IRS Finalizes Amended Regulations Allowing Forfeitures to Be Used for QNECs and QMACs

The IRS has finalized amendments to its regulations under Code §§ 401(k) and (m) to permit the use of forfeitures to fund qualified nonelective contributions (QNECs) and qualified matching contributions (QMACs). QNECs and QMACs are amounts used to correct nondiscrimination testing failures or to satisfy the nondiscrimination safe harbors under Code §§ 401(k)(12) and 401(m)(11). Prior to amendment, the regulations defining QNECs and QMACs considered nonelective and matching contributions “qualified” only if they satisfied the nonforfeitability and distribution requirements applicable to elective deferrals at the time the contributions were made. Thus, at the time they were first contributed, the amounts had to be 100% vested and not distributable before death, disability, severance from employment, age 59-1/2, or plan termination. (For plan years beginning before 2019, QNECs and QMACs also cannot be included in hardship distributions (see our Checkpoint article).) By imposing these requirements at the time the contributions were made, the definition effectively prohibited the use of forfeitures (typically, forfeited profit-sharing contributions) for QMACs or QNECs. Asked to change that definition, the IRS in 2017 proposed amendments that would not require satisfaction of the nonforfeitability and distribution restrictions until the contributions were allocated to a participant’s account (see our Checkpoint article). The IRS has now finalized those amendments.

The final amendments adopt the language of the proposal without any substantive changes. References to the applicable “distribution requirements” have been recharacterized as “distribution limitations,” and the applicability dates in the amendments have been revised to specify that the final amendments apply to taxable years ending on or after July 20, 2018. Notwithstanding the applicability date, the regulations’ preamble indicates that taxpayers may apply the final amendments to earlier periods. The preamble also notes that the regulations do not address the protected benefit rules under Code § 411(d)(6), but violations generally may be avoided by making changes prospectively for future plan years. Also, midyear amendments to plans that allocate forfeitures at year-end may be permissible if they are adopted before all conditions to receive an allocation for the year have been satisfied.

EBIA Comment: Now that these regulations have been finalized, plan sponsors and advisors of 401(k) plans with forfeitures have clear authority to use plan forfeitures for QMACs or QNECs to the extent permitted by their plan documents. The regulations also effectively clarify the ability to use forfeitures for corrections, as the IRS’s Employee Plans Compliance Resolution System (EPCRS) (see our Checkpoint article) defines QNEC for correction purposes by reference to the regulations. Regarding the applicability date, we note that the preamble is inconsistent with the text of the regulations: The preamble states that the regulations are applicable to plan years beginning on or after July 20, 2018, while the regulations refer to plan years ending on or after that date. The inconsistency seems unlikely to have any practical consequences, however, given the preamble’s statement that the rule can also be relied upon for earlier periods. For more information, see EBIA’s 401(k) Plans manual at Sections IX.D (“Safe Harbor Contributions, QNECs, QMACs”), IX.E(“Allocation of Forfeitures”), XXI.K (“ADP Corrective Contributions: QNECs and QMACs”), and XXXIV.E.1(“Errors Involving Eligibility: Failure to Include Eligible Employees in 401(k) or 401(m) Portion of Plan”).

Contributing Editors: EBIA Staff.