) with 
respect to which the options are exercisable, and the years in which the 
options are first exercisable (without regard to acceleration 
provisions) are as follows:

------------------------------------------------------------------------
                                                Fair market
                                Date of grant     value of      First
                                                   stock     exercisable
------------------------------------------------------------------------
Option 1.....................  April 1, 2004..      $60,000         2005
Option 2.....................  May 1, 2004....       40,000         2006
Option 3.....................  June 1, 2004...       20,000         2005
------------------------------------------------------------------------

    (ii) On June 1, 2005, E exercises Option 3. At the time of exercise 
of Option 3, the fair market value of X stock (at the time of grant) 
with respect to which options held by E are first exercisable in 2005 
does not exceed $100,000. On September 1, 2005, a change of control of X 
Corporation occurs, and, under the terms of its option plan, Option 2 
becomes immediately exercisable. Under the rules of this section, 
because E's exercise of Option 3 occurs before the change of control and 
the effects of an acceleration provision are not taken into account 
until it is triggered, Option 3 is treated as an incentive stock option 
in its entirety. Option 1 is treated as an incentive stock option in its 
entirety. Option 2 is bifurcated into an incentive stock option for 
stock with a fair market value of $20,000 on the date of grant and a 
nonstatutory option for stock with a fair market value of $20,000 on the 
date of grant because it exceeds the $100,000 limitation for 2003 by 
$20,000 (Option 1 for $60,000 + Option 3 for $20,000 + Option 2 for 
$40,000 = $120,000).

[[Page 1165]]

    (iii) Assume the same facts as in paragraph (ii) of this Example 4, 
except that the change of control occurs on May 1, 2005. Because options 
are taken into account in the order in which they are granted, Option 1 
and Option 2 are treated as incentive stock options in their entirety. 
Because the exercise of Option 3 (on June 1, 2005) takes place after the 
acceleration provision is triggered, Option 3 is treated as a 
nonstatutory option in its entirety.
    Example 5. Cancellation of option. (i) In 2004, X Corporation grants 
E three incentive stock options (determined without regard to this 
section) to acquire stock with an aggregate fair market value of 
$140,000 as of the date of grant. The dates of grant, the fair market 
value of the stock (as of the applicable date of grant) with respect to 
which the options are exercisable, and the years in which the options 
are first exercisable (without regard to acceleration provisions) are as 
follows:

------------------------------------------------------------------------
                                                Fair market
                                Date of grant     value of      First
                                                   stock     exercisable
------------------------------------------------------------------------
Option 1.....................  April 1, 2004..      $60,000         2005
Option 2.....................  May 1, 2004....       40,000         2005
Option 3.....................  June 1, 2004...       40,000         2005
------------------------------------------------------------------------

    (ii) On December 31, 2004, Option 2 is canceled. Because Option 2 is 
canceled before the calendar year during which it would have become 
exercisable for the first time, it is disregarded. As a result, Option 1 
and Option 3 are treated as incentive stock options in their entirety.
    (iii) Assume the same facts as in paragraph (ii) of this Example 5, 
except that Option 2 is canceled on January 1, 2005. Because Option 2 is 
not canceled prior to the calendar year during which it would have 
become exercisable for the first time (2005), it is treated as an 
outstanding option for purposes of determining whether the $100,000 
limitation for 2005 has been exceeded. Because options are taken into 
account in the order in which granted, Option 1 is treated as an 
incentive stock option in its entirety. Because Option 3 exceeds the 
$100,000 limitation by $40,000 (Option 1 for $60,000 + Option 2 for 
$40,000 + Option 3 for $40,000 = $140,000), it is treated as a 
nonstatutory option in its entirety.
    (iv) Assume the same facts as in paragraph (i) of this Example 5, 
except that on January 1, 2005, E exercises Option 2 and immediately 
sells the stock in a disqualifying disposition. A disqualifying 
disposition has no effect on the determination of whether the underlying 
option is considered outstanding during the calendar year during which 
it is first exercisable. Because options are taken into account in the 
order in which granted, Option 1 is treated as an incentive stock option 
in its entirety. Because Option 3 exceeds the $100,000 limitation by 
$40,000 (Option 1 for $60,000 + Option 2 for $40,000 + Option 3 for 
$40,000 = $140,000), it is treated as a nonstatutory option in its 
entirety.
    Example 6. Designation of stock. On January 1, 2004, X grants E an 
immediately exercisable incentive stock option (determined without 
regard to this section) to acquire X stock with a fair market value of 
$150,000 on that date. Under the rules of this section, the option is 
bifurcated and treated as an incentive stock option for X stock with a 
fair market value of $100,000 and a nonstatutory option for X stock with 
a fair market value of $50,000. In these circumstances, X may designate 
the stock that is treated as stock acquired pursuant to the exercise of 
an incentive stock option by issuing a separate certificate (or 
certificates) for $100,000 of stock and identifying such certificates as 
Incentive Stock Option Stock in its transfer records. In the absence of 
such a designation (or a designation in the corporation's transfer 
records or the plan records) shares with a fair market value of $100,000 
are deemed purchased first under an incentive stock option, and shares 
with a fair market value of $50,000 are deemed purchased under a 
nonstatutory option.

[T.D. 9144, 69 FR 46415, Aug. 3, 2004; 69 FR 70551, Dec. 7, 2004]



Sec. 1.422-5  Permissible provisions.

    (a) General rule. An option that otherwise qualifies as an incentive 
stock option does not fail to be an incentive stock option merely 
because such option contains one or more of the provisions described in 
paragraphs (b), (c), and (d) of this section.
    (b) Cashless exercise. (1) An option does not fail to be an 
incentive stock option merely because the optionee may exercise the 
option with previously acquired stock of the corporation that granted 
the option or stock of the corporation whose stock is being offered for 
purchase under the option. For special rules relating to the use of 
statutory option stock to pay the option price of an incentive stock 
option, see Sec. 1.424-1(c)(3).
    (2) All shares acquired through the exercise of an incentive stock 
option

[[Page 1166]]

are individually subject to the holding period requirements described in 
Sec. 1.422-1(a) and the disqualifying disposition rules of Sec. 1.422-
1(b), regardless of whether the option is exercised with previously 
acquired stock of the corporation that granted the option or stock of 
the corporation whose stock is being offered for purchase under the 
option. If an incentive stock option is exercised with such shares, and 
the exercise results in the basis allocation described in paragraph 
(b)(3) of this section, the optionee's disqualifying disposition of any 
of the stock acquired through such exercise is treated as a 
disqualifying disposition of the shares with the lowest basis.
    (3) If the exercise of an incentive stock option with previously 
acquired shares is comprised in part of an exchange to which section 
1036 (and so much of section 1031 as relates to section 1036) applies, 
then:
    (i) The optionee's basis in the incentive stock option shares 
received in the section 1036 exchange is the same as the optionee's 
basis in the shares surrendered in the exchange, increased, if 
applicable, by any amount included in gross income as compensation 
pursuant to sections 421 through 424 or section 83. Except for purposes 
of Sec. 1.422-1(a), the holding period of the shares is determined 
under section 1223. For purposes of Sec. 1.422-1 and sections 421(b) 
and 83 and the regulations thereunder, the amount paid for the shares 
purchased under the option is the fair market value of the shares 
surrendered on the date of the exchange.
    (ii) The optionee's basis in the incentive stock option shares not 
received pursuant to the section 1036 exchange is zero. For all 
purposes, the holding period of such shares begins as of the date that 
such shares are transferred to the optionee. For purposes of Sec. 
1.422-1(b) and sections 421(b) and 83 and the regulations thereunder, 
the amount paid for the shares is considered to be zero.
    (c) Additional compensation. An option does not fail to be an 
incentive stock option merely because the optionee has the right to 
receive additional compensation, in cash or property, when the option is 
exercised, provided such additional compensation is includible in income 
under section 61 or section 83. The amount of such additional 
compensation may be determined in any manner, including by reference to 
the fair market value of the stock at the time of exercise or to the 
option price.
    (d) Option subject to a condition. (1) An option does not fail to be 
an incentive stock option merely because the option is subject to a 
condition, or grants a right, that is not inconsistent with the 
requirements of Sec. Sec. 1.422-2 and 1.422-4.
    (2) An option that includes an alternative right is not an incentive 
stock option if the requirements of Sec. 1.422-2 are effectively 
avoided by the exercise of the alternative right. For example, an 
alternative right extending the option term beyond ten years, setting an 
option price below fair market value, or permitting transferability 
prevents an option from qualifying as an incentive stock option. If 
either of two options can be exercised, but not both, each such option 
is a disqualifying alternative right with respect to the other, even 
though one or both options would individually satisfy the requirements 
of Sec. Sec. 1.422-2, 1.422-4, and this section.
    (3) An alternative right to receive a taxable payment of cash and/or 
property in exchange for the cancellation or surrender of the option 
does not disqualify the option as an incentive stock option if the right 
is exercisable only when the then fair market value of the stock exceeds 
the exercise price of the option and the option is otherwise 
exercisable, the right is transferable only when the option is otherwise 
transferable, and the exercise of the right has economic and tax 
consequences no more favorable than the exercise of the option followed 
by an immediate sale of the stock. For this purpose, the exercise of the 
alternative right does not have the same economic and tax consequences 
if the payment exceeds the difference between the then fair market value 
of the stock and the exercise price of the option.
    (e) Examples. The principles of this section are illustrated by the 
following examples:

    Example 1. On June 1, 2004, X Corporation grants an incentive stock 
option to A, an employee of X Corporation, entitling A to

[[Page 1167]]

purchase 100 shares of X Corporation common stock at $10 per share. The 
option provides that A may exercise the option with previously acquired 
shares of X Corporation common stock. X Corporation has only one class 
of common stock outstanding. Under the rules of section 83, the shares 
transferable to A through the exercise of the option are transferable 
and not subject to a substantial risk of forfeiture. On June 1, 2005, 
when the fair market value of an X Corporation share is $25, A uses 40 
shares of X Corporation common stock, which A had purchased on the open 
market on June 1, 2002, for $5 per share, to pay the full option price. 
After exercising the option, A owns 100 shares of incentive stock option 
stock. Under section 1036 (and so much of section 1031 as relates to 
section 1036), 40 of the shares have a $200 aggregate carryover basis 
(the $5 purchase price x 40 shares) and a three-year holding period for 
purposes of determining capital gain, and 60 of the shares have a zero 
basis and a holding period beginning on June 1, 2005, for purposes of 
determining capital gain. All 100 shares have a holding period beginning 
on June 1, 2005, for purposes of determining whether the holding period 
requirements of Sec. 1.422-1(a) are met.
    Example 2. Assume the same facts as in Example 1. Assume further 
that, on September 1, 2005, A sells 75 of the shares that A acquired 
through exercise of the incentive stock option for $30 per share. 
Because the holding period requirements were not satisfied, A made a 
disqualifying disposition of the 75 shares on September 1, 2005. Under 
the rules of paragraphs (b)(2) and (b)(3) of this section, A has sold 
all 60 of the non-section-1036 shares and 15 of the 40 section-1036 
shares. Therefore, under paragraph (b)(3) of this section and section 
83(a), the amount of compensation attributable to A's exercise of the 
option and subsequent disqualifying disposition of 75 shares is $1,500 
(the difference between the fair market value of the stock on the date 
of transfer, $1,875 (75 shares at $25 per share), and the amount paid 
for the stock, $375 (60 shares at $0 per share plus 15 shares at $25 per 
share)). In addition, A must recognize a capital gain of $675, which 
consists of $375 ($450, the amount realized from the sale of 15 shares, 
less A's basis of $75) plus $300 ($1,800, the amount realized from the 
sale of 60 shares, less A's basis of $1,500 resulting from the inclusion 
of that amount in income as compensation). Accordingly, A must include 
in gross income for the taxable year in which the sale occurs $1,500 as 
compensation and $675 as capital gain. For its taxable year in which the 
disqualifying disposition occurs, if otherwise allowable under section 
162 and if the requirements of Sec. 1.83-6(a) are met, X Corporation is 
allowed a deduction of $1,500 for the compensation paid to A.
    Example 3. Assume the same facts as in Example 2, except that, 
instead of selling the 75 shares of incentive stock option stock on 
September 1, 2005, A uses those shares to exercise a second incentive 
stock option. The second option was granted to A by X Corporation on 
January 1, 2005, entitling A to purchase 100 shares of X Corporation 
common stock at $22.50 per share. As in Example 2, A has made a 
disqualifying disposition of the 75 shares of stock pursuant to Sec. 
1.424-1(c). Under paragraph (b) of this section, A has disposed of all 
60 of the non-section-1036 shares and 15 of the 40 section-1036 shares. 
Therefore, pursuant to paragraph (b)(3) of this section and section 
83(a), the amount of compensation attributable to A's exercise of the 
first option and subsequent disqualifying disposition of 75 shares is 
$1,500 (the difference between the fair market value of the stock on the 
date of transfer, $1,875 (75 shares at $25 per share), and the amount 
paid for the stock, $375 (60 shares at $0 per share plus 15 shares at 
$25 per share)). Unlike Example 2, A does not recognize any capital gain 
as a result of exercising the second option because, for all purposes 
other than the determination of whether the exercise is a disposition 
pursuant to section 424(c), the exercise is considered an exchange to 
which section 1036 applies. Accordingly, A must include in gross income 
for the taxable year in which the disqualifying disposition occurs 
$1,500 as compensation. If the requirements of Sec. 83(h) and Sec. 
1.83-6(a) are satisfied and the deduction is otherwise allowable under 
section 162, for its taxable year in which the disqualifying disposition 
occurs, X Corporation is allowed a deduction of $1,500 for the 
compensation paid to A. After exercising the second option, A owns a 
total of 125 shares of incentive stock option stock. Under section 1036 
(and so much of section 1031 as relates to section 1036), the 100 
``new'' shares of incentive stock option stock have the following bases 
and holding periods: 15 shares have a $75 carryover basis and a three-
year-and-three-month holding period for purposes of determining capital 
gain, 60 shares have a $1,500 basis resulting from the inclusion of that 
amount in income as compensation and a three-month holding period for 
purposes of determining capital gain, and 25 shares have a zero basis 
and a holding period beginning on September 1, 2005, for purposes of 
determining capital gain. All 100 shares have a holding period beginning 
on September 1, 2005, for purposes of determining whether the holding 
period requirements of Sec. 1.422-1(a) are met.
    Example 4. Assume the same facts as in Example 2, except that, 
instead of selling the 75 shares of incentive stock option stock on 
September 1, 2005, A uses those shares to exercise a nonstatutory 
option. The nonstatutory option was granted to A by X Corporation on 
January 1, 2005, entitling A to purchase 100 shares of X Corporation 
common

[[Page 1168]]

stock at $22.50 per share. Unlike Example 3, A has not made a 
disqualifying disposition of the 75 shares of stock. After exercising 
the nonstatutory option, A owns a total of 100 shares of incentive stock 
option stock and 25 shares of nonstatutory stock option stock. Under 
section 1036 (and so much of section 1031 as relates to section 1036), 
the 75 new shares of incentive stock option stock have the same basis 
and holding period as the 75 old shares used to exercise the 
nonstatutory option. The additional 25 shares of stock received upon 
exercise of the nonstatutory option are taxed under the rules of section 
83(a). Accordingly, A must include in gross income for the taxable year 
in which the transfer of such shares occurs $750 (25 shares at $30 per 
share) as compensation. A's basis in such shares is the same as the 
amount included in gross income. For its taxable year in which the 
transfer occurs, X Corporation is allowed a deduction of $750 for the 
compensation paid to A to the extent the requirements of section 83(h) 
and Sec. 1.83-6(a) are satisfied and the deduction is otherwise 
allowable under section 162.
    Example 5. Assume the same facts in Example 1, except that the 
shares transferred pursuant to the exercise of the incentive stock 
option are subject to a substantial risk of forfeiture and not 
transferable (substantially nonvested) for a period of six months after 
such transfer. Assume further that the shares that A uses to exercise 
the incentive stock option are similarly restricted. Such shares were 
transferred to A on January 1, 2005, through A's exercise of a 
nonstatutory stock option which was granted to A on January 1, 2004. A 
paid $5 per share for the stock when its fair market value was $22.50 
per share. A did not file a section 83(b) election to include the $700 
spread (the difference between the option price and the fair market 
value of the stock on date of exercise of the nonstatutory option) in 
gross income as compensation. After exercising the incentive stock 
option with the 40 substantially-nonvested shares, A owns 100 shares of 
substantially-nonvested incentive stock option stock. Section 1036 (and 
so much of section 1031 as relates to section 1036) applies to the 40 
shares exchanged in exercise of the incentive stock option. However, 
pursuant to section 83(g), the stock received in such exchange, because 
it is incentive stock option stock, is not subject to restrictions and 
conditions substantially similar to those to which the stock given in 
such exchange was subject. For purposes of section 83(a) and Sec. 1.83-
1(b)(1), therefore, A has disposed of the 40 shares of substantially-
nonvested stock on June 1, 2005, and must include in gross income as 
compensation $800 (the difference between the amount realized upon such 
disposition, $1,000, and the amount paid for the stock, $200). 
Accordingly, 40 shares of the incentive stock option stock have a $1,000 
basis (the $200 original basis plus the $800 included in income as 
compensation) and 60 shares of the incentive stock option stock have a 
zero basis. For its taxable year in which the disposition of the 
substantially-nonvested stock occurs, X Corporation is allowed a 
deduction of $800 for the compensation paid to A, provided the 
requirements of section 83(h) and Sec. 1.83-6(a) are satisfied and the 
deduction is otherwise allowable under section 162.

    (f) Effective/applicability date--(1) In general. Except for Sec. 
1.422-2(b)(6) Example 1 (iii), the regulations under this section are 
effective on August 3, 2004. Section 1.422-2(b)(6) Example 1 (iii) is 
effective on November 17, 2009. Section 1.422-2(b)(6) Example 1 (iii) 
applies to statutory options granted on or after January 1, 2010.
    (2) Reliance and transition period. For statutory options granted on 
or before June 9, 2003, taxpayers may rely on the 1984 proposed 
regulations LR-279-81 (49 FR 4504), the 2003 proposed regulations REG-
122917-02 (68 FR 34344), or this section until the earlier of January 1, 
2006, or the first regularly scheduled stockholders meeting of the 
granting corporation occurring 6 months after August 3, 2004. For 
statutory options granted after June 9, 2003, and before the earlier of 
January 1, 2006, or the first regularly scheduled stockholders meeting 
of the granting corporation occurring at least 6 months after August 3, 
2004, taxpayers may rely on either REG-122917-02 or this section. 
Taxpayers may not rely on LR-279-81 or REG-122917-02 after December 31, 
2005. Reliance on LR-279-81, REG-122917-02, or this section must be in 
its entirety, and all statutory options granted during the reliance 
period must be treated consistently.

[T.D. 9144, 69 FR 46417, Aug. 3, 2004; 69 FR 61310, Oct. 18, 2004; 69 FR 
70551, Dec. 7, 2004; T.D. 9471, 74 FR 59078, Nov. 17, 2009]



Sec. 1.423-1  Applicability of section 421(a).

    (a) General rule. Subject to the provisions of section 423(c) and 
Sec. 1.423-2(k), the special rules of income tax treatment provided in 
section 421(a) apply with respect to the transfer of a share of stock to 
an individual pursuant to the individual's exercise of an option granted 
under an employee stock purchase plan, as defined in Sec. 1.423-2, if 
the following conditions are satisfied--

[[Page 1169]]

    (1) The individual makes no disposition of such share before the 
later of the expiration of the two-year period from the date of the 
grant of the option pursuant to which such share was transferred or the 
expiration of the one-year period from the date of transfer of such 
share to the individual; and
    (2) At all times during the period beginning on the date of the 
grant of the option and ending on the day three months before the date 
of exercise, the individual was an employee of the corporation granting 
the option, a related corporation, or a corporation (or a related 
corporation) substituting or assuming the stock option in a transaction 
to which section 424(a) applies.
    (b) Cross-references. For rules relating to the requisite employment 
relationship, see Sec. 1.421-1(h). For rules relating to the effect of 
a disqualifying disposition, see section 421(b) and Sec. 1.421-2(b). 
For the definition of the term ``disposition,'' see section 424(c) and 
Sec. 1.424-1(c). For the definition of the term ``related 
corporation,'' see Sec. 1.421-1(i).
    (c) Effective/applicability date. The regulations under this section 
are effective on November 17, 2009. The regulations under this section 
apply to options granted under an employee stock purchase plan on or 
after January 1, 2010.

[T.D. 9471, 74 FR 59078, Nov. 17, 2009]



Sec. 1.423-2  Employee stock purchase plan defined.

    (a) In general--(1) The term ``employee stock purchase plan'' means 
a plan that meets the requirements of paragraphs (a)(2) and (a)(3) of 
this section. If the terms of the plan do not satisfy the requirements 
of paragraph (a)(3) of this section, then such requirements may be 
satisfied by the terms of an offering made under the plan. However, 
where the requirements of paragraph (a)(3) of this section are satisfied 
by the terms of an offering, such requirements will be treated as 
satisfied only with respect to options exercised under that offering. 
One or more offerings may be made under an employee stock purchase plan. 
Offerings may be consecutive or overlapping, and the terms of each 
offering need not be identical provided the terms of the plan and the 
offering together satisfy the requirements of paragraphs (a)(2) and 
(a)(3) of this section. The plan and the terms of an offering must be in 
writing or electronic form, provided that such writing or electronic 
form is adequate to establish the terms of the plan or offering, as 
applicable.
    (2) To satisfy the requirements of this paragraph (a)(2) and Sec. 
1.423-1, the plan must meet both of the following requirements--
    (i) The plan must provide that options can be granted only to 
employees of the employer corporation or of a related corporation (as 
defined in paragraph (i) of Sec. 1.421-1) to purchase stock in any such 
corporation (see paragraph (b) of this section); and
    (ii) The plan must be approved by the stockholders of the granting 
corporation within 12 months before or after the date the plan is 
adopted (see paragraph (c) of this section).
    (3) To satisfy the requirements of this paragraph (a)(3) and Sec. 
1.423-1, the terms of the plan or offering must meet all of the 
following requirements--
    (i) An employee cannot be granted an option if, immediately after 
the option is granted, the employee owns stock possessing 5 percent or 
more of the total combined voting power or value of all classes of stock 
of the employer corporation or of a related corporation (see paragraph 
(d) of this section);
    (ii) Options must be granted to all employees of any corporation 
whose employees are granted any options by reason of their employment by 
the corporation (see paragraph (e) of this section);
    (iii) All employees granted options must have the same rights and 
privileges (see paragraph (f) of this section);
    (iv) The option price cannot be less than the lesser of--
    (A) An amount equal to 85 percent of the fair market value of the 
stock at the time the option is granted, or
    (B) An amount not less than 85 percent of the fair market value of 
the stock at the time the option is exercised (see paragraph (g) of this 
section).
    (v) Options cannot be exercised after the expiration of--
    (A) Five years from the date the option is granted if, under the 
terms of such plan, the option price cannot be less than 85 percent of 
the fair market

[[Page 1170]]

value of the stock at the time the option is exercised, or
    (B) Twenty-seven months from the date the option is granted, if the 
option price is not determined in the manner described in paragraph 
(a)(3)(v)(A) of this section (see paragraph (h) of this section).
    (vi) No employee may be granted an option that permits the 
employee's rights to purchase stock under all employee stock purchase 
plans of the employer corporation and its related corporations to accrue 
at a rate that exceeds $25,000 of fair market value of the stock 
(determined at the time the option is granted) for each calendar year in 
which the option is outstanding at any time (see paragraph (i) of this 
section); and
    (vii) Options are not transferable by the optionee other than by 
will or the laws of descent and distribution, and are exercisable, 
during the lifetime of the optionee, only by the optionee (see paragraph 
(j) of this section).
    (4) The determination of whether a particular option is an option 
granted under an employee stock purchase plan is made at the time the 
option is granted. If the terms of an option are inconsistent with the 
terms of the employee stock purchase plan or the offering under the plan 
pursuant to which the option is granted, the option will not be treated 
as granted under an employee stock purchase plan. If an option with 
terms that are inconsistent with the terms of the plan or an offering 
under the plan is granted to an employee who is entitled to the grant of 
an option under the terms of the plan or offering, and the employee is 
not granted an option under the offering that qualifies as an option 
granted under an employee stock purchase plan, the offering will not 
meet the requirements of paragraph (e) of this section. Accordingly, 
none of the options granted under the offering will be eligible for the 
special tax treatment of section 421. However, if an option with terms 
that are inconsistent with the terms of the plan or an offering under 
the plan is granted to an individual who is not entitled to the grant of 
an option under the terms of the plan or offering, the option will not 
be treated as an option granted under an employee stock purchase plan 
but the grant of the option will not disqualify the options granted 
under the plan or offering. If, at the time of grant, an option 
qualifies as an option granted under an employee stock purchase plan, 
but after the time of grant one or more of the requirements of paragraph 
(a)(3) of this section is not satisfied with respect to the option, the 
option will not be treated as granted under an employee stock purchase 
plan but this failure to comply with the terms of the option will not 
disqualify the other options granted under the plan or offering.
    (5) Examples. The following examples illustrate the principles of 
paragraph (a):

    Example 1. Corporation A operates an employee stock purchase plan 
under which options for A stock are granted to employees of A. The terms 
of an offering provide that the option price will be 90 percent of the 
fair market value of A stock on the date of exercise. A grants an option 
under the offering to Employee Z, an employee of A. The terms of the 
option provide that the option price will be 85 percent of the fair 
market value of A stock on the date of exercise. Because the terms of 
Z's option are inconsistent with the terms of the offering, the option 
granted to Z will not be treated as an option granted under the employee 
stock purchase plan. Further, unless Z is granted an option under the 
offering that qualifies as an option granted under the employee stock 
purchase plan, the offering will not meet the requirements of paragraph 
(e) of this section and none of the options granted under the offering 
will be eligible for the special tax treatment of section 421.
    Example 2. Corporation B operates an employee stock purchase plan 
that provides that options for B stock may only be granted to employees 
of B. Under the terms of the plan, options may not be granted to 
consultants and other non-employees. B grants an option to Consultant Y, 
a consultant of B. Because Y is ineligible to receive an option under 
the plan because Y is not an employee, the grant of the option to Y is 
inconsistent with the terms of the plan and the option granted to Y will 
not be treated as an option granted under the employee stock purchase 
plan. However, the grant of the option to Y will not disqualify the 
options granted under the plan or any offering because Y was not 
entitled to the grant of an option under the plan.
    Example 3. Corporation C operates an employee stock purchase plan 
under which options for C stock are granted to employees of C. C grants 
an option pursuant to an offering

[[Page 1171]]

under the plan to Employee X, an employee of C who is a highly 
compensated employee. The terms of the employee stock purchase plan 
exclude highly compensated employees from participation in the plan. 
Because X is ineligible to receive an option under the plan by reason of 
X's exclusion from participation in the plan, the option granted to X 
will not be treated as an option granted under the employee stock 
purchase plan. However, the grant of the option to X will not disqualify 
the options granted under the plan or offering because X was not 
entitled to the grant of an option under the plan.
    Example 4. Corporation D operates an employee stock purchase plan 
under which options for D stock are granted to employees of D. D grants 
an option pursuant to an offering under the plan to Employee W, an 
employee of D. The terms of the option provide that the option price 
will be 90 percent of the fair market value of D stock on the date of 
exercise. On the date of exercise, W pays only 85 percent of the fair 
market value of D stock. Because the terms of W's option are not 
satisfied, the option granted to W will not be treated as an option 
granted under the employee stock purchase plan. However, the failure to 
comply with the terms of the option granted to W will not disqualify the 
options granted under the plan or offering.

    (b) Options restricted to employees. An employee stock purchase plan 
must provide that options can be granted only to employees of the 
employer corporation (or employees of its related corporations) to 
purchase stock in the employer corporation (or one of its related 
corporations). If such a provision is not included in the terms of the 
plan, the plan will not be an employee stock purchase plan and options 
granted under the plan will not qualify for the special tax treatment of 
section 421. For rules relating to the employment requirement, see Sec. 
1.421-1(h).
    (c) Stockholder approval--(1) An employee stock purchase plan must 
be approved by the stockholders of the granting corporation within 12 
months before or after the date such plan is adopted. The approval of 
the stockholders must comply with all applicable provisions of the 
corporate charter and bylaws and of applicable State law prescribing the 
method and degree of stockholder approval required for the issuance of 
corporate stock or options. If the applicable State law does not 
prescribe a method and degree of stockholder approval, then an employee 
stock purchase plan must be approved--
    (i) By a majority of the votes cast at a duly held stockholder's 
meeting at which a quorum representing a majority of all outstanding 
voting stock is, either in person or by proxy, present and voting on the 
plan; or
    (ii) By a method and in a degree that would be treated as adequate 
under applicable State law in the case of an action requiring 
stockholder approval (such as, an action on which stockholders would be 
entitled to vote if the action were taken at a duly held stockholders' 
meeting).
    (2) For purposes of the stockholder approval required by this 
paragraph (c), ordinarily, a plan is adopted when it is approved by the 
granting corporation's board of directors, and the date of the board's 
action is the reference point for determining whether stockholder 
approval occurs within the applicable 24-month period. However, if the 
board's action is subject to a condition (such as stockholder approval) 
or the happening of a particular event, the plan is adopted on the date 
the condition is met or the event occurs, unless the board's resolution 
fixes the date of adoption as the date of the board's action.
    (3) An employee stock purchase plan, as adopted and approved, must 
designate the maximum aggregate number of shares that may be issued 
under the plan, and the corporations or class of corporations whose 
employees may be offered options under the plan. A plan that merely 
provides that the number of shares that may be issued under the plan may 
not exceed a stated percentage of the shares outstanding at the time of 
each offering or grant under the plan does not satisfy the requirements 
of this paragraph (c)(3). However, the maximum aggregate number of 
shares that may be issued under the plan may be stated in terms of a 
percentage of the authorized, issued, or outstanding shares on the date 
of the adoption of the plan. The plan may specify that the maximum 
aggregate number of shares available for grants under the plan may 
increase annually by a specified percentage of the authorized, issued, 
or outstanding shares on the date of the adoption of the plan. A

[[Page 1172]]

plan that provides that the maximum aggregate number of shares that may 
be issued as options under the plan may change based on any other 
specific circumstances satisfies the requirements of this paragraph only 
if the stockholders approve an immediately determinable maximum number 
of shares that may be issued under the plan in any event. If there is 
more than one employee stock purchase plan under which options may be 
granted and stockholders of the granting corporation merely approve a 
maximum aggregate number of shares that are available for issuance under 
the plans, the stockholder approval requirements described in paragraph 
(c)(1) of this section are not satisfied. A separate maximum aggregate 
number of shares available for issuance pursuant to options must be 
specified and approved for each plan.
    (4) Once an employee stock purchase plan is approved by the 
stockholders of the granting corporation, the plan need not be 
reapproved by the stockholders of the granting corporation unless the 
plan is amended or changed in a manner that is considered the adoption 
of a new plan, in which case the plan must be reapproved within the 
prescribed 24-month period. Any increase in the aggregate number of 
shares that may be issued under the plan (other than an increase merely 
reflecting a change in the number of outstanding shares, such as a stock 
dividend or stock split) will be considered the adoption of a new plan 
requiring stockholder approval within the prescribed 24-month period. 
Similarly, a change in the designation of corporations whose employees 
may be offered options under the plan will be considered the adoption of 
a new plan requiring stockholder approval within the prescribed 24-month 
period unless the plan provides that designations of participating 
corporations may be made from time to time from among a group consisting 
of the granting corporation and its related corporations. The group from 
among which such changes and designations are permitted without 
additional stockholder approval may include corporations having become 
parents or subsidiaries of the granting corporation after the adoption 
and approval of the plan. In addition, a change in the granting 
corporation or the stock available for purchase under the plan will be 
considered the adoption of a new plan requiring stockholder approval 
within the prescribed 24-month period. Any other changes in the terms of 
an employee stock purchase plan are not considered the adoption of a new 
plan and, thus, do not require stockholder approval.
    (5) Examples. The following examples illustrate the principles of 
this paragraph (c):

    Example 1. (i) Corporation E is a subsidiary of Corporation F, a 
publicly traded corporation. On January 1, 2010, E adopts an employee 
stock purchase plan under which options for E stock are granted to E 
employees.
    (ii) To meet the requirements of paragraph (c)(1) of this section, 
the plan must be approved by the stockholders of E (in this case, F) 
within 12 months before or after January 1, 2010.
    (iii) Assume the same facts as in paragraph (i) of this Example 1, 
except that the plan was approved by the stockholders of E (in this 
case, F) on March 1, 2010. On January 1, 2012, E changes the plan to 
provide that options for F stock will be granted to E employees under 
the plan. Because there is a change in the stock available for grant 
under the plan, under paragraph (c)(4) of this section, the change is 
considered the adoption of a new plan that must be approved by the 
stockholders of E (in this case, F) within 12 months before or after 
January 1, 2012.
    Example 2. (i) Assume the same facts as in paragraph (i) of Example 
1, except that on March 15, 2011, F completely disposes of its interest 
in E. Thereafter, E continues to grant options for E stock to E 
employees under the plan.
    (ii) The new E options are granted under a plan that meets the 
stockholder approval requirements of paragraph (c)(1) of this section 
without regard to whether E seeks approval of the plan from the 
stockholders of E after F disposes of its interest in E.
    (iii) Assume the same facts as in paragraph (i) of this Example 2, 
except that under the plan as adopted on January 1, 2010, only options 
for F stock are granted to E employees. Assume further that, after F 
disposes of its interest in E, E changes the plan to provide for the 
grant of options for E stock to E employees. Because there is a change 
in the stock available for purchase or grant under the plan, under 
paragraph (c)(4) of this section, the stockholders of E must approve the 
plan within 12 months before or after the change to the plan to meet the 
stockholder approval requirements of paragraph (c) of this section.

[[Page 1173]]

    Example 3. (i) Corporation G maintains an employee stock purchase 
plan providing options for G stock. Corporation H does not maintain an 
employee stock purchase plan. On May 15, 2010, G and H consolidate under 
State law to form one corporation. The new corporation is named 
Corporation H. The consolidation agreement describes the G plan, 
including the maximum aggregate number of shares available for issuance 
under the plan after the consolidation. Additionally, the consolidation 
agreement states that the plan will be continued by H after the 
consolidation. The consolidation agreement is approved by the 
stockholders of G and H on May 1, 2010. H assumes the plan formerly 
maintained by G and continues to grant options under the plan to all 
eligible employees, but the options are for H stock.
    (ii) Because there is a change in the granting corporation (from G 
to H) and the stock available for purchase, under paragraph (c)(4) of 
this section, H is considered to have adopted a new plan. Because the 
plan is fully described in the consolidation agreement, including the 
maximum aggregate number of shares available for issuance under the 
plan, the approval of the consolidation agreement by the stockholders 
constitutes approval of the plan. Thus, the stockholder approval of the 
consolidation agreement satisfies the stockholder approval requirements 
of paragraph (c)(1) of this section, and the plan is considered to be 
adopted by H and approved by its stockholders on May 1, 2010.
    Example 4. Corporation I adopts an employee stock purchase plan on 
November 1, 2010. On that date, there are two million shares of I stock 
outstanding. The plan provides that the maximum aggregate number of 
shares that may be issued under the plan may not exceed 15 percent of 
the number of shares of I stock outstanding on November 1, 2010. Because 
the maximum aggregate number of shares that may be issued under the plan 
is designated in the plan, the requirements of paragraph (c)(3) of this 
section are met.
    Example 5. (i) Corporation J adopts an employee stock purchase plan 
on March 15, 2010. The plan provides that the maximum aggregate number 
of shares of J stock available for issuance under the plan is 50,000, 
increased on each anniversary date of the adoption of the plan by 5 
percent of the then outstanding shares. Because the maximum aggregate 
number of shares is not designated under the plan, the requirements of 
paragraph (c)(3) of this section are not met.
    (ii) Assume the same facts as in paragraph (i) of this Example 5, 
except that the plan provides that the maximum aggregate number of 
shares available under the plan is the lesser of (a) 50,000 shares, 
increased each anniversary date of the adoption of the plan by 5 percent 
of the then-outstanding shares, or (b) 200,000 shares. Because the 
maximum aggregate number of shares that may be issued under the plan is 
designated as the lesser of two numbers, one of which provides an 
immediately determinable maximum aggregate number of shares that may be 
issued under the plan in any event, the requirements of paragraph (c)(3) 
of this section are met.

    (d) Options granted to certain shareholders--(1) An employee stock 
purchase plan or offering must, by its terms, provide that an employee 
cannot be granted an option if the employee, immediately after the 
option is granted, owns stock possessing 5 percent or more of the total 
combined voting power or value of all classes of stock of the employer 
corporation or a related corporation. In determining whether the stock 
ownership of an employee equals or exceeds this 5 percent limit, the 
rules of section 424(d) (relating to attribution of stock ownership) 
shall apply, and stock that the employee may purchase under outstanding 
options (whether or not the options qualify for the special tax 
treatment afforded by section 421(a)) shall be treated as stock owned by 
the employee. An option is outstanding for purposes of this paragraph 
(d) although under its terms it may be exercised only in installments or 
after the expiration of a fixed period of time. If an option is granted 
to an employee whose stock ownership (as determined under this paragraph 
(d)) exceeds the limitation set forth in this paragraph (d), no portion 
of the option will be treated as having been granted under an employee 
stock purchase plan.
    (2) The determination of the percentage of the total combined voting 
power or value of all classes of stock of the employer corporation (or a 
related corporation) that is owned by the employee is made by comparing 
the voting power or value of the shares owned (or treated as owned) by 
the employee to the aggregate voting power or value of all shares 
actually issued and outstanding immediately after the grant of the 
option to the employee. The aggregate voting power or value of all 
shares actually issued and outstanding immediately after the grant of 
the option does not include the voting power or value of treasury shares 
or shares authorized for issue under outstanding options held by the 
employee or any other person.

[[Page 1174]]

    (3) Examples. The following examples illustrate the principles of 
this paragraph (d):

    Example 1. Employee V, an employee of Corporation K, owns 6,000 
shares of K common stock, the only class of K stock outstanding. K has 
100,000 shares of its common stock outstanding. Because V owns 6 percent 
of the combined voting power or value of all classes of K stock, K 
cannot grant an option to V under K's employee stock purchase plan. If 
V's father and brother each owned 3,000 shares of K stock and V did not 
own any K stock, then the result would be the same because, under 
section 424(d), an individual is treated as owning stock held by the 
person's father and brother. Similarly, the result would be the same if, 
instead of actually owning 6,000 shares, V merely held an option on 
6,000 shares of K stock, irrespective of whether the transfer of stock 
under the option could qualify for the special tax treatment of section 
421, because this paragraph (d) provides that stock the employee may 
purchase under outstanding options is treated as stock owned by such 
employee.
    Example 2. Assume the same facts as in Example 1, except that K is a 
50 percent subsidiary corporation of Corporation L. Irrespective of 
whether V owns any L stock, V cannot receive an option from L under L's 
employee stock purchase plan because he owns 5 percent of the total 
combined voting power of all classes of stock of a subsidiary of L, in 
this example, K. An employee who owns (or is treated as owning) stock in 
excess of the limitation of this paragraph (d), in any corporation in a 
group of related corporations, consisting of a parent and its subsidiary 
corporations, cannot receive an option under an employee stock purchase 
plan from any corporation in the group.
    Example 3. Employee U is an employee of Corporation M. M has only 
one class of stock, of which 100,000 shares are issued and outstanding. 
Assuming U does not own (and is not treated as owning) any stock in M or 
in any related corporation of M, M may grant an option to U under its 
employee stock purchase plan for 4,999 shares, because immediately after 
the grant of the option, U would not own 5 percent or more of the 
combined voting power or value of all classes of M stock actually issued 
and outstanding at such time. The 4,999 shares that U would be treated 
as owning under this paragraph (d) would not be added to the 100,000 
shares actually issued and outstanding immediately after the grant for 
purposes of determining whether U's stock ownership exceeds the 
limitation of this paragraph (d).
    Example 4. Assume the same facts as in Example 3 but instead of an 
option for 4,999 shares, M grants U an option, purportedly under its 
employee stock purchase plan, for 5,000 shares. No portion of this 
option will be treated as granted under an employee stock purchase plan 
because U's stock ownership exceeds the limitation of this paragraph 
(d).

    (e) Employees covered by plan--(1) Subject to the provisions of this 
paragraph (e) and the limitations of paragraphs (d), (f) and (i) of this 
section, an employee stock purchase plan or offering must, by its terms, 
provide that options are to be granted to all employees of any 
corporation whose employees are granted any of such options by reason of 
their employment by that corporation, except that one or more of the 
following categories of employees may be excluded from the coverage of 
the plan or offering--
    (i) Employees who have been employed less than two years;
    (ii) Employees whose customary employment is 20 hours or less per 
week;
    (iii) Employees whose customary employment is for not more than five 
months in any calendar year; and
    (iv) Highly compensated employees (within the meaning of section 
414(q)).
    (2) A plan or offering does not fail to satisfy the coverage 
provision of paragraph (e)(1) of this section in the following 
circumstances--
    (i) The plan or offering excludes employees who have completed a 
shorter period of service or whose customary employment is for fewer 
hours per week or fewer months in a calendar year than is specified in 
paragraphs (e)(1)(i), (ii) and (iii) of this section, provided the 
exclusion is applied in an identical manner to all employees of every 
corporation whose employees are granted options under the plan or 
offering.
    (ii) The plan or offering excludes highly compensated employees 
(within the meaning of section 414(q)) with compensation above a certain 
level or who are officers or subject to the disclosure requirements of 
section 16(a) of the Securities Exchange Act of 1934, provided the 
exclusion is applied in an identical manner to all highly compensated 
employees of every corporation whose employees are granted options under 
the plan or offering.
    (3) Notwithstanding paragraph (e)(1) of this section, employees who 
are citizens or residents of a foreign jurisdiction (without regard to 
whether they are also citizens of the United States

[[Page 1175]]

or resident aliens (within the meaning of section 7701(b)(1)(A))) may be 
excluded from the coverage of an employee stock purchase plan or 
offering under the following circumstances--
    (i) The grant of an option under the plan or offering to a citizen 
or resident of the foreign jurisdiction is prohibited under the laws of 
such jurisdiction; or
    (ii) Compliance with the laws of the foreign jurisdiction would 
cause the plan or offering to violate the requirements of section 423.
    (4) No option granted under a plan or offering that excludes from 
participation any employees, other than those who may be excluded under 
this paragraph (e), and those barred from participation by reason of 
paragraphs (d), (f) and (i) of this section, can be regarded as having 
been granted under an employee stock purchase plan. If an option is not 
granted to any employee who is entitled to the grant of an option under 
the terms of the plan or offering, none of the options granted under 
such offering will be treated as having been granted under an employee 
stock purchase plan. However, a plan that, by its terms, permits all 
eligible employees to elect to participate in an offering will not 
violate the requirements of this paragraph solely because eligible 
employees who elect not to participate in the offering are not granted 
options pursuant to such offering.
    (5) For purposes of this paragraph (e), the existence of the 
employment relationship between an individual and the corporation 
participating under the plan will be determined under Sec. 1.421-1(h).
    (6) Examples. The following examples illustrate the principles of 
this paragraph (e):

    Example 1. Corporation N has a stock purchase plan that meets all 
the requirements of paragraphs (a)(2) and (a)(3) of this section except 
that options are not required to be granted to employees whose weekly 
rate of pay is less than $1,000. As a matter of corporate practice, 
however, N grants options under its plan to all employees, irrespective 
of their weekly rate of pay. Even though N's plan is operated in 
compliance with the requirements of this paragraph (e), N's plan is not 
an employee stock purchase plan because the terms of the plan exclude a 
category of employees that is not permitted under this paragraph (e).
    Example 2. Assume the same facts as in Example 1, except that the 
first offering under N's plan provides that options will be granted to 
all employees of N. The terms of the first offering will be treated as 
part of the terms of N's plan, but only for purposes of the first 
offering. Because the terms of the first offering satisfy the 
requirements of this paragraph (e), stock transferred pursuant to 
options exercised under the first offering will be treated as stock 
transferred pursuant to the exercise of options granted under an 
employee stock purchase plan for purposes of section 421.
    Example 3. Corporation O has a stock purchase plan that excludes 
from participation all employees who have been employed less than one 
year. Assuming all other requirements of paragraphs (a)(2) and (a)(3) of 
this section are satisfied, O's plan qualifies as an employee stock 
purchase plan under section 423.
    Example 4. Corporation P has a stock purchase plan that excludes 
from participation clerical employees who have been employed less than 
two years. However, non-clerical employees with less than two years of 
service are permitted to participate in the plan. P's plan is not an 
employee stock purchase plan because the exclusion of employees who have 
been employed less than two years applies only to certain employees of P 
and is not applied in an identical manner to all employees of P. If, 
instead, P's plan excludes from participation all employees (both 
clerical and non-clerical) who have been employed less than two years, 
then P's plan would qualify as an employee stock purchase plan under 
section 423 assuming all other requirements of paragraphs (a)(2) and 
(a)(3) of this section are satisfied.
    Example 5. Corporation Q has a stock purchase plan that excludes 
from participation all officers who are highly compensated employees 
(within the meaning of section 414(q)). Assuming all other requirements 
of paragraphs (a)(2) and (a)(3) of this section are satisfied, Q's plan 
qualifies as an employee stock purchase plan under section 423.
    Example 6. Corporation R maintains an employee stock purchase plan 
that excludes from participation all highly compensated employees 
(within the meaning of section 414(q)), except highly compensated 
employees who are officers of R. R's plan is not an employee stock 
purchase plan because the exclusion of all highly compensated employees 
except highly compensated employees who are officers of R is not a 
permissible exclusion under paragraph (e)(2)(ii) of this section.
    Example 7. Corporation S is the parent corporation of Subsidiary YY 
and Subsidiary ZZ. S maintains an employee stock purchase plan with both 
YY and ZZ participating in

[[Page 1176]]

the same offering under the plan. Under the terms of the offering under 
the plan, all employees of YY and ZZ are permitted to participate in the 
plan with the exception of ZZ's highly compensated employees with annual 
compensation greater than $300,000. None of the options granted under 
the offering will be considered granted under an employee stock purchase 
plan because the exclusion of highly compensated employees with annual 
compensation greater than $300,000 is not applied in an identical manner 
to all employees of YY and ZZ granted options in the same offering.
    Example 8. Assume the same facts as in Example 7, except that 
Corporation S establishes separate offerings under the plan for YY and 
ZZ. Under the terms of the separate offering for YY, all employees of YY 
are permitted to participate in the plan. Under the terms of the 
separate offering established for ZZ, all employees of ZZ are permitted 
to participate in the plan with the exception of ZZ's highly compensated 
employees with annual compensation greater than $300,000. The options 
granted under the separate offering for YY will be considered granted 
under an employee stock purchase plan. Further, the options granted 
under the separate offering for ZZ will be considered granted under an 
employee stock purchase plan because the exclusion of highly compensated 
employees with annual compensation greater than $300,000 is applied in 
an identical manner to all employees of ZZ granted options in the same 
offering.
    Example 9. The laws of Country A require that options granted to 
residents of Country A be transferable during the lifetime of the option 
recipient. Corporation T has a stock purchase plan that excludes 
residents of Country A from participation in the plan. Because 
compliance with the laws of Country A would cause options granted to 
residents of Country A to violate paragraph (j) of this section, T may 
exclude residents of Country A from participation in the plan. Assuming 
all other requirements of paragraph (a)(2) of this section are 
satisfied, T's plan qualifies as an employee stock purchase plan under 
section 423.

    (f) Equal rights and privileges--(1) Except as otherwise provided in 
paragraphs (f)(2) through (f)(6) of this section, an employee stock 
purchase plan or offering must, by its terms, provide that all employees 
granted options under the plan or offering shall have the same rights 
and privileges. Thus, the provisions applying to one option under an 
offering (such as the provisions relating to the method of payment for 
the stock and the determination of the purchase price per share) must 
apply to all other options under the offering in the same manner. If all 
the options granted under a plan or offering do not, by their terms, 
give the respective optionees the same rights and privileges, none of 
the options will be treated as having been granted under an employee 
stock purchase plan for purposes of section 421.
    (2) The requirements of this paragraph (f) do not prevent the 
maximum amount of stock that an employee may purchase from being 
determined on the basis of a uniform relationship to the total 
compensation, or the basic or regular rate of compensation, of all 
employees.
    (3) A plan or offering will not fail to satisfy the requirements of 
this paragraph (f) because the plan or offering provides that no 
employee may purchase more than a maximum amount of stock fixed under 
the plan or offering.
    (4) A plan or offering will not fail to satisfy the requirements of 
this paragraph (f) if, in order to comply with the laws of a foreign 
jurisdiction, the terms of an option granted under a plan or offering to 
citizens or residents of such foreign jurisdiction (without regard to 
whether they are also citizens of the United States or resident aliens 
(within the meaning of section 7701(b)(1)(A))) are less favorable than 
the terms of options granted under the same plan or offering to 
employees resident in the United States.
    (5)(i) Except as provided in this paragraph and paragraph (f)(5)(ii) 
of this section, a plan or offering permitting one or more employees to 
carry forward amounts that were withheld but not applied toward the 
purchase of stock under an earlier plan or offering and apply the 
amounts towards the purchase of additional stock under a subsequent plan 
or offering will be a violation of the equal rights and privileges under 
paragraph (f)(1) of this section. However, the carry forward of amounts 
withheld but not applied toward the purchase of stock under an earlier 
plan or offering will not violate the equal rights and privileges 
requirement of paragraph (f)(1) of this section, if all other employees 
participating in

[[Page 1177]]

the current plan or offering are permitted to make direct payments 
toward the purchase of shares under a subsequent plan or offering in an 
amount equal to the excess of the greatest amount which any employee is 
allowed to carry forward from an earlier plan or offering over the 
amount, if any, the employee will carry forward from an earlier plan or 
offering.
    (ii) A plan or offering will not fail to satisfy the requirements of 
this section merely because employees are permitted to carry forward 
amounts representing a fractional share, that were withheld but not 
applied toward the purchase of stock under an earlier plan or offering 
and apply the amounts toward the purchase of additional stock under a 
subsequent plan or offering.
    (6) Paragraph (f) does not prohibit the delaying of the grant of an 
option to any employee who is barred from being granted an option solely 
by reason of the employee's failing to meet a minimum service 
requirement set forth in paragraph (e)(1) of this section until the 
employee meets such requirement.
    (7) Examples. The following examples illustrate the principles of 
this paragraph (f):

    Example 1. Corporation U has an employee stock purchase plan that 
provides that the maximum amount of stock that each employee may 
purchase under the offering is one share for each $100 of annual gross 
pay. The plan meets the requirements of this paragraph (f).
    Example 2. Corporation V has an employee stock purchase plan that 
provides that the maximum amount of stock that each employee may 
purchase under the offering is one share for each $100 of annual gross 
pay up to and including $10,000, and two shares for each $100 of annual 
gross pay in excess of $10,000. The plan will not meet the requirements 
of this paragraph (f) because the amount of stock that may be purchased 
under the plan is not based on a uniform relationship to the total 
compensation of all employees.
    Example 3. Corporation W has an employee stock purchase plan that 
provides that options to purchase stock in an amount equal to ten 
percent of an employee's annual salary at a price equal to 85 percent of 
the fair market value on the first day of the offering will be granted 
to all employees other than those who have been employed less than 18 
months. In addition, the plan provides that employees who have not yet 
met the minimum service requirements on the first day of the offering 
will be granted similar options on the date the 18 month service 
requirement has been attained. The plan meets the requirements of this 
paragraph (f).
    Example 4. Corporation X is the parent corporation of Subsidiary AA, 
Subsidiary BB and Subsidiary CC. X maintains an employee stock purchase 
plan with AA, BB and CC participating in the same offering under the 
plan. Under the terms of the offering under the plan, options to 
purchase stock at a price equal to 90 percent of the fair market value 
at the time the option is exercised will be granted to all employees. 
Certain employees of AA are residents of Country B. The laws of Country 
B provide that options granted to employees who are residents of Country 
B must have a purchase price not less than 95 percent of the fair market 
value at the time the option is exercised. The plan will not fail to 
satisfy the requirements of this paragraph (f) merely because the 
residents of Country B are granted options under the plan to purchase 
stock at a price equal to 95 percent of the fair market value at the 
time the option is exercised.
    Example 5. Assume the same facts as in Example 4, except that 
Corporation X establishes two separate offerings under the plan: A 
separate offering for the employees of AA and a separate offering for 
the employees of BB and CC. Under the separate offering for the 
employees of BB and CC, options are granted to all employees with an 
exercise price equal to 90 percent of the fair market value at the time 
the option is exercised. Under the separate offering for the employees 
of AA, options are granted to all employees with an exercise price equal 
to 95 percent of the fair market value at the time the option is 
exercised. The plan does not violate the equal rights and privileges 
requirement of this paragraph (f) merely because the exercise price of 
options granted under one offering is less than the exercise price of 
options granted under a separate offering.
    Example 6. Corporation Y maintains an employee stock purchase plan. 
Employee T is employed by Y. T is granted an option under the current 
offering to purchase a maximum of 100 shares of Y stock at an option 
price equal to 85 percent of the fair market value of the stock at 
exercise. The plan permits the carry forward of withheld but unused 
amounts from an earlier offering. Prior to the exercise date, $2000 of 
T's salary has been withheld and is available to be applied toward the 
purchase of Y stock. On the exercise date, the fair market value of Y 
stock is $20 per share. T is able to purchase 100 shares of Y stock at 
$17 per share for an aggregate purchase price of $1700. T can carry 
forward $300 to the subsequent offering. Each employee in the subsequent 
offering other than T will be permitted to make direct payments

[[Page 1178]]

toward the purchase of shares under the subsequent offering in a maximum 
amount of $300 less any amount the employee has carried forward from an 
earlier offering. The plan does not violate the equal rights and 
privileges requirement of this paragraph (f).

    (g) Option price--(1) An employee stock purchase plan or offering 
must, by its terms, provide that the option price will not be less than 
the lesser of--
    (i) An amount equal to 85 percent of the fair market value of the 
stock at the time the option is granted, or
    (ii) An amount that under the terms of the option may not be less 
than 85 percent of the fair market value of the stock at the time the 
option is exercised.
    (2) For purposes of determining the option price, the fair market 
value of the stock may be determined in any reasonable manner, including 
the valuation methods permitted under Sec. 20.2031-2. However, the 
option price must meet the minimum pricing requirements of this 
paragraph (g). For general rules relating to the option price, see Sec. 
1.421-1(e). For rules relating to the determination of when an option is 
granted, see Sec. Sec. 1.421-1(c) and 1.423-2(h)(2). Any option that 
does not meet the minimum pricing requirements of this paragraph (g) 
will not be treated as an option granted under an employee stock 
purchase plan irrespective of whether the plan or offering satisfies 
those requirements. If an option that does not meet the minimum pricing 
requirements is granted to an employee who is entitled to the grant of 
an option under the terms of the plan or offering, and the employee is 
not granted an option under such offering that qualifies as an option 
granted under an employee stock purchase plan, the offering will not 
meet the requirements of paragraph (e) of this section. Accordingly, 
none of the options granted under the offering will be eligible for the 
special tax treatment of section 421.
    (3) The option price may be stated either as a percentage or as a 
dollar amount. If the option price is stated as a dollar amount, then 
the requirement of this paragraph (g) can only be met by a plan or 
offering in which the price is fixed at not less than 85 percent of the 
fair market value of the stock at the time the option is granted. If the 
fixed price is less than 85 percent of the fair market value of the 
stock at grant, then the option cannot meet the requirement of this 
paragraph (g) even if a decline in the fair market value of the stock 
results in such fixed price being not less than 85 percent of the fair 
market value of the stock at the time the option is exercised, because 
that result was not certain to occur under the terms of the option.
    (4) Examples. The following examples illustrate the principles of 
this paragraph (g):

    Example 1. Corporation Z has an employee stock purchase plan that 
provides that the option price will be 85 percent of the fair market 
value of the stock on the first day of the offering (which is the date 
of grant in this case), or 85 percent of the fair market value of the 
stock at exercise, whichever amount is the lesser. Upon the exercise of 
an option issued under Z's plan, Z agrees to accept an option price that 
is less than the minimum amount allowable under the terms of such plan. 
Notwithstanding that the option was issued under an employee stock 
purchase plan, the transfer of stock pursuant to the exercise of such 
option does not satisfy the requirement of this paragraph (g) and cannot 
qualify for the special tax treatment of section 421.
    Example 2. Corporation AA has an employee stock purchase plan that 
provides that the option price is set at 85 percent of the fair market 
value of AA stock at exercise, but not less than $80 per share. On the 
first day of the offering (which is the date of grant in this case), the 
fair market value of AA stock is $100 per share. The option satisfies 
the requirement of this paragraph (g), and can qualify for the special 
tax treatment of section 421.
    Example 3. Assume the same facts as in Example 2, except that the 
option price is set at 85 percent of the fair market value of AA stock 
at exercise, but not more than $80 per share. This option cannot satisfy 
the requirement of this paragraph (g) irrespective of whether, at the 
time the option is exercised, 85 percent of the fair market value of AA 
stock is $80 or less.

    (h) Option period--(1) An employee stock purchase plan or offering 
must, by its terms, provide that options granted under the plan cannot 
be exercised after the expiration of 27 months from the date of grant 
unless, under the terms of the plan or offering, the option price is not 
less than 85 percent

[[Page 1179]]

of the fair market value of the stock at the time of the exercise of the 
option. If the option price is not less than 85 percent of the fair 
market value of the stock at the time the option is exercised, then the 
option period provided under the plan must not exceed five years from 
the date of grant. If the requirements of this paragraph (h) are not met 
by the terms of the plan or offering, then options issued under such 
plan or offering will not be treated as options granted under an 
employee stock purchase plan irrespective of whether the options, by 
their terms, are exercisable beyond the period allowable under this 
paragraph (h). An option that provides that the option price is not less 
than 85 percent of the fair market value of the stock at exercise may 
have an option period of 5 years irrespective of whether the fair market 
value of the stock at exercise is more or less than the fair market 
value of the stock at grant. However, if the option provides that the 
option price is 85 percent of the fair market value of the stock at 
exercise, but not more than some other fixed amount determined in 
accordance with the provisions of paragraph (g) of this section, then 
irrespective of the price paid on exercise, the option period must not 
be more than 27 months.
    (2) Section 1.421-1(c) provides that, for purposes of Sec. Sec. 
1.421-1 through 1.424-1, the language ``the date of the granting of the 
option'' and the ``time such option is granted,'' and similar phrases 
refer to the date or time when the granting corporation completes the 
corporate action constituting an offer of stock for sale to an 
individual under the terms and conditions of a statutory option. With 
respect to options granted under an employee stock purchase plan, the 
principles of Sec. 1.421-1(c) shall be applied without regard to the 
requirement that the minimum option price must be fixed or determinable 
in order for the corporate action constituting an offer of stock to be 
considered complete.
    (3) The date of grant will be the first day of an offering if the 
terms of an employee stock purchase plan or offering designate a maximum 
number of shares that may be purchased by each employee during the 
offering. Similarly, the date of grant will be the first day of an 
offering if the terms of the plan or offering require the application of 
a formula to establish, on the first day of the offering, the maximum 
number of shares that may be purchased by each employee during the 
offering. It is not required that an employee stock purchase plan or 
offering designate a maximum number of shares that may be purchased by 
each employee during the offering or incorporate a formula to establish 
a maximum number of shares that may be purchased by each employee during 
the offering. If the maximum number of shares that can be purchased 
under an option is not fixed or determinable until the date the option 
is exercised, then the date of exercise will be the date of grant of the 
option.
    (4) Examples. The following examples illustrate the principles of 
this paragraph (h):

    Example 1. (i) Corporation BB has an employee stock purchase plan 
that provides that the option price will be the lesser of 85 percent of 
the fair market value of the stock on the first day of an offering or 85 
percent of the fair market value of the stock on the last day of the 
offering. Options are exercised on the last day of the offering. One 
million shares of BB stock are reserved for issuance under the plan. The 
plan provides that no employee may be permitted to purchase stock under 
the plan at a rate that exceeds $25,000 in fair market value of the BB 
stock (determined on the date of grant) for each calendar year during 
which an option granted to the employee is outstanding. The terms of 
each option granted under an offering provide that a maximum of 500 
shares may be purchased by the option recipient during the offering. 
Because the maximum number of shares that can be purchased under the 
option is fixed and determinable on the first day of the offering, the 
date of grant for the option is the first day of the offering.
    (ii) Assume the same facts as in paragraph (i) of Example 1, except 
that BB's plan excludes all employees who have been employed less than 
18 months. The plan provides that employees who have not yet met the 
minimum service requirements on the first day of an offering will be 
granted an option on the date the 18-month service requirement has been 
attained. With respect to those employees who have been employed less 
than 18 months on the first day of an offering, the date of grant for 
the option is the date the 18-month service requirement has been 
attained.

[[Page 1180]]

    Example 2. Assume the same facts as in paragraph (i) of Example 1, 
except that the terms of each option granted do not provide that a 
maximum of 500 shares may be purchased by the option recipient during 
the offering. Notwithstanding the fixed number of shares reserved for 
issuance under the plan and the $25,000 limitation set forth in the 
plan, the maximum number of shares that can be purchased under the 
option is not fixed or determinable until the last day of the offering 
when the option is exercised. Therefore the date of grant for the option 
is the last day of the offering when the option is exercised.
    Example 3. Corporation CC has an employee stock purchase plan that 
provides that the option price will be 85 percent of the fair market 
value of the stock on the last day of the offering. Options are 
exercised on the last day of the offering. Each offering under the plan 
begins on January 1 and ends on December 31 of the same calendar year. 
The terms of each option granted under an offering provide that the 
maximum number of shares that may be purchased by any employee during 
the offering equals $25,000 divided by the fair market value of the 
stock on the first day of the offering. The maximum number of shares 
that can be purchased under the option is fixed and determinable on the 
first day of the offering and therefore the date of grant for the option 
is the first day of the offering.
    Example 4. Assume the same facts as in Example 3 except that the 
terms of each option granted under an offering provide that the maximum 
number of shares that may be purchased by any employee during the 
offering equals 10 percent of the employee's annual salary (determined 
as of January 1 of the year in which the offering commences) divided by 
the fair market value of the stock on the first day of the offering. The 
maximum number of shares that can be purchased under the option is fixed 
and determinable on the first day of the offering and therefore the date 
of grant for the option is the first day of the offering.

    (i) Annual $25,000 limitation--(1) An employee stock purchase plan 
or offering must, by its terms, provide that no employee may be 
permitted to purchase stock under all the employee stock purchase plans 
of the employer corporation and its related corporations at a rate that 
exceeds $25,000 in fair market value of the stock (determined at the 
time the option is granted) for each calendar year in which any option 
granted to the employee is outstanding at any time. In applying the 
foregoing limitation--
    (i) The right to purchase stock under an option accrues when the 
option (or any portion thereof) first becomes exercisable during the 
calendar year;
    (ii) The right to purchase stock under an option accrues at the rate 
provided in the option, but in no case may such rate exceed $25,000 of 
fair market value of such stock (determined at the time such option is 
granted) for any one calendar year; and
    (iii) A right to purchase stock that has accrued under one option 
granted pursuant to the plan may not be carried over to any other 
option.
    (2) If an option is granted under an employee stock purchase plan 
that satisfies the requirement of this paragraph (i), but the option 
gives the optionee the right to buy stock in excess of the maximum rate 
allowable under this paragraph (i), then no portion of the option will 
be treated as having been granted under an employee stock purchase plan. 
Furthermore, if the option was granted to an employee entitled to the 
grant of an option under the terms of the plan or offering, and the 
employee is not granted an option under the offering that qualifies as 
an option granted under an employee stock purchase plan, then the 
offering will not meet the requirements of paragraph (e) of this 
section. Accordingly, none of the options granted under the offering 
will be eligible for the special tax treatment of section 421.
    (3) The limitation of this paragraph (i) applies only to options 
granted under employee stock purchase plans and does not limit the 
amount of stock that an employee may purchase under incentive stock 
options (as defined in section 422(b)) or any other stock options except 
those to which section 423 applies. Stock purchased under options to 
which section 423 does not apply will not limit the amount that an 
employee may purchase under an employee stock purchase plan, except for 
purposes of the 5-percent stock ownership provision of paragraph (d) of 
this section.
    (4) Under the limitation of this paragraph (i), an employee may 
purchase up to $25,000 of stock (based on the fair market value of the 
stock at the time the option was granted) in each calendar year during 
which an option

[[Page 1181]]

granted to the employee under an employee stock purchase plan is 
outstanding. Alternatively, an employee may purchase more than $25,000 
of stock (based on the fair market value of such stock at the time the 
option was granted) in a calendar year, so long as the total amount of 
stock that the employee purchases does not exceed $25,000 in fair market 
value of the stock (determined at the time the option was granted) for 
each calendar year in which any option was outstanding. If, in any 
calendar year, the employee holds two or more outstanding options 
granted under employee stock purchase plans of the employer corporation, 
or a related corporation, then the employee's purchases of stock 
attributable to that year under all options granted under employee stock 
purchase plans must not exceed $25,000 in fair market value of the stock 
(determined at the time the options were granted). Under an employee 
stock purchase plan, an employee may not purchase stock in anticipation 
that the option will be outstanding in some future year. Thus, the 
employee may purchase only the amount of stock that does not exceed the 
limitation of this paragraph (i) for the year of the purchase and for 
preceding years during which the option was outstanding. Thus, the 
amount of stock that may be purchased under an option depends on the 
number of years in which the option is actually outstanding. The amount 
of stock that may be purchased under an employee stock purchase plan may 
not be increased by reason of the failure to grant an option in an 
earlier year under such plan, or by reason of the failure to exercise an 
earlier option. For example, if an option is granted to an individual 
and expires without having been exercised at all, then the failure to 
exercise the option does not increase the amount of stock which such 
individual may be permitted to purchase under an option granted in a 
year following the year of such expiration. If an option granted under 
an employee stock purchase plan is outstanding in more than one calendar 
year, then stock purchased pursuant to the exercise of such an option 
will be applied first, to the extent allowable under this paragraph (i), 
against the $25,000 limitation for the earliest year in which the option 
was outstanding, then, against the $25,000 limitation for each 
succeeding year, in order.
    (5) Examples. The following examples illustrate the principles of 
this paragraph (i):

    Example 1. Assume that Corporation DD maintains an employee stock 
purchase plan and that Employee S is employed by DD. On June 1, 2010, DD 
grants S an option under the plan to purchase a total of 750 shares of 
DD stock at $85 per share. On that date, the fair market value of DD 
stock is $100 per share. The option provides that it may be exercised at 
any time but cannot be exercised after May 31, 2012. Under this 
paragraph (i), the option must not permit S to purchase more than 250 
shares of DD stock during the calendar year 2010, because 250 shares are 
equal to $25,000 in fair market value of DD stock determined at the time 
of grant. During the calendar year 2011, S may purchase under the option 
an amount of DD stock equal to the difference between $50,000 in fair 
market value of DD stock (determined at the time the option was granted) 
and the fair market value of DD stock (determined at the time of grant 
of the option) purchased during the year 2010. During the calendar year 
2012, S may purchase an amount of DD stock equal to the difference 
between $75,000 in fair market value of the stock (determined at the 
time of grant of the option) and the total amount of the fair market 
value of the stock (determined at the time of grant of the option) 
purchased under the option during the calendar years 2010 and 2011. S 
may purchase $25,000 of stock for the year 2010, and $25,000 of stock 
for the year 2012, although the option was outstanding for only a part 
of each of such years. However, S may not be granted another option 
under an employee stock purchase plan of DD or a related corporation to 
purchase stock of DD or a related corporation during the calendar years 
2010, 2011, and 2012, so long as the option granted June 1, 2010, is 
outstanding.
    Example 2. Assume the same facts as in Example 1, except that the 
option granted to S in 2010 is terminated in 2011 without any part of 
the option having been exercised, and that subsequent to the termination 
and during 2011, S is granted another option under DD's employee stock 
purchase plan. Under that option, S may be permitted to purchase $25,000 
of stock for 2011. The failure of S to exercise the option granted to S 
in 2010, does not increase the amount of stock that S may be permitted 
to purchase under the option granted to S in 2011.
    Example 3. Assume the same facts as in Example 1, except that, on 
May 31, 2012, S exercised the option granted to S in 2010, and

[[Page 1182]]

purchased 600 shares of DD stock. Five hundred shares, the maximum 
amount of stock that could have been purchased in 2011, under the 
option, are treated as having been purchased for the years 2010 and 
2011. Only 100 shares of the stock are treated as having been purchased 
for 2012. After S's exercise of the option on May 31, 2012, S is granted 
another option under DD's employee stock purchase plan. S may be 
permitted under the new option to purchase for 2012 stock having a fair 
market value of no more than $15,000 at the time the new option is 
granted.
    Example 4. Corporation EE maintains an employee stock purchase plan 
and Employee R is employed by EE. On August 1, 2010, EE grants R an 
option under the plan to purchase 150 shares of EE stock at $85 per 
share during each of the calendar years 2010, 2011, and 2012. On that 
date, the fair market value of EE stock is $100 per share. The option 
provides that it may be exercised at any time during years 2010, 2011, 
and 2012. Because this option permits R to purchase only $15,000 of EE's 
stock for each year the option is outstanding, R could be granted 
another option by EE, or by a related corporation, in year 2010, 
permitting R to purchase an additional $10,000 of stock during each of 
the calendar years 2010, 2011, and 2012.
    Example 5. Corporation FF maintains an employee stock purchase plan 
and Employee Q is employed by FF. On September 1, 2010, FF grants Q an 
option under the plan that will be automatically exercised on August 31, 
2011, and August 31, 2012. The terms of the option provide that no more 
than 150 shares may be purchased on each date that the option is 
automatically exercised. On August 31, 2011, Q may purchase under the 
option an amount of FF stock equal to $50,000 in fair market value of FF 
stock (determined at the time the option was granted). On August 31, 
2012, Q may purchase under the option an amount of FF stock equal to the 
difference between $75,000 in fair market value of FF stock (determined 
at the time the option was granted) and the fair market value of FF 
stock (determined at the time of grant of the option) purchased during 
year 2011.

    (j) Restriction on transferability. An employee stock purchase plan 
or offering must, by its terms, provide that options granted under the 
plan are not transferable by the optionee other than by will or the laws 
of descent and distribution, and must be exercisable, during the 
optionee's lifetime, only by the optionee. For general rules relating to 
the restriction on transferability required by this paragraph (j), see 
Sec. 1.421-1(b)(2). For a limited exception to the requirement of this 
paragraph (j), see section 424(h)(3).
    (k) Special rule where option price is between 85 percent and 100 
percent of value of stock--(1)(i) If all the conditions necessary for 
the application of section 421(a) exist, this paragraph (k) provides 
additional rules that are applicable in cases where, at the time the 
option is granted, the option price per share is less than 100 percent 
(but not less than 85 percent) of the fair market value of the share. In 
that case, upon the disposition of the share by the employee after the 
expiration of the two-year and the one-year holding periods, or upon the 
employee's death while owning the share (whether occurring before or 
after the expiration of such periods), there shall be included in the 
employee's gross income as compensation (and not as gain upon the sale 
or exchange of a capital asset) the lesser of--
    (A) The amount, if any, by which the price paid under the option was 
exceeded by the fair market value of the share at the time the option 
was granted, or
    (B) The amount, if any, by which the price paid under the option was 
exceeded by the fair market value of the share at the time of such 
disposition or death.
    (ii) For purposes of applying the rules of this paragraph (k), if 
the option price is not fixed or determinable at the time the option is 
granted, the option price will be computed as if the option had been 
exercised at such time. The amount of compensation resulting from the 
application of this paragraph (k) shall be included in the employee's 
gross income for the taxable year in which the disposition occurs, or 
for the taxable year closing with the employee's death, whichever event 
results in the application of this paragraph (k).
    (iii) The application of the special rules provided in this 
paragraph (k) shall not affect the rules provided in section 421(a) with 
respect to the employee exercising the option, the employer corporation, 
or a related corporation. Thus, notwithstanding the inclusion of an 
amount as compensation in the gross income of an employee, as provided 
in this paragraph (k), no income results to the employee at the time the 
stock is transferred to the employee, and no deduction under

[[Page 1183]]

section 162 is allowable at any time to the employer corporation or a 
related corporation with respect to such amount.
    (iv) If, during the employee's lifetime, the employee exercises an 
option granted under an employee stock purchase plan, but the employee 
dies before the stock is transferred to the employee pursuant to the 
exercise of the option, then for the purpose of sections 421 and 423, on 
the employee's death, the stock is deemed to be transferred immediately 
to the employee, and immediately thereafter, the employee is deemed to 
have transferred the stock to the employee's executor, administrator, 
trustee, beneficiary by operation of law, heir, or legatee, as the case 
may be.
    (2) If the special rules provided in this paragraph (k) are 
applicable to the disposition of a share of stock by an employee, then 
the basis of the share in the employee's hands at the time of the 
disposition, determined under section 1011, shall be increased by an 
amount equal to the amount includible as compensation in the employee's 
gross income under this paragraph (k). However, the basis of a share of 
stock acquired after the death of an employee by the exercise of an 
option granted to the employee under an employee stock purchase plan 
shall be determined in accordance with the rules of section 421(c) and 
Sec. 1.421-2(c). If the special rules provided in this paragraph (k) 
are applicable to a share of stock upon the death of an employee, then 
the basis of the share in the hands of the estate or the person 
receiving the stock by bequest or inheritance shall be determined under 
section 1014, and shall not be increased by reason of the inclusion upon 
the decedent's death of any amount in the decedent's gross income under 
this paragraph (k). See Example (9) of this paragraph (k) with respect 
to the determination of basis of the share in the hands of a surviving 
joint owner.
    (3) Examples. The following examples illustrate the principles of 
this paragraph (k):

    Example 1. On June 1, 2010, Corporation GG grants to Employee P, an 
employee of GG, an option under GG's employee stock purchase plan to 
purchase a share of GG stock for $85. The fair market value of GG stock 
on such date is $100 per share. On June 1, 2011, P exercises the option 
and on that date GG transfers the share of stock to P. On January 1, 
2013, P sells the share for $150, its fair market value on that date. 
P's income tax return is filed on the basis of the calendar year. The 
income tax consequences to P and GG are as follows--
    (i) Compensation in the amount of $15 is includible in P's gross 
income for the year 2013, the year of the disposition of the share. The 
$15 represents the difference between the option price ($85) and the 
fair market value of the share on the date the option was granted 
($100), because the value is less than the fair market value of the 
share on the date of disposition ($150). For the purpose of computing 
P's gain or loss on the sale of the share, P's cost basis of $85 is 
increased by $15, the amount includible in P's gross income as 
compensation. Thus, P's basis for the share is $100. Because the share 
was sold for $150, P realizes a gain of $50, which is treated as long-
term capital gain; and
    (ii) GG is not entitled to any deduction under section 162 at any 
time with respect to the share transferred to P.
    Example 2. Assume the same facts as in Example 1, except that P 
sells the share of GG stock on January 1, 2014, for $75, its fair market 
value on that date. Because $75 is less than the option price ($85), no 
amount in respect of the sale is includible as compensation in P's gross 
income for the year 2014. P's basis for determining gain or loss on the 
sale is $85. Because P sold the share for $75, P realized a loss of $10 
on the sale that is treated as a long-term capital loss.
    Example 3. Assume the same facts as in Example 1, except that the 
option provides that the option price shall be 90 percent of the fair 
market value of the stock on the day the option is exercised. On June 1, 
2011, when the option is exercised, the fair market value of the stock 
is $120 per share so that P pays $108 for the share of the stock. 
Compensation in the amount of $10 is includible in P's gross income for 
the year 2013, the year of the disposition of the share. This is 
determined in the following manner: The excess of the fair market value 
of the stock at the time of the disposition ($150) over the price paid 
for the share ($108) is $42; and the excess of the fair market value of 
the stock at the time the option was granted ($100) over the option 
price, computed as if the option had been exercised at such time ($90), 
is $10. Accordingly, $10, the lesser, is includible in gross income. In 
this situation, P's cost basis of $108 is increased by $10, the amount 
includible in P's gross income as compensation. Thus, P's basis for the 
share is $118. Because the share was sold for $150, P realizes a gain of 
$32 that is treated as long-term capital gain.

[[Page 1184]]

    Example 4. Assume the same facts as in Example 1, except that the 
option provides that the option price shall be the lesser of 95 percent 
of the fair market value of the stock on the first day of the offering 
period and 95 percent of the fair market value of the stock on the day 
the option is exercised. On June 1, 2011, when the option is exercised, 
the fair market value of the stock is $120 per share. P pays $95 for the 
share of the stock. Compensation in the amount of $5 is includible in 
P's gross income for the year 2013, the year of the disposition of the 
share. This is determined in the following manner: The excess of the 
fair market value of the stock at the time of the disposition ($150) 
over the price paid for the share ($95) is $55; and the excess of the 
fair market value of the stock at the time the option was granted ($100) 
over the option price, computed as if the option had been exercised at 
such time ($95), is $5. Accordingly, $5, the lesser, is includible in 
gross income. In this situation, P's cost basis of $95 is increased by 
$5, the amount includible in P's gross income as compensation. Thus, P's 
basis for the share is $100. Because the share was sold for $150, P 
realizes a gain of $50 that is treated as long-term capital gain.
    Example 5. Assume the same facts as in Example 1, except that 
instead of selling the share on January 1, 2013, P makes a gift of the 
share on that day. In that case $15 is includible as compensation in P's 
gross income for 2013. P's cost basis of $85 is increased by $15, the 
amount includible in P's gross income as compensation. Thus, P's basis 
for the share is $100, which becomes the donee's basis, as of the time 
of the gift, for determining gain or loss.
    Example 6. Assume the same facts as in Example 2, except that 
instead of selling the share on January 1, 2014, P makes a gift of the 
share on that date. Because the fair market value of the share on that 
day ($75) is less than the option price ($85), no amount in respect of 
the disposition by way of gift is includible as compensation in P's 
gross income for 2014. P's basis for the share is $85, which becomes the 
donee's basis, as of the time of the gift, for the purpose of 
determining gain. The donee's basis for the purpose of determining loss, 
determined under section 1015(a), is $75 (fair market value of the share 
at the date of gift).
    Example 7. Assume the same facts as in Example 1, except that after 
acquiring the share of stock on June 1, 2011, P dies on August 1, 2012, 
at which time the share has a fair market value of $150. Compensation in 
the amount of $15 is includible in P's gross income for the taxable year 
closing with P's death, $15 being the difference between the option 
price ($85) and the fair market value of the share when the option was 
granted ($100), because such value is less than the fair market value at 
date of death ($150). The basis of the share in the hands of P's estate 
is determined under section 1014 without regard to the $15 includible in 
the decedent's gross income.
    Example 8. Assume the same facts as in Example 7, except that P dies 
on August 1, 2011, at which time the share has a fair market value of 
$150. Although P's death occurred within one year after the transfer of 
the share to P, the income tax consequences are the same as in Example 
7.
    Example 9. Assume the same facts as in Example 1, except that the 
share of stock was issued in the names of P and P's spouse jointly with 
right of survivorship, and that P and P's spouse sold the share on June 
15, 2012, for $150, its fair market value on that date. Compensation in 
the amount of $15 is includible in P's gross income for the year 2012, 
the year of the disposition of the share. The basis of the share in the 
hands of P and P's spouse for the purpose of determining gain or loss on 
the sale is $100, that is, the cost of $85 increased by the amount of 
$15 includible as compensation in P's gross income. The gain of $50 on 
the sale is treated as long-term capital gain, and is divided equally 
between P and P's spouse.
    Example 10. Assume the same facts as in Example 1, except that the 
share of stock was issued in the names of P and P's spouse jointly with 
right of survivorship, and that P predeceased P's spouse on August 1, 
2012, at which time the share had a fair market value of $150. 
Compensation in the amount of $15 is includible in P's gross income for 
the taxable year closing with his death. See Example 7. The basis of the 
share in the hands of P's spouse as survivor is determined under section 
1014 without regard to the $15 includible in the decedent's gross 
income.
    Example 11. Assume the same facts as in Example 10, except that P's 
spouse predeceased P on July 1, 2012. Section 423(c) does not apply in 
respect of the death of P's spouse. Upon the subsequent death of P on 
August 1, 2012, the income tax consequences in respect of P's taxable 
year closing with the date of P's death, and in respect of the basis of 
the share in the hands of P's estate, are the same as in Example 7. If P 
had sold the share on July 15, 2012 (after the death of P's spouse), for 
$150, its fair market value at that time, the income tax consequences 
would be the same as in Example 1.

    (l) Effective/applicability date. The regulations under this section 
are effective on November 17, 2009. The regulations under this section 
apply to options granted under an employee stock purchase plan on or 
after January 1, 2010.

[T.D. 9471, 74 FR 59078, Nov. 17, 2009; 74 FR 67973, Dec. 22, 2009]

[[Page 1185]]



Sec. 1.424-1  Definitions and special rules applicable to statutory 
options.

