Td 9075

§602.101 OMB Control numbers.
*****
(b) * * *

CFR part or section where
identified and described

Current OMB
control No.

*****
1.66–4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1545–1770

*****
David A. Mader,
Commissioner for
Services and Enforcement.
Approved July 1, 2003.
Gregory F. Jenner,
Assistant Secretary of the Treasury.
(Filed by the Office of the Federal Register on July 9, 2003,
8:45 a.m., and published in the issue of the Federal Register
for July 10, 2003, 68 F.R. 41067)

Section 457.—Deferred
Compensation Plans of State
and Local Governments and
Tax-Exempt Organizations

SUPPLEMENTARY INFORMATION:

per application for approval as a custodian
with an estimated average of 35 hours for
each application submitted to qualify as a
custodian.
Comments concerning the accuracy
of this burden estimate and suggestions for reducing this burden should
be sent to the Internal Revenue Service,
Attn: IRS Reports Clearance Officer,
W:CAR:MP:T:T:SP, Washington, DC
20224, and 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.
Books or records relating to this 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.

Paperwork Reduction Act

Background

The collection of information contained in these final regulations 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
1545–1580. Responses to this collection
of information are mandatory.
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
control number assigned by the Office of
Management and Budget.
The estimated burden per respondent
varies from .033 hour to 2 hours per trust
established depending upon individual
respondents’ circumstances, with an estimated average of one hour for each trust
established, and from 20 hours to 50 hours

Section 131 of the Revenue Act of
1978 (92 Stat. 2779) added section 457
to the Internal Revenue Code of 1954.
On September 27, 1982, final regulations (T.D. 7836, 1982–2 C.B. 91 [47 FR
42335]) under section 457 (the 1982 regulations) were published in the Federal
Register. The 1982 regulations provided
guidance for complying with the changes
to the applicable tax law made by the
Revenue Act of 1978 relating to deferred
compensation plans maintained by state
and local governments and rural electric
cooperatives.
Section 1107 of the Tax Reform Act
of 1986 (100 Stat. 2494) extended section 457 to tax-exempt organizations. Section 6064 of the Technical and Miscellaneous Act of 1988 (102 Stat. 3700) codified certain exceptions for certain plans.

Creation and Worker Assistance Act of
2002, and other legislation. The regulations also make various technical changes
and clarifications to the existing final regulations on many discrete issues. These regulations provide the public with guidance
necessary to comply with the law and will
affect plan sponsors, administrators, participants, and beneficiaries.
DATES: Effective Date: July 11, 2003.
Applicability Date: These regulations
apply to taxable years beginning after December 31, 2001. See “Effective date of
the regulations” for additional information
concerning the applicability of these regulations.

26 CFR 1.457–1: General overviews of section 457.

FOR
FURTHER
INFORMATION
CONTACT: Cheryl Press, (202) 622–6060
(not a toll-free number).

T.D. 9075
DEPARTMENT OF
THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
Compensation Deferred Under
Eligible Deferred Compensation
Plans
AGENCY: Internal
(IRS), Treasury.

Revenue

Service

ACTION: Final regulations.
SUMMARY: This document contains final
regulations that provide guidance on deferred compensation plans of state and local governments and tax-exempt entities.
The regulations reflect the changes made
to section 457 by the Tax Reform Act of
1986, the Small Business Job Protection
Act of 1996, the Taxpayer Relief Act of
1997, the Economic Growth and Tax Relief Reconciliation Act of 2001, the Job

September 29, 2003

608

2003-39 I.R.B.

Notice 88–68, 1988–1 C.B. 556, addressed
the treatment of nonelective deferred compensation of nonemployees, and provided
an exception under which section 457 does
not to apply to certain church plans.
Section 1404 of the Small Business Job
Protection Act of 1996 (110 Stat. 1755)
added section 457(g) which requires that
section 457(b) plans maintained by state
and local government employers hold all
plan assets and income in trust, or in custodial accounts or annuity contracts (described in section 401(f) of the Internal
Revenue Code), for the exclusive benefit
of participants and beneficiaries.
Section 1071 of the Taxpayer Relief Act
of 1997 (111 Stat. 788) permits certain
accrued benefits to be cashed out.
Sections 615, 631, 632, 634, 635, 641,
647, and 649 of the Economic Growth
and Tax Relief Reconciliation Act of 2001
(EGTRRA) (115 Stat. 38) included increases in elective deferral limits, repeal of
the rules coordinating the section 457 plan
limit with contributions to certain other
types of plans, catch-up contributions for
individuals age 50 or over, extension of
qualified domestic relation order rules to
section 457 plans, rollovers among various qualified plans, section 403(b) contracts and individual retirement arrangements (IRAs), and transfers to purchase
service credits under governmental pension plans.
Section 411(o)(8) and (p)(5) of the Job
Creation and Worker Assistance Act of
2002 (116 Stat. 21) clarified certain provisions in EGTRRA concerning section 457
plans, including the use of certain compensation reduction elections to be taken
into account in determining includible
compensation.
On May 8, 2002, a notice of proposed
rulemaking (REG–105885–99, 2002–1
C.B. 1103 [67 FR 30826]) was published
in the Federal Register to issue new
regulations under section 457, including
amending the 1982 regulations to conform
them to the legislative changes that had
been made to section 457 since 1982.
Following publication of the proposed
regulations, comments were received and
a public hearing was held on August 28,
2002. After consideration of the comments received, the proposed regulations

2003-39 I.R.B.

are adopted by this Treasury decision, subject to a number of changes that are generally summarized below.
Summary of Comments Received and
Changes Made
1. Excess Deferrals
The proposed regulations addressed the
income tax treatment of excess deferrals
and the effect of excess deferrals on plan
eligibility under section 457(b). The proposed regulations provided that an eligible
governmental plan may self-correct and
distribute excess deferrals and continue
to satisfy the eligibility requirements of
section 457(b) (including the distribution
rules and the funding rules) by reason of a
distribution of excess deferrals. However,
the proposed regulations provided that if
an excess deferral arose under an eligible
plan of a tax-exempt employer, the plan
was no longer an eligible plan.
Commentators objected to the less favorable treatment for eligible plans of taxexempt employers.
After consideration of the comments received, the regulations extend self-correction for excess deferrals to eligible plans
of tax-exempt employers. If there is an excess deferral under such plan, the plan may
distribute to a participant any excess deferrals (and any income allocable to such
amount) not later than the first April 15 following the close of the taxable year of the
excess deferrals, comparable to the rules
for qualified plans under section 402(g).
In such a case, the plan will continue to
be treated as an eligible plan. However,
in accordance with section 457(c), any excess deferral is included in the gross income of a participant for the taxable year
of the excess deferral. If an excess deferral
is not corrected by distribution, the plan is
an ineligible plan under which benefits are
taxable in accordance with ineligible plan
rules.
The income tax treatment and payroll
tax reporting of distributions of excess
deferrals from eligible section 457(b)
governmental plans are similar to the
treatment and reporting of distribution of
excess deferrals from tax-qualified plans.
Such amounts should be reported on Form
1099 and taxed in the year of distribution
to the extent of distributed earnings on
the excess deferrals. For eligible section

609

457(b) tax-exempt plans, the excess deferrals are subject to income tax in the
year of distribution to the extent of distributed earnings on the excess deferrals
and such earnings should be reported on
Form W–2 for the year of distribution. See
also Notice 2003–20, 2003–19 I.R.B. 894,
for information regarding the withholding
and reporting requirements applicable to
eligible plans generally.
2. Aggregation Rules in the Proposed
Regulations
The proposed regulations included several rules that aggregate multiple plans for
purposes of meeting the eligibility requirements of section 457(b). These regulations retain all of these rules. For example, the regulations provide that in any case
in which multiple plans are used to avoid
or evade the eligibility requirements under the regulations, the Commissioner may
apply the eligibility requirements as if the
plans were a single plan. Also, an eligible employer is required to have no more
than one normal retirement age for each
participant under all of the eligible plans
it sponsors. In addition, all deferrals under
all eligible plans under which an individual participates by virtue of his or her relationship with a single employer are treated
as though deferred under a single plan for
purposes of determining excess deferrals.
Finally, annual deferrals under all eligible
plans are combined for purposes of determining the maximum deferral limits.
Few comments were received with respect to the aggregation rules under the
proposed regulations. However, one commentator requested that, where it is determined that multiple eligible plans maintained by a single employer, which have
been aggregated pursuant to the proposed
regulations, contain excess deferrals, the
employer have the ability to disaggregate
those plans solely for the purpose of either
(1) distributing the excess deferrals under
the self-correcting mechanism or (2) limiting the characterization of such plans as
"ineligible" to the one(s) that actually contain the excess deferrals. Taking into account the ability for all eligible plans to
self-correct by distribution, these regulations retain without material revision the
aggregation rules that were in the proposed
regulations.

September 29, 2003

3. Deferral of Sick, Vacation, and Back
Pay

5. Plan Terminations, Plan-to-Plan
Transfers, and Rollovers

The proposed regulations would have
allowed an eligible plan to permit participants to elect to defer compensation, including accumulated sick and vacation pay
and back pay, only if an agreement providing for the deferral is entered into before the beginning of the month in which
the amounts would otherwise be paid or
made available and the participant is an
employee in that month. Comments requested that terminating participants be allowed to elect deferral for accumulated
sick and vacation pay and back pay even if
the participant is not employed at the time
of the deferral.
The final regulations retain the rule under which the deferral election must be
made during employment and before the
beginning of the month when the compensation would have been payable. However,
the regulations include a special rule that
allows an election for sick pay, vacation
pay, or back pay that is not yet payable
(subject of course to the maximum deferral limitations of section 457 in the year of
deferral). Under the special rule, an employee who is retiring or otherwise having a severance from employment during a
month may nevertheless elect to defer, for
example, his or her unused vacation pay
after the beginning of the month, provided
that the vacation pay would otherwise have
been payable before the employee has a
severance from employment and the election is made before the date on which the
vacation pay would otherwise have been
payable.

The regulations include certain rules
regarding plan terminations, plan-to-plan
transfers, and rollovers. These topics have
been affected by the statutory changes
that impose a trust requirement on eligible
governmental plans. The direct rollovers
that were permitted by EGTRRA beginning in 2002 for eligible governmental
plans provide participants affected by
these types of events the ability to retain their retirement savings in a funded,
tax-deferred savings vehicle by rollover to
an IRA, qualified plan, or section 403(b)
contract. The regulations provide an outline for the different plan termination and
plan-to-plan transfer alternatives available
to sponsors of eligible governmental plans
in these situations.

4. Unforeseeable Emergency
Distributions
The proposed regulations added examples that would illustrate when an unforeseeable emergency occurred. In particular,
one example provided that the need to pay
for the funeral expenses of a family member may constitute an unforeseeable emergency. Several commentators requested
clarification in the final regulations of the
definition of family member. The regulations have been modified to define a family
member as a spouse or dependent as defined in section 152(a).

September 29, 2003

a. Plan terminations
The regulations allow a plan to have
provisions permitting plan termination
whereupon amounts can be distributed
without violating the distribution requirements of section 457. Under the regulations, an eligible plan is terminated only
if all amounts deferred under the plan are
paid to participants as soon as administratively practicable. If the amounts deferred
under the plan are not distributed, the plan
is treated as a frozen plan and must continue to comply with all of the applicable
statutory requirements necessary for plan
eligibility.
b. Plan-to-plan transfers among eligible
governmental plans and purchase of
permissive service credit by plan-to-plan
transfer
The proposed regulations would have
allowed plan-to-plan transfers between eligible governmental plans under new circumstances, as well as the purchase of permissive service credits by transfer from
an eligible governmental plan to a governmental defined benefit plan, but only if the
transfers were made by plans within the
same state. Commentators objected to the
requirement under the new transfer rules
that the transfers be to plans within the
same state.
Upon consideration of the comments
received, the regulations allow transfers
among eligible governmental plans in

610

three situations. In each case, the transferor plan must provide for transfers, the
receiving plan must provide for the receipt of transfers, and the participant or
beneficiary whose amounts deferred are
being transferred must be entitled to an
amount deferred immediately after the
transfer that is at least equal to the amount
deferred with respect to that participant
or beneficiary immediately before the
transfer. Transfers are permitted among
eligible governmental plans in the following three cases:

•

A person-by-person transfer is permitted for any beneficiary and for any
participant who has had a severance
from employment with the transferring
employer and is performing services
for the entity maintaining the receiving
plan (whether or not the other plan is
within the same state).

•

No severance from employment is required if the entire plan’s assets for all
participants and beneficiaries are transferred to another eligible governmental
plan within the same state.

•

No severance from employment is required for a transfer from one eligible
governmental plan of an employer to
another eligible governmental plan of
the same employer.
The final regulations also allow a
plan-to-plan transfer from an eligible governmental plan to a governmental defined
benefit plan for permissive service credit,
without regard to whether the defined
benefit plan is maintained by a governmental entity that is in the same state. In
addition, language that was in an example
which implied that section 415(n) (which
addresses the application of maximum
benefit limitations with respect to certain
contributions) might apply to such a transfer has been eliminated because Treasury
and the IRS have concluded that section
415(n) does not apply to such a transfer
in any case in which the actuarial value
of the benefit increase that results from
the transfer does not exceed the amount
transferred.
c. Plan-to-plan transfers among eligible
plans of tax-exempt entities
The regulations retain the rule from the
1982 regulations allowing a plan-to-plan

2003-39 I.R.B.

transfer after a participant has had a severance from employment.
d. Rollovers
The proposed regulations specified
the treatment of amounts rolled into or
out of an eligible governmental plan and
stated that amounts rolled into the plan
are treated as amounts deferred under
the plan for purposes of the regulations.
Some commentators requested that consideration be given to allowing eligible
governmental plans to have the same flexibility that they claimed was permitted for
qualified plans with respect to the timing
of distributions of rolled-in assets. Specifically, these commentators requested the
ability for an eligible governmental plan
to allow a participant to receive a distribution of rolled-in assets even though the
participant may not yet be eligible for
a distribution of other assets held under
the plan. Commentators pointed out that,
since section 402(c)(10) allows an eligible
governmental plan to accept a rollover
contribution only if the rolled-in assets
from other plan types are separately accounted for (in order to apply the section
72(t) early withdrawal income tax for distributions from these assets), this ability
should not cause administrative problems
for plan sponsors. Commentators also
asserted that the flexibility to design an
eligible governmental plan to permit such
distributions would be beneficial to its
participants.
These regulations do not permit an
eligible governmental plan to distribute
rolled-in assets to a participant who is not
yet eligible for a distribution until future
guidance of general applicability is published that addresses this issue. Treasury
and the IRS intend to issue, in the near
future, guidance of general applicability
resolving this issue in coordination with
the applicable rules for qualified plans and
section 403(b) contracts.
Commentators also requested clarification on the order of accounts for partial
distributions to participants who have
rolled-in assets that are subject to the early
withdrawal income tax. They requested
that consideration be given in final regulations to clarifying that the participant may
be treated as receiving a partial distribution

first from other plan assets to minimize the
early withdrawal income tax that would
otherwise apply. These regulations clarify
that, if a rollover is received by an eligible
governmental plan from an IRA, qualified
plan, or section 403(b) contract, then distributions from the eligible governmental
plan are subject to the early withdrawal
income tax in accordance with the plan’s
method of accounting, i.e., for purposes
of applying the section 72(t) early withdrawal income tax, a distribution is treated
as made from an eligible governmental
plan’s separate account for rollovers from
an IRA, qualified plan, or section 403(b)
contract only if the plan accounts for the
distribution as a distribution from that
account. Thus, for example, an eligible
governmental plan may provide that any
unforeseeable emergency withdrawal is
made from other accounts to the extent
possible, in which event the early withdrawal tax will not apply assuming that
the plan only debits such other accounts to
reflect the distribution.
The proposed regulations had requested comments on the issue of separate
accounting for rolled-in amounts and
asked if there are any special characteristics that would be lost if multiple types
of separate accounts were not maintained.
Commentators asked for the regulations
to permit maintenance of a single rollover
account for all amounts that are rolled
into the eligible governmental plan. These
regulations require separate accounting
only to the extent mandated by section
402(c)(10), i.e., only for rollovers from
IRAs, qualified plans and section 403(b)
contracts. Section 72(t)(9) provides that
the early withdrawal income tax applies to
distributions from rollovers attributable to
IRAs, qualified plans, and section 403(b)
contracts. Thus, if an eligible governmental plan accepts a rollover from another
eligible governmental plan of an amount
that was originally deferred under an eligible governmental plan and commingles
that rollover in the same separate account
that includes a rollover amount from an
IRA, qualified plan, or section 403(b) contract, then distributions from that account
will be subject to the early withdrawal
income tax. Accordingly, in order to avoid
this result, eligible governmental plans

may choose to establish three separate
accounts for a participant even though
these regulations only require that a single
separate rollover account be maintained
for all amounts that are rolled into an eligible governmental plan: first, an account
for all amounts deferred under that plan;
second, an account for any rollover from
another eligible governmental plan (disregarding any amounts that originated from
an IRA, qualified plan, or section 403(b)
contract); and third, an account for any
rollover amount from an IRA, qualified
plan, or section 403(b) contract (including
any amounts rolled over from another
eligible governmental plan that originated
from an IRA, qualified plan, or section
403(b) contract). These regulations include an example illustrating that the early
withdrawal income tax would not apply to
a partial distribution from a plan with such
accounts assuming that the plan debits
either of the first two such other accounts
to reflect the distribution.
6. Ineligible Plans
The proposed regulations included
guidance regarding ineligible plans under
section 457(f). Section 457(f) generally
provides that, in the case of an agreement or arrangement for the deferral of
compensation, the deferred compensation is included in gross income when
deferred or, if later, when the rights to
payment of the deferred compensation
cease to be subject to a substantial risk of
forfeiture. Section 457(f) was in section
457 when it was added to the Code in
1978 for governmental employees, and
extended to employees of tax-exempt
organizations (other than churches or certain church-controlled organizations) in
1986, because unfunded amounts held by
a tax-exempt entity compound tax free
like an eligible plan, a qualified plan, or
a section 403(b) contract. Section 457(f)
was viewed as essential in order to provide an incentive for employers that are
not subject to income taxes to adopt an
eligible plan, a qualified plan, or a section
403(b) contract.1
Section 457(f) does not apply to an
eligible plan, a qualified plan, a section
403(b) contract, a section 403(c) contract,
a transfer of property described in section

1

See generally the Report to the Congress on the Tax Treatment of Deferred Compensation under Section 457, Department of the Treasury, January 1992 (available from the Office of Tax
Policy, Room 5315, Treasury Department, 1500 Pennsylvania Avenue, NW, Washington DC 20220).

