Certain Cash or Deferred Arrangements and Employee and matching Contributions Under Employee Plans: Retirement Plans; Cash or Deferred Arrangement

Part IV. Items of General Interest
Notice of Proposed Rulemaking
and Notice of Public Hearing
Retirement Plans; Cash or
Deferred Arrangements Under
Section 401(k) and Matching
Contributions or Employee
Contributions Under Section
401(m) Regulations
REG–108639–99
AGENCY: Internal
(IRS), Treasury.

FOR
FURTHER
INFORMATION
CONTACT: Concerning the regulations,
R. Lisa Mojiri-Azad or John T. Ricotta at
(202) 622–6060 (not a toll-free number);
concerning submissions and the hearing, and/or to be placed on the building
access list to attend the hearing, LaNita
Van Dyke, (202) 622–7180 (not a toll-free
number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act

Revenue

Service

ACTION: Notice of proposed rulemaking
and notice of public hearing.
SUMMARY: This document contains proposed regulations that would provide guidance for certain retirement plans containing cash or deferred arrangements under
section 401(k) and providing for matching contributions or employee contributions under section 401(m). These regulations affect sponsors of plans that contain cash or deferred arrangements or provide for employee or matching contributions, and participants in these plans. This
document also contains a notice of public
hearing on these proposed regulations.
DATES: Written and electronic comments
and requests to speak (with outlines of oral
comments) at a public hearing scheduled
for November 12, 2003, must be received
by October 22, 2003.
ADDRESSES: Send submissions to:
CC:PA:RU (REG–108639–99), room
5226, Internal Revenue Service, POB
7604, Ben Franklin Station, Washington,
DC 20044. Submissions may be hand
delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to:
CC:PA:RU (REG–108639–99), Courier's
Desk, Internal Revenue Service, 1111
Constitution Avenue, NW, Washington,
DC. Alternatively, taxpayers may submit
comments electronically via the Internet directly to the IRS Internet site at:
www.irs.gov/regs. The public hearing will
be held in the IRS Auditorium (7th Floor),
Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC.

September 2, 2003

The collections of information contained in this notice of proposed rulemaking have been submitted to the Office of
Management and Budget for review in
accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)).
Comments on the collections of information should be sent to the Office of
Management and Budget, Attn: Desk Officer for the Department of the Treasury,
Office of Information and Regulatory
Affairs, Washington, DC 20503, with
copies to the Internal Revenue Service,
Attn: IRS Reports Clearance Officer,
W:CAR:MP:T:T:SP, Washington, DC
20224. Comments on the collections of
information should be received by September 15, 2003. Comments are specifically
requested concerning:
Whether the proposed collections of information are necessary for the proper performance of the functions of the IRS, including whether the information will have
practical utility;
The accuracy of the estimated burden
associated with the proposed collection of
information (see below);
How the quality, utility, and clarity of
the information to be collected may be enhanced;
How the burden of complying with the
proposed collection of information may be
minimized, including through the application of automated collection techniques
or other forms of information technology;
and
Estimates of capital or start-up costs
and costs of operation, maintenance, and
purchase of services to provide information.

431

The collections of information in
these proposed regulations are contained in §§1.401(k)–1(d)(3)(iii)(C),
1.401(k)–2(b)(3), 1.401(k)–3(d), 1.401
(k)–3(f), 1.401(k)–3(g), 1.401(k)–4(d)(3),
1.401(m)–3(e), 1.401(m)–3(g) and 1.401
(m)–3(h).
The information required
by §§1.401(k)–3(d), 1.401(k)–3(f), 1.401
(k)–3(g), 1.401(m)–3(e), 1.401(m)–3(g)
and 1.401(m)–3(h) is required by the IRS
to comply with the requirements of sections 401(k)(12)(D) and 401(m)(11)(A)(ii)
regarding notices that must be provided
to eligible participants to apprize them of
their rights and obligations under certain
plans. This information will be used by
participants to determine whether to participate in the plan, and by the IRS to confirm that the plan complies with applicable
qualification requirements to avoid adverse tax consequences. The information
required by §1.401(k)–4(d)(3) is required
by the IRS to comply with the requirements of section 401(k)(11)(B)(iii)(II)
regarding notices that must be provided
to eligible participants to apprize them
of their rights and obligations under certain plans. This information will be used
by participants to determine whether to
participate in the plan, and by the IRS to
confirm that the plan complies with applicable qualification requirements to avoid
adverse tax consequences. The information required by §1.401(k)–2(b)(3) will
be used by employees to file their income
tax returns and by the IRS to assess the
correct amount of tax. The information
provided under §1.40(k)–1(d)(3)(iii)(C)
will be used by employers in determining
whether to make hardship distributions to
participants. The collections of information are mandatory. The respondents are
businesses or other for-profit institutions,
and nonprofit institutions.
Estimated total annual reporting burden: 26,500 hours.
The estimated annual burden per respondent is 1 hour, 10 minutes.
Estimated number of respondents:
22,500.
The estimated annual frequency of responses: On occasion.
An agency may not conduct or sponsor,
and a person is not required to respond to, a
collection of information unless it displays

2003-35 I.R.B.

a valid control number assigned by the Office of Management and Budget.
Books or records relating to a collection
of information must be retained as long
as their contents may become material in
the administration of any internal revenue
law. Generally, tax returns and tax return
information are confidential, as required
by 26 U.S.C. 6103.
Background
This document contains proposed new
comprehensive regulations setting forth
the requirements (including the nondiscrimination requirements) for cash or deferred arrangements under section 401(k)
and for matching contributions and employee contributions under section 401(m)
of the Internal Revenue Code (Code).
Comprehensive final regulations under sections 401(k) and 401(m) of the
Code were last published in the Federal
Register 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, 1995–1
C.B. 54, published on December 22, 1994.
Since 1994, many significant changes have
been made to sections 401(k) and 401(m)
by the Small Business 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 Tax Relief Reconciliation Act
of 2001, Public Law 107–16 (115 Stat.
38) (EGTRRA).
The most substantial changes to the section 401(k) and section 401(m) provisions
were made to the methodology for testing the amount of elective contributions,
matching contributions, and employee
contributions for nondiscrimination. Section 401(a)(4) prohibits discrimination in
contribution or benefits in favor of highly
compensated employees (within the meaning of section 414(q)) (HCEs). Section
401(k) provides a special nondiscrimination test for elective contributions under a
cash or deferred arrangement that is part
of a profit-sharing plan, stock bonus plan,
pre-ERISA money purchase plan, or rural
cooperative plan, called the actual deferral
percentage (ADP) test. Section 401(m)
provides a parallel test for matching contributions and employee contributions
under a defined contribution plan, called

2003-35 I.R.B.

the actual contribution percentage (ACP)
test.
These special nondiscrimination
standards are provided in recognition of
the fact that the amount of elective contributions and employee contributions (and
corresponding matching contributions) is
determined by the employee's utilization
of the contribution opportunity offered
under the plan. This is in contrast to the
situation in other defined contribution
plans where the amount of contributions
is determined by the amount the employer
decides to contribute.
Sections 401(k) and 401(m) provide
alternative methods for satisfying the
applicable nondiscrimination rules: a
mathematical comparison and a number
of design-based methods. The inherent
variation in the amount of contributions
among employees noted above, and the
fact that the economic situation of HCEs
may make them more likely to make elective or employee contributions, means that
the usual nondiscrimination test under
section 401(a)(4) — under which for each
HCE with a contribution level there must
be a specified number of nonhighly compensated employees (NHCEs) with equal
or greater contributions — is not appropriate. Instead, average rates of contribution
are used in the ADP and ACP tests (with
a built-in differential permitted for HCEs)
and minimum standards for nonelective or
matching contributions are provided in the
design-based alternatives.
Prior to the enactment of SBJPA, sections 401(k) and 401(m) provided only for
mathematical comparison. Specifically,
the ADP and ACP tests compare the average of the rates of contributions of the
HCEs to the average of the rates of contributions of the NHCEs. For this purpose,
the rate of contributions for an employee
is the amount of contributions for an
employee divided by the employee’s compensation for the plan year. These tests
are satisfied if the average rate of HCE
contributions does not exceed 1.25 times
the average rate of contributions of the
NHCEs. Alternatively, these tests are
satisfied if the average rate of HCE contributions does not exceed the average rate of
contributions of the NHCEs by more than
2 percentage points and is no more than 2
times the average rate of contributions of
the NHCEs. To the extent that these tests
are not satisfied, the statute provides for
correction through distribution to HCEs

432

(or forfeiture of nonvested matching contributions) or, to the extent provided in
regulations, recharacterization of elective
contributions as after-tax contributions. In
addition, to the extent provided in regulations, nonelective contributions can be
made to NHCEs and elective contributions
and certain matching contributions can be
moved between the ADP and ACP tests, in
order the reduce the discrepancy between
the average rates of contribution for the
HCEs and the NHCEs.
SBJPA added design-based alternative
methods of satisfying the ADP and ACP
tests. Under these methods, if a plan meets
certain contribution and notice requirements, the plan is deemed to satisfy the
nondiscrimination rules without regard
to actual utilization of the contribution
opportunity offered under the plan. These
regulations reflect this change and the
other changes that were made to sections
401(k) and 401(m) under SBJPA, TRA
’97 and EGTRRA since the issuance of
final regulations under those sections.
SBJPA made the following significant
changes affecting section 401(k) and section 401(m) plans:

•

The ADP test and ACP test were
amended to allow the use of prior year
data for NHCEs.

•

The method of distributing to correct
failures of the ADP test or ACP test
was changed to require distribution to
the HCEs with the highest contributions.

•

Tax-exempt organizations and Indian
tribal governments are permitted to
maintain section 401(k) plans.

•

A safe harbor alternative to the ADP
test and ACP test was introduced in order to provide a design-based method
to satisfy the nondiscrimination tests.

•

The SIMPLE 401(k) plan (an alternative design-based method to satisfy
the nondiscrimination tests for small
employers that corresponds to the provisions of section 408(p) for SIMPLE
IRA plans by providing for smaller
contributions) was added.

•

A special testing option was provided
for plans that permit participation before employees meet the minimum age

September 2, 2003

and service requirements, in order to
encourage employers to permit employees to start participating sooner.
TRA '97 made the following significant
changes affecting section 401(k) and section 401(m) plans:

•

Matching contributions for self-employed individuals are no longer
treated as elective contributions.
EGTRRA made the following significant changes affecting section 401(k) and
section 401(m) plans:

•

•

•

•

Notice 97–2, 1997–1 C.B. 348, provided initial guidance on prior year
ADP and ACP testing and guidance on
correction of excess contributions and
excess aggregate contributions, including distribution to the HCEs with the
highest contributions.

•

Rev. Proc. 97–9, 1997–1 C.B. 624,
provided model amendments for SIMPLE 401(k) plans.

•

Notice 98–1, 1998–1 C.B. 327, provided additional guidance on prior year
testing issues.

•

Notice 98–52, 1998–2 C.B. 632, and
Notice 2000–3, 2000–1 C.B. 413, provided guidance on safe harbor section
401(k) plans.

•

Rev. Rul. 2000–8, 2000–1 C.B. 617,
addressed the use of automatic enrollment features in section 401(k) plans.

State and local governmental plans are
treated as automatically satisfying the
ADP and ACP tests.

•

•

401(m) plans addressing these statutory
changes and other items have been issued
by the IRS, including:

Catch-up contributions were added to
provide for additional elective contributions for participants age 50 or older.
The Secretary was directed to change
the section 401(k) regulations to
shorten the period of time that an
employee is stopped from making
elective contributions under the safe
harbor rules for hardship distributions.
Beginning in 2006, section 401(k)
plans will be permitted to allow employees to designate their elective
contributions as “Roth contributions”
that will be subject to taxation under
the rules applicable to Roth IRAs under section 408A.
Section 401(k) plans using the designbased safe harbor and providing no additional contributions in a year are exempted from the top-heavy rules of
section 416.

•

Distributions from section 401(k)
plans are permitted upon “severance
from employment” rather than “separation from service.”

•

The multiple use test specified in section 401(m)(9) is repealed.

•

Faster vesting is required for matching
contributions

•

Matching contributions are taken into
account in satisfying the top-heavy requirements of section 416.
In addition, since publication of the final regulations, a number of items of guidance affecting section 401(k) and section

September 2, 2003

•

Notice 2001–56, 2001–2 C.B. 277,
and Notice 2002–4, 2002–2 I.R.B.
298, provided initial guidance related
to the changes made by EGTRRA.
These items of guidance are incorporated
into these proposed regulations with some
modifications and the proposed regulations have been reorganized as indicated
in the tables of contents at proposed
§§1.401(k)–0 and 1.401(m)–0. Treasury
and the IRS believe that a single restatement of the section 401(k) and section
401(m) rules serves the interests of plan
sponsors, third-party administrators, plan
participants, and plan beneficiaries.
The process of reviewing and integrating all existing administrative guidance
under sections 401(k) and 401(m) has led
Treasury and the IRS to reconsider certain
rules and to propose certain changes in
those rules. To the extent practicable,
this preamble identifies the substantive
changes and explains the underlying analysis. In many cases, the changes will
clarify or simplify existing guidance and
will reduce plan administrative burdens.
Treasury and the IRS appreciate the
fact that plan sponsors and third-party
administrators have developed systems
and practices in the application of existing

433

administrative guidance to the design and
operation of section 401(k) and section
401(m) plans. In many cases, the details
of these systems and practices have been
determined through a plan sponsor's or
administrator's interpretation of specific
terms in existing guidance or, where no
guidance has been provided, through a
plan sponsor's or administrator's best legal
and practical judgment. As a result, these
systems and practices may differ from administrator to administrator, from sponsor
to sponsor, or from plan to plan.
Treasury and the IRS also recognize
that certain of the substantive changes in
these proposed regulations will require
changes in plan design or plan operation.
However, the proposed regulations are not
otherwise intended to require significant
changes in plan systems and practices that
were developed under existing guidance
and that conform to the requirements of
sections 401(k) and 401(m). Therefore,
Treasury and the IRS specifically request
that plan sponsors and third-party administrators comment on points where the
proposed regulations might have the unintended effect of requiring a change to plan
systems or practices so that Treasury and
the IRS can further evaluate whether such
a change is in fact appropriate or whether
Treasury and the IRS should instead make
an adjustment in the final regulations.
Explanation of Provisions
1. Rules Applicable to All Cash or
Deferred Arrangements
Section 401(k)(1) provides that a profitsharing, stock bonus, pre-ERISA money
purchase or rural cooperative plan will not
fail to qualify under section 401(a) merely
because it contains a qualified cash or deferred arrangement. Section 1.401(k)–1
would set forth the general definition of a
cash or deferred arrangement (CODA), the
additional requirements that a CODA must
satisfy in order to be a qualified CODA,
and the treatment of contributions made
under a qualified or nonqualified CODA.
As under the existing final regulations,
a CODA is defined as an arrangement under which employees can make a cash or
deferred election with respect to contributions to, or accruals or benefits under, a
plan intended to satisfy the requirements

2003-35 I.R.B.

of section 401(a). A cash or deferred election is any direct or indirect election by
an employee (or modification of an earlier
election) to have the employer either: 1)
provide an amount to the employee in the
form of cash or some other taxable benefit
that is not currently available; or 2) contribute an amount to a trust, or provide an
accrual or other benefit, under a plan deferring the receipt of compensation. A cash or
deferred election can include a salary reduction agreement, but the specific reference to a salary reduction agreement has
been eliminated as unnecessary. In addition, the proposed regulations would incorporate prior guidance on automatic enrollment, and thus would reflect the fact
that a CODA can specify that the default
that applies in the absence of an affirmative
election by an employee can be a contribution to a trust, as described in Rev. Rul.
2000–8.1
The proposed regulations would continue to provide that the definition of a
CODA excludes contributions that are
treated as after-tax employee contributions at the time of the contribution and
contributions made pursuant to certain
one-time irrevocable elections, but would
also specify that a CODA does not include
an arrangement under which dividends
paid to an ESOP are either distributed to
a participant or reinvested in employer
securities in the ESOP pursuant to an
election by the participant or beneficiary
under section 404(k)(2)(A)(iii) as added
by EGTRRA.
The proposed regulations would also
specify that a contribution is made pursuant to a cash or deferred election only if
the contribution is made after the election
is made. Thus, a contribution made in anticipation of an employee's election is not
treated as an elective contribution. Similarly, the regulations would provide that a
contribution is made pursuant to a cash or
deferred election only if the contribution is
made after the employee's performance of
services which relate to the compensation
that, but for the election, would be paid

to the employee. (If the payment of compensation would have preceded the performance of services, a contribution made
no earlier than the date the compensation
would have been paid, but for the election,
is also treated as made pursuant to a cash or
deferred election). Accordingly, amounts
contributed in anticipation of future performance of services generally would not be
treated as elective contributions under section 401(k). These restrictions on the timing of contributions are consistent with the
fundamental premise of elective contributions, that these are contributions that are
paid to the plan as a result of an employee
election not to receive those amounts in
cash. Moreover, ensuring that contributions are made after the employee's election furthers plan administrability.
The deductibility of these prefunded
elective contributions (as well as prefunded matching contributions) for the
taxable year in which the contribution was
made was addressed in Notice 2002–48,
2002–29 I.R.B.139. In that notice, the IRS
indicated that it was reviewing issues other
than the deductibility of prefunded contributions but, pending additional guidance,
would not challenge the deductibility of
the contributions provided actual payment
is made during the taxable year for which
the deduction is claimed and the amount
deducted does not exceed the applicable
limit under section 404(a)(3)(A)(i). After
considering this issue, the IRS and Treasury have concluded that the prefunding
of elective contributions and matching
contributions is inconsistent with sections
401(k) and 401(m). Thus, under these proposed regulations, an employer would not
be able to prefund elective contributions
to accelerate the deduction for elective
contributions. Once these regulations are
finalized, employer contributions made
under the facts in Notice 2002–48 would
no longer be permitted to be taken into account under the ADP test or the ACP test
and would not satisfy any plan requirement to provide elective contributions or
matching contributions.

2. Qualified CODAs
A. General rules relating to qualified
CODAs
Elective contributions under a qualified
CODA are treated as employer contributions and generally are not included in the
employee's gross income at the time the
cash would have been received (but for the
cash or deferred election), or at the time
contributed to the plan. Elective contributions under a qualified CODA are included
in the employee's gross income however, if
the contributions are in excess of the section 402(g) limit for a year, are designated
Roth contributions (under section 402A,
effective for tax years beginning after December 31, 2005) or are recharacterized as
after-tax contributions as part of a correction of an ADP test failure.
A CODA is not qualified unless it is
part of a profit sharing plan, stock bonus
plan, pre-ERISA money purchase plan,
or rural cooperative plan and provides
for an election between contributions to
the plan or payments directly in cash. In
addition, a CODA is not qualified unless it
meets the following requirements: 1) the
elective contributions under the CODA
satisfy either the ADP test set forth in section 401(k)(3) or one of the design-based
alternatives in section 401(k)(11) or (12);
2) elective contributions under the CODA
are nonforfeitable at all times; 3) elective
contributions are distributable only on the
occurrence of certain events, including
attainment of age 591/2, hardship, death,
disability, severance from employment,
or termination of the plan; 4) the group
of employees eligible to participate in the
CODA satisfies the coverage requirements
of section 410(b)(1); 5) no other benefit (other than matching contributions or
another specified benefit) is conditioned,
directly or indirectly, upon the employee's
making or not making elective contributions under the CODA; and 6) no more
than 1 year of service is required for eligibility to elect to make a cash or deferred
election.
Subject to certain exceptions, state and
local governmental plans are not allowed

1

The Department of Labor has advised Treasury and the IRS that, under Title I of the Employee Retirement Income Security Act of 1974 (ERISA), 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 relieve certain 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 participant or 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 of instructions to the contrary. See 29 CFR
2550.404c–1 and 57 FR 46924.

2003-35 I.R.B.

434

September 2, 2003

to include a qualified CODA. Plans sponsored by Indian tribal governments and rural cooperatives are allowed to include a
qualified CODA.
B. Nondiscrimination rules applicable to
CODAs
As under the existing regulations, the
proposed regulations would provide that
the special nondiscrimination standards
set forth in section 401(k) are the exclusive
means by which a qualified CODA can
satisfy the nondiscrimination in amount
of contribution requirement of section
401(a)(4). These special nondiscrimination standards now include: the ADP
test, the ADP safe harbor and the SIMPLE 401(k) plan. Pursuant to section
401(k)(3)(G), a state or local governmental plan is deemed to satisfy the ADP test.
In addition, as under existing regulations, the plan must satisfy the requirements of §1.401(a)(4)–4 with respect
to the nondiscriminatory availability of
benefits, rights and features, including
the availability of each level of elective
contributions, matching contributions, and
after-tax employee contributions. The
provisions of the existing regulations related to compliance with sections 410(b)
and 401(a)(4) would be revised to clarify
the relationship of the rules under sections
410(b) and 401(a)(4) to the requirements
for a qualified CODA and to remove redundant provisions. Except as provided
below, however, these rules are substantively unchanged.
These proposed regulations are designed to provide simple, practical
rules that accommodate legitimate plan
changes. At the same time, the rules
are intended to be applied by employers
in a manner that does not make use of
changes in plan testing procedures or
other plan provisions to inflate inappropriately the ADP for NHCEs (which is
used as a benchmark for testing the ADP
for HCEs) or to otherwise manipulate the
nondiscrimination testing requirements of
section 401(k). Further, these nondiscrimination requirements are part of the overall
requirement that benefits or contributions
not discriminate in favor of HCEs. Therefore, a plan will not be treated as satisfying
the requirements of section 401(k) if there
are repeated changes to plan testing procedures or plan provisions that have the

September 2, 2003

effect of distorting the ADP so as to increase significantly the permitted ADP
for HCEs, or otherwise manipulate the
nondiscrimination rules of section 401(k),
if a principal purpose of the changes was
to achieve such a result.
C. Aggregation and disaggregation of
plans
The proposed regulations would consolidate the rules in the existing regulations regarding identification of CODAs
and plans for purposes of demonstrating compliance with the requirements of
section 401(k). As under the existing
regulations, all CODAs included in a plan
are treated as a single CODA for purposes of applying the nondiscrimination
tests. For this purpose, a plan is generally
defined by reference to §1.410(b)–7(a)
and (b) after application of the mandatory
disaggregation rules of §1.410(b)–7(c)
(other than the mandatory disaggregation
of section 401(k) and section 401(m)
plans) and permissive aggregation rules
of §1.410(b)–7(d), as modified under
these regulations. For example, if a plan
covers collectively bargained employees
and noncollectively bargained employees,
the elective contributions for the separate
groups of employees must be subject to
separate nondiscrimination tests under
section 401(k). The proposed regulations would also retain the special rules
in the existing regulations that permit
the aggregation of certain employees in
different collective bargaining units and
the prohibition on restructuring under
§1.401(a)(4)–9(c).
The proposed regulations would
change the treatment of a CODA under
a plan which includes an ESOP. Section
1.410(b)–7(c)(2) provides that the portion
of a plan that is an ESOP and the portion
that is not an ESOP are treated as separate plans for purposes of section 410(b)
(except as provided in §54.4975–11(e)).
Accordingly, under the existing regulations, such a plan must apply two separate
nondiscrimination tests: one for elective
contributions going into the ESOP portion
(and invested in employer stock) and one
for elective contributions going in the
non-ESOP portion of the plan. The additional testing results in increased expense
and administrative difficulty for the plan
and creates the possibility that the ESOP

435

portion or the non-ESOP portion may fail
the ADP test or ACP test because HCEs
may be more or less likely to invest in
employer securities than NHCEs.
Since the issuance of the existing regulations, the use of an ESOP as the employer
stock fund in a section 401(k) plan has
become much more widespread. In light
of this development, the proposed regulations would eliminate disaggregation of
the ESOP and non-ESOP portions of a
single section 414(l) plan for purposes of
ADP testing. The same rule would apply
for ACP testing under section 401(m). In
addition, the proposed regulations would
provide that, for purposes of applying the
ADP test or the ACP test, an employer
could permissively aggregate two section
414(l) plans, one that is an ESOP and one
that is not.
However, the exception to mandatory
disaggregation of ESOPs from non-ESOPs
set forth in these proposed regulations
would not apply for purposes of satisfying
section 410(b). Accordingly, the group
of eligible employees under the ESOP
and non-ESOP portions of the plan must
still separately satisfy the requirements of
sections 401(a)(4) and 410(b).
The proposed regulations would also
provide that a single testing method must
apply to all CODAs under a plan. This
has the effect of restricting an employer's
ability to aggregate section 414(l) plans for
purposes of section 410(b), if those plans
apply inconsistent testing methods. For
example, a plan that applies the ADP test
of section 401(k)(3) may not be aggregated
with a plan that uses the ADP safe harbor
of section 401(k)(12) for purposes of section 410(b).
D. Restrictions on withdrawals
As discussed above, a qualified CODA
must provide that elective contributions
may only be distributed after certain
events, including hardship and severance
from employment. EGTRRA amended
section 401(k)(2)(B)(i)(I) by replacing
“separation from service” with “severance
from employment.” This change eliminated the “same desk rule” as a standard
for distributions under section 401(k)
plans.
In addition, EGTRRA amended Code
section 401(k)(10) by deleting disposition
by a corporation of substantially all of the

2003-35 I.R.B.

assets of a trade or business and disposition of a corporation's interest in a subsidiary, leaving termination of the plan as
the only distributable event described in
section 401(k)(10). Finally, EGTRRA directs the Secretary of the Treasury to revise the regulations relating to distributions under section 401(k)(2)(B)(i)(IV) to
provide that the period during which an
employee is prohibited from making elective and employee contributions following a hardship distribution is 6 months
(instead of 12 months as required under
§1.401(k)–1(d)(2)(iv)(B)(4) of the existing
regulations).2
Notice 2001–56 and Notice 2002–4
provided guidance on these EGTRRA
changes to the distribution rules for elective contributions. That guidance is incorporated in these proposed regulations.
In connection with the change to severance from employment, comments are
requested on whether a change in status
from employee to leased employee described in section 414(n) should be treated
as a severance from employment that
would permit a distribution to be made.
In addition, the proposed regulations do
not include reference to “retirement” (included in the existing regulation) as an
event allowing distribution because retirement is not listed in the statute, and is
subsumed by severance from employment.
In addition to the statutory changes,
the rules relating to hardship distributions
have been reorganized in order to clarify
certain ambiguities, including the relationship between the generally applicable
rules, employee representations, and the
safe harbors provided under the existing
regulations. The existing regulations set
forth two basic requirements (i.e., the
employee has an immediate and heavy
financial need and the distribution is necessary to satisfy that need) followed by
safe harbor provisions. The proposed
regulations would retain those basic requirements, but would clarify that each
safe harbor is separately applicable to
each basic requirement. In addition, the
proposed regulations would provide that
an employee representation used for purposes of determining that a distribution
is necessary to satisfy an immediate and
heavy financial need must provide that the

need cannot reasonably be relieved by any
available distribution or nontaxable plan
loan (even if the distribution or loan would
not be sufficient to satisfy the financial
need), but need not provide that a loan
from a commercial source will be taken
if no such loan in an amount sufficient to
satisfy the need is available on reasonable
commercial terms.
The proposed regulations would also
modify the existing regulations to add
other types of defined contribution plans
to the list of plans that an employer may
maintain after the termination of the plan
that contains the qualified CODA while
still providing for distribution of elective
contributions upon plan termination. The
list of such plans has been expanded to
include not only an ESOP and a SEP,
but also a SIMPLE IRA plan, a plan or
contract that satisfies section 403(b) and a
section 457 plan.
Finally, under the existing regulations,
a plan that receives a plan-to-plan transfer that includes elective contributions,
QNECs, or QMACs, must provide that the
restrictions on withdrawals continue after
the transfer. These proposed regulations
would also make explicit a requirement
that the transferor plan will fail to comply
with the restrictions on withdrawals if it
transfers elective contributions, QNECs,
or QMACs to a plan that does not provide
for these restrictions. However, a transferor plan will not fail to comply with this
requirement if it reasonably concludes that
the transferee plan provides for restrictions on withdrawals. What constitutes a
basis for a reasonable conclusion would
be comparable to the rules related to acceptance of rollover distributions. See
§1.401(a)(31)–1, A–14.
E. Other rules for qualified CODAs
The proposed regulations would generally retain the additional requirements
set forth in the existing regulations that a
CODA must satisfy in order to be qualified, with some modifications. First, in order to be a qualified CODA the arrangement must provide an employee with an
effective opportunity to elect to receive the
amount in cash no less than once during the
plan year. Under the proposed regulations,

whether an employee has an effective opportunity is determined based on all the
relevant facts and circumstances, including notice of the availability of the election,
the period of time before the cash is currently available during which an election
may be made, and any other conditions on
elections.
The proposed regulations would also
provide that a plan must provide for satisfaction of one of the specific nondiscrimination alternatives described in section 401(k). As with the existing regulations, the plan may accomplish this by incorporating by reference the ADP test of
section 401(k)(3) and the regulations under
proposed §1.401(k)–2, if that is the nondiscrimination alternative being used. If, with
respect to the nondiscrimination alternative being used there are optional choices,
the plan must provide which of the optional
choices will apply. For example, a plan
that uses the ADP test of section 401(k)(3)
must specify whether it is using the current year testing method or prior year testing method. Additionally, a plan that uses
the prior year testing method must specify
whether the ADP for eligible NHCEs for
the first plan year is 3% or the ADP for
the eligible NHCEs for the first plan year.
Similarly, a plan that uses the safe harbor method must specify whether the safe
harbor contribution will be the nonelective safe harbor contribution or the matching safe harbor contribution and is not permitted to provide that ADP testing will be
used if the requirements for the safe harbor are not satisfied. The safe harbors are
intended to provide employees with a minimum threshold in benefits in exchange for
easier compliance for the plan sponsor. It
would be inconsistent with this approach
to providing benefits to allow an employer
to deliver smaller benefits to NHCEs and
revert to testing.
The proposed regulations would retain
the existing rules relating to the section
401(k)(4)(A) prohibition on having benefits (other than a match) contingent on
making or not making an elective contribution. However, the proposed regulations
would specify that, in the case of a benefit that requires an amount to be withheld from an employee's pay, an employer
is not violating the section 401(k)(4)(A)

2

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 rollover
distribution. While the change affects distributions from a section 401(k) plan, there is no specific reference to the change in these proposed regulations because these regulations are under
sections 401(k) and 401(m).

2003-35 I.R.B.

436

September 2, 2003

contingent benefit rule merely because the
CODA restricts elective contributions to
amounts available after such withholding
from the employee's pay (after deduction
of all applicable income and employment
taxes). In addition, these proposed regulations also reflect the amendment to section 416(c)(2)(A) under which matching
contributions can be taken into account for
purposes of satisfying the top-heavy minimum contribution requirement without violating the prohibition on making benefits
contingent on making or not making elective contributions.
To reflect the amendment of section
401(k)(4)(B) by SBJPA to allow tax exempt organizations to maintain section
401(k) plans, the proposed regulations
would also eliminate the provision prohibiting a tax-exempt employer from
adopting a section 401(k) plan.
As under the existing final regulations,
these proposed regulations would provide
that a partnership is permitted to maintain a CODA, and individual partners are
permitted to make cash or deferred elections with respect to compensation attributable to services rendered to the entity,
under the same rules that apply to common-law employees. This rule has been
extended to sole proprietors. The provisions of these regulations also reflect the
enactment of section 402(g)(8) (initially
section 402(g)(9) as enacted by TRA '97)
providing that matching contributions with
respect to partners and sole proprietors are
no longer treated as elective contributions.
3. Nonqualified CODAs
The proposed regulations would generally retain the rules in the existing regulations applicable to a nonqualified CODA
(i.e., a CODA that fails one or more of
the applicable requirements to be a qualified CODA). Because elective contributions under such an arrangement are not
entitled to the constructive receipt relief
set forth in section 402(e)(3), the contributions are currently taxable to the employee.
In addition, the plan to which such contributions are made must satisfy any nondiscrimination requirements that would otherwise apply under section 401(a)(4).

September 2, 2003

4. The Actual Deferral Percentage (ADP)
Test
A. General rules relating to the ADP test
Section 1.401(k)–2 sets forth the rules
for a CODA that is applying the ADP test
contained in section 401(k)(3). Under the
ADP test, the percentage of compensation
deferred for the eligible HCEs is compared
annually to the percentage of compensation deferred for eligible NHCEs, and if
certain limits are exceeded by the HCEs,
corrective action must be taken by the plan.
Correction can be made through the distribution of excess contributions, the recharacterization of excess contributions, or the
contribution of additional employer contributions.
Section 401(k)(3)(A), as amended by
SBJPA, generally provides for the use of
prior year data in determining the ADP of
NHCEs, while current year data is used for
HCEs. This testing option is referred to
as the prior year testing method. Alternatively, a plan may provide for the use
of current year data for determining the
ADPs for both NHCEs and HCEs, which is
known as the current year testing method.
The proposed regulations would use the
term applicable year to describe the year
for which the ADP is determined for the
NHCEs.
Section 401(k)(3)(F), as added by
SBJPA, provides that a plan benefitting
otherwise excludable employees and that,
pursuant to section 410(b)(4)(B), is being
treated as two separate plans for purposes
of section 410(b), is permitted to disregard
NHCEs who have not met the minimum
age and service requirements of section
410(a)(1)(A). Thus, the proposed regulations would permit such a plan to perform
the ADP test by comparing the ADP for
all eligible HCEs for the plan year and the
ADP of eligible NHCEs for the applicable
year, disregarding all NHCEs who have
not met the minimum age and service
requirements of section 410(a)(1)(A). The
proposed regulations treat this rule as permissive. Accordingly, the new statutory
provision does not eliminate the existing testing option under which a plan
benefitting otherwise excludable employees is disaggregated into separate plans
where the ADP test is performed separately for all eligible employees who have
completed the minimum age and service

437

requirements of section 410(a)(1)(A) and
for all eligible employees who have not
completed the minimum age and service
requirements of section 410(a)(1)(A).
B. Elective contributions used in the ADP
test
The proposed regulations would generally follow the existing regulations in
defining which elective contributions are
reflected in the ADP test and which ones
are not. The proposed regulations would
reflect the rule contained in the regulations under section 414(v), under which
catch-up contributions that are in excess
of a statutory limit or an employer-provided limit are not taken into account under the ADP test. See §1.414(v). In addition, the proposed regulations would incorporate the rule in §1.402(g)–1 that provides excess deferrals that are distributed
are still taken into account under the ADP
test (with the exception of deferrals made
by NHCEs that were in violation of section 401(a)(30)). The proposed regulations
retain the rule that elective contributions
must be paid to the trust within 12 months
after the end of the plan year. However, for
plans subject to Title I of ERISA, contributions must be paid to the trust much sooner
in order to satisfy the Department of Labor's regulations relating to when elective
contributions become plan assets.
Section 401(k)(3) provides that the actual deferral ratio (ADR) of an HCE who is
eligible to participate in 2 or more CODAs
of the same employer is calculated by treating all CODAs in which the employee is
eligible to participate as one CODA. The
existing regulations implement this rule
by aggregating the elective contributions
of such an HCE for all plan years that
end with or within a single calendar year.
This can yield an inappropriate result if
the plan years are different, because more
than 12 months of elective contributions
could be included in an employee's ADR.
These proposed regulations would modify
this rule to provide that the ADR for each
HCE participating in more than one CODA
is determined by aggregating the HCE's
elective contributions that are within the
plan year of the CODA being tested. In
addition, the definition of period of participation for purposes of determining compensation would be modified to take into

2003-35 I.R.B.

account periods of participation under another plan where the elective contributions
must be aggregated for an HCE. As a result, even in the case of plans with different plan years, each of the employer's
CODAs will use 12 months of elective contributions and 12 months of compensation
in determining the ADR for an HCE who
participates in multiple arrangements.
The proposed regulations would retain
the rule in the existing regulations that
provides that the HCE aggregation of
elective contributions under CODAs does
not apply where the CODAs are within
plans that cannot be aggregated under
§1.410(b)–7(d), but only after applying
the modifications to the section 410(b)
aggregation and disaggregation rules for
section 401(k) plans provided in the proposed regulations. The non-application
of the HCE aggregation rule would have
less significance in light of the change
described above relating to the elimination
of the required disaggregation of ESOP
and non-ESOP plans. In addition, the
proposed regulations would clarify that,
in determining whether two plans could
be aggregated for this purpose, the prohibition on aggregating plans with CODAs
that apply inconsistent testing methods set
forth under these proposed regulations and
the section 410(b) prohibition on aggregating plans that have different plan years
would not apply.
C. Additional employer contributions used
in the ADP test
The proposed regulations would generally retain the rules in the existing regulations permitting a plan to take qualified nonelective contributions or qualified
matching contributions (i.e., nonelective
or matching contributions that satisfy the
vesting and distribution limitations of section 401(k)(2)(B) and (C)) into account under the ADP test, except as described below. Thus, an employer whose CODA has
failed the ADP test can correct this failure
by making additional qualified nonelective contributions (QNECs) or qualified
matching contributions (QMACs) for its
NHCEs. The proposed regulations would
no longer describe such contributions as

being treated as elective contributions under the arrangement, but would nonetheless permit such contributions to be taken
into account under the ADP test.
As under the existing regulations, these
proposed regulations would provide that
QNECs must satisfy four requirements
in addition to the vesting and distribution
rules described above before they can be
taken into account under the ADP test: 1)
The amount of nonelective contributions,
including the QNECs that are used under
the ADP test or the ACP test, must satisfy
section 401(a)(4); 2) the nonelective contributions, excluding the QNECs that are
used under the ADP test or the ACP test,
must satisfy section 401(a)(4); 3) the plan
to which the QNEC or QMAC is made
must be a plan that can be aggregated with
the plan maintaining the CODA; and 4) the
QNECs or QMACs must not be contingent
on the performance of services after the
allocation date and must be contributed
within 12 months after the end of the plan
year within which the contribution is to
be allocated.3 Thus, in the case of a plan
using prior year ADP testing, any QNECs
that are to be allocated to the NHCEs for
the prior plan year must be contributed
before the last day of the current plan year
in order to be taken into account.
Some plans provide a correction mechanism for a failed ADP test that targets
QNECs to certain NHCEs in order to reduce the total contributions to NHCEs under the correction. Under the method that
minimizes the total QNECs allocated to
NHCEs under the correction, the employer
makes a QNEC to the extent permitted by
the section 415 limits to the NHCE with
the lowest compensation during the year
in order to raise that NHCE's ADR. If the
plan still fails to pass the ADP test, the employer continues expanding the group of
NHCEs who receive QNECs to the next
lowest-paid NHCE until the ADP test is
satisfied. By using this bottom-up leveling technique, the employer can pass the
ADP test by contributing small amounts of
money to NHCEs who have very low compensation for the plan year (for example,
an employee who terminated employment
in early January with $300 of compensation). This is because of the fact that the

ADP test is based on an unweighted average of ADRs and a small dollar (but high
percentage of compensation) contribution
to a terminated or other partial-year employee has a larger impact on the ADP test
than a more significant contribution to a
full-year employee.
The IRS and Treasury have been
concerned that, by using these types of
techniques, employers may pass the ADP
test by making high percentage QNECs
to a small number of employees with low
compensation rather than providing contributions to a broader group of NHCEs.
In addition, the legislative history to
EGTRRA expresses Congressional intent
that the Secretary of the Treasury will use
his existing authority to address situations
where qualified nonelective contributions
are targeted to certain participants with
lower compensation in order to increase
the ADP of the NHCEs. (See EGTRRA
Conference Report, H.R. Conf. Rep.
107–84, 240).
Accordingly, the proposed regulations
would add a new requirement that a QNEC
must satisfy in order to be taken into account under the ADP test. This requirement, designed to limit the use of targeted
QNECs, would generally treat a plan as
providing impermissibly targeted QNECs
if less than half of all NHCEs are receiving QNECs and would also treat a QNEC
as impermissibly targeted if the contribution is more than double the QNECs other
nonhighly compensated employees are receiving, when expressed as a percentage of
compensation. However, QNECs that do
not exceed 5% of compensation are never
treated as targeted and would always satisfy the new requirement.
This restriction on targeting QNECs
would be implemented in the proposed
regulations by providing that a QNEC
that exceeds 5% of compensation could
be taken into account for the ADP test
only to the extent the contribution, when
expressed as a percentage of compensation, does not exceed two times the
plan's representative contribution rate.
The plan's representative contribution rate
would be defined as the lowest contribution rate among a group of NHCEs that is
half of all the eligible NHCEs under the
arrangement (or the lowest contribution

3

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 made
no later than 30 days after the end of the section 404(a)(6) period applicable to the taxable year with or within which the limitation year ends.

2003-35 I.R.B.

438

September 2, 2003

rate among all eligible NHCEs under the
arrangement who are employed on the last
day of the year, if greater). For purposes
of determining an NHCE's contribution
rate, the employee's qualified nonelective
contributions and the qualified matching
contributions taken into account under
the ADP test for the plan year are added
together and the sum is divided by the
employee's compensation for the same
period. The proposed regulations under
section 401(m) would provide parallel restrictions on QNECs taken into account in
ACP testing, and a QNEC cannot be taken
into account under both the ADP and ACP
test (including for purposes of determining
the representative contribution rate). As
discussed more fully below, the proposed
regulations would also have a limitation on
targeting matching contributions, which
would limit the extent to which QMACs
can be targeted as a means of avoiding the
restrictions on targeted QNECs.
The proposed regulations would also
implement a prohibition against double
counting of QNECs that was set forth in
Notice 98–1. Generally, QNECs used in
an ADP or ACP test, used to satisfy the
safe harbor under section 401(k), or under
a SIMPLE 401(k) plan can not be used
again to demonstrate compliance with
another test under section 401(k)(3) or
401(m)(2). For example, double counting could arise when QNECs on behalf of
NHCEs are used to determine the ADP under current year testing in year 1 and then,
if the employer elected prior year testing,
are used again in year 2 to determine the
ADP of NHCEs. However, unlike Notice
98–1, these proposed regulations would
not contain the additional limitations on
double counting elective contributions or
matching contributions that were moved
between the ADP and ACP tests.
D. Correction
Section 401(k)(8)(C), as amended by
the SBJPA, provides that, for purposes
of correcting a plan's failure to meet the
nondiscrimination requirements of section
401(k)(3), distribution of excess contributions is made on the basis of the amount of
the contributions by, or on behalf of, each
HCE. The proposed regulations would
implement this correction procedure in the
same manner as set forth in Notice 97–2.

