Final QSLOB Regs Provide New Rules for Allocating Shared Employees

 [4830-01-u]

 ACTION: Final regulations.

 SUMMARY: This document contains amendments to the final regulations under section 414(r) of the Internal Revenue Code, which provide that an employer may be treated as operating separate lines of business for purposes of applying the minimum coverage requirements of section 410(b) and the minimum participation requirements of section 401(a)(26). The regulations reflect the enactment of section 414(r) by the Tax Reform Act of 1986 and subsequent changes made by the Technical and Miscellaneous Revenue Act of 1988 and the Public Debt Limit Increase Act of 1989. The regulations provide guidance necessary to comply with the law and affect sponsors of and participants in tax-qualified retirement plans and certain other employee benefit plans.

 DATES: These regulations are effective January 1, 1994.

 The regulations apply to plan years beginning on or after January 1, 1994, except as provided in the transition rules of section 1.414(r)-1(d)(9).

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

 SUPPLEMENTARY INFORMATION:

BACKGROUND

Proposed regulations under section 414(r) and related provisions of the Internal Revenue Code (Code) were published in the Federal Register on February 1, 1991 (56 FR 3988). Written comments were received from the public on the proposed regulations. In addition, a public hearing on the proposed regulations was held on May 16, 1991. After consideration of all the written comments received and the statements made at the public hearing, the proposed regulations under section 414(r) were adopted, as modified, by final regulations (TD 8376) published in the Federal Register on December 4, 1991 (56 FR 63420). On August 10, 1992, proposed regulations were published in the Federal Register (57 FR 35536) to extend the effective date of the final regulations under section 414(r) (and related regulations), generally to plan years beginning on or after January 1, 1994.

 On September 7, 1993, proposed regulations amending the final regulations under sections 414(r) and 410(b) were published in the Federal Register (58 FR 47090). Written comments were received from the public on the proposed regulations, and a public hearing was held on November 10, 1993. After consideration of all the written comments received and the statements made at the public hearing, these regulations are adopted as modified by this Treasury decision.

 Temporary regulations (TD 8173) and proposed regulations under section 414(q) of the Code (relating to the definition of highly compensated employee) were published in the Federal Register on February 19, 1988 (53 FR 4965 and 4999). In conjunction with the February 1991 proposed regulations under section 414(r), amendments to the temporary regulations (TD 8334) and proposed regulations under section 414(q) were published in the Federal Register on February 1, 1991 (56 FR 3976 and 4023). The amendments related to the employee exclusions for purposes of satisfying the 50-employee requirement for a separate line of business under section 414(r)(2)(A) of the Code.

 Under section 7805(e)(2) of the Code, the February 1991 amendments to the temporary regulations under section 414(q) expired after three years (January 31, 1994). In order to retain the application of those rules, the February 1991 proposed regulations under section 414(q) are adopted by this Treasury decision.

EXPLANATION OF PROVISIONS

1. OVERVIEW

In general, all employees of a single employer, determined under section 414 of the Code, are taken into account for purposes of applying the minimum coverage requirements of section 410(b) and the minimum participation requirements of section 401(a)(26) to a qualified plan. Section 410(b)(5) provides an exception if an employer operates qualified separate lines of business under section 414(r). If the employer is treated as operating qualified separate lines of business, section 410(b)(5) generally permits the employer to apply the minimum coverage requirements separately with respect to the employees of each qualified separate line of business. A similar exception is provided for purposes of applying the minimum participation requirements of section 401(a)(26) and the 55-percent average benefits test of section 129(d)(8).

An employer is treated as operating qualified separate lines of business if (1) the employer designates its lines of business by reference to the property or services provided by each line, (2) each line of business is organized and operated separately from the remainder of the employer, and (3) each of these separate lines of business meets additional statutory requirements (including administrative scrutiny) and thus constitutes a qualified separate line of business. Each employee of an employer that operates qualified separate lines of business is assigned to a particular line of business for purposes of nondiscrimination testing.

The September 1993 proposed regulations amend the final regulations under section 414(r) generally to address issues raised since the publication of the final regulations. The proposed regulations include the following major changes:

- Allowing an employee to be treated as a substantial-service employee with respect to a line of business if at least 50 percent of the employee's services are provided to that line.

- Applying the separate management and separate workforce tests to a line of business without regard to substantial-service employees of other lines.

- Excluding nonresident aliens in applying the separate management and separate workforce tests.

- Expanding the special rules for vertically integrated lines of business and transferred employees.

- Increasing access to individual determinations under administrative scrutiny.

- Clarifying the treatment of employees who change from one disaggregation population to another.

 In general, comments received on the changes included in the proposed regulations were favorable. Accordingly, these final regulations incorporate those changes. In addition, in response to comments, certain further modifications have been made to the regulations. The more significant modifications are discussed below.

2. RESIDUAL SHARED EMPLOYEES

Most of the comments received on the September 1993 proposed regulations pertained to the allocation of residual shared employees, that is, employees who provide services to more than one qualified separate line of business and who are not substantial-service employees with respect to any line of business. The December 1991 regulations provide three alternative allocation methods for residual shared employees, which are intended to assure that, as a group, residual shared employees receive benefits representative of the benefits provided to the workforce generally.

 Under the dominant line of business method, all residual shared employees are allocated to the employer's dominant line of business. Generally, a qualified separate line of business is dominant if at least 50 percent of the employer's substantial-service employees are assigned to that line. Alternatively, a line of business may be dominant if at least 35 percent of the employer's substantial-service employees are assigned to that line and the line satisfies any one of four possible conditions, such as a certain level of revenue or a certain size compared with the employer's other lines. The other two allocation methods, the pro-rata method and the highly compensated employee (HCE) percentage ratio method, provide formulas under which residual shared employees are allocated among the employer's various qualified separate lines of business.

 Employers have commented that the allocation rules do not adequately accommodate current benefit arrangements for employees who provide services to more than one qualified separate line of business. For example, the employer might cover residual shared employees in the plan maintained for a line that the employer considers its core business, even though that line does not satisfy the dominant line of business standard. Residual shared employees therefore cannot all be allocated to that line, potentially causing a change in their benefits. Employers also have commented that the pro- rata and HCE percentage ratio methods may require employees in the same department to be allocated to different qualified separate lines of business, which in turn may require different benefits to be provided to employees who work together.

 In response to comments, these final regulations change the allocation rules in two ways. First, the standard for the alternative test of dominance is lowered from 35 percent to 25 percent, giving employers more flexibility in establishing a dominant line. Second, the regulations provide an additional allocation alternative, the small group method.

 Under the small group method, with respect to each residual shared employee, the employer chooses a qualified separate line of business to which the employee is allocated. The residual shared employees need not all be allocated to the same qualified separate line of business; the employer thus has great flexibility in selecting the plans under which residual shared employees benefit. In order to prevent this new allocation method from being used to provide highly compensated employees with excessive benefits relative to the nonhighly compensated employees, its use is subject to three requirements.

 First, the entire group of the employer's residual shared employees cannot exceed three percent of the employees taken into account in applying section 410(b). In addition, the qualified separate line of business to which the employer allocates a residual shared employee must include at least 10 percent of the employer's substantial-service employees and must satisfy the administrative scrutiny statutory safe harbor after the allocation, that is, the concentration of highly compensated employees in the line of business must be between 50 and 200 percent of the concentration of highly compensated employees in the workforce generally. Finally, the allocation of residual shared employees must be reasonable; criteria for determining whether an allocation is reasonable are set forth in the regulations.

3. GATEWAY

 Section 410(b)(5)(B) provides that separate-line-of-business testing does not apply to a plan unless the plan benefits such employees as qualify under a classification that is set up by the employer and is found not to discriminate in favor of highly compensated employees. Because the employer-wide nondiscriminatory classification test of section 410(b)(5)(B) is a prerequisite to separate-line-of-business testing, it is sometimes referred to as the "Gateway."

 Under the December 1991 regulations, the Gateway is applied in the same basic manner as the nondiscriminatory classification test under the section 410(b) regulations. Those regulations establish an unsafe harbor ratio percentage for a plan, that is, a minimum ratio of the relative coverage rates of nonhighly compensated and highly compensated employees. The unsafe harbor percentage applicable to a plan depends on the concentration of nonhighly compensated employees in the employer's workforce.