    (a) Substitutions and assumptions of options--(1) In general. (i) 
This paragraph (a) provides rules under which an eligible corporation 
(as defined in paragraph (a)(2) of this section) may, by reason of a 
corporate transaction (as defined in paragraph (a)(3) of this section), 
substitute a new statutory option (new option) for an outstanding 
statutory option (old option) or assume an old option without such 
substitution or assumption being considered a modification of the old 
option. For the definition of modification, see paragraph (e) of this 
section.
    (ii) For purposes of Sec. Sec. 1.421-1 through 1.424-1, the phrase 
``substituting or assuming a stock option in a transaction to which 
section 424 applies,'' ``substituting or assuming a stock option in a 
transaction to which Sec. 1.424-1(a) applies,'' and similar phrases 
means a substitution of a new option for an old option or an assumption 
of an old option that meets the requirements of this paragraph (a). For 
a substitution or assumption to qualify under this paragraph (a), the 
substitution or assumption must meet all of the requirements described 
in paragraphs (a)(4) and (a)(5) of this section.
    (2) Eligible corporation. For purposes of this paragraph (a), the 
term eligible corporation means a corporation that is the employer of 
the optionee or a related corporation of such corporation. For purposes 
of this paragraph (a), the determination of whether a corporation is the 
employer of the optionee or a related corporation of such corporation is 
based upon all of the relevant facts and circumstances existing 
immediately after the corporate transaction. See Sec. 1.421-1(h) for 
rules concerning the employment relationship.
    (3) Corporate transaction. For purposes of this paragraph (a), the 
term corporate transaction includes--
    (i) A corporate merger, consolidation, acquisition of property or 
stock, separation, reorganization, or liquidation;
    (ii) A distribution (excluding an ordinary dividend or a stock split 
or stock dividend described in Sec. 1.424-1(e)(4)(v)) or change in the 
terms or number of outstanding shares of such corporation; and
    (iii) Such other corporate events prescribed by the Commissioner in 
published guidance.
    (4) By reason of. (i) For a change in an option or issuance of a new 
option to qualify as a substitution or assumption under this paragraph 
(a), the change must be made by an eligible corporation (as defined in 
paragraph (a)(2) of this section) and occur by reason of a corporate 
transaction (as defined in paragraph (a)(3) of this section).
    (ii) Generally, a change in an option or issuance of a new option is 
considered to be by reason of a corporate transaction, unless the 
relevant facts and circumstances demonstrate that such change or 
issuance is made for reasons unrelated to such corporate transaction. 
For example, a change in an option or issuance of a new option will be 
considered to be made for reasons unrelated to a corporate transaction 
if there is an unreasonable delay between the corporate transaction and 
such change in the option or issuance of a new option, or if the 
corporate transaction serves no substantial corporate business purpose 
independent of the change in options. Similarly, a change in the number 
or price of shares purchasable under an option merely to reflect market 
fluctuations in the price of the stock purchasable under an option is 
not by reason of a corporate transaction.
    (iii) A change in an option or issuance of a new option is by reason 
of a distribution or change in the terms or number of the outstanding 
shares of a corporation (as described in paragraph (a)(3)(ii) of this 
section) only if the option as changed, or the new option issued, is an 
option on the same stock as under the old option (or if such class of 
stock is eliminated in the change in capital structure, on other stock 
of the same corporation).
    (5) Other requirements. For a change in an option or issuance of a 
new option to qualify as a substitution or assumption under this 
paragraph (a), all of the requirements described in this paragraph 
(a)(5) must be met.
    (i) In the case of an issuance of a new option (or a portion 
thereof) in exchange for an old option (or portion thereof), the 
optionee's rights under the old option (or portion thereof)

[[Page 1186]]

must be canceled, and the optionee must lose all rights under the old 
option (or portion thereof). There cannot be a substitution of a new 
option for an old option within the meaning of this paragraph (a) if the 
optionee may exercise both the old option and the new option. It is not 
necessary to have a complete substitution of a new option for the old 
option. However, any portion of such option which is not substituted or 
assumed in a transaction to which this paragraph (a) applies is an 
outstanding option to purchase stock or, to the extent paragraph (e) of 
this section applies, a modified option.
    (ii) The excess of the aggregate fair market value of the shares 
subject to the new or assumed option immediately after the change in the 
option or issuance of a new option over the aggregate option price of 
such shares must not exceed the excess of the aggregate fair market 
value of all shares subject to the old option (or portion thereof) 
immediately before the change in the option or issuance of a new option 
over the aggregate option price of such shares.
    (iii) On a share by share comparison, the ratio of the option price 
to the fair market value of the shares subject to the option immediately 
after the change in the option or issuance of a new option must not be 
more favorable to the optionee than the ratio of the option price to the 
fair market value of the stock subject to the old option (or portion 
thereof) immediately before the change in the option or issuance of a 
new option. The number of shares subject to the new or assumed option 
may be adjusted to compensate for any change in the aggregate spread 
between the aggregate option price and the aggregate fair market value 
of the shares subject to the option immediately after the change in the 
option or issuance of the new option as compared to the aggregate spread 
between the option price and the aggregate fair market value of the 
shares subject to the option immediately before the change in the option 
or issuance of the new option.
    (iv) The new or assumed option must contain all terms of the old 
option, except to the extent such terms are rendered inoperative by 
reason of the corporate transaction.
    (v) The new option or assumed option must not give the optionee 
additional benefits that the optionee did not have under the old option.
    (6) Obligation to substitute or assume not necessary. For a change 
in the option or issuance of a new option to meet the requirements of 
this paragraph (a), it is not necessary to show that the corporation 
changing an option or issuing a new option is under any obligation to do 
so. In fact, this paragraph (a) may apply even when the option that is 
being replaced or assumed expressly provides that it will terminate upon 
the occurrence of certain corporate transactions. However, this 
paragraph (a) cannot be applied to revive a statutory option which, for 
reasons not related to the corporate transaction, expires before it can 
properly be replaced or assumed under this paragraph (a).
    (7) Issuance of stock without meeting the requirements of this 
paragraph (a). A change in the terms of an option resulting in a 
modification of such option occurs if an optionee's new employer (or a 
related corporation of the new employer) issues its stock (or stock of a 
related corporation) upon exercise of such option without satisfying all 
of the requirements described in paragraphs (a)(4) and (5) of this 
section.
    (8) Date of grant. For purposes of applying the rules of this 
paragraph (a), a substitution or assumption is considered to occur on 
the date that the optionee would, but for this paragraph (a), be 
considered to have been granted the option that the eligible corporation 
is substituting or assuming. A substitution or an assumption that occurs 
by reason of a corporate transaction may occur before or after the 
corporate transaction.
    (9) Any reasonable methods may be used to determine the fair market 
value of the stock subject to the option immediately before the 
assumption or substitution and the fair market value of the stock 
subject to the option immediately after the assumption or substitution. 
Such methods include the valuation methods described in Sec. 20.2031-2 
of this chapter (the Estate Tax Regulations). In the case of stock

[[Page 1187]]

listed on a stock exchange, the fair market value may be based on the 
last sale before and the first sale after the assumption or substitution 
if such sales clearly reflect the fair market value of the stock, or may 
be based upon an average selling price during a longer period, such as 
the day or week before, and the day or week after, the assumption or 
substitution. If the stocks are not listed, or if they are newly issued, 
it will be reasonable to base the determination on experience over even 
longer periods. In the case of a merger, consolidation, or other 
reorganization which is arrived at by arm's-length negotiations, the 
fair market value of the stocks subject to the option before and after 
the assumption or substitution may be based upon the values assigned to 
the stock for purposes of the reorganization. For example, if in the 
case of a merger the parties treat each share of the merged company as 
being equal in value to a share of the surviving company, it will be 
reasonable to assume that the stocks are of equal value so that the 
substituted option may permit the employee to purchase at the same price 
one share of the surviving company for each share he could have 
purchased of the merged company.
    (10) Examples. The principles of this paragraph (a) are illustrated 
by the following examples:

    Example 1. Eligible corporation. X Corporation acquires a new 
subsidiary, Y Corporation, and transfers some of its employees to Y. Y 
Corporation wishes to grant to its new employees and to the employees of 
X Corporation new options for Y shares in exchange for old options for X 
shares that were previously granted by X Corporation. Because Y 
Corporation is an employer with respect to its own employees and a 
related corporation of X Corporation, Y Corporation is an eligible 
corporation under paragraph (a)(2) of this section with respect to both 
the employees of X and Y Corporations.
    Example 2. Corporate transaction. (i) On January 1, 2004, Z 
Corporation grants E, an employee of Z, an option to acquire 100 shares 
of Z common stock. At the time of grant, the fair market value of Z 
common stock is $200 per share. E's option price is $200 per share. On 
July 1, 2005, when the fair market value of Z common stock is $400, Z 
declares a stock dividend of preferred stock distributed on common stock 
that causes the fair market value of Z common stock to decrease to $200 
per share. On the same day, Z grants to E a new option to acquire 200 
shares of Z common stock in exchange for E's old option. The new option 
has an exercise price of $100 per share.
    (ii) A stock dividend other than that described in Sec. 1.424-
1(e)(4)(v) is a corporate transaction under paragraph (a)(3)(ii) of this 
section. Generally, the issuance of a new option is considered to be by 
reason of a corporate transaction. None of the facts in this Example 2 
indicate that the new option is not issued by reason of the stock 
dividend. In addition, the new option is issued on the same stock as the 
old option. Thus, the substitution occurs by reason of the corporate 
transaction. Assuming the other requirements of this section are met, 
the issuance of the new option is a substitution that meets the 
requirements of this paragraph (a) and is not a modification of the 
option.
    (iii) Assume the same facts as in paragraph (i) of this Example 2. 
Assume further that on December 1, 2005, Z declares an ordinary cash 
dividend. On the same day, Z grants E a new option to acquire Z stock in 
substitution for E's old option. Under paragraph (a)(3)(ii) of this 
section, an ordinary cash dividend is not a corporate transaction. Thus, 
the exchange of the new option for the old option does not meet the 
requirements of this paragraph (a) and is a modification of the option.
    Example 3. Corporate transaction. On March 15, 2004, A Corporation 
grants E, an employee of A, an option to acquire 100 shares of A stock 
at $50 per share, the fair market value of A stock on the date of grant. 
On May 2, 2005, A Corporation transfers several employees, including E, 
to B Corporation, a related corporation. B Corporation arranges to 
purchase some assets from A on the same day as E's transfer to B. Such 
purchase is without a substantial business purpose independent of making 
the exchange of E's old options for the new options appear to be by 
reason of a corporate transaction. The following day, B Corporation 
grants to E, one of its new employees, an option to acquire shares of B 
stock in exchange for the old option held by E to acquire A stock. Under 
paragraph (a)(3)(i) of this section, the purchase of assets is a 
corporate transaction. Generally, the substitution of an option is 
considered to occur by reason of a corporate transaction. However, in 
this case, the relevant facts and circumstances demonstrate that the 
issuance of the new option in exchange for the old option occurred by 
reason of the change in E's employer rather than a corporate transaction 
and that the sale of assets is without a substantial corporate business 
purpose independent of the change in the options. Thus, the exchange of 
the new option for the old option is not by reason of a corporate 
transaction that meets the requirements of this paragraph (a) and is a 
modification of the old option.

[[Page 1188]]

    Example 4. Corporate transaction. (i) E, an employee of Corporation 
A, holds an option to acquire 100 shares of Corporation A stock. On 
September 1, 2006, Corporation A has one class of stock outstanding and 
declares a stock dividend of one share of common stock for each 
outstanding share of common stock. The rights associated with the common 
stock issued as a dividend are the same as the rights under existing 
shares of stock. In connection with the stock dividend, E's option is 
exchanged for an option to acquire 200 shares of Corporation A stock. 
The per-share exercise price is equal to one half of the per-share 
exercise price of the original option. The stock dividend merely changes 
the number of shares of Corporation A outstanding and effects no other 
change to the stock of Corporation A. The option is proportionally 
adjusted and the aggregate exercise price remains the same and therefore 
satisfies the requirements described in Sec. 1.424-1(e)(4)(v).
    (ii) The stock dividend is not a corporate transaction under 
paragraph (a)(3) of this section, and the declaration of the stock 
dividend is not a modification of the old option under paragraph (a) of 
this section. Pursuant to Sec. 1.424-1(e)(4)(v), the exercise price of 
the old option may be adjusted proportionally with the change in the 
number of outstanding shares of Corporation A such that the ratio of the 
aggregate exercise price of the option to the number of shares covered 
by the option is the same both before and after the stock dividend. The 
adjustment of E's option is not treated as a modification of the option.
    Example 5. Additional benefit. On June 1, 2004, P Corporation 
acquires 100 percent of the shares of S Corporation and issues a new 
option to purchase P shares in exchange for an old option to purchase S 
shares that is held by E, an employee of S. On the date of the exchange, 
E's old option is exercisable for 3 more years, and, after the exchange, 
E's new option is exercisable for 5 years. Because the new option is 
exercisable for an additional period of time beyond the time allowed 
under the old option, the effect of the exchange of the new option for 
the old option is to give E an additional benefit that E did not enjoy 
under the old option. Thus, the requirements of paragraph (a)(5) of this 
section are not met, and this paragraph (a) does not apply to the 
exchange of the new option for the old option. Therefore, the exchange 
is a modification of the old options.
    Example 6. Spread and ratio tests. E is an employee of S 
Corporation. E holds an old option that was granted to E by S to 
purchase 60 shares of S at $12 per share. On June 1, 2005, S Corporation 
is merged into P Corporation, and on such date P issues a new option to 
purchase P shares in exchange for E's old option to purchase S shares. 
Immediately before the exchange, the fair market value of an S share is 
$32; immediately after the exchange, the fair market value of a P share 
is $24. The new option entitles E to buy P shares at $9 per share. 
Because, on a share-by-share comparison, the ratio of the new option 
price ($9 per share) to the fair market value of a P share immediately 
after the exchange ($24 per share) is not more favorable to E than the 
ratio of the old option price ($12 per share) to the fair market value 
of an S share immediately before the exchange ($32 per share) (\9/24\ = 
\12/32\), the requirements of paragraph (a)(5)(iii) of this section are 
met. The number of shares subject to E's option to purchase P stock is 
set at 80. Because the excess of the aggregate fair market value over 
the aggregate option price of the shares subject to E's new option to 
purchase P stock, $1,200 (80 x $24 minus 80 x $9), is not greater than 
the excess of the aggregate fair market value over the aggregate option 
price of the shares subject to E's old option to purchase S stock, 
$1,200 (60 x $32 minus 60 x $12), the requirements of paragraph 
(a)(5)(ii) of this section are met.
    Example 7. Ratio test and partial substitution. Assume the same 
facts as in Example 6, except that the fair market value of an S share 
immediately before the exchange of the new option for the old option is 
$8, that the option price is $10 per share, and that the fair market 
value of a P share immediately after the exchange is $12. P sets the new 
option price at $15 per share. Because, on a share-by-share comparison, 
the ratio of the new option price ($15 per share) to the fair market 
value of a P share immediately after the exchange ($12) is not more 
favorable to E than the ratio of the old option price ($10 per share) to 
the fair market value of an S share immediately before the substitution 
($8 per share) (\15/12\ = \10/8\), the requirements of paragraph 
(a)(5)(iii) of this section are met. Assume further that the number of 
shares subject to E's P option is set at 20, as compared to 60 shares 
under E's old option to buy S stock. Immediately after the exchange, 2 
shares of P are worth $24, which is what 3 shares of S were worth 
immediately before the exchange (2 x $12 = 3 x $8). Thus, to achieve a 
complete substitution of a new option for E's old option, E would need 
to receive a new option to purchase 40 shares of P (i.e., 2 shares of P 
for each 3 shares of S that E could have purchased under the old option 
(\2/3\ = \40/60\)). Because E's new option is for only 20 shares of P, P 
has replaced only \1/2\ of E's old option, and the other \1/2\ is still 
outstanding.
    Example 8. Partial substitution. X Corporation forms a new 
corporation, Y Corporation, by a transfer of certain assets and, in a 
spin-off, distributes the shares of Y Corporation to the stockholders of 
X Corporation. E, an employee of X Corporation, is thereafter an 
employee of Y. Y wishes to substitute a new option to purchase some of 
its stock for E's old option to purchase 100 shares of X. E's

[[Page 1189]]

old option to purchase shares of X, at $50 a share, was granted when the 
fair market value of an X share was $50, and an X share was worth $100 
just before the distribution of the Y shares to X's stockholders. 
Immediately after the spin-off, which is also the time of the 
substitution, each share of X and each share of Y is worth $50. Based on 
these facts, a new option to purchase 200 shares of Y at an option price 
of $25 per share could be granted to E in complete substitution of E's 
old option. In the alternative, it would also be permissible in 
connection with the spin off, to grant E a new option to purchase 100 
shares of Y, at an option price of $25 per share, and for E to retain an 
option to purchase 100 shares of X under the old option, with the option 
price adjusted to $25. However, because X is no longer a related 
corporation with respect to Y, E must exercise the option for 100 shares 
of X within three months from the date of the spin off for the option to 
be treated as a statutory option. See Sec. 1.421-1(h). It would also be 
permissible to grant E a new option to purchase 100 shares of Y, at an 
option price of $25 per share, in substitution for E's right to purchase 
50 of the shares under the old option.
    Example 9. Stockholder approval requirements. (i) X Corporation, a 
publicly traded corporation, adopts an incentive stock option plan that 
meets the requirements of Sec. 1.422-2. Under the plan, options to 
acquire X stock are granted to X employees. X Corporation is acquired by 
Y Corporation and becomes a subsidiary corporation of Y Corporation. 
After the acquisition, X employees remain employees of X. In connection 
with the acquisition, Y Corporation substitutes new options to acquire Y 
stock for the old options to acquire X stock previously granted to the 
employees of X. As a result of this substitution, on exercise of the new 
options, X employees receive Y Corporation stock.
    (ii) Because the requirements of Sec. 1.422-2 were met on the date 
of grant, the substitution of the new Y options for the old X options 
does not require new stockholder approval. If the other requirements of 
paragraphs (a)(4) and (5) of this section are met, the issuance of new 
options for Y stock in exchange for the old options for X stock meets 
the requirements of this paragraph (a) and is not a modification of the 
old options.
    (iii) Assume the same facts as in paragraphs (i) and (ii) of this 
Example 9. Assume further that as part of the acquisition, X amends its 
plan to allow future grants under the plan to be grants to acquire Y 
stock. Because the amendment of the plan to allow options on a different 
stock is considered the adoption of a new plan under Sec. 1.422-
2(b)(2)(iii), the stockholders of X (in this case, Y) must approve the 
plan within 12 months before or after the date of the amendment of the 
plan. If the stockholders of X (in this case, Y) timely approve the 
plan, the future grants to acquire Y stock will be incentive stock 
options (assuming the other requirements of Sec. 1.422-2 have been 
met).
    Example 10. Modification. X Corporation merges into Y Corporation. Y 
Corporation retains employees of X who hold old options to acquire X 
Corporation stock. When the former employees of X exercise the old 
options, Y Corporation issues Y stock to the former employees of X. 
Under paragraph (a)(7) of this section, because Y issues its stock on 
exercise of the old options for X stock, there is a change in the terms 
of the old options for X stock. Thus, the issuance of Y stock on 
exercise of the old options is a modification of the old options.
    Example 11. Eligible corporation. (i) D Corporation grants an option 
to acquire 100 shares of D Corporation stock to E, an employee of D 
Corporation. S Corporation is a subsidiary of D Corporation. On March 1, 
2005, D Corporation spins off S Corporation. E remains an employee of D 
Corporation. In connection with the spin off, D Corporation substitutes 
a new option to acquire D Corporation stock and a new option to acquire 
S Corporation stock for the old option in a manner that meets the 
requirements of paragraph (a) of this section.
    (ii) The substitution of the new option to acquire S and D stock for 
the old option to acquire D stock is not a modification of the old 
option. However, because S is no longer a related corporation with 
respect to D Corporation, E must exercise the option for S stock within 
three months from March 1, 2005, for the option to be treated as a 
statutory option. See Sec. 1.421-1(h).
    (iii) Assume the same facts as in paragraph (i) of this Example 11 
except that E's employment with D Corporation is terminated on February 
20, 2005. The substitution of the new option to acquire S and D stock 
for the old option to acquire D stock is not a modification of the old 
option. However, because the employment relationship between E and D 
Corporation terminated on February 20, 2005, E must exercise the option 
for the D and S stock within three months from February 20, 2005, for 
the option to be treated as a statutory option. See Sec. 1.421-1(h).

    (b) Acquisition of new stock. (1) Section 424(b) provides that the 
rules provided by sections 421 through 424 which are applicable with 
respect to stock transferred to an individual upon his exercise of an 
option, shall likewise be applicable with respect to stock acquired by a 
distribution or an exchange to which section 305, 354, 355, 356, or 1036 
(or so much of section 1031 as relates to section 1036) applies. Stock 
so acquired shall, for purposes of sections

[[Page 1190]]

421 through 424, be considered as having been transferred to the 
individual upon his exercise of the option. A similar rule shall be 
applied in the case of a series of such acquisitions. With respect to 
such acquisitions, section 424(b) does not make inapplicable any of the 
provisions of section 305, 354, 355, 356, or 1036 (or so much of section 
1031 as relates to section 1036).
    (2) The application of this paragraph may be illustrated by the 
following example:

    Example. If, with respect to stock transferred pursuant to the 
timely exercise of a statutory option, there is a distribution of new 
stock to which section 305(a) is applicable, and if there is a 
disposition of such new stock before the expiration of the applicable 
holding period required with respect to the stock originally acquired 
pursuant to the exercise of such option, such disposition makes section 
421 inapplicable to the transfer of the original stock pursuant to the 
exercise of the option to the extent that the disposition effects a 
reduction of the individual's total interest in the old and new stock. 
However, if the new stock, as well as the old stock, is not disposed of 
before the expiration of the holding period required with respect to the 
original stock acquired pursuant to the exercise of the option, the 
special tax treatment provided by section 421 is applicable to both the 
original shares and the shares acquired by virtue of the distribution to 
which section 305(a) applies.

    (c) Disposition of stock. (1) For purposes of sections 421 through 
424, the term ``disposition of stock'' includes a sale, exchange, gift, 
or any transfer of legal title, but does not include--
    (i) A transfer from a decedent to his estate or a transfer by 
bequest or inheritance; or
    (ii) An exchange to which is applicable section 354, 355, 356, or 
1036 (or so much of section 1031 as relates to section 1036); or
    (iii) A mere pledge or hypothecation. However, a disposition of the 
stock pursuant to a pledge or hypothecation is a disposition by the 
individual, even though the making of the pledge or hypothecation is not 
such a disposition.
    (iv) A transfer between spouses or incident to divorce (described in 
section 1041(a)). The special tax treatment of Sec. 1.421-2(a) with 
respect to the transferred stock applies to the transferee. However, see 
Sec. 1.421-1(b)(2) for the treatment of the transfer of a statutory 
option incident to divorce.
    (2) A share of stock acquired by an individual pursuant to the 
exercise of a statutory option is not considered disposed of by the 
individual if such share is taken in the name of the individual and 
another person jointly with right of survivorship, or is subsequently 
transferred into such joint ownership, or is retransferred from such 
joint ownership to the sole ownership of the individual. However, any 
termination of such joint ownership (other than a termination effected 
by the death of a joint owner) is a disposition of such share, except to 
the extent the individual reacquires ownership of the share. For 
example, if such individual and his joint owner transfer such share to 
another person, the individual has made a disposition of such share. 
Likewise, if a share of stock held in the joint names of such individual 
and another person is transferred to the name of such other person, 
there is a disposition of such share by the individual. If an individual 
exercises a statutory option and a share of stock is transferred to 
another or is transferred to such individual in his name as trustee for 
another, the individual has made a disposition of such share. However, a 
termination of joint ownership resulting from the death of one of the 
owners is not a disposition of such share. For determination of basis in 
the hands of the survivor where joint ownership is terminated by the 
death of one of the owners, see section 1014.
    (3) If an optionee exercises an incentive stock option with 
statutory option stock and the applicable holding period requirements 
(under Sec. 1.422-1(a) or Sec. 1.423-1(a)) with respect to such 
statutory option stock are not met before such transfer, then sections 
354, 355, 356, or 1036 (or so much of 1031 as relates to 1036) do not 
apply to determine whether there is a disposition of those shares. 
Therefore, there is a disposition of the statutory option stock, and the 
special tax treatment of Sec. 1.421-2(a) does not apply to such stock.
    (4) The application of this paragraph may be illustrated by the 
following examples:

    Example 1. On June 1, 2004, the X Corporation grants to E, an 
employee, a statutory

[[Page 1191]]

option to purchase 100 shares of X Corporation stock at $100 per share, 
the fair market value of X Corporation stock on that date. On June 1, 
2005, while employed by X Corporation, E exercises the option in full 
and pays X Corporation $10,000, and on that day X Corporation transfers 
to E 100 shares of its stock having a fair market value of $12,000. 
Before June 1, 2006, E makes no disposition of the 100 shares so 
purchased. E realizes no income on June 1, 2005, with respect to the 
transfer to him of the 100 shares of X Corporation stock. X Corporation 
is not entitled to any deduction at any time with respect to its 
transfer to E of the stock. E's basis for such 100 shares is $10,000.
    Example 2. Assume the same facts as in example (1), except assume 
that on August 1, 2006, three years and two months after the transfer of 
the shares to him, E sells the 100 shares of X Corporation stock for 
$13,000 which is the fair market value of the stock on that date. For 
the taxable year in which the sale occurs, E realizes a gain of $3,000 
($13,000 minus E's basis of $10,000), which is treated as capital gain.
    Example 3. Assume the same facts as in example (2), except assume 
that on August 1, 2006, E makes a gift of the 100 shares of Y 
Corporation stock to his son. Such disposition results in no realization 
of gain to E either for the taxable year in which the option is 
exercised or the taxable year in which the gift is made. E's basis of 
$10,000 becomes the donee's basis for determining gain or loss.
    Example 4. Assume the same facts as in example (1), except assume 
that on May 1, 2006, E sells the 100 shares of X Corporation stock for 
$13,000. The special rules of section 421(a) are not applicable to the 
transfer of the stock by X Corporation to E, because disposition of the 
stock was made by E within two years from the date the options were 
granted and within one year of the date that the shares were transferred 
to him.
    Example 5. Assume the same facts as in example (1), except assume 
that E dies on September 1, 2005, owning the 100 shares of X Corporation 
stock acquired by him pursuant to his exercise on June 1, 2005, of the 
statutory option. On the date of death, the fair market value of the 
stock is $12,500. No income is realized by E by reason of the transfer 
of the 100 shares to his estate. If the stock is valued as of the date 
of E's death for estate tax purposes, the basis of the 100 shares in the 
hands of the executor is $12,500.
    Example 6. Assume the same facts as in example (1), except assume 
that on June 1, 2005, when the option is exercised by E the 100 shares 
are transferred by X to E and his wife W, as joint owners with right of 
survivorship, and that E dies on July 1, 2005. Neither the transfer into 
joint ownership nor the termination of such joint ownership by E's death 
is a disposition. Because E has made no disqualifying disposition of the 
shares, section 421(a) is applicable and E realizes no compensation 
income at death with respect to the shares even though he held the stock 
less than 2 years after the transfer of the shares to him pursuant to 
his exercise of the option. See Sec. 1.421-2(b)(2).
    Example 7. On January 1, 2004, X Corporation grants to E, an 
employee of X Corporation, an incentive stock option to purchase 100 
shares of X Corporation stock at $100 per share (the fair market value 
of an X Corporation share on that date). On January 1, 2005, when the 
fair market value of a share of X Corporation stock is $200, E exercises 
half of the option, pays X Corporation $5,000 in cash, and is 
transferred 50 shares of X Corporation stock with an aggregate fair 
market value of $10,000. E makes no disposition of the shares before 
January 2, 2006. Under Sec. 1.421-2(a), no income is recognized by E on 
the transfer of shares pursuant to the exercise of the incentive stock 
option, and X Corporation is not entitled to any deduction at any time 
with respect to its transfer of the shares to E. E's basis in the shares 
is $5,000.
    Example 8. Assume the same facts as in Example 7, except that on 
December 1, 2005, one year and 11 months after the grant of the option 
and 11 months after the transfer of the 50 shares to E, E uses 25 of 
those shares, with a fair market value of $5,000, to pay for the 
remaining 50 shares purchasable under the option. On that day, X 
Corporation transfers 50 of its shares, with an aggregate fair market 
value of $10,000, to E. Because E disposed of the 25 shares before the 
expiration of the applicable holding periods, Sec. 1.421-2(a) does not 
apply to the January 1, 2005, transfer of the 25 shares used by E to 
exercise the remainder of the option. As a result of the disqualifying 
disposition of the 25 shares, E recognizes compensation income under the 
rules of Sec. 1.421-2(b).
    Example 9. On January 1, 2005, X Corporation grants an incentive 
stock option to E, an employee of X Corporation. The exercise price of 
the option is $10 per share. On June 1, 2005, when the fair market value 
of an X Corporation share is $20, E exercises the option and purchases 5 
shares with an aggregate fair market value of $100. On January 1, 2006, 
when the fair market value of an X Corporation share is $50, X 
Corporation is acquired by Y Corporation in a section 368(a)(1)(A) 
reorganization. As part of the acquisition, all X Corporation shares are 
converted into Y Corporation shares. After the conversion, if an 
optionee holds a fractional share of Y Corporation stock, Y Corporation 
will purchase the fractional share for cash equal to its fair market 
value. After applying the conversion formula to the shares held by E, E 
has 10 \1/2\ Y Corporation shares. Y Corporation purchases E's one-half 
share for $25, the fair market value of one-half of a Y Corporation 
share on the conversion date. Because E sells the one-half share prior

[[Page 1192]]

to expiration of the holding periods described in Sec. 1.422-1(a), the 
sale is a disqualifying disposition of the one-half share. Thus, in 
2006, E must recognize compensation income of $5 (one-half of the fair 
market value of an X Corporation share on the date of exercise of the 
option, or $10, less one-half of the exercise price per share, or $5). 
For purposes of computing any additional gain, E's basis in the one-half 
share increases to $10 (reflecting the $5 included in income as 
compensation). E recognizes an additional gain of $15 ($25, the fair 
market value of the one-half share, less $10, the basis in such share). 
The extent to which the additional $15 of gain is treated as a 
redemption of Y Corporation stock is determined under section 302.

    (d) Attribution of stock ownership. To determine the amount of stock 
owned by an individual for purposes of applying the percentage 
limitations relating to certain stockholders described in Sec. Sec. 
1.422-2(f) and 1.423-2(d), shares of the employer corporation or of a 
related corporation that are owned (directly or indirectly) by or for 
the individual's brothers and sisters (whether by the whole or half 
blood), spouse, ancestors, and lineal descendants, are considered to be 
owned by the individual. Also, for such purposes, if a domestic or 
foreign corporation, partnership, estate, or trust owns (directly or 
indirectly) shares of the employer corporation or of a related 
corporation, the shares are considered to be owned proportionately by or 
for the stockholders, partners, or beneficiaries of the corporation, 
partnership, estate, or trust. The extent to which stock held by the 
optionee as a trustee of a voting trust is considered owned by the 
optionee is determined under all of the facts and circumstances.
    (e) Modification, extension, or renewal of option. (1) This 
paragraph (e) provides rules for determining whether a share of stock 
transferred to an individual upon the individual's exercise of an option 
after the terms of the option have been changed is transferred pursuant 
to the exercise of a statutory option.
    (2) Any modification, extension, or renewal of the terms of an 
option to purchase shares is considered the granting of a new option. 
The new option may or may not be a statutory option. To determine the 
date of grant of the new option for purposes of section 422 or 423, see 
Sec. 1.421-1(c).
    (3) If section 423(c) applies to an option then, in case of a 
modification, extension, or renewal of an option, the highest of the 
following values shall be considered to be the fair market value of the 
stock at the time of the granting of such option for purposes of 
applying the rules of sections 423(b)(6)--
    (i) The fair market value on the date of the original granting of 
the option,
    (ii) The fair market value on the date of the making of such 
modification, extension, or renewal, or
    (iii) The fair market value at the time of the making of any 
intervening modification, extension, or renewal.
    (4)(i) For purposes of Sec. Sec. 1.421-1 through 1.424-1 the term 
modification means any change in the terms of the option (or change in 
the terms of the plan pursuant to which the option was granted or in the 
terms of any other agreement governing the arrangement) that gives the 
optionee additional benefits under the option regardless of whether the 
optionee in fact benefits from the change in terms. In contrast, for 
example, a change in the terms of the option shortening the period 
during which the option is exercisable is not a modification. However, a 
change providing an extension of the period during which an option may 
be exercised (such as after termination of employment) or a change 
providing an alternative to the exercise of the option (such as a stock 
appreciation right) is a modification regardless of whether the optionee 
in fact benefits from such extension or alternative right. Similarly, a 
change providing an additional benefit upon exercise of the option (such 
as the payment of a cash bonus) or a change providing more favorable 
terms for payment for the stock purchased under the option (such as the 
right to tender previously acquired stock) is a modification.
    (ii) If an option is not immediately exercisable in full, a change 
in the terms of the option to accelerate the time at which the option 
(or any portion thereof) may be exercised is not a modification for 
purposes of this section. Additionally, no modification occurs if a 
provision accelerating the time when an option may first be exercised is 
removed prior to the year in which it would otherwise be triggered.

[[Page 1193]]

For example, if an acceleration provision is timely removed to avoid 
exceeding the $100,000 limitation described in Sec. 1.422-4, a 
modification of the option does not occur.
    (iii) A change to an option which provides, either by its terms or 
in substance, that the optionee may receive an additional benefit under 
the option at the future discretion of the grantor, is a modification at 
the time that the option is changed to provide such discretion. In 
addition, the exercise of discretion to provide an additional benefit is 
a modification of the option. However, it is not a modification for the 
grantor to exercise discretion specifically reserved under an option 
with respect to the payment of a cash bonus at the time of exercise, the 
availability of a loan at exercise, the right to tender previously 
acquired stock for the stock purchasable under the option, or the 
payment of employment taxes and/or required withholding taxes resulting 
from the exercise of a statutory option. An option is not modified 
merely because an optionee is offered a change in the terms of an option 
if the change to the option is not made. An offer to change the terms of 
an option that remains open less than 30 days is not a modification of 
the option. However, if an offer to change the terms of an option 
remains outstanding for 30 days or more, there is a modification of the 
option as of the date the offer to change the option is made.
    (iv) A change in the terms of the stock purchasable under the option 
that increases the value of the stock is a modification of such option, 
except to the extent that a new option is substituted for such option by 
reason of the change in the terms of the stock in accordance with 
paragraph (a) of this section.
    (v) If an option is amended solely to increase the number of shares 
subject to the option, the increase is not considered a modification of 
the option but is treated as the grant of a new option for the 
additional shares. Notwithstanding the previous sentence, if the 
exercise price and number of shares subject to an option are 
proportionally adjusted to reflect a stock split (including a reverse 
stock split) or stock dividend, and the only effect of the stock split 
or stock dividend is to increase (or decrease) on a pro rata basis the 
number of shares owned by each shareholder of the class of stock subject 
to the option, then the option is not modified if it is proportionally 
adjusted to reflect the stock split or stock dividend and the aggregate 
exercise price of the option is not less than the aggregate exercise 
price before the stock split or stock dividend.
    (vi) Any change in the terms of an option made in an attempt to 
qualify the option as a statutory option grants additional benefits to 
the optionee and is, therefore, a modification. However, if the terms of 
an option are changed to provide that the optionee cannot transfer the 
option except by will or by the laws of descent and distribution in 
order to meet the requirements of section 422(b)(5) or 423(b)(9) such 
change is not a modicication.
    (vii) An extension of an option refers to the granting by the 
corporation to the optionee of an additional period of time within which 
to exercise the option beyond the time originally prescribed. A renewal 
of an option is the granting by the corporation of the same rights or 
privileges contained in the original option on the same terms and 
conditions. The rules of this paragraph apply as well to successive 
modifications, extensions, and renewals.
    (viii) Any inadvertent change to the terms of an option (or change 
in the terms of the plan pursuant to which the option was granted or in 
the terms of any other agreement governing the arrangement) that is 
treated as a modification under this paragraph (e) is not considered a 
modification of the option to the extent the change in the terms of the 
option is removed by the earlier of the date the option is exercised or 
the last day of the calendar year during which such change occurred. 
Thus, for example, if the terms of an option are inadvertently changed 
on March 1 to extend the exercise period and the change is removed on 
November, then if the option is not exercised prior to November 1, the 
option is not considered modified under this paragraph (e).
    (5) A statutory option may, as a result of a modification, 
extension, or renewal, thereafter cease to be a statutory option, or any 
option may, by

[[Page 1194]]

modification, extension, or renewal, thereafter become a statutory 
option.
    (6) [Reserved]
    (7) The application of this paragraph may be illustrated by the 
following examples:

    Example 1. On June 1, 2004, the X Corporation grants to an employee 
an option under X's employee stock purchase plan to purchase 100 shares 
of the stock of X Corporation at $90 per share, such option to be 
exercised on or before June 1, 2006. At the time the option is granted, 
the fair market value of the X Corporation stock is $100 per share. On 
February 1, 2005, before the employee exercises the option, X 
Corporation modifies the option to provide that the price at which the 
employee may purchase the stock shall be $80 per share. On February 1, 
2005, the fair market value of the X Corporation stock is $90 per share. 
Under section 424(h), the X Corporation is deemed to have granted an 
option to the employee on February 1, 2005. Such option shall be treated 
as an option to purchase at $80 per share 100 shares of stock having a 
fair market value of $100 per share, that is, the higher of the fair 
market value of the stock on June 1, 2004, or on February 1, 1965. 
Because the requirements of Sec. 1.424-1(e)(3) and Sec. 1.423-2(g) 
have not been met, the exercise of such option by the employee after 
February 1, 2005, is not the exercise of a statutory option.
    Example 2. On June 1, 2004, the X Corporation grants to an employee 
an option under X's employee stock purchase plan to purchase 100 shares 
of X Corporation stock at $90 per share, exercisable after December 31, 
2005, and on or before June 1, 2006. On June 1, 2004, the fair market 
value of X Corporation's stock is $100 per share. On February 1, 2005, X 
Corporation modifies the option to provide that the option shall be 
exercisable on or before September 1, 2006. On February 1, 2005, the 
fair market value of X Corporation stock is $110 per share. Under 
section 424(h), X Corporation is deemed to have granted an option to the 
employee on February 1, 2005, to purchase at $90 per share 100 shares of 
stock having a fair market value of $110 per share, that is, the higher 
of the fair market value of the stock on June 1, 2004, or on February 1, 
2005. Because the requirements of Sec. 1.424-1(e)(3) and Sec. 1.423-
2(g) have not been met, the exercise of such option by the employee is 
not the exercise of a statutory option.
    Example 3. The facts are the same as in example (1), except that the 
employee exercised the option to the extent of 50 shares on January 15, 
2005, before the date of the modification of the option. Any exercise of 
the option after February 1, 2005, the date of the modification, is not 
the exercise of a statutory option. See example (1) in this 
subparagraph. The exercise of the option on January 15, 2005, pursuant 
to which 50 shares were acquired, is the exercise of a statutory option.

    (f) Definitions. The following definitions apply for purposes of 
Sec. Sec. 1.421-1 through 1.424-1:
    (1) Parent corporation. The term parent corporation, or parent, 
means any corporation (other than the employer corporation) in an 
unbroken chain of corporations ending with the employer corporation if, 
at the time of the granting of the option, each of the corporations 
other than the employer corporation owns stock possessing 50 percent or 
more of the total combined voting power of all classes of stock in one 
of the other corporations in such chain.
    (2) Subsidiary corporation. The term subsidiary corporation, or 
subsidiary, means any corporation (other than the employer corporation) 
in an unbroken chain of corporations beginning with the employer 
corporation if, at the time of the granting of the option, each of the 
corporations other than the last corporation in an unbroken chain owns 
stock possessing 50 percent or more of the total combined voting power 
of all classes of stock in one of the other corporations in such chain.
    (g) Effective/applicability date--(1) In general. Except for Sec. 
1.424-1(a)(10) Example 9 (iii), the regulations under this section are 
effective on August 3, 2004. Section 1.424-1(a)(10) Example 9 (iii) is 
effective on November 17, 2009. Section 1.424-1(a)(10) Example 9 (iii) 
applies to statutory options granted on or after January 1, 2010.
    (2) Reliance and transition period. For statutory options granted on 
or before June 9, 2003, taxpayers may rely on the 1984 proposed 
regulations LR-279-81 (49 FR 4504), the 2003 proposed regulations REG-
122917-02 (68 FR 34344), or this section until the earlier of January 1, 
2006, or the first regularly scheduled stockholders meeting of the 
granting corporation occurring 6 months after August 3, 2004. For 
statutory options granted after June 9, 2003, and before the earlier of 
January 1, 2006, or the first regularly scheduled stockholders meeting 
of the granting corporation occurring at least 6 months after August 3, 
2004, taxpayers may rely on either REG-122917-02 or this section. 
Taxpayers may not rely on LR-279-81

[[Page 1195]]

or REG-122917-02 after December 31, 2005. Reliance on LR-279-81, REG-
122917-02, or this section must be in its entirety, and all statutory 
options granted during the reliance period must be treated consistently.

[T.D. 6887, 31 FR 8808, June 24, 1966, as amended by T.D. 9144, 69 FR 
46419, Aug. 3, 2004; 69 FR 61310, 61311, Oct. 18, 2004; 69 FR 70551, 
Dec. 7, 2004; T.D. 9471, 74 FR 59087, Nov. 17, 2009]

    Editorial Note: By T.D. 9144, 69 FR 46420, Aug. 3, 2004, the 
Internal Revenue Service published a document in the Federal Register 
attempting to amend Sec. 1.424-1 (c)(4)(vi) and (viii). However, 
because of inaccurate language, this amendment could not be 
incorporated. For the convenience of the user, the language at 69 FR 
61311, Oct. 18, 2004, is set forth as follows:

    11. Section 1.424-1(c)(4)(vi), the last sentence is removed.

    12. Section 1.424-1(c)(4)(viii), second sentence, the language 
``Thus, for example, if the terms of an option are inadvertently changed 
on March 1 to extend the exercise period and the change is removed on 
November, then if the option is not exercised prior to November 1, the 
option is not considered modified under this paragraph (e).'' is removed 
and the language ``Thus for example, if the terms of an option are 
inadvertently changed on March 1 to extend the exercise period and the 
change is removed on November 1, then if the option is not exercised 
prior to November 1, the option is not considered modified under this 
paragraph (e).'' is added in its place.

    13. Section 1.424-1(g)(2), third sentence, the language ``For 
statutory options granted after June 9, 2003, and before the earlier of 
January 1, 2006, or the first regularly scheduled stockholders meeting 
of the granting corporation occurring 6 months after August 3, 2004, 
taxpayers may rely on either the REG-122917-02 or this section.'' is 
removed and the language ``For statutory options granted after June 9, 
2003, and before the earlier of January 1, 2006, or the first regularly 
scheduled stockholders meeting of the granting corporation occurring at 
least 6 months after August 3, 2004, taxpayers may rely on either the 
REG-122917-02 or this section.'' is added in its place.



Sec. Sec. 1.425-1.429  [Reserved]



Sec. 1.430(d)-1  Determination of target normal cost and funding target.

    (a) In general--(1) Overview. This section sets forth rules for 
determining a plan's target normal cost and funding target under 
sections 430(b) and 430(d), including guidance relating to the rules 
regarding actuarial assumptions under sections 430(h)(1), 430(h)(4), and 
430(h)(5). Section 430 and this section apply to single employer defined 
benefit plans (including multiple employer plans as defined in section 
413(c)) that are subject to section 412, but do not apply to 
multiemployer plans (as defined in section 414(f)). For further guidance 
on actuarial assumptions, see Sec. 1.430(h)(2)-1 (relating to interest 
rates) and Sec. Sec. 1.430(h)(3)-1 and 1.430(h)(3)-2 (relating to 
mortality tables). See also Sec. 1.430(i)-1 for the determination of 
the funding target and the target normal cost for a plan that is in at-
risk status.
    (2) Organization of regulation. Paragraph (b) of this section sets 
forth certain definitions that apply for purposes of section 430. 
Paragraph (c) of this section provides rules regarding which benefits 
are taken into account in determining a plan's target normal cost and 
funding target. Paragraph (d) of this section sets forth the rules 
regarding the plan provisions that are taken into account in making 
these determinations, and paragraph (e) of this section provides rules 
on the plan population that is taken into account for this purpose. 
Paragraph (f) of this section provides rules relating to the actuarial 
assumptions and the plan's funding method that are used to determine 
present values. Paragraph (g) of this section contains effective/
applicability dates and transition rules.
    (3) Special rules for multiple employer plans. In the case of a 
multiple employer plan to which section 413(c)(4)(A) applies, the rules 
of section 430 and this section are applied separately for each employer 
under the plan, as if each employer maintained a separate plan. Thus, 
the plan's funding target and target normal cost are computed separately 
for each employer under such a multiple employer plan. In the case of a 
multiple employer plan to which section 413(c)(4)(A) does not apply 
(that is, a plan described in section 413(c)(4)(B) that has not made the 
election for section 413(c)(4)(A) to apply), the rules of section 430 
and this section are applied as if all participants in the plan were 
employed by a single employer.

[[Page 1196]]

    (b) Definitions--(1) Target normal cost--(i) In general. For a plan 
that is not in at-risk status under section 430(i) for a plan year, 
subject to the adjustments described in paragraph (b)(1)(iii) of this 
section, the target normal cost of the plan for the plan year is the 
present value (determined as of the valuation date) of all benefits 
under the plan that accrue during, are earned during, or are otherwise 
allocated to service for the plan year under the applicable rules of 
this section, including paragraph (c)(1)(ii)(B), (C), or (D) of this 
section. See Sec. 1.430(i)-1(d) and (e)(2) for the determination of the 
target normal cost for a plan that is in at-risk status.
    (ii) Benefits allocated to a plan year. The benefits that accrue, 
are earned, or are otherwise allocated to service for the plan year are 
based on the actual benefits accrued, earned, or otherwise allocated to 
service for the plan year through the valuation date and benefits 
expected to accrue, be earned, or be otherwise allocated to service for 
the plan year for the period from the valuation date through the end of 
the plan year. The benefits that are allocated to the plan year under 
the rules of paragraph (c) of this section include any increase in 
benefits during the plan year that is attributable to increases in 
compensation for the current plan year even if that increase in benefits 
is with respect to benefits attributable to service performed in a 
preceding plan year. In addition, the benefits that are allocated to the 
plan year under the rules of paragraph (c) of this section include any 
increase in benefits during the plan year that arises on account of 
mandatory employee contributions (within the meaning of Sec. 1.411(c)-
1(c)(4)) that are made during the plan year.
    (iii) Special adjustments--(A) In general. The target normal cost of 
the plan for the plan year (determined under paragraph (b)(1)(i) of this 
section) is adjusted (not below zero) by adding the amount of plan-
related expenses expected to be paid from plan assets during the plan 
year and subtracting the amount of mandatory employee contributions 
(within the meaning of Sec. 1.411(c)-1(c)(4)) that are expected to be 
made during the plan year.
    (B) Plan-related expenses. [Reserved]
    (2) Funding target. For a plan that is not in at-risk status under 
section 430(i) for a plan year, the funding target of the plan for the 
plan year is the present value (determined as of the valuation date) of 
all benefits under the plan that have been accrued, earned, or otherwise 
allocated to years of service prior to the first day of the plan year 
under the applicable rules of this section, including paragraph 
(c)(1)(ii)(B), (C), or (D) of this section. See Sec. 1.430(i)-1(c) and 
(e)(1) for the determination of the funding target for a plan that is in 
at-risk status.
    (3) Funding target attainment percentage--(i) In general. Except as 
otherwise provided in this paragraph (b)(3), the funding target 
attainment percentage of a plan for a plan year is a fraction (expressed 
as a percentage)--
    (A) The numerator of which is the value of plan assets for the plan 
year (determined under the rules of Sec. 1.430(g)-1) after subtraction 
of the prefunding balance and the funding standard carryover balance 
under section 430(f)(4)(B) and Sec. 1.430(f)-1(c); and
    (B) The denominator of which is the funding target of the plan for 
the plan year (determined without regard to the at-risk rules of section 
430(i) and Sec. 1.430(i)-1).
    (ii) Determination of funding target attainment percentage for plans 
with delayed effective dates. If section 430 does not apply for purposes 
of determining the plan's minimum required contribution for a plan year 
that begins on or after January 1, 2008 (as is the case for a plan 
described in section 104, 105, or 106 of the Pension Protection Act of 
2006 (PPA '06), Public Law 109-280 (120 Stat. 780)), then the funding 
target attainment percentage is determined for that plan year in 
accordance with the rules of paragraph (b)(3)(i) of this section in the 
same manner as for a plan to which section 430 applies to determine the 
plan's minimum required contribution, except that the value of plan 
assets that forms the numerator under paragraph (b)(3)(i)(A) of this 
section is determined without subtraction of the funding standard 
carryover balance or the credit balance under the funding standard 
account.
    (iii) Special rule for plans with zero funding target. If the 
funding target of

[[Page 1197]]

the plan is equal to zero for a plan year, then the funding target 
attainment percentage under this paragraph (b)(3) is equal to 100 
percent for the plan year.
    (4) Present value. The present value of a benefit (including a 
portion of a benefit) with respect to a participant that is taken into 
account under the rules of paragraph (c) of this section is determined 
as of the valuation date by multiplying the amount of that benefit by 
the probability that the benefit will be paid at a future date and then 
discounting the resulting product using the appropriate interest rate 
under Sec. 1.430(h)(2)-1. The probability that the benefit will be paid 
with respect to the participant at such future date is determined using 
the actuarial assumptions that satisfy the standards of paragraph (f) of 
this section as to the probability of future service, advancement in 
age, and other events (such as death, disability, termination of 
employment, and selection of optional form of benefit) that affect 
whether the participant or beneficiary will be eligible for the benefit 
and whether the benefit will be paid at that future date.
    (c) Benefits taken into account--(1) In general--(i) Benefits earned 
or accrued. The benefits taken into account in determining the target 
normal cost and the funding target under paragraph (b) of this section 
are all benefits earned or accrued under the plan that have not yet been 
paid as of the valuation date, including retirement-type and ancillary 
benefits (within the meaning of Sec. 1.411(d)-3(g)). The benefits taken 
into account are based on the participant's or beneficiary's status 
(such as active employee, vested or partially vested terminated 
employee, or disabled participant) as of the valuation date, and those 
benefits are allocated to the funding target or the target normal cost 
under paragraph (c)(1)(ii) of this section.
    (ii) Allocation of benefits--(A) In general. To the extent that the 
amount of a participant's benefit that is expected to be paid is a 
function of the accrued benefit, the allocation of the benefit for 
purposes of determining the funding target and the target normal cost is 
made using the rules of paragraph (c)(1)(ii)(B) of this section. To the 
extent that the amount of a participant's benefit that is expected to be 
paid is not a function of the accrued benefit, but is a function of the 
participant's years of service (or is the excess of a function of the 
participant's years of service over a function of the participant's 
accrued benefit), the allocation of the benefit for purposes of 
determining the funding target and the target normal cost is made using 
the rules of paragraph (c)(1)(ii)(C) of this section. To the extent that 
the amount of a participant's benefit that is expected to be paid is not 
allocated under the rules of paragraph (c)(1)(ii)(B) or (C) of this 
section, the allocation of the benefit for purposes of determining the 
funding target and the target normal cost is made using the rules of 
paragraph (c)(1)(ii)(D) of this section.
    (B) Benefits that are based on accrued benefits. If the allocation 
of the benefit for purposes of determining the funding target and the 
target normal cost is made under this paragraph (c)(1)(ii)(B), then the 
portion of a participant's benefit that is taken into account in the 
funding target for a plan year is determined by applying the function to 
the accrued benefit as of the first day of the plan year, and the 
portion of the benefit that is taken into account in determining the 
target normal cost for the plan year is determined by applying that 
function to the increase in the accrued benefit during the plan year. 
For example, a benefit that is assumed to be payable at a particular 
early retirement age in the amount of 90 percent of the accrued benefit 
is taken into account in the funding target in the amount of 90 percent 
of the accrued benefit as of the beginning of the plan year, and that 
benefit is taken into account in the target normal cost in the amount of 
90 percent of the increase in the accrued benefit during the plan year.
    (C) Benefits that are based on service. If the allocation of the 
benefit for purposes of determining the funding target and the target 
normal cost is made under this paragraph (c)(1)(ii)(C), then the portion 
of a participant's benefit that is taken into account in determining the 
funding target for a plan year is determined by applying the function to 
the participant's years of

[[Page 1198]]

service as of the first day of the plan year, and the portion of the 
benefit that is taken into account in determining the target normal cost 
for the plan year is determined by applying that function to the 
increase in the participant's years of service during the plan year. For 
example, if a plan provides a post-retirement death benefit of $500 per 
year of service, then the funding target is determined based on a death 
benefit of $500 multiplied by a participant's years of service at the 
beginning of the year, and if the participant earns or is expected to 
earn a full year of service during the plan year, the target normal cost 
is based on the additional $500 in death benefits attributable to that 
additional year of service.
    (D) Other benefits. If the allocation of the benefit for purposes of 
determining the funding target and the target normal cost is made under 
this paragraph (c)(1)(ii)(D), then the portion of a participant's 
benefit that is taken into account in determining the funding target for 
a plan year is equal to the total benefit multiplied by the ratio of the 
participant's years of service as of the first day of the plan year to 
the years of service the participant will have at the time of the event 
that causes the benefit to be payable (whether the benefit is expected 
to be paid at the time of that decrement or at a future time), and the 
portion of the benefit that is taken into account in determining the 
target normal cost for the plan year is the increase in the 
proportionate benefit attributable to the increase in the participant's 
years of service during the plan year. For example, if a plan provides a 
Social Security supplement for a participant who retires after 30 years 
of service that is equal to a participant's Social Security benefit, the 
funding target with respect to the benefit payable beginning at a 
particular age (which reflects the probability of retirement at that 
age) is determined based on the projected Social Security benefit 
payable at the particular age multiplied by a fraction, the numerator of 
which is the participant's years of service as of the first day of the 
plan year and the denominator of which is the participant's projected 
years of service at the particular age. In such a case, if the 
participant earns or is expected to earn a full year of service during 
the plan year, the target normal cost is determined based on the 
projected Social Security benefit payable at the particular age 
multiplied by a fraction, the numerator of which is one and the 
denominator of which is the participant's projected years of service at 
the particular age.
    (iii) Application of section 436 limitations to funding target and 
target normal cost determination--(A) Effect of limitation on 
unpredictable contingent event benefits. The determination of the 
funding target and the target normal cost of a plan for a plan year must 
take into account any limitation on unpredictable contingent event 
benefits under section 436(b) with respect to unpredictable contingent 
events which occurred before the valuation date, but must not take into 
account anticipated funding-based limitations on unpredictable 
contingent event benefits under section 436(b) with respect to 
unpredictable contingent events which are expected to occur on or after 
the valuation date.
    (B) Effect of limitation on applicability of plan amendments. See 
paragraph (d) of this section for rules regarding the treatment of plan 
amendments that take effect during the plan year taking into account the 
restrictions under section 436(c).
    (C) Effect of limitation on prohibited payments. The determination 
of the funding target and the target normal cost of a plan for a plan 
year must take into account any limitation on prohibited payments under 
section 436(d) with respect to any annuity starting date that was before 
the valuation date, but must not take into account any limitation on 
prohibited payments under section 436(d) for any annuity starting date 
on or after the valuation date (however, the determination must take 
into account benefit distributions under plan provisions that allow new 
annuity starting dates with respect to distributions that were limited 
under section 436(d)).
    (D) Effect of limitation on benefit accruals. Except as otherwise 
provided in this paragraph (c)(1)(iii)(D), the determination of the 
funding target of a

[[Page 1199]]

plan for a plan year must take into account any limitation on benefit 
accruals under section 436(e) applicable before the valuation date. 
However, if the plan terms provide for the automatic restoration of 
benefit accruals as permitted under Sec. 1.436-1(a)(4)(ii)(B), and the 
restoration of benefits as of the valuation date will not be treated as 
resulting from a plan amendment under the rules of Sec. 1.436-1(c)(3) 
(because the period of limitation as of the valuation date does not 
exceed 12 months and the adjusted funding target attainment percentage 
for the plan would not be less than 60 percent taking into account the 
restored benefit accruals), then the determination of the funding target 
of a plan for a plan year must not take into account the limitation on 
benefit accruals under section 436(e) for that period. The determination 
of the target normal cost of a plan for a plan year must not take into 
account any limitation on benefit accruals under section 436(e). Thus, 
if an employer wishes to take a plan freeze into account in determining 
the target normal cost, the plan must be specifically amended to cease 
accruals.
    (iv) Effect of other limitations of benefits--(A) Liquidity 
shortfalls. The determination of the funding target and the target 
normal cost of a plan for a plan year must take into account any 
restrictions on payments under section 401(a)(32) on account of a 
liquidity shortfall (as defined in section 430(j)(4)) for periods 
preceding the valuation date. The determination of the funding target 
and the target normal cost must not take into account any restrictions 
on payments under section 401(a)(32) on account of a liquidity shortfall 
or possible liquidity shortfall for any period on or after the valuation 
date.
    (B) High 25 limitation. The determination of the funding target and 
the target normal cost of a plan for a plan year must take into account 
any restrictions on payments under Sec. 1.401(a)(4)-5(b) to highly 
compensated employees to the extent that benefits were not paid or will 
not be paid because of a limitation that applied prior to the valuation 
date. If a benefit that was otherwise restricted was paid prior to the 
valuation date but with suitable security (such as an escrow account) 
provided to the plan in the event of a plan termination, the benefit is 
treated as distributed for purposes of section 430 and this section. 
Accordingly, the funding target does not include any liability for the 
benefit and the plan assets do not include the security. The 
determination of the funding target and the target normal cost of a plan 
for a plan year must not take into account any restrictions on payments 
under Sec. 1.401(a)(4)-5(b) to highly compensated employees that are 
anticipated with respect to annuity starting dates on or after the 
valuation date on account of the funded status of the plan.
    (2) Benefits provided by insurance--(i) General rule. A plan 
generally is required to reflect in the plan's funding target and target 
normal cost the liability for benefits that are funded through insurance 
contracts held by the plan, and to include the corresponding insurance 
contracts in plan assets. Paragraph (c)(2)(ii) of this section sets 
forth an alternative to this general approach. A plan's treatment of 
benefits funded through insurance contracts pursuant to this paragraph 
(c)(2) is part of the plan's funding method. Accordingly, that treatment 
can be changed only with the consent of the Commissioner.
    (ii) Separate funding of insured benefits. As an alternative to the 
treatment described in paragraph (c)(2)(i) of this section, in the case 
of benefits that are funded through insurance contracts, the liability 
for benefits provided under such contracts is permitted to be excluded 
from the plan's funding target and target normal cost, provided that the 
corresponding insurance contracts are excluded from plan assets. This 
treatment is only available with respect to insurance purchased from an 
insurance company licensed under the laws of a State and only to the 
extent that a participant's or beneficiary's right to receive those 
benefits is an irrevocable contractual right under the insurance 
contracts, based on premiums paid to the insurance company prior to the 
valuation date. For example, in the case of a retired participant 
receiving benefits from an annuity contract in pay status under which no 
premiums are required on or after the

[[Page 1200]]

valuation date, the liability for benefits provided by the contract is 
permitted to be excluded from the plan's funding target provided that 
the value of the contract is also excluded from the value of plan 
assets. Similarly, in the case of an active or deferred vested 
participant whose benefits are funded by a life insurance or annuity 
contract under which further premiums are required on or after the 
valuation date, the liability for benefits, if any, that would be paid 
from the contract if no further premiums were to be paid (for example, 
if the contract were to go on reduced paid-up status) is permitted to be 
excluded from the plan's funding target and target normal cost, provided 
that the value of the contract is excluded from the value of plan 
assets. By contrast, if the plan trustee can surrender a contract to the 
insurer for its cash value, then the participant's or beneficiary's 
right to receive those benefits is not an irrevocable contractual right 
and, therefore, the liability for benefits provided under the contract 
must be taken into account in determining the plan's funding target and 
target normal cost and the contracts cannot be excluded from plan 
assets.
    (d) Plan provisions taken into account--(1) General rule--(i) Plan 
provisions adopted by valuation date. Except as otherwise provided in 
this paragraph (d), a plan's funding target and target normal cost for a 
plan year are determined based on plan provisions that are adopted no 
later than the valuation date for the plan year and that take effect on 
or before the last day of the plan year. For example, in the case of a 
plan amendment adopted on or before the valuation date for the plan year 
that has an effective date occurring in the current plan year, the plan 
amendment is taken into account in determining the funding target and 
the target normal cost for the current plan year if it is permitted to 
take effect under the rules of section 436(c) for the current plan year, 
but the amendment is not taken into account for the current plan year if 
it does not take effect until a future plan year.
    (ii) Plan provisions adopted after valuation date. If a plan 
administrator makes the election described in section 412(d)(2) with 
respect to a plan amendment, then the plan amendment is treated as 
having been adopted on the first day of the plan year for purposes of 
this paragraph (d). Section 412(d)(2) applies to any plan amendment 
adopted no later than 2\1/2\ months after the close of the plan year, 
including an amendment adopted during the plan year. Thus, if an 
amendment is adopted after the valuation date for a plan year (and no 
later than 2\1/2\ months after the close of the plan year), but takes 
effect by the last day of the plan year, the amendment is taken into 
account in determining the plan's funding target and target normal cost 
for the plan year if the plan administrator makes the election described 
in section 412(d)(2) with respect to such amendment.
    (iii) Determination of when an amendment takes effect. For purposes 
of this paragraph (d)(1), the determination of whether an amendment that 
increases benefits takes effect and when it takes effect is determined 
in accordance with the rules of section 436(c) and Sec. 1.436-1(c)(5). 
For purposes of this paragraph (d)(1), in the case of an amendment that 
decreases benefits, the amendment takes effect under a plan on the first 
date on which the benefits of any individual who is or could be a 
participant or beneficiary under the plan would be less than those 
benefits would be under the pre-amendment plan provisions if the 
individual were on that date to satisfy the applicable conditions for 
the benefits. In either case, the determination of when an amendment 
takes effect is unaffected by an election under section 412(d)(2).
    (2) Special rule for certain amendments increasing liabilities. In 
the case of a plan amendment that is not required to be taken into 
account under the rules of paragraph (d)(1) of this section because it 
is adopted after the valuation date for the plan year, the plan 
amendment must be taken into account in determining a plan's funding 
target and target normal cost for the plan year if the plan amendment--
    (i) Takes effect by the last day of the plan year;
    (ii) Increases the liabilities of the plan by reason of increases in 
benefits,

[[Page 1201]]

establishment of new benefits, changing the rate of benefit accrual, or 
changing the rate at which benefits become nonforfeitable; and
    (iii) Would not be permitted to take effect under the rules of 
section 436(c) if those rules were applied--
    (A) By treating the increase in the target normal cost for the plan 
year attributable to the amendment (and all other amendments that must 
be taken into account solely because of the application of the rules in 
this paragraph (d)(2)) as if the increase were an increase in the 
funding target for the plan year; and
    (B) By taking into account all unpredictable contingent event 
benefits permitted to be paid for unpredictable contingent events that 
occurred during the current plan year and all plan amendments that took 
effect in the current plan year (including all amendments to which this 
paragraph (d)(2) applies for the plan year).
    (3) Allocation of benefits attributable to plan amendments. If a 
plan amendment is taken into account for a plan year under the rules of 
this paragraph (d), then the allocation of benefits that is used to 
determine the funding target and the target normal cost for that plan 
year is based on the plan as amended. Thus, if an amendment that is 
taken into account for a plan year increases a participant's accrued 
benefit for service prior to the beginning of the plan year, then the 
present value of that increase is included in the funding target for the 
plan year.
    (e) Plan population taken into account--(1) In general. In making 
any determination of the funding target or target normal cost under 
paragraph (b) of this section, the plan population is determined as of 
the valuation date. The plan population must include three classes of 
individuals--
    (i) Participants currently employed in the service of the employer;
    (ii) Participants who are retired under the plan or who are 
otherwise no longer employed in the service of the employer; and
    (iii) All other individuals currently entitled to benefits under the 
plan.
    (2) Assumption regarding rehiring of former employees--(i) Special 
exclusion for ``rule of parity'' cases. Certain individuals may be 
excluded from the class of individuals described in paragraph (e)(1)(ii) 
of this section. The excludable individuals are those former employees 
who, prior to the valuation date for the plan year, have terminated 
service with the employer without vested benefits and whose service 
might be taken into account in future years because the ``rule of 
parity'' of section 411(a)(6)(D) does not permit that service to be 
disregarded. However, if the plan's experience as to separated employees 
returning to service has been such that the exclusion described in this 
paragraph (e)(2) would be unreasonable, then no such exclusion is 
permitted.
    (ii) Application to partially vested participants. Whether former 
employees who are terminated with partially vested benefits are assumed 
to return to service is determined under the same rules that apply to 
former employees without vested benefits under paragraph (e)(2)(i) of 
this section.
    (3) Anticipated future participants. In making any determination of 
the funding target or target normal cost under paragraph (b) of this 
section, the actuarial assumptions and funding method used for the plan 
must not anticipate the affiliation with the plan of future participants 
not employed in the service of the employer on the plan's valuation 
date. However, any such determination may anticipate the affiliation 
with the plan of current employees who have not yet satisfied the 
participation (age and service) requirements of the plan as of the 
valuation date.
    (f) Actuarial assumptions and funding method used in determination 
of present value--(1) Selection of actuarial assumptions and funding 
method--(i) General rules. The determination of any present value or 
other computation under section 430 and this section must be made on the 
basis of actuarial assumptions and a funding method. Except as otherwise 
specifically provided (for example, in Sec. 1.430(h)(2)-1(b)(6) or 
section 4006(a)(3)(E)(iv) of the Employee Retirement Income Security Act 
of 1974, as amended (ERISA)), the same actuarial assumptions and funding 
method must be used for all computations

[[Page 1202]]

under sections 430 and 436. For example, the actuarial assumptions and 
the funding method used in making a certification of the adjusted 
funding target attainment percentage for a plan year must be the same as 
those disclosed on the actuarial report under section 6059 (Schedule SB, 
``Single-Employer Defined Benefit Plan Actuarial Information'' of Form 
5500, ``Annual Return/Report of Employee Benefit Plan'').
    (ii) Changes in actuarial assumptions and funding method. Actuarial 
assumptions established for a plan year cannot subsequently be changed 
for that plan year unless the Commissioner determines that the 
assumptions that were used are unreasonable. Similarly, a funding method 
established for a plan year cannot subsequently be changed for that plan 
year unless the Commissioner determines that the use of that funding 
method for that plan year is impermissible.
    (iii) Procedures for establishing actuarial assumptions and funding 
method. For purposes of this paragraph (f)(1), in the case of a plan for 
which an actuarial report under section 6059 (Schedule SB of Form 5500) 
is required to be filed for a plan year, actuarial assumptions and the 
funding method are established by the filing of the actuarial report if 
it is filed no later than the due date (with extensions) for the report. 
In the case of a plan for which an actuarial report for a plan year is 
not required to be filed, actuarial assumptions and the funding method 
are established by the delivery of the completed report to the employer 
if it is delivered no later than what would be the due date (with 
extensions) for filing the actuarial report were such a filing required. 
If the actuarial report is not filed or delivered by the applicable date 
described in the two preceding sentences, then the same actuarial 
assumptions (such as the same interest rate and mortality table 
elections) and funding method as were used for the preceding plan year 
apply for all computations under sections 430 and 436 for the current 
plan year, unless the Commissioner permits or requires other actuarial 
assumptions or another funding method permitted under section 430 to be 
used for the current plan year.
    (iv) Scope of funding method. A plan's funding method includes not 
only the overall funding method used by the plan but also each specific 
method of computation used in applying the overall method. However, the 
choice of which actuarial assumptions are appropriate to the overall 
method or to the specific method of computation is not a part of the 
funding method. The assumed earnings rate used for purposes of 
determining the actuarial value of assets under section 430(g)(3)(B) is 
treated as an actuarial assumption, rather than as part of the funding 
method.
    (2) Interest and mortality rates. Section 430(h)(2) and Sec. 
1.430(h)(2)-1 set forth the interest rates, and section 430(h)(3) and 
Sec. Sec. 1.430(h)(3)-1 and 1.430(h)(3)-2 set forth the mortality 
tables, that must be used for purposes of determining any present value 
under this section. However, notwithstanding the requirement to use the 
mortality tables, in the case of a plan which has fewer than 100 
participants and beneficiaries who are not in pay status, the actuarial 
assumptions may assume no pre-retirement mortality, but only if that 
assumption would be a reasonable assumption.
    (3) Other assumptions. In the case of actuarial assumptions other 
than those specified in sections 430(h)(2), 430(h)(3), and 430(i), each 
of those actuarial assumptions must be reasonable (taking into account 
the experience of the plan and reasonable expectations). In addition, 
the actuarial assumptions (other than those specified in sections 
430(h)(2), 430(h)(3), and 430(i)) must, in combination, offer the plan's 
enrolled actuary's best estimate of anticipated experience under the 
plan based on information determined as of the valuation date. See 
paragraph (f)(4)(iii) of this section for special rules for determining 
the present value of a single-sum and similar distributions.
    (4) Probability of benefit payments in single sum or other optional 
forms--(i) In general. This paragraph (f)(4) provides rules relating to 
the probability that benefit payments will be paid as single sums or 
other optional forms under a plan and the impact of that probability on 
the determination of the present value of those benefit payments under 
section 430.

[[Page 1203]]

    (ii) General rules of application. Any determination of present 
value or any other computation under this section must take into 
account--
    (A) The probability that future benefit payments under the plan will 
be made in the form of any optional form of benefit provided under the 
plan (including single-sum distributions), determined on the basis of 
the plan's experience and other related assumptions, in accordance with 
paragraph (f)(3) of this section; and
    (B) Any difference in the present value of future benefit payments 
that results from the use of actuarial assumptions in determining the 
amount of benefit payments in any such optional form of benefit that are 
different from those prescribed by section 430(h).
    (iii) Single-sum and similar distributions--(A) Distributions using 
section 417(e) assumptions. In the case of a distribution that is 
subject to section 417(e)(3) and that is determined using the applicable 
interest rates and applicable mortality table under section 417(e)(3), 
for purposes of applying paragraph (f)(4)(ii) of this section, the 
computation of the present value of that distribution is treated as 
having taken into account any difference in present value that results 
from the use of actuarial assumptions that are different from those 
prescribed by section 430(h) (as required under paragraph (f)(4)(ii)(B) 
of this section) if and only if the present value of the distribution is 
determined in accordance with this paragraph (f)(4)(iii).
    (B) Substitution of annuity form. Except as otherwise provided in 
this paragraph (f)(4)(iii), the present value of a distribution is 
determined in accordance with this paragraph (f)(4)(iii) if that present 
value is determined as the present value, using special actuarial 
assumptions, of the annuity (either the deferred or immediate annuity) 
which is used under the plan to determine the amount of the 
distribution. Under these special assumptions, for the period beginning 
with the expected annuity starting date for the distribution, the 
current applicable mortality table under section 417(e)(3) that would 
apply to a distribution with an annuity starting date occurring on the 
valuation date is substituted for the mortality table under section 
430(h)(3) that would otherwise be used. In addition, under these special 
assumptions, the valuation interest rates under section 430(h)(2) are 
used for purposes of discounting the projected annuity payments from 
their expected payment dates to the valuation date (as opposed to the 
interest rates under section 417(e)(3) which the plan uses to determine 
the amount of the benefit).
    (C) Optional application of generational mortality and phase-in of 
interest rates. In determining the present value of a distribution under 
this paragraph (f)(4)(iii), if a plan uses the generational mortality 
tables under Sec. 1.430(h)(3)-1(a)(4) or Sec. 1.430(h)(3)-2, the plan 
is permitted to use a 50-50 male-female blend of the annuitant mortality 
rates under the Sec. 1.430(h)(3)-1(a)(4) generational mortality tables 
in lieu of the applicable mortality table under section 417(e)(3) that 
would apply to a distribution with an annuity starting date occurring on 
the valuation date. Similarly, a plan is permitted to make adjustments 
to the interest rates in order to reflect differences between the phase-
in of the section 430(h)(2) segment rates under section 430(h)(2)(G) and 
the adjustments to the segment rates under section 417(e)(3)(D)(iii).
    (D) Distributions subject to section 417(e)(3) using other 
assumptions. In the case of a distribution that is subject to section 
417(e)(3) but that is determined on a basis other than using the 
applicable interest rates and the applicable mortality table under 
section 417(e)(3), for purposes of applying paragraph (f)(4)(ii)(B) of 
this section, the computation of present value must take into account 
the extent to which the present value of the distribution is different 
from the present value determined using the rules of paragraph 
(f)(4)(iii)(B) of this section, based on actuarial assumptions that 
satisfy the requirements of paragraph (f)(3) of this section. If the 
plan provides that the amount of the benefit is based on a comparison of 
the section 417(e)(3) benefit (that is, the benefit determined using the 
applicable interest rates and the applicable mortality table under 
section 417(e)(3)) with another benefit determined using some other 
basis,

[[Page 1204]]

then paragraph (f)(4)(ii)(B) of this section is applied as of the 
valuation date by comparing the present value of the section 417(e)(3) 
benefit determined under the rules of paragraph (f)(4)(iii)(B) of this 
section with the present value of the other benefit. The rule of this 
paragraph (f)(4)(iii)(D) applies, for example, where a distribution that 
is subject to section 417(e)(3) is determined as the greater of the 
benefit determined using the applicable interest rates and the 
applicable mortality table under section 417(e)(3) and the benefit 
determined using some other basis, or where the amount of a distribution 
that is subject to section 417(e)(3) is determined using an interest 
rate other than the applicable interest rates as required under section 
415(b)(2)(E)(ii) (see Sec. 1.417(e)-1(d)(1)).
    (5) Distributions from applicable defined benefit plans under 
section 411(a)(13)(C)--(i) In general. In the case of an applicable 
defined benefit plan described in section 411(a)(13)(C), if the amount 
of a future distribution is based on an interest adjustment applied to 
the current accumulated benefit, then the amount of that distribution is 
determined by projecting the future interest credits or equivalent 
amount under the plan's interest crediting rules using actuarial 
assumptions that satisfy the requirements of paragraph (f)(3) of this 
section. Thus, if a plan provides for a single-sum distribution equal to 
the balance of a participant's hypothetical account under a cash balance 
plan, then the amount of that future distribution is equal to the 
projected account balance at the expected date of payment determined 
using actuarial assumptions that satisfy the requirements of paragraph 
(f)(3) of this section.
    (ii) Annuity distributions--(A) General rule. In the case of an 
applicable defined benefit plan described in section 411(a)(13)(C), if 
the amount of an annuity distribution is based on either the balance of 
a hypothetical account maintained for a participant or the accumulated 
percentage of a participant's final average compensation, then the 
amount of that annuity distribution is calculated by converting the 
projected account balance (or accumulated percentage of final average 
compensation), in accordance with paragraph (f)(5)(i) of this section, 
to an annuity by applying the plan's annuity conversion provisions using 
the rules of this paragraph (f)(5)(ii).
    (B) Use of current annuity factors. Except as otherwise provided in 
paragraph (f)(5)(ii)(C) of this section, if the plan bases the 
conversion of the projected account balance (or accumulated percentage 
of final average compensation) to an annuity using the applicable 
interest rates and applicable mortality table under section 417(e)(3), 
then the amount of the annuity distribution is determined by dividing 
the projected account balance (or accumulated percentage of final 
average compensation) by an annuity factor corresponding to the assumed 
form of payment using, for the period beginning with the annuity 
starting date, the current applicable mortality table under section 
417(e)(3) that would apply to a distribution with an annuity starting 
date occurring on the valuation date (in lieu of the mortality table 
under section 430(h)(3) that would otherwise be used) and the valuation 
interest rates under section 430(h)(2) (as opposed to the interest rates 
under section 417(e)(3) which the plan uses to determine the amount of 
the annuity).
    (C) Optional application of generational mortality and phase-in of 
segment rates. In determining the amount of an annuity distribution 
under paragraph (f)(5)(ii)(B) of this section, a plan is permitted to 
apply the options described in paragraph (f)(4)(iii)(C) of this section.
    (D) Distributions using assumptions other than assumptions under 
section 417(e)(3). In applying this paragraph (f)(5)(ii), in the case of 
a plan that determines an annuity using a basis other than the 
applicable interest rates and applicable mortality table under section 
417(e)(3), the amount of the annuity distribution must be based on 
actuarial assumptions that satisfy the requirements of paragraph (f)(3) 
of this section.
    (6) Unpredictable contingent event benefits. Any determination of 
present value or any other computation under this section must take into 
account, based on information as of the valuation date, the probability 
that future

[[Page 1205]]

benefits (or increased benefits) will become payable under the plan due 
to the occurrence of an unpredictable contingent event (as described in 
Sec. 1.436-1(j)(9)). For this purpose, this probability with respect to 
an unpredictable contingent event may be assumed to be zero if there is 
not more than a de minimis likelihood that the unpredictable contingent 
event will occur.
    (7) Reasonable techniques permitted--(i) Determination of benefits 
to be paid during the plan year. Any reasonable technique can be used to 
determine the present value of the benefits expected to be paid during a 
plan year, based on the interest rates and mortality assumptions 
applicable for the plan year. For example, the present value of a 
monthly retirement annuity payable at the beginning of each month can be 
determined--
    (A) Using the standard actuarial approximation that reflects 13/
24ths of the discounted expected payments for the year as of the 
beginning of the year and 11/24ths of the discounted expected payments 
for the year as of the end of the year;
    (B) By assuming a uniform distribution of death during the year; or
    (C) By assuming that the payment is made in the middle of the year.
    (ii) Determination of target normal cost. In the case of a 
participant for whom there is a less than 100 percent probability that 
the participant will terminate employment during the plan year, for 
purposes of determining the benefits expected to accrue, be earned, or 
otherwise allocated to service during the plan year which are used to 
determine the target normal cost, it is permissible to assume the 
participant will not terminate during the plan year, unless using this 
method of calculation would be unreasonable.
    (8) Approval of significant changes in actuarial assumptions for 
large plans--(i) In general. Except as otherwise provided in paragraph 
(f)(8)(iii) of this section, any actuarial assumptions used to determine 
the funding target of a plan for a plan year during which the plan is 
described in paragraph (f)(8)(ii) of this section cannot be changed from 
the actuarial assumptions that were used for the preceding plan year 
without the approval of the Commissioner if the changes in assumptions 
result in a decrease in the plan's funding shortfall (within the meaning 
of section 430(c)(4)) for the current plan year (disregarding the effect 
on the plan's funding shortfall resulting from changes in interest and 
mortality assumptions under sections 430(h)(2) and (h)(3)) that either 
exceeds $50,000,000, or exceeds $5,000,000 and is 5 percent or more of 
the funding target of the plan before such change.
    (ii) Affected plans. A plan is described in this paragraph 
(f)(8)(ii) for a plan year if--
    (A) The plan is a defined benefit plan (other than a multiemployer 
plan) to which title IV of ERISA applies; and
    (B) The aggregate unfunded vested benefits used to determine 
variable-rate premiums for the plan year (as determined under section 
4006(a)(3)(E)(iii) of ERISA) of the plan and all other plans maintained 
by the contributing sponsors (as defined in section 4001(a)(13) of 
ERISA) and members of such sponsors' controlled groups (as defined in 
section 4001(a)(14) of ERISA) which are covered by title IV of ERISA 
(disregarding multiemployer plans and disregarding plans with no 
unfunded vested benefits) exceed $50,000,000.
    (iii) Automatic approval to resume use of previously used 
assumptions upon exiting at-risk status during phase-in. A plan that is 
not in at-risk status for the current plan year and that was in at-risk 
status for the prior plan year (but not for a period of 5 or more 
consecutive plan years) is granted automatic approval to use the 
actuarial assumptions that were applied before the plan entered at-risk 
status and that were used in combination with the required at-risk 
assumptions during the period the plan was in at-risk status.
    (9) Examples. The following examples illustrate the rules of this 
section. Unless otherwise indicated, these examples are based on the 
following assumptions: The normal retirement age is 65, the minimum 
required contribution for the plan is determined under the rules of 
section 430 starting in 2008, the plan year is the calendar year, the 
valuation date is January 1, no plan-related expenses are paid or 
expected to be paid from plan assets, and the plan does not

[[Page 1206]]

provide for mandatory employee contributions. The examples are as 
follows:

    Example 1. (i) Plan P provides an accrued benefit equal to 1.0% of a 
participant's highest 3-year average compensation for each year of 
service. Plan P provides that an early retirement benefit can be 
received at age 60 equal to the participant's accrued benefit reduced by 
0.5% per month for early commencement. On January 1, 2010, Participant A 
is age 60 and has 12 years of past service. Participant A's compensation 
for the years 2007 through 2009 was $47,000, $50,000, and $52,000, 
respectively. Participant A's rate of compensation at December 31, 2009, 
is $54,000 and A's rate of compensation for 2010 is assumed not to 
increase at any point during 2010. Decrements are applied at the 
beginning of the plan year.
    (ii) Participant A's annual accrued benefit as of January 1, 2010, 
is $5,960 [0.01 x 12 x ($47,000 + $50,000 + $52,000) / 3]. Participant 
A's expected benefit accrual for 2010 is $800 [0.01 x 13 x ($50,000 + 
$52,000 + $54,000) / 3 - $5,960], to the extent that Participant A is 
expected to continue in employment for the full 2010 plan year.
    (iii) Because the early retirement benefit is a function of the 
participant's accrued benefit, the allocation of the benefit for 
purposes of determining the target normal cost and funding target is 
made under paragraph (c)(1)(ii)(B) of this section. Accordingly, for 
Participant A, the early retirement benefit that is taken into account 
with respect to the decrement at age 60 when determining the 2010 
funding target is $4,172 [$5,960 accrued benefit x (1 - 0.005 x 60 
months)]. The expected accrual of the early retirement benefit during 
2010 that is taken into account for Participant A with respect to the 
decrement at age 60 when determining the 2010 target normal cost is 
zero, because in this example the age-60 decrement would be applied as 
of January 1, 2010, before Participant A would earn any additional 
benefits. (But see paragraph (f)(7)(ii) of this section for an 
alternative approach for determining the expected accrual with respect 
to the decrement at age 60.)
    (iv) The early retirement benefit for Participant A with respect to 
the decrement at age 61 that is taken into account in determining the 
funding target for the 2010 plan year is $4,529.60 [$5,960 accrued 
benefit x (1 - 0.005 x 48 months)]. The portion of the early retirement 
benefit that is taken into account for Participant A with respect to the 
decrement at age 61 that is taken into account in determining the target 
normal cost for the 2010 plan year is $608 [$800 expected annual accrual 
x (1 - 0.005 x 48 months)].
    Example 2. (i) The facts are the same as in Example 1. In addition, 
the plan offers a $500 temporary monthly supplement to participants who 
complete 15 years of service and retire from active employment after 
attaining age 60. The temporary supplement is payable until the 
participant turns age 62. In addition, the supplement is limited so that 
it does not exceed the participant's Social Security benefit payable at 
age 62. On January 1, 2010, Participant B is age 55 and has 20 years of 
past service, and Participant C is age 60 and has 14 years of past 
service. For Participants B and C, the projected Social Security benefit 
is greater than $500 per month.
    (ii) Because the temporary supplement is not a function of the 
participant's accrued benefit or service, the allocation of the benefit 
for purposes of determining the target normal cost and funding target is 
made under paragraph (c)(1)(ii)(D) of this section. The portion of the 
annual temporary supplement for Participant B with respect to the early 
retirement decrement occurring at age 60 that is taken into account in 
determining the funding target for the 2010 plan year is $4,800 [($500 x 
12 months) x 20 years of past service / 25 years of service at assumed 
early retirement age]. The portion of the annual temporary supplement 
for Participant B with respect to the early retirement decrement 
occurring at age 61 that is taken into account in determining the 
funding target for the 2010 plan year is $4,615 [($500 x 12 months) x 20 
years of past service / 26 years of service at assumed early retirement 
age]. In each case, the allocable portion of the benefit is assumed to 
be payable until age 62 (or the participant's death, if earlier).
    (iii) For Participant B, the portion of the annual temporary 
supplement with respect to the early retirement decrement occurring at 
age 60 that is taken into account in determining the target normal cost 
for the 2010 plan year is $240 [($500 x 12 months) x 1 year of service 
expected to be earned during the plan year / 25 years of service at 
assumed early retirement age]. The portion of the annual temporary 
supplement with respect to the early retirement decrement occurring at 
age 61 that is taken into account in determining the target normal cost 
for the 2010 plan year is $230.77 [($500 x 12 months) x 1 year of 
service expected to be earned during the plan year / 26 years of service 
at assumed early retirement age]. The present value of these amounts 
reflects a payment period beginning with the decrement at age 60 or 61, 
as applicable, until age 62 (or assumed death, if earlier).
    (iv) For Participant C, the portion of the annual temporary 
supplement with respect to the early retirement decrement occurring at 
age 61 (when the participant is first eligible for the benefit) that is 
taken into account in determining the funding target for the 2010 plan 
year is $5,600 [($500 x 12 months) x 14 years of past service / 15 years 
of service at assumed early retirement age]. The

[[Page 1207]]

present value of this amount reflects a payment period beginning with 
the decrement at age 61 until age 62 (or death if earlier).
    Example 3. (i) The facts are the same as in Example 1. The plan also 
provides a single-sum death benefit (in addition to the qualified pre-
retirement spouse's benefit) equal to the greater of the participant's 
annual accrued benefit at the time of death, or $10,000. The benefit is 
limited as necessary to ensure that the plan meets the incidental death 
benefit requirements of section 401(a).
    (ii) The determination of the portion of the death benefit that is 
taken into account in determining the target normal cost and funding 
target is made under paragraph (c)(1)(ii)(B) of this section to the 
extent that it is a function of the participant's accrued benefit and 
under paragraph (c)(1)(ii)(D) of this section to the extent that it 
relates to the part of the death benefit that is not a function of the 
participant's accrued benefit.
    (iii) The portion of the single-sum death benefit corresponding to 
the accrued benefit, or $5,960, is taken into account when determining 
the 2010 funding target for Participant A.
    (iv) The excess of the death benefit over Participant A's accrued 
benefit is $4,040 (that is, $10,000 - $5,960). Because this part of the 
death benefit is not a function of the participant's accrued benefit nor 
is it a function of service, the determination of the corresponding 
portion of the death benefit taken into account in determining the 
target normal cost and funding target for 2010 is made under paragraph 
(c)(1)(ii)(D) of this section. For example, for Participant A, the 
portion of this benefit with respect to the death decrement occurring at 
age 64 that is taken into account for purposes of determining the 
funding target for the 2010 plan year is $3,030 ($4,040 x 12 years of 
past service / 16 years of service at assumed age of death).
    (v) The total single-sum death benefit for Participant A with 
respect to the death decrement at age 64 that is taken into account in 
determining the funding target for the 2010 plan year is $8,990 ($5,960 
+ $3,030).
    (vi) Similarly, the portion of the single-sum death benefit for 
Participant A that is taken into account in determining the target 
normal cost for the 2010 plan year is equal to the sum of the expected 
increase in the accrued benefit during 2010, and the expected change in 
the allocable portion of the excess death benefit attributable to 
service during 2010 as determined in accordance with paragraph 
(c)(1)(ii)(D) of this section. As described in Example 1, the expected 
increase in Participant A's accrued benefit during 2010 is $800, to the 
extent that Participant A is expected to continue in employment for the 
full 2010 plan year.
    (vii) At the end of 2010, Participant A's accrued benefit is 
expected to be $6,760 ($5,960 + $800). The excess portion of the single-
sum death benefit to be allocated in accordance with paragraph 
(c)(1)(ii)(D) of this section is $3,240 ($10,000 - $6,760), and the 
allocable portion of the excess benefit for Participant A as of December 
31, 2010, with respect to the death decrement at age 64, is $2,632.50 
($3,240 x 13 years of service as of December 31, 2010 / 16 years of 
service at assumed age of death). The change in the allocable portion of 
Participant A's excess death benefit due to an additional year of 
service, with respect to the death decrement at age 64, is a decrease of 
$397.50. Therefore, the target normal cost for the 2010 plan year 
attributable to Participant A, with respect to the death decrement at 
age 64, will reflect a single-sum death benefit of $402.50 ($800 
expected increase in Participant A's accrued benefit minus a $397.50 
expected decrease in the allocable portion of the death benefit in 
excess of the accrued benefit).
    Example 4. (i) The facts are the same as in Example 3, except that 
the plan provides a single-sum death benefit equal to the greater of the 
present value of the qualified pre-retirement survivor annuity or 100 
times the amount of the participant's monthly retirement benefit with 
service projected to normal retirement age. The valuation is based on 
the assumption that all surviving spouses choose to receive their 
benefit in the form of a single sum. For Participant A, the value of the 
qualified pre-retirement survivor annuity is less than 100 times 
Participant A's projected monthly retirement benefit.
    (ii) The allocation of the death benefit that is a function of 
Participant A's accrued benefit is based on service and compensation to 
the first day of the plan year for purposes of determining the funding 
target, and the allocation of the death benefit that is a function of 
the increase in Participant A's accrued benefit during the plan year for 
purposes of determining the target normal cost is made in accordance 
with paragraph (c)(1)(ii)(B) of this section. As described in Example 1, 
Participant A's accrued benefit based on service and compensation as of 
January 1, 2010, is $5,960, or $496.67 per month. Accordingly, the 
portion of the single-sum death benefit corresponding to the accrued 
benefit, or $49,667 (100 times $496.67), is taken into account when 
determining the 2010 funding target for Participant A.
    (iii) In addition, the funding target and the target normal cost 
reflect a portion of Participant A's death benefit in excess of the 
amount based on Participant A's accrued benefit. Based on Participant 
A's average compensation as of the first day of the plan year, 
Participant A's accrued benefit with service projected to normal 
retirement is $8,443 [.01 x 17 years of service at age 65 x ($47,000 + 
$50,000 + $52,000) / 3], or $703.61 per month. The corresponding death 
benefit is $70,361.

