[Federal Register Volume 72, Number 143 (Thursday, July 26, 2007)]
[Rules and Regulations]
[Pages 41128-41160]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 07-3649]



[[Page 41127]]

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

Part III





Department of the Treasury





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



Internal Revenue Service



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



26 CFR Parts 1, 31, 54 and 602



 Revised Regulations Concerning Section 403(b) Tax-Sheltered Annuity 
Contracts; Final Rule

  Federal Register / Vol. 72, No. 143 / Thursday, July 26, 2007 / Rules 
and Regulations  

[[Page 41128]]


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

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1, 31, 54, and 602

[TD 9340]
RIN 1545-BB64


Revised Regulations Concerning Section 403(b) Tax-Sheltered 
Annuity Contracts

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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

SUMMARY: This document promulgates final regulations under section 
403(b) of the Internal Revenue Code and under related provisions of 
sections 402(b), 402(g), 402A, and 414(c). The regulations provide 
updated guidance on section 403(b) contracts of public schools and tax-
exempt organizations described in section 501(c)(3). These regulations 
will affect sponsors of section 403(b) contracts, administrators, 
participants, and beneficiaries.

DATES: Effective Date: July 26, 2007.
    Applicability Date: These regulations generally apply for taxable 
years beginning after December 31, 2008. However, see the 
``Applicability date'' section in this preamble for additional 
information regarding the applicability of these regulations.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, John 
Tolleris, (202) 622-6060; concerning the regulations as applied to 
church-related entities, Robert Architect (202) 283-9634 (not toll-free 
numbers).

SUPPLEMENTARY INFORMATION: 

Paperwork Reduction Act

    The collection of information in Sec.  1.403(b)-10(b)(2)(i)(C) of 
these final regulations has been approved by the Office of Management 
and Budget in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3507(d)) under control number 1545-2068. Responses to this 
collection of information are required in order to provide certain 
benefits.
    The estimated burden per respondent varies among the plan 
administrator/payor/recordkeeper, depending upon individual 
respondents' circumstances, with an estimated average of 4.1 hours. 
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, 
SE: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.
    The collection of information in Sec.  1.403(b)-10(b)(2)(i)(C) of 
these final regulations was not contained in the prior notice of 
proposed rulemaking. For this reason, this additional collection of 
information has been reviewed and, pending receipt and evaluation of 
public comments, approved by the Office of Management and Budget in 
accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) 
under control number 1545-2068. Comments concerning this additional 
collection of information should be sent to the Internal Revenue 
Service, Attn: IRS Reports Clearance Officer, SE: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. Comments on the 
collection of information should be received by September 24, 2007. 
Comments are specifically requested concerning:
    Whether the proposed collection of information is necessary for the 
proper performance of the functions of the Internal Revenue Service, 
including whether the information will have practical utility;
    The accuracy of the estimated burden associated with the proposed 
collection of information (see above);
    How the quality, utility, and clarity of the information to be 
collected may be enhanced;
    How the burden of complying with the proposed collections of 
information may be minimized, including through the application of 
automated collection techniques or other forms of information 
technology; and
    Estimates of capital or start-up costs and costs of operation, 
maintenance, and purchase of service to provide information.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    The estimated burden per respondent varies among the plan 
administrator/payor/recordkeeper, depending upon individual 
respondents' circumstances, with an estimated average of 4.1 hours.
    Books or records relating to a collection of information must be 
retained as long as their contents might 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

    Regulations (TD 6783) under section 403(b) of the Internal Revenue 
Code (Code) were originally published in the Federal Register (29 FR 
18356) on December 24, 1964 (1965-1 CB 180). Those regulations provided 
guidance for complying with section 403(b), which had been enacted in 
1958 in section 23(a) of the Technical Amendments Act of 1958, Public 
Law 85-866 (1958), relating to tax-sheltered annuity arrangements 
established for employees by public schools and tax-exempt 
organizations described in section 501(c)(3). Since 1964, additional 
regulations were issued under section 403(b) to reflect rules relating 
to certain eligible rollover distributions \1\ and required minimum 
distributions under section 401(a)(9).\2\ See Sec.  601.601(d)(2) 
relating to objectives and standards for publishing regulations, 
revenue rulings and revenue procedures in the Internal Revenue 
Bulletin.
---------------------------------------------------------------------------

    \1\ See TD 8619, September 22, 1995 (60 FR 49199).
    \2\ See TD 8987, April 17, 2002 (67 FR 18987).
---------------------------------------------------------------------------

    On November 16, 2004, a notice of proposed rulemaking (REG-155608-
02) was published in the Federal Register (69 FR 67075) that proposed a 
comprehensive update of the regulations under section 403(b) (2004 
proposed regulations), including: amending the 1964 and subsequent 
regulations to conform them to the numerous amendments made to section 
403(b) by subsequent legislation, including section 1022(e) of the 
Employee Retirement Income Security Act of 1974 (ERISA) (88 Stat. 829), 
Public Law 93-406; section 251 of the Tax Equity and Fiscal 
Responsibility Act of 1982 (TEFRA) (96 Stat. 324, 529), Public Law 97-
248; section 1120 of the Tax Reform Act of 1986 (TRA '86) (100 Stat. 
2085, 2463), Public Law 99-514; section 1450(a) of the Small Business 
Job Protection Act of 1996 (SBJPA) (110 Stat. 1755, 1814), Public Law 
104-188; and sections 632, 646, and 647 of the Economic Growth and Tax 
Relief Reconciliation Act of 2001 (EGTRRA) (115 Stat. 38, 113, 126, 
127), Public Law 107-16. The 2004 proposed regulations also included 
controlled group rules under section 414(c) for entities that are tax-
exempt under section 501(a).
    Following publication of the 2004 proposed regulations, comments 
were received and a public hearing was held on February 15, 2005. After 
consideration of the comments received, the 2004 proposed regulations 
are adopted by this Treasury decision,

[[Page 41129]]

subject to a number of changes, some of which are summarized below in 
this preamble.
    Section 403(b) was also amended by sections 811, 821, 822, 824, 
826, and 829 of the Pension Protection Act of 2006 (PPA '06) (120 Stat. 
780), Public Law 109-280. These final regulations reflect these 
amendments.

Sections 403(b) and 414(c) Statutory Provisions

    Section 403(b) provides an exclusion from gross income for certain 
contributions made by specific types of employers for their employees 
and by certain ministers to specified types of funding arrangements. 
The employers are limited to public schools and section 501(c)(3) 
organizations. There are three categories of funding arrangements to 
which section 403(b) applies: (1) Annuity contracts (as defined in 
section 401(g)) issued by an insurance company; (2) custodial accounts 
that are invested solely in mutual funds; and (3) retirement income 
accounts, which are only permitted for church employees and certain 
ministers. Except as otherwise indicated, an annuity contract, for 
purposes of these final regulations, includes a custodial account that 
is invested solely in mutual funds.
    The exclusion applies to employer nonelective contributions 
(including matching contributions) and elective deferrals (other than 
designated Roth contributions) within the meaning of section 
402(g)(3)(C) (which applies to section 403(b) contributions made 
pursuant to a salary reduction agreement). The exclusion applies only 
if certain requirements relating to availability, nondiscrimination, 
and distribution are satisfied. Section 403(b) arrangements may also 
include after-tax employee contributions.
    Section 403(b)(1)(C) requires that the contract be nonforfeitable 
(except for the failure to pay future premiums), regardless of the type 
of contribution used to purchase the contract. Section 403(b)(1)(E) 
requires a section 403(b) contract purchased under a salary reduction 
agreement to satisfy the requirements of section 401(a)(30) relating to 
limitations on elective deferrals under section 402(g)(1). In addition, 
all contributions to a section 403(b) arrangement, when expressed as 
annual additions under section 415(c)(2), must not exceed the 
applicable limit of section 415.
    Section 403(b)(5) provides that all section 403(b) contracts 
purchased for an individual by an employer are treated as purchased 
under a single contract for purposes of the requirements of section 
403(b). Other aggregation rules apply both on an individual and 
aggregate basis. For example, the section 402(g) limitations on 
elective deferrals apply to all elective deferrals during the year with 
respect to an individual and the limitations of section 401(a)(30) 
apply to all elective deferrals made by an employer to that employer's 
plans with respect to an individual during the year. The contribution 
limitations of section 415 generally apply on an employer-by-employer 
basis.
    Section 403(b)(12) requires a section 403(b) contract that provides 
for elective deferrals to make elective deferrals available to all 
employees (the universal availability rule) and requires other 
contributions to satisfy the general nondiscrimination requirements 
applicable to qualified plans. These rules are discussed further in 
this preamble under the heading ``Section 403(b) Nondiscrimination and 
Universal Availability Rules.''
    A section 403(b) contract is also required to provide that it will 
satisfy the required minimum distribution requirements of section 
401(a)(9), the incidental benefit requirements of section 401(a), and 
the rollover distribution rules of section 402(c).
    Many section 403(b) arrangements of employers that are section 
501(c)(3) organizations are subject to the Employee Retirement Income 
Security Act of 1974 (ERISA), which includes rules substantially 
identical to the rules for qualified plans, including rules parallel to 
the section 414(l) transfer rules, the section 401(a)(11) qualified 
joint and survivor annuity (QJSA) transferee plan rules, and the anti-
cutback rules of section 411(d)(6) (which apply to transfers). See 
sections 204(g), 205, and 208 of ERISA. However, as discussed in this 
preamble under the heading ``Interaction Between Title I of ERISA and 
Section 403(b) of the Code,'' Title I of ERISA does not apply to 
governmental plans, certain church plans, or a tax-exempt employer's 
section 403(b) program that is not considered to constitute the 
establishment or maintenance of an ``employee pension benefit plan'' 
under Title I of ERISA.
    Section 414(c) authorizes the Secretary of the Treasury to issue 
regulations treating all employees of trades or businesses which are 
under common control as employed by a single employer.

Explanation of Provisions

Overview

    Like the 2004 proposed regulations, these final regulations are a 
comprehensive update of the current regulations under section 403(b). 
These regulations replace the existing final regulations that were 
adopted in 1964 and reflect the numerous legal changes that have been 
made in section 403(b) since then and many of the positions that have 
been taken in interpretive guidance that has been issued under section 
403(b).
    As was noted in the preamble to the 2004 proposed regulations, the 
effect of the various amendments made to section 403(b) within the past 
40 years has been to diminish the extent to which the rules governing 
section 403(b) plans differ from the rules governing other tax-favored 
employer-based retirement plans, including arrangements that include 
salary reduction contributions, such as section 401(k) plans and 
section 457(b) plans for state and local governmental entities. 
However, there remain significant differences between section 403(b) 
plans and section 401(a) and governmental section 457(b) plans. For 
example, section 403(b) is limited to certain specific employers and 
employees (namely, employees of a public school, employees of a section 
501(c)(3) organization, and certain ministers) and to certain funding 
arrangements (namely, an insurance annuity contract, a custodial 
account that is limited to mutual fund shares, or a church retirement 
income account). Also, section 403(b) contains the universal 
availability requirement for section 403(b) elective deferrals and 
provides consequences for failing to satisfy certain of the section 
403(b) rules (described in this preamble under the heading ``Effect of 
a Failure to Satisfy Section 403(b)'') \3\ that differ in significant 
respects from the consequences applicable to qualified plans.
---------------------------------------------------------------------------

    \3\ Other differences between the rules applicable to section 
403(b) plans and qualified plans include the following: the 
definition of compensation (including the five-year rule) in section 
403(b)(3); the special section 403(b) catch-up elective deferral in 
section 402(g)(7); and the section 415 aggregation rules. An 
additional difference relates to when a severance from employment 
occurs for purposes of section 403(b) plans maintained by State and 
local government employers. See Sec.  1.403(b)-6(h) of these 
regulations.
---------------------------------------------------------------------------

    The final regulations, as did the 2004 proposed regulations, 
require the section 403(b) contract to satisfy both in form and 
operation the applicable requirements for exclusion. The final 
regulations also require that the contract

[[Page 41130]]

be maintained pursuant to a written plan as described in the next 
section.
    The final regulations, like the proposed regulations, provide rules 
under which tax-exempt entities are aggregated and treated as a single 
employer under section 414(c). These rules apply to plans referenced in 
section 414(b), (c), (m), (o), and (t), such as plans qualified under 
section 401(a) or 403(a), as well as section 403(b) plans.
    Comments on the 2004 proposed regulations raised a number of 
questions and concerns about:
     The requirement in the 2004 proposed regulations under 
which a section 403(b) contract would be required to be maintained 
pursuant to a written plan;
     The elimination of certain non-statutory exclusions that a 
section 403(b) plan was permitted to have under Notice 89-23 (1989-1 CB 
654) for purposes of the universal availability rule;
     The elimination of Rev. Rul. 90-24 (1990-1 CB 97), which 
allowed a section 403(b) contract to be exchanged for another contract; 
and
     The controlled group rules under section 414(c) for 
entities that are tax-exempt under section 501(a).

These final regulations include a number of revisions to reflect the 
comments received, as described further in this preamble.

Written Plan Requirement

    These regulations retain the requirement from the 2004 proposed 
regulations that a section 403(b) contract be issued pursuant to a 
written plan which, in both form and operation, satisfies the 
requirements of section 403(b) and these regulations. This requirement 
implements the statutory requirements of section 403(b)(1)(D), which 
provides that the contract must be purchased ``under a plan'' that 
satisfies the nondiscrimination requirements delineated in section 
403(b)(12).
    The existence of a written plan facilitates the allocation of plan 
responsibilities among the employer, the issuer of the contract, and 
any other parties involved in implementing the plan. Without such a 
central document for a comprehensive summary of responsibilities, there 
is a risk that many of the important responsibilities required under 
the statute and final regulations may not be allocated to any party. 
While a section 403(b) contract issued to an employee can provide for 
the issuer to perform many of these functions by itself, the contract 
cannot satisfy the function of setting forth the eligibility criteria 
for other employees, nor can the issuer by itself coordinate those Code 
requirements that depend on other contracts, such as the loan 
limitations under section 72(p). The issuer must rely on information or 
representations provided by either the employer or the employee for 
employment-based information that is essential for compliance with 
section 403(b) provisions, such as the limitations on elective 
deferrals in section 402(g) and the requirements of section 72(p)(2) 
for a plan loan that is not a taxable deemed distribution. In addition 
to providing a central locus to coordinate those functions, the 
maintenance of a written plan also benefits participants by providing a 
central document setting forth their rights and enables government 
agencies to determine whether the arrangements satisfy applicable law 
and, in particular, for determining which employees are eligible to 
participate in the plan.
    The 2004 proposed regulations would have required that the section 
403(b) plan include all of the material provisions regarding 
eligibility, benefits, applicable limitations, the contracts available 
under the plan, and the time and form under which benefit distributions 
would be made. The proposed regulations would not have required that 
there be a single plan document. However, under the proposed 
regulations, the written plan requirement would be satisfied by 
complying with the plan document rules applicable to qualified plans.
    Some comments raised concerns that the written plan requirement 
would impose additional administrative burdens. In response, the final 
regulations make a number of clarifications, including that the plan is 
permitted to allocate to the employer or another person the 
responsibility for performing functions to administer the plan, 
including functions to comply with section 403(b). Any such allocation 
must identify who is responsible for compliance with the requirements 
of the Code that apply based on the aggregated contracts issued to a 
participant, including loans under section 72(p) and the requirements 
for obtaining a hardship withdrawal under Sec.  1.403(b)-6 of these 
regulations.
    Additional comments recommended that certain responsibilities be 
permitted to be allocated to employees. The IRS and Treasury Department 
have concluded that it is generally inappropriate to allocate these 
responsibilities to employees for a number of reasons. First, employees 
often lack the expertise to systematically meet these responsibilities 
and may not recognize the importance of performing these actions 
(including not fully appreciating the tax consequences of failing to 
perform the responsibility). Second, an individual employee may have a 
self-interest in a particular transaction. In addition, while there are 
various factors that will often cause an employer or issuer to have an 
interest in procedures that ensure that the requirements of section 
403(b) are satisfied (including income tax withholding requirements), 
an employee generally bears the income tax exposure and other risks of 
failing to comply with rules set forth in the plan. The IRS and 
Treasury Department believe it is important to prevent failures in 
advance so as to minimize the cases in which the adverse effects of a 
failure fall on the employee. See the discussion in this preamble under 
the heading ``Contract Exchanges.''
    In response to comments, the final regulations clarify the 
requirement that the plan include all of the material provisions by 
permitting the plan to incorporate by reference other documents, 
including the insurance policy or custodial account, which as a result 
of such reference would become part of the plan. As a result, a plan 
may include a wide variety of documents, but it is important for the 
employer that adopts the plan to ensure that there is no conflict with 
other documents that are incorporated by reference. If a plan does 
incorporate other documents by reference, then, in the event of a 
conflict with another document, except in rare and unusual cases, the 
plan would govern. In the case of a plan that is funded through 
multiple issuers, it is expected that an employer would adopt a single 
plan document to coordinate administration among the issuers, rather 
than having a separate document for each issuer.
    Finally, comments also indicated that, while section 403(b) 
contracts that are subject to ERISA are maintained pursuant to written 
plans, there may be a potential cost associated with satisfying the 
written plan requirement for those employers that do not have existing 
plan documents, such as public schools. To address this concern, the 
IRS and Treasury Department expect to publish guidance which includes 
model plan provisions that may be used by public school employers for 
this purpose. Because the requirement for a written plan will not go 
into effect until 2009 (see the discussion under the heading 
``Applicability date''), employers would be expected to adopt a written 
plan (including applicable amendments) no later than the applicability 
date of these regulations.

[[Page 41131]]

Contract Exchanges, Plan-to-Plan Transfers, and Purchases of Permissive 
Service Credit

    The final regulations, like the 2004 proposed regulations, provide 
for three specific kinds of non-taxable exchanges or transfers of 
amounts in section 403(b) contracts. Specifically, under the final 
regulations, a non-taxable exchange or transfer is permitted for a 
section 403(b) contract if either: (1) It is a mere change of 
investment within the same plan (contract exchange); (2) it constitutes 
a plan-to-plan transfer, so that there is another employer plan 
receiving the exchange; or (3) it is a transfer to purchase permissive 
service credit (or a repayment to a defined benefit governmental plan). 
If an exchange or transfer does not constitute a change of investment 
within the plan, a plan-to-plan transfer, or a purchase of permissive 
service credit, the exchange or transfer would be treated as a taxable 
distribution of benefits in the form of property if the exchange occurs 
after a distributable event (assuming the distribution is not rolled 
over to an eligible retirement plan) or as a taxable conversion to a 
section 403(c) nonqualified annuity contract if a distributable event 
has not occurred. See the ``Effect of a Failure to Satisfy Section 
403(b)'' section in this preamble for discussion of section 403(c) 
nonqualified annuity contracts. In any case in which a distributable 
event has occurred, a participant in a section 403(b) plan can always 
change the investment through a distribution and non-taxable rollover 
from a section 403(b) contract to an IRA annuity, as long as the 
distribution is an eligible rollover distribution. Note, however, that 
an IRA annuity cannot include provisions permitting participant loans. 
See section 408(e)(3) and (4) and Sec. Sec.  1.408-1(c)(5) and 1.408-
3(c).
    Any contract exchange, plan-to-plan transfer, or purchase of 
permissive service credit that is permitted under the final regulations 
is not treated as a distribution for purposes of the section 403(b) 
distribution restrictions (so that such an exchange or transfer may be 
made before severance from employment or another distribution event).
Contract Exchanges
    Rev. Rul. 73-124 (1973-1 CB 200) and Rev. Rul. 90-24 (1990-1 CB 97) 
dealt with contract exchanges. Rev. Rul. 73-124 had allowed section 
403(b) contracts to be exchanged, without income inclusion, if, 
pursuant to an agreement with the employer, the employee cashed in the 
first contract and immediately transmitted the cash proceeds for 
contribution to the successor contract to which all subsequent employer 
contributions would be made. This ruling was replaced by Rev. Rul. 90-
24 which does not provide for the first contract to be cashed in but 
allows section 403(b) contracts to be exchanged, without income 
inclusion, so long as the successor contract includes distribution 
restrictions that are the same or more stringent than the distribution 
restrictions in the contract that is being exchanged.
    The 2004 proposed regulations would have imposed additional 
restrictions on contract exchanges by limiting tax-free contract 
exchanges to situations in which the new contract is provided under the 
plan. The proposal was intended to improve compliance with the Code 
requirements that apply on an aggregated basis because, without 
coordination, it is difficult, if not impossible, for a plan to comply 
with those tax requirements. These requirements include certain 
distribution restrictions, including the rule that requires the 
suspension of deferrals for a plan that uses the hardship withdrawal 
suspension safe harbor rules for elective deferrals, and the section 
72(p) rules for loans. In addition, these changes make it easier for 
employers to respond to an IRS inquiry or audit. For example, where 
assets have been transferred to an insurance carrier or mutual fund 
that has no subsequent connection to the plan or the employer, IRS 
audits and related investigations have revealed that employers 
encounter substantial difficulty in demonstrating compliance with 
hardship withdrawal and loan rules. These problems are particularly 
acute when an individual's benefits are held by numerous carriers. Such 
multiple contract issuers are commonly associated with plans in which 
Rev. Rul. 90-24 exchanges have occurred.
    Commentators generally objected to the proposal to limit exchanges 
allowed under Rev. Rul. 90-24. They argued that such exchanges enable 
participants to change funding arrangements and claimed that these 
exchanges have generally been responsible for improved efficiency and 
lower cost in the section 403(b) market. Comments often included 
specific suggestions, such as limiting any restrictions on exchanges to 
active employees and effectuating compliance with loan restrictions by 
alternative methods, such as having the issuer report loans on, for 
example, a Form 1099-R (Distributions From Pensions, Annuities, 
Retirement or Profit-Sharing Plans, IRA, Insurance Contracts), or 
notify the employer about loans. Other comments included a 
recommendation that the employer be involved to ensure that the 
exchange is within the plan. Comments also suggested that a grandfather 
may be necessary for exchanges made before the applicability date of 
the restrictions imposed by the final regulations.
    These final regulations include a number of changes to reflect 
these comments. The regulations allow contract exchanges with certain 
characteristics associated with Rev. Rul. 90-24, but under rules that 
are generally similar to those applicable to qualified plans.
    Unlike the 2004 proposed regulations, these regulations permit an 
exchange of one contract for another to constitute a mere change of 
investment within the same plan, but only if certain conditions are 
satisfied in order to facilitate compliance with tax requirements. 
Specifically, the other contract must include distribution restrictions 
that are not less stringent than those imposed on the contract being 
exchanged and the employer must enter into an agreement with the issuer 
of the other contract under which the employer and the issuer will from 
time to time in the future provide each other with certain information. 
This includes information concerning the participant's employment and 
information that takes into account other section 403(b) contracts or 
qualified employer plans, such as whether a severance from employment 
has occurred for purposes of the distribution restrictions and whether 
the hardship withdrawal rules in the regulations are satisfied. 
Additional information that is required is information necessary for 
the resulting contract or any other contract to which contributions 
have been made by the employer to satisfy other tax requirements, such 
as whether a plan loan constitutes a deemed distribution under section 
72(p).
    These regulations also authorize the IRS to issue guidance of 
general applicability allowing exchanges in other cases. This authority 
is limited to cases in which the resulting contract has procedures that 
the IRS determines are reasonably designed to ensure compliance with 
those requirements of section 403(b) or other tax provisions that 
depend on either information concerning the participant's employment or 
information that takes into account other section 403(b) contracts or 
qualified employer plans. For example, the procedures must be 
reasonably designed to determine whether a severance from employment 
has occurred for purposes of the

[[Page 41132]]

distribution restrictions, whether the hardship withdrawal rules are 
satisfied, and whether a plan loan constitutes a deemed distribution 
under section 72(p). By contrast, procedures that rely on an employee 
certification, such as whether a severance from employment has occurred 
or whether the participant has other outstanding loans, would generally 
not be adequate to meet this standard, because such a certification is 
not disinterested, and also because of the lack of employer oversight 
in the certification process to ensure accuracy.
Plan-to-Plan Transfers
    The final regulations expand the rules in the 2004 proposed 
regulations under which plan-to-plan transfers would have been 
permitted only if the participant was an employee of the employer 
maintaining the receiving plan. Under the final regulations, plan-to-
plan transfers are permitted if the participant whose assets are being 
transferred is an employee or former employee of the employer (or 
business of the employer) that maintains the receiving plan and certain 
additional requirements are met. However, the final regulations retain 
the rules that were in the 2004 proposed regulations prohibiting a 
plan-to-plan transfer to a qualified plan, an eligible plan under 
section 457(b), or any other type of plan that is not a section 403(b) 
plan, except as described in the next paragraph. Similarly, a section 
403(b) plan is not permitted to accept a transfer from a qualified 
plan, an eligible plan under section 457(b), or any other type of plan 
that is not a section 403(b) plan.
Purchases of Permissive Service Credit and Certain Repayments
    The final regulations, like the 2004 proposed regulations, include 
an exception permitting a section 403(b) plan to provide for the 
transfer of its assets to a qualified plan under section 401(a) to 
purchase permissive service credit under a defined benefit governmental 
plan or to make a repayment to a defined benefit governmental plan.

Limitations on Contributions

    The final regulations, like the 2004 proposed regulations, provide 
that the section 403(b) exclusion applies only to the extent that all 
amounts contributed by the employer for the purchase of an annuity 
contract for the participant do not exceed the applicable limits under 
section 415. The final regulations retain the rule in the 2004 proposed 
regulations that if an excess annual addition is made to a contract 
that otherwise satisfies the requirements of section 403(b), then the 
portion of the contract that includes the excess will fail to be a 
section 403(b) contract (and instead will be a contract to which 
section 403(c), relating to nonqualified annuity contracts, applies) 
and the remaining portion of the contract that includes the 
contribution that is not in excess of the section 415 limitations is a 
section 403(b) contract. This rule under which only the excess annual 
addition is subject to section 403(c) does not apply unless, for the 
year of the excess and each year thereafter, the issuer of the contract 
maintains separate accounts for the portion that includes the excess 
and for the section 403(b) portion (which is the portion that includes 
the amount that is not in excess of the section 415 limitations).
    With respect to section 403(b) elective deferrals, section 403(b) 
applies only if the contract is purchased under a plan that includes 
the elective deferral limits under section 402(g), including 
aggregation of all plans, contracts, or arrangements of the employer 
that are subject to the limits of section 402(g). As in the 2004 
proposed regulations, the final regulations require a section 403(b) 
contract to include this limit on section 403(b) elective deferrals, as 
imposed under sections 401(a)(30) and 402(g). For purposes of the final 
regulations, the term ``elective deferral'' includes a designated Roth 
contribution as well as a pre-tax elective contribution. These rules 
are generally the same as the rules for qualified cash or deferred 
arrangements (CODAs) under section 401(k).
    Any contribution made for a participant to a section 403(b) 
contract for a taxable year that exceeds either the section 415 maximum 
annual contribution limits or the section 402(g) elective deferral 
limit constitutes an excess contribution that is included in gross 
income for that taxable year (or, if later, the taxable year in which 
the contract becomes nonforfeitable). The final regulations, like the 
2004 proposed regulations, provide that the section 403(b) plan 
(including contracts under the plan) may provide that any excess 
deferral as a result of a failure to comply with the section 402(g) 
elective deferral limit for the taxable year with respect to any 
section 403(b) elective deferral made for a participant by the employer 
will be distributed to the participant, with allocable net income, no 
later than April 15 or otherwise in accordance with section 402(g).