September 2, 2003

Thus, the total amount of excess contributions is determined using the rules under
the existing final regulations (i.e., based
on high percentages). Then that total
amount is apportioned among the HCEs
by assigning the excess to be distributed
first to those HCEs who have the greatest
dollar amount of contributions taken into
account under the ADP test (as opposed to
the highest deferral percentage). If these
amounts are distributed or recharacterized
in accordance with these regulations, the
plan complies with the ADP test for the
plan year with no obligation to recalculate
the ADP test.
The proposed regulations would provide a special rule for correcting through
distribution of excess contributions in the
case of an HCE who participates in multiple plans with CODAs. In that case,
the proposed regulations would provide
that, for purposes of determining which
HCE will be apportioned a share of the total excess contributions to be distributed
from a plan, all contributions in CODAs in
which such an HCE participates are aggregated and the HCE with the highest dollar amount of contributions will be apportioned excess contributions first. However, only actual contributions under the
plan undergoing correction — rather than
all contributions taken into account in calculating the employee's ADR — may be
distributed from a plan. If the high dollar
HCE's actual contributions under the plan
are insufficient to allow full correction,
then the HCE with the next highest dollar amount of contributions is apportioned
the remaining excess contributions. If additional correction is needed, this process
is repeated until the excess contributions
are completely apportioned. This correction mechanism is applied independently
to each CODA in which the HCE participates. If correction is needed in more than
one CODA, the ADRs of HCEs who have
received corrective distributions under the
other arrangements are not recalculated after correction in the first plan.
The proposed regulations would generally follow the rules in the existing regulations on the determination of net income
attributable to excess contributions. The
existing regulations provide for a reasonable determination of net income attributable to an excess contribution, but do
not specify which contribution within the
plan year is to be treated as the excess

439

contribution to be distributed. This provision would be retained in the proposed
regulations along with the existing alternative method of determining the net income,
which approximates the result that would
apply if the excess contribution is made
on the first day of the plan year. However, to the extent the employee is or will
be credited with allocable gain or loss on
those excess contributions for the period
after the end of the plan year (the gap period), the proposed regulations would now
require that income be determined for that
period. As under the existing regulations,
the determination of the income for the gap
period could be based on the income determined using the alternative method for
the aggregate of the plan year and the gap
period or using 10% of the income for the
plan year (determined under the alternative
method) for each month in the gap period.
The proposed regulations would permit
the recharacterization of excess contributions in a manner that generally follows
the existing regulations. However, the year
the employee must include the recharacterized contribution in current income has
been changed to match the year that the
employee would have had to include the
excess contribution in income, had it been
distributed. Thus, if the recharacterized
amount is less than $100, it is included in
gross income in the year that it is recharacterized, rather than the year of the earliest
elective contributions for the employee.
The proposed regulations would retain
the rules in the existing regulations regarding the timing and tax treatment of distributions of excess contributions, coordination with the distribution of excess deferrals and the treatment of matches attributable to excess contributions.
E. Special rules relating to prior year
testing
The proposed regulations would generally follow the rules set forth in Notice 98–1 regarding prior year testing, including the limitations on switching from
current year testing to prior year testing.
However, the proposed regulations would
provide that a plan is permitted to be inconsistent between the choice of current
year testing method and prior year testing
method, as applied for ADP purposes and
ACP purposes. In such a case, any movement of elective contributions or QMACs

2003-35 I.R.B.

between the ADP and ACP tests (including
recharacterization) would be prohibited.
The proposed regulations would generally incorporate the rules set forth in
Notice 98–1 relating to plan coverage
changes in the case of a plan using prior
year testing. Thus, in the case of a plan
that uses prior year testing and experiences a plan coverage change affecting
more than 10% of the NHCEs, the ADP
of the NHCEs would generally be determined as the weighted average of the
ADP of the NHCEs of the plans in which
the NHCEs participated in the prior year.
The definition of plan coverage change
includes changes in the group of eligible
employees under a plan resulting from the
establishment or amendment of a plan,
a plan merger or spin-off or a change in
the way plans are combined or separated
under the section 410(b) rules. The definition under the proposed regulations would
also include a reclassification of a substantial group of employees that has the
same effect as amending the plan. These
proposed regulations retain the rule that
a plan that experiences coverage changes
affecting 10% or less of the NHCEs disregards those changes in calculating the
ADP for the NHCEs. Similarly, a plan
that merely experiences a spin-off is not
required to recalculate the ADP for the
NHCEs.
5. Safe Harbor Section 401(k) Plans
Section 401(k)(12) provides a design-based safe harbor method under
which a CODA is treated as satisfying the
ADP test if the arrangement meets certain contribution and notice requirements.
Section 1.401(k)–3 of these proposed regulations, which sets forth the requirements
for these arrangements, generally follows
the rules set forth in Notice 98–52 and
Notice 2000–3. Thus, a plan satisfies
the section 401(k) safe harbor if it makes
specified QMACs for all eligible NHCEs.
The matching contributions can be under
a basic matching formula that provides
for QMACs equal to 100% of the first
3% of elective contributions and 50% of
the next 2% or an enhanced matching
formula that is at least as generous in the
aggregate, provided the rate of matching contributions under the enhanced
matching formula does not increase as the
employee's rate of elective contributions

2003-35 I.R.B.

increases. In lieu of QMACs, the plan is
permitted to provide QNECs equal to 3%
of compensation for all eligible NHCEs.
In addition, notice must be provided to
each eligible employee, within a reasonable time before the beginning of the year,
of their right to defer under the plan.
A plan using the safe harbor method
must also comply with certain other requirements. Among these is the requirement in section 401(k)(12)(B)(ii) that provides that the rate of matching contribution for any elective contribution on the
part of any HCE cannot exceed the rate
of matching contribution that would apply
to any NHCE with the same rate of elective contribution. Notice 98–52 advised
that the general rules on aggregating contributions for HCEs eligible under more
than one CODA would apply for this purpose. The IRS and Treasury have determined that such aggregation is not applicable under the ADP safe harbor. Accordingly, these proposed regulations would
not require that elective or matching contributions on behalf of an HCE who is
eligible to participate in more than one
plan of the same employer be aggregated
for purposes of the requirement of section
401(k)(12)(B)(ii). Thus, the rate of match
for purposes of determining whether an
HCE has a higher matching rate is based
only on matching contributions with respect to elective contributions under the
safe harbor plan. However, for an employer that uses the safe harbor method of
satisfying the ACP test, the rule in Notice 98–52 is retained for applying the ACP
safe harbor, with an exception for nonsimultaneous participation (as discussed in
connection with the ACP safe harbor below).
These proposed regulations do not
provide any rules relating to suspension
of employee contributions under a plan
that provides that safe harbor matching
contributions are made with respect to
the sum of elective contributions and employee contributions. Although Notice
2000–3 specifically permitted suspension
of employee contributions in certain circumstances, the IRS and Treasury have
determined that there are no limits on suspending employee contributions, provided
that safe harbor matching contributions
are made with respect to elective contributions. This is because the restrictions on
suspension of elective contributions are

440

sufficient to ensure an eligible NHCE can
get the full matching contribution.
The proposed regulations do not include any exception to the requirements
for safe harbor matching contributions
with respect to catch-up contributions.
Treasury and the IRS are aware that there
are questions concerning the extent to
which catch up contributions are required
to be matched under a plan that provides
for safe harbor matching contributions.
Treasury and the IRS are interested in
comments on the specific circumstances
under which elective contributions by a
NHCE to a safe harbor plan would be less
than the amount required to be matched,
e.g., less than 5% of safe harbor compensation, but would be treated by the plan as
catch-up contributions, and on the extent
to which a safe harbor plan should be
required to match catch-up contributions
under such circumstances.
Section 401(k)(12)(D) contains a requirement that each eligible employee be
provided with a notice of the employee's
rights and obligations under the plan.
These proposed regulations do not address the extent to which the notice can
be provided through electronic media. As
noted in the preamble to other regulations,
the IRS and the Treasury Department are
considering the extent to which the notice
described in section 401(k)(12)(D), as well
as other notices under the various Internal
Revenue Code requirements relating to
qualified retirement plans, can be provided electronically, taking into account
the effect of the Electronic Signatures
in Global and National Commerce Act
(E-SIGN), Public Law 106–229 (114 Stat.
464 (2000)). The IRS and the Treasury
Department anticipate issuing proposed
regulations regarding these issues, and invite comments on these issues. Until those
proposed regulations are issued, plan administrators and employers may continue
to rely on the interim guidance in Q&A–7
of Notice 2000–3 on use of electronic
media to satisfy the notice requirement in
section 401(k)(12)(D).
These proposed regulations would clarify that a section 401(k) safe harbor plan
must generally be adopted before the beginning of the plan year and be maintained
throughout a full 12-month plan year. This
requirement is consistent with the notion
that the statute specifies a certain contribution level for nonhighly compensated

September 2, 2003

employees in order to be deemed to pass
the nondiscrimination requirements. If the
contribution level is not maintained for
a full 12-month year, the employer contributions made on behalf of nonhighly
compensated employees should not support what could be a full year's contribution by the highly compensated employees.
The proposed regulations would adopt
the exception to the requirement that a section 401(k) safe harbor plan be in place before the beginning of the plan year that was
provided in Notice 2000–3. Under that option, an employer could adopt a section
401(k) safe harbor plan which has contingent non-elective contributions, provided
the employer notifies employees of this
contingent arrangement before the start of
the year, amends the plan to provide the
nonelective contributions no less than 30
days before the end of the year, and provides employees with a follow-up notice if
the contribution will be made. Similarly,
the proposed regulations would adopt the
exception for a section 401(k) safe harbor plan that uses the matching contribution alternative. Under that exception, an
employer can amend the plan to eliminate
matching contributions with respect to future elective deferrals, provided that the
matching contributions are made with respect to pre-amendment elective deferrals,
employees are provided with notice of the
change and the opportunity to change their
elections, and the plan satisfies the ADP or
ACP test for the plan year using the current
year testing method.
The proposed regulations would recognize the practical difficulty in a 12-month
requirement by following the rule in Notice 98–52 that allowed a short plan year in
the first plan year and would allow a short
plan year in certain other circumstances.
Specifically, a section 401(k) safe harbor
plan could have a short plan year in the
year the plan terminates, if the plan termination is in connection with a merger
or acquisition involving the employer, or
the employer incurs a substantial business
hardship comparable to a substantial business hardship described in section 412(d).
In addition, a section 401(k) safe harbor
plan could have a short plan year if the plan
terminates, the employer makes the safe
harbor contributions for the short year, employees are provided notice of the change,

September 2, 2003

and the plan passes the ADP test. Finally, a safe harbor plan could have a short
plan year if it is preceded and followed by
12-month plan years as a section 401(k)
safe harbor plan.
Under section 401(k)(12)(F), safe harbor contributions are permitted to be made
to a plan other than the plan that contains
the CODA. These proposed regulations reflect that rule and provide that the plan
to which the safe harbor contributions are
made need not be a plan that can be aggregated with the plan that contains the cash
or deferred arrangement.
Whether a contribution is taken into account for purposes of the safe harbor is
determined in accordance with the rules
regarding inclusion in ADP testing under
proposed §1.401(k)–2(a). Thus, for example, a plan that provides for safe harbor
matching contributions in 2006 need not
provide for a matching contribution with
respect to an elective contribution made
during the first 21/2 months of 2007 and
attributable to service during 2006, unless
that elective contribution is taken into account for 2006.
6. SIMPLE 401(k) Plans
Pursuant to section 401(k)(11), a SIMPLE 401(k) plan is treated as satisfying the
requirements of section 401(k)(3)(A)(ii)
if the contribution, vesting, notice and
exclusive plan requirements of section 401(k)(11) are satisfied. Section
1.401(k)–4 of these proposed regulations reflects the provisions of section
401(k)(11) in a manner that follows the
positions reflected in the model amendments set forth in Rev. Proc. 97–9.
7. Matching Contributions and Employee
Contributions.
Section 401(m)(2) sets forth a nondiscrimination test, the ACP test, with respect to matching contributions and employee contributions that is parallel to the
nondiscrimination test for elective contributions set forth in section 401(k). Section
1.401(m)–1 of the proposed regulations
would set forth this test in a manner that
is consistent with the nondiscrimination
test set forth in proposed §1.401(k)–1(b).
Thus, satisfaction of the ACP test, the ACP
safe harbor or the SIMPLE 401(k) provisions of the proposed regulations under

441

section 401(k) are the exclusive means that
matching contributions and employee contributions can use to satisfy the nondiscrimination in amount of contribution requirements of section 401(a)(4). An antiabuse provision comparable to that provided in connection with the proposed regulations under section 401(k) limits the
ability of an employer to make repeated
changes in plan provisions or testing procedures that have the effect of distorting
the ACP so as to increase significantly
the permitted ACP for HCEs, or otherwise
manipulate the nondiscrimination rules of
section 401(m), if a principal purpose of
the changes was to achieve such a result.
These proposed regulations also include provisions regarding plan aggregation and disaggregation that are similar to
those proposed for CODAs under section
401(k). For example, matching contributions made under the portion of a plan
that is an ESOP and the portion of the
same plan that is not an ESOP would not
be disaggregated under these proposed
regulations.
The definitions of matching contribution and employee contribution under
§1.401(m)–1 of the proposed regulations
would generally follow the definitions in
the existing regulations. Thus, whether an
employer contribution is on account of an
elective deferral or employee contribution
— and thus is a matching contribution
— is determined based on all the relevant
facts and circumstances. However, the
proposed regulations would provide that
a contribution would not be treated as a
matching contribution on account of an
elective deferral if it is contributed before
the employee's performance of services
with respect to which the elective deferral
is made (or when the cash that is subject
to the cash or deferred election would
be currently available, if earlier) and an
employer contribution is not a matching
contribution made on account of an employee contribution if it is contributed
before the employee contribution. Thus,
under these regulations, an employer
would not be able to prefund matching
contributions to accelerate the deduction
for those contributions and, as noted above
with respect to the timing of elective contributions, employer contributions made
under the facts in Notice 2002–48 would
not be taken into account under the ACP

2003-35 I.R.B.

test and would not satisfy any plan requirement to provide matching contributions.
8. ACP Test for Matching Contributions
and Employee Contributions
Section 1.401(m)–2 of the proposed
regulations would provide rules for the
ACP test that generally parallel the rules
applicable to the ADP test in proposed
§1.401(k)–2. Thus, for example, the ACP
test may be run by comparing the ACP for
eligible HCEs for the current year with
the ACP for eligible NHCEs for either
the current plan year or the prior plan
year. Similarly, the proposed regulations
reflect the special ACP testing rule in
section 401(m)(5)(C) for a plan that provides for early participation, comparable
to the special ADP testing rule in section
401(k)(3)(F), as set forth in proposed
§1.401(k)–2(a)(1)(iii).
The determination of the actual contribution ratio (ACR) for an eligible employee, and the contributions that are taken
into account in determining that ACR, under these proposed regulations are comparable to the rules under the proposed section 401(k) regulations. Thus, for example, the ACR for an HCE who has matching contributions or employee contributions under two or more plans is determined by adding together matching contributions and employee contributions under
all plans of the employer during the plan
year of the plan being tested, in a manner comparable to that for determining the
ADR of an HCE who participates in two or
more CODAs.
The proposed regulations would retain the rule from the existing regulations
under which a QMAC that is taken into account in the ADP test is excluded from the
ACP test. In addition, the proposed regulations would continue to allow QNECs
to be taken into account for ACP testing,
but would provide essentially the same
restrictions on targeting QNECs to a small
number of NHCEs as is provided in proposed §1.401(k)–2. The only difference
in the rules would be that the contribution percentages used to determine the
lowest contribution percentage would be
based on the sum of the QNECs and those
matching contributions taken into account
in the ACP test, rather than the sum of
the QNECs and the QMACs taken into
account under the ADP test. Because

2003-35 I.R.B.

QNECs that do not exceed 5% are not
subject to the limits on targeted QNECs
under either the ADP test or the ACP test,
an employer is permitted to take into account up to 10% in QNECs for an eligible
NHCE, 5% in ADP testing and 5% in
ACP testing, without regard to how many
NHCEs receive QNECs.
In addition, to prevent an employer
from using targeted matching contributions to circumvent the limitation on
targeted QNECs, the proposed regulations
would provide that matching contributions
are not taken into account in the ACP test
to the extent the matching rate for the
contribution exceeds the greater of 100%
and 2 times the representative matching
rate. Paralleling the rule to limit targeted
QNECs, the representative plan matching
rate is the lowest matching rate for any
eligible employee in a group of NHCEs
that consists of half of all eligible NHCEs
in the plan for the plan year (or the lowest
matching rate for all eligible NHCEs in the
plan who are employed by the employer
on the last day of the plan year, if greater).
For this purpose, the matching rate is the
ratio of the matching contributions to the
contributions that are being matched, and
only NHCEs who make elective deferrals
or employee contributions for the plan
year are taken into account.
The proposed regulations would set
limits on the use of elective contributions
in the ACP test that are in addition to
the rules in the existing regulations under
which elective contributions may be taken
into account for the ACP test only to the
extent the plan satisfies the ADP test,
determined by including such elective
contributions in the ADP test. Under the
new rule, the proposed regulations would
provide that elective contributions under
a plan that is not subject to the ADP test,
such as a plan that uses the safe harbor
method of section 401(k)(12) or a contract
or arrangement subject to the requirements
of section 403(b)(12)(A)(ii), may not be
taken into account for the ACP test. In the
absence of this prohibition, contributions
that are not properly considered “excess”
could be taken into account under the ACP
test.
The provisions of these proposed regulations regarding correction of excess
aggregate contributions, including allocation of excess aggregate contributions

442

and determination of allocable income,
would generally be consistent with the
provisions of the proposed regulations
under section 401(k). These proposed
regulations continue the provisions of the
current regulations regarding correction
through distribution of vested matching
contributions and forfeiture of unvested
matching contributions. Similarly, the
proposed regulations reflect the provisions
of section 411(a)(3)(G) which permit the
forfeiture of a matching contribution made
with respect to an excess deferral, excess
contribution, or excess aggregate contribution. This provision is necessary to allow
forfeiture of matching contributions that
would otherwise violate section 401(a)(4).
9. Safe Harbor Section 401(m) Plans
Section 401(m)(11) provides a designbased safe harbor method of satisfying the
ACP test contained in section 401(m)(2).
Under section 401(m)(11), a defined contribution plan is treated as satisfying the
ACP test with respect to matching contributions if the plan satisfies the ADP safe
harbor of section 401(k)(12) and matching
contributions are not made with respect to
employee contributions or elective contributions in excess of 6% of an employee's
compensation. For a plan that satisfies the
ADP safe harbor using a 3% nonelective
contribution, two additional requirements
that apply to a plan that satisfies the ADP
safe harbor using matching contributions
also apply: 1) the rate of an employer's
matching contribution does not increase as
the rate of employee contributions or elective deferrals increase; and 2) the matching contribution with respect to any HCE at
any rate of employee contribution or elective deferral is not greater than with respect to any NHCE. In addition, the ratio of matching contributions on behalf of
an HCE to that HCE's elective deferrals
and employee contributions for a plan year
cannot be greater than the ratio of matching contributions to elective deferrals or
employee contributions that would apply
with respect to any NHCE who contributes
(as an elective deferral or employee contribution) the same percentage of safe harbor
compensation for that plan year.
Section 1.401(m)–3 of these proposed
regulations, which sets forth the requirements for these plans, would generally
follow the rules set forth in Notice 98–52

September 2, 2003

and Notice 2000–3. These proposed regulations would clarify that, for purposes
of determining whether an HCE has a
higher rate of matching contributions
than any NHCE, any NHCE who is an
eligible employee under the safe harbor
CODA must be taken into account, even
if the NHCE is not eligible for a matching contribution. This means that a plan
with a provision which limits matching
contributions to employees who are employed on the last day of the plan year
will not be able to satisfy the ACP safe
harbor, since a NHCE who is not eligible
to receive a matching contribution on
account of the last day requirement will
nonetheless be taken into consideration
in determining whether the plan satisfies
section 401(m)(11)(B)(iii). The proposed
regulations also include the requirement
that matching contributions made at the
employer's discretion with respect to any
employee cannot exceed a dollar amount
equal to 4% of the employee's compensation and that a safe harbor plan must
permit all eligible NHCEs to make sufficient elective contributions (or employee
contributions, if applicable) to receive the
maximum matching contribution provided
under the plan.
The proposed regulations would provide a special rule for satisfying section
401(m)(11)(B)(iii) in the case of an HCE
who participates in two or more plans that
provide for matching contributions. Under
this rule, a plan will not fail to satisfy the
requirements of section 401(m)(11)(B)(iii)
merely because an HCE participates during the plan year in more than one plan that
provides for matching contributions, provided that the HCE is not simultaneously
an eligible employee under two plans that
provide for matching contributions maintained by an employer for a plan year; and
the period used to determine compensation for purposes of determining matching contributions under each such plan is
limited to periods when the HCE participated in the plan. In such a case, an HCE
can transfer from a plan with a more generous matching schedule to an otherwise
safe harbor section 401(m) plan (for example, as a result of switching jobs within the
controlled group) without causing the safe
harbor plan to violate section 401(m)(11).
However, the plan which is not the safe
harbor plan will still have to aggregate

September 2, 2003

matching contributions for the HCE under
the rule set forth in section 401(m)(2)(B).
The safe harbor in section 401(m)(11)
does not apply to employee contributions.
Consequently, a plan that provides for employee contributions and matching contributions must satisfy the ACP test even
though the matching contributions satisfy
the safe harbor requirements for section
401(m)(11). However, the proposed regulations would also adopt the position in
Notice 98–52 that the ACP test is permitted
to be applied by disregarding all matching
contributions with respect to all eligible
employees. If the ADP safe harbor using
matching contributions is satisfied but the
ACP safe harbor is not satisfied, the proposed regulations would adopt the position
in Notice 98–52 that the ACP test is permitted to be applied disregarding matching
contributions for any employee that do not
exceed 4% of compensation.
Proposed Effective Date
The regulations are proposed to apply
for plan years beginning no sooner than
12 months after publication of final regulations in the Federal Register. However,
it is anticipated that the preamble for the
final regulations will permit plan sponsors
to implement the final regulations for the
first plan year beginning after publication
of final regulations in the Federal Register.
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a significant
regulatory action as defined in Executive
Order 12866. Therefore, a regulatory
assessment is not required. It is hereby
certified that the collection of information in these regulations will not have a
significant economic impact on a substantial number of small entities. This
certification is based upon the conclusion that few plans containing qualified
CODAs will correct excess contributions
through the recharacterization of these
amounts as employee contributions under §1.401(k)–2(b)(3) of these proposed
regulations. The collections of information contained in §§1.401(k)–3(d), (f) and
1.401(m)–3(e) are required by statutory
provisions. However, the IRS has considered alternatives that would lessen the

443

impact of these statutory requirements on
small entities and has requested comments
on the use of electronic media to satisfy
these notice requirements. Thus, the collection of information in these regulations
will not have a significant economic impact on a substantial number of small
entities. Therefore, an analysis under the
Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section
7805(f) of the Code, this notice of proposed rulemaking will be submitted to the
Chief Counsel for Advocacy of the Small
Business Administration for comment on
its impact on small business.
Comments and Public Hearing
Before these proposed regulations are
adopted as final regulations, consideration
will be given to any electronic or written comments (preferably a signed original and eight (8) copies) that are submitted
timely to the IRS. In addition to the other
requests for comments set forth in this document, the IRS and Treasury also request
comments on the clarity of the proposed
rule and how it may be made easier to understand. All comments will be available
for public inspection and copying.
A public hearing has been scheduled for
November 12, 2003, at 10 a.m. in the IRS
Auditorium (7th Floor), Internal Revenue
Building, 1111 Constitution Avenue, NW,
Washington, DC. Due to building security
procedures, visitors must enter at the Constitution Avenue, NW, entrance, located
between 10th and 12th Streets, NW. In addition, all visitors must present photo identification to enter the building. Because
of access restrictions, visitors will not be
admitted beyond the immediate entrance
area more than 30 minutes before the hearing starts. For information about having
your name placed on the building access
list to attend the hearing, see the “FOR
FURTHER INFORMATION CONTACT”
section of this preamble.
The rules of 26 CFR 601.601(a)(3) apply to the hearing.
Persons who wish to present oral comments at the hearing must submit written
comments and an outline of the topics to
be discussed and the time to be devoted
to each topic (signed original and eight (8)
copies) by October 22, 2003.
A period of 10 minutes will be allotted
to each person for making comments.

2003-35 I.R.B.

An agenda showing the scheduling of
the speakers will be prepared after the
deadline for receiving outlines has passed.
Copies of the agenda will be available free
of charge at the hearing.
Drafting Information
The principal authors of these regulations are R. Lisa Mojiri-Azad and John T.
Ricotta of the Office of the Division Counsel/Associate Chief Counsel (Tax Exempt
and Government Entities). However, other
personnel from the IRS and Treasury participated in their development.
*****
Proposed Amendments to The
Regulations
Accordingly, 26 CFR part 1 is proposed
to be amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805
26 U.S.C. 401(m)(9) * * *
Par. 2. Sections 1.401(k)–0 and
1.401(k)–1 are revised and §§1.401(k)–2
through 1.401(k)–6 are added to read as
follows:
§1.401(k)–0 Table of contents.
This section contains first a list of section headings and then a list of the paragraphs in each section in §§1.401(k)–1
through 1.401(k)–6.
LIST OF SECTIONS
§1.401(k)–1 Certain cash or deferred arrangements.
§1.401(k)–2 ADP test.
§1.401(k)–3 Safe harbor requirements.
§1.401(k)–4 SIMPLE 401(k) plan requirements.
§1.401(k)–5 Special rules for mergers, acquisitions and similar events. [Reserved].
§1.401(k)–6 Definitions.
LIST OF PARAGRAPHS
§1.401(k)–1 Certain cash or deferred
arrangements.
(a) General rules.
(1) Certain plans permitted to include cash
or deferred arrangements.

2003-35 I.R.B.

(2) Rules applicable to cash or deferred
arrangements generally.
(i) Definition of cash or deferred arrangement.
(ii) Treatment of after-tax employee contributions.
(iii) Treatment of ESOP dividend election.
(iv) Treatment of elective contributions as
plan assets.
(3) Rules applicable to cash or deferred
elections generally.
(i) Definition of cash or deferred election.
(ii) Automatic enrollment.
(iii) Rules related to timing.
(A) Requirement that amounts not be currently available.
(B) Contribution may not precede election.
(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 deferred
arrangement.
(ii) Treatment of elective contributions as
employer contributions.
(iii) Tax treatment of employees.
(iv) Application of nondiscrimination requirements to plan that includes a qualified
cash or deferred arrangement.
(A) Exclusive means of amounts testing.
(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 includes
a nonqualified cash or deferred arrangement.
(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 individuals.
(i) Application of general rules.
(ii) Treatment of matching contributions
made on behalf of self-employed individuals.
(iii) Timing of self-employed individual's
cash or deferred election.

444

(b) Coverage and nondiscrimination requirements.
(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 arrangements within a plan.
(iii) Aggregation of plans.
(A) In general.
(B) Plans with inconsistent ADP testing
methods.
(iv) Disaggregation of plans and separate
testing.
(A) In general.
(B) Restructuring prohibited.
(v) Modifications to section 410(b) rules.
(A) Certain disaggregation rules not applicable.
(B) Permissive aggregation of collective
bargaining units.
(C) Multiemployer plans.
(vi) Examples.
(c) Nonforfeitability requirements.
(1) General rule.
(2) Definition of immediately nonforfeitable.
(3) Example.
(d) Distribution limitation.
(1) General rule.
(2) Rules applicable to distributions upon
severance from employment.
(3) Rules applicable to hardship distributions.
(i) Distribution must be on account of hardship.
(ii) Limit on maximum distributable
amount.
(A) General rule.
(B) Grandfathered amounts.
(iii) Immediate and heavy financial need.
(A) In general.
(B) Deemed immediate and heavy financial need.
(iv) Distribution necessary to satisfy financial 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 counterproductive actions.
(E) Distribution deemed necessary to satisfy immediate and heavy financial need.
(F) Definition of other plans.
(v) Commissioner may expand standards.

September 2, 2003

(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 qualified
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 governments.
(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.
(ii) Definition of other benefits.
(iii) Effect of certain statutory limits.
(iv) Nonqualified deferred compensation.
(v) Plan loans and distributions.
(vi) Examples.
(7) Plan provision requirement.
(f) Effective dates.
(1) General rule.
(2) Collectively bargained plans.
§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 testing method.
(3) Determination of ADR.
(i) General rule.

September 2, 2003

(ii) ADR of HCEs eligible under more than
one arrangement.
(A) General rule.
(B) Plans not permitted to be aggregated.
(iii) Examples.
(4) Elective contributions taken into account 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 satisfy
the ACP test.
(6) Qualified nonelective contributions and
qualified matching contributions that may
be taken into account under the ADP test.
(i) Timing of allocation.
(ii) Requirement that amount satisfy section 401(a)(4).
(iii) Aggregation must be permitted.
(iv) Disproportionate contributions not
taken into account.
(A) General rule.
(B) Definition of representative contribution rate.
(C) Definition of applicable contribution
rate.
(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 recharacterized.
(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 excess
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 excess
contributions for each HCE.

445

(B) Limit on amount apportioned to any
individual.
(C) Apportionment to additional HCEs.
(iv) Income allocable to excess contributions.
(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 distributions.
(A) General rule.
(B) Rule for de minimis distributions.
(vii) Other rules.
(A) No employee or spousal consent required.
(B) Treatment of corrective distributions as
elective contributions.
(C) No reduction of required minimum
distribution.
(D) Partial distributions.
(viii) Examples.
(3) Recharacterization of excess contributions.
(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 excess
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 testing
method.

2003-35 I.R.B.

(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 methods
for the ADP and ACP test.
(4) Rules for plan coverage changes.
(i) In general.
(ii) Optional rule for minor plan coverage
changes.
(iii) Definitions.
(A) Plan coverage change.
(B) Prior year subgroup.
(C) Weighted average of the ADPs for the
prior year subgroups.
(iv) Examples.
§1.401(k)–3 Safe harbor requirements.
(a) ADP test safe harbor.
(b) Safe harbor nonelective contribution
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 contributions.
(5) Use of safe harbor match not precluded
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 compensation
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.

2003-35 I.R.B.

(iii) References to SPD.
(3) Timing requirement.
(i) General rule.
(ii) Deemed satisfaction of timing requirement.
(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 harbor
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 contributions to satisfy other nondiscrimination
tests.
(3) Early participation rules.
(4) Satisfying safe harbor contribution requirement under another defined contribution plan.
(5) Contributions used only once.
§1.401(k)–4 SIMPLE 401(k) plan
requirements.
(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.

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§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 deferred
arrangements.
(a) General rules—(1) Certain plans
permitted to include cash or deferred
arrangements.
A plan, other than a
profit-sharing, stock bonus, pre-ERISA
money purchase pension, or rural cooperative plan, does not satisfy the requirements
of section 401(a) if the plan includes a cash
or deferred arrangement. A profit-sharing,
stock bonus, pre-ERISA money purchase
pension, or rural cooperative plan does
not fail to satisfy the requirements of
section 401(a) merely because the plan
includes a cash or deferred arrangement.
A cash or deferred arrangement is part of
a plan for purposes of this section if any
contributions to the plan, or accruals or
other benefits under the plan, are made or
provided pursuant to the cash or deferred
arrangement.
(2) Rules applicable to cash or deferred
arrangements generally—(i) Definition of
cash or deferred arrangement. Except as
provided in paragraphs (a)(2)(ii) and (iii)
of this section, a cash or deferred arrangement is an arrangement under which an eligible employee may make a cash or deferred election with respect to contributions to, or accruals or other benefits under, a plan that is intended to satisfy the
requirements of section 401(a) (including
a contract that is intended to satisfy the requirements of section 403(a)).
(ii) Treatment of after-tax employee
contributions. A cash or deferred arrangement does not include an arrangement
under which amounts contributed under a
plan at an employee's election are designated or treated at the time of contribution
as after-tax employee contributions (e.g.,
by treating the contributions as taxable
income subject to applicable withholding
requirements). See also section 414(h)(1).
This is the case even if the employee's
election to make after-tax employee contributions is made before the amounts
subject to the election are currently available to the employee.
(iii) Treatment of ESOP dividend election. A cash or deferred arrangement

September 2, 2003

does not include an arrangement under
an ESOP under which dividends are either distributed or invested pursuant to
an election made by participants or their
beneficiaries in accordance with section
404(k)(2)(A)(iii).
(iv) Treatment of elective contributions
as plan assets. The extent to which elective contributions constitute plan assets
for purposes of the prohibited transaction
provisions of section 4975 and Title I of
the Employee Retirement Income Security
Act of 1974 is determined in accordance
with regulations and rulings issued by
the Department of Labor. See 29 CFR
2510.3–102.
(3) Rules applicable to cash or deferred
elections generally—(i) Definition of cash
or deferred election. A cash or deferred
election is any direct or indirect election
(or modification of an earlier election) by
an employee to have the employer either—
(A) Provide an amount to the employee
in the form of cash (or some other taxable
benefit) that is not currently available; or
(B) Contribute an amount to a trust, or
provide an accrual or other benefit, under a
plan deferring the receipt of compensation.
(ii) Automatic enrollment. For purposes of determining whether an election
is a cash or deferred election, it is irrelevant whether the default that applies in
the absence of an affirmative election is
described in paragraph (a)(3)(i)(A) of
this section (i.e., the employee receives
an amount in cash or some other taxable
benefit) or in paragraph (a)(3)(i)(B) of this
section (i.e., the employer contributes an
amount to a trust or provides an accrual
or other benefit under a plan deferring the
receipt of compensation).
(iii) Rules related to timing—(A) Requirement that amounts not be currently
available. A cash or deferred election can
only be made with respect to an amount
that is not currently available to the employee on the date of the election. Further, a cash or deferred election can only be
made with respect to amounts that would
(but for the cash or deferred election) become currently available after the later of
the date on which the employer adopts the
cash or deferred arrangement or the date
on which the arrangement first becomes effective.
(B) Contribution may not precede election. A contribution is made pursuant to a

September 2, 2003

cash or deferred election only if the contribution is made after the election is made.
In addition, a contribution is made pursuant to a cash or deferred election only
if the contribution is made after the employee's performance of services with respect to which the contribution is made
(or when the cash or other taxable benefit
would be currently available, if earlier).
(iv) Current availability defined. Cash
or another taxable benefit is currently
available to the employee if it has been
paid to the employee or if the employee is
able currently to receive the cash or other
taxable benefit at the employee's discretion. An amount is not currently available
to an employee if there is a significant
limitation or restriction on the employee's
right to receive the amount currently. Similarly, an amount is not currently available
as of a date if the employee may under no
circumstances receive the amount before a
particular time in the future. The determination of whether an amount is currently
available to an employee does not depend
on whether it has been constructively received by the employee for purposes of
section 451.
(v) Certain one-time elections not
treated as cash or deferred elections. A
cash or deferred election does not include a
one-time irrevocable election upon an employee's commencement of employment
with the employer, or upon the employee's
first becoming eligible under the plan or
any other plan of the employer (whether
or not such other plan has terminated),
to have contributions equal to a specified
amount or percentage of the employee's
compensation (including no amount of
compensation) made by the employer on
the employee's behalf to the plan and a
specified amount or percentage of the
employee's compensation (including no
amount of compensation) divided among
all other plans of the employer (including
plans not yet established) for the duration
of the employee's employment with the
employer, or in the case of a defined benefit plan to receive accruals or other benefits
(including no benefits) under such plans.
Thus, for example, employer contributions
made pursuant to a one-time irrevocable
election described in this paragraph are
not treated as having been made pursuant
to a cash or deferred election and are not
includible in an employee's gross income
by reason of §1.402(a)–1(d). In the case of

447

an irrevocable election made on or before
December 23, 1994—
(A) The election does not fail to be
treated as a one-time irrevocable election
under this paragraph (a)(3)(v) merely because an employee was previously eligible under another plan of the employer
(whether or not such other plan has terminated); and
(B) In the case of a plan in which partners may participate, the election does not
fail to be treated as a one-time irrevocable election under this paragraph (a)(3)(v)
merely because the election was made after
commencement of employment or after the
employee's first becoming eligible under
any plan of the employer, provided that the
election was made before the first day of
the first plan year beginning after December 31,1988, or, if later, March 31,1989.
(vi) Tax treatment of employees. An
amount generally is includible in an employee's gross income for the taxable
year in which the employee actually or
constructively receives the amount. But
for sections 402(e)(3) and 401(k), an
employee is treated as having received
an amount that is contributed to a plan
pursuant to the employee's cash or deferred election. This is the case even if the
election to defer is made before the year
in which the amount is earned, or before
the amount is currently available. See
§1.402(a)–1(d).
(vii) Examples. The following examples illustrate the application of paragraph
(a)(3) of this section:
Example 1. (i) An employer maintains a profitsharing plan under which each eligible employee has
an election to defer an annual bonus payable on January 30 each year. The bonus equals 10% of compensation during the previous calendar year. Deferred
amounts are not treated as after-tax employee contributions. The bonus is currently available on January
30.
(ii) An election made prior to January 30 to defer
all or part of the bonus is a cash or deferred election,
and the bonus deferral arrangement is a cash or deferred arrangement.
Example 2. (i) An employer maintains a profitsharing plan which provides for discretionary profit
sharing contributions and under which each eligible
employee may elect to reduce his compensation by
up to 10% and to have the employer contribute such
amount to the plan. The employer pays each employee every two weeks for services during the immediately preceding two weeks. The employee's election to defer compensation for a payroll period must
be made prior to the date the amount would otherwise be paid. The employer contributes to the plan the
amount of compensation that each employee elected
to defer, at the time it would otherwise be paid to the

2003-35 I.R.B.

employee, and does not treat the contribution as an
after-tax employee contribution.
(ii) The election is a cash or deferred election and
the contributions are elective contributions.
Example 3. (i) The facts are the same as in Example 2, except that the employer makes a $10,000 contribution on January 31 of the plan year that is in addition to the contributions that satisfy the employer's
obligation to make contributions with respect to cash
or deferred elections for prior payroll periods. Employee A makes an election on February 15 to defer
$2,000 from compensation that is not currently available and the employer reduces the employee's compensation to reflect the election.
(ii) None of the additional $10,000 contributed
January 31 is a contribution made pursuant to Employee A's cash or deferred election, because the contribution was made before the election was made. Accordingly, the employer must make an additional contribution of $2,000 in order to satisfy its obligation
to contribute an amount to the plan pursuant to Employee A's election. The $10,000 contribution can be
allocated under the plan terms providing for discretionary profit sharing contributions.
Example 4. (i) The facts are the same as in Example 3, except that Employee A had an outstanding election to defer $500 from each payroll period's
compensation.
(ii) None of the additional $10,000 contributed
January 31 is a contribution made pursuant to Employee A's cash or deferred election for future payroll periods, because the contribution was made before the earlier of Employee A's performance of services to which the contribution is attributable or when
the compensation would be currently available. Accordingly, the employer must make an additional contribution of $500 per payroll period in order to satisfy
its obligation to contribute an amount to the plan pursuant to Employee A's election. The $10,000 contribution can be allocated under the plan terms providing for discretionary profit sharing contributions.
Example 5. (i) Employer B establishes a money
purchase pension plan in 1986. This is the first qualified plan established by Employer B. All salaried
employees are eligible to participate under the plan.
Hourly-paid employees are not eligible to participate
under the plan. In 2000, Employer B establishes a
profit-sharing plan under which all employees (both
salaried and hourly) are eligible. Employer B permits
all employees on the effective date of the profit-sharing plan to make a one-time irrevocable election to
have Employer B contribute 5% of compensation on
their behalf to the plan and make no other contribution to any other plan of Employer B (including plans
not yet established) for the duration of the employee's
employment with Employer B, and have their salaries
reduced by 5%.
(ii) The election provided under the profit-sharing plan is not a one-time irrevocable election within
the meaning of paragraph (a)(3)(v) of this section
with respect to the salaried employees of Employer
B who, before becoming eligible to participate under
the profit-sharing plan, became eligible to participate
under the money purchase pension plan. The election
under the profit-sharing plan is a one-time irrevocable
election within the meaning of paragraph (a)(3)(v) of
this section with respect to the hourly employees, because they were not previously eligible to participate
under another plan of the employer.

2003-35 I.R.B.

