\[4830-01-p\]

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

\[REG-108639-99\]

RINs 1545-AX26, 1545-AX43

Retirement plans; Cash or deferred arrangements under section 401(k) and
matching contributions or employee contributions under section 401(m)
Regulations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

SUMMARY: This document contains proposed regulations that would provide
guidance for certain retirement plans containing cash or deferred
arrangements under section 401(k) and providing for matching
contributions or employee contributions under section 401(m). These
regulations affect sponsors of plans that contain cash or deferred
arrangements or provide for employee or matching contributions, and
participants in these plans. This document also contains a notice of
public hearing on these proposed regulations.

DATES: Written and electronic comments and requests to speak (with
outlines of oral comments) at a public hearing scheduled for November
12, 2003, must be received by October 22, 2003.

ADDRESSES: Send submissions to: CC:PA:RU (REG-108639-99), room 5226,
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC
20044. Submissions may be hand delivered Monday through Friday between
the hours of 8 a.m. and 4 p.m. to: CC:PA:RU (REG-108639-99), Courier's
Desk, Internal Revenue Service, 1111 Constitution Avenue, NW.,
Washington, DC. Alternatively, taxpayers may submit comments
electronically via the Internet directly to the IRS Internet site at:
www.irs.gov/regs. The public hearing will be held in the IRS Auditorium
(7th Floor), Internal Revenue Building, 1111 Constitution Avenue, NW.,
Washington, DC.

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

SUPPLEMENTARY INFORMATION:

**Paperwork Reduction Act**

The collections of information contained in this notice of proposed
rulemaking have been submitted to the Office of Management and Budget
for review in accordance with the Paperwork Reduction Act of 1995 (44
U.S.C. 3507(d)). Comments on the collections of information should be
sent to the Office of Management and Budget, Attn: Desk Officer for the
Department of the Treasury, Office of Information and Regulatory
Affairs, Washington, DC 20503, with copies to the Internal Revenue
Service, Attn: IRS Reports Clearance Officer, W:CAR:MP:T:T:SP
Washington, DC 20224. Comments on the collections of information should
be received by Septermber 15, 2003. Comments are specifically requested
concerning:

Whether the proposed collections of information are necessary for the
proper performance of the functions of the IRS, including whether the
information will have practical utility;

The accuracy of the estimated burden associated with the proposed
collection of information (see below);

How the quality, utility, and clarity of the information to be collected
may be enhanced;

How the burden of complying with the proposed collection of information
may be minimized, including through the application of automated
collection techniques or other forms of information technology; and

Estimates of capital or start-up costs and costs of operation,
maintenance, and purchase of services to provide information.

The collections of information in these proposed regulations are
contained in §§1.401(k)-1(d)(3)(iii)(C), 1.401(k)-2(b)(3),
1.401(k)-3(d), 1.401(k)-3(f), 1.401(k)-3(g), 1.401(k)-4(d)(3),
1.401(m)-3(e), 1.401(m)-3(g) and 1.401(m)-3(h). The information required
by §§1.401(k)-3(d), 1.401(k)-3(f), 1.401(k)-3(g), 1.401(m)-3(e),
1.401(m)-3(g) and 1.401(m)-3(h) is required by the IRS to comply with
the requirements of sections 401(k)(12)(D) and 401(m)(11)(A)(ii)
regarding notices that must be provided to eligible participants to
apprize them of their rights and obligations under certain plans. This
information will be used by participants to determine whether to
participate in the plan, and by the IRS to confirm that the plan
complies with applicable qualification requirements to avoid adverse tax
consequences. The information required by §1.401(k)-4(d)(3) is required
by the IRS to comply with the requirements of section
401(k)(11)(B)(iii)(II) regarding notices that must be provided to
eligible participants to apprize them of their rights and obligations
under certain plans. This information will be used by participants to
determine whether to participate in the plan, and by the IRS to confirm
that the plan complies with applicable qualification requirements to
avoid adverse tax consequences. The information required by
§1.401(k)-2(b)(3) will be used by employees to file their income tax
returns and by the IRS to assess the correct amount of tax. The
information provided under §1.40(k)-1(d)(3)(iii)(C) will be used by
employers in determining whether to make hardship distributions to
participants. The collections of information are mandatory. The
respondents are businesses or other for-profit institutions, and
nonprofit institutions.

Estimated total annual reporting burden: 26,500 hours.

The estimated annual burden per respondent is 1 hour, 10 minutes.

Estimated number of respondents: 22,500.

The estimated annual frequency of responses: On occasion.

An agency may not conduct or sponsor, and a person is not required to
respond to, a collection of information unless it displays a valid
control number assigned by the Office of Management and Budget.

Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.

**Background**

This document contains proposed new comprehensive regulations setting
forth the requirements (including the nondiscrimination requirements)
for cash or deferred arrangements under section 401(k) and for matching
contributions and employee contributions under section 401(m) of the
Internal Revenue Code (Code).

Comprehensive final regulations under sections 401(k) and 401(m) of the
Code were last published in the **Federal Register** in TD 8357
(published August 9, 1991) and TD 8376 (published December 2, 1991) and
amended by TD 8581 published on December 22, 1994. Since 1994, many
significant changes have been made to sections 401(k) and 401(m) by the
Small Business Job Protection Act of 1996, Public Law 104-188 (110 Stat.
1755) (SBJPA), the Taxpayer Relief Act of 1997, Public Law 105-34 (111
Stat. 788) (TRA '97), and the Economic Growth and Tax Relief
Reconciliation Act of 2001, Public Law 107-16 (115 Stat. 38) (EGTRRA).

The most substantial changes to the section 401(k) and section 401(m)
provisions were made to the methodology for testing the amount of
elective contributions, matching contributions, and employee
contributions for nondiscrimination. Section 401(a)(4) prohibits
discrimination in contribution or benefits in favor of highly
compensated employees (within the meaning of section 414(q)) (HCEs).
Section 401(k) provides a special nondiscrimination test for elective
contributions under a cash or deferred arrangement that is part of a
profit-sharing plan, stock bonus plan, pre-ERISA money purchase plan, or
rural cooperative plan, called the actual deferral percentage (ADP)
test. Section 401(m) provides a parallel test for matching contributions
and employee contributions under a defined contribution plan, called the
actual contribution percentage (ACP) test. These special
nondiscrimination standards are provided in recognition of the fact that
the amount of elective contributions and employee contributions (and
corresponding matching contributions) is determined by the employee\'s
utilization of the contribution opportunity offered under the plan. This
is in contrast to the situation in other defined contribution plans
where the amount of contributions is determined by the amount the
employer decides to contribute.

Sections 401(k) and 401(m) provide alternative methods for satisfying
the applicable nondiscrimination rules: a mathematical comparison and a
number of design-based methods. The inherent variation in the amount of
contributions among employees noted above, and the fact that the
economic situation of HCEs may make them more likely to make elective or
employee contributions, means that the usual nondiscrimination test
under section 401(a)(4) \-- under which for each HCE with a contribution
level there must be a specified number of nonhighly compensated
employees (NHCEs) with equal or greater contributions \-- is not
appropriate. Instead, average rates of contribution are used in the ADP
and ACP tests (with a built-in differential permitted for HCEs) and
minimum standards for nonelective or matching contributions are provided
in the design-based alternatives.

Prior to the enactment of SBJPA, sections 401(k) and 401(m) provided
only for mathematical comparison. Specifically, the ADP and ACP tests
compare the average of the rates of contributions of the HCEs to the
average of the rates of contributions of the NHCEs. For this purpose,
the rate of contributions for an employee is the amount of contributions
for an employee divided by the employee's compensation for the plan
year. These tests are satisfied if the average rate of HCE contributions
does not exceed 1.25 times the average rate of contributions of the
NHCEs. Alternatively, these tests are satisfied if the average rate of
HCE contributions does not exceed the average rate of contributions of
the NHCEs by more than 2 percentage points and is no more than 2 times
the average rate of contributions of the NHCEs. To the extent that these
tests are not satisfied, the statute provides for correction through
distribution to HCEs (or forfeiture of nonvested matching contributions)
or, to the extent provided in regulations, recharacterization of
elective contributions as after-tax contributions. In addition, to the
extent provided in regulations, nonelective contributions can be made to
NHCEs and elective contributions and certain matching contributions can
be moved between the ADP and ACP tests, in order the reduce the
discrepancy between the average rates of contribution for the HCEs and
the NHCEs.

SBJPA added design-based alternative methods of satisfying the ADP and
ACP tests. Under these methods, if a plan meets certain contribution and
notice requirements, the plan is deemed to satisfy the nondiscrimination
rules without regard to actual utilization of the contribution
opportunity offered under the plan. These regulations reflect this
change and the other changes that were made to sections 401(k) and
401(m) under SBJPA, TRA '97 and EGTRRA since the issuance of final
regulations under those sections.

SBJPA made the following significant changes affecting section 401(k)
and section 401(m) plans:

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

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

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

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

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

-   A special testing option was provided for plans that permit
    participation before employees meet the minimum age and service
    requirements, in order to encourage employers to permit employees to
    start participating sooner.

TRA '97 made the following significant changes affecting section 401(k)
and section 401(m) plans:

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

-   Matching contributions for self-employed individuals are no longer
    treated as elective contributions.

EGTRRA made the following significant changes affecting section 401(k)
and section 401(m) plans:

-   Catch-up contributions were added to provide for additional elective
    contributions for participants age 50 or older.

-   The Secretary was directed to change the section 401(k) regulations
    to shorten the period of time that an employee is stopped from
    making elective contributions under the safe harbor rules for
    hardship distributions.

-   Beginning in 2006, section 401(k) plans will be permitted to allow
    employees to designate their elective contributions as "Roth
    contributions" that will be subject to taxation under the rules
    applicable to Roth IRAs under section 408A.

-   Section 401(k) plans using the design-based safe harbor and
    providing no additional contributions in a year are exempted from
    the top-heavy rules of section 416.

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

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

-   Faster vesting is required for matching contributions

-   Matching contributions are taken into account in satisfying the
    top-heavy requirements of section 416.

In addition, since publication of the final regulations, a number of
items of guidance affecting section 401(k) and section 401(m) plans
addressing these statutory changes and other items have been issued by
the IRS, including:

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

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

-   Notice 98-1 (1998-1 C.B. 327) provided additional guidance on prior
    year testing issues.

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

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

-   Notice 2001-56 (2001-2 C.B. 277) and Notice 2002-4 (2002-2
    I.R.B. 298) provided initial guidance related to the changes made by
    EGTRRA.

These items of guidance are incorporated into these proposed regulations
with some modifications and the proposed regulations have been
reorganized as indicated in the tables of contents at proposed
§§1.401(k)-0 and 1.401(m)-0. Treasury and the IRS believe that a single
restatement of the section 401(k) and section 401(m) rules serves the
interests of plan sponsors, third-party administrators, plan
participants, and plan beneficiaries.

The process of reviewing and integrating all existing administrative
guidance under sections 401(k) and 401(m) has led Treasury and the IRS
to reconsider certain rules and to propose certain changes in those
rules. To the extent practicable, this preamble identifies the
substantive changes and explains the underlying analysis. In many cases,
the changes will clarify or simplify existing guidance and will reduce
plan administrative burdens.

Treasury and the IRS appreciate the fact that plan sponsors and
third-party administrators have developed systems and practices in the
application of existing administrative guidance to the design and
operation of section 401(k) and section 401(m) plans. In many cases, the
details of these systems and practices have been determined through a
plan sponsor's or administrator's interpretation of specific terms in
existing guidance or, where no guidance has been provided, through a
plan sponsor's or administrator's best legal and practical judgment. As
a result, these systems and practices may differ from administrator to
administrator, from sponsor to sponsor, or from plan to plan.

Treasury and the IRS also recognize that certain of the substantive
changes in these proposed regulations will require changes in plan
design or plan operation. However, the proposed regulations are not
otherwise intended to require significant changes in plan systems and
practices that were developed under existing guidance and that conform
to the requirements of sections 401(k) and 401(m). Therefore, Treasury
and the IRS specifically request that plan sponsors and third-party
administrators comment on points where the proposed regulations might
have the unintended effect of requiring a change to plan systems or
practices so that Treasury and the IRS can further evaluate whether such
a change is in fact appropriate or whether Treasury and the IRS should
instead make an adjustment in the final regulations.

**Explanation of Provisions**

1\. [Rules Applicable to All Cash or Deferred Arrangements]{.underline}

Section 401(k)(1) provides that a profit-sharing, stock bonus, pre-ERISA
money purchase or rural cooperative plan will not fail to qualify under
section 401(a) merely because it contains a qualified cash or deferred
arrangement. Section 1.401(k)-1 would set forth the general definition
of a cash or deferred arrangement (CODA), the additional requirements
that a CODA must satisfy in order to be a qualified CODA, and the
treatment of contributions made under a qualified or nonqualified CODA.

As under the existing final regulations, a CODA is defined as an
arrangement under which employees can make a cash or deferred election
with respect to contributions to, or accruals or benefits under, a plan
intended to satisfy the requirements of section 401(a). A cash or
deferred election is any direct or indirect election by an employee (or
modification of an earlier election) to have the employer either: 1)
provide an amount to the employee in the form of cash or some other
taxable benefit that is not currently available; or 2) contribute an
amount to a trust, or provide an accrual or other benefit, under a plan
deferring the receipt of compensation. A cash or deferred election can
include a salary reduction agreement, but the specific reference to a
salary reduction agreement has been eliminated as unnecessary. In
addition, the proposed regulations would incorporate prior guidance on
automatic enrollment, and thus would reflect the fact that a CODA can
specify that the default that applies in the absence of an affirmative
election by an employee can be a contribution to a trust, as described
in Rev. Rul. 2000-8.[^1]

The proposed regulations would continue to provide that the definition
of a CODA excludes contributions that are treated as after-tax employee
contributions at the time of the contribution and contributions made
pursuant to certain one-time irrevocable elections, but would also
specify that a CODA does not include an arrangement under which
dividends paid to an ESOP are either distributed to a participant or
reinvested in employer securities in the ESOP pursuant to an election by
the participant or beneficiary under section 404(k)(2)(A)(iii) as added
by EGTRRA.

The proposed regulations would also specify that a contribution is made
pursuant to a cash or deferred election only if the contribution is made
after the election is made. Thus, a contribution made in anticipation of
an employee's election is not treated as an elective contribution.
Similarly, the regulations would provide that a contribution is made
pursuant to a cash or deferred election only if the contribution is made
after the employee's performance of services which relate to the
compensation that, but for the election, would be paid to the employee.
(If the payment of compensation would have preceded the performance of
services, a contribution made no earlier than the date the compensation
would have been paid, but for the election, is also treated as made
pursuant to a cash or deferred election). Accordingly, amounts
contributed in anticipation of future performance of services generally
would not be treated as elective contributions under section 401(k).
These restrictions on the timing of contributions are consistent with
the fundamental premise of elective contributions, that these are
contributions that are paid to the plan as a result of an employee
election not to receive those amounts in cash. Moreover, ensuring that
contributions are made after the employee's election furthers plan
administrability.

The deductibility of these prefunded elective contributions (as well as
prefunded matching contributions) for the taxable year in which the
contribution was made was addressed in Notice 2002-48 (2002-29
I.R.B.139). In that notice, the IRS indicated that it was reviewing
issues other than the deductibility of prefunded contributions but,
pending additional guidance, would not challenge the deductibility of
the contributions provided actual payment is made during the taxable
year for which the deduction is claimed and the amount deducted does not
exceed the applicable limit under section 404(a)(3)(A)(i). After
considering this issue, the IRS and Treasury have concluded that the
prefunding of elective contributions and matching contributions is
inconsistent with sections 401(k) and 401(m). Thus, under these proposed
regulations, an employer would not be able to prefund elective
contributions to accelerate the deduction for elective contributions.
Once these regulations are finalized, employer contributions made under
the facts in Notice 2002-48 would no longer be permitted to be taken
into account under the ADP test or the ACP test and would not satisfy
any plan requirement to provide elective contributions or matching
contributions.

2\. [Qualified CODAs]{.underline}

A. [General rules relating to qualified CODAs]{.underline}

Elective contributions under a qualified CODA are treated as employer
contributions and generally are not included in the employee's gross
income at the time the cash would have been received (but for the cash
or deferred election), or at the time contributed to the plan. Elective
contributions under a qualified CODA are included in the employee's
gross income however, if the contributions are in excess of the section
402(g) limit for a year, are designated Roth contributions (under
section 402A, effective for tax years beginning after December 31, 2005)
or are recharacterized as after-tax contributions as part of a
correction of an ADP test failure.

A CODA is not qualified unless it is part of a profit sharing plan,
stock bonus plan, pre-ERISA money purchase plan, or rural cooperative
plan and provides for an election between contributions to the plan or
payments directly in cash. In addition, a CODA is not qualified unless
it meets the following requirements: 1) the elective contributions under
the CODA satisfy either the ADP test set forth in section 401(k)(3) or
one of the design-based alternatives in section 401(k)(11) or (12); 2)
elective contributions under the CODA are nonforfeitable at all times;
3) elective contributions are distributable only on the occurrence of
certain events, including attainment of age 59½, hardship, death,
disability, severance from employment, or termination of the plan; 4)
the group of employees eligible to participate in the CODA satisfies the
coverage requirements of section 410(b)(1); 5) no other benefit (other
than matching contributions or another specified benefit) is
conditioned, directly or indirectly, upon the employee's making or not
making elective contributions under the CODA; and 6) no more than 1 year
of service is required for eligibility to elect to make a cash or
deferred election.

Subject to certain exceptions, State and local governmental plans are
not allowed to include a qualified CODA. Plans sponsored by Indian
tribal governments and rural cooperatives are allowed to include a
qualified CODA.

B. [Nondiscrimination rules applicable to CODAs]{.underline}

As under the existing regulations, the proposed regulations would
provide that the special nondiscrimination standards set forth in
section 401(k) are the exclusive means by which a qualified CODA can
satisfy the nondiscrimination in amount of contribution requirement of
section 401(a)(4). These special nondiscrimination standards now
include: the ADP test, the ADP safe harbor and the SIMPLE 401(k) plan.
Pursuant to section 401(k)(3)(G), a State or local governmental plan is
deemed to satisfy the ADP test.

In addition, as under existing regulations, the plan must satisfy the
requirements of §1.401(a)(4)-4 with respect to the nondiscriminatory
availability of benefits, rights and features, including the
availability of each level of elective contributions, matching
contributions, and after-tax employee contributions. The provisions of
the existing regulations related to compliance with sections 410(b) and
401(a)(4) would be revised to clarify the relationship of the rules
under sections 410(b) and 401(a)(4) to the requirements for a qualified
CODA and to remove redundant provisions. Except as provided below,
however, these rules are substantively unchanged.

These proposed regulations are designed to provide simple, practical
rules that accommodate legitimate plan changes. At the same time, the
rules are intended to be applied by employers in a manner that does not
make use of changes in plan testing procedures or other plan provisions
to inflate inappropriately the ADP for NHCEs (which is used as a
benchmark for testing the ADP for HCEs) or to otherwise manipulate the
nondiscrimination testing requirements of section 401(k). Further, these
nondiscrimination requirements are part of the overall requirement that
benefits or contributions not discriminate in favor of HCEs. Therefore,
a plan will not be treated as satisfying the requirements of section
401(k) if there are repeated changes to plan testing procedures or plan
provisions that have the effect of distorting the ADP so as to increase
significantly the permitted ADP for HCEs, or otherwise manipulate the
nondiscrimination rules of section 401(k), if a principal purpose of the
changes was to achieve such a result.

C. [Aggregation and disaggregation of plans]{.underline}

The proposed regulations would consolidate the rules in the existing
regulations regarding identification of CODAs and plans for purposes of
demonstrating compliance with the requirements of section 401(k). As
under the existing regulations, all CODAs included in a plan are treated
as a single CODA for purposes of applying the nondiscrimination tests.
For this purpose, a plan is generally defined by reference to
§1.410(b)-7(a) and (b) after application of the mandatory disaggregation
rules of §1.410(b)-7(c) (other than the mandatory disaggregation of
section 401(k) and section 401(m) plans) and permissive aggregation
rules of §1.410(b)-7(d), as modified under these regulations. For
example, if a plan covers collectively bargained employees and
noncollectively bargained employees, the elective contributions for the
separate groups of employees must be subject to separate
nondiscrimination tests under section 401(k). The proposed regulations
would also retain the special rules in the existing regulations that
permit the aggregation of certain employees in different collective
bargaining units and the prohibition on restructuring under
§1.401(a)(4)-9(c).

The proposed regulations would change the treatment of a CODA under a
plan which includes an ESOP. Section 1.410(b)-7(c)(2) provides that the
portion of a plan that is an ESOP and the portion that is not an ESOP
are treated as separate plans for purposes of section 410(b) (except as
provided in §54.4975-11(e)). Accordingly, under the existing
regulations, such a plan must apply two separate nondiscrimination
tests: one for elective contributions going into the ESOP portion (and
invested in employer stock) and one for elective contributions going in
the non-ESOP portion of the plan. The additional testing results in
increased expense and administrative difficulty for the plan and creates
the possibility that the ESOP portion or the non-ESOP portion may fail
the ADP test or ACP test because HCEs may be more or less likely to
invest in employer securities than NHCEs.

Since the issuance of the existing regulations, the use of an ESOP as
the employer stock fund in a section 401(k) plan has become much more
widespread. In light of this development, the proposed regulations would
eliminate disaggregation of the ESOP and non-ESOP portions of a single
section 414(l) plan for purposes of ADP testing. The same rule would
apply for ACP testing under section 401(m). In addition, the proposed
regulations would provide that, for purposes of applying the ADP test or
the ACP test, an employer could permissively aggregate two section
414(l) plans, one that is an ESOP and one that is not.

However, the exception to mandatory disaggregation of ESOPs from
non-ESOPs set forth in these proposed regulations would not apply for
purposes of satisfying section 410(b). Accordingly, the group of
eligible employees under the ESOP and non-ESOP portions of the plan must
still separately satisfy the requirements of sections 401(a)(4) and
410(b).

The proposed regulations would also provide that a single testing method
must apply to all CODAs under a plan. This has the effect of restricting
an employer's ability to aggregate section 414(l) plans for purposes of
section 410(b), if those plans apply inconsistent testing methods. For
example, a plan that applies the ADP test of section 401(k)(3) may not
be aggregated with a plan that uses the ADP safe harbor of section
401(k)(12) for purposes of section 410(b).

D. [Restrictions on withdrawals]{.underline}

As discussed above, a qualified CODA must provide that elective
contributions may only be distributed after certain events, including
hardship and severance from employment. EGTRRA amended section
401(k)(2)(B)(i)(I) by replacing "separation from service" with
"severance from employment." This change eliminated the "same desk rule"
as a standard for distributions under section 401(k) plans.

In addition, EGTRRA amended Code section 401(k)(10) by deleting
disposition by a corporation of substantially all of the assets of a
trade or business and disposition of a corporation's interest in a
subsidiary, leaving termination of the plan as the only distributable
event described in section 401(k)(10). Finally, EGTRRA directs the
Secretary of the Treasury to revise the regulations relating to
distributions under section  401(k)(2)(B)(i)(IV) to provide that the
period during which an employee is prohibited from making elective and
employee contributions following a hardship distribution is 6 months
(instead of 12 months as required under §1.401(k)-1(d)(2)(iv)(B)(*4*) of
the existing regulations).[^2]

Notice 2001-56 and Notice 2002-4 provided guidance on these EGTRRA
changes to the distribution rules for elective contributions. That
guidance is incorporated in these proposed regulations. In connection
with the change to severance from employment, comments are requested on
whether a change in status from employee to leased employee described in
section 414(n) should be treated as a severance from employment that
would permit a distribution to be made. In addition, the proposed
regulations do not include reference to "retirement" (included in the
existing regulation) as an event allowing distribution because
retirement is not listed in the statute, and is subsumed by severance
from employment.

In addition to the statutory changes, the rules relating to hardship
distributions have been reorganized in order to clarify certain
ambiguities, including the relationship between the generally applicable
rules, employee representations, and the safe harbors provided under the
existing regulations. The existing regulations set forth two basic
requirements (i.e., the employee has an immediate and heavy financial
need and the distribution is necessary to satisfy that need) followed by
safe harbor provisions. The proposed regulations would retain those
basic requirements, but would clarify that each safe harbor is
separately applicable to each basic requirement. In addition, the
proposed regulations would provide that an employee representation used
for purposes of determining that a distribution is necessary to satisfy
an immediate and heavy financial need must provide that the need cannot
reasonably be relieved by any available distribution or nontaxable plan
loan (even if the distribution or loan would not be sufficient to
satisfy the financial need), but need not provide that a loan from a
commercial source will be taken if no such loan in an amount sufficient
to satisfy the need is available on reasonable commercial terms.

The proposed regulations would also modify the existing regulations to
add other types of defined contribution plans to the list of plans that
an employer may maintain after the termination of the plan that contains
the qualified CODA while still providing for distribution of elective
contributions upon plan termination. The list of such plans has been
expanded to include not only an ESOP and a SEP, but also a SIMPLE IRA
plan, a plan or contract that satisfies section 403(b) and a section 457
plan.

Finally, under the existing regulations, a plan that receives a
plan-to-plan transfer that includes elective contributions, QNECs, or
QMACs, must provide that the restrictions on withdrawals continue after
the transfer. These proposed regulations would also make explicit a
requirement that the transferor plan will fail to comply with the
restrictions on withdrawals if it transfers elective contributions,
QNECs, or QMACs to a plan that does not provide for these restrictions.
However, a transferor plan will not fail to comply with this requirement
if it reasonably concludes that the transferee plan provides for
restrictions on withdrawals. What constitutes a basis for a reasonable
conclusion would be comparable to the rules related to acceptance of
rollover distributions. See §1.401(a)(31)-1, A-14.

