[Federal Register Volume 68, Number 133 (Friday, July 11, 2003)]
[Rules and Regulations]
[Pages 41230-41250]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-17523]


=======================================================================
-----------------------------------------------------------------------

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9075]
RIN 1545-AX52


Compensation Deferred Under Eligible Deferred Compensation Plans

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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

SUMMARY: This document contains final regulations that provide guidance 
on deferred compensation plans of state and local governments and tax-
exempt entities. The regulations reflect the changes made to section 
457 by the Tax Reform Act of 1986, the Small Business Job Protection 
Act of 1996, the Taxpayer Relief Act of 1997, the Economic Growth and 
Tax Relief Reconciliation Act of 2001, the Job Creation and Worker 
Assistance Act of 2002, and other legislation. The regulations also 
make various technical changes and clarifications to the existing final 
regulations on many discrete issues. These regulations provide the 
public with guidance necessary to comply with the law and will affect 
plan sponsors, administrators, participants, and beneficiaries.

DATES: Effective Date: These final regulations are effective July 11, 
2003.
    Applicability Date: These regulations apply to taxable years 
beginning after December 31, 2001. See ``Effective date of the 
regulations'' for additional information concerning the applicability 
of these regulations.

FOR FURTHER INFORMATION CONTACT: Cheryl Press, (202) 622-6060 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in these final regulations 
has been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under 
control number 1545-1580. Responses to this collection of information 
are mandatory.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number assigned by the Office of 
Management and Budget.
    The estimated burden per respondent varies from .033 hour to 2 
hours per trust established depending upon individual respondents' 
circumstances, with an estimated average of one hour for each trust 
established, and from 20 hours to 50 hours per application for approval 
as a custodian with an estimated average of 35 hours for each 
application submitted to qualify as a custodian.
    Comments concerning the accuracy of this burden estimate and 
suggestions for reducing this burden should be sent to the Internal 
Revenue Service, Attn: IRS Reports Clearance Officer, W:CAR:MP:T:T:SP 
Washington, DC 20224, and to the Office of Management and Budget, Attn: 
Desk Officer for the Department of the Treasury, Office of Information 
and Regulatory Affairs, Washington, DC 20503.
    Books or records relating to this collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    Section 131 of the Revenue Act of 1978 (92 Stat. 2779) added 
section 457 to the Internal Revenue Code of 1954. On September 27, 
1982, final regulations (TD 7836, 1982-2 C.B. 91) under section 457 
(the 1982 regulations) were published in the Federal Register (47 FR 
42335). The 1982 regulations provided guidance for complying with the 
changes to the applicable tax law made by the Revenue Act of 1978 
relating to deferred compensation plans maintained by state and local 
governments and rural electric cooperatives.
    Section 1107 of the Tax Reform Act of 1986 (100 Stat. 2494) 
extended section 457 to tax-exempt organizations. Section 6064 of the 
Technical and Miscellaneous Act of 1988 (102 Stat. 3700) codified 
certain exceptions for certain plans. Notice 88-68, 1988-1 C.B. 556, 
addressed the treatment of nonelective deferred compensation of 
nonemployees, and provided an exception under which section 457 does 
not to apply to certain church plans.
    Section 1404 of the Small Business Job Protection Act of 1996 (110 
Stat. 1755) added section 457(g) which requires that section 457(b) 
plans maintained by state and local government employers hold all plan 
assets and income in trust, or in custodial accounts or annuity 
contracts (described in section 401(f) of the Internal Revenue Code), 
for the exclusive benefit of participants and beneficiaries.
    Section 1071 of the Taxpayer Relief Act of 1997 (111 Stat. 788) 
permits certain accrued benefits to be cashed out.
    Sections 615, 631, 632, 634, 635, 641, 647, and 649 of the Economic 
Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) (115 Stat. 
38) included increases in elective deferral limits, repeal of the rules 
coordinating the section 457 plan limit with contributions to certain 
other types of plans, catch-up contributions for individuals age 50 or 
over, extension of qualified domestic relation order rules to section 
457 plans, rollovers among various qualified plans, section 403(b) 
contracts and individual retirement arrangements (IRAs), and transfers 
to purchase service credits under governmental pension plans.
    Section 411(o)(8) and (p)(5) of the Job Creation and Worker 
Assistance Act of 2002 (116 Stat. 21) clarified certain provisions in 
EGTRRA concerning section 457 plans, including the use of certain 
compensation reduction

[[Page 41231]]

elections to be taken into account in determining includible 
compensation.
    On May 8, 2002, a notice of proposed rulemaking (REG-105885-99) was 
published in the Federal Register (67 FR 30826) to issue new 
regulations under section 457, including amending the 1982 regulations 
to conform them to the legislative changes that had been made to 
section 457 since 1982.
    Following publication of the proposed regulations, comments were 
received and a public hearing was held on August 28, 2002. After 
consideration of the comments received, the proposed regulations are 
adopted by this Treasury decision, subject to a number of changes that 
are generally summarized below.

Summary of Comments Received and Changes Made

1. Excess Deferrals

    The proposed regulations addressed the income tax treatment of 
excess deferrals and the effect of excess deferrals on plan eligibility 
under section 457(b). The proposed regulations provided that an 
eligible governmental plan may self-correct and distribute excess 
deferrals and continue to satisfy the eligibility requirements of 
section 457(b) (including the distribution rules and the funding rules) 
by reason of a distribution of excess deferrals. However, the proposed 
regulations provided that if an excess deferral arose under an eligible 
plan of a tax-exempt employer, the plan was no longer an eligible plan.
    Commentators objected to the less favorable treatment for eligible 
plans of tax-exempt employers.
    After consideration of the comments received, the regulations 
extend self-correction for excess deferrals to eligible plans of tax-
exempt employers. If there is an excess deferral under such plan, the 
plan may distribute to a participant any excess deferrals (and any 
income allocable to such amount) not later than the first April 15 
following the close of the taxable year of the excess deferrals, 
comparable to the rules for qualified plans under section 402(g). In 
such a case, the plan will continue to be treated as an eligible plan. 
However, in accordance with section 457(c), any excess deferral is 
included in the gross income of a participant for the taxable year of 
the excess deferral. If an excess deferral is not corrected by 
distribution, the plan is an ineligible plan under which benefits are 
taxable in accordance with ineligible plan rules.
    The income tax treatment and payroll tax reporting of distributions 
of excess deferrals from eligible section 457(b) governmental plans are 
similar to the treatment and reporting of distribution of excess 
deferrals from tax-qualified plans. Such amounts should be reported on 
Form 1099 and taxed in the year of distribution to the extent of 
distributed earnings on the excess deferrals. For eligible section 
457(b) tax-exempt plans, the excess deferrals are subject to income tax 
in the year of distribution to the extent of distributed earnings on 
the excess deferrals and such earnings should be reported on Form W-2 
for the year of distribution. See also Notice 2003-20, 2003-19 I.R.B. 
894, for information regarding the withholding and reporting 
requirements applicable to eligible plans generally.

2. Aggregation Rules in the Proposed Regulations

    The proposed regulations included several rules that aggregate 
multiple plans for purposes of meeting the eligibility requirements of 
section 457(b). These regulations retain all of these rules. For 
example, the regulations provide that in any case in which multiple 
plans are used to avoid or evade the eligibility requirements under the 
regulations, the Commissioner may apply the eligibility requirements as 
if the plans were a single plan. Also, an eligible employer is required 
to have no more than one normal retirement age for each participant 
under all of the eligible plans it sponsors. In addition, all deferrals 
under all eligible plans under which an individual participates by 
virtue of his or her relationship with a single employer are treated as 
though deferred under a single plan for purposes of determining excess 
deferrals. Finally, annual deferrals under all eligible plans are 
combined for purposes of determining the maximum deferral limits.
    Few comments were received with respect to the aggregation rules 
under the proposed regulations. However, one commentator requested 
that, where it is determined that multiple eligible plans maintained by 
a single employer, which have been aggregated pursuant to the proposed 
regulations, contain excess deferrals, the employer have the ability to 
disaggregate those plans solely for the purpose of either (1) 
distributing the excess deferrals under the self-correcting mechanism 
or (2) limiting the characterization of such plans as ``ineligible'' to 
the one(s) that actually contain the excess deferrals. Taking into 
account the ability for all eligible plans to self-correct by 
distribution, these regulations retain without material revision the 
aggregation rules that were in the proposed regulations.

3. Deferral of Sick, Vacation, and Back Pay

    The proposed regulations would have allowed an eligible plan to 
permit participants to elect to defer compensation, including 
accumulated sick and vacation pay and back pay, only if an agreement 
providing for the deferral is entered into before the beginning of the 
month in which the amounts would otherwise be paid or made available 
and the participant is an employee in that month. Comments requested 
that terminating participants be allowed to elect deferral for 
accumulated sick and vacation pay and back pay even if the participant 
is not employed at the time of the deferral.
    The final regulations retain the rule under which the deferral 
election must be made during employment and before the beginning of the 
month when the compensation would have been payable. However, the 
regulations include a special rule that allows an election for sick 
pay, vacation pay, or back pay that is not yet payable (subject of 
course to the maximum deferral limitations of section 457 in the year 
of deferral). Under the special rule, an employee who is retiring or 
otherwise having a severance from employment during a month may 
nevertheless elect to defer, for example, his or her unused vacation 
pay after the beginning of the month, provided that the vacation pay 
would otherwise have been payable before the employee has a severance 
from employment and the election is made before the date on which the 
vacation pay would otherwise have been payable.

4. Unforeseeable Emergency Distributions

    The proposed regulations added examples that would illustrate when 
an unforeseeable emergency occurred. In particular, one example 
provided that the need to pay for the funeral expenses of a family 
member may constitute an unforeseeable emergency. Several commentators 
requested clarification in the final regulations of the definition of 
family member. The regulations have been modified to define a family 
member as a spouse or dependent as defined in section 152(a).

5. Plan Terminations, Plan-to-Plan Transfers, and Rollovers

    The regulations include certain rules regarding plan terminations, 
plan-to-plan transfers, and rollovers. These topics have been affected 
by the statutory changes that impose a trust requirement on eligible 
governmental plans. The direct rollovers that were permitted by EGTRRA 
beginning in

[[Page 41232]]

2002 for eligible governmental plans provide participants affected by 
these types of events the ability to retain their retirement savings in 
a funded, tax-deferred savings vehicle by rollover to an IRA, qualified 
plan, or section 403(b) contract. The regulations provide a outline for 
the different plan termination and plan-to-plan transfer alternatives 
available to sponsors of eligible governmental plans in these 
situations.
a. Plan Terminations
    The regulations allow a plan to have provisions permitting plan 
termination whereupon amounts can be distributed without violating the 
distribution requirements of section 457. Under the regulations, an 
eligible plan is terminated only if all amounts deferred under the plan 
are paid to participants as soon as administratively practicable. If 
the amounts deferred under the plan are not distributed, the plan is 
treated as a frozen plan and must continue to comply with all of the 
applicable statutory requirements necessary for plan eligibility.
b. Plan-to-Plan Transfers Among Eligible Governmental Plans and 
Purchase of Permissive Service Credit by Plan-to-Plan Transfer
    The proposed regulations would have allowed plan-to-plan transfers 
between eligible governmental plans under new circumstances, as well as 
the purchase of permissive service credits by transfer from an eligible 
governmental plan to a governmental defined benefit plan, but only if 
the transfers were made by plans within the same State. Commentators 
objected to the requirement under the new transfer rules that the 
transfers be to plans within the same State.
    Upon consideration of the comments received, the regulations allow 
transfers among eligible governmental plans in three situations. In 
each case, the transferor plan must provide for transfers, the 
receiving plan must provide for the receipt of transfers, and the 
participant or beneficiary whose amounts deferred are being transferred 
must be entitled to an amount deferred immediately after the transfer 
that is at least equal to the amount deferred with respect to that 
participant or beneficiary immediately before the transfer. Transfers 
are permitted among eligible governmental plans in the following three 
cases:
    [sbull] A person-by-person transfer is permitted for any 
beneficiary and for any participant who has had a severance from 
employment with the transferring employer and is performing services 
for the entity maintaining the receiving plan (whether or not the other 
plan is within the same State).
    [sbull] No severance from employment is required if the entire 
plan's assets for all participants and beneficiaries are transferred to 
another eligible governmental plan within the same State.
    [sbull] No severance from employment is required for a transfer 
from one eligible governmental plan of an employer to another eligible 
governmental plan of the same employer.
    The final regulations also allow a plan-to-plan transfer from an 
eligible governmental plan to a governmental defined benefit plan for 
permissive service credit, without regard to whether the defined 
benefit plan is maintained by a governmental entity that is in the same 
State. In addition, language that was in an example which implied that 
section 415(n) (which addresses the application of maximum benefit 
limitations with respect to certain contributions) might apply to such 
a transfer has been eliminated because Treasury and the IRS have 
concluded that section 415(n) does not apply to such a transfer in any 
case in which the actuarial value of the benefit increase that results 
from the transfer does not exceed the amount transferred.
c. Plan-to-Plan Transfers Among Eligible Plans of Tax-Exempt Entities
    The regulations retain the rule from the 1982 regulations allowing 
a plan-to-plan transfer after a participant has had a severance from 
employment.
d. Rollovers
    The proposed regulations specified the treatment of amounts rolled 
into or out of an eligible governmental plan and stated that amounts 
rolled into the plan are treated as amounts deferred under the plan for 
purposes of the regulations. Some commentators requested that 
consideration be given to allowing eligible governmental plans to have 
the same flexibility that they claimed was permitted for qualified 
plans with respect to the timing of distributions of rolled-in assets. 
Specifically, these commentators requested the ability for an eligible 
governmental plan to allow a participant to receive a distribution of 
rolled-in assets even though the participant may not yet be eligible 
for a distribution of other assets held under the plan.
    Commentators pointed out that, since section 402(c)(10) allows an 
eligible governmental plan to accept a rollover contribution only if 
the rolled-in assets from other plan types are separately accounted for 
(in order to apply the section 72(t) early withdrawal income tax for 
distributions from these assets), this ability should not cause 
administrative problems for plan sponsors. Commentators also asserted 
that the flexibility to design an eligible governmental plan to permit 
such distributions would be beneficial to its participants.
    These regulations do not permit an eligible governmental plan to 
distribute rolled-in assets to a participant who is not yet eligible 
for a distribution until future guidance of general applicability is 
published that addresses this issue. Treasury and the IRS intend to 
issue, in the near future, guidance of general applicability resolving 
this issue in coordination with the applicable rules for qualified 
plans and section 403(b) contracts.
    Commentators also requested clarification on the order of accounts 
for partial distributions to participants who have rolled-in assets 
that are subject to the early withdrawal income tax. They requested 
that consideration be given in final regulations to clarifying that the 
participant may be treated as receiving a partial distribution first 
from other plan assets to minimize the early withdrawal income tax that 
would otherwise apply. These regulations clarify that, if a rollover is 
received by an eligible governmental plan from an IRA, qualified plan, 
or section 403(b) contract, then distributions from the eligible 
governmental plan are subject to the early withdrawal income tax in 
accordance with the plan's method of accounting, i.e., for purposes of 
applying the section 72(t) early withdrawal income tax, a distribution 
is treated as made from an eligible governmental plan's separate 
account for rollovers from an IRA, qualified plan, or section 403(b) 
contract only if the plan accounts for the distribution as a 
distribution from that account. Thus, for example, an eligible 
governmental plan may provide that any unforeseeable emergency 
withdrawal is made from other accounts to the extent possible, in which 
event the early withdrawal tax will not apply assuming that the plan 
only debits such other accounts to reflect the distribution.
    The proposed regulations had requested comments on the issue of 
separate accounting for rolled-in amounts and asked if there are any 
special characteristics that would be lost if multiple types of 
separate accounts were not maintained. Commentators asked for the 
regulations to permit maintenance of a single rollover account for all 
amounts that are rolled into the eligible governmental plan. These 
regulations require separate accounting only to the extent mandated by 
section

[[Page 41233]]

402(c)(10), i.e., only for rollovers from IRAs, qualified plans and 
section 403(b) contracts. Section 72(t)(9) provides that the early 
withdrawal income tax applies to distributions from rollovers 
attributable to IRAs, qualified plans, and section 403(b) contracts. 
Thus, if an eligible governmental plan accepts a rollover from another 
eligible governmental plan of an amount that was originally deferred 
under an eligible governmental plan and commingles that rollover in the 
same separate account that includes a rollover amount from an IRA, 
qualified plan, or section 403(b) contract, then distributions from 
that account will be subject to the early withdrawal income tax. 
Accordingly, in order to avoid this result, eligible governmental plans 
may choose to establish three separate accounts for a participant even 
though these regulations only require that a single separate rollover 
account be maintained for all amounts that are rolled into an eligible 
governmental plan: First, an account for all amounts deferred under 
that plan; second, an account for any rollover from another eligible 
governmental plan (disregarding any amounts that originated from an 
IRA, qualified plan, or section 403(b) contract); and third, an account 
for any rollover amount from an IRA, qualified plan, or section 403(b) 
contract (including any amounts rolled over from another eligible 
governmental plan that originated from an IRA, qualified plan, or 
section 403(b) contract). These regulations include an example 
illustrating that the early withdrawal income tax would not apply to a 
partial distribution from a plan with such accounts assuming that the 
plan debits either of the first two such other accounts to reflect the 
distribution.