(4) Rules applicable to qualified cash
or deferred arrangements—(i) Definition
of qualified cash or deferred arrangement.
A qualified cash or deferred arrangement
is a cash or deferred arrangement that satisfies the requirements of paragraphs (b),
(c), (d), and (e) of this section.
(ii) Treatment of elective contributions
as employer contributions. Except as
otherwise provided in §1.401(k)–2(b)(3),
elective contributions under a qualified
cash or deferred arrangement are treated
as employer contributions. Thus, for example, elective contributions are treated
as employer contributions for purposes of
sections 401(a) and 401(k), 402, 404, 409,
411, 412, 415, 416, and 417.
(iii) Tax treatment of employees. Except
as provided in section 402(g), 402A (effective for years beginning after December 31, 2005), or 1.401(k)–2(b)(3), elective contributions under a qualified cash or
deferred arrangement are neither includible in an employee's gross income at the
time the cash would have been includible
in the employee's gross income (but for the
cash or deferred election), nor at the time
the elective contributions are contributed
to the plan. See §1.402(a)–1(d)(2)(i).
(iv) Application of nondiscrimination
requirements to plan that includes a qualified cash or deferred arrangement—(A)
Exclusive means of amounts testing. Elective contributions under a qualified cash or
deferred arrangement satisfy the requirements of section 401(a)(4) with respect
to amounts if and only if the amount of
elective contributions satisfies the nondiscrimination test of section 401(k) under
paragraph (b)(1) of this section. See
§1.401(a)(4)–1(b)(2)(ii)(B).
(B) Testing benefits, rights and features. A plan that includes a qualified
cash or deferred arrangement must satisfy the requirements of section 401(a)(4)
with respect to benefits, rights and features in addition to the requirements
regarding amounts described in paragraph
(a)(4)(iv)(A) of this section. For example,
the right to make each level of elective
contributions under a cash or deferred
arrangement is a benefit, right or feature
subject to the requirements of section
401(a)(4).
See §1.401(a)(4)–4(e)(3)(i)
and (iii)(D). Thus, for example, if all employees are eligible to make a stated level
of elective contributions under a cash or
deferred arrangement, but that level of

448

contributions can only be made from compensation in excess of a stated amount,
such as the Social Security taxable wage
base, the arrangement will generally favor
HCEs with respect to the availability of
elective contributions and thus will generally not satisfy the requirements of section
401(a)(4).
(C) Minimum coverage requirement.
A qualified cash or deferred arrangement
is treated as a separate plan that must
satisfy the requirements of section 410(b).
See §1.410(b)–7(c)(1) for special rules.
The determination of whether a cash or
deferred arrangement satisfies the requirements of section 410(b) must be made
without regard to the modifications to
the disaggregation rules set forth in paragraph (b)(4)(v) of this section. See also
§1.401(a)(4)–11(g)(3)(vii)(A), relating to
corrective amendments that may be made
to satisfy the minimum coverage requirements of section 410(b).
(5) Rules applicable to nonqualified
cash or deferred arrangements—(i) Definition of nonqualified cash or deferred
arrangement. A nonqualified cash or deferred arrangement is a cash or deferred
arrangement that fails to satisfy one or
more of the requirements in paragraph (b),
(c), (d) or (e) of this section.
(ii) Treatment of elective contributions
as nonelective contributions. Except as
specifically provided otherwise, elective
contributions under a nonqualified cash
or deferred arrangement are treated as
nonelective employer contributions. Thus,
for example, the elective contributions
are treated as nonelective employer contributions for purposes of sections 401(a)
(including section 401(a)(4)) and 401(k),
404, 409, 411, 412, 415, 416, and 417
and are not subject to the requirements of
section 401(m).
(iii) Tax treatment of employees. Elective contributions under a nonqualified
cash or deferred arrangement are includible in an employee's gross income at the
time the cash or other taxable amount that
the employee would have received (but for
the cash or deferred election) would have
been includible in the employee's gross
income. See §1.402(a)–1(d)(1).
(iv) Qualification of plan that includes
a nonqualified cash or deferred arrangement—(A) In general. A profit-sharing,
stock bonus, pre-ERISA money purchase
pension, or rural cooperative plan does

September 2, 2003

not fail to satisfy the requirements of
section 401(a) merely because the plan
includes a nonqualified cash or deferred
arrangement.
In determining whether
the plan satisfies the requirements of
section 401(a)(4), the nondiscrimination 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) and
1.410(b)–9 (definition of section 401(k)
plan).
(B) Application of section 401(a)(4) to
certain plans. The amount of employer
contributions under a nonqualified cash or
deferred arrangement is treated as satisfying section 401(a)(4) if the arrangement is
part of a collectively bargained plan that
automatically satisfies the requirements of
section 410(b). See §§1.401(a)(4)–1(c)(5)
and 1.410(b)–2(b)(7). Additionally, the
requirements of sections 401(a)(4) and
410(b) do not apply to a governmental plan (within the meaning of section
414(d)) maintained by a state or local government or political subdivision thereof
(or agency or instrumentality thereof). See
sections 401(a)(5) and 410(c)(1)(A).
(v) Example. The following example
illustrates the application of this paragraph
(a)(5):
Example. (i) For the 2006 plan year, Employer A
maintains a collectively bargained plan that includes
a cash or deferred arrangement. Employer contributions under the cash or deferred arrangement do not
satisfy the nondiscrimination test of section 401(k)
and paragraph (b) of this section.
(ii) The arrangement is a nonqualified cash or deferred arrangement. The employer contributions under the cash or deferred arrangement are considered
to be nondiscriminatory under section 401(a)(4), and
the elective contributions are generally treated as employer contributions under paragraph (a)(5)(ii) of this
section. Under paragraph (a)(5)(iii) of this section
and under §1.402(a)–1(d)(1), however, the elective
contributions are includible in each employee's gross
income.

(6) Rules applicable to cash or deferred
arrangements of self-employed individuals
—(i) Application of general rules. Generally, a partnership or sole proprietorship is
permitted to maintain a cash or deferred
arrangement, and individual partners or
owners are permitted to make cash or deferred elections with respect to compensation attributable to services rendered to the
entity, under the same rules that apply to
other cash or deferred arrangements. For

September 2, 2003

example, any contributions made on behalf of an individual partner or owner pursuant to a cash or deferred arrangement
of a partnership or sole proprietorship are
elective contributions unless they are designated or treated as after-tax employee
contributions. In the case of a partnership, a cash or deferred arrangement includes any arrangement that directly or indirectly permits individual partners to vary
the amount of contributions made on their
behalf. Consistent with §1.402(a)–1(d),
the elective contributions under such an arrangement are includible in income and are
not deductible under section 404(a) unless
the arrangement is a qualified cash or deferred arrangement (i.e., the requirements
of section 401(k) and this section are satisfied). Also, even if the arrangement is
a qualified cash or deferred arrangement,
the elective contributions are includible in
gross income and are not deductible under
section 404(a) to the extent they exceed the
applicable limit under section 402(g). See
also §1.401(a)–30.
(ii) Treatment of matching contributions made on behalf of self-employed
individuals.
Under section 402(g)(8),
matching contributions made on behalf of
a self-employed individual are not treated
as elective contributions made pursuant to
a cash or deferred election, without regard
to whether such matching contributions
indirectly permit individual partners to
vary the amount of contributions made on
their behalf.
(iii) Timing of self-employed individual's cash or deferred election. For purposes of paragraph (a)(3)(iv) of this section, a partner's compensation is deemed
currently available on the last day of the
partnership taxable year and a sole proprietor's compensation is deemed currently
available on the last day of the individual's taxable year. Accordingly, a self-employed individual may not make a cash
or deferred election with respect to compensation for a partnership or sole proprietorship taxable year after the last day of
that year. See §1.401(k)–2(a)(4)(ii) for the
rules regarding when these contributions
are treated as allocated.
(b) Coverage and nondiscrimination requirements—(1) In general. A cash or deferred arrangement satisfies this paragraph
(b) for a plan year only if—

449

(i) The group of eligible employees under the cash or deferred arrangement (including any employee taken into account
for purposes of section 410(b) pursuant
to §1.401(a)(4)–11(g)(3)(vii)(A)) satisfies
the requirements of section 410(b) (including the average benefit percentage test, if
applicable); and
(ii) The cash or deferred arrangement
satisfies—
(A) The ADP test of section 401(k)(3)
described in §1.401(k)–2;
(B) The ADP safe harbor provisions of section 401(k)(12) described
in §1.401(k)–3; or
(C) The SIMPLE 401(k) provisions of section 401(k)(11) described
in §1.401(k)–4.
(2) Automatic satisfaction by certain plans. Notwithstanding paragraph
(b)(1) of this section, a governmental plan
(within the meaning of section 414(d))
maintained by a state or local government
or political subdivision thereof (or agency
or instrumentality thereof) shall be treated
as meeting the requirements of this paragraph (b).
(3) Anti-abuse provisions. Sections
1.401(k)–1 through 1.401(k)–6 are
designed to provide simple, practical
rules that accommodate legitimate plan
changes. At the same time, the rules are
intended to be applied by employers in a
manner that does not make use of changes
in plan testing procedures or other plan
provisions to inflate inappropriately the
ADP for NHCEs (which is used as a
benchmark for testing the ADP for HCEs)
or to otherwise manipulate the nondiscrimination testing requirements of this
paragraph (b). Further, this paragraph (b)
is part of the overall requirement that benefits or contributions not discriminate in
favor of HCEs. Therefore, a plan will not
be treated as satisfying the requirements
of this paragraph (b) if there are repeated
changes to plan testing procedures or plan
provisions that have the effect of distorting
the ADP so as to increase significantly the
permitted ADP for HCEs, or otherwise
manipulate the nondiscrimination rules of
this paragraph, if a principal purpose of
the changes was to achieve such a result.
(4) Aggregation and restructuring—(i)
In general. This paragraph (b)(4) contains

2003-35 I.R.B.

the exclusive rules for aggregating and disaggregating plans and cash or deferred arrangements for purposes of this section,
and §§1.401(k)–2 through 1.401(k)–6.
(ii) Aggregation of cash or deferred arrangements within a plan. Except as otherwise specifically provided in this paragraph (b)(4), all cash or deferred arrangements included in a plan are treated as a
single cash or deferred arrangement and a
plan must apply a single test under paragraph (b)(1)(ii) of this section with respect to all such arrangements within the
plan. Thus, for example, if two groups
of employees are eligible for separate cash
or deferred arrangements under the same
plan, all contributions under both cash or
deferred arrangements must be treated as
made under a single cash or deferred arrangement subject to a single test, even if
they have significantly different features,
such as different limits on elective contributions.
(iii) Aggregation of plans—(A) In
general. For purposes of this section
and §§1.401(k)–2 through 1.401(k)–6, the
term plan means a plan within the meaning
of §1.410(b)–7(a) and (b), after application of the mandatory disaggregation 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 example, two plans
(within the meaning of §1.410(b)–7(b))
that are treated as a single plan pursuant
to the permissive aggregation rules of
§1.410(b)–7(d) are treated as a single plan
for purposes of section 401(k) and section
401(m).
(B) Plans with inconsistent ADP testing methods.
Pursuant to paragraph
(b)(4)(ii) of this section, a single testing
method must apply with respect to all
cash or deferred arrangements under a
plan. Thus, in applying the permissive
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 meaning of
§1.410(b)–7(b)) that applies the current
year testing method may not be aggregated with another plan that applies the
prior year testing method. Similarly, an
employer may not aggregate a plan (within
the meaning of §1.410(b)–7(b)) using the
ADP safe harbor provisions of section

2003-35 I.R.B.

401(k)(12) and another plan that is using
the ADP test of section 401(k)(3).
(iv) Disaggregation of plans and separate testing—(A) In general. If a cash or
deferred arrangement is included in a plan
(within the meaning of §1.410(b)–7(b))
that is mandatorily disaggregated under
the rules of section 410(b) (as modified by this paragraph (b)(4)), the cash
or deferred arrangement must be disaggregated in a consistent manner. For
example, in the case of an employer that
is treated as operating qualified separate
lines of business under section 414(r), if
the eligible employees under a cash or
deferred arrangement are in more than
one qualified separate line of business,
only those employees within each qualified separate line of business may be
taken into account in determining whether
each disaggregated portion of the plan
complies with the requirements of section
401(k), unless the employer is applying
the special rule for employer-wide plans
in §1.414(r)–1(c)(2)(ii) with respect to
the plan. Similarly, if a cash or deferred
arrangement under which employees are
permitted to participate before they have
completed the minimum age and service
requirements of section 410(a)(1) applies section 410(b)(4)(B) for determining
whether the plan complies with section
410(b)(1), then the arrangement must be
treated as two separate arrangements, one
comprising all eligible employees who
have met the age and service requirements
of section 410(a)(1) and one comprising
all eligible employees who have not met
the age and service requirements under
section 410(a)(1), unless the plan is using
the rule in §1.401(k)–2(a)(1)(iii)(A).
(B) Restructuring prohibited. Restructuring under §1.401(a)(4)–9(c) may not
be used to demonstrate compliance with
the requirements of section 401(k). See
§1.401(a)(4)–9(c)(3)(ii).
(v) Modifications to section 410(b)
rules—(A) Certain disaggregation rules
not applicable. The mandatory disaggregation rules relating to section 401(k)
plans and section 401(m) plans set forth
in §1.410(b)–7(c)(1) and ESOP and
non-ESOP portions of a plan set forth in
§1.410(b)–7(c)(2) shall not apply for purposes of this section and §§1.401(k)–2
through 1.401(k)–6.
Accordingly,
notwithstanding §1.410(b)–7(d)(2), an

450

ESOP and a non-ESOP which are different plans (within the meaning of
§1.410(b)–7(b)) are permitted to be aggregated for these purposes.
(B) Permissive aggregation of collective bargaining units. Notwithstanding
the general rule under section 410(b) and
§1.410(b)–7(c) that a plan that benefits
employees who are included in a unit of
employees covered by a collective bargaining agreement and employees who
are not included in the collective bargaining unit is treated as comprising separate
plans, an employer can treat two or more
separate collective bargaining units as
a single collective bargaining unit for
purposes of this section and §1.401(k)–2
through §1.401(k)–6, provided that the
combinations of units are determined on
a basis that is reasonable and reasonably
consistent from year to year. Thus, for
example, if a plan benefits employees in
three categories (e.g., employees included
in collective bargaining unit A, employees
included in collective bargaining unit B,
and employees who are not included in
any collective bargaining unit), the plan
can be treated as comprising three separate plans, each of which benefits only
one category of employees. However, if
collective bargaining units A and B are
treated as a single collective bargaining
unit, the plan will be treated as comprising
only two separate plans, one benefitting all employees who are included in
a collective bargaining unit and another
benefitting all other employees. Similarly,
if a plan benefits only employees who are
included in collective bargaining unit A
and employees who are included in collective bargaining unit B, the plan can be
treated as comprising two separate plans.
However, if collective bargaining units A
and B are treated as a single collective
bargaining unit, the plan will be treated as
a single plan. An employee is treated as
included in a unit of employees covered
by a collective bargaining agreement if
and only if the employee is a collectively
bargained employee within the meaning
of §1.410(b)–6(d)(2).
(C) Multiemployer plans. Notwithstanding §1.410(b)–7(c)(4)(ii)(C), the
portion of the plan that is maintained pursuant to a collective bargaining agreement
(within the meaning of §1.413–1(a)(2)) is
treated as a single plan maintained by a

September 2, 2003

single employer that employs all the employees benefitting under the same benefit
computation formula and covered pursuant
to that collective bargaining agreement.
The rules of paragraph (b)(4)(v)(B) of
this section (including the permissive aggregation of collective bargaining units)
apply to the resulting deemed single plan
in the same manner as they would to
a single employer plan, except that the
plan administrator is substituted for the
employer where appropriate and appropriate fiduciary obligations are taken into
account. The noncollectively bargained
portion of the plan is treated as maintained
by one or more employers, depending on
whether the noncollectively bargaining
unit employees who benefit under the plan
are employed by one or more employers.
(vi) Examples. The following examples
illustrate the application of this paragraph
(b)(4):
Example 1. (i) Employer A maintains Plan V, a
profit-sharing plan that includes a cash or deferred
arrangement in which all of the employees of Employer A are eligible to participate. For purposes of
applying section 410(b), Employer A is treated as operating qualified separate lines of business under section 414(r) in accordance with §1.414(r)–1(b). However, Employer A applies the special rule for employer-wide plans in §1.414(r)–1(c)(2)(ii) to the portion of its profit-sharing plan that consists of elective
contributions under the cash or deferred arrangement
(and to no other plans or portions of plans).
(ii) Under these facts, the requirements of this section and §§1.401(k)–2 through 1.401(k)–6 must be
applied on an employer-wide rather than a qualified
separate line of business basis.
Example 2. (i) Employer B maintains Plan W, a
profit-sharing plan that includes a cash or deferred arrangement in which all of the employees of Employer
B are eligible to participate. For purposes of applying section 410(b), the plan treats the cash or deferred
arrangement as two separate plans, one for the employees who have completed the minimum age and
service eligibility conditions under section 410(a)(1)
and the other for employees who have not completed
the conditions. The plan provides that it will satisfy the section 401(k) safe harbor requirement of
§1.401(k)–3 with respect to the employees who have
met the minimum age and service conditions and that
it will meet the ADP test requirements of §1.401(k)–2
with respect to the employees who have not met the
minimum age and service conditions.
(ii) Under these facts, the cash or deferred arrangement must be disaggregated on a consistent basis with the disaggregation of Plan W. Thus, the requirements of §1.401(k)–2 must be applied by comparing the ADP for eligible HCEs who have not completed the minimum age and service conditions with
the ADP for eligible NHCEs for the applicable year
who have not completed the minimum age and service conditions.
Example 3. (i) Employer C maintains Plan X, a
stock-bonus plan including an ESOP. The plan also

September 2, 2003

includes a cash or deferred arrangement for participants in the ESOP and non-ESOP portions of the plan.
(ii) Pursuant to paragraph (b)(4)(v)(A) of this
section the ESOP and non-ESOP portions of the
stock-bonus plan are a single cash or deferred
arrangement for purposes of this section and
§§1.401(k)–2 through 1.401(k)–6. However, as
provided in paragraph (a)(4)(iv)(C) of this section,
the ESOP and non-ESOP portions of the plan are still
treated as separate plans for purposes of satisfying
the requirements of section 410(b).

(c) Nonforfeitability requirements—(1)
General rule. A cash or deferred arrangement satisfies this paragraph (c) only if
the amount attributable to an employee's
elective contributions are immediately
nonforfeitable, within the meaning of
paragraph (c)(2) of this section, are disregarded for purposes of applying section
411(a) to other contributions or benefits,
and the contributions remain nonforfeitable even if the employee makes no
additional elective contributions under a
cash or deferred arrangement.
(2) Definition of immediately nonforfeitable. An amount is immediately
nonforfeitable if it is immediately nonforfeitable within the meaning of section
411, and would be nonforfeitable under
the plan regardless of the age and service
of the employee or whether the employee
is employed on a specific date. An amount
that is subject to forfeitures or suspensions
permitted by section 411(a)(3) does not
satisfy the requirements of this paragraph
(c).
(3) Example. The following example
illustrates the application of this paragraph
(c):
Example. (i) Employees B and C are covered by
Employer Y's stock bonus plan, which includes a cash
or deferred arrangement. All employees participating
in the plan have a nonforfeitable right to a percentage of their account balance derived from all contributions (including elective contributions) as shown 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 not
satisfy paragraph (c) of this section because elective
contributions are not immediately nonforfeitable.

451

Thus, the cash or deferred arrangement is a nonqualified cash or deferred arrangement.

(d) Distribution limitation—(1) General rule. A cash or deferred arrangement
satisfies this paragraph (d) only if amounts
attributable to elective contributions may
not be distributed before one of the following events, and any distributions so
permitted also satisfy the additional requirements of paragraphs (d)(2) through
(5) of this section (to the extent applicable)—
(i) The employee's death, disability, or
severance from employment;
(ii) In the case of a profit-sharing, stock
bonus or rural cooperative plan, the employee's attainment of age 591/2, or the employee's hardship; or
(iii) The termination of the plan.
(2) Rules applicable to distributions
upon severance from employment. An
employee has a severance from employment when the employee ceases to be an
employee of the employer maintaining
the plan. An employee does not have a
severance from employment if, in connection with a change of employment, the
employee's new employer maintains such
plan with respect to the employee. For
example, a new employer maintains a plan
with respect to an employee by continuing
or assuming sponsorship of the plan or
by accepting a transfer of plan assets and
liabilities (within the meaning of section
414(l)) with respect to the employee).
(3) Rules applicable to hardship distributions—(i) Distribution must be on account of hardship. A distribution is treated
as made after an employee's hardship for
purposes of paragraph (d)(1)(ii) of this section if and only if it is made on account
of the hardship. For purposes of this rule,
a distribution is made on account of hardship only if the distribution both is made
on account of an immediate and heavy financial need of the employee and is necessary to satisfy the financial need. The determination of the existence of an immediate and heavy financial need and of the
amount necessary to meet the need must
be made in accordance with nondiscriminatory and objective standards set forth in
the plan.
(ii) Limit on maximum distributable
amount—(A) General rule. A distribution
on account of hardship must be limited
to the maximum distributable amount.
The maximum distributable amount is

2003-35 I.R.B.

equal to the employee's total elective contributions as of the date of distribution,
reduced by the amount of previous distributions of elective contributions. Thus,
the maximum distributable amount does
not include earnings, QNECs or QMACs,
unless grandfathered under paragraph
(d)(3)(ii)(B) of this section.
(B) Grandfathered amounts. If the
plan provides, the maximum distributable
amount may be increased for amounts
credited to the employee's account as of a
date specified in the plan that is no later
than December 31, 1988, or if later, the
end of the last plan year ending before July
1, 1989 (or in the case of a collectively
bargained plan, the earlier of—
(1) the later of January 1, 1989, or the
date on which the last of the collective bargaining agreements in effect on March 1,
1986, terminates (determined without regard to any extension thereof after February 28, 1986); or
(2) January 1, 1991, and consisting of—
(i) Income allocable to elective contributions;
(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 employee has an immediate and heavy
financial need is to be determined based
on all the relevant facts and circumstances.
Generally, for example, the need to pay
the funeral expenses of a family member
would constitute an immediate and heavy
financial need. A distribution made to
an employee for the purchase of a boat
or television would generally not constitute a distribution made on account of an
immediate and heavy financial need. A financial need may be immediate and heavy
even if it was reasonably foreseeable or
voluntarily incurred by the employee.
(B) Deemed immediate and heavy financial need. A distribution is deemed to
be on account of an immediate and heavy
financial need of the employee if the distribution is for—
(1) Expenses for medical care described
in section 213(d) previously incurred by
the employee, the employee's spouse, or
any dependents of the employee (as defined in section 152) or necessary for these
persons to obtain medical care described in
section 213(d);

2003-35 I.R.B.

(2) Costs directly related to the purchase of a principal residence for the employee (excluding mortgage payments);
(3) Payment of tuition, related educational fees, and room and board expenses,
for up to the next 12 months of post-secondary education for the employee, or the
employee's spouse, children, or dependents (as defined in section 152); or
(4) Payments necessary to prevent the
eviction of the employee from the employee's principal residence or foreclosure
on the mortgage on that residence.
(iv) Distribution necessary to satisfy financial need—(A) Distribution may not
exceed amount of need. A distribution
is treated as necessary to satisfy an immediate and heavy financial need of an
employee only to the extent the amount
of the distribution is not in excess of the
amount required to satisfy the financial
need. For this purpose, the amount required to satisfy the financial need may include any amounts necessary to pay any
federal, state, or local income taxes or
penalties reasonably anticipated to result
from the distribution.
(B) No alternative means available. A
distribution is not treated as necessary to
satisfy an immediate and heavy financial
need of an employee to the extent the
need may be relieved from other resources
that are reasonably available to the employee. This determination generally is to
be made on the basis of all the relevant
facts and circumstances. For purposes of
this paragraph (d)(3)(iv), the employee's
resources are deemed to include those
assets of the employee's spouse and minor children that are reasonably available
to the employee. Thus, for example, a
vacation home owned by the employee
and the employee's spouse, whether as
community property, joint tenants, tenants
by the entirety, or tenants in common,
generally will be deemed a resource of the
employee. However, property held for the
employee's child under an irrevocable trust
or under the Uniform Gifts to Minors Act
(or comparable State law) is not treated as
a resource of the employee.
(C) Employer reliance on employee
representation. For purposes of paragraph
(d)(3)(iv)(B) of this section, an immediate
and heavy financial need generally may
be treated as not capable of being relieved
from other resources that are reasonably
available to the employee, if the employer

452

relies upon the employee's written representation, unless the employer has actual
knowledge to the contrary, that the need
cannot reasonably be relieved—
(1) Through reimbursement or compensation by insurance or otherwise;
(2) By liquidation of the employee's assets;
(3) By cessation of elective contributions or employee contributions under the
plan;
(4) By other distributions or nontaxable (at the time of the loan) loans from
plans maintained by the employer or by
any other employer; or
(5) By borrowing from commercial
sources on reasonable commercial terms
in an amount sufficient to satisfy the need.
(D) Employee need not take counterproductive actions. For purposes of this
paragraph (d)(3)(iv), a need cannot reasonably be relieved by one of the actions described in paragraph (d)(3)(iv)(C) of this
section if the effect would be to increase
the amount of the need. For example, the
need for funds to purchase a principal residence cannot reasonably be relieved by a
plan loan if the loan would disqualify the
employee from obtaining other necessary
financing.
(E) Distribution deemed necessary to
satisfy immediate and heavy financial
need. A distribution is deemed necessary
to satisfy an immediate and heavy financial need of an employee if each of the
following requirements are satisfied—
(1) The employee has obtained all
distributions, other than hardship distributions, and all nontaxable (at the time of
the loan) loans currently available under
the plan and all other plans maintained by
the employer; and
(2) The employee is prohibited, under the terms of the plan or an otherwise
legally enforceable agreement, from making elective contributions and employee
contributions to the plan and all other
plans maintained by the employer for at
least 6 months after receipt of the hardship
distribution.
(F) Definition of other plans. For purposes of paragraph (d)(3)(iv)(C)(4) and
(E)(1) of this section, the phrase “plans
maintained by the employer” means all
qualified and nonqualified plans of deferred compensation maintained by the
employer, including a cash or deferred
arrangement that is part of a cafeteria

September 2, 2003

plan within the meaning of section 125.
However, it does not include the mandatory employee contribution portion of a
defined benefit plan or a health or welfare
benefit plan (including one that is part of
a cafeteria plan). In addition, for purposes
of paragraph (d)(3)(iv)(E)(2) of this section, the phrase “plans maintained by the
employer” also includes a stock option,
stock purchase, or similar plan maintained
by the employer. See §1.401(k)–6 for the
continued treatment of suspended employees as eligible employees.
(v) Commissioner may expand standards. The Commissioner may prescribe
additional guidance of general applicability, published in the Internal Revenue Bulletin (see 601.601(d)(2) of this chapter),
expanding the list of deemed immediate
and heavy financial needs and prescribing
additional methods for distributions to be
deemed necessary to satisfy an immediate
and heavy financial need.
(4) Rules applicable to distributions
upon plan termination—(i) No alternative
defined contribution plan. A distribution may not be made under paragraph
(d)(1)(iii) of this section if the employer
establishes or maintains an alternative
defined contribution plan. For purposes
of the preceding sentence, the definition of the term “employer” contained in
§1.401(k)–6 is applied as of the date of
plan termination, and a plan is an alternative defined contribution plan only if it is
a defined contribution plan that exists at
any time during the period beginning on
the date of plan termination and ending
12 months after distribution of all assets
from the terminated plan. However, if at
all times during the 24-month period beginning 12 months before the termination,
fewer than 2% of the employees who were
eligible under the defined contribution
plan that includes the cash or deferred
arrangement as of the date of plan termination are eligible under the other defined
contribution plan, the other plan is not
an alternative defined contribution plan.
In addition, a defined contribution plan
is not treated as an alternative defined
contribution plan if it is an employee
stock ownership plan as defined in section 4975(e)(7) or 409(a), a simplified
employee pension as defined in section
408(k), a SIMPLE IRA plan as defined in
section 408(p), a plan or contract that satisfies the requirements of section 403(b),

September 2, 2003

or a plan that satisfies the requirements of
section 457.
(ii) Lump sum requirement for certain distributions. A distribution may be
made under paragraph (d)(1)(iii) of this
section only if it is a lump sum distribution. The term lump sum distribution
has the meaning provided in section
402(e)(4)(D) (without regard to section
402(e)(4)(D)(i)(I), (II), (III) and (IV)). In
addition, a lump sum distribution includes
a distribution of an annuity contract from
a trust that is part of a plan described in
section 401(a) and which is exempt from
tax under section 501(a) or an annuity plan
described in 403(a).
(5) Rules applicable to all distributions—(i) Exclusive distribution rules.
Amounts attributable to elective contributions may not be distributed on account of
any event not described in this paragraph
(d), such as completion of a stated period
of plan participation or the lapse of a fixed
number of years. For example, if excess
deferrals (and income) for an employee's
taxable year are not distributed within
the time prescribed in §1.402(g)–1(e)(2)
or (3), the amounts may be distributed
only on account of an event described in
this paragraph (d). Pursuant to section
401(k)(8), the prohibition on distributions
set forth in this section does not apply
to a distribution of excess contributions
under §1.401(k)–2(b). In addition, the
prohibition on distributions set forth in
this paragraph (d) does not apply to a
distribution of excess annual additions
pursuant to §1.415–6(b)(6)(iv).
(ii) Deemed distributions. The cost of
life insurance (determined under section
72) is not treated as a distribution for purposes of section 401(k)(2) and this paragraph (d). The making of a loan is not
treated as a distribution, even if the loan
is secured by the employee's accrued benefit attributable to elective contributions or
is includible in the employee's income under section 72(p). However, the reduction,
by reason of default on a loan, of an employee's accrued benefit derived from elective contributions is treated as a distribution.
(iii) ESOP dividend distributions. A
plan does not fail to satisfy the requirements of this paragraph (d) merely by reason of a dividend distribution described in
section 404(k)(2).

453

(iv) Limitations apply after transfer.
The limitations of this paragraph (d)
generally continue to apply to amounts
attributable to elective contributions (including QNECs and qualified matching
contributions taken into account for the
ADP test under §1.401(k)–2(a)(6)) that
are transferred to another qualified plan of
the same or another employer. Thus, the
transferee plan will generally fail to satisfy the requirements of section 401(a) and
this section if transferred amounts may
be distributed before the times specified
in this paragraph (d). In addition, a cash
or deferred arrangement fails to satisfy
the limitations of this paragraph (d) if it
transfers amounts to a plan that does not
provide that the transferred amounts may
not be distributed before the times specified in this paragraph (d). The transferor
plan does not fail to comply with the preceding sentence if it reasonably concludes
that the transferee plan provides that
the transferred amounts may not be distributed before the times specified in this
paragraph (d). What constitutes a basis for
a reasonable conclusion is comparable to
the rules related to acceptance of rollover
distributions. See §1.401(a)(31)–1, A–14.
The limitations of this paragraph (d) cease
to apply after the transfer, however, if
the amounts could have been distributed
at the time of the transfer (other than
on account of hardship), and the transfer is an elective transfer described in
§1.411(d)–4, Q&A–3(b)(1). The limitations of this paragraph (d) also do not
apply to amounts that have been paid in
a direct rollover to the plan after being
distributed by another plan.
(6) Examples. The following examples
illustrate the application of this paragraph
(d):
Example 1. Employer M maintains Plan V, a
profit-sharing plan that includes a cash or deferred
arrangement. Elective contributions under the arrangement may be withdrawn for any reason after
two years following the end of the plan year in which
the contributions were made. Because the plan
permits distributions of elective contributions before
the occurrence of one of the events specified in
section 401(k)(2)(B) and this paragraph (d), the cash
or deferred arrangement is a nonqualified cash or
deferred arrangement and the elective contributions
are currently includible in income under section 402.
Example 2. (i) Employer N maintains Plan W, a
profit-sharing plan that includes a cash or deferred
arrangement. Plan W provides for distributions upon
a participant's severance from employment, death
or disability. All employees of Employer N and its
wholly owned subsidiary, Employer O, are eligible to

2003-35 I.R.B.

participate in Plan W. Employer N agrees to sell all
issued and outstanding shares of Employer O to an
unrelated entity, Employer T, effective on December
31, 2006. Following the transaction, Employer O
will be a wholly owned subsidiary of Employer
T. Additionally, individuals who are employed by
Employer O on the effective date of the sale continue to be employed by Employer O following the
sale. Following the transaction, all employees of
Employer O will cease to participate in Plan W and
will become eligible to participate in the cash or
deferred arrangement maintained by Employer T,
Plan X. No assets will be transferred from Plan W to
Plan X, except in the case of a direct rollover within
the meaning of section 401(a)(31).
(ii) Employer O ceases to be a member of Employer N's controlled group as a result of the sale.
Therefore, employees of Employer O who participated in Plan W will have a severance from employment and are eligible to receive a distribution from
Plan W.
Example 3. (i) Employer Q maintains Plan Y, a
profit-sharing plan that includes a cash or deferred arrangement. Plan Y, the only plan maintained by Employer Q, does not provide for loans. However, Plan
Y provides that elective contributions under the arrangement may be distributed to an eligible employee
on account of hardship using the deemed immediate and heavy financial need provisions of paragraph
(d)(3)(iii)(B) of this section and provisions regarding distributions necessary to satisfy financial need of
paragraphs (d)(3)(iv)(A) through (D) of this section.
Employee A is an eligible employee in Plan Y with
an account balance of $50,000 attributable to elective
contributions made by Employee A. The total amount
of elective contributions made by Employee A, who
has not previously received a distribution from Plan
Y, is $20,000. Employee A requests a $15,000 hardship distribution of his elective contributions to pay
6 months of college tuition and room and board expenses for his dependent child. At the time of the distribution request, the sole asset of Employee A (that is
reasonably available to Employee A within the meaning of paragraph (d)(3)(iv)(B) of this section) is a savings account with an available balance of $10,000.
(ii) A distribution is made on account of hardship
only if the distribution both is made on account of an
immediate and heavy financial need of the employee
and is necessary to satisfy the financial need. Under
paragraph (d)(3)(iii)(B) of this section, a distribution
for payment of up to the next 12 months of post-secondary education and room and board expenses for
Employee A's dependant child is deemed to be on account of an immediate and heavy financial need of
Employee A.
(iii) A distribution is treated as necessary to
satisfy Employee A's immediate and heavy financial
need to the extent the need may not be relieved from
other resources reasonably available to Employee
A. Under paragraph (d)(3)(iv)(B) of this section,
Employee A's $10,000 savings account is a resource
that is reasonably available to the employee and must
be taken into account in determining the amount
necessary to satisfy Employee A's immediate and
heavy financial need. Thus, Employee A may receive a distribution of only $5,000 of his elective
contributions on account of this hardship, plus an
amount necessary to pay any federal, state, or local

2003-35 I.R.B.

income taxes or penalties reasonably anticipated to
result from the distribution.
Example 4. (i) The facts are the same as in Example 3. Employee B, another employee of Employer Q has an account balance of $25,000, attributable to Employee B's elective contributions. The
total amount of elective contributions made by Employee B, who has not previously received a distribution from Plan Y, is $15,000. Employee B requests
a $10,000 distribution of his elective contributions to
pay 6 months of college tuition and room and board
expenses for his dependent child. Employee B makes
a written representation (with respect to which Employer Q has no actual knowledge to the contrary) that
the need cannot reasonably be relieved: 1) through reimbursement or compensation by insurance or otherwise; 2) by liquidation of the employee's assets; 3) by
cessation of elective contributions or employee contributions under the plan; 4) by other distributions
or nontaxable (at the time of the loan) loans from
plans maintained by the employer or by any other employer; or 5) by borrowing from commercial sources
on reasonable commercial terms in an amount sufficient to satisfy the need.
(ii) Under paragraph (d)(3)(iii)(B) of this section,
a distribution for payment of up to the next 12 months
of post-secondary education and room and board expenses for Employee B's dependant child is deemed
to be on account of an Employee B's immediate and
heavy financial need. In addition, because Employer
Q can rely on Employee B's written representation,
the distribution is considered necessary to satisfy
Employee B's immediate and heavy financial need.
Therefore, Employee B may receive a $10,000
distribution of his elective contributions on account
of hardship plus an amount necessary to pay any
federal, state, or local income taxes or penalties
reasonably anticipated to result from the distribution.
Example 5. (i) The facts are the same as in
Example 3, except Plan Y provides for hardship
distributions using the safe harbor rule of paragraph
(d)(3)(iv)(E) of this section. Accordingly, Plan Y
provides for a 6 month suspension of an eligible
employee's elective contributions and employee contributions to the plan after the receipt of a hardship
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 months
of post-secondary education and room and board expenses for Employee A's dependant child is deemed
to be on account of an Employee A's immediate and
heavy financial need. In addition, because Employee
A is not eligible for any other distribution or loan from
Plan Y and Plan Y suspends Employee A's elective
contributions and employee contributions following
receipt of the hardship distribution, the distribution
will be deemed necessary to satisfy Employee A's immediate and heavy financial need (and Employee A
is not required to first liquidate his savings account).
Therefore, Employee A may receive a $15,000 distribution of his elective contributions on account of
hardship plus an amount necessary to pay any federal, state, or local income taxes or penalties reasonably anticipated to result from the distribution.
Example 6. Employer R maintains a pre-ERISA
money purchase pension plan that includes a cash
or deferred arrangement that is not a rural cooperative plan. Elective contributions under the arrangement may be distributed to an employee on account

454

of hardship. Under paragraph (d)(1) of this section,
hardship is a permissible distribution event only in a
profit-sharing, stock bonus or rural cooperative plan.
Since elective contributions under the arrangement
may be distributed before a permissible distribution
event occurs, the cash or deferred arrangement does
not satisfy this paragraph (d), and is not a qualified
cash or deferred arrangement. Moreover, the plan is
not a qualified plan because a money purchase pension plan may not provide for payment of benefits
upon hardship. See §1.401–1(b)(1)(i).

(e) Additional requirements for qualified cash or deferred arrangements—(1)
Qualified plan requirement. A cash or deferred arrangement satisfies this paragraph
(e) only if the plan of which it is a part is
a profit-sharing, stock bonus, pre-ERISA
money purchase or rural cooperative plan
that otherwise satisfies the requirements
of section 401(a) (taking into account the
cash or deferred arrangement). A plan that
includes a cash or deferred arrangement
may provide for other contributions, including employer contributions (other than
elective contributions), employee contributions, or both. However, except as expressly permitted under section 401(m),
410(b)(2)(A)(ii) or 416(c)(2)(A), elective
contributions and matching contributions
taken into account under §1.401(k)–2(a)
may not be taken into account for purposes
of determining whether any other contributions under any plan (including the plan to
which the contributions are made) satisfy
the requirements of section 401(a).
(2) Election requirements—(i) Cash
must be available. A cash or deferred
arrangement satisfies this paragraph (e)
only if the arrangement provides that
the amount that each eligible employee
may defer as an elective contribution is
available to the employee in cash. Thus,
for example, if an eligible employee is
provided the option to receive a taxable
benefit (other than cash) or to have the
employer contribute on the employee's
behalf to a profit-sharing plan an amount
equal to the value of the taxable benefit,
the arrangement is not a qualified cash or
deferred arrangement. Similarly, if an employee has the option to receive a specified
amount in cash or to have the employer
contribute an amount in excess of the specified cash amount to a profit-sharing plan
on the employee's behalf, any contribution
made by the employer on the employee's
behalf in excess of the specified cash
amount is not treated as made pursuant to
a qualified cash or deferred arrangement.

