Bulletin No. 2005-5January 31, 2005

HIGHLIGHTSOF THIS ISSUEThese synopses are intended only as aids to the reader inidentifying the subject matter covered. They may not berelied upon as authoritative interpretations.

INCOME TAX

Rev. Rul. 2005–5, page 445.LIFO; price indexes; department stores. The November2004 Bureau of Labor Statistics price indexes are acceptedfor use by department stores employing the retail inventoryand last-in, first-out inventory methods for valuing inventoriesfor tax years ended on, or with reference to, November 30,2004.

Notice 2005–6, page 448.This notice announces that the Treasury Department and theService will issue regulations providing that certain exchangesdescribed in section 354 of the Code by a U.S. person involv-ing securities of a foreign or domestic corporation will not besubject to section 367(a).

EMPLOYEE PLANS

T.D. 9169, page 381.Final regulations provide guidance for certain retirement planscontaining cash or deferred arrangements under section401(k) of the Code, and provide for matching contributions oremployee contributions under section 401(m).

ADMINISTRATIVE

Notice 2005–3, page 447.Presidentially declared disasters. This notice advises tax-payers that Rev. Proc. 2004–13, 2004–4 I.R.B. 335, will bemodified retroactively to provide additional tax relief to taxpay-ers (transferors) involved in section 1031 like-kind exchangetransactions affected by a Presidentially declared disaster (in-

cluding Hurricanes Charley, Frances, Ivan, and Jeanne, andTropical Storm Bonnie), terroristic or military action, or ser-vice in a combat zone or contingency operation. Rev. Proc.2004–13 modified.

Announcement 2005–10, page 450.This document contains a notice of public hearing on pro-posed regulations (REG–114726–04, 2004–47 I.R.B. 857)under section 401(a) of the Code that provide rules permittingdistributions to be made from a pension plan under a phasedretirement program and set forth requirements for a bona fidephased retirement program. The public hearing is scheduledfor March 14, 2005.

Announcement 2005–11, page 451.This document contains a correction to proposed regulations(REG–149519–03, 2004–5 I.R.B. 1009) which relate to thetreatment of transactions between a partnership and its part-ners as disguised sales of partnership interests between thepartners.

Announcements of Disbarments and Suspensions begin on page 450.Finding Lists begin on page ii.Index for January begins on page iv.

The IRS MissionProvide America’s taxpayers top quality service by helpingthem understand and meet their tax responsibilities and by

applying the tax law with integrity and fairness to all.

IntroductionThe Internal Revenue Bulletin is the authoritative instrument ofthe Commissioner of Internal Revenue for announcing officialrulings and procedures of the Internal Revenue Service and forpublishing Treasury Decisions, Executive Orders, Tax Conven-tions, legislation, court decisions, and other items of generalinterest. It is published weekly and may be obtained from theSuperintendent of Documents on a subscription basis. Bulletincontents are compiled semiannually into Cumulative Bulletins,which are sold on a single-copy basis.

It is the policy of the Service to publish in the Bulletin all sub-stantive rulings necessary to promote a uniform application ofthe tax laws, including all rulings that supersede, revoke, mod-ify, or amend any of those previously published in the Bulletin.All published rulings apply retroactively unless otherwise indi-cated. Procedures relating solely to matters of internal man-agement are not published; however, statements of internalpractices and procedures that affect the rights and duties oftaxpayers are published.

Revenue rulings represent the conclusions of the Service on theapplication of the law to the pivotal facts stated in the revenueruling. In those based on positions taken in rulings to taxpayersor technical advice to Service field offices, identifying detailsand information of a confidential nature are deleted to preventunwarranted invasions of privacy and to comply with statutoryrequirements.

Rulings and procedures reported in the Bulletin do not have theforce and effect of Treasury Department Regulations, but theymay be used as precedents. Unpublished rulings will not berelied on, used, or cited as precedents by Service personnel inthe disposition of other cases. In applying published rulings andprocedures, the effect of subsequent legislation, regulations,

court decisions, rulings, and procedures must be considered,and Service personnel and others concerned are cautionedagainst reaching the same conclusions in other cases unlessthe facts and circumstances are substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.This part includes rulings and decisions based on provisions ofthe Internal Revenue Code of 1986.

Part II.—Treaties and Tax Legislation.This part is divided into two subparts as follows: Subpart A,Tax Conventions and Other Related Items, and Subpart B, Leg-islation and Related Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.To the extent practicable, pertinent cross references to thesesubjects are contained in the other Parts and Subparts. Alsoincluded in this part are Bank Secrecy Act Administrative Rul-ings. Bank Secrecy Act Administrative Rulings are issued bythe Department of the Treasury’s Office of the Assistant Sec-retary (Enforcement).

Part IV.—Items of General Interest.This part includes notices of proposed rulemakings, disbar-ment and suspension lists, and announcements.

The last Bulletin for each month includes a cumulative indexfor the matters published during the preceding months. Thesemonthly indexes are cumulated on a semiannual basis, and arepublished in the last Bulletin of each semiannual period.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

January 31, 2005 2005–5 I.R.B.

Part I. Rulings and Decisions Under the Internal Revenue Codeof 1986Section 401.—QualifiedPension, Profit-Sharing,and Stock Bonus Plans26 CFR 1.401(k)–1: Certain cash or deferred ar-rangements.

T.D. 9169

DEPARTMENT OFTHE TREASURYInternal Revenue Service26 CFR Part 1 and 601

Retirement Plans; Cash orDeferred Arrangements UnderSection 401(k) and MatchingContributions or EmployeeContributions Under Section401(m) Regulations

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains finalregulations that provide guidance for cer-tain retirement plans containing cash or de-ferred arrangements under section 401(k)and providing for matching contributionsor employee contributions under section401(m). These regulations affect spon-sors of plans that contain cash or deferredarrangements or provide for employee ormatching contributions, and participants inthese plans.

EFFECTIVE DATE: December 29, 2004.

FOR FURTHER INFORMATIONCONTACT: Concerning the regulations,R. Lisa Mojiri-Azad or John T. Ricotta at(202) 622–6060 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information con-tained in these final regulations have beenreviewed and approved by the Office ofManagement and Budget in accordancewith the Paperwork Reduction Act of 1995

(44 U.S.C. 3507(d)) under control number1545–1669. Responses to this collectionof information are mandatory.

An agency may not conduct or sponsor,and a person is not required to respond to, acollection of information unless it displaysa valid control number assigned by the Of-fice of Management and Budget.

The estimated annual burden per re-spondent varies from .033 hour to 2.5hours, depending on the individual cir-cumstances, with an estimated average of1 hour, 10 minutes.

Comments concerning the accuracyof this burden estimate and sugges-tions for reducing this burden shouldbe sent to the Internal Revenue Service,Attn: IRS Reports Clearance Officer,SE:W:CAR:MP:T:T:SP, Washington, DC20224, and to the Office of Manage-ment and Budget, Attn: Desk Officer forthe Department of the Treasury, Officeof Information and Regulatory Affairs,Washington, DC 20503.

Books or records relating to a collectionof information must be retained as longas their contents might become material inthe administration of any internal revenuelaw. Generally, tax returns and tax returninformation are confidential, as requiredby 26 U.S.C. 6103.

Background

This document contains final regu-lations setting forth the requirements(including the nondiscrimination require-ments) for cash or deferred arrangementsunder section 401(k) and for matchingcontributions and employee contributionsunder section 401(m) of the Internal Rev-enue Code (Code).

Comprehensive final regulations un-der sections 401(k) and 401(m) of theCode were last published in the FederalRegister in T.D. 8357, 1991–2 C.B. 181,(published August 9, 1991) and T.D. 8376,1991–2 C.B. 245, (published December 2,1991) and amended by T.D. 8581, 1995–1C.B. 54, published on December 22, 1994(the pre-SBJPA regulations). Since 1994,many significant changes have been madeto sections 401(k) and 401(m) by the SmallBusiness Job Protection Act of 1996,

Public Law 104–188 (110 Stat. 1755)(SBJPA), the Taxpayer Relief Act of 1997,Public Law 105–34 (111 Stat. 788) (TRA’97), and the Economic Growth and TaxRelief Reconciliation Act of 2001, PublicLaw 107–16 (115 Stat. 38) (EGTRRA).

The most substantial changes to thestatutory provisions of section 401(k) andsection 401(m) were made to the method-ology for testing the amount of electivecontributions, matching contributions,and employee contributions for nondis-crimination. Section 401(a)(4) prohibitsdiscrimination in contributions or benefitsin favor of highly compensated employ-ees, within the meaning of section 414(q)(HCEs). Section 401(k) provides a spe-cial nondiscrimination test for electivecontributions under a cash or deferredarrangement that is part of a profit-shar-ing plan, stock bonus plan, pre-ERISAmoney purchase plan, or rural cooperativeplan, called the actual deferral percentage(ADP) test. Section 401(m) provides aparallel test for matching contributionsand employee contributions under a de-fined contribution plan, called the actualcontribution percentage (ACP) test. Thesespecial nondiscrimination standards areprovided in recognition of the fact thatthe amount of elective contributions andemployee contributions (and correspond-ing matching contributions) is determinedby the employee’s utilization of the con-tribution opportunity offered under theplan. This is in contrast to the situationin other defined contribution plans wherethe amount of contributions is determinedby the amount the employer decides tocontribute.

Sections 401(k) and 401(m) provide al-ternative methods for satisfying the appli-cable nondiscrimination rules: a mathe-matical comparison and a number of de-sign-based methods. The inherent varia-tion in the amount of contributions amongemployees, and the fact that the economicsituation of HCEs may make them morelikely to make elective or employee contri-butions, means that the usual nondiscrim-ination test under section 401(a)(4) — un-der which, for each HCE with a contribu-tion level, there must be a specified num-ber of nonhighly compensated employees

2005–5 I.R.B. 381 January 31, 2005

(NHCEs) with equal or greater contribu-tions — is not appropriate. Instead, aver-age rates of contributions are used in theADP and ACP tests (with a built-in differ-ential permitted for HCEs) and minimumstandards for nonelective or matching con-tributions are provided in the design-basedalternatives.

Prior to the enactment of SBJPA, sec-tions 401(k) and 401(m) provided only formathematical comparison. Specifically,the ADP and ACP tests compare the av-erage of the rates of contributions of theHCEs to the average of the rates of contri-butions of the NHCEs. For this purpose,the rate of contributions for an employeeis the amount of contributions for an em-ployee divided by the employee’s compen-sation for the plan year. These tests aresatisfied if the average rate of HCE contri-butions does not exceed 1.25 times the av-erage rate of contributions of the NHCEs.Alternatively, these tests are satisfied if theaverage rate of HCE contributions does notexceed the average rate of contributionsof the NHCEs by more than 2 percentagepoints and is no more than 2 times the aver-age rate of contributions of the NHCEs. Tothe extent that these tests are not satisfied,the statute provides for correction throughdistribution to HCEs (or forfeiture of non-vested matching contributions) or, to theextent provided in regulations, recharac-terization of elective contributions as af-ter-tax contributions. In addition, to theextent provided in regulations, nonelectivecontributions can be made to NHCEs andelective contributions and certain match-ing contributions can be moved betweenthe ADP and ACP tests, in order to re-duce the discrepancy between the averagerates of contribution for the HCEs and theNHCEs.

SBJPA added design-based alterna-tive methods of satisfying the ADP andACP tests. Under these methods, if a planmeets certain contribution and notice re-quirements, the plan is deemed to satisfythe nondiscrimination rules without regardto actual utilization of the contribution op-portunity offered under the plan. Theseregulations reflect this change and theother changes that were made to sections401(k) and 401(m) under SBJPA, TRA’97 and EGTRRA since the issuance ofthe pre-SBJPA regulations.

SBJPA made the following significantchanges affecting section 401(k) and sec-tion 401(m) plans:

• The ADP test and ACP test wereamended to allow the use of prior yeardata for NHCEs.

• The method of distributing to correctfailures of the ADP test or ACP testwas changed to require distribution tothe HCEs with the highest contribu-tions.

• Tax-exempt organizations and Indiantribal governments are permitted tomaintain section 401(k) plans.

• Safe harbor alternatives to the ADPtest and ACP test were introduced inorder to provide design-based methodsto satisfy the nondiscrimination tests.

• The SIMPLE 401(k) plan (an alterna-tive design-based method to satisfy thenondiscrimination tests for small em-ployers that corresponds to the provi-sions of section 408(p) for SIMPLEIRA plans by providing for smallercontributions) was added.

• A special testing option was providedfor plans that permit participation be-fore employees meet the minimum ageand service requirements, in order toencourage employers to permit em-ployees to start participating sooner.

TRA ’97 made the following significantchanges affecting section 401(k) and sec-tion 401(m) plans:

• Grandfathered state and local govern-mental plans are treated as automat-ically satisfying the ADP and ACPtests.

• Matching contributions for self-em-ployed individuals are no longertreated as elective contributions.

EGTRRA made the following signifi-cant changes affecting section 401(k) andsection 401(m) plans:

• Catch-up contributions were added toprovide for additional elective contri-butions for participants age 50 or older.

• The Secretary is directed to change thesection 401(k) regulations to shortenthe period of time that an employee isstopped from making elective contri-butions under the safe harbor rules forhardship distributions.

• Beginning in 2006, section 401(k)plans will be permitted to allow em-ployees to designate their electivecontributions as “Roth contributions”that will generally be subject to taxa-tion under the rules applicable to RothIRAs under section 408A.

• Section 401(k) plans using the design-based safe harbor and providing no ad-ditional contributions in a year are ex-empted from the top-heavy rules ofsection 416.

• Distributions from section 401(k)plans are permitted upon “severancefrom employment” rather than “sepa-ration from service.”

• The multiple use test formerly speci-fied in section 401(m)(9) is repealed.

• Faster vesting is required for matchingcontributions.

• Matching contributions are taken intoaccount in satisfying the top-heavy re-quirements of section 416.

In addition, since publication of the pre-SBJPA regulations, a number of items ofguidance affecting section 401(k) and sec-tion 401(m) plans addressing these statu-tory changes and other issues have been re-leased by the IRS, including:

• Notice 97–2, 1997–1 C.B. 348, pro-vides initial guidance on prior yearADP and ACP testing and guidanceon correction of excess contributionsand excess aggregate contributions, in-cluding distribution to the HCEs withthe highest contributions.

• Rev. Proc. 97–9, 1997–1 C.B.624, provides model amendments forSIMPLE 401(k) plans.

• Notice 98–1, 1998–1 C.B. 327, pro-vides additional guidance on prior yeartesting issues.

• Notice 98–52, 1998–2 C.B. 632, andNotice 2000–3, 2000–1 C.B. 413, pro-vides guidance on safe harbor section401(k) plans.

• Rev. Rul. 2000–8, 2000–1 C.B. 617,addresses the use of automatic enroll-ment features in section 401(k) plans.

• Notice 2001–56, 2001–2 C.B. 277, andNotice 2002–4, 2002–1 C.B. 298, pro-vided initial guidance related to thechanges made by EGTRRA.

These items of guidance, with somemodification, were incorporated into the

January 31, 2005 382 2005–5 I.R.B.

proposed regulations (REG–108639–99,2003–2 C.B. 431) under section 401(k)and section 401(m) which were publishedin the Federal Register on July 17, 2003.68 Fed. Reg. 42,476.

On November 12, 2003, a public hear-ing was held on the proposed regulations.After consideration of the comments, thesefinal regulations adopt the provisions ofthe proposed regulations with certain mod-ifications, the most significant of which arehighlighted below.

Explanation of Provisions

1. Rules Applicable to All Cash orDeferred Arrangements

Section 401(k)(1) provides that a profit-sharing, stock bonus, pre-ERISA moneypurchase or rural cooperative plan will notfail to qualify under section 401(a) merelybecause it contains a qualified cash or de-ferred arrangement. As under the pro-posed regulations, §1.401(k)–1 sets forththe general definition of a cash or deferredarrangement (CODA), the additional re-quirements that a CODA must satisfy in or-der to be a qualified CODA, and the treat-ment of contributions made under a quali-fied or nonqualified CODA.

As under the proposed regulations, thefinal regulations define a CODA as anarrangement under which employees canmake a cash or deferred election with re-spect to contributions to, or accruals orbenefits under, a plan intended to satisfythe requirements of section 401(a). A cashor deferred election is any direct or indi-rect election by an employee (or modifica-tion of an earlier election) to have the em-ployer either: 1) provide an amount to theemployee in the form of cash or some othertaxable benefit that is not currently avail-able; or 2) contribute an amount to a trust,or provide an accrual or other benefit, un-der a plan deferring the receipt of compen-sation. These final regulations retain thedefinition of a CODA from the proposedregulations, with some minor modifica-tions. First, the exclusion of an arrange-ment under which employees make after-tax contributions from the definition of a

CODA does not encompass an arrange-ment under which employees make desig-nated Roth contributions.1 Second, the fi-nal regulations clarify that the regulatoryprovision specifying that compliance withsection 401(k) and section 402(e)(3) is theonly means of providing a cash or deferredelection to an employee without violatingthe constructive receipt rules is limited tocash or deferred elections under which thecontribution or accrual is made under aqualified plan or trust.

As under the proposed regulations,these final regulations incorporate priorguidance on automatic enrollment and thusreflect the fact that a CODA can specifythat the default that applies in the absenceof an affirmative election by an employeecan be a contribution to a trust, as de-scribed in Rev. Rul. 2000–8. Althoughthe facts of Rev. Rul. 2000–8 specifieda certain percentage of compensation thatwould apply as a default, the percentagechosen was merely illustrative. Thus,the final regulations do not constrain thechoice of default provisions.2 However, inorder to be a qualified CODA, as indicatedin Rev. Rul. 2000–8, it is essential that theemployee have an effective opportunity toelect to receive cash in lieu of the defaultemployer contribution.

These final regulations also clarify therules relating to one-time irrevocable elec-tions that are not treated as cash or de-ferred elections. First, the final regula-tions replace the requirement that the elec-tion be made upon commencement of em-ployment or first becoming eligible underthe plan or any plan of the employer withthe requirement that the election be madeno later than first becoming eligible underthe plan or any other plan of the employer.Second, the final regulations define anyother plan of the employer for this purposeto mean any plan or arrangement that is de-scribed in section 219(g)(5)(D), which in-cludes a section 457(b) governmental planand a section 403(b) plan, as well as a qual-ified plan.

The final regulations retain the rule thata contribution is made pursuant to a cashor deferred election only if the contribu-

tion is made after the relevant election.Thus, a contribution made in anticipationof an employee’s election is not treatedas an elective contribution. A number ofcommentators indicated that the rule in theproposed regulation requiring that electivecontributions not precede the services towhich they relate (or the date when thecompensation would otherwise be paid, ifearlier than the date when the services areperformed) was too broad. Some of thesecommentators suggested the addition of anexception to cover instances where the em-ployer has administrative reasons for de-positing the contributions before the em-ployee’s services or pay day (for example,the temporary absence of the bookkeeperresponsible for transmitting funds to theplan), while others suggested loosening therule where the early contribution does notresult in an accelerated deduction.

After considering these comments, theIRS and Treasury have concluded thatthe prefunding of elective contributionsand matching contributions is inconsistentwith sections 401(k) and 401(m) and thatthe restrictions on the timing of contribu-tions are consistent with the fundamentalpremise of elective contributions (i.e.,these are contributions that are paid to theplan as a result of an employee electionnot to receive those amounts in cash).Accordingly, the final regulations gener-ally provide that contributions are madepursuant to a cash or deferred electiononly if the contributions are made afterthe employee’s performance of serviceswhich relate to the compensation that, butfor the election, would have been paid tothe employee. Amounts contributed inanticipation of future performance of ser-vices generally are not treated as electivecontributions under these final regula-tions. Thus, an employer is not able toprefund elective contributions in orderto accelerate the deductions for electivecontributions; and employer contributionsmade under the facts in Notice 2002–48,2002–2 C.B. 130, are no longer permittedto be taken into account under the ADPtest or the ACP test and would not satisfy

1 A designated Roth contribution is an elective contribution that is included in income. The Treasury and the IRS expect to issue guidance on designated Roth contributions in the near future.

2 The Department of Labor has advised Treasury and the IRS that, under Title I of the Employee Retirement Income Security Act of 1974 (“ERISA”) (88 Stat. 829), Public Law 93–406,fiduciaries of a plan must ensure that the plan is administered prudently and solely in the interest of plan participants and beneficiaries. While ERISA section 404(c) may serve to relievecertain fiduciaries from liability when participants or beneficiaries exercise control over the assets in their individual accounts, the Department of Labor has taken the position that a participantor beneficiary will not be considered to have exercised control when the participant or beneficiary is merely apprised of investments that will be made on his or her behalf in the absence ofinstructions to the contrary. See 29 CFR 2550.404c–1 and 57 FR 46924.

2005–5 I.R.B. 383 January 31, 2005

any plan requirement to provide electivecontributions or matching contributions.

The proposed regulations contained anexception to the rule precluding the fund-ing of elective contributions before the per-formance of services in the situation wherethe compensation would also have beenpaid, but for the election, before the perfor-mance of services and that exception hasbeen retained in the final regulations. Af-ter consideration of the administrative con-cerns raised by the comments, these finalregulations also include an exception foroccasional bona fide administrative con-siderations. Under this exception, em-ployer contributions will not fail to satisfythe regulatory requirements relating to thetiming of elective contributions merely be-cause contributions for an occasional payperiod are made before the services withrespect to that pay period are performed,provided that the early contributions aremade for bona fide administrative consid-erations and are not made early with aprincipal purpose of accelerating deduc-tions. In addition, the final regulations in-clude changes to the rules precluding theprefunding of matching contributions dis-cussed below.

One commentator asked for clarifica-tion of the interaction between these tim-ing rules and the rule under the regulationsthat treats a self-employed individual’searned income as being currently avail-able on the last day of the individual’staxable year and whether this last day ruleprecludes a partner from making electivecontributions during the year through areduction in the partner’s draw. The re-striction on the timing of contributionsis not intended to prevent a partner fromdeferring amounts that are paid to thepartner throughout the year on account ofservices performed by the partner duringthe year, and the final regulations havebeen modified to clarify this point. How-ever, self-employed individuals who takeadvantage of this opportunity to deferamounts during the year must make surethat the amount contributed during theyear will not exceed the limits (such as thelimits of section 415) that will apply to theindividual, based on the individual’s ac-tual earned income for the relevant period.

2. Qualified CODAs

A. General rules relating to qualifiedCODAs

Elective contributions under a qualifiedCODA are treated as employer contribu-tions for purposes of the Internal RevenueCode.3 Elective contributions under aqualified CODA generally are not in-cluded in the employee’s gross income atthe time the cash would have been received(but for the cash or deferred election) or atthe time contributed to the plan. Electivecontributions under a qualified CODA areincluded in the employee’s gross income,however, if the contributions are in ex-cess of the section 402(g) limit for a year,are designated Roth contributions (undersection 402A, effective for tax years be-ginning after December 31, 2005), or arerecharacterized as after-tax contributionsas part of a correction of an ADP test fail-ure.

A CODA is not qualified unless it ispart of a profit sharing plan, stock bonusplan, pre-ERISA money purchase plan,or rural cooperative plan and provides foran election between contributions to theplan or payments directly in cash. In ad-dition, a CODA is not qualified unless itmeets the following requirements: 1) theelective contributions under the CODAsatisfy either the ADP test set forth in sec-tion 401(k)(3) or one of the design-basedalternatives in section 401(k)(11) or (12);2) elective contributions under the CODAare nonforfeitable at all times; 3) electivecontributions are distributable only on theoccurrence of certain events, includingattainment of age 591/2, hardship, death,disability, severance from employment,or termination of the plan; 4) the groupof employees eligible to participate in theCODA satisfies the coverage requirementsof section 410(b)(1); 5) no other benefit(other than matching contributions andcertain other specified benefits) is con-ditioned, directly or indirectly, upon theemployee’s making or not making electivecontributions under the CODA; and 6) nomore than 1 year of service is requiredfor eligibility to elect to make a cash ordeferred election.

Subject to certain exceptions, State andlocal governmental plans are not allowed

to include a qualified CODA. Plans spon-sored by Indian tribal governments and ru-ral cooperatives are allowed to include aqualified CODA.

B. Nondiscrimination rules applicable toqualified CODAs

As under the proposed regulations,these final regulations provide that thespecial nondiscrimination standards setforth in section 401(k) (the ADP test,the ADP safe harbor and the SIMPLE401(k) plan) are the exclusive means bywhich a qualified CODA can satisfy thenondiscriminatory amount of contributionrequirement of section 401(a)(4). Pursuantto section 401(k)(3)(G), a State or localgovernmental plan is deemed to satisfy theADP test.

These final regulations retain the rulethat the plan must satisfy the requirementsof §1.401(a)(4)–4 with respect to benefits,rights and features in addition to the re-quirements that contributions satisfy thenondiscrimination requirements of section401(k). In addition to stating that the avail-ability of each level of elective contribu-tion is a right or feature subject to the re-quirements of section 401(a)(4), the finalregulations point out that the right to makea designated Roth contribution is a right orfeature.

The proposed regulations included ananti-abuse rule which provided that a planwill not be treated as satisfying the require-ments of section 401(k) if there are re-peated changes to plan testing proceduresor plan provisions that have the effect ofdistorting the ADP so as to increase signif-icantly the permitted deferrals for HCEs,or otherwise manipulate the nondiscrimi-nation rules of section 401(k), if a princi-pal purpose of the changes was to achievesuch a result.

Several commentators suggested elimi-nating the anti-abuse rule in the proposedregulations. One of these commentatorssuggested that the proposed regulation’srestrictions on ADP testing (including therestriction on the use of targeted QNECsand changes in testing method discussedbelow) made the anti-abuse rule unneces-sary and noted that there may be legiti-mate reasons (for example, change in par-ticipant demographics or merger of plans

3 The Department of Labor has advised Treasury and the IRS that its view is that amounts a participant pays to or has withheld by an employer, whether pursuant to a cash or deferred electionor otherwise, for contribution to an employee benefit plan constitute participant contributions for purposes of Subtitle A and Part 4 of Subtitle B of Title I of ERISA.

January 31, 2005 384 2005–5 I.R.B.

for administrative reasons) for changes toa section 401(k) plan’s testing procedures.Another commentator suggested that theanti-abuse rule be replaced with guidanceaddressing various specific abusive trans-actions.

After considering these comments, IRSand Treasury have determined that theneed for rules to prevent abuse associatedwith changes in plan testing procedures orother plan provisions to inflate inappropri-ately the ADP for NHCEs or to otherwisemanipulate the nondiscrimination pro-visions of section 401(k) outweighs theconcerns raised by these commentators.In addition, IRS and Treasury do not be-lieve that the anti-abuse provisions of theproposed regulations constrain legitimatetesting procedure changes. Therefore,these final regulations retain the anti-abuseprovisions of the proposed regulations.

C. Aggregation and disaggregation ofplans

As under the proposed regulations,these final regulations consolidate therules regarding identification of CODAsand plans for purposes of demonstratingcompliance with the requirements of sec-tion 401(k) and retain the rule that allCODAs included in a plan are treated as asingle CODA for purposes of applying thenondiscrimination tests. For this purpose,a plan is generally defined by reference to§1.410(b)–7(a) and (b) after applicationof the mandatory disaggregation rules of§1.410(b)–7(c) (other than the mandatorydisaggregation of section 401(k) and sec-tion 401(m) plans) and permissive aggre-gation rules of §1.410(b)–7(d), as modi-fied under these regulations. For example,if a plan covers collectively bargainedemployees and noncollectively bargainedemployees, the elective contributions forthe separate groups of employees mustbe treated separately for nondiscrimina-tion under section 401(k). As under theproposed regulations, the final regulationsretain the special rules in the pre-SBJPAregulations that permit the aggregation ofcertain employees in different collectivebargaining units and the prohibition onrestructuring under §1.401(a)(4)–9(c).

The proposed regulations included achange to the treatment of a CODA un-der a plan that includes an ESOP. Underthe pre-SBJPA regulations, such a plan

must be disaggregated into the ESOP andnon-ESOP portions and apply two sepa-rate ADP and ACP tests: one for electivecontributions going into the ESOP por-tion (and invested in employer stock) andone for elective contributions going inthe non-ESOP portion of the plan. Theproposed regulations eliminated the dis-aggregation of the ESOP and non-ESOPportions of a single section 414(l) planfor purposes of ADP and ACP testing andallowed an employer to permissively ag-gregate two section 414(l) plans, one thatis an ESOP and one that is not.

Commentators responded favorably tothis change. Therefore, the final regula-tions retain the rule of the proposed reg-ulations that eliminates the disaggregationof the ESOP and non-ESOP portions forthe ADP and ACP tests. Several of thesecommentators suggested that plans be per-mitted to implement this change before theeffective date of the regulations. Afterconsidering these comments, the IRS andTreasury have determined that it would notbe in the best interest of plan administra-tion to allow this change to be made beforethe effective date of the entire regulations.However, as discussed below, a plan is per-mitted to implement this change for planyears that end after December 29, 2004,provided the plan applies all the rules ofthese final regulations, to the extent appli-cable, for that plan year and all subsequentplan years.

These final regulations retain the pro-posed regulations’ requirement that asingle testing method must apply to allCODAs under a plan (after applicationof the aggregation and disaggregationrules as modified). This has the effect ofrestricting an employer’s ability to aggre-gate section 414(l) plans for purposes ofsection 410(b) if those plans apply incon-sistent testing methods. For example, aplan that applies the ADP test of section401(k)(3) may not be aggregated witha plan that uses the ADP safe harbor ofsection 401(k)(12) for purposes of section410(b). However, the final regulationsmake clear that if a plan is disaggregatedinto separate plans under the rules of sec-tion 410(b), each separate plan can applya different testing method. Thus, for ex-ample, if an employer maintaining a planthat covers otherwise excludible employ-ees is using the optional rule of section410(b)(4)(B) to determine whether the

plan satisfies the requirements of section410(b), then the plan is treated as com-prising two separate plans for purposes ofsection 410(b) and the plan covering theemployees who have satisfied the min-imum age and service requirements ofsection 410(a)(1)(A) can use the ADP safeharbor of section 401(k)(12), while theplan covering the remaining employeesuses the ADP test of section 401(k)(3).

D. Requirement that the electivecontributions be immediatelynonforfeitable

The final regulations reflect the statu-tory requirement that elective contribu-tions to a qualified CODA be immediatelynonforfeitable. However, the final regu-lations clarify that the reference to thesecontributions being “disregarded for pur-poses of applying section 411(a) to othercontributions” is limited to being disre-garded for purposes of section 411(a)(2).Thus, for example, elective contributionsunder a qualified CODA are taken into ac-count for purposes of determining whethera participant is a nonvested participant forpurposes of section 411(a)(6)(D)(iii).

E. Restrictions on withdrawals

As discussed above, a qualified CODAmust provide that elective contributionsmay only be distributed after certainevents, including hardship and severancefrom employment. EGTRRA amendedsection 401(k)(2)(B)(i)(I) by replacing“separation from service” with “severancefrom employment.” This change elimi-nated the “same desk rule” as a standardfor distributions under section 401(k)plans.

In addition, EGTRRA amended sec-tion 401(k)(10) by deleting dispositionby a corporation of substantially all ofthe assets of a trade or business and dis-position of a corporation’s interest in asubsidiary, leaving termination of the planas the only distributable event describedin section 401(k)(10). Further, EGTRRAdirects the Secretary of the Treasury torevise the regulations relating to distri-butions under section 401(k)(2)(B)(i)(IV)to provide that the period during whichan employee is prohibited from makingelective and employee contributions fol-lowing a hardship distribution is 6 months

2005–5 I.R.B. 385 January 31, 2005

(instead of 12 months as required un-der §1.401(k)–1(d)(2)(iv)(B)(4) of thepre-SBJPA regulations).4 Finally, sec-tion 662 of EGTRRA amended section404(k)(2) to allow a deduction for divi-dends paid on employer securities held byan ESOP if those dividends are reinvestedin employer securities pursuant to an elec-tion by the participant or beneficiary toreinvest the dividends or have them paidin cash. Section 662 of EGTRRA is ef-fective for taxable years of a corporationbeginning on or after January 1, 2002.

Notice 2001–56, Notice 2002–2,2002–1 C.B. 285, and Notice 2002–4provided guidance on these EGTRRAchanges to the distribution rules for elec-tive contributions. That guidance wasgenerally incorporated in the proposedregulations. These final regulations adoptthe rules in the proposed regulations butclarify that the requirement that a partici-pant must have obtained all distributionscurrently available under all qualifiedplans of the employer in order to qualifyfor a hardship distribution applies equallyto a distribution of an ESOP dividend.This implements the rule set forth in No-tice 2002–2.

Comments were requested on whether achange in status from a common law em-ployee to a leased employee described insection 414(n) should be treated as a sev-erance from employment that would per-mit a distribution to be made. After re-viewing the comments, these final regula-tions do not add the change to leased em-ployee to the list of distributable eventsand retain the use of the section 410(b) def-inition of employee for purposes of sec-tion 401(k). Because an individual whois a leased employee (as defined in sec-tion 414(n)) is treated as an employee ofthe recipient of the individual’s servicesfor purposes of section 410(b) (unless thesafe harbor plan requirements described insection 414(n)(5) are met), the individualdoes not incur a severance from employ-ment as a result of becoming a leased em-ployee.

In addition to the statutory changes,the rules relating to hardship distributionswere reorganized in the proposed regula-tions in order to clarify certain ambigu-ities, including the relationship between

the generally applicable rules, employeerepresentations, and the safe harbors pro-vided under the pre-SBJPA regulations.The final regulations adopt the rules inthe proposed regulations with some minormodifications. In response to comments,the final regulations add funeral expensesand certain expenses relating to the repairof damage to the employee’s principal res-idence to the list of events that are deemedto be immediate and heavy financial needs.

The pre-SBJPA regulations and theproposed regulations treated medical ex-penses for an employee’s spouse or depen-dent described in section 152 as a deemedheavy and financial need. The WorkingFamilies Tax Relief Act of 2004 (118 Stat.1166), Public Law 108–311, modifiedsection 152’s definition of dependent, ef-fective for tax years beginning in 2005.These final regulations revise the proposedregulations to disregard certain provisionsin section 152’s definition of dependentin the case of post-secondary educationalexpenses. These final regulations alsorevise the proposed regulations to treatexpenses for (or necessary to obtain) med-ical care that would be deductible undersection 213(d) (determined without regardto whether the expenses exceed 7.5% ofadjusted gross income) as a deemed heavyand financial need. These changes havethe effect of allowing medical expensesand post-secondary educational expensesfor an employee, spouse, or dependent(without regard to the change in the def-inition of dependent under the WorkingFamilies Tax Relief Act of 2004) to betreated as a deemed heavy and financialneed. The modifications in these final reg-ulations also effectively expand the defini-tion of dependent for medical expenses toinclude a non-custodial child who is sub-ject to the special rule of section 152(e),but would exclude nonprescription drugsor medicine (other than insulin). Prior tothe effective date of these regulations withrespect to a plan, a sponsor can continue tointerpret the plan terms and the pre-SBJPAregulations without regard to the statutorychange in the definition of dependent.

Some commentators asked for specificguidance on the documentation and verifi-cation requirements for a hardship distri-bution. The final regulations do not ad-

dress this issue. However, taxpayers arereminded that section 6001 requires thatthey keep the records necessary to demon-strate compliance with the qualification re-quirements of section 401 and the rules ofsection 401(k) and 401(m).

F. Other rules for qualified CODAs

The final regulations retain the addi-tional requirements set forth in the pre-SBJPA regulations that a CODA must sat-isfy in order to be qualified, with someminor modifications. First, in order to bea qualified CODA, the arrangement mustprovide an employee with an effective op-portunity to elect to receive the amountin cash no less than once during the planyear. Whether an employee has an effec-tive opportunity is determined based on allthe relevant facts and circumstances, in-cluding adequacy of notice of the avail-ability of the election, the period of timebefore the cash is currently available dur-ing which an election may be made, andany other conditions on elections.

The final regulations also require a planto provide for satisfaction of one of thespecific nondiscrimination alternatives de-scribed in section 401(k). As with the pre-SBJPA regulations, the plan may accom-plish this by incorporating by reference theADP test of section 401(k)(3) and the regu-lations under proposed §1.401(k)–2(a) and(b), if that is the nondiscrimination alter-native being used. If, with respect to thenondiscrimination alternative being used,there are optional choices available, theplan must provide which of the optionalchoices will apply. For example, a planthat uses the ADP test of section 401(k)(3)must specify whether it is using the cur-rent year testing method or prior year test-ing method. Additionally, a plan that usesthe prior year testing method must specifywhether the ADP for eligible NHCEs forthe first plan year is 3% or the actual ADPfor the eligible NHCEs for the first planyear. The final regulations also providethat the Commissioner may, in guidanceof general applicability, specify the defaultoptions that will apply under the plan if thenondiscrimination test is incorporated byreference in accordance with the final reg-ulations.

4 Under section 402(c), as amended by the IRS Restructuring and Reform Act of 1998, Public Law 105–206 (112 Stat. 685), and EGTRRA, a hardship distribution is not an eligible rolloverdistribution. While the change affects distributions from a section 401(k) plan, there is no specific reference to the change in these regulations because these regulations are under sections401(k) and (m).

January 31, 2005 386 2005–5 I.R.B.

Additionally, a plan that uses the safeharbor method must specify whether thesafe harbor contribution will be the non-elective safe harbor contribution or thematching safe harbor contribution and isnot permitted to provide that ADP testingwill be used if the requirements for the safeharbor are not satisfied. The safe harborsare intended to provide employees witha minimum threshold in benefits in ex-change for easier compliance for the plansponsor. It would be inconsistent with thisapproach to providing benefits to allowan employer to deliver smaller benefitsto NHCEs and revert to testing. Accord-ingly, if, at the beginning of the plan year,a plan contains an allocation formula thatincludes safe harbor matching or nonelec-tive contributions, these regulations clarifythat, except to the extent permitted under§1.401(k)–3 and §1.401(m)–3, the planmay not be amended to revert to testingfor the plan year.

The final regulations retain the existingrules relating to the section 401(k)(4)(A)prohibition on having benefits (other thana match) contingent on making or not mak-ing an elective contribution. These finalregulations also reflect the amendment tosection 416(c)(2)(A) (under which match-ing contributions can be taken into accountfor purposes of satisfying the top-heavyminimum contribution requirement with-out violating the prohibition on makingbenefits contingent on making or not mak-ing elective contributions), the amendmentof section 401(k)(4)(B) by SBJPA (allow-ing tax exempt organizations to maintainsection 401(k) plans), and the enactmentof section 402(g)(8) (providing that match-ing contributions with respect to partnersand sole proprietors are no longer treatedas elective contributions).

3. The Actual Deferral Percentage (ADP)Test

A. General rules relating to the ADP test

Section 1.401(k)–2 sets forth the rulesfor a CODA that is applying the ADP testcontained in section 401(k)(3). Under theADP test, the percentage of compensationdeferred for the eligible HCEs is comparedannually to the percentage of compensa-tion deferred for eligible NHCEs, and ifcertain limits are exceeded by the HCEs,corrective action must be taken by the plan.

Correction can be made through the distri-bution of excess contributions, the rechar-acterization of excess contributions, or ad-ditional employer contributions.

Section 401(k)(3)(A), as amended bySBJPA, generally provides for the use ofprior year data in determining the ADP ofNHCEs, while current year data is used forHCEs. This testing option is referred toas the prior year testing method. Alter-natively, a plan may provide for the useof current year data for determining theADPs for both NHCEs and HCEs, which isknown as the current year testing method.The regulations use the term applicableyear to describe the year for which theADP is determined for the NHCEs.

Section 401(k)(3)(F), as added bySBJPA, provides that a plan benefitingotherwise excludable employees and that,pursuant to section 410(b)(4)(B), is beingtreated as two separate plans for purposesof section 410(b), is permitted to disregardNHCEs who have not met the minimumage and service requirements of section410(a)(1)(A). Thus, the regulations permitsuch a plan to perform the ADP test bycomparing the ADP for all eligible HCEsfor the plan year and the ADP of eligibleNHCEs for the applicable year, disre-garding all NHCEs who have not met theminimum age and service requirementsof section 410(a)(1)(A). Because section401(k)(3)(F) is permissive, the final reg-ulations follow the proposed regulationsand do not eliminate the existing test-ing option under which a plan benefitingotherwise excludable employees is dis-aggregated into separate plans where theADP test is performed separately for all el-igible employees who have completed theminimum age and service requirements ofsection 410(a)(1)(A) and for all eligibleemployees who have not completed theminimum age and service requirements.

B. Elective contributions used in the ADPtest

The regulations generally follow theproposed regulations in defining whichelective contributions are reflected in theADP test and which ones are not. Thus,these regulations reflect the rule containedin the regulations under section 414(v),under which catch-up contributions thatare in excess of a statutory limit or anemployer-provided limit are not taken

into account under the ADP test. See§1.414(v)–1. The final regulations adda comparable rule for additional electivecontributions that are made by reason ofan eligible employee’s qualified militaryservice pursuant to section 414(u). Thefinal regulations retain the rule that elec-tive contributions must be paid to the trustwithin 12 months after the end of the planyear. However, for plans subject to TitleI of ERISA, contributions must be paid tothe trust much sooner in order to satisfythe Department of Labor’s regulationsrelating to when elective contributionsbecome plan assets.

Section 401(k)(3) provides that theactual deferral ratio (ADR) of an HCEwho is eligible to participate in 2 or moreCODAs of the same employer is calcu-lated by treating all CODAs in whichthe employee is eligible to participate asone CODA. These final regulations adoptthe provision in the proposed regulationsthat provides that the ADR for each HCEparticipating in more than one CODAis determined by aggregating the HCE’selective contributions that are within theplan year of the CODA being tested.

C. Additional employer contributions usedin the ADP test

The final regulations generally retainthe rules in the proposed regulations per-mitting a plan to take qualified nonelec-tive contributions or qualified matchingcontributions (i.e., nonelective or match-ing contributions that satisfy the vestingand distribution limitations of section401(k)(2)(B) and (C)) into account underthe ADP test, except as described below.Thus, an employer whose CODA hasfailed the ADP test can correct this failureby making additional qualified nonelec-tive contributions (QNECs) or qualifiedmatching contributions (QMACs) for itsNHCEs.

As under the pre-SBJPA regulations,these final regulations provide that QNECsmust satisfy four requirements in additionto the vesting and distribution rules de-scribed above before they can be takeninto account under the ADP test: 1) Theamount of nonelective contributions, in-cluding the QNECs that are used underthe ADP test or the ACP test, must sat-isfy section 401(a)(4); 2) the amount ofnonelective contributions, excluding the

2005–5 I.R.B. 387 January 31, 2005

QNECs that are used under the ADPtest or the ACP test, must satisfy section401(a)(4); 3) the plan to which the QNECor QMAC is made must be a plan that canbe aggregated with the plan maintainingthe CODA; and 4) the QNECs or QMACsmust not be contingent on the performanceof services after the allocation date andmust be contributed within 12 months af-ter the end of the plan year within whichthe contribution is to be allocated.5 Thus,in the case of a plan using prior year ADPtesting, any QNECs that are to be allocatedto the NHCEs for the prior plan year mustbe contributed before the last day of thecurrent plan year in order to be taken intoaccount.

Some plans provide a correction mech-anism for a failed ADP test that targetsQNECs to certain NHCEs in order to re-duce the total contributions to NHCEs un-der the correction. Under the method thatminimizes the total QNECs allocated toNHCEs under the correction, the employermakes a QNEC to the extent permitted bythe section 415 limits to the NHCE withthe lowest compensation during the yearin order to raise that NHCE’s ADR. If theplan still fails to pass the ADP test, the em-ployer continues expanding the group ofNHCEs who receive QNECs to the nextlowest-paid NHCE until the ADP test issatisfied. By using this bottom-up level-ing technique, the employer can pass theADP test by contributing small amounts ofmoney to NHCEs who have very low com-pensation for the plan year (for example,an employee who terminated employmentin early January with $300 of compensa-tion). This is because of the fact that theADP test is based on an unweighted aver-age of ADRs and a small dollar (but highpercentage of compensation) contributionto a terminated or other partial-year em-ployee has a larger impact on the ADP testthan the same contribution to a full-yearemployee.

The IRS and Treasury have been con-cerned that, by using this type of tech-nique, employers may pass the ADPtest by making high percentage QNECsto a small number of employees withlow compensation rather than provid-ing contributions to a broader group ofNHCEs. In addition, the legislative his-

tory to EGTRRA expresses Congressionalintent that the Secretary of the Treasurywill use his existing authority to addresssituations where qualified nonelectivecontributions are targeted to certain partic-ipants with lower compensation in orderto increase the ADP of the NHCEs. (SeeEGTRRA Conference Report, H.R. Conf.Rep. 107–84, 240).

Accordingly, the proposed regulationsadded a new requirement that a QNECmust satisfy in order to be taken into ac-count under the ADP test. This require-ment, designed to limit the use of targetedQNECs, generally prohibited a plan fromcounting QNECs for purposes of the ADPtest to the extent that QNECs are more thandouble the QNECs at least half of the otherNHCEs are receiving, when expressed as apercentage of compensation.

The restriction on targeting QNECs isimplemented by providing that a QNECfor an NHCE that exceeds 5% of compen-sation could be taken into account for theADP test only to the extent the contribu-tion, when expressed as a percentage ofcompensation, does not exceed two timesthe plan’s representative contribution rate.The plan’s representative contribution rateis defined as the lowest contribution rate(i.e., the sum of QNECs made and QMACstaken into account for an employee dividedby the employee’s compensation) among agroup of NHCEs that is half of all the el-igible NHCEs under the arrangement (orthe lowest contribution rate among all eli-gible NHCEs under the arrangement whoare employed on the last day of the year, ifgreater).

While some commentators applaudedthe restriction on targeted QNECs, a num-ber of commentators suggested that certaintypes of contributions be exempted fromthe definition of targeted QNECs. Inparticular, commentators suggested thatQNECs equal to a flat dollar amount thatare made to all NHCEs and QNECs thatare made in connection with an employer’sobligation to pay a prevailing wage underthe Davis-Bacon Act (46 Stat. 1494), Pub-lic Law 71–798, Service Contract Act of1965 (79 Stat. 1965), Public Law 89–386,or similar legislation should be able tobe taken into account under the ADP test(even though such contributions create

widely different contribution percentagesamong the NHCE population) becausethey are not “targeted”.

After reviewing the comments, the IRSand Treasury believe that the restrictionson targeting QNECs should apply essen-tially as they were proposed. While flatdollar QNEC contributions may not havethe appearance of targeting, allowing thosecontributions to skew the results of theADP test undermines the integrity of theADP test. However, the final regulationsprovide more flexibility for QNECs thatare made in connection with an employer’sobligation to pay a prevailing wage underthe Davis-Bacon Act (46 Stat. 1494), Pub-lic Law 71–798, Service Contract Act of1965 (79 Stat. 1965), Public Law 89–286,or similar legislation by allowing a QNECof up to 10% of compensation to be takeninto account under the ADP test in such acase.

The final regulations under section401(m) provide parallel restrictions onQNECs taken into account in ACP test-ing, and a QNEC cannot be taken intoaccount under both the ADP and ACPtest (including for purposes of determin-ing the representative contribution rate).As discussed more fully below, the finalregulations generally retain the proposedregulations limitation on targeting match-ing contributions, which limits the extentto which QMACs can be targeted as ameans of avoiding the restrictions on tar-geted QNECs.

D. Correction

Section 401(k)(8)(C), as amended bySBJPA, provides that, for purposes ofcorrecting a plan’s failure to meet thenondiscrimination requirements of sec-tion 401(k)(3), the distribution of excesscontributions is made on the basis of theamount of the contributions by, or on be-half of, each HCE. The final regulationsimplement this correction procedure in thesame manner as set forth in Notice 97–2.Thus, the total amount of excess contribu-tions is determined using the rules underthe pre-SBJPA regulations (i.e., basedon high percentages). Then, that totalamount is apportioned among the HCEsby assigning the excess to be distributed

5 With respect to this timing requirement, it should be noted that in order to be taken into account for purposes of section 415(c) for a limitation year, the contributions will need to be madewithin the time frame set forth in the regulations under section 415 (generally, no later than 30 days after the end of the section 404(a)(6) period applicable to the taxable year with or withinwhich the limitation year ends).

January 31, 2005 388 2005–5 I.R.B.

first to those HCEs who have the greatestdollar amount of contributions taken intoaccount under the ADP test (as opposed tothe highest deferral percentage). If theseamounts are distributed or recharacterizedin accordance with these regulations, theplan complies with the ADP test for theplan year with no obligation to recalculatethe ADP test.

The final regulations generally followthe rules in the proposed regulations onthe determination of net income attribut-able to excess contributions. However, theregulatory language regarding the calcu-lation of gap period income (i.e., incomefor the period after the plan year) has beenclarified to specify that gap period incomeneeds to be included only to the extent theemployee is or would be credited with al-locable gain or loss on those excess con-tributions for that period, if the total ac-count were to be distributed. In addition, inresponse to administrative concerns raisedby comments, the final regulations providethat a distribution of excess contributionsis not required to include the income allo-cable to the excess contributions for a pe-riod that is no more than 7 days before thedistribution. As under the pre-SBJPA reg-ulations, the determination of the incomefor the gap period could be based on theincome determined using the alternativemethod for the aggregate of the plan yearand the gap period or using 10% of the in-come for the plan year (determined underthe alternative method) for each month inthe gap period.

The final regulations retain the rulesin the proposed regulations regarding thetiming and tax treatment of distributionsof excess contributions, coordination withthe distribution of excess deferrals and thetreatment of matches attributable to excesscontributions. However, the final regu-lations clarify that if excess contributionsare distributed, they are includible in in-come on the dates the elective contribu-tions would have been received by the em-ployee had the employee originally electedto receive the amounts in cash, treatingthe excess contributions that are being dis-tributed as the first elective contributionsfor the plan year.

4. Safe Harbor Section 401(k) Plans

Section 401(k)(12) provides a de-sign-based safe harbor method under

which a CODA is treated as satisfyingthe ADP test if the arrangement meetscertain contribution and notice require-ments. Section 1.401(k)–3 of these finalregulations, which sets forth the require-ments for these arrangements, generallyfollows the rules set forth in Notice 98–52and Notice 2000–3. Thus, a plan satis-fies the section 401(k) safe harbor if itmakes specified QMACs for all eligibleNHCEs. The matching contributions canbe under a basic matching formula thatprovides for QMACs equal to 100% of thefirst 3% of elective contributions and 50%of the next 2% or an enhanced matchingformula that is at least as generous in theaggregate, provided the rate of match-ing contributions under the enhancedmatching formula does not increase as theemployee’s rate of elective contributionsincreases. In lieu of QMACs, the plan ispermitted to provide QNECs equal to 3%of compensation for all eligible NHCEs.In addition, notice must be provided toeach eligible employee, within a reason-able time before the beginning of the year,of the employee’s right to defer under theplan.

The proposed regulations did not in-clude any exception to the requirementsfor safe harbor matching contributionswith respect to catch-up contributions.As part of the proposed regulations theIRS and Treasury solicited comments onthe specific circumstances under whichelective contributions by an NHCE to asafe harbor plan would be less than theamount required to be matched, e.g., lessthan 5% of safe harbor compensation, butwould be treated by the plan as catch-upcontributions, and on the extent to whicha safe harbor plan should be requiredto match catch-up contributions undersuch circumstances. After reviewing thecomments and the applicable statutoryprovisions (including the amendments tosection 414(v)(3)(B) made by the Job Cre-ation and Worker Assistance Act of 2002,(JCWAA) (Public Law 107–147)), theIRS and Treasury have determined that nosuch exception is appropriate.

Section 401(k)(12)(D) contains a re-quirement that each eligible employeebe provided with a written notice of theemployee’s rights and obligations underthe plan. These final regulations providethat the notice can be provided in writingor through another medium that is pre-

scribed by the Commissioner as satisfyingthe requirement for a written notice. Asreflected in the priority guidance plan,the IRS and Treasury are currently de-veloping guidance setting forth the extentto which the notice described in section401(k)(12)(D), as well as other noticesunder the various requirements relating toqualified retirement plans, can be providedelectronically, taking into account the ef-fect of the Electronic Signatures in Globaland National Commerce Act (E-SIGN)(114 Stat. 464), Public Law 106–229.Until that guidance is issued, plan admin-istrators and employers may continue torely on the interim guidance in Q&A–7of Notice 2000–3 on the use of electronicmedia to satisfy the notice requirement insection 401(k)(12)(D).