[[Page 1208]]

    (iv) The excess of the death benefit over Participant A's accrued 
benefit as of January 1, 2010, is $20,694 (that is, $70,361 - $49,667). 
Because this part of the death benefit is not a function of Participant 
A's accrued benefit or service, the portion that is taken into account 
in determining the funding target is determined under paragraph 
(c)(1)(ii)(D) of this section. For Participant A, the portion of this 
benefit with respect to the death decrement occurring at age 64 that is 
taken into account when determining the funding target for the 2010 plan 
year is $15,521 ($20,694 x 12 years of past service / 16 years of 
service at assumed age of death). The total single-sum death benefit for 
Participant A with respect to the death decrement at age 64 reflected in 
the funding target for the 2010 plan year is $65,188 ($49,667 + 
$15,521).
    (v) Similarly, the portion of the single-sum death benefit for 
Participant A that is taken into account when determining the target 
normal cost for 2010 is equal to the sum of the death benefit based on 
the expected increase in the accrued benefit during 2010 and the 
expected change in the allocable portion of the excess death benefit 
attributable to service during 2010 as determined in accordance with 
paragraph (c)(1)(ii)(D) of this section.
    (vi) At the end of 2010, Participant A's accrued benefit is expected 
to be $6,760 ($5,960 + $800), or $563.33 per month, and the associated 
death benefit is $56,333. The expected increase in the amount of the 
death benefit attributable to the increase in Participant A's accrued 
benefit is therefore $6,666 ($56,333 - $49,667).
    (vii) Participant A's projected accrued benefit at normal retirement 
based on average compensation as of the end of 2010 is $8,840 [.01 x 17 
years of service at age 65 x ($50,000 + $52,000 + $54,000) / 3], or 
$736.67 per month. The corresponding death benefit is $73,667. The 
excess portion of the single-sum death benefit to be allocated in 
accordance with paragraph (c)(1)(ii)(D) of this section is $17,334 
($73,667 - $56,333), and the allocable portion of the excess benefit for 
Participant A as of December 31, 2010, with respect to the death 
decrement at age 64, is $14,084 ($17,334 x 13 years of service as of 
December 31, 2010 / 16 years of service at assumed age of death).
    (viii) The change in the allocable portion of Participant A's excess 
death benefit during 2010, with respect to the death decrement at age 
64, is a decrease of $1,437 ($14,084 - $15,521). Therefore, the target 
normal cost for the 2010 plan year attributable to Participant A, with 
respect to the death decrement at age 64, will reflect a single-sum 
death benefit of $5,229 ($6,666 expected increase in Participant A's 
death benefit based on the expected increase in the accrued benefit, 
minus an expected decrease of $1,437 in the amount of the death benefit 
in excess of the amount attributable to the accrued benefit).
    Example 5. (i) The facts are the same as in Example 1. In addition, 
the plan provides a disability benefit to participants who become 
disabled after completing 15 years of service. The disability benefit is 
payable at normal retirement age or an earlier date if elected by a 
participant. For purposes of calculating the disability benefit, service 
continues to accrue until normal retirement age (unless recovery or 
commencement of retirement benefits occurs earlier). Further, 
compensation is deemed to continue at the same rate as when the 
disability began.
    (ii) Participant A will be eligible for the disability benefit at 
age 63 after completion of 15 years of service. Participant A's annual 
disability benefit at normal retirement age is $9,180 (that is, 1% of 
highest 3-year average compensation of $54,000 multiplied by 17 years of 
deemed service at normal retirement age).
    (iii) The portion of the disability benefit based on the 
participant's accrued benefit as of the valuation date that is taken 
into account in determining the target normal cost and funding target is 
determined in accordance with paragraph (c)(1)(ii)(B) of this section. 
Accordingly, the portion of the disability benefit corresponding to 
Participant A's accrued benefit as of January 1, 2010, or $5,960, is 
taken into account when determining the 2010 funding target.
    (iv) The excess of Participant A's disability benefit over the 
accrued benefit as of January 1, 2010, is $3,220 ($9,180 - $5,960). 
Because this portion of the disability benefit is not based on 
Participant A's accrued benefit or service, the portion that is taken 
into account in determining the funding target is determined under 
paragraph (c)(1)(ii)(D) of this section. The portion of Participant A's 
excess disability benefit with respect to the disability decrement 
occurring at age 63 that is taken into account when determining the 2010 
funding target is $2,576 [$3,220 x (12 years of past service / 15 years 
of service at assumed date of disability)]. The total disability benefit 
for Participant A, with respect to the disability decrement occurring at 
age 63, that is taken into account in determining the funding target for 
the 2010 plan year is $8,536 ($5,960 + $2,576).
    (v) The portion of Participant A's disability benefit with respect 
to the disability decrement occurring at age 64 that is taken into 
account when determining the 2010 funding target is $8,375 [$5,960 + 
$3,220 x (12 years of past service / 16 years of service at assumed date 
of disability)].

[[Page 1209]]

    (vi) If in fact Participant A becomes disabled at age 63, the 
funding target will reflect the full disability benefit to which 
Participant A will be entitled at normal retirement age, based on 
service projected to normal retirement age (17 years) and final average 
compensation reflecting compensation projected to normal retirement age 
at the rate Participant A was earning at the time of disablement.
    Example 6. (i) The facts are the same as in Example 5, except that 
the disability benefit is based on the accrued benefit calculated using 
service and compensation earned to the date of disability.
    (ii) Because the disability benefit is a function of the 
participant's accrued benefit, the portion of Participant A's disability 
benefit that is taken into account when determining the funding target 
for the 2010 plan year is Participant A's annual accrued benefit as of 
January 1, 2010, or $5,960, as determined in Example 1. This amount is 
taken into account for both the disability decrement occurring at age 63 
and the disability decrement occurring at age 64.
    (iii) Similarly, the benefit accrual for Participant A with respect 
to the disability decrements occurring at age 63 and age 64 that is 
taken into account when determining the target normal cost for the 2010 
plan year is equal to Participant A's expected benefit accrual for 2010 
determined in Example 1, or $800.
    Example 7. (i) Retiree D, a participant in Plan P, is a male age 72 
and is receiving a $100 monthly straight life annuity. The 2009 
actuarial valuation is performed using the segment rates applicable for 
September 2008 (determined without regard to the transition rule of 
section 430(h)(2)(G)), and the 2009 annuitant and nonannuitant (male and 
female) mortality tables (published in Notice 2008-85). See Sec. 
601.601(d)(2) relating to objectives and standards for publishing 
regulations, revenue rulings and revenue procedures in the Internal 
Revenue Bulletin.
    (ii) The present value of Retiree D's straight life annuity on the 
valuation date is $10,535.79. This is equal to the sum of: $5,029.99, 
which is the present value of payments expected to be made during the 
first 5 years, using the first segment interest rate of 5.07%; 
$5,322.26, which is the present value of payments expected to be made 
during the next 15 years, using the second segment interest rate of 
6.09%; and $183.54, which is the present value of payments expected to 
be made after 20 years, using the third segment interest rate of 6.56%.
    Example 8. (i) The facts are the same as in Example 7. Plan P does 
not provide for early retirement benefits or single-sum distributions. 
The actuary assumes that no participants terminate employment prior to 
age 50 (other than by death), there is a 5% probability of withdrawal at 
age 50, and that those participants who withdraw receive a deferred 
annuity starting at age 65. Participant E is a male age 46 on January 1, 
2009, and has an annual accrued benefit of $23,000 beginning at age 65.
    (ii) Before taking into account the 5% probability of withdrawal, 
the funding target associated with Participant E's assumed age 50 
withdrawal benefit in the 2009 actuarial valuation is $68,396.75. This 
is equal to the sum of: $6,925.29, which is the present value of 
payments expected to be made during the year the participant turns age 
65 (the 20th year after the valuation date), using the second segment 
interest rate of 6.09%; and $61,471.46, which is the present value of 
payments expected to be made after the 20th year, using the third 
segment interest rate of 6.56%.
    (iii) Taking the 5% probability of withdrawal into account, the 
funding target for the 2009 plan year associated with Participant E's 
assumed age 50 withdrawal benefit is $3,419.84 ($68,396.75 x 5%).
    Example 9. (i) The facts are the same as in Example 8, except the 
plan offers a single-sum distribution payable at normal retirement age 
(age 65) determined based on the applicable interest rates and the 
applicable mortality table under section 417(e)(3). The actuary assumes 
that 70% of the participants will elect a single sum upon retirement and 
the remaining 30% will elect a straight life annuity.
    (ii) Before taking into account the 5% probability of withdrawal or 
the 70% probability of electing a single-sum payment, the portion of the 
2009 funding target that is attributable to Participant E's assumed 
single-sum payment, deferred to age 65, is $70,052.30. This is 
calculated in the same manner as the present value of annuity payments, 
except that, for the period after the annuity starting date, the 2009 
applicable mortality rates are substituted for the 2009 male annuitant 
mortality rates. This portion of the funding target for the 2009 plan 
year is equal to the sum of: $6,929.00, which is the present value of 
annuity payments expected to be made between age 65 and 66 (during the 
20th year after the valuation date), using the second segment interest 
rate of 6.09%; and $63,123.30, which is the present value of annuity 
payments expected to be made after the 20th year following the valuation 
date, using the third segment interest rate of 6.56%. These present 
value amounts reflect the 2009 male nonannuitant mortality rates prior 
to the assumed commencement of benefits at age 65 and the 100% 
probability of retiring at age 65.
    (iii) Taking the 5% probability of withdrawal and the 70% 
probability of electing a single-sum payment into account, the portion 
of the 2009 funding target attributable to Participant E's assumed 
single-sum payment based on withdrawal at age 50 is

[[Page 1210]]

$2,451.83 ($70,052.30 x 5% x 70%). After taking into account the 5% 
probability of withdrawal and the 30% probability of electing a straight 
life annuity, the portion of the 2009 funding target that is 
attributable to Participant E's assumed straight life annuity (based on 
assumed withdrawal at age 50), deferred to age 65, is equal to 30% of 
the result obtained in Example 8.
    Example 10. (i) The facts are the same as in Example 9, except the 
plan offers an immediate single sum upon withdrawal at age 50 determined 
based on the applicable interest rates and the applicable mortality 
table under section 417(e)(3). The actuary assumes that 70% of the 
participants will elect to receive a single-sum distribution upon 
withdrawal.
    (ii) Before taking into account the 5% probability of withdrawal and 
the 70% probability of electing a single-sum payment, the portion of the 
funding target for the 2009 plan year that is attributable to 
Participant E's assumed single-sum payment based on withdrawal at age 50 
is $68,908.39. This is calculated in the same manner as the present 
value of annuity payments, except that the 2009 applicable mortality 
rates are substituted for the 2009 male annuitant and nonannuitant 
mortality rates after the annuity starting date. This portion of the 
2009 funding target is equal to the sum of $6,815.85, which is the 
present value of annuity payments expected to be made between age 65 and 
66 (during the 20th year after the valuation date), using the second 
segment interest rate of 6.09%, and $62,092.54, which is the present 
value of annuity payments expected to be made after the 20th year 
following the valuation date, using the third segment interest rate of 
6.56%. These present value amounts reflect the 2009 male nonannuitant 
mortality rates prior to the assumed single-sum distribution age of 50.
    (iii) Applying the 5% probability of withdrawal at age 50 and the 
70% probability of electing a single-sum payment, the portion of the 
funding target for the 2009 plan year that is attributable to 
Participant E's assumed single-sum payment (based on withdrawal at age 
50) is $2,411.79 ($68,908.39 x 5% x 70%).
    Example 11. (i) The facts are the same as in Example 8, except that 
the plan sponsor elects under section 430(h)(2)(D)(ii) to use the 
monthly corporate bond yield curve instead of segment rates. The 
enrolled actuary assumes payments are made monthly throughout the year 
and uses the interest rate from the middle of the monthly corporate bond 
yield curve because this mid-year yield rate most closely matches the 
average timing of benefits paid. In accordance with Sec. 1.430(h)(2)-
1(e)(4), the applicable monthly corporate bond yield curve is the yield 
curve derived from December 2008 rates.
    (ii) Before taking into account the 5% probability of withdrawal, 
the funding target associated with Participant E's assumed age 50 
withdrawal benefit in the 2009 actuarial valuation is $67,394.12. This 
reflects the sum of each year's expected payments, discounted at the 
yield rates described in paragraph (i) of this Example 11, as shown 
below:

----------------------------------------------------------------------------------------------------------------
                  Age                             Maturity                   Yield rate           Present value
----------------------------------------------------------------------------------------------------------------
65.....................................  19.5......................  6.97%.....................        $5,897.88
66.....................................  20.5......................  6.90%.....................         5,524.69
67.....................................  21.5......................  6.84%.....................         5,164.63
68 and over............................  Varies....................  Varies....................        50,806.92
                                                                                                ----------------
    Total..............................  ..........................  ..........................        67,394.12
----------------------------------------------------------------------------------------------------------------

    (iii) Applying the 5% probability of withdrawal, the portion of the 
funding target for the 2009 plan year attributable to Participant E's 
assumed withdrawal at age 50 is $3,369.71 ($67,394.12 x 5%).
    Example 12. (i) The facts are the same as in Example 10, except that 
the plan determines the amount of the immediate single-sum distribution 
upon withdrawal at age 50 based on the applicable interest rates under 
section 417(e)(3) or an interest rate of 6.25%, whichever produces the 
higher amount. The applicable mortality table under section 417(e)(3) is 
used for both calculations.
    (ii) Before taking into account the 5% probability of withdrawal and 
the 70% probability of electing a single-sum payment, the present value 
of Participant E's single-sum distribution as of January 1, 2009, using 
an interest rate of 6.25%, based on withdrawal at age 50, is $77,391.88. 
This amount is determined by calculating the projected single-sum 
distribution at age 50 using the applicable mortality rate under section 
417(e)(3) and an interest rate of 6.25%, or $94,789.10, and discounting 
the result to the January 1, 2009, valuation date using the first 
segment rate of 5.07% (because the single-sum distribution is assumed to 
be paid 4 years after the valuation date) and the male non-annuitant 
mortality rates for 2009.
    (iii) Before taking into account the 5% probability of withdrawal 
and the 70% probability of electing a single-sum payment, the present 
value as of January 1, 2009, of Participant E's age-50 single-sum 
distribution using the applicable interest rates and applicable 
mortality table under section 417(e)(3)

[[Page 1211]]

is $68,908.39, as developed in Example 10. Corresponding to plan 
provisions, the present value reflected in the funding target is the 
larger of this amount or the present value of the amount based on a 
6.25% interest rate, or $77,391.88.
    (iv) Applying the 5% probability of withdrawal at age 50 and the 70% 
probability of electing a single-sum payment, the portion of the funding 
target for the 2009 plan year that is attributable to Participant E's 
assumed single-sum payment (based on withdrawal at age 50) is $2,708.72 
($77,391.88 x 5% x 70%).
    Example 13. (i) Plan Q is a cash balance plan that permits an 
immediate payment of a single sum equal to the participant's 
hypothetical account balance upon termination of employment. Plan Q's 
terms provide that the hypothetical account is credited with interest at 
a market-related rate, based on a specified index. The January 1, 2009, 
actuarial valuation is performed using the 24-month average segment 
rates applicable for September 2008 (determined without regard to the 
transition rule of section 430(h)(2)(G)). Participant F is a male age 61 
on January 1, 2009, and has a hypothetical account balance equal to 
$150,000 on that date. In the 2009 actuarial valuation, the enrolled 
actuary assumes that the hypothetical account balances will increase 
with annual interest credits of 7% until the participant commences 
receiving his or her benefit, corresponding to the actuary's best 
estimate of future interest rates credited under the terms of the plan. 
The actuary also assumes that all participants will retire on the first 
day of the plan year in which they attain age 65 (that is, no 
participant will terminate employment prior to age 65 other than by 
death), and that 100% of participants will elect a single sum upon 
retirement.
    (ii) Participant F's hypothetical account balance projected to 
January 1, 2013 (the plan year in which F attains age 65) is $196,619.40 
based on the assumed annual interest crediting rate of 7%. The funding 
target for the 2009 plan year attributable to Participant F's benefit at 
age 65 is $158,525.81, which is calculated by discounting the projected 
hypothetical account balance of $196,619.40 using the first segment rate 
of 5.07% and the male non-annuitant mortality rates.
    Example 14. (i) The facts are the same as in Example 13, except that 
the actuary assumes that 10% of the participants will choose to collect 
their benefits in the form of a straight life annuity. The plan provides 
that the participant's account balance at retirement is converted to an 
annuity using the applicable interest rates and applicable mortality 
table under section 417(e)(3).
    (ii) Participant F's hypothetical account balance projected to 
January 1, 2013 (the plan year in which F attains age 65) is 
$196,619.40, as outlined in Example 13. This amount is converted to an 
annuity payable commencing at age 65 by dividing the projected account 
balance by an annuity factor based on the applicable mortality table for 
2009 under section 417(e)(3) (corresponding to the valuation date) and 
the interest rates used for the valuation. The resulting annuity factor 
is 10.8321, reflecting one year of interest at the first segment rate 
(5.07%) corresponding to the first year of the expected annuity payments 
(the fifth year after the valuation date), 15 years of interest at the 
second segment rate (6.09%) and all remaining years at the third segment 
rate (6.56%). The projected future annuity is therefore $196,619.40 
divided by 10.8321, or $18,151.55 per year.
    (iii) Before taking into account the 10% probability that the 
participant will elect to take the distribution in the form of a 
lifetime annuity, the funding target associated with the future annuity 
payout for Participant F is $149,120.41. This is equal to the sum of 
$14,242.79, which is the present value of the annuity payment expected 
to made during the year the participant turns age 65 (the 5th year after 
the valuation date), using the first segment interest rate of 5.07%; 
$116,321.72, which is the present value of payments expected to be made 
during the 6th through the 20th years following the valuation date, 
using the second segment interest rate of 6.09%; and $18,555.90, which 
is the present value of payments expected to be made after the 20th year 
following the valuation date, using the third segment interest rate of 
6.56%.
    (iv) Applying the 10% probability of electing a lifetime annuity, 
the portion of the 2009 funding target attributable to Participant F's 
assumed lifetime annuity payable at age 65 is $14,912.04. The portion of 
the 2009 funding target attributable to Participant F's assumed single-
sum payment is 90% of the result obtained in Example 13.
    Example 15. (i) Plan H provides a monthly benefit of $50 times 
service for all participants. Plan H has a funding target of $1,000,000 
and an actuarial value of assets of $810,000 as of January 1, 2010. No 
annuity contracts have been purchased, and Plan H has no funding 
standard carryover balance or prefunding balance as of January 1, 2010. 
The enrolled actuary certifies that the January 1, 2010, AFTAP is 81%. 
Effective July 1, 2010, Plan H is amended on June 14, 2010, to increase 
the plan's monthly benefit to $55 for years of service earned on or 
after July 1, 2010. The present value of the increase in plan benefits 
during 2010 (reflecting benefit accruals attributable to the six months 
between July 1, 2010, and December 31, 2010) is $25,000.
    (ii) The amendment increases benefits for future service only, and 
so the funding target is unaffected. Since section 436(c) only

[[Page 1212]]

restricts plan amendments that increase plan liabilities, the plan 
amendment can take effect.
    (iii) If the $25,000 present value of the increase in plan benefits 
during 2010 were included in Plan H's funding target of $1,000,000, the 
total would be $1,025,000, and the AFTAP would be 79.02% (that is, 
$810,000/$1,025,000). Since this is less than 80%, the amendment would 
not have been permitted to take effect if the 2010 increase were 
included in the funding target instead of target normal cost.
    (iv) Because the amendment was adopted after the January 1, 2010, 
valuation date, the plan sponsor would generally have the option of 
deciding whether to reflect this amendment in the January 1, 2010, 
valuation or defer recognition of the amendment to the January 1, 2011, 
valuation. However, under paragraph (d)(2) of this section, because the 
plan amendment would not have been permitted to take effect under the 
provisions of section 436 if the increase in the target normal cost for 
the plan year had been taken into account in the funding target, the 
actuary must take into account the amendment in the January 1, 2010, 
valuation for purposes of section 430. Thus, the target normal cost for 
the plan year includes the $25,000 that results from the plan amendment.

    (g) Effective/applicability dates and transition rules--(1) 
Statutory effective date/applicability date--(i) In general. Section 430 
generally applies to plan years beginning on or after January 1, 2008. 
The applicability of section 430 for purposes of determining the minimum 
required contribution is delayed for certain plans in accordance with 
sections 104 through 106 of PPA '06.
    (ii) Applicability of special adjustments. The special adjustments 
of paragraph (b)(1)(iii) of this section (relating to adjustments to the 
target normal cost for plan-related expenses and mandatory employee 
contributions) apply to plan years beginning after December 31, 2008. In 
addition, a plan sponsor may elect to make the special adjustments of 
paragraph (b)(1)(iii) of this section for a plan year beginning in 2008. 
This election must take into account both adjustments described in 
paragraph (b)(1)(iii) of this section. This election is subject to the 
same rules that apply to an election to add an amount to the plan's 
prefunding balance pursuant to Sec. 1.430(f)-1(f), and it must be made 
in the same manner as the election made under Sec. 1.430(f)-1(f). Thus, 
the election can be made no later than the last day for making the 
minimum required contribution for the plan year to which the election 
relates.
    (2) Effective date/applicability date of regulations. This section 
applies to plan years beginning on or after January 1, 2010, regardless 
of whether section 430 applies to determine the minimum required 
contribution for the plan year. For plan years beginning before January 
1, 2010, plans are permitted to rely on the provisions set forth in this 
section for purposes of satisfying the requirements of section 430.
    (3) Approval for changes in funding method--(i) 2008 plan year. Any 
changes in a plan's funding method that are made for the first plan year 
beginning in 2008 that are not inconsistent with the requirements of 
section 430 are treated as having been approved by the Commissioner and 
do not require the Commissioner's specific prior approval.
    (ii) Application of this section--(A) First plan year for which 
regulations are effective. Except as otherwise provided in paragraph 
(g)(3)(ii)(B) of this section, any change in a plan's funding method for 
the first plan year that begins on or after January 1, 2010, is treated 
as having been approved by the Commissioner and does not require the 
Commissioner's specific prior approval.
    (B) Optional earlier application of regulations. For the first plan 
year that a plan applies all the provisions of this section, Sec. Sec. 
1.430(f)-1, 1.430(g)-1, 1.430(i)-1, and 1.436-1, any change in a plan's 
funding method for that plan year is treated as having been approved by 
the Commissioner and does not require the Commissioner's specific prior 
approval. For example, if the change in funding method includes a change 
in the valuation software, the change in the valuation software is 
treated as having been approved by the Commissioner and does not require 
the Commissioner's specific prior approval. If that plan year begins 
before January 1, 2010, the automatic approval for a change in funding 
method under paragraph (g)(3)(ii)(A) of this section does not apply to 
the plan.
    (C) Special rule for changes in allocation. Any change in a plan's 
funding method for a plan year earlier than the first plan year 
beginning on or after January 1, 2010, that is necessary to

[[Page 1213]]

apply the rules of paragraph (c)(1)(ii) of this section is treated as 
having been approved by the Commissioner and does not require the 
Commissioner's specific prior approval.
    (iii) First plan year for which section 430 applies to determine 
minimum funding. For a plan for which the minimum required contribution 
is not determined under section 430 for the first plan year that begins 
on or after January 1, 2008, pursuant to sections 104 through 106 of PPA 
'06, any change in a plan's funding method for the first plan year to 
which section 430 applies to determine the plan's minimum required 
contribution is treated as having been approved by the Commissioner and 
does not require the Commissioner's specific prior approval.
    (4) Approval for changes in actuarial assumptions. The 
Commissioner's specific prior approval is not required with respect to 
any actuarial assumptions that are adopted for the first plan year for 
which section 430 applies to determine the minimum required contribution 
for the plan and that are not inconsistent with the requirements of 
section 430.
    (5) Transition rule for determining funding target attainment 
percentage for the 2007 plan year--(i) In general. For purposes of the 
first plan year beginning on or after January 1, 2008, the funding 
target attainment percentage for the plan's prior plan year (the 2007 
plan year) is determined as the fraction (expressed as a percentage), 
the numerator of which is the value of plan assets determined under 
paragraph (g)(5)(ii) of this section, and the denominator of which is 
the plan's current liability determined pursuant to section 412(l)(7) 
(as in effect prior to amendment by PPA '06) as of the valuation date 
for the 2007 plan year.
    (ii) Determination of value of plan assets--(A) In general. The 
value of plan assets for the 2007 plan year under this paragraph 
(g)(5)(ii)(A) is determined as the value of plan assets as described in 
paragraph (g)(5)(ii)(B) of this section, reduced by the plan's funding 
standard account credit balance for the 2007 plan year as described in 
paragraph (g)(5)(iii)(A) of this section except to the extent provided 
in paragraph (g)(5)(iii)(B) of this section.
    (B) Value of plan assets. The value of plan assets for the 2007 plan 
year under this paragraph (g)(5)(ii)(B) is determined under section 
412(c)(2) as in effect for the 2007 plan year, except that the value of 
plan assets prior to subtracting the plan's funding standard account 
credit balance described in paragraph (g)(5)(iii)(A) of this section 
must be adjusted so that it is neither less than 90 percent of the fair 
market value of plan assets nor greater than 110 percent of the fair 
market value of plan assets on the valuation date for that plan year. If 
the value of plan assets prior to adjustment under this paragraph 
(g)(5)(ii)(B) is less than 90 percent of the fair market value of plan 
assets on the valuation date, then the value of plan assets under this 
paragraph (g)(5)(ii)(B) is equal to 90 percent of the fair market value 
of plan assets. If the value of plan assets determined under this 
paragraph (g)(5)(ii)(B) is greater than 110 percent of the fair market 
value of plan assets on the valuation date, then the value of plan 
assets under this paragraph (g)(5)(ii)(B) is equal to 110 percent of the 
fair market value of plan assets.
    (iii) Subtraction of credit balance--(A) In general. If a plan has a 
funding standard account credit balance as of the valuation date for the 
2007 plan year, then, except as described in paragraph (g)(5)(iii)(B) of 
this section, that balance is subtracted from the value of plan assets 
described in paragraph (g)(5)(ii)(B) of this section as of that 
valuation date to determine the value of plan assets for the 2007 plan 
year. However, the value of plan assets is not reduced below zero.
    (B) Effect of funding standard carryover balance reduction for the 
2008 plan year. Notwithstanding the rules of paragraph (g)(5)(iii)(A) of 
this section, for the first plan year beginning in 2008, if the employer 
has made an election to reduce some or all of the funding standard 
carryover balance as of the first day of that year in accordance with 
Sec. 1.430(f)-1(e), then the present value (determined as of the 
valuation date for the 2007 plan year using the valuation interest rate 
for that 2007 plan year) of the amount so reduced is not treated as part 
of the funding standard account credit balance when

[[Page 1214]]

that balance is subtracted from the value of plan assets pursuant to 
paragraph (g)(5)(iii)(A) of this section.

[T.D. 9467, 74 FR 53035, Oct. 15, 2009]



Sec. 1.430(f)-1  Effect of prefunding balance and funding standard 
carryover balance.

    (a) In general--(1) Overview. This section provides rules relating 
to the application of prefunding and funding standard carryover balances 
under section 430(f). Section 430 and this section apply to single 
employer defined benefit plans (including multiple employer plans) that 
are subject to section 412, but do not apply to multiemployer plans (as 
defined in section 414(f)). Paragraph (b) of this section sets forth 
rules regarding a plan's prefunding balance and a plan sponsor's 
election to maintain a funding standard carryover balance. Paragraph (c) 
of this section provides rules under which those balances must be 
subtracted from plan assets. Paragraph (d) of this section describes a 
plan sponsor's election to use those balances to offset the minimum 
required contribution. Paragraph (e) of this section describes a plan 
sponsor's election to reduce those balances (which will affect the 
determination of the value of plan assets for purposes of sections 430 
and 436). Paragraph (f) of this section sets forth rules regarding 
elections under this section. Paragraph (g) of this section contains 
examples. Paragraph (h) of this section contains effective/applicability 
dates and transition rules.
    (2) Special rules for multiple employer plans. In the case of a 
multiple employer plan to which section 413(c)(4)(A) applies, the rules 
of this section are applied separately for each employer under the plan, 
as if each employer maintained a separate plan. Thus, each employer 
under such a multiple employer plan may have a separate funding standard 
carryover balance and a prefunding balance for the plan. In the case of 
a multiple employer plan to which section 413(c)(4)(A) does not apply 
(that is, a plan described in section 413(c)(4)(B) that has not made the 
election for section 413(c)(4)(A) to apply), the rules of this section 
are applied as if all participants in the plan were employed by a single 
employer.
    (b) Maintenance of balances--(1) Prefunding balance--(i) In general. 
A plan sponsor is permitted to elect to maintain a prefunding balance 
for a plan. A prefunding balance maintained for a plan consists of a 
beginning balance of zero, increased by the amount of excess 
contributions to the extent the employer elects to do so as described in 
paragraph (b)(1)(ii) of this section, and decreased to the extent 
provided in paragraph (b)(1)(iii) of this section. The plan sponsor's 
initial election to add to the prefunding balance under paragraph 
(b)(1)(ii) of this section constitutes an election to maintain a 
prefunding balance. The prefunding balance is adjusted further for 
investment return and interest as provided in paragraphs (b)(3) and 
(b)(4) of this section.
    (ii) Increases--(A) In general. If the plan sponsor of a plan elects 
to add to the plan's prefunding balance, as of the first day of a plan 
year following the first effective plan year for the plan, the 
prefunding balance is increased by the amount so elected by the plan 
sponsor for the plan year. The amount added to the prefunding balance 
cannot exceed the present value of the excess contributions for the 
preceding plan year determined under paragraph (b)(1)(ii)(B) of this 
section, increased for interest in accordance with paragraph 
(b)(1)(iv)(A) of this section.
    (B) Present value of excess contribution. The present value of the 
excess contribution for the preceding plan year is the excess, if any, 
of--
    (1) The present value (determined under the rules of paragraph 
(b)(1)(iv)(B) of this section) of the employer contributions (other than 
contributions to avoid or terminate benefit limitations described in 
Sec. 1.436-1(f)(2)) to the plan for such preceding plan year; over
    (2) The minimum required contribution for such preceding plan year.
    (C) Treatment of unpaid minimum required contributions. For purposes 
of this paragraph (b)(1)(ii), a contribution made during a plan year to 
correct an unpaid minimum required contribution (within the meaning of 
section 4971(c)(4)) for a prior plan year is not

[[Page 1215]]

treated as a contribution for the current plan year.
    (iii) Decreases. As of the first day of each plan year, the 
prefunding balance of a plan is decreased (but not below zero) by the 
sum of--
    (A) Any amount of the prefunding balance that was used under 
paragraph (d) of this section to offset the minimum required 
contribution of the plan for the preceding plan year; and
    (B) Any reduction in the prefunding balance under paragraph (e) of 
this section for the plan year.
    (iv) Adjustments for interest--(A) Adjustment of excess 
contribution. The present value of the excess contribution for the 
preceding year (as determined under paragraph (b)(1)(ii)(B) of this 
section) is increased for interest accruing for the period between the 
valuation date for the preceding plan year and the first day of the 
current plan year. For this purpose, interest is determined by using the 
plan's effective interest rate under section 430(h)(2)(A) for the 
preceding plan year, except to the extent provided in paragraph 
(b)(3)(iii) of this section.
    (B) Determination of present value. The present value of the 
contributions described in paragraph (b)(1)(ii)(B)(1) of this section is 
determined as of the valuation date for the preceding plan year, using 
the plan's effective interest rate under section 430(h)(2)(A) for the 
preceding plan year.
    (2) Funding standard carryover balance--(i) In general. A funding 
standard carryover balance is automatically established for a plan that 
had a positive balance in the funding standard account under section 
412(b) (as in effect prior to amendment by the Pension Protection Act of 
2006 (PPA '06), Public Law 109-280 (120 Stat. 780)) as of the end of the 
pre-effective plan year for the plan. The funding standard carryover 
balance as of the beginning of the first effective plan year for the 
plan is the positive balance in the funding standard account under 
section 412(b) (as in effect prior to amendment by PPA '06) as of the 
end of the pre-effective plan year for the plan. After that date, the 
funding standard carryover balance is decreased to the extent provided 
in paragraph (b)(2)(ii) of this section and adjusted further for 
investment return and interest as provided in paragraphs (b)(3) and 
(b)(4) of this section.
    (ii) Decreases. As of the first day of each plan year, the funding 
standard carryover balance of a plan is decreased (but not below zero) 
by the sum of--
    (A) Any amount of the funding standard carryover balance that was 
used under paragraph (d) of this section to offset the minimum required 
contribution of the plan for the preceding plan year; and
    (B) Any reduction in the funding standard carryover balance under 
paragraph (e) of this section for the plan year.
    (3) Adjustments for investment experience--(i) In general. A plan's 
prefunding balance under paragraph (b)(1) of this section and a plan's 
funding standard carryover balance under paragraph (b)(2) of this 
section as of the first day of a plan year must be adjusted to reflect 
the actual rate of return on plan assets for the preceding plan year. 
For this purpose, the actual rate of return on plan assets for the 
preceding plan year is determined on the basis of fair market value and 
must take into account the amount and timing of all contributions, 
distributions, and other plan payments made during that period.
    (ii) Ordering rules for adjustments. In general, the adjustment for 
actual rate of return on plan assets is applied to the balance after any 
reduction of prefunding and funding standard carryover balances for that 
preceding plan year under paragraph (e) of this section and after 
subtracting amounts used to offset the minimum required contribution for 
the preceding plan year pursuant to paragraph (d) of this section. 
However, see paragraph (d)(1)(ii)(D) of this section for a special 
ordering rule when adjusting for investment experience.
    (iii) Special rule for excess contributions attributable to use of 
funding balances. Notwithstanding paragraph (b)(1)(iv)(A) of this 
section, to the extent that a contribution is included in the present 
value of excess contributions solely because the minimum required 
contribution has been offset under paragraph (d) of this section, the 
contribution is adjusted for investment

[[Page 1216]]

experience under the rules of this paragraph (b)(3).
    (4) Valuation date other than the first day of the plan year--(i) In 
general. If a plan's valuation date is not the first day of the plan 
year, then, solely for purposes of applying paragraphs (c), (d), and (e) 
of this section, the plan's prefunding and funding standard carryover 
balances (if any) determined under this paragraph (b) are increased from 
the first day of the plan year to the valuation date using the plan's 
effective interest rate under section 430(h)(2)(A) for the plan year.
    (ii) Special rule for adjustments for investment experience. In the 
case of a plan with a valuation date that is not the first day of the 
plan year, for purposes of applying the subtraction under paragraph 
(b)(3)(ii) of this section for amounts used to offset the minimum 
required contribution for the preceding plan year and the decreases 
under paragraphs (b)(1)(iii) and (b)(2)(ii) of this section, the amount 
of the prefunding balance or funding standard carryover balance that is 
used to offset the minimum required contribution under paragraph (d) of 
this section or reduced under paragraph (e) of this section is 
discounted from the valuation date to the first day of the plan year 
using the effective interest rate under section 430(h)(2)(A) for the 
plan year.
    (5) Special rule for quarterly contributions--(i) Quarterly 
contributions due on or after the valuation date. For purposes of 
applying a prefunding balance or funding standard carryover balance to 
required installments described in section 430(j)(3) that are due on or 
after the valuation date for the plan year for which they are due, the 
respective balances are increased from the beginning of the year to the 
date of the election (using the plan's effective interest rate for the 
plan year) to determine the amount available to offset the required 
quarterly installment. The amounts used to offset required quarterly 
installments are then discounted from that date to the first day of the 
plan year for purposes of the subtraction under paragraph (b)(3)(ii) of 
this section and the decreases under paragraphs (b)(1)(iii) and 
(b)(2)(ii) of this section, using the effective interest rate for the 
plan year. However, see paragraph (d)(1)(i)(B) of this section for a 
special rule regarding late quarterly installments when determining the 
amount that is used to offset the minimum required contribution for the 
plan year.
    (ii) Quarterly contributions due before the valuation date. 
[Reserved]
    (c) Effect of balances on the value of plan assets--(1) In general. 
In the case of any plan with a prefunding balance or a funding standard 
carryover balance, the amount of those balances is subtracted from the 
value of plan assets for purposes of sections 430 and 436, except as 
otherwise provided in paragraphs (c)(2), (c)(3), and (d)(3) of this 
section and Sec. 1.436-1(j)(1)(ii)(B).
    (2) Subtraction of balances in determining new shortfall 
amortization base--(i) Prefunding balance. For purposes of determining 
whether a plan is exempt from the requirement to establish a new 
shortfall amortization base under section 430(c)(5), the amount of the 
prefunding balance is subtracted from the value of plan assets only if 
an election under paragraph (d) of this section to use the prefunding 
balance to offset the minimum required contribution is made for the plan 
year.
    (ii) Funding standard carryover balance. For purposes of determining 
whether a plan is exempt from the requirement to establish a new 
shortfall amortization base under section 430(c)(5), the funding 
standard carryover balance is not subtracted from the value of plan 
assets regardless of whether any portion of either the funding standard 
carryover balance or the prefunding balance is used to offset the 
minimum required contribution for the plan year under paragraph (d) of 
this section.
    (3) Special rule for certain binding agreements with PBGC. If there 
is in effect for a plan year a binding written agreement with the 
Pension Benefit Guaranty Corporation (PBGC) which provides that all or a 
portion of the prefunding balance or funding standard carryover balance 
(or both balances) is not available to offset the minimum required 
contribution for a plan year, that specified amount is not subtracted

[[Page 1217]]

from the value of plan assets for purposes of determining the funding 
shortfall under section 430(c)(4). For example, if a plan has no 
prefunding balance and a $20 million funding standard carryover balance, 
a PBGC agreement provides that $5 million of a plan's funding standard 
carryover balance is unavailable to offset the minimum required 
contribution for a plan year, and the plan's assets are $100 million, 
then the value of plan assets for purposes of determining the funding 
shortfall under section 430(c)(4) is reduced by $15 million ($20 million 
less $5 million) to $85 million. For purposes of this paragraph (c)(3), 
an agreement with the PBGC is taken into account with respect to a plan 
year only if the agreement was executed prior to the valuation date for 
the plan year.
    (d) Election to apply balances against minimum required 
contribution--(1) In general--(i) Amount of offset to minimum required 
contribution--(A) Effect of use of balances. Subject to the limitations 
provided in this paragraph (d), in the case of any plan year with 
respect to which the plan sponsor elects to use all or a portion of the 
prefunding balance or the funding standard carryover balance to offset 
the minimum required contribution for the plan year, the minimum 
required contribution for the plan year (determined after taking into 
account any waiver under section 412(c)) is offset as of the valuation 
date for the plan year by the amount so used.
    (B) Special rule for late quarterly contributions--(1) Quarterly 
contributions due on or after the valuation date. Notwithstanding 
paragraph (d)(1)(i)(A) of this section, if the plan sponsor elects to 
use all or a portion of the prefunding balance or the funding standard 
carryover balance to satisfy a required installment under section 
430(j)(3) that is due on or after the valuation date, the amount used to 
offset the minimum required contribution for the plan year is the 
portion of the balance so used, discounted in accordance with the rules 
of paragraph (b)(5) of this section, unless the date of the election is 
after the due date of the required installment. If the election to use 
all or a portion of the prefunding balance or the funding standard 
carryover balance to satisfy the required installments under section 
430(j)(3) is made after the due date for the required installment, then 
the amount used to offset the minimum required contribution for the plan 
year is the portion of the balance so used, discounted from the date of 
the election to the due date of the required installment at the 
effective interest rate plus 5 percentage points, and then further 
discounted from the installment due date to the valuation date at the 
effective interest rate. For example, if a quarterly installment of 
$20,250 is due on April 15 for a calendar year plan with a valuation 
date on January 1 and an effective interest rate of 6 percent, and the 
installment is satisfied by an election to apply the funding standard 
carryover balance that is made on July 1 (2\1/2\; months after the April 
15 due date), then the amount used to offset the minimum required 
contribution under this paragraph (d)(1)(i) is $19,481 (that is, $20,250 
/ 1.11(\2.5/12\) / 1.06(\3.5/12\). However, the amount by which the 
funding standard carryover balance is reduced under paragraph (b)(2)(ii) 
of this section is $19,669 (that is, $20,250 / 1.06(\6/12\).
    (2) Quarterly contributions due before the valuation date. 
[Reserved]
    (ii) Maximum amount of available balances and coordination of 
elections--(A) General requirement to follow chronology. In general, the 
amount of prefunding and funding standard carryover balances that may be 
used to offset the minimum required contribution for a plan year must 
take into account any decrease in those balances which results from a 
prior election either to use the prefunding balance or funding standard 
carryover balance under section 430(f)(3) and this paragraph (d) or to 
reduce those balances under section 430(f)(5) and paragraph (e) of this 
section (including deemed elections under section 436(f)(3) and Sec. 
1.436-1(a)(5)). For example, for a calendar plan year with a January 1 
valuation date, a deemed election under section 436(f)(3) and Sec. 
1.436-1(a)(5) on April 1, 2010 (the first day of the 4th month of the 
plan year) will reduce the available prefunding balance or funding 
standard carryover balance that can be used with respect to an election 
made after April 1, 2010.

[[Page 1218]]

    (B) Exception to chronological rule. Notwithstanding the general 
rule of paragraph (d)(1)(ii)(A) of this section, all elections under 
section 430(f)(5) and paragraph (e) of this section to reduce the 
prefunding balance or funding standard carryover balance for the current 
plan year (including deemed elections under section 436(f)(3) and Sec. 
1.436-1(a)(5)) are deemed to occur on the valuation date for the plan 
year and before any election under section 430(f)(3) and this paragraph 
(d) to offset the minimum required contribution for the current plan 
year. Accordingly, if an election to use the prefunding balance or 
funding standard carryover balance to offset the minimum required 
contribution for the plan year (including an election to satisfy the 
quarterly contribution requirement) has been made prior to the election 
to reduce the prefunding balance or funding standard carryover balance, 
then the amount available for use to offset the otherwise applicable 
minimum required contribution for the plan year under this paragraph (d) 
will be retroactively reduced. However, an election to reduce a 
prefunding balance or funding standard carryover balance for a plan year 
does not affect a prior election to use a prefunding balance or funding 
standard carryover balance to offset a minimum required contribution for 
a prior plan year.
    (C) Investment experience. In addition to reflecting any decrease in 
the prefunding balance or the funding standard carryover balance which 
results from a prior election for the previous year either to use the 
prefunding balance or funding standard carryover balance under section 
430(f)(3) and this paragraph (d) to offset the minimum required 
contribution for such prior plan year or to reduce those balances under 
section 430(f)(5) and paragraph (e) of this section (including deemed 
elections under section 436(f)(3) and Sec. 1.436-1(a)(5)), the prior 
plan year's prefunding and funding standard carryover balances must be 
adjusted under the rules of paragraph (b)(3) of this section for 
investment experience for that prior plan year before determining the 
amount of those balances available for such an election for the current 
plan year.
    (D) Special rule for current year elections that are made before 
prior year elections. This paragraph (d)(1)(ii)(D) sets forth a special 
rule that applies if, for the current plan year, a plan sponsor makes an 
election under this paragraph (d) or paragraph (e) of this section 
(including a deemed election under section 436(f)(3) and Sec. 1.436-
1(a)(5)), and then subsequently makes an election under this paragraph 
(d) to offset the minimum required contribution for the prior plan year. 
This special rule applies solely for purposes of determining the amount 
of prefunding and funding standard carryover balances available for that 
subsequent election. Under this special rule, in lieu of decreasing the 
funding standard carryover balance or prefunding balance as of the 
valuation date for the current year to take into account the current 
year election, the funding standard carryover balance or prefunding 
balance as of the valuation date for the prior plan year is decreased by 
the amount of the prior year equivalent of the current year election. 
The prior year equivalent of the current year election is determined by 
dividing the amount of the current year election (as of the first day of 
the current plan year) by a number equal to 1 plus the rate of 
investment return for the prior plan year determined under paragraph 
(b)(3) of this section. If this paragraph (d)(1)(ii)(D) applies for a 
plan year, then the funding standard carryover balance and prefunding 
balance are nonetheless adjusted in accordance with the rules of 
paragraph (b) of this section, after the application of the rules of 
this paragraph (d)(1)(ii)(D). Thus, the amount used to offset the 
minimum required contribution for the earlier plan year is subtracted 
from the prefunding balance or funding standard carryover balance as of 
the valuation date for that year prior to the adjustment for investment 
return under paragraph (b)(3) of this section for that plan year, and 
the amount by which the prefunding balance or funding standard carryover 
balance is decreased for the second year is based on the elections made 
for the second year.
    (2) Requirement to use funding standard carryover balance before 
prefunding

[[Page 1219]]

balance. To the extent that a plan has a funding standard carryover 
balance greater than zero, no amount of the plan's prefunding balance 
may be used to offset the minimum required contribution. Thus, a plan's 
funding standard carryover balance must be exhausted before the plan's 
prefunding balance may be applied under paragraph (d)(1) of this section 
to offset the minimum required contribution.
    (3) Limitation for underfunded plans--(i) In general. An election to 
use the prefunding balance or funding standard carryover balance to 
offset the minimum required contribution under this paragraph (d) is not 
available for a plan year if the plan's prior plan year funding ratio is 
less than 80 percent. For purposes of this paragraph (d)(3), except as 
otherwise provided in this paragraph (d)(3) or paragraph (h)(3) of this 
section, the plan's prior plan year funding ratio is the fraction 
(expressed as a percentage)--
    (A) The numerator of which is the value of plan assets on the 
valuation date for the preceding plan year, reduced by the amount of any 
prefunding balance (but not the amount of any funding standard carryover 
balance); and
    (B) The denominator of which is the funding target of the plan for 
the preceding plan year (determined without regard to the at-risk rules 
of section 430(i)(1)).
    (ii) Special rule for second year of a new plan with no past 
service. In the case of a new plan that was neither the result of a 
merger nor involved in a spinoff, if the prior plan year was the first 
year of the plan and the funding target for the prior plan year was 
zero, then the plan's prior plan year funding ratio is deemed to be 80 
percent for purposes of this paragraph (d)(3).
    (iii) Special rule for plans that are the result of a merger. 
[Reserved]
    (iv) Special rules for plans that are involved in a spinoff. 
[Reserved]
    (e) Election to reduce balances--(1) In general. A plan sponsor may 
make an election for a plan year to reduce any portion of a plan's 
prefunding and funding standard carryover balances under this paragraph 
(e). If such an election is made, the amount of those balances that must 
be subtracted from the value of plan assets pursuant to paragraph (c)(1) 
of this section will be smaller and, accordingly, the value of plan 
assets taken into account for purposes of sections 430 and 436 will be 
larger. Thus, this election to reduce a plan's prefunding and funding 
standard carryover balances is taken into account in the determination 
of the value of plan assets for the plan year and applies for all 
purposes under sections 430 and 436, including for purposes of 
determining the plan's prior plan year funding ratio under paragraph 
(d)(3) of this section for the following plan year. See also section 
436(f)(3) and Sec. 1.436-1(a)(5) for a rule under which the plan 
sponsor is deemed to make the election described in this paragraph (e). 
The rules of paragraph (d)(1)(ii) of this section also apply for 
purposes of determining the maximum amount of prefunding balance or 
funding standard carryover balance that is available for an election 
under this paragraph (e).
    (2) Requirement to reduce funding standard carryover balance before 
prefunding balance. To the extent that a plan has a funding standard 
carryover balance greater than zero, no election under paragraph (e)(1) 
of this section is permitted to be made that reduces the plan's 
prefunding balance. Thus, a plan must exhaust its funding standard 
carryover balance before it is permitted to make an election under 
paragraph (e)(1) of this section with respect to its prefunding balance.
    (f) Elections--(1) Method of making elections--(i) In general. Any 
election under this section by the plan sponsor must be made by 
providing written notification of the election to the plan's enrolled 
actuary and the plan administrator. The written notification must set 
forth the relevant details of the election, including the specific 
dollar amount involved in the election (except as provided in paragraph 
(f)(1)(ii) of this section). Thus, except as provided in paragraph 
(f)(1)(ii) of this section, a conditional or formula-based election 
generally does not satisfy the requirements of this paragraph (f).
    (ii) Standing elections to increase or use balances. A plan sponsor 
may provide a standing election in writing to the plan's enrolled 
actuary to use the funding standard carryover balance and the

[[Page 1220]]

prefunding balance to offset the minimum required contribution for the 
plan year to the extent needed to avoid an unpaid minimum required 
contribution under section 4971(c)(4) taking into account any 
contributions that are or are not made. In addition, a plan sponsor may 
provide a standing election in writing to the plan's enrolled actuary to 
add the maximum amount possible each year to the prefunding balance. Any 
election made pursuant to a standing election under this paragraph 
(f)(1)(ii) is deemed to occur on the last day available to make the 
election for the plan year as provided under paragraph (f)(2)(i) of this 
section. Any standing election under this paragraph (f)(1)(ii) remains 
in effect for the plan with respect to the enrolled actuary named in the 
election, unless--
    (A) The standing election is revoked under the rules of paragraph 
(f)(3) of this section; or
    (B) The enrolled actuary who signs the actuarial report under 
section 6059 (Schedule SB, ``Single-Employer Defined Benefit Plan 
Actuarial Information'' of Form 5500, ``Annual Return/Report of Employee 
Benefit Plan'') for the plan for the plan year is not the enrolled 
actuary named in the standing election.
    (2) Timing of elections--(i) General rule. Except as otherwise 
provided in paragraph (f)(2)(ii) or (iii) of this section, any election 
under this section with respect to a plan year must be made no later 
than the last date for making the minimum required contribution for the 
plan year as described in section 430(j)(1). For this purpose, an 
election to add to the prefunding balance relates to the plan year for 
which excess contributions were made. For example, an election to add to 
the prefunding balance as of the first day of the plan year that begins 
on January 1, 2010 (in an amount not in excess of the present value of 
the excess contribution as of the valuation date in 2009, adjusted for 
interest under the rules of paragraph (b)(1)(ii) of this section), must 
be made no later than September 15, 2010, even though the election is 
reported on the 2010 Schedule SB of Form 5500, which is not due until 
2011. Except for the standing elections covered by paragraph (f)(1)(ii) 
of this section, an election under this section may not be made prior to 
the first day of the plan year to which the election relates.
    (ii) Special rule for standing election revoked by a change in 
enrolled actuary. If there is a change in enrolled actuary for the plan 
year which would result in a revocation of the standing election under 
the rule of paragraph (f)(1)(ii)(B) of this section, then the plan 
sponsor may reinstate the revoked standing election by providing a 
replacement to the new enrolled actuary by the due date of the Schedule 
SB of Form 5500.
    (iii) Election to reduce balances. Any election under paragraph (e) 
of this section to reduce the prefunding balance or funding standard 
carryover balance for a plan year (for example, in order to avoid or 
terminate a benefit restriction under section 436) must be made by the 
end of the plan year to which the election relates.
    (iv) Earlier elections. This paragraph (f)(2) sets forth the latest 
date that an election can be made. A plan sponsor is permitted to make 
an earlier election, and in certain circumstances may need to make such 
an election in order to timely satisfy a quarterly contribution 
requirement under section 430(j)(3).
    (3) Irrevocability of elections--(i) In general. Except as otherwise 
provided in this paragraph (f)(3), a plan sponsor's election under this 
section with respect to the plan's prefunding balance or funding 
standard carryover balance is irrevocable (and must be unconditional). A 
standing election by the plan sponsor may be revoked by providing 
written notification of the revocation to the plan's enrolled actuary 
and the plan administrator on or before the date the corresponding 
election is deemed to occur pursuant to paragraph (f)(1)(ii) of this 
section.
    (ii) Exception for certain elections. An election to use the 
prefunding balance or funding standard carryover balance to offset the 
minimum required contribution for a plan year (including an election to 
satisfy the quarterly contribution requirements for a plan year) is 
permitted to be revoked to the extent the amount the plan sponsor 
elected to use to offset the minimum contribution requirements 
(including

[[Page 1221]]

an election used to satisfy the quarterly contribution requirements) 
exceeds the minimum required contribution for a plan year (determined 
without regard to the election under paragraph (d) of this section) if 
and only if the election is revoked by providing written notification of 
the revocation to the plan's enrolled actuary and the plan administrator 
by the deadline set forth in paragraph (f)(3)(iii) of this section. If 
no such revocation is made, then, under paragraph (b) of this section, 
the funding standard carryover balance or prefunding balance is 
decreased by the entire amount that the plan sponsor elected to use to 
offset the minimum required contribution for a plan year (including an 
election to satisfy the quarterly contribution requirements for a plan 
year).
    (iii) Deadline for revoking election. The deadline for revoking the 
election described in paragraph (f)(3)(ii) of this section is generally 
the end of the plan year. However, for plans with a valuation date other 
than the first day of the plan year, the deadline for the revocation is 
the deadline for contributions for the plan year as described in section 
430(j)(1). In addition, for the first plan year beginning in 2008, the 
deadline for the revocation for all plans is deferred to the due date 
(including extensions) of the Schedule SB, ``Single-Employer Defined 
Benefit Plan Actuarial Information'' of Form 5500, ``Annual Return/
Report of Employee Benefit Plan''.
    (4) Plan sponsor--(i) In general. For purposes of the elections 
described in this section, except as otherwise provided in paragraph 
(f)(4)(ii) of this section, any reference to the plan sponsor means the 
employer or employers responsible for making contributions to or under 
the plan.
    (ii) Certain multiple employer plans. For purposes of the elections 
described in this section, in the case of plans that are multiple 
employer plans to which section 413(c)(4)(A) does not apply, any 
reference to the plan sponsor means the plan administrator within the 
meaning of section 414(g).
    (g) Examples. The following examples illustrate the rules of this 
section:

    Example 1. (i) Plan P is a defined benefit plan with a plan year 
that is the calendar year and a valuation date of January 1. The funding 
standard carryover balance of Plan P is $25,000 and the prefunding 
balance is zero as of the beginning of the 2010 plan year. The sponsor 
of Plan P, Sponsor S, does not elect to use any portion of the balance 
to offset the minimum required contribution for 2010 pursuant to 
paragraph (d)(1) of this section, or to reduce any portion of the 
funding standard carryover balance prior to the determination of the 
value of plan assets for 2010, pursuant to paragraph (e)(1) of this 
section. The actual rate of return on Plan P's assets for 2010 is 2%. 
Plan P's effective interest rate for 2010 is 6%. The minimum required 
contribution for Plan P under section 430 for 2010 is $100,000, and no 
quarterly installments are required for Plan P for the 2010 plan year. 
As of January 1, 2010, the value of plan assets is $1,100,000 and the 
funding target is $1,000,000. Therefore, the prior plan year funding 
ratio for Plan P for 2010, as determined under paragraph (d)(3) of this 
section, is 110%.
    (ii) Sponsor S makes a contribution to Plan P of $150,000 on 
December 1, 2010, for the 2010 plan year and makes no other 
contributions for the 2010 plan year. Because this contribution was made 
on a date other than the valuation date for the 2010 plan year, the 
contribution must be adjusted to reflect interest that would otherwise 
have accrued between the valuation date and the date of the 
contribution, at the effective interest rate for the 2010 plan year. The 
amount of the contribution after adjustment is $142,198, determined as 
$150,000 discounted for 11 months of compound interest at an effective 
annual interest rate of 6%.
    (iii) The excess of employer contributions for 2010 over the minimum 
required contribution for 2010, as of the valuation date, is $42,198 
($142,198 less $100,000). Accordingly, the increase in Plan P's 
prefunding balance as of January 1, 2011, cannot exceed $44,730 (which 
is the present value of the excess contribution of $42,198 adjusted for 
12 months of interest at an effective interest rate of 6%).
    (iv) Plan P's funding standard carryover balance as of January 1, 
2011, is $25,500 (which is the funding standard carryover balance as of 
January 1, 2010, adjusted for investment experience during 2010 at a 
rate of 2%).
    Example 2. (i) The facts are the same as in Example 1, except that 
the contribution of $150,000 is made on February 1, 2011, for the 2010 
plan year.
    (ii) The amount of the contribution after adjustment is $140,824, 
which is determined as $150,000 discounted for 13 months of interest at 
an effective interest rate of 6%. Accordingly, the increase in Plan P's 
prefunding balance as of January 1, 2011, cannot exceed $43,273 (which 
is the present value of the excess contribution of $40,824 adjusted

[[Page 1222]]

for 12 months of interest at an effective interest rate of 6%).
    (iii) Plan P's funding standard carryover balance as of January 1, 
2011, is $25,500, as developed in Example 1 of this section. If Sponsor 
S elects to increase the prefunding balance as of January 1, 2011, by 
the present value of the excess contribution adjusted for interest, or 
$43,273, the total of the funding standard carryover balance and 
prefunding balance as of January 1, 2011, is $68,773.
    Example 3. (i) The facts are the same as in Example 1, except that 
Sponsor S contributes $90,539 to Plan P on February 1, 2011, for the 
2010 plan year and makes no other contributions to Plan P for the 2010 
plan year. In addition, on February 1, 2011, Sponsor S elects to use 
$15,000 of the funding standard carryover balance to offset P's minimum 
required contribution for 2010, pursuant to paragraph (d)(1) of this 
section. This is permitted because Plan P's prior-year funding ratio 
determined under paragraph (d)(3) of this section is 110%, and is 
therefore not less than 80%.
    (ii) Because the contribution was made on a date other than the 
valuation date for the 2010 plan year, the contribution must be adjusted 
to reflect interest that would otherwise have accrued between the 
valuation date and the date of the contribution, at the effective 
interest rate for the 2010 plan year. The amount of the contribution 
after adjustment is $85,000, determined as $90,539 discounted for 13 
months of compound interest at an effective interest rate of 6%. The 
adjusted contribution of $85,000 plus the $15,000 of the funding 
standard carryover balance used to offset the minimum required 
contribution equals the minimum required contribution for the 2010 plan 
year of $100,000. Therefore, no excess contributions are available to 
increase the prefunding balance, and the prefunding balance as of 
January 1, 2011, remains zero.
    (iii) The funding standard carryover balance as of January 1, 2011, 
is adjusted for investment experience during the 2010 plan year, in 
accordance with paragraph (b)(3) of this section. The amount of the 
adjustment is $200, determined as the actual rate of return on plan 
assets for 2010 as applied to the 2010 funding standard carryover 
balance after reduction for the amount of that balance used under 
paragraph (d)(1) of this section (that is, $25,000 less $15,000, 
multiplied by the actual rate of return of 2%).
    (iv) The funding standard carryover balance, as of January 1, 2011, 
is $10,200, determined as the 2010 funding standard carryover balance 
less the amount used to offset the 2010 minimum required contribution, 
adjusted for investment experience during the 2010 year ($25,000 less 
$15,000 plus $200).
    Example 4. (i) The facts are the same as in Example 3, except that 
Sponsor S contributes $150,000 (instead of $90,539) to Plan P on 
February 1, 2011, for the 2010 plan year.
    (ii) Because the contribution was made on a date other than the 
valuation date for the 2010 plan year, the contribution must be adjusted 
to reflect interest that would otherwise have accrued between the 
valuation date and the date of the contribution, at the effective 
interest rate for the 2010 plan year. The amount of the contribution 
after adjustment is $140,824, determined as $150,000 discounted for 13 
months of interest at an effective interest rate of 6%.
    (iii) Because Sponsor S elected to use $15,000 of the funding 
standard carryover balance to offset the minimum required contribution 
for 2010 of $100,000, the cash contribution requirement for 2010, 
adjusted with interest to January 1, 2010, is $85,000. The adjusted 
contribution of $140,824 exceeds this amount by $55,824. Of this amount, 
$15,000 exceeds the minimum required contribution only because of 
Sponsor S's election to use the funding standard carryover balance to 
offset the minimum required contribution as provided in paragraph (d)(1) 
of this section. The remaining $40,824 ($140,824 minus $100,000) results 
from cash contributions made in excess of the minimum required 
contribution before offset by the funding standard carryover balance.
    (iv) The portion of the excess contribution resulting solely because 
the minimum required contribution was offset by a portion of the funding 
standard carryover balance is adjusted for investment experience during 
2009, pursuant to paragraph (b)(3)(iii) of this section. Accordingly, 
this portion of the present value of the excess contribution adjusted 
for interest as of January 1, 2011, is $15,300 ($15,000 adjusted for 
investment experience during 2010 at a rate of 2%).
    (v) The excess contribution resulting from cash contributions in 
excess of the minimum required contribution before offset by the funding 
standard carryover balance is adjusted for interest at the effective 
interest rate for 2010, pursuant to paragraph (b)(1)(iv)(A) of this 
section. Accordingly, this portion of the present value of the excess 
contribution adjusted for interest as of January 1, 2011, is $43,273 
($40,824 increased by the effective interest rate of 6%). The increase 
in Plan P's prefunding balance as of January 1, 2011, cannot exceed the 
total present value of the excess contribution adjusted for interest of 
$58, 573 ($15,300 plus $43,273).
    (vi) The funding standard carryover balance as of January 1, 2011, 
is $10,200, determined as the 2010 funding standard carryover balance 
less the $15,000 used to offset the 2010 minimum required contribution, 
adjusted for investment experience during the 2010 plan year as 
developed in Example 3 ($25,000 less $15,000 plus $200).
    (vii) Sponsor S elects to increase the prefunding balance by the 
maximum amount

[[Page 1223]]

of the present value of the excess contribution adjusted for interest of 
$58,573, resulting in a total of the funding standard carryover balance 
and the prefunding balance as of January 1, 2011, of $68,773, the same 
amount as that developed in Example 2.
    Example 5. (i) Plan Q is a defined benefit plan with a plan year 
that is the calendar year and a valuation date of July 1. The funding 
standard carryover balance of Plan Q is $50,000 as of January 1, 2010, 
the beginning of the 2010 plan year. The prefunding balance of Plan Q as 
of the beginning of the 2010 plan year is $0. The actual rate of return 
on Plan Q's assets for 2010 is 10%. Plan Q's effective interest rate for 
2010 is 6.25%. The funding ratio for Plan Q for 2009 (the prior plan 
year funding ratio with respect to 2010, as determined under paragraph 
(d)(3) of this section) is 85%, which is not less than 80%. The minimum 
required contribution for Plan Q for 2010 is $200,000. Sponsor T makes a 
contribution to Plan Q of $190,000 on July 1, 2010, for the 2010 plan 
year, and makes no other contributions for the 2010 plan year. Sponsor T 
elects to use $10,000 of the funding standard carryover balance to 
offset Plan Q's minimum required contribution in 2010.
    (ii) Pursuant to paragraph (b)(4) of this section, the funding 
standard carryover balance is increased to $51,539 as of July 1, 2010 
(that is, an increase to reflect 6 months of interest at an effective 
interest rate of 6.25%) for the purpose of adjusting plan assets under 
paragraph (c) of this section, and for applying any election to use or 
reduce Plan Q's funding standard carryover balance under paragraph (d) 
or (e) of this section. However, Sponsor T does not elect in 2010 to 
reduce any portion of the funding standard carryover balance pursuant to 
paragraph (e) of this section. The funding standard carryover balance 
($51,539) is subtracted from the value of plan assets, as of July 1, 
2010, prior to the determination of the minimum funding contribution, 
and $51,539 is the maximum amount that may applied against the minimum 
required contribution.
    (iii) The value of the funding standard carryover balance as of 
January 1, 2011, is determined by first discounting the amount used to 
offset the minimum required contribution for 2010 from July 1, 2010, to 
January 1, 2010, using the effective interest rate of 6.25%, and 
subtracting the discounted amount from the January 1, 2010, funding 
standard carryover balance. The resulting amount is adjusted for 
investment experience to January 1, 2011, using a rate equal to the 
actual rate of return on plan assets of 10% during 2010. Thus, the 
$10,000 used to offset Plan Q's minimum required contribution as of July 
1, 2010, is discounted for 6 months of interest, at an effective 
interest rate of 6.25%, to obtain an amount of $9,701 as of January 1, 
2010. The remaining funding standard carryover balance as of January 1, 
2010, solely for purposes of determining the adjustment for investment 
experience during 2010, is $40,299 ($50,000--$9,701), and the adjustment 
for investment experience is $4,030 ($40,299 x 10%). The value of the 
funding standard carryover balance as of January 1, 2011, is $44,329 
(that is, $50,000 - $9,701 + $4,030).
    Example 6. (i) The facts are the same as in Example 5, except that 
Sponsor T contributes $200,000 on July 1, 2010, for the 2010 plan year.
    (ii) The cash contribution required for 2010, after offsetting the 
minimum required contribution by $10,000 of the funding standard 
carryover balance in accordance with T's election, is $190,000. The 
difference, or $10,000, must be adjusted to January 1, 2011, to 
determine the maximum amount that can be added to the prefunding balance 
as of that date.
    (iii) The excess contribution is first adjusted to January 1, 2010, 
by discounting for 6 months of interest using the effective interest 
rate for 2010 of 6.25%. This results in an excess contribution of $9,701 
($10,000 / 1.0625 \0.5\). Because this amount is an excess contribution 
solely because of Sponsor T's election to offset the minimum required 
contribution for 2010 by a portion of the funding standard carryover 
balance, the amount is then adjusted for investment experience during 
2010 at a rate of 10%, in accordance with paragraph (b)(3)(iii) of this 
section, for a present value of the excess contribution adjusted for 
interest of $10,671 ($9,701 x 1.10) as of January 1, 2011.
    Example 7. (i) The facts are the same as in Example 4. Plan P's 
effective interest rate for 2011 is 6.5%, and the rate of return on 
investments during 2011 is 7%. All required quarterly installments for 
the 2011 plan year were made by the applicable due dates. On February 1, 
2012, Sponsor S elects to use $50,000 of Plan P's prefunding and funding 
standard carryover balances to offset the minimum required contribution 
for the 2011 plan year. On April 15, 2012, Sponsor S elects to use Plan 
P's prefunding and funding standard carryover balances to offset the 
2012 minimum required contribution by $20,000, in accordance with 
paragraph (d) of this section, in order to offset the required quarterly 
installment then due.
    (ii) When adjusting Plan P's prefunding and funding standard 
carryover balances to reflect Sponsor S's election to use them to offset 
the 2011 minimum required contribution, the remaining $10,200 in the 
funding standard carryover balance as of January 1, 2011, must be used 
before any portion of the prefunding balance. The prefunding balance is 
reduced by the remaining $39,800 ($50,000 total election minus $10,200 
from the funding standard carryover balance).
    (iii) The amount available for Sponsor S's election to use Plan P's 
prefunding and funding standard carryover balances to offset the

[[Page 1224]]

2012 minimum required contribution is determined by reducing the January 
1, 2011, prefunding and funding standard carryover balances to reflect 
the election to use the prefunding and funding standard carryover 
balances to offset the 2011 minimum required contribution, and by 
adjusting the resulting amount to January 1, 2012, using the rate of 
investment return for Plan P during 2011. Accordingly, the available 
amount in Plan P's funding standard carryover balance as of January 1, 
2012, is zero. The available amount in Plan P's prefunding balance as of 
January 1, 2012, is $20,087 ($58,573 minus $39,800, increased by 7%). 
Therefore, Sponsor S has $20,087 available to offset the minimum 
required contribution for the 2012 plan year.
    Example 8. (i) The facts are the same as in Example 7, except that 
based on the enrolled actuary's certification of the AFTAP on July 1, 
2012, Sponsor S is deemed to elect to reduce the January 1, 2012, 
prefunding balance by $15,000 under section 436(f)(3).
    (ii) In accordance with paragraph (d)(1)(ii)(B) of this section, the 
deemed election to reduce the prefunding balance is deemed to occur on 
the first day of the plan year, and before the date of any election to 
offset the minimum required contribution for the 2012 plan year. The 
deemed election does not affect Sponsor S's election to offset the 2011 
minimum contribution because that election was made on February 1, 2012, 
before the date of the deemed election, July 1, 2012.
    (iii) As shown in Example 7, the available prefunding balance as of 
January 1, 2012, after reflecting the February 1, 2012, election to 
offset the 2011 minimum required contribution but before reflecting the 
April 15, 2012, election to offset the 2012 minimum required 
contribution, is $20,087. Adjusting this amount to reflect the deemed 
election to reduce the prefunding balance by $15,000 leaves a balance of 
$5,087 available to offset the minimum required contribution for 2012.
    (iv) The portion of the quarterly installment due April 15, 2012 
that was not covered by the remaining $5,087 prefunding balance is 
considered unpaid retroactive to April 15, 2012.
    Example 9. (i) The facts are the same as in Example 8, except that 
Sponsor S does not make the election to offset the 2011 minimum required 
contribution until August 1, 2012, and the deemed election as of July 1, 
2012, reduces Plan P's prefunding and funding standard carryover 
balances as of January 1, 2012, by $68,500. Sponsor S does not elect to 
use Plan P's prefunding and funding standard carryover balances to 
offset the 2012 minimum contribution.
    (ii) In accordance with paragraph (d)(1)(ii)(A) of this section, the 
July 1, 2012, deemed election to reduce Plan P's prefunding and funding 
standard carryover balances must be taken into account before 
determining the amount available to offset the 2011 minimum required 
contribution because the election to offset the 2011 minimum required 
contribution was made after the date of the deemed election, July 1, 
2012.
    (iii) Pursuant to paragraph (d)(1)(ii)(C) of this section, the 
January 1, 2011, prefunding and funding standard carryover balances are 
adjusted to January 1, 2012, using Plan P's rate of investment return 
for 2011 of 7%. This results in an available funding standard carryover 
balance of $10,914 ($10,200 x 1.07) and an available prefunding balance 
of $62,673 (58,573 x 1.07) as of January 1, 2012.
    (iv) Paragraph (d)(2) of this section requires that the funding 
standard carryover balance must be used before reducing Plan P's 
prefunding balance. Accordingly, the funding standard carryover balance 
is eliminated, and the prefunding balance is reduced by the remaining 
$57,586 ($68,500 - $10,914), resulting in an available prefunding 
balance of $5,087 ($62,673 - $57,586) as of January 1, 2012.
    (v) In accordance with paragraph (d)(1)(ii)(D) of this section, the 
remaining balance is adjusted to January 1, 2011, to determine the 
amount available to offset the 2011 minimum required contribution. This 
adjustment is done by dividing the remaining balance by 1 plus the rate 
of investment return for 2011. Accordingly, the amount available to 
offset the 2011 minimum required contribution is $4,754 ($5,087 / 1.07).
    (vi) If the plan sponsor elects to use the $4,754 available balance 
to offset the 2011 minimum required contribution, the funding standard 
carryover balance as of January 1, 2012 (prior to the deemed reduction 
under section 436(f)(3)) is $5,827 ($10,200 less $4,754, plus $381 for 
investment experience at a rate of 7%). The prefunding balance as of 
January 1, 2012 (prior to the deemed reduction under section 436(f)(3)) 
is $62,673 (that is, $58,573 x 1.07). The deemed election to reduce Plan 
P's balance is first applied to eliminate the funding standard carryover 
balance, and the remaining $62,673 ($68,500 less $5,827) reduces the 
January 1, 2012, prefunding balance to zero.
    Example 10. (i) Plan V is a defined benefit plan with a plan year 
that is the calendar year and a valuation date of December 31. The 
valuation is based on the fair market value of plan assets, which 
amounts to $1,000,000 as of December 31, 2010, before any adjustments. 
As of January 1, 2010, Plan V's funding standard carryover balance is $0 
and its prefunding balance is $125,000. Plan V's effective interest rate 
for 2010 is 5.5%. The enrolled actuary's certification of AFTAP for 2010 
on March 31, 2010, results in a deemed reduction of $15,000 in the 
plan's prefunding balance as of January 1, 2010. Plan V's sponsor 
elected to use the prefunding balance to offset any portion of the 
minimum required contribution for 2010 not covered by cash 
contributions.

[[Page 1225]]

    (ii) In accordance with paragraph (b)(4)(i) of this section, the 
amount of the prefunding balance subtracted from plan assets is 
increased from the first day of the plan year to the valuation date 
using the effective interest rate of 5.5% for 2009. Accordingly, the 
prefunding balance used for this purpose is $116,050 [($125,000 - 
$15,000 deemed reduction) x 1.055].
    (iii) The fair market value of plan assets used for the December 31, 
2010, valuation is $883,950 ($1,000,000 - $116,050).
    Example 11. (i) The facts are the same as in Example 10. The minimum 
contribution for Plan V for the 2010 plan year is $45,000; no quarterly 
installments are required for Plan V for 2010. Plan V's sponsor makes a 
contribution of $20,000 for the 2010 plan year on July 1, 2011. The 
actual rate of return on assets for Plan V during 2010 is 10%.
    (ii) The contribution of $20,000 is discounted to December 31, 2010, 
using the effective interest rate of 5.5% to determine the remaining 
balance of the 2010 minimum required contribution. Accordingly, the 
contribution is adjusted to $19,472 ($20,000 / 1.055 \0.5\) as of 
December 31, 2010, and the balance of the minimum required contribution 
is $25,528 ($45,000 - $19,472). This balance will be covered by the plan 
sponsor's election to use the prefunding balance to offset any portion 
of the minimum required contribution not covered by cash contributions.
    (iii) Under section (b)(4)(ii) of this section, the amount used to 
offset the 2010 minimum required contribution for the purpose of 
adjusting the prefunding balance is discounted to January 1, 2010, using 
the effective interest rate for 2010. This amount is calculated as 
$24,197 ($25,528 / 1.055).
    (iv) The prefunding balance as of January 1, 2011, is reduced by the 
deemed election of $15,000 and the discounted amount used to offset the 
2010 minimum required contribution ($24,197), and adjusted for 
investment experience for 2010 using the actual rate of return of 10%. 
Accordingly, the prefunding balance as of January 1, 2011 is $94,383 
[($125,000 - $15,000 - $24,197) x 1.10].
    Example 12. (i) The facts are the same as in Example 11, except that 
the enrolled actuary's certification of the AFTAP as of March 31, 2011, 
results in a deemed reduction of the prefunding balance as of January 1, 
2011, of $75,000.
    (ii) Under paragraph (d)(1)(ii) of this section, the deemed 
reduction of the prefunding balance is applied before the election to 
use the prefunding balance to offset the balance of the minimum required 
contribution for 2010. To determine the amount of the prefunding balance 
available to cover the remaining minimum required contribution for 2010, 
the deemed reduction is adjusted for investment experience to January 1, 
2010, using the actual rate of return of 10% for 2010. Accordingly, the 
adjusted deemed reduction is $68,182 ($75,000 / 1.10) and the available 
prefunding balance as of January 1, 2010, is $41,818 ($125,000 - $15,000 
adjusted deemed reduction for 2010 - $68,182 adjusted deemed reduction 
for 2011).
    (iii) This amount is then adjusted to December 31, 2010, using the 
effective interest rate of 5.5%. The amount of the prefunding balance 
available to offset the 2009 minimum required contribution as of 
December 31, 2010, is $44,118 ($41,818 x 1.055). This amount is larger 
than the election made by Plan V's sponsor to offset the minimum 
required contribution for 2010 ($25,528) and so the election remains 
valid.

    (h) Effective/applicability date and transition rules--(1) Statutory 
effective date/applicability date. Section 430 generally applies to plan 
years beginning on or after January 1, 2008. The applicability of 
section 430 for purposes of determining the minimum required 
contribution is delayed for certain plans in accordance with sections 
104 through 106 of PPA '06.
    (2) Effective date/applicability date of regulations. This section 
applies to plan years beginning on or after January 1, 2010. For plan 
years beginning before January 1, 2010, plans are permitted to rely on 
the provisions set forth in this section for purposes of satisfying the 
requirements of section 430.
    (3) Special lookback rule for 2007 plan year's funding ratio--(i) 
Plan assets. For purposes of determining a plan's prior plan year 
funding ratio under paragraph (d)(3) of this section with respect to the 
first plan year beginning on or after January 1, 2008, the value of plan 
assets on the valuation date of the preceding plan year (the ``2007 plan 
year'') is determined under section 412(c)(2) as in effect for the 2007 
plan year, except that, for this purpose--
    (A) If the value of plan assets is less than 90 percent of the fair 
market value of plan assets for the 2007 plan year on that date, such 
value is considered to be 90 percent of the fair market value; and
    (B) If the value of plan assets is greater than 110 percent of the 
fair market value of plan assets for the 2007 plan year on that date, 
such value is considered to be 110 percent of the fair market value.
    (ii) Funding target. For purposes of determining a plan's prior plan 
year funding ratio under paragraph (d)(3) of

[[Page 1226]]

this section with respect to the first plan year beginning on or after 
January 1, 2008, the funding target of the plan for the preceding plan 
year is equal to the plan's current liability under section 412(l)(7) 
(as in effect prior to amendment by PPA '06) on the valuation date for 
the 2007 plan year.
    (iii) Special rules for new plans, mergers, and spinoffs. In the 
case of a plan described in paragraph (d)(3)(ii), (d)(3)(iii), or 
(d)(3)(iv) of this section, the plan's prior plan year funding ratio 
with respect to the first plan year beginning on or after January 1, 
2008 is determined using rules similar to the rules of paragraphs 
(d)(3)(ii), (d)(3)(iii), and (d)(3)(iv) of this section.
    (4) First effective plan year. For purposes of this section, the 
term first effective plan year means the first plan year beginning on or 
after the date section 430 applies for purposes of determining the 
minimum required contribution for the plan.
    (5) Pre-effective plan year. For purposes of this section, the term 
pre-effective plan year means the plan year immediately preceding the 
first effective plan year.

[T.D. 9467, 74 FR 54046, Oct. 15, 2009]



Sec. 1.430(g)-1  Valuation date and valuation of plan assets.