2003-39 I.R.B.

611

September 29, 2003

83, a trust to which section 402(b) applies, or a qualified governmental excess
benefit arrangement described in section
415(m). The proposed regulations stated
that section 457(f) applies if the date on
which there is no substantial risk of forfeiture with respect to the compensation
deferred precedes the date on which there
is a transfer of property to which section
83 applies. The proposed regulations
included several examples, including an
example illustrating that section 457(f)
does not fail to apply merely because benefits are subsequently paid by a transfer
of property. Comments were requested on
the coordination of sections 457(f) and 83
under the proposed regulations.
In response, a number of commentators
objected to the proposed coordination of
sections 457(f) and 83, including arguing
that the proposed regulation would place
tax-exempt organizations at a competitive
disadvantage when it comes to attracting
and retaining executive talent because it
would effectively eliminate the use of discounted mutual fund options as a tax effective component of total compensation.
Some commentators also asserted that the
proposed regulations were ambiguous as
to their applicability to steeply discounted
mutual fund options, and recommended
that, if the provision is not removed, at a
minimum future guidance should be more
specific.
The final regulations retain the interpretation of the coordination of sections
457(f) and 83 that was in the proposed regulations, and also clarify the application
of the rule by adding an example involving an option grant. The regulations also
include a clarification that, when benefits
are paid or made available under an ineligible plan, the amount included in gross income is equal to the amount paid or made
available, but only to the extent that the
amount exceeds the amount the participant
included in gross income when he or she
obtained a vested right to the benefit.
7. Severance Pay and Other Exceptions
In 2000, the IRS issued Announcement
2000–1, 2000–1 C.B. 294, which provided
interim guidance on certain broad-based,
nonelective plans of a state or local government that were in existence before
1999. Comments were requested on arrangements, such as those maintained

September 29, 2003

by certain state or local governmental
educational institutions, under which supplemental compensation is payable as an
incentive to terminate employment, or as
an incentive to retain retirement-eligible
employees, to ensure an appropriate workforce during periods in which a temporary
surplus or deficit in workforce is anticipated. Treasury and the IRS continue to
be interested in receiving comments on
this issue, which should be sent to the
following address: Internal Revenue Service, Attn: CC:DOM:CORP:R (Section
457 Plans), Room 5201, P. O. Box 7604,
Ben Franklin Station, Washington, D.C.
20044. Written comments may be hand
delivered Monday through Friday between
8 a.m. and 4 p.m. to: Internal Revenue
Service, Courier’s Desk, Attn: CC:PA:RU
(Section 457 Plans), 1111 Constitution
Avenue, NW, Washington, DC 20224.
Alternatively, written comments may be
submitted electronically via the Internet
by selecting the “Tax Regs” option on
the IRS Home Page, or by submitting
them directly to the IRS Internet site at:
http://www.irs.gov/tax_regs/reglist.html.
Comments should be received by October
9, 2003.
8. Effective Date of the Regulations
The proposed regulations included a
general effective date under which the
regulations would have applied to taxable years beginning after December 31,
2001. This is the general effective date
for the changes made in section 457 by
EGTRRA. Commentators did not express
concern about this effective date and some
commentators also stated that eligible
governmental plans have adopted plan
amendments to address the changes that
have been allowed by EGTRRA, so that
it would be appropriate to have the final
regulations effective date coincide with
the effective date for EGTRRA.
These regulations are generally applicable to taxable years beginning after December 31, 2001, subject to certain specific transition rules. Under one of these
transition rules, for taxable years beginning after December 31, 2001, and before
January 1, 2004, a plan will not fail to be an
eligible plan if it is operated in accordance
with a reasonable, good faith interpretation
of section 457(b). Whether a plan is operated in accordance with a reasonable, good

612

faith interpretation of section 457(b) will
generally be determined based on all of the
relevant facts and circumstances, including
the extent to which the employer has resolved unclear issues in its favor. The regulations state that a plan will be deemed
to be operated in accordance with a reasonable, good faith interpretation of section 457(b) if it is operated in accordance
with the terms of these regulations. The
IRS will also deem a plan to be operated in
accordance with a reasonable, good faith
interpretation of section 457(b) if it is operated in accordance with the terms of the
1982 regulations as in effect for taxable
years beginning before January 1, 2002 (to
the extent those 1982 regulations are consistent with subsequent changes in law, including EGTRRA) or in accordance with
the terms of the 2001 proposed regulations.
However, a plan will be deemed not to be
operated in accordance with a reasonable,
good faith interpretation of section 457(b)
if it is operated in a manner that is inconsistent with the terms of the 1982 regulations as in effect for taxable years beginning before January 1, 2002 (to the extent those 1982 regulations are consistent
with subsequent changes in law, including
EGTRRA), except to the extent permitted
under either these final regulations or the
2001 proposed regulations.
Further, there is a special delayed effective date for the rule under which an eligible governmental plan cannot distribute
rollover account benefits to a participant
who is not yet eligible for a distribution.
Thus, this rule is not applicable until years
beginning after December 31, 2003, since
this issue is expected to be resolved before
that date.
The regulations also retain the rule in
the proposed regulations under which the
regulations do not apply with respect to
an option that lacked a readily ascertainable fair market value (within the meaning of section 83(e)(3)) at grant that was
granted on or before May 8, 2002. Thus,
the status of such an option under section
457(f) would be determined without regard
to these regulations.
Special Analyses
It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment

2003-39 I.R.B.

is not required. It has also been determined
that section 553(b) of the Administrative
Procedure Act (5 U.S.C. chapter 5) does
not apply to these regulations. 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. The collection of
information in the regulations is in section
1.457–8(a)(3)(ii)(B) and consists of the requirement that a custodian of a custodial
account may be a person other than a bank
only if the person demonstrates to the satisfaction of the Commissioner that the manner in which the person will administer the
custodial account will be consistent with
the requirement of section 457(g)(1) and
(3) of the Code. This certification is based
on the fact that the cost of submitting this
information is small, even for small entities. Therefore, a Regulatory Flexibility
Analysis under the Regulatory Flexibility
Act (5 U.S.C. chapter 6) is not required.
Pursuant to section 7805(f) of the Code,
the notice of proposed rulemaking preceding these regulations was submitted to the
Chief Counsel for Advocacy of the Small
Business Administration for comment on
its impact on small business.
*****
Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 *
Par. 2. Sections 1.457–1, 1.457–2,
1.457–3 and 1.457–4 are revised to read as
follows:
§1.457–1 General overviews of section
457.
Section 457 provides rules for nonqualified deferred compensation plans established by eligible employers as defined
under §1.457–2(d). Eligible employers
can establish either deferred compensation
plans that are eligible plans and that meet
the requirements of section 457(b) and
§§1.457–3 through 1.457–10, or deferred
compensation plans or arrangements that
do not meet the requirements of section
457(b) and §§1.457–3 through 1.457–10

2003-39 I.R.B.

and that are subject to tax treatment under
section 457(f) and §1.457–11.
§1.457–2 Definitions.
This section sets forth the definitions
that are used under §§1.457–1 through
1.457–11.
(a) Amount(s) deferred. Amount(s) deferred means the total annual deferrals under an eligible plan in the current and prior
years, adjusted for gain or loss. Except
as provided at §§1.457–4(c)(1)(iii) and
1.457–6(a), amount(s) deferred includes
any rollover amount held by an eligible
plan as provided under §1.457–10(e).
(b) Annual deferral(s)—(1) Annual deferral(s) means, with respect to a taxable
year, the amount of compensation deferred
under an eligible plan, whether by salary
reduction or by nonelective employer contribution. The amount of compensation deferred under an eligible plan is taken into
account as an annual deferral in the taxable
year of the participant in which deferred,
or, if later, the year in which the amount of
compensation deferred is no longer subject
to a substantial risk of forfeiture.
(2) If the amount of compensation deferred under the plan during a taxable year
is not subject to a substantial risk of forfeiture, the amount taken into account as
an annual deferral is not adjusted to reflect
gain or loss allocable to the compensation
deferred. If, however, the amount of compensation deferred under the plan during
the taxable year is subject to a substantial risk of forfeiture, the amount of compensation deferred that is taken into account as an annual deferral in the taxable
year in which the substantial risk of forfeiture lapses must be adjusted to reflect gain
or loss allocable to the compensation deferred until the substantial risk of forfeiture
lapses.
(3) If the eligible plan is a defined benefit plan within the meaning of section
414(j), the annual deferral for a taxable
year is the present value of the increase
during the taxable year of the participant’s
accrued benefit that is not subject to a
substantial risk of forfeiture (disregarding
any such increase attributable to prior annual deferrals). For this purpose, present
value must be determined using actuarial
assumptions and methods that are reasonable (both individually and in the aggregate), as determined by the Commissioner.

613

(4) For purposes solely of applying
§ 1.457–4 to determine the maximum
amount of the annual deferral for a participant for a taxable year under an eligible
plan, the maximum amount is reduced by
the amount of any deferral for the participant under a plan described at paragraph
(k)(4)(i) of this section (relating to certain plans in existence before January 1,
1987) as if that deferral were an annual
deferral under another eligible plan of the
employer.
(c) Beneficiary. Beneficiary means a
person who is entitled to benefits in respect
of a participant following the participant’s
death or an alternate payee as described in
§1.457–10(c).
(d) Catch-up. Catch-up amount or
catch-up limitation for a participant for
a taxable year means the annual deferral permitted under section 414(v) (as
described in §1.457–4(c)(2)) or section
457(b)(3) (as described in §1.457–4(c)(3))
to the extent the amount of the annual
deferral for the participant for the taxable
year is permitted to exceed the plan ceiling applicable under section 457(b)(2) (as
described in §1.457–4(c)(1)).
(e) Eligible employer. Eligible employer means an entity that is a state that
establishes a plan or a tax-exempt entity
that establishes a plan. The performance
of services as an independent contractor for a state or local government or a
tax-exempt entity is treated as the performance of services for an eligible employer. The term eligible employer does
not include a church as defined in section
3121(w)(3)(A), a qualified church-controlled organization as defined in section
3121(w)(3)(B), or the federal government
or any agency or instrumentality thereof.
Thus, for example, a nursing home which
is associated with a church, but which is
not itself a church (as defined in section
3121(w)(3)(A)) or a qualified church-controlled organization as defined in section
3121(w)(3)(B)), would be an eligible
employer if it is a tax-exempt entity as
defined in paragraph (m) of this section.
(f) Eligible plan. An eligible plan
is a plan that meets the requirements of
§§1.457–3 through 1.457–10 that is established and maintained by an eligible
employer. An eligible governmental plan
is an eligible plan that is established and
maintained by an eligible employer as
defined in paragraph (l) of this section.

September 29, 2003

An arrangement does not fail to constitute a single eligible governmental plan
merely because the arrangement is funded
through more than one trustee, custodian,
or insurance carrier. An eligible plan of a
tax-exempt entity is an eligible plan that is
established and maintained by an eligible
employer as defined in paragraph (m) of
this section.
(g) Includible compensation. Includible compensation of a participant means,
with respect to a taxable year, the participant’s compensation, as defined in section
415(c)(3), for services performed for the
eligible employer. The amount of includible compensation is determined without
regard to any community property laws.
(h) Ineligible plan. Ineligible plan
means a plan established and maintained
by an eligible employer that is not maintained in accordance with §§1.457–3
through 1.457–10. A plan that is not
established by an eligible employer as
defined in paragraph (e) of this section is
neither an eligible nor an ineligible plan.
(i) Nonelective employer contribution.
A nonelective employer contribution is
a contribution made by an eligible employer for the participant with respect to
which the participant does not have the
choice to receive the contribution in cash
or property. Solely for purposes of section
457 and §§1.457–2 through 1.457–11,
the term nonelective employer contribution includes employer contributions that
would be described in section 401(m) if
they were contributions to a qualified plan.
(j) Participant. Participant in an eligible plan means an individual who is currently deferring compensation, or who has
previously deferred compensation under
the plan by salary reduction or by nonelective employer contribution and who has not
received a distribution of his or her entire
benefit under the eligible plan. Only individuals who perform services for the eligible employer, either as an employee or as
an independent contractor, may defer compensation under the eligible plan.
(k) Plan. Plan includes any agreement
or arrangement between an eligible employer and a participant or participants (including an individual employment agreement) under which the payment of compensation is deferred (whether by salary
reduction or by nonelective employer contribution). The following types of plans

September 29, 2003

are not treated as agreements or arrangements under which compensation is deferred: a bona fide vacation leave, sick
leave, compensatory time, severance pay,
disability pay, or death benefit plan described in section 457(e)(11)(A)(i) and any
plan paying length of service awards to
bona fide volunteers (and their beneficiaries) on account of qualified services performed by such volunteers as described
in section 457(e)(11)(A)(ii). Further, the
term plan does not include any of the following (and section 457 and §§1.457–2
through 1.457–11 do not apply to any of
the following)—
(1) Any nonelective deferred compensation under which all individuals (other
than those who have not satisfied any applicable initial service requirement) with
the same relationship with the eligible
employer are covered under the same plan
with no individual variations or options
under the plan as described in section
457(e)(12), but only to the extent the
compensation is attributable to services
performed as an independent contractor;
(2) An agreement or arrangement described in §1.457–11(b);
(3) Any plan satisfying the conditions
in section 1107(c)(4) of the Tax Reform
Act of 1986 (100 Stat. 2494) (TRA ’86)
(relating to certain plans for state judges);
and
(4) Any of the following plans or arrangements (to which specific transitional
statutory exclusions apply)—
(i) A plan or arrangement of a tax-exempt entity in existence prior to January 1, 1987, if the conditions of section
1107(c)(3)(B) of the TRA ’86, as amended
by section 1011(e)(6) of the Technical and
Miscellaneous Revenue Act of 1988 (102
Stat. 3700) (TAMRA), are satisfied (see
§1.457–2(b)(4) for a special rule regarding
such plan);
(ii) A collectively bargained nonelective deferred compensation plan in effect
on December 31, 1987, if the conditions
of section 6064(d)(2) of TAMRA are satisfied;
(iii) Amounts described in section
6064(d)(3) of TAMRA (relating to certain nonelective deferred compensation
arrangements in effect before 1989); and

614

(iv) Any plan satisfying the conditions
in section 1107(c)(4) or (5) of TRA ’86 (relating to certain plans for certain individuals with respect to which the Service issued
guidance before 1977).
(l) State. State means a state (treating
the District of Columbia as a state as provided under section 7701(a)(10)), a political subdivision of a state, and any agency
or instrumentality of a state.
(m) Tax-exempt entity. Tax-exempt entity includes any organization exempt from
tax under subtitle A of the Internal Revenue Code, except that a governmental unit
(including an international governmental
organization) is not a tax-exempt entity.
(n) Trust. Trust means a trust described
under section 457(g) and §1.457–8. Custodial accounts and contracts described in
section 401(f) are treated as trusts under
the rules described in §1.457–8(a)(2).
§ 1.457–3 General introduction to eligible
plans.
(a) Compliance in form and operation.
An eligible plan is a written plan established and maintained by an eligible employer that is maintained, in both form and
operation, in accordance with the requirements of §§1.457–4 through 1.457–10. An
eligible plan must contain all the material terms and conditions for benefits under the plan. An eligible plan may contain
certain optional features not required for
plan eligibility under section 457(b), such
as distributions for unforeseeable emergencies, loans, plan-to-plan transfers, additional deferral elections, acceptance of
rollovers to the plan, and distributions of
smaller accounts to eligible participants.
However, except as otherwise specifically
provided in §§1.457–4 through 1.457–10,
if an eligible plan contains any optional
provisions, the optional provisions must
meet, in both form and operation, the relevant requirements under section 457 and
§§1.457–2 through 1.457–10.
(b) Treatment as single plan. In any
case in which multiple plans are used
to avoid or evade the requirements of
§§1.457–4 through 1.457–10, the Commissioner may apply the rules under
§§1.457–4 through 1.457–10 as if the
plans were a single plan.
See also
§1.457–4(c)(3)(v) (requiring an eligible employer to have no more than one
normal retirement age for each participant

2003-39 I.R.B.

under all of the eligible plans it sponsors),
the second sentence of §1.457–4(e)(2)
(treating deferrals under all eligible plans
under which an individual participates
by virtue of his or her relationship with
a single employer as a single plan for
purposes of determining excess deferrals),
and §1.457–5 (combining annual deferrals
under all eligible plans).
§1.457–4 Annual deferrals, deferral
limitations, and deferral agreements
under eligible plans.
(a) Taxation of annual deferrals. Annual deferrals that satisfy the requirements
of paragraphs (b) and (c) of this section are
excluded from the gross income of a participant in the year deferred or contributed
and are not includible in gross income until paid to the participant in the case of an
eligible governmental plan, or until paid or
otherwise made available to the participant
in the case of an eligible plan of a tax-exempt entity. See §1.457–7.
(b) Agreement for deferral. In order to
be an eligible plan, the plan must provide
that compensation may be deferred for any
calendar month by salary reduction only if
an agreement providing for the deferral has
been entered into before the first day of the
month in which the compensation is paid
or made available. A new employee may
defer compensation payable in the calendar month during which the participant
first becomes an employee if an agreement
providing for the deferral is entered into on
or before the first day on which the participant performs services for the eligible employer. An eligible plan may provide that if
a participant enters into an agreement providing for deferral by salary reduction under the plan, the agreement will remain in
effect until the participant revokes or alters
the terms of the agreement. Nonelective
employer contributions are treated as being made under an agreement entered into
before the first day of the calendar month.
(c) Maximum deferral limitations—(1)
Basic annual limitation. (i) Except as described in paragraphs (c)(2) and (3) of this
section, in order to be an eligible plan, the
plan must provide that the annual deferral
amount for a taxable year (the plan ceiling)
may not exceed the lesser of—
(A) The applicable annual dollar
amount specified in section 457(e)(15):
$11,000 for 2002; $12,000 for 2003;

2003-39 I.R.B.

