Notice 2006-107

accordance with the guidance contained
in this notice, the IRS may assert additional income taxes and penalties under
§§ 6651(a)(1) and (2), 6654, and 6662 if
it is determined that the amount of taxes
reported and paid for calendar year 2005
or 2006 was underreported or underpaid.
Interest imposed under Chapter 67 of the
Code will apply to any underpayments
of tax resulting from a service provider’s
failure to include amounts includible in
gross income under § 409A for calendar
year 2005 or 2006. For purposes of determining the amount includible in income
under § 409A in a subsequent year, the
service provider may treat an amount as
previously included in income only if the
service provider has actually included the
amount in gross income in a previous year.
B. Calculation of Additional Tax under
§ 409A(a)(1)(B)(i)(I)
Section
409A(a)(1)(B)(i)(I)
provides that if compensation is required
to be included in gross income under
§ 409A(a)(1)(A), the tax imposed on
such income is increased by the sum
of two additional taxes equal to the
amount of interest determined under
§ 409A(a)(1)(B)(ii) plus an amount equal
to 20% of the compensation which is required to be included in gross income.
Section 409A(a)(1)(B)(ii) provides that
the amount of interest is the amount of
interest at the underpayment rate plus 1
percentage point on the underpayments
that would have occurred had the deferred
compensation been includible in gross
income for the taxable year in which first
deferred or, if later, the first taxable year in
which such deferred compensation is not
subject to a substantial risk of forfeiture.
Section 885(d)(1) of the Act provides
that § 409A generally applies to amounts
deferred after December 31, 2004. Section 885(d)(2)(B) of the Act provides that
amounts deferred in taxable years beginning before January 1, 2005, shall be
treated as amounts deferred in a taxable
year beginning on or after such date if
the plan under which the deferral is made
is materially modified after October 3,
2004. Accordingly, for purposes of the
calculation of the additional tax under
§ 409A(a)(1)(B)(ii), taxpayers may treat
amounts deferred under a plan that were
originally deferred on or before January 1,

December 18, 2006

2005 but became subject to § 409A due to
the material modification of the plan after
October 3, 2004 as deferred on January 1,
2005.
V. REQUEST FOR COMMENTS
The provisions of this notice are intended as interim guidance only. The
Treasury Department and the IRS are
currently formulating general guidance
with respect to the income inclusion requirements, the additional taxes, and the
reporting and withholding requirements of
§ 409A. The Treasury Department and the
IRS request comments on all aspects of
these requirements, including but not limited to the topics addressed in this notice.
Comments must be submitted by March
18, 2007. All materials submitted will be
available for public inspection and copying.
Comments may be submitted to Internal Revenue Service, CC:PA:LPD:RU
(Notice 2006–100), Room 5203, PO Box
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 the Courier’s Desk at 1111
Constitution Avenue, NW, Washington,
DC 20224, Attn: CC:PA:LPD:RU (Notice
2006–100), Room 5203. Submissions
may also be sent electronically via the
internet to the following email address:
[email protected].
Include the notice number (Notice
2006–100) in the subject line.
VI. EFFECT ON OTHER
DOCUMENTS
Notice 2005–94 is superseded. Notice
2005–1 is modified.
VII. EFFECTIVE DATE
This notice is effective with respect
to employers’ and payers’ reporting and
wage withholding requirements and with
respect to service providers’ filing requirements and tax payment obligations
relating to amounts includible in gross
income under § 409A for calendar years
2005 and 2006.
VIII. DRAFTING INFORMATION

vision Counsel/Associate Chief Counsel
(Tax Exempt and Governments Entities),
although other Treasury and IRS officials participated in its development. For
further information on the provisions
of this notice addressing the calculation
of the amount includible in income under § 409A, contact Stephen Tackney
at (202) 927–9639; for further information on other provisions of this notice,
including the reporting and withholding
provisions contained in this notice, contact Mr. Parkinson at (202) 622–6040 (not
toll-free numbers).