Catch-Up Contributions

    A section 403(b) plan may provide for additional catch-up 
contributions for a participant who is age 50 by the end of the year, 
provided that those age 50 catch-up contributions do not exceed the 
catch-up limit under section 414(v) for the taxable year ($5,000 for 
2007). In addition, a section 403(b) plan may provide that an employee 
of a qualified organization who has at least 15 years of service 
(disregarding any period during which an individual is not an employee 
of the eligible employer) is entitled to a special section 403(b) 
catch-up limit. Under the special section 403(b) catch-up limit, the 
section 402(g) limit is increased by the lowest of the following three 
amounts: (i) $3,000; (ii) the excess of $15,000 over the amount not 
included in gross income for prior taxable years by reason of the 
special section 403(b) catch-up rules, plus elective deferrals that are 
designated Roth contributions; \4\ or (iii) the excess of (A) $5,000 
multiplied by the number of years of service of the employee with the 
qualified organization, over (B) the total elective deferrals made for 
the employee by the qualified organization for prior taxable years. For 
this purpose, a qualified organization is an eligible employer that is 
a school, hospital, health and welfare service agency (including a home 
health service agency), or a church-related organization.
---------------------------------------------------------------------------

    \4\ A technical correction was made to section 402(g)(7)(A)(ii) 
by section 407(a) the Gulf Opportunity Zone Act of 2005 (119 Stat. 
2577), Pub. L 109-135, to clarify that the aggregate $15,000 limit 
on such contributions was reduced not only by pre-tax elective 
deferrals made pursuant to the special section 403(b) catch-up 
rules, but also by designated Roth contributions. Treasury has 
recommended that this language be further changed to reflect the 
intent that the reduction for designated Roth contributions at 
section 402(g)(7)(A)(ii)(II) be limited to designated Roth 
contributions that have been made pursuant to the special section 
403(b) catch-up rules.
---------------------------------------------------------------------------

    The 2004 proposed regulations defined a health and welfare service 
agency as either an organization whose primary activity is to provide 
medical care as defined in section 213(d)(1) (such as a hospice), or a 
section 501(c)(3) organization whose primary activity is the prevention 
of cruelty to individuals or animals or which provides substantial 
personal services to the needy as part of its primary activity (such as 
a section 501(c)(3) organization that provides meals to needy 
individuals). In response to several commentators' requests, the final 
regulations expand this definition to include an adoption agency and an 
agency that provides either home health services or assistance to 
individuals with substance abuse problems or that provides help to the 
disabled.
    Like the 2004 proposed regulations, the final regulations provide 
that any

[[Page 41133]]

catch-up contribution for an employee who is eligible for both an age 
50 catch-up and the special section 403(b) catch-up is treated first as 
a special section 403(b) catch-up to the extent a special section 
403(b) catch-up is permitted, and then as an amount contributed as an 
age 50 catch-up (to the extent the age 50 catch-up amount exceeds the 
maximum special section 403(b) catch-up).

Timing of Distributions and Benefits

    The final regulations, like the 2004 proposed regulations, contain 
provisions reflecting the statutory rules regarding when distributions 
can be made from a section 403(b) plan. Distributions of amounts 
attributable to section 403(b) elective deferrals may not be paid to a 
participant earlier than when the participant has a severance from 
employment, has a hardship, becomes disabled (within the meaning of 
section 72(m)(7)), or attains age 59\1/2\. Hardship is generally 
defined under regulations issued under section 401(k). In addition, 
amounts held in a custodial account attributable to employer 
contributions (that are not section 403(b) elective deferrals) may not 
be paid to a participant before the participant has a severance from 
employment, becomes disabled (within the meaning of section 72(m)(7)), 
or attains age 59\1/2\. This rule also applies to amounts transferred 
out of a custodial account to an annuity contract or retirement income 
account, including earnings thereon.
    The final regulations, as did the 2004 proposed regulations, 
include a number of exceptions to the timing restrictions. For example, 
the rule for elective deferrals does not apply to distributions of 
section 403(b) elective deferrals (not including earnings thereon) that 
were contributed before January 1, 1989.
    The final regulations, as did the 2004 proposed regulations, 
reflect the direct rollover rules of section 401(a)(31) and the related 
requirements of section 402(f) concerning the written explanation 
requirement for distributions that qualify as eligible rollover 
distributions, including conforming the timing rule to the rule for 
qualified plans.
    In addition to the restrictions described in this preamble, the 
final regulations generally retain, with certain modifications, the 
additional rules from the 2004 proposed regulations relating to when 
distributions are permitted to be made from a section 403(b) plan, 
including the restrictions described in this preamble imposed by 
section 403(b)(7)(A)(ii) and (11) on distribution of amounts held in 
custodial accounts and elective deferrals, and the tax treatment of 
distributions from section 403(b) plans. Comments raised no objections 
to the various rules that were proposed in 2004, other than concerning 
the general rule requiring the occurrence of a stated event. The 2004 
proposed regulations generally would have required the occurrence of a 
stated event in order to commence distributions of amounts attributable 
to employer contributions to section 403(b) plans other than elective 
deferrals or distributions from custodial accounts. The stated event 
rule is substantially the same as the rule applicable to qualified 
defined contribution plans that are not money purchase pension plans 
(under Sec.  1.401-1(b)(1)(ii)), so that a plan is permitted to provide 
for a distribution upon completion of a fixed number of years (such as 
five years of participation), the attainment of a stated age, or upon 
the occurrence of some other identified event (such as the occurrence 
of a financial need,\5\ including a need to buy a home).
---------------------------------------------------------------------------

    \5\ See, for example, Rev. Rul. 56-693 (1956-2 CB 282).
---------------------------------------------------------------------------

    However, the final regulations make a number of changes relating to 
distributions. First, the final regulations clarify that after-tax 
employee contributions are not subject to any in-service distribution 
restrictions. Second, the regulations address comments that were made 
regarding certain disability arrangements by clarifying that, if an 
insurance contract includes provisions under which contributions will 
be continued in the event a participant becomes disabled, then that 
benefit is treated as an incidental benefit that must satisfy the 
incidental benefit requirement applicable to qualified plans (at Sec.  
1.401-1(b)(1)(ii)). Third, changes were made to reflect elective 
deferrals that are designated Roth contributions, discussed further 
later in this preamble under the heading, ``Requirement of Certain 
Separate Accounts Under Section 403(b).'' Fourth, Sec.  1.403(b)-
7(b)(5) has been added referencing the automatic rollover rules of 
section 401(a)(31), in accordance with section 403(b)(10). See Notice 
2005-5, 2005-1 CB 337, for rules interpreting this requirement. Fifth, 
a cross-reference to certain employment tax rules was added, discussed 
under the heading ``Employment Taxes.'' Sixth, in response to comments, 
the final regulations provide that the general rule requiring the 
occurrence of a stated event in order for distributions to commence 
does not apply to insurance contracts issued before January 1, 2009, 
and a special rule has been added allowing conforming amendments to be 
adopted by plans that are subject to ERISA. Section 1.403(b)-10(c) has 
been clarified to indicate that in order to be treated as a 
distribution under this section, the distribution must be pursuant to a 
QDRO as described in section 206(d)(3) of ERISA and the Department of 
Labor's guidance.

Severance From Employment

    The final regulations, like the 2004 proposed regulations, define 
severance from employment in a manner that is generally the same as the 
regulations under section 401(k) (see Sec.  1.401(k)-1(d)(2)), but 
provide that, for purposes of distributions from a section 403(b) plan, 
a severance from employment occurs on any date on which the employee 
ceases to be employed by an eligible employer that maintains the 
section 403(b) plan. Thus, a severance from employment would occur when 
an employee ceases to be employed by an eligible employer, even though 
the employee may continue to be employed by an entity that is part of 
the same controlled group but that is not an eligible employer, or on 
any date on which the employee works in a capacity that is not 
employment with an eligible employer. Examples of the situations that 
constitute a severance from employment include: an employee 
transferring from a section 501(c)(3) organization to a for-profit 
subsidiary of the section 501(c)(3) organization; an employee ceasing 
to work for a public school, but continuing to be employed by the same 
State; and an individual employed as a minister for an entity that is 
neither a State nor a section 501(c)(3) organization ceasing to perform 
services as a minister, but continuing to be employed by the same 
entity.

Section 401(a)(9)

    The final regulations, like the 2004 proposed regulations, require 
section 403(b) plans to comply with rules similar to those in the 
existing regulations relating to the required minimum distribution 
requirements of section 401(a)(9), but with some minor changes (for 
example, omitting the special rules for 5-percent owners). Thus, 
section 403(b) contracts must satisfy the incidental benefit rules. 
Guidance concerning the application of the incidental benefit 
requirements to permissible nonretirement benefits such as life, 
accident, or health benefits is contained in revenue rulings.\6\
---------------------------------------------------------------------------

    \6\ See, for example, Rev. Rul. 61-121 (1961-2 CB 65); Rev. Rul. 
68-304 (1968-1 CB 179); Rev. Rul. 72-240 (1972-1 CB 108); Rev. Rul. 
72-241 (1972-1 CB 108); Rev. Rul. 73-239 (1973-1 CB 201); and Rev. 
Rul. 74-115 (1974-1 CB 100).

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

[[Page 41134]]

Loans

    The final regulations adopt the provisions in the 2004 proposed 
regulations relating to loans to participants from a section 403(b) 
contract.

QDROs

    The final regulations also adopt the 2004 proposed regulations'' 
limited rules relating to QDROs under section 414(p). Section 414(p)(9) 
provides that the QDRO rules only apply to plans that are subject to 
the anti-alienation provisions of section 401(a)(13), except that 
section 414(p)(9) also provides that the section 414(p) QDRO rules 
apply to a section 403(b) contract. The final regulations, like the 
proposed regulations, clarify that the QDRO rules under section 414(p) 
apply to section 403(b) plans. The Secretary of Labor has authority to 
interpret the QDRO provisions, section 206(d)(3), and its parallel 
provision at section 414(p) of the Code, and to issue QDRO regulations 
in consultation with the Secretary of the Treasury. 29 U.S.C. 
1056(d)(3)(N). Under section 401(n) of the Internal Revenue Code, the 
Secretary of the Treasury has authority to issue rules and regulations 
necessary to coordinate the requirements of section 414(p) (and the 
regulations issued by the Secretary of Labor thereunder) with the other 
provisions of Chapter I of Subtitle A of the Code.

Taxation of Distributions and Benefits From a Section 403(b) Contract

    The final regulations, like the 2004 proposed regulations, reflect 
the statutory provisions regarding the taxation of distributions and 
benefits from section 403(b) contracts, including the provision that 
generally only amounts actually distributed from a section 403(b) 
contract are includible in the gross income of the recipient under 
section 72 for the year in which distributed. The final regulations 
also reflect the rule that any payment that constitutes an eligible 
rollover distribution is not taxed in the year distributed to the 
extent the payment is rolled over to an eligible retirement plan. The 
payor must withhold 20 percent Federal income tax, however, if an 
eligible rollover distribution is not rolled over in a direct rollover. 
Another provision requires the payor to give proper written notice to 
the section 403(b) participant or beneficiary concerning the eligible 
rollover distribution provision.

Section 403(b) Nondiscrimination and Universal Availability Rules

Nondiscrimination
    Section 403(b)(12)(A)(i) requires that employer contributions, 
other than elective deferrals, and after-tax employee contributions 
made under a section 403(b) contract satisfy a specified series of 
requirements (the nondiscrimination requirements) in the same manner as 
a qualified plan under section 401(a). These nondiscrimination 
requirements include rules relating to nondiscrimination in 
contributions, benefits, and coverage (sections 401(a)(4) and 410(b)), 
a limitation on the amount of compensation that can be taken into 
account (section 401(a)(17)), and the average contribution percentage 
rules of section 401(m) (relating to matching and after-tax employee 
contributions).
    Notice 89-23 discusses these requirements and provides a good faith 
reasonable standard for satisfying these requirements. The 2004 
proposed regulations would have eliminated the good faith reasonable 
standard for satisfying the nondiscrimination requirements of section 
403(b)(12)(A)(i) for non-governmental plans. Comments acknowledged the 
need for and the IRS's authority to make this change. Accordingly, 
these final regulations do not include the Notice 89-23 good faith 
reasonable standard.
    However, as discussed in this preamble under the heading 
``Treatment of Controlled Groups that Include Certain Entities,'' the 
Notice 89-23 good faith reasonable standard will continue to apply to 
State and local public schools (and certain church entities) for 
determining the controlled group. Although the general 
nondiscrimination requirements do not apply to governmental plans 
(within the meaning of section 414(d)), these plans are required to 
limit the amount of compensation to the amount permitted under section 
401(a)(17) for all purposes under the plan, including, for example the 
amount of compensation taken into account for employer contributions, 
and are required to satisfy the universal availability rule (described 
in this preamble under the heading ``Universal Availability for 
Elective Deferrals''). A non-governmental section 403(b) plan that 
provides for nonelective employer contributions must satisfy the 
coverage requirements of section 410(b) and the nondiscrimination 
requirements of section 401(a)(4) with respect to such contributions.
    These final regulations, like the 2004 proposed regulations, 
require a section 403(b) plan to comply with the nondiscrimination 
requirements for matching contributions in the same manner as a 
qualified plan. Thus, a non-governmental section 403(b) plan that 
provides for matching contribution must satisfy the nondiscrimination 
requirements of section 401(m). The nondiscrimination requirements are 
generally tested using compensation as defined in section 414(s) and 
are applied on an aggregated basis taking into account all plans of the 
employer. See the discussion under the heading ``Treatment of 
Controlled Groups that Include Certain Entities.''
    The nondiscrimination requirements do not apply to section 403(b) 
elective deferrals. Instead, a universal availability requirement, 
discussed further in the next section, applies to all section 403(b) 
elective deferrals (including elective deferrals made under a 
governmental section 403(b) plan).
Universal Availability for Elective Deferrals
    The universal availability requirement of section 403(b)(12)(A)(ii) 
provides that all employees of the eligible employer must be permitted 
to elect to have section 403(b) elective deferrals contributed on their 
behalf if any employee of the eligible employer may elect to have the 
organization make section 403(b) elective deferrals. Under the 2004 
proposed regulations, the universal availability requirement would not 
have been satisfied unless the contributions were made pursuant to a 
section 403(b) plan and the plan permitted all employees of an employer 
an opportunity to make elective deferrals if any employee of that 
employer has the right to make elective deferrals.
    The rules in the final regulations relating to the universal 
availability requirement are substantially similar to those in the 2004 
proposed regulations. The final regulations clarify that the employee's 
right to make elective deferrals also includes the right to designate 
section 403(b) elective deferrals as designated Roth contributions (if 
any employee of the eligible employer may elect to have the 
organization make section 403(b) elective deferrals as designated Roth 
contributions).
    The preamble to the 2004 proposed regulations requested comments 
regarding certain exclusions that have been permitted under 
transitional guidance issued in 1989. Specifically, Notice 89-23 had 
allowed, pending issuance of regulatory guidance, the exclusion of the 
following classes of employees for purposes of the universal 
availability rule: Employees who are

[[Page 41135]]

covered by a collective bargaining agreement; employees who make a one-
time election to participate in a governmental plan described in 
section 414(d), instead of a section 403(b) plan; professors who are 
providing services on a temporary basis to another public school for up 
to one year and for whom section 403(b) contributions are being made at 
a rate no greater than the rate each such professor would receive under 
the section 403(b) plan of the original public school; and employees 
who are affiliated with a religious order and who have taken a vow of 
poverty where the religious order provides for the support of such 
employees in their retirement.
    The comments submitted in response to the request generally 
requested to have these exclusions continue to be allowed. However, 
after consideration of the comments received, the IRS and Treasury 
Department have concluded that these exclusions are inconsistent with 
the statute and, accordingly, they are not permitted under these 
regulations. Nonetheless, as described further in the following 
paragraphs, other rules may provide relief with respect to individuals 
who are under a vow of poverty and to certain university professors 
affected.
    Rev. Rul. 68-123 (1968-1 CB 35), as clarified by Rev. Rul. 83-127 
(1983-2 CB 25), generally excludes from gross income, and from wage 
withholding, income of an individual working under a vow of poverty for 
an employer controlled by a church and the individual is treated as 
working as an agent of the church, not as an employee. While these 
regulations do not provide an exclusion from the universal availability 
requirement for individuals working under a vow of poverty, individuals 
who work for an institution that is controlled by the church 
organization and whose compensation from the employer is not treated as 
wages for purposes of income tax withholding under Rev. Rul. 68-123 may 
be excluded from the section 403(b) plan without violating the 
universal availability requirement because they are not treated as 
employees of the entity maintaining the section 403(b) plan.
    With respect to an exclusion relating to visiting professors, if an 
individual is rendering services to a university as a visiting 
professor, but continues to receive his or her compensation from his or 
her home university and elective deferrals on his or her behalf are 
made under the home university's section 403(b) plan, the final 
regulations do not, for purposes of section 403(b) and in any case in 
which such treatment is appropriate, preclude the plan maintained by 
the home university from treating the visiting professor as an eligible 
employee of the home university.
    The discussion in this preamble under the heading ``Applicability 
date'' describes transition relief for any existing plan that excludes, 
in accordance with Notice 89-23, collective bargaining employees, 
visiting professors, government employees who make a one-time election, 
or employees who work under a vow of poverty.

Rules Relating to Funding Arrangements

    These regulations retain, with certain modifications, the rules in 
the 2004 proposed regulations relating to the permitted investments for 
a section 403(b) contract. In general, a section 403(b) plan must be 
funded either by an annuity contract issued by an insurance company 
qualified to issue annuities in a State or a custodial account held by 
a bank (or a person who satisfies the conditions in section 401(f)(2)) 
where all of the amounts in the account are held for the exclusive 
benefit of plan participants or their beneficiaries in regulated 
investment companies (mutual funds) and certain other conditions are 
satisfied (including restrictions on distributions). Additional rules 
apply with respect to retirement income accounts for plans of a church 
or a convention or association of churches as discussed in the next 
section.

Special Rules for Church Plans' Retirement Income Accounts

    The final regulations, like the 2004 proposed regulations, include 
a number of special rules for church plans. Under section 403(b)(9), a 
retirement income account for employees of a church-related 
organization is treated as an annuity contract for purposes of section 
403(b). Under these regulations, the rules for a retirement income 
account are based largely on the provisions of section 403(b)(9) and 
the legislative history of TEFRA. The regulations define a retirement 
income account as a defined contribution program established or 
maintained by a church-related organization under which (i) there is 
separate accounting for the retirement income account's interest in the 
underlying assets (namely, it must be possible at all times to 
determine the retirement income account's interest in the underlying 
assets and to distinguish that interest from any interest that is not 
part of the retirement income account), (ii) investment performance is 
based on gains and losses on those assets, and (iii) the assets held in 
the account cannot be used for, or diverted to, purposes other than for 
the exclusive benefit of plan participants or their beneficiaries. For 
this purpose, assets are treated as diverted to the employer if the 
employer borrows assets from the account. A retirement income account 
must be maintained pursuant to a program which is a plan and the plan 
document must state (or otherwise evidence in a similarly clear manner) 
the intent to constitute a retirement income account.
    If any asset of a retirement income account is owned or used by a 
participant or beneficiary, then that ownership or use is treated as a 
distribution to that participant or beneficiary. The regulations also 
provide that a retirement income account that is treated as an annuity 
contract is not a custodial account (even if it is invested in stock of 
a regulated investment company).
    A life annuity can generally only be provided from an individual 
account by the purchase of an insurance annuity contract. However, in 
light of the special rules applicable to church retirement income 
accounts, the final regulations, like the 2004 proposed regulations, 
permit a life annuity to be paid from such an account if certain 
conditions are satisfied. The conditions are that the distribution from 
the account has an actuarial present value, at the annuity starting 
date, that is equal to the participant's or beneficiary's accumulated 
benefit, based on reasonable actuarial assumptions, including 
assumptions regarding interest and mortality, and that the plan sponsor 
guarantee benefits in the event that a payment is due that exceeds the 
participant's or beneficiary's accumulated benefit.

Termination of a Section 403(b) Plan

    The final regulations adopt the provisions of the 2004 proposed 
regulations permitting an employer to amend its section 403(b) plan to 
eliminate future contributions for existing participants, and allowing 
plan provisions that permit plan termination and a resulting 
distribution of accumulated benefits, with the associated right to roll 
over eligible rollover distributions to an eligible retirement plan, 
such as an individual retirement account or annuity (IRA). Comments on 
the rules in the 2004 proposed regulations regarding plan termination 
were favorable. In general, the distribution of accumulated benefits is 
permitted under these regulations only if the employer (taking into 
account all entities that are treated as a

[[Page 41136]]

single employer under section 414 on the date of the termination) does 
not make contributions to any section 403(b) contract that is not part 
of the plan during the period beginning on the date of plan termination 
and ending 12 months after distribution of all assets from the 
terminated plan. However, if at all times during the period beginning 
12 months before the termination and ending 12 months after 
distribution of all assets from the terminated plan, fewer than 2 
percent of the employees who were eligible under the section 403(b) 
plan as of the date of plan termination are eligible under the 
alternative section 403(b) contract, the other section 403(b) contract 
is disregarded. In order for a section 403(b) plan to be considered 
terminated, all accumulated benefits under the plan must be distributed 
to all participants and beneficiaries as soon as administratively 
practicable after termination of the plan. A distribution for this 
purpose includes delivery of a fully paid individual insurance annuity 
contract.

Effect of a Failure To Satisfy Section 403(b)

    These regulations include revisions to the 2004 proposed 
regulations that address the effects of a failure to satisfy section 
403(b). Section 403(b)(5) provides for all of the contracts purchased 
for an employee by an employer to be treated as a single contract for 
purposes of section 403(b). Thus, if a contract fails to satisfy any of 
the section 403(b) requirements, then not only that contract but also 
any other contract purchased for that individual by that employer would 
fail to be a contract that qualifies for tax-deferral under section 
403(b).
    Under these regulations, as under the 2004 proposed regulations, if 
a contract includes any amount that fails to satisfy the requirements 
of these regulations, then, except for special rules relating to 
vesting conditions and excess contributions (under section 415 or 
section 402(g)), that contract and any other contract purchased for 
that individual by that employer does not constitute a section 403(b) 
contract. In addition, if a contract is not established pursuant to a 
written plan, then the contract does not satisfy section 403(b). Thus, 
if an employer fails to have a written plan, any contract purchased by 
that employer would not be a section 403(b) contract. Similarly, if an 
employer is not an eligible employer for purposes of section 403(b), 
none of the contracts purchased by that employer is a section 403(b) 
contract. If a plan fails to satisfy the nondiscrimination rules 
(including a failure to operate the plan in accordance with its 
coverage provisions or a failure to operate the plan in a manner that 
satisfies the nondiscrimination rules), none of the contracts issued 
under the plan would be section 403(b) contracts.
    However, under these regulations, any operational failure, other 
than those described in the preceding paragraph, that is solely within 
a specific contract generally will not adversely affect the contracts 
issued to other employees that qualify in form and operation with 
section 403(b). Thus, for example, if an employee's elective deferrals 
under a contract, when aggregated with any other contract, plan, or 
arrangement of the employer for that employee during a calendar year, 
exceed the maximum deferral amount permitted under section 402(g)(1)(A) 
(as made applicable by section 403(b)(1)(E)), the failure would 
adversely affect the contracts issued to the employee by that employer, 
but would not adversely affect any other employee's contracts.

