SERVICE TIDIES UP SECTION 401(k) REGULATIONS; DELAYS RULE THAT PARTNER'S VARIANCE OF CONTRIBUTION AMOUNTS RESULTS IN DEEMED CODA.

Notice 88-127

The purpose of this notice is to provide guidance to taxpayers regarding the effective dates for certain provisions addressed in final and proposed regulations concerning cash or deferred arrangements published in the Federal Register on August 8, 1988, (53 FR 29658 and 53 FR 29719), to correct citations in the proposed regulations, and to clarify certain provisions in the final regulations.

I. BACKGROUND

Section 401(k) of the Internal Revenue Code provides, in general, that a qualified cash or deferred arrangement is an arrangement which is part of a profit-sharing or stock bonus plan, a pre-ERISA money purchase plan, or a rural electric cooperative plan under which an eligible employee may elect to have the employer make certain payments to a trust under the plan on behalf of the employee, or to the employee in cash. On November 10, 1981, the Federal Register published proposed regulations regarding cash or deferred arrangements (46 FR 55544). On August 8, 1988, final regulations (5) FR 29658, T.D. 8217) and proposed regulations (53 FR 29719) relating to cash or deferred arrangements described under section 401(k) of the Internal Revenue Code of 1986 and proposed regulations (5) FR 29719) relating to nondiscrimination requirements for employee and matching contributions were published in the Federal Register.

II. APPLICABILITY TO PARTNERSHIPS

Section 1.401(k)-1(a)(6)(ii) of the proposed regulations, concerning applicability to partnerships, generally provides that an arrangement that directly or indirectly permits individual partners to vary the amount of contributions made on their behalf on a year- to-year basis will be deemed to constitute a cash or deferred arrangement with respect to such partners. Section 1.401(k)- 1(a)(3)(iii) of the final regulations provides, in general, that a one-time irrevocable election made by an employee to have the employer contribute a specified amount or percentage of compensation to a plan for the duration of the employee's employment with the employer, will not be treated as having been made pursuant to a cash or deferred arrangement if the election is made upon commencement of employment or upon the employee's first becoming eligible under any plan of the employer.

Final regulations will be amended to provide that the provisions of section 1.401(k)-1(a)(6)(ii) of the proposed regulations will be effective for contributions made with respect to plan years beginning after December 31, 1988. In addition, contributions made by partners to arrangements described in section 1.401(k)-1(a)(6)(ii) of the proposed regulations will constitute elective deferrals under section 402(g)(8) of the Code for any partnership year beginning before January 1, 1989, only if the arrangement under which the contributions were made utilized the nondiscrimination test of section 401(k)(3) for the plan year ending with or within such partnership year.

Final regulations will also be amended to provide that an individual's one-time irrevocable election to participate or not to participate in a plan in which only partners may participate will not constitute a cash or deferred election if such election is made on or before the later of the first day of the first plan year beginning after December 31, 1988, or March 31, 1989, without regard to whether the election is made upon the commencement of employment or upon the employee's first becoming eligible under any plan of the employer.

III. HARDSHIP DISTRIBUTIONS

Section 1.401(k)-1(d) of the final regulations generally permits hardship distributions to be made from a qualified cash or deferred arrangement if the participant has an immediate and heavy financial need and the distribution is necessary to satisfy such financial need. The final regulations provide that a plan may provide that certain expenses will be deemed to constitute immediate and heavy financial needs, and that an employee will be deemed to lack other resources reasonably available to meet the financial need if certain requirements are satisfied. Section 1.401(k)-1(d)(2)(iv)(A) of the regulations provides that a plan will not be treated as violating section 411(d)(6) of the Code merely because the plan is amended to modify the standards for hardship distributions to reflect the applicable requirements in the final regulations. Section 1.401(k)- 1(d)(2)(iv)(B) of the regulations provides that the exception to section 411(d)(6) set forth in paragraph (d)(2)(iv)(A) is available only with respect to an amendment that is effective on or before the first day of the first plan year commencing on or after January 1, 1989.