Diversification Requirements
for Qualified Defined
Contribution Plans Holding
Publicly Traded Employer
Securities
Notice 2006–107
I. PURPOSE
This notice provides transitional guidance on § 401(a)(35) of the Internal Revenue Code, added by section 901 of the
Pension Protection Act of 2006, Public
Law 109–280, 120 Stat. 780 (PPA ’06),
which provides diversification rights with
respect to publicly traded employer securities held by a defined contribution plan.
This notice also states that Treasury and
the Service expect to issue regulations under § 401(a)(35) that incorporate the transitional relief in this notice and requests
comments on the transitional guidance in
this notice and on the topics that need to
be addressed in the regulations.
II. BACKGROUND
Section 401(a)(35), as added by section
901 of PPA ‘06, provides that, to remain
qualified under § 401(a), a defined contribution plan (other than certain employee
stock ownership plans) must provide applicable individuals with the right to divest employer securities in their accounts
and reinvest those amounts in certain diversified investments. Section 901 also
added a parallel provision, section 204(j),
to the Employee Retirement Income Se-

The principal author of this notice is
Don M. Parkinson of the Office of Di-

1114

2006–51 I.R.B.

curity Act of 1974 (ERISA).1 In addition,
section 101(m) of ERISA, as added by section 507 of PPA ‘06, requires a plan to provide applicable individuals with a notice
describing diversification rights under section 204(j) of ERISA and providing information on the importance of diversifying
investments.
The diversification requirements of
§ 401(a)(35) are generally effective with
respect to plan years beginning after December 31, 2006, subject to certain special
effective date rules, including a special
rule with respect to plans maintained pursuant to a collective bargaining agreement.
See section 901(c) of PPA ’06. The notice
requirements of section 101(m) of ERISA
are effective with respect to plan years
beginning after December 31, 2006.
III. TRANSITIONAL GUIDANCE
This Part III provides transitional guidance with respect to § 401(a)(35). The
transitional guidance provided in this Part
III applies pending the issuance of further
guidance.
A. Scope of Application.
Section 401(a)(35) imposes diversification requirements for defined contribution
plans that hold publicly traded employer
securities.
Section 401(a)(35)(G)(iv)
provides that the term employer security has the meaning given such term
by section 407(d)(1) of ERISA. Under
§ 401(a)(35)(G)(v), the term publicly
traded employer securities means employer securities which are readily tradable on an established securities market.
For this purpose, if a plan holds employer
securities that are not publicly traded,
then, except as provided in Treasury regulations, those employer securities are
nevertheless treated as publicly traded
employer securities if any employer corporation, or any member of the controlled
group of corporations that includes an
employer corporation, has issued a class
of stock that is a publicly traded employer
security. For this purpose, an employer
corporation means any corporation that is
an employer maintaining the plan and a
controlled group of corporations has the

meaning given under § 1563(a), except
that 50% is substituted for 80% wherever
it occurs in § 1563.2
However, under this notice, a plan (and
an investment option described in the last
paragraph of Part IIIC of this notice) is
not treated as holding employer securities
to which § 401(a)(35) applies with respect
to any securities held by either an investment company registered under the Investment Company Act of 1940 or a similar
pooled investment vehicle that is regulated
and subject to periodic examination by a
State or Federal agency and with respect to
which investment in the securities is made
both in accordance with the stated investment objectives of the investment vehicle
and independent of the employer and any
affiliate thereof, but only if the holdings of
the investment company or similar investment vehicle are diversified so as to minimize the risk of large losses.
In addition, § 401(a)(35) does not apply to an employee stock ownership plan
(ESOP) if (1) there are no contributions
held in the plan (or earnings thereunder)
which are elective deferrals, employee after-tax contributions, or matching contributions that are subject to § 401(k) or (m)
and (2) the plan is, for purposes of § 414(l)
and §1.414(l)–1 of the Income Tax Regulations, a separate plan from any other
plan maintained by the employer. Thus,
an ESOP is subject to § 401(a)(35) if either the ESOP holds any contributions to
which § 401(k) or (m) applies (or earnings
thereon) or the ESOP is a portion of a plan
that holds any amounts that are not part of
the ESOP.
B. Applicable Individuals Who Have
Diversification Rights.
Section 401(a)(35) provides applicable
individuals with diversification rights with
respect to publicly traded employer securities held in the plan under subparagraphs
(B) and (C) of § 401(a)(35). The diversification rights under subparagraph (B) of
§ 401(a)(35) apply with respect to elective deferrals and employee contributions
(and earnings thereon) and are required to
be available to (1) any participant, (2) any
alternate payee who has an account under the plan, and (3) any beneficiary of

