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401(k) Plans

Final regs: treatment of employer plan contributions as QMAC/QNECs tested at time of allocation

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

T.D. 9835, 7/19/2018; Reg. § 1.401(k)-1Reg. § 1.401(k)-6Reg. § 1.401(m)-1Reg. § 1.401(m)-5

IRS has issued final regs that adopt with no substantive change proposed reliance regs issued in January 2017 and provide that employer contributions to a 401(k) plan are treated as qualified matching contributions (QMACs) or qualified nonelective contributions (QNECs) if they satisfy applicable nonforfeitability and distribution requirements when they are allocated to participants’ accounts. These contributions no longer have to meet the nonforfeitability and distribution requirements when they are contributed to the plan.

Background. To be considered a qualified cash or deferred arrangement (CODA), a plan must satisfy several requirements, including certain requirements relating to distributions, nonforfeiture, and nondiscrimination. Employer contributions taken into account for purposes of applying the nondiscrimination requirements may include, in addition to contributions made pursuant to an employee’s election, matching contributions that meet the distribution and nonforfeitability requirements of Code Sec. 401(k)(2)(B) and Code Sec. 401(k)(2)(C), and QNECs. A QNEC is an employer contribution, other than a matching contribution, with respect to which the distribution and nonforfeitability requirements of Code Sec. 401(k)(2)(B) and Code Sec. 401(k)(2)(C) are met. (Code Sec. 401(m)(4)(C))

Special nondiscrimination rules require a 401(k) plan to satisfy the “actual deferral percentage” (ADP) test, so highly compensated employees (HCEs) can’t elect to defer a disproportionately higher amount of their salary. (Code Sec. 401(k)(3)(A)) Similar requirements—the actual contribution percentage (ACP) test—apply to limit employer matching or employee contributions made on behalf of HCEs. (Code Sec. 401(m)(2))

In applying the ADP and ACP tests, employers may, under conditions delineated in the regs, take into account certain QMACs and QNECs made on behalf of the employee by the employer.

Under prior Reg. § 1.401(k)-6 (before amendment by the new final regs), QMACs and QNECs were matching contributions and employer contributions (other than elective or matching contributions) that satisfy the nonforfeitability requirements of Reg. § 1.401(k)-1(c) and the distribution requirements of Reg. § 1.401(k)-1(d), “when they are contributed to the plan.” Similarly, prior Reg. § 1.401(m)-5, included independent definitions of QMACs and QNECs, as matching contributions and employer contributions (other than elective or matching contributions) that satisfy the nonforfeitability and distribution requirements of Reg. § 1.401(k)-1(c) and Reg. § 1.401(k)-1(d) “at the time the contribution is made.”

Reason for change. Before 2017, IRS received comments with respect to the definitions of QMACs and QNECs under Reg. § 1.401(k)-6 and Reg. § 1.401(m)-5 asserting that employer contributions should qualify as QMACs and QNECs as long as they  satisfy applicable nonforfeitability and distribution requirements at the time they are allocated to participants’ accounts, rather than when they are first contributed to the plan.

Commenters pointed out that interpreting the statutory rules to require satisfaction of applicable nonforfeitability and distribution requirements at the time amounts are first contributed to the plan would preclude plan sponsors with plans that allow the use of amounts in plan forfeiture accounts to offset future employer contributions under the plan from applying such amounts to fund QMACs and QNECs. This is because the amounts would have been allocated to the forfeiture accounts only after a participant incurred a forfeiture of benefits and, thus, generally would have been subject to a vesting schedule when they were first contributed to the plan.

Commenters asked that QMAC and QNEC requirements not be interpreted to prevent the use of plan forfeitures to fund QMACs and QNECs, and urged that the nonforfeitability and distribution requirements apply when QMACs and QNECs are allocated to participants’ accounts and not when the contributions are first made to the plan.

2017 proposed regs reflected suggested change. In January 2017, IRS issued proposed regs that amended Reg. § 1.401(k)-6 to provide that amounts used to fund QMACs and QNECs must be nonforfeitable and subject to distribution limitations in accordance with Reg. § 1.401(k)-1(c) and Reg. § 1.401(k)-1(d) when allocated to participants’ accounts, as opposed to when first contributed to the plan. As a result, under the proposed regs, which taxpayers could apply to periods preceding their adoption as final, forfeitures could be permitted to be used to fund QMACs and QNECs.

Regs now final. The final regs adopt the 2017 proposed regs’ changed definitions of QMACs and QNECs to provide that employer contributions to a plan are QMACs or QNECs if they satisfy applicable nonforfeitability requirements and distribution limitations at the time they are allocated to participants’ accounts. (Reg. § 1.401(k)-6Reg. § 1.401(m)-5) Accordingly, forfeitures of prior contributions can be used to fund QMACs and QNECs.

While no substantive changes were made to the proposed regs, IRS did make an amendment in the final regs to change the reference to “distribution requirements” in the existing definitions of QMACs and QNECs and Reg. § 1.401(k)-6 and Reg. § 1.401(m)-5 to “distribution limitations,” consistent with the heading of Reg. § 1.401(k)-1(d).

Effective date. The final regs are effective on July 20, 2018, and apply to plan years beginning on or after that date. (Reg. § 1.401(k)-1(g)(5)) However, taxpayers may apply the final regs to earlier periods. (T.D. 9835)

References: For cash or deferred arrangements (CODAs)—the 401(k) plan rules, see FTC 2d/FIN ¶ H-8975 ; United States Tax Reporter ¶ 4014.17.

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