Final Regs on Qualified Plan Compensation Limit

 [4830-01-u]

 ACTION: Final regulations.

 SUMMARY: This document contains final regulations relating to the compensation limit for tax-qualified retirement plans under section 401(a)(17) of the Internal Revenue Code of 1986. These regulations reflect changes made by the Tax Reform Act of 1986, the Technical and Miscellaneous Revenue Act of 1988, and the Omnibus Budget Reconciliation Act of 1993. These regulations provide guidance necessary to comply with the law and affect sponsors of, and participants in, tax-qualified retirement plans.

 DATES: These regulations are effective January 1, 1994, and apply to plan years beginning on or after January 1, 1994, except as otherwise provided in section 1.401(a)(17)-1(d).

 FOR FURTHER INFORMATION CONTACT: Marjorie Hoffman at (202) 622-4606 (not a toll-free number).

 SUPPLEMENTARY INFORMATION:

BACKGROUND

On September 19, 1991, final regulations under section 401(a)(17) (TD 8362) were published in the Federal Register (56 FR 47603). On August 10, 1992, the IRS published in the Federal Register (57 FR 35536) regulations proposing to extend the effective date of the final regulations under section 401(a)(17) (and related regulations), generally to plan years beginning on or after January 1, 1994.

 On December 30, 1993, proposed regulations under section 401(a)(17) amending the final regulations were published in the Federal Register (58 FR 69302). Written comments were received from the public on the proposed regulations. Because the only request for a public hearing was withdrawn, no public hearing was held. After considering all of the written comments received, the proposed regulations are adopted as modified by this Treasury decision.

STATUTORY AUTHORITY

 This document contains amendments to the Income Tax Regulations (26 CFR Part 1) under section 401(a)(17) of the Internal Revenue Code (Code). These regulations reflect the enactment of section 401(a)(17) by section 1106 of the Tax Reform Act of 1986 (TRA '86), and subsequent statutory changes made by section 1011(d)(4) of the Technical and Miscellaneous Revenue Act of 1988 (TAMRA) and section 13212 of the Omnibus Budget Reconciliation Act of 1993 (OBRA '93). These regulations are issued under the authority contained in section 7805 of the Code.

EXPLANATION OF PROVISIONS

1. OVERVIEW

 Section 401(a)(17) of the Code provides an annual compensation limit for each employee under a qualified plan. This limit applies to a plan in two ways. First, a plan may not base contributions or benefits on compensation in excess of the annual limit. Thus, a plan does not satisfy section 401(a)(17) unless it provides that an employee's compensation in excess of the annual limit is not used in determining allocations or accruals for a plan year to which the annual limit applies. Second, the amount of an employee's annual compensation that may be taken into account in applying certain specified nondiscrimination rules under the Code is subject to the annual compensation limit. Thus, for example, an employee's compensation in excess of the annual limit is disregarded in determining the accrual rates for defined benefit plans under those nondiscrimination rules. The annual compensation limit applies separately to each group of plans that is treated as a single plan for purposes of the applicable nondiscrimination requirement.

 These final regulations adopt the provisions of the proposed regulations with only minor modifications, as described below.

2. CHANGES MADE BY OBRA '93

 a. LOWER LIMIT

Prior to its amendment by OBRA '93, the annual compensation limit was $200,000 adjusted for cost of living increases ($235,840 for 1993). Section 401(a)(17) was amended by OBRA '93 to reduce the annual compensation limit to $150,000 and to modify the manner in which cost of living adjustments are made to the limit.

 b. ANNUAL ADJUSTMENT OF COMPENSATION LIMIT

Prior to the effective date of the OBRA '93 changes, the annual compensation limit was increased annually based on the section 415 cost of living adjustment. After the effective date of OBRA '93, the annual compensation limit, as adjusted for changes in the cost of living, is rounded down to the next lowest multiple of $10,000. Thus, the annual compensation limit increases only when the cost of living adjustment would increase the limit by an increment of at least $10,000. These final regulations retain the rules in the September 1991 regulations that any increase in the limit is effective for the plan year, or other 12-month period used to determine compensation, commencing in the calendar year for which the limit is adjusted and that the increase applies only to compensation for the year of the increase and subsequent years that are used in determining an employee's benefit.

 c. PRORATION OF THE LIMIT

These regulations retain the requirement in the September 1991 regulations that the annual compensation limit must be prorated if compensation for a period of less than 12 months is used for a plan year. However, in response to comments on the proposed regulations, the final regulations clarify that no proration is required merely because the amount of elective contributions, matching contributions, or employee contributions that is contributed for each pay period during a plan year is determined separately using compensation for that pay period. For example, a section 401(k) plan provides each employee with the right to elect to defer up to 6 percent of compensation for a plan year, and then, in accordance with each employee's election for the plan year, contributions are made monthly using the employee's compensation for that pay period. Although the compensation for the plan year that may be taken into account in determining each employee's elective contributions is subject to the annual compensation limit, the compensation for each month would not required to be limited to $12,500 (1/12 of $150,000) in this situation.

3. EFFECTIVE DATE AND TRANSITION RULES.

 Section 401(a)(17) is generally effective for plan years beginning on or after January 1, 1989. The changes made by OBRA '93 are generally effective for plan years beginning on or after January 1, 1994. Special statutory effective dates are provided for collectively bargained plans. In addition, OBRA '93 provides a special grandfather rule for certain eligible participants in governmental plans.

 These regulations under section 401(a)(17) are generally effective at the same time that the reduced limit under OBRA '93 applies to the plan. However, in the case of plans maintained by tax- exempt organizations, the regulations are effective for plan years beginning on or after January 1, 1996.

 Minor modifications have been made to the examples in these regulations to reflect the OBRA '93 statutory change, the change in the effective date of the regulations from the date in the 1991 regulations, and an employer's choice of complying with the provisions of these regulations prior to the effective date.

 a. FRESH-START RULES

The regulations retain the rule from the September 1991 regulations that benefits accrued or allocations made under a plan for plan years prior to the effective date of section 401(a)(17) are not subject to the annual compensation limit. The regulations also retain the rule in the proposed regulations that the benefits accrued or allocations made under a plan for plan years prior to the effective date of the OBRA '93 changes are not subject to the reduced annual compensation limit.

 In order to satisfy the requirements of section 401(a)(17), a defined benefit plan must "fresh start" the benefits of all employees with accrued benefits that are based on compensation that exceeded the annual compensation limit. In order to implement the reduced limit under OBRA '93, a defined benefit plan must again "fresh start" the benefits of all employees with accrued benefits that are based on compensation that exceeded the OBRA '93 $150,000 compensation limit.

