IRS PROPOSES EXPANSION OF NONDISCRIMINATION SAFE HARBORS.

Notice 92-31

I. PURPOSE

This notice describes and requests comments on certain proposed changes to the general requirements for safe harbor plans in the final regulations under section 401(a)(4) and section 414(s). These proposed changes are designed to increase the number of plans that can demonstrate nondiscrimination in the amount of benefits under section 401(a)(4) using the regulatory safe harbors. They are described in this notice so that the public may comment on them before they are formally published in a notice of proposed rulemaking. Specifically, the proposal would modify the safe harbor requirements to:

o ELIMINATE UNIFORMITY RULES FOR VESTING AND SERVICE CREDITING. Eliminate the threshold requirement that a safe harbor plan provide uniform vesting and service crediting for all employees.

o SIGNIFICANTLY REDUCE RESTRICTIONS ON SERVICE CREDIT WITH ANOTHER EMPLOYER OR DURING A LEAVE OF ABSENCE. Permit a safe harbor plan to provide credit for service with a prior employer and to credit service during a leave of absence or a transfer to another employer in a wide range of circumstances.

o SIGNIFICANTLY REDUCE RESTRICTIONS ON PERMITTED OFFSETS. Permit a safe harbor defined benefit plan to provide an offset for benefits under a prior qualified defined contribution, qualified defined benefit, or certain foreign plan of the employer or another employer.

o EXPAND IMPUTED COMPENSATION RULES IN SECTION 414(s) FOR LEAVES OF ABSENCE AND TRANSFERS. Permit a safe harbor defined benefit plan to credit compensation during a leave of absence or transfer to another employer under the same circumstances that the plan would be permitted to credit service.

o ALLOW COMPENSATION ADJUSTMENTS FOR TRANSFERRED EMPLOYEES. Generally permit a safe harbor plan to take compensation increases into account after an employee transfers out of the coverage group for the plan.

o RELAX FRESH-START RULES. Generally permit a safe harbor plan to adjust each employee's frozen accrued benefit for future compensation increases regardless of when the fresh start occurs. In the case of an acquisition or merger, permit the acquiring employer to make a fresh start solely for the affected employees.

II. SUMMARY OF RELEVANT EXISTING SAFE HARBOR RULES

The final regulations under section 401(a)(4) provide safe harbors on which employers may rely in satisfying the requirement that the amount of benefits under the plan be nondiscriminatory. The regulations require that a safe harbor plan generally be uniform as to plan provisions that affect the determination of the amount of an employee's benefit. Thus, the regulations require that the same benefit formula apply to all employees in a safe harbor plan and that it provide an annual benefit that is either the same percentage of average annual compensation or the same dollar amount for all employees with the same number of years of service at normal retirement age. In addition, the regulations require a safe harbor plan to use the same definition of years of service for all purposes and the same vesting schedule for all employees in the plan. Because qualified plan rules generally are applied on the basis of the controlled-group employer, as defined in section 414, the regulations generally only permit actual service with the employer (or a predecessor employer within the meaning of section 414(a)) to be taken into account under a safe harbor plan.

The regulations provide certain exceptions to these safe harbor requirements. For example, in a safe harbor defined benefit plan, an offset for an employee's vested frozen accrued benefit under a prior defined benefit plan may be disregarded, provided that the offset provision applies uniformly to all employees in the plan, the plan credits years of service earned under the prior defined benefit plan, and the benefit offset is attributable to those years of service. If the prior plan is a plan of another employer, the employees must also have become employed by the current employer as a result of an acquisition or merger. For this purpose, an acquisition or merger includes any stock or asset acquisition, merger, or similar transaction involving a change in the employer of the employees of a trade or business.

In addition, the regulations permit a safe harbor plan to continue to credit service indefinitely while an employee is on jury duty or in military service and for up to six months during other leaves of absence. In order to facilitate crediting of service for purposes of benefit accrual during leaves of absence, parallel provisions in the final regulations under section 414(s) permit a safe harbor defined benefit plan to treat compensation as continuing during a leave of absence for the same periods.

III. ELIMINATE THE UNIFORM VESTING AND SERVICE CREDITING REQUIREMENT FOR SAFE HARBOR PLANS

A. Background

Many employers have indicated that the safe harbors are presently unavailable to them because their plans apply different vesting and service crediting provisions to different groups of employees for a variety of reasons.

