[Federal Register Volume 59, Number 122 (Monday, June 27, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-15439]


[[Page Unknown]]

[Federal Register: June 27, 1994]


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DEPARTMENT OF THE TREASURY
26 CFR Part 1

[TD 8548]
RIN 1545-AR61

 

Qualified Separate Lines of Business

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains amendments to the final regulations 
under section 414(r) of the Internal Revenue Code, which provide that 
an employer may be treated as operating separate lines of business for 
purposes of applying the minimum coverage requirements of section 
410(b) and the minimum participation requirements of section 
401(a)(26). The regulations reflect the enactment of section 414(r) by 
the Tax Reform Act of 1986 and subsequent changes made by the Technical 
and Miscellaneous Revenue Act of 1988 and the Public Debt Limit 
Increase Act of 1989. The regulations provide guidance necessary to 
comply with the law and affect sponsors of and participants in tax-
qualified retirement plans and certain other employee benefit plans.

DATES: These regulations are effective January 1, 1994.
    The regulations apply to plan years beginning on or after January 
1, 1994, except as provided in the transition rules of Sec. 1.414(r)-
1(d)(9).

FOR FURTHER INFORMATION CONTACT: Patricia McDermott at (202) 622-4606 
(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    Proposed regulations under section 414(r) and related provisions of 
the Internal Revenue Code (Code) were published in the Federal Register 
on February 1, 1991 (56 FR 3988). Written comments were received from 
the public on the proposed regulations. In addition, a public hearing 
on the proposed regulations was held on May 16, 1991. After 
consideration of all the written comments received and the statements 
made at the public hearing, the proposed regulations under section 
414(r) were adopted, as modified, by final regulations (TD 8376) 
published in the Federal Register on December 4, 1991 (56 FR 63420). On 
August 10, 1992, proposed regulations were published in the Federal 
Register (57 FR 35536) to extend the effective date of the final 
regulations under section 414(r) (and related regulations), generally 
to plan years beginning on or after January 1, 1994.
    On September 7, 1993, proposed regulations amending the final 
regulations under sections 414(r) and 410(b) were published in the 
Federal Register (58 FR 47090). Written comments were received from the 
public on the proposed regulations, and a public hearing was held on 
November 10, 1993. After consideration of all the written comments 
received and the statements made at the public hearing, these 
regulations are adopted as modified by this Treasury decision.
    Temporary regulations (TD 8173) and proposed regulations under 
section 414(q) of the Code (relating to the definition of highly 
compensated employee) were published in the Federal Register on 
February 19, 1988 (53 FR 4965 and 4999). In conjunction with the 
February 1991 proposed regulations under section 414(r), amendments to 
the temporary regulations (TD 8334) and proposed regulations under 
section 414(q) were published in the Federal Register on February 1, 
1991 (56 FR 3976 and 4023). The amendments related to the employee 
exclusions for purposes of satisfying the 50-employee requirement for a 
separate line of business under section 414(r)(2)(A) of the Code.
    Under section 7805(e)(2) of the Code, the February 1991 amendments 
to the temporary regulations under section 414(q) expired after three 
years (January 31, 1994). In order to retain the application of those 
rules, the February 1991 proposed regulations under section 414(q) are 
adopted by this Treasury decision.

Explanation of Provisions

1. Overview

    In general, all employees of a single employer, determined under 
section 414 of the Code, are taken into account for purposes of 
applying the minimum coverage requirements of section 410(b) and the 
minimum participation requirements of section 401(a)(26) to a qualified 
plan. Section 410(b)(5) provides an exception if an employer operates 
qualified separate lines of business under section 414(r). If the 
employer is treated as operating qualified separate lines of business, 
section 410(b)(5) generally permits the employer to apply the minimum 
coverage requirements separately with respect to the employees of each 
qualified separate line of business. A similar exception is provided 
for purposes of applying the minimum participation requirements of 
section 401(a)(26) and the 55-percent average benefits test of section 
129(d)(8).
    An employer is treated as operating qualified separate lines of 
business if (1) the employer designates its lines of business by 
reference to the property or services provided by each line, (2) each 
line of business is organized and operated separately from the 
remainder of the employer, and (3) each of these separate lines of 
business meets additional statutory requirements (including 
administrative scrutiny) and thus constitutes a qualified separate line 
of business. Each employee of an employer that operates qualified 
separate lines of business is assigned to a particular line of business 
for purposes of nondiscrimination testing.
    The September 1993 proposed regulations amend the final regulations 
under section 414(r) generally to address issues raised since the 
publication of the final regulations. The proposed regulations include 
the following major changes:

