IRS OPENS DOOR TO CODA QUALIFICATION FOR PARTNERSHIPS THAT OPTED OUT OF PREVIOUS ELECTION.

Rev. Proc. 91-47

SECTION 1. PURPOSE

This Revenue Procedure provides limited relief to certain partnership plans that failed to make the election provided in Notice 88-127 (section II), 1988-2 C.B. 538. Pursuant to this procedure, if the conditions below are satisfied, the plan or the cash or deferred arrangement (CODA) (whichever is applicable) will be treated as containing a qualified CODA. Thus, the plan will not be disqualified merely because of the failure to amend the plan in accordance with Notice 88-127, but elective contributions under the plan are not excludible or deductible under section 404 above the limit set forth in section 402(g).

SECTION. 2. BACKGROUND INFORMATION

01 On August 8, 1988, the Department of Treasury issued proposed and final regulations under section 401(k) of the Code (the 1988 regulations). These regulations are generally effective for plan years beginning after December 31, 1986. The Department of Treasury has issued final regulations under section 401(k) of the Code. Section 1.401(k)-1(a) of the regulations provides that a plan permitting an election between cash and a deferral under a qualified plan contains a CODA governed by section 401(k) of the Code. If the arrangement does not satisfy the requirements of section 401(k) with respect to qualified CODAs, it is a nonqualified CODA.

02 In order to be qualified, a CODA must, among other requirements,

(1) satisfy the actual deferral percentage test of section 401(k)(3),

(2) immediately and fully vest elective contributions and contributions treated as elective contributions, and

(3) restrict distributions as provided in section 401(k)(2).

03 Under section 401(k)(1) of the Code, a profit-sharing plan, stock bonus plan, pre-ERISA money purchase plan, or a rural cooperative plan does not fail to satisfy section 401(a) merely because it includes a CODA. A money purchase plan (other than a pre- ERISA money purchase plan) or a defined benefit plan that includes a CODA is not qualified.

04 A plan that is permitted to contain a nonqualified CODA and does in fact have one is a qualified plan only if it satisfies section 401(a)(4) without applying the special nondiscrimination test of section 401(k)(3), the actual deferral percentage (ADP) test. In testing a nonqualified CODA under section 401(a)(4), the plan must treat the elective deferrals as nonelective employer contributions. Even if the plan satisfies section 401(a)(4), the elective contributions are includible in a participant's income when they would have been received but for the CODA election. See section 1.401(k)-1(a)(5) of the final regulations.

05 Section 1.401(k)-1(a)(6) of the 1988 regulations and the final regulations specifically provides that arrangements under partnership plans that permit individual partners to vary the amount of contributions that will be contributed on their behalf are CODAs. Under Notice 88-127, until the later of March 31, 1989, or the first day of the first plan year beginning after December 31, 1988, a partnership plan could give individuals the right to make irrevocable elections into or out of the plan. If this election was timely made, amounts contributed were not considered contributed pursuant to a cash or deferred election. If this election was not made, the plan may contain a nonqualified CODA.

SECTION. 3. RELIEF

01 Regulations under section 401(b) of the Code permit plans to be retroactively amended during the "remedial amendment period" to correct defects arising because of new statutory provisions. Although some partnership plans did not obtain one-time irrevocable elections by the time provided in Notice 88-127, the remedial amendment period for these plans is still in effect. See section 1.401(b)- 1(c)(1)(iii).

02 If the conditions set forth in section 4 of this revenue procedure are met, the Service will deem nonqualified CODAs contained in partnership plans to be qualified CODAs and provide the relief set forth in section 3.05, below. In such cases, a partnership plan will not be treated as maintaining a nonqualified CODA merely because it did not timely obtain one-time irrevocable elections in accordance with Notice 88-127. This treatment is available even if the plan is not otherwise permitted to maintain a CODA.