6. Ineligible Plans

    The proposed regulations included guidance regarding ineligible 
plans under section 457(f). Section 457(f) generally provides that, in 
the case of an agreement or arrangement for the deferral of 
compensation, the deferred compensation is included in gross income 
when deferred or, if later, when the rights to payment of the deferred 
compensation cease to be subject to a substantial risk of forfeiture. 
Section 457(f) was in section 457 when it was added to the Code in 1978 
for governmental employees, and extended to employees of tax-exempt 
organizations (other than churches or certain church-controlled 
organizations) in 1986, because unfunded amounts held by a tax-exempt 
entity compound tax free like an eligible plan, a qualified plan, or a 
section 403(b) contract. Section 457(f) was viewed as essential in 
order to provide an incentive for employers that are not subject to 
income taxes to adopt an eligible plan, a qualified plan, or a section 
403(b) contract.\1\
---------------------------------------------------------------------------

    \1\ See generally the Report to the Congress on the Tax 
Treatment of Deferred Compensation under Section 457, Department of 
the Treasury, January 1992 (available from the Office of Tax Policy, 
Room 5315, Treasury Department, 1500 Pennsylvania Avenue NW., 
Washington DC 20220).
---------------------------------------------------------------------------

    Section 457(f) does not apply to an eligible plan, a qualified 
plan, a section 403(b) contract, a section 403(c) contract, a transfer 
of property described in section 83, a trust to which section 402(b) 
applies, or a qualified governmental excess benefit arrangement 
described in section 415(m). The proposed regulations stated that 
section 457(f) applies if the date on which there is no substantial 
risk of forfeiture with respect to the compensation deferred precedes 
the date on which there is a transfer of property to which section 83 
applies. The proposed regulations included several examples, including 
an example illustrating that section 457(f) does not fail to apply 
merely because benefits are subsequently paid by a transfer of 
property. Comments were requested on the coordination of sections 
457(f) and 83 under the proposed regulations.
    In response, a number of commentators objected to the proposed 
coordination of sections 457(f) and 83, including arguing that the 
proposed regulation would place tax-exempt organizations at a 
competitive disadvantage when it comes to attracting and retaining 
executive talent because it would effectively eliminate the use of 
discounted mutual fund options as a tax effective component of total 
compensation. Some commentators also asserted that the proposed 
regulations were ambiguous as to their applicability to steeply 
discounted mutual fund options, and recommended that, if the provision 
is not removed, at a minimum future guidance should be more specific.
    The final regulations retain the interpretation of the coordination 
of sections 457(f) and 83 that was in the proposed regulations, and 
also clarify the application of the rule by adding an example involving 
an option grant. The regulations also include a clarification that, 
when benefits are paid or made available under an ineligible plan, the 
amount included in gross income is equal to the amount paid or made 
available, but only to the extent that the amount exceeds the amount 
the participant included in gross income when he or she obtained a 
vested right to the benefit.

7. Severance Pay and Other Exceptions

    In 2000, the IRS issued Announcement 2000-1 (2000-1 C.B. 294), 
which provided interim guidance on certain broad-based, nonelective 
plans of a state or local government that were in existence before 
1999. Comments were requested on arrangements, such as those maintained 
by certain state or local governmental educational institutions, under 
which supplemental compensation is payable as an incentive to terminate 
employment, or as an incentive to retain retirement-eligible employees, 
to ensure an appropriate workforce during periods in which a temporary 
surplus or deficit in workforce is anticipated. Treasury and the IRS 
continue to be interested in receiving comments on this issue, which 
should be sent to the following address: Internal Revenue Service, 
Attn: CC:DOM:CORP:R (Section 457 Plans), Room 5201, P.O. Box 7604, Ben 
Franklin Station, Washington, DC 20044. Written comments may be hand 
delivered Monday through Friday between 8 a.m. and 4 p.m. to: Internal 
Revenue Service, Courier's Desk, Attn: CC:PA:RU (Section 457 Plans), 
1111 Constitution Avenue, NW., Washington, DC 20224. Alternatively, 
written comments may be submitted electronically via the Internet by 
selecting the ``Tax Regs'' option on the IRS Home Page, or by 
submitting them directly to the IRS Internet site at: http://www.irs.gov/tax_regs/reglist.html. Comments should be received by 
October 9, 2003.

8. Effective Date of the Regulations

    The proposed regulations included a general effective date under 
which the regulations would have applied to taxable years beginning 
after December 31, 2001. This is the general effective date for the 
changes made in section 457 by EGTRRA. Commentators did not express 
concern about this effective date and some commentators also stated 
that eligible governmental plans have adopted plan amendments to 
address the changes that have been allowed by EGTRRA, so that it would 
be appropriate to have the final regulations effective date coincide 
with the effective date for EGTRRA.
    These regulations are generally applicable to taxable years 
beginning after December 31, 2001, subject to certain specific 
transition rules. Under one of these transition rules, for taxable 
years beginning after December 31, 2001, and before January 1, 2004, a 
plan will not fail to be an eligible plan if it

[[Page 41234]]

is operated in accordance with a reasonable, good faith interpretation 
of section 457(b). Whether a plan is operated in accordance with a 
reasonable, good faith interpretation of section 457(b) will generally 
be determined based on all of the relevant facts and circumstances, 
including the extent to which the employer has resolved unclear issues 
in its favor. The regulations state that a plan will be deemed to be 
operated in accordance with a reasonable, good faith interpretation of 
section 457(b) if it is operated in accordance with the terms of these 
regulations. The IRS will also deem a plan to be operated in accordance 
with a reasonable, good faith interpretation of section 457(b) if it is 
operated in accordance with the terms of the 1982 regulations as in 
effect for taxable years beginning before January 1, 2002 (to the 
extent those 1982 regulations are consistent with subsequent changes in 
law, including EGTRRA) or in accordance with the terms of the 2001 
proposed regulations. However, a plan will be deemed not to be operated 
in accordance with a reasonable, good faith interpretation of section 
457(b) if it is operated in a manner that is inconsistent with the 
terms of the 1982 regulations as in effect for taxable years beginning 
before January 1, 2002 (to the extent those 1982 regulations are 
consistent with subsequent changes in law, including EGTRRA) except to 
the extent permitted under either these final regulations or the 2001 
proposed regulations.
    Further, there is a special delayed effective date for the rule 
under which an eligible governmental plan cannot distribute rollover 
account benefits to a participant who is not yet eligible for a 
distribution. Thus, this rule is not applicable until years beginning 
after December 31, 2003, since this issue is expected to be resolved 
before that date.
    The regulations also retain the rule in the proposed regulations 
under which the regulations do not apply with respect to an option that 
lacked a readily ascertainable fair market value (within the meaning of 
section 83(e)(3)) at grant that was granted on or before May 8, 2002. 
Thus, the status of such an option under section 457(f) would be 
determined without regard to these regulations.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It has also been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations. It is hereby 
certified that the collection of information in these regulations will 
not have a significant economic impact on a substantial number of small 
entities. The collection of information in the regulations is in 
section 1.457-8(a)(3)(ii)(B) and consists of the requirement that a 
custodian of a custodial account may be a person other than a bank only 
if the person demonstrates to the satisfaction of the Commissioner that 
the manner in which the person will administer the custodial account 
will be consistent with the requirement of section 457(g)(1) and (3) of 
the Code. This certification is based on the fact that the cost of 
submitting this information is small, even for small entities. 
Therefore, a Regulatory Flexibility Analysis under the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to 
section 7805(f) of the Code, the notice of proposed rulemaking 
preceding these regulations was submitted to the Chief Counsel for 
Advocacy of the Small Business Administration for comment on its impact 
on small business.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

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


0
Par. 2. Sections 1.457-1, 1.457-2, 1.457-3 and 1.457-4 are revised to 
read as follows:


Sec.  1.457-1  General overviews of section 457.

    Section 457 provides rules for nonqualified deferred compensation 
plans established by eligible employers as defined under Sec.  1.457-
2(d). Eligible employers can establish either deferred compensation 
plans that are eligible plans and that meet the requirements of section 
457(b) and Sec. Sec.  1.457-3 through 1.457-10, or deferred 
compensation plans or arrangements that do not meet the requirements of 
section 457(b) and Sec. Sec.  1.457-3 through 1.457-10 and that are 
subject to tax treatment under section 457(f) and Sec.  1.457-11.


Sec.  1.457-2  Definitions.

    This section sets forth the definitions that are used under 
Sec. Sec.  1.457-1 through 1.457-11.
    (a) Amount(s) deferred. Amount(s) deferred means the total annual 
deferrals under an eligible plan in the current and prior years, 
adjusted for gain or loss. Except as provided at Sec. Sec.  1.457-
4(c)(1)(iii) and 1.457-6(a), amount(s) deferred includes any rollover 
amount held by an eligible plan as provided under Sec.  1.457-10(e).
    (b) Annual deferral(s)--(1) Annual deferral(s) means, with respect 
to a taxable year, the amount of compensation deferred under an 
eligible plan, whether by salary reduction or by nonelective employer 
contribution. The amount of compensation deferred under an eligible 
plan is taken into account as an annual deferral in the taxable year of 
the participant in which deferred, or, if later, the year in which the 
amount of compensation deferred is no longer subject to a substantial 
risk of forfeiture.
    (2) If the amount of compensation deferred under the plan during a 
taxable year is not subject to a substantial risk of forfeiture, the 
amount taken into account as an annual deferral is not adjusted to 
reflect gain or loss allocable to the compensation deferred. If, 
however, the amount of compensation deferred under the plan during the 
taxable year is subject to a substantial risk of forfeiture, the amount 
of compensation deferred that is taken into account as an annual 
deferral in the taxable year in which the substantial risk of 
forfeiture lapses must be adjusted to reflect gain or loss allocable to 
the compensation deferred until the substantial risk of forfeiture 
lapses.
    (3) If the eligible plan is a defined benefit plan within the 
meaning of section 414(j), the annual deferral for a taxable year is 
the present value of the increase during the taxable year of the 
participant's accrued benefit that is not subject to a substantial risk 
of forfeiture (disregarding any such increase attributable to prior 
annual deferrals). For this purpose, present value must be determined 
using actuarial assumptions and methods that are reasonable (both 
individually and in the aggregate), as determined by the Commissioner.
    (4) For purposes solely of applying Sec.  1.457-4 to determine the 
maximum amount of the annual deferral for a participant for a taxable 
year under an eligible plan, the maximum amount is reduced by the 
amount of any deferral for the participant under a plan described at 
paragraph (k)(4)(i) of this

[[Page 41235]]

section (relating to certain plans in existence before January 1, 1987) 
as if that deferral were an annual deferral under another eligible plan 
of the employer.
    (c) Beneficiary. Beneficiary means a person who is entitled to 
benefits in respect of a participant following the participant's death 
or an alternate payee as described in Sec.  1.457-10(c).
    (d) Catch-up. Catch-up amount or catch-up limitation for a 
participant for a taxable year means the annual deferral permitted 
under section 414(v) (as described in Sec.  1.457-4(c)(2)) or section 
457(b)(3) (as described in Sec.  1.457-4(c)(3)) to the extent the 
amount of the annual deferral for the participant for the taxable year 
is permitted to exceed the plan ceiling applicable under section 
457(b)(2) (as described in Sec.  1.457-4(c)(1)).
    (e) Eligible employer. Eligible employer means an entity that is a 
State that establishes a plan or a tax-exempt entity that establishes a 
plan. The performance of services as an independent contractor for a 
State or local government or a tax-exempt entity is treated as the 
performance of services for an eligible employer. The term eligible 
employer does not include a church as defined in section 3121(w)(3)(A), 
a qualified church-controlled organization as defined in section 
3121(w)(3)(B), or the Federal government or any agency or 
instrumentality thereof. Thus, for example, a nursing home which is 
associated with a church, but which is not itself a church (as defined 
in section 3121(w)(3)(A)) or a qualified church-controlled organization 
as defined in section 3121(w)(3)(B)), would be an eligible employer if 
it is a tax-exempt entity as defined in paragraph (m) of this section.
    (f) Eligible plan. An eligible plan is a plan that meets the 
requirements of Sec. Sec.  1.457-3 through 1.457-10 that is established 
and maintained by an eligible employer. An eligible governmental plan 
is an eligible plan that is established and maintained by an eligible 
employer as defined in paragraph (l) of this section. An arrangement 
does not fail to constitute a single eligible governmental plan merely 
because the arrangement is funded through more than one trustee, 
custodian, or insurance carrier. An eligible plan of a tax-exempt 
entity is an eligible plan that is established and maintained by an 
eligible employer as defined in paragraph (m) of this section.
    (g) Includible compensation. Includible compensation of a 
participant means, with respect to a taxable year, the participant's 
compensation, as defined in section 415(c)(3), for services performed 
for the eligible employer. The amount of includible compensation is 
determined without regard to any community property laws.
    (h) Ineligible plan. Ineligible plan means a plan established and 
maintained by an eligible employer that is not maintained in accordance 
with Sec. Sec.  1.457-3 through 1.457-10. A plan that is not 
established by an eligible employer as defined in paragraph (e) of this 
section is neither an eligible nor an ineligible plan.
    (i) Nonelective employer contribution. A nonelective employer 
contribution is a contribution made by an eligible employer for the 
participant with respect to which the participant does not have the 
choice to receive the contribution in cash or property. Solely for 
purposes of section 457 and Sec. Sec.  1.457-2 through 1.457-11, the 
term nonelective employer contribution includes employer contributions 
that would be described in section 401(m) if they were contributions to 
a qualified plan.
    (j) Participant. Participant in an eligible plan means an 
individual who is currently deferring compensation, or who has 
previously deferred compensation under the plan by salary reduction or 
by nonelective employer contribution and who has not received a 
distribution of his or her entire benefit under the eligible plan. Only 
individuals who perform services for the eligible employer, either as 
an employee or as an independent contractor, may defer compensation 
under the eligible plan.
    (k) Plan. Plan includes any agreement or arrangement between an 
eligible employer and a participant or participants (including an 
individual employment agreement) under which the payment of 
compensation is deferred (whether by salary reduction or by nonelective 
employer contribution). The following types of plans are not treated as 
agreements or arrangement under which compensation is deferred: a bona 
fide vacation leave, sick leave, compensatory time, severance pay, 
disability pay, or death benefit plan described in section 
457(e)(11)(A)(i) and any plan paying length of service awards to bona 
fide volunteers (and their beneficiaries) on account of qualified 
services performed by such volunteers as described in section 
457(e)(11)(A)(ii). Further, the term plan does not include any of the 
following (and section 457 and Sec. Sec.  1.457-2 through 1.457-11 do 
not apply to any of the following)--
    (1) Any nonelective deferred compensation under which all 
individuals (other than those who have not satisfied any applicable 
initial service requirement) with the same relationship with the 
eligible employer are covered under the same plan with no individual 
variations or options under the plan as described in section 
457(e)(12), but only to the extent the compensation is attributable to 
services performed as an independent contractor;
    (2) An agreement or arrangement described in Sec.  1.457-11(b);
    (3) Any plan satisfying the conditions in section 1107(c)(4) of the 
Tax Reform Act of 1986 (100 Stat. 2494) (TRA '86) (relating to certain 
plans for State judges); and
    (4) Any of the following plans or arrangements (to which specific 
transitional statutory exclusions apply)--
    (i) A plan or arrangement of a tax-exempt entity in existence prior 
to January 1, 1987, if the conditions of section 1107(c)(3)(B) of the 
TRA '86, as amended by section 1011(e)(6) of Technical and 
Miscellaneous Revenue Act of 1988 (102 Stat. 3700) (TAMRA), are 
satisfied (see Sec.  1.457-2(b)(4) for a special rule regarding such 
plan);
    (ii) A collectively bargained nonelective deferred a compensation 
plan in effect on December 31, 1987, if the conditions of section 
6064(d)(2) of TAMRA are satisfied;
    (iii) Amounts described in section 6064(d)(3) of TAMRA (relating to 
certain nonelective deferred compensation arrangements in effect before 
1989); and
    (iv) Any plan satisfying the conditions in section 1107(c)(4) or 
(5) of TRA '86 (relating to certain plans for certain individuals with 
respect to which the Service issued guidance before 1977).
    (l) State. State means a State (treating the District of Columbia 
as a State as provided under section 7701(a)(10)), a political 
subdivision of a State, and any agency or instrumentality of a State.
    (m) Tax-exempt entity. Tax-exempt entity includes any organization 
exempt from tax under subtitle A of the Internal Revenue Code, except 
that a governmental unit (including an international governmental 
organization) is not a tax-exempt entity.
    (n) Trust. Trust means a trust described under section 457(g) and 
Sec.  1.457-8. Custodial accounts and contracts described in section 
401(f) are treated as trusts under the rules described in Sec.  1.457-
8(a)(2).

[[Page 41236]]

Sec.  1.457-3  General introduction to eligible plans.

