Limitation on Annual Compensation for Qualified Plans

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8547]

RIN 1545-AR54

Limitation on Annual Compensation for Qualified Plans

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to the

compensation limit for tax-qualified retirement plans under section

401(a)(17) of the Internal Revenue Code of 1986. These regulations

reflect changes made by the Tax Reform Act of 1986, the Technical and

Miscellaneous Revenue Act of 1988, and the Omnibus Budget

Reconciliation Act of 1993. These regulations provide guidance

necessary to comply with the law and affect sponsors of, and

participants in, tax-qualified retirement plans.

DATES: These regulations are effective January 1, 1994, and apply to

plan years beginning on or after January 1, 1994, except as otherwise

provided in Sec. 1.401(a)(17)-1(d).

FOR FURTHER INFORMATION CONTACT: Marjorie Hoffman at (202) 622-4606

(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On September 19, 1991, final regulations under section 401(a)(17)

(TD 8362) were published in the Federal Register (56 FR 47603). On

August 10, 1992, the IRS published in the Federal Register (57 FR

35536) regulations proposing to extend the effective date of the final

regulations under section 401(a)(17) (and related regulations),

generally to plan years beginning on or after January 1, 1994.

On December 30, 1993, proposed regulations under section 401(a)(17)

amending the final regulations were published in the Federal Register

(58 FR 69302). Written comments were received from the public on the

proposed regulations. Because the only request for a public hearing was

withdrawn, no public hearing was held. After considering all of the

written comments received, the proposed regulations are adopted as

modified by this Treasury decision.

Statutory Authority

This document contains amendments to the Income Tax Regulations (26

CFR Part 1) under section 401(a)(17) of the Internal Revenue Code

(Code). These regulations reflect the enactment of section 401(a)(17)

by section 1106 of the Tax Reform Act of 1986 (TRA '86), and subsequent

statutory changes made by section 1011(d)(4) of the Technical and

Miscellaneous Revenue Act of 1988 (TAMRA) and section 13212 of the

Omnibus Budget Reconciliation Act of 1993 (OBRA '93). These regulations

are issued under the authority contained in section 7805 of the Code.

Explanation of Provisions

1. Overview

Section 401(a)(17) of the Code provides an annual compensation

limit for each employee under a qualified plan. This limit applies to a

plan in two ways. First, a plan may not base contributions or benefits

on compensation in excess of the annual limit. Thus, a plan does not

satisfy section 401(a)(17) unless it provides that an employee's

compensation in excess of the annual limit is not used in determining

allocations or accruals for a plan year to which the annual limit

applies. Second, the amount of an employee's annual compensation that

may be taken into account in applying certain specified

nondiscrimination rules under the Code is subject to the annual

compensation limit. Thus, for example, an employee's compensation in

excess of the annual limit is disregarded in determining the accrual

rates for defined benefit plans under those nondiscrimination rules.

The annual compensation limit applies separately to each group of plans

that is treated as a single plan for purposes of the applicable

nondiscrimination requirement.

These final regulations adopt the provisions of the proposed

regulations with only minor modifications, as described below.

2. Changes Made by OBRA '93

a. Lower Limit

Prior to its amendment by OBRA '93, the annual compensation limit

was $200,000 adjusted for cost of living increases ($235,840 for 1993).

Section 401(a)(17) was amended by OBRA '93 to reduce the annual

compensation limit to $150,000 and to modify the manner in which cost

of living adjustments are made to the limit.

b. Annual Adjustment of Compensation Limit

Prior to the effective date of the OBRA '93 changes, the annual

compensation limit was increased annually based on the section 415 cost

of living adjustment. After the effective date of OBRA '93, the annual

compensation limit, as adjusted for changes in the cost of living, is

rounded down to the next lowest multiple of $10,000. Thus, the annual

compensation limit increases only when the cost of living adjustment

would increase the limit by an increment of at least $10,000. These

final regulations retain the rules in the September 1991 regulations

that any increase in the limit is effective for the plan year, or other

12-month period used to determine compensation, commencing in the

calendar year for which the limit is adjusted and that the increase

applies only to compensation for the year of the increase and

subsequent years that are used in determining an employee's benefit.

c. Proration of the Limit

These regulations retain the requirement in the September 1991

regulations that the annual compensation limit must be prorated if

compensation for a period of less than 12 months is used for a plan

year. However, in response to comments on the proposed regulations, the

final regulations clarify that no proration is required merely because

the amount of elective contributions, matching contributions, or

employee contributions that is contributed for each pay period during a

plan year is determined separately using compensation for that pay

period. For example, a section 401(k) plan provides each employee with

the right to elect to defer up to 6 percent of compensation for a plan

year, and then, in accordance with each employee's election for the

plan year, contributions are made monthly using the employee's

compensation for that pay period. Although the compensation for the

plan year that may be taken into account in determining each employee's

elective contributions is subject to the annual compensation limit, the

compensation for each month would not required to be limited to $12,500

(\1/12\ of $150,000) in this situation.

3. Effective Date and Transition Rules

Section 401(a)(17) is generally effective for plan years beginning

on or after January 1, 1989. The changes made by OBRA '93 are generally

effective for plan years beginning on or after January 1, 1994. Special

statutory effective dates are provided for collectively bargained

plans. In addition, OBRA '93 provides a special grandfather rule for

certain eligible participants in governmental plans.

These regulations under section 401(a)(17) are generally effective

at the same time that the reduced limit under OBRA '93 applies to the

plan. However, in the case of plans maintained by tax-exempt

organizations, the regulations are effective for plan years beginning

on or after January 1, 1996.

Minor modifications have been made to the examples in these

regulations to reflect the OBRA '93 statutory change, the change in the

effective date of the regulations from the date in the 1991

regulations, and an employer's choice of complying with the provisions

of these regulations prior to the effective date.

a. Fresh-Start Rules

The regulations retain the rule from the September 1991 regulations

that benefits accrued or allocations made under a plan for plan years

prior to the effective date of section 401(a)(17) are not subject to

the annual compensation limit. The regulations also retain the rule in

the proposed regulations that the benefits accrued or allocations made

under a plan for plan years prior to the effective date of the OBRA '93

changes are not subject to the reduced annual compensation limit.

In order to satisfy the requirements of section 401(a)(17), a

defined benefit plan must ``fresh start'' the benefits of all employees

with accrued benefits that are based on compensation that exceeded the

annual compensation limit. In order to implement the reduced limit

under OBRA '93, a defined benefit plan must again ``fresh start'' the

benefits of all employees with accrued benefits that are based on

compensation that exceeded the OBRA '93 $150,000 compensation limit.

As in the proposed regulations, these final regulations provide

guidance on the implementation of these and other multiple fresh starts

and coordinate the regulations with the fresh-start rules of the

section 401(a)(4) regulations. For example, the regulations continue to

cross-reference the section 401(a)(4) regulations for the definition of

an employee's frozen accrued benefit. Thus, an employee's frozen

accrued benefit as of the OBRA '93 effective date includes benefits

accrued as a result of an amendment made within the TRA '86 remedial

amendment period that is recognized under section 401(b) as effective

before the OBRA '93 effective date.

b. Amendments to Comply With Section 401(a)(17)

In conjunction with publishing these regulations under section

401(a)(17), the IRS issued Rev. Proc. 94-13, 1994-3 I.R.B. 18, dated

January 18, 1994. Rev. Proc. 94-13 provides guidance on the remedial

amendment treatment for plans being amended for section 401(a)(17),

including guidance on the conditions under which a plan may be amended

to comply retroactively with section 401(a)(17) even if the amendment

results in a reduction of a benefit protected under section 411(d)(6).