September 2, 2003

This cash availability requirement applies
even if the cash or deferred arrangement is
part of a cafeteria plan within the meaning
of section 125.
(ii) Frequency of elections. A cash or
deferred arrangement satisfies this paragraph (e) only if the arrangement provides
an employee with an effective opportunity
to make (or change) a cash or deferred
election at least once during each plan year.
Whether an employee has an effective opportunity is determined based on all the
relevant facts and circumstances, including notice of the availability of the election,
the period of time during which an election
may be made, and any other conditions on
elections.
(3) Separate accounting requirement—(i) General rule. A cash or deferred
arrangement satisfies this paragraph (e)
only if the portion of an employee's benefit
subject to the requirements of paragraphs
(c) and (d) of this section is determined
by an acceptable separate accounting between that portion and any other benefits.
Separate accounting is not acceptable unless gains, losses, withdrawals, and other
credits or charges are separately allocated
on a reasonable and consistent basis to
the accounts subject to the requirements
of paragraphs (c) and (d) of this section
and to other accounts. Subject to section
401(a)(4), forfeitures are not required to
be allocated to the accounts in which benefits are subject to paragraphs (c) and (d)
of this section.
(ii) Satisfaction of separate accounting
requirement. The requirements of paragraph (e)(3)(i) of this section are treated
as satisfied if all amounts held under a
plan that includes a cash or deferred arrangement (and, if applicable, under another plan to which QNECs and QMACs
are made) are subject to the requirements
of paragraphs (c) and (d) of this section.
(4) Limitations on cash or deferred
arrangements of state and local governments—(i) General rule. A cash or
deferred arrangement does not satisfy the
requirements of this paragraph (e) if the
arrangement is adopted after May 6, 1986,
by a state or local government or political subdivision thereof, or any agency or
instrumentality thereof (a governmental
unit). For purposes of this paragraph
(e)(4), an employer that has made a legally
binding commitment to adopt a cash or

September 2, 2003

deferred arrangement is treated as having
adopted the arrangement on that date.
(ii) Rural cooperative plans and Indian
tribal governments. This paragraph (e)(4)
does not apply to a rural cooperative plan
or to a plan of an employer which is an Indian tribal government (as defined in section 7701(a)(40)), a subdivision of an Indian tribal government (determined in accordance with section 7871(d)), an agency
or instrumentality of an Indian tribal government or subdivision thereof, or a corporation chartered under federal, state or
tribal law which is owned in whole or in
part by any of the entities in this paragraph
(e)(4)(ii).
(iii) Adoption after May 6, 1986. A
cash or deferred arrangement is treated as
adopted after May 6, 1986, with respect to
all employees of any employer that adopts
the arrangement after such date.
(iv) Adoption before May 7, 1986. If
a governmental unit adopted a cash or
deferred arrangement before May 7, 1986,
then any cash or deferred arrangement
adopted by the unit at any time is treated
as adopted before that date. If an employer adopted an arrangement prior to
such date, all employees of the employer
may participate in the arrangement.
(5) One-year eligibility requirement. A
cash or deferred arrangement satisfies this
paragraph (e) only if no employee is required to complete a period of service with
the employer maintaining the plan extending beyond the period permitted under section 410(a)(1) (determined without regard
to section 410(a)(1)(B)(i)) to be eligible to
make a cash or deferred election under the
arrangement.
(6) Other benefits not contingent upon
elective contributions—(i) General rule.
A cash or deferred arrangement satisfies
this paragraph (e) only if no other benefit
is conditioned (directly or indirectly) upon
the employee's electing to make or not to
make elective contributions under the arrangement. The preceding sentence does
not apply to —
(A) Any matching contribution (as defined in §1.401(m)–1(a)(2)) made by reason of such an election;
(B) Any benefit, right or feature (such
as a plan loan) that requires, or results
in, an amount to be withheld from an
employee's pay (e.g. to pay for the benefit
or to repay the loan), to the extent the cash
or deferred arrangement restricts elective

455

contributions to amounts available after
such withholding from the employee's pay
(after deduction of all applicable income
and employment taxes);
(C) Any reduction in the employer's
top-heavy contributions under section
416(c)(2) because of matching contributions that resulted from the elective
contributions; or
(D) Any benefit that is provided at the
employee's election under a plan described
in section 125(d) in lieu of an elective contribution under a qualified cash or deferred
arrangement.
(ii) Definition of other benefits. For
purposes of this paragraph (e)(6), other
benefits include, but are not limited to,
benefits under a defined benefit plan;
nonelective contributions under a defined
contribution plan; the availability, cost,
or amount of health benefits; vacations
or vacation pay; life insurance; dental
plans; legal services plans; loans (including plan loans); financial planning
services; subsidized retirement benefits;
stock options; property subject to section
83; and dependent care assistance. Also,
increases in salary and bonuses (other than
those actually subject to the cash or deferred election) are benefits for purposes
of this paragraph (e)(6). The ability to
make after-tax employee contributions
is a benefit, but that benefit is not contingent upon an employee's electing to
make or not make elective contributions
under the arrangement merely because the
amount of elective contributions reduces
dollar-for-dollar the amount of after-tax
employee contributions that may be made.
Additionally, benefits under any other plan
or arrangement (whether or not qualified)
are not contingent upon an employee's
electing to make or not to make elective
contributions under a cash or deferred
arrangement merely because the elective
contributions are or are not taken into
account as compensation under the other
plan or arrangement for purposes of determining benefits.
(iii) Effect of certain statutory limits.
Any benefit under an excess benefit plan
described in section 3(36) of the Employee
Retirement Income Security Act of 1974
that is dependent on the employee's electing to make or not to make elective contributions is not treated as contingent.
(iv) Nonqualified deferred compensation. Participation in a nonqualified

2003-35 I.R.B.

deferred compensation plan is treated as
contingent for purposes of this paragraph
(e)(6) only to the extent that an employee
may receive additional deferred compensation under the nonqualified plan to the
extent the employee makes or does not
make elective contributions. Deferred
compensation under a nonqualified plan
of deferred compensation that is dependent on an employee's having made the
maximum elective deferrals under section
402(g) or the maximum elective contributions permitted under the terms of the plan
also is not treated as contingent.
(v) Plan loans and distributions. A loan
or distribution of elective contributions is
not a benefit conditioned on an employee's
electing to make or not make elective contributions under the arrangement merely
because the amount of the loan or distribution is based on the amount of the employee's account balance.
(vi) Examples. The following examples
illustrate the application of this paragraph
(e)(6):
Example 1. Employer T maintains a cash or deferred arrangement for all of its employees. Employer
T also maintains a nonqualified deferred compensation plan for two highly paid executives, Employees
R and C. Under the terms of the nonqualified deferred
compensation plan, R and C are eligible to participate
only if they do not make elective contributions under
the cash or deferred arrangement. Participation in the
nonqualified plan is a contingent benefit for purposes
of this paragraph (e)(6), because R's and C's participation is conditioned on their electing not to make
elective contributions under the cash or deferred arrangement.
Example 2. Employer T maintains a cash or deferred arrangement for all its employees. Employer
T also maintains a nonqualified deferred compensation plan for two highly paid executives, Employees
R and C. Under the terms of the arrangements, Employees R and C may defer a maximum of 10% of
their compensation, and may allocate their deferral
between the cash or deferred arrangement and the
nonqualified deferred compensation plan in any way
they choose (subject to the overall 10% maximum).
Because the maximum deferral available under the
nonqualified deferred compensation plan depends on
the elective deferrals made under the cash or deferred
arrangement, the right to participate in the nonqualified plan is a contingent benefit for purposes of paragraph (e)(6).

(7) Plan provision requirement. A plan
that includes a cash or deferred arrangement satisfies this paragraph (e) only if
it provides that the nondiscrimination requirements of section 401(k) will be met.

2003-35 I.R.B.

Thus, the plan must provide for satisfaction of one of the specific alternatives described in paragraph (b)(1)(ii) of this section and, if with respect to that alternative there are optional choices, which of
the optional choices will apply. For example, a plan that uses the ADP test of section 401(k)(3), as described in paragraph
(b)(1)(ii)(A) of this section, must specify
whether it is using the current year testing
method or prior year testing method. Additionally, a plan that uses the prior year
testing method must specify whether the
ADP for eligible NHCEs for the first plan
year is 3% or the ADP for the eligible
NHCEs for the first plan year. Similarly,
a plan that uses the safe harbor method of
section 401(k)(12), as described in paragraph (b)(1)(ii)(B) of this section, must
specify whether the safe harbor contribution will be the nonelective safe harbor
contribution or the matching safe harbor
contribution and is not permitted to provide that ADP testing will be used if the
requirements for the safe harbor are not
satisfied. For purposes of this paragraph
(e)(7), a plan may incorporate by reference the provisions of section 401(k)(3)
and §1.401(k)–2 if that is the nondiscrimination test being applied.
(f) Effective dates—(1) General rule.
This section and §§1.401(k)–2 through
1.401(k)–6 apply to plan years that begin
on or after the date that is 12 months after
the issuance of these regulations in final
form, except as otherwise provided in this
paragraph (f).
(2) Collectively bargained plans. In
the case of a plan maintained pursuant to
one or more collective bargaining agreements between employee representatives
and one or more employers in effect on the
date described in paragraph (f)(1) of this
section, the provisions of this section and
§§1.401(k)–2 through 1.401(k)–6 apply to
the later of the first plan year beginning after the termination of the last such agreement or the plan year described in paragraph (f)(1) of this section.
§1.401(k)–2 ADP test.
(a) Actual deferral percentage (ADP)
test—(1) In general—(i) ADP test formula. A cash or deferred arrangement
satisfies the ADP test for a plan year only
if—

456

(A) The ADP for the eligible HCEs for
the plan year is not more than the ADP for
the eligible NHCEs for the applicable year
multiplied by 1.25; or
(B) The excess of the ADP for the eligible HCEs for the plan year over the ADP
for the eligible NHCEs for the applicable
year is not more than 2 percentage points,
and the ADP for the eligible HCEs for the
plan year is not more than the ADP for
the eligible NHCEs for the applicable year
multiplied by 2.
(ii) HCEs as sole eligible employees.
If, for the applicable year for determining
the ADP of the NHCEs for a plan year,
there are no eligible NHCEs (i.e., all of the
eligible employees under the cash or deferred arrangement for the applicable year
are HCEs), the arrangement is deemed to
satisfy the ADP test for the plan year.
(iii) Special rule for early participation.
If a cash or deferred arrangement provides
that employees are eligible to participate
before they have completed the minimum
age and service requirements of section
410(a)(1)(A), and if the plan applies section 410(b)(4)(B) in determining whether
the cash or deferred arrangement meets
the requirements of section 410(b)(1), then
in determining whether the arrangement
meets 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 disaggregation under §1.410(b)–7(c)(3)), using the
ADP for all eligible HCEs for the plan year
and the ADP of eligible NHCEs for the applicable year, disregarding all NHCEs who
have not met the minimum age and service
requirements of section 410(a)(1)(A); or
(B) Pursuant to §1.401(k)–1(b)(4), the
plan is disaggregated into separate plans
and the ADP test is performed separately
for all eligible employees who have completed the minimum age and service requirements of section 410(a)(1)(A) and for
all eligible employees who have not completed the minimum age and service requirements of section 410(a)(1)(A).
(2) Determination of ADP—(i) General
rule. The ADP for a group of eligible employees (either eligible HCEs or eligible
NHCEs) for a plan year or applicable year
is the average of the ADRs of the eligible employees in that group for that year.

September 2, 2003

The ADP for a group of eligible employees is calculated to the nearest hundredth
of a percentage point.
(ii) Determination of applicable year
under current year and prior year testing
method. The ADP test is applied using
the prior year testing method or the current
year testing method. Under the prior year
testing method, the applicable year for determining the ADP for the eligible NHCEs
is the plan year immediately preceding the
plan year for which the ADP test is being
performed. Under the prior year testing
method, the ADP for the eligible NHCEs
is determined using the ADRs for the eligible employees who were NHCEs in that
preceding plan year, regardless of whether
those NHCEs are eligible employees or
NHCEs in the plan year for which the ADP
test is being calculated. Under the current year testing method, the applicable
year for determining the ADP for the eligible NHCEs is the same plan year as the
plan year for which the ADP test is being performed. Under either method, the
ADP for eligible HCEs is the average of
the ADRs of the eligible HCEs for the plan
year for which the ADP test is being performed. See paragraph (c) of this section
for additional rules for the prior year testing method.
(3) Determination of ADR—(i) General
rule. The ADR of an eligible employee for
a plan year or applicable year is the sum of
the employee's elective contributions taken
into account with respect to such employee
for the year, determined under the rules of
paragraphs (a)(4) and (5) of this section,
and the qualified nonelective contributions
and qualified matching contributions taken
into account with respect to such employee
under paragraph (a)(6) of this section for
the year, divided by the employee's compensation taken into account for the year.

The ADR is calculated to the nearest hundredth of a percentage point. If no elective
contributions, qualified nonelective contributions, or qualified matching contributions are taken into account under this section with respect to an eligible employee
for the year, the ADR of the employee is
zero.
(ii) ADR of HCEs eligible under more
than one arrangement—(A) General rule.
Pursuant to section 401(k)(3)(A), the ADR
of an HCE who is an eligible employee in
more than one cash or deferred arrangement of the same employer is calculated
by treating all contributions with respect
to such HCE under any such arrangement
as being made under the cash or deferred
arrangement being tested. Thus, the ADR
for such an HCE is calculated by accumulating all contributions under any cash
or deferred arrangement (other than a
cash or deferred arrangement described
in paragraph (a)(3)(ii)(B) of this section)
that would be taken into account under
this section for the plan year, if the cash
or deferred arrangement under which the
contribution was made applied this section
and had the same plan year. For example,
in the case of a plan with a 12-month
plan year, the ADR for the plan year of
that plan for an HCE who participates in
multiple cash or deferred arrangements of
the same employer is the sum of all contributions during such 12-month period that
would be taken into account with respect
to the HCE under all such arrangements in
which the HCE is an eligible employee, divided by the HCE's compensation for that
12-month period (determined using the
compensation definition for the plan being
tested), without regard to the plan year of
the other plans and whether those plans
are satisfying this section or §1.401(k)–3.
(B) Plans not permitted to be aggregated. Cash or deferred arrangements

under plans that are not permitted to
be aggregated under §1.401(k)–1(b)(4)
(determined without regard to the prohibition on aggregating plans with inconsistent testing methods set forth in
§1.401(k)–1(b)(4)(iii)(B) and the prohibition on aggregating plans with different
plan years set forth in §1.410(b)–7(d)(5))
are not aggregated under this paragraph
(a)(3)(ii).
(iii) Examples. The following examples
illustrate the application of this paragraph
(a)(3):
Example 1. (i) Employee A, an HCE with compensation of $120,000, is eligible to make elective
contributions under Plan S and Plan T, two profitsharing plans maintained by Employer H with calendar year plan years, each of which includes a cash or
deferred arrangement. During the current plan year,
Employee A makes elective contributions of $6,000
to Plan S and $4,000 to Plan T.
(ii) Under each plan, the ADR for Employee A is
determined by dividing Employee A's total elective
contributions under both arrangements by Employee
A's compensation taken into account under the plan
for the year. Therefore, Employee A's ADR under
each plan is 8.33% ($10,000/$120,000).
Example 2. (i) The facts are the same as in Example 1, except that Plan T defines compensation (for
deferral and testing purposes) to exclude all bonuses
paid to an employee. Plan S defines compensation
(for deferral and testing purposes) to include bonuses
paid to an employee. During the current year, Employee A's compensation included a $10,000 bonus.
Therefore, Employee A's compensation under Plan T
is $110,000 and Employee A's compensation under
Plan 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's
ADR is 8.33% ($10,000/$120,000).
Example 3. (i) Employer J sponsors two profitsharing plans, Plan U and Plan V, each of which includes a cash or deferred arrangement. Plan U's plan
year begins on July 1 and ends on June 30. Plan V
has a calendar year plan year. Compensation under
both plans is limited to the participant's compensation during the period of participation. Employee B
is an HCE who participates in both plans. Employee
B's monthly compensation and elective contributions
to each plan for the 2005 and 2006 calendar years are
as 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 the plan
year ended June 30, 2006, is equal to Employee B's
total elective contributions under Plan U and Plan V
for the plan year ending June 30, 2006, divided by
Employee B's compensation for that period. Therefore, Employee B's ADR under Plan U for the plan

September 2, 2003

year ending June 30, 2006, is (($900 x 6) + ($1,250 x
6)) / (($10,000 x 6) + ($11,500 x 6)), or 10%.
(iii) Under Plan V, Employee B's ADR for the
plan year ended December 31, 2005, is equal to total elective contributions under Plan U and V for the

457

plan year ending December 31, 2005, divided by Employee B's compensation for that period. Therefore,
Employee B's ADR under Plan V for the plan year
ending December 31, 2005, is ($10,800/$120,000),
or 9%.

2003-35 I.R.B.

Example 4. (i) The facts are the same as Example
3, except that Employee B first becomes eligible to
participate in Plan U on January 1, 2006.
(ii) Under Plan U, Employee B's ADR for the plan
year ended June 30, 2006, is equal to Employee B's
total elective contributions under Plan U and V for
the plan year ending June 30, 2006, divided by Employee B's compensation for that period. Therefore,
Employee B's ADR under Plan U for the plan year
ending June 30, 2006, is (($400 x 6)+ ($1,250 x 6)) /
(($10,000 x 6) + ($11,500 x 6)), or 7.67%.

(4) Elective contributions taken into
account under the ADP test—(i) General
rule. An elective contribution is taken into
account in determining the ADR for an
eligible employee for a plan year or applicable year only if each of the following
requirements is satisfied:
(A) The elective contribution is allocated to the eligible employee's account
under the plan as of a date within that year.
For purposes of this rule, an elective contribution is considered allocated as of a date
within a year only if—
(1) The allocation is not contingent on
the employee's participation in the plan or
performance of services on any date subsequent to that date; and
(2) The elective contribution is actually
paid to the trust no later than the end of
the 12-month period immediately following the year to which the contribution relates.
(B) The elective contribution relates to
compensation that either—
(1) Would have been received by the
employee in the year but for the employee's
election to defer under the arrangement; or
(2) Is attributable to services performed
by the employee in the year and, but for the
employee's election to defer, would have
been received by the employee within 21/2
months after the close of the year, but only
if the plan so provides for elective contributions that relate to compensation that
would have been received after the close
of a year to be allocated to such prior year
rather than the year in which the compensation would have been received.
(ii) Elective contributions for partners
and self-employed individuals. For purposes of this paragraph (a)(4), a partner's
distributive share of partnership income is
treated as received on the last day of the
partnership taxable year and a sole proprietor's compensation is treated as received
on the last day of the individual's taxable
year. Thus, an elective contribution made
on behalf of a partner or sole proprietor is

2003-35 I.R.B.

treated as allocated to the partner's account
for the plan year that includes the last day
of the partnership taxable year, provided
the requirements of paragraph (a)(4)(i) of
this section are met.
(iii) Elective contributions for HCEs.
Elective contributions of an HCE must
include any excess deferrals, as described
in §1.402(g)–1(a), even if those excess
deferrals are distributed, pursuant to
§1.402(g)–1(e).
(5) Elective contributions not taken into
account under the ADP test—(i) General
rule. Elective contributions that do not satisfy the requirements of paragraph (a)(4)(i)
of this section may not be taken into account in determining the ADR of an eligible employee for the plan year or applicable year with respect to which the
contributions were made, or for any other
plan year. Instead, the amount of the elective contributions must satisfy the requirements of section 401(a)(4) (without regard
to the ADP test) for the plan year for which
they are allocated under the plan as if they
were nonelective contributions and were
the only nonelective contributions for that
year. See §§1.401(a)(4)–1(b)(2)(ii)(B) and
1.410(b)–7(c)(1).
(ii) Elective contributions for NHCEs.
Elective contributions of an NHCE shall
not include any excess deferrals, as described in §1.402(g)–1(a), to the extent the
excess deferrals are prohibited under section 401(a)(30). However, to the extent
that the excess deferrals are not prohibited
under section 401(a)(30), they are included
in elective contributions even if distributed
pursuant to §1.402(g)–1(e).
(iii) Elective contributions treated as
catch-up contributions.
Elective contributions that are treated as catch-up
contributions under section 414(v) because they exceed a statutory limit or employer-provided limit (within the meaning
of §1.414(v)–1(b)(1)) are not taken into
account under paragraph (a)(4) of this
section for the plan year for which the
contributions were made, or for any other
plan year.
(iv) Elective contributions used to satisfy the ACP test. Except to the extent
necessary to demonstrate satisfaction of
the requirement of §1.401(m)–2(a)(6)(ii),
elective contributions taken into account
for the ACP test under §1.401(m)–2(a)(6)
are not taken into account under paragraph
(a)(4) of this section.

458

(6) Qualified nonelective contributions
and qualified matching contributions that
may be taken into account under the ADP
test. Qualified nonelective contributions
and qualified matching contributions may
be taken into account in determining the
ADR for an eligible employee for a plan
year or applicable year but only to the extent the contributions satisfy the following
requirements.
(i) Timing of allocation. The qualified nonelective contribution or qualified
matching contribution is allocated to the
employee's account as of a date within
that year within the meaning of paragraph
(a)(4)(i)(A) of this section. Consequently,
under the prior year testing method, in order to be taken into account in calculating the ADP for the eligible NHCEs for
the applicable year, a qualified nonelective
contribution or qualified matching contribution must be contributed no later than
the end of the 12-month period immediately following the applicable year even
though the applicable year is different than
the plan year being tested.
(ii) Requirement that amount satisfy
section 401(a)(4). The amount of nonelective contributions, including those qualified nonelective contributions taken into
account under this paragraph (a)(6) and
those qualified nonelective contributions
taken into account for the ACP test of section 401(m)(2) under §1.401(m)–2(a)(6),
satisfies the requirements of section
401(a)(4).
See §1.401(a)(4)–1(b)(2).
The amount of nonelective contributions,
excluding those qualified nonelective contributions taken into account under this
paragraph (a)(6) and those qualified nonelective contributions taken into account
for the ACP test of section 401(m)(2)
under §1.401(m)–2(a)(6), satisfies the
requirements of section 401(a)(4). See
§1.401(a)(4)–1(b)(2).
In the case of
an employer that is applying the special rule for employer-wide plans in
§1.414(r)–1(c)(2)(ii) with respect to the
cash or deferred arrangement, the determination of whether the qualified nonelective
contributions satisfy the requirements of
this paragraph (a)(6)(ii) must be made
on an employer-wide basis regardless of
whether the plans to which the qualified
nonelective contributions are made are
satisfying the requirements of section
410(b) on an employer-wide basis. Conversely, in the case of an employer that

September 2, 2003

is treated as operating qualified separate
lines of business, and does not apply the
special rule for employer-wide plans in
§1.414(r)–1(c)(2)(ii) with respect to the
cash or deferred arrangement, then the
determination of whether the qualified
nonelective contributions satisfy the requirements of this paragraph (a)(6)(ii)
is not permitted to be made on an employer-wide basis regardless of whether
the plans to which the qualified nonelective contributions are made are satisfying
the requirements of section 410(b) on that
basis.
(iii) Aggregation must be permitted.
The plan that contains the cash or deferred
arrangement and the plan or plans to which
the qualified nonelective contributions or
qualified matching contributions are
made, are plans that would be permitted
to be aggregated under §1.401(k)–1(b)(4).
If the plan year of the plan that contains the cash or deferred arrangement is
changed to satisfy the requirement under
§1.410(b)–7(d)(5) that aggregated plans
have the same plan year, qualified nonelective contributions and qualified matching
contributions may be taken into account in
the resulting short plan year only if such
qualified nonelective contributions and
qualified matching contributions could
have been taken into account under an
ADP test for a plan with the same short
plan year.
(iv) Disproportionate contributions not
taken into account—(A) General rule.
Qualified nonelective contributions cannot
be taken into account for a plan year for
an NHCE to the extent such contributions exceed the product of that NHCE's
compensation and the greater of 5% or
two times the plan's representative contribution rate. Any qualified nonelective

contribution taken into account under
an ACP test under §1.401(m)–2(a)(6)
(including the determination of the representative contribution rate for purposes of
§1.401(m)–2(a)(6)(v)(B)), is not permitted to be taken into account for purposes
of this paragraph (a)(6) (including the
determination of the representative contribution rate under paragraph (a)(6)(iv)(B)
of this section).
(B) Definition of representative contribution rate. For purposes of this paragraph
(a)(6)(iv), the plan's representative contribution rate is the lowest applicable contribution rate of any eligible NHCE among
a group of eligible NHCEs that consists of
half of all eligible NHCEs for the plan year
(or, if greater, the lowest applicable contribution rate of any eligible NHCE in the
group of all eligible NHCEs for the plan
year and who is employed by the employer
on the last day of the plan year).
(C) Definition of applicable contribution rate. For purposes of this paragraph
(a)(6)(iv), the applicable contribution rate
for an eligible NHCE is the sum of the
qualified matching contributions taken
into account under this paragraph (a)(6)
for the eligible NHCE for the plan year
and the qualified nonelective contributions
made for that eligible NHCE for the plan
year, divided by that eligible NHCE's
compensation for the same period.
(v) Qualified matching contributions.
Qualified matching contributions satisfy
this paragraph (a)(6) only to the extent that
such qualified matching contributions are
matching contributions that are not precluded from being taken into account under the ACP test for the plan year under the
rules of §1.401(m)–2(a)(5)(ii).
(vi) Contributions only used once.
Qualified nonelective contributions and

qualified matching contributions can not
be taken into account under this paragraph
(a)(6) to the extent such contributions
are taken into account for purposes of
satisfying any other ADP test, any ACP
test, or the requirements of §1.401(k)–3,
1.401(m)–3 or 1.401(k)–4. Thus, for example, matching contributions that are
made pursuant to §1.401(k)–3(c) cannot
be taken into account under the ADP test.
Similarly, if a plan switches from the current year testing method to the prior year
testing method pursuant to §1.401(k)–2(c),
qualified nonelective contributions that are
taken into account under the current year
testing method for a year may not be taken
into account under the prior year testing
method for the next year.
(7) Examples. The following examples
illustrate the application of this paragraph
(a):
Example 1. (i) Employer X has three employees,
A, B, and C. Employer X sponsors a profit-sharing
plan (Plan Z) that includes a cash or deferred arrangement. Each year, Employer X determines a bonus attributable to the prior year. Under the cash or deferred
arrangement, each eligible employee may elect to receive none, all or any part of the bonus in cash. X
contributes the remainder to Plan Z. The portion of
the bonus paid in cash, if any, is paid 2 months after the end of the plan year and thus is included in
compensation for the following plan year. Employee
A is an HCE, while Employees B and C are NHCEs.
The plan uses the current year testing method and defines compensation to include elective contributions
and bonuses paid during each plan year. In February of 2005, Employer X determined that no bonuses
will be paid for 2004. In February of 2006, Employer
X provided a bonus for each employee equal to 10%
of regular compensation for 2005. For the 2005 plan
year, A, B, and C have the following compensation
and make the following elections:

Employee

Compensation

A

$100,000

$4,340

B

60,000

2,860

C

45,000

1,250

September 2, 2003

459

Elective Contribution

2003-35 I.R.B.

(ii) For each employee, the ratio of elective contributions to the employee's compensation for the plan year is:
Employee

Ratio of Elective Contribution to Compensation

A

$4,340/$100,000

B

2,860/60,000

4.77

C

1,250/45,000

2.78

(iii) The ADP for the HCEs (Employee A) is
4.34%. 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 test under paragraph (a)(1)(i) of this section.

ADR
4.34%

Example 2. (i) The facts are the same as in Example 1, except that elective contributions are made pursuant to a salary reduction agreement throughout the
plan year, and no bonuses are paid. As provided by

section 414(s)(2), Employer X includes elective contributions in compensation. During the year, B and C
defer the same amount as in Example 1, but A defers
$5,770. Thus, the compensation and elective contributions for A, B, and C are:

Employee

Gross Compensation

A

$100,000

$5,770

B

60,000

2,860

4.77

C

45,000

1,250

2.78

(ii) The ADP for the HCEs (Employee A) is
5.77%. 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, because
the ADP for the HCEs does not exceed the ADP for
the NHCEs by more than 2 percentage points and the
ADP for the HCEs does not exceed the ADP for the

Elective Contributions

NHCEs multiplied by 2 (3.78% x 2 = 7.56%), the
plan satisfies the ADP test under paragraph (a)(1)(ii)
of this section.
Example 3. (i) Employees D through L are eligible employees in Plan T, a profit-sharing plan that
contains a cash or deferred arrangement. The plan is
a calendar year plan that uses the prior year testing
method. Plan T provides that elective contributions

ADR
5.77%

are included in compensation (as provided under section 414(s)(2)). Each eligible employee may elect to
defer up to 6% of compensation under the cash or deferred arrangement. Employees D and E are HCEs.
The compensation, elective contributions, and ADRs
of Employees D and E for the 2006 plan year are
shown below:

Employee

Compensation for
2006 Plan Year

Elective Contributions for
2006 Plan
Year

D

$100,000

$10,000

10%

E

$95,000

$4,750

5%

(ii) During the 2005 plan year, Employees F
through L were eligible NHCEs. The compensation,
elective contributions and ADRs of Employees F

ADR for 2006 Plan Year

through L for the 2005 plan year are shown in the
following table:

Employee

Compensation 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%. Because Plan T is using the prior year testing method,

2003-35 I.R.B.

Elective Contributions for
2005 Plan Year

the applicable year for determining the NHCE ADP
is the prior plan year (i.e., 2005). The NHCE ADP is

460

ADR for 2005 Plan Year

determined using the ADRs for NHCEs eligible during the prior plan year (without regard to whether they

September 2, 2003

are eligible under the plan during the plan year). The
ADP for the NHCEs is 3.71% (the sum of the individual ADRs, 26%, divided by 7 employees). Because
7.5% exceeds 4.64% (3.71% x 1.25), Plan T does not
satisfy the ADP test under paragraph (a)(1)(i) of this
section. In addition, because the ADP for the HCEs
exceeds the ADP for the NHCEs by more than 2 percentage 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 qualified

cash or deferred arrangement unless the ADP failure
is corrected under paragraph (b) of this section.
Example 4. (i) Plan U is a calendar year profitsharing plan that contains a cash or deferred arrangement and uses the current year testing method. Plan
U provides that elective contributions are included in
compensation (as provided under section 414(s)(2)).
The following amounts are contributed under Plan
U for the 2006 plan year: (A) QNECs equal to 2%
of each employee's compensation; (B) Contributions
equal to 6% of each employee's compensation that are
not immediately vested under the terms of the plan;

Employee

Compensation

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 satisfy 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 the
ADP for the NHCEs is 0.6%.
(iv) The 2% QNECs satisfies the timing requirement of paragraph (a)(6)(i) of this section because it is
paid within 12-month after the plan year for which allocated. All nonelective contributions also satisfy the
requirements relating to section 401(a)(4) set forth in
paragraph (a)(6)(ii) of this section (because all employees receive an 8% nonelective contribution and
the nonelective contributions excluding the QNECs
is 6% for all employees). In addition, the QNECs are
not disproportionate under paragraph (a)(6)(iv) of this
section because no QNEC for an NHCE exceeds the
product of the plan's applicable contribution rate (2%)
and that NHCE's compensation.
(v) Because the rules of paragraph (a)(6) of this
section are satisfied, the 2% QNECs may be taken
into account in applying the ADP test of section
401(k)(3) and paragraph (a)(1) of this section. The
6% nonelective contributions, however, may not be
taken into account because they are not QNECs.
(vi) If the 2% QNECs are taken into account, the
ADP for the HCEs is 4.5%, and the actual deferral
percentage for the NHCEs is 2.6%. Because 4.5% is
not more than two percentage points greater than 2.6
percent, and not more than two times 2.6, the cash or
deferred arrangement satisfies the ADP test of section
401(k)(3) under paragraph (a)(1)(ii) of this section.
Example 5. (i) The facts are the same as Example
4, 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 contributed for the 2005 plan year during 2005 or 2006.
(ii) In 2007, it is determined that the elective contributions alone do not satisfy the ADP test of section 401(k)(3) and paragraph (a)(1) of this section for

September 2, 2003

Elective Contributions

(C) 3% of each employee's compensation that the employee may elect to receive as cash or to defer under the plan. Both types of nonelective contributions
are made for the HCEs (employees M and N) and the
NHCEs (employees O through S) for the plan year
and are contributed after the end of the plan year and
before the end of the following plan year. In addition, neither type of nonelective contributions is used
for any other ADP or ACP test.
(ii) For the 2006 plan year, the compensation,
elective contributions, and actual deferral ratios of
employees M through S are shown in the following
table:

2006 because the 2006 ADP for the eligible HCEs,
consisting of employees M and N, is 2.5% and the
2005 ADP for the eligible NHCEs is 0.8%. An additional QNEC of 2% of compensation is made for each
eligible NHCE in 2007 and allocated for 2005.
(iii) The 2% QNECs that are made in 2007 and allocated for the 2005 plan year do not satisfy the timing requirement of paragraph (a)(6)(i) of this section
for the applicable year for the 2005 plan year because
they were not contributed before the last day of the
2006 plan year. Accordingly, the 2% QNECs do not
satisfy the rules of paragraph (a)(6) of this section and
may not be taken into account in applying the ADP
test of section 401(k)(3) and paragraph (a)(1) of this
section for the 2006 plan year. The cash or deferred
arrangement fails to be a qualified cash or deferred
arrangement unless the ADP failure is corrected under paragraph (b) of this section.
Example 6. (i) The facts are the same as Example 4, except that the ADP for the HCEs is 4.6%
and there is no 6% nonelective contribution under
the plan. The employer would like to take into account the 2% QNEC in determining the ADP for the
NHCEs but not in determining the ADP for the HCEs.
(ii) The elective contributions alone fail the requirements of section 401(k) and paragraph (a)(1) of
this 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 account in determining the ADP of the NHCEs because
they fail to satisfy the requirements relating to section 401(a)(4) set forth in paragraph (a)(6)(ii) of this
section. This is because the amount of nonelective
contributions, excluding those QNECs that would
be taken into account under the ADP test, would be
2% of compensation for the HCEs and 0% for the
NHCEs. Therefore, the cash or deferred arrangement
fails to be a qualified cash or deferred arrangement

461

Actual Deferral Ratio

unless the ADP failure is corrected under paragraph
(b) of this section.
Example 7. (i) The facts are the same as Example
6, except that Employee R receives a QNEC in an
amount of $500 and no QNECs are made on behalf
of the other employees.
(ii) If the QNEC could be taken into account under paragraph (a)(6) of this section, the ADP for the
NHCEs would be 2.6% and the plan would satisfy the
ADP test. The QNEC is disproportionate under paragraph (a)(6)(iv) of this section, and cannot be taken
into account under paragraph (a)(6) of this section, to
the extent it exceeds the greater of 5% and two times
the plan's representative contribution rate (0%), multiplied by Employee R's compensation. The plan's
representative contribution rate is 0% because it is the
lowest applicable contribution rate among a group of
NHCEs that is at least half of all NHCEs, or all the
NHCEs who are employed on the last day of the plan
year. Therefore, the QNEC may be taken into account
under the ADP test only to the extent it does not exceed 5% times Employee R's compensation (or $250)
and the cash or deferred arrangement fails to satisfy
the ADP test and must correct under paragraph (b) of
this section.
Example 8. (i) The facts are the same as in Example 4 except that the plan changes from the current
year testing method to the prior year testing method
for the following plan year (2006 plan year). The
ADP for the HCEs for the 2006 plan year is 3.5%.
(ii) The 2% QNECs may not be taken into account
in determining the ADP for the NHCEs for the applicable year (2005 plan year) in satisfying the ADP test
for the 2006 plan year because they were taken into
account in satisfying the ADP test for the 2005 plan
year. Accordingly, the NHCE ADP for the applicable
year is 0.6%. The elective contributions for the plan
year fail the requirements of section 401(k) and paragraph (a)(1) of this section because the HCE ADP for

2003-35 I.R.B.

the 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% x
2)), determined using the applicable year ADP for the
NHCEs. Therefore, the cash or deferred arrangement
fails to be a qualified cash or deferred arrangement
unless the ADP failure is corrected under paragraph
(b) of this section.

Highly compensated employees

Example 9. (i)(A) Employer N maintains Plan
X, a profit sharing plan that contains a cash or deferred arrangement and that uses the current year testing method. Plan X provides for employee contributions, elective contributions, and matching contributions. Matching contributions on behalf of nonhighly
compensated employees are qualified matching contributions (QMACs) and are contributed during the

2005 plan year. Matching contributions on behalf of
highly compensated employees are not QMACs, because they fail to satisfy the nonforfeitability requirement of §1.401(k)–1(c). The elective contributions
and matching contributions with respect to HCEs for
the 2005 plan year are shown in the following table:

Elective
Contributions

Total Matching
Contributions

Matching
contributions
that are
not QMACs

QMACs

15%

5%

5%

0%

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

Nonhighly compensated employees
(ii) The plan fails to satisfy the ADP test of section
401(k)(3)(A) and paragraph (a)(1) of this section because the ADP for HCEs (15%) is more than 125% of
the ADP for NHCEs (11%), and more than 2 percentage points greater than 11%. However, the plan pro-

Elective
Contributions

Total Matching
Contributions

Matching
contributions
that are
not QMACs

QMACs

11%

4%

0%

4%

vides that QMACs may be used to meet the requirements of section 401(k)(3)(A)(ii) provided that they
are not used for any other ADP or ACP test. QMACs
equal to 1% of compensation are taken into account
for each NHCE in applying the ADP test. After this

adjustment, the applicable ADP and ACP (taking into
account the provisions of §1.401(m)–2(a)(5)(ii)) for
the plan year are as follows:

Actual Deferral Percentage

Actual Contribution Percentage

HCEs

15%

5%

Nonhighly compensated employees

12%

3%

(iii) The elective contributions and QMACs
taken into account for purposes of the ADP test of
section 401(k)(3) satisfy the requirements of section
401(k)(3)(A)(ii) under paragraph (a)(1)(ii) of this
section because the ADP for HCEs (15%) is not
more than the ADP for NHCEs multiplied by 1.25
(12% x 1.25 = 15%).

(b) Correction of excess contributions—(1) Permissible correction methods—(i) In general. A cash or deferred
arrangement does not fail to satisfy the
requirements of section 401(k)(3) and
paragraph (a)(1) of this section if the employer, in accordance with the terms of
the plan that includes the cash or deferred
arrangement, uses any of the following
correction methods—
(A) Qualified nonelective contributions or qualified matching contributions.
The employer makes qualified nonelective contributions or qualified matching
contributions that are taken into account

2003-35 I.R.B.

under this section and, in combination
with other amounts taken into account
under paragraph (a) of this section, allow
the cash or deferred arrangement to satisfy
the requirements of paragraph (a)(1) of
this section.
(B) Excess contributions distributed.
Excess contributions are distributed in
accordance with paragraph (b)(2) of this
section.
(C) Excess contributions recharacterized. Excess contributions are recharacterized in accordance with paragraph (b)(3)
of this section.
(ii) Combination of correction methods. A plan may provide for the use of
any of the correction methods described
in paragraph (b)(1)(i) of this section, may
limit elective contributions in a manner
designed to prevent excess contributions

462

from being made, or may use a combination of these methods, to avoid or correct
excess contributions. A plan may require
or permit an HCE to elect whether any
excess contributions are to be recharacterized or distributed. If the plan uses
a combination of correction methods,
any contribution made under paragraph
(b)(1)(i)(A) of this section must be taken
into account before application of the correction methods in paragraph (b)(1)(i)(B)
or (C) of this section.
(iii) Exclusive means of correction.
A failure to satisfy the requirements of
paragraph (a)(1) of this section may not
be corrected using any method other than
the ones described in paragraphs (b)(1)(i)
and (ii) of this section. Thus, excess
contributions for a plan year may not
remain unallocated or be allocated to a
suspense account for allocation to one or

September 2, 2003

more employees in any future year. In
addition, excess contributions may not
be corrected using the retroactive correction rules of §1.401(a)(4)–11(g). See
§1.401(a)(4)–11(g)(3)(vii) and (5).
(2) Corrections through distribution—(i) General rule. This paragraph
(b)(2) contains the rules for correction of
excess contributions through a distribution from the plan. Correction through
a distribution generally involves a 4 step
process. First, the plan must determine,
in accordance with paragraph (b)(2)(ii)
of this section, the total amount of excess contributions that must be distributed
under the plan. Second, the plan must
apportion the total amount of excess contributions among HCEs in accordance
with paragraph (b)(2)(iii) of this section.
Third, the plan must determine the income
allocable to excess contributions in accordance with paragraph (b)(2)(iv) of this
section. Finally, the plan must distribute
the apportioned excess contributions and
allocable income in accordance with paragraph (b)(2)(v) of this section. Paragraph
(b)(2)(vi) of this section provides rules
relating to the tax treatment of these distributions. Paragraph (b)(2)(vii) provides
other rules relating to these distributions.
(ii) Calculation of total amount to
be distributed.
The following procedures must be used to determine the total
amount of the excess contributions to be
distributed—
(A) Calculate the dollar amount of
excess contributions for each HCE. The
amount of excess contributions attributable to a given HCE for a plan year is
the amount (if any) by which the HCE's
contributions taken into account under this
section must be reduced for the HCE's
ADR to equal the highest permitted ADR
under the plan. To calculate the highest
permitted ADR under a plan, the ADR
of the HCE with the highest ADR is reduced by the amount required to cause that
HCE's ADR to equal the ADR of the HCE
with the next highest ADR. If a lesser
reduction would enable the arrangement
to satisfy the requirements of paragraph
(b)(2)(ii)(C) of this section, only this
lesser reduction is used in determining the
highest permitted ADR.
(B) Determination of the total amount
of excess contributions. The process described in paragraph (b)(2)(ii)(A) of this

September 2, 2003

section must be repeated until the arrangement would satisfy the requirements of
paragraph (b)(2)(ii)(C) of this section. The
sum of all reductions for all HCEs determined under paragraph (b)(2)(ii)(A) of this
section is the total amount of excess contributions for the plan year.
(C) Satisfaction of ADP. A cash or
deferred arrangement satisfies this paragraph (b)(2)(ii)(C) if the arrangement
would satisfy the requirements of paragraph (a)(1)(ii) of this section if the ADR
for each HCE were determined after
the reductions described in paragraph
(b)(2)(ii)(A) of this section.
(iii) Apportionment of total amount of
excess contributions among the HCEs.
The following procedures must be used in
apportioning the total amount of excess
contributions determined under paragraph
(b)(2)(ii) of this section among the HCEs:
(A) Calculate the dollar amount of excess contributions for each HCE. The contributions of the HCE with the highest dollar amount of contributions taken into account under this section are reduced by the
amount required to cause that HCE's contributions to equal the dollar amount of the
contributions taken into account under this
section for the HCE with the next highest
dollar amount of contributions taken account under this section. If a lesser apportionment to the HCE would enable the
plan to apportion the total amount of excess contributions, only the lesser apportionment would apply.
(B) Limit on amount apportioned to
any individual. For purposes of this
paragraph (b)(2)(iii), the amount of contributions taken into account under this
section with respect to an HCE who is an
eligible employee in more than one plan
of an employer is determined by taking
into account all contributions otherwise
taken into account with respect to such
HCE under any plan of the employer
during the plan year of the plan being
tested as being made under the plan being
tested. However, the amount of excess
contributions apportioned for a plan year
with respect to any HCE must not exceed
the amount of contributions actually contributed to the plan for the HCE for the
plan year. Thus, in the case of an HCE
who is an eligible employee in more than
one plan of the same employer to which
elective contributions are made and whose
ADR is calculated in accordance with

463

paragraph (a)(3)(ii) of this section, the
amount required to be distributed under
this paragraph (b)(2)(iii) shall not exceed
the contributions actually contributed to
the plan and taken into account 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 the
total amount of excess contributions determined under paragraph (b)(2)(ii) of this
section have been apportioned.
(iv) Income allocable to excess contributions—(A) General rule. The income
allocable to excess contributions is equal
to the sum of the allocable gain or loss for
the plan year and, to the extent the excess
contributions are or will be credited with
allocable gain or loss for the period after
the close of the plan year (gap period), the
allocable gain or loss for the gap period.
(B) Method of allocating income. A
plan may use any reasonable method for
computing the income allocable to excess
contributions, provided that the method
does not violate section 401(a)(4), is used
consistently for all participants and for all
corrective distributions under the plan for
the plan year, and is used by the plan for allocating income to participant's accounts.
See §1.401(a)(4)–1(c)(8).
(C) Alternative method of allocating
plan year income. A plan may allocate
income to excess contributions for the
plan year by multiplying the income for
the plan year allocable to the elective
contributions and other amounts taken
into account under this section (including
contributions made for the plan year),
by a fraction, the numerator of which is
the excess contributions for the employee
for the plan year, and the denominator of
which is the account balance attributable
to elective contributions and other contributions taken into account under this
section as of the beginning of the plan year
(including any additional amount of such
contributions made for the plan year).
(D) Safe harbor method of allocating gap period income. A plan may use
the safe harbor method in this paragraph
(b)(2)(iv)(D) to determine income on
excess contributions for the gap period.
Under this safe harbor method, income
on excess contributions for the gap period
is equal to 10% of the income allocable
to excess contributions for the plan year
that would be determined under paragraph

2003-35 I.R.B.