    (a) Compliance in form and operation. An eligible plan is a written 
plan established and maintained by an eligible employer that is 
maintained, in both form and operation, in accordance with the 
requirements of Sec. Sec.  1.457-4 through 1.457-10. An eligible plan 
must contain all the material terms and conditions for benefits under 
the plan. An eligible plan may contain certain optional features not 
required for plan eligibility under section 457(b), such as 
distributions for unforeseeable emergencies, loans, plan-to-plan 
transfers, additional deferral elections, acceptance of rollovers to 
the plan, and distributions of smaller accounts to eligible 
participants. However, except as otherwise specifically provided in 
Sec. Sec.  1.457-4 through 1.457-10, if an eligible plan contains any 
optional provisions, the optional provisions must meet, in both form 
and operation, the relevant requirements under section 457 and 
Sec. Sec.  1.457-2 through 1.457-10.
    (b) Treatment as single plan. In any case in which multiple plans 
are used to avoid or evade the requirements of Sec. Sec.  1.457-4 
through 1.457-10, the Commissioner may apply the rules under Sec. Sec.  
1.457-4 through 1.457-10 as if the plans were a single plan. See also 
Sec.  1.457-4(c)(3)(v) (requiring an eligible employer to have no more 
than one normal retirement age for each participant under all of the 
eligible plans it sponsors), the second sentence of Sec.  1.457-4(e)(2) 
(treating deferrals under all eligible plans under which an individual 
participates by virtue of his or her relationship with a single 
employer as a single plan for purposes of determining excess 
deferrals), and Sec.  1.457-5 (combining annual deferrals under all 
eligible plans).


Sec.  1.457-4  Annual deferrals, deferral limitations, and deferral 
agreements under eligible plans.

    (a) Taxation of annual deferrals. Annual deferrals that satisfy the 
requirements of paragraphs (b) and (c) of this section are excluded 
from the gross income of a participant in the year deferred or 
contributed and are not includible in gross income until paid to the 
participant in the case of an eligible governmental plan, or until paid 
or otherwise made available to the participant in the case of an 
eligible plan of a tax-exempt entity. See Sec.  1.457-7.
    (b) Agreement for deferral. In order to be an eligible plan, the 
plan must provide that compensation may be deferred for any calendar 
month by salary reduction only if an agreement providing for the 
deferral has been entered into before the first day of the month in 
which the compensation is paid or made available. A new employee may 
defer compensation payable in the calendar month during which the 
participant first becomes an employee if an agreement providing for the 
deferral is entered into on or before the first day on which the 
participant performs services for the eligible employer. An eligible 
plan may provide that if a participant enters into an agreement 
providing for deferral by salary reduction under the plan, the 
agreement will remain in effect until the participant revokes or alters 
the terms of the agreement. Nonelective employer contributions are 
treated as being made under an agreement entered into before the first 
day of the calendar month.
    (c) Maximum deferral limitations--(1) Basic annual limitation. (i) 
Except as described in paragraphs (c)(2) and (3) of this section, in 
order to be an eligible plan, the plan must provide that the annual 
deferral amount for a taxable year (the plan ceiling) may not exceed 
the lesser of--
    (A) The applicable annual dollar amount specified in section 
457(e)(15): $11,000 for 2002; $12,000 for 2003; $13,000 for 2004; 
$14,000 for 2005; and $15,000 for 2006 and thereafter. After 2006, the 
$15,000 amount is adjusted for cost-of-living in the manner described 
in paragraph (c)(4) of this section; or
    (B) 100 percent of the participant's includible compensation for 
the taxable year.
    (ii) The amount of annual deferrals permitted by the 100 percent of 
includible compensation limitation under paragraph (c)(1)(i)(B) of this 
section is determined under section 457(e)(5) and Sec.  1.457-2(g).
    (iii) For purposes of determining the plan ceiling under this 
paragraph (c), the annual deferral amount does not include any rollover 
amounts received by the eligible plan under Sec.  1.457-10(e).
    (iv) The provisions of this paragraph (c)(1) are illustrated by the 
following examples:

    Example 1. (i) Facts. Participant A, who earns $14,000 a year, 
enters into a salary reduction agreement in 2006 with A's eligible 
employer and elects to defer $13,000 of A's compensation for that 
year. Participant A is not eligible for the catch-up described in 
paragraph (c)(2) or (3) of this section, participates in no other 
retirement plan, and has no other income exclusions taken into 
account in computing includible compensation.
    (ii) Conclusion. The annual deferral limit for A in 2006 is the 
lesser of $15,000 or 100 percent of includible compensation, 
$14,000. A's annual deferral of $13,000 is permitted under the plan 
because it is not in excess of $14,000 and thus does not exceed 100 
percent of A's includible compensation.
    Example 2. (i) Facts. Assume the same facts as in Example 1, 
except that A's eligible employer provides an immediately vested, 
matching employer contribution under the plan for participants who 
make salary reduction deferrals under A's eligible plan. The 
matching contribution is equal to 100 percent of elective 
contributions, but not in excess of 10 percent of compensation (in 
A's case, $1,400).
    (ii) Conclusion. Participant A's annual deferral exceeds the 
limitations of this paragraph (c)(1). A's maximum deferral 
limitation in 2006 is $14,000. A's salary reduction deferral of 
$13,000 combined with A's eligible employer's nonelective employer 
contribution of $1,400 exceeds the basic annual limitation of this 
paragraph (c)(1) because A's annual deferrals total $14,400. A has 
an excess deferral for the taxable year of $400, the amount 
exceeding A's permitted annual deferral limitation. The $400 excess 
deferral is treated as described in paragraph (e) of this section.
    Example 3. (i) Facts. Beginning in year 2002, Eligible Employer 
X contributes $3,000 per year for five years to Participant B's 
eligible plan account. B's interest in the account vests in 2006. B 
has annual compensation of $50,000 in each of the five years 2002 
through 2006. Participant B is 41 years old. B is not eligible for 
the catch-up described in paragraph (c)(2) or (3) of this section, 
participates in no other retirement plan, and has no other income 
exclusions taken into account in computing includible compensation. 
Adjusted for gain or loss, the value of B's benefit when B's 
interest in the account vests in 2006 is $17,000.
    (ii) Conclusion. Under this vesting schedule, $17,000 is taken 
into account as an annual deferral in 2006. B's annual deferrals 
under the plan are limited to a maximum of $15,000 in 2006. Thus, 
the aggregate of the amounts deferred, $17,000, is in excess of the 
B's maximum deferral limitation by $2,000. The $2,000 is treated as 
an excess deferral described in paragraph (e) of this section.

    (2) Age 50 catch-up--(i) In general. In accordance with section 
414(v) and the regulations thereunder, an eligible governmental plan 
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 age 50 catch-up 
contributions for a taxable year under section 414(v) is as follows: 
$1,000 for 2002; $2,000 for 2003; $3,000 for 2004; $4,000 for 2005; and 
$5,000 for 2006 and thereafter. After 2006, the $5,000 amount is 
adjusted for cost-of-living. For additional guidance, see regulations 
under section 414(v).
    (ii) Coordination with special section 457 catch-up. In accordance 
with sections 414(v)(6)(C) and 457(e)(18), the age 50 catch-up 
described in this paragraph (c)(2) does not apply for any

[[Page 41237]]

taxable year for which a higher limitation applies under the special 
section 457 catch-up under paragraph (c)(3) of this section. Thus, for 
purposes of this paragraph (c)(2)(ii) and paragraph (c)(3) of this 
section, the special section 457 catch-up under paragraph (c)(3) of 
this section applies for any taxable year if and only if the plan 
ceiling taking into account paragraph (c)(1) of this section and the 
special section 457 catch-up described in paragraph (c)(3) of this 
section (and disregarding the age 50 catch-up described in this 
paragraph (c)(2)) is larger than the plan ceiling taking into account 
paragraph (c)(1) of this section and the age 50 catch-up described in 
this paragraph (c)(2) (and disregarding the special section 457 catch-
up described in paragraph (c)(3) of this section). Thus, if a plan so 
provides, a participant who is eligible for the age 50 catch-up for a 
year and for whom the year is also one of the participant's last three 
taxable years ending before the participant attains normal retirement 
age is eligible for the larger of--
    (A) The plan ceiling under paragraph (c)(1) of this section and the 
age 50 catch-up described in this paragraph (c)(2) (and disregarding 
the special section 457 catch-up described in paragraph (c)(3) of this 
section) or
    (B) The plan ceiling under paragraph (c)(1) of this section and the 
special section 457 catch-up described in paragraph (c)(3) of this 
section (and disregarding the age 50 catch-up described in this 
paragraph (c)(2)).
    (iii) Examples. The provisions of this paragraph (c)(2) are 
illustrated by the following examples:

    Example 1. (i) Facts. Participant C, who is 55, is eligible to 
participate in an eligible governmental plan in 2006. The plan 
provides a normal retirement age of 65. The plan provides 
limitations on annual deferrals up to the maximum permitted under 
paragraphs (c)(1) and (3) of this section and the age 50 catch-up 
described in this paragraph (c)(2). For 2006, C will receive 
compensation of $40,000 from the eligible employer. C desires to 
defer the maximum amount possible in 2006. The applicable basic 
dollar limit of paragraph (c)(1)(i)(A) of this section is $15,000 
for 2006 and the additional dollar amount permitted under the age 50 
catch-up is $5,000 for 2006.
    (ii) Conclusion. C is eligible for the age 50 catch-up in 2006 
because C is 55 in 2006. However, C is not eligible for the special 
section 457 catch-up under paragraph (c)(3) of this section in 2006 
because 2006 is not one of the last three taxable years ending 
before C attains normal retirement age. Accordingly, the maximum 
that C may defer for 2006 is $20,000.
    Example 2. (i) Facts. The facts are the same as in Example 1, 
except that, in 2006, C will attain age 62. The maximum amount that 
C can elect under the special section 457 catch-up under paragraph 
(c)(3) of this section is $2,000 for 2006.
    (ii) Conclusion. The maximum that C may defer for 2006 is 
$20,000. This is the sum of the basic plan ceiling under paragraph 
(c)(1) of this section equal to $15,000 and the age 50 catch-up 
equal to $5,000. The special section 457 catch-up under paragraph 
(c)(3) of this section is not applicable since it provides a smaller 
plan ceiling.
    Example 3. (i) Facts. The facts are the same as in Example 2, 
except that the maximum additional amount that C can elect under the 
special section 457 catch-up under paragraph (c)(3) of this section 
is $7,000 for 2006.
    (ii) Conclusion. The maximum that C may defer for 2006 is 
$22,000. This is the sum of the basic plan ceiling under paragraph 
(c)(1) of this section equal to $15,000, plus the additional special 
section 457 catch-up under paragraph (c)(3) of this section equal to 
$7,000. The additional dollar amount permitted under the age 50 
catch-up is not applicable to C for 2006 because it provides a 
smaller plan ceiling.

    (3) Special section 457 catch-up--(i) In general. Except as 
provided in paragraph (c)(2)(ii) of this section, an eligible plan may 
provide that, for one or more of the participant's last three taxable 
years ending before the participant attains normal retirement age, the 
plan ceiling is an amount not in excess of the lesser of--
    (A) Twice the dollar amount in effect under paragraph (c)(1)(i)(A) 
of this section; or
    (B) The underutilized limitation determined under paragraph 
(c)(3)(ii) of this section.
    (ii) Underutilized limitation. The underutilized amount determined 
under this paragraph (c)(3)(ii) is the sum of--
    (A) The plan ceiling established under paragraph (c)(1) of this 
section for the taxable year; plus
    (B) The plan ceiling established under paragraph (c)(1) of this 
section (or under section 457(b)(2) for any year before the 
applicability date of this section) for any prior taxable year or 
years, less the amount of annual deferrals under the plan for such 
prior taxable year or years (disregarding any annual deferrals under 
the plan permitted under the age 50 catch-up under paragraph (c)(2) of 
this section).
    (iii) Determining underutilized limitation under paragraph 
(c)(3)(ii)(B) of this section. A prior taxable year is taken into 
account under paragraph (c)(3)(ii)(B) of this section only if it is a 
year beginning after December 31, 1978, in which the participant was 
eligible to participate in the plan, and in which compensation deferred 
(if any) under the plan during the year was subject to a plan ceiling 
established under paragraph (c)(1) of this section. This paragraph 
(c)(3)(iii) is subject to the special rules in paragraph (c)(3)(iv) of 
this section.
    (iv) Special rules concerning application of the coordination limit 
for years prior to 2002 for purposes of determining the underutilized 
limitation--(A) General rule. For purposes of determining the 
underutilized limitation for years prior to 2002, participants remain 
subject to the rules in effect prior to the repeal of the coordination 
limitation under section 457(c)(2). Thus, the applicable basic annual 
limitation under paragraph (c)(1) of this section and the special 
section 457 catch-up under this paragraph (c)(3) for years in effect 
prior to 2002 are reduced, for purposes of determining a participant's 
underutilized amount under a plan, by amounts excluded from the 
participant's income for any prior taxable year by reason of a 
nonelective employer contribution, salary reduction or elective 
contribution under any other eligible section 457(b) plan, or a salary 
reduction or elective contribution under any 401(k) qualified cash or 
deferred arrangement, section 402(h)(1)(B) simplified employee pension 
(SARSEP), section 403(b) annuity contract, and section 408(p) simple 
retirement account, or under any plan for which a deduction is allowed 
because of a contribution to an organization described in section 
501(c)(18) (pre-2002 coordination plans). Similarly, in applying the 
section 457(b)(2)(B) limitation for includible compensation for years 
prior to 2002, the limitation is 33\1/3\ percent of the participant's 
compensation includible in gross income.
    (B) Coordination limitation applied to participant. For purposes of 
determining the underutilized limitation for years prior to 2002, the 
coordination limitation applies to pre-2002 coordination plans of all 
employers for whom a participant has performed services, whether or not 
those are plans of the participant's current eligible employer. Thus, 
for purposes of determining the amount excluded from a participant's 
gross income in any prior taxable year under paragraph (c)(3)(ii)(B) of 
this section, the participant's annual deferrals under an eligible 
plan, and salary reduction or elective deferrals under all other pre-
2002 coordination plans, must be determined on an aggregate basis. To 
the extent that the combined deferrals for years prior to 2002 exceeded 
the maximum deferral limitations, the amount is treated as an excess 
deferral under paragraph (e) of this section for those prior years.

[[Page 41238]]

    (C) Special rule where no annual deferrals under the eligible plan. 
A participant who, although eligible, did not defer any compensation 
under the eligible plan in any year before 2002 is not subject to the 
coordinated deferral limit, even though the participant may have 
deferred compensation under one of the other pre-2002 coordination 
plans. An individual is treated as not having deferred compensation 
under an eligible plan for a prior taxable year if all annual deferrals 
under the plan are distributed in accordance with paragraph (e) of this 
section. Thus, to the extent that a participant participated solely in 
one or more of the other pre-2002 coordination plans during a prior 
taxable year (and not the eligible plan), the participant is not 
subject to the coordinated limitation for that prior taxable year. 
However, the participant is treated as having deferred an amount in a 
prior taxable year, for purposes of determining the underutilized 
limitation for that prior taxable year under this paragraph 
(c)(3)(iv)(C), to the extent of the participant's aggregate salary 
reduction contributions and elective deferrals under all pre-2002 
coordination plans up to the maximum deferral limitations in effect 
under section 457(b) for that prior taxable year. To the extent an 
employer did not offer an eligible plan to an individual in a prior 
given year, no underutilized limitation is available to the individual 
for that prior year, even if the employee subsequently becomes eligible 
to participate in an eligible plan of the employer.
    (D) Examples. The provisions of this paragraph (c)(3)(iv) are 
illustrated by the following examples:

    Example 1. (i) Facts. In 2001 and in years prior to 2001, 
Participant D earned $50,000 a year and was eligible to participate 
in both an eligible plan and a section 401(k) plan. However, D had 
always participated only in the section 401(k) plan and had always 
deferred the maximum amount possible. For each year before 2002, the 
maximum amount permitted under section 401(k) exceeded the 
limitation of paragraph (c)(3)(i) of this section. In 2002, D is in 
the 3-year period prior to D's attainment of the eligible plan's 
normal retirement age of 65, and D now wants to participate in the 
eligible plan and make annual deferrals of up to $30,000 under the 
plan's special section 457 catch-up provisions.
    (ii) Conclusion. Participant D is treated as having no 
underutilized amount under paragraph (c)(3)(ii)(B) of this section 
for 2002 for purposes of the catch-up limitation under section 
457(b)(3) and paragraph (c)(3) of this section because, in each of 
the years before 2002, D has deferred an amount equal to or in 
excess of the limitation of paragraph (c)(3)(i) of this section 
under all of D's coordinated plans.
    Example 2. (i) Facts. Assume the same facts as in Example 1, 
except that D only deferred $2,500 per year under the section 401(k) 
plan for one year before 2002.
    (ii) Conclusion. D is treated as having an underutilized amount 
under paragraph (c)(3)(ii)(B) of this section for 2002 for purposes 
of the special section 457 catch-up limitation. This is because D 
has deferred an amount for prior years that is less than the 
limitation of paragraph (c)(1)(i) of this section under all of D's 
coordinated plans.
    Example 3. (i) Facts. Participant E, who earned $15,000 for 
2000, entered into a salary reduction agreement in 2000 with E's 
eligible employer and elected to defer $3,000 for that year under 
E's eligible plan. For 2000, E's eligible employer provided an 
immediately vested, matching employer contribution under the plan 
for participants who make salary reduction deferrals under E's 
eligible plan. The matching contribution was equal to 67 percent of 
elective contributions, but not in excess of 10 percent of 
compensation before salary reduction deferrals (in E's case, 
$1,000). For 2000, E was not eligible for any catch-up contribution, 
participated in no other retirement plan, and had no other income 
exclusions taken into account in computing taxable compensation.
    (ii) Conclusion. Participant E's annual deferral equaled the 
maximum limitation of section 457(b) for 2000. E's maximum deferral 
limitation in 2000 was $4,000 because E's includible compensation 
was $12,000 ($15,000 minus the deferral of $3,000) and the 
applicable limitation for 2000 was one third of the individual's 
includible compensation (one-third of $12,000 equals $4,000). E's 
salary reduction deferral of $3,000 combined with E's eligible 
employer's matching contribution of $1,000 equals the limitation of 
section 457(b) for 2000 because E's annual deferrals totaled $4,000. 
E's underutilized amount for 2000 is zero.