    (a) In general--(1) Overview. This section provides rules relating 
to a plan's valuation date and the valuation of a plan's assets for a 
plan year under section 430(g). Section 430 and this section apply to 
single employer defined benefit plans (including multiple employer plans 
as defined in section 413(c)) that are subject to the rules of section 
412, but do not apply to multiemployer plans (as defined in section 
414(f)). Paragraph (b) of this section describes valuation date rules. 
Paragraph (c) of this section describes rules regarding the 
determination of the asset value for purposes of a plan's actuarial 
valuation. Paragraph (d) of this section contains rules for taking 
employer contributions into account in the determination of the value of 
plan assets. Paragraph (e) of this section contains examples. Paragraph 
(f) of this section sets forth effective/applicability dates and 
transition rules.
    (2) Special rules for multiple employer plans. In the case of a 
multiple employer plan to which section 413(c)(4)(A) applies, the rules 
of section 430 and this section are applied separately for each employer 
under the plan as if each employer maintained a separate plan. Thus, in 
such a case, the value of plan assets is determined separately for each 
employer under the plan. In the case of a multiple employer plan to 
which section 413(c)(4)(A) does not apply (that is, a plan described in 
section 413(c)(4)(B) that has not made the election for section 
413(c)(4)(A) to apply), the rules of section 430 and this section are 
applied as if all participants in the plan were employed by a single 
employer.
    (b) Valuation date--(1) In general. The determination of the funding 
target, target normal cost, and value of plan assets for a plan year is 
made as of the valuation date for that plan year. Except as otherwise 
provided in paragraph (b)(2) of this section, the valuation date for any 
plan year is the first day of the plan year.
    (2) Exception for small plans--(i) In general. If, on each day 
during the preceding plan year, a plan had 100 or fewer participants 
determined by applying the rules of Sec. 1.430(d)-1(e)(1) and (2) 
(including active and inactive participants and all other individuals 
entitled to future benefits), then the plan may designate any day during 
the plan year as its valuation date for that plan year and succeeding 
plan years. For purposes of this paragraph (b)(2)(i), all defined 
benefit plans (other than multiemployer plans as defined in section 
414(f)) maintained by an employer are treated as one plan, but only 
participants with respect to that employer are taken into account.
    (ii) Employer determination. For purposes of this paragraph (b)(2), 
the employer includes all members of the employer's controlled group 
determined pursuant to section 414(b), (c), (m), and (o) and includes 
any predecessor of the employer that, during the prior year, employed 
any employees of the employer who are covered by the plan.
    (iii) Application of exception in first plan year. In the case of 
the first plan year of any plan, the exception for small plans under 
paragraph (b)(2)(i) of

[[Page 1227]]

this section is applied by taking into account the number of 
participants that the plan is reasonably expected to have on each day 
during the first plan year.
    (iv) Valuation date is part of funding method. The selection of a 
plan's valuation date is part of the plan's funding method and, 
accordingly, may only be changed with the consent of the Commissioner. A 
change of a plan's valuation date that is required by section 430 is 
treated as having been approved by the Commissioner and does not require 
the Commissioner's prior specific approval. Thus, if a plan that ceases 
to be eligible for the small plan exception under this paragraph (b)(2) 
for a plan year because the number of participants exceeded 100 in the 
prior plan year, then the resulting change in the valuation date to the 
first day of the plan year is automatically approved by the 
Commissioner.
    (c) Determination of asset value--(1) In general--(i) General use of 
fair market value. Except as otherwise provided in this paragraph (c), 
the value of plan assets for purposes of section 430 is equal to the 
fair market value of plan assets on the valuation date. Prior year 
contributions made after the valuation date and current year 
contributions made before the valuation date are taken into account to 
the extent provided in paragraph (d) of this section.
    (ii) Fair market value. The fair market value of an asset is 
determined as the price at which the asset would change hands between a 
willing buyer and a willing seller, neither being under any compulsion 
to buy or sell and both having reasonable knowledge of relevant facts. 
Except as otherwise provided by the Commissioner, any guidance on the 
valuation of insurance contracts under Subchapter D of Chapter 1 the 
Internal Revenue Code applies for purposes of this paragraph (c)(1)(ii).
    (2) Averaging of fair market values--(i) In general. Subject to the 
plan asset corridor rules of paragraph (c)(2)(iii) of this section, a 
plan is permitted to determine the value of plan assets on the valuation 
date as the average of the fair market value of assets on the valuation 
date and the adjusted fair market value of assets determined for one or 
more earlier determination dates (adjusted using the method described in 
paragraph (c)(2)(ii) of this section). The method of determining the 
value of assets is part of the plan's funding method and, accordingly, 
may only be changed with the consent of the Commissioner.
    (ii) Adjusted fair market value--(A) Determination dates. The period 
of time between each determination date (treating the valuation date as 
a determination date) must be equal and that period of time cannot 
exceed 12 months. In addition, the earliest determination date with 
respect to a plan year cannot be earlier than the last day of the 25th 
month before the valuation date of the plan year (or a similar period in 
the case of a valuation date that is not the first day of a month). In a 
typical situation, the earlier determination dates will be the two 
immediately preceding valuation dates. However, these rules also permit 
the use of more frequent determination dates. For example, monthly or 
quarterly determination dates may be used.
    (B) Adjustments for contributions and distributions. The adjusted 
fair market value of plan assets for a prior determination date is the 
fair market value of plan assets on that date, increased for 
contributions included in the plan's asset balance on the valuation date 
that were not included in the plan's asset balance on the earlier 
determination date, reduced for benefits and all other amounts paid from 
plan assets during the period beginning with the prior determination 
date and ending immediately before the valuation date, and adjusted for 
expected earnings as described in paragraph (c)(2)(ii)(D) of this 
section. For this purpose, the fair market value of assets as of a 
determination date includes any contribution for a plan year that ends 
with or prior to the determination date that is receivable as of the 
determination date (but only if the contribution is actually made within 
8\1/2\ months after the end of the applicable plan year). If the 
contribution that is receivable as of the determination date is for a 
plan year beginning on or after January 1, 2008, then only the present 
value as of the determination date (determined using the effective 
interest rate under section 430(h)(2)(A) for the plan year

[[Page 1228]]

for which the contribution is made) is included in the fair market value 
of assets.
    (C) Treatment of spin-offs and plan-to-plan transfers. For purposes 
of determining the adjusted fair market value of plan assets, assets 
spun-off from a plan as a result of a spin-off described in Sec. 
1.414(l)-1(b)(4) are treated as an amount paid from plan assets. Except 
as otherwise provided by the Commissioner, for purposes of determining 
the adjusted fair market value of plan assets, assets that are added to 
a plan as a result of a plan-to-plan transfer described in Sec. 
1.414(l)-1(b)(3) are treated in the same manner as contributions.
    (D) Adjustments for expected earnings. [Reserved]
    (E) Assumed rate of return. [Reserved]
    (F) Limitation on the assumed rate of return for periods within plan 
years for which the three segment rates were used. [Reserved]
    (G) Limitation on the assumed rate of return for periods within plan 
years for which the full yield curve was used. [Reserved]
    (iii) Restriction to 90-110 percent corridor--(A) In general. This 
paragraph (c)(2)(iii) provides rules for applying the 90 to 110 percent 
corridor set forth in section 430(g)(3)(B)(iii). The rules for 
accounting for contribution receipts under paragraphs (d)(1) and (d)(2) 
of this section are applied prior to the application of the 90 to 110 
percent corridor under this paragraph (c)(2)(iii).
    (B) Asset value less than 90 percent of fair market value. If the 
value of plan assets determined under paragraph (c)(2)(i) of this 
section is less than 90 percent of the fair market value of plan assets, 
then the value of plan assets under this paragraph (c)(2) is equal to 90 
percent of the fair market value of plan assets.
    (C) Asset value greater than 110 percent of fair market value. If 
the value of plan assets determined under paragraph (c)(2)(i) of this 
section is greater than 110 percent of the fair market value of plan 
assets, then the value of plan assets under this paragraph (c)(2) is 
equal to 110 percent of the fair market value of plan assets.
    (3) Qualified transfers to health benefit accounts. In the case of a 
qualified transfer (as defined in section 420), any assets so 
transferred are not treated as plan assets for purposes of section 430 
and this section.
    (d) Accounting for contribution receipts--(1) Prior year 
contributions--(i) In general. For purposes of determining the value of 
plan assets under paragraph (c) of this section, if an employer makes a 
contribution to the plan after the valuation date for the current plan 
year and the contribution is for an earlier plan year, then the present 
value of the contribution determined as of that valuation date is taken 
into account as an asset of the plan as of the valuation date, but only 
if the contribution is made before the deadline for contributions as 
described in section 430(j)(1) for the plan year immediately preceding 
the current plan year. For this purpose, the present value is determined 
using the effective interest rate under section 430(h)(2)(A) for the 
plan year for which the contribution is made.
    (ii) Special rule for contributions for the 2007 plan year--(A) 
Timely contributions. Notwithstanding paragraph (d)(1)(i) of this 
section, if the employer makes a contribution to the plan after the 
valuation date for the first plan year that begins on or after January 
1, 2008, and the contribution is for the immediately preceding plan year 
and is made by the deadline for contributions for that preceding plan 
year under section 412(c)(10) (as in effect before amendment by the 
Pension Protection Act of 2006 (PPA '06), Public Law 109-280 (120 Stat. 
780)), then the contribution is taken into account as a plan asset under 
paragraph (d)(1)(i) of this section without applying any present value 
discount.
    (B) Late contributions. If a contribution is for the plan year that 
immediately precedes the first plan year that begins on or after January 
1, 2008, and is not described in paragraph (d)(1)(ii)(A) of this 
section, then the rules of paragraph (d)(1)(i) apply to the contribution 
except that the present value is determined using the valuation interest 
rate under section 412(c)(2) for that plan year.
    (iii) Ordering rules. For purposes of this paragraph (d)(1), the 
ordering rules

[[Page 1229]]

of section 4971(c)(4)(B) apply for purposes of determining the plan year 
for which a contribution is made.
    (2) Current year contributions made before valuation date. In the 
case of a plan with a valuation date that is not the first day of the 
plan year, for purposes of determining the value of plan assets under 
paragraph (c) of this section, if an employer makes a contribution for a 
plan year before that year's valuation date, that contribution (and any 
interest on the contribution for the period between the contribution 
date and the valuation date, determined using the effective interest 
rate under section 430(h)(2)(A) for the plan year) must be subtracted 
from plan assets in determining the value of plan assets as of the 
valuation date. If the result of this subtraction is a number less than 
zero, the value of plan assets as of the valuation date is equal to 
zero.
    (e) Examples. [Reserved]
    (f) Effective/applicability dates and transition rules--(1) 
Statutory effective date/applicability date. Section 430 generally 
applies to plan years beginning on or after January 1, 2008. The 
applicability of section 430 for purposes of determining the minimum 
required contribution is delayed for certain plans in accordance with 
sections 104 through 106 of PPA '06.
    (2) Effective date/applicability date of regulations--(i) In 
general. This section applies to plan years beginning on or after 
January 1, 2010, regardless of whether section 430 applies to determine 
the minimum required contribution for the plan year. For plan years 
beginning before January 1, 2010, plans are permitted to rely on the 
provisions set forth in this section for purposes of satisfying the 
requirements of section 430.
    (ii) Permission to use averaging for 2008. For purposes of 
determining the actuarial value of assets for a plan year beginning 
during 2008 using the averaging rules of paragraph (c)(2) of this 
section, a plan is permitted to apply an assumed earnings rate of zero 
under paragraph (c)(2)(ii)(E) of this section (even if zero is not the 
actuary's best estimate of the anticipated annual rate of return on plan 
assets).
    (3) Approval for changes in the valuation date and valuation method. 
Any change in a plan's valuation date or asset valuation method that 
satisfies the rules of this section and is made for either the first 
plan year beginning in 2008, the first plan year beginning in 2009, or 
the first plan year beginning in 2010 is treated as having been approved 
by the Commissioner and does not require the Commissioner's specific 
prior approval. In addition, a change in a plan's valuation date or 
asset valuation method for the first plan year to which section 430 
applies to determine the plan's minimum required contribution (even if 
that plan year begins after December 31, 2010) that satisfies the rules 
of this section is treated as having been approved by the Commissioner 
and does not require the Commissioner's specific prior approval.

[T.D. 9467, 74 FR 53053, Oct. 15, 2009]



Sec. 1.430(h)(2)-1  Interest rates used to determine present value.

    (a) In general--(1) Overview. This section provides rules relating 
to the interest rates to be applied for a plan year under section 
430(h)(2). Section 430(h)(2) and this section apply to single employer 
defined benefit plans (including multiple employer plans as defined in 
section 413(c)) that are subject to section 412 but do not apply to 
multiemployer plans (as defined in section 414(f)). Paragraph (b) of 
this section describes how the segment interest rates are used for a 
plan year. Paragraph (c) of this section describes those segment rates. 
Paragraph (d) of this section describes the monthly corporate bond yield 
curve that is used to develop the segment rates. Paragraph (e) of this 
section describes certain elections that are permitted to be made under 
this section. Paragraph (f) of this section describes other rules 
related to interest rates. Paragraph (g) of this section contains 
examples. Paragraph (h) of this section contains effective/applicability 
dates and transition rules.
    (2) Special rules for multiple employer plans. In the case of a 
multiple employer plan to which section 413(c)(4)(A) applies, the rules 
of section 430 and this section are applied separately for each employer 
under the plan as if each employer maintained a separate plan. Thus, 
each employer under such a multiple employer plan

[[Page 1230]]

may make elections with respect to the interest rate rules under this 
section that are independent of the elections of other employers under 
the plan. In the case of a multiple employer plan to which section 
413(c)(4)(A) does not apply (that is, a plan described in section 
413(c)(4)(B) that has not made the election for section 413(c)(4)(A) to 
apply), the rules of section 430 and this section are applied as if all 
participants in the plan were employed by a single employer.
    (b) Interest rates for determining plan liabilities--(1) In general. 
The interest rates used in determining the present value of the benefits 
that are included in the target normal cost and the funding target for 
the plan for a plan year are determined as set forth in this paragraph 
(b).
    (2) Benefits payable within 5 years--(i) Plans with valuation dates 
at the beginning of the plan year. If the valuation date is the first 
day of the plan year, in the case of benefits expected to be payable 
during the 5-year period beginning on the valuation date for the plan 
year, the interest rate used in determining the present value of the 
benefits that are included in the target normal cost and the funding 
target for the plan is the first segment rate with respect to the 
applicable month, as described in paragraph (c)(2)(i) of this section.
    (ii) Plans with valuation dates other than the first day of the plan 
year. [Reserved]
    (3) Benefits payable after 5 years and within 20 years. In the case 
of benefits expected to be payable during the 15-year period beginning 
after the end of the period described in paragraph (b)(2) of this 
section, the interest rate used in determining the present value of the 
benefits that are included in the target normal cost and the funding 
target for the plan is the second segment rate with respect to the 
applicable month, as described in paragraph (c)(2)(ii) of this section.
    (4) Benefits payable after 20 years. In the case of benefits 
expected to be payable after the period described in paragraph (b)(3) of 
this section, the interest rate used in determining the present value of 
the benefits that are included in the target normal cost and the funding 
target for the plan is the third segment rate with respect to the 
applicable month, as described in paragraph (c)(2)(iii) of this section.
    (5) Applicable month. Except as otherwise provided in paragraph (e) 
of this section, the term applicable month for purposes of this 
paragraph (b) means the month that includes the valuation date of the 
plan for the plan year.
    (6) Special rule for certain airlines--(i) In general. Pursuant to 
section 6615 of the U.S. Troop Readiness, Veterans' Care, Katrina 
Recovery, and Iraq Accountability Appropriations Act, 2007, Public Law 
110-28 (121 Stat. 112), for a plan sponsor that makes the election 
described in section 402(a)(2) of the Pension Protection Act of 2006 
(PPA '06), Public Law 109-280 (120 Stat. 780), the interest rate 
required to be used to determine the plan's funding target for each of 
the 10 years under that election is 8.25 percent (rather than the 
segment rates otherwise described in this paragraph (b) or the full 
yield curve as permitted under paragraph (e)(4) of this section).
    (ii) Special interest rate not applicable for other purposes. The 
special interest rate described in paragraph (b)(6)(i) of this section 
does not apply for other purposes such as the determination of the 
plan's target normal cost.
    (c) Segment rates--(1) Overview. This paragraph (c) sets forth rules 
for determining the first, second, and third segment rates for purposes 
of paragraph (b) of this section. The first, second, and third segment 
rates are set forth in revenue rulings, notices, or other guidance 
published in the Internal Revenue Bulletin. See Sec. 601.601(d)(2) 
relating to objectives and standards for publishing regulations, revenue 
rulings and revenue procedures in the Internal Revenue Bulletin. See 
paragraph (h)(4) of this section for a transition rule under which the 
definition of the segment rates is modified for plan years beginning in 
2008 and 2009.
    (2) Definition of segment rates--(i) First segment rate. For 
purposes of this section, except as otherwise provided under the 
transition rule of paragraph (h)(4) of this section, the first segment 
rate is, with respect to any month, the single rate of interest 
determined by the Commissioner on the basis of the average of the 
monthly corporate bond

[[Page 1231]]

yield curves (described in paragraph (d) of this section) for the 24-
month period ending with the month preceding that month, taking into 
account only the first 5 years of each of those yield curves.
    (ii) Second segment rate. For purposes of this section, except as 
otherwise provided under the transition rule of paragraph (h)(4) of this 
section, the second segment rate is, with respect to any month, the 
single rate of interest determined by the Commissioner on the basis of 
the average of the monthly corporate bond yield curves (described in 
paragraph (d) of this section) for the 24-month period ending with the 
month preceding that month, taking into account only the portion of each 
of those yield curves corresponding to the 15-year period that follows 
the end of the 5-year period described in paragraph (c)(2)(i) of this 
section.
    (iii) Third segment rate. For purposes of this section, except as 
otherwise provided under the transition rule of paragraph (h)(4) of this 
section, the third segment rate is, with respect to any month, the 
single rate of interest determined by the Commissioner on the basis of 
the average of the monthly corporate bond yield curves (described in 
paragraph (d) of this section) for the 24-month period ending with the 
month preceding that month, taking into account only the portion of each 
of those yield curves corresponding to the 40-year period that follows 
the end of the 15-year period described in paragraph (c)(2)(ii) of this 
section.
    (d) Monthly corporate bond yield curve--(1) In general. For purposes 
of this section, the monthly corporate bond yield curve is, with respect 
to any month, a yield curve that is prescribed by the Commissioner for 
that month based on yields for that month on investment grade corporate 
bonds with varying maturities that are in the top three quality levels 
available.
    (2) Determination and publication of yield curve. A description of 
the methodology for determining the monthly corporate bond yield curve 
is provided in guidance issued by the Commissioner that is published in 
the Internal Revenue Bulletin. The yield curve for a month will be set 
forth in revenue rulings, notices, or other guidance published in the 
Internal Revenue Bulletin. See Sec. 601.601(d)(2) relating to 
objectives and standards for publishing regulations, revenue rulings and 
revenue procedures in the Internal Revenue Bulletin.
    (e) Elections--(1) In general. This paragraph (e) describes 
elections for a plan year that a plan sponsor can make to use 
alternative interest rates under this section. Any election under this 
paragraph (e) must be made by providing written notification of the 
election to the plan's enrolled actuary. Any election in this paragraph 
(e) may be adopted for a plan year without obtaining the consent of the 
Commissioner, but, once adopted, that election will apply for that plan 
year and all future plan years and may be changed only with the consent 
of the Commissioner.
    (2) Election for alternative applicable month. As an alternative to 
defining the applicable month as the month that includes the valuation 
date for the plan year, a plan sponsor that is using segment rates as 
provided under paragraph (b) of this section may elect to use one of the 
4 months preceding that month as the applicable month.
    (3) Election not to apply transition rule. The plan sponsor may 
elect not to apply the transition rule in paragraph (h)(4) of this 
section.
    (4) Election to use full yield curve--(i) In general. For purposes 
of determining the plan's funding target and target normal cost, and for 
all other purposes under section 430 (including the determination of 
shortfall amortization installments, waiver installments, and the 
present values of those installments as described in paragraph (f)(2) of 
this section), the plan sponsor may elect to use interest rates under 
the monthly corporate bond yield curve described in paragraph (d) of 
this section for the month preceding the month that includes the 
valuation date in lieu of the segment rates determined under paragraph 
(c) of this section. In order to address the timing of benefit payments 
during a year, reasonable approximations are permitted to be used to 
value benefit payments that are expected to be made during a plan year.
    (ii) Reasonable techniques permitted. In the case of a plan sponsor 
using the

[[Page 1232]]

monthly corporate bond yield curve under this paragraph (e)(4), if with 
respect to a decrement the benefit is only expected to be paid for one-
half of a year (because the decrement was assumed to occur in the middle 
of the year), the interest rate for that year can be determined as if 
the benefit were being paid for the entire year. See Sec. 1.430(d)-
1(f)(7) for additional reasonable techniques that can be used in 
determining present value.
    (5) Plan sponsor. For purposes of the elections described in this 
section, any reference to the plan sponsor generally means the employer 
or employers responsible for making contributions to or under the plan. 
In the case of plans that are multiple employer plans to which section 
413(c)(4)(A) does not apply, any reference to the plan sponsor means the 
plan administrator within the meaning of section 414(g).
    (f) Interest rates used for other purposes--(1) Effective interest 
rate--(i) In general. Except as otherwise provided in paragraph (f)(2) 
of this section, the effective interest rate determined under section 
430(h)(2)(A) for the plan year is the single interest rate that, if used 
to determine the present value of the benefits that are taken into 
account in determining the plan's funding target for the plan year, 
would result in an amount equal to the plan's funding target determined 
for the plan year under section 430(d) as described in Sec. 1.430(d)-
1(b)(2) (without regard to calculations for plans in at-risk status 
under section 430(i)).
    (ii) Zero funding target. If, for the plan year, the plan's funding 
target is equal to zero, then the effective interest rate determined 
under section 430(h)(2)(A) for the plan year is the single interest rate 
that, if used to determine the present value of the benefits that are 
taken into account in determining the plan's target normal cost for the 
plan year, would result in an amount equal to the plan's target normal 
cost determined for the plan year under section 430(b) as described in 
Sec. 1.430(d)-1(b)(1) (without regard to calculations for plans in at-
risk status under section 430(i)).
    (2) Interest rates used for determining shortfall amortization 
installments and waiver amortization installments. The interest rates 
used to determine the amount of shortfall amortization installments and 
waiver amortization installments and the present value of those 
installments are determined based on the dates those installments are 
assumed to be paid, using the same timing rules that apply in 
determining target normal cost as described in paragraph (b) of this 
section. Thus, for a plan that uses the segment rates described in 
paragraph (c) of this section, the first segment rate applies to the 
installments assumed to be paid during the first 5-year period beginning 
on the valuation date for the plan year, and the second segment rate 
applies to the installments assumed to be paid during the subsequent 15-
year period. For purposes of this paragraph (f)(2), the shortfall 
amortization installments for a plan year are assumed to be paid on the 
valuation date for that plan year. For example, for a plan that uses the 
segment rates described in paragraph (c) of this section, the shortfall 
amortization installment for the fifth plan year following the current 
plan year (the sixth installment) is assumed to be paid on the valuation 
date for that year so that such shortfall amortization installment will 
be determined using the second segment rate.
    (g) Examples. The following examples illustrate the rules of this 
section:

    Example 1. (i) The January 1, 2009, valuation of Plan P is performed 
using the segment rates applicable for September 2008 (determined 
without regard to the transition rule of section 430(h)(2)(G)), and the 
2009 annuitant and nonannuitant (male and female) mortality tables as 
published in Notice 2008-85. See Sec. 601.601(d)(2) relating to 
objectives and standards for publishing regulations, revenue rulings and 
revenue procedures in the Internal Revenue Bulletin. Plan P provides for 
early retirement benefits as early as age 50, and offers a single-sum 
distribution payable immediately at retirement. The single-sum payment 
is equal to the present value of the participant's accrued benefit, 
based on the applicable interest rates and the applicable mortality 
table under section 417(e)(3). Participant E is the only participant in 
the plan, and is a male age 46 as of January 1, 2009, with an annual 
accrued benefit of $23,000 payable beginning at age 65. The actuary 
assumes a 100% probability that Participant E will terminate at age 50 
and will elect to receive his benefit in the form of a single-sum 
payment.

[[Page 1233]]

    (ii) Plan P's funding target is $68,908 as of January 1, 2009. This 
figure is based on the male nonannuitant rates for ages prior to age 50, 
the applicable mortality rates under section 417(e)(3) for ages 50 and 
later, and segment interest rates of 5.07% for the first 5 years after 
the valuation date, 6.09% for the next 15 years, and 6.56% for periods 
more than 20 years after the valuation date. (See Sec. 1.430(d)-
1(f)(9), Example 10, for additional details.)
    (iii) The present value of Participant E's benefits as of January 1, 
2009, is $68,908 if a single interest rate of 6.52805% is substituted 
for the segment interest rates but all other assumptions remain the 
same. Thus (rounded), the effective interest rate for Plan P is 6.53% 
for 2009.
    Example 2. (i) The facts are the same as for Example 1, except that 
Plan P offers a single-sum distribution equal to the present value of 
the accrued benefit based on the applicable interest rates under section 
417(e)(3) or an interest rate of 6.25%, whichever produces the higher 
amount. The applicable mortality table under section 417(e)(3) is used 
for both calculations.
    (ii) The present value of Participant E's age-50 single-sum 
distribution as of January 1, 2009 (when Participant E is age 46) is 
$77,392. This amount is determined by calculating the projected single-
sum distribution at age 50 using the applicable mortality table under 
section 417(e)(3) and an interest rate of 6.25%, and discounting the 
result to January 1, 2009, using the first segment rate of 5.07% and 
male nonannuitant mortality rates for 2009. Because this amount is 
larger than the present value of Participant E's single-sum payment 
based on the applicable interest rates under section 417(e)(3) (that is, 
$68,908), the funding target for Plan P is $77,392 as of January 1, 
2009. (See Sec. 1.430(d)-1(f)(9), Example 12 for additional details.)
    (iii) The effective interest rate is the single interest rate that 
will produce the same funding target if substituted for the segment 
interest rates keeping all other assumptions the same, including the 
fixed interest rate used by the plan to determine single-sum payments. 
The only segment interest rate used to develop the funding target of 
$77,392 was the first segment rate of 5.07%. Therefore, considering only 
this calculation, the single interest rate that would produce the same 
funding target would be 5.07%.
    (iv) However, the effective interest rate must also reflect the fact 
that the single-sum payment under Plan P is equal to the greater of the 
present value of Participant E's accrued benefit based on the fixed rate 
of 6.25% or the applicable interest rates under section 417(e)(3). If 
the single rate of 5.07% is substituted for the segment rates used to 
calculate the present value of the single-sum payment based on the 
applicable interest rates, the resulting funding target would be higher 
than $77,392.
    (v) Using a single interest rate of 6.0771%, the January 1, 2009, 
present value of Participant E's single-sum payment based on the 
applicable interest rates is $77,392, and the present value of 
Participant E's single sum payment based on the plan's interest rate of 
6.25% is $74,494. Plan P's funding target is the larger of the two, or 
$77,392, which is the same as the funding target based on the segment 
interest rates used for the 2009 valuation. Therefore, Plan P's 
effective interest rate for 2009 (rounded) is 6.08%.

    (h) Effective/applicability dates and transition rules--(1) 
Statutory effective date/applicability date. Section 430 generally 
applies to plan years beginning on or after January 1, 2008. The 
applicability of section 430 for purposes of determining the minimum 
required contribution is delayed for certain plans in accordance with 
sections 104 through 106 of PPA'06.
    (2) Effective date/applicability date of regulations. This section 
applies to plan years beginning on or after January 1, 2010, regardless 
of whether section 430 applies to determine the minimum required 
contribution for the plan year. For plan years beginning before January 
1, 2010, plans are permitted to rely on the provisions set forth in this 
section for purposes of satisfying the requirements of section 430.
    (3) Approval for changes in interest rate. Any change to an election 
under paragraph (e) of this section that is made for the first plan year 
beginning in 2009 or the first plan year beginning in 2010 is treated as 
having been approved by the Commissioner and does not require the 
Commissioner's specific prior approval.
    (4) Transition rule--(i) In general. Notwithstanding the general 
rules for determination of segment rates under paragraph (c)(2) of this 
section, for plan years beginning in 2008 or 2009, the first, second, or 
third segment rate for a plan with respect to any month is equal to the 
sum of--
    (A) The product of that rate for that month determined without 
regard to this paragraph (h)(4), multiplied by the applicable 
percentage; and
    (B) The product of the weighted average interest rate determined 
under the rules of paragraph (h)(4)(iii) of this section, multiplied by 
a percentage equal

[[Page 1234]]

to 100 percent minus the applicable percentage.
    (ii) Applicable percentage. For purposes of this paragraph (h)(4), 
the applicable percentage is 33\1/3\ percent for plan years beginning in 
2008 and 66\2/3\ percent for plan years beginning in 2009.
    (iii) Weighted average interest rate. The weighted average interest 
rate for purposes of paragraph (h)(4)(i)(B) of this section is the 
weighted average interest rate under section 412(b)(5)(B)(ii)(II) (as 
that provision was in effect for plan years beginning in 2007) as of--
    (A) The month which contains the first day of the plan year;
    (B) The month which contains the valuation date (if the applicable 
month is determined under paragraph (b)(5) of this section); or
    (C) The applicable month (if the applicable month is determined 
under paragraph (e)(2) of this section).
    (iv) New plans ineligible. The transition rule of this paragraph 
(h)(4) does not apply if the first plan year of the plan begins on or 
after January 1, 2008.

[T.D. 9467, 74 FR 53055, Oct. 15, 2009]



Sec. 1.430(h)(3)-1  Mortality tables used to determine present value.

    (a) Basis for mortality tables--(1) In general. This section sets 
forth rules for the mortality tables to be used in determining present 
value or making any computation under section 430. Generally applicable 
mortality tables for participants and beneficiaries are set forth in 
this section pursuant to section 430(h)(3)(A). In lieu of using the 
mortality tables provided under this section with respect to 
participants and beneficiaries, plan-specific substitute mortality 
tables are permitted to be used for this purpose pursuant to section 
430(h)(3)(C) provided that the requirements of Sec. 1.430(h)(3)-2 are 
satisfied. Mortality tables that may be used with respect to disabled 
individuals are to be provided in guidance published in the Internal 
Revenue Bulletin. See Sec. 601.601(d)(2)(ii)(b) of this chapter.
    (2) Static tables or generational tables permitted. The generally 
applicable mortality tables provided under section 430(h)(3)(A) are the 
static tables described in paragraph (a)(3) of this section and the 
generational mortality tables described in paragraph (a)(4) of this 
section. A plan is permitted to use either of those sets of mortality 
tables with respect to participants and beneficiaries pursuant to this 
section.
    (3) Static tables. The static mortality tables that are permitted to 
be used pursuant to paragraph (a)(2) of this section are updated 
annually to reflect expected improvements in mortality experience as 
described in paragraph (c)(2) of this section. Static mortality tables 
that are to be used with respect to valuation dates occurring during 
2008 are provided in paragraph (e) of this section. The mortality tables 
to be used with respect to valuation dates occurring in later years are 
to be provided in guidance published in the Internal Revenue Bulletin. 
See Sec. 601.601(d)(2)(ii)(b) of this chapter.
    (4) Generational mortality tables--(i) In general. The generational 
mortality tables that are permitted to be used pursuant to paragraph 
(a)(2) of this section are determined pursuant to this paragraph (a)(4) 
using the base mortality tables and projection factors set forth in 
paragraph (d) of this section. Under the generational mortality tables, 
the probability of an individual's death at a particular age is 
determined as the individual's base mortality rate (that is, the 
applicable mortality rate from the table set forth in paragraph (d) of 
this section for the age for which the probability of death is being 
determined) multiplied by the mortality improvement factor. The 
mortality improvement factor is equal to (1-projection factor for that 
age)\n\, where n is equal to the projection period. For this purpose, 
the projection period is the number of years between 2000 and the year 
for which the probability of death is being determined.
    (ii) Examples of calculation. As an example of the use of 
generational mortality tables under paragraph (a)(4)(i) of this section, 
for purposes of determining the probability of death at age 54 for a 
male annuitant born in 1974, the base mortality rate is .005797, the 
projection factor is .020, and the projection period (the period from 
the year 2000 until the year the participant will attain age 54) is 28 
years, so that the mortality improvement factor is

[[Page 1235]]

.567976, and the probability of death at age 54 is .003293. Similarly, 
under these generational mortality tables, the probability of death at 
age 55 for the same male annuitant would be determined by using the base 
mortality rate and projection factor at age 55, and a projection period 
of 29 years (the period from the year 2000 until the year the 
participant will attain age 55). Thus, the base mortality rate is 
.005905, the projection factor is .019, so that the mortality 
improvement factor is .573325 ((1-.019)\29\), and the probability of 
death at age 55 is .003385 (.573325 times .005905). Because these 
generational mortality tables reflect expected improvements in mortality 
experience, no periodic updates are needed.
    (b) Use of the tables--(1) Separate tables for annuitants and 
nonannuitants--(i) In general. Separate tables are provided for use for 
annuitants and nonannuitants. The nonannuitant mortality table is 
applied to determine the probability of survival for a nonannuitant for 
the period before the nonannuitant is projected to commence receiving 
benefits. The annuitant mortality table is applied to determine the 
present value of benefits for each annuitant, and for each nonannuitant 
for the period beginning when the nonannuitant is projected to commence 
receiving benefits. For purposes of this section, an annuitant means a 
plan participant who has commenced receiving benefits and a nonannuitant 
means a plan participant who has not yet commenced receiving benefits 
(for example, an active employee or a terminated vested participant). A 
participant whose benefit has partially commenced is treated as an 
annuitant with respect to the portion of the benefit which has commenced 
and a nonannuitant with respect to the balance of the benefit. In 
addition, for any period in which an annuitant is projected to be 
receiving benefits, any beneficiary with respect to that annuitant is 
also treated as an annuitant for purposes of this paragraph (b)(1).
    (ii) Examples of calculation. As an example of the use of separate 
annuitant and nonannuitant tables under paragraph (b)(1)(i) of this 
section, with respect to a 45-year-old active participant who is 
projected to commence receiving an annuity at age 55, the funding target 
would be determined using the nonannuitant mortality table for the 
period before the participant attains age 55 (so that, if the static 
mortality tables are used pursuant to paragraph (a)(3) of this section, 
the probability of an active male participant living from age 45 to age 
55 using the table that applies for a plan year beginning in 2008 is 
98.61%) and the annuitant mortality table for the period ages 55 and 
above. Similarly, if a 45-year-old terminated vested participant is 
projected to commence an annuity at age 65, the funding target would be 
determined using the nonannuitant mortality table for the period before 
the participant attains age 65 and the annuitant mortality table for 
ages 65 and above.
    (2) Small plan tables. If static mortality tables are used pursuant 
to paragraph (a)(3) of this section, as an alternative to the separate 
static tables specified for annuitants and nonannuitants pursuant to 
paragraph (b)(1) of this section, a combined static table that applies 
the same mortality rates to both annuitants and nonannuitants is 
permitted to be used for a small plan. For this purpose, a small plan is 
defined as a plan with 500 or fewer participants (including both active 
and inactive participants) on the valuation date.
    (c) Construction of static tables--(1) Source of basic rates. The 
static mortality tables that are used pursuant to paragraph (a)(3) of 
this section are based on the base mortality tables set forth in 
paragraph (d) of this section.
    (2) Projected mortality improvements. The mortality rates under the 
base mortality tables are projected to improve using the projection 
factors provided in Projection Scale AA, as set forth in paragraph (d) 
of this section. Using these projection factors, the mortality rate for 
an individual at each age is determined as the individual's base 
mortality rate (that is, the applicable base mortality rate from the 
table set forth in paragraph (d) of this section for the individual at 
that age) multiplied by the mortality improvement factor. The mortality 
improvement factor is equal to (1-projection factor for that age)\n\, 
where n is equal

[[Page 1236]]

to the projection period. The annuitant mortality rates for a plan year 
are determined using a projection period that runs from the calendar 
year 2000 until 7 years after the calendar year that contains the 
valuation date for the plan year. The nonannuitant mortality rates for a 
plan year are determined using a projection period that runs from the 
calendar year 2000 until 15 years after the calendar year that contains 
the valuation date for the plan year. Thus, for example, for a plan year 
with a January 1, 2012, valuation date, the annuitant mortality rates 
are determined using a projection period that runs from 2000 until 2019 
(19 years) and the nonannuitant mortality rates are determined using a 
projection period that runs from 2000 until 2027 (27 years).
    (3) Construction of combined tables for small plans. The combined 
mortality tables that are permitted to be used for small plans pursuant 
to paragraph (b)(2) of this section are constructed from the separate 
nonannuitant and annuitant tables using the weighting factors for small 
plans that are set forth in paragraph (d) of this section. The weighting 
factors are applied to develop these mortality tables using the 
following equation: Combined mortality rate = [nonannuitant rate \*\ (1-
weighting factor)] + [annuitant rate \*\ weighting factor].
    (d) Base mortality tables and projection factors. The following base 
mortality tables and projection factors are used to determine 
generational mortality tables for purposes of determining present value 
or making any computation under section 430 as set forth in paragraph 
(a)(4) of this section. In addition, the following base mortality tables 
and projection factors are used to determine the static mortality tables 
that are used for purposes of determining present value or making any 
computation under section 430 as set forth in paragraphs (a)(3) and (c) 
of this section. See Sec. 1.430(h)(3)-2(c)(3) for rules regarding the 
required use of the projection factors set forth in this paragraph (d) 
in connection with a plan-specific substitute mortality table.

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                      Male         Male         Male         Male        Female       Female       Female       Female
                                                 -------------------------------------------------------------------------------------------------------
                                                   Base non-       Base                                Base non-       Base
                       Age                         annuitant    annuitant     Scale AA    Weighting    annuitant    annuitant     Scale AA    Weighting
                                                   mortality    mortality    projection  factors for   mortality    mortality    projection  factors for
                                                  rates (year  rates (year    factors    small plans  rates (year  rates (year    factors    small plans
                                                     2000)        2000)                                  2000)        2000)
--------------------------------------------------------------------------------------------------------------------------------------------------------
1...............................................     0.000637     0.000637        0.020     0.000571     0.000571        0.020
2...............................................     0.000430     0.000430        0.020     0.000372     0.000372        0.020
3...............................................     0.000357     0.000357        0.020     0.000278     0.000278        0.020
4...............................................     0.000278     0.000278        0.020     0.000208     0.000208        0.020
5...............................................     0.000255     0.000255        0.020     0.000188     0.000188        0.020
6...............................................     0.000244     0.000244        0.020     0.000176     0.000176        0.020
7...............................................     0.000234     0.000234        0.020     0.000165     0.000165        0.020
8...............................................     0.000216     0.000216        0.020     0.000147     0.000147        0.020
9...............................................     0.000209     0.000209        0.020     0.000140     0.000140        0.020
10..............................................     0.000212     0.000212        0.020     0.000141     0.000141        0.020
11..............................................     0.000219     0.000219        0.020     0.000143     0.000143        0.020
12..............................................     0.000228     0.000228        0.020     0.000148     0.000148        0.020
13..............................................     0.000240     0.000240        0.020     0.000155     0.000155        0.020
14..............................................     0.000254     0.000254        0.019     0.000162     0.000162        0.018
15..............................................     0.000269     0.000269        0.019     0.000170     0.000170        0.016
16..............................................     0.000284     0.000284        0.019     0.000177     0.000177        0.015
17..............................................     0.000301     0.000301        0.019     0.000184     0.000184        0.014
18..............................................     0.000316     0.000316        0.019     0.000188     0.000188        0.014
19..............................................     0.000331     0.000331        0.019     0.000190     0.000190        0.015
20..............................................     0.000345     0.000345        0.019     0.000191     0.000191        0.016
21..............................................     0.000357     0.000357        0.018     0.000192     0.000192        0.017
22..............................................     0.000366     0.000366        0.017     0.000194     0.000194        0.017
23..............................................     0.000373     0.000373        0.015     0.000197     0.000197        0.016
24..............................................     0.000376     0.000376        0.013     0.000201     0.000201        0.015
25..............................................     0.000376     0.000376        0.010     0.000207     0.000207        0.014
26..............................................     0.000378     0.000378        0.006     0.000214     0.000214        0.012
27..............................................     0.000382     0.000382        0.005     0.000223     0.000223        0.012
28..............................................     0.000393     0.000393        0.005     0.000235     0.000235        0.012
29..............................................     0.000412     0.000412        0.005     0.000248     0.000248        0.012
30..............................................     0.000444     0.000444        0.005     0.000264     0.000264        0.010
31..............................................     0.000499     0.000499        0.005     0.000307     0.000307        0.008
32..............................................     0.000562     0.000562        0.005     0.000350     0.000350        0.008

[[Page 1237]]

 
33..............................................     0.000631     0.000631        0.005     0.000394     0.000394        0.009
34..............................................     0.000702     0.000702        0.005     0.000435     0.000435        0.010
35..............................................     0.000773     0.000773        0.005     0.000475     0.000475        0.011
36..............................................     0.000841     0.000841        0.005     0.000514     0.000514        0.012
37..............................................     0.000904     0.000904        0.005     0.000554     0.000554        0.013
38..............................................     0.000964     0.000964        0.006     0.000598     0.000598        0.014
39..............................................     0.001021     0.001021        0.007     0.000648     0.000648        0.015
40..............................................     0.001079     0.001079        0.008     0.000706     0.000706        0.015
41..............................................     0.001142     0.001157        0.009       0.0045     0.000774     0.000774        0.015
42..............................................     0.001215     0.001312        0.010       0.0091     0.000852     0.000852        0.015
43..............................................     0.001299     0.001545        0.011       0.0136     0.000937     0.000937        0.015
44..............................................     0.001397     0.001855        0.012       0.0181     0.001029     0.001029        0.015
45..............................................     0.001508     0.002243        0.013       0.0226     0.001124     0.001124        0.016       0.0084
46..............................................     0.001616     0.002709        0.014       0.0272     0.001223     0.001223        0.017       0.0167
47..............................................     0.001734     0.003252        0.015       0.0317     0.001326     0.001335        0.018       0.0251
48..............................................     0.001860     0.003873        0.016       0.0362     0.001434     0.001559        0.018       0.0335
49..............................................     0.001995     0.004571        0.017       0.0407     0.001550     0.001896        0.018       0.0419
50..............................................     0.002138     0.005347        0.018       0.0453     0.001676     0.002344        0.017       0.0502
51..............................................     0.002288     0.005528        0.019       0.0498     0.001814     0.002459        0.016       0.0586
52..............................................     0.002448     0.005644        0.020       0.0686     0.001967     0.002647        0.014       0.0744
53..............................................     0.002621     0.005722        0.020       0.0953     0.002135     0.002895        0.012       0.0947
54..............................................     0.002812     0.005797        0.020       0.1288     0.002321     0.003190        0.010       0.1189
55..............................................     0.003029     0.005905        0.019       0.2066     0.002526     0.003531        0.008       0.1897
56..............................................     0.003306     0.006124        0.018       0.3173     0.002756     0.003925        0.006       0.2857
57..............................................     0.003628     0.006444        0.017       0.3780     0.003010     0.004385        0.005       0.3403
58..............................................     0.003997     0.006895        0.016       0.4401     0.003291     0.004921        0.005       0.3878
59..............................................     0.004414     0.007485        0.016       0.4986     0.003599     0.005531        0.005       0.4360
60..............................................     0.004878     0.008196        0.016       0.5633     0.003931     0.006200        0.005       0.4954
61..............................................     0.005382     0.009001        0.015       0.6338     0.004285     0.006919        0.005       0.5805
62..............................................     0.005918     0.009915        0.015       0.7103     0.004656     0.007689        0.005       0.6598
63..............................................     0.006472     0.010951        0.014       0.7902     0.005039     0.008509        0.005       0.7520
64..............................................     0.007028     0.012117        0.014       0.8355     0.005429     0.009395        0.005       0.8043
65..............................................     0.007573     0.013419        0.014       0.8832     0.005821     0.010364        0.005       0.8552
66..............................................     0.008099     0.014868        0.013       0.9321     0.006207     0.011413        0.005       0.9118
67..............................................     0.008598     0.016460        0.013       0.9510     0.006583     0.012540        0.005       0.9367
68..............................................     0.009069     0.018200        0.014       0.9639     0.006945     0.013771        0.005       0.9523
69..............................................     0.009510     0.020105        0.014       0.9714     0.007289     0.015153        0.005       0.9627
70..............................................     0.009922     0.022206        0.015       0.9740     0.007613     0.016742        0.005       0.9661
71..............................................     0.010912     0.024570        0.015       0.9766     0.008309     0.018579        0.006       0.9695
72..............................................     0.012892     0.027281        0.015       0.9792     0.009700     0.020665        0.006       0.9729
73..............................................     0.015862     0.030387        0.015       0.9818     0.011787     0.022970        0.007       0.9763
74..............................................     0.019821     0.033900        0.015       0.9844     0.014570     0.025458        0.007       0.9797
75..............................................     0.024771     0.037834        0.014       0.9870     0.018049     0.028106        0.008       0.9830
76..............................................     0.030710     0.042169        0.014       0.9896     0.022224     0.030966        0.008       0.9864
77..............................................     0.037640     0.046906        0.013       0.9922     0.027094     0.034105        0.007       0.9898
78..............................................     0.045559     0.052123        0.012       0.9948     0.032660     0.037595        0.007       0.9932
79..............................................     0.054469     0.057927        0.011       0.9974     0.038922     0.041506        0.007       0.9966
80..............................................     0.064368     0.064368        0.010       1.0000     0.045879     0.045879        0.007       1.0000
81..............................................     0.072041     0.072041        0.009       1.0000     0.050780     0.050780        0.007       1.0000
82..............................................     0.080486     0.080486        0.008       1.0000     0.056294     0.056294        0.007       1.0000
83..............................................     0.089718     0.089718        0.008       1.0000     0.062506     0.062506        0.007       1.0000
84..............................................     0.099779     0.099779        0.007       1.0000     0.069517     0.069517        0.007       1.0000
85..............................................     0.110757     0.110757        0.007       1.0000     0.077446     0.077446        0.006       1.0000
86..............................................     0.122797     0.122797        0.007       1.0000     0.086376     0.086376        0.005       1.0000
87..............................................     0.136043     0.136043        0.006       1.0000     0.096337     0.096337        0.004       1.0000
88..............................................     0.150590     0.150590        0.005       1.0000     0.107303     0.107303        0.004       1.0000
89..............................................     0.166420     0.166420        0.005       1.0000     0.119154     0.119154        0.003       1.0000
90..............................................     0.183408     0.183408        0.004       1.0000     0.131682     0.131682        0.003       1.0000
91..............................................     0.199769     0.199769        0.004       1.0000     0.144604     0.144604        0.003       1.0000
92..............................................     0.216605     0.216605        0.003       1.0000     0.157618     0.157618        0.003       1.0000
93..............................................     0.233662     0.233662        0.003       1.0000     0.170433     0.170433        0.002       1.0000
94..............................................     0.250693     0.250693        0.003       1.0000     0.182799     0.182799        0.002       1.0000
95..............................................     0.267491     0.267491        0.002       1.0000     0.194509     0.194509        0.002       1.0000
96..............................................     0.283905     0.283905        0.002       1.0000     0.205379     0.205379        0.002       1.0000
97..............................................     0.299852     0.299852        0.002       1.0000     0.215240     0.215240        0.001       1.0000
98..............................................     0.315296     0.315296        0.001       1.0000     0.223947     0.223947        0.001       1.0000
99..............................................     0.330207     0.330207        0.001       1.0000     0.231387     0.231387        0.001       1.0000
100.............................................     0.344556     0.344556        0.001       1.0000     0.237467     0.237467        0.001       1.0000
101.............................................     0.358628     0.358628        0.000       1.0000     0.244834     0.244834        0.000       1.0000

[[Page 1238]]

 
102.............................................     0.371685     0.371685        0.000       1.0000     0.254498     0.254498        0.000       1.0000
103.............................................     0.383040     0.383040        0.000       1.0000     0.266044     0.266044        0.000       1.0000
104.............................................     0.392003     0.392003        0.000       1.0000     0.279055     0.279055        0.000       1.0000
105.............................................     0.397886     0.397886        0.000       1.0000     0.293116     0.293116        0.000       1.0000
106.............................................     0.400000     0.400000        0.000       1.0000     0.307811     0.307811        0.000       1.0000
107.............................................     0.400000     0.400000        0.000       1.0000     0.322725     0.322725        0.000       1.0000
108.............................................     0.400000     0.400000        0.000       1.0000     0.337441     0.337441        0.000       1.0000
109.............................................     0.400000     0.400000        0.000       1.0000     0.351544     0.351544        0.000       1.0000
110.............................................     0.400000     0.400000        0.000       1.0000     0.364617     0.364617        0.000       1.0000
111.............................................     0.400000     0.400000        0.000       1.0000     0.376246     0.376246        0.000       1.0000
112.............................................     0.400000     0.400000        0.000       1.0000     0.386015     0.386015        0.000       1.0000
113.............................................     0.400000     0.400000        0.000       1.0000     0.393507     0.393507        0.000       1.0000
114.............................................     0.400000     0.400000        0.000       1.0000     0.398308     0.398308        0.000       1.0000
115.............................................     0.400000     0.400000        0.000       1.0000     0.400000     0.400000        0.000       1.0000
116.............................................     0.400000     0.400000        0.000       1.0000     0.400000     0.400000        0.000       1.0000
117.............................................     0.400000     0.400000        0.000       1.0000     0.400000     0.400000        0.000       1.0000
118.............................................     0.400000     0.400000        0.000       1.0000     0.400000     0.400000        0.000       1.0000
119.............................................     0.400000     0.400000        0.000       1.0000     0.400000     0.400000        0.000       1.0000
120.............................................     1.000000     1.000000        0.000       1.0000     1.000000     1.000000        0.000       1.0000
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (e) Static mortality tables with respect to valuation dates 
occurring during 2008. The following static mortality tables are used 
pursuant to paragraph (a)(3) of this section for determining present 
value or making any computation under section 430 with respect to 
valuation dates occurring during 2008.

----------------------------------------------------------------------------------------------------------------
                                        Male         Male         Male        Female       Female       Female
                                   -----------------------------------------------------------------------------
                                        Non-                    Optional       Non-                    Optional
                Age                  annuitant    Annuitant     combined    annuitant    Annuitant     combined
                                     mortality    mortality    table for    mortality    mortality    table for
                                       rates        rates     small plans     rates        rates     small plans
----------------------------------------------------------------------------------------------------------------
1.................................     0.000400     0.000400     0.000400     0.000359     0.000359     0.000359
2.................................     0.000270     0.000270     0.000270     0.000234     0.000234     0.000234
3.................................     0.000224     0.000224     0.000224     0.000175     0.000175     0.000175
4.................................     0.000175     0.000175     0.000175     0.000131     0.000131     0.000131
5.................................     0.000160     0.000160     0.000160     0.000118     0.000118     0.000118
6.................................     0.000153     0.000153     0.000153     0.000111     0.000111     0.000111
7.................................     0.000147     0.000147     0.000147     0.000104     0.000104     0.000104
8.................................     0.000136     0.000136     0.000136     0.000092     0.000092     0.000092
9.................................     0.000131     0.000131     0.000131     0.000088     0.000088     0.000088
10................................     0.000133     0.000133     0.000133     0.000089     0.000089     0.000089
11................................     0.000138     0.000138     0.000138     0.000090     0.000090     0.000090
12................................     0.000143     0.000143     0.000143     0.000093     0.000093     0.000093
13................................     0.000151     0.000151     0.000151     0.000097     0.000097     0.000097
14................................     0.000163     0.000163     0.000163     0.000107     0.000107     0.000107
15................................     0.000173     0.000173     0.000173     0.000117     0.000117     0.000117
16................................     0.000183     0.000183     0.000183     0.000125     0.000125     0.000125
17................................     0.000194     0.000194     0.000194     0.000133     0.000133     0.000133
18................................     0.000203     0.000203     0.000203     0.000136     0.000136     0.000136
19................................     0.000213     0.000213     0.000213     0.000134     0.000134     0.000134
20................................     0.000222     0.000222     0.000222     0.000132     0.000132     0.000132
21................................     0.000235     0.000235     0.000235     0.000129     0.000129     0.000129
22................................     0.000247     0.000247     0.000247     0.000131     0.000131     0.000131
23................................     0.000263     0.000263     0.000263     0.000136     0.000136     0.000136
24................................     0.000278     0.000278     0.000278     0.000142     0.000142     0.000142
25................................     0.000298     0.000298     0.000298     0.000150     0.000150     0.000150
26................................     0.000329     0.000329     0.000329     0.000162     0.000162     0.000162
27................................     0.000340     0.000340     0.000340     0.000169     0.000169     0.000169
28................................     0.000350     0.000350     0.000350     0.000178     0.000178     0.000178
29................................     0.000367     0.000367     0.000367     0.000188     0.000188     0.000188
30................................     0.000396     0.000396     0.000396     0.000210     0.000210     0.000210
31................................     0.000445     0.000445     0.000445     0.000255     0.000255     0.000255
32................................     0.000501     0.000501     0.000501     0.000291     0.000291     0.000291
33................................     0.000562     0.000562     0.000562     0.000320     0.000320     0.000320
34................................     0.000626     0.000626     0.000626     0.000345     0.000345     0.000345
35................................     0.000689     0.000689     0.000689     0.000368     0.000368     0.000368

[[Page 1239]]

 
36................................     0.000749     0.000749     0.000749     0.000389     0.000389     0.000389
37................................     0.000806     0.000806     0.000806     0.000410     0.000410     0.000410
38................................     0.000839     0.000839     0.000839     0.000432     0.000432     0.000432
39................................     0.000869     0.000869     0.000869     0.000458     0.000458     0.000458
40................................     0.000897     0.000897     0.000897     0.000499     0.000499     0.000499
41................................     0.000928     0.000955     0.000928     0.000547     0.000547     0.000547
42................................     0.000964     0.001070     0.000965     0.000602     0.000602     0.000602
43................................     0.001007     0.001243     0.001010     0.000662     0.000662     0.000662
44................................     0.001058     0.001474     0.001066     0.000727     0.000727     0.000727
45................................     0.001116     0.001763     0.001131     0.000776     0.000779     0.000776
46................................     0.001168     0.002109     0.001194     0.000824     0.000882     0.000825
47................................     0.001225     0.002513     0.001266     0.000873     0.001037     0.000877
48................................     0.001284     0.002975     0.001345     0.000944     0.001244     0.000954
49................................     0.001345     0.003495     0.001433     0.001021     0.001502     0.001041
50................................     0.001408     0.004072     0.001529     0.001130     0.001812     0.001164
51................................     0.001472     0.004146     0.001605     0.001252     0.001931     0.001292
52................................     0.001538     0.004168     0.001718     0.001422     0.002142     0.001476
53................................     0.001647     0.004226     0.001893     0.001617     0.002415     0.001693
54................................     0.001767     0.004281     0.002091     0.001842     0.002744     0.001949
55................................     0.001948     0.004428     0.002460     0.002100     0.003130     0.002295
56................................     0.002177     0.004663     0.002966     0.002400     0.003586     0.002739
57................................     0.002446     0.004983     0.003405     0.002682     0.004067     0.003153
58................................     0.002758     0.005413     0.003926     0.002933     0.004565     0.003566
59................................     0.003046     0.005876     0.004457     0.003207     0.005130     0.004045
60................................     0.003366     0.006435     0.005095     0.003503     0.005751     0.004617
61................................     0.003802     0.007175     0.005940     0.003818     0.006418     0.005327
62................................     0.004180     0.007904     0.006825     0.004149     0.007132     0.006117
63................................     0.004680     0.008864     0.007986     0.004490     0.007893     0.007049
64................................     0.005082     0.009807     0.009030     0.004838     0.008715     0.007956
65................................     0.005476     0.010861     0.010232     0.005187     0.009613     0.008972
66................................     0.005994     0.012218     0.011795     0.005531     0.010586     0.010140
67................................     0.006363     0.013527     0.013176     0.005866     0.011632     0.011267
68................................     0.006557     0.014731     0.014436     0.006189     0.012774     0.012460
69................................     0.006876     0.016273     0.016004     0.006495     0.014055     0.013773
70................................     0.007009     0.017702     0.017424     0.006784     0.015529     0.015233
71................................     0.007888     0.019586     0.019312     0.007411     0.016975     0.016683
72................................     0.009646     0.021747     0.021495     0.008666     0.018881     0.018604
73................................     0.012283     0.024223     0.024006     0.010548     0.020673     0.020433
74................................     0.015799     0.027024     0.026849     0.013058     0.022912     0.022712
75................................     0.020195     0.030622     0.030486     0.016195     0.024916     0.024768
76................................     0.025470     0.034131     0.034041     0.019959     0.027451     0.027349
77................................     0.031624     0.038547     0.038493     0.024351     0.030694     0.030629
78................................     0.038657     0.043489     0.043464     0.029370     0.033835     0.033805
79................................     0.046569     0.049071     0.049064     0.035017     0.037355     0.037347
80................................     0.055360     0.055360     0.055360     0.041291     0.041291     0.041291
81................................     0.062905     0.062905     0.062905     0.045702     0.045702     0.045702
82................................     0.071350     0.071350     0.071350     0.050664     0.050664     0.050664
83................................     0.079534     0.079534     0.079534     0.056255     0.056255     0.056255
84................................     0.089800     0.089800     0.089800     0.062565     0.062565     0.062565
85................................     0.099680     0.099680     0.099680     0.070761     0.070761     0.070761
86................................     0.110516     0.110516     0.110516     0.080120     0.080120     0.080120
87................................     0.124300     0.124300     0.124300     0.090716     0.090716     0.090716
88................................     0.139683     0.139683     0.139683     0.101042     0.101042     0.101042
89................................     0.154366     0.154366     0.154366     0.113903     0.113903     0.113903
90................................     0.172706     0.172706     0.172706     0.125879     0.125879     0.125879
91................................     0.188113     0.188113     0.188113     0.138232     0.138232     0.138232
92................................     0.207060     0.207060     0.207060     0.150672     0.150672     0.150672
93................................     0.223365     0.223365     0.223365     0.165391     0.165391     0.165391
94................................     0.239646     0.239646     0.239646     0.177391     0.177391     0.177391
95................................     0.259578     0.259578     0.259578     0.188755     0.188755     0.188755
96................................     0.275506     0.275506     0.275506     0.199303     0.199303     0.199303
97................................     0.290981     0.290981     0.290981     0.212034     0.212034     0.212034
98................................     0.310600     0.310600     0.310600     0.220611     0.220611     0.220611
99................................     0.325288     0.325288     0.325288     0.227940     0.227940     0.227940
100...............................     0.339424     0.339424     0.339424     0.233930     0.233930     0.233930
101...............................     0.358628     0.358628     0.358628     0.244834     0.244834     0.244834
102...............................     0.371685     0.371685     0.371685     0.254498     0.254498     0.254498
103...............................     0.383040     0.383040     0.383040     0.266044     0.266044     0.266044
104...............................     0.392003     0.392003     0.392003     0.279055     0.279055     0.279055
105...............................     0.397886     0.397886     0.397886     0.293116     0.293116     0.293116

[[Page 1240]]

 
106...............................     0.400000     0.400000     0.400000     0.307811     0.307811     0.307811
107...............................     0.400000     0.400000     0.400000     0.322725     0.322725     0.322725
108...............................     0.400000     0.400000     0.400000     0.337441     0.337441     0.337441
109...............................     0.400000     0.400000     0.400000     0.351544     0.351544     0.351544
110...............................     0.400000     0.400000     0.400000     0.364617     0.364617     0.364617
111...............................     0.400000     0.400000     0.400000     0.376246     0.376246     0.376246
112...............................     0.400000     0.400000     0.400000     0.386015     0.386015     0.386015
113...............................     0.400000     0.400000     0.400000     0.393507     0.393507     0.393507
114...............................     0.400000     0.400000     0.400000     0.398308     0.398308     0.398308
115...............................     0.400000     0.400000     0.400000     0.400000     0.400000     0.400000
116...............................     0.400000     0.400000     0.400000     0.400000     0.400000     0.400000
117...............................     0.400000     0.400000     0.400000     0.400000     0.400000     0.400000
118...............................     0.400000     0.400000     0.400000     0.400000     0.400000     0.400000
119...............................     0.400000     0.400000     0.400000     0.400000     0.400000     0.400000
120...............................     1.000000     1.000000     1.000000     1.000000     1.000000     1.000000
----------------------------------------------------------------------------------------------------------------

    (f) Effective/Applicability date. This section applies for plan 
years beginning on or after January 1, 2008.

[T.D. 9419, 73 FR 44639, July 31, 2008]



Sec. 1.430(h)(3)-2  Plan-specific substitute mortality tables used to 
determine present value.

    (a) In general. This section sets forth rules for the use of 
substitute mortality tables under section 430(h)(3)(C) in determining 
any present value or making any computation under section 430 in 
accordance with Sec. 1.430(h)(3)-1(a)(1). In order to use substitute 
mortality tables, a plan sponsor must obtain approval to use substitute 
mortality tables for the plan in accordance with the procedures set 
forth in paragraph (b) of this section. Paragraph (c) of this section 
sets forth rules for the development of substitute mortality tables, 
including guidelines for determining whether a plan has sufficient 
credible mortality experience to use substitute mortality tables. 
Paragraph (d) of this section sets forth special rules regarding the use 
of substitute mortality tables. The Commissioner may, in revenue rulings 
and procedures, notices or other guidance published in the Internal 
Revenue Bulletin (see Sec. 601.601(d)(2)(ii)(b) of this chapter), 
provide additional guidance regarding approval and use of substitute 
mortality tables under section 430(h)(3)(C) and related matters.
    (b) Procedures for obtaining approval to use substitute mortality 
tables--(1) Written request to use substitute mortality tables--(i) 
General requirements. In order to use substitute mortality tables, a 
plan sponsor must submit a written request to the Commissioner that 
demonstrates that those substitute mortality tables meet the 
requirements of section 430(h)(3)(C) and this section. This request must 
state the first plan year and the term of years (not more than 10) that 
the tables are requested to be used.
    (ii) Time for written request--(A) In general. Except as provided in 
this paragraph (b)(1)(ii), substitute mortality tables cannot be used 
for a plan year unless the plan sponsor submits the written request 
described in paragraph (b)(1)(i) of this section at least 7 months prior 
to the first day of the first plan year for which the substitute 
mortality tables are to apply.
    (B) Special rule for requests submitted on or before October 1, 
2007. Notwithstanding the rule of paragraph (b)(1)(ii)(A) of this 
section, the timing of the written request described in paragraph 
(b)(1)(i) of this section does not prevent a plan from using substitute 
mortality tables for a plan year provided that the written request is 
submitted no later than October 1, 2007.
    (C) Special rule for requests submitted on or before October 1, 
2008, with respect to plan years beginning during 2009. Notwithstanding 
the rule of paragraph (b)(1)(ii)(A) of this section, the timing of the 
written request described in paragraph (b)(1)(i) of this section does 
not prevent a plan from using substitute mortality tables for a plan 
year

[[Page 1241]]

that begins during 2009 provided that the written request is submitted 
no later than October 1, 2008.
    (2) Commissioner's review of request--(i) In general. During the 
180-day period that begins on the date the plan sponsor submits a 
request to use substitute mortality tables for a plan pursuant to this 
section, the Commissioner will determine whether the request to use 
substitute mortality tables satisfies the requirements of this section 
(including any published guidance issued pursuant to paragraph (a) of 
this section), and will either approve or deny the request. The 
Commissioner will deny a request if the request fails to meet the 
requirements of this section or if the Commissioner determines that a 
substitute mortality table does not sufficiently reflect the mortality 
experience of the applicable plan population.
    (ii) Request for additional information. The Commissioner may 
request additional information with respect to the submission. Failure 
to provide that information on a timely basis constitutes grounds for 
denial of the request.
    (iii) Deemed approval. Except as provided in paragraph (b)(2)(iv) of 
this section, if the Commissioner does not issue a denial within the 
180-day review period, the request is deemed to have been approved.
    (iv) Extension of time permitted. The Commissioner and a plan 
sponsor may, before the expiration of the 180-day review period, agree 
in writing to extend that period, provided that any such agreement also 
specifies any revisions in the plan sponsor's request, including any 
change in the requested term of use of the substitute mortality tables.
    (c) Development of substitute mortality tables--(1) Mortality 
experience requirements--(i) In general. Substitute mortality tables 
must reflect the actual mortality experience of the pension plan for 
which the tables are to be used and that mortality experience must be 
credible mortality experience as described in paragraph (c)(1)(ii) of 
this section. Separate mortality tables must be established for each 
gender under the plan, and a substitute mortality table is permitted to 
be established for a gender only if the plan has credible mortality 
experience with respect to that gender.
    (ii) Credible mortality experience. There is credible mortality 
experience for a gender within a plan if and only if, over the period 
covered by the experience study described in paragraph (c)(2)(ii) of 
this section, there are at least 1,000 deaths within that gender.
    (iii) Gender without credible mortality experience--(A) In general. 
If, for the first year for which a plan uses substitute mortality 
tables, one gender has credible mortality experience but the other 
gender does not have credible mortality experience, the substitute 
mortality tables are used for the gender that does have credible 
mortality experience and the mortality tables under Sec. 1.430(h)(3)-1 
are used for the gender that does not have credible mortality 
experience. For a subsequent plan year, the plan sponsor may continue to 
use substitute mortality tables for the gender with credible mortality 
experience without using substitute mortality tables for the other 
gender only if the other gender continues to lack credible mortality 
experience for that subsequent plan year.
    (B) Demonstration of lack of credible mortality experience for a 
gender. In general, in order to demonstrate that a gender within a plan 
does not have credible mortality experience for a plan year, the 
demonstration that the gender population within the plan has fewer than 
1,000 deaths over a 4-year period must be made using a 4-year period 
that ends less than 3 years before the first day of that plan year. For 
example, if a plan uses substitute mortality tables based on credible 
mortality experience obtained over a 4-year experience study period for 
its male population and the standard mortality tables under Sec. 
1.430(h)(3)-1 for its female population, there must be a demonstration 
that the plan's female population does not have at least 1,000 deaths in 
a 4-year period that ends less than 3 years before the first day of that 
plan year. However, if the experience study period described in 
paragraph (c)(2)(ii)(A) of this section exceeds 4 years, then in order 
to demonstrate that a gender within a plan does not have credible 
mortality experience for a plan year, the mortality experience

[[Page 1242]]

of that population must be analyzed over a period that is the same 
length as the experience study on which the substitute mortality tables 
are based and that ends less than 3 years before the first day of that 
plan year.
    (iv) Disabled individuals. Under section 430(h)(3)(D), separate 
mortality tables are permitted to be used for certain disabled 
individuals. If such separate mortality tables are used for those 
disabled individuals, then those individuals are disregarded for all 
purposes under this section. Thus, if the mortality tables under section 
430(h)(3)(D) are used for disabled individuals under a plan, mortality 
experience with respect to those individuals must be excluded in 
developing mortality rates for substitute mortality tables under this 
section.
    (2) Base table and base year--(i) In general. Development of a 
substitute mortality table under this section requires creation of a 
base table and identification of a base year under this paragraph 
(c)(2). The base table and base year are then used to determine a 
substitute mortality table under paragraph (c)(3) of this section.
    (ii) Experience study and base table requirements--(A) In general. 
The base table for a plan population must be developed from an 
experience study of the mortality experience of that plan population 
that generates amounts-weighted mortality rates based on experience data 
for the plan that is collected over an experience study period. The 
minimum length of the experience study period is 2 years. The maximum 
length of the experience study period is 5 years, but can be extended by 
the Commissioner in revenue rulings, notices, or other guidance 
published in the Internal Revenue Bulletin (see Sec. 
601.601(d)(2)(ii)(b) of this chapter). The last day of the final year 
reflected in the experience data must be less than 3 years before the 
first day of the first plan year for which the substitute mortality 
tables are to apply. For example, if July 1, 2009, is the first day of 
the first plan year for which the substitute mortality tables will be 
used, then an experience study using calendar year data must include 
data collected for a period that ends no earlier than December 31, 2006.
    (B) Amounts-weighted mortality rates. The amounts-weighted mortality 
rate for an age is equal to the quotient determined by dividing the sum 
of the accrued benefits (or payable benefits, in the case of individuals 
in pay status) for all individuals at that age at the beginning of the 
year who died during the year, by the sum of the accrued benefits (or 
payable benefits, in the case of individuals in pay status) for all 
individuals at that age at the beginning of the year, with appropriate 
adjustments for individuals who left the relevant plan population during 
the year for reasons other than death. Because amounts-weighted 
mortality rates for a plan cannot be determined without accrued (or 
payable) benefits, the mortality experience study used to develop a base 
table cannot include periods before the plan was established.
    (C) Grouping of ages. Amounts-weighted mortality rates may be 
derived from amounts-weighted mortality rates for age groups. The 
Commissioner, in revenue rulings, notices, or other guidance published 
in the Internal Revenue Bulletin (see Sec. 601.601(d)(2)(ii)(b) of this 
chapter), may specify grouping rules (for example, 5-year age groups, 
except for extreme ages such as ages above 100 or below 20) and methods 
for developing amounts-weighted mortality rates for individual ages from 
amounts-weighted mortality rates initially determined for each age 
group.
    (D) Base table construction. The base tables must be constructed 
from the amounts-weighted mortality rates determined in paragraph 
(c)(2)(ii)(B) of this section. The base tables must be constructed 
either directly through graduation of the amounts-weighted mortality 
rates or indirectly by applying a level percentage to the applicable 
mortality table set forth in Sec. 1.430(h)(3)-1, provided that the 
adjusted table sufficiently reflects the mortality experience of the 
plan. The Commissioner also may permit the use of other recognized 
mortality tables in the construction of base tables, applying a similar 
mortality experience standard.
    (iii) Base year requirements. The base year is the calendar year 
that contains

[[Page 1243]]

the day before the midpoint of the experience study period. If the base 
table is constructed by applying a level percentage to a table set forth 
in Sec. 1.430(h)(3)-1, then the percentage must be applied to the table 
under Sec. 1.430(h)(3)-1 after it has been projected to the base year 
using Projection Scale AA, as set forth in Sec. 1.430(h)(3)-1(d). Thus, 
for example, if the base year of the mortality experience study is 2005, 
the applicable base (year 2000) mortality rates must be projected 5 
years prior to determining the level percentage to be applied to the 
applicable projected base (year 2000) mortality rates.
    (iv) Change in number of individuals covered by table. Experience 
data cannot be used to develop a base table if the number of individuals 
in the population covered by the table (for example, the male annuitant 
population) as of the last day of the plan year before the year the 
request to use substitute mortality tables is made, compared to the 
average number of individuals in that population over the years covered 
by the experience study on which the substitute mortality tables are 
based, reflects a difference of 20 percent or more, unless it is 
demonstrated to the satisfaction of the Commissioner that the experience 
data is accurately predictive of future mortality of that plan 
population (taking into account the effect of the change in individuals) 
after appropriate adjustments to the data are made (for example, 
excluding data from individuals with respect to a spun-off portion of 
the plan). For this purpose, a reasonable estimate of the number of 
individuals in the population covered by the table may be used, such as 
the estimated number of participants and beneficiaries used for purposes 
of the PBGC Form 1-ES.
    (3) Determination of substitute mortality tables--(i) In general. A 
plan's substitute mortality tables must be generational mortality 
tables. Substitute mortality tables are determined using the base 
mortality tables developed pursuant to paragraph (c)(2) of this section 
and the projection factors provided in Projection Scale AA, as set forth 
in Sec. 1.430(h)(3)-1(d). Under the generational mortality tables, the 
probability of an individual's death at a particular age is determined 
as the individual's base mortality rate (that is, the applicable 
mortality rate from the base mortality table for the age for which the 
probability of death is being determined) multiplied by the mortality 
improvement factor. The mortality improvement factor is equal to (1 - 
projection factor for that age) \n\, where n is equal to the projection 
period (the number of years between the base year for the base mortality 
table and the calendar year in which the individual attains the age for 
which the probability of death is being determined).
    (ii) Example of calculation. As an example of the use of 
generational mortality tables under paragraph (c)(3)(i) of this section, 
if approved substitute mortality tables are based on data collected 
during 2005 and 2006, the base year would be 2005 because 2005 would be 
the year that contains the day before the midpoint of the experience 
study period. If the tables show a base mortality rate of .006000 for 
male annuitants at age 54, the probability of death at age 54 for a male 
annuitant born in 1974 would be determined using the base mortality rate 
of .006000, the age-54 projection factor of .020 (pursuant to the Scale 
AA Projection Factors set forth in Sec. 1.430(h)(3)-1(d)) and a 
projection period of 23 years. The projection period is the number of 
years between the base year of 2005 and the calendar year in which the 
individual reaches age 54. Accordingly, the mortality improvement factor 
would be .628347 and the probability of death at age 54 would be 
.003770.
    (4) Separate tables for specified populations--(i) In general. 
Except as provided in this paragraph (c)(4), separate substitute 
mortality tables are permitted to be used for separate populations 
within a gender under a plan only if--
    (A) All individuals of that gender in the plan are divided into 
separate populations;
    (B) Each separate population has credible mortality experience as 
provided in paragraph (c)(4)(iii) of this section; and
    (C) The separate substitute mortality table for each separate 
population is developed using mortality experience data for that 
population.

[[Page 1244]]

    (ii) Annuitant and nonannuitant separate populations. 
Notwithstanding paragraph (c)(4)(i)(B) of this section, substitute 
mortality tables for separate populations of annuitants and 
nonannuitants within a gender may be used even if only one of those 
separate populations has credible mortality experience. Similarly, if 
separate populations that satisfy paragraph (c)(4)(i)(B) of this section 
are established, then any of those populations may be further subdivided 
into separate annuitant and nonannuitant subpopulations, provided that 
at least one of the two resulting subpopulations has credible mortality 
experience. The standard mortality tables under Sec. 1.430(h)(3)-1 are 
used for a resulting subpopulation that does not have credible mortality 
experience. For example, in the case of a plan that has credible 
mortality experience for both its male hourly and salaried individuals, 
if the male salaried annuitant population has credible mortality 
experience, the plan may use substitute mortality tables with respect to 
that population even if the standard mortality tables under Sec. 
1.430(h)(3)-1 are used for the male salaried nonannuitant population 
(because that nonannuitant population does not have credible mortality 
experience).
    (iii) Credible mortality experience for separate populations. In 
determining whether a separate population within a gender has credible 
mortality experience, the requirements of paragraph (c)(1)(ii) of this 
section must be satisfied but, in applying that paragraph (c)(1)(ii), 
the separate population should be substituted for the particular gender. 
In demonstrating that an annuitant or nonannuitant population within a 
gender or within a separate population does not have credible mortality 
experience, the requirements of paragraph (c)(1)(iii) of this section 
must be satisfied but, in applying that paragraph, the annuitant (or 
nonannuitant) population should be substituted for the particular 
gender.
    (d) Special rules--(1) All plans in controlled group must use 
substitute mortality tables--(i) In general. Except as otherwise 
provided in this paragraph (d)(1), substitute mortality tables are 
permitted to be used for a plan for a plan year only if, for that plan 
year (or any portion of that plan year), substitute mortality tables are 
also approved and used for each other pension plan subject to the 
requirements of section 430 that is maintained by the sponsor and by 
each member of the plan sponsor's controlled group. For purposes of this 
section, the term controlled group means any group treated as a single 
employer under paragraph (b), (c), (m), or (o) of section 414.
    (ii) Plans without credible experience--(A) In general. For the 
first year for which a plan uses substitute mortality tables, the use of 
substitute mortality tables for the plan is not prohibited merely 
because another plan described in paragraph (d)(1)(i) of this section 
cannot use substitute mortality tables because neither the males nor the 
females under that other plan have credible mortality experience for a 
plan year. For each subsequent plan year, the plan sponsor may continue 
to use substitute mortality tables for the plan with credible mortality 
experience without using substitute mortality tables for the other plan 
only if neither the males nor the females under that other plan have 
credible mortality experience for that subsequent plan year.
    (B) Analysis of mortality experience. For each plan year in which a 
plan uses substitute mortality tables, in order to demonstrate that the 
male and female populations of another plan maintained by the plan 
sponsor (or by a member of the plan sponsor's controlled group) do not 
have credible mortality experience, the requirements of paragraph 
(c)(1)(iii)(B) of this section must be satisfied for that plan year. 
Thus, a plan is not prohibited from using substitute mortality tables 
for a plan year merely because another plan in the controlled group of 
the plan sponsor does not have at least 1,000 male deaths and does not 
have at least 1,000 female deaths in a 4-year period (or a period that 
is the length of the experience study period if the experience study 
period under paragraph (c)(2)(ii)(A) of this section is longer than 4 
years) that ends less than 3 years before the first day of that plan 
year.
    (iii) Newly affiliated plans not using substitute mortality tables--
(A) In general. The use of substitute mortality

[[Page 1245]]

tables for a plan is not prohibited merely because a newly affiliated 
plan does not use substitute mortality tables, but only through the last 
day of the plan year of the plan using substitute mortality tables that 
contains the last day of the period described in section 
410(b)(6)(C)(ii) for either the newly affiliated plan or the plan using 
substitute mortality tables, whichever is later. Thus, for the following 
plan year, the mortality tables prescribed under Sec. 1.430(h)(3)-1 
apply with respect to the plan (and all other plans within the plan 
sponsor's controlled group, including the newly affiliated plan) 
unless--
    (1) Approval to use substitute mortality tables has been obtained 
with respect to the newly affiliated plan pursuant to paragraph (b)(1) 
of this section; or
    (2) The newly affiliated plan cannot use substitute mortality tables 
because neither the males nor the females under the plan have credible 
mortality experience as described in paragraph (c)(1)(ii) of this 
section (as determined in accordance with the rules of paragraph 
(d)(1)(iv) of this section).
    (B) Definition of newly affiliated plan. For purposes of this 
section, a plan is treated as a newly affiliated plan if it becomes 
maintained by the plan sponsor (or by a member of the plan sponsor's 
controlled group) in connection with a merger, acquisition, or similar 
transaction described in Sec. 1.410(b)-2(f). A plan also is treated as 
a newly affiliated plan for purposes of this section if the plan is 
established in connection with a transfer of assets and liabilities from 
another employer's plan in connection with a merger, acquisition, or 
similar transaction described in Sec. 1.410(b)-2(f).
    (iv) Demonstration of credible mortality experience for newly 
affiliated plan--(A) In general. In general, in the case of a newly 
affiliated plan described in paragraph (d)(1)(iii) of this section, the 
demonstration of whether credible mortality experience exists for the 
plan for a plan year may be made by either including or excluding 
mortality experience data for the period prior to the date the plan 
becomes maintained by a member of the new plan sponsor's controlled 
group. If a plan sponsor excludes mortality experience data for the 
period prior to the date the plan becomes maintained within the new plan 
sponsor's controlled group, the exclusion must apply for all populations 
within the plan.
    (B) Demonstration of credible mortality experience. Regardless of 
whether mortality experience data for the period prior to the date a 
newly affiliated plan becomes maintained within the new plan sponsor's 
controlled group is included or excluded for a plan year, the provisions 
of this section, including the demonstration of credible mortality 
experience in accordance with paragraph (c)(1)(ii) of this section, must 
be satisfied before substitute mortality tables may be used with respect 
to the plan. Thus, for example, the plan must meet the rule in paragraph 
(c)(2)(ii)(A) of this section that the base table be based on mortality 
experience data for the plan over a 2-year or longer consecutive period 
that ends less than 3 years before the first day of the plan year for 
which substitute mortality tables will be used.
    (C) Demonstration of lack of credible mortality experience. In the 
case of a newly affiliated plan described in paragraph (d)(1)(iii) of 
this section, in order to demonstrate a lack of credible mortality 
experience with respect to a gender for a plan year, the rules of 
paragraph (c)(1)(iii)(B) of this section generally will apply. However, 
a special rule applies if the plan's mortality experience demonstration 
for a plan year is made by excluding mortality experience for the period 
prior to the date the plan becomes maintained by a member of the new 
plan sponsor's controlled group. In such a case, an employer is 
permitted to demonstrate a plan's lack of credible mortality experience 
using an experience study period of less than four years, provided that 
the experience study period begins with the date the plan becomes 
maintained within the sponsor's controlled group and ends not more than 
one year and one day before the first day of the plan year with respect 
to which the lack of credible mortality experience demonstration is 
made.
    (D) Example. The following example illustrates the application of 
this paragraph (d)(1):


[[Page 1246]]


    Example. (i) Employer A is a corporation and maintains Plan M, which 
has a calendar year plan year and has obtained approval to use 
substitute mortality tables for 10 years beginning with the plan year 
that begins on January 1, 2009. Employer B is a corporation and 
maintains Plan N, which does not use substitute mortality tables and has 
a calendar year plan year. On July 1, 2010, Employer A acquires 100% of 
the stock of Employer B.
    (ii) Pursuant to paragraph (d)(1)(iii) of this section, the 
maintenance of Plan N within the controlled group that maintains Plan M 
does not impair the use of substitute mortality tables by Plan M through 
the end of the plan year that ends on December 31, 2011.
    (iii) Pursuant to paragraph (d)(1)(iii) of this section, beginning 
with the plan year that begins on January 1, 2012, Plan M continues to 
use substitute mortality tables only if either Plan N obtains approval 
to use substitute mortality tables or Employer A can demonstrate that 
Plan N does not have credible mortality experience. Pursuant to 
paragraph (d)(1)(iv)(C) of this section, Employer A is permitted to 
either exclude mortality experience date for the period of time before 
July 1, 2010 (the date Plan N became maintained with Employer A's 
controlled group), or include that mortality experience data for 
purposes of demonstrating that Plan N does not have credible mortality 
experience. Thus, if there is an experience study that shows that the 
male and female populations of Plan N each do not have 1,000 deaths 
during the period from July 1, 2010, through December 31, 2010, then the 
maintenance of Plan N within the Employer A's controlled group does not 
impair Plan M's use of substitute mortality tables for Plan M's 2012 
plan year.
    (iv) For Plan M's 2013 plan year, pursuant to paragraph 
(d)(1)(iv)(C) of this section, the maintenance of Plan N within Employer 
A's controlled group does not impair Plan M's use of substitute 
mortality tables if there is an experience study that shows that the 
male and female populations of Plan N each do not have 1,000 deaths 
during the period from July 1, 2010, through December 31, 2011.

    (2) Duration of use of tables. Except as provided in paragraph 
(d)(4) of this section, substitute mortality tables are used with 
respect to a plan for the term of consecutive plan years specified in 
the plan sponsor's written request to use such tables under paragraph 
(b)(1) of this section and approved by the Commissioner, or such shorter 
period prescribed by the Commissioner in the approval to use substitute 
mortality tables. Following the end of such term of use, or following 
any early termination of use described in paragraph (d)(4) of this 
section, the mortality tables specified in Sec. 1.430(h)(3)-1 apply 
with respect to the plan unless approval under paragraph (b)(1) of this 
section has been received by the plan sponsor to use substitute 
mortality tables for a further term.
    (3) Aggregation--(i) Permissive aggregation of plans. In order for a 
plan sponsor to use a set of substitute mortality tables with respect to 
two or more plans, the rules of this section are applied by treating 
those plans as a single plan. In such a case, the substitute mortality 
tables must be used for the aggregated plans and must be based on data 
collected with respect to those aggregated plans.
    (ii) Required aggregation of plans. In general, plans are not 
required to be aggregated for purposes of applying the rules of this 
section. However, for purposes of this section, a plan is required to be 
aggregated with any plan that was previously spun off from that plan for 
purposes of this section if the Commissioner determines that one purpose 
of the spinoff is to avoid the use of substitute mortality tables for 
any of the plans that were involved in the spinoff.
    (4) Early termination of use of tables--(i) General rule. A plan's 
substitute mortality tables cannot be used as of the earliest of--
    (A) The plan year in which the plan fails to satisfy the 
requirements of paragraph (c)(1) of this section (regarding credible 
mortality experience requirements and demonstrations);
    (B) The plan year in which the plan fails to satisfy the 
requirements of paragraph (d)(1) of this section (regarding use of 
substitute mortality tables by controlled group members);
    (C) The second plan year following the plan year in which there is a 
significant change in individuals covered by the plan as described in 
paragraph (d)(4)(ii) of this section;
    (D) The plan year following the plan year in which a substitute 
mortality table used for a plan population is no longer accurately 
predictive of future mortality of that population, as determined by the 
Commissioner or as certified by the plan's actuary to the satisfaction 
of the Commissioner; or

[[Page 1247]]

    (E) The date specified in guidance published in the Internal Revenue 
Bulletin (see Sec. 601.601(d)(2)(ii)(b) of this chapter) pursuant to a 
replacement of mortality tables specified under section 430(h)(3)(A) and 
Sec. 1.430(h)(3)-1 (other than annual updates to the static mortality 
tables issued pursuant to Sec. 1.430(h)(3)-1(a)(3)).
    (ii) Significant change in coverage--(A) Change in coverage from 
time of experience study. For purposes of applying the rules of 
paragraph (d)(4)(i)(C) of this section, a significant change in the 
individuals covered by a substitute mortality table occurs if there is 
an increase or decrease in the number of individuals of at least 20 
percent compared to the average number of individuals in that population 
over the years covered by the experience study on which the substitute 
mortality tables are based. However, a change in coverage is not treated 
as significant if the plan's actuary certifies in writing to the 
satisfaction of the Commissioner that the substitute mortality tables 
used for the plan population continue to be accurately predictive of 
future mortality of that population (taking into account the effect of 
the change in the population).
    (B) Change in coverage from time of certification. For purposes of 
applying the rules of paragraph (d)(4)(i)(C) of this section, a 
significant change in the individuals covered by a substitute mortality 
table occurs if there is an increase or decrease in the number of 
individuals covered by a substitute mortality table of at least 20 
percent compared to the number of individuals in a plan year for which a 
certification described in paragraph (d)(4)(ii)(A) of this section was 
made on account of a prior change in coverage. However, a change in 
coverage is not treated as significant if the plan's actuary certifies 
in writing to the satisfaction of the Commissioner that the substitute 
mortality tables used by the plan with respect to the covered population 
continue to be accurately predictive of future mortality of that 
population (taking into account the effect of the change in the plan 
population).
    (e) Effective/Applicability date. This section applies for plan 
years beginning on or after January 1, 2009.