Requirement of Certain Separate Accounts Under Section 403(b)

    The final regulations, like the 2004 proposed regulations, include 
technical provisions addressing certain situations in which a separate 
account \7\ is necessary under section 403(b). For example, a separate 
bookkeeping account is required for any contract in which only a 
portion of the employee's interest is vested because, in such a case, 
separate accounting for each type of contribution (and earnings 
thereon) that is subject to a different vesting schedule is necessary 
to determine which vested contributions, including earnings thereon, 
are treated as held under a section 403(b) contract. In addition, the 
final regulations also clarify that if the section 403(b) plan fails to 
establish a separate account for contributions in excess of the section 
415(c) limitation under section 403(c) (relating to nonqualified 
annuity contracts whose present values are generally subject to current 
taxation), so that such excess contributions are commingled in a single 
insurance contract with contributions intended to qualify under section 
403(b) without maintaining a separate account for each amount, then 
none of the amounts held under the insurance contract qualify for tax 
deferral under section 403(b). Any such separate account must be 
established by the time the excess contribution is made to the plan. 
The separate account for excess contributions under section 415(c) is 
necessary to effectuate differences in the tax treatment of 
distributions (for example, because of the need to properly allocate 
basis under section 72 and separately identify amounts that can be 
rolled over). Similarly, a separate account is required for elective 
deferrals to be treated as held in a designated Roth account, as 
described in the following paragraph.
---------------------------------------------------------------------------

    \7\ These rules are not related to segregated asset accounts 
under section 817(h).
---------------------------------------------------------------------------

Designated Roth Accounts

    These regulations also include final regulations relating to 
elective deferrals that are designated Roth contributions under a 
section 403(b) plan. These regulations, however, do not address the 
taxation of a distribution of designated Roth contributions from a 
section 403(b) plan. See Sec.  1.402A-1 for those rules. The final 
regulations relating to elective deferrals under a section 403(b) plan 
that are designated Roth contributions are substantially unchanged from 
the proposed regulations that were issued in January of 2006 regarding 
designated Roth accounts under a section 403(b) plan.\8\
---------------------------------------------------------------------------

    \8\ REG-146459-05, published in the Federal Register (71 FR 
4320) on January 26, 2006.
---------------------------------------------------------------------------

Interaction Between Title I of ERISA and Section 403(b) of the Code

    The Treasury Department and the IRS consulted with the Department 
of Labor in connection with both the 2004 proposed regulations and 
these final regulations concerning the interaction between Title I of 
ERISA and section 403(b) of the Internal Revenue Code. In particular, 
the consultation focused on whether the requirements imposed on 
employers in these regulations would exceed the scope of the Department 
of Labor's safe harbor regulation at 29 CFR 2510.3-2(f) and result in 
all section 403(b) programs sponsored by tax-exempt employers (other 
than governmental plans and certain church plans) falling under the 
purview of ERISA.
    According to the Department of Labor, Title I of ERISA generally 
applies to ``any plan, fund, or program * * * established or maintained 
by an employer or by an employee organization, or by both, to the 
extent that * * * such plan, fund, or program * * * provides retirement 
income to employees, or * * * results in a deferral of income by 
employees for periods extending to the termination of covered 
employment or beyond.'' ERISA section 3(2)(A). However, governmental 
plans and church plans are generally excluded from coverage under Title 
I of ERISA. ERISA section 4(b)(1) and (2). Therefore,

[[Page 41137]]

contracts purchased or provided under a program that is either a 
``governmental plan'' under section 3(32) of ERISA or a ``church plan'' 
under section 3(33) of ERISA are not generally covered under Title I. 
However, section 403(b) of the Internal Revenue Code is also available 
with respect to contracts purchased or provided by employers for 
employees of a section 501(c)(3) organization, and many programs for 
the purchase of section 403(b) contracts offered by such employers are 
covered under Title I of ERISA as part of an ``employee pension benefit 
plan'' within the meaning of section 3(2)(A) of ERISA. The Department 
of Labor promulgated a regulation in 1975, 29 CFR 2510.3-2(f), 
describing circumstances under which an employer's program for the 
purchase of section 403(b) contracts for its employees, which is not 
otherwise excluded from coverage under Title I, will not be considered 
to constitute the establishment or maintenance of an ``employee pension 
benefit plan'' under Title I of ERISA.
    As described in the preamble to the 2004 proposed regulations, the 
Department of Labor advised the Treasury Department and the IRS that 
the proposed regulations did not appear to require, but left open the 
possibility that an employer may undertake, responsibilities in 
connection with a section 403(b) program that would exceed the limits 
in the safe harbor and constitute establishing and maintaining an 
ERISA-covered plan. Comments submitted on the proposal supported the 
continued availability of non-Title I section 403(b) programs to 
employees of tax-exempt employers and asked for additional guidance for 
employers who offer their employees access to such programs.
    According to the Department of Labor, review of the final section 
403(b) regulations has not led the Department of Labor to change its 
view on the principles that apply in determining whether any given 
section 403(b) program is covered by Title I of ERISA. Even though the 
differences between the tax rules for section 403(b) programs and those 
governing other ERISA-covered pension plans may have diminished as a 
result of the final section 403(b) regulations, the Department of Labor 
continues to be of the view that tax-exempt employers can comply with 
the requirements in the section 403(b) regulations and remain within 
the Department of Labor's safe harbor for tax-sheltered annuity 
programs funded solely by salary deferrals. The Department of Labor 
notes, however, that the new section 403(b) regulations offer employers 
considerable flexibility in shaping the extent and nature of their 
involvement. The question of whether any particular employer, in 
complying with the section 403(b) regulations, has established or 
maintained a plan covered under Title I of ERISA must be analyzed on a 
case-by-case basis applying the criteria set forth in 29 CFR Sec.  
2510.3-2(f) and section 3(2) of ERISA. To assist employers interested 
in offering their employees access to a tax sheltered annuity program 
that would not be an ERISA-covered plan, the Department of Labor is 
issuing, in conjunction with the final publication of this regulation, 
a Field Assistance Bulletin to provide additional guidance on the 
interaction of the safe harbor and the requirements in these final 
regulations. The Field Assistance Bulletin can be found at http://www.dol.gov/ebsa.

Treatment of Controlled Groups That Include Tax-Exempt Entities

    The final regulations retain the basic rules in the 2004 proposed 
regulations regarding controlled groups for entities that are tax-
exempt under section 501(a), but with a number of modifications to 
reflect the comments that were made. As in the 2004 proposed 
regulations, these rules are not limited to section 403(b) plans, but 
apply more broadly for purposes of determining when tax-exempt entities 
are treated as a single employer under section 414(b), (c), (m), and 
(o). Thus, for example, these rules apply for purposes of plans 
maintained by a tax-exempt entity that are intended to be qualified 
under section 401(a). These rules can apply to treat two section 501(c) 
organizations as a single employer, or a section 501(c) organization 
and a non-section 501(c) organization as a single employer, if the 
organizations are under common control. For a section 501(c)(3) 
organization that makes contributions to a section 403(b) plan, these 
rules would be generally relevant for purposes of the nondiscrimination 
requirements, as well as for the section 415 contribution limitations, 
the special section 403(b) catch-up contributions, and the section 
401(a)(9) minimum distribution rules.
    Under the rules in the 2004 proposed regulations, the employer for 
a plan maintained by a section 501(c) organization would include not 
only the organization whose employees participate in the plan, but also 
any other organization that is under common control with the tax-exempt 
organization. Under the 2004 proposed regulations, the existence of 
control would be determined based on the facts and circumstances. For 
this purpose, common control would exist between a tax-exempt 
organization and another organization if at least 80 percent of the 
directors or trustees of one organization were either representatives 
of, or directly or indirectly controlled by, the other organization.\9\ 
The 2004 proposed regulations permitted tax-exempt organizations to 
choose to be aggregated (permissive aggregation) if they maintained a 
single plan covering one or more employees from each organization and 
the organizations regularly coordinated their day-to-day exempt 
activities. These rules were subject to an overall anti-abuse rule. The 
final regulations retain the basic rules in the 2004 proposed 
regulations and the anti-abuse rule, and add an example to illustrate 
when the anti-abuse rule might apply.
---------------------------------------------------------------------------

    \9\ Treas. Reg. Sec.  1.512(b)-1(1)(4)(i)(b) uses a similar test 
to determine control of a non-stock organization. Note that those 
regulations do not reflect amendments that were made in section 
512(b)(13) by section 1041(a) of the Taxpayer Relief Act of 1997 
(111 Stat. 788).
---------------------------------------------------------------------------

    Comments on the 2004 proposed regulations generally approved of the 
proposed controlled group rules, but some comments argued for expanding 
the category of entities that can use the permissive aggregation rules. 
These comments typically did not recommend an overall standard for when 
permissive aggregation should be permitted, but identified certain 
specific practices which would be facilitated by permissive 
aggregation. In response, these regulations authorize the IRS to issue 
published guidance permitting other types of combinations of entities 
that include tax-exempt entities to elect to be treated as under common 
control for one or more specified purposes. This authority is limited 
to situations in which there are substantial business reasons for 
maintaining each entity in a separate trust, corporation, or other 
form, and under which common control treatment would be consistent with 
the anti-abuse standards in the regulations. It is expected that this 
authority would not be exercised unless the IRS determines that the 
organizations are so integrated in their operations as to effectively 
constitute a single coordinated employer for purposes of sections 
414(b), (c), (m), and (o), including common employee benefit plans.
    A comment was also received stating that a legally required 
trusteeship for a labor union that has been imposed in order to correct 
corruption or financial malpractice \10\ should not constitute control. 
In response, a change was made to the regulations to reflect the intent

[[Page 41138]]

that whether a person has the power to appoint and replace a trustee or 
director is based on facts and circumstances. For example, that power 
would generally not exist if that power was extremely limited due to 
the application of other laws, such as where a labor union was put 
under trusteeship pursuant to a court order, the trusteeship is for the 
sole purpose of correcting corruption, financial malpractice, or 
similar circumstances, and the replacement trustees were permitted to 
serve only for the time necessary for that purpose.
---------------------------------------------------------------------------

    \10\ See 29 U.S.C. 462.
---------------------------------------------------------------------------

    These controlled group rules for tax-exempt entities generally do 
not apply to certain church entities under section 3121(w)(3). These 
rules also do not apply to a State or local government or a federal 
government entity. Until further guidance is issued, church entities 
under section 3121(w)(3)(A) and (B) and State or local government 
public schools that sponsor section 403(b) plans can continue to rely 
on the rules in Notice 89-23 for determining the controlled group.

Employment Taxes

    These regulations include several new cross-references to certain 
rules concerning the application of employment taxes. For example, the 
definition of an elective deferral at Sec.  1.403(b)-2(a)(7) of these 
regulations refers to Sec.  1.402(g)(3)-1 of these regulations, which 
in turn refers to section 3121(a)(5)(D). See Sec.  31.3121(a)(5)-2T of 
the temporary regulations for additional guidance on section 
3121(a)(5)(D) (defining salary reduction agreement for purposes of the 
Federal Insurance Contributions Act (FICA)).
    As another example, Sec.  1.403(b)-7(f) of these regulations 
generally references the special income tax withholding rules under 
section 3405 for purposes of income tax withholding on distributions 
from section 403(b) contracts and also references the special rules at 
Sec.  1.72(p)-l, Q&A-15, and Sec.  35.3405(c)-1, Q&A-11, relating to 
income tax withholding for loans deemed distributed from qualified 
employer plans, including section 403(b) contracts. However, the 
general income tax withholding rules apply for purposes of income tax 
withholding for annuity contracts or custodial accounts that are not 
section 403(b) contracts, as well as for cases in which an annuity 
contract or custodial account ceases to qualify as a section 403(b) 
contract. See section 3401 and Sec. Sec.  1.83-8(a) and 35.3405-1T, 
Q&A-18.

Effect of These Regulations on Other Guidance

    Since the existing regulations were issued in 1964, a number of 
revenue rulings and other items of guidance under section 403(b) have 
become outdated as a result of changes in law. In addition, as a result 
of the inclusion in these regulations of much of the guidance that the 
IRS has issued regarding section 403(b), these regulations effectively 
supersede or substantially modify a number of revenue rulings and 
notices that have been issued under section 403(b). Thus, as indicated 
in the preamble to the 2004 proposed regulations, the IRS anticipates 
taking action in the future to obsolete many revenue rulings, notices, 
and other guidance under section 403(b).\11\
---------------------------------------------------------------------------

    \11\ When these regulations go into effect, the following 
guidance will be outdated or superseded by these regulations and it 
is expected that guidance will be issued in the future to formally 
supersede these items: Rev. Rul. 64-333 (1964-2 CB 114); Rev. Rul. 
65-200 (1965-2 CB 141); Rev. Rul. 66-254 (1966-2 CB. 125); Rev. Rul. 
66-312 (1966-2 CB 127); Rev. Rul. 67-78 (1967-1 CB 94); Rev. Rul. 
67-69 (1967-1 CB 93); Rev. Rul. 67-361 (1967-2 CB 153); Rev. Rul. 
67-387 (1967-2 CB 153); Rev. Rul. 67-388 (1967-2 CB 153); Rev. Rul. 
68-179 (1968-1 CB 179); Rev. Rul. 68-482 (1968-2 CB 186); Rev. Rul. 
68-487 (1968-2 CB 187); Rev. Rul. 68-488 (1968-2 CB 188); Rev. Rul. 
69-629 (1969-2 CB 101)--; Rev. Rul. 70-243 (1970-1 CB 107); Rev. 
Rul. 87-114 (1987-2 CB 116); Rev. Rul. 90-24 (1990-1 CB 97); Notice 
90-73 (1990-2 CB 353); Notice 92-36 (1992-2 CB 364); and 
Announcement 95-48 (1995-23 IRB 13). In addition, Notice 89-23 
(1989-1 CB 654) is likewise superseded as a result of these 
regulations, except to the extent described above under the heading 
``Treatment of Controlled Groups that Include Tax-Exempt Entities.'' 
It is expected that the following guidance will not be superseded 
when these regulations are issued in final form: Rev. Rul. 66-254 
(1966-2 CB 125); Rev. Rul. 68-33 (1968-1 CB 175); Rev. Rul 68-58 
(1968-1 CB 176); Rev. Rul. 68-116 (1968-1 CB 177); Rev. Rul. 68-648 
(1968-2 CB 49); Rev. Rul. 68-488 (1968-2 CB 188); and Rev. Rul. 69-
146 (1969-1 CB 132).
---------------------------------------------------------------------------

    However, the positions taken in certain rulings and other 
outstanding guidance are expected to be retained. For example, it is 
intended that the existing rules \12\ for determining when employees 
are performing services for a public school will continue to apply. 
Further, as discussed above in the preamble under the heading, 
``Treatment of Controlled Groups that Include Tax-Exempt Entities,'' 
church entities under section 3121(w)(3)(A) and (B) and public schools 
that sponsor section 403(b) plans can continue to rely on the rules in 
Notice 89-23 for determining the controlled group. In addition, certain 
positions taken in prior guidance are expected to be reevaluated in 
light of these regulations, such as Rev. Rul. 2004-67 (2004-28 IRB 28), 
which revised the group trust rules of Rev. Rul. 81-100 (1981-1 CB 
326). With the issuance of these regulations, a number of conforming 
changes will be considered for the compliance programs maintained by 
the IRS, as most recently published in Rev. Proc. 2006-27 (2006-22 IRB 
945) (EPCRS), including, for example, to reflect the written plan 
requirement and the positions described above in this preamble under 
the heading, ``Effect of a Failure to Satisfy Section 403(b).''
---------------------------------------------------------------------------

    \12\ Rev. Rul. 73-607 (1973-2 CB 145) and Rev. Rul. 80-139 
(1980-1 CB 88).
---------------------------------------------------------------------------

    The prior regulations under section 403(b) had included certain 
rules for determining the amount of the contributions made for an 
employee under a defined benefit plan, based on the employee's pension 
under the plan. These rules are generally no longer applicable for 
section 403(b) because the limitations on contributions to a section 
403(b) contract under section 415(c) are no longer coordinated with 
accruals under a defined benefit plan.\13\ However, the rules for 
determining the amount of contributions made for an employee under a 
defined benefit plan in the prior regulations under section 403(b) had 
also been used for purposes of section 402(b) (relating to nonqualified 
plans funded through trusts). These regulations replace those rules 
with regulations under section 402(b) that provide for the same rules 
(those in the section 403(b) regulations that were in effect prior to 
these regulations) to continue to apply for purposes of section 402(b). 
However, these section 402(b) regulations also authorize the 
Commissioner to issue guidance for determining the amount of the 
contributions made for an employee under a defined benefit plan under 
section 402(b).
---------------------------------------------------------------------------

    \13\ However, see Sec.  1.403(b)-10(f)(2) of these regulations 
for a special rule applicable to certain church defined benefit 
plans that were in effect on September 3, 1982.
---------------------------------------------------------------------------

Applicability Date

    These regulations are generally applicable for taxable years 
beginning after December 31, 2008. Thus, because individuals will 
almost uniformly be on a calendar taxable year, these regulations will 
generally apply on January 1, 2009. However, these regulations include 
a number of explicit transition rules.
    For a section 403(b) plan maintained pursuant to one or more 
collective bargaining agreements that have been ratified and are in 
effect on July 26, 2007, the regulations do not apply until the earlier 
of: (1) The date on which the last of such collective bargaining 
agreements terminates (determined

[[Page 41139]]

without regard to any extension thereof after July 26, 2007); or (2) 
July 26, 2010. For a section 403(b) plan maintained by a church-related 
organization for which the authority to amend the plan is held by a 
church convention (within the meaning of section 414(e)), the 
regulations do not apply before the beginning of the first plan year 
following December 31, 2009.
    There are also special applicability dates for several of the 
specific provisions in these regulations. First, special rules apply to 
plans which may have included one or more of the exclusions that Notice 
89-23 permitted for the universal availability rule, but which are no 
longer permitted under these regulations. Specifically, a special rule 
applies if a plan has eligibility conditions for elective deferrals 
relating to employees who make a one-time election to participate in a 
governmental plan described in section 414(d) instead of a section 
403(b) plan, professors who are providing services on a temporary basis 
to another school for up to one year and for whom section 403(b) 
contributions are being made at a rate no greater than the rate each 
such professor would receive under the section 403(b) plan of the 
original school, or employees who are affiliated with a religious order 
and who have taken a vow of poverty where the religious order provides 
for the support of such employees in their retirement. If, as permitted 
by Notice 89-23, a plan excludes any of these three classes of 
employees from eligibility to make elective deferrals on July 26, 2007, 
the plan is permitted to continue that exclusion until taxable years 
beginning on or after January 1, 2010. In addition, if a plan excludes 
employees covered by a collective bargaining agreement from eligibility 
to make elective deferrals on July 26, 2007, the plan is permitted to 
continue that exclusion until the later of (i) the first day of the 
first taxable year that begins after December 31, 2008, or (ii) the 
earlier of (I) the date that such agreement terminates (determined 
without regard to any extension thereof after July 26, 2007) or (II) 
July 26, 2010. In the case of a governmental plan (as defined in 
section 414(d)) for which the authority to amend the plan is held by a 
legislative body that meets in legislative session, the plan is 
permitted to continue the exclusion until the earlier of: (i) The close 
of the first regular legislative session of the legislative body with 
the authority to amend the plan that begins on or after January 1, 
2009; or (ii) January 1, 2011.
    These regulations (at Sec.  1.403(b)-6(b)) also provide that a 
section 403(b) contract is permitted to distribute retirement benefits 
to the participant no earlier than the earliest of the participant's 
severance from employment or upon the prior occurrence of some event, 
subject to a number of exceptions (relating to distributions from 
custodial accounts, distributions attributable to section 403(b) 
elective deferrals, correction of excess deferrals, distributions at 
plan termination, and payment of after-tax employee contributions). 
This rule does not apply for contracts issued before January 1, 2009. 
In addition, in order to permit plans to comply with the rules relating 
to in-service distributions for contracts issued before January 1, 
2009, the regulations provide that an amendment adopted before January 
1, 2009, to comply with these rules does not violate the anti-cutback 
rules of section 204(g) of ERISA.
    These regulations (at Sec.  1.403(b)-8(c)(2)) also do not permit a 
life insurance contract, an endowment contract, a health or accident 
insurance contract, or a property, casualty, or liability insurance 
contract to constitute an annuity contract for purposes of section 
403(b). This rule does not apply for contracts issued before September 
24, 2007.
    These regulations also include specific rules relating to contract 
exchanges that were permitted under Rev. Rul. 90-24. These new rules do 
not apply to contracts received in an exchange that occurred on or 
before September 24, 2007, assuming that the exchange (including the 
contract received in the exchange) satisfies applicable pre-existing 
legal requirements (including Rev. Rul. 90-24).
    Finally, these regulations include special applicability date rules 
to coordinate with recently issued regulations under sections 402A and 
415.
    For periods following July 26, 2007 and before the applicable date, 
taxpayers can rely on these regulations, except that (1) such reliance 
must be on a consistent and reasonable basis and (2) the special rule 
at Sec.  1.403(b)-10(a) of these regulations permitting accumulated 
benefits to be distributed on plan termination can be relied upon only 
if all of the contracts issued under the plan at that time satisfy all 
of the applicable requirements of these regulations (other than the 
requirement at Sec.  1.403(b)-3(b)(3)(i) of these regulations that 
there be a written plan).

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 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. 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. This certification is based upon the determination that 
respondents will need to spend minimal time (an average of 4.1 hours 
per year) complying with the contract exchange requirements in these 
regulations, and small entities are generally expected to spend much 
less time. Thus, the cost of complying with this statutory requirement 
is small, even for small entities. Therefore, a Regulatory Flexibility 
Analysis is not required under the Regulatory Flexibility Act (5 U.S.C. 
chapter 6).
    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 businesses.

Drafting Information

    The principal authors of these regulations are R. Lisa Mojiri-Azad 
and John Tolleris, Office of the Division Counsel/Associate Chief 
Counsel (Tax Exempt and Government Entities), IRS. However, other 
personnel from the IRS and the Treasury Department participated in 
their development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 31

    Employment taxes, Income taxes, Penalties, Pensions, Railroad 
retirement, Reporting and recordkeeping requirements, Social security, 
Unemployment compensation.

26 CFR Part 54

    Excise taxes, Pensions, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR parts 1, 31, 54, and 602 are amended as follows:

[[Page 41140]]

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by removing 
the entry for Sec.  1.403(b)-3 and adding entries in numerical order to 
read in part as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.403(b)-6 also issued under 26 U.S.C. 403(b)(10). * * *
    Section 1.414(c)-5 also issued under 26 U.S.C. 414(b), (c), and 
(o). * * *

0
Par. 2. Section 1.402(b)-1 is amended by revising paragraphs (a)(2) and 
(b)(2)(ii) to read as follows:


Sec.  1.402(b)-1  Treatment of beneficiary of a trust not exempt under 
section 501(a).

    (a) * * *
    (2) Determination of amount of employer contributions. If, for an 
employee, the actual amount of employer contributions referred to in 
paragraph (a)(1) of this section for any taxable year of the employee 
is not determinable or for any other reason is not known, then, except 
as set forth in rules prescribed by the Commissioner in revenue 
rulings, notices, or other guidance published in the Internal Revenue 
Bulletin (see Sec.  601.601(d)(2)(ii)(b) of this chapter), such amount 
shall be either--
    (i) The excess of--
    (A) The amount determined as of the end of such taxable year in 
accordance with the formula described in Sec.  1.403(b)-1(d)(4), as it 
appeared in the April 1, 2006, edition of 26 CFR Part 1; over
    (B) The amount determined as of the end of the prior taxable year 
in accordance with the formula described in paragraph (a)(2)(i)(A) of 
this section; or
    (ii) The amount determined under any other method utilizing 
recognized actuarial principles that are consistent with the provisions 
of the plan under which such contributions are made and the method 
adopted by the employer for funding the benefits under the plan.
    (b) * * *
    (2) * * *
    (ii) If a separate account in a trust for the benefit of two or 
more employees is not maintained for each employee, the value of the 
employee's interest in such trust is determined in accordance with 
rules prescribed by the Commissioner under the authority in paragraph 
(a)(2) of this section.
* * * * *

0
Par. 3. Section 1.402(g)(3)-1 is added to read as follows:


Sec.  1.402(g)(3)-1  Employer contributions to purchase a section 
403(b) contract under a salary reduction agreement.

    (a) General rule. With respect to an annuity contract under section 
403(b), except as provided in paragraph (b) of this section, an 
elective deferral means an employer contribution to purchase an annuity 
contract under section 403(b) under a salary reduction agreement within 
the meaning of section 3121(a)(5)(D).
    (b) Special rule. Notwithstanding paragraph (a) of this section, 
for purposes of section 403(b), an elective deferral only includes a 
contribution that is made pursuant to a cash or deferred election (as 
defined at Sec.  1.401(k)-1(a)(3)). Thus, for purposes of section 
402(g)(3)(C), an elective deferral does not include a contribution that 
is made pursuant to an employee's one-time irrevocable election made on 
or before the employee's first becoming eligible to participate under 
the employer's plans or a contribution made as a condition of 
employment that reduces the employee's compensation.
    (c) Applicable date. This section is applicable for taxable years 
beginning after December 31, 2008.

0
Par. 4. Section 1.402A-1, A-1 is revised to read as follows:


Sec.  1.402A-1  Designated Roth Accounts.

* * * * *
    A-1. A designated Roth account is a separate account under a 
qualified cash or deferred arrangement under a section 401(a) plan, or 
under a section 403(b) plan, to which designated Roth contributions are 
permitted to be made in lieu of elective contributions and that 
satisfies the requirements of Sec.  1.401(k)-1(f) (in the case of a 
section 401(a) plan) or Sec.  1.403(b)-3(c) (in the case of a section 
403(b) plan).
* * * * *

0
Par. 5. Section 1.403(b)-0 is added to read as follows:


Sec.  1.403(b)-0  Taxability under an annuity purchased by a section 
501(c)(3) organization or a public school.

    This section lists the headings that appear in Sec. Sec.  1.403(b)-
1 through 1.403(b)-11.

Sec.  1.403(b)-1 General overview of taxability under an annuity 
contract purchased by a section 501(c)(3) organization or a public 
school.

Sec.  1.403(b)-2 Definitions.

    (a) Application of definitions.
    (b) Definitions.

Sec.  1.403(b)-3 Exclusion for contributions to purchase section 
403(b) contracts.

    (a) Exclusion for section 403(b) contracts.
    (b) Application of requirements.
    (c) Special rules for designated Roth section 403(b) 
contributions.
    (d) Effect of failure.

Sec.  1.403(b)-4 Contribution limitations.

    (a) Treatment of contributions in excess of limitations.
    (b) Maximum annual contribution.
    (c) Section 403(b) elective deferrals.
    (d) Employer contributions for former employees.
    (e) Special rules for determining years of service.
    (f) Excess contributions of deferrals.

Sec.  1.403(b)-5 Nondiscrimination rules.

    (a) Nondiscrimination rules for contributions other than section 
403(b) elective deferrals.
    (b) Universal availability required for section 403(b) elective 
deferrals.
    (c) Plan required.
    (d) Church plans exception.
    (e) Other rules.

Sec.  1.403(b)-6 Timing of distributions and benefits.

    (a) Distributions generally.
    (b) Distributions from contracts other than custodial accounts 
or amounts attributable to section 403(b) elective deferrals.
    (c) Distributions from custodial accounts that are not 
attributable to section 403(b) elective deferrals.
    (d) Distribution of section 403(b) elective deferrals.
    (e) Minimum required distributions for eligible plans.
    (f) Loans.
    (g) Death benefits and other incidental benefits.
    (h) Special rule regarding severance from employment.

Sec.  1.403(b)-7 Taxation of distributions and benefits.

    (a) General rules for when amounts are included in gross income.
    (b) Rollovers to individual retirement arrangements and other 
eligible retirement plans.
    (c) Special rules for certain corrective distributions.
    (d) Amounts taxable under section 72(p)(1).
    (e) Special rules relating to distributions from a designated 
Roth account.
    (f) Certain rules relating to employment taxes.

Sec.  1.403(b)-8 Funding.

    (a) Investments.
    (b) Contributions to the plan.
    (c) Annuity contracts.
    (d) Custodial accounts.
    (e) Retirement income accounts.
    (f) Combining assets.

Sec.  1.403(b)-9 Special rules for church plans.