    (v) Normal retirement age--(A) General rule. For purposes of the 
special section 457 catch-up in this paragraph (c)(3), a plan must 
specify the normal retirement age under the plan. A plan may define 
normal retirement age as any age that is on or after the earlier of age 
65 or the age at which participants have the right to retire and 
receive, under the basic defined benefit pension plan of the State or 
tax-exempt entity (or a money purchase pension plan in which the 
participant also participates if the participant is not eligible to 
participate in a defined benefit plan), immediate retirement benefits 
without actuarial or similar reduction because of retirement before 
some later specified age, and that is not later than age 70\1/2\. 
Alternatively, a plan may provide that a participant is allowed to 
designate a normal retirement age within these ages. For purposes of 
the special section 457 catch-up in this paragraph (c)(3), an entity 
sponsoring more than one eligible plan may not permit a participant to 
have more than one normal retirement age under the eligible plans it 
sponsors.
    (B) Special rule for eligible plans of qualified police or 
firefighters. An eligible plan with participants that include qualified 
police or firefighters as defined under section 415(b)(2)(H)(ii)(I) may 
designate a normal retirement age for such qualified police or 
firefighters that is earlier than the earliest normal retirement age 
designated under the general rule of paragraph (c)(3)(i)(A) of this 
section, but in no event may the normal retirement age be earlier than 
age 40. Alternatively, a plan may allow a qualified police or 
firefighter participant to designate a normal retirement age that is 
between age 40 and age 70\1/2\.
    (vi) Examples. The provisions of this paragraph (c)(3) are 
illustrated by the following examples:

    Example 1. (i) Facts. Participant F, who will turn 61 on April 
1, 2006, becomes eligible to participate in an eligible plan on 
January 1, 2006. The plan provides a normal retirement age of 65. 
The plan provides limitations on annual deferrals up to the maximum 
permitted under paragraphs (c)(1) through (3) of this section. For 
2006, F will receive compensation of $40,000 from the eligible 
employer. F desires to defer the maximum amount possible in 2006. 
The applicable basic dollar limit of paragraph (c)(1)(i)(A) of this 
section is $15,000 for 2006 and the additional dollar amount 
permitted under the age 50 catch-up in paragraph (c)(2) of this 
section for an individual who is at least age 50 is $5,000 for 2006.
    (ii) Conclusion. F is not eligible for the special section 457 
catch-up under paragraph (c)(3) of this section in 2006 because 2006 
is not one of the last three taxable years ending before F attains 
normal retirement age. Accordingly, the maximum that F may defer for 
2006 is $20,000. See also paragraph (c)(2)(iii) Example 1 of this 
section.
    Example 2. (i) Facts. The facts are the same as in Example 1 
except that, in 2006, F elects to defer only $2,000 under the plan 
(rather than the maximum permitted amount of $20,000). In addition, 
assume that the applicable basic dollar limit of paragraph 
(c)(1)(i)(A) of this section continues to be $15,000 for 2007 and 
the additional dollar amount permitted under the age 50 catch-up in 
paragraph (c)(2) of this section for an individual who is at least 
age 50 continues to be $5,000 for 2007. In F's taxable year 2007, 
which is one of the last three taxable years ending before F attains 
the plan's normal retirement age of 65, F again receives a salary of 
$40,000 and elects to defer the maximum amount permissible under the 
plan's catch-up provisions prescribed under paragraph (c) of this 
section.
    (ii) Conclusion. For 2007, which is one of the last three 
taxable years ending before F attains the plan's normal retirement 
age of 65, the applicable limit on deferrals for F is the larger of 
the amount under the special section 457 catch-up or $20,000, which 
is the basic annual limitation ($15,000) and the age

[[Page 41239]]

50 catch-up limit of section 414(v) ($5,000). For 2007, F's special 
section 457 catch-up amount is the lesser of two times the basic 
annual limitation ($30,000) or the sum of the basic annual 
limitation ($15,000) plus the $13,000 underutilized limitation under 
paragraph (c)(3)(ii) of this section (the $15,000 plan ceiling in 
2006, minus the $2,000 contributed for F in 2006), or $28,000. Thus, 
the maximum amount that F may defer in 2007 is $28,000.
    Example 3. (i) Facts. The facts are the same as in Examples 1 
and 2, except that F does not make any contributions to the plan 
before 2010. In addition, assume that the applicable basic dollar 
limitation of paragraph (c)(1)(i)(A) of this section continues to be 
$15,000 for 2010 and the additional dollar amount permitted under 
the age 50 catch-up in paragraph (c)(2) of this section for an 
individual who is at least age 50 continues to be $5,000 for 2010. 
In F's taxable year 2010, the year in which F attains age 65 (which 
is the normal retirement age under the plan), F desires to defer the 
maximum amount possible under the plan. F's compensation for 2010 is 
again $40,000.
    (ii) Conclusion. For 2010, the maximum amount that F may defer 
is $20,000. The special section 457 catch-up provisions under 
paragraph (c)(3) of this section are not applicable because 2010 is 
not a taxable year ending before the year in which F attains normal 
retirement age.

    (4) Cost-of-living adjustment. For years beginning after December 
31, 2006, the $15,000 dollar limitation in paragraph (c)(1)(i)(A) of 
this section will be adjusted to take into account increases in the 
cost-of-living. The adjustment in the dollar limitation is made at the 
same time and in the same manner as under section 415(d) (relating to 
qualified plans under section 401(a)), except that the base period is 
the calendar quarter beginning July 1, 2005 and any increase which is 
not a multiple of $500 will be rounded to the next lowest multiple of 
$500.
    (d) Deferral of sick, vacation, and back pay under an eligible 
plan--(1) In general. An eligible plan may provide that a participant 
may elect to defer accumulated sick pay, accumulated vacation pay, and 
back pay under an eligible plan if the requirements of section 457(b) 
are satisfied. For example, the plan must provide, in accordance with 
paragraph (b) of this section, that these amounts may be deferred for 
any calendar month only if an agreement providing for the deferral is 
entered into before the beginning of the month in which the amounts 
would otherwise be paid or made available and the participant is an 
employee in that month. In the case of accumulated sick pay, vacation 
pay, or back pay that is payable before the participant has a severance 
from employment, the requirements of the preceding sentence are deemed 
to be satisfied if the agreement providing for the deferral is entered 
into before the amount is currently available (as defined in 
regulations under section 401(k)).
    (2) Examples. The provisions of this paragraph (d) are illustrated 
by the following examples:

    Example 1. (i) Facts. Participant G, who is age 62 in 2003, is 
an employee who participates in an eligible plan providing a normal 
retirement age of 65. Under the terms of G's employer's eligible 
plan and G's sick leave plan, G may, during November of 2003 (which 
is one of the three years prior to normal retirement age), make a 
one-time election to contribute amounts representing accumulated 
sick pay to the eligible plan in December of 2003 (within the 
maximum deferral limitations). Alternatively, such amounts may 
remain in the ``bank'' under the sick leave plan. No cash out of the 
sick pay is available until the month in which a participant ceases 
to be employed by the employer. The total value of G's accumulated 
sick pay (determined, in accordance with the terms of the sick leave 
plan, by reference to G's current salary) is $4,000 in December of 
2003.
    (ii) Conclusion. Under the terms of the eligible plan and sick 
leave plan, G may elect before December of 2003 to defer the $4,000 
value of accumulated sick pay under the eligible plan, provided that 
G's other annual deferrals to the eligible plan for 2003, when added 
to the $4,000, do not exceed G's maximum deferral limitation for the 
year.
    Example 2. (i) Facts. Same facts as in Example 1, except that G 
will separate from service on January 17, 2004, and elects, on 
January 4, 2004, to defer G's accumulated sick and vacation pay 
(which totals $12,000) that is payable on January 15, 2004.
    (ii) Conclusion. G may elect before January 15, 2004 to defer 
the accumulated sick and vacation pay under the eligible plan, even 
if the election is made after the beginning of January, because the 
agreement providing for the deferral is entered into before the 
amount is currently available and G does not cease to be an employee 
before the amount is currently available. G will have $12,000 of 
includible compensation in 2004 because the deferral is taken into 
account in the definition of includible compensation.
    Example 3. (i) Facts. Employer X maintains an eligible plan and 
a vacation leave plan. Under the terms of the vacation leave plan, 
employees generally accrue three weeks of vacation per year. Up to 
one week's unused vacation may be carried over from one year to the 
next, so that in any single year an employee may have a maximum of 
four weeks vacation time. At the beginning of each calendar year, 
under the terms of the eligible plan (which constitutes an agreement 
providing for the deferral), the value of any unused vacation time 
from the prior year in excess of one week is automatically 
contributed to the eligible plan, to the extent of the employee's 
maximum deferral limitations. Amounts in excess of the maximum 
deferral limitations are forfeited.
    (ii) Conclusion. The value of the unused vacation pay 
contributed to X's eligible plan pursuant to the terms of the plan 
and the terms of the vacation leave plan is treated as an annual 
deferral to the eligible plan in the calendar year the contribution 
is made. No amounts contributed to the eligible plan will be 
considered made available to a participant in X's eligible plan.

    (e) Excess deferrals under an eligible plan--(1) In general. Any 
amount deferred under an eligible plan for the taxable year of a 
participant that exceeds the maximum deferral limitations set forth in 
paragraphs (c)(1) through (3) of this section, and any amount that 
exceeds the individual limitation under Sec.  1.457-5, constitutes an 
excess deferral that is taxable in accordance with Sec.  1.457-11 for 
that taxable year. Thus, an excess deferral is includible in gross 
income in the taxable year deferred or, if later, the first taxable 
year in which there is no substantial risk of forfeiture.
    (2) Excess deferrals under an eligible governmental plan other than 
as a result of the individual limitation. In order to be an eligible 
governmental plan, the plan must provide that any excess deferral 
resulting from a failure of a plan to apply the limitations of 
paragraphs (c)(1) through (3) of this section to amounts deferred under 
the eligible plan (computed without regard to the individual limitation 
under Sec.  1.457-5) will be distributed to the participant, with 
allocable net income, as soon as administratively practicable after the 
plan determines that the amount is an excess deferral. For purposes of 
determining whether there is an excess deferral resulting from a 
failure of a plan to apply the limitations of paragraphs (c)(1) through 
(3) of this section, all plans under which an individual participates 
by virtue of his or her relationship with a single employer are treated 
as a single plan (without regard to any differences in funding). An 
eligible governmental plan does not fail to satisfy the requirements of 
paragraphs (a) through (d) of this section or Sec. Sec.  1.457-6 
through 1.457-10 (including the distribution rules under Sec.  1.457-6 
and the funding rules under Sec.  1.457-8) solely by reason of a 
distribution made under this paragraph (e)(2). If such excess deferrals 
are not corrected by distribution under this paragraph (e)(2), the plan 
will be an ineligible plan under which benefits are taxable in 
accordance with Sec.  1.457-11.
    (3) Excess deferrals under an eligible plan of a tax-exempt 
employer other than as a result of the individual limitation. If a plan 
of a tax-exempt employer fails to comply with the limitations of 
paragraphs (c)(1) through (3) of this section, the plan will be an 
ineligible plan under which benefits are taxable in accordance with 
Sec.  1.457-11.

[[Page 41240]]

However, a plan may distribute to a participant any excess deferrals 
(and any income allocable to such amount) not later than the first 
April 15 following the close of the taxable year of the excess 
deferrals. In such a case, the plan will continue to be treated as an 
eligible plan. However, any excess deferral is included in the gross 
income of a participant for the taxable year of the excess deferral. If 
the excess deferrals are not corrected by distribution under this 
paragraph (e)(3), the plan is an ineligible plan under which benefits 
are taxable in accordance with Sec.  1.457-11. For purposes of 
determining whether there is an excess deferral resulting from a 
failure of a plan to apply the limitations of paragraphs (c)(1) through 
(3) of this section, all eligible plans under which an individual 
participates by virtue of his or her relationship with a single 
employer are treated as a single plan.
    (4) Excess deferrals arising from application of the individual 
limitation. An eligible plan may provide that an excess deferral that 
is a result solely of a failure to comply with the individual 
limitation under Sec.  1.457-5 for a taxable year may be distributed to 
the participant, with allocable net income, as soon as administratively 
practicable after the plan determines that the amount is an excess 
deferral. An eligible plan does not fail to satisfy the requirements of 
paragraphs (a) through (d) of this section or Sec. Sec.  1.457-6 
through 1.457-10 (including the distribution rules under Sec.  1.457-6 
and the funding rules under Sec.  1.457-8) solely by reason of a 
distribution made under this paragraph (e)(4). Although a plan will 
still maintain eligible status if excess deferrals are not distributed 
under this paragraph (e)(4), a participant must include the excess 
amounts in income as provided in paragraph (e)(1) of this section.
    (5) Examples. The provisions of this paragraph (e) are illustrated 
by the following examples:

    Example 1. (i) Facts. In 2006, the eligible plan of State 
Employer X in which Participant H participates permits a maximum 
deferral of the lesser of $15,000 or 100 percent of includible 
compensation. In 2006, H, who has compensation of $28,000, 
nevertheless defers $16,000 under the eligible plan. Participant H 
is age 45 and normal retirement age under the plan is age 65. For 
2006, the applicable dollar limit under paragraph (c)(1)(i)(A) of 
this section is $15,000. Employer X discovers the error in January 
of 2007 when it completes H's 2006 Form W-2 and promptly distributes 
$1,022 to H (which is the sum of the $1,000 excess and $22 of 
allocable net income).
    (ii) Conclusion. Participant H has deferred $1,000 in excess of 
the $15,000 limitation provided for under the plan for 2006. The 
$1,000 excess must be included by H in H's income for 2006. In order 
to correct the failure and still be an eligible plan, the plan must 
distribute the excess deferral, with allocable net income, as soon 
as administratively practicable after determining that the amount 
exceeds the plan deferral limitations. In this case, $22 of the 
distribution of $1,022 is included in H's gross income for 2007 (and 
is not an eligible rollover distribution). If the excess deferral 
were not distributed, the plan would be an ineligible plan with 
respect to which benefits are taxable in accordance with Sec.  
1.457-11.
    Example 2. (i) Facts. The facts are the same as in Example 1, 
except that X uses a number of separate arrangements with different 
trustees and annuity insurers to permit employees to defer and H 
elects deferrals under several of the funding arrangements none of 
which exceeds $15,000 for any individual funding arrangement, but 
which total $16,000.
    (ii) Conclusion. The conclusion is the same as in Example 1.
    Example 3. (i) Facts. The facts are the same as in Example 1, 
except that H's deferral under the eligible plan is limited to 
$11,000 and H also makes a salary reduction contribution of $5,000 
to an annuity contract under section 403(b) with the same Employer 
X.
    (ii) Conclusion. H's deferrals are within the plan deferral 
limitations of Employer X. Because of the repeal of the application 
of the coordination limitation under former paragraph (2) of section 
457(c), H's salary reduction deferrals under the annuity contract 
are no longer considered in determining H's applicable deferral 
limits under paragraphs (c)(1) through (3) of this section.
    Example 4. (i) Facts. The facts are the same as in Example 1, 
except that H's deferral under the eligible governmental plan is 
limited to $14,000 and H also makes a deferral of $4,000 to an 
eligible governmental plan of a different employer. Participant H is 
age 45 and normal retirement age under both eligible plans is age 
65.
    (ii) Conclusion. Because of the application of the individual 
limitation under Sec.  1.457-5, H has an excess deferral of $3,000 
(the sum of $14,000 plus $4,000 equals $18,000, which is $3,000 in 
excess of the dollar limitation of $15,000). The $3,000 excess 
deferral, with allocable net income, may be distributed from either 
plan as soon as administratively practicable after determining that 
the combined amount exceeds the deferral limitations. If the $3,000 
excess deferral is not distributed to H, each plan will continue to 
be an eligible plan, but the $3,000 must be included by H in H's 
income for 2006.
    Example 5. (i) Facts. Assume the same facts as in Example 3, 
except that H's deferral under the eligible governmental plan is 
limited to $14,000 and H also makes a deferral of $4,000 to an 
eligible plan of Employer Y, a tax-exempt entity.
    (ii) Conclusion. The results are the same as in Example 3, 
namely, because of the application of the individual limitation 
under Sec.  1.457-5, H has an excess deferral of $3,000. If the 
$3,000 excess deferral is not distributed to H, each plan will 
continue to be an eligible plan, but the $3,000 must be included by 
H in H's income for 2006.
    Example 6. (i) Facts. Assume the same facts as in Example 5, 
except that X is a tax-exempt entity and thus its plan is an 
eligible plan of a tax-exempt entity.
    (ii) Conclusion. The results are the same as in Example 5, 
namely, because of the application of the individual limitation 
under Sec.  1.457-5, H has an excess deferral of $3,000. If the 
$3,000 excess deferral is not distributed to H, each plan will 
continue to be an eligible plan, but the $3,000 must be included by 
H into H's income for 2006.