 As in the proposed regulations, these final regulations provide guidance on the implementation of these and other multiple fresh starts and coordinate the regulations with the fresh-start rules of the section 401(a)(4) regulations. For example, the regulations continue to cross-reference the section 401(a)(4) regulations for the definition of an employee's frozen accrued benefit. Thus, an employee's frozen accrued benefit as of the OBRA '93 effective date includes benefits accrued as a result of an amendment made within the TRA '86 remedial amendment period that is recognized under section 401(b) as effective before the OBRA '93 effective date.

 b. AMENDMENTS TO COMPLY WITH SECTION 401(a)(17)

In conjunction with publishing these regulations under section 401(a)(17), the IRS issued Rev. Proc. 94-13, 1994-3 I.R.B. 18, dated January 18, 1994. Rev. Proc. 94-13 provides guidance on the remedial amendment treatment for plans being amended for section 401(a)(17), including guidance on the conditions under which a plan may be amended to comply retroactively with section 401(a)(17) even if the amendment results in a reduction of a benefit protected under section 411(d)(6). Rev. Proc. 94-13 also provides guidance on the extent to which section 204(h) of the Employee Retirement Income Security Act of 1974 (ERISA) will not apply to a plan amendment that limits an employee's compensation taken into account under the plan to the maximum permitted under section 401(a)(17) of the Code.

 Commentators requested that this guidance be incorporated into the final regulations. The IRS and the Treasury believe these issues are appropriately addressed in Rev. Proc. 94-13. The guidance under section 411(d)(6) in Rev. Proc. 94-13 is provided pursuant to the specific delegation of authority in section 1.411(d)-4, Q&A-2(b) to the Commissioner to provide, through the publication of revenue rulings, notices, and other documents of general applicability, for the elimination or reduction of section 411(d)(6) protected benefits to the extent that the reduction is necessary to permit compliance with the other requirements of section 401(a). The guidance under section 204(h) of ERISA is provided pursuant to the delegation of authority to the IRS under section 101(a) of Reorganization Plan No. 4 of 1978 (1979-1 C.B. 480) to issue regulations, rulings, opinions, variances, and waivers under section 204 of ERISA.

 c. APPLICATION OF $150,000 LIMIT TO ACCRUALS OR ALLOCATIONS IN PLAN YEARS FOR WHICH OBRA '93 IS EFFECTIVE

One commentator suggested that the reduced limit should not apply to compensation for years beginning before the OBRA '93 effective date that is used in determining post-effective date benefit accruals. The regulations, however, continue to provide that benefits accruing, or allocations made, for plan years beginning on or after the OBRA '93 effective date may not take into account compensation for any year in excess of the OBRA '93 annual compensation limit applicable to that year (generally $150,000 for years beginning before the OBRA '93 effective date). Thus, compensation for any plan year before OBRA '93 applies to the plan that is used to determine benefits accruing in plan years beginning on or after the OBRA '93 effective date is generally limited to $150,000. In the absence of this rule, post-effective date accruals under many defined benefit plans would be determined taking into account compensation in excess of $150,000. For example, this happens when a defined benefit plan determines annual accruals as a percentage of each employee's highest average annual compensation for a specified number of years (including years prior to the effective date of OBRA '93).

 d. COLLECTIVELY BARGAINED PLANS.

TRA '86 and OBRA '93 provide a deferred effective date for collectively bargained plans. In response to comments, these regulations clarify that the rules of section 1.410(b)-10(a)(2) apply for purposes of determining whether a plan is a collectively bargained plan. Thus, if a plan is a collectively bargained plan (within the meaning of section 1.410(b)-10(a)(2)(iii)), the deferred effective date applies in determining the plan allocations or benefit accruals of both collectively bargained and noncollectively bargained employees.

 e. GOVERNMENTAL PLANS

These final regulations retain the special effective date for governmental plans (within the meaning of section 414(d)) in order to provide governmental employers with adequate time to amend their plans to comply with section 401(a)(17). Thus, the regulations provide that these governmental plans will automatically satisfy the requirements of section 401(a)(17) for plan years beginning before the later of January 1, 1996, or 90 days after the opening of the first legislative session beginning on or after January 1, 1996, of the governing body with authority to amend the plan, if that body does not meet continuously.

 The final regulations continue to implement the grandfather rule in OBRA '93 for individuals who first became participants in governmental plans before the first plan year beginning after December 31, 1995 or, if earlier, the first plan year for which the plan is amended to comply with OBRA '93. Under the grandfather rule, the annual compensation limit will not apply for those individuals to the extent that the limit would reduce the amount of compensation taken into account under the plan below the amount that was allowed to be taken into account under the plan as in effect on July 1, 1993. However, in order for this grandfather rule to apply to a plan, the plan must be amended, effective for plan years beginning after December 31, 1995, to incorporate by reference the annual compensation limits of section 401(a)(17) for those participants who are not grandfathered under OBRA '93.

 f. GOOD FAITH COMPLIANCE PRIOR TO THE REGULATORY EFFECTIVE DATE

For plan years beginning on or after the date that section 401(a)(17) first applies to a plan, but before these regulations apply to the plan, the plan must be operated in accordance with a reasonable, good faith interpretation of the requirements of section 401(a)(17). Whether compliance is reasonable and in good faith will be determined on the basis of all of the relevant facts and circumstances, including the extent to which the employer has resolved unclear issues in its favor. Reasonable, good faith interpretation will be deemed to exist, however, if a plan is operated in accordance with the 1990 regulations, the September 1991 regulations, the December 1993 regulations, or these regulations. However, for any plan with a regulatory effective date that is later than the OBRA '93 effective date for the plan (e.g., a plan maintained by a tax-exempt organization), a reasonable, good faith interpretation must reflect the OBRA '93 amendments to section 401(a)(17).

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) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and, therefore, a Regulatory Flexibility Analysis is not required. 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 business.

DRAFTING INFORMATION

 The principal author of these final regulations is Marjorie Hoffman of the Office of the Associate Chief Counsel (Employee Benefits and Exempt Organizations), IRS. 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.

Treasury Decision 8547

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 continues to read, in part, as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.401(a)(17)-1 is revised to read as follows:

SECTION 1.401(a)(17)-1 LIMITATION ON ANNUAL COMPENSATION.

(a) COMPENSATION LIMIT REQUIREMENT -- (1) IN GENERAL. In order to be a qualified plan, a plan must satisfy section 401(a)(17). Section 401(a)(17) provides an annual compensation limit for each employee under a qualified plan. This limit applies to a qualified plan in two ways. First, a plan may not base allocations, in the case of a defined contribution plan, or benefit accruals, in the case of a defined benefit plan, on compensation in excess of the annual compensation limit. Second, the amount of an employee's annual compensation that may be taken into account in applying certain specified nondiscrimination rules under the Internal Revenue Code is subject to the annual compensation limit. These two limitations are set forth in paragraphs (b) and (c) of this section, respectively. Paragraph (d) of this section provides the effective dates of section 401(a)(17), the amendments made by section 13212 of the Omnibus Budget Reconciliation Act of 1993 (OBRA '93), and this section. Paragraph (e) of this section provides rules for determining post- effective-date accrued benefits under the fresh-start rules.