--Allowing an employee to be treated as a substantial-service employee 
with respect to a line of business if at least 50 percent of the 
employee's services are provided to that line.
--Applying the separate management and separate workforce tests to a 
line of business without regard to substantial-service employees of 
other lines.
--Excluding nonresident aliens in applying the separate management and 
separate workforce tests.
--Expanding the special rules for vertically integrated lines of 
business and transferred employees.
--Increasing access to individual determinations under administrative 
scrutiny.
--Clarifying the treatment of employees who change from one 
disaggregation population to another.

In general, comments received on the changes included in the proposed 
regulations were favorable. Accordingly, these final regulations 
incorporate those changes. In addition, in response to comments, 
certain further modifications have been made to the regulations. The 
more significant modifications are discussed below.

2. Residual Shared employees

    Most of the comments received on the September 1993 proposed 
regulations pertained to the allocation of residual shared employees, 
that is, employees who provide services to more than one qualified 
separate line of business and who are not substantial-service employees 
with respect to any line of business. The December 1991 regulations 
provide three alternative allocation methods for residual shared 
employees, which are intended to assure that, as a group, residual 
shared employees receive benefits representative of the benefits 
provided to the workforce generally.
    Under the dominant line of business method, all residual shared 
employees are allocated to the employer's dominant line of business. 
Generally, a qualified separate line of business is dominant if at 
least 50 percent of the employer's substantial-service employees are 
assigned to that line. Alternatively, a line of business may be 
dominant if at least 35 percent of the employer's substantial-service 
employees are assigned to that line and the line satisfies any one of 
four possible conditions, such as a certain level of revenue or a 
certain size compared with the employer's other lines. The other two 
allocation methods, the pro-rata method and the highly compensated 
employee (HCE) percentage ratio method, provide formulas under which 
residual shared employees are allocated among the employer's various 
qualified separate lines of business.
    Employers have commented that the allocation rules do not 
adequately accommodate current benefit arrangements for employees who 
provide services to more than one qualified separate line of business. 
For example, the employer might cover residual shared employees in the 
plan maintained for a line that the employer considers its core 
business, even though that line does not satisfy the dominant line of 
business standard. Residual shared employees therefore cannot all be 
allocated to that line, potentially causing a change in their benefits. 
Employers also have commented that the pro-rata and HCE percentage 
ratio methods may require employees in the same department to be 
allocated to different qualified separate lines of business, which in 
turn may require different benefits to be provided to employees who 
work together.
    In response to comments, these final regulations change the 
allocation rules in two ways. First, the standard for the alternative 
test of dominance is lowered from 35 percent to 25 percent, giving 
employers more flexibility in establishing a dominant line. Second, the 
regulations provide an additional allocation alternative, the small 
group method.
    Under the small group method, with respect to each residual shared 
employee, the employer chooses a qualified separate line of business to 
which the employee is allocated. The residual shared employees need not 
all be allocated to the same qualified separate line of business; the 
employer thus has great flexibility in selecting the plans under which 
residual shared employees benefit. In order to prevent this new 
allocation method from being used to provide highly compensated 
employees with excessive benefits relative to the nonhighly compensated 
employees, its use is subject to three requirements.
    First, the entire group of the employer's residual shared employees 
cannot exceed three percent of the employees taken into account in 
applying section 410(b). In addition, the qualified separate line of 
business to which the employer allocates a residual shared employee 
must include at least 10 percent of the employer's substantial-service 
employees and must satisfy the administrative scrutiny statutory safe 
harbor after the allocation, that is, the concentration of highly 
compensated employees in the line of business must be between 50 and 
200 percent of the concentration of highly compensated employees in the 
workforce generally. Finally, the allocation of residual shared 
employees must be reasonable; criteria for determining whether an 
allocation is reasonable are set forth in the regulations.