a deceased participant. For this purpose,
employee contributions include both employee after-tax contributions and rollover
contributions held under the plan. The
diversification rights under subparagraph
(C) of § 401(a)(35) apply with respect to
other employer contributions (and earnings thereon) and are required to be available to each applicable individual who is
either (1) a participant who has completed
at least three years of service, (2) an alternate payee who has an account under the
plan with respect to a participant who has
completed at least three years of service,
or (3) a beneficiary of a deceased participant. For purposes of this notice, persons
who are entitled to receive diversification
rights are termed “applicable individuals.”
For purposes of § 401(a)(35)(C) and
§ 401(a)(35)(H) (the transitional rule described in paragraph E of this Part III),
the date on which a participant completes
three years of service occurs immediately
after the end of the third vesting computation period provided for under the plan that
constitutes the completion of a third year
of service under § 411(a)(5). However, for
a plan that uses the elapsed time method of
crediting service for vesting purposes (or
a plan that provides for immediate vesting
without using a vesting computation period or the elapsed time method of determining vesting), the date on which a participant completes three years of service is
the third anniversary of the participant’s
date of hire.
C. Basic Divestiture Rules.
An applicable individual is required to
be permitted to elect to direct the plan to
divest any publicly traded employer securities held in his or her account under the
plan and to reinvest an equivalent amount
in other investment options offered under
the plan with respect to the portion of the
account that is subject to subparagraph (B)
or (C) of § 401(a)(35) to the extent applicable. This diversification right only applies
when publicly traded employer securities
are held under the plan and allocated to the
participant’s or beneficiary’s account.
Under § 401(a)(35)(D)(i), the investment options offered must include not less
than three investment options, other than

1 Under section 101 of Reorganization Plan No. 4 of 1978 (43 FR 47713), the Secretary of the Treasury has interpretive jurisdiction over the subject matter addressed in this notice for purposes
of section 204(j) of ERISA. Thus, the transitional guidance provided in this notice with respect to § 401(a)(35) also applies for purposes of section 204(j) of ERISA.
2

See §401(a)(35)(F)(ii) for an exception that applies to certain controlled groups with publicly traded securities.

2006–51 I.R.B.

1115

December 18, 2006

employer securities, to which the applicable individual may direct the proceeds of
the divestment of employer securities, and
each investment option must be diversified
and have materially different risk and return characteristics. For this purpose, investment options that satisfy the requirements of § 2550.404c–1(b)(3) of the Department of Labor Regulations are treated
as being diversified and having materially
different risk and return characteristics.

Similarly, the following are examples
of restrictions or conditions that are not
prohibited by § 401(a)(35)(D)(ii)(II), provided that the limitations apply without
regard to a prior exercise of rights to divest
employer securities:

•

A provision that limits the extent to
which an individual’s account balance
can be invested in employer securities.
Thus, a provision that does not allow
more than 10% of an individual’s account balance to be invested in employer securities is permitted.

•

A provision under which an employer
securities investment fund is closed,
i.e., other amounts invested under the
plan cannot be transferred into an investment in a class of employer securities (and no contributions are permitted
to be invested in that class of employer
securities).

D. Restrictions or Conditions on
Divestiture Rights.
1. Conditions or Restrictions. Under § 401(a)(35)(D)(ii)(I), a plan is not
treated as failing to meet the requirements
of § 401(a)(35) merely because the plan
limits the time for divestment and reinvestment to periodic, reasonable opportunities occurring no less frequently than quarterly. Section 401(a)(35)(D)(ii)(II) prohibits a plan from imposing restrictions
or conditions with respect to the investment of employer securities that are not
imposed on the investment of other assets
of the plan. For purposes of this prohibition in § 401(a)(35)(D)(ii)(II), except as
described below in this Part IIID, a restriction or condition with respect to employer
securities includes: (1) a restriction on an
applicable individual’s rights to divest an
investment in employer securities that is
not imposed on an investment that is not
in employer securities; and (2) a benefit
that is conditioned on investment in employer securities. Thus, the following are
examples of prohibited restrictions or conditions:

•

A plan allows applicable individuals
the right to divest employer securities
on a periodic basis (such as quarterly),
but permits divestiture of another investment on a more frequent basis
(such as daily). However, see paragraph 4 of this Part IIID for a transitional rule.