E. [Other rules for qualified CODAs]{.underline}

The proposed regulations would generally retain the additional
requirements set forth in the existing regulations that a CODA must
satisfy in order to be qualified, with some modifications. First, in
order to be a qualified CODA the arrangement must provide an employee
with an effective opportunity to elect to receive the amount in cash no
less than once during the plan year. Under the proposed regulations,
whether an employee has an effective opportunity is determined based on
all the relevant facts and circumstances, including notice of the
availability of the election, the period of time before the cash is
currently available during which an election may be made, and any other
conditions on elections.

The proposed regulations would also provide that a plan must provide for
satisfaction of one of the specific nondiscrimination alternatives
described in section 401(k). As with the existing regulations, the plan
may accomplish this by incorporating by reference the ADP test of
section 401(k)(3) and the regulations under proposed §1.401(k)-2, if
that is the nondiscrimination alternative being used. If, with respect
to the nondiscrimination alternative being used there are optional
choices, the plan must provide which of the optional choices will apply.
For example, a plan that uses the ADP test of section 401(k)(3) must
specify whether it is using the current year testing method or prior
year testing method. Additionally, a plan that uses the prior year
testing method must specify whether the ADP for eligible NHCEs for the
first plan year is 3% or the ADP for the eligible NHCEs for the first
plan year. Similarly, a plan that uses the safe harbor method must
specify whether the safe harbor contribution will be the nonelective
safe harbor contribution or the matching safe harbor contribution and is
not permitted to provide that ADP testing will be used if the
requirements for the safe harbor are not satisfied. The safe harbors are
intended to provide employees with a minimum threshold in benefits in
exchange for easier compliance for the plan sponsor. It would be
inconsistent with this approach to providing benefits to allow an
employer to deliver smaller benefits to NHCEs and revert to testing.

The proposed regulations would retain the existing rules relating to the
section 401(k)(4)(A) prohibition on having benefits (other than a match)
contingent on making or not making an elective contribution. However,
the proposed regulations would specify that, in the case of a benefit
that requires an amount to be withheld from an employee's pay, an
employer is not violating the section 401(k)(4)(A) contingent benefit
rule merely because the CODA restricts elective contributions to amounts
available after such withholding from the employee's pay (after
deduction of all applicable income and employment taxes). In addition,
these proposed regulations also reflect the amendment to section
416(c)(2)(A) under which matching contributions can be taken into
account for purposes of satisfying the top-heavy minimum contribution
requirement without violating the prohibition on making benefits
contingent on making or not making elective contributions.

To reflect the amendment of section 401(k)(4)(B) by SBJPA to allow tax
exempt organizations to maintain section 401(k) plans, the proposed
regulations would also eliminate the provision prohibiting a tax-exempt
employer from adopting a section 401(k) plan.

As under the existing final regulations, these proposed regulations
would provide that a partnership is permitted to maintain a CODA, and
individual partners are permitted to make cash or deferred elections
with respect to compensation attributable to services rendered to the
entity, under the same rules that apply to common-law employees. This
rule has been extended to sole proprietors. The provisions of these
regulations also reflect the enactment of section 402(g)(8) (initially
section 402(g)(9) as enacted by TRA '97) providing that matching
contributions with respect to partners and sole proprietors are no
longer treated as elective contributions.

3\. [Nonqualified CODAs]{.underline}

The proposed regulations would generally retain the rules in the
existing regulations applicable to a nonqualified CODA (i.e., a CODA
that fails one or more of the applicable requirements to be a qualified
CODA). Because elective contributions under such an arrangement are not
entitled to the constructive receipt relief set forth in section
402(e)(3), the contributions are currently taxable to the employee. In
addition, the plan to which such contributions are made must satisfy any
nondiscrimination requirements that would otherwise apply under section
401(a)(4).

4\. [The Actual Deferral Percentage (ADP) Test]{.underline}

A. [General rules relating to the ADP test]{.underline}

Section 1.401(k)-2 sets forth the rules for a CODA that is applying the
ADP test contained in section 401(k)(3). Under the ADP test, the
percentage of compensation deferred for the eligible HCEs is compared
annually to the percentage of compensation deferred for eligible NHCEs,
and if certain limits are exceeded by the HCEs, corrective action must
be taken by the plan. Correction can be made through the distribution of
excess contributions, the recharacterization of excess contributions, or
the contribution of additional employer contributions.

Section 401(k)(3)(A), as amended by SBJPA, generally provides for the
use of prior year data in determining the ADP of NHCEs, while current
year data is used for HCEs. This testing option is referred to as the
prior year testing method. Alternatively, a plan may provide for the use
of current year data for determining the ADPs for both NHCEs and HCEs,
which is known as the current year testing method. The proposed
regulations would use the term applicable year to describe the year for
which the ADP is determined for the NHCEs.

Section 401(k)(3)(F), as added by SBJPA, provides that a plan
benefitting otherwise excludable employees and that, pursuant to section
410(b)(4)(B), is being treated as two separate plans for purposes of
section 410(b), is permitted to disregard NHCEs who have not met the
minimum age and service requirements of section 410(a)(1)(A). Thus, the
proposed regulations would permit such a plan to perform the ADP test by
comparing the ADP for all eligible HCEs for the plan year and the ADP of
eligible NHCEs for the applicable year, disregarding all NHCEs who have
not met the minimum age and service requirements of section
410(a)(1)(A). The proposed regulations treat this rule as permissive.
Accordingly, the new statutory provision does not eliminate the existing
testing option under which a plan benefitting otherwise excludable
employees is disaggregated into separate plans where the ADP test is
performed separately for all eligible employees who have completed the
minimum age and service requirements of section 410(a)(1)(A) and for all
eligible employees who have not completed the minimum age and service
requirements of section 410(a)(1)(A).

B. [Elective contributions used in the ADP test]{.underline}

The proposed regulations would generally follow the existing regulations
in defining which elective contributions are reflected in the ADP test
and which ones are not. The proposed regulations would reflect the rule
contained in the regulations under section 414(v), under which catch-up
contributions that are in excess of a statutory limit or an
employer-provided limit are not taken into account under the ADP test.
See §1.414(v). In addition, the proposed regulations would incorporate
the rule in §1.402(g)-1 that provides excess deferrals that are
distributed are still taken into account under the ADP test (with the
exception of deferrals made by NHCEs that were in violation of section
401(a)(30)). The proposed regulations retain the rule that elective
contributions must be paid to the trust within 12 months after the end
of the plan year. However, for plans subject to Title I of ERISA,
contributions must be paid to the trust much sooner in order to satisfy
the Department of Labor's regulations relating to when elective
contributions become plan assets.

Section 401(k)(3) provides that the actual deferral ratio (ADR) of an
HCE who is eligible to participate in 2 or more CODAs of the same
employer is calculated by treating all CODAs in which the employee is
eligible to participate as one CODA. The existing regulations implement
this rule by aggregating the elective contributions of such an HCE for
all plan years that end with or within a single calendar year. This can
yield an inappropriate result if the plan years are different, because
more than 12 months of elective contributions could be included in an
employee's ADR. These proposed regulations would modify this rule to
provide that the ADR for each HCE participating in more than one CODA is
determined by aggregating the HCE's elective contributions that are
within the plan year of the CODA being tested. In addition, the
definition of period of participation for purposes of determining
compensation would be modified to take into account periods of
participation under another plan where the elective contributions must
be aggregated for an HCE. As a result, even in the case of plans with
different plan years, each of the employer's CODAs will use 12 months of
elective contributions and 12 months of compensation in determining the
ADR for an HCE who participates in multiple arrangements.

The proposed regulations would retain the rule in the existing
regulations that provides that the HCE aggregation of elective
contributions under CODAs does not apply where the CODAs are within
plans that cannot be aggregated under §1.410(b)-7(d), but only after
applying the modifications to the section 410(b) aggregation and
disaggregation rules for section 401(k) plans provided in the proposed
regulations. The non-application of the HCE aggregation rule would have
less significance in light of the change described above relating to the
elimination of the required disaggregation of ESOP and non-ESOP plans.
In addition, the proposed regulations would clarify that, in determining
whether two plans could be aggregated for this purpose, the prohibition
on aggregating plans with CODAs that apply inconsistent testing methods
set forth under these proposed regulations and the section 410(b)
prohibition on aggregating plans that have different plan years would
not apply.

C. [Additional employer contributions used in the ADP test]{.underline}

The proposed regulations would generally retain the rules in the
existing regulations permitting a plan to take qualified nonelective
contributions or qualified matching contributions (i.e., nonelective or
matching contributions that satisfy the vesting and distribution
limitations of section 401(k)(2)(B) and (C)) into account under the ADP
test, except as described below. Thus, an employer whose CODA has failed
the ADP test can correct this failure by making additional qualified
nonelective contributions (QNECs) or qualified matching contributions
(QMACs) for its NHCEs. The proposed regulations would no longer describe
such contributions as being treated as elective contributions under the
arrangement, but would nonetheless permit such contributions to be taken
into account under the ADP test.

As under the existing regulations, these proposed regulations would
provide that QNECs must satisfy four requirements in addition to the
vesting and distribution rules described above before they can be taken
into account under the ADP test: 1) The amount of nonelective
contributions, including the QNECs that are used under the ADP test or
the ACP test, must satisfy section 401(a)(4); 2) the nonelective
contributions, excluding the QNECs that are used under the ADP test or
the ACP test, must satisfy section 401(a)(4); 3) the plan to which the
QNEC or QMAC is made must be a plan that can be aggregated with the plan
maintaining the CODA; and 4) the QNECs or QMACs must not be contingent
on the performance of services after the allocation date and must be
contributed within 12 months after the end of the plan year within which
the contribution is to be allocated.[^3] Thus, in the case of a plan
using prior year ADP testing, any QNECs that are to be allocated to the
NHCEs for the prior plan year must be contributed before the last day of
the current plan year in order to be taken into account.

Some plans provide a correction mechanism for a failed ADP test that
targets QNECs to certain NHCEs in order to reduce the total
contributions to NHCEs under the correction. Under the method that
minimizes the total QNECs allocated to NHCEs under the correction, the
employer makes a QNEC to the extent permitted by the section 415 limits
to the NHCE with the lowest compensation during the year in order to
raise that NHCE's ADR. If the plan still fails to pass the ADP test, the
employer continues expanding the group of NHCEs who receive QNECs to the
next lowest-paid NHCE until the ADP test is satisfied. By using this
bottom-up leveling technique, the employer can pass the ADP test by
contributing small amounts of money to NHCEs who have very low
compensation for the plan year (for example, an employee who terminated
employment in early January with \$300 of compensation). This is because
of the fact that the ADP test is based on an unweighted average of ADRs
and a small dollar (but high percentage of compensation) contribution to
a terminated or other partial-year employee has a larger impact on the
ADP test than a more significant contribution to a full-year employee.

The IRS and Treasury have been concerned that, by using these types of
techniques, employers may pass the ADP test by making high percentage
QNECs to a small number of employees with low compensation rather than
providing contributions to a broader group of NHCEs. In addition, the
legislative history to EGTRRA expresses Congressional intent that the
Secretary of the Treasury will use his existing authority to address
situations where qualified nonelective contributions are targeted to
certain participants with lower compensation in order to increase the
ADP of the NHCEs. (See EGTRRA Conference Report, H.R. Conf. Rep. 107-84,
240).

Accordingly, the proposed regulations would add a new requirement that a
QNEC must satisfy in order to be taken into account under the ADP test.
This requirement, designed to limit the use of targeted QNECs, would
generally treat a plan as providing impermissibly targeted QNECs if less
than half of all NHCEs are receiving QNECs and would also treat a QNEC
as impermissibly targeted if the contribution is more than double the
QNECs other nonhighly compensated employees are receiving, when
expressed as a percentage of compensation. However, QNECs that do not
exceed 5% of compensation are never treated as targeted and would always
satisfy the new requirement.

This restriction on targeting QNECs would be implemented in the proposed
regulations by providing that a QNEC that exceeds 5% of compensation
could be taken into account for the ADP test only to the extent the
contribution, when expressed as a percentage of compensation, does not
exceed two times the plan\'s representative contribution rate. The
plan's representative contribution rate would be defined as the lowest
contribution rate among a group of NHCEs that is half of all the
eligible NHCEs under the arrangement (or the lowest contribution rate
among all eligible NHCEs under the arrangement who are employed on the
last day of the year, if greater). For purposes of determining an NHCE's
contribution rate, the employee's qualified nonelective contributions
and the qualified matching contributions taken into account under the
ADP test for the plan year are added together and the sum is divided by
the employee's compensation for the same period. The proposed
regulations under section 401(m) would provide parallel restrictions on
QNECs taken into account in ACP testing, and a QNEC cannot be taken into
account under both the ADP and ACP test (including for purposes of
determining the representative contribution rate). As discussed more
fully below, the proposed regulations would also have a limitation on
targeting matching contributions, which would limit the extent to which
QMACs can be targeted as a means of avoiding the restrictions on
targeted QNECs.

The proposed regulations would also implement a prohibition against
double counting of QNECs that was set forth in Notice 98-1. Generally,
QNECs used in an ADP or ACP test, used to satisfy the safe harbor under
section 401(k), or under a SIMPLE 401(k) plan can not be used again to
demonstrate compliance with another test under section 401(k)(3) or
401(m)(2). For example, double counting could arise when QNECs on behalf
of NHCEs are used to determine the ADP under current year testing in
year 1 and then, if the employer elected prior year testing, are used
again in year 2 to determine the ADP of NHCEs. However, unlike Notice
98-1, these proposed regulations would not contain the additional
limitations on double counting elective contributions or matching
contributions that were moved between the ADP and ACP tests.

D. [Correction]{.underline}

Section 401(k)(8)(C), as amended by the SBJPA, provides that, for
purposes of correcting a plan's failure to meet the nondiscrimination
requirements of section 401(k)(3), distribution of excess contributions
is made on the basis of the amount of the contributions by, or on behalf
of, each HCE. The proposed regulations would implement this correction
procedure in the same manner as set forth in Notice 97-2. Thus, the
total amount of excess contributions is determined using the rules under
the existing final regulations (i.e., based on high percentages). Then
that total amount is apportioned among the HCEs by assigning the excess
to be distributed first to those HCEs who have the greatest dollar
amount of contributions taken into account under the ADP test (as
opposed to the highest deferral percentage). If these amounts are
distributed or recharacterized in accordance with these regulations, the
plan complies with the ADP test for the plan year with no obligation to
recalculate the ADP test.

The proposed regulations would provide a special rule for correcting
through distribution of excess contributions in the case of an HCE who
participates in multiple plans with CODAs. In that case, the proposed
regulations would provide that, for purposes of determining which HCE
will be apportioned a share of the total excess contributions to be
distributed from a plan, all contributions in CODAs in which such an HCE
participates are aggregated and the HCE with the highest dollar amount
of contributions will apportioned excess contributions first. However,
only actual contributions under the plan undergoing correction \--
rather than all contributions taken into account in calculating the
employee's ADR \-- may be distributed from a plan. If the high dollar
HCE's actual contributions under the plan are insufficient to allow full
correction, then the HCE with the next highest dollar amount of
contributions is apportioned the remaining excess contributions. If
additional correction is needed, this process is repeated until the
excess contributions are completely apportioned. This correction
mechanism is applied independently to each CODA in which the HCE
participates. If correction is needed in more than one CODA, the ADRs of
HCEs who have received corrective distributions under the other
arrangements are not recalculated after correction in the first plan.

The proposed regulations would generally follow the rules in the
existing regulations on the determination of net income attributable to
excess contributions. The existing regulations provide for a reasonable
determination of net income attributable to an excess contribution, but
do not specify which contribution within the plan year is to be treated
as the excess contribution to be distributed. This provision would be
retained in the proposed regulations along with the existing alternative
method of determining the net income, which approximates the result that
would apply if the excess contribution is made on the first day of the
plan year. However, to the extent the employee is or will be credited
with allocable gain or loss on those excess contributions for the period
after the end of the plan year (the gap period), the proposed
regulations would now require that income be determined for that period.
As under the existing regulations, the determination of the income for
the gap period could be based on the income determined using the
alternative method for the aggregate of the plan year and the gap period
or using 10% of the income for the plan year (determined under the
alternative method) for each month in the gap period.

The proposed regulations would permit the recharacterization of excess
contributions in a manner that generally follows the existing
regulations. However, the year the employee must include the
recharacterized contribution in current income has been changed to match
the year that the employee would have had to include the excess
contribution in income, had it been distributed. Thus, if the
recharacterized amount is less than \$100, it is included in gross
income in the year that it is recharacterized, rather than the year of
the earliest elective contributions for the employee.

The proposed regulations would retain the rules in the existing
regulations regarding the timing and tax treatment of distributions of
excess contributions, coordination with the distribution of excess
deferrals and the treatment of matches attributable to excess
contributions.

E. [Special rules relating to prior year testing]{.underline}

The proposed regulations would generally follow the rules set forth in
Notice 98-1 regarding prior year testing, including the limitations on
switching from current year testing to prior year testing. However, the
proposed regulations would provide that a plan is permitted to be
inconsistent between the choice of current year testing method and prior
year testing method, as applied for ADP purposes and ACP purposes. In
such a case, any movement of elective contributions or QMACs between the
ADP and ACP tests (including recharacterization) would be prohibited.

The proposed regulations would generally incorporate the rules set forth
in Notice 98-1 relating to plan coverage changes in the case of a plan
using prior year testing. Thus, in the case of a plan that uses prior
year testing and experiences a plan coverage change affecting more than
10% of the NHCEs, the ADP of the NHCEs would generally be determined as
the weighted average of the ADP of the NHCEs of the plans in which the
NHCEs participated in the prior year. The definition of plan coverage
change includes changes in the group of eligible employees under a plan
resulting from the establishment or amendment of a plan, a plan merger
or spin-off or a change in the way plans are combined or separated under
the section 410(b) rules. The definition under the proposed regulations
would also include a reclassification of a substantial group of
employees that has the same effect as amending the plan. These proposed
regulations retain the rule that a plan that experiences coverage
changes affecting 10% or less of the NHCEs disregards those changes in
calculating the ADP for the NHCEs. Similarly, a plan that merely
experiences a spin-off is not required to recalculate the ADP for the
NHCEs.

5\. [Safe Harbor Section 401(k) Plans]{.underline}

Section 401(k)(12) provides a design-based safe harbor method under
which a CODA is treated as satisfying the ADP test if the arrangement
meets certain contribution and notice requirements. Section 1.401(k)-3
of these proposed regulations, which sets forth the requirements for
these arrangements, generally follows the rules set forth in Notice
98-52 and Notice 2000-3. Thus, a plan satisfies the section 401(k) safe
harbor if it makes specified QMACs for all eligible NHCEs. The matching
contributions can be under a basic matching formula that provides for
QMACs equal to 100% of the first 3% of elective contributions and 50% of
the next 2% or an enhanced matching formula that is at least as generous
in the aggregate, provided the rate of matching contributions under the
enhanced matching formula does not increase as the employee\'s rate of
elective contributions increases. In lieu of QMACs, the plan is
permitted to provide QNECs equal to 3% of compensation for all eligible
NHCEs. In addition, notice must be provided to each eligible employee,
within a reasonable time before the beginning of the year, of their
right to defer under the plan.

A plan using the safe harbor method must also comply with certain other
requirements. Among these is the requirement in section
401(k)(12)(B)(ii) that provides that the rate of matching contribution
for any elective contribution on the part of any HCE cannot exceed the
rate of matching contribution that would apply to any NHCE with the same
rate of elective contribution. Notice 98-52 advised that the general
rules on aggregating contributions for HCEs eligible under more than one
CODA would apply for this purpose. The IRS and Treasury have determined
that such aggregation is not applicable under the ADP safe harbor.
Accordingly, these proposed regulations would not require that elective
or matching contributions on behalf of an HCE who is eligible to
participate in more than one plan of the same employer be aggregated for
purposes of the requirement of section 401(k)(12)(B)(ii). Thus, the rate
of match for purposes of determining whether an HCE has a higher
matching rate is based only on matching contributions with respect to
elective contributions under the safe harbor plan. However, for an
employer that uses the safe harbor method of satisfying the ACP test,
the rule in Notice 98-52 is retained for applying the ACP safe harbor,
with an exception for nonsimultaneous participation (as discussed in
connection with the ACP safe harbor below).

These proposed regulations do not provide any rules relating to
suspension of employee contributions under a plan that provides that
safe harbor matching contributions are made with respect to the sum of
elective contributions and employee contributions. Although Notice
2000-3 specifically permitted suspension of employee contributions in
certain circumstances, the IRS and Treasury have determined that there
are no limits on suspending employee contributions, provided that safe
harbor matching contributions are made with respect to elective
contributions. This is because the restrictions on suspension of
elective contributions are sufficient to ensure an eligible NHCE can get
the full matching contribution.

The proposed regulations do not include any exception to the
requirements for safe harbor matching contributions with respect to
catch-up contributions. Treasury and the IRS are aware that there are
questions concerning the extent to which catch up contributions are
required to be matched under a plan that provides for safe harbor
matching contributions. Treasury and the IRS are interested in comments
on the specific circumstances under which elective contributions by a
NHCE to a safe harbor plan would be less than the amount required to be
matched, e.g., less than 5% of safe harbor compensation, but would be
treated by the plan as catch-up contributions, and on the extent to
which a safe harbor plan should be required to match catch-up
contributions under such circumstances.

Section 401(k)(12)(D) contains a requirement that each eligible employee
be provided with a notice of the employee's rights and obligations under
the plan. These proposed regulations do not address the extent to which
the notice can be provided through electronic media. As noted in the
preamble to other regulations, the IRS and the Treasury Department are
considering the extent to which the notice described in section
401(k)(12)(D), as well as other notices under the various Internal
Revenue Code requirements relating to qualified retirement plans, can be
provided electronically, taking into account the effect of the
Electronic Signatures in Global and National Commerce Act (E-SIGN),
Public Law 106-229 (114 Stat. 464 (2000)). The IRS and the Treasury
Department anticipate issuing proposed regulations regarding these
issues, and invite comments on these issues. Until those proposed
regulations are issued, plan administrators and employers may continue
to rely on the interim guidance in Q&A-7 of Notice 2000-3 on use of
electronic media to satisfy the notice requirement in section
401(k)(12)(D).

These proposed regulations would clarify that a section 401(k) safe
harbor plan must generally be adopted before the beginning of the plan
year and be maintained throughout a full 12-month plan year. This
requirement is consistent with the notion that the statute specifies a
certain contribution level for nonhighly compensated employees in order
to be deemed to pass the nondiscrimination requirements. If the
contribution level is not maintained for a full 12-month year, the
employer contributions made on behalf of nonhighly compensated employees
should not support what could be a full year's contribution by the
highly compensated employees.

The proposed regulations would adopt the exception to the requirement
that a section 401(k) safe harbor plan be in place before the beginning
of the plan year that was provided in Notice 2000-3. Under that option,
an employer could adopt a section 401(k) safe harbor plan which has
contingent non-elective contributions, provided the employer notifies
employees of this contingent arrangement before the start of the year,
amends the plan to provide the nonelective contributions no less than 30
days before the end of the year, and provides employees with a follow-up
notice if the contribution will be made. Similarly, the proposed
regulations would adopt the exception for a section 401(k) safe harbor
plan that uses the matching contribution alternative. Under that
exception, an employer can amend the plan to eliminate matching
contributions with respect to future elective deferrals, provided that
the matching contributions are made with respect to pre-amendment
elective deferrals, employees are provided with notice of the change and
the opportunity to change their elections, and the plan satisfies the
ADP or ACP test for the plan year using the current year testing method.

The proposed regulations would recognize the practical difficulty in a
12-month requirement by following the rule in Notice 98-52 that allowed
a short plan year in the first plan year and would allow a short plan
year in certain other circumstances. Specifically, a section 401(k) safe
harbor plan could have a short plan year in the year the plan
terminates, if the plan termination is in connection with a merger or
acquisition involving the employer, or the employer incurs a substantial
business hardship comparable to a substantial business hardship
described in section 412(d). In addition, a section 401(k) safe harbor
plan could have a short plan year if the plan terminates, the employer
makes the safe harbor contributions for the short year, employees are
provided notice of the change, and the plan passes the ADP test.
Finally, a safe harbor plan could have a short plan year if it is
preceded and followed by 12-month plan years as a section 401(k) safe
harbor plan.

Under section 401(k)(12)(F), safe harbor contributions are permitted to
be made to a plan other than the plan that contains the CODA. These
proposed regulations reflect that rule and provide that the plan to
which the safe harbor contributions are made need not be a plan that can
be aggregated with the plan that contains the cash or deferred
arrangement.

Whether a contribution is taken into account for purposes of the safe
harbor is determined in accordance with the rules regarding inclusion in
ADP testing under proposed §1.401(k)-2(a). Thus, for example, a plan
that provides for safe harbor matching contributions in 2006 need not
provide for a matching contribution with respect to an elective
contribution made during the first 2½ months of 2007 and attributable to
service during 2006, unless that elective contribution is taken into
account for 2006.

6\. [SIMPLE 401(k) Plans]{.underline}

Pursuant to section 401(k)(11), a SIMPLE 401(k) plan is treated as
satisfying the requirements of section 401(k)(3)(A)(ii) if the
contribution, vesting, notice and exclusive plan requirements of section
401(k)(11) are satisfied. Section 1.401(k)-4 of these proposed
regulations reflects the provisions of section 401(k)(11) in a manner
that follows the positions reflected in the model amendments set forth
in Rev. Proc. 97-9.