These final regulations specify that asection 401(k) safe harbor plan must gen-erally be adopted before the beginning ofthe plan year and be maintained through-out a full 12-month plan year. This re-quirement is consistent with the notion thatthe statute specifies a certain contributionlevel for NHCEs in order to be deemed topass the nondiscrimination requirements.If the contribution level is not maintainedfor a full 12-month year, the employercontributions made on behalf of NHCEsshould not support what could be a fullyear’s contribution by the HCEs.

The final regulations adopt the excep-tions to this 12-month rule that were setforth in the proposed regulations. Thus, asection 401(k) safe harbor plan could havea short plan year in the year the plan termi-nates, provided the plan termination is inconnection with a merger or acquisition in-volving the employer, or the employer in-curs a substantial business hardship com-parable to a substantial business hardshipdescribed in section 412(d). A section401(k) safe harbor plan could also havea short plan year in the year the plan ter-minates (without regard to the reason forthe termination or the financial conditionof the employer) if the employer makesthe safe harbor contributions for the shortyear, employees are provided notice of thechange, and the plan passes the ADP test.In either case, the employer must make thesafe harbor contributions through the dateof plan termination.

In addition, a safe harbor plan couldhave a short plan year if it is preceded andfollowed by plan years as a section 401(k)

2005–5 I.R.B. 389 January 31, 2005

safe harbor plan. Under these final regula-tions, the following plan year is permittedto be shorter than 12 months if the shortplan year is as a result of a plan termination(whether or not the plan termination is inconnection with a merger or acquisition in-volving the employer). These final regula-tions clarify that this treatment is unavail-able if in the following plan year safe har-bor matching contributions are reduced orsuspended. In the event that the short planyear is followed by another short plan year,this treatment is available if the plan sat-isfies the 401(k) safe harbor requirementsfor the 12 month period immediately fol-lowing the first short plan year.

5. SIMPLE 401(k) Plans

Pursuant to section 401(k)(11), aSIMPLE 401(k) plan is treated as sat-isfying the requirements of section401(k)(3)(A)(ii) if the contribution, vest-ing, notice and exclusive plan require-ments of section 401(k)(11) are satisfied.Section 1.401(k)–4 of these regulations re-flects the provisions of section 401(k)(11)in a manner that follows the positions re-flected in the model amendments set forthin Rev. Proc. 97–9.

6. Matching Contributions and EmployeeContributions

Section 401(m)(2) sets forth a nondis-crimination test, the ACP test, with re-spect to matching contributions and em-ployee contributions that is parallel tothe nondiscrimination test for electivecontributions set forth in section 401(k).Section 1.401(m)–1 of the regulations setsforth this test in a manner that is con-sistent with the nondiscrimination testset forth in §1.401(k)–1(b). Thus, sat-isfaction of the ACP test, the ACP safeharbor or the SIMPLE 401(k) provisionsis the exclusive means that can be used tosatisfy the nondiscrimination in amountof contribution requirements of section401(a)(4) with respect to employee con-tributions and matching contributions.An anti-abuse provision comparable tothat provided in connection with the reg-ulations under section 401(k) limits theability of an employer to make repeatedchanges in plan provisions or testing pro-cedures that have the effect of distortingthe ACP so as to increase significantly thepermitted ACP for HCEs, or otherwise

manipulate the nondiscrimination rules ofsection 401(m), if a principal purpose ofthe changes was to achieve such a result.

The final regulations also include provi-sions regarding plan aggregation and dis-aggregation that are similar to those thatapply for CODAs under section 401(k).For example, matching contributions madeunder the portion of a plan that is an ESOPand the portion of the same plan that is notan ESOP are not disaggregated under thesefinal regulations.

The definitions of matching contri-bution and employee contribution under§1.401(m)–1 of the regulations generallyfollow the definitions in the pre-SBJPAregulations. Thus, whether an employercontribution is on account of an electivedeferral or employee contribution — andthus is a matching contribution — is deter-mined based on all the relevant facts andcircumstances.

The final regulations generally followthe proposed regulations in providing thata contribution is not treated as a match-ing contribution on account of an electivedeferral if it is contributed before the em-ployee’s performance of services with re-spect to which the elective deferral is made(or when the cash that is subject to thecash or deferred election would be cur-rently available, if earlier) and an employercontribution is not a matching contributionmade on account of an employee contribu-tion if it is contributed before the employeecontribution. Thus, under these regula-tions, an employer would not be able toprefund matching contributions to acceler-ate the deduction for those contributions;and, as noted above with respect to thetiming of elective contributions, employercontributions made under the facts in No-tice 2002–48 would not be taken into ac-count under the ACP test and would notsatisfy any plan requirement to providematching contributions.

However, in response to comments, thefinal regulations make an exception to thisprefunding restriction for forfeitures andfor contributions that result in a matchingallocation of employer securities releasedfrom encumbrance under a securities ac-quisition loan in a leveraged ESOP, pro-vided that the contributions are for a re-quired payment that is due under the loanterms and are not made early with a prin-cipal purpose of accelerating deductions.

7. ACP Test for Matching Contributionsand Employee Contributions

Section 1.401(m)–2 of the final reg-ulations provides rules for the ACP testthat generally parallel the rules applica-ble to the ADP test in §1.401(k)–2. Thus,for example, the ACP test may be run bycomparing the ACP for eligible HCEs forthe current year with the ACP for eligi-ble NHCEs for either the current plan yearor the prior plan year. The determinationof the actual contribution ratio (ACR) foran eligible employee, and the contributionsthat are taken into account in determiningthat ACR, under the final regulations arecomparable to the rules under the section401(k) regulations. Thus, for example, theACR for an HCE who has matching con-tributions or employee contributions undertwo or more plans is determined by addingtogether matching contributions and em-ployee contributions under all plans of theemployer during the plan year of the planbeing tested, in a manner comparable tothat for determining the ADR of an HCEwho participates in two or more CODAs.

The final regulations allow QNECsto be taken into account for ACP test-ing, but would provide essentially thesame restrictions on targeting QNECs toa small number of NHCEs as is providedin §1.401(k)–2. The only difference in therules is that the contribution percentagesused to determine the lowest contribu-tion percentage is based on the sum ofthe QNECs and those matching contribu-tions taken into account in the ACP test,rather than the sum of the QNECs andthe QMACs taken into account under theADP test. Because QNECs that do notexceed 5% are not subject to the limits ontargeted QNECs under either the ADP testor the ACP test, an employer is permittedto take into account up to 10% in QNECsfor an eligible NHCE, 5% in ADP testingand 5% in ACP testing, without regard tohow many NHCEs receive QNECs (witheach of those numbers doubled for QNECsthat are made in connection with an em-ployer’s obligation to provide a prevailingwage under the Davis-Bacon Act (46 Stat.1494), Public Law 71–798, Service Con-tract Act of 1965 (79 Stat. 1965), PublicLaw 89–286, or similar legislation).

In addition, to prevent an employerfrom using targeted matching contribu-tions to circumvent the limitation on tar-

January 31, 2005 390 2005–5 I.R.B.

geted QNECs, the proposed regulationsprovided a parallel rule to limit targetedmatching contributions for NHCEs frombeing taken into account in the ACP testto the extent the matching rate for thecontribution exceeds the greater of 100%and 2 times the representative matchingrate. These final regulations retain thisbasic rule with modifications to make itmore consistent with the rule for QNECs.First, similar to the rule for QNECs, underthese final regulations, a contribution thatmatches an elective contribution may betaken into account to the extent it does notexceed the greater of 5% of compensation.Only then does the rate of matching con-tribution rate become relevant. Further, indetermining the representative matchingrate these final regulations provide a newrule if the matching rate is not the samefor all levels of elective contributions foran employee. In that case, the employee’smatching rate is determined assuming thatan employee’s elective deferrals are equalto 6 percent of compensation. There isalso a parallel rule for matching contribu-tions for employee contributions.

8. Changes to other regulations

These regulations include a numberof cross-reference changes to other reg-ulations to reflect the structure of thesefinal regulations. However, no changeswere made to the regulations under section401(a)(26) and the rule relating to treatingmatching contributions as employer con-tributions for purposes of section 416 (see§1.416–1, Q&A M–19) because these reg-ulations have not been updated to reflectrecent statutory changes.

Effective Date

These final regulations apply for planyears beginning on or after January 1,2006. However, plan sponsors are per-mitted to apply these final regulations toany plan year that ends after December29, 2004, provided the plan applies allthe rules of these final regulations, to theextent applicable, for that plan year andall subsequent plan years. Taxpayers are

cautioned, however, that a decision to ap-ply these regulations in the middle of aplan year could only be successfully im-plemented if the plan has been operated inaccordance with these regulations for thatyear.

For plan years beginning before the ef-fective date of these regulations with re-spect to a plan, the plan must apply therules of the prior regulations (as they ap-peared in the April 1, 2004 edition of 26CFR part 1), the statutory provisions ofsection 401(k) and (m), and applicable IRSnotices.

Special Analyses

It has been determined that this Trea-sury decision is not a significant regula-tory action as defined in Executive Order12866. Therefore, a regulatory assessmentis not required. It has also been deter-mined that section 553(b) of the Admin-istrative Procedure Act (5 U.S.C. chapter5) does not apply to these regulations. Itis hereby certified that the collection ofinformation in these regulations will nothave a significant economic impact on asubstantial number of small entities. Thiscertification is based upon the conclusionthat few plans containing qualified cashor deferred arrangements will correct ex-cess contributions through the recharac-terization of these amounts as employeecontributions under §1.401(k)–2(b)(3) ofthese regulations. The collection of in-formation contained in §1.401(k)–3(d), (f),and §1.401(m)–3(e) are required by statu-tory provisions. However, the IRS hasconsidered alternatives that would lessenthe impact of these statutory requirementson small entities. Thus, the collectionof information in these regulations willonly have a minimal economic impact onmost small entities. Therefore, an anal-ysis under the Regulatory Flexibility Act(5 U.S.C. chapter 6) is not required. Pur-suant to section 7805(f) of the Code, theproposed regulations preceding these reg-ulations were submitted to the Chief Coun-sel for Advocacy of the Small BusinessAdministration for comment on its impacton small business.

Drafting Information

The principal authors of these reg-ulations are R. Lisa Mojiri-Azad andJohn T. Ricotta of the Office of the Di-vision Counsel/Associate Chief Counsel(Tax Exempt and Government Entities).However, other personnel from the IRSand Treasury participated in their devel-opment.

* * * * *

Proposed Amendments to theRegulations

Accordingly, 26 CFR parts 1 and 601are amended to read as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation forpart 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *§1.401(k)–1 also issued under 26

U.S.C. 401(m)(9).§1.401(k)–2 also issued under 26

U.S.C. 401(m)(9).§1.401(k)–3 also issued under 26

U.S.C. 401(m)(9).§1.401(k)–4 also issued under 26

U.S.C. 401(m)(9).§1.401(k)–5 also issued under 26

U.S.C. 401(m)(9).§1.401(k)–6 also issued under 26

U.S.C. 401(m)(9).

* * * * *§1.401(m)–1 also issued under 26

U.S.C. 401(m)(9).§1.401(m)–2 also issued under 26

U.S.C. 401(m)(9).§1.401(m)–3 also issued under 26

U.S.C. 401(m)(9).§1.401(m)–4 also issued under 26

U.S.C. 401(m)(9).§1.401(m)–5 also issued under 26

U.S.C. 401(m)(9).

* * * * *Par. 2. For each section set forth be-

low, remove the text that appears in the col-umn labeled “Remove” and replace withthe text that appears in the column labeled“Insert”:

2005–5 I.R.B. 391 January 31, 2005

Regulation cite Remove Insert

§1.72(p)–1, Q&A–12 “1.401(k)–1(d)(6)(ii)” “1.401(k)–1(d)(5)(iii)”

§1.401(a)(4)–1(b)(2)(ii)(B) “1.401(k)–1(b)(4)” “1.401(k)–2(a)(5)(i)”

§1.401(a)(4)–1(b)(2)(ii)(B) “1.401(k)–1(b)(4)(i)” “1.401(k)–2(a)(4)(i)”

§1.401(a)(4)–1(b)(2)(ii)(B) “1.401(m)–1(b)(4)(ii)(A)” “1.401(m)–2(a)(4)(iii)”

§1.401(a)(4)–1(b)(2)(ii)(B) “1.401(k)–1(b)(5)” “1.401(k)–2(a)(6)”

§1.401(a)(4)–1(b)(2)(ii)(B) “1.401(m)–1(b)(5)” “1.401(m)–2(a)(6)”

§1.401(a)(4)–4(e)(3)(iii)(D) “1.401(k)–1(g)(3)” “1.401(k)–6”

§1.401(a)(4)–4(e)(3)(iii)(F) “1.401(m)–1(f)(6)” “1.401(m)–1(a)(3)”

§1.401(a)(4)–4(e)(3)(iii)(G) “1.401(m)–1(f)(12)” “1.401(m)–1(a)(2)”

§1.401(a)(4)–4(e)(3)(iii)(G) “1.401(k)–1(f)(1)(i)” “1.401(k)–2(b)(1)(i)”

§1.401(a)(4)–4(e)(3)(iii)(G) “1.401(m)–1(e)(1)(i), and1.401(m)–2(c)”

“1.401(m)–2(b)(1)(i)”

§1.401(a)(4)–9(c)(3)(ii) “1.401(k)–1(b)(3)(ii) and1.401(m)–1(b)(3)(ii)”

“1.401(k)–1(b)(4)(iv)(B) and1.401(m)–1(b)(4)(iv)(B)”

§1.401(a)(4)–11(g)(3)(vii)(A) “1.401(k)–1(g)(13)(ii)” “1.401(k)–6”

§1.401(a)(4)–11(g)(3)(vii)(A) “1.401(k)–1(g)(4)” “1.401(k)–6”

§1.401(a)(4)–11(g)(3)(vii)(A) “1.401(m)–1(f)(4)” “1.401(m)–5”

§1.401(a)(4)–11(g)(6), Example 7 “1.401(k)–1(f)” “1.401(k)–2(b)”

§1.401(a)(17)–1(b)(3)(iii)(B) “1.401(k)–1(g)(3)” “1.401(k)–6”

§1.401(a)(17)–1(b)(3)(iii)(B) “1.401(m)–1(f)(12)” “1.401(m)–5”

§1.401(a)(17)–1(b)(3)(iii)(B) “1.401(m)–1(f)(6)” “1.401(m)–5”

§1.401(a)(17)–1(d)(5)(ii) “1.401(m)-(f)(6)” “1.401(m)–1(a)(3)”

§1.401(l)–1(a)(4)(iii) “1.401(k)–1(g)(3)” “1.401(k)–6”

§1.401(l)–1(a)(4)(iii) “1.401(m)–1(f)(6) or (f)(12)” “1.401(m)–1(a)(3) or (a)(2)”

§1.402(a)–1(d)(1) “1.401(k)–1(a)(3)(iii) and (2)(i)” “1.401(k)–1(a)(3)(iv) and (2)(iv)”

§1.402(a)–1(d)(2)(i) “1.401(k)–1(g)(3)” “1.401(k)–6”

§1.402(a)–1(d)(2)(i) “1.401(k)–1(a)(4)(i)” “1.401(k)–1(a)(4)(i)”

§1.402(a)–1(d)(2)(i) “1.401(k)–1(a)(7)” “1.401(k)–1(a)(5)(iv)(B)”

§1.402(a)–1(d)(2)(ii) “1.401(m)–1(f)(12)” “1.401(m)–1(a)(2)”

§1.402(a)–1(d)(2)(iii) “1.401(k)–1(a)(4)(iv)” “1.401(k)–1(a)(3)(v)”

§1.402(a)–1(d)(2)(iii) “1.401(k)–1(a)(6)(ii)(C)” “1.401(k)–1(a)(3)(v)(B)”

§1.402(a)–1(d)(3)(ii)(A) “1.401(k)-(g)(12)” “1.401(k)–6”

§1.402(a)–1(d)(3)(iv) “1.401(k)–1(a)(7)” “1.401–1(a)(5)(iv)(B)”

§1.402(c)–2, Q&A–4(c) “1.401(k)–1(f)” “1.401(k)–2(b)(2)”

§1.402(c)–2, Q&A–4(c) “1.401(m)–1(e)(3)” “1.401(m)–2(b)(2)”

§1.402(g)–1(c)(2) “1.401(k)–1(a)(3)(iv)” “1.401(k)–1(a)(3)(v)”

§1.402(g)–1(e)(6) “1.401(k)–1(f)(5)(i)” “1.401(k)–2(b)(4)(i)”

§1.410(b)–3(a)(3), Example 2 “1.401(k)–1(g)(4)” “1.401(k)–6”

§1.410(b)–3(a)(3), Example 3 “1.401(m)–1(f)(4)” “1.401(m)–5”

January 31, 2005 392 2005–5 I.R.B.

Regulation cite Remove Insert

§1.410(b)–7(c)(1) “1.401(k)–1(b)(4)(iv)” “1.401(k)–2(a)(5)”

§1.410(b)–9 “1.401(k)–1(g)(3)” “1.401(k)–6”

§1.410(b)–9 “1.401(k)–1(a)(4)(i)” “1.401(k)–1(a)(4)(i)”

§1.410(b)–9 “1.401(k)–1(b)(5)” “1.401(k)–1(a)(6)”

§1.410(b)–9 “1.401(m)–1(f)(12)” “1.401(m)–1(a)(2)”

§1.410(b)–9 “1.401(m)–1(e)(1)” “1.401(m)–2(b)(1)”

§1.410(b)–9 “1.401(k)–1(f)(2)” “1.401(k)–6”

§1.410(b)–9 “1.401(m)–1(f)(8)” “1.401(m)–5”

§1.411(a)–4(b)(7) “1.401(m)–1(f)(12)” “1.401(m)–1(a)(2)”

§1.411(a)–4(b)(7) “1.401(m)–1(e)(1)” “1.401(m)–2(b)(1)”

§1.411(a)–4(b)(7) “1.401(k)–1(f)(2) and (g)(7)” “1.401(k)–2(b)(2)(ii) and §1.401(k)–6”

§1.411(a)–4(b)(7) “1.401(m)–1(f)(8)” “1.401(m)–5”

§1.411(d)–4(d), Q&A–2(b)(2)(x) “1.401(k)–1(d)(2)” “1.401(k)–1(d)(3)”

§1.411(d)–4(d), Q&A–2(b)(2)(x) “1.401(k)–1(d)(2)” “1.401(k)–1(d)(3)”

§1.414(r)–5(g)(2)(iv)(A) “1.401(m)–1(f)(12)” “1.401(m)–1(a)(2)”

§1.414(r)–5(g)(2)(iv)(A) “1.401(k)–1(g)(3)” “1.401(k)–6”

§1.414(r)–5(g)(2)(iv)(B) “1.401(m)–1(f)(12)” “1.401(m)–1(a)(2)”

§1.414(r)–5(g)(3)(iv) “1.401(k)–1(g)(3)” “1.401(k)–6”

§54.4979–1(b)(1) “1.401(m)–1(f)(8)” “1.401(m)–5”

§54.4979–1(b)(2) “1.401(k)–1(g)(7)” “1.401(k)–6”

§54.4979–1(c)(1) “1.401(k)–1(b)(5)” “1.401(k)–2(a)(6)”

§54.4979–1(c)(1) “1.401(m)–1(b)(5)” “1.401(m)–2(a)(6)”

§54.4979–1(c)(1) “1.401(k)–1(f)(1)(i) and (6)(i)” “1.401(m)–2(b)(1)(i) and (5)(i)”

§54.4979–1(c)(1) “1.401(m)–1(e)(1)(i)” “1.401(m)–2(b)(1)(i)”

§54.4979–1(c)(2) “1.401(k)–1(f)(1)(i) and (6)(i)” “1.401(k)–2(b)(1)(i) and (6)(i)”

§54.4979–1(c)(2) “1.401(k)–1(f)(3)(ii) and (4)(v)” “1.401(k)–2(b)(3)(ii) and (2)(vi)”

§54.4979–1(c)(2) “1.401(m)–1(e)(3)(v)” “1.401(m)–2(b)(2)(vi)”

§54.4979–1(c)(3) “1.401(k)–1(f)(4)(ii)” “1.401(k)–2(b)(2)(iv)”

§54.4979–1(c)(3) “1.401(m)–1(e)(3)(ii)” “1.401(m)–2(b)(2)(iv)”

Par. 3. In §1.410(b)–3, paragraph(a)(2)(i) is revised to read a follows:

Employees and former employees whobenefit under a plan.

(a) * * *(2) * * * (i) Exceptions to allocation or

accrual requirement—(i) Section 401(k)and 401(m) plans. Notwithstanding para-graph (a)(1) of this section, an employee istreated as benefiting under a section 401(k)plan for a plan year if and only if the em-ployee is an eligible employee as definedin §1.401(k)–6 under the plan. Similarly,an employee is treated as benefiting un-

der a section 401(m) plan for a plan yearif and only if the employee is an eligibleemployee as defined in §1.401(m)–5 un-der the plan for the plan year.

* * *Par. 4. Sections 1.401(k)–0 and

1.401(k)–1 are revised and §§1.401(k)–2through 1.401(k)–6 are added to read asfollows:

§1.401(k)–0 Table of contents.

This section contains first a list of sec-tion headings and then a list of the para-

graphs in each section in §§1.401(k)–1through 1.401(k)–6.

LIST OF SECTIONS

§1.401(k)–1 Certain cash or deferredarrangements.

§1.401(k)–2 ADP test.§1.401(k)–3 Safe harbor requirements.§1.401(k)–4 SIMPLE 401(k) plan re-

quirements.§1.401(k)–5 Special rules for mergers,

acquisitions and similar events. [Re-served].

§1.401(k)–6 Definitions.

2005–5 I.R.B. 393 January 31, 2005

LIST OF PARAGRAPHS

§1.401(k)–1 Certain cash or deferredarrangements.

(a) General rules.(1) Certain plans permitted to include

cash or deferred arrangements.(2) Rules applicable to cash or deferred

arrangements generally.(i) Definition of cash or deferred ar-

rangement.(ii) Treatment of after-tax employee

contributions.(iii) Treatment of ESOP dividend elec-

tion.(iv) Treatment of elective contributions

as plan assets.(3) Rules applicable to cash or deferred

elections generally.(i) Definition of cash or deferred elec-

tion.(ii) Automatic enrollment.(iii) Rules related to timing.(A) Requirement that amounts not be

currently available.(B) Contribution may not precede elec-

tion.(C) Contribution may not precede ser-

vices.(iv) Current availability defined.(v) Certain one-time elections not

treated as cash or deferred elections.(vi) Tax treatment of employees.(vii) Examples.(4) Rules applicable to qualified cash or

deferred arrangements.(i) Definition of qualified cash or de-

ferred arrangement.(ii) Treatment of elective contributions

as employer contributions.(iii) Tax treatment of employees.(iv) Application of nondiscrimination

requirements to plan that includes a quali-fied cash or deferred arrangement.

(A) Exclusive means of amounts test-ing.

(B) Testing benefits, rights and features.(C) Minimum coverage requirement.(5) Rules applicable to nonqualified

cash or deferred arrangements.(i) Definition of nonqualified cash or

deferred arrangement.(ii) Treatment of elective contributions

as nonelective contributions.(iii) Tax treatment of employees.

(iv) Qualification of plan that includesa nonqualified cash or deferred arrange-ment.

(A) In general.(B) Application of section 401(a)(4) to

certain plans.(v) Example.(6) Rules applicable to cash or deferred

arrangements of self-employed individu-als.

(i) Application of general rules.(ii) Treatment of matching contribu-

tions made on behalf of self-employedindividuals.

(iii) Timing of self-employed individ-ual’s cash or deferred election.

(iv) Special rule for certain payments toself-employed individuals.

(b) Coverage and nondiscrimination re-quirements.

(1) In general.(2) Automatic satisfaction by certain

plans.(3) Anti-abuse provisions.(4) Aggregation and restructuring.(i) In general.(ii) Aggregation of cash or deferred ar-

rangements within a plan.(iii) Aggregation of plans.(A) In general.(B) Plans with inconsistent ADP testing

methods.(iv) Disaggregation of plans and sepa-

rate testing.(A) In general.(B) Restructuring prohibited.(v) Modifications to section 410(b)

rules.(A) Certain disaggregation rules not ap-

plicable.(B) Permissive aggregation of collec-

tive bargaining units.(C) Multiemployer plans.(vi) Examples.(c) Nonforfeitability requirements.(1) General rule.(2) Definition of immediately nonfor-

feitable.(3) Example.(d) Distribution limitation.(1) General rule.(2) Rules applicable to distributions

upon severance from employment.(3) Rules applicable to hardship distri-

butions.(i) Distribution must be on account of

hardship.

(ii) Limit on maximum distributableamount.

(A) General rule.(B) Grandfathered amounts.(iii) Immediate and heavy financial

need.(A) In general.(B) Deemed immediate and heavy fi-

nancial need.(iv) Distribution necessary to satisfy fi-

nancial need.(A) Distribution may not exceed

amount of need.(B) No alternative means available.(C) Employer reliance on employee

representation.(D) Employee need not take counter-

productive actions.(E) Distribution deemed necessary to

satisfy immediate and heavy financialneed.

(F) Definition of other plans.(v) Commissioner may expand stan-

dards.(4) Rules applicable to distributions

upon plan termination.(i) No alternative defined contribution

plan.(ii) Lump sum requirement for certain

distributions.(5) Rules applicable to all distributions.(i) Exclusive distribution rules.(ii) Deemed distributions.(iii) ESOP dividend distributions.(iv) Limitations apply after transfer.(6) Examples.(e) Additional requirements for quali-

fied cash or deferred arrangements.(1) Qualified plan requirement.(2) Election requirements.(i) Cash must be available.(ii) Frequency of elections.(3) Separate accounting requirement.(i) General rule.(ii) Satisfaction of separate accounting

requirement.(4) Limitations on cash or deferred

arrangements of state and local govern-ments.

(i) General rule.(ii) Rural cooperative plans and Indian

tribal governments.(iii) Adoption after May 6, 1986.(iv) Adoption before May 7, 1986.(5) One-year eligibility requirement.(6) Other benefits not contingent upon

elective contributions.(i) General rule.

January 31, 2005 394 2005–5 I.R.B.

(ii) Definition of other benefits.(iii) Effect of certain statutory limits.(iv) Nonqualified deferred compensa-

tion.(v) Plan loans and distributions.(vi) Examples.(7) Plan provision requirement.(f) Special rules for designated Roth

contributions. [Reserved].(g) Effective dates.(1) General rule.(2) Early implementation permitted.(3) Collectively bargained plans.(4) Applicability of prior regulations.

§1.401(k)–2 ADP test.

(a) Actual deferral percentage (ADP)test.

(1) In general.(i) ADP test formula.(ii) HCEs as sole eligible employees.(iii) Special rule for early participation.(2) Determination of ADP.(i) General rule.(ii) Determination of applicable year

under current year and prior year testingmethod.

(3) Determination of ADR.(i) General rule.(ii) ADR of HCEs eligible under more

than one arrangement.(A) General rule.(B) Plans not permitted to be aggre-

gated.(iii) Examples.(4) Elective contributions taken into ac-

count under the ADP test.(i) General rule.(ii) Elective contributions for partners

and self-employed individuals.(iii) Elective contributions for HCEs.(5) Elective contributions not taken into

account under the ADP test.(i) General rule.(ii) Elective contributions for NHCEs.(iii) Elective contributions treated as

catch-up contributions.(iv) Elective contributions used to sat-

isfy the ACP test.(v) Additional elective contributions

pursuant to section 414(u).(6) Qualified nonelective contributions

and qualified matching contributions thatmay be taken into account under the ADPtest.

(i) Timing of allocation.

(ii) Requirement that amount satisfysection 401(a)(4).

(iii) Aggregation must be permitted.(iv) Disporportionate contributions not

taken into account.(A) General rule.(B) Definition of representative contri-

bution rate.(C) Definition of applicable contribu-

tion rate.(D) Special rule for prevailing wage

contributions.(v) Qualified matching contributions.(vi) Contributions only used once.(7) Examples.(b) Correction of excess contributions.(1) Permissible correction methods.(i) In general.(A) Qualified nonelective contributions

or qualified matching contributions.(B) Excess contributions distributed.(C) Excess contributions recharacter-

ized.(ii) Combination of correction methods.(iii) Exclusive means of correction.(2) Corrections through distribution.(i) General rule.(ii) Calculation of total amount to be

distributed.(A) Calculate the dollar amount of ex-

cess contributions for each HCE.(B) Determination of the total amount

of excess contributions.(C) Satisfaction of ADP.(iii) Apportionment of total amount of

excess contributions among the HCEs.(A) Calculate the dollar amount of ex-

cess contributions for each HCE.(B) Limit on amount apportioned to any

individual.(C) Apportionment to additional HCEs.(iv) Income allocable to excess contri-

butions.(A) General rule.(B) Method of allocating income.(C) Alternative method of allocating

plan year income.(D) Safe harbor method of allocating

gap period income.(E) Alternative method for allocating

plan year and gap period income.(v) Distribution.(vi) Tax treatment of corrective distri-

butions.(A) General rule.(B) Rule for de minimis distributions.(vii) Other rules.

(A) No employee or spousal consent re-quired.

(B) Treatment of corrective distribu-tions as elective contributions.

(C) No reduction of required minimumdistribution.

(D) Partial distributions.(viii) Examples.(3) Recharacterization of excess contri-

butions.(i) General rule.(ii) Treatment of recharacterized excess

contributions.(iii) Additional rules.(A) Time of recharacterization.(B) Employee contributions must be

permitted under plan.(C) Treatment of recharacterized excess

contributions.(4) Rules applicable to all corrections.(i) Coordination with distribution of ex-

cess deferrals.(A) Treatment of excess deferrals that

reduce excess contributions.(B) Treatment of excess contributions

that reduce excess deferrals.(ii) Forfeiture of match on distributed

excess contributions.(iii) Permitted forfeiture of QMAC.(iv) No requirement for recalculation.(v) Treatment of excess contributions

that are catch-up contributions.(5) Failure to timely correct.(i) Failure to correct within 21/2 months

after end of plan year.(ii) Failure to correct within 12 months

after end of plan year.(c) Additional rules for prior year test-

ing method.(1) Rules for change in testing method.(i) General rule.(ii) Situations permitting a change to the

prior year testing method.(2) Calculation of ADP under the prior

year testing method for the first plan year.(i) Plans that are not successor plans.(ii) First plan year defined.(iii) Successor plans.(3) Plans using different testing meth-

ods for the ADP and ACP test.(4) Rules for plan coverage changes.(i) In general.(ii) Optional rule for minor plan cover-

age changes.(iii) Definitions.(A) Plan coverage change.(B) Prior year subgroup.

2005–5 I.R.B. 395 January 31, 2005

(C) Weighted average of the ADPs forthe prior year subgroups.

(iv) Examples.

§1.401(k)–3 Safe harbor requirements.

(a) ADP test safe harbor.(b) Safe harbor nonelective contribu-

tion requirement.(1) General rule.(2) Safe harbor compensation defined.(c) Safe harbor matching contribution

requirement.(1) In general.(2) Basic matching formula.(3) Enhanced matching formula.(4) Limitation on HCE matching contri-

butions.(5) Use of safe harbor match not pre-

cluded by certain plan provisions.(i) Safe harbor matching contributions

on employee contributions.(ii) Periodic matching contributions.(6) Permissible restrictions on elective

contributions by NHCEs.(i) General rule.(ii) Restrictions on election periods.(iii) Restrictions on amount of elective

contributions.(iv) Restrictions on types of compensa-

tion that may be deferred.(v) Restrictions due to limitations under

the Internal Revenue Code.(7) Examples.(d) Notice requirement.(1) General rule.(2) Content requirement.(i) General rule.(ii) Minimum content requirement.(iii) References to SPD.(3) Timing requirement.(i) General rule.(ii) Deemed satisfaction of timing re-

quirement.(e) Plan year requirement.(1) General rule.(2) Initial plan year.(3) Change of plan year.(4) Final plan year.(f) Plan amendments adopting safe har-

bor nonelective contributions.(1) General rule.(2) Contingent notice provided.(3) Follow-up notice requirement.(g) Permissible reduction or suspension

of safe harbor matching contributions.(1) General rule.(2) Notice of suspension requirement.

(h) Additional rules.(1) Contributions taken into account.(2) Use of safe harbor nonelective con-

tributions to satisfy other nondiscrimina-tion tests.

(3) Early participation rules.(4) Satisfying safe harbor contribution

requirement under another defined contri-bution plan.

(5) Contributions used only once.

§1.401(k)–4 SIMPLE 401(k) planrequirements.

(a) General rule.(b) Eligible employer.(1) General rule.(2) Special rule.(c) Exclusive plan.(1) General rule.(2) Special rule.(d) Election and notice.(1) General rule.(2) Employee elections.(i) Initial plan year of participation.(ii) Subsequent plan years.(iii) Election to terminate.(3) Employee notices.(e) Contributions.(1) General rule.(2) Elective contributions.(3) Matching contributions.(4) Nonelective contributions.(5) SIMPLE compensation.(f) Vesting.(g) Plan year.(h) Other rules.

§1.401(k)–5 Special rules for mergers,acquisitions and similar events.[Reserved].

§1.401(k)–6 Definitions.

§1.401(k)–1 Certain cash or deferredarrangements.

(a) General rules—(1) Certain planspermitted to include cash or deferredarrangements. A plan, other than aprofit-sharing, stock bonus, pre-ERISAmoney purchase pension, or rural coopera-tive plan, does not satisfy the requirementsof section 401(a) if the plan includes a cashor deferred arrangement. A profit-sharing,stock bonus, pre-ERISA money purchasepension, or rural cooperative plan doesnot fail to satisfy the requirements ofsection 401(a) merely because the plan

includes a cash or deferred arrangement.A cash or deferred arrangement is part ofa plan for purposes of this section if anycontributions to the plan, or accruals orother benefits under the plan, are made orprovided pursuant to the cash or deferredarrangement.

(2) Rules applicable to cash or deferredarrangements generally—(i) Definition ofcash or deferred arrangement. Except asprovided in paragraphs (a)(2)(ii) and (iii)of this section, a cash or deferred arrange-ment is an arrangement under which an el-igible employee may make a cash or de-ferred election with respect to contribu-tions to, or accruals or other benefits un-der, a plan that is intended to satisfy therequirements of section 401(a) (includinga contract that is intended to satisfy the re-quirements of section 403(a)).

(ii) Treatment of after-tax employeecontributions. A cash or deferred arrange-ment does not include an arrangementunder which amounts contributed under aplan at an employee’s election are desig-nated or treated at the time of contributionas after-tax employee contributions (e.g.,by treating the contributions as taxableincome subject to applicable withholdingrequirements). See also section 414(h)(1).A designated Roth contribution, however,is not treated as an after-tax contributionfor purposes of this section, §1.401(k)–2through §1.401(k)–6 and §1.401(m)–1through §1.401(m)–5. A contribution canbe an after-tax employee contribution un-der the rule of this paragraph (a)(2)(ii)even if the employee’s election to makeafter-tax employee contributions is madebefore the amounts subject to the electionare currently available to the employee.

(iii) Treatment of ESOP dividend elec-tion. A cash or deferred arrangementdoes not include an arrangement underan ESOP under which dividends are ei-ther distributed or invested pursuant toan election made by participants or theirbeneficiaries in accordance with section404(k)(2)(A)(iii).

(iv) Treatment of elective contributionsas plan assets. The extent to which elec-tive contributions constitute plan assetsfor purposes of the prohibited transactionprovisions of section 4975 and Title I ofthe Employee Retirement Income Secu-rity Act of 1974 (88 Stat. 829), PublicLaw 93–406, is determined in accordancewith regulations and rulings issued by

January 31, 2005 396 2005–5 I.R.B.

the Department of Labor. See 29 CFR2510.3–102.

(3) Rules applicable to cash or deferredelections generally—(i) Definition of cashor deferred election. A cash or deferredelection is any direct or indirect election(or modification of an earlier election) byan employee to have the employer either—

(A) Provide an amount to the employeein the form of cash (or some other taxablebenefit) that is not currently available; or

(B) Contribute an amount to a trust, orprovide an accrual or other benefit, under aplan deferring the receipt of compensation.

(ii) Automatic enrollment. For pur-poses of determining whether an electionis a cash or deferred election, it is irrel-evant whether the default that applies inthe absence of an affirmative electionis described in paragraph (a)(3)(i)(A) ofthis section (i.e., the employee receivesan amount in cash or some other taxablebenefit) or in paragraph (a)(3)(i)(B) of thissection (i.e., the employer contributes anamount to a trust or provides an accrualor other benefit under a plan deferring thereceipt of compensation).

(iii) Rules related to timing—(A) Re-quirement that amounts not be currentlyavailable. A cash or deferred election canonly be made with respect to an amountthat is not currently available to the em-ployee on the date of the election. Fur-ther, a cash or deferred election can only bemade with respect to amounts that would(but for the cash or deferred election) be-come currently available after the later ofthe date on which the employer adopts thecash or deferred arrangement or the date onwhich the arrangement first becomes ef-fective.

(B) Contribution may not precede elec-tion. A contribution is made pursuant to acash or deferred election only if the contri-bution is made after the election is made.

(C) Contribution may not precede ser-vices—(1) General rule. Contributions aremade pursuant to a cash or deferred elec-tion only if the contributions are made af-ter the employee’s performance of servicewith respect to which the contributions aremade (or when the cash or other taxablebenefit would be currently available, if ear-lier).

(2) Exception for bona fide administra-tive considerations. The timing of con-tributions will not be treated as failing tosatisfy the requirements of this paragraph

(a)(3)(iii)(C) merely because contributionsfor a pay period are occasionally made be-fore the services with respect to that payperiod are performed, provided the contri-butions are made early in order to accom-modate bona fide administrative consider-ations (for example, the temporary absenceof the bookkeeper with responsibility totransmit contributions to the plan) and arenot paid early with a principal purpose ofaccelerating deductions.

(iv) Current availability defined. Cashor another taxable benefit is currentlyavailable to the employee if it has beenpaid to the employee or if the employee isable currently to receive the cash or othertaxable benefit at the employee’s discre-tion. An amount is not currently availableto an employee if there is a significantlimitation or restriction on the employee’sright to receive the amount currently. Sim-ilarly, an amount is not currently availableas of a date if the employee may under nocircumstances receive the amount before aparticular time in the future. The determi-nation of whether an amount is currentlyavailable to an employee does not dependon whether it has been constructively re-ceived by the employee for purposes ofsection 451.

(v) Certain one-time elections nottreated as cash or deferred elections. Acash or deferred election does not includea one-time irrevocable election made nolater than the employee’s first becomingeligible under the plan or any other planor arrangement of the employer that is de-scribed in section 219(g)(5)(A) (whetheror not such other plan or arrangement hasterminated), to have contributions equalto a specified amount or percentage ofthe employee’s compensation (includingno amount of compensation) made by theemployer on the employee’s behalf to theplan and a specified amount or percentageof the employee’s compensation (includ-ing no amount of compensation) dividedamong all other plans or arrangements ofthe employer (including plans or arrange-ments not yet established) for the durationof the employee’s employment with theemployer, or in the case of a defined bene-fit plan to receive accruals or other benefits(including no benefits) under such plans.Thus, for example, employer contributionsmade pursuant to a one-time irrevocableelection described in this paragraph arenot treated as having been made pursuant

to a cash or deferred election and are notincludible in an employee’s gross incomeby reason of §1.402(a)–1(d). In the case ofan irrevocable election made on or beforeDecember 23, 1994—

(A) The election does not fail to betreated as a one-time irrevocable electionunder this paragraph (a)(3)(v) merely be-cause an employee was previously eligi-ble under another plan of the employer(whether or not such other plan has termi-nated); and

(B) In the case of a plan in which part-ners may participate, the election does notfail to be treated as a one-time irrevoca-ble election under this paragraph (a)(3)(v)merely because the election was made af-ter commencement of employment or af-ter the employee’s first becoming eligibleunder any plan of the employer, providedthat the election was made before the firstday of the first plan year beginning af-ter December 31, 1988, or, if later, March31,1989.

(vi) Tax treatment of employees. Anamount generally is includible in an em-ployee’s gross income for the taxableyear in which the employee actually orconstructively receives the amount. Butfor section 402(e)(3), an employee istreated as having received an amount thatis contributed to an exempt trust or plandescribed in section 401(a) or 403(a) pur-suant to the employee’s cash or deferredelection. This is the case even if the elec-tion to defer is made before the year inwhich the amount is earned, or beforethe amount is currently available. See§1.402(a)–1(d).

(vii) Examples. The following exam-ples illustrate the application of this para-graph (a)(3):

Example 1. (i) An employer maintains a profit-sharing plan under which each eligible employee hasan election to defer an annual bonus payable on Jan-uary 30 each year. The bonus equals 10% of compen-sation during the previous calendar year. Deferredamounts are not treated as after-tax employee contri-butions. The bonus is currently available on January30.

(ii) An election made prior to January 30 to deferall or part of the bonus is a cash or deferred election,and the bonus deferral arrangement is a cash or de-ferred arrangement.

Example 2. (i) An employer maintains a profit-sharing plan which provides for discretionary profitsharing contributions and under which each eligibleemployee may elect to reduce his compensation byup to 10% and to have the employer contribute suchamount to the plan. The employer pays each em-ployee every two weeks for services during the imme-

2005–5 I.R.B. 397 January 31, 2005

diately preceding two weeks. The employee’s elec-tion to defer compensation for a payroll period mustbe made prior to the date the amount would otherwisebe paid. The employer contributes to the plan theamount of compensation that each employee electedto defer, at the time it would otherwise be paid to theemployee, and does not treat the contribution as anafter-tax employee contribution.

(ii) The election is a cash or deferred election andthe contributions are elective contributions.

Example 3. (i) The facts are the same as in Exam-ple 2, except that the employer makes a $10,000 con-tribution on January 31 of the plan year that is in ad-dition to the contributions that satisfy the employer’sobligation to make contributions with respect to cashor deferred elections for prior payroll periods. Em-ployee A makes an election on February 15 to defer$2,000 from compensation that is not currently avail-able and the employer reduces the employee’s com-pensation to reflect the election.

(ii) None of the additional $10,000 contributedJanuary 31 is a contribution made pursuant to Em-ployee A’s cash or deferred election, because the con-tribution was made before the election was made. Ac-cordingly, the employer must make an additional con-tribution of $2,000 in order to satisfy its obligationto contribute an amount to the plan pursuant to Em-ployee A’s election. The $10,000 contribution maybe allocated under the plan terms providing for dis-cretionary profit sharing contributions.

Example 4. (i) The facts are the same as in Ex-ample 3, except that Employee A had an outstand-ing election to defer $500 from each payroll period’scompensation. The $10,000 additional payment thatis contributed early is not made early in order to ac-commodate bona fide administrative considerations.

(ii) None of the additional $10,000 contributedJanuary 31 is a contribution made pursuant to Em-ployee A’s cash or deferred election for future payrollperiods, because the contribution was made beforethe earlier of Employee A’s performance of servicesto which the contribution is attributable or when thecompensation would be currently available. Further-more, the exception for early contributions in para-graph (a)(3)(iii)(C)(2) of this section does not apply.Accordingly, the employer must make an additionalcontribution of $500 per payroll period in order to sat-isfy its obligation to contribute an amount to the planpursuant to Employee A’s election. The $10,000 con-tribution may be allocated under the plan terms pro-viding for discretionary profit sharing contributions.

Example 5. (i) Employer B establishes a moneypurchase pension plan in 1986. This is the first qual-ified plan established by Employer B. All salariedemployees are eligible to participate under the plan.Hourly-paid employees are not eligible to participateunder the plan. In 2000, Employer B establishes aprofit-sharing plan under which all employees (bothsalaried and hourly) are eligible. Employer B permitsall employees on the effective date of the profit-shar-ing plan to make a one-time irrevocable election tohave Employer B contribute 5% of compensation ontheir behalf to the plan and make no other contribu-tion to any other plan of Employer B (including plansnot yet established) for the duration of the employee’semployment with Employer B, and have their salariesreduced by 5%.

(ii) The election provided under the profit-shar-ing plan is not a one-time irrevocable election within

the meaning of paragraph (a)(3)(v) of this sectionwith respect to the salaried employees of EmployerB who, before becoming eligible to participate underthe profit-sharing plan, became eligible to participateunder the money purchase pension plan. The electionunder the profit-sharing plan is a one-time irrevocableelection within the meaning of paragraph (a)(3)(v) ofthis section with respect to the hourly employees, be-cause they were not previously eligible to participateunder another plan of the employer.

(4) Rules applicable to qualified cashor deferred arrangements—(i) Definitionof qualified cash or deferred arrangement.A qualified cash or deferred arrangementis a cash or deferred arrangement that sat-isfies the requirements of paragraphs (b),(c), (d), and (e) of this section.

(ii) Treatment of elective contributionsas employer contributions. Except asotherwise provided in §1.401(k)–2(b)(3),elective contributions under a qualifiedcash or deferred arrangement (includingdesignated Roth contributions) are treatedas employer contributions. Thus, for ex-ample, elective contributions under suchan arrangement are treated as employercontributions for purposes of sections401(a), 401(k), 402, 404, 409, 411, 412,415, 416, and 417.

(iii) Tax treatment of employees. Exceptas provided in section 402(g), 402A (effec-tive for taxable years beginning after De-cember 31, 2005), or §1.401(k)–2(b)(3),elective contributions under a qualifiedcash or deferred arrangement are neitherincludible in an employee’s gross incomeat the time the cash would have been in-cludible in the employee’s gross income(but for the cash or deferred election),nor at the time the elective contribu-tions are contributed to the plan. See§1.402(a)–1(d)(2)(i).

(iv) Application of nondiscriminationrequirements to plan that includes a qual-ified cash or deferred arrangement—(A)Exclusive means of amounts testing. Elec-tive contributions (including electivecontributions that are designated Rothcontributions) under a qualified cash ordeferred arrangement satisfy the require-ments of section 401(a)(4) with respectto amounts if and only if the amount ofelective contributions satisfies the nondis-crimination test of section 401(k) underparagraph (b)(1) of this section. See§1.401(a)(4)–1(b)(2)(ii)(B).

(B) Testing benefits, rights and fea-tures. A plan that includes a qualifiedcash or deferred arrangement must sat-

isfy the requirements of section 401(a)(4)with respect to benefits, rights and fea-tures in addition to the requirements re-garding amounts described in paragraph(a)(4)(iv)(A) of this section. For example,the right to make each level of electivecontributions under a cash or deferredarrangement and the right to make desig-nated Roth contributions are rights or fea-tures subject to the requirements of section401(a)(4). See §1.401(a)(4)–4(e)(3)(i) and(iii)(D). Thus, for example, if all employ-ees are eligible to make a stated levelof elective contributions under a cash ordeferred arrangement, but that level ofcontributions can only be made from com-pensation in excess of a stated amount,such as the Social Security taxable wagebase, the arrangement will generally favorHCEs with respect to the availability ofelective contributions and thus will gener-ally not satisfy the requirements of section401(a)(4).

(C) Minimum coverage requirement. Aqualified cash or deferred arrangement istreated as a separate plan that must sat-isfy the requirements of section 410(b).See §1.410(b)–7(c)(1) for special rules.The determination of whether a cash ordeferred arrangement satisfies the require-ments of section 410(b) must be madewithout regard to the modifications tothe disaggregation rules set forth in para-graph (b)(4)(v) of this section. See also§1.401(a)(4)–11(g)(3)(vii)(A), relating tocorrective amendments that may be madeto satisfy the minimum coverage require-ments of section 410(b).

(5) Rules applicable to nonqualifiedcash or deferred arrangements—(i) Def-inition of nonqualified cash or deferredarrangement. A nonqualified cash or de-ferred arrangement is a cash or deferredarrangement that fails to satisfy one ormore of the requirements in paragraph (b),(c), (d) or (e) of this section.

(ii) Treatment of elective contributionsas nonelective contributions. Except asspecifically provided otherwise, electivecontributions under a nonqualified cash ordeferred arrangement are treated as non-elective employer contributions. Thus, forexample, the elective contributions undersuch an arrangement are treated as non-elective employer contributions for pur-poses of sections 401(a) (including section401(a)(4)) and 401(k), 404, 409, 411, 412,

January 31, 2005 398 2005–5 I.R.B.

415, 416, and 417 and are not subject to therequirements of section 401(m).

(iii) Tax treatment of employees. Elec-tive contributions under a nonqualifiedcash or deferred arrangement are includi-ble in an employee’s gross income at thetime the cash or other taxable amount thatthe employee would have received (but forthe cash or deferred election) would havebeen includible in the employee’s grossincome. See §1.402(a)–1(d)(1).

(iv) Qualification of plan that includesa nonqualified cash or deferred arrange-ment— (A) In general. A profit-sharing,stock bonus, pre-ERISA money purchasepension, or rural cooperative plan doesnot fail to satisfy the requirements ofsection 401(a) merely because the planincludes a nonqualified cash or deferredarrangement. In determining whetherthe plan satisfies the requirements ofsection 401(a)(4), the nondiscrimina-tion tests of sections 401(k), paragraph(b)(1) of this section, section 401(m)(2)and §1.401(m)–1(b) may not be used.See §§1.401(a)(4)–1(b)(2)(ii)(B) and1.410(b)–9 (definition of section 401(k)plan).

(B) Application of section 401(a)(4) tocertain plans. The amount of employercontributions under a nonqualified cash ordeferred arrangement is treated as satisfy-ing section 401(a)(4) if the arrangement ispart of a collectively bargained plan thatautomatically satisfies the requirements ofsection 410(b). See §§1.401(a)(4)–1(c)(5)and 1.410(b)–2(b)(7). Additionally, therequirements of sections 401(a)(4) and410(b) do not apply to a governmen-tal plan (within the meaning of section414(d)) maintained by a State or local gov-ernment or political subdivision thereof(or agency or instrumentality thereof). Seesections 401(a)(5) and 410(c)(1)(A).

(v) Example. The following exampleillustrates the application of this paragraph(a)(5):

Example. (i) For the 2006 plan year, Employer Amaintains a collectively bargained plan that includesa cash or deferred arrangement. Employer contribu-tions under the cash or deferred arrangement do notsatisfy the nondiscrimination test of section 401(k)and paragraph (b) of this section.

(ii) The arrangement is a nonqualified cash or de-ferred arrangement. The employer contributions un-der the cash or deferred arrangement are consideredto be nondiscriminatory under section 401(a)(4), andthe elective contributions are generally treated as em-ployer contributions under paragraph (a)(5)(ii) of thissection. Under paragraph (a)(5)(iii) of this section

and under §1.402(a)–1(d)(1), however, the electivecontributions are includible in each employee’s grossincome.

(6) Rules applicable to cash or deferredarrangements of self-employed individu-als—(i) Application of general rules. Gen-erally, a partnership or sole proprietorshipis permitted to maintain a cash or deferredarrangement, and individual partners orowners are permitted to make cash or de-ferred elections with respect to compen-sation attributable to services rendered tothe entity, under the same rules that ap-ply to other cash or deferred arrangements.For example, any contributions made onbehalf of an individual partner or ownerpursuant to a cash or deferred arrangementof a partnership or sole proprietorship areelective contributions unless they are des-ignated or treated as after-tax employeecontributions. In the case of a partner-ship, a cash or deferred arrangement in-cludes any arrangement that directly or in-directly permits individual partners to varythe amount of contributions made on theirbehalf. Consistent with §1.402(a)–1(d),the elective contributions under such an ar-rangement are includible in income and arenot deductible under section 404(a) unlessthe arrangement is a qualified cash or de-ferred arrangement (i.e., the requirementsof section 401(k) and this section are sat-isfied). Also, even if the arrangement isa qualified cash or deferred arrangement,the elective contributions are includible ingross income and are not deductible undersection 404(a) to the extent they exceed theapplicable limit under section 402(g). Seealso §1.401(a)–30.

(ii) Treatment of matching contribu-tions made on behalf of self-employedindividuals. Under section 402(g)(8),matching contributions made on behalf ofa self-employed individual are not treatedas elective contributions made pursuant toa cash or deferred election, without regardto whether such matching contributionsindirectly permit individual partners tovary the amount of contributions made ontheir behalf.

(iii) Timing of self-employed individ-ual’s cash or deferred election. For pur-poses of paragraph (a)(3)(iv) of this sec-tion, a partner’s compensation is deemedcurrently available on the last day of thepartnership taxable year and a sole propri-etor’s compensation is deemed currentlyavailable on the last day of the individ-

ual’s taxable year. Accordingly, a self-em-ployed individual may not make a cashor deferred election with respect to com-pensation for a partnership or sole propri-etorship taxable year after the last day ofthat year. See §1.401(k)–2(a)(4)(ii) for therules regarding when these contributionsare treated as allocated.

