# Retirement Plans; Cash or Deferred Arrangements Under Section 401(k) and Matching Contributions or Employee Contributions Under Section 401(m) Regulations

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URL: https://www.frixlaw.com/law-library/documents/fr%3A04-28011

## Record

- **Collection:** Federal Register
- **Document type:** Rule
- **Published:** December 29, 2004
- **Citation:** 69 FR 78144

## Text

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 601
[TD-9169]
RIN 1545-AX26 and 1545-AX43
Retirement Plans; Cash or Deferred Arrangements Under Section 401(k) and Matching Contributions or Employee Contributions Under Section 401(m) Regulations

AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Final regulations.

SUMMARY:

This document contains final regulations that provide guidance for certain retirement plans containing cash or deferred arrangements under section 401(k) and providing for matching contributions or employee contributions under section 401(m). These regulations affect sponsors of plans that contain cash or deferred arrangements or provide for employee or matching contributions, and participants in these plans.

DATES:

Effective Date: These regulations are effective December 29, 2004.

FOR FURTHER INFORMATION CONTACT:

Concerning the regulations, R. Lisa Mojiri-Azad or John T. Ricotta at (202) 622-6060 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information contained in these final regulations have been reviewed and 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 1545-1669. Responses to this collection of information are mandatory.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number assigned by the Office of Management and Budget.

The estimated annual burden per respondent varies from .033 hour to 2.5 hours, depending on the individual circumstances, with an estimated average of 1 hour, 10 minutes.

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.

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

This document contains final regulations setting forth the requirements (including the nondiscrimination requirements) for cash or deferred arrangements under section 401(k) and for matching contributions and employee contributions under section 401(m) of the Internal Revenue Code (Code).

Comprehensive final regulations under sections 401(k) and 401(m) of the Code were last published in the
Federal Register
in TD 8357 (published August 9, 1991) and TD 8376 (published December 2, 1991) and amended by TD 8581 published on December 22, 1994 (the pre-SBJPA regulations). Since 1994, many significant changes have been made to sections 401(k) and 401(m) by the Small Business Job Protection Act of 1996, Public Law 104-188 (110 Stat. 1755) (SBJPA), the Taxpayer Relief Act of 1997, Public Law 105-34 (111 Stat. 788) (TRA '97), and the Economic Growth and Tax Relief Reconciliation Act of 2001, Public Law 107-16 (115 Stat. 38) (EGTRRA).

The most substantial changes to the statutory provisions of section 401(k) and section 401(m) were made to the methodology for testing the amount of elective contributions, matching contributions, and employee contributions for nondiscrimination. Section 401(a)(4) prohibits discrimination in contributions or benefits in favor of highly compensated employees, within the meaning of section 414(q) (HCEs). Section 401(k) provides a special nondiscrimination test for elective contributions under a cash or deferred arrangement that is part of a profit-sharing plan, stock bonus plan, pre-ERISA money purchase plan, or rural cooperative plan, called the actual deferral percentage (ADP) test. Section 401(m) provides a parallel test for matching contributions and employee contributions under a defined contribution plan, called the actual contribution percentage (ACP) test. These special nondiscrimination standards are provided in recognition of the fact that the amount of elective contributions and employee contributions (and corresponding matching contributions) is determined by the employee's utilization of the contribution opportunity offered under the plan. This is in contrast to the situation in other defined contribution plans where the amount of contributions is determined by the amount the employer decides to contribute.

Sections 401(k) and 401(m) provide alternative methods for satisfying the applicable nondiscrimination rules: a mathematical comparison and a number of design-based methods. The inherent variation in the amount of contributions among employees, and the fact that the economic situation of HCEs may make them more likely to make elective or employee contributions, means that the usual nondiscrimination test under section 401(a)(4)—under which, for each HCE with a contribution level, there must be a specified number of nonhighly compensated employees (NHCEs) with equal or greater contributions—is not appropriate. Instead, average rates of contributions are used in the ADP and ACP tests (with a built-in differential permitted for HCEs) and minimum standards for nonelective or matching contributions are provided in the design-based alternatives.

Prior to the enactment of SBJPA, sections 401(k) and 401(m) provided only for mathematical comparison. Specifically, the ADP and ACP tests compare the average of the rates of contributions of the HCEs to the average of the rates of contributions of the NHCEs. For this purpose, the rate of contributions for an employee is the amount of contributions for an employee divided by the employee's compensation for the plan year. These tests are satisfied if the average rate of HCE contributions does not exceed 1.25 times the average rate of contributions of the NHCEs. Alternatively, these tests are satisfied if the average rate of HCE contributions does not exceed the average rate of contributions of the NHCEs by more than 2 percentage points and is no more than 2 times the average rate of contributions of the NHCEs. To the extent that these tests are not satisfied, the statute provides for correction through distribution to HCEs (or forfeiture of nonvested matching contributions) or, to the extent provided in regulations, recharacterization of elective contributions as after-tax contributions. In addition, to the extent provided in regulations, nonelective contributions can be made to NHCEs and elective contributions and certain matching contributions can be moved between the ADP and ACP tests, in order the reduce the discrepancy between the average rates of

contribution for the HCEs and the NHCEs.

SBJPA added design-based alternative methods of satisfying the ADP and ACP tests. Under these methods, if a plan meets certain contribution and notice requirements, the plan is deemed to satisfy the nondiscrimination rules without regard to actual utilization of the contribution opportunity offered under the plan. These regulations reflect this change and the other changes that were made to sections 401(k) and 401(m) under SBJPA, TRA '97 and EGTRRA since the issuance of the pre-SBJPA regulations.

SBJPA made the following significant changes affecting section 401(k) and section 401(m) plans:

• The ADP test and ACP test were amended to allow the use of prior year data for NHCEs.

• The method of distributing to correct failures of the ADP test or ACP test was changed to require distribution to the HCEs with the highest contributions.

• Tax-exempt organizations and Indian tribal governments are permitted to maintain section 401(k) plans.

• Safe harbor alternatives to the ADP test and ACP test were introduced in order to provide design-based methods to satisfy the nondiscrimination tests.

• The SIMPLE 401(k) plan (an alternative design-based method to satisfy the nondiscrimination tests for small employers that corresponds to the provisions of section 408(p) for SIMPLE IRA plans by providing for smaller contributions) was added.

• A special testing option was provided for plans that permit participation before employees meet the minimum age and service requirements, in order to encourage employers to permit employees to start participating sooner.

TRA '97 made the following significant changes affecting section 401(k) and section 401(m) plans:

• Grandfathered state and local governmental plans are treated as automatically satisfying the ADP and ACP tests.

• Matching contributions for self-employed individuals are no longer treated as elective contributions.

EGTRRA made the following significant changes affecting section 401(k) and section 401(m) plans:

• Catch-up contributions were added to provide for additional elective contributions for participants age 50 or older.

• The Secretary is directed to change the section 401(k) regulations to shorten the period of time that an employee is stopped from making elective contributions under the safe harbor rules for hardship distributions.

• Beginning in 2006, section 401(k) plans will be permitted to allow employees to designate their elective contributions as “Roth contributions” that will generally be subject to taxation under the rules applicable to Roth IRAs under section 408A.

• Section 401(k) plans using the design-based safe harbor and providing no additional contributions in a year are exempted from the top-heavy rules of section 416.

• Distributions from section 401(k) plans are permitted upon “severance from employment” rather than “separation from service.”

• The multiple use test formerly specified in section 401(m)(9) is repealed.

• Faster vesting is required for matching contributions.

• Matching contributions are taken into account in satisfying the top-heavy requirements of section 416.

In addition, since publication of the pre-SBJPA regulations, a number of items of guidance affecting section 401(k) and section 401(m) plans addressing these statutory changes and other issues have been released by the IRS, including:

• Notice 97-2 (1997-1 C.B. 348) provides initial guidance on prior year ADP and ACP testing and guidance on correction of excess contributions and excess aggregate contributions, including distribution to the HCEs with the highest contributions.

• Rev. Proc. 97-9 (1997-1 C.B. 624) provides model amendments for SIMPLE 401(k) plans.

• Notice 98-1 (1998-1 C.B. 327) provides additional guidance on prior year testing issues.

• Notice 98-52 (1998-2 C.B. 632) and Notice 2000-3 (2000-1 C.B. 413) provides guidance on safe harbor section 401(k) plans.

• Rev. Rul. 2000-8 (2000-1 C.B. 617) addresses the use of automatic enrollment features in section 401(k) plans.

• Notice 2001-56 (2001-2 C.B. 277) and Notice 2002-4 (2002-1 C.B. 298) provided initial guidance related to the changes made by EGTRRA.

These items of guidance, with some modification, were incorporated into the proposed regulations under section 401(k) and section 401(m) which were published in the
Federal Register
on July 17, 2003. 68 FR 42476.

On November 12, 2003, a public hearing was held on the proposed regulations. After consideration of the comments, these final regulations adopt the provisions of the proposed regulations with certain modifications, the most significant of which are highlighted below.

Explanation of Provisions

1. Rules Applicable to All Cash or Deferred Arrangements

Section 401(k)(1) provides that a profit-sharing, stock bonus, pre-ERISA money purchase or rural cooperative plan will not fail to qualify under section 401(a) merely because it contains a qualified cash or deferred arrangement. As under the proposed regulations, § 1.401(k)-1 sets forth the general definition of a cash or deferred arrangement (CODA), the additional requirements that a CODA must satisfy in order to be a qualified CODA, and the treatment of contributions made under a qualified or nonqualified CODA.

As under the proposed regulations, the final regulations define a CODA as an arrangement under which employees can make a cash or deferred election with respect to contributions to, or accruals or benefits under, a plan intended to satisfy the requirements of section 401(a). A cash or deferred election is any direct or indirect election by an employee (or modification of an earlier election) to have the employer either: (1) Provide an amount to the employee in the form of cash or some other taxable benefit that is not currently available; or (2) contribute an amount to a trust, or provide an accrual or other benefit, under a plan deferring the receipt of compensation. These final regulations retain the definition of a CODA from the proposed regulations, with some minor modifications. First, the exclusion of an arrangement under which employees make after-tax contributions from the definition of a CODA does not encompass an arrangement under which employees make designated Roth contributions.
1

Second, the final regulations clarify that the regulatory provision specifying that compliance with section 401(k) and section 402(e)(3) is the only means of providing a cash or deferred election to an employee without violating the constructive receipt rules is limited to cash or deferred elections under which the contribution or accrual is made under a qualified plan or trust.

1
A designated Roth contribution is an elective contribution that is included in income. The Treasury and the IRS expect to issue guidance on designated Roth contributions in the near future.

As under the proposed regulations, these final regulations incorporate prior guidance on automatic enrollment and thus reflect the fact that a CODA can specify that the default that applies in the absence of an affirmative election by

an employee can be a contribution to a trust, as described in Rev. Rul. 2000-8. Although the facts of Rev. Rul. 2000-8 specified a certain percentage of compensation that would apply as a default, the percentage chosen was merely illustrative. Thus, the final regulations do not constrain the choice of default provisions.
2

However, in order to be a qualified CODA, as indicated in Rev. Rul. 2000-8, it is cash in lieu of the default employer contribution.

2
The Department of Labor has advised Treasury and the IRS that, under Title I of the Employee Retirement Income Security Act of 1974 (“ERISA”) (88 Stat. 829), Public Law 93-406, fiduciaries of a plan must ensure that the plan is administered prudently and solely in the interest of plan participants and beneficiaries. While ERISA section 404(c) may serve to relieve certain fiduciaries from liability when participants or beneficiaries exercise control over the assets in their individual accounts, the Department of Labor has taken the position that a participant or beneficiary will not be considered to have exercised control when the participant or beneficiary is merely apprised of investments that will be made on his or her behalf in the absence of instructions to the contrary.
See
29 CFR 2550.404c-1 and 57 FR 46924.

These final regulations also clarify the rules relating to one-time irrevocable elections that are not treated as cash or deferred elections. First, the final regulations replace the requirement that the election be made upon commencement of employment or first becoming eligible under the plan or any plan of the employer with the requirement that the election be made no later than first becoming eligible under the plan or any other plan of the employer. Second, the final regulations define any other plan of the employer for this purpose to mean any plan or arrangement that is described in section 219(g)(5)(D), which includes a section 457(b) governmental plan and a section 403(b) plan, as well as a qualified plan.