(2) ANNUAL COMPENSATION LIMIT FOR PLAN YEARS BEGINNING BEFORE JANUARY 1, 1994. For purposes of this section, for plan years beginning prior to the OBRA '93 effective date, annual compensation limit means $200,000, adjusted as provided by the Commissioner. The amount of the annual compensation limit is adjusted at the same time and in the same manner as under section 415(d). The base period for the annual adjustment is the calendar quarter ending December 31, 1988, and the first adjustment is effective on January 1, 1990. Any increase in the annual compensation limit is effective as of January 1 of a calendar year and applies to any plan year beginning in that calendar year. In any plan year beginning prior to the OBRA '93 effective date, if compensation for any plan year beginning prior to the statutory effective date is used for determining allocations or benefit accruals, or when applying any nondiscrimination rule, then the annual compensation limit for the first plan year beginning on or after the statutory effective date (generally $200,000) must be applied to compensation for that prior plan year.

(3) ANNUAL COMPENSATION LIMIT FOR PLAN YEARS BEGINNING ON OR AFTER JANUARY 1, 1994 -- (i) IN GENERAL. For purposes of this section, for plan years beginning on or after the OBRA '93 effective date, annual compensation limit means $150,000, adjusted as provided by the Commissioner. The adjusted dollar amount of the annual compensation limit is determined by adjusting the $150,000 amount for changes in the cost of living as provided in paragraph (a)(3)(ii) of this section and rounding this adjusted dollar amount as provided in paragraph (a)(3)(iii) of this section. Any increase in the annual compensation limit is effective as of January 1 of a calendar year and applies to any plan year beginning in that calendar year. For example, if a plan has a plan year beginning July 1, 1994, and ending June 30, 1995, the annual compensation limit in effect on January 1, 1994 ($150,000), applies to the plan for the entire plan year.

(ii) COST OF LIVING ADJUSTMENT. The $150,000 amount is adjusted for changes in the cost of living by the Commissioner at the same time and in the same manner as under section 415(d). The base period for the annual adjustment is the calendar quarter ending December 31, 1993.

(iii) ROUNDING OF ADJUSTED COMPENSATION LIMIT. After the $150,000, adjusted in accordance with paragraph (a)(3)(ii) of this section, exceeds the annual compensation limit for the prior calendar year by $10,000 or more, the annual compensation limit will be increased by the amount of such excess, rounded down to the next lowest multiple of $10,000.

(4) ADDITIONAL GUIDANCE. The Commissioner may, in revenue rulings and procedures, notices, and other guidance, published in the Internal Revenue Bulletin (see section 601.601(d)(2)(ii)(b) of this chapter), provide any additional guidance that may be necessary or appropriate concerning the annual limits on compensation under section 401(a)(17).

(b) PLAN LIMIT ON COMPENSATION -- (1) GENERAL RULE. A plan does not satisfy section 401(a)(17) unless it provides that the compensation taken into account for any employee in determining plan allocations or benefit accruals for any plan year is limited to the annual compensation limit. For purposes of this rule, allocations and benefit accruals under a plan include all benefits provided under the plan, including ancillary benefits.

(2) PLAN-YEAR-BY-PLAN-YEAR REQUIREMENT. For purposes of this paragraph (b), the limit in effect for the current plan year applies only to the compensation for that year that is taken into account in determining plan allocations or benefit accruals for the year. The compensation for any prior plan year taken into account in determining an employee's allocations or benefit accruals for the current plan year is subject to the applicable annual compensation limit in effect for that prior year. Thus, increases in the annual compensation limit apply only to compensation taken into account for the plan year in which the increase is effective. In addition, if compensation for any plan year beginning prior to the OBRA '93 effective date is used for determining allocations or benefit accruals in a plan year beginning on or after the OBRA '93 effective date, then the annual compensation limit for that prior year is the annual compensation limit in effect for the first plan year beginning on or after the OBRA '93 effective date (generally $150,000).

(3) APPLICATION OF LIMIT TO A PLAN YEAR -- (i) IN GENERAL. For purposes of applying this paragraph (b), the annual compensation limit is applied to the compensation for the plan year on which allocations or benefit accruals are based.

(ii) COMPENSATION FOR THE PLAN YEAR. If a plan determines compensation used in determining allocations or benefit accruals for a plan year based on compensation for the plan year, then the annual compensation limit that applies to the compensation for the plan year is the limit in effect for the calendar year in which the plan year begins. Alternatively, if a plan determines compensation used in determining allocations or benefit accruals for the plan year on the basis of compensation for a 12-consecutive-month period, or periods, ending no later than the last day of the plan year, then the annual compensation limit applies to compensation for each of those periods based on the annual compensation limit in effect for the respective calendar year in which each 12-month period begins.

(iii) COMPENSATION FOR A PERIOD OF LESS THAN 12-MONTHS -- (A) PRORATION REQUIRED. If compensation for a period of less than 12 months is used for a plan year, then the otherwise applicable annual compensation limit is reduced in the same proportion as the reduction in the 12-month period. For example, if a defined benefit plan provides that the accrual for each month in a plan year is separately determined based on the compensation for that month and the plan year accrual is the sum of the accruals for all months, then the annual compensation limit for each month is 1/12th of the annual compensation limit for the plan year. In addition, if the period for determining compensation used in calculating an employee's allocation or accrual for a plan year is a short plan year (i.e., shorter than 12 months), the annual compensation limit is an amount equal to the otherwise applicable annual compensation limit multiplied by a fraction, the numerator of which is the number of months in the short plan year, and the denominator of which is 12.

(B) NO PRORATION REQUIRED FOR PARTICIPATION FOR LESS THAN A FULL PLAN YEAR. Notwithstanding paragraph (b)(3)(iii)(A) of this section, a plan is not treated as using compensation for less than 12 months for a plan year merely because the plan formula provides that the allocation or accrual for each employee is based on compensation for the portion of the plan year during which the employee is a participant in the plan. In addition, no proration is required merely because an employee is covered under a plan for less than a full plan year, provided that allocations or benefit accruals are otherwise determined using compensation for a period of at least 12 months. Finally, notwithstanding paragraph (b)(3)(iii)(A) of this section, no proration is required merely because the amount of elective contributions (within the meaning of section 1.401(k)-1(g)(3)), matching contributions (within the meaning of section 1.401(m)- 1(f)(12)), or employee contributions (within the meaning of section 1.401(m)-1(f)(6)) that is contributed for each pay period during a plan year is determined separately using compensation for that pay period.

(4) LIMITS ON MULTIPLE EMPLOYER AND MULTIEMPLOYER PLANS. For purposes of this paragraph (b), in the case of a plan described in section 413(c) or 414(f) (a plan maintained by more than one employer), the annual compensation limit applies separately with respect to the compensation of an employee from each employer maintaining the plan instead of applying to the employee's total compensation from all employers maintaining the plan.

(5) FAMILY AGGREGATION. [Reserved]

(6) EXAMPLES. The following examples illustrate the rules in this paragraph (b).

EXAMPLE 1. Plan X is a defined benefit plan with a calendar year plan year and bases benefits on the average of an employee's high 3 consecutive years' compensation. The OBRA '93 effective date for Plan X is January 1, 1994. Employee A's high 3 consecutive years' compensation prior to the application of the annual compensation limits is $160,000 (1994), $155,000 (1993), and $135,000 (1992). To satisfy this paragraph (b), Plan X cannot base plan benefits for Employee A in 1994 on compensation in excess of $145,000 (the average of $150,000 (A's 1994 compensation capped by the annual compensation limit), $150,000 (A's 1993 compensation capped by the $150,000 annual compensation limit applicable to all years before 1994), and $135,000 (A's 1992 compensation capped by the $150,000 annual compensation limit applicable to all years before 1994)). For purposes of determining the 1994 accrual, each year (1994, 1993, and 1992), not the average of the 3 years, is subject to the 1994 annual compensation limit of $150,000.