3. Gateway

    Section 410(b)(5)(B) provides that separate-line-of-business 
testing does not apply to a plan unless the plan benefits such 
employees as qualify under a classification that is set up by the 
employer and is found not to discriminate in favor of highly 
compensated employees. Because the employer-wide nondiscriminatory 
classification test of section 410(b)(5)(B) is a prerequisite to 
separate-line-of-business testing, it is sometimes referred to as the 
``Gateway.''
    Under the December 1991 regulations, the Gateway is applied in the 
same basic manner as the nondiscriminatory classification test under 
the section 410(b) regulations. Those regulations establish an unsafe 
harbor ratio percentage for a plan, that is, a minimum ratio of the 
relative coverage rates of nonhighly compensated and highly compensated 
employees. The unsafe harbor percentage applicable to a plan depends on 
the concentration of nonhighly compensated employees in the employer's 
workforce.
    If a qualified separate line of business has a disproportionate 
share of the employer's highly compensated employees, the plan 
maintained for that line of business may have a very low ratio 
percentage on an employer-wide basis, even though it covers a high 
percentage of the nonhighly compensated employees in that line. The 
December 1991 regulations therefore provide a reduced unsafe harbor 
percentage if the plan has a ratio percentage of at least 90 percent on 
a qualified-separate-line-of-business basis. Although most plans pass 
the Gateway test in its current form, some commentators on the 
September 1993 proposed regulations have noted continued difficulty in 
the case of plans maintained for certain lines of business that cover a 
high percentage of the nonhighly compensated employees in those lines.
    In response to those comments, these final regulations provide 
that, if a plan has a ratio percentage of at least 90 percent on a 
qualified-separate-line-of-business basis, but its employer-wide ratio 
percentage falls below the plan's reduced unsafe harbor percentage, the 
plan nonetheless is deemed to satisfy section 410(b)(5)(B) on an 
employer-wide basis if the Commissioner determines that, based on 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. For this 
purpose, included among the relevant facts and circumstances are facts 
and circumstances such as those listed in Sec. 1.410(b)-4(c)(3)(ii). In 
making these determinations, the Commissioner will determine which 
other facts and circumstances are relevant, including any of the facts 
and circumstances listed in section 5 of Rev. Proc. 93-41, 1993-2 C.B. 
536, that the Commissioner determines are relevant.

4. Other Changes

    These final regulations also make the following changes:

--Expansion of the minimum and maximum benefit safe harbor to apply to 
career average plans.
--Allowing more flexibility in the employees taken into account for 
purposes of the minimum benefit safe harbor.
--Clarification of the application of section 401(a)(26) to employer-
wide plans.
--Clarification of the disaggregation population rules after a change 
in disaggregation population groups.
--Finalization of the regulations under section 414(q) relating to 
employees excluded for purposes of the 50-employee requirement under 
section 414(r)(2)(A).

5. Notice 92-36 relief

    A concern has been raised that the anti-cutback rules of section 
411(d)(6) might eliminate an employer's option to comply with the 
nondiscrimination requirements of the Tax Reform Act of 1986 (including 
the provisions of section 414(r)) and related legislation by amending 
its plans in the 1994 plan year to reduce the level of benefits 
provided to highly compensated employees for that year. Employers are 
reminded that Notice 92-36, 1992-2 C.B. 364, provided broad transition 
relief giving employers the opportunity to retain their amendment 
options until the last day of the 1994 plan year without being treated 
as violating section 411(d)(6).