$13,000 for 2004; $14,000 for 2005; and
$15,000 for 2006 and thereafter. After
2006, the $15,000 amount is adjusted for
cost-of-living in the manner described in
paragraph (c)(4) of this section; or
(B) 100 percent of the participant’s includible compensation for the taxable year.
(ii) The amount of annual deferrals permitted by the 100 percent of includible
compensation limitation under paragraph
(c)(1)(i)(B) of this section is determined
under section 457(e)(5) and §1.457–2(g).
(iii) For purposes of determining the
plan ceiling under this paragraph (c), the
annual deferral amount does not include
any rollover amounts received by the eligible plan under §1.457–10(e).
(iv) The provisions of this paragraph
(c)(1) are illustrated by the following examples:
Example 1 (i) Facts. Participant A, who earns
$14,000 a year, enters into a salary reduction agreement in 2006 with A’s eligible employer and elects to
defer $13,000 of A’s compensation for that year. A
is not eligible for the catch-up described in paragraph
(c)(2) or (3) of this section, participates in no other
retirement plan, and has no other income exclusions
taken into account in computing includible compensation.
(ii) Conclusion. The annual deferral limit for A
in 2006 is the lesser of $15,000 or 100 percent of includible compensation, $14,000. A’s annual deferral
of $13,000 is permitted under the plan because it is
not in excess of $14,000 and thus does not exceed 100
percent of A’s includible compensation.
Example 2. (i) Facts. Assume the same facts
as in Example 1, except that A’s eligible employer
provides an immediately vested, matching employer
contribution under the plan for participants who
make salary reduction deferrals under A’s eligible
plan. The matching contribution is equal to 100
percent of elective contributions, but not in excess of
10 percent of compensation (in A’s case, $1,400).
(ii) Conclusion. Participant A’s annual deferral
exceeds the limitations of this paragraph (c)(1). A’s
maximum deferral limitation in 2006 is $14,000. A’s
salary reduction deferral of $13,000 combined with
A’s eligible employer’s nonelective employer contribution of $1,400 exceeds the basic annual limitation
of this paragraph (c)(1) because A’s annual deferrals
total $14,400. A has an excess deferral for the taxable
year of $400, the amount exceeding A’s permitted annual deferral limitation. The $400 excess deferral is
treated as described in paragraph (e) of this section.
Example 3. (i) Facts. Beginning in year 2002,
Eligible Employer X contributes $3,000 per year for
five years to B’s eligible plan account. B’s interest in
the account vests in 2006. B has annual compensation
of $50,000 in each of the five years 2002 through
2006. B is 41 years old. B is not eligible for the
catch-up described in paragraph (c)(2) or (3) of this
section, participates in no other retirement plan, and
has no other income exclusions taken into account
in computing includible compensation. Adjusted for

615

gain or loss, the value of B’s benefit when B’s interest
in the account vests in 2006 is $17,000.
(ii) Conclusion. Under this vesting schedule,
$17,000 is taken into account as an annual deferral
in 2006. B’s annual deferrals under the plan are
limited to a maximum of $15,000 in 2006. Thus,
the aggregate of the amounts deferred, $17,000, is
in excess of B’s maximum deferral limitation by
$2,000. The $2,000 is treated as an excess deferral
described in paragraph (e) of this section.

(2) Age 50 catch-up—(i) In general. In
accordance with section 414(v) and the
regulations thereunder, an eligible governmental plan may provide for catch-up
contributions for a participant who is age
50 by the end of the year, provided that
such age 50 catch-up contributions do
not exceed the catch-up limit under section 414(v)(2) for the taxable year. The
maximum amount of age 50 catch-up contributions for a taxable year under section
414(v) is as follows: $1,000 for 2002;
$2,000 for 2003; $3,000 for 2004; $4,000
for 2005; and $5,000 for 2006 and thereafter. After 2006, the $5,000 amount is
adjusted for cost-of-living. For additional
guidance, see regulations under section
414(v).
(ii) Coordination with special section
457 catch-up. In accordance with sections
414(v)(6)(C) and 457(e)(18), the age 50
catch-up described in this paragraph (c)(2)
does not apply for any taxable year for
which a higher limitation applies under the
special section 457 catch-up under paragraph (c)(3) of this section. Thus, for purposes of this paragraph (c)(2)(ii) and paragraph (c)(3) of this section, the special section 457 catch-up under paragraph (c)(3)
of this section applies for any taxable year
if and only if the plan ceiling taking into
account paragraph (c)(1) of this section
and the special section 457 catch-up described in paragraph (c)(3) of this section
(and disregarding the age 50 catch-up described in this paragraph (c)(2)) is larger
than the plan ceiling taking into account
paragraph (c)(1) of this section and the age
50 catch-up described in this paragraph
(c)(2) (and disregarding the special section
457 catch-up described in paragraph (c)(3)
of this section). Thus, if a plan so provides,
a participant who is eligible for the age 50
catch-up for a year and for whom the year
is also one of the participant’s last three
taxable years ending before the participant
attains normal retirement age is eligible for
the larger of—

September 29, 2003

(A) The plan ceiling under paragraph
(c)(1) of this section and the age 50
catch-up described in this paragraph (c)(2)
(and disregarding the special section 457
catch-up described in paragraph (c)(3) of
this section) or
(B) The plan ceiling under paragraph
(c)(1) of this section and the special section
457 catch-up described in paragraph (c)(3)
of this section (and disregarding the age
50 catch-up described in this paragraph
(c)(2)).
(iii) Examples. The provisions of this
paragraph (c)(2) are illustrated by the following examples:
Example 1. (i) Facts. Participant C, who is 55, is
eligible to participate in an eligible governmental plan
in 2006. The plan provides a normal retirement age
of 65. The plan provides limitations on annual deferrals up to the maximum permitted under paragraphs
(c)(1) and (3) of this section and the age 50 catch-up
described in this paragraph (c)(2). For 2006, C will
receive compensation of $40,000 from the eligible
employer. C desires to defer the maximum amount
possible in 2006. The applicable basic dollar limit of
paragraph (c)(1)(i)(A) of this section is $15,000 for
2006 and the additional dollar amount permitted under the age 50 catch-up is $5,000 for 2006.
(ii) Conclusion. C is eligible for the age 50
catch-up in 2006 because C is 55 in 2006. However,
C is not eligible for the special section 457 catch-up
under paragraph (c)(3) of this section in 2006 because
2006 is not one of the last three taxable years ending
before C attains normal retirement age. Accordingly,
the maximum that C may defer for 2006 is $20,000.
Example 2. (i) Facts. The facts are the same as
in Example 1, except that, in 2006, C will attain age
62. The maximum amount that C can elect under the
special section 457 catch-up under paragraph (c)(3)
of this section is $2,000 for 2006.
(ii) Conclusion. The maximum that C may defer
for 2006 is $20,000. This is the sum of the basic plan
ceiling under paragraph (c)(1) of this section equal to
$15,000 and the age 50 catch-up equal to $5,000. The
special section 457 catch-up under paragraph (c)(3)
of this section is not applicable since it provides a
smaller plan ceiling.
Example 3. (i) Facts. The facts are the same as
in Example 2, except that the maximum additional
amount that C can elect under the special section
457 catch-up under paragraph (c)(3) of this section
is $7,000 for 2006.
(ii) Conclusion. The maximum that C may defer
for 2006 is $22,000. This is the sum of the basic plan
ceiling under paragraph (c)(1) of this section equal
to $15,000, plus the additional special section 457
catch-up under paragraph (c)(3) of this section equal
to $7,000. The additional dollar amount permitted
under the age 50 catch-up is not applicable to C for
2006 because it provides a smaller plan ceiling.

(3) Special section 457 catch-up—(i)
In general. Except as provided in paragraph (c)(2)(ii) of this section, an eligible plan may provide that, for one or more
of the participant’s last three taxable years

September 29, 2003

ending before the participant attains normal retirement age, the plan ceiling is an
amount not in excess of the lesser of—
(A) Twice the dollar amount in effect
under paragraph (c)(1)(i)(A) of this section; or
(B) The underutilized limitation determined under paragraph (c)(3)(ii) of this
section.
(ii) Underutilized limitation. The underutilized amount determined under this
paragraph (c)(3)(ii) is the sum of—
(A) The plan ceiling established under
paragraph (c)(1) of this section for the taxable year; plus
(B) The plan ceiling established under
paragraph (c)(1) of this section (or under
section 457(b)(2) for any year before the
applicability date of this section) for any
prior taxable year or years, less the amount
of annual deferrals under the plan for such
prior taxable year or years (disregarding
any annual deferrals under the plan permitted under the age 50 catch-up under paragraph (c)(2) of this section).
(iii) Determining underutilized limitation under paragraph (c)(3)(ii)(B) of this
section. A prior taxable year is taken into
account under paragraph (c)(3)(ii)(B) of
this section only if it is a year beginning
after December 31, 1978, in which the participant was eligible to participate in the
plan, and in which compensation deferred
(if any) under the plan during the year was
subject to a plan ceiling established under
paragraph (c)(1) of this section. This paragraph (c)(3)(iii) is subject to the special
rules in paragraph (c)(3)(iv) of this section.
(iv) Special rules concerning application of the coordination limit for years
prior to 2002 for purposes of determining
the underutilized limitation—(A) General
rule. For purposes of determining the
underutilized limitation for years prior
to 2002, participants remain subject to
the rules in effect prior to the repeal of
the coordination limitation under section
457(c)(2). Thus, the applicable basic
annual limitation under paragraph (c)(1)
of this section and the special section
457 catch-up under this paragraph (c)(3)
for years in effect prior to 2002 are reduced, for purposes of determining a
participant’s underutilized amount under
a plan, by amounts excluded from the
participant’s income for any prior taxable
year by reason of a nonelective employer

616

contribution, salary reduction or elective
contribution under any other eligible section 457(b) plan, or a salary reduction
or elective contribution under any 401(k)
qualified cash or deferred arrangement,
section 402(h)(1)(B) simplified employee
pension (SARSEP), section 403(b) annuity contract, and section 408(p) simple
retirement account, or under any plan for
which a deduction is allowed because of a
contribution to an organization described
in section 501(c)(18) (pre-2002 coordination plans). Similarly, in applying the
section 457(b)(2)(B) limitation for includible compensation for years prior to
2002, the limitation is 331/3 percent of the
participant’s compensation includible in
gross income.
(B) Coordination limitation applied to
participant. For purposes of determining
the underutilized limitation for years prior
to 2002, the coordination limitation applies to pre-2002 coordination plans of all
employers for whom a participant has performed services, whether or not those are
plans of the participant’s current eligible
employer. Thus, for purposes of determining the amount excluded from a participant’s gross income in any prior taxable
year under paragraph (c)(3)(ii)(B) of this
section, the participant’s annual deferrals
under an eligible plan, and salary reduction or elective deferrals under all other
pre-2002 coordination plans, must be determined on an aggregate basis. To the extent that the combined deferrals for years
prior to 2002 exceeded the maximum deferral limitations, the amount is treated as
an excess deferral under paragraph (e) of
this section for those prior years.
(C) Special rule where no annual deferrals under the eligible plan. A participant who, although eligible, did not
defer any compensation under the eligible plan in any year before 2002 is not
subject to the coordinated deferral limit,
even though the participant may have deferred compensation under one of the other
pre-2002 coordination plans. An individual is treated as not having deferred compensation under an eligible plan for a prior
taxable year if all annual deferrals under
the plan are distributed in accordance with
paragraph (e) of this section. Thus, to
the extent that a participant participated
solely in one or more of the other pre-2002
coordination plans during a prior taxable

2003-39 I.R.B.

year (and not the eligible plan), the participant is not subject to the coordinated limitation for that prior taxable year. However, the participant is treated as having deferred an amount in a prior taxable year,
for purposes of determining the underutilized limitation for that prior taxable year
under this paragraph (c)(3)(iv)(C), to the
extent of the participant’s aggregate salary
reduction contributions and elective deferrals under all pre-2002 coordination plans
up to the maximum deferral limitations in
effect under section 457(b) for that prior
taxable year. To the extent an employer
did not offer an eligible plan to an individual in a prior given year, no underutilized
limitation is available to the individual for
that prior year, even if the employee subsequently becomes eligible to participate in
an eligible plan of the employer.
(D) Examples. The provisions of this
paragraph (c)(3)(iv) are illustrated by the
following examples:
Example 1. (i) Facts. In 2001 and in years prior to
2001, Participant D earned $50,000 a year and was eligible to participate in both an eligible plan and a section 401(k) plan. However, D had always participated
only in the section 401(k) plan and had always deferred the maximum amount possible. For each year
before 2002, the maximum amount permitted under
section 401(k) exceeded the limitation of paragraph
(c)(3)(i) of this section. In 2002, D is in the 3-year
period prior to D’s attainment of the eligible plan’s
normal retirement age of 65, and D now wants to participate in the eligible plan and make annual deferrals
of up to $30,000 under the plan’s special section 457
catch-up provisions.
(ii) Conclusion. Participant D is treated as
having no underutilized amount under paragraph
(c)(3)(ii)(B) of this section for 2002 for purposes of
the catch-up limitation under section 457(b)(3) and
paragraph (c)(3) of this section because, in each of
the years before 2002, D has deferred an amount
equal to or in excess of the limitation of paragraph
(c)(3)(i) of this section under all of D’s coordinated
plans.
Example 2. (i) Facts. Assume the same facts as
in Example 1, except that D only deferred $2,500 per
year under the section 401(k) plan for one year before
2002.
(ii) Conclusion. D is treated as having an underutilized amount under paragraph (c)(3)(ii)(B) of this
section for 2002 for purposes of the special section
457 catch-up limitation. This is because D has deferred an amount for prior years that is less than the
limitation of paragraph (c)(1)(i) of this section under
all of D’s coordinated plans.
Example 3. (i) Facts. Participant E, who earned
$15,000 for 2000, entered into a salary reduction
agreement in 2000 with E’s eligible employer and
elected to defer $3,000 for that year under E’s
eligible plan. For 2000, E’s eligible employer provided an immediately vested, matching employer
contribution under the plan for participants who

2003-39 I.R.B.

make salary reduction deferrals under E’s eligible
plan. The matching contribution was equal to 67
percent of elective contributions, but not in excess of
10 percent of compensation before salary reduction
deferrals (in E’s case, $1,000). For 2000, E was not
eligible for any catch-up contribution, participated in
no other retirement plan, and had no other income
exclusions taken into account in computing taxable
compensation.
(ii) Conclusion. Participant E’s annual deferral
equaled the maximum limitation of section 457(b)
for 2000. E’s maximum deferral limitation in 2000
was $4,000 because E’s includible compensation was
$12,000 ($15,000 minus the deferral of $3,000) and
the applicable limitation for 2000 was one third of
the individual’s includible compensation (one-third
of $12,000 equals $4,000). E’s salary reduction
deferral of $3,000 combined with E’s eligible employer’s matching contribution of $1,000 equals the
limitation of section 457(b) for 2000 because E’s
annual deferrals totaled $4,000. E’s underutilized
amount for 2000 is zero.

