Center Employee Stock Ownership Plans; Section 411(d)(6) Protected Benefits (Taxpayer Relief Act of 1997); Qualified Retirement Plan Benefits

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8781]

RIN 1545-AV95

Center Employee Stock Ownership Plans; Section 411(d)(6)

Protected Benefits (Taxpayer Relief Act of 1997); Qualified Retirement

Plan Benefits

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains final and temporary regulations

providing for changes to the rules regarding qualified retirement plan

benefits that are protected from reduction by plan amendment, that have

been made necessary by the Taxpayer Relief Act of 1997 (TRA '97). The

temporary regulations change the existing regulations to conform with

the TRA '97 rules regarding in-kind distribution requirements for

certain employee stock ownership plans, and specify the time period

during which certain plan amendments for which relief has been granted

by TRA '97 may be made without violating the prohibition against plan

amendments that reduce accrued benefits. These temporary regulations

affect sponsors of qualified retirement plans, employers that maintain

qualified retirement plans, and qualified retirement plan participants.

The final regulations amend the existing final regulations to cross-

reference the temporary regulations. The text of the temporary

regulations also serves as the text of the proposed regulations set

forth in the notice of proposed rulemaking on this subject in the

Proposed Rules section of this issue of the Federal Register.

DATES: These regulations are effective September 4, 1998.

FOR FURTHER INFORMATION CONTACT: Linda S.F. Marshall, (202) 622-6030

(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains amendments to the Income Tax Regulations (26

CFR part 1) under section 411(d)(6). These temporary regulations change

the rules under section 411(d)(6) regarding qualified retirement plan

benefits that are protected from reduction by plan amendment, to take

into account amendments made by the Taxpayer Relief Act of 1997 (TRA

'97), Public Law 105-34, 111 Stat. 788 (1997). Specifically, these

temporary regulations change the existing regulations to conform to the

TRA '97 amendments to section 409 regarding the general requirement

that employee stock ownership plans offer distributions in the form of

employer securities. In addition, these temporary regulations specify

the time period during which certain plan amendments for which relief

has been granted by TRA '97 may be made without violating section

411(d)(6).

Explanation of Provisions

Section 411(d)(6) provides that a plan is not treated as satisfying

the requirements of section 411 if the accrued benefit of a participant

is decreased by a plan amendment. Under section 411(d)(6)(B), a plan

amendment that eliminates an optional form of benefit is treated as

reducing accrued benefits to the extent that the amendment applies to

benefits accrued as of the later of the adoption date or the effective

date of the amendment. Sections 1.411(d)-4, Q&A-1(b)(1) and

1.401(a)(4)-4(e) specify that different optional forms of benefit

within the meaning of section 411(d)(6)(B) result from differences in

the medium of a distribution (e.g., cash or in-kind) from a plan.

Section 411(d)(6)(C) provides that any tax credit employee stock

ownership plan or any employee stock ownership plan is not treated as

failing to meet the requirements of section 411(d)(6) merely because it

modifies distribution options in a nondiscriminatory manner.

Special Rules Regarding Medium of Distribution From ESOPs

Section 409(h) contains requirements relating to distributions from

tax credit employee stock ownership plans. Section 4975(e)(7) extends

the requirements of section 409(h) to other employee stock ownership

plans as well, and section 401(a)(23) extends the requirements of

section 409(h) to qualified plans that are stock bonus plans. Under

section 409(h)(1)(A), an employee stock ownership plan or other stock

bonus plan generally is required to make distributions available in the

form of employer securities. Prior to its amendment by TRA '97, section

409(h)(2) provided an exception to this rule in the case of an employer

whose charter or bylaws restrict the ownership of substantially all

outstanding employer securities to employees or to a trust described in

section 401(a).

