[Federal Register Volume 71, Number 140 (Friday, July 21, 2006)]
[Rules and Regulations]
[Pages 41357-41359]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-11545]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9275]
RIN 1545-BC87


Exclusion of Employees of 501(c)(3) Organizations in 401(k) and 
401(m) Plans

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations under section 410(b) 
of the Internal Revenue Code. The final regulations permit, in certain 
circumstances, employees of a tax-exempt organization described in 
section 501(c)(3) to be excluded for the purpose of testing whether a 
section 401(k) plan (or a section 401(m) plan that is provided under 
the same general arrangement as the section 401(k) plan of the 
employer) meets the requirements for minimum coverage specified in 
section 410(b). These regulations affect tax-exempt employers described 
in section 501(c)(3), retirement plans sponsored by these employers, 
and participants in these plans.

DATES: Effective Date: July 21, 2006.
    Applicability Date: These regulations apply to plan years beginning 
after December 31, 1996.

FOR FURTHER INFORMATION CONTACT: Linda L. Conway, 202-622-6060, or 
Michael P. Brewer, 202-622-6090 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    This document contains final amendments to the Income Tax 
Regulations (26 CFR part 1) under section 410(b) of the Internal 
Revenue Code of 1986 (Code). On March 16, 2004, a notice of proposed 
rulemaking (REG-149752-03) was published in the Federal Register (69 FR 
12291) under section 410(b). The regulations implement a directive by 
Congress, contained in section 664 of the Economic Growth and Tax 
Relief Reconciliation Act of 2001 (Pub. L. 107-16, 115 Stat. 38) 
(EGTRRA), to amend Sec.  1.410(b)-6(g) of the regulations.
    Prior to the enactment of the Small Business Job Protection Act of 
1996 (Pub. L. 104-188, 110 Stat. 1755) (SBJPA), both governmental and 
tax-exempt entities generally were subject to the section 410(b) 
coverage requirements and precluded from maintaining section 401(k) 
plans pursuant to section 401(k)(4)(B). To prevent the section 
401(k)(4)(B) prohibition from causing a plan to fail section 410(b), 
the existing regulations provide that employees of either governmental 
or tax-exempt entities who are precluded from being eligible employees 
under a section 401(k) plan by reason of section 401(k)(4)(B) may be 
treated as excludable in applying the minimum coverage rules to a 
section 401(k) plan or a section 401(m) plan that is provided under the 
same general arrangement as the section 401(k) plan, if more than 95 
percent of the employees of the employer who are not precluded from 
being eligible employees by section 401(k)(4)(B) benefit under the plan 
for the plan year. Although tax-exempt organizations described in 
section 501(c)(3) were precluded by section 401(k)(4)(B) from 
maintaining a section 401(k) plan, they were permitted to allow their 
employees to make salary reduction contributions to a plan or contract 
that satisfies section 403(b) (a section 403(b) plan).
    Section 1426(a) of SBJPA amended section 401(k)(4)(B), effective 
for plan years beginning after December 31, 1996, to allow 
nongovernmental tax-exempt organizations (including organizations 
exempt under section 501(c)(3)) to maintain section 401(k) plans. Thus, 
a section 501(c)(3) tax-exempt organization can now maintain a section 
401(k) plan, a section 403(b) plan, or both. Prior to the enactment of 
SBJPA, many eligible tax-exempt organizations maintained section 403(b) 
plans. In light of this provision of SBJPA, section 664 of EGTRRA 
directed the Secretary of the Treasury to modify the regulations under 
section 410(b) to provide that employees of an organization described 
in section 403(b)(1)(A)(i) (a section 501(c)(3) organization) who are 
eligible to make contributions under section 403(b) pursuant to a 
salary reduction agreement may be treated as excludable with respect to 
a plan under section 401(k) or a plan under section 401(m) that is 
provided under the same general arrangement as a plan under section 
401(k), if (1) no employee of an organization described in section 
403(b)(1)(A)(i) is eligible to participate in such section 401(k) plan 
or section 401(m) plan and (2) 95 percent of the