•

A plan under which a participant who
divests his or her account of employer
securities receives less favorable treatment (such as a lower rate of matching
contributions) than a participant whose
account remains invested in employer
securities.

December 18, 2006

However, a provision under which, if a
participant divests his or her account balance with respect to investment in a class
of employer securities, the participant is
not permitted for a period of time thereafter to reinvest in that class of employer
securities is a restriction that is prohibited
by § 401(a)(35)(D)(ii)(II), because this
limitation takes into account a prior exercise of rights to divest employer securities.
2. Permitted Restrictions. A restriction imposed by reason of the application
of securities laws or a restriction that
is reasonably designed to ensure compliance with such laws is not an impermissible restriction or condition under
§ 401(a)(35)(D)(ii)(II). Thus, for example, for purposes of ensuring compliance
with Rule 10b–5 of the Securities and
Exchange Commission, a plan may limit
divestiture rights for participants who are
subject to Section 16(b) of the Securities
Exchange Act of 1934 to a period (such as
3 to 12 days) following publication of the
employer’s quarterly earnings statements.
In addition, an impermissible restriction
or condition under § 401(a)(35)(D)(ii)(II)
does not include the imposition of fees
on other investment options under the
plan merely because fees are not imposed
with respect to investments in employer
securities. Further, a plan may restrict the
application of otherwise applicable diversification rights under the plan for up to 90

1116

days following an initial public offering of
the employer’s stock.
3. Transition Rule Through March 30,
2007 for Continuation of Existing Restrictions or Conditions. For the period from
January 1, 2007, through March 30, 2007,
a plan does not impose a restriction or condition prohibited by § 401(a)(35)(D)(ii)(II)
merely because the plan restricts diversification rights with respect to employer securities pursuant to a plan provision that
was in effect on December 18, 2006. However, any such restriction that continues to
be imposed on or after March 31, 2007, violates § 401(a)(35)(D)(ii)(II).
4. Transition Rule for 2007 for Grandfathered Investments. For the period prior
to January 1, 2008, a plan does not impose a restriction or condition prohibited
by § 401(a)(35)(D)(ii)(II) merely because
the plan, as in effect on December 18,
2006, (1) does not impose an otherwise applicable restriction on a stable value fund
or (2) allows applicable individuals the
right to divest employer securities on a periodic basis, but permits divestiture of another investment on a more frequent basis, provided that the other investment is
not a generally available investment (e.g.,
the other investment is only available to a
fixed class of participants). However, any
such restriction that continues to be imposed after December 31, 2007, violates
§ 401(a)(35)(D)(ii)(II).
E. Transition Rule under § 401(a)(35)(H).
Section 401(a)(35)(H) provides a special transition rule under which, for employer securities acquired in a plan year
beginning before January 1, 2007, the
diversification rights under subparagraph
(C) of §401(a)(35) only apply to the applicable percentage of the number of shares
of those securities. The applicable percentage is 33% for the first plan year to
which § 401(a)(35) applies, 66% for the
second plan year, and 100% for all subsequent plan years. If a plan holds more than
one class of securities, § 401(a)(35)(H)
applies separately with respect to each
class. This transition rule does not apply
to a participant who, before the first plan
year beginning after December 31, 2005,
had attained age 55 and completed at least
three years of service.

2006–51 I.R.B.

F. Notice under Section 101(m) of ERISA.
In addition to amending the Code and
ERISA to provide applicable individuals
with the divestiture rights discussed in
this notice, PPA ’06 also added section
101(m) to ERISA, which requires plans
to notify applicable individuals of these
rights. Specifically, plan administrators
must provide a notice to applicable individuals not later than 30 days before the
first date on which the individuals are eligible to exercise their rights. The notice
must set forth the diversification rights
provided under § 401(a)(35) and describe
the importance of diversifying the investment of retirement account assets. Section
101(m) of ERISA is effective for plan
years beginning after December 31, 2006.