    (a) Retirement income accounts.
    (b) Retirement income account defined.
    (c) Special deduction rule for self-employed ministers.

[[Page 41141]]

Sec.  1.403(b)-10 Miscellaneous provisions.

    (a) Plan terminations and frozen plans.
    (b) Contract exchanges and plan-to-plan transfers.
    (c) Qualified domestic relations orders.
    (d) Rollovers to a section 403(b) contract.
    (e) Deemed IRAs.
    (f) Defined benefit plans.
    (g) Other rules relating to section 501(c)(3) organizations.

Sec.  1.403(b)-11 Applicable date.

    (a) General rule.
    (b) Collective bargaining agreements.
    (c) Church conventions.
    (d) Special rules for plans that exclude certain types of 
employees from elective deferrals.
    (e) Special rules for plans that permit in-service 
distributions.
    (f) Special rule for life insurance contracts.
    (g) Special rule for contracts received in an exchange.


0
Par. 6. Sections 1.403(b)-1, 1.403(b)-2, and 1.403(b)-3 are revised to 
read as follows:


Sec.  1.403(b)-1  General overview of taxability under an annuity 
contract purchased by a section 501(c)(3) organization or a public 
school.

    Section 403(b) and Sec. Sec.  1.403(b)-2 through 1.403(b)-10 
provide rules for the Federal income tax treatment of an annuity 
purchased for an employee by an employer that is either a tax-exempt 
entity under section 501(c)(3) (relating to certain religious, 
charitable, scientific, or other types of organizations) or a public 
school, or for a minister described in section 414(e)(5)(A). See 
section 403(a) (relating to qualified annuities) for rules regarding 
the taxation of an annuity purchased under a qualified annuity plan 
that meets the requirements of section 404(a)(2), and see section 
403(c) (relating to nonqualified annuities) for rules regarding the 
taxation of other types of annuities.


Sec.  1.403(b)-2  Definitions.

    (a) Application of definitions. The definitions set forth in this 
section are applicable for purposes of Sec.  1.403(b)-1, this section 
and Sec. Sec.  1.403(b)-3 through 1.403(b)-11.
    (b) Definitions--(1) Accumulated benefit means the total benefit to 
which a participant or beneficiary is entitled under a section 403(b) 
contract, including all contributions made to the contract and all 
earnings thereon.
    (2) Annuity contract means a contract that is issued by an 
insurance company qualified to issue annuities in a State and that 
includes payment in the form of an annuity. See Sec.  1.401(f)-1(d)(2) 
and (e) for the definition of an annuity, and see Sec.  1.403(b)-
8(c)(3) for a special rule for certain State plans. See also Sec. Sec.  
1.403(b)-8(d) and 1.403(b)-9(a) for additional rules regarding the 
treatment of custodial accounts and retirement income accounts as 
annuity contracts.
    (3) Beneficiary means a person who is entitled to benefits in 
respect of a participant following the participant's death or an 
alternate payee pursuant to a qualified domestic relations order, as 
described in Sec.  1.403(b)-10(c).
    (4) Catch-up amount or catch-up limitation for a participant for a 
taxable year means a section 403(b) elective deferral permitted under 
section 414(v) (as described in Sec.  1.403(b)-4(c)(2)) or section 
402(g)(7) (as described in Sec.  1.403(b)-4(c)(3)).
    (5) Church means a church as defined in section 3121(w)(3)(A) and a 
qualified church-controlled organization as defined in section 
3121(w)(3)(B).
    (6) Church-related organization means a church or a convention or 
association of churches, including an organization described in section 
414(e)(3)(A).
    (7) Elective deferral means an elective deferral under Sec.  
1.402(g)-1 (with respect to an employer contribution to a section 
403(b) contract) and any other amount that constitutes an elective 
deferral under section 402(g)(3).
    (8) (i) Eligible employer means--
    (A) A State, but only with respect to an employee of the state 
performing services for a public school;
    (B) A section 501(c)(3) organization with respect to any employee 
of the section 501(c)(3) organization;
    (C) Any employer of a minister described in section 414(e)(5)(A), 
but only with respect to the minister; or
    (D) A minister described in section 414(e)(5)(A), but only with 
respect to a retirement income account established for the minister.
    (ii) An entity is not an eligible employer under paragraph 
(a)(8)(i)(A) of this section if it treats itself as not being a State 
for any other purpose of the Internal Revenue Code, and a subsidiary or 
other affiliate of an eligible employer is not an eligible employer 
under paragraph (a)(8)(i) of this section if the subsidiary or other 
affiliate is not an entity described in paragraph (a)(8)(i) of this 
section.
    (9) Employee means a common-law employee performing services for 
the employer, and does not include a former employee or an independent 
contractor. Subject to any rules in Sec.  1.403(b)-1, this section and 
Sec. Sec.  1.403(b)-3 through 1.403(b)-11 that are specifically 
applicable to ministers, an employee also includes a minister described 
in section 414(e)(5)(A) when performing services in the exercise of his 
or her ministry.
    (10) Employee performing services for a public school means an 
employee performing services as an employee for a public school of a 
State. This definition is not applicable unless the employee's 
compensation for performing services for a public school is paid by the 
State. Further, a person occupying an elective or appointive public 
office is not an employee performing services for a public school 
unless such office is one to which an individual is elected or 
appointed only if the individual has received training, or is 
experienced, in the field of education. The term public office includes 
any elective or appointive office of a State.
    (11) Includible compensation means the employee's compensation 
received from an eligible employer that is includible in the 
participant's gross income for Federal income tax purposes (computed 
without regard to section 911) for the most recent period that is a 
year of service. Includible compensation for a minister who is self-
employed means the minister's earned income as defined in section 
401(c)(2) (computed without regard to section 911) for the most recent 
period that is a year of service. Includible compensation does not 
include any compensation received during a period when the employer is 
not an eligible employer. Includible compensation also includes any 
elective deferral or other amount contributed or deferred by the 
eligible employer at the election of the employee that would be 
includible in the gross income of the employee but for the rules of 
section 125, 132(f)(4), 402(e)(2), 402(h)(1)(B), 402(k), or 457(b). The 
amount of includible compensation is determined without regard to any 
community property laws. See section 415(c)(3)(A) through (D) for 
additional rules, and see Sec.  1.403(b)-4(d) for a special rule 
regarding former employees.
    (12) Participant means an employee for whom a section 403(b) 
contract is currently being purchased, or an employee or former 
employee for whom a section 403(b) contract has previously been 
purchased and who has not received a distribution of his or her entire 
accumulated benefit under the contract.
    (13) Plan means a plan as described in Sec.  1.403(b)-3(b)(3).

[[Page 41142]]

    (14) Public school means a State-sponsored educational organization 
described in section 170(b)(1)(A)(ii) (relating to educational 
organizations that normally maintain a regular faculty and curriculum 
and normally have a regularly enrolled body of pupils or students in 
attendance at the place where educational activities are regularly 
carried on).
    (15) Retirement income account means a defined contribution program 
established or maintained by a church-related organization to provide 
benefits under section 403(b) for its employees or their beneficiaries 
as described in Sec.  1.403(b)-9.
    (16) Section 403(b) contract; section 403(b) plan--(i) Section 
403(b) contract means a contract that satisfies the requirements of 
Sec.  1.403(b)-3. If for any taxable year an employer contributes to 
more than one section 403(b) contract for a participant or beneficiary, 
then, under section 403(b)(5), all such contracts are treated as one 
contract for purposes of section 403(b) and Sec.  1.403(b)-1, this 
section, and Sec. Sec.  1.403(b)-3 through 1.403(b)-11. See also Sec.  
1.403(b)-3(b)(1).
    (ii) Section 403(b) plan means the plan of the employer under which 
the section 403(b) contracts for its employees are maintained.
    (17) Section 403(b) elective deferral; designated Roth 
contribution--(i) Section 403(b) elective deferral means an elective 
deferral that is an employer contribution to a section 403(b) plan for 
an employee. See Sec.  1.403(b)-5(b) for additional rules with respect 
to a section 403(b) elective deferral.
    (ii) Designated Roth contribution under a section 403(b) plan means 
a section 403(b) elective deferral that satisfies Sec.  1.403(b)-3(c).
    (18) Section 501(c)(3) organization means an organization that is 
described in section 501(c)(3) (relating to certain religious, 
charitable, scientific, or other types of organizations) and exempt 
from tax under section 501(a).
    (19) Severance from employment means that the employee ceases to be 
employed by the employer maintaining the plan. See Sec.  1.401(k)-1(d) 
for additional guidance concerning severance from employment. See also 
Sec.  1.403(b)-6(h) for a special rule under which severance from 
employment is determined by reference to employment with the eligible 
employer.
    (20) State means a State, a political subdivision of a State, or 
any agency or instrumentality of a State. For this purpose, the 
District of Columbia is treated as a State. In addition, for purposes 
of determining whether an individual is an employee performing services 
for a public school, an Indian tribal government is treated as a State, 
as provided under section 7871(a)(6)(B). See also section 1450(b) of 
the Small Business Job Protection Act of 1996 (110 Stat. 1755, 1814) 
for special rules treating certain contracts purchased in a plan year 
beginning before January 1, 1995, that include contributions by an 
Indian tribal government as section 403(b) contracts, whether or not 
those contributions are for employees performing services for a public 
school.
    (21) Year of service means each full year during which an 
individual is a full-time employee of an eligible employer, plus 
fractional credit for each part of a year during which the individual 
is either a full-time employee of an eligible employer for a part of 
the year or a part-time employee of an eligible employer. See Sec.  
1.403(b)-4(e) for rules for determining years of service.


Sec.  1.403(b)-3  Exclusion for contributions to purchase section 
403(b) contracts.

    (a) Exclusion for section 403(b) contracts. Amounts contributed by 
an eligible employer for the purchase of an annuity contract for an 
employee are excluded from the gross income of the employee under 
section 403(b) only if each of the requirements in paragraphs (a)(1) 
through (9) of this section is satisfied. In addition, amounts 
contributed by an eligible employer for the purchase of an annuity 
contract for an employee pursuant to a cash or deferred election (as 
defined at Sec.  1.401(k)-1(a)(3)) are not includible in an employee's 
gross income at the time the cash would have been includible in the 
employee's gross income (but for the cash or deferred election) if each 
of the requirements in paragraphs (a)(1) through (9) of this section is 
satisfied. However, the preceding two sentences generally do not apply 
to designated Roth contributions; see paragraph (c) of this section and 
Sec.  1.403(b)-7(e) for special taxation rules that apply with respect 
to designated Roth contributions under a section 403(b) plan.
    (1) Not a contract issued under qualified plan or eligible 
governmental plan. The annuity contract is not purchased under a 
qualified plan (under section 401(a) or 403(a)) or an eligible 
governmental plan under section 457(b).
    (2) Nonforfeitability. The rights of the employee under the annuity 
contract (disregarding rights to future premiums) are nonforfeitable. 
An employee's rights under a contract fail to be nonforfeitable unless 
the employee for whom the contract is purchased has at all times a 
fully vested and nonforfeitable right (as defined in regulations under 
section 411) to all benefits provided under the contract. See paragraph 
(d)(2) of this section for additional rules regarding the 
nonforfeitability requirement of this paragraph (a)(2).
    (3) Nondiscrimination. In the case of an annuity contract purchased 
by an eligible employer other than a church, the contract is purchased 
under a plan that satisfies section 403(b)(12) (relating to 
nondiscrimination requirements, including universal availability). See 
Sec.  1.403(b)-5.
    (4) Limitations on elective deferrals. In the case of an elective 
deferral, the contract satisfies section 401(a)(30) (relating to 
limitations on elective deferrals). A contract does not satisfy section 
401(a)(30) as required under this paragraph (a)(4) unless the contract 
requires that all elective deferrals for an employee not exceed the 
limits of section 402(g)(1), including elective deferrals for the 
employee under the contract and any other elective deferrals under the 
plan under which the contract is purchased and under all other plans, 
contracts, or arrangements of the employer. See Sec.  1.401(a)-30.
    (5) Nontransferability. The contract is not transferable. This 
paragraph (a)(5) does not apply to a contract issued before January 1, 
1963. See section 401(g).
    (6) Minimum required distributions. The contract satisfies the 
requirements of section 401(a)(9) (relating to minimum required 
distributions). See Sec.  1.403(b)-6(e).
    (7) Rollover distributions. The contract provides that, if the 
distributee of an eligible rollover distribution elects to have the 
distribution paid directly to an eligible retirement plan, as defined 
in section 402(c)(8)(B), and specifies the eligible retirement plan to 
which the distribution is to be paid, then the distribution will be 
paid to that eligible retirement plan in a direct rollover. See Sec.  
1.403(b)-7(b)(2).
    (8) Limitation on incidental benefits. The contract satisfies the 
incidental benefit requirements of section 401(a). See Sec.  1.403(b)-
6(g).
    (9) Maximum annual additions. The annual additions to the contract 
do not exceed the applicable limitations of section 415(c) (treating 
contributions and other additions as annual additions). See paragraph 
(b) of this section and Sec.  1.403(b)-4(b) and (f).
    (b) Application of requirements--(1) Aggregation of contracts. In 
accordance with section 403(b)(5), for purposes of determining whether 
this section is satisfied, all section 403(b) contracts purchased for 
an individual by an employer are treated as purchased under a single 
contract. Additional

[[Page 41143]]

aggregation rules apply under section 402(g) for purposes of satisfying 
paragraph (a)(4) of this section and under section 415 for purposes of 
satisfying paragraph (a)(9) of this section.
    (2) Disaggregation for excess annual additions. In accordance with 
the last sentence of section 415(a)(2), if an excess annual addition is 
made to a contract that otherwise satisfies the requirements of this 
section, then the portion of the contract that includes such excess 
annual addition fails to be a section 403(b) contract (as further 
described in paragraph (d)(1) of this section) and the remaining 
portion of the contract is a section 403(b) contract. This paragraph 
(b)(2) is not satisfied unless, for the year of the excess and each 
year thereafter, the issuer of the contract maintains separate accounts 
for each such portion. Thus, the entire contract fails to be a section 
403(b) contract if an excess annual addition is made and a separate 
account is not maintained with respect to the excess.
    (3) Plan in form and operation. (i) A contract does not satisfy 
paragraph (a) of this section unless it is maintained pursuant to a 
plan. For this purpose, a plan is a written defined contribution plan, 
which, in both form and operation, satisfies the requirements of Sec.  
1.403(b)-1, Sec.  1.403(b)-2, this section, and Sec. Sec.  1.403(b)-4 
through 1.403(b)-11. For purposes of Sec.  1.403(b)-1, Sec.  1.403(b)-
2, this section, and Sec. Sec.  1.403(b)-4 through 1.403(b)-11, the 
plan must contain all the material terms and conditions for 
eligibility, benefits, applicable limitations, the contracts available 
under the plan, and the time and form under which benefit distributions 
would be made. For purposes of Sec.  1.403(b)-1, Sec.  1.403(b)-2, this 
section, and Sec. Sec.  1.403(b)-4 through 1.403(b)-11, a plan may 
contain certain optional features that are consistent with but not 
required under section 403(b), such as hardship withdrawal 
distributions, loans, plan-to-plan or annuity contract-to-annuity 
contract transfers, and acceptance of rollovers to the plan. However, 
if a plan contains any optional provisions, the optional provisions 
must meet, in both form and operation, the relevant requirements under 
section 403(b), this section and Sec. Sec.  1.403(b)-4 through 
1.403(b)-11.
    (ii) The plan may allocate responsibility for performing 
administrative functions, including functions to comply with the 
requirements of section 403(b) and other tax requirements. Any such 
allocation must identify responsibility for compliance with the 
requirements of the Internal Revenue Code that apply on the basis of 
the aggregated contracts issued to a participant under a plan, 
including loans under section 72(p) and the conditions for obtaining a 
hardship withdrawal under Sec.  1.403(b)-6. A plan is permitted to 
assign such responsibilities to parties other than the eligible 
employer, but not to participants (other than employees of the employer 
a substantial portion of whose duties are administration of the plan), 
and may incorporate by reference other documents, including the 
insurance policy or custodial account, which thereupon become part of 
the plan.
    (iii) This paragraph (b)(3) applies to contributions to an annuity 
contract by a church only if the annuity is part of a retirement income 
account, as defined in Sec.  1.403(b)-9.
    (4) Exclusion limited for former employees--(i) General rule. 
Except as provided in paragraph (b)(4)(ii) of this section and in Sec.  
1.403(b)-4(d), the exclusion from gross income provided by section 
403(b) does not apply to contributions made for former employees. For 
this purpose, a contribution is not made for a former employee if the 
contribution is with respect to compensation that would otherwise be 
paid for a payroll period that begins before severance from employment.
    (ii) Exceptions. The exclusion from gross income provided by 
section 403(b) applies to contributions made for former employees with 
respect to compensation described in Sec.  1.415(c)-2(e)(3)(i) 
(relating to certain compensation paid by the later of 2\1/2\ months 
after severance from employment or the end of the limitation year that 
includes the date of severance from employment), and compensation 
described in Sec.  1.415(c)-2(e)(4), Sec.  1.415(c)-2(g)(4), or Sec.  
1.415(c)-2(g)(7) (relating to compensation paid to participants who are 
permanently and totally disabled or relating to qualified military 
service under section 414(u)).
    (c) Special rules for designated Roth section 403(b) contributions. 
(1) The rules of Sec.  1.401(k)-1(f)(1) and (2) for designated Roth 
contributions under a qualified cash or deferred arrangement apply to 
designated Roth contributions under a section 403(b) plan. Thus, a 
designated Roth contribution under a section 403(b) plan is a section 
403(b) elective deferral that is designated irrevocably by the employee 
at the time of the cash or deferred election as a designated Roth 
contribution that is being made in lieu of all or a portion of the 
section 403(b) elective deferrals the employee is otherwise eligible to 
make under the plan; that is treated by the employer as includible in 
the employee's gross income at the time the employee would have 
received the amount in cash if the employee had not made the cash or 
deferred election (such as by treating the contributions as wages 
subject to applicable withholding requirements); and that is maintained 
in a separate account (within the meaning of Sec.  1.401(k)-1(f)(2)).
    (2) A designated Roth contribution under a section 403(b) plan must 
satisfy the requirements applicable to section 403(b) elective 
deferrals. Thus, for example, designated Roth contributions under a 
section 403(b) plan must satisfy the requirements of Sec.  1.403(b)-
6(d). Similarly, a designated Roth account under a section 403(b) plan 
is subject to the rules of section 401(a)(9)(A) and (B) and Sec.  
1.403(b)-6(e).
    (d) Effect of failure--(1) General rules. (i) If a contract 
includes any amount that fails to satisfy the requirements of section 
403(b), Sec.  1.403(b)-1, Sec.  1.403(b)-2, this section, or Sec. Sec.  
1.403(b)-4 through 1.403(b)-11, then, except as otherwise provided in 
paragraph (d)(2) of this section (relating to failure to satisfy 
nonforfeitability requirements) or Sec.  1.403(b)-4(f) (relating to 
excess contributions under section 415 and excess deferrals under 
section 402(g)), the contract is not a section 403(b) contract. In 
addition, section 403(b)(5) and paragraph (b)(1) of this section 
provide that, for purposes of determining whether a contract satisfies 
section 403(b), all section 403(b) contracts purchased for an 
individual by an employer are treated as purchased under a single 
contract. Thus, except as provided in paragraph (b)(2) of this section 
or as otherwise provided in this paragraph (d), a failure to satisfy 
section 403(b) with respect to any contract issued to an individual by 
an employer adversely affects all contracts issued to that individual 
by that employer.
    (ii) In accordance with paragraph (b)(3) of this section, a failure 
to operate in accordance with the terms of a plan adversely affects all 
of the contracts issued by the employer to the employee or employees 
with respect to whom the operational failure occurred. Such a failure 
does not adversely affect any other contract if the failure is neither 
a failure to satisfy the nondiscrimination requirements of Sec.  
1.403(b)-5 (a nondiscrimination failure) nor a failure of the employer 
to be an eligible employer as defined in Sec.  1.403(b)-2 (an employer 
eligibility failure). However, any failure that is not an operational 
failure adversely affects all contracts issued under the plan, 
including: a failure to have contracts issued pursuant to a written 
defined contribution plan

[[Page 41144]]

which, in form, satisfies the requirements of Sec.  1.403(b)-1, Sec.  
1.403(b)-2, this section and Sec. Sec.  1.403(b)-4 through 1.403(b)-11 
(a written plan failure); a nondiscrimination failure; or an employer 
eligibility failure.
    (iii) See other applicable Internal Revenue Code provisions for the 
treatment of a contract that is not a section 403(b) contract, such as 
sections 61, 83, 402(b), and 403(c). Thus, for example, section 403(c) 
(relating to nonqualified annuities) applies if any annuity contract 
issued by an insurance company fails to satisfy section 403(b), based 
on the value of the contract at the time of the failure. However, see 
paragraph (d)(2) of this section for special rules with respect to the 
nonforfeitability requirement of paragraph (a)(2) of this section.
    (2) Failure to satisfy nonforfeitability requirement--(i) Treatment 
before contract becomes nonforfeitable. If an annuity contract issued 
by an insurance company would qualify as a section 403(b) contract but 
for the failure to satisfy the nonforfeitability requirement of 
paragraph (a)(2) of this section, then the contract is treated as a 
contract to which section 403(c) applies. See Sec.  1.403(b)-8(d)(4) 
for a rule under which a custodial account that fails to satisfy the 
nonforfeitability requirement of paragraph (a)(2) of this section is 
treated as a section 401(a) qualified plan for certain purposes.
    (ii) Treatment when contract becomes nonforfeitable--(A) In 
general. Notwithstanding paragraph (d)(2)(i) of this section, on or 
after the date on which the participant's interest in a contract 
described in paragraph (d)(2)(i) of this section becomes 
nonforfeitable, the contract may be treated as a section 403(b) 
contract if no election has been made under section 83(b) with respect 
to the contract, the participant's interest in the contract has been 
subject to a substantial risk of forfeiture (as defined in section 83) 
before becoming nonforfeitable, each contribution under the contract 
that is subject to a different vesting schedule is maintained in a 
separate account, and the contract has at all times satisfied the 
requirements of paragraph (a) of this section other than the 
nonforfeitability requirement of paragraph (a)(2) of this section. 
Thus, for example, for the current year and each prior year, no 
contribution can have been made to the contract that would cause the 
contract to fail to be a section 403(b) contract as a result of 
contributions exceeding the limitations of section 415 (except to the 
extent permitted under paragraph (b)(2) of this section) or to fail to 
satisfy the nondiscrimination rules described in Sec.  1.403(b)-5. See 
also Sec.  1.403(b)-10(a)(1) for a special rule in connection with 
termination of a section 403(b) plan.
    (B) Partial vesting. For purposes of applying this paragraph (d), 
if only a portion of a participant's interest in a contract becomes 
nonforfeitable in a year, then the portion that is nonforfeitable and 
the portion that fails to be nonforfeitable are each treated as 
separate contracts. In addition, for purposes of applying this 
paragraph (d), if a contribution is made to an annuity contract in 
excess of the limitations of section 415(c) and the excess is 
maintained in a separate account, then the portion of the contract that 
includes the excess contributions account and the remainder are each 
treated as separate contracts. Thus, if an annuity contract that 
includes an excess contributions account changes from forfeitable to 
nonforfeitable during a year, then the portion that is not attributable 
to the excess contributions account constitutes a section 403(b) 
contract (assuming it otherwise satisfies the requirements to be a 
section 403(b) contract) and is not included in gross income, and the 
portion that is attributable to the excess contributions account is 
included in gross income in accordance with section 403(c). See Sec.  
1.403(b)-4(f) for additional rules.

0
Par. 7. Sections 1.403(b)-4, 1.403(b)-5, 1.403(b)-6, 1.403(b)-7, 
1.403(b)-8, 1.403(b)-9, 1.403(b)-10, and 1.403(b)-11 are added to read 
as follows:


Sec.  1.403(b)-4  Contribution limitations.