Under section 1361, certain small business corporations that do not

have more than 75 shareholders are eligible to elect treatment as S

corporations whose tax attributes generally flow through to

shareholders in accordance with the rules of subchapter S of chapter 1

of subtitle A of the Internal Revenue Code. Prior to the Small Business

Job Protection Act of 1996 (SBJPA), Public Law 104-188, 110 Stat. 1755

(1996), an S corporation could not maintain an employee stock ownership

plan because an S corporation could not have a qualified trust

described in section 401(a) as a shareholder. SBJPA amended the

requirements for S corporations, effective for tax years beginning

after December 31, 1996, to permit certain tax-exempt organizations,

including qualified trusts described in section 401(a), to be S

corporation shareholders.

TRA '97 made an additional change to the rules governing qualified

plans holding securities of an S corporation employer, to make it

easier for S corporation employers to facilitate employee ownership of

employer securities through qualified plans. Section 1506 of TRA '97

extends the exception of section 409(h)(2) to cover S corporations,

effective for taxable years beginning after December 31, 1997. Pursuant

to this change, tax credit employee stock ownership plans, employee

stock ownership plans, and other stock bonus plans established and

maintained by S corporation employers are not required to offer

distributions in the form of employer securities.

Section 1.411(d)-4, Q&A-2(d)(2)(ii) provides an exception from the

requirements of section 411(d)(6) for plan amendments that eliminate

optional forms of benefit from a tax credit employee stock ownership

plan, an employee stock ownership plan, or a stock bonus plan, for

certain employers. Section 1.411(d)-4, Q&A-2(d)(2)(ii) applies to

employers that become substantially employee-owned, if the employer

otherwise meets the requirements of section 409(h)(2) with respect to

restrictions on the ownership of outstanding employer stock. These

temporary regulations expand this exception from the requirements of

section 411(d)(6) to apply to S corporations as well, to reflect the

TRA '97 changes to section 409(h).

[[Page 47173]]

Rules for Plan Amendments Pursuant to TRA '97

Section 1541 of TRA '97 contains provisions relating to plan

amendments that are adopted as a result of TRA '97. If section 1541

applies to a plan amendment, section 1541(a) provides that the plan

will be treated as operated in accordance with its terms and will not

fail to satisfy the requirements of section 411(d)(6) by reason of the

amendment. Section 1541 applies to a plan amendment that is made

pursuant to a legislative change in the pension and employee benefit

provisions of TRA '97, provided the following conditions are satisfied.

First, the plan amendment must be adopted before the first day of the

first plan year beginning on or after January 1, 1999 (2001, in the

case of a governmental plan, as defined in section 414(d)). Second, the

plan must be operated in accordance with the terms of the plan

amendment, beginning on the date the legislative change takes effect,

or, if the amendment is not required by the legislative change, the

effective date of the amendment specified by the plan. Third, the plan

amendment must be made retroactively effective.

The remedial amendment period for adopting plan amendments to which

section 1541 of TRA '97 applies was extended pursuant to the rules of

section 401(b) in Rev. Proc. 98-14 (1998-4 I.R.B. 22). To provide a

uniform time for plan amendment, these temporary regulations extend the

time for the section 411(d)(6) relief provided by section 1541 of TRA

'97 to the end of the remedial amendment period for these plan

amendments.

Other Section 411(d)(6) Issues

In Notice 98-29 (1998-22 I.R.B. 8), the IRS requested public

comment regarding a number of possible methods of providing section

411(d)(6) relief, particularly for defined contribution plans. The IRS

will also consider comments submitted pursuant to Notice 98-29 that

propose other methods of providing section 411(d)(6) relief to address

special concerns of employee stock ownership plans.

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)

does not apply to these regulations, and because the regulation does

not impose a collection of information on small entities, the

Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply.

Pursuant to section 7805(f) of the Internal Revenue Code, these

temporary regulations will be submitted to the Chief Counsel for

Advocacy of the Small Business Administration for comment on their

impact on small business.

Drafting Information: The principal author of these regulations is

Linda S.F. Marshall, Office of the Associate Chief Counsel (Employee

Benefits and Exempt Organizations). 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 is amended by adding

an entry in numerical order to read in part as follows:

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

Sec. 1.411(d)-4T also issued under 26 U.S.C. 411(d)(6). * * *

Par. 2. Section 1.411(d)-4 is amended by:

1. Removing the reference ``Q&A-5'' and adding Q&A-2'' in its place

in the first sentence of Q&A-2(d)(1) introductory text.