EXAMPLE 2. Assume the same facts as Example 1, except that Employee A's high 3 consecutive years' compensation prior to the application of the limits is $185,000 (1997), $175,000 (1996), and $165,000 (1995). Assume that the annual compensation limit is first adjusted to $160,000 for plan years beginning on or after January 1, 1997. Plan X cannot base plan benefits for Employee A in 1997 on compensation in excess of $153,333 (the average of $160,000 (A's 1997 compensation capped by the 1997 limit), $150,000 (A's 1996 compensation capped by the 1996 limit), and $150,000 (A's 1995 compensation capped by the 1995 limit)).

EXAMPLE 3. Plan Y is a defined benefit plan that bases benefits on an employee's high consecutive 36 months of compensation ending within the plan year. Employee B's high 36 months are the period September 1995 to August 1998, in which Employee B earned $50,000 in each month. Assume that the annual compensation limit is first adjusted to $160,000 for plan years beginning on or after January 1, 1997. The annual compensation limit is $150,000, $150,000, and $160,000 in 1995, 1996, and 1997, respectively. To satisfy this paragraph (b), Plan Y cannot base Employe B's plan benefits for the 1998 plan year on compensation in excess of $153,333. This amount is determined by applying the applicable annual compensation limit to compensation for each of the three 12-consecutive-month periods. The September 1995 to August 1996 period is capped by the annual compensation limit of $150,000 for 1995; the September 1996 to August 1997 period is capped by the annual compensation limit of $150,000 for 1996; and the September 1997 to August 1998 period is capped by the annual compensation limit of $160,000 for 1997. The average of these capped amounts is the annual compensation limit applicable in determining benefits for the 1998 year.

EXAMPLE 4. (a) Employer P is a partnership. Employer P maintains Plan Z, a profit-sharing plan that provides for an annual allocation of employer contributions of 15 percent of plan year compensation for employees other than self-employed individuals, and 13.0435 percent of plan year compensation for self-employed individuals. The plan year of Plan Z is the calendar year. The OBRA '93 effective date for Plan Z is January 1, 1994. In order to satisfy section 401(a)(17), as amended by OBRA '93, the plan provides that, beginning with the 1994 plan year, the plan year compensation used in determining the allocation of employer contributions for each employee may not exceed the annual limit in effect for the plan year under OBRA '93. Plan Z defines compensation for self-employed individuals (employees within the meaning of section 401(c)(1)) as the self- employed individual's net profit from self-employment attributable to Employer P minus the amount of the self-employed individual's deduction under section 164(f) for one-half of self-employment taxes. Plan Z defines compensation for all other employees as wages within the meaning of section 3401(a). Employee C and Employee D are partners of Employer P and thus are self-employed individuals. Neither Employee C nor Employee D owns an interest in any other business or is a common-law employee in any business. For the 1994 calendar year, Employee C has net profit from self-employment of $80,000, and Employee D has net profit from self-employment of $175,000. The deduction for Employee C under section 164(f) for one-half of self- employment taxes is $4,828. The deduction for Employee D under section 164(f) for one-half of self-employment taxes is $6,101

(b) The plan year compensation under the plan formula for Employee C is $75,172 ($80,000 minus $4,828). The allocation of employer contributions under the plan allocation formula for 1994 for Employee C is $9,805 ($75,172 (Employee C's plan year compensation for 1994) multiplied by 13.0435%). The plan year compensation under the plan formula before application of the annual limit under section 401(a)(17) for Employee D is $168,899 ($175,000 minus $6101). After application of the annual limit, the plan year compensation for the 1994 plan year for Employee D is $150,000 (the annual limit for 1994). Therefore, the allocation of employer contributions under the plan allocation formula for 1994 for Employee D is $19,565 ($150,000 (Employee D's plan year compensation after application of the annual limit for 1994) multiplied by 13.0435%).

EXAMPLE 5. The facts are the same as in Example 4, except that Plan Z provides that plan year compensation for self- employed individuals is defined as earned income within the meaning of section 401(c)(2) attributable to Employer P. In addition, Plan Z provides for an annual allocation of employer contributions of 15 percent of plan year compensation for all employees in the plan, including self-employed individuals, such as Employees C and D. The net profit from self-employment for Employee C and the net profit from self-employment for Employee D are the same as provided in Example 4. However, the earned income of Employee C determined in accordance with section 401(c)(2) is $65,367 ($80,000 minus $4,828 minus $9,805). The earned income of Employee D determined in accordance with section 401(c)(2) is $146,869 ($175,000 minus $6,101 minus $22,030). Therefore, the allocation of employer contributions under the plan allocation formula for 1994 for Employee C is $9,805 ($65,367 (Employee C's plan year compensation for 1994) multiplied by 15%). Employee D's earned income for 1994 does not exceed the 1994 annual limit of $150,000. Therefore, the allocation of employer contributions under the plan allocation formula for 1994 for Employee D is $22,030 ($146,869 (Employee D's plan year compensation for 1994) multiplied by 15%).

(c) LIMIT ON COMPENSATION FOR NONDISCRIMINATION RULES -- (1) GENERAL RULE. The annual compensation limit applies for purposes of applying the nondiscrimination rules under sections 401(a)(4), 401(a)(5), 401(l), 401(k)(3), 401(m)(2), 403(b)(12), 404(a)(2) and 410(b)(2). The annual compensation limit also applies in determining whether an alternative method of determining compensation impermissibly discriminates under section 414(s)(3). Thus, for example, the annual compensation limit applies when determining a self-employed individual's total earned income that is used to determine the equivalent alternative compensation amount under section 1.414(s)-1(g)(1). This paragraph (c) provides rules for applying the annual compensation limit for these purposes. For purposes of this paragraph (c), compensation means the compensation used in applying the applicable nondiscrimination rule.

(2) PLAN-YEAR-BY-PLAN-YEAR REQUIREMENT. For purposes of this paragraph (c), when applying an applicable nondiscrimination rule for a plan year, the compensation for each plan year taken into account is limited to the applicable annual compensation limit in effect for that year, and an employee's compensation for that plan year in excess of the limit is disregarded. Thus, if the nondiscrimination provision is applied on the basis of compensation determined over a period of more than one year (for example, average annual compensation), the annual compensation limit in effect for each of the plan years that is taken into account in determining the average applies to the respective plan year's compensation. In addition, if compensation for any plan year beginning prior to the OBRA '93 effective date is used when applying any nondiscrimination rule in a plan year beginning on or after the OBRA '93 effective date, then the annual compensation limit for that prior year is the annual compensation limit for the first plan year beginning on or after the OBRA '93 effective date (generally $150,000).