7\. [Matching Contributions and Employee Contributions]{.underline}.

Section 401(m)(2) sets forth a nondiscrimination test, the ACP test,
with respect to matching contributions and employee contributions that
is parallel to the nondiscrimination test for elective contributions set
forth in section 401(k). Section 1.401(m)-1 of the proposed regulations
would set forth this test in a manner that is consistent with the
nondiscrimination test set forth in proposed §1.401(k)-1(b). Thus,
satisfaction of the ACP test, the ACP safe harbor or the SIMPLE 401(k)
provisions of the proposed regulations under section 401(k) are the
exclusive means that matching contributions and employee contributions
can use to satisfy the nondiscrimination in amount of contribution
requirements of section 401(a)(4). An anti-abuse provision comparable to
that provided in connection with the proposed regulations under section
401(k) limits the ability of an employer to make repeated changes in
plan provisions or testing procedures that have the effect of distorting
the ACP so as to increase significantly the permitted ACP for HCEs, or
otherwise manipulate the nondiscrimination rules of section 401(m), if a
principal purpose of the changes was to achieve such a result.

These proposed regulations also include provisions regarding plan
aggregation and disaggregation that are similar to those proposed for
CODAs under section 401(k). For example, matching contributions made
under the portion of a plan that is an ESOP and the portion of the same
plan that is not an ESOP would not be disaggregated under these proposed
regulations.

The definitions of matching contribution and employee contribution under
§1.401(m)-1 of the proposed regulations would generally follow the
definitions in the existing regulations. Thus, whether an employer
contribution is on account of an elective deferral or employee
contribution -- and thus is a matching contribution \-- is determined
based on all the relevant facts and circumstances. However, the proposed
regulations would provide that a contribution would not be treated as a
matching contribution on account of an elective deferral if it is
contributed before the employee's performance of services with respect
to which the elective deferral is made (or when the cash that is subject
to the cash or deferred election would be currently available, if
earlier) and an employer contribution is not a matching contribution
made on account of an employee contribution if it is contributed before
the employee contribution. Thus, under these regulations, an employer
would not be able to prefund matching contributions to accelerate the
deduction for those contributions and, as noted above with respect to
the timing of elective contributions, employer contributions made under
the facts in Notice 2002-48 would not be taken into account under the
ACP test and would not satisfy any plan requirement to provide matching
contributions.

8\. [ACP Test for Matching Contributions and Employee
Contributions]{.underline}

Section 1.401(m)-2 of the proposed regulations would provide rules for
the ACP test that generally parallel the rules applicable to the ADP
test in proposed §1.401(k)-2. Thus, for example, the ACP test may be run
by comparing the ACP for eligible HCEs for the current year with the ACP
for eligible NHCEs for either the current plan year or the prior plan
year. Similarly, the proposed regulations reflect the special ACP
testing rule in section 401(m)(5)(C) for a plan that provides for early
participation, comparable to the special ADP testing rule in section
401(k)(3)(F), as set forth in proposed §1.401(k)-2(a)(1)(iii).

The determination of the actual contribution ratio (ACR) for an eligible
employee, and the contributions that are taken into account in
determining that ACR, under these proposed regulations are comparable to
the rules under the proposed section 401(k) regulations. Thus, for
example, the ACR for an HCE who has matching contributions or employee
contributions under two or more plans is determined by adding together
matching contributions and employee contributions under all plans of the
employer during the plan year of the plan being tested, in a manner
comparable to that for determining the ADR of an HCE who participates in
two or more CODAs.

The proposed regulations would retain the rule from the existing
regulations under which a QMAC that is taken into account in the ADP
test is excluded from the ACP test. In addition, the proposed
regulations would continue to allow QNECs to be taken into account for
ACP testing, but would provide essentially the same restrictions on
targeting QNECs to a small number of NHCEs as is provided in proposed
§1.401(k)-2. The only difference in the rules would be that the
contribution percentages used to determine the lowest contribution
percentage would be based on the sum of the QNECs and those matching
contributions taken into account in the ACP test, rather than the sum of
the QNECs and the QMACs taken into account under the ADP test. Because
QNECs that do not exceed 5% are not subject to the limits on targeted
QNECs under either the ADP test or the ACP test, an employer is
permitted to take into account up to 10% in QNECs for an eligible NHCE,
5% in ADP testing and 5% in ACP testing, without regard to how many
NHCEs receive QNECs.

In addition, to prevent an employer from using targeted matching
contributions to circumvent the limitation on targeted QNECs, the
proposed regulations would provide that matching contributions are not
taken into account in the ACP test to the extent the matching rate for
the contribution exceeds the greater of 100% and 2 times the
representative matching rate. Paralleling the rule to limit targeted
QNECs, the representative plan matching rate is the lowest matching rate
for any eligible employee in a group of NHCEs that consists of half of
all eligible NHCEs in the plan for the plan year (or the lowest matching
rate for all eligible NHCEs in the plan who are employed by the employer
on the last day of the plan year, if greater). For this purpose, the
matching rate is the ratio of the matching contributions to the
contributions that are being matched, and only NHCEs who make elective
deferrals or employee contributions for the plan year are taken into
account.

The proposed regulations would set limits on the use of elective
contributions in the ACP test that are in addition to the rules in the
existing regulations under which elective contributions may be taken
into account for the ACP test only to the extent the plan satisfies the
ADP test, determined by including such elective contributions in the ADP
test. Under the new rule, the proposed regulations would provide that
elective contributions under a plan that is not subject to the ADP test,
such as a plan that uses the safe harbor method of section 401(k)(12) or
a contract or arrangement subject to the requirements of section
403(b)(12)(A)(ii), may not be taken into account for the ACP test. In
the absence of this prohibition, contributions that are not properly
considered "excess" could be taken into account under the ACP test.

The provisions of these proposed regulations regarding correction of
excess aggregate contributions, including allocation of excess aggregate
contributions and determination of allocable income, would generally be
consistent with the provisions of the proposed regulations under section
401(k). These proposed regulations continue the provisions of the
current regulations regarding correction through distribution of vested
matching contributions and forfeiture of unvested matching
contributions. Similarly, the proposed regulations reflect the
provisions of section 411(a)(3)(G) which permit the forfeiture of a
matching contribution made with respect to an excess deferral, excess
contribution, or excess aggregate contribution. This provision is
necessary to allow forfeiture of matching contributions that would
otherwise violate section 401(a)(4).

9\. [Safe Harbor Section 401(m) Plans]{.underline}

Section 401(m)(11) provides a design-based safe harbor method of
satisfying the ACP test contained in section 401(m)(2). Under section
401(m)(11), a defined contribution plan is treated as satisfying the ACP
test with respect to matching contributions if the plan satisfies the
ADP safe harbor of section 401(k)(12) and matching contributions are not
made with respect to employee contributions or elective contributions in
excess of 6% of an employee's compensation. For a plan that satisfies
the ADP safe harbor using a 3% nonelective contribution, two additional
requirements that apply to a plan that satisfies the ADP safe harbor
using matching contributions also apply: 1) the rate of an employer's
matching contribution does not increase as the rate of employee
contributions or elective deferrals increase; and 2) the matching
contribution with respect to any HCE at any rate of employee
contribution or elective deferral is not greater than with respect to
any NHCE. In addition, the ratio of matching contributions on behalf of
an HCE to that HCE's elective deferrals and employee contributions for a
plan year cannot be greater than the ratio of matching contributions to
elective deferrals or employee contributions that would apply with
respect to any NHCE who contributes (as an elective deferral or employee
contribution) the same percentage of safe harbor compensation for that
plan year.

Section 1.401(m)-3 of these proposed regulations, which sets forth the
requirements for these plans, would generally follow the rules set forth
in Notice 98-52 and Notice 2000-3. These proposed regulations would
clarify that, for purposes of determining whether an HCE has a higher
rate of matching contributions than any NHCE, any NHCE who is an
eligible employee under the safe harbor CODA must be taken into account,
even if the NHCE is not eligible for a matching contribution. This means
that a plan with a provision which limits matching contributions to
employees who are employed on the last day of the plan year will not be
able to satisfy the ACP safe harbor, since a NHCE who is not eligible to
receive a matching contribution on account of the last day requirement
will nonetheless be taken into consideration in determining whether the
plan satisfies section 401(m)(11)(B)(iii). The proposed regulations also
include the requirement that matching contributions made at the
employer\'s discretion with respect to any employee cannot exceed a
dollar amount equal to 4% of the employee\'s compensation and that a
safe harbor plan must permit all eligible NHCEs to make sufficient
elective contributions (or employee contributions, if applicable) to
receive the maximum matching contribution provided under the plan.

The proposed regulations would provide a special rule for satisfying
section 401(m)(11)(B)(iii) in the case of an HCE who participates in two
or more plans that provide for matching contributions. Under this rule,
a plan will not fail to satisfy the requirements of section
401(m)(11)(B)(iii) merely because an HCE participates during the plan
year in more than one plan that provides for matching contributions,
provided that the HCE is not simultaneously an eligible employee under
two plans that provide for matching contributions maintained by an
employer for a plan year; and the period used to determine compensation
for purposes of determining matching contributions under each such plan
is limited to periods when the HCE participated in the plan. In such a
case, an HCE can transfer from a plan with a more generous matching
schedule to an otherwise safe harbor section 401(m) plan (for example,
as a result of switching jobs within the controlled group) without
causing the safe harbor plan to violate section 401(m)(11). However, the
plan which is not the safe harbor plan will still have to aggregate
matching contributions for the HCE under the rule set forth in section
401(m)(2)(B).

The safe harbor in section 401(m)(11) does not apply to employee
contributions. Consequently, a plan that provides for employee
contributions and matching contributions must satisfy the ACP test even
though the matching contributions satisfy the safe harbor requirements
for section 401(m)(11). However, the proposed regulations would also
adopt the position in Notice 98-52 that the ACP test is permitted to be
applied by disregarding all matching contributions with respect to all
eligible employees. If the ADP safe harbor using matching contributions
is satisfied but the ACP safe harbor is not satisfied, the proposed
regulations would adopt the position in Notice 98-52 that the ACP test
is permitted to be applied disregarding matching contributions for any
employee that do not exceed 4% of compensation.

**Proposed Effective Date**

The regulations are proposed to apply for plan years beginning no sooner
than 12 months after publication of final regulations in the **Federal
Register**. However, it is anticipated that the preamble for the final
regulations will permit plan sponsors to implement the final regulations
for the first plan year beginning after publication of final regulations
in the **Federal Register**.

**Special Analyses**

It has been determined that this notice of proposed rulemaking is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It is hereby
certified that the collection of information in these regulations will
not have a significant economic impact on a substantial number of small
entities. This certification is based upon the conclusion that few plans
containing qualified CODAs will correct excess contributions through the
recharacterization of these amounts as employee contributions under
§1.401(k)-2(b)(3) of these proposed regulations. The collections of
information contained in §§1.401(k)-3(d), (f) and 1.401(m)-3(e) are
required by statutory provisions. However, the IRS has considered
alternatives that would lessen the impact of these statutory
requirements on small entities and has requested comments on the use of
electronic media to satisfy these notice requirements. Thus, the
collection of information in these regulations will not have a
significant economic impact on a substantial number of small entities.
Therefore, an analysis under the Regulatory Flexibility Act (5 U.S.C.
chapter 6) is not required. Pursuant to section 7805(f) of the Code,
this notice of proposed rulemaking will be submitted to the Chief
Counsel for Advocacy of the Small Business Administration for comment on
its impact on small business.

**Comments and Public Hearing**

Before these proposed regulations are adopted as final regulations,
consideration will be given to any electronic or written comments
(preferably a signed original and eight (8) copies) that are submitted
timely to the IRS. In addition to the other requests for comments set
forth in this document, the IRS and Treasury also request comments on
the clarity of the proposed rule and how it may be made easier to
understand. All comments will be available for public inspection and
copying.

A public hearing has been scheduled for November 12, 2003, at 10 a.m. in
the IRS Auditorium (7th Floor), Internal Revenue Building, 1111
Constitution Avenue NW., Washington, DC. Due to building security
procedures, visitors must enter at the Constitution Avenue, NW.,
entrance, located between 10^th^ and 12^th^ Streets, NW. In addition,
all visitors must present photo identification to enter the building.
Because of access restrictions, visitors will not be admitted beyond the
immediate entrance area more than 30 minutes before the hearing starts.
For information about having your name placed on the building access
list to attend the hearing, see the "FOR FURTHER INFORMATION CONTACT"
section of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing.

Persons who wish to present oral comments at the hearing must submit
written comments and an outline of the topics to be discussed and the
time to be devoted to each topic (signed original and eight (8) copies)
by October 22, 2003.

A period of 10 minutes will be allotted to each person for making
comments.

An agenda showing the scheduling of the speakers will be prepared after
the deadline for receiving outlines has passed. Copies of the agenda
will be available free of charge at the hearing.

**Drafting Information**

The principal authors of these regulations are R. Lisa Mojiri-Azad and
John T. Ricotta of the Office of the Division Counsel/Associate Chief
Counsel (Tax Exempt and Government Entities). However, other personnel
from the IRS and Treasury participated in their development.

**List of Subjects in 26 CFR Part 1**

Income taxes, Reporting and recordkeeping requirements.

**Proposed Amendments to The Regulations**

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1\--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in part
as follows:

Authority: 26 U.S.C. 7805

> 26 U.S.C. 401(m)(9) \* \* \*

Par. 2. Sections 1.401(k)-0 and 1.401(k)-1 are revised and §§1.401(k)-2
through 1.401(k)-6 are added to read as follows:

[§1.401(k)‑0 Table of contents]{.underline}.

This section contains first a list of section headings and then a list
of the paragraphs in each section in §§1.401(k)-1 through 1.401(k)-6.

LIST OF SECTIONS

§1.401(k)-1 Certain cash or deferred arrangements.

§1.401(k)-2 ADP test.

§1.401(k)-3 Safe harbor requirements.

§1.401(k)-4 SIMPLE 401(k) plan requirements.

§1.401(k)-5 Special rules for mergers, acquisitions and similar events.
*\[Reserved\]*.

§1.401(k)-6 Definitions.

LIST OF PARAGRAPHS

[§1.401(k)-1 Certain cash or deferred arrangements.]{.underline}

\(a\) General rules.

\(1\) Certain plans permitted to include cash or deferred arrangements.

\(2\) Rules applicable to cash or deferred arrangements generally.

\(i\) Definition of cash or deferred arrangement.

\(ii\) Treatment of after-tax employee contributions.

\(iii\) Treatment of ESOP dividend election.

\(iv\) Treatment of elective contributions as plan assets.

\(3\) Rules applicable to cash or deferred elections generally.

\(i\) Definition of cash or deferred election.

\(ii\) Automatic enrollment.

\(iii\) Rules related to timing.

\(A\) Requirement that amounts not be currently available.

\(B\) Contribution may not precede election.

\(iv\) Current availability defined.

\(v\) Certain one-time elections not treated as cash or deferred
elections.

\(vi\) Tax treatment of employees.

\(vii\) Examples.

\(4\) Rules applicable to qualified cash or deferred arrangements.

\(i\) Definition of qualified cash or deferred arrangement.

\(ii\) Treatment of elective contributions as employer contributions.

\(iii\) Tax treatment of employees.

\(iv\) Application of nondiscrimination requirements to plan that
includes a qualified cash or deferred arrangement.

\(A\) Exclusive means of amounts testing.

\(B\) Testing benefits, rights and features.

\(C\) Minimum coverage requirement.

\(5\) Rules applicable to nonqualified cash or deferred arrangements.

\(i\) Definition of nonqualified cash or deferred arrangement.

\(ii\) Treatment of elective contributions as nonelective contributions.

\(iii\) Tax treatment of employees.

\(iv\) Qualification of plan that includes a nonqualified cash or
deferred arrangement.

\(A\) In general.

\(B\) Application of section 401(a)(4) to certain plans.

\(v\) Example.

\(6\) Rules applicable to cash or deferred arrangements of self-employed
individuals.

\(i\) Application of general rules.

\(ii\) Treatment of matching contributions made on behalf of
self-employed individuals.

\(iii\) Timing of self-employed individual's cash or deferred election.

\(b\) Coverage and nondiscrimination requirements.

\(1\) In general.

\(2\) Automatic satisfaction by certain plans.

\(3\) Anti-abuse provisions.

\(4\) Aggregation and restructuring.

\(i\) In general.

\(ii\) Aggregation of cash or deferred arrangements within a plan.

\(iii\) Aggregation of plans.

\(A\) In general.

\(B\) Plans with inconsistent ADP testing methods.

\(iv\) Disaggregation of plans and separate testing.

\(A\) In general.

\(B\) Restructuring prohibited.

\(v\) Modifications to section 410(b) rules.

\(A\) Certain disaggregation rules not applicable.

\(B\) Permissive aggregation of collective bargaining units.

\(C\) Multiemployer plans.

\(vi\) Examples.

\(c\) Nonforfeitability requirements.

\(1\) General rule.

\(2\) Definition of immediately nonforfeitable.

\(3\) Example.

\(d\) Distribution limitation.

\(1\) General rule.

\(2\) Rules applicable to distributions upon severance from employment.

\(3\) Rules applicable to hardship distributions.

\(i\) Distribution must be on account of hardship.

\(ii\) Limit on maximum distributable amount.

\(A\) General rule.

\(B\) Grandfathered amounts.

\(iii\) Immediate and heavy financial need.

\(A\) In general.

\(B\) Deemed immediate and heavy financial need.

\(iv\) Distribution necessary to satisfy financial need.

\(A\) Distribution may not exceed amount of need.

\(B\) No alternative means available.

\(C\) Employer reliance on employee representation.

\(D\) Employee need not take counterproductive actions.

\(E\) Distribution deemed necessary to satisfy immediate and heavy
financial need.

\(F\) Definition of other plans.

\(v\) Commissioner may expand standards.

\(4\) Rules applicable to distributions upon plan termination.

\(i\) No alternative defined contribution plan.

\(ii\) Lump sum requirement for certain distributions.

\(5\) Rules applicable to all distributions.

\(i\) Exclusive distribution rules.

\(ii\) Deemed distributions.

\(iii\) ESOP dividend distributions.

\(iv\) Limitations apply after transfer.

\(6\) Examples.

\(e\) Additional requirements for qualified cash or deferred
arrangements.

\(1\) Qualified plan requirement.

\(2\) Election requirements.

\(i\) Cash must be available.

\(ii\) Frequency of elections.

\(3\) Separate accounting requirement.

\(i\) General rule.

\(ii\) Satisfaction of separate accounting requirement.

\(4\) Limitations on cash or deferred arrangements of state and local
governments.

\(i\) General rule.

\(ii\) Rural cooperative plans and Indian tribal governments.

\(iii\) Adoption after May 6, 1986.

\(iv\) Adoption before May 7, 1986.

\(5\) One-year eligibility requirement.

\(6\) Other benefits not contingent upon elective contributions.

\(i\) General rule.

\(ii\) Definition of other benefits.

\(iii\) Effect of certain statutory limits.

\(iv\) Nonqualified deferred compensation.

\(v\) Plan loans and distributions.

\(vi\) Examples.

\(7\) Plan provision requirement.

\(f\) Effective dates.

\(1\) General rule.

\(2\) Collectively bargained plans.

[§1.401(k)-2 ADP test]{.underline}.

\(a\) Actual deferral percentage (ADP) test.

\(1\) In general.

\(i\) ADP test formula.

\(ii\) HCEs as sole eligible employees.

\(iii\) Special rule for early participation.

\(2\) Determination of ADP.

\(i\) General rule.

\(ii\) Determination of applicable year under current year and prior
year testing method.

\(3\) Determination of ADR.

\(i\) General rule.

\(ii\) ADR of HCEs eligible under more than one arrangement.

\(A\) General rule.

\(B\) Plans not permitted to be aggregated.

\(iii\) Examples.

\(4\) Elective contributions taken into account under the ADP test.

\(i\) General rule.

\(ii\) Elective contributions for partners and self-employed
individuals.

\(iii\) Elective contributions for HCEs.

\(5\) Elective contributions not taken into account under the ADP test.

\(i\) General rule.

\(ii\) Elective contributions for NHCEs.

\(iii\) Elective contributions treated as catch-up contributions.

\(iv\) Elective contributions used to satisfy the ACP test.

\(6\) Qualified nonelective contributions and qualified matching
contributions that may be taken into account under the ADP test.

\(i\) Timing of allocation.

\(ii\) Requirement that amount satisfy section 401(a)(4).

\(iii\) Aggregation must be permitted.

\(iv\) Disproportionate contributions not taken into account.

\(A\) General rule.

\(B\) Definition of representative contribution rate.

\(C\) Definition of applicable contribution rate.

\(v\) Qualified matching contributions.

\(vi\) Contributions only used once.

\(7\) Examples.

\(b\) Correction of excess contributions.

\(1\) Permissible correction methods.

\(i\) In general.

\(A\) Qualified nonelective contributions or qualified matching
contributions.

\(B\) Excess contributions distributed.

\(C\) Excess contributions recharacterized.

\(ii\) Combination of correction methods.

\(iii\) Exclusive means of correction.

\(2\) Corrections through distribution.

\(i\) General rule.

\(ii\) Calculation of total amount to be distributed.

\(A\) Calculate the dollar amount of excess contributions for each HCE.

\(B\) Determination of the total amount of excess contributions.

\(C\) Satisfaction of ADP.

\(iii\) Apportionment of total amount of excess contributions among the
HCEs.

\(A\) Calculate the dollar amount of excess contributions for each HCE.

\(B\) Limit on amount apportioned to any individual.

\(C\) Apportionment to additional HCEs.

\(iv\) Income allocable to excess contributions.

\(A\) General rule.

\(B\) Method of allocating income.

\(C\) Alternative method of allocating plan year income.

\(D\) Safe harbor method of allocating gap period income.

\(E\) Alternative method for allocating plan year and gap period income.

\(v\) Distribution.

\(vi\) Tax treatment of corrective distributions.

\(A\) General rule.

\(B\) Rule for de minimis distributions.

\(vii\) Other rules.

\(A\) No employee or spousal consent required.

\(B\) Treatment of corrective distributions as elective contributions.

\(C\) No reduction of required minimum distribution.

\(D\) Partial distributions.

\(viii\) Examples.

\(3\) Recharacterization of excess contributions.

\(i\) General rule.

\(ii\) Treatment of recharacterized excess contributions.

\(iii\) Additional rules.

\(A\) Time of recharacterization.

\(B\) Employee contributions must be permitted under plan.

\(C\) Treatment of recharacterized excess contributions.

\(4\) Rules applicable to all corrections.

\(i\) Coordination with distribution of excess deferrals.

\(A\) Treatment of excess deferrals that reduce excess contributions.

\(B\) Treatment of excess contributions that reduce excess deferrals.

\(ii\) Forfeiture of match on distributed excess contributions.

\(iii\) Permitted forfeiture of QMAC.

\(iv\) No requirement for recalculation.

\(v\) Treatment of excess contributions that are catch-up contributions.

\(5\) Failure to timely correct.

\(i\) Failure to correct within 2½ months after end of plan year.

\(ii\) Failure to correct within 12 months after end of plan year.

\(c\) Additional rules for prior year testing method.

\(1\) Rules for change in testing method.

\(i\) General rule.

\(ii\) Situations permitting a change to the prior year testing method.

\(2\) Calculation of ADP under the prior year testing method for the
first plan year.

\(i\) Plans that are not successor plans.

\(ii\) First plan year defined.

\(iii\) Successor plans.

\(3\) Plans using different testing methods for the ADP and ACP test.

\(4\) Rules for plan coverage changes.

\(i\) In general.

\(ii\) Optional rule for minor plan coverage changes.

\(iii\) Definitions.

\(A\) Plan coverage change.

\(B\) Prior year subgroup.

\(C\) Weighted average of the ADPs for the prior year subgroups.

\(iv\) Examples.

[§1.401(k)-3 Safe harbor requirements]{.underline}.

\(a\) ADP test safe harbor.

\(b\) Safe harbor nonelective contribution requirement.

\(1\) General rule.

\(2\) Safe harbor compensation defined.

\(c\) Safe harbor matching contribution requirement.

\(1\) In general.

\(2\) Basic matching formula.

\(3\) Enhanced matching formula.

\(4\) Limitation on HCE matching contributions.

\(5\) Use of safe harbor match not precluded by certain plan provisions.

\(i\) Safe harbor matching contributions on employee contributions.

\(ii\) Periodic matching contributions.

\(6\) Permissible restrictions on elective contributions by NHCEs.

\(i\) General rule.

\(ii\) Restrictions on election periods.

\(iii\) Restrictions on amount of elective contributions.

\(iv\) Restrictions on types of compensation that may be deferred.

\(v\) Restrictions due to limitations under the Internal Revenue Code.

\(7\) Examples.

\(d\) Notice requirement.

\(1\) General rule.

\(2\) Content requirement.

\(i\) General rule.

\(ii\) Minimum content requirement.

\(iii\) References to SPD.

\(3\) Timing requirement.

\(i\) General rule.

\(ii\) Deemed satisfaction of timing requirement.

\(e\) Plan year requirement.

\(1\) General rule.

\(2\) Initial plan year.

\(3\) Change of plan year.

\(4\) Final plan year.

\(f\) Plan amendments adopting safe harbor nonelective contributions.

\(1\) General rule.

\(2\) Contingent notice provided.

\(3\) Follow-up notice requirement.