(iv) Special rule for certain paymentsto self-employed individuals. For pur-poses of sections 401(k) and 401(m), theearned income of a self-employed individ-ual for a taxable year constitutes paymentfor services during that year. Thus, forexample, if a partnership provides forcash advance payments during the taxableyear to be made to a partner based onthe value of the partner’s services priorto the date of payment (and which donot exceed a reasonable estimate of thepartner’s earned income for the taxableyear), a contribution of a portion of thesepayments to a profit sharing plan in accor-dance with an election to defer the portionof the advance payments does not fail tobe made pursuant to a cash or deferredelection within the meaning of paragraph(a)(3)(iii) of this section merely becausethe contribution is made before the amountof the partner’s earned income is finallydetermined and reported. However, see§1.401(k)–2(a)(4)(ii) for rules on whenearned income is treated as received.

(b) Coverage and nondiscrimination re-quirements—(1) In general. A cash or de-ferred arrangement satisfies this paragraph(b) for a plan year only if—

(i) The group of eligible employees un-der the cash or deferred arrangement (in-cluding any employees taken into accountfor purposes of section 410(b) pursuantto §1.401(a)(4)–11(g)(3)(vii)(A)) satisfiesthe requirements of section 410(b) (includ-ing the average benefit percentage test, ifapplicable); and

(ii) The cash or deferred arrangementsatisfies—

(A) The ADP test of section 401(k)(3)described in §1.401(k)–2;

(B) The ADP safe harbor provi-sions of section 401(k)(12) describedin §1.401(k)–3; or

(C) The SIMPLE 401(k) provi-sions of section 401(k)(11) describedin §1.401(k)–4.

(2) Automatic satisfaction by cer-tain plans. Notwithstanding paragraph(b)(1) of this section, a governmental plan

2005–5 I.R.B. 399 January 31, 2005

(within the meaning of section 414(d))maintained by a State or local governmentor political subdivision thereof (or agencyor instrumentality thereof) shall be treatedas meeting the requirements of this para-graph (b).

(3) Anti-abuse provisions. This sec-tion and §§1.401(k)–1 through 1.401(k)–6are designed to provide simple, practicalrules that accommodate legitimate planchanges. At the same time, the rules areintended to be applied by employers in amanner that does not make use of changesin plan testing procedures or other planprovisions to inflate inappropriately theADP for NHCEs (which is used as abenchmark for testing the ADP for HCEs)or to otherwise manipulate the nondis-crimination testing requirements of thisparagraph (b). Further, this paragraph (b)is part of the overall requirement that ben-efits or contributions not discriminate infavor of HCEs. Therefore, a plan will notbe treated as satisfying the requirementsof this paragraph (b) if there are repeatedchanges to plan testing procedures or planprovisions that have the effect of distortingthe ADP so as to increase significantly thepermitted ADP for HCEs, or otherwisemanipulate the nondiscrimination rules ofthis paragraph, if a principal purpose ofthe changes was to achieve such a result.

(4) Aggregation and restructuring—(i)In general. This paragraph (b)(4) containsthe exclusive rules for aggregating and dis-aggregating plans and cash or deferred ar-rangements for purposes of this section,and §§1.401(k)–2 through 1.401(k)–6.

(ii) Aggregation of cash or deferred ar-rangements within a plan. Except as oth-erwise specifically provided in this para-graph (b)(4), all cash or deferred arrange-ments included in a plan are treated as asingle cash or deferred arrangement and aplan must apply a single test under para-graph (b)(1)(ii) of this section with re-spect to all such arrangements within theplan. Thus, for example, if two groupsof employees are eligible for separate cashor deferred arrangements under the sameplan, all contributions under both cash ordeferred arrangements must be treated asmade under a single cash or deferred ar-rangement subject to a single test, even ifthey have significantly different features,such as different limits on elective contri-butions.

(iii) Aggregation of plans—(A) In gen-eral. For purposes of this section and§§1.401(k)–2 through 1.401(k)–6, theterm plan means a plan within the mean-ing of §1.410(b)–7(a) and (b), after ap-plication of the mandatory disaggregationrules of §1.410(b)–7(c), and the permis-sive aggregation rules of §1.410(b)–7(d),as modified by paragraph (b)(4)(v) of thissection. Thus, for example, two plans(within the meaning of §1.410(b)–7(b))that are treated as a single plan pursuantto the permissive aggregation rules of§1.410(b)–7(d) are treated as a single planfor purposes of sections 401(k) and (m).

(B) Plans with inconsistent ADP testingmethods. Pursuant to paragraph (b)(4)(ii)of this section, a single testing methodmust apply with respect to all cash or de-ferred arrangements under a plan. Thus,in applying the permissive aggregationrules of §1.410(b)–7(d), an employer maynot aggregate plans (within the meaningof §1.410(b)–7(b)) that apply inconsis-tent testing methods. For example, a plan(within the meaning of §1.410(b)–7(b))that applies the current year testing methodmay not be aggregated with anotherplan that applies the prior year testingmethod. Similarly, an employer may notaggregate a plan (within the meaning of§1.410(b)–7(b)) using the ADP safe har-bor provisions of section 401(k)(12) andanother plan that is using the ADP test ofsection 401(k)(3).

(iv) Disaggregation of plans and sepa-rate testing—(A) In general. If a cash ordeferred arrangement is included in a plan(within the meaning of §1.410(b)–7(b))that is mandatorily disaggregated underthe rules of section 410(b) (as modifiedby this paragraph (b)(4)), the cash or de-ferred arrangement must be disaggregatedin a consistent manner. For example, inthe case of an employer that is treatedas operating qualified separate lines ofbusiness under section 414(r), if the eli-gible employees under a cash or deferredarrangement are in more than one quali-fied separate line of business, only thoseemployees within each qualified sepa-rate line of business may be taken intoaccount in determining whether eachdisaggregated portion of the plan com-plies with the requirements of section401(k), unless the employer is applyingthe special rule for employer-wide plansin §1.414(r)–1(c)(2)(ii) with respect to

the plan. Similarly, if a cash or deferredarrangement under which employees arepermitted to participate before they havecompleted the minimum age and servicerequirements of section 410(a)(1) ap-plies section 410(b)(4)(B) for determiningwhether the plan complies with section410(b)(1), then the arrangement must betreated as two separate arrangements, onecomprising all eligible employees whohave met the age and service requirementsof section 410(a)(1) and one comprisingall eligible employees who have not metthe age and service requirements undersection 410(a)(1), unless the plan is usingthe rule in §1.401(k)–2(a)(1)(iii)(A).

(B) Restructuring prohibited. Restruc-turing under §1.401(a)(4)–9(c) may notbe used to demonstrate compliance withthe requirements of section 401(k). See§1.401(a)(4)–9(c)(3)(ii).

(v) Modifications to section 410(b)rules—(A) Certain disaggregation rulesnot applicable. The mandatory disag-gregation rules relating to section 401(k)plans and section 401(m) plans set forthin §1.410(b)–7(c)(1) and ESOP andnon-ESOP portions of a plan set forthin §1.410(b)–7(c)(2) shall not apply forpurposes of this section and §§1.401(k)–2through 1.401(k)–6. Accordingly, not-withstanding §1.410(b)–7(d)(2), an ESOPand a non-ESOP which are different plans(within the meaning of section 414(l), asdescribed in §1.410(b)–7(b)) are permittedto be aggregated for these purposes.

(B) Permissive aggregation of collec-tive bargaining units. Notwithstandingthe general rule under section 410(b) and§1.410(b)–7(c) that a plan that benefitsemployees who are included in a unit ofemployees covered by a collective bar-gaining agreement and employees whoare not included in the collective bargain-ing unit is treated as comprising separateplans, an employer can treat two or moreseparate collective bargaining units as asingle collective bargaining unit for pur-poses of this section and §§1.401(k)–2through 1.401(k)–6, provided that thecombinations of units are determined ona basis that is reasonable and reasonablyconsistent from year to year. Thus, forexample, if a plan benefits employees inthree categories (e.g., employees includedin collective bargaining unit A, employeesincluded in collective bargaining unit B,and employees who are not included in

January 31, 2005 400 2005–5 I.R.B.

any collective bargaining unit), the plancan be treated as comprising three sep-arate plans, each of which benefits onlyone category of employees. However, ifcollective bargaining units A and B aretreated as a single collective bargainingunit, the plan will be treated as comprisingonly two separate plans, one benefiting allemployees who are included in a collec-tive bargaining unit and another benefitingall other employees. Similarly, if a planbenefits only employees who are includedin collective bargaining unit A and em-ployees who are included in collectivebargaining unit B, the plan can be treatedas comprising two separate plans. How-ever, if collective bargaining units A andB are treated as a single collective bar-gaining unit, the plan will be treated asa single plan. An employee is treated asincluded in a unit of employees coveredby a collective bargaining agreement ifand only if the employee is a collectivelybargained employee within the meaningof §1.410(b)–6(d)(2).

(C) Multiemployer plans. Notwith-standing §1.410(b)–7(c)(4)(ii)(C), theportion of the plan that is maintained pur-suant to a collective bargaining agreement(within the meaning of §1.413–1(a)(2)) istreated as a single plan maintained by asingle employer that employs all the em-ployees benefiting under the same benefitcomputation formula and covered pur-suant to that collective bargaining agree-ment. The rules of paragraph (b)(4)(v)(B)of this section (including the permissiveaggregation of collective bargaining units)apply to the resulting deemed single planin the same manner as they would to asingle employer plan, except that the planadministrator is substituted for the em-ployer where appropriate and that appro-priate fiduciary obligations are taken intoaccount. The noncollectively bargained

portion of the plan is treated as maintainedby one or more employers, depending onwhether the noncollectively bargainingunit employees who benefit under the planare employed by one or more employers.

(vi) Examples. The following examplesillustrate the application of this paragraph(b)(4):

Example 1. (i) Employer A maintains Plan V, aprofit-sharing plan that includes a cash or deferredarrangement in which all of the employees of Em-ployer A are eligible to participate. For purposes ofapplying section 410(b), Employer A is treated as op-erating qualified separate lines of business under sec-tion 414(r) in accordance with §1.414(r)–1(b). How-ever, Employer A applies the special rule for em-ployer-wide plans in §1.414(r)–1(c)(2)(ii) to the por-tion of its profit-sharing plan that consists of electivecontributions under the cash or deferred arrangement(and to no other plans or portions of plans).

(ii) Under these facts, the requirements of this sec-tion and §§1.401(k)–2 through 1.401(k)–6 must beapplied on an employer-wide rather than a qualifiedseparate line of business basis.

Example 2. (i) Employer B maintains Plan W, aprofit-sharing plan that includes a cash or deferred ar-rangement in which all of the employees of EmployerB are eligible to participate. For purposes of apply-ing section 410(b), the plan treats the cash or deferredarrangement as two separate plans, one for the em-ployees who have completed the minimum age andservice eligibility conditions under section 410(a)(1)and the other for employees who have not completedthe conditions. The plan provides that it will sat-isfy the section 401(k) safe harbor requirement of§1.401(k)–3 with respect to the employees who havemet the minimum age and service conditions and thatit will meet the ADP test requirements of §1.401(k)–2with respect to the employees who have not met theminimum age and service conditions.

(ii) Under these facts, the cash or deferred ar-rangement must be disaggregated on a consistent ba-sis with the disaggregation of Plan W. Thus, the re-quirements of §1.401(k)–2 must be applied by com-paring the ADP for eligible HCEs who have not com-pleted the minimum age and service conditions withthe ADP for eligible NHCEs for the applicable yearwho have not completed the minimum age and ser-vice conditions.

Example 3. (i) Employer C maintains Plan X, astock-bonus plan including an ESOP. The plan also

includes a cash or deferred arrangement for partici-pants in the ESOP and non-ESOP portions of the plan.

(ii) Pursuant to paragraph (b)(4)(v)(A) of thissection the ESOP and non-ESOP portions of thestock-bonus plan are a single cash or deferredarrangement for purposes of this section and§§1.401(k)–2 through 1.401(k)–6. However, asprovided in paragraph (a)(4)(iv)(C) of this section,the ESOP and non-ESOP portions of the plan are stilltreated as separate plans for purposes of satisfyingthe requirements of section 410(b).

(c) Nonforfeitability requirements—(1)General rule. A cash or deferred arrange-ment satisfies this paragraph (c) only if theamount attributable to an employee’s elec-tive contributions are immediately nonfor-feitable, within the meaning of paragraph(c)(2) of this section, are disregarded forpurposes of applying section 411(a)(2) toother contributions or benefits, and thecontributions remain nonforfeitable evenif the employee makes no additional elec-tive contributions under a cash or deferredarrangement.

(2) Definition of immediately non-forfeitable. An amount is immediatelynonforfeitable if it is immediately non-forfeitable within the meaning of section411, and would be nonforfeitable underthe plan regardless of the age and serviceof the employee or whether the employeeis employed on a specific date. An amountthat is subject to forfeitures or suspensionspermitted by section 411(a)(3) does notsatisfy the requirements of this paragraph(c).

(3) Example. The following exampleillustrates the application of this paragraph(c):

Example. (i) Employees B and C are coveredby Employer Y’s stock bonus plan, which includesa cash or deferred arrangement. All employees par-ticipating in the plan have a nonforfeitable right toa percentage of their account balance derived fromall contributions (including elective contributions) asshown in the following table:

Years of service Nonforfeitable percentage

Less than 1 0%

1 20%

2 40%

3 60%

4 80%

5 or more 100%

(ii) The cash or deferred arrangement does notsatisfy paragraph (c) of this section because elective

contributions are not immediately nonforfeitable. Thus, the cash or deferred arrangement is a nonqual-ified cash or deferred arrangement.

2005–5 I.R.B. 401 January 31, 2005

(d) Distribution limitation—(1) Gen-eral rule. A cash or deferred arrangementsatisfies this paragraph (d) only if amountsattributable to elective contributions maynot be distributed before one of the fol-lowing events, and any distributions sopermitted also satisfy the additional re-quirements of paragraphs (d)(2) through(5) of this section (to the extent applica-ble)—

(i) The employee’s death, disability, orseverance from employment;

(ii) In the case of a profit-sharing, stockbonus or rural cooperative plan, the em-ployee’s attainment of age 591/2, or the em-ployee’s hardship; or

(iii) The termination of the plan.(2) Rules applicable to distributions

upon severance from employment. Anemployee has a severance from employ-ment when the employee ceases to be anemployee of the employer maintainingthe plan. An employee does not have aseverance from employment if, in con-nection with a change of employment, theemployee’s new employer maintains suchplan with respect to the employee. Forexample, a new employer maintains a planwith respect to an employee by continuingor assuming sponsorship of the plan orby accepting a transfer of plan assets andliabilities (within the meaning of section414(l)) with respect to the employee.

(3) Rules applicable to hardship distri-butions—(i) Distribution must be on ac-count of hardship. A distribution is treatedas made after an employee’s hardship forpurposes of paragraph (d)(1)(ii) of this sec-tion if and only if it is made on account ofthe hardship. For purposes of this rule, adistribution is made on account of hard-ship only if the distribution both is madeon account of an immediate and heavy fi-nancial need of the employee and is neces-sary to satisfy the financial need. The de-termination of the existence of an imme-diate and heavy financial need and of theamount necessary to meet the need mustbe made in accordance with nondiscrimi-natory and objective standards set forth inthe plan.

(ii) Limit on maximum distributableamount—(A) General rule. A distributionon account of hardship must be limitedto the maximum distributable amount.The maximum distributable amount isequal to the employee’s total elective con-tributions as of the date of distribution,

reduced by the amount of previous distri-butions of elective contributions. Thus,the maximum distributable amount doesnot include earnings, QNECs or QMACs,unless grandfathered under paragraph(d)(3)(ii)(B) of this section.

(B) Grandfathered amounts. If the planso provides, the maximum distributableamount may be increased for amountscredited to the employee’s account as ofa date specified in the plan that is no laterthan December 31, 1988, or if later, theend of the last plan year ending before July1, 1989 (or in the case of a collectivelybargained plan, the earlier of—

(1) The later of January 1, 1989, or thedate on which the last of the collective bar-gaining agreements in effect on March 1,1986, terminates (determined without re-gard to any extension thereof after Febru-ary 28, 1986); or

(2) January 1, 1991, and consisting of—(i) Income allocable to elective contri-

butions;(ii) Qualified nonelective contributions

and allocable income; and(iii) Qualified matching contributions

and allocable income.(iii) Immediate and heavy financial

need—(A) In general. Whether an em-ployee has an immediate and heavy fi-nancial need is to be determined based onall the relevant facts and circumstances.Generally, for example, the need to paythe funeral expenses of a family memberwould constitute an immediate and heavyfinancial need. A distribution made toan employee for the purchase of a boator television would generally not consti-tute a distribution made on account of animmediate and heavy financial need. A fi-nancial need may be immediate and heavyeven if it was reasonably foreseeable orvoluntarily incurred by the employee.

(B) Deemed immediate and heavy fi-nancial need. A distribution is deemed tobe on account of an immediate and heavyfinancial need of the employee if the dis-tribution is for—

(1) Expenses for (or necessary to ob-tain) medical care that would be deductibleunder section 213(a) (determined withoutregard to whether the expenses exceed7.5% of adjusted gross income);

(2) Costs directly related to the pur-chase of a principal residence for the em-ployee (excluding mortgage payments);

(3) Payment of tuition, related educa-tional fees, and room and board expenses,for up to the next 12 months of post-sec-ondary education for the employee, orthe employee’s spouse, children, or de-pendents (as defined in section 152, and,for taxable years beginning on or afterJanuary 1, 2005, without regard to section152(b)(1), (b)(2) and (d)(1)(B));

(4) Payments necessary to prevent theeviction of the employee from the em-ployee’s principal residence or foreclosureon the mortgage on that residence;

(5) Payments for burial or funeral ex-penses for the employee’s deceased parent,spouse, children or dependents (as definedin section 152, and, for taxable years be-ginning on or after January 1, 2005, with-out regard to section 152(d)(1)(B)); or

(6) Expenses for the repair of damageto the employee’s principal residence thatwould qualify for the casualty deductionunder section 165 (determined without re-gard to whether the loss exceeds 10% ofadjusted gross income).

(iv) Distribution necessary to satisfy fi-nancial need—(A) Distribution may notexceed amount of need. A distributionis treated as necessary to satisfy an im-mediate and heavy financial need of anemployee only to the extent the amountof the distribution is not in excess of theamount required to satisfy the financialneed. For this purpose, the amount re-quired to satisfy the financial need may in-clude any amounts necessary to pay anyfederal, state, or local income taxes orpenalties reasonably anticipated to resultfrom the distribution.

(B) No alternative means available. Adistribution is not treated as necessary tosatisfy an immediate and heavy financialneed of an employee to the extent theneed may be relieved from other resourcesthat are reasonably available to the em-ployee. This determination generally is tobe made on the basis of all the relevantfacts and circumstances. For purposes ofthis paragraph (d)(3)(iv), the employee’sresources are deemed to include thoseassets of the employee’s spouse and mi-nor children that are reasonably availableto the employee. Thus, for example, avacation home owned by the employeeand the employee’s spouse, whether ascommunity property, joint tenants, tenantsby the entirety, or tenants in common,generally will be deemed a resource of

January 31, 2005 402 2005–5 I.R.B.

the employee. However, property held forthe employee’s child under an irrevocabletrust or under the Uniform Gifts to Mi-nors Act (or comparable State law) is nottreated as a resource of the employee.

(C) Employer reliance on employeerepresentation. For purposes of paragraph(d)(3)(iv)(B) of this section, an immediateand heavy financial need generally maybe treated as not capable of being relievedfrom other resources that are reasonablyavailable to the employee, if the employerrelies upon the employee’s representation(made in writing or such other form asmay be prescribed by the Commissioner),unless the employer has actual knowledgeto the contrary, that the need cannot rea-sonably be relieved—

(1) Through reimbursement or compen-sation by insurance or otherwise;

(2) By liquidation of the employee’s as-sets;

(3) By cessation of elective contribu-tions or employee contributions under theplan;

(4) By other currently available distri-butions (including distribution of ESOPdividends under section 404(k)) and non-taxable (at the time of the loan) loans, un-der plans maintained by the employer or byany other employer; or

(5) By borrowing from commercialsources on reasonable commercial termsin an amount sufficient to satisfy the need.

(D) Employee need not take counter-productive actions. For purposes of thisparagraph (d)(3)(iv), a need cannot reason-ably be relieved by one of the actions de-scribed in paragraph (d)(3)(iv)(C) of thissection if the effect would be to increasethe amount of the need. For example, theneed for funds to purchase a principal res-idence cannot reasonably be relieved by aplan loan if the loan would disqualify theemployee from obtaining other necessaryfinancing.

(E) Distribution deemed necessary tosatisfy immediate and heavy financialneed. A distribution is deemed necessaryto satisfy an immediate and heavy finan-cial need of an employee if each of thefollowing requirements are satisfied—

(1) The employee has obtained all othercurrently available distributions (includingdistribution of ESOP dividends under sec-tion 404(k), but not hardship distributions)and nontaxable (at the time of the loan)

loans, under the plan and all other plansmaintained by the employer; and

(2) The employee is prohibited, un-der the terms of the plan or an otherwiselegally enforceable agreement, from mak-ing elective contributions and employeecontributions to the plan and all otherplans maintained by the employer for atleast 6 months after receipt of the hardshipdistribution.

(F) Definition of other plans. For pur-poses of paragraph (d)(3)(iv)(C)(4) and(E)(1) of this section, the phrase plansmaintained by the employer means allqualified and nonqualified plans of de-ferred compensation maintained by theemployer, including a cash or deferredarrangement that is part of a cafeteria planwithin the meaning of section 125. How-ever, it does not include the mandatoryemployee contribution portion of a de-fined benefit plan or a health or welfarebenefit plan (including one that is partof a cafeteria plan). In addition, for pur-poses of paragraph (d)(3)(iv)(E)(2) of thissection, the phrase plans maintained bythe employer also includes a stock option,stock purchase, or similar plan maintainedby the employer. See §1.401(k)–6 for thecontinued treatment of suspended employ-ees as eligible employees.

(v) Commissioner may expand stan-dards. The Commissioner may prescribeadditional guidance of general applicabil-ity, published in the Internal Revenue Bul-letin (see 601.601(d)(2) of this chapter),expanding the list of deemed immediateand heavy financial needs and prescribingadditional methods for distributions to bedeemed necessary to satisfy an immediateand heavy financial need.

(4) Rules applicable to distributionsupon plan termination—(i) No alternativedefined contribution plan. A distribu-tion may not be made under paragraph(d)(1)(iii) of this section if the employerestablishes or maintains an alternativedefined contribution plan. For purposesof the preceding sentence, the defini-tion of the term “employer” contained in§1.401(k)–6 is applied as of the date ofplan termination, and a plan is an alterna-tive defined contribution plan only if it isa defined contribution plan that exists atany time during the period beginning onthe date of plan termination and ending12 months after distribution of all assetsfrom the terminated plan. However, if

at all times during the 24-month periodbeginning 12 months before the date ofplan termination, fewer than 2% of theemployees who were eligible under thedefined contribution plan that includesthe cash or deferred arrangement as ofthe date of plan termination are eligibleunder the other defined contribution plan,the other plan is not an alternative definedcontribution plan. In addition, a definedcontribution plan is not treated as an al-ternative defined contribution plan if itis an employee stock ownership plan asdefined in section 4975(e)(7) or 409(a), asimplified employee pension as definedin section 408(k), a SIMPLE IRA planas defined in section 408(p), a plan orcontract that satisfies the requirements ofsection 403(b), or a plan that is describedin section 457(b) or (f).

(ii) Lump sum requirement for cer-tain distributions. A distribution maybe made under paragraph (d)(1)(iii) ofthis section only if it is a lump sum dis-tribution. The term lump sum distribu-tion has the meaning provided in section402(e)(4)(D) (without regard to section402(e)(4)(D)(i)(I), (II), (III) and (IV)). Inaddition, a lump sum distribution includesa distribution of an annuity contract froma trust that is part of a plan described insection 401(a) and which is exempt fromtax under section 501(a) or an annuity plandescribed in 403(a).

(5) Rules applicable to all distribu-tions—(i) Exclusive distribution rules.Amounts attributable to elective contribu-tions may not be distributed on account ofany event not described in this paragraph(d), such as completion of a stated periodof plan participation or the lapse of a fixednumber of years. For example, if excessdeferrals (and income) for an employee’staxable year are not distributed withinthe time prescribed in §1.402(g)–1(e)(2)or (3), the amounts may be distributedonly on account of an event described inthis paragraph (d). Pursuant to section401(k)(8), the prohibition on distributionsset forth in this section does not apply to adistribution of excess contributions under§1.401(k)–2(b).

(ii) Deemed distributions. The cost oflife insurance (determined under section72) is not treated as a distribution for pur-poses of section 401(k)(2) and this para-graph (d). The making of a loan is nottreated as a distribution, even if the loan

2005–5 I.R.B. 403 January 31, 2005

is secured by the employee’s accrued ben-efit attributable to elective contributions oris includible in the employee’s income un-der section 72(p). However, the reduc-tion, by reason of default on a loan, of anemployee’s accrued benefit derived fromelective contributions is treated as a distri-bution.

(iii) ESOP dividend distributions. Aplan does not fail to satisfy the require-ments of this paragraph (d) merely by rea-son of a dividend distribution described insection 404(k)(2).

(iv) Limitations apply after transfer.The limitations of this paragraph (d)generally continue to apply to amountsattributable to elective contributions (in-cluding QNECs and qualified matchingcontributions taken into account for theADP test under §1.401(k)–2(a)(6)) thatare transferred to another qualified planof the same or another employer. Thus,the transferee plan will generally fail tosatisfy the requirements of section 401(a)and this section if transferred amounts maybe distributed before the times specifiedin this paragraph (d). In addition, a cashor deferred arrangement fails to satisfythe limitations of this paragraph (d) if ittransfers amounts to a plan that does notprovide that the transferred amounts maynot be distributed before the times speci-fied in this paragraph (d). The transferorplan does not fail to comply with the pre-ceding sentence if it reasonably concludesthat the transferee plan provides thatthe transferred amounts may not be dis-tributed before the times specified in thisparagraph (d). What constitutes a basisfor a reasonable conclusion is determinedunder standards comparable to those underthe rules related to acceptance of rolloverdistributions. See §1.401(a)(31)–1, A–14.The limitations of this paragraph (d) ceaseto apply after the transfer, however, ifthe amounts could have been distributedat the time of the transfer (other than onaccount of hardship), and the transfer is anelective transfer described in §1.411(d)–4,Q&A–3(b)(1). The limitations of thisparagraph (d) also do not apply to amountsthat have been paid in a direct rollover tothe plan after being distributed by anotherplan.

(6) Examples. The following examplesillustrate the application of this paragraph(d):

Example 1. Employer M maintains Plan V, aprofit-sharing plan that includes a cash or deferredarrangement. Elective contributions under the ar-rangement may be withdrawn for any reason aftertwo years following the end of the plan year in whichthe contributions were made. Because the plan per-mits distributions of elective contributions before theoccurrence of one of the events specified in section401(k)(2)(B) and this paragraph (d), the cash or de-ferred arrangement is a nonqualified cash or deferredarrangement and the elective contributions are cur-rently includible in income under section 402.

Example 2. (i) Employer N maintains Plan W, aprofit-sharing plan that includes a cash or deferredarrangement. Plan W provides for distributions upona participant’s severance from employment, deathor disability. All employees of Employer N and itswholly owned subsidiary, Employer O, are eligibleto participate in Plan W. Employer N agrees to sellall issued and outstanding shares of Employer O toan unrelated entity, Employer T, effective on Decem-ber 31, 2006. Following the transaction, EmployerO will be a wholly owned subsidiary of EmployerT. Additionally, individuals who are employed byEmployer O on the effective date of the sale con-tinue to be employed by Employer O following thesale. Following the transaction, all employees ofEmployer O will cease to participate in Plan W andwill become eligible to participate in the cash ordeferred arrangement maintained by Employer T,Plan X. No assets will be transferred from Plan W toPlan X, except in the case of a direct rollover withinthe meaning of section 401(a)(31).

(ii) Employer O ceases to be a member of Em-ployer N’s controlled group as a result of the sale.Therefore, employees of Employer O who partici-pated in Plan W will have a severance from employ-ment and are eligible to receive a distribution fromPlan W.

Example 3. (i) Employer Q maintains Plan Y, aprofit-sharing plan that includes a cash or deferred ar-rangement. Plan Y, the only plan maintained by Em-ployer Q, does not provide for loans. However, PlanY provides that elective contributions under the ar-rangement may be distributed to an eligible employeeon account of hardship using the deemed immedi-ate and heavy financial need provisions of paragraph(d)(3)(iii)(B) of this section and provisions regard-ing distributions necessary to satisfy financial need ofparagraphs (d)(3)(iv)(A) through (D) of this section.Employee A is an eligible employee in Plan Y withan account balance of $50,000 attributable to electivecontributions made by Employee A. The total amountof elective contributions made by Employee A, whohas not previously received a distribution from PlanY, is $20,000. Employee A requests a $15,000 hard-ship distribution of his elective contributions to pay6 months of college tuition and room and board ex-penses for his dependent. At the time of the distribu-tion request, the sole asset of Employee A (that is rea-sonably available to Employee A within the meaningof paragraph (d)(3)(iv)(B) of this section) is a savingsaccount with an available balance of $10,000.

(ii) A distribution is made on account of hardshiponly if the distribution both is made on account of animmediate and heavy financial need of the employeeand is necessary to satisfy the financial need. Underparagraph (d)(3)(iii)(B) of this section, a distributionfor payment of up to the next 12 months of post-sec-

ondary education and room and board expenses forEmployee A’s dependent is deemed to be on accountof an immediate and heavy financial need of Em-ployee A.

(iii) A distribution is treated as necessary to sat-isfy Employee A’s immediate and heavy financialneed to the extent the need may not be relieved fromother resources reasonably available to Employee A.Under paragraph (d)(3)(iv)(B) of this section, Em-ployee A’s $10,000 savings account is a resource thatis reasonably available to the employee and must betaken into account in determining the amount neces-sary to satisfy Employee A’s immediate and heavyfinancial need. Thus, Employee A may receive a dis-tribution of only $5,000 of his elective contributionson account of this hardship, plus an amount neces-sary to pay any federal, state, or local income taxesor penalties reasonably anticipated to result from thedistribution.

Example 4. (i) The facts are the same as in Ex-ample 3. Employee B, another employee of Em-ployer Q has an account balance of $25,000, attrib-utable to Employee B’s elective contributions. Thetotal amount of elective contributions made by Em-ployee B, who has not previously received a distribu-tion from Plan Y, is $15,000. Employee B requestsa $10,000 distribution of his elective contributions topay 6 months of college tuition and room and boardexpenses for his child. Employee B makes a writ-ten representation (with respect to which EmployerQ has no actual knowledge to the contrary) that theneed cannot reasonably be relieved:

A) Through reimbursement or compensation byinsurance or otherwise;

B) By liquidation of the employee’s assets;C) By cessation of elective contributions or em-

ployee contributions under the plan;D) By other distributions or nontaxable (at the

time of the loan) loans from plans maintained by theemployer or by any other employer; or

E) By borrowing from commercial sources onreasonable commercial terms in an amount sufficientto satisfy the need.

(ii) Under paragraph (d)(3)(iii)(B) of this section,a distribution for payment of up to the next 12 monthsof post-secondary education and room and board ex-penses for Employee B’s child is deemed to be onaccount of an Employee B’s immediate and heavy fi-nancial need. In addition, because Employer Q canrely on Employee B’s written representation, the dis-tribution is considered necessary to satisfy EmployeeB’s immediate and heavy financial need. Therefore,Employee B may receive a $10,000 distribution of hiselective contributions on account of hardship plus anamount necessary to pay any federal, state, or localincome taxes or penalties reasonably anticipated toresult from the distribution.

Example 5. (i) The facts are the same as inExample 3, except Plan Y provides for hardshipdistributions using the safe harbor rule of paragraph(d)(3)(iv)(E) of this section. Accordingly, Plan Yprovides for a 6 month suspension of an eligibleemployee’s elective contributions and employeecontributions to the plan after the receipt of a hard-ship distribution by such eligible employee.

(ii) Under paragraph (d)(3)(iii)(B) of this section,a distribution for payment of up to the next 12 monthsof post-secondary education and room and board ex-penses for Employee A’s dependent is deemed to be

January 31, 2005 404 2005–5 I.R.B.

on account of an Employee A’s immediate and heavyfinancial need. In addition, because Employee A isnot eligible for any other distribution or loan fromPlan Y and Plan Y suspends Employee A’s electivecontributions and employee contributions followingreceipt of the hardship distribution, the distributionwill be deemed necessary to satisfy Employee A’s im-mediate and heavy financial need (and Employee Ais not required to first liquidate his savings account).Therefore, Employee A may receive a $15,000 dis-tribution of his elective contributions on account ofhardship plus an amount necessary to pay any fed-eral, state, or local income taxes or penalties reason-ably anticipated to result from the distribution.

Example 6. Employer R maintains a pre-ERISAmoney purchase pension plan that includes a cashor deferred arrangement that is not a rural coopera-tive plan. Elective contributions under the arrange-ment may be distributed to an employee on accountof hardship. Under paragraph (d)(1) of this section,hardship is a permissible distribution event only in aprofit-sharing, stock bonus or rural cooperative plan.Since elective contributions under the arrangementmay be distributed before a permissible distributionevent occurs, the cash or deferred arrangement doesnot satisfy this paragraph (d), and is not a qualifiedcash or deferred arrangement. Moreover, the plan isnot a qualified plan because a money purchase pen-sion plan may not provide for payment of benefitsupon hardship. See §1.401–1(b)(1)(i).

(e) Additional requirements for quali-fied cash or deferred arrangements—(1)Qualified plan requirement. A cash or de-ferred arrangement satisfies this paragraph(e) only if the plan of which it is a part isa profit-sharing, stock bonus, pre-ERISAmoney purchase or rural cooperative planthat otherwise satisfies the requirementsof section 401(a) (taking into account thecash or deferred arrangement). A plan thatincludes a cash or deferred arrangementmay provide for other contributions, in-cluding employer contributions (other thanelective contributions), employee contri-butions, or both. However, except as ex-pressly permitted under section 401(m),410(b)(2)(A)(ii) or 416(c)(2)(A), electivecontributions and matching contributionstaken into account under §1.401(k)–2(a)may not be taken into account for purposesof determining whether any other contri-butions under any plan (including the planto which the contributions are made) sat-isfy the requirements of section 401(a).

(2) Election requirements—(i) Cashmust be available. A cash or deferredarrangement satisfies this paragraph (e)only if the arrangement provides that theamount that each eligible employee maydefer as an elective contribution is avail-able to the employee in cash. Thus, for ex-ample, if an eligible employee is provided

the option to receive a taxable benefit(other than cash) or to have the employercontribute on the employee’s behalf to aprofit-sharing plan an amount equal to thevalue of the taxable benefit, the arrange-ment is not a qualified cash or deferred ar-rangement. Similarly, if an employee hasthe option to receive a specified amountin cash or to have the employer contributean amount in excess of the specified cashamount to a profit-sharing plan on theemployee’s behalf, any contribution madeby the employer on the employee’s behalfin excess of the specified cash amount isnot treated as made pursuant to a qualifiedcash or deferred arrangement, but wouldbe treated as a matching contribution. Thiscash availability requirement applies evenif the cash or deferred arrangement is partof a cafeteria plan within the meaning ofsection 125.

(ii) Frequency of elections. A cash ordeferred arrangement satisfies this para-graph (e) only if the arrangement providesan employee with an effective opportunityto make (or change) a cash or deferredelection at least once during each plan year.Whether an employee has an effective op-portunity is determined based on all therelevant facts and circumstances, includ-ing the adequacy of notice of the availabil-ity of the election, the period of time dur-ing which an election may be made, andany other conditions on elections.

(3) Separate accounting require-ment—(i) General rule. A cash or de-ferred arrangement satisfies this paragraph(e) only if the portion of an employee’sbenefit subject to the requirements ofparagraphs (c) and (d) of this section isdetermined by an acceptable separate ac-counting between that portion and anyother benefits. Separate accounting isnot acceptable unless contributions andwithdrawals are attributed to the sepa-rate accounts and gains, losses, and othercredits or charges are separately allocatedon a reasonable and consistent basis tothe accounts subject to the requirementsof paragraphs (c) and (d) of this sectionand to other accounts. Subject to section401(a)(4), forfeitures are not required tobe allocated to the accounts in which ben-efits are subject to paragraphs (c) and (d)of this section. The separate accountingrequirement of this paragraph (e)(3)(i) ap-plies at the time the elective contributionis contributed to the plan and continues to

apply until the contribution is distributedunder the plan.

(ii) Satisfaction of separate accountingrequirement. The requirements of para-graph (e)(3)(i) of this section are treated assatisfied if all amounts held under a planthat includes a qualified cash or deferredarrangement (and, if applicable, under an-other plan to which QNECs and QMACsare made) are subject to the requirementsof paragraphs (c) and (d) of this section.

(4) Limitations on cash or deferredarrangements of state and local gov-ernments—(i) General rule. A cash ordeferred arrangement does not satisfy therequirements of this paragraph (e) if thearrangement is adopted after May 6, 1986,by a State or local government or polit-ical subdivision thereof, or any agencyor instrumentality thereof (a governmen-tal unit). For purposes of this paragraph(e)(4), an employer that has made a legallybinding commitment to adopt a cash ordeferred arrangement is treated as havingadopted the arrangement on that date.

(ii) Rural cooperative plans and Indiantribal governments. This paragraph (e)(4)does not apply to a rural cooperative planor to a plan of an employer which is an In-dian tribal government (as defined in sec-tion 7701(a)(40)), a subdivision of an In-dian tribal government (determined in ac-cordance with section 7871(d)), an agencyor instrumentality of an Indian tribal gov-ernment or subdivision thereof, or a cor-poration chartered under Federal, State ortribal law which is owned in whole or inpart by any of the entities in this paragraph(e)(4)(ii).

(iii) Adoption after May 6, 1986. Acash or deferred arrangement is treated asadopted after May 6, 1986, with respect toall employees of any employer that adoptsthe arrangement after such date.

(iv) Adoption before May 7, 1986. Ifa governmental unit adopted a cash ordeferred arrangement before May 7, 1986,then any cash or deferred arrangementadopted by the unit at any time is treatedas adopted before that date. If an employeradopted an arrangement prior to such date,all employees of the employer may partic-ipate in the arrangement.

(5) One-year eligibility requirement. Acash or deferred arrangement satisfies thisparagraph (e) only if no employee is re-quired to complete a period of service withthe employer maintaining the plan extend-

2005–5 I.R.B. 405 January 31, 2005

ing beyond the period permitted under sec-tion 410(a)(1) (determined without regardto section 410(a)(1)(B)(i)) to be eligible tomake a cash or deferred election under thearrangement.

(6) Other benefits not contingent uponelective contributions—(i) General rule.A cash or deferred arrangement satisfiesthis paragraph (e) only if no other benefitis conditioned (directly or indirectly) uponthe employee’s electing to make or not tomake elective contributions under the ar-rangement. The preceding sentence doesnot apply to —

(A) Any matching contribution (as de-fined in §1.401(m)–1(a)(2)) made by rea-son of such an election;

(B) Any benefit, right or feature (suchas a plan loan) that requires, or results in,an amount to be withheld from an em-ployee’s pay (e.g., to pay for the benefit orto repay the loan), to the extent the cashor deferred arrangement restricts electivecontributions to amounts available aftersuch withholding from the employee’s pay(after deduction of all applicable incomeand employment taxes);

(C) Any reduction in the employer’stop-heavy contributions under section416(c)(2) because of matching contri-butions that resulted from the electivecontributions; or

(D) Any benefit that is provided atthe employee’s election under a plan de-scribed in section 125(d) in lieu of anelective contribution under a qualifiedcash or deferred arrangement.

(ii) Definition of other benefits. For pur-poses of this paragraph (e)(6), other bene-fits include, but are not limited to, benefitsunder a defined benefit plan; nonelectivecontributions under a defined contributionplan; the availability, cost, or amount ofhealth benefits; vacations or vacation pay;life insurance; dental plans; legal servicesplans; loans (including plan loans); finan-cial planning services; subsidized retire-ment benefits; stock options; property sub-ject to section 83; and dependent care as-sistance. Also, increases in salary, bonusesor other cash remuneration (other than theamount that would be contributed underthe cash or deferred election) are benefitsfor purposes of this paragraph (e)(6). Theability to make after-tax employee con-tributions is a benefit, but that benefit isnot contingent upon an employee’s elect-ing to make or not make elective con-

tributions under the arrangement merelybecause the amount of elective contribu-tions reduces dollar-for-dollar the amountof after-tax employee contributions thatmay be made. Additionally, benefits underany other plan or arrangement (whetheror not qualified) are not contingent uponan employee’s electing to make or not tomake elective contributions under a cashor deferred arrangement merely becausethe elective contributions are or are nottaken into account as compensation underthe other plan or arrangement for purposesof determining benefits.

(iii) Effect of certain statutory limits.Any benefit under an excess benefit plandescribed in section 3(36) of the EmployeeRetirement Income Security Act of 1974(88 Stat. 829), Public Law 93–406, thatis dependent on the employee’s electing tomake or not to make elective contributionsis not treated as contingent. Deferred com-pensation under a nonqualified plan of de-ferred compensation that is dependent onan employee’s having made the maximumelective deferrals under section 402(g) orthe maximum elective contributions per-mitted under the terms of the plan also isnot treated as contingent.

(iv) Nonqualified deferred compensa-tion. Except as otherwise provided in para-graph (e)(6)(iii) of this section, participa-tion in a nonqualified deferred compensa-tion plan is treated as contingent for pur-poses of this paragraph (e)(6) to the extentthat an employee may receive additionaldeferred compensation under the nonqual-ified plan to the extent the employee makesor does not make elective contributions.

(v) Plan loans and distributions. A loanor distribution of elective contributions isnot a benefit conditioned on an employee’selecting to make or not make elective con-tributions under the arrangement merelybecause the amount of the loan or distri-bution is based on the amount of the em-ployee’s account balance.

(vi) Examples. The following examplesillustrate the application of this paragraph(e)(6):

Example 1. Employer T maintains a cash or de-ferred arrangement for all of its employees. Em-ployer T also maintains a nonqualified deferred com-pensation plan for two highly paid executives, Em-ployees R and C. Under the terms of the nonqualifieddeferred compensation plan, R and C are eligible toparticipate only if they do not make elective contribu-tions under the cash or deferred arrangement. Partici-pation in the nonqualified plan is a contingent benefit

for purposes of this paragraph (e)(6), because R’s andC’s participation is conditioned on their electing notto make elective contributions under the cash or de-ferred arrangement.

Example 2. Employer T maintains a cash or de-ferred arrangement for all its employees. Employer Talso maintains a nonqualified deferred compensationplan for two highly paid executives, Employees R andC. Under the terms of the arrangements, EmployeesR and C may defer a maximum of 10% of their com-pensation, and may allocate their deferral betweenthe cash or deferred arrangement and the nonqualifieddeferred compensation plan in any way they choose(subject to the overall 10% maximum). Because themaximum deferral available under the nonqualifieddeferred compensation plan depends on the electivedeferrals made under the cash or deferred arrange-ment, the right to participate in the nonqualified planis a contingent benefit for purposes of this paragraph(e)(6).

(7) Plan provision requirement. A planthat includes a cash or deferred arrange-ment satisfies this paragraph (e) only ifit provides that the nondiscrimination re-quirements of section 401(k) will be met.Thus, the plan must provide for satisfac-tion of one of the specific alternatives de-scribed in paragraph (b)(1)(ii) of this sec-tion and, if with respect to that alterna-tive there are optional choices, which ofthe optional choices will apply. For exam-ple, a plan that uses the ADP test of sec-tion 401(k)(3), as described in paragraph(b)(1)(ii)(A) of this section, must specifywhether it is using the current year testingmethod or prior year testing method. Ad-ditionally, a plan that uses the prior yeartesting method must specify whether theADP for eligible NHCEs for the first planyear is 3% or the ADP for the eligibleNHCEs for the first plan year. Similarly,a plan that uses the safe harbor method ofsection 401(k)(12), as described in para-graph (b)(1)(ii)(B) of this section, mustspecify whether the safe harbor contribu-tion will be the nonelective safe harborcontribution or the matching safe harborcontribution and is not permitted to pro-vide that ADP testing will be used if therequirements for the safe harbor are notsatisfied. For purposes of this paragraph(e)(7), a plan may incorporate by refer-ence the provisions of section 401(k)(3)and §1.401(k)–2 if that is the nondiscrim-ination test being applied. The Commis-sioner may, in guidance of general appli-cability, published in the Internal RevenueBulletin (see §601.601(d)(2) of this chap-ter), specify the options that will apply un-der the plan if the nondiscrimination test

January 31, 2005 406 2005–5 I.R.B.

is incorporated by reference in accordancewith the preceding sentence.

(f) Special rules for designated Rothcontributions. [Reserved].

(g) Effective dates—(1) General rule.Except as otherwise provided in this para-graph (g), this section and §§1.401(k)–2through 1.401(k)–6 apply to plan years thatbegin on or after January 1, 2006.

(2) Early implementation permitted.A plan is permitted to apply the rules ofthis section and §§1.401(k)–2 through1.401(k)–6 to any plan year that endsafter December 29, 2004, provided theplan applies all the rules of this sectionand §§1.401(k)–2 through 1.401(k)–6 andall the rules of §§1.401(m)–1 through1.401(m)–5, to the extent applicable, forthat plan year and all subsequent planyears.

(3) Collectively bargained plans. Inthe case of a plan maintained pursuant toone or more collective bargaining agree-ments between employee representativesand one or more employers in effect onthe date described in paragraph (g)(1) ofthis section, the provisions of this sectionand §§1.401(k)–2 through 1.401(k)–6 ap-ply to the later of the first plan year begin-ning after the termination of the last suchagreement or the first plan year describedin paragraph (g)(1) of this section.

(4) Applicability of prior regulations.For any plan year before a plan appliesthis section and §§1.401(k)–2 through1.401(k)–6 (either the first plan year be-ginning on or after January 1, 2006, orsuch earlier year, as provided in paragraph(g)(2) of this section), §1.401(k)–1 (asit appeared in the April 1, 2004, editionof 26 CFR part 1) applies to the plan tothe extent that section, as it so appears,reflects the statutory provisions of section401(k) as in effect for the relevant year.

§1.401(k)–2 ADP test.

(a) Actual deferral percentage (ADP)test—(1) In general—(i) ADP test for-mula. A cash or deferred arrangementsatisfies the ADP test for a plan year onlyif—

(A) The ADP for the eligible HCEs forthe plan year is not more than the ADP forthe eligible NHCEs for the applicable yearmultiplied by 1.25; or

(B) The excess of the ADP for the eligi-ble HCEs for the plan year over the ADP

for the eligible NHCEs for the applicableyear is not more than 2 percentage points,and the ADP for the eligible HCEs for theplan year is not more than the ADP forthe eligible NHCEs for the applicable yearmultiplied by 2.

(ii) HCEs as sole eligible employees.If, for the applicable year for determiningthe ADP of the NHCEs for a plan year,there are no eligible NHCEs (i.e, all of theeligible employees under the cash or de-ferred arrangement for the applicable yearare HCEs), the arrangement is deemed tosatisfy the ADP test for the plan year.

(iii) Special rule for early participation.If a cash or deferred arrangement providesthat employees are eligible to participatebefore they have completed the minimumage and service requirements of section410(a)(1)(A), and if the plan applies sec-tion 410(b)(4)(B) in determining whetherthe cash or deferred arrangement meetsthe requirements of section 410(b)(1), thenin determining whether the arrangementmeets the requirements under paragraph(a)(1) of this section, either—

(A) Pursuant to section 401(k)(3)(F),the ADP test is performed under the plan(determined without regard to disaggrega-tion under §1.410(b)–7(c)(3)), using theADP for all eligible HCEs for the plan yearand the ADP of eligible NHCEs for the ap-plicable year, disregarding all NHCEs whohave not met the minimum age and servicerequirements of section 410(a)(1)(A); or

(B) Pursuant to §1.401(k)–1(b)(4), theplan is disaggregated into separate plansand the ADP test is performed separatelyfor all eligible employees who have com-pleted the minimum age and service re-quirements of section 410(a)(1)(A) and forall eligible employees who have not com-pleted the minimum age and service re-quirements of section 410(a)(1)(A).

(2) Determination of ADP—(i) Generalrule. The ADP for a group of eligible em-ployees (either eligible HCEs or eligibleNHCEs) for a plan year or applicable yearis the average of the ADRs of the eligi-ble employees in that group for that year.The ADP for a group of eligible employ-ees is calculated to the nearest hundredthof a percentage point.

(ii) Determination of applicable yearunder current year and prior year testingmethod. The ADP test is applied usingthe prior year testing method or the currentyear testing method. Under the prior year

testing method, the applicable year for de-termining the ADP for the eligible NHCEsis the plan year immediately preceding theplan year for which the ADP test is beingperformed. Under the prior year testingmethod, the ADP for the eligible NHCEsis determined using the ADRs for the eli-gible employees who were NHCEs in thatpreceding plan year, regardless of whetherthose NHCEs are eligible employees orNHCEs in the plan year for which the ADPtest is being calculated. Under the cur-rent year testing method, the applicableyear for determining the ADP for the eli-gible NHCEs is the same plan year as theplan year for which the ADP test is be-ing performed. Under either method, theADP for eligible HCEs is the average ofthe ADRs of the eligible HCEs for the planyear for which the ADP test is being per-formed. See paragraph (c) of this sectionfor additional rules for the prior year test-ing method.

(3) Determination of ADR—(i) Generalrule. The ADR of an eligible employee fora plan year or applicable year is the sumof the employee’s elective contributionstaken into account with respect to such em-ployee for the year, determined under therules of paragraphs (a)(4) and (5) of thissection, and the qualified nonelective con-tributions and qualified matching contri-butions taken into account with respect tosuch employee under paragraph (a)(6) ofthis section for the year, divided by theemployee’s compensation taken into ac-count for the year. The ADR is calculatedto the nearest hundredth of a percentagepoint. If no elective contributions, quali-fied nonelective contributions, or qualifiedmatching contributions are taken into ac-count under this section with respect to aneligible employee for the year, the ADR ofthe employee is zero.

(ii) ADR of HCEs eligible under morethan one arrangement—(A) General rule.Pursuant to section 401(k)(3)(A), the ADRof an HCE who is an eligible employee inmore than one cash or deferred arrange-ment of the same employer is calculatedby treating all contributions with respectto such HCE under any such arrange-ment as being made under the cash ordeferred arrangement being tested. Thus,the ADR for such an HCE is calculated byaccumulating all contributions under anycash or deferred arrangement (other thana cash or deferred arrangement described

2005–5 I.R.B. 407 January 31, 2005

in paragraph (a)(3)(ii)(B) of this section)that would be taken into account underthis section for the plan year, if the cashor deferred arrangement under which thecontribution was made applied this sectionand had the same plan year. For exam-ple, in the case of a plan with a 12-monthplan year, the ADR for the plan year ofthat plan for an HCE who participates inmultiple cash or deferred arrangements ofthe same employer is the sum of all contri-butions during such 12-month period thatwould be taken into account with respectto the HCE under all such arrangements inwhich the HCE is an eligible employee, di-vided by the HCE’s compensation for that12-month period (determined using thecompensation definition for the plan beingtested), without regard to the plan year ofthe other plans and whether those plansare satisfying this section or §1.401(k)–3.

(B) Plans not permitted to be aggre-gated. Cash or deferred arrangements

under plans that are not permitted tobe aggregated under §1.401(k)–1(b)(4)(determined without regard to the pro-hibition on aggregating plans with in-consistent testing methods set forth in§1.401(k)–1(b)(4)(iii)(B) and the prohibi-tion on aggregating plans with differentplan years set forth in §1.410(b)–7(d)(5))are not aggregated under this paragraph(a)(3)(ii).

(iii) Examples. The following examplesillustrate the application of this paragraph(a)(3):

Example 1. (i) Employee A, an HCE with com-pensation of $120,000, is eligible to make electivecontributions under Plan S and Plan T, two profit-sharing plans maintained by Employer H with calen-dar year plan years, each of which includes a cash ordeferred arrangement. During the current plan year,Employee A makes elective contributions of $6,000to Plan S and $4,000 to Plan T.