Although some plans will be required
to comply with § 401(a)(35) as early as
January 1, 2007, the Department of Labor has advised Treasury and the Service
that section 101(m) of ERISA does not require plans to furnish notices before January 1, 2007. Pursuant to this interpretation, plans with plan years beginning on
or after January 1, 2007, but before February 1, 2007, are not required to furnish
the model notice included herein (or a notice otherwise meeting the requirements of
section 101(m) of ERISA) earlier than January 1, 2007. The Department, however,
encourages plans to furnish notice on the
earliest possible date.

G. Model Notice.
Section 507(c) of PPA ’06 directs the
Secretary of the Treasury to prescribe
a model notice for purposes of section
101(m) of ERISA3. The model below is
being issued pursuant to that directive.
The model may have to be adapted
to reflect particular plan provisions. For
example, changes would generally be necessary if either the plan has more than
one class of employer securities, the plan
provides the same diversification rights
for participants without regard to whether
they have three years of service, some of
the plan’s investment options are closed,
the plan receives participant elections
electronically, or the transition rule at
§ 401(a)(35)(H) is being applied.

Notice of Your Rights Concerning
Employer Securities
This notice informs you of an important change in Federal law that provides specific rights concerning investments in employer
securities (company stock). Because you may now or in the future have investments in company stock under the [insert name of
plan], you should take the time to read this notice carefully.
Your Rights Concerning Employer Securities
For plan years beginning after December 31, 2006, the Plan must allow you to elect to move any portion of your account that is
invested in company stock from that investment into other investment alternatives under the Plan. This right extends to all of the
company stock held under the Plan, except that it does not apply to your account balance attributable to [identify any accounts to
which the rights apply only after three years of service] until you have three years of service. [Insert description of any advance
notice requirement before a diversification election becomes effective.] You may contact the person identified below for specific
information regarding this new right, including how to make this election. In deciding whether to exercise this right, you will
want to give careful consideration to the information below that describes the importance of diversification. All of the investment
options under the Plan are available to you if you decide to diversify out of company stock.
The Importance of Diversifying Your Retirement Savings
To help achieve long-term retirement security, you should give careful consideration to the benefits of a well-balanced and
diversified investment portfolio. Spreading your assets among different types of investments can help you achieve a favorable rate
of return, while minimizing your overall risk of losing money. This is because market or other economic conditions that cause
one category of assets, or one particular security, to perform very well often cause another asset category, or another particular
security, to perform poorly. If you invest more than 20% of your retirement savings in any one company or industry, your
savings may not be properly diversified. Although diversification is not a guarantee against loss, it is an effective strategy to
help you manage investment risk.
In deciding how to invest your retirement savings, you should take into account all of your assets, including any retirement savings
outside of the Plan. No single approach is right for everyone because, among other factors, individuals have different financial
goals, different time horizons for meeting their goals, and different tolerances for risk. Therefore, you should carefully consider the
rights described in this notice and how these rights affect the amount of money that you invest in company stock through the Plan.
It is also important to periodically review your investment portfolio, your investment objectives, and the investment options under
the Plan to help ensure that your retirement savings will meet your retirement goals.
For More Information
If you have any questions about your rights under this new law, including how to make this election, contact [enter name
and contact information].

3

Section 101(m) of ERISA is under the jurisdiction of the Department of Labor.

2006–51 I.R.B.