(v) Normal retirement age—(A) General rule. For purposes of the special section 457 catch-up in this paragraph (c)(3),
a plan must specify the normal retirement
age under the plan. A plan may define normal retirement age as any age that is on
or after the earlier of age 65 or the age at
which participants have the right to retire
and receive, under the basic defined benefit pension plan of the state or tax-exempt
entity (or a money purchase pension plan
in which the participant also participates
if the participant is not eligible to participate in a defined benefit plan), immediate retirement benefits without actuarial or
similar reduction because of retirement before some later specified age, and that is
not later than age 701/2. Alternatively, a
plan may provide that a participant is allowed to designate a normal retirement age
within these ages. For purposes of the special section 457 catch-up in this paragraph
(c)(3), an entity sponsoring more than one
eligible plan may not permit a participant
to have more than one normal retirement
age under the eligible plans it sponsors.
(B) Special rule for eligible plans of
qualified police or firefighters. An eligible
plan with participants that include qualified police or firefighters as defined under
section 415(b)(2)(H)(ii)(I) may designate
a normal retirement age for such qualified
police or firefighters that is earlier than
the earliest normal retirement age designated under the general rule of paragraph
(c)(3)(i)(A) of this section, but in no event
may the normal retirement age be earlier

617

than age 40. Alternatively, a plan may allow a qualified police or firefighter participant to designate a normal retirement age
that is between age 40 and age 701/2.
(vi) Examples. The provisions of this
paragraph (c)(3) are illustrated by the following examples:
Example 1. (i) Facts. Participant F, who will turn
61 on April 1, 2006, becomes eligible to participate
in an eligible plan on January 1, 2006. The plan provides a normal retirement age of 65. The plan provides limitations on annual deferrals up to the maximum permitted under paragraphs (c)(1) through (3)
of this section. For 2006, F will receive compensation of $40,000 from the eligible employer. F desires
to defer the maximum amount possible in 2006. The
applicable basic dollar limit of paragraph (c)(1)(i)(A)
of this section is $15,000 for 2006 and the additional
dollar amount permitted under the age 50 catch-up in
paragraph (c)(2) of this section for an individual who
is at least age 50 is $5,000 for 2006.
(ii) Conclusion. F is not eligible for the special
section 457 catch-up under paragraph (c)(3) of this
section in 2006 because 2006 is not one of the last
three taxable years ending before F attains normal
retirement age. Accordingly, the maximum that F
may defer for 2006 is $20,000. See also paragraph
(c)(2)(iii) Example 1 of this section.
Example 2. (i) Facts. The facts are the same as
in Example 1 except that, in 2006, F elects to defer
only $2,000 under the plan (rather than the maximum
permitted amount of $20,000). In addition, assume
that the applicable basic dollar limit of paragraph
(c)(1)(i)(A) of this section continues to be $15,000
for 2007 and the additional dollar amount permitted
under the age 50 catch-up in paragraph (c)(2) of
this section for an individual who is at least age 50
continues to be $5,000 for 2007. In F’s taxable year
2007, which is one of the last three taxable years
ending before F attains the plan’s normal retirement
age of 65, F again receives a salary of $40,000 and
elects to defer the maximum amount permissible
under the plan’s catch-up provisions prescribed
under paragraph (c) of this section.
(ii) Conclusion. For 2007, which is one of the last
three taxable years ending before F attains the plan’s
normal retirement age of 65, the applicable limit on
deferrals for F is the larger of the amount under the
special section 457 catch-up or $20,000, which is
the basic annual limitation ($15,000) and the age 50
catch-up limit of section 414(v) ($5,000). For 2007,
F’s special section 457 catch-up amount is the lesser
of two times the basic annual limitation ($30,000) or
the sum of the basic annual limitation ($15,000) plus
the $13,000 underutilized limitation under paragraph
(c)(3)(ii) of this section (the $15,000 plan ceiling in
2006, minus the $2,000 contributed for F in 2006), or
$28,000. Thus, the maximum amount that F may defer in 2007 is $28,000.
Example 3. (i) Facts. The facts are the same as
in Examples 1 and 2, except that F does not make
any contributions to the plan before 2010. In addition, assume that the applicable basic dollar limitation of paragraph (c)(1)(i)(A) of this section continues to be $15,000 for 2010 and the additional dollar
amount permitted under the age 50 catch-up in paragraph (c)(2) of this section for an individual who is at
least age 50 continues to be $5,000 for 2010. In F’s

September 29, 2003

taxable year 2010, the year in which F attains age 65
(which is the normal retirement age under the plan), F
desires to defer the maximum amount possible under
the plan. F’s compensation for 2010 is again $40,000.
(ii) Conclusion. For 2010, the maximum amount
that F may defer is $20,000. The special section
457 catch-up provisions under paragraph (c)(3) of this
section are not applicable because 2010 is not a taxable year ending before the year in which F attains
normal retirement age.

(4) Cost-of-living adjustment.
For
years beginning after December 31, 2006,
the $15,000 dollar limitation in paragraph
(c)(1)(i)(A) of this section will be adjusted to take into account increases in
the cost-of-living. The adjustment in the
dollar limitation is made at the same time
and in the same manner as under section
415(d) (relating to qualified plans under
section 401(a)), except that the base period is the calendar quarter beginning July
1, 2005, and any increase which is not a
multiple of $500 will be rounded to the
next lowest multiple of $500.
(d) Deferral of sick, vacation, and back
pay under an eligible plan—(1) In general.
An eligible plan may provide that a participant may elect to defer accumulated sick
pay, accumulated vacation pay, and back
pay under an eligible plan if the requirements of section 457(b) are satisfied. For
example, the plan must provide, in accordance with paragraph (b) of this section,
that these amounts may be deferred for any
calendar month only if an agreement providing for the deferral is entered into before the beginning of the month in which
the amounts would otherwise be paid or
made available and the participant is an
employee in that month. In the case of accumulated sick pay, vacation pay, or back
pay that is payable before the participant
has a severance from employment, the requirements of the preceding sentence are
deemed to be satisfied if the agreement
providing for the deferral is entered into
before the amount is currently available
(as defined in regulations under section
401(k)).
(2) Examples. The provisions of this
paragraph (d) are illustrated by the following examples:
Example 1. (i) Facts. Participant G, who is age 62
in 2003, is an employee who participates in an eligible
plan providing a normal retirement age of 65. Under
the terms of G’s employer’s eligible plan and G’s sick
leave plan, G may, during November of 2003 (which
is one of the three years prior to normal retirement
age), make a one-time election to contribute amounts
representing accumulated sick pay to the eligible plan

September 29, 2003

in December of 2003 (within the maximum deferral
limitations). Alternatively, such amounts may remain
in the “bank” under the sick leave plan. No cash out
of the sick pay is available until the month in which
a participant ceases to be employed by the employer.
The total value of G’s accumulated sick pay (determined, in accordance with the terms of the sick leave
plan, by reference to G’s current salary) is $4,000 in
December of 2003.
(ii) Conclusion. Under the terms of the eligible
plan and sick leave plan, G may elect before December of 2003 to defer the $4,000 value of accumulated
sick pay under the eligible plan, provided that G’s
other annual deferrals to the eligible plan for 2003,
when added to the $4,000, do not exceed G’s maximum deferral limitation for the year.
Example 2. (i) Facts. Same facts as in Example
1, except that G will separate from service on January
17, 2004, and elects, on January 4, 2004, to defer
G’s accumulated sick and vacation pay (which totals
$12,000) that is payable on January 15, 2004.
(ii) Conclusion. G may elect before January 15,
2004, to defer the accumulated sick and vacation pay
under the eligible plan, even if the election is made after the beginning of January, because the agreement
providing for the deferral is entered into before the
amount is currently available and G does not cease to
be an employee before the amount is currently available. G will have $12,000 of includible compensation
in 2004 because the deferral is taken into account in
the definition of includible compensation.
Example 3. (i) Facts. Employer X maintains an
eligible plan and a vacation leave plan. Under the
terms of the vacation leave plan, employees generally accrue three weeks of vacation per year. Up to
one week’s unused vacation may be carried over from
one year to the next, so that in any single year an employee may have a maximum of four weeks vacation
time. At the beginning of each calendar year, under
the terms of the eligible plan (which constitutes an
agreement providing for the deferral), the value of any
unused vacation time from the prior year in excess of
one week is automatically contributed to the eligible
plan, to the extent of the employee’s maximum deferral limitations. Amounts in excess of the maximum
deferral limitations are forfeited.
(ii) Conclusion. The value of the unused vacation pay contributed to X’s eligible plan pursuant to
the terms of the plan and the terms of the vacation
leave plan is treated as an annual deferral to the eligible plan in the calendar year the contribution is made.
No amounts contributed to the eligible plan will be
considered made available to a participant in X’s eligible plan.

(e) Excess deferrals under an eligible
plan—(1) In general. Any amount deferred under an eligible plan for the taxable
year of a participant that exceeds the maximum deferral limitations set forth in paragraphs (c)(1) through (3) of this section,
and any amount that exceeds the individual limitation under §1.457–5, constitutes
an excess deferral that is taxable in accordance with §1.457–11 for that taxable year.
Thus, an excess deferral is includible in
gross income in the taxable year deferred

618

or, if later, the first taxable year in which
there is no substantial risk of forfeiture.
(2) Excess deferrals under an eligible
governmental plan other than as a result of
the individual limitation. In order to be an
eligible governmental plan, the plan must
provide that any excess deferral resulting
from a failure of a plan to apply the limitations of paragraphs (c)(1) through (3) of
this section to amounts deferred under the
eligible plan (computed without regard to
the individual limitation under §1.457–5)
will be distributed to the participant, with
allocable net income, as soon as administratively practicable after the plan determines that the amount is an excess deferral. For purposes of determining whether
there is an excess deferral resulting from
a failure of a plan to apply the limitations of paragraphs (c)(1) through (3) of
this section, all plans under which an individual participates by virtue of his or
her relationship with a single employer are
treated as a single plan (without regard to
any differences in funding). An eligible
governmental plan does not fail to satisfy
the requirements of paragraphs (a) through
(d) of this section or §§1.457–6 through
1.457–10 (including the distribution rules
under §1.457–6 and the funding rules under §1.457–8) solely by reason of a distribution made under this paragraph (e)(2).
If such excess deferrals are not corrected
by distribution under this paragraph (e)(2),
the plan will be an ineligible plan under
which benefits are taxable in accordance
with §1.457–11.
(3) Excess deferrals under an eligible
plan of a tax-exempt employer other than
as a result of the individual limitation.
If a plan of a tax-exempt employer fails
to comply with the limitations of paragraphs (c)(1) through (3) of this section,
the plan will be an ineligible plan under
which benefits are taxable in accordance
with §1.457–11. However, a plan may distribute to a participant any excess deferrals
(and any income allocable to such amount)
not later than the first April 15 following
the close of the taxable year of the excess
deferrals. In such a case, the plan will
continue to be treated as an eligible plan.
However, any excess deferral is included
in the gross income of a participant for the
taxable year of the excess deferral. If the
excess deferrals are not corrected by distribution under this paragraph (e)(3), the plan
is an ineligible plan under which benefits

2003-39 I.R.B.

are taxable in accordance with §1.457–11.
For purposes of determining whether there
is an excess deferral resulting from a failure of a plan to apply the limitations of
paragraphs (c)(1) through (3) of this section, all eligible plans under which an individual participates by virtue of his or
her relationship with a single employer are
treated as a single plan.
(4) Excess deferrals arising from application of the individual limitation. An
eligible plan may provide that an excess
deferral that is a result solely of a failure to comply with the individual limitation under §1.457–5 for a taxable year may
be distributed to the participant, with allocable net income, as soon as administratively practicable after the plan determines that the amount is an excess deferral. An eligible plan does not fail to satisfy
the requirements of paragraphs (a) through
(d) of this section or §§1.457–6 through
1.457–10 (including the distribution rules
under §1.457–6 and the funding rules under §1.457–8) solely by reason of a distribution made under this paragraph (e)(4).
Although a plan will still maintain eligible
status if excess deferrals are not distributed
under this paragraph (e)(4), a participant
must include the excess amounts in income
as provided in paragraph (e)(1) of this section.
(5) Examples. The provisions of this
paragraph (e) are illustrated by the following examples:
Example 1. (i) Facts. In 2006, the eligible plan of
State Employer X in which Participant H participates
permits a maximum deferral of the lesser of $15,000
or 100 percent of includible compensation. In 2006,
H, who has compensation of $28,000, nevertheless
defers $16,000 under the eligible plan. Participant H
is age 45 and normal retirement age under the plan
is age 65. For 2006, the applicable dollar limit under
paragraph (c)(1)(i)(A) of this section is $15,000. Employer X discovers the error in January of 2007 when
it completes H’s 2006 Form W–2 and promptly distributes $1,022 to H (which is the sum of the $1,000
excess and $22 of allocable net income).
(ii) Conclusion. Participant H has deferred
$1,000 in excess of the $15,000 limitation provided
for under the plan for 2006. The $1,000 excess must
be included by H in H’s income for 2006. In order
to correct the failure and still be an eligible plan,
the plan must distribute the excess deferral, with
allocable net income, as soon as administratively
practicable after determining that the amount exceeds
the plan deferral limitations. In this case, $22 of the
distribution of $1,022 is included in H’s gross income
for 2007 (and is not an eligible rollover distribution).
If the excess deferral were not distributed, the plan
would be an ineligible plan with respect to which
benefits are taxable in accordance with §1.457–11.

2003-39 I.R.B.

Example 2. (i) Facts. The facts are the same as
in Example 1, except that X uses a number of separate arrangements with different trustees and annuity
insurers to permit employees to defer and H elects
deferrals under several of the funding arrangements
none of which exceeds $15,000 for any individual
funding arrangement, but which total $16,000.
(ii) Conclusion. The conclusion is the same as in
Example 1.
Example 3. (i) Facts. The facts are the same as in
Example 1, except that H’s deferral under the eligible
plan is limited to $11,000 and H also makes a salary
reduction contribution of $5,000 to an annuity contract under section 403(b) with the same Employer
X.
(ii) Conclusion. H’s deferrals are within the plan
deferral limitations of Employer X. Because of the
repeal of the application of the coordination limitation under former paragraph (2) of section 457(c), H’s
salary reduction deferrals under the annuity contract
are no longer considered in determining H’s applicable deferral limits under paragraphs (c)(1) through (3)
of this section.
Example 4. (i) Facts. The facts are the same as
in Example 1, except that H’s deferral under the eligible governmental plan is limited to $14,000 and H
also makes a deferral of $4,000 to an eligible governmental plan of a different employer. Participant H is
age 45 and normal retirement age under both eligible
plans is age 65.
(ii) Conclusion. Because of the application of the
individual limitation under §1.457–5, H has an excess
deferral of $3,000 (the sum of $14,000 plus $4,000
equals $18,000, which is $3,000 in excess of the dollar limitation of $15,000). The $3,000 excess deferral, with allocable net income, may be distributed
from either plan as soon as administratively practicable after determining that the combined amount exceeds the deferral limitations. If the $3,000 excess
deferral is not distributed to H, each plan will continue to be an eligible plan, but the $3,000 must be
included by H in H’s income for 2006.
Example 5. (i) Facts. Assume the same facts
as in Example 3, except that H’s deferral under the
eligible governmental plan is limited to $14,000 and
H also makes a deferral of $4,000 to an eligible plan
of Employer Y, a tax-exempt entity.
(ii) Conclusion. The results are the same as in
Example 3, namely, because of the application of the
individual limitation under §1.457–5, H has an excess
deferral of $3,000. If the $3,000 excess deferral is
not distributed to H, each plan will continue to be an
eligible plan, but the $3,000 must be included by H
in H’s income for 2006.
Example 6. (i) Facts. Assume the same facts as in
Example 5, except that X is a tax-exempt entity and
thus its plan is an eligible plan of a tax-exempt entity.
(ii) Conclusion. The results are the same as in
Example 5, namely, because of the application of the
individual limitation under §1.457–5, H has an excess
deferral of $3,000. If the $3,000 excess deferral is
not distributed to H, each plan will continue to be an
eligible plan, but the $3,000 must be included by H
into H’s income for 2006.