(b)(2)(iv)(C) of this section, multiplied by
the number of calendar months that have
elapsed since the end of the plan year.
For purposes of calculating the number
of calendar months that have elapsed under the safe harbor method, a corrective
distribution that is made on or before the
fifteenth day of a month is treated as made
on the last day of the preceding month and
a distribution made after the fifteenth day
of a month is treated as made on the last
day of the month.
(E) Alternative method for allocating
plan year and gap period income. A
plan may determine the allocable gain
or loss for the aggregate of the plan year
and the gap period by applying the alternative method provided by paragraph
(b)(2)(iv)(C) of this section to this aggregate period. This is accomplished by
substituting the income for the plan year
and the gap period for the income for the
plan year and by substituting the contributions taken into account under this section
for the plan year and the gap period for
the contributions taken account under this
section for the plan year in determining the
fraction that is multiplied by that income.
(v) Distribution. Within 12 months after the close of the plan year in which the
excess contribution arose, the plan must
distribute to each HCE the excess contributions apportioned to such HCE under paragraph (b)(2)(iii) of this section and the allocable income. Except as otherwise provided in this paragraph (b)(2)(v) and paragraph (b)(4)(i) of this section, a distribution of excess contributions must be in addition to any other distributions made during the year and must be designated as a
corrective distribution by the employer. In
the event of a complete termination of the
plan during the plan year in which an excess contribution arose, the corrective distribution must be made as soon as administratively feasible after the date of termination of the plan, but in no event later than
12 months after the date of termination. If
the entire account balance of an HCE is
distributed prior to when the plan makes a
distribution of excess contributions in accordance with this paragraph (b)(2), the
distribution is deemed to have been a corrective distribution of excess contributions
(and income) to the extent that a corrective
distribution would otherwise have been required.

2003-35 I.R.B.

(vi) Tax treatment of corrective distributions—(A) General rule. Except as provided in paragraph (b)(2)(vi)(B) of this
section, a corrective distribution of excess
contributions (and income) that is made
within 21/2 months after the end of the plan
year for which the excess contributions
were made is includible in the employee's
gross income on the earliest date any elective contributions by the employee during
the plan year would have been received by
the employee had the employee originally
elected to receive the amounts in cash. A
corrective distribution of excess contributions (and income) that is made more than
21/2 months after the end of the plan year
for which the contributions were made is
includible in the employee's gross income
in the employee's taxable year in which
distributed. Regardless of when the corrective distribution is made, it is not subject
to the early distribution tax of section 72(t).
See paragraph (b)(4) of this section for additional rules relating to the employer excise tax on amounts distributed more than
21/2 months after the end of the plan year.
See also §1.402(c)–2, A–4 for restrictions
on rolling over distributions that are excess
contributions.
(B) Rule for de minimis distributions.
If the total amount of excess contributions, determined under this paragraph
(b)(2), and excess aggregate contributions
determined under §1.401(m)–2(b)(2) distributed to a recipient under a plan for any
plan year is less than $100 (excluding income), a corrective distribution of excess
contributions (and income) is includible
in the gross income of the recipient in the
taxable year of the recipient in which the
corrective distribution is made.
(vii) Other rules—(A) No employee or
spousal consent required. A corrective
distribution of excess contributions (and
income) may be made under the terms of
the plan without regard to any notice or
consent otherwise required under sections
411(a)(11) and 417.
(B) Treatment of corrective distributions as elective contributions. Excess
contributions are treated as employer contributions for purposes of sections 404 and
415 even if distributed from the plan.
(C) No reduction of required minimum
distribution. A distribution of excess
contributions (and income) is not treated
as a distribution for purposes of determining whether the plan satisfies the

464

minimum distribution requirements of
section 401(a)(9). See §1.401(a)(9)–5,
Q&A–9(b).
(D) Partial distributions. Any distribution of less than the entire amount of excess
contributions (and allocable income) with
respect to any HCE is treated as a pro rata
distribution of excess contributions and allocable income.
(viii) Examples. The following examples illustrate the application of this paragraph (b)(2). For purposes of these examples, none of the plans provide for catch-up
contributions under section 414(v). The
examples are as follows:
Example 1. (i) Plan P, a calendar year profit-sharing plan that includes a cash or deferred arrangement, provides for distribution of excess contributions to HCEs to the extent necessary to satisfy the
ADP test. Employee A, an HCE, has elective contributions of $12,000 and $200,000 in compensation,
for an ADR of 6%, and Employee B, a second HCE,
has elective contributions of $8,960 and compensation of $128,000, for an ADR of 7%. The ADP for
the NHCEs is 3%. Under the ADP test, the ADP of
the two HCEs under the plan may not exceed 5% (i.e.,
2 percentage points more than the ADP of the NHCEs
under the plan). The ADP for the 2 HCEs under the
plan is 6.5%. Therefore, there must be a correction of
excess contributions.
(ii) The total amount of excess contributions for
the HCEs is determined under paragraph (b)(2)(ii) of
this section as follows: the elective contributions of
Employee B (the HCE with the highest ADR) are reduced by $1,280 in order to reduce his ADR to 6%
($7,680/$128,000), which is the ADR of Employee
A.
(iii) Because the ADP of the HCEs determined after the $1,280 reduction to Employee B still exceeds
5%, further reductions in elective contributions are
necessary in order to reduce the ADP of the HCEs
to 5%. The elective contributions of Employee A and
Employee B are each reduced by 1% of compensation ($2,000 and $1,280 respectively). Because the
ADP of the HCEs determined after the reductions
equals 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 apportioned
among the HCEs under paragraph (b)(2)(iii) of this
section first to the HCE with the highest amount of
elective contributions. Therefore, Employee A is
apportioned $3,040 (the amount required to cause
Employee A's elective contributions to equal the next
highest dollar amount of elective contributions).
(v) Because the total amount of excess contributions has not been apportioned, further apportionment
is necessary. The balance ($1,520) of the total amount
of excess contributions is apportioned equally among
Employee A and Employee B ($760 to each).
(vi) Therefore, the cash or deferred arrangement
will satisfy the requirements of paragraph (a)(1) of
this section if, by the end of the 12 month period following the end of the 2006 plan year, Employee A
receives a corrective distribution of excess contributions equal to $3,800 ($3,040 + $760) and allocable

September 2, 2003

income and Employee B receives a corrective distribution of $760 and allocable income.
Example 2. (i) The facts are the same as in Example 1, except Employee A's ADR is based on $3,000
of elective contributions to this plan and $9,000 of
elective contributions to another plan of the employer.
(ii) The total amount of excess contributions
($4,560 = $1,280+$2,000+$1,280) is apportioned
among the HCEs under paragraph (b)(2)(iii) of this
section first to the HCE with the highest amount
of elective contributions. The amount of elective
contributions for Employee A is $12,000. Therefore,
Employee A is apportioned $3,040 (the amount required to cause Employee A's elective contributions
to equal the next highest dollar amount of elective contributions). However, pursuant to paragraph
(b)(2)(iii)(B) of this section, no more than the amount
actually contributed to the plan may be apportioned
to an HCE. Accordingly, no more than $3,000 may
be apportioned to Employee A. Therefore, the remaining $1,560 must be apportioned to Employee B.
(ii) The cash or deferred arrangement will satisfy
the requirements of paragraph (a)(1) of this section if,
by the end of the 12 month period following the end of
the 2006 plan year, Employee A receives a corrective
distribution of excess contributions equal to $3,000
(total amount of elective contributions actually contributed to the plan for Employee A) and allocable
income and Employee B receives a corrective distribution of $1,560 and allocable income.
Example 3. (i) The facts are the same as in Example 1. The plan allocates income on a daily basis. The
corrective distributions are made in February 2007.
The excess contribution that must be distributed to
Employee A as a corrective distribution is $3,800.
This amount must be increased (or decreased) to reflect gains (or losses) allocable to that amount during the 2006 plan year. The plan uses a reasonable
method that satisfies paragraph (b)(2)(iv)(B) of this
section to determine the gain during the 2006 plan
year allocable to the $3,800 as $145. Therefore, as of
the end of the 2006 plan year, the amount of corrective distribution that is required would be $3,945.
(ii) Because the plan allocates income on a daily
basis, excess contributions are credited with gain or
loss during the gap period. Therefore, the corrective
distribution must include income allocable to $3,945
through the date of distribution. For the period from
January 1 through 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 corrective distribution of $4,050.
Example 4. (i) The facts are the same as in Example 1. The plan determines plan year income using the
alternative method for calculating income provided
in paragraph (b)(2)(iv)(C) of this section and using
the portion of the participant's account attributable
to elective contributions, including elective contributions made for the plan year. The plan uses the safe
harbor method provided in paragraph (b)(2)(iv)(D) of
this section for allocating gap period income. The
corrective distribution is made during the last week
of February 2007. At the beginning of the 2006 plan
year, $100,000 of Employee A's plan account was attributable to elective contributions. During the 2006

September 2, 2003

plan year, $10,000 in elective contributions were contributed to the plan for Employee A. The income allocable to Employee A's account attributable to elective
contributions for the 2006 plan year is $8,000.
(ii) Therefore, the plan year income allocable to
the $3,800 corrective distribution for Employee A
is $266.65 ($8,000 multiplied by $3,800 divided by
$110,000). Therefore, as of the end of the 2006 plan
year, the amount of corrective distribution that is required is $4,066.65. This amount must be increased
by the gap period income of $53.32 (10% multiplied
by $266.65 (2006 plan year income attributable to the
excess contribution) multiplied by 2 (number of calendar months since end of 2006 plan year). Therefore, the plan will satisfy the requirements of paragraph (a)(1) of this section if Employee A receives a
corrective distribution of $4,119.97.
Example 5. (i) The facts are the same as in Example 4, except that the plan provides for quarterly
valuations based on the account balance at the end of
the quarter.
(ii) Because the plan's method for allocating income does not allocate any income to amounts distributed during the quarter, Employee A will not be
credited with an allocation of income with respect to
the amount distributed. Accordingly, Plan P need not
plan adjust the distribution of excess contribution for
income during the gap period and thus satisfies paragraph (a)(1) of this section if Employee A receives a
corrective distribution of $4,066.65.

(3) Recharacterization of excess contributions—(i) General rule. Excess contributions are recharacterized in accordance
with this paragraph (b)(3) only if the excess contributions that would have to be
distributed under (b)(2) of this section if
the plan was correcting through distribution of excess contributions are recharacterized as described in paragraph (b)(3)(ii)
of this section, and all of the conditions set
forth in paragraph (b)(3)(iii) of this section
are satisfied.
(ii) Treatment of recharacterized excess
contributions.
Recharacterized excess
contributions are includible in the employee's gross income as if such amounts
were distributed under paragraph (b)(2) of
this section. The recharacterized excess
contributions must be treated as employee
contributions for purposes of section 72,
sections 401(a)(4) and 401(m). This requirement is not treated as satisfied unless
the payor or plan administrator reports
the recharacterized excess contributions
as employee contributions to the Internal
Revenue Service and the employee by
timely providing such federal tax forms
and accompanying instructions and timely
taking such other action as prescribed
by the Commissioner in revenue rulings,
notices and other guidance published
in the Internal Revenue Bulletin (see
601.601(d)(2) of this chapter) as well as

465

the applicable federal tax forms and accompanying instructions.
(iii) Additional rules—(A) Time of
recharacterization. Excess contributions
may not be recharacterized under this
paragraph (b)(3) after 21/2 months after
the close of the plan year to which the
recharacterization relates. Recharacterization is deemed to have occurred on the
date on which the last of those HCEs with
excess contributions to be recharacterized
is notified in accordance with paragraph
(b)(3)(ii) of this section.
(B) Employee contributions must be
permitted under plan. The amount of
recharacterized excess contributions, in
combination with the employee contributions actually made by the HCE, may not
exceed the maximum amount of employee
contributions (determined without regard
to the ACP test of section 401(m)(2)) permitted under the provisions of the plan as
in effect on the first day of the plan year.
(C) Treatment of recharacterized excess contributions. Recharacterized excess contributions continue to be treated as
employer contributions for all other purposes under the Internal Revenue Code,
including sections 401(a) (other than sections 401(a)(4) and 401(m)), 404, 409,
411, 412, 415, 416, and 417. Thus, for
example, recharacterized excess contributions remain subject to the requirements of
§1.401(k)–1(c) and (d); must be deducted
under section 404; and are treated as employer contributions described in section
415(c)(2)(A) and §1.415–6(b).
(4) Rules applicable to all corrections—(i) Coordination with distribution
of excess deferrals—(A) Treatment of excess deferrals that reduce excess contributions. The amount of excess contributions
(and allocable income) to be distributed
under paragraph (b)(2) of this section or
the amount of excess contributions recharacterized under paragraph (b)(3) of this
section with respect to an employee for
a plan year, is reduced by any amounts
previously distributed to the employee
from the plan to correct excess deferrals
for the employee's taxable year ending
with or within the plan year in accordance
with section 402(g)(2).
(B) Treatment of excess contributions
that reduce excess deferrals.
Under
§1.402(g)–1(e), the amount required to be
distributed to correct an excess deferral to
an employee for a taxable year is reduced

2003-35 I.R.B.

by any excess contributions (and allocable
income) previously distributed or excess
contributions recharacterized with respect
to the employee for the plan year beginning with or within the taxable year. The
amount of excess contributions includible
in the gross income of the employee, and
the amount of excess contributions reported by the payer or plan administrator
as includible in the gross income of the
employee, does not include the amount of
any reduction under §1.402(g)–1(e)(6).
(ii) Forfeiture of match on distributed
excess contributions. A matching contribution is taken into account under section
401(a)(4) even if the match is with respect to an elective contribution that is
distributed or recharacterized under this
paragraph (b). This requires that, after
correction of excess contributions, each
level of matching contributions be currently and effectively available to a group
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 of matching contributions to all employees will not
meet the requirements of section 401(a)(4)
if elective contributions are distributed
under this paragraph (b) to HCEs to the
extent needed to meet the requirements of
section 401(k)(3), while matching contributions attributable to those elective contributions remain allocated to the HCEs'
accounts. Under section 411(a)(3)(G)
and §1.411(a)–4(b)(7), a plan may forfeit matching contributions attributable
to excess contributions, excess aggregate
contributions or excess deferrals to avoid
a violation of section 401(a)(4). See
also §1.401(a)(4)–11(g)(vii)(B) regarding
the use of additional allocations to the
accounts of NHCEs for the purpose of
correcting a discriminatory rate of matching contributions.
(iii) Permitted forfeiture of QMAC. Pursuant to section 401(k)(8)(E), a qualified
matching contribution is not treated as forfeitable under §1.401(k)–1(c) merely because under the plan it is forfeited in accordance with paragraph (b)(4)(ii) of this
section.
(iv) No requirement for recalculation.
If excess contributions are distributed or
recharacterized in accordance with paragraphs (b)(2) and (3) of this section, the
cash or deferred arrangement is treated as
meeting the nondiscrimination test of section 401(k)(3) regardless of whether the

2003-35 I.R.B.

ADP for the HCEs, if recalculated after the
distributions or recharacterizations, would
satisfy section 401(k)(3).
(v) Treatment of excess contributions that are catch-up contributions. A
cash or deferred arrangement does not
fail to meet the requirements of section
401(k)(3) and paragraph (a)(1) of this section merely because excess contributions
that are catch-up contributions because
they exceed the ADP limit, as described in
§1.414(v)–1(b)(1)(iii), are not corrected in
accordance with this paragraph (b).
(5) Failure to timely correct—(i) Failure to correct within 21/2 months after end
of plan year. If a plan does not correct excess contributions within 21/2 months after the close of the plan year for which
the excess contributions are made, the employer will be liable for a 10% excise tax
on the amount of the excess contributions.
See section 4979 and §54.4979–1 of this
chapter. Qualified nonelective contributions and qualified matching contributions
properly taken into account under paragraph (a)(6) of this section for a plan year
may enable a plan to avoid having excess
contributions, even if the contributions are
made after the close of the 21/2 month period.
(ii) Failure to correct within 12 months
after end of plan year. If excess contributions are not corrected within 12 months
after the close of the plan year for which
they were made, the cash or deferred arrangement will fail to satisfy the requirements of section 401(k)(3) for the plan
year for which the excess contributions are
made and all subsequent plan years during
which the excess contributions remain in
the trust.
(c) Additional rules for prior year testing method—(1) Rules for change in testing method—(i) General rule. A plan is
permitted to change from the prior year
testing method to the current year testing method for any plan year. A plan
is permitted to change from the current
year testing method to the prior year testing method only in situations described in
paragraph (c)(1)(ii) of this section. For
purposes of this paragraph (c)(1), a plan
that uses the safe harbor method described
in §1.401(k)–3 or a SIMPLE 401(k) plan
is treated as using the current year testing
method for that plan year.

466

(ii) Situations permitting a change to
the prior year testing method. The situations described in this paragraph (c)(1)(ii)
are:
(A) The plan is not the result of the aggregation of two or more plans, and the
current year testing method was used under
the plan for each of the 5 plan years preceding the plan year of the change (or if lesser,
the number of plan years the plan has been
in existence, including years in which the
plan was a portion of another plan).
(B) The plan is the result of the aggregation of two or more plans, and for each
of the plans that are being aggregated (the
aggregating plans), the current year testing method was used for each of the 5
plan years preceding the plan year of the
change (or if lesser, the number of plan
years since that aggregating plan has been
in existence, including years in which the
aggregating plan was a portion of another
plan).
(C) A transaction described in section
410(b)(6)(C)(i) and §1.410(b)–2(f) occurs
and—
(1) As a result of the transaction, the
employer maintains both a plan using the
prior year testing method and a plan using
the current year testing method; and
(2) The change from the current year
testing method to the prior year testing
method occurs within the transition period
described in section 410(b)(6)(C)(ii).
(2) Calculation of ADP under the prior
year testing method for the first plan
year—(i) Plans that are not successor
plans. If, for the first plan year of any plan
(other than a successor plan), the plan uses
the prior year testing method, the plan is
permitted to use either that first plan year
as the applicable year for determining the
ADP for eligible NHCEs, or use 3% as
the ADP for eligible NHCEs, for applying
the ADP test for that first plan year. A
plan (other than a successor plan) that
uses the prior year testing method but has
elected for its first plan year to use that
year as the applicable year is not treated as
changing its testing method in the second
plan year and is not subject to the limitations on double counting on QNECs under
paragraph (a)(6)(vi) of this section for the
second plan year.
(ii) First plan year defined. For purposes of this paragraph (c)(2), the first
plan year of any plan is the first year in

September 2, 2003

which the plan provides for elective contributions. Thus, the rules of this paragraph (c)(2) do not apply to a plan (within
the meaning of §1.410(b)–7(b)) for a plan
year if for such plan year the plan is aggregated under §1.401(k)–1(b)(4) with any
other plan that provides for elective contributions in the prior year.
(iii) Successor plans. A plan is a successor plan if 50% or more of the eligible employees for the first plan year were
eligible employees under a qualified cash
or deferred arrangement maintained by the
employer in the prior year. If a plan that
is a successor plan uses the prior year testing method for its first plan year, the ADP
for the group of NHCEs for the applicable
year must be determined under paragraph
(c)(4) of this section.
(3) Plans using different testing methods for the ADP and ACP test. Except
as otherwise provided in this paragraph
(c)(3), a plan may use the current year testing method or prior year testing method for
the ADP test for a plan year without regard
to whether the current year testing method
or prior year testing method is used for the
ACP test for that year. For example, a plan
may use the prior year testing method for
the ADP test and the current year testing
method for its ACP test for the plan year.
However, plans that use different testing
methods under this paragraph (c)(3) cannot use—
(i) The recharacterization method of
paragraph (b)(3) of this section to correct
excess contributions for a plan year;
(ii) The rules of §1.401(m)–2(a)(6)(ii)
to take elective contributions into account
under the ACP test (rather than the ADP
test); or
(iii) The rules of paragraph (a)(6)(v) of
this section to take qualified matching contributions into account under the ADP test
(rather than the ACP test).
(4) Rules for plan coverage
changes—(i) In general. A plan that
uses the prior year testing method and experiences a plan coverage change during
a plan year satisfies the requirements of
this section for that year only if the plan
provides that the ADP for the NHCEs for
the plan year is the weighted average of
the ADPs for the prior year subgroups.
(ii) Optional rule for minor plan coverage changes. If a plan coverage change

September 2, 2003

occurs and 90% or more of the total number of the NHCEs from all prior year subgroups are from a single prior year subgroup, then, in lieu of using the weighted
averages described in paragraph (c)(4)(i)
of this section, the plan may provide that
the ADP for the group of eligible NHCEs
for the prior year under the plan is the
ADP of the NHCEs for the prior year of
the plan under which that single prior year
subgroup was eligible.
(iii) Definitions. The following definitions apply for purposes of this paragraph
(c)(4):
(A) Plan coverage change. The term
plan coverage change means a change in
the group or groups of eligible employees
under a plan on account of—
(1) The establishment or amendment of
a plan;
(2) A plan merger or spinoff under section 414(l);
(3) A change in the way plans (within
the meaning of §1.410(b)–7(b)) are
combined or separated for purposes of
§1.401(k)–1(b)(4) (e.g., permissively
aggregating plans not previously aggregated under §1.410(b)–7(d), or ceasing
to permissively aggregate plans under
§1.410(b)–7(d));
(4) A reclassification of a substantial
group of employees that has the same effect as amending the plan (e.g., a transfer
of a substantial group of employees from
one 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 term
prior year subgroup means all NHCEs
for the prior plan year who, in the prior
year, were eligible employees under a
specific plan maintained by the employer
that included a qualified cash or deferred
arrangement and who would have been
eligible employees in the prior year under
the plan being tested if the plan coverage
change had first been effective as of the
first day of the prior plan year instead of
first being effective during the plan year.
The determination of whether an NHCE
is a member of a prior year subgroup is
made without regard to whether the NHCE
terminated employment during the prior
year.
(C) Weighted average of the ADPs
for the prior year subgroups. The term
weighted average of the ADPs for the
prior year subgroups means the sum, for

467

all prior year subgroups, of the adjusted
ADPs for the plan year. The term adjusted
ADP with respect to a prior year subgroup
means the ADP for the prior plan year of
the specific plan under which the members
of the prior year subgroup were eligible
employees on the first day of the prior plan
year, multiplied by a fraction, the numerator of which is the number of NHCEs in
the prior year subgroup and denominator
of which is the total number of NHCEs in
all prior year subgroups.
(iv) Examples. The following examples
illustrate the application of this paragraph
(c)(4):
Example 1. (i) Employer B maintains two
calendar year plans, Plan O and Plan P, each of
which includes a cash or deferred arrangement.
The plans were not permissively aggregated under
§1.410(b)–7(d) for the 2005 plan year. Both plans
use the prior year testing method. Plan O had 300
eligible employees who were NHCEs for the 2005
plan year, and their ADP for that year was 6%.
Sixty of the eligible employees who were NHCEs
for the 2005 plan year under Plan O, terminated
their employment during that year. Plan P had 100
eligible employees who were NHCEs for 2005, and
the 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 and
Plan P for the 2006 plan year under § 1.410(b)–7(d)
is a plan coverage change that results in treating
the plans as one plan (Plan OP) for purposes of
§1.401(k)–1(b)(4). Therefore, the prior year ADP
for the NHCEs under Plan OP for the 2006 plan year
is the weighted average of the ADPs for the prior
year subgroups: the Plan O prior year subgroup and
the Plan P prior year subgroup.
(iii) The Plan O prior year subgroup consists of
the 300 employees who, in the 2005 plan year, were
eligible NHCEs under Plan O and who would have
been eligible under Plan OP for the 2005 plan year if
Plan O and Plan P had been permissively aggregated
for that plan year. The Plan P prior year subgroup
consists of the 100 employees who, in the 2005 plan
year, were eligible NHCEs under Plan P and would
have been eligible under Plan OP for the 2005 plan
year if Plan O and Plan P had been permissively aggregated for that plan year.
(iv) The weighted average of the ADPs for the
prior year subgroups is the sum of the adjusted ADP
for the Plan O prior year subgroup and the adjusted
ADP for the Plan P prior year subgroup. The adjusted
ADP for the Plan O prior year subgroup is 4.5%, calculated as follows: 6% (the ADP for the NHCEs under Plan O for the 2005 plan year) x 300/400 (the
number of NHCEs in the Plan O prior year subgroup
divided by the total number of NHCEs in all prior year
subgroups). The adjusted ADP for the Plan P prior
year subgroup is 1%, calculated as follows: 4% (the
ADP for the NHCEs under Plan P for the 2005 plan
year) x 100/400 (the number of NHCEs in the Plan
P prior year subgroup divided by the total number of
NHCEs in all prior year subgroups). Thus, the prior
year ADP for NHCEs under Plan OP for the 2006

2003-35 I.R.B.

plan year is 5.5% (the sum of adjusted ADPs for the
prior year subgroups, 4.5% plus 1%).
(v) As provided in paragraph (c)(4)(iii)(B) of this
section, the determination of whether an NHCE is
a member of a prior year subgroup is made without
regard to whether that NHCE terminated employed
during the prior year. Thus, the prior ADP for the
NHCEs under Plan OP for the 2006 plan year is unaffected by the termination of the 60 NHCEs covered
by Plan O during the 2005 plan year.
Example 2. (i) The facts are the same as Example
1, except that the 60 employees who terminated employment during the 2005 plan are instead spun-off to
another plan.
(ii) The permissive aggregation of Plan O and
Plan P for the 2006 plan year under §1.410(b)–7(d)
is a plan coverage change that results in treating
the plans as one plan (Plan OP) for purposes of
§1.401(k)–1(b)(4) and the spin-off of the 60 employees is a plan coverage change. Therefore, the prior
year ADP for the NHCEs under Plan OP for the 2006
plan year is the weighted average of the ADPs for the
prior year subgroups: the Plan O prior year subgroup
and the Plan P prior year subgroup.
(iii) For purposes of determining the prior year
subgroups, the employees who would have been eligible employees in the prior year under the plan being tested are determined as if both plan coverage
changes had first been effective as of the first day
of the prior plan year. The Plan O prior year subgroup consists of the 240 employees who, in the 2005
plan year, were eligible NHCEs under Plan O and
would have been eligible under Plan OP for the 2005
plan year if the spin-off had occurred at the beginning of the 2005 plan year and Plan O and Plan P had
been permissively aggregated under §1.410(b)–7(d)
for that plan year. The Plan P prior year subgroup
consists of the 100 employees who, in the 2005 plan
year, were eligible NHCEs under Plan P and would
have been eligible under Plan OP for the 2005 plan
year if Plan O and Plan P had been permissively aggregated under §1.410(b)–7(d) for that plan year.
(iv) The weighted average of the ADPs for the
prior year subgroups is the sum of the adjusted ADP
with respect to the prior year subgroup consisting of
eligible NHCEs from Plan O and the adjusted ADP
with respect to the prior year subgroup consisting of
eligible NHCEs from Plan P. The adjusted ADP for
the prior year subgroup consisting of eligible NHCEs
under Plan O is 4.23%, calculated as follows: 6% (the
ADP for the NHCEs under Plan O for the 2005 plan
year) x 240/340 (the number of NHCEs in that prior
year subgroup divided by the total number of NHCEs
in all prior year subgroups). The adjusted ADP for the
prior year subgroup consisting of the eligible NHCEs
from Plan P is 1.18%, calculated as follows: 4% (the
ADP for the NHCEs under Plan P for the 2005 plan
year) x 100/340 (the number of NHCEs in that prior
year subgroup divided by the total number of NHCEs
in all prior year subgroups). Thus, the prior year ADP
for NHCEs under Plan OP for the 2006 plan year is
5.41% (the sum of adjusted ADPs for the prior year
subgroups, 4.23% plus 1.18%).
Example 3. (i) The facts are the same as in Example 1, except that instead of Plan O and Plan P being
permissively aggregated for the 2006 plan year, 200
of the employees eligible under Plan O were spun-off
from Plan O and merged into Plan P.

2003-35 I.R.B.

(ii) The spin-off from Plan O and merger to Plan P
for the 2006 plan year are plan coverage changes for
Plan P. Therefore, the prior year ADP for the NHCEs
under Plan P for the 2006 plan year is the weighted
average of the ADPs for the prior year subgroups under Plan P. There are 2 subgroups under Plan P for
the 2006 plan year. The Plan O prior year subgroup
consists of the 200 employees who, in the 2005 plan
year, were eligible NHCEs under Plan O and who
would have been eligible under Plan P for the 2005
plan year if the spin-off and merger had occurred on
the first day of the 2005 plan year. The Plan P prior
year subgroup consists of the 100 employees who, in
the 2005 plan year, were eligible NHCEs under Plan
P for the 2005 plan year.
(iii) The weighted average of the ADPs for the
prior year subgroups is the sum of the adjusted ADP
for the Plan O prior year subgroup and the adjusted
ADP for the Plan P prior year subgroup. The adjusted
ADP for the Plan O prior year subgroup is 4.0%, calculated as follows: 6% (the ADP for the NHCEs under Plan O for the 2005 plan year) x 200/300 (the
number of NHCEs in the Plan O prior year subgroup
divided by the total number of NHCEs in all prior year
subgroups). The adjusted ADP for the Plan P prior
year subgroup is 1.33%, calculated as follows: 4%
(the ADP for the NHCEs under Plan P for the 2005
plan year) x 100/300 (the number of NHCEs in the
Plan P prior year subgroup divided by the total number of NHCEs in all prior year subgroups). Thus, the
prior year ADP for NHCEs under Plan P for the 2006
plan year is 5.33% (the sum of adjusted ADPs for the
2 prior year subgroups, 4.0% plus 1.33%).
(iv) The spin-off from Plan O for the 2006 plan
year is a plan coverage change for Plan O. Therefore, the prior year ADP for the NHCEs under Plan
O for the 2006 plan year is the weighted average of
the ADPs for the prior year subgroups under Plan O.
In this case, there is only one prior year subgroup under Plan O, the employees who were NHCEs of Employer B for the 2005 plan year and who were eligible for the 2005 plan year under Plan O. Because
there is only one prior year subgroup under Plan O,
the weighted average of the ADPs for the prior year
subgroup under Plan O is equal to the NHCE ADP for
the prior year (2005 plan year) under Plan O, or 6%.
Example 4. (i) Employer C maintains a calendar
year plan, Plan Q, which includes a cash or deferred
arrangement that uses the prior year testing method.
Plan Q covers employees of Division A and Division B. In 2005, Plan Q had 500 eligible employees
who were NHCEs, and the ADP for those NHCEs for
2005 was 2%. Effective January 1, 2006, Employer
C amends the eligibility provisions under Plan Q to
exclude employees of Division B effective January 1,
2006. In addition, effective on that same date, Employer C establishes a new calendar year plan, Plan
R, which includes a cash or deferred arrangement that
uses the prior year testing method. The only eligible
employees under Plan R are the 100 employees of Division B who were eligible employees under Plan Q.
(ii) Plan R is a successor plan, within the meaning
of paragraph (c)(2)(iii) of this section (because all of
the employees were eligible employees under Plan Q
in the prior year). Therefore, Plan R cannot use the
first plan year rule set forth in paragraph (c)(2)(i) of
this section.
(iii) The amendment to the eligibility provisions
of Plan Q and the establishment of Plan R are plan

468

coverage 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 NHCE
ADP for the 2006 plan year under the rules set forth
in paragraph (c)(4) of this section.
(iv) The prior year ADP for NHCEs under Plan Q
is the weighted average of the ADPs for the prior year
subgroups. Plan Q has only one prior year subgroup
(because the only NHCEs who would have been eligible employees under Plan Q for the 2005 plan year
if the amendment to the Plan Q eligibility provisions
had occurred as of the first day of that plan year were
eligible employees under Plan Q). Therefore, for purposes of the 2006 plan year under Plan Q, the ADP
for NHCEs for the prior year is the weighted average
of the ADPs for the prior year subgroups, or 2%, the
same as if the plan amendment had not occurred.
(v) Similarly, Plan R has only one prior year subgroup (because the only NHCEs who would have
been eligible employees under Plan R for the 2005
plan year if the plan were established as of the first
day of that plan year were eligible employees under
Plan Q). Therefore, for purposes of the 2006 testing
year under Plan R, the ADP for NHCEs for the prior
year is the weighted average of the ADPs for the prior
year subgroups, or 2%, the same as that of Plan Q.
Example 5. (i) The facts are the same as in Example 4, except that the provisions of Plan R extend eligibility to 50 hourly employees who previously were
not eligible employees under any qualified cash or deferred arrangement maintained by Employer C.
(ii) Plan R is a successor plan (because 100 of
Plan R's 150 eligible employees were eligible employees under another qualified cash or deferred arrangement maintained by Employer C in the prior
year). Therefore, Plan R cannot use the first plan year
rule set forth in paragraph (c)(2)(i) of this section.
(iii) The establishment of Plan R is a plan coverage change that affects Plan R. Because the 50 hourly
employees were not eligible employees under any
qualified cash or deferred arrangement of Employer
C for the prior plan year, they do not comprise a prior
year subgroup. Accordingly, Plan R still has only one
prior year subgroup. Therefore, for purposes of the
2006 testing year under Plan R, the ADP for NHCEs
for the prior year is the weighted average of the ADPs
for the prior year subgroups, or 2%, the same as that
of Plan Q.

§1.401(k)–3 Safe harbor requirements.
(a) ADP test safe harbor. A cash or deferred arrangement satisfies the ADP safe
harbor provision of section 401(k)(12) for
a plan year if the arrangement satisfies
the safe harbor contribution requirement of
paragraph (b) or (c) of this section for the
plan year, the notice requirement of paragraph (d) of this section, the plan year requirements of paragraph (e) of this section, and the additional rules of paragraphs
(f), (g) and (h) of this section, as applicable. Pursuant to section 401(k)(12)(E)(ii),
the safe harbor contribution requirement of
paragraph (b) or (c) of this section must be
satisfied without regard to section 401(l).

September 2, 2003

The contributions made under paragraphs
(b) and (c) of this section are referred to
as safe harbor nonelective contributions
and safe harbor matching contributions, respectively.
(b) Safe harbor nonelective contribution requirement—(1) General rule. The
safe harbor nonelective contribution requirement of this paragraph is satisfied if,
under the terms of the plan, the employer
is required to make a qualified nonelective
contribution on behalf of each eligible
NHCE equal to at least 3% of the employee's safe harbor compensation.
(2) Safe harbor compensation defined. For purposes of this section, safe
harbor compensation means compensation as defined in §1.401(k)–6 (which
incorporates the definition of compensation in §1.414(s)–1); provided, however, that the rule in the last sentence of
§1.414(s)–1(d)(2)(iii) (which generally
permits a definition of compensation to
exclude all compensation in excess of a
specified dollar amount) does not apply in
determining the safe harbor compensation
of NHCEs. Thus, for example, the plan
may limit the period used to determine
safe harbor compensation to the eligible
employee's period of participation.
(c) Safe harbor matching contribution
requirement—(1) In general. The safe
harbor matching contribution requirement
of this paragraph (c) is satisfied if, under the plan, qualified matching contributions are made on behalf of each eligible NHCE in an amount determined under the basic matching formula of section 401(k)(12)(B)(i)(I), as described in
paragraph (c)(2) of this section, or under
an enhanced matching formula of section
401(k)(12)(B)(i)(II), as described in paragraph (c)(3) of this section.
(2) Basic matching formula. Under
the basic matching formula, each eligible
NHCE receives qualified matching contributions in an amount equal to the sum
of—
(i) 100% of the amount of the employee's elective contributions that do not
exceed 3% of the employee's safe harbor
compensation; and
(ii) 50% of the amount of the employee's elective contributions that exceed
3% of the employee's safe harbor compensation but that do not exceed 5% of the
employee's safe harbor compensation.

September 2, 2003

(3) Enhanced matching formula. Under an enhanced matching formula, each
eligible NHCE receives a matching contribution under a formula that, at any rate
of elective contributions by the employee,
provides an aggregate amount of qualified
matching contributions at least equal to the
aggregate amount of qualified matching
contributions that would have been provided under the basic matching formula of
paragraph (c)(2) of this section. In addition, under an enhanced matching formula,
the ratio of matching contributions on behalf of an employee under the plan for a
plan year to the employee's elective contributions may not increase as the amount
of an employee's elective contributions increases.
(4) Limitation on HCE matching contributions. The safe harbor matching contribution requirement of this paragraph (c) is
not satisfied if the ratio of matching contributions made on account of an HCE's
elective contributions under the cash or
deferred arrangement for a plan year to
those elective contributions is greater than
the ratio of matching contributions to elective contributions that would apply with
respect to any eligible NHCE with elective contributions at the same percentage
of safe harbor compensation.
(5) Use of safe harbor match not precluded by certain plan provisions—(i)
Safe harbor matching contributions on
employee contributions. The safe harbor
matching contribution requirement of this
paragraph (c) will not fail to be satisfied
merely because safe harbor matching
contributions are made on both elective
contributions and employee contributions
if safe harbor matching contributions are
made with respect to the sum of elective
contributions and employee contributions
on the same terms as safe harbor matching
contributions are made with respect to
elective contributions. Alternatively, the
safe harbor matching contribution requirement of this paragraph (c) will not fail
to be satisfied merely because safe harbor matching contributions are made on
both elective contributions and employee
contributions if safe harbor matching contributions on elective contributions are
not affected by the amount of employee
contributions.
(ii) Periodic matching contributions.
The safe harbor matching contribution
requirement of this paragraph (c) will not

469

fail to be satisfied merely because the
plan provides that safe harbor matching
contributions will be made separately with
respect to each payroll period (or with
respect to all payroll periods ending with
or within each month or quarter of a plan
year) taken into account under the plan for
the plan year, provided that safe harbor
matching contributions with respect to any
elective contributions made during a plan
year quarter are contributed to the plan by
the last day of the immediately following
plan year quarter.
(6) Permissible restrictions on elective
contributions by NHCEs—(i) General
rule. The safe harbor matching contribution requirement of this paragraph (c)
is not satisfied if elective contributions
by NHCEs are restricted, unless the restrictions are permitted by this paragraph
(c)(6).
(ii) Restrictions on election periods. A
plan may limit the frequency and duration of periods in which eligible employees may make or change cash or deferred
elections under a plan. However, an employee must have a reasonable opportunity
(including a reasonable period after receipt
of the notice described in paragraph (d) of
this section) to make or change a cash or
deferred election for the plan year. For purposes of this paragraph (c)(6)(ii), a 30-day
period is deemed to be a reasonable period
to make or change a cash or deferred election.
(iii) Restrictions on amount of elective
contributions. A plan is permitted to limit
the amount of elective contributions that
may be made by an eligible employee
under a plan, provided that each NHCE
who is an eligible employee is permitted
(unless the employee is restricted under
paragraph (c)(6)(v) of this section) to
make elective contributions in an amount
that is at least sufficient to receive the maximum amount of matching contributions
available under the plan for the plan year,
and the employee is permitted to elect any
lesser amount of elective contributions.
However, a plan may require eligible employees to make cash or deferred elections
in whole percentages of compensation or
whole dollar amounts.
(iv) Restrictions on types of compensation that may be deferred. A plan may
limit the types of compensation that may
be deferred by an eligible employee under
a plan, provided that each eligible NHCE

2003-35 I.R.B.

is permitted to make elective contributions under a definition of compensation
that would be a reasonable definition
of compensation within the meaning of
§1.414(s)–1(d)(2). Thus, the definition of
compensation from which elective contributions may be made is not required to
satisfy the nondiscrimination requirement
of §1.414(s)–1(d)(3).
(v) Restrictions due to limitations under the Internal Revenue Code. A plan
may limit the amount of elective contributions made by an eligible employee under
a plan—
(A) Because of the limitations of section 402(g) or section 415; or
(B) Because, on account of a hardship distribution, an employee's ability
to make elective contributions has been
suspended for 6 months in accordance
with §1.401(k)–1(d)(3)(iv)(E).
(7) Examples. The following examples
illustrate the safe harbor contribution requirement of this paragraph (c):
Example 1. (i) Beginning January 1, 2006,
Employer A maintains Plan L covering employees
(including HCEs and NHCEs) in Divisions D and E.
Plan L contains a cash or deferred arrangement and
provides qualified matching contributions equal to
100% of each eligible employee's elective contributions up to 3% of compensation and 50% of the next
2% of compensation. For purposes of the matching
contribution formula, safe harbor compensation is
defined as all compensation within the meaning of
section 415(c)(3) (a definition that satisfies section
414(s)). Also, each employee is permitted to make
elective contributions from all safe harbor compensation within the meaning of section 415(c)(3)
and may change a cash or deferred election at any
time. Plan L limits the amount of an employee's
elective contributions for purposes of section 402(g)
and section 415, and, in the case of a hardship
distribution, suspends an employee's ability to make
elective contributions for 6 months in accordance
with §1.401(k)–1(d)(3)(iv)(E). All contributions
under Plan L are nonforfeitable and are subject to the
withdrawal restrictions of section 401(k)(2)(B). Plan
L provides for no other contributions and Employer
A maintains no other plans. Plan L is maintained on
a calendar-year basis and all contributions for a plan
year are made within 12 months after the end of the
plan year.
(ii) Based on these facts, matching contributions
under Plan L are safe harbor matching contributions
because they are qualified matching contributions
equal to the basic matching formula. Accordingly,
Plan L satisfies the safe harbor contribution requirement of this paragraph (c).
Example 2. (i) The facts are the same as in Example 1, except that instead of providing a basic matching contribution, Plan L provides a qualified matching contribution equal to 100% of each eligible employee's elective contributions up to 4% of safe harbor
compensation.