[[Page 41358]]

employees who are not employees of an organization described in section 
403(b)(1)(A)(i) are eligible to participate in such plan under such 
section 401(k) or (m).
    The amendment to Sec.  1.410(b)-6(g) of the regulations pursuant to 
section 664 of EGTRRA allows the continued maintenance of section 
403(b) plans by these organizations without requiring the same 
employees to be covered under a section 401(k) plan and the section 
403(b) plan. In certain circumstances, the amendments will help an 
employer that maintains both a section 401(k) plan and a section 403(b) 
plan that provides for contributions under a salary reduction agreement 
(within the meaning of section 402(g)) to satisfy the section 410(b) 
coverage requirements with respect to the section 401(k) plan without 
the employer having to provide dual coverage for employees.
    Only a few comments were received on the proposed regulations. No 
public hearing was requested or held. After consideration of the 
comments received, the final regulations adopt the provisions of the 
proposed regulations with certain modifications described below.

Explanation of Provisions

    These final regulations retain the rule that provides that 
employees of governmental entities who are precluded from being 
eligible employees under a section 401(k) plan by reason of section 
401(k)(4)(B)(ii) may be treated as excludable employees if more than 95 
percent of the employees of the employer who are not precluded from 
being eligible employees by reason of section 401(k)(4)(B)(ii) benefit 
under the plan for the year.
    As directed by section 664 of EGTRRA, these final regulations also 
provide that employees of a section 501(c)(3) organization who are 
eligible to make contributions under section 403(b) pursuant to a 
salary reduction agreement (within the meaning of section 402(g)) may 
be treated as excludable with respect to a section 401(k) plan, or a 
section 401(m) plan that is provided under the same general arrangement 
as a section 401(k) plan, if (1) no employee of a section 501(c)(3) 
organization is eligible to participate in such section 401(k) plan or 
section 401(m) plan; and (2) at least 95 percent of the employees who 
are neither employees of a section 501(c)(3) organization nor employees 
of a governmental entity who are precluded from being eligible 
employees under a section 401(k) plan by reason of section 
401(k)(4)(B)(ii) are eligible to participate in such section 401(k) 
plan or section 401(m) plan.
    The proposed regulations, in an attempt to simplify the language in 
section 664 of EGTRRA, would have provided that, for purposes of 
testing either a section 401(k) plan, or a section 401(m) plan that is 
provided under the same general arrangement, employees of a section 
501(c)(3) organization who are eligible to make salary reduction 
contributions (within the meaning of section 402(g)) under a section 
403(b) plan may be treated as excludible employees if no employee of 
the organization (rather than no employee of any organization described 
in section 403(b)(1)(A)(ii) (as in the language in section 664 of 
EGTRRA)) is eligible to participate in the section 401(k) plan or 
401(m) plan, and 95% of the employees of the employer who are not 
employees of the organization (rather than an organization described in 
section 403(b)(1)(A)(ii) (as in the language in section 664 of EGTRRA)) 
are eligible to participate in the section 401(k) plan or section 
401(m) plan. After further consideration, the IRS and Treasury 