Rev. Proc. 94-13 also provides guidance on the extent to which section

204(h) of the Employee Retirement Income Security Act of 1974 (ERISA)

will not apply to a plan amendment that limits an employee's

compensation taken into account under the plan to the maximum permitted

under section 401(a)(17) of the Code.

Commentators requested that this guidance be incorporated into the

final regulations. The IRS and the Treasury believe these issues are

appropriately addressed in Rev. Proc. 94-13. The guidance under section

411(d)(6) in Rev. Proc. 94-13 is provided pursuant to the specific

delegation of authority in Sec. 1.411(d)-4, Q&A-2(b) to the

Commissioner to provide, through the publication of revenue rulings,

notices, and other documents of general applicability, for the

elimination or reduction of section 411(d)(6) protected benefits to the

extent that the reduction is necessary to permit compliance with the

other requirements of section 401(a). The guidance under section 204(h)

of ERISA is provided pursuant to the delegation of authority to the IRS

under section 101(a) of Reorganization Plan No. 4 of 1978 (1979-1 C.B.

480) to issue regulations, rulings, opinions, variances, and waivers

under section 204 of ERISA.

c. Application of $150,000 Limit to Accruals or Allocations in Plan

Years for Which OBRA '93 is Effective

One commentator suggested that the reduced limit should not apply

to compensation for years beginning before the OBRA '93 effective date

that is used in determining post-effective date benefit accruals. The

regulations, however, continue to provide that benefits accruing, or

allocations made, for plan years beginning on or after the OBRA '93

effective date may not take into account compensation for any year in

excess of the OBRA '93 annual compensation limit applicable to that

year (generally $150,000 for years beginning before the OBRA '93

effective date). Thus, compensation for any plan year before OBRA '93

applies to the plan that is used to determine benefits accruing in plan

years beginning on or after the OBRA '93 effective date is generally

limited to $150,000. In the absence of this rule, post-effective date

accruals under many defined benefit plans would be determined taking

into account compensation in excess of $150,000. For example, this

happens when a defined benefit plan determines annual accruals as a

percentage of each employee's highest average annual compensation for a

specified number of years (including years prior to the effective date

of OBRA '93).

d. Collectively Bargained Plans

TRA '86 and OBRA '93 provide a deferred effective date for

collectively bargained plans. In response to comments, these

regulations clarify that the rules of Sec. 1.410(b)-10(a)(2) apply for

purposes of determining whether a plan is a collectively bargained

plan. Thus, if a plan is a collectively bargained plan (within the

meaning of Sec. 1.410(b)-10(a)(2)(iii)), the deferred effective date

applies in determining the plan allocations or benefit accruals of both

collectively bargained and noncollectively bargained employees.

e. Governmental Plans

These final regulations retain the special effective date for

governmental plans (within the meaning of section 414(d)) in order to

provide governmental employers with adequate time to amend their plans

to comply with section 401(a)(17). Thus, the regulations provide that

these governmental plans will automatically satisfy the requirements of

section 401(a)(17) for plan years beginning before the later of January

1, 1996, or 90 days after the opening of the first legislative session

beginning on or after January 1, 1996, of the governing body with

authority to amend the plan, if that body does not meet continuously.

The final regulations continue to implement the grandfather rule in

OBRA '93 for individuals who first became participants in governmental

plans before the first plan year beginning after December 31, 1995 or,

if earlier, the first plan year for which the plan is amended to comply

with OBRA '93. Under the grandfather rule, the annual compensation

limit will not apply for those individuals to the extent that the limit

would reduce the amount of compensation taken into account under the

plan below the amount that was allowed to be taken into account under

the plan as in effect on July 1, 1993. However, in order for this

grandfather rule to apply to a plan, the plan must be amended,

effective for plan years beginning after December 31, 1995, to

incorporate by reference the annual compensation limits of section

401(a)(17) for those participants who are not grandfathered under OBRA

'93.

f. Good Faith Compliance Prior to the Regulatory Effective Date

For plan years beginning on or after the date that section

401(a)(17) first applies to a plan, but before these regulations apply

to the plan, the plan must be operated in accordance with a reasonable,

good faith interpretation of the requirements of section 401(a)(17).

Whether compliance is reasonable and in good faith will be determined

on the basis of all of the relevant facts and circumstances, including

the extent to which the employer has resolved unclear issues in its

favor. Reasonable, good faith interpretation will be deemed to exist,

however, if a plan is operated in accordance with the 1990 regulations,

the September 1991 regulations, the December 1993 regulations, or these

regulations. However, for any plan with a regulatory effective date

that is later than the OBRA '93 effective date for the plan (e.g., a

plan maintained by a tax-exempt organization), a reasonable, good faith

interpretation must reflect the OBRA '93 amendments to section

401(a)(17).

Special Analyses

It has been determined that this Treasury decision is not a

significant regulatory action as defined in EO 12866. Therefore, a

regulatory assessment is not required. It also has been determined that

section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)

and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to

these regulations, and, therefore, a Regulatory Flexibility Analysis is

not required. Pursuant to section 7805(f) of the Internal Revenue Code,

the notice of proposed rulemaking preceding these regulations was

submitted to the Small Business Administration for comment on its

impact on small business.

Drafting Information

The principal author of these final regulations is Marjorie Hoffman

of the Office of the Associate Chief Counsel (Employee Benefits and

Exempt Organizations), IRS. However, other personnel from the IRS and

Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read,

in part, as follows:

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

Par. 2. Section 1.401(a)(17)-1 is revised to read as follows:

Sec. 1.401(a)(17)-1 Limitation on annual compensation.

(a) Compensation limit requirement--(1) In general. In order to be

a qualified plan, a plan must satisfy section 401(a)(17). Section

401(a)(17) provides an annual compensation limit for each employee

under a qualified plan. This limit applies to a qualified plan in two

ways. First, a plan may not base allocations, in the case of a defined

contribution plan, or benefit accruals, in the case of a defined

benefit plan, on compensation in excess of the annual compensation

limit. Second, the amount of an employee's annual compensation that may

be taken into account in applying certain specified nondiscrimination

rules under the Internal Revenue Code is subject to the annual

compensation limit. These two limitations are set forth in paragraphs

(b) and (c) of this section, respectively. Paragraph (d) of this

section provides the effective dates of section 401(a)(17), the

amendments made by section 13212 of the Omnibus Budget Reconciliation

Act of 1993 (OBRA '93), and this section. Paragraph (e) of this section

provides rules for determining post-effective-date accrued benefits

under the fresh-start rules.