B. Description of the proposal

In response, the proposal would eliminate the requirement that a safe harbor plan use the same definition of years of service for all purposes and the same vesting schedule for all employees in the plan. Consequently, a safe harbor plan would be subject to the same rule as other plans that, based on all the relevant facts and circumstances, the vesting and service-crediting provisions of the plan must be nondiscriminatory. The regulations would, however, retain a general requirement that benefits under a safe harbor defined benefit plan must accrue over the same period of service that is used in applying the benefit formula.

IV. SIGNIFICANTLY REDUCE SAFE HARBOR RESTRICTIONS ON SERVICE CREDITING AND BENEFIT OFFSETS

A. Background

Some employers have commented that, under their plans, they credit years of service with other entities that are not part of the controlled-group employer but are related in a practical business sense (e.g., joint venture or same industry). This service is frequently credited in conjunction with an offset for benefits attributable to the service that are provided under the plan of the other entity. Employers have also indicated that it is not uncommon to continue to credit service for more than six months while employees are on leaves of absence.

B. Description of the proposal

In response to these concerns, the proposal would eliminate the requirement that only actual service with the employer or a predecessor employer can be credited under a safe harbor plan. The proposal would also eliminate the requirement that generally only six months of imputed service can be credited during a leave of absence. Instead, as set forth below, a safe harbor plan could provide credit for pre-participation service (i.e., service credited to transferee employees for service with the employer or a prior employer prior to plan entry) or imputed service (i.e., service credited during a transfer to another employer, a leave of absence, or a period of reduced services) in a broad range of circumstances and without specific time limits. Under the proposal, a plan that credits pre- participation service or imputed service could satisfy the nondiscrimination in amounts requirement on a safe harbor basis with respect to that service if the following basic requirements were satisfied:

o A plan provision crediting pre-participation service or imputed service to any highly compensated employee applies to all similarly situated nonhighly compensated employees;

o The employer has a legitimate business reason, based on all the relevant facts and circumstances, for crediting service with the other employer as service under its plan (or, in the case of a leave of absence or reduction in work schedule, for crediting service at the level being credited); and

o In operation, and based on all the relevant facts and circumstances, the service credit does not discriminate significantly in favor of highly compensated employees.

The rule in the final regulations that, for purposes of section 410(b), treats an employee credited with imputed service under the plan of an employer as an employee of that employer during the period of imputed service, rather than as a former employee, would be retained. As under current law, any credit for imputed service must satisfy the requirement of section 401(a)(2) that a plan be maintained for the exclusive benefit of employees. However, it is expected that Rev. Rul. 73-238, 1973-1 C.B. 193, will be reconsidered to the extent that it would not permit the crediting of imputed service described in this proposal.

In conjunction with the proposed changes regarding crediting of pre-participation service, restrictions on benefit offset provisions for safe harbor plans would be significantly reduced. In general, the rules would provide that if pre-participation service is credited under a plan, any offset for vested benefits under a prior plan (qualified defined contribution plan, qualified defined benefit plan, or certain foreign plan) of the employer or another employer that are attributable to the same service will be disregarded in determining whether the plan is a safe harbor plan. If the prior plan is a defined benefit plan, the benefit under the prior plan attributable to the pre-participation service would not need to be frozen as required under the current rules. Therefore, the benefit under the prior plan could be increased to take into account either increases in the employee's compensation or plan amendments. As currently required under the regulations, the same offset provision in a plan would be required to apply to all similarly situated employees in the plan.

C. Description of criteria for satisfying each of the three requirements for crediting pre-participation or imputed service

1. Same treatment for all similarly situated employees

Whether two employees are similarly situated would be based on reasonable business criteria relating to the crediting of service. Generally, the determination of whether employees are similarly situated would focus on the event resulting in the employees being covered under the plan and on the situation of the employees during the period for which pre-participation service or imputed service is credited. For example, employees who transfer into the plan as a result of a merger and who were in the same plan of a prior employer would be similarly situated.

2. Legitimate business reason for crediting service

The following would be examples of possible legitimate business reasons for an employer maintaining a plan to treat service with another employer as service under its plan: the two employers share interrelated business operations, or one employer has a significant ownership interest in the other employer (though not enough ownership to create a controlled group); the employers maintain the same multiple-employer plan; the employers share similar attributes, such as operation in the same industry or the same geographic area; or the employees of one employer become employees of another employer as a result of an acquisition or merger.