 If a qualified separate line of business has a disproportionate share of the employer's highly compensated employees, the plan maintained for that line of business may have a very low ratio percentage on an employer-wide basis, even though it covers a high percentage of the nonhighly compensated employees in that line. The December 1991 regulations therefore provide a reduced unsafe harbor percentage if the plan has a ratio percentage of at least 90 percent on a qualified-separate-line-of- business basis. Although most plans pass the Gateway test in its current form, some commentators on the September 1993 proposed regulations have noted continued difficulty in the case of plans maintained for certain lines of business that cover a high percentage of the nonhighly compensated employees in those lines.

 In response to those comments, these final regulations provide that, if a plan has a ratio percentage of at least 90 percent on a qualified-separate-line-of-business basis, but its employer-wide ratio percentage falls below the plan's reduced unsafe harbor percentage, the plan nonetheless is deemed to satisfy section 410(b)(5)(B) on an employer-wide basis if the Commissioner determines that, based on all of the relevant facts and circumstances, the plan benefits such employees as qualify under a classification of employees that does not discriminate in favor of highly compensated employees. For this purpose, included among the relevant facts and circumstances are facts and circumstances such as those listed in section 1.410(b)-4(c)(3)(ii). In making these determinations, the Commissioner will determine which other facts and circumstances are relevant, including any of the facts and circumstances listed in section 5 of Rev. Proc. 93-41, 1993-2 C.B. 536, that the Commissioner determines are relevant.

4. OTHER CHANGES

These final regulations also make the following changes:

- Expansion of the minimum and maximum benefit safe harbor to apply to career average plans.

- Allowing more flexibility in the employees taken into account for purposes of the minimum benefit safe harbor.

- Clarification of the application of section 401(a)(26) to employer-wide plans.

- Clarification of the disaggregation population rules after a change in disaggregation population groups.

- Finalization of the regulations under section 414(q) relating to employees excluded for purposes of the 50-employee requirement under section 414(r)(2)(A).

5. NOTICE 92-36 RELIEF

 A concern has been raised that the anti-cutback rules of section 411(d)(6) might eliminate an employer's option to comply with the nondiscrimination requirements of the Tax Reform Act of 1986 (including the provisions of section 414(r)) and related legislation by amending its plans in the 1994 plan year to reduce the level of benefits provided to highly compensated employees for that year. Employers are reminded that Notice 92-36, 1992-2 C.B. 364, provided broad transition relief giving employers the opportunity to retain their amendment options until the last day of the 1994 plan year without being treated as violating section 411(d)(6).

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 regulations is Patricia McDermott 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 8548

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. * * *

Section 1.414(q)-1 also issued under 26 U.S.C. 414(q). * * *

Par. 2. Section 1.410(b)-0 is amended as follows:

1. The entries for section 1.410(b)-7(c)(4) and (c)(5) are revised.

2. The entry for (c)(6) is removed.

3. The revised entries read as follows:

SECTION 1.410(b)-0 TABLE OF CONTENTS. * * *

* * * * *

SECTION 1.410(b)-7 DEFINITION OF PLAN AND RULES GOVERNING PLAN DISAGGREGATION AND AGGREGATION.

* * * * *

(c) * * *

(4) Plans benefiting certain disaggregation populations of employees.

(i) In general.

(ii) Definition of disaggregation population.

(5) Additional rules for plans benefiting employees of more than one qualified separate line of business.

* * * * *

SECTION 1.410(b)-2 [AMENDED]

Par. 3. Section 1.410(b)-2 is amended as follows:

1. Paragraph (b)(7) is amended by removing the reference "section 1.410(b)-7(c)(5)" from the second sentence and adding "section 1.410(b)-7(c)(4)" in its place.

SECTION 1.410(b)-6 [AMENDED]

Par. 4. Section 1.410(b)-6 is amended as follows:

1. Paragraph (d)(1) is amended by removing the reference "section 1.410(b)-7(c)(5)" from the second sentence and adding "section 1.410(b)-7(c)(4)" in its place.

2. Paragraph (d)(2)(iv) is amended by removing the reference "section 1.410(b)-7(c)(5)" from the fourth sentence of Example 2(i) and adding "section 1.410(b)-7(c)(4)" in its place.

Par. 5. Section 1.410(b)-7 is amended as follows:

1. Paragraphs (c)(4) and (c)(5) are revised.

2. Paragraph (c)(6) is removed.

3. Paragraph (d)(4) is amended by removing the reference "(c)(5)" from the second and third sentences and adding "(c)(4)" in its place.

4. The revised provisions read as follows:

SECTION 1.410(b)-7 DEFINITION OF PLAN AND RULES GOVERNING PLAN DISAGGREGATION AND AGGREGATION.

* * * * *

(c) * * *

(4) PLANS BENEFITING CERTAIN DISAGGREGATION POPULATIONS OF EMPLOYEES -- (i) IN GENERAL -- (A) SINGLE PLAN MUST BE TREATED AS SEPARATE PLANS. If a plan (i.e., a single plan within the meaning of section 414(l)) benefits employees of more than one disaggregation population, the plan must be disaggregated and treated as separate plans, each separate plan consisting of the portion of the plan benefiting the employees of each disaggregation population. See paragraph (c)(4)(ii) of this section for the definition of disaggregation population.

(B) BENEFIT ACCRUALS OR ALLOCATIONS ATTRIBUTABLE TO CURRENT STATUS. Except as otherwise provided in paragraph (c)(4)(i)(C) of this section, in applying the rule of paragraph (c)(4)(i)(A) of this section, the portion of the plan benefiting employees of a disaggregation population consists of all benefits accrued by, or all allocations made to, employees while they were members of the disaggregation population.

(C) EXCEPTIONS FOR CERTAIN BENEFIT ACCRUALS -- (1) ATTRIBUTION OF BENEFITS TO FIRST DISAGGREGATION POPULATION. If employees benefiting under a plan change from one disaggregation population to a second disaggregation population, benefits they accrue while members of the second disaggregation population that are attributable to years of service previously credited while the employees were members of the first disaggregation population may be treated as provided to them in their status as members of the first disaggregation population and thus included in the portion of the plan benefiting employees of the first disaggregation population. This special treatment is available only if it is applied on a consistent basis, if it does not result in significant discrimination in favor of highly compensated employees, and if the plan provision providing the additional benefits applies on the same terms to all similarly-situated employees. For example, if all formerly collectively bargained employees accrue additional benefits under a plan after becoming noncollectively bargained employees, then those benefit increases may be treated as included in the portion of the plan benefiting collectively bargained employees if they are attributable to years of service credited while the employees were collectively bargained (e.g., where the additional benefits result from compensation increases that occur while the employees are noncollectively bargained or from plan amendments affecting benefits earned while collectively bargained that are adopted while the employees are noncollectively bargained) and if such treatment does not result in significant discrimination in favor of highly compensated employees.

(2) ATTRIBUTION OF BENEFITS TO CURRENT DISAGGREGATION POPULATION. If employees benefiting under a plan change from one disaggregation population to another disaggregation population, benefits they accrue while members of the first disaggregation population may be treated as provided to them in their current status and thus included in the portion of the plan benefiting employees of the disaggregation population of which they are currently members. This special treatment is available only if it is applied on a consistent basis and if it does not result in significant discrimination in favor of highly compensated employees.

(D) CHANGE IN DISAGGREGATION POPULATIONS -- (1) REASONABLE TREATMENT. If, in previous years, the configuration of a plan's disaggregation populations differed from their configuration for the current year, for purposes of the benefits accrued by, or allocations made to, an employee for those years, the employee's status as a member of a current disaggregation population for those years must be determined on a reasonable basis. A different configuration occurs, for example, if disaggregation populations exist for the first time, such as when an employer is first treated as operating qualified separate lines of business, or if the existing disaggregation populations change, such as when an employer redesignates its qualified separate lines of business.

(2) EXAMPLE. The following example illustrates the application of this paragraph (c)(4)(i)(D).

EXAMPLE. (a) Employer X operates Divisions M and N, which are treated as qualified separate lines of business for the first time in 1998. Thus, the disaggregation populations of employees of Division M and employees of Division N exist for the first time. Since 1981 Employer X has maintained a defined benefit plan, Plan P, for employees of Division M. Plan P provides a normal retirement benefit of one percent of average annual compensation for each year of service up to 25. Employee A has worked for Division M since 1981 and has never worked for Division N. Employee B has worked for Division N since 1989 and worked for Division M from 1981 to 1988. Employee C has worked in the headquarters of Employer X since 1981. For the period 1981 to 1988 Employee C was credited with years of service under Plan P.