Par. 3. Sections 1.457–5 through
1.457–12 are added to read as follows:

619

§1.457–5 Individual limitation for
combined annual deferrals under multiple
eligible plans.
(a) General rule. The individual limitation under section 457(c) and this section
equals the basic annual deferral limitation under §1.457–4(c)(1)(i)(A), plus
either the age 50 catch-up amount under
§1.457–4(c)(2), or the special section 457
catch-up amount under §1.457–4(c)(3),
applied by taking into account the combined annual deferral for the participant
for any taxable year under all eligible
plans. While an eligible plan may include
provisions under which it will limit deferrals to meet the individual limitation under
section 457(c) and this section, annual
deferrals by a participant that exceed the
individual limit under section 457(c) and
this section (but do not exceed the limits
under § 1.457–4(c)) will not cause a plan
to lose its eligible status. However, to the
extent the combined annual deferrals for a
participant for any taxable year exceed the
individual limitation under section 457(c)
and this section for that year, the amounts
are treated as excess deferrals as described
in §1.457–4(e).
(b) Limitation applied to participant.
The individual limitation in this section
applies to eligible plans of all employers
for whom a participant has performed
services, including both eligible governmental plans and eligible plans of a
tax-exempt entity and both eligible plans
of the employer and eligible plans of
other employers. Thus, for purposes of
determining the amount excluded from
a participant’s gross income in any taxable year (including the underutilized
limitation under §1.457–4(c)(3)(ii)(B)),
the participant’s annual deferral under
an eligible plan, and the participant’s
annual deferrals under all other eligible
plans, must be determined on an aggregate
basis. To the extent that the combined
annual deferral amount exceeds the maximum deferral limitation applicable under
§1.457–4(c)(1)(i)(A), (c)(2), or (c)(3), the
amount is treated as an excess deferral
under §1.457–4(e).
(c) Special rules for catch-up amounts
under multiple eligible plans. For purposes of applying section 457(c) and this
section, the special section 457 catch-up
under §1.457–4(c)(3) is taken into account only to the extent that an annual

September 29, 2003

deferral is made for a participant under
an eligible plan as a result of plan provisions permitted under §1.457–4(c)(3). In
addition, if a participant has annual deferrals under more than one eligible plan
and the applicable catch-up amount under
§1.457–4(c)(2) or (3) is not the same for
each such eligible plan for the taxable
year, section 457(c) and this section are
applied using the catch-up amount under
whichever plan has the largest catch-up
amount applicable to the participant.
(d) Examples. The provisions of this
section are illustrated by the following examples:
Example 1. (i) Facts. Participant F is age 62 in
2006 and participates in two eligible plans during
2006, Plans J and K, which are each eligible plans
of two different governmental entities. Each plan
includes provisions allowing the maximum annual
deferral permitted under §1.457–4(c)(1) through
(3). For 2006, the underutilized amount under
§1.457–4(c)(3)(ii)(B) is $20,000 under Plan J and is
$40,000 under Plan K. Normal retirement age is age
65 under both plans. Participant F defers $15,000
under each plan. Participant F’s includible compensation is in each case in excess of the deferral.
Neither plan designates the $15,000 contribution as a
catch-up permitted under each plan’s special section
457 catch-up provisions.
(ii) Conclusion. For purposes of applying this
section to Participant F for 2006, the maximum exclusion is $20,000. This is equal to the sum of $15,000
plus $5,000, which is the age 50 catch-up amount.
Thus, F has an excess amount of $10,000 which is
treated as an excess deferral for Participant F for 2006
under §1.457–4(e).
Example 2. (i) Facts. Participant E, who will turn
63 on April 1, 2006, participates in four eligible plans
during 2006. Plan W which is an eligible governmental plan; and Plans X, Y, and Z which are each eligible plans of three different tax-exempt entities. For
2006, the limitation that applies to Participant E under
all four plans under §1.457–4(c)(1)(i)(A) is $15,000.
For 2006, the additional age 50 catch-up limitation
that applies to Participant E under all four plans under
§1.457–4(c)(2) is $5,000. Further, for 2006, different
limitations under §1.457–4(c)(3) and (c)(3)(ii)(B) apply to Participant E under each of these plans, as follows: under Plan W, the underutilized limitation under §1.457–4(c)(3)(ii)(B) is $7,000; under Plan X, the
underutilized limitation under §1.457–4(c)(3)(ii)(B)
is $2,000; under Plan Y, the underutilized limitation
under §1.457–4(c)(3)(ii)(B) is $8,000; and under Plan
Z, §1.457–4(c)(3) is not applicable since normal retirement age is age 62 under Plan Z. Participant E’s
includible compensation is in each case in excess of
any applicable deferral.
(ii) Conclusion. For purposes of applying this
section to Participant E for 2006, Participant E could
elect to defer $23,000 under Plan Y, which is the
maximum deferral limitation under §1.457–4(c)(1)
through (3), and to defer no amount under Plans W,
X, and Z. The $23,000 maximum amount is equal to
the sum of $15,000 plus $8,000, which is the catch-up
amount applicable to Participant E under Plan Y and

September 29, 2003

which is the largest catch-up amount applicable to
Participant E under any of the four plans for 2006. Alternatively, Participant E could instead elect to defer
the following combination of amounts: an aggregate
total of $20,000 to any of the four plans; or $22,000
to Plan W and none to any of the other three plans.
(iii) If the underutilized amount under Plans W, X,
and Y for 2006 were in each case zero (because E had
always contributed the maximum amount or E was a
new participant) or an amount not in excess of $5,000,
the maximum exclusion under this section would be
$20,000 for Participant E for 2006 ($15,000 plus the
$5,000 age 50 catch-up amount), which Participant E
could contribute to any of the plans.

§1.457–6 Timing of distributions under
eligible plans.
(a) In general. Except as provided in
paragraph (c) of this section (relating to
distributions on account of an unforeseeable emergency), paragraph (e) of this section (relating to distributions of small accounts), §1.457–10(a) (relating to plan terminations), or §1.457–10(c) (relating to
domestic relations orders), amounts deferred under an eligible governmental plan
may not be paid to a participant or beneficiary before the participant has a severance
from employment with the eligible employer or when the participant attains age
701/2 , if earlier. For rules relating to loans,
see paragraph (f) of this section. This section does not apply to distributions of excess amounts under §1.457–4(e). However, except to the extent set forth by the
Commissioner in revenue rulings, notices,
and other guidance published in the Internal Revenue Bulletin, this section applies
to amounts held in a separate account for
eligible rollover distributions maintained
by an eligible governmental plan as described in §1.457–10(e)(2).
(b) Severance from employment—(1)
Employees. An employee has a severance from employment with the eligible
employer if the employee dies, retires,
or otherwise has a severance from employment with the eligible employer. See
regulations under section 401(k) for additional guidance concerning severance
from employment.
(2) Independent contractors—(i) In
general. An independent contractor is
considered to have a severance from employment with the eligible employer upon
the expiration of the contract (or in the
case of more than one contract, all contracts) under which services are performed
for the eligible employer if the expiration

620

constitutes a good-faith and complete
termination of the contractual relationship. An expiration does not constitute a
good faith and complete termination of
the contractual relationship if the eligible employer anticipates a renewal of a
contractual relationship or the independent contractor becoming an employee.
For this purpose, an eligible employer is
considered to anticipate the renewal of
the contractual relationship with an independent contractor if it intends to contract
again for the services provided under the
expired contract, and neither the eligible
employer nor the independent contractor
has eliminated the independent contractor
as a possible provider of services under
any such new contract. Further, an eligible employer is considered to intend to
contract again for the services provided
under an expired contract if the eligible
employer’s doing so is conditioned only
upon incurring a need for the services, the
availability of funds, or both.
(ii) Special rule. Notwithstanding paragraph (b)(2)(i) of this section, the plan is
considered to satisfy the requirement described in paragraph (a) of this section that
no amounts deferred under the plan be paid
or made available to the participant before the participant has a severance from
employment with the eligible employer if,
with respect to amounts payable to a participant who is an independent contractor,
an eligible plan provides that—
(A) No amount will be paid to the participant before a date at least 12 months after the day on which the contract expires
under which services are performed for the
eligible employer (or, in the case of more
than one contract, all such contracts expire); and
(B) No amount payable to the participant on that date will be paid to the participant if, after the expiration of the contract
(or contracts) and before that date, the participant performs services for the eligible
employer as an independent contractor or
an employee.
(c) Rules applicable to distributions
for unforeseeable emergencies—(1) In
general. An eligible plan may permit a
distribution to a participant or beneficiary
faced with an unforeseeable emergency.
The distribution must satisfy the requirements of paragraph (c)(2) of this section.
(2) Requirements—(i) Unforeseeable
emergency defined. An unforeseeable

2003-39 I.R.B.

emergency must be defined in the plan
as a severe financial hardship of the participant or beneficiary resulting from an
illness or accident of the participant or
beneficiary, the participant’s or beneficiary’s spouse, or the participant’s or
beneficiary’s dependent (as defined in
section 152(a)); loss of the participant’s
or beneficiary’s property due to casualty
(including the need to rebuild a home
following damage to a home not otherwise
covered by homeowner’s insurance, e.g.,
as a result of a natural disaster); or other
similar extraordinary and unforeseeable
circumstances arising as a result of events
beyond the control of the participant or
the beneficiary. For example, the imminent foreclosure of or eviction from
the participant’s or beneficiary’s primary
residence may constitute an unforeseeable
emergency. In addition, the need to pay
for medical expenses, including non-refundable deductibles, as well as for the
cost of prescription drug medication, may
constitute an unforeseeable emergency.
Finally, the need to pay for the funeral
expenses of a spouse or a dependent
(as defined in section 152(a)) may also
constitute an unforeseeable emergency.
Except as otherwise specifically provided
in this paragraph (c)(2)(i), the purchase of
a home and the payment of college tuition
are not unforeseeable emergencies under
this paragraph (c)(2)(i).
(ii) Unforeseeable emergency distribution standard. Whether a participant or
beneficiary is faced with an unforeseeable
emergency permitting a distribution under this paragraph (c) is to be determined
based on the relevant facts and circumstances of each case, but, in any case, a
distribution on account of unforeseeable
emergency may not be made to the extent that such emergency is or may be relieved through reimbursement or compensation from insurance or otherwise, by liquidation of the participant’s assets, to the
extent the liquidation of such assets would
not itself cause severe financial hardship,
or by cessation of deferrals under the plan.
(iii) Distribution necessary to satisfy
emergency need. Distributions because of
an unforeseeable emergency must be limited to the amount reasonably necessary to
satisfy the emergency need (which may include any amounts necessary to pay any
federal, state, or local income taxes or

2003-39 I.R.B.

penalties reasonably anticipated to result
from the distribution).
(d) Minimum required distributions for
eligible plans. In order to be an eligible
plan, a plan must meet the distribution requirements of section 457(d)(1) and (2).
Under section 457(d)(2), a plan must meet
the minimum distribution requirements of
section 401(a)(9). See section 401(a)(9)
and the regulations thereunder for these
requirements. Section 401(a)(9) requires
that a plan begin lifetime distributions to a
participant no later than April 1 of the calendar year following the later of the calendar year in which the participant attains
age 701/2 or the calendar year in which the
participant retires.
(e) Distributions of smaller accounts—(1) In general.
An eligible
plan may provide for a distribution of
all or a portion of a participant’s benefit if this paragraph (e)(1) is satisfied.
This paragraph (e)(1) is satisfied if the
participant’s total amount deferred (the
participant’s total account balance) which
is not attributable to rollover contributions
(as defined in section 411(a)(11)(D)) is
not in excess of the dollar limit under
section 411(a)(11)(A), no amount has
been deferred under the plan by or for
the participant during the two-year period
ending on the date of the distribution,
and there has been no prior distribution
under the plan to the participant under
this paragraph (e). An eligible plan is not
required to permit distributions under this
paragraph (e).
(2) Alternative provisions possible.
Consistent with the provisions of paragraph (e)(1) of this section, a plan may
provide that the total amount deferred
for a participant or beneficiary will be
distributed automatically to the participant or beneficiary if the requirements of
paragraph (e)(1) of this section are met.
Alternatively, if the requirements of paragraph (e)(1) of this section are met, the
plan may provide for the total amount deferred for a participant or beneficiary to be
distributed to the participant or beneficiary
only if the participant or beneficiary so
elects. The plan is permitted to substitute
a specified dollar amount that is less than
the total amount deferred. In addition,
these two alternatives can be combined;
for example, a plan could provide for
automatic distributions for up to $500, but
allow a participant or beneficiary to elect

621

a distribution if the total account balance
is above $500.
(f) Loans from eligible plans—(1) Eligible plans of tax-exempt entities. If a participant or beneficiary receives (directly or
indirectly) any amount deferred as a loan
from an eligible plan of a tax-exempt entity, that amount will be treated as having
been paid or made available to the individual as a distribution under the plan, in violation of the distribution requirements of
section 457(d).
(2) Eligible governmental plans. The
determination of whether the availability
of a loan, the making of a loan, or a failure to repay a loan made from a trustee (or
a person treated as a trustee under section
457(g)) of an eligible governmental plan to
a participant or beneficiary is treated as a
distribution (directly or indirectly) for purposes of this section, and the determination
of whether the availability of the loan, the
making of the loan, or a failure to repay the
loan is in any other respect a violation of
the requirements of section 457(b) and the
regulations, depends on the facts and circumstances. Among the facts and circumstances are whether the loan has a fixed
repayment schedule and bears a reasonable rate of interest, and whether there are
repayment safeguards to which a prudent
lender would adhere. Thus, for example,
a loan must bear a reasonable rate of interest in order to satisfy the exclusive benefit requirement of section 457(g)(1) and
§1.457–8(a)(1). See also §1.457–7(b)(3)
relating to the application of section 72(p)
with respect to the taxation of a loan made
under an eligible governmental plan, and
§1.72(p)–1 relating to section 72(p)(2).
(3) Example. The provisions of paragraph (f)(2) of this section are illustrated
by the following example:
Example. (i) Facts. Eligible Plan X of State Y
is funded through Trust Z. Plan X permits an employee’s account balance under Plan X to be paid in a
single sum at severance from employment with State
Y. Plan X includes a loan program under which any
active employee with a vested account balance may
receive a loan from Trust Z. Loans are made pursuant to plan provisions regarding loans that are set
forth in the plan under which loans bear a reasonable rate of interest and are secured by the employee’s
account balance. In order to avoid taxation under
§1.457–7(b)(3) and section 72(p)(1), the plan provisions limit the amount of loans and require loans to be
repaid in level installments as required under section
72(p)(2). Participant J’s vested account balance under Plan X is $50,000. J receives a loan from Trust Z
in the amount of $5,000 on December 1, 2003, to be
repaid in level installments made quarterly over the

September 29, 2003

5-year period ending on November 30, 2008. Participant J makes the required repayments until J has
a severance from employment from State Y in 2005
and subsequently fails to repay the outstanding loan
balance of $2,250. The $2,250 loan balance is offset against J’s $80,000 account balance benefit under
Plan X, and J elects to be paid the remaining $77,750
in 2005.
(ii) Conclusion. The making of the loan to J will
not be treated as a violation of the requirements of
section 457(b) or the regulations. The cancellation
of the loan at severance from employment does not
cause Plan X to fail to satisfy the requirements for
plan eligibility under section 457. In addition, because the loan satisfies the maximum amount and repayment requirements of section 72(p)(2), J is not required to include any amount in income as a result of
the loan until 2005, when J has income of $2,250 as
a result of the offset (which is a permissible distribution under this section) and income of $77,750 as a
result of the distribution made in 2005.

§1.457–7 Taxation of distributions under
eligible plans.
(a) General rules for when amounts are
included in gross income. The rules for determining when an amount deferred under
an eligible plan is includible in the gross
income of a participant or beneficiary depend on whether the plan is an eligible
governmental plan or an eligible plan of
a tax-exempt entity. Paragraph (b) of this
section sets forth the rules for an eligible
governmental plan. Paragraph (c) of this
section sets forth the rules for an eligible
plan of a tax-exempt entity.
(b) Amounts included in gross income
under an eligible governmental plan—(1)
Amounts included in gross income in year
paid under an eligible governmental plan.
Except as provided in paragraphs (b)(2)
and (3) of this section (or in §1.457–10(c)
relating to payments to a spouse or former
spouse pursuant to a qualified domestic relations order), amounts deferred under an
eligible governmental plan are includible
in the gross income of a participant or beneficiary for the taxable year in which paid
to the participant or beneficiary under the
plan.
(2) Rollovers to individual retirement
arrangements and other eligible retirement plans. A trustee-to-trustee transfer
in accordance with section 401(a)(31)
(generally referred to as a direct rollover)
from an eligible government plan is not
includible in gross income of a participant
or beneficiary in the year transferred. In
addition, any payment made from an eligible government plan in the form of an
eligible rollover distribution (as defined

September 29, 2003

in section 402(c)(4)) is not includible in
gross income in the year paid to the extent
the payment is transferred to an eligible
retirement plan (as defined in section
402(c)(8)(B)) within 60 days, including
the transfer to the eligible retirement plan
of any property distributed from the eligible governmental plan. For this purpose,
the rules of section 402(c)(2) through
(7) and (9) apply. Any trustee-to-trustee
transfer under this paragraph (b)(2) from
an eligible government plan is a distribution that is subject to the distribution
requirements of §1.457–6.
(3) Amounts taxable under section
72(p)(1). In accordance with section
72(p), the amount of any loan from an
eligible governmental plan to a participant
or beneficiary (including any pledge or
assignment treated as a loan under section
72(p)(1)(B)) is treated as having been
received as a distribution from the plan
under section 72(p)(1), except to the extent set forth in section 72(p)(2) (relating
to loans that do not exceed a maximum
amount and that are repayable in accordance with certain terms) and §1.72(p)–1.
Thus, except to the extent a loan satisfies
section 72(p)(2), any amount loaned from
an eligible governmental plan to a participant or beneficiary (including any pledge
or assignment treated as a loan under section 72(p)(1)(B)) is includible in the gross
income of the participant or beneficiary
for the taxable year in which the loan is
made. See generally §1.72(p)–1.
(4) Examples. The provisions of this
paragraph (b) are illustrated by the following examples:
Example 1. (i) Facts. Eligible Plan G of a governmental entity permits distribution of benefits in a single sum or in installments of up to 20 years, with such
benefits to commence at any date that is after severance from employment (up to the later of severance
from employment or the plan’s normal retirement age
of 65). Effective for participants who have a severance from employment after December 31, 2001,
Plan X allows an election—as to both the date on
which payments are to begin and the form in which
payments are to be made—to be made by the participant at any time that is before the commencement
date selected. However, Plan X chooses to require
elections to be filed at least 30 days before the commencement date selected in order for Plan X to have
enough time to be able to effectuate the election.
(ii) Conclusion. No amounts are included in gross
income before actual payments begin. If installment
payments begin (and the installment payments are
payable over at least 10 years so as not to be eligible
rollover distributions), the amount included in gross
income for any year is equal to the amount of the installment payment paid during the year.