2003-35 I.R.B.

(ii) Plan L's formula is an enhanced matching formula because each eligible NHCE receives safe harbor matching contributions at a rate that, at any rate of
elective contributions, provides an aggregate amount
of qualified matching contributions at least equal to
the aggregate amount of qualified matching contributions that would have been received under the basic
safe harbor matching formula, and the rate of matching contributions does not increase as the rate of an
employee's elective contributions increases. Accordingly, Plan L satisfies the safe harbor contribution requirement of this paragraph (c).
Example 3. (i) The facts are the same as in Example 1, except that instead of permitting each employee
to make elective contributions from all compensation
within the meaning of section 415(c)(3), each employee's elective contributions under Plan L are limited to 15% of the employee's “basic compensation.”
Basic compensation is defined under Plan L as compensation within the meaning of section 415(c)(3),
but excluding overtime pay.
(ii) The definition of basic compensation under
Plan L is a reasonable definition of compensation
within the meaning of §1.414(s)–1(d)(2).
(iii) Plan L will not fail to satisfy the safe harbor
contribution requirement of this paragraph (c) merely
because Plan L limits the amount of elective contributions and the types of compensation that may be
deferred by eligible employees, provided that each eligible NHCE may make elective contributions equal
to at least 4% of the employee's safe harbor compensation.
Example 4. (i) The facts are the same as in Example 1, except that Plan L provides that only employees
employed on the last day of the plan year will receive
a safe harbor matching contribution.
(ii) Even if the plan that provides for employee
contributions and matching contributions satisfies the
minimum coverage requirements of section 410(b)(1)
taking into account this last-day requirement, Plan L
would not satisfy the safe harbor contribution requirement of this paragraph (c) because safe harbor matching contributions are not made on behalf of all eligible
NHCEs who make elective contributions.
(iii) The result would be the same if, instead of
providing safe harbor matching contributions under
an enhanced formula, Plan L provides for a 3% safe
harbor nonelective contribution that is restricted to eligible employees under the cash or deferred arrangement who are employed on the last day of the plan
year.
Example 5. (i) The facts are the same as in Example 1, except that instead of providing qualified
matching contributions under the basic matching formula to employees in both Divisions D and E, employees in Division E are provided qualified matching contributions under the basic matching formula,
while safe harbor matching contributions continue to
be provided to employees in Division D under the enhanced matching formula described in Example 2.
(ii) Even if Plan L satisfies §1.401(a)(4)–4 with
respect to each rate of matching contributions available to employees under the plan, the plan would fail
to satisfy the safe harbor contribution requirement of
this paragraph (c) because the rate of matching contributions with respect to HCEs in Division D at a rate
of elective contributions between 3% and 5% would
be greater than that with respect to NHCEs in Division E at the same rate of elective contributions. For

470

example, an HCE in Division D who would have a
4% rate of elective contributions would have a rate
of matching contributions of 100% while an NHCE
in Division E who would have the same rate of elective contributions would have a lower rate of matching contributions.

(d) Notice requirement—(1) General
rule. The notice requirement of this paragraph (d) is satisfied for a plan year if each
eligible employee is given written notice
of the employee's rights and obligations
under the plan and the notice satisfies the
content requirement of paragraph (d)(2) of
this section and the timing requirement of
paragraph (d)(3) of this section.
(2) Content requirement—(i) General
rule. The content requirement of this paragraph (d)(2) is satisfied if the notice is—
(A) Sufficiently accurate and comprehensive to inform the employee of the employee's rights and obligations under the
plan; and
(B) Written in a manner calculated to be
understood by the average employee eligible to participate in the plan.
(ii) Minimum content requirement.
Subject to the requirements of paragraph
(d)(2)(iii) of this section, a notice is not
considered sufficiently accurate and comprehensive unless the notice accurately
describes—
(A) The safe harbor matching contribution or safe harbor nonelective contribution formula used under the plan (including a description of the levels of safe harbor matching contributions, if any, available under the plan);
(B) Any other contributions under the
plan or matching contributions to another
plan on account of elective contributions
or employee contributions under the plan
(including the potential for discretionary
matching contributions) and the conditions
under which such contributions are made;
(C) The plan to which safe harbor contributions will be made (if different than
the plan containing the cash or deferred arrangement);
(D) The type and amount of compensation that may be deferred under the plan;
(E) How to make cash or deferred
elections, including any administrative
requirements that apply to such elections;
(F) The periods available under the plan
for making cash or deferred elections;
(G) Withdrawal and vesting provisions
applicable to contributions under the plan;
and

September 2, 2003

(H) Information that makes it easy
to obtain additional information about
the plan (including an additional copy
of the summary plan description) such
as telephone numbers, addresses and, if
applicable, electronic addresses, of individuals or offices from whom employees
can obtain such plan information.
(iii) References to SPD. A plan will not
fail to satisfy the content requirements of
this paragraph (d)(2) merely because, in
the case of information described in paragraph (d)(2)(ii)(B) of this section (relating to any other contributions under the
plan), paragraph (d)(2)(ii)(C) of this section (relating to the plan to which safe harbor contributions will be made) or paragraph (d)(2)(ii)(D) of this section (relating
to the type and amount of compensation
that may be deferred under the plan), the
notice cross-references the relevant portions of a summary plan description that
provides the same information that would
be provided in accordance with such paragraphs and that has been provided (or is
concurrently provided) to employees.
(3) Timing requirement—(i) General
rule. The timing requirement of this
paragraph (d)(3) is satisfied if the notice
is provided within a reasonable period
before the beginning of the plan year (or,
in the year an employee becomes eligible, within a reasonable period before
the employee becomes eligible). The determination of whether a notice satisfies
the timing requirement of this paragraph
(d)(3) is based on all of the relevant facts
and circumstances.
(ii) Deemed satisfaction of timing requirement. The timing requirement of this
paragraph (d)(3) is deemed to be satisfied
if at least 30 days (and no more than 90
days) before the beginning of each plan
year, the notice is given to each eligible
employee for the plan year. In the case of
an employee who does not receive the notice within the period described in the previous sentence because the employee becomes eligible after the 90th day before
the beginning of the plan year, the timing requirement is deemed to be satisfied
if the notice is provided no more than 90
days before the employee becomes eligible (and no later than the date the employee becomes eligible). Thus, for example, the preceding sentence would apply in the case of any employee eligible

September 2, 2003

for the first plan year under a newly established plan that provides for elective contributions, or would apply in the case of the
first plan year in which an employee becomes eligible under an existing plan that
provides for elective contributions.
(e) Plan year requirement—(1) General rule. Except as provided in this paragraph (e) or in paragraph (f) of this section,
a plan will fail to satisfy the requirements
of section 401(k)(12) and this section unless plan provisions that satisfy the rules of
this section are adopted before the first day
of the plan year and remain in effect for
an entire 12-month plan year. Moreover,
if, as described under paragraph (g)(4) of
this section, safe harbor matching or nonelective contributions will be made to another plan for a plan year, provisions specifying that the safe harbor contributions will
be made in the other plan and providing
that the contributions will be QNECs or
QMACs must also be adopted before the
first day of that plan year.
(2) Initial plan year. A newly established plan (other than a successor
plan within the meaning of §1.401(k)–
2(c)(2)(iii)) will not be treated as violating the requirements of this paragraph
(e) merely because the plan year is less
than 12 months, provided that the plan
year is at least 3 months long (or, in the
case of a newly established employer that
establishes the plan as soon as administratively feasible after the employer comes
into existence, a shorter period). Similarly, a cash or deferred arrangement will
not fail to satisfy the requirement of this
paragraph (e) if it is added to an existing
profit sharing, stock bonus, or pre-ERISA
money purchase pension plan for the first
time during that year provided that—
(i) The plan is not a successor plan; and
(ii) The cash or deferred arrangement is
made effective no later than 3 months prior
to the end of the plan year.
(3) Change of plan year. A plan that
has a short plan year as a result of changing
its plan year will not fail to satisfy the requirements of paragraph (e)(1) of this section merely because the plan year has less
than 12 months, provided that—
(i) The plan satisfied the requirements
of this section for the immediately preceding plan year; and
(ii) The plan satisfies the requirements
of this section for the immediately following plan year.

471

(4) Final plan year. A plan that terminates during a plan year will not fail to satisfy the requirements of paragraph (e)(1)
of this section merely because the final
plan year is less than 12 months, provided
that—
(i) The plan would satisfy the requirements of paragraph (g) of this section,
treating the termination of the plan as a
reduction or suspension of safe harbor
matching contributions, other than the
requirement that employees have a reasonable opportunity to change their cash
or deferred elections and, if applicable,
employee contribution elections; or
(ii) The plan termination is in connection with a transaction described in section
410(b)(6)(C) or the employer incurs a substantial business hardship comparable to a
substantial business hardship described in
section 412(d).
(f) Plan amendments adopting safe
harbor nonelective contributions—(1)
General rule. Notwithstanding paragraph
(e)(1) of this section, a plan that provides
for the use of the current year testing
method may be amended after the first
day of the plan year and no later than 30
days before the last day of the plan year to
adopt the safe harbor method of this section using nonelective contributions under
paragraph (b) of this section, but only
if the plan provides the contingent and
follow-up notices described in this section. A plan amendment made pursuant
to this paragraph (f)(1) for a plan year
may provide for the use of the safe harbor
method described in this section solely for
that plan year and a plan sponsor is not
limited in the number of years for which it
is permitted to adopt an amendment providing for the safe harbor method of this
section using nonelective contributions
under paragraph (b) of this section.
(2) Contingent notice provided. A plan
satisfies the requirement to provide the
contingent notice under this paragraph
(f)(2) if it provides a notice that would satisfy the requirements of paragraph (d) of
this section, except that, in lieu of setting
forth the safe harbor contributions used
under the plan as set forth in paragraph
(d)(2)(ii)(A) of this section, the notice
specifies that the plan may be amended
during the plan year to include the safe
harbor nonelective contribution and that,
if the plan is amended, a follow-up notice
will be provided.

2003-35 I.R.B.

(3) Follow-up notice requirement. A
plan satisfies the requirement to provide
a follow-up notice under this paragraph
(f)(3) if, no later than 30 days before the
last day of the plan year, each eligible employee is given a notice that states that the
safe harbor nonelective contributions will
be made for the plan year. This notice
is permitted to be combined with a contingent notice provided under paragraph
(f)(2) of this section for the next plan year.
(g) Permissible reduction or suspension
of safe harbor matching contributions —
(1) General rule. A plan that provides for
safe harbor matching contributions will not
fail to satisfy the requirements of section
401(k)(3) for a plan year merely because
the plan is amended during a plan year to
reduce or suspend safe harbor matching
contributions on future elective contributions (and, if applicable, employee contributions) provided that—
(i) All eligible employees are provided
the supplemental notice in accordance
with paragraph (g)(2) of this section;
(ii) The reduction or suspension of safe
harbor matching contributions is effective
no earlier than the later of 30 days after
eligible employees are provided the notice described in paragraph (g)(2) of this
section and the date the amendment is
adopted;
(iii) Eligible employees are given a reasonable opportunity (including a reasonable period after receipt of the supplemental notice) prior to the reduction or suspension of safe harbor matching contributions
to change their cash or deferred elections
and, if applicable, their employee contribution elections;
(iv) The plan is amended to provide that
the ADP test will be satisfied for the entire
plan year in which the reduction or suspension occurs using the current year testing
method described in §1.401(k)–2(a)(2)(ii);
and
(v) The plan satisfies the requirements
of this section (other than this paragraph
(g)) with respect to amounts deferred
through the effective date of the amendment.
(2) Notice of suspension requirement.
The notice of suspension requirement of
this paragraph (g)(2) is satisfied if each
eligible employee is given a written notice
that explains—

2003-35 I.R.B.

(i) The consequences of the amendment
which reduces or suspends matching contributions on future elective contributions
and, if applicable, employee contributions;
(ii) The procedures for changing their
cash or deferred election and, if applicable,
their employee contribution elections; and
(iii) The effective date of the amendment.
(h) Additional rules—(1) Contributions
taken into account. A contribution is taken
into account for purposes of this section
for a plan year if and only if the contribution would be taken into account for such
plan year under the rules of §1.401(k)–2(a)
or 1.401(m)–2(a). Thus, for example, a
safe harbor matching contribution must be
made within 12 months of the end of the
plan year. Similarly, an elective contribution that would be taken into account for a
plan year under §1.401(k)–2(a)(4)(i)(B)(2)
must be taken into account for such plan
year for purposes of this section, even if the
compensation would have been received
after the close of the plan year.
(2) Use of safe harbor nonelective
contributions to satisfy other nondiscrimination tests. A safe harbor nonelective
contribution used to satisfy the nonelective contribution requirement under
paragraph (b) of this section may also be
taken into account for purposes of determining whether a plan satisfies section
401(a)(4). Thus, these contributions are
not subject to the limitations on qualified nonelective contributions under
§1.401(k)–2(a)(6)(ii), but are subject to
the rules generally applicable to nonelective contributions under section 401(a)(4).
See §1.401(a)(4)–1(b)(2)(ii). However,
pursuant to section 401(k)(12)(E)(ii), to
the extent they are needed to satisfy the
safe harbor contribution requirement of
paragraph (b) of this section, safe harbor nonelective contributions may not
be taken into account under any plan for
purposes of section 401(l) (including the
imputation of permitted disparity under
§1.401(a)(4)–7).
(3) Early participation rules. Section
401(k)(3)(F) and §1.401(k)–2(a)(1)(iii)(A),
which provide an alternative nondiscrimination rule for certain plans that
provide for early participation, do not
apply for purposes of section 401(k)(12)
and this section. Thus, a plan is not
treated as satisfying this section with
respect to the eligible employees who

472

have not completed the minimum age
and service requirements of section
410(a)(1)(A) unless the plan satisfies the
requirements of this section with respect
to such eligible employees.
(4) Satisfying safe harbor contribution
requirement under another defined contribution plan. Safe harbor matching or nonelective contributions may be made to the
plan that contains the cash or deferred arrangement or to another defined contribution plan that satisfies section 401(a) or
403(a). If safe harbor contributions are
made to another defined contribution plan,
the safe harbor plan must specify the plan
to which the safe harbors are made and
contribution requirement of paragraph (b)
or (c) of this section must be satisfied in
the other defined contribution plan in the
same manner as if the contributions were
made to the plan that contains the cash or
deferred arrangement. Consequently, the
plan to which the contributions are made
must have the same plan year as the plan
containing the cash and deferred arrangement and each employee eligible under the
plan containing the cash or deferred arrangement must be eligible under the same
conditions under the other defined contribution plan. The plan to which the safe
harbor contributions are made need not be
a plan that can be aggregated with the plan
that contains the cash or deferred arrangement.
(5) Contributions used only once. Safe
harbor matching or nonelective contributions cannot be used to satisfy the requirements of this section with respect to more
than one plan.
§1.401(k)–4 SIMPLE 401(k) plan
requirements.
(a) General rule. A cash or deferred
arrangement satisfies the SIMPLE 401(k)
plan provision of section 401(k)(11) for a
plan year if the arrangement satisfies the
requirements of paragraphs (b) through (i)
of this section for that year. A plan that
contains a cash or deferred arrangement
that satisfies this section is referred to as
a SIMPLE 401(k) plan. Pursuant to section 401(k)(11), a SIMPLE 401(k) plan is
treated as satisfying the ADP test of section 401(k)(3)(A)(ii) for that year.
(b) Eligible employer—(1) General
rule. A SIMPLE 401(k) plan must be

September 2, 2003

established by an eligible employer. Eligible employer for purposes of this section
means, with respect to any plan year,
an employer that had no more than 100
employees who received at least $5,000
of SIMPLE compensation, as defined in
paragraph (e)(5) of this section, from the
employer for the prior calendar year.
(2) Special rule. An eligible employer
that establishes a SIMPLE 401(k) plan for
a plan year and that fails to be an eligible employer for any subsequent plan year,
is treated as an eligible employer for the
2 plan years following the last plan year
the employer was an eligible employer. If
the failure is due to any acquisition, disposition, or similar transaction involving an
eligible employer, the preceding sentence
applies only if the provisions of section
410(b)(6)(C)(i) are satisfied.
(c) Exclusive plan—(1) General rule.
The SIMPLE 401(k) plan must be the exclusive plan for each SIMPLE 401(k) plan
participant for the plan year. This requirement is satisfied if there are no contributions made, or benefits accrued, for services during the plan year on behalf of
any SIMPLE 401(k) plan participant under any other qualified plan maintained by
the employer. Other qualified plan for purposes of this section means any plan, contract, pension, or trust described in section
219(g)(5)(A) or (B).
(2) Special rule. A SIMPLE 401(k)
plan will not be treated as failing the requirements of this paragraph (c) merely
because any SIMPLE 401(k) plan participant receives an allocation of forfeitures
under another plan of the employer.
(d) Election and notice—(1) General
rule. An eligible employer establishing or
maintaining a SIMPLE 401(k) plan must
satisfy the election and notice requirements in paragraphs (d)(2) and (d)(3) of
this section.
(2) Employee elections—(i) Initial plan
year of participation. For the plan year in
which an employee first becomes eligible
under the SIMPLE 401(k) plan, the employee must be permitted to make a cash
or deferred election under the plan during
a 60-day period that includes either the day
the employee becomes eligible or the day
before.
(ii) Subsequent plan years. For each
subsequent plan year, each eligible employee must be permitted to make or modify his cash or deferred election during the

September 2, 2003

60-day period immediately preceding such
plan year.
(iii) Election to terminate. An eligible
employee must be permitted to terminate
his cash or deferred election at any time.
If an employee does terminate his cash or
deferred election, the plan is permitted to
provide that such employee cannot have
elective contributions made under the plan
for the remainder of the plan year.
(3) Employee notices. The employer
must notify each eligible employee within
a reasonable time prior to each 60-day
election period, or on the day the election
period starts, that he or she can make a cash
or deferred election, or modify a prior election, if applicable, during that period. The
notice must state whether the eligible employer will make the matching contributions described in paragraph (e)(3) of this
section or the nonelective contributions described in paragraph (e)(4) of this section.
(e) Contributions—(1) General rule.
A SIMPLE 401(k) plan satisfies the contribution requirements of this paragraph
(e) for a plan year only if no contributions
may be made to the SIMPLE 401(k) plan
during such year, other than contributions
described in this paragraph (e) and rollover
contributions described in §1.402(c)–2,
Q&A–1(a).
(2) Elective contributions. Subject to
the limitations on annual additions under section 415, each eligible employee
must be permitted to make an election
to have up to $10,000 of elective contributions made on the employee's behalf
under the SIMPLE 401(k) plan for a plan
year. The $10,000 limit is increased beginning in 2006 in the same manner as
the $160,000 amount is adjusted under
section 415(d), except that pursuant to
section 408(p)(2)(E)(ii) the base period
shall be the calendar quarter beginning
July 1, 2004, and any increase which is
not a multiple of $500 is rounded to the
next lower multiple of $500.
(3) Matching contributions. Each plan
year, the eligible employer must contribute
a matching contribution to the account of
each eligible employee on whose behalf
elective contributions were made for the
plan year. The amount of the matching
contribution must equal the lesser of the
eligible employee's elective contributions
for the plan year or 3% of the eligible employee's SIMPLE compensation for the entire plan year.

473

(4) Nonelective contributions. For any
plan year, in lieu of contributing matching
contributions described in paragraph (e)(3)
of this section, an eligible employer may,
in accordance with plan terms, contribute a
nonelective contribution to the account of
each eligible employee in an amount equal
to 2% of the eligible employee's SIMPLE
compensation for the entire plan year. The
eligible employer may limit the nonelective contributions to those eligible employees who received at least $5,000 of SIMPLE compensation from the employer for
the entire plan year.
(5) SIMPLE compensation. Except
as otherwise provided, the term SIMPLE
compensation for purposes of this section
means the sum of wages, tips, and other
compensation from the eligible employer
subject to federal income tax withholding
(as described in section 6051(a)(3)) and
the employee's elective contributions made
under any other plan, and if applicable,
elective deferrals under a section 408(p)
SIMPLE IRA plan, a section 408(k)(6)
SARSEP, or a plan or contract that satisfies the requirements of section 403(b),
and compensation deferred under a section
457 plan, required to be reported by the
employer on Form W–2 (as described in
section 6051(a)(8)). For self-employed individuals, SIMPLE compensation means
net earnings from self-employment determined under section 1402(a) prior to
subtracting any contributions made under
the SIMPLE 401(k) plan on behalf of the
individual.
(f) Vesting. All benefits attributable to
contributions described in paragraph (e) of
this section must be nonforfeitable at all
times.
(g) Plan year. The plan year of a SIMPLE 401(k) plan must be the whole calendar year. Thus, in general, a SIMPLE
401(k) plan can be established only on January 1 and can be terminated only on December 31. However, in the case of an
employer that did not previously maintain
a SIMPLE 401(k) plan, the establishment
date can be as late as October 1 (or later in
the case of an employer that comes into existence after October 1 and establishes the
SIMPLE 401(k) plan as soon as administratively feasible after the employer comes
into existence).
(h) Other rules. A SIMPLE 401(k) plan
is not treated as a top-heavy plan under
section 416. See section 416(g)(4)(G).

2003-35 I.R.B.

§1.401(k)–5 Special rules for mergers,
acquisitions and similar events.
[Reserved].
§1.401(k)–6 Definitions.
Unless otherwise provided, the definitions of this section govern for purposes of
section 401(k) and the regulations thereunder.
Actual contribution percentage (ACP)
test. Actual contribution percentage test
or ACP test means the test described in
§1.401(m)–2(a)(1).
Actual deferral percentage (ADP). Actual deferral percentage or ADP means the
ADP of the group of eligible employees as
defined in §1.401(k)–2(a)(2).
Actual deferral percentage (ADP)
test. Actual deferral percentage test or
ADP test means the test described in
§1.401(k)–2(a)(1).
Actual deferral ratio (ADR). Actual
deferral ratio or ADR means the ADR
of an eligible employee as defined in
§1.401(k)–2(a)(3).
Cash or deferred arrangement. Cash
or deferred arrangement is defined in
§1.401(k)–1(a)(2).
Cash or deferred election.
Cash
or deferred election is defined in
§1.401(k)–1(a)(3).
Compensation. Compensation means
compensation as defined in section 414(s)
and §1.414(s)–1. The period used to determine an employee's compensation for
a plan year must be either the plan year
or the calendar year ending within the
plan year. Whichever period is selected
must be applied uniformly to determine
the compensation of every eligible employee under the plan for that plan year.
A plan may, however, limit the period
taken into account under either method
to that portion of the plan year or calendar year in which the employee was
an eligible employee, provided that this
limit is applied uniformly to all eligible
employees under the plan for the plan
year. In the case of an HCE whose ADR
is determined under §1.401(k)–2(a)(3)(ii),
period of participation includes periods under another plan for which elective contributions are aggregated under
§1.401(k)–2(a)(3)(ii). See also section
401(a)(17) and §1.401(a)(17)–1(c)(1).
Current year testing method. Current
year testing method means the testing

2003-35 I.R.B.

method described in §1.401(k)–2(a)(2)(ii)
or §1.401(m)–2(a)(2)(ii) under which the
applicable year is the current plan year.
Elective contributions. Elective contributions means employer contributions
made to a plan pursuant to a cash or deferred election under a cash or deferred
arrangement (whether or not the arrangement is a qualified cash or deferred arrangement under §1.401(k)–1(a)(4)).
Eligible employee—(1) General rule.
Eligible employee means an employee who
is directly or indirectly eligible to make a
cash or deferred election under the plan for
all or a portion of the plan year. For example, if an employee must perform purely
ministerial or mechanical acts (e.g., formal
application for participation or consent to
payroll withholding) in order to be eligible
to make a cash or deferred election for a
plan year, the employee is an eligible employee for the plan year without regard to
whether the employee performs the acts.
(2) Conditions on eligibility. An employee who is unable to make a cash or
deferred election because the employee
has not contributed to another plan is
also an eligible employee. By contrast,
if an employee must perform additional
service (e.g., satisfy a minimum period
of service requirement) in order to be eligible to make a cash or deferred election
for a plan year, the employee is not an
eligible employee for the plan year unless
the service is actually performed. See
§1.401(k)–1(e)(5), however, for certain
limits on the use of minimum service requirements. An employee who would be
eligible to make elective contributions but
for a suspension due to a distribution, a
loan, or an election not to participate in the
plan, is treated as an eligible employee for
purposes of section 401(k)(3) for a plan
year even though the employee may not
make a cash or deferred election by reason
of the suspension. Finally, an employee
does not fail to be treated as an eligible
employee merely because the employee
may receive no additional annual additions
because of section 415(c)(1).
(3) Certain one-time elections. An employee is not an eligible employee merely
because the employee, upon commencing
employment with the employer or upon the
employee's first becoming eligible to make
a cash or deferred election under any arrangement of the employer, is given the

474

one-time opportunity to elect, and the employee does in fact elect, not to be eligible to make a cash or deferred election under the plan or any other plan maintained
by the employer (including plans not yet
established) for the duration of the employee's employment with the employer.
This rule applies in addition to the rules
in §1.401(k)–1(a)(3)(v) relating to the definition of a cash or deferred election. In
no event is an election made after December 23, 1994, treated as a one-time irrevocable election under this paragraph if
the election is made by an employee who
previously became eligible under another
plan (whether or not terminated) of the employer.
Eligible HCE. Eligible HCE means an
eligible employee who is an HCE.
Eligible NHCE. Eligible NHCE means
an eligible employee who is not an HCE.
Employee. Employee means an employee within the meaning of §1.410(b)–9.
Employee stock ownership plan
(ESOP). Employee stock ownership plan
or ESOP means the portion of a plan
that is an ESOP within the meaning of
§1.410(b)–7(c)(2).
Employer. Employer means an employer within the meaning of §1.410(b)–9.
Excess contributions. Excess contributions means, with respect to a plan
year, the amount of total excess contributions apportioned to an HCE under
§1.401(k)–2(b)(2)(iii).
Excess deferrals.
Excess deferrals
means excess deferrals as defined in
§1.402(g)–1(e)(3).
Highly compensated employee (HCE).
Highly compensated employee or HCE has
the meaning provided in section 414(q).
Matching contributions. Matching contributions means matching contributions
as defined in §1.401(m)–1(a)(2).
Nonelective contributions. Nonelective
contributions means employer contributions (other than matching contributions)
with respect to which the employee may
not elect to have the contributions paid
to the employee in cash or other benefits
instead of being contributed to the plan.
Non-employee stock ownership plan
(non-ESOP). Non-employee stock ownership plan or non-ESOP means the portion
of a plan that is not an ESOP within the
meaning of §1.410(b)–7(c)(2).

September 2, 2003

Non-highly compensated employee
(NHCE). Non-highly compensated employee or NHCE means an employee who
is not an HCE.
Plan.
Plan is defined in
§1.401(k)–1(b)(4).
Pre-ERISA money purchase pension
plan. (1) Pre-ERISA money purchase
pension 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, included
a salary reduction agreement; and
(iii) Under which neither the employee
contributions nor the employer contributions, including elective contributions,
may exceed the levels (as a percentage of
compensation) provided for by the contribution 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 or
before that date, even if no funds had yet
been paid to the trust associated with the
plan.
Prior year testing method.
Prior
year testing method means the testing method under which the applicable year is the prior plan year, as
described in §1.401(k)–2(a)(2)(ii) or
§1.401(m)–2(a)(2)(ii).
Qualified matching contributions
(QMACs).
Qualified matching contributions or QMACs means matching
contributions that, except as provided
otherwise in §1.401(k)–1(c) and (d), satisfy the requirements of §1.401(k)–1(c)
and (d) as though the contributions were
elective contributions, without regard
to whether the contributions are actually taken into account under the ADP
test under §1.401(k)–2(a)(6) or the ACP
test under §1.401(m)–2(a)(6). Thus, the
matching contributions must satisfy the
vesting requirements of §1.401(k)–1(c)
and be subject to the distribution requirements of §1.401(k)–1(d) when they
are contributed to the plan. See also
§1.401(k)–2(b)(4)(iii) for a rule providing
that a matching contribution does not fail
to qualify as a QMAC solely because it
is forfeitable under section 411(a)(3)(G)
because it is a matching contribution with
respect to an excess deferral, excess contribution, or excess aggregate contribution.
Qualified nonelective contributions
(QNECs).
Qualified nonelective contributions or QNECs means employer

September 2, 2003

contributions, other than elective contributions or matching contributions,
that, except as provided otherwise in
§1.401(k)–1(c) and (d), satisfy the requirements of §1.401(k)–1(c) and (d)
as though the contributions were elective contributions, without regard to
whether the contributions are actually
taken into account under the ADP test
under §1.401(k)–2(a)(6) or the ACP test
under §1.401(m)–2(a)(6). Thus, the nonelective contributions must satisfy the
vesting requirements of §1.401(k)–1(c)
and be subject to the distribution requirements of §1.401(k)–1(d) when they are
contributed to the plan.
Rural cooperative plans. Rural cooperative plan means a plan described in section 401(k)(7).
Par. 3. Sections 1.401(m)–0 through
1.401(m)–2 are revised and sections
1.401(m)–3 through 1.401(m)–5 are
added to read as follows:
§1.401(m)–0 Table of contents.
This section contains first a list of section headings and then a list of the paragraphs in each section in §§1.401(m)–1
through 1.401(m)–5.
LIST OF SECTIONS
§1.401(m)–1 Employee contributions and
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. [Reserved].
§1.401(m)–5 Definitions.
LIST OF PARAGRAPHS
§1.401(m)–1 Employee contributions and
matching contributions.
(a) General nondiscrimination rules.
(1) Nondiscriminatory amount of contributions.
(i) Exclusive means of amounts testing.
(ii) Testing benefits, rights and features.
(2) Matching contributions.
(i) In general.
(ii) Employer contributions made on account of an employee contribution or elective deferral.
(iii) Employer contributions not on account of an employee contribution or
elective deferral.

475

(3) Employee contributions.
(i) In general.
(ii) Certain contributions not treated as employee contributions.
(iii) Qualified cost-of-living arrangements.
(b) Nondiscrimination requirements for
amount of contributions.
(1) Matching contributions and employee
contributions.
(2) Automatic satisfaction by certain plans.
(3) Anti-abuse provisions.
(4) Aggregation and restructuring.
(i) In general.
(ii) Aggregation of employee contributions
and matching contributions within a plan.
(iii) Aggregation of plans.
(A) In general.
(B) Arrangements with inconsistent ACP
testing methods.
(iv) Disaggregation of plans and separate
testing.
(A) In general.
(B) Restructuring prohibited.
(v) Certain disaggregation rules not applicable.
(c) Additional requirements.
(1) Separate testing for employee contributions and matching contributions.
(2) Plan provision requirement.
(d) Effective date.
§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 testing method.
(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 aggregated.
(iii) Example.
(4) Employee contributions and matching
contributions taken into account under the
ACP test.
(i) Employee contributions.
(ii) Recharacterized elective contributions.
(iii) Matching contributions.
(5) Matching contributions not taken into
account under the ACP test.

2003-35 I.R.B.

(i) General rule.
(ii) Disproportionate matching contributions.
(A) Matching contributions in excess of
100%.
(B) Representative matching rate.
(C) Definition of matching rate.
(iii) Qualified matching contributions used
to satisfy the ADP test.
(iv) Matching contributions taken into account under safe harbor provisions.
(v) Treatment of forfeited matching contributions.
(6) Qualified nonelective contributions and
elective contributions that may be taken
into account under the ACP test.
(i) Timing of allocation.
(ii) Elective contributions taken into account 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 contribution rate.
(C) Definition of applicable contribution
rate.
(vi) Contribution only used once.
(7) Examples.
(b) Correction of excess aggregate contributions.
(1) Permissible correction methods.
(i) In general.
(A) Additional contributions.
(B) Excess aggregate contributions distributed 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 each HCE.
(B) Determination of the total amount of
excess aggregate contributions.
(C) Satisfaction of ACP.
(iii) Apportionment of total amount of
excess aggregate contributions among the
HCEs.
(A) Calculate the dollar amount of excess
aggregate contributions for each HCE.
(B) Limit on amount apportioned to any
HCE.
(C) Apportionment to additional HCEs.

2003-35 I.R.B.

(iv) Income allocable to excess aggregate
contributions.
(A) General rule.
(B) Method of allocating income.
(C) Alternative method of allocating income 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 recharacterized
elective contributions.
(v) Distribution and forfeiture.
(vi) Tax treatment of corrective distributions.
(A) General rule.
(B) Rule for de minimis distributions.
(3) Other rules.
(i) No employee or spousal consent required.
(ii) Treatment of corrective distributions
and forfeited contributions as employer
contributions.
(iii) No reduction of required minimum
distribution.
(iv) Partial correction.
(v) Matching contributions on excess contributions, excess deferrals and excess aggregate contributions.
(A) Corrective distributions not permitted.
(B) Coordination with section 401(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 testing
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 methods
for the ACP and ADP test.
(4) Rules for plan coverage change.
(i) In general.
(ii) Optional rule for minor plan coverage
changes.
(iii) Definitions.
(A) Plan coverage change.
(B) Prior year subgroup.
(C) Weighted average of the ACPs for the
prior year subgroups.
(iv) Examples.

476

§1.401(m)–3 Safe harbor requirements.
(a) ACP test safe harbor.
(b) Safe harbor nonelective contribution
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 contributions.
(iv) Restrictions on types of compensation
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 nonelective
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 contributions to satisfy other nondiscrimination
tests.
(3) Early participation rules.
(4) Satisfying safe harbor contribution requirement under another defined contribution 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 and
matching contributions.
(a)
General
nondiscrimination
rules—(1) Nondiscriminatory amount
of contributions—(i) Exclusive means of

September 2, 2003

amounts testing. A defined contribution
plan does not satisfy section 401(a) for a
plan year unless the amount of employee
contributions and matching contributions
to the plan for the plan year satisfies section 401(a)(4). The amount of employee
contributions and matching contributions
under a plan satisfies the requirements of
section 401(a)(4) with respect to amounts
if and only if the amount of employee
contributions and matching contributions
satisfies the nondiscrimination test of section 401(m) under paragraph (b) of this
section and the plan satisfies the additional
requirements of paragraph (c) of this section. See §1.401(a)(4)–1(b)(2)(ii)(B).
(ii) Testing benefits, rights and features. A plan that provides for employee
contributions or matching contributions
must satisfy the requirements of section
401(a)(4) relating to benefits, rights and
features in addition to the requirement
regarding amounts described in paragraph
(a)(1)(i) of this section. For example,
the right to make each level of employee
contributions and the right to each level
of matching contributions under the plan
are benefits, rights or features subject to
the requirements of section 401(a)(4).
See §1.401(a)(4)–4(e)(3)(i) and (iii)(F)
through (G).
(2) Matching contributions—(i) In
general. For purposes of section 401(m),
this section and §§1.401(m)–2 through
1.401(m)–5, matching contributions are—
(A) Any employer contribution (including a contribution made at the employer's
discretion) to a defined contribution plan
on account of an employee contribution to
a plan maintained by the employer;
(B) Any employer contribution (including a contribution made at the employer's
discretion) to a defined contribution plan
on account of an elective deferral; and
(C) Any forfeiture allocated on the basis
of employee contributions, matching contributions, or elective deferrals.
(ii) Employer contributions made on
account of an employee contribution or
elective deferral. Whether an employer
contribution is made on account of an
employee contribution or an elective deferral is determined on the basis of all the
relevant facts and circumstances, including the relationship between the employer
contribution and employee actions outside
the plan. An employer contribution made
to a defined contribution plan on account

September 2, 2003

of contributions made by an employee
under an employer-sponsored savings
arrangement that are not held in a plan
that is intended to be a qualified plan or a
plan described in §1.402(g)–1(b) is not a
matching contribution.
(iii) Employer contributions not on account of an employee contribution or elective deferral. An employer contribution is
not a matching contribution made on account of an elective deferral if it is contributed before the cash or deferred election is made or before the employee's performance of services with respect to which
the elective deferral is made (or when the
cash that is subject to the cash or deferred
election would be currently available, if
earlier). In addition, an employer contribution is not a matching contribution made
on account of an employee contribution if
it is contributed before the employee contribution.
(3) Employee contributions—(i) In
general. For purposes of section 401(m),
this section and §§1.401(m)–2 through
1.401(m)–5, employee contributions are
contributions to a plan that are designated
or treated at the time of contribution as
after-tax employee contributions (e.g.,
by treating the contributions as taxable
income subject to applicable withholding
requirements) and are allocated to an individual account for each eligible employee
to which attributable earnings and losses
are allocated. See §1.401(k)–1(a)(2)(ii).
The term employee contributions includes—
(A) Employee contributions to the defined contribution portion of a plan described in section 414(k);
(B) Employee contributions applied to
the purchase of whole life insurance protection or survivor benefit protection under
a defined contribution plan;
(C) Amounts attributable to excess
contributions within the meaning of
section 401(k)(8)(B) that are recharacterized as employee contributions under
§1.401(k)–2(b)(3); and
(D) Employee contributions to a plan or
contract that satisfies the requirements of
section 403(b).
(ii) Certain contributions not treated as
employee contributions. The term employee contributions does not include repayment of loans, repayment of distributions described in section 411(a)(7)(C), or

477

employee contributions that are transferred
to the plan from another plan.
(iii) Qualified cost-of-living arrangements.
Employee contributions to a
qualified cost-of-living arrangement described in section 415(k)(2)(B) are treated
as employee contributions to a defined
contribution plan, without regard to the
requirement that the employee contributions be allocated to an individual account
to which attributable earnings and losses
are allocated.
(b) Nondiscrimination requirements for
amount of contributions—(1) Matching
contributions and employee contributions.
The matching contributions and employee
contributions under a plan satisfy this
paragraph (b) for a plan year only if the
plan satisfies—
(i)The ACP test of section 401(m)(2)
described in §1.401(m)–2;
(ii) The ACP safe harbor provisions
of section 401(m)(11) described in
§1.401(m)–3; or
(iii) The SIMPLE 401(k) provisions of
sections 401(k)(11) and 401(m)(10) described in §1.401(k)–4.
(2) Automatic satisfaction by certain plans. Notwithstanding paragraph
(b)(1) of this section, the requirements of
this section are treated as satisfied with
respect to employee contributions and
matching contributions under a collectively bargained plan (or the portion of
a plan) that automatically satisfies section 410(b). See §§1.401(a)(4)–1(c)(5)
and 1.410(b)–2(b)(7). Additionally, the
requirements of sections 401(a)(4) and
410(b) do not apply to a governmental plan (within the meaning of section
414(d)) maintained by a state or local government or political subdivision thereof
(or agency or instrumentality thereof). See
sections 401(a)(5)(G), 403(b)(12)(C) and
410(c)(1)(A).
(3) Anti-abuse provisions. Sections
1.401(m)–1 through 1.401(m)–5 are
designed to provide simple, practical
rules that accommodate legitimate plan
changes. At the same time, the rules are
intended to be applied by employers in a
manner that does not make use of changes
in plan testing procedures or other plan
provisions to inflate inappropriately the
ACP for NHCEs (which is used as a
benchmark for testing the ACP for HCEs)
or to otherwise manipulate the nondiscrimination testing requirements of this

2003-35 I.R.B.

paragraph (b). Further, this paragraph (b)
is part of the overall requirement that benefits or contributions not discriminate in
favor of HCEs. Therefore, a plan will not
be treated as satisfying the requirements
of this paragraph (b) if there are repeated
changes to plan testing procedures or plan
provisions that have the effect of distorting
the ACP so as to increase significantly the
permitted ACP for HCEs, or otherwise
manipulate the nondiscrimination rules of
this paragraph, if a principal purpose of
the changes was to achieve such a result.
(4) Aggregation and restructuring—(i)
In general. This paragraph (b)(4) contains the exclusive rules for aggregating
and disaggregating plans that provide for
employee contributions and matching contributions for purposes of this section and
§§1.401(m)–2 through 1.401(m)–5.
(ii) Aggregation of employee contributions and matching contributions within
a plan. Except as otherwise specifically
provided in this paragraph (b)(4) and
§1.401(m)–3(f)(1), a plan must be subject
to a single test under paragraph (b)(1) of
this section with respect to all employee
contributions and matching contributions
and all eligible employees under the
plan. Thus, for example, if two groups
of employees are eligible for matching
contributions under a plan, all employee
contributions and matching contributions
under the plan must be subject to a single
test, even if they have significantly different features, such as different rates of
match.
(iii) Aggregation of plans—(A) In
general. The term plan means a plan
within the meaning of §1.410(b)–7(a) and
(b), after application of the mandatory
disaggregation 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 example, two plans (within the meaning of
§1.410(b)–7(b)) that are treated as a single
plan pursuant to the permissive aggregation rules of §1.410(b)–7(d) are treated
as a single plan for purposes of sections
401(k) and 401(m).
(B) Arrangements with inconsistent
ACP testing methods. Pursuant to paragraph (b)(4)(ii) of this section, a single
testing method must apply with respect to
all employee contributions and matching
contributions and all eligible employees

2003-35 I.R.B.

under a plan. Thus, in applying the permissive 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 meaning
of §1.410(b)–7) that applies the current
year testing method may not be aggregated with another plan that applies the
prior year testing method. Similarly, an
employer may not aggregate a plan (within
the meaning of §1.410(b)–7) that is using
the ACP safe harbor provisions of section
401(m)(11) and another plan that is using
the ACP test of section 401(m)(2).
(iv) Disaggregation of plans and separate testing—(A) In general. If employee
contributions or matching contributions
are included in a plan (within the meaning
of §1.410(b)–7(b)) that is mandatorily
disaggregated under the rules of section
410(b) (as modified by this paragraph
(b)(4)), the matching contributions and
employee contributions under that plan
must be disaggregated in a consistent
manner. For example, in the case of
an employer that is treated as operating
qualified separate lines of business under
section 414(r), if the eligible employees
under a plan which provides for employee
contributions or matching contributions
are in more than one qualified separate line
of business, only those employees within
each qualified separate line of business
may be taken into account in determining
whether each disaggregated portion of the
plan complies with the requirements of
section 401(m), unless the employer is applying the special rule for employer-wide
plans in §1.414(r)–1(c)(2)(ii) with respect to the plan. Similarly, if a plan that
provides for employee contributions or
matching contributions under which employees are permitted to participate before
they have completed the minimum age and
service requirements of section 410(a)(1)
applies section 410(b)(4)(B) for determining whether the plan complies with section
410(b)(1), then the plan must be treated
as two separate plans, one comprising
all eligible employees who have met the
minimum age and service requirements of
section 410(a)(1) and one comprising all
eligible employees who have not met the
minimum age and service requirements of
section 410(a)(1), unless the plan is using
the rule in §1.401(m)–2(a)(1)(iii)(A).