(2) Annual compensation limit for plan years beginning before

January 1, 1994. For purposes of this section, for plan years beginning

prior to the OBRA '93 effective date, annual compensation limit means

$200,000, adjusted as provided by the Commissioner. The amount of the

annual compensation limit is adjusted at the same time and in the same

manner as under section 415(d). The base period for the annual

adjustment is the calendar quarter ending December 31, 1988, and the

first adjustment is effective on January 1, 1990. Any increase in the

annual compensation limit is effective as of January 1 of a calendar

year and applies to any plan year beginning in that calendar year. In

any plan year beginning prior to the OBRA '93 effective date, if

compensation for any plan year beginning prior to the statutory

effective date is used for determining allocations or benefit accruals,

or when applying any nondiscrimination rule, then the annual

compensation limit for the first plan year beginning on or after the

statutory effective date (generally $200,000) must be applied to

compensation for that prior plan year.

(3) Annual compensation limit for plan years beginning on or after

January 1, 1994--(i) In general. For purposes of this section, for plan

years beginning on or after the OBRA '93 effective date, annual

compensation limit means $150,000, adjusted as provided by the

Commissioner. The adjusted dollar amount of the annual compensation

limit is determined by adjusting the $150,000 amount for changes in the

cost of living as provided in paragraph (a)(3)(ii) of this section and

rounding this adjusted dollar amount as provided in paragraph

(a)(3)(iii) of this section. Any increase in the annual compensation

limit is effective as of January 1 of a calendar year and applies to

any plan year beginning in that calendar year. For example, if a plan

has a plan year beginning July 1, 1994, and ending June 30, 1995, the

annual compensation limit in effect on January 1, 1994 ($150,000),

applies to the plan for the entire plan year.

(ii) Cost of living adjustment. The $150,000 amount is adjusted for

changes in the cost of living by the Commissioner at the same time and

in the same manner as under section 415(d). The base period for the

annual adjustment is the calendar quarter ending December 31, 1993.

(iii) Rounding of adjusted compensation limit. After the $150,000,

adjusted in accordance with paragraph (a)(3)(ii) of this section,

exceeds the annual compensation limit for the prior calendar year by

$10,000 or more, the annual compensation limit will be increased by the

amount of such excess, rounded down to the next lowest multiple of

$10,000.

(4) Additional guidance. The Commissioner may, in revenue rulings

and procedures, notices, and other guidance, published in the Internal

Revenue Bulletin (see Sec. 601.601(d)(2)(ii)(b) of this chapter),

provide any additional guidance that may be necessary or appropriate

concerning the annual limits on compensation under section 401(a)(17).

(b) Plan limit on compensation--(1) General rule. A plan does not

satisfy section 401(a)(17) unless it provides that the compensation

taken into account for any employee in determining plan allocations or

benefit accruals for any plan year is limited to the annual

compensation limit. For purposes of this rule, allocations and benefit

accruals under a plan include all benefits provided under the plan,

including ancillary benefits.

(2) Plan-year-by-plan-year requirement. For purposes of this

paragraph (b), the limit in effect for the current plan year applies

only to the compensation for that year that is taken into account in

determining plan allocations or benefit accruals for the year. The

compensation for any prior plan year taken into account in determining

an employee's allocations or benefit accruals for the current plan year

is subject to the applicable annual compensation limit in effect for

that prior year. Thus, increases in the annual compensation limit apply

only to compensation taken into account for the plan year in which the

increase is effective. In addition, if compensation for any plan year

beginning prior to the OBRA '93 effective date is used for determining

allocations or benefit accruals in a plan year beginning on or after

the OBRA '93 effective date, then the annual compensation limit for

that prior year is the annual compensation limit in effect for the

first plan year beginning on or after the OBRA '93 effective date

(generally $150,000).

(3) Application of limit to a plan year--(i) In general. For

purposes of applying this paragraph (b), the annual compensation limit

is applied to the compensation for the plan year on which allocations

or benefit accruals are based.

(ii) Compensation for the plan year. If a plan determines

compensation used in determining allocations or benefit accruals for a

plan year based on compensation for the plan year, then the annual

compensation limit that applies to the compensation for the plan year

is the limit in effect for the calendar year in which the plan year

begins. Alternatively, if a plan determines compensation used in

determining allocations or benefit accruals for the plan year on the

basis of compensation for a 12-consecutive-month period, or periods,

ending no later than the last day of the plan year, then the annual

compensation limit applies to compensation for each of those periods

based on the annual compensation limit in effect for the respective

calendar year in which each 12-month period begins.

(iii) Compensation for a period of less than 12-months--(A)

Proration required. If compensation for a period of less than 12 months

is used for a plan year, then the otherwise applicable annual

compensation limit is reduced in the same proportion as the reduction

in the 12-month period. For example, if a defined benefit plan provides

that the accrual for each month in a plan year is separately determined

based on the compensation for that month and the plan year accrual is

the sum of the accruals for all months, then the annual compensation

limit for each month is \1/12\th of the annual compensation limit for

the plan year. In addition, if the period for determining compensation

used in calculating an employee's allocation or accrual for a plan year

is a short plan year (i.e., shorter than 12 months), the annual

compensation limit is an amount equal to the otherwise applicable

annual compensation limit multiplied by a fraction, the numerator of

which is the number of months in the short plan year, and the

denominator of which is 12.

(B) No proration required for participation for less than a full

plan year. Notwithstanding paragraph (b)(3)(iii)(A) of this section, a

plan is not treated as using compensation for less than 12 months for a

plan year merely because the plan formula provides that the allocation

or accrual for each employee is based on compensation for the portion

of the plan year during which the employee is a participant in the

plan. In addition, no proration is required merely because an employee

is covered under a plan for less than a full plan year, provided that

allocations or benefit accruals are otherwise determined using

compensation for a period of at least 12 months. Finally,

notwithstanding paragraph (b)(3)(iii)(A) of this section, no proration

is required merely because the amount of elective contributions (within

the meaning of Sec. 1.401(k)-1(g)(3)), matching contributions (within

the meaning of Sec. 1.401(m)-1(f)(12)), or employee contributions

(within the meaning of Sec. 1.401(m)-1(f)(6)) that is contributed for

each pay period during a plan year is determined separately using

compensation for that pay period.

(4) Limits on multiple employer and multiemployer plans. For

purposes of this paragraph (b), in the case of a plan described in

section 413(c) or 414(f) (a plan maintained by more than one employer),

the annual compensation limit applies separately with respect to the

compensation of an employee from each employer maintaining the plan

instead of applying to the employee's total compensation from all

employers maintaining the plan.

(5) Family aggregation. [Reserved]

(6) Examples. The following examples illustrate the rules in this

paragraph (b).

Example 1. Plan X is a defined benefit plan with a calendar year

plan year and bases benefits on the average of an employee's high 3

consecutive years' compensation. The OBRA '93 effective date for

Plan X is January 1, 1994. Employee A's high 3 consecutive years'

compensation prior to the application of the annual compensation

limits is $160,000 (1994), $155,000 (1993), and $135,000 (1992). To

satisfy this paragraph (b), Plan X cannot base plan benefits for

Employee A in 1994 on compensation in excess of $145,000 (the

average of $150,000 (A's 1994 compensation capped by the annual

compensation limit), $150,000 (A's 1993 compensation capped by the

$150,000 annual compensation limit applicable to all years before

1994), and $135,000 (A's 1992 compensation capped by the $150,000

annual compensation limit applicable to all years before 1994)). For

purposes of determining the 1994 accrual, each year (1994, 1993, and

1992), not the average of the 3 years, is subject to the 1994 annual

compensation limit of $150,000.