(ii) Under each plan, the ADR for Employee A isdetermined by dividing Employee A’s total electivecontributions under both arrangements by EmployeeA’s compensation taken into account under the plan

for the year. Therefore, Employee A’s ADR undereach plan is 8.33% ($10,000/$120,000).

Example 2. (i) The facts are the same as in Exam-ple 1, except that Plan T defines compensation (fordeferral and testing purposes) to exclude all bonusespaid to an employee. Plan S defines compensation(for deferral and testing purposes) to include bonusespaid to an employee. During the current year, Em-ployee A’s compensation included a $10,000 bonus.Therefore, Employee A’s compensation under Plan Tis $110,000 and Employee A’s compensation underPlan S is $120,000.

(ii) Employee A’s ADR under Plan T is 9.09%($10,000/$110,000) and under Plan S, Employee A’sADR is 8.33% ($10,000/$120,000).

Example 3. (i) Employer J sponsors two profit-sharing plans, Plan U and Plan V, each of which in-cludes a cash or deferred arrangement. Plan U’s planyear begins on July 1 and ends on June 30. Plan Vhas a calendar year plan year. Compensation underboth plans is limited to the participant’s compensa-tion during the period of participation. Employee Bis an HCE who participates in both plans. EmployeeB’s monthly compensation and elective contributionsto each plan for the 2005 and 2006 calendar years areas follows:

Calendar year Monthly Compensation Monthly Elective Contribution to Plan U Monthly Elective Contribution to Plan V

2005 $10,000 $500 $400

2006 $11,500 $700 $550

(ii) Under Plan U, Employee B’s ADR for theplan year ended June 30, 2006, is equal to EmployeeB’s total elective contributions under Plan U and PlanV for the plan year ending June 30, 2006, divided byEmployee B’s compensation for that period. There-fore, Employee B’s ADR under Plan U for the planyear ending June 30, 2006, is (($900 x 6) + ($1,250 x6)) / (($10,000 x 6) + ($11,500 x 6)), or 10%.

(iii) Under Plan V, Employee B’s ADR for theplan year ended December 31, 2005, is equal to to-tal elective contributions under Plan U and V for theplan year ending December 31, 2005, divided by Em-ployee B’s compensation for that period. Therefore,Employee B’s ADR under Plan V for the plan yearending December 31, 2005, is ($10,800/$120,000),or 9%.

Example 4. (i) The facts are the same as Example3, except that Employee B first becomes eligible toparticipate in Plan U on January 1, 2006.

(ii) Under Plan U, Employee B’s ADR for theplan year ended June 30, 2006, is equal to EmployeeB’s total elective contributions under Plan U and Vfor the plan year ending June 30, 2006, divided byEmployee B’s compensation for that period. There-fore, Employee B’s ADR under Plan U for the planyear ending June 30, 2006, is (($400 x 6)+ ($1,250 x6)) / (($10,000 x 6) + ($11,500 x 6)), or 7.67%.

(4) Elective contributions taken intoaccount under the ADP test—(i) Generalrule. An elective contribution is taken intoaccount in determining the ADR for aneligible employee for a plan year or ap-

plicable year only if each of the followingrequirements is satisfied—

(A) The elective contribution is allo-cated to the eligible employee’s accountunder the plan as of a date within that year.For purposes of this rule, an elective con-tribution is considered allocated as of adate within a year only if—

(1) The allocation is not contingent onthe employee’s participation in the plan orperformance of services on any date sub-sequent to that date; and

(2) The elective contribution is actuallypaid to the trust no later than the end ofthe 12-month period immediately follow-ing the year to which the contribution re-lates.

(B) The elective contribution relates tocompensation that either—

(1) Would have been received by theemployee in the year but for the em-ployee’s election to defer under the ar-rangement; or

(2) Is attributable to services performedby the employee in the year and, but forthe employee’s election to defer, wouldhave been received by the employee within21/2 months after the close of the year, butonly if the plan provides for elective con-

tributions that relate to compensation thatwould have been received after the closeof a year to be allocated to such prior yearrather than the year in which the compen-sation would have been received.

(ii) Elective contributions for partnersand self-employed individuals. For pur-poses of this paragraph (a)(4), a partner’sdistributive share of partnership income istreated as received on the last day of thepartnership taxable year and a sole propri-etor’s compensation is treated as receivedon the last day of the individual’s taxableyear. Thus, an elective contribution madeon behalf of a partner or sole proprietor istreated as allocated to the partner’s accountfor the plan year that includes the last dayof the partnership taxable year, providedthe requirements of paragraph (a)(4)(i) ofthis section are met.

(iii) Elective contributions for HCEs.Elective contributions of an HCE mustinclude any excess deferrals, as describedin §1.402(g)–1(a), even if those excessdeferrals are distributed, pursuant to§1.402(g)–1(e).

(5) Elective contributions not taken intoaccount under the ADP test—(i) Generalrule. Elective contributions that do not sat-

January 31, 2005 408 2005–5 I.R.B.

isfy the requirements of paragraph (a)(4)(i)of this section may not be taken into ac-count in determining the ADR of an el-igible employee for the plan year or ap-plicable year with respect to which thecontributions were made, or for any otherplan year. Instead, the amount of the elec-tive contributions must satisfy the require-ments of section 401(a)(4) (without regardto the ADP test) for the plan year for whichthey are allocated under the plan as if theywere nonelective contributions and werethe only nonelective contributions for thatyear. See §§1.401(a)(4)–1(b)(2)(ii)(B) and1.410(b)–7(c)(1).

(ii) Elective contributions for NHCEs.Elective contributions of an NHCE shallnot include any excess deferrals, as de-scribed in §1.402(g)–1(a), to the extent theexcess deferrals are prohibited under sec-tion 401(a)(30). However, to the extentthat the excess deferrals are not prohibitedunder section 401(a)(30), they are includedin elective contributions even if distributedpursuant to §1.402(g)–1(e).

(iii) Elective contributions treated ascatch-up contributions. Elective con-tributions that are treated as catch-upcontributions under section 414(v) be-cause they exceed a statutory limit or em-ployer-provided limit (within the meaningof §1.414(v)–1(b)(1)) are not taken intoaccount under paragraph (a)(4) of thissection for the plan year for which thecontributions were made, or for any otherplan year.

(iv) Elective contributions used to sat-isfy the ACP test. Except to the extentnecessary to demonstrate satisfaction ofthe requirement of §1.401(m)–2(a)(6)(ii),elective contributions taken into accountfor the ACP test under §1.401(m)–2(a)(6)are not taken into account under paragraph(a)(4) of this section.

(v) Additional elective contributionspursuant to section 414(u). Additionalelective contributions made pursuant tosection 414(u) by reason of an eligibleemployee’s qualified military service arenot taken into account under paragraph(a)(4) of this section for the plan year forwhich the contributions are made, or forany other plan year.

(6) Qualified nonelective contributionsand qualified matching contributions thatmay be taken into account under the ADPtest. Qualified nonelective contributionsand qualified matching contributions may

be taken into account in determining theADR for an eligible employee for a planyear or applicable year but only to the ex-tent the contributions satisfy the followingrequirements—

(i) Timing of allocation. The quali-fied nonelective contribution or qualifiedmatching contribution is allocated to theemployee’s account as of a date withinthat year within the meaning of paragraph(a)(4)(i)(A) of this section. Consequently,under the prior year testing method, in or-der to be taken into account in calculat-ing the ADP for the eligible NHCEs forthe applicable year, a qualified nonelectivecontribution or qualified matching contri-bution must be contributed no later thanthe end of the 12-month period immedi-ately following the applicable year eventhough the applicable year is different thanthe plan year being tested.

(ii) Requirement that amount satisfysection 401(a)(4). The amount of nonelec-tive contributions, including those quali-fied nonelective contributions taken intoaccount under this paragraph (a)(6) andthose qualified nonelective contributionstaken into account for the ACP test of sec-tion 401(m)(2) under §1.401(m)–2(a)(6),satisfies the requirements of section401(a)(4). See §1.401(a)(4)–1(b)(2). Theamount of nonelective contributions, ex-cluding those qualified nonelective con-tributions taken into account under thisparagraph (a)(6) and those qualified non-elective contributions taken into accountfor the ACP test of section 401(m)(2)under §1.401(m)–2(a)(6), satisfies therequirements of section 401(a)(4). See§1.401(a)(4)–1(b)(2). In the case ofan employer that is applying the spe-cial rule for employer-wide plans in§1.414(r)–1(c)(2)(ii) with respect to thecash or deferred arrangement, the determi-nation of whether the qualified nonelectivecontributions satisfy the requirements ofthis paragraph (a)(6)(ii) must be madeon an employer-wide basis regardless ofwhether the plans to which the qualifiednonelective contributions are made aresatisfying the requirements of section410(b) on an employer-wide basis. Con-versely, in the case of an employer thatis treated as operating qualified separatelines of business, and does not apply thespecial rule for employer-wide plans in§1.414(r)–1(c)(2)(ii) with respect to thecash or deferred arrangement, then the

determination of whether the qualifiednonelective contributions satisfy the re-quirements of this paragraph (a)(6)(ii)is not permitted to be made on an em-ployer-wide basis regardless of whetherthe plans to which the qualified nonelec-tive contributions are made are satisfyingthe requirements of section 410(b) on thatbasis.

(iii) Aggregation must be permitted.The plan that contains the cash or deferredarrangement and the plan or plans to whichthe qualified nonelective contributionsor qualified matching contributions aremade, are plans that would be permittedto be aggregated under §1.401(k)–1(b)(4).If the plan year of the plan that con-tains the cash or deferred arrangement ischanged to satisfy the requirement under§1.410(b)–7(d)(5) that aggregated planshave the same plan year, qualified nonelec-tive contributions and qualified matchingcontributions may be taken into account inthe resulting short plan year only if suchqualified nonelective contributions andqualified matching contributions couldhave been taken into account under anADP test for a plan with the same shortplan year.

(iv) Disproportionate contributions nottaken into account—(A) General rule.Qualified nonelective contributions can-not be taken into account for a plan yearfor an NHCE to the extent such contribu-tions exceed the product of that NHCE’scompensation and the greater of 5% ortwo times the plan’s representative con-tribution rate. Any qualified nonelectivecontribution taken into account underan ACP test under §1.401(m)–2(a)(6)(including the determination of the repre-sentative contribution rate for purposes of§1.401(m)–2(a)(6)(v)(B)), is not permit-ted to be taken into account for purposesof this paragraph (a)(6) (including thedetermination of the representative contri-bution rate under paragraph (a)(6)(iv)(B)of this section).

(B) Definition of representative contri-bution rate. For purposes of this paragraph(a)(6)(iv), the plan’s representative contri-bution rate is the lowest applicable contri-bution rate of any eligible NHCE amonga group of eligible NHCEs that consists ofhalf of all eligible NHCEs for the plan year(or, if greater, the lowest applicable con-tribution rate of any eligible NHCE in thegroup of all eligible NHCEs for the plan

2005–5 I.R.B. 409 January 31, 2005

year and who is employed by the employeron the last day of the plan year).

(C) Definition of applicable contribu-tion rate. For purposes of this paragraph(a)(6)(iv), the applicable contribution ratefor an eligible NHCE is the sum of thequalified matching contributions takeninto account under this paragraph (a)(6)for the eligible NHCE for the plan yearand the qualified nonelective contribu-tions made for the eligible NHCE for theplan year, divided by the eligible NHCE’scompensation for the same period.

(D) Special rule for prevailing wagecontributions. Notwithstanding paragraph(a)(6)(iv)(A) of this section, qualifiednonelective contributions that are madein connection with an employer’s obli-gation to pay prevailing wages under theDavis-Bacon Act (46 Stat. 1494), Pub-lic Law 71–798, Service Contract Act of1965 (79 Stat. 1965), Public Law 89–286,or similar legislation can be taken intoaccount for a plan year for an NHCE to the

extent such contributions do not exceed10 percent of that NHCE’s compensation.

(v) Qualified matching contributions.Qualified matching contributions satisfythis paragraph (a)(6) only to the extent thatsuch qualified matching contributions arematching contributions that are not pre-cluded from being taken into account un-der the ACP test for the plan year underthe rules of §1.401(m)–2(a)(5)(ii).

(vi) Contributions only used once.Qualified nonelective contributions andqualified matching contributions cannotbe taken into account under this paragraph(a)(6) to the extent such contributionsare taken into account for purposes ofsatisfying any other ADP test, any ACPtest, or the requirements of §1.401(k)–3,1.401(m)–3 or 1.401(k)–4. Thus, for ex-ample, matching contributions that aremade pursuant to §1.401(k)–3(c) cannotbe taken into account under the ADP test.Similarly, if a plan switches from the cur-rent year testing method to the prior yeartesting method pursuant to §1.401(k)–2(c),

qualified nonelective contributions that aretaken into account under the current yeartesting method for a year may not be takeninto account under the prior year testingmethod for the next year.

(7) Examples. The following examplesillustrate the application of this paragraph(a):

Example 1. (i) Employer X has three employees,A, B, and C. Employer X sponsors a profit-sharingplan (Plan Z) that includes a cash or deferred arrange-ment. Each year, Employer X determines a bonus at-tributable to the prior year. Under the cash or deferredarrangement, each eligible employee may elect to re-ceive none, all or any part of the bonus in cash. Xcontributes the remainder to Plan Z. The portion ofthe bonus paid in cash, if any, is paid 2 months af-ter the end of the plan year and thus is included incompensation for the following plan year. EmployeeA is an HCE, while Employees B and C are NHCEs.The plan uses the current year testing method and de-fines compensation to include elective contributionsand bonuses paid during each plan year. In Febru-ary of 2005, Employer X determined that no bonuseswill be paid for 2004. In February of 2006, EmployerX provided a bonus for each employee equal to 10%of regular compensation for 2005. For the 2005 planyear, A, B, and C have the following compensationand make the following elections:

Employee Compensation Elective Contribution

A $100,000 $4,340

B 60,000 2,860

C 45,000 1,250

(ii) For each employee, the ratio of elective contri-butions to the employee’s compensation for the planyear is:

Employee Ratio of Elective Contribution to Compensation ADR

A $4,340/$100,000 4.34%

B 2,860/60,000 4.77

C 1,250/45,000 2.78

(iii) The ADP for the HCEs (Employee A) is4.34%. The ADP for the NHCEs is 3.78% ((4.77% +2.78%)/2). Because 4.34% is less than 4.73% (3.78%multiplied by 1.25), the plan satisfies the ADP testunder paragraph (a)(1)(i) of this section.

Example 2. (i) The facts are the same as in Exam-ple 1, except that elective contributions are made pur-suant to a salary reduction agreement throughout theplan year, and no bonuses are paid. As provided bysection 414(s)(2), Employer X includes elective con-

tributions in compensation. During the year, B and Cdefer the same amount as in Example 1, but A defers$5,770. Thus, the compensation and elective contri-butions for A, B, and C are:

Employee Compensation Elective Contributions ADR

A $100,000 $5,770 5.77%

B 60,000 2,860 4.77

C 45,000 1,250 2.78

(ii) The ADP for the HCEs (Employee A) is5.77%. The ADP for the NHCEs is 3.78% ((4.77%+ 2.78%)/2). Because 5.77% exceeds 4.73% (3.78%x 1.25), the plan does not satisfy the ADP test under

paragraph (a)(1)(i) of this section. However, becausethe ADP for the HCEs does not exceed the ADP forthe NHCEs by more than 2 percentage points and theADP for the HCEs does not exceed the ADP for the

NHCEs multiplied by 2 (3.78% x 2 = 7.56%), theplan satisfies the ADP test under paragraph (a)(1)(ii)of this section.

January 31, 2005 410 2005–5 I.R.B.

Example 3. (i) Employees D through L are eli-gible employees in Plan T, a profit-sharing plan thatcontains a cash or deferred arrangement. The plan isa calendar year plan that uses the prior year testing

method. Plan T provides that elective contributionsare included in compensation (as provided under sec-tion 414(s)(2)). Each eligible employee may elect todefer up to 6% of compensation under the cash or de-

ferred arrangement. Employees D and E are HCEs.The compensation, elective contributions, and ADRsof Employees D and E for the 2006 plan year areshown below:

Employee Compensation for2006 Plan Year

Elective Contributions for 2006 PlanYear

ADR for 2006 Plan Year

D $100,000 $10,000 10%

E $95,000 $4,750 5%

(ii) During the 2005 plan year, Employees Fthrough L were eligible NHCEs. The compensation,

elective contributions and ADRs of Employees F through L for the 2005 plan year are shown in thefollowing table:

Employee Compensation for 2005 Plan Year Elective Contributions for 2005 PlanYear

ADR for 2005 Plan Year

F $60,000 $3,600 6%

G $40,000 $1,600 4%

H $30,000 $1,200 4%

I $20,000 $600 3%

J $20,000 $600 3%

K $10,000 $300 3%

L $5,000 $150 3%

(iii) The ADP for 2006 for the HCEs is 7.5%. Be-cause Plan T is using the prior year testing method,the applicable year for determining the NHCE ADPis the prior plan year (i.e., 2005). The NHCE ADP isdetermined using the ADRs for NHCEs eligible dur-ing the prior plan year (without regard to whether theyare eligible under the plan during the plan year). TheADP for the NHCEs is 3.71% (the sum of the individ-ual ADRs, 26%, divided by 7 employees). Because7.5% exceeds 4.64% (3.71% x 1.25), Plan T does notsatisfy the ADP test under paragraph (a)(1)(i) of thissection. In addition, because the ADP for the HCEsexceeds the ADP for the NHCEs by more than 2 per-centage points, Plan T does not satisfy the ADP test

under paragraph (a)(1)(ii) of this section. Therefore,the cash or deferred arrangement fails to be a qual-ified cash or deferred arrangement unless the ADPfailure is corrected under paragraph (b) of this sec-tion.

Example 4. (i) Plan U is a calendar year profit-sharing plan that contains a cash or deferred arrange-ment and uses the current year testing method. PlanU provides that elective contributions are included incompensation (as provided under section 414(s)(2)).The following amounts are contributed under PlanU for the 2006 plan year: QNECs equal to 2% ofeach employee’s compensation; Contributions equalto 6% of each employee’s compensation that are not

immediately vested under the terms of the plan; 3%of each employee’s compensation that the employeemay elect to receive as cash or to defer under the plan.Both types of nonelective contributions are made forthe HCEs (employees M and N) and the NHCEs (em-ployees O through S) for the plan year and are con-tributed after the end of the plan year and before theend of the following plan year. In addition, neithertype of nonelective contributions is used for any otherADP or ACP test.

(ii) For the 2006 plan year, the compensation,elective contributions, and actual deferral ratios ofemployees M through S are shown in the followingtable:

Employee Compensation Elective Contributions Actual Deferral Ratio

M $100,000 $3,000 3%

N $100,000 $2,000 2%

O $60,000 $1,800 3%

P $40,000 0 0

Q $30,000 0 0

R $5,000 0 0

S $20,000 0 0

(iii) The elective contributions alone do not sat-isfy the ADP test of section 401(k)(3) and paragraph(a)(1) of this section because the ADP for the HCEs,consisting of employees M and N, is 2.5% and theADP for the NHCEs is 0.6%.

(iv) The 2% QNECs satisfies the timing require-ment of paragraph (a)(6)(i) of this section because it ispaid within 12-month after the plan year for which al-located. All nonelective contributions also satisfy the

requirements relating to section 401(a)(4) set forth inparagraph (a)(6)(ii) of this section (because all em-ployees receive an 8% nonelective contribution andthe nonelective contributions excluding the QNECsis 6% for all employees). In addition, the QNECsare not disproportionate under paragraph (a)(6)(iv) ofthis section because no QNEC for an NHCE exceedsthe product of the plan’s applicable contribution rate(2%) and that NHCE’s compensation.

(v) Because the rules of paragraph (a)(6) of thissection are satisfied, the 2% QNECs may be takeninto account in applying the ADP test of section401(k)(3) and paragraph (a)(1) of this section. The6% nonelective contributions, however, may not betaken into account because they are not QNECs.

(vi) If the 2% QNECs are taken into account, theADP for the HCEs is 4.5%, and the actual deferralpercentage for the NHCEs is 2.6%. Because 4.5% is

2005–5 I.R.B. 411 January 31, 2005

not more than two percentage points greater than 2.6percent, and not more than two times 2.6, the cash ordeferred arrangement satisfies the ADP test of section401(k)(3) under paragraph (a)(1)(ii) of this section.

Example 5. (i) The facts are the same as Example4, except the plan uses the prior year testing method.In addition, the NHCE ADP for the 2005 plan year(the prior plan year) is 0.8% and no QNECs are con-tributed for the 2005 plan year during 2005 or 2006.

(ii) In 2007, it is determined that the elective con-tributions alone do not satisfy the ADP test of sec-tion 401(k)(3) and paragraph (a)(1) of this section for2006 because the 2006 ADP for the eligible HCEs,consisting of employees M and N, is 2.5% and the2005 ADP for the eligible NHCEs is 0.8%. An addi-tional QNEC of 2% of compensation is made for eacheligible NHCE in 2007 and allocated for 2005.

(iii) The 2% QNECs that are made in 2007 and al-located for the 2005 plan year do not satisfy the tim-ing requirement of paragraph (a)(6)(i) of this sectionfor the applicable year for the 2005 plan year becausethey were not contributed before the last day of the2006 plan year. Accordingly, the 2% QNECs do notsatisfy the rules of paragraph (a)(6) of this section andmay not be taken into account in applying the ADPtest of section 401(k)(3) and paragraph (a)(1) of thissection for the 2006 plan year. The cash or deferredarrangement fails to be a qualified cash or deferredarrangement unless the ADP failure is corrected un-der paragraph (b) of this section.

Example 6. (i) The facts are the same as Exam-ple 4, except that the ADP for the HCEs is 4.6%and there is no 6% nonelective contribution underthe plan. The employer would like to take into ac-count the 2% QNEC in determining the ADP for theNHCEs but not in determining the ADP for the HCEs.

(ii) The elective contributions alone fail the re-quirements of section 401(k) and paragraph (a)(1) ofthis section because the HCE ADP for the plan year(4.6%) exceeds 0.75% (0.6% x 1.25) and 1.2% (0.6%x 2).

(iii) The 2% QNECs may not be taken into ac-count in determining the ADP of the NHCEs becausethey fail to satisfy the requirements relating to sec-tion 401(a)(4) set forth in paragraph (a)(6)(ii) of thissection. This is because the amount of nonelectivecontributions, excluding those QNECs that wouldbe taken into account under the ADP test, would be2% of compensation for the HCEs and 0% for theNHCEs. Therefore, the cash or deferred arrangementfails to be a qualified cash or deferred arrangementunless the ADP failure is corrected under paragraph(b) of this section.

Example 7. (i) The facts are the same as Example6, except that Employee R receives a QNEC in anamount of $500 and no QNECs are made on behalfof the other employees.

(ii) If the QNEC could be taken into account un-der paragraph (a)(6) of this section, the ADP for theNHCEs would be 2.6% and the plan would satisfy theADP test. The QNEC is disproportionate under para-graph (a)(6)(iv) of this section, and cannot be takeninto account under paragraph (a)(6) of this section, tothe extent it exceeds the greater of 5% and two timesthe plan’s representative contribution rate (0%), mul-tiplied by Employee R’s compensation. The plan’srepresentative contribution rate is 0% because it is thelowest applicable contribution rate among a group ofNHCEs that is at least half of all NHCEs, or all theNHCEs who are employed on the last day of the planyear. Therefore, the QNEC may be taken into accountunder the ADP test only to the extent it does not ex-ceed 5% times Employee R’s compensation (or $250)

and the cash or deferred arrangement fails to satisfythe ADP test and must correct under paragraph (b) ofthis section.

Example 8. (i) The facts are the same as in Ex-ample 4 except that the plan changes from the currentyear testing method to the prior year testing methodfor the following plan year (2007 plan year). TheADP for the HCEs for the 2007 plan year is 3.5%.

(ii) The 2% QNECs may not be taken into accountin determining the ADP for the NHCEs for the appli-cable year (2006 plan year) in satisfying the ADP testfor the 2007 plan year because they were taken intoaccount in satisfying the ADP test for the 2006 planyear. Accordingly, the NHCE ADP for the applicableyear is 0.6%. The elective contributions for the planyear fail the requirements of section 401(k) and para-graph (a)(1) of this section because the HCE ADP forthe plan year (3.5%) exceeds the ADP limit of 1.2%(the greater of 0.75% (0.6% x 1.25) and 1.2% (0.6% x2)), determined using the applicable year ADP for theNHCEs. Therefore, the cash or deferred arrangementfails to be a qualified cash or deferred arrangementunless the ADP failure is corrected under paragraph(b) of this section.

Example 9. (i)(A) Employer N maintains PlanX, a profit sharing plan that contains a cash or de-ferred arrangement and that uses the current year test-ing method. Plan X provides for employee contribu-tions, elective contributions, and matching contribu-tions. Matching contributions on behalf of NHCEsare qualified matching contributions (QMACs) andare contributed during the 2005 plan year. Matchingcontributions on behalf of HCEs are not QMACs, be-cause they fail to satisfy the nonforfeitability require-ment of §1.401(k)–1(c). The elective contributionsand matching contributions with respect to HCEs forthe 2005 plan year are shown in the following table:

ElectiveContributions

Total MatchingContributions

Matchingcontributions that arenot QMACs

QMACs

Highly compensated employees 15% 5% 5% 0%

(B) The elective contributions and matching con-tributions with respect to the NHCEs for the 2005plan year are shown in the following table:

ElectiveContributions

Total MatchingContributions

Matchingcontributions that arenot QMACs

QMACs

Nonhighly compensated employees 11% 4% 0% 4%

(ii) The plan fails to satisfy the ADP test of section401(k)(3)(A) and paragraph (a)(1) of this section be-cause the ADP for HCEs (15%) is more than 125% ofthe ADP for NHCEs (11%), and more than 2 percent-age points greater than 11%. However, the plan pro-vides that QMACs may be used to meet the require-ments of section 401(k)(3)(A)(ii) provided that they

are not used for any other ADP or ACP test. QMACsequal to 1% of compensation are taken into accountfor each NHCE in applying the ADP test. After thisadjustment, the applicable ADP and ACP (taking intoaccount the provisions of §1.401(m)–2(a)(5)(ii)) forthe plan year are as follows:

Actual Deferral Percentage Actual Contribution Percentage

HCEs 15% 5%

Nonhighly compensated employees 12 3

January 31, 2005 412 2005–5 I.R.B.

(iii) The elective contributions and QMACstaken into account for purposes of the ADP test ofsection 401(k)(3) satisfy the requirements of section401(k)(3)(A)(ii) under paragraph (a)(1)(ii) of thissection because the ADP for HCEs (15%) is not morethan the ADP for NHCEs multiplied by 1.25 (12% x1.25 = 15%).

(b) Correction of excess contribu-tions—(1) Permissible correction meth-ods—(i) In general. A cash or deferredarrangement does not fail to satisfy therequirements of section 401(k)(3) andparagraph (a)(1) of this section if the em-ployer, in accordance with the terms ofthe plan that includes the cash or deferredarrangement, uses any of the followingcorrection methods—

(A) Qualified nonelective contribu-tions or qualified matching contributions.The employer makes qualified nonelec-tive contributions or qualified matchingcontributions that are taken into accountunder this section and, in combinationwith other amounts taken into accountunder paragraph (a) of this section, allowthe cash or deferred arrangement to satisfythe requirements of paragraph (a)(1) ofthis section.

(B) Excess contributions distributed.Excess contributions are distributed inaccordance with paragraph (b)(2) of thissection.

(C) Excess contributions recharacter-ized. Excess contributions are recharacter-ized in accordance with paragraph (b)(3)of this section.

(ii) Combination of correction meth-ods. A plan may provide for the use ofany of the correction methods describedin paragraph (b)(1)(i) of this section, maylimit elective contributions in a mannerdesigned to prevent excess contributionsfrom being made, or may use a combina-tion of these methods, to avoid or correctexcess contributions. A plan may per-mit an HCE to elect whether any excesscontributions are to be recharacterized ordistributed. If the plan uses a combinationof correction methods, any contributionmade under paragraph (b)(1)(i)(A) of thissection must be taken into account beforeapplication of the correction methods inparagraph (b)(1)(i)(B) or (C) of this sec-tion.

(iii) Exclusive means of correction.A failure to satisfy the requirements ofparagraph (a)(1) of this section may notbe corrected using any method other thanthe ones described in paragraphs (b)(1)(i)

and (ii) of this section. Thus, excesscontributions for a plan year may notremain unallocated or be allocated to asuspense account for allocation to one ormore employees in any future year. Inaddition, excess contributions may notbe corrected using the retroactive cor-rection rules of §1.401(a)(4)–11(g). See§1.401(a)(4)–11(g)(3)(vii) and (5).

(2) Corrections through distribu-tion—(i) General rule. This paragraph(b)(2) contains the rules for correction ofexcess contributions through a distribu-tion from the plan. Correction througha distribution generally involves a 4-stepprocess. First, the plan must determine,in accordance with paragraph (b)(2)(ii)of this section, the total amount of ex-cess contributions that must be distributedunder the plan. Second, the plan mustapportion the total amount of excess con-tributions among HCEs in accordancewith paragraph (b)(2)(iii) of this section.Third, the plan must determine the incomeallocable to excess contributions in ac-cordance with paragraph (b)(2)(iv) of thissection. Finally, the plan must distributethe apportioned excess contributions andallocable income in accordance with para-graph (b)(2)(v) of this section. Paragraph(b)(2)(vi) of this section provides rulesrelating to the tax treatment of these dis-tributions. Paragraph (b)(2)(vii) providesother rules relating to these distributions.

(ii) Calculation of total amount tobe distributed. The following proce-dures must be used to determine the totalamount of the excess contributions to bedistributed—

(A) Calculate the dollar amount ofexcess contributions for each HCE. Theamount of excess contributions attribut-able to a given HCE for a plan year isthe amount (if any) by which the HCE’scontributions taken into account under thissection must be reduced for the HCE’sADR to equal the highest permitted ADRunder the plan. To calculate the highestpermitted ADR under a plan, the ADRof the HCE with the highest ADR is re-duced by the amount required to cause thatHCE’s ADR to equal the ADR of the HCEwith the next highest ADR. If a lesserreduction would enable the arrangementto satisfy the requirements of paragraph(b)(2)(ii)(C) of this section, only this lesserreduction is used in determining the high-est permitted ADR.

(B) Determination of the total amountof excess contributions. The process de-scribed in paragraph (b)(2)(ii)(A) of thissection must be repeated until the arrange-ment would satisfy the requirements ofparagraph (b)(2)(ii)(C) of this section. Thesum of all reductions for all HCEs deter-mined under paragraph (b)(2)(ii)(A) of thissection is the total amount of excess con-tributions for the plan year.

(C) Satisfaction of ADP. A cash ordeferred arrangement satisfies this para-graph (b)(2)(ii)(C) if the arrangementwould satisfy the requirements of para-graph (a)(1)(ii) of this section if theADR for each HCE were determinedafter the reductions described in paragraph(b)(2)(ii)(A) of this section.

(iii) Apportionment of total amount ofexcess contributions among the HCEs.The following procedures must be used inapportioning the total amount of excesscontributions determined under paragraph(b)(2)(ii) of this section among the HCEs:

(A) Calculate the dollar amount of ex-cess contributions for each HCE. The con-tributions of the HCE with the highest dol-lar amount of contributions taken into ac-count under this section are reduced by theamount required to cause that HCE’s con-tributions to equal the dollar amount of thecontributions taken into account under thissection for the HCE with the next highestdollar amount of contributions taken ac-count under this section. If a lesser ap-portionment to the HCE would enable theplan to apportion the total amount of ex-cess contributions, only the lesser appor-tionment would apply.

(B) Limit on amount apportioned to anyindividual. For purposes of this paragraph(b)(2)(iii), the amount of contributionstaken into account under this section withrespect to an HCE who is an eligibleemployee in more than one plan of anemployer is determined by taking intoaccount all contributions otherwise takeninto account with respect to such HCEunder any plan of the employer during theplan year of the plan being tested as beingmade under the plan being tested. How-ever, the amount of excess contributionsapportioned for a plan year with respect toany HCE must not exceed the amount ofcontributions actually contributed to theplan for the HCE for the plan year. Thus, inthe case of an HCE who is an eligible em-ployee in more than one plan of the same

2005–5 I.R.B. 413 January 31, 2005

employer to which elective contributionsare made and whose ADR is calculatedin accordance with paragraph (a)(3)(ii)of this section, the amount required to bedistributed under this paragraph (b)(2)(iii)shall not exceed the contributions actuallycontributed to the plan and taken into ac-count under this section for the plan year.

(C) Apportionment to additional HCEs.The procedure in paragraph (b)(2)(iii)(A)of this section must be repeated until thetotal amount of excess contributions de-termined under paragraph (b)(2)(ii) of thissection has been apportioned.

(iv) Income allocable to excess contri-butions—(A) General rule. The incomeallocable to excess contributions is equalto the sum of the allocable gain or loss forthe plan year and, to the extent the excesscontributions are or will be credited withgain or loss for the gap period (i.e., the pe-riod after the close of the plan year andprior to the distribution) if the total accountwere to be distributed, the allocable gain orloss during that period.

(B) Method of allocating income. Aplan may use any reasonable method forcomputing the income allocable to excesscontributions, provided that the methoddoes not violate section 401(a)(4), is usedconsistently for all participants and for allcorrective distributions under the plan forthe plan year, and is used by the plan for al-locating income to participant’s accounts.See §1.401(a)(4)–1(c)(8). A plan will notfail to use a reasonable method for com-puting the income allocable to excess con-tributions merely because the income allo-cable to excess contributions is determinedon a date that is no more than 7 days beforethe distribution.

(C) Alternative method of allocatingplan year income. A plan may allocateincome to excess contributions for theplan year by multiplying the income forthe plan year allocable to the elective con-tributions and other amounts taken intoaccount under this section (including con-tributions made for the plan year), by afraction, the numerator of which is the ex-cess contributions for the employee for theplan year, and the denominator of whichis the sum of the—

(1) Account balance attributable toelective contributions and other contribu-tions taken into account under this sectionas of the beginning of the plan year, and

(2) Any additional amount of such con-tributions made for the plan year.

(D) Safe harbor method of allocat-ing gap period income. A plan may usethe safe harbor method in this paragraph(b)(2)(iv)(D) to determine income onexcess contributions for the gap period.Under this safe harbor method, incomeon excess contributions for the gap periodis equal to 10% of the income allocableto excess contributions for the plan yearthat would be determined under paragraph(b)(2)(iv)(C) of this section, multiplied bythe number of calendar months that haveelapsed since the end of the plan year.For purposes of calculating the numberof calendar months that have elapsed un-der the safe harbor method, a correctivedistribution that is made on or before thefifteenth day of a month is treated as madeon the last day of the preceding month anda distribution made after the fifteenth dayof a month is treated as made on the lastday of the month.

(E) Alternative method for allocatingplan year and gap period income. Aplan may determine the allocable gain orloss for the aggregate of the plan yearand the gap period by applying the al-ternative method provided by paragraph(b)(2)(iv)(C) of this section to this ag-gregate period. This is accomplished bysubstituting the income for the plan yearand the gap period for the income for theplan year and by substituting the contribu-tions taken into account under this sectionfor the plan year and the gap period forthe contributions taken account under thissection for the plan year in determining thefraction that is multiplied by that income.

(v) Distribution. Within 12 months af-ter the close of the plan year in which theexcess contribution arose, the plan mustdistribute to each HCE the excess con-tributions apportioned to such HCE un-der paragraph (b)(2)(iii) of this section andthe allocable income. Except as otherwiseprovided in this paragraph (b)(2)(v) andparagraph (b)(4)(i) of this section, a dis-tribution of excess contributions must bein addition to any other distributions madeduring the year and must be designated as acorrective distribution by the employer. Inthe event of a complete termination of theplan during the plan year in which an ex-cess contribution arose, the corrective dis-tribution must be made as soon as adminis-tratively feasible after the date of termina-

tion of the plan, but in no event later than12 months after the date of termination. Ifthe entire account balance of an HCE isdistributed prior to when the plan makes adistribution of excess contributions in ac-cordance with this paragraph (b)(2), thedistribution is deemed to have been a cor-rective distribution of excess contributions(and income) to the extent that a correctivedistribution would otherwise have been re-quired.

(vi) Tax treatment of corrective dis-tributions—(A) General rule. Except asprovided in this paragraph (b)(2)(vi), acorrective distribution of excess contri-butions (and income) that is made within21/2 months after the end of the plan yearfor which the excess contributions weremade is includible in the employee’s grossincome on the dates the elective contribu-tions would have been received by the em-ployee had the employee originally electedto receive the amounts in cash, treating theexcess contributions that are being dis-tributed as the first elective contributionsfor the plan year. A corrective distribu-tion of excess contributions (and income)that is made more than 21/2 months afterthe end of the plan year for which thecontributions were made is includible inthe employee’s gross income in the em-ployee’s taxable year in which distributed.Regardless of when the corrective distri-bution is made, it is not subject to the earlydistribution tax of section 72(t). See alsoparagraph (b)(4) of this section for addi-tional rules relating to the employer excisetax on amounts distributed more than 21/2

months after the end of the plan year. Seealso §1.402(c)–2, A–4 for restrictions onrolling over distributions that are excesscontributions.

(B) Rule for de minimis distributions.If the total amount of excess contribu-tions, determined under this paragraph(b)(2), and excess aggregate contributionsdetermined under §1.401(m)–2(b)(2) dis-tributed to a recipient under a plan for anyplan year is less than $100 (excluding in-come), a corrective distribution of excesscontributions (and income) is includiblein the gross income of the recipient in thetaxable year of the recipient in which thecorrective distribution is made.

(vii) Other rules—(A) No employee orspousal consent required. A correctivedistribution of excess contributions (andincome) may be made under the terms of

January 31, 2005 414 2005–5 I.R.B.

the plan without regard to any notice orconsent otherwise required under sections411(a)(11) and 417.

(B) Treatment of corrective distribu-tions as elective contributions. Excesscontributions are treated as employer con-tributions for purposes of sections 404 and415 even if distributed from the plan.

(C) No reduction of required minimumdistribution. A distribution of excess con-tributions (and income) is not treated asa distribution for purposes of determin-ing whether the plan satisfies the mini-mum distribution requirements of section401(a)(9). See §1.401(a)(9)–5, A–9(b).

(D) Partial distributions. Any distribu-tion of less than the entire amount of ex-cess contributions (and allocable income)with respect to any HCE is treated as apro rata distribution of excess contribu-tions and allocable income.

(viii) Examples. The following exam-ples illustrate the application of this para-graph (b)(2). For purposes of these exam-ples, none of the plans provide for catch-upcontributions under section 414(v). Theexamples are as follows:

Example 1. (i) Plan P, a calendar year profit-shar-ing plan that includes a cash or deferred arrangement,provides for distribution of excess contributions toHCEs to the extent necessary to satisfy the ADP test.For the 2006 plan year, Employee A, an HCE, haselective contributions of $12,000 and $200,000 incompensation, for an ADR of 6%, and Employee B, asecond HCE, has elective contributions of $8,960 andcompensation of $128,000, for an ADR of 7%. TheADP for the NHCEs is 3% for the 2006 plan year.Under the ADP test, the ADP of the two HCEs un-der the plan may not exceed 5% (i.e., 2 percentagepoints more than the ADP of the NHCEs under theplan). The ADP for the 2 HCEs under the plan is6.5%. Therefore, there must be a correction of ex-cess contributions for the 2006 plan year.

(ii) The total amount of excess contributions forthe HCEs is determined under paragraph (b)(2)(ii) ofthis section as follows: the elective contributions ofEmployee B (the HCE with the highest ADR) are re-duced by $1,280 in order to reduce his ADR to 6%($7,680/$128,000), which is the ADR of EmployeeA.

(iii) Because the ADP of the HCEs determined af-ter the $1,280 reduction to Employee B still exceeds5%, further reductions in elective contributions arenecessary in order to reduce the ADP of the HCEsto 5%. The elective contributions of Employee Aand Employee B are each reduced by 1% of com-pensation ($2,000 and $1,280 respectively). Becausethe ADP of the HCEs determined after the reductionsequals 5%, the plan would satisfy the requirements of(a)(1)(ii) of this section.

(iv) The total amount of excess contributions($4,560 = $1,280+$2,000+$1,280) is apportionedamong the HCEs under paragraph (b)(2)(iii) of thissection first to the HCE with the highest amount of

elective contributions. Therefore, Employee A isapportioned $3,040 (the amount required to causeEmployee A’s elective contributions to equal the nexthighest dollar amount of elective contributions).

(v) Because the total amount of excess contribu-tions has not been apportioned, further apportionmentis necessary. The balance ($1,520) of the total amountof excess contributions is apportioned equally amongEmployee A and Employee B ($760 to each).

(vi) Therefore, the cash or deferred arrangementwill satisfy the requirements of paragraph (a)(1) ofthis section if, by the end of the 12 month period fol-lowing the end of the 2006 plan year, Employee Areceives a corrective distribution of excess contribu-tions equal to $3,800 ($3,040 + $760) and allocableincome and Employee B receives a corrective distri-bution of $760 and allocable income.

Example 2. (i) The facts are the same as in Exam-ple 1, except Employee A’s ADR is based on $3,000of elective contributions to this plan and $9,000 ofelective contributions to another plan of the employer.

(ii) The total amount of excess contributions($4,560 = $1,280+$2,000+$1,280) is apportionedamong the HCEs under paragraph (b)(2)(iii) of thissection first to the HCE with the highest amountof elective contributions. The amount of electivecontributions for Employee A is $12,000. Therefore,Employee A is apportioned $3,040 (the amount re-quired to cause Employee A’s elective contributionsto equal the next highest dollar amount of elec-tive contributions). However, pursuant to paragraph(b)(2)(iii)(B) of this section, no more than the amountactually contributed to the plan may be apportionedto an HCE. Accordingly, no more than $3,000 maybe apportioned to Employee A. Therefore, the re-maining $1,560 must be apportioned to Employee B.

(ii) The cash or deferred arrangement will satisfythe requirements of paragraph (a)(1) of this section if,by the end of the 12 month period following the end ofthe 2006 plan year, Employee A receives a correctivedistribution of excess contributions equal to $3,000(total amount of elective contributions actually con-tributed to the plan for Employee A) and allocableincome and Employee B receives a corrective distri-bution of $1,560 and allocable income.

Example 3. (i) The facts are the same as in Exam-ple 1. The plan allocates income on a daily basis. Thecorrective distributions are made in February 2007.The excess contribution that must be distributed toEmployee A as a corrective distribution is $3,800.This amount must be increased (or decreased) to re-flect gains (or losses) allocable to that amount dur-ing the 2006 plan year. The plan uses a reasonablemethod that satisfies paragraph (b)(2)(iv)(B) of thissection to determine the gain during the 2006 planyear allocable to the $3,800 as $145. Therefore, as ofthe end of the 2006 plan year, the amount of correc-tive distribution that is required would be $3,945.

(ii) Because the plan allocates income on a dailybasis, excess contributions are credited with gain orloss during the gap period. Therefore, the correctivedistribution must include income allocable to $3,945through the date of distribution. For the period fromJanuary 1 through the date of distribution (or if theplan provides 7 days before the date of distribution),the income allocable to $3,945 is $105. Therefore,the plan will satisfy the requirements of paragraph(a)(1) of this section if Employee A receives a cor-rective distribution of $4,050.

Example 4. (i) The facts are the same as in Exam-ple 1. The plan determines plan year income using thealternative method for calculating income providedin paragraph (b)(2)(iv)(C) of this section and usingthe portion of the participant’s account attributableto elective contributions, including elective contribu-tions made for the plan year. The plan uses the safeharbor method provided in paragraph (b)(2)(iv)(D) ofthis section for allocating gap period income. Thecorrective distribution is made during the last weekof February 2007. At the beginning of the 2006 planyear, $100,000 of Employee A’s plan account repre-sents elective contributions plus attributable earnings.During the 2006 plan year, $10,000 in elective con-tributions were contributed to the plan for EmployeeA. The income allocable to Employee A’s account at-tributable to elective contributions for the 2006 planyear is $8,000.

(ii) Therefore, the plan year income allocable tothe $3,800 corrective distribution for Employee Ais $266.65 ($8,000 multiplied by $3,800 divided by$110,000). Therefore, as of the end of the 2006 planyear, the amount of corrective distribution that is re-quired is $4,066.65. This amount must be increasedby the gap period income of $53.32 (10% multipliedby $266.65 (2006 plan year income attributable to theexcess contribution) multiplied by 2 (number of cal-endar months since end of 2006 plan year). There-fore, the plan will satisfy the requirements of para-graph (a)(1) of this section if Employee A receives acorrective distribution of $4,119.97.

Example 5. (i) The facts are the same as in Ex-ample 4, except that the plan provides for quarterlyvaluations based on the account balance at the end ofthe quarter.

(ii) Because the plan’s method for allocating in-come does not allocate any income to amounts dis-tributed during the quarter, Employee A will not becredited with an allocation of income with respect tothe amount distributed. Accordingly, Plan P need notplan adjust the distribution of excess contribution forincome during the gap period and thus satisfies para-graph (a)(1) of this section if Employee A receives acorrective distribution of $4,066.65.

(3) Recharacterization of excess contri-butions—(i) General rule. Excess contri-butions are recharacterized in accordancewith this paragraph (b)(3) only if the ex-cess contributions that would have to bedistributed under (b)(2) of this section ifthe plan was correcting through distribu-tion of excess contributions are recharac-terized as described in paragraph (b)(3)(ii)of this section, and all of the conditions setforth in paragraph (b)(3)(iii) of this sectionare satisfied.

(ii) Treatment of recharacterized excesscontributions. Recharacterized excesscontributions are includible in the em-ployee’s gross income as if such amountswere distributed under paragraph (b)(2) ofthis section. The recharacterized excesscontributions are treated as employee con-tributions for purposes of section 72, sec-tions 401(a)(4), 401(m), §1.401(k)–1(d)

2005–5 I.R.B. 415 January 31, 2005

and §1.401(k)–2. This requirement is nottreated as satisfied unless the payor or planadministrator reports the recharacterizedexcess contributions as employee contri-butions to the Internal Revenue Serviceand the employee by timely providingsuch Federal tax forms and accompany-ing instructions and timely taking suchother action as is prescribed by the Com-missioner in revenue rulings, notices andother guidance published in the InternalRevenue Bulletin (see §601.601(d)(2) ofthis chapter) as well as the applicableFederal tax forms and accompanying in-structions.

(iii) Additional rules—(A) Time ofrecharacterization. Excess contributionsmay not be recharacterized under thisparagraph (b)(3) after 21/2 months afterthe close of the plan year to which therecharacterization relates. Recharacteri-zation is deemed to have occurred on thedate on which the last of those HCEs withexcess contributions to be recharacterizedis notified in accordance with paragraph(b)(3)(ii) of this section.

(B) Employee contributions must bepermitted under plan. The amount ofrecharacterized excess contributions, incombination with the employee contribu-tions actually made by the HCE, may notexceed the maximum amount of employeecontributions (determined without regardto the ACP test of section 401(m)(2)) per-mitted under the provisions of the plan asin effect on the first day of the plan year.

(C) Treatment of recharacterized ex-cess contributions. Recharacterized ex-cess contributions continue to be treatedas employer contributions for all purposesunder the Internal Revenue Code (otherthan those specified in paragraph (b)(3)(ii)of this section), including section 401(a)and sections 404, 409, 411, 412, 415, 416,and 417. Thus, for example, recharacter-ized excess contributions remain subjectto the requirements of §1.401(k)–1(c);must be deducted under section 404; andare treated as employer contributions de-scribed in section 415(c)(2)(A).

(4) Rules applicable to all correc-tions—(i) Coordination with distributionof excess deferrals—(A) Treatment of ex-cess deferrals that reduce excess contribu-tions. The amount of excess contributions(and allocable income) to be distributedunder paragraph (b)(2) of this section orthe amount of excess contributions rechar-

acterized under paragraph (b)(3) of thissection with respect to an employee for aplan year, is reduced by any amounts pre-viously distributed to the employee fromthe plan to correct excess deferrals for theemployee’s taxable year ending with orwithin the plan year in accordance withsection 402(g)(2).

(B) Treatment of excess contribu-tions that reduce excess deferrals. Under§1.402(g)–1(e), the amount required to bedistributed to correct an excess deferral toan employee for a taxable year is reducedby any excess contributions (and allocableincome) previously distributed or excesscontributions recharacterized with respectto the employee for the plan year begin-ning with or within the taxable year. Theamount of excess contributions includiblein the gross income of the employee, andthe amount of excess contributions re-ported by the payer or plan administratoras includible in the gross income of theemployee, does not include the amount ofany reduction under §1.402(g)–1(e)(6).

(ii) Forfeiture of match on distributedexcess contributions. A matching contri-bution is taken into account under section401(a)(4) even if the match is with re-spect to an elective contribution that isdistributed or recharacterized under thisparagraph (b). This requires that, aftercorrection of excess contributions, eachlevel of matching contributions be cur-rently and effectively available to a groupof employees that satisfies section 410(b).See §1.401(a)(4)–4(e)(3)(iii)(G). Thus, aplan that provides the same rate of match-ing contributions to all employees will notmeet the requirements of section 401(a)(4)if elective contributions are distributedunder this paragraph (b) to HCEs to theextent needed to meet the requirements ofsection 401(k)(3), while matching contri-butions attributable to those elective con-tributions remain allocated to the HCEs’accounts. Under section 411(a)(3)(G)and §1.411(a)–4(b)(7), a plan may for-feit matching contributions attributableto excess contributions, excess aggregatecontributions or excess deferrals to avoida violation of section 401(a)(4). See also§1.401(a)(4)–11(g)(3)(vii)(B) regardingthe use of additional allocations to theaccounts of NHCEs for the purpose ofcorrecting a discriminatory rate of match-ing contributions.

(iii) Permitted forfeiture of QMAC. Pur-suant to section 401(k)(8)(E), a qualifiedmatching contribution is not treated as for-feitable under §1.401(k)–1(c) merely be-cause under the plan it is forfeited in ac-cordance with paragraph (b)(4)(ii) of thissection.

(iv) No requirement for recalculation.If excess contributions are distributed orrecharacterized in accordance with para-graphs (b)(2) and (3) of this section, thecash or deferred arrangement is treated asmeeting the nondiscrimination test of sec-tion 401(k)(3) regardless of whether theADP for the HCEs, if recalculated after thedistributions or recharacterizations, wouldsatisfy section 401(k)(3).

(v) Treatment of excess contribu-tions that are catch-up contributions.A cash or deferred arrangement does notfail to meet the requirements of section401(k)(3) and paragraph (a)(1) of this sec-tion merely because excess contributionsthat are catch-up contributions becausethey exceed the ADP limit, as described in§1.414(v)–1(b)(1)(iii), are not corrected inaccordance with this paragraph (b).

(5) Failure to timely correct—(i) Fail-ure to correct within 21/2 months after endof plan year. If a plan does not correct ex-cess contributions within 21/2 months af-ter the close of the plan year for whichthe excess contributions are made, the em-ployer will be liable for a 10% excise taxon the amount of the excess contributions.See section 4979 and §54.4979–1 of thischapter. Qualified nonelective contribu-tions and qualified matching contributionsproperly taken into account under para-graph (a)(6) of this section for a plan yearmay enable a plan to avoid having excesscontributions, even if the contributions aremade after the close of the 21/2 month pe-riod.

(ii) Failure to correct within 12 monthsafter end of plan year. If excess contribu-tions are not corrected within 12 monthsafter the close of the plan year for whichthey were made, the cash or deferred ar-rangement will fail to satisfy the require-ments of section 401(k)(3) for the planyear for which the excess contributions aremade and all subsequent plan years duringwhich the excess contributions remain inthe trust.

(c) Additional rules for prior year test-ing method—(1) Rules for change in test-ing method—(i) General rule. A plan is

January 31, 2005 416 2005–5 I.R.B.

permitted to change from the prior yeartesting method to the current year test-ing method for any plan year. A planis permitted to change from the currentyear testing method to the prior year test-ing method only in situations described inparagraph (c)(1)(ii) of this section. Forpurposes of this paragraph (c)(1), a planthat uses the safe harbor method describedin §1.401(k)–3 or a SIMPLE 401(k) planis treated as using the current year testingmethod for that plan year.