The final regulations retain the rule that a contribution is made pursuant to a cash or deferred election only if the contribution is made after the relevant election. Thus, a contribution made in anticipation of an employee's election is not treated as an elective contribution. A number of commentators indicated that the rule in the proposed regulation requiring that elective contributions not precede the services to which they relate (or the date when the compensation would otherwise be paid, if earlier than the date when the services are performed) was too broad. Some of these commentators suggested the addition of an exception to cover instances where the employer has administrative reasons for depositing the contributions before the employee's services or pay day (for example, the temporary absence of the bookkeeper responsible for transmitting funds to the plan), while others suggested loosening the rule where the early contribution does not result in an accelerated deduction.

After considering these comments, the IRS and Treasury have concluded that the prefunding of elective contributions and matching contributions is inconsistent with sections 401(k) and 401(m) and that the restrictions on the timing of contributions are consistent with the fundamental premise of elective contributions (
i.e.
, these are contributions that are paid to the plan as a result of an employee election not to receive those amounts in cash). Accordingly, the final regulations generally provide that contributions are made pursuant to a cash or deferred election only if the contributions are made after the employee's performance of services which relate to the compensation that, but for the election, would have been paid to the employee. Amounts contributed in anticipation of future performance of services generally are not treated as elective contributions under these final regulations. Thus, an employer is not able to prefund elective contributions in order to accelerate the deductions for elective contributions; and employer contributions made under the facts in Notice 2002-48 (2002-2 C.B.139) are no longer permitted to be taken into account under the ADP test or the ACP test and would not satisfy any plan requirement to provide elective contributions or matching contributions.

The proposed regulations contained an exception to the rule precluding the funding of elective contributions before the performance of services in the situation where the compensation would also have been paid, but for the election, before the performance of services and that exception has been retained in the final regulations. After consideration of the administrative concerns raised by the comments, these final regulations also include an exception for occasional bona fide administrative considerations. Under this exception, employer contributions will not fail to satisfy the regulatory requirements relating to the timing of elective contributions merely because contributions for an occasional pay period are made before the services with respect to that pay period are performed, provided that the early contributions are made for bona fide administrative considerations and are not made early with a principal purpose of accelerating deductions. In addition, the final regulations include changes to the rules precluding the prefunding of matching contributions discussed below.

One commentator asked for clarification of the interaction between these timing rules and the rule under the regulations that treats a self-employed individual's earned income as being currently available on the last day of the individual's taxable year and whether this last day rule precludes a partner from making elective contributions during the year through a reduction in the partner's draw. The restriction on the timing of contributions is not intended to prevent a partner from deferring amounts that are paid to the partner throughout the year on account of services performed by the partner during the year, and the final regulations have been modified to clarify this point. However, self-employed individuals who take advantage of this opportunity to defer amounts during the year must make sure that the amount contributed during the year will not exceed the limits (such as the limits of section 415) that will apply to the individual, based on the individual's actual earned income for the relevant period.

2. Qualified CODAs

A. General Rules Relating to Qualified CODAs

Elective contributions under a qualified CODA are treated as employer contributions for purposes of the Internal Revenue Code.
3

Elective contributions under a qualified CODA generally are not included in the employee's gross income at the time the cash would have been received (but for the cash or deferred election) or at the time contributed to the plan. Elective contributions under a qualified CODA are included in the employee's gross income, however, if the contributions are in excess of the section 402(g) limit for a year, are designated Roth contributions (under section 402A, effective for tax years beginning after December 31, 2005), or are recharacterized as after-tax contributions as part of a correction of an ADP test failure.

3
The Department of Labor has advised Treasury and the IRS that its view is that amounts a participant pays to or has withheld by an employer, whether pursuant to a cash or deferred election or otherwise, for contribution to an employee benefit plan constitute participant contributions for purposes of Subtitle A and Part 4 of Subtitle B of Title I of ERISA.

A CODA is not qualified unless it is part of a profit sharing plan, stock bonus plan, pre-ERISA money purchase plan, or rural cooperative plan and provides for an election between contributions to the plan or payments directly in cash.

In addition, a CODA is not qualified unless it meets the following requirements: (1) The elective contributions under the CODA satisfy either the ADP test set forth in section 401(k)(3) or one of the design-based alternatives in section 401(k)(11) or (12); (2) elective contributions under the CODA are nonforfeitable at all times; (3) elective contributions are distributable only on the occurrence of certain events, including attainment of age 59
1/2
, hardship, death, disability, severance from employment, or termination of the plan; (4) the group of employees eligible to participate in the CODA satisfies the coverage requirements of section 410(b)(1); (5) no other benefit (other than matching contributions and certain other specified benefits) is conditioned, directly or indirectly, upon the employee's making or not making elective contributions under the CODA; and (6) no more than 1 year of service is required for eligibility to elect to make a cash or deferred election.

Subject to certain exceptions, State and local governmental plans are not allowed to include a qualified CODA. Plans sponsored by Indian tribal governments and rural cooperatives are allowed to include a qualified CODA.

B. Nondiscrimination Rules Applicable to Qualified CODAs

As under the proposed regulations, these final regulations provide that the special nondiscrimination standards set forth in section 401(k) (the ADP test, the ADP safe harbor and the SIMPLE 401(k) plan) are the exclusive means by which a qualified CODA can satisfy the nondiscriminatory amount of contribution requirement of section 401(a)(4). Pursuant to section 401(k)(3)(G), a State or local governmental plan is deemed to satisfy the ADP test.

These final regulations retain the rule that the plan must satisfy the requirements of § 1.401(a)(4)-4 with respect to benefits, rights and features in addition to the requirements that contributions satisfy the nondiscrimination requirements of section 401(k). In addition to stating that the availability of each level of elective contribution is a right or feature subject to the requirements of section 401(a)(4), the final regulations point out that the right to make a designated Roth contribution is a right or feature.

The proposed regulations included an anti-abuse rule which provided that a plan will not be treated as satisfying the requirements of section 401(k) if there are repeated changes to plan testing procedures or plan provisions that have the effect of distorting the ADP so as to increase significantly the permitted deferrals for HCEs, or otherwise manipulate the nondiscrimination rules of section 401(k), if a principal purpose of the changes was to achieve such a result.

Several commentators suggested eliminating the anti-abuse rule in the proposed regulations. One of these commentators suggested that the proposed regulation's restrictions on ADP testing (including the restriction on the use of targeted QNECs and changes in testing method discussed below) made the anti-abuse rule unnecessary and noted that there may be legitimate reasons (for example, change in participant demographics or merger of plans for administrative reasons) for changes to a section 401(k) plan's testing procedures. Another commentator suggested that the anti-abuse rule be replaced with guidance addressing various specific abusive transactions.

After considering these comments, IRS and Treasury have determined that the need for rules to prevent abuse associated with changes in plan testing procedures or other plan provisions to inflate inappropriately the ADP for NHCEs or to otherwise manipulate the nondiscrimination provisions of section 401(k) outweighs the concerns raised by these commentators. In addition, IRS and Treasury do not believe that the anti-abuse provisions of the proposed regulations constrain legitimate testing procedure changes. Therefore, these final regulations retain the anti-abuse provisions of the proposed regulations.

C. Aggregation and Disaggregation of Plans

As under the proposed regulations, these final regulations consolidate the rules regarding identification of CODAs and plans for purposes of demonstrating compliance with the requirements of section 401(k) and retain the rule that all CODAs included in a plan are treated as a single CODA for purposes of applying the nondiscrimination tests. For this purpose, a plan is generally defined by reference to § 1.410(b)-7(a) and (b) after application of the mandatory disaggregation rules of § 1.410(b)-7(c) (other than the mandatory disaggregation of section 401(k) and section 401(m) plans) and permissive aggregation rules of § 1.410(b)-7(d), as modified under these regulations. For example, if a plan covers collectively bargained employees and noncollectively bargained employees, the elective contributions for the separate groups of employees must be treated separately for nondiscrimination under section 401(k). As under the proposed regulations, the final regulations retain the special rules in the pre-SBJPA regulations that permit the aggregation of certain employees in different collective bargaining units and the prohibition on restructuring under § 1.401(a)(4)-9(c).

The proposed regulations included a change to the treatment of a CODA under a plan that includes an ESOP. Under the pre-SBJPA regulations, such a plan must be disaggregated into the ESOP and non-ESOP portions and apply two separate ADP and ACP tests: one for elective contributions going into the ESOP portion (and invested in employer stock) and one for elective contributions going in the non-ESOP portion of the plan. The proposed regulations eliminated the disaggregation of the ESOP and non-ESOP portions of a single section 414(l) plan for purposes of ADP and ACP testing and allowed an employer to permissively aggregate two section 414(l) plans, one that is an ESOP and one that is not.

Commentators responded favorably to this change. Therefore, the final regulations retain the rule of the proposed regulations that eliminates the disaggregation of the ESOP and non-ESOP portions for the ADP and ACP tests. Several of these commentators suggested that plans be permitted to implement this change before the effective date of the regulations. After considering these comments, the IRS and Treasury have determined that it would not be in the best interest of plan administration to allow this change to be made before the effective date of the entire regulations. However, as discussed below, a plan is permitted to implement this change for plan years that end after December 29, 2004, provided the plan applies all the rules of these final regulations, to the extent applicable, for that plan year and all subsequent plan years

These final regulations retain the proposed regulations' requirement that a single testing method must apply to all CODAs under a plan (after application of the aggregation and disaggregation rules as modified). This has the effect of restricting an employer's ability to aggregate section 414(l) plans for purposes of section 410(b) if those plans apply inconsistent testing methods. For example, a plan that applies the ADP test of section 401(k)(3) may not be aggregated with a plan that uses the ADP safe harbor of section 401(k)(12) for purposes of section 410(b). However, the final regulations make clear that if a plan is disaggregated into separate plans under the rules of section 410(b), each separate plan can apply a different testing method. Thus, for example, if an

employer maintaining a plan that covers otherwise excludible employees is using the optional rule of section 410(b)(4)(B) to determine whether the plan satisfies the requirements of section 410(b), then the plan is treated as comprising two separate plans for purposes of section 410(b) and the plan covering the employees who have satisfied the minimum age and service requirements of section 410(a)(1)(A) can use the ADP safe harbor of section 401(k)(12), while the plan covering the remaining employees uses the ADP test of section 401(k)(3).

D. Requirement That the Elective Contributions Be Immediately Nonforfeitable

The final regulations reflect the statutory requirement that elective contributions to a qualified CODA be immediately nonforfeitable. However, the final regulations clarify that the reference to these contributions being “disregarded for purposes of applying section 411(a) to other contributions” is limited to being disregarded for purposes of section 411(a)(2). Thus, for example, elective contributions under a qualified CODA are taken into account for purposes of determining whether a participant is a nonvested participant for purposes of section 411(a)(6)(D)(iii).

E. Restrictions on Withdrawals

As discussed above, a qualified CODA must provide that elective contributions may only be distributed after certain events, including hardship and severance from employment. EGTRRA amended section 401(k)(2)(B)(i)(I) by replacing “separation from service” with “severance from employment.” This change eliminated the “same desk rule” as a standard for distributions under section 401(k) plans.

In addition, EGTRRA amended section 401(k)(10) by deleting disposition by a corporation of substantially all of the assets of a trade or business and disposition of a corporation's interest in a subsidiary, leaving termination of the plan as the only distributable event described in section 401(k)(10). Further, EGTRRA directs the Secretary of the Treasury to revise the regulations relating to distributions under section 401(k)(2)(B)(i)(IV) to provide that the period during which an employee is prohibited from making elective and employee contributions following a hardship distribution is 6 months (instead of 12 months as required under § 1.401(k)-1(d)(2)(iv)(B)(
4
) of the pre-SBJPA regulations).
4

Finally, section 662 of EGTRRA amended section 404(k)(2) to allow a deduction for dividends paid on employer securities held by an ESOP if those dividends are reinvested in employer securities pursuant to an election by the participant or beneficiary to reinvest the dividends or have them paid in cash. Section 662 of EGTRRA is effective for taxable years of a corporation beginning on or after January 1, 2002.

4
Under section 402(c), as amended by the IRS Restructuring and Reform Act of 1998, Public Law 105-206 (112 Stat. 685), and EGTRRA, a hardship distribution is not an eligible rollover distribution. While the change affects distributions from a section 401(k) plan, there is no specific reference to the change in these regulations because these regulations are under sections 401(k) and (m).

Notice 2001-56, Notice 2002-2 (2002-1 C.B. 285), and Notice 2002-4 provided guidance on these EGTRRA changes to the distribution rules for elective contributions. That guidance was generally incorporated in the proposed regulations. These final regulations adopt the rules in the proposed regulations but clarify that the requirement that a participant must have obtained all distributions currently available under all qualified plans of the employer in order to qualify for a hardship distribution applies equally to a distribution of an ESOP dividend. This implements the rule set forth in Notice 2002-2.