(b) For purposes of the benefits accrued by Employee A under Plan P during years 1981 through 1997, Employee A is reasonably treated as having been a member of the Division M disaggregation population for those years. For purposes of the benefits accrued by Employee B under Plan P during years 1981 through 1988, Employee B is reasonably treated as having been a member of the Division M disaggregation population for 1981 through 1988 and as having changed to the Division N disaggregation population for 1989 through 1997. For purposes of the benefits accrued by Employee C under Plan P during years 1981 through 1988, Employee C is reasonably treated as having been a member of the Division M disaggregation population for those years. Moreover, any benefit accruals for Employee B and Employee C in years after 1988, that result from increases in average annual compensation after 1988 and that are attributable to years of service credited for 1981 through 1988, may be treated as provided to Employee B and Employee C in their status as members of the Division M disaggregation population if the requirements of paragraph (c)(4)(i)(C)(1) of this section are otherwise met.

(ii) DEFINITION OF DISAGGREGATION POPULATION -- (A) PLAN BENEFITING EMPLOYEES OF QUALIFIED SEPARATE LINES OF BUSINESS. If an employer is treated as operating qualified separate lines of business for purposes of section 410(b) in accordance with section 1.414(r)- 1(b), and a plan benefits employees of more than one qualified separate line of business, the employees of each qualified separate line of business are separate disaggregation populations. In this case, the portion of the plan benefiting the employees of each qualified separate line of business is treated as a separate plan maintained by that qualified separate line of business. However, employees of different qualified separate lines of business who are benefiting under a plan that is tested under the special rule for employer-wide plans in section 1.414(r)-1(c)(2)(ii) for a plan year are not separate disaggregation populations merely because they are employees of different qualified separate lines of business.

(B) PLAN BENEFITING COLLECTIVELY BARGAINED EMPLOYEES. If a plan benefits both collectively bargained employees and noncollectively bargained employees, the collectively bargained employees are one disaggregation population and the noncollectively bargained employees are another disaggregation population. If the population of collectively bargained employees includes employees covered under different collective bargaining agreements, the population of employees covered under each collective bargaining agreement is also a separate disaggregation population.

(C) PLAN MAINTAINED BY MORE THAN ONE EMPLOYER. If a plan benefits employees of more than one employer, the employees of each employer are separate disaggregation populations. In this case, the portion of the plan benefiting the employees of each employer is treated as a separate plan maintained by that employer, which must satisfy section 410(b) by reference only to that employer's employees. However, for purposes of this paragraph (c)(4)(ii)(C), if the plan of one employer (or, in the case of a plan maintained by more than one employer, the plan provisions applicable to the employees of one employer) treats compensation or service with another employer as compensation or service with the first employer, then the current accruals attributable to that compensation or service are treated as provided to an employee of the first employer under the plan of the first employer (or the portion of a plan maintained by more than one employer benefiting employees of the first employer), and the provisions of paragraph (c)(4)(i)(C) of this section do not apply to those accruals. Thus, for example, if Plan A maintained by Employer X imputes service or compensation for an employee of Employer Y, then Plan A is not treated as benefiting the employees of more than one employer merely because of this imputation.

(5) ADDITIONAL RULE FOR PLANS BENEFITING EMPLOYEES OF MORE THAN ONE QUALIFIED SEPARATE LINE OF BUSINESS. If a plan benefiting employees of more than one qualified separate line of business satisfies the reasonable classification requirement of section 1.410(b)-4(b) before the application of paragraph (c)(4) of this section, then any portion of the plan that is treated as a separate plan as a result of the application of paragraphs (c)(4)(i)(a) and (ii)(a) of this section is deemed to satisfy that requirement.

* * * * *

Par. 6. Section 1.414(q)-1 is added to read as follows:

SECTION 1.414(q)-1 HIGHLY COMPENSATED EMPLOYEE.

Q&A-1 through Q&A-8: [Reserved] See section 1.414(q)-1T, Q&A-1 through Q&A-8 for further guidance.

Q-9: How is the top-paid group determined?

A-9: (a) [Reserved] See section 1.414(q)-1T, Q&A-9(a) for further guidance.

(b) NUMBER OF EMPLOYEES IN THE TOP-PAID GROUP -- (1) EXCLUSIONS. The number of employees who are in the top-paid group for a year is equal to 20 percent of the total number of active employees of the employer for such year. However, solely for purposes of determining the total number of active employees in the top-paid group for a year, the employees described in section 1.414(q)-1T, A-9(b)(1)(i), (ii) and (iii)(B) are disregarded. Paragraph (g) of this A-9 provides rules for determining those employees who are excluded for purposes of applying section 414(r)(2)(A), relating to the 50-employee requirement applicable to a qualified separate line of business.

(i) through (iii) [Reserved] See section 1.414(q)-1T, Q&A- 9(b)(1)(i) through (iii) for further guidance.

(2) ALTERNATIVE EXCLUSION PROVISIONS -- (i) and (ii) [Reserved] See section 1.414(q)-1T, Q&A-9(b)(2)(i) and (ii) for further guidance.

(iii) METHOD OF ELECTION. The elections in this paragraph (b)(2) must be provided for in all plans of the employer and must be uniform and consistent with respect to all situations in which the section 414(q) definition is applicable to the employer. Thus, with respect to all plan years beginning in the same calendar year, the employer must apply the test uniformly for purposes of determining its top- paid group with respect to all its qualified plans and employee benefit plans. If either election is changed during the determination year, no recalculation of the look-back year based on the new election is required, provided the change in election does not result in discrimination in operation.

(c) through (f) [Reserved] See section 1.414(q)-1T, Q&A-9(c) through (f) for further guidance.

(g) excluded employees under section 414(r)(2)(A) -- (1) IN GENERAL. This paragraph (g) provides the rules for determining which employees are excluded employees for purposes of applying section 414(r)(2)(A), relating to the 50-employee requirement applicable to a qualified separate line of business.

(2) EXCLUDED EMPLOYEES -- (i) AGE AND SERVICE EXCLUSION. All employees are excluded who are described in section 1.414(q)-1T, A- 9(b)(1)(i) (relating to exclusions based on age or service). For this purpose, the rules in section 1.414(q)-1T, A-9(e) and (f) (relating respectively to the 17section -hour rule and the 6-month rule) apply. However, the election in section 1.414(q)-1T, A-9(b)(2)(i) (permitting the employer to elect reduced minimum age or service requirements) does not apply.

(ii) NONRESIDENT ALIEN EXCLUSION. All employees are excluded who are described in section 1.414(q)-1T, A-9(b)(1)(ii) (relating to the exclusion of nonresident aliens with no U.S.-source income from the employer).

(iii) INCLUSION OF EMPLOYEES COVERED UNDER A COLLECTIVE BARGAINING AGREEMENT. All employees are included who are described in section 1.414(q)-1T, A-9(b)(1)(iii)(A) (relating to employees covered under a collective bargaining agreement) and who are not otherwise described in paragraph (g)(2)(i) or (ii) of this A-9. For this purpose, the exclusion in section 1.414(q)-1T, A-9(b)(1)(iii)(B) and the related election in section 1.414(q)-1T, A-9(b)(2)(ii) do not apply.

(3) APPLICABLE PERIOD. The determination of which employees are excluded employees is made on the basis of the testing year specified in the regulations under section 414(r) and not on the basis of the determination year or the look-back year under section 414(q).

(h) EFFECTIVE DATE. The provisions of this A-9 apply to plan years and testing years beginning on or after January 1, 1994.

Q&A-10 through Q&A-15: [Reserved] See section 1.414(q)-1T, Q&A- 10 through Q&A-15 for further guidance.

Par. 7. Section 1.414(q)-1T, paragraph A-9, is amended as follows:

1. The introductory text of paragraph (b)(1) is revised.

2. Paragraph (b)(2)(iii) is revised.

3. Paragraph (g) is removed.

4. The revised provisions read as follows:

SECTION 1.414(q)-1T HIGHLY COMPENSATED EMPLOYEE (TEMPORARY).