1117

December 18, 2006

IV. REGULATIONS
The Service and Treasury plan to issue
regulations under § 401(a)(35) and those
regulations will be consistent with the transitional guidance issued in this notice.
V. COMMENTS REQUESTED
Comments
are
requested
on
§ 401(a)(35), including the issues
raised in Part III of this notice and issues
that should be addressed in regulations.
Any comments received on the notice
rules, including the model notice above,
will be provided to the Department of
Labor.
Written comments should be submitted
by March 18, 2007. Send submissions
to CC:PA:LPD:DRU (Notice 2006–107),
Room 5203, Internal Revenue Service,
POB 7604, Ben Franklin Station, Washington, D.C. 20044. Comments may be
hand delivered to CC:PA:LPD:DRU (Notice 2006–107), Room 5203, Internal Revenue Service, 1111 Constitution Avenue,
NW, Washington, DC. Alternatively, comments may be submitted via the Internet
at [email protected]
(Notice 2006–107). All comments will be
available for public inspection.
VI. Paperwork Reduction Act
The collection of information contained
in this notice has been reviewed and approved by the Office of Management and
Budget in accordance with the Paperwork
Reduction Act (44 U.S.C. 3507) under
control number 1545–2049. An agency
may not conduct or sponsor, and a person
is not required to respond to, a collection
of information unless the collection of
information displays a valid OMB control
number.
The collection of information in this notice is in the model notice provision of IIIF.
This information is required under section
507 of PPA’06. This information will be
used to allow individual plans to comply
with applicable law. The likely respondents are businesses or other for-profit institutions, and small businesses or organizations.
The estimated total annual reporting
and/or recordkeeping burden is 7,725
hours.
The estimated annual burden per respondent and/or recordkeeper varies from

December 18, 2006

1 minute to 3 hours, depending on individual circumstances, with an estimated average of 3/4’s of an hour. The estimated number of respondents and/or recordkeepers is
10,300.
The estimated frequency of responses is
occasional.
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.
DRAFTING INFORMATION
The principal drafter of this notice is
Robert Gertner of the Employee Plans,
Tax Exempt and Government Entities Division. For further information regarding
this notice, please contact the Employee
Plans’ taxpayer assistance telephone service at (877) 829–5500 (a toll-free number) between the hours of 8:30 a.m. and
4:30 p.m. Eastern Time, Monday through
Friday. Mr. Gertner may be reached at
(202) 283–9888 (not a toll-free number).

Application of the
Self-Employment
Contributions Act (SECA)
Tax to Payments Made by
the U.S. Department of
Agriculture (USDA) Under
the Conservation Reserve
Program (CRP)
Notice 2006–108
I. Overview and Purpose
This notice sets forth a proposed revenue ruling concerning the application of
the Self-Employment Contributions Act
(SECA) tax to payments made by the U.S.
Department of Agriculture (USDA) under
the Conservation Reserve Program (CRP),
16 U.S.C. 3831. CRP was authorized
in 1985. It is one of several programs
administered by the USDA that provide
payments in exchange for diverting land
from agricultural use to other uses.
The Service has previously issued
an announcement addressing the SECA

1118

tax treatment of payments made by the
USDA under land diversion programs.
Announcement 83–43, 1983–10 I.R.B.
29, provides guidance in a Question and
Answer format related to land diversion
programs sponsored by the USDA for
purposes of special use valuation under
section 2032A of the Code, estate tax deferral under section 6166 of the Code, and
the SECA tax. In Q&A 3, the Service
stated that a farmer who receives cash or
a payment in kind from the USDA for
participation in a land diversion program
is liable for self-employment tax on the
cash or payment in kind received. The announcement was consistent with guidance
provided in Rev. Rul. 60–32, 1960–1 C.B.
23, with respect to two earlier land diversion programs conducted under the Soil
Bank Act. Both the announcement and
the revenue ruling concluded that participants in the land diversion programs were
subject to SECA taxes on their payments
if the participants were otherwise operating a farm or materially participating in
the production of commodities on a farm
operated by others.
However, Rev. Rul. 60–32 also states
that participants in land diversion programs are not subject to SECA tax on the
payments, if they do not operate a farm or
materially participate in farming activities.
The material participation factor is relevant for SECA under these circumstances
only with respect to the exception from net
income from self-employment provided
in section 1402(a)(1) for rentals from real
property. Some taxpayers may have read
the reference to material participation as
implying that the rental exception could
potentially apply to payments under a land
diversion program.
More recently, the treatment of CRP
payments for purposes of SECA, and more
specifically, the potential application of the
rental exception under section 1402(a)(1)
was addressed by the Court of Appeals for
the Sixth Circuit in Wuebker v. Commissioner, 205 F.3d 897 (6th Cir. 2000). The
Court held that CRP payments were net income from self-employment because they
were received in exchange for performing tasks “that are intrinsic to the farming trade or business” such as tilling, seeding, fertilizing and weed control. Moreover, notwithstanding the fact that the CRP
statutes labeled the payments as “rent”, the
court concluded the payments are not rent

2006–51 I.R.B.