Comments were requested on whether a change in status from a common law employee to a leased employee described in section 414(n) should be treated as a severance from employment that would permit a distribution to be made. After reviewing the comments, these final regulations do not add the change to leased employee to the list of distributable events and retain the use of the section 410(b) definition of employee for purposes of section 401(k). Because an individual who is a leased employee (as defined in section 414(n)) is treated as an employee of the recipient of the individual's services for purposes of section 410(b) (unless the safe harbor plan requirements described in section 414(n)(5) are met), the individual does not incur a severance from employment as a result of becoming a leased employee.

In addition to the statutory changes, the rules relating to hardship distributions were reorganized in the proposed regulations in order to clarify certain ambiguities, including the relationship between the generally applicable rules, employee representations, and the safe harbors provided under the pre-SBJPA regulations. The final regulations adopt the rules in the proposed regulations with some minor modifications. In response to comments, the final regulations add funeral expenses and certain expenses relating to the repair of damage to the employee's principal residence to the list of events that are deemed to be immediate and heavy financial needs.

The pre-SBJPA regulations and the proposed regulations treated medical expenses for an employee's spouse or dependent described in section 152 as a deemed heavy and financial need. The Working Families Tax Relief Act of 2004 (118 Stat. 1166), Public Law 108-311, modified section 152's definition of dependent, effective for tax years beginning in 2005. These final regulations revise the proposed regulations to disregard certain provisions in section 152's definition of dependent in the case of post-secondary educational expenses. These final regulations also revise the proposed regulations to treat expenses for (or necessary to obtain) medical care that would be deductible under section 213(d) (determined without regard to whether the expenses exceed 7.5% of adjusted gross income) as a deemed heavy and financial need. These changes have the effect of allowing medical expenses and post-secondary educational expenses for an employee, spouse, or dependent (without regard to the change in the definition of dependent under the Working Families Tax Relief Act of 2004) to be treated as a deemed heavy and financial need. The modifications in these final regulations also effectively expand the definition of dependent for medical expenses to include a non-custodial child who is subject to the special rule of section 152(e), but would exclude nonprescription drugs or medicine (other than insulin). Prior to the effective date of these regulations with respect to a plan, a sponsor can continue to interpret the plan terms and the pre-SBJPA regulations without regard to the statutory change in the definition of dependent.

Some commentators asked for specific guidance on the documentation and verification requirements for a hardship distribution. The final regulations do not address this issue. However, taxpayers are reminded that section 6001 requires that they keep the records necessary to demonstrate compliance with the qualification requirements of section 401 and the rules of section 401(k) and 401(m).

F. Other Rules for Qualified CODAs

The final regulations retain the additional requirements set forth in the

pre-SBJPA regulations that a CODA must satisfy in order to be qualified, with some minor modifications. First, in order to be a qualified CODA, the arrangement must provide an employee with an effective opportunity to elect to receive the amount in cash no less than once during the plan year. Whether an employee has an effective opportunity is determined based on all the relevant facts and circumstances, including adequacy of notice of the availability of the election, the period of time before the cash is currently available during which an election may be made, and any other conditions on elections.

The final regulations also require a plan to provide for satisfaction of one of the specific nondiscrimination alternatives described in section 401(k). As with the pre-SBJPA regulations, the plan may accomplish this by incorporating by reference the ADP test of section 401(k)(3) and the regulations under proposed § 1.401(k)-2(a) and (b), if that is the nondiscrimination alternative being used. If, with respect to the nondiscrimination alternative being used, there are optional choices available, the plan must provide which of the optional choices will apply. For example, a plan that uses the ADP test of section 401(k)(3) must specify whether it is using the current year testing method or prior year testing method. Additionally, a plan that uses the prior year testing method must specify whether the ADP for eligible NHCEs for the first plan year is 3% or the actual ADP for the eligible NHCEs for the first plan year. The final regulations also provide that the Commissioner may, in guidance of general applicability, specify the default options that will apply under the plan if the nondiscrimination test is incorporated by reference in accordance with the final regulations.

Additionally, a plan that uses the safe harbor method must specify whether the safe harbor contribution will be the nonelective safe harbor contribution or the matching safe harbor contribution and is not permitted to provide that ADP testing will be used if the requirements for the safe harbor are not satisfied. The safe harbors are intended to provide employees with a minimum threshold in benefits in exchange for easier compliance for the plan sponsor. It would be inconsistent with this approach to providing benefits to allow an employer to deliver smaller benefits to NHCEs and revert to testing. Accordingly, if, at the beginning of the plan year, a plan contains an allocation formula that includes safe harbor matching or nonelective contributions, these regulations clarify that, except to the extent permitted under § 1.401(k)-3 and § 1.401(m)-3, the plan may not be amended to revert to testing for the plan year.

The final regulations retain the existing rules relating to the section 401(k)(4)(A) prohibition on having benefits (other than a match) contingent on making or not making an elective contribution. These final regulations also reflect the amendment to section 416(c)(2)(A) (under which matching contributions can be taken into account for purposes of satisfying the top-heavy minimum contribution requirement without violating the prohibition on making benefits contingent on making or not making elective contributions), the amendment of section 401(k)(4)(B) by SBJPA (allowing tax exempt organizations to maintain section 401(k) plans), and the enactment of section 402(g)(8) (providing that matching contributions with respect to partners and sole proprietors are no longer treated as elective contributions).

3. The Actual Deferral Percentage (ADP) Test

A. General Rules Relating to the ADP Test

Section 1.401(k)-2 sets forth the rules for a CODA that is applying the ADP test contained in section 401(k)(3). Under the ADP test, the percentage of compensation deferred for the eligible HCEs is compared annually to the percentage of compensation deferred for eligible NHCEs, and if certain limits are exceeded by the HCEs, corrective action must be taken by the plan. Correction can be made through the distribution of excess contributions, the recharacterization of excess contributions, or additional employer contributions.

Section 401(k)(3)(A), as amended by SBJPA, generally provides for the use of prior year data in determining the ADP of NHCEs, while current year data is used for HCEs. This testing option is referred to as the prior year testing method. Alternatively, a plan may provide for the use of current year data for determining the ADPs for both NHCEs and HCEs, which is known as the current year testing method. The regulations use the term applicable year to describe the year for which the ADP is determined for the NHCEs.

Section 401(k)(3)(F), as added by SBJPA, provides that a plan benefiting otherwise excludable employees and that, pursuant to section 410(b)(4)(B), is being treated as two separate plans for purposes of section 410(b), is permitted to disregard NHCEs who have not met the minimum age and service requirements of section 410(a)(1)(A). Thus, the regulations permit such a plan to perform the ADP test by comparing the ADP for all eligible HCEs for the plan year and the ADP of eligible NHCEs for the applicable year, disregarding all NHCEs who have not met the minimum age and service requirements of section 410(a)(1)(A). Because section 401(k)(3)(F) is permissive, the final regulations follow the proposed regulations and do not eliminate the existing testing option under which a plan benefiting otherwise excludable employees is disaggregated into separate plans where the ADP test is performed separately for all eligible employees who have completed the minimum age and service requirements of section 410(a)(1)(A) and for all eligible employees who have not completed the minimum age and service requirements.

B. Elective Contributions Used in the ADP Test

The regulations generally follow the proposed regulations in defining which elective contributions are reflected in the ADP test and which ones are not. Thus, these regulations reflect the rule contained in the regulations under section 414(v), under which catch-up contributions that are in excess of a statutory limit or an employer-provided limit are not taken into account under the ADP test. See § 1.414(v)-1. The final regulations add a comparable rule for additional elective contributions that are made by reason of an eligible employee's qualified military service pursuant to section 414(u). The final regulations retain the rule that elective contributions must be paid to the trust within 12 months after the end of the plan year. However, for plans subject to Title I of ERISA, contributions must be paid to the trust much sooner in order to satisfy the Department of Labor's regulations relating to when elective contributions become plan assets.

Section 401(k)(3) provides that the actual deferral ratio (ADR) of an HCE who is eligible to participate in 2 or more CODAs of the same employer is calculated by treating all CODAs in which the employee is eligible to participate as one CODA. These final regulations adopt the provision in the proposed regulations that provides that the ADR for each HCE participating in more than one CODA is determined by aggregating the HCE's elective contributions that are within the plan year of the CODA being tested.

C. Additional Employer Contributions Used in the ADP Test

The final regulations generally retain the rules in the proposed regulations permitting a plan to take qualified nonelective contributions or qualified matching contributions (
i.e.
, nonelective or matching contributions that satisfy the vesting and distribution limitations of section 401(k)(2)(B) and (C)) into account under the ADP test, except as described below. Thus, an employer whose CODA has failed the ADP test can correct this failure by making additional qualified nonelective contributions (QNECs) or qualified matching contributions (QMACs) for its NHCEs.

As under the pre-SBJPA regulations, these final regulations provide that QNECs must satisfy four requirements in addition to the vesting and distribution rules described above before they can be taken into account under the ADP test: (1) The amount of nonelective contributions, including the QNECs that are used under the ADP test or the ACP test, must satisfy section 401(a)(4); (2) the amount of nonelective contributions, excluding the QNECs that are used under the ADP test or the ACP test, must satisfy section 401(a)(4); (3) the plan to which the QNEC or QMAC is made must be a plan that can be aggregated with the plan maintaining the CODA; and (4) the QNECs or QMACs must not be contingent on the performance of services after the allocation date and must be contributed within 12 months after the end of the plan year within which the contribution is to be allocated.
5

Thus, in the case of a plan using prior year ADP testing, any QNECs that are to be allocated to the NHCEs for the prior plan year must be contributed before the last day of the current plan year in order to be taken into account.

5
With respect to this timing requirement, it should be noted that in order to be taken into account for purposes of section 415(c) for a limitation year, the contributions will need to be made within the time frame set forth in the regulations under section 415 (generally, no later than 30 days after the end of the section 404(a)(6) period applicable to the taxable year with or within which the limitation year ends).

Some plans provide a correction mechanism for a failed ADP test that targets QNECs to certain NHCEs in order to reduce the total contributions to NHCEs under the correction. Under the method that minimizes the total QNECs allocated to NHCEs under the correction, the employer makes a QNEC to the extent permitted by the section 415 limits to the NHCE with the lowest compensation during the year in order to raise that NHCE's ADR. If the plan still fails to pass the ADP test, the employer continues expanding the group of NHCEs who receive QNECs to the next lowest-paid NHCE until the ADP test is satisfied. By using this bottom-up leveling technique, the employer can pass the ADP test by contributing small amounts of money to NHCEs who have very low compensation for the plan year (for example, an employee who terminated employment in early January with $300 of compensation). This is because of the fact that the ADP test is based on an unweighted average of ADRs and a small dollar (but high percentage of compensation) contribution to a terminated or other partial-year employee has a larger impact on the ADP test than the same contribution to a full-year employee.

The IRS and Treasury have been concerned that, by using this type of technique, employers may pass the ADP test by making high percentage QNECs to a small number of employees with low compensation rather than providing contributions to a broader group of NHCEs. In addition, the legislative history to EGTRRA expresses Congressional intent that the Secretary of the Treasury will use his existing authority to address situations where qualified nonelective contributions are targeted to certain participants with lower compensation in order to increase the ADP of the NHCEs. (
See
EGTRRA Conference Report, H.R. Conf. Rep. 107-84, 240).

Accordingly, the proposed regulations added a new requirement that a QNEC must satisfy in order to be taken into account under the ADP test. This requirement, designed to limit the use of targeted QNECs, generally prohibited a plan from counting QNECs for purposes of the ADP test to the extent that QNECs are more than double the QNECs at least half of the other NHCEs are receiving, when expressed as a percentage of compensation.

The restriction on targeting QNECs is implemented by providing that a QNEC for an NHCE that exceeds 5% of compensation could be taken into account for the ADP test only to the extent the contribution, when expressed as a percentage of compensation, does not exceed two times the plan's representative contribution rate. The plan's representative contribution rate is defined as the lowest contribution rate (
i.e.
, the sum of QNECs made and QMACs taken into account for an employee divided by the employee's compensation) among a group of NHCEs that is half of all the eligible NHCEs under the arrangement (or the lowest contribution rate among all eligible NHCEs under the arrangement who are employed on the last day of the year, if greater).

While some commentators applauded the restriction on targeted QNECs, a number of commentators suggested that certain types of contributions be exempted from the definition of targeted QNECs. In particular, commentators suggested that QNECs equal to a flat dollar amount that are made to all NHCEs and QNECs that are made in connection with an employer's obligation to pay a prevailing wage under the Davis-Bacon Act (46 Stat. 1494), Public Law 71-798, Service Contract Act of 1965 (79 Stat. 1965), Public Law 89-386, or similar legislation should be able to be taken into account under the ADP test (even though such contributions create widely different contribution percentages among the NHCE population) because they are not “targeted”.

