IRS ISSUES TRANSITION RELIEF FROM FINAL NONDISCRIMINATION RULES.

Notice 91-38

I. PURPOSE

This notice describes transition rules that will be in effect for the recently finalized nondiscrimination regulations (56 FR 47524, September 19, 1991) as well as the final regulations to be issued shortly with respect to employers operating separate fines of business. While both regulations will be effective for plan years beginning on or after January 1, 1992, considerable flexibility will be given to plan sponsors with respect to the 1992 plan year in order to permit plan design decisions to be made during that year. This notice provides plan sponsors with a description of these transition provisions to assist employers in bringing plans into compliance with the regulations.

II. SECTION 401(a)(4) -- NONDISCRIMINATION REQUIREMENTS

Final regulations were issued under section 401(a)(4) on September 19, 1991. These regulations are effective for plan years beginning on or after January 1, 1992. Under section 401(b), plan sponsors have until the last day of the 1992 plan year to amend their plans, retroactively, to comply with the section 401(a)(4) and related requirements. However, if a plan sponsor does not act by the first day of the 1992 plan year, section 411(d)(6) will limit the amendment options available to the plan sponsor. In addition, the regulations provide several opportunities for plan sponsors to have a fresh start and some of these provisions are affected by the plan sponsor's action or failure to act by the effective date of the regulations.

Recognizing the need of plan sponsors for adequate time to review their plans and select among their design alternatives, this notice provides broad transition relief intended to eliminate situations in which an employer must act by the effective date of the regulations in order to take full advantage of its compliance alternatives. Thus, under this notice, plan sponsors may retain their plan design options through the last day of the 1992 plan year, thereby permitting them a minimum of 15 months from the date of publication of the final regulations to review those regulations and make their amendment decisions.

A. Extension of Alternative II D.

The transition relief provided by Alternative II D of Notice 88-131, 1988-2 C.B. 546, is extended through the last day of the 1992 plan year for individually designed plans, including volume submitter plans. In the case of an employer who adopts a master or protoype plan, or a regional prototype plan, Alternative II D is extended through the last day of the 1992 plan year or the last day of the plan year that includes the end of the period set foreign in Rev. Proc. 89-9, section 13, 1989-1 C.B. 780, if later.

Employers are reminded that adoption of a plan amendment that meets the requirements of the Tax Reform Act of 1986 ("TRA '86") does not preclude them from operating under Alternative II D (see Notice 89-92, 1989-2 C.B. 410, II G.3.). Under Alternative II D, distributions may be made under the amended formula, including distributions to highly compensated employees described in section 414(q)(1)(A) or (B). However, in applying Alternative II D in 1992, benefits accrued in the 1992 plan year will be subject to the benefit payment restrictions of Alternative II D.

In addition, pursuant to this notice, any employer may operate under Alternative II D for the 1992 plan year (or, in the case of a master or prototype plan or a regional prototype plan, the last day of the plan year that includes the end of the period set forth in Rev. Proc. 89-9, section 13, if later) regardless of whether the employer operated under Alternative II D in any prior plan year. Thus, as an example, an employer that adopted Model Amendment 2 or Model Amendment 3, or operated under Alternative II D, and subsequently adopted a plan amendment, will be entitled to the transition relief provided by Alternative II D for the 1992 plan year, even if distributions have been made to the highly compensated employees described in section 414(q)(1)(A) or (B) under the amended formula. As another example, an employer who needs transition relief only for the 1992 plan year may operate under Alternative II D for the first time in the 1992 plan year. These examples illustrate common situations covered by this provision and are not intended to be exhaustive. In applying Alternative II D in 1992, benefits accrued in the 1992 plan year will be subject to the benefit payment restrictions of Alternative II D.

B. Excess accruals under Alternative II D disregarded for nondiscrimination testing.

When an employer that is using Alternative II D retroactively amends its plan formula before the end of the 1992 plan year, there may be benefits accrued under Alternative II D that exceed the benefits provided under the amended plan formula. Under this notice, these excess accruals may be disregarded for purposes of testing nondiscrimination under section 401(a)(4). Thus, for example, if a plan, as retroactively amended, would otherwise satisfy the uniformity requirements for a safe harbor, it will continue to satisfy those requirements despite differences in benefits arising from the application of Alternative II D. Similarly, accrued benefits for purposes of the general test will be unaffected by excess accruals arising under Alternative II D.

C. Excess accruals under Alternative II D do not limit access to fresh-start rules.

The final regulations under section 401(a)(4) provide fresh- start rules under which an employer is permitted to disregard benefits accrued prior to the plan year being tested for purposes of the safe harbors or the general test. In order to comply with the anti-cutback requirements of section 411(d)(6), an employer wishing to use the fresh-start alternative must either amend the plan before the first day of the plan year immediately following the fresh-start date or amend the plan in such a way that benefits provided under the amended formula equal or exceed benefits provided under the prior formula. Pursuant to this notice, although section 411(d)(6) protects the excess accruals under Alternative II D, the formula adopted by retroactive amendment does not have to equal or exceed the Alternative II D formula in order for the plan to use the last day of the 1991 plan year (or earlier year) as a fresh-start date.

For example, a plan sponsor that applies Alternative II D to a calendar year plan, thereby extending a formula that is not a safe- harbor formula through the 1992 plan year, may wish to satisfy a safe-harbor formula for 1989 and later plan years. This employer can adopt a safe-harbor formula by December 31, 1992, effective January 1, 1989, and qualify for the safe harbor using a fresh-start rule with a fresh-start date of December 31, 1988 (including, if applicable, the compensation adjustments to the pre-fresh-start benefit) without regard to whether the new formula provides greater benefits than the benefits accrued under the prior formula during the Alternative II D period.