(ii) Situations permitting a change tothe prior year testing method. The situa-tions described in this paragraph (c)(1)(ii)are:

(A) The plan is not the result of the ag-gregation of two or more plans, and thecurrent year testing method was used un-der the plan for each of the 5 plan yearspreceding the plan year of the change (orif lesser, the number of plan years the planhas been in existence, including years inwhich the plan was a portion of anotherplan).

(B) The plan is the result of the aggre-gation of two or more plans, and for eachof the plans that are being aggregated (theaggregating plans), the current year test-ing method was used for each of the 5plan years preceding the plan year of thechange (or if lesser, the number of planyears since that aggregating plan has beenin existence, including years in which theaggregating plan was a portion of anotherplan).

(C) A transaction described in section410(b)(6)(C)(i) and §1.410(b)–2(f) occursand—

(1) As a result of the transaction, theemployer maintains both a plan using theprior year testing method and a plan usingthe current year testing method; and

(2) The change from the current yeartesting method to the prior year testingmethod occurs within the transition perioddescribed in section 410(b)(6)(C)(ii).

(2) Calculation of ADP under the prioryear testing method for the first planyear—(i) Plans that are not successorplans. If, for the first plan year of any plan(other than a successor plan), the plan usesthe prior year testing method, the plan ispermitted to use either that first plan yearas the applicable year for determining theADP for eligible NHCEs, or use 3% as theADP for eligible NHCEs, for applying theADP test for that first plan year. A plan

(other than a successor plan) that uses theprior year testing method but has electedfor its first plan year to use that year as theapplicable year is not treated as changingits testing method in the second plan yearand is not subject to the limitations on dou-ble counting on QNECs under paragraph(a)(6)(vi) of this section for the secondplan year.

(ii) First plan year defined. For pur-poses of this paragraph (c)(2), the firstplan year of any plan is the first year inwhich the plan provides for elective con-tributions. Thus, the rules of this para-graph (c)(2) do not apply to a plan (withinthe meaning of §1.410(b)–7(b)) for a planyear if for such plan year the plan is ag-gregated under §1.401(k)–1(b)(4) with anyother plan that provided for elective contri-butions in the prior year.

(iii) Successor plans. A plan is a suc-cessor plan if 50% or more of the eligi-ble employees for the first plan year wereeligible employees under a qualified cashor deferred arrangement maintained by theemployer in the prior year. If a plan thatis a successor plan uses the prior year test-ing method for its first plan year, the ADPfor the group of NHCEs for the applicableyear must be determined under paragraph(c)(4) of this section.

(3) Plans using different testing meth-ods for the ADP and ACP test. Exceptas otherwise provided in this paragraph(c)(3), a plan may use the current year test-ing method or prior year testing method forthe ADP test for a plan year without regardto whether the current year testing methodor prior year testing method is used for theACP test for that year. For example, a planmay use the prior year testing method forthe ADP test and the current year testingmethod for its ACP test for the plan year.However, plans that use different testingmethods under this paragraph (c)(3) can-not use—

(i) The recharacterization method ofparagraph (b)(3) of this section to correctexcess contributions for a plan year;

(ii) The rules of §1.401(m)–2(a)(6)(ii)to take elective contributions into accountunder the ACP test (rather than the ADPtest); or

(iii) The rules of paragraph (a)(6)(v) ofthis section to take qualified matching con-tributions into account under the ADP test(rather than the ACP test).

(4) Rules for plan coveragechanges—(i) In general. A plan thatuses the prior year testing method and ex-periences a plan coverage change duringa plan year satisfies the requirements ofthis section for that year only if the planprovides that the ADP for the NHCEs forthe plan year is the weighted average ofthe ADPs for the prior year subgroups.

(ii) Optional rule for minor plan cov-erage changes. If a plan coverage changeoccurs and 90% or more of the total num-ber of the NHCEs from all prior year sub-groups are from a single prior year sub-group, then, in lieu of using the weightedaverages described in paragraph (c)(4)(i)of this section, the plan may provide thatthe ADP for the group of eligible NHCEsfor the prior year under the plan is theADP of the NHCEs for the prior year ofthe plan under which that single prior yearsubgroup was eligible.

(iii) Definitions. The following defini-tions apply for purposes of this paragraph(c)(4):

(A) Plan coverage change. The termplan coverage change means a change inthe group or groups of eligible employeesunder a plan on account of—

(1) The establishment or amendment ofa plan;

(2) A plan merger or spinoff under sec-tion 414(l);

(3) A change in the way plans (withinthe meaning of §1.410(b)–7(b)) arecombined or separated for purposes of§1.401(k)–1(b)(4) (e.g., permissively ag-gregating plans not previously aggre-gated under §1.410(b)–7(d), or ceasingto permissively aggregate plans under§1.410(b)–7(d));

(4) A reclassification of a substantialgroup of employees that has the same ef-fect as amending the plan (e.g., a transferof a substantial group of employees fromone division to another division); or

(5) A combination of any of paragraphs(c)(4)(iii)(A)(1) through (4) of this section.

(B) Prior year subgroup. The termprior year subgroup means all NHCEsfor the prior plan year who, in the prioryear, were eligible employees under aspecific plan maintained by the employerthat included a qualified cash or deferredarrangement and who would have beeneligible employees in the prior year underthe plan being tested if the plan coveragechange had first been effective as of the

2005–5 I.R.B. 417 January 31, 2005

first day of the prior plan year instead offirst being effective during the plan year.The determination of whether an NHCEis a member of a prior year subgroup ismade without regard to whether the NHCEterminated employment during the prioryear.

(C) Weighted average of the ADPsfor the prior year subgroups. The termweighted average of the ADPs for theprior year subgroups means the sum, forall prior year subgroups, of the adjustedADPs for the plan year. The term adjustedADP with respect to a prior year subgroupmeans the ADP for the prior plan year ofthe specific plan under which the membersof the prior year subgroup were eligibleemployees on the first day of the prior planyear, multiplied by a fraction, the numer-ator of which is the number of NHCEs inthe prior year subgroup and denominatorof which is the total number of NHCEs inall prior year subgroups.

(iv) Examples. The following examplesillustrate the application of this paragraph(c)(4):

Example 1. (i) Employer B maintains twocalendar year plans, Plan O and Plan P, each ofwhich includes a cash or deferred arrangement.The plans were not permissively aggregated under§1.410(b)–7(d) for the 2005 plan year. Both plansuse the prior year testing method. Plan O had 300eligible employees who were NHCEs for the 2005plan year, and their ADP for that year was 6%.Sixty of the eligible employees who were NHCEsfor the 2005 plan year under Plan O, terminatedtheir employment during that year. Plan P had 100eligible employees who were NHCEs for 2005, andthe ADP for those NHCEs for that plan was 4%.Plan O and Plan P are permissively aggregated under§1.410(b)–7(d) for the 2006 plan year.

(ii) The permissive aggregation of Plan O andPlan P for the 2006 plan year under §1.410(b)–7(d)is a plan coverage change that results in treatingthe plans as one plan (Plan OP) for purposes of§1.401(k)–1(b)(4). Therefore, the prior year ADPfor the NHCEs under Plan OP for the 2006 plan yearis the weighted average of the ADPs for the prioryear subgroups: the Plan O prior year subgroup andthe Plan P prior year subgroup.

(iii) The Plan O prior year subgroup consists ofthe 300 employees who, in the 2005 plan year, wereeligible NHCEs under Plan O and who would havebeen eligible under Plan OP for the 2005 plan year ifPlan O and Plan P had been permissively aggregatedfor that plan year. The Plan P prior year subgroupconsists of the 100 employees who, in the 2005 planyear, were eligible NHCEs under Plan P and wouldhave been eligible under Plan OP for the 2005 planyear if Plan O and Plan P had been permissively ag-gregated for that plan year.

(iv) The weighted average of the ADPs for theprior year subgroups is the sum of the adjusted ADPfor the Plan O prior year subgroup and the adjusted

ADP for the Plan P prior year subgroup. The adjustedADP for the Plan O prior year subgroup is 4.5%, cal-culated as follows: 6% (the ADP for the NHCEs un-der Plan O for the 2005 plan year) x 300/400 (thenumber of NHCEs in the Plan O prior year subgroupdivided by the total number of NHCEs in all prioryear subgroups). The adjusted ADP for the Plan Pprior year subgroup is 1%, calculated as follows: 4%(the ADP for the NHCEs under Plan P for the 2005plan year) x 100/400 (the number of NHCEs in thePlan P prior year subgroup divided by the total num-ber of NHCEs in all prior year subgroups). Thus, theprior year ADP for NHCEs under Plan OP for the2006 plan year is 5.5% (the sum of adjusted ADPsfor the prior year subgroups, 4.5% plus 1%).

(v) As provided in paragraph (c)(4)(iii)(B) of thissection, the determination of whether an NHCE is amember of a prior year subgroup is made without re-gard to whether that NHCE terminated employmentduring the prior year. Thus, the prior ADP for theNHCEs under Plan OP for the 2006 plan year is un-affected by the termination of the 60 NHCEs coveredby Plan O during the 2005 plan year.

Example 2. (i) The facts are the same as Example1, except that the 60 employees who terminated em-ployment during the 2005 plan are instead spun-off toanother plan.

(ii) The permissive aggregation of Plan O andPlan P for the 2006 plan year under §1.410(b)–7(d)is a plan coverage change that results in treatingthe plans as one plan (Plan OP) for purposes of§1.401(k)–1(b)(4) and the spin-off of the 60 employ-ees is a plan coverage change. Therefore, the prioryear ADP for the NHCEs under Plan OP for the 2006plan year is the weighted average of the ADPs for theprior year subgroups: the Plan O prior year subgroupand the Plan P prior year subgroup.

(iii) For purposes of determining the prior yearsubgroups, the employees who would have been eli-gible employees in the prior year under the plan be-ing tested are determined as if both plan coveragechanges had first been effective as of the first dayof the prior plan year. The Plan O prior year sub-group consists of the 240 employees who, in the 2005plan year, were eligible NHCEs under Plan O andwould have been eligible under Plan OP for the 2005plan year if the spin-off had occurred at the begin-ning of the 2005 plan year and Plan O and Plan P hadbeen permissively aggregated under §1.410(b)–7(d)for that plan year. The Plan P prior year subgroupconsists of the 100 employees who, in the 2005 planyear, were eligible NHCEs under Plan P and wouldhave been eligible under Plan OP for the 2005 planyear if Plan O and Plan P had been permissively ag-gregated under §1.410(b)–7(d) for that plan year.

(iv) The weighted average of the ADPs for theprior year subgroups is the sum of the adjusted ADPwith respect to the prior year subgroup consisting ofeligible NHCEs from Plan O and the adjusted ADPwith respect to the prior year subgroup consisting ofeligible NHCEs from Plan P. The adjusted ADP forthe prior year subgroup consisting of eligible NHCEsunder Plan O is 4.23%, calculated as follows: 6% (theADP for the NHCEs under Plan O for the 2005 planyear) x 240/340 (the number of NHCEs in that prioryear subgroup divided by the total number of NHCEsin all prior year subgroups). The adjusted ADP for theprior year subgroup consisting of the eligible NHCEsfrom Plan P is 1.18%, calculated as follows: 4% (the

ADP for the NHCEs under Plan P for the 2005 planyear) x 100/340 (the number of NHCEs in that prioryear subgroup divided by the total number of NHCEsin all prior year subgroups). Thus, the prior year ADPfor NHCEs under Plan OP for the 2006 plan year is5.41% (the sum of adjusted ADPs for the prior yearsubgroups, 4.23% plus 1.18%).

Example 3. (i) The facts are the same as in Exam-ple 1, except that instead of Plan O and Plan P beingpermissively aggregated for the 2006 plan year, 200of the employees eligible under Plan O were spun-offfrom Plan O and merged into Plan P.

(ii) The spin-off from Plan O and merger to Plan Pfor the 2006 plan year are plan coverage changes forPlan P. Therefore, the prior year ADP for the NHCEsunder Plan P for the 2006 plan year is the weightedaverage of the ADPs for the prior year subgroups un-der Plan P. There are 2 subgroups under Plan P forthe 2006 plan year. The Plan O prior year subgroupconsists of the 200 employees who, in the 2005 planyear, were eligible NHCEs under Plan O and whowould have been eligible under Plan P for the 2005plan year if the spin-off and merger had occurred onthe first day of the 2005 plan year. The Plan P prioryear subgroup consists of the 100 employees who, inthe 2005 plan year, were eligible NHCEs under PlanP for the 2005 plan year.

(iii) The weighted average of the ADPs for theprior year subgroups is the sum of the adjusted ADPfor the Plan O prior year subgroup and the adjustedADP for the Plan P prior year subgroup. The adjustedADP for the Plan O prior year subgroup is 4.0%, cal-culated as follows: 6% (the ADP for the NHCEs un-der Plan O for the 2005 plan year) x 200/300 (thenumber of NHCEs in the Plan O prior year subgroupdivided by the total number of NHCEs in all prioryear subgroups). The adjusted ADP for the Plan Pprior year subgroup is 1.33%, calculated as follows:4% (the ADP for the NHCEs under Plan P for the2005 plan year) x 100/300 (the number of NHCEsin the Plan P prior year subgroup divided by the totalnumber of NHCEs in all prior year subgroups). Thus,the prior year ADP for NHCEs under Plan P for the2006 plan year is 5.33% (the sum of adjusted ADPsfor the 2 prior year subgroups, 4.0% plus 1.33%).

(iv) The spin-off from Plan O for the 2006 planyear is a plan coverage change for Plan O. There-fore, the prior year ADP for the NHCEs under PlanO for the 2006 plan year is the weighted average ofthe ADPs for the prior year subgroups under Plan O.In this case, there is only one prior year subgroup un-der Plan O, the employees who were NHCEs of Em-ployer B for the 2005 plan year and who were eli-gible for the 2005 plan year under Plan O. Becausethere is only one prior year subgroup under Plan O,the weighted average of the ADPs for the prior yearsubgroup under Plan O is equal to the NHCE ADP forthe prior year (2005 plan year) under Plan O, or 6%.

Example 4. (i) Employer C maintains a calendaryear plan, Plan Q, which includes a cash or deferredarrangement that uses the prior year testing method.Plan Q covers employees of Division A and Divi-sion B. In 2005, Plan Q had 500 eligible employeeswho were NHCEs, and the ADP for those NHCEs for2005 was 2%. Effective January 1, 2006, EmployerC amends the eligibility provisions under Plan Q toexclude employees of Division B effective January1, 2006. In addition, effective on that same date, Em-ployer C establishes a new calendar year plan, Plan

January 31, 2005 418 2005–5 I.R.B.

R, which includes a cash or deferred arrangement thatuses the prior year testing method. The only eligibleemployees under Plan R are the 100 employees of Di-vision B who were eligible employees under Plan Q.

(ii) Plan R is a successor plan, within the meaningof paragraph (c)(2)(iii) of this section (because all ofthe employees were eligible employees under Plan Qin the prior year). Therefore, Plan R cannot use thefirst plan year rule set forth in paragraph (c)(2)(i) ofthis section.

(iii) The amendment to the eligibility provisionsof Plan Q and the establishment of Plan R are plancoverage changes within the meaning of paragraph(c)(4)(iii)(A) of this section for Plan Q and Plan R.Accordingly, each plan must determine the NHCEADP for the 2006 plan year under the rules set forthin paragraph (c)(4) of this section.

(iv) The prior year ADP for NHCEs under Plan Qis the weighted average of the ADPs for the prior yearsubgroups. Plan Q has only one prior year subgroup(because the only NHCEs who would have been eli-gible employees under Plan Q for the 2005 plan yearif the amendment to the Plan Q eligibility provisionshad occurred as of the first day of that plan year wereeligible employees under Plan Q). Therefore, for pur-poses of the 2006 plan year under Plan Q, the ADPfor NHCEs for the prior year is the weighted averageof the ADPs for the prior year subgroups, or 2%, thesame as if the plan amendment had not occurred.

(v) Similarly, Plan R has only one prior year sub-group (because the only NHCEs who would havebeen eligible employees under Plan R for the 2005plan year if the plan were established as of the firstday of that plan year were eligible employees underPlan Q). Therefore, for purposes of the 2006 testingyear under Plan R, the ADP for NHCEs for the prioryear is the weighted average of the ADPs for the prioryear subgroups, or 2%, the same as that of Plan Q.

Example 5. (i) The facts are the same as in Exam-ple 4, except that the provisions of Plan R extend eli-gibility to 50 hourly employees who previously werenot eligible employees under any qualified cash or de-ferred arrangement maintained by Employer C.

(ii) Plan R is a successor plan (because 100 ofPlan R’s 150 eligible employees were eligible em-ployees under another qualified cash or deferred ar-rangement maintained by Employer C in the prioryear). Therefore, Plan R cannot use the first plan yearrule set forth in paragraph (c)(2)(i) of this section.

(iii) The establishment of Plan R is a plan cover-age change that affects Plan R. Because the 50 hourlyemployees were not eligible employees under anyqualified cash or deferred arrangement of EmployerC for the prior plan year, they do not comprise a prioryear subgroup. Accordingly, Plan R still has only oneprior year subgroup. Therefore, for purposes of the2006 testing year under Plan R, the ADP for NHCEsfor the prior year is the weighted average of the ADPsfor the prior year subgroups, or 2%, the same as thatof Plan Q.

§1.401(k)–3 Safe harbor requirements.

(a) ADP test safe harbor. A cash or de-ferred arrangement satisfies the ADP safeharbor provision of section 401(k)(12) fora plan year if the arrangement satisfiesthe safe harbor contribution requirement of

paragraph (b) or (c) of this section for theplan year, the notice requirement of para-graph (d) of this section, the plan year re-quirements of paragraph (e) of this sec-tion, and the additional rules of paragraphs(f), (g) and (h) of this section, as applica-ble. Pursuant to section 401(k)(12)(E)(ii),the safe harbor contribution requirement ofparagraph (b) or (c) of this section must besatisfied without regard to section 401(l).The contributions made under paragraphs(b) and (c) of this section are referred toas safe harbor nonelective contributionsand safe harbor matching contributions, re-spectively.

(b) Safe harbor nonelective contribu-tion requirement—(1) General rule. Thesafe harbor nonelective contribution re-quirement of this paragraph is satisfied if,under the terms of the plan, the employeris required to make a qualified nonelectivecontribution on behalf of each eligibleNHCE equal to at least 3% of the em-ployee’s safe harbor compensation.

(2) Safe harbor compensation de-fined. For purposes of this section, safeharbor compensation means compensa-tion as defined in §1.401(k)–6 (whichincorporates the definition of compen-sation in §1.414(s)–1); provided, how-ever, that the rule in the last sentence of§1.414(s)–1(d)(2)(iii) (which generallypermits a definition of compensation toexclude all compensation in excess of aspecified dollar amount) does not apply indetermining the safe harbor compensationof NHCEs. Thus, for example, the planmay limit the period used to determinesafe harbor compensation to the eligibleemployee’s period of participation.

(c) Safe harbor matching contributionrequirement—(1) In general. The safeharbor matching contribution requirementof this paragraph (c) is satisfied if, un-der the plan, qualified matching contribu-tions are made on behalf of each eligi-ble NHCE in an amount determined un-der the basic matching formula of sec-tion 401(k)(12)(B)(i)(I), as described inparagraph (c)(2) of this section, or underan enhanced matching formula of section401(k)(12)(B)(i)(II), as described in para-graph (c)(3) of this section.

(2) Basic matching formula. Underthe basic matching formula, each eligibleNHCE receives qualified matching con-tributions in an amount equal to the sumof—

(i) 100% of the amount of the em-ployee’s elective contributions that do notexceed 3% of the employee’s safe harborcompensation; and

(ii) 50% of the amount of the em-ployee’s elective contributions that exceed3% of the employee’s safe harbor com-pensation but that do not exceed 5% of theemployee’s safe harbor compensation.

(3) Enhanced matching formula. Un-der an enhanced matching formula, eacheligible NHCE receives a matching con-tribution under a formula that, at any rateof elective contributions by the employee,provides an aggregate amount of qualifiedmatching contributions at least equal to theaggregate amount of qualified matchingcontributions that would have been pro-vided under the basic matching formula ofparagraph (c)(2) of this section. In addi-tion, under an enhanced matching formula,the ratio of matching contributions on be-half of an employee under the plan for aplan year to the employee’s elective con-tributions may not increase as the amountof an employee’s elective contributions in-creases.

(4) Limitation on HCE matching contri-butions. The safe harbor matching contri-bution requirement of this paragraph (c) isnot satisfied if the ratio of matching con-tributions made on account of an HCE’selective contributions under the cash ordeferred arrangement for a plan year tothose elective contributions is greater thanthe ratio of matching contributions to elec-tive contributions that would apply withrespect to any eligible NHCE with elec-tive contributions at the same percentageof safe harbor compensation.

(5) Use of safe harbor match not pre-cluded by certain plan provisions—(i)Safe harbor matching contributions onemployee contributions. The safe harbormatching contribution requirement of thisparagraph (c) will not fail to be satis-fied merely because safe harbor matchingcontributions are made on both electivecontributions and employee contributionsif safe harbor matching contributions aremade with respect to the sum of electivecontributions and employee contributionson the same terms as safe harbor matchingcontributions are made with respect toelective contributions. Alternatively, thesafe harbor matching contribution require-ment of this paragraph (c) will not failto be satisfied merely because safe har-

2005–5 I.R.B. 419 January 31, 2005

bor matching contributions are made onboth elective contributions and employeecontributions if safe harbor matching con-tributions on elective contributions arenot affected by the amount of employeecontributions.

(ii) Periodic matching contributions.The safe harbor matching contributionrequirement of this paragraph (c) will notfail to be satisfied merely because the planprovides that safe harbor matching con-tributions will be made separately withrespect to each payroll period (or withrespect to all payroll periods ending withor within each month or quarter of a planyear) taken into account under the plan forthe plan year, provided that safe harbormatching contributions with respect to anyelective contributions made during a planyear quarter are contributed to the plan bythe last day of the immediately followingplan year quarter.

(6) Permissible restrictions on electivecontributions by NHCEs—(i) Generalrule. The safe harbor matching contri-bution requirement of this paragraph (c)is not satisfied if elective contributionsby NHCEs are restricted, unless the re-strictions are permitted by this paragraph(c)(6).

(ii) Restrictions on election periods. Aplan may limit the frequency and dura-tion of periods in which eligible employ-ees may make or change cash or deferredelections under a plan. However, an em-ployee must have a reasonable opportunity(including a reasonable period after receiptof the notice described in paragraph (d) ofthis section) to make or change a cash ordeferred election for the plan year. For pur-poses of this paragraph (c)(6)(ii), a 30-dayperiod is deemed to be a reasonable periodto make or change a cash or deferred elec-tion.

(iii) Restrictions on amount of electivecontributions. A plan is permitted to limitthe amount of elective contributions thatmay be made by an eligible employeeunder a plan, provided that each NHCEwho is an eligible employee is permitted(unless the employee is restricted underparagraph (c)(6)(v) of this section) to makeelective contributions in an amount thatis at least sufficient to receive the max-imum amount of matching contributionsavailable under the plan for the plan year,and the employee is permitted to elect anylesser amount of elective contributions.

However, a plan may require eligible em-ployees to make cash or deferred electionsin whole percentages of compensation orwhole dollar amounts.

(iv) Restrictions on types of compen-sation that may be deferred. A plan maylimit the types of compensation that maybe deferred by an eligible employee undera plan, provided that each eligible NHCEis permitted to make elective contribu-tions under a definition of compensationthat would be a reasonable definitionof compensation within the meaning of§1.414(s)–1(d)(2). Thus, the definition ofcompensation from which elective con-tributions may be made is not required tosatisfy the nondiscrimination requirementof §1.414(s)–1(d)(3).

(v) Restrictions due to limitations un-der the Internal Revenue Code. A planmay limit the amount of elective contribu-tions made by an eligible employee undera plan—

(A) Because of the limitations of sec-tion 402(g) or 415; or

(B) Because, on account of a hard-ship distribution, an employee’s ability tomake elective contributions has been sus-pended for 6 months in accordance with§1.401(k)–1(d)(3)(iv)(E).

(7) Examples. The following examplesillustrate the safe harbor contribution re-quirement of this paragraph (c):

Example 1. (i) Beginning January 1, 2006, Em-ployer A maintains Plan L covering employees inDivisions D and E, each of which includes HCEsand NHCEs. Plan L contains a cash or deferredarrangement and provides qualified matching contri-butions equal to 100% of each eligible employee’selective contributions up to 3% of compensation and50% of the next 2% of compensation. For purposesof the matching contribution formula, safe harborcompensation is defined as all compensation withinthe meaning of section 415(c)(3) (a definition thatsatisfies section 414(s)). Also, each employee ispermitted to make elective contributions from allsafe harbor compensation within the meaning ofsection 415(c)(3) and may change a cash or deferredelection at any time. Plan L limits the amount ofan employee’s elective contributions for purposesof section 402(g) and section 415, and, in the caseof a hardship distribution, suspends an employee’sability to make elective contributions for 6 monthsin accordance with §1.401(k)–1(d)(3)(iv)(E). Allcontributions under Plan L are nonforfeitable andare subject to the withdrawal restrictions of section401(k)(2)(B). Plan L provides for no other contri-butions and Employer A maintains no other plans.Plan L is maintained on a calendar-year basis, andall contributions for a plan year are made within 12months after the end of the plan year.

(ii) Based on these facts, matching contributionsunder Plan L are safe harbor matching contributions

because they are qualified matching contributionsequal to the basic matching formula. Accordingly,Plan L satisfies the safe harbor contribution require-ment of this paragraph (c).

Example 2. (i) The facts are the same as in Exam-ple 1, except that instead of providing a basic match-ing contribution, Plan L provides a qualified match-ing contribution equal to 100% of each eligible em-ployee’s elective contributions up to 4% of safe har-bor compensation.

(ii) Plan L’s formula is an enhanced matching for-mula because each eligible NHCE receives safe har-bor matching contributions at a rate that, at any rate ofelective contributions, provides an aggregate amountof qualified matching contributions at least equal tothe aggregate amount of qualified matching contribu-tions that would have been received under the basicsafe harbor matching formula, and the rate of match-ing contributions does not increase as the rate of anemployee’s elective contributions increases. Accord-ingly, Plan L satisfies the safe harbor contribution re-quirement of this paragraph (c).

Example 3. (i) The facts are the same as in Exam-ple 2, except that instead of permitting each employeeto make elective contributions from all compensationwithin the meaning of section 415(c)(3), each em-ployee’s elective contributions under Plan L are lim-ited to 15% of the employee’s basic compensation.Basic compensation is defined under Plan L as com-pensation within the meaning of section 415(c)(3),but excluding overtime pay.

(ii) The definition of basic compensation underPlan L is a reasonable definition of compensationwithin the meaning of §1.414(s)–1(d)(2).

(iii) Plan L will not fail to satisfy the safe harborcontribution requirement of this paragraph (c) merelybecause Plan L limits the amount of elective contri-butions and the types of compensation that may bedeferred by eligible employees, provided that each el-igible NHCE may make elective contributions equalto at least 4% of the employee’s safe harbor compen-sation.

Example 4. (i) The facts are the same as in Exam-ple 1, except that Plan L provides that only employeesemployed on the last day of the plan year will receivea safe harbor matching contribution.

(ii) Even if the plan that provides for employeecontributions and matching contributions satisfies theminimum coverage requirements of section 410(b)(1)taking into account this last-day requirement, Plan Lwould not satisfy the safe harbor contribution require-ment of this paragraph (c) because safe harbor match-ing contributions are not made on behalf of all eligibleNHCEs who make elective contributions.

(iii) The result would be the same if, instead ofproviding safe harbor matching contributions, Plan Lprovides for a 3% safe harbor nonelective contribu-tion that is restricted to eligible employees under thecash or deferred arrangement who are employed onthe last day of the plan year.

Example 5. (i) The facts are the same as in Ex-ample 1, except that instead of providing qualifiedmatching contributions under the basic matching for-mula to employees in both Divisions D and E, em-ployees in Division E are provided qualified match-ing contributions under the basic matching formula,while safe harbor matching contributions continue tobe provided to employees in Division D under the en-hanced matching formula described in Example 2.

January 31, 2005 420 2005–5 I.R.B.

(ii) Even if Plan L satisfies §1.401(a)(4)–4 withrespect to each rate of matching contributions avail-able to employees under the plan, the plan would failto satisfy the safe harbor contribution requirement ofthis paragraph (c) because the rate of matching con-tributions with respect to HCEs in Division D at a rateof elective contributions between 3% and 5% wouldbe greater than that with respect to NHCEs in Divi-sion E at the same rate of elective contributions. Forexample, an HCE in Division D who would have a4% rate of elective contributions would have a rateof matching contributions of 100% while an NHCEin Division E who would have the same rate of elec-tive contributions would have a lower rate of match-ing contributions.

(d) Notice requirement—(1) Generalrule. The notice requirement of this para-graph (d) is satisfied for a plan year ifeach eligible employee is given noticeof the employee’s rights and obligationsunder the plan and the notice satisfies thecontent requirement of paragraph (d)(2)of this section and the timing requirementof paragraph (d)(3) of this section. Thenotice must be in writing or in such otherform as may be approved by the Commis-sioner.

(2) Content requirement—(i) Generalrule. The content requirement of this para-graph (d)(2) is satisfied if the notice is—

(A) Sufficiently accurate and compre-hensive to inform the employee of the em-ployee’s rights and obligations under theplan; and

(B) Written in a manner calculated tobe understood by the average employeeeligible to participate in the plan.

(ii) Minimum content requirement.Subject to the requirements of paragraph(d)(2)(iii) of this section, a notice is notconsidered sufficiently accurate and com-prehensive unless the notice accuratelydescribes—

(A) The safe harbor matching contribu-tion or safe harbor nonelective contribu-tion formula used under the plan (includ-ing a description of the levels of safe har-bor matching contributions, if any, avail-able under the plan);

(B) Any other contributions under theplan or matching contributions to anotherplan on account of elective contributionsor employee contributions under the plan(including the potential for discretionarymatching contributions) and the conditionsunder which such contributions are made;

(C) The plan to which safe harbor con-tributions will be made (if different thanthe plan containing the cash or deferred ar-rangement);

(D) The type and amount of compensa-tion that may be deferred under the plan;

(E) How to make cash or deferredelections, including any administrativerequirements that apply to such elections;

(F) The periods available under the planfor making cash or deferred elections;

(G) Withdrawal and vesting provisionsapplicable to contributions under the plan;and

(H) Information that makes it easyto obtain additional information aboutthe plan (including an additional copyof the summary plan description) suchas telephone numbers, addresses and, ifapplicable, electronic addresses, of indi-viduals or offices from whom employeescan obtain such plan information.

(iii) References to SPD. A plan will notfail to satisfy the content requirements ofthis paragraph (d)(2) merely because, inthe case of information described in para-graph (d)(2)(ii)(B) of this section (relat-ing to any other contributions under theplan), paragraph (d)(2)(ii)(C) of this sec-tion (relating to the plan to which safe har-bor contributions will be made) or para-graph (d)(2)(ii)(D) of this section (relatingto the type and amount of compensationthat may be deferred under the plan), thenotice cross-references the relevant por-tions of a summary plan description thatprovides the same information that wouldbe provided in accordance with such para-graphs and that has been provided (or isconcurrently provided) to employees.

(3) Timing requirement—(i) Generalrule. The timing requirement of this para-graph (d)(3) is satisfied if the notice isprovided within a reasonable period be-fore the beginning of the plan year (or,in the year an employee becomes eligi-ble, within a reasonable period beforethe employee becomes eligible). The de-termination of whether a notice satisfiesthe timing requirement of this paragraph(d)(3) is based on all of the relevant factsand circumstances.

(ii) Deemed satisfaction of timing re-quirement. The timing requirement of thisparagraph (d)(3) is deemed to be satisfiedif at least 30 days (and no more than 90days) before the beginning of each planyear, the notice is given to each eligibleemployee for the plan year. In the case ofan employee who does not receive the no-tice within the period described in the pre-vious sentence because the employee be-

comes eligible after the 90th day beforethe beginning of the plan year, the tim-ing requirement is deemed to be satisfiedif the notice is provided no more than 90days before the employee becomes eligi-ble (and no later than the date the em-ployee becomes eligible). Thus, for ex-ample, the preceding sentence would ap-ply in the case of any employee eligiblefor the first plan year under a newly estab-lished plan that provides for elective con-tributions, or would apply in the case of thefirst plan year in which an employee be-comes eligible under an existing plan thatprovides for elective contributions.

(e) Plan year requirement—(1) Gen-eral rule. Except as provided in this para-graph (e) or in paragraph (f) of this section,a plan will fail to satisfy the requirementsof section 401(k)(12) and this section un-less plan provisions that satisfy the rules ofthis section are adopted before the first dayof the plan year and remain in effect for anentire 12-month plan year. In addition, ex-cept as provided in paragraph (g) of thissection, a plan which includes provisionsthat satisfy the rules of this section will notsatisfy the requirements of §1.401(k)–1(b)if it is amended to change such provisionsfor that plan year. Moreover, if, as de-scribed under paragraph (h)(4) of this sec-tion, safe harbor matching or nonelectivecontributions will be made to another planfor a plan year, provisions under that otherplan specifying that the safe harbor contri-butions will be made and providing that thecontributions will be QNECs or QMACsmust also be adopted before the first dayof that plan year.

(2) Initial plan year. A newlyestablished plan (other than a suc-cessor plan within the meaning of§1.401(k)–2(c)(2)(iii)) will not be treatedas violating the requirements of this para-graph (e) merely because the plan year isless than 12 months, provided that the planyear is at least 3 months long (or, in thecase of a newly established employer thatestablishes the plan as soon as administra-tively feasible after the employer comesinto existence, a shorter period). Simi-larly, a cash or deferred arrangement willnot fail to satisfy the requirement of thisparagraph (e) if it is added to an existingprofit sharing, stock bonus, or pre-ERISAmoney purchase pension plan for the firsttime during that year provided that—

(i) The plan is not a successor plan; and

2005–5 I.R.B. 421 January 31, 2005

(ii) The cash or deferred arrangement ismade effective no later than 3 months priorto the end of the plan year.

(3) Change of plan year. A plan thathas a short plan year as a result of changingits plan year will not fail to satisfy the re-quirements of paragraph (e)(1) of this sec-tion merely because the plan year has lessthan 12 months, provided that—

(i) The plan satisfied the requirementsof this section for the immediately preced-ing plan year; and

(ii) The plan satisfies the requirementsof this section (determined without regardto paragraph (g) of this section) for theimmediately following plan year (or forthe immediately following 12 months ifthe immediately following plan year is lessthan 12 months).

(4) Final plan year. A plan that termi-nates during a plan year will not fail to sat-isfy the requirements of paragraph (e)(1)of this section merely because the finalplan year is less than 12 months, providedthat the plan satisfies the requirement ofthis section through the date of terminationand either—

(i) The plan would satisfy the require-ments of paragraph (g) of this section,treating the termination of the plan as areduction or suspension of safe harbormatching contributions, other than therequirement that employees have a rea-sonable opportunity to change their cashor deferred elections and, if applicable,employee contribution elections; or

(ii) The plan termination is in connec-tion with a transaction described in section410(b)(6)(C) or the employer incurs a sub-stantial business hardship comparable to asubstantial business hardship described insection 412(d).

(f) Plan amendments adopting safeharbor nonelective contributions—(1)General rule. Notwithstanding paragraph(e)(1) of this section, a plan that providesfor the use of the current year testingmethod may be amended after the firstday of the plan year and no later than 30days before the last day of the plan yearto adopt the safe harbor method of thissection, effective as of the first day of theplan year, using nonelective contributionsunder paragraph (b) of this section, butonly if the plan provides the contingentand follow-up notices described in thissection. A plan amendment made pur-suant to this paragraph (f)(1) for a plan

year may provide for the use of the safeharbor method described in this sectionsolely for that plan year and a plan sponsoris not limited in the number of years forwhich it is permitted to adopt an amend-ment providing for the safe harbor methodof this section using nonelective contribu-tions under paragraph (b) of this sectionand this paragraph (f).

(2) Contingent notice provided. A plansatisfies the requirement to provide thecontingent notice under this paragraph(f)(2) if it provides a notice that would sat-isfy the requirements of paragraph (d) ofthis section, except that, in lieu of settingforth the safe harbor contributions usedunder the plan as set forth in paragraph(d)(2)(ii)(A) of this section, the noticespecifies that the plan may be amendedduring the plan year to include the safeharbor nonelective contribution and that,if the plan is amended, a follow-up noticewill be provided.

(3) Follow-up notice requirement. Aplan satisfies the requirement to providea follow-up notice under this paragraph(f)(3) if, no later than 30 days before thelast day of the plan year, each eligible em-ployee is given a notice that states that thesafe harbor nonelective contributions willbe made for the plan year. The notice mustbe in writing or in such other form as maybe prescribed by the Commissioner andis permitted to be combined with a con-tingent notice provided under paragraph(f)(2) of this section for the next plan year.

(g) Permissible reduction or suspen-sion of safe harbor matching contribu-tions—(1) General rule. A plan thatprovides for safe harbor matching contri-butions will not fail to satisfy the require-ments of section 401(k)(3) for a plan yearmerely because the plan is amended dur-ing a plan year to reduce or suspend safeharbor matching contributions on futureelective contributions (and, if applicable,employee contributions) provided that—

(i) All eligible employees are providedthe supplemental notice in accordancewith paragraph (g)(2) of this section;

(ii) The reduction or suspension of safeharbor matching contributions is effectiveno earlier than the later of 30 days aftereligible employees are provided the no-tice described in paragraph (g)(2) of thissection and the date the amendment isadopted;

(iii) Eligible employees are given a rea-sonable opportunity (including a reason-able period after receipt of the supplemen-tal notice) prior to the reduction or suspen-sion of safe harbor matching contributionsto change their cash or deferred electionsand, if applicable, their employee contri-bution elections;

(iv) The plan is amended to provide thatthe ADP test will be satisfied for the entireplan year in which the reduction or suspen-sion occurs using the current year testingmethod described in §1.401(k)–2(a)(2)(ii);and

(v) The plan satisfies the requirementsof this section (other than this paragraph(g)) with respect to amounts deferredthrough the effective date of the amend-ment.

(2) Notice of suspension requirement.The notice of suspension requirement ofthis paragraph (g)(2) is satisfied if each el-igible employee is given a notice (in writ-ing or such other form as prescribed by theCommissioner) that explains—

(i) The consequences of the amendmentwhich reduces or suspends matching con-tributions on future elective contributionsand, if applicable, employee contributions;

(ii) The procedures for changing theircash or deferred election and, if applicable,their employee contribution elections; and

(iii) The effective date of the amend-ment.

(h) Additional rules—(1) Contributionstaken into account. A contribution is takeninto account for purposes of this sectionfor a plan year if and only if the contribu-tion would be taken into account for suchplan year under the rules of §1.401(k)–2(a)or 1.401(m)–2(a). Thus, for example, asafe harbor matching contribution must bemade within 12 months of the end of theplan year. Similarly, an elective contribu-tion that would be taken into account for aplan year under §1.401(k)–2(a)(4)(i)(B)(2)must be taken into account for such planyear for purposes of this section, even if thecompensation would have been receivedafter the close of the plan year.

(2) Use of safe harbor nonelectivecontributions to satisfy other nondis-crimination tests. A safe harbor non-elective contribution used to satisfy thenonelective contribution requirement un-der paragraph (b) of this section mayalso be taken into account for purposesof determining whether a plan satisfies

January 31, 2005 422 2005–5 I.R.B.

section 401(a)(4). Thus, these contribu-tions are not subject to the limitations onqualified nonelective contributions under§1.401(k)–2(a)(6)(ii), but are subject tothe rules generally applicable to nonelec-tive contributions under section 401(a)(4).See §1.401(a)(4)–1(b)(2)(ii). However,pursuant to section 401(k)(12)(E)(ii), tothe extent they are needed to satisfy thesafe harbor contribution requirement ofparagraph (b) of this section, safe har-bor nonelective contributions may notbe taken into account under any plan forpurposes of section 401(l) (including theimputation of permitted disparity under§1.401(a)(4)–7).

(3) Early participation rules. Sec-tion 401(k)(3)(F) and §1.401(k)–2(a)(1)(iii)(A), which provide an alternativenondiscrimination rule for certain plansthat provide for early participation, do notapply for purposes of section 401(k)(12)and this section. Thus, a plan is not treatedas satisfying this section with respectto the eligible employees who have notcompleted the minimum age and servicerequirements of section 410(a)(1)(A) un-less the plan satisfies the requirements ofthis section with respect to such eligibleemployees. However, a plan is permittedto apply the rules of section 410(b)(4)(B)to treat the plan as two separate plans forpurposes of section 410(b) and apply thesafe harbor requirements of this sectionto one plan and apply the requirementsof §1.401(k)–2 to the other plan. See§1.401(k)–1(b)(4)(vi), Example 2.

(4) Satisfying safe harbor contributionrequirement under another defined contri-bution plan. Safe harbor matching or non-elective contributions may be made to theplan that contains the cash or deferred ar-rangement or to another defined contribu-tion plan that satisfies section 401(a) or403(a). If safe harbor contributions aremade to another defined contribution plan,the safe harbor plan must specify the planto which the safe harbor contributions aremade and the contribution requirement ofparagraph (b) or (c) of this section mustbe satisfied in the other defined contri-bution plan in the same manner as if thecontributions were made to the plan thatcontains the cash or deferred arrangement.Consequently, the plan to which the con-tributions are made must have the sameplan year as the plan containing the cashand deferred arrangement and each em-

ployee eligible under the plan containingthe cash or deferred arrangement must beeligible under the same conditions underthe other defined contribution plan. Theplan to which the safe harbor contributionsare made need not be a plan that can beaggregated with the plan that contains thecash or deferred arrangement.

(5) Contributions used only once. Safeharbor matching or nonelective contribu-tions cannot be used to satisfy the require-ments of this section with respect to morethan one plan.

§1.401(k)–4 SIMPLE 401(k) planrequirements.

(a) General rule. A cash or deferredarrangement satisfies the SIMPLE 401(k)plan provision of section 401(k)(11) for aplan year if the arrangement satisfies therequirements of paragraphs (b) through (i)of this section for that year. A plan thatcontains a cash or deferred arrangementthat satisfies this section is referred to asa SIMPLE 401(k) plan. Pursuant to sec-tion 401(k)(11), a SIMPLE 401(k) plan istreated as satisfying the ADP test of sec-tion 401(k)(3)(A)(ii) for that year.

(b) Eligible employer—(1) Generalrule. A SIMPLE 401(k) plan must beestablished by an eligible employer. Eligi-ble employer for purposes of this sectionmeans, with respect to any plan year, anemployer that had no more than 100 em-ployees who each received at least $5,000of SIMPLE compensation, as defined inparagraph (e)(5) of this section, from theemployer for the prior calendar year.

(2) Special rule. An eligible employerthat establishes a SIMPLE 401(k) plan fora plan year and that fails to be an eligi-ble employer for any subsequent plan year,is treated as an eligible employer for the2 plan years following the last plan yearthe employer was an eligible employer. Ifthe failure is due to any acquisition, dis-position, or similar transaction involvingan eligible employer, the preceding sen-tence applies only if the provisions of sec-tion 410(b)(6)(C)(i) are satisfied.

(c) Exclusive plan—(1) General rule.The SIMPLE 401(k) plan must be the ex-clusive plan for each SIMPLE 401(k) planparticipant for the plan year. This require-ment is satisfied if there are no contribu-tions made, or benefits accrued, for ser-vices during the plan year on behalf of

any SIMPLE 401(k) plan participant un-der any other qualified plan maintained bythe employer. Other qualified plan for pur-poses of this section means any plan, con-tract, pension, or trust described in section219(g)(5)(A) or (B).

(2) Special rule. A SIMPLE 401(k)plan will not be treated as failing the re-quirements of this paragraph (c) merelybecause any SIMPLE 401(k) plan partic-ipant receives an allocation of forfeituresunder another plan of the employer.

(d) Election and notice—(1) Generalrule. An eligible employer establishing ormaintaining a SIMPLE 401(k) plan mustsatisfy the election and notice require-ments in paragraphs (d)(2) and (3) of thissection.

(2) Employee elections—(i) Initial planyear of participation. For the plan year inwhich an employee first becomes eligibleunder the SIMPLE 401(k) plan, the em-ployee must be permitted to make a cashor deferred election under the plan duringa 60-day period that includes either the daythe employee becomes eligible or the daybefore.

(ii) Subsequent plan years. For eachsubsequent plan year, each eligible em-ployee must be permitted to make or mod-ify his cash or deferred election during the60-day period immediately preceding suchplan year.

(iii) Election to terminate. An eligibleemployee must be permitted to terminatehis cash or deferred election at any time.If an employee does terminate his cash ordeferred election, the plan is permitted toprovide that such employee cannot haveelective contributions made under the planfor the remainder of the plan year.

(3) Employee notices. The employermust notify each eligible employee withina reasonable time prior to each 60-dayelection period, or on the day the elec-tion period starts, that he or she can makea cash or deferred election, or modify aprior election, if applicable, during that pe-riod. The notice must state whether theeligible employer will make the matchingcontributions described in paragraph (e)(3)of this section or the nonelective contribu-tions described in paragraph (e)(4) of thissection.

(e) Contributions—(1) General rule.A SIMPLE 401(k) plan satisfies the con-tribution requirements of this paragraph(e) for a plan year only if no contribu-

2005–5 I.R.B. 423 January 31, 2005

tions may be made to the SIMPLE 401(k)plan during such year, other than contri-butions described in this paragraph (e)and rollover contributions described in§1.402(c)–2, Q&A–1(a).

(2) Elective contributions. Subject tothe limitations on annual additions un-der section 415, each eligible employeemust be permitted to make an electionto have up to $10,000 of elective contri-butions made on the employee’s behalfunder the SIMPLE 401(k) plan for a planyear. The $10,000 limit is increased be-ginning in 2006 in the same manner asthe $160,000 amount is adjusted undersection 415(d), except that pursuant tosection 408(p)(2)(E)(ii) the base periodshall be the calendar quarter beginningJuly 1, 2004, and any increase which isnot a multiple of $500 is rounded to thenext lower multiple of $500.

(3) Matching contributions. Each planyear, the eligible employer must contributea matching contribution to the account ofeach eligible employee on whose behalfelective contributions were made for theplan year. The amount of the matchingcontribution must equal the lesser of theeligible employee’s elective contributionsfor the plan year or 3% of the eligibleemployee’s SIMPLE compensation for theentire plan year.

(4) Nonelective contributions. For anyplan year, in lieu of contributing matchingcontributions described in paragraph (e)(3)of this section, an eligible employer may,in accordance with plan terms, contributea nonelective contribution to the accountof each eligible employee in an amountequal to 2% of the eligible employee’sSIMPLE compensation for the entire planyear. The eligible employer may limit thenonelective contributions to those eligibleemployees who received at least $5,000 ofSIMPLE compensation from the employerfor the entire plan year.

(5) SIMPLE compensation. Exceptas otherwise provided, the term SIMPLEcompensation for purposes of this sectionmeans the sum of wages, tips, and othercompensation from the eligible employersubject to federal income tax withhold-ing (as described in section 6051(a)(3))and the employee’s elective contribu-tions made under any other plan, andif applicable, elective deferrals undera section 408(p) SIMPLE IRA plan, asection 408(k)(6) SARSEP, or a plan or

contract that satisfies the requirementsof section 403(b), and compensation de-ferred under a section 457 plan, requiredto be reported by the employer on FormW–2 (as described in section 6051(a)(8)).For self-employed individuals, SIMPLEcompensation means net earnings fromself-employment determined under sec-tion 1402(a) prior to subtracting any con-tributions made under the SIMPLE 401(k)plan on behalf of the individual.

(f) Vesting. All benefits attributable tocontributions described in paragraph (e) ofthis section must be nonforfeitable at alltimes.

(g) Plan year. The plan year of aSIMPLE 401(k) plan must be the wholecalendar year. Thus, in general, a SIMPLE401(k) plan can be established only onJanuary 1 and can be terminated only onDecember 31. However, in the case of anemployer that did not previously maintaina SIMPLE 401(k) plan, the establishmentdate can be as late as October 1 (or laterin the case of an employer that comes intoexistence after October 1 and establishesthe SIMPLE 401(k) plan as soon as ad-ministratively feasible after the employercomes into existence).

(h) Other rules. A SIMPLE 401(k) planis not treated as a top-heavy plan undersection 416. See section 416(g)(4)(G).

§1.401(k)–5 Special rules for mergers,acquisitions and similar events.[Reserved].

§1.401(k)–6 Definitions.

Unless otherwise provided, the defini-tions of this section govern for purposes ofsection 401(k) and the regulations thereun-der.

Actual contribution percentage (ACP)test. Actual contribution percentage testor ACP test means the test described in§1.401(m)–2(a)(1).

Actual deferral percentage (ADP). Ac-tual deferral percentage or ADP means theADP of the group of eligible employees asdefined in §1.401(k)–2(a)(2).

Actual deferral percentage (ADP)test. Actual deferral percentage test orADP test means the test described in§1.401(k)–2(a)(1).

Actual deferral ratio (ADR). Actualdeferral ratio or ADR means the ADR

of an eligible employee as defined in§1.401(k)–2(a)(3).

Cash or deferred arrangement. Cashor deferred arrangement is defined in§1.401(k)–1(a)(2).

Cash or deferred election. Cashor deferred election is defined in§1.401(k)–1(a)(3).

Compensation. Compensation meanscompensation as defined in section 414(s)and §1.414(s)–1. The period used to de-termine an employee’s compensation fora plan year must be either the plan yearor the calendar year ending within theplan year. Whichever period is selectedmust be applied uniformly to determinethe compensation of every eligible em-ployee under the plan for that plan year.A plan may, however, limit the periodtaken into account under either methodto that portion of the plan year or cal-endar year in which the employee wasan eligible employee, provided that thislimit is applied uniformly to all eligibleemployees under the plan for the planyear. In the case of an HCE whose ADRis determined under §1.401(k)–2(a)(3)(ii),period of participation includes peri-ods under another plan for which elec-tive contributions are aggregated under§1.401(k)–2(a)(3)(ii). See also section401(a)(17) and §1.401(a)(17)–1(c)(1).

Current year testing method. Currentyear testing method means the testingmethod described in §1.401(k)–2(a)(2)(ii)or 1.401(m)–2(a)(2)(ii) under which theapplicable year is the current plan year.

Elective contributions. Elective con-tributions means employer contributionsmade to a plan pursuant to a cash or de-ferred election under a cash or deferredarrangement (whether or not the arrange-ment is a qualified cash or deferred ar-rangement under §1.401(k)–1(a)(4)).

Eligible employee—(1) General rule.Eligible employee means an employeewho is directly or indirectly eligible tomake a cash or deferred election under theplan for all or a portion of the plan year.For example, if an employee must per-form purely ministerial or mechanical acts(e.g., formal application for participationor consent to payroll withholding) in orderto be eligible to make a cash or deferredelection for a plan year, the employee isan eligible employee for the plan yearwithout regard to whether the employeeperforms the acts.

January 31, 2005 424 2005–5 I.R.B.

(2) Conditions on eligibility. An em-ployee who is unable to make a cash ordeferred election because the employeehas not contributed to another plan is alsoan eligible employee. By contrast, if anemployee must perform additional service(e.g., satisfy a minimum period of ser-vice requirement) in order to be eligibleto make a cash or deferred election fora plan year, the employee is not an eli-gible employee for the plan year unlessthe service is actually performed. See§1.401(k)–1(e)(5), however, for certainlimits on the use of minimum service re-quirements. An employee who would beeligible to make elective contributions butfor a suspension due to a distribution, aloan, or an election not to participate in theplan, is treated as an eligible employee forpurposes of section 401(k)(3) for a planyear even though the employee may notmake a cash or deferred election by reasonof the suspension. Finally, an employeedoes not fail to be treated as an eligibleemployee merely because the employeemay receive no additional annual additionsbecause of section 415(c)(1).

(3) Certain one-time elections. An em-ployee is not an eligible employee merelybecause the employee, no later than theemployee’s first becoming eligible tomake a cash or deferred election underany plan or arrangement of the employer(described in section 219(g)(5)(A)), isgiven the one-time opportunity to elect,and the employee does in fact elect, notto be eligible to make a cash or deferredelection under the plan or any other planor arrangement maintained by the em-ployer (including plans not yet estab-lished) for the duration of the employee’semployment with the employer. Thisrule applies in addition to the rules in§1.401(k)–1(a)(3)(v) relating to the def-inition of a cash or deferred election. Inno event is an election made after De-cember 23, 1994, treated as a one-timeirrevocable election under this paragraphif the election is made by an employeewho previously became eligible under an-other plan or arrangement (whether or notterminated) of the employer.