\(g\) Permissible reduction or suspension of safe harbor matching
contributions.

\(1\) General rule.

\(2\) Notice of suspension requirement.

\(h\) Additional rules.

\(1\) Contributions taken into account.

\(2\) Use of safe harbor nonelective contributions to satisfy other
nondiscrimination tests.

\(3\) Early participation rules.

\(4\) Satisfying safe harbor contribution requirement under another
defined contribution plan.

\(5\) Contributions used only once.

[§1.401(k)-4 SIMPLE 401(k) plan requirements]{.underline}.

\(a\) General rule.

\(b\) Eligible employer.

\(1\) General rule.

\(2\) Special rule.

\(c\) Exclusive plan.

\(1\) General rule.

\(2\) Special rule.

\(d\) Election and notice.

\(1\) General rule.

\(2\) Employee elections.

\(i\) Initial plan year of participation.

\(ii\) Subsequent plan years.

\(iii\) Election to terminate.

\(3\) Employee notices.

\(e\) Contributions.

\(1\) General rule.

\(2\) Elective contributions.

\(3\) Matching contributions.

\(4\) Nonelective contributions.

\(5\) SIMPLE compensation.

\(f\) Vesting.

\(g\) Plan year.

\(h\) Other rules.

[§1.401(k)-5 Special rules for mergers, acquisitions and similar
events]{.underline}. *\[Reserved\]*

[§1.401(k)-6 Definitions]{.underline}.

[§1.401(k)‑1 Certain cash or deferred arrangements]{.underline}.

\(a\) [General rules]{.underline}\--(1) [Certain plans permitted to
include cash or deferred arrangements]{.underline}. A plan, other than a
profit‑sharing, stock bonus, pre‑ERISA money purchase pension, or rural
cooperative plan, does not satisfy the requirements of section 401(a) if
the plan includes a cash or deferred arrangement. A profit‑sharing,
stock bonus, pre‑ERISA money purchase pension, or rural cooperative plan
does not fail to satisfy the requirements of section 401(a) merely
because the plan includes a cash or deferred arrangement. A cash or
deferred arrangement is part of a plan for purposes of this section if
any contributions to the plan, or accruals or other benefits under the
plan, are made or provided pursuant to the cash or deferred arrangement.

\(2\) [Rules applicable to cash or deferred arrangements
generally]{.underline}\--(i) [Definition of cash or deferred
arrangement]{.underline}. Except as provided in paragraphs (a)(2)(ii)
and (iii) of this section, a cash or deferred arrangement is an
arrangement under which an eligible employee may make a cash or deferred
election with respect to contributions to, or accruals or other benefits
under, a plan that is intended to satisfy the requirements of section
401(a) (including a contract that is intended to satisfy the
requirements of section 403(a)).

\(ii\) [Treatment of after‑tax employee contributions]{.underline}. A
cash or deferred arrangement does not include an arrangement under which
amounts contributed under a plan at an employee's election are
designated or treated at the time of contribution as after‑tax employee
contributions (e.g., by treating the contributions as taxable income
subject to applicable withholding requirements). See also section
414(h)(1). This is the case even if the employee's election to make
after-tax employee contributions is made before the amounts subject to
the election are currently available to the employee.

\(iii\) [Treatment of ESOP dividend election]{.underline}. A cash or
deferred arrangement does not include an arrangement under an ESOP under
which dividends are either distributed or invested pursuant to an
election made by participants or their beneficiaries in accordance with
section 404(k)(2)(A)(iii).

\(iv\) [Treatment of elective contributions as plan assets]{.underline}.
The extent to which elective contributions constitute plan assets for
purposes of the prohibited transaction provisions of section 4975 and
Title I of the Employee Retirement Income Security Act of 1974 is
determined in accordance with regulations and rulings issued by the
Department of Labor. See 29 CFR 2510.3-102.

\(3\) [Rules applicable to cash or deferred elections
generally]{.underline}\--(i) [Definition of cash or deferred
election]{.underline}. A cash or deferred election is any direct or
indirect election (or modification of an earlier election) by an
employee to have the employer either\--

\(A\) Provide an amount to the employee in the form of cash (or some
other taxable benefit) that is not currently available; or

\(B\) Contribute an amount to a trust, or provide an accrual or other
benefit, under a plan deferring the receipt of compensation.

\(ii\) [Automatic enrollment]{.underline}. For purposes of determining
whether an election is a cash or deferred election, it is irrelevant
whether the default that applies in the absence of an affirmative
election is described in paragraph (a)(3)(i)(A) of this section (i.e.,
the employee receives an amount in cash or some other taxable benefit)
or in paragraph (a)(3)(i)(B) of this section (i.e., the employer
contributes an amount to a trust or provides an accrual or other benefit
under a plan deferring the receipt of compensation).

\(iii\) [Rules related to timing]{.underline}\--(A) [Requirement that
amounts not be currently available]{.underline}. A cash or deferred
election can only be made with respect to an amount that is not
currently available to the employee on the date of the election.
Further, a cash or deferred election can only be made with respect to
amounts that would (but for the cash or deferred election) become
currently available after the later of the date on which the employer
adopts the cash or deferred arrangement or the date on which the
arrangement first becomes effective.

\(B\) [Contribution may not precede election]{.underline}. A
contribution is made pursuant to a cash or deferred election only if the
contribution is made after the election is made. In addition, a
contribution is made pursuant to a cash or deferred election only if the
contribution is made after the employee's performance of services with
respect to which the contribution is made (or when the cash or other
taxable benefit would be currently available, if earlier).

\(iv\) [Current availability defined]{.underline}. Cash or another
taxable benefit is currently available to the employee if it has been
paid to the employee or if the employee is able currently to receive the
cash or other taxable benefit at the employee's discretion. An amount is
not currently available to an employee if there is a significant
limitation or restriction on the employee's right to receive the amount
currently. Similarly, an amount is not currently available as of a date
if the employee may under no circumstances receive the amount before a
particular time in the future. The determination of whether an amount is
currently available to an employee does not depend on whether it has
been constructively received by the employee for purposes of section
451.

\(v\) [Certain one‑time elections not treated as cash or deferred
elections]{.underline}. A cash or deferred election does not include a
one‑time irrevocable election upon an employee's commencement of
employment with the employer, or upon the employee's first becoming
eligible under the plan or any other plan of the employer (whether or
not such other plan has terminated), to have contributions equal to a
specified amount or percentage of the employee's compensation (including
no amount of compensation) made by the employer on the employee's behalf
to the plan and a specified amount or percentage of the employee's
compensation (including no amount of compensation) divided among all
other plans of the employer (including plans not yet established) for
the duration of the employee's employment with the employer, or in the
case of a defined benefit plan to receive accruals or other benefits
(including no benefits) under such plans. Thus, for example, employer
contributions made pursuant to a one‑time irrevocable election described
in this paragraph are not treated as having been made pursuant to a cash
or deferred election and are not includible in an employee's gross
income by reason of §1.402(a)‑1(d). In the case of an irrevocable
election made on or before December 23, 1994\--

\(A\) The election does not fail to be treated as a one-time irrevocable
election under this paragraph (a)(3)(v) merely because an employee was
previously eligible under another plan of the employer (whether or not
such other plan has terminated); and

\(B\) In the case of a plan in which partners may participate, the
election does not fail to be treated as a one-time irrevocable election
under this paragraph (a)(3)(v) merely because the election was made
after commencement of employment or after the employee's first becoming
eligible under any plan of the employer, provided that the election was
made before the first day of the first plan year beginning after
December 31,1988, or, if later, March 31,1989.

\(vi\) [Tax treatment of employees]{.underline}. An amount generally is
includible in an employee's gross income for the taxable year in which
the employee actually or constructively receives the amount. But for
sections 402(e)(3) and 401(k), an employee is treated as having received
an amount that is contributed to a plan pursuant to the employee's cash
or deferred election. This is the case even if the election to defer is
made before the year in which the amount is earned, or before the amount
is currently available. See §1.402(a)‑1(d).

\(vii\) [Examples]{.underline}. The following examples illustrate the
application of paragraph (a)(3) of this section:

[Example 1]{.underline}. (i) An employer maintains a profit‑sharing plan
under which each eligible employee has an election to defer an annual
bonus payable on January 30 each year. The bonus equals 10% of
compensation during the previous calendar year. Deferred amounts are not
treated as after‑tax employee contributions. The bonus is currently
available on January 30.

\(ii\) An election made prior to January 30 to defer all or part of the
bonus is a cash or deferred election, and the bonus deferral arrangement
is a cash or deferred arrangement.

[Example 2]{.underline}. (i) An employer maintains a profit‑sharing plan
which provides for discretionary profit sharing contributions and under
which each eligible employee may elect to reduce his compensation by up
to 10% and to have the employer contribute such amount to the plan. The
employer pays each employee every two weeks for services during the
immediately preceding two weeks. The employee's election to defer
compensation for a payroll period must be made prior to the date the
amount would otherwise be paid. The employer contributes to the plan the
amount of compensation that each employee elected to defer, at the time
it would otherwise be paid to the employee, and does not treat the
contribution as an after-tax employee contribution.

\(ii\) The election is a cash or deferred election and the contributions
are elective contributions.

[Example 3]{.underline}. (i) The facts are the same as in [Example
2]{.underline}, except that the employer makes a \$10,000 contribution
on January 31 of the plan year that is in addition to the contributions
that satisfy the employer's obligation to make contributions with
respect to cash or deferred elections for prior payroll periods.
Employee A makes an election on February 15 to defer \$2,000 from
compensation that is not currently available and the employer reduces
the employee's compensation to reflect the election.

\(ii\) None of the additional \$10,000 contributed January 31 is a
contribution made pursuant to Employee A's cash or deferred election,
because the contribution was made before the election was made.
Accordingly, the employer must make an additional contribution of
\$2,000 in order to satisfy its obligation to contribute an amount to
the plan pursuant to Employee A's election. The \$10,000 contribution
can be allocated under the plan terms providing for discretionary profit
sharing contributions.

[Example 4]{.underline}. (i) The facts are the same as in [Example
3]{.underline}, except that Employee A had an outstanding election to
defer \$500 from each payroll period's compensation.

\(ii\) None of the additional \$10,000 contributed January 31 is a
contribution made pursuant to Employee A's cash or deferred election for
future payroll periods, because the contribution was made before the
earlier of Employee A\'s performance of services to which the
contribution is attributable or when the compensation would be currently
available. Accordingly, the employer must make an additional
contribution of \$500 per payroll period in order to satisfy its
obligation to contribute an amount to the plan pursuant to Employee A's
election. The \$10,000 contribution can be allocated under the plan
terms providing for discretionary profit sharing contributions.

[Example 5]{.underline}. (i) Employer B establishes a money purchase
pension plan in 1986. This is the first qualified plan established by
Employer B. All salaried employees are eligible to participate under the
plan. Hourly‑paid employees are not eligible to participate under the
plan. In 2000, Employer B establishes a profit‑sharing plan under which
all employees (both salaried and hourly) are eligible. Employer B
permits all employees on the effective date of the profit‑sharing plan
to make a one‑time irrevocable election to have Employer B contribute 5%
of compensation on their behalf to the plan and make no other
contribution to any other plan of Employer B (including plans not yet
established) for the duration of the employee's employment with Employer
B, and have their salaries reduced by 5%.

\(ii\) The election provided under the profit‑sharing plan is not a
one‑time irrevocable election within the meaning of paragraph (a)(3)(v)
of this section with respect to the salaried employees of Employer B
who, before becoming eligible to participate under the profit‑sharing
plan, became eligible to participate under the money purchase pension
plan. The election under the profit‑sharing plan is a one‑time
irrevocable election within the meaning of paragraph (a)(3)(v) of this
section with respect to the hourly employees, because they were not
previously eligible to participate under another plan of the employer.

\(4\) [Rules applicable to qualified cash or deferred
arrangements]{.underline}\--(i) [Definition of qualified cash or
deferred arrangement]{.underline}. A qualified cash or deferred
arrangement is a cash or deferred arrangement that satisfies the
requirements of paragraphs (b), (c), (d), and (e) of this section.

\(ii\) [Treatment of elective contributions as employer
contributions]{.underline}. Except as otherwise provided in
§1.401(k)-2(b)(3), elective contributions under a qualified cash or
deferred arrangement are treated as employer contributions. Thus, for
example, elective contributions are treated as employer contributions
for purposes of sections 401(a) and 401(k), 402, 404, 409, 411, 412,
415, 416, and 417.

\(iii\) [Tax treatment of employees]{.underline}. Except as provided in
section 402(g), 402A (effective for years beginning after December 31,
2005), or 1.401(k)-2(b)(3), elective contributions under a qualified
cash or deferred arrangement are neither includible in an employee's
gross income at the time the cash would have been includible in the
employee's gross income (but for the cash or deferred election), nor at
the time the elective contributions are contributed to the plan. See
§1.402(a)‑1(d)(2)(i).

\(iv\) [Application of nondiscrimination requirements to plan that
includes a qualified cash or deferred arrangement]{.underline}\--(A)
[Exclusive means of amounts testing]{.underline}. Elective contributions
under a qualified cash or deferred arrangement satisfy the requirements
of section 401(a)(4) with respect to amounts if and only if the amount
of elective contributions satisfies the nondiscrimination test of
section 401(k) under paragraph (b)(1) of this section. See
§1.401(a)(4)‑1(b)(2)(ii)(B).

\(B\) [Testing benefits, rights and features]{.underline}. A plan that
includes a qualified cash or deferred arrangement must satisfy the
requirements of section 401(a)(4) with respect to benefits, rights and
features in addition to the requirements regarding amounts described in
paragraph (a)(4)(iv)(A) of this section. For example, the right to make
each level of elective contributions under a cash or deferred
arrangement is a benefit, right or feature subject to the requirements
of section 401(a)(4). See §1.401(a)(4)‑4(e)(3)(i) and (iii)(D). Thus,
for example, if all employees are eligible to make a stated level of
elective contributions under a cash or deferred arrangement, but that
level of contributions can only be made from compensation in excess of a
stated amount, such as the Social Security taxable wage base, the
arrangement will generally favor HCEs with respect to the availability
of elective contributions and thus will generally not satisfy the
requirements of section 401(a)(4).

\(C\) [Minimum coverage requirement]{.underline}. A qualified cash or
deferred arrangement is treated as a separate plan that must satisfy the
requirements of section 410(b). See §1.410(b)-7(c)(1) for special rules.
The determination of whether a cash or deferred arrangement satisfies
the requirements of section 410(b) must be made without regard to the
modifications to the disaggregation rules set forth in paragraph
(b)(4)(v) of this section. See also §1.401(a)(4)‑11(g)(3)(vii)(A),
relating to corrective amendments that may be made to satisfy the
minimum coverage requirements of section 410(b).

\(5\) [Rules applicable to nonqualified cash or deferred
arrangements]{.underline}\--(i) [Definition of nonqualified cash or
deferred arrangement]{.underline}. A nonqualified cash or deferred
arrangement is a cash or deferred arrangement that fails to satisfy one
or more of the requirements in paragraph (b), (c), (d) or (e) of this
section.

\(ii\) [Treatment of elective contributions as nonelective
contributions]{.underline}. Except as specifically provided otherwise,
elective contributions under a nonqualified cash or deferred arrangement
are treated as nonelective employer contributions. Thus, for example,
the elective contributions are treated as nonelective employer
contributions for purposes of sections 401(a) (including section
401(a)(4)) and 401(k), 404, 409, 411, 412, 415, 416, and 417 and are not
subject to the requirements of section 401(m).

\(iii\) [Tax treatment of employees]{.underline}. Elective contributions
under a nonqualified cash or deferred arrangement are includible in an
employee's gross income at the time the cash or other taxable amount
that the employee would have received (but for the cash or deferred
election) would have been includible in the employee's gross income. See
§1.402(a)‑1(d)(1).

\(iv\) [Qualification of plan that includes a nonqualified cash or
deferred arrangement]{.underline}\-- (A) [In general]{.underline}. A
profit‑sharing, stock bonus, pre‑ERISA money purchase pension, or rural
cooperative plan does not fail to satisfy the requirements of section
401(a) merely because the plan includes a nonqualified cash or deferred
arrangement. In determining whether the plan satisfies the requirements
of section 401(a)(4), the nondiscrimination tests of sections 401(k),
paragraph (b)(1) of this section, section 401(m)(2) and §1.401(m)-1(b)
may not be used. See §§1.401(a)(4)‑1(b)(2)(ii)(B) and 1.410(b)‑9
(definition of section 401(k) plan).

\(B\) [Application of section 401(a)(4) to certain plans]{.underline}.
The amount of employer contributions under a nonqualified cash or
deferred arrangement is treated as satisfying section 401(a)(4) if the
arrangement is part of a collectively bargained plan that automatically
satisfies the requirements of section 410(b). See §§1.401(a)(4)‑1(c)(5)
and 1.410(b)‑2(b)(7). Additionally, the requirements of sections
401(a)(4) and 410(b) do not apply to a governmental plan (within the
meaning of section 414(d)) maintained by a State or local government or
political subdivision thereof (or agency or instrumentality thereof).
See sections 401(a)(5) and 410(c)(1)(A).

\(v\) [Example]{.underline}. The following example illustrates the
application of this paragraph (a)(5):

[Example]{.underline}. (i) For the 2006 plan year, Employer A maintains
a collectively bargained plan that includes a cash or deferred
arrangement. Employer contributions under the cash or deferred
arrangement do not satisfy the nondiscrimination test of section 401(k)
and paragraph (b) of this section.

\(ii\) The arrangement is a nonqualified cash or deferred arrangement.
The employer contributions under the cash or deferred arrangement are
considered to be nondiscriminatory under section 401(a)(4), and the
elective contributions are generally treated as employer contributions
under paragraph (a)(5)(ii) of this section. Under paragraph (a)(5)(iii)
of this section and under §1.402(a)‑1(d)(1), however, the elective
contributions are includible in each employee's gross income.

\(6\) [Rules applicable to cash or deferred arrangements of
self-employed individuals]{.underline} \--(i) [Application of general
rules]{.underline}. Generally, a partnership or sole proprietorship is
permitted to maintain a cash or deferred arrangement, and individual
partners or owners are permitted to make cash or deferred elections with
respect to compensation attributable to services rendered to the entity,
under the same rules that apply to other cash or deferred arrangements.
For example, any contributions made on behalf of an individual partner
or owner pursuant to a cash or deferred arrangement of a partnership or
sole proprietorship are elective contributions unless they are
designated or treated as after-tax employee contributions. In the case
of a partnership, a cash or deferred arrangement includes any
arrangement that directly or indirectly permits individual partners to
vary the amount of contributions made on their behalf. Consistent with
§1.402(a)-1(d), the elective contributions under such an arrangement are
includible in income and are not deductible under section 404(a) unless
the arrangement is a qualified cash or deferred arrangement (i.e., the
requirements of section 401(k) and this section are satisfied). Also,
even if the arrangement is a qualified cash or deferred arrangement, the
elective contributions are includible in gross income and are not
deductible under section 404(a) to the extent they exceed the applicable
limit under section 402(g). See also §1.401(a)-30.

\(ii\) [Treatment of matching contributions made on behalf of
self-employed individuals]{.underline}. Under section 402(g)(8),
matching contributions made on behalf of a self-employed individual are
not treated as elective contributions made pursuant to a cash or
deferred election, without regard to whether such matching contributions
indirectly permit individual partners to vary the amount of
contributions made on their behalf.

\(iii\) [Timing of self-employed individual's cash or deferred
election]{.underline}. For purposes of paragraph (a)(3)(iv) of this
section, a partner's compensation is deemed currently available on the
last day of the partnership taxable year and a sole proprietor's
compensation is deemed currently available on the last day of the
individual's taxable year. Accordingly, a self-employed individual may
not make a cash or deferred election with respect to compensation for a
partnership or sole proprietorship taxable year after the last day of
that year. See §1.401(k)‑2(a)(4)(ii) for the rules regarding when these
contributions are treated as allocated.

\(b\) [Coverage and nondiscrimination requirements]{.underline}\--(1)
[In general]{.underline}. A cash or deferred arrangement satisfies this
paragraph (b) for a plan year only if\--

\(i\) The group of eligible employees under the cash or deferred
arrangement (including any employee taken into account for purposes of
section 410(b) pursuant to §1.401(a)(4)-11(g)(3)(vii)(A)) satisfies the
requirements of section 410(b) (including the average benefit percentage
test, if applicable); and

\(ii\) The cash or deferred arrangement satisfies\--

\(A\) The ADP test of section 401(k)(3) described in §1.401(k)-2;

\(B\) The ADP safe harbor provisions of section 401(k)(12) described in
§1.401(k)-3; or

\(C\) The SIMPLE 401(k) provisions of section 401(k)(11) described in
§1.401(k)-4.

\(2\) [Automatic satisfaction by certain plans]{.underline}.
Notwithstanding paragraph (b)(1) of this section, a governmental plan
(within the meaning of section 414(d)) maintained by a State or local
government or political subdivision thereof (or agency or
instrumentality thereof) shall be treated as meeting the requirements of
this paragraph (b).

\(3\) [Anti-abuse provisions]{.underline}. Sections 1.401(k)-1 through
1.401(k)-6 are designed to provide simple, practical rules that
accommodate legitimate plan changes. At the same time, the rules are
intended to be applied by employers in a manner that does not make use
of changes in plan testing procedures or other plan provisions to
inflate inappropriately the ADP for NHCEs (which is used as a benchmark
for testing the ADP for HCEs) or to otherwise manipulate the
nondiscrimination testing requirements of this paragraph (b). Further,
this paragraph (b) is part of the overall requirement that benefits or
contributions not discriminate in favor of HCEs. Therefore, a plan will
not be treated as satisfying the requirements of this paragraph (b) if
there are repeated changes to plan testing procedures or plan provisions
that have the effect of distorting the ADP so as to increase
significantly the permitted ADP for HCEs, or otherwise manipulate the
nondiscrimination rules of this paragraph, if a principal purpose of the
changes was to achieve such a result.

\(4\) [Aggregation and restructuring]{.underline}\--(i) [In
general]{.underline}. This paragraph (b)(4) contains the exclusive rules
for aggregating and disaggregating plans and cash or deferred
arrangements for purposes of this section, and §§1.401(k)-2 through
1.401(k) -6.

\(ii\) [Aggregation of cash or deferred arrangements within a
plan]{.underline}. Except as otherwise specifically provided in this
paragraph (b)(4), all cash or deferred arrangements included in a plan
are treated as a single cash or deferred arrangement and a plan must
apply a single test under paragraph (b)(1)(ii) of this section with
respect to all such arrangements within the plan. Thus, for example, if
two groups of employees are eligible for separate cash or deferred
arrangements under the same plan, all contributions under both cash or
deferred arrangements must be treated as made under a single cash or
deferred arrangement subject to a single test, even if they have
significantly different features, such as different limits on elective
contributions.

\(iii\) [Aggregation of plans]{.underline}\--(A) [In
general]{.underline}. For purposes of this section and §§1.401(k)-2
through 1.401(k)-6, the term plan means a plan within the meaning of
§1.410(b)-7(a) and (b), after application of the mandatory
disaggregation rules of §1.410(b)-7(c), and the permissive aggregation
rules of §1.410(b)-7(d), as modified by paragraph (b)(4)(v) of this
section. Thus, for example, two plans (within the meaning of
§1.410(b)-7(b)) that are treated as a single plan pursuant to the
permissive aggregation rules of §1.410(b)-7(d) are treated as a single
plan for purposes of section 401(k) and section 401(m).

\(B\) [Plans with inconsistent ADP testing methods]{.underline}.
Pursuant to paragraph (b)(4)(ii) of this section, a single testing
method must apply with respect to all cash or deferred arrangements
under a plan. Thus, in applying the permissive aggregation rules of
§1.410(b)-7(d), an employer may not aggregate plans (within the meaning
of §1.410(b)-7(b)) that apply inconsistent testing methods. For example,
a plan (within the meaning of §1.410(b)-7(b)) that applies the current
year testing method may not be aggregated with another plan that applies
the prior year testing method. Similarly, an employer may not aggregate
a plan (within the meaning of §1.410(b)-7(b)) using the ADP safe harbor
provisions of section 401(k)(12) and another plan that is using the ADP
test of section 401(k)(3).

\(iv\) [Disaggregation of plans and separate testing]{.underline}\--(A)
[In general]{.underline}. If a cash or deferred arrangement is included
in a plan (within the meaning of §1.410(b)-7(b)) that is mandatorily
disaggregated under the rules of section 410(b) (as modified by this
paragraph (b)(4)), the cash or deferred arrangement must be
disaggregated in a consistent manner. For example, in the case of an
employer that is treated as operating qualified separate lines of
business under section 414(r), if the eligible employees under a cash or
deferred arrangement are in more than one qualified separate line of
business, only those employees within each qualified separate line of
business may be taken into account in determining whether each
disaggregated portion of the plan complies with the requirements of
section 401(k), unless the employer is applying the special rule for
employer-wide plans in §1.414(r)-1(c)(2)(ii) with respect to the plan.
Similarly, if a cash or deferred arrangement under which employees are
permitted to participate before they have completed the minimum age and
service requirements of section 410(a)(1) applies section 410(b)(4)(B)
for determining whether the plan complies with section 410(b)(1), then
the arrangement must be treated as two separate arrangements, one
comprising all eligible employees who have met the age and service
requirements of section 410(a)(1) and one comprising all eligible
employees who have not met the age and service requirements under
section 410(a)(1), unless the plan is using the rule in
§1.401(k)-2(a)(1)(iii)(A).