622

Example 2. (i) Facts. Same facts as in Example
1, except that the same rules are extended to participants who had a severance from employment before
January 1, 2002.
(ii) Conclusion. For all participants (that is, both
those who have a severance from employment after
December 31, 2001, and those who have a severance
from employment before January 1, 2002, including
those whose benefit payments have commenced before January 1, 2002), no amounts are included in
gross income before actual payments begin. If installment payments begin (and the installment payments
are payable over at least 10 years so as not to be eligible rollover distributions), the amount included in
gross income for any year is equal to the amount of
the installment payment paid during the year.

(c) Amounts included in gross income
under an eligible plan of a tax-exempt entity—(1) Amounts included in gross income in year paid or made available under an eligible plan of a tax-exempt entity. Amounts deferred under an eligible
plan of a tax-exempt entity are includible
in the gross income of a participant or beneficiary for the taxable year in which paid
or otherwise made available to the participant or beneficiary under the plan. Thus,
amounts deferred under an eligible plan of
a tax-exempt entity are includible in the
gross income of the participant or beneficiary in the year the amounts are first
made available under the terms of the plan,
even if the plan has not distributed the
amounts deferred. Amounts deferred under an eligible plan of a tax-exempt entity
are not considered made available to the
participant or beneficiary solely because
the participant or beneficiary is permitted
to choose among various investments under the plan.
(2) When amounts deferred are considered to be made available under an eligible plan of a tax-exempt entity—(i) General rule. Except as provided in paragraphs (c)(2)(ii) through (iv) of this section, amounts deferred under an eligible
plan of a tax-exempt entity are considered
made available (and, thus, are includible in
the gross income of the participant or beneficiary under this paragraph (c)) at the earliest date, on or after severance from employment, on which the plan allows distributions to commence, but in no event later
than the date on which distributions must
commence pursuant to section 401(a)(9).
For example, in the case of a plan that
permits distribution to commence on the
date that is 60 days after the close of the
plan year in which the participant has a

2003-39 I.R.B.

severance from employment with the eligible employer, amounts deferred are considered to be made available on that date.
However, distributions deferred in accordance with paragraphs (c)(2)(ii) through
(iv) of this section are not considered made
available prior to the applicable date under
paragraphs (c)(2)(ii) through (iv) of this
section. In addition, no portion of a participant or beneficiary’s account is treated as
made available (and thus currently includible in income) under an eligible plan of a
tax-exempt entity merely because the participant or beneficiary under the plan may
elect to receive a distribution in any of the
following circumstances:
(A) A distribution in the event of
an unforeseeable emergency to the extent the distribution is permitted under
§1.457–6(c).
(B) A distribution from an account for
which the total amount deferred is not in
excess of the dollar limit under section
411(a)(11)(A) to the extent the distribution
is permitted under §1.457–6(e).
(ii) Initial election to defer commencement of distributions—(A) In general. An
eligible plan of a tax-exempt entity may
provide a period for making an initial
election during which the participant or
beneficiary may elect, in accordance with
the terms of the plan, to defer the payment
of some or all of the amounts deferred
to a fixed or determinable future time.
The period for making this initial election
must expire prior to the first time that any
such amounts would be considered made
available under the plan under paragraph
(c)(2)(i) of this section.
(B) Failure to make initial election
to defer commencement of distributions.
Generally, if no initial election is made by
a participant or beneficiary under this paragraph (c)(2)(ii), then the amounts deferred
under an eligible plan of a tax-exempt
entity are considered made available and
taxable to the participant or beneficiary
in accordance with paragraph (c)(2)(i) of
this section at the earliest time, on or after
severance from employment (but in no
event later than the date on which distributions must commence pursuant to section
401(a)(9)), that distribution is permitted
to commence under the terms of the plan.
However, the plan may provide for a default payment schedule that applies if no
election is made. If the plan provides for

2003-39 I.R.B.

a default payment schedule, the amounts
deferred are includible in the gross income
of the participant or beneficiary in the
year the amounts deferred are first made
available under the terms of the default
payment schedule.
(iii) Additional election to defer commencement of distribution. An eligible
plan of a tax-exempt entity is permitted to
provide that a participant or beneficiary
who has made an initial election under
paragraph (c)(2)(ii)(A) of this section may
make one additional election to defer (but
not accelerate) commencement of distributions under the plan before distributions
have commenced in accordance with the
initial deferral election under paragraph
(c)(2)(ii)(A) of this section. Amounts
payable to a participant or beneficiary
under an eligible plan of a tax-exempt
entity are not treated as made available
merely because the plan allows the participant to make an additional election
under this paragraph (c)(2)(iii). A participant or beneficiary is not precluded from
making an additional election to defer
commencement of distributions merely
because the participant or beneficiary has
previously received a distribution under
§1.457–6(c) because of an unforeseeable
emergency, has received a distribution
of smaller amounts under §1.457–6(e),
has made (and revoked) other deferral or
method of payment elections within the
initial election period, or is subject to a
default payment schedule under which the
commencement of benefits is deferred (for
example, until a participant is age 65).
(iv) Election as to method of payment.
An eligible plan of a tax-exempt entity
may provide that an election as to the
method of payment under the plan may
be made at any time prior to the time the
amounts are distributed in accordance
with the participant or beneficiary’s initial
or additional election to defer commencement of distributions under paragraph
(c)(2)(ii) or (iii) of this section. Where no
method of payment is elected, the entire
amount deferred will be includible in the
gross income of the participant or beneficiary when the amounts first become
made available in accordance with a participant’s initial or additional elections to
defer under paragraphs (c)(2)(ii) and (iii)
of this section, unless the eligible plan
provides for a default method of payment

623

(in which case amounts are considered
made available and taxable when paid
under the terms of the default payment
schedule). A method of payment means a
distribution or a series of periodic distributions commencing on a date determined
in accordance with paragraph (c)(2)(ii) or
(iii) of this section.
(3) Examples. The provisions of this
paragraph (c) are illustrated by the following examples:
Example 1. (i) Facts. Eligible Plan X of a tax-exempt entity provides that a participant’s total account
balance, representing all amounts deferred under the
plan, is payable to a participant in a single sum 60
days after severance from employment throughout
these examples, unless, during a 30-day period immediately following the severance, the participant elects
to receive the single sum payment at a later date (that
is not later than the plan’s normal retirement age of
65) or elects to receive distribution in 10 annual installments to begin 60 days after severance from employment (or at a later date, if so elected, that is not
later than the plan’s normal retirement age of 65). On
November 13, 2004, K, a calendar year taxpayer, has
a severance from employment with the eligible employer. K does not, within the 30-day window period,
elect to postpone distributions to a later date or to receive payment in 10 fixed annual installments.
(ii) Conclusion. The single sum payment is
payable to K 60 days after the date K has a severance
from employment (January 12, 2005), and is includible in the gross income of K in 2005 under section
457(a).
Example 2. (i) Facts. The terms of eligible Plan
X are the same as described in Example 1. Participant L participates in eligible Plan X. On November 11, 2003, L has a severance from the employment
of the eligible employer. On November 24, 2003, L
makes an initial deferral election not to receive the
single-sum payment payable 60 days after the severance, and instead elects to receive the amounts in 10
annual installments to begin 60 days after severance
from employment.
(ii) Conclusion. No portion of L’s account is considered made available in 2003 or 2004 before a payment is made and no amount is includible in the gross
income of L until distributions commence. The annual installment payable in 2004 will be includible in
L’s gross income in 2004.
Example 3. (i) Facts. The facts are the same as in
Example 1, except that eligible Plan X also provides
that those participants who are receiving distributions
in 10 annual installments may, at any time and without restriction, elect to receive a cash out of all remaining installments. Participant M elects to receive
a distribution in 10 annual installments commencing
in 2004.
(ii) Conclusion. M’s total account balance, representing the total of the amounts deferred under the
plan, is considered made available and is includible
in M’s gross income in 2004.
Example 4. (i) Facts. The facts are the same
as in Example 3, except that, instead of providing
for an unrestricted cashout of remaining payments,
the plan provides that participants or beneficiaries

September 29, 2003

who are receiving distributions in 10 annual installments may accelerate the payment of the amount remaining payable to the participant upon the occurrence of an unforeseeable emergency as described in
§1.457–6(c)(1) in an amount not exceeding that described in §1.457–6(c)(2).
(ii) Conclusion. No amount is considered made
available to participant M on account of M’s right to
accelerate payments upon the occurrence of an unforeseeable emergency.
Example 5. (i) Facts. Eligible Plan Y of a taxexempt entity provides that distributions will commence 60 days after a participant’s severance from
employment unless the participant elects, within a
30-day window period following severance from employment, to defer distributions to a later date (but
no later than the year following the calendar year the
participant attains age 701/2). The plan provides that
a participant who has elected to defer distributions to
a later date may make an election as to form of distribution at any time prior to the 30th day before distributions are to commence.
(ii) Conclusion. No amount is considered made
available prior to the date distributions are to commence by reason of a participant’s right to defer or
make an election as to the form of distribution.
Example 6. (i) Facts. The facts are the same as in
Example 1, except that the plan also permits participants who have made an initial election to defer distribution to make one additional deferral election at
any time prior to the date distributions are scheduled
to commence. Participant N has a severance from employment at age 50. The next day, during the 30-day
period provided in the plan, N elects to receive distribution in the form of 10 annual installment payments beginning at age 55. Two weeks later, within
the 30-day window period, N makes a new election
permitted under the plan to receive 10 annual installment payments beginning at age 60 (instead of age
55). When N is age 59, N elects under the additional
deferral election provisions, to defer distributions until age 65.
(ii) Conclusion. In this example, N’s election to
defer distributions until age 65 is a valid election. The
two elections N makes during the 30-day window period are not additional deferral elections described in
paragraph (c)(2)(iii) of this section because they are
made before the first permissible payout date under
the plan. Therefore, the plan is not precluded from
allowing N to make the additional deferral election.
However, N can make no further election to defer distributions beyond age 65 (or accelerate distribution
before age 65) because this additional deferral election can only be made once.

§1.457–8 Funding rules for eligible plans.
(a) Eligible governmental plans—(1) In
general. In order to be an eligible governmental plan, all amounts deferred under the plan, all property and rights purchased with such amounts, and all income
attributable to such amounts, property, or
rights, must be held in trust for the exclusive benefit of participants and their beneficiaries. A trust described in this paragraph (a) that also meets the requirements

September 29, 2003

of §§1.457–3 through 1.457–10 is treated
as an organization exempt from tax under
section 501(a), and a participant’s or beneficiary’s interest in amounts in the trust is
includible in the gross income of the participants and beneficiaries only to the extent, and at the time, provided for in section
457(a) and §§1.457–4 through 1.457–10.
(2) Trust requirement. (i) A trust described in this paragraph (a) must be established pursuant to a written agreement
that constitutes a valid trust under state law.
The terms of the trust must make it impossible, prior to the satisfaction of all liabilities with respect to participants and
their beneficiaries, for any part of the assets and income of the trust to be used for,
or diverted to, purposes other than for the
exclusive benefit of participants and their
beneficiaries.
(ii) Amounts deferred under an eligible
governmental plan must be transferred to
a trust within a period that is not longer
than is reasonable for the proper administration of the participant accounts (if any).
For purposes of this requirement, the plan
may provide for amounts deferred for a
participant under the plan to be transferred
to the trust within a specified period after
the date the amounts would otherwise
have been paid to the participant. For example, the plan could provide for amounts
deferred under the plan at the election of
the participant to be contributed to the
trust within 15 business days following the
month in which these amounts would otherwise have been paid to the participant.
(3) Custodial accounts and annuity
contracts treated as trusts—(i) In general.
For purposes of the trust requirement
of this paragraph (a), custodial accounts
and annuity contracts described in section 401(f) that satisfy the requirements
of this paragraph (a)(3) are treated as
trusts under rules similar to the rules of
section 401(f). Therefore, the provisions
of §1.401(f)–1(b) will generally apply to
determine whether a custodial account or
an annuity contract is treated as a trust.
The use of a custodial account or annuity
contract as part of an eligible governmental plan does not preclude the use of a trust
or another custodial account or annuity
contract as part of the same plan, provided
that all such vehicles satisfy the requirements of section 457(g)(1) and (3) and
paragraphs (a)(1) and (2) of this section

624

and that all assets and income of the plan
are held in such vehicles.
(ii) Custodial accounts—(A) In general. A custodial account is treated as a
trust, for purposes of section 457(g)(1) and
paragraphs (a)(1) and (2) of this section,
if the custodian is a bank, as described
in section 408(n), or a person who meets
the nonbank trustee requirements of paragraph (a)(3)(ii)(B) of this section, and the
account meets the requirements of paragraphs (a)(1) and (2) of this section, other
than the requirement that it be a trust.
(B) Nonbank trustee status. The custodian of a custodial account may be a
person other than a bank only if the person
demonstrates to the satisfaction of the
Commissioner that the manner in which
the person will administer the custodial
account will be consistent with the requirements of section 457(g)(1) and (3).
To do so, the person must demonstrate
that the requirements of §1.408–2(e)(2)
through (6) (relating to nonbank trustees)
are met. The written application must
be sent to the address prescribed by the
Commissioner in the same manner as prescribed under §1.408–2(e). To the extent
that a person has already demonstrated to
the satisfaction of the Commissioner that
the person satisfies the requirements of
§1.408–2(e) in connection with a qualified
trust (or custodial account or annuity contract) under section 401(a), that person is
deemed to satisfy the requirements of this
paragraph (a)(3)(ii)(B).
(iii) Annuity contracts. An annuity contract is treated as a trust for purposes of
section 457(g)(1) and paragraph (a)(1) of
this section if the contract is an annuity
contract, as defined in section 401(g), that
has been issued by an insurance company
qualified to do business in the state, and the
contract meets the requirements of paragraphs (a)(1) and (2) of this section, other
than the requirement that it be a trust. An
annuity contract does not include a life,
health or accident, property, casualty, or liability insurance contract.
(4) Combining assets. [Reserved]
(b) Eligible plans maintained by tax-exempt entity—(1) General rule. In order
to be an eligible plan of a tax-exempt entity, the plan must be unfunded and plan
assets must not be set aside for participants or their beneficiaries. Under section

2003-39 I.R.B.