Eligible HCE. Eligible HCE means aneligible employee who is an HCE.

Eligible NHCE. Eligible NHCE meansan eligible employee who is not an HCE.

Employee. Employee means an em-ployee within the meaning of §1.410(b)–9.

Employee stock ownership plan(ESOP). Employee stock ownership planor ESOP means the portion of a planthat is an ESOP within the meaning of§1.410(b)–7(c)(2).

Employer. Employer means an em-ployer within the meaning of §1.410(b)–9.

Excess contributions. Excess contri-butions means, with respect to a planyear, the amount of total excess contri-butions apportioned to an HCE under§1.401(k)–2(b)(2)(iii).

Excess deferrals. Excess deferralsmeans excess deferrals as defined in§1.402(g)–1(e)(3).

Highly compensated employee (HCE).Highly compensated employee or HCE hasthe meaning provided in section 414(q).

Matching contributions. Matching con-tributions means matching contributionsas defined in §1.401(m)–1(a)(2).

Nonelective contributions. Nonelectivecontributions means employer contribu-tions (other than matching contributions)with respect to which the employee maynot elect to have the contributions paidto the employee in cash or other benefitsinstead of being contributed to the plan.

Non-employee stock ownership plan(non-ESOP). Non-employee stock owner-ship plan or non-ESOP means the portionof a plan that is not an ESOP within themeaning of §1.410(b)–7(c)(2).

Non-highly compensated employee(NHCE). Non-highly compensated em-ployee or NHCE means an employee whois not an HCE.

Plan. Plan is defined in §1.401(k)–1(b)(4).

Pre-ERISA money purchase pensionplan. (1) Pre-ERISA money purchase pen-sion plan is a pension plan—

(i) That is a defined contribution plan(as defined in section 414(i));

(ii) That was in existence on June 27,1974, and as in effect on that date, includeda salary reduction agreement; and

(iii) Under which neither the employeecontributions nor the employer contribu-tions, including elective contributions,may exceed the levels (as a percentage ofcompensation) provided for by the contri-bution formula in effect on June 27, 1974.

(2) A plan was in existence on June 27,1974, if it was a written plan adopted on orbefore that date, even if no funds had yetbeen paid to the trust associated with theplan.

Prior year testing method. Prioryear testing method means the test-ing method under which the appli-cable year is the prior plan year, asdescribed in §1.401(k)–2(a)(2)(ii) or1.401(m)–2(a)(2)(ii).

Qualified matching contributions(QMACs). Qualified matching con-tributions or QMACs means matchingcontributions that, except as providedotherwise in §1.401(k)–1(c) and (d), sat-isfy the requirements of §1.401(k)–1(c)and (d) as though the contributions wereelective contributions, without regard towhether the contributions are actuallytaken into account under the ADP test un-der §1.401(k)–2(a)(6) or the ACP test un-der §1.401(m)–2(a)(6). Thus, the match-ing contributions must satisfy the vestingrequirements of §1.401(k)–1(c) and besubject to the distribution requirements of§1.401(k)–1(d) when they are contributedto the plan. See also §1.401(k)–2(b)(4)(iii)for a rule providing that a matching contri-bution does not fail to qualify as a QMACsolely because it is forfeitable under sec-tion 411(a)(3)(G) as a result of being amatching contribution with respect to anexcess deferral, excess contribution, orexcess aggregate contribution.

Qualified nonelective contributions(QNECs). Qualified nonelective con-tributions or QNECs means employercontributions, other than elective con-tributions or matching contributions,that, except as provided otherwise in§1.401(k)–1(c) and (d), satisfy the re-quirements of §1.401(k)–1(c) and (d)as though the contributions were elec-tive contributions, without regard towhether the contributions are actuallytaken into account under the ADP testunder §1.401(k)–2(a)(6) or the ACP testunder §1.401(m)–2(a)(6). Thus, the non-elective contributions must satisfy thevesting requirements of §1.401(k)–1(c)and be subject to the distribution require-ments of §1.401(k)–1(d) when they arecontributed to the plan.

Rural cooperative plans. Rural cooper-ative plan means a plan described in sec-tion 401(k)(7).

Par. 5. Sections 1.401(m)–0 through1.401(m)–2 are revised and sections1.401(m)–3 through 1.401(m)–5 are addedto read as follows:

2005–5 I.R.B. 425 January 31, 2005

§1.401(m)–0 Table of contents.

This section contains first a list of sec-tion headings and then a list of the para-graphs in each section in §§1.401(m)–1through 1.401(m)–5.

LIST OF SECTIONS

§1.401(m)–1 Employee contributionsand matching contributions.

§1.401(m)–2 ACP test.§1.401(m)–3 Safe harbor requirements.§1.401(m)–4 Special rules for mergers,

acquisitions and similar events. [Re-served].

§1.401(m)–5 Definitions.

LIST OF PARAGRAPHS

§1.401(m)–1 Employee contributions andmatching contributions.

(a) General nondiscrimination rules.(1) Nondiscriminatory amount of con-

tributions.(i) Exclusive means of amounts testing.(ii) Testing benefits, rights and features.(2) Matching contributions.(i) In general.(ii) Employer contributions made on ac-

count of an employee contribution or elec-tive deferral.

(iii) Employer contributions not on ac-count of an employee contribution or elec-tive deferral.

(A) General rule.(B) Special rule for forfeitures and re-

leased ESOP shares.(C) Exception for bona fide administra-

tive considerations.(3) Employee contributions.(i) In general.(ii) Certain contributions not treated as

employee contributions.(iii) Qualified cost-of-living arrange-

ments.(b) Nondiscrimination requirements for

amount of contributions.(1) Matching contributions and em-

ployee contributions.(2) Automatic satisfaction by certain

plans.(3) Anti-abuse provisions.(4) Aggregation and restructuring.(i) In general.(ii) Aggregation of employee contribu-

tions and matching contributions within aplan.

(iii) Aggregation of plans.(A) In general.(B) Arrangements with inconsistent

ACP testing methods.(iv) Disaggregation of plans and sepa-

rate testing.(A) In general.(B) Restructuring prohibited.(v) Certain disaggregation rules not ap-

plicable.(c) Additional requirements.(1) Separate testing for employee con-

tributions and matching contributions.(2) Plan provision requirement.(d) Effective date.(1) General rule.(2) Early implementation permitted.(3) Applicability of prior regulations.

§1.401(m)–2 ACP test.

(a) Actual contribution percentage(ACP) test.

(1) In general.(i) ACP test formula.(ii) HCEs as sole eligible employees.(iii) Special rule for early participation.(2) Determination of ACP.(i) General rule.(ii) Determination of applicable year

under current year and prior year testingmethod.

(3) Determination of ACR.(i) General rule.(ii) ACR of HCEs eligible under more

than one plan.(A) General rule.(B) Plans not permitted to be aggre-

gated.(iii) Example.(4) Employee contributions and match-

ing contributions taken into account underthe ACP test.

(i) Employee contributions.(ii) Recharacterized elective contribu-

tions.(iii) Matching contributions.(5) Employee contributions and match-

ing contributions not taken into accountunder the ACP test.

(i) General rule.(ii) Disproportionate matching contri-

butions.(A) Matching contributions in excess of

100%.(B) Representative matching rate.(C) Definition of matching rate.

(iii) Qualified matching contributionsused to satisfy the ADP test.

(iv) Matching contributions taken intoaccount under safe harbor provisions.

(v) Treatment of forfeited matchingcontributions.

(vi) Additional employee contributionsor matching contributions pursuant to sec-tion 414(u).

(6) Qualified nonelective contributionsand elective contributions that may betaken into account under the ACP test.

(i) Timing of allocation.(ii) Elective contributions taken into ac-

count under the ACP test.(iii) Requirement that amount satisfy

section 401(a)(4).(iv) Aggregation must be permitted.(v) Disproportionate contributions not

taken into account.(A) General rule.(B) Definition of representative contri-

bution rate.(C) Definition of applicable contribu-

tion rate.(D) Special rule for prevailing wage

contributions.(vi) Contribution only used once.(7) Examples.(b) Correction of excess aggregate con-

tributions.(1) Permissible correction methods.(i) In general.(A) Additional contributions.(B) Excess aggregate contributions dis-

tributed or forfeited.(ii) Combination of correction methods.(iii) Exclusive means of correction.(2) Correction through distribution.(i) General rule.(ii) Calculation of total amount to be

distributed.(A) Calculate the dollar amount of

excess aggregate contributions for eachHCE.

(B) Determination of the total amountof excess aggregate contributions.

(C) Satisfaction of ACP.(iii) Apportionment of total amount of

excess aggregate contributions among theHCEs.

(A) Calculate the dollar amount ofexcess aggregate contributions for eachHCE.

(B) Limit on amount apportioned to anyHCE.

(C) Apportionment to additional HCEs.

January 31, 2005 426 2005–5 I.R.B.

(iv) Income allocable to excess aggre-gate contributions.

(A) General rule.(B) Method of allocating income.(C) Alternative method of allocating in-

come for the plan year.(D) Safe harbor method of allocating

gap period income.(E) Alternative method of allocating

plan year and gap period income.(F) Allocable income for recharacter-

ized elective contributions.(v) Distribution and forfeiture.(vi) Tax treatment of corrective distri-

butions.(A) General rule.(B) Rule for de minimis distributions.(3) Other rules.(i) No employee or spousal consent re-

quired.(ii) Treatment of corrective distribu-

tions and forfeited contributions as em-ployer contributions.

(iii) No reduction of required minimumdistribution.

(iv) Partial correction.(v) Matching contributions on excess

contributions, excess deferrals and excessaggregate contributions.

(A) Corrective distributions not permit-ted.

(B) Coordination with section401(a)(4).

(vi) No requirement for recalculation.(4) Failure to timely correct.(i) Failure to correct within 21/2 months

after end of plan year.(ii) Failure to correct within 12 months

after end of plan year.(5) Examples.(c) Additional rules for prior year test-

ing method.(1) Rules for change in testing method.(2) Calculation of ACP under the prior

year testing method for the first plan year.(i) Plans that are not successor plans.(ii) First plan year defined.(iii) Plans that are successor plans.(3) Plans using different testing meth-

ods for the ACP and ADP test.(4) Rules for plan coverage change.(i) In general.(ii) Optional rule for minor plan cover-

age changes.(iii) Definitions.

(A) Plan coverage change.(B) Prior year subgroup.(C) Weighted average of the ACPs for

the prior year subgroups.(iv) Examples.

§1.401(m)–3 Safe harbor requirements.

(a) ACP test safe harbor.(b) Safe harbor nonelective contribu-

tion requirement.(c) Safe harbor matching contribution

requirement.(d) Limitation on contributions.(1) General rule.(2) Matching rate must not increase.(3) Limit on matching contributions.(4) Limitation on rate of match.(5) HCEs participating in multiple

plans.(6) Permissible restrictions on elective

deferrals by NHCEs.(i) General rule.(ii) Restrictions on election periods.(iii) Restrictions on amount of contribu-

tions.(iv) Restrictions on types of compensa-

tion that may be deferred.(v) Restrictions due to limitations under

the Internal Revenue Code.(e) Notice requirement.(f) Plan year requirement.(1) General rule.(2) Initial plan year.(3) Change of plan year.(4) Final plan year.(g) Plan amendments adopting nonelec-

tive safe harbor contributions.(h) Permissible reduction or suspension

of safe harbor matching contributions.(1) General rule.(2) Notice of suspension requirement.(i) Reserved.(j) Other rules.(1) Contributions taken into account.(2) Use of safe harbor nonelective con-

tributions to satisfy other nondiscrimina-tion tests.

(3) Early participation rules.(4) Satisfying safe harbor contribution

requirement under another defined contri-bution plan.

(5) Contributions used only once.(6) Plan must satisfy ACP with respect

to employee contributions.

§1.401(m)–4 Special rules for mergers,acquisitions and similar events.[Reserved].

§1.401(m)–5 Definitions.

§1.401(m)–1 Employee contributions andmatching contributions.

(a) General nondiscriminationrules—(1) Nondiscriminatory amountof contributions—(i) Exclusive means ofamounts testing. A defined contributionplan does not satisfy section 401(a) for aplan year unless the amount of employeecontributions and matching contributionsto the plan for the plan year satisfies sec-tion 401(a)(4). The amount of employeecontributions and matching contributionsunder a plan satisfies the requirements ofsection 401(a)(4) with respect to amountsif and only if the amount of employeecontributions and matching contributionssatisfies the nondiscrimination test of sec-tion 401(m) under paragraph (b) of thissection and the plan satisfies the additionalrequirements of paragraph (c) of this sec-tion. See §1.401(a)(4)–1(b)(2)(ii)(B).

(ii) Testing benefits, rights and fea-tures. A plan that provides for employeecontributions or matching contributionsmust satisfy the requirements of section401(a)(4) relating to benefits, rights andfeatures in addition to the requirementregarding amounts described in paragraph(a)(1)(i) of this section. For example,the right to make each level of employeecontributions and the right to each levelof matching contributions under the planare benefits, rights or features subject tothe requirements of section 401(a)(4).See §1.401(a)(4)–4(e)(3)(i) and (iii)(F)through (G).

(2) Matching contributions—(i) Ingeneral. For purposes of section 401(m),this section and §§1.401(m)–2 through1.401(m)–5, matching contributions are—

(A) Any employer contribution (includ-ing a contribution made at the employer’sdiscretion) to a defined contribution planon account of an employee contribution toa plan maintained by the employer;

(B) Any employer contribution (includ-ing a contribution made at the employer’sdiscretion) to a defined contribution planon account of an elective deferral; and

2005–5 I.R.B. 427 January 31, 2005

(C) Any forfeiture allocated on the basisof employee contributions, matching con-tributions, or elective deferrals.

(ii) Employer contributions made onaccount of an employee contribution orelective deferral. Whether an employercontribution is made on account of anemployee contribution or an elective de-ferral is determined on the basis of all therelevant facts and circumstances, includ-ing the relationship between the employercontribution and employee actions outsidethe plan. An employer contribution madeto a defined contribution plan on accountof contributions made by an employeeunder an employer-sponsored savings ar-rangement that are not held in a plan thatis intended to be a qualified plan or otherarrangement described in §1.402(g)–1(b)is not a matching contribution.

(iii) Employer contributions not on ac-count of an employee contribution or elec-tive deferral—(A) General rule. Employercontributions are not matching contribu-tions made on account of elective defer-rals if they are contributed before the cashor deferred election is made or before theemployees’ performance of services withrespect to which the elective deferrals aremade (or when the cash that is subject tothe cash or deferred elections would becurrently available, if earlier). In addition,an employer contribution is not a matchingcontribution made on account of an em-ployee contribution if it is contributed be-fore the employee contribution.

(B) Exceptions for forfeitures andreleased ESOP shares. The rule of para-graph (a)(3)(iii)(A) of this section doesnot apply to a forfeiture that is allocatedas a matching contribution. In addi-tion, an allocation of shares from anESOP loan suspense account describedin §54.4975–11(c) and (d) of this chapterwill not fail to be treated as a matchingcontribution solely because the employercontribution that resulted in the releaseand allocation of those shares from thesuspense account is made before the em-ployees’ performance of services withrespect to which the elective deferrals aremade (or when the cash that is subject tothe cash or deferred elections would becurrently available, if earlier) providedthat—

(1) The contribution is for a requiredpayment that is due under the loan terms;and

(2) The contribution is not made earlywith a principal purpose of acceleratingdeductions.

(C) Exception for bona fide admin-istrative considerations. The timing ofcontributions will not be treated as fail-ing to satisfy the requirements of thisparagraph (a)(3)(iii) merely because con-tributions are occasionally made beforethe employees’ performance of serviceswith respect to which the elective deferralsare made (or when the cash that is subjectto the cash or deferred elections wouldbe currently available, if earlier) in orderto accommodate bona fide administrativeconsiderations and are not paid early witha principal purpose of accelerating deduc-tions.

(3) Employee contributions—(i) Ingeneral. For purposes of section 401(m),this section and §§1.401(m)–2 through1.401(m)–5, employee contributions arecontributions to a plan that are designatedor treated at the time of contribution asafter-tax employee contributions (e.g., bytreating the contributions as taxable in-come subject to applicable withholdingrequirements) and are allocated to an indi-vidual account for each eligible employeeto which attributable earnings and lossesare allocated. See §1.401(k)–1(a)(2)(ii).The term employee contributions in-cludes—

(A) Employee contributions to the de-fined contribution portion of a plan de-scribed in section 414(k);

(B) Employee contributions applied tothe purchase of whole life insurance pro-tection or survivor benefit protection undera defined contribution plan;

(C) Amounts attributable to excesscontributions within the meaning of sec-tion 401(k)(8)(B) that are recharacter-ized as employee contributions under§1.401(k)–2(b)(3); and

(D) Employee contributions to a plan orcontract that satisfies the requirements ofsection 403(b).

(ii) Certain contributions not treatedas employee contributions. The termemployee contributions does not includedesignated Roth contributions, repaymentof loans, rollover contributions, repay-ment of distributions described in section411(a)(7)(C), or employee contributionsthat are transferred to the plan from an-other plan.

(iii) Qualified cost-of-living arrange-ments. Employee contributions to a quali-fied cost-of-living arrangement describedin section 415(k)(2)(B) are treated asemployee contributions to a defined con-tribution plan, without regard to the re-quirement that the employee contributionsbe allocated to an individual account towhich attributable earnings and losses areallocated.

(b) Nondiscrimination requirements foramount of contributions—(1) Matchingcontributions and employee contributions.The matching contributions and employeecontributions under a plan satisfy thisparagraph (b) for a plan year only if theplan satisfies—

(i)The ACP test of section 401(m)(2)described in §1.401(m)–2;

(ii) The ACP safe harbor provi-sions of section 401(m)(11) describedin §1.401(m)–3; or

(iii) The SIMPLE 401(k) provisions ofsections 401(k)(11) and 401(m)(10) de-scribed in §1.401(k)–4.

(2) Automatic satisfaction by certainplans. Notwithstanding paragraph (b)(1)of this section, the requirements of thissection are treated as satisfied with re-spect to employee contributions andmatching contributions under a collec-tively bargained plan (or the portion ofa plan) that automatically satisfies sec-tion 410(b). See §§1.401(a)(4)–1(c)(5)and 1.410(b)–2(b)(7). Additionally, therequirements of sections 401(a)(4) and410(b) do not apply to a governmen-tal plan (within the meaning of section414(d)) maintained by a State or local gov-ernment or political subdivision thereof(or agency or instrumentality thereof)and, accordingly such plans are not re-quired to comply with this section. Seesections 401(a)(5)(G), 403(b)(12)(C) and410(c)(1)(A).

(3) Anti-abuse provisions. Sections1.401(m)–1 through 1.401(m)–5 aredesigned to provide simple, practicalrules that accommodate legitimate planchanges. At the same time, the rules areintended to be applied by employers in amanner that does not make use of changesin plan testing procedures or other planprovisions to inflate inappropriately theACP for NHCEs (which is used as abenchmark for testing the ACP for HCEs)or to otherwise manipulate the nondis-crimination testing requirements of this

January 31, 2005 428 2005–5 I.R.B.

paragraph (b). Further, this paragraph (b)is part of the overall requirement that ben-efits or contributions not discriminate infavor of HCEs. Therefore, a plan will notbe treated as satisfying the requirementsof this paragraph (b) if there are repeatedchanges to plan testing procedures or planprovisions that have the effect of distort-ing the ACP so as to increase significantlythe permitted ACP for HCEs, or otherwisemanipulate the nondiscrimination rules ofthis paragraph, if a principal purpose ofthe changes was to achieve such a result.

(4) Aggregation and restructuring—(i)In general. This paragraph (b)(4) con-tains the exclusive rules for aggregatingand disaggregating plans that provide foremployee contributions and matching con-tributions for purposes of this section and§§1.401(m)–2 through 1.401(m)–5.

(ii) Aggregation of employee contribu-tions and matching contributions withina plan. Except as otherwise specificallyprovided in this paragraph (b)(4) and§1.401(m)–3(j)(6), a plan must be subjectto a single test under paragraph (b)(1) ofthis section with respect to all employeecontributions and matching contribu-tions and all eligible employees under theplan. Thus, for example, if two groupsof employees are eligible for matchingcontributions under a plan, all employeecontributions and matching contributionsunder the plan must be subject to a singletest, even if they have significantly dif-ferent features, such as different rates ofmatch.

(iii) Aggregation of plans—(A) Ingeneral. The term plan means a planwithin the meaning of §1.410(b)–7(a) and(b), after application of the mandatorydisaggregation rules of §1.410(b)–7(c),and the permissive aggregation rules of§1.410(b)–7(d), as modified by paragraph(b)(4)(v) of this section. Thus, for ex-ample, two plans (within the meaning of§1.410(b)–7(b)) that are treated as a singleplan pursuant to the permissive aggrega-tion rules of §1.410(b)–7(d) are treatedas a single plan for purposes of sections401(k) and 401(m).

(B) Arrangements with inconsistentACP testing methods. Pursuant to para-graph (b)(4)(ii) of this section, a singletesting method must apply with respect toall employee contributions and matchingcontributions and all eligible employeesunder a plan. Thus, in applying the permis-

sive aggregation rules of §1.410(b)–7(d),an employer may not aggregate plans(within the meaning of §1.410(b)–7(b))that apply inconsistent testing methods.For example, a plan (within the meaningof §1.410(b)–7) that applies the currentyear testing method may not be aggre-gated with another plan that applies theprior year testing method. Similarly, anemployer may not aggregate a plan (withinthe meaning of §1.410(b)–7) that is usingthe ACP safe harbor provisions of section401(m)(11) and another plan that is usingthe ACP test of section 401(m)(2).

(iv) Disaggregation of plans and sepa-rate testing—(A) In general. If employeecontributions or matching contributionsare included in a plan (within the mean-ing of §1.410(b)–7(b)) that is mandatorilydisaggregated under the rules of section410(b) (as modified by this paragraph(b)(4)), the matching contributions andemployee contributions under that planmust be disaggregated in a consistentmanner. For example, in the case ofan employer that is treated as operatingqualified separate lines of business undersection 414(r), if the eligible employeesunder a plan which provides for employeecontributions or matching contributionsare in more than one qualified separate lineof business, only those employees withineach qualified separate line of businessmay be taken into account in determiningwhether each disaggregated portion of theplan complies with the requirements ofsection 401(m), unless the employer is ap-plying the special rule for employer-wideplans in §1.414(r)–1(c)(2)(ii) with re-spect to the plan. Similarly, if a plan thatprovides for employee contributions ormatching contributions under which em-ployees are permitted to participate beforethey have completed the minimum age andservice requirements of section 410(a)(1)applies section 410(b)(4)(B) for determin-ing whether the plan complies with section410(b)(1), then the plan must be treatedas two separate plans, one comprisingall eligible employees who have met theminimum age and service requirements ofsection 410(a)(1) and one comprising alleligible employees who have not met theminimum age and service requirements ofsection 410(a)(1), unless the plan is usingthe rule in §1.401(m)–2(a)(1)(iii)(A).

(B) Restructuring prohibited. Restruc-turing under §1.401(a)(4)–9(c) may not

be used to demonstrate compliance withthe requirements of section 401(m). See§1.401(a)(4)–9(c)(3)(ii).

(v) Certain disaggregation rules notapplicable. The mandatory disaggre-gation rules relating to section 401(k)plans and section 401(m) plans set forthin §1.410(b)–7(c)(1) and to ESOP andnon-ESOP portions of a plan set forth in§1.410(b)–7(c)(2) shall not apply for pur-poses of this section and §§1.401(m)–2through 1.401(m)–5. Accordingly, not-withstanding §1.410(b)–7(d)(2), an ESOPand a non-ESOP which are different plans(within the meaning of section 414(l), asdescribed in §1.410(b)–7(b)) are permittedto be aggregated for these purposes.

(c) Additional requirements—(1) Sepa-rate testing for employee contributionsand matching contributions. Under§1.410(b)–7(c)(1), the group of employeeswho are eligible to make employee con-tributions or eligible to receive matchingcontributions must satisfy the require-ments of section 410(b) as if those em-ployees were covered under a separateplan. The determination of whether theseparate plan satisfies the requirementsof section 410(b) must be made withoutregard to the modifications to the dis-aggregation rules set forth in paragraph(b)(4)(v) of this section. In addition, ex-cept as expressly permitted under section401(k), 410(b)(2)(A)(ii), or 416(c)(2)(A),employee contributions, matching contri-butions and elective contributions takeninto account under §1.401(m)–2(a)(6) maynot be taken into account for purposes ofdetermining whether any other contribu-tions under any plan (including the planto which the employee contributions ormatching contributions are made) satisfythe requirements of section 401(a). Seealso §1.401(a)(4)–11(g)(3)(vii) for specialrules relating to corrections of violationsof the minimum coverage requirements ordiscriminatory rates of matching contribu-tions.

(2) Plan provision requirement. Aplan that provides for employee contribu-tions or matching contributions satisfiesthis section only if it provides that thenondiscrimination requirements of section401(m) will be met. Thus, the plan mustprovide for satisfaction of one of the spe-cific alternatives described in paragraph(b)(1) of this section and, if with respect tothat alternative there are optional choices,

2005–5 I.R.B. 429 January 31, 2005

which of the optional choices will apply.For example, a plan that uses the ACPtest of section 401(m)(2), as described inparagraph (b)(1)(i) of this section, mustspecify whether it is using the currentyear testing method or prior year testingmethod. Additionally, a plan that usesthe prior year testing method must spec-ify whether the ACP for eligible NHCEsfor the first plan year is 3% or the ACPfor the eligible NHCEs for the first planyear. Similarly, a plan that uses the safeharbor method of section 401(m)(11), asdescribed in paragraph (b)(1)(ii) of thissection, must specify whether the safe har-bor contribution will be the nonelectivesafe harbor contribution or the matchingsafe harbor contribution and is not per-mitted to provide that ACP testing willbe used if the requirements for the safeharbor are not satisfied. For purposes ofthis paragraph (c)(2), a plan may incorpo-rate by reference the provisions of section401(m)(2) and §1.401(m)–2 if that is thenondiscrimination test being applied. TheCommissioner may, in guidance of gen-eral applicability, published in the InternalRevenue Bulletin (see §601.601(d)(2) ofthis chapter), specify the options that willapply under the plan if the nondiscrimi-nation test is incorporated by reference inaccordance with the preceding sentence.

(d) Effective date—(1) General rule.Except as otherwise provided in this para-graph (d), this section and §§1.401(m)–2through 1.401(m)–5 apply to plan yearsthat begin on or after January 1, 2006.

(2) Early implementation permitted.A plan is permitted to apply the rules ofthis section and §§1.401(m)–2 through1.401(m)–5 to any plan year that endsafter December 29, 2004, provided theplan applies all the rules of this sectionand §§1.401(m)–2 through 1.401(m)–5and all the rules of §§1.401(k)–1 through1.401(k)–6, to the extent applicable, forthat plan year and all subsequent planyears.

(3) Applicability of prior regulations.For any plan year, before a plan appliesthis section and §§1.401(m)–2 through1.401(m)–5 (either the first plan year be-ginning on or after January 1, 2006 orsuch earlier year, as provided in paragraph(d)(2) of this section), §1.401(m)–1 and§1.401(m)–2 (as they appeared in the April1, 2004 edition of 26 CFR part 1) applyto the plan to the extent those sections, as

they so appear, reflect the statutory provi-sions of section 401(m) as in effect for therelevant year.

§1.401(m)–2 ACP test.

(a) Actual contribution percentage(ACP) test—(1) In general—(i) ACP testformula. A plan satisfies the ACP test fora plan year only if—

(A) The ACP for the eligible HCEs forthe plan year is not more than the ACP forthe eligible NHCEs for the applicable yearmultiplied by 1.25; or

(B) The excess of the ACP for the eli-gible HCEs for the plan year over the ACPfor the eligible NHCEs for the applicableyear is not more than 2 percentage points,and the ACP for the eligible HCEs for theplan year is not more than the ACP forthe eligible NHCEs for the applicable yearmultiplied by 2.

(ii) HCEs as sole eligible employees. If,for the applicable year there are no eligibleNHCEs (i.e., all of the eligible employeesunder the plan for the applicable year areHCEs), the plan is deemed to satisfy theACP test.

(iii) Special rule for early participation.If a plan providing for employee contribu-tions or matching contributions providesthat employees are eligible to participatebefore they have completed the minimumage and service requirements of section410(a)(1)(A), and if the plan applies sec-tion 410(b)(4)(B) in determining whetherthe plan meets the requirements of section410(b)(1), then in determining whether theplan meets the requirements under para-graph (a)(1) of this section either—

(A) Pursuant to section 401(m)(5)(C),the ACP test is performed under the plan(determined without regard to disaggrega-tion under §1.410(b)–7(c)(3)), using theACP for all eligible HCEs for the plan yearand the ACP of eligible NHCEs for the ap-plicable year, disregarding all NHCEs whohave not met the minimum age and servicerequirements of section 410(a)(1)(A); or

(B) Pursuant to §1.401(m)–1(b)(4), theplan is disaggregated into separate plansand the ACP test is performed separatelyfor all eligible employees who have com-pleted the minimum age and service re-quirements of section 410(a)(1)(A) and forall eligible employees who have not com-pleted the minimum age and service re-quirements of section 410(a)(1)(A).

(2) Determination of ACP—(i) Generalrule. The ACP for a group of eligibleemployees (either eligible HCEs or eligi-ble NHCEs) for a plan year or applicableyear is the average of the ACRs of eligi-ble employees in the group for that year.The ACP for a group of eligible employ-ees is calculated to the nearest hundredthof a percentage point.

(ii) Determination of applicable yearunder current year and prior year testingmethod. The ACP test is applied usingthe prior year testing method or the cur-rent year testing method. Under the prioryear testing method, the applicable yearfor determining the ACP for the eligibleNHCEs is the plan year immediately pre-ceding the plan year for which the ACP testis being calculated. Under the prior yeartesting method, the ACP for the eligibleNHCEs is determined using the ACRs forthe eligible employees who were NHCEsin that preceding plan year, regardless ofwhether those NHCEs are eligible employ-ees or NHCEs in the plan year for whichthe ACP test is being performed. Underthe current year testing method, the appli-cable year for determining the ACP for el-igible NHCEs is the same plan year as theplan year for which the ACP test is beingcalculated. Under either method, the ACPfor the eligible HCEs is determined usingthe ACRs of eligible employees who areHCEs for the plan year for which the ACPtest is being performed. See paragraph (c)of this section for additional rules for theprior year testing method.

(3) Determination of ACR—(i) Generalrule. The ACR of an eligible employeefor the plan year or applicable year is thesum of the employee contributions andmatching contributions taken into accountwith respect to such employee (determinedunder the rules of paragraphs (a)(4) and(5) of this section), and the qualified non-elective and elective contributions takeninto account under paragraph (a)(6) of thissection for the year, divided by the em-ployee’s compensation taken into accountfor the year. The ACR is calculated to thenearest hundredth of a percentage point. Ifno employee contributions, matching con-tributions, elective contributions, or qual-ified nonelective contributions are takeninto account under this section with respectto an eligible employee for the year, theACR of the employee is zero.

January 31, 2005 430 2005–5 I.R.B.

(ii) ACR of HCEs eligible under morethan one plan—(A) General rule. Pur-suant to section 401(m)(2)(B), the ACRof an HCE who is an eligible employeein more than one plan of an employer towhich matching contributions or employeecontributions are made is calculated bytreating all contributions with respect tosuch HCE under any such plan as beingmade under the plan being tested. Thus,the ACR for such an HCE is calculatedby accumulating all matching contribu-tions and employee contributions underany plan (other than a plan described inparagraph (a)(3)(ii)(B) of this section) thatwould be taken into account under thissection for the plan year, if the plan underwhich the contribution was made appliedthis section and had the same plan year.For example, in the case of a plan witha 12-month plan year, the ACR for theplan year of that plan for an HCE whoparticipates in multiple plans of the sameemployer that provide for matching con-tributions or employee contributions isthe sum of all such contributions duringsuch 12-month period that would be takeninto account with respect to the HCEunder all plans in which the HCE is aneligible employee, divided by the HCE’scompensation for that 12-month period(determined using the compensation def-inition for the plan being tested), withoutregard to the plan year of the other plansand whether those plans are satisfying thissection or §1.401(m)–3.

(B) Plans not permitted to be aggre-gated. Contributions under plans thatare not permitted to be aggregated under§1.401(m)–1(b)(4) (determined withoutregard to the prohibition on aggregatingplans with inconsistent testing methodsset forth in §1.401(m)–1(b)(4)(iii)(B)and the prohibition on aggregating planswith different plan years set forth in§1.410(b)–7(d)(5)) are not aggregatedunder this paragraph (a)(3)(ii).

(iii) Example. The following exam-ple illustrates the application of para-graph (a)(3)(ii) of this section. See also§1.401(k)–2(a)(3)(iii) for additional ex-amples of the application of the parallelrule under section 401(k)(3)(A). The ex-ample is as follows:

Example. Employee A, an HCE with compen-sation of $120,000, is eligible to make employeecontributions under Plan S and Plan T, two calen-dar-year profit-sharing plans of Employer H. Plan

S and Plan T use the same definition of compensa-tion. Plan S provides a match equal to 50% of eachemployee’s contributions and Plan T has no match.During the current plan year, Employee A elects tocontribute $4,000 in employee contributions to PlanT and $4,000 in employee contributions to Plan S.There are no other contributions made on behalf ofEmployee A. Each plan must calculate Employee A’sACR by dividing the total employee contributionsby Employee A and matching contributions underboth plans by $120,000. Therefore, Employee A’sACR under each plan is 8.33% ($4,000+ $4,000+$2,000/$120,000).

(4) Employee contributions and match-ing contributions taken into account underthe ACP test—(i) Employee contributions.An employee contribution is taken into ac-count in determining the ACR for an eligi-ble employee for the plan year or applica-ble year in which the contribution is made.For purposes of the preceding sentence, anamount withheld from an employee’s pay(or a payment by the employee to an agentof the plan) is treated as contributed at thetime of such withholding (or payment) ifthe funds paid are transmitted to the trustwithin a reasonable period after the with-holding (or payment).

(ii) Recharacterized elective contribu-tions. Excess contributions recharacter-ized in accordance with §1.401(k)–2(b)(3)are taken into account as employee con-tributions for the plan year that includesthe time at which the excess contributionis includible in the gross income of the em-ployee under §1.401(k)–2(b)(3)(ii).

(iii) Matching contributions. A match-ing contribution is taken into account indetermining the ACR for an eligible em-ployee for a plan year or applicable yearonly if each of the following requirementsis satisfied—

(A) The matching contribution is allo-cated to the employee’s account under theterms of the plan as of a date within thatyear;

(B) The matching contribution is madeon account of (or the matching contri-bution is allocated on the basis of) theemployee’s elective deferrals or employeecontributions for that year; and

(C) The matching contribution is actu-ally paid to the trust no later than the end ofthe 12-month period immediately follow-ing the year that contains that date.

(5) Employee contributions and match-ing contributions not taken into accountunder the ACP test—(i) General rule.Matching contributions that do not satisfythe requirements of paragraph (a)(4)(iii)

of this section may not be taken into ac-count in the ACP test for the plan yearwith respect to which the contributionswere made, or for any other plan year.Instead, the amount of the matching con-tributions must satisfy the requirementsof section 401(a)(4) (without regard tothe ACP test) for the plan year for whichthey are allocated under the plan as if theywere nonelective contributions and werethe only nonelective contributions for thatyear. See §§1.401(a)(4)–1(b)(2)(ii)(B)and 1.410(b)–7(c)(1).

(ii) Disproportionate matching contri-butions—(A) Matching contributions inexcess of 100%. A matching contributionwith respect to an elective deferral for anNHCE is not taken into account underthe ACP test to the extent it exceeds thegreatest of:

(1) 5% of compensation;(2) the employee’s elective deferrals for

a year; and(3) the product of 2 times the plan’s

representative matching rate and the em-ployee’s elective deferrals for a year.

(B) Representative matching rate. Forpurposes of this paragraph (a)(5)(ii), theplan’s representative matching rate isthe lowest matching rate for any eligibleNHCE among a group of NHCEs that con-sists of half of all eligible NHCEs in theplan for the plan year who make electivedeferrals for the plan year (or, if greater,the lowest matching rate for all eligibleNHCEs in the plan who are employed bythe employer on the last day of the planyear and who make elective deferrals forthe plan year).

(C) Definition of matching rate. Forpurposes of this paragraph (a)(5)(ii), thematching rate for an employee generally isthe matching contributions made for suchemployee divided by the employee’s elec-tive deferrals for the year. If the matchingrate is not the same for all levels of electivedeferrals for an employee, the employee’smatching rate is determined assuming thatan employee’s elective deferrals are equalto 6 percent of compensation.

(D) Application to matching contribu-tions that match employee contributions.If a plan provides a match with respectto the sum of the employee’s employeecontributions and elective deferrals, thatsum is substituted for the amount of theemployee’s elective deferrals in para-graphs (a)(5)(ii)(A) and (C) of this section

2005–5 I.R.B. 431 January 31, 2005

and employees who make either em-ployee contributions or elective deferralsare taken into account under paragraph(a)(5)(ii)(B) of this section. Similarly, ifa plan provides a match with respect tothe employee’s employee contributions,but not elective deferrals, the employee’semployee contributions are substitutedfor the amount of the employee’s electivedeferrals in paragraphs (a)(5)(ii) (A) and(C) of this section and employees whomake employee contributions are takeninto account under paragraph (a)(5)(ii)(B)of this section.

(iii) Qualified matching contributionsused to satisfy the ADP test. Qualifiedmatching contributions that are takeninto account for the ADP test of section401(k)(3) under §1.401(k)–2(a)(6) are nottaken into account in determining an eligi-ble employee’s ACR.

(iv) Matching contributions taken intoaccount under safe harbor provisions. Aplan that satisfies the ACP safe harborrequirements of section 401(m)(11) fora plan year but nonetheless must satisfythe requirements of this section becauseit provides for employee contributionsfor such plan year is permitted to applythis section disregarding all matchingcontributions with respect to all eligibleemployees. In addition, a plan that satis-fies the ADP safe harbor requirements of§1.401(k)–3 for a plan year using quali-fied matching contributions but does notsatisfy the ACP safe harbor requirementsof section 401(m)(11) for such plan year ispermitted to apply this section by exclud-ing matching contributions with respect toall eligible employees that do not exceed4% of each employee’s compensation. Ifa plan disregards matching contributionspursuant to this paragraph (a)(5)(iv), thedisregard must apply with respect to alleligible employees.

(v) Treatment of forfeited matching con-tributions. A matching contribution that isforfeited because the contribution to whichit relates is treated as an excess contribu-tion, excess deferral, or excess aggregatecontribution is not taken into account forpurposes of this section.

(vi) Additional employee contributionsor matching contributions pursuant to sec-tion 414(u). Additional employee contri-butions and matching contributions madeby reason of an eligible employee’s qual-ified military service under section 414(u)

are not taken into account under paragraph(a)(4) of this section for the plan year forwhich the contributions are made, or forany other plan year.

(6) Qualified nonelective contributionsand elective contributions that may betaken into account under the ACP test.Qualified nonelective contributions andelective contributions may be taken intoaccount in determining the ACR for aneligible employee for a plan year or ap-plicable year, but only to the extent thecontributions satisfy the following re-quirements—

(i) Timing of allocation. The quali-fied nonelective contribution is allocatedto the employee’s account as of a datewithin that year (within the meaning of§1.401(k)–2(a)(4)(i)(A)) and the electivecontribution satisfies §1.401(k)–2(a)(4)(i).Consequently, under the prior year test-ing method, in order to be taken into ac-count in calculating the ACP for the groupof eligible NHCEs for the applicable year,a qualified nonelective contribution mustbe contributed no later than the end of the12-month period following the applicableyear even though the applicable year is dif-ferent than the plan year being tested.

(ii) Elective contributions taken intoaccount under the ACP test. Elective con-tributions may be taken into account forthe ACP test only if the cash or deferredarrangement under which the elective con-tributions are made is required to satisfythe ADP test in §1.401(k)–2(a)(1) and,then only to the extent that the cash ordeferred arrangement would satisfy thattest, including such elective contributionsin the ADP for the plan year or applicableyear. Thus, for example, elective deferralsmade pursuant to a salary reduction agree-ment under an annuity described in section403(b) are not permitted to be taken intoaccount in an ACP test. Similarly, electivecontributions under a cash or deferred ar-rangement that is using the section 401(k)safe harbor described in §1.401(k)–3 can-not be taken into account in an ACP test.

(iii) Requirement that amount satisfysection 401(a)(4). The amount of non-elective contributions, including thosequalified nonelective contributions takeninto account under this paragraph (a)(6)and those qualified nonelective contribu-tions taken into account for the ADP testunder paragraph §1.401(k)–2(a)(6), andthe amount of nonelective contributions,

excluding those qualified nonelectivecontributions taken into account underthis paragraph (a)(6) for the ACP testand those qualified nonelective contri-butions taken into account for the ADPtest under paragraph §1.401(k)–2(a)(6),satisfies the requirements of section401(a)(4). See §1.401(a)(4)–1(b)(2). Inthe case of an employer that is apply-ing the special rule for employer-wideplans in §1.414(r)–1(c)(2)(ii) with re-spect to the plan, the determination ofwhether the qualified nonelective contri-butions satisfy the requirements of thisparagraph (a)(6)(iii) must be made on anemployer-wide basis regardless of whetherthe plans to which the qualified nonelec-tive contributions are made are satisfyingthe requirements of section 410(b) on anemployer-wide basis. Conversely, in thecase of an employer that is treated as oper-ating qualified separate lines of business,and does not apply the special rule for em-ployer-wide plans in §1.414(r)–1(c)(2)(ii)with respect to the plan, then the determi-nation of whether the qualified nonelectivecontributions satisfy the requirements ofthis paragraph (a)(6)(iii) is not permittedto be made on an employer-wide basisregardless of whether the plans to whichthe qualified nonelective contributions aremade are satisfying the requirements ofsection 410(b) on that basis.

(iv) Aggregation must be permitted.The plan that provides for employee ormatching contributions and the plan orplans to which the qualified nonelectivecontributions or elective contributions aremade are plans that would be permitted tobe aggregated under §1.401(m)–1(b)(4).If the plan year of the plan that providesfor employee or matching contributionsis changed to satisfy the requirement un-der §1.410(b)–7(d)(5) that aggregatedplans have the same plan year, qualifiednonelective contributions and electivecontributions may be taken into accountin the resulting short plan year only ifsuch qualified nonelective and electivecontributions could have been taken intoaccount under an ADP test for a plan withthat same short plan year.

(v) Disproportionate contributions nottaken into account—(A) General rule.Qualified nonelective contributions can-not be taken into account for an applicableyear for an NHCE to the extent suchcontributions exceed the product of that

January 31, 2005 432 2005–5 I.R.B.

NHCE’s compensation and the greater of5% and 2 times the plan’s representativecontribution rate. Any qualified non-elective contribution taken into accountin an ADP test under §1.401(k)–2(a)(6)(including the determination of the repre-sentative contribution rate for purposes of§1.401(k)–2(a)(6)(iv)(B)) is not permittedto be taken into account for purposes ofthis paragraph (a)(6) (including the deter-mination of the representative contributionrate for purposes of paragraph (a)(6)(v)(B)of this section).

(B) Definition of representative contri-bution rate. For purposes of this paragraph(a)(6)(v), the plan’s representative contri-bution rate is the lowest applicable contri-bution rate of any eligible NHCE amonga group of eligible NHCEs that consistsof half of all eligible NHCEs for the planyear (or, if greater, the lowest applicablecontribution rate of any eligible NHCE inthe group of all eligible NHCEs for the ap-plicable year and who is employed by theemployer on the last day of the applicableyear).

(C) Definition of applicable contribu-tion rate. For purposes of this paragraph

(a)(6)(v), the applicable contribution ratefor an eligible NHCE is the sum of thematching contributions taken into accountunder this section for the employee forthe plan year and the qualified nonelectivecontributions made for that employee forthe plan year, divided by that employee’scompensation for the same period.

(D) Special rule for prevailing wagecontributions. Notwithstanding paragraph(a)(6)(v)(A) of this section, qualified non-elective contributions that are made inconnection with an employer’s obliga-tion to pay prevailing wages under theDavis-Bacon Act (46 Stat. 1494), Pub-lic Law 71–798, Service Contract Act of1965 (79 Stat. 1965), Public Law 89–286,or similar legislation can be taken intoaccount for a plan year for an NHCE to theextent such contributions do not exceed10 percent of that NHCE’s compensation.

(vi) Contribution only used once. Qual-ified nonelective contributions cannot betaken into account under this paragraph(a)(6) to the extent such contributionsare taken into account for purposes ofsatisfying any other ACP test, any ADPtest, or the requirements of §1.401(k)–3,

1.401(m)–3 or 1.401(k)–4. Thus, for ex-ample, qualified nonelective contributionsthat are made pursuant to §1.401(k)–3(b)cannot be taken into account under theACP test. Similarly, if a plan switchesfrom the current year testing method tothe prior year testing method pursuant to§1.401(m)–2(c)(1), qualified nonelectivecontributions that are taken into accountunder the current year testing method fora plan year may not be taken into accountunder the prior year testing method for thenext plan year.

(7) Examples. The following examplesillustrate the application of this paragraph(a). See §1.401(k)–2(a)(6) for additionalexamples of the parallel rules under sec-tion 401(k)(3)(A). The examples are as fol-lows:

Example 1. (i) Employer L maintains Plan U, aprofit-sharing plan under which $.50 matching contri-butions are made for each dollar of employee contri-butions. Plan U uses the current year testing method.The chart below shows the average employee contri-butions (as a percentage of compensation) and match-ing contributions (as a percentage of compensation)for Plan U’s HCEs and NHCEs for the 2006 planyear:

Employee Contributions Matching Contributions Actual Contribution Percentage

Highly compensated employees 4% 2% 6%

Nonhighly compensated employees 3% 1.5% 4.5%

(ii) The matching rate for all NHCEs is 50% andthus the matching contributions are not dispropor-tionate under paragraph (a)(5)(ii) of this section. Ac-cordingly, they are taken into account in determiningthe ACR of eligible employees.

(iii) Because the ACP for the HCEs (6.0%) ex-ceeds 5.63% (4.5% x 1.25), Plan U does not satisfythe ACP test under paragraph (a)(1)(i)(A) of this sec-tion. However, because the ACP for the HCEs doesnot exceed the ACP for the NHCEs by more than 2

percentage points and the ACP for the HCEs does notexceed the ACP for the NHCEs multiplied by 2 (4.5%x 2 = 9%), the plan satisfies the ACP test under para-graph (a)(1)(i)(B) of this section.

Example 2. (i) Employees A through F are eligi-ble employees in Plan V, a profit-sharing plan of Em-ployer M that includes a cash or deferred arrangementand permits employee contributions. Under Plan V,a $.50 matching contribution is made for each dollarof elective contributions and employee contributions.

Plan V uses the current year testing method and doesnot provide for elective contributions to be taken intoaccount in determining an eligible employee’s ACR.For the 2006 plan year, Employees A and B are HCEsand the remaining employees are NHCEs. The com-pensation, elective contributions, employee contribu-tions, and matching contributions for the 2006 planyear are shown in the following table:

Employee Compensation Elective Contributions Employee Contributions Matching Contributions

A $190,000 $15,000 $ 3,500 $9,250

B 100,000 $ 5,000 $10,000 $7,500

C 85,000 $12,000 $0 $6,000

D 70,000 $ 9,500 $0 $4,750

E 40,000 $10,000 $0 $5,000

F 10,000 $0 $0 $0

(ii) The matching rate for all NHCEs is 50% andthus the matching contributions are not dispropor-tionate under paragraph (a)(5)(ii) of this section. Ac-cordingly, they are taken into account in determining

the ACR of eligible employees, as shown in the fol-lowing table:

2005–5 I.R.B. 433 January 31, 2005

Employee Compensation Employee Contributions Matching Contributions ACR %

A $190,000 $ 3,500 $9,250 6.71

B 100,000 $10,000 $7,500 17.50

C 85,000 $0 $6,000 7.06

D 70,000 $0 $4,750 6.79

E 40,000 $0 $5,000 12.50

F 10,000 $0 $0 0

(iii) The ACP for the HCEs is 12.11% ((6.71%+ 17.50%)/2). The ACP for the NHCEs is 6.59%((7.06% + 6.79% + 12.50% + 0.%)/4). Plan V fails tosatisfy the ACP test under paragraph (a)(1)(i)(A) ofthis section because the ACP of HCEs is more than125% of the ACP of the NHCEs (6.59% x 1.25 =8.24%). In addition, Plan V fails to satisfy the ACPtest under paragraph (a)(1)(i)(B) of this section be-cause the ACP for the HCEs exceeds the ACP of theother employees by more than 2 percentage points(6.59% + 2% = 8.59%). Therefore, the plan failsto satisfy the requirements of section 401(m)(2) andparagraph (a)(1) of this section unless the ACP fail-ure is corrected under paragraph (b) of this section.

Example 3. (i) The facts are the same as Example2, except that the plan provides that the NHCEs’ elec-tive contributions may be used to meet the require-

ments of section 401(m) to the extent needed underthat section.

(ii) Pursuant to paragraph (a)(6)(ii) of this sec-tion, the $10,000 of elective contributions for Em-ployee E may be taken into account in determiningthe ACP rather than the ADP to the extent that theplan satisfies the requirements of §1.401(k)–2(a)(1)excluding from the ADP this $10,000. In this case,if the $10,000 were excluded from the ADP for theNHCEs, the ADP for the HCEs is 6.45% (7.89%+ 5.00%)/2 and the ADP for the NHCEs would be6.92% (14.12% + 13.57% + 0% +0%)/4) and the planwould satisfy the requirements of §1.401(k)–2(a)(1)excluding from the ADP the elective contributionsfor NHCEs that are taken into account under section401(m).

(iii) After taking into account the $10,000 of elec-tive contributions for Employee E in the ACP test,

the ACP for the NHCEs is 12.84% (7.06% + 6.79%+ 37.50% + 0%)/4. Therefore the plan satisfies theACP test because the ACP for the HCEs (12.11%) isless than 1.25 times the ACP for the NHCEs.

Example 4. (i) The facts are the same as Example2, except that Plan V provides for a higher than 50%match rate on the elective contributions and employeecontributions for all NHCEs. The match rate is de-fined as the rate, rounded up to the next whole per-cent, necessary to allow the plan to satisfy the ACPtest, but not in excess of 100%. In this case, an in-crease in the match rate from 50% to 74% will besufficient to allow the plan to satisfy the ACP test.Thus, for the 2006 plan year, the compensation, elec-tive contributions, employee contributions, match-ing contributions at a 74% match rate of the eligibleNHCEs (employees C through F) are shown in thefollowing table:

Employee Compensation Elective Contributions Employee Contributions Matching Contributions

C $85,000 $12,000 $0 $8,880

D 70,000 $ 9,500 $0 $7,030

E 40,000 $10,000 $0 $7,400

F 10,000 $0 $0 $0

(ii) The matching rate for all NHCEs is 74%and thus the matching contributions are not dispro-portionate under paragraph (a)(5)(ii) of this section.Therefore, the matching contributions may be takeninto account in determining the ACP for the NHCEs.

(iii) The ACP for the NHCEs is 9.75% (10.45%+ 10.04% + 18.50% + 0%)/4. Because the ACP forthe HCEs (12.11%) is less than 1.25 times the ACP

for the NHCEs, the plan satisfies the requirements ofsection 401(m).

Example 5. (i) The facts are the same as Example4, except that: Employee E’s elective contributionsare $2,000 (rather than $10,000) and pursuant to para-graph (a)(6)(ii) of this section, the $2,000 of electivecontributions for Employee E are taken into accountin determining the ACP rather than the ADP. In ad-dition, Plan V provides that the higher match rate is

not limited to 100% and applies only for a specifiedgroup of NHCEs. The only member of that groupis Employee E. Under the plan provision, the highermatch rate is a 400% match. Thus, for the 2006 planyear, the compensation, elective contributions, em-ployee contributions, matching contributions of theeligible NHCEs (employees C through F) are shownin the following table:

Employee Compensation Elective Contributions Employee Contributions Matching Contributions

C $85,000 $12,000 $0 $6,000

D 70,000 $ 9,500 $0 $4,750

E 40,000 $ 2,000 $0 $8,000

F 10,000 $0 $0 $0

(ii) If the entire matching contribution made onbehalf of Employee E were taken into account underthe ACP test, Plan V would satisfy the test, becausethe ACP for the NHCEs would be 9.71% (7.06% +6.79% + 25.00% + 0%)/4. Because the ACP for theHCEs (12.11%) is less than 1.25 times what the ACPfor the NHCEs would be, the plan would satisfy therequirements of section 401(m).