(3) PLAN-BY-PLAN LIMIT. For purposes of this paragraph (c), the annual compensation limit applies separately to each plan (or group of plans treated as a single plan) of an employer for purposes of the applicable nondiscrimination requirement. For this purpose, the plans included in the testing group taken into account in determining whether the average benefit percentage test of section 1.410(b)-5 is satisfied are generally treated as a single plan.

(4) APPLICATION OF LIMIT TO A PLAN YEAR. The rules provided in paragraph (b)(3) of this section regarding the application of the limit to a plan year apply for purposes of this paragraph (c).

(5) LIMITS ON MULTIPLE EMPLOYER AND MULTIEMPLOYER PLANS. The rule provided in paragraph (b)(4) of this section regarding the application of the limit to multiple employer and multiemployer plans applies for purposes of this paragraph (c).

(d) EFFECTIVE DATE -- (1) STATUTORY EFFECTIVE DATE -- (i) GENERAL RULE. Except as otherwise provided in this paragraph (d), section 401(a)(17) applies to a plan as of the first plan year beginning on or after January 1, 1989. For purposes of this section, statutory effective date generally means the first day of the first plan year that section 401(a)(17) is applicable to a plan. In the case of governmental plans, statutory effective date means the first day of the first plan year for which the plan is not deemed to satisfy section 401(a)(17) by reason of paragraph (d)(4) of this section.

(ii) EXCEPTION FOR COLLECTIVELY BARGAINED PLANS. In the case of a plan maintained pursuant to one or more collective bargaining agreements between employee representatives and one or more employers ratified before March 1, 1986, section 401(a)(17) applies to allocations and benefit accruals for plan years beginning on or after the earlier of --

(A) January 1, 1991; or

(B) The later of January 1, 1989, or the date on which the last of the collective bargaining agreements terminates (determined without regard to any extension or renegotiation of any agreement occurring after February 28, 1986). For purposes of this paragraph (d)(1)(ii), the rules of section 1.410(b)-10(a)(2) apply for purposes of determining whether a plan is maintained pursuant to one or more collective bargaining agreements, and any extension or renegotiation of a collective bargaining agreement, which extension or renegotiation is ratified after February 28, 1986, is to be disregarded in determining the date on which the agreement terminates.

(2) OBRA '93 EFFECTIVE DATE -- (i) IN GENERAL. For purposes of this section, OBRA '93 effective date means the first day of the first plan year beginning on or after January 1, 1994, except as provided in this paragraph (d)(2).

(ii) EXCEPTION FOR COLLECTIVELY BARGAINED PLANS -- (A) IN GENERAL. In the case of a plan maintained pursuant to one or more collective bargaining agreements between employee representatives and 1 or more employers ratified before August 10, 1993, OBRA '93 effective date means the first day of the first plan year beginning on or after the earlier of --

(1) The latest of --

(i) January 1, 1994;

(ii) The date on which the last of such collective bargaining agreements terminates (without regard to any extension, amendment, or, modification of such agreements on or after August 10, 1993); or

(iii) In the case of a plan maintained pursuant to collective bargaining under the Railway Labor Act, the date of execution of an extension or replacement of the last of such collective bargaining agreements in effect on August 10, 1993; or

(2) January 1, 1997.

(B) DETERMINATION OF WHETHER PLAN IS COLLECTIVELY BARGAINED. For purposes of this paragraph (d)(2)(ii), the rules of section 1.410(b)- 10(a)(2) apply for purposes of determining whether a plan is maintained pursuant to one or more collective bargaining agreements, except that August 10, 1993, is substituted for March 1, 1986, as the date before which the collective bargaining agreements must be ratified.

(3) REGULATORY EFFECTIVE DATE. This section 1.401(a)(17)-1 applies to plan years beginning on or after the OBRA '93 effective date. However, in the case of a plan maintained by an organization that is exempt from income taxation under section 501(a), including plans subject to section 403(b)(12)(A)(i) (nonelective plans), this section 1.401(a)(17)-1 applies to plan years beginning on or after January 1, 1996. For plan years beginning before the effective date of these regulations and on or after the statutory effective date, a plan must be operated in accordance with a reasonable, good faith interpretation of section 401(a)(17), taking into account, if applicable, the OBRA '93 reduction to the annual compensation limit under section 401(a)(17).

(4) SPECIAL RULES FOR GOVERNMENTAL PLANS -- (i) DEEMED SATISFACTION BY GOVERNMENTAL PLANS. In the case of governmental plans described in section 414(d), including plans subject to section 403(b)(12)(A)(i) (nonelective plans), section 401(a)(17) is considered satisfied for plan years beginning before the later of January 1, 1996, or 90 days after the opening of the first legislative session beginning on or after January 1, 1996, of the governing body with authority to amend the plan, if that body does not meet continuously. For purposes of this paragraph (d)(4), the term governing body with authority to amend the plan means the legislature, board, commission, council, or other governing body with authority to amend the plan.

(ii) TRANSITION RULE FOR GOVERNMENTAL PLANS -- (A) IN GENERAL. In the case of an eligible participant in a governmental plan (within the meaning of section 414(d)), the annual compensation limit under this section shall not apply to the extent that the application of the limitation would reduce the amount of compensation that is allowed to be taken into account under the plan below the amount that was allowed to be taken into account under the plan as in effect on July 1, 1993. Thus, for example, if a plan as in effect on July 1, 1993, determined benefits without any reference to a limit on compensation, then the annual compensation limit in effect under this section will not apply to any eligible participant in any future year.

(B) ELIGIBLE PARTICIPANT. For purposes of this paragraph (d)(4)(ii), an eligible participant is an individual who first became a participant in the plan prior to the first day of the first plan year beginning after the earlier of --

(1) The last day of the plan year by which a plan amendment to reflect the amendments made by section 13212 of OBRA '93 is both adopted and effective; or

(2) December 31, 1995.

(C) PLAN MUST BE AMENDED TO INCORPORATE LIMITS. This paragraph (d)(4)(ii) shall not apply to any eligible participant in a plan unless the plan is amended so that the plan incorporates by reference the annual compensation limit under section 401(a)(17), effective with respect to noneligible participants for plan years beginning after December 31, 1995 (or earlier, if the plan amendment so provides).

(5) BENEFITS EARNED PRIOR TO EFFECTIVE DATE -- (i) IN GENERAL. Allocations under a defined contribution plan or benefits accrued under a defined benefit plan for plan years beginning before the statutory effective date are not subject to the annual compensation limit. Allocations under a defined contribution plan or benefits accrued under a defined benefit plan for plan years beginning on or after the statutory effective date, but before the OBRA '93 effective date, are subject to the annual compensation limit under paragraph (a)(2) of this section. However these allocations or accruals are not subject to the OBRA '93 reduction to the annual compensation limit described in paragraph (a)(3) of this section.

(ii) ALLOCATION FOR A PLAN YEAR. The allocations for a plan year include amounts described in section 1.401(a)(4)-2(c)(ii) or section 1.401(m)-1(f)(6) plus the earnings, expenses, gains, and losses attributable to those amounts.