\(B\) [Restructuring prohibited]{.underline}. Restructuring under
§1.401(a)(4)-9(c) may not be used to demonstrate compliance with the
requirements of section 401(k). See §1.401(a)(4)-9(c)(3)(ii).

\(v\) [Modifications to section 410(b) rules]{.underline}\--(A) [Certain
disaggregation rules not applicable]{.underline}. The mandatory
disaggregation rules relating to section 401(k) plans and section 401(m)
plans set forth in §1.410(b)-7(c)(1) and ESOP and non-ESOP portions of a
plan set forth in §1.410(b)-7(c)(2) shall not apply for purposes of this
section and §§1.401(k)-2 through 1.401(k)-6. Accordingly,
notwithstanding §1.410(b)-7(d)(2), an ESOP and a non-ESOP which are
different plans (within the meaning of §1.410(b)-7(b)) are permitted to
be aggregated for these purposes.

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

\(C\) [Multiemployer plans]{.underline}. Notwithstanding
§1.410(b)-7(c)(4)(ii)(C), the portion of the plan that is maintained
pursuant to a collective bargaining agreement (within the meaning of
§1.413-1(a)(2)) is treated as a single plan maintained by a single
employer that employs all the employees benefitting under the same
benefit computation formula and covered pursuant to that collective
bargaining agreement. The rules of paragraph (b)(4)(v)(B) of this
section (including the permissive aggregation of collective bargaining
units) apply to the resulting deemed single plan in the same manner as
they would to a single employer plan, except that the plan administrator
is substituted for the employer where appropriate and appropriate
fiduciary obligations are taken into account. The noncollectively
bargained portion of the plan is treated as maintained by one or more
employers, depending on whether the noncollectively bargaining unit
employees who benefit under the plan are employed by one or more
employers.

\(vi\) [Examples]{.underline}. The following examples illustrate the
application of this paragraph (b)(4):

[Example 1]{.underline}. (i) Employer A maintains Plan V, a
profit‑sharing plan that includes a cash or deferred arrangement in
which all of the employees of Employer A are eligible to participate.
For purposes of applying section 410(b), Employer A is treated as
operating qualified separate lines of business under section 414(r) in
accordance with §1.414(r)‑1(b). However, Employer A applies the special
rule for employer-wide plans in §1.414(r)‑1(c)(2)(ii) to the portion of
its profit‑sharing plan that consists of elective contributions under
the cash or deferred arrangement (and to no other plans or portions of
plans).

\(ii\) Under these facts, the requirements of this section and
§§1.401(k)-2 through 1.401(k)-6 must be applied on an employer‑wide
rather than a qualified separate line of business basis.

[Example 2]{.underline}. (i) Employer B maintains Plan W, a
profit-sharing plan that includes a cash or deferred arrangement in
which all of the employees of Employer B are eligible to participate.
For purposes of applying section 410(b), the plan treats the cash or
deferred arrangement as two separate plans, one for the employees who
have completed the minimum age and service eligibility conditions under
section 410(a)(1) and the other for employees who have not completed the
conditions. The plan provides that it will satisfy the section 401(k)
safe harbor requirement of §1.401(k)-3 with respect to the employees who
have met the minimum age and service conditions and that it will meet
the ADP test requirements of §1.401(k)-2 with respect to the employees
who have not met the minimum age and service conditions.

\(ii\) Under these facts, the cash or deferred arrangement must be
disaggregated on a consistent basis with the disaggregation of Plan W.
Thus, the requirements of §1.401(k)-2 must be applied by comparing the
ADP for eligible HCEs who have not completed the minimum age and service
conditions with the ADP for eligible NHCEs for the applicable year who
have not completed the minimum age and service conditions.

[Example 3]{.underline}. (i) Employer C maintains Plan X, a stock-bonus
plan including an ESOP. The plan also includes a cash or deferred
arrangement for participants in the ESOP and non-ESOP portions of the
plan.

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

\(c\) [Nonforfeitability requirements]{.underline}\--(1) [General
rule]{.underline}. A cash or deferred arrangement satisfies this
paragraph (c) only if the amount attributable to an employee's elective
contributions are immediately nonforfeitable, within the meaning of
paragraph (c)(2) of this section, are disregarded for purposes of
applying section 411(a) to other contributions or benefits, and the
contributions remain nonforfeitable even if the employee makes no
additional elective contributions under a cash or deferred arrangement.

\(2\) [Definition of immediately nonforfeitable]{.underline}. An amount
is immediately nonforfeitable if it is immediately nonforfeitable within
the meaning of section 411, and would be nonforfeitable under the plan
regardless of the age and service of the employee or whether the
employee is employed on a specific date. An amount that is subject to
forfeitures or suspensions permitted by section 411(a)(3) does not
satisfy the requirements of this paragraph (c).

\(3\) [Example]{.underline}. The following example illustrates the
application of this paragraph (c):

[Example]{.underline} . (i) Employees B and C are covered by Employer
Y's stock bonus plan, which includes a cash or deferred arrangement. All
employees participating in the plan have a nonforfeitable right to a
percentage of their account balance derived from all contributions
(including elective contributions) as shown in the following table:

  ----------------------------------- -----------------------------------
  Years of service                    Nonforfeitable percentage

  Less than 1                         0%

  1                                   20%

  2                                   40%

  3                                   60%

  4                                   80%

  5 or more                           100%
  ----------------------------------- -----------------------------------

\(ii\) The cash or deferred arrangement does not satisfy paragraph (c)
of this section because elective contributions are not immediately
nonforfeitable. Thus, the cash or deferred arrangement is a nonqualified
cash or deferred arrangement.

\(d\) [Distribution limitation]{.underline}\--(1) [General
rule]{.underline}. A cash or deferred arrangement satisfies this
paragraph (d) only if amounts attributable to elective contributions may
not be distributed before one of the following events, and any
distributions so permitted also satisfy the additional requirements of
paragraphs (d)(2) through (5) of this section (to the extent
applicable)\--

\(i\) The employee's death, disability, or severance from employment;

\(ii\) In the case of a profit‑sharing, stock bonus or rural cooperative
plan, the employee's attainment of age 59½, or the employee's hardship;
or

\(iii\) The termination of the plan.

\(2\) [Rules applicable to distributions upon severance from
employment]{.underline}. An employee has a severance from employment
when the employee ceases to be an employee of the employer maintaining
the plan. An employee does not have a severance from employment if, in
connection with a change of employment, the employee's new employer
maintains such plan with respect to the employee. For example, a new
employer maintains a plan with respect to an employee by continuing or
assuming sponsorship of the plan or by accepting a transfer of plan
assets and liabilities (within the meaning of section 414(l)) with
respect to the employee).

\(3\) [Rules applicable to hardship distributions]{.underline}\--(i)
[Distribution must be on account of hardship]{.underline}. A
distribution is treated as made after an employee's hardship for
purposes of paragraph (d)(1)(ii) of this section if and only if it is
made on account of the hardship. For purposes of this rule, a
distribution is made on account of hardship only if the distribution
both is made on account of an immediate and heavy financial need of the
employee and is necessary to satisfy the financial need. The
determination of the existence of an immediate and heavy financial need
and of the amount necessary to meet the need must be made in accordance
with nondiscriminatory and objective standards set forth in the plan.

\(ii\) [Limit on maximum distributable amount]{.underline}\--(A)
[General rule]{.underline}. A distribution on account of hardship must
be limited to the maximum distributable amount. The maximum
distributable amount is equal to the employee's total elective
contributions as of the date of distribution, reduced by the amount of
previous distributions of elective contributions. Thus, the maximum
distributable amount does not include earnings, QNECs or QMACs, unless
grandfathered under paragraph (d)(3)(ii)(B) of this section.

\(B\) [Grandfathered amounts]{.underline}. If the plan provides, the
maximum distributable amount may be increased for amounts credited to
the employee's account as of a date specified in the plan that is no
later than December 31, 1988, or if later, the end of the last plan year
ending before July 1, 1989 (or in the case of a collectively bargained
plan, the earlier of\--

([1]{.underline}) the later of January 1, 1989, or the date on which the
last of the collective bargaining agreements in effect on March 1, 1986
terminates (determined without regard to any extension thereof after
February 28, 1986); or

([2]{.underline}) January 1, 1991) and consisting of\--

([i]{.underline}) Income allocable to elective contributions;

([ii]{.underline}) Qualified nonelective contributions and allocable
income; and

([iii]{.underline}) Qualified matching contributions and allocable
income.

\(iii\) [Immediate and heavy financial need]{.underline}\--(A) [In
general]{.underline}. Whether an employee has an immediate and heavy
financial need is to be determined based on all the relevant facts and
circumstances. Generally, for example, the need to pay the funeral
expenses of a family member would constitute an immediate and heavy
financial need. A distribution made to an employee for the purchase of a
boat or television would generally not constitute a distribution made on
account of an immediate and heavy financial need. A financial need may
be immediate and heavy even if it was reasonably foreseeable or
voluntarily incurred by the employee.

\(B\) [Deemed immediate and heavy financial need]{.underline}. A
distribution is deemed to be on account of an immediate and heavy
financial need of the employee if the distribution is for\--

([1]{.underline}) Expenses for medical care described in section 213(d)
previously incurred by the employee, the employee's spouse, or any
dependents of the employee (as defined in section 152) or necessary for
these persons to obtain medical care described in section 213(d);

([2]{.underline}) Costs directly related to the purchase of a principal
residence for the employee (excluding mortgage payments);

([3]{.underline}) Payment of tuition, related educational fees, and room
and board expenses, for up to the next 12 months of post‑secondary
education for the employee, or the employee's spouse, children, or
dependents (as defined in section 152); or

([4]{.underline}) Payments necessary to prevent the eviction of the
employee from the employee's principal residence or foreclosure on the
mortgage on that residence.

\(iv\) [Distribution necessary to satisfy financial
need]{.underline}\--(A) [Distribution may not exceed amount of
need]{.underline}. A distribution is treated as necessary to satisfy an
immediate and heavy financial need of an employee only to the extent the
amount of the distribution is not in excess of the amount required to
satisfy the financial need. For this purpose, the amount required to
satisfy the financial need may include any amounts necessary to pay any
federal, state, or local income taxes or penalties reasonably
anticipated to result from the distribution.

\(B\) [No alternative means available]{.underline}. A distribution is
not treated as necessary to satisfy an immediate and heavy financial
need of an employee to the extent the need may be relieved from other
resources that are reasonably available to the employee. This
determination generally is to be made on the basis of all the relevant
facts and circumstances. For purposes of this paragraph (d)(3)(iv), the
employee's resources are deemed to include those assets of the
employee's spouse and minor children that are reasonably available to
the employee. Thus, for example, a vacation home owned by the employee
and the employee's spouse, whether as community property, joint tenants,
tenants by the entirety, or tenants in common, generally will be deemed
a resource of the employee. However, property held for the employee's
child under an irrevocable trust or under the Uniform Gifts to Minors
Act (or comparable State law) is not treated as a resource of the
employee.

\(C\) [Employer reliance on employee representation]{.underline}. For
purposes of paragraph (d)(3)(iv)(B) of this section, an immediate and
heavy financial need generally may be treated as not capable of being
relieved from other resources that are reasonably available to the
employee, if the employer relies upon the employee's written
representation, unless the employer has actual knowledge to the
contrary, that the need cannot reasonably be relieved\--

([1]{.underline}) Through reimbursement or compensation by insurance or
otherwise;

([2]{.underline}) By liquidation of the employee's assets;

([3]{.underline}) By cessation of elective contributions or employee
contributions under the plan;

([4]{.underline}) By other distributions or nontaxable (at the time of
the loan) loans from plans maintained by the employer or by any other
employer; or

([5]{.underline}) By borrowing from commercial sources on reasonable
commercial terms in an amount sufficient to satisfy the need.

\(D\) [Employee need not take counterproductive actions]{.underline}.
For purposes of this paragraph (d)(3)(iv), a need cannot reasonably be
relieved by one of the actions described in paragraph (d)(3)(iv)(C) of
this section if the effect would be to increase the amount of the need.
For example, the need for funds to purchase a principal residence cannot
reasonably be relieved by a plan loan if the loan would disqualify the
employee from obtaining other necessary financing.

\(E\) [Distribution deemed necessary to satisfy immediate and heavy
financial need]{.underline}. A distribution is deemed necessary to
satisfy an immediate and heavy financial need of an employee if each of
the following requirements are satisfied\--

([1]{.underline}) The employee has obtained all distributions, other
than hardship distributions, and all nontaxable (at the time of the
loan) loans currently available under the plan and all other plans
maintained by the employer; and

([2]{.underline}) The employee is prohibited, under the terms of the
plan or an otherwise legally enforceable agreement, from making elective
contributions and employee contributions to the plan and all other plans
maintained by the employer for at least 6 months after receipt of the
hardship distribution.

\(F\) [Definition of other plans]{.underline}. For purposes of paragraph
(d)(3)(iv)(C)([4]{.underline}) and (E)([1]{.underline}) of this section,
the phrase "plans maintained by the employer" means all qualified and
nonqualified plans of deferred compensation maintained by the employer,
including a cash or deferred arrangement that is part of a cafeteria
plan within the meaning of section 125. However, it does not include the
mandatory employee contribution portion of a defined benefit plan or a
health or welfare benefit plan (including one that is part of a
cafeteria plan). In addition, for purposes of paragraph
(d)(3)(iv)(E)([2]{.underline}) of this section, the phrase "plans
maintained by the employer" also includes a stock option, stock
purchase, or similar plan maintained by the employer. See §1.401(k)‑6
for the continued treatment of suspended employees as eligible
employees.

\(v\) [Commissioner may expand standards]{.underline}. The Commissioner
may prescribe additional guidance of general applicability, published in
the Internal Revenue Bulletin (see 601.601(d)(2) of this chapter),
expanding the list of deemed immediate and heavy financial needs and
prescribing additional methods for distributions to be deemed necessary
to satisfy an immediate and heavy financial need.

\(4\) [Rules applicable to distributions upon plan
termination]{.underline}\--(i) [No alternative defined contribution
plan]{.underline}. A distribution may not be made under paragraph
(d)(1)(iii) of this section if the employer establishes or maintains an
alternative defined contribution plan. For purposes of the preceding
sentence, the definition of the term "employer" contained in §1.401(k)-6
is applied as of the date of plan termination, and a plan is an
alternative defined contribution plan only if it is a defined
contribution plan that exists at any time during the period beginning on
the date of plan termination and ending 12 months after distribution of
all assets from the terminated plan. However, if at all times during the
24‑month period beginning 12 months before the termination, fewer than
2% of the employees who were eligible under the defined contribution
plan that includes the cash or deferred arrangement as of the date of
plan termination are eligible under the other defined contribution plan,
the other plan is not an alternative defined contribution plan. In
addition, a defined contribution plan is not treated as an alternative
defined contribution plan if it is an employee stock ownership plan as
defined in section 4975(e)(7) or 409(a), a simplified employee pension
as defined in section 408(k), a SIMPLE IRA plan as defined in section
408(p), a plan or contract that satisfies the requirements of section
403(b), or a plan that satisfies the requirements of section 457.

\(ii\) [Lump sum requirement for certain distributions]{.underline}. A
distribution may be made under paragraph (d)(1)(iii) of this section
only if it is a lump sum distribution. The term lump sum distribution
has the meaning provided in section 402(e)(4)(D) (without regard to
section 402(e)(4)(D)(i)(I), (II), (III) and (IV)). In addition, a lump
sum distribution includes a distribution of an annuity contract from a
trust that is part of a plan described in section 401(a) and which is
exempt from tax under section 501(a) or an annuity plan described in
403(a).

\(5\) [Rules applicable to all distributions]{.underline}\--(i)
[Exclusive distribution rules]{.underline}. Amounts attributable to
elective contributions may not be distributed on account of any event
not described in this paragraph (d), such as completion of a stated
period of plan participation or the lapse of a fixed number of years.
For example, if excess deferrals (and income) for an employee's taxable
year are not distributed within the time prescribed in §1.402(g)‑1(e)(2)
or (3), the amounts may be distributed only on account of an event
described in this paragraph (d). Pursuant to section 401(k)(8), the
prohibition on distributions set forth in this section does not apply to
a distribution of excess contributions under §1.401(k)-2(b). In
addition, the prohibition on distributions set forth in this paragraph
(d) does not apply to a distribution of excess annual additions pursuant
to §1.415-6(b)(6)(iv).

\(ii\) [Deemed distributions]{.underline}. The cost of life insurance
(determined under section 72) is not treated as a distribution for
purposes of section 401(k)(2) and this paragraph (d). The making of a
loan is not treated as a distribution, even if the loan is secured by
the employee's accrued benefit attributable to elective contributions or
is includible in the employee's income under section 72(p). However, the
reduction, by reason of default on a loan, of an employee's accrued
benefit derived from elective contributions is treated as a
distribution.

\(iii\) [ESOP dividend distributions]{.underline}. A plan does not fail
to satisfy the requirements of this paragraph (d) merely by reason of a
dividend distribution described in section 404(k)(2).

\(iv\) [Limitations apply after transfer]{.underline}. The limitations
of this paragraph (d) generally continue to apply to amounts
attributable to elective contributions (including QNECs and qualified
matching contributions taken into account for the ADP test under
§1.401(k)-2(a)(6)) that are transferred to another qualified plan of the
same or another employer. Thus, the transferee plan will generally fail
to satisfy the requirements of section 401(a) and this section if
transferred amounts may be distributed before the times specified in
this paragraph (d). In addition, a cash or deferred arrangement fails to
satisfy the limitations of this paragraph (d) if it transfers amounts to
a plan that does not provide that the transferred amounts may not be
distributed before the times specified in this paragraph (d). The
transferor plan does not fail to comply with the preceding sentence if
it reasonably concludes that the transferee plan provides that the
transferred amounts may not be distributed before the times specified in
this paragraph (d). What constitutes a basis for a reasonable conclusion
is comparable to the rules related to acceptance of rollover
distributions. See §1.401(a)(31)-1, A-14. The limitations of this
paragraph (d) cease to apply after the transfer, however, if the amounts
could have been distributed at the time of the transfer (other than on
account of hardship), and the transfer is an elective transfer described
in §1.411(d)‑4, Q&A‑3(b)(1). The limitations of this paragraph (d) also
do not apply to amounts that have been paid in a direct rollover to the
plan after being distributed by another plan.

\(6\) [Examples]{.underline}. The following examples illustrate the
application of this paragraph (d):

[Example 1]{.underline}. Employer M maintains Plan V, a profit‑sharing
plan that includes a cash or deferred arrangement. Elective
contributions under the arrangement may be withdrawn for any reason
after two years following the end of the plan year in which the
contributions were made. Because the plan permits distributions of
elective contributions before the occurrence of one of the events
specified in section 401(k)(2)(B) and this paragraph (d), the cash or
deferred arrangement is a nonqualified cash or deferred arrangement and
the elective contributions are currently includible in income under
section 402.

[Example 2]{.underline}. (i) Employer N maintains Plan W, a
profit-sharing plan that includes a cash or deferred arrangement. Plan W
provides for distributions upon a participant's severance from
employment, death or disability. All employees of Employer N and its
wholly owned subsidiary, Employer O, are eligible to participate in Plan
W. Employer N agrees to sell all issued and outstanding shares of
Employer O to an unrelated entity, Employer T, effective on December 31,
2006. Following the transaction, Employer O will be a wholly owned
subsidiary of Employer T. Additionally, individuals who are employed by
Employer O on the effective date of the sale continue to be employed by
Employer O following the sale. Following the transaction, all employees
of Employer O will cease to participate in Plan W and will become
eligible to participate in the cash or deferred arrangement maintained
by Employer T, Plan X. No assets will be transferred from Plan W to Plan
X, except in the case of a direct rollover within the meaning of section
401(a)(31).

\(ii\) Employer O ceases to be a member of Employer N's controlled group
as a result of the sale. Therefore, employees of Employer O who
participated in Plan W will have a severance from employment and are
eligible to receive a distribution from Plan W.

[Example 3]{.underline}. (i) Employer Q maintains Plan Y, a
profit-sharing plan that includes a cash or deferred arrangement. Plan
Y, the only plan maintained by Employer Q, does not provide for loans.
However, Plan Y provides that elective contributions under the
arrangement may be distributed to an eligible employee on account of
hardship using the deemed immediate and heavy financial need provisions
of paragraph (d)(3)(iii)(B) of this section and provisions regarding
distributions necessary to satisfy financial need of paragraphs
(d)(3)(iv)(A) through (D) of this section. Employee A is an eligible
employee in Plan Y with an account balance of \$50,000 attributable to
elective contributions made by Employee A. The total amount of elective
contributions made by Employee A, who has not previously received a
distribution from Plan Y, is \$20,000. Employee A requests a \$15,000
hardship distribution of his elective contributions to pay 6 months of
college tuition and room and board expenses for his dependent child. At
the time of the distribution request, the sole asset of Employee A (that
is reasonably available to Employee A within the meaning of paragraph
(d)(3)(iv)(B) of this section) is a savings account with an available
balance of \$10,000.

\(ii\) A distribution is made on account of hardship only if the
distribution both is made on account of an immediate and heavy financial
need of the employee and is necessary to satisfy the financial need.
Under paragraph (d)(3)(iii)(B) of this section, a distribution for
payment of up to the next 12 months of post-secondary education and room
and board expenses for Employee A's dependant child is deemed to be on
account of an immediate and heavy financial need of Employee A.

\(iii\) A distribution is treated as necessary to satisfy Employee A's
immediate and heavy financial need to the extent the need may not be
relieved from other resources reasonably available to Employee A. Under
paragraph (d)(3)(iv)(B) of this section, Employee A's \$10,000 savings
account is a resource that is reasonably available to the employee and
must be taken into account in determining the amount necessary to
satisfy Employee A's immediate and heavy financial need. Thus, Employee
A may receive a distribution of only \$5,000 of his elective
contributions on account of this hardship, plus an amount necessary to
pay any federal, state, or local income taxes or penalties reasonably
anticipated to result from the distribution.

[Example 4]{.underline}. (i) The facts are the same as in [Example
3]{.underline}. Employee B, another employee of Employer Q has an
account balance of \$25,000, attributable to Employee B's elective
contributions. The total amount of elective contributions made by
Employee B, who has not previously received a distribution from Plan Y,
is \$15,000. Employee B requests a \$10,000 distribution of his elective
contributions to pay 6 months of college tuition and room and board
expenses for his dependent child. Employee B makes a written
representation (with respect to which Employer Q has no actual knowledge
to the contrary) that the need cannot reasonably be relieved: 1) through
reimbursement or compensation by insurance or otherwise; 2) by
liquidation of the employee's assets; 3) by cessation of elective
contributions or employee contributions under the plan; 4) by other
distributions or nontaxable (at the time of the loan) loans from plans
maintained by the employer or by any other employer; or 5) by borrowing
from commercial sources on reasonable commercial terms in an amount
sufficient to satisfy the need.

\(ii\) Under paragraph (d)(3)(iii)(B) of this section, a distribution
for payment of up to the next 12 months of post-secondary education and
room and board expenses for Employee B's dependant child is deemed to be
on account of an Employee B's immediate and heavy financial need. In
addition, because Employer Q can rely on Employee B's written
representation, the distribution is considered necessary to satisfy
Employee B's immediate and heavy financial need. Therefore, Employee B
may receive a \$10,000 distribution of his elective contributions on
account of hardship plus an amount necessary to pay any federal, state,
or local income taxes or penalties reasonably anticipated to result from
the distribution.

[Example 5]{.underline}. (i) The facts are the same as in [Example
3]{.underline}, except Plan Y provides for hardship distributions using
the safe harbor rule of paragraph (d)(3)(iv)(E) of this section.
Accordingly, Plan Y provides for a 6 month suspension of an eligible
employee's elective contributions and employee contributions to the plan
after the receipt of a hardship distribution by such eligible employee.

\(ii\) Under paragraph (d)(3)(iii)(B) of this section, a distribution
for payment of up to the next 12 months of post-secondary education and
room and board expenses for Employee A's dependant child is deemed to be
on account of an Employee A's immediate and heavy financial need. In
addition, because Employee A is not eligible for any other distribution
or loan from Plan Y and Plan Y suspends Employee A's elective
contributions and employee contributions following receipt of the
hardship distribution, the distribution will be deemed necessary to
satisfy Employee A's immediate and heavy financial need (and Employee A
is not required to first liquidate his savings account). Therefore,
Employee A may receive a \$15,000 distribution of his elective
contributions on account of hardship plus an amount necessary to pay any
federal, state, or local income taxes or penalties reasonably
anticipated to result from the distribution.

[Example 6]{.underline}. Employer R maintains a pre‑ERISA money purchase
pension plan that includes a cash or deferred arrangement that is not a
rural cooperative plan. Elective contributions under the arrangement may
be distributed to an employee on account of hardship. Under paragraph
(d)(1) of this section, hardship is a permissible distribution event
only in a profit‑sharing, stock bonus or rural cooperative plan. Since
elective contributions under the arrangement may be distributed before a
permissible distribution event occurs, the cash or deferred arrangement
does not satisfy this paragraph (d), and is not a qualified cash or
deferred arrangement. Moreover, the plan is not a qualified plan because
a money purchase pension plan may not provide for payment of benefits
upon hardship. See §1.401‑1(b)(1)(i).