Special Analyses

    It has been determined that this Treasury Decision is not a 
significant regulatory action as defined in EO 12866. Therefore, a 
regulatory assessment is not required. It also has been determined that 
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) 
and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to 
these regulations, and, therefore, a Regulatory Flexibility Analysis is 
not required. Pursuant to section 7805(f) of the Internal Revenue Code, 
the notice of proposed rulemaking preceding these regulations was 
submitted to the Small Business Administration for comment on its 
impact on small business.

Drafting Information

    The principal author of these regulations is Patricia McDermott of 
the Office of the Associate Chief Counsel (Employee Benefits and Exempt 
Organizations), IRS. However, other personnel from the IRS and Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read, 
in part, as follows:

    Authority: 26 U.S.C. 7805. * * *

    Section 1.414(q)-1 also issued under 26 U.S.C. 414(q). * * *
    Par. 2. Section 1.410(b)-0 is amended as follows:
    1. The entries for Sec. 1.410(b)-7(c)(4) and (c)(5) are revised.
    2. The entry for (c)(6) is removed.
    3. The revised entries read as follows:


Sec. 1.410(b)-0  Table of Contents. * * *

* * * * *

Sec. 1.410(b)-7  Definition of plan and rules governing plan 
disaggregation and aggregation.

* * * * *
    (c) * * *
    (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.
* * * * *


Sec. 1.410(b)-2  [Amended]

    Par. 3. Section 1.410(b)-2 is amended as follows:
    1. Paragraph (b)(7) is amended by removing the reference 
``Sec. 1.410(b)-7(c)(5)'' from the second sentence and adding 
``Sec. 1.410(b)-7(c)(4)'' in its place.


Sec. 1.410(b)-6   [Amended]

    Par. 4. Section 1.410(b)-6 is amended as follows:
    1. Paragraph (d)(1) is amended by removing the reference 
``Sec. 1.410(b)-7(c)(5)'' from the second sentence and adding 
``Sec. 1.410(b)-7(c)(4)'' in its place.
    2. Paragraph (d)(2)(iv) is amended by removing the reference 
``Sec. 1.410(b)-7(c)(5)'' from the fourth sentence of Example 2(i) and 
adding ``Sec. 1.410(b)-7(c)(4)'' in its place.


Sec. 1.410(b)-7  [Amended]

    Par. 5. Section 1.410(b)-7 is amended as follows:
    1. Paragraphs (c)(4) and (c)(5) are revised.
    2. Paragraph (c)(6) is removed.
    3. Paragraph (d)(4) is amended by removing the reference ``(c)(5)'' 
from the second and third sentences and adding ``(c)(4)'' in its place.
    4. The revised provisions read as follows:


Sec. 1.410(b)-7  Definition of plan and rules governing plan 
disaggregation and aggregation.

* * * * *
    (c) * * *
    (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 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, 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.
* * * * *
    Par. 6. Section 1.414(q)-1 is added to read as follows:


Sec. 1.414(q)-1   Highly compensated employee.

    Q&A-1 through 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) through (iii) [Reserved] See Sec. 1.414(q)-1T, Q&A-9(b)(1) (i) 
through (iii) for further guidance.
    (2) Alternative exclusion provisions--(i) and (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) through (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.
    (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.


Sec. 1.414(g)-1T  [Amended]

    Par. 7. Section 1.414(q)-1T, paragraph A-9, is amended as follows:
    1. The introductory text of paragraph (b)(1) is revised.
    2. Paragraph (b)(2)(iii) is revised.
    3. Paragraph (g) is removed.
    4. The revised provisions read as follows:


Sec. 1.414(q)-1T  Highly compensated employee (Temporary).