Example 2. Assume the same facts as Example 1, except that

Employee A's high 3 consecutive years' compensation prior to the

application of the limits is $185,000 (1997), $175,000 (1996), and

$165,000 (1995). Assume that the annual compensation limit is first

adjusted to $160,000 for plan years beginning on or after January 1,

1997. Plan X cannot base plan benefits for Employee A in 1997 on

compensation in excess of $153,333 (the average of $160,000 (A's

1997 compensation capped by the 1997 limit), $150,000 (A's 1996

compensation capped by the 1996 limit), and $150,000 (A's 1995

compensation capped by the 1995 limit)).

Example 3. Plan Y is a defined benefit plan that bases benefits

on an employee's high consecutive 36 months of compensation ending

within the plan year. Employee B's high 36 months are the period

September 1995 to August 1998, in which Employee B earned $50,000 in

each month. Assume that the annual compensation limit is first

adjusted to $160,000 for plan years beginning on or after January 1,

1997. The annual compensation limit is $150,000, $150,000, and

$160,000 in 1995, 1996, and 1997, respectively. To satisfy this

paragraph (b), Plan Y cannot base Employee B's plan benefits for the

1998 plan year on compensation in excess of $153,333. This amount is

determined by applying the applicable annual compensation limit to

compensation for each of the three 12-consecutive-month periods. The

September 1995 to August 1996 period is capped by the annual

compensation limit of $150,000 for 1995; the September 1996 to

August 1997 period is capped by the annual compensation limit of

$150,000 for 1996; and the September 1997 to August 1998 period is

capped by the annual compensation limit of $160,000 for 1997. The

average of these capped amounts is the annual compensation limit

applicable in determining benefits for the 1998 year.

Example 4. (a) Employer P is a partnership. Employer P maintains

Plan Z, a profit-sharing plan that provides for an annual allocation

of employer contributions of 15 percent of plan year compensation

for employees other than self-employed individuals, and 13.0435

percent of plan year compensation for self-employed individuals. The

plan year of Plan Z is the calendar year. The OBRA '93 effective

date for Plan Z is January 1, 1994. In order to satisfy section

401(a)(17), as amended by OBRA '93, the plan provides that,

beginning with the 1994 plan year, the plan year compensation used

in determining the allocation of employer contributions for each

employee may not exceed the annual limit in effect for the plan year

under OBRA '93. Plan Z defines compensation for self-employed

individuals (employees within the meaning of section 401(c)(1)) as

the self-employed individual's net profit from self-employment

attributable to Employer P minus the amount of the self-employed

individual's deduction under section 164(f) for one-half of self-

employment taxes. Plan Z defines compensation for all other

employees as wages within the meaning of section 3401(a). Employee C

and Employee D are partners of Employer P and thus are self-employed

individuals. Neither Employee C nor Employee D owns an interest in

any other business or is a common-law employee in any business. For

the 1994 calendar year, Employee C has net profit from self-

employment of $80,000, and Employee D has net profit from self-

employment of $175,000. The deduction for Employee C under section

164(f) for one-half of self-employment taxes is $4,828. The

deduction for Employee D under section 164(f) for one-half of self-

employment taxes is $6,101

(b) The plan year compensation under the plan formula for

Employee C is $75,172 ($80,000 minus $4,828). The allocation of

employer contributions under the plan allocation formula for 1994

for Employee C is $9,805 ($75,172 (Employee C's plan year

compensation for 1994) multiplied by 13.0435%). The plan year

compensation under the plan formula before application of the annual

limit under section 401(a)(17) for Employee D is $168,899 ($175,000

minus $6101). After application of the annual limit, the plan year

compensation for the 1994 plan year for Employee D is $150,000 (the

annual limit for 1994). Therefore, the allocation of employer

contributions under the plan allocation formula for 1994 for

Employee D is $19,565 ($150,000 (Employee D's plan year compensation

after application of the annual limit for 1994) multiplied by

13.0435%).

Example 5. The facts are the same as in Example 4, except that

Plan Z provides that plan year compensation for self-employed

individuals is defined as earned income within the meaning of

section 401(c)(2) attributable to Employer P. In addition, Plan Z

provides for an annual allocation of employer contributions of 15

percent of plan year compensation for all employees in the plan,

including self-employed individuals, such as Employees C and D. The

net profit from self-employment for Employee C and the net profit

from self-employment for Employee D are the same as provided in

Example 4. However, the earned income of Employee C determined in

accordance with section 401(c)(2) is $65,367 ($80,000 minus $4,828

minus $9,805). The earned income of Employee D determined in

accordance with section 401(c)(2) is $146,869 ($175,000 minus $6,101

minus $22,030). Therefore, the allocation of employer contributions

under the plan allocation formula for 1994 for Employee C is $9,805

($65,367 (Employee C's plan year compensation for 1994) multiplied

by 15%). Employee D's earned income for 1994 does not exceed the

1994 annual limit of $150,000. Therefore, the allocation of employer

contributions under the plan allocation formula for 1994 for

Employee D is $22,030 ($146,869 (Employee D's plan year compensation

for 1994) multiplied by 15%).

(c) Limit on compensation for nondiscrimination rules--(1) General

rule. The annual compensation limit applies for purposes of applying

the nondiscrimination rules under sections 401(a)(4), 401(a)(5),

401(l), 401(k)(3), 401(m)(2), 403(b)(12), 404(a)(2) and 410(b)(2). The

annual compensation limit also applies in determining whether an

alternative method of determining compensation impermissibly

discriminates under section 414(s)(3). Thus, for example, the annual

compensation limit applies when determining a self-employed

individual's total earned income that is used to determine the

equivalent alternative compensation amount under Sec. 1.414(s)-1(g)(1).

This paragraph (c) provides rules for applying the annual compensation

limit for these purposes. For purposes of this paragraph (c),

compensation means the compensation used in applying the applicable

nondiscrimination rule.

(2) Plan-year-by-plan-year requirement. For purposes of this

paragraph (c), when applying an applicable nondiscrimination rule for a

plan year, the compensation for each plan year taken into account is

limited to the applicable annual compensation limit in effect for that

year, and an employee's compensation for that plan year in excess of

the limit is disregarded. Thus, if the nondiscrimination provision is

applied on the basis of compensation determined over a period of more

than one year (for example, average annual compensation), the annual

compensation limit in effect for each of the plan years that is taken

into account in determining the average applies to the respective plan

year's compensation. In addition, if compensation for any plan year

beginning prior to the OBRA '93 effective date is used when applying

any nondiscrimination rule in a plan year beginning on or after the

OBRA '93 effective date, then the annual compensation limit for that

prior year is the annual compensation limit for the first plan year

beginning on or after the OBRA '93 effective date (generally $150,000).