478

(B) Restructuring prohibited. Restructuring under §1.401(a)(4)–9(c) may not
be used to demonstrate compliance with
the requirements of section 401(m). See
§1.401(a)(4)–9(c)(3)(ii).
(v) Certain disaggregation rules not
applicable.
The mandatory disaggregation rules relating to section 401(k)
plans and section 401(m) plans set forth
in §1.410(b)–7(c)(1) and to ESOP and
non-ESOP portions of a plan set forth
in §1.410(b)–7(c)(2) shall not apply for
purposes of this section and §§1.401(m)–2
through 1.401(m)–5.
Accordingly,
notwithstanding §1.410(b)–7(d)(2), an
ESOP and a non-ESOP which are different plans (within the meaning of
§1.410(b)–7(b)) are permitted to be aggregated for these purposes.
(c) Additional requirements—(1) Separate testing for employee contributions
and matching contributions.
Under
§1.410(b)–7(c)(1), the group of employees who are eligible to make employee contributions or eligible to receive
matching contributions must satisfy the
requirements of section 410(b) as if those
employees were covered under a separate
plan. The determination of whether the
separate plan satisfies the requirements
of section 410(b) must be made without
regard to the modifications to the disaggregation rules set forth in paragraph
(b)(4)(v) of this section. In addition, except as expressly permitted under section
401(k), 410(b)(2)(A)(ii), or 416(c)(2)(A),
employee contributions, matching contributions and elective contributions taken
into account under §1.401(m)–2(a)(6) may
not be taken into account for purposes of
determining whether any other contributions under any plan (including the plan
to which the employee contributions or
matching contributions are made) satisfy
the requirements of section 401(a). See
also §1.401(a)(4)–11(g)(3)(vii) for special
rules relating to corrections of violations
of the minimum coverage requirements or
discriminatory rates of matching contributions.
(2) Plan provision requirement. A
plan that provides for employee contributions or matching contributions satisfies
this section only if it provides that the
nondiscrimination requirements of section
401(m) will be met. Thus, the plan must
provide for satisfaction of one of the specific alternatives described in paragraph

September 2, 2003

(b)(1) of this section and, if with respect to
that alternative there are optional choices,
which of the optional choices will apply.
For example, a plan that uses the ACP
test of section 401(m)(2), as described in
paragraph (b)(1)(i) of this section, must
specify whether it is using the current
year testing method or prior year testing
method. Additionally, a plan that uses
the prior year testing method must specify whether the ACP for eligible NHCEs
for the first plan year is 3% or the ACP
for the eligible NHCEs for the first plan
year. Similarly, a plan that uses the safe
harbor method of section 401(m)(11), as
described in paragraph (b)(1)(ii) of this
section, must specify whether the safe
harbor contribution will be the nonelective
safe harbor contribution or the matching
safe harbor contribution and is not permitted to provide that ACP testing will
be used if the requirements for the safe
harbor are not satisfied. For purposes of
this paragraph (c)(2), a plan may incorporate by reference the provisions of section
401(m)(2) and §1.401(m)–2 if that is the
nondiscrimination test being applied.
(d) Effective date. This section and
§§1.401(m)–2 through 1.401(m)–5 apply
to plan years that begin on or after the date
that is 12 months after the issuance of these
regulations in final form.
§1.401(m)–2 ACP test.
(a) Actual contribution percentage
(ACP) test—(1) In general—(i) ACP test
formula. A plan satisfies the ACP test for
a plan year only if—
(A) The ACP for the eligible HCEs for
the plan year is not more than the ACP for
the eligible NHCEs for the applicable year
multiplied by 1.25; or
(B) The excess of the ACP for the eligible HCEs for the plan year over the ACP
for the eligible NHCEs for the applicable
year is not more than 2 percentage points,
and the ACP for the eligible HCEs for the
plan year is not more than the ACP for
the eligible NHCEs for the applicable year
multiplied by 2.
(ii) HCEs as sole eligible employees. If,
for the applicable year there are no eligible
NHCEs (i.e., all of the eligible employees
under the plan for the applicable year are
HCEs), the plan is deemed to satisfy the
ACP test.

September 2, 2003

(iii) Special rule for early participation.
If a plan providing for employee contributions or matching contributions provides
that employees are eligible to participate
before they have completed the minimum
age and service requirements of section
410(a)(1)(A), and if the plan applies section 410(b)(4)(B) in determining whether
the plan meets the requirements of section
410(b)(1), then in determining whether the
plan meets the requirements under paragraph (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 disaggregation under §1.410(b)–7(c)(3)), using the
ACP for all eligible HCEs for the plan year
and the ACP of eligible NHCEs for the applicable year, disregarding all NHCEs who
have not met the minimum age and service
requirements of section 410(a)(1)(A); or
(B) Pursuant to §1.401(m)–1(b)(4), the
plan is disaggregated into separate plans
and the ACP test is performed separately
for all eligible employees who have completed the minimum age and service requirements of section 410(a)(1)(A) and for
all eligible employees who have not completed the minimum age and service requirements of section 410(a)(1)(A).
(2) Determination of ACP—(i) General
rule. The ACP for a group of eligible employees (either eligible HCEs or eligible
NHCEs) for a plan year or applicable year
is the average of the ACRs of eligible employees in the group for that year. The
ACP for a group of eligible employees is
calculated to the nearest hundredth of a
percentage point.
(ii) Determination of applicable year
under current year and prior year testing
method. The ACP test is applied using
the prior year testing method or the current year testing method. Under the prior
year testing method, the applicable year
for determining the ACP for the eligible
NHCEs is the plan year immediately preceding the plan year for which the ACP test
is being calculated. Under the prior year
testing method, the ACP for the eligible
NHCEs is determined using the ACRs for
the eligible employees who were NHCEs
in that preceding plan year, regardless of
whether those NHCEs are eligible employees or NHCEs in the plan year for which
the ACP test is being performed. Under

479

the current year testing method, the applicable year for determining the ACP for eligible NHCEs is the same plan year as the
plan year for which the ACP test is being
calculated. Under either method, the ACP
for the eligible HCEs is determined using
the ACRs of eligible employees who are
HCEs for the plan year for which the ACP
test is being performed. See paragraph (c)
of this section for additional rules for the
prior year testing method.
(3) Determination of ACR—(i) General
rule. The ACR of an eligible employee for
the plan year or applicable year is the sum
of the employee contributions and matching contributions taken into account with
respect to such employee (determined under the rules of paragraphs (a)(4) and (a)(5)
of this section), and the qualified nonelective and elective contributions taken into
account under paragraph (a)(6) of this section for the year, divided by the employee's
compensation taken into account for the
year. The ACR is calculated to the nearest hundredth of a percentage point. If no
employee contributions, matching contributions, elective contributions, or qualified
nonelective contributions are taken into account under this section with respect to an
eligible employee for the year, the ACR of
the employee is zero.
(ii) ACR of HCEs eligible under more
than one plan—(A) General rule. Pursuant to section 401(m)(2)(B), the ACR
of an HCE who is an eligible employee
in more than one plan of an employer to
which matching contributions or employee
contributions are made is calculated by
treating all contributions with respect to
such HCE under any such plan as being
made under the plan being tested. Thus,
the ACR for such an HCE is calculated by
accumulating all matching contributions
and employee contributions under any plan
(other than a plan described in paragraph
(a)(3)(ii)(B) of this section) that would be
taken into account under this section for
the plan year, if the plan under which the
contribution was made applied this section
and had the same plan year. For example,
in the case of a plan with a 12-month plan
year, the ACR for the plan year of that plan
for an HCE who participates in multiple
plans of the same employer that provide for
matching contributions or employee contributions is the sum of all such contributions during such 12-month period that
would be taken into account with respect

2003-35 I.R.B.

to the HCE under all plans in which the
HCE is an eligible employee, divided by
the HCE's compensation for that 12-month
period (determined using the compensation definition for the plan being tested),
without regard to the plan year of the other
plans and whether those plans are satisfying this section or §1.401(m)–3.
(B) Plans not permitted to be aggregated. Contributions under plans that
are not permitted to be aggregated under
§1.401(m)–1(b)(4) (determined without
regard to the prohibition on aggregating
plans with inconsistent testing methods
set forth in §1.401(m)–1(b)(4)(iii)(B)
and the prohibition on aggregating plans
with different plan years set forth in
§1.410(b)–7(d)(5)) are not aggregated
under this paragraph (a)(3)(ii).
(iii) Example. The following example illustrates the application of paragraph (a)(3)(ii) of this section. See also
§1.401(k)–2(a)(3)(iii) for additional examples of the application of the parallel
rule under section 401(k)(3)(A). The example is as follows:
Example. Employee A, an HCE with compensation of $120,000, is eligible to make employee
contributions under Plan S and Plan T, two calendar-year profit-sharing plans of Employer H. Plan
S and Plan T use the same definition of compensation. Plan S provides a match equal to 50% of each
employee's contributions and Plan T has no match.
During the current plan year, Employee A elects to
contribute $4,000 in employee contributions to Plan
T and $4,000 in employee contributions to Plan S.
There are no other contributions made on behalf of
Employee A. Each plan must calculate Employee A's
ACR by dividing the total employee contributions
by Employee A and matching contributions under
both plans by $120,000. Therefore, Employee A's
ACR under each plan is 8.33% ($4,000+ $4,000+
$2,000/$120,000).

(4) Employee contributions and matching contributions taken into account under
the ACP test—(i) Employee contributions.
An employee contribution is taken into account in determining the ACR for an eligible employee for the plan year or applicable year in which the contribution is made.
For purposes of the preceding sentence, an
amount withheld from an employee's pay
(or a payment by the employee to an agent
of the plan) is treated as contributed at the
time of such withholding (or payment) if
the funds paid are transmitted to the trust
within a reasonable period after the withholding (or payment).
(ii) Recharacterized elective contributions. Excess contributions recharacterized in accordance with §1.401(k)–2(b)(3)

2003-35 I.R.B.

are taken into account as employee contributions for the plan year that includes
the time at which the excess contribution
is includible in the gross income of the employee under §1.401(k)–2(b)(3)(ii)(A).
(iii) Matching contributions. A matching contribution is taken into account in
determining the ACR for an eligible employee for a plan year or applicable year
only if each of the following requirements
is satisfied—
(A) The matching contribution is allocated to the employee's account under the
terms of the plan as of a date within that
year;
(B) The matching contribution is made
on account of (or the matching contribution is allocated on the basis of) the
employee's elective deferrals or employee
contributions for that year; and
(C) The matching contribution is actually paid to the trust no later than the end of
the 12-month period immediately following the year that contains that date.
(5) Matching contributions not taken
into account under the ACP test—(i) General rule. Matching contributions that do
not satisfy the requirements of paragraph
(a)(4)(iii) of this section may not be taken
into account in the ACP test for the plan
year with respect to which the contributions were made, or for any other plan
year. Instead, the amount of the matching contributions must satisfy the requirements of section 401(a)(4) (without regard
to the ACP test) for the plan year for which
they are allocated under the plan as if they
were nonelective contributions and were
the only nonelective contributions for that
year. See §§1.401(a)(4)–1(b)(2)(ii)(B) and
1.410(b)–7(c)(1).
(ii) Disproportionate matching contributions—(A) Matching contributions in
excess of 100%. A matching contribution
with respect to any employee contribution
or elective deferral for an NHCE is not
taken into account under the ACP test to
the extent the matching rate with respect
to the employee contribution or elective
deferral exceeds the greater of 100% and
2 times the plan's representative matching
rate.
(B) Representative matching rate. For
purposes of this paragraph (a)(5)(ii), the
plan's representative matching rate is the
lowest matching rate for any eligible
NHCE among a group of NHCEs that
consists of half of all eligible NHCEs in

480

the plan for the plan year who make elective deferrals or employee contributions
for the plan year (or, if greater, the lowest
matching rate for all eligible NHCEs in
the plan who are employed by the employer on the last day of the plan year and
who make elective deferrals or employee
contributions for the plan year).
(C) Definition of matching rate. For
purposes of this paragraph (a)(5)(ii), the
matching rate for an employee is the
matching contributions made for such
employee divided by the elective deferrals
or employee contributions that are being
matched.
(iii) Qualified matching contributions
used to satisfy the ADP test. Qualified
matching contributions that are taken
into account for the ADP test of section
401(k)(3) under §1.401(k)–2(a)(6) are
not taken into account in determining an
eligible employee's ACR.
(iv) Matching contributions taken into
account under safe harbor provisions. A
plan that satisfies the ACP safe harbor
requirements of section 401(m)(11) for
a plan year but nonetheless must satisfy
the requirements of this section because
it provides for employee contributions
for such plan year is permitted to apply
this section disregarding all matching
contributions with respect to all eligible
employees. In addition, a plan that satisfies the ADP safe harbor requirements of
§1.401(k)–3 for a plan year using qualified matching contributions but does not
satisfy the ACP safe harbor requirements
of section 401(m)(11) for such plan year is
permitted to apply this section by excluding matching contributions with respect to
all eligible employees that do not exceed
4% of each employee's compensation. If
a plan disregards matching contributions
pursuant to this paragraph (a)(5)(iv), the
disregard must apply with respect to all
eligible employees.
(v) Treatment of forfeited matching contributions. A matching contribution that is
forfeited because the contribution to which
it relates is treated as an excess contribution, excess deferral, or excess aggregate
contribution is not taken into account for
purposes of this section.
(6) Qualified nonelective contributions
and elective contributions that may be
taken into account under the ACP test.
Qualified nonelective contributions and
elective contributions may be taken into

September 2, 2003

account in determining the ACR for an
eligible employee for a plan year or applicable year, but only to the extent the
contributions satisfy the following requirements—
(i) Timing of allocation. The qualified nonelective contribution is allocated
to the employee's account as of a date
within that year (within the meaning of
§1.401(k)–2(a)(4)(i)(A)) and the elective
contribution satisfies §1.401(k)–2(a)(4)(i).
Consequently, under the prior year testing method, in order to be taken into account in calculating the ACP for the group
of eligible NHCEs for the applicable year,
a qualified nonelective contribution must
be contributed no later than the end of the
12-month period following the applicable
year even though the applicable year is different than the plan year being tested.
(ii) Elective contributions taken into
account under the ACP test. Elective contributions may be taken into account for
the ACP test only if the cash or deferred
arrangement under which the elective contributions are made is required to satisfy
the ADP test in §1.401(k)–2(a)(1) and,
then only to the extent that the cash or
deferred arrangement would satisfy that
test, including such elective contributions
in the ADP for the plan year or applicable
year. Thus, for example, elective deferrals
made pursuant to a salary reduction agreement under an annuity described in section
403(b) are not permitted to be taken into
account in an ACP test. Similarly, elective
contributions under a cash or deferred arrangement 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 satisfy
section 401(a)(4). The amount of nonelective contributions, including those
qualified nonelective contributions taken
into account under this paragraph (a)(6)
and those qualified nonelective contributions taken into account for the ADP test
under paragraph §1.401(k)–2(a)(6), and
the amount of nonelective contributions,
excluding those qualified nonelective
contributions taken into account under
this paragraph (a)(6) for the ACP test
and those qualified nonelective contributions taken into account for the ADP
test under paragraph §1.401(k)–2(a)(6),
satisfies the requirements of section
401(a)(4). See §1.401(a)(4)–1(b)(2). In

September 2, 2003

the case of an employer that is applying the special rule for employer-wide
plans in §1.414(r)–1(c)(2)(ii) with respect to the plan, the determination of
whether the qualified nonelective contributions satisfy the requirements of this
paragraph (a)(6)(iii) must be made on an
employer-wide basis regardless of whether
the plans to which the qualified nonelective contributions are made are satisfying
the requirements of section 410(b) on an
employer-wide basis. Conversely, in the
case of an employer that is treated as operating qualified separate lines of business,
and does not apply the special rule for employer-wide plans in §1.414(r)–1(c)(2)(ii)
with respect to the plan, then the determination of whether the qualified nonelective
contributions satisfy the requirements of
this paragraph (a)(6)(iii) is not permitted
to be made on an employer-wide basis
regardless of whether the plans to which
the qualified nonelective contributions are
made are satisfying the requirements of
section 410(b) on that basis.
(iv) Aggregation must be permitted.
The plan that provides for employee or
matching contributions and the plan or
plans to which the qualified nonelective
contributions or elective contributions are
made are plans that would be permitted to
be aggregated under §1.401(m)–1(b)(4).
If the plan year of the plan that provides
for employee or matching contributions
is changed to satisfy the requirement
under §1.410(b)–7(d)(5) that aggregated
plans have the same plan year, qualified
nonelective contributions and elective
contributions may be taken into account
in the resulting short plan year only if
such qualified nonelective and elective
contributions could have been taken into
account under an ADP test for a plan with
that same short plan year.
(v) Disproportionate contributions not
taken into account—(A) General rule.
Qualified nonelective contributions cannot
be taken into account for an applicable
year for an NHCE to the extent such
contributions exceed the product that
NHCE's compensation and the greater of
5% and 2 times the plan's representative
contribution rate. Any qualified nonelective contribution taken into account
in an ADP test under §1.401(k)–2(a)(6)
(including the determination of the representative contribution rate for purposes of

481

§1.401(k)–2(a)(6)(iv)(B)) is not permitted
to be taken into account for purposes of
this paragraph (a)(6) (including the determination of the representative contribution
rate for purposes of paragraph (a)(6)(v)(B)
of this section).
(B) Definition of representative contribution rate. For purposes of this paragraph
(a)(6)(v), the plan's representative contribution rate is the lowest applicable contribution rate of any eligible NHCE among
a group of eligible NHCEs that consists
of half of all eligible NHCEs for the plan
year (or, if greater, the lowest applicable
contribution rate of any eligible NHCE in
the group of all eligible NHCEs for the applicable year and who is employed by the
employer on the last day of the applicable
year).
(C) Definition of applicable contribution rate. For purposes of this paragraph
(a)(6)(v), the applicable contribution rate
for an eligible NHCE is the sum of the
matching contributions taken into account
under this section for the employee for
the plan year and the qualified nonelective
contributions made for that employee for
the plan year, divided by that employee's
compensation for the same period.
(vi) Contribution only used once. Qualified nonelective contributions can not be
taken into account under this paragraph
(a)(6) to the extent such contributions
are taken into account for purposes of
satisfying any other ACP test, any ADP
test, or the requirements of §1.401(k)–3,
1.401(m)–3 or 1.401(k)–4. Thus, for example, qualified nonelective contributions
that are made pursuant to §1.401(k)–3(b)
cannot be taken into account under the
ACP test. Similarly, if a plan switches
from the current year testing method to
the prior year testing method pursuant to
§1.401(m)–2(c)(1), qualified nonelective
contributions that are taken into account
under the current year testing method for
a plan year may not be taken into account
under the prior year testing method for the
next plan year.
(7) Examples. The following examples
illustrate the application of this paragraph
(a). See §1.401(k)–2(a)(6) for additional
examples of the parallel rules under section 401(k)(3)(A). The examples are as follows:
Example 1. (i) Employer L maintains Plan U,
a profit-sharing plan under which $.50 matching
contributions are made for each dollar of employee

2003-35 I.R.B.

contributions. Plan U uses the current year testing method. The chart below shows the average

employee contributions (as a percentage of compensation) and matching contributions (as a percentage
of compensation) for Plan U's highly compensated

employees and nonhighly compensated employees
for the 2006 plan year:

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% and
thus the matching contributions are not disproportionate under paragraph (a)(5)(ii) of this section. Accordingly, they are taken into account in determining the
ACR of eligible employees, as shown in the following table.
(iii) Because the ACP for the HCEs (6.0%) exceeds 5.63% (4.5% x 1.25), Plan U does not satisfy
the ACP test under paragraph (a)(1)(i)(A) of this section. However, because the ACP for the HCEs does

not exceed the ACP for the NHCEs by more than 2
percentage points and the ACP for the HCEs does not
exceed the ACP for the NHCEs multiplied by 2 (4.5%
x 2 = 9%), the plan satisfies the ACP test under paragraph (a)(1)(i)(B) of this section.
Example 2. (i) Employees A through F are eligible employees in Plan V, a profit-sharing plan of Employer M that includes a cash or deferred arrangement
and permits employee contributions. Under Plan V,
a $.50 matching contribution is made for each dollar

Employee

Compensation

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% and
thus the matching contributions are not disproportionate under paragraph (a)(5)(ii) of this section. Accord-

Elective Contributions

of elective contributions and employee contributions.
Plan V uses the current year testing method and does
not provide for elective contributions to be taken into
account in determining an eligible employee's ACR.
For the 2006 plan year, Employees A and B are HCEs
and the remaining employees are NHCEs. The compensation, elective contributions, employee contributions, and matching contributions for the 2006 plan
year are shown in the following table:

Employee
Contributions

Matching Contributions

ingly, they are taken into account in determining the
ACR of eligible employees, as shown in the following table:

Employee

Compensation

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

(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
to satisfy the ACP test under paragraph (a)(1)(i)(A)
of this section because the ACP of highly compensated employees is more than 125% of the ACP of the
nonhighly compensated employees (6.59% x 1.25 =
8.24%). In addition, Plan V fails to satisfy the ACP
test under paragraph (a)(1)(i)(B) of this section because the ACP for the HCEs exceeds the ACP of the

2003-35 I.R.B.

Employee
Contributions

Matching Contributions

other employees by more than 2 percentage points
(6.59% + 2% = 8.59%). Therefore, the plan fails
to satisfy the requirements of section 401(m)(2) and
paragraph (a)(1) of this section unless the ACP failure is corrected under paragraph (b) of this section.
Example 3. (i) The facts are the same as Example
2, except that the plan provides that the nonhighly
compensated employees' elective contributions may
be used to meet the requirements of section 401(m)
to the extent needed under that section.

482

ACR %

0

(ii) Pursuant to paragraph (a)(6)(ii) of this section, the $10,000 of elective contributions for Employee E may be taken into account in determining
the ACP rather than the ADP to the extent that the
plan 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 the
NHCEs, the ADP for the highly compensated employees is 6.45% (7.89% + 5.00%)/2 and the ADP
for the nonhighly compensated employees would be

September 2, 2003

6.92% (14.12% + 13.57% + 0% +0%)/4) and the plan
would satisfy the requirements of §1.401(k)–2(a)(1)
excluding from the ADP the elective contributions
for NHCEs that are taken into account under section
401(m).
(iii) After taking into account the $10,000 of elective contributions for Employee E in the ACP test,
the ACP for the nonhighly compensated employees is

12.84% (7.06% + 6.79% + 37.50 % + 0%)/4. Therefore the plan satisfies the ACP test because the ACP
for the HCEs (12.11%) is less than 1.25 times the
ACP for the nonhighly compensated employees.
Example 4. (i) The facts are the same as Example 2, except that Plan V provides for a higher than
50% match rate on the elective contributions and employee contributions for all NHCEs. The match rate is

Employee

Compensation

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 disproportionate under paragraph (a)(5)(ii) of this section. Therefore, the matching contributions may be taken into 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 for
the HCEs (12.11%) is less than 1.25 times the ACP
for the NHCEs, the plan satisfies the requirements of
section 401(m).

Elective Contributions

defined as the rate, rounded up to the next whole percent, necessary to allow the plan to satisfy the ACP
test, but not in excess of 100%. In this case, an increase in the match rate from 50% to 74% will be sufficient to allow the plan to satisfy the ACP test. Thus,
for the 2006 plan year, the compensation, elective
contributions, employee contributions, matching contributions at a 74% match rate of the eligible NHCEs
(employees C through F) are shown in the following
table:

Employee
Contributions

Example 5. (i) The facts are the same as Example 4, except that: Employee E's elective contributions are $2,000 (rather than $10,000) and pursuant
to paragraph (a)(6)(ii) of this section, the $2,000 of
elective contributions for Employee E are taken into
account in determining the ACP rather than the ADP.
In addition, Plan V provides that the higher match
rate is not limited to 100% and applies only for a
specified group of nonhighly compensated employees. The only member of that group is Employee E.

Under the plan provision, the higher match rate is a
400% match. Thus, for the 2006 plan year, the compensation, elective contributions, employee contributions, matching contributions of the eligible NHCEs
(employees C through F) are shown in the following
table:

Employee

Compensation

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 on
behalf of Employee E were taken into account under
the ACP test, Plan V would satisfy the test, because
the ACP for the NHCEs would be 9.71% (7.06% +
6.79% + 25.00% + 0%)/4. Because the ACP for the
HCEs (12.11%) is less than 1.25 times what the ACP
for the NHCEs would be, the plan would satisfy the
requirements of section 401(m).
(iii) Pursuant to paragraph (a)(5)(ii) of this section, however, matching contributions for an eligible
NHCE that are based on a matching rate in excess
of the greater of 100% and twice the plan's representative matching rate cannot be taken into account
in applying the ACP test. The plan's representative
matching rate is the lowest matching rate for any eligible employee in a group of NHCEs that is at least
half of all eligible employees who are NHCEs in the
plan for the plan year who make elective contributions or employee contributions for the plan year. For
Plan V, the group of NHCEs who make such contributions consists of Employees C, D and E. The matching rates for these three employees are 50%, 50% and
400% respectively. The lowest matching rate for a

September 2, 2003

Elective Contributions

Matching Contributions

Employee
Contributions

group of NHCEs that is at least 1/2 of all the NHCEs
who make elective contributions or employee contributions (or 2 NHCEs) is 50%. Because 400% is
more than twice the plan's representative matching
rate, only the matching contributions made on behalf
of Employee E that do not exceed 100% (or in this
case $2,000) satisfy the requirements of paragraph
(a)(5)(ii) of this section and may be taken into account under the ACP test. Accordingly, the ACP for
the NHCEs is 5.96% (7.06% + 6.79% + 10% + 0%)/4
and the plan fails to satisfy the requirements of section 401(m)(2) and paragraph (a)(1) of this section
unless the ACP failure is corrected under paragraph
(b) of this section.
Example 6. (i) The facts are the same as Example 2, except that Plan V provides a QNEC equal to
13% of pay for Employee F that will be taken into
account under the ACP test to the extent the contributions satisfy the requirements of paragraph (a)(6) of
this section.
(ii) Pursuant to paragraph (a)(6)(v) of this section,
a QNEC cannot be taken into account in determining
an NHCE's ACR to the extent it exceeds the greater of

483

Matching Contributions

5% and the product of the employee's compensation
and the plan's representative contribution rate. The
plan's representative contribution rate is two times the
lowest applicable contribution rate for any eligible
employee in a group of NHCEs that is at least half of
all eligible employees who are NHCEs in the plan for
the plan year. For Plan V, the applicable contribution
rates for Employees C, D, E and F are 7.06%, 6.79%,
12.5% and 13% respectively. The lowest applicable
rate for a group of NHCEs that is at least 1/2 of all the
NHCEs is 12.50% (the lowest applicable rate for the
group of NHCEs that consists of Employees E and F).
(iii) Under paragraph (a)(6)(v)(B) of this section,
the plan's representative contribution rate is 2 times
12.50% or 25.00%. Accordingly, the QNECs for Employee F can be taken into account under the ACP test
only to the extent they do not exceed 25.00% of compensation. In this case, all of the QNECs for Employee F may be taken into account under the ACP
test.
(iv) After taking into account the QNECs for Employee F, the ACP for the NHCEs is 9.84% (7.06%
+ 6.79% + 12.50% + 13%)/4. Because the ACP for

2003-35 I.R.B.

the HCEs (12.11%) is less than 1.25 times the ACP
for the NHCEs, the plan satisfies the requirements of
section 401(m)(2) and paragraph (a)(1) of this section.

(b) Correction of excess aggregate
contributions—(1) Permissible correction methods—(i) In general. A plan
that provides for employee contributions
or matching contributions does not fail
to satisfy the requirements of section
401(m)(2) and paragraph (a)(1) of this
section if the employer, in accordance
with the terms of the plan, uses either of
the following correction methods—
(A) Additional contributions. The employer makes additional contributions that
are taken into account for the ACP test under this section that, in combination with
the other contributions taken into account
under this section, allow the plan to satisfy
the requirements of paragraph (a)(1) of this
section.
(B) Excess aggregate contributions distributed or forfeited. Excess aggregate
contributions are distributed or forfeited in
accordance with paragraph (b)(2) of this
section.
(ii) Combination of correction methods.
A plan may provide for the use of either of
the correction methods described in paragraph (b)(1)(i) of this section, may limit
employee contributions or matching contributions in a manner that prevents excess
aggregate contributions from being made,
or may use a combination of these methods, to avoid or correct excess aggregate
contributions. If a plan uses a combination of correction methods, any contributions made under paragraph (b)(1)(i)(A) of
this section must be taken into account before application of the correction method
in paragraph (b)(1)(i)(B) of this section.
(iii) Exclusive means of correction. A
failure to satisfy the requirements of paragraph (a)(1) of this section may not be corrected using any method other than one
described in paragraph (b)(1)(i) or (ii) of
this section. Thus, excess aggregate contributions for a plan year may not be corrected by forfeiting vested matching contributions, distributing nonvested matching contributions, recharacterizing matching contributions, or not making matching contributions required under the terms
of the plan. Similarly, excess aggregate
contributions for a plan year may not remain unallocated or be allocated to a suspense account for allocation to one or more

2003-35 I.R.B.

employees in any future year. In addition, excess aggregate contributions may
not be corrected using the retroactive correction rules of §1.401(a)(4)–11(g). See
§1.401(a)(4)–11(g)(3)(vii) and (5).
(2) Correction through distribution—(i) General rule. This paragraph
(b)(2) contains the rules for correction of
excess aggregate contributions through
a distribution from the plan. Correction
through a distribution generally involves
a four step process. First, the plan must
determine, in accordance with paragraph
(b)(2)(ii) of this section, the total amount
of excess aggregate contributions that
must be distributed under the plan. Second, the plan must apportion the total
amount of excess aggregate contributions
among the HCEs in accordance with paragraph (b)(2)(iii) of this section. Third,
the plan must determine the income allocable to excess aggregate contributions
in accordance with paragraph (b)(2)(iv)
of this section. Finally, the plan must
distribute the apportioned contributions,
together with allocable income (or forfeit
the apportioned matching contributions,
if forfeitable) in accordance with paragraph (b)(2)(v) of this section. Paragraph
(b)(2)(vi) of this section provides rules
relating to the tax treatment of these distributions.
(ii) Calculation of total amount to
be distributed. The following procedures
must be used to determine the total amount
of the excess aggregate contributions to be
distributed—
(A) Calculate the dollar amount of
excess aggregate contributions for each
HCE. The amount of excess aggregate
contributions attributable to an HCE for a
plan year is the amount (if any) by which
the HCE's contributions taken into account
under this section must be reduced for the
HCE's ACR to equal the highest permitted
ACR under the plan. To calculate the
highest permitted ACR under a plan, the
ACR of the HCE with the highest ACR is
reduced by the amount required to cause
that HCE's ACR to equal the ACR of
the HCE with the next highest ACR. If
a lesser reduction would enable the plan
to satisfy the requirements of paragraph
(b)(2)(ii)(C) of this section, only this lesser
reduction applies.
(B) Determination of the total amount
of excess aggregate contributions.
The process described in paragraph

484

(b)(2)(ii)(A) of this section must be
repeated until the plan would satisfy the
requirements of paragraph (b)(2)(ii)(C)
of this section. The sum of all reductions
for all HCEs determined under paragraph
(b)(2)(ii)(A) of this section is the total
amount of excess aggregate contributions
for the plan year.
(C) Satisfaction of ACP. A plan satisfies this paragraph (b)(2)(ii)(C) if the
plan would satisfy the requirements of
paragraph (a)(1)(i) of this section if the
ACR for each HCE were determined after the reductions described in paragraph
(b)(2)(ii)(A) of this section.
(iii) Apportionment of total amount of
excess aggregate contributions among the
HCEs. The following procedures must be
used in apportioning the total amount of
excess aggregate contributions determined
under paragraph (b)(2)(ii) of this section
among the HCEs—
(A) Calculate the dollar amount of
excess aggregate contributions for each
HCE. The contributions with respect to
the HCE with the highest dollar amount
of contributions taken account under this
section are reduced by the amount required to cause that HCE's contributions
to equal the dollar amount of contributions taken into account under this section
for the HCE with the next highest dollar
amount of such contributions. If a lesser
apportionment to the HCE would enable
the plan to apportion the total amount of
excess aggregate contributions, only the
lesser apportionment would apply.
(B) Limit on amount apportioned to
any HCE. For purposes of this paragraph
(b)(2)(iii), the contributions for an HCE
who is an eligible employee in more than
one plan of an employer to which matching
contributions and employee contributions
are made is determined by adding together
all contributions otherwise taken into account in determining the ACR of the HCE
under the rules of paragraph (a)(3)(ii)
of this section. However, the amount of
contributions apportioned with respect to
an HCE must not exceed the amount of
contributions taken into account under this
section that were actually made on behalf
of the HCE to the plan for the plan year.
Thus, in the case of an HCE who is an
eligible employee in more than one plan
of the same employer to which employee
contributions or matching contributions
are made and whose ACR is calculated

September 2, 2003

in accordance with paragraph (a)(3)(ii) of
this section, the amount distributed under
this paragraph (b)(2)(iii) will not exceed
such contributions actually contributed to
the plan for the plan year that are taken
into account 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 the
total amount of excess aggregate contributions have been apportioned.
(iv) Income allocable to excess aggregate contributions—(A) General rule.
The income allocable to excess aggregate
contributions is equal to the sum of the
allocable gain or loss for the plan year
and, to the extent the excess aggregate
contributions are or will be credited with
allocable gain or loss for the period after
the close of the plan year (the gap period),
the allocable gain or loss for the gap period.
(B) Method of allocating income. A
plan may use any reasonable method for
computing the income allocable to excess
aggregate contributions, provided that the
method does not violate section 401(a)(4),
is used consistently for all participants and
for all corrective distributions under the
plan for the plan year, and is used by the
plan for allocating income to participants'
accounts. See §1.401(a)(4)–1(c)(8).
(C) Alternative method of allocating income for the plan year. A plan may allocate income to excess aggregate contributions for the plan year by multiplying the
income for the plan year allocable to employee contributions, matching contributions and other amounts taken into account
under this section (including the contributions for the year), by a fraction, the numerator of which is the excess aggregate
contributions for the employee for the plan
year, and the denominator of which is the
account balance attributable to employee
contributions and matching contributions
and other amounts taken into account under this section as of the beginning of the
plan year (including any additional such
contributions for the plan year).
(D) Safe harbor method of allocating gap period income. A plan may use
the safe harbor method in this paragraph
(b)(2)(iv)(D) to determine income on excess aggregate contributions for the gap
period. Under this safe harbor method,
income on excess aggregate contributions

September 2, 2003

for the gap period is equal to 10% of the
income allocable to excess aggregate contributions for the plan year that would be
determined under paragraph (b)(2)(iv)(C)
of this section, multiplied by the number
of calendar months that have elapsed since
the end of the plan year. For purposes of
calculating the number of calendar months
that have elapsed under the safe harbor
method, a corrective distribution that is
made on or before the fifteenth day of a
month is treated as made on the last day
of the preceding month and a distribution
made after the fifteenth day of a month
is treated as made on the last day of the
month.
(E) Alternative method of allocating
plan year and gap period income. A
plan may determine the allocable gain
or loss for the aggregate of the plan year
and the gap period by applying the alternative method provided by paragraph
(b)(2)(iv)(C) of this section to that aggregate period. This is accomplished by
substituting the income for the plan year
and the gap period for the income for the
plan year and by substituting the contributions taken into account under this section
for the plan year and the gap period for the
contributions taken into account for the
plan year in determining the fraction that
is multiplied by that income.
(F) Allocable income for recharacterized elective contributions. If recharacterized elective contributions are distributed
as excess aggregate contributions, the
income allocable to the excess aggregate
contributions is determined as if recharacterized elective contributions had been
distributed as excess contributions. Thus,
income must be allocated to the recharacterized amounts distributed using the
methods in §1.401(k)–2(b)(2)(iv).
(v) Distribution and forfeiture. Within
12 months after the close of the plan year
in which the excess aggregate contribution
arose, the plan must distribute to each HCE
the contributions apportioned to such HCE
under paragraph (b)(2)(iii) of this section
(and the allocable income) to the extent
they are vested or forfeit such amounts, if
forfeitable. Except as otherwise provided
in this paragraph (b)(2)(v), a distribution
of excess aggregate contributions must be
in addition to any other distributions made
during the year and must be designated as a
corrective distribution by the employer. In
the event of a complete termination of the

485

plan during the plan year in which an excess aggregate contribution arose, the corrective distribution must be made as soon
as administratively feasible after the date
of termination of the plan, but in no event
later than 12 months after the date of termination. If the entire account balance of an
HCE is distributed prior to when the plan
makes a distribution of excess aggregate
contributions in accordance with this paragraph (b)(2), the distribution is deemed to
have been a corrective distribution of excess aggregate contributions (and income)
to the extent that a corrective distribution
would otherwise have been required.
(vi) Tax treatment of corrective distributions—(A) General rule. Except as otherwise provided in paragraph (b)(2)(vi)(B)
of this section, a corrective distribution
of excess aggregate contributions (and income) that is made within 21/2 months after the end of the plan year for which the
excess aggregate contributions were made
is includible in the employee's gross income for the taxable year of the employee
ending with or within the plan year for
which the excess aggregate contributions
were made. A corrective distribution of excess aggregate contributions (and income)
that is made more than 21/2 months after
the plan year for which the excess aggregate contributions were made is includible
in the employee's gross income in the taxable year of the employee in which distributed. The portion of the distribution
that is treated as an investment in the contract under section 72 is determined without regard to any plan contributions other
than those distributed as excess aggregate
contributions. Regardless of when the corrective distribution is made, it is not subject to the early distribution tax of section
72(t). See paragraph (b)(4) of this section for additional rules relating to the employer excise tax on amounts distributed
more than 21/2 months after the end of the
plan year. See also §1.402(c)–2, A–4 prohibiting rollover of distributions that are
excess aggregate contributions.
(B) Rule for de minimis distributions.
If the total amount of excess aggregate
contributions determined under this paragraph (b)(2), and excess contributions
determined under §1.401(k)–2(b)(2) distributed to a recipient under a plan for any
plan year is less than $100 (excluding income), a corrective distribution of excess
aggregate contributions (and income) is

2003-35 I.R.B.

includible in gross income in the recipient's taxable year in which the corrective
distribution is made.
(3) Other rules—(i) No employee or
spousal consent required. A distribution
of excess aggregate contributions (and income) may be made under the terms of
the plan without regard to any notice or
consent otherwise required under sections
411(a)(11) and 417.
(ii) Treatment of corrective distributions and forfeited contributions as
employer contributions. Excess aggregate
contributions (other than amounts attributable to employee contributions), including
forfeited matching contributions, are
treated as employer contributions for
purposes of sections 404 and 415 even
if distributed from the plan. Forfeited
matching contributions that are reallocated to the accounts of other participants
for the plan year in which the forfeiture
occurs are treated under section 415 as
annual additions for the participants to
whose accounts they are reallocated and
for the participants from whose accounts
they are forfeited.
(iii) No reduction of required minimum
distribution. A distribution of excess
aggregate contributions (and income) is
not treated as a distribution for purposes
of determining whether the plan satisfies
the minimum distribution requirements
of section 401(a)(9). See §1.401(a)(9)–5,
A–9(b).
(iv) Partial correction. Any distribution
of less than the entire amount of excess
aggregate contributions (and allocable income) is treated as a pro rata distribution
of excess aggregate contributions and allocable income.
(v) Matching contributions on excess
contributions, excess deferrals and excess
aggregate contributions—(A) Corrective
distributions not permitted. A matching
contribution may not be distributed merely
because the contribution to which it relates
is treated as an excess contribution, excess
deferral, or excess aggregate contribution.
(B) Coordination
with
section
401(a)(4). A matching contribution is

2003-35 I.R.B.

taken into account under section 401(a)(4)
even if the match is distributed, unless the
distributed contribution is an excess aggregate contribution. This requires that, after
correction of excess aggregate contributions, each level of matching contributions
be currently and effectively available to a
group 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 of
matching contributions to all employees
will not meet the requirements of section 401(a)(4) if employee contributions
are distributed under this paragraph (b)
to HCEs to the extent needed to meet
the requirements of section 401(m)(2),
while matching contributions attributable to employee contributions remain
allocated to the HCEs' accounts. This
is because the level of matching contributions will be higher for a group
of employees that consists entirely of
HCEs. Under section 411(a)(3)(G) and
§1.411(a)–4(b)(7), a plan may forfeit
matching contributions attributable to
excess contributions, excess aggregate
contributions and excess deferrals to avoid
a violation of section 401(a)(4). See also
§1.401(a)(4)–11(g)(3)(vii)(B) regarding
the use of additional allocations to the
accounts of NHCEs for the purpose of
correcting a discriminatory rate of matching contributions. A plan is permitted to
provide for which contributions are to be
distributed to satisfy the ACP test so as to
avoid discriminatory matching rates that
would otherwise violate section 401(a)(4).
For example, the plan may provide that
unmatched employee contributions will
be distributed before matched employee
contributions.
(vi) No requirement for recalculation.
If the distributions and forfeitures described in paragraph (b)(2) of this section
are made, the employee contributions
and matching contributions are treated as
meeting the nondiscrimination test of section 401(m)(2) regardless of whether the
ACP for the HCEs, if recalculated after the
distributions and forfeitures, would satisfy
section 401(m)(2).