0
Par. 3. Sections 1.457-5 through 1.457-12 are added to read as follows:


Sec.  1.457-5  Individual limitation for combined annual deferrals 
under multiple eligible plans

    (a) General rule. The individual limitation under section 457(c) 
and this section equals the basic annual deferral limitation under 
Sec.  1.457-4(c)(1)(i)(A), plus either the age 50 catch-up amount under 
Sec.  1.457-4(c)(2), or the special section 457 catch-up amount under 
Sec.  1.457-4(c)(3), applied by taking into account the combined annual 
deferral for the participant for any taxable year under all eligible 
plans. While an eligible plan may include provisions under which it 
will limit deferrals to meet the individual limitation under section 
457(c) and this section, annual deferrals by a participant that exceed 
the individual limit under section 457(c) and this section (but do not 
exceed the limits under Sec.  1.457-4(c)) will not cause a plan to lose 
its eligible status. However, to the extent the combined annual 
deferrals for a participant for any taxable year exceed the individual 
limitation under section 457(c) and this section for that year, the 
amounts are treated as excess deferrals as described in Sec.  1.457-
4(e).
    (b) Limitation applied to participant. The individual limitation in 
this section applies to eligible plans of all employers for whom a 
participant has performed services, including both eligible 
governmental plans and eligible plans of a tax-exempt entity and both 
eligible plans of the employer and eligible plans of other employers. 
Thus, for purposes of determining the amount excluded from a 
participant's gross income in any taxable year (including the 
underutilized limitation under Sec.  1.457-4 (c)(3)(ii)(B)), the 
participant's annual deferral under an eligible plan, and the 
participant's annual deferrals under all other eligible plans, must be 
determined on an aggregate basis. To the extent that the combined 
annual deferral amount exceeds the maximum deferral limitation 
applicable under Sec.  1.457-4 (c)(1)(i)(A), (c)(2), or (c)(3), the 
amount

[[Page 41241]]

is treated as an excess deferral under Sec.  1.457-4(e).
    (c) Special rules for catch-up amounts under multiple eligible 
plans. For purposes of applying section 457(c) and this section, the 
special section 457 catch-up under Sec.  1.457-4 (c)(3) is taken into 
account only to the extent that an annual deferral is made for a 
participant under an eligible plan as a result of plan provisions 
permitted under Sec.  1.457-4 (c)(3). In addition, if a participant has 
annual deferrals under more than one eligible plan and the applicable 
catch-up amount under Sec.  1.457-4 (c)(2) or (3) is not the same for 
each such eligible plan for the taxable year, section 457(c) and this 
section are applied using the catch-up amount under whichever plan has 
the largest catch-up amount applicable to the participant.
    (d) Examples. The provisions of this section are illustrated by the 
following examples:

    Example 1. (i) Facts. Participant F is age 62 in 2006 and 
participates in two eligible plans during 2006, Plans J and K, which 
are each eligible plans of two different governmental entities. Each 
plan includes provisions allowing the maximum annual deferral 
permitted under Sec.  1.457-4(c)(1) through (3). For 2006, the 
underutilized amount under Sec.  1.457-4 (c)(3)(ii)(B) is $20,000 
under Plan J and is $40,000 under Plan K. Normal retirement age is 
age 65 under both plans. Participant F defers $15,000 under each 
plan. Participant F's includible compensation is in each case in 
excess of the deferral. Neither plan designates the $15,000 
contribution as a catch-up permitted under each plan's special 
section 457 catch-up provisions.
    (ii) Conclusion. For purposes of applying this section to 
Participant F for 2006, the maximum exclusion is $20,000. This is 
equal to the sum of $15,000 plus $5,000, which is the age 50 catch-
up amount. Thus, F has an excess amount of $10,000 which is treated 
as an excess deferral for Participant F for 2006 under Sec.  1.457-
4(e).
    Example 2. (i) Facts. Participant E, who will turn 63 on April 
1, 2006, participates in four eligible plans during 2006: Plan W 
which is an eligible governmental plan; and Plans X, Y, and Z which 
are each eligible plans of three different tax-exempt entities. For 
2006, the limitation that applies to Participant E under all four 
plans under Sec.  1.457-4 (c)(1)(i)(A) is $15,000. For 2006, the 
additional age 50 catch-up limitation that applies to Participant E 
under all four plans under Sec.  1.457-4 (c)(2) is $5,000. Further, 
for 2006, different limitations under Sec.  1.457-4(c)(3) and 
(c)(3)(ii)(B) apply to Participant E under each of these plans, as 
follows: under Plan W, the underutilized limitation under Sec.  
1.457-4 (c)(3)(ii)(B) is $7,000; under Plan X, the underutilized 
limitation under Sec.  1.457-4 (c)(3)(ii)(B) is $2,000; under Plan 
Y, the underutilized limitation under Sec.  1.457-4 (c)(3)(ii)(B) is 
$8,000; and under Plan Z, Sec.  1.457-4 (c)(3) is not applicable 
since normal retirement age is age 62 under Plan Z. Participant E's 
includible compensation is in each case in excess of any applicable 
deferral.
    (ii) Conclusion. For purposes of applying this section to 
Participant E for 2006, Participant E could elect to defer $23,000 
under Plan Y, which is the maximum deferral limitation under Sec.  
1.457-4 (c)(1) through (3), and to defer no amount under Plans W, X, 
and Z. The $23,000 maximum amount is equal to the sum of $15,000 
plus $8,000, which is the catch-up amount applicable to Participant 
E under Plan Y and which is the largest catch-up amount applicable 
to Participant E under any of the four plans for 2006. 
Alternatively, Participant E could instead elect to defer the 
following combination of amounts: an aggregate total of $20,000 to 
any of the four plans; or $22,000 to Plan W and none to any of the 
other three plans.
    (iii) If the underutilized amount under Plans W, X, and Y for 
2006 were in each case zero (because E had always contributed the 
maximum amount or E was a new participant) or an amount not in 
excess of $5,000, the maximum exclusion under this section would be 
$20,000 for Participant E for 2006 ($15,000 plus the $5,000 age 50 
catch-up amount), which Participant E could contribute to any of the 
plans.


Sec.  1.457-6  Timing of distributions under eligible plans.

    (a) In general. Except as provided in paragraph (c) of this section 
(relating to distributions on account of an unforeseeable emergency), 
paragraph (e) of this section (relating to distributions of small 
accounts), Sec.  1.457-10(a) (relating to plan terminations), or Sec.  
1.457-10(c) (relating to domestic relations orders), amounts deferred 
under an eligible governmental plan may not be paid to a participant or 
beneficiary before the participant has a severance from employment with 
the eligible employer or when the participant attains age 70\1/2\, if 
earlier. For rules relating to loans, see paragraph (f) of this 
section. This section does not apply to distributions of excess amounts 
under Sec.  1.457-4(e). However, except to the extent set forth by the 
Commissioner in revenue rulings, notices, and other guidance published 
in the Internal Revenue Bulletin, this section applies to amounts held 
in a separate account for eligible rollover distributions maintained by 
an eligible governmental plan as described in Sec.  1.457-10(e)(2).
    (b) Severance from employment--(1) Employees. An employee has a 
severance from employment with the eligible employer if the employee 
dies, retires, or otherwise has a severance from employment with the 
eligible employer. See regulations under section 401(k) for additional 
guidance concerning severance from employment.
    (2) Independent contractors--(i) In general. An independent 
contractor is considered to have a severance from employment with the 
eligible employer upon the expiration of the contract (or in the case 
of more than one contract, all contracts) under which services are 
performed for the eligible employer 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 eligible employer anticipates a 
renewal of a contractual relationship or the independent contractor 
becoming an employee. For this purpose, an eligible employer 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 eligible 
employer nor the independent contractor has eliminated the independent 
contractor as a possible provider of services under any such new 
contract. Further, an eligible employer is considered to intend to 
contract again for the services provided under an expired contract if 
the eligible employer's doing so is conditioned only upon incurring a 
need for the services, the availability of funds, or both.
    (ii) Special rule. Notwithstanding paragraph (b)(2)(i) of this 
section, the plan is considered to satisfy the requirement described in 
paragraph (a) of this section that no amounts deferred under the plan 
be paid or made available to the participant before the participant has 
a severance from employment with the eligible employer if, with respect 
to amounts payable to a participant who is an independent contractor, 
an eligible plan provides that--
    (A) No amount will be paid to the participant before a date at 
least 12 months after the day on which the contract expires under which 
services are performed for the eligible employer (or, in the case of 
more than one contract, all such contracts expire); and
    (B) No amount payable to the participant on that date will be paid 
to the participant if, after the expiration of the contract (or 
contracts) and before that date, the participant performs services for 
the eligible employer as an independent contractor or an employee.
    (c) Rules applicable to distributions for unforeseeable 
emergencies--(1) In general. An eligible plan may permit a distribution 
to a participant or beneficiary faced with an unforeseeable emergency. 
The distribution must satisfy the requirements of paragraph (c)(2) of 
this section.
    (2) Requirements--(i) Unforeseeable emergency defined. An 
unforeseeable emergency must be defined in the plan

[[Page 41242]]

as a severe financial hardship of the participant or beneficiary 
resulting from an illness or accident of the participant or 
beneficiary, the participant's or beneficiary's spouse, or the 
participant's or beneficiary's dependent (as defined in section 
152(a)); loss of the participant's or beneficiary's property due to 
casualty (including the need to rebuild a home following damage to a 
home not otherwise covered by homeowner's insurance, e.g., as a result 
of a natural disaster); or other similar extraordinary and 
unforeseeable circumstances arising as a result of events beyond the 
control of the participant or the beneficiary. For example, the 
imminent foreclosure of or eviction from the participant's or 
beneficiary'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 cost of prescription 
drug medication, may constitute an unforeseeable emergency. Finally, 
the need to pay for the funeral expenses of a spouse or a dependent (as 
defined in section 152(a)) may also constitute an unforeseeable 
emergency. Except as otherwise specifically provided in this paragraph 
(c)(2)(i), the purchase of a home and the payment of college tuition 
are not unforeseeable emergencies under this paragraph (c)(2)(i).
    (ii) Unforeseeable emergency distribution standard. Whether a 
participant or beneficiary is faced with an unforeseeable emergency 
permitting a distribution under this paragraph (c) 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 participant's assets, to the extent the liquidation 
of such assets would not itself cause severe financial hardship, or by 
cessation of deferrals under the plan.
    (iii) Distribution necessary to satisfy emergency need. 
Distributions because of an unforeseeable emergency must be limited to 
the amount reasonably necessary to satisfy the emergency need (which 
may include any amounts necessary to pay any federal, state, or local 
income taxes or penalties reasonably anticipated to result from the 
distribution).
    (d) Minimum required distributions for eligible plans. In order to 
be an eligible plan, a plan must meet the distribution requirements of 
section 457(d)(1) and (2). Under section 457(d)(2), a plan must meet 
the minimum distribution requirements of section 401(a)(9). See section 
401(a)(9) and the regulations thereunder for these requirements. 
Section 401(a)(9) requires that a plan begin lifetime distributions to 
a participant no later than April 1 of the calendar year following the 
later of the calendar year in which the participant attains age 70\1/2\ 
or the calendar year in which the participant retires.
    (e) Distributions of smaller accounts--(1) In general. An eligible 
plan may provide for a distribution of all or a portion of a 
participant's benefit if this paragraph (e)(1) is satisfied. This 
paragraph (e)(1) is satisfied if the participant's total amount 
deferred (the participant's total account balance) which is not 
attributable to rollover contributions (as defined in section 
411(a)(11)(D)) is not in excess of the dollar limit under section 
411(a)(11)(A), no amount has been deferred under the plan by or for the 
participant during the two-year period ending on the date of the 
distribution, and there has been no prior distribution under the plan 
to the participant under this paragraph (e). An eligible plan is not 
required to permit distributions under this paragraph (e).
    (2) Alternative provisions possible. Consistent with the provisions 
of paragraph (e)(1) of this section, a plan may provide that the total 
amount deferred for a participant or beneficiary will be distributed 
automatically to the participant or beneficiary if the requirements of 
paragraph (e)(1) of this section are met. Alternatively, if the 
requirements of paragraph (e)(1) of this section are met, the plan may 
provide for the total amount deferred for a participant or beneficiary 
to be distributed to the participant or beneficiary only if the 
participant or beneficiary so elects. The plan is permitted to 
substitute a specified dollar amount that is less than the total amount 
deferred. In addition, these two alternatives can be combined; for 
example, a plan could provide for automatic distributions for up to 
$500, but allow participants or beneficiary to elect a distribution if 
the total account balance is above $500.
    (f) Loans from eligible plans--(1) Eligible plans of tax-exempt 
entities. If a participant or beneficiary receives (directly or 
indirectly) any amount deferred as a loan from an eligible plan of a 
tax-exempt entity, that amount will be treated as having been paid or 
made available to the individual as a distribution under the plan, in 
violation of the distribution requirements of section 457(d).
    (2) Eligible governmental plans. The determination of whether the 
availability of a loan, the making of a loan, or a failure to repay a 
loan made from a trustee (or a person treated as a trustee under 
section 457(g)) of an eligible governmental plan 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 457(b) and the regulations, 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 satisfy the exclusive benefit requirement of 
section 457(g)(1) and Sec.  1.457-8(a)(1). See also Sec.  1.457-7(b)(3) 
relating to the application of section 72(p) with respect to the 
taxation of a loan made under an eligible governmental plan, and Sec.  
1.72(p)-1 relating to section 72(p)(2).
    (3) Example. The provisions of paragraph (f)(2) of this section are 
illustrated by the following example:

    Example. (i) Facts. Eligible Plan X of State Y is funded through 
Trust Z. Plan X permits an employee's account balance under Plan X 
to be paid in a single sum at severance from employment with State 
Y. Plan X includes a loan program under which any active employee 
with a vested account balance may receive a loan from Trust Z. Loans 
are made pursuant to plan provisions regarding loans that are set 
forth in the plan under which loans bear a reasonable rate of 
interest and are secured by the employee's account balance. In order 
to avoid taxation under Sec.  1.457-7(b)(3) and section 72(p)(1), 
the plan provisions limit the amount of loans and require loans to 
be repaid in level installments as required under section 72(p)(2). 
Participant J's vested account balance under Plan X is $50,000. J 
receives a loan from Trust Z in the amount of $5,000 on December 1, 
2003, to be repaid in level installments made quarterly over the 5-
year period ending on November 30, 2008. Participant J makes the 
required repayments until J has a severance from employment from 
State Y in 2005 and subsequently fails to repay the outstanding loan 
balance of $2,250. The $2,250 loan balance is offset against J's 
$80,000 account balance benefit under Plan X, and J elects to be 
paid the remaining $77,750 in 2005.
    (ii) Conclusion. The making of the loan to J will not be treated 
as a violation of the requirements of section 457(b) or the 
regulations. The cancellation of the loan at severance from 
employment does not cause Plan X to fail to satisfy the requirements 
for plan eligibility under section 457. In addition, because the 
loan satisfies the maximum amount and repayment

[[Page 41243]]

requirements of section 72(p)(2), J is not required to include any 
amount in income as a result of the loan until 2005, when J has 
income of $2,250 as a result of the offset (which is a permissible 
distribution under this section) and income of $77,750 as a result 
of the distribution made in 2005.


Sec.  1.457-7  Taxation of Distributions Under Eligible Plans.