(iii) BENEFITS ACCRUED FOR YEARS BEFORE THE EFFECTIVE DATE. The benefits accrued for plan years prior to a specified date by any employee are the employee's benefits accrued under the plan, determined as if those benefits had been frozen (as defined in section 1.401(a)(4)-13(c)(3)(i)) as of the day immediately preceding such specified date. Thus, for example, benefits accrued for those plan years generally do not include any benefits accrued under an amendment increasing prior benefits that is adopted after the date on which the employee's benefits under the plan must be treated as frozen.

(e) DETERMINATION OF POST-EFFECTIVE-DATE ACCRUED BENEFITS -- (1) IN GENERAL. The plan formula that is used to determine the amount of allocations or benefit accruals for plan years beginning on or after the dates described in paragraph (d)(1) or (2) must comply with section 401(a)(17) as in effect on such date. This paragraph (e) provides rules for applying section 401(a)(17) in the case of section 401(a)(17) employees who accrue additional benefits under a defined benefit plan in a plan year beginning on or after the relevant effective date. Paragraph (e)(2) of this section contains definitions used in applying these rules. Paragraphs (e)(3) and (e)(4) of this section explain the application of the fresh-start rules in section 1.401(a)(4)-13 to the determination of the accrued benefits of section 401(a)(17) employees.

(2) DEFINITIONS. For purposes of this paragraph (e), the following definitions apply:

(i) SECTION 401(a)(17) EMPLOYEE. An employee is a section 401(a)(17) employee as of a date, on or after the statutory effective date, if the employee's current accrued benefit as of that date is based on compensation for a year prior to the statutory effective date that exceeded the annual compensation limit for the first plan year beginning on or after the statutory effective date. In addition, an employee is a section 401(a)(17) employee as of a date, on or after the OBRA '93 effective date, if the employee's current accrued benefit as of that date is based on compensation for a year prior to the OBRA '93 effective date that exceeded the annual compensation limit for the first plan year beginning on or after the OBRA '93 effective date. For this purpose, a current accrued benefit is not treated as based on compensation that exceeded the relevant annual compensation limit, if a plan makes a fresh start using the formula with wear-away described in section 1.401(a)(4)-13(c)(4)(ii), and the employee's accrued benefit determined under section 1.401(a)(4)- 13(c)(4)(ii)(B), taking into account the annual compensation limit, exceeds the employee's frozen accrued benefit (or, if applicable, the employee's adjusted accrued benefit) as of the fresh-start date.

(ii) SECTION 401(a)(17) FRESH-START DATE. Section 401(a)(17) fresh-start date means a fresh-start date as defined in section 1.401(a)(4)-12 not earlier than the last day of the last plan year beginning before the statutory effective date, and not later than the last day of the last plan year beginning before the effective date of these regulations.

(iii) OBRA '93 FRESH-START DATE. OBRA '93 fresh-start date means a fresh-start date as defined in section 1.401(a)(4)-12 not earlier than the last day of the last plan year beginning before the OBRA '93 effective date, and not later than the last day of the last plan year beginning before the effective date of these regulations.

(iv) SECTION 401(a)(17) FROZEN ACCRUED BENEFIT. Section 401(a)(17) frozen accrued benefit means the accrued benefit for any section 401(a)(17) employee frozen (as defined in section 1.401(a)(4)-13(c)(3)(i)) as of the last day of the last plan year beginning before the statutory effective date.

(v) OBRA '93 FROZEN ACCRUED BENEFIT. OBRA '93 frozen accrued benefit means the accrued benefit for any section 401(a)(17) employee frozen (as defined in section 1.401(a)(4)-13(c)(3)(i)) as of the OBRA '93 fresh-start date.

(3) APPLICATION OF FRESH-START RULES -- (i) GENERAL RULE. In order to satisfy section 401(a)(17), a defined benefit plan must determine the accrued benefit of each section 401(a)(17) employee by applying the fresh-start rules in section 1.401(a)(4)-13(c). The fresh-start rules must be applied using a section 401(a)(17) fresh- start date and using the plan benefit formula, after amendment to comply with section 401(a)(17) and this section, as the formula applicable to benefit accruals in the current plan year. In addition, the fresh-start rules must be applied to determine the accrued benefit of each section 401(a)(17) employee using an OBRA '93 fresh- start date and using the plan benefit formula, after amendment to comply with the reduction in the section 401(a)(17) annual compensation limit described in paragraph (a)(3) of this section, as the formula applicable to benefit accruals in the current plan year.

(ii) CONSISTENCY RULES IN SECTION 1.401(a)(4)-13(c) AND (d) -- (A) GENERAL RULE. In applying the fresh-start rules of section 1.401(a)(4)-13(c) and (d), the group of section 401(a)(17) employees is a fresh-start group. See section 1.401(a)(4)-13(c)(5)(ii)(A). Thus, the consistency rules of those sections govern, unless otherwise provided. For example, if the plan is using a fresh-start date applicable to all employees and is not adjusting frozen accrued benefits under section 1.401(a)(4)-13(d) for employees who are not section 401(a)(17) employees, then the frozen accrued benefits for section 401(a)(17) employees may not be adjusted under section 1.401(a)(4)-13(d) or this paragraph (e).

(B) DETERMINATION OF ADJUSTED ACCRUED BENEFIT. If the fresh- start rules of section 1.401(a)(4)-13(c) and (d) are applied to determine the benefits of all employees after a fresh-start date, the plan will not fail to satisfy the consistency requirement of section 1.401(a)(4)-13(c)(5)(i) merely because the plan makes the adjustment described in section 1.401(a)(4)-13(d) to the frozen accrued benefits of employees who are not section 401(a)(17) employees, but does not make the adjustment to the frozen accrued benefits of section 401(a)(17) employees. In addition, the plan does not fail to satisfy the consistency requirement of section 1.401(a)(4)-13(c)(5)(i) merely because the plan makes the adjustment described in section 1.401(a)(4)-13(d) for section 401(a)(17) employees on the basis of the compensation formula that was used to determine the frozen accrued benefit (as required under paragraph (e)(4)(iii) of this section) but makes the adjustment for employees who are not section 401(a)(17) employees on the basis of any other method provided in section 1.401(a)(4)-13(d)(8).

(4) PERMITTED ADJUSTMENTS TO FROZEN ACCRUED BENEFIT OF SECTION 401(a)(17) EMPLOYEES -- (i) GENERAL RULE. Except as otherwise provided in paragraphs (e)(4)(ii) and (iii) of this section, the rules in section 1.401(a)(4)-13(c)(3) (permitting certain adjustments to frozen accrued benefits) apply to section 401(a)(17) frozen accrued benefits or OBRA '93 frozen accrued benefits.

(ii) OPTIONAL FORMS OF BENEFIT. After either the section 401(a)(17) fresh-start date or the OBRA '93 fresh-start date, a plan may be amended either to provide a new optional form of benefit or to make an optional form of benefit available with respect to the section 401(a)(17) frozen accrued benefit or the OBRA '93 frozen accrued benefit, provided that the optional form of benefit is not subsidized. Whether an optional form is subsidized may be determined using any reasonable actuarial assumptions.