\(e\) [Additional requirements for qualified cash or deferred
arrangements]{.underline}\--(1) [Qualified plan
requirement]{.underline}. A cash or deferred arrangement satisfies this
paragraph (e) only if the plan of which it is a part is a
profit‑sharing, stock bonus, pre‑ERISA money purchase or rural
cooperative plan that otherwise satisfies the requirements of section
401(a) (taking into account the cash or deferred arrangement). A plan
that includes a cash or deferred arrangement may provide for other
contributions, including employer contributions (other than elective
contributions), employee contributions, or both. However, except as
expressly permitted under section 401(m), 410(b)(2)(A)(ii) or
416(c)(2)(A), elective contributions and matching contributions taken
into account under §1.401(k)-2(a) may not be taken into account for
purposes of determining whether any other contributions under any plan
(including the plan to which the contributions are made) satisfy the
requirements of section 401(a).

\(2\) [Election requirements]{.underline}\--(i) [Cash must be
available]{.underline}. A cash or deferred arrangement satisfies this
paragraph (e) only if the arrangement provides that the amount that each
eligible employee may defer as an elective contribution is available to
the employee in cash. Thus, for example, if an eligible employee is
provided the option to receive a taxable benefit (other than cash) or to
have the employer contribute on the employee's behalf to a
profit‑sharing plan an amount equal to the value of the taxable benefit,
the arrangement is not a qualified cash or deferred arrangement.
Similarly, if an employee has the option to receive a specified amount
in cash or to have the employer contribute an amount in excess of the
specified cash amount to a profit‑sharing plan on the employee's behalf,
any contribution made by the employer on the employee's behalf in excess
of the specified cash amount is not treated as made pursuant to a
qualified cash or deferred arrangement. This cash availability
requirement applies even if the cash or deferred arrangement is part of
a cafeteria plan within the meaning of section 125.

\(ii\) [Frequency of elections]{.underline}. A cash or deferred
arrangement satisfies this paragraph (e) only if the arrangement
provides an employee with an effective opportunity to make (or change) a
cash or deferred election at least once during each plan year. Whether
an employee has an effective opportunity is determined based on all the
relevant facts and circumstances, including notice of the availability
of the election, the period of time during which an election may be
made, and any other conditions on elections.

\(3\) [Separate accounting requirement]{.underline}\--(i) [General
rule]{.underline}. A cash or deferred arrangement satisfies this
paragraph (e) only if the portion of an employee's benefit subject to
the requirements of paragraphs (c) and (d) of this section is determined
by an acceptable separate accounting between that portion and any other
benefits. Separate accounting is not acceptable unless gains, losses,
withdrawals, and other credits or charges are separately allocated on a
reasonable and consistent basis to the accounts subject to the
requirements of paragraphs (c) and (d) of this section and to other
accounts. Subject to section 401(a)(4), forfeitures are not required to
be allocated to the accounts in which benefits are subject to paragraphs
(c) and (d) of this section.

\(ii\) [Satisfaction of separate accounting requirement]{.underline}.
The requirements of paragraph (e)(3)(i) of this section are treated as
satisfied if all amounts held under a plan that includes a cash or
deferred arrangement (and, if applicable, under another plan to which
QNECs and QMACs are made) are subject to the requirements of paragraphs
(c) and (d) of this section.

\(4\) [Limitations on cash or deferred arrangements of state and local
governments]{.underline}\--(i) [General rule]{.underline}. A cash or
deferred arrangement does not satisfy the requirements of this paragraph
(e) if the arrangement is adopted after May 6, 1986, by a State or local
government or political subdivision thereof, or any agency or
instrumentality thereof (a governmental unit). For purposes of this
paragraph (e)(4), an employer that has made a legally binding commitment
to adopt a cash or deferred arrangement is treated as having adopted the
arrangement on that date.

\(ii\) [Rural cooperative plans and Indian tribal
governments]{.underline}. This paragraph (e)(4) does not apply to a
rural cooperative plan or to a plan of an employer which is an Indian
tribal government (as defined in section 7701(a)(40)), a subdivision of
an Indian tribal government (determined in accordance with section
7871(d)), an agency or instrumentality of an Indian tribal government or
subdivision thereof, or a corporation chartered under Federal, State or
tribal law which is owned in whole or in part by any of the entities in
this paragraph (e)(4)(ii).

\(iii\) [Adoption after May 6, 1986]{.underline}. A cash or deferred
arrangement is treated as adopted after May 6, 1986, with respect to all
employees of any employer that adopts the arrangement after such date.

\(iv\) [Adoption before May 7, 1986]{.underline}. If a governmental unit
adopted a cash or deferred arrangement before May 7, 1986, then any cash
or deferred arrangement adopted by the unit at any time is treated as
adopted before that date. If an employer adopted an arrangement prior to
such date, all employees of the employer may participate in the
arrangement.

\(5\) [One‑year eligibility requirement]{.underline}. A cash or deferred
arrangement satisfies this paragraph (e) only if no employee is required
to complete a period of service with the employer maintaining the plan
extending beyond the period permitted under section 410(a)(1)
(determined without regard to section 410(a)(1)(B)(i)) to be eligible to
make a cash or deferred election under the arrangement.

\(6\) [Other benefits not contingent upon elective
contributions]{.underline}\--(i) [General rule]{.underline}. A cash or
deferred arrangement satisfies this paragraph (e) only if no other
benefit is conditioned (directly or indirectly) upon the employee's
electing to make or not to make elective contributions under the
arrangement. The preceding sentence does not apply to \--

\(A\) Any matching contribution (as defined in §1.401(m)-1(a)(2)) made
by reason of such an election;

\(B\) Any benefit, right or feature (such as a plan loan) that requires,
or results in, an amount to be withheld from an employee's pay (e.g. to
pay for the benefit or to repay the loan), to the extent the cash or
deferred arrangement restricts elective contributions to amounts
available after such withholding from the employee's pay (after
deduction of all applicable income and employment taxes);

\(C\) Any reduction in the employer's top-heavy contributions under
section 416(c)(2) because of matching contributions that resulted from
the elective contributions; or

\(D\) Any benefit that is provided at the employee's election under a
plan described in section 125(d) in lieu of an elective contribution
under a qualified cash or deferred arrangement.

\(ii\) [Definition of other benefits]{.underline}. For purposes of this
paragraph (e)(6), other benefits include, but are not limited to,
benefits under a defined benefit plan; nonelective contributions under a
defined contribution plan; the availability, cost, or amount of health
benefits; vacations or vacation pay; life insurance; dental plans; legal
services plans; loans (including plan loans); financial planning
services; subsidized retirement benefits; stock options; property
subject to section 83; and dependent care assistance. Also, increases in
salary and bonuses (other than those actually subject to the cash or
deferred election) are benefits for purposes of this paragraph (e)(6).
The ability to make after‑tax employee contributions is a benefit, but
that benefit is not contingent upon an employee's electing to make or
not make elective contributions under the arrangement merely because the
amount of elective contributions reduces dollar‑for‑dollar the amount of
after‑tax employee contributions that may be made. Additionally,
benefits under any other plan or arrangement (whether or not qualified)
are not contingent upon an employee's electing to make or not to make
elective contributions under a cash or deferred arrangement merely
because the elective contributions are or are not taken into account as
compensation under the other plan or arrangement for purposes of
determining benefits.

\(iii\) [Effect of certain statutory limits]{.underline}. Any benefit
under an excess benefit plan described in section 3(36) of the Employee
Retirement Income Security Act of 1974 that is dependent on the
employee's electing to make or not to make elective contributions is not
treated as contingent.

\(iv\) [Nonqualified deferred compensation]{.underline}. Participation
in a nonqualified deferred compensation plan is treated as contingent
for purposes of this paragraph (e)(6) only to the extent that an
employee may receive additional deferred compensation under the
nonqualified plan to the extent the employee makes or does not make
elective contributions. Deferred compensation under a nonqualified plan
of deferred compensation that is dependent on an employee's having made
the maximum elective deferrals under section 402(g) or the maximum
elective contributions permitted under the terms of the plan also is not
treated as contingent.

\(v\) [Plan loans and distributions]{.underline}. A loan or distribution
of elective contributions is not a benefit conditioned on an employee's
electing to make or not make elective contributions under the
arrangement merely because the amount of the loan or distribution is
based on the amount of the employee's account balance.

\(vi\) [Examples]{.underline}. The following examples illustrate the
application of this paragraph (e)(6):

[Example 1]{.underline}. Employer T maintains a cash or deferred
arrangement for all of its employees. Employer T also maintains a
nonqualified deferred compensation plan for two highly paid executives,
Employees R and C. Under the terms of the nonqualified deferred
compensation plan, R and C are eligible to participate only if they do
not make elective contributions under the cash or deferred arrangement.
Participation in the nonqualified plan is a contingent benefit for
purposes of this paragraph (e)(6), because R's and C's participation is
conditioned on their electing not to make elective contributions under
the cash or deferred arrangement.

[Example 2]{.underline}. Employer T maintains a cash or deferred
arrangement for all its employees. Employer T also maintains a
nonqualified deferred compensation plan for two highly paid executives,
Employees R and C. Under the terms of the arrangements, Employees R and
C may defer a maximum of 10% of their compensation, and may allocate
their deferral between the cash or deferred arrangement and the
nonqualified deferred compensation plan in any way they choose (subject
to the overall 10% maximum). Because the maximum deferral available
under the nonqualified deferred compensation plan depends on the
elective deferrals made under the cash or deferred arrangement, the
right to participate in the nonqualified plan is a contingent benefit
for purposes of paragraph (e)(6).

\(7\) [Plan provision requirement]{.underline}. A plan that includes a
cash or deferred arrangement satisfies this paragraph (e) only if it
provides that the nondiscrimination requirements of section 401(k) will
be met. Thus, the plan must provide for satisfaction of one of the
specific alternatives described in paragraph (b)(1)(ii) of this section
and, if with respect to that alternative there are optional choices,
which of the optional choices will apply. For example, a plan that uses
the ADP test of section 401(k)(3), as described in paragraph
(b)(1)(ii)(A) of this section, must specify whether it is using the
current year testing method or prior year testing method. Additionally,
a plan that uses the prior year testing method must specify whether the
ADP for eligible NHCEs for the first plan year is 3% or the ADP for the
eligible NHCEs for the first plan year. Similarly, a plan that uses the
safe harbor method of section 401(k)(12), as described in paragraph
(b)(1)(ii)(B) of this section, must specify whether the safe harbor
contribution will be the nonelective safe harbor contribution or the
matching safe harbor contribution and is not permitted to provide that
ADP testing will be used if the requirements for the safe harbor are not
satisfied. For purposes of this paragraph (e)(7), a plan may incorporate
by reference the provisions of section 401(k)(3) and §1.401(k)-2 if that
is the nondiscrimination test being applied.

\(f\) [Effective dates]{.underline}\--(1) [General rule]{.underline}.
This section and §§1.401(k)-2 through 1.401(k)-6 apply to plan years
that begin on or after the date that is 12 months after the issuance of
these regulations in final form, except as otherwise provided in this
paragraph (f).

\(2\) [Collectively bargained plans]{.underline}. In the case of a plan
maintained pursuant to one or more collective bargaining agreements
between employee representatives and one or more employers in effect on
the date described in paragraph (f)(1) of this section, the provisions
of this section and §§1.401(k)-2 through 1.401(k)-6 apply to the later
of the first plan year beginning after the termination of the last such
agreement or the plan year described in paragraph (f)(1) of this
section.

[§1.401(k)‑2 ADP test]{.underline}.

\(a\) [Actual deferral percentage (ADP) test]{.underline}\--(1) [In
general]{.underline}\--(i) [ADP test formula]{.underline}. A cash or
deferred arrangement satisfies the ADP test for a plan year only if\--

\(A\) The ADP for the eligible HCEs for the plan year is not more than
the ADP for the eligible NHCEs for the applicable year multiplied by
1.25; or

\(B\) The excess of the ADP for the eligible HCEs for the plan year over
the ADP for the eligible NHCEs for the applicable year is not more than
2 percentage points, and the ADP for the eligible HCEs for the plan year
is not more than the ADP for the eligible NHCEs for the applicable year
multiplied by 2.

\(ii\) [HCEs as sole eligible employees]{.underline}. If, for the
applicable year for determining the ADP of the NHCEs for a plan year,
there are no eligible NHCEs (i.e, all of the eligible employees under
the cash or deferred arrangement for the applicable year are HCEs), the
arrangement is deemed to satisfy the ADP test for the plan year.

\(iii\) [Special rule for early participation]{.underline}. If a cash or
deferred arrangement provides that employees are eligible to participate
before they have completed the minimum age and service requirements of
section 410(a)(1)(A), and if the plan applies section 410(b)(4)(B) in
determining whether the cash or deferred arrangement meets the
requirements of section 410(b)(1), then in determining whether the
arrangement meets the requirements under paragraph (a)(1) of this
section, either\--

\(A\) Pursuant to section 401(k)(3)(F), the ADP test is performed under
the plan (determined without regard to disaggregation under
§1.410(b)-7(c)(3)), using the ADP for all eligible HCEs for the plan
year and the ADP of eligible NHCEs for the applicable year, disregarding
all NHCEs who have not met the minimum age and service requirements of
section 410(a)(1)(A); or

\(B\) Pursuant to §1.401(k)-1(b)(4), the plan is disaggregated into
separate plans and the ADP test is performed separately for all eligible
employees who have completed the minimum age and service requirements of
section 410(a)(1)(A) and for all eligible employees who have not
completed the minimum age and service requirements of section
410(a)(1)(A).

\(2\) [Determination of ADP]{.underline}\--(i) [General
rule]{.underline}. The ADP for a group of eligible employees (either
eligible HCEs or eligible NHCEs) for a plan year or applicable year is
the average of the ADRs of the eligible employees in that group for that
year. The ADP for a group of eligible employees is calculated to the
nearest hundredth of a percentage point.

\(ii\) [Determination of applicable year under current year and prior
year testing method]{.underline}. The ADP test is applied using the
prior year testing method or the current year testing method. Under the
prior year testing method, the applicable year for determining the ADP
for the eligible NHCEs is the plan year immediately preceding the plan
year for which the ADP test is being performed. Under the prior year
testing method, the ADP for the eligible NHCEs is determined using the
ADRs for the eligible employees who were NHCEs in that preceding plan
year, regardless of whether those NHCEs are eligible employees or NHCEs
in the plan year for which the ADP test is being calculated. Under the
current year testing method, the applicable year for determining the ADP
for the eligible NHCEs is the same plan year as the plan year for which
the ADP test is being performed. Under either method, the ADP for
eligible HCEs is the average of the ADRs of the eligible HCEs for the
plan year for which the ADP test is being performed. See paragraph (c)
of this section for additional rules for the prior year testing method.

\(3\) [Determination of ADR]{.underline}\--(i) [General
rule]{.underline}. The ADR of an eligible employee for a plan year or
applicable year is the sum of the employee's elective contributions
taken into account with respect to such employee for the year,
determined under the rules of paragraphs (a)(4) and (5) of this section,
and the qualified nonelective contributions and qualified matching
contributions taken into account with respect to such employee under
paragraph (a)(6) of this section for the year, divided by the employee's
compensation taken into account for the year. The ADR is calculated to
the nearest hundredth of a percentage point. If no elective
contributions, qualified nonelective contributions, or qualified
matching contributions are taken into account under this section with
respect to an eligible employee for the year, the ADR of the employee is
zero.

\(ii\) [ADR of HCEs eligible under more than one
arrangement]{.underline}\--(A) [General rule]{.underline}. Pursuant to
section 401(k)(3)(A), the ADR of an HCE who is an eligible employee in
more than one cash or deferred arrangement of the same employer is
calculated by treating all contributions with respect to such HCE under
any such arrangement as being made under the cash or deferred
arrangement being tested. Thus, the ADR for such an HCE is calculated by
accumulating all contributions under any cash or deferred arrangement
(other than a cash or deferred arrangement described in paragraph
(a)(3)(ii)(B) of this section) that would be taken into account under
this section for the plan year, if the cash or deferred arrangement
under which the contribution was made applied this section and had the
same plan year. For example, in the case of a plan with a 12-month plan
year, the ADR for the plan year of that plan for an HCE who participates
in multiple cash or deferred arrangements of the same employer is the
sum of all contributions during such 12-month period that would be taken
into account with respect to the HCE under all such arrangements in
which the HCE is an eligible employee, divided by the HCE's compensation
for that 12-month period (determined using the compensation definition
for the plan being tested), without regard to the plan year of the other
plans and whether those plans are satisfying this section or
§1.401(k)-3.

\(B\) [Plans not permitted to be aggregated]{.underline}. Cash or
deferred arrangements under plans that are not permitted to be
aggregated under §1.401(k)‑1(b)(4) (determined without regard to the
prohibition on aggregating plans with inconsistent testing methods set
forth in §1.401(k)-1(b)(4)(iii)(B) and the prohibition on aggregating
plans with different plan years set forth in §1.410(b)-7(d)(5)) are not
aggregated under this paragraph (a)(3)(ii).

\(iii\) [Example]{.underline}s. The following examples illustrate the
application of this paragraph (a)(3):

[Example 1]{.underline}. (i) Employee A, an HCE with compensation of
\$120,000, is eligible to make elective contributions under Plan S and
Plan T, two profit-sharing plans maintained by Employer H with calendar
year plan years, each of which includes a cash or deferred arrangement.
During the current plan year, Employee A makes elective contributions of
\$6,000 to Plan S and \$4,000 to Plan T.

\(ii\) Under each plan, the ADR for Employee A is determined by dividing
Employee A's total elective contributions under both arrangements by
Employee A's compensation taken into account under the plan for the
year. Therefore, Employee A's ADR under each plan is 8.33%
(\$10,000/\$120,000).

[Example 2]{.underline}. (i) The facts are the same as in [Example
1]{.underline}, except that Plan T defines compensation (for deferral
and testing purposes) to exclude all bonuses paid to an employee. Plan S
defines compensation (for deferral and testing purposes) to include
bonuses paid to an employee. During the current year, Employee A's
compensation included a \$10,000 bonus. Therefore, Employee A's
compensation under Plan T is \$110,000 and Employee A's compensation
under Plan S is \$120,000.

\(ii\) Employee A's ADR under Plan T is 9.09% (\$10,000/\$110,000) and
under Plan S, Employee A's ADR is 8.33% (\$10,000/\$120,000).

[Example 3]{.underline}. (i) Employer J sponsors two profit-sharing
plans, Plan U and Plan V, each of which includes a cash or deferred
arrangement. Plan U's plan year begins on July 1 and ends on June 30.
Plan V has a calendar year plan year. Compensation under both plans is
limited to the participant's compensation during the period of
participation. Employee B is an HCE who participates in both plans.
Employee B's monthly compensation and elective contributions to each
plan for the 2005 and 2006 calendar years are as follows:

  ------------ ------------------- ------------------- -------------------
  Calendar     Monthly             Monthly Elective    Monthly Elective
  year         Compensation        Contribution to     Contribution to
                                   Plan U              Plan V

  2005         \$10,000            \$500               \$400

  2006         \$11,500            \$700               \$550
  ------------ ------------------- ------------------- -------------------

\(ii\) Under Plan U, Employee B's ADR for the plan year ended June 30,
2006, is equal to Employee B's total elective contributions under Plan U
and Plan V for the plan year ending June 30, 2006 divided by Employee
B's compensation for that period. Therefore, Employee B's ADR under Plan
U for the plan year ending June 30, 2006, is ((\$900 x 6) + (\$1,250 x 6
)) / ((\$10,000 x 6) + (\$11,500 x 6)), or 10%.

\(iii\) Under Plan V, Employee B's ADR for the plan year ended December
31, 2005, is equal to total elective contributions under Plan U and V
for the plan year ending December 31, 2005, divided by Employee B's
compensation for that period. Therefore, Employee B's ADR under Plan V
for the plan year ending December 31, 2005, is (\$10,800/\$120,000), or
9%.

[Example 4]{.underline}. (i) The facts are the same as [Example
3]{.underline}, except that Employee B first becomes eligible to
participate in Plan U on January 1, 2006.

\(ii\) Under Plan U, Employee B's ADR for the plan year ended June 30,
2006, is equal to Employee B's total elective contributions under Plan U
and V for the plan year ending June 30, 2006, divided by Employee B's
compensation for that period. Therefore, Employee B's ADR under Plan U
for the plan year ending June 30, 2006, is ((\$400 x 6)+ (\$1,250 x 6 ))
/ ((\$10,000 x 6) + (\$11,500 x 6)), or 7.67%.

\(4\) [Elective contributions taken into account under the ADP
test]{.underline}\--(i) [General rule]{.underline}. An elective
contribution is taken into account in determining the ADR for an
eligible employee for a plan year or applicable year only if each of the
following requirements is satisfied:

\(A\) The elective contribution is allocated to the eligible employee's
account under the plan as of a date within that year. For purposes of
this rule, an elective contribution is considered allocated as of a date
within a year only if\--

([1]{.underline}) The allocation is not contingent on the employee's
participation in the plan or performance of services on any date
subsequent to that date; and

([2]{.underline}) The elective contribution is actually paid to the
trust no later than the end of the 12-month period immediately following
the year to which the contribution relates.

\(B\) The elective contribution relates to compensation that either\--

([1]{.underline}) Would have been received by the employee in the year
but for the employee's election to defer under the arrangement; or

([2]{.underline}) Is attributable to services performed by the employee
in the year and, but for the employee's election to defer, would have
been received by the employee within 2½ months after the close of the
year, but only if the plan so provides for elective contributions that
relate to compensation that would have been received after the close of
a year to be allocated to such prior year rather than the year in which
the compensation would have been received.

\(ii\) [Elective contributions for partners and self-employed
individuals]{.underline}. For purposes of this paragraph (a)(4), a
partner's distributive share of partnership income is treated as
received on the last day of the partnership taxable year and a sole
proprietor's compensation is treated as received on the last day of the
individual's taxable year. Thus, an elective contribution made on behalf
of a partner or sole proprietor is treated as allocated to the partner's
account for the plan year that includes the last day of the partnership
taxable year, provided the requirements of paragraph (a)(4)(i) of this
section are met.

\(iii\) [Elective contributions for HCEs]{.underline}. Elective
contributions of an HCE must include any excess deferrals, as described
in §1.402(g)-1(a), even if those excess deferrals are distributed,
pursuant to §1.402(g)-1(e).

\(5\) [Elective contributions not taken into account under the ADP
test]{.underline}\--(i) [General rule]{.underline}. Elective
contributions that do not satisfy the requirements of paragraph
(a)(4)(i) of this section may not be taken into account in determining
the ADR of an eligible employee for the plan year or applicable year
with respect to which the contributions were made, or for any other plan
year. Instead, the amount of the elective contributions must satisfy the
requirements of section 401(a)(4) (without regard to the ADP test) for
the plan year for which they are allocated under the plan as if they
were nonelective contributions and were the only nonelective
contributions for that year. See §§1.401(a)(4)‑1(b)(2)(ii)(B) and
1.410(b)‑7(c)(1).

\(ii\) [Elective contributions for NHCEs]{.underline}. Elective
contributions of an NHCE shall not include any excess deferrals, as
described in §1.402(g)-1(a), to the extent the excess deferrals are
prohibited under section 401(a)(30). However, to the extent that the
excess deferrals are not prohibited under section 401(a)(30), they are
included in elective contributions even if distributed pursuant to
§1.402(g)-1(e).

\(iii\) [Elective contributions treated as catch-up
contributions]{.underline}. Elective contributions that are treated as
catch-up contributions under section 414(v) because they exceed a
statutory limit or employer-provided limit (within the meaning of
§1.414(v)-1(b)(1)) are not taken into account under paragraph (a)(4) of
this section for the plan year for which the contributions were made, or
for any other plan year.

\(iv\) [Elective contributions used to satisfy the ACP
test]{.underline}. Except to the extent necessary to demonstrate
satisfaction of the requirement of §1.401(m)‑2(a)(6)(ii), elective
contributions taken into account for the ACP test under
§1.401(m)‑2(a)(6) are not taken into account under paragraph (a)(4) of
this section.

\(6\) [Qualified nonelective contributions and qualified matching
contributions that may be taken into account under the ADP
test]{.underline}. Qualified nonelective contributions and qualified
matching contributions may be taken into account in determining the ADR
for an eligible employee for a plan year or applicable year but only to
the extent the contributions satisfy the following requirements.

\(i\) [Timing of allocation]{.underline}. The qualified nonelective
contribution or qualified matching contribution is allocated to the
employee's account as of a date within that year within the meaning of
paragraph (a)(4)(i)(A) of this section. Consequently, under the prior
year testing method, in order to be taken into account in calculating
the ADP for the eligible NHCEs for the applicable year, a qualified
nonelective contribution or qualified matching contribution must be
contributed no later than the end of the 12-month period immediately
following the applicable year even though the applicable year is
different than the plan year being tested.

\(ii\) [Requirement that amount satisfy section 401(a)(4)]{.underline}.
The amount of nonelective contributions, including those qualified
nonelective contributions taken into account under this paragraph (a)(6)
and those qualified nonelective contributions taken into account for the
ACP test of section 401(m)(2) under §1.401(m)-2(a)(6), satisfies the
requirements of section 401(a)(4). See §1.401(a)(4)-1(b)(2). The amount
of nonelective contributions, excluding those qualified nonelective
contributions taken into account under this paragraph (a)(6) and those
qualified nonelective contributions taken into account for the ACP test
of section 401(m)(2) under §1.401(m)-2(a)(6), satisfies the requirements
of section 401(a)(4). See §1.401(a)(4)-1(b)(2). In the case of an
employer that is applying the special rule for employer-wide plans in
§1.414(r)-1(c)(2)(ii) with respect to the cash or deferred arrangement,
the determination of whether the qualified nonelective contributions
satisfy the requirements of this paragraph (a)(6)(ii) must be made on an
employer-wide basis regardless of whether the plans to which the
qualified nonelective contributions are made are satisfying the
requirements of section 410(b) on an employer-wide basis. Conversely, in
the case of an employer that is treated as operating qualified separate
lines of business, and does not apply the special rule for employer-wide
plans in §1.414(r)-1(c)(2)(ii) with respect to the cash or deferred
arrangement, then the determination of whether the qualified nonelective
contributions satisfy the requirements of this paragraph (a)(6)(ii) is
not permitted to be made on an employer-wide basis regardless of whether
the plans to which the qualified nonelective contributions are made are
satisfying the requirements of section 410(b) on that basis.