* * * * *
    A-9:
* * * * *
    (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.
* * * * *
    (2) * * *
    (iii) Method of election. [Reserved] See Sec. 1.414(q)-1, Q&A-
9(b)(2)(iii) for further information.
* * * * *


Sec. 1.414(r)-0  [Amended]

    Par. 8. Section 1.414(r)-0, paragraph (b), is amended as follows:
    1. Entries for Sec. 1.414(r)-2, paragraphs (b)(2) (i) and (ii), are 
added.
    2. The entries for Sec. 1.414(r)-3 are amended by:
    a. Removing the entries for paragraphs (c)(4)(i) and (c)(4)(ii);
    b. Revising the entry for paragraph (c)(5)(iii) and adding entries 
for paragraphs (c)(5)(iii) (A) and (B).
    3. The entries for Sec. 1.414(r)-6 are amended by:
    a. Revising the entry for paragraph (b).
    b. Removing the entries for paragraphs (c) and (c)(1) through 
(c)(12).
    4. The entries for Sec. 1.414(r)-7 are amended by:
    a. Removing the entry for paragraph (c)(2);
    b. Redesignating the entries for paragraphs (c)(3) through (c)(5) 
as paragraphs (c)(2) through (c)(4);
    c. Adding new entries for paragraphs (c)(5) and (c)(5)(i) through 
(c)(5)(iv);
    d. Removing the entries for paragraphs (d) and (d)(1) through 
(d)(3).
    5. The entries for Sec. 1.414(r)-8 are amended by:
    a. Revising the entry for paragraph (b)(2)(iii) and adding entries 
for paragraphs (b)(2)(iii) (A) and (B).
    b. Removing the entry for paragraph (d)(4).
    c. Redesignating the entry for paragraph (d)(5) as paragraph 
(d)(4).
    6. The added and revised entries read as follows:


Sec. 1.414(r)-0  Table of Contents.

* * * * *
    (b) * * *
* * * * *

Sec. 1.414(r)-2 Line of business.

* * * * *
    (b) * * *
    (2) * * *
    (i) In general.
    (ii) Timing of provision of property or services.
* * * * *

Sec. 1.414(r)-3 Separate line of business.

* * * * *
    (c) * * *
    (5) * * *
    (iii) Optional rule for employees who change status.
    (A) In general.
    (B) Change in employee's status.
* * * * *

Sec. 1.414(r)-6 Qualified separate line of business--administrative 
scrutiny requirement--individual determinations.

* * * * *
    (b) Authority to establish procedures.

Sec. 1.414(r)-7 Determination of the employees of an employer's 
qualified separate lines of business.

* * * * *
    (c) * * *
    (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)

* * * * *
    (b) * * *
    (2) * * *
    (iii) Modification of unsafe harbor percentage for plans 
satisfying ratio percentage test at 90 percent level.
    (A) General Rule.
    (B) Facts and circumstances alternative.

* * * * *


Sec. 1.414(r)-1  [Amended]

    Par. 9. Section 1.414(r)-1 is amended as follows:
    1. The fourth and seventh sentences of the Example in paragraph 
(c)(2)(ii) are amended by adding the language ``nonhighly compensated'' 
immediately after ``nonexcludable.''
    2. Paragraph (c)(3)(ii) is revised.
    3. The last sentence of paragraph (d)(4) is amended by adding the 
language ``scrutiny'' immediately after ``administrative.''
    4. Paragraph (d)(9)(i) is amended by removing the reference 
``1992'' from the end of the sentence and adding the language ``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))'' in its 
place.
    5. The last sentence of paragraph (e) is amended by removing the 
language ``and new conditions under which an individual determination 
may be requested under section Sec. 1.414(r)-6''.
    6. The revised provision reads as follows:


Sec. 1.414(r)-1  Requirements applicable to qualified separate lines of 
business.

* * * * *
    (c) * * *
    (3) * * *
    (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.
* * * * *


Sec. 1.414(r)-2  [Amended]

    Par. 10. Section 1.414(r)-2 is amended as follows:
    1. Paragraph (b)(2) is revised.
    2. Example 1 and Example 2 in paragraph (c)(3) are revised.
    3. The revised provisions read as follows:


Sec. 1.414(r)-2  Line of business.