    (a) Treatment of contributions in excess of limitations. The 
exclusion provided under Sec.  1.403(b)-3(a) applies to a participant 
only if the amounts contributed by the employer for the purchase of an 
annuity contract for the participant do not exceed the applicable limit 
under sections 415 and 402(g), as described in this section. Under 
Sec.  1.403(b)-3(a)(4), a section 403(b) contract is required to 
include the limits on elective deferrals imposed by section 402(g), as 
described in paragraph (c) of this section. See paragraph (f) of this 
section for special rules concerning excess contributions and 
deferrals. Rollover contributions made to a section 403(b) contract, as 
described in Sec.  1.403(b)-10(d), are not taken into account for 
purposes of the limits imposed by section 415, Sec.  1.403(b)-3(a)(9), 
section 402(g), Sec.  1.403(b)-3(a)(4), and this section, but after-tax 
employee contributions are taken into account under section 415, Sec.  
1.403(b)-3(a)(9), and paragraph (b) of this section.
    (b) Maximum annual contribution--(1) General rule. In accordance 
with section 415(a)(2) and Sec.  1.403(b)-3(a)(9), the contributions 
for any participant under a section 403(b) contract (namely, employer 
nonelective contributions (including matching contributions), section 
403(b) elective deferrals, and after-tax employee contributions) are 
not permitted to exceed the limitations imposed by section 415. Under 
section 415(c), contributions are permitted to be made for participants 
in a defined contribution plan, subject to the limitations set forth 
therein (which are generally the lesser of a dollar limit for a year or 
the participant's compensation for the year). For purposes of section 
415, contributions made for a participant are aggregated to the extent 
applicable under section 414(b), (c), (m), (n), and (o). For purposes 
of section 415(a)(2), Sec. Sec.  1.403(b)-1 through 1.403(b)-3, this 
section, and Sec. Sec.  1.403(b)-5 through 1.403(b)-11, a contribution 
means any annual addition, as defined in section 415(c).
    (2) Special rules. See section 415(k)(4) for a special rule under 
which contributions to section 403(b) contracts are generally 
aggregated with contributions under other arrangements in applying 
section 415. For purposes of applying section 415(c)(1)(B) (relating to 
compensation) with respect to a section 403(b) contract, except as 
provided in section 415(c)(3)(C), a participant's includible 
compensation (as defined in Sec.  1.403(b)-2) is substituted for the 
participant's compensation, as described in section 415(c)(3)(E). Any 
age 50 catch-up contributions under paragraph (c)(2) of this section 
are disregarded in applying section 415.
    (c) Section 403(b) elective deferrals--(1) Basic limit under 
section 402(g)(1). In accordance with section 402(g)(1)(A), the section 
403(b) elective deferrals for any individual are included in the 
individual's gross income to the extent the amount of such deferrals, 
plus all other elective deferrals for the individual, for the taxable 
year exceeds the applicable dollar amount under section 402(g)(1)(B). 
The applicable annual dollar amount under section 402(g)(1)(B) is 
$15,000, adjusted for cost-of-living after 2006 in the manner described 
in section 402(g)(4). See Sec.  1.403(b)-5(b) for a universal 
availability rule that applies if any employee is permitted to have any 
section 403(b) elective deferrals made on his or her behalf.
    (2) Age 50 catch-up--(i) In general. In accordance with section 
414(v) and the regulations thereunder, a section 403(b) contract may 
provide for catch-up contributions for a participant who is age 50 by 
the end of the year, provided that such age 50 catch-up contributions 
do not exceed the catch-up limit under

[[Page 41145]]

section 414(v)(2) for the taxable year. The maximum amount of 
additional age 50 catch-up contributions for a taxable year under 
section 414(v) is $5,000, adjusted for cost-of-living after 2006 in the 
manner described in section 414(v)(2)(C). For additional requirements, 
see regulations under section 414(v).
    (ii) Coordination with special section 403(b) catch-up. In 
accordance with sections 414(v)(6)(A)(ii) and 402(g)(7)(A), the age 50 
catch-up described in this paragraph (c)(2) may apply for any taxable 
year in which a participant also qualifies for the special section 
403(b) catch-up under paragraph (c)(3) of this section.
    (3) Special section 403(b) catch-up for certain organizations--(i) 
Amount of the special section 403(b) catch-up. In the case of a 
qualified employee of a qualified organization for whom the basic 
section 403(b) elective deferrals for any year are not less than the 
applicable dollar amount under section 402(g)(1)(B), the section 403(b) 
elective deferral limitation of section 402(g)(1) for the taxable year 
of the qualified employee is increased by the least of--
    (A) $3,000;
    (B) The excess of--
    (1) $15,000, over
    (2) The total elective deferrals described in section 
402(g)(7)(A)(ii) made for the qualified employee by the qualified 
organization for prior years, or
    (C) The excess of--
    (1) $5,000 multiplied by the number of years of service of the 
employee with the qualified organization, over
    (2) The total elective deferrals (as defined at Sec.  1.403(b)-2) 
made for the employee by the qualified organization for prior years.
    (ii) Qualified organization. (A) For purposes of this paragraph 
(c)(3), qualified organization means an eligible employer that is--
    (1) An educational organization described in section 
170(b)(1)(A)(ii);
    (2) A hospital;
    (3) A health and welfare service agency (including a home health 
service agency);
    (4) A church-related organization; or
    (5) Any organization described in section 414(e)(3)(B)(ii).
    (B) All entities that are in a church-related organization or an 
organization controlled by a church-related organization under section 
414(e)(3)(B)(ii) are treated as a single qualified organization (so 
that years of service and any special section 403(b) catch-up elective 
deferrals previously made for a qualified employee for a church or 
other entity within a church-related organization or an organization 
controlled by the church-related organization are taken into account 
for purposes of applying this paragraph (c)(3) to the employee with 
respect to any other entity within the same church-related organization 
or organization controlled by a church-related organization).
    (C) For purposes of this paragraph (c)(3)(ii), a health and welfare 
service agency means--
    (1) An organization whose primary activity is to provide services 
that constitute medical care as defined in section 213(d)(1) (such as a 
hospice);
    (2) A section 501(c)(3) organization whose primary activity is the 
prevention of cruelty to individuals or animals;
    (3) An adoption agency; or
    (4) An agency that provides substantial personal services to the 
needy as part of its primary activity (such as a section 501(c)(3) 
organization that either provides meals to needy individuals, is a home 
health service agency, provides services to help individuals who have 
substance abuse, or provides help to the disabled).
    (iii) Qualified employee. For purposes of this paragraph (c)(3), 
qualified employee means an employee who has completed at least 15 
years of service (as defined under paragraph (e) of this section) 
taking into account only employment with the qualified organization. 
Thus, an employee who has not completed at least 15 years of service 
(as defined under paragraph (e) of this section) taking into account 
only employment with the qualified organization is not a qualified 
employee.
    (iv) Coordination with age 50 catch-up. In accordance with sections 
402(g)(1)(C) and 402(g)(7), any catch-up amount contributed by an 
employee who is eligible for both an age 50 catch-up and a special 
section 403(b) catch-up is treated first as an amount contributed as a 
special section 403(b) catch-up to the extent a special section 403(b) 
catch-up is permitted, and then as an amount contributed as an age 50 
catch-up (to the extent the catch-up amount exceeds the maximum special 
section 403(b) catch-up after taking into account sections 402(g) and 
415(c), this paragraph (c)(3), and any limitations on the special 
section 403(b) catch-up that are imposed by the terms of the plan).
    (4) Coordination with designated Roth contributions. See 
regulations under section 402A for rules for determining whether an 
elective deferral is a pre-tax elective deferral or a designated Roth 
contribution.
    (5) Examples. The provisions of this paragraph (c) are illustrated 
by the following examples:

    Example 1. (i) Facts illustrating application of the basic 
dollar limit. Participant B, who is 45, is eligible to participate 
in a State university section 403(b) plan in 2006. B is not a 
qualified employee, as defined in paragraph (c)(3)(iii) of this 
section. The plan permits section 403(b) elective deferrals, but no 
other employer contributions are made under the plan. The plan 
provides limitations on section 403(b) elective deferrals up to the 
maximum permitted under paragraphs (c)(1) and (3) of this section 
and the additional age 50 catch-up amount described in paragraph 
(c)(2) of this section. For 2006, B will receive includible 
compensation of $42,000 from the eligible employer. B desires to 
elect to have the maximum section 403(b) elective deferral possible 
contributed in 2006. For 2006, the basic dollar limit for section 
403(b) elective deferrals under paragraph (c)(1) of this section is 
$15,000 and the additional dollar amount permitted under the age 50 
catch-up is $5,000.
    (ii) Conclusion. B is not eligible for the age 50 catch-up in 
2006 because B is 45 in 2006. B is also not eligible for the special 
section 403(b) catch-up under paragraph (c)(3) of this section 
because B is not a qualified employee. Accordingly, the maximum 
section 403(b) elective deferral that B may elect for 2006 is 
$15,000.
    Example 2. (i) Facts illustrating application of the includible 
compensation limitation. The facts are the same as in Example 1, 
except B's includible compensation is $14,000.
    (ii) Conclusion. Under section 415(c), contributions may not 
exceed 100 percent of includible compensation. Accordingly, the 
maximum section 403(b) elective deferral that B may elect for 2006 
is $14,000.
    Example 3. (i) Facts illustrating application of the age 50 
catch-up. Participant C, who is 55, is eligible to participate in a 
State university section 403(b) plan in 2006. The plan permits 
section 403(b) elective deferrals, but no other employer 
contributions are made under the plan. The plan provides limitations 
on section 403(b) elective deferrals up to the maximum permitted 
under paragraphs (c)(1) and (c)(3) of this section and the 
additional age 50 catch-up amount described in paragraph (c)(2) of 
this section. For 2006, C will receive includible compensation of 
$48,000 from the eligible employer. C desires to elect to have the 
maximum section 403(b) elective deferral possible contributed in 
2006. For 2006, the basic dollar limit for section 403(b) elective 
deferrals under paragraph (c)(1) of this section is $15,000 and the 
additional dollar amount permitted under the age 50 catch-up is 
$5,000. C does not have 15 years of service and thus is not a 
qualified employee, as defined in paragraph (c)(3)(iii) of this 
section.
    (ii) Conclusion. C is eligible for the age 50 catch-up in 2006 
because C is 55 in 2006. C is not eligible for the special section 
403(b) catch-up under paragraph (c)(3) of this section because C is 
not a qualified employee (as defined in paragraph (c)(3)(iii) of 
this section). Accordingly, the maximum section 403(b) elective 
deferral that C may elect for 2006 is $20,000 ($15,000 plus $5,000).
    Example 4. (i) Facts illustrating application of both the age 50 
and the special section

[[Page 41146]]

403(b) catch-up. The facts are the same as in Example 3, except that 
C is a qualified employee for purposes of the special section 403(b) 
catch-up provisions in paragraph (c)(3) of this section. For 2006, 
the maximum additional section 403(b) elective deferral for which C 
qualifies under the special section 403(b) catch-up under paragraph 
(c)(3) of this section is $3,000.
    (ii) Conclusion. The maximum section 403(b) elective deferrals 
that C may elect for 2006 is $23,000. This is the sum of the basic 
limit on section 403(b) elective deferrals under paragraph (c)(1) of 
this section equal to $15,000, plus the $3,000 additional special 
section 403(b) catch-up amount for which C qualifies under paragraph 
(c)(3) of this section, plus the additional age 50 catch-up amount 
of $5,000.
    Example 5. (i) Facts illustrating calculation of years of 
service with a predecessor organization for purposes of the special 
section 403(b) catch-up. Participant A is an employee of hospital H 
and is eligible to participate in a section 403(b) plan of H in 
2006. A does not have 15 years of service with H, but A has 
previously made special section 403(b) catch-up deferrals to a 
section 403(b) plan maintained by hospital P which has since been 
acquired by H.
    (ii) Conclusion. The special section 403(b) catch-up amount for 
which A qualifies under paragraph (c)(3) of this section must be 
calculated taking into account A's prior years of service and 
section 403(b) elective deferrals with the predecessor hospital if 
and only if A did not have any severance from service in connection 
with the acquisition.
    Example 6. (i) Facts illustrating application of the age 50 
catch-up and the section 415(c) dollar limitation. The facts are the 
same as in Example 4, except that the employer makes a nonelective 
contribution for each employee equal to 20 percent of C's 
compensation (which is $48,000). Thus, the employer makes a 
nonelective contribution for C for 2006 equal to $9,600. The plan 
provides that a participant is not permitted to make section 403(b) 
elective deferrals to the extent the section 403(b) elective 
deferrals would result in contributions in excess of the maximum 
permitted under section 415 and provides that contributions are 
reduced in the following order: the special section 403(b) catch-up 
elective deferrals under paragraph (c)(3) of this section are 
reduced first; the age 50 catch-up elective deferrals under 
paragraph (c)(2) of this section are reduced second; and then the 
basic section 403(b) elective deferrals under paragraph (c)(1) of 
this section are reduced. For 2006, the applicable dollar limit 
under section 415(c)(1)(A) is $44,000.
    (ii) Conclusion. The maximum section 403(b) elective deferral 
that C may elect for 2006 is $23,000. This is the sum of the basic 
limit on section 403(b) elective deferrals under paragraph (c)(1) of 
this section equal to $15,000, plus the $3,000 additional special 
section 403(b) catch-up amount for which C qualifies under paragraph 
(c)(3) of this section, plus the additional age 50 catch-up amount 
of $5,000. The limit in paragraph (b) of this section would not be 
exceeded because the sum of the $9,600 nonelective contribution and 
the $23,000 section 403(b) elective deferrals does not exceed the 
lesser of $49,000 (which is the sum of $44,000 plus the $5,000 
additional age 50 catch-up amount) or $53,000 (which is the sum of 
C's includible compensation for 2006 ($48,000) plus the $5,000 
additional age 50 catch-up amount).
    Example 7. (i) Facts further illustrating application of the age 
50 catch-up and the section 415(c) dollar limitation. The facts are 
the same as in Example 6, except that C's includible compensation 
for 2006 is $58,000 and the plan provides for a nonelective 
contribution equal to 50 percent of includible compensation, so that 
the employer nonelective contribution for C for 2006 is $29,000 (50 
percent of $58,000).
    (ii) Conclusion. The maximum section 403(b) elective deferral 
that C may elect for 2006 is $20,000. A section 403(b) elective 
deferral in excess of this amount would exceed the sum of the limit 
in section 415(c)(1)(A) plus the additional age 50 catch-up amount, 
because the sum of the employer's nonelective contribution of 
$29,000 plus a section 403(b) elective deferral in excess of $20,000 
would exceed $49,000 (the sum of the $44,000 limit in section 
415(c)(1)(A) plus the $5,000 additional age 50 catch-up amount). 
(Note that a section 403(b) elective deferral in excess of $20,000 
would also exceed the limitations of section 402(g) unless a special 
section 403(b) catch-up were permitted.)
    Example 8. (i) Facts further illustrating application of the age 
50 catch-up and the section 415(c) dollar limitation. The facts are 
the same as in Example 7, except that the plan provides for a 
nonelective contribution for C equal to $44,000 (which is the limit 
in section 415(c)(1)(A)).
    (ii) Conclusion. The maximum section 403(b) elective deferral 
that C may elect for 2006 is $5,000. A section 403(b) elective 
deferral in excess of this amount would exceed the sum of the limit 
in section 415(c)(1)(A) plus the additional age 50 catch-up amount 
($5,000), because the sum of the employer's nonelective contribution 
of $44,000 plus a section 403(b) elective deferral in excess of 
$5,000 would exceed $49,000 (the sum of the $44,000 limit in section 
415(c)(1)(A) plus the $5,000 additional age 50 catch-up amount).
    Example 9. (i) Facts illustrating application of the age 50 
catch-up and the section 415(c) includible compensation limitation. 
The facts are the same as in Example 7, except that C's includible 
compensation for 2006 is $28,000, so that the employer nonelective 
contribution for C for 2006 is $14,000 (50 percent of $28,000).
    (ii) Conclusion. The maximum section 403(b) elective deferral 
that C may elect for 2006 is $19,000. A section 403(b) elective 
deferral in excess of this amount would exceed the sum of the limit 
in section 415(c)(1)(B) plus the additional age 50 catch-up amount, 
because C's includible compensation is $28,000 and the sum of the 
employer's nonelective contribution of $14,000 plus a section 403(b) 
elective deferral in excess of $19,000 would exceed $33,000 (which 
is the sum of 100 percent of C's includible compensation plus the 
$5,000 additional age 50 catch-up amount).
    Example 10. (i) Facts illustrating that section 403(b) elective 
deferrals cannot exceed compensation otherwise payable. Employee D 
is age 60, has includible compensation of $14,000, and wishes to 
contribute section 403(b) elective deferrals of $20,000 for the 
year. No nonelective contributions are made for Employee D.
    (ii) Conclusion. Because a contribution is a section 403(b) 
elective deferral only if it relates to an amount that would 
otherwise be included in the participant's compensation, the 
effective limitation on section 403(b) elective deferrals for a 
participant whose compensation is less than the basic dollar limit 
for section 403(b) elective deferrals is the participant's 
compensation. Thus, D cannot make section 403(b) elective deferrals 
in excess of D's actual compensation, which is $14,000, even though 
the basic dollar limit exceeds that amount.
    Example 11. (i) Facts illustrating calculation of the special 
section 403(b) catch-up. For 2006, employee E, who is age 53, is 
eligible to participate in a section 403(b) plan of hospital H, 
which is a section 501(c)(3) organization. H's plan permits section 
403(b) elective deferrals and provides for an employer contribution 
of 10 percent of a participant's compensation. The plan provides 
limitations on section 403(b) elective deferrals up to the maximum 
permitted under paragraphs (c)(1), (2), and (3) of this section. For 
2006, E's includible compensation is $50,000. E wishes to elect to 
have the maximum section 403(b) elective deferral possible 
contributed in 2006. E has previously made $62,000 of section 403(b) 
elective deferrals under the plan, but has never made an election 
for a special section 403(b) catch-up elective deferral. For 2006, 
the basic dollar limit for section 403(b) elective deferrals under 
paragraph (c)(1) of this section is $15,000, the additional dollar 
amount permitted under the age 50 catch-up is $5,000, E's employer 
will make a nonelective contribution of $5,000 (10% of $50,000 
compensation), and E is a qualified employee of a qualified employer 
as defined in paragraph (c)(3) of this section.
    (ii) Conclusion. The maximum section 403(b) elective deferrals 
that E may elect under H's section 403(b) plan for 2006 is $23,000. 
This is the sum of the basic limit on section 403(b) elective 
deferrals for 2006 under paragraph (c)(1) of this section equal to 
$15,000, plus the $3,000 maximum additional special section 403(b) 
catch-up amount for which D qualifies in 2006 under paragraph (c)(3) 
of this section, plus the additional age 50 catch-up amount of 
$5,000. The limitation on the additional special section 403(b) 
catch-up amount is not less than $3,000 because the limitation at 
paragraph (c)(3)(i)(B) of this section is $15,000 ($15,000 minus 
zero) and the limitation at paragraph (c)(3)(i)(C) of this section 
is $13,000 ($5,000 times 15, minus $62,000 of total deferrals in 
prior years). These conclusions would be unaffected if H were an 
eligible governmental employer under section 457(b) that has a 
section 457(b) eligible governmental plan and E were in the past to 
have made annual deferrals to that plan, because contributions to a 
section 457(b) eligible governmental plan do not

[[Page 41147]]

constitute elective deferrals; and these conclusions would also be 
the same if H had a section 401(k) plan and E were in the past to 
have made elective deferrals to that plan, assuming that those 
elective deferrals did not exceed $10,000 ($5,000 times 15, minus 
the sum of $62,000 plus $10,000, equals $3,000), so as to result in 
the limitation at paragraph (c)(3)(i)(C) of this section being less 
than $3,000.
    Example 12. (i) Facts illustrating calculation of the special 
section 403(b) catch-up in the next calendar year. The facts are the 
same as in Example 11, except that, for 2007, E has includible 
compensation of $60,000. For 2007, E now has previously made $85,000 
of section 403(b) elective deferrals ($62,000 deferred before 2006, 
plus the $15,000 in basic section 403(b) elective deferrals in 2006, 
the $3,000 maximum additional special section 403(b) catch-up amount 
in 2006, plus the $5,000 age 50 catch-up amount in 2006). However, 
the $5,000 age 50 catch-up amount deferred in 2006 is disregarded 
for purposes of applying the limitation at paragraph (c)(3)(i)(B) of 
this section to determine the special section 403(b) catch-up 
amount. Thus, for 2007, only $80,000 of section 403(b) elective 
deferrals are taken into account in applying the limitation at 
paragraph (c)(3)(i)(B) of this section. For 2007, the basic dollar 
limit for section 403(b) elective deferrals under paragraph (c)(1) 
of this section is assumed to be $16,000, the additional dollar 
amount permitted under the age 50 catch-up is assumed to be $5,000, 
and E's employer contributes $6,000 (10% of $60,000) as a non-
elective contribution.
    (ii) Conclusion. The maximum section 403(b) elective deferral 
that D may elect under H's section 403(b) plan for 2007 is $21,000. 
This is the sum of the basic limit on section 403(b) elective 
deferrals under paragraph (c)(1) of this section equal to $16,000, 
plus the additional age 50 catch-up amount of $5,000. E is not 
entitled to any additional special section 403(b) catch-up amount 
for 2007 under paragraph (c)(3) of this section due to the 
limitation at paragraph (c)(3)(i)(C) of this section (16 times 
$5,000 equals $80,000, minus D's total prior section 403(b) elective 
deferrals of $80,000 equals zero).

    (d) Employer contributions for former employees--(1) Includible 
compensation deemed to continue for nonelective contributions. For 
purposes of applying paragraph (b) of this section, a former employee 
is deemed to have monthly includible compensation for the period 
through the end of the taxable year of the employee in which he or she 
ceases to be an employee and through the end of each of the next five 
taxable years. The amount of the monthly includible compensation is 
equal to one twelfth of the former employee's includible compensation 
during the former employee's most recent year of service. Accordingly, 
nonelective employer contributions for a former employee must not 
exceed the limitation of section 415(c)(1) up to the lesser of the 
dollar amount in section 415(c)(1)(A) or the former employee's annual 
includible compensation based on the former employee's average monthly 
compensation during his or her most recent year of service.
    (2) Examples. The provisions of paragraph (d)(1) of this section 
are illustrated by the following examples:

    Example 1. (i) Facts. Private college M is a section 501(c)(3) 
organization operated on the basis of a June 30 fiscal year that 
maintains a section 403(b) plan for its employees. In 2004, M amends 
the plan to provide for a temporary early retirement incentive under 
which the college will make a nonelective contribution for any 
participant who satisfies certain minimum age and service conditions 
and who retires before June 30, 2006. The contribution will equal 
110 percent of the participant's rate of pay for one year and will 
be payable over a period ending no later than the end of the fifth 
fiscal year that begins after retirement. It is assumed for purposes 
of this Example 1 that, in accordance with Sec.  1.401(a)(4)-10(b) 
and under the facts and circumstances, the post-retirement 
contributions made for participants who satisfy the minimum age and 
service conditions and retire before June 30, 2006, do not 
discriminate in favor of former employees who are highly compensated 
employees. Employee A retires under the early retirement incentive 
on March 12, 2006, and A's annual includible compensation for the 
period from March 1, 2005, through February 28, 2006 (which is A's 
most recent one year of service) is $30,000. The applicable dollar 
limit under section 415(c)(1)(A) is assumed to be $44,000 for 2006 
and $45,000 for 2007. The college contributes $30,000 for A for 2006 
and $3,000 for A for 2007 (totaling $33,000 or 110 percent of 
$30,000). No other contributions are made to a section 403(b) 
contract for A for those years.
    (ii) Conclusion. The contributions made for A do not exceed A's 
includible compensation for 2006 or 2007.
    Example 2. (i) Facts. Private college N is a section 501(c)(3) 
organization that maintains a section 403(b) plan for its employees. 
The plan provides for N to make monthly nonelective contributions 
equal to 20 percent of the monthly includible compensation for each 
eligible employee. In addition, the plan provides for contributions 
to continue for 5 years following the retirement of any employee 
after age 64 and completion of at least 20 years of service (based 
on the employee's average annual rate of base salary in the 
preceding 3 calendar years ended before the date of retirement). It 
is assumed for purposes of this Example 2 that, in accordance with 
Sec.  1.401(a)(4)-10(b) and under the facts and circumstances, the 
post-retirement contributions made for participants who satisfy the 
minimum age and service conditions do not discriminate in favor of 
former employees who are highly compensated employees. Employee B 
retires on July 1, 2006, at age 64 after completion of 20 or more 
years of service. At that date, B's annual includible compensation 
for the most recently ended fiscal year of N is $72,000 and B's 
average monthly rate of base salary for 2003 through 2005 is $5,000. 
N contributes $1,200 per month (20 percent of 1/12th of $72,000) 
from January of 2006 through June of 2006 and contributes $1,000 (20 
percent of $5,000) per month for B from July of 2006 through June of 
2011. The applicable dollar limit under section 415(c)(1)(A) is 
$44,000 for 2006 through 2011. No other contributions are made to a 
section 403(b) contract for B for those years.
    (ii) Conclusion. The contributions made for B do not exceed B's 
includible compensation for any of the years from 2006 through 2010.
    Example 3. (i) Facts. A public university maintains a section 
403(b) under which it contributes annually 10% of compensation for 
participants, including for the first 5 calendar years following the 
date on which the participant ceases to be an employee. The plan 
provides that if a participant who is a former employee dies during 
the first 5 calendar years following the date on which the 
participant ceases to be an employee, a contribution is made that is 
equal to the lesser of--
    (A) The excess of the individual's includible compensation for 
that year over the contributions previously made for the individual 
for that year; or
    (B) The total contributions that would have been made on the 
individual's behalf thereafter if he or she had survived to the end 
of the 5-year period.
    (ii) Individual C's annual includible compensation is $72,000 
(so that C's monthly includible compensation is $6,000). A $600 
contribution is made for C for January of the first taxable year 
following retirement (10% of individual C's monthly includible 
compensation of $6,000). Individual C dies during February of that 
year. The university makes a contribution for individual C for 
February equal to $11,400 (C's monthly includible compensation for 
January and February, reduced by $600).
    (iii) Conclusion. The contribution does not exceed the amount of 
individual C's includible compensation for the taxable year for 
purposes of section 415(c), but any additional contributions would 
exceed C's includible compensation for purposes of section 415(c).