The final regulations will be amended to provide that a plan will not be treated as violating section 411(d)(6) merely because it is amended to specify or modify nondiscriminatory and objective standards that will be used for determining the existence of an immediate and heavy financial need, the amount necessary to meet the need, and other conditions relating to eligibility to receive a hardship distribution. Thus, for example, a plan will not be treated as violating section 411(d)(6) merely because it is amended to specify or modify the resources an employee must utilize before qualifying for a hardship distribution or to require employees to provide additional statements or representations to establish the existence of a hardship. This exception to section 411(d)(6) is available only with respect to an amendment that is adopted within the time period permitted for required amendments to the plan under section 1140 of the Tax Reform Act of 1986 (as extended in the regulations under section 401(b)) and that is retroactively effective to the date on which the plan began operating in accordance with such standards.

The preamble to the final regulations provides that for plan years beginning before January 1, 1988, operation in accordance with regulations proposed on November 10, 1981, is a reasonable interpretation of section 401(k). The final regulations will be amended to provide that with respect to hardship distributions made on or before March 31, 1989, operation in accordance with the regulations proposed on November 10, 1981, is a reasonable interpretation of section 401(k).

The final regulations will also be amended to clarify that for purposes of section 1.401(k)-1(d)(2)(iii)(B)(a) of the regulations the phrase "and all other plans maintained by the employer" includes all qualified and nonqualified plans of deferred compensation maintained by the employer, other than the mandatory employee contribution portion of a defined benefit plan, but does not include health or welfare benefit plans. For these purposes, the phrase includes stock option, stock purchase, and similar plans. It also includes a cash or deferred arrangement that is part of a cafeteria plan within the meaning of section 125 of the Code. Further, for purposes of section 1.401(k)-1(d)(2)(iii)(B)(3) of the regulations, a cessation of elective deferrals made pursuant to a cash or deferred arrangement that forms a part of a cafeteria plan, within the meaning of section 125 of the Code, will not be considered a revocation of an election, as described in section 1.125-1, Q/A-15 of the proposed regulations.

IV. AGGREGATION OF PLANS

Section 1.401(k)-1(b)(5)(ii) of the final regulations provides that contributions and allocations under a plan or portion of a plan described in section 4975(e)(7) (an ESOP) may not be combined with contributions and allocations under a plan not described in section 4975(e)(7) (a non-ESOP) for purposes of determining whether either the ESOP or the non-ESOP satisfies section 1.401(k)-1(b) of the regulations and sections 401(a)(4), 401(k) and 401(b). Section 1.401(m)-1(b)(4)(ii) of the proposed regulations contains a similar rule for matching contributions. Section 1.401(k)-1(g)(8)(ii) of the final regulations provides that for plan years beginning after December 31, 1986, in the case of a highly compensated employee who is eligible to participate in more than one cash or deferred arrangement of the same employer, the actual deferral ratio shall be calculated by treating all the cash or deferred arrangements in which the employee is eligible to participate as one arrangement. Section 1.401(m)-1(f)(13)(ii) of the proposed regulations contains a similar provision for matching contributions.

Final regulations will provide that the mandatory aggregation of elective contributions under section 1.401(k)-1(g)(8)(ii) of the final regulations will not be required in the case of contributions to plans that may not be aggregated under section 1.401(k)- 1(b)(5)(ii) of the final regulations. Similarly, aggregation of matching contributions and employee contributions under section 1.401(m)-1(f)(13)(ii) of the proposed regulations will not be required in the case of contributions to plans that may not be aggregated under section 1.401(m)-1(b)(4)(ii) of the proposed regulations.