\(iii\) [Aggregation must be permitted]{.underline}. The plan that
contains the cash or deferred arrangement and the plan or plans to which
the qualified nonelective contributions or qualified matching
contributions are made, are plans that would be permitted to be
aggregated under §1.401(k)‑1(b)(4). If the plan year of the plan that
contains the cash or deferred arrangement is changed to satisfy the
requirement under §1.410(b)‑7(d)(5) that aggregated plans have the same
plan year, qualified nonelective contributions and qualified matching
contributions may be taken into account in the resulting short plan year
only if such qualified nonelective contributions and qualified matching
contributions could have been taken into account under an ADP test for a
plan with the same short plan year.

\(iv\) [Disproportionate contributions not taken into
account]{.underline}\--(A) [General rule]{.underline}. Qualified
nonelective contributions cannot be taken into account for a plan year
for an NHCE to the extent such contributions exceed the product of that
NHCE's compensation and the greater of 5% or two times the plan\'s
representative contribution rate. Any qualified nonelective contribution
taken into account under an ACP test under §1.401(m)-2(a)(6) (including
the determination of the representative contribution rate for purposes
of §1.401(m)-2(a)(6)(v)(B)), is not permitted to be taken into account
for purposes of this paragraph (a)(6) (including the determination of
the representative contribution rate under paragraph (a)(6)(iv)(B) of
this section).

\(B\) [Definition of representative contribution rate]{.underline}. For
purposes of this paragraph (a)(6)(iv), the plan\'s representative
contribution rate is the lowest applicable contribution rate of any
eligible NHCE among a group of eligible NHCEs that consists of half of
all eligible NHCEs for the plan year (or, if greater, the lowest
applicable contribution rate of any eligible NHCE in the group of all
eligible NHCEs for the plan year and who is employed by the employer on
the last day of the plan year).

\(C\) [Definition of applicable contribution rate]{.underline}. For
purposes of this paragraph (a)(6)(iv), the applicable contribution rate
for an eligible NHCE is the sum of the qualified matching contributions
taken into account under this paragraph (a)(6) for the eligible NHCE for
the plan year and the qualified nonelective contributions made for that
eligible NHCE for the plan year, divided by that eligible NHCE\'s
compensation for the same period.

\(v\) [Qualified matching contributions]{.underline}. Qualified matching
contributions satisfy this paragraph (a)(6) only to the extent that such
qualified matching contributions are matching contributions that are not
precluded from being taken into account under the ACP test for the plan
year under the rules of §1.401(m)-2(a)(5)(ii).

\(vi\) [Contributions only used once]{.underline}. Qualified nonelective
contributions and qualified matching contributions can not be taken into
account under this paragraph (a)(6) to the extent such contributions are
taken into account for purposes of satisfying any other ADP test, any
ACP test, or the requirements of §1.401(k)-3, 1.401(m)-3 or 1.401(k)-4.
Thus, for example, matching contributions that are made pursuant to
§1.401(k)-3(c) cannot be taken into account under the ADP test.
Similarly, if a plan switches from the current year testing method to
the prior year testing method pursuant to §1.401(k)-2(c), qualified
nonelective contributions that are taken into account under the current
year testing method for a year may not be taken into account under the
prior year testing method for the next year

\(7\) [Examples]{.underline}. The following examples illustrate the
application of this paragraph

(a):

[Example 1]{.underline}. (i) Employer X has three employees, A, B, and
C. Employer X sponsors a profit‑sharing plan (Plan Z) that includes a
cash or deferred arrangement. Each year, Employer X determines a bonus
attributable to the prior year. Under the cash or deferred arrangement,
each eligible employee may elect to receive none, all or any part of the
bonus in cash. X contributes the remainder to Plan Z. The portion of the
bonus paid in cash, if any, is paid 2 months after the end of the plan
year and thus is included in compensation for the following plan year.
Employee A is an HCE, while Employees B and C are NHCEs. The plan uses
the current year testing method and defines compensation to include
elective contributions and bonuses paid during each plan year. In
February of 2005, Employer X determined that no bonuses will be paid for
2004. In February of 2006, Employer X provided a bonus for each employee
equal to 10% of regular compensation for 2005. For the 2005 plan year,
A, B, and C have the following compensation and make the following
elections:

  ----------------------- ----------------------- -----------------------
  Employee                Compensation            Elective Contribution

  A                       \$100,000               \$4,340

  B                       60,000                  2,860

  C                       45,000                  1,250
  ----------------------- ----------------------- -----------------------

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

  ---------- ---------------------------------------- -------------------
  Employee   Ratio of Elective Contribution to        ADR
             Compensation                             

  A          \$4,340/\$100,000                        4.34%

  B          2,860/60,000                             4.77

  C          1,250/45,000                             2.78
  ---------- ---------------------------------------- -------------------

\(iii\) The ADP for the HCEs (Employee A) is 4.34%. The ADP for the
NHCEs is 3.78% ((4.77% + 2.78%)/2). Because 4.34% is less than 4.73%
(3.78% multiplied by 1.25), the plan satisfies the ADP test under
paragraph (a)(1)(i) of this section.

[Example 2]{.underline}. (i) The facts are the same as in [Example
1]{.underline}, except that elective contributions are made pursuant to
a salary reduction agreement throughout the plan year, and no bonuses
are paid. As provided by section 414(s)(2), Employer X includes elective
contributions in compensation. During the year, B and C defer the same
amount as in [Example 1]{.underline}, but A defers \$5,770. Thus, the
compensation and elective contributions for A, B, and C are:

  ------------ --------------------- --------------------- ---------------
  Employee     Gross Compensation    Elective              ADR
                                     Contributions         

  A            \$ 100,000            \$ 5,770              5.77%

  B            60,000                2,860                 4.77

  C            45,000                1,250                 2.78
  ------------ --------------------- --------------------- ---------------

\(ii\) The ADP for the HCEs (Employee A) is 5.77 %. The ADP for the
NHCEs is 3.78% ((4.77% + 2.78%)/2). Because 5.77% exceeds 4.73% (3.78% x
1.25), the plan does not satisfy the ADP test under paragraph (a)(1)(i)
of this section. However, because the ADP for the HCEs does not exceed
the ADP for the NHCEs by more than 2 percentage points and the ADP for
the HCEs does not exceed the ADP for the NHCEs multiplied by 2 (3.78% x
2 = 7.56%), the plan satisfies the ADP test under paragraph (a)(1)(ii)
of this section.

[Example 3]{.underline}. (i) Employees D through L are eligible
employees in Plan T, a profit‑sharing plan that contains a cash or
deferred arrangement. The plan is a calendar year plan that uses the
prior year testing method. Plan T provides that elective contributions
are included in compensation (as provided under section 414(s)(2)). Each
eligible employee may elect to defer up to 6% of compensation under the
cash or deferred arrangement. Employees D and E are HCEs. The
compensation, elective contributions, and ADRs of Employees D and E for
the 2006 plan year are shown below:

+---------+-----------------+-------------------+---------------------+
| E       | Compensation    | Elective          | ADR for 2006 Plan   |
| mployee | for             | Contributions for | Year                |
|         |                 | 2006 Plan Year    |                     |
|         | 2006 Plan Year  |                   |                     |
+---------+-----------------+-------------------+---------------------+
| D       | \$100,000       | \$10,000          | 10%                 |
+---------+-----------------+-------------------+---------------------+
| E       | \$95,000        | \$4,750           | 5%                  |
+---------+-----------------+-------------------+---------------------+

\(ii\) During the 2005 plan year, Employees F through L were eligible
NHCEs. The compensation, elective contributions and ADRs of Employees F
through L for the 2005 plan year are shown in the following table:

  ---------- ------------------ -------------------- ---------------------
  Employee   Compensation for   Elective             ADR for 2005 Plan
             2005 Plan Year     Contributions for    Year
                                2005 Plan Year       

  F          \$60,000           \$3,600              6%

  G          \$40,000           \$1,600              4%

  H          \$30,000           \$1,200              4%

  I          \$20,000           \$ 600               3%

  J          \$20,000           \$600                3%

  K          \$10,000           \$300                3%

  L          \$5,000            \$150                3%
  ---------- ------------------ -------------------- ---------------------

\(iii\) The ADP for 2006 for the HCEs is 7.5%. Because Plan T is using
the prior year testing method, the applicable year for determining the
NHCE ADP is the prior plan year (i.e., 2005). The NHCE ADP is determined
using the ADRs for NHCEs eligible during the prior plan year (without
regard to whether they are eligible under the plan during the plan
year). The ADP for the NHCEs is 3.71% (the sum of the individual ADRs,
26%, divided by 7 employees). Because 7.5% exceeds 4.64% (3.71% x 1.25),
Plan T does not satisfy the ADP test under paragraph (a)(1)(i) of this
section. In addition, because the ADP for the HCEs exceeds the ADP for
the NHCEs by more than 2 percentage points, Plan T does not satisfy the
ADP test under paragraph (a)(1)(ii) of this section. Therefore, the cash
or deferred arrangement fails to be a qualified cash or deferred
arrangement unless the ADP failure is corrected under paragraph (b) of
this section.

[Example 4]{.underline}. (i) Plan U is a calendar year profit‑sharing
plan that contains a cash or deferred arrangement and uses the current
year testing method. Plan U provides that elective contributions are
included in compensation (as provided under section 414(s)(2)). The
following amounts are contributed under Plan U for the 2006 plan year:
(A) QNECs equal to 2% of each employee's compensation; (B) Contributions
equal to 6% of each employee's compensation that are not immediately
vested under the terms of the plan; (C) 3% of each employee's
compensation that the employee may elect to receive as cash or to defer
under the plan. Both types of nonelective contributions are made for the
HCEs (employees M and N) and the NHCEs (employees O through S) for the
plan year and are contributed after the end of the plan year and before
the end of the following plan year. In addition, neither type of
nonelective contributions is used for any other ADP or ACP test.

\(ii\) For the 2006 plan year, the compensation, elective contributions,
and actual deferral ratios of employees M through S are shown in the
following table:

  ------------ ----------------- ------------------- --------------------
  Employee     Compensation      Elective            Actual Deferral
                                 Contributions       Ratio

  M            \$100,000         \$3,000             3%

  N            \$100,000         \$2,000             2%

  O            \$ 60,000         \$1,800             3%

  P            \$40,000          0                   0

  Q            \$30,000          0                   0

  R            \$5,000           0                   0

  S            \$20,000          0                   0
  ------------ ----------------- ------------------- --------------------

\(iii\) The elective contributions alone do not satisfy the ADP test of
section 401(k)(3) and paragraph (a)(1) of this section because the ADP
for the HCEs, consisting of employees M and N, is 2.5% and the ADP for
the NHCEs is 0.6%.

\(iv\) The 2% QNECs satisfies the timing requirement of paragraph
(a)(6)(i) of this section because it is paid within 12-month after the
plan year for which allocated. All nonelective contributions also
satisfy the requirements relating to section 401(a)(4) set forth in
paragraph (a)(6)(ii) of this section (because all employees receive an
8% nonelective contribution and the nonelective contributions excluding
the QNECs is 6% for all employees). In addition, the QNECs are not
disproportionate under paragraph (a)(6)(iv) of this section because no
QNEC for an NHCE exceeds the product of the plan's applicable
contribution rate (2%) and that NHCE's compensation.

\(v\) Because the rules of paragraph (a)(6) of this section are
satisfied, the 2% QNECs may be taken into account in applying the ADP
test of section 401(k)(3) and paragraph (a)(1) of this section. The 6%
nonelective contributions, however, may not be taken into account
because they are not QNECs.

\(vi\) If the 2% QNECs are taken into account, the ADP for the HCEs is
4.5%, and the actual deferral percentage for the NHCEs is 2.6%. Because
4.5% is not more than two percentage points greater than 2.6 percent,
and not more than two times 2.6, the cash or deferred arrangement
satisfies the ADP test of section 401(k)(3) under paragraph (a)(1)(ii)
of this section.

[Example 5]{.underline}. (i) The facts are the same as [Example
4]{.underline}, except the plan uses the prior year testing method. In
addition, the NHCE ADP for the 2005 plan year (the prior plan year) is
0.8% and no QNECs are contributed for the 2005 plan year during 2005 or
2006.

\(ii\) In 2007, it is determined that the elective contributions alone
do not satisfy the ADP test of section 401(k)(3) and paragraph (a)(1) of
this section for 2006 because the 2006 ADP for the eligible HCEs,
consisting of employees M and N, is 2.5% and the 2005 ADP for the
eligible NHCEs is 0.8%. An additional QNEC of 2% of compensation is made
for each eligible NHCE in 2007 and allocated for 2005.

\(iii\) The 2% QNECs that are made in 2007 and allocated for the 2005
plan year do not satisfy the timing requirement of paragraph (a)(6)(i)
of this section for the applicable year for the 2005 plan year because
they were not contributed before the last day of the 2006 plan year.
Accordingly, the 2% QNECs do not satisfy the rules of paragraph (a)(6)
of this section and may not be taken into account in applying the ADP
test of section 401(k)(3) and paragraph (a)(1) of this section for the
2006 plan year. The cash or deferred arrangement fails to be a qualified
cash or deferred arrangement unless the ADP failure is corrected under
paragraph (b) of this section.

[Example 6]{.underline}. (i) The facts are the same as [Example
4]{.underline}, except that the ADP for the HCEs is 4.6% and there is no
6% nonelective contribution under the plan. The employer would like to
take into account the 2% QNEC in determining the ADP for the NHCEs but
not in determining the ADP for the HCEs.

\(ii\) The elective contributions alone fail the requirements of section
401(k) and paragraph (a)(1) of this section because the HCE ADP for the
plan year (4.6%) exceeds 0.75% (0.6% x 1.25) and 1.2% (0.6% x 2).

\(iii\) The 2% QNECs may not be taken into account in determining the
ADP of the NHCEs because they fail to satisfy the requirements relating
to section 401(a)(4) set forth in paragraph (a)(6)(ii) of this section.
This is because the amount of nonelective contributions, excluding those
QNECs that would be taken into account under the ADP test, would be 2%
of compensation for the HCEs and 0% for the NHCEs. Therefore, the cash
or deferred arrangement fails to be a qualified cash or deferred
arrangement unless the ADP failure is corrected under paragraph (b) of
this section.

[Example 7]{.underline}. (i) The facts are the same as [Example
6]{.underline}, except that Employee R receives a QNEC in an amount of
\$500 and no QNECs are made on behalf of the other employees.

\(ii\) If the QNEC could be taken into account under paragraph (a)(6) of
this section, the ADP for the NHCEs would be 2.6% and the plan would
satisfy the ADP test. The QNEC is disproportionate under paragraph
(a)(6)(iv) of this section, and cannot be taken into account under
paragraph (a)(6) of this section, to the extent it exceeds the greater
of 5% and two times the plan's representative contribution rate (0%),
multiplied by Employee R's compensation. The plan's representative
contribution rate is 0% because it is the lowest applicable contribution
rate among a group of NHCEs that is at least half of all NHCEs, or all
the NHCEs who are employed on the last day of the plan year. Therefore,
the QNEC may be taken into account under the ADP test only to the extent
it does not exceed 5% times Employee R's compensation (or \$250) and the
cash or deferred arrangement fails to satisfy the ADP test and must
correct under paragraph (b) of this section.

[Example 8]{.underline}. (i) The facts are the same as in [Example
4]{.underline} except that the plan changes from the current year
testing method to the prior year testing method for the following plan
year (2006 plan year). The ADP for the HCEs for the 2006 plan year is
3.5%.

\(ii\) The 2% QNECs may not be taken into account in determining the ADP
for the NHCEs for the applicable year (2005 plan year) in satisfying the
ADP test for the 2006 plan year because they were taken into account in
satisfying the ADP test for the 2005 plan year. Accordingly, the NHCE
ADP for the applicable year is 0.6%. The elective contributions for the
plan year fail the requirements of section 401(k) and paragraph (a)(1)
of this section because the HCE ADP for the plan year (3.5%) exceeds the
ADP limit of 1.2% (the greater of 0.75% (0.6% x 1.25) and 1.2% (0.6% x
2)), determined using the applicable year ADP for the NHCEs. Therefore,
the cash or deferred arrangement fails to be a qualified cash or
deferred arrangement unless the ADP failure is corrected under paragraph
(b) of this section.

[Example 9]{.underline}. (i)(A) Employer N maintains Plan X, a profit
sharing plan that contains a cash or deferred arrangement and that uses
the current year testing method. Plan X provides for employee
contributions, elective contributions, and matching contributions.
Matching contributions on behalf of nonhighly compensated employees are
qualified matching contributions (QMACs) and are contributed during the
2005 plan year. Matching contributions on behalf of highly compensated
employees are not QMACs, because they fail to satisfy the
nonforfeitability requirement of §1.401(k)-1(c). The elective
contributions and matching contributions with respect to HCEs for the
2005 plan year are shown in the following table:

+---------------------+------------+-------------+-----------+--------+
|                     | Elective   | Total       | Matching  | QMACs  |
|                     |            | Matching    | cont      |        |
|                     | Con        | Co          | ributions |        |
|                     | tributions | ntributions | that are  |        |
|                     |            |             | not QMACs |        |
+---------------------+------------+-------------+-----------+--------+
| Highly compensated  | 15%        | 5%          | 5%        | 0%     |
| employees           |            |             |           |        |
+---------------------+------------+-------------+-----------+--------+

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

  --------------------- --------------- --------------- --------------- ---------
                        Elective        Total Matching  Matching        QMACs
                        Contributions   Contributions   contributions   
                                                        that are not    
                                                        QMACs           

  Nonhighly compensated 11%             4%              0%              4%
  employees                                                             
  --------------------- --------------- --------------- --------------- ---------

\(ii\) The plan fails to satisfy the ADP test of section 401(k)(3)(A)
and paragraph (a)(1) of this section because the ADP for HCEs (15%) is
more than 125% of the ADP for NHCEs (11%), and more than 2 percentage
points greater than 11%. However, the plan provides that QMACs may be
used to meet the requirements of section 401(k)(3)(A)(ii) provided that
they are not used for any other ADP or ACP test. QMACs equal to 1% of
compensation are taken into account for each NHCE in applying the ADP
test. After this adjustment, the applicable ADP and ACP (taking into
account the provisions of §1.401(m)-2(a)(5)(ii)) for the plan year are
as follows:

  ----------------------- ----------------------- -----------------------
                          Actual Deferral         Actual Contribution
                          Percentage              Percentage

  HCEs                    15%                     5%

  Nonhighly compensated   12                      3
  employees                                       
  ----------------------- ----------------------- -----------------------

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

\(b\) [Correction of excess contributions]{.underline}\--(1)
[Permissible correction methods]{.underline}\--(i) [In
general]{.underline}. A cash or deferred arrangement does not fail to
satisfy the requirements of section 401(k)(3) and paragraph (a)(1) of
this section if the employer, in accordance with the terms of the plan
that includes the cash or deferred arrangement, uses any of the
following correction methods\--

\(A\) [Qualified nonelective contributions or qualified matching
contributions]{.underline}. The employer makes qualified nonelective
contributions or qualified matching contributions that are taken into
account under this section and, in combination with other amounts taken
into account under paragraph (a) of this section, allow the cash or
deferred arrangement to satisfy the requirements of paragraph (a)(1) of
this section.

\(B\) [Excess contributions distributed]{.underline}. Excess
contributions are distributed in accordance with paragraph (b)(2) of
this section.

\(C\) [Excess contributions recharacterized]{.underline}. Excess
contributions are recharacterized in accordance with paragraph (b)(3) of
this section.

\(ii\) [Combination of correction methods]{.underline}. A plan may
provide for the use of any of the correction methods described in
paragraph (b)(1)(i) of this section, may limit elective contributions in
a manner designed to prevent excess contributions from being made, or
may use a combination of these methods, to avoid or correct excess
contributions. A plan may require or permit an HCE to elect whether any
excess contributions are to be recharacterized or distributed. If the
plan uses a combination of correction methods, any contribution made
under paragraph (b)(1)(i)(A) of this section must be taken into account
before application of the correction methods in paragraph (b)(1)(i)(B)
or (C) of this section. (iii) [Exclusive means of
correction]{.underline}. A failure to satisfy the requirements of
paragraph (a)(1) of this section may not be corrected using any method
other than the ones described in paragraphs (b)(1)(i) and (ii) of this
section. Thus, excess contributions for a plan year may not remain
unallocated or be allocated to a suspense account for allocation to one
or more employees in any future year. In addition, excess contributions
may not be corrected using the retroactive correction rules of
§1.401(a)(4)‑11(g). See §1.401(a)(4)-11(g)(3)(vii) and (5).

\(2\) [Corrections through distribution]{.underline}\--(i) [General
rule]{.underline}. This paragraph (b)(2) contains the rules for
correction of excess contributions through a distribution from the plan.
Correction through a distribution generally involves a 4 step process.
First, the plan must determine, in accordance with paragraph (b)(2)(ii)
of this section, the total amount of excess contributions that must be
distributed under the plan. Second, the plan must apportion the total
amount of excess contributions among HCEs in accordance with paragraph
(b)(2)(iii) of this section. Third, the plan must determine the income
allocable to excess contributions in accordance with paragraph
(b)(2)(iv) of this section. Finally, the plan must distribute the
apportioned excess contributions and allocable income in accordance with
paragraph (b)(2)(v) of this section. Paragraph (b)(2)(vi) of this
section provides rules relating to the tax treatment of these
distributions. Paragraph (b)(2)(vii) provides other rules relating to
these distributions.

\(ii\) [Calculation of total amount to be distributed]{.underline}. The
following procedures must be used to determine the total amount of the
excess contributions to be distributed\--

\(A\) [Calculate the dollar amount of excess contributions for each
HCE]{.underline}. The amount of excess contributions attributable to a
given HCE for a plan year is the amount (if any) by which the HCE's
contributions taken into account under this section must be reduced for
the HCE's ADR to equal the highest permitted ADR under the plan. To
calculate the highest permitted ADR under a plan, the ADR of the HCE
with the highest ADR is reduced by the amount required to cause that
HCE's ADR to equal the ADR of the HCE with the next highest ADR. If a
lesser reduction would enable the arrangement to satisfy the
requirements of paragraph (b)(2)(ii)(C) of this section, only this
lesser reduction is used in determining the highest permitted ADR.

\(B\) [Determination of the total amount of excess
contributions]{.underline}. The process described in paragraph
(b)(2)(ii)(A) of this section must be repeated until the arrangement
would satisfy the requirements of paragraph (b)(2)(ii)(C) of this
section. The sum of all reductions for all HCEs determined under
paragraph (b)(2)(ii)(A) of this section is the total amount of excess
contributions for the plan year.

\(C\) [Satisfaction of ADP]{.underline}. A cash or deferred arrangement
satisfies this paragraph (b)(2)(ii)(C) if the arrangement would satisfy
the requirements of paragraph (a)(1)(ii) of this section if the ADR for
each HCE were determined after the reductions described in paragraph
(b)(2)(ii)(A) of this section.

\(iii\) [Apportionment of total amount of excess contributions among the
HCEs]{.underline}. The following procedures must be used in apportioning
the total amount of excess contributions determined under paragraph
(b)(2)(ii) of this section among the HCEs:

\(A\) [Calculate the dollar amount of excess contributions for each
HCE]{.underline}. The contributions of the HCE with the highest dollar
amount of contributions taken into account under this section are
reduced by the amount required to cause that HCE's contributions to
equal the dollar amount of the contributions taken into account under
this section for the HCE with the next highest dollar amount of
contributions taken account under this section. If a lesser
apportionment to the HCE would enable the plan to apportion the total
amount of excess contributions, only the lesser apportionment would
apply.

\(B\) [Limit on amount apportioned to any individual]{.underline}. For
purposes of this paragraph (b)(2)(iii), the amount of contributions
taken into account under this section with respect to an HCE who is an
eligible employee in more than one plan of an employer is determined by
taking into account all contributions otherwise taken into account with
respect to such HCE under any plan of the employer during the plan year
of the plan being tested as being made under the plan being tested.
However, the amount of excess contributions apportioned for a plan year
with respect to any HCE must not exceed the amount of contributions
actually contributed to the plan for the HCE for the plan year. Thus, in
the case of an HCE who is an eligible employee in more than one plan of
the same employer to which elective contributions are made and whose ADR
is calculated in accordance with paragraph (a)(3)(ii) of this section,
the amount required to be distributed under this paragraph (b)(2)(iii)
shall not exceed the contributions actually contributed to the plan and
taken into account under this section for the plan year.

\(C\) [Apportionment to additional HCEs]{.underline}. The procedure in
paragraph (b)(2)(iii)(A) of this section must be repeated until the
total amount of excess contributions determined under paragraph
(b)(2)(ii) of this section have been apportioned.

\(iv\) [Income allocable to excess contributions]{.underline}\--(A)
[General rule]{.underline}. The income allocable to excess contributions
is equal to the sum of the allocable gain or loss for the plan year and,
to the extent the excess contributions are or will be credited with
allocable gain or loss for the period after the close of the plan year
(gap period), the allocable gain or loss for the gap period.