457(b)(6) and this paragraph (b), an eligible plan of a tax-exempt entity must provide that all amounts deferred under the
plan, all property and rights to property (including rights as a beneficiary of a contract providing life insurance protection)
purchased with such amounts, and all income attributable to such amounts, property, or rights, must remain (until paid or
made available to the participant or beneficiary) solely the property and rights of the
eligible employer (without being restricted
to the provision of benefits under the plan),
subject only to the claims of the eligible
employer’s general creditors.
(2) Additional requirements. For purposes of paragraph (b)(1) of this section,
the plan must be unfunded regardless of
whether or not the amounts were deferred
pursuant to a salary reduction agreement
between the eligible employer and the participant. Any funding arrangement under
an eligible plan of a tax-exempt entity that
sets aside assets for the exclusive benefit of
participants violates this requirement, and
amounts deferred are generally immediately includible in the gross income of plan
participants and beneficiaries. Nothing in
this paragraph (b) prohibits an eligible plan
from permitting participants and their beneficiaries to make an election among different investment options available under
the plan, such as an election affecting the
investment of the amounts described in
paragraph (b)(1) of this section.
§1.457–9 Effect on eligible plans when
not administered in accordance with
eligibility requirements.
(a) Eligible governmental plans. A plan
of a state ceases to be an eligible governmental plan on the first day of the first plan
year beginning more than 180 days after
the date on which the Commissioner notifies the state in writing that the plan is
being administered in a manner that is inconsistent with one or more of the requirements of §§1.457–3 through 1.457–8, or
§1.457–10. However, the plan may correct the plan inconsistencies specified in
the written notification before the first day
of that plan year and continue to maintain
plan eligibility. If a plan ceases to be an
eligible governmental plan, amounts subsequently deferred by participants will be
includible in income when deferred, or, if
later, when the amounts deferred cease to

2003-39 I.R.B.

be subject to a substantial risk of forfeiture, as provided at §1.457–11. Amounts
deferred before the date on which the plan
ceases to be an eligible governmental plan,
and any earnings thereon, will be treated as
if the plan continues to be an eligible governmental plan and will not be includible
in participant’s or beneficiary’s gross income until paid to the participant or beneficiary.
(b) Eligible plans of tax-exempt entities.
A plan of a tax-exempt entity ceases to be
an eligible plan on the first day that the
plan fails to satisfy one or more of the requirements of §§1.457–3 through 1.457–8,
or §1.457–10. See §1.457–11 for rules regarding the treatment of an ineligible plan.
§1.457–10 Miscellaneous provisions.
(a) Plan terminations and frozen
plans—(1) In general. An eligible employer may amend its plan to eliminate future deferrals for existing participants or to
limit participation to existing participants
and employees. An eligible plan may
also contain provisions that permit plan
termination and permit amounts deferred
to be distributed on termination. In order
for a plan to be considered terminated,
amounts deferred under an eligible plan
must be distributed to all plan participants
and beneficiaries as soon as administratively practicable after termination of the
eligible plan. The mere provision for, and
making of, distributions to participants
or beneficiaries upon a plan termination
will not cause an eligible plan to cease to
satisfy the requirements of section 457(b)
or the regulations.
(2) Employers that cease to be eligible employers—(i) Plan not terminated.
An eligible employer that ceases to be an
eligible employer may no longer maintain an eligible plan. If the employer was
a tax-exempt entity and the plan is not
terminated as permitted under paragraph
(a)(2)(ii) of this section, the tax consequences to participants and beneficiaries
in the previously eligible (unfunded) plan
of an ineligible employer are determined
in accordance with either section 451 if
the employer becomes an entity other than
a state or §1.457–11 if the employer becomes a state. If the employer was a state
and the plan is neither terminated as permitted under paragraph (a)(2)(ii) of this
section nor transferred to another eligible

625

plan of that state as permitted under paragraph (b) of this section, the tax consequences to participants in the previously
eligible governmental plan of an ineligible employer, the assets of which are held
in trust pursuant to §1.457–8(a), are determined in accordance with section 402(b)
(section 403(c) in the case of an annuity
contract) and the trust is no longer to be
treated as a trust that is exempt from tax
under section 501(a).
(ii) Plan termination. As an alternative to determining the tax consequences
to the plan and participants under paragraph (a)(2)(i) of this section, the employer
may terminate the plan and distribute the
amounts deferred (and all plan assets) to
all plan participants as soon as administratively practicable in accordance with paragraph (a)(1) of this section. Such distribution may include eligible rollover distributions in the case of a plan that was an
eligible governmental plan. In addition,
if the employer is a state, another alternative to determining the tax consequences
under paragraph (a)(2)(i) of this section is
to transfer the assets of the eligible governmental plan to an eligible governmental
plan of another eligible employer within
the same state under the plan-to-plan transfer rules of paragraph (b) of this section.
(3) Examples. The provisions of this
paragraph (a) are illustrated by the following examples:
Example 1. (i) Facts. Employer Y, a corporation that owns a state hospital, sponsors an eligible
governmental plan funded through a trust. Employer
Y is acquired by a for-profit hospital and Employer
Y ceases to be an eligible employer under section
457(e)(1) or §1.457–2(e). Employer Y terminates the
plan and, during the next 6 months, distributes to participants and beneficiaries all amounts deferred that
were under the plan.
(ii) Conclusion. The termination and distribution
does not cause the plan to fail to be an eligible governmental plan. Amounts that are distributed as eligible
rollover distributions may be rolled over to an eligible
retirement plan described in section 402(c)(8)(B).
Example 2. (i) Facts. The facts are the same as in
Example 1, except that Employer Y decides to continue to maintain the plan.
(ii) Conclusion. If Employer Y continues to
maintains the plan, the tax consequences to participants and beneficiaries will be determined in accordance with either section 402(b) if the compensation
deferred is funded through a trust, section 403(c) if
the compensation deferred is funded through annuity
contracts, or §1.457–11 if the compensation deferred
is not funded through a trust or annuity contract. In
addition, if Employer Y continues to maintain the
plan, the trust will no longer be treated as exempt
from tax under section 501(a).

September 29, 2003

Example 3. (i) Facts. Employer Z, a corporation that owns a tax-exempt hospital, sponsors an unfunded eligible plan. Employer Z is acquired by a forprofit hospital and is no longer an eligible employer
under section 457(e)(1) or §1.457–2(e). Employer Z
terminates the plan and distributes all amounts deferred under the eligible plan to participants and beneficiaries within a one-year period.
(ii) Conclusion. Distributions under the plan are
treated as made under an eligible plan of a tax-exempt
entity and the distributions of the amounts deferred
are includible in the gross income of the participant
or beneficiary in the year distributed.
Example 4. (i) Facts. The facts are the same as in
Example 3, except that Employer Z decides to maintain instead of terminate the plan.
(ii) Conclusion. If Employer Z maintains the
plan, the tax consequences to participants and beneficiaries in the plan will thereafter be determined in
accordance with section 451.

(b) Plan-to-plan transfers—(1) General rule. An eligible governmental plan
may provide for the transfer of amounts
deferred by a participant or beneficiary
to another eligible governmental plan if
the conditions in paragraphs (b)(2), (3),
or (4) of this section are met. An eligible
plan of a tax-exempt entity may provide
for transfers of amounts deferred by a
participant to another eligible plan of
a tax-exempt entity if the conditions in
paragraph (b)(5) of this section are met.
In addition, an eligible governmental plan
may accept transfers from another eligible
governmental plan as described in the first
sentence of this paragraph (b)(1), and an
eligible plan of a tax-exempt entity may
accept transfers from another eligible plan
of a tax-exempt entity as described in the
preceding sentence. However, a state may
not transfer the assets of its eligible governmental plan to a tax-exempt entity’s
eligible plan and the plan of a tax-exempt
entity may not accept such a transfer. Similarly, a tax-exempt entity may not transfer
the assets of its eligible plan to an eligible
governmental plan and an eligible governmental plan may not accept such a transfer.
In addition, if the conditions in paragraph
(b)(4) of this section (relating to permissive past service credit and repayments
under section 415) are met, an eligible
governmental plan of a state may provide
for the transfer of amounts deferred by a
participant or beneficiary to a qualified
plan (under section 401(a)) maintained by
a state. However, a qualified plan may not
transfer assets to an eligible governmental
plan or to an eligible plan of a tax-exempt
entity, and an eligible governmental plan

September 29, 2003

or the plan of a tax-exempt entity may not
accept such a transfer.
(2) Requirements for post-severance
plan-to-plan transfers among eligible
governmental plans. A transfer under
paragraph (b)(1) of this section from an
eligible governmental plan to another eligible governmental plan is permitted if the
following conditions are met —
(i) The transferor plan provides for
transfers;
(ii) The receiving plan provides for the
receipt of transfers;
(iii) The participant or beneficiary
whose amounts deferred are being transferred will have an amount deferred immediately after the transfer at least equal
to the amount deferred with respect to that
participant or beneficiary immediately
before the transfer; and
(iv) In the case of a transfer for a participant, the participant has had a severance from employment with the transferring employer and is performing services
for the entity maintaining the receiving
plan.
(3) Requirements for plan-to-plan
transfers of all plan assets of eligible
governmental plans. A transfer under
paragraph (b)(1) of this section from an
eligible governmental plan to another eligible governmental plan is permitted if the
following conditions are met —
(i) The transfer is from an eligible governmental plan to another eligible governmental plan within the same state;
(ii) All of the assets held by the transferor plan are transferred;
(iii) The transferor plan provides for
transfers;
(iv) The receiving plan provides for the
receipt of transfers;
(v) The participant or beneficiary
whose amounts deferred are being transferred will have an amount deferred immediately after the transfer at least equal
to the amount deferred with respect to that
participant or beneficiary immediately
before the transfer; and
(vi) The participants or beneficiaries
whose deferred amounts are being transferred are not eligible for additional annual
deferrals in the receiving plan unless they
are performing services for the entity
maintaining the receiving plan.
(4) Requirements for plan-to-plan
transfers among eligible governmental
plans of the same employer. A transfer

626

under paragraph (b)(1) of this section from
an eligible governmental plan to another
eligible governmental plan is permitted if
the following conditions are met —
(i) The transfer is from an eligible governmental plan to another eligible governmental plan of the same employer (and, for
this purpose, the employer is not treated
as the same employer if the participant’s
compensation is paid by a different entity);
(ii) The transferor plan provides for
transfers;
(iii) The receiving plan provides for the
receipt of transfers;
(iv) The participant or beneficiary
whose amounts deferred are being transferred will have an amount deferred immediately after the transfer at least equal
to the amount deferred with respect to that
participant or beneficiary immediately
before the transfer; and
(v) The participant or beneficiary
whose deferred amounts are being transferred is not eligible for additional annual
deferrals in the receiving plan unless the
participant or beneficiary is performing
services for the entity maintaining the
receiving plan.
(5) Requirements for post-severance
plan-to-plan transfers among eligible
plans of tax-exempt entities. A transfer
under paragraph (b)(1) of this section from
an eligible plan of a tax-exempt employer
to another eligible plan of a tax-exempt
employer is permitted if the following
conditions are met —
(i) The transferor plan provides for
transfers;
(ii) The receiving plan provides for the
receipt of transfers;
(iii) The participant or beneficiary
whose amounts deferred are being transferred will have an amount deferred immediately after the transfer at least equal
to the amount deferred with respect to that
participant or beneficiary immediately
before the transfer; and
(iv) In the case of a transfer for a participant, the participant has had a severance from employment with the transferring employer and is performing services
for the entity maintaining the receiving
plan.
(6) Treatment of amount transferred
following a plan-to-plan transfer between
eligible plans. Following a transfer of
any amount between eligible plans under

2003-39 I.R.B.

paragraphs (b)(1) through (b)(5) of this
section —
(i) the transferred amount is subject
to the restrictions of §1.457–6 (relating
to when distributions are permitted to be
made to a participant under an eligible
plan) in the receiving plan in the same
manner as if the transferred amount had
been originally been deferred under the
receiving plan if the participant is performing services for the entity maintaining the
receiving plan, and
(ii) in the case of a transfer between eligible plans of tax-exempt entities, except
as otherwise determined by the Commissioner, the transferred amount is subject to
§1.457–7(c)(2) (relating to when amounts
are considered to be made available under
an eligible plan of a tax-exempt entity) in
the same manner as if the elections made
by the participant or beneficiary under the
transferor plan had been made under the
receiving plan.
(7) Examples. The provisions of paragraphs (b)(1) through (6) of this section are
illustrated by the following examples:
Example 1. (i) Facts. Participant A, the president
of City X’s hospital, has accepted a position with another hospital which is a tax-exempt entity. A participates in the eligible governmental plan of City X. A
would like to transfer the amounts deferred under City
X’s eligible governmental plan to the eligible plan of
the tax-exempt hospital.
(ii) Conclusion. City X’s plan may not transfer
A’s amounts deferred to the tax-exempt employer’s
eligible plan. In addition, because the amounts deferred would no longer be held in trust for the exclusive benefit of participants and their beneficiaries,
the transfer would violate the exclusive benefit rule
of section 457(g) and §1.457–8(a).
Example 2. (i) Facts. County M, located in State
S, operates several health clinics and maintains an eligible governmental plan for employees of those clinics. One of the clinics operated by County M is being acquired by a hospital operated by State S, and
employees of that clinic will become employees of
State S. County M permits those employees to transfer their balances under County M’s eligible governmental plan to the eligible governmental plan of State
S.
(ii) Conclusion. If the eligible governmental
plans of County M and State S provide for the
transfer and acceptance of the transfer (and the other
requirements of paragraph (b)(1) of this section are
satisfied), then the requirements of paragraph (b)(2)
of this section are satisfied and, thus, the transfer will
not cause either plan to violate the requirements of
section 457 or these regulations.
Example 3. (i) Facts. City Employer Z, a hospital, sponsors an eligible governmental plan. City
Employer Z is located in State B. All of the assets
of City Employer Z are being acquired by a tax-exempt hospital. City Employer Z, in accordance with
the plan-to-plan transfer rules of paragraph (b) of this

2003-39 I.R.B.

section, would like to transfer the total amount of assets deferred under City Employer Z’s eligible governmental plan to the acquiring tax-exempt entity’s
eligible plan.
(ii) Conclusion. City Employer Z may not permit participants to transfer the amounts to the eligible
plan of the tax-exempt entity. In addition, because the
amounts deferred would no longer be held in trust for
the exclusive benefit of participants and their beneficiaries, the transfer would violate the exclusive benefit rule of section 457(g) and §1.457–8(a).
Example 4. (i) Facts. The facts are the same as
in Example 3, except that City Employer Z, instead
of transferring all of its assets to the eligible plan of
the tax-exempt entity, decides to transfer all of the
amounts deferred under City Z’s eligible governmental plan to the eligible governmental plan of County B
in which City Z is located. County B’s eligible plan
does not cover employees of City Z, but is willing to
allow the assets of City Z’s plan to be transferred to
County B’s plan, a related state government entity,
also located in State B.
(ii) Conclusion. If City Employer Z’s (transferor)
eligible governmental plan provides for such transfer and the eligible governmental plan of County B
permits the acceptance of such a transfer (and the
other requirements of paragraph (b)(1) of this section are satisfied), then the requirements of paragraph
(b)(3) of this section are satisfied and, thus, City Employer Z may transfer the total amounts deferred under its eligible governmental plan, prior to termination of that plan, to the eligible governmental plan
maintained by County B. However, the participants
of City Employer Z whose deferred amounts are being transferred are not eligible to participate in the eligible governmental plan of County B, the receiving
plan, unless they are performing services for County
B.
Example 5. (i) Facts. State C has an eligible governmental plan. Employees of City U in State C are
among the eligible employees for State C’s plan and
City U decides to adopt another eligible governmental plan only for its employees. State C decides to allow employees to elect to transfer all of the amounts
deferred for an employee under State C’s eligible
governmental plan to City U’s eligible governmental plan.
(ii) Conclusion. If State C’s (transferor) eligible
governmental plan provides for such transfer and the
eligible governmental plan of City U permits the acceptance of such a transfer (and the other requirements of paragraph (b)(1) of this section are satisfied), then the requirements of paragraph (b)(4) of this
section are satisfied and, thus, State C may transfer
the total amounts deferred under its eligible governmental plan to the eligible governmental plan maintained by City U.

(8) Purchase of permissive past service
credit by plan-to-plan transfers from an
eligible governmental plan to a qualified
plan—(i) General rule. An eligible governmental plan of a state may provide for
the transfer of amounts deferred by a participant or beneficiary to a defined benefit governmental plan (as defined in section
414(d)), and no amount shall be includible
in gross income by reason of the transfer,

627

if the conditions in paragraph (b)(8)(ii) of
this section are met. A transfer under this
paragraph (b)(8) is not treated as a distribution for purposes of §1.457–6. Therefore,
such a transfer may be made before severance from employment.
(ii) Conditions for plan-to-plan transfers from an eligible governmental plan
to a qualified plan. A transfer may be
made under this paragraph (b)(8) only if
the transfer is either—
(A) For the purchase of permissive
past service credit (as defined in section
415(n)(3)(A)) under the receiving defined
benefit governmental plan; or
(B) A repayment to which section
415 does not apply by reason of section
415(k)(3).
(iii) Example. The provisions of this
paragraph (b)(8) are illustrated by the following example:
Example. (i) Facts. Plan X is an eligible governmental plan maintained by County Y for its employees. Plan X provides for distributions only in the
event of death, an unforeseeable emergency, or severance from employment with County Y (including
retirement from County Y). Plan S is a qualified defined benefit plan maintained by State T for its employees. County Y is within State T. Employee A is
an employee of County Y and is a participant in Plan
X. Employee A previously was an employee of State
T and is still entitled to benefits under Plan S. Plan
S includes provisions allowing participants in certain
plans, including Plan X, to transfer assets to Plan S for
the purchase of past service credit under Plan S and
does not permit the amount transferred to exceed the
amount necessary to fund the benefit resulting from
the past service credit. Although not required to do
so, Plan X allows Employee A to transfer assets to
Plan S to provide a past service benefit under Plan S.
(ii) Conclusion. The transfer is permitted under
this paragraph (b)(8).

(c) Qualified domestic relations orders
under eligible plans—(1) General rule.
An eligible plan does not become an ineligible plan described in section 457(f)
solely because its administrator or sponsor
complies with a qualified domestic relations order as defined in section 414(p),
including an order requiring the distribution of the benefits of a participant to an
alternate payee in advance of the general
rules for eligible plan distributions under
§1.457–6. If a distribution or payment is
made from an eligible plan to an alternate
payee pursuant to a qualified domestic
relations order, rules similar to the rules
of section 402(e)(1)(A) shall apply to the
distribution or payment.