* * * * *
    (b) * * *
    (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.
* * * * *
    (c) * * *
    (3) * * *

    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.
* * * * *


Sec. 1.414(r)-3  [Amended]

    Par. 11. Section 1.414(r)-3 is amended as follows:
    1. The second sentence of paragraph (b)(4) is revised.
    2. Paragraph (c)(2)(ii) is revised.
    3. Paragraph (c)(4) is revised.
    4. Paragraph (c)(5)(iii) is revised.
    5. The last sentence of the introductory text of paragraph (c)(6) 
is revised.
    6. A sentence is added to the end of Example 2 of paragraph (c)(6).
    7. In paragraph (c)(6), the phrase ``(in accordance with paragraph 
(c)(5)(iii) of this section)'' is removed from the seventh sentence of 
Example 3, the fifth sentence of Example 4, the fifth and sixth 
sentences of Example 5, and the fifth sentence of Example 7.
    8. Two sentences are added to the end of Example 5 of paragraph 
(c)(6).
    9. A sentence is added to the end of the introductory text of 
paragraph (c)(7).
    10. Example 1 of paragraph (c)(7) is revised.
    11. In Example 2 of paragraph (c)(7), the phrase ``(in accordance 
with paragraph (c)(5)(iii) of this section)'' is removed from the third 
sentence.
    12. Examples 3 and 4 of paragraph (c)(7) are redesignated Examples 
4 and 5, respectively, and a new Example 3 is added.
    13. The first sentence of newly designated Example 5 in paragraph 
(c)(7) is amended by removing the reference ``Example 3'' and adding 
``Example 4'' in its place.
    14. Paragraph (d)(2) is revised.
    15. Example 1 of paragraph (d)(4) is revised.
    16. The additions and revisions read as follows:


Sec. 1.414(r)-3  Separate line of business.

* * * * *
    (b) * * *
    (4) 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. * * 
*
    (c) * * *
    (2) * * *
    (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.
* * * * *
    (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) * * *
    (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.
    (c) * * *
    (6) * * * 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 substantial-service 
employees with respect to the line of business.
* * * * *
    Example 2. * * * 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 5. * * * 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 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.
* * * * *
    (7) * * * 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 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 
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.
* * * * *
    (d) * * *
    (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).
* * * * *
    (4) * * *

    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.
* * * * *


Sec. 1.414(r)-4   [Amended]

    Par. 12. Section 1.414(r)-4 is amended by removing the reference 
``Sec. 1.414(q)-1T'' from the last sentence of paragraph (b) and adding 
``Sec. 1.414(q)-1'' in its place.


Sec. 1.414(r)-5   [Amended]

    Par. 13. Section 1.414(r)-5 is amended as follows:
    1. Paragraph (b)(5)(ii) is revised.
    2. Paragraphs (d)(1)(ii) (B) and (C) are revised.
    3. The concluding text of paragraph (d)(1) is removed.
    4. Paragraph (d)(1)(iii) is added.
    5. Example 2 of paragraph (d)(4) is revised.
    6. The last sentence of paragraph (g)(2)(iii)(A) is revised.
    7. Paragraph (g)(2)(iii)(D) is amended by:
    a. Revising the third sentence;
    b. Adding a sentence to the end.
    8. Paragraph (g)(3)(ii)(B) is amended by adding the language 
``described'' immediately after ``amount'' and removing the language 
``described'' from after ``employee.''
    9. The last sentence of paragraph (g)(3)(iii)(B) is amended by:
    a. Adding the word ``qualified'' immediately before ``disability'';
    b. Removing the reference ``Sec. 1.401(a)(4)-3(d)(6)(vi)'' and 
adding ``section 411(a)(9)'' in its place.
    10. A sentence is added to the end of paragraph (g)(3)(iii)(C).
    11. The last sentence of paragraph (g)(3)(iii)(D) is revised.
    12. Paragraph (g)(5) is revised.
    13. A sentence is added after the third sentence of paragraph 
(g)(6).
    14. The revised provisions read as follows:


Sec. 1.414(r)-5  Qualified separate line of business--administrative 
scrutiny requirement--safe harbors.