(3) Plan-by-plan limit. For purposes of this paragraph (c), the

annual compensation limit applies separately to each plan (or group of

plans treated as a single plan) of an employer for purposes of the

applicable nondiscrimination requirement. For this purpose, the plans

included in the testing group taken into account in determining whether

the average benefit percentage test of Sec. 1.410(b)-5 is satisfied are

generally treated as a single plan.

(4) Application of limit to a plan year. The rules provided in

paragraph (b)(3) of this section regarding the application of the limit

to a plan year apply for purposes of this paragraph (c).

(5) Limits on multiple employer and multiemployer plans. The rule

provided in paragraph (b)(4) of this section regarding the application

of the limit to multiple employer and multiemployer plans applies for

purposes of this paragraph (c).

(d) Effective date--(1) Statutory effective date--(i) General rule.

Except as otherwise provided in this paragraph (d), section 401(a)(17)

applies to a plan as of the first plan year beginning on or after

January 1, 1989. For purposes of this section, statutory effective date

generally means the first day of the first plan year that section

401(a)(17) is applicable to a plan. In the case of governmental plans,

statutory effective date means the first day of the first plan year for

which the plan is not deemed to satisfy section 401(a)(17) by reason of

paragraph (d)(4) of this section.

(ii) Exception for collectively bargained plans. In the case of a

plan maintained pursuant to one or more collective bargaining

agreements between employee representatives and one or more employers

ratified before March 1, 1986, section 401(a)(17) applies to

allocations and benefit accruals for plan years beginning on or after

the earlier of--

(A) January 1, 1991; or

(B) The later of January 1, 1989, or the date on which the last of

the collective bargaining agreements terminates (determined without

regard to any extension or renegotiation of any agreement occurring

after February 28, 1986). For purposes of this paragraph (d)(1)(ii),

the rules of Sec. 1.410(b)-10(a)(2) apply for purposes of determining

whether a plan is maintained pursuant to one or more collective

bargaining agreements, and any extension or renegotiation of a

collective bargaining agreement, which extension or renegotiation is

ratified after February 28, 1986, is to be disregarded in determining

the date on which the agreement terminates.

(2) OBRA '93 effective date--(i) In general. For purposes of this

section, OBRA '93 effective date means the first day of the first plan

year beginning on or after January 1, 1994, except as provided in this

paragraph (d)(2).

(ii) Exception for collectively bargained plans--(A) In general. In

the case of a plan maintained pursuant to one or more collective

bargaining agreements between employee representatives and 1 or more

employers ratified before August 10, 1993, OBRA '93 effective date

means the first day of the first plan year beginning on or after the

earlier of--

(1) The latest of--

(i) January 1, 1994;

(ii) The date on which the last of such collective bargaining

agreements terminates (without regard to any extension, amendment, or,

modification of such agreements on or after August 10, 1993); or

(iii) In the case of a plan maintained pursuant to collective

bargaining under the Railway Labor Act, the date of execution of an

extension or replacement of the last of such collective bargaining

agreements in effect on August 10, 1993; or

(2) January 1, 1997.

(B) Determination of whether plan is collectively bargained. For

purposes of this paragraph (d)(2)(ii), the rules of Sec. 1.410(b)-

10(a)(2) apply for purposes of determining whether a plan is maintained

pursuant to one or more collective bargaining agreements, except that

August 10, 1993, is substituted for March 1, 1986, as the date before

which the collective bargaining agreements must be ratified.

(3) Regulatory effective date. This Sec. 1.401(a)(17)-1 applies to

plan years beginning on or after the OBRA '93 effective date. However,

in the case of a plan maintained by an organization that is exempt from

income taxation under section 501(a), including plans subject to

section 403(b)(12)(A)(i) (nonelective plans), this Sec. 1.401(a)(17)-1

applies to plan years beginning on or after January 1, 1996. For plan

years beginning before the effective date of these regulations and on

or after the statutory effective date, a plan must be operated in

accordance with a reasonable, good faith interpretation of section

401(a)(17), taking into account, if applicable, the OBRA '93 reduction

to the annual compensation limit under section 401(a)(17).

(4) Special rules for governmental plans--(i) Deemed satisfaction

by governmental plans. In the case of governmental plans described in

section 414(d), including plans subject to section 403(b)(12)(A)(i)

(nonelective plans), section 401(a)(17) is considered satisfied for

plan years beginning before the later of January 1, 1996, or 90 days

after the opening of the first legislative session beginning on or

after January 1, 1996, of the governing body with authority to amend

the plan, if that body does not meet continuously. For purposes of this

paragraph (d)(4), the term governing body with authority to amend the

plan means the legislature, board, commission, council, or other

governing body with authority to amend the plan.

(ii) Transition rule for governmental plans--(A) In general. In the

case of an eligible participant in a governmental plan (within the

meaning of section 414(d)), the annual compensation limit under this

section shall not apply to the extent that the application of the

limitation would reduce the amount of compensation that is allowed to

be taken into account under the plan below the amount that was allowed

to be taken into account under the plan as in effect on July 1, 1993.

Thus, for example, if a plan as in effect on July 1, 1993, determined

benefits without any reference to a limit on compensation, then the

annual compensation limit in effect under this section will not apply

to any eligible participant in any future year.

(B) Eligible participant. For purposes of this paragraph

(d)(4)(ii), an eligible participant is an individual who first became a

participant in the plan prior to the first day of the first plan year

beginning after the earlier of--

(1) The last day of the plan year by which a plan amendment to

reflect the amendments made by section 13212 of OBRA '93 is both

adopted and effective; or

(2) December 31, 1995.

(C) Plan must be amended to incorporate limits. This paragraph

(d)(4)(ii) shall not apply to any eligible participant in a plan unless

the plan is amended so that the plan incorporates by reference the

annual compensation limit under section 401(a)(17), effective with

respect to noneligible participants for plan years beginning after

December 31, 1995 (or earlier, if the plan amendment so provides).

(5) Benefits earned prior to effective date--(i) In general.

Allocations under a defined contribution plan or benefits accrued under

a defined benefit plan for plan years beginning before the statutory

effective date are not subject to the annual compensation limit.

Allocations under a defined contribution plan or benefits accrued under

a defined benefit plan for plan years beginning on or after the

statutory effective date, but before the OBRA '93 effective date, are

subject to the annual compensation limit under paragraph (a)(2) of this

section. However, these allocations or accruals are not subject to the

OBRA '93 reduction to the annual compensation limit described in

paragraph (a)(3) of this section.

(ii) Allocation for a plan year. The allocations for a plan year

include amounts described in Sec. 1.401(a)(4)-2(c)(ii) or

Sec. 1.401(m)-1(f)(6) plus the earnings, expenses, gains, and losses

attributable to those amounts.

(iii) Benefits accrued for years before the effective date. The

benefits accrued for plan years prior to a specified date by any

employee are the employee's benefits accrued under the plan, determined

as if those benefits had been frozen (as defined in Sec. 1.401(a)(4)-

13(c)(3)(i)) as of the day immediately preceding such specified date.

Thus, for example, benefits accrued for those plan years generally do

not include any benefits accrued under an amendment increasing prior

benefits that is adopted after the date on which the employee's

benefits under the plan must be treated as frozen.