V. MATCHING CONTRIBUTIONS

Final regulations will be amended to clarify that for purposes of section 1.401(k)-1(g)(6) the term "matching contributions" will include discretionary employer contributions that are allocated with respect to employee contributions or elective contributions. Final regulations will also be amended to clarify that multiple use of the alternative methods of compliance contained in section 401(k)(3)(A)(ii)(II) and 401(m)(2)(A)(ii) occurs only if the actual deferral percentage of the group of highly compensated employees described in section 1.401(m)-2(b)(1)(i) of the proposed regulations exceeds 125 percent of the actual deferral percentage of nonhighly compensated employees and if the actual contribution percentage of such highly compensated employees exceeds 125 percent of the actual contribution percentage of nonhighly compensated employees. Further guidance will be provided in the near future with respect to the applicable aggregate limit in cases in which the actual deferral percentage or actual contribution percentage of nonhighly compensated employees is less than two percent.

VI. DEFINITION OF COMPENSATION

Section 1.401(k)-1(g)(9)(ii) provides that, for plan years beginning after December 31, 1988, or on or after the later date provided in section 1.401(k)-1(h), a plan must take into account all compensation received by a participant for the plan year in which the plan is being tested for compliance with the nondiscrimination tests of section 401(k)(3). Section 1.401(k)-1(g)(9)(ii) of the proposed regulations clarifies that, in the case of an employee who begins, resumes, or ceases to be eligible to make elective contributions during a plan year, all compensation received by the employee during the entire plan year must be taken into account. In addition, for the first plan year of the cash or deferred arrangement, the compensation to be taken into account in computing the actual deferral ratio of an employee includes compensation received by the employee during the 12-month period ending on the last day of such plan year. Similar rules are contained in section 1.401(m)-1(f)(14) of the proposed regulations.

Final regulations will be amended to provided that, for plan years beginning before January 1, 1990, or before the later date provided in section 1.401(k)-1(h) if applicable, a plan may limit the compensation taken into account to compensation received by an employee while the employee is a plan participant.

VII. CORRECTIONS

The first sentence in section 1.401(m)-1(e)(3)(i) of the proposed regulations published in the Federal Register on August 8, 1988, (53 FR 29719) should be corrected to read as follows: "Excess aggregate contributions (and income allocable thereto) are corrected in accordance with this paragraph (e)(3) only if such excess aggregate contributions and allocable income are designated by the employer as a distribution of excess aggregate contributions (and income) and are distributed to the appropriate highly compensated employees, after the close of the plan year in which the excess aggregate contribution arose and within twelve months after the close of the plan year."

The citation to paragraph (g)(8)(iii)(A)(1) in the first sentence of section 1.401(k)-1(f)(5)(iii) of the proposed regulations published in the Federal Register on August 8, 1988, (53 FR 29719) should read "paragraph (g)(8)(iii)(A)(2)." The citation to paragraph (g)(8)(iii)(A)(2) in the second sentence of section 1.401(k)- 1(f)(5)(iii) of the proposed regulations should read "paragraph (g)(8)(iii)(A)(1)."

The citation to paragraph (f)(13)(iii)(1) in the first sentence of section 1.401(m)-1(e)(4)(iii) of the proposed regulations should read "paragraph (f)(13)(iii)(2)." The citation to paragraph (f)(13)(iii)(2) in the second sentence of section 1.401(m)- 1(e)(4)(iii) should read "paragraph (f)(13)(iii)(1)."

ADMINISTRATIVE PRONOUNCEMENT

This document serves as an "administrative pronouncement" as that term is described in section 1.6661-3(b)(2) of the Income Tax Regulations and may be relied upon to the same extent as a revenue ruling or revenue procedure.

DRAFTING INFORMATION

The principal author of this notice is Catherine Livingston Fernandez of the Office of Assistant Chief Counsel, (Employee Benefits and Exempt Organizations). For further information regarding this notice contact the Employee Plans Technical and Actuarial assistance telephone service between the hours of 1:30 p.m. and 4 p.m., Eastern Time, Monday through Friday on (202) 566-6783/6784 (not a toll-free number). Ms. Fernandez's telephone number is (202) 566- 3060 (not a toll-free call).