* * * * *

A-9:

* * * * *

(b) NUMBER OF EMPLOYEES IN THE TOP-PAID GROUP -- (1) EXCLUSIONS. [Reserved] See section 1.414(q)-1, Q&A-9(b)(1) for further information.

* * * * *

(2) * * *

(iii) METHOD OF ELECTION. [Reserved] See section 1.414(q)-1, Q&A-9(b)(2)(iii) for further information.

* * * * *

Par. 8. Section 1.414(r)-0, paragraph (b), is amended as follows:

1. Entries for section 1.414(r)-2, paragraphs (b)(2)(i) and (ii), are added.

2. The entries for section 1.414(r)-3 are amended by:

a. Removing the entries for paragraphs (c)(4)(i) and (c)(4)(ii);

b. Revising the entry for paragraph (c)(5)(iii) and adding entries for paragraphs (c)(5)(iii)(A) and (B).

3. The entries for section 1.414(r)-6 are amended by:

a. Revising the entry for paragraph (b).

b. Removing the entries for paragraphs (c) and (c)(1) through (c)(12).

4. The entries for section 1.414(r)-7 are amended by:

a. Removing the entry for paragraph (c)(2);

b. Redesignating the entries for paragraphs (c)(3) through (c)(5) as paragraphs (c)(2) through (c)(4);

c. Adding new entries for paragraphs (c)(5) and (c)(5)(i) through (c)(5)(iv);

d. Removing the entries for paragraphs (d) and (d)(1) through (d)(3).

5. The entries for section 1.414(r)-8 are amended by:

a. Revising the entry for paragraph (b)(2)(iii) and adding entries for paragraphs (b)(2)(iii)(A) and (B).

b. Removing the entry for paragraph (d)(4).

c. Redesignating the entry for paragraph (d)(5) as paragraph (d)(4).

6. The added and revised entries read as follows:

SECTION 1.414(r)-0 TABLE OF CONTENTS.

* * * * *

(b) * * *

* * * * *

SECTION 1.414(r)-2 LINE OF BUSINESS.

* * * * *

(b) * * *

(2) * * *

(i) In general.

(ii) Timing of provision of property or services.

* * * * *

SECTION 1.414(r)-3 SEPARATE LINE OF BUSINESS.

* * * * *

(c) * * *

(5) * * *

(iii) Optional rule for employees who change status.

(A) In general.

(B) Change in employee's status.

* * * * *

SECTION 1.414(r)-6 QUALIFIED SEPARATE LINE OF BUSINESS - ADMINISTRATIVE SCRUTINY REQUIREMENT - INDIVIDUAL DETERMINATIONS.

* * * * *

(b) Authority to establish procedures.

SECTION 1.414(r)-7 DETERMINATION OF THE EMPLOYEES OF AN EMPLOYER'S QUALIFIED SEPARATE LINES OF BUSINESS.

* * * * *

(c) * * *

(5) Small group method.

(i) In general.

(ii) Size of group.

(iii) Composition of qualified separate line of business.

(iv) Reasonable allocation.

SECTION 1.414(r)-8 SEPARATE APPLICATION OF SECTION 410(b)

* * * * *

(b) * * *

(2) * * *

(iii) Modification of unsafe harbor percentage for plans satisfying ratio percentage test at 90 percent level.

(A) General Rule.

(B) Facts and circumstances alternative.

* * * * *

Par. 9. Section 1.414(r)-1 is amended as follows:

1. The fourth and seventh sentences of the Example in paragraph (c)(2)(ii) are amended by adding the language "nonhighly compensated" immediately after "nonexcludable."

2. Paragraph (c)(3)(ii) is revised.

3. The last sentence of paragraph (d)(4) is amended by adding the language "scrutiny" immediately after "administrative."

4. Paragraph (d)(9)(i) is amended by removing the reference "1992" from the end of the sentence and adding the language "1994 (or January 1, 1996, in the case of plans maintained by organizations exempt from income taxation under section 501(a), including plans subject to section 403(b)(12)(A)(i) (nonelective plans))" in its place.

5. The last sentence of paragraph (e) is amended by removing the language "and new conditions under which an individual determination may be requested under section section 1.414(r)-6".

6. The revised provision reads as follows:

SECTION 1.414(r)-1 REQUIREMENTS APPLICABLE TO QUALIFIED SEPARATE LINES OF BUSINESS.

* * * * *

(c) * * *

(3) * * *

(ii) SPECIAL RULE FOR EMPLOYER-WIDE PLANS. Notwithstanding the first sentence of paragraph (c)(3)(i) of this section, an employer that is treated as operating qualified separate lines of business in accordance with paragraph (b) of this section for purposes of both sections 410(b) and 401(a)(26) may apply the requirements of section 401(a)(26) on an employer-wide rather than a qualified-separate-line- of-business basis with respect to any plan (within the meaning of section 1.414(r)-9(c)(2), but without regard to the mandatory disaggregation rule of section 1.401(a)(26)-2(d)(1)(iv) for portions of a plan that benefit employees of different qualified separate lines of business), but only if the special rule for employer-wide plans in paragraph (c)(2)(ii) of this section is applied to the same plan for the same plan year.

* * * * *

Par. 10. Section 1.414(r)-2 is amended as follows:

1. Paragraph (b)(2) is revised.

2. Example 1 and Example 2 in paragraph (c)(3) are revised.

3. The revised provisions read as follows:

SECTION 1.414(r)-2 LINE OF BUSINESS.

* * * * *

(b) * * *

(2) PROPERTY AND SERVICES PROVIDED TO CUSTOMERS -- (i) IN GENERAL. Property, whether real or personal, tangible or intangible, is provided by an employer to a customer if the employer provides the property to or on behalf of the customer for consideration. Similarly, services are provided by an employer to a customer if the employer renders the services to or on behalf of the customer for consideration. An individual item of property or service is taken into account under this paragraph (b)(2) only if the employer provides the item to a person other than the employer in the ordinary course of a trade or business conducted by the employer and the person to whom the employer provides the item is acting in the capacity of a customer of the employer. A type of tangible property is deemed to be provided to customers of the employer for purposes of this section if, with respect to a business that produces or manufactures that type of tangible property, the employer satisfies the special rule in section 1.414(r)-3(d)(2)(iii)(B) for vertically integrated businesses.

(ii) TIMING OF PROVISION OF PROPERTY OR SERVICES. Generally an employer determines its lines of business on the basis of the property and services it provides to its customers for consideration during the testing year. However, it is not necessary both that property or services actually be provided, and that consideration for the property or services actually be paid, during the current testing year. For an employer to be considered to provide property or services to customers for consideration during a testing year under this paragraph (b)(2), it is sufficient that the property or services actually be provided to customers during the testing year, the consideration actually be paid during the testing year, or the employer actually incur significant costs during the testing year associated with the provision of the property or services to a specified customer or specified customers.

* * * * *

(c) * * *

(3) * * *

EXAMPLE 1. Employer H operates several dairy farms and dairy product processing plants. The dairy farms provide part of their output of milk and milk by-products to Employer H's dairy product processing plants and also sell part to retail distributors unrelated to Employer H. The dairy farms' provision of milk and milk by-products to Employer H's dairy product processing plants does not constitute the provision of property or services to customers of Employer H because the milk and milk by-products are not provided to a person other than employer H. However, the dairy farms' provision of milk and milk by-products to independent retail distributors does constitute the provision of property or services to customers of Employer H under paragraph (b)(2) of this section.

EXAMPLE 2. The facts are the same as in Example 1, except that the dairy farms provide their entire output of milk and milk by-products to Employer H's dairy product processing plants. The dairy farms' provision of milk and milk by-products to the dairy product processing plants generally does not constitute the provision of property or services to customers of Employer H because the milk and milk by-products are not provided to a person other than Employer H. However, paragraph (b)(2)(i) of this section provides a special rule for vertically integrated businesses that satisfy section 1.414(r)- 3(d)(2)(iii)(B). If section 1.414(r)-3(d)(2)(iii)(B) is satisfied, then, under the special rule of paragraph (b)(2)(i) of this section, the milk and milk by-products are deemed to be provided to customers of Employer H.