Because a leave of absence is by definition temporary, an employer generally would not have a legitimate business reason for continuing to credit any service based on a leave of absence to an individual after the individual has permanently ceased to perform services as an employee and is not expected to return. It is anticipated that a rebuttable presumption would be provided that, after two years, an employee on leave of absence is not expected to return to service with the employer maintaining the plan. Jury duty or military service could automatically rebut the presumption. Other evidence, such as the terms of an employment contract, or specific leave to pursue a degree requiring more than two years of study, could also rebut the presumption. Similar rules would apply in the case of crediting service as if the employee were performing services on a full-time basis where there is a temporary change to a part-time work schedule.

3. No significant discrimination

a. Pre-participation service

The following would be examples of potentially relevant facts and circumstances for determining whether, in operation, the crediting of pre-participation service discriminates significantly: whether the service credit does not duplicate benefits but merely makes an employee whole (i.e., prevents the employee from being disadvantaged by a change in job or employer or provides the employee with benefits comparable to those of other employees in the plan); the degree of the business ties between the current employer and the prior employer, such as the degree of ownership interest or other affiliation; the degree of excess coverage under section 410(b) of nonhighly compensated employees in the plan, taking into account employees who are credited with pre-participation service; whether the prior employer maintains a qualified plan for its employees; the existence of reciprocal service credit by other plans of the employer or the prior employer; the relative number of employees other than 5 percent owners or the employer's most highly compensated employees who have been or are expected over time to be credited with pre- participation service; the circumstances underlying the employee's transfer into the group of employees covered by the plan; and the type of service being credited (e.g., vesting service as compared to service under the benefit formula or accrual method).

b. Imputed service

To the extent relevant, the kind of facts and circumstances described above would also apply for determining whether credit for imputed service discriminates significantly. In addition, relevant facts and circumstances for determining whether, in operation, crediting imputed service during a leave of absence or a period of reduced services discriminates significantly would generally take into account the relative availability of the leaves of absence or temporary part-time work schedules, respectively.

V. EXPAND RULES IN SECTION 414(s) FOR IMPUTED COMPENSATION

A. Background

Some employers have indicated that, when an employee transfers to or from a related employer, the employee's compensation with the related employer is taken into account in determining the employee's benefit under the current employer's plan. In addition, employers have indicated that, under a plan benefit formula, compensation is sometimes treated as continuing during a leave of absence for more than the six-month period permitted under the final regulations under section 414(5), or an employee's compensation is treated as continuing at a full-time rate for purposes of pension benefits while the employee is temporarily working part-time.

B. Description of the proposal

To accommodate these types of plan provisions, the regulations under section 414(s) would be modified to permit a defined benefit plan to include imputed compensation as section 414(s) compensation under the same circumstances that the plan would be permitted to impute service or to credit pre-participation service with another employer. Thus, the similarly situated, legitimate business reason, and no significant discrimination requirements discussed in Part IV above would apply.

The regulations currently provide that the amount of imputed compensation is generally based on the rate of compensation in effect for the employee when the leave of absence begins or for the employee's job grade while an employee is on a leave of absence. The proposal would expand those options by permitting a plan to determine the amount of imputed compensation for a period when an employee is working for another employer by reference to the actual compensation paid by the other employer.

VI. ALLOW COMPENSATION ADJUSTMENTS FOR TRANSFERRED EMPLOYEES

A. Background

Some employers have indicated that, when an employee transfers out of the group of employees covered by a plan, their plan formula takes into account post-transfer increases in the employee's compensation. Under the final regulations, a plan that provides current accruals in the form of additional benefits based on compensation increases after an employee transfers out of the coverage group violates the safe harbor requirement that benefits accrue over the same period of service that is used in applying the benefit formula.

B. Description of the proposal

The regulations would be modified to allow a safe harbor plan to continue the accrual of additional benefits for employees who transfer out of the coverage group for the plan (e.g., transfer to another division or another employer) based on compensation increases after the transfer even though those employees are no longer being credited with years of service under the plan's benefit formula. However, in order to be a safe harbor plan, the plan would have to be able to satisfy section 410(b) if the nonhighly compensated employees in the plan who accrue benefits solely because of compensation increases were treated as not benefiting under the plan.