[T.D. 9419, 73 FR 44644, July 31, 2008]



Sec. 1.430(i)-1  Special rules for plans in at-risk status.

    (a) In general--(1) Overview. This section provides special rules 
related to determining the funding target and making other computations 
for certain defined benefit plans that are in at-risk status for the 
plan year. Section 430(i) and this section apply to single employer 
defined benefit plans (including multiple employer plans) but do not 
apply to multiemployer plans (as defined in section 414(f)). Paragraph 
(b) of this section describes rules for determining whether a plan is in 
at-risk status for a plan year, including the determination of a plan's 
funding target attainment percentage and at-risk funding target 
attainment percentage. Paragraph (c) of this section describes the 
funding target for a plan in at-risk status. Paragraph (d) of this 
section describes the target normal cost for a plan in at-risk status. 
Paragraph (e) of this section describes rules regarding how the funding 
target and the target normal cost are determined for a plan that has 
been in at-risk status for fewer than 5 consecutive plan years. 
Paragraph (f) of this section sets forth effective/applicability dates 
and transition rules.
    (2) Special rules for multiple employer plans. In the case of a 
multiple employer plan to which section 413(c)(4)(A) applies, the rules 
of section 430 and this section are applied separately for each employer 
under the plan, as if each employer maintained a separate plan. For 
example, at-risk status is determined separately for each employer under 
such a multiple employer plan. In the case of a multiple employer plan 
to which section 413(c)(4)(A) does not apply (that is, a plan described 
in section 413(c)(4)(B) that has not made the election for section 
413(c)(4)(A) to apply), the rules of section 430 and this section are 
applied as if all participants in the plan were employed by a single 
employer.

[[Page 1248]]

    (b) Determination of at-risk status of a plan--(1) General rule. 
Except as otherwise provided in this section, a plan is in at-risk 
status for a plan year if--
    (i) The funding target attainment percentage for the preceding plan 
year (determined under paragraph (b)(3) of this section) is less than 80 
percent; and
    (ii) The at-risk funding target attainment percentage for the 
preceding plan year (determined under paragraph (b)(4) of this section) 
is less than 70 percent.
    (2) Small plan exception. If, on each day during the preceding plan 
year, a plan had 500 or fewer participants (including both active and 
inactive participants), determined in accordance with the same rules 
that apply for purposes of Sec. 1.430(g)-1(b)(2)(ii), then the plan is 
not treated as being in at-risk status for the plan year.
    (3) Funding target attainment percentage. For purposes of this 
section, except as otherwise provided in paragraph (b)(5) of this 
section, the funding target attainment percentage of a plan for a plan 
year is the funding target attainment percentage as defined in Sec. 
1.430(d)-1(b)(3).
    (4) At-risk funding target attainment percentage. Except as 
otherwise provided in paragraph (b)(5) of this section, the at-risk 
funding target attainment percentage of a plan for a plan year is a 
fraction (expressed as a percentage)--
    (i) The numerator of which is the value of plan assets for the plan 
year after subtraction of the prefunding balance and the funding 
standard carryover balance under section 430(f)(4)(B); and
    (ii) The denominator of which is the at-risk funding target of the 
plan for the plan year (determined under paragraph (c) of this section, 
but without regard to the loading factor imposed under paragraph 
(c)(2)(ii) of this section).
    (5) Special rules--(i) Special rule for new plans. Except as 
otherwise provided in paragraph (b)(5)(iii) of this section, in the case 
of a new plan that was neither the result of a merger nor involved in a 
spinoff, the funding target attainment percentage under paragraph (b)(3) 
of this section and the at-risk funding target attainment percentage 
under paragraph (b)(4) of this section are equal to 100 percent for 
years before the plan exists.
    (ii) Special rule for plans with zero funding target. Except as 
otherwise provided in paragraph (b)(5)(iii) of this section, if the 
funding target of the plan is equal to zero for a plan year, then the 
funding target attainment percentage under paragraph (b)(3) of this 
section and the at-risk funding target attainment percentage under 
paragraph (b)(4) of this section are equal to 100 percent for that plan 
year.
    (iii) Exception when plan has predecessor plan that was in at-risk 
status. [Reserved]
    (iv) Special rules for plans that are the result of a merger. 
[Reserved]
    (v) Special rules for plans that are involved in a spinoff. 
[Reserved]
    (6) Special rule for determining at-risk status of plans of 
specified automobile manufacturers. See section 430(i)(4)(C) for special 
rules for determining the at-risk status of plans of specified 
automobile and automobile parts manufacturers.
    (c) Funding target for plans in at-risk status--(1) In general. If 
the plan has been in at-risk status for 5 consecutive years, including 
the current plan year, then the funding target for the plan is the at-
risk funding target determined under paragraph (c)(2) of this section. 
See paragraph (e) of this section for the determination of the funding 
target where the plan is in at-risk status for the plan year but was not 
in at-risk status for one or more of the 4 preceding plan years.
    (2) At-risk funding target--(i) Use of modified actuarial 
assumptions. Except as otherwise provided in this paragraph (c)(2), the 
at-risk funding target of the plan under this paragraph (c)(2) for the 
plan year is equal to the present value of all benefits accrued or 
earned under the plan as of the beginning of the plan year, as 
determined in accordance with Sec. 1.430(d)-1 but using the additional 
actuarial assumptions described in paragraph (c)(3) of this section.
    (ii) Funding target includes load. The at-risk funding target is 
increased by the sum of--

[[Page 1249]]

    (A) $700 multiplied by the number of participants in the plan 
(including active participants, inactive participants, and 
beneficiaries); plus
    (B) Four percent of the funding target (determined under Sec. 
1.430(d)-1(b)(2) as if the plan was not in at-risk status) of the plan 
for the plan year.
    (iii) Minimum amount. Notwithstanding any otherwise applicable 
provisions of this section, the at-risk funding target of a plan for a 
plan year is not less than the plan's funding target for the plan year 
determined without regard to this section.
    (3) Additional actuarial assumptions--(i) In general. The actuarial 
assumptions used to determine a plan's at-risk funding target for a plan 
year are the actuarial assumptions that are applied under section 430, 
with the modifications described in this paragraph (c)(3).
    (ii) Special retirement age assumption--(A) Participants eligible to 
retire and collect benefits within 11 years. Subject to paragraph 
(c)(3)(ii)(B) of this section, if a participant would be eligible to 
commence an immediate distribution by the end of the 10th plan year 
after the current plan year (that is, the end of the 11th plan year 
beginning with the current plan year), that participant is assumed to 
commence an immediate distribution at the earliest retirement age under 
the plan, or, if later, at the end of the current plan year. The rule of 
this paragraph (c)(3)(ii)(A) does not affect the application of plan 
assumptions regarding an employee's termination of employment prior to 
the employee's earliest retirement age.
    (B) Participants otherwise assumed to retire immediately. The 
special retirement age assumption of paragraph (c)(3)(ii)(A) of this 
section does not apply to a participant to the extent the participant is 
otherwise assumed to commence benefits during the current plan year 
under the actuarial assumptions for the plan. For example, if generally 
applicable retirement assumptions would provide for a 25 percent 
probability that a participant will commence benefits during the current 
plan year, the special retirement age assumption of paragraph 
(c)(3)(ii)(A) of this section requires the plan's enrolled actuary to 
assume a 75 percent probability that the participant will commence 
benefits at the end of the plan year.
    (C) Definition of earliest retirement date. For purposes of this 
paragraph (c)(3)(ii), a plan's earliest retirement date for an employee 
is the earliest date on which the employee can commence receiving an 
immediate distribution of a fully vested benefit under the plan. See 
Sec. 1.401(a)-20, Q&A-17(b).
    (iii) Requirement to assume most valuable benefit. All participants 
and beneficiaries who are assumed to retire on a particular date are 
assumed to elect the optional form of benefit available under the plan 
that would result in the highest present value of benefits commencing at 
that date.
    (iv) Reasonable techniques permitted. The plan's actuary is 
permitted to use reasonable techniques in determining the actuarial 
assumptions that are required to be used pursuant to this paragraph 
(c)(3). For example, the plan's actuary is permitted to use reasonable 
assumptions in determining the optional form of benefit under the plan 
that would result in the highest present value of benefits for this 
purpose.
    (d) Target normal cost of plans in at-risk status--(1) General rule. 
If the plan has been in at-risk status for 5 consecutive years, 
including the current plan year, then the target normal cost for the 
plan is the at-risk target normal cost determined under paragraph (d)(2) 
of this section. See paragraph (e) of this section for the determination 
of the target normal cost where the plan is in at-risk status for the 
plan year but was not in at-risk status for one or more of the 4 
preceding plan years.
    (2) At-risk target normal cost--(i) Use of modified actuarial 
assumptions--(A) In general. Except as otherwise provided in this 
paragraph (d)(2), the at-risk target normal cost of a plan for the plan 
year is equal to the present value (determined as of the valuation date) 
of all benefits that accrue during, are earned during, or are otherwise 
allocated to service in the plan year, as determined in accordance with 
Sec. 1.430(d)-1 but using the additional actuarial assumptions 
described in paragraph (c)(3) of this section.

[[Page 1250]]

    (B) Special adjustments. The target normal cost of the plan for the 
plan year (determined under paragraph (d)(2)(i)(A) of this section) is 
adjusted (not below zero) by adding the amount of plan-related expenses 
expected to be paid from plan assets during the plan year and 
subtracting the amount of any mandatory employee contributions expected 
to be made during the plan year.
    (C) Plan-related expenses. For purposes of this paragraph (d)(2), 
plan-related expenses are determined using the rules of Sec. 1.430(d)-
1(b)(1)(iii)(B).
    (ii) Loading factor. The at-risk target normal cost is increased by 
a loading factor equal to 4 percent of the present value (determined as 
of the valuation date) of all benefits under the plan that accrue, are 
earned, or are otherwise allocated to service for the plan year under 
the applicable rules of Sec. 1.430(d)-1(c)(1)(ii)(B), (C), or (D), 
determined as if the plan were not in at-risk status.
    (iii) Minimum amount. The at-risk target normal cost of a plan for a 
plan year is not less than the plan's target normal cost determined 
without regard to section 430(i) and this section.
    (e) Transition between applicable funding targets and applicable 
target normal costs--(1) Funding target. If a plan that is in at-risk 
status for the plan year has not been in at-risk status for one or more 
of the preceding 4 plan years, the plan's funding target for the plan 
year is determined as the sum of--
    (i) The funding target determined without regard to section 430(i) 
and this section; plus
    (ii) The phase-in percentage for the plan year multiplied by the 
excess of--
    (A) The at-risk funding target determined under paragraph (c)(2) of 
this section (determined taking into account paragraph (e)(4) of this 
section); over
    (B) The funding target determined without regard to section 430(i) 
and this section.
    (2) Target normal cost. If a plan that is in at-risk status for the 
plan year has not been in at-risk status for one or more of the 
preceding 4 plan years, the plan's target normal cost for the plan year 
is determined as the sum of--
    (i) The target normal cost determined without regard to section 
430(i) and this section; plus
    (ii) The phase-in percentage for the plan year multiplied by the 
excess of--
    (A) The at-risk target normal cost determined under paragraph (d)(2) 
of this section (determined taking into account paragraph (e)(4) of this 
section); over
    (B) The target normal cost determined without regard to section 
430(i) and this section.
    (3) Phase-in percentage. For purposes of this paragraph (e), the 
phase-in percentage is 20 percent multiplied by the number of 
consecutive plan years that the plan has been in at-risk status 
(including the current plan year) and not taking into account years 
before the first effective plan year for a plan.
    (4) Transition funding target and target normal cost determined 
without load. Notwithstanding paragraph (c)(2)(ii) of this section, if a 
plan has not been in at-risk status for 2 or more of the preceding 4 
plan years (not taking into account years before the first effective 
plan year for a plan), then the plan's at-risk funding target that is 
used for purposes of paragraph (e)(1)(ii)(A) of this section (to 
calculate the plan's funding target where the plan has been in at-risk 
status for fewer than 5 plan years) is determined without regard to the 
loading factor set forth in paragraph (c)(2)(ii) of this section. 
Similarly, if a plan has not been in at-risk status for 2 or more of the 
preceding 4 plan years (not taking into account years before the first 
effective plan year for a plan), then the plan's at-risk target normal 
cost that is used for purposes of paragraph (e)(2)(ii)(A) of this 
section (to calculate the plan's target normal cost where the plan has 
been in at-risk status for fewer than 5 plan years) is determined 
without regard to the loading factor set forth in paragraph (d)(2)(ii) 
of this section.
    (f) Effective/applicability dates and transition rules--(1) 
Statutory effective date/applicability date--(i) General rule. Section 
430 generally applies to plan years beginning on or after January 1, 
2008. The applicability of section 430 for purposes of determining the 
minimum required contribution is delayed for

[[Page 1251]]

certain plans in accordance with sections 104 through 106 of the Pension 
Protection Act of 2006 (PPA '06), Public Law 109-280 (120 Stat. 780).
    (ii) Applicability of special adjustments to target normal cost. The 
special adjustments of paragraph (d)(2)(i)(B) of this section (relating 
to adjustments to the target normal cost for plan-related expenses and 
mandatory employee contributions) apply to plan years beginning after 
December 31, 2008. In addition, a plan sponsor may elect to make the 
special adjustments of paragraph (d)(2)(i)(B) of this section for plan 
years beginning in 2008. This election is made in the same manner and is 
subject to the same rules as an election to add an amount to the plan's 
prefunding balance pursuant to Sec. 1.430(f)-1(f). Thus, the election 
can be made no later than the last day for making the minimum required 
contribution for the plan year to which the election relates.
    (2) Effective date/applicability date of regulations. This section 
applies to plan years beginning on or after January 1, 2010. For plan 
years beginning before January 1, 2010, plans are permitted to rely on 
the provisions set forth in this section for purposes of satisfying the 
requirements of section 430.
    (3) First effective plan year. For purposes of this section, the 
first effective plan year for a plan is the first plan year to which 
section 430 applies to the plan for purposes of determining the minimum 
required contribution.
    (4) Transition rule for determining at-risk status. In the case of 
plan years beginning in 2008, 2009, and 2010, paragraph (b)(1)(i) of 
this section is applied by substituting the following percentages for 
``80 percent''--
    (i) 65 percent in the case of 2008;
    (ii) 70 percent in the case of 2009; and
    (iii) 75 percent in the case of 2010.

[T.D. 9467, 74 FR 53058, Oct. 15, 2009]



Sec. 1.431(c)(6)-1  Mortality tables used to determine current 
liability.

    (a) Mortality tables used to determine current liability. The 
mortality assumptions that apply to a defined benefit plan for the plan 
year pursuant to section 430(h)(3)(A) and Sec. 1.430(h)(3)-1(a)(2) are 
used to determine a multiemployer plan's current liability for purposes 
of applying the rules of section 431(c)(6). A multiemployer plan is 
permitted to apply either the static mortality tables used pursuant to 
Sec. 1.430(h)(3)-1(a)(3) or generational mortality tables used pursuant 
to Sec. 1.430(h)(3)-1(a)(4) for this purpose. However, for this 
purpose, a multiemployer plan is not permitted to use substitute 
mortality tables under Sec. 1.430(h)(3)-2.
    (b) Effective/applicability date. This section applies for plan 
years beginning on or after January 1, 2008.

[T.D. 9419, 73 FR 44648, July 31, 2008]



Sec. Sec. 1.432-1.435  [Reserved]



Sec. 1.436-0  Table of contents.

    This section contains a listing of the major headings of Sec. 
1.436-1.



Sec. 1.436-1  Limits on benefits and benefit accruals under single 
employer defined benefit plans.

    (a) General rules.
    (1) Qualification requirement.
    (2) Organization of the regulation.
    (3) Special rules for certain plans.
    (4) Treatment of plan as of close of prohibited or cessation period.
    (5) Deemed election to reduce funding balances.
    (b) Limitation on shutdown benefits and other unpredictable 
contingent event benefits.
    (1) In general.
    (2) Exemption if section 436 contribution is made.
    (3) Rules of application.
    (4) Prior unpredictable contingent event.
    (c) Limitations on plan amendments increasing liability for 
benefits.
    (1) In general.
    (2) Exemption if section 436 contribution is made.
    (3) Rules of application regarding pre-existing plan provisions.
    (4) Exceptions.
    (5) Rule for determining when an amendment takes effect.
    (6) Treatment of mergers, consolidations, and transfers of plan 
assets into a plan. [Reserved]
    (d) Limitations on prohibited payments.
    (1) AFTAP less than 60 percent.
    (2) Bankruptcy.
    (3) Limited payment if AFTAP at least 60 percent but less than 80 
percent.
    (4) Exception for cessation of benefit accruals.
    (5) Right to delay commencement.
    (6) Plan alternative for special optional forms.

[[Page 1252]]

    (7) Exception for distributions permitted without consent of the 
participant under section 411(a)(11).
    (e) Limitation on benefit accruals for plans with severe funding 
shortfalls.
    (1) In general.
    (2) Exemption if section 436 contribution is made.
    (3) Special rule under section 203 of the Worker, Retiree, and 
Employer Recovery Act of 2008. [Reserved]
    (f) Methods to avoid or terminate benefit limitations.
    (1) In general.
    (2) Current year contributions to avoid or terminate benefit 
limitations.
    (3) Security to increase adjusted funding target attainment 
percentage.
    (4) Examples.
    (g) Rules of operation for periods prior to and after certification.
    (1) In general.
    (2) Periods prior to certification during which a presumption 
applies.
    (3) Periods prior to certification during which no presumption 
applies.
    (4) Modification of the presumed AFTAP.
    (5) Periods after certification of AFTAP.
    (6) Examples.
    (h) Presumed underfunding for purposes of benefit limitations.
    (1) Presumption of continued underfunding.
    (2) Presumption of underfunding beginning on first day of 4th month 
for certain underfunded plans.
    (3) Presumption of underfunding beginning on first day of 10th 
month.
    (4) Certification of AFTAP.
    (5) Examples of rules of paragraphs (h)(1), (h)(2), and (h)(3) of 
this section.
    (6) Examples of application of paragraph (h)(4) of this section.
    (i) [Reserved]
    (j) Definitions.
    (1) Adjusted funding target attainment percentage.
    (2) Annuity starting date.
    (3) First effective plan year.
    (4) Funding target.
    (5) Prior year adjusted funding target attainment percentage.
    (6) Prohibited payment.
    (7) Section 436 contributions.
    (8) Section 436 measurement date.
    (9) Unpredictable contingent event.
    (10) Examples.
    (k) Effective/applicability dates.
    (1) Statutory effective date.
    (2) Collectively bargained plan exception.
    (3) Effective date/applicability date of regulations.

[T.D. 9467, 74 FR 53060, Oct. 15, 2009]



Sec. 1.436-1  Limits on benefits and benefit accruals under single 
employer defined benefit plans.

    (a) General rules--(1) Qualification requirement. Section 401(a)(29) 
provides that a defined benefit pension plan that is subject to section 
412 and that is not a multiemployer plan (within the meaning of section 
414(f)) is a qualified plan only if it satisfies the requirements of 
section 436. This section provides rules relating to funding-based 
limitations on certain benefits under section 436, and the requirements 
of section 436 are satisfied only if the plan meets the requirements of 
this section beginning with the plan's first effective plan year. This 
section applies to single employer defined benefit plans (including 
multiple employer plans), but does not apply to multiemployer plans.
    (2) Organization of the regulation. Paragraph (b) of this section 
describes limitations on shutdown benefits and other unpredictable 
contingent event benefits. Paragraph (c) of this section describes 
limitations on plan amendments increasing liabilities. Paragraph (d) of 
this section describes limitations on prohibited payments. Paragraph (e) 
of this section describes limitations on benefit accruals. Paragraph (f) 
of this section provides rules relating to methods to avoid or terminate 
benefit limitations. Paragraph (g) of this section provides rules for 
the operation of the plan in relation to benefit limitations under 
section 436. Paragraph (h) of this section describes related 
presumptions regarding underfunding that apply for purposes of the 
benefit limitations under section 436 and requirements relating to 
certifications. Paragraph (j) of this section contains definitions. 
Paragraph (k) of this section contains effective/applicability date 
provisions.
    (3) Special rules for certain plans--(i) New plans. The limitations 
described in paragraphs (b), (c), and (e) of this section do not apply 
to a plan for the first 5 plan years of the plan. Except as otherwise 
provided by the Commissioner in guidance of general applicability, plan 
years of the plan include the following (in addition to plan years 
during which the plan was maintained by the employer or plan sponsor):

[[Page 1253]]

    (A) Plan years when the plan was maintained by a predecessor 
employer within the meaning of Sec. 1.415(f)-1(c)(1).
    (B) Plan years of another defined benefit plan maintained by a 
predecessor employer within the meaning of Sec. 1.415(f)-1(c)(2) within 
the preceding five years if any participants in the plan participated in 
that other defined benefit plan (even if the plan maintained by the 
employer is not the plan that was maintained by the predecessor 
employer).
    (C) Plan years of another defined benefit plan maintained by the 
employer within the preceding five years if any participants in the plan 
participated in that other defined benefit plan.
    (ii) Application of section 436 after termination of a plan--(A) In 
general. Except as otherwise provided in paragraph (a)(3)(ii)(B) of this 
section, any section 436 limitations in effect immediately before the 
termination of a plan do not cease to apply thereafter.
    (B) Exception for payments pursuant to plan termination. The 
limitations under section 436(d) and paragraph (d) of this section do 
not apply to prohibited payments (within the meaning of paragraph (j)(6) 
of this section) that are made to carry out the termination of a plan in 
accordance with applicable law. For example, a plan sponsor's purchase 
of an irrevocable commitment from an insurer to pay benefit liabilities 
in connection with the standard termination of a plan in accordance with 
section 4041(b)(3) of the Employee Retirement Income Security Act of 
1974, as amended (ERISA), and in accordance with 29 CFR 4041.28, does 
not violate section 436(d) or this section.
    (iii) Multiple employer plans. In the case of a multiple employer 
plan to which section 413(c)(4)(A) applies, this section applies 
separately with respect to each employer under the plan, as if each 
employer maintained a separate plan. Thus, the benefit limitations under 
section 436 and this section could apply differently to participants who 
are employees of different employers under such a multiple employer 
plan. In the case of a multiple employer plan to which section 
413(c)(4)(A) does not apply (that is, a plan described in section 
413(c)(4)(B) that has not made the election for section 413(c)(4)(A) to 
apply), this section applies as if all participants in the plan were 
employed by a single employer.
    (4) Treatment of plan as of close of prohibited or cessation 
period--(i) Application to prohibited payments and accruals--(A) 
Resumption of prohibited payments. If a limitation on prohibited 
payments under paragraph (d) of this section applied to a plan as of a 
section 436 measurement date (as defined in paragraph (j)(8) of this 
section), but that limit no longer applies to the plan as of a later 
section 436 measurement date, then the limitation on prohibited payments 
under the plan does not apply to benefits with annuity starting dates 
(as defined in paragraph (j)(2) of this section) that are on or after 
that later section 436 measurement date. Any amendment to eliminate an 
optional form of benefit that contains a prohibited payment with respect 
to an annuity starting date during a period in which the limitations of 
section 436(d) and paragraph (d) of this section do not apply to the 
plan is subject to the rules of section 411(d)(6).
    (B) Resumption of benefit accruals. If a limitation on benefit 
accruals under paragraph (e) of this section applied to a plan as of a 
section 436 measurement date, but that limit no longer applies to the 
plan as of a later section 436 measurement date, then that limitation 
does not apply to benefit accruals that are based on service on or after 
that later section 436 measurement date, except to the extent that the 
plan provides that benefit accruals will not resume when the limitation 
ceases to apply. The plan must comply with the rules relating to partial 
years of participation and the prohibition on double proration under 
Department of Labor regulation 29 CFR 2530.204-2(c) and (d).
    (ii) Restoration of options and missed benefit accruals--(A) Option 
to amend plan. A plan is permitted to be amended to provide participants 
who had an annuity starting date within a period during which a 
limitation under paragraph (d) of this section applied to the plan with 
the opportunity to make a new election under which the form of benefit 
previously elected is modified, subject to applicable qualification 
requirements. A participant who makes

[[Page 1254]]

such a new election is treated as having a new annuity starting date 
under sections 415 and 417. Similarly, a plan is permitted to be amended 
to provide that any benefit accruals which were limited under the rules 
of paragraph (e) of this section are credited under the plan when the 
limitation no longer applies, subject to applicable qualification 
requirements. Any such plan amendment with respect to a new annuity 
starting date or crediting of benefit accruals is subject to the 
requirements of section 436(c) and paragraph (c) of this section.
    (B) Automatic plan provisions. A plan is permitted to provide that 
participants who had an annuity starting date within a period during 
which a limitation under paragraph (d) of this section applied to the 
plan will be provided with the opportunity to have a new annuity 
starting date (which would constitute a new annuity starting date under 
sections 415 and 417) under which the form of benefit previously elected 
may be modified, subject to applicable qualification requirements, once 
the limitations of paragraph (d) of this section cease to apply. In 
addition, subject to the rules of paragraph (c)(3) of this section, a 
plan is permitted to provide for the automatic restoration of benefit 
accruals that had been limited under section 436(e) as of the section 
436 measurement date that the limitation ceases to apply.
    (iii) Shutdown and other unpredictable contingent event benefits. If 
unpredictable contingent event benefits with respect to an unpredictable 
contingent event that occurs during the plan year are not permitted to 
be paid after the occurrence of the event because of the limitations of 
section 436(b) and paragraph (b) of this section, but are permitted to 
be paid later in the plan year as a result of additional contributions 
under paragraph (f)(2) of this section or pursuant to the enrolled 
actuary's certification of the adjusted funding target attainment 
percentage for the plan year that meets the requirements of paragraph 
(g)(5)(ii)(B) of this section, then those unpredictable contingent event 
benefits must automatically become payable, retroactive to the period 
those benefits would have been payable under the terms of the plan 
(other than plan terms implementing the requirements of section 436(b)). 
If the benefits do not become payable during the plan year in accordance 
with the preceding sentence, then the plan is treated as if it does not 
provide for those benefits. However, all or any portion of those 
benefits can be restored pursuant to a plan amendment that meets the 
requirements of section 436(c) and paragraph (c) of this section and 
other applicable qualification requirements.
    (iv) Treatment of plan amendments that do not take effect. If a plan 
amendment does not take effect as of the effective date of the amendment 
because of the limitations of section 436(c) and paragraph (c) of this 
section, but is permitted to take effect later in the plan year as a 
result of additional contributions under paragraph (f)(2) of this 
section or pursuant to the enrolled actuary's certification of the 
adjusted funding target attainment percentage for the plan year that 
meets the requirements of paragraph (g)(5)(ii)(C) of this section, then 
the plan amendment must automatically take effect as of the first day of 
the plan year (or, if later, the original effective date of the 
amendment). If the plan amendment cannot take effect during the plan 
year, then it must be treated as if it were never adopted, unless the 
plan amendment provides otherwise.
    (v) Example. The following example illustrates the rules of this 
paragraph (a)(4):

    Example. (i) Plan T is a non-collectively bargained defined benefit 
plan with a plan year that is the calendar year and a valuation date of 
January 1. As of January 1, 2011, Plan T does not have a funding 
standard carryover balance or a prefunding balance. Plan T's sponsor is 
not in bankruptcy. Beginning January 1, 2011, Plan T is subject to the 
restriction on prohibited payments under paragraph (d)(3) of this 
section based on a presumed adjusted funding target attainment 
percentage (AFTAP) of 75%.
    (ii) U is a participant in Plan T. Participant U retires on February 
1, 2011, and elects to receive benefits in the form of a single sum. 
Plan T may pay only a portion (generally, 50%) of the prohibited 
payment. Accordingly, U elects in accordance with paragraph (d)(3)(ii) 
of this section to receive 50% of U's benefit in a single sum (up to the 
2011 PBGC maximum benefit guarantee amount described in paragraph 
(d)(3)(iii)(C) of this

[[Page 1255]]

section) and the remainder as an immediately commencing straight life 
annuity.
    (iii) On March 1, 2011, the enrolled actuary for the Plan certifies 
that the AFTAP for 2011 is 80%. Accordingly, beginning March 1, 2011, 
Plan T is no longer subject to the restriction under paragraph (d)(3) of 
this section.
    (iv) Effective March 1, 2011, Plan T is amended to provide that a 
participant whose benefits were restricted under paragraph (d)(3) of 
this section with respect to an annuity starting date between January 1, 
2011, and February 28, 2011, may elect, within a specified period on or 
after March 1, 2011, a new annuity starting date and receive the 
remainder of his or her pension benefits in an accelerated form of 
payment. Plan T's enrolled actuary determines that the AFTAP, taking 
into account the amendment, would still be 80%. The amendment is 
permitted to take effect because Plan T would have an AFTAP of 80% 
taking into account the amendment and is therefore neither subject to 
the restriction on plan amendments in paragraph (c) of this section nor 
the restrictions on prohibited payments under paragraphs (d)(1) and 
(d)(3) of this section. Accordingly, Participant U may elect, within the 
specified period and subject to otherwise applicable qualification 
rules, including spousal consent, to receive the remainder of U's 
benefits in the form of a single sum on or after March 1, 2011.

    (5) Deemed election to reduce funding balances--(i) Limitations on 
accelerated benefit payments. If a benefit limitation under paragraph 
(d)(1) or (d)(3) of this section would (but for this paragraph (a)(5)) 
apply to a plan, the employer is treated as having made an election 
under section 430(f) to reduce the prefunding balance or funding 
standard carryover balance by such amount as is necessary for the 
adjusted funding target attainment percentage to be at the applicable 
threshold (60 or 80 percent, as the case may be) in order for the 
benefit limitation not to apply to the plan. The determination of 
whether a benefit limitation under paragraph (d) of this section would 
apply to a plan is based on whether the plan provides for an optional 
form of benefit that would be limited under section 436(d) and is not 
based on whether any participant elects payment of benefits in such a 
form.
    (ii) Other limitations for collectively bargained plans--(A) General 
rule. In the case of a collectively bargained plan to which a benefit 
limitation under paragraph (b), (c), or (e) of this section would (but 
for this paragraph (a)(5)) apply, the employer is treated as having made 
an election under section 430(f) to reduce the prefunding balance or 
funding standard carryover balance by such amount as is necessary for 
the adjusted funding target attainment percentage to be at the 
applicable threshold (60 or 80 percent, as the case may be) in order for 
the benefit limitation not to apply to the plan, taking into account the 
adjustments described in paragraph (g)(2)(iii)(A), (g)(3)(ii)(A), or 
(g)(5)(i)(B) of this section, whichever applies.
    (B) Collectively bargained plans. A plan is considered a 
collectively bargained plan for purposes of this paragraph (a)(5)(ii) 
if--
    (1) At least 50 percent of the employees benefiting under the plan 
(within the meaning of Sec. 1.410(b)-3(a)) are members of collective 
bargaining units for which the benefit levels under the plan are 
specified under a collective bargaining agreement; or
    (2) At least 25 percent of the participants in the plan are members 
of collective bargaining units for which the benefit levels under the 
plan are specified under a collective bargaining agreement.
    (iii) Exception for insufficient funding balances--(A) In general. 
Paragraphs (a)(5)(i) and (a)(5)(ii) of this section apply with respect 
to a benefit limitation for any plan year only if the application of 
those paragraphs would result in the corresponding benefit limitation 
not applying for such plan year. Thus, if the plan's prefunding and 
funding standard carryover balances were reduced to zero and the 
resulting increase in plan assets taken into account would still not 
increase the plan's adjusted funding target attainment percentage enough 
to reach the threshold percentage applicable to the benefit limitation, 
the deemed election to reduce those balances pursuant to paragraph 
(a)(5)(i) or (a)(5)(ii) of this section does not apply.
    (B) Presumed adjusted funding target attainment percentage less than 
60 percent. During any period when a plan is presumed to have an 
adjusted funding target attainment percentage of less than 60 percent as 
a result of paragraph

[[Page 1256]]

(h)(3) of this section, the plan is treated as if the prefunding balance 
and the funding standard carryover balance are insufficient to increase 
the adjusted funding target attainment percentage to the threshold 
percentage of 60 percent. Accordingly, the deemed election to reduce 
those balances pursuant to paragraphs (a)(5)(i) and (a)(5)(ii) of this 
section does not apply to the plan.
    (iv) Other rules--(A) Date of deemed election. If an election is 
deemed to be made pursuant to this paragraph (a)(5), then the plan 
sponsor is treated as having made that election on the date as of which 
the applicable benefit limitation would otherwise apply.
    (B) Coordination with section 436 contributions. The determination 
of whether one of the benefit limitations described in paragraph 
(a)(5)(ii)(A) of this section would otherwise apply is made without 
regard to any contribution described in paragraph (f)(2) of this 
section. Thus, the requirement to reduce the prefunding balance or 
funding standard carryover balance under paragraph (a)(5)(ii) of this 
section cannot be avoided through the use of a section 436 contribution.
    (C) Coordination with elections to offset minimum required 
contribution. See Sec. 1.430(f)-1(d)(1)(ii) for rules on the 
coordination of elections to offset the minimum required contribution 
and the deemed election to reduce the prefunding and funding standard 
carryover balances under this paragraph (a)(5).
    (v) Example. The following example illustrates the rules of this 
paragraph (a)(5):

    Example. (i) Plan W is a collectively bargained, single employer 
defined benefit plan sponsored by Sponsor X, with a plan year that is 
the calendar year and a valuation date of January 1.
    (ii) The enrolled actuary for Plan W issues a certification on March 
1, 2010, that the 2010 AFTAP is 81%. Sponsor X adopts an amendment on 
March 25, 2010, to increase benefits under a formula based on 
participant compensation, with an effective date of May 1, 2010. 
(Because the formula is based on compensation, the exception in 
paragraph (c)(4)(i) of this section does not apply.) The plan's enrolled 
actuary determines that the plan's AFTAP for 2010 would be 75% if the 
benefits attributable to the plan amendment were taken into account in 
determining the funding target.
    (iii) Because the AFTAP would be below the 80% threshold if the 
benefits attributable to the plan amendment were taken into account in 
determining the funding target, Sponsor X is deemed pursuant to 
paragraph (a)(5)(ii) of this section to have made an election to reduce 
Plan W's prefunding and funding standard carryover balances by the 
amount necessary for the AFTAP to reach the 80% threshold (reflecting 
the increase in funding target attributable to the plan amendment), 
provided that the amount of those balances is sufficient for this 
purpose.
    (iv) If the deemed election described in paragraph (iii) of this 
example occurs, the plan amendment takes effect on its effective date 
(May 1, 2010). See paragraph (f) of this section for other methods to 
avoid or terminate benefit limitations (where, for example, the amount 
necessary for a benefit limitation not to apply for a plan year exceeds 
the sum of the prefunding balance and the funding standard carryover 
balance).

    (6) Notice requirements. See section 101(j) of ERISA for rules 
requiring the plan administrator of a single employer plan to provide a 
written notice to participants and beneficiaries within 30 days after 
certain specified dates, which depend on whether the plan has become 
subject to a restriction described in the ERISA provisions that are 
parallel to Internal Revenue Code sections 436(b), 436(d), and 436(e) 
(ERISA sections 206(g)(1), 206(g)(3), and 206(g)(4), respectively).
    (b) Limitation on shutdown benefits and other unpredictable 
contingent event benefits--(1) In general. Except as otherwise provided 
in this paragraph (b), a plan satisfies section 436(b) and this 
paragraph (b) only if it provides that unpredictable contingent event 
benefits with respect to any unpredictable contingent events occurring 
during a plan year will not be paid if the adjusted funding target 
attainment percentage for the plan year is--
    (i) Less than 60 percent; or
    (ii) 60 percent or more, but would be less than 60 percent if the 
adjusted funding target attainment percentage were redetermined applying 
an actuarial assumption that the likelihood of occurrence of the 
unpredictable contingent event during the plan year is 100 percent.
    (2) Exemption if section 436 contribution is made. The prohibition 
on payment of

[[Page 1257]]

unpredictable contingent event benefits under paragraph (b)(1) of this 
section ceases to apply with respect to benefits attributable to an 
unpredictable contingent event occurring during the plan year upon 
payment by the plan sponsor of the contribution described in paragraph 
(f)(2)(iii) of this section with respect to that event. If the prior 
sentence applies with respect to an unpredictable contingent event, then 
all benefits with respect to the unpredictable contingent event must be 
paid, including benefits for periods prior to the contribution. See 
paragraph (f) of this section for additional rules.
    (3) Rules of application--(i) Participant-by-participant 
application. The limitations of section 436(b) and this paragraph (b) 
apply on a participant-by-participant basis. Thus, whether payment or 
commencement of an unpredictable contingent event benefit under a plan 
is restricted with respect to a participant is determined based on 
whether the participant satisfies the plan's eligibility requirements 
(other than the attainment of any age, performance of any service, 
receipt or derivation of any compensation, or the occurrence of death or 
disability) for such a benefit in a plan year in which the limitations 
of section 436(b) and this paragraph (b) apply.
    (ii) Multiple contingencies. In the case of a plan that provides for 
a benefit that depends upon the occurrence of more than one 
unpredictable contingent event with respect to a participant, the 
unpredictable contingent event for purposes of section 436(b) and this 
paragraph (b) occurs upon the last to occur of those unpredictable 
contingent events.
    (iii) Cessation of benefits. Cessation of a benefit under a plan 
upon the occurrence of a specified event is not an unpredictable 
contingent event for purposes of section 436(b) and this paragraph (b). 
Thus, section 436(b) and this paragraph (b) do not prohibit provisions 
of a plan that provide for cessation, suspension, or reduction of any 
benefits upon occurrence of any event. However, upon any subsequent 
recommencement of benefits (including any restoration of benefits), the 
rules of section 436 and this section will apply.
    (4) Prior unpredictable contingent event. Unpredictable contingent 
event benefits attributable to an unpredictable contingent event that 
occurred within a period during which no limitation under this paragraph 
(b) applied to the plan are not affected by the limitation described in 
this paragraph (b) as it applies in a subsequent period. For example, if 
a plant shutdown occurs in 2010 and the plan's funded status is such 
that benefits contingent upon that plant shutdown are not subject to the 
limitation described in this paragraph (b) for that calendar plan year, 
this paragraph (b) does not apply to restrict payment of those benefits 
even if another plant shutdown occurs in 2012 that results in the 
restriction of benefits that are contingent upon that later plant 
shutdown under this paragraph (b) (where the plan's adjusted funding 
target attainment percentage for 2012 would be less than 60 percent 
taking into account the liability attributable to those shutdown 
benefits).
    (c) Limitations on plan amendments increasing liability for 
benefits--(1) In general. Except as otherwise provided in this paragraph 
(c), a plan satisfies section 436(c) and this paragraph (c) only if the 
plan provides that no amendment to the plan that has the effect of 
increasing liabilities of the plan by reason of increases in benefits, 
establishment of new benefits, changing the rate of benefit accrual, or 
changing the rate at which benefits become nonforfeitable will take 
effect in a plan year if the adjusted funding target attainment 
percentage for the plan year is--
    (i) Less than 80 percent; or
    (ii) 80 percent or more, but would be less than 80 percent if the 
benefits attributable to the amendment were taken into account in 
determining the adjusted funding target attainment percentage.
    (2) Exemption if section 436 contribution is made--(i) General rule. 
The limitations on plan amendments in paragraph (c)(1) of this section 
cease to apply with respect to an amendment upon payment by the plan 
sponsor of the contribution described in paragraph (f)(2)(iv) of this 
section, so that

[[Page 1258]]

the amendment is permitted to take effect as of the later of the first 
day of the plan year or the effective date of the amendment. See 
paragraph (f) of this section for additional rules.
    (ii) Amendments that do not increase funding target. If the amount 
of the contribution described in paragraph (f)(2)(iv) of this section is 
$0 (because the amendment increases benefits solely for future periods), 
the amendment is permitted to take effect without regard to this 
paragraph (c). However, see Sec. 1.430(d)-1(d)(2) for a rule that 
requires such an amendment to be taken into account in determining the 
funding target and the target normal cost in certain situations.
    (3) Rules of application regarding pre-existing plan provisions. If 
a plan contains a provision that provides for the automatic restoration 
of benefit accruals that were not permitted to accrue because of the 
application of section 436(e) and paragraph (e) of this section, the 
restoration of those accruals is generally treated as a plan amendment 
that is subject to section 436(c). However, such a provision is 
permitted to take effect without regard to the limits of section 436(c) 
and this paragraph (c) if--
    (i) The continuous period of the limitation is 12 months or less; 
and
    (ii) The plan's enrolled actuary certifies that the adjusted funding 
target attainment percentage for the plan would not be less than 60 
percent taking into account the restored benefit accruals for the prior 
plan year.
    (4) Exceptions--(i) Benefit increases based on compensation--(A) In 
general. In accordance with section 436(c)(3), section 436(c) and this 
paragraph (c) do not apply to any amendment that provides for an 
increase in benefits under a formula that is not based on a 
participant's compensation, but only if the rate of increase in benefits 
does not exceed the contemporaneous rate of increase in average wages of 
participants covered by the amendment. The determination of the rate of 
increase in average wages is made by taking into consideration the net 
increase in average wages from the period of time beginning with the 
effective date of the most recent benefit increase applicable to all of 
those participants who are covered by the current amendment and ending 
on the effective date of the current amendment.
    (B) Application to participants who are not currently employed. If 
an amendment applies to both currently employed participants and other 
participants, all participants to whom the amendment applies are 
included in determining the increase in average wages of the 
participants covered by the amendment for purposes of this paragraph 
(c)(4)(i). For this purpose, participants who are not employees at any 
time during the period from the effective date of the most recent 
earlier benefit increase applicable to all of the participants who are 
covered by the current amendment and ending on the effective date of the 
current amendment are treated as having no increase or decrease in wages 
for the period after severance from employment.
    (C) Separate amendments for different plan populations. In lieu of a 
single amendment that applies to both currently employed participants 
and other participants as described in paragraph (c)(4)(i)(B) of this 
section, the employer can adopt multiple amendments--such as one that 
increases benefits for participants currently employed on the effective 
date of the current amendment and another one that increases benefits 
for other participants. In that case, the two amendments are considered 
separately in determining the increase in average wages, and the 
exception in this paragraph (c)(4)(i) applies separately to each 
amendment. Thus, the increase in benefits for currently employed 
participants takes effect if it satisfies the exception under this 
paragraph (c)(4), but the amendment increasing benefits for other 
participants who received no increase in wages from the employer during 
the period over which the increase in average wages is separately 
subject to the rules of this paragraph (c) without regard to the rules 
of this paragraph (c)(4).
    (ii) Plan provisions providing for accelerated vesting. To the 
extent that any amendment provides for (or any pre-existing plan 
provision results in) a mandatory increase in the vesting of benefits 
under the Code or ERISA (such as vesting rate increases pursuant to 
statute, plan termination amendments or

[[Page 1259]]

partial terminations under section 411(d)(3), and vesting increases 
required by the rules for top-heavy plans under section 416), that 
amendment (or pre-existing plan provision) does not constitute an 
amendment that changes the rate at which benefits become nonforfeitable 
for purposes of section 436(c) and this paragraph (c). However, this 
paragraph (c)(4)(ii) applies only to the extent the increase in vesting 
is necessary to enable the plan to continue to satisfy the requirements 
for qualified plans.
    (iii) Authority for additional exceptions. The Commissioner may, in 
guidance of general applicability, issue additional rules under which 
other amendments to a plan are not treated as amendments to which 
section 436(c) and this paragraph (c) apply. See Sec. 601.601(d)(2) 
relating to objectives and standards for publishing regulations, revenue 
rulings and revenue procedures in the Internal Revenue Bulletin.
    (5) Rule for determining when an amendment takes effect. For 
purposes of section 436(c) and this paragraph (c), in the case of an 
amendment that increases benefits, the amendment takes effect under a 
plan on the first date on which any individual who is or could be a 
participant or beneficiary under the plan would obtain a legal right to 
the increased benefit if the individual were on that date to satisfy the 
applicable requirements for entitlement to the benefit (such as the 
attainment of any age, performance of any service, receipt or derivation 
of any compensation, or the occurrence of death, disability, or 
severance from employment).
    (6) Treatment of mergers, consolidations, and transfers of plan 
assets into a plan. [Reserved]
    (d) Limitations on prohibited payments--(1) AFTAP less than 60 
percent. A plan satisfies the requirements of section 436(d)(1) and this 
paragraph (d)(1) only if the plan provides that, if the plan's adjusted 
funding target attainment percentage for a plan year is less than 60 
percent, a participant or beneficiary is not permitted to elect an 
optional form of benefit that includes a prohibited payment, and the 
plan will not pay any prohibited payment, with an annuity starting date 
on or after the applicable section 436 measurement date.
    (2) Bankruptcy. A plan satisfies the requirements of section 
436(d)(2) and this paragraph (d)(2) only if the plan provides that a 
participant or beneficiary is not permitted to elect an optional form of 
benefit that includes a prohibited payment, and the plan will not pay 
any prohibited payment, with an annuity starting date that occurs during 
any period in which the plan sponsor is a debtor in a case under title 
11, United States Code, or similar Federal or State law, except for 
payments made within a plan year with an annuity starting date that 
occurs on or after the date on which the enrolled actuary of the plan 
certifies that the plan's adjusted funding target attainment percentage 
for that plan year is not less than 100 percent.
    (3) Limited payment if AFTAP at least 60 percent but less than 80 
percent--(i) In general. A plan satisfies the requirements of section 
436(d)(3) and this paragraph (d)(3) only if the plan provides that, in 
any case in which the plan's adjusted funding target attainment 
percentage for a plan year is 60 percent or more but is less than 80 
percent, a participant or beneficiary is not permitted to elect the 
payment of an optional form of benefit that includes a prohibited 
payment, and the plan will not pay any prohibited payment, with an 
annuity starting date on or after the applicable section 436 measurement 
date, unless the present value, determined in accordance with section 
417(e)(3), of the portion of the benefit that is being paid in a 
prohibited payment (which portion is determined under paragraph 
(d)(3)(iii)(B) of this section) does not exceed the lesser of--
    (A) 50 percent of the present value (determined in accordance with 
section 417(e)(3)) of the benefit payable in the optional form of 
benefit that includes the prohibited payment; or
    (B) 100 percent of the PBGC maximum benefit guarantee amount 
described in paragraph (d)(3)(iii)(C) of this section.
    (ii) Bifurcation if optional form unavailable--(A) Requirement to 
offer bifurcation. If an optional form of benefit that is otherwise 
available under the terms of the plan is not available as of

[[Page 1260]]

the annuity starting date because of the application of paragraph 
(d)(3)(i) of this section, then the plan must permit the participant or 
beneficiary to elect to--
    (1) Receive the unrestricted portion of that optional form of 
benefit (determined under the rules of paragraph (d)(3)(iii)(D) of this 
section) at that annuity starting date, determined by treating the 
unrestricted portion of the benefit as if it were the participant's or 
beneficiary's entire benefit under the plan;
    (2) Commence benefits with respect to the participant's or 
beneficiary's entire benefit under the plan in any other optional form 
of benefit available under the plan at the same annuity starting date 
that satisfies paragraph (d)(3)(i) of this section; or
    (3) Defer commencement of the payments to the extent described in 
paragraph (d)(5) of this section.
    (B) Rules relating to bifurcation. If the participant or beneficiary 
elects payment of the unrestricted portion of the benefit as described 
in paragraph (d)(3)(ii)(A)(1) of this section, then the plan must permit 
the participant or beneficiary to elect payment of the remainder of the 
participant's or beneficiary's benefits under the plan in any optional 
form of benefit at that annuity starting date otherwise available under 
the plan that would not have included a prohibited payment if that 
optional form applied to the entire benefit of the participant or 
beneficiary. The rules of Sec. 1.417(e)-1 are applied separately to the 
separate optional forms for the unrestricted portion of the benefit and 
the remainder of the benefit (the restricted portion).
    (C) Plan alternative that anticipates election of payment that 
includes a prohibited payment. With respect to an optional form of 
benefit that includes a prohibited payment and that is not permitted to 
be paid under paragraph (d)(3)(i) of this section, for which no 
additional information from the participant or beneficiary (such as 
information regarding a social security leveling optional form of 
benefit) is needed to make that determination, rather than wait for the 
participant or beneficiary to elect such optional form of benefit, a 
plan is permitted to provide for separate elections with respect to the 
restricted and unrestricted portions of that optional form of benefit. 
However, the rule in the preceding sentence applies only if--
    (1) The plan applies the rule to all such optional forms; and
    (2) The plan identifies the option that the bifurcation election 
replaces.
    (iii) Definitions applicable to limited payment option--(A) In 
general. The definitions in this paragraph (d)(3)(iii) apply for 
purposes of this paragraph (d)(3).
    (B) Portion of benefit being paid in a prohibited payment. If a 
benefit is being paid in an optional form for which any of the payments 
is greater than the amount payable under a straight life annuity to the 
participant or beneficiary (plus any social security supplements 
described in the last sentence of section 411(a)(9) payable to the 
participant or beneficiary) with the same annuity starting date, then 
the portion of the benefit that is being paid in a prohibited payment is 
the excess of each payment over the smallest payment during the 
participant's lifetime under the optional form of benefit (treating a 
period after the annuity starting date and during the participant's 
lifetime in which no payments are made as a payment of zero).
    (C) PBGC maximum benefit guarantee amount. The PBGC maximum benefit 
guarantee amount described in this paragraph (d)(3)(iii)(C) is the 
present value (determined under guidance prescribed by the Pension 
Benefit Guaranty Corporation, using the interest and mortality 
assumptions under section 417(e)) of the maximum benefit guarantee with 
respect to a participant (based on the participant's age or the 
beneficiary's age at the annuity starting date) under section 4022 of 
ERISA for the year in which the annuity starting date occurs.
    (D) Unrestricted portion of the benefit--(1) General rule. Except as 
otherwise provided in this paragraph (d)(3)(iii)(D), the unrestricted 
portion of the benefit with respect to any optional form of benefit is 
50 percent of the amount payable under the optional form of benefit.
    (2) Special rule for forms which include social security leveling or 
a refund of employee contributions. For an optional

[[Page 1261]]

form of benefit that is a prohibited payment on account of a social 
security leveling feature (as defined in Sec. 1.411(d)-3(g)(16)) or a 
refund of employee contributions feature (as defined in Sec. 1.411(d)-
3(g)(11)), the unrestricted portion of the benefit is the optional form 
of benefit that would apply if the participant's or beneficiary's 
accrued benefit were 50 percent smaller.
    (3) Limited to PBGC maximum benefit guarantee amount. After the 
application of the preceding rules of this paragraph (d)(3)(iii)(D), the 
unrestricted portion of the benefit with respect to the optional form of 
benefit is reduced, to the extent necessary, so that the present value 
(determined in accordance with section 417(e)) of the unrestricted 
portion of that optional form of benefit does not exceed the PBGC 
maximum benefit guarantee amount (described in paragraph (d)(3)(iii)(C) 
of this section).
    (iv) Other rules--(A) One time application. A plan satisfies the 
requirements of this paragraph (d)(3) only if the plan provides that, in 
the case of a participant with respect to whom a prohibited payment (or 
series of prohibited payments under a single optional form of benefit) 
is made pursuant to paragraph (d)(3)(i) or (ii) of this section, no 
additional prohibited payment may be made with respect to that 
participant during any period of consecutive plan years for which 
prohibited payments are limited under this paragraph (d).
    (B) Treatment of beneficiaries. For purposes of this paragraph 
(d)(3), benefits provided with respect to a participant and any 
beneficiary of the participant (including an alternate payee, as defined 
in section 414(p)(8)) are aggregated. If the only benefits paid under 
the plan with respect to the participant are death benefits payable to 
the beneficiary, then paragraph (d)(3)(iii)(B) of this section is 
applied by substituting the lifetime of the beneficiary for the lifetime 
of the participant. If the accrued benefit of a participant is allocated 
to such an alternate payee and one or more other persons, then the 
unrestricted amount under paragraph (d)(3)(iii)(D) of this section is 
allocated among such persons in the same manner as the accrued benefit 
is allocated, unless a qualified domestic relations order (as defined in 
section 414(p)(1)(A)) with respect to the participant or the alternate 
payee provides otherwise. See paragraphs (j)(2)(ii) and (j)(6)(ii) of 
this section for other special rules relating to beneficiaries.
    (C) Treatment of annuity purchases and plan transfers. This 
paragraph (d)(3)(iv)(C) applies for purposes of applying paragraphs 
(d)(3)(i) and (iii)(D) of this section. In the case of a prohibited 
payment described in paragraph (j)(6)(i)(B) of this section (relating to 
purchase from an insurer), the present value of the portion of the 
benefit that is being paid in a prohibited payment is the cost to the 
plan of the irrevocable commitment and, in the case of a prohibited 
payment described in paragraph (j)(6)(i)(C) of this section (relating to 
certain plan transfers), the present value of the portion of the benefit 
that is being paid in a prohibited payment is the present value of the 
liabilities transferred (determined in accordance with section 414(l)). 
In addition, the present value of the accrued benefit is substituted for 
the present value of the benefit payable in the optional form of benefit 
that includes the prohibited payment in paragraph (d)(3)(i)(A) of this 
section. (Further, see Sec. 1.411(d)-4, A-2(a)(3)(ii), for a rule under 
section 411(d)(6) that applies to an optional form of benefit that 
includes a prohibited payment described in paragraph (j)(6)(i)(B) of 
this section.)
    (v) Examples. The following examples illustrate the rules of this 
paragraph (d)(3):

    Example 1. (i) Plan A has a plan year that is the calendar year, and 
is subject to the restriction on prohibited payments under paragraph 
(d)(3) of this section for the 2010 plan year. Participant P is not 
married, and retires at age 65 during 2010, while the restriction under 
paragraph (d)(3) of this section applies to Plan A. P's accrued benefit 
is $10,000 per month, payable commencing at age 65 as a straight life 
annuity. Plan A provides for an optional single-sum payment (subject to 
the restrictions under section 436) equal to the present value of the 
participant's accrued benefit using actuarial assumptions under section 
417(e). P's single-sum payment, determined without regard to this 
paragraph (d), is calculated to be $1,416,000, payable at age 65.
    (ii) The PBGC guaranteed monthly benefit for a straight life annuity 
payable at age 65

[[Page 1262]]

in 2010 (for purposes of this example) is assumed to be $4,500. The PBGC 
maximum benefit guarantee amount at age 65 is assumed to be $637,200 for 
2010.
    (iii) Because Participant P retires during a period when the 
restriction in paragraph (d)(3) of this section applies to Plan A, only 
a portion of the benefit can be paid in the form of a single sum. P 
elects a single-sum payment. Because a single-sum payment is a 
prohibited payment, a determination must be made whether the payment can 
be paid under paragraph (d)(3)(i) of this section. In this case, because 
the present value of the portion of Participant P's benefit that is 
being paid in a prohibited payment exceeds the lesser of 50% of the 
benefit or the PBGC maximum benefit guarantee amount, it cannot be paid 
under paragraph (d)(3)(i) of this section. Accordingly, the maximum 
single sum that P can receive is $637,200 (that is, the lesser of 50% of 
$1,416,000 or $637,200).
    (iv) Pursuant to paragraph (d)(3)(ii) of this section, Plan A must 
offer P the option to bifurcate the benefit into unrestricted and 
restricted portions. The unrestricted portion is a monthly straight life 
annuity of $4,500, which can be paid in a single sum of $637,200. If P 
elects to receive the unrestricted portion of the benefit in the form of 
a single sum, then, with respect to the $5,500 restricted portion, Plan 
A must permit P to elect any form of benefit that would otherwise be 
permitted with respect to the full $10,000 and that is not a prohibited 
payment. Alternatively, Plan A may provide that P is permitted to elect 
to defer commencement of the restricted portion, subject to applicable 
qualification rules.
    Example 2. (i) The facts are the same as in Example 1. In addition, 
Plan A provides an optional form of payment (subject to any benefit 
restrictions under section 436) that consists of a partial payment equal 
to the total return of employee contributions to the plan accumulated 
with interest, with an annuity payment for the remainder of the 
participant's benefit.
    (ii) Participant Q is not married, and retires at age 65 during 
2010, while Plan A is subject to the restriction under paragraph (d)(3) 
of this section. Participant Q has an accrued benefit equal to a 
straight life annuity of $3,000 per month. Under the optional form 
described in paragraph (i) of this Example 2, Q may elect a partial 
payment of $99,120 (representing the return of employee contributions 
accumulated with interest), plus a straight life annuity of $2,300 per 
month. The present value of Participant Q's accrued benefit, using 
actuarial assumptions under section 417(e), is $424,800.
    (iii) Because the present value of the portion of Q's benefit that 
is being paid in a prohibited payment ($99,120) does not exceed the 
lesser of 50% of the present value of benefits (50% of $424,800) or 100% 
of the PBGC maximum benefit guarantee amount ($637,200 at age 65 for 
2010), the optional form described in paragraph (i) of this Example 2 is 
permitted to be paid under paragraph (d)(3)(i) of this section.
    Example 3. (i) The facts are the same as in Example 1. In addition, 
Plan A provides an optional form of payment under a social security 
leveling option (subject to any benefit restrictions under section 436) 
that consists of an increased temporary benefit payable until age 62, 
with reduced payments beginning at age 62. The benefit is structured so 
that the combination of the participant's pension benefit and Social 
Security benefit provides an approximately level income for the 
participant's lifetime. The PBGC maximum benefit guarantee amount at age 
55 is assumed to be $362,776 for 2010.
    (ii) Participant R retires at age 55 in 2010 and is eligible to 
receive a level lifetime annuity of $1,200 per month beginning 
immediately. Instead, Participant R elects to receive a benefit under 
the social security leveling optional form of payment. Participant R's 
Social Security benefit payable at age 62 is projected, under the terms 
specified in Plan A, to be $1,500 per month. The Plan A adjustment 
factor for the social security leveling option using the minimum present 
value requirements of section 417(e)(3) is .590 at age 55. Therefore, 
Participant R's benefit payable from age 55 to age 62 is $2,085 per 
month ($1,200 + .590 x $1,500), and the benefit payable for 
Participant's lifetime, beginning after age 62, is $585 per month 
($2,085-$1,500).
    (iii) Because the optional form provides some payments which are 
greater than payments described in paragraph (j)(6)(i)(A) of this 
section ($1,200), the portion of the benefit that is being paid in a 
prohibited payment is $1,500 per month which is payable from age 55 to 
age 62. Using the applicable interest and mortality rates under section 
417(e) as in effect for Plan A at the time the benefit commences, the 
present value of a temporary benefit of $1,500 per month ($2,085-$585) 
payable from age 55 to age 62 is $106,417, and the present value of the 
entire benefit (a temporary benefit of $2,085 per month payable from age 
55 to age 62 plus a deferred lifetime benefit of $585 commencing at age 
62) is $207,468.
    (iv) Because $106,417 is more than 50% of $207,468 (and because 50% 
of Participant R's benefit is less than $362,776, which is the PBGC 
maximum guaranteed benefit amount at age 55 for 2010), Participant R can 
only receive 50% of the benefit in the form of the social security 
leveling option. Pursuant to paragraph (d)(3)(ii) of this section, Plan 
A must offer Participant R the option to bifurcate the benefit into 
unrestricted and restricted portions. Participant R elects to receive 
the restricted portion of the early retirement benefit as a level 
lifetime annuity of $600 commencing at age 55.

[[Page 1263]]

    (v) Participant R elects to receive the unrestricted portion of the 
early retirement benefit in the social security leveling form of 
payment. This portion of the benefit is determined under the social 
security leveling form of payment as if Participant R's benefit was one-
half of the early retirement benefit, or $600. However, using a monthly 
level lifetime benefit of $600 and a monthly social security benefit of 
$1,500, Participant R would have a negative benefit after age 62 ($600 + 
.590 x $1,500 is only $1,485; offsetting $1,500 at age 62 would produce 
a negative amount). Plan A provides that in this situation, the benefit 
under the social security leveling option is an actuarially equivalent 
monthly annuity payable until age 62, with zero payable thereafter. 
Using the actuarial equivalence factor of .590 at age 55, the plan 
administrator determines that the unrestricted portion of Participant 
R's benefit is $1,463 per month, payable from age 55 to age 62 ($600 + 
.590 x $1,463 = $1,463 payable until age 62; $1,463-$1,463 = zero 
payable after age 62).
    (vi) Combining the unrestricted and restricted portions of the 
benefit, Participant R will receive a total of $2,063 per month from age 
55 to age 62 ($1,463 from the unrestricted portion of the benefit plus 
$600 from the restricted portion of the benefit), and $600 per month 
beginning at age 62 (zero from the unrestricted portion of the benefit 
plus $600 from the restricted portion of the benefit).

    (4) Exception for cessation of benefit accruals. This paragraph (d) 
does not apply to a plan for a plan year if the terms of the plan, as in 
effect for the period beginning on September 1, 2005, provided for no 
benefit accruals with respect to any participants. If a plan that is 
described in this paragraph (d)(4) provides for benefit accruals during 
any time on or after September 1, 2005 (treating benefit increases 
pursuant to a plan amendment as benefit accruals), this paragraph (d)(4) 
ceases to apply for the plan as of the date any benefits accrue under 
the plan (or the date the amendment takes effect). For example, the 
exception in this paragraph (d)(4) does not apply to a plan after the 
plan increases benefits to take into account increases in the 
limitations under section 415(b) on or after September 1, 2005.
    (5) Right to delay commencement. If a participant or beneficiary 
requests a distribution in an optional form of benefit that includes a 
prohibited payment that is not permitted to be paid under paragraph 
(d)(1), (d)(2), or (d)(3) of this section, the participant retains the 
right to delay commencement of benefits in accordance with the terms of 
the plan and applicable qualification requirements (such as sections 
411(a)(11) and 401(a)(9)).
    (6) Plan alternative for special optional forms. A plan is permitted 
to offer optional forms of benefit that are solely available during the 
period in which paragraph (d)(1), (d)(2), or (d)(3) of this section 
applies to limit prohibited payments under the plan. For example, a plan 
may permit participants or beneficiaries who commence benefits during 
the period in which paragraph (d)(1) of this section (or paragraph 
(d)(2) of this section) applies to limit prohibited payments under the 
plan to elect, within a specified period after the date on which that 
paragraph ceases to apply to limit prohibited payments under the plan, 
to receive the remaining benefit in the form of a single-sum payment 
equal to the present value of the remaining benefit, but only to the 
extent then permitted under this paragraph (d). As another example, 
during a period when paragraph (d)(3) of this section applies to a plan, 
the plan may permit participants and beneficiaries to elect payment in 
an optional form of benefit that provides for the current payment of the 
unrestricted portion of the benefit, with a delayed commencement for the 
restricted portion of the benefit (subject to other applicable 
qualification requirements, such as sections 411(a)(11) and 401(a)(9)), 
or may satisfy paragraph (d)(3)(i) of this section by permitting 
participants and beneficiaries to elect an optional form of benefit that 
combines an unsubsidized single-sum payment for over 50 percent of the 
accrued benefit with a subsidized early retirement life annuity for the 
remainder of the accrued benefit. Any such optional forms must satisfy 
this paragraph (d) and applicable qualification requirements, including 
satisfaction of section 417(e) and section 415 (at each annuity starting 
date).
    (7) Exception for distributions permitted without consent of the 
participant under section 411(a)(11). [Reserved]
    (e) Limitation on benefit accruals for plans with severe funding 
shortfalls--(1)

[[Page 1264]]

In general. Except as otherwise provided in this paragraph (e), a plan 
satisfies the requirements of section 436(e) and this paragraph (e) only 
if it provides that, in any case in which the plan's adjusted funding 
target attainment percentage for a plan year is less than 60 percent, 
benefit accruals under the plan will cease as of the applicable section 
436 measurement date. If a plan is required to cease benefit accruals 
under this paragraph (e), then the plan is not permitted to be amended 
in a manner that would increase the liabilities of the plan by reason of 
an increase in benefits or establishment of new benefits. The preceding 
sentence applies regardless of whether an amendment would otherwise be 
permissible under paragraph (c)(2) or (c)(3) of this section.
    (2) Exemption if section 436 contribution is made. The prohibition 
on additional benefit accruals under a plan described in paragraph 
(e)(1) of this section ceases to apply with respect to a plan year, 
effective as of the first day of the plan year, upon payment by the plan 
sponsor of the contribution described in paragraph (f)(2)(v) of this 
section. See paragraph (f) of this section for additional rules.
    (3) Special rule under section 203 of the Worker, Retiree, and 
Employer Recovery Act of 2008. [Reserved]
    (f) Methods to avoid or terminate benefit limitations--(1) In 
general. This paragraph (f) sets forth rules relating to employer 
contributions and other methods to avoid or terminate the application of 
section 436 limitations under a plan for a plan year. In general, there 
are four methods a plan sponsor may utilize to avoid or terminate one or 
more of the benefit limitations under this section for a plan year. Two 
of these methods (where the plan sponsor elects to reduce the prefunding 
balance or funding standard carryover balance and where the plan sponsor 
makes additional contributions under section 430 for the prior plan year 
within the time period provided by section 430(j)(1) that are not added 
to the prefunding balance) involve increasing the amount of plan assets 
which are taken into account in determining the adjusted funding target 
attainment percentage. The other two methods (making a contribution that 
is specifically designated as a current year contribution to avoid or 
terminate application of a benefit limitation under paragraph (b), (c), 
or (e) of this section, and providing security under section 436(f)(1)) 
are described in paragraphs (f)(2) and (f)(3) of this section, 
respectively.
    (2) Current year contributions to avoid or terminate benefit 
limitations--(i) General rules--(A) Amount of contribution--(1) In 
general. This paragraph (f)(2) sets forth rules regarding contributions 
to avoid or terminate the application of section 436 limitations under a 
plan for a plan year that apply to unpredictable contingent event 
benefits, plan amendments that increase liabilities for benefits, and 
benefit accruals.
    (2) Interest adjustment. Any contribution made by a plan sponsor 
pursuant to this paragraph (f)(2) on a date other than the valuation 
date for the plan year must be adjusted with interest at the plan's 
effective interest rate under section 430(h)(2)(A) for the plan year. If 
the plan's effective interest rate for the plan year has not been 
determined at the time of the contribution, then this interest 
adjustment must be made using the highest of the three segment rates as 
applicable for the plan year under section 430(h)(2)(C). In such a case, 
if the effective interest rate for the plan year under section 
430(h)(2)(A) is subsequently determined to be less than that highest 
rate, the excess is recharacterized as an employer contribution taken 
into account under section 430 for the current plan year.
    (B) Timing requirement for section 436 contributions. Any 
contribution described in this paragraph (f)(2) must be paid before the 
unpredictable contingent event benefits are permitted to be paid, the 
plan amendment is permitted to take effect, or the benefit accruals are 
permitted to resume. In addition, any contribution described in this 
paragraph (f)(2) must be paid during the plan year.
    (C) Prefunding balance or funding standard carryover balance may not 
be used. No prefunding balance or funding standard carryover balance 
under section 430(f) may be used as a contribution described in this 
paragraph (f)(2). However, a plan sponsor is permitted

[[Page 1265]]

to elect to reduce the funding standard carryover balance or the 
prefunding balance in order to increase the adjusted funding target 
attainment percentage for a plan year. See paragraph (a)(5) of this 
section for a rule mandating such a reduction in certain situations.
    (ii) Section 436 contributions separate from minimum required 
contributions--(A) In general. The contributions described in this 
paragraph (f)(2) are contributions described in sections 436(b)(2), 
436(c)(2), and 436(e)(2), and are separate from any minimum required 
contributions under section 430. Thus, if a plan sponsor makes a 
contribution described in this paragraph (f)(2) for a plan year but does 
not make the minimum required contribution for the plan year, the plan 
fails to satisfy the minimum funding requirements under section 430 for 
the plan year. In addition, a contribution described in this paragraph 
(f)(2) is disregarded in determining the maximum addition to the 
prefunding balance under section 430(f)(6) and Sec. 1.430(f)-
1(b)(1)(ii).
    (B) Designation requirement. Any contribution made by a plan sponsor 
pursuant to this paragraph (f)(2) must be designated as such at the time 
the contribution is used to avoid or terminate the limitations under 
this paragraph (f)(2), including designation of the benefits or 
amendments to which the limits do not apply because of the contribution. 
Except as specifically provided in paragraph (f)(2)(i)(A)(2), (g) or (h) 
of this section, such a contribution cannot be subsequently 
recharacterized with respect to any plan year as a contribution to 
satisfy a minimum required contribution obligation, or otherwise. The 
designation must be made in accordance with the rules and procedures 
that otherwise apply to elections under Sec. 1.430(f)-1(f) with respect 
to the prefunding and funding standard carryover balances.
    (C) Requirement to recertify AFTAP. If the plan's enrolled actuary 
has already certified the adjusted funding target attainment percentage 
for the plan year, a plan sponsor is treated as making the contribution 
described in paragraph (f)(2)(iii)(B), (f)(2)(iv)(B), or (f)(2)(v) of 
this section for the plan year only after the plan's enrolled actuary 
certifies an updated adjusted funding target attainment percentage for 
the plan year that takes into account the increased liability for the 
unpredictable contingent event benefits, the plan amendments, or 
restored accruals, and the associated section 436 contribution, under 
the rules of paragraph (h)(4)(v) of this section. See also paragraph 
(g)(4)(i) of this section for a requirement to modify the presumed 
adjusted funding target attainment percentage to take the liability for 
the unpredictable contingent event benefits or plan amendments, and the 
associated section 436 contribution, into account (if the contribution 
described in paragraph (f)(2)(iii)(B), (f)(2)(iv)(B), or (f)(2)(v) of 
this section is made before the plan's enrolled actuary certifies the 
adjusted funding target attainment percentage for the plan year).
    (iii) Contribution for unpredictable contingent event benefits. In 
the case of a contribution to avoid or terminate the application of the 
limitation on benefits attributable to an unpredictable contingent event 
under section 436(b)--
    (A) In the event that the adjusted funding target attainment 
percentage for the plan year determined without taking into account the 
liability attributable to the unpredictable contingent event benefits is 
less than 60 percent, the amount of the contribution under section 
436(b)(2) is equal to the amount of the increase in the funding target 
of the plan for the plan year if the benefits attributable to the 
unpredictable contingent event were included in the determination of the 
funding target.
    (B) In the event that the adjusted funding target attainment 
percentage for the plan year determined without taking into account the 
liability attributable to the unpredictable contingent event benefits is 
60 percent or more, the amount of the contribution under section 
436(b)(2) is the amount that would be sufficient to result in an 
adjusted funding target attainment percentage for the plan year of 60 
percent if the contribution (and any prior section 436 contributions 
made for the plan year) were included as part of the plan assets and the 
funding target were to take into account the adjustments described in 
paragraph (g)(2)(iii)(A),

[[Page 1266]]

(g)(3)(ii)(A), or (g)(5)(i)(B) of this section, whichever applies.
    (iv) Contribution for plan amendments increasing liability for 
benefits. In the case of a contribution to avoid or terminate the 
application of the limitation on benefits attributable to a plan 
amendment under section 436(c)--
    (A) In the event that the adjusted funding target attainment 
percentage for the plan year determined without taking into account the 
liability attributable to the plan amendment is less than 80 percent, 
the amount of the contribution under section 436(c)(2) is equal to the 
amount of the increase in the funding target of the plan for the plan 
year if the liabilities attributable to the amendment were included in 
the determination of the funding target.
    (B) In the event that the adjusted funding target attainment 
percentage for the plan year determined without taking into account the 
liability attributable to the plan amendment is 80 percent or more, the 
amount of the contribution under section 436(c)(2) is the amount that 
would be sufficient to result in an adjusted funding target attainment 
percentage for the plan year of 80 percent if the contribution (and any 
prior section 436 contributions made for the plan year) were included as 
part of the plan assets and the funding target were to take into account 
the adjustments described in paragraph (g)(2)(iii)(A), (g)(3)(ii)(A), or 
(g)(5)(i)(B) of this section, whichever applies.
    (v) Contribution required for continued benefit accruals. In the 
case of a contribution to avoid or terminate the application of the 
limitation on accruals under section 436(e), the amount of the 
contribution under section 436(e)(2) is equal to the amount sufficient 
to result in an adjusted funding target attainment percentage for the 
plan year of 60 percent if the contribution (and any prior section 436 
contributions made for the plan year) were included as part of the plan 
assets and the funding target were to take into account the adjustments 
described in paragraph (g)(2)(iii)(A) or (g)(5)(i)(B) of this section, 
whichever applies.
    (3) Security to increase adjusted funding target attainment 
percentage--(i) In general. For purposes of avoiding benefit limitations 
under section 436, a plan sponsor may provide security in the form 
described in paragraph (f)(3)(ii) of this section. In such a case, the 
adjusted funding target attainment percentage for the plan year is 
determined by treating as an asset of the plan any security provided by 
a plan sponsor by the valuation date for the plan year in a form meeting 
the requirements of paragraph (f)(3)(ii) of this section. However, this 
security is not taken into account as a plan asset for any other 
purpose, including section 430.
    (ii) Form of security. The forms of security permitted under 
paragraph (f)(3)(i) of this section are limited to--
    (A) A bond issued by a corporate surety company that is an 
acceptable surety for purposes of section 412 of ERISA; or
    (B) Cash, or United States obligations which mature in 3 years or 
less, held in escrow by a bank or an insurance company.
    (iii) Enforcement. Any form of security provided under paragraph 
(f)(3)(i) of this section must provide--
    (A) That it will be paid to the plan upon the earliest of--
    (1) The plan termination date as defined in section 4048 of ERISA;
    (2) If there is a failure to make a payment of the minimum required 
contribution for any plan year beginning after the security is provided, 
the due date for the payment under section 430(j)(1) or 430(j)(3); or
    (3) If the plan's adjusted funding target attainment percentage is 
less than 60 percent (without regard to any security provided under this 
paragraph (f)(3)) for a consecutive period of 7 plan years, the 
valuation date for the last plan year in the 7-year period; and
    (B) That the plan administrator must notify the surety, bank, or 
insurance company that issued or holds the security of any event 
described in paragraph (f)(3)(iii)(A) of this section within 10 days of 
its occurrence.
    (iv) Release of security. The form of security is permitted to 
provide that it will be released (and any amounts thereunder will be 
refunded to the plan sponsor together with any interest accrued thereon) 
as provided in the agreement governing the security, but such release is 
not permitted until the

[[Page 1267]]

plan's enrolled actuary has certified that the plan's adjusted funding 
target attainment percentage for a plan year is at least 90 percent 
(without regard to any security provided under this paragraph (f)(3)) or 
until replacement security has been provided in accordance with 
paragraph (f)(3)(vi) of this section.
    (v) Contribution of security to plan. Any security provided under 
this paragraph (f)(3) that is subsequently turned over to the plan 
(whether pursuant to the enforcement mechanism of paragraph (f)(3)(iii) 
of this section or after its release under paragraph (f)(3)(iv) of this 
section) is treated as a contribution by the plan sponsor taken into 
account under section 430 when contributed and, if turned over pursuant 
to paragraph (f)(3)(iii) of this section, is not a contribution under 
paragraph (f)(2) of this section.
    (vi) Replacement security. If security has been provided to a plan 
pursuant to this paragraph (f)(3), the plan sponsor may provide new 
security to the plan and subsequently or simultaneously have the 
original security released, but only if--
    (A) The new security is in a form that satisfies the requirements of 
paragraph (f)(3)(ii) of this section;
    (B) The amount of the new security is no less than the amount of the 
original security, determined at the time the original security is 
released; and
    (C) The period described in paragraph (f)(3)(iii)(A)(3) of this 
section with respect to the new security is the same as the period that 
applied under that paragraph to the original security.
    (4) Examples. The following examples illustrate the rules of this 
paragraph (f):

    Example 1. (i) Plan Z is a non-collectively bargained defined 
benefit plan with a plan year that is the calendar year and a valuation 
date of January 1. Plan Z's sponsor is not in bankruptcy, and Plan Z did 
not purchase any annuities in 2009 or 2010. As of January 1, 2011, Plan 
Z does not have a funding standard carryover balance or a prefunding 
balance, and is not in at-risk status. As of that date, Plan Z has plan 
assets (and adjusted plan assets) of $2,000,000 and a funding target 
(and an adjusted funding target) of $2,550,000. On March 1, 2011, the 
enrolled actuary for the plan certifies that the AFTAP as of January 1, 
2011, is 78.43%. The effective interest rate for Plan Z for the 2011 
plan year is 5.5%.
    (ii) On May 1, 2011, the plan sponsor amends Plan Z to increase 
benefits. The enrolled actuary for the plan determines that the present 
value, as of January 1, 2011, of the increase in the funding target due 
to the amendment is $400,000. Because the AFTAP prior to the plan 
amendment is less than 80%, Plan Z is subject to the restriction on plan 
amendments in paragraph (c) of this section, and the amendment cannot 
take effect unless the employer utilizes one of the methods described in 
paragraph (f) of this section to avoid benefit limitations.
    (iii) In order for the amendment to be permitted to take effect, the 
plan sponsor makes a contribution described in paragraph (f)(2) of this 
section. Because the AFTAP prior to the amendment was less than 80%, the 
provisions of paragraph (f)(2)(iv)(A) of this section apply. The amount 
of the contribution as of January 1, 2011, needed to avoid the 
restriction on plan amendments under paragraph (c) of this section is 
equal to the amount of the increase in funding target attributable to 
the amendment, or $400,000. Under the provisions of paragraph 
(f)(2)(iv)(A) of this section, this contribution is required even 
though, if the contribution were included as part of the plan assets and 
the liabilities attributable to the plan amendment were included in the 
funding target, the AFTAP would be 81.36% (that is, adjusted plan assets 
of $2,000,000 plus the contribution of $400,000 as of January 1, 2011; 
divided by the adjusted funding target of $2,550,000 increased to 
reflect the additional $400,000 in the funding target attributable to 
the plan amendment).
    (iv) However, because the contribution is not paid until May 1, 
2011, the necessary contribution amount must be adjusted to reflect 
interest from the valuation date to the date of the contribution, at 
Plan Z's effective interest rate for the 2011 plan year. The amount of 
the required contribution after adjustment is $407,203, determined as 
$400,000 increased for 4 months of compound interest at an effective 
annual interest rate of 5.5%.
    (v) A contribution of $407,203 is made on May 1, 2011, and is 
designated as a contribution under paragraph (f)(2) of this section with 
respect to the May 1, 2011, plan amendment. Accordingly, the 
contribution is not applied toward minimum funding requirements under 
section 430, and is not eligible for inclusion in the prefunding balance 
under Sec. 1.430(f)-1(b)(1). Since this contribution meets the 
requirements of paragraph (f)(2) of this section, the plan amendment 
takes effect in accordance with its terms.
    Example 2. (i) The facts are the same as in Example 1, except that 
the plan is in at-risk status under section 430(i). The funding target 
determined under section 430(i) is $2,600,000, and the funding target 
determined without regard to section 430(i) is $2,550,000.

[[Page 1268]]

    (ii) On May 1, 2011, the plan sponsor amends Plan Z to increase 
benefits. The plan's enrolled actuary determines that the present value 
as of January 1, 2011 of the increase in the funding target due to the 
amendment (taking into account the at-risk status of the plan) is 
$440,000. Because the AFTAP prior to the plan amendment is 78.43% 
(determined taking into account the at-risk status of Plan Z), Plan Z is 
subject to the restriction on plan amendments in paragraph (c) of this 
section, and the amendment cannot take effect unless the employer 
utilizes one of the methods described in this paragraph (f) to avoid 
benefit limitations.
    (iii) In order for this amendment to be permitted to take effect, 
the plan sponsor makes a contribution described in paragraph (f)(2) of 
this section. Because the AFTAP prior to the amendment was less than 
80%, the provisions of paragraph (f)(2)(iv)(A) of this section apply. 
The amount of the contribution as of January 1, 2011, needed to avoid 
the restriction on plan amendments under paragraph (c) of this section 
is equal to the amount of the increase in funding target attributable to 
the amendment, or $440,000. Under the provisions of paragraph 
(f)(2)(iv)(A) of this section, this contribution is required even 
though, if the contribution were included as part of the plan assets and 
the liability attributable to the plan amendment were included in the 
funding target, the AFTAP would exceed 80%.
    (iv) However, because the contribution is not paid until May 1, 
2011, the necessary contribution amount must be adjusted to reflect 
interest from the valuation date to the date of the contribution, at 
Plan Z's effective interest rate for the 2011 plan year. The amount of 
the required contribution after adjustment is $447,923, determined as 
$440,000 increased for 4 months of compound interest at an effective 
annual interest rate of 5.5%.
    (v) A contribution of $447,923 is made on May 1, 2011, and is 
designated as a contribution under paragraph (f)(2) of this section with 
respect to the May 1, 2011, plan amendment. Accordingly, the 
contribution is not applied toward minimum funding requirements under 
section 430, and is not eligible for inclusion in the prefunding balance 
under Sec. 1.430(f)-1(b)(1). Since this contribution meets the 
requirements of paragraph (f)(2) of this section, the plan amendment 
takes effect in accordance with its terms.
    Example 3. (i) The facts are the same as in Example 1, except that 
the enrolled actuary for the plan does not issue the certification of 
the 2011 AFTAP until September 1, 2011. Prior to October 1, 2010, the 
enrolled actuary had certified the 2010 AFTAP to be 82%. Other than this 
amendment, no other amendment or unpredictable contingent event has 
occurred that requires a recertification. As of May 1, 2011, the plan's 
effective interest rate for the 2011 plan year has not yet been 
determined. The highest of the three segment rates applicable to the 
2011 plan year under section 430(h)(2)(C) is 6%.
    (ii) Because the enrolled actuary has not certified the actual AFTAP 
as of January 1, 2011, and the amendment is scheduled to take effect 
after April 1, 2011, the rules of paragraph (h)(2)(iii) of this section 
apply. Accordingly, the AFTAP for 2011 (prior to reflecting the effect 
of the amendment) is presumed to be 10 percentage points lower than the 
2010 AFTAP, or 72%. Because this presumed AFTAP is less than 80%, the 
restriction on plan amendments in paragraph (c) of this section applies, 
and the plan amendment cannot take effect.
    (iii) In order to allow the plan amendment to take effect, the plan 
sponsor decides to make a contribution under paragraph (f)(2) of this 
section on May 1, 2011. Because the presumed AFTAP was less than 80% 
prior to reflecting the plan amendment, the rules of paragraph 
(f)(2)(iv)(A) of this section apply, and the amount of the contribution 
under section 436(c)(2) is the amount of the increase in the funding 
target for the year if the plan amendment were included in the 
determination of the funding target. Accordingly, an additional 
contribution of $400,000 is required as of January 1, 2011, to avoid the 
restriction on plan amendments under paragraph (c) of this section.
    (iv) However, since the contribution is not made until May 1, 2011, 
the amount of the required contribution must be adjusted to reflect 
interest from the valuation date to the date of the contribution. Since 
the effective interest rate has not yet been determined, the interest 
adjustment is based on the highest of the three segment rates applicable 
for the 2011 plan year under section 430(h)(2)(C), or 6%. The amount of 
the required contribution after adjustment is $407,845, determined as 
$400,000 increased for 4 months of compound interest at the highest 
segment interest rate for 2011, or 6%.
    (v) A contribution of $407,845 is made on May 1, 2011, and is 
designated as a contribution under paragraph (f)(2) of this section with 
respect to the May 1, 2011, plan amendment. Accordingly, the 
contribution is not applied toward minimum funding requirements under 
section 430, and is not eligible for inclusion in the prefunding balance 
under Sec. 1.430(f)-1(b)(1). Since this contribution meets the 
requirements of paragraph (f)(2) of this section, the plan amendment 
takes effect in accordance with its terms.
    (vi) After the plan's effective interest rate for 2011 has been 
determined to be 5.5%, the amount of excess interest previously 
contributed is recharacterized as an employer contribution taken into 
account under section 430 for 2011 (because that rate for the year is 
less than 6%).