D. Simplified nondiscrimination testing for benefits, rights and features through end of 1992 plan year.

For the 1992 plan year, the requirement that benefits, rights and features be currently and effectively available on a nondiscriminatory basis is met if it is satisfied as of the last day of the 1992 plan year, treating any plan amendment made during the plan year regarding eligibility for a benefit, right or feature as if the amendment had been in effect for the entire plan year. Thus (unlike the general rule under the section 401(a)(4) final regulations) for the 1992 plan year, an employer can satisfy the nondiscriminatory availability of benefits, rights and features requirement of section 401(a)(4) by expanding the eligibility for a particular benefit, right or feature at any time up to the last day of the plan year.

E. Amendments may be grouped for purposes of satisfying nondiscrimination requirement for plan amendments through the end of the 1992 plan year.

In general, in order to satisfy the nondiscrimination requirements of section 401(a)(4), a plan amendment must not discriminate significantly in favor of highly compensated employees. Many employers have made, or intend to make, interim amendments in achieving compliance with TRA '86. Consideration of any one of these amendments, without considering the effect of the other amendments effective during the transition period, may not adequately reflect the employer's overall compliance effort. Therefore, any one or more amendments adopted and effective during the TRA '86 transition period through the end of the 1992 plan year, may be grouped by the employer and treated as a single amendment for purposes of satisfying the nondiscrimination requirements.

For example, an employer that adopted Model Amendment 2 freezing benefit accruals for the highly compensated employees in early 1989, might determine that the prior plan design in fact satisfies section 401(a)(4) and choose to continue the prior formula. If this employer amends the plan to restore the frozen accruals to the highly compensated employees, that amendment in isolation could be considered significantly discriminatory. However, when viewed in conjunction with the original amendment freezing benefit accruals for the highly compensated, the two amendments together do not discriminate significantly in favor of highly compensated employees.

F. Special rules for contributory defined benefit plans may be satisfied by amendments made by end of 1992 plan year.

Under the final section 401(a)(4) regulations, employee contributions are disregarded in a contributory defined benefit plan provided the plan ceases employee contributions before the first day of the 1992 plan year. Pursuant to this notice, a plan that ceases employee contributions by the last day of the 1992 plan year is treated as satisfying this requirement. Similarly, certain contributory defined benefit plans in existence on May 14, 1990, were treated as delivering nondiscriminatory employee-provided benefits if the right to make employee contributions is extended to employees at all levels of compensation by the first day of the 1992 plan year. Pursuant to this notice, a plan sponsor may satisfy this requirement by expanding the right to make employee contributions effective as of any date through the last day of the 1992 plan year.

G. Clean slate rule for cumulative disparity satisfied by amendments made by end of 1992 plan year.

Under the final regulations, an employee in a defined contribution plan is not subject to the cumulative disparity limits of section 401(1) unless the employee also benefits under a defined benefit plan of the employer that uses permitted disparity (either under section 401(1) or through imputation under the section 401(a)(4) regulations) in a plan year beginning after December 31, 1991. Under this notice, benefits accrued under a defined benefit plan during the 1992 plan year will be disregarded for purposes of determining whether an employee in a defined contribution plan is subject to the cumulative disparity limits.

H. Clean-slate rule for noncollectively bargained employees in collectively bargained plans satisfied by amendments made by end of 1992 plan year.

Under the final regulations, collectively bargained employees and noncollectively bargained employees are tested separately for purposes of the coverage and nondiscrimination requirements of sections 410(b) and 401(a)(4), respectively. The regulations provide an exception under which noncollectively bargained employees benefiting under a multiemployer plan pursuant to a collective bargaining agreement may be treated as collectively bargained employees for plan years beginning before January 1, 1992. This rule was intended to give the plan sponsors an opportunity to amend the plan to eliminate coverage for noncollectively bargained employees where it would otherwise be difficult or impossible to satisfy the nondiscrimination rules with respect to the noncollectively bargained employees. In order to give plan sponsors additional time to consider their alternatives and make any necessary amendments, under this notice noncollectively bargained employees benefiting under a multiemployer plan pursuant to a collective bargaining agreement will be treated as collectively bargained for plan years beginning before January 1, 1993.

III. SECTION 414(r) -- SEPARATE LINE OF BUSINESS PROVISIONS

Final regulations under section 414(r) separate line of business provisions will be issued shortly. These regulations will be effective for plan years beginning on or after January 1, 1992. However, pursuant to section 204(b)(1) of the Public Debt Limit Increase Act of 1989, for plan years beginning before the Commissioner issues guidelines and begins issuing determinations under section 414(r)(2)(C) of the Internal Revenue Code, an employer shall be treated as operating separate lines of business if the employer reasonably determines in good faith that it meets the requirements of section 414(r) (other than paragraph (2)(C) thereof). Employers will have at least 6 months notice before the period of reasonable good faith compliance ends.

IV. EFFECT ON OTHER DOCUMENTS

Rev. Proc. 89-65, 1989-2 C.B. 786, Notice 88-131, 1988-2 C.B. 546, Notice 89-92, 1989-2 C.B. 410, and Notice 90-73, 1990-2 C.B. 153, are modified.

V. DRAFTING INFORMATION

The principal author of this notice is Lynette Owings of the Employee Plans Technical and Actuarial Division. For further information regarding this notice, please contact the Employee Plans Technical and Actuarial Division's taxpayer assistance telephone service between the hours of 1:30 p.m. and 4 p.m. Eastern Time, Monday through Thursday on (202) 566-6783/6784 (not a toll-free call). Ms. Owings' telephone number is (202) 343-0729 (also not a toll-free call).