* * * * *

Par. 11. Section 1.414(r)-3 is amended as follows:

1. The second sentence of paragraph (b)(4) is revised.

2. Paragraph (c)(2)(ii) is revised.

3. Paragraph (c)(4) is revised.

4. Paragraph (c)(5)(iii) is revised.

5. The last sentence of the introductory text of paragraph (c)(6) is revised.

6. A sentence is added to the end of Example 2 of paragraph (c)(6).

7. In paragraph (c)(6), the phrase "(in accordance with paragraph (c)(5)(iii) of this section)" is removed from the seventh sentence of Example 3, the fifth sentence of Example 4, the fifth and sixth sentences of Example 5, and the fifth sentence of Example 7.

8. Two sentences are added to the end of Example 5 of paragraph (c)(6).

9. A sentence is added to the end of the introductory text of paragraph (c)(7).

10. Example 1 of paragraph (c)(7) is revised.

11. In Example 2 of paragraph (c)(7), the phrase "(in accordance with paragraph (c)(5)(iii) of this section)" is removed from the third sentence.

12. Examples 3 and 4 of paragraph (c)(7) are redesignated Examples 4 and 5, respectively, and a new Example 3 is added.

13. The first sentence of newly designated Example 5 in paragraph (c)(7) is amended by removing the reference "Example 3" and adding "Example 4" in its place.

14. Paragraph (d)(2) is revised.

15. Example 1 of paragraph (d)(4) is revised.

16. The additions and revisions read as follows:

SECTION 1.414(r)-3 SEPARATE LINE OF BUSINESS.

* * * * *

(b) * * *

(4) SEPARATE EMPLOYEE WORKFORCE. * * * A line of business has its own separate workforce only if at least 90 percent of the employees who provide services to the line of business, and who are not substantial-service employees with respect to any other line of business, are substantial-service employees with respect to the line of business. * * *

(c) * * *

(2) * * *

(ii) The denominator of which is the total number of employees who provide services to the line of business within the meaning of paragraph (c)(5) of this section and who are not substantial-service employees with respect to any other line of business.

* * * * *

(4) EMPLOYEES TAKEN INTO ACCOUNT. For purposes of applying this paragraph (c), only employees who are employees on the first testing day are taken into account. For this purpose, there are no excludable employees except nonresident aliens described in section 410(b)(3)(C). Consequently, all other employees who are employees on the first testing day are taken into account, including collectively bargained employees. For the definition of first testing day, see section 1.414(r)-11(b)(7).

(5) * * *

(iii) OPTIONAL RULE FOR EMPLOYEES WHO CHANGE STATUS -- (A) IN GENERAL. Solely for purposes of the separateness rules of this section and the assignment rules of section 1.414(r)-7, if an employee changes status as described in paragraph (c)(5)(iii)(B) of this section, an employer may, for up to three consecutive testing years after the base year (within the meaning of paragraph (c)(5)(iii)(B)(1) or (2) of this section), treat the employee as providing the same level of service to its lines of business as the employee provided in the base year.

(B) CHANGE IN EMPLOYEE'S STATUS. An employee changes status as described in this paragraph (c)(5)(iii)(B) if --

(1) For a testing year (the base year), the employee was a substantial-service employee with respect to a qualified separate line of business of the employer (prior line of business) and, for the immediately succeeding testing year, the employee is not a substantial-service employee with respect to that prior line of business; or

(2) For a testing year (the base year), the employee was a residual shared employee and, for the immediately succeeding testing year, the employee is a substantial-service employee with respect to a qualified separate line of business.

(c) * * *

(6) * * * Unless otherwise specified, it is assumed that the employees and their services described in these examples are taken into account under paragraphs (c)(4) and (5) of this section for the testing year and that the employer does not use the option under section 1.414(r)-11(b)(2) to treat employees who provide less than 75 percent of their services to a line of business as substantial- service employees with respect to the line of business.

* * * * *

EXAMPLE 2. * * * Moreover, because Employees M and N provide at least 75 percent of their services to Employer A's tire and automotive products line of business and are substantial-service employees with respect to that line, they are disregarded in applying paragraph (b)(4) of this section to any other line of business, even if they provide services to the other line.

* * * * *

EXAMPLE 5. * * * Under the definition of substantial- service employee in section 1.414(r)-11(b)(2), Employer A may treat Employee R as a substantial-service employee with respect to the tire and automotive products line of business because Employee R provides at least 50 percent of his services to that line. In that case, Employee R would be disregarded in applying paragraph (b)(4) of this section to the construction machinery and agricultural equipment lines of business.

* * * * *

(7) * * * Unless otherwise specified, it is assumed that employees who provide services to a line of business are not substantial-service employees with respect to any other line of business and that, in determining the top-paid employees with respect to a line of business, the employer is using the option under section 1.414(r)-11(b)(3) to disregard all employees who provide less than 25 percent of their services to that line of business.

EXAMPLE 1. (a) Employer C operates three lines of business as determined under section 1.414(r)-2. One of its lines of business is the operation of a chain of athletic equipment and apparel stores. Of Employer C's total workforce, 12,000 employees provide more than a negligible amount of the services they provide to Employer C to the athletic equipment and apparel stores line of business, within the meaning of paragraph (c)(5) of this section. Of the 1,200 employees who constitute the top ten percent by compensation of those 12,000 employees, 930 are substantial-service employees with respect to that line of business. Because 930 is 77.5 percent of 1,200, less than 80 percent of the top-paid employees with respect to the line of business are substantial-service employees with respect to that line of business. Therefore, Employer C's athletic equipment and apparel stores line of business does not have its own separate management under paragraph (b)(5) of this section.

(b) Assume that, in determining the top-paid employees with respect to the athletic equipment and apparel stores line of business, Employer C chooses to disregard all employees who provide less than 25 percent of their services to the line of business as permitted under the definition in section 1.414(r)- 11(b)(3). Of the 12,000 employees who provide more than a negligible amount of their services to the athletic equipment and apparel stores line of business, 10,000 provide at least 25 percent of their services to that line. Of the 1,000 employees who constitute the top ten percent by compensation of those 10,000 employees, 930 are substantial-service employees with respect to the athletic equipment and apparel stores line of business. Because 930 is 93 percent of 1,000, at least 80 percent of the top-paid employees with respect to the line of business are substantial-service employees with respect to that line of business. Therefore, Employer C's athletic equipment and apparel stores line of business has its own separate management and satisfies the requirement of paragraph (b)(5) of this section.

* * * * *

EXAMPLE 3. The facts are the same as in Example 2 except that Employee X provides 60 percent of his services to Employer C's second line of business, an athletic equipment factory, and 30 percent of his service to Employer C's third line of business, a fast-food chain. Because Employee X provides at least 50 percent of his services to the athletic equipment factory line of business, Employer C chooses to treat him as a substantial-service employee with respect to that line of business, as permitted under section 1.414(r)-11(b)(2). Thus, Employee X is taken into account as a substantial-service employee with respect to the athletic equipment factory line of business and is disregarded in applying the separate workforce and separate management requirements under paragraphs (b)(4) and (5) to the fast-food chain line of business.

* * * * *

(d) * * *

(2) REQUIREMENTS. Two lines of business satisfy the requirements of this paragraph (d) with respect to a type of property or service only if --

(i) One of the lines of business (the upstream line of business) provides a type of property or service to the other line of business (the downstream line of business);

(ii) The downstream line of business either --

(A) Uses, consumes, or substantially modifies the property or service in the course of itself providing property or services to customers of the employer; or

(B) Provides the same property or service to customers of the employer at a different level in the chain of commercial distribution from the upstream line of business (e.g., retail versus wholesale); and

(iii) The upstream line of business either --

(A) Provides the same type of property or service to customers of the employer, and at least 25 percent of the total number of units of the same type of property or service provided by the upstream line of business to all persons (including customers of the employer, the downstream line of business, and all other lines of business of the employer) are provided to customers of the employer by the upstream line of business, when measured on a uniform basis; or

(B) Provides to the downstream line of business property consisting primarily of a type of tangible property (i.e., goods, not services) that it produces or manufactures, and some entities outside the employer's controlled group that are engaged in a similar business as the upstream line of business provide the same type of tangible property to unrelated customers (i.e., customers outside those entities' respective controlled groups).