After reviewing the comments, the IRS and Treasury believe that the restrictions on targeting QNECs should apply essentially as they were proposed. While flat dollar QNEC contributions may not have the appearance of targeting, allowing those contributions to skew the results of the ADP test undermines the integrity of the ADP test. However, the final regulations provide more flexibility for QNECs that are made in connection with an employer's obligation to pay a prevailing wage under the Davis-Bacon Act (46 Stat. 1494), Public Law 71-798, Service Contract Act of 1965 (79 Stat. 1965), Public Law 89-286, or similar legislation by allowing a QNEC of up to 10% of compensation to be taken into account under the ADP test in such a case.

The final regulations under section 401(m) provide parallel restrictions on QNECs taken into account in ACP testing, and a QNEC cannot be taken into account under both the ADP and ACP test (including for purposes of determining the representative contribution rate). As discussed more fully below, the final regulations generally retain the proposed regulations limitation on targeting matching contributions, which limits the extent to which QMACs can be targeted as a means of avoiding the restrictions on targeted QNECs.

D. Correction

Section 401(k)(8)(C), as amended by SBJPA, provides that, for purposes of correcting a plan's failure to meet the nondiscrimination requirements of section 401(k)(3), the distribution of excess contributions is made on the basis of the amount of the contributions

by, or on behalf of, each HCE. The final regulations implement this correction procedure in the same manner as set forth in Notice 97-2. Thus, the total amount of excess contributions is determined using the rules under the pre-SBJPA regulations (
i.e.
, based on high percentages). Then, that total amount is apportioned among the HCEs by assigning the excess to be distributed first to those HCEs who have the greatest dollar amount of contributions taken into account under the ADP test (as opposed to the highest deferral percentage). If these amounts are distributed or recharacterized in accordance with these regulations, the plan complies with the ADP test for the plan year with no obligation to recalculate the ADP test.

The final regulations generally follow the rules in the proposed regulations on the determination of net income attributable to excess contributions. However, the regulatory language regarding the calculation of gap period income (
i.e.
, income for the period after the plan year) has been clarified to specify that gap period income needs to be included only to the extent the employee is or would be credited with allocable gain or loss on those excess contributions for that period, if the total account were to be distributed. In addition, in response to administrative concerns raised by comments, the final regulations provide that a distribution of excess contributions is not required to include the income allocable to the excess contributions for a period that is no more than 7 days before the distribution. As under the pre-SBJPA regulations, the determination of the income for the gap period could be based on the income determined using the alternative method for the aggregate of the plan year and the gap period or using 10% of the income for the plan year (determined under the alternative method) for each month in the gap period.

The final regulations retain the rules in the proposed regulations regarding the timing and tax treatment of distributions of excess contributions, coordination with the distribution of excess deferrals and the treatment of matches attributable to excess contributions. However, the final regulations clarify that if excess contributions are distributed, they are includible in income on the dates the elective contributions would have been received by the employee had the employee originally elected to receive the amounts in cash, treating the excess contributions that are being distributed as the first elective contributions for the plan year.

4. Safe Harbor Section 401(k) Plans

Section 401(k)(12) provides a design-based safe harbor method under which a CODA is treated as satisfying the ADP test if the arrangement meets certain contribution and notice requirements. Section 1.401(k)-3 of these final regulations, which sets forth the requirements for these arrangements, generally follows the rules set forth in Notice 98-52 and Notice 2000-3. Thus, a plan satisfies the section 401(k) safe harbor if it makes specified QMACs for all eligible NHCEs. The matching contributions can be under a basic matching formula that provides for QMACs equal to 100% of the first 3% of elective contributions and 50% of the next 2% or an enhanced matching formula that is at least as generous in the aggregate, provided the rate of matching contributions under the enhanced matching formula does not increase as the employee's rate of elective contributions increases. In lieu of QMACs, the plan is permitted to provide QNECs equal to 3% of compensation for all eligible NHCEs. In addition, notice must be provided to each eligible employee, within a reasonable time before the beginning of the year, of the employee's right to defer under the plan.

The proposed regulations did not include any exception to the requirements for safe harbor matching contributions with respect to catch-up contributions. As part of the proposed regulations the IRS and Treasury solicited comments on the specific circumstances under which elective contributions by an NHCE to a safe harbor plan would be less than the amount required to be matched,
e.g.
, less than 5% of safe harbor compensation, but would be treated by the plan as catch-up contributions, and on the extent to which a safe harbor plan should be required to match catch-up contributions under such circumstances. After reviewing the comments and the applicable statutory provisions (including the amendments to section 414(v)(3)(B) made by the Job Creation and Worker Assistance Act of 2002, (JCWAA) (Public Law 107-147)), the IRS and Treasury have determined that no such exception is appropriate.

Section 401(k)(12)(D) contains a requirement that each eligible employee be provided with a written notice of the employee's rights and obligations under the plan. These final regulations provide that the notice can be provided in writing or through another medium that is prescribed by the Commissioner as satisfying the requirement for a written notice. As reflected in the priority guidance plan, the IRS and Treasury are currently developing guidance setting forth the extent to which the notice described in section 401(k)(12)(D), as well as other notices under the various requirements relating to qualified retirement plans, can be provided electronically, taking into account the effect of the Electronic Signatures in Global and National Commerce Act (E-SIGN) (114 Stat. 464), Public Law 106-229. Until that guidance is issued, plan administrators and employers may continue to rely on the interim guidance in Q&A-7 of Notice 2000-3 on the use of electronic media to satisfy the notice requirement in section 401(k)(12)(D).

These final regulations specify that a section 401(k) safe harbor plan must generally be adopted before the beginning of the plan year and be maintained throughout a full 12-month plan year. This requirement is consistent with the notion that the statute specifies a certain contribution level for NHCEs in order to be deemed to pass the nondiscrimination requirements. If the contribution level is not maintained for a full 12-month year, the employer contributions made on behalf of NHCEs should not support what could be a full year's contribution by the HCEs.

The final regulations adopt the exceptions to this 12-month rule that were set forth in the proposed regulations. Thus, a section 401(k) safe harbor plan could have a short plan year in the year the plan terminates, provided the plan termination is in connection with a merger or acquisition involving the employer, or the employer incurs a substantial business hardship comparable to a substantial business hardship described in section 412(d). A section 401(k) safe harbor plan could also have a short plan year in the year the plan terminates (without regard to the reason for the termination or the financial condition of the employer) if the employer makes the safe harbor contributions for the short year, employees are provided notice of the change, and the plan passes the ADP test. In either case, the employer must make the safe harbor contributions through the date of plan termination.

In addition, a safe harbor plan could have a short plan year if it is preceded and followed by plan years as a section 401(k) safe harbor plan. Under these final regulations, the following plan year is permitted to be shorter than 12 months if the short plan year is as a result of a plan termination (whether or not the plan termination is in connection with a merger or acquisition involving the employer). These final regulations clarify that this treatment is

unavailable if in the following plan year safe harbor matching contributions are reduced or suspended. In the event that the short plan year is followed by another short plan year, this treatment is available if the plan satisfies the 401(k) safe harbor requirements for the 12 month period immediately following the first short plan year.

5. SIMPLE 401(k) Plans

Pursuant to section 401(k)(11), a SIMPLE 401(k) plan is treated as satisfying the requirements of section 401(k)(3)(A)(ii) if the contribution, vesting, notice and exclusive plan requirements of section 401(k)(11) are satisfied. Section 1.401(k)-4 of these regulations reflects the provisions of section 401(k)(11) in a manner that follows the positions reflected in the model amendments set forth in Rev. Proc. 97-9.

6. Matching Contributions and Employee Contributions.

Section 401(m)(2) sets forth a nondiscrimination test, the ACP test, with respect to matching contributions and employee contributions that is parallel to the nondiscrimination test for elective contributions set forth in section 401(k). Section 1.401(m)-1 of the regulations sets forth this test in a manner that is consistent with the nondiscrimination test set forth in § 1.401(k)-1(b). Thus, satisfaction of the ACP test, the ACP safe harbor or the SIMPLE 401(k) provisions is the exclusive means that can be used to satisfy the nondiscrimination in amount of contribution requirements of section 401(a)(4) with respect to employee contributions and matching contributions. An anti-abuse provision comparable to that provided in connection with the regulations under section 401(k) limits the ability of an employer to make repeated changes in plan provisions or testing procedures that have the effect of distorting the ACP so as to increase significantly the permitted ACP for HCEs, or otherwise manipulate the nondiscrimination rules of section 401(m), if a principal purpose of the changes was to achieve such a result.

The final regulations also include provisions regarding plan aggregation and disaggregation that are similar to those that apply for CODAs under section 401(k). For example, matching contributions made under the portion of a plan that is an ESOP and the portion of the same plan that is not an ESOP are not disaggregated under these final regulations.

The definitions of matching contribution and employee contribution under § 1.401(m)-1 of the regulations generally follow the definitions in the pre-SBJPA regulations. Thus, whether an employer contribution is on account of an elective deferral or employee contribution—and thus is a matching contribution—is determined based on all the relevant facts and circumstances.

The final regulations generally follow the proposed regulations in providing that a contribution is not treated as a matching contribution on account of an elective deferral if it is contributed before the employee's performance of services with respect to which the elective deferral is made (or when the cash that is subject to the cash or deferred election would be currently available, if earlier) and an employer contribution is not a matching contribution made on account of an employee contribution if it is contributed before the employee contribution. Thus, under these regulations, an employer would not be able to prefund matching contributions to accelerate the deduction for those contributions; and, as noted above with respect to the timing of elective contributions, employer contributions made under the facts in Notice 2002-48 would not be taken into account under the ACP test and would not satisfy any plan requirement to provide matching contributions.

However, in response to comments, the final regulations make an exception to this prefunding restriction for forfeitures and for contributions that result in a matching allocation of employer securities released from encumbrance under a securities acquisition loan in a leveraged ESOP, provided that the contributions are for a required payment that is due under the loan terms and are not made early with a principal purpose of accelerating deductions.

7. ACP Test for Matching Contributions and Employee Contributions

Section 1.401(m)-2 of the final regulations provides rules for the ACP test that generally parallel the rules applicable to the ADP test in § 1.401(k)-2. Thus, for example, the ACP test may be run by comparing the ACP for eligible HCEs for the current year with the ACP for eligible NHCEs for either the current plan year or the prior plan year. The determination of the actual contribution ratio (ACR) for an eligible employee, and the contributions that are taken into account in determining that ACR, under the final regulations are comparable to the rules under the section 401(k) regulations. Thus, for example, the ACR for an HCE who has matching contributions or employee contributions under two or more plans is determined by adding together matching contributions and employee contributions under all plans of the employer during the plan year of the plan being tested, in a manner comparable to that for determining the ADR of an HCE who participates in two or more CODAs.

The final regulations allow QNECs to be taken into account for ACP testing, but would provide essentially the same restrictions on targeting QNECs to a small number of NHCEs as is provided in § 1.401(k)-2. The only difference in the rules is that the contribution percentages used to determine the lowest contribution percentage is based on the sum of the QNECs and those matching contributions taken into account in the ACP test, rather than the sum of the QNECs and the QMACs taken into account under the ADP test. Because QNECs that do not exceed 5% are not subject to the limits on targeted QNECs under either the ADP test or the ACP test, an employer is permitted to take into account up to 10% in QNECs for an eligible NHCE, 5% in ADP testing and 5% in ACP testing, without regard to how many NHCEs receive QNECs (with each of those numbers doubled for QNECs that are made in connection with an employer's obligation to provide a prevailing wage under the Davis-Bacon Act (46 Stat. 1494), Public Law 71-798, Service Contract Act of 1965 (79 Stat. 1965), Public Law 89-286, or similar legislation).

In addition, to prevent an employer from using targeted matching contributions to circumvent the limitation on targeted QNECs, the proposed regulations provided a parallel rule to limit targeted matching contributions for NHCEs from being taken into account in the ACP test to the extent the matching rate for the contribution exceeds the greater of 100% and 2 times the representative matching rate. These final regulations retain this basic rule with modifications to make it more consistent with the rule for QNECs. First, similar to the rule for QNECs, under these final regulations, a contribution that matches an elective contribution may be taken into account to the extent it does not exceed the greater of 5% of compensation. Only then does the rate of matching contribution rate become relevant. Further, in determining the representative matching rate these final regulations provide a new rule if the matching rate is not the same for all levels of elective contributions for an employee. In that case, the employee's matching rate is determined assuming that an employee's elective deferrals are

equal to 6 percent of compensation. There is also a parallel rule for matching contributions for employee contributions.