(e) Determination of post-effective-date accrued benefits--(1) In

general. The plan formula that is used to determine the amount of

allocations or benefit accruals for plan years beginning on or after

the dates described in paragraph (d)(1) or (2) must comply with section

401(a)(17) as in effect on such date. This paragraph (e) provides rules

for applying section 401(a)(17) in the case of section 401(a)(17)

employees who accrue additional benefits under a defined benefit plan

in a plan year beginning on or after the relevant effective date.

Paragraph (e)(2) of this section contains definitions used in applying

these rules. Paragraphs (e)(3) and (e)(4) of this section explain the

application of the fresh-start rules in Sec. 1.401(a)(4)-13 to the

determination of the accrued benefits of section 401(a)(17) employees.

(2) Definitions. For purposes of this paragraph (e), the following

definitions apply:

(i) Section 401(a)(17) employee. An employee is a section

401(a)(17) employee as of a date, on or after the statutory effective

date, if the employee's current accrued benefit as of that date is

based on compensation for a year prior to the statutory effective date

that exceeded the annual compensation limit for the first plan year

beginning on or after the statutory effective date. In addition, an

employee is a section 401(a)(17) employee as of a date, on or after the

OBRA '93 effective date, if the employee's current accrued benefit as

of that date is based on compensation for a year prior to the OBRA '93

effective date that exceeded the annual compensation limit for the

first plan year beginning on or after the OBRA '93 effective date. For

this purpose, a current accrued benefit is not treated as based on

compensation that exceeded the relevant annual compensation limit, if a

plan makes a fresh start using the formula with wear-away described in

Sec. 1.401(a)(4)-13(c)(4)(ii), and the employee's accrued benefit

determined under Sec. 1.401(a)(4)-13(c)(4)(ii)(B), taking into account

the annual compensation limit, exceeds the employee's frozen accrued

benefit (or, if applicable, the employee's adjusted accrued benefit) as

of the fresh-start date.

(ii) Section 401(a)(17) fresh-start date. Section 401(a)(17) fresh-

start date means a fresh-start date as defined in Sec. 1.401(a)(4)-12

not earlier than the last day of the last plan year beginning before

the statutory effective date, and not later than the last day of the

last plan year beginning before the effective date of these

regulations.

(iii) OBRA '93 fresh-start date. OBRA '93 fresh-start date means a

fresh-start date as defined in Sec. 1.401(a)(4)-12 not earlier than the

last day of the last plan year beginning before the OBRA '93 effective

date, and not later than the last day of the last plan year beginning

before the effective date of these regulations.

(iv) Section 401(a)(17) frozen accrued benefit. Section 401(a)(17)

frozen accrued benefit means the accrued benefit for any section

401(a)(17) employee frozen (as defined in Sec. 1.401(a)(4)-13(c)(3)(i))

as of the last day of the last plan year beginning before the statutory

effective date.

(v) OBRA '93 frozen accrued benefit. OBRA '93 frozen accrued

benefit means the accrued benefit for any section 401(a)(17) employee

frozen (as defined in Sec. 1.401(a)(4)-13(c)(3)(i)) as of the OBRA '93

fresh-start date.

(3) Application of fresh-start rules--(i) General rule. In order to

satisfy section 401(a)(17), a defined benefit plan must determine the

accrued benefit of each section 401(a)(17) employee by applying the

fresh-start rules in Sec. 1.401(a)(4)-13(c). The fresh-start rules must

be applied using a section 401(a)(17) fresh-start date and using the

plan benefit formula, after amendment to comply with section 401(a)(17)

and this section, as the formula applicable to benefit accruals in the

current plan year. In addition, the fresh-start rules must be applied

to determine the accrued benefit of each section 401(a)(17) employee

using an OBRA '93 fresh-start date and using the plan benefit formula,

after amendment to comply with the reduction in the section 401(a)(17)

annual compensation limit described in paragraph (a)(3) of this

section, as the formula applicable to benefit accruals in the current

plan year.

(ii) Consistency rules in Sec. 1.401(a)(4)-13(c) and (d)--(A)

General rule. In applying the fresh-start rules of Sec. 1.401(a)(4)-

13(c) and (d), the group of section 401(a)(17) employees is a fresh-

start group. See Sec. 1.401(a)(4)-13(c)(5)(ii)(A). Thus, the

consistency rules of those sections govern, unless otherwise provided.

For example, if the plan is using a fresh-start date applicable to all

employees and is not adjusting frozen accrued benefits under

Sec. 1.401(a)(4)-13(d) for employees who are not section 401(a)(17)

employees, then the frozen accrued benefits for section 401(a)(17)

employees may not be adjusted under Sec. 1.401(a)(4)-13(d) or this

paragraph (e).

(B) Determination of adjusted accrued benefit. If the fresh-start

rules of Sec. 1.401(a)(4)-13(c) and (d) are applied to determine the

benefits of all employees after a fresh-start date, the plan will not

fail to satisfy the consistency requirement of Sec. 1.401(a)(4)-

13(c)(5)(i) merely because the plan makes the adjustment described in

Sec. 1.401(a)(4)-13(d) to the frozen accrued benefits of employees who

are not section 401(a)(17) employees, but does not make the adjustment

to the frozen accrued benefits of section 401(a)(17) employees. In

addition, the plan does not fail to satisfy the consistency requirement

of Sec. 1.401(a)(4)-13(c)(5)(i) merely because the plan makes the

adjustment described in Sec. 1.401(a)(4)-13(d) for section 401(a)(17)

employees on the basis of the compensation formula that was used to

determine the frozen accrued benefit (as required under paragraph

(e)(4)(iii) of this section) but makes the adjustment for employees who

are not section 401(a)(17) employees on the basis of any other method

provided in Sec. 1.401(a)(4)-13(d)(8).

(4) Permitted adjustments to frozen accrued benefit of section

401(a)(17) employees--(i) General rule. Except as otherwise provided in

paragraphs (e)(4)(ii) and (iii) of this section, the rules in

Sec. 1.401(a)(4)-13(c)(3) (permitting certain adjustments to frozen

accrued benefits) apply to section 401(a)(17) frozen accrued benefits

or OBRA '93 frozen accrued benefits.

(ii) Optional forms of benefit. After either the section 401(a)(17)

fresh-start date or the OBRA '93 fresh-start date, a plan may be

amended either to provide a new optional form of benefit or to make an

optional form of benefit available with respect to the section

401(a)(17) frozen accrued benefit or the OBRA '93 frozen accrued

benefit, provided that the optional form of benefit is not subsidized.

Whether an optional form is subsidized may be determined using any

reasonable actuarial assumptions.