    (3) Disabled employees. See also section 415(c)(3)(C) which sets 
forth a special rule under which compensation may be treated as 
continuing for purposes of section 415 for certain former employees who 
are disabled.
    (e) Special rules for determining years of service--(1) In general. 
For purposes of determining a participant's includible compensation 
under paragraph (b)(2) of this section and a participant's years of 
service under paragraphs (c)(3) (special section 403(b) catch-up for 
qualified employees of certain organizations) and (d) (employer 
contributions for former employees) of this section, an employee must 
be credited with a full year of service for each year during which the 
individual is a full-time employee of the eligible employer for the 
entire work period, and a fraction of a year for each

[[Page 41148]]

part of a work period during which the individual is a full-time or 
part-time employee of the eligible employer. An individual's number of 
years of service equals the aggregate of the annual work periods during 
which the individual is employed by the eligible employer.
    (2) Work period. A year of service is based on the employer's 
annual work period, not the employee's taxable year. For example, in 
determining whether a university professor is employed full time, the 
annual work period is the school's academic year. However, in no case 
may an employee accumulate more than one year of service in a twelve-
month period.
    (3) Service with more than one eligible employer--(i) General rule. 
With respect to any section 403(b) contract of an eligible employer, 
except as provided in paragraph (e)(3)(ii) of this section, any period 
during which an individual is not an employee of that eligible employer 
is disregarded for purposes of this paragraph (e).
    (ii) Special rule for church employees. With respect to any section 
403(b) contract of an eligible employer that is a church-related 
organization, any period during which an individual is an employee of 
that eligible employer and any other eligible employer that is a 
church-related organization that has an association (as defined in 
section 414(e)(3)(D)) with that eligible employer is taken into account 
on an aggregated basis, but any period during which an individual is 
not an employee of a church-related organization or is an employee of a 
church-related organization that does not have an association with that 
eligible employer is disregarded for purposes of this paragraph (e).
    (4) Full-time employee for full year. Each annual work period 
during which an individual is employed full time by the eligible 
employer constitutes one year of service. In determining whether an 
individual is employed full-time, the amount of work which he or she 
actually performs is compared with the amount of work that is normally 
required of individuals performing similar services from which 
substantially all of their annual compensation is derived.
    (5) Other employees. (i) An individual is treated as performing a 
fraction of a year of service for each annual work period during which 
he or she is a full-time employee for part of the annual work period 
and for each annual work period during which he or she is a part-time 
employee either for the entire annual work period or for a part of the 
annual work period.
    (ii) In determining the fraction that represents the fractional 
year of service for an individual employed full time for part of an 
annual work period, the numerator is the period of time (such as weeks 
or months) during which the individual is a full-time employee during 
that annual work period, and the denominator is the period of time that 
is the annual work period.
    (iii) In determining the fraction that represents the fractional 
year of service of an individual who is employed part time for the 
entire annual work period, the numerator is the amount of work 
performed by the individual, and the denominator is the amount of work 
normally required of individuals who perform similar services and who 
are employed full time for the entire annual work period.
    (iv) In determining the fraction representing the fractional year 
of service of an individual who is employed part time for part of an 
annual work period, the fractional year of service that would apply if 
the individual were a part-time employee for a full annual work period 
is multiplied by the fractional year of service that would apply if the 
individual were a full-time employee for the part of an annual work 
period.
    (6) Work performed. For purposes of this paragraph (e), in 
measuring the amount of work of an individual performing particular 
services, the work performed is determined based on the individual's 
hours of service (as defined under section 410(a)(3)(C)), except that a 
plan may use a different measure of work if appropriate under the facts 
and circumstances. For example, a plan may provide for a university 
professor's work to be measured by the number of courses taught during 
an annual work period in any case in which that individual's work 
assignment is generally based on a specified number of courses to be 
taught.
    (7) Most recent one-year period of service. For purposes of 
paragraph (d) of this section, in the case of a part-time employee or a 
full-time employee who is employed for only part of the year determined 
on the basis of the employer's annual work period, the employee's most 
recent periods of service are aggregated to determine his or her most 
recent one-year period of service. In such a case, there is first taken 
into account his or her service during the annual work period for which 
the last year of service's includible compensation is being determined; 
then there is taken into account his or her service during his next 
preceding annual work period based on whole months; and so forth, until 
the employee's service equals, in the aggregate, one year of service.
    (8) Less than one year of service considered as one year. If, at 
the close of a taxable year, an employee has, after application of all 
of the other rules in this paragraph (e), some portion of one year of 
service (but has accumulated less than one year of service), the 
employee is deemed to have one year of service. Except as provided in 
the previous sentence, fractional years of service are not rounded up.
    (9) Examples. The provisions of this paragraph (e) are illustrated 
by the following examples:

    Example 1. (i) Facts. Individual G is employed half-time in 2004 
and 2005 as a clerk by H, a hospital which is a section 501(c)(3) 
organization. G earns $20,000 from H in each of those years, and 
retires on December 31, 2005.
    (ii) Conclusion. For purposes of determining G's includible 
compensation during G's last year of service under paragraph (d) of 
this section, G's most recent periods of service are aggregated to 
determine G's most recent one-year period of service. In this case, 
since D worked half-time in 2004 and 2005, the compensation D earned 
in those two years are aggregated to produce D's includible 
compensation for D's last full year in service. Thus, in this case, 
the $20,000 that D earned in 2004 and 2005 for D's half-time work 
are aggregated, so that D has $40,000 of includible compensation for 
D's most recent one-year of service for purposes of applying 
paragraphs (b)(2), (c)(3), and (d) of this section.
    Example 2. (i) Facts. Individual H is employed as a part-time 
professor by public University U during the first semester of its 
two-semester 2004-2005 academic year. While H teaches one course 
generally for 3 hours a week during the first semester of the 
academic year, U's full-time faculty members generally teach for 9 
hours a week during the full academic year.
    (ii) Conclusion. For purposes of calculating how much of a year 
of service H performs in the 2004-2005 academic year (before 
application of the special rules of paragraphs (e)(7) and (8) of 
this section concerning less than one year of service), paragraph 
(e)(5)(iv) of this section is applied as follows: since H teaches 
one course at U for 3 hours per week for 1 semester and other 
faculty members at U teach 9 hours per week for 2 semesters, H is 
considered to have completed 3/18 or 1/6 of a year of service during 
the 2004-2005 academic year, determined as follows:
    (A) The fractional year of service if H were a part-time 
employee for a full year is 3/9 (number of hours employed divided by 
the usual number of hours of work required for that position).
    (B) The fractional year of service if H were a full-time 
employee for half of a year is \1/2\ (one semester, divided by the 
usual 2-semester annual work period).
    (C) These fractions are multiplied to obtain the fractional year 
of service: \3/9\ times \1/2\, or \3/18\, equals \1/6\ of a year of 
service.


[[Page 41149]]


    (f) Excess contributions or deferrals--(1) Inclusion in gross 
income. Any contribution made for a participant to a section 403(b) 
contract for the taxable year that exceeds either the maximum annual 
contribution limit set forth in paragraph (b) of this section or the 
maximum annual section 403(b) elective deferral limit set forth in 
paragraph (c) of this section constitutes an excess contribution that 
is included in gross income for that taxable year. See Sec.  1.403(b)-
3(d)(1)(iii) and (2)(i) for additional rules, including special rules 
relating to contracts that fail to be nonforfeitable. See also section 
4973 for an excise tax applicable with respect to excess contributions 
to a custodial account and section 4979(f)(2)(B) for a special rule 
applicable if excess matching contributions, excess after-tax employee 
contributions, and excess section 403(b) elective deferrals do not 
exceed $100.
    (2) Separate account required for certain excess contributions; 
distribution of excess elective deferrals. A contract to which a 
contribution is made that exceeds the maximum annual contribution limit 
set forth in paragraph (b) of this section is not a section 403(b) 
contract unless the excess contribution is held in a separate account 
which constitutes a separate account for purposes of section 72. See 
also Sec.  1.403(b)-3(a)(4) and paragraph (f)(4) of this section for 
additional rules with respect to the requirements of section 401(a)(30) 
and any excess deferral.
    (3) Ability to distribute excess contributions. A contract does not 
fail to satisfy the requirements of Sec.  1.403(b)-3, the distribution 
rules of Sec.  1.403(b)-6 or 1.403(b)-9, or the funding rules of Sec.  
1.403(b)-8 solely by reason of a distribution made from a separate 
account under paragraph (f)(2) of this section or made under paragraph 
(f)(4) of this section.
    (4) Excess section 403(b) elective deferrals. A section 403(b) 
contract may provide that any excess deferral as a result of a failure 
to comply with the limitation under paragraph (c) of this section for a 
taxable year with respect to any section 403(b) elective deferral made 
for a participant by the employer will be distributed to the 
participant, with allocable net income, no later than April 15 of the 
following taxable year or otherwise in accordance with section 402(g). 
See section 402(g)(2)(A) for rules permitting the participant to 
allocate excess deferrals among the plans in which the participant has 
made elective deferrals, and see section 402(g)(2)(C) for special rules 
to determine the tax treatment of such a distribution.
    (5) Examples. The provisions of this paragraph (f) are illustrated 
by the following examples:

    Example 1. (i) Facts. Individual D's employer makes a $46,000 
contribution for 2006 to an individual annuity insurance policy for 
Individual D that would otherwise be a section 403(b) contract. The 
contribution does not include any elective deferrals and the 
applicable limit under section 415(c) is $44,000 for 2006. The 
$2,000 section 415(c) excess is put into a separate account under 
the policy. Employer includes $2,000 in D's gross income as wages 
for 2006 and, to the extent of the amount held in the separate 
account for the section 415(c) excess contribution, does not treat 
the account as a contract to which section 403(b) applies.
    (ii) Conclusion. The separate account for the section 415(c) 
excess contribution is a contract to which section 403(c) applies, 
but the excess contribution does not cause the rest of the contract 
to fail section 403(b).
    Example 2. (i) Facts. Same facts as Example 1, except that the 
contribution is made to purchase mutual funds that are held in a 
custodial account, instead of an individual annuity insurance 
policy.
    (ii) Conclusion. The conclusion is the same as in Example 1, 
except that the purchase constitutes a transfer described in section 
83.
    Example 3. (i) Facts. Same facts as Example 1, except that the 
amount held in the separate account for the section 415(c) excess 
contribution is subsequently distributed to D.
    (ii) Conclusion. The distribution is included in gross income to 
the extent provided under section 72 relating to distributions from 
a section 403(c) contract.
    Example 4. (i) Facts. Individual E makes section 403(b) elective 
deferrals totaling $15,500 for 2006, when E is age 45 and the 
applicable limit on section 403(b) elective deferrals is $15,000. On 
April 14, 2007, the plan refunds the $500 excess along with 
applicable earnings of $65.
    (ii) Conclusion. The $565 payment constitutes a distribution of 
an excess deferral under paragraph (f)(4) of this section. Under 
section 402(g), the $500 excess deferral is included in E's gross 
income for 2006. The additional $65 is included in E's gross income 
for 2007 and, because the distribution is made by April 15, 2007 (as 
provided in section 402(g)(2)), the $65 is not subject to the 
additional 10 percent income tax on early distributions under 
section 72(t).


Sec.  1.403(b)-5  Nondiscrimination rules.

    (a) Nondiscrimination rules for contributions other than section 
403(b) elective deferrals--(1) General rule. Under section 
403(b)(12)(A)(i), employer contributions and after-tax employee 
contributions to a section 403(b) plan must satisfy all of the 
following requirements (the nondiscrimination requirements) in the same 
manner as a qualified plan under section 401(a):
    (i) Section 401(a)(4) (relating to nondiscrimination in 
contributions and benefits), taking section 401(a)(5) into account.
    (ii) Section 401(a)(17) (limiting the amount of compensation that 
can be taken into account).
    (iii) Section 401(m) (relating to matching and after-tax employee 
contributions).
    (iv) Section 410(b) (relating to minimum coverage).
    (2) Nonapplication to section 403(b) elective deferrals. The 
requirements of this paragraph (a) do not apply to section 403(b) 
elective deferrals.
    (3) Compensation for testing. Except as may otherwise be 
specifically permitted under the provisions referenced in paragraph 
(a)(1) of this section, compliance with those provisions is tested 
using compensation as defined in section 414(s) (and without regard to 
section 415(c)(3)(E)). In addition, for purposes of paragraph (a)(1) of 
this section, there may be excluded employees who are permitted to be 
excluded under paragraph (b)(4)(ii)(D) and (E) of this section. 
However, as provided in paragraph (b)(4)(i) of this section, the 
exclusion of any employee listed in paragraph (b)(4)(ii)(D) or (E) of 
this section is subject to the conditions applicable under section 
410(b)(4).
    (4) Employer aggregation rules. See regulations under section 
414(b), (c), (m), and (o) for rules treating entities as a single 
employer for purposes of the nondiscrimination requirements.
    (5) Special rules for governmental plans. Paragraphs (a)(1)(i), 
(iii), and (iv) of this section do not apply to a governmental plan as 
defined in section 414(d) (but contributions to a governmental plan 
must comply with paragraphs (a)(1)(ii) and (b) of this section).
    (b) Universal availability required for section 403(b) elective 
deferrals--(1) General rule. Under section 403(b)(12)(A)(ii), all 
employees of the eligible employer must be permitted to have section 
403(b) elective deferrals contributed on their behalf if any employee 
of the eligible employer may elect to have the organization make 
section 403(b) elective deferrals. Further, the employee's right to 
make elective deferrals also includes the right to designate section 
403(b) elective deferrals as designated Roth contributions.
    (2) Effective opportunity required. For purposes of paragraph 
(b)(1) of this section, an employee is not treated as being permitted 
to have section 403(b) elective deferrals contributed on the employee's 
behalf unless the employee is provided an effective opportunity that 
satisfies the requirements of this

[[Page 41150]]

paragraph (b)(2). Whether an employee has an effective opportunity is 
determined based on all the relevant facts and circumstances, including 
notice of the availability of the election, the period of time during 
which an election may be made, and any other conditions on elections. A 
section 403(b) plan satisfies the effective opportunity requirement of 
this paragraph (b)(2) only if, at least once during each plan year, the 
plan provides an employee with an effective opportunity to make (or 
change) a cash or deferred election (as defined at Sec.  1.401(k)-
1(a)(3)) between cash or a contribution to the plan. Further, an 
effective opportunity includes the right to have section 403(b) 
elective deferrals made on his or her behalf up to the lesser of the 
applicable limits in Sec.  1.403(b)-4(c) (including any permissible 
catch-up elective deferrals under Sec.  1.403(b)-4(c)(2) and (3)) or 
the applicable limits under the contract with the largest limitation, 
and applies to part-time employees as well as full-time employees. An 
effective opportunity is not considered to exist if there are any other 
rights or benefits (other than rights or benefits listed in Sec.  
1.401(k)-1(e)(6)(i)(A), (B), or (D)) that are conditioned (directly or 
indirectly) upon a participant making or failing to make a cash or 
deferred election with respect to a contribution to a section 403(b) 
contract.
    (3) Special rules. (i) In the case of a section 403(b) plan that 
covers the employees of more than one section 501(c)(3) organization, 
the universal availability requirement of this paragraph (b) applies 
separately to each common law entity (that is, applies separately to 
each section 501(c)(3) organization). In the case of a section 403(b) 
plan that covers the employees of more than one State entity, this 
requirement applies separately to each entity that is not part of a 
common payroll. An eligible employer may condition the employee's right 
to have section 403(b) elective deferrals made on his or her behalf on 
the employee electing a section 403(b) elective deferral of more than 
$200 for a year.
    (ii) For purposes of this paragraph (b)(3), an employer that 
historically has treated one or more of its various geographically 
distinct units as separate for employee benefit purposes may treat each 
unit as a separate organization if the unit is operated independently 
on a day-to-day basis. Units are not geographically distinct if such 
units are located within the same Standard Metropolitan Statistical 
Area (SMSA).
    (4) Exclusions--(i) Exclusions for special types of employees. A 
plan does not fail to satisfy the universal availability requirement of 
this paragraph (b) merely because it excludes one or more of the types 
of employees listed in paragraph (b)(4)(ii) of this section. However, 
the exclusion of any employee listed in paragraph (b)(4)(ii)(D) or (E) 
of this section is subject to the conditions applicable under section 
410(b)(4). Thus, if any employee listed in paragraph (b)(4)(ii)(D) of 
this section has the right to have section 403(b) elective deferrals 
made on his or her behalf, then no employee listed in that paragraph 
(b)(4)(ii)(D) of this section may be excluded under this paragraph 
(b)(4) and, if any employee listed in paragraph (b)(4)(ii)(E) of this 
section has the right to have section 403(b) elective deferrals made on 
his or her behalf, then no employee listed in that paragraph 
(b)(4)(ii)(E) of this section may be excluded under this paragraph 
(b)(4).
    (ii) List of special types of excludible employees. The following 
types of employees are listed in this paragraph (b)(4)(ii):
    (A) Employees who are eligible under another section 403(b) plan, 
or a section 457(b) eligible governmental plan, of the employer which 
permits an amount to be contributed or deferred at the election of the 
employee.
    (B) Employees who are eligible to make a cash or deferred election 
(as defined at Sec.  1.401(k)-1(a)(3)) under a section 401(k) plan of 
the employer.
    (C) Employees who are non-resident aliens described in section 
410(b)(3)(C).
    (D) Subject to the conditions applicable under section 410(b)(4) 
(including section 410(b)(4)(B) permitting separate testing for 
employees not meeting minimum age and service requirements), employees 
who are students performing services described in section 3121(b)(10).
    (E) Subject to the conditions applicable under section 410(b)(4), 
employees who normally work fewer than 20 hours per week (or such lower 
number of hours per week as may be set forth in the plan).
    (iii) Special rules. (A) A section 403(b) plan is permitted to take 
into account coverage under another plan, as permitted in paragraphs 
(b)(4)(ii)(A) and (B) of this section, only if the rights to make 
elective deferrals with respect to that coverage would satisfy 
paragraphs (b)(2) and (4)(i) of this section if that coverage were 
provided under the section 403(b) plan.
    (B) For purposes of paragraph (b)(4)(ii)(E) of this section, an 
employee normally works fewer than 20 hours per week if and only if--
    (1 ) For the 12-month period beginning on the date the employee's 
employment commenced, the employer reasonably expects the employee to 
work fewer than 1,000 hours of service (as defined in section 
410(a)(3)(C)) in such period; and
    (2 ) For each plan year ending after the close of the 12-month 
period beginning on the date the employee's employment commenced (or, 
if the plan so provides, each subsequent 12-month period), the employee 
worked fewer than 1,000 hours of service in the preceding 12-month 
period. (See, however, section 202(a)(1) of the Employee Retirement 
Income Security Act of 1974 (ERISA) (88 Stat. 829) Public Law 93-406, 
and regulations under section 410(a) of the Internal Revenue Code 
applicable with respect to plans that are subject to Title I of ERISA.)
    (c) Plan required. Contributions to an annuity contract do not 
satisfy the requirements of this section unless the contributions are 
made pursuant to a plan, as defined in Sec.  1.403(b)-3(b)(3), and the 
terms of the plan satisfy this section.
    (d) Church plans exception. This section does not apply to a 
section 403(b) contract purchased by a church (as defined in Sec.  
1.403(b)-2).
    (e) Other rules. This section only reflects requirements of the 
Internal Revenue Code applicable for purposes of section 403(b) and 
does not include other requirements. Specifically, this section does 
not reflect the requirements of ERISA that may apply with respect to 
section 403(b) arrangements, such as the vesting requirements at 29 
U.S.C. 1053.


Sec.  1.403(b)-6   Timing of distributions and benefits.

    (a) Distributions generally. This section provides special rules 
regarding the timing of distributions from, and the benefits that may 
be provided under, a section 403(b) contract, including limitations on 
when early distributions can be made (in paragraphs (b) through (d) of 
this section), required minimum distributions (in paragraph (e) of this 
section), and special rules relating to loans (in paragraph (f) of this 
section) and incidental benefits (in paragraph (g) of this section).
    (b) Distributions from contracts other than custodial accounts or 
amounts attributable to section 403(b) elective deferrals. Except as 
provided in paragraph (c) of this section relating to distributions 
from custodial accounts, paragraph (d) of this section relating to 
distributions attributable to section 403(b) elective deferrals, Sec.  
1.403(b)-4(f) (relating to correction of excess deferrals), or Sec.  
1.403(b)-10(a) (relating to

[[Page 41151]]

plan termination), a section 403(b) contract is permitted to distribute 
retirement benefits to the participant no earlier than upon the earlier 
of the participant's severance from employment or upon the prior 
occurrence of some event, such as after a fixed number of years, the 
attainment of a stated age, or disability. See Sec.  1.401-1(b)(1)(ii) 
for additional guidance. This paragraph (b) does not apply to after-tax 
employee contributions or earnings thereon.
    (c) Distributions from custodial accounts that are not attributable 
to section 403(b) elective deferrals. Except as provided in Sec.  
1.403(b)-4(f) (relating to correction of excess deferrals) or Sec.  
1.403(b)-10(a) (relating to plan termination), distributions from a 
custodial account, as defined in Sec.  1.403(b)-8(d)(2), may not be 
paid to a participant before the participant has a severance from 
employment, dies, becomes disabled (within the meaning of section 
72(m)(7)), or attains age 59\1/2\. Any amounts transferred out of a 
custodial account to an annuity contract or retirement income account, 
including earnings thereon, continue to be subject to this paragraph 
(c). This paragraph (c) does not apply to distributions that are 
attributable to section 403(b) elective deferrals.
    (d) Distribution of section 403(b) elective deferrals--(1) 
Limitation on distributions--(i) General rule. Except as provided in 
Sec.  1.403(b)-4(f) (relating to correction of excess deferrals) or 
Sec.  1.403(b)-10(a) (relating to plan termination), distributions of 
amounts attributable to section 403(b) elective deferrals may not be 
paid to a participant earlier than the earliest of the date on which 
the participant has a severance from employment, dies, has a hardship, 
becomes disabled (within the meaning of section 72(m)(7)), or attains 
age 59\1/2\.
    (ii) Special rule for pre-1989 section 403(b) elective deferrals. 
For special rules relating to amounts held as of the close of the 
taxable year beginning before January 1, 1989 (which does not apply to 
earnings thereon), see section 1123(e)(3) of the Tax Reform Act of 1986 
(100 Stat. 2085, 2475) Public Law 99-514, and section 1011A(c)(11) of 
the Technical and Miscellaneous Revenue Act of 1988 (102 Stat. 3342, 
3476) Public Law 100-647.
    (2) Hardship rules. A hardship distribution under this paragraph 
(d) has the same meaning as a distribution on account of hardship under 
Sec.  1.401(k)-1(d)(3) and is subject to the rules and restrictions set 
forth in Sec.  1.401(k)-1(d)(3) (including limiting the amount of a 
distribution in the case of hardship to the amount necessary to satisfy 
the hardship). In addition, a hardship distribution is limited to the 
aggregate dollar amount of the participant's section 403(b) elective 
deferrals under the contract (and may not include any income thereon), 
reduced by the aggregate dollar amount of the distributions previously 
made to the participant from the contract.
    (3) Failure to keep separate accounts. If a section 403(b) contract 
includes both section 403(b) elective deferrals and other contributions 
and the section 403(b) elective deferrals are not maintained in a 
separate account, then distributions may not be made earlier than the 
later of--
    (i) Any date permitted under paragraph (d)(1) of this section; and
    (ii) Any date permitted under paragraph (b) or (c) of this section 
with respect to contributions that are not section 403(b) elective 
deferrals (whichever applies to the contributions that are not section 
403(b) elective deferrals).
    (e) Minimum required distributions for eligible plans--(1) In 
general. Under section 403(b)(10), a section 403(b) contract must meet 
the minimum distribution requirements of section 401(a)(9) (in both 
form and operation). See section 401(a)(9) for these requirements.
    (2) Treatment as IRAs. For purposes of applying the distribution 
rules of section 401(a)(9) to section 403(b) contracts, the minimum 
distribution rules applicable to individual retirement annuities 
described in section 408(b) and individual retirement accounts 
described in section 408(a) apply to section 403(b) contracts. 
Consequently, except as otherwise provided in paragraphs (e)(3) through 
(e)(5) of this section, the distribution rules in section 401(a)(9) are 
applied to section 403(b) contracts in accordance with the provisions 
in Sec.  1.408-8 for purposes of determining required minimum 
distributions.
    (3) Required beginning date. The required beginning date for 
purposes of section 403(b)(10) is April 1 of the calendar year 
following the later of the calendar year in which the employee attains 
70\1/2\ or the calendar year in which the employee retires from 
employment with the employer maintaining the plan. However, for any 
section 403(b) contract that is not part of a governmental plan or 
church plan, the required beginning date for a 5-percent owner is April 
1 of the calendar year following the calendar year in which the 
employee attains 70\1/2\.
    (4) Surviving spouse rule does not apply. The special rule in Sec.  
1.408-8, A-5 (relating to spousal beneficiaries), does not apply to a 
section 403(b) contract. Thus, the surviving spouse of a participant is 
not permitted to treat a section 403(b) contract as the spouse's own 
section 403(b) contract, even if the spouse is the sole beneficiary.
    (5) Retirement income accounts. For purposes of Sec.  1.401(a)(9)-
6, A-4 (relating to annuity contracts), annuity payments provided with 
respect to retirement income accounts do not fail to satisfy the 
requirements of section 401(a)(9) merely because the payments are not 
made under an annuity contract purchased from an insurance company, 
provided that the relationship between the annuity payments and the 
retirement income accounts is not inconsistent with any rules 
prescribed by the Commissioner in revenue rulings, notices, or other 
guidance published in the Internal Revenue Bulletin (see Sec.  
601.601(d)(2)(ii)(b) of this chapter). See also Sec.  1.403(b)-9(a)(5 
for additional rules relating to annuities payable from a retirement 
income account).
    (6) Special rules for benefits accruing before December 31, 1986. 
(i) The distribution rules provided in section 401(a)(9) do not apply 
to the undistributed portion of the account balance under the section 
403(b) contract valued as of December 31, 1986, exclusive of subsequent 
earnings (pre-'87 account balance). The distribution rules provided in 
section 401(a)(9) apply to all benefits under section 403(b) contracts 
accruing after December 31, 1986 (post-'86 account balance), including 
earnings after December 31, 1986. Consequently, the post-'86 account 
balance includes earnings after December 31, 1986, on contributions 
made before January 1, 1987, in addition to the contributions made 
after December 31, 1986, and earnings thereon.
    (ii) The issuer or custodian of the section 403(b) contract must 
keep records that enable it to identify the pre-'87 account balance and 
subsequent changes as set forth in paragraph (d)(6)(iii) of this 
section and provide such information upon request to the relevant 
employee or beneficiaries with respect to the contract. If the issuer 
or custodian does not keep such records, the entire account balance is 
treated as subject to section 401(a)(9).
    (iii) In applying the distribution rules in section 401(a)(9), only 
the post-'86 account balance is used to calculate the required minimum 
distribution for a calendar year. The amount of any distribution from a 
contract is treated as being paid from the post-'86 account balance to 
the extent the distribution is required to satisfy the minimum