03 However, the elective deferrals under a qualified CODA are subject to sections 402(g) and 401(a)(30) of the Code. Section 402(g) of the Code limits the elective deferrals that may be made on behalf of an individual under a qualified CODA with respect to the individual's tax year. In addition, unless distributed in a timely manner, elective deferrals in excess of the 402(g) limit (excess deferrals) are included in the individual's income in both the year of contribution and the year of distribution. Under Section 401(a)(30), a plan must provide, as a qualification requirement, that it will not accept excess deferrals.

04 Thus, if a partnership plan is deemed to have maintained a qualified CODA, any contributions on behalf of the partners subject to the cash or deferred election that exceed the 402(g) limit for the year are deductible only up to that limit, and are not deductible or excludible in excess of that limit.

05 If the conditions listed in section 4 are met, however, the following provisions will apply:

(1) The Service will not treat the CODA as a nonqualified CODA for plan years beginning before January 1, 1992, solely because it permitted elective contributions under a nonqualified CODA. In addition, the plan will not be disqualified solely due to the existence of excess deferrals that arise because the plan is treated under this revenue procedure as maintaining a qualified CODA.

(2) Deductions for elective contributions under the CODA will not be disallowed for the year of contribution if failure to comply with Notice 88-127 is the sole reason for the disallowance. Similarly, under section 402(g), the excess deferral need only be taken into income once (in the year of distribution) rather than in both the year of contribution and the year of distribution.

(3) The plan need not be amended to satisfy the qualified CODA requirements for the year or years in question. As a result, elective contributions made under these arrangements may be distributed without regard to CODA distribution restrictions.

(4) Except as provided in section 4.01(2)(iii) of this revenue procedure, the Service will not treat a contribution as a nondeductible contribution for purposes of section 4972 to the extent it is nondeductible solely by operation of this revenue procedure.

SECTION 4. CONDITIONS

01 In order to qualify for this relief, the following conditions must be satisfied by the earlier of (a) the last day of the first plan year beginning on or after January 1, 1992, or (b) the date required under section 4.02 of this revenue procedure.

(1) The plan must distribute the excess deferrals (that is, the contributions in excess of those allowed under section 402(g)) for the applicable years, and all income allocable to those amounts.

(2) The plan must satisfy the ADP test for the year or years in question. Excess contributions and all allocable income may be distributed, or Qualified Nonelective Contributions (QNCs) may be added for the nonhighly compensated employees (as provided below) to satisfy the ADP test. See section 1.401(k)- 1(g)(13)(ii) for the definition of a QNC. For purposes of the ADP test:

(i) All contributions on behalf of a partner that the partner could have elected not to have contributed to the plan must be treated as elective deferrals.

(ii) Any contributions that met the QNC requirements when made, but for the distribution restrictions, may be treated as QNCs for this purpose.

(iii) Additional QNCs may be contributed as needed to satisfy the ADP test. The QNCs are annual additions in the plan year in which they are contributed, rather than the plan year for which they are allocated. In addition, they are deductible to the extent allowable under section 404(a) in the year contributed. No plan amendment is required in order to make these additional contributions, provided that such contributions are only added to the extent necessary to satisfy the ADP test for the year or years at issue. However, if these contributions are nondeductible, they will be treated as such for purposes of section 4972.

(3) The plan administrator must issue a Form 1099-R for the distribution, indicating that the amount is a return of excess contributions or deferrals and earnings that is taxable in the year distributed.

(4) The plan must take whatever steps are necessary to satisfy the qualification requirements of section 401(a) for future years. This would include:

(i) A plan permitted to maintain a CODA may choose to do one of the following: maintain a qualified CODA, maintain a non- qualified CODA, eliminate the election, or terminate the plan.

(ii) A plan not permitted to maintain a CODA must either amend the plan to eliminate the election or terminate the plan after making qualifying amendments.

(iii) If partners are given the right to elect not to participate in the amended plan, the election is a cash or deferred election unless it satisfies section 1.401(k)- 1(a)(3)(iv) of the regulations. Thus, to avoid characterization of the election as a cash or deferred election, only individuals who have just commenced employment or just become eligible for any plan of the employer may be given the election.

02 If a plan is already under examination, or comes under examination before meeting the conditions of this procedure, the Service may require the employer to promptly satisfy the conditions in order to be eligible for this relief.