8. Changes to Other Regulations

These regulations include a number of cross-reference changes to other regulations to reflect the structure of these final regulations. However, no changes were made to the regulations under section 401(a)(26) and the rule relating to treating matching contributions as employer contributions for purposes of section 416 (see § 1.416-1, Q&A M-19) because these regulations have not been updated to reflect recent statutory changes.

Effective Date

These final regulations apply for plan years beginning on or after January 1, 2006. However, plan sponsors are permitted to apply these final regulations to any plan year that ends after December 29, 2004, provided the plan applies all the rules of these final regulations, to the extent applicable, for that plan year and all subsequent plan years. Taxpayers are cautioned, however, that a decision to apply these regulations in the middle of a plan year could only be successfully implemented if the plan has been operated in accordance with these regulations for that year.

For plan years beginning before the effective date of these regulations with respect to a plan, the plan must apply the rules of the prior regulations (as they appeared in the April 1, 2004 edition of 26 CFR part 1), the statutory provisions of section 401(k) and (m), and applicable IRS notices.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. It is hereby certified that the collection of information in these regulations will not have a significant economic impact on a substantial number of small entities. This certification is based upon the conclusion that few plans containing qualified cash or deferred arrangements will correct excess contributions through the recharacterization of these amounts as employee contributions under § 1.401(k)-2(b)(3) of these regulations. The collection of information contained in § 1.401(k)-3(d), (f), and § 1.401(m)-3(e) are required by statutory provisions. However, the IRS has considered alternatives that would lessen the impact of these statutory requirements on small entities. Thus, the collection of information in these regulations will only have a minimal economic impact on most small entities. Therefore, an analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Code, the proposed regulations preceding these regulations were submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Drafting Information

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

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 601 are amended as follows:

PART 1—INCOME TAXES

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

Authority:

26 U.S.C. 7805 * * *

Section 1.401(k)-1 also issued under 26 U.S.C. 401(m)(9).

Section 1.401(k)-2 also issued under 26 U.S.C. 401(m)(9).

Section 1.401(k)-3 also issued under 26 U.S.C. 401(m)(9).

Section 1.401(k)-4 also issued under 26 U.S.C. 401(m)(9).

Section 1.401(k)-5 also issued under 26 U.S.C. 401(m)(9).

Section 1.401(k)-6 also issued under 26 U.S.C. 401(m)(9).

Section 1.401(m)-1 also issued under 26 U.S.C. 401(m)(9).

Section 1.401(m)-2 also issued under 26 U.S.C. 401(m)(9).

Section 1.401(m)-3 also issued under 26 U.S.C. 401(m)(9).

Section 1.401(m)-4 also issued under 26 U.S.C. 401(m)(9).

Section 1.401(m)-5 also issued under 26 U.S.C. 401(m)(9).

Par. 2.
For each section set forth below, remove the text that appears in the column labeled “Remove” and replace with the text that appears in the column labeled “Insert”:

Regulation cite
Remove
Insert

§ 1.72(p)-1, Q&A-12
“1.401(k)-1(d)(6)(ii)”
“1.401(k)-1(d)(5)(iii)”

§ 1.401(a)(4)-1(b)(2)(ii)(B)
“1.401(k)-1(b)(4)”
“1.401(k)-2(a)(5)(i)”

§ 1.401(a)(4)-1(b)(2)(ii)(B)
“1.401(k)-1(b)(4)(i)”
“1.401(k)-2(a)(4)(i)”

§ 1.401(a)(4)-1(b)(2)(ii)(B)
“1.401(m)-1(b)(4)(ii)(A)”
“1.401(m)-2(a)(4)(iii)”

§ 1.401(a)(4)-1(b)(2)(ii)(B)
“1.401(k)-1(b)(5)”
“1.401(k)-2(a)(6”

§ 1.401(a)(4)-1(b)(2)(ii)(B)
“1.401(m)-1(b)(5)”
“1.401(m)-2(a)(6)”

§ 1.401(a)(4)-4(e)(3)(iii)(D)
“1.401(k)-1(g)(3)”
“1.401(k)-6”

§ 1.401(a)(4)-4(e)(3)(iii)(F)
“1.401(m)-1(f)(6)”
“1.401(m)-1(a)(3)”

§ 1.401(a)(4)-4(e)(3)(iii)(G)
“1.401(m)-1(f)(12)”
“1.401(m)-1(a)(2)”

§ 1.401(a)(4)-4(e)(3)(iii)(G)
“1.401(k)-1(f)(1)(i)”
“1.401(k)-2(b)(1)(i)”

§ 1.401(a)(4)-4(e)(3)(iii)(G)
“1.401(m)-1(e)(1)(i), and 1.401(m)-2(c)”
“1.401(m)-2(b)(1)(i)”

§ 1.401(a)(4)-9(c)(3)(ii)
“1.401(k)-1(b)(3)(ii) and 1.401(m)-1(b)(3)(ii)”
“1.401(k)-1(b)(4)(iv)(B) and 1.401(m)-1(b)(4)(iv)(B)”

§ 1.401(a)(4)-11(g)(3)(vii)(A)
“1.401(k)-1(g)(13)(ii)”
“1.401(k)-6”

§ 1.401(a)(4)-11(g)(3)(vii)(A)
“1.401(k)-1(g)(4)”
“1.401(k)-6”

§ 1.401(a)(4)-11(g)(3)(vii)(A)
“1.401(m)-1(f)(4)”
“1.401(m)-5”

§ 1.401(a)(4)-11(g)(6), Example 7
“1.401(k)-1(f)”
“1.401(k)-2(b)”

§ 1.401(a)(17)-1(b)(3)(iii)(B)
“1.401(k)-1(g)(3)”
“1.401(k)-6”

§ 1.401(a)(17)-1(b)(3)(iii)(B)
“1.401(m)-1(f)(12)”
“1.401(m)-5”

§ 1.401(a)(17)-1(b)(3)(iii)(B)
“1.401(m)-1(f)(6)”
“1.401(m)-5”

§ 1.401(a)(17)-1(d)(5)(ii)
“1.401(m)-(f)(6)”
“1.401(m)-1(a)(3)”

§ 1.401(l)-1(a)(4)(iii)
“1.401(k)-1(g)(3)”
“1.401(k)-6”

§ 1.401(l)-1(a)(4)(iii)
“1.401(m)-1(f)(6) or (f)(12)”
“1.401(m)-1(a)(3) or (a)(2)”

§ 1.402(a)-1(d)(1)
“1.401(k)-1(a)(3)(iii) and (2)(i)”
“1.401(k)-1(a)(3)(iv) and (2)(iv)”

§ 1.402(a)-1(d)(2)(i)
“1.401(k)-1(g)(3)”
“1.401(k)-6”

§ 1.402(a)-1(d)(2)(i)
“1.401(k)-1(a)(4)(i)”
“1.401(k)-1(a)(4)(i)”

§ 1.402(a)-1(d)(2)(i)
“1.401(k)-1(a)(7)”
“1.401(k)-1(a)(5)(iv)(B)”

§ 1.402(a)-1(d)(2)(ii)
“1.401(m)-1(f)(12)”
“1.401(m)-1(a)(2)”

§ 1.402(a)-1(d)(2)(iii)
“1.401(k)-1(a)(4)(iv)”
“1.401(k)-1(a)(3)(v)”

§ 1.402(a)-1(d)(2)(iii)
“1.401(k)-1(a)(6)(ii)(C)”
“1.401(k)-1(a)(3)(v)(B)”

§ 1.402(a)-1(d)(3)(ii)(A)
“1.401(k)-(g)(12)”
“1.401(k)-6”

§ 1.402(a)-1(d)(3)(iv)
“1.401(k)-1(a)(7)”
“1.401-1(a)(5)(iv)(B)”

§ 1.402(c)-2, Q&A-4(c)
“1.401(k)-1(f)”
“1.401(k)-2(b)(2)”

§ 1.402(c)-2, Q&A-4(c)
“1.401(m)-1(e)(3)”
“1.401(m)-2(b)(2)”

§ 1.402(g)-1(c)(2)
“1.401(k)-1(a)(3)(iv)”
“1.401(k)-1(a)(3)(v)”

§ 1.402(g)-1(e)(6)
“1.401(k)-1(f)(5)(i)”
“1.401(k)-2(b)(4)(i)”

§ 1.410(b)-3(a)(3), Example 2
“1.401(k)-1(g)(4)”
“1.401(k)-6”

§ 1.410(b)-3(a)(3), Example 3
“1.401(m)-1(f)(4)”
“1.401(m)-5”

§ 1.410(b)-7(c)(1)
“1.401(k)-1(b)(4)(iv)”
“1.401(k)-2(a)(5)”

§ 1.410(b)-9
“1.401(k)-1(g)(3)”
“1.401(k)-6”

§ 1.410(b)-9
“1.401(k)-1(a)(4)(i)”
“1.401(k)-1(a)(4)(i)”

§ 1.410(b)-9
“1.401(k)-1(b)(5)”
“1.401(k)-1(a)(6)”

§ 1.410(b)-9
“1.401(m)-1(f)(12)”
“1.401(m)-1(a)(2)”

§ 1.410(b)-9
“1.401(m)-1(e)(1)”
“1.401(m)-2(b)(1)”

§ 1.410(b)-9
“1.401(f)-1(f)(2)”
“1.401(k)-6”

§ 1.410(b)-9
“1.401(m)-1(f)(8)”
“1.401(m)-5”

§ 1.411(a)-4(b)(7)
“1.401(m)-1(f)(12)”
“1.401(m)-1(a)(2)”

§ 1.411(a)-4(b)(7)
“1.401(m)-1(e)(1)”
“1.401(m)-2(b)(1)”

§ 1.411(a)-4(b)(7)
“1.401(k)-1(f)(2) and (g)(7)”
“1.401(k)-2(b)(2)(ii) and 1.401(k)-6”

§ 1.411(a)-4(b)(7)
“1.401(m)-1(f)(8)”
“1.401(m)-5”

§ 1.411(d)-4(d), Q&A-2(b)(2)(x)
“1.401(k)-1(d)(2)”
“1.401(k)-1(d)(3)”

§ 1.411(d)-4(d), Q&A-2(b)(2)(x)
“1.401(k)-1(d)(2)”
“1.401(k)-1(d)(3)”

§ 1.414(r)-5(g)(2)(iv)(A)
“1.401(m)-1(f)(12)”
“1.401(m)-1(a)(2)”

§ 1.414(r)-5(g)(2)(iv)(A)
“1.401(k)-1(g)(3)”
“1.401(k)-6”

§ 1.414(r)-5(g)(2)(iv)(B)
“1.401(m)-1(f)(12)”
“1.401(m)-1(a)(2)”

§ 1.414(r)-5(g)(3)(iv)
“1.401(k)-1(g)(3)”
“1.401(k)-6”

§ 54.4979-1(b)(1)
“1.401(m)-1(f)(8)”
“1.401(m)-5”

§ 54.4979-1(b)(2)
“1.401(k)-1(g)(7)”
“1.401(k)-6”

§ 54.4979-1(c)(1)
“1.401(k)-1(b)(5)”
“1.401(k)-2(a)(6)”

§ 54.4979-1(c)(1)
“1.401(m)-1(b)(5)”
“1.401(m)-2(a)(6)”

§ 54.4979-1(c)(1)
“1.401(k)-1(f)(1)(i) and (6)(i)”
“1.401(m)-2(b)(1)(i) and (5)(i)”

§ 54.4979-1(c)(1)
“1.401(m)-1(e)(1)(i)”
“1.401(m)-2(b)(1)(i)”

§ 54.4979-1(c)(2)
“1.401(k)-1(f)(1)(i) and (6)(i)”
“1.401(k)-2(b)(1)(i) and (6)(i)”

§ 54.4979-1(c)(2)
“1.401(k)-1(f)(3)(ii) and (4)(v)”
“1.401(k)-2(b)(3)(ii) and (2)(vi)”

§ 54.4979-1(c)(2)
“1.401(m)-1(e)(3)(v)”
“1.401(m)-2(b)(2)(vi)”

§ 54.4979-1(c)(3)
“1.401(k)-1(f)(4)(ii)”
“1.401(k)-2(b)(2)(iv)”

§ 54.4979-1(c)(3)
“1.401(m)-1(e)(3)(ii)”
“1.401(m)-2(b)(2)(iv)”

Par. 3.
In § 1.410(b)-3, paragraph (a)(2)(i) is revised to read a follows:

§ 1.410(b)-3
Employees and former employees who benefit under a plan.
(a) * * *

(2)
Exceptions to allocation or accrual requirement
—(i)
Section 401(k) and 401(m) plans.
Notwithstanding paragraph (a)(1) of this section, an employee is treated as benefiting under a section 401(k) plan for a plan year if and only if the employee is an eligible employee as defined in § 1.401(k)-6 under the plan. Similarly, an employee is treated as benefiting under a section 401(m) plan for a plan year if and only if the employee is an eligible employee as defined in § 1.401(m)-5 under the plan for the plan year.