(iii) Adjusting section 401(a)(17) accrued benefits--(A) In

general. If the plan adjusts accrued benefits for employees under the

rules of Sec. 1.401(a)(4)-13(d) as of a fresh-start date, the adjusted

accrued benefit (within the meaning of section Sec. 1.401(a)(4)-13(d))

for each section 401(a)(17) employee must be determined after the

fresh-start date by reference to the plan's compensation formula that

was actually used to determine the frozen accrued benefit as of the

fresh-start date. For this purpose, the plan's compensation formula

incorporates the plan's underlying compensation definition and

compensation averaging period. In making the adjustment, the

denominator of the adjustment fraction described in Sec. 1.401(a)(4)-

13(d)(8)(i) is the employee's compensation as of the fresh-start date

using the plan's compensation formula as of that date and, in the case

of an OBRA '93 fresh-start date, reflecting the annual compensation

limits that applied as of the fresh-start date. The numerator of the

adjustment fraction is the employee's updated compensation (i.e.,

compensation for the current plan year within the meaning of

Sec. 1.401(a)(4)-13(d)(8)), determined after applying the annual

compensation limits to each year's compensation that is used in the

plan's compensation formula as of the fresh-start date. Similarly, in

applying the alternative rule in Sec. 1.401(a)(4)-13(d)(8)(v), the

updated compensation that is substituted must be determined after

applying the annual compensation limits to each year's compensation

that is used in the plan's compensation formula. Thus, no adjustment

will be permitted unless the updated compensation (determined after

applying the annual compensation limit) exceeds the compensation that

was used to determine the employee's frozen accrued benefit.

(B) Multiple fresh starts. If a plan makes more than one fresh

start with respect to a section 401(a)(17) employee, the employee's

frozen accrued benefit as of the latest fresh-start date will either be

determined by applying the current benefit formula to the employee's

total years of service as of that fresh-start date or will consist of

the sum of the employee's frozen accrued benefit (or adjusted accrued

benefit (as defined in Sec. 1.401(a)(4)-13(d)(8)(i))) as of the

previous fresh-start date plus additional frozen accruals since the

previous fresh start. If the frozen accrued benefit consists of such a

sum, in making the adjustments described in paragraph (e)(4)(iii)(A) of

this section, separate adjustments must be made to that previously

frozen accrued benefit (or adjusted accrued benefit) and the additional

frozen accruals to the extent that the frozen accrued benefit and the

additional accruals have been determined using different compensation

formulas or different compensation limits (i.e., the section 401(a)(17)

limit before and after the reduction in limit described in paragraph

(a)(3) of this section). In this case, if the plan is applying the

adjustment fraction of Sec. 1.401(a)(4)-13(d)(8)(i), the denominator of

the separate adjustment fraction for adjusting each portion of the

frozen accrued benefit must reflect the actual compensation formula,

and, if applicable, compensation limit, originally used for determining

that portion. For example, the frozen accrued benefit of a section

401(a)(17) employee as of the OBRA '93 fresh-start date may be based on

the sum of the section 401(a)(17) frozen accrued benefit (determined

without any annual compensation limit) plus benefit accruals in the

years between the statutory effective date and the OBRA '93 effective

date (based on compensation that was subject to the annual compensation

limits for those years). In this example, in adjusting the section

401(a)(17) frozen accrued benefit, the denominator of the adjustment

fraction does not reflect any annual compensation limit. Similarly, in

adjusting the frozen accruals for years between the statutory effective

date and the OBRA '93 effective date, the denominator of the adjustment

fraction reflects the level of the annual compensation limit in effect

for those years.

(5) Examples. The following examples illustrate the rules in this

paragraph (e).

Example 1. (a) Employer X maintains Plan Y, a calendar year

defined benefit plan providing an annual benefit for each year of

service equal to 2 percent of compensation averaged over an

employee's high 3 consecutive calendar years' compensation. Section

401(a)(17) applies to Plan Y in 1989. As of the close of the last

plan year beginning before January 1, 1989 (i.e., the 1988 plan

year), Employee A, with 5 years of service, had accrued a benefit of

$25,000 which equals 10 percent (2 percent multiplied by 5 years of

service) of average compensation of $250,000. Employer X decides to

comply with the provisions of this section for plan years before the

effective date of this section. Employer X decides to make the

amendment effective for plan years beginning on or after January 1,

1989, and uses December 31, 1988 as the section 401(a)(17) fresh-

start date. Plan Y, as amended, provides that, in determining an

employee's benefit, compensation taken into account is limited in

accordance with the provisions of this section to the annual

compensation limit under section 401(a)(17), and that, for section

401(a)(17) employees, the employee's accrued benefit is the greater

of

(i) The employee's benefit under the plan's benefit formula

(after the plan formula is amended to comply with section

401(a)(17)) as applied to the employee's total years of service; and

(ii) The employee's accrued benefit as of December 31, 1988,

determined as though the employee terminated employment on that date

without regard to any plan amendments after that date.

Employer X decides not to amend Plan Y to provide for the

adjustments permitted under Sec. 1.401(a)(4)-13(d) to the accrued

benefit of section 401(a)(17) employees as of December 31, 1988.

(b) Under Plan Y, Employee A's accrued benefit at the end of

1989 is $25,000, which is the greater of Employee A's accrued

benefit as of the last day of the 1988 plan year ($25,000), and

$24,000, which is Employee A's benefit based on the plan's benefit

formula applied to Employee A's total years of service ($200,000

multiplied by (2 percent multiplied by 6 years of service)). The

formula of Plan Y applicable to section 401(a)(17) employees for

calculating their accrued benefits for years after the section

401(a)(17) fresh-start date is the formula in Sec. 1.401(a)-

13(c)(4)(ii) (formula with wear-away). The fresh-start formula is

applied using a benefit formula for the 1989 plan year that

satisfies section 401(a)(17) and this section, and the December 31,

1988 fresh-start date used for the plan is a section 401(a)(17)

fresh-start date within the meaning of paragraph (e)(2)(ii) of this

section. Thus, Plan Y, as amended, satisfies paragraph (e)(3)(i) of

this section for plan years commencing prior to the OBRA '93

effective date.

Example 2. Assume the same facts as in Example 1, except that

the plan formula provides that effective January 1, 1989, for

section 401(a)(17) employees, an employee's benefit will equal the

sum of the employee's accrued benefit as of December 31, 1988

(determined as though the employee terminated employment on that

date and without regard to any amendments after that date), and 2

percent of compensation averaged over an employee's high 3

consecutive years' compensation times years of service taking into

account only years of service after December 31, 1988. Thus, under

Plan Y's formula, Employee A's accrued benefit as of December 31,

1989 is $29,000, which is equal to the sum of $25,000 (Employee A's

accrued benefit as of December 31, 1988) plus $4,000 ($200,000

multiplied by (2 percent multiplied by 1 year of service)). The

formula of Plan Y applicable to section 401(a)(17) employees for

calculating their accrued benefits for years after the section

401(a)(17) fresh-start date is the formula in Sec. 1.401(a)-

13(c)(4)(i) (formula without wear-away). The fresh-start formula is

applied using a benefit formula for the 1989 plan year that

satisfies section 401(a)(17) and this section, and the December 31,

1988 fresh-start date used for the plan is a section 401(a)(17)

fresh-start date within the meaning of paragraph (e)(2)(ii) of this

section. Thus, Plan Y, as amended, satisfies paragraph (e)(3)(i) of

this section for plan years commencing prior to the OBRA '93

effective date.

Example 3. (a) Assume the same facts as in Example 1, except

that the plan formula provides that effective January 1, 1989, an

employee's benefit equals the greater of the plan formulas in

Example 1 and Example 2. The formula of Plan Y applicable to section

401(a)(17) employees for calculating their accrued benefits for

years after the section 401(a)(17) fresh-start date is the formula

in Sec. 1.401(a)-13(c)(4)(iii) (formula with extended wear-away).