* * * * *
    (b) * * *
    (5) * * *
    (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.
* * * * *
    (d) * * *
    (1) * * *
    (ii) * * *
    (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.
* * * * *
    (4) * * *
    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.
* * * * *
    (g) * * *
    (2) * * *
    (iii) * * *
    (A) * * * 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).
* * * * *
    (D) * * * 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 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.
* * * * *
    (3) * * *
    (iii) * * *
    (C) * * * 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) * * * 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).
* * * * *
    (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) * * * 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). * * *


Sec. 1.414(r)-6  [Amended]

    Par. 14. Section 1.414(r)-6 is amended as follows:
    1. Paragraph (a) is amended by:
    a. Revising the third sentence.
    b. Adding a new sentence immediately following the second sentence.
    c. Removing the last sentence.
    2. Paragraph (b) is revised.
    3. Paragraph (c) is removed.
    4. The addition and revisions read as follows:


Sec. 1.414(r)-6  Qualified separate line of business--administrative 
scrutiny requirement--individual determinations

    (a) * * * 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 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.


Sec. 1.414(r)-7  [Amended]

    Par. 15. Section 1.414(r)-7 is amended as follows:
    1. The last sentence of paragraph (a)(1) is revised.
    2. Paragraph (b)(2)(ii) is amended by removing the language ``with 
respect to a qualified separate line of business''.
    3. The last sentence of paragraph (b)(3) is amended by removing the 
language ``(including whether the residual shared employee is eligible 
for assignment under paragraph (c)(2) of this section)''.
    4. Paragraph (c)(1) is revised.
    5. Paragraph (c)(2) is removed.
    6. Paragraphs (c)(3) through (c)(5) are redesignated (c)(2) through 
(c)(4), respectively, and a new paragraph (c)(5) is added.
    7. Redesignated paragraphs (c)(2)(i), (c)(3)(i) and (c)(4)(i) are 
amended by removing the language ``who are not assigned under paragraph 
(c)(2) of this section''.
    8. Redesignated paragraphs (c)(2)(i), (c)(2)(v), and Example 2, 
Example 3 and Example 4 of paragraph (c)(2)(v) are amended by removing 
the reference ``paragraph (c)(3)'' and adding ``paragraph (c)(2)'' in 
its place.
    9. Redesignated paragraph (c)(2)(i) and paragraph (ii) of Example 1 
of redesignated paragraph (c)(2)(v) are amended by removing the 
reference ``paragraph (c)(3)(ii)'' and adding ``paragraph (c)(2)(ii)'' 
in its place.
    10. Redesignated paragraph (c)(2)(i) is amended by removing the 
reference ``paragraph (c)(3)(iv)'' and adding ``paragraph (c)(2)(iv)'' 
in its place.
    11. Redesignated paragraph (c)(2)(iii)(A) is revised.
    12. Redesignated paragraph (c)(2)(iv) is revised.
    13. Example 1 of redesignated paragraph (c)(2)(v) is amended by 
removing the third sentence of paragraph (i).
    14. Example 2 of redesignated paragraph (c)(2)(v) is amended by 
removing the reference ``35 percent'' from the second sentence and 
adding ``25 percent'' in its place.
    15. The first sentence of redesignated paragraph (c)(2)(v), Example 
4 (ii) is amended by:
    a. Removing the reference ``35'' and adding ``25'' in its place;
    b. Removing the reference ``paragraph (c)(3)(iii)'' and adding 
``paragraph (c)(2)(iv)'' in its place.
    16. The second sentence of redesignated paragraph (c)(2)(v), 
Example 4 (ii) is amended by removing the reference ``paragraph 
(c)(3)(iii)(B)'' and adding ``paragraph (c)(2)(iv)(B)'' in its place.
    17. Redesignated paragraphs (c)(3)(i), (c)(3)(ii), and the 
introductory language and third sentence of Example 1 of redesignated 
paragraph (c)(3)(iii) are amended by removing the reference ``paragraph 
(c)(4)'' and adding ``paragraph (c)(3)'' in its place.
    18. Redesignated paragraph (c)(3)(i) is amended by removing the 
reference ``(c)(3)(iii)'' and adding ``(c)(2)(iii)'' in its place.
    19. Redesignated paragraphs (c)(3)(ii)(A) and (c)(3)(ii)(B) are 
amended by removing the reference ``(c)(4)(i)'' and adding 
``(c)(3)(i)'' in its place.
    20. The first sentence of Example 1 of redesignated paragraph 
(c)(3)(iii) is amended by removing the reference ``paragraph 
(c)(3)(iv)'' and adding ``paragraph (c)(2)(v)'' in its place and by 
removing the word ``and'' and adding ``except'' in its place.
    21. Redesignated paragraphs (c)(4)(i), (c)(4)(ii), and (c)(4)(iii) 
are amended by removing the reference ``paragraph (c)(5)'' and adding 
``paragraph (c)(4)'' in its place.
    22. Redesignated paragraph (c)(4)(iii)(E) is amended by removing 
the reference ``(c)(5)(iii)'' and adding ``(c)(4)(iii)'' in its place.
    23. Paragraph (d) is removed.
    24. The added and revised provisions read as follows:


Sec. 1.414(r)-7  Determination of the employees of an employer's 
qualified separate lines of business.

    (a) * *  *
    (1) In general. * * * Paragraph (c) of this section provides 
methods for allocating residual shared employees among qualified 
separate lines of business.
* * * * *
    (c) * * *
    (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) * * *
    (iii) * * * (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.
* * * * *
    (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.
* * * * *
    (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 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.


Sec. 1.414(r)-8  [Amended]

    Par. 16. Section 1.414(r)-8 is amended as follows:
    1. Paragraph (b)(2)(iii) is revised.
    2. In Example 1 and Example 4 of paragraph (b)(4), the reference 
``1993'' is removed from each place it appears and ``1994'' is added in 
its place.
    3. Example 2 in paragraph (b)(4) is revised.
    4. Example 3 and Example 4 in paragraph (b)(4) are redesignated as 
Example 5 and Example 6 respectively, and new Example 3 and Example 4 
are added.
    5. In the fifth sentence of redesignated Example 5(ii) in paragraph 
(b)(4), the reference ``Sec. 1.410(b)-7(c)(4)'' is removed and 
``Sec. 1.410(b)-7(c)(5)'' is added in its place.
    6. In the first and third sentences of redesignated Example 6 in 
paragraph (b)(4), the reference ``Example 3'' is removed and ``Example 
2'' is added in its place.
    7. Paragraph (d)(4) is removed.
    8. Paragraph (d)(5) is redesignated (d)(4).
    9. The additions and revisions read as follows:


Sec. 1.414(r)-8  Separate application of section 410(b).

* * * * *
    (b) * * *
    (2) * * *
    (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.
* * * * *
    (4) * * *
    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.
* * * * *


Sec. 1.414(r)-11  [Amended]

    Par. 17. Section 1.414(r)-11 is amended as follows:
    1. Paragraph (b)(2) is revised.
    2. The first sentence of paragraph (b)(3) is removed and two new 
sentences are added in its place.
    3. Paragraph (b)(4) is revised.
    4. Paragraph (c)(2)(v) is amended by removing the references 
``1.414(r)-7(c)(3)'' and ``1.414(r)-7(c)(4)'' and adding ``1.414(r)-
7(c)(2)'' and ``1.414(r)-7(c)(3)'' in their respective places.
    5. The added and revised provisions read as follows:


Sec. 1.414(r)-11  Definitions and special rules.

* * * * *
    (b) * * *
    (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. * * *
    (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.
* * * * *
Margaret Milner Richardson,
Commissioner of Internal Revenue.

    Approved: June 14, 1994.
Leslie Samuels,
Assistant Secretary of the Treasury.
[FR Doc. 94-15439 Filed 6-23-94; 8:45 am]
BILLING CODE 4830-01-U