2. Adding a sentence at the end of Q&A-2(d)(3) to read as follows:

Sec. 1.411(d)-4 Section 411(d)(6) protected benefits.

* * * * *

Q-2: * * *

A-2: * * *

(d) * * *

(3) * * * (For taxable years beginning after December 31, 1997, see

Sec. 1.411(d)-4T Q&A-2(d).)

* * * * *

Par. 3. Section 1.411(d)-4T is added to read as follows:

Sec. 1.411(d)-4T Section 411(d)(6) protected benefits (temporary).

Q&A-1: [Reserved]. For further information, see Sec. 1.411(d)-4

Q&A-1.

Q-2: To what extent may section 411(d)(6) protected benefits under

a plan be reduced or eliminated?

A-2: (a) through (c) [Reserved]. For further information, see

Sec. 1.411(d)-4 Q&A-2 (a) through (c).

(d) ESOP and stock bonus plan exception--(1) In general. Subject to

the limitations in paragraph (d)(2) of this Q&A-2, a tax credit

employee stock ownership plan (as defined in section 409(a)), an

employee stock ownership plan (as defined in section 4975(e)(7)), or a

stock bonus plan that is not an employee stock ownership plan will not

be treated as violating the requirements of section 411(d)(6) merely

because of the circumstances described in paragraph (d)(1)(ii) of this

Q&A-2.

(i) [Reserved]. For further information, see Sec. 1.411(d)-4 Q&A-

2(d)(1)(i).

(ii) Employer becomes substantially employee-owned or is an S

corporation. The employer eliminates, or retains the discretion to

eliminate, with respect to all participants, optional forms of benefit

by substituting cash distributions for distributions in the form of

employer stock with respect to benefits subject to section 409(h) in

the circumstances described in paragraph (d)(1)(ii)(A) or (B) of this

Q&A-2, but only if the employer otherwise meets the requirements of

section 409(h)(2)--

(A) The employer becomes substantially employee-owned; or

(B) For taxable years of the employer beginning after December 31,

1997, the employer is an S corporation as defined in section 1361.

(iii) and (iv) [Reserved]. For further information, see

Sec. 1.411(d)-4 Q&A-2(d)(1) (iii) and (iv).

(2) Limitations on ESOP and stock bonus plan exceptions.

[Reserved]. For further information, see Sec. 1.411(d)-4 Q&A-2(d)(2).

(3) Effective date. Paragraph (d) of this Q&A-2 applies for taxable

years beginning after December 31, 1997. For taxable years beginning

prior to January 1, 1998, see Sec. 1.411(d)-4 Q&A-2(d).

(4) [Reserved]. For further information, see Sec. 1.411(d)-4 Q&A-

2(d)(4).

Q&A-3 through Q&A-10 [Reserved]. For further information, see

Sec. 1.411(d)-4 Q&A-3 through Q&A-10.

Q-11: To what extent may a plan amendment that is made pursuant to

the Taxpayer Relief Act of 1997 (TRA '97) (Public Law 105-34, 111 Stat.

788) reduce or eliminate section 411(d)(6) protected benefits?

A-11: A plan amendment does not violate the requirements of section

411(d)(6) merely because the plan amendment reduces or eliminates

section 411(d)(6) protected benefits as of the effective date of the

plan amendment, provided that--

(a) The plan amendment is made pursuant to an amendment made by

title XV, or subtitle H of title X, of TRA '97; and

(b) The plan amendment is adopted no later than the last day of any

[[Page 47174]]

remedial amendment period that applies to the plan pursuant to

Secs. 1.401(b)-1 and 1.401(b)-1T for changes under TRA '97.

Approved: July 24, 1998.

Michael P. Dolan,

Deputy Commissioner of Internal Revenue.

Donald C. Lubick,

Assistant Secretary of the Treasury.

[FR Doc. 98-23569 Filed 9-3-98; 8:45 am]

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