(iii) ADJUSTING SECTION 401(a)(17) ACCRUED BENEFITS -- (A) IN GENERAL. If the plan adjusts accrued benefits for employees under the rules of section 1.401(a)(4)-13(d) as of a fresh-start date, the adjusted accrued benefit (within the meaning of sections 1.401(a)(4)- 13(d)) for each section 401(a)(17) employee must be determined after the fresh-start date by reference to the plan's compensation formula that was actually used to determine the frozen accrued benefit as of the fresh-start date. For this purpose, the plan's compensation formula incorporates the plan's underlying compensation definition and compensation averaging period. In making the adjustment, the denominator of the adjustment fraction described in section 1.401(a)(4)-13(d)(8)(i) is the employee's compensation as of the fresh-start date using the plan's compensation formula as of that date and, in the case of an OBRA '93 fresh-start date, reflecting the annual compensation limits that applied as of the fresh-start date. The numerator of the adjustment fraction is the employee's updated compensation (i.e., compensation for the current plan year within the meaning of section 1.401(a)(4)-13(d)(8)), determined after applying the annual compensation limits to each year's compensation that is used in the plan's compensation formula as of the fresh-start date. Similarly, in applying the alternative rule in section 1.401(a)(4)- 13(d)(8)(v), the updated compensation that is substituted must be determined after applying the annual compensation limits to each year's compensation that is used in the plan's compensation formula. Thus, no adjustment will be permitted unless the updated compensation (determined after applying the annual compensation limit) exceeds the compensation that was used to determine the employee's frozen accrued benefit.

(B) MULTIPLE FRESH STARTS. If a plan makes more than one fresh start with respect to a section 401(a)(17) employee, the employee's frozen accrued benefit as of the latest fresh-start date will either be determined by applying the current benefit formula to the employee's total years of service as of that fresh-start date or will consist of the sum of the employee's frozen accrued benefit (or adjusted accrued benefit (as defined in section 1.401(a)(4)- 13(d)(8)(i))) as of the previous fresh-start date plus additional frozen accruals since the previous fresh start. If the frozen accrued benefit consists of such a sum, in making the adjustments described in paragraph (e)(4)(iii)(A) of this section, separate adjustments must be made to that previously frozen accrued benefit (or adjusted accrued benefit) and the additional frozen accruals to the extent that the frozen accrued benefit and the additional accruals have been determined using different compensation formulas or different compensation limits (i.e., the section 401(a)(17) limit before and after the reduction in limit described in paragraph (a)(3) of this section). In this case, if the plan is applying the adjustment fraction of section 1.401(a)(4)-13(d)(8)(i), the denominator of the separate adjustment fraction for adjusting each portion of the frozen accrued benefit must reflect the actual compensation formula, and, if applicable, compensation limit, originally used for determining that portion. For example, the frozen accrued benefit of a section 401(a)(17) employee as of the OBRA '93 fresh-start date may be based on the sum of the section 401(a)(17) frozen accrued benefit (determined without any annual compensation limit) plus benefit accruals in the years between the statutory effective date and the OBRA '93 effective date (based on compensation that was subject to the annual compensation limits for those years). In this example, in adjusting the section 401(a)(17) frozen accrued benefit, the denominator of the adjustment fraction does not reflect any annual compensation limit. Similarly, in adjusting the frozen accruals for years between the statutory effective date and the OBRA '93 effective date, the denominator of the adjustment fraction reflects the level of the annual compensation limit in effect for those years.

(5) EXAMPLES. The following examples illustrate the rules in this paragraph (e).

EXAMPLE 1. (a) Employer X maintains Plan Y, a calendar year defined benefit plan providing an annual benefit for each year of service equal to 2 percent of compensation averaged over an employee's high 3 consecutive calendar years' compensation. Section 401(a)(17) applies to Plan Y in 1989. As of the close of the last plan year beginning before January 1, 1989 (i.e., the 1988 plan year), Employee A, with 5 years of service, had accrued a benefit of $25,000 which equals 10 percent (2 percent multiplied by 5 years of service) of average compensation of $250,000. Employer X decides to comply with the provisions of this section for plan years before the effective date of this section. Employer X decides to make the amendment effective for plan years beginning on or after January 1, 1989, and uses December 31, 1988 as the section 401(a)(17) fresh-start date. Plan Y, as amended, provides that, in determining an employee's benefit, compensation taken into account is limited in accordance with the provisions of this section to the annual compensation limit under section 401(a)(17), and that, for section 401(a)(17) employees, the employee's accrued benefit is the greater of --

(i) The employee's benefit under the plan's benefit formula (after the plan formula is amended to comply with section 401(a)(17)) as applied to the employee's total years of service; and

(ii) The employee's accrued benefit as of December 31, 1988, determined as though the employee terminated employment on that date without regard to any plan amendments after that date. Employer X decides not to amend Plan Y to provide for the adjustments permitted under section 1.401(a)(4)-13(d) to the accrued benefit of section 401(a)(17) employees as of December 31, 1988.

(b) Under Plan Y, Employee A's accrued benefit at the end of 1989 is $25,000, which is the greater of Employee A's accrued benefit as of the last day of the 1988 plan year ($25,000), and $24,000, which is Employee A's benefit based on the plan's benefit formula applied to Employee A's total years of service ($200,000 multiplied by (2 percent multiplied by 6 years of service)). The formula of Plan Y applicable to section 401(a)(17) employees for calculating their accrued benefits for years after the section 401(a)(17) fresh-start date is the formula in section 1.401(a)-13(c)(4)(ii) (formula with wear- away). The fresh-start formula is applied using a benefit formula for the 1989 plan year that satisfies section 401(a)(17) and this section, and the December 31, 1988 fresh-start date used for the plan is a section 401(a)(17) fresh-start date within the meaning of paragraph (e)(2)(ii) of this section. Thus, Plan Y, as amended, satisfies paragraph (e)(3)(i) of this section for plan years commencing prior to the OBRA '93 effective date.

EXAMPLE 2. Assume the same facts as in Example 1, except that the plan formula provides that effective January 1, 1989, for section 401(a)(17) employees, an employee's benefit will equal the sum of the employee's accrued benefit as of December 31, 1988 (determined as though the employee terminated employment on that date and without regard to any amendments after that date), and 2 percent of compensation averaged over an employee's high 3 consecutive years' compensation times years of service taking into account only years of service after December 31, 1988. Thus, under Plan Y's formula, Employee A's accrued benefit as of December 31, 1989 is $29,000, which is equal to the sum of $25,000 (Employee A's accrued benefit as of December 31, 1988) plus $4,000 ($200,000 multiplied by (2 percent multiplied by 1 year of service)). The formula of Plan Y applicable to section 401(a)(17) employees for calculating their accrued benefits for years after the section 401(a)(17) fresh- start date is the formula in section 1.401(a)-13(c)(4)(i) (formula without wear-away). The fresh-start formula is applied using a benefit formula for the 1989 plan year that satisfies section 401(a)(17) and this section, and the December 31, 1988 fresh-start date used for the plan is a section 401(a)(17) fresh-start date within the meaning of paragraph (e)(2)(ii) of this section. Thus, Plan Y, as amended, satisfies paragraph (e)(3)(i) of this section for plan years commencing prior to the OBRA '93 effective date.