[[Page 1269]]


    (g) Rules of operation for periods prior to and after 
certification--(1) In general. Section 436(h) and paragraph (h) of this 
section set forth a series of presumptions that apply before the 
enrolled actuary for a plan issues a certification of the plan's 
adjusted funding target attainment percentage for the plan year. This 
paragraph (g) sets forth rules for the application of limitations under 
sections 436(b), 436(c), 436(d), and 436(e) prior to and during the 
period those presumptions apply to the plan, and describes the 
interaction of those presumptions with plan operations after the plan's 
enrolled actuary has issued a certification of the plan's adjusted 
funding target attainment percentage for the plan year. Paragraph (g)(2) 
of this section sets forth rules that apply to periods during which a 
presumption under section 436(h) and paragraph (h) of this section 
applies. Paragraph (g)(3) of this section sets forth rules that apply to 
periods during which no presumptions under section 436(h) and paragraph 
(h) of this section apply but which are prior to the enrolled actuary's 
certification of the plan's adjusted funding target attainment 
percentage for the plan year. Paragraph (g)(4) of this section sets 
forth rules for modifying the plan's presumed adjusted funding target 
attainment percentage in certain situations. Paragraph (g)(5) of this 
section sets forth rules that apply after the enrolled actuary's 
certification of the plan's adjusted funding target attainment 
percentage for a plan year. Paragraph (g)(6) of this section sets forth 
examples illustrating the rules in this paragraph (g).
    (2) Periods prior to certification during which a presumption 
applies--(i) Plan must follow presumptions. A plan must provide that, 
for any period during which a presumption under section 436(h) and 
paragraph (h)(1), (2), or (3) of this section applies to the plan, the 
limitations applicable under section 436 and paragraphs (b), (c), (d), 
and (e) of this section are applied to the plan as if the adjusted 
funding target attainment percentage for the year were the presumed 
adjusted funding target attainment percentage determined under the rules 
of section 436(h) and paragraph (h)(1), (2), or (3) of this section, as 
applicable, updated to take into account certain unpredictable 
contingent event benefits and plan amendments in accordance with section 
436 and the rules of this paragraph (g).
    (ii) Determination of amount of reduction in balances--(A) In 
general. During the period described in this paragraph (g)(2), the rules 
of paragraph (a)(5) of this section (relating to the deemed election to 
reduce the funding standard carryover balance and the prefunding 
balance) must be applied based on the presumed adjusted funding target 
attainment percentage. This paragraph (g)(2)(ii) provides rules for the 
determination of the reduction that applies as of the first day of the 
plan year, and, in certain circumstances, that applies later in the plan 
year. Paragraph (g)(2)(iii) of this section provides additional rules 
that apply with respect to unpredictable contingent event benefits or 
plan amendments, which rules must be applied prior to the application of 
paragraph (g)(2)(iv) of this section relating to section 436 
contributions. The reapplication of the rules under this paragraph 
(g)(2) regarding the deemed election in paragraph (a)(5) of this section 
may require an additional reduction in the prefunding and funding 
standard carryover balances if the amount of the reduction in those 
balances that is necessary to reach the applicable threshold to avoid 
the application of a section 436 limitation exceeds the amount that was 
initially reduced. Prior reductions of the prefunding and funding 
standard carryover balances continue to apply.
    (B) Reduction in balances at the first day of plan year--(1) Plans 
with a certified AFTAP for the prior plan year. If section 436(h)(1) and 
paragraph (h)(1) of this section apply to determine the presumed 
adjusted funding target attainment percentage as of the first day of the 
current plan year based on the plan's enrolled actuary certification of 
the adjusted funding target attainment percentage for the prior plan 
year made during that prior plan year, then, in order to determine the 
amount of the reduction (if any) in the funding standard carryover 
balance and prefunding balance under this paragraph (g)(2)(ii), a 
presumed adjusted

[[Page 1270]]

funding target must be established as of the first day of the plan year, 
and that amount is then compared to the interim value of adjusted plan 
assets as of that date. For this purpose, the interim value of adjusted 
plan assets is equal to the value of adjusted plan assets (within the 
meaning of paragraph (j)(1)(ii) of this section) as of the first day of 
the plan year, determined without regard to future contributions and 
future elections with respect to the plan's prefunding and funding 
standard carryover balances under section 430(f) (for example, elections 
to add to the prefunding balance for the prior plan year, elections to 
use the prefunding and funding standard carryover balances to offset the 
minimum required contribution for a year, and elections (including 
deemed elections under paragraph (a)(5) of this section) to reduce the 
prefunding and funding standard carryover balances for the current plan 
year), and the presumed adjusted funding target is equal to the interim 
value of adjusted plan assets for the plan year divided by the presumed 
adjusted funding target attainment percentage. As provided in Sec. 
1.430(f)-1(e)(1), the rules of Sec. 1.430(f)-1(d)(1)(ii) apply for 
purposes of determining the amount of the prefunding balance or the 
funding standard carryover balance that is available for reduction.
    (2) Plans with presumed AFTAP deemed under 60 percent. If paragraph 
(g)(2)(ii)(B)(1) of this section does not apply to the plan for a plan 
year and the last day of the plan year is on or after the first day of 
the 10th month of the plan year, such that the presumed adjusted funding 
target attainment percentage for the prior plan year is conclusively 
presumed to be less than 60 percent under section 436(h)(2) and 
paragraph (h)(3) of this section, then no reduction in the funding 
standard carryover balance and prefunding balance is required under this 
paragraph (g)(2)(ii)(B). However, see paragraph (g)(2)(iv)(A) of this 
section for rules for determining the amount of a section 436 
contribution that would permit unpredictable contingent event benefits 
to be paid in such a case.
    (3) Treatment of short plan years. If paragraph (g)(2)(ii)(B)(1) of 
this section does not apply to the plan for a plan year but the last day 
of the plan year is before the first day of the 10th month of the plan 
year, such that section 436(h)(2) and paragraph (h)(3) of this section 
did not apply for that plan year, then paragraph (g)(2)(ii)(B)(1) of 
this section must be applied as of the first day of the next plan year 
based on the presumed adjusted funding target attainment percentage as 
of that last day of the prior short plan year.
    (C) Change in presumed AFTAP later in the plan year. If the presumed 
adjusted funding target attainment percentage for the plan year changes 
during the year, the rules regarding the deemed election to reduce the 
prefunding and funding standard carryover balances described in 
paragraph (a)(5) of this section must be reapplied based on the new 
presumed adjusted funding target attainment percentage. This will 
typically occur on the first day of the 4th month of a plan year, but 
could happen at a different date if the enrolled actuary certifies the 
adjusted funding target attainment percentage for the prior plan year 
during the current plan year. In order to determine the amount of any 
reduction in the prefunding and funding standard carryover balances that 
would apply in such a situation, a new presumed adjusted funding target 
must be established, which is then compared to the updated interim value 
of adjusted plan assets. For this purpose, the updated interim value of 
adjusted plan assets for the plan year is determined as the interim 
value of adjusted plan assets as of the first day of the plan year 
updated to take into account contributions for the prior plan year and 
section 430(f) elections with respect to the plan's prefunding and 
funding standard carryover balances made before the date of the change 
in the presumed adjusted funding target attainment percentage, and the 
new presumed adjusted funding target is equal to the updated interim 
value of adjusted plan assets divided by the new presumed adjusted 
funding target attainment percentage.
    (D) Plans funded below the threshold. If, after application of 
paragraph (g)(2)(ii)(B) and (C) of this section, the

[[Page 1271]]

presumed adjusted funding target attainment percentage under this 
paragraph (g)(2)(ii) is less than the 60 percent threshold under section 
436(e), then no benefit accruals are permitted under the plan unless the 
plan sponsor makes a section 436 contribution as provided in paragraph 
(g)(2)(iv)(A) of this section. See paragraph (g)(5)(ii) of this section 
for rules that apply on and after the date the enrolled actuary for the 
plan issues a certification of the adjusted funding target attainment 
percentage of the plan for the current plan year.
    (iii) Calculation of inclusive presumed AFTAP for application to 
unpredictable contingent event benefits and plan amendments--(A) 
Requirement to calculate inclusive presumed AFTAP. For purposes of 
applying the limitations under paragraphs (b) and (c) of this section 
during the period described in this paragraph (g)(2), an inclusive 
presumed adjusted funding target attainment percentage must be 
calculated. The inclusive presumed adjusted funding target attainment 
percentage is the ratio (expressed as a percentage) of the interim value 
of adjusted plan assets (updated to take into account contributions for 
the prior plan year, any prior section 436 contributions made for the 
plan year to the extent not previously taken into account in the interim 
value of adjusted plan assets for the plan year, and section 430(f) 
elections with respect to the plan's prefunding and funding standard 
carryover balances made before the date of the unpredictable contingent 
event or the date the plan amendment would take effect) to the inclusive 
presumed adjusted funding target. The inclusive presumed adjusted 
funding target is calculated as the presumed adjusted funding target 
determined under paragraph (g)(2)(ii)(B) or (C) of this section, 
increased to take into account--
    (1) The unpredictable contingent event benefits or plan amendment;
    (2) Any unpredictable contingent event benefits that are permitted 
to be paid as a result of any unpredictable contingent event that 
occurred, or plan amendment that has taken effect, in the prior plan 
year to the extent not taken into account in the prior plan year 
adjusted funding target attainment percentage; and
    (3) Any other unpredictable contingent event benefits that are 
permitted to be paid as a result of any unpredictable contingent event 
that occurred, or plan amendment that has taken effect, in the current 
plan year to the extent not previously taken into account in the 
presumed adjusted funding target for the plan year.
    (B) Mandatory reduction for collectively bargained plans. During the 
period described in this paragraph (g)(2), the rules of paragraph 
(a)(5)(ii) of this section (relating to the deemed election to reduce 
the funding standard carryover balance and the prefunding balance) must 
be applied by treating the inclusive presumed adjusted funding target 
attainment percentage determined under this paragraph (g)(2)(iii) as if 
it were the adjusted funding target attainment percentage.
    (C) Optional reduction for plans that are not collectively bargained 
plans. A plan sponsor of a plan that is not a collectively bargained 
plan (and, thus, is not required to reduce the funding standard 
carryover balance and the prefunding balance under the rules of 
paragraph (a)(5)(ii) of this section) is permitted to elect to reduce 
those balances in order to increase the updated interim value of 
adjusted plan assets that is used to determine the inclusive presumed 
adjusted funding target attainment percentage under this paragraph 
(g)(2)(iii).
    (D) Plans funded below the threshold. If, after application of 
paragraph (g)(2)(iii)(B) and (C) of this section, the inclusive presumed 
adjusted funding target attainment percentage determined under this 
paragraph (g)(2)(iii) is less than the applicable threshold under 
section 436(b) or 436(c), then the plan is not permitted to provide any 
benefits attributable to the unpredictable contingent event, nor is the 
plan amendment permitted to take effect, unless the plan sponsor makes a 
section 436 contribution as provided in paragraph (g)(2)(iv) of this 
section. See paragraph (g)(5)(ii) of this section for rules that apply 
on and after the date the enrolled actuary for the plan issues a 
certification of the adjusted funding

[[Page 1272]]

target attainment percentage of the plan for the current plan year.
    (E) Plans funded at or above the threshold. If, after application of 
paragraph (g)(2)(iii)(B) or (C) of this section, the inclusive presumed 
adjusted funding target attainment percentage is greater than or equal 
to the applicable threshold under section 436(b) or 436(c), then the 
plan is not permitted to limit the payment of unpredictable contingent 
event benefits described in paragraph (b) of this section, nor is the 
plan permitted to restrict a plan amendment increasing benefit 
liabilities described in paragraph (c) of this section from taking 
effect, based on an expectation that the limitations under paragraph (b) 
or (c) of this section will apply following the enrolled actuary's 
certification of the adjusted funding target attainment percentage for 
the plan year.
    (iv) Section 436 contributions--(A) Plans with presumed AFTAP below 
60 percent--(1) Unpredictable contingent event benefits. If the presumed 
adjusted funding target attainment percentage for a plan is less than 60 
percent, then unpredictable contingent event benefits are permitted to 
be paid as a result of an unpredictable contingent event occurring 
during the period described in this paragraph (g)(2) if the plan sponsor 
makes the section 436 contribution described in paragraph (f)(2)(iii)(A) 
of this section.
    (2) Plan amendments. If the presumed adjusted funding target 
attainment percentage for a plan is less than 60 percent, then no plan 
amendment increasing plan liabilities is permitted to take effect during 
the period described in this paragraph (g)(2). See paragraph (e)(1) of 
this section.
    (3) Benefit accruals. If the presumed adjusted funding target 
attainment percentage for a plan year of less than 60 percent is 
determined based on the plan's enrolled actuary certification of the 
adjusted funding target attainment percentage for the prior plan year 
made during that prior plan year (as opposed to being presumed to be 
less than 60 percent under the rules of section 436(h)(2) and paragraph 
(h)(3) of this section because the actuary has not certified the 
adjusted funding target attainment percentage for the prior plan year 
before the first day of the 10th month of the prior plan year), then 
benefits are permitted to accrue if the plan sponsor makes a section 436 
contribution in the amount necessary to bring the ratio of the updated 
interim value of adjusted plan assets to the presumed adjusted funding 
target up to 60 percent, as described in paragraph (f)(2)(v) of this 
section.
    (B) Plan amendments for plans with presumed AFTAP below 80 percent. 
If the presumed adjusted funding target attainment percentage for a plan 
is less than 80 percent, but is not less than 60 percent, then a plan 
amendment increasing plan liabilities is permitted to take effect during 
the period described in this paragraph (g)(2) if the plan sponsor makes 
a section 436 contribution described in paragraph (f)(2)(iv)(A) of this 
section.
    (C) Contributions required to reach threshold. If a plan is 
described in paragraph (g)(2)(iii)(D) of this section and neither 
paragraph (g)(2)(iv)(A) nor (B) of this section apply to the plan, then 
unpredictable contingent event benefits are permitted to be paid or the 
plan amendment is permitted to become effective during the period this 
paragraph (g)(2) applies to the plan only if the plan sponsor makes a 
section 436 contribution in the amount necessary to bring the ratio of 
the updated interim value of adjusted plan assets to the inclusive 
presumed adjusted funding target up to the applicable threshold under 
section 436(b) or (c), as described in paragraph (f)(2)(iii)(B) or 
(f)(2)(iv)(B) of this section. This paragraph (g)(2)(iv)(C) applies, for 
example, if an unpredictable contingent event occurs in the case of a 
plan with a presumed adjusted funding target attainment percentage of 
more than 60 percent where taking into account the unpredictable 
contingent event benefit in the inclusive presumed adjusted funding 
target would cause the ratio of the interim value of adjusted plan 
assets to the inclusive presumed adjusted funding target to be less than 
60 percent.
    (v) Bankruptcy of plan sponsor. Pursuant to section 436(d)(2), 
during any period in which the plan sponsor of a plan is a debtor in a 
case under title 11, United States Code, or any similar

[[Page 1273]]

Federal or State law (as described in paragraph (d)(2) of this section), 
no prohibited payment within the meaning of paragraph (j)(6) of this 
section may be paid if the plan's enrolled actuary has not yet certified 
the plan's adjusted funding target attainment percentage for the plan 
year to be at least 100 percent. Thus, the presumption rules of 
paragraph (h) of this section do not apply for purposes of section 
436(d)(2) and this paragraph (g)(2)(v).
    (3) Periods prior to certification during which no presumption 
applies--(i) Prohibited payments and benefit accruals. If no 
presumptions under section 436(h) apply to a plan during a period and 
the plan's enrolled actuary has not yet issued the certification of the 
plan's actual adjusted funding target attainment percentage for the plan 
year, the plan is not permitted to limit prohibited payments under 
paragraph (d) of this section or the accrual of benefits under paragraph 
(e) of this section based on an expectation that those paragraphs will 
apply to the plan once an actuarial certification is issued. However, 
see paragraph (g)(2)(v) of this section for a restriction on prohibited 
payments during any period in which the plan sponsor of a plan is a 
debtor in a case under title 11, United States Code, or any similar 
Federal or State law.
    (ii) Unpredictable contingent event benefits and plan amendments 
increasing benefit liability--(A) In general. If no presumptions under 
section 436(h) apply to a plan during a period and the plan's enrolled 
actuary has not yet issued a certification of the plan's adjusted 
funding target attainment percentage for the plan year, the limitations 
on unpredictable contingent event benefits under paragraph (b) of this 
section and plan amendments increasing benefit liabilities under 
paragraph (c) of this section must be applied during that period by 
following the rules of paragraphs (g)(2)(iii) of this section, based on 
the inclusive presumed adjusted funding target determined using the 
prior plan year adjusted funding target attainment percentage. Thus, 
whether unpredictable contingent event benefits are permitted to be paid 
or a plan amendment is permitted to take effect during a plan year is 
determined by calculating the ratio of the interim value of adjusted 
plan assets to the inclusive presumed adjusted funding target, where the 
inclusive presumed adjusted funding target is determined by dividing the 
interim value of adjusted plan assets by the prior plan year adjusted 
funding target attainment percentage and then adding the adjustments 
described in paragraphs (g)(2)(iii)(A)(1), (2) and (3) of this section. 
If, after application of paragraphs (g)(2)(iii)(B) and (C) of this 
section, that ratio is less than the applicable threshold under section 
436(b) or 436(c), then the plan is not permitted to provide any benefits 
attributable to the unpredictable contingent event, nor is the plan 
amendment permitted to take effect, unless the plan sponsor makes the 
contribution described in paragraph (g)(2)(iv)(C) of this section.
    (B) Recharacterization of contributions made to avoid benefit 
limitations. In any case where, pursuant to paragraph (g)(3)(ii)(A) of 
this section, the plan sponsor makes section 436 contributions to avoid 
the application of the applicable benefit limitation, to the extent 
those contributions would not be needed to permit the payment of the 
unpredictable contingent event benefits or for the plan amendment to go 
into effect based on a subsequent certification of the adjusted funding 
target attainment percentage for the current plan year that takes into 
account the increase in the liability attributable to the unpredictable 
contingent event benefits or plan amendment, the excess section 436 
contributions are recharacterized as employer contributions taken into 
account under section 430 for the current plan year.
    (4) Modification of the presumed AFTAP--(i) Section 436 
contributions. If, in accordance with the rules of paragraph (g)(2)(iv) 
of this section, unpredictable contingent event benefits are permitted 
to be paid, or a plan amendment takes effect, during the plan year 
because the plan sponsor makes a contribution described in paragraph 
(f)(2)(iii)(B) or (f)(2)(iv)(B) of this section, then the presumed 
adjusted funding target must be adjusted to reflect

[[Page 1274]]

any increase in the funding target attributable to the unpredictable 
contingent event benefits or the plan amendment and the interim value of 
plan assets must be increased by the present value of the contribution. 
Similarly, if benefit accruals are permitted to resume in a plan year 
because the plan sponsor makes the contribution described in paragraph 
(f)(2)(v) of this section, then the presumed adjusted funding target 
must be adjusted to reflect any increase in the funding target 
attributable to the benefit accruals for the prior plan year and the 
interim value of adjusted plan assets must be increased by the present 
value of the contribution. The adjustment to the presumed adjusted 
funding target is made as of the date of the contribution, and that date 
is a section 436 measurement date.
    (ii) Modification of the presumed AFTAP for reduction in balances. 
If a plan's funding standard carryover balance or prefunding balance is 
reduced under the rules of paragraph (g)(2) or (g)(3) of this section, 
then the presumed adjusted funding target attainment percentage for the 
plan year is increased to reflect the higher interim value of adjusted 
plan assets resulting from the reduction in the funding standard 
carryover balance or prefunding balance. The date of the event that 
causes the reduction is a section 436 measurement date.
    (5) Periods after certification of AFTAP--(i) Plan must follow 
certified AFTAP--(A) In general. The rules of paragraphs (g)(2) and 
(g)(3) of this section no longer apply for a plan year on and after the 
date the enrolled actuary for the plan issues a certification of the 
adjusted funding target attainment percentage of the plan for the 
current plan year, provided that the certification is issued before the 
first day of the 10th month of the plan year. For example, the plan must 
provide that the limitations on prohibited payments apply for 
distributions with annuity starting dates on and after the date of that 
certification using the certified adjusted funding target attainment 
percentage of the plan for the plan year. Similarly, the plan must 
provide that any prohibition on accruals under paragraph (e) of this 
section as a result of the enrolled actuary's certification that the 
adjusted funding target attainment percentage of the plan for the plan 
year is less than 60 percent is effective as of the date of the 
certification and that any prohibition on accruals ceases to be 
effective on the date the enrolled actuary issues a certification that 
the adjusted funding target attainment percentage of the plan for the 
plan year is at least 60 percent.
    (B) Unpredictable contingent events and plan amendments. In the case 
of a plan that has been issued a certification of the plan's adjusted 
funding target attainment percentage for a plan year by the plan's 
enrolled actuary, the plan sponsor must comply with the requirements of 
paragraphs (b) and (c) of this section for an unpredictable contingent 
event that occurs or a plan amendment that takes effect on or after the 
date of the enrolled actuary's certification. Thus, the plan 
administrator must determine if the adjusted funding target attainment 
percentage would be at or above the applicable threshold if it were 
modified to take into account--
    (1) The unpredictable contingent event or plan amendment;
    (2) Any other unpredictable contingent event benefits that were 
permitted to be paid as a result of any unpredictable contingent event 
that occurred, and any other plan amendment that took effect, earlier 
during the plan year to the extent not taken into account in the 
certified adjusted funding target attainment percentage for the plan 
year; and
    (3) Any earlier section 436 contributions made for the plan year to 
the extent those contributions were not taken into account in the 
certified adjusted funding target attainment percentage.
    (C) Application of rule for deemed election to reduce funding 
balances. After the adjusted funding target attainment percentage for a 
plan year is certified by the plan's enrolled actuary, the deemed 
election to reduce the prefunding and funding standard carryover 
balances under paragraph (a)(5) of this section must be reapplied based 
on the actual funding target for the year

[[Page 1275]]

(provided the certification is issued before the first day of the 10th 
month of the plan year). The reapplication of the rules under this 
paragraph (g)(5) regarding the deemed election in paragraph (a)(5) of 
this section may require an additional reduction in the prefunding and 
funding standard carryover balances if the amount of the reduction in 
the prefunding and funding standard carryover balances that is necessary 
to reach the applicable threshold to avoid the application of a section 
436 limitation exceeds the amount that was initially reduced. Prior 
reductions of the prefunding and funding standard carryover balances 
continue to apply.
    (ii) Applicability to prior periods--(A) In general. Except as 
otherwise provided in this paragraph (g)(5)(ii), the enrolled actuary's 
certification of the adjusted funding target attainment percentage for 
the plan for the plan year does not affect prior periods. For example, 
the certification does not affect the application of the limitation 
under paragraph (d) of this section for distributions with annuity 
starting dates before the certification or the application of the 
limitation under paragraph (e) of this section prior to the date of that 
certification. See paragraph (a)(4) of this section for rules relating 
to the period of time after benefits cease to be limited. Except as 
otherwise provided in this paragraph (g)(5)(ii), the enrolled actuary's 
certification of the adjusted funding target attainment percentage for 
the plan for the plan year does not affect the application of the 
limitation under paragraph (b) or (c) of this section to unpredictable 
contingent event benefits, or a plan amendment that increases the 
liability for benefits, where the unpredictable contingent event occurs 
or the amendment takes effect during the periods to which paragraphs 
(g)(2) and (g)(3) of this section apply.
    (B) Special rule for unpredictable contingent event benefits. If a 
plan does not pay benefits attributable to an unpredictable contingent 
event because of the application of paragraph (g)(2)(iii)(D) or 
(g)(3)(ii)(A) of this section, then the plan must pay the benefits 
attributable to that event that were not previously paid if such 
benefits would be permitted under the rules of section 436 based on a 
certified adjusted funding target attainment percentage for the plan 
year that takes into account the increase in the funding target that 
would be attributable to those unpredictable contingent event benefits.
    (C) Special rule for plan amendments that increase liability. If a 
plan amendment does not take effect because of the application of 
paragraph (g)(2)(iii)(D) or (g)(3)(ii)(A) of this section, the plan 
amendment must go into effect if it would be permitted under the rules 
of section 436 based on a certified actual adjusted funding target 
attainment percentage for the plan year that takes into account the 
increase in the funding target attributable to the plan amendment, 
unless the plan amendment provides otherwise.
    (D) Ordering rule for multiple unpredictable contingent events or 
plan amendments. [Reserved]
    (6) Examples. The following examples illustrate the rules of this 
paragraph (g). Unless otherwise indicated, these examples are based on 
the following facts: each plan has a plan year that is the calendar year 
and a valuation date of January 1; section 436 applies to the plan 
beginning in 2008; the plan has no funding standard carryover balance; 
the plan sponsor is not in bankruptcy; no annuity purchases have been 
made from the plan; and the plan offers a lump sum form of payment. No 
plan is in at-risk status for the years discussed in the examples. The 
examples read as follows:

    Example 1. (i) The plan's certified AFTAP as of January 1, 2010, is 
75%. As of January 1, 2011, Plan A has assets of $3,300,000 and a 
prefunding balance of $300,000. Beginning on January 1, 2011, Plan A's 
AFTAP for 2011 is presumed to be 75%, under the rules of paragraph (h) 
of this section and based on the certified AFTAP for 2010.
    (ii) Based on Plan A's presumed AFTAP of 75%, Plan A would continue 
to be subject to the restriction on prohibited payments in paragraph 
(d)(3) of this section as of January 1, 2011. However, under the 
provisions of paragraph (a)(5) of this section, if the prefunding 
balance is large enough, Plan A's sponsor is deemed to elect to reduce 
the prefunding balance to the extent needed to avoid this restriction.

[[Page 1276]]

    (iii) The amount needed to avoid the restriction in paragraph (d)(3) 
of this section is determined by comparing the presumed adjusted funding 
target for Plan A with the interim value of adjusted plan assets as of 
the valuation date. The interim value of adjusted plan assets for Plan A 
is $3,000,000 (that is, the asset value of $3,300,000 reduced by the 
prefunding balance of $300,000). The presumed adjusted funding target 
for Plan A is the interim value of the adjusted plan assets divided by 
the presumed AFTAP, or $4,000,000 (that is, $3,000,000 divided by 75%).
    (iv) In order to avoid the restriction on prohibited payments in 
paragraph (d)(3) of this section, Plan A's presumed AFTAP must be 
increased to 80%. This requires an increase in Plan A's adjusted plan 
assets of $200,000 (that is, 80% of the presumed adjusted funding target 
of $4,000,000, minus the interim value of the adjusted plan assets of 
$3,000,000). Plan A's prefunding balance as of January 1, 2011, is 
reduced by $200,000 under the deemed election provisions of paragraph 
(a)(5) of this section. Accordingly, Plan A's prefunding balance is 
$100,000 (that is, $300,000 minus $200,000) and the interim value of 
adjusted plan assets is increased to $3,200,000 (that is, $3,300,000 
minus the reduced prefunding balance of $100,000). Pursuant to paragraph 
(g)(4)(ii) of this section, the presumed adjusted funding target 
attainment percentage for Plan A is redetermined as 80% and Plan A must 
pay the full amount of the accelerated benefit distributions elected by 
participants with an annuity starting date of January 1, 2011, or later.
    Example 2. (i) The facts are the same as in Example 1. As of April 
1, 2011, the enrolled actuary for Plan A has not certified the 2011 
AFTAP. Therefore, beginning April 1, 2011, Plan A's AFTAP is presumed to 
be reduced by 10 percentage points to 70%, in accordance with paragraph 
(h)(2) of this section. Under the provisions of paragraph (g)(2)(ii)(B) 
of this section, the deemed election to reduce the prefunding and 
funding standard carryover balances described in paragraph (a)(5) of 
this section must be reapplied based on the new presumed AFTAP.
    (ii) In accordance with paragraph (g)(2)(ii)(C) of this section, a 
new presumed adjusted funding target must be determined based on the new 
presumed AFTAP and must be compared to an updated interim value of 
adjusted plan assets. The new presumed adjusted funding target is 
$3,200,000 divided by the new presumed AFTAP of 70%, or $4,571,429.
    (iii) In order to avoid the restriction on prohibited payments in 
paragraph (d)(3) of this section, Plan A's presumed AFTAP must be 
increased to 80%. This requires an additional increase in Plan A's 
adjusted plan assets of $457,143 (that is, 80% of the new presumed 
adjusted funding target of $4,571,429, minus the updated interim value 
of the adjusted plan assets of $3,200,000 reflecting the deemed 
reduction in Plan A's prefunding balance).
    (iv) Plan A's remaining prefunding balance as of January 1, 2011, is 
only $100,000, which is not enough to avoid the restriction on 
prohibited payments under paragraph (d)(3) of this section. Accordingly, 
unless Plan A's sponsor utilizes one of the methods described in 
paragraph (f) of this section to avoid the restriction, Plan A is 
subject to the restriction on prohibited payments in paragraph (d)(3) of 
this section and cannot pay accelerated benefit distributions elected by 
participants with an annuity starting date of April 1, 2011, or later.
    (v) Plan A's prefunding balance remains at $100,000 because, under 
paragraph (a)(5)(iii) of this section, the deemed reduction rules do not 
apply if the prefunding balance is not large enough to increase the 
adjusted value of plan assets enough to avoid the restriction. However, 
the earlier deemed reduction of $200,000 continues to apply because all 
elections (including deemed elections) to reduce a plan's funding 
standard carryover balance or prefunding balance are irrevocable and 
must be unconditional in accordance with paragraph (g)(2)(ii)(A) of this 
section.
    Example 3. (i) The facts are the same as in Example 1. On July 1, 
2011, the enrolled actuary for Plan A calculates the actual adjusted 
funding target as $3,700,000 as of January 1, 2011. Therefore, the 2011 
AFTAP would have been 81.08% without reducing the prefunding balance 
(that is, plan assets of $3,300,000 minus the prefunding balance of 
$300,000, divided by the adjusted funding target of $3,700,000), and 
Plan A would not have been subject to the restrictions under paragraph 
(d)(3) of this section.
    (ii) However, paragraph (g)(5)(i)(C) of this section requires that 
any prior reductions in the prefunding or funding standard carryover 
balances continue to apply, and so Plan A's prefunding balance remains 
at the reduced amount of $100,000 as of January 1, 2011. The enrolled 
actuary certifies that the 2011 AFTAP is 86.49% (that is, plan assets of 
$3,300,000 reduced by the prefunding balance of $100,000, divided by the 
adjusted funding target of $3,700,000).
    Example 4. (i) Plan B is a collectively bargained plan with assets 
of $2,500,000 and a prefunding balance of $150,000 as of January 1, 
2011. On August 14, 2010, the enrolled actuary for Plan B certified the 
AFTAP for 2010 to be 83%. No unpredictable contingent events giving rise 
to unpredictable contingent event benefits occurred during 2010 and no 
plan amendments took effect in 2010 that were not taken into account in 
the certified AFTAP.
    (ii) On January 10, 2011, Plan B's sponsor amends the plan to 
increase benefits effective on February 1, 2011. The amendment would 
increase Plan B's funding target by

[[Page 1277]]

$350,000. Under the rules of paragraph (g)(3) of this section, the 
determination of whether the amendment is permitted to take effect is 
based on a comparison of the inclusive presumed adjusted funding target 
with the updated interim value of adjusted plan assets.
    (iii) Plan B's interim value of adjusted plan assets as of the 
valuation date is $2,350,000 (that is, $2,500,000 minus the prefunding 
balance of $150,000). Prior to reflecting the amendment, Plan B's 
presumed adjusted funding target as of January 1, 2011, is $2,831,325, 
which is equal to the interim value of adjusted plan assets as of the 
valuation date of $2,350,000, divided by the presumed AFTAP of 83%. 
Increasing Plan B's presumed adjusted funding target by $350,000 to 
reflect the amendment results in an inclusive presumed adjusted funding 
target of $3,181,325 and would result in a presumed AFTAP of 73.87% 
(that is, the interim value of adjusted plan assets as of the valuation 
date of $2,350,000 divided by the inclusive presumed adjusted funding 
target of $3,181,325).
    (iv) Because Plan B's presumed AFTAP was over 80% prior to taking 
the amendment into account but would be less than 80% if the amendment 
were taken into account, section 436(c) and paragraph (c) of this 
section prohibit the plan amendment from taking effect unless the 
adjusted plan assets are increased so that the inclusive presumed AFTAP 
would be increased to 80%. This would require an additional amount of 
$195,060 (that is, 80% of the inclusive presumed adjusted funding target 
of $3,181,325 less the interim value of adjusted plan assets of 
$2,350,000).
    (v) Plan B's prefunding balance of $150,000 is not large enough for 
Plan B to avoid the restriction on plan amendments, and therefore the 
deemed election to reduce the prefunding balance under paragraph (a)(5) 
of this section does not apply, and the amendment cannot take effect 
unless the plan sponsor makes a contribution described in paragraph 
(f)(2) of this section.
    Example 5. (i) The facts are the same as in Example 4, except that 
Plan B's sponsor decides to make a contribution on February 1, 2011, to 
avoid the benefit limitation as provided in paragraph (f)(2) of this 
section. As of February 1, 2011, Plan B's effective interest rate for 
the 2011 plan year has not yet been determined. Pursuant to paragraph 
(f)(2)(i)(A)(2) of this section, Plan B's effective interest rate for 
2011 is treated as 6.25%, which is the largest of the three segment 
interest rates applicable to the 2011 plan year, as provided in 
paragraph (f)(2)(i)(A)(2) of this section.
    (ii) The amount of the contribution as of January 1, 2011, needed to 
avoid the restriction on plan amendments under paragraph (c) of this 
section is $195,060. However, because the contribution is not paid until 
February 1, 2011, the necessary contribution amount must be adjusted to 
reflect interest that would otherwise have accrued between the valuation 
date and the date of the contribution, at Plan B's effective interest 
rate for the 2011 plan year. The amount of the required contribution 
after adjustment is $196,048, determined as $195,060 increased for one 
month of compound interest at an effective annual interest rate of 
6.25%.
    (iii) In accordance with paragraph (g)(4)(i) of this section, the 
inclusive presumed AFTAP as of February 1, 2011, is 80 percent.
    Example 6. (i) The facts are the same as in Example 5. As of April 
1, 2011, the enrolled actuary for the plan has not certified the 2011 
AFTAP. Beginning April 1, 2011, Plan A's presumed AFTAP is equal to be 
70%, 10 percentage points lower than the inclusive presumed AFTAP as of 
February 1, 2011, in accordance with paragraphs (g)(2)(iii)(A) and 
(h)(2) of this section. On July 1, 2011, the enrolled actuary for the 
plan calculates the actual adjusted funding target, prior to taking the 
plan amendment into account, as $2,700,000, and determines the actual 
effective interest rate for 2011 to be 5.25%. On this basis, the actual 
AFTAP for 2011 (prior to taking the amendment into account) as 87.04% 
(that is, adjusted assets of $2,350,000 divided by the adjusted funding 
target of $2,700,000). Reflecting the $350,000 increase in funding 
target due to the plan amendment would increase the adjusted funding 
target to $3,050,000 and would decrease Plan B's AFTAP to 77.05%.
    (ii) Based on the calculated adjusted funding target, the amount 
that was necessary to avoid the benefit restriction under paragraph (c) 
of this section was $90,000 (that is, 80% of the adjusted funding target 
reflecting the plan amendment (or $3,050,000), minus the adjusted value 
of plan assets of $2,350,000). This amount must be adjusted for interest 
between the valuation date and the date the contribution was made using 
the effective interest rate for Plan B. Therefore, the amount required 
on the payment date of February 1, 2011, was $90,385 (that is, $90,000 
adjusted for compound interest for one month at Plan B's effective 
interest rate of 5.25% per year).
    (iii) Under paragraph (g)(3)(ii)(B) of this section, the 
contribution made on February 1, 2011, is recharacterized as an employer 
contribution under section 430 to the extent that it exceeded the amount 
necessary to avoid application of the restriction on plan amendments 
under paragraph (c) of this section. Therefore, $105,663 (that is, the 
$196,048 actual contribution paid on February 1, 2011, minus the $90,385 
required contribution based on the actual AFTAP) is recharacterized as 
an employer contribution under section 430 for the 2011 plan year. As 
such, it may be applied toward the minimum required contribution for 
2011, or the plan sponsor can elect to credit the contribution to Plan 
B's

[[Page 1278]]

prefunding balance to the extent that the contributions for the 2011 
plan year exceed the minimum required contribution.
    (iv) This recharacterization applied only because the 436 
contribution was made during a period prior to the certification of Plan 
B's actual AFTAP for 2011 and during which no presumption applied (that 
is, when section 436 is applied based on the 2010 AFTAP, which was high 
enough that no restrictions applied for 2010). If the contribution had 
been made during a time when the presumptions applied (for instance, 
after April 1, 2011, when the presumed AFTAP was under 80%) then the 
only portion of the 436 contribution that would be recharacterized as an 
employer contribution under section 430 would be the portion of the 
interest adjustment attributable to the difference between the highest 
segment rate (6.25%) and the plan's actual effective interest rate 
(5.25%), in accordance with paragraph (f)(2)(i)(A)(2) of this section.
    (v) After reflecting the plan amendment and the present value of the 
portion of the section 436 contribution that is not recharacterized as 
an employer contribution under section 430, the adjusted assets as of 
January 1, 2011, for purposes of section 436 are $2,440,000 ($2,350,000 
plus $90,000) and the inclusive adjusted funding target is $3,050,000. 
Accordingly, the enrolled actuary certifies the inclusive AFTAP for 2011 
as 80% ($2,440,00 / $3,050,000). Note that assets for section 430 
purposes are not increased to reflect the section 436 contribution as of 
January 1, 2011.
    Example 7. (i) The facts are the same as in Example 6, except that 
on July 1, 2011, the enrolled actuary for Plan B calculates the actual 
adjusted funding target (before reflecting the plan amendment) as 
$3,000,000 and certifies the actual AFTAP as 78.33% prior to reflecting 
the plan amendment (that is, adjusted plan assets of $2,350,000 divided 
by the actual adjusted funding target of $3,000,000). Based on the 
provisions of paragraph (c) of this section, because the AFTAP prior to 
reflecting the amendment is less than 80%, the contribution required to 
avoid the restriction on plan amendments would have been the amount 
equal to the increase in funding target due to the plan amendment, or 
$350,000.
    (ii) However, according to paragraph (g)(5)(ii)(A) of this section, 
the enrolled actuary's certification of the 2011 AFTAP does not affect 
the application of the limitation under paragraph (c) of this section to 
the amendment, because the amendment to Plan B took effect prior to the 
date of the certification. Therefore, it is not necessary for Plan B's 
sponsor to contribute an additional amount in order for the plan 
amendment to remain in effect regardless of the extent to which the 
certified AFTAP for the plan year is less than the presumed inclusive 
AFTAP.

    (h) Presumed underfunding for purposes of benefit limitations--(1) 
Presumption of continued underfunding--(i) In general. This paragraph 
(h)(1) applies to a plan for a plan year if a limitation under paragraph 
(b), (c), (d), or (e) of this section applied to the plan on the last 
day of the preceding plan year. If this paragraph (h)(1) applies to a 
plan, the first day of the plan year is a section 436 measurement date 
and the presumed adjusted funding target attainment percentage for the 
plan is the percentage under paragraph (h)(1)(ii) or (iii) of this 
section, whichever applies to the plan, beginning on that first day of 
the plan year and ending on the date specified in paragraph (h)(1)(iv) 
of this section.
    (ii) Rule where preceding year certification issued during preceding 
year--(A) General rule. In any case in which the plan's enrolled actuary 
has issued a certification under paragraph (h)(4) of this section of the 
adjusted funding target attainment percentage for the plan year 
preceding the current plan year before the first day of the current plan 
year, the presumed adjusted funding target attainment percentage of the 
plan for the current plan year is equal to the prior plan year adjusted 
funding target attainment percentage until it is changed under paragraph 
(h)(1)(iv) of this section.
    (B) Special rule for late certifications. If the certification of 
the adjusted funding target attainment percentage for the prior plan 
year occurred after the first day of the 10th month of that prior plan 
year, the plan is treated as if no such certification was made, unless 
the certification took into account the effect of any unpredictable 
contingent event benefits that are permitted to be paid based on 
unpredictable contingent events that occurred, and any plan amendments 
that became effective, during the prior plan year but before the 
certification (and any associated section 436 contributions).
    (iii) No certification for preceding year issued during preceding 
year--(A) Deemed percentage continues. In any case in which the plan's 
enrolled actuary has not issued a certification under paragraph (h)(4) 
of this section of the adjusted funding target attainment percentage of 
the plan for the plan year

[[Page 1279]]

preceding the current plan year during that prior plan year, the 
presumed adjusted funding target attainment percentage of the plan for 
the current plan year is equal to the presumed adjusted funding target 
attainment percentage that applied on the last day of the preceding plan 
year until the presumed adjusted funding target attainment percentage is 
changed under paragraph (h)(1)(iii)(B) or (h)(1)(iv) of this section. 
Thus, if the prior plan year was a 12-month plan year (so that the last 
day of the plan year was after the first day of the 10th month of the 
plan year and the rules of section 436(h)(2) and paragraph (h)(3) of 
this section applied to the plan for that plan year), then the presumed 
adjusted funding target attainment percentage for the current plan year 
is presumed to be less than 60 percent. By contrast, if the prior plan 
year was less than 9 months, the presumed adjusted funding target 
attainment percentage for the current plan year is the presumed adjusted 
funding target attainment percentage at the last day of the preceding 
plan year.
    (B) Enrolled actuary's certification in following year. In any case 
in which the plan's enrolled actuary has issued the certification under 
paragraph (h)(4) of this section of the adjusted funding target 
attainment percentage of the plan for the plan year preceding the 
current plan year on or after the first day of the current plan year, 
the date of that prior plan year certification is a new section 436 
measurement date for the current plan year. In such a case, the presumed 
adjusted funding target attainment percentage for the current plan year 
is equal to the prior plan year adjusted funding target attainment 
percentage (reduced by 10 percentage points if paragraph (h)(2)(iv) of 
this section applies to the plan) until it is changed under paragraph 
(h)(1)(iv) of this section. The rules of paragraph (h)(1)(ii)(B) of this 
section apply for purposes of determining whether the enrolled actuary 
has issued a certification of the adjusted funding target attainment 
percentage for the prior plan year during the current plan year.
    (iv) Duration of use of presumed adjusted funding target attainment 
percentage. If this paragraph (h)(1) applies to a plan for a plan year, 
the presumed adjusted funding target attainment percentage determined 
under this paragraph (h)(1) applies until the earliest of--
    (A) The first day of the 4th month of the plan year if paragraph 
(h)(2) of this section applies;
    (B) The first day of the 10th month of the plan year if paragraph 
(h)(3) of this section applies;
    (C) The date of a change in the presumed adjusted funding target 
attainment percentage under paragraph (g)(4) of this section; or
    (D) The date the enrolled actuary issues a certification under 
paragraph (h)(4) of this section of the adjusted funding target 
attainment percentage for the plan year.
    (2) Presumption of underfunding beginning on first day of 4th month 
for certain underfunded plans--(i) In general. This paragraph (h)(2) 
applies to a plan for a plan year if--
    (A) The enrolled actuary for the plan has not issued a certification 
of the adjusted funding target attainment percentage for the plan year 
before the first day of the 4th month of the plan year; and
    (B) The plan's adjusted funding target attainment percentage for the 
preceding plan year was either--
    (1) At least 60 percent but less than 70 percent; or
    (2) At least 80 percent but less than 90 percent.
    (ii) Special rule for first plan year a plan is subject to section 
436. This paragraph (h)(2) also applies to a plan for the first 
effective plan year if--
    (A) The enrolled actuary for the plan has not issued a certification 
of the adjusted funding target attainment percentage for the plan year 
before the first day of the 4th month of the plan year; and
    (B) The prior plan year adjusted funding target attainment 
percentage is at least 70 percent but less than 80 percent.
    (iii) Presumed adjusted funding target attainment percentage. If 
this paragraph (h)(2) applies to a plan for a plan year and the date of 
the enrolled actuary's certification of the adjusted funding target 
attainment percentage under paragraph (h)(4) of this section for the 
prior plan year (taking into account

[[Page 1280]]

the special rules for late certifications under paragraph (h)(1)(ii)(B) 
of this section) occurred before the first day of the 4th month of the 
current plan year, then, commencing on the first day of the 4th month of 
the current plan year--
    (A) The presumed adjusted funding target attainment percentage of 
the plan for the plan year is reduced by 10 percentage points; and
    (B) The first day of the 4th month of the plan year is a section 436 
measurement date.
    (iv) Certification for prior plan year. If this paragraph (h)(2) 
applies to a plan and the date of the enrolled actuary's certification 
of the adjusted funding target attainment percentage under paragraph 
(h)(4) of this section for the prior plan year (taking into account the 
rules for late certifications under paragraph (h)(1)(ii)(B) of this 
section) occurs on or after the first day of the 4th month of the 
current plan year, then, commencing on the date of that prior plan year 
certification--
    (A) The presumed adjusted funding target attainment percentage of 
the plan for the current plan year is equal to 10 percentage points less 
than the prior plan year adjusted funding target attainment percentage; 
and
    (B) The date of the prior plan year certification is a section 436 
measurement date.
    (v) Duration of use of presumed adjusted funding target attainment 
percentage. If this paragraph (h)(2) applies to a plan for a plan year, 
the presumed adjusted funding target attainment percentage determined 
under this paragraph (h)(2) applies until the earliest of--
    (A) The first day of the 10th month of the plan year if paragraph 
(h)(3) of this section applies;
    (B) The date of a change in the presumed adjusted funding target 
attainment percentage under paragraph (g)(4) of this section; or
    (C) The date the enrolled actuary issues a certification under 
paragraph (h)(4) of this section of the adjusted funding target 
attainment percentage for the plan year.
    (3) Presumption of underfunding beginning on first day of 10th 
month. In any case in which no certification of the specific adjusted 
funding target attainment percentage for the current plan year under 
paragraph (h)(4) of this section is made with respect to the plan before 
the first day of the 10th month of the plan year, then, commencing on 
the first day of the 10th month of the current plan year--
    (i) The presumed adjusted funding target attainment percentage of 
the plan for the plan year is presumed to be less than 60 percent; and
    (ii) The first day of the 10th month of the plan year is a section 
436 measurement date.
    (4) Certification of AFTAP--(i) Rules generally applicable to 
certifications--(A) In general. The enrolled actuary's certification 
referred to in this section must be made in writing, must be signed and 
dated to show the date of the signature, must be provided to the plan 
administrator, and, except as otherwise provided in paragraph (h)(4)(ii) 
of this section, must certify the plan's adjusted funding target 
attainment percentage for the plan year. Except in the case of a range 
certification described in paragraph (h)(4)(ii) of this section, the 
certification must set forth the value of plan assets, the prefunding 
balance, the funding standard carryover balance, the value of the 
funding target used in the determination, the aggregate amount of 
annuity purchases included in the adjusted value of plan assets and the 
adjusted funding target, the unpredictable contingent event benefits 
permitted to be paid for unpredictable contingent events that occurred 
during the current plan year that were taken into account for the 
current plan year (including any associated section 436 contributions), 
the plan amendments that took effect in the current plan year that were 
taken into account for the current plan year (including any associated 
section 436 contributions), any benefit accruals that were restored for 
the plan year (including any section 436 contributions), and any other 
relevant factors. The actuarial assumptions and funding methods used in 
the calculation for the certification must be the actuarial assumptions 
and funding methods used for the plan for purposes of determining the 
minimum required

[[Page 1281]]

contributions under section 430 for the plan year.
    (B) Determination of plan assets. For purposes of making any 
determination of the adjusted funding target attainment percentage under 
this section, the determination is not permitted to include in plan 
assets contributions that have not been made to the plan by the 
certification date. Thus, the enrolled actuary's certification of the 
adjusted funding target attainment percentage for a plan year cannot 
take into account contributions that are expected to be made after the 
certification date. Notwithstanding the foregoing, for plan years 
beginning before January 1, 2009, the enrolled actuary's certification 
of the adjusted funding target attainment percentage is permitted to 
take into account employer contributions for the prior plan year that 
are reasonably expected to be made for that prior plan year but have not 
been contributed by the date of the enrolled actuary's certification. 
See paragraphs (h)(4)(iii) and (v) of this section for rules relating to 
changes in the certified percentage.
    (ii) Special rules for certification within range--(A) In general. 
Under this paragraph (h)(4)(ii), the plan's enrolled actuary is 
permitted to certify during a plan year that the plan's adjusted funding 
target attainment percentage for that plan year either is less than 60 
percent, is 60 percent or higher (but is less than 80 percent), is 80 
percent or higher, or is 100 percent or higher. If the enrolled actuary 
has issued such a range certification for a plan year and the enrolled 
actuary subsequently issues a certification of the specific adjusted 
funding target attainment percentage for the plan before the end of that 
plan year, then the certification of the specific adjusted funding 
target attainment percentage is treated as a change in the applicable 
percentage to which paragraph (h)(4)(iii) of this section applies.
    (B) Effect of range certification before certification of specific 
percentage. If a plan's enrolled actuary issues a range certification 
pursuant to this paragraph (h)(4)(ii), then, for purposes of this 
section (including application of the limitations of sections 436(b) and 
(c), contributions described in sections 436(b)(2), 436(c)(2), and 
436(e)(2), and the mandatory reduction of the prefunding and funding 
standard carryover balances under paragraph (a)(5) of this section), the 
plan is treated as having a certified percentage at the smallest value 
within the applicable range until a certification of the plan's specific 
adjusted funding target attainment percentage for the plan year has been 
issued under paragraph (h)(4)(i) of this section. However, if the plan's 
enrolled actuary has issued a range certification for the plan year but 
does not issue a certification of the specific adjusted funding target 
attainment percentage for the plan by the last day of that plan year, 
the adjusted funding target attainment percentage for the plan is 
retroactively deemed to be less than 60 percent as of the first day of 
the 10th month of the plan year.
    (C) Effect of range certification on and after certification of 
specific percentage. Once the certification of the specific adjusted 
funding target attainment percentage is issued by the plan's enrolled 
actuary, the certified percentage applies for all purposes of this 
section on and after the date of that certification. If the plan sponsor 
made section 436 contributions to avoid application of a benefit 
limitation during the period a range certification was in effect, those 
section 436 contributions are recharacterized as employer contributions 
under section 430 to the extent the contributions exceed the amount 
necessary to avoid application of a limitation based on the specific 
adjusted funding target attainment percentage as certified by the plan's 
enrolled actuary on or before the last day of the plan year.
    (iii) Change of certified percentage--(A) Application of new 
percentage. If the enrolled actuary for the plan provides a 
certification of the adjusted funding target attainment percentage of 
the plan for the plan year under this paragraph (h)(4) (including a 
range certification) and that certified percentage is superseded by a 
subsequent determination of the adjusted funding target attainment 
percentage for that plan year, then, except to the extent provided in 
paragraph (h)(4)(iv)(B) of this section, that later percentage must be 
applied for the portion of the plan year

[[Page 1282]]

beginning on the date of the earlier certification. The subsequent 
determination could be the correction of a prior incorrect certification 
or it could be an update of a prior correct certification to take into 
account subsequent facts under the rules of paragraph (h)(4)(v) of this 
section. The implications of such a change depend on whether the change 
is a material change or an immaterial change. See paragraph (h)(4)(iv) 
of this section.
    (B) Material change. A change in a plan's certified adjusted funding 
target attainment percentage constitutes a material change for a plan 
year if plan operations with respect to benefits that are addressed by 
section 436, taking into account any actual contributions and elections 
under section 430(f) made by the plan sponsor based on the prior 
certified percentage, would have been different based on the subsequent 
determination of the plan's adjusted funding target attainment 
percentage for the plan year. A change in a plan's adjusted funding 
target attainment percentage for a plan year can be a material change 
even if the only impact of the change occurs in the following plan year 
under the rules for determining the presumed adjusted funding target 
attainment percentage in that following year.
    (C) Immaterial change. In general, an immaterial change is any 
change in an adjusted funding target attainment percentage for a plan 
year that is not a material change. In addition, subject to the 
requirement to recertify the adjusted funding target attainment 
percentage in paragraph (h)(4)(v)(B) of this section, a change in 
adjusted funding target attainment percentage is deemed to be an 
immaterial change if it merely reflects a change in the funding target 
for the plan year or the value of the adjusted plan assets after the 
date of the enrolled actuary's certification resulting from--
    (1) Additional contributions for the preceding year that are made by 
the plan sponsor;
    (2) The plan sponsor's election to reduce the prefunding balance or 
funding standard carryover balance;
    (3) The plan sponsor's election to apply the prefunding balance or 
funding standard carryover balance to offset the prior plan year's 
minimum required contribution;
    (4) A change in funding method or actuarial assumptions, where such 
change required actual approval of the Commissioner (rather than deemed 
approval);
    (5) Unpredictable contingent event benefits which are permitted to 
be paid because the employer makes the section 436 contribution 
described in paragraph (f)(2)(iii)(A) of this section;
    (6) Unpredictable contingent event benefits which are permitted to 
be paid because the plan's enrolled actuary determines that the increase 
in the funding target attributable to the occurrence of the 
unpredictable contingent event would not cause the plan's adjusted 
funding target attainment percentage to fall below 60 percent;
    (7) A plan amendment which takes effect because the employer makes 
the section 436 contribution described in paragraph (f)(2)(iv)(A) of 
this section, the liability for which was not taken into account in the 
certification of the adjusted funding target attainment percentage; or
    (8) A plan amendment which takes effect because the plan's enrolled 
actuary determines that the increase in the funding target attributable 
to the plan amendment would not cause the plan's adjusted funding target 
attainment percentage to fall below 80 percent, the liability for which 
was not taken into account in the certification of the adjusted funding 
target attainment percentage.
    (iv) Effect of change in percentage--(A) Material change. In the 
case of a material change, if the plan's prior operations were in 
accordance with the prior certification of the adjusted funding target 
attainment percentage for the plan year (rather than the actual adjusted 
funding target attainment percentage for the plan year), then the plan 
will not have satisfied the requirements of section 401(a)(29) and 
section 436. Even if the plan's prior operations were in accordance with 
the subsequent certification of the adjusted funding target attainment 
percentage, the plan will not have satisfied the qualification 
requirements of section 401(a) because the plan will not have been 
operated in accordance with its

[[Page 1283]]

terms during the period of time the prior certification applied. In 
addition, in the case of a material change, the rules requiring 
application of a presumed adjusted funding target attainment percentage 
under paragraphs (h)(1) through (h)(3) of this section continue to apply 
from and after the date of the prior certification until the date of the 
subsequent certification.
    (B) Immaterial change. An immaterial change in the adjusted funding 
target attainment percentage applies prospectively only and does not 
change the inapplicability of the presumptions under paragraphs (h)(1), 
(2), and (3) of this section prior to the date of the later 
certification.
    (v) Rules relating to updated certification--(A) In general. This 
paragraph (h)(4)(v) sets forth rules relating to updates of an actuary's 
certification of the plan's adjusted funding target attainment 
percentage for a plan year. Paragraphs (h)(4)(v)(B) and (D) of this 
section require that an updated adjusted funding target attainment 
percentage be certified in certain situations. Even if the updated 
adjusted funding target attainment percentage is not required to be 
certified, plan administrators may request that the actuary prepare an 
updated certification of the adjusted funding target attainment 
percentage, as described in paragraphs (h)(4)(v)(C) and (E) of this 
section. Any updated adjusted funding target attainment percentage 
determined under this paragraph (h)(4)(v) will apply beginning as of the 
date of the event that gave rise to the need for the update which is a 
section 436 measurement date. Thus, pursuant to this paragraph 
(h)(4)(v), the updated funding target attainment percentage applies 
thereafter for all purposes of section 436, including application with 
respect to unpredictable contingent events occurring on or after the 
measurement date (but not for unpredictable contingent events that 
occurred before such measurement date or for benefits with annuity 
starting dates before that measurement date). The updated adjusted 
funding target attainment percentage will continue to apply for the 
remainder of the plan year and will be used for the presumed adjusted 
funding target attainment percentage for the next plan year, unless 
there is a later updated certification of adjusted funding target 
attainment percentage for the plan year.
    (B) Requirement to recertify AFTAP if plan sponsor contributes to 
threshold. If, during the plan year, unpredictable contingent event 
benefits are permitted to be paid, a plan amendment takes effect, or 
benefits are permitted to accrue because the plan sponsor makes a 
contribution described in paragraph (f)(2)(iii)(B), (f)(2)(iv)(B), or 
(f)(2)(v) of this section, then, in accordance with paragraph 
(f)(2)(ii)(C) of this section, the plan's enrolled actuary must issue an 
updated certification of the adjusted funding target attainment 
percentage that takes into account such contribution as well as the 
liability for unpredictable contingent event benefits that are permitted 
to be paid, plan amendments that take effect during the plan year, and 
restored benefits.
    (C) Optional recertification of AFTAP after other unpredictable 
contingent event or plan amendment. Except as provided in paragraph 
(h)(4)(v)(D) of this section, if, during a plan year, unpredictable 
contingent event benefits are permitted to be paid, or a plan amendment 
takes effect, because either the plan sponsor makes a contribution 
described in paragraph (f)(2)(iii)(A) or (f)(2)(iv)(A) of this section, 
or the plan's enrolled actuary determines that the increase in the 
funding target attributable to the occurrence of the unpredictable 
contingent event or the plan amendment would not cause the plan's 
adjusted funding target attainment percentage to fall below the 
applicable 60 percent or 80 percent threshold (taking into account the 
occurrence of all previous unpredictable contingent event benefits and 
plan amendments to the extent not already reflected in the certified 
adjusted funding target attainment percentage for the plan year (or 
update)), then the plan administrator may request that the plan actuary 
issue an updated certification of the adjusted funding target attainment 
percentage that takes into account the unpredictable contingent event 
benefits or plan amendments and any associated section 436 contribution.

[[Page 1284]]

    (D) Requirement to recertify AFTAP after deemed immaterial change. 
If a change in the adjusted funding target attainment percentage as a 
result of one of the items listed in paragraph (h)(4)(iii)(C) of this 
section would be a material change, then the change is treated as an 
immaterial change only if the plan's enrolled actuary recertifies the 
adjusted funding target attainment percentage for the plan year as soon 
as practicable after the event that gives rise to the change.
    (E) Optional recertification after other immaterial change. If a 
change in the adjusted funding target attainment percentage is 
immaterial, then the plan administrator may request that the plan 
actuary issue an updated certification of the adjusted funding target 
attainment percentage that takes into account the unpredictable 
contingent event benefits or plan amendments and any associated section 
436 contribution.
    (5) Examples of rules of paragraphs (h)(1), (h)(2), and (h)(3) of 
this section. The following examples illustrate the rules of paragraphs 
(h)(1), (h)(2), and (h)(3) of this section. Unless otherwise indicated, 
the examples in this section are based on the information in this 
paragraph (h)(5). Each plan is a non-collectively bargained defined 
benefit plan with a plan year that is the calendar year and a valuation 
date of January 1. The plan year is subject to section 436 in 2008. The 
plan does not have a funding standard carryover balance or a prefunding 
balance as of any of the dates mentioned, and the plan sponsor does not 
elect to utilize any of the methods in paragraph (f) of this section to 
avoid applicable benefit restrictions. No range certification under 
paragraph (h)(4) of this section has been issued. The plan sponsor is 
not in bankruptcy. The examples read as follows:

    Example 1. (i) On July 15, 2010, the adjusted funding target 
attainment percentage (``AFTAP'') for Plan T for 2010 is certified to be 
65%. Based on this AFTAP, Plan T is subject to the restriction on 
prohibited payments in paragraph (d)(3) of this section for the 
remainder of 2010.
    (ii) Beginning January 1, 2011, Plan T's AFTAP for 2011 is presumed 
to be equal to the AFTAP for 2010, or 65%, under the provisions of 
paragraph (h)(1)(ii) of this section. Accordingly, the restriction on 
prohibited payments in paragraph (d)(3) of this section continues to 
apply.
    (iii) On March 1, 2011, the enrolled actuary for the plan certifies 
that the actual AFTAP for 2011 is 80%. Therefore, beginning March 1, 
2011, Plan T is no longer subject to the restriction under paragraph 
(d)(3) of this section, and so Plan T resumes paying the full amount of 
any prohibited payments elected by participants with an annuity starting 
date of March 1, 2011, or later.
    Example 2. (i) The facts are the same as in Example 1, except that 
the enrolled actuary for the plan does not certify the AFTAP for 2011 
until June 1, 2011, when it is certified to be 66%.
    (ii) Beginning January 1, 2011, Plan T's AFTAP for 2011 is presumed 
to be equal to the AFTAP for 2010, or 65%, under the provisions of 
paragraph (h)(1)(ii) of this section. Accordingly, the restriction on 
prohibited payments in paragraph (d)(3) of this section continues to 
apply.
    (iii) Pursuant to paragraph (h)(2)(iv) of this section, beginning 
April 1, 2011, the AFTAP for 2011 is presumed to be 55% (10 percentage 
points less than the AFTAP for 2010). Plan T is subject to the 
restriction on prohibited payments under paragraph (d)(1) of this 
section for annuity starting dates on or after April 1, 2011. In 
addition, Plan T is subject to the restriction on unpredictable 
contingent event benefits under paragraph (b) of this section for 
unpredictable contingent events occurring on or after April 1, 2011 and 
benefits are required to be frozen on and after April 1, 2011 under 
paragraph (e) of this section.
    (iv) Once the enrolled actuary for the plan certifies that the AFTAP 
for 2011 for Plan T is 66%, Plan T is no longer subject to the 
restriction under paragraph (d)(1) of this section, but it is subject to 
the restriction under paragraph (d)(3) of this section. Plan T must 
resume paying prohibited payments, as restricted under paragraph (d)(3) 
of this section, for participants who elect benefits in accelerated 
forms of payment and who have an annuity starting date of June 1, 2011, 
or later. In addition, Plan T must provide benefits for any 
unpredictable contingent event occurring on or after January 1, 2011, to 
the extent permitted under paragraph (b) of this section. Similarly, 
Plan T is no longer subject to the restriction on benefit accruals under 
paragraph (e) of this section, and benefit accruals resume under Plan T 
beginning June 1, 2011, unless Plan T provides otherwise.
    Example 3. (i) The facts are the same as in Example 1, except that 
the enrolled actuary for the plan does not certify the 2011 AFTAP until 
November 15, 2011. Beginning October 1, 2011, Plan T is conclusively 
presumed to have an AFTAP of less than 60%, in accordance with the 
provisions of paragraph (h)(3) of this section. Accordingly, Plan T is 
subject

[[Page 1285]]

to the restrictions in paragraphs (b), (d)(1), and (e) of this section 
commencing on October 1, 2011.
    (ii) On November 15, 2011, the enrolled actuary for the plan 
certifies that the AFTAP for 2011 is 72%. However, because the 
certification occurred after September 30, 2011, the certification does 
not constitute a new section 436 measurement date, and Plan T continues 
to be subject to the restrictions on unpredictable contingent event 
benefits, prohibited payments, and benefit accruals under paragraphs 
(b), (d)(1), and (e) of this section.
    (iii) Beginning January 1, 2012, the 2012 AFTAP for Plan T is 
presumed to be equal to the 2011 AFTAP of 72%. Because the presumed 2012 
AFTAP is between 70% and 80% and, therefore, paragraph (h)(2) of this 
section (which provides for a 10 percentage point reduction in a plan's 
AFTAP in certain cases) will not apply, the presumed AFTAP will remain 
at 72% until the plan's enrolled actuary certifies the AFTAP for 2012 or 
until paragraph (h)(3) of this section applies on the first day of the 
10th month of the plan year. Because the presumed AFTAP is 72%, Plan T 
is no longer subject to the restrictions on prohibited payments under 
paragraph (d)(1) of this section, and Plan T must provide benefits for 
any unpredictable contingent event occurring on or after January 1, 
2012, to the extent permitted under paragraph (b) of this section and 
must resume paying prohibited payments, as restricted under paragraph 
(d)(3) of this section, that are elected by participants with annuity 
starting dates on or after January 1, 2012. Similarly, Plan T is no 
longer subject to the restriction on benefit accruals under paragraph 
(e) of this section, and benefit accruals resume under Plan T beginning 
January 1, 2012, unless Plan T provides otherwise.
    Example 4. (i) The facts are the same as in Example 3, except that 
the enrolled actuary for the plan does not issue a certification of the 
AFTAP for 2011 for Plan T until February 1, 2012.
    (ii) Beginning on January 1, 2012, the presumptions in paragraph 
(h)(1)(iii) of this section apply for the 2012 plan year. Because the 
enrolled actuary for the plan has not certified the AFTAP for 2011, the 
presumed AFTAP as of October 1, 2011, continues to apply for the period 
beginning January 1, 2012. Therefore, the AFTAP as of January 1, 2012, 
is presumed to be less than 60%, and Plan T continues to be subject to 
the restrictions on unpredictable contingent event benefits under 
paragraph (b) of this section, prohibited payments under paragraph 
(d)(1) of this section, and benefit accruals under paragraph (e) of this 
section.
    (iii) On February 1, 2012, the enrolled actuary for the plan 
certifies that the AFTAP for 2011 for Plan T is 65%. Because the 
enrolled actuary for the plan has not issued a certification of the 
AFTAP for 2012, the provisions of paragraph (h)(1)(iii)(B) of this 
section apply. Accordingly, the certification date for the 2011 AFTAP 
(February 1, 2012) is a section 436 measurement date and 65% is the 
presumed AFTAP for 2012 beginning on that date.
    (iv) Because the presumed AFTAP is over 60% but less than 80%, the 
full restriction on prohibited payments under paragraph (d)(1) of this 
section no longer applies; however, the partial restriction on 
prohibited payments under paragraph (d)(3) of this section applies 
beginning on February 1, 2012. Therefore, Plan T must pay a portion of 
the prohibited payments elected by participants with annuity starting 
dates on or after February 1, 2012. Furthermore, based on the presumed 
AFTAP of 65%, the restriction on unpredictable contingent event benefits 
under paragraph (b) of this section ceases to apply for events occurring 
on or after February 1, 2012, to the extent permitted under paragraph 
(b) of this section and the restriction on benefit accruals under 
paragraph (e) of this section no longer applies so that, unless Plan T 
provides otherwise, benefit accruals will resume as of February 1, 2012.
    Example 5. (i) The facts are the same as in Example 3, except that 
the enrolled actuary for the plan does not issue a certification of the 
actual AFTAP for Plan T as of January 1, 2011, until May 1, 2012.
    (ii) Beginning on January 1, 2012, the presumptions in paragraph 
(h)(1)(iii) of this section apply for the 2012 plan year. Because the 
enrolled actuary for the plan has not certified the actual AFTAP as of 
January 1, 2011, the presumed AFTAP as of October 1, 2011, continues to 
apply for the period beginning January 1, 2012. Therefore, the AFTAP as 
of January 1, 2012, is presumed to be less than 60%, and Plan T 
continues to be subject to the restrictions on unpredictable contingent 
event benefits under paragraph (b) of this section, on prohibited 
payments under paragraph (d)(1) of this section, and on benefit accruals 
under paragraph (e) of this section.
    (iii) Since the enrolled actuary for the plan has not issued a 
certification of the actual AFTAP as of January 1, 2011, the rules of 
paragraph (h)(1)(iii) of this section apply beginning April 1, 2012, and 
the AFTAP is presumed to remain less than 60%. Plan T continues to be 
subject to the restrictions on unpredictable contingent event benefits 
under paragraph (b) of this section, on prohibited payments under 
paragraph (d)(1) of this section, and on benefit accruals under 
paragraph (e) of this section.
    (iv) On May 1, 2012, the enrolled actuary for the plan certifies 
that the actual AFTAP for 2011 for Plan T is 65%. Because the enrolled 
actuary for the plan has not issued a certification of the actual AFTAP 
as of January 1, 2012, the provisions of paragraph (h)(2)(iv) of this 
section apply. Accordingly,

[[Page 1286]]

on May 1, 2012, the 2012 AFTAP is presumed to be 10 percentage points 
less than the 2011 AFTAP, or 55%, so that the restrictions under 
paragraphs (b), (d), and (e) of this section continue to apply.
    Example 6. (i) The enrolled actuary for Plan V certifies the plan's 
AFTAP for 2010 to be 69%. Based on this AFTAP, Plan V is subject to the 
restriction in paragraph (d)(3) of this section, and can only pay a 
portion (generally 50%) of the prohibited payments otherwise due to plan 
participants who commence benefits while the restriction is in effect. 
The enrolled actuary for the plan does not issue a certification of the 
AFTAP for 2011 until June 1, 2011.
    (ii) Beginning January 1, 2011, Plan V's 2011 AFTAP is presumed to 
be equal to the 2010 AFTAP, or 69%, under the provisions of paragraph 
(h)(1)(ii) of this section. Accordingly, the restriction on prohibited 
payments in paragraph (d)(3) of this section continues to apply from 
January 1, 2011, through March 31, 2011, and Plan T may only pay a 
portion of the prohibited payments otherwise due to participants who 
commence benefit payments during this period.
    (iii) Beginning April 1, 2011, the provisions of paragraph 
(h)(2)(ii) of this section apply. Under those provisions, the AFTAP 
beginning April 1, 2011, is presumed to be 10 percentage points lower 
than the presumed 2011 AFTAP, or 59%. Because Plan V's presumed AFTAP 
for 2011 is less than 60%, the restrictions on unpredictable contingent 
event benefits under paragraph (b) of this section, on the payment of 
accelerated benefit distributions under paragraph (d)(1) of this 
section, and on benefit accruals under paragraph (e) of this section 
apply. Accordingly, Plan V cannot pay any unpredictable contingent event 
benefits for events occurring on or after April 1, 2011, or prohibited 
payments to participants with an annuity starting date on or after April 
1, 2011, and benefit accruals cease as of April 1, 2011.
    (iv) On June 1, 2011, Plan V's enrolled actuary certifies that the 
plan's AFTAP for 2011 is 71%. Therefore, the restrictions on 
unpredictable contingent event benefits, prohibited payments, and 
benefit accruals in paragraphs (b), (d)(1), and (e) of this section no 
longer apply, but the partial restriction on benefit payments in 
paragraph (d)(3) of this section does apply. Accordingly, Plan V begins 
paying unpredictable contingent event benefits for events occurring on 
or after January 1, 2011, to the extent permitted under paragraph (b) of 
this section and a portion of the prohibited payments elected by 
participants with an annuity starting date on or after June 1, 2011. 
Benefit accruals previously restricted under paragraph (e) of this 
section resume effective June 1, 2011, unless Plan V provides otherwise.
    (v) Participants who were not able to elect an accelerated form of 
payment during the period from April 1, 2011, through May 31, 2011, 
would be able to elect a new annuity starting date with a partial 
distribution of accelerated benefits effective June 1, 2011, if Plan V 
contained a preexisting provision permitting such an election after the 
restriction in paragraph (d)(1) of this section no longer applies. This 
is permitted because, under paragraph (a)(4)(ii)(B) of this section, a 
preexisting provision of this type is not considered a plan amendment 
and is therefore not subject to the plan amendment restriction in 
paragraph (c) of this section even though Plan V's AFTAP for 2011 is 
less than 80%.
    (vi) Benefit accruals for the period beginning April 1, 2011, 
through May 31, 2011, would be automatically restored if Plan V 
contained a preexisting provision to retroactively restore benefit 
accruals restricted under paragraph (e) of this section after the 
restriction no longer applies. This is permitted because under paragraph 
(a)(4)(ii)(B) of this section, a preexisting provision of this type is 
not considered to be a plan amendment and is therefore not subject to 
the plan amendment restriction in paragraph (c) of this section even 
though Plan V's AFTAP for 2011 is less than 80%, because the period of 
the restriction did not exceed 12 months.

    (6) Examples of rules of paragraph (h)(4) of this section. The 
following examples illustrate the rules of paragraph (h)(4) of this 
section:

    Example 1. (i) Plan Y is a non-collectively bargained defined 
benefit plan with a plan year that is the calendar year and a valuation 
date of January 1. Plan Y does not have a funding standard carryover 
balance or a prefunding balance. Plan Y's sponsor is not in bankruptcy. 
In June of 2010, the actual AFTAP for 2010 for Plan Y is certified as 
65%. On the last day of the 2010 plan year, Plan Y is subject to the 
restrictions in paragraph (d)(3) of this section.
    (ii) The enrolled actuary for the plan issues a range certification 
on March 21, 2011, certifying that the AFTAP for 2011 is at least 60% 
and less than 80%. Because the certification was issued before the first 
day of the 4th month of the plan year, the 10 percentage point reduction 
in the presumed AFTAP under paragraph (h)(2) of this section does not 
apply. In addition, because the enrolled actuary for the plan has 
certified that the AFTAP is within this range, Plan Y is not subject to 
the full restriction on accelerated benefit payments in paragraph (d)(1) 
of this section or the restriction on benefit accruals under paragraph 
(e) of this section.
    (iii) On August 1, 2011, the enrolled actuary for the plan certifies 
that the actual AFTAP as of January 1, 2011, is 75.86%. This AFTAP falls 
within the previously certified range.

[[Page 1287]]

Thus, the change is immaterial under paragraph (h)(4)(iii) of this 
section and the new certification does not change the applicability or 
inapplicability of the restrictions in this section.
    Example 2. (i) The facts are the same as in Example 1, except that 
the plan sponsor makes an additional contribution for the 2010 plan year 
on September 1, 2011, that is not added to the prefunding balance. 
Reflecting this contribution, the enrolled actuary for the plan issues a 
revised certification stating that the AFTAP for 2011 is 81%, and Plan Y 
is no longer subject to the restriction on accelerated benefit payments 
under paragraph (d)(3) of this section on that date.
    (ii) Although the revised certification changes the applicability of 
the restriction under paragraph (d)(3) of this section, the change is 
not a material change under paragraph (h)(4)(iii)(C)(1) of this section 
because the AFTAP changed only because of additional contributions for 
the preceding year made by the plan sponsor after the date of the 
enrolled actuary's initial certification.

    (i) [Reserved]
    (j) Definitions. For purposes of this section--
    (1) Adjusted funding target attainment percentage--(i) In general. 
Except as otherwise provided in this paragraph (j)(1), the adjusted 
funding target attainment percentage for a plan year is the fraction 
(expressed as a percentage)--
    (A) The numerator of which is the adjusted plan assets for the plan 
year described in paragraph (j)(1)(ii) of this section; and
    (B) The denominator of which is the adjusted funding target for the 
plan year described in paragraph (j)(1)(iii) of this section.
    (ii) Adjusted plan assets--(A) General rule. The adjusted plan 
assets for a plan year is generally determined by--
    (1) Subtracting the plan's funding standard carryover balance and 
prefunding balance as of the valuation date from the value of plan 
assets for the plan year under section 430(g) (but treating the 
resulting value as zero if it is below zero); and
    (2) Increasing the resulting value by the aggregate amount of 
purchases of annuities for participants and beneficiaries (other than 
participants who, at the time of the purchase, were highly compensated 
employees as defined in section 414(q), which definition includes highly 
compensated former employees under Sec. 1.414(q)-1T, Q&A-4) which were 
made by the plan during the preceding 2 plan years, to the extent not 
included in plan assets for purposes of section 430.
    (B) Special rule for plans that are fully funded without regard to 
subtraction of funding balances from plan assets. If for a plan year the 
value of plan assets determined without subtracting the funding standard 
carryover balance and the prefunding balance is not less than 100 
percent of the plan's funding target determined under section 430 
without regard to section 430(i), then the adjusted value of plan assets 
used in the calculation of the adjusted funding target attainment 
percentage for the plan year is determined without subtracting the 
plan's funding standard carryover balance and prefunding balance from 
the value of plan assets for the plan year.
    (C) Special rule for plans with section 436 contributions. If an 
employer makes a contribution described in paragraph (f)(2) of this 
section after the valuation date in order to avoid or terminate 
limitations under section 436, then the present value of that 
contribution (determined using the effective interest rate under section 
430(h)(2)(A) for the plan year) is permitted to be added to the plan 
assets as of the valuation date for purposes of determining or 
redetermining the adjusted funding target attainment percentage for a 
plan year, but only if the liability for the benefits, amendment, or 
accruals that would have been limited (but for the contribution) is 
included in determining the adjusted funding target for the plan year.
    (D) Transition rule. Paragraph (j)(1)(ii)(B) of this section is 
applied to plan years beginning after 2007 and before 2011 by 
substituting for ``100 percent'' the applicable percentage determined in 
accordance with the following table:

------------------------------------------------------------------------
   In the case of a plan year beginning in calendar      The applicable
                        year:                            percentage is:
------------------------------------------------------------------------
2008.................................................                 92
2009.................................................                 94
2010.................................................                 96
------------------------------------------------------------------------

    (E) Limitation on transition rule. Paragraph (j)(1)(ii)(D) of this 
section does not apply with respect to the current plan year unless, for 
each plan year beginning after December 31, 2007, and before the current 
plan year, the value of

[[Page 1288]]

plan assets determined without subtracting the funding standard 
carryover balance and the prefunding balance is not less than the 
product of--
    (1) The applicable percentage determined under paragraph 
(j)(1)(ii)(D) of this section for that plan year; and
    (2) The funding target (determined without regard to the at-risk 
rules of section 430(i)) for that plan year.
    (iii) Adjusted funding target--(A) In general. Except as otherwise 
provided in this paragraph (j)(1)(iii), the adjusted funding target 
equals the funding target for the plan year, determined in accordance 
with the rules set forth in Sec. 1.430(d)-1, but without regard to the 
at-risk rules under section 430(i), increased by the aggregate amount of 
purchases of annuities that were added to assets for purposes of 
determining the plan's adjusted plan assets under paragraph 
(j)(1)(ii)(A)(2) of this section. The definition of adjusted funding 
target for a plan maintained by a commercial airline for which the plan 
sponsor has made the election described in section 402(a)(1) of Pension 
Protection Act of 2006 (PPA '06), Public Law 109-280 (120 Stat. 780), is 
the same as if it did not make such an election.
    (B) Adjusted funding target after updated certification. After the 
plan's enrolled actuary prepares an updated certification of the 
adjusted funding target attainment percentage under paragraph (h)(4)(v) 
of this section, the adjusted funding target will also be updated to 
reflect unpredictable contingent event benefits and plan amendments not 
already taken into account.
    (iv) Plans with zero adjusted funding target. If the adjusted 
funding target for the plan year is zero, then the adjusted funding 
target attainment percentage for the plan year is 100 percent.
    (v) Plans with end of year valuation dates. [Reserved]
    (vi) Special rule for plans that are the result of a merger. 
[Reserved]
    (vii) Special rule for plans that are involved in a spinoff. 
[Reserved]
    (2) Annuity starting date--(i) General rule. The term annuity 
starting date means, as applicable--
    (A) The first day of the first period for which an amount is payable 
as an annuity as described in section 417(f)(2)(A)(i);
    (B) In the case of a benefit not payable in the form of an annuity, 
the annuity starting date is the annuity starting date for the qualified 
joint and survivor annuity that is payable under the plan at the same 
time as the benefit that is not payable as an annuity;
    (C) In the case of an amount payable under a retroactive annuity 
starting date, the benefit commencement date (instead of the date 
determined under paragraphs (j)(2)(i)(A) and (B) of this section);
    (D) The date of the purchase of an irrevocable commitment from an 
insurer to pay benefits under the plan; and
    (E) The date of any transfer to another plan described in paragraph 
(j)(6)(i)(C) of this section.
    (ii) Special rule for beneficiaries. If a participant commences 
benefits at an annuity starting date (as defined in paragraph (j)(2)(i) 
of this section) and, after the death of the participant, payments 
continue to a beneficiary, the annuity starting date for the payments to 
the participant constitutes the annuity starting date for payments to 
the beneficiary, except that a new annuity starting date occurs 
(determined by applying paragraph (j)(2)(i)(A), (B), and (C) of this 
section to the payments to the beneficiary) if the amounts payable to 
all beneficiaries of the participant in the aggregate at any future date 
can exceed the monthly amount that would have been paid to the 
participant had he or she not died.
    (3) First effective plan year. The first effective plan year for a 
plan is the first plan year to which section 436 applies to the plan 
under paragraph (k)(1) or (k)(2) of this section.
    (4) Funding target. In general, the funding target means the funding 
target under Sec. 1.430(d)-1, without regard to the at-risk rules under 
section 430(i) and Sec. 1.430(i)-1. However, solely for purposes of 
sections 436(b)(2)(A) and (c)(2)(A), the funding target means the 
funding target under Sec. 1.430(i)-1 if the plan is in at-risk status 
for the plan year.
    (5) Prior plan year adjusted funding target attainment percentage--
(i) In general. Except as otherwise provided in this paragraph (j)(5), 
the prior plan year adjusted funding target attainment percentage is the 
adjusted funding target attainment percentage determined

[[Page 1289]]

under paragraph (j)(1) of this section for the immediately preceding 
plan year.
    (ii) Special rules--(A) Special rule for new plans. In the case of a 
plan established during the plan year that was not the result of a 
merger or spinoff, the adjusted funding target attainment percentage is 
equal to 100 percent for plan years before the plan was established. 
Except as otherwise provided in paragraph (j)(5)(ii)(B) of this section, 
a plan that has a predecessor plan in accordance with Sec. 1.415(f)-
1(c) is not a plan established during the plan year under this paragraph 
(j)(5)(ii)(A). Instead, if the plan has a predecessor plan, the adjusted 
funding target attainment percentage for the prior plan year is the 
adjusted funding target attainment percentage for the prior plan year 
for the predecessor plan (and that predecessor plan's adjusted funding 
target attainment percentage is treated as equal to 100 percent on any 
date on which it is terminated, other than in a distress termination).
    (B) Special rules for plans that are the result of a merger. 
[Reserved]
    (C) Special rules for plans that are involved in a spinoff. 
[Reserved]
    (iii) Special rules for 2007 plan year--(A) General determination of 
2007 adjusted funding target attainment percentage. In the case of the 
first plan year beginning in 2008, except as otherwise provided in this 
paragraph (j)(5), the adjusted funding target attainment percentage for 
the immediately preceding plan year (the 2007 plan year) is determined 
as the fraction (expressed as a percentage)--
    (1) The numerator of which is the value of plan assets determined 
under paragraph (j)(5)(iii)(B) of this section increased by the 
aggregate amount of purchases of annuities for participants and 
beneficiaries (other than participants who, at the time of the purchase, 
were highly compensated employees as defined in section 414(q), which 
definition includes highly compensated former employees under Sec. 
1.414(q)-1T, Q&A-4 which were made by the plan during the preceding 2 
plan years, to the extent not included in plan assets under section 
412(c)(2) (as in effect prior to amendment by PPA '06); and
    (2) The denominator of which is the plan's current liability 
determined pursuant to section 412(l)(7) (as in effect prior to 
amendment by PPA '06) on the valuation date for the 2007 plan year 
increased by the aggregate amount of purchases of annuities that were 
added to the plan assets under the rules of paragraph (j)(5)(iii)(A)(1) 
of this section.
    (B) General determination of value of plan assets--(1) In general. 
The value of plan assets for purposes of this paragraph (j)(5)(iii) is 
determined under section 412(c)(2) as in effect for the 2007 plan year, 
except that the value of plan assets prior to subtracting the plan's 
funding standard account credit balance described in paragraph 
(j)(5)(iii)(B)(2) of this section must be adjusted so that the value of 
plan assets is neither less than 90 percent of the fair market value of 
plan assets nor greater than 110 percent of the fair market value of 
plan assets on the valuation date for that plan year.
    (2) Subtraction of credit balance. If a plan has a funding standard 
account credit balance as of the valuation date for the 2007 plan year, 
that balance is subtracted from the value of plan assets described in 
paragraph (j)(5)(iii)(B)(1) of this section as of that valuation date. 
However, the subtraction does not apply if the value of plan assets 
prior to adjustment under paragraph (j)(5)(iii)(B)(1) of this section is 
greater than or equal to 90 percent of the plan's current liability as 
of the valuation date for the 2007 plan year.
    (3) Effect of funding standard carryover balance reduction for 2007 
plan year. Notwithstanding paragraph (j)(5)(iii)(B)(2) of this section, 
if, for the first plan year beginning in 2008, the employer has made an 
election to reduce some or all of the funding standard carryover balance 
as of the first day of that year in accordance with Sec. 1.430(f)-1(e), 
then the present value (determined as of the valuation date for the 2007 
plan year using the valuation interest rate for that plan year) of the 
amount so reduced is not treated as part of the funding standard account 
credit balance when that balance is subtracted from the asset value 
under paragraph (j)(5)(iii)(B)(2) of this section.