    (a) General rules for when amounts are included in gross income. 
The rules for determining when an amount deferred under an eligible 
plan is includible in the gross income of a participant or beneficiary 
depend on whether the plan is an eligible governmental plan or an 
eligible plan of a tax-exempt entity. Paragraph (b) of this section 
sets forth the rules for an eligible governmental plan. Paragraph (c) 
of this section sets forth the rules for an eligible plan of a tax-
exempt entity.
    (b) Amounts included in gross income under an eligible governmental 
plan--(1) Amounts included in gross income in year paid under an 
eligible governmental plan. Except as provided in paragraphs (b)(2) and 
(3) of this section (or in Sec.  1.457-10(c) relating to payments to a 
spouse or former spouse pursuant to a qualified domestic relations 
order), amounts deferred under an eligible governmental plan are 
includible in the gross income of a participant or beneficiary for the 
taxable year in which paid to the participant or beneficiary under the 
plan.
    (2) Rollovers to individual retirement arrangements and other 
eligible retirement plans. A trustee-to-trustee transfer in accordance 
with section 401(a)(31) (generally referred to as a direct rollover) 
from an eligible government plan is not includible in gross income of a 
participant or beneficiary in the year transferred. In addition, any 
payment made from an eligible government plan 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 transferred to an eligible retirement plan (as defined in section 
402(c)(8)(B)) within 60 days, including the transfer to the eligible 
retirement plan of any property distributed from the eligible 
governmental plan. For this purpose, the rules of section 402(c)(2) 
through (7) and (9) apply. Any trustee-to-trustee transfer under this 
paragraph (b)(2) from an eligible government plan is a distribution 
that is subject to the distribution requirements of Sec.  1.457-6.
    (3) Amounts taxable under section 72(p)(1). In accordance with 
section 72(p), the amount of any loan from an eligible governmental 
plan 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 plan 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. Thus, except to the 
extent a loan satisfies section 72(p)(2), any amount loaned from an 
eligible governmental plan 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. See generally Sec.  
1.72(p)-1.
    (4) Examples. The provisions of this paragraph (b) are illustrated 
by the following examples:

    Example 1. (i) Facts. Eligible Plan G of a governmental entity 
permits distribution of benefits in a single sum or in installments 
of up to 20 years, with such benefits to commence at any date that 
is after severance from employment (up to the later of severance 
from employment or the plan's normal retirement age of 65). 
Effective for participants who have a severance from employment 
after December 31, 2001, Plan X allows an election--as to both the 
date on which payments are to begin and the form in which payments 
are to be made--to be made by the participant at any time that is 
before the commencement date selected. However, Plan X chooses to 
require elections to be filed at least 30 days before the 
commencement date selected in order for Plan X to have enough time 
to be able to effectuate the election.
    (ii) Conclusion. No amounts are included in gross income before 
actual payments begin. If installment payments begin (and the 
installment payments are payable over at least 10 years so as not to 
be eligible rollover distributions), the amount included in gross 
income for any year is equal to the amount of the installment 
payment paid during the year.
    Example 2. (i) Facts. Same facts as in Example 1, except that 
the same rules are extended to participants who had a severance from 
employment before January 1, 2002.
    (ii) Conclusion. For all participants (that is, both those who 
have a severance from employment after December 31, 2001, and those 
who have a severance from employment before January 1, 2002, 
including those whose benefit payments have commenced before January 
1, 2002), no amounts are included in gross income before actual 
payments begin. If installment payments begin (and the installment 
payments are payable over at least 10 years so as not to be eligible 
rollover distributions), the amount included in gross income for any 
year is equal to the amount of the installment payment paid during 
the year.

    (c) Amounts included in gross income under an eligible plan of a 
tax-exempt entity--(1) Amounts included in gross income in year paid or 
made available under an eligible plan of a tax-exempt entity. Amounts 
deferred under an eligible plan of a tax-exempt entity are includible 
in the gross income of a participant or beneficiary for the taxable 
year in which paid or otherwise made available to the participant or 
beneficiary under the plan. Thus, amounts deferred under an eligible 
plan of a tax-exempt entity are includible in the gross income of the 
participant or beneficiary in the year the amounts are first made 
available under the terms of the plan, even if the plan has not 
distributed the amounts deferred. Amounts deferred under an eligible 
plan of a tax-exempt entity are not considered made available to the 
participant or beneficiary solely because the participant or 
beneficiary is permitted to choose among various investments under the 
plan.
    (2) When amounts deferred are considered to be made available under 
an eligible plan of a tax-exempt entity--(i) General rule. Except as 
provided in paragraphs (c)(2)(ii) through (iv) of this section, amounts 
deferred under an eligible plan of a tax-exempt entity are considered 
made available (and, thus, are includible in the gross income of the 
participant or beneficiary under this paragraph (c)) at the earliest 
date, on or after severance from employment, on which the plan allows 
distributions to commence, but in no event later than the date on which 
distributions must commence pursuant to section 401(a)(9). For example, 
in the case of a plan that permits distribution to commence on the date 
that is 60 days after the close of the plan year in which the 
participant has a severance from employment with the eligible employer, 
amounts deferred are considered to be made available on that date. 
However, distributions deferred in accordance with paragraphs 
(c)(2)(ii) through (iv) of this section are not considered made 
available prior to the applicable date under paragraphs (c)(2)(ii) 
through (iv) of this section. In addition, no portion of a participant 
or beneficiary's account is treated as made available (and thus 
currently includible in income) under an eligible plan of a tax-exempt 
entity merely because the participant or beneficiary under the plan may 
elect to receive a distribution in any of the following circumstances:
    (A) A distribution in the event of an unforeseeable emergency to 
the extent the distribution is permitted under Sec.  1.457-6(c).
    (B) A distribution from an account for which the total amount 
deferred is not in excess of the dollar limit under section 
411(a)(11)(A) to the extent the

[[Page 41244]]

distribution is permitted under Sec.  1.457-6(e).
    (ii) Initial election to defer commencement of distributions--(A) 
In general. An eligible plan of a tax-exempt entity may provide a 
period for making an initial election during which the participant or 
beneficiary may elect, in accordance with the terms of the plan, to 
defer the payment of some or all of the amounts deferred to a fixed or 
determinable future time. The period for making this initial election 
must expire prior to the first time that any such amounts would be 
considered made available under the plan under paragraph (c)(2)(i) of 
this section.
    (B) Failure to make initial election to defer commencement of 
distributions. Generally, if no initial election is made by a 
participant or beneficiary under this paragraph (c)(2)(ii), then the 
amounts deferred under an eligible plan of a tax-exempt entity are 
considered made available and taxable to the participant or beneficiary 
in accordance with paragraph (c)(2)(i) of this section at the earliest 
time, on or after severance from employment ( but in no event later 
than the date on which distributions must commence pursuant to section 
401(a)(9)), that distribution is permitted to commence under the terms 
of the plan. However, the plan may provide for a default payment 
schedule that applies if no election is made. If the plan provides for 
a default payment schedule, the amounts deferred are includible in the 
gross income of the participant or beneficiary in the year the amounts 
deferred are first made available under the terms of the default 
payment schedule.
    (iii) Additional election to defer commencement of distribution. An 
eligible plan of a tax-exempt entity is permitted to provide that a 
participant or beneficiary who has made an initial election under 
paragraph (c)(2)(ii)(A) of this section may make one additional 
election to defer (but not accelerate) commencement of distributions 
under the plan before distributions have commenced in accordance with 
the initial deferral election under paragraph (c)(2)(ii)(A) of this 
section. Amounts payable to a participant or beneficiary under an 
eligible plan of a tax-exempt entity are not treated as made available 
merely because the plan allows the participant to make an additional 
election under this paragraph (c)(2)(iii). A participant or beneficiary 
is not precluded from making an additional election to defer 
commencement of distributions merely because the participant or 
beneficiary has previously received a distribution under Sec.  1.457-
6(c) because of an unforeseeable emergency, has received a distribution 
of smaller amounts under Sec.  1.457-6(e), has made (and revoked) other 
deferral or method of payment elections within the initial election 
period, or is subject to a default payment schedule under which the 
commencement of benefits is deferred (for example, until a participant 
is age 65).
    (iv) Election as to method of payment. An eligible plan of a tax-
exempt entity may provide that an election as to the method of payment 
under the plan may be made at any time prior to the time the amounts 
are distributed in accordance with the participant or beneficiary's 
initial or additional election to defer commencement of distributions 
under paragraph (c)(2)(ii) or (iii) of this section. Where no method of 
payment is elected, the entire amount deferred will be includible in 
the gross income of the participant or beneficiary when the amounts 
first become made available in accordance with a participant's initial 
or additional elections to defer under paragraphs (c)(2)(ii) and (iii) 
of this section, unless the eligible plan provides for a default method 
of payment (in which case amounts are considered made available and 
taxable when paid under the terms of the default payment schedule). A 
method of payment means a distribution or a series of periodic 
distributions commencing on a date determined in accordance with 
paragraph (c)(2)(ii) or (iii) of this section.
    (3) Examples. The provisions of this paragraph (c) are illustrated 
by the following examples:

    Example 1. (i) Facts. Eligible Plan X of a tax-exempt entity 
provides that a participant's total account balance, representing 
all amounts deferred under the plan, is payable to a participant in 
a single sum 60 days after severance from employment throughout 
these examples, unless, during a 30-day period immediately following 
the severance, the participant elects to receive the single sum 
payment at a later date (that is not later than the plan's normal 
retirement age of 65) or elects to receive distribution in 10 annual 
installments to begin 60 days after severance from employment (or at 
a later date, if so elected, that is not later than the plan's 
normal retirement age of 65). On November 13, 2004, participant K, a 
calendar year taxpayer, has a severance from employment with the 
eligible employer. K does not, within the 30-day window period, 
elect to postpone distributions to a later date or to receive 
payment in 10 fixed annual installments.
    (ii) Conclusion. The single sum payment is payable to K 60 days 
after the date K has a severance from employment (January 12, 2005), 
and is includible in the gross income of K in 2005 under section 
457(a).
    Example 2. (i) Facts. The terms of eligible Plan X are the same 
as described in Example 1. Participant L participates in eligible 
Plan X. On November 11, 2003, L has a severance from the employment 
of the eligible employer. On November 24, 2003, L makes an initial 
deferral election not to receive the single-sum payment payable 60 
days after the severance, and instead elects to receive the amounts 
in 10 annual installments to begin 60 days after severance from 
employment.
    (ii) Conclusion. No portion of L's account is considered made 
available in 2003 or 2004 before a payment is made and no amount is 
includible in the gross income of L until distributions commence. 
The annual installment payable in 2004 will be includible in L's 
gross income in 2004.
    Example 3. (i) Facts. The facts are the same as in Example 1, 
except that eligible Plan X also provides that those participants 
who are receiving distributions in 10 annual installments may, at 
any time and without restriction, elect to receive a cash out of all 
remaining installments. Participant M elects to receive a 
distribution in 10 annual installments commencing in 2004.
    (ii) Conclusion. M's total account balance, representing the 
total of the amounts deferred under the plan, is considered made 
available and is includible in M's gross income in 2004.
    Example 4. (i) Facts. The facts are the same as in Example 3, 
except that, instead of providing for an unrestricted cashout of 
remaining payments, the plan provides that participants or 
beneficiaries who are receiving distributions in 10 annual 
installments may accelerate the payment of the amount remaining 
payable to the participant upon the occurrence of an unforeseeable 
emergency as described in Sec.  1.457-6(c)(1) in an amount not 
exceeding that described in Sec.  1.457-6(c)(2).
    (ii) Conclusion. No amount is considered made available to 
participant M on account of M's right to accelerate payments upon 
the occurrence of an unforeseeable emergency.
    Example 5. (i) Facts. Eligible Plan Y of a tax-exempt entity 
provides that distributions will commence 60 days after a 
participant's severance from employment unless the participant 
elects, within a 30-day window period following severance from 
employment, to defer distributions to a later date (but no later 
than the year following the calendar year the participant attains 
age 70\1/2\). The plan provides that a participant who has elected 
to defer distributions to a later date may make an election as to 
form of distribution at any time prior to the 30th day before 
distributions are to commence.
    (ii) Conclusion. No amount is considered made available prior to 
the date distributions are to commence by reason of a participant's 
right to defer or make an election as to the form of distribution.
    Example 6. (i) Facts. The facts are the same as in Example 1, 
except that the plan also permits participants who have made an 
initial election to defer distribution to make one additional 
deferral election at any time prior to the date distributions are 
scheduled to commence. Participant N has a severance from employment 
at age 50. The next day, during the 30-day period provided in the 
plan, N elects to receive distribution in the form of 10 annual 
installment payments

[[Page 41245]]

beginning at age 55. Two weeks later, within the 30-day window 
period, N makes a new election permitted under the plan to receive 
10 annual installment payments beginning at age 60 (instead of age 
55). When N is age 59, N elects under the additional deferral 
election provisions, to defer distributions until age 65.
    (ii) Conclusion. In this example, N's election to defer 
distributions until age 65 is a valid election. The two elections N 
makes during the 30-day window period are not additional deferral 
elections described in paragraph (c)(2)(iii) of this section because 
they are made before the first permissible payout date under the 
plan. Therefore, the plan is not precluded from allowing N to make 
the additional deferral election. However, N can make no further 
election to defer distributions beyond age 65 (or accelerate 
distribution before age 65) because this additional deferral 
election can only be made once.


Sec.  1.457-8  Funding rules for eligible plans.

    (a) Eligible governmental plans--(1) In general. In order to be an 
eligible governmental plan, all amounts deferred under the plan, all 
property and rights purchased with such amounts, and all income 
attributable to such amounts, property, or rights, must be held in 
trust for the exclusive benefit of participants and their 
beneficiaries. A trust described in this paragraph (a) that also meets 
the requirements of Sec. Sec.  1.457-3 through 1.457-10 is treated as 
an organization exempt from tax under section 501(a), and a 
participant's or beneficiary's interest in amounts in the trust is 
includible in the gross income of the participants and beneficiaries 
only to the extent, and at the time, provided for in section 457(a) and 
Sec. Sec.  1.457-4 through 1.457-10.
    (2) Trust requirement. (i) A trust described in this paragraph (a) 
must be established pursuant to a written agreement that constitutes a 
valid trust under State law. The terms of the trust must make it 
impossible, prior to the satisfaction of all liabilities with respect 
to participants and their beneficiaries, for any part of the assets and 
income of the trust to be used for, or diverted to, purposes other than 
for the exclusive benefit of participants and their beneficiaries.
    (ii) Amounts deferred under an eligible governmental plan must be 
transferred to a trust within a period that is not longer than is 
reasonable for the proper administration of the participant accounts 
(if any). For purposes of this requirement, the plan may provide for 
amounts deferred for a participant under the plan to be transferred to 
the trust within a specified period after the date the amounts would 
otherwise have been paid to the participant. For example, the plan 
could provide for amounts deferred under the plan at the election of 
the participant to be contributed to the trust within 15 business days 
following the month in which these amounts would otherwise have been 
paid to the participant.
    (3) Custodial accounts and annuity contracts treated as trusts--(i) 
In general. For purposes of the trust requirement of this paragraph 
(a), custodial accounts and annuity contracts described in section 
401(f) that satisfy the requirements of this paragraph (a)(3) are 
treated as trusts under rules similar to the rules of section 401(f). 
Therefore, the provisions of Sec.  1.401(f)-1(b) will generally apply 
to determine whether a custodial account or an annuity contract is 
treated as a trust. The use of a custodial account or annuity contract 
as part of an eligible governmental plan does not preclude the use of a 
trust or another custodial account or annuity contract as part of the 
same plan, provided that all such vehicles satisfy the requirements of 
section 457(g)(1) and (3) and paragraphs (a)(1) and (2) of this section 
and that all assets and income of the plan are held in such vehicles.
    (ii) Custodial accounts--(A) In general. A custodial account is 
treated as a trust, for purposes of section 457(g)(1) and paragraphs 
(a)(1) and (2) of this section, if the custodian is a bank, as 
described in section 408(n), or a person who meets the nonbank trustee 
requirements of paragraph (a)(3)(ii)(B) of this section, and the 
account meets the requirements of paragraphs (a)(1) and (2) of this 
section, other than the requirement that it be a trust.
    (B) Nonbank trustee status. The custodian of a custodial account 
may be a person other than a bank only if the person demonstrates to 
the satisfaction of the Commissioner that the manner in which the 
person will administer the custodial account will be consistent with 
the requirements of section 457(g)(1) and (3). To do so, the person 
must demonstrate that the requirements of Sec.  1.408-2(e)(2) through 
(6) (relating to nonbank trustees) are met. The written application 
must be sent to the address prescribed by the Commissioner in the same 
manner as prescribed under Sec.  1.408-2(e). To the extent that a 
person has already demonstrated to the satisfaction of the Commissioner 
that the person satisfies the requirements of Sec.  1.408-2(e) in 
connection with a qualified trust (or custodial account or annuity 
contract) under section 401(a), that person is deemed to satisfy the 
requirements of this paragraph (a)(3)(ii)(B).
    (iii) Annuity contracts. An annuity contract is treated as a trust 
for purposes of section 457(g)(1) and paragraph (a)(1) of this section 
if the contract is an annuity contract, as defined in section 401(g), 
that has been issued by an insurance company qualified to do business 
in the State, and the contract meets the requirements of paragraphs 
(a)(1) and (2) of this section, other than the requirement that it be a 
trust. An annuity contract does not include a life, health or accident, 
property, casualty, or liability insurance contract.
    (4) Combining assets. [Reserved]
    (b) Eligible plans maintained by tax-exempt entity--(1) General 
rule. In order to be an eligible plan of a tax-exempt entity, the plan 
must be unfunded and plan assets must not be set aside for participants 
or their beneficiaries. Under section 457(b)(6) and this paragraph (b), 
an eligible plan of a tax-exempt entity must provide that all amounts 
deferred under the plan, all property and rights to property (including 
rights as a beneficiary of a contract providing life insurance 
protection) purchased with such amounts, and all income attributable to 
such amounts, property, or rights, must remain (until paid or made 
available to the participant or beneficiary) solely the property and 
rights of the eligible employer (without being restricted to the 
provision of benefits under the plan), subject only to the claims of 
the eligible employer's general creditors.
    (2) Additional requirements. For purposes of a paragraph (b)(1) of 
this section, the plan must be unfunded regardless of whether or not 
the amounts were deferred pursuant to a salary reduction agreement 
between the eligible employer and the participant. Any funding 
arrangement under an eligible plan of a tax-exempt entity that sets 
aside assets for the exclusive benefit of participants violates this 
requirement, and amounts deferred are generally immediately includible 
in the gross income of plan participants and beneficiaries. Nothing in 
this paragraph (b) prohibits an eligible plan from permitting 
participants and their beneficiaries to make an election among 
different investment options available under the plan, such as an 
election affecting the investment of the amounts described in paragraph 
(b)(1) of this section.