* * * * *

(4) * * *

EXAMPLE 1. Employer E operates two lines of business as determined under section 1.414(r)-2, one engaged in upholstery textile manufacturing and the other in furniture manufacturing. During the testing year, the upholstery textile line of business provides its entire output of upholstery textiles to the furniture line of business. The furniture line of business uses the upholstery textiles in the manufacture of upholstered furniture for sale to customers of Employer E. The furniture line of business thus substantially modifies the upholstery textiles provided to it by the upholstery textile line of business in providing upholstered furniture products to customers of Employer E. In addition, although the upholstery textile line of business does not provide upholstery textiles to customers of Employer E, some entities engaged in upholstery textile manufacturing provide upholstery textiles to customers outside their controlled groups. Under these facts, Employer E's two lines of business satisfy the requirements of this paragraph (d) with respect to upholstery textiles for the testing year.

* * * * *

SECTION 1.414(r)-4 [AMENDED]

Par. 12. Section 1.414(r)-4 is amended by removing the reference "section 1.414(q)-1T" from the last sentence of paragraph (b) and adding "section 1.414(q)-1" in its place.

Par. 13. Section 1.414(r)-5 is amended as follows:

1. Paragraph (b)(5)(ii) is revised.

2. Paragraphs (d)(1)(ii)(B) and (C) are revised.

3. The concluding text of paragraph (d)(1) is removed.

4. Paragraph (d)(1)(iii) is added.

5. Example 2 of paragraph (d)(4) is revised.

6. The last sentence of paragraph (g)(2)(iii)(A) is revised.

7. Paragraph (g)(2)(iii)(D) is amended by:

a. Revising the third sentence;

b. Adding a sentence to the end.

8. Paragraph (g)(3)(ii)(B) is amended by adding the language "described" immediately after "amount" and removing the language "described" from after "employee."

9. The last sentence of paragraph (g)(3)(iii)(B) is amended by:

a. Adding the word "qualified" immediately before "disability";

b. Removing the reference "section 1.401(a)(4)-3(d)(6)(vi)" and adding "section 411(a)(9)" in its place.

10. A sentence is added to the end of paragraph (g)(3)(iii)(C).

11. The last sentence of paragraph (g)(3)(iii)(D) is revised.

12. Paragraph (g)(5) is revised.

13. A sentence is added after the third sentence of paragraph (g)(6).

14. The revised provisions read as follows:

SECTION 1.414(r)-5 QUALIFIED SEPARATE LINE OF BUSINESS -- ADMINISTRATIVE SCRUTINY REQUIREMENT - SAFE HARBORS.

* * * * *

(b) * * *

(5) * * *

(ii) No more than five percent of the employees of the separate line of business for the current testing year were employees of a different separate line of business for the immediately preceding testing year, and no more than five percent of the employees of the separate line of business for the immediately preceding testing year are employees of a different separate line of business for the current testing year.

* * * * *

(d) * * *

(1) * * *

(ii) * * *

(B) No more than 10 percent of the employees who are substantial-service employees with respect to the acquired line of business were substantial-service employees with respect to a different separate line of business for the immediately preceding testing year; and

(C) No more than 10 percent of the employees who were substantial-service employees with respect to the acquired line of business for the immediately preceding testing year are substantial- service employees with respect to a different separate line of business in the respective testing year.

(iii) If the transaction described in paragraph (d)(1) of this section occurs after the first testing day in a testing year, the determinations required by paragraphs (d)(1)(ii)(B) and (C) of this section with respect to that testing year are made as of the date of the transaction.

* * * * *

(4) * * *

EXAMPLE 2. The facts are the same as in Example 1 except that, by the first testing day in 1997 (Transition Year 1), there are 300 additional substantial-service employees with respect to the pharmaceutical supplies line of business, increasing the total number to 4,300. Of those 300 employees, 250 were substantial-service employees with respect to a different separate line of business for testing year 1996 and 50 are new hires. Assume that, on the first testing day in Transition Year 1, the pharmaceutical supplies line of business satisfies the requirements of section 1.414(r)-3 (taking into account section 1.414(r)-1(d)(4)) and therefore constitutes a separate line of business. Because 250 is 6 percent of 4,300, no more than ten percent of the employees who are substantial- service employees with respect to the pharmaceutical supplies line of business were substantial-service employees with respect to a different separate line of business for the immediately preceding testing year. The 50 newly hired employees are disregarded in making this determination. Under these facts, the pharmaceutical supplies separate line of business satisfies the safe harbor in this paragraph (d) for Transition Year 1.

* * * * *

(g) * * *

(2) * * *

(iii) * * *

(A) * * * For purposes of this paragraph (g)(2)(iii), the normal accrual rate is the percentage (not less than 0) determined by subtracting the employee's normalized accrued benefit as of the end of the prior plan year (expressed as a percentage of average annual compensation as of the end of the prior plan year) from the employee's normalized accrued benefit as of the end of the plan year (expressed as a percentage of average annual compensation as of the end of the plan year).

* * * * *

(D) * * * However, a plan may disregard in a reasonable and consistent manner: years before the effective date of these regulations as set forth in section 1.414(r)-1(d)(9)(i), years more than 10 years preceding the current plan year, and years for which the employer does not use this paragraph (g)(2) to satisfy this safe harbor with respect to the separate line of business. * * * If a plan provides a defined benefit minimum that uses more than five consecutive years for calculating average annual compensation or the plan is an accumulation plan as defined in section 1.401(a)(4)-12, the 0.75 percent annual accrual rate in paragraph (g)(2)(iii)(A) of this section is multiplied by 133.3 percent, resulting in a normal accrual rate equal to 1.0 percent.

* * * * *

(3) * * *

(iii) * * *

(C) * * * In addition, no adjustment is made to the maximum normal accrual rate because the plan uses more than five consecutive years for calculating average annual compensation or the plan is an accumulation plan as defined in section 1.401(a)(4)-12.

(D) * * * In the case of a plan with subsidized optional forms, the determination of accrual rate for the plan year under paragraph (g)(2)(iii)(A) of this section is the percentage (not less than 0) determined by subtracting the largest of the sums of the employee's normalized QJSAs and QSUPPs determined for each age under section 1.401(a)(4)-3(d)(1)(ii) as of the end of the prior plan year (expressed as a percentage of average annual compensation as of the end of the prior plan year) from the largest of the sums of the employee's normalized QJSAs and QSUPPs determined for each age under section 1.401(a)(4)-3(d)(1)(ii) as of the end of the plan year (expressed as a percentage of average annual compensation as of the end of the plan year).

* * * * *

(5) CERTAIN CONTINGENCY PROVISIONS IGNORED. For purposes of this paragraph (g), an employee's accrual or allocation rate is determined without regard to any minimum benefit or any maximum benefit limitation that is applicable to the employee only if the separate line of business fails otherwise to satisfy the requirement of administrative scrutiny.

(6) * * * For purposes of the minimum benefit requirement of paragraph (g)(2) of this section, section 410(b)(4) may be applied with reference to the lowest minimum age requirement, and with reference to the lowest minimum service requirement, applicable under any plan of the employer that benefits highly compensated employees of the separate line of business, as if all the plans were a single plan under section 1.410(b)-6(b)(2), or, if no plan of the employer benefits highly compensated employees of the separate line of business, with reference to the greatest age and service requirements permitted under section 410(a)(1)(A). * * *

Par. 14. Section 1.414(r)-6 is amended as follows:

1. Paragraph (a) is amended by:

a. Revising the third sentence.

b. Adding a new sentence immediately following the second sentence.

c. Removing the last sentence.

2. Paragraph (b) is revised.

3. Paragraph (c) is removed.

4. The addition and revisions read as follows:

SECTION 1.414(r)-6 QUALIFIED SEPARATE LINE OF BUSINESS -- ADMINISTRATIVE SCRUTINY REQUIREMENT -- INDIVIDUAL DETERMINATIONS

(a) * * * The Commissioner shall issue such an individual determination only when it is consistent with the purpose of section 414(r), taking into account the nondiscrimination requirements of sections 401(a)(4) and 410(b). Paragraph (b) of this section authorizes the Commissioner to establish procedures for requesting and granting individual determinations.

(b) AUTHORITY TO ESTABLISH PROCEDURES. 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 for requesting and granting individual determinations under this section. For example, such guidance may specify the circumstances in which an employer may request an individual determination and factors to be taken into account in deciding whether to grant a favorable individual determination. In addition, such guidance may describe situations that automatically fail the administrative scrutiny requirement.