[[Page 41152]]

distribution requirement with respect to that contract for a calendar 
year. Any amount distributed in a calendar year from a contract in 
excess of the required minimum distribution for a calendar year with 
respect to that contract is treated as paid from the pre-'87 account 
balance, if any, of that contract.
    (iv) If an amount is distributed from the pre-'87 account balance 
and rolled over to another section 403(b) contract, the amount is 
treated as part of the post-'86 account balance in that second 
contract. However, if the pre-'87 account balance under a section 
403(b) contract is directly transferred to another section 403(b) 
contract (as permitted under Sec.  1.403(b)-10(b)), the amount 
transferred retains its character as a pre-'87 account balance, 
provided the issuer of the transferee contract satisfies the 
recordkeeping requirements of paragraph (e)(6)(ii) of this section.
    (v) The distinction between the pre-'87 account balance and the 
post-'86 account balance provided for under this paragraph (e)(6) of 
this section has no relevance for purposes of determining the portion 
of a distribution that is includible in income under section 72.
    (vi) The pre-'87 account balance must be distributed in accordance 
with the incidental benefit requirement of Sec.  1.401-1(b)(1)(i). 
Distributions attributable to the pre-'87 account balance are treated 
as satisfying this requirement if all distributions from the section 
403(b) contract (including distributions attributable to the post-'86 
account balance) satisfy the requirements of Sec.  1.401-1(b)(1)(i) 
without regard to this section, and distributions attributable to the 
post-'86 account balance satisfy the rules of this paragraph (e) 
(without regard to this paragraph (e)(6)). Distributions attributable 
to the pre-'87 account balance are treated as satisfying the incidental 
benefit requirement if all distributions from the section 403(b) 
contract (including distributions attributable to both the pre-'87 
account balance and the post-'86 account balance) satisfy the rules of 
this paragraph (e) (without regard to this paragraph (e)(6)).
    (7) Application to multiple contracts for an employee. The required 
minimum distribution must be separately determined for each section 
403(b) contract of an employee. However, because, as provided in 
paragraph (e)(2) of this section, the distribution rules in section 
401(a)(9) apply to section 403(b) contracts in accordance with the 
provisions in Sec.  1.408-8, the required minimum distribution from one 
section 403(b) contract of an employee is permitted to be distributed 
from another section 403(b) contract in order to satisfy section 
401(a)(9). Thus, as provided in Sec.  1.408-8, A-9, with respect to 
IRAs, the required minimum distribution amount from each contract is 
then totaled and the total minimum distribution taken from any one or 
more of the individual section 403(b) contracts. However, consistent 
with the rules in Sec.  1.408-8, A-9, only amounts in section 403(b) 
contracts that an individual holds as an employee may be aggregated. 
Amounts in section 403(b) contracts that an individual holds as a 
beneficiary of the same decedent may be aggregated, but such amounts 
may not be aggregated with amounts held in section 403(b) contracts 
that the individual holds as the employee or as the beneficiary of 
another decedent. Distributions from section 403(b) contracts do not 
satisfy the minimum distribution requirements for IRAs, nor do 
distributions from IRAs satisfy the minimum distribution requirements 
for section 403(b) contracts.
    (f) Loans. The determination of whether the availability of a loan, 
the making of a loan, or a failure to repay a loan made from an issuer 
of a section 403(b) contract to a participant or beneficiary is treated 
as a distribution (directly or indirectly) for purposes of this 
section, and the determination of whether the availability of the loan, 
the making of the loan, or a failure to repay the loan is in any other 
respect a violation of the requirements of section 403(b) and 
Sec. Sec.  1.403(b)-1 through 1.403(b)-5, this section, and Sec. Sec.  
1.403(b)-7 through 1.403(b)-11, depends on the facts and circumstances. 
Among the facts and circumstances are whether the loan has a fixed 
repayment schedule and bears a reasonable rate of interest, and whether 
there are repayment safeguards to which a prudent lender would adhere. 
Thus, for example, a loan must bear a reasonable rate of interest in 
order to be treated as not being a distribution. However, a plan loan 
offset is a distribution for purposes of this section. See Sec.  
1.72(p)-1, Q&A-13. See also Sec.  1.403(b)-7(d) relating to the 
application of section 72(p) with respect to the taxation of a loan 
made under a section 403(b) contract. (Further, see section 408(b)(1) 
of Title I of ERISA and 29 CFR 2550.408b-1 of the Department of Labor 
regulations concerning additional requirements applicable with respect 
to plans that are subject to Title I of ERISA.)
    (g) Death benefits and other incidental benefits. An annuity is not 
a section 403(b) contract if it fails to satisfy the incidental benefit 
requirement of Sec.  1.401-1(b)(1)(ii) (in form or in operation). For 
purposes of this paragraph (g), to the extent the incidental benefit 
requirement of Sec.  1.401-1(b)(1)(ii) requires a distribution of the 
participant's or beneficiary's accumulated benefit, that requirement is 
deemed to be satisfied if distributions satisfy the minimum 
distribution requirements of section 401(a)(9). In addition, if a 
contract issued by an insurance company qualified to issue annuities in 
a State includes provisions under which, in the event a participant 
becomes disabled, benefits will be provided by the insurance carrier as 
if employer contributions were continued until benefit distribution 
commences, then that benefit is treated as an incidental benefit (as 
insurance for a deferred annuity benefit in the event of disability) 
that must satisfy the incidental benefit requirement of Sec.  1.401-
1(b)(1)(ii) (taking into account any other incidental benefits provided 
under the plan).
    (h) Special rule regarding severance from employment. For purposes 
of this section, severance from employment occurs on any date on which 
an employee ceases to be an employee of an eligible employer, even 
though the employee may continue to be employed either by another 
entity that is treated as the same employer where either that other 
entity is not an entity that can be an eligible employer (such as 
transferring from a section 501(c)(3) organization to a for-profit 
subsidiary of the section 501(c)(3) organization) or in a capacity that 
is not employment with an eligible employer (for example, ceasing to be 
an employee performing services for a public school but continuing to 
work for the same State employer). Thus, this paragraph (h) does not 
apply if an employee transfers from one section 501(c)(3) organization 
to another section 501(c)(3) organization that is treated as the same 
employer or if an employee transfers from one public school to another 
public school of the same State employer.
    (i) Certain limitations do not apply to rollover contributions. The 
limitations on distributions in paragraphs (b) through (d) of this 
section do not apply to amounts held in a separate account for eligible 
rollover distributions as described in Sec.  1.403(b)-10(d).


Sec.  1.403(b)-7  Taxation of distributions and benefits.

    (a) General rules for when amounts are included in gross income. 
Except as provided in this section (or in Sec.  1.403(b)-10(c) relating 
to payments pursuant to a qualified domestic relations order), amounts 
actually

[[Page 41153]]

distributed from a section 403(b) contract are includible in the gross 
income of the recipient participant or beneficiary (in the year in 
which so distributed) under section 72 (relating to annuities). For an 
additional income tax that may apply to certain early distributions 
that are includible in gross income, see section 72(t).
    (b) Rollovers to individual retirement arrangements and other 
eligible retirement plans--(1) Timing of taxation of rollovers. In 
accordance with sections 402(c), 403(b)(8), and 403(b)(10), a direct 
rollover in accordance with section 401(a)(31) is not includible in the 
gross income of a participant or beneficiary in the year rolled over. 
In addition, any payment made in the form of an eligible rollover 
distribution (as defined in section 402(c)(4)) is not includible in 
gross income in the year paid to the extent the payment is contributed 
to an eligible retirement plan (as defined in section 402(c)(8)(B)) 
within 60 days, including the contribution to the eligible retirement 
plan of any property distributed. For this purpose, the rules of 
section 402(c)(2) through (7) and (c)(9) apply. Thus, to the extent 
that a portion of a distribution (including a distribution from a 
designated Roth account) would be excluded from gross income if it were 
not rolled over, if that portion of the distribution is to be rolled 
over into an eligible retirement plan that is not an IRA, the rollover 
must be accomplished through a direct rollover of the entire 
distribution to a plan qualified under section 401(a) or section 403(b) 
plan and that plan must agree to separately account for the amount not 
includible in income (so that a 60-day rollover to a plan qualified 
under section 401(a) or another section 403(b) plan is not available 
for this portion of the distribution). Any direct rollover under this 
paragraph (b)(1) is a distribution that is subject to the distribution 
requirements of Sec.  1.403(b)-6.
    (2) Requirement that contract provide rollover options for eligible 
rollover distributions. As required in Sec.  1.403(b)-3(a)(7), an 
annuity contract is not a section 403(b) contract unless the contract 
provides that if the distributee of an eligible rollover distribution 
elects to have the distribution paid directly to an eligible retirement 
plan (as defined in section 402(c)(8)(B)) and specifies the eligible 
retirement plan to which the distribution is to be paid, then the 
distribution will be paid to that eligible retirement plan in a direct 
rollover. For purposes of determining whether a contract satisfies this 
requirement, the provisions of section 401(a)(31) apply to the annuity 
as though it were a plan qualified under section 401(a) unless 
otherwise provided in section 401(a)(31). Thus, the special rule in 
Sec.  1.401(k)-1(f)(3)(ii) with respect to distributions from a 
designated Roth account that are expected to total less than $200 
during a year applies to designated Roth accounts under a section 
403(b) plan. In applying the provisions of this paragraph (b)(2), the 
payor of the eligible rollover distribution from the contract is 
treated as the plan administrator.
    (3) Requirement that contract payor provide notice of rollover 
option to distributees. To ensure that the distributee of an eligible 
rollover distribution from a section 403(b) contract has a meaningful 
right to elect a direct rollover, section 402(f) requires that the 
distributee be informed of the option. Thus, within a reasonable time 
period before making the initial eligible rollover distribution, the 
payor must provide an explanation to the distributee of his or her 
right to elect a direct rollover and the income tax withholding 
consequences of not electing a direct rollover. For purposes of 
satisfying the reasonable time period requirement, the plan timing rule 
provided in section 402(f)(1) and Sec.  1.402(f)-1 applies to section 
403(b) contracts.
    (4) Mandatory withholding upon certain eligible rollover 
distributions from contracts. If a distributee of an eligible rollover 
distribution from a section 403(b) contract does not elect to have the 
eligible rollover distribution paid directly to an eligible retirement 
plan in a direct rollover, the eligible rollover distribution is 
subject to 20-percent income tax withholding imposed under section 
3405(c). See section 3405(c) and Sec.  31.3405(c)-1 of this chapter for 
provisions regarding the withholding requirements relating to eligible 
rollover distributions.
    (5) Automatic rollover for certain mandatory distributions under 
section 401(a)(31). In accordance with section 403(b)(10), a section 
403(b) plan is required to comply with section 401(a)(31) (including 
automatic rollover for certain mandatory distributions) in the same 
manner as a qualified plan.
    (c) Special rules. See section 402(g)(2)(C) for special rules to 
determine the tax treatment of a distribution of excess deferrals, and 
see Sec.  1.401(m)-1(e)(3)(v) for the tax treatment of corrective 
distributions of after-tax employee contributions and matching 
contributions to comply with section 401(m). See sections 402(l) and 
403(b)(2) for a special rule regarding distributions for certain 
retired public safety officers made from a governmental plan for the 
direct payment of certain premiums.
    (d) Amounts taxable under section 72(p)(1). In accordance with 
section 72(p), the amount of any loan from a section 403(b) contract to 
a participant or beneficiary (including any pledge or assignment 
treated as a loan under section 72(p)(1)(B)) is treated as having been 
received as a distribution from the contract under section 72(p)(1), 
except to the extent set forth in section 72(p)(2) (relating to loans 
that do not exceed a maximum amount and that are repayable in 
accordance with certain terms) and Sec.  1.72(p)-1. See generally Sec.  
1.72(p)-1. Thus, except to the extent a loan satisfies section 
72(p)(2), any amount loaned from a section 403(b) contract to a 
participant or beneficiary (including any pledge or assignment treated 
as a loan under section 72(p)(1)(B)) is includible in the gross income 
of the participant or beneficiary for the taxable year in which the 
loan is made. A deemed distribution is not an actual distribution for 
purposes of Sec.  1.403(b)-6, as provided at Sec.  1.72(p)-1, Q&A-12 
and Q&A-13. (Further, see section 408(b)(1) of Title I of ERISA 
concerning the effect of noncompliance with Title I loan requirements 
for plans that are subject to Title I of ERISA.)
    (e) Special rules relating to distributions from a designated Roth 
account. If an amount is distributed from a designated Roth account 
under a section 403(b) plan, the amount, if any, that is includible in 
gross income and the amount, if any, that may be rolled over to another 
section 403(b) plan is determined under Sec.  1.402A-1. Thus, the 
designated Roth account is treated as a separate contract for purposes 
of section 72. For example, the rules of section 72(b) must be applied 
separately to annuity payments with respect to a designated Roth 
account under a section 403(b) plan and separately to annuity payments 
with respect to amounts attributable to any other contributions to the 
section 403(b) plan.
    (f) Aggregation of contracts. In accordance with section 403(b)(5), 
the rules of this section are applied as if all annuity contracts for 
the employee by the employer are treated as a single contract.
    (g) Certain rules relating to employment taxes. With respect to 
contributions under the Federal Insurance Contributions Act (FICA) 
under Chapter 21, see section 3121(a)(5)(D) for a special rule relating 
to section 403(b) contracts. With respect to income tax withholding on 
distributions from section 403(b) contracts, see section 3405 
generally. However, see section 3401 for income

[[Page 41154]]

tax withholding applicable to annuity contracts or custodial accounts 
that are not section 403(b) contracts or for cases in which an annuity 
contract or custodial account ceases to be a section 403(b) contract. 
See also Sec.  1.72(p)-1, Q&A-15, and Sec.  35.3405(c)-1, Q&A-11 of 
this chapter, for special rules relating to income tax withholding for 
loans made from certain employer plans, including section 403(b) 
contracts.


Sec.  1.403(b)-8  Funding.

    (a) Investments. Section 403(b) and Sec.  1.403(b)-3(a) only apply 
to amounts held in an annuity contract (as defined in Sec.  1.403(b)-
2), including a custodial account that is treated as an annuity 
contract under paragraph (d) of this section, or a retirement income 
account that is treated as an annuity contract under Sec.  1.403(b)-9.
    (b) Contributions to the plan. Contributions to a section 403(b) 
plan must be transferred to the insurance company issuing the annuity 
contract (or the entity holding assets of any custodial or retirement 
income account that is treated as an annuity contract) within a period 
that is not longer than is reasonable for the proper administration of 
the plan. For purposes of this requirement, the plan may provide for 
section 403(b) elective deferrals for a participant under the plan to 
be transferred to the annuity contract within a specified period after 
the date the amounts would otherwise have been paid to the participant. 
For example, the plan could provide for section 403(b) elective 
deferrals under the plan to be contributed within 15 business days 
following the month in which these amounts would otherwise have been 
paid to the participant.
    (c) Annuity contracts--(1) Generally. As defined in Sec.  1.403(b)-
2, and except as otherwise permitted under this section, an annuity 
contract means a contract that is issued by an insurance company 
qualified to issue annuities in a State and that includes payment in 
the form of an annuity. This paragraph (c) sets forth additional rules 
regarding annuity contracts.
    (2) Certain insurance contracts. Neither a life insurance contract, 
as defined in section 7702, an endowment contract, a health or accident 
insurance contract, nor a property, casualty, or liability insurance 
contract meets the definition of an annuity contract. See Sec.  
1.401(f)-4(e). If a contract issued by an insurance company qualified 
to issue annuities in a State provides death benefits as part of the 
contract, then that coverage is permitted, assuming that those death 
benefits do not cause the contract to fail to satisfy any requirement 
applicable to section 403(b) contracts, for example, assuming that 
those benefits satisfy the incidental benefit requirement of Sec.  
1.401-1(b)(1)(i), as required by Sec.  1.403(b)-6(g).
    (3) Special rule for certain contracts. This paragraph (c)(3) 
applies in the case of a contract issued under a State section 403(b) 
plan established on or before May 17, 1982, or for an employee who 
becomes covered for the first time under the plan after May 17, 1982, 
unless the Commissioner had before that date issued any written 
communication (either to the employer or financial institution) to the 
effect that the arrangement under which the contract was issued did not 
meet the requirements of section 403(b). The requirement that the 
contract be issued by an insurance company qualified to issue annuities 
in a State does not apply to a contract described in the preceding 
sentence if one of the following two conditions is satisfied and that 
condition has been satisfied continuously since May 17, 1982--
    (i) Benefits under the contract are provided from a separately 
funded retirement reserve that is subject to supervision of the State 
insurance department; or
    (ii) Benefits under the contract are provided from a fund that is 
separate from the fund used to provide statutory benefits payable under 
a state retirement system and that is part of a State teachers 
retirement system (including a state university retirement system) to 
purchase benefits that are unrelated to the basic benefits provided 
under the retirement system, and the death benefit provided under the 
contract does not at any time exceed the larger of the reserve or the 
contribution made for the employee.
    (d) Custodial accounts--(1) Treatment as a section 403(b) contract. 
Under section 403(b)(7), a custodial account is treated as an annuity 
contract for purposes of Sec. Sec.  1.403(b)-1 through 1.403(b)-7, this 
section and Sec. Sec.  1.403(b)-9 through 1.403(b)-11. See section 
403(b)(7)(B) for special rules regarding the tax treatment of custodial 
accounts and section 4973(c) for an excise tax that applies to excess 
contributions to a custodial account.
    (2) Custodial account defined. A custodial account means a plan, or 
a separate account under a plan, in which an amount attributable to 
section 403(b) contributions (or amounts rolled over to a section 
403(b) contract, as described in Sec.  1.403(b)-10(d)) is held by a 
bank or a person who satisfies the conditions in section 401(f)(2), 
if--
    (i) All of the amounts held in the account are invested in stock of 
a regulated investment company (as defined in section 851(a) relating 
to mutual funds);
    (ii) The requirements of Sec.  1.403(b)-6(c) (imposing restrictions 
on distributions with respect to a custodial account) are satisfied 
with respect to the amounts held in the account;
    (iii) The assets held in the account cannot be used for, or 
diverted to, purposes other than for the exclusive benefit of plan 
participants or their beneficiaries (for which purpose, assets are 
treated as diverted to the employer if the employer borrows assets from 
the account); and
    (iv) The account is not part of a retirement income account.
    (3) Effect of definition. The requirement in paragraph (d)(2)(i) of 
this section is not satisfied if the account includes any assets other 
than stock of a regulated investment company.
    (4) Treatment of custodial account. A custodial account is treated 
as a section 401 qualified plan solely for purposes of subchapter F of 
subtitle A and subtitle F of the Internal Revenue Code with respect to 
amounts received by it (and income from investment thereof). This 
treatment only applies to a custodial account that constitutes a 
section 403(b) contract under Sec. Sec.  1.403(b)-1 through 1.403(b)-7, 
this section and Sec. Sec.  1.403(b)-9 through 1.403(b)-11 or that 
would constitute a section 403(b) contract under Sec. Sec.  1.403(b)-1 
through 1.403(b)-7, this section and Sec. Sec.  1.403(b)-9 through 
1.403(b)-11 if the amounts held in the account were to satisfy the 
nonforfeitability requirement of Sec.  1.403(b)-3(a)(2).
    (e) Retirement income accounts. See Sec.  1.403(b)-9 for special 
rules under which a retirement income account for employees of a 
church-related organization is treated as a section 403(b) contract for 
purposes of Sec. Sec.  1.403(b)-1 through 1.403(b)-7, this section and 
Sec. Sec.  1.403(b)-9 through 1.403(b)-11.
    (f) Combining assets. To the extent permitted by the Commissioner 
in revenue rulings, notices, or other guidance published in the 
Internal Revenue Bulletin (see Sec.  601.601(d)(2)(ii)(b) of this 
chapter), trust assets held under a custodial account and trust assets 
held under a retirement income account, as described in Sec.  1.403(b)-
9(a)(6), may be invested in a group trust with trust assets held under 
a qualified plan or individual retirement plan. For this purpose, a 
trust includes a custodial account that is treated as a trust under 
section 401(f).

[[Page 41155]]

Sec.  1.403(b)-9  Special rules for church plans.

    (a) Retirement income accounts--(1) Treatment as a section 403(b) 
contract. Under section 403(b)(9), a retirement income account for 
employees of a church-related organization (as defined in Sec.  
1.403(b)-2) is treated as an annuity contract for purposes of 
Sec. Sec.  1.403(b)-1 through 1.403(b)-8, this section, Sec.  1.403(b)-
10 and Sec.  1.403(b)-11.
    (2) Retirement income account defined--(i) In general. A retirement 
income account means a defined contribution program established or 
maintained by a church-related organization under which--
    (A) There is separate accounting for the retirement income 
account's interest in the underlying assets (namely, there must be 
sufficient separate accounting in order for it to be possible at all 
times to determine the retirement income account's interest in the 
underlying assets and to distinguish that interest from any interest 
that is not part of the retirement income account);
    (B) Investment performance is based on gains and losses on those 
assets; and
    (C) The assets held in the account cannot be used for, or diverted 
to, purposes other than for the exclusive benefit of plan participants 
or their beneficiaries (and for this purpose, assets are treated as 
diverted to the employer if there is a loan or other extension of 
credit from assets in the account to the employer).
    (ii) Plan required. A retirement income account must be maintained 
pursuant to a program which is a plan (as defined in Sec.  1.403(b)-
3(b)(3)) and the plan document must state (or otherwise evidence in a 
similarly clear manner) the intent to constitute a retirement income 
account.
    (3) Ownership or use constitutes distribution. Any asset of a 
retirement income account that is owned or used by a participant or 
beneficiary is treated as having been distributed to that participant 
or beneficiary. See Sec. Sec.  1.403(b)-6 and 1.403(b)-7 for rules 
relating to distributions.
    (4) Coordination of retirement income account with custodial 
account rules. A retirement income account that is treated as an 
annuity contract is not a custodial account (as defined in Sec.  
1.403(b)-8(d)(2)), even if it is invested solely in stock of a 
regulated investment company.
    (5) Life annuities. A retirement income account may distribute 
benefits in a form that includes a life annuity only if--
    (i) The amount of the distribution form has an actuarial present 
value, at the annuity starting date, equal to the participant's or 
beneficiary's accumulated benefit, based on reasonable actuarial 
assumptions, including regarding interest and mortality; and
    (ii) The plan sponsor guarantees benefits in the event that a 
payment is due that exceeds the participant's or beneficiary's 
accumulated benefit.
    (6) Combining retirement income account assets with other assets. 
For purposes of Sec.  1.403(b)-8(f) relating to combining assets, 
retirement income account assets held in trust (including a custodial 
account that is treated as a trust under section 401(f)) are subject to 
the same rules regarding combining of assets as custodial account 
assets. In addition, retirement income account assets are permitted to 
be commingled in a common fund with amounts devoted exclusively to 
church purposes (such as a fund from which unfunded pension payments 
are made to former employees of the church). However, unless otherwise 
permitted by the Commissioner, no assets of the plan sponsor, other 
than retirement income account assets, may be combined with custodial 
account assets or any other assets permitted to be combined under Sec.  
1.403(b)-8(f). This paragraph (a)(6) is subject to any additional rules 
issued by the Commissioner in revenue rulings, notices, or other 
guidance published in the Internal Revenue Bulletin (see Sec.  
601.601(d)(2)(ii)(b) of this chapter).
    (7) Trust treated as tax exempt. A trust (including a custodial 
account that is treated as a trust under section 401(f)) that includes 
no assets other than assets of a retirement income account is treated 
as an organization that is exempt from taxation under section 501(a).
    (b) No compensation limitation up to $10,000. See section 415(c)(7) 
for special rules regarding certain annual additions not exceeding 
$10,000.
    (c) Special deduction rule for self-employed ministers. See section 
404(a)(10) for a special rule regarding the deductibility of a 
contribution made by a self-employed minister.


Sec.  1.403(b)-10  Miscellaneous provisions.

    (a) Plan terminations and frozen plans--(1) In general. An employer 
is permitted to amend its section 403(b) plan to eliminate future 
contributions for existing participants or to limit participation to 
existing participants and employees (to the extent consistent with 
Sec.  1.403(b)-5). A section 403(b) plan is permitted to contain 
provisions that provide for plan termination and that allow accumulated 
benefits to be distributed on termination. However, in the case of a 
section 403(b) contract that is subject to the distribution 
restrictions in Sec.  1.403(b)-6(c) or (d) (relating to custodial 
accounts and section 403(b) elective deferrals), termination of the 
plan and the distribution of accumulated benefits is permitted only if 
the employer (taking into account all entities that are treated as the 
same employer under section 414(b), (c), (m), or (o) on the date of the 
termination) does not make contributions to any section 403(b) contract 
that is not part of the plan during the period beginning on the date of 
plan termination and ending 12 months after distribution of all assets 
from the terminated plan. However, if at all times during the period 
beginning 12 months before the termination and ending 12 months after 
distribution of all assets from the terminated plan, fewer than 2 
percent of the employees who were eligible under the section 403(b) 
plan as of the date of plan termination are eligible under the 
alternative section 403(b) contract, the alternative section 403(b) 
contract is disregarded. To the extent a contract fails to satisfy the 
nonforfeitability requirement of Sec.  1.403(b)-3(a)(2) at the date of 
plan termination, the contact is not, and cannot later become, a 
section 403(b) contract. In order for a section 403(b) plan to be 
considered terminated, all accumulated benefits under the plan must be 
distributed to all participants and beneficiaries as soon as 
administratively practicable after termination of the plan. For this 
purpose, delivery of a fully paid individual insurance annuity contract 
is treated as a distribution. The mere provision for, and making of, 
distributions to participants or beneficiaries upon plan termination 
does not cause a contract to cease to be a section 403(b) contract. See 
Sec.  1.403(b)-7 for rules regarding the tax treatment of 
distributions, including Sec.  1.403(b)-7(b)(1) under which an eligible 
rollover distribution is not included in gross income if paid in a 
direct rollover to an eligible retirement plan or if transferred to an 
eligible retirement plan within 60 days.
    (2) Employers that cease to be eligible employers. An employer that 
ceases to be an eligible employer may no longer contribute to a section 
403(b) contract for any subsequent period, and the contract will fail 
to satisfy Sec.  1.403(b)-3(a) if any further contributions are made 
with respect to a period after the employer ceases to be an eligible 
employer.
    (b) Contract exchanges and plan-to-plan transfers--(1) Contract 
exchanges and transfers--(i) General rule. If the conditions in 
paragraph (b)(2) of this section are met, a section 403(b) contract 
held under a section 403(b)