Sec.  1.457-9  Effect on eligible plans when not administered in 
accordance with eligibility requirements.

    (a) Eligible governmental plans. A plan of a State ceases to be an 
eligible governmental plan on the first day of the first plan year 
beginning more than

[[Page 41246]]

180 days after the date on which the Commissioner notifies the State in 
writing that the plan is being administered in a manner that is 
inconsistent with one or more of the requirements of Sec. Sec.  1.457-3 
through 1.457-8, or 1.457-10. However, the plan may correct the plan 
inconsistencies specified in the written notification before the first 
day of that plan year and continue to maintain plan eligibility. If a 
plan ceases to be an eligible governmental plan, amounts subsequently 
deferred by participants will be includible in income when deferred, 
or, if later, when the amounts deferred cease to be subject to a 
substantial risk of forfeiture, as provided at Sec.  1.457-11. Amounts 
deferred before the date on which the plan ceases to be an eligible 
governmental plan, and any earnings thereon, will be treated as if the 
plan continues to be an eligible governmental plan and will not be 
includible in participant's or beneficiary's gross income until paid to 
the participant or beneficiary.
    (b) Eligible plans of tax-exempt entities. A plan of a tax-exempt 
entity ceases to be an eligible plan on the first day that the plan 
fails to satisfy one or more of the requirements of Sec. Sec.  1.457-3 
through 1.457-8, or Sec.  1.457-10. See Sec.  1.457-11 for rules 
regarding the treatment of an ineligible plan.


Sec.  1.457-10  Miscellaneous provisions.

    (a) Plan terminations and frozen plans--(1) In general. An eligible 
employer may amend its plan to eliminate future deferrals for existing 
participants or to limit participation to existing participants and 
employees. An eligible plan may also contain provisions that permit 
plan termination and permit amounts deferred to be distributed on 
termination. In order for a plan to be considered terminated, amounts 
deferred under an eligible plan must be distributed to all plan 
participants and beneficiaries as soon as administratively practicable 
after termination of the eligible plan. The mere provision for, and 
making of, distributions to participants or beneficiaries upon a plan 
termination will not cause an eligible plan to cease to satisfy the 
requirements of section 457(b) or the regulations.
    (2) Employers that cease to be eligible employers--(i) Plan not 
terminated. An eligible employer that ceases to be an eligible employer 
may no longer maintain an eligible plan. If the employer was a tax-
exempt entity and the plan is not terminated as permitted under a 
paragraph (a)(2)(ii) of this section, the tax consequences to 
participants and beneficiaries in the previously eligible (unfunded) 
plan of an ineligible employer are determined in accordance with either 
section 451 if the employer becomes an entity other than a State or 
Sec.  1.457-11 if the employer becomes a State. If the employer was a 
State and the plan is neither terminated as permitted under paragraph 
(a)(2)(ii) of this section nor transferred to another eligible plan of 
that State as permitted under paragraph (b) of this section, the tax 
consequences to participants in the previously eligible governmental 
plan of an ineligible employer, the assets of which are held in trust 
pursuant to Sec.  1.457-8(a), are determined in accordance with section 
402(b) (section 403(c) in the case of an annuity contract) and the 
trust is no longer to be treated as a trust that is exempt from tax 
under section 501(a).
    (ii) Plan termination. As an alternative to determining the tax 
consequences to the plan and participants under paragraph (a)(2)(i) of 
this section, the employer may terminate the plan and distribute the 
amounts deferred (and all plan assets) to all plan participants as soon 
as administratively practicable in accordance with paragraph (a)(1) of 
this section. Such distribution may include eligible rollover 
distributions in the case of a plan that was an eligible governmental 
plan. In addition, if the employer is a State, another alternative to 
determining the tax consequences under paragraph (a)(2)(i) of this 
section is to transfer the assets of the eligible governmental plan to 
an eligible governmental plan of another eligible employer within the 
same State under the plan-to-plan transfer rules of paragraph (b) of 
this section.
    (3) Examples. The provisions of this paragraph (a) are illustrated 
by the following examples:

     Example 1. (i) Facts. Employer Y, a corporation that owns a 
State hospital, sponsors an eligible governmental plan funded 
through a trust. Employer Y is acquired by a for-profit hospital and 
Employer Y ceases to be an eligible employer under section 457(e)(1) 
or Sec.  1.457-2(e). Employer Y terminates the plan and, during the 
next 6 months, distributes to participants and beneficiaries all 
amounts deferred that were under the plan.
    (ii) Conclusion. The termination and distribution does not cause 
the plan to fail to be an eligible governmental plan. Amounts that 
are distributed as eligible rollover distributions may be rolled 
over to an eligible retirement plan described in section 
402(c)(8)(B).
     Example 2. (i) Facts. The facts are the same as in Example 1, 
except that Employer Y decides to continue to maintain the plan.
    (ii) Conclusion. If Employer Y continues to maintain the plan, 
the tax consequences to participants and beneficiaries will be 
determined in accordance with either section 402(b) if the 
compensation deferred is funded through a trust, section 403(c) if 
the compensation deferred is funded through annuity contracts, or 
Sec.  1.457-11 if the compensation deferred is not funded through a 
trust or annuity contract. In addition, if Employer Y continues to 
maintain the plan, the trust will no longer be treated as exempt 
from tax under section 501(a).
    Example 3. (i) Facts. Employer Z, a corporation that owns a tax-
exempt hospital, sponsors an unfunded eligible plan. Employer Z is 
acquired by a for-profit hospital and is no longer an eligible 
employer under section 457(e)(1) or Sec.  1.457-2(e). Employer Z 
terminates the plan and distributes all amounts deferred under the 
eligible plan to participants and beneficiaries within a one-year 
period.
    (ii) Conclusion. Distributions under the plan are treated as 
made under an eligible plan of a tax-exempt entity and the 
distributions of the amounts deferred are includible in the gross 
income of the participant or beneficiary in the year distributed.
    Example 4. (i) Facts. The facts are the same as in Example 3, 
except that Employer Z decides to maintain instead of terminate the 
plan.
    (ii) Conclusion. If Employer Z maintains the plan, the tax 
consequences to participants and beneficiaries in the plan will 
thereafter be determined in accordance with section 451.

    (b) Plan-to-plan transfers--(1) General rule. An eligible 
governmental plan may provide for the transfer of amounts deferred by a 
participant or beneficiary to another eligible governmental plan if the 
conditions in paragraph (b)(2), (3), or (4) of this section are met. An 
eligible plan of a tax-exempt entity may provide for transfers of 
amounts deferred by a participant to another eligible plan of a tax-
exempt entity if the conditions in paragraph (b)(5) of this section are 
met. In addition, an eligible governmental plan may accept transfers 
from another eligible governmental plan as described in the first 
sentence of this paragraph (b)(1), and an eligible plan of a tax-exempt 
entity may accept transfers from another eligible plan of a tax-exempt 
entity as described in the preceding sentence. However, a State may not 
transfer the assets of its eligible governmental plan to a tax-exempt 
entity's eligible plan and the plan of a tax-exempt entity may not 
accept such a transfer. Similarly, a tax-exempt entity may not transfer 
the assets of its eligible plan to an eligible governmental plan and an 
eligible governmental plan may not accept such a transfer. In addition, 
if the conditions in paragraph (b)(4) of this section (relating to 
permissive past service credit and repayments under section 415) are 
met, an eligible governmental plan of a State may provide for the 
transfer of amounts

[[Page 41247]]

deferred by a participant or beneficiary to a qualified plan (under 
section 401(a)) maintained by a State. However, a qualified plan may 
not transfer assets to an eligible governmental plan or to an eligible 
plan of a tax-exempt entity, and an eligible governmental plan or the 
plan of a tax-exempt entity may not accept such a transfer.
    (2) Requirements for post-severance plan-to-plan transfers among 
eligible governmental plans. A transfer under paragraph (b)(1) of this 
section from an eligible governmental plan to another eligible 
governmental plan is permitted if the following conditions are met--
    (i) The transferor plan provides for transfers;
    (ii) The receiving plan provides for the receipt of transfers;
    (iii) The participant or beneficiary whose amounts deferred are 
being transferred will have an amount deferred immediately after the 
transfer at least equal to the amount deferred with respect to that 
participant or beneficiary immediately before the transfer; and
    (iv) In the case of a transfer for a participant, the participant 
has had a severance from employment with the transferring employer and 
is performing services for the entity maintaining the receiving plan.
    (3) Requirements for plan-to-plan transfers of all plan assets of 
eligible governmental plan. A transfer under paragraph (b)(1) of this 
section from an eligible governmental plan to another eligible 
governmental plan is permitted if the following conditions are met--
    (i) The transfer is from an eligible governmental plan to another 
eligible governmental plan within the same State;
    (ii) All of the assets held by the transferor plan are transferred;
    (iii) The transferor plan provides for transfers;
    (iv) The receiving plan provides for the receipt of transfers;
    (v) The participant or beneficiary whose amounts deferred are being 
transferred will have an amount deferred immediately after the transfer 
at least equal to the amount deferred with respect to that participant 
or beneficiary immediately before the transfer; and
    (vi) The participants or beneficiaries whose deferred amounts are 
being transferred are not eligible for additional annual deferrals in 
the receiving plan unless they are performing services for the entity 
maintaining the receiving plan.
    (4) Requirements for plan-to-plan transfers among eligible 
governmental plans of the same employer. A transfer under paragraph 
(b)(1) of this section from an eligible governmental plan to another 
eligible governmental plan is permitted if the following conditions are 
met--
    (i) The transfer is from an eligible governmental plan to another 
eligible governmental plan of the same employer (and, for this purpose, 
the employer is not treated as the same employer if the participant's 
compensation is paid by a different entity);
    (ii) The transferor plan provides for transfers;
    (iii) The receiving plan provides for the receipt of transfers;
    (iv) The participant or beneficiary whose amounts deferred are 
being transferred will have an amount deferred immediately after the 
transfer at least equal to the amount deferred with respect to that 
participant or beneficiary immediately before the transfer; and
    (v) The participant or beneficiary whose deferred amounts are being 
transferred is not eligible for additional annual deferrals in the 
receiving plan unless the participant or beneficiary is performing 
services for the entity maintaining the receiving plan.
    (5) Requirements for post-severance plan-to-plan transfers among 
eligible plans of tax-exempt entities. A transfer under paragraph 
(b)(1) of this section from an eligible plan of a tax-exempt employer 
to another eligible plan of a tax-exempt employer is permitted if the 
following conditions are met--
    (i) The transferor plan provides for transfers;
    (ii) The receiving plan provides for the receipt of transfers;
    (iii) The participant or beneficiary whose amounts deferred are 
being transferred will have an amount deferred immediately after the 
transfer at least equal to the amount deferred with respect to that 
participant or beneficiary immediately before the transfer; and
    (iv) In the case of a transfer for a participant, the participant 
has had a severance from employment with the transferring employer and 
is performing services for the entity maintaining the receiving plan.
    (6) Treatment of amount transferred following a plan-to-plan 
transfer between eligible plans. Following a transfer of any amount 
between eligible plans under paragraphs (b)(1) through (b)(5) of this 
section--
    (i) The transferred amount is subject to the restrictions of Sec.  
1.457-6 (relating to when distributions are permitted to be made to a 
participant under an eligible plan) in the receiving plan in the same 
manner as if the transferred amount had been originally been deferred 
under the receiving plan if the participant is performing services for 
the entity maintaining the receiving plan, and
    (ii) In the case of a transfer between eligible plans of tax-exempt 
entities, except as otherwise determined by the Commissioner, the 
transferred amount is subject to Sec.  1.457-7(c)(2) (relating to when 
amounts are considered to be made available under an eligible plan of a 
tax-exempt entity) in the same manner as if the elections made by the 
participant or beneficiary under the transferor plan had been made 
under the receiving plan.
    (7) Examples. The provisions of paragraphs (b)(1) through (6) of 
this section are illustrated by the following examples:

    Example 1. (i) Facts. Participant A, the president of City X's 
hospital, has accepted a position with another hospital which is a 
tax-exempt entity. A participates in the eligible governmental plan 
of City X. A would like to transfer the amounts deferred under City 
X's eligible governmental plan to the eligible plan of the tax-
exempt hospital.
    (ii) Conclusion. City X's plan may not transfer A's amounts 
deferred to the tax-exempt employer's eligible plan. In addition, 
because the amounts deferred would no longer be held in trust for 
the exclusive benefit of participants and their beneficiaries, the 
transfer would violate the exclusive benefit rule of section 457(g) 
and Sec.  1.457-8(a).
    Example 2. (i) Facts. County M, located in State S, operates 
several health clinics and maintains an eligible governmental plan 
for employees of those clinics. One of the clinics operated by 
County M is being acquired by a hospital operated by State S, and 
employees of that clinic will become employees of State S. County M 
permits those employees to transfer their balances under County M's 
eligible governmental plan to the eligible governmental plan of 
State S.
    (ii) Conclusion. If the eligible governmental plans of County M 
and State S provide for the transfer and acceptance of the transfer 
(and the other requirements of paragraph (b)(1) of this section are 
satisfied), then the requirements of paragraph (b)(2) of this 
section are satisfied and, thus, the transfer will not cause either 
plan to violate the requirements of section 457 or these 
regulations.
    Example 3. (i) Facts. City Employer Z, a hospital, sponsors an 
eligible governmental plan. City Employer Z is located in State B. 
All of the assets of City Employer Z are being acquired by a tax-
exempt hospital. City Employer Z, in accordance with the plan-to-
plan transfer rules of paragraph (b) of this section, would like to 
transfer the total amount of assets deferred under City Employer Z's 
eligible governmental plan to the acquiring tax-exempt entity's 
eligible plan.
    (ii) Conclusion. City Employer Z may not permit participants to 
transfer the amounts to

[[Page 41248]]

the eligible plan of the tax-exempt entity. In addition, because the 
amounts deferred would no longer be held in trust for the exclusive 
benefit of participants and their beneficiaries, the transfer would 
violate the exclusive benefit rule of section 457(g) and Sec.  
1.457-8(a).
    Example 4. (i) Facts. The facts are the same as in Example 3, 
except that City Employer Z, instead of transferring all of its 
assets to the eligible plan of the tax-exempt entity, decides to 
transfer all of the amounts deferred under City Z's eligible 
governmental plan to the eligible governmental plan of County B in 
which City Z is located. County B's eligible plan does not cover 
employees of City Z, but is willing to allow the assets of City Z's 
plan to be transferred to County B's plan, a related state 
government entity, also located in State B.
    (ii) Conclusion. If City Employer Z's (transferor) eligible 
governmental plan provides for such transfer and the eligible 
governmental plan of County B permits the acceptance of such a 
transfer (and the other requirements of paragraph (b)(1) of this 
section are satisfied), then the requirements of paragraph (b)(3) of 
this section are satisfied and, thus, City Employer Z may transfer 
the total amounts deferred under its eligible governmental plan, 
prior to termination of that plan, to the eligible governmental plan 
maintained by County B. However, the participants of City Employer Z 
whose deferred amounts are being transferred are not eligible to 
participate in the eligible governmental plan of County B, the 
receiving plan, unless they are performing services for County B.
    Example 5. (i) Facts. State C has an eligible governmental plan. 
Employees of City U in State C are among the eligible employees for 
State C's plan and City U decides to adopt another eligible 
governmental plan only for its employees. State C decides to allow 
employees to elect to transfer all of the amounts deferred for an 
employee under State C's eligible governmental plan to City U's 
eligible governmental plan.
    (ii) Conclusion. If State C's (transferor) eligible governmental 
plan provides for such transfer and the eligible governmental plan 
of City U permits the acceptance of such a transfer (and the other 
requirements of paragraph (b)(1) of this section are satisfied), 
then the requirements of paragraph (b)(4) of this section are 
satisfied and, thus, State C may transfer the total amounts deferred 
under its eligible governmental plan to the eligible governmental 
plan maintained by City U.