The fresh-start formula is applied using a benefit formula for the

1989 plan year that satisfies section 401(a)(17) and this section,

and the December 31, 1988 fresh-start date used for the plan is a

section 401(a)(17) fresh-start date within the meaning of paragraph

(e)(2)(ii) of this section. Thus, Plan Y, as amended, satisfies

paragraph (e)(3)(i) of this section for plan years commencing prior

to the OBRA '93 effective date.

(b) Assume that for each of the years 1991-93 Employee A's

annual compensation under the plan compensation formula,

disregarding the amendment to comply with section 401(a)(17) is

$300,000. The annual compensation limit is adjusted to $222,220,

$228,860, and $235,840 for plan years beginning January 1, 1991,

1992, and 1993, respectively. Because Employer X has decided to

amend Plan Y to comply with the provisions of this section effective

for plan years beginning on or after January 1, 1989, and has used

December 31, 1988 as the section 401(a)(17) fresh-start date, the

compensation that may be taken into account for plan benefits in

1993 cannot exceed $228,973 (the average of $222,220, $228,860, and

$235,840). Therefore, as of December 31, 1993, the benefit

determined under the fresh-start formula with wear-away would be

$45,795 ($228,973 multiplied by (2 percent multiplied by 10 years of

service)). The benefit determined under the fresh-start formula

without wear-away would be $47,897, which is equal to $25,000

(Employee A's section 401(a)(17) frozen accrued benefit) plus

$22,897 ($228,973 multiplied by (2 percent multiplied by 5 years of

service)). Because Employee A's accrued benefit is being determined

using the fresh-start formula with extended wear-away, Employee A's

accrued benefit as of December 31, 1993, is equal to $47,897, the

greater of the two amounts.

Example 4. (a) Assume the same facts as in Example 3, except

that Plan Y satisfies Sec. 1.401(a)(4)-13(d)(3) through (d)(7) and

that the amendment to Plan Y effective for plan years beginning

after December 31, 1988, also provided for adjustments to the

section 401(a)(17) frozen accrued benefit in accordance with

Sec. 1.401(a)(4)-13(d) using the fraction described in

Sec. 1.401(a)(4)-13(d)(8)(i).

(b) As of December 31, 1993, the numerator of Employee A's

compensation fraction is $228,973 (the average of Employee A's

annual compensation for 1991, 1992, and 1993, as limited by the

respective annual limit for each of those years). The denominator of

Employee A's compensation fraction determined in accordance with

paragraph (e)(4)(iii) of this section is $250,000 (the average of

Employee A's high 3 consecutive calendar year compensation as of

December 31, 1988, determined without regard to section 401(a)(17)).

Therefore, Employee A's compensation fraction is $228,973/$250,000.

Because the compensation adjustment fraction is less than 1,

Employee A's section 401(a)(17) frozen accrued benefit is not

adjusted. Therefore, Employee A's accrued benefit as of December 31,

1993, would still be $47,897, which is equal to $25,000 (Employee

A's section 401(a)(17) frozen accrued benefit) plus $22,897

($228,973 multiplied by (2 percent multiplied by 5 years of

service).

Example 5. (a) Assume the same facts as in Example 3, except

that as of January 1, 1994, Plan Y is amended to provide that

benefits will be determined based on compensation of $150,000 (the

limit in effect under section 401(a)(17) for plan years beginning on

or after the OBRA '93 effective date) and that for section

401(a)(17) employees, each employee's accrued benefit will be

determined under Sec. 1.401(a)(4)-13(c)(4)(i) (formula without wear-

away) using December 31, 1993 as the OBRA '93 fresh-start date.

(b) Assume that for each of the years 1996-98 Employee A's

annual compensation under the plan compensation definition,

disregarding the amendment to comply with section 401(a)(17), is

$400,000. Assume that the annual compensation limit is first

adjusted to $160,000 for plan years beginning on or after January 1,

1997, and is not adjusted for the plan year beginning on or after

January 1, 1998. The compensation that may be taken into account for

the 1998 plan year cannot exceed $156,667 (the average of $150,000

for 1996, $160,000 for 1997, and $160,000 for 1998).

(c) Therefore, at the end of December 31, 1998, Employee A's

accrued benefit is $63,564, which is equal to $47,897 (Employee A's

OBRA '93 frozen accrued benefit) plus $15,667 ($156,667 multiplied

by (2 percent multiplied by 5 years of service)).

Example 6. (a) Assume the same facts as in Example 5, except

that, for the fresh-start group (in this case the section 401(a)(17)

employees), the amendments to Plan Y provide for adjustments to the

section 401(a)(17) frozen accrued benefit and the OBRA '93 frozen

accrued benefit in accordance with Sec. 1.401(a)(4)-13(d) using the

fraction described in Sec. 1.401(a)(4)-13(d)(8)(i).

(b) Employee A's frozen accrued benefit as of December 31, 1993,

is adjusted as of December 31, 1998, as follows:

(1) Employee A's frozen accrued benefit as of December 31, 1993,

is the sum of Employee A's section 401(a)(17) frozen accrued benefit

($25,000) and Employee A's frozen accruals for the years 1989-93

($22,897).

(2) The numerator of Employee A's adjustment fraction is

$156,667 (the average of $150,000, $160,000, and $160,000). The

denominator of Employee A's adjustment fraction with respect to

Employee A's section 401(a)(17) frozen accrued benefit is $250,000,

and the denominator of Employee A's adjustment fraction with respect

to the rest of Employee A's frozen accrued benefit is $228,973 (the

average of Employee A's annual compensation for 1991, 1992, and

1993, as limited by the respective annual limit for each of those

years).

(3) Employee A's section 401(a)(17) frozen accrued benefit as

adjusted through December 31, 1998, remains $25,000. The

compensation adjustment fraction determined in accordance with

paragraph (e)(4)(iii) of this section is less than one ($156,667

divided by $250,000).

(4) Employee A's frozen accruals for the years 1989-93, as

adjusted through December 31, 1998, remain $22,897 because the

adjustment fraction is less than one ($156,667 divided by $228,973).

(5) Employee A's adjusted accrued benefit as of December 31,

1998, equals $47,897 (the sum of the $25,000 and $22,897 amounts

from paragraphs (b)(3) and (b)(4), respectively, of this Example).

(c) Employee A's section 401(a)(17) frozen accrued benefit will

not be adjusted for compensation increases until the numerator of

the fraction used to adjust that frozen accrued benefit exceeds the

denominator of $250,000 used in determining those accruals.

Similarly, the portion of Employee A's OBRA '93 frozen accrued

benefit attributable to the frozen accruals for the years 1989-1993

will not be adjusted for compensation increases until the numerator

of the fraction used to adjust those frozen accruals exceeds the

denominator of $228,973 used in determining those accruals.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

Approved: June 14, 1994.

Leslie Samuels,

Assistant Secretary of the Treasury.

[FR Doc. 94-15440 Filed 6-23-94; 8:45 am]

BILLING CODE 4830-01-U