Par. 4.
Sections 1.401(k)-0 and 1.401(k)-1 are revised and §§ 1.401(k)-2 through 1.401(k)-6 are added to read as follows:

§ 1.401(k)-0
Table of contents.
This section contains first a list of section headings and then a list of the paragraphs in each section in §§ 1.401(k)-1 through 1.401(k)-6.

List of Sections

§ 1.401(k)-1 Certain cash or deferred arrangements.

§ 1.401(k)-2 ADP test.

§ 1.401(k)-3 Safe harbor requirements.

§ 1.401(k)-4 SIMPLE 401(k) plan requirements.

§ 1.401(k)-5 Special rules for mergers, acquisitions and similar events. [Reserved]

§ 1.401(k)-6 Definitions.

List of Paragraphs

§ 1.401(k)-1
Certain cash or deferred arrangements.

(a) General rules.

(1) Certain plans permitted to include cash or deferred arrangements.

(2) Rules applicable to cash or deferred arrangements generally.

(i) Definition of cash or deferred arrangement.

(ii) Treatment of after-tax employee contributions.

(iii) Treatment of ESOP dividend election.

(iv) Treatment of elective contributions as plan assets.

(3) Rules applicable to cash or deferred elections generally.

(i) Definition of cash or deferred election.

(ii) Automatic enrollment.

(iii) Rules related to timing.

(A) Requirement that amounts not be currently available.

(B) Contribution may not precede election.

(C) Contribution may not precede services.

(iv) Current availability defined.

(v) Certain one-time elections not treated as cash or deferred elections.

(vi) Tax treatment of employees.

(vii) Examples.

(4) Rules applicable to qualified cash or deferred arrangements.

(i) Definition of qualified cash or deferred arrangement.

(ii) Treatment of elective contributions as employer contributions.

(iii) Tax treatment of employees.

(iv) Application of nondiscrimination requirements to plan that includes a qualified cash or deferred arrangement.

(A) Exclusive means of amounts testing.

(B) Testing benefits, rights and features.

(C) Minimum coverage requirement.

(5) Rules applicable to nonqualified cash or deferred arrangements.

(i) Definition of nonqualified cash or deferred arrangement.

(ii) Treatment of elective contributions as nonelective contributions.

(iii) Tax treatment of employees.

(iv) Qualification of plan that includes a nonqualified cash or deferred arrangement.

(A) In general.

(B) Application of section 401(a)(4) to certain plans.

(v) Example.

(6) Rules applicable to cash or deferred arrangements of self-employed individuals.

(i) Application of general rules.

(ii) Treatment of matching contributions made on behalf of self-employed individuals.

(iii) Timing of self-employed individual's cash or deferred election.

(iv) Special rule for certain payments to self-employed individuals.

(b) Coverage and nondiscrimination requirements.

(1) In general.

(2) Automatic satisfaction by certain plans.

(3) Anti-abuse provisions.

(4) Aggregation and restructuring.

(i) In general.

(ii) Aggregation of cash or deferred arrangements within a plan.

(iii) Aggregation of plans.

(A) In general.

(B) Plans with inconsistent ADP testing methods.

(iv) Disaggregation of plans and separate testing.

(A) In general.

(B) Restructuring prohibited.

(v) Modifications to section 410(b) rules.

(A) Certain disaggregation rules not applicable.

(B) Permissive aggregation of collective bargaining units.

(C) Multiemployer plans.

(vi) Examples.

(c) Nonforfeitability requirements.

(1) General rule.

(2) Definition of immediately nonforfeitable.

(3) Example.

(d) Distribution limitation.

(1) General rule.

(2) Rules applicable to distributions upon severance from employment.

(3) Rules applicable to hardship distributions.

(i) Distribution must be on account of hardship.

(ii) Limit on maximum distributable amount.

(A) General rule.

(B) Grandfathered amounts.

(iii) Immediate and heavy financial need.

(A) In general.

(B) Deemed immediate and heavy financial need.

(iv) Distribution necessary to satisfy financial need.

(A) Distribution may not exceed amount of need.

(B) No alternative means available.

(C) Employer reliance on employee representation.

(D) Employee need not take counterproductive actions.

(E) Distribution deemed necessary to satisfy immediate and heavy financial need.

(F) Definition of other plans.

(v) Commissioner may expand standards.

(4) Rules applicable to distributions upon plan termination.

(i) No alternative defined contribution plan.

(ii) Lump sum requirement for certain distributions.

(5) Rules applicable to all distributions.

(i) Exclusive distribution rules.

(ii) Deemed distributions.

(iii) ESOP dividend distributions.

(iv) Limitations apply after transfer.

(6) Examples.

(e) Additional requirements for qualified cash or deferred arrangements.

(1) Qualified plan requirement.

(2) Election requirements.

(i) Cash must be available.

(ii) Frequency of elections.

(3) Separate accounting requirement.

(i) General rule.

(ii) Satisfaction of separate accounting requirement.

(4) Limitations on cash or deferred arrangements of state and local governments.

(i) General rule.

(ii) Rural cooperative plans and Indian tribal governments.

(iii) Adoption after May 6, 1986.

(iv) Adoption before May 7, 1986.

(5) One-year eligibility requirement.

(6) Other benefits not contingent upon elective contributions.

(i) General rule.

(ii) Definition of other benefits.

(iii) Effect of certain statutory limits.

(iv) Nonqualified deferred compensation.

(v) Plan loans and distributions.

(vi) Examples.

(7) Plan provision requirement.

(f) Special rules for designated Roth contributions. [Reserved]

(g) Effective dates.

(1) General rule.

(2) Early implementation permitted.

(3) Collectively bargained plans.

(4) Applicability of prior regulations.

§ 1.401(k)-2 ADP Test

(a) Actual deferral percentage (ADP) Test.

(1) In general.

(i) ADP test formula.

(ii) HCEs as sole eligible employees.

(iii) Special rule for early participation.

(2) Determination of ADP.

(i) General rule.

(ii) Determination of applicable year under current year and prior year testing method.

(3) Determination of ADR.

(i) General rule.

(ii) ADR of HCEs eligible under more than one arrangement.

(A) General rule.

(B) Plans not permitted to be aggregated.

(iii) Examples.

(4) Elective contributions taken into account under the ADP test.

(i) General rule.

(ii) Elective contributions for partners and self-employed individuals.

(iii) Elective contributions for HCEs.

(5) Elective contributions not taken into account under the ADP test.

(i) General rule.

(ii) Elective contributions for NHCEs.

(iii) Elective contributions treated as catch-up contributions.

(v) Additional elective contributions pursuant to section 414(u).

(iv) Elective contributions used to satisfy the ACP test.

(6) Qualified nonelective contributions and qualified matching contributions that may be taken into account under the ADP test.

(i) Timing of allocation.

(ii) Requirement that amount satisfy section 401(a)(4).

(iii) Aggregation must be permitted.

(iv) Disporportionate contributions not taken into account.

(A) General rule.

(B) Definition of representative contribution rate.

(C) Definition of applicable contribution rate.

(D) Special rule for prevailing wage contributions.

(v) Qualified matching contributions.

(vi) Contributions only used once.

(7) Examples.

(b) Correction of excess contributions.

(1) Permissible correction methods.

(i) In general.

(A) Qualified nonelective contributions or qualified matching contributions.

(B) Excess contributions distributed.

(C) Excess contributions recharacterized.

(ii) Combination of correction methods.

(iii) Exclusive means of correction.

(2) Corrections through distribution.

(i) General rule.

(ii) Calculation of total amount to be distributed.

(A) Calculate the dollar amount of excess contributions for each HCE.

(B) Determination of the total amount of excess contributions.

(C) Satisfaction of ADP.

(iii) Apportionment of total amount of excess contributions among the HCEs.

(A) Calculate the dollar amount of excess contributions for each HCE.

(B) Limit on amount apportioned to any individual.

(C) Apportionment to additional HCEs.

(iv) Income allocable to excess contributions.

(A) General rule.

(B) Method of allocating income.

(C) Alternative method of allocating plan year income.

(D) Safe harbor method of allocating gap period income.

(E) Alternative method for allocating plan year and gap period income.

(v) Distribution.

(vi) Tax treatment of corrective distributions.

(A) General rule.

(B) Rule for
de minimis
distributions.

(vii) Other rules.

(A) No employee or spousal consent required.

(B) Treatment of corrective distributions as elective contributions.

(C) No reduction of required minimum distribution.

(D) Partial distributions.

(viii) Examples.

(3) Recharacterization of excess contributions.

(i) General rule.

(ii) Treatment of recharacterized excess contributions.

(iii) Additional rules.

(A) Time of recharacterization.

(B) Employee contributions must be permitted under plan.

(C) Treatment of recharacterized excess contributions.

(4) Rules applicable to all corrections.

(i) Coordination with distribution of excess deferrals.

(A) Treatment of excess deferrals that reduce excess contributions.

(B) Treatment of excess contributions that reduce excess deferrals.

(ii) Forfeiture of match on distributed excess contributions.

(iii) Permitted forfeiture of QMAC.

(iv) No requirement for recalculation.

(v) Treatment of excess contributions that are catch-up contributions.

(5) Failure to timely correct.

(i) Failure to correct within 2
1/2
months after end of plan year.

(ii) Failure to correct within 12 months after end of plan year.

(c) Additional rules for prior year testing method.

(1) Rules for change in testing method.

(i) General rule.

(ii) Situations permitting a change to the prior year testing method.

(2) Calculation of ADP under the prior year testing method for the first plan year.

(i) Plans that are not successor plans.

(ii) First plan year defined.

(iii) Successor plans.

(3) Plans using different testing methods for the ADP and ACP test.

(4) Rules for plan coverage changes.

(i) In general.

(ii) Optional rule for minor plan coverage changes.

(iii) Definitions.

(A) Plan coverage change.

(B) Prior year subgroup.

(C) Weighted average of the ADPs for the prior year subgroups.

(iv) Examples.

§ 1.401(k)-3 Safe harbor requirements

(a) ADP test safe harbor.

(b) Safe harbor nonelective contribution requirement.

(1) General rule.

(2) Safe harbor compensation defined.

(c) Safe harbor matching contribution requirement.

(1) In general.

(2) Basic matching formula.

(3) Enhanced matching formula.

(4) Limitation on HCE matching contributions.

(5) Use of safe harbor match not precluded by certain plan provisions.

(i) Safe harbor matching contributions on employee contributions.

(ii) Periodic matching contributions.

(6) Permissible restrictions on elective contributions by NHCEs.

(i) General rule.

(ii) Restrictions on election periods.

(iii) Restrictions on amount of elective contributions.

(iv) Restrictions on types of compensation that may be deferred.

(v) Restrictions due to limitations under the Internal Revenue Code.

(7) Examples.

(d) Notice requirement.

(1) General rule.

(2) Content requirement.

(i) General rule.

(ii) Minimum content requirement.

(iii) References to SPD.

(3) Timing requirement.

(i) General rule.

(ii) Deemed satisfaction of timing requirement.

(e) Plan year requirement.

(1) General rule.

(2) Initial plan year.

(3) Change of plan year.

(4) Final plan year.

(f) Plan amendments adopting safe harbor nonelective contributions.

(1) General rule.

(2) Contingent notice provided.

(3) Follow-up notice requirement.

(g) Permissible reduction or suspension of safe harbor matching contributions.

(1) General rule.

(2) Notice of suspension requirement.

(h) Additional rules.

(1) Contributions taken into account.

(2) Use of safe harbor nonelective contributions to satisfy other nondiscrimination tests.

(3) Early participation rules.

(4) Satisfying safe harbor contribution requirement under another defined contribution plan.

(5) Contributions used only once.

§ 1.401(k)-4 SIMPLE 401(k) Plan Requirements

(a) General rule.

(b) Eligible employer.

(1) General rule.

(2) Special rule.

(c) Exclusive plan.

(1) General rule.

(2) Special rule.

(d) Election and notice.

(1) General rule.

(2) Employee elections.

(i) Initial plan year of participation.

(ii) Subsequent plan years.

(iii) Election to terminate.

(3) Employee notices.

(e) Contributions.

(1) General rule.

(2) Elective contributions.

(3) Matching contributions.

(4) Nonelective contributions.

(5) SIMPLE compensation.

(f) Vesting.

(g) Plan year.

(h) Other rules.