(iii) Pursuant to paragraph (a)(5)(ii) of this sec-tion, however, matching contributions for an eligibleNHCE that exceed the greatest of 5% of compensa-tion, the employee’s elective deferrals and 2 times theproduct of the plan’s representative matching rate andthe employee’s elective deferrals cannot be taken intoaccount in applying the ACP test. The plan’s repre-sentative matching rate is the lowest matching rate for

any eligible employee in a group of NHCEs that is atleast half of all eligible employees who are NHCEsin the plan for the plan year who make elective con-tributions for the plan year. For Plan V, the group ofNHCEs who make such contributions consists of Em-ployees C, D and E. The matching rates for these threeemployees are 50%, 50% and 400% respectively. Thelowest matching rate for a group of NHCEs that is at

January 31, 2005 434 2005–5 I.R.B.

least half of all the NHCEs who make elective contri-butions (or 2 NHCEs) is 50%. Because 400% is morethan twice the plan’s representative matching rate andthe matching contributions exceed 5% of compensa-tion, the full amount of matching contributions is nottaken into account. Only $2,000 of the matching con-tributions made on behalf of Employee E (matchingcontributions that do not exceed the greatest of 5%of compensation, the employee’s elective deferrals,or the product of 100% (2 times the representativematching rate) and the employee’s elective deferrals)satisfy the requirements of paragraph (a)(5)(ii) of thissection and may be taken into account under the ACPtest. Accordingly, the ACP for the NHCEs is 5.96%(7.06% + 6.79% + 10% + 0%)/4 and the plan failsto satisfy the requirements of section 401(m)(2) andparagraph (a)(1) of this section unless the ACP fail-ure is corrected under paragraph (b) of this section.

Example 6. (i) The facts are the same as Exam-ple 2, except that Plan V provides a QNEC equal to13% of pay for Employee F that will be taken intoaccount under the ACP test to the extent the contri-butions satisfy the requirements of paragraph (a)(6)of this section.

(ii) Pursuant to paragraph (a)(6)(v) of this sec-tion, a QNEC cannot be taken into account in deter-mining an NHCE’s ACR to the extent it exceeds thegreater of 5% and the product of the employee’s com-pensation and the plan’s representative contributionrate. The plan’s representative contribution rate istwo times the lowest applicable contribution rate forany eligible employee in a group of NHCEs that is atleast half of all eligible employees who are NHCEsin the plan for the plan year. For Plan V, the appli-cable contribution rates for Employees C, D, E andF are 7.06%, 6.79%, 12.5% and 13% respectively.The lowest applicable contribution rate for a groupof NHCEs that is at least half of all the NHCEs is12.50% (the lowest applicable contribution rate forthe group of NHCEs that consists of Employees E andF).

(iii) Under paragraph (a)(6)(v)(B) of this section,the plan’s representative contribution rate is 2 times12.50% or 25.00%. Accordingly, the QNECs for Em-ployee F can be taken into account under the ACP testonly to the extent they do not exceed 25.00% of com-pensation. In this case, all of the QNECs for Em-ployee F may be taken into account under the ACPtest.

(iv) After taking into account the QNECs for Em-ployee F, the ACP for the NHCEs is 9.84% (7.06% +6.79% + 12.50% + 13%)/4. Because the ACP for theHCEs (12.11%) is less than 1.25 times the ACP forthe NHCEs, the plan satisfies the requirements of sec-tion 401(m)(2) and paragraph (a)(1) of this section.

(b) Correction of excess aggregatecontributions—(1) Permissible correc-tion methods—(i) In general. A plan thatprovides for employee contributions ormatching contributions does not fail to sat-isfy the requirements of section 401(m)(2)and paragraph (a)(1) of this section if theemployer, in accordance with the termsof the plan, uses either of the followingcorrection methods—

(A) Additional contributions. The em-ployer makes additional contributions that

are taken into account for the ACP test un-der this section that, in combination withthe other contributions taken into accountunder this section, allow the plan to satisfythe requirements of paragraph (a)(1) of thissection.

(B) Excess aggregate contributions dis-tributed or forfeited. Excess aggregatecontributions are distributed or forfeited inaccordance with paragraph (b)(2) of thissection.

(ii) Combination of correction methods.A plan may provide for the use of either ofthe correction methods described in para-graph (b)(1)(i) of this section, may limitemployee contributions or matching con-tributions in a manner that prevents excessaggregate contributions from being made,or may use a combination of these meth-ods, to avoid or correct excess aggregatecontributions. If a plan uses a combina-tion of correction methods, any contribu-tions made under paragraph (b)(1)(i)(A) ofthis section must be taken into account be-fore application of the correction methodin paragraph (b)(1)(i)(B) of this section.

(iii) Exclusive means of correction. Afailure to satisfy the requirements of para-graph (a)(1) of this section may not be cor-rected using any method other than onedescribed in paragraph (b)(1)(i) or (ii) ofthis section. Thus, excess aggregate con-tributions for a plan year may not be cor-rected by forfeiting vested matching con-tributions, distributing nonvested match-ing contributions, recharacterizing match-ing contributions, or not making match-ing contributions required under the termsof the plan. Similarly, excess aggregatecontributions for a plan year may not re-main unallocated or be allocated to a sus-pense account for allocation to one or moreemployees in any future year. In addi-tion, excess aggregate contributions maynot be corrected using the retroactive cor-rection rules of §1.401(a)(4)–11(g). See§1.401(a)(4)–11(g)(3)(vii) and (5).

(2) Correction through distribu-tion—(i) General rule. This paragraph(b)(2) contains the rules for correction ofexcess aggregate contributions througha distribution from the plan. Correctionthrough a distribution generally involvesa 4-step process. First, the plan mustdetermine, in accordance with paragraph(b)(2)(ii) of this section, the total amountof excess aggregate contributions thatmust be distributed under the plan. Sec-

ond, the plan must apportion the totalamount of excess aggregate contributionsamong the HCEs in accordance with para-graph (b)(2)(iii) of this section. Third,the plan must determine the income al-locable to excess aggregate contributionsin accordance with paragraph (b)(2)(iv)of this section. Finally, the plan mustdistribute the apportioned contributions,together with allocable income (or forfeitthe apportioned matching contributions,if forfeitable) in accordance with para-graph (b)(2)(v) of this section. Paragraph(b)(2)(vi) of this section provides rulesrelating to the tax treatment of these dis-tributions.

(ii) Calculation of total amount tobe distributed. The following proceduresmust be used to determine the total amountof the excess aggregate contributions to bedistributed—

(A) Calculate the dollar amount ofexcess aggregate contributions for eachHCE. The amount of excess aggregatecontributions attributable to an HCE for aplan year is the amount (if any) by whichthe HCE’s contributions taken into ac-count under this section must be reducedfor the HCE’s ACR to equal the highestpermitted ACR under the plan. To calcu-late the highest permitted ACR under aplan, the ACR of the HCE with the highestACR is reduced by the amount required tocause that HCE’s ACR to equal the ACRof the HCE with the next highest ACR. Ifa lesser reduction would enable the planto satisfy the requirements of paragraph(b)(2)(ii)(C) of this section, only this lesserreduction applies.

(B) Determination of the total amountof excess aggregate contributions.The process described in paragraph(b)(2)(ii)(A) of this section must be re-peated until the plan would satisfy therequirements of paragraph (b)(2)(ii)(C)of this section. The sum of all reductionsfor all HCEs determined under paragraph(b)(2)(ii)(A) of this section is the totalamount of excess aggregate contributionsfor the plan year.

(C) Satisfaction of ACP. A plan sat-isfies this paragraph (b)(2)(ii)(C) if theplan would satisfy the requirements ofparagraph (a)(1)(i) of this section if theACR for each HCE were determined af-ter the reductions described in paragraph(b)(2)(ii)(A) of this section.

2005–5 I.R.B. 435 January 31, 2005

(iii) Apportionment of total amount ofexcess aggregate contributions among theHCEs. The following procedures must beused in apportioning the total amount ofexcess aggregate contributions determinedunder paragraph (b)(2)(ii) of this sectionamong the HCEs—

(A) Calculate the dollar amount ofexcess aggregate contributions for eachHCE. The contributions with respect tothe HCE with the highest dollar amountof contributions taken account under thissection are reduced by the amount re-quired to cause that HCE’s contributionsto equal the dollar amount of contribu-tions taken into account under this sectionfor the HCE with the next highest dollaramount of such contributions. If a lesserapportionment to the HCE would enablethe plan to apportion the total amount ofexcess aggregate contributions, only thelesser apportionment would apply.

(B) Limit on amount apportioned toany HCE. For purposes of this paragraph(b)(2)(iii), the contributions for an HCEwho is an eligible employee in more thanone plan of an employer to which matchingcontributions and employee contributionsare made is determined by adding togetherall contributions otherwise taken into ac-count in determining the ACR of the HCEunder the rules of paragraph (a)(3)(ii) ofthis section. However, the amount ofcontributions apportioned with respect toan HCE must not exceed the amount ofcontributions taken into account under thissection that were actually made on behalfof the HCE to the plan for the plan year.Thus, in the case of an HCE who is aneligible employee in more than one planof the same employer to which employeecontributions or matching contributionsare made and whose ACR is calculatedin accordance with paragraph (a)(3)(ii) ofthis section, the amount distributed underthis paragraph (b)(2)(iii) will not exceedsuch contributions actually contributed tothe plan for the plan year that are takeninto account under this section for the planyear.

(C) Apportionment to additional HCEs.The procedure in paragraph (b)(2)(iii)(A)of this section must be repeated until thetotal amount of excess aggregate contribu-tions have been apportioned.

(iv) Income allocable to excess ag-gregate contributions—(A) General rule.The income allocable to excess aggregate

contributions is equal to the sum of theallocable gain or loss for the plan yearand, to the extent the excess aggregatecontributions are or will be credited withgain or loss for the gap period (i.e., theperiod after the close of the plan year andprior to the distribution) if there was a totaldistribution of the account, the allocablegain or loss during that period.

(B) Method of allocating income. Aplan may use any reasonable method forcomputing the income allocable to excessaggregate contributions, provided that themethod does not violate section 401(a)(4),is used consistently for all participants andfor all corrective distributions under theplan for the plan year, and is used by theplan for allocating income to participants’accounts. See §1.401(a)(4)–1(c)(8). Aplan will not fail to use a reasonablemethod for computing the income alloca-ble to excess contributions merely becausethe income allocable to excess aggregatecontributions is determined on a date thatis no more than 7 days before the distribu-tion.

(C) Alternative method of allocating in-come for the plan year. A plan may allo-cate income to excess aggregate contribu-tions for the plan year by multiplying theincome for the plan year allocable to em-ployee contributions, matching contribu-tions and other amounts taken into accountunder this section (including the contribu-tions for the year), by a fraction, the nu-merator of which is the excess aggregatecontributions for the employee for the planyear, and the denominator of which is thesum of the—

(1) Account balance attributable to em-ployee contributions and matching contri-butions and other amounts taken into ac-count under this section as of the beginningof the plan year; and

(2) Any additional such contributionsfor the plan year.

(D) Safe harbor method of allocat-ing gap period income. A plan may usethe safe harbor method in this paragraph(b)(2)(iv)(D) to determine income on ex-cess aggregate contributions for the gapperiod. Under this safe harbor method,income on excess aggregate contributionsfor the gap period is equal to 10% of theincome allocable to excess aggregate con-tributions for the plan year that would bedetermined under paragraph (b)(2)(iv)(C)of this section, multiplied by the number

of calendar months that have elapsed sincethe end of the plan year. For purposes ofcalculating the number of calendar monthsthat have elapsed under the safe harbormethod, a corrective distribution that ismade on or before the fifteenth day of amonth is treated as made on the last dayof the preceding month and a distributionmade after the fifteenth day of a monthis treated as made on the last day of themonth.

(E) Alternative method of allocatingplan year and gap period income. Aplan may determine the allocable gain orloss for the aggregate of the plan yearand the gap period by applying the al-ternative method provided by paragraph(b)(2)(iv)(C) of this section to that ag-gregate period. This is accomplished bysubstituting the income for the plan yearand the gap period for the income for theplan year and by substituting the contribu-tions taken into account under this sectionfor the plan year and the gap period for thecontributions taken into account for theplan year in determining the fraction thatis multiplied by that income.

(F) Allocable income for recharacter-ized elective contributions. If recharacter-ized elective contributions are distributedas excess aggregate contributions, the in-come allocable to the excess aggregatecontributions is determined as if rechar-acterized elective contributions had beendistributed as excess contributions. Thus,income must be allocated to the rechar-acterized amounts distributed using themethods in §1.401(k)–2(b)(2)(iv).

(v) Distribution and forfeiture. Within12 months after the close of the plan yearin which the excess aggregate contributionarose, the plan must distribute to each HCEthe contributions apportioned to such HCEunder paragraph (b)(2)(iii) of this section(and the allocable income) to the extentthey are vested or forfeit such amounts, ifforfeitable. Except as otherwise providedin this paragraph (b)(2)(v), a distributionof excess aggregate contributions must bein addition to any other distributions madeduring the year and must be designated as acorrective distribution by the employer. Inthe event of a complete termination of theplan during the plan year in which an ex-cess aggregate contribution arose, the cor-rective distribution must be made as soonas administratively feasible after the dateof termination of the plan, but in no event

January 31, 2005 436 2005–5 I.R.B.

later than 12 months after the date of termi-nation. If the entire account balance of anHCE is distributed prior to when the planmakes a distribution of excess aggregatecontributions in accordance with this para-graph (b)(2), the distribution is deemed tohave been a corrective distribution of ex-cess aggregate contributions (and income)to the extent that a corrective distributionwould otherwise have been required.

(vi) Tax treatment of corrective dis-tributions—(A) General rule. Exceptas otherwise provided in this paragraph(b)(2)(vi), a corrective distribution of ex-cess aggregate contributions (and income)that is made within 21/2 months after theend of the plan year for which the excessaggregate contributions were made is in-cludible in the employee’s gross incomefor the taxable year of the employee end-ing with or within the plan year for whichthe excess aggregate contributions weremade. A corrective distribution of excessaggregate contributions (and income) thatis made more than 21/2 months after theplan year for which the excess aggregatecontributions were made is includible inthe employee’s gross income in the taxableyear of the employee in which distributed.The portion of the distribution that istreated as an investment in the contract(and is therefore not subject to tax undersection 72) is determined without regardto any plan contributions other than thosedistributed as excess aggregate contribu-tions. Regardless of when the correctivedistribution is made, it is not subject to theearly distribution tax of section 72(t). Seeparagraph (b)(4) of this section for addi-tional rules relating to the employer excisetax on amounts distributed more than 21/2months after the end of the plan year. Seealso §1.402(c)–2, A–4 prohibiting rolloverof distributions that are excess aggregatecontributions.

(B) Rule for de minimis distributions.If the total amount of excess aggregatecontributions determined under this para-graph (b)(2), and excess contributionsdetermined under §1.401(k)–2(b)(2) dis-tributed to a recipient under a plan for anyplan year is less than $100 (excluding in-come), a corrective distribution of excessaggregate contributions (and income) isincludible in gross income in the recipi-ent’s taxable year in which the correctivedistribution is made, except to the extent

the corrective distribution is a return ofemployee contributions.

(3) Other rules—(i) No employee orspousal consent required. A distributionof excess aggregate contributions (and in-come) may be made under the terms ofthe plan without regard to any notice orconsent otherwise required under sections411(a)(11) and 417.

(ii) Treatment of corrective distribu-tions and forfeited contributions as em-ployer contributions. Excess aggregatecontributions (other than amounts attrib-utable to employee contributions), in-cluding forfeited matching contributions,are treated as employer contributions forpurposes of sections 404 and 415 evenif distributed from the plan. Forfeitedmatching contributions that are reallo-cated to the accounts of other participantsfor the plan year in which the forfeitureoccurs are treated under section 415 asannual additions for the participants towhose accounts they are reallocated andfor the participants from whose accountsthey are forfeited.

(iii) No reduction of required mini-mum distribution. A distribution of excessaggregate contributions (and income) isnot treated as a distribution for purposesof determining whether the plan satisfiesthe minimum distribution requirementsof section 401(a)(9). See §1.401(a)(9)–5,A–9(b).

(iv) Partial correction. Any distribu-tion of less than the entire amount of ex-cess aggregate contributions (and alloca-ble income) is treated as a pro rata dis-tribution of excess aggregate contributionsand allocable income.

(v) Matching contributions on excesscontributions, excess deferrals and excessaggregate contributions—(A) Correctivedistributions not permitted. A matchingcontribution may not be distributed merelybecause the contribution to which it relatesis treated as an excess contribution, excessdeferral, or excess aggregate contribution.

(B) Coordination with section401(a)(4). A matching contribution istaken into account under section 401(a)(4)even if the match is distributed, unless thedistributed contribution is an excess aggre-gate contribution. This requires that, aftercorrection of excess aggregate contribu-tions, each level of matching contributionsbe currently and effectively available to agroup of employees that satisfies section

410(b). See §1.401(a)(4)–4(e)(3)(iii)(G).Thus, a plan that provides the same rate ofmatching contributions to all employeeswill not meet the requirements of section401(a)(4) if employee contributions aredistributed under this paragraph (b) toHCEs to the extent needed to meet therequirements of section 401(m)(2), whilematching contributions attributable toemployee contributions remain allocatedto the HCEs’ accounts. This is becausethe level of matching contributions willbe higher for a group of employees thatconsists entirely of HCEs. Under section411(a)(3)(G) and §1.411(a)–4(b)(7), a planmay forfeit matching contributions attrib-utable to excess contributions, excess ag-gregate contributions and excess deferralsto avoid a violation of section 401(a)(4).See also §1.401(a)(4)–11(g)(3)(vii)(B) re-garding the use of additional allocations tothe accounts of NHCEs for the purpose ofcorrecting a discriminatory rate of match-ing contributions. A plan is permitted toprovide for which contributions are to bedistributed to satisfy the ACP test so as toavoid discriminatory matching rates thatwould otherwise violate section 401(a)(4).For example, the plan may provide thatunmatched employee contributions willbe distributed before matched employeecontributions.

(vi) No requirement for recalculation.If the distributions and forfeitures de-scribed in paragraph (b)(2) of this sectionare made, the employee contributionsand matching contributions are treated asmeeting the nondiscrimination test of sec-tion 401(m)(2) regardless of whether theACP for the HCEs, if recalculated after thedistributions and forfeitures, would satisfysection 401(m)(2).

(4) Failure to timely correct—(i) Fail-ure to correct within 21/2 months after endof plan year. If a plan does not correctexcess aggregate contributions within 21/2

months after the close of the plan year forwhich the excess aggregate contributionsare made, the employer will be liable fora 10% excise tax on the amount of theexcess aggregate contributions. See sec-tion 4979 and §54.4979–1 of this chapter.Qualified nonelective contributions prop-erly taken into account under paragraph(a)(6) of this section for a plan year mayenable a plan to avoid having excess ag-gregate contributions, even if the contribu-

2005–5 I.R.B. 437 January 31, 2005

tions are made after the close of the 21/2month period.

(ii) Failure to correct within 12 monthsafter end of plan year. If excess aggregatecontributions are not corrected within 12months after the close of the plan year forwhich they were made, the plan will fail tomeet the requirements of section 401(a)(4)for the plan year for which the excess ag-gregate contributions were made and all

subsequent plan years in which the excessaggregate contributions remain in the trust.

(5) Examples. The following examplesillustrate the application of this paragraph.See also §1.401(k)–2(b) for additional ex-amples of the parallel correction rules ap-plicable to cash or deferred arrangements.For purposes of these examples, none ofthe plans provide for catch-up contribu-

tions under section 414(v). The examplesare as follows:

Example 1. (i) Employer L maintains a plan thatprovides for employee contributions and fully vestedmatching contributions. The plan provides that fail-ures of the ACP test are corrected by distribution. In2006, the ACP for the eligible NHCEs is 6%. Thus,the ACP for the eligible HCEs may not exceed 8%.The three HCEs who participate have the followingcompensation, contributions, and ACRs:

Employee Compensation Employee contributions and matching contributions Actual Contribution Ratio

A 200,000 14,000 7%

B 150,000 13,500 9

C 100,000 12,000 12

Average 9.33%

(ii) The total amount of excess aggregate contri-butions for the HCEs is determined under paragraph(b)(2)(ii) of this section as follows: the matchingand employee contributions of Employee C (the HCEwith the highest ACR) is reduced by 3% of compen-sation (or $3,000) in order to reduce the ACR of thatHCE to 9%, which is the ACR of Employee B.

(iii) Because the ACP of the HCEs determinedafter the $3,000 reduction still exceeds 8%, furtherreductions in matching contributions and employeecontributions are necessary in order to reduce theACP of the HCEs to 8%. The employee contributionsand matching contributions for Employees B and Care reduced by an additional .5% of compensation or$1,250 ($750 and $500 respectively). Because theACP of the HCEs determined after the reductionsnow equals 8%, the plan would satisfy the require-ments of (a)(1)(ii) of this section.

(iv) The total amount of excess aggregate con-tributions ($4,250) is apportioned among the HCEsunder paragraph (b)(2)(iii) of this section first to theHCE with the highest amount of matching contribu-tions and employee contributions. Therefore, Em-

ployee A is apportioned $500 (the amount required tocause A’s matching contributions and employee con-tributions to equal the next highest dollar amount ofmatching contributions and employee contributions).

(v) Because the total amount of excess aggregatecontributions has not been apportioned, further ap-portionment is necessary. The balance ($3,750) of thetotal amount of excess aggregate contributions is ap-portioned equally among Employees A and B ($1,500to each, the amount required to cause their contri-butions to equal the next highest dollar amount ofmatching contributions and employee contributions).

(vi) Because the total amount of excess aggre-gate contributions has not been apportioned, furtherapportionment is necessary. The balance ($750) ofthe total amount of excess aggregate contributions isapportioned equally among Employees A, B and C($250 to each, the amount required to allocate the to-tal amount of excess aggregate contributions for theplan).

(vii) Therefore, the plan will satisfy the require-ments of paragraph (a)(1) of this section if, by the endof the 12 month period following the end of the 2006

plan year, Employee A receives a corrective distribu-tion of excess aggregate contributions equal to $2,250($500 + $1,500 + $250) and allocable income, Em-ployee B receives a corrective distribution of $250and allocable income and Employee C receives a cor-rective distribution of $1,750 ($1,500 + $250) and al-locable income.

Example 2. (i) Employee D is the sole HCE whois eligible to participate in a cash or deferred arrange-ment maintained by Employer M. The plan that in-cludes the arrangement, Plan X, permits employeecontributions and provides a fully vested matchingcontribution equal to 50% of elective contributions.Plan X is a calendar year plan. Plan X corrects ex-cess contributions by recharacterization and providesthat failures of the ACP test are corrected by distri-bution. For the 2006 plan year, D’s compensation is$200,000, and D’s elective contributions are $15,000.The actual deferral percentages and actual contribu-tion percentages for Employee D and the other eligi-ble employees under Plan X are shown in the follow-ing table:

Actual Deferral Percentage Actual Contribution Percentage

Employee D 7.5% 3.75%

NHCEs 4% 2%

(ii) In February 2007, Employer M determinesthat D’s actual deferral ratio must be reduced to 6%,or $12,000, which requires a recharacterization of$3,000 as an employee contribution. This increasesD’s actual contribution ratio to 5.25% ($7,500 inmatching contributions plus $3,000 recharacterizedas employee contributions, divided by $200,000 incompensation). Since D’s actual contribution ratiomust be limited to 4% for Plan X to satisfy the actualcontribution percentage test, Plan X must distribute1.25% or $2,500 of D’s employee contributionsand matching contributions together with allocableincome. If $2,500 in matching contributions andallocable income is distributed, this will correct theexcess aggregate contributions and will not result in

a discriminatory rate of matching contributions. SeeExample 8.

Example 3. (i) The facts are the same as in Ex-ample 2, except that Employee D also had electivecontributions under Plan Y, maintained by an em-ployer unrelated to M. In January 2007, D requestsand receives a distribution of $1,200 in excess defer-rals from Plan X. Pursuant to the terms of Plan X, Dforfeits the $600 match on the excess deferrals to cor-rect a discriminatory rate of match.

(ii) The $3,000 that would otherwise have beenrecharacterized for Plan X to satisfy the actual defer-ral percentage test is reduced by the $1,200 alreadydistributed as an excess deferral, leaving $1,800 tobe recharacterized. See §1.401(k)–2(b)(4)(i)(A).D’s actual contribution ratio is now 4.35% ($7,500

in matching contributions plus $1,800 in recharac-terized contributions less $600 forfeited matchingcontributions attributable to the excess deferrals,divided by $200,000 in compensation).

(iii) The matching and employee contributions forEmployee D must be reduced by .35% of compen-sation in order to reduce the ACP of the HCEs to4%. The plan must provide for forfeiture of addi-tional matching contributions to prevent a discrimi-natory rate of matching contributions. See Example8.

Example 4. (i) The facts are the same as in Exam-ple 3, except that D does not request a distribution ofexcess deferrals until March 2007. Employer X hasalready recharacterized $3,000 as employee contribu-tions.

January 31, 2005 438 2005–5 I.R.B.

(ii) Under §1.402(g)–1(e)(6), the amount of ex-cess deferrals is reduced by the amount of excesscontributions that are recharacterized. Because theamount recharacterized is greater than the excessdeferrals, Plan X is neither required nor permittedto make a distribution of excess deferrals, and therecharacterization has corrected the excess deferrals.

Example 5. (i) For the 2006 plan year, EmployeeF defers $10,000 under Plan M and $6,000 under PlanN. Plans M and N, which have calendar plan years aremaintained by unrelated employers. Plan M providesa fully vested, 100% matching contribution, does nottake elective contributions into account under section401(m) or take matching contributions into accountunder section 401(k) and provides that excess contri-butions and excess aggregate contributions are cor-rected by distribution. Under Plan M, Employee F isallocated excess contributions of $600 and excess ag-gregate contributions of $1,600. Employee F timelyrequests and receives a distribution of the $1,000 ex-cess deferral from Plan M and, pursuant to the termsof Plan M, forfeits the corresponding $1,000 match-ing contribution.

(ii) No distribution is required or permitted to cor-rect the excess contributions because $1,000 has beendistributed by Plan M as excess deferrals. The distri-bution required to correct the excess aggregate contri-butions (after forfeiting the matching contribution) is$600 ($1,600 in excess aggregate contributions minus$1,000 in forfeited matching contributions). If Em-ployee F had corrected the excess deferrals of $1,000by withdrawing $1,000 from Plan N, Plan M wouldhave had to correct the $600 excess contributionsin Plan M by distributing $600. Since Employee Fthen would have forfeited $600 (instead of $1,000)in matching contributions, Employee F would havehad $1,000 ($1,600 in excess aggregate contributionsminus $600 in forfeited matching contributions) re-maining of excess aggregate contributions in Plan M.These would have been corrected by distributing anadditional $1,000 from Plan M.

Example 6. (i) Employee G is the sole HCEin a profit sharing plan under which the employermatches 100% of employee contributions up to 2%of compensation, and 50% of employee contribu-tions up to the next 4% of compensation. For the2008 plan year, Employee G has compensation of$100,000 and makes a 7% employee contributionof $7,000. Employee G receives a 4% matchingcontribution or $4,000. Thus, Employee G’s actualcontribution ratio (ACR) is 11%. The actual con-tribution percentage for the NHCEs is 5%, and theemployer determines that Employee G’s ACR mustbe reduced to 7% to comply with the rules of section401(m).

(ii) In this case, the plan satisfies the require-ments of section if it distributes the unmatchedemployee contributions of $1,000, and $2,000 ofmatched employee contributions with their relatedmatches of $1,000. This would leave Employee Gwith 4% employee contributions, and 3% matchingcontributions, for an ACR of 7%. Alternatively,the plan could distribute all matching contributionsand satisfy this section. However, the plan couldnot distribute $4,000 of Employee G’s employeecontributions without forfeiting the related matchingcontributions because this would result in a discrim-inatory rate of matching contributions. See alsoExample 7.

Example 7. (i) Employee H is an HCE in Em-ployer X’s profit sharing plan, which matches 100%of employee contributions up to 5% of compensation.The matching contribution is vested at the rate of 20%per year. In 2006, Employee H makes $5,000 in em-ployee contributions and receives $5,000 of match-ing contributions. Employee H is 60% vested in thematching contributions at the end of the 2006 planyear. In February 2007, Employer X determines thatEmployee H has excess aggregate contributions of$1,000. The plan provides that only matching contri-butions will be distributed as excess aggregate con-tributions.

(ii) Employer X has two options available in dis-tributing Employee H’s excess aggregate contribu-tions. The first option is to distribute $600 of vestedmatching contributions and forfeit $400 of nonvestedmatching contributions. These amounts are in pro-portion to Employee H’s vested and nonvested inter-ests in all matching contributions. The second optionis to distribute $1,000 of vested matching contribu-tions, leaving the nonvested matching contributionsin the plan.

(iii) If the second option is chosen, the plan mustalso provide a separate vesting schedule for vestingthese nonvested matching contributions. This is nec-essary because the nonvested matching contributionsmust vest as rapidly as they would have had no dis-tribution been made. Thus, 50% must vest in each ofthe next 2 years.

(iv) The plan will not satisfy the nondiscrimina-tory availability requirement of section 401(a)(4) ifonly nonvested matching contributions are forfeitedbecause the effect is that matching contributions forHCEs vest more rapidly than those for NHCEs. See§1.401(m)–2(b)(3)(v)(B).

Example 8. (i) Employer Y maintains a calen-dar year profit sharing plan that includes a cash ordeferred arrangement. Elective contributions arematched at the rate of 100%. After-tax employeecontributions are permitted under the plan only forNHCEs and are matched at the same rate. No em-ployees make excess deferrals. Employee J, an HCE,makes an $8,000 elective contribution and receivesan $8,000 matching contribution.

(ii) Employer Y performs the actual deferralpercentage (ADP) and the actual contribution per-centage (ACP). To correct failures of the ADP andACP tests, the plan distributes to A $1,000 of ex-cess contributions and $500 of excess aggregatecontributions. After the distributions, EmployeeJ’s contributions for the year are $7,000 of electivecontributions and $7,500 of matching contributions.As a result, Employee J has received a higher ef-fective rate of matching contributions than NHCEs($7,000 of elective contributions matched by $7,500is an effective matching rate of 107 percent). If thisamount remains in Employee J’s account withoutcorrection, it will cause the plan to fail to satisfysection 401(a)(4), because only an HCE receives thehigher matching contribution rate. The remaining$500 matching contribution may be forfeited (butnot distributed) under section 411(a)(3)(G), if theplan so provides. The plan could instead correctthe discriminatory rate of matching contributionsby making additional allocations to the accounts ofNHCEs. See §1.401(a)(4)–11(g)(3)(vii)(B) and (6),Example 7.

(c) Additional rules for prior year test-ing method—(1) Rules for change in test-ing method. A plan is permitted to changefrom the prior year testing method to thecurrent year testing method for any planyear. A plan is permitted to change fromthe current year testing method to the prioryear testing method only in situations de-scribed in §1.401(k)–2(c)(1)(ii). For pur-poses of this paragraph (c)(1), a plan thatuses the safe harbor method described in§1.401(m)–3 or a SIMPLE 401(k) plan istreated as using the current year testingmethod for that plan year.

(2) Calculation of ACP under the prioryear testing method for the first planyear—(i) Plans that are not successorplans. If, for the first plan year of any plan(other than a successor plan), a plan usesthe prior year testing method, the plan ispermitted to use either that first plan yearas the applicable year for determining theACP for the eligible NHCEs, or 3% as theACP for eligible NHCEs, for applying theACP test for that first plan year. A plan(other than a successor plan) that uses theprior year testing method but has electedfor its first plan year to use that year as theapplicable year for determining the ACPfor the eligible NHCEs is not treated aschanging its testing method in the secondplan year and is not subject to the limita-tions on double counting under paragraph(a)(6)(vi) of this section for the secondplan year.

(ii) First plan year defined. For pur-poses of this paragraph (c)(2), the firstplan year of any plan is the first year inwhich the plan provides for employeecontributions or matching contributions.Thus, the rules of this paragraph (c)(2) donot apply to a plan (within the meaningof §1.410(b)–7) for a plan year if for suchplan year the plan is aggregated under§1.401(m)–1(b)(4) with any other planthat provides for employee or matchingcontributions in the prior year.

(iii) Plans that are successor plans. Aplan is a successor plan if 50% or moreof the eligible employees for the first planyear were eligible employees under an-other plan maintained by the employer inthe prior year that provides for employeecontributions or matching contributions. Ifa plan that is a successor plan uses the prioryear testing method for its first plan year,the ACP for the group of NHCEs for the

2005–5 I.R.B. 439 January 31, 2005

applicable year must be determined underparagraph (c)(4) of this section.

(3) Plans using different testing meth-ods for the ACP and ADP test. Exceptas otherwise provided in this paragraph(c)(3), a plan may use the current year test-ing method or prior year testing method forthe ACP test for a plan year without regardto whether the current year testing methodor prior year testing method is used for theADP test for that year. For example, a planmay use the prior year testing method forthe ACP test and the current year testingmethod for its ADP test for the plan year.However, plans that use different testingmethods under this paragraph (c)(3) can-not use —

(i) The recharacterization method of§1.401(k)–2(b)(3) to correct excess con-tributions for a plan year;

(ii) The rules of paragraph (a)(6)(ii) ofthis section to take elective contributionsinto account under the ACP test (ratherthan the ADP test); or

(iii) The rules of paragraph§1.401(k)–2(a)(6) to take qualifiedmatching contributions into account underthe ADP test (rather than the ACP test).

(4) Rules for plan coverage change—(i)In general. A plan that uses the prior yeartesting method that experiences a plan cov-erage change during a plan year satisfiesthe requirements of this section for thatyear only if the plan provides that the ACPfor the NHCEs for the plan year is theweighted average of the ACPs for the prioryear subgroups.

(ii) Optional rule for minor plan cov-erage changes. If a plan coverage changeoccurs and 90% or more of the total num-ber of the NHCEs from all prior year sub-groups are from a single prior year sub-group, then, in lieu of using the weightedaverages described in paragraph (c)(4)(i)of this section, the plan may provide thatthe ACP for the group of eligible NHCEsfor the prior year under the plan is theACP of the NHCEs for the prior year ofthe plan under which that single prior yearsubgroup was eligible.

(iii) Definitions. The following defini-tions apply for purposes of this paragraph(c)(4)—

(A) Plan coverage change. The termplan coverage change means a change inthe group or groups of eligible employeesunder a plan on account of—

(1) The establishment or amendment ofa plan;

(2) A plan merger or spinoff under sec-tion 414(l);

(3) A change in the way plans (withinthe meaning of §1.410(b)–7) are com-bined or separated for purposes of§1.401(m)–1(b)(4) (e.g., permissivelyaggregating plans not previously aggre-gated under §1.410(b)–7(d), or ceasingto permissively aggregate plans under§1.410(b)–7(d));

(4) A reclassification of a substantialgroup of employees that has the same ef-fect as amending the plan (e.g., a transferof a substantial group of employees fromone division to another division); or

(5) A combination of any of paragraphs(c)(4)(iii)(A)(1) through (4) of this section.

(B) Prior year subgroup. The termprior year subgroup means all NHCEs forthe prior plan year who, in the prior year,were eligible employees under a specificplan that provides for employee contri-butions or matching contributions main-tained by the employer and who wouldhave been eligible employees in the prioryear under the plan being tested if the plancoverage change had first been effectiveas of the first day of the prior plan yearinstead of first being effective during theplan year. The determination of whetheran NHCE is a member of a prior year sub-group is made without regard to whetherthe NHCE terminated employment duringthe prior year.

(C) Weighted average of the ACPsfor the prior year subgroups. The termweighted average of the ACPs for theprior year subgroups means the sum, forall prior year subgroups, of the adjustedACPs for the plan year. The term adjustedACP with respect to a prior year subgroupmeans the ACP for the prior plan year ofthe specific plan under which the membersof the prior year subgroup were eligibleemployees on the first day of the prior planyear, multiplied by a fraction, the numer-ator of which is the number of NHCEs inthe prior year subgroup and denominatorof which is the total number of NHCEs inall prior year subgroups.

(iv) Example. The following exampleillustrate the application of this paragraph(c)(4). See also §1.401(k)–2(c)(4) for ex-amples of the parallel rules applicable tothe ADP test. The example is as follows:

Example. (i) Employer B maintains two plans,Plan N and Plan P, each of which provides foremployee contributions or matching contributions.The plans were not permissively aggregated under§1.410(b)–7(d) for the 2005 testing year. Both plansuse the prior year testing method. Plan N had 300eligible employees who were NHCEs for 2005, andtheir ACP for that year was 6%. Plan P had 100eligible employees who were NHCEs for 2005, andthe ACP for those NHCEs for that plan was 4%.Plan N and Plan P are permissively aggregated under§1.410(b)–7(d) for the 2006 plan year.

(ii) The permissive aggregation of Plan N andPlan P for the 2006 testing year under §1.410(b)–7(d)is a plan coverage change that results in treating theplans as one plan (Plan NP). Therefore, the prior yearACP for the NHCEs under Plan NP for the 2006 test-ing year is the weighted average of the ACPs for theprior year subgroups.

(iii) The first step in determining the weighted av-erage of the ACPs for the prior year subgroups is toidentify the prior year subgroups. With respect tothe 2006 testing year, an employee is a member ofa prior year subgroup if the employee was an NHCEof Employer B for the 2005 plan year, was an eligibleemployee for the 2005 plan year under any section401(k) plan maintained by Employer B, and wouldhave been an eligible employee in the 2005 plan yearunder Plan NP if Plan N and Plan P had been permis-sively aggregated under §1.410(b)–7(d) for that planyear. The NHCEs who were eligible employees un-der separate plans for the 2005 plan year compriseseparate prior year subgroups. Thus, there are twoprior year subgroups under Plan NP for the 2006 test-ing year: the 300 NHCEs who were eligible employ-ees under Plan N for the 2005 plan year and the 100NHCEs who were eligible employees under Plan Pfor the 2005 plan year.

(iv) The weighted average of the ACPs for theprior year subgroups is the sum of the adjusted ACPwith respect to the prior year subgroup that consists ofthe NHCEs who were eligible employees under PlanN, and the adjusted ACP with respect to the prior yearsubgroup that consists of the NHCEs who were eligi-ble employees under Plan P. The adjusted ACP for theprior year subgroup that consists of the NHCEs whowere eligible employees under Plan N is 4.5%, cal-culated as follows: 6% (the ACP for the NHCEs un-der Plan N for the prior year) x 300/400 (the numberof NHCEs in that prior year subgroup divided by thetotal number of NHCEs in all prior year subgroups),which equals 4.5%. The adjusted ACP for the prioryear subgroup that consists of the NHCEs who wereeligible employees under Plan P is 1%, calculated asfollows: 4% (the ACP for the NHCEs under Plan Pfor the prior year) x 100/400 (the number of NHCEsin that prior year subgroup divided by the total num-ber of NHCEs in all prior year subgroups), whichequals 1%. Thus, the prior year ACP for NHCEs un-der Plan NP for the 2006 testing year is 5.5% (the sumof adjusted ACPs for the prior year subgroups, 4.5%plus 1%).

§1.401(m)–3 Safe harbor requirements.

(a) ACP test safe harbor. Matchingcontributions under a plan satisfy theACP safe harbor provisions of section

January 31, 2005 440 2005–5 I.R.B.

401(m)(11) for a plan year if the plansatisfies the safe harbor contribution re-quirement of paragraphs (b) or (c) of thissection for the plan year, the limitations onmatching contributions of paragraph (d)of this section, the notice requirement ofparagraph (e) of this section, the plan yearrequirements of paragraph (f) of this sec-tion, and the additional rules of paragraphs(g), (h) and (j) of this section, as applica-ble. Pursuant to section 401(k)(12)(E)(ii),the safe harbor contribution requirementof paragraphs (b) and (c) of this sectionmust be satisfied without regard to sec-tion 401(l). The contributions made underparagraphs (b) and (c) of this section arereferred to as safe harbor nonelectivecontributions and safe harbor matchingcontributions, respectively.

(b) Safe harbor nonelective contribu-tion requirement. A plan satisfies the safeharbor nonelective contribution require-ment of this paragraph (b) if it satisfiesthe safe harbor nonelective contributionrequirement of §1.401(k)–3(b).

(c) Safe harbor matching contributionrequirement. A plan satisfies the safe har-bor matching contribution requirement ofthis paragraph (c) if it satisfies the safe har-bor matching contribution requirement of§1.401(k)–3(c).

(d) Limitation on contributions—(1)General rule. A plan that provides formatching contributions meets the require-ments of this section only if it satisfies thelimitations on contributions set forth inthis paragraph (d).

(2) Matching rate must not increase. Aplan that provides for matching contribu-tions meets the requirements of this para-graph (d) only if the ratio of matching con-tributions on behalf of an employee underthe plan for a plan year to the employee’selective deferrals and employee contribu-tions, does not increase as the amount ofan employee’s elective deferrals and em-ployee contributions increases.

(3) Limit on matching contributions. Aplan that provides for matching contribu-tions satisfies the requirements of this sec-tion only if—

(i) Matching contributions are notmade with respect to elective defer-rals or employee contributions that ex-ceed 6% of the employee’s safe harborcompensation (within the meaning of§1.401(k)–3(b)(2)); and

(ii) Matching contributions that are dis-cretionary do not exceed 4% of the em-ployee’s safe harbor compensation.

(4) Limitation on rate of match. Aplan meets the requirements of this sectiononly if the ratio of matching contributionson behalf of an HCE to that HCE’s elec-tive deferrals or employee contributions(or the sum of elective deferrals and em-ployee contributions) for that plan year isno greater than the ratio of matching con-tributions to elective deferrals or employeecontributions (or the sum of elective de-ferrals and employee contributions) thatwould apply with respect to any NHCE forwhom the elective deferrals or employeecontributions (or the sum of elective de-ferrals and employee contributions) are thesame percentage of safe harbor compensa-tion. An employee is taken into accountfor purposes of this paragraph (d)(4) if theemployee is an eligible employee underthe cash or deferred arrangement with re-spect to which the contributions requiredby paragraph (b) or (c) of this section arebeing made for a plan year. A plan will notfail to satisfy this paragraph (d)(4) merelybecause the plan provides that matchingcontributions will be made separately withrespect to each payroll period (or with re-spect to all payroll periods ending withor within each month or quarter of a planyear) taken into account under the planfor the plan year, provided that matchingcontributions with respect to any electivedeferrals or employee contributions madeduring a plan year quarter are contributedto the plan by the last day of the immedi-ately following plan year quarter.

(5) HCEs participating in multipleplans. The rules of section 401(m)(2)(B)and §1.401(m)–2(a)(3)(ii) apply for pur-poses of determining the rate of matchingcontributions under paragraph (d)(4) ofthis section. However, a plan will notfail to satisfy the safe harbor matchingcontribution requirements of this sectionmerely because an HCE participates dur-ing the plan year in more than one planthat provides for matching contributions,provided that —

(i) The HCE is not simultaneously aneligible employee under two plans thatprovide for matching contributions main-tained by an employer for a plan year; and

(ii) The period used to determine com-pensation for purposes of determiningmatching contributions under each such

plan is limited to periods when the HCEparticipated in the plan.

(6) Permissible restrictions on electivedeferrals by NHCEs—(i) General rule.A plan does not satisfy the safe harborrequirements of this section, if electivedeferrals or employee contributions byNHCEs are restricted, unless the restric-tions are permitted by this paragraph(d)(6).

(ii) Restrictions on election periods. Aplan may limit the frequency and dura-tion of periods in which eligible employ-ees may make or change contribution elec-tions under a plan. However, an employeemust have a reasonable opportunity (in-cluding a reasonable period after receipt ofthe notice described in paragraph (e) of thissection) to make or change a contributionelection for the plan year. For purposes ofthis section, a 30-day period is deemed tobe a reasonable period to make or changea contribution election.

(iii) Restrictions on amount of con-tributions. A plan is permitted to limitthe amount of contributions that may bemade by an eligible employee under aplan, provided that each NHCE who isan eligible employee is permitted (unlessthe employee is restricted under para-graph (d)(6)(v) of this section) to makecontributions in an amount that is at leastsufficient to receive the maximum amountof matching contributions available un-der the plan for the plan year, and theemployee is permitted to elect any lesseramount of contributions. However, a planmay require eligible employees to makecontribution elections in whole percent-ages of compensation or whole dollaramounts.

(iv) Restrictions on types of compensa-tion that may be deferred. A plan maylimit the types of compensation that maybe deferred or contributed by an eligibleemployee under a plan, provided that eacheligible NHCE is permitted to make con-tributions under a definition of compen-sation that would be a reasonable defini-tion of compensation within the meaningof §1.414(s)–1(d)(2). Thus, the defini-tion of compensation from which contri-butions may be made is not required to sat-isfy the nondiscrimination requirement of§1.414(s)–1(d)(3).

(v) Restrictions due to limitations underthe Internal Revenue Code. A plan may

2005–5 I.R.B. 441 January 31, 2005

limit the amount of contributions made byan eligible employee under a plan—

(A) Because of the limitations of sec-tion 402(g) or section 415; or

(B) Because, on account of a hard-ship distribution, an employee’s abil-ity to make contributions has been sus-pended for 6 months in accordance with§1.401(k)–1(d)(3)(iv)(E).

(e) Notice requirement. A plan satisfiesthe notice requirement of this paragraph(e) if it satisfies the notice requirement of§1.401(k)–3(d).

(f) Plan year requirement—(1) Generalrule. Except as provided in this paragraph(f) or in paragraph (g) of this section, aplan will fail to satisfy the requirementsof section 401(m)(11) and this section un-less plan provisions that satisfy the rulesof this section are adopted before the firstday of that plan year and remain in effectfor an entire 12-month plan year. In addi-tion, except as provided in paragraph (h)of this section, a plan which includes pro-visions that satisfy the rules of this sec-tion will not satisfy the requirements of§1.401(m)–1(b) if it is amended to changesuch provisions for that plan year. More-over, if, as described in paragraph (j)(4) ofthis section, safe harbor matching or non-elective contributions will be made to an-other plan for a plan year, provisions underthat other plan specifying that the safe har-bor contributions will be made and provid-ing that the contributions will be QNECsor QMACs must also be adopted before thefirst day of that plan year.

(2) Initial plan year. A newlyestablished plan (other than a suc-cessor plan within the meaning of§1.401(m)–2(c)(2)(iii)) will not be treatedas violating the requirements of this para-graph (f) merely because the plan yearis less than 12 months, provided that theplan year is at least 3 months long (or, inthe case of a newly established employerthat establishes the plan as soon as ad-ministratively feasible after the employercomes into existence, a shorter period).Similarly, a plan will not fail to satisfy therequirements of this paragraph (f) for thefirst plan year in which matching contribu-tions are provided under the plan providedthat—

(i) The plan is not a successor plan; and(ii) The amendment providing for

matching contributions is made effectiveat the same time as the adoption of a cash

or deferred arrangement that satisfies therequirements of §1.401(k)–3, taking intoaccount the rules of §1.401(k)–3(e)(2).

(3) Change of plan year. A plan thathas a short plan year as a result of changingits plan year will not fail to satisfy the re-quirements of paragraph (f)(1) of this sec-tion merely because the plan year has lessthan 12 months, provided that—

(i) The plan satisfied the requirementsof this section for the immediately preced-ing plan year; and

(ii) The plan satisfies the requirementsof this section (determined without regardto paragraph (h) of this section) for the im-mediately following plan year or for theimmediately following 12 months if theimmediately following plan year is lessthan 12 months.

(4) Final plan year. A plan that termi-nates during a plan year will not fail to sat-isfy the requirements of paragraph (f)(1) ofthis section merely because the final planyear is less than 12 months, provided thatthe plan satisfies the requirement of thissection through the date of termination andeither—

(i) The plan would satisfy the require-ments of paragraph (h) of this section,treating the termination of the plan as areduction or suspension of safe harbormatching contributions, other than therequirement that employees have a rea-sonable opportunity to change their cashor deferred elections and, if applicable,employee contribution elections; or

(ii) The plan termination is in connec-tion with a transaction described in section410(b)(6)(C) or the employer incurs a sub-stantial business hardship, comparable to asubstantial business hardship described insection 412(d).

(g) Plan amendments adopting non-elective safe harbor contributions. Not-withstanding paragraph (f)(1) of this sec-tion, a plan that provides for the use ofthe current year testing method may beamended after the first day of the planyear and no later than 30 days before thelast day of the plan year to adopt the safeharbor method of this section, effectiveas of the first day of the plan year, usingnonelective contributions under paragraph(b) of this section if the plan satisfies therequirements of §1.401(k)–3(f).

(h) Permissible reduction or suspen-sion of safe harbor matching contribu-tions—(1) General rule. A plan that

provides for safe harbor matching con-tributions will not fail to satisfy the re-quirements of section 401(m)(2) for a planyear merely because the plan is amendedduring a plan year to reduce or suspendsafe harbor matching contributions on fu-ture elective deferrals and, if applicable,employee contributions provided—

(i) All eligible employees are providedthe supplemental notice in accordancewith paragraph (h)(2) of this section;

(ii) The reduction or suspension of safeharbor matching contributions is effectiveno earlier than the later of 30 days aftereligible employees are provided the no-tice described in paragraph (h)(2) of thissection and the date the amendment isadopted;

(iii) Eligible employees are given a rea-sonable opportunity (including a reason-able period after receipt of the supplemen-tal notice) prior to the reduction or suspen-sion of safe harbor matching contributionsto change their cash or deferred electionsand, if applicable, their employee contri-bution elections;

(iv) The plan is amended to providethat the ACP test will be satisfied forthe entire plan year in which the re-duction or suspension occurs using thecurrent year testing method described in§1.401(m)–2(a)(1)(ii); and

(v) The plan satisfies the requirementsof this section (other than this paragraph(h)) with respect to amounts deferredthrough the effective date of the amend-ment.

(2) Notice of suspension requirement.The notice of suspension requirementof this paragraph (h)(2) is satisfied ifeach eligible employee is given no-tice that satisfies the requirements of§1.401(k)–3(g)(2).

(i) [Reserved].(j) Other rules—(1) Contributions

taken into account. A contribution istaken into account for purposes of thissection for a plan year under the samerules as §1.401(k)–3(h)(1).

(2) Use of safe harbor nonelectivecontributions to satisfy other nondiscrim-ination tests. A safe harbor nonelectivecontribution used to satisfy the nonelectivecontribution requirement under paragraph(b) of this section may also be takeninto account for purposes of determiningwhether a plan satisfies section 401(a)(4)under the same rules as §1.401(k)–3(h)(2).

January 31, 2005 442 2005–5 I.R.B.

(3) Early participation rules.Section 401(m)(5)(C) and §1.401(m)–2(a)(1)(iii)(A) which provide an alterna-tive nondiscrimination rule for certainplans that provide for early participation,does not apply for purposes of section401(m)(11) and this section. Thus, a planis not treated as satisfying this section withrespect to the eligible employees who havenot completed the minimum age and ser-vice requirements of section 410(a)(1)(A)unless the plan satisfies the requirementsof this section with respect to such eligibleemployees.

(4) Satisfying safe harbor contributionrequirement under another defined contri-bution plan. Safe harbor matching or non-elective contributions may be made to an-other defined contribution plan under thesame rules as §1.401(k)–3(h)(4). Conse-quently, each NHCE under the plan pro-viding for matching contributions must beeligible under the same conditions underthe other defined contribution plan and theplan to which the contributions are mademust have the same plan year as the planproviding for matching contributions.

(5) Contributions used only once. Safeharbor matching or nonelective contribu-tions cannot be used to satisfy the require-ments of this section with respect to morethan one plan.

(6) Plan must satisfy ACP with respectto employee contributions. If the plan pro-vides for employee contributions, in addi-tion to satisfying the requirements of thissection, it must also satisfy the ACP test of§1.401(m)–2. See §1.401(m)–2(a)(5)(iv)for special rules under which the ACP testis permitted to be performed disregardingsome or all matching when this section issatisfied with respect to the matching con-tributions.