When employees transfer to another employer and the original employer treats compensation with the other employer as section 414(s) compensation in accordance with the proposal in Part V, the original employer would have the option of treating all those nonhighly compensated employees who continue to accrue benefits after the transfer solely because of higher compensation from the other employer as excludable employees.

VII. RELAX FRESH-START RULES TO FACILITATE POST-EFFECTIVE DATE AMENDMENTS

A. Summary of relevant safe harbor fresh-start rules

The final regulations permit an employer with a safe harbor plan to disregard benefits accrued before a specified date under another formula if the employer makes a fresh start under its plan as of that date. One of the requirements for making a fresh start is that the employer freeze the accrued benefit of, and apply the new formula to, every employee in the plan as of the fresh-start date. Thus, an employee's accrued benefit as of the fresh-start date may not be adjusted to take into account future increases in the employee's compensation. As a transition rule, however, the regulations provide that, if the fresh-start date is before the effective date of the final regulations under section 401(a)(4), each employee's accrued benefit as of the fresh-start date may be adjusted to take into account compensation increases provided that certain additional requirements are met. One of these additional requirements is that the plan provided meaningful coverage as of the fresh-start date. This requirement is satisfied if the group of employees who are eligible for these adjustments (i.e., the group of employees with accrued benefits under the plan as of the fresh-start date) satisfied section 410(b) as in effect on that date.

B. Background

Employers have indicated that requiring each employee's accrued benefit to be frozen in order for a plan to make a fresh start will significantly restrict their ability to take advantage of the regulatory safe harbors if a plan is amended after the effective date of the regulations. Employers have indicated that this is a particular concern when there is a transfer of plan assets and liabilities in conjunction with an acquisition or merger and a fresh start is needed for only the affected employees.

C. Description of the proposal

1. Allow adjustments for compensation increases after a fresh start

In response to these concerns, the fresh start rules would be relaxed to permit adjustments to each employee's accrued benefit, as of a fresh-start date, to take into account future compensation increases regardless of when the fresh start occurred, provided that the requirements under the current transition rule permitting these adjustments were satisfied. In addition, if the fresh-start date is after the effective date of the regulations, the group of employees eligible for these adjustments would be required to separately satisfy section 410(b) for five plan years after the fresh-start date rather than only on the fresh start date.

2. Allow separate fresh start for acquisitions or mergers

If an employer acquires the employees of a trade or business through an acquisition or merger and there is also a transfer of plan assets and liabilities, the acquiring employer could make a fresh start under the proposal solely with respect to the acquired employees. Alternatively, the employer could make a fresh start solely with respect to the employees of the acquired trade or business as of the fresh-start date, including additional employees who are hired by or transferred into the acquired trade or business on or before the fresh start date. Thus, an employer could freeze the transferred accrued benefits and apply the ongoing benefit formula in its plan in determining the benefits of the new employees without having to freeze the accrued benefits of the other employees in the plan whose benefits are already determined under that benefit formula. In this case, the fresh-start date could be any date during the transition period described in section 410(b)(6)(C)(ii) with respect to that transaction (or, if later, the effective date of the final regulations).

Where a fresh start is made solely with respect to employees of an acquired trade or business, the proposed rule in Section C.1 of this Part VII permitting the accrued benefit as of the fresh-start date to be adjusted to take into future compensation increases, could be applied taking into account solely the employees affected by the fresh start. In this context, the requirement for meaningful coverage as of the fresh-start date would not apply to pre-effective date fresh starts. For post-effective date fresh starts, the group of affected employees would only be required to separately satisfy section 410(b) (with respect to the acquiring employer and without regard to section 410(b)(6)(C)) either as of the date of the acquisition or merger or as of the fresh-start date.

VIII. COMMENTS

The Service and Treasury invite comments on the proposals described in this notice. Comments should be submitted in writing, referencing Notice 92-31, and addressed to --

     Associate Chief Counsel

The principal author of this notice is Marjorie Hoffman of the Office of the Associate Chief Counsel (Employee Benefits and Exempt Organizations). For further information, contact Ms. Hoffman at 202- 377-9372 (not a toll-free number).