[[Page 41156]]

plan is permitted to be exchanged for another section 403(b) contract 
held under that section 403(b) plan. Further, if the conditions in 
paragraph (b)(3) of this section are met, a section 403(b) plan is 
permitted to provide for the transfer of its assets (including any 
assets held in a custodial account or retirement income account that 
are treated as section 403(b) contracts) to another section 403(b) 
plan. In addition, if the conditions in paragraph (b)(4) of this 
section (relating to permissive service credit and repayments under 
section 415) are met, a section 403(b) plan is permitted to provide for 
the transfer of its assets to a qualified plan under section 401(a). 
However, neither a qualified plan nor an eligible governmental plan 
under section 457(b) may transfer assets to a section 403(b) plan, and 
a section 403(b) plan may not accept such a transfer. In addition, a 
section 403(b) contract may not be exchanged for an annuity contract 
that is not a section 403(b) contract. Neither a plan-to-plan transfer 
nor a contract exchange permitted under this paragraph (b) is treated 
as a distribution for purposes of the distribution restrictions at 
Sec.  1.403(b)-6. Therefore, such a transfer or exchange may be made 
before severance from employment or another distribution event. 
Further, no amount is includible in gross income by reason of such a 
transfer or exchange.
    (ii) ERISA rules. See Sec.  1.414(l)-1 for other rules that are 
applicable to section 403(b) plans that are subject to section 208 of 
the Employee Retirement Income Security Act of 1974 (88 Stat. 829, 
865).
    (2) Requirements for contract exchange within the same plan--(i) 
General rule. A section 403(b) contract of a participant or beneficiary 
may be exchanged under paragraph (b)(1) of this section for another 
section 403(b) contract of that participant or beneficiary under the 
same section 403(b) plan if each of the following conditions are met:
    (A) The plan under which the contract is issued provides for the 
exchange.
    (B) The participant or beneficiary has an accumulated benefit 
immediately after the exchange that is at least equal to the 
accumulated benefit of that participant or beneficiary immediately 
before the exchange (taking into account the accumulated benefit of 
that participant or beneficiary under both section 403(b) contracts 
immediately before the exchange).
    (C) The other contract is subject to distribution restrictions with 
respect to the participant that are not less stringent than those 
imposed on the contract being exchanged, and the employer enters into 
an agreement with the issuer of the other contract under which the 
employer and the issuer will from time to time in the future provide 
each other with the following information:
    (1) Information necessary for the resulting contract, or any other 
contract to which contributions have been made by the employer, to 
satisfy section 403(b), including information concerning the 
participant's employment and information that takes into account other 
section 403(b) contracts or qualified employer plans (such as whether a 
severance from employment has occurred for purposes of the distribution 
restrictions in Sec.  1.403(b)-6 and whether the hardship withdrawal 
rules of Sec.  1.403(b)-6(d)(2) are satisfied).
    (2) Information necessary for the resulting contract, or any other 
contract to which contributions have been made by the employer, to 
satisfy other tax requirements (such as whether a plan loan satisfies 
the conditions in section 72(p)(2) so that the loan is not a deemed 
distribution under section 72(p)(1)).
    (ii) Accumulated benefit. The condition in paragraph (b)(2)(i)(B) 
of this section is satisfied if the exchange would satisfy section 
414(l)(1) if the exchange were a transfer of assets.
    (iii) Authority for future guidance. Subject to such conditions as 
the Commissioner determines to be appropriate, the Commissioner may 
issue rules of general applicability, in revenue rulings, notices, or 
other guidance published in the Internal Revenue Bulletin (see Sec.  
601.601(d)(2)(ii)(b) of this chapter), permitting an exchange of one 
section 403(b) contract for another section 403(b) contract for an 
exchange that does not satisfy paragraph (b)(2)(i)(C) of this section. 
Any such rules must require the resulting contract to set forth 
procedures that the Commissioner determines are reasonably designed to 
ensure compliance with those requirements of section 403(b) or other 
tax provisions that depend on either information concerning the 
participant's employment or information that takes into account other 
section 403(b) contracts or other employer plans (such as whether a 
severance from employment has occurred for purposes of the distribution 
restrictions in Sec.  1.403(b)-6, whether the hardship withdrawal rules 
of Sec.  1.403(b)-6(d)(2) are satisfied, and whether a plan loan 
constitutes a deemed distribution under section 72(p)).
    (3) Requirements for plan-to-plan transfers. (i) A plan-to-plan 
transfer under paragraph (b)(1) of this section from a section 403(b) 
plan to another section 403(b) plan is permitted if each of the 
following conditions are met--
    (A) In the case of a transfer for a participant, the participant is 
an employee or former employee of the employer (or the business of the 
employer) for the receiving plan.
    (B) In the case of a transfer for a beneficiary of a deceased 
participant, the participant was an employee or former employee of the 
employer (or business of the employer) for the receiving plan.
    (C) The transferor plan provides for transfers.
    (D) The receiving plan provides for the receipt of transfers.
    (E) The participant or beneficiary whose assets are being 
transferred has an accumulated benefit immediately after the transfer 
that is at least equal to the accumulated benefit of that participant 
or beneficiary immediately before the transfer.
    (F) The receiving plan provides that, to the extent any amount 
transferred is subject to any distribution restrictions under Sec.  
1.403(b)-6, the receiving plan imposes restrictions on distributions to 
the participant or beneficiary whose assets are being transferred that 
are not less stringent than those imposed on the transferor plan.
    (G) If a plan-to-plan transfer does not constitute a complete 
transfer of the participant's or beneficiary's interest in the section 
403(b) plan, the transferee plan treats the amount transferred as a 
continuation of a pro rata portion of the participant's or 
beneficiary's interest in the section 403(b) plan (for example, a pro 
rata portion of the participant's or beneficiary's interest in any 
after-tax employee contributions).
    (ii) Accumulated benefit. The condition in paragraph (b)(3)(i)(D) 
of this section is satisfied if the transfer would satisfy section 
414(l)(1).
    (4) Purchases of permissive service credit by contract-to-plan 
transfers from a section 403(b) contract to a qualified plan--(i) 
General rule. If the conditions in paragraph (b)(4)(ii) of this section 
are met, a section 403(b) plan may provide for the transfer of assets 
held in the plan to a qualified defined benefit plan that is a 
governmental plan (as defined in section 414(d)).
    (ii) Conditions for plan-to-plan transfers. A transfer may be made 
under this paragraph (b)(4) only if the transfer is either--
    (A) For the purchase of permissive service credit (as defined in 
section 415(n)(3)(A)) under the receiving defined benefit plan; or

[[Page 41157]]

    (B) A repayment to which section 415 does not apply by reason of 
section 415(k)(3).
    (c) Qualified domestic relations orders. In accordance with the 
second sentence of section 414(p)(9), any distribution from an annuity 
contract under section 403(b) (including a distribution from a 
custodial account or retirement income account that is treated as a 
section 403(b) contract) pursuant to a qualified domestic relations 
order is treated in the same manner as a distribution from a plan to 
which section 401(a)(13) applies. Thus, for example, a section 403(b) 
plan does not fail to satisfy the distribution restrictions set forth 
in Sec.  1.403(b)-6(b), (c), or (d) merely as a result of distribution 
made pursuant to a qualified domestic relations order under section 
414(p), so that such a distribution is permitted without regard to 
whether the employee from whose contract the distribution is made has 
had a severance from employment or another event permitting a 
distribution to be made under section 403(b). In the case of a plan 
that is subject to Title I of ERISA, see also section 206(d)(3) of 
ERISA under which the prohibition against assignment or alienation of 
plan benefits under section 206(d)(1) of ERISA does not apply to an 
order that is determined to be a qualified domestic relations order.
    (d) Rollovers to a section 403(b) contract--(1) General rule. A 
section 403(b) contract may accept a contribution that is an eligible 
rollover distribution (as defined in section 402(c)(4)) made from 
another eligible retirement plan (as defined in section 402(c)(8)(B)). 
Any amount contributed to a section 403(b) contract as an eligible 
rollover distribution is not taken into account for purposes of the 
limits in Sec.  1.403(b)-4, but, except as otherwise specifically 
provided (for example, at Sec.  1.403(b)-6(i)), is otherwise treated in 
the same manner as an amount held under a section 403(b) contract for 
purposes of Sec. Sec.  1.403(b)-3 through 1.403(b)-9 and this section.
    (2) Special rules relating to after-tax employee contributions and 
designated Roth contributions. A section 403(b) plan that receives an 
eligible rollover distribution that includes after-tax employee 
contributions or designated Roth contributions is required to obtain 
information regarding the employee's section 72 basis in the amount 
rolled over. A section 403(b) plan is permitted to receive an eligible 
rollover distribution that includes designated Roth contributions only 
if the plan permits employees to make elective deferrals that are 
designated Roth contributions.
    (e) Deemed IRAs. See regulations under section 408(q) for special 
rules relating to deemed IRAs.
    (f) Defined benefit plans--(1) Defined benefit plans generally. 
Except for a TEFRA church defined benefit plan as defined in paragraph 
(f)(2) of this section, section 403(b) does not apply to any 
contributions or accrual under a defined benefit plan.
    (2) TEFRA church defined benefit plans. See section 251(e)(5) of 
the Tax Equity and Fiscal Responsibility Act of 1982, Public Law 97-
248, for a provision permitting certain arrangements established by a 
church-related organization and in effect on September 3, 1982 (a TEFRA 
church defined benefit plan) to be treated as section 403(b) contract 
even though it is a defined benefit arrangement. In accordance with 
section 403(b)(1), for purposes of applying section 415 to a TEFRA 
church defined benefit plan, the accruals under the plan are limited to 
the maximum amount permitted under section 415(c) when expressed as an 
annual addition, and, for this purpose, the rules at Sec.  1.402(b)-
1(a)(2) for determining the present value of an accrual under a 
nonqualified defined benefit plan also apply for purposes of converting 
the accrual under a TEFRA church defined benefit plan to an annual 
addition. See section 415(b) for additional limits applicable to TEFRA 
church defined benefit plans.
    (g) Other rules relating to section 501(c)(3) organizations. See 
section 501(c)(3) and regulations thereunder for the substantive 
standards for tax-exemption under that section, including the 
requirement that no part of the organization's net earnings inure to 
the benefit of any private shareholder or individual. See also sections 
4941 (self dealing), 4945 (taxable expenditures), and 4958 (excess 
benefit transactions), and the regulations thereunder, for rules 
relating to excise taxes imposed on certain transactions involving 
organizations described in section 501(c)(3).


Sec.  1.403(b)-11  Applicable dates.

    (a) General rule. Except as otherwise provided in this section, 
Sec. Sec.  1.403(b)-1 through 1.403(b)-10 apply for taxable years 
beginning after December 31, 2008.
    (b) Collective bargaining agreements. In the case of a section 
403(b) plan maintained pursuant to one or more collective bargaining 
agreements that have been ratified and in effect on July 26, 2007, 
Sec. Sec.  1.403(b)-1 through 1.403(b)-10 do not apply before the 
earlier of--
    (1) The date on which the last of the collective bargaining 
agreements terminates (determined without regard to any extension 
thereof after July 26, 2007); or
    (2) July 26, 2010.
    (c) Church conventions; retirement income account. (1) In the case 
of a section 403(b) plan maintained by a church-related organization 
for which the authority to amend the plan is held by a church 
convention (within the meaning of section 414(e)), Sec. Sec.  1.403(b)-
1 through 1.403(b)-10 do not apply before the first day of the first 
plan year that begins after December 31, 2009.
    (2) In the case of a loan or other extension of credit to the 
employer that was entered into under a retirement income account before 
July 26, 2007 the plan does not fail to satisfy Sec.  1.403(b)-
9(a)(2)(C) on account of the loan or other extension of credit if the 
plan takes reasonable steps to eliminate the loan or other extension of 
credit to the employer before the applicable date for Sec.  1.403(b)-
9(a)(2) or as promptly as practical thereafter (including taking steps 
after July 26, 2007 and before the applicable date).
    (d) Special rules for plans that exclude certain types of employees 
from elective deferrals. (1) If, on July 26, 2007, a plan excludes any 
of the following categories of employees, then the plan does not fail 
to satisfy Sec.  1.403(b)-5(b) as a result of that exclusion before the 
first day of the first taxable year that begins after December 31, 
2009:
    (i) Employees who make a one-time election to participate in a 
governmental plan described in section 414(d) that is not a section 
403(b) plan.
    (ii) Professors who are providing services on a temporary basis to 
another educational organization (as defined under section 
170(b)(1)(A)(ii)) for up to one year and for whom section 403(b) 
contributions are being made at a rate no greater than the rate each 
such professor would receive under the section 403(b) plan of the 
original educational organization.
    (iii) Employees who are affiliated with a religious order and who 
have taken a vow of poverty where the religious order provides for the 
support of such employees in their retirement from eligibility to make 
elective deferrals.
    (2) If, on July 26, 2007, a plan excludes employees who are covered 
by a collective bargaining agreement from eligibility to make elective 
deferrals, the plan does not fail to satisfy Sec.  1.403(b)-5(b) 
(relating to universal availability) as

[[Page 41158]]

a result of that exclusion before the later of--
    (i) The first day of the first taxable year that begins after 
December 31, 2008; or
    (ii) The earlier of--
    (A) The date on which the related collective bargaining agreement 
terminates (determined without regard to any extension thereof after 
July 26, 2007); or
    (B) July 26, 2010.
    (3) In the case of a governmental plan (as defined in section 
414(d)) for which the authority to amend the plan is held by a 
legislative body that meets in legislative session, the plan does not 
fail to satisfy Sec.  1.403(b)-5(b) as a result of any exclusion in 
paragraph (d)(1)(i), (d)(1)(ii),(d)(1)(iii), or (d)(2) of this section 
before the earlier of --
    (i) The close of the first regular legislative session of the 
legislative body with the authority to amend the plan that begins on or 
after January 1, 2009; or
    (ii) January 1, 2011.
    (e) Special rules for plans that permit in-service distributions. 
(1) Section 1.403(b)-6(b) does not apply to a contract issued by an 
insurance company before January 1, 2009.
    (2) Any amendment to comply with the requirements of Sec.  
1.403(b)-6 (disregarding paragraph (e)(1) of this section) that is 
adopted before January 1, 2009, or such later date as may be permitted 
under guidance issued by the Commissioner in revenue rulings, notices, 
or other guidance published in the Internal Revenue Bulletin (see Sec.  
601.601(d)(2)(ii)(b) of this chapter), does not violate section 204(g) 
of the Employee Retirement Income Security Act of 1974 to the extent 
the amendment eliminates or reduces a right to receive benefit 
distributions during employment.
    (f) Special rule for life insurance contracts. Section 1.403(b)-
8(c)(2) does not apply to a contract issued before September 24, 2007.
    (g) Special rule for contracts received in an exchange. Section 
1.403(b)-10(b)(2) does not apply to a contract received in an exchange 
that occurred on or before September 24, 2007 if the exchange 
(including the contract received in the exchange) satisfies such rules 
as the Commissioner has prescribed in guidance of general applicability 
at the time of the exchange.
    (h) Special rule for coordination with regulations under section 
415. Section 1.403(b)-3(b)(4)(ii) is applicable for taxable years 
beginning on or after July 1, 2007.
    (i) Special rule for coordination with regulations under section 
402A. Sections 1.403(b)-3(c), 1.403(b)-7(e), and 1.403(b)-10(d)(2) are 
applicable with respect to taxable years beginning on or after January 
1, 2007.


Sec.  1.403(d)-1  [Removed]

0
Par. 8. Section 1.403(d)-1 is removed.

0
Par. 9. Section 1.414(c)-5 is redesignated as Sec.  1.414(c)-6 and new 
Sec.  1.414(c)-5 is added to read as follows:


Sec.  1.414(c)-5  Certain tax-exempt organizations.

    (a) Application. This section applies to an organization that is 
exempt from tax under section 501(a). The rules of this section only 
apply for purposes of determining when entities are treated as the same 
employer for purposes of section 414(b), (c), (m), and (o) (including 
the sections referred to in section 414(b), (c), (m), (o), and (t)), 
and are in addition to the rules otherwise applicable under section 
414(b), (c), (m), and (o) for determining when entities are treated as 
the same employer. Except to the extent set forth in paragraphs (d), 
(e), and (f) of this section, this section does not apply to any 
church, as defined in section 3121(w)(3)(A), or any qualified church-
controlled organization, as defined in section 3121(w)(3)(B).
    (b) General rule. In the case of an organization that is exempt 
from tax under section 501(a) (an exempt organization) whose employees 
participate in a plan, the employer with respect to that plan includes 
the exempt organization whose employees participate in the plan and any 
other organization that is under common control with that exempt 
organization. For this purpose, common control exists between an exempt 
organization and another organization if at least 80 percent of the 
directors or trustees of one organization are either representatives 
of, or directly or indirectly controlled by, the other organization. A 
trustee or director is treated as a representative of another exempt 
organization if he or she also is a trustee, director, agent, or 
employee of the other exempt organization. A trustee or director is 
controlled by another organization if the other organization has the 
general power to remove such trustee or director and designate a new 
trustee or director. Whether a person has the power to remove or 
designate a trustee or director is based on facts and circumstances. To 
illustrate the rules of this paragraph (b), if exempt organization A 
has the power to appoint at least 80 percent of the trustees of exempt 
organization B (which is the owner of the outstanding shares of 
corporation C, which is not an exempt organization) and to control at 
least 80 percent of the directors of exempt organization D, then, under 
this paragraph (b) and Sec.  1.414(b)-1, entities A, B, C, and D are 
treated as the same employer with respect to any plan maintained by A, 
B, C, or D for purposes of the sections referenced in section 414(b), 
(c), (m), (o), and (t).
    (c) Permissive aggregation with entities having a common exempt 
purpose--(1) General rule. For purposes of this section, exempt 
organizations that maintain a plan to which section 414(c) applies that 
covers one or more employees from each organization may treat 
themselves as under common control for purposes of section 414(c) (and, 
thus, as a single employer for all purposes for which section 414(c) 
applies) if each of the organizations regularly coordinates their day-
to-day exempt activities. For example, an entity that provides a type 
of emergency relief within one geographic region and another exempt 
organization that provides that type of emergency relief within another 
geographic region may treat themselves as under common control if they 
have a single plan covering employees of both entities and regularly 
coordinate their day-to-day exempt activities. Similarly, a hospital 
that is an exempt organization and another exempt organization with 
which it coordinates the delivery of medical services or medical 
research may treat themselves as under common control if there is a 
single plan covering employees of the hospital and employees of the 
other exempt organization and the coordination is a regular part of 
their day-to-day exempt activities.
    (2) Authority to permit aggregation. (i) For determining when 
entities are treated as the same employer under section 414(b), (c), 
(m), and (o), the Commissioner may issue rules of general 
applicability, in revenue rulings, notices, or other guidance published 
in the Internal Revenue Bulletin (see Sec.  601.601(d)(2)(ii)(b) of 
this chapter), permitting other types of combinations of entities that 
include exempt organizations to elect to be treated as under common 
control for one or more specified purposes if:
    (A) There are substantial business reasons for maintaining each 
entity in a separate trust, corporation, or other form; and
    (B) Such treatment would be consistent with the anti-abuse 
standards in paragraph (f) of this section.
    (ii) For example, this authority might be exercised in any 
situation in which

[[Page 41159]]

the organizations are so integrated in their operations as to 
effectively constitute a single coordinated employer for purposes of 
section 414(b), (c), (m), and (o), including common employee benefit 
plans.
    (d) Permissive disaggregation between qualified church controlled 
organizations and other entities. In the case of a church plan (as 
defined in section 414(e)) to which contributions are made by more than 
one common law entity, any employer may apply paragraphs (b) and (c) of 
this section to those entities that are not a church (as defined in 
section 403(b)(12)(B) and Sec.  1.403(b)-2) separately from those 
entities that are churches. For example, in the case of a group of 
entities consisting of a church (as defined in section 3121(w)(3)(A)), 
a secondary school (that is treated as a church under Sec.  1.403(b)-
2), and several nursing homes each of which receives more than 25 
percent of its support from fees paid by residents (so that none of 
them is a qualified church-controlled organization under Sec.  
1.403(b)-2 and section 3121(w)(3)(B)), the nursing homes may treat 
themselves as being under common control with each other, but not as 
being under common control with the church and the school, even though 
the nursing homes would be under common control with the school and the 
church under paragraph (b) of this section.
    (e) Application to certain church entities under section 
3121(w)(3). [Reserved].
    (f) Anti-abuse rule. In any case in which the Commissioner 
determines that the structure of one or more exempt organizations 
(which may include an exempt organization and an entity that is not 
exempt from income tax) or the positions taken by those organizations 
has the effect of avoiding or evading any requirements imposed under 
section 401(a), 403(b), or 457(b), or any applicable section (as 
defined in section 414(t)), or any other provision for which section 
414(c) applies, the Commissioner may treat an entity as under common 
control with the exempt organization.
    (g) Examples. The provisions of this section are illustrated by the 
following examples:

    Example 1. (i) Facts. Organization A is a tax-exempt 
organization under section 501(c)(3) which owns 80% or more of the 
total value of all classes of stock of corporation B, which is a for 
profit organization.
    (ii) Conclusion. Under paragraph (a) of this section, this 
section does not alter the rules of section 414(b) and (c), so that 
organization A and corporation B are under common control under 
Sec.  1.414(c)-2(b).
    Example 2. (i) Facts. Organization M is a hospital which is a 
tax-exempt organization under section 501(c)(3) and organization N 
is a medical clinic which is also a tax-exempt organization under 
section 501(c)(3). N is located in a city and M is located in a 
nearby suburb. There is a history of regular coordination of day-to-
day activities between M and N, including periodic transfers of 
staff, coordination of staff training, common sources of income, and 
coordination of budget and operational goals. A single section 
403(b) plan covers professional and staff employees of both the 
hospital and the medical clinic. While a number of members of the 
board of directors of M are also on the board of directors of N, 
there is less than 80% overlap in board membership. Both 
organizations have approximately the same percentage of employees 
who are highly compensated and have appropriate business reasons for 
being maintained in separate entities.
    (ii) Conclusion. M and N are not under common control under this 
section, but, under paragraph (c) of this section, may chose to 
treat themselves as under common control, assuming both of them act 
in a manner that is consistent with that choice for purposes of 
Sec.  1.403(b)-5(a), sections 401(a), 403(b), and 457(b), and any 
other applicable section (as defined in section 414(t)), or any 
other provision for which section 414(c) applies.
    Example 3. (i) Facts. Organization O and P are each tax-exempt 
organizations under section 501(c)(3). Each organization maintains a 
qualified plan for its employees, but one of the plans would not 
satisfy section 410(b) (or section 401(a)(4)) if the organizations 
were under common control. The two organizations are closely related 
and, while the organizations have several trustees in common, the 
common trustees constitute fewer than 80 percent of the trustees of 
either organization. Organization O has the power to remove any of 
the trustees of P and to select the slate of replacement nominees.
    (ii) Conclusion. Under these facts, pursuant to paragraphs (b) 
and (f) of this section, the Commissioner treats the entities as 
under common control.

    (h) Applicable date. This section applies for plan years beginning 
after December 31, 2008.

0
Par. 10. For each entry listed in the ``Location'' column, remove the 
language in the ``Remove'' column and add the language in the ``Add'' 
column in its place.

------------------------------------------------------------------------
            Location                    Remove                Add
------------------------------------------------------------------------
Sec.   1.101-1(a)(2)(ii)........  paragraph (a) or    Sec.   1.403(b)-3.
                                   (b) of Sec.
                                   1.403(b)-1.
Sec.   1.101-1(a)(2)(ii)........  paragraph (c)(3)    Sec.   1.403(b)-7.
                                   of Sec.
                                   1.403(b)-1.
Sec.   1.401(a)(9)-1, A-1.......  Sec.   1.403(b)-3.  Sec.   1.403(b)-
                                                       6(e).
Sec.   1.401(a)(31)-1.            Sec.   1.403(b)-2.  Sec.   1.403(b)-
 introductory text.                                    7(b).
Sec.   1.401(a)(31)-1, A-1(b)(3)  Sec.   1.403(b)-2.  Sec.   1.403(b)-
                                                       7(b).
Sec.   1.402(c)-2, introductory   Sec.   1.403(b)-2.  Sec.   1.403(b)-
 text.                                                 7(b).
Sec.   1.402(c)-2, A-1(b)(4)....  Sec.   1.403(b)-2.  Sec.   1.403(b)-
                                                       7(b).
Sec.   1.402(f)-1, introductory   Sec.   1.403(b)-2.  Sec.   1.403(b)-
 text.                                                 7(b).
Sec.   1.403(a)-1(a)............  Sec.   1.403(b)-1.  Sec.  Sec.
                                                       1.403(b)-1
                                                       through 1.403(b)-
                                                       10.
Sec.   1.403(c)-1, all locations  Sec.   1.403(b)-    Sec.   1.403(b)-3.
                                   1(b).
Sec.   1.403(c)-1, all locations  Sec.   1.403(b)-    Sec.   1.403(b)-
                                   1(b)(2).            3(c).
------------------------------------------------------------------------

PART 31--EMPLOYMENT TAXES, INCOME TAXES, PENALTIES, PENSIONS, 
RAILROAD RETIREMENT, REPORTING AND RECORDKEEPING REQUIREMENTS, 
SOCIAL SECURITY, UNEMPLOYMENT COMPENSATION

0
Par. 11. The authority citation for part 31 continues to read in part 
as follows:

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


0
Par. 12. For each entry listed in the ``Location'' column, remove the 
language in the ``Remove'' column and add the language in the ``Add'' 
column in its place.

[[Page 41160]]



------------------------------------------------------------------------
            Location                    Remove                Add
------------------------------------------------------------------------
Sec.   31.3405(c)-1, all          Sec.   1.403(b)-2,  Sec.   1.403(b)-
 locations.                        Q&A-1.              7(b).
Sec.   31.3405(c)-1, A-1(b).....  Sec.   1.403(b)-2,  Sec.   1.403(b)-
                                   Q&A-3.              7(b).
Sec.   31.3405(c)-1, A-1(b).....  Sec.   1.403(b)-2,  Sec.   1.403(b)-
                                   Q&A-1 and Q&A-2.    7(b).
Sec.   31.3405(c)-1, A-2........  Sec.   1.403(b)-2,  Sec.   1.403(b)-
                                   Q&A-2.              7(b).
------------------------------------------------------------------------

PART 54--EXCISE TAXES. PENSIONS, REPORTING AND RECORDKEEPING 
REQUIREMENTS

0
Par. 13. The authority citation for part 54 continues to read in part 
as follows:

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


0
Par. 14. For the entry listed in the ``Location'' column, remove the 
language in the ``Remove'' column and add the language in the ``Add'' 
column in its place.

------------------------------------------------------------------------
            Location                    Remove                Add
------------------------------------------------------------------------
Sec.   54.4974-2, A-3(a)(2).....  Sec.   1.403(b)-3.  Sec.   1.403(b)-
                                                       6(e).
------------------------------------------------------------------------

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

0
Par 15. The authority citation for part 602 continues to read in part 
as follows:

    Authority: 26 U.S.C. 7805.


0
Par 16. In Sec.  602.101, paragraph (b) is amended by removing the 
entry for Sec.  1.403(b)-2 and adding entries to the table for 
Sec. Sec.  1.403(b)-7 and 1.402(b)-10 to read as follows:


Sec.  602.101  OMB Control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
                                                            Current OMB
   CFR part or section where identified and described       control No.
------------------------------------------------------------------------
 
                                * * * * *
1.403(b)-7..............................................       1545-1341
1.403(b)-10.............................................       1545-2068
 
                                * * * * *
------------------------------------------------------------------------


Kevin M. Brown,
Deputy Commissioner for Services and Enforcement.
    Approved: July 2, 2007.
Eric Solomon,
Assistant Secretary of Treasury (Tax Policy).
[FR Doc. 07-3649 Filed 7-23-07; 8:45 am]
BILLING CODE 4830-01-P