Par. 15. Section 1.414(r)-7 is amended as follows:

1. The last sentence of paragraph (a)(1) is revised.

2. Paragraph (b)(2)(ii) is amended by removing the language "with respect to a qualified separate line of business".

3. The last sentence of paragraph (b)(3) is amended by removing the language "(including whether the residual shared employee is eligible for assignment under paragraph (c)(2) of this section)".

4. Paragraph (c)(1) is revised.

5. Paragraph (c)(2) is removed.

6. Paragraphs (c)(3) through (c)(5) are redesignated (c)(2) through (c)(4), respectively, and a new paragraph (c)(5) is added.

7. Redesignated paragraphs (c)(2)(i), (c)(3)(i) and (c)(4)(i) are amended by removing the language "who are not assigned under paragraph (c)(2) of this section".

8. Redesignated paragraphs (c)(2)(i), (c)(2)(v), and Example 2, Example 3 and Example 4 of paragraph (c)(2)(v) are amended by removing the reference "paragraph (c)(3)" and adding "paragraph (c)(2)" in its place.

9. Redesignated paragraph (c)(2)(i) and paragraph (ii) of Example 1 of redesignated paragraph (c)(2)(v) are amended by removing the reference "paragraph (c)(3)(ii)" and adding "paragraph (c)(2)(ii)" in its place.

10. Redesignated paragraph (c)(2)(i) is amended by removing the reference "paragraph (c)(3)(iv)" and adding "paragraph (c)(2)(iv)" in its place.

11. Redesignated paragraph (c)(2)(iii)(A) is revised.

12. Redesignated paragraph (c)(2)(iv) is revised.

13. Example 1 of redesignated paragraph (c)(2)(v) is amended by removing the third sentence of paragraph (i).

14. Example 2 of redesignated paragraph (c)(2)(v) is amended by removing the reference "35 percent" from the second sentence and adding "25 percent" in its place.

15. The first sentence of redesignated paragraph (c)(2)(v), Example 4(ii) is amended by:

a. Removing the reference "35" and adding "25" in its place;

b. Removing the reference "paragraph (c)(3)(iii)" and adding "paragraph (c)(2)(iv)" in its place.

16. The second sentence of redesignated paragraph (c)(2)(v), Example 4(ii) is amended by removing the reference "paragraph (c)(3)(iii)(B)" and adding "paragraph (c)(2)(iv)(B)" in its place.

17. Redesignated paragraphs (c)(3)(i), (c)(3)(ii), and the introductory language and third sentence of Example 1 of redesignated paragraph (c)(3)(iii) are amended by removing the reference "paragraph (c)(4)" and adding "paragraph (c)(3)" in its place.

18. Redesignated paragraph (c)(3)(i) is amended by removing the reference "(c)(3)(iii)" and adding "(c)(2)(iii)" in its place.

19. Redesignated paragraphs (c)(3)(ii)(A) and (c)(3)(ii)(B) are amended by removing the reference "(c)(4)(i)" and adding "(c)(3)(i)" in its place.

20. The first sentence of Example 1 of redesignated paragraph (c)(3)(iii) is amended by removing the reference "paragraph (c)(3)(iv)" and adding "paragraph (c)(2)(v)" in its place and by removing the word "and" and adding "except" in its place.

21. Redesignated paragraphs (c)(4)(i), (c)(4)(ii), and (c)(4)(iii) are amended by removing the reference "paragraph (c)(5)" and adding "paragraph (c)(4)" in its place.

22. Redesignated paragraph (c)(4)(iii)(E) is amended by removing the reference "(c)(5)(iii)" and adding "(c)(4)(iii)" in its place.

23. Paragraph (d) is removed.

24. The added and revised provisions read as follows:

SECTION 1.414(r)-7 DETERMINATION OF THE EMPLOYEES OF AN EMPLOYER'S QUALIFIED SEPARATE LINES OF BUSINESS.

(a) * * *

(1) IN GENERAL. * * * Paragraph (c) of this section provides methods for allocating residual shared employees among qualified separate lines of business.

* * * * *

(c) * * *

(1) IN GENERAL. All residual shared employees must be allocated among an employer's qualified separate lines of business under one of the allocation methods provided in paragraphs (c)(2) through (5) of this section. An employer is permitted to select which method of allocation to apply for the testing year to residual shared employees. However, the same allocation method must be used for all of the employer's residual shared employees and for all purposes listed in paragraph (a)(2) of this section with respect to the testing year.

(2) * * *

(iii) * * * (A) DETERMINATION OF PERCENTAGE. The employee assignment percentage of a qualified separate line of business is the fraction (expressed as a percentage) --

(1) The numerator of which is the number of substantial-service employees with respect to the qualified separate line of business who are assigned to that line of business under paragraph (b) of this section; and

(2) The denominator of which is the total number of substantial- service employees who are assigned to all qualified separate lines of business of the employer under paragraph (b) of this section.

* * * * *

(iv) OPTION TO APPLY REDUCED PERCENTAGE. An employer is permitted to determine whether it has a dominant line of business by substituting 25 percent for 50 percent in paragraph (c)(2)(ii) of this section. This option is available for a testing year only if the qualified separate line of business satisfies one of the following requirements:

(A) The qualified separate line of business accounts for at least 60 percent of the employer's gross revenues for the employer's latest fiscal year ending in the testing year.

(B) The employee assignment percentage of the qualified separate line of business would be at least 60 percent if collectively bargained employees were taken into account.

(C) Each qualified separate line of business of the employer satisfies the statutory safe harbor of section 1.414(r)-5(b), the average benefits safe harbor of section 1.414(r)-5(f), or the minimum or maximum benefits safe harbor of section 1.414(r)-5(g). Whether a qualified separate line of business satisfies one of these safe harbors is determined after the application of this section, including the assignment of all residual shared employees under this paragraph (c)(2).

(D) The employee assignment percentage of the qualified separate line of business is at least twice the employee assignment percentages of each of the employer's other qualified separate lines of business.

* * * * *

(5) SMALL GROUP METHOD -- (i) IN GENERAL. Under the method of allocation provided for in this paragraph (c)(5), each residual shared employee is allocated to a qualified separate line of business chosen by the employer. This method does not apply unless all of the requirements of paragraphs (c)(5)(ii), (iii), and (iv) of this section are satisfied.

(ii) SIZE OF GROUP. The total number of the employer's residual shared employees allocated under this paragraph (c) must not exceed three percent of all of the employer's employees. For this purpose, the employer's employees include only those employees taken into account under paragraph (c)(2)(iii)(B) of this section.

(iii) COMPOSITION OF QUALIFIED SEPARATE LINE OF BUSINESS. The qualified separate line of business to which the residual shared employee is allocated must have an employee assignment percentage under paragraph (c)(2)(iii) of this section of at least ten percent. In addition, the qualified separate line of business to which the residual shared employee is allocated must satisfy the statutory safe harbor under section 1.414(r)-5(b) after the employee is so allocated.

(iv) REASONABLE ALLOCATION. The allocation of residual shared employees under the small group method provided for in this paragraph (c)(5) must be reasonable. Reasonable allocations generally include allocations that are based on the level of services that the residual shared employees provide to the employer's qualified separate lines of business, the similar treatment of similarly-situated residual shared employees, and other bona fide business criteria; in contrast, an allocation that is designed to maximize benefits for select employees is not considered a reasonable allocation. For example, allocation of all residual shared employees who work in the same department, or at the same location, to the same qualified separate line of business would be an indication of reasonableness. However, allocation of a group of similarly-situated residual shared employees to a qualified separate line of business for which they provide minimal services might not be considered reasonable. In addition, the allocation of the professional employees of a department to one qualified separate line of business and the allocation of the support staff of the same department to a different qualified separate line of business would not be reasonable.

Par. 16. Section 1.414(r)-8 is amended as follows:

1. Paragraph (b)(2)(iii) is revised.

2. In Example 1 and Example 4 of paragraph (b)(4), the reference "1993" is removed from each place it appears and "1994" is added in its place.

3. Example 2 in paragraph (b)(4) is revised.

4. Example 3 and Example 4 in paragraph (b)(4) are redesignated as Example 5 and Example 6 respectively, and new Example 3 and Example 4 are added.