486

(4) Failure to timely correct—(i) Failure to correct within 21/2 months after end
of plan year. If a plan does not correct
excess aggregate contributions within 21/2
months after the close of the plan year for
which the excess aggregate contributions
are made, the employer will be liable for
a 10% excise tax on the amount of the
excess aggregate contributions. See section 4979 and §54.4979–1 of this chapter.
Qualified nonelective contributions properly taken into account under paragraph
(a)(6) of this section for a plan year may
enable a plan to avoid having excess aggregate contributions, even if the contributions are made after the close of the 21/2
month period.
(ii) Failure to correct within 12 months
after end of plan year. If excess aggregate
contributions are not corrected within 12
months after the close of the plan year for
which they were made, the plan will fail to
meet the requirements of section 401(a)(4)
for the plan year for which the excess aggregate contributions were made and all
subsequent plan years in which the excess
aggregate contributions remain in the trust.
(5) Examples. The following examples
illustrate the application of this paragraph.
See also §1.401(k)–2(b) for additional examples of the parallel correction rules applicable to cash or deferred arrangements.
For purposes of these examples, none of
the plans provide for catch-up contributions under section 414(v). The examples
are as follows:
Example 1. (i) Employer L maintains a plan that
provides for employee contributions and fully vested
matching contributions. The plan provides that failures of the ACP test are corrected by distribution. In
2006, 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 following
compensation, contributions, and ACRs:

September 2, 2003

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 contributions for the HCEs is determined under paragraph
(b)(2)(ii) of this section as follows: the matching
and employee contributions of Employee C (the HCE
with the highest ACR) is reduced by 3% of compensation (or $3,000) in order to reduce the ACR of that
HCE to 9%, which is the ACR of Employee B.
(iii) Because the ACP of the HCEs determined
after the $3,000 reduction still exceeds 8%, further
reductions in matching contributions and employee
contributions are necessary in order to reduce the
ACP of the HCEs to 8%. The employee contributions
and matching contributions for Employees B and C
are reduced by an additional .5% of compensation or
$1,250 ($750 and $500 respectively). Because the
ACP of the HCEs determined after the reductions
now equals 8%, the plan would satisfy the requirements of (a)(1)(ii) of this section.
(iv) The total amount of excess aggregate contributions ($4,250) is apportioned among the HCEs
under paragraph (b)(2)(iii) of this section first to the
HCE with the highest amount of matching contributions and employee contributions. Therefore, Employee A is apportioned $500 (the amount required to

cause A's matching contributions and employee contributions to equal the next highest dollar amount of
matching contributions and employee contributions).
(v) Because the total amount of excess aggregate
contributions has not been apportioned, further apportionment is necessary. The balance ($3,750) of the
total amount of excess aggregate contributions is apportioned equally among Employees A and B ($1,500
to each, the amount required to cause their contributions to equal the next highest dollar amount of
matching contributions and employee contributions).
(vi) Because the total amount of excess aggregate contributions has not been apportioned, further
apportionment is necessary. The balance ($750) of
the total amount of excess aggregate contributions is
apportioned equally among Employees A, B and C
($250 to each, the amount required to allocate the total amount of excess aggregate contributions for the
plan).
(vii) Therefore, the plan will satisfy the requirements of paragraph (a)(1) of this section if, by the
end of the 12 month period following the end of the
2006 plan year, Employee A receives a corrective distribution of excess aggregate contributions equal to

Actual Deferral Percentage
Employee D
NHCEs
(ii) In February 2007, Employer M determines
that 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 increases
D's actual contribution ratio to 5.25% ($7,500 in
matching contributions plus $3,000 recharacterized
as employee contributions, divided by $200,000 in
compensation). Since D's actual contribution ratio
must be limited to 4% for Plan X to satisfy the actual
contribution percentage test, Plan X must distribute
1.25% or $2,500 of D's employee contributions
and matching contributions together with allocable
income. If $2,500 in matching contributions and
allocable income is distributed, this will correct the
excess aggregate contributions and will not result in
a discriminatory rate of matching contributions. See
Example 8.
Example 3. (i) The facts are the same as in Example 2, except that Employee D also had elective
contributions under Plan Y, maintained by an employer unrelated to M. In January 2007, D requests
and receives a distribution of $1,200 in excess deferrals from Plan X. Pursuant to the terms of Plan X, D
forfeits the $600 match on the excess deferrals to correct a discriminatory rate of match.

September 2, 2003

$2,250 ($500 + $1,500 + $250) and allocable income,
Employee B receives a corrective distribution of $250
and allocable income and Employee C receives a corrective distribution of $1,750 ($1,500 + $250) and allocable income.
Example 2. (i) Employee D is the sole HCE who
is eligible to participate in a cash or deferred arrangement maintained by Employer M. The plan that includes the arrangement, Plan X, permits employee
contributions and provides a fully vested matching
contribution equal to 50% of elective contributions.
Plan X is a calendar year plan. Plan X corrects excess contributions by recharacterization and provides
that failures of the ACP test are corrected by distribution. 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 contribution percentages for Employee D and the other eligible employees under Plan X are shown in the following table:

Actual Contribution Percentage

7.5%

3.75%

4%

2%

(ii) The $3,000 that would otherwise have been
recharacterized for Plan X to satisfy the actual deferral percentage test is reduced by the $1,200 already distributed as an excess deferral, leaving $1,800
to be 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 recharacterized contributions less $600 forfeited matching contributions attributable to the excess deferrals, divided
by $200,000 in compensation).
(iii) The matching and employee contributions for
Employee D must be reduced by .35% of compensation in order to reduce the ACP of the HCEs to
4%. The plan must provide for forfeiture of additional matching contributions to prevent a discriminatory rate of matching contributions. See Example
8.
Example 4. (i) The facts are the same as in Example 3, except that D does not request a distribution of
excess deferrals until March 2007. Employer X has
already recharacterized $3,000 as employee contributions.
(ii) Under §1.402(g)–1(e)(6), the amount of
excess deferrals is reduced by the amount of excess
contributions that are recharacterized. Because the

487

amount recharacterized is greater than the excess
deferrals, Plan X is neither required nor permitted
to make a distribution of excess deferrals, and the
recharacterization has corrected the excess deferrals.
Example 5. (i) For the 2006 plan year, Employee
F defers $10,000 under Plan M and $6,000 under Plan
N. Plans M and N, which have calendar plan years are
maintained by unrelated employers. Plan M provides
a fully vested, 100% matching contribution, does not
take elective contributions into account under section
401(m) or take matching contributions into account
under section 401(k) and provides that excess contributions and excess aggregate contributions are corrected by distribution. Under Plan M, Employee F is
allocated excess contributions of $600 and excess aggregate contributions of $1,600. Employee F timely
requests and receives a distribution of the $1,000 excess deferral from Plan M and, pursuant to the terms
of Plan M, forfeits the corresponding $1,000 matching contribution.
(ii) No distribution is required or permitted to
correct the excess contributions because $1,000 has
been distributed by Plan M as excess deferrals. The
distribution required to correct the excess aggregate

2003-35 I.R.B.

contributions (after forfeiting the matching contribution) is $600 ($1,600 in excess aggregate contributions minus $1,000 in forfeited matching contributions). If Employee F had corrected the excess deferrals of $1,000 by withdrawing $1,000 from Plan
N, Plan M would have had to correct the $600 excess
contributions in Plan M by distributing $600. Since
Employee F then would have forfeited $600 (instead
of $1,000) in matching contributions, Employee F
would have had $1,000 ($1,600 in excess aggregate
contributions minus $600 in forfeited matching contributions) remaining of excess aggregate contributions in Plan M. These would have been corrected by
distributing an additional $1,000 from Plan M.
Example 6. (i) Employee G is the sole highly
compensated employee in a profit sharing plan under which the employer matches 100% of employee
contributions up to 2% of compensation, and 50% of
employee contributions up to the next 4% of compensation. For the 2008 plan year, Employee G has
compensation of $100,000 and makes a 7% employee
contribution of $7,000. Employee G receives a 4%
matching contribution or $4,000. Thus, Employee
G's actual contribution ratio (ACR) is 11%. The actual contribution percentage for the nonhighly compensated employees is 5%, and the employer determines that Employee G's ACR must be reduced to 7%
to comply with the rules of section 401(m).
(ii) In this case, the plan satisfies the requirements of section if it distributes the unmatched
employee contributions of $1,000, and $2,000 of
matched employee contributions with their related
matches of $1,000. This would leave Employee G
with 4% employee contributions, and 3% matching
contributions, for an ACR of 7%. Alternatively,
the plan could distribute all matching contributions
and satisfy this section. However, the plan could
not distribute $4,000 of Employee G's employee
contributions without forfeiting the related matching
contributions because this would result in a discriminatory rate of matching contributions. See also
Example 7.
Example 7. (i) Employee H is an HCE in Employer 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 employee contributions and receives $5,000 of matching contributions. Employee H is 60% vested in the
matching contributions at the end of the 2006 plan
year. In February 2007, Employer X determines that
Employee H has excess aggregate contributions of
$1,000. The plan provides that only matching contributions will be distributed as excess aggregate contributions.
(ii) Employer X has two options available in distributing Employee H's excess contributions. The
first option is to distribute $600 of vested matching
contributions and forfeit $400 of nonvested matching contributions. These amounts are in proportion
to Employee H's vested and nonvested interests in all
matching contributions. The second option is to distribute $1,000 of vested matching contributions, leaving the nonvested matching contributions in the plan.
(iii) If the second option is chosen, the plan must
also provide a separate vesting schedule for vesting
these nonvested matching contributions. This is necessary because the nonvested matching contributions

2003-35 I.R.B.

must vest as rapidly as they would have had no distribution been made. Thus, 50% must vest in each of
the next 2 years.
(iv) The plan will not satisfy the nondiscriminatory availability requirement of section 401(a)(4) if
only nonvested matching contributions are distributed
because the effect is that matching contributions for
HCEs vest more rapidly than those for NHCEs. See
§1.401(m)–1(e)(4).
Example 8. (i) Employer Y maintains a calendar year profit sharing plan that includes a cash or
deferred arrangement. Elective contributions are
matched at the rate of 100%. After-tax employee
contributions are permitted under the plan only for
nonhighly compensated employees and are matched
at the same rate. No employees make excess deferrals. Employee J, a highly compensated employee,
makes an $8,000 elective contribution and receives
an $8,000 matching contribution.
(ii) Employer Y performs the actual deferral percentage (ADP) and the actual contribution percentage (ACP). To correct failures of the ADP and ACP
tests, the plan distributes to A $1,000 of excess contributions and $500 of excess aggregate contributions.
After the distributions, Employee J's contributions
for the year are $7,000 of elective contributions and
$7,500 of matching contributions. As a result, Employee J has received a higher effective rate of matching contributions than nonhighly compensated employees ($7,000 of elective contributions matched by
$7,500 is an effective matching rate of 107 percent).
If this amount remains in Employee J's account without correction, it will cause the plan to fail to satisfy section 401(a)(4), because only a highly compensated employee receives the higher matching contribution rate. The remaining $500 matching contribution may be forfeited (but not distributed) under
section 411(a)(3)(G), if the plan so provides. The
plan could instead correct the discriminatory rate of
matching contributions by making additional allocations to the accounts of nonhighly compensated employees. See §1.401(a)(4)–11(g)(3)(vii)(B) and (6),
Example 7.

(c) Additional rules for prior year testing method—(1) Rules for change in testing method. A plan is permitted to change
from the prior year testing method to the
current year testing method for any plan
year. A plan is permitted to change from
the current year testing method to the prior
year testing method only in situations described in §1.401(k)–2(c)(1)(ii). For purposes of this paragraph (c)(1), a plan that
uses the safe harbor method described in
§1.401(m)–3 or a SIMPLE 401(k) plan is
treated as using the current year testing
method for that plan year
(2) Calculation of ACP under the prior
year testing method for the first plan
year—(i) Plans that are not successor
plans. If, for the first plan year of any plan
(other than a successor plan), a plan uses
the prior year testing method, the plan is
permitted to use either that first plan year
as the applicable year for determining the

488

ACP for the eligible NHCEs, or 3% as the
ACP for eligible NHCEs, for applying the
ACP test for that first plan year. A plan
(other than a successor plan) that uses the
prior year testing method but has elected
for its first plan year to use that year as the
applicable year for determining the ACP
for the eligible NHCEs is not treated as
changing its testing method in the second
plan year and is not subject to the limitations on double counting under paragraph
(a)(6)(vi) of this section for the second
plan year.
(ii) First plan year defined. For purposes of this paragraph (c)(2), the first
plan year of any plan is the first year in
which the plan provides for employee
contributions or matching contributions.
Thus, the rules of this paragraph (c)(2) do
not apply to a plan (within the meaning
of §1.410(b)–7) for a plan year if for such
plan year the plan is aggregated under
§1.401(m)–1(b)(4) with any other plan
that provides for employee or matching
contributions in the prior year.
(iii) Plans that are successor plans. A
plan is a successor plan if 50% or more
of the eligible employees for the first plan
year were eligible employees under another plan maintained by the employer in
the prior year that provides for employee
contributions or matching contributions. If
a plan that is a successor plan uses the prior
year testing method for its first plan year,
the ACP for the group of NHCEs for the
applicable year must be determined under
paragraph (c)(4) of this section.
(3) Plans using different testing methods for the ACP and ADP test. Except
as otherwise provided in this paragraph
(c)(3), a plan may use the current year testing method or prior year testing method for
the ACP test for a plan year without regard
to whether the current year testing method
or prior year testing method is used for the
ADP test for that year. For example, a plan
may use the prior year testing method for
the ACP test and the current year testing
method for its ADP test for the plan year.
However, plans that use different testing
methods under this paragraph (c)(3) cannot use —
(i) The recharacterization method of
§1.401(k)–2(b)(3) to correct excess contributions for a plan year;
(ii) The rules of paragraph (a)(6)(ii) of
this section to take elective contributions

September 2, 2003

into account under the ACP test (rather
than the ADP test); or
(iii) The rules of paragraph §1.401(k)–
2(a)(6) to take qualified matching contributions into account under the ADP test
(rather than the ACP test).
(4) Rules for plan coverage change—(i)
In general. A plan that uses the prior year
testing method that experiences a plan coverage change during a plan year satisfies
the requirements of this section for that
year only if the plan provides that the ACP
for the NHCEs for the plan year is the
weighted average of the ACPs for the prior
year subgroups.
(ii) Optional rule for minor plan coverage changes. If a plan coverage change
occurs and 90% or more of the total number of the NHCEs from all prior year subgroups are from a single prior year subgroup, then, in lieu of using the weighted
averages described in paragraph (c)(4)(i)
of this section, the plan may provide that
the ACP for the group of eligible NHCEs
for the prior year under the plan is the
ACP of the NHCEs for the prior year of
the plan under which that single prior year
subgroup was eligible.
(iii) Definitions. The following definitions apply for purposes of this paragraph
(c)(4)—
(A) Plan coverage change. The term
plan coverage change means a change in
the group or groups of eligible employees
under a plan on account of—
(1) The establishment or amendment of
a plan;
(2) A plan merger or spinoff under section 414(l);
(3) A change in the way plans (within
the meaning of §1.410(b)–7) are combined or separated for purposes of
§1.401(m)–1(b)(4) (e.g., permissively
aggregating plans not previously aggregated under §1.410(b)–7(d), or ceasing
to permissively aggregate plans under
§1.410(b)–7(d));
(4) A reclassification of a substantial
group of employees that has the same effect as amending the plan (e.g., a transfer
of a substantial group of employees from
one 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 term
prior year subgroup means all NHCEs for
the prior plan year who, in the prior year,
were eligible employees under a specific

September 2, 2003

plan that provides for employee contributions or matching contributions maintained
by the employer and who would have been
eligible employees in the prior year under
the plan being tested if the plan coverage
change had first been effective as of the
first day of the prior plan year instead of
first being effective during the plan year.
The determination of whether an NHCE is
a member of a prior year subgroup is made
without regard to whether the NHCE terminated employment during the prior year.
(C) Weighted average of the ACPs
for the prior year subgroups. The term
weighted average of the ACPs for the
prior year subgroups means the sum, for
all prior year subgroups, of the adjusted
ACPs for the plan year. The term adjusted
ACP with respect to a prior year subgroup
means the ACP for the prior plan year of
the specific plan under which the members
of the prior year subgroup were eligible
employees on the first day of the prior plan
year, multiplied by a fraction, the numerator of which is the number of NHCEs in
the prior year subgroup and denominator
of which is the total number of NHCEs in
all prior year subgroups.
(iv) Example. The following example
illustrate the application of this paragraph
(c)(4). See also §1.401(k)–2(c)(4) for examples of the parallel rules applicable to
the ADP test. The example is as follows:
Example. (i) Employer B maintains two plans,
Plan N and Plan P, each of which provides for
employee contributions or matching contributions.
The plans were not permissively aggregated under
§ 1.410(b)–7(d) for the 2005 testing year. Both plans
use the prior year testing method. Plan N had 300
eligible employees who were NHCEs for 2005, and
their ACP for that year was 6%. Plan P had 100
eligible employees who were NHCEs for 2005, and
the 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 and
Plan P for the 2006 testing year under § 1.410(b)–7(d)
is a plan coverage change that results in treating the
plans as one plan (Plan NP). Therefore, the prior year
ACP for the NHCEs under Plan NP for the 2006 testing year is the weighted average of the ACPs for the
prior year subgroups.
(iii) The first step in determining the weighted average of the ACPs for the prior year subgroups is to
identify the prior year subgroups. With respect to
the 2006 testing year, an employee is a member of
a prior year subgroup if the employee was an NHCE
of Employer B for the 2005 plan year, was an eligible
employee for the 2005 plan year under any section
401(k) plan maintained by Employer B, and would
have been an eligible employee in the 2005 plan year
under Plan NP if Plan N and Plan P had been permissively aggregated under §1.410(b)–7(d) for that plan

489

year. The NHCEs who were eligible employees under separate plans for the 2005 plan year comprise
separate prior year subgroups. Thus, there are two
prior year subgroups under Plan NP for the 2006 testing year: the 300 NHCEs who were eligible employees under Plan N for the 2005 plan year and the 100
NHCEs who were eligible employees under Plan P
for the 2005 plan year.
(iv) The weighted average of the ACPs for the
prior year subgroups is the sum of the adjusted ACP
with respect to the prior year subgroup that consists of
the NHCEs who were eligible employees under Plan
N, and the adjusted ACP with respect to the prior year
subgroup that consists of the NHCEs who were eligible employees under Plan P. The adjusted ACP for the
prior year subgroup that consists of the NHCEs who
were eligible employees under Plan N is 4.5%, calculated as follows: 6% (the ACP for the NHCEs under Plan N for the prior year) x 300/400 (the number
of NHCEs in that prior year subgroup divided by the
total number of NHCEs in all prior year subgroups),
which equals 4.5%. The adjusted ACP for the prior
year subgroup that consists of the NHCEs who were
eligible employees under Plan P is 1%, calculated as
follows: 4% (the ACP for the NHCEs under Plan P
for the prior year) x 100/400 (the number of NHCEs
in that prior year subgroup divided by the total number of NHCEs in all prior year subgroups), which
equals 1%. Thus, the prior year ACP for NHCEs under Plan NP for the 2006 testing year is 5.5% (the sum
of adjusted ACPs for the prior year subgroups, 4.5%
plus 1%).

§1.401(m)–3 Safe harbor requirements.
(a) ACP test safe harbor. Matching
contributions under a plan satisfy the
ACP safe harbor provisions of section
401(m)(11) for a plan year if the plan
satisfies the safe harbor contribution requirement of paragraphs (b) or (c) of this
section for the plan year, the limitations on
matching contributions of paragraph (d)
of this section, the notice requirement of
paragraph (e) of this section, the plan year
requirements of paragraph (f) of this section, and the additional rules of paragraphs
(g), (h) and (j) of this section, as applicable. Pursuant to section 401(k)(12)(E)(ii),
the safe harbor contribution requirement
of paragraphs (b) and (c) of this section
must be satisfied without regard to section
401(l). The contributions made under
paragraphs (b) and (c) of this section are
referred to as safe harbor nonelective
contributions and safe harbor matching
contributions, respectively.
(b) Safe harbor nonelective contribution requirement. A plan satisfies the safe
harbor nonelective contribution requirement of this paragraph (b) if it satisfies
the safe harbor nonelective contribution
requirement of §1.401(k)–3(b).

2003-35 I.R.B.

(c) Safe harbor matching contribution
requirement. A plan satisfies the safe harbor matching contribution requirement of
this paragraph (c) if it satisfies the safe harbor matching contribution requirement of
§1.401(k)–3(c).
(d) Limitation on contributions–(1)
General rule. A plan that provides for
matching contributions meets the requirements of this section only if it satisfies the
limitations on contributions set forth in
this paragraph (d).
(2) Matching rate must not increase. A
plan that provides for matching contributions meets the requirements of this paragraph (d) only if the ratio of matching contributions on behalf of an employee under
the plan for a plan year to the employee's
elective deferrals and employee contributions, does not increase as the amount of
an employee's elective deferrals and employee contributions increases.
(3) Limit on matching contributions. A
plan that provides for matching contributions satisfies the requirements of this section only if—
(i) Matching contributions are not
made with respect to elective deferrals or employee contributions that exceed 6% of the employee's safe harbor
compensation (within the meaning of
§1.401(k)–3(b)(2)); and
(ii) Matching contributions that are discretionary do not exceed 4% of the employee's safe harbor compensation.
(4) Limitation on rate of match. A
plan meets the requirements of this section only if the ratio of matching contributions on behalf of an HCE to that HCE's
elective deferrals or employee contributions (or the sum of elective deferrals and
employee contributions) for that plan year
is no greater than the ratio of matching
contributions to elective deferrals or employee contributions (or the sum of elective
deferrals and employee contributions) that
would apply with respect to any NHCE for
whom the elective deferrals or employee
contributions (or the sum of elective deferrals and employee contributions) are the
same percentage of safe harbor compensation. An employee is taken into account
for purposes of this paragraph (d)(4) if the
employee is an eligible employee under
the cash or deferred arrangement with respect to which the contributions required
by paragraph (b) or (c) of this section are
being made for a plan year. A plan will not

2003-35 I.R.B.

fail to satisfy this paragraph (d)(4) merely
because the plan provides that matching
contributions will be made separately with
respect to each payroll period (or with respect to all payroll periods ending with
or within each month or quarter of a plan
year) taken into account under the plan
for the plan year, provided that matching
contributions with respect to any elective
deferrals or employee contributions made
during a plan year quarter are contributed
to the plan by the last day of the immediately following plan year quarter.
(5) HCEs participating in multiple
plans. The rules of section 401(m)(2)(B)
and §1.401(m)–2(a)(3)(ii) apply for purposes of determining the rate of matching
contributions under paragraph (d)(4) of
this section. However, a plan will not
fail to satisfy the safe harbor matching
contribution requirements of this section
merely because an HCE participates during the plan year in more than one plan
that provides for matching contributions,
provided that —
(i) The HCE is not simultaneously an
eligible employee under two plans that
provide for matching contributions maintained by an employer for a plan year; and
(ii) The period used to determine compensation for purposes of determining
matching contributions under each such
plan is limited to periods when the HCE
participated in the plan.
(6) Permissible restrictions on elective
deferrals by NHCEs—(i) General rule.
A plan does not satisfy the safe harbor
requirements of this section, if elective
deferrals or employee contributions by
NHCEs are restricted, unless the restrictions are permitted by this paragraph
(d)(6).
(ii) Restrictions on election periods. A
plan may limit the frequency and duration of periods in which eligible employees may make or change contribution elections under a plan. However, an employee
must have a reasonable opportunity (including a reasonable period after receipt of
the notice described in paragraph (e) of this
section) to make or change a contribution
election for the plan year. For purposes of
this section, a 30-day period is deemed to
be a reasonable period to make or change
a contribution election.
(iii) Restrictions on amount of contributions. A plan is permitted to limit
the amount of contributions that may be

490

made by an eligible employee under a
plan, provided that each NHCE who is
an eligible employee is permitted (unless
the employee is restricted under paragraph (d)(6)(v) of this section) to make
contributions in an amount that is at least
sufficient to receive the maximum amount
of matching contributions available under the plan for the plan year, and the
employee is permitted to elect any lesser
amount of contributions. However, a plan
may require eligible employees to make
contribution elections in whole percentages of compensation or whole dollar
amounts.
(iv) Restrictions on types of compensation that may be deferred. A plan may
limit the types of compensation that may
be deferred or contributed by an eligible
employee under a plan, provided that each
eligible NHCE is permitted to make contributions under a definition of compensation that would be a reasonable definition of compensation within the meaning
of §1.414(s)–1(d)(2). Thus, the definition of compensation from which contributions may be made is not required to satisfy the nondiscrimination requirement of
§1.414(s)–1(d)(3).
(v) Restrictions due to limitations under
the Internal Revenue Code. A plan may
limit the amount of contributions made by
an eligible employee under a plan—
(A) Because of the limitations of section 402(g) or section 415; or
(B) Because, on account of a hardship distribution, an employee's ability
to make contributions has been suspended for 6 months in accordance with
§1.401(k)–1(d)(3)(iv)(E).
(e) Notice requirement. A plan satisfies
the notice requirement of this paragraph
(e) if it satisfies the notice requirement of
§1.401(k)–3(d).
(f) Plan year requirement —(1) General rule. Except as provided in this paragraph (f) or in paragraph (g) of this section,
a plan will fail to satisfy the requirements
of section 401(m)(11) and this section unless plan provisions that satisfy the rules
of this section are adopted before the first
day of that plan year and remain in effect
for an entire 12-month plan year. Moreover, if, as described in paragraph (j)(4) of
this section, safe harbor matching or nonelective contributions will be made to another plan for a plan year, provisions specifying that the safe harbor contributions will

September 2, 2003

be made in the other plan and providing
that the contributions will be QNECs or
QMACs must be also be adopted before
the first day of that plan year.
(2) Initial plan year. A newly established plan (other than a successor
plan within the meaning of §1.401(m)–2
(c)(2)(iii)) will not be treated as violating
the requirements of this paragraph (f)
merely because the plan year is less than
12 months, provided that the plan year is
at least 3 months long (or, in the case of
a newly established employer that establishes the plan as soon as administratively
feasible after the employer comes into existence, a shorter period). Similarly, a plan
will not fail to satisfy the requirements of
this paragraph (f) for the first plan year
in which matching contributions are provided under the plan provided that—
(i) The plan is not a successor plan; and
(ii) The amendment providing for
matching contributions is made effective
at the same time as the adoption of a cash
or deferred arrangement that satisfies the
requirements of §1.401(k)–3, taking into
account the rules of §1.401(k)–3(e)(2).
(3) Change of plan year. A plan that
has a short plan year as a result of changing
its plan year will not fail to satisfy the requirements of paragraph (f)(1) of this section merely because the plan year has less
than 12 months, provided that—
(i) The plan satisfied the requirements
of this section for the immediately preceding plan year; and
(ii) The plan satisfies the requirements
of this section for the immediately following plan year.
(4) Final plan year. A plan that terminates during a plan year will not fail to satisfy the requirements of paragraph (f)(1)
of this section merely because the final
plan year is less than 12 months, provided
that—
(i) The plan would satisfy the requirements of paragraph (h) of this section,
treating the termination of the plan as a
reduction or suspension of safe harbor
matching contributions, other than the
requirement that employees have a reasonable opportunity to change their cash
or deferred elections and, if applicable,
employee contribution elections; or
(ii) The plan termination is in connection with a transaction described in section
410(b)(6)(C) or the employer incurs a substantial business hardship, comparable to a

September 2, 2003

substantial business hardship described in
section 412(d).
(g) Plan amendments adopting nonelective safe harbor contributions.
Notwithstanding paragraph (f)(1) of this
section, a plan that provides for the use
of the current year testing method may
be amended after the first day of the plan
year and no later than 30 days before
the last day of the plan year to adopt the
safe harbor method of this section using
nonelective contributions under paragraph
(b) of this section if the plan satisfies the
requirements of §1.401(k)–3(f).
(h) Permissible reduction or suspension of safe harbor matching contributions—(1) General rule. A plan that
provides for safe harbor matching contributions will not fail to satisfy the requirements of section 401(m)(2) for a plan
year merely because the plan is amended
during a plan year to reduce or suspend
safe harbor matching contributions on
future elective deferrals and, if applicable,
employee contributions provided—
(i) All eligible employees are provided
the supplemental notice in accordance
with paragraph (h)(2) of this section;
(ii) The reduction or suspension of safe
harbor matching contributions is effective
no earlier than the later of 30 days after
eligible employees are provided the notice described in paragraph (h)(2) of this
section and the date the amendment is
adopted;
(iii) Eligible employees are given a reasonable opportunity (including a reasonable period after receipt of the supplemental notice) prior to the reduction or suspension of safe harbor matching contributions
to change their cash or deferred elections
and, if applicable, their employee contribution elections;
(iv) The plan is amended to provide
that the ACP test will be satisfied for
the entire plan year in which the reduction or suspension occurs using the
current year testing method described in
§1.401(m)–2(a)(1)(ii); and
(v) The plan satisfies the requirements
of this section (other than this paragraph
(h)) with respect to amounts deferred
through the effective date of the amendment.
(2) Notice of suspension requirement.
The notice of suspension requirement of
this paragraph (h)(2) is satisfied if each
eligible employee is given a written notice

491

that satisfies the content requirements of
§1.401(k)–3(e)(3).
(i) [Reserved]
(j) Other rules—(1) Contributions
taken into account. A contribution is
taken into account for purposes of this
section for a plan year under the same
rules as §1.401(k)–3(h)(1).
(2) Use of safe harbor nonelective
contributions to satisfy other nondiscrimination tests. A safe harbor nonelective
contribution used to satisfy the nonelective
contribution requirement under paragraph
(b) of this section may also be taken
into account for purposes of determining
whether a plan satisfies section 401(a)(4)
under the same rules as §1.401(k)–3(h)(2).
(3) Early participation rules. Section 401 (m)(5)(C) and §1.401(m)–
2(a)(1)(iii)(A) which provide an alternative nondiscrimination rule for certain
plans that provide for early participation,
does not apply for purposes of section
401(m)(11) and this section. Thus, a plan
is not treated as satisfying this section
with respect to the eligible employees
who have not completed the minimum
age and service requirements of section
410(a)(1)(A) unless the plan satisfies the
requirements of this section with respect
to such eligible employees.
(4) Satisfying safe harbor contribution
requirement under another defined contribution plan. Safe harbor matching or nonelective contributions may be made to another defined contribution plan under the
same rules as §1.401(k)–3(h)(4). Consequently, each NHCE under the plan providing for matching contributions must be
eligible under the same conditions under
the other defined contribution plan and the
plan to which the contributions are made
must have the same plan year as the plan
providing for matching contributions.
(5) Contributions used only once. Safe
harbor matching or nonelective contributions cannot be used to satisfy the requirements of this section with respect to more
than one plan.
(6) Plan must satisfy ACP with respect
to employee contributions. If the plan provides for employee contributions, in addition to satisfying the requirements of this
section, it must also satisfy the ACP test of
§1.401(m)–2. See §1.401(m)–2(a)(5)(iii)
for specials rules under which the ACP
test is permitted to be run taking into account only employee contributions when

2003-35 I.R.B.

this section is satisfied with respect to the
matching contributions.
§1.401(m)–4 Special rules for mergers,
acquisitions and similar events.
[Reserved]
§1.401(m)–5 Definitions.
Unless otherwise provided, the definitions of this section govern for purposes of
section 401(m) and the regulations thereunder.
Actual
contribution
percentage
(ACP). Actual contribution percentage
or 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 test
or ACP test means the test described in
§1.401(m)–2(a)(1).
Actual contribution ratio (ACR). Actual contribution ratio or ACR means the
ACR of an eligible employee as defined in
§1.401(m)–2(a)(3).
Actual deferral percentage (ADP)
test. Actual deferral percentage test or
ADP test means the test described in
§1.401(k)–2(a)(1).
Compensation. Compensation means
compensation as defined in section 414(s)
and §1.414(s)–1. The period used to determine an employee's compensation for a
plan year must be either the plan year or the
calendar year ending within the plan year.
Whichever period is selected must be applied uniformly to determine the compensation of every eligible employee under the
plan for that plan year. A plan may, however, limit the period taken into account
under either method to that portion of the
plan year or calendar year in which the employee was an eligible employee, provided
that this limit is applied uniformly to all
eligible employees under the plan for the
plan 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 determined under §1.401(m)–2(a)(3)(ii), period
of participation includes periods under another plan for which matching contributions or employee contributions are aggregated under §1.401(m)–2(a)(3)(ii).
Current year testing method. Current year testing method means the
testing method under which the applicable year is the current plan year, as

2003-35 I.R.B.

described in §1.401(m)–2(a)(2)(ii) or
1.401(k)–2(a)(2)(ii).
Elective contributions. Elective contributions means elective contributions as defined in §1.401(k)–6.
Elective deferrals. Elective deferrals
means elective deferrals described in section 402(g)(3).
Eligible employee—(1) General rule.
Eligible employee means an employee who
is directly or indirectly eligible to make an
employee contribution or to receive an allocation of matching contributions (including matching contributions derived from
forfeitures) under the plan for all or a portion of the plan year. For example, if an
employee must perform purely ministerial
or mechanical acts (e.g., formal application for participation or consent to payroll withholding) in order to be eligible to
make an employee contribution for a plan
year, the employee is an eligible employee
for the plan year without regard to whether
the employee performs these acts.
(2) Conditions on eligibility. An employee who is unable to make employee
contributions or to receive an allocation
of matching contributions because the employee has not contributed to another plan
is also an eligible employee. By contrast, if
an employee must perform additional service (e.g., satisfy a minimum period of service requirement) in order to be eligible to
make an employee contribution or to receive an allocation of matching contributions for a plan year, the employee is not an
eligible employee for the plan year unless
the service is actually performed. An employee who would be eligible to make employee contributions but for a suspension
due to a distribution, a loan, or an election
not to participate in the plan, is treated as
an eligible employee for purposes of section 401(m) for a plan year even though the
employee may not make employee contributions or receive an allocation of matching contributions by reason of the suspension. Finally, an employee does not fail to
be treated as an eligible employee merely
because the employee may receive no additional annual additions because of section 415(c)(1).
(3) Certain one-time elections. An employee is not an eligible employee merely
because the employee, upon commencing
employment with the employer or upon the
employee's first becoming eligible under

492

any plan of the employer providing for employee or matching contributions, is given
a one-time opportunity to elect, and the
employee in fact does elect, not to be eligible to make employee contributions or to
receive allocations of matching contributions under the plan or any other plan maintained by the employer (including plans
not yet established) for the duration of
the employee's employment with the employer. In no event is an election made after December 23, 1994, treated as one-time
irrevocable election under this paragraph if
the election is made by an employee who
previously became eligible under another
plan (whether or not terminated) of the employer.
Eligible HCE. Eligible HCE means an
eligible employee who is an HCE.
Eligible NHCE. Eligible NHCE means
an eligible employee who is not an HCE.
Employee. Employee means an employee within the meaning of §1.410(b)–9.
Employee contributions.
Employee
contributions means employee contributions as defined in 1.401(m)–1(a)(3).
Employee stock ownership plan
(ESOP). Employee stock ownership plan
or ESOP means the portion of a plan
that is an ESOP within the meaning of
§1.410(b)–7(c)(2).
Employer. Employer means an employer within the meaning of §1.410(b)–9.
Excess aggregate contributions. Excess
aggregate contributions means, with respect to a plan year, the amount of excess
aggregate contributions apportioned to an
HCE under §1.401(m)–2(b)(2)(iii).
Excess contributions. Excess contribution means with respect to a plan year, the
amount of excess contribution apportioned
to an HCE under §1.401(k)–2(b)(2)(iii).
Excess deferrals.
Excess deferrals
means excess deferrals as defined in
§1.402(g)–1(e)(3).
Highly compensated employee (HCE).
Highly compensated employee or HCE has
the meaning provided in section 414(q).
Matching contributions. Matching contribution is defined in §1.401(m)–1(a)(2).
Nonelective contributions. Nonelective
contributions means employer contributions (other than matching contributions)
with respect to which the employee may
not elect to have the contributions paid
to the employee in cash or other benefits
instead of being contributed to the plan.

September 2, 2003

Non-employee stock ownership plan
(non-ESOP). Non-employee stock ownership plan or non-ESOP means the portion
of a plan that is not an ESOP within the
meaning of §1.410(b)–7(c)(2).
Non-highly compensated employee
(NHCE). Non-highly compensated employee or NHCE means an employee who
is not an HCE.
Plan. Plan means plan as defined in
§1.401(m)–1(b)(4).
Prior year testing method.
Prior
year testing method means the testing method under which the applicable year is the prior plan year, as
described in §1.401(m)–2(a)(2)(ii) or
§1.401(k)–2(a)(2)(ii).
Qualified matching contributions
(QMAC). Qualified matching contributions or QMAC means matching contributions that satisfy the requirements
of §1.401(k)–1(c) and (d) at the time the
contribution is made, without regard to
whether the contributions are actually
taken into account as elective contributions under §1.401(k)–2(a)(6). See also
§1.401(k)–2(b)(4)(iii) for a rule providing
that a matching contribution does not fail
to qualify as a QMAC solely because it
is forfeitable under section 411(a)(3)(G)
because it is a matching contribution with
respect to an excess deferral, excess contribution, or excess aggregate contribution.
Qualified nonelective contributions
(QNEC). Qualified nonelective contributions or QNEC means employer contributions, other than elective contributions
or matching contributions, that satisfy the
requirements of §1.401(k)–1(c) and (d) at
the time the contribution is made, without
regard to whether the contributions are
actually taken into account under the ADP
test under §1.401(k)–2(a)(6) or the ADP
test under §1.401(m)–2(a)(6).
Judith B. Tomaso,
Acting Deputy Commissioner for
Services and Enforcement.
(Filed by the Office of the Federal Register on July 16, 2003,
8:45 a.m., and published in the issue of the Federal Register
for July 17, 2003, 68 F.R. 42475)

September 2, 2003

Notice of Proposed Rulemaking;
Notice of Public Hearing;
and Withdrawal of Previously
Proposed Regulations
Credit for Increasing Research
Activities
REG–133791–02 and
REG–105606–99
AGENCY: Internal
(IRS), Treasury.

Revenue

Service

The public hearing will be held in room
4718, Internal Revenue Building, 1111
Constitution Avenue, NW, Washington,
DC 20224.
FOR
FURTHER
INFORMATION
CONTACT: Concerning these proposed
regulations, Jolene J. Shiraishi at (202)
622–3120 (not a toll-free call); concerning
submissions of comments, the hearing,
and to be placed on the building access
list to attend the hearing, Guy Traynor at
(202) 622–7180 (not a toll-free call).
SUPPLEMENTARY INFORMATION:

ACTION: Notice of proposed rulemaking;
notice of public hearing; and withdrawal of
previously proposed regulations.
SUMMARY: This document contains
proposed regulations relating to the computation and allocation of the credit for
increasing research activities for members
of a controlled group of corporations or a
group of trades or businesses under common control. These proposed regulations
reflect changes made to section 41 by the
Revenue Reconciliation Act of 1989 and
the Small Business Job Protection Act of
1996, which introduced the alternative
incremental research credit. This document also provides notice of a public
hearing on these proposed regulations
and withdraws the proposed regulations
(REG–105606–99, 2000–1 C.B. 421 [65
FR 258]) published in the Federal Register
on January 4, 2000.
DATES: Written or electronic comments
must be received by October 23, 2003. Requests to speak and outlines of the topics to
be discussed at the public hearing scheduled for November 13, 2003, at 10 a.m.
must be received by October 23, 2003.
ADDRESSES: Send submissions to:
CC:PA:RU (REG–133791–02), room
5226, Internal Revenue Service, POB
7604, Ben Franklin Station, Washington,
DC 20044. Submissions may also be
hand delivered Monday through Friday
between the hours of 8 a.m. and 4 p.m. to:
CC:PA:RU (REG–133791–02), Courier's
Desk, Internal Revenue Service, 1111
Constitution Avenue, NW, Washington,
DC 20224. Alternatively, taxpayers may
submit comments electronically via the Internet by submitting comments directly to
the IRS Internet site at: www.irs.gov/regs.

493

Background
On January 4, 2000, Treasury and the
IRS published in the Federal Register
(REG–105606–99, 2000–1 C.B. 421 [65
FR 258]) proposed amendments to the
regulations under section 41(f) (2000
proposed regulations) relating to the computation and allocation of the credit for
increasing research activities (research
credit) for members of a controlled group
of corporations or a group of trades or businesses under common control (controlled
group). The 2000 proposed regulations
reflected changes made to section 41 by
the Revenue Reconciliation Act of 1989
(the 1989 Act) and the Small Business Job
Protection Act of 1996. Treasury and the
IRS received written comments from two
commentators. A public hearing was held
on April 26, 2000. After considering the
written comments and the statements at
the public hearing, Treasury and the IRS
are withdrawing the 2000 proposed regulations and are proposing new regulations.
Summary of Comments and
Explanation of Provisions
Overview
These new proposed regulations for
members of a controlled group under
section 41(f) follow the research credit
computation rule contained in the 2000
proposed regulations. The computation of
the research credit for a controlled group
(group credit) under these new proposed
regulations is done by treating all of the
members of a controlled group as a single
taxpayer. Unlike the 2000 proposed regulations, these new proposed regulations
then allocate the group credit among the

2003-35 I.R.B.