Department have concluded that this simplification of the statutory 
language might not in all cases result in the same employees being 
excludible as would be excludible by applying the statutory language, 
which was not the intent. Thus, the final regulations more closely 
track the language in section 664 of EGTRRA than the proposed 
regulations.
    The few comments received on the proposed regulations generally did 
not ask for changes to the basic rule but rather asked for further 
explanation as to the proper interpretation of the rule, including the 
scope of the exclusion and the interaction of the rule with other rules 
in the regulations under section 410(b). As explained further below, 
the IRS and Treasury Department believe that the answers to the 
questions raised in the comments is reasonably clear under the existing 
language, and have decided not to expand guidance in the regulation 
beyond the specific direction of Congress.
    Commentators requested clarification as to when a section 401(m) 
plan is provided under the same general arrangement as a section 401(k) 
plan for purposes of these regulations. Generally, a section 401(m) 
plan is provided under the same general arrangement as a section 401(k) 
plan only to the extent that the matching contributions are contingent 
upon elective deferrals in the section 401(k) plan.
    Commentators asked for clarification of the relationship between 
the proposed regulations and Sec.  1.410(b)-7(f) and whether matching 
contributions made under a 401(a) tax-qualified plan may be taken into 
account when applying the coverage requirements of section 410(b) to 
matching contributions provided as part of a section 403(b) plan. 
Treasury regulation Sec.  1.410(b)-7(f) permits a plan subject to 
section 403(b)(12)(A)(i), which requires the universal availability of 
the right to defer, to satisfy section 410(b) by taking into account 
plans that are not subject to section 403(b)(12)(A)(i). Accordingly, a 
section 403(b) plan is permitted to satisfy the section 410(b) coverage 
requirements for matching contributions by taking into account matching 
contributions that are provided under a plan that is not subject to 
section 403(b)(12)(A)(i) (e.g., a section 401(a) tax-qualified plan). 
However, because Treasury regulation Sec.  1.410(b)-7(f) does not 
permit a section 401(a) tax-qualified plan to satisfy the requirements 
of section 410(b) by taking into account a plan subject to section 
403(b)(12)(A)(i), a section 401(a) tax-qualified plan must satisfy the 
section 410(b) coverage requirements by disregarding coverage under a 
section 403(b) plan. These regulations provide the rules for 
disregarding employees of a governmental or tax-exempt entity for 
purposes of applying the coverage requirements of section 410(b) to a 
section 401(k) plan or a section 401(m) plan that is provided under the 
same general arrangement as the section 401(k) plan.
    Commentators asked whether employees of a tax-exempt organization 
described in section 501(c)(3) who would be eligible to make salary 
reduction contributions under a section 403(b) plan but for the 
exclusions permitted under section 403(b)(12), such as nonresident 
aliens and employees who normally work less than 20 hours per week, are 
taken into account as employees who are eligible to make salary 
reduction contributions for purposes of these regulations. These 
regulations provide that such employees are not taken into account 
unless they are actually eligible to make salary reduction 
contributions to the section 403(b) plan.