§ 1.401(k)-5 Special Rules for Mergers, Acquisitions and Similar Events. [Reserved]

§ 1.401(k)-6 Definitions.

§ 1.401(k)-1
Certain cash or deferred arrangements.

(a)
General rules
—(1)
Certain plans permitted to include cash or deferred arrangements.
A plan, other than a profit-sharing, stock bonus, pre-ERISA money purchase pension, or rural cooperative plan, does not satisfy the requirements of section 401(a) if the plan includes a cash or deferred arrangement. A profit-sharing, stock bonus, pre-ERISA money purchase pension, or rural cooperative plan does not fail to satisfy the requirements of section 401(a) merely because the plan includes a cash or deferred arrangement. A cash or deferred arrangement is part of a plan for purposes of this section if any contributions to the plan, or accruals or other benefits under the plan, are made or provided pursuant to the cash or deferred arrangement.

(2)
Rules applicable to cash or deferred arrangements generally
—(i)
Definition of cash or deferred arrangement.
Except as provided in paragraphs (a)(2)(ii) and (iii) of this section, a cash or deferred arrangement is an arrangement under which an eligible employee may make a cash or deferred election with respect to contributions to, or accruals or other benefits under, a plan that is intended to satisfy the requirements of section 401(a) (including a contract that is intended to satisfy the requirements of section 403(a)).

(ii)
Treatment of after-tax employee contributions.
A cash or deferred arrangement does not include an arrangement under which amounts contributed under a plan at an employee's election are designated or treated at the time of contribution as after-tax employee contributions (
e.g.
, by treating the contributions as taxable income subject to applicable withholding requirements).
See also
section 414(h)(1). A designated Roth contribution, however, is not treated as an after-tax contribution for purposes of this section, § 1.401(k)-2 through § 1.401(k)-6 and § 1.401(m)-1 through § 1.401(m)-5. A contribution can be an after-tax employee contribution under the rule of this paragraph (a)(2)(ii) even if the employee's election to make after-

tax employee contributions is made before the amounts subject to the election are currently available to the employee.

(iii)
Treatment of ESOP dividend election.
A cash or deferred arrangement does not include an arrangement under an ESOP under which dividends are either distributed or invested pursuant to an election made by participants or their beneficiaries in accordance with section 404(k)(2)(A)(iii).

(iv)
Treatment of elective contributions as plan assets.
The extent to which elective contributions constitute plan assets for purposes of the prohibited transaction provisions of section 4975 and Title I of the Employee Retirement Income Security Act of 1974 (88 Stat. 829), Public Law 93-406, is determined in accordance with regulations and rulings issued by the Department of Labor.
See
29 CFR 2510.3-102.

(3)
Rules applicable to cash or deferred elections generally
—(i)
Definition of cash or deferred election.
A cash or deferred election is any direct or indirect election (or modification of an earlier election) by an employee to have the employer either—

(A) Provide an amount to the employee in the form of cash (or some other taxable benefit) that is not currently available; or

(B) Contribute an amount to a trust, or provide an accrual or other benefit, under a plan deferring the receipt of compensation.

(ii)
Automatic enrollment.
For purposes of determining whether an election is a cash or deferred election, it is irrelevant whether the default that applies in the absence of an affirmative election is described in paragraph (a)(3)(i)(A) of this section (
i.e.
, the employee receives an amount in cash or some other taxable benefit) or in paragraph (a)(3)(i)(B) of this section (
i.e.
, the employer contributes an amount to a trust or provides an accrual or other benefit under a plan deferring the receipt of compensation).

(iii)
Rules related to timing
—(A)
Requirement that amounts not be currently available.
A cash or deferred election can only be made with respect to an amount that is not currently available to the employee on the date of the election. Further, a cash or deferred election can only be made with respect to amounts that would (but for the cash or deferred election) become currently available after the later of the date on which the employer adopts the cash or deferred arrangement or the date on which the arrangement first becomes effective.

(B)
Contribution may not precede election.
A contribution is made pursuant to a cash or deferred election only if the contribution is made after the election is made.

(C)
Contribution may not precede services
—(
1
)
General rule.
Contributions are made pursuant to a cash or deferred election only if the contributions are made after the employee's performance of service with respect to which the contributions are made (or when the cash or other taxable benefit would be currently available, if earlier).

(
2
)
Exception for bona fide administrative considerations.
The timing of contributions will not be treated as failing to satisfy the requirements of this paragraph (a)(3)(iii)(C) merely because contributions for a pay period are occasionally made before the services with respect to that pay period are performed, provided the contributions are made early in order to accommodate bona fide administrative considerations (for example, the temporary absence of the bookkeeper with responsibility to transmit contributions to the plan) and are not paid early with a principal purpose of accelerating deductions.

(iv)
Current availability defined.
Cash or another taxable benefit is currently available to the employee if it has been paid to the employee or if the employee is able currently to receive the cash or other taxable benefit at the employee's discretion. An amount is not currently available to an employee if there is a significant limitation or restriction on the employee's right to receive the amount currently. Similarly, an amount is not currently available as of a date if the employee may under no circumstances receive the amount before a particular time in the future. The determination of whether an amount is currently available to an employee does not depend on whether it has been constructively received by the employee for purposes of section 451.

(v)
Certain one-time elections not treated as cash or deferred elections.
A cash or deferred election does not include a one-time irrevocable election made no later than the employee's first becoming eligible under the plan or any other plan or arrangement of the employer that is described in section 219(g)(5)(A) (whether or not such other plan or arrangement has terminated), to have contributions equal to a specified amount or percentage of the employee's compensation (including no amount of compensation) made by the employer on the employee's behalf to the plan and a specified amount or percentage of the employee's compensation (including no amount of compensation) divided among all other plans or arrangements of the employer (including plans or arrangements not yet established) for the duration of the employee's employment with the employer, or in the case of a defined benefit plan to receive accruals or other benefits (including no benefits) under such plans. Thus, for example, employer contributions made pursuant to a one-time irrevocable election described in this paragraph are not treated as having been made pursuant to a cash or deferred election and are not includible in an employee's gross income by reason of § 1.402(a)-1(d). In the case of an irrevocable election made on or before December 23, 1994—

(A) The election does not fail to be treated as a one-time irrevocable election under this paragraph (a)(3)(v) merely because an employee was previously eligible under another plan of the employer (whether or not such other plan has terminated); and

(B) In the case of a plan in which partners may participate, the election does not fail to be treated as a one-time irrevocable election under this paragraph (a)(3)(v) merely because the election was made after commencement of employment or after the employee's first becoming eligible under any plan of the employer, provided that the election was made before the first day of the first plan year beginning after December 31, 1988, or, if later, March 31,1989.

(vi)
Tax treatment of employees.
An amount generally is includible in an employee's gross income for the taxable year in which the employee actually or constructively receives the amount. But for section 402(e)(3), an employee is treated as having received an amount that is contributed to an exempt trust or plan described in section 401(a) or 403(a) pursuant to the employee's cash or deferred election. This is the case even if the election to defer is made before the year in which the amount is earned, or before the amount is currently available.
See
§ 1.402(a)-1(d).

(vii)
Examples.
The following examples illustrate the application of this paragraph (a)(3):

Example 1.

(i) An employer maintains a profit-sharing plan under which each eligible employee has an election to defer an annual bonus payable on January 30 each year. The bonus equals 10% of compensation during the previous calendar year. Deferred amounts are not treated as after-tax employee contributions. The bonus is currently available on January 30.

(ii) An election made prior to January 30 to defer all or part of the bonus is a cash or deferred election, and the bonus deferral arrangement is a cash or deferred arrangement.

Example 2.

(i) An employer maintains a profit-sharing plan which provides for discretionary profit sharing contributions and under which each eligible employee may elect to reduce his compensation by up to 10% and to have the employer contribute such amount to the plan. The employer pays each employee every two weeks for services during the immediately preceding two weeks. The employee's election to defer compensation for a payroll period must be made prior to the date the amount would otherwise be paid. The employer contributes to the plan the amount of compensation that each employee elected to defer, at the time it would otherwise be paid to the employee, and does not treat the contribution as an after-tax employee contribution.

(ii) The election is a cash or deferred election and the contributions are elective contributions.

Example 3.

(i) The facts are the same as in
Example 2,
except that the employer makes a $10,000 contribution on January 31 of the plan year that is in addition to the contributions that satisfy the employer's obligation to make contributions with respect to cash or deferred elections for prior payroll periods. Employee A makes an election on February 15 to defer $2,000 from compensation that is not currently available and the employer reduces the employee's compensation to reflect the election.

(ii) None of the additional $10,000 contributed January 31 is a contribution made pursuant to Employee A's cash or deferred election, because the contribution was made before the election was made. Accordingly, the employer must make an additional contribution of $2,000 in order to satisfy its obligation to contribute an amount to the plan pursuant to Employee A's election. The $10,000 contribution may be allocated under the plan terms providing for discretionary profit sharing contributions.

Example 4.

(i) The facts are the same as in
Example 3,
except that Employee A had an outstanding election to defer $500 from each payroll period's compensation. The $10,000 additional payment that is contributed early is not made early in order to accommodate bona fide administrative considerations.

(ii) None of the additional $10,000 contributed January 31 is a contribution made pursuant to Employee A's cash or deferred election for future payroll periods, because the contribution was made before the earlier of Employee A's performance of services to which the contribution is attributable or when the compensation would be currently available. Furthermore, the exception for early contributions in paragraph (a)(3)(iii)(C)(
2
) of this section does not apply. Accordingly, the employer must make an additional contribution of $500 per payroll period in order to satisfy its obligation to contribute an amount to the plan pursuant to Employee A's election. The $10,000 contribution may be allocated under the plan terms providing for discretionary profit sharing contributions.

Example 5.

(i) Employer B establishes a money purchase pension plan in 1986. This is the first qualified plan established by Employer B. All salaried employees are eligible to participate under the plan. Hourly-paid employees are not eligible to participate under the plan. In 2000, Employer B establishes a profit-sharing plan under which all employees (both salaried and hourly) are eligible. Employer B permits all employees on the effective date of the profit-sharing plan to make a one-time irrevocable election to have Employer B contribute 5% of compensation on their behalf to the plan and make no other contribution to any other plan of Employer B (including plans not yet established) for the duration of the employee's employment with Employer B, and have their salaries reduced by 5%.

(ii) The election provided under the profit-sharing plan is not a one-time irrevocable election within the meaning of paragraph (a)(3)(v) of this section with respect to the salaried employees of Employer B who, before becoming eligible to participate under the profit-sharing plan, became eligible to participate under the money purchase pension plan. The election under the profit-sharing plan is a one-time irrevocable election within the meaning of paragraph (a)(3)(v) of this section with respect to the hourly employees, because they were not previously eligible to participate under another plan of the employer.

(4)
Rules applicable to qualified cash or deferred arrangements
—(i)
Definition of qualified cash or deferred arrangement.
A qualified cash or deferred arrangement is a cash or deferred arrangement that satisfies the requirements of paragraphs (b), (c), (d), and (e) of this section.

(ii)
Treatment of elective contributions as employer contributions.
Except as otherwise provided in § 1.401(k)-2(b)(3), elective contributions under a qualified cash or deferred arrangement (including designated Roth contributions) are treated as employer contributions. Thus, for example, elective contributions under such an arrangement are treated as employer contributions for purposes of sections 401(a), 401(k), 402, 404, 409, 411, 412, 415, 416, and 417.

(iii)
Tax treatment of employees.
Except as provided in section 402(g), 402A (effective for taxable years beginning after December 31, 2005), or § 1.401(k)-2(b)(3), elective contributions under a qualified cash or deferred arrangement are neither includible in an employee's gross income at the time the cash would have been includible in the employee's gross income (but for the cash or deferred election), nor at the time the elective contributions are contributed to the plan.
See
§ 1.402(a)-1(d)(2)(i).

(iv)
Application of nondiscrimination requirements to plan that includes a qualified cash or deferred arrangement
—(A)
Exclusive means of amounts testing.
Elective contributions (including elective contributions that are designated Roth contributions) under a qualified cash or deferred arrangement satisfy the requirements of section 401(a)(4) with respect to amounts if and only if the amount of elective contributions satisfies the nondiscrimination test of section 401(k) under paragraph (b)(1) of this section.
See
§ 1.401(a)(4)-1(b)(2)(ii)(B).