5. In the fifth sentence of redesignated Example 5(ii) in paragraph (b)(4), the reference "section 1.410(b)-7(c)(4)" is removed and "section 1.410(b)-7(c)(5)" is added in its place.

6. In the first and third sentences of redesignated Example 6 in paragraph (b)(4), the reference "Example 3" is removed and "Example 2" is added in its place.

7. Paragraph (d)(4) is removed.

8. Paragraph (d)(5) is redesignated (d)(4).

9. The additions and revisions read as follows:

SECTION 1.414(R)-8 SEPARATE APPLICATION OF SECTION 410(b).

* * * * *

(b) * * *

(2) * * *

(iii) MODIFICATION OF UNSAFE HARBOR PERCENTAGE FOR PLANS SATISFYING RATIO PERCENTAGE TEST AT 90 PERCENT LEVEL -- (A) GENERAL RULE. If a plan benefits a group of employees for a plan year that would satisfy the ratio percentage test of section 1.410(b)-2(b)(2) on a qualified-separate-line-of-business basis under paragraph (b)(3) of this section if the percentage in section 1.410(b)-2(b)(2) were increased to 90 percent, the unsafe harbor percentage in section 1.410(b)-4(c)(4)(ii) for the plan is reduced by five percentage points (not five percent) for the plan year and is applied without regard to the requirement that the unsafe harbor percentage not be less than 20 percent. Thus, if the requirements of this paragraph (b)(2)(iii)(A) are satisfied, the unsafe harbor percentage in section 1.410(b)-4(c)(4)(ii) is treated as 35 percent, reduced by 3/4 of a percentage point for each whole percentage point by which the nonhighly compensated employee concentration percentage exceeds 60 percent.

(B) FACTS AND CIRCUMSTANCES ALTERNATIVE. If a plan satisfies the requirements of paragraph (b)(2)(iii)(A) of this section, but has a ratio percentage on an employer-wide basis that falls below the unsafe harbor percentage determined under paragraph (b)(2)(iii)(A) of this section, the plan nonetheless is deemed to satisfy section 410(b)(5)(B) on an employer-wide basis if the Commissioner determines that, on the basis of all of the relevant facts and circumstances, the plan benefits such employees as qualify under a classification of employees that does not discriminate in favor of highly compensated employees.

* * * * *

(4) * * *

EXAMPLE 2. The facts are the same as in Example 1. All of the 50 highly compensated employees treated as employees of Line 2 benefit under Plan Y, and 80 of the 100 nonhighly compensated employees treated as employees of Line 2 benefit under Plan Y. Thus, Plan Y benefits 50 percent of all Employer A's highly compensated employees (50 out of 100) and only 4 percent of all Employer A's nonhighly compensated employees (80 out of 2,000). Thus, while Plan Y has a ratio percentage of 80 percent (80% section 100%) on a qualified-separate-line-of-business basis, it has a ratio percentage of only 8 percent (4% section 50%) on an employer-wide basis. See section 1.410(b)-9. Under section 1.410(b)-4(c)(4)(iii), the nonhighly compensated employee concentration percentage is 2,000/2,100 or 95 percent. Because 8 percent is less than 20 percent (the unsafe harbor percentage applicable to Employer A under section 1.410(b)-4(c)(4)(ii)), Plan Y does not satisfy the nondiscriminatory classification test of section 1.410(b)-4 on an employer-wide basis. Nor does Plan Y satisfy the ratio percentage test of section 1.410(b)- 2(b)(2) on an employer-wide basis, since 8 percent is less than 70 percent. Under these facts, Plan Y does not satisfy section 410(b)(5)(B) on an employer-wide basis in accordance with paragraph (b)(2) of this section for the plan year of Plan Y beginning in the 1994 testing year, and therefore fails to satisfy section 410(b) for that year. This is true even though Plan Y satisfies section 410(b) on a qualified-separate-line-of- business basis in accordance with paragraph (b)(3) of this section.

EXAMPLE 3. The facts are the same as in Example 2, except that all of the employees treated as employees of Line 2 benefit under Plan Y. Thus, Plan Y benefits 50 percent of all of Employer A's highly compensated employees (50 out of 100) and 5 percent of all of Employer A's nonhighly compensated employees (100 out of 2,000). Plan Y therefore has a ratio percentage of 100 percent (100% section 100%) on a qualified-separate-line- of-business basis and a ratio percentage of 10 percent (5% section 50%) on an employer-wide basis. Because Plan Y has a ratio percentage of at least 90 percent on a qualified-separate- line-of-business basis, a reduced unsafe harbor percentage applies to Plan Y under paragraph (b)(2)(iii)(A) of this section. The reduced unsafe harbor percentage applicable to Plan Y is 8.75 percent because Employer A's nonhighly compensated employee concentration percentage is 95 percent. Plan Y's employer-wide ratio percentage of 10 percent therefore exceeds the unsafe harbor percentage. Plan Y thus satisfies section 410(b)(5)(B) on an employer-wide basis in accordance with paragraph (b)(2) of this section for the plan year of Plan Y beginning in the 1994 testing year. Plan Y also satisfies section 410(b) on a qualified-separate-line-of-business basis in accordance with paragraph (b)(3) of this section.

EXAMPLE 4. The facts are the same as in Example 3, except that Employer A's total nonexcludable nonhighly compensated employees are 2,500 (rather than 2,000), of whom 100 are treated as employees of Line 2 and of whom 90 benefit under Plan Y. Plan Y has a ratio percentage of 90 percent (90% section 100%) on a qualified-separate-line-of-business basis, and Employer A's nonhighly compensated employee concentration percentage is 2,500/2,600 or 96 percent. Thus, the reduced unsafe harbor percentage applicable to Plan Y under paragraph (b)(2)(iii)(A) of this section is 8 percent. Plan Y benefits 50 percent of all of Employer A's highly compensated employees (50 out of 100) and 3.6 percent of all of Employer A's nonhighly compensated employees (90 out of 2,500). Plan Y therefore has a ratio percentage of only 7.2 percent (3.6% section 50%) on an employer-wide basis, which falls below the reduced unsafe harbor percentage of 8 percent. Nonetheless, under paragraph (b)(2)(iii)(B) of this section, Plan Y will be deemed to satisfy section 410(b)(5)(B) on an employer-wide basis if the Commissioner determines that, on the basis of all of the relevant facts and circumstances, the plan benefits such employees as qualify under a classification of employees that does not discriminate in favor of highly compensated employees.

* * * * *

Par. 17. Section 1.414(r)-11 is amended as follows:

1. Paragraph (b)(2) is revised.

2. The first sentence of paragraph (b)(3) is removed and two new sentences are added in its place.

3. Paragraph (b)(4) is revised.

4. Paragraph (c)(2)(v) is amended by removing the references "1.414(r)-7(c)(3)" and "1.414(r)-7(c)(4)" and adding "1.414(r)- 7(c)(2)" and "1.414(r)-7(c)(3)" in their respective places.

5. The added and revised provisions read as follows:

SECTION 1.414(r)-11 DEFINITIONS AND SPECIAL RULES.

* * * * *

(b) * * *

(2) SUBSTANTIAL-SERVICE EMPLOYEE. An employee is a substantial- service employee with respect to a line of business for a testing year if at least 75 percent of the employee's services are provided to that line of business for that testing year within the meaning of section 1.414(r)-3(c)(5). In addition, if an employee provides at least 50% and less than 75% of the employee's services to a line of business for the testing year within the meaning of section 1.414(r)- 3(c)(5), the employer may treat that employee as a substantial- service employee with respect to that line of business provided the employee is so treated for all purposes of these regulations. The employer may choose such treatment separately with respect to each employee.

(3) TOP-PAID EMPLOYEE. Generally, an employee is a top-paid employee with respect to a line of business for a testing year if the employee is among the top 10 percent by compensation of those employees who provide services to that line of business for that testing year within the meaning of section 1.414(r)-3(c)(5) and who are not substantial-service employees within the meaning of paragraph (b)(2) of this section with respect to any other line of business. In addition, in determining the group of top-paid employees, the employer may choose to disregard all employees who provide less than 25 percent of their services to the line of business. * * *

(4) RESIDUAL SHARED EMPLOYEE. An employee is a residual shared employee for a testing year if the employee is not a substantial- service employee with respect to any line of business for the testing year.

* * * * *