EXAMPLE 3. (a) Assume the same facts as in Example 1, except that the plan formula provides that effective January 1, 1989, an employee's benefit equals the greater of the plan formulas in Example 1 and Example 2. The formula of Plan Y applicable to section 401(a)(17) employees for calculating their accrued benefits for years after the section 401(a)(17) fresh- start date is the formula in section 1.401(a)-13(c)(4)(iii) (formula with extended wear-away). The fresh-start formula is applied using a benefit formula for the 1989 plan year that satisfies section 401(a)(17) and this section, and the December 31, 1988 fresh-start date used for the plan is a section 401(a)(17) fresh-start date within the meaning of paragraph (e)(2)(ii) of this section. Thus, Plan Y, as amended, satisfies paragraph (e)(3)(i) of this section for plan years commencing prior to the OBRA '93 effective date.

(b) Assume that for each of the years 1991-93 Employee A's annual compensation under the plan compensation formula, disregarding the amendment to comply with section 401(a)(17) is $300,000. The annual compensation limit is adjusted to $222,220, $228,860, and $235,840 for plan years beginning January 1, 1991, 1992, and 1993, respectively. Because Employer X has decided to amend Plan Y to comply with the provisions of this section effective for plan years beginning on or after January 1, 1989, and has used December 31, 1988 as the section 401(a)(17) fresh- start date, the compensation that may be taken into account for plan benefits in 1993 cannot exceed $228,973 (the average of $222,220, $228,860, and $235,840). Therefore, as of December 31, 1993, the benefit determined under the fresh-start formula with wear-away would be $45,795 ($228,973 multiplied by (2 percent multiplied by 10 years of service)). The benefit determined under the fresh-start formula without wear-away would be $47,897, which is equal to $25,000 (Employee A's section 401(a)(17) frozen accrued benefit) plus $22,897 ($228,973 multiplied by (2 percent multiplied by 5 years of service)). Because Employee A's accrued benefit is being determined using the fresh-start formula with extended wear-away, Employee A's accrued benefit as of December 31, 1993, is equal to $47,897, the greater of the two amounts.

EXAMPLE 4. (a) Assume the same facts as in Example 3, except that Plan Y satisfies section 1.401(a)(4)-13(d)(3) through (d)(7) and that the amendment to Plan Y effective for plan years beginning after December 31, 1988, also provided for adjustments to the section 401(a)(17) frozen accrued benefit in accordance with section 1.401(a)(4)-13(d) using the fraction described in section 1.401(a)(4)-13(d)(8)(i).

(b) As of December 31, 1993, the numerator of Employee A's compensation fraction is $228,973 (the average of Employee A's annual compensation for 1991, 1992, and 1993, as limited by the respective annual limit for each of those years). The denominator of Employee A's compensation fraction determined in accordance with paragraph (e)(4)(iii) of this section is $250,000 (the average of Employee A's high 3 consecutive calendar year compensation as of December 31, 1988, determined without regard to section 401(a)(17)). Therefore, Employee A's compensation fraction is $228,973/$250,000. Because the compensation adjustment fraction is less than 1, Employee A's section 401(a)(17) frozen accrued benefit is not adjusted. Therefore, Employee A's accrued benefit as December 31, 1993, would still be $47,897, which is equal to $25,000 (Employee A's section 401(a)(17) frozen accrued benefit) plus $22,897 ($228,973 multiplied by (2 percent multiplied by 5 years of service).

EXAMPLE 5. (a) Assume the same facts as in Example 3, except that as of January 1, 1994, Plan Y is amended to provide that benefits will be determined based on compensation of $150,000 (the limit in effect under section 401(a)(17) for plan years beginning on or after the OBRA '93 effective date) and that for section 401(a)(17) employees, each employee's accrued benefit will be determined under section 1.401(a)(4)-13(c)(4)(i) (formula without wear-away) using December 31, 1993 as the OBRA '93 fresh-start date.

(b) Assume that for each of the years 1996-98 Employee A's annual compensation under the plan compensation definition, disregarding the amendment to comply with section 401(a)(17), is $400,000. Assume that the annual compensation limit is first adjusted to $160,000 for plan years beginning on or after January 1, 1997, and is not adjusted for the plan year beginning on or after January 1, 1998. The compensation that may be taken into account for the 1998 plan year cannot exceed $156,667 (the average of $150,000 for 1996, $160,000 for 1997, and $160,000 for 1998).

(c) Therefore, at the end of December 31, 1998, Employee A's accrued benefit is $63,564, which is equal to $47,897 (Employee A's OBRA '93 frozen accrued benefit) plus $15,667 ($156,667 multiplied by (2 percent multiplied by 5 years of service)).

EXAMPLE 6. (a) Assume the same facts as in Example 5, except that, for the fresh-start group (in this case the section 401(a)(17) employees), the amendments to Plan Y provide for adjustments to the section 401(a)(17) frozen accrued benefit and the OBRA '93 frozen accrued benefit in accordance with section 1.401(a)(4)-13(d) using the fraction described in section 1.401(a)(4)-13(d)(8)(i).

(b) Employee A's frozen accrued benefit as of December 31, 1993, is adjusted as of December 31, 1998, as follows:

(1) Employee A's frozen accrued benefit as of December 31, 1993, is the sum of Employee A's section 401(a)(17) frozen accrued benefit ($25,000) and Employee A's frozen accruals for the years 1989-93 ($22,897).

(2) The numerator of Employee A's adjustment fraction is $156,667 (the average of $150,000, $160,000, and $160,000). The denominator of Employee A's adjustment fraction with respect to Employee A's section 401(a)(17) frozen accrued benefit is $250,000, and the denominator of Employee A's adjustment fraction with respect to the rest of Employee A's frozen accrued benefit is $228,973 (the average of Employee A's annual compensation for 1991, 1992, and 1993, as limited by the respective annual limit for each of those years).

(3) Employee A's section 401(a)(17) frozen accrued benefit as adjusted through December 31, 1998, remains $25,000. The compensation adjustment fraction determined in accordance with paragraph (e)(4)(iii) of this section is less than one ($156,667 divided by $250,000).

(4) Employee A's frozen accruals for the years 1989-93, as adjusted through December 31, 1998, remain $22,897 because the adjustment fraction is less than one ($156,667 divided by $228,973).

(5) Employee A's adjusted accrued benefit as of December 31, 1998, equals $47,897 (the sum of the $25,000 and $22,897 amounts from paragraphs (b)(3) and (b)(4), respectively, of this EXAMPLE).

(c) Employee A's section 401(a)(17) frozen accrued benefit will not be adjusted for compensation increases until the numerator of the fraction used to adjust that frozen accrued benefit exceeds the denominator of $250,000 used in determining those accruals. Similarly, the portion of Employee A's OBRA '93 frozen accrued benefit attributable to the frozen accruals for the years 1989-1993 will not be adjusted for compensation increases until the numerator of the fraction used to adjust those frozen accruals exceeds the denominator of $228,973 used in determining those accruals.