§1.401(m)–4 Special rules for mergers,acquisitions and similar events.[Reserved].

§1.401(m)–5 Definitions.

Unless otherwise provided, the defini-tions of this section govern for purposes ofsection 401(m) and the regulations there-under.

Actual contribution percentage(ACP). Actual contribution percentageor ACP means the ACP of the group

of eligible employees as defined in§1.401(m)–2(a)(2)(i).

Actual contribution percentage (ACP)test. Actual contribution percentage testor ACP test means the test described in§1.401(m)–2(a)(1).

Actual contribution ratio (ACR). Ac-tual contribution ratio or ACR means theACR of an eligible employee as definedin §1.401(m)–2(a)(3).

Actual deferral percentage (ADP)test. Actual deferral percentage test orADP test means the test described in§1.401(k)–2(a)(1).

Compensation. Compensation meanscompensation as defined in section 414(s)and §1.414(s)–1. The period used to de-termine an employee’s compensation for aplan year must be either the plan year or thecalendar year ending within the plan year.Whichever period is selected must be ap-plied uniformly to determine the compen-sation of every eligible employee under theplan for that plan year. A plan may, how-ever, limit the period taken into accountunder either method to that portion of theplan year or calendar year in which the em-ployee was an eligible employee, providedthat this limit is applied uniformly to alleligible employees under the plan for theplan year. See also section 401(a)(17) and§1.401(a)(17)–1(c)(1). For this purpose,in case of an HCE whose ACR is deter-mined under §1.401(m)–2(a)(3)(ii), periodof participation includes periods under an-other plan for which matching contribu-tions or employee contributions are aggre-gated under §1.401(m)–2(a)(3)(ii).

Current year testing method. Cur-rent year testing method means thetesting method under which the appli-cable year is the current plan year, asdescribed in §1.401(k)–2(a)(2)(ii) or1.401(m)–2(a)(2)(ii).

Elective contributions. Elective contri-butions means elective contributions as de-fined in §1.401(k)–6.

Elective deferrals. Elective deferralsmeans elective deferrals described in sec-tion 402(g)(3).

Eligible employee—(1) General rule.Eligible employee means an employeewho is directly or indirectly eligible tomake an employee contribution or toreceive an allocation of matching contri-butions (including matching contributionsderived from forfeitures) under the planfor all or a portion of the plan year. For

example, if an employee must performpurely ministerial or mechanical acts (e.g.,formal application for participation or con-sent to payroll withholding) in order to beeligible to make an employee contributionfor a plan year, the employee is an eligibleemployee for the plan year without regardto whether the employee performs theseacts.

(2) Conditions on eligibility. An em-ployee who is unable to make employeecontributions or to receive an allocationof matching contributions because the em-ployee has not contributed to another planis also an eligible employee. By contrast, ifan employee must perform additional ser-vice (e.g., satisfy a minimum period of ser-vice requirement) in order to be eligible tomake an employee contribution or to re-ceive an allocation of matching contribu-tions for a plan year, the employee is not aneligible employee for the plan year unlessthe service is actually performed. An em-ployee who would be eligible to make em-ployee contributions but for a suspensiondue to a distribution, a loan, or an electionnot to participate in the plan, is treated asan eligible employee for purposes of sec-tion 401(m) for a plan year even though theemployee may not make employee contri-butions or receive an allocation of match-ing contributions by reason of the suspen-sion. Finally, an employee does not fail tobe treated as an eligible employee merelybecause the employee may receive no ad-ditional annual additions because of sec-tion 415(c)(1).

(3) Certain one-time elections. An em-ployee is not an eligible employee merelybecause the employee, no later than theemployee’s first becoming eligible underany plan or arrangement described in sec-tion 219(g)(5)(A) and providing for em-ployee or matching contributions, is givena one-time opportunity to elect, and theemployee in fact does elect, not to be el-igible to make employee contributions orto receive allocations of matching contri-butions under the plan or any other plan orarrangement maintained by the employer(including plans not yet established) forthe duration of the employee’s employ-ment with the employer. In no event isan election made after December 23, 1994,treated as a one-time irrevocable electionunder this paragraph if the election is madeby an employee who previously becameeligible under another plan or arrangement

2005–5 I.R.B. 443 January 31, 2005

(whether or not terminated) of the em-ployer.

Eligible HCE. Eligible HCE means aneligible employee who is an HCE.

Eligible NHCE. Eligible NHCE meansan eligible employee who is not an HCE.

Employee. Employee means an em-ployee within the meaning of §1.410(b)–9.

Employee contributions. Employeecontributions means employee contribu-tions as defined in §1.401(m)–1(a)(3).

Employee stock ownership plan(ESOP). Employee stock ownership planor ESOP means the portion of a planthat is an ESOP within the meaning of§1.410(b)–7(c)(2).

Employer. Employer means an em-ployer within the meaning of §1.410(b)–9.

Excess aggregate contributions. Excessaggregate contributions means, with re-spect to a plan year, the amount of excessaggregate contributions apportioned to anHCE under §1.401(m)–2(b)(2)(iii).

Excess contributions. Excess con-tributions means with respect to a planyear, the amount of excess contribu-tions apportioned to an HCE under§1.401(k)–2(b)(2)(iii).

Excess deferrals. Excess deferralsmeans excess deferrals as defined in§1.402(g)–1(e)(3).

Highly compensated employee (HCE).Highly compensated employee or HCE hasthe meaning provided in section 414(q).

Matching contributions. Matching con-tribution is defined in §1.401(m)–1(a)(2).

Nonelective contributions. Nonelectivecontributions means employer contribu-tions (other than matching contributions)with respect to which the employee maynot elect to have the contributions paidto the employee in cash or other benefitsinstead of being contributed to the plan.

Non-employee stock ownership plan(non-ESOP). Non-employee stock owner-ship plan or non-ESOP means the portionof a plan that is not an ESOP within themeaning of §1.410(b)–7(c)(2).

Non-highly compensated employee(NHCE). Non-highly compensated em-ployee or NHCE means an employee whois not an HCE.

Plan. Plan means plan as defined in§1.401(m)–1(b)(4).

Prior year testing method. Prioryear testing method means the test-ing method under which the appli-cable year is the prior plan year, asdescribed in §1.401(k)–2(a)(2)(ii) or1.401(m)–2(a)(2)(ii).

Qualified matching contributions(QMAC). Qualified matching contribu-tions or QMAC means matching contri-butions that satisfy the requirements of§1.401(k)–1(c) and (d) at the time thecontribution is made, without regard towhether the contributions are actuallytaken into account as elective contribu-tions under §1.401(k)–2(a)(6). See also§1.401(k)–2(b)(4)(iii) for a rule providingthat a matching contribution does not failto qualify as a QMAC solely because it

is forfeitable under section 411(a)(3)(G)because it is a matching contribution withrespect to an excess deferral, excess contri-bution, or excess aggregate contribution.

Qualified nonelective contributions(QNEC). Qualified nonelective contribu-tions or QNEC means employer contri-butions, other than elective contributionsor matching contributions, that satisfy therequirements of §1.401(k)–1(c) and (d) atthe time the contribution is made, withoutregard to whether the contributions areactually taken into account under the ADPtest under §1.401(k)–2(a)(6) or the ADPtest under §1.401(m)–2(a)(6).

PART 602—OMB CONTROLNUMBERS UNDER THE PAPERWORKREDUCTION ACT

Par. 6. The authority citation for part602 continues to read as follows:

Authority: 26 U.S.C. 7808.Par. 7. In §602.101, paragraph (b)

is revised by removing the entries for“1.401(k)–1” and adding a new entry innumerical order in the table to read, inpart, as follows:

§602.101 OMB Control numbers.

* * * * *(b) * * *

CFR part or section whereidentified and described

Current OMBControl No.

* * * * *

1.401(k)–1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1545–1669* * * * *

Par. 8. In §602.101, paragraph (b) isamended by adding entries in numericalorder to the table to read, in part, as fol-lows:

§602.101 OMB Control numbers.

* * * * *(b) * * *

January 31, 2005 444 2005–5 I.R.B.

CFR part or section whereidentified and described

Current OMBControl No.

* * * * *

1.401(k)–2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1545–1669* * * * *

1.401(k)–3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1545–1669* * * * *

1.401(k)–4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1545–1669* * * * *

1.401(k)–3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1545–1699* * * * *

Mark E. Matthews,Deputy Commissioner forServices and Enforcement.

Approved December 15, 2004.

Gregory F. Jenner,Acting Assistant Secretary of the Treasury.

(Filed by the Office of the Federal Register on December 28,2004, 8:45 a.m., and published in the issue of the FederalRegister for December 29, 2004, 69 F.R. 78143)

Section 472.—Last-in,First-out Inventories26 CFR 1.472–1: Last-in, first-out inventories.

LIFO; price indexes; departmentstores. The November 2004 Bureau of

Labor Statistics price indexes are acceptedfor use by department stores employingthe retail inventory and last-in, first-outinventory methods for valuing inventoriesfor tax years ended on, or with referenceto, November 30, 2004.

Rev. Rul. 2005–5

The following Department Store In-ventory Price Indexes for November 2004were issued by the Bureau of Labor Statis-tics. The indexes are accepted by the Inter-nal Revenue Service, under § 1.472–1(k)of the Income Tax Regulations and Rev.Proc. 86–46, 1986–2 C.B. 739, for ap-propriate application to inventories ofdepartment stores employing the retailinventory and last-in, first-out inventory

methods for tax years ended on, or withreference to, November 30, 2004.

The Department Store Inventory PriceIndexes are prepared on a national basisand include (a) 23 major groups of depart-ments, (b) three special combinations ofthe major groups — soft goods, durablegoods, and miscellaneous goods, and (c) astore total, which covers all departments,including some not listed separately, ex-cept for the following: candy, food, liquor,tobacco, and contract departments.

BUREAU OF LABOR STATISTICS, DEPARTMENT STOREINVENTORY PRICE INDEXES BY DEPARTMENT GROUPS

(January 1941 = 100, unless otherwise noted)

Groups Nov. 2003 Nov. 2004

Percent Changefrom Nov. 2003to Nov. 20041

1. Piece Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 480.5 507.8 5.72. Domestics and Draperies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 548.6 535.3 -2.43. Women’s and Children’s Shoes . . . . . . . . . . . . . . . . . . . . . . . . . . . . 649.8 656.6 1.04. Men’s Shoes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 845.3 842.9 -0.35. Infants’ Wear . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 598.3 584.3 -2.36. Women’s Underwear. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 514.2 518.5 0.87. Women’s Hosiery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343.3 342.0 -0.48. Women’s and Girls’ Accessories . . . . . . . . . . . . . . . . . . . . . . . . . . . 555.8 583.1 4.99. Women’s Outerwear and Girls’ Wear . . . . . . . . . . . . . . . . . . . . . . . 375.7 376.8 0.310. Men’s Clothing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 549.5 542.5 -1.311. Men’s Furnishings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 598.3 581.5 -2.812. Boys’ Clothing and Furnishings . . . . . . . . . . . . . . . . . . . . . . . . . . . . 451.0 430.1 -4.613. Jewelry. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 866.8 879.0 1.414. Notions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 797.2 789.1 -1.015. Toilet Articles and Drugs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 976.2 998.6 2.316. Furniture and Bedding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 612.9 601.7 -1.817. Floor Coverings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 594.5 590.2 -0.7

2005–5 I.R.B. 445 January 31, 2005

BUREAU OF LABOR STATISTICS, DEPARTMENT STOREINVENTORY PRICE INDEXES BY DEPARTMENT GROUPS

(January 1941 = 100, unless otherwise noted)

Groups Nov. 2003 Nov. 2004

Percent Changefrom Nov. 2003to Nov. 20041

18. Housewares. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 712.6 711.8 -0.119. Major Appliances. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 210.0 201.6 -4.020. Radio and Television. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44.3 40.7 -8.121. Recreation and Education2. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82.2 79.5 -3.322. Home Improvements2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124.9 130.6 4.623. Automotive Accessories2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112.0 113.1 1.0

Groups 1–15: Soft Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 567.7 566.4 -0.2Groups 16–20: Durable Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 388.9 380.5 -2.2Groups 21–23: Misc. Goods2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93.9 92.9 -1.1

Store Total3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 503.1 499.6 -0.7

1Absence of a minus sign before the percentage change in this column signifies a price increase.2Indexes on a January 1986 = 100 base.3The store total index covers all departments, including some not listed separately, except for the following: candy, food, liquor,tobacco and contract departments.

DRAFTING INFORMATION

The principal author of this revenueruling is Michael Burkom of the Officeof Associate Chief Counsel (Income Taxand Accounting). For further informa-tion regarding this revenue ruling, contactMr. Burkom at (202) 622–7924 (not atoll-free call).

Section 7508.—Time forPerforming Certain ActsPostponed by Reason ofService in Combat Zone orContingency Operation

Taxpayers are advised that the time for performingcertain acts relating to like-kind exchanges of prop-erty under § 1031 of the Code may be postponed byreason of service in a combat zone or contingency op-eration. See Notice 2005-3, page 447.

Section 7508A.—Authorityto Postpone CertainDeadlines by Reason ofPresidentially DeclaredDisaster or Terroristic orMilitary Actions

Taxpayers are advised that certain deadlines relat-ing to like-kind exchanges of property under § 1031of the Code may be postponed by reason of Presiden-tially declared disaster or terroristic or military ac-tions. See Notice 2005-3, page 447.

January 31, 2005 446 2005–5 I.R.B.

Part III. Administrative, Procedural, and MiscellaneousAdditional Relief for Like-KindExchanges for WhichDeadlines May Be PostponedUnder §§ 7508 and 7508A ofthe Internal Revenue Code

Notice 2005–3

This notice advises taxpayers that theInternal Revenue Service and TreasuryDepartment will modify retroactively Rev.Proc. 2004–13, 2004–4 I.R.B. 335, toprovide additional tax relief to taxpayers(transferors) involved in § 1031 like-kindexchange transactions affected by a Presi-dentially declared disaster, a terroristic ormilitary action, service in a combat zone,or service with respect to contingencyoperations. Rev. Proc. 2004–13 will bemodified to expand the list of time-sen-sitive acts under §§ 7508 and 7508A asdescribed below under EXPANDED LISTOF TIME-SENSITIVE ACTS. Rev. Proc.2004–13 also will be modified as de-scribed below under SPECIAL RELIEFFOR § 1031 TRANSACTIONS to (1)expand the categories of taxpayers quali-fying for relief, and (2) provide additionalpostponements of certain § 1031 dead-lines.

Under this notice, taxpayers are enti-tled immediately to additional tax relief if,with respect to a Presidentially declareddisaster, the Service has issued an IRSNews Release or other guidance autho-rizing postponement of deadlines under§ 7508A. For example, additional reliefunder this notice is immediately availableto victims of Hurricanes Charley, Frances,Ivan and Jeanne, and Tropical StormBonnie, who were granted relief in priorIRS News Releases. Taxpayers may relyon this notice until Rev. Proc. 2004–13 ismodified as described in this notice.

BACKGROUND

Under § 1031, taxpayers generally donot recognize gain or loss on the exchangeof property held for productive use in atrade or business or for investment if suchproperty is exchanged solely for propertyof like kind that is to be held either forproductive use in a trade or business orfor investment. In the case of a deferred

like-kind exchange under § 1031(a)(3),however, two particular requirementsmust be met. First, replacement propertymust be identified by midnight of the 45th

day after the taxpayer transfers the relin-quished property (45-day identificationperiod). Section 1.1031(k)–1(b)(2)(i) ofthe Income Tax Regulations. Second, un-der § 1.1031(k)–1(b)(2)(ii), the taxpayermust receive the replacement property bymidnight of the earlier of—

(1) The 180th day after the taxpayertransfers the relinquished property (180-day exchange period); or

(2) The due date (including extensions)of the taxpayer’s income tax return for thetaxable year in which the taxpayer trans-ferred the relinquished property (due dateof return exchange period).

Rev. Proc. 2000–37, 2000–2 C.B. 308,modified by Rev. Proc. 2004–51, 2004–33I.R.B. 294, provides a safe harbor underwhich transactions will qualify for treat-ment under § 1031 if a taxpayer meets therequirements of a 5-business day period toenter into a qualified exchange accommo-dation agreement (QEAA), a 45-day iden-tification period, a 180-day exchange pe-riod, and a 180-day combined time pe-riod, which are set forth in section 4.02(3)through (6) of Rev. Proc. 2000–37.

Generally, section 7508 postpones thetime for performing specified acts for in-dividuals serving in the Armed Forces ofthe United States, or serving in support ofsuch Armed Forces, in a combat zone, orwith respect to a contingency operation.

Generally, section 7508A permits theSecretary to postpone specified dead-lines for taxpayers affected by a Presi-dentially declared disaster (as defined in§ 1033(h)(3)) or a terroristic or militaryaction (as defined in § 692(c)(2)).

Rev. Proc. 2004–13 provides an up-dated list of time sensitive acts, the per-formance of which may be postponed un-der §§ 7508 and 7508A. The list of acts inRev. Proc. 2004–13 supplements the listof acts that are automatically postponedunder § 7508 and the list of acts in the reg-ulations under § 7508A for which the Ser-vice may authorize postponements. Rev.Proc. 2004–13 does not itself entitle tax-payers to any postponements under § 7508or § 7508A. Rather, for taxpayers to be

entitled to a postponement with respect toany act listed in Rev. Proc. 2004–13, theService generally will issue an IRS NewsRelease or other guidance providing suchrelief with respect to a specific Presiden-tially declared disaster area, terroristic ormilitary action, service in a combat zone,or service with respect to contingency op-erations.

EXPANDED LIST OFTIME-SENSITIVE ACTS

Section 6 of Rev. Proc. 2004–13 willbe modified to add to the list of time-sensi-tive acts, the performance of which may bepostponed under §§ 7508 and 7508A, theacts described in section 4.02(3), (4), (5)and (6) of Rev. Proc. 2000–37, modifiedby Rev. Proc. 2004–51, relating to cer-tain like-kind exchanges of property under§ 1031.

SPECIAL RELIEF FOR § 1031TRANSACTIONS

Overview

Rev. Proc. 2004–13 also will be mod-ified to include a 120-day postponementfor meeting certain § 1031 like-kind ex-change deadlines under the circumstancesset forth below under General Rule andAdditional Relief for Substantially Dam-aged Identified Property. Taxpayers mayuse the postponement rules provided bythis notice in lieu of the general extensiondates provided by the IRS News Release orother guidance issued with respect to a spe-cific Presidentially declared disaster. Thedeadlines to which the 120-day postpone-ments apply are—

(1) The 45-day identification period andthe 180-day exchange period (but not thedue date of return exchange period) fordeferred like-kind exchanges set forth in§ 1.1031(k)–1(b)(2); and

(2) The 5-business day period to en-ter into a QEAA, the 45-day identifica-tion period, the 180-day exchange period,and the 180-day combined time period setforth in section 4.02(3) through (6) of Rev.Proc. 2000–37, modified by Rev. Proc.2004–51.

2005–5 I.R.B. 447 January 31, 2005

General Rule

The last day of a 45-day identificationperiod set forth in § 1.1031(k)–1(b)(2), thelast day of a 180-day exchange period setforth in § 1.1031(k)–1(b)(2), and the lastday of a period set forth in section 4.02(3)through (6) of Rev. Proc. 2000–37, mod-ified by Rev. Proc. 2004–51, that fallson or after the date of a Presidentially de-clared disaster is postponed by 120 days orto the last day of the general disaster ex-tension period authorized by an IRS NewsRelease or other guidance announcing taxrelief for victims of the specific Presiden-tially declared disaster, whichever is later.

A taxpayer who is a transferor qualifiesfor a postponement under the General Ruleonly if—

(1) The relinquished property wastransferred on or before the date ofthe Presidentially declared disaster,or in a transaction governed by Rev.Proc. 2000–37, modified by Rev. Proc.2004–51, qualified indicia of ownershipwere transferred to the exchange accom-modation titleholder on or before that date;and

(2) The taxpayer (transferor)—(a) Is an “affected taxpayer” as defined

in § 301.7508A–1(d)(1) of the Procedureand Administration Regulations; or

(b) Has difficulty meeting the 45-dayidentification or 180-day exchange dead-line set forth in § 1.1031(k)–1(b)(2), ora deadline set forth in section 4.02(3)through (6) of Rev. Proc. 2000–37, mod-ified by Rev. Proc. 2004–51, due to thePresidentially declared disaster for thefollowing or similar reasons:

(i) The relinquished property or thereplacement property is located in acovered disaster area (as defined in§ 301.7508A–1(d)(2)) as provided in theIRS News Release or other guidance (thecovered disaster area);

(ii) The principal place of business ofany party to the transaction (for exam-ple, a qualified intermediary, exchange ac-commodation titleholder, transferee, set-tlement attorney, lender, financial institu-tion, or a title insurance company) is lo-cated in the covered disaster area;

(iii) Any party to the transaction (or anemployee of such a party who is involvedin the § 1031 transaction) is killed, injured,or missing as a result of the Presidentiallydeclared disaster;

(iv) A document prepared in connectionwith the exchange (for example, the agree-ment between the transferor and the qual-ified intermediary or the deed to the relin-quished property or replacement property)or a relevant land record is destroyed, dam-aged, or lost as a result of the Presidentiallydeclared disaster;

(v) A lender decides not to fund eitherpermanently or temporarily a real estateclosing due to the Presidentially declareddisaster or refuses to fund a loan to thetaxpayer because flood, disaster, or otherhazard insurance is not available due to thePresidentially declared disaster; or

(vi) A title insurance company is notable to provide the required title insurancepolicy necessary to settle or close a realestate transaction due to the Presidentiallydeclared disaster.

Additional Relief for SubstantiallyDamaged Identified Property

The postponement described in theGeneral Rule also applies to the last dayof a 45-day identification period describedin § 1.1031(k)–1(b)(2) and the last day ofa 45-day identification period describedin section 4.05(4) of Rev. Proc. 2000–37,modified by Rev. Proc. 2004–51, that fallsprior to the date of a Presidentially de-clared disaster if an identified replacementproperty (in the case of an exchange de-scribed in § 1.1031(k)–1), or an identifiedrelinquished property (in the case of an ex-change described in Rev. Proc. 2000–37,modified by Rev. Proc. 2004–51) is sub-stantially damaged by the Presidentiallydeclared disaster.

EFFECTIVE DATE

Taxpayers may apply the proposedmodifications to Rev. Proc. 2004–13 de-scribed in this notice for acts that may beperformed on or after January 26, 2004,the effective date of Rev. Proc. 2004–13.

DRAFTING INFORMATION

The principal author of this notice isMichael F. Schmit of the Office of Asso-ciate Chief Counsel (Income Tax and Ac-counting). For further information regard-ing this notice, contact Mr. Schmit at (202)622–4960 or J. Peter Baumgarten at (202)622–4920 (not toll-free calls).

Announcement of Ruleto be Included in FinalRegulations Under Section367(a) Regarding CertainExchanges of Securities forStock or Securities

Notice 2005–6

This notice announces that Trea-sury and the Internal Revenue Service(“the Service”) will amend Treas. Reg.§1.367(a)–3 regarding certain exchangesunder section 354 by U.S. persons of secu-rities of a foreign corporation in a reorgani-zation described in section 368(a)(1)(E) orsecurities of a domestic or foreign corpo-ration pursuant to an asset reorganizationdescribed in section 368(a)(1).

BACKGROUND

Section 354(a)(1) provides that no gainor loss shall be recognized by a share-holder if stock or securities in a corpora-tion that is a party to a reorganization are,in pursuance of the plan of reorganization,exchanged solely for stock or securities insuch corporation or in another corporationa party to the reorganization. Section 354further provides that a security holder maysurrender securities and receive securitiesin the same principal amount or in a lesserprincipal amount without the recognitionof gain or loss.

Under section 367(a), gain is recog-nized if a U.S. person transfers property toa foreign corporation in connection withan exchange described in section 354 un-less an exception applies. Treasury Reg.§1.367(a)–3(a) provides, in part, that if inan exchange described in section 354, aU.S. person exchanges stock of a foreigncorporation in a reorganization describedin section 368(a)(1)(E), or a U.S. personexchanges stock of a domestic or foreigncorporation for stock of a foreign corpo-ration pursuant to an asset reorganizationdescribed in section 368(a)(1)(C), (D) or(F) that is not treated as an indirect stocktransfer under Treas. Reg. §1.367(a)–3(d),such section 354 exchange is not a trans-fer to a foreign corporation subject tosection 367(a). This language excludesfrom the scope of section 367(a) certainstock-for-stock exchanges under section354 by U.S. persons, but does not address

January 31, 2005 448 2005–5 I.R.B.

whether exchanges of securities for stockor exchanges of securities for securities,that would qualify for nonrecognitionunder section 354, are subject to section367(a).

DISCUSSION

The Treasury Department and the Ser-vice will issue regulations under Treas.Reg. §1.367(a)–3 to provide that an ex-change described in section 354 by a U.S.person of securities of a foreign corpora-tion for stock or securities of the foreigncorporation in a reorganization describedin section 368(a)(1)(E) will not be subjectto section 367(a). The regulations will fur-ther provide that an exchange describedin section 354 by a U.S. person of secu-rities of a domestic or a foreign corpora-tion for stock or securities of a foreign cor-poration pursuant to an asset reorganiza-tion described in section 368(a)(1), that isnot treated as an indirect transfer describedin Treas. Reg. §1.367(a)–3(d), will not

be subject to section 367(a). Conformingamendments to other portions of the regu-lations under sections 367 and 6038B willbe made as well.

EFFECTIVE DATE

Regulations to be issued incorporatingthe guidance set forth in this notice willapply to transfers of securities after Jan-uary 5, 2005. Until such regulations areissued, taxpayers may rely on this notice.Taxpayers also may apply the provisions ofthis notice to transfers of securities occur-ring on or after July 20, 1998 (the effec-tive date of Treas. Reg. §1.367(a)–3(a))and on or before January 5, 2005. Taxpay-ers applying this notice, however, must doso consistently to all transactions within itsscope.

COMMENTS

Written comments on the issues ad-dressed in this notice may be submitted

to the Office of Associate Chief Coun-sel International, Attention: Mark R.Pollard (Notice 2004–6), room 4555,CC:INTL:BR3, Internal Revenue Ser-vice, 1111 Constitution Avenue, NW,Washington, DC 20224. Alternatively,taxpayers may submit comments electron-ically to Notice.Comments@m1.irscoun-sel.treas.gov. Comments will be availablefor public inspection and copying. Trea-sury and the IRS request comments byApril 28, 2005.

DRAFTING INFORMATION

The principal author of this notice isMark R. Pollard of the Office of AssociateChief Counsel (International). For furtherinformation regarding this notice, contactMr. Pollard at (202) 622–3860 (not a toll-free call).

2005–5 I.R.B. 449 January 31, 2005

Part IV. Items of General Interest

Announcement of Disciplinary Actions InvolvingAttorneys, Certified Public Accountants, Enrolled Agents,and Enrolled Actuaries — Suspensions, Censures,Disbarments, and ResignationsAnnouncement 2005-2

Under Title 31, Code of Federal Regu-lations, Part 10, attorneys, certified publicaccountants, enrolled agents, and enrolledactuaries may not accept assistance from,or assist, any person who is under disbar-ment or suspension from practice beforethe Internal Revenue Service if the assis-tance relates to a matter constituting prac-tice before the Internal Revenue Serviceand may not knowingly aid or abet another

person to practice before the Internal Rev-enue Service during a period of suspen-sion, disbarment, or ineligibility of suchother person.

To enable attorneys, certified publicaccountants, enrolled agents, and enrolledactuaries to identify persons to whomthese restrictions apply, the Director, Of-fice of Professional Responsibility, willannounce in the Internal Revenue Bulletin

their names, their city and state, their pro-fessional designation, the effective dateof disciplinary action, and the period ofsuspension. This announcement will ap-pear in the weekly Bulletin at the earliestpracticable date after such action and willcontinue to appear in the weekly Bulletinsfor five successive weeks.

Consent Suspensions From Practice Before the InternalRevenue Service

Under Title 31, Code of Federal Regu-lations, Part 10, an attorney, certified pub-lic accountant, enrolled agent, or enrolledactuary, in order to avoid institution or con-clusion of a proceeding for his or her dis-barment or suspension from practice be-

fore the Internal Revenue Service, may of-fer his or her consent to suspension fromsuch practice. The Director, Office of Pro-fessional Responsibility, in his discretion,may suspend an attorney, certified publicaccountant, enrolled agent, or enrolled ac-

tuary in accordance with the consent of-fered.

The following individuals have beenplaced under consent suspension frompractice before the Internal Revenue Ser-vice:

Name Address Designation Date of Suspension

Nadler, Herbert New York, NY Enrolled Actuary November 1, 2004toFebruary 28, 2005

Distribution From a PensionPlan Under a PhasedRetirement Program; Hearing

Announcement 2005–10

AGENCY Internal Revenue Service(IRS), Treasury.

ACTION: Notice of public hearing on pro-posed rulemaking.

SUMMARY: This document contains anotice of public hearing on a proposedrulemaking (REG–114726–04, 2004–47I.R.B. 857) that provide rules permittingdistributions to be made from a pensionplan under a phased retirement programand set forth requirements for a bona fidephased retirement program.

January 31, 2005 450 2005–5 I.R.B.

DATES: The public hearing is being heldon March 14, 2005, at 10 a.m. The IRSmust receive outlines of the topics to bediscussed at the hearing by February 21,2005.

ADDRESSES: The public hearing is beheld in the Auditorium, Internal Rev-enue Service Building, 1111 Consti-tution Avenue, NW, Washington, DC.Send submissions to: CC:PA:LPD:PR(REG–114726–04), Room 5203, Inter-nal Revenue Service, PO Box 7604, BenFranklin Station, Washington, DC 20044.Submissions may be hand delivered Mon-day through Friday between the hours of8 a.m. and 4 p.m. to CC:PA:LPD:PR(REG–114726–04), Courier’s Desk, In-ternal Revenue Service, 1111 Consti-tution Avenue, NW, Washington, DC,or sent electronically, via the IRS In-ternet site at http://www.irs.gov/regsor via the Federal eRulemaking Por-tal at www.regulations.gov (IRS andREG–114726–04).

FOR FURTHER INFORMATIONCONTACT: Concerning the regulations,Cathy Vohs, (202) 622–6090; concerningsubmissions, the hearing, and/or place-ment on the building access list to attendthe hearing, Sonya M. Cruse of the Pub-lications and Regulations Branch, LegalProcessing Division, Associate ChiefCounsel (Procedure and Administration),at (202) 622–4693 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

The subject of the public hearingis the notice of proposed rulemaking(REG–114726–04) that was publishedin the Federal Register on Wednesday,November 10, 2004 (69 FR 65108).

The rules of 26 CFR 601.601(a)(3) ap-ply to the hearing.

Persons who have submitted writtencomments and wish to present oral com-ments at the hearing, must submit anoutline of the topics to be discussed andthe amount of time to be devoted to each

topic (signed original and eight (8) copies)by February 21, 2005.

A period of 10 minutes is allotted toeach person for presenting oral comments.

After the deadline for receiving out-lines has passed, the IRS will prepare anagenda containing the schedule of speak-ers. Copies of the agenda will be madeavailable, free of charge, at the hearing.

Because of access restrictions, the IRSwill not admit visitors beyond the imme-diate entrance area more than 15 minutesbefore the hearing starts. For informa-tion about having your name placed onthe building access list to attend the hear-ing, see the “FOR FURTHER INFORMA-TION CONTACT” section of this docu-ment.

Cynthia E. Grigsby,Acting Chief, Publications

and Regulations Branch,Legal Processing Division,

Associate Chief Counsel(Procedure and Administration).

(Filed by the Office of the Federal Register on December 27,2004, 8:45 a.m., and published in the issue of the FederalRegister for December 28, 2004, 69 F.R. 77678)

Section 707 RegardingDisguised Sales, Generally;Correction

Announcement 2005–11

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Correction to notice of pro-posed rulemaking and notice of publichearing.

SUMMARY: This document containsa correction to proposed regulations(REG–149519–03, 2004–51 I.R.B. 1009)which were published in the Federal Reg-ister on Friday, November 26, 2004 (69FR 68838). The proposed regulationsrelates to the treatment of transactionsbetween a partnership and its partners asdisguised sales of partnership interestsbetween the partners.

FOR FURTHER INFORMATIONCONTACT: Deane M. Burke orChristopher L. Trump, (202) 622–3070(not a toll-free number).

SUPPLEMENTARY INFORMATION:

BACKGROUND

The proposed regulations that is thesubject of this correction is under sec-tion 707(a)(2)(B) of the Internal RevenueCode.

Need for correction

As published, the notice of proposedrulemaking and notice of public hearingcontain an error that may prove to be mis-leading and is in need of clarification.

Correction to Publication

Accordingly, the publication of theproposed regulations (REG–149519–03),which was the subject of FR Doc.04–26112, is corrected as follows:

On page 68843, column 3, in the pre-amble under the paragraph heading, “Re-view of Existing Regulations”, line 5,the language “§§ 1.707–3, 1.707–4, and1.707-5.” is corrected to read “§§ 1.707–3,1.707–4, 1.707–5 and 1.707–6.”.

Cynthia E. Grigsby,Acting Chief, Regulationsand Publications Branch,

Legal Processing Division,Associate Chief Counsel

(Procedure and Administration).

(Filed by the Office of the Federal Register on December 20,2004, 8:45 a.m., and published in the issue of the FederalRegister for December 21, 2004, 69 F.R. 76422)

2005–5 I.R.B. 451 January 31, 2005

Definition of TermsRevenue rulings and revenue procedures(hereinafter referred to as “rulings”) thathave an effect on previous rulings use thefollowing defined terms to describe the ef-fect:

Amplified describes a situation whereno change is being made in a prior pub-lished position, but the prior position is be-ing extended to apply to a variation of thefact situation set forth therein. Thus, ifan earlier ruling held that a principle ap-plied to A, and the new ruling holds that thesame principle also applies to B, the earlierruling is amplified. (Compare with modi-fied, below).

Clarified is used in those instanceswhere the language in a prior ruling is be-ing made clear because the language hascaused, or may cause, some confusion.It is not used where a position in a priorruling is being changed.

Distinguished describes a situationwhere a ruling mentions a previously pub-lished ruling and points out an essentialdifference between them.

Modified is used where the substanceof a previously published position is beingchanged. Thus, if a prior ruling held that aprinciple applied to A but not to B, and thenew ruling holds that it applies to both A

and B, the prior ruling is modified becauseit corrects a published position. (Comparewith amplified and clarified, above).

Obsoleted describes a previously pub-lished ruling that is not considered deter-minative with respect to future transac-tions. This term is most commonly used ina ruling that lists previously published rul-ings that are obsoleted because of changesin laws or regulations. A ruling may alsobe obsoleted because the substance hasbeen included in regulations subsequentlyadopted.

Revoked describes situations where theposition in the previously published rulingis not correct and the correct position isbeing stated in a new ruling.

Superseded describes a situation wherethe new ruling does nothing more than re-state the substance and situation of a previ-ously published ruling (or rulings). Thus,the term is used to republish under the1986 Code and regulations the same po-sition published under the 1939 Code andregulations. The term is also used whenit is desired to republish in a single rul-ing a series of situations, names, etc., thatwere previously published over a period oftime in separate rulings. If the new rul-ing does more than restate the substance

of a prior ruling, a combination of termsis used. For example, modified and su-perseded describes a situation where thesubstance of a previously published rulingis being changed in part and is continuedwithout change in part and it is desired torestate the valid portion of the previouslypublished ruling in a new ruling that is selfcontained. In this case, the previously pub-lished ruling is first modified and then, asmodified, is superseded.

Supplemented is used in situations inwhich a list, such as a list of the names ofcountries, is published in a ruling and thatlist is expanded by adding further names insubsequent rulings. After the original rul-ing has been supplemented several times, anew ruling may be published that includesthe list in the original ruling and the ad-ditions, and supersedes all prior rulings inthe series.

Suspended is used in rare situationsto show that the previous published rul-ings will not be applied pending somefuture action such as the issuance of newor amended regulations, the outcome ofcases in litigation, or the outcome of aService study.

AbbreviationsThe following abbreviations in current useand formerly used will appear in materialpublished in the Bulletin.

A—Individual.Acq.—Acquiescence.B—Individual.BE—Beneficiary.BK—Bank.B.T.A.—Board of Tax Appeals.C—Individual.C.B.—Cumulative Bulletin.CFR—Code of Federal Regulations.CI—City.COOP—Cooperative.Ct.D.—Court Decision.CY—County.D—Decedent.DC—Dummy Corporation.DE—Donee.Del. Order—Delegation Order.DISC—Domestic International Sales Corporation.DR—Donor.E—Estate.EE—Employee.E.O.—Executive Order.

ER—Employer.ERISA—Employee Retirement Income Security Act.EX—Executor.F—Fiduciary.FC—Foreign Country.FICA—Federal Insurance Contributions Act.FISC—Foreign International Sales Company.FPH—Foreign Personal Holding Company.F.R.—Federal Register.FUTA—Federal Unemployment Tax Act.FX—Foreign corporation.G.C.M.—Chief Counsel’s Memorandum.GE—Grantee.GP—General Partner.GR—Grantor.IC—Insurance Company.I.R.B.—Internal Revenue Bulletin.LE—Lessee.LP—Limited Partner.LR—Lessor.M—Minor.Nonacq.—Nonacquiescence.O—Organization.P—Parent Corporation.PHC—Personal Holding Company.PO—Possession of the U.S.PR—Partner.

PRS—Partnership.PTE—Prohibited Transaction Exemption.Pub. L.—Public Law.REIT—Real Estate Investment Trust.Rev. Proc.—Revenue Procedure.Rev. Rul.—Revenue Ruling.S—Subsidiary.S.P.R.—Statement of Procedural Rules.Stat.—Statutes at Large.T—Target Corporation.T.C.—Tax Court.T.D. —Treasury Decision.TFE—Transferee.TFR—Transferor.T.I.R.—Technical Information Release.TP—Taxpayer.TR—Trust.TT—Trustee.U.S.C.—United States Code.X—Corporation.Y—Corporation.Z —Corporation.

January 31, 2005 i 2005–5 I.R.B.

Numerical Finding List1

Bulletins 2005–1 through 2005–5

Announcements:

2005-1, 2005-1 I.R.B. 257

2005-2, 2005-2 I.R.B. 319

2005-3, 2005-2 I.R.B. 270

2005-4, 2005-2 I.R.B. 319

2005-5, 2005-3 I.R.B. 353

2005-6, 2005-4 I.R.B. 377

2005-7, 2005-4 I.R.B. 377

2005-8, 2005-4 I.R.B. 380

2005-9, 2005-4 I.R.B. 380

2005-10, 2005-5 I.R.B. 450

2005-11, 2005-5 I.R.B. 451

Notices:

2005-1, 2005-2 I.R.B. 274

2005-2, 2005-3 I.R.B. 337

2005-3, 2005-5 I.R.B. 447

2005-4, 2005-2 I.R.B. 289

2005-5, 2005-3 I.R.B. 337

2005-6, 2005-5 I.R.B. 448

2005-7, 2005-3 I.R.B. 340

2005-8, 2005-4 I.R.B. 368

2005-9, 2005-4 I.R.B. 369

Proposed Regulations:

REG-129709-03, 2005-3 I.R.B. 351

REG-139683-04, 2005-4 I.R.B. 371

REG-159824-04, 2005-4 I.R.B. 372

Revenue Procedures:

2005-1, 2005-1 I.R.B. 1

2005-2, 2005-1 I.R.B. 86

2005-3, 2005-1 I.R.B. 118

2005-4, 2005-1 I.R.B. 128

2005-5, 2005-1 I.R.B. 170

2005-6, 2005-1 I.R.B. 200

2005-7, 2005-1 I.R.B. 240

2005-8, 2005-1 I.R.B. 243

2005-9, 2005-2 I.R.B. 303

2005-10, 2005-3 I.R.B. 341

2005-11, 2005-2 I.R.B. 307

2005-12, 2005-2 I.R.B. 311

Revenue Rulings:

2005-1, 2005-2 I.R.B. 258

2005-2, 2005-2 I.R.B. 259

2005-3, 2005-3 I.R.B. 334

2005-4, 2005-4 I.R.B. 366

2005-5, 2005-5 I.R.B. 445

Tax Conventions:

2005-3, 2005-2 I.R.B. 270

Treasury Decisions:

9164, 2005-3 I.R.B. 320

9165, 2005-4 I.R.B. 357

9167, 2005-2 I.R.B. 261

9168, 2005-4 I.R.B. 354

9169, 2005-5 I.R.B. 381

9170, 2005-4 I.R.B. 363

1 A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2004–27 through 2004–52 is in Internal Revenue Bulletin2004–52, dated December 27, 2004.

2005–5 I.R.B. ii January 31, 2005

Finding List of Current Actions onPreviously Published Items1

Bulletins 2005–1 through 2005–5

Notices:

88-30

Obsoleted by

Notice 2005-4, 2005-2 I.R.B. 289

88-132

Obsoleted by

Notice 2005-4, 2005-2 I.R.B. 289

89-29

Obsoleted by

Notice 2005-4, 2005-2 I.R.B. 289

89-38

Obsoleted by

Notice 2005-4, 2005-2 I.R.B. 289

Proposed Regulations:

REG-149519-03

Corrected by

Ann. 2005-11, 2005-5 I.R.B. 451

REG-114726-04

Corrected by

Ann. 2005-10, 2005-5 I.R.B. 450

Revenue Procedures:

98-16

Modified and superseded by

Rev. Proc. 2005-11, 2005-2 I.R.B. 307

2001-22

Superseded by

Rev. Proc. 2005-12, 2005-2 I.R.B. 311

2002-9

Modified and amplified by

Rev. Proc. 2005-9, 2005-2 I.R.B. 303

2004-1

Superseded by

Rev. Proc. 2005-1, 2005-1 I.R.B. 1

2004-2

Superseded by

Rev. Proc. 2005-2, 2005-1 I.R.B. 86

2004-3

Superseded by

Rev. Proc. 2005-3, 2005-1 I.R.B. 118

2004-4

Superseded by

Rev. Proc. 2005-4, 2005-1 I.R.B. 128

2004-5

Superseded by

Rev. Proc. 2005-5, 2005-1 I.R.B. 170

Revenue Procedures— Continued:

2004-6

Superseded by

Rev. Proc. 2005-6, 2005-1 I.R.B. 200

2004-7

Superseded by

Rev. Proc. 2005-7, 2005-1 I.R.B. 240

2004-8

Superseded by

Rev. Proc. 2005-8, 2005-1 I.R.B. 243

2004-13

Modified by

Notice 2005-3, 2005-5 I.R.B. 447

2004-35

Corrected by

Ann. 2005-4, 2005-2 I.R.B. 319

2004-60

Superseded by

Rev. Proc. 2005-10, 2005-3 I.R.B. 341

Revenue Rulings:

92-63

Modified and superseded by

Rev. Rul. 2005-3, 2005-3 I.R.B. 334

95-63

Modified and superseded by

Rev. Rul. 2005-3, 2005-3 I.R.B. 334

2004-103

Superseded by

Rev. Rul. 2005-3, 2005-3 I.R.B. 334

1 A cumulative list of current actions on previously published items in Internal Revenue Bulletins 2004–27 through 2004–52 is in Internal Revenue Bulletin 2004–52, dated December 27,2004.

January 31, 2005 iii 2005–5 I.R.B.

INDEXInternal Revenue Bulletins 2005–1 through2005–5

The abbreviation and number in parenthesis following the index entryrefer to the specific item; numbers in roman and italic type followingthe parentheses refer to the Internal Revenue Bulletin in which the itemmay be found and the page number on which it appears.

Key to Abbreviations:Ann AnnouncementCD Court DecisionDO Delegation OrderEO Executive OrderPL Public LawPTE Prohibited Transaction ExemptionRP Revenue ProcedureRR Revenue RulingSPR Statement of Procedural RulesTC Tax ConventionTD Treasury DecisionTDO Treasury Department Order

EMPLOYEE PLANSCorporations, prohibited allocations of securities in an S corpo-

ration (TD 9164) 3, 320; (REG–129709–03) 3, 351Determination letters, issuing procedures (RP 6) 1, 200Full funding limitations, weighted average interest rate for:

January 2005 (Notice 9) 4, 369Letter rulings:

And, determination letters, areas which will not be issuedfrom:Associates Chief Counsel and Division Counsel (TE/GE)

(RP 3) 1, 118Associate Chief Counsel (International ) (RP 7) 1, 240

And information letters, procedures (RP 4) 1, 128User fees, request for letter rulings (RP 8) 1, 243

Nonqualified deferred compensation, new section 409A (Notice1) 2, 274

Proposed Regulations:26 CFR 1.409(p)–1, added; prohibited allocations of securi-

ties in an S corporation (REG–129709–03) 3, 351Qualified retirement plans:

Automatic rollover, model language (Notice 5) 3, 337Benefits during phased retirement, REG–114726–04, hearing

(Ann 10) 5, 450Cash or deferred arrangements under section 401(k), match-

ing contributions or employee contributions under section401(m) (TD 9169) 5, 381

Regulations:26 CFR 1.409(p)–1T, revised; prohibited allocations of secu-

rities in an S corporation (TD 9164) 3, 32026 CFR 1.401(k)–0, –1, revised; 1.401(k)–2 thru –6, added;

1.401(m)–0 thru –2, revised; 1.401(m)–3 thru –5, added;1.410(b)–3, revised; 602.101, revised; cash or deferred ar-rangements under section 401(k) and matching contribu-

EMPLOYEE PLANS—Cont.tions or employee contributions under section 401(m) reg-ulations (TD 9169) 5, 381

Technical advice to IRS employees (RP 5) 1, 170

EMPLOYMENT TAXForm W-2, 2005, new code Z, Box 12 (Ann 5) 3, 353Letter rulings and information letters issued by Associate Of-

fices, determination letters issued by Operating Divisions (RP1) 1, 1

Partnership’s contributions to partner’s Health Savings Account(HSA), S corporation’s contributions to HSAs of 2-percentshareholder-employees (Notice 8) 4, 368

Regulations:26 CFR 31.3121(b)(2)–1, revised; 31.3121(b)(10)–2,

amended; 31.3306(c)(10)–2, amended; student FICAexception (TD 9167) 2, 261

Student FICA exception:Application under sections 3121(b)(10) and 3306(c)(10)(B)

(TD 9167) 2, 261Treatment of amounts paid by certain institutions of higher

education (RP 11) 2, 307Technical Advice Memoranda (TAMs) and Technical Expedited

Advice Memoranda (TEAMs) (RP 2) 1, 86

ESTATE TAXLetter rulings and information letters issued by Associate Of-

fices, determination letters issued by Operating Divisions (RP1) 1, 1

Technical Advice Memoranda (TAMs) and Technical ExpeditedAdvice Memoranda (TEAMs) (RP 2) 1, 86

EXCISE TAXAlcohol and biodiesel fuels, aviation grade kerosene, sales of

gasoline to state and local governments and nonprofit organi-zations (Notice 4) 2, 289

Letter rulings and information letters issued by Associate Of-fices, determination letters issued by Operating Divisions (RP1) 1, 1

Technical Advice Memoranda (TAMs) and Technical ExpeditedAdvice Memoranda (TEAMs) (RP 2) 1, 86

EXEMPT ORGANIZATIONSAnnual notice to donors regarding pending and settled declara-

tory judgment suits (Ann 1) 1, 257Declaratory judgment suits (Ann 9) 4, 380Letter rulings:

And determination letters, areas which will not be issuedfrom, Associates Chief Counsel and Division Counsel(TE/GE) (RP 3) 1, 118

And information letters, procedures (RP 4) 1, 128

2005–5 I.R.B. iv January 31, 2005

EXEMPT ORGANIZATIONS—Cont.User fees, request for letter rulings (RP 8) 1, 243

List of organizations classified as private foundations (Ann 7) 4,377

Revocations (Ann 8) 4, 380Technical advice to IRS employees (RP 5) 1, 170

GIFT TAXLetter rulings and information letters issued by Associate Of-

fices, determination letters issued by Operating Divisions (RP1) 1, 1

Technical Advice Memoranda (TAMs) and Technical ExpeditedAdvice Memoranda (TEAMs) (RP 2) 1, 86

INCOME TAXAccounting methods, change to a method provided in sections

1.263(a)–4, 1.263(a)–5, and 1.167(a)–3(b) (RP 9) 2, 303Annual notice to donors regarding pending and settled declara-

tory judgment suits (Ann 1) 1, 257Corporations:

Clarification of section 1374 effective dates, S corporations(TD 9170) 4, 363; (REG–139683–04) 4, 371

S corporation, relief for late shareholders, Rev. Proc.2004–35, correction (Ann 4) 2, 319

Credits:Low-income housing credit:

Satisfactory bond, “bond factor” amounts for the period:January through March 2005 (RR 1) 2, 258

Declaratory judgment suits (Ann 9) 4, 380Disciplinary actions involving attorneys, certified public accoun-

tants, enrolled agents and enrolled actuaries (Ann 2) 2, 319Disguised sales, section 707, REG–149519–03, correction (Ann

11) 5, 451Form 656, Offer in Compromise, revision, check-the-box (Ann

6) 4, 377Information reporting for acquisitions (Notice 7) 3, 340Interest:

Investment:Federal short-term, mid-term, and long-term rates for:

January 2005 (RR 2) 2, 259Suspension applicability to amended returns (RR 4) 4, 366

Inventory:LIFO, price indexes used by department stores for:

November 2004 (RR 5) 5, 445Letter rulings:

And determination letters, areas which will not be issuedfrom:Associates Chief Counsel and Division Counsel (TE/GE)

(RP 3) 1, 118Associate Chief Counsel (International ) (RP 7) 1, 240

And information letters issued by Associate Offices, determi-nation letters issued by Operating Divisions (RP 1) 1, 1

Nonqualified deferred compensation, new section 409A (Notice1) 2, 274

INCOME TAX—Cont.Optional 10-year writeoff, rules governing the time and manner

for making and revoking an election under section 59(e) (TD9168) 4, 354

Partnership’s contributions to partner’s Health Savings Account(HSA), S corporation’s contributions to HSAs of 2-percentshareholder-employees (Notice 8) 4, 368

Per diem allowances updated, 2005 (RP 10) 3, 341Practice before the Internal Revenue Service:

Best practices (TD 9165) 4, 357State or local bond opinions (REG–159824–04) 4, 372

Pre-Filing Agreement (PFA) (RP 12) 2, 311Presidentially declared disasters, like-kind exchanges affected by

(Notice 3) 5, 447Private foundations, organizations now classified as (Ann 7) 4,

377Proposed Regulations:

26 CFR 1.1374–8, –10, amended; section 1374 effective dates(REG–139683–04) 4, 371

31 CFR 10.35, amended; 10.36, 10.38, revised; 10.39, added;10.52, revised; regulations governing practice before theInternal Revenue Service (REG–159824–04) 4, 372

Regulations:26 CFR 1.59–1, added; 602.101, amended; optional 10-year

writeoff of certain tax preferences (TD 9168) 4, 35426 CFR 1.1374–8, –10, amended; 1.1374–8T, –10T, added;

section 1374 effective dates (TD 9170) 4, 36331 CFR 10.33, amended; 10.35 thru 10.38, added; 10.52,

amended; regulations governing practice before the Inter-nal Revenue Service (TD 9165) 4, 357

Revocations, exempt organizations (Ann 8) 4, 380Section 901(j)(5) Presidential waiver, section 901(j)(1) no longer

applies to Libya (RR 3) 3, 334Stock, exchange of securities of foreign corporation, domestic

corporation (Notice 6) 5, 448Tax conventions, U.S. and Swiss pension plans for tax treaty ben-

efits, agreement (Ann 3) 2, 270Technical Advice Memoranda (TAMs) and Technical Expedited

Advice Memoranda (TEAMs) (RP 2) 1, 86Tonnage tax regime, election (Notice 2) 3, 337

SELF-EMPLOYMENT TAXLetter rulings and information letters issued by Associate Of-

fices, determination letters issued by Operating Divisions (RP1) 1, 1

Partnership’s contributions to partner’s Health Savings Account(HSA), S corporation’s contributions to HSAs of 2-percentshareholder-employees (Notice 8) 4, 368

Technical Advice Memoranda (TAMs) and Technical ExpeditedAdvice Memoranda (TEAMs) (RP 2) 1, 86

January 31, 2005 v 2005–5 I.R.B.*U.S. Government Printing Office: 2005—310–365/60172