(B)
Testing benefits, rights and features.
A plan that includes a qualified cash or deferred arrangement must satisfy the requirements of section 401(a)(4) with respect to benefits, rights and features in addition to the requirements regarding amounts described in paragraph (a)(4)(iv)(A) of this section. For example, the right to make each level of elective contributions under a cash or deferred arrangement and the right to make designated Roth contributions are rights or features subject to the requirements of section 401(a)(4).
See
§ 1.401(a)(4)-4(e)(3)(i) and (iii)(D). Thus, for example, if all employees are eligible to make a stated level of elective contributions under a cash or deferred arrangement, but that level of contributions can only be made from compensation in excess of a stated amount, such as the Social Security taxable wage base, the arrangement will generally favor HCEs with respect to the availability of elective contributions and thus will generally not satisfy the requirements of section 401(a)(4).

(C)
Minimum coverage requirement.
A qualified cash or deferred arrangement is treated as a separate plan that must satisfy the requirements of section 410(b).
See
§ 1.410(b)-7(c)(1) for special rules. The determination of whether a cash or deferred arrangement satisfies the requirements of section 410(b) must be made without regard to the modifications to the disaggregation rules set forth in paragraph (b)(4)(v) of this section.
See also
§ 1.401(a)(4)-11(g)(3)(vii)(A), relating to corrective amendments that may be made to satisfy the minimum coverage requirements of section 410(b).

(5)
Rules applicable to nonqualified cash or deferred arrangements
—(i)
Definition of nonqualified cash or deferred arrangement.
A nonqualified cash or deferred arrangement is a cash or deferred arrangement that fails to satisfy one or more of the requirements in paragraph (b), (c), (d) or (e) of this section.

(ii)
Treatment of elective contributions as nonelective contributions.
Except as specifically provided otherwise, elective contributions under a nonqualified cash or deferred arrangement are treated as nonelective employer contributions. Thus, for example, the elective

contributions under such an arrangement are treated as nonelective employer contributions for purposes of sections 401(a) (including section 401(a)(4)) and 401(k), 404, 409, 411, 412, 415, 416, and 417 and are not subject to the requirements of section 401(m).

(iii)
Tax treatment of employees.
Elective contributions under a nonqualified cash or deferred arrangement are includible in an employee's gross income at the time the cash or other taxable amount that the employee would have received (but for the cash or deferred election) would have been includible in the employee's gross income.
See
§ 1.402(a)-1(d)(1).

(iv)
Qualification of plan that includes a nonqualified cash or deferred arrangement
— (A)
In general.
A profit-sharing, stock bonus, pre-ERISA money purchase pension, or rural cooperative plan does not fail to satisfy the requirements of section 401(a) merely because the plan includes a nonqualified cash or deferred arrangement. In determining whether the plan satisfies the requirements of section 401(a)(4), the nondiscrimination tests of sections 401(k), paragraph (b)(1) of this section, section 401(m)(2) and § 1.401(m)-1(b) may not be used.
See
§§ 1.401(a)(4)-1(b)(2)(ii)(B) and 1.410(b)-9 (definition of section 401(k) plan).

(B)
Application of section 401(a)(4) to certain plans.
The amount of employer contributions under a nonqualified cash or deferred arrangement is treated as satisfying section 401(a)(4) if the arrangement is part of a collectively bargained plan that automatically satisfies the requirements of section 410(b).
See
§§ 1.401(a)(4)-(c)(5) and 1.410(b)-2(b)(7). Additionally, the requirements of sections 401(a)(4) and 410(b) do not apply to a governmental plan (within the meaning of section 414(d)) maintained by a State or local government or political subdivision thereof (or agency or instrumentality thereof).
See
sections 401(a)(5) and 410(c)(1)(A).

(v)
Example.
The following example illustrates the application of this paragraph (a)(5):

Example.

(i) For the 2006 plan year, Employer A maintains a collectively bargained plan that includes a cash or deferred arrangement. Employer contributions under the cash or deferred arrangement do not satisfy the nondiscrimination test of section 401(k) and paragraph (b) of this section.

(ii) The arrangement is a nonqualified cash or deferred arrangement. The employer contributions under the cash or deferred arrangement are considered to be nondiscriminatory under section 401(a)(4), and the elective contributions are generally treated as employer contributions under paragraph (a)(5)(ii) of this section. Under paragraph (a)(5)(iii) of this section and under § 1.402(a)-1(d)(1), however, the elective contributions are includible in each employee's gross income.

(6)
Rules applicable to cash or deferred arrangements of self-employed individuals
—(i)
Application of general rules.
Generally, a partnership or sole proprietorship is permitted to maintain a cash or deferred arrangement, and individual partners or owners are permitted to make cash or deferred elections with respect to compensation attributable to services rendered to the entity, under the same rules that apply to other cash or deferred arrangements. For example, any contributions made on behalf of an individual partner or owner pursuant to a cash or deferred arrangement of a partnership or sole proprietorship are elective contributions unless they are designated or treated as after-tax employee contributions. In the case of a partnership, a cash or deferred arrangement includes any arrangement that directly or indirectly permits individual partners to vary the amount of contributions made on their behalf. Consistent with § 1.402(a)-1(d), the elective contributions under such an arrangement are includible in income and are not deductible under section 404(a) unless the arrangement is a qualified cash or deferred arrangement (
i.e.
, the requirements of section 401(k) and this section are satisfied). Also, even if the arrangement is a qualified cash or deferred arrangement, the elective contributions are includible in gross income and are not deductible under section 404(a) to the extent they exceed the applicable limit under section 402(g).
See also
§ 1.401(a)-30.

(ii)
Treatment of matching contributions made on behalf of self-employed individuals.
Under section 402(g)(8), matching contributions made on behalf of a self-employed individual are not treated as elective contributions made pursuant to a cash or deferred election, without regard to whether such matching contributions indirectly permit individual partners to vary the amount of contributions made on their behalf.

(iii)
Timing of self-employed individual's cash or deferred election.
For purposes of paragraph (a)(3)(iv) of this section, a partner's compensation is deemed currently available on the last day of the partnership taxable year and a sole proprietor's compensation is deemed currently available on the last day of the individual's taxable year. Accordingly, a self-employed individual may not make a cash or deferred election with respect to compensation for a partnership or sole proprietorship taxable year after the last day of that year. See § 1.401(k)-2(a)(4)(ii) for the rules regarding when these contributions are treated as allocated.

(iv)
Special rule for certain payments to self-employed individuals.
For purposes of sections 401(k) and 401(m), the earned income of a self-employed individual for a taxable year constitutes payment for services during that year. Thus, for example, if a partnership provides for cash advance payments during the taxable year to be made to a partner based on the value of the partner's services prior to the date of payment (and which do not exceed a reasonable estimate of the partner's earned income for the taxable year), a contribution of a portion of these payments to a profit sharing plan in accordance with an election to defer the portion of the advance payments does not fail to be made pursuant to a cash or deferred election within the meaning of paragraph (a)(3)(iii) of this section merely because the contribution is made before the amount of the partner's earned income is finally determined and reported. However, see § 1.401(k)-2(a)(4)(ii) for rules on when earned income is treated as received.

(b)
Coverage and nondiscrimination requirements
—(1)
In general.
A cash or deferred arrangement satisfies this paragraph (b) for a plan year only if—

(i) The group of eligible employees under the cash or deferred arrangement (including any employees taken into account for purposes of section 410(b) pursuant to § 1.401(a)(4)-11(g)(3)(vii)(A)) satisfies the requirements of section 410(b) (including the average benefit percentage test, if applicable); and

(ii) The cash or deferred arrangement satisfies—

(A) The ADP test of section 401(k)(3) described in § 1.401(k)-2;

(B) The ADP safe harbor provisions of section 401(k)(12) described in § 1.401(k)-3; or

(C) The SIMPLE 401(k) provisions of section 401(k)(11) described in § 1.401(k)-4.

(2)
Automatic satisfaction by certain plans.
Notwithstanding paragraph (b)(1) of this section, a governmental plan (within the meaning of section 414(d)) maintained by a State or local government or political subdivision thereof (or agency or instrumentality thereof) shall be treated as meeting the requirements of this paragraph (b).

(3)
Anti-abuse provisions.
This section and §§ 1.401(k)-2 through 1.401(k)-6 are designed to provide simple, practical rules that

accommodate legitimate plan changes. At the same time, the rules are intended to be applied by employers in a manner that does not make use of changes in plan testing procedures or other plan provisions to inflate inappropriately the ADP for NHCEs (which is used as a benchmark for testing the ADP for HCEs) or to otherwise manipulate the nondiscrimination testing requirements of this paragraph (b). Further, this paragraph (b) is part of the overall requirement that benefits or contributions not discriminate in favor of HCEs. Therefore, a plan will not be treated as satisfying the requirements of this paragraph (b) if there are repeated changes to plan testing procedures or plan provisions that have the effect of distorting the ADP so as to increase significantly the permitted ADP for HCEs, or otherwise manipulate the nondiscrimination rules of this paragraph, if a principal purpose of the changes was to achieve such a result.

(4)
Aggregation and restructuring
—(i)
In general.
This paragraph (b)(4) contains the exclusive rules for aggregating and disaggregating plans and cash or deferred arrangements for purposes of this section, and §§ 1.401(k)-2 through 1.401(k)-6.

(ii)
Aggregation of cash or deferred arrangements within a plan.
Except as otherwise specifically provided in this paragraph (b)(4), all cash or deferred arrangements included in a plan are treated as a single cash or deferred arrangement and a plan must apply a single test under paragraph (b)(1)(ii) of this section with respect to all such arrangements within the plan. Thus, for example, if two groups of employees are eligible for separate cash or deferred arrangements under the same plan, all contributions under both cash or deferred arrangements must be treated as made under a single cash or deferred arrangement subject to a single test, even if they have significantly different features, such as different limits on elective contributions.

(iii)
Aggregation of plans
—(A)
In general.
For purposes of this section and §§ 1.401(k)-2 through 1.401(k)-6, the term
plan
means a plan within the meaning of § 1.410(b)-7(a) and (b), after application of the mandatory disaggregation rules of § 1.410(b)-7(c), and the permissive aggregation rules of § 1.410(b)-7(d), as modified by paragraph (b)(4)(v) of this section. Thus, for example, two plans (within the meaning of § 1.410(b)-7(b)) that are treated as a single plan pursuant to the permissive aggregation rules of § 1.410(b)-7(d) are treated as a single plan for purposes of sections 401(k) and (m).

(B)
Plans with inconsistent ADP testing methods.
Pursuant to paragraph (b)(4)(ii) of this section, a single testing method must apply with respect to all cash or deferred arrangements under a plan. Thus, in applying the permissive aggregation rules of § 1.410(b)-7(d), an employer may not aggregate plans (within the meaning of § 1.410(b)-7(b)) that apply inconsistent testing methods. For example, a plan (within the meaning of § 1.410(b)-7(b)) that applies the current year testing method may not be aggregated with another plan that applies the prior year testing method. Similarly, an employer may not aggregate a plan (within the meaning of § 1.410(b)-7(b)) using the ADP safe harbor provisions of section 401(k)(12) and another plan that is using the ADP test of section 401(k)(3).

(iv)
Disaggregation of plans and separate testing
—(A)
In general.
If a cash or deferred arrangement is included in a plan (within the meaning of § 1.410(b)-7(b)) that is mandatorily disaggregated under the rules of section 410(b) (as modified by this paragraph (b)(4)), the cash or deferred arrangement must be disaggregated in a consistent manner. For example, in the case of an employer that is treated as operating qualified separate lines of business under section 414(r), if the eligible employees under a cash or deferred arrangement are in more than one qualified separate line of business, only those employees within each qualified separate line of business may be taken into account in determining whether each disaggregated portion of the plan complies with the requirements of section 401(k), unless the employer is applying the special rule for employer-wide plans in § 1.414(r)-1(c)(2)(ii) with respect to the plan. Similarly, if a cash or deferred arrangement under which employees are permitted to participate before they have completed the minimum age and service requirements of section 410(a)(1) applies section 410(b)(4)(B) for determining whether the plan complies with section 410(b)(1), then the arrangement must be treated as two separate arrangements, one comprising all eligible employees who have met the age and service requirements of section 410(a)(1) and one comprising all eligible employees who have not met the age and service requirements under section 410(a)(1), unless the plan is using the rule in § 1.401(k)-2(a)(1)(iii)(A).

(B)
Restructuring prohibited.
Restructuring under § 1.401(a)(4)-9(c) may not be used to demonstrate compliance with the requirements of section 401(k).
See
§ 1.401(a)(4)-9(c)(3)(ii).

(v)
Modifications to section 410(b) rules
—(A)
Certain disaggregation rules not applicable.
The mandatory disaggregation rules relating to section 401(k) plans and section 401(m) plans set forth in § 1.410(b)-7(c)(1) and ESOP and non-ESOP portions of a plan set forth in § 1.410(b)-7(c)(2) shall not apply for purposes of this section an

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A04-28011. Public record. Not legal advice.