    (8) Purchase of permissive past service credit by plan-to-plan 
transfers from an eligible governmental plan to a qualified plan--(i) 
General rule. An eligible governmental plan of a State may provide for 
the transfer of amounts deferred by a participant or beneficiary to a 
defined benefit governmental plan (as defined in section 414(d)), and 
no amount shall be includible in gross income by reason of the 
transfer, if the conditions in paragraph (b)(8)(ii) of this section are 
met. A transfer under this paragraph (b)(8) is not treated as a 
distribution for purposes of Sec.  1.457-6. Therefore, such a transfer 
may be made before severance from employment.
    (ii) Conditions for plan-to-plan transfers from an eligible 
governmental plan to a qualified plan. A transfer may be made under 
this paragraph (b)(8) only if the transfer is either--
    (A) For the purchase of permissive past service credit (as defined 
in section 415(n)(3)(A)) under the receiving defined benefit 
governmental plan; or
    (B) A repayment to which section 415 does not apply by reason of 
section 415(k)(3).
    (iii) Example. The provisions of this paragraph (b)(8) are 
illustrated by the following example:

    Example. (i) Facts. Plan X is an eligible governmental plan 
maintained by County Y for its employees. Plan X provides for 
distributions only in the event of death, an unforeseeable 
emergency, or severance from employment with County Y (including 
retirement from County Y). Plan S is a qualified defined benefit 
plan maintained by State T for its employees. County Y is within 
State T. Employee A is an employee of County Y and is a participant 
in Plan X. Employee A previously was an employee of State T and is 
still entitled to benefits under Plan S. Plan S includes provisions 
allowing participants in certain plans, including Plan X, to 
transfer assets to Plan S for the purchase of past service credit 
under Plan S and does not permit the amount transferred to exceed 
the amount necessary to fund the benefit resulting from the past 
service credit. Although not required to do so, Plan X allows 
Employee A to transfer assets to Plan S to provide a past service 
benefit under Plan S.
    (ii) Conclusion. The transfer is permitted under this paragraph 
(b)(8).

    (c) Qualified domestic relations orders under eligible plans--(1) 
General rule. An eligible plan does not become an ineligible plan 
described in section 457(f) solely because its administrator or sponsor 
complies with a qualified domestic relations order as defined in 
section 414(p), including an order requiring the distribution of the 
benefits of a participant to an alternate payee in advance of the 
general rules for eligible plan distributions under Sec.  1.457-6. If a 
distribution or payment is made from an eligible plan to an alternate 
payee pursuant to a qualified domestic relations order, rules similar 
to the rules of section 402(e)(1)(A) shall apply to the distribution or 
payment.
    (2) Examples. The provisions of this paragraph (c) are illustrated 
by the following examples:

    Example 1. (i) Facts. Participant C and C's spouse D are 
divorcing. C is employed by State S and is a participant in an 
eligible plan maintained by State S. C has an account valued at 
$100,000 under the plan. Pursuant to the divorce, a court issues a 
qualified domestic relations order on September 1, 2003 that 
allocates 50 percent of C's $100,000 plan account to D and 
specifically provides for an immediate distribution to D of D's 
share within 6 months of the order. Payment is made to D in January 
of 2004.
    (ii) Conclusion. State S's eligible plan does not become an 
ineligible plan described in section 457(f) and Sec.  1.457-11 
solely because its administrator or sponsor complies with the 
qualified domestic relations order requiring the immediate 
distribution to D in advance of the general rules for eligible plan 
distributions under Sec.  1.457-6. In accordance with section 
402(e)(1)(A), D (not C) must include the distribution in gross 
income. The distribution is includible in D's gross income in 2004. 
If the qualified domestic relations order were to provide for 
distribution to D at a future date, amounts deferred attributable to 
D's share will be includible in D's gross income when paid to D.
    Example 2. (i) Facts. The facts are the same as in Example 1, 
except that S is a tax-exempt entity, instead of a State.
    (ii) Conclusion. State S's eligible plan does not become an 
ineligible plan described in section 457(f) and Sec.  1.457-11 
solely because its administrator or sponsor complies with the 
qualified domestic relations order requiring the immediate 
distribution to D in advance of the general rules for eligible plan 
distributions under Sec.  1.457-6. In accordance with section 
402(e)(1)(A), D (not C) must include the distribution in gross 
income. The distribution is includible in D's gross income in 2004, 
assuming that the plan did not make the distribution available to D 
in 2003. If the qualified domestic relations order were to provide 
for distribution to D at a future date, amounts deferred 
attributable to D's share would be includible in D's gross income 
when paid or made available to D.

    (d) Death benefits and life insurance proceeds. A death benefit 
plan under section 457(e)(11) is not an eligible plan. In addition, no 
amount paid or made available under an eligible plan as death benefits 
or life insurance proceeds is excludable from gross income under 
section 101.
    (e) Rollovers to eligible governmental plans--(1) General rule. An 
eligible governmental plan may accept contributions that are eligible 
rollover distributions (as defined in section 402(c)(4)) made from 
another eligible retirement plan (as defined in section 402(c)(8)(B)) 
if the conditions in paragraph (e)(2) of this section are met. Amounts 
contributed to an eligible governmental plan as eligible rollover 
distributions are not taken into account for purposes of the annual 
limit on annual deferrals by a participant in Sec.  1.457-4(c) or Sec.  
1.457-5, but are otherwise treated in the same manner as amounts 
deferred under section 457 for purposes of Sec. Sec.  1.457-3 through 
1.457-9 and this section.

[[Page 41249]]

    (2) Conditions for rollovers to an eligible governmental plan. An 
eligible governmental plan that permits eligible rollover distributions 
made from another eligible retirement plan to be paid into the eligible 
governmental plan is required under this paragraph (e)(2) to provide 
that it will separately account for any eligible rollover distributions 
it receives. A plan does not fail to satisfy this requirement if it 
separately accounts for particular types of eligible rollover 
distributions (for example, if it maintains a separate account for 
eligible rollover distributions attributable to annual deferrals that 
were made under other eligible governmental plans and a separate 
account for amounts attributable to other eligible rollover 
distributions), but this requirement is not satisfied if any such 
separate account includes any amount that is not attributable to an 
eligible rollover distribution.
    (3) Example. The provisions of this paragraph (e) are illustrated 
by the following example:

    Example. (i) Facts. Plan T is an eligible governmental plan that 
provides that employees who are eligible to participate in Plan T 
may make rollover contributions to Plan T from amounts distributed 
to an employee from an eligible retirement plan. An eligible 
retirement plan is defined in Plan T as another eligible 
governmental plan, a qualified section 401(a) or 403(a) plan, or a 
section 403(b) contract, or an individual retirement arrangement 
(IRA) that holds such amounts. Plan T requires rollover 
contributions to be paid by the eligible retirement plan directly to 
Plan T (a direct rollover) or to be paid by the participant within 
60 days after the date on which the participant received the amount 
from the other eligible retirement plan. Plan T does not take 
rollover contributions into account for purposes of the plan's 
limits on amounts deferred that conform to Sec.  1.457-4(c). 
Rollover contributions paid to Plan T are invested in the trust in 
the same manner as amounts deferred under Plan T and rollover 
contributions (and earnings thereon) are available for distribution 
to the participant at the same time and in the same manner as 
amounts deferred under Plan T. In addition, Plan T provides that, 
for each participant who makes a rollover contribution to Plan T, 
the Plan T record-keeper is to establish a separate account for the 
participant's rollover contributions. The record-keeper calculates 
earnings and losses for investments held in the rollover account 
separately from earnings and losses on other amounts held under the 
plan and calculates disbursements from and payments made to the 
rollover account separately from disbursements from and payments 
made to other amounts held under the plan.
    (ii) Conclusion. Plan T does not lose its status as an eligible 
governmental plan as a result of the receipt of rollover 
contributions. The conclusion would not be different if the Plan T 
record-keeper were to establish two separate accounts, one of which 
is for the participant's rollover contributions attributable to 
annual deferrals that were made under an eligible governmental plan 
and the other of which is for other rollover contributions.

    (f) Deemed IRAs under eligible governmental plans. See regulations 
under section 408(q) for guidance regarding the treatment of separate 
accounts or annuities as individual retirement plans (IRAs). Sec.  
1.457-11 Tax treatment of participants if plan is not an eligible plan.
    (a) In general. Under section 457(f), if an eligible employer 
provides for a deferral of compensation under any agreement or 
arrangement that is an ineligible plan--
    (1) Compensation deferred under the agreement or arrangement is 
includible in the gross income of the participant or beneficiary for 
the first taxable year in which there is no substantial risk of 
forfeiture (within the meaning of section 457(f)(3)(B)) of the rights 
to such compensation;
    (2) If the compensation deferred is subject to a substantial risk 
of forfeiture, the amount includible in gross income for the first 
taxable year in which there is no substantial risk of forfeiture 
includes earnings thereon to the date on which there is no substantial 
risk of forfeiture;
    (3) Earnings credited on the compensation deferred under the 
agreement or arrangement that are not includible in gross income under 
paragraph (a)(2) of this section are includible in the gross income of 
the participant or beneficiary only when paid or made available to the 
participant or beneficiary, provided that the interest of the 
participant or beneficiary in any assets (including amounts deferred 
under the plan) of the entity sponsoring the agreement or arrangement 
is not senior to the entity's general creditors; and
    (4) Amounts paid or made available to a participant or beneficiary 
under the agreement or arrangement are includible in the gross income 
of the participant or beneficiary under section 72, relating to 
annuities.
    (b) Exceptions. Paragraph (a) of this section does not apply with 
respect to--
    (1) A plan described in section 401(a) which includes a trust 
exempt from tax under section 501(a);
    (2) An annuity plan or contract described in section 403;
    (3) That portion of any plan which consists of a transfer of 
property described in section 83;
    (4) That portion of any plan which consists of a trust to which 
section 402(b) applies; or
    (5) A qualified governmental excess benefit arrangement described 
in section 415(m).
    (c) Amount included in income. The amount included in gross income 
on the applicable date under paragraphs (a)(1) and (a)(2) of this 
section is equal to the present value of the compensation (including 
earnings to the extent provided in paragraph (a)(2) of this section) on 
that date. For purposes of applying section 72 on the applicable date 
under paragraphs (a)(3) and (4) of this section, the participant is 
treated as having paid investment in the contract (or basis) to the 
extent that the deferred compensation has been taken into account by 
the participant in accordance with paragraphs (a)(1) and (a)(2) of this 
section.
    (d) Coordination of section 457(f) with section 83-- (1) General 
rules. Under paragraph (b)(3) of this section, section 457(f) and 
paragraph (a) of this section do not apply to that portion of any plan 
which consists of a transfer of property described in section 83. For 
this purpose, a transfer of property described in section 83 means a 
transfer of property to which section 83 applies. Section 457(f) and 
paragraph (a) of this section do not apply if the date on which there 
is no substantial risk of forfeiture with respect to compensation 
deferred under an agreement or arrangement that is not an eligible plan 
is on or after the date on which there is a transfer of property to 
which section 83 applies. However, section 457(f) and paragraph (a) of 
this section apply if the date on which there is no substantial risk of 
forfeiture with respect to compensation deferred under an agreement or 
arrangement that is not an eligible plan precedes the date on which 
there is a transfer of property to which section 83 applies. If 
deferred compensation payable in property is includible in gross income 
under section 457(f), then, as provided in section 72, the amount 
includible in gross income when that property is later transferred or 
made available to the service provider is the excess of the value of 
the property at that time over the amount previously included in gross 
income under section 457(f).
    (2) Examples. The provisions of this paragraph (d) are illustrated 
in the following examples:

    Example 1. (i) Facts. As part of an arrangement for the deferral 
of compensation, an eligible employer agrees on December 1, 2002 to 
pay an individual rendering services for the eligible employer a 
specified dollar amount on January 15, 2005. The arrangement 
provides for the payment to be made in the form of property having a 
fair market value equal to the specified dollar

[[Page 41250]]

amount. The individual's rights to the payment are not subject to a 
substantial risk of forfeiture (within the meaning of section 
457(f)(3)(B)).
    (ii) Conclusion. In this Example 1, because there is no 
substantial risk of forfeiture with respect to the agreement to 
transfer property in 2005, the present value (as of December 1, 
2002) of the payment is includible in the individual's gross income 
for 2002. Under paragraph (a)(4) of this section, when the payment 
is made on January 15, 2005, the amount includible in the 
individual's gross income is equal to the excess of the fair market 
value of the property when paid, over the amount that was includible 
in gross income for 2002 (which is the basis allocable to that 
payment).
    Example 2.  (i) Facts. As part of an arrangement for the 
deferral of compensation, individuals A and B rendering services for 
a tax-exempt entity each receive in 2010 property that is subject to 
a substantial risk of forfeiture (within the meaning of section 
457(f)(3)(B) and within the meaning of section 83(c)(1)). Individual 
A makes an election to include the fair market value of the property 
in gross income under section 83(b) and individual B does not make 
this election. The substantial risk of forfeiture for the property 
transferred to individual A lapses in 2012 and the substantial risk 
of forfeiture for the property transferred to individual B also 
lapses in 2012. Thus, the property transferred to individual A is 
included in A's gross income for 2010 when A makes a section 83(b) 
election and the property transferred to individual B is included in 
B's gross income for 2012 when the substantial risk of forfeiture 
for the property lapses.
    (ii) Conclusion. In this Example 2, in each case, the 
compensation deferred is not subject to section 457(f) or this 
section because section 83 applies to the transfer of property on or 
before the date on which there is no substantial risk of forfeiture 
with respect to compensation deferred under the arrangement.
    Example 3.  (i) Facts. In 2004, Z, a tax-exempt entity, grants 
an option to acquire property to employee C. The option lacks a 
readily ascertainable fair market value, within the meaning of 
section 83(e)(3), has a value on the date of grant equal to 
$100,000, and is not subject to a substantial risk of forfeiture 
(within the meaning of section 457(f)(3)(B) and within the meaning 
of section 83(c)(1)). Z exercises the option in 2012 by paying an 
exercise price of $75,000 and receives property that has a fair 
market value (for purposes of section 83) equal to $300,000.
    (ii) Conclusion. In this Example 3, under section 83(e)(3), 
section 83 does not apply to the grant of the option. Accordingly, C 
has income of $100,000 in 2004 under section 457(f). In 2012, C has 
income of $125,000, which is the value of the property transferred 
in 2012, minus the allocable portion of the basis that results from 
the $100,000 of income in 2004 and the $75,000 exercise price.
    Example 4.  (i) Facts. In 2010, X, a tax-exempt entity, agrees 
to pay deferred compensation to employee D. The amount payable is 
$100,000 to be paid 10 years later in 2020. The commitment to make 
the $100,000 payment is not subject to a substantial risk of 
forfeiture. In 2010, the present value of the $100,000 is $50,000. 
In 2018, X transfers to D property having a fair market value (for 
purposes of section 83) equal to $70,000. The transfer is in partial 
settlement of the commitment made in 2010 and, at the time of the 
transfer in 2018, the present value of the commitment is $80,000. In 
2020, X pays D the $12,500 that remains due.
    (ii) Conclusion. In this Example 4, D has income of $50,000 in 
2010. In 2018, D has income of $30,000, which is the amount 
transferred in 2018, minus the allocable portion of the basis that 
results from the $50,000 of income in 2010. (Under section 
72(e)(2)(B), income is allocated first. The income is equal to 
$30,000 ($80,000 minus the $50,000 basis), with the result that the 
allocable portion of the basis is equal to $40,000 ($70,000 minus 
the $30,000 of income).) In 2020, D has income of $2,500 ($12,500 
minus $10,000, which is the excess of the original $50,000 basis 
over the $40,000 basis allocated to the transfer made in 2018).


Sec.  1.457-12  Effective dates.

    (a) General effective date. Except as otherwise provided in this 
section, Sec. Sec.  1.457-1 through 1.457-11 apply for taxable years 
beginning after December 31, 2001.
    (b) Transition period for eligible plans to comply with EGTRRA. For 
taxable years beginning after December 31, 2001, and before January 1, 
2004, a plan does not fail to be an eligible plan as a result of 
requirements imposed by the Economic Growth and Tax Relief 
Reconciliation Act of 2001 (115 Stat. 385) (EGTRRA) (Public Law 107-16) 
June 7, 2001, if it is operated in accordance with a reasonable, good 
faith interpretation of EGTRRA.
    (c) Special rule for distributions from rollover accounts. The last 
sentence of Sec.  1.457-6(a) (relating to distributions of amounts held 
in a separate account for eligible rollover distributions) applies for 
taxable years beginning after December 31, 2003.
    (d) Special rule for options. Section 1.457-11(d) does not apply 
with respect to an option without a readily ascertainable fair market 
value (within the meaning of section 83(e)(3)) that was granted on or 
before May 8, 2002.
    (e) Special rule for qualified domestic relations orders. Section 
1.457-10(c) (relating to qualified domestic relations orders) applies 
for transfers, distributions, and payments made after December 31, 
2001.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

0
Par. 4. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.


0
Par. 5. In Sec.  602.101, paragraph (b) is amended by adding an entry 
in numerical order to the table to read as follows:


Sec.  602.101  OMB Control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
                                                             Current OMB
     CFR part or section where identified and described      control No.
------------------------------------------------------------------------
 
                                * * * * *
1.457-8....................................................    1545-1580
 
                                * * * * *
------------------------------------------------------------------------


Robert E. Wenzel,
Deputy Commissioner for Services and Enforcement.
    Approved: July 2, 2003.
Pamela F. Olson,
Assistant Secretary of Treasury (Tax Policy)
[FR Doc. 03-17523 Filed 7-10-03; 8:45 am]
BILLING CODE 4830-01-P