[[Page 1290]]

    (C) Plan with end-of-year valuation date. With respect to the first 
plan year beginning in 2008, if the plan had a valuation date under 
section 412 that was the last day of the plan year for each of the plan 
years beginning in 2006 and 2007, the adjusted funding target attainment 
percentage for the 2007 plan year may be determined as the fraction 
(expressed as a percentage)--
    (1) The numerator of which is the value of plan assets determined 
under paragraph (j)(5)(iii)(D) of this section increased by the 
aggregate amount of purchases of annuities for participants and 
beneficiaries (other than participants who, at the time of the purchase, 
were highly compensated employees as defined in section 414(q), which 
definition includes highly compensated former employees under Sec. 
1.414(q)-1T, Q&A-4 which were made by the plan during the preceding 2 
plan years, to the extent not included in plan assets under section 
412(c)(2) (as in effect prior to amendment by PPA '06); and
    (2) The denominator of which is the plan's current liability 
determined pursuant to section 412(l)(7) (as in effect prior to 
amendment by PPA '06) on the valuation date for the second plan year 
that begins before 2008 (the 2006 plan year), including the increase in 
current liability for the 2006 plan year, increased by the aggregate 
amount of purchases of annuities that were added to the plan assets 
under the rules of paragraph (j)(5)(iii)(C)(1) of this section.
    (D) Special asset determinations for 2006 adjusted funding target 
attainment percentage--(1) General rule. If the adjusted funding target 
attainment percentage for the 2007 plan year is determined under the 
rules of paragraph (j)(5)(iii)(C) of this section, then the value of 
plan assets is determined as the value of plan assets under section 
412(c)(2) as in effect for the 2006 plan year, adjusted as provided in 
this paragraph (j)(5)(iii)(D).
    (2) Inclusion of contributions for 2006. Contributions made for the 
2006 plan year are taken into account in determining the value of plan 
assets, regardless of whether those contributions are made during the 
plan year or after the end of the plan year and within the period 
specified under section 412(c)(10) (as in effect prior to amendment by 
PPA '06).
    (3) Restriction to 90-110 percent corridor. The value of plan assets 
taking into account the amount of contributions made for the 2006 plan 
year is increased or decreased, as necessary, so that it is neither less 
than 90 percent of the fair market value of plan assets nor greater than 
110 percent of the fair market value of plan assets on the valuation 
date for the 2006 plan year (taking into account assets attributable to 
contributions for the 2006 plan year).
    (4) Subtraction of credit balance. The plan's funding standard 
account credit balance as of the end of the 2006 plan year is generally 
subtracted from the value of plan assets determined after application of 
paragraph (j)(5)(iii)(D)(3) of this section. However, this subtraction 
does not apply if the value of plan assets is greater than or equal to 
90 percent of the plan's current liability determined under section 
412(l)(7) (as in effect prior to amendment by PPA '06) on the valuation 
date for the 2006 plan year.
    (E) Special rules for mergers and spinoffs. Rules similar to the 
rules of paragraph (j)(5)(ii) of this section apply for purposes of 
determining the adjusted funding target attainment percentage for the 
2007 plan year in the case of a newly established plan, a plan that is 
the result of a merger of two plans, or a plan that is in involved in a 
spinoff.
    (6) Prohibited payment--(i) General rule. The term prohibited 
payment means--
    (A) Any payment for a month that is in excess of the monthly amount 
paid under a straight life annuity (plus any social security supplements 
described in the last sentence of section 411(a)(9)) to a participant or 
beneficiary whose annuity starting date occurs during any period that a 
limitation under paragraph (d) of this section is in effect;
    (B) Any payment for the purchase of an irrevocable commitment from 
an insurer to pay benefits;
    (C) Any transfer of assets and liabilities to another plan 
maintained by the same employer (or by any member of the employer's 
controlled group) that is made in order to avoid or terminate

[[Page 1291]]

the application of section 436 benefit limitations; and
    (D) Any other amount that is identified as a prohibited payment by 
the Commissioner in revenue rulings and procedures, notices, and other 
guidance published in the Internal Revenue Bulletin (see Sec. 
601.601(d)(2) relating to objectives and standards for publishing 
regulations, revenue rulings and revenue procedures in the Internal 
Revenue Bulletin).
    (ii) Special rule for beneficiaries. In the case of a beneficiary 
that is not an individual, the amount that is a prohibited payment is 
determined by substituting for the amount in paragraph (j)(1)(i)(A) of 
this section the monthly amount payable in installments over 240 months 
that is actuarially equivalent to the benefit payable to the 
beneficiary.
    (7) Section 436 contributions. Section 436 contributions are the 
contributions described in paragraph (f)(2) of this section that are 
made in order to avoid the application of section 436 limitations under 
a plan for a plan year.
    (8) Section 436 measurement date. A section 436 measurement date is 
the date that is used to determine when the limitations of sections 
436(d) and 436(e) apply or cease to apply, and is also used for 
calculations with respect to applying the limitations of paragraphs (b) 
and (c) of this section. See paragraphs (h)(1)(i), (h)(2)(iii)(B), 
(h)(2)(iv)(B), and (h)(3)(i) of this section regarding section 436 
measurement dates that result from application of the presumptions under 
paragraph (h) of this section.
    (9) Unpredictable contingent event. An unpredictable contingent 
event benefit means any benefit or increase in benefits to the extent 
the benefit or increase would not be payable but for the occurrence of 
an unpredictable contingent event. For this purpose, an unpredictable 
contingent event means a plant shutdown (whether full or partial) or 
similar event, or an event (including the absence of an event) other 
than the attainment of any age, performance of any service, receipt or 
derivation of any compensation, or the occurrence of death or 
disability. For example, if a plan provides for an unreduced early 
retirement benefit upon the occurrence of an event other than the 
attainment of any age, performance of any service, receipt or derivation 
of any compensation, or the occurrence of death or disability, then that 
unreduced early retirement benefit is an unpredictable contingent event 
benefit to the extent of any portion of the benefit that would not be 
payable but for the occurrence of the event, even if the remainder of 
the benefit is payable without regard to the occurrence of the event. 
Similarly, if a plan includes a benefit payable upon the presence 
(including the absence) of circumstances specified in the plan (other 
than the attainment of any age, performance of any service, receipt or 
derivation of any compensation, or the occurrence of death or 
disability), but not upon a severance from employment that does not 
include those circumstances, that benefit is an unpredictable contingent 
event benefit.
    (10) Examples. The following examples illustrate the rules of this 
paragraph (j):

    Example 1. (i) Plan S is a non-collectively bargained defined 
benefit plan with a plan year that is the calendar year and a valuation 
date of January 1. The first effective plan year is 2008. Plan S is not 
in at-risk status for 2008.
    (ii) As of January 1, 2008, Plan S has a value of plan assets (equal 
to the market value of assets) of $2,100,000 and a funding standard 
carryover balance of $200,000. During 2006, assets from Plan S were used 
to purchase a total of $100,000 in annuities for employees other than 
highly compensated employees. No annuities were purchased during 2007. 
On May 1, 2008, the enrolled actuary for the plan determines that the 
funding target as of January 1, 2008, is $2,500,000.
    (iii) The adjusted value of assets for Plan S as of January 1, 2008, 
is $2,000,000 (that is, plan assets of $2,100,000, plus annuity 
purchases of $100,000, and minus the funding standard carryover balance 
of $200,000). The adjusted funding target is $2,600,000 (that is, the 
funding target of $2,500,000, increased by the annuity purchases of 
$100,000).
    (iv) Based on the above adjusted plan assets and adjusted funding 
target, the adjusted funding target attainment percentage (AFTAP) as of 
January 1, 2008, would be 76.92%. Since the AFTAP is less than 80% but 
is at least 60%, Plan S is subject to the restrictions in paragraph 
(d)(3) of this section.
    Example 2. (i) The facts are the same as in Example 1, except that 
it is reasonable to expect that the plan sponsor will make a 
contribution of $80,000 to Plan S for the 2007 plan

[[Page 1292]]

year by September 15, 2008. This amount is in excess of the minimum 
required contribution for 2007. The plan sponsor elects to reduce the 
funding standard carryover balance by $80,000.
    (ii) Because it is reasonable to expect that the $80,000 will be 
contributed by the plan sponsor, that amount is taken into account when 
the enrolled actuary certifies the 2008 AFTAP under the special rule in 
paragraph (h)(4)(i)(B) of this section for plan years beginning before 
2009. Accordingly, the enrolled actuary for the plan certifies the 2008 
AFTAP as 80% (that is, adjusted plan assets of $2,080,000, reflecting 
the $80,000 in contributions receivable, divided by the adjusted funding 
target of $2,600,000).
    (iii) The ability to take contributions into account before they are 
actually paid to the plan is available only for plan years beginning 
before 2009. Furthermore, if the employer does not actually make the 
contribution and the difference between the incorrect certification and 
the corrected AFTAP constitutes a material change, the plan will have 
violated section 401(a)(29) or will not have been operated in accordance 
with its terms.
    Example 3. (i) Plan R is a defined benefit plan with a plan year 
that is the calendar year and a valuation date of January 1. Section 436 
applies to Plan R for 2008. The valuation interest rate for the 2007 
plan year for Plan R is 7%. The fair market value of assets of Plan R as 
of January 1, 2007, is $1,000,000. The actuarial value of assets of Plan 
R as of January 1, 2007, is $1,200,000. The current liability of Plan R 
as of January 1, 2007, is $1,500,000. The funding standard account 
credit balance as of January 1, 2007, is $80,000. The funding standard 
carryover balance of Plan R is $50,000 as of the beginning of the 2008 
plan year. The sponsor of Plan R, Sponsor T, elects in 2008 to reduce 
the funding standard carryover balance in accordance with Sec. 
1.430(f)-1 by $45,000. No annuities were purchased using plan assets 
during 2005 or 2006.
    (ii) Pursuant to paragraph (j)(5)(iii)(B)(1) of this section, the 
asset value used to determine the AFTAP for the 2007 plan year is 
limited to 110% of the fair market value of assets on January 1, 2007, 
or $1,100,000 (110% of $1,000,000).
    (iii) Pursuant to paragraph (j)(5)(iii)(B)(2) of this section, the 
funding standard account credit balance as of January 1, 2007, is 
subtracted from the asset value used to determine the AFTAP for the 2007 
plan year. However, pursuant to paragraph (j)(5)(iii)(B)(3) of this 
section, the present value of the amount by which Sponsor T elected to 
reduce the funding standard carryover balance in 2008 is not subtracted.
    (iv) The present value, determined at an interest rate of 7%, of the 
$45,000 reduction in the funding standard carryover balance elected by 
Sponsor T in 2008 is $42,056. Thus, $42,056 is not subtracted from the 
2007 plan year asset value. Accordingly, the funding standard account 
credit balance that is subtracted from the 2007 plan year asset value is 
$37,944 (that is, $80,000 less $42,056).
    (v) Thus, the asset value that is used to determine the FTAP for the 
2007 plan year is $1,100,000 less $37,944, or $1,062,056. Accordingly, 
for purposes of this section, the FTAP for the 2007 plan year for Plan R 
is 70.8% (that is, $1,062,056 divided by $1,500,000).
    Example 4. (i) Plan T is a non-collectively bargained defined 
benefit plan that was established prior to 2007. Plan T has a plan year 
that is the calendar year and a valuation date of January 1. The first 
effective plan year is 2008; the plan met the conditions of paragraph 
(j)(1)(ii)(E) of this section for 2008. As of January 1, 2009, Plan T 
has a value of plan assets (equal to the market value of assets) of 
$3,000,000, a funding standard carryover balance of $150,000, and a 
prefunding balance of $50,000. During 2007 and 2008, assets from Plan T 
were used to purchase a total of $400,000 in annuities for employees 
other than highly compensated employees. The funding target for Plan T 
(without regard to the at-risk rules of section 430(i)) is $3,200,000 as 
of January 1, 2009.
    (ii) The plan's funding status is calculated in accordance with 
paragraph (j)(1)(ii)(B) of this section to determine whether the special 
rule for fully-funded plans applies to Plan T. Accordingly, the value of 
plan assets determined without subtracting the funding standard 
carryover balance and the prefunding balance is 93.75% of the plan's 
funding target ($3,000,000 / $3,200,000). The applicable transitional 
percentage in paragraph (j)(1)(ii)(D) of this section is 94% for 2009. 
Because the percentage calculated above is less than 94%, the transition 
rule does not apply to Plan T.
    (iii) Accordingly, the January 1, 2009, AFTAP for Plan T is 
calculated without reflecting the special rule in paragraph 
(j)(1)(ii)(B) of this section. The AFTAP as of January 1, 2009, is 
calculated by dividing the adjusted assets by the adjusted funding 
target. For this purpose, the value of assets is increased by the 
annuities purchased for nonhighly compensated employees during 2007 and 
2008, and decreased by the funding standard carryover balance and the 
prefunding balance as of January 1, 2009, resulting in an adjusted asset 
value of $3,200,000 (that is, $3,000,000 + $400,000-$150,000-$50,000). 
The funding target is increased by the annuities purchased for nonhighly 
compensated employees during 2007 and 2008, resulting in an adjusted 
funding target of $3,600,000 (that is, $3,200,000 + $400,000). The AFTAP 
for Plan T for 2009 is therefore $3,200,000 / $3,600,000, or 88.89%.


[[Page 1293]]


    (k) Effective/applicability dates--(1) Statutory effective date. 
Section 436 generally applies to plan years beginning on or after 
January 1, 2008. The applicability of section 436 for purposes of 
determining the minimum required contribution is delayed for certain 
plans in accordance with sections 104 through 106 of PPA '06.
    (2) Collectively bargained plan exception--(i) In general. In the 
case of a collectively bargained plan that is maintained pursuant to one 
or more collective bargaining agreements between employee 
representatives and one or more employers ratified before January 1, 
2008, section 436 does not apply to plan years beginning before the 
earlier of--
    (A) January 1, 2010; or
    (B) The later of--
    (1) The date on which the last such collective bargaining agreement 
relating to the plan terminates (determined without regard to any 
extension thereof agreed to after August 17, 2006); or
    (2) The first day of the first plan year to which section 436 would 
(but for this paragraph (k)(2)) apply.
    (ii) Treatment of certain plan amendments. For purposes of this 
paragraph (k)(2), any plan amendment made pursuant to a collective 
bargaining agreement relating to the plan which amends the plan solely 
to conform to any requirement added by section 436 is not treated as a 
termination of the collective bargaining agreement.
    (iii) Treatment of plans with both collectively bargained and non-
collectively bargained employees. In the case of a plan with respect to 
which a collective bargaining agreement applies to some, but not all, of 
the plan participants, the plan is considered a collectively bargained 
plan for purposes of this paragraph (k)(2) if it is considered a 
collectively bargained plan under the rules of paragraph (a)(5)(ii)(B) 
of this section.
    (3) Effective date/applicability date of regulations. This section 
applies to plan years beginning on or after January 1, 2010. For plan 
years beginning before January 1, 2010, plans are permitted to rely on 
the provisions set forth in this section for purposes of satisfying the 
requirements of section 436.

[T.D. 9467, 74 FR 53061, Oct. 15, 2009]



Sec. Sec. 1.437-1.440  [Reserved]

[[Page 1295]]



                              FINDING AIDS




  --------------------------------------------------------------------

  A list of CFR titles, subtitles, chapters, subchapters and parts and 
an alphabetical list of agencies publishing in the CFR are included in 
the CFR Index and Finding Aids volume to the Code of Federal Regulations 
which is published separately and revised annually.

  Table of CFR Titles and Chapters
  Alphabetical List of Agencies Appearing in the CFR
  Table of OMB Control Numbers
  List of CFR Sections Affected

[[Page 1297]]



                    Table of CFR Titles and Chapters




                      (Revised as of April 1, 2014)

                      Title 1--General Provisions

         I  Administrative Committee of the Federal Register 
                (Parts 1--49)
        II  Office of the Federal Register (Parts 50--299)
       III  Administrative Conference of the United States (Parts 
                300--399)
        IV  Miscellaneous Agencies (Parts 400--500)

                    Title 2--Grants and Agreements

            Subtitle A--Office of Management and Budget Guidance 
                for Grants and Agreements
         I  Office of Management and Budget Governmentwide 
                Guidance for Grants and Agreements (Parts 2--199)
        II  Office of Management and Budget Guidance (Parts 200--
                299)
            Subtitle B--Federal Agency Regulations for Grants and 
                Agreements
       III  Department of Health and Human Services (Parts 300-- 
                399)
        IV  Department of Agriculture (Parts 400--499)
        VI  Department of State (Parts 600--699)
       VII  Agency for International Development (Parts 700--799)
      VIII  Department of Veterans Affairs (Parts 800--899)
        IX  Department of Energy (Parts 900--999)
        XI  Department of Defense (Parts 1100--1199)
       XII  Department of Transportation (Parts 1200--1299)
      XIII  Department of Commerce (Parts 1300--1399)
       XIV  Department of the Interior (Parts 1400--1499)
        XV  Environmental Protection Agency (Parts 1500--1599)
     XVIII  National Aeronautics and Space Administration (Parts 
                1800--1899)
        XX  United States Nuclear Regulatory Commission (Parts 
                2000--2099)
      XXII  Corporation for National and Community Service (Parts 
                2200--2299)
     XXIII  Social Security Administration (Parts 2300--2399)
      XXIV  Housing and Urban Development (Parts 2400--2499)
       XXV  National Science Foundation (Parts 2500--2599)
      XXVI  National Archives and Records Administration (Parts 
                2600--2699)
     XXVII  Small Business Administration (Parts 2700--2799)
    XXVIII  Department of Justice (Parts 2800--2899)

[[Page 1298]]

       XXX  Department of Homeland Security (Parts 3000--3099)
      XXXI  Institute of Museum and Library Services (Parts 3100--
                3199)
     XXXII  National Endowment for the Arts (Parts 3200--3299)
    XXXIII  National Endowment for the Humanities (Parts 3300--
                3399)
     XXXIV  Department of Education (Parts 3400--3499)
      XXXV  Export-Import Bank of the United States (Parts 3500--
                3599)
    XXXVII  Peace Corps (Parts 3700--3799)
     LVIII  Election Assistance Commission (Parts 5800--5899)

                        Title 3--The President

         I  Executive Office of the President (Parts 100--199)

                           Title 4--Accounts

         I  Government Accountability Office (Parts 1--199)
        II  Recovery Accountability and Transparency Board (Parts 
                200--299)

                   Title 5--Administrative Personnel

         I  Office of Personnel Management (Parts 1--1199)
        II  Merit Systems Protection Board (Parts 1200--1299)
       III  Office of Management and Budget (Parts 1300--1399)
         V  The International Organizations Employees Loyalty 
                Board (Parts 1500--1599)
        VI  Federal Retirement Thrift Investment Board (Parts 
                1600--1699)
      VIII  Office of Special Counsel (Parts 1800--1899)
        IX  Appalachian Regional Commission (Parts 1900--1999)
        XI  Armed Forces Retirement Home (Parts 2100--2199)
       XIV  Federal Labor Relations Authority, General Counsel of 
                the Federal Labor Relations Authority and Federal 
                Service Impasses Panel (Parts 2400--2499)
        XV  Office of Administration, Executive Office of the 
                President (Parts 2500--2599)
       XVI  Office of Government Ethics (Parts 2600--2699)
       XXI  Department of the Treasury (Parts 3100--3199)
      XXII  Federal Deposit Insurance Corporation (Parts 3200--
                3299)
     XXIII  Department of Energy (Parts 3300--3399)
      XXIV  Federal Energy Regulatory Commission (Parts 3400--
                3499)
       XXV  Department of the Interior (Parts 3500--3599)
      XXVI  Department of Defense (Parts 3600-- 3699)
    XXVIII  Department of Justice (Parts 3800--3899)
      XXIX  Federal Communications Commission (Parts 3900--3999)
       XXX  Farm Credit System Insurance Corporation (Parts 4000--
                4099)
      XXXI  Farm Credit Administration (Parts 4100--4199)

[[Page 1299]]

    XXXIII  Overseas Private Investment Corporation (Parts 4300--
                4399)
     XXXIV  Securities and Exchange Commission (Parts 4400--4499)
      XXXV  Office of Personnel Management (Parts 4500--4599)
    XXXVII  Federal Election Commission (Parts 4700--4799)
        XL  Interstate Commerce Commission (Parts 5000--5099)
       XLI  Commodity Futures Trading Commission (Parts 5100--
                5199)
      XLII  Department of Labor (Parts 5200--5299)
     XLIII  National Science Foundation (Parts 5300--5399)
       XLV  Department of Health and Human Services (Parts 5500--
                5599)
      XLVI  Postal Rate Commission (Parts 5600--5699)
     XLVII  Federal Trade Commission (Parts 5700--5799)
    XLVIII  Nuclear Regulatory Commission (Parts 5800--5899)
      XLIX  Federal Labor Relations Authority (Parts 5900--5999)
         L  Department of Transportation (Parts 6000--6099)
       LII  Export-Import Bank of the United States (Parts 6200--
                6299)
      LIII  Department of Education (Parts 6300--6399)
       LIV  Environmental Protection Agency (Parts 6400--6499)
        LV  National Endowment for the Arts (Parts 6500--6599)
       LVI  National Endowment for the Humanities (Parts 6600--
                6699)
      LVII  General Services Administration (Parts 6700--6799)
     LVIII  Board of Governors of the Federal Reserve System 
                (Parts 6800--6899)
       LIX  National Aeronautics and Space Administration (Parts 
                6900--6999)
        LX  United States Postal Service (Parts 7000--7099)
       LXI  National Labor Relations Board (Parts 7100--7199)
      LXII  Equal Employment Opportunity Commission (Parts 7200--
                7299)
     LXIII  Inter-American Foundation (Parts 7300--7399)
      LXIV  Merit Systems Protection Board (Parts 7400--7499)
       LXV  Department of Housing and Urban Development (Parts 
                7500--7599)
      LXVI  National Archives and Records Administration (Parts 
                7600--7699)
     LXVII  Institute of Museum and Library Services (Parts 7700--
                7799)
    LXVIII  Commission on Civil Rights (Parts 7800--7899)
      LXIX  Tennessee Valley Authority (Parts 7900--7999)
       LXX  Court Services and Offender Supervision Agency for the 
                District of Columbia (Parts 8000--8099)
      LXXI  Consumer Product Safety Commission (Parts 8100--8199)
    LXXIII  Department of Agriculture (Parts 8300--8399)
     LXXIV  Federal Mine Safety and Health Review Commission 
                (Parts 8400--8499)
     LXXVI  Federal Retirement Thrift Investment Board (Parts 
                8600--8699)
    LXXVII  Office of Management and Budget (Parts 8700--8799)
      LXXX  Federal Housing Finance Agency (Parts 9000--9099)
   LXXXIII  Special Inspector General for Afghanistan 
                Reconstruction (Parts 9300--9399)

[[Page 1300]]

    LXXXIV  Bureau of Consumer Financial Protection (Parts 9400--
                9499)
    LXXXVI  National Credit Union Administration (Parts 9600--
                9699)
     XCVII  Department of Homeland Security Human Resources 
                Management System (Department of Homeland 
                Security--Office of Personnel Management) (Parts 
                9700--9799)
     XCVII  Council of the Inspectors General on Integrity and 
                Efficiency (Parts 9800--9899)

                      Title 6--Domestic Security

         I  Department of Homeland Security, Office of the 
                Secretary (Parts 1--99)
         X  Privacy and Civil Liberties Oversight Board (Parts 
                1000--1099)

                         Title 7--Agriculture

            Subtitle A--Office of the Secretary of Agriculture 
                (Parts 0--26)
            Subtitle B--Regulations of the Department of 
                Agriculture
         I  Agricultural Marketing Service (Standards, 
                Inspections, Marketing Practices), Department of 
                Agriculture (Parts 27--209)
        II  Food and Nutrition Service, Department of Agriculture 
                (Parts 210--299)
       III  Animal and Plant Health Inspection Service, Department 
                of Agriculture (Parts 300--399)
        IV  Federal Crop Insurance Corporation, Department of 
                Agriculture (Parts 400--499)
         V  Agricultural Research Service, Department of 
                Agriculture (Parts 500--599)
        VI  Natural Resources Conservation Service, Department of 
                Agriculture (Parts 600--699)
       VII  Farm Service Agency, Department of Agriculture (Parts 
                700--799)
      VIII  Grain Inspection, Packers and Stockyards 
                Administration (Federal Grain Inspection Service), 
                Department of Agriculture (Parts 800--899)
        IX  Agricultural Marketing Service (Marketing Agreements 
                and Orders; Fruits, Vegetables, Nuts), Department 
                of Agriculture (Parts 900--999)
         X  Agricultural Marketing Service (Marketing Agreements 
                and Orders; Milk), Department of Agriculture 
                (Parts 1000--1199)
        XI  Agricultural Marketing Service (Marketing Agreements 
                and Orders; Miscellaneous Commodities), Department 
                of Agriculture (Parts 1200--1299)
       XIV  Commodity Credit Corporation, Department of 
                Agriculture (Parts 1400--1499)
        XV  Foreign Agricultural Service, Department of 
                Agriculture (Parts 1500--1599)
       XVI  Rural Telephone Bank, Department of Agriculture (Parts 
                1600--1699)

[[Page 1301]]

      XVII  Rural Utilities Service, Department of Agriculture 
                (Parts 1700--1799)
     XVIII  Rural Housing Service, Rural Business-Cooperative 
                Service, Rural Utilities Service, and Farm Service 
                Agency, Department of Agriculture (Parts 1800--
                2099)
        XX  Local Television Loan Guarantee Board (Parts 2200--
                2299)
       XXV  Office of Advocacy and Outreach, Department of 
                Agriculture (Parts 2500--2599)
      XXVI  Office of Inspector General, Department of Agriculture 
                (Parts 2600--2699)
     XXVII  Office of Information Resources Management, Department 
                of Agriculture (Parts 2700--2799)
    XXVIII  Office of Operations, Department of Agriculture (Parts 
                2800--2899)
      XXIX  Office of Energy Policy and New Uses, Department of 
                Agriculture (Parts 2900--2999)
       XXX  Office of the Chief Financial Officer, Department of 
                Agriculture (Parts 3000--3099)
      XXXI  Office of Environmental Quality, Department of 
                Agriculture (Parts 3100--3199)
     XXXII  Office of Procurement and Property Management, 
                Department of Agriculture (Parts 3200--3299)
    XXXIII  Office of Transportation, Department of Agriculture 
                (Parts 3300--3399)
     XXXIV  National Institute of Food and Agriculture (Parts 
                3400--3499)
      XXXV  Rural Housing Service, Department of Agriculture 
                (Parts 3500--3599)
     XXXVI  National Agricultural Statistics Service, Department 
                of Agriculture (Parts 3600--3699)
    XXXVII  Economic Research Service, Department of Agriculture 
                (Parts 3700--3799)
   XXXVIII  World Agricultural Outlook Board, Department of 
                Agriculture (Parts 3800--3899)
       XLI  [Reserved]
      XLII  Rural Business-Cooperative Service and Rural Utilities 
                Service, Department of Agriculture (Parts 4200--
                4299)

                    Title 8--Aliens and Nationality

         I  Department of Homeland Security (Immigration and 
                Naturalization) (Parts 1--499)
         V  Executive Office for Immigration Review, Department of 
                Justice (Parts 1000--1399)

                 Title 9--Animals and Animal Products

         I  Animal and Plant Health Inspection Service, Department 
                of Agriculture (Parts 1--199)

[[Page 1302]]

        II  Grain Inspection, Packers and Stockyards 
                Administration (Packers and Stockyards Programs), 
                Department of Agriculture (Parts 200--299)
       III  Food Safety and Inspection Service, Department of 
                Agriculture (Parts 300--599)

                           Title 10--Energy

         I  Nuclear Regulatory Commission (Parts 0--199)
        II  Department of Energy (Parts 200--699)
       III  Department of Energy (Parts 700--999)
         X  Department of Energy (General Provisions) (Parts 
                1000--1099)
      XIII  Nuclear Waste Technical Review Board (Parts 1300--
                1399)
      XVII  Defense Nuclear Facilities Safety Board (Parts 1700--
                1799)
     XVIII  Northeast Interstate Low-Level Radioactive Waste 
                Commission (Parts 1800--1899)

                      Title 11--Federal Elections

         I  Federal Election Commission (Parts 1--9099)
        II  Election Assistance Commission (Parts 9400--9499)

                      Title 12--Banks and Banking

         I  Comptroller of the Currency, Department of the 
                Treasury (Parts 1--199)
        II  Federal Reserve System (Parts 200--299)
       III  Federal Deposit Insurance Corporation (Parts 300--399)
        IV  Export-Import Bank of the United States (Parts 400--
                499)
         V  Office of Thrift Supervision, Department of the 
                Treasury (Parts 500--599)
        VI  Farm Credit Administration (Parts 600--699)
       VII  National Credit Union Administration (Parts 700--799)
      VIII  Federal Financing Bank (Parts 800--899)
        IX  Federal Housing Finance Board (Parts 900--999)
         X  Bureau of Consumer Financial Protection (Parts 1000--
                1099)
        XI  Federal Financial Institutions Examination Council 
                (Parts 1100--1199)
       XII  Federal Housing Finance Agency (Parts 1200--1299)
      XIII  Financial Stability Oversight Council (Parts 1300--
                1399)
       XIV  Farm Credit System Insurance Corporation (Parts 1400--
                1499)
        XV  Department of the Treasury (Parts 1500--1599)
       XVI  Office of Financial Research (Parts 1600--1699)
      XVII  Office of Federal Housing Enterprise Oversight, 
                Department of Housing and Urban Development (Parts 
                1700--1799)
     XVIII  Community Development Financial Institutions Fund, 
                Department of the Treasury (Parts 1800--1899)

[[Page 1303]]

               Title 13--Business Credit and Assistance

         I  Small Business Administration (Parts 1--199)
       III  Economic Development Administration, Department of 
                Commerce (Parts 300--399)
        IV  Emergency Steel Guarantee Loan Board (Parts 400--499)
         V  Emergency Oil and Gas Guaranteed Loan Board (Parts 
                500--599)

                    Title 14--Aeronautics and Space

         I  Federal Aviation Administration, Department of 
                Transportation (Parts 1--199)
        II  Office of the Secretary, Department of Transportation 
                (Aviation Proceedings) (Parts 200--399)
       III  Commercial Space Transportation, Federal Aviation 
                Administration, Department of Transportation 
                (Parts 400--1199)
         V  National Aeronautics and Space Administration (Parts 
                1200--1299)
        VI  Air Transportation System Stabilization (Parts 1300--
                1399)

                 Title 15--Commerce and Foreign Trade

            Subtitle A--Office of the Secretary of Commerce (Parts 
                0--29)
            Subtitle B--Regulations Relating to Commerce and 
                Foreign Trade
         I  Bureau of the Census, Department of Commerce (Parts 
                30--199)
        II  National Institute of Standards and Technology, 
                Department of Commerce (Parts 200--299)
       III  International Trade Administration, Department of 
                Commerce (Parts 300--399)
        IV  Foreign-Trade Zones Board, Department of Commerce 
                (Parts 400--499)
       VII  Bureau of Industry and Security, Department of 
                Commerce (Parts 700--799)
      VIII  Bureau of Economic Analysis, Department of Commerce 
                (Parts 800--899)
        IX  National Oceanic and Atmospheric Administration, 
                Department of Commerce (Parts 900--999)
        XI  Technology Administration, Department of Commerce 
                (Parts 1100--1199)
      XIII  East-West Foreign Trade Board (Parts 1300--1399)
       XIV  Minority Business Development Agency (Parts 1400--
                1499)
            Subtitle C--Regulations Relating to Foreign Trade 
                Agreements
        XX  Office of the United States Trade Representative 
                (Parts 2000--2099)
            Subtitle D--Regulations Relating to Telecommunications 
                and Information
     XXIII  National Telecommunications and Information 
                Administration, Department of Commerce (Parts 
                2300--2399)

[[Page 1304]]

                    Title 16--Commercial Practices

         I  Federal Trade Commission (Parts 0--999)
        II  Consumer Product Safety Commission (Parts 1000--1799)

             Title 17--Commodity and Securities Exchanges

         I  Commodity Futures Trading Commission (Parts 1--199)
        II  Securities and Exchange Commission (Parts 200--399)
        IV  Department of the Treasury (Parts 400--499)

          Title 18--Conservation of Power and Water Resources

         I  Federal Energy Regulatory Commission, Department of 
                Energy (Parts 1--399)
       III  Delaware River Basin Commission (Parts 400--499)
        VI  Water Resources Council (Parts 700--799)
      VIII  Susquehanna River Basin Commission (Parts 800--899)
      XIII  Tennessee Valley Authority (Parts 1300--1399)

                       Title 19--Customs Duties

         I  U.S. Customs and Border Protection, Department of 
                Homeland Security; Department of the Treasury 
                (Parts 0--199)
        II  United States International Trade Commission (Parts 
                200--299)
       III  International Trade Administration, Department of 
                Commerce (Parts 300--399)
        IV  U.S. Immigration and Customs Enforcement, Department 
                of Homeland Security (Parts 400--599)

                     Title 20--Employees' Benefits

         I  Office of Workers' Compensation Programs, Department 
                of Labor (Parts 1--199)
        II  Railroad Retirement Board (Parts 200--399)
       III  Social Security Administration (Parts 400--499)
        IV  Employees' Compensation Appeals Board, Department of 
                Labor (Parts 500--599)
         V  Employment and Training Administration, Department of 
                Labor (Parts 600--699)
        VI  Office of Workers' Compensation Programs, Department 
                of Labor (Parts 700--799)
       VII  Benefits Review Board, Department of Labor (Parts 
                800--899)
      VIII  Joint Board for the Enrollment of Actuaries (Parts 
                900--999)
        IX  Office of the Assistant Secretary for Veterans' 
                Employment and Training Service, Department of 
                Labor (Parts 1000--1099)

[[Page 1305]]

                       Title 21--Food and Drugs

         I  Food and Drug Administration, Department of Health and 
                Human Services (Parts 1--1299)
        II  Drug Enforcement Administration, Department of Justice 
                (Parts 1300--1399)
       III  Office of National Drug Control Policy (Parts 1400--
                1499)

                      Title 22--Foreign Relations

         I  Department of State (Parts 1--199)
        II  Agency for International Development (Parts 200--299)
       III  Peace Corps (Parts 300--399)
        IV  International Joint Commission, United States and 
                Canada (Parts 400--499)
         V  Broadcasting Board of Governors (Parts 500--599)
       VII  Overseas Private Investment Corporation (Parts 700--
                799)
        IX  Foreign Service Grievance Board (Parts 900--999)
         X  Inter-American Foundation (Parts 1000--1099)
        XI  International Boundary and Water Commission, United 
                States and Mexico, United States Section (Parts 
                1100--1199)
       XII  United States International Development Cooperation 
                Agency (Parts 1200--1299)
      XIII  Millennium Challenge Corporation (Parts 1300--1399)
       XIV  Foreign Service Labor Relations Board; Federal Labor 
                Relations Authority; General Counsel of the 
                Federal Labor Relations Authority; and the Foreign 
                Service Impasse Disputes Panel (Parts 1400--1499)
        XV  African Development Foundation (Parts 1500--1599)
       XVI  Japan-United States Friendship Commission (Parts 
                1600--1699)
      XVII  United States Institute of Peace (Parts 1700--1799)

                          Title 23--Highways

         I  Federal Highway Administration, Department of 
                Transportation (Parts 1--999)
        II  National Highway Traffic Safety Administration and 
                Federal Highway Administration, Department of 
                Transportation (Parts 1200--1299)
       III  National Highway Traffic Safety Administration, 
                Department of Transportation (Parts 1300--1399)

                Title 24--Housing and Urban Development

            Subtitle A--Office of the Secretary, Department of 
                Housing and Urban Development (Parts 0--99)
            Subtitle B--Regulations Relating to Housing and Urban 
                Development
         I  Office of Assistant Secretary for Equal Opportunity, 
                Department of Housing and Urban Development (Parts 
                100--199)

[[Page 1306]]

        II  Office of Assistant Secretary for Housing-Federal 
                Housing Commissioner, Department of Housing and 
                Urban Development (Parts 200--299)
       III  Government National Mortgage Association, Department 
                of Housing and Urban Development (Parts 300--399)
        IV  Office of Housing and Office of Multifamily Housing 
                Assistance Restructuring, Department of Housing 
                and Urban Development (Parts 400--499)
         V  Office of Assistant Secretary for Community Planning 
                and Development, Department of Housing and Urban 
                Development (Parts 500--599)
        VI  Office of Assistant Secretary for Community Planning 
                and Development, Department of Housing and Urban 
                Development (Parts 600--699) [Reserved]
       VII  Office of the Secretary, Department of Housing and 
                Urban Development (Housing Assistance Programs and 
                Public and Indian Housing Programs) (Parts 700--
                799)
      VIII  Office of the Assistant Secretary for Housing--Federal 
                Housing Commissioner, Department of Housing and 
                Urban Development (Section 8 Housing Assistance 
                Programs, Section 202 Direct Loan Program, Section 
                202 Supportive Housing for the Elderly Program and 
                Section 811 Supportive Housing for Persons With 
                Disabilities Program) (Parts 800--899)
        IX  Office of Assistant Secretary for Public and Indian 
                Housing, Department of Housing and Urban 
                Development (Parts 900--1699)
         X  Office of Assistant Secretary for Housing--Federal 
                Housing Commissioner, Department of Housing and 
                Urban Development (Interstate Land Sales 
                Registration Program) (Parts 1700--1799)
       XII  Office of Inspector General, Department of Housing and 
                Urban Development (Parts 2000--2099)
        XV  Emergency Mortgage Insurance and Loan Programs, 
                Department of Housing and Urban Development (Parts 
                2700--2799)
        XX  Office of Assistant Secretary for Housing--Federal 
                Housing Commissioner, Department of Housing and 
                Urban Development (Parts 3200--3899)
      XXIV  Board of Directors of the HOPE for Homeowners Program 
                (Parts 4000--4099)
       XXV  Neighborhood Reinvestment Corporation (Parts 4100--
                4199)

                           Title 25--Indians

         I  Bureau of Indian Affairs, Department of the Interior 
                (Parts 1--299)
        II  Indian Arts and Crafts Board, Department of the 
                Interior (Parts 300--399)
       III  National Indian Gaming Commission, Department of the 
                Interior (Parts 500--599)
        IV  Office of Navajo and Hopi Indian Relocation (Parts 
                700--799)
         V  Bureau of Indian Affairs, Department of the Interior, 
                and Indian Health Service, Department of Health 
                and Human Services (Part 900)

[[Page 1307]]

        VI  Office of the Assistant Secretary-Indian Affairs, 
                Department of the Interior (Parts 1000--1199)
       VII  Office of the Special Trustee for American Indians, 
                Department of the Interior (Parts 1200--1299)

                      Title 26--Internal Revenue

         I  Internal Revenue Service, Department of the Treasury 
                (Parts 1--End)

           Title 27--Alcohol, Tobacco Products and Firearms

         I  Alcohol and Tobacco Tax and Trade Bureau, Department 
                of the Treasury (Parts 1--399)
        II  Bureau of Alcohol, Tobacco, Firearms, and Explosives, 
                Department of Justice (Parts 400--699)

                   Title 28--Judicial Administration

         I  Department of Justice (Parts 0--299)
       III  Federal Prison Industries, Inc., Department of Justice 
                (Parts 300--399)
         V  Bureau of Prisons, Department of Justice (Parts 500--
                599)
        VI  Offices of Independent Counsel, Department of Justice 
                (Parts 600--699)
       VII  Office of Independent Counsel (Parts 700--799)
      VIII  Court Services and Offender Supervision Agency for the 
                District of Columbia (Parts 800--899)
        IX  National Crime Prevention and Privacy Compact Council 
                (Parts 900--999)
        XI  Department of Justice and Department of State (Parts 
                1100--1199)

                            Title 29--Labor

            Subtitle A--Office of the Secretary of Labor (Parts 
                0--99)
            Subtitle B--Regulations Relating to Labor
         I  National Labor Relations Board (Parts 100--199)
        II  Office of Labor-Management Standards, Department of 
                Labor (Parts 200--299)
       III  National Railroad Adjustment Board (Parts 300--399)
        IV  Office of Labor-Management Standards, Department of 
                Labor (Parts 400--499)
         V  Wage and Hour Division, Department of Labor (Parts 
                500--899)
        IX  Construction Industry Collective Bargaining Commission 
                (Parts 900--999)
         X  National Mediation Board (Parts 1200--1299)
       XII  Federal Mediation and Conciliation Service (Parts 
                1400--1499)
       XIV  Equal Employment Opportunity Commission (Parts 1600--
                1699)

[[Page 1308]]

      XVII  Occupational Safety and Health Administration, 
                Department of Labor (Parts 1900--1999)
        XX  Occupational Safety and Health Review Commission 
                (Parts 2200--2499)
       XXV  Employee Benefits Security Administration, Department 
                of Labor (Parts 2500--2599)
     XXVII  Federal Mine Safety and Health Review Commission 
                (Parts 2700--2799)
        XL  Pension Benefit Guaranty Corporation (Parts 4000--
                4999)

                      Title 30--Mineral Resources

         I  Mine Safety and Health Administration, Department of 
                Labor (Parts 1--199)
        II  Bureau of Safety and Environmental Enforcement, 
                Department of the Interior (Parts 200--299)
        IV  Geological Survey, Department of the Interior (Parts 
                400--499)
         V  Bureau of Ocean Energy Management, Department of the 
                Interior (Parts 500--599)
       VII  Office of Surface Mining Reclamation and Enforcement, 
                Department of the Interior (Parts 700--999)
       XII  Office of Natural Resources Revenue, Department of the 
                Interior (Parts 1200--1299)

                 Title 31--Money and Finance: Treasury

            Subtitle A--Office of the Secretary of the Treasury 
                (Parts 0--50)
            Subtitle B--Regulations Relating to Money and Finance
         I  Monetary Offices, Department of the Treasury (Parts 
                51--199)
        II  Fiscal Service, Department of the Treasury (Parts 
                200--399)
        IV  Secret Service, Department of the Treasury (Parts 
                400--499)
         V  Office of Foreign Assets Control, Department of the 
                Treasury (Parts 500--599)
        VI  Bureau of Engraving and Printing, Department of the 
                Treasury (Parts 600--699)
       VII  Federal Law Enforcement Training Center, Department of 
                the Treasury (Parts 700--799)
      VIII  Office of International Investment, Department of the 
                Treasury (Parts 800--899)
        IX  Federal Claims Collection Standards (Department of the 
                Treasury--Department of Justice) (Parts 900--999)
         X  Financial Crimes Enforcement Network, Department of 
                the Treasury (Parts 1000--1099)

                      Title 32--National Defense

            Subtitle A--Department of Defense
         I  Office of the Secretary of Defense (Parts 1--399)

[[Page 1309]]

         V  Department of the Army (Parts 400--699)
        VI  Department of the Navy (Parts 700--799)
       VII  Department of the Air Force (Parts 800--1099)
            Subtitle B--Other Regulations Relating to National 
                Defense
       XII  Defense Logistics Agency (Parts 1200--1299)
       XVI  Selective Service System (Parts 1600--1699)
      XVII  Office of the Director of National Intelligence (Parts 
                1700--1799)
     XVIII  National Counterintelligence Center (Parts 1800--1899)
       XIX  Central Intelligence Agency (Parts 1900--1999)
        XX  Information Security Oversight Office, National 
                Archives and Records Administration (Parts 2000--
                2099)
       XXI  National Security Council (Parts 2100--2199)
      XXIV  Office of Science and Technology Policy (Parts 2400--
                2499)
     XXVII  Office for Micronesian Status Negotiations (Parts 
                2700--2799)
    XXVIII  Office of the Vice President of the United States 
                (Parts 2800--2899)

               Title 33--Navigation and Navigable Waters

         I  Coast Guard, Department of Homeland Security (Parts 
                1--199)
        II  Corps of Engineers, Department of the Army (Parts 
                200--399)
        IV  Saint Lawrence Seaway Development Corporation, 
                Department of Transportation (Parts 400--499)

                          Title 34--Education

            Subtitle A--Office of the Secretary, Department of 
                Education (Parts 1--99)
            Subtitle B--Regulations of the Offices of the 
                Department of Education
         I  Office for Civil Rights, Department of Education 
                (Parts 100--199)
        II  Office of Elementary and Secondary Education, 
                Department of Education (Parts 200--299)
       III  Office of Special Education and Rehabilitative 
                Services, Department of Education (Parts 300--399)
        IV  Office of Vocational and Adult Education, Department 
                of Education (Parts 400--499)
         V  Office of Bilingual Education and Minority Languages 
                Affairs, Department of Education (Parts 500--599)
        VI  Office of Postsecondary Education, Department of 
                Education (Parts 600--699)
       VII  Office of Educational Research and Improvement, 
                Department of Education (Parts 700--799)[Reserved]
            Subtitle C--Regulations Relating to Education
        XI  National Institute for Literacy (Parts 1100--1199)
       XII  National Council on Disability (Parts 1200--1299)

[[Page 1310]]

                          Title 35 [Reserved]

             Title 36--Parks, Forests, and Public Property

         I  National Park Service, Department of the Interior 
                (Parts 1--199)
        II  Forest Service, Department of Agriculture (Parts 200--
                299)
       III  Corps of Engineers, Department of the Army (Parts 
                300--399)
        IV  American Battle Monuments Commission (Parts 400--499)
         V  Smithsonian Institution (Parts 500--599)
        VI  [Reserved]
       VII  Library of Congress (Parts 700--799)
      VIII  Advisory Council on Historic Preservation (Parts 800--
                899)
        IX  Pennsylvania Avenue Development Corporation (Parts 
                900--999)
         X  Presidio Trust (Parts 1000--1099)
        XI  Architectural and Transportation Barriers Compliance 
                Board (Parts 1100--1199)
       XII  National Archives and Records Administration (Parts 
                1200--1299)
        XV  Oklahoma City National Memorial Trust (Parts 1500--
                1599)
       XVI  Morris K. Udall Scholarship and Excellence in National 
                Environmental Policy Foundation (Parts 1600--1699)

             Title 37--Patents, Trademarks, and Copyrights

         I  United States Patent and Trademark Office, Department 
                of Commerce (Parts 1--199)
        II  U.S. Copyright Office, Library of Congress (Parts 
                200--299)
       III  Copyright Royalty Board, Library of Congress (Parts 
                300--399)
        IV  Assistant Secretary for Technology Policy, Department 
                of Commerce (Parts 400--599)

           Title 38--Pensions, Bonuses, and Veterans' Relief

         I  Department of Veterans Affairs (Parts 0--199)
        II  Armed Forces Retirement Home (Parts 200--299)

                       Title 39--Postal Service

         I  United States Postal Service (Parts 1--999)
       III  Postal Regulatory Commission (Parts 3000--3099)

                  Title 40--Protection of Environment

         I  Environmental Protection Agency (Parts 1--1099)
        IV  Environmental Protection Agency and Department of 
                Justice (Parts 1400--1499)
         V  Council on Environmental Quality (Parts 1500--1599)
        VI  Chemical Safety and Hazard Investigation Board (Parts 
                1600--1699)

[[Page 1311]]

       VII  Environmental Protection Agency and Department of 
                Defense; Uniform National Discharge Standards for 
                Vessels of the Armed Forces (Parts 1700--1799)

          Title 41--Public Contracts and Property Management

            Subtitle A--Federal Procurement Regulations System 
                [Note]
            Subtitle B--Other Provisions Relating to Public 
                Contracts
        50  Public Contracts, Department of Labor (Parts 50-1--50-
                999)
        51  Committee for Purchase From People Who Are Blind or 
                Severely Disabled (Parts 51-1--51-99)
        60  Office of Federal Contract Compliance Programs, Equal 
                Employment Opportunity, Department of Labor (Parts 
                60-1--60-999)
        61  Office of the Assistant Secretary for Veterans' 
                Employment and Training Service, Department of 
                Labor (Parts 61-1--61-999)
   62--100  [Reserved]
            Subtitle C--Federal Property Management Regulations 
                System
       101  Federal Property Management Regulations (Parts 101-1--
                101-99)
       102  Federal Management Regulation (Parts 102-1--102-299)
  103--104  [Reserved]
       105  General Services Administration (Parts 105-1--105-999)
       109  Department of Energy Property Management Regulations 
                (Parts 109-1--109-99)
       114  Department of the Interior (Parts 114-1--114-99)
       115  Environmental Protection Agency (Parts 115-1--115-99)
       128  Department of Justice (Parts 128-1--128-99)
  129--200  [Reserved]
            Subtitle D--Other Provisions Relating to Property 
                Management [Reserved]
            Subtitle E--Federal Information Resources Management 
                Regulations System [Reserved]
            Subtitle F--Federal Travel Regulation System
       300  General (Parts 300-1--300-99)
       301  Temporary Duty (TDY) Travel Allowances (Parts 301-1--
                301-99)
       302  Relocation Allowances (Parts 302-1--302-99)
       303  Payment of Expenses Connected with the Death of 
                Certain Employees (Part 303-1--303-99)
       304  Payment of Travel Expenses from a Non-Federal Source 
                (Parts 304-1--304-99)

                        Title 42--Public Health

         I  Public Health Service, Department of Health and Human 
                Services (Parts 1--199)
        IV  Centers for Medicare & Medicaid Services, Department 
                of Health and Human Services (Parts 400--599)

[[Page 1312]]

         V  Office of Inspector General-Health Care, Department of 
                Health and Human Services (Parts 1000--1999)

                   Title 43--Public Lands: Interior

            Subtitle A--Office of the Secretary of the Interior 
                (Parts 1--199)
            Subtitle B--Regulations Relating to Public Lands
         I  Bureau of Reclamation, Department of the Interior 
                (Parts 400--999)
        II  Bureau of Land Management, Department of the Interior 
                (Parts 1000--9999)
       III  Utah Reclamation Mitigation and Conservation 
                Commission (Parts 10000--10099)

             Title 44--Emergency Management and Assistance

         I  Federal Emergency Management Agency, Department of 
                Homeland Security (Parts 0--399)
        IV  Department of Commerce and Department of 
                Transportation (Parts 400--499)

                       Title 45--Public Welfare

            Subtitle A--Department of Health and Human Services 
                (Parts 1--199)
            Subtitle B--Regulations Relating to Public Welfare
        II  Office of Family Assistance (Assistance Programs), 
                Administration for Children and Families, 
                Department of Health and Human Services (Parts 
                200--299)
       III  Office of Child Support Enforcement (Child Support 
                Enforcement Program), Administration for Children 
                and Families, Department of Health and Human 
                Services (Parts 300--399)
        IV  Office of Refugee Resettlement, Administration for 
                Children and Families, Department of Health and 
                Human Services (Parts 400--499)
         V  Foreign Claims Settlement Commission of the United 
                States, Department of Justice (Parts 500--599)
        VI  National Science Foundation (Parts 600--699)
       VII  Commission on Civil Rights (Parts 700--799)
      VIII  Office of Personnel Management (Parts 800--899)
         X  Office of Community Services, Administration for 
                Children and Families, Department of Health and 
                Human Services (Parts 1000--1099)
        XI  National Foundation on the Arts and the Humanities 
                (Parts 1100--1199)
       XII  Corporation for National and Community Service (Parts 
                1200--1299)
      XIII  Office of Human Development Services, Department of 
                Health and Human Services (Parts 1300--1399)

[[Page 1313]]

       XVI  Legal Services Corporation (Parts 1600--1699)
      XVII  National Commission on Libraries and Information 
                Science (Parts 1700--1799)
     XVIII  Harry S. Truman Scholarship Foundation (Parts 1800--
                1899)
       XXI  Commission on Fine Arts (Parts 2100--2199)
     XXIII  Arctic Research Commission (Part 2301)
      XXIV  James Madison Memorial Fellowship Foundation (Parts 
                2400--2499)
       XXV  Corporation for National and Community Service (Parts 
                2500--2599)

                          Title 46--Shipping

         I  Coast Guard, Department of Homeland Security (Parts 
                1--199)
        II  Maritime Administration, Department of Transportation 
                (Parts 200--399)
       III  Coast Guard (Great Lakes Pilotage), Department of 
                Homeland Security (Parts 400--499)
        IV  Federal Maritime Commission (Parts 500--599)

                      Title 47--Telecommunication

         I  Federal Communications Commission (Parts 0--199)
        II  Office of Science and Technology Policy and National 
                Security Council (Parts 200--299)
       III  National Telecommunications and Information 
                Administration, Department of Commerce (Parts 
                300--399)
        IV  National Telecommunications and Information 
                Administration, Department of Commerce, and 
                National Highway Traffic Safety Administration, 
                Department of Transportation (Parts 400--499)

           Title 48--Federal Acquisition Regulations System

         1  Federal Acquisition Regulation (Parts 1--99)
         2  Defense Acquisition Regulations System, Department of 
                Defense (Parts 200--299)
         3  Health and Human Services (Parts 300--399)
         4  Department of Agriculture (Parts 400--499)
         5  General Services Administration (Parts 500--599)
         6  Department of State (Parts 600--699)
         7  Agency for International Development (Parts 700--799)
         8  Department of Veterans Affairs (Parts 800--899)
         9  Department of Energy (Parts 900--999)
        10  Department of the Treasury (Parts 1000--1099)
        12  Department of Transportation (Parts 1200--1299)
        13  Department of Commerce (Parts 1300--1399)
        14  Department of the Interior (Parts 1400--1499)

[[Page 1314]]

        15  Environmental Protection Agency (Parts 1500--1599)
        16  Office of Personnel Management, Federal Employees 
                Health Benefits Acquisition Regulation (Parts 
                1600--1699)
        17  Office of Personnel Management (Parts 1700--1799)
        18  National Aeronautics and Space Administration (Parts 
                1800--1899)
        19  Broadcasting Board of Governors (Parts 1900--1999)
        20  Nuclear Regulatory Commission (Parts 2000--2099)
        21  Office of Personnel Management, Federal Employees 
                Group Life Insurance Federal Acquisition 
                Regulation (Parts 2100--2199)
        23  Social Security Administration (Parts 2300--2399)
        24  Department of Housing and Urban Development (Parts 
                2400--2499)
        25  National Science Foundation (Parts 2500--2599)
        28  Department of Justice (Parts 2800--2899)
        29  Department of Labor (Parts 2900--2999)
        30  Department of Homeland Security, Homeland Security 
                Acquisition Regulation (HSAR) (Parts 3000--3099)
        34  Department of Education Acquisition Regulation (Parts 
                3400--3499)
        51  Department of the Army Acquisition Regulations (Parts 
                5100--5199)
        52  Department of the Navy Acquisition Regulations (Parts 
                5200--5299)
        53  Department of the Air Force Federal Acquisition 
                Regulation Supplement (Parts 5300--5399) 
                [Reserved]
        54  Defense Logistics Agency, Department of Defense (Parts 
                5400--5499)
        57  African Development Foundation (Parts 5700--5799)
        61  Civilian Board of Contract Appeals, General Services 
                Administration (Parts 6100--6199)
        63  Department of Transportation Board of Contract Appeals 
                (Parts 6300--6399)
        99  Cost Accounting Standards Board, Office of Federal 
                Procurement Policy, Office of Management and 
                Budget (Parts 9900--9999)

                       Title 49--Transportation

            Subtitle A--Office of the Secretary of Transportation 
                (Parts 1--99)
            Subtitle B--Other Regulations Relating to 
                Transportation
         I  Pipeline and Hazardous Materials Safety 
                Administration, Department of Transportation 
                (Parts 100--199)
        II  Federal Railroad Administration, Department of 
                Transportation (Parts 200--299)
       III  Federal Motor Carrier Safety Administration, 
                Department of Transportation (Parts 300--399)
        IV  Coast Guard, Department of Homeland Security (Parts 
                400--499)

[[Page 1315]]

         V  National Highway Traffic Safety Administration, 
                Department of Transportation (Parts 500--599)
        VI  Federal Transit Administration, Department of 
                Transportation (Parts 600--699)
       VII  National Railroad Passenger Corporation (AMTRAK) 
                (Parts 700--799)
      VIII  National Transportation Safety Board (Parts 800--999)
         X  Surface Transportation Board, Department of 
                Transportation (Parts 1000--1399)
        XI  Research and Innovative Technology Administration, 
                Department of Transportation (Parts 1400--1499) 
                [Reserved]
       XII  Transportation Security Administration, Department of 
                Homeland Security (Parts 1500--1699)

                   Title 50--Wildlife and Fisheries

         I  United States Fish and Wildlife Service, Department of 
                the Interior (Parts 1--199)
        II  National Marine Fisheries Service, National Oceanic 
                and Atmospheric Administration, Department of 
                Commerce (Parts 200--299)
       III  International Fishing and Related Activities (Parts 
                300--399)
        IV  Joint Regulations (United States Fish and Wildlife 
                Service, Department of the Interior and National 
                Marine Fisheries Service, National Oceanic and 
                Atmospheric Administration, Department of 
                Commerce); Endangered Species Committee 
                Regulations (Parts 400--499)
         V  Marine Mammal Commission (Parts 500--599)
        VI  Fishery Conservation and Management, National Oceanic 
                and Atmospheric Administration, Department of 
                Commerce (Parts 600--699)

[[Page 1317]]





           Alphabetical List of Agencies Appearing in the CFR




                      (Revised as of April 1, 2014)

                                                  CFR Title, Subtitle or 
                     Agency                               Chapter

Administrative Committee of the Federal Register  1, I
Administrative Conference of the United States    1, III
Advisory Council on Historic Preservation         36, VIII
Advocacy and Outreach, Office of                  7, XXV
Afghanistan Reconstruction, Special Inspector     22, LXXXIII
     General for
African Development Foundation                    22, XV
  Federal Acquisition Regulation                  48, 57
Agency for International Development              2, VII; 22, II
  Federal Acquisition Regulation                  48, 7
Agricultural Marketing Service                    7, I, IX, X, XI
Agricultural Research Service                     7, V
Agriculture Department                            2, IV; 5, LXXIII
  Advocacy and Outreach, Office of                7, XXV
  Agricultural Marketing Service                  7, I, IX, X, XI
  Agricultural Research Service                   7, V
  Animal and Plant Health Inspection Service      7, III; 9, I
  Chief Financial Officer, Office of              7, XXX
  Commodity Credit Corporation                    7, XIV
  Economic Research Service                       7, XXXVII
  Energy Policy and New Uses, Office of           2, IX; 7, XXIX
  Environmental Quality, Office of                7, XXXI
  Farm Service Agency                             7, VII, XVIII
  Federal Acquisition Regulation                  48, 4
  Federal Crop Insurance Corporation              7, IV
  Food and Nutrition Service                      7, II
  Food Safety and Inspection Service              9, III
  Foreign Agricultural Service                    7, XV
  Forest Service                                  36, II
  Grain Inspection, Packers and Stockyards        7, VIII; 9, II
       Administration
  Information Resources Management, Office of     7, XXVII
  Inspector General, Office of                    7, XXVI
  National Agricultural Library                   7, XLI
  National Agricultural Statistics Service        7, XXXVI
  National Institute of Food and Agriculture      7, XXXIV
  Natural Resources Conservation Service          7, VI
  Operations, Office of                           7, XXVIII
  Procurement and Property Management, Office of  7, XXXII
  Rural Business-Cooperative Service              7, XVIII, XLII, L
  Rural Development Administration                7, XLII
  Rural Housing Service                           7, XVIII, XXXV, L
  Rural Telephone Bank                            7, XVI
  Rural Utilities Service                         7, XVII, XVIII, XLII, L
  Secretary of Agriculture, Office of             7, Subtitle A
  Transportation, Office of                       7, XXXIII
  World Agricultural Outlook Board                7, XXXVIII
Air Force Department                              32, VII
  Federal Acquisition Regulation Supplement       48, 53
Air Transportation Stabilization Board            14, VI
Alcohol and Tobacco Tax and Trade Bureau          27, I
Alcohol, Tobacco, Firearms, and Explosives,       27, II
     Bureau of
AMTRAK                                            49, VII
American Battle Monuments Commission              36, IV
American Indians, Office of the Special Trustee   25, VII

[[Page 1318]]

Animal and Plant Health Inspection Service        7, III; 9, I
Appalachian Regional Commission                   5, IX
Architectural and Transportation Barriers         36, XI
     Compliance Board
Arctic Research Commission                        45, XXIII
Armed Forces Retirement Home                      5, XI
Army Department                                   32, V
  Engineers, Corps of                             33, II; 36, III
  Federal Acquisition Regulation                  48, 51
Bilingual Education and Minority Languages        34, V
     Affairs, Office of
Blind or Severely Disabled, Committee for         41, 51
     Purchase from People Who Are
Broadcasting Board of Governors                   22, V
  Federal Acquisition Regulation                  48, 19
Bureau of Ocean Energy Management, Regulation,    30, II
     and Enforcement
Census Bureau                                     15, I
Centers for Medicare & Medicaid Services          42, IV
Central Intelligence Agency                       32, XIX
Chemical Safety and Hazardous Investigation       40, VI
     Board
Chief Financial Officer, Office of                7, XXX
Child Support Enforcement, Office of              45, III
Children and Families, Administration for         45, II, III, IV, X
Civil Rights, Commission on                       5, LXVIII; 45, VII
Civil Rights, Office for                          34, I
Council of the Inspectors General on Integrity    5, XCVIII
     and Efficiency
Court Services and Offender Supervision Agency    5, LXX
     for the District of Columbia
Coast Guard                                       33, I; 46, I; 49, IV
Coast Guard (Great Lakes Pilotage)                46, III
Commerce Department                               2, XIII; 44, IV; 50, VI
  Census Bureau                                   15, I
  Economic Analysis, Bureau of                    15, VIII
  Economic Development Administration             13, III
  Emergency Management and Assistance             44, IV
  Federal Acquisition Regulation                  48, 13
  Foreign-Trade Zones Board                       15, IV
  Industry and Security, Bureau of                15, VII
  International Trade Administration              15, III; 19, III
  National Institute of Standards and Technology  15, II
  National Marine Fisheries Service               50, II, IV
  National Oceanic and Atmospheric                15, IX; 50, II, III, IV, 
       Administration                             VI
  National Telecommunications and Information     15, XXIII; 47, III, IV
       Administration
  National Weather Service                        15, IX
  Patent and Trademark Office, United States      37, I
  Productivity, Technology and Innovation,        37, IV
       Assistant Secretary for
  Secretary of Commerce, Office of                15, Subtitle A
  Technology Administration                       15, XI
  Technology Policy, Assistant Secretary for      37, IV
Commercial Space Transportation                   14, III
Commodity Credit Corporation                      7, XIV
Commodity Futures Trading Commission              5, XLI; 17, I
Community Planning and Development, Office of     24, V, VI
     Assistant Secretary for
Community Services, Office of                     45, X
Comptroller of the Currency                       12, I
Construction Industry Collective Bargaining       29, IX
     Commission
Consumer Financial Protection Bureau              5, LXXXIV; 12, X
Consumer Product Safety Commission                5, LXXI; 16, II
Copyright Royalty Board                           37, III
Corporation for National and Community Service    2, XXII; 45, XII, XXV
Cost Accounting Standards Board                   48, 99
Council on Environmental Quality                  40, V
Court Services and Offender Supervision Agency    5, LXX; 28, VIII
     for the District of Columbia
Customs and Border Protection                     19, I

[[Page 1319]]

Defense Contract Audit Agency                     32, I
Defense Department                                2, XI; 5, XXVI; 32, 
                                                  Subtitle A; 40, VII
  Advanced Research Projects Agency               32, I
  Air Force Department                            32, VII
  Army Department                                 32, V; 33, II; 36, III, 
                                                  48, 51
  Defense Acquisition Regulations System          48, 2
  Defense Intelligence Agency                     32, I
  Defense Logistics Agency                        32, I, XII; 48, 54
  Engineers, Corps of                             33, II; 36, III
  National Imagery and Mapping Agency             32, I
  Navy Department                                 32, VI; 48, 52
  Secretary of Defense, Office of                 2, XI; 32, I
Defense Contract Audit Agency                     32, I
Defense Intelligence Agency                       32, I
Defense Logistics Agency                          32, XII; 48, 54
Defense Nuclear Facilities Safety Board           10, XVII
Delaware River Basin Commission                   18, III
District of Columbia, Court Services and          5, LXX; 28, VIII
     Offender Supervision Agency for the
Drug Enforcement Administration                   21, II
East-West Foreign Trade Board                     15, XIII
Economic Analysis, Bureau of                      15, VIII
Economic Development Administration               13, III
Economic Research Service                         7, XXXVII
Education, Department of                          2, XXXIV; 5, LIII
  Bilingual Education and Minority Languages      34, V
       Affairs, Office of
  Civil Rights, Office for                        34, I
  Educational Research and Improvement, Office    34, VII
       of
  Elementary and Secondary Education, Office of   34, II
  Federal Acquisition Regulation                  48, 34
  Postsecondary Education, Office of              34, VI
  Secretary of Education, Office of               34, Subtitle A
  Special Education and Rehabilitative Services,  34, III
       Office of
  Vocational and Adult Education, Office of       34, IV
Educational Research and Improvement, Office of   34, VII
Election Assistance Commission                    2, LVIII; 11, II
Elementary and Secondary Education, Office of     34, II
Emergency Oil and Gas Guaranteed Loan Board       13, V
Emergency Steel Guarantee Loan Board              13, IV
Employee Benefits Security Administration         29, XXV
Employees' Compensation Appeals Board             20, IV
Employees Loyalty Board                           5, V
Employment and Training Administration            20, V
Employment Standards Administration               20, VI
Endangered Species Committee                      50, IV
Energy, Department of                             2, IX; 5, XXIII; 10, II, 
                                                  III, X
  Federal Acquisition Regulation                  48, 9
  Federal Energy Regulatory Commission            5, XXIV; 18, I
  Property Management Regulations                 41, 109
Energy, Office of                                 7, XXIX
Engineers, Corps of                               33, II; 36, III
Engraving and Printing, Bureau of                 31, VI
Environmental Protection Agency                   2, XV; 5, LIV; 40, I, IV, 
                                                  VII
  Federal Acquisition Regulation                  48, 15
  Property Management Regulations                 41, 115
Environmental Quality, Office of                  7, XXXI
Equal Employment Opportunity Commission           5, LXII; 29, XIV
Equal Opportunity, Office of Assistant Secretary  24, I
     for
Executive Office of the President                 3, I
  Administration, Office of                       5, XV
  Environmental Quality, Council on               40, V
  Management and Budget, Office of                2, Subtitle A; 5, III, 
                                                  LXXVII; 14, VI; 48, 99

[[Page 1320]]

  National Drug Control Policy, Office of         21, III
  National Security Council                       32, XXI; 47, 2
  Presidential Documents                          3
  Science and Technology Policy, Office of        32, XXIV; 47, II
  Trade Representative, Office of the United      15, XX
       States
Export-Import Bank of the United States           2, XXXV; 5, LII; 12, IV
Family Assistance, Office of                      45, II
Farm Credit Administration                        5, XXXI; 12, VI
Farm Credit System Insurance Corporation          5, XXX; 12, XIV
Farm Service Agency                               7, VII, XVIII
Federal Acquisition Regulation                    48, 1
Federal Aviation Administration                   14, I
  Commercial Space Transportation                 14, III
Federal Claims Collection Standards               31, IX
Federal Communications Commission                 5, XXIX; 47, I
Federal Contract Compliance Programs, Office of   41, 60
Federal Crop Insurance Corporation                7, IV
Federal Deposit Insurance Corporation             5, XXII; 12, III
Federal Election Commission                       5, XXXVII; 11, I
Federal Emergency Management Agency               44, I
Federal Employees Group Life Insurance Federal    48, 21
     Acquisition Regulation
Federal Employees Health Benefits Acquisition     48, 16
     Regulation
Federal Energy Regulatory Commission              5, XXIV; 18, I
Federal Financial Institutions Examination        12, XI
     Council
Federal Financing Bank                            12, VIII
Federal Highway Administration                    23, I, II
Federal Home Loan Mortgage Corporation            1, IV
Federal Housing Enterprise Oversight Office       12, XVII
Federal Housing Finance Agency                    5, LXXX; 12, XII
Federal Housing Finance Board                     12, IX
Federal Labor Relations Authority                 5, XIV, XLIX; 22, XIV
Federal Law Enforcement Training Center           31, VII
Federal Management Regulation                     41, 102
Federal Maritime Commission                       46, IV
Federal Mediation and Conciliation Service        29, XII
Federal Mine Safety and Health Review Commission  5, LXXIV; 29, XXVII
Federal Motor Carrier Safety Administration       49, III
Federal Prison Industries, Inc.                   28, III
Federal Procurement Policy Office                 48, 99
Federal Property Management Regulations           41, 101
Federal Railroad Administration                   49, II
Federal Register, Administrative Committee of     1, I
Federal Register, Office of                       1, II
Federal Reserve System                            12, II
  Board of Governors                              5, LVIII
Federal Retirement Thrift Investment Board        5, VI, LXXVI
Federal Service Impasses Panel                    5, XIV
Federal Trade Commission                          5, XLVII; 16, I
Federal Transit Administration                    49, VI
Federal Travel Regulation System                  41, Subtitle F
Financial Crimes Enforcement Network              31, X
Financial Research Office                         12, XVI
Financial Stability Oversight Council             12, XIII
Fine Arts, Commission on                          45, XXI
Fiscal Service                                    31, II
Fish and Wildlife Service, United States          50, I, IV
Food and Drug Administration                      21, I
Food and Nutrition Service                        7, II
Food Safety and Inspection Service                9, III
Foreign Agricultural Service                      7, XV
Foreign Assets Control, Office of                 31, V
Foreign Claims Settlement Commission of the       45, V
     United States
Foreign Service Grievance Board                   22, IX
Foreign Service Impasse Disputes Panel            22, XIV
Foreign Service Labor Relations Board             22, XIV
Foreign-Trade Zones Board                         15, IV

[[Page 1321]]

Forest Service                                    36, II
General Services Administration                   5, LVII; 41, 105
  Contract Appeals, Board of                      48, 61
  Federal Acquisition Regulation                  48, 5
  Federal Management Regulation                   41, 102
  Federal Property Management Regulations         41, 101
  Federal Travel Regulation System                41, Subtitle F
  General                                         41, 300
  Payment From a Non-Federal Source for Travel    41, 304
       Expenses
  Payment of Expenses Connected With the Death    41, 303
       of Certain Employees
  Relocation Allowances                           41, 302
  Temporary Duty (TDY) Travel Allowances          41, 301
Geological Survey                                 30, IV
Government Accountability Office                  4, I
Government Ethics, Office of                      5, XVI
Government National Mortgage Association          24, III
Grain Inspection, Packers and Stockyards          7, VIII; 9, II
     Administration
Harry S. Truman Scholarship Foundation            45, XVIII
Health and Human Services, Department of          2, III; 5, XLV; 45, 
                                                  Subtitle A,
  Centers for Medicare & Medicaid Services        42, IV
  Child Support Enforcement, Office of            45, III
  Children and Families, Administration for       45, II, III, IV, X
  Community Services, Office of                   45, X
  Family Assistance, Office of                    45, II
  Federal Acquisition Regulation                  48, 3
  Food and Drug Administration                    21, I
  Human Development Services, Office of           45, XIII
  Indian Health Service                           25, V
  Inspector General (Health Care), Office of      42, V
  Public Health Service                           42, I
  Refugee Resettlement, Office of                 45, IV
Homeland Security, Department of                  2, XXX; 6, I; 8, I
  Coast Guard                                     33, I; 46, I; 49, IV
  Coast Guard (Great Lakes Pilotage)              46, III
  Customs and Border Protection                   19, I
  Federal Emergency Management Agency             44, I
  Human Resources Management and Labor Relations  5, XCVII
       Systems
  Immigration and Customs Enforcement Bureau      19, IV
  Transportation Security Administration          49, XII
HOPE for Homeowners Program, Board of Directors   24, XXIV
     of
Housing and Urban Development, Department of      2, XXIV; 5, LXV; 24, 
                                                  Subtitle B
  Community Planning and Development, Office of   24, V, VI
       Assistant Secretary for
  Equal Opportunity, Office of Assistant          24, I
       Secretary for
  Federal Acquisition Regulation                  48, 24
  Federal Housing Enterprise Oversight, Office    12, XVII
       of
  Government National Mortgage Association        24, III
  Housing--Federal Housing Commissioner, Office   24, II, VIII, X, XX
       of Assistant Secretary for
  Housing, Office of, and Multifamily Housing     24, IV
       Assistance Restructuring, Office of
  Inspector General, Office of                    24, XII
  Public and Indian Housing, Office of Assistant  24, IX
       Secretary for
  Secretary, Office of                            24, Subtitle A, VII
Housing--Federal Housing Commissioner, Office of  24, II, VIII, X, XX
     Assistant Secretary for
Housing, Office of, and Multifamily Housing       24, IV
     Assistance Restructuring, Office of
Human Development Services, Office of             45, XIII
Immigration and Customs Enforcement Bureau        19, IV
Immigration Review, Executive Office for          8, V
Independent Counsel, Office of                    28, VII
Indian Affairs, Bureau of                         25, I, V

[[Page 1322]]

Indian Affairs, Office of the Assistant           25, VI
     Secretary
Indian Arts and Crafts Board                      25, II
Indian Health Service                             25, V
Industry and Security, Bureau of                  15, VII
Information Resources Management, Office of       7, XXVII
Information Security Oversight Office, National   32, XX
     Archives and Records Administration
Inspector General
  Agriculture Department                          7, XXVI
  Health and Human Services Department            42, V
  Housing and Urban Development Department        24, XII, XV
Institute of Peace, United States                 22, XVII
Inter-American Foundation                         5, LXIII; 22, X
Interior Department                               2, XIV
  American Indians, Office of the Special         25, VII
       Trustee
  Bureau of Ocean Energy Management, Regulation,  30, II
       and Enforcement
  Endangered Species Committee                    50, IV
  Federal Acquisition Regulation                  48, 14
  Federal Property Management Regulations System  41, 114
  Fish and Wildlife Service, United States        50, I, IV
  Geological Survey                               30, IV
  Indian Affairs, Bureau of                       25, I, V
  Indian Affairs, Office of the Assistant         25, VI
       Secretary
  Indian Arts and Crafts Board                    25, II
  Land Management, Bureau of                      43, II
  National Indian Gaming Commission               25, III
  National Park Service                           36, I
  Natural Resource Revenue, Office of             30, XII
  Ocean Energy Management, Bureau of              30, V
  Reclamation, Bureau of                          43, I
  Secretary of the Interior, Office of            2, XIV; 43, Subtitle A
  Surface Mining Reclamation and Enforcement,     30, VII
       Office of
Internal Revenue Service                          26, I
International Boundary and Water Commission,      22, XI
     United States and Mexico, United States 
     Section
International Development, United States Agency   22, II
     for
  Federal Acquisition Regulation                  48, 7
International Development Cooperation Agency,     22, XII
     United States
International Joint Commission, United States     22, IV
     and Canada
International Organizations Employees Loyalty     5, V
     Board
International Trade Administration                15, III; 19, III
International Trade Commission, United States     19, II
Interstate Commerce Commission                    5, XL
Investment Security, Office of                    31, VIII
James Madison Memorial Fellowship Foundation      45, XXIV
Japan-United States Friendship Commission         22, XVI
Joint Board for the Enrollment of Actuaries       20, VIII
Justice Department                                2, XXVIII; 5, XXVIII; 28, 
                                                  I, XI; 40, IV
  Alcohol, Tobacco, Firearms, and Explosives,     27, II
       Bureau of
  Drug Enforcement Administration                 21, II
  Federal Acquisition Regulation                  48, 28
  Federal Claims Collection Standards             31, IX
  Federal Prison Industries, Inc.                 28, III
  Foreign Claims Settlement Commission of the     45, V
       United States
  Immigration Review, Executive Office for        8, V
  Offices of Independent Counsel                  28, VI
  Prisons, Bureau of                              28, V
  Property Management Regulations                 41, 128
Labor Department                                  5, XLII
  Employee Benefits Security Administration       29, XXV
  Employees' Compensation Appeals Board           20, IV
  Employment and Training Administration          20, V
  Employment Standards Administration             20, VI

[[Page 1323]]

  Federal Acquisition Regulation                  48, 29
  Federal Contract Compliance Programs, Office    41, 60
       of
  Federal Procurement Regulations System          41, 50
  Labor-Management Standards, Office of           29, II, IV
  Mine Safety and Health Administration           30, I
  Occupational Safety and Health Administration   29, XVII
  Office of Workers' Compensation Programs        20, VII
  Public Contracts                                41, 50
  Secretary of Labor, Office of                   29, Subtitle A
  Veterans' Employment and Training Service,      41, 61; 20, IX
       Office of the Assistant Secretary for
  Wage and Hour Division                          29, V
  Workers' Compensation Programs, Office of       20, I
Labor-Management Standards, Office of             29, II, IV
Land Management, Bureau of                        43, II
Legal Services Corporation                        45, XVI
Library of Congress                               36, VII
  Copyright Royalty Board                         37, III
  U.S. Copyright Office                           37, II
Local Television Loan Guarantee Board             7, XX
Management and Budget, Office of                  5, III, LXXVII; 14, VI; 
                                                  48, 99
Marine Mammal Commission                          50, V
Maritime Administration                           46, II
Merit Systems Protection Board                    5, II, LXIV
Micronesian Status Negotiations, Office for       32, XXVII
Millennium Challenge Corporation                  22, XIII
Mine Safety and Health Administration             30, I
Minority Business Development Agency              15, XIV
Miscellaneous Agencies                            1, IV
Monetary Offices                                  31, I
Morris K. Udall Scholarship and Excellence in     36, XVI
     National Environmental Policy Foundation
Museum and Library Services, Institute of         2, XXXI
National Aeronautics and Space Administration     2, XVIII; 5, LIX; 14, V
  Federal Acquisition Regulation                  48, 18
National Agricultural Library                     7, XLI
National Agricultural Statistics Service          7, XXXVI
National and Community Service, Corporation for   2, XXII; 45, XII, XXV
National Archives and Records Administration      2, XXVI; 5, LXVI; 36, XII
  Information Security Oversight Office           32, XX
National Capital Planning Commission              1, IV
National Commission for Employment Policy         1, IV
National Commission on Libraries and Information  45, XVII
     Science
National Council on Disability                    34, XII
National Counterintelligence Center               32, XVIII
National Credit Union Administration              5, LXXXVI; 12, VII
National Crime Prevention and Privacy Compact     28, IX
     Council
National Drug Control Policy, Office of           21, III
National Endowment for the Arts                   2, XXXII
National Endowment for the Humanities             2, XXXIII
National Foundation on the Arts and the           45, XI
     Humanities
National Highway Traffic Safety Administration    23, II, III; 47, VI; 49, V
National Imagery and Mapping Agency               32, I
National Indian Gaming Commission                 25, III
National Institute for Literacy                   34, XI
National Institute of Food and Agriculture        7, XXXIV
National Institute of Standards and Technology    15, II
National Intelligence, Office of Director of      32, XVII
National Labor Relations Board                    5, LXI; 29, I
National Marine Fisheries Service                 50, II, IV
National Mediation Board                          29, X
National Oceanic and Atmospheric Administration   15, IX; 50, II, III, IV, 
                                                  VI
National Park Service                             36, I
National Railroad Adjustment Board                29, III
National Railroad Passenger Corporation (AMTRAK)  49, VII

[[Page 1324]]

National Science Foundation                       2, XXV; 5, XLIII; 45, VI
  Federal Acquisition Regulation                  48, 25
National Security Council                         32, XXI
National Security Council and Office of Science   47, II
     and Technology Policy
National Telecommunications and Information       15, XXIII; 47, III, IV
     Administration
National Transportation Safety Board              49, VIII
Natural Resources Conservation Service            7, VI
Natural Resource Revenue, Office of               30, XII
Navajo and Hopi Indian Relocation, Office of      25, IV
Navy Department                                   32, VI
  Federal Acquisition Regulation                  48, 52
Neighborhood Reinvestment Corporation             24, XXV
Northeast Interstate Low-Level Radioactive Waste  10, XVIII
     Commission
Nuclear Regulatory Commission                     2, XX; 5, XLVIII; 10, I
  Federal Acquisition Regulation                  48, 20
Occupational Safety and Health Administration     29, XVII
Occupational Safety and Health Review Commission  29, XX
Ocean Energy Management, Bureau of                30, V
Offices of Independent Counsel                    28, VI
Office of Workers' Compensation Programs          20, VII
Oklahoma City National Memorial Trust             36, XV
Operations Office                                 7, XXVIII
Overseas Private Investment Corporation           5, XXXIII; 22, VII
Patent and Trademark Office, United States        37, I
Payment From a Non-Federal Source for Travel      41, 304
     Expenses
Payment of Expenses Connected With the Death of   41, 303
     Certain Employees
Peace Corps                                       2, XXXVII; 22, III
Pennsylvania Avenue Development Corporation       36, IX
Pension Benefit Guaranty Corporation              29, XL
Personnel Management, Office of                   5, I, XXXV; 45, VIII
  Human Resources Management and Labor Relations  5, XCVII
       Systems, Department of Homeland Security
  Federal Acquisition Regulation                  48, 17
  Federal Employees Group Life Insurance Federal  48, 21
       Acquisition Regulation
  Federal Employees Health Benefits Acquisition   48, 16
       Regulation
Pipeline and Hazardous Materials Safety           49, I
     Administration
Postal Regulatory Commission                      5, XLVI; 39, III
Postal Service, United States                     5, LX; 39, I
Postsecondary Education, Office of                34, VI
President's Commission on White House             1, IV
     Fellowships
Presidential Documents                            3
Presidio Trust                                    36, X
Prisons, Bureau of                                28, V
Privacy and Civil Liberties Oversight Board       6, X
Procurement and Property Management, Office of    7, XXXII
Productivity, Technology and Innovation,          37, IV
     Assistant Secretary
Public Contracts, Department of Labor             41, 50
Public and Indian Housing, Office of Assistant    24, IX
     Secretary for
Public Health Service                             42, I
Railroad Retirement Board                         20, II
Reclamation, Bureau of                            43, I
Recovery Accountability and Transparency Board    4, II
Refugee Resettlement, Office of                   45, IV
Relocation Allowances                             41, 302
Research and Innovative Technology                49, XI
     Administration
Rural Business-Cooperative Service                7, XVIII, XLII, L
Rural Development Administration                  7, XLII
Rural Housing Service                             7, XVIII, XXXV, L
Rural Telephone Bank                              7, XVI
Rural Utilities Service                           7, XVII, XVIII, XLII, L
Saint Lawrence Seaway Development Corporation     33, IV

[[Page 1325]]

Science and Technology Policy, Office of          32, XXIV
Science and Technology Policy, Office of, and     47, II
     National Security Council
Secret Service                                    31, IV
Securities and Exchange Commission                5, XXXIV; 17, II
Selective Service System                          32, XVI
Small Business Administration                     2, XXVII; 13, I
Smithsonian Institution                           36, V
Social Security Administration                    2, XXIII; 20, III; 48, 23
Soldiers' and Airmen's Home, United States        5, XI
Special Counsel, Office of                        5, VIII
Special Education and Rehabilitative Services,    34, III
     Office of
State Department                                  2, VI; 22, I; 28, XI
  Federal Acquisition Regulation                  48, 6
Surface Mining Reclamation and Enforcement,       30, VII
     Office of
Surface Transportation Board                      49, X
Susquehanna River Basin Commission                18, VIII
Technology Administration                         15, XI
Technology Policy, Assistant Secretary for        37, IV
Tennessee Valley Authority                        5, LXIX; 18, XIII
Thrift Supervision Office, Department of the      12, V
     Treasury
Trade Representative, United States, Office of    15, XX
Transportation, Department of                     2, XII; 5, L
  Commercial Space Transportation                 14, III
  Contract Appeals, Board of                      48, 63
  Emergency Management and Assistance             44, IV
  Federal Acquisition Regulation                  48, 12
  Federal Aviation Administration                 14, I
  Federal Highway Administration                  23, I, II
  Federal Motor Carrier Safety Administration     49, III
  Federal Railroad Administration                 49, II
  Federal Transit Administration                  49, VI
  Maritime Administration                         46, II
  National Highway Traffic Safety Administration  23, II, III; 47, IV; 49, V
  Pipeline and Hazardous Materials Safety         49, I
       Administration
  Saint Lawrence Seaway Development Corporation   33, IV
  Secretary of Transportation, Office of          14, II; 49, Subtitle A
  Surface Transportation Board                    49, X
  Transportation Statistics Bureau                49, XI
Transportation, Office of                         7, XXXIII
Transportation Security Administration            49, XII
Transportation Statistics Bureau                  49, XI
Travel Allowances, Temporary Duty (TDY)           41, 301
Treasury Department                               5, XXI; 12, XV; 17, IV; 
                                                  31, IX
  Alcohol and Tobacco Tax and Trade Bureau        27, I
  Community Development Financial Institutions    12, XVIII
       Fund
  Comptroller of the Currency                     12, I
  Customs and Border Protection                   19, I
  Engraving and Printing, Bureau of               31, VI
  Federal Acquisition Regulation                  48, 10
  Federal Claims Collection Standards             31, IX
  Federal Law Enforcement Training Center         31, VII
  Financial Crimes Enforcement Network            31, X
  Fiscal Service                                  31, II
  Foreign Assets Control, Office of               31, V
  Internal Revenue Service                        26, I
  Investment Security, Office of                  31, VIII
  Monetary Offices                                31, I
  Secret Service                                  31, IV
  Secretary of the Treasury, Office of            31, Subtitle A
  Thrift Supervision, Office of                   12, V
Truman, Harry S. Scholarship Foundation           45, XVIII
United States and Canada, International Joint     22, IV
     Commission
United States and Mexico, International Boundary  22, XI
     and Water Commission, United States Section
U.S. Copyright Office                             37, II

[[Page 1326]]

Utah Reclamation Mitigation and Conservation      43, III
     Commission
Veterans Affairs Department                       2, VIII; 38, I
  Federal Acquisition Regulation                  48, 8
Veterans' Employment and Training Service,        41, 61; 20, IX
     Office of the Assistant Secretary for
Vice President of the United States, Office of    32, XXVIII
Vocational and Adult Education, Office of         34, IV
Wage and Hour Division                            29, V
Water Resources Council                           18, VI
Workers' Compensation Programs, Office of         20, I
World Agricultural Outlook Board                  7, XXXVIII

[[Page 1327]]







                      Table of OMB Control Numbers



The OMB control numbers for chapter I of title 26 were consolidated into 
Sec. Sec.  601.9000 and 602.101 at 50 FR 10221, Mar. 14, 1985. At 61 FR 
58008, Nov. 12, 1996, Sec.  601.9000 was removed. Section 602.101 is 
reprinted below for the convenience of the user.