September 29, 2003

(2) Examples. The provisions of this
paragraph (c) are illustrated by the following examples:
Example 1. (i) Facts. Participant C and C’s
spouse D are divorcing. C is employed by State S
and is a participant in an eligible plan maintained by
State S. C has an account valued at $100,000 under
the plan. Pursuant to the divorce, a court issues a
qualified domestic relations order on September 1,
2003, that allocates 50 percent of C’s $100,000 plan
account to D and specifically provides for an immediate distribution to D of D’s share within 6 months
of the order. Payment is made to D in January of
2004.
(ii) Conclusion. State S’s eligible plan does not
become an ineligible plan described in section 457(f)
and §1.457–11 solely because its administrator or
sponsor complies with the qualified domestic relations order requiring the immediate distribution to D
in advance of the general rules for eligible plan distributions under §1.457–6. In accordance with section
402(e)(1)(A), D (not C) must include the distribution
in gross income. The distribution is includible in
D’s gross income in 2004. If the qualified domestic
relations order were to provide for distribution to D
at a future date, amounts deferred attributable to D’s
share will be includible in D’s gross income when
paid to D.
Example 2. (i) Facts. The facts are the same as
in Example 1, except that S is a tax-exempt entity,
instead of a state.
(ii) Conclusion. State S’s eligible plan does not
become an ineligible plan described in section 457(f)
and §1.457–11 solely because its administrator or
sponsor complies with the qualified domestic relations order requiring the immediate distribution to
D in advance of the general rules for eligible plan
distributions under § 1.457–6. In accordance with
section 402(e)(1)(A), D (not C) must include the
distribution in gross income. The distribution is
includible in D’s gross income in 2004, assuming
that the plan did not make the distribution available
to D in 2003. If the qualified domestic relations order
were to provide for distribution to D at a future date,
amounts deferred attributable to D’s share would be
includible in D’s gross income when paid or made
available to D.

(d) Death benefits and life insurance
proceeds. A death benefit plan under section 457(e)(11) is not an eligible plan. In
addition, no amount paid or made available
under an eligible plan as death benefits or
life insurance proceeds is excludable from
gross income under section 101.
(e) Rollovers to eligible governmental
plans—(1) General rule. An eligible governmental plan may accept contributions
that are eligible rollover distributions (as
defined in section 402(c)(4)) made from
another eligible retirement plan (as defined
in section 402(c)(8)(B)) if the conditions
in paragraph (e)(2) of this section are
met. Amounts contributed to an eligible
governmental plan as eligible rollover
distributions are not taken into account

September 29, 2003

for purposes of the annual limit on annual
deferrals by a participant in §1.457–4(c) or
§1.457–5, but are otherwise treated in the
same manner as amounts deferred under
section 457 for purposes of §§1.457–3
through 1.457–9 and this section.
(2) Conditions for rollovers to an eligible governmental plan. An eligible
governmental plan that permits eligible
rollover distributions made from another
eligible retirement plan to be paid into
the eligible governmental plan is required
under this paragraph (e)(2) to provide that
it will separately account for any eligible
rollover distributions it receives. A plan
does not fail to satisfy this requirement if it
separately accounts for particular types of
eligible rollover distributions (for example, if it maintains a separate account for
eligible rollover distributions attributable
to annual deferrals that were made under
other eligible governmental plans and a
separate account for amounts attributable
to other eligible rollover distributions), but
this requirement is not satisfied if any such
separate account includes any amount that
is not attributable to an eligible rollover
distribution.
(3) Example. The provisions of this
paragraph (e) are illustrated by the following example:
Example. (i) Facts. Plan T is an eligible governmental plan that provides that employees who are
eligible to participate in Plan T may make rollover
contributions to Plan T from amounts distributed to
an employee from an eligible retirement plan. An
eligible retirement plan is defined in Plan T as another eligible governmental plan, a qualified section
401(a) or 403(a) plan, or a section 403(b) contract,
or an individual retirement arrangement (IRA) that
holds such amounts. Plan T requires rollover contributions to be paid by the eligible retirement plan
directly to Plan T (a direct rollover) or to be paid
by the participant within 60 days after the date on
which the participant received the amount from the
other eligible retirement plan. Plan T does not take
rollover contributions into account for purposes of
the plan’s limits on amounts deferred that conform
to §1.457–4(c). Rollover contributions paid to Plan
T are invested in the trust in the same manner as
amounts deferred under Plan T and rollover contributions (and earnings thereon) are available for distribution to the participant at the same time and in
the same manner as amounts deferred under Plan T.
In addition, Plan T provides that, for each participant
who makes a rollover contribution to Plan T, the Plan
T record-keeper is to establish a separate account for
the participant’s rollover contributions. The recordkeeper calculates earnings and losses for investments
held in the rollover account separately from earnings
and losses on other amounts held under the plan and
calculates disbursements from and payments made to
the rollover account separately from disbursements

628

from and payments made to other amounts held under the plan.
(ii) Conclusion. Plan T does not lose its status as
an eligible governmental plan as a result of the receipt
of rollover contributions. The conclusion would not
be different if the Plan T record-keeper were to establish two separate accounts, one of which is for the
participant’s rollover contributions attributable to annual deferrals that were made under an eligible governmental plan and the other of which is for other
rollover contributions.

(f) Deemed IRAs under eligible governmental plans. See regulations under
section 408(q) for guidance regarding the
treatment of separate accounts or annuities
as individual retirement plans (IRAs).
§1.457–11 Tax treatment of participants if
plan is not an eligible plan.
(a) In general. Under section 457(f), if
an eligible employer provides for a deferral
of compensation under any agreement or
arrangement that is an ineligible plan––
(1) Compensation deferred under the
agreement or arrangement is includible
in the gross income of the participant
or beneficiary for the first taxable year
in which there is no substantial risk of
forfeiture (within the meaning of section
457(f)(3)(B)) of the rights to such compensation;
(2) If the compensation deferred is subject to a substantial risk of forfeiture, the
amount includible in gross income for the
first taxable year in which there is no substantial risk of forfeiture includes earnings
thereon to the date on which there is no
substantial risk of forfeiture;
(3) Earnings credited on the compensation deferred under the agreement or arrangement that are not includible in gross
income under paragraph (a)(2) of this section are includible in the gross income of
the participant or beneficiary only when
paid or made available to the participant
or beneficiary, provided that the interest
of the participant or beneficiary in any assets (including amounts deferred under the
plan) of the entity sponsoring the agreement or arrangement is not senior to the
entity’s general creditors; and
(4) Amounts paid or made available to a
participant or beneficiary under the agreement or arrangement are includible in the
gross income of the participant or beneficiary under section 72, relating to annuities.
(b) Exceptions. Paragraph (a) of this
section does not apply with respect to––

2003-39 I.R.B.

(1) A plan described in section 401(a)
which includes a trust exempt from tax under section 501(a);
(2) An annuity plan or contract described in section 403;
(3) That portion of any plan which consists of a transfer of property described in
section 83;
(4) That portion of any plan which consists of a trust to which section 402(b) applies; or
(5) A qualified governmental excess
benefit arrangement described in section
415(m).
(c) Amount included in income. The
amount included in gross income on the
applicable date under paragraphs (a)(1)
and (a)(2) of this section is equal to the
present value of the compensation (including earnings to the extent provided in
paragraph (a)(2) of this section) on that
date. For purposes of applying section 72
on the applicable date under paragraphs
(a)(3) and (4) of this section, the participant is treated as having paid investment in
the contract (or basis) to the extent that the
deferred compensation has been taken into
account by the participant in accordance
with paragraphs (a)(1) and (a)(2) of this
section.
(d) Coordination of section 457(f) with
section 83— (1) General rules. Under
paragraph (b)(3) of this section, section
457(f) and paragraph (a) of this section do
not apply to that portion of any plan which
consists of a transfer of property described
in section 83. For this purpose, a transfer
of property described in section 83 means
a transfer of property to which section 83
applies. Section 457(f) and paragraph (a)
of this section do not apply if the date on
which there is no substantial risk of forfeiture with respect to compensation deferred under an agreement or arrangement
that is not an eligible plan is on or after the
date on which there is a transfer of property to which section 83 applies. However, section 457(f) and paragraph (a) of
this section apply if the date on which there
is no substantial risk of forfeiture with respect to compensation deferred under an
agreement or arrangement that is not an
eligible plan precedes the date on which
there is a transfer of property to which section 83 applies. If deferred compensation
payable in property is includible in gross
income under section 457(f), then, as provided in section 72, the amount includible

2003-39 I.R.B.

in gross income when that property is later
transferred or made available to the service provider is the excess of the value of
the property at that time over the amount
previously included in gross income under
section 457(f).
(2) Examples. The provisions of this
paragraph (d) are illustrated in the following examples:
Example 1. (i) Facts. As part of an arrangement
for the deferral of compensation, an eligible employer
agrees on December 1, 2002, to pay an individual rendering services for the eligible employer a specified
dollar amount on January 15, 2005. The arrangement
provides for the payment to be made in the form of
property having a fair market value equal to the specified dollar amount. The individual’s rights to the payment are not subject to a substantial risk of forfeiture
(within the meaning of section 457(f)(3)(B)).
(ii) Conclusion. In this Example 1, because there
is no substantial risk of forfeiture with respect to the
agreement to transfer property in 2005, the present
value (as of December 1, 2002) of the payment is includible in the individual’s gross income for 2002.
Under paragraph (a)(4) of this section, when the payment is made on January 15, 2005, the amount includible in the individual’s gross income is equal to
the excess of the fair market value of the property
when paid, over the amount that was includible in
gross income for 2002 (which is the basis allocable
to that payment).
Example 2. (i) Facts. As part of an arrangement for the deferral of compensation, individuals
A and B rendering services for a tax–exempt entity
each receive in 2010 property that is subject to a substantial risk of forfeiture (within the meaning of section 457(f)(3)(B) and within the meaning of section
83(c)(1)). Individual A makes an election to include
the fair market value of the property in gross income
under section 83(b) and individual B does not make
this election. The substantial risk of forfeiture for the
property transferred to individual A lapses in 2012
and the substantial risk of forfeiture for the property
transferred to individual B also lapses in 2012. Thus,
the property transferred to individual A is included
in A’s gross income for 2010 when A makes a section 83(b) election and the property transferred to individual B is included in B’s gross income for 2012
when the substantial risk of forfeiture for the property
lapses.
(ii) Conclusion. In this Example 2, in each case,
the compensation deferred is not subject to section
457(f) or this section because section 83 applies to
the transfer of property on or before the date on which
there is no substantial risk of forfeiture with respect
to compensation deferred under the arrangement.
Example 3. (i) Facts. In 2004, Z, a tax–exempt
entity, grants an option to acquire property to employee C. The option lacks a readily ascertainable fair
market value, within the meaning of section 83(e)(3),
has a value on the date of grant equal to $100,000, and
is not subject to a substantial risk of forfeiture (within
the meaning of section 457(f)(3)(B) and within the
meaning of section 83(c)(1)). Z exercises the option
in 2012 by paying an exercise price of $75,000 and
receives property that has a fair market value (for purposes of section 83) equal to $300,000.

629

(ii) Conclusion. In this Example 3, under section
83(e)(3), section 83 does not apply to the grant of the
option. Accordingly, C has income of $100,000 in
2004 under section 457(f). In 2012, C has income of
$125,000, which is the value of the property transferred in 2012, minus the allocable portion of the basis that results from the $100,000 of income in 2004
and the $75,000 exercise price.
Example 4. (i) Facts. In 2010, X, a tax–exempt
entity, agrees to pay deferred compensation to employee D. The amount payable is $100,000 to be paid
10 years later in 2020. The commitment to make
the $100,000 payment is not subject to a substantial
risk of forfeiture. In 2010, the present value of the
$100,000 is $50,000. In 2018, X transfers to D property having a fair market value (for purposes of section 83) equal to $70,000. The transfer is in partial
settlement of the commitment made in 2010 and, at
the time of the transfer in 2018, the present value of
the commitment is $80,000. In 2020, X pays D the
$12,500 that remains due.
(ii) Conclusion. In this Example 4, D has income of $50,000 in 2010. In 2018, D has income
of $30,000, which is the amount transferred in 2018,
minus the allocable portion of the basis that results
from the $50,000 of income in 2010. (Under section
72(e)(2)(B), income is allocated first. The income is
equal to $30,000 ($80,000 minus the $50,000 basis),
with the result that the allocable portion of the basis is
equal to $40,000 ($70,000 minus the $30,000 of income).) In 2020, D has income of $2,500 ($12,500
minus $10,000, which is the excess of the original
$50,000 basis over the $40,000 basis allocated to the
transfer made in 2018).

§ 1.457–12 Effective dates.
(a) General effective date. Except
as otherwise provided in this section,
§§1.457–1 through 1.457–11 apply for
taxable years beginning after December
31, 2001.
(b) Transition period for eligible plans
to comply with EGTRRA. For taxable years
beginning after December 31, 2001, and
before January 1, 2004, a plan does not fail
to be an eligible plan as a result of requirements imposed by the Economic Growth
and Tax Relief Reconciliation Act of 2001
(115 Stat. 385) (EGTRRA) (Public Law
107–16) June 7, 2001, if it is operated in
accordance with a reasonable, good faith
interpretation of EGTRRA.
(c) Special rule for distributions from
rollover accounts. The last sentence of
§1.457–6(a) (relating to distributions of
amounts held in a separate account for eligible rollover distributions) applies for taxable years beginning after December 31,
2003.
(d) Special rule for options. Section
1.457–11(d) does not apply with respect to
an option without a readily ascertainable
fair market value (within the meaning of

September 29, 2003

section 83(e)(3)) that was granted on or
before May 8, 2002.
(e) Special rule for qualified domestic
relations orders. Section 1.457–10(c) (relating to qualified domestic relations orders) applies for transfers, distributions,
and payments made after December 31,
2001.

Part 602—OMB CONTROL NUMBERS
UNDER THE PAPERWORK
REDUCTION ACT

Par. 5. In §602.101, paragraph (b) is
amended by adding an entry in numerical
order to the table to read as follows:

Par. 4. The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805.

§602.101 OMB Control numbers.
*****
(b) * * *

CFR part or section where
identified and described

Current OMB
control No.

*****
1.457–8 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1545–1580

*****
Robert E. Wenzel,
Deputy Commissioner for
Services and Enforcement.
Approved July 2, 2003.
Pamela F. Olson,
Assistant Secretary of the Treasury
(Tax Policy).
(Filed by the Office of the Federal Register on July 10, 2003,
8:45 a.m., and published in the issue of the Federal Register
for July 11, 2003, 68 F.R. 41230)

Section 645.—Certain
Revocable Trusts Treated
as Part of Estate
A testamentary trust under section 1.1361-1(h)(iv)
includes a trust that receives S corporation stock from
a qualified revocable trust for which an election under
section 645 is made. See T.D. 9078, page 630.

SUMMARY: This document contains final
regulations relating to a qualified subchapter S trust election for testamentary trusts
under section 1361 of the Internal Revenue
Code. The Small Business Job Protection
Act of 1996 and the Taxpayer Relief Act of
1997 made changes to the applicable law.
The final regulations affect S corporations
and their shareholders.
DATES: Effective Date: These regulations
are effective July 17, 2003.
Applicability Date:
For dates of
applicability of these regulations, see
§1.1361–1(k)(2)(i) and (ii).
FOR
FURTHER
INFORMATION
CONTACT: Concerning the final regulations, Deane M. Burke, (202) 622–3070
(not a toll-free number).
SUPPLEMENTARY INFORMATION:

Section 1361.—S Corporation
Defined
26 CFR 1.1361–1: S corporation defined.

Background

ACTION: Final regulations.

This document amends section 1361 of
the Income Tax Regulations (26 CFR part
1) regarding a qualified subchapter S trust
(QSST) election for testamentary trusts
and the definition of testamentary trusts.
On August 24, 2001, a notice of proposed rulemaking (REG–106431–01,
2001–2 C.B. 272 [66 FR 44565]) relating to QSST elections for testamentary
trusts and the period for which former
qualified subpart E trusts and testamentary trusts may be permitted shareholders
under section 1361 was published in the
Federal Register. No public hearing was
requested. Comments responding to the
proposed regulations were received. After

September 29, 2003

630

T.D. 9078
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Part 1
Qualified Subchapter S Trust
Election for Testamentary Trusts
AGENCY: Internal
(IRS), Treasury.

Revenue

Service

consideration of the comments, the proposed regulations are adopted as revised
by this Treasury decision.
Section 1361(a) defines an S corporation as a small business corporation for
which an election under section 1362(a) is
in effect for the year. Section 1361(b) provides, in part, that a small business corporation is a domestic corporation that is
not an ineligible corporation and that does
not have as a shareholder a person (other
than an estate, a trust described in section
1361(c)(2), or an organization described in
section 1361(c)(6)) who is not an individual. Under section 1361(c)(2), qualified
subpart E trusts and testamentary trusts are
permitted S corporation shareholders. A
qualified subpart E trust is a trust, all of
which is treated (under subpart E of part
I of subchapter J, chapter 1) as owned by
an individual who is a citizen or resident
of the United States. A qualified subpart
E trust that continues in existence after the
death of the deemed owner (former qualified subpart E trust) is a permitted shareholder, but only for the 2-year period beginning on the day of the deemed owner’s
death. A testamentary trust is a trust to
which S corporation stock is transferred
pursuant to the terms of a will, but only for
the 2-year period beginning on the day the
stock is transferred to the trust.
Summary of Comments and
Explanation of Provisions
These final regulations are substantially
the same as the proposed regulations, but
reflect certain revisions based on the comments that were received. The revisions
are discussed below.

2003-39 I.R.B.