Effective Date

    As directed by Congress in section 664 of EGTRRA, these final 
regulations apply to plan years beginning after December 31, 1996. 
However, the preamble to the proposed regulations provided that 
taxpayers were permitted to rely on the proposed regulations, and if 
and to the extent that the final regulations were more restrictive, the 
final regulations would be prospective. As described above, the final 
regulations

[[Page 41359]]

make certain modifications to the proposed regulations. These may be 
more restrictive than the proposed regulations under certain limited 
circumstances. Consequently, for plan years beginning after December 
31, 1996, but before January 1, 2007, an employer is permitted to 
determine the excludible employees under a section 401(k) plan or 
section 401(m) plan using either Sec.  1.410(b)-6(g) in the proposed 
regulations or these final regulations.

Special Analyses

    It has been determined that this is not a significant regulatory 
action as defined in Executive Order 12866. Therefore, a regulatory 
assessment is not required. It also has been determined that section 
553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does 
not apply to these regulations, and, because these regulations do not 
impose a collection of information on small entities, the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) does not apply.

Drafting Information

    The principal authors of these regulations are Linda L. Conway and 
Michael P. Brewer of the Office of the Division Counsel/Associate Chief 
Counsel (Tax Exempt and Government Entities). However, other personnel 
from the IRS and Treasury participated in the development of these 
regulations.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of 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 is amended by removing 
the entry for Sec. Sec.  1.410(b)-2 through 1.410(b)-10 and adding 
entries in numerical order to read, in part, as follows:

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

    Sec.  1.410(b)-2 also issued under 26 U.S.C. 410(b)(6).
    Sec.  1.410(b)-3 also issued under 26 U.S.C. 410(b)(6).
    Sec.  1.410(b)-4 also issued under 26 U.S.C. 410(b)(6).
    Sec.  1.410(b)-5 also issued under 26 U.S.C. 410(b)(6).
    Sec.  1.410(b)-6 also issued under 26 U.S.C. 410(b)(6) and 
section 664 of the Economic Growth and Tax Relief Reconciliation Act 
of 2001 (Public Law 107-16, 115 Stat. 38).
    Sec.  1.410(b)-7 also issued under 26 U.S.C. 410(b)(6).
    Sec.  1.410(b)-8 also issued under 26 U.S.C. 410(b)(6).
    Sec.  1.410(b)-9 also issued under 26 U.S.C. 410(b)(6).
    Sec.  1.410(b)-10 also issued under 26 U.S.C. 410(b)(6).* * *


0
Par. 2. Section 1.410(b)-0 is amended by:
0
1. Revising the entry for 1.410(b)-6(g).
0
2. Adding entries for 1.410(b)-6(g)(1), (g)(2), and (g)(3).
    The revision and additions read as follows:


Sec.  1.410(b)-0  Table of contents.

* * * * *


Sec.  1.410(b)-6  Excludable employees.

* * * * *
    (g) Employees of certain governmental or tax-exempt entities.
    (1) Plans covered.
    (2) Employees of governmental entities.
    (3) Employees of tax-exempt entities.
* * * * *

0
Par. 3. In Sec.  1.410(b)-6, paragraph (g) is revised to read as 
follows:


Sec.  1.410(b)-6  Excludable employees.

* * * * *
    (g) Employees of certain governmental or tax-exempt entities--(1) 
Plans covered. For purposes of testing either a section 401(k) plan, or 
a section 401(m) plan that is provided under the same general 
arrangement as a section 401(k) plan, an employer may treat as 
excludable those employees described in paragraphs (g)(2) and (3) of 
this section.
    (2) Employees of governmental entities. Employees of governmental 
entities who are precluded from being eligible employees under a 
section 401(k) plan by reason of section 401(k)(4)(B)(ii) may be 
treated as excludable employees if more than 95 percent of the 
employees of the employer who are not precluded from being eligible 
employees by reason of section 401(k)(4)(B)(ii) benefit under the plan 
for the year.
    (3) Employees of tax-exempt entities. Employees of an organization 
described in section 403(b)(1)(A)(i) who are eligible to make salary 
reduction contributions under section 403(b) may be treated as 
excludable with respect to a section 401(k) plan, or a section 401(m) 
plan that is provided under the same general arrangement as a section 
401(k) plan, if--
    (i) No employee of an organization described in section 
403(b)(1)(A)(i) is eligible to participate in such section 401(k) plan 
or section 401(m) plan; and
    (ii) At least 95 percent of the employees who are neither employees 
of an organization described in section 403(b)(1)(A)(i) nor employees 
of a governmental entity who are precluded from being eligible 
employees under a section 401(k) plan by reason of section 
401(k)(4)(B)(ii) are eligible to participate in such section 401(k) 
plan or section 401(m) plan.
* * * * *

0
Par. 4. In Sec.  1.410(b)-10, paragraph (e) is added to read as 
follows:


Sec.  1.410(b)-10  Effective dates and transition rules.

* * * * *
    (e) Effective date for provisions relating to exclusion of 
employees of certain tax-exempt entities. The provisions in Sec.  
1.410(b)-6(g) apply to plan years beginning after December 31, 1996. 
For plan years to which Sec.  1.410(b)-6 applies that begin before 
January 1, 1997, Sec.  1.410(b)-6(g) (as it appeared in the April 1, 
2005 edition of 26 CFR part 1) applies.

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
    Approved: June 30, 2006.
Eric Solomon,
Acting Deputy Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. E6-11545 Filed 7-20-06; 8:45 am]
BILLING CODE 4830-01-P