     PART 602_OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Sec.  602.101  OMB Control numbers.

    (a) Purpose. This part collects and displays the control numbers 
assigned to collections of information in Internal Revenue Service 
regulations by the Office of Management and Budget (OMB) under the 
Paperwork Reduction Act of 1980. The Internal Revenue Service intends 
that this part comply with the requirements of Sec. Sec.  1320.7(f), 
1320.12, 1320.13, and 1320.14 of 5 CFR part 1320 (OMB regulations 
implementing the Paperwork Reduction Act), for the display of control 
numbers assigned by OMB to collections of information in Internal 
Revenue Service regulations. This part does not display control numbers 
assigned by the Office of Management and Budget to collections of 
information of the Bureau of Alcohol, Tobacco, and Firearms.
    (b) Display.

------------------------------------------------------------------------
                                                             Current OMB
     CFR part or section where identified and described      control No.
------------------------------------------------------------------------
1.1(h)-1(e)................................................    1545-1654
1.23-5.....................................................    1545-0074
1.25-1T....................................................    1545-0922
                                                               1545-0930
1.25-2T....................................................    1545-0922
                                                               1545-0930
1.25-3T....................................................    1545-0922
                                                               1545-0930
1.25-4T....................................................    1545-0922
1.25-5T....................................................    1545-0922
1.25-6T....................................................    1545-0922
1.25-7T....................................................    1545-0922
1.25-8T....................................................    1545-0922
1.25A-1....................................................    1545-1630
1.28-1.....................................................    1545-0619
1.31-2.....................................................    1545-0074
1.32-2.....................................................    1545-0074
1.32-3.....................................................    1545-1575
1.36B-5....................................................    1545-2232
1.37-1.....................................................    1545-0074
1.37-3.....................................................    1545-0074
1.41-2.....................................................    1545-0619
1.41-3.....................................................    1545-0619
1.41-4A....................................................    1545-0074
1.41-4 (b) and (c).........................................    1545-0074
1.41-8(b)..................................................    1545-1625
1.41-8(d)..................................................    1545-0732
1.41-9.....................................................    1545-0619
1.42-1T....................................................    1545-0984
                                                               1545-0988
1.42-2.....................................................    1545-1005
1.42-5.....................................................    1545-1357
1.42-6.....................................................    1545-1102
1.42-8.....................................................    1545-1102
1.42-10....................................................    1545-1102
1.42-13....................................................    1545-1357
1.42-14....................................................    1545-1423
1.42-17....................................................    1545-1357
1.42-18....................................................    1545-2088
1.43-3(a)(3)...............................................    1545-1292
1.43-3(b)(3)...............................................    1545-1292
1.44B-1....................................................    1545-0219
1.45D-1....................................................    1545-1765
1.45G-1....................................................    1545-2031
1.46-1.....................................................    1545-0123
                                                               1545-0155
1.46-3.....................................................    1545-0155
1.46-4.....................................................    1545-0155
1.46-5.....................................................    1545-0155
1.46-6.....................................................    1545-0155
1.46-8.....................................................    1545-0155
1.46-9.....................................................    1545-0155
1.46-10....................................................    1545-0118
1.46-11....................................................    1545-0155
1.47-1.....................................................    1545-0155
                                                               1545-0166
1.47-3.....................................................    1545-0155
                                                               1545-0166
1.47-4.....................................................    1545-0123
1.47-5.....................................................    1545-0092
1.47-6.....................................................    1545-0099
1.48-3.....................................................    1545-0155
1.48-4.....................................................    1545-0155
                                                               1545-0808
1.48-5.....................................................    1545-0155
1.48-6.....................................................    1545-0155
1.48-12....................................................    1545-0155
                                                               1545-1783
1.50A-1....................................................    1545-0895
1.50A-2....................................................    1545-0895
1.50A-3....................................................    1545-0895
1.50A-4....................................................    1545-0895
1.50A-5....................................................    1545-0895
1.50A-6....................................................    1545-0895
1.50A-7....................................................    1545-0895
1.50B-1....................................................    1545-0895
1.50B-2....................................................    1545-0895
1.50B-3....................................................    1545-0895

[[Page 1328]]

 
1.50B-4....................................................    1545-0895
1.50B-5....................................................    1545-0895
1.51-1.....................................................    1545-0219
                                                               1545-0241
                                                               1545-0244
                                                               1545-0797
1.52-2.....................................................    1545-0219
1.52-3.....................................................    1545-0219
1.56-1.....................................................    1545-0123
1.56(g)-1..................................................    1545-1233
1.56A-1....................................................    1545-0227
1.56A-2....................................................    1545-0227
1.56A-3....................................................    1545-0227
1.56A-4....................................................    1545-0227
1.56A-5....................................................    1545-0227
1.57-5.....................................................    1545-0227
1.58-1.....................................................    1545-0175
1.58-9(c)(5)(iii)(B).......................................    1545-1093
1.58-9(e)(3)...............................................    1545-1093
1.59-1.....................................................    1545-1903
1.61-2.....................................................    1545-0771
1.61-2T....................................................    1545-0771
1.61-4.....................................................    1545-0187
1.61-15....................................................    1545-0074
1.62-2.....................................................    1545-1148
1.63-1.....................................................    1545-0074
1.66-4.....................................................    1545-1770
1.67-2T....................................................    1545-0110
1.67-3.....................................................    1545-1018
1.67-3T....................................................    1545-0118
1.71-1T....................................................    1545-0074
1.72-4.....................................................    1545-0074
1.72-6.....................................................    1545-0074
1.72-9.....................................................    1545-0074
1.72-17....................................................    1545-0074
1.72-17A...................................................    1545-0074
1.72-18....................................................    1545-0074
1.74-1.....................................................    1545-1100
1.79-2.....................................................    1545-0074
1.79-3.....................................................    1545-0074
1.83-2.....................................................    1545-0074
1.83-5.....................................................    1545-0074
1.83-6.....................................................    1545-1448
1.103-10...................................................    1545-0123
                                                               1545-0940
1.103-15AT.................................................    1545-0720
1.103-18...................................................    1545-1226
1.103(n)-2T................................................    1545-0874
1.103(n)-4T................................................    1545-0874
1.103A-2...................................................    1545-0720
1.105-4....................................................    1545-0074
1.105-5....................................................    1545-0074
1.105-6....................................................    1545-0074
1.108-4....................................................    1545-1539
1.108-5....................................................    1545-1421
1.108-7....................................................    1545-2155
1.108(i)-1.................................................    1545-2147
1.108(i)-2.................................................    1545-2147
1.110-1....................................................    1545-1661
1.117-5....................................................    1545-0869
1.118-2....................................................    1545-1639
1.119-1....................................................    1545-0067
1.120-3....................................................    1545-0057
1.121-1....................................................    1545-0072
1.121-2....................................................    1545-0072
1.121-3....................................................    1545-0072
1.121-4....................................................    1545-0072
                                                               1545-0091
1.121-5....................................................    1545-0072
1.127-2....................................................    1545-0768
1.132-1T...................................................    1545-0771
1.132-2....................................................    1545-0771
1.132-2T...................................................    1545-0771
1.132-5....................................................    1545-0771
1.132-5T...................................................    1545-0771
                                                               1545-1098
1.132-9(b).................................................    1545-1676
1.141-1....................................................    1545-1451
1.141-12...................................................    1545-1451
1.142-2....................................................    1545-1451
1.142(f)(4)-1..............................................    1545-1730
1.148-0....................................................    1545-1098
1.148-1....................................................    1545-1098
1.148-2....................................................    1545-1098
                                                               1545-1347
1.148-3....................................................    1545-1098
                                                               1545-1347
1.148-4....................................................    1545-1098
                                                               1545-1347
1.148-5....................................................    1545-1098
                                                               1545-1490
1.148-6....................................................    1545-1098
                                                               1545-1451
1.148-7....................................................    1545-1098
                                                               1545-1347
1.148-8....................................................    1545-1098
1.148-11...................................................    1545-1098
                                                               1545-1347
1.149(e)-1.................................................    1545-0720
1.150-1....................................................    1545-1347
1.151-1....................................................    1545-0074
1.152-3....................................................    1545-0071
                                                               1545-1783
1.152-4....................................................    1545-0074
1.152-4T...................................................    1545-0074
1.162-1....................................................    1545-0139
1.162-2....................................................    1545-0139
1.162-3....................................................    1545-0139
1.162-4....................................................    1545-0139
1.162-5....................................................    1545-0139
1.162-6....................................................    1545-0139
1.162-7....................................................    1545-0139
1.162-8....................................................    1545-0139
1.162-9....................................................    1545-0139
1.162-10...................................................    1545-0139
1.162-11...................................................    1545-0139
1.162-12...................................................    1545-0139
1.162-13...................................................    1545-0139
1.162-14...................................................    1545-0139
1.162-15...................................................    1545-0139
1.162-16...................................................    1545-0139
1.162-17...................................................    1545-0139
1.162-18...................................................    1545-0139
1.162-19...................................................    1545-0139
1.162-20...................................................    1545-0139
1.162-24...................................................    1545-2115
1.162-27...................................................    1545-1466
1.163-5....................................................    1545-0786
                                                               1545-1132
1.163-8T...................................................    1545-0995
1.163-10T..................................................    1545-0074
1.163-13...................................................    1545-1491
1.163(d)-1.................................................    1545-1421
1.165-1....................................................    1545-0177
1.165-2....................................................    1545-0177
1.165-3....................................................    1545-0177
1.165-4....................................................    1545-0177
1.165-5....................................................    1545-0177
1.165-6....................................................    1545-0177
1.165-7....................................................    1545-0177
1.165-8....................................................    1545-0177
1.165-9....................................................    1545-0177
1.165-10...................................................    1545-0177
1.165-11...................................................    1545-0074

[[Page 1329]]

 
                                                               1545-0177
                                                               1545-0786
1.165-12...................................................    1545-0786
1.166-1....................................................    1545-0123
1.166-2....................................................    1545-1254
1.166-4....................................................    1545-0123
1.166-10...................................................    1545-0123
1.167(a)-5T................................................    1545-1021
1.167(a)-7.................................................    1545-0172
1.167(a)-11................................................    1545-0152
                                                               1545-0172
1.167(a)-12................................................    1545-0172
1.167(d)-1.................................................    1545-0172
1.167(e)-1.................................................    1545-0172
1.167(f)-11................................................    1545-0172
1.167(l)-1.................................................    1545-0172
1.168(d)-1.................................................    1545-1146
1.168(f)(8)-1T.............................................    1545-0923
1.168(i)-1.................................................    1545-1331
1.168-5....................................................    1545-0172
1.169-4....................................................    1545-0172
1.170-1....................................................    1545-0074
1.170-2....................................................    1545-0074
1.170-3....................................................    1545-0123
1.170A-1...................................................    1545-0074
1.170A-2...................................................    1545-0074
1.170A-4(A)(b).............................................    1545-0123
1.170A-8...................................................    1545-0074
1.170A-9...................................................    1545-0052
                                                               1545-0074
1.170A-11..................................................    1545-0074
                                                               1545-0123
                                                               1545-1868
1.170A-12..................................................    1545-0020
                                                               1545-0074
1.170A-13..................................................    1545-0074
                                                               1545-0754
                                                               1545-0908
                                                               1545-1431
1.170A-13(f)...............................................    1545-1464
1.170A-14..................................................    1545-0763
1.171-4....................................................    1545-1491
1.171-5....................................................    1545-1491
1.172-1....................................................    1545-0172
1.172-13...................................................    1545-0863
1.173-1....................................................    1545-0172
1.174-3....................................................    1545-0152
1.174-4....................................................    1545-0152
1.175-3....................................................    1545-0187
1.175-6....................................................    1545-0152
1.177-1....................................................    1545-0172
1.179-2....................................................    1545-1201
1.179-3....................................................    1545-1201
1.179-5....................................................    1545-0172
                                                               1545-1201
1.179B-1T..................................................    1545-2076
1.179C-1...................................................    1545-2103
1.179C-1T..................................................    1545-2103
1.180-2....................................................    1545-0074
1.181-1....................................................    1545-2059
1.181-2....................................................    1545-2059
1.181-3....................................................    1545-2059
1.182-6....................................................    1545-0074
1.183-1....................................................    1545-0195
1.183-2....................................................    1545-0195
1.183-3....................................................    1545-0195
1.183-4....................................................    1545-0195
1.190-3....................................................    1545-0074
1.194-2....................................................    1545-0735
1.194-4....................................................    1545-0735
1.195-1....................................................    1545-1582
1.197-1T...................................................    1545-1425
1.197-2....................................................    1545-1671
1.199-6....................................................    1545-1966
1.213-1....................................................    1545-0074
1.215-1T...................................................    1545-0074
1.217-2....................................................    1545-0182
1.243-3....................................................    1545-0123
1.243-4....................................................    1545-0123
1.243-5....................................................    1545-0123
1.248-1....................................................    1545-0172
1.261-1....................................................    1545-1041
1.263(a)-1.................................................    1545-2248
1.263(a)-3.................................................    1545-2248
1.263(a)-5.................................................    1545-1870
1.263(e)-1.................................................    1545-0123
1.263A-1...................................................    1545-0987
1.263A-1T..................................................    1545-0187
1.263A-2...................................................    1545-0987
1.263A-3...................................................    1545-0987
1.263A-8(b)(2)(iii)........................................    1545-1265
1.263A-9(d)(1).............................................    1545-1265
1.263A-9(f)(1)(ii).........................................    1545-1265
1.263A-9(f)(2)(iv).........................................    1545-1265
1.263A-9(g)(2)(iv)(C)......................................    1545-1265
1.263A-9(g)(3)(iv).........................................    1545-1265
1.265-1....................................................    1545-0074
1.265-2....................................................    1545-0123
1.266-1....................................................    1545-0123
1.267(f)-1.................................................    1545-0885
1.268-1....................................................    1545-0184
1.274-1....................................................    1545-0139
1.274-2....................................................    1545-0139
1.274-3....................................................    1545-0139
1.274-4....................................................    1545-0139
1.274-5....................................................    1545-0771
1.274-5A...................................................    1545-0139
                                                               1545-0771
1.274-5T...................................................    1545-0074
                                                               1545-0172
                                                               1545-0771
1.274-6....................................................    1545-0139
                                                               1545-0771
1.274-6T...................................................    1545-0074
                                                               1545-0771
1.274-7....................................................    1545-0139
1.274-8....................................................    1545-0139
1.279-6....................................................    1545-0123
1.280C-4...................................................    1545-1155
1.280F-3T..................................................    1545-0074
1.280G-1...................................................    1545-1851
1.281-4....................................................    1545-0123
1.302-4....................................................    1545-0074
1.305-3....................................................    1545-0123
1.305-5....................................................    1545-1438
1.307-2....................................................    1545-0074
1.312-15...................................................    1545-0172
1.316-1....................................................    1545-0123
1.331-1....................................................    1545-0074
1.332-4....................................................    1545-0123
1.332-6....................................................    1545-2019
1.336-2....................................................    1545-2125
1.336-4....................................................    1545-2125
1.337(d)-1.................................................    1545-1160
1.337(d)-2.................................................    1545-1160
                                                               1545-1774
1.337(d)-4.................................................    1545-1633
1.337(d)-5.................................................    1545-1672
1.337(d)-6.................................................    1545-1672
1.337(d)-7.................................................    1545-1672
1.338-2....................................................    1545-1658
1.338-5....................................................    1545-1658
1.338-10...................................................    1545-1658
1.338-11...................................................    1545-1990

[[Page 1330]]

 
1.338(h)(10)-1.............................................    1545-1658
1.338(i)-1.................................................    1545-1990
1.341-7....................................................    1545-0123
1.351-3....................................................    1545-2019
1.355-5....................................................    1545-2019
1.362-2....................................................    1545-0123
1.362-4....................................................    1545-2247
1.367(a)-1T................................................    1545-0026
1.367(a)-2T................................................    1545-0026
1.367(a)-3.................................................    1545-0026
                                                               1545-1478
1.367(a)-3T................................................    1545-2183
1.367(a)-6T................................................    1545-0026
1.367(a)-7.................................................    1545-2183
1.367(a)-7T................................................    1545-2183
1.367(a)-8.................................................    1545-1271
                                                               1545-2056
                                                               1545-2183
1.367(b)-1.................................................    1545-1271
1.367(b)-3T................................................    1545-1666
1.367(d)-1T................................................    1545-0026
1.367(e)-1.................................................    1545-1487
1.367(e)-2.................................................    1545-1487
1.368-1....................................................    1545-1691
1.368-3....................................................    1545-2019
1.371-1....................................................    1545-0123
1.371-2....................................................    1545-0123
1.374-3....................................................    1545-0123
1.381(b)-1.................................................    1545-0123
1.381(c)(4)-1..............................................    1545-0123
                                                               1545-0152
                                                               1545-0879
1.381(c)(5)-1..............................................    1545-0123
                                                               1545-0152
1.381(c)(6)-1..............................................    1545-0123
                                                               1545-0152
1.381(c)(8)-1..............................................    1545-0123
1.381(c)(10)-1.............................................    1545-0123
1.381(c)(11)-1(k)..........................................    1545-0123
1.381(c)(13)-1.............................................    1545-0123
1.381(c)(17)-1.............................................    1545-0045
1.381(c)(22)-1.............................................    1545-1990
1.381(c)(25)-1.............................................    1545-0045
1.382-1T...................................................    1545-0123
1.382-2....................................................    1545-0123
1.382-2T...................................................    1545-0123
1.382-3....................................................    1545-1281
                                                               1545-1345
1.382-4....................................................    1545-1120
1.382-6....................................................    1545-1381
1.382-8....................................................    1545-1434
1.382-9....................................................    1545-1120
                                                               1545-1260
                                                               1545-1275
                                                               1545-1324
1.382-11...................................................    1545-2019
1.382-91...................................................    1545-1260
                                                               1545-1324
1.383-1....................................................    1545-0074
                                                               1545-1120
1.401-1....................................................    1545-0020
                                                               1545-0197
                                                               1545-0200
                                                               1545-0534
                                                               1545-0710
1.401(a)-11................................................    1545-0710
1.401(a)-20................................................    1545-0928
1.401(a)-31................................................    1545-1341
1.401(a)-50................................................    1545-0710
1.401(a)(31)-1.............................................    1545-1341
1.401(b)-1.................................................    1545-0197
1.401(f)-1.................................................    1545-0710
1.401(k)-1.................................................    1545-1039
                                                               1545-1069
                                                               1545-1669
                                                               1545-1930
1.401(k)-2.................................................    1545-1669
1.401(k)-3.................................................    1545-1669
1.401(k)-4.................................................    1545-1669
1.401(m)-3.................................................    1545-1699
1.401(a)(9)-1..............................................    1545-1573
1.401(a)(9)-3..............................................    1545-1466
1.401(a)(9)-4..............................................    1545-1573
1.401-12(n)................................................    1545-0806
1.401-14...................................................    1545-0710
1.402(c)-2.................................................    1545-1341
1.402(f)-1.................................................    1545-1341
                                                               1545-1632
1.402A-1...................................................    1545-1992
1.403(b)-1.................................................    1545-0710
1.403(b)-3.................................................    1545-0996
1.403(b)-7.................................................    1545-1341
1.403(b)-10................................................    1545-2068
1.404(a)-4.................................................    1545-0710
1.404(a)-12................................................    1545-0710
1.404A-2...................................................    1545-0123
1.404A-6...................................................    1545-0123
1.408-2....................................................    1545-0390
1.408-5....................................................    1545-0747
1.408-6....................................................    1545-0203
                                                               1545-0390
1.408-7....................................................    1545-0119
1.408(q)-1.................................................    1545-1841
1.408A-2...................................................    1545-1616
1.408A-4...................................................    1545-1616
1.408A-5...................................................    1545-1616
1.408A-7...................................................    1545-1616
1.410(a)-2.................................................    1545-0710
1.410(d)-1.................................................    1545-0710
1.411(a)-11................................................    1545-1471
                                                               1545-1632
1.411(d)-4.................................................    1545-1545
1.411(d)-6.................................................    1545-1477
1.412(b)-5.................................................    1545-0710
1.412(c)(1)-2..............................................    1545-0710
1.412(c)(2)-1..............................................    1545-0710
1.412(c)(3)-2..............................................    1545-0710
1.414(c)-5.................................................    1545-0797
1.414(r)-1.................................................    1545-1221
1.415-2....................................................    1545-0710
1.415-6....................................................    1545-0710
1.417(a)(3)-1..............................................    1545-0928
1.417(e)-1.................................................    1545-1471
                                                               1545-1724
1.417(e)-1T................................................    1545-1471
1.419A(f)(6)-1.............................................    1545-1795
1.422-1....................................................    1545-0820
1.430(f)-1.................................................    1545-2095
1.430(g)-1.................................................    1545-2095
1.430(h)(2)-1..............................................    1545-2095
1.436-1....................................................    1545-2095
1.441-2....................................................    1545-1748
1.442-1....................................................    1545-0074
                                                               1545-0123
                                                               1545-0134
                                                               1545-0152
                                                               1545-0820
                                                               1545-1748
1.443-1....................................................    1545-0123
1.444-3T...................................................    1545-1036
1.444-4....................................................    1545-1591
1.446-1....................................................    1545-0074
                                                               1545-0152
1.446-4(d).................................................    1545-1412

[[Page 1331]]

 
1.448-1(g).................................................    1545-0152
1.448-1(h).................................................    1545-0152
1.448-1(i).................................................    1545-0152
1.448-2....................................................    1545-1855
1.448-2T...................................................    1545-0152
                                                               1545-1855
1.451-1....................................................    1545-0091
1.451-4....................................................    1545-0123
1.451-5....................................................    1545-0074
1.451-6....................................................    1545-0074
1.451-7....................................................    1545-0074
1.453-1....................................................    1545-0152
1.453-2....................................................    1545-0152
1.453-8....................................................    1545-0152
                                                               1545-0228
1.453-10...................................................    1545-0152
1.453A-1...................................................    1545-0152
                                                               1545-1134
1.453A-2...................................................    1545-0152
                                                               1545-1134
1.453A-3...................................................    1545-0963
1.454-1....................................................    1545-0074
1.455-2....................................................    1545-0152
1.455-6....................................................    1545-0123
1.456-2....................................................    1545-0123
1.456-6....................................................    1545-0123
1.456-7....................................................    1545-0123
1.457-8....................................................    1545-1580
1.458-1....................................................    1545-0879
1.458-2....................................................    1545-0152
1.460-1....................................................    1545-1650
1.460-6....................................................    1545-1031
                                                               1545-1572
                                                               1545-1732
1.461-1....................................................    1545-0074
1.461-2....................................................    1545-0096
1.461-4....................................................    1545-0917
1.461-5....................................................    1545-0917
1.463-1T...................................................    1545-0916
1.465-1T...................................................    1545-0712
1.466-1T...................................................    1545-0152
1.466-4....................................................    1545-0152
1.468A-3...................................................    1545-1269
                                                               1545-1378
                                                               1545-1511
1.468A-3(h), 1.468A-7, and 1.468A-8(d).....................    1545-2091
1.468A-4...................................................    1545-0954
1.468A-7...................................................    1545-0954
                                                               1545-1511
1.468A-8...................................................    1545-1269
1.468B-1...................................................    1545-1631
1.468B-1(j)................................................    1545-1299
1.468B-2(k)................................................    1545-1299
1.468B-2(l)................................................    1545-1299
1.468B-3(b)................................................    1545-1299
1.468B-3(e)................................................    1545-1299
1.468B-5(b)................................................    1545-1299
1.468B-9...................................................    1545-1631
1.469-1....................................................    1545-1008
1.469-2T...................................................    1545-0712
                                                               1545-1091
1.469-4T...................................................    1545-0985
                                                               1545-1037
1.469-7....................................................    1545-1244
1.471-2....................................................    1545-0123
1.471-5....................................................    1545-0123
1.471-6....................................................    1545-0123
1.471-8....................................................    1545-0123
1.471-11...................................................    1545-0123
                                                               1545-0152
1.472-1....................................................    1545-0042
                                                               1545-0152
1.472-2....................................................    1545-0152
1.472-3....................................................    1545-0042
1.472-5....................................................    1545-0152
1.472-8....................................................    1545-0028
                                                               1545-0042
                                                               1545-1767
1.475(a)-4.................................................    1545-1945
1.475(b)-4.................................................    1545-1496
1.481-4....................................................    1545-0152
1.481-5....................................................    1545-0152
1.482-1....................................................    1545-1364
1.482-4....................................................    1545-1364
1.482-7....................................................    1545-1364
                                                               1545-1794
1.482-9(b).................................................    1545-2149
1.501(a)-1.................................................    1545-0056
                                                               1545-0057
1.501(c)(3)-1..............................................    1545-0056
1.501(c)(9)-5..............................................    1545-0047
1.501(c)(17)-3.............................................    1545-0047
1.501(e)-1.................................................    1545-0814
1.503(c)-1.................................................    1545-0047
                                                               1545-0052
1.505(c)-1T................................................    1545-0916
1.507-1....................................................    1545-0052
1.507-2....................................................    1545-0052
1.508-1....................................................    1545-0052
                                                               1545-0056
1.509(a)-3.................................................    1545-0047
1.509(a)-4.................................................    1545-2157
1.509(a)-5.................................................    1545-0047
1.509(c)-1.................................................    1545-0052
1.512(a)-1.................................................    1545-0687
1.512(a)-4.................................................    1545-0047
                                                               1545-0687
1.521-1....................................................    1545-0051
                                                               1545-0058
1.527-2....................................................    1545-0129
1.527-5....................................................    1545-0129
1.527-6....................................................    1545-0129
1.527-9....................................................    1545-0129
1.528-8....................................................    1545-0127
1.533-2....................................................    1545-0123
1.534-2....................................................    1545-0123
1.542-3....................................................    1545-0123
1.545-2....................................................    1545-0123
1.545-3....................................................    1545-0123
1.547-2....................................................    1545-0045
                                                               1545-0123
1.547-3....................................................    1545-0123
1.551-4....................................................    1545-0074
1.552-3....................................................    1545-0099
1.552-4....................................................    1545-0099
1.552-5....................................................    1545-0099
1.556-2....................................................    1545-0704
1.561-1....................................................    1545-0044
1.561-2....................................................    1545-0123
1.562-3....................................................    1545-0123
1.563-2....................................................    1545-0123
1.564-1....................................................    1545-0123
1.565-1....................................................    1545-0043
                                                               1545-0123
1.565-2....................................................    1545-0043
1.565-3....................................................    1545-0043
1.565-5....................................................    1545-0043
1.565-6....................................................    1545-0043
1.585-1....................................................    1545-0123
1.585-3....................................................    1545-0123
1.585-8....................................................    1545-1290
1.586-2....................................................    1545-0123
1.593-1....................................................    1545-0123
1.593-6....................................................    1545-0123

[[Page 1332]]

 
1.593-6A...................................................    1545-0123
1.593-7....................................................    1545-0123
1.595-1....................................................    1545-0123
1.597-2....................................................    1545-1300
1.597-4....................................................    1545-1300
1.597-6....................................................    1545-1300
1.597-7....................................................    1545-1300
1.611-2....................................................    1545-0099
1.611-3....................................................    1545-0007
                                                               1545-0099
                                                               1545-1784
1.612-4....................................................    1545-0074
1.612-5....................................................    1545-0099
1.613-3....................................................    1545-0099
1.613-4....................................................    1545-0099
1.613-6....................................................    1545-0099
1.613-7....................................................    1545-0099
1.613A-3...................................................    1545-0919
1.613A-3(e)................................................    1545-1251
1.613A-3(l)................................................    1545-0919
1.613A-5...................................................    1545-0099
1.613A-6...................................................    1545-0099
1.614-2....................................................    1545-0099
1.614-3....................................................    1545-0099
1.614-5....................................................    1545-0099
1.614-6....................................................    1545-0099
1.614-8....................................................    1545-0099
1.617-1....................................................    1545-0099
1.617-3....................................................    1545-0099
1.617-4....................................................    1545-0099
1.631-1....................................................    1545-0007
1.631-2....................................................    1545-0007
1.641(b)-2.................................................    1545-0092
1.642(c)-1.................................................    1545-0092
1.642(c)-2.................................................    1545-0092
1.642(c)-5.................................................    1545-0074
1.642(c)-6.................................................    1545-0020
                                                               1545-0074
                                                               1545-0092
1.642(g)-1.................................................    1545-0092
1.642(i)-1.................................................    1545-0092
1.645-1....................................................    1545-1578
1.663(b)-2.................................................    1545-0092
1.664-1....................................................    1545-0196
1.664-1(a)(7)..............................................    1545-1536
1.664-1(c).................................................    1545-2101
1.664-2....................................................    1545-0196
1.664-3....................................................    1545-0196
1.664-4....................................................    1545-0020
                                                               1545-0196
1.665(a)-0A through
1.665(g)-2A................................................    1545-0192
1.666(d)-1A................................................    1545-0092
1.671-4....................................................    1545-1442
1.671-5....................................................    1545-1540
1.701-1....................................................    1545-0099
1.702-1....................................................    1545-0074
1.703-1....................................................    1545-0099
1.704-2....................................................    1545-1090
1.706-1....................................................    1545-0074
                                                               1545-0099
                                                               1545-0134
1.706-1T...................................................    1545-0099
1.707-3(c)(2)..............................................    1545-1243
1.707-5(a)(7)(ii)..........................................    1545-1243
1.707-6(c).................................................    1545-1243
1.707-8....................................................    1545-1243
1.708-1....................................................    1545-0099
1.732-1....................................................    1545-0099
                                                               1545-1588
1.736-1....................................................    1545-0074
1.743-1....................................................    1545-0074
                                                               1545-1588
1.751-1....................................................    1545-0074
                                                               1545-0099
                                                               1545-0941
1.752-2....................................................    1545-1905
1.752-5....................................................    1545-1090
1.752-7....................................................    1545-1843
1.754-1....................................................    1545-0099
1.755-1....................................................    1545-0099
1.761-2....................................................    1545-1338
1.801-1....................................................    1545-0123
                                                               1545-0128
1.801-3....................................................    1545-0123
1.801-5....................................................    1545-0128
1.801-8....................................................    1545-0128
1.804-4....................................................    1545-0128
1.811-2....................................................    1545-0128
1.812-2....................................................    1545-0128
1.815-6....................................................    1545-0128
1.818-4....................................................    1545-0128
1.818-5....................................................    1545-0128
1.818-8....................................................    1545-0128
1.819-2....................................................    1545-0128
1.821-1....................................................    1545-1027
1.821-3....................................................    1545-1027
1.821-4....................................................    1545-1027
1.822-5....................................................    1545-1027
1.822-6....................................................    1545-1027
1.822-8....................................................    1545-1027
1.822-9....................................................    1545-1027
1.823-2....................................................    1545-1027
1.823-5....................................................    1545-1027
1.823-6....................................................    1545-1027
1.825-1....................................................    1545-1027
1.826-1....................................................    1545-1027
1.826-2....................................................    1545-1027
1.826-3....................................................    1545-1027
1.826-4....................................................    1545-1027
1.826-6....................................................    1545-1027
1.831-3....................................................    1545-0123
1.831-4....................................................    1545-0123
1.832-4....................................................    1545-1227
1.832-5....................................................    1545-0123
1.848-2(g)(8)..............................................    1545-1287
1.848-2(h)(3)..............................................    1545-1287
1.848-2(i)(4)..............................................    1545-1287
1.851-2....................................................    1545-1010
1.851-4....................................................    1545-0123
1.852-1....................................................    1545-0123
1.852-4....................................................    1545-0123
                                                               1545-0145
1.852-6....................................................    1545-0123
                                                               1545-0144
1.852-7....................................................    1545-0074
1.852-9....................................................    1545-0074
                                                               1545-0123
                                                               1545-0144
                                                               1545-0145
                                                               1545-1783
1.852-11...................................................    1545-1094
1.853-3....................................................    1545-2035
1.853-4....................................................    1545-2035
1.854-2....................................................    1545-0123
1.855-1....................................................    1545-0123
1.856-2....................................................    1545-0123
                                                               1545-1004
1.856-6....................................................    1545-0123
1.856-7....................................................    1545-0123
1.856-8....................................................    1545-0123
1.857-8....................................................    1545-0123
1.857-9....................................................    1545-0074
1.858-1....................................................    1545-0123
1.860-2....................................................    1545-0045

[[Page 1333]]

 
1.860-4....................................................    1545-0045
                                                               1545-1054
                                                               1545-1057
1.860E-1...................................................    1545-1675
1.860E-2(a)(5).............................................    1545-1276
1.860E-2(a)(7).............................................    1545-1276
1.860E-2(b)(2).............................................    1545-1276
1.860G-2...................................................    1545-2110
1.861-2....................................................    1545-0089
1.861-3....................................................    1545-0089
1.861-4....................................................    1545-1900
1.861-8....................................................    1545-0126
1.861-8(e)(6) and (g)......................................    1545-1224
1.861-9T...................................................    1545-0121
                                                               1545-1072
1.861-18...................................................    1545-1594
1.863-1....................................................    1545-1476
1.863-3....................................................    1545-1476
                                                               1545-1556
1.863-3A...................................................    1545-0126
1.863-4....................................................    1545-0126
1.863-7....................................................    1545-0132
1.863-8....................................................    1545-1718
1.863-9....................................................    1545-1718
1.864-4....................................................    1545-0126
1.871-1....................................................    1545-0096
1.871-6....................................................    1545-0795
1.871-7....................................................    1545-0089
1.871-10...................................................    1545-0089
                                                               1545-0165
1.874-1....................................................    1545-0089
1.881-4....................................................    1545-1440
1.882-4....................................................    1545-0126
1.883-0....................................................    1545-1677
1.883-1....................................................    1545-1677
1.883-2....................................................    1545-1677
1.883-3....................................................    1545-1677
1.883-4....................................................    1545-1677
1.883-5....................................................    1545-1677
1.884-0....................................................    1545-1070
1.884-1....................................................    1545-1070
1.884-2....................................................    1545-1070
1.884-2T...................................................    1545-0126
                                                               1545-1070
1.884-4....................................................    1545-1070
1.884-5....................................................    1545-1070
1.892-1T...................................................    1545-1053
1.892-2T...................................................    1545-1053
1.892-3T...................................................    1545-1053
1.892-4T...................................................    1545-1053
1.892-5T...................................................    1545-1053
1.892-6T...................................................    1545-1053
1.892-7T...................................................    1545-1053
1.897-2....................................................    1545-0123
                                                               1545-0902
1.897-3....................................................    1545-0123
1.897-5T...................................................    1545-0902
1.897-6T...................................................    1545-0902
1.901-2....................................................    1545-0746
1.901-2A...................................................    1545-0746
1.901-3....................................................    1545-0122
1.902-1....................................................    1545-0122
                                                               1545-1458
1.904-1....................................................    1545-0121
                                                               1545-0122
1.904-2....................................................    1545-0121
                                                               1545-0122
1.904-3....................................................    1545-0121
1.904-4....................................................    1545-0121
1.904-5....................................................    1545-0121
1.904-7....................................................    1545-2104
1.904-7T...................................................    1545-2104
1.904(f)-1.................................................    1545-0121
                                                               1545-0122
1.904(f)-2.................................................    1545-0121
1.904(f)-3.................................................    1545-0121
1.904(f)-4.................................................    1545-0121
1.904(f)-5.................................................    1545-0121
1.904(f)-6.................................................    1545-0121
1.904(f)-7.................................................    1545-1127
1.905-2....................................................    1545-0122
1.905-3T...................................................    1545-1056
1.905-4T...................................................    1545-1056
1.905-5T...................................................    1545-1056
1.911-1....................................................    1545-0067
                                                               1545-0070
1.911-2....................................................    1545-0067
                                                               1545-0070
1.911-3....................................................    1545-0067
                                                               1545-0070
1.911-4....................................................    1545-0067
                                                               1545-0070
1.911-5....................................................    1545-0067
                                                               1545-0070
1.911-6....................................................    1545-0067
                                                               1545-0070
1.911-7....................................................    1545-0067
                                                               1545-0070
1.913-13...................................................    1545-0067
1.921-1T...................................................    1545-0190
                                                               1545-0884
                                                               1545-0935
                                                               1545-0939
1.921-2....................................................    1545-0884
1.921-3T...................................................    1545-0935
1.923-1T...................................................    1545-0935
1.924(a)-1T................................................    1545-0935
1.925(a)-1T................................................    1545-0935
1.925(b)-1T................................................    1545-0935
1.926(a)-1T................................................    1545-0935
1.927(a)-1T................................................    1545-0935
1.927(b)-1T................................................    1545-0935
1.927(d)-1.................................................    1545-0884
1.927(d)-2T................................................    1545-0935
1.927(e)-1T................................................    1545-0935
1.927(e)-2T................................................    1545-0935
1.927(f)-1.................................................    1545-0884
1.931-1....................................................    1545-0074
                                                               1545-0123
1.934-1....................................................    1545-0782
1.935-1....................................................    1545-0074
                                                               1545-0087
                                                               1545-0803
1.936-1....................................................    1545-0215
                                                               1545-0217
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1.1503(d)-1................................................    1545-1946
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1.6038B-1..................................................    1545-1617
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1.6081-2...................................................    1545-0148
                                                               1545-1036
                                                               1545-1054
1.6081-3...................................................    1545-0233
1.6081-4...................................................    1545-0188
                                                               1545-1479
1.6081-6...................................................    1545-0148
                                                               1545-1054
1.6081-7...................................................    1545-0148
                                                               1545-1054
1.6091-3...................................................    1545-0089
1.6107-1...................................................    1545-0074
                                                               1545-1231
1.6109-1...................................................    1545-0074
1.6109-2...................................................    1545-2176
1.6115-1...................................................    1545-1464
1.6151-1...................................................    1545-0074
1.6153-1...................................................    1545-0087
1.6153-4...................................................    1545-0087
1.6161-1...................................................    1545-0087
1.6162-1...................................................    1545-0087
1.6164-1...................................................    1545-0135
1.6164-2...................................................    1545-0135
1.6164-3...................................................    1545-0135
1.6164-5...................................................    1545-0135
1.6164-6...................................................    1545-0135
1.6164-7...................................................    1545-0135
1.6164-8...................................................    1545-0135
1.6164-9...................................................    1545-0135
1.6302-1...................................................    1545-0257
1.6302-2...................................................    1545-0098
                                                               1545-0257
1.6411-1...................................................    1545-0098
                                                               1545-0135
                                                               1545-0582
1.6411-2...................................................    1545-0098
                                                               1545-0582
1.6411-3...................................................    1545-0098
                                                               1545-0582
1.6411-4...................................................    1545-0582
1.6414-1...................................................    1545-0096
1.6425-1...................................................    1545-0170
1.6425-2...................................................    1545-0170
1.6425-3...................................................    1545-0170
1.6654-1...................................................    1545-0087
                                                               1545-0140
1.6654-2...................................................    1545-0087
1.6654-3...................................................    1545-0087
1.6654-4...................................................    1545-0087
1.6655(e)-1................................................    1545-1421
1.6662-3(c)................................................    1545-0889

[[Page 1338]]

 
1.6662-4(e) and (f)........................................    1545-0889
1.6662-6...................................................    1545-1426
1.6694-1...................................................    1545-0074
1.6694-2...................................................    1545-0074
1.6694-2(c)................................................    1545-1231
1.6694-2(c)(3).............................................    1545-1231
1.6694-3(e)................................................    1545-1231
1.6695-1...................................................    1545-0074
                                                               1545-1385
1.6695-2...................................................    1545-1570
1.6696-1...................................................    1545-0074
                                                               1545-0240
1.6851-1...................................................    1545-0086
                                                               1545-0138
1.6851-2...................................................    1545-0086
                                                               1545-0138
1.7476-1...................................................    1545-0197
1.7476-2...................................................    1545-0197
1.7519-2T..................................................    1545-1036
1.7520-1...................................................    1545-1343
1.7520-2...................................................    1545-1343
1.7520-3...................................................    1545-1343
1.7520-4...................................................    1545-1343
1.7701(l)-3................................................    1545-1642
1.7872-15..................................................    1545-1792
1.9100-1...................................................    1545-0074
1.9101-1...................................................    1545-0008
2.1-4......................................................    1545-0123
2.1-5......................................................    1545-0123
2.1-6......................................................    1545-0123
2.1-10.....................................................    1545-0123
2.1-11.....................................................    1545-0123
2.1-12.....................................................    1545-0123
2.1-13.....................................................    1545-0123
2.1-20.....................................................    1545-0123
2.1-22.....................................................    1545-0123
2.1-26.....................................................    1545-0123
3.2........................................................    1545-0123
4.954-1....................................................    1545-1068
4.954-2....................................................    1545-1068
5.6411-1...................................................    1545-0042
                                                               1545-0074
                                                               1545-0098
                                                               1545-0129
                                                               1545-0172
                                                               1545-0582
                                                               1545-0619
5c.44F-1...................................................    1545-0619
5c.128-1...................................................    1545-0123
5c.168(f)(8)-1.............................................    1545-0123
5c.168(f)(8)-2.............................................    1545-0123
5c.168(f)(8)-6.............................................    1545-0123
5c.168(f)(8)-8.............................................    1545-0123
5c.305-1...................................................    1545-0110
5c.442-1...................................................    1545-0152
5f.103-1...................................................    1545-0720
5f.103-3...................................................    1545-0720
5f.6045-1..................................................    1545-0715
6a.103A-2..................................................    1545-0123
                                                               1545-0720
6a.103A-3..................................................    1545-0720
7.465-1....................................................    1545-0712
7.465-2....................................................    1545-0712
7.465-3....................................................    1545-0712
7.465-4....................................................    1545-0712
7.465-5....................................................    1545-0712
7.936-1....................................................    1545-0217
7.999-1....................................................    1545-0216
7.6039A-1..................................................    1545-0015
7.6041-1...................................................    1545-0115
11.410-1...................................................    1545-0710
11.412(c)-7................................................    1545-0710
11.412(c)-11...............................................    1545-0710
12.7.......................................................    1545-0190
12.8.......................................................    1545-0191
12.9.......................................................    1545-0195
14a.422A-1.................................................    1545-0123
15A.453-1..................................................    1545-0228
16.3-1.....................................................    1545-0159
16A.126-2..................................................    1545-0074
16A.1255-1.................................................    1545-0184
16A.1255-2.................................................    1545-0184
18.1371-1..................................................    1545-0130
18.1378-1..................................................    1545-0130
18.1379-1..................................................    1545-0130
18.1379-2..................................................    1545-0130
20.2010-2T.................................................    1545-0015
20.2011-1..................................................    1545-0015
20.2014-5..................................................    1545-0015
                                                               1545-0260
20.2014-6..................................................    1545-0015
20.2016-1..................................................    1545-0015
20.2031-2..................................................    1545-0015
20.2031-3..................................................    1545-0015
20.2031-4..................................................    1545-0015
20.2031-6..................................................    1545-0015
20.2031-7..................................................    1545-0020
20.2031-10.................................................    1545-0015
20.2032-1..................................................    1545-0015
20.2032A-3.................................................    1545-0015
20.2032A-4.................................................    1545-0015
20.2032A-8.................................................    1545-0015
20.2039-4..................................................    1545-0015
20.2051-1..................................................    1545-0015
20.2053-3..................................................    1545-0015
20.2053-9..................................................    1545-0015
20.2053-10.................................................    1545-0015
20.2055-1..................................................    1545-0015
20.2055-2..................................................    1545-0015
                                                               1545-0092
20.2055-3..................................................    1545-0015
20.2056(b)-4...............................................    1545-0015
20.2056(b)-7...............................................    1545-0015
                                                               1545-1612
20.2056A-2.................................................    1545-1443
20.2056A-3.................................................    1545-1360
20.2056A-4.................................................    1545-1360
20.2056A-10................................................    1545-1360
20.2106-1..................................................    1545-0015
20.2106-2..................................................    1545-0015
20.2204-1..................................................    1545-0015
20.2204-2..................................................    1545-0015
20.6001-1..................................................    1545-0015
20.6011-1..................................................    1545-0015
20.6018-1..................................................    1545-0015
                                                               1545-0531
20.6018-2..................................................    1545-0015
20.6018-3..................................................    1545-0015
20.6018-4..................................................    1545-0015
                                                               1545-0022
20.6036-2..................................................    1545-0015
20.6060-1(a)(1)............................................    1545-1231
20.6061-1..................................................    1545-0015
20.6065-1..................................................    1545-0015
20.6075-1..................................................    1545-0015
20.6081-1..................................................    1545-0015
                                                               1545-0181
                                                               1545-1707
20.6091-1..................................................    1545-0015
20.6107-1..................................................    1545-1231
20.6161-1..................................................    1545-0015
                                                               1545-0181
20.6161-2..................................................    1545-0015
                                                               1545-0181

[[Page 1339]]

 
20.6163-1..................................................    1545-0015
20.6166-1..................................................    1545-0181
20.6166A-1.................................................    1545-0015
20.6166A-3.................................................    1545-0015
20.6324A-1.................................................    1545-0754
20.7520-1..................................................    1545-1343
20.7520-2..................................................    1545-1343
20.7520-3..................................................    1545-1343
20.7520-4..................................................    1545-1343
22.0.......................................................    1545-0015
25.2511-2..................................................    1545-0020
25.2512-2..................................................    1545-0020
25.2512-3..................................................    1545-0020
25.2512-5..................................................    1545-0020
25.2512-9..................................................    1545-0020
25.2513-1..................................................    1545-0020
25.2513-2..................................................    1545-0020
                                                               1545-0021
25.2513-3..................................................    1545-0020
25.2518-2..................................................    1545-0959
25.2522(a)-1...............................................    1545-0196
25.2522(c)-3...............................................    1545-0020
                                                               1545-0196
25.2523(a)-1...............................................    1545-0020
                                                               1545-0196
25.2523(f)-1...............................................    1545-0015
25.2701-2..................................................    1545-1241
25.2701-4..................................................    1545-1241
25.2701-5..................................................    1545-1273
25.2702-5..................................................    1545-1485
25.2702-6..................................................    1545-1273
25.6001-1..................................................    1545-0020
                                                               1545-0022
25.6011-1..................................................    1545-0020
25.6019-1..................................................    1545-0020
25.6019-2..................................................    1545-0020
25.6019-3..................................................    1545-0020
25.6019-4..................................................    1545-0020
25.6060-1(a)(1)............................................    1545-1231
25.6061-1..................................................    1545-0020
25.6065-1..................................................    1545-0020
25.6075-1..................................................    1545-0020
25.6081-1..................................................    1545-0020
25.6091-1..................................................    1545-0020
25.6091-2..................................................    1545-0020
25.6107-1..................................................    1545-1231
25.6151-1..................................................    1545-0020
25.6161-1..................................................    1545-0020
25.7520-1..................................................    1545-1343
25.7520-2..................................................    1545-1343
25.7520-3..................................................    1545-1343
25.7520-4..................................................    1545-1343
26.2601-1..................................................    1545-0985
26.2632-1..................................................    1545-0985
                                                               1545-1892
26.2642-1..................................................    1545-0985
26.2642-2..................................................    1545-0985
26.2642-3..................................................    1545-0985
26.2642-4..................................................    1545-0985
26.2642-6..................................................    1545-1902
26.2652-2..................................................    1545-0985
26.2654-1..................................................    1545-1902
26.2662-1..................................................    1545-0015
                                                               1545-0985
26.2662-2..................................................    1545-0985
26.6060-1(a)(1)............................................    1545-1231
26.6107-1..................................................    1545-1231
31.3102-3..................................................    1545-0029
                                                               1545-0059
                                                               1545-0065
31.3121(b)(19)-1...........................................    1545-0029
31.3121(d)-1...............................................    1545-0004
31.3121(i)-1...............................................    1545-0034
31.3121(k)-4...............................................    1545-0137
31.3121(r)-1...............................................    1545-0029
31.3121(s)-1...............................................    1545-0029
31.3121(v)(2)-1............................................    1545-1643
31.3302(a)-2...............................................    1545-0028
31.3302(a)-3...............................................    1545-0028
31.3302(b)-2...............................................    1545-0028
31.3302(e)-1...............................................    1545-0028
31.3306(c)(18)-1...........................................    1545-0029
31.3401(a)-1...............................................    1545-0029
31.3401(a)(6)..............................................    1545-1484
31.3401(a)(6)-1............................................    1545-0029
                                                               1545-0096
                                                               1545-0795
31.3401(a)(7)-1............................................    1545-0029
31.3401(a)(8)(A)-1 ........................................    1545-0029
                                                               1545-0666
31.3401(a)(8)(C)-1 ........................................    1545-0029
31.3401(a)(15)-1...........................................    1545-0182
31.3401(c)-1...............................................    1545-0004
31.3402(b)-1...............................................    1545-0010
31.3402(c)-1...............................................    1545-0010
31.3402(f)(1)-1............................................    1545-0010
31.3402(f)(2)-1............................................    1545-0010
                                                               1545-0410
31.3402(f)(3)-1............................................    1545-0010
31.3402(f)(4)-1............................................    1545-0010
31.3402(f)(4)-2............................................    1545-0010
31.3402(f)(5)-1............................................    1545-0010
                                                               1545-1435
31.3402(h)(1)-1............................................    1545-0029
31.3402(h)(3)-1............................................    1545-0010
                                                               1545-0029
31.3402(h)(4)-1............................................    1545-0010
31.3402(i)-(1).............................................    1545-0010
31.3402(i)-(2).............................................    1545-0010
31.3402(k)-1...............................................    1545-0065
31.3402(l)-(1).............................................    1545-0010
31.3402(m)-(1).............................................    1545-0010
31.3402(n)-(1).............................................    1545-0010
31.3402(o)-2...............................................    1545-0415
31.3402(o)-3...............................................    1545-0008
                                                               1545-0010
                                                               1545-0415
                                                               1545-0717
31.3402(p)-1...............................................    1545-0415
                                                               1545-0717
31.3402(q)-1...............................................    1545-0238
                                                               1545-0239
31.3404-1..................................................    1545-0029
31.3405(c)-1...............................................    1545-1341
31.3406(a)-1...............................................    1545-0112
31.3406(a)-2...............................................    1545-0112
31.3406(a)-3...............................................    1545-0112
31.3406(a)-4...............................................    1545-0112
31.3406(b)(2)-1............................................    1545-0112
31.3406(b)(2)-2............................................    1545-0112
31.3406(b)(2)-3............................................    1545-0112
31.3406(b)(2)-4............................................    1545-0112
31.3406(b)(2)-5............................................    1545-0112
31.3406(b)(3)-1............................................    1545-0112
31.3406(b)(3)-2............................................    1545-0112
31.3406(b)(3)-3............................................    1545-0112
31.3406(b)(3)-4............................................    1545-0112
31.3406(b)(4)-1............................................    1545-0112
31.3406(c)-1...............................................    1545-0112
31.3406(d)-1...............................................    1545-0112
31.3406(d)-2...............................................    1545-0112
31.3406(d)-3...............................................    1545-0112
31.3406(d)-4...............................................    1545-0112
31.3406(d)-5...............................................    1545-0112

[[Page 1340]]

 
31.3406(e)-1...............................................    1545-0112
31.3406(f)-1...............................................    1545-0112
31.3406(g)-1...............................................    1545-0096
                                                               1545-0112
                                                               1545-1819
31.3406(g)-2...............................................    1545-0112
31.3406(g)-3...............................................    1545-0112
31.3406(h)-1...............................................    1545-0112
31.3406(h)-2...............................................    1545-0112
31.3406(h)-3...............................................    1545-0112
31.3406(i)-1...............................................    1545-0112
31.3501(a)-1T..............................................    1545-0771
31.3503-1..................................................    1545-0024
31.3504-1..................................................    1545-0029
31.6001-1..................................................    1545-0798
31.6001-2..................................................    1545-0034
                                                               1545-0798
31.6001-3..................................................    1545-0798
31.6001-4..................................................    1545-0028
31.6001-5..................................................    1545-0798
31.6001-6..................................................    1545-0029
                                                               1459-0798
31.6011(a)-1...............................................    1545-0029
                                                               1545-0034
                                                               1545-0035
                                                               1545-0059
                                                               1545-0074
                                                               1545-0256
                                                               1545-0718
                                                               1545-2097
31.6011(a)-2...............................................    1545-0001
                                                               1545-0002
31.6011(a)-3...............................................    1545-0028
31.6011(a)-3A..............................................    1545-0955
31.6011(a)-4...............................................    1545-0034
                                                               1545-0035
                                                               1545-0718
                                                               1545-1413
                                                               1545-2097
31.6011(a)-5...............................................    1545-0028
                                                               1545-0718
                                                               1545-2097
31.6011(a)-6...............................................    1545-0028
31.6011(a)-7...............................................    1545-0074
31.6011(a)-8...............................................    1545-0028
31.6011(a)-9...............................................    1545-0028
31.6011(a)-10..............................................    1545-0112
31.6011(b)-1...............................................    1545-0003
31.6011(b)-2...............................................    1545-0029
31.6051-1..................................................    1545-0008
                                                               1545-0182
                                                               1545-0458
                                                               1545-1729
31.6051-2..................................................    1545-0008
31.6051-3..................................................    1545-0008
31.6053-1..................................................    1545-0029
                                                               1545-0062
                                                               1545-0064
                                                               1545-0065
                                                               1545-1603
31.6053-2..................................................    1545-0008
31.6053-3..................................................    1545-0065
                                                               1545-0714
31.6053-4..................................................    1545-0065
                                                               1545-1603
31.6060-1(a)(1)............................................    1545-1231
31.6065(a)-1...............................................    1545-0029
31.6071(a)-1...............................................    1545-0001
                                                               1545-0028
                                                               1545-0029
31.6071(a)-1A..............................................    1545-0955
31.6081(a)-1...............................................    1545-0008
                                                               1545-0028
31.6091-1..................................................    1545-0028
                                                               1545-0029
31.6107-1..................................................    1545-1231
31.6157-1..................................................    1545-0955
31.6205-1..................................................    1545-0029
                                                               1545-2097
31.6301(c)-1AT.............................................    1545-0035
                                                               1545-0112
                                                               1545-0257
31.6302-1..................................................    1545-1413
31.6302-2..................................................    1545-1413
31.6302-3..................................................    1545-1413
31.6302-4..................................................    1545-1413
31.6302(c)-2...............................................    1545-0001
                                                               1545-0257
31.6302(c)-2A..............................................    1545-0955
31.6302(c)-3...............................................    1545-0257
31.6402(a)-2...............................................    1545-0256
                                                               1545-2097
31.6413(a)-1...............................................    1545-0029
                                                               1545-2097
31.6413(a)-2...............................................    1545-0029
                                                               1545-0256
                                                               1545-2097
31.6413(c)-1...............................................    1545-0029
                                                               1545-0171
31.6414-1..................................................    1545-0029
                                                               1545-2097
32.1.......................................................    1545-0029
                                                               1545-0415
32.2.......................................................    1545-0029
35a.3406-2.................................................    1545-0112
35a.9999-5.................................................    1545-0029
36.3121(l)(1)-1............................................    1545-0137
36.3121(l)(1)-2............................................    1545-0137
36.3121(l)(3)-1............................................    1545-0123
36.3121(1)(7)-1............................................    1545-0123
36.3121(1)(10)-1...........................................    1545-0029
36.3121(1)(10)-3...........................................    1545-0029
36.3121(1)(10)-4...........................................    1545-0257
40.6060-1(a)(1)............................................    1545-1231
40.6107-1..................................................    1545-1231
40.6302(c)-3(b)(2)(ii).....................................    1545-1296
40.6302(c)-3(b)(2)(iii)....................................    1545-1296
40.6302(c)-3(e)............................................    1545-1296
40.6302(c)-3(f)(2)(ii).....................................    1545-1296
41.4481-1..................................................    1545-0143
41.4481-2..................................................    1545-0143
41.4483-3..................................................    1545-0143
41.6001-1..................................................    1545-0143
41.6001-2..................................................    1545-0143
41.6001-3..................................................    1545-0143
41.6060-1(a)(1)............................................    1545-1231
41.6071(a)-1...............................................    1545-0143
41.6081(a)-1...............................................    1545-0143
41.6091-1..................................................    1545-0143
41.6107-1..................................................    1545-1231
41.6109-1..................................................    1545-0143
41.6151(a)-1...............................................    1545-0143
41.6156-1..................................................    1545-0143
41.6161(a)(1)-1............................................    1545-0143
44.4401-1..................................................    1545-0235
44.4403-1..................................................    1545-0235
44.4412-1..................................................    1545-0236
44.4901-1..................................................    1545-0236
44.4905-1..................................................    1545-0236
44.4905-2..................................................    1545-0236
44.6001-1..................................................    1545-0235
44.6011(a)-1...............................................    1545-0235
                                                               1545-0236
44.6060-1(a)(1)............................................    1545-1231

[[Page 1341]]

 
44.6071-1..................................................    1545-0235
44.6091-1..................................................    1545-0235
44.6107-1..................................................    1545-1231
44.6151-1..................................................    1545-0235
44.6419-1..................................................    1545-0235
44.6419-2..................................................    1545-0235
46.4371-4..................................................    1545-0023
46.4374-1..................................................    1545-0023
46.4375-1..................................................    1545-2238
46.4376-1..................................................    1545-2238
46.4701-1..................................................    1545-0023
                                                               1545-0257
48.4041-4..................................................    1545-0023
48.4041-5..................................................    1545-0023
48.4041-6..................................................    1545-0023
48.4041-7..................................................    1545-0023
48.4041-9..................................................    1545-0023
48.4041-10.................................................    1545-0023
48.4041-11.................................................    1545-0023
48.4041-12.................................................    1545-0023
48.4041-13.................................................    1545-0023
48.4041-18.................................................    1545-0023
48.4041-19.................................................    1545-0023
48.4041-20.................................................    1545-0023
48.4041-21.................................................    1545-1270
48.4042-2..................................................    1545-0023
48.4052-1..................................................    1545-1418
48.4061(a)-1...............................................    1545-0023
48.4061(a)-2...............................................    1545-0023
48.4061(b)-3...............................................    1545-0023
48.4064-1..................................................    1545-0014
                                                               1545-0242
48.4071-1..................................................    1545-0023
48.4073-1..................................................    1545-0023
48.4073-3..................................................    1545-0023
                                                               1545-1074
                                                               1545-1087
48.4081-2..................................................    1545-1270
                                                               1545-1418
48.4081-3..................................................    1545-1270
                                                               1545-1418
                                                               1545-1897
48.4081-4(b)(2)(ii)........................................    1545-1270
48.4081-4(b)(3)(i).........................................    1545-1270
48.4081-4(c)...............................................    1545-1270
48.4081-6(c)(1)(ii)........................................    1545-1270
48.4081-7..................................................    1545-1270
                                                               1545-1418
48.4082-1T.................................................    1545-1418
48.4082-2..................................................    1545-1418
48.4082-6..................................................    1545-1418
48.4082-7..................................................    1545-1418
48.4091-3..................................................    1545-1418
48.4101-1..................................................    1545-1418
48.4101-1T.................................................    1545-1418
48.4101-2..................................................    1545-1418
48.4161(a)-1...............................................    1545-0723
48.4161(a)-2...............................................    1545-0723
48.4161(a)-3...............................................    1545-0723
48.4161(b)-1...............................................    1545-0723
48.4216(a)-2...............................................    1545-0023
48.4216(a)-3...............................................    1545-0023
48.4216(c)-1...............................................    1545-0023
48.4221-1..................................................    1545-0023
48.4221-2..................................................    1545-0023
48.4221-3..................................................    1545-0023
48.4221-4..................................................    1545-0023
48.4221-5..................................................    1545-0023
48.4221-6..................................................    1545-0023
48.4221-7..................................................    1545-0023
48.4222(a)-1...............................................    1545-0014
                                                               1545-0023
48.4223-1..................................................    1545-0023
                                                               1545-0257
                                                               1545-0723
48.6302(c)-1...............................................    1545-0023
                                                               1545-0257
48.6412-1..................................................    1545-0723
48.6416(a)-1...............................................    1545-0023
                                                               1545-0723
48.6416(a)-2...............................................    1545-0723
48.6416(a)-3...............................................    1545-0723
48.6416(b)(1)-1............................................    1545-0723
48.6416(b)(1)-2............................................    1545-0723
48.6416(b)(1)-3............................................    1545-0723
48.6416(b)(1)-4............................................    1545-0723
48.6416(b)(2)-1............................................    1545-0723
48.6416(b)(2)-2............................................    1545-0723
48.6416(b)(2)-3............................................    1545-0723
                                                               1545-1087
48.6416(b)(2)-4............................................    1545-0723
48.6416(b)(3)-1............................................    1545-0723
48.6416(b)(3)-2............................................    1545-0723
48.6416(b)(3)-3............................................    1545-0723
48.6416(b)(4)-1............................................    1545-0723
48.6416(b)(5)-1............................................    1545-0723
48.6416(c)-1...............................................    1545-0723
48.6416(e)-1...............................................    1545-0023
                                                               1545-0723
48.6416(f)-1...............................................    1545-0023
                                                               1545-0723
48.6416(g)-1...............................................    1545-0723
48.6416(h)-1...............................................    1545-0723
48.6420(c)-2...............................................    1545-0023
48.6420(f)-1...............................................    1545-0023
48.6420-1..................................................    1545-0162
                                                               1545-0723
48.6420-2..................................................    1545-0162
                                                               1545-0723
48.6420-3..................................................    1545-0162
                                                               1545-0723
48.6420-4..................................................    1545-0162
                                                               1545-0723
48.6420-5..................................................    1545-0162
                                                               1545-0723
48.6420-6..................................................    1545-0162
                                                               1545-0723
48.6421-0..................................................    1545-0162
                                                               1545-0723
48.6421-1..................................................    1545-0162
                                                               1545-0723
48.6421-2..................................................    1545-0162
                                                               1545-0723
48.6421-3..................................................    1545-0162
                                                               1545-0723
48.6421-4..................................................    1545-0162
                                                               1545-0723
48.6421-5..................................................    1545-0162
                                                               1545-0723
48.6421-6..................................................    1545-0162
                                                               1545-0723
48.6421-7..................................................    1545-0162
                                                               1545-0723
48.6424-0..................................................    1545-0723
48.6424-1..................................................    1545-0723
48.6424-2..................................................    1545-0723
48.6424-3..................................................    1545-0723
48.6424-4..................................................    1545-0723
48.6424-5..................................................    1545-0723
48.6424-6..................................................    1545-0723
48.6427-0..................................................    1545-0723
48.6427-1..................................................    1545-0023
                                                               1545-0162
                                                               1545-0723

[[Page 1342]]

 
48.6427-2..................................................    1545-0162
                                                               1545-0723
48.6427-3..................................................    1545-0723
48.6427-4..................................................    1545-0723
48.6427-5..................................................    1545-0723
48.6427-8..................................................    1545-1418
48.6427-9..................................................    1545-1418
48.6427-10.................................................    1545-1418
48.6427-11.................................................    1545-1418
49.4251-1..................................................    1545-1075
49.4251-2..................................................    1545-1075
49.4251-4(d)(2)............................................    1545-1628
49.4253-3..................................................    1545-0023
49.4253-4..................................................    1545-0023
49.4264(b)-1...............................................    1545-0023
                                                               1545-0224
                                                               1545-0225
                                                               1545-0226
                                                               1545-0230
                                                               1545-0257
                                                               1545-0912
49.4271-1(d)...............................................    1545-0685
49.5000B-1.................................................    1545-2177
51.8T......................................................    1545-2209
52.4682-1(b)(2)(iii).......................................    1545-1153
52.4682-2(b)...............................................    1545-1153
                                                               1545-1361
52.4682-2(d)...............................................    1545-1153
                                                               1545-1361
52.4682-3(c)(2)............................................    1545-1153
52.4682-3(g)...............................................    1545-1153
52.4682-4(f)...............................................    1545-0257
                                                               1545-1153
52.4682-5(d)...............................................    1545-1361
52.4682-5(f)...............................................    1545-1361
53.4940-1..................................................    1545-0052
                                                               1545-0196
53.4942(a)-1...............................................    1545-0052
53.4942(a)-2...............................................    1545-0052
53.4942(a)-3...............................................    1545-0052
53.4942(b)-3...............................................    1545-0052
53.4945-1..................................................    1545-0052
53.4945-4..................................................    1545-0052
53.4945-5..................................................    1545-0052
53.4945-6..................................................    1545-0052
53.4947-1..................................................    1545-0196
53.4947-2..................................................    1545-0196
53.4948-1..................................................    1545-0052
53.4958-6..................................................    1545-1623
53.4961-2..................................................    1545-0024
53.4963-1..................................................    1545-0024
53.6001-1..................................................    1545-0052
53.6011-1..................................................    1545-0049
                                                               1545-0052
                                                               1545-0092
                                                               1545-0196
53.6060-1(a)(1)............................................    1545-1231
53.6065-1..................................................    1545-0052
53.6071-1..................................................    1545-0049
53.6081-1..................................................    1545-0066
                                                               1545-0148
53.6107-1..................................................    1545-1231
53.6161-1..................................................    1545-0575
54.4972-1..................................................    1545-0197
54.4975-7..................................................    1545-0575
54.4977-1T.................................................    1545-0771
54.4980B-6.................................................    1545-1581
54.4980B-7.................................................    1545-1581
54.4980B-8.................................................    1545-1581
54.4980F-1.................................................    1545-1780
54.4981A-1T................................................    1545-0203
54.6011-1..................................................    1545-0575
54.6011-1T.................................................    1545-0575
54.6060-1(a)(1)............................................    1545-1231
54.6107-1..................................................    1545-1231
54.9801-3..................................................    1545-1537
54.9801-4..................................................    1545-1537
54.9801-5..................................................    1545-1537
54.9801-6..................................................    1545-1537
54.9812-1T.................................................    1545-2165
54.9815-1251T..............................................    1545-2178
54.9815-2711T..............................................    1545-2179
54.9815-2712T..............................................    1545-2180
54.9815-2714T..............................................    1545-2172
54.9815-2715...............................................    1545-2229
54.9815-2719AT.............................................    1545-2181
54.9815-2719T..............................................    1545-2182
55.6001-1..................................................    1545-0123
55.6011-1..................................................    1545-0123
                                                               1545-0999
                                                               1545-1016
55.6060-1(a)(1)............................................    1545-1231
55.6061-1..................................................    1545-0999
55.6071-1..................................................    1545-0999
55.6107-1..................................................    1545-1231
56.4911-6..................................................    1545-0052
56.4911-7..................................................    1545-0052
56.4911-9..................................................    1545-0052
56.4911-10.................................................    1545-0052
56.6001-1..................................................    1545-1049
56.6011-1..................................................    1545-1049
56.6060-1(a)(1)............................................    1545-1231
56.6081-1..................................................    1545-1049
56.6107-1..................................................    1545-1231
56.6161-1..................................................    1545-0257
                                                               1545-1049
57.2(e)(2)(i)..............................................    1545-2249
145.4051-1.................................................    1545-0745
145.4052-1.................................................    1545-0120
                                                               1545-0745
                                                               1545-1076
145.4061-1.................................................    1545-0224
                                                               1545-0230
                                                               1545-0257
                                                               1545-0745
156.6001-1.................................................    1545-1049
156.6011-1.................................................    1545-1049
156.6060-1(a)(1)...........................................    1545-1231
156.6081-1.................................................    1545-1049
156.6107-1.................................................    1545-1231
156.6161-1.................................................    1545-1049
157.6001-1.................................................    1545-1824
157.6011-1.................................................    1545-1824
157.6060-1(a)(1)...........................................    1545-1231
157.6081-1.................................................    1545-1824
157.6107-1.................................................    1545-1231
157.6161-1.................................................    1545-1824
301.6011-2.................................................    1545-0225
                                                               1545-0350
                                                               1545-0387
                                                               1545-0441
                                                               1545-0957
301.6011(g)-1..............................................    1545-2079
301.6017-1.................................................    1545-0090
301.6034-1.................................................    1545-0092
301.6035-1.................................................    1545-0123
301.6036-1.................................................    1545-0013
                                                               1545-0773
301.6047-1.................................................    1545-0367
                                                               1545-0957
301.6056-1.................................................    1545-2251
301.6056-2.................................................    1545-2251
301.6057-1.................................................    1545-0710
301.6057-2.................................................    1545-0710

[[Page 1343]]

 
301.6058-1.................................................    1545-0710
301.6059-1.................................................    1545-0710
301.6103(c)-1..............................................    1545-1816
301.6103(n)-1..............................................    1545-1841
301.6103(p)(2)(B)-1........................................    1545-1757
301.6104(a)-1..............................................    1545-0495
301.6104(a)-5..............................................    1545-0056
301.6104(a)-6..............................................    1545-0056
301.6104(b)-1..............................................    1545-0094
                                                               1545-0742
301.6104(d)-1..............................................    1545-1655
301.6104(d)-2..............................................    1545-1655
301.6104(d)-3..............................................    1545-1655
301.6109-1.................................................    1545-0003
                                                               1545-0295
                                                               1545-0367
                                                               1545-0387
                                                               1545-0957
                                                               1545-1461
                                                               1545-2242
301.6109-3.................................................    1545-1564
301.6110-3.................................................    1545-0074
301.6110-5.................................................    1545-0074
301.6111-1T................................................    1545-0865
                                                               1545-0881
301.6111-2.................................................    1545-0865
                                                               1545-1687
301.6112-1.................................................    1545-0865
                                                               1545-1686
301.6112-1T................................................    1545-0865
                                                               1545-1686
301.6114-1.................................................    1545-1126
                                                               1545-1484
301.6222(a)-2..............................................    1545-0790
301.6222(b)-1..............................................    1545-0790
301.6222(b)-2..............................................    1545-0790
301.6222(b)-3..............................................    1545-0790
301.6223(b)-1..............................................    1545-0790
301.6223(c)-1..............................................    1545-0790
301.6223(e)-2..............................................    1545-0790
301.6223(g)-1..............................................    1545-0790
301.6223(h)-1..............................................    1545-0790
301.6224(b)-1..............................................    1545-0790
301.6224(c)-1..............................................    1545-0790
301.6224(c)-3..............................................    1545-0790
301.6227(c)-1..............................................    1545-0790
301.6227(d)-1..............................................    1545-0790
301.6229(b)-2..............................................    1545-0790
301.6230(b)-1..............................................    1545-0790
301.6230(e)-1..............................................    1545-0790
301.6231(a)(1)-1...........................................    1545-0790
301.6231(a)(7)-1...........................................    1545-0790
301.6231(c)-1..............................................    1545-0790
301.6231(c)-2..............................................    1545-0790
301.6241-1T................................................    1545-0130
301.6316-4.................................................    1545-0074
301.6316-5.................................................    1545-0074
301.6316-6.................................................    1545-0074
301.6316-7.................................................    1545-0029
301.6324A-1................................................    1545-0015
301.6361-1.................................................    1545-0024
                                                               1545-0074
301.6361-2.................................................    1545-0024
301.6361-3.................................................    1545-0074
301.6402-2.................................................    1545-0024
                                                               1545-0073
                                                               1545-0091
301.6402-3.................................................    1545-0055
                                                               1545-0073
                                                               1545-0091
                                                               1545-0132
                                                               1545-1484
301.6402-5.................................................    1545-0928
301.6404-1.................................................    1545-0024
301.6404-2T................................................    1545-0024
301.6404-3.................................................    1545-0024
301.6405-1.................................................    1545-0024
301.6501(c)-1..............................................    1545-1241
                                                               1545-1637
301.6501(d)-1..............................................    1545-0074
                                                               1545-0430
301.6501(o)-2..............................................    1545-0728
301.6511(d)-1..............................................    1545-0024
                                                               1545-0582
301.6511(d)-2..............................................    1545-0024
                                                               1545-0582
301.6511(d)-3..............................................    1545-0024
                                                               1545-0582
301.6652-2.................................................    1545-0092
301.6685-1.................................................    1545-0092
301.6689-1T................................................    1545-1056
301.6707-1T................................................    1545-0865
                                                               1545-0881
301.6708-1T................................................    1545-0865
301.6712-1.................................................    1545-1126
301.6723-1A(d).............................................    1545-0909
301.6903-1.................................................    1545-0013
                                                               1545-1783
301.6905-1.................................................    1545-0074
301.7001-1.................................................    1545-0123
301.7101-1.................................................    1545-1029
301.7207-1.................................................    1545-0092
301.7216-2.................................................    1545-0074
301.7216-2(o)..............................................    1545-1209
301.7425-3.................................................    1545-0854
301.7430-2(c)..............................................    1545-1356
301.7502-1.................................................    1545-1899
301.7507-8.................................................    1545-0123
301.7507-9.................................................    1545-0123
301.7513-1.................................................    1545-0429
301.7517-1.................................................    1545-0015
301.7605-1.................................................    1545-0795
301.7623-1.................................................    1545-0409
                                                               1545-1534
301.7654-1.................................................    1545-0803
301.7701-3.................................................    1545-1486
301.7701-4.................................................    1545-1465
301.7701-7.................................................    1545-1600
301.7701-16................................................    1545-0795
301.7701(b)-1..............................................    1545-0089
301.7701(b)-2..............................................    1545-0089
301.7701(b)-3..............................................    1545-0089
301.7701(b)-4..............................................    1545-0089
301.7701(b)-5..............................................    1545-0089
301.7701(b)-6..............................................    1545-0089
301.7701(b)-7..............................................    1545-0089
                                                               1545-1126
301.7701(b)-9..............................................    1545-0089
301.7805-1.................................................    1545-0805
301.9000-5.................................................    1545-1850
301.9001-1.................................................    1545-0220
301.9100-2.................................................    1545-1488
301.9100-3.................................................    1545-1488
301.9100-4T................................................    1545-0016
                                                               1545-0042
                                                               1545-0074
                                                               1545-0129
                                                               1545-0172
                                                               1545-0619
301.9100-6T................................................    1545-0872
301.9100-7T................................................    1545-0982
301.9100-8.................................................    1545-1112
301.9100-11T...............................................    1545-0123
301.9100-12T...............................................    1545-0026

[[Page 1344]]

 
                                                               1545-0074
                                                               1545-0172
                                                               1545-1027
301.9100-14T...............................................    1545-0046
301.9100-15T...............................................    1545-0046
301.9100-16T...............................................    1545-0152
302.1-7....................................................    1545-0024
305.7701-1.................................................    1545-0823
305.7871-1.................................................    1545-0823
404.6048-1.................................................    1545-0160
420.0-1....................................................    1545-0710
Part 509...................................................    1545-0846
Part 513...................................................    1545-0834
Part 514...................................................    1545-0845
Part 521...................................................    1545-0848
601.104....................................................    1545-0233
601.105....................................................    1545-0091
601.201....................................................    1545-0019
                                                               1545-0819
601.204....................................................    1545-0152
601.401....................................................    1545-0257
601.504....................................................    1545-0150
601.601....................................................    1545-0800
601.602....................................................    1545-0295
                                                               1545-0387
                                                               1545-0957
601.702....................................................    1545-0429
------------------------------------------------------------------------


(26 U.S.C. 7805)

[T.D. 8011, 50 FR 10222, Mar. 14, 1985]

    Editorial Note: For Federal Register citations affecting Sec.  
602.101, see the List of CFR Sections Affected, which appears in the 
Finding Aids section of the printed volume and at www.fdsys.gov.

[[Page 1345]]



List of CFR Sections Affected



All changes in this volume of the Code of Federal Regulations (CFR) that 
were made by documents published in the Federal Register since January 
1, 2009 are enumerated in the following list. Entries indicate the 
nature of the changes effected. Page numbers refer to Federal Register 
pages. The user should consult the entries for chapters, parts and 
subparts as well as sections for revisions.
For changes to this volume of the CFR prior to this listing, consult the 
annual edition of the monthly List of CFR Sections Affected (LSA). The 
LSA is available at www.fdsys.gov. For changes to this volume of the CFR 
prior to 2001, see the ``List of CFR Sections Affected, 1949-1963, 1964-
1972, 1973-1985, and 1986-2000'' published in 11 separate volumes. The 
``List of CFR Sections Affected 1986-2000'' is available at 
www.fdsys.gov.

                                  2009

26 CFR
                                                                   74 FR
                                                                    Page
Chapter I
1.401(a)(9)-1 Amended..............................................45994
1.401(a)(9)-6 Amended..............................................45994
1.401(k)-0 Amended..................................................8207
1.401(k)-1 (b)(1)(ii)(C) revised; (b)(1)(ii)(D) added; (e)(7) 
        amended.....................................................8207
1.401(k)-2 (a)(5)(vi) and (b)(5)(iii) added; (b)(2)(iv)(A), (D), 
        (vi)(A) and (4)(iii) revised; (b)(2)(iv)(E) and (viii) 
        Examples 3, 4 and 5 removed.................................8207
1.401(k)-3 (a) revised; (d)(3)(ii), (e)(1), (h)(2) and (3) 
        amended; (i), (j) and (k) added.............................8208
1.401(k)-6 Amended..................................................8210
1.401(m)-0 Amended..................................................8210
1.401(m)-1 (b)(1)(iii) revised; (b)(1)(iv) added; (b)(4)(iii)(B) 
        and (c)(2) amended..........................................8210
1.401(m)-2 (a)(5)(iv), (6)(ii) and (b)(2)(vi)(B) amended; 
        (a)(5)(v), (b)(2)(iv)(A), (D) and (vi)(A) revised; 
        (b)(2)(iv)(E) removed; (b)(2)(iv)(F) redesignated as new 
        (b)(2)(iv)(E); (b)(4)(iii) added............................8210
    (b)(2)(iv)(D) corrected........................................12551
1.401(m)-3 (a) revised; (f)(1) and (j)(3) amended...................8211
1.402(c)-2 A-4 amended..............................................8211
1.403(b)-6 (e)(2) amended; (e)(8) added............................45994
1.411(a)-4 (b)(7) revised...........................................8211
1.411(d)-3 (a)(1) amended..........................................61276
1.414(w)-1 Added....................................................8212
1.421-1 (c)(1) and (j)(1) revised..................................59077
1.422-2 (b)(6) Example 1 amended...................................59077
1.422-5 (f)(1) revised.............................................59078
1.423-1 Revised....................................................59078
1.423-2 Revised....................................................59078
    (a)(1) and (i)(5) Example 5 correctly amended; (d)(3) 
correctly revised..................................................67973
1.424-1 (a)(10) Example 9 amended; (g)(1) revised..................59087
1.430(d)-1 Added...................................................53035
1.430(f)-1 Added...................................................53046
1.430(g)-1 Added...................................................53053
1.430(h)(2)-1 Added................................................53055
1.430(i)-1 Added...................................................53058
1.436-0 Added......................................................53060
1.436-1 Added......................................................53061

                                  2010

26 CFR
                                                                   75 FR
                                                                    Page
Chapter I
1.401(a)(35)-1 Added...............................................27931
1.403(b)-4 (c)(5) Example 12 correctly amended.....................65566
1.403(b)-6 (e)(5) correctly amended................................65566
1.403(b)-7 (b)(1) correctly amended................................65566

[[Page 1346]]

1.403(b)-10 (b)(3) heading correctly revised; (b)(3)(i) heading 
        correctly added............................................65566
1.408-7 (d)(2) amended.............................................64084
1.411(a)(13)-1 Added...............................................64135
1.411(b)(5)-1 Added................................................64137
    (b)(1)(ii)(A) and (d)(1)(iii) correctly revised; (b)(1)(iv) 
Example 4, (c)(5) Examples 2 and 3 and (f)(2)(iii) correctly 
amended............................................................81456

                                  2011

26 CFR
                                                                   76 FR
                                                                    Page
Chapter I
1.411(a)(13)-1 (e)(1)(iii)(E) corrected.............................4244

                                  2012

26 CFR
                                                                   77 FR
                                                                    Page
Chapter I
1.411(d)-4 Amended.................................................66918

                                  2013

26 CFR
                                                                   78 FR
                                                                    Page
Chapter I
1.401(k)-0 Amended.................................................68737
1.401(k)-3 Authority citation and (e)(1) amended; (e)(4)(i), (ii), 
        (g), (1) and (2) revised...................................68737
1.401(m)-0 Amended.................................................68738
1.401(m)-3 (f)(1) amended; (f)(4)(i), (ii), (h), (1) and (2) 
        revised; (h)(1)(i) added...................................68738

                                  2014

 (No regulations published from January 1, 2014, through April 1, 2014)


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