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 8806]

RIN 1545-AV94

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

final regulations change the existing final 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 final regulations affect

sponsors of qualified retirement plans, employers that maintain

qualified retirement plans, and qualified retirement plan participants.

The amendments to the temporary regulations remove previously issued

temporary regulations on the same subject.

DATES: These regulations are effective January 8, 1999.

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 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). On September 4, 1998,

temporary regulations (TD 8781) under section 411(d)(6) were published

in the Federal Register (63 FR 47172). A notice of proposed rulemaking

(REG-101363-98), cross-referencing the temporary regulations, was

published in the Federal Register (63 FR 47214) on the same day. The

temporary regulations conform the regulations 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, the 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).

One written comment responding to the notice of proposed rulemaking

was received. No public hearing was requested or held. The proposed

regulations under section 411(d)(6) are adopted by this Treasury

decision, and the corresponding temporary regulations are removed.

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.

[[Page 1126]]

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

regulations retain the provision in the temporary regulations to expand

the exception of Sec. 1.411(d)-4, Q&A-2(d)(2)(ii) 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).

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 regulations add a new

Sec. 1.411(d)-4, Q&A-11 to retain the rule of Sec. 1.411(d)-4T, Q&A-11

of the temporary regulations extending 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.

The sole commentator raised a concern regarding whether this

extension of the time period for section 411(d)(6) relief originally

provided under section 1541 of TRA '97 restricts the time during which

any plan amendment can be made to eliminate in-kind distributions of

employer securities from employee stock ownership plans of S

corporations. The extension of the time period for this section 1541

statutory relief pursuant to Sec. 1.411(d)-4, Q&A-11 does not restrict

the time period during which a plan amendment can be made to eliminate

these in-kind distributions as permitted under Sec. 1.411(d)-4, Q&A-

2(d)(2)(ii); to the contrary, the Sec. 1.411(d)-4, Q&A-11 extension of

this statutory relief period provides an additional time period for the

adoption of certain plan amendments to eliminate these in-kind

distributions after these in-kind distributions have been eliminated in

operation. Under the ongoing rule of Sec. 1.411(d)-4, Q&A-2(d)(2)(ii),

a plan amendment to eliminate these in-kind distributions that is

effective with respect to distributions payable after the date the

amendment is adopted can be made at any time during taxable years of

the employer beginning after December 31, 1997.

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, the notice of

proposed rulemaking preceding these regulations was submitted to the

Small Business Administration for comment on its impact on small

businesses.

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. Revising Q&A-2(d)(2)(ii).

2. Removing the last sentence of Q&A-2(d)(3).

3. Adding Q&A-11.

The additions and revisions read as follows:

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

* * * * *

Q-2: * * *

A-2: * * *

(d) * * *

(2) * * *

(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.

* * * * *

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 1127]]

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.

Sec. 1.411(d)-4T [Removed]

Par. 3. Section 1.411(d)-4T is removed.

Robert E. Wenzel,

Deputy Commissioner of Internal Revenue.

Approved: December 14, 1998.

Donald C. Lubick,

Assistant Secretary of the Treasury.

[FR Doc. 99-152 Filed 1-7-99; 8:45 am]

BILLING CODE 4830-01-U