SECTION 5. EXAMPLE

01 The M, N, P and Q Partnership maintains a profit-sharing plan under which all contributions are immediately 100% vested. The plan provides a contribution equal to 10% of compensation above the taxable wage base (TWB) and equal to 5% below the TWB. The TWB is $48,000 for the 1989 year. The four partners have the right to choose a contribution percentage of less than 10% for the portion of the contribution above the TWB and less than 5% for the portion of the contribution below the TWB. The plan has a fiscal year beginning on December 1, 1989, and is not top heavy for the year. The plan did not obtain one-time irrevocable elections into or out of the plan, and was not otherwise amended before the first day of the 1989 plan year to eliminate the election or become a qualified CODA. Thus, the requirements of Notice 88-127 were not satisfied. The partnership taxable year is the calendar year, and the plan requires elections to be made just before the last day of the partnership taxable year. Partners M, N, P and Q are highly compensated employees.

02 The following chart summarizes the compensation and contributions for the 1989 plan year:

                       Percentage of                  Overall

(1) The ADP test must be satisfied. Thus, the actual deferral percentage for the highly compensated employees for the 1989 plan year cannot exceed the greater of (a) 1.25 times the nonhighly compensated actual deferral percentage, or (b) the lesser of two percentage points above the nonhighly compensated actual deferral percentage or two times that percentage.

M.N.P & O PROFIT-SHARING PLAN ADP DATA:

Highly Compensated Actual Deferral Percentage = 5.2

Nonhighly Compensated Actual Deferral Percentage = 5 (treating all the contributions on behalf of the nonhighly compensated as QNCs)

As shown above, the plan passes the ADP test because the highly compensated actual deferral percentage is less than seven percent, the maximum allowed under the ADP test where the nonhighly compensated actual deferral percentage is five percent.

(2) The 402(g) limit for 1989 was $7,624. Thus, any elective contribution on behalf of the partners above the applicable 402(g) limit must be distributed.

     M 10,000 - 7,624 = 2,376 must be distributed.

(4) The same steps will have to be taken to satisfy the conditions of this revenue procedure for the 1990 year, and any later years. The ADP test must be satisfied for each year at issue, and any necessary corrections must be made for that year. Of course, as excess contributions or excess deferrals, these distributions are not subject to the early withdrawal tax under section 72(t).

04 Partnership does not use the relief provided by this revenue procedure:

(1) It must be determined whether the plan is qualified. As a profit-sharing plan, the plan is permitted to maintain a nonqualified CODA. However, the plan must satisfy all of the applicable qualification requirements, including the requirement that the allocations may not discriminate in favor of the highly compensated employees. In determining whether this latter requirement is met, the plan may take permitted disparity into account in a manner that satisfies section 401(a)(4) and the regulations thereunder.

(2) If the profit-sharing plan is qualified, with a nonqualified CODA, the contributions are not excluded from income under section 402(a)(8), and the elective contributions are includible in income as if they were after-tax contributions in the year made. In addition, any deduction under section 404 taken by a partner for the contribution subject to the election is disallowed for the year made. For example, if M took a $10,000 deduction for his elective contribution, this deduction would be disallowed for 1989 (the earliest date the elective contributions would have been received if M had originally elected to receive the amounts as cash) and would not be excludible from income under section 402(a)(8).

05 If the Partnership had instead maintained a money purchase plan (other than a pre-ERISA money purchase plan) giving partners a cash or deferred election, the plan would be disqualified for maintaining a cash or deferred arrangement unless the relief provided by this revenue procedure was used.

SECTION 6. DRAFTING INFORMATION

The principal author of this revenue procedure is Karen Field of the Employee Plans Technical and Actuarial Division. For more information, call the Employee Plans Technical and Actuarial Division's Taxpayer Assistance Number, (202) 566-6783 (not a toll- free number). The Taxpayer Assistance Number operates Monday through Thursday between the hours of 1:30 pm and 4:00 pm, Eastern Time. Mrs. Field's telephone number is (202) 343-0729 (also not a toll-free number).