\(B\) [Method of allocating income]{.underline}. A plan may use any
reasonable method for computing the income allocable to excess
contributions, provided that the method does not violate section
401(a)(4), is used consistently for all participants and for all
corrective distributions under the plan for the plan year, and is used
by the plan for allocating income to participant's accounts. See
§1.401(a)(4)‑1(c)(8).

\(C\) [Alternative method of allocating plan year income]{.underline}. A
plan may allocate income to excess contributions for the plan year by
multiplying the income for the plan year allocable to the elective
contributions and other amounts taken account under this section
(including contributions made for the plan year), by a fraction, the
numerator of which is the excess contributions for the employee for the
plan year, and the denominator of which is the account balance
attributable to elective contributions and other contributions taken
into account under this section as of the beginning of the plan year
(including any additional amount of such contributions made for the plan
year).

\(D\) [Safe harbor method of allocating gap period income]{.underline}.
A plan may use the safe harbor method in this paragraph (b)(2)(iv)(D) to
determine income on excess contributions for the gap period. Under this
safe harbor method, income on excess contributions for the gap period is
equal to 10% of the income allocable to excess contributions for the
plan year that would be determined under paragraph (b)(2)(iv)(C) of this
section, multiplied by the number of calendar months that have elapsed
since the end of the plan year. For purposes of calculating the number
of calendar months that have elapsed under the safe harbor method, a
corrective distribution that is made on or before the fifteenth day of a
month is treated as made on the last day of the preceding month and a
distribution made after the fifteenth day of a month is treated as made
on the last day of the month.

\(E\) [Alternative method for allocating plan year and gap period
income]{.underline}. A plan may determine the allocable gain or loss for
the aggregate of the plan year and the gap period by applying the
alternative method provided by paragraph (b)(2)(iv)(C) of this section
to this aggregate period. This is accomplished by substituting the
income for the plan year and the gap period for the income for the plan
year and by substituting the contributions taken into account under this
section for the plan year and the gap period for the contributions taken
account under this section for the plan year in determining the fraction
that is multiplied by that income.

\(v\) [Distribution]{.underline}. Within 12 months after the close of
the plan year in which the excess contribution arose, the plan must
distribute to each HCE the excess contributions apportioned to such HCE
under paragraph (b)(2)(iii) of this section and the allocable income.
Except as otherwise provided in this paragraph (b)(2)(v) and paragraph
(b)(4)(i) of this section, a distribution of excess contributions must
be in addition to any other distributions made during the year and must
be designated as a corrective distribution by the employer. In the event
of a complete termination of the plan during the plan year in which an
excess contribution arose, the corrective distribution must be made as
soon as administratively feasible after the date of termination of the
plan, but in no event later than 12 months after the date of
termination. If the entire account balance of an HCE is distributed
prior to when the plan makes a distribution of excess contributions in
accordance with this paragraph (b)(2), the distribution is deemed to
have been a corrective distribution of excess contributions (and income)
to the extent that a corrective distribution would otherwise have been
required.

\(vi\) [Tax treatment of corrective distributions]{.underline}\--(A)
[General rule]{.underline}. Except as provided in paragraph
(b)(2)(vi)(B) of this section, a corrective distribution of excess
contributions (and income) that is made within 2½ months after the end
of the plan year for which the excess contributions were made is
includible in the employee's gross income on the earliest date any
elective contributions by the employee during the plan year would have
been received by the employee had the employee originally elected to
receive the amounts in cash. A corrective distribution of excess
contributions (and income) that is made more than 2½ months after the
end of the plan year for which the contributions were made is includible
in the employee's gross income in the employee's taxable year in which
distributed. Regardless of when the corrective distribution is made, it
is not subject to the early distribution tax of section 72(t). See
paragraph (b)(4) of this section for additional rules relating to the
employer excise tax on amounts distributed more than 2½ months after the
end of the plan year. See also §1.402(c)-2, A-4 for restrictions on
rolling over distributions that are excess contributions.

\(B\) [Rule for de minimis distributions]{.underline}. If the total
amount of excess contributions, determined under this paragraph (b)(2),
and excess aggregate contributions determined under §1.401(m)-2(b)(2)
distributed to a recipient under a plan for any plan year is less than
\$100 (excluding income), a corrective distribution of excess
contributions (and income) is includible in the gross income of the
recipient in the taxable year of the recipient in which the corrective
distribution is made.

\(vii\) [Other rules]{.underline}\--(A) [No employee or spousal consent
required]{.underline}. A corrective distribution of excess contributions
(and income) may be made under the terms of the plan without regard to
any notice or consent otherwise required under sections 411(a)(11) and
417.

\(B\) [Treatment of corrective distributions as elective
contributions]{.underline}. Excess contributions are treated as employer
contributions for purposes of sections 404 and 415 even if distributed
from the plan.

\(C\) [No reduction of required minimum distribution]{.underline}. A
distribution of excess contributions (and income) is not treated as a
distribution for purposes of determining whether the plan satisfies the
minimum distribution requirements of section 401(a)(9). See
§1.401(a)(9)-5, Q&A-9(b).

\(D\) [Partial distributions]{.underline}. Any distribution of less than
the entire amount of excess contributions (and allocable income) with
respect to any HCE is treated as a pro rata distribution of excess
contributions and allocable income.

\(viii\) [Examples]{.underline}. The following examples illustrate the
application of this paragraph (b)(2). For purposes of these examples,
none of the plans provide for catch-up contributions under section
414(v). The examples are as follows:

[Example 1]{.underline}. (i) Plan P, a calendar year profit-sharing plan
that includes a cash or deferred arrangement, provides for distribution
of excess contributions to HCEs to the extent necessary to satisfy the
ADP test. Employee A, an HCE, has elective contributions of \$12,000 and
\$200,000 in compensation, for an ADR of 6%, and Employee B, a second
HCE, has elective contributions of \$8,960 and compensation of
\$128,000, for an ADR of 7%. The ADP for the NHCEs is 3%. Under the ADP
test, the ADP of the two HCEs under the plan may not exceed 5% (i.e., 2
percentage points more than the ADP of the NHCEs under the plan). The
ADP for the 2 HCEs under the plan is 6.5%. Therefore, there must be a
correction of excess contributions.

\(ii\) The total amount of excess contributions for the HCEs is
determined under paragraph (b)(2)(ii) of this section as follows: the
elective contributions of Employee B (the HCE with the highest ADR) are
reduced by \$1,280 in order to reduce his ADR to 6% (\$7,680/\$128,000),
which is the ADR of Employee A.

\(iii\) Because the ADP of the HCEs determined after the \$1,280
reduction to Employee B still exceeds 5%, further reductions in elective
contributions are necessary in order to reduce the ADP of the HCEs to
5%. The elective contributions of Employee A and Employee B are each
reduced by 1% of compensation (\$2,000 and \$1,280 respectively).
Because the ADP of the HCEs determined after the reductions equals 5%,
the plan would satisfy the requirements of (a)(1)(ii) of this section.

\(iv\) The total amount of excess contributions (\$4,560 =
\$1,280+\$2,000+\$1,280) is apportioned among the HCEs under paragraph
(b)(2)(iii) of this section first to the HCE with the highest amount of
elective contributions. Therefore, Employee A is apportioned \$3,040
(the amount required to cause Employee A's elective contributions to
equal the next highest dollar amount of elective contributions).

\(v\) Because the total amount of excess contributions has not been
apportioned, further apportionment is necessary. The balance (\$1,520)
of the total amount of excess contributions is apportioned equally among
Employee A and Employee B (\$760 to each).

\(vi\) Therefore, the cash or deferred arrangement will satisfy the
requirements of paragraph (a)(1) of this section if, by the end of the
12 month period following the end of the 2006 plan year, Employee A
receives a corrective distribution of excess contributions equal to
\$3,800 (\$3,040 + \$760) and allocable income and Employee B receives a
corrective distribution of \$760 and allocable income.

[Example 2]{.underline}. (i) The facts are the same as in [Example
1]{.underline}, except Employee A's ADR is based on \$3,000 of elective
contributions to this plan and \$9,000 of elective contributions to
another plan of the employer.

\(ii\) The total amount of excess contributions (\$4,560 =
\$1,280+\$2,000+\$1,280) is apportioned among the HCEs under paragraph
(b)(2)(iii) of this section first to the HCE with the highest amount of
elective contributions. The amount of elective contributions for
Employee A is \$12,000. Therefore, Employee A is apportioned \$3,040
(the amount required to cause Employee A\'s elective contributions to
equal the next highest dollar amount of elective contributions).
However, pursuant to paragraph (b)(2)(iii)(B) of this section, no more
than the amount actually contributed to the plan may be apportioned to
an HCE. Accordingly, no more than \$3,000 may be apportioned to Employee
A. Therefore, the remaining \$1,560 must be apportioned to Employee B.

\(ii\) The cash or deferred arrangement will satisfy the requirements of
paragraph (a)(1) of this section if, by the end of the 12 month period
following the end of the 2006 plan year, Employee A receives a
corrective distribution of excess contributions equal to \$3,000 (total
amount of elective contributions actually contributed to the plan for
Employee A) and allocable income and Employee B receives a corrective
distribution of \$1,560 and allocable income.

[Example 3]{.underline}. (i) The facts are the same as in [Example
1]{.underline}. The plan allocates income on a daily basis. The
corrective distributions are made in February 2007. The excess
contribution that must be distributed to Employee A as a corrective
distribution is \$3,800. This amount must be increased (or decreased) to
reflect gains (or losses) allocable to that amount during the 2006 plan
year. The plan uses a reasonable method that satisfies paragraph
(b)(2)(iv)(B) of this section to determine the gain during the 2006 plan
year allocable to the \$3,800 as \$145. Therefore, as of the end of the
2006 plan year, the amount of corrective distribution that is required
would be \$3,945.

\(ii\) Because the plan allocates income on a daily basis, excess
contributions are credited with gain or loss during the gap period.
Therefore, the corrective distribution must include income allocable to
\$3,945 through the date of distribution. For the period from January 1
through the date of distribution, the income allocable to \$3,945 is
\$105. Therefore, the plan will satisfy the requirements of paragraph
(a)(1) of this section if Employee A receives a corrective distribution
of \$4,050.

[Example 4]{.underline}. (i) The facts are the same as in [Example
1]{.underline}. The plan determines plan year income using the
alternative method for calculating income provided in paragraph
(b)(2)(iv)(C) of this section and using the portion of the participant's
account attributable to elective contributions, including elective
contributions made for the plan year. The plan uses the safe harbor
method provided in paragraph (b)(2)(iv)(D) of this section for
allocating gap period income. The corrective distribution is made during
the last week of February 2007. At the beginning of the 2006 plan year,
\$100,000 of Employee A\'s plan account was attributable to elective
contributions. During the 2006 plan year, \$10,000 in elective
contributions were contributed to the plan for Employee A. The income
allocable to Employee A\'s account attributable to elective
contributions for the 2006 plan year is \$8,000.

\(ii\) Therefore, the plan year income allocable to the \$3,800
corrective distribution for Employee A is \$266.65 (\$8,000 multiplied
by \$3,800 divided by \$110,000). Therefore, as of the end of the 2006
plan year, the amount of corrective distribution that is required is
\$4,066.65. This amount must be increased by the gap period income of
\$53.32 (10% multiplied by \$266.65 (2006 plan year income attributable
to the excess contribution) multiplied by 2 (number of calendar months
since end of 2006 plan year). Therefore, the plan will satisfy the
requirements of paragraph (a)(1) of this section if Employee A receives
a corrective distribution of \$4,119.97.

[Example 5]{.underline}. (i) The facts are the same as in [Example
4]{.underline}, except that the plan provides for quarterly valuations
based on the account balance at the end of the quarter.

\(ii\) Because the plan's method for allocating income does not allocate
any income to amounts distributed during the quarter, Employee A will
not be credited with an allocation of income with respect to the amount
distributed. Accordingly, Plan P need not plan adjust the distribution
of excess contribution for income during the gap period and thus
satisfies paragraph (a)(1) of this section if Employee A receives a
corrective distribution of \$4,066.65.

\(3\) [Recharacterization of excess contributions]{.underline}\--(i)
[General rule]{.underline}. Excess contributions are recharacterized in
accordance with this paragraph (b)(3) only if the excess contributions
that would have to be distributed under (b)(2) of this section if the
plan was correcting through distribution of excess contributions are
recharacterized as described in paragraph (b)(3)(ii) of this section,
and all of the conditions set forth in paragraph (b)(3)(iii) of this
section are satisfied.

\(ii\) [Treatment of recharacterized excess contributions]{.underline}.
Recharacterized excess contributions are includible in the employee's
gross income as if such amounts were distributed under paragraph (b)(2)
of this section. The recharacterized excess contributions must be
treated as employee contributions for purposes of section 72, sections
401(a)(4) and 401(m). This requirement is not treated as satisfied
unless the payor or plan administrator reports the recharacterized
excess contributions as employee contributions to the Internal Revenue
Service and the employee by timely providing such Federal tax forms and
accompanying instructions and timely taking such other action as
prescribed by the Commissioner in revenue rulings, notices and other
guidance published in the Internal Revenue Bulletin (see 601.601(d)(2)
of this chapter) as well as the applicable federal tax forms and
accompanying instructions.

\(iii\) [Additional rules]{.underline}\--(A) [Time of
recharacterization]{.underline}. Excess contributions may not be
recharacterized under this paragraph (b)(3) after 2½ months after the
close of the plan year to which the recharacterization relates.
Recharacterization is deemed to have occurred on the date on which the
last of those HCEs with excess contributions to be recharacterized is
notified in accordance with paragraph (b)(3)(ii) of this section.

\(B\) [Employee contributions must be permitted under plan]{.underline}.
The amount of recharacterized excess contributions, in combination with
the employee contributions actually made by the HCE, may not exceed the
maximum amount of employee contributions (determined without regard to
the ACP test of section 401(m)(2)) permitted under the provisions of the
plan as in effect on the first day of the plan year.

\(C\) [Treatment of recharacterized excess contributions]{.underline}.
Recharacterized excess contributions continue to be treated as employer
contributions for all other purposes under the Internal Revenue Code,
including sections 401(a) (other than sections 401(a)(4) and 401(m)),
404, 409, 411, 412, 415, 416, and 417. Thus, for example,
recharacterized excess contributions remain subject to the requirements
of §1.401(k)-1(c) and (d); must be deducted under section 404; and are
treated as employer contributions described in section 415(c)(2)(A) and
§1.415-6(b).

\(4\) [Rules applicable to all corrections]{.underline}\--(i)
[Coordination with distribution of excess deferrals]{.underline}\--(A)
[Treatment of excess deferrals that reduce excess
contributions]{.underline}. The amount of excess contributions (and
allocable income) to be distributed under paragraph (b)(2) of this
section or the amount of excess contributions recharacterized under
paragraph (b)(3) of this section with respect to an employee for a plan
year, is reduced by any amounts previously distributed to the employee
from the plan to correct excess deferrals for the employee's taxable
year ending with or within the plan year in accordance with section
402(g)(2).

\(B\) [Treatment of excess contributions that reduce excess
deferrals]{.underline}. Under §1.402(g)‑1(e), the amount required to be
distributed to correct an excess deferral to an employee for a taxable
year is reduced by any excess contributions (and allocable income)
previously distributed or excess contributions recharacterized with
respect to the employee for the plan year beginning with or within the
taxable year. The amount of excess contributions includible in the gross
income of the employee, and the amount of excess contributions reported
by the payer or plan administrator as includible in the gross income of
the employee, does not include the amount of any reduction under
§1.402(g)‑1(e)(6).

\(ii\) [Forfeiture of match on distributed excess
contributions]{.underline}. A matching contribution is taken into
account under section 401(a)(4) even if the match is with respect to an
elective contribution that is distributed or recharacterized under this
paragraph (b). This requires that, after correction of excess
contributions, each level of matching contributions be currently and
effectively available to a group of employees that satisfies section
410(b). See §1.401(a)(4)‑4(e)(3)(iii)(G). Thus, a plan that provides the
same rate of matching contributions to all employees will not meet the
requirements of section 401(a)(4) if elective contributions are
distributed under this paragraph (b) to HCEs to the extent needed to
meet the requirements of section 401(k)(3), while matching contributions
attributable to those elective contributions remain allocated to the
HCEs' accounts. Under section 411(a)(3)(G) and §1.411(a)-4(b)(7), a plan
may forfeit matching contributions attributable to excess contributions,
excess aggregate contributions or excess deferrals to avoid a violation
of section 401(a)(4). See also §1.401(a)(4)-11(g)(vii)(B) regarding the
use of additional allocations to the accounts of NHCEs for the purpose
of correcting a discriminatory rate of matching contributions.

\(iii\) [Permitted forfeiture of QMAC]{.underline}. Pursuant to section
401(k)(8)(E), a qualified matching contribution is not treated as
forfeitable under §1.401(k)-1(c) merely because under the plan it is
forfeited in accordance with paragraph (b)(4)(ii) of this section.

\(iv\) [No requirement for recalculation]{.underline}. If excess
contributions are distributed or recharacterized in accordance with
paragraphs (b)(2) and (3) of this section, the cash or deferred
arrangement is treated as meeting the nondiscrimination test of section
401(k)(3) regardless of whether the ADP for the HCEs, if recalculated
after the distributions or recharacterizations, would satisfy section
401(k)(3).

\(v\) [Treatment of excess contributions that are catch-up
contributions]{.underline}. A cash or deferred arrangement does not fail
to meet the requirements of section 401(k)(3) and paragraph (a)(1) of
this section merely because excess contributions that are catch-up
contributions because they exceed the ADP limit, as described in
§1.414(v)-1(b)(1)(iii), are not corrected in accordance with this
paragraph (b).

\(5\) [Failure to timely correct]{.underline}\--(i) [Failure to correct
within 2½ months after end of plan year]{.underline}. If a plan does not
correct excess contributions within 2½ months after the close of the
plan year for which the excess contributions are made, the employer will
be liable for a 10% excise tax on the amount of the excess
contributions. See section 4979 and §54.4979‑1 of this chapter.
Qualified nonelective contributions and qualified matching contributions
properly taken into account under paragraph (a)(6) of this section for a
plan year may enable a plan to avoid having excess contributions, even
if the contributions are made after the close of the 2½ month period.

\(ii\) [Failure to correct within 12 months after end of plan
year]{.underline}. If excess contributions are not corrected within 12
months after the close of the plan year for which they were made, the
cash or deferred arrangement will fail to satisfy the requirements of
section 401(k)(3) for the plan year for which the excess contributions
are made and all subsequent plan years during which the excess
contributions remain in the trust.

\(c\) [Additional rules for prior year testing method]{.underline}\--(1)
[Rules for change in testing method]{.underline}\--(i) [General
rule]{.underline}. A plan is permitted to change from the prior year
testing method to the current year testing method for any plan year. A
plan is permitted to change from the current year testing method to the
prior year testing method only in situations described in paragraph
(c)(1)(ii) of this section. For purposes of this paragraph (c)(1), a
plan that uses the safe harbor method described in §1.401(k)-3 or a
SIMPLE 401(k) plan is treated as using the current year testing method
for that plan year.

\(ii\) [Situations permitting a change to the prior year testing
method]{.underline}. The situations described in this paragraph
(c)(1)(ii) are:

\(A\) The plan is not the result of the aggregation of two or more
plans, and the current year testing method was used under the plan for
each of the 5 plan years preceding the plan year of the change (or if
lesser, the number of plan years the plan has been in existence,
including years in which the plan was a portion of another plan).

\(B\) The plan is the result of the aggregation of two or more plans,
and for each of the plans that are being aggregated (the aggregating
plans), the current year testing method was used for each of the 5 plan
years preceding the plan year of the change (or if lesser, the number of
plan years since that aggregating plan has been in existence, including
years in which the aggregating plan was a portion of another plan).

\(C\) A transaction described in section 410(b)(6)(C)(i) and
§1.410(b)‑2(f) occurs and\--

([1]{.underline}) As a result of the transaction, the employer maintains
both a plan using the prior year testing method and a plan using the
current year testing method; and

([2]{.underline}) The change from the current year testing method to the
prior year testing method occurs within the transition period described
in section 410(b)(6)(C)(ii).

\(2\) [Calculation of ADP under the prior year testing method for the
first plan year]{.underline}\--(i) [Plans that are not successor
plans]{.underline}. If, for the first plan year of any plan (other than
a successor plan), the plan uses the prior year testing method, the plan
is permitted to use either that first plan year as the applicable year
for determining the ADP for eligible NHCEs, or use 3% as the ADP for
eligible NHCEs, for applying the ADP test for that first plan year. A
plan (other than a successor plan) that uses the prior year testing
method but has elected for its first plan year to use that year as the
applicable year is not treated as changing its testing method in the
second plan year and is not subject to the limitations on double
counting on QNECs under paragraph (a)(6)(vi) of this section for the
second plan year.

\(ii\) [First plan year defined]{.underline}. For purposes of this
paragraph (c)(2), the first plan year of any plan is the first year in
which the plan provides for elective contributions. Thus, the rules of
this paragraph (c)(2) do not apply to a plan (within the meaning of
§1.410(b)-7(b)) for a plan year if for such plan year the plan is
aggregated under §1.401(k)‑1(b)(4) with any other plan that provides for
elective contributions in the prior year.

\(iii\) [Successor plans]{.underline}. A plan is a successor plan if 50%
or more of the eligible employees for the first plan year were eligible
employees under a qualified cash or deferred arrangement maintained by
the employer in the prior year. If a plan that is a successor plan uses
the prior year testing method for its first plan year, the ADP for the
group of NHCEs for the applicable year must be determined under
paragraph (c)(4) of this section.

\(3\) [Plans using different testing methods for the ADP and ACP
test]{.underline}. Except as otherwise provided in this paragraph
(c)(3), a plan may use the current year testing method or prior year
testing method for the ADP test for a plan year without regard to
whether the current year testing method or prior year testing method is
used for the ACP test for that year. For example, a plan may use the
prior year testing method for the ADP test and the current year testing
method for its ACP test for the plan year. However, plans that use
different testing methods under this paragraph (c)(3) cannot use\--

\(i\) The recharacterization method of paragraph (b)(3) of this section
to correct excess contributions for a plan year;

\(ii\) The rules of §1.401(m)-2(a)(6)(ii) to take elective contributions
into account under the ACP test (rather than the ADP test); or

\(iii\) The rules of paragraph (a)(6)(v) of this section to take
qualified matching contributions into account under the ADP test (rather
than the ACP test).

\(4\) [Rules for plan coverage changes]{.underline}\--(i) [In
general]{.underline}. A plan that uses the prior year testing method and
experiences a plan coverage change during a plan year satisfies the
requirements of this section for that year only if the plan provides
that the ADP for the NHCEs for the plan year is the weighted average of
the ADPs for the prior year subgroups.

\(ii\) [Optional rule for minor plan coverage changes]{.underline}. If a
plan coverage change occurs and 90% or more of the total number of the
NHCEs from all prior year subgroups are from a single prior year
subgroup, then, in lieu of using the weighted averages described in
paragraph (c)(4)(i) of this section, the plan may provide that the ADP
for the group of eligible NHCEs for the prior year under the plan is the
ADP of the NHCEs for the prior year of the plan under which that single
prior year subgroup was eligible.

\(iii\) [Definitions]{.underline}. The following definitions apply for
purposes of this paragraph (c)(4):

\(A\) [Plan coverage change]{.underline}. The term plan coverage change
means a change in the group or groups of eligible employees under a plan
on account of\--

([1]{.underline}) The establishment or amendment of a plan;

([2]{.underline}) A plan merger or spinoff under section 414(l);

([3]{.underline}) A change in the way plans (within the meaning of
§1.410(b)-7(b)) are combined or separated for purposes of
§1.401(k)‑1(b)(4) (e.g., permissively aggregating plans not previously
aggregated under §1.410(b)‑7(d), or ceasing to permissively aggregate
plans under §1.410(b)‑7(d));

([4]{.underline}) A reclassification of a substantial group of employees
that has the same effect as amending the plan (e.g., a transfer of a
substantial group of employees from one division to another division);
or

([5]{.underline}) A combination of any of paragraphs
(c)(4)(iii)(A)([1]{.underline}) through ([4]{.underline}) of this
section.

\(B\) [Prior year subgroup]{.underline}. The term prior year subgroup
means all NHCEs for the prior plan year who, in the prior year, were
eligible employees under a specific plan maintained by the employer that
included a qualified cash or deferred arrangement and who would have
been eligible employees in the prior year under the plan being tested if
the plan coverage change had first been effective as of the first day of
the prior plan year instead of first being effective during the plan
year. The determination of whether an NHCE is a member of a prior year
subgroup is made without regard to whether the NHCE terminated
employment during the prior year.

\(C\) [Weighted average of the ADPs for the prior year
subgroups]{.underline}. The term weighted average of the ADPs for the
prior year subgroups means the sum, for all prior year subgroups, of the
adjusted ADPs for the plan year. The term adjusted ADP with respect to a
prior year subgroup means the ADP for the prior plan year of the
specific plan under which the members of the prior year subgroup were
eligible employees on the first day of the prior plan year, multiplied
by a fraction, the numerator of which is the number of NHCEs in the
prior year subgroup and denominator of which is the total number of
NHCEs in all prior year subgroups.

\(iv\) [Examples]{.underline}. The following examples illustrate the
application of this paragraph (c)(4):

[Example 1]{.underline}. (i) Employer B maintains two calendar year
plans, Plan O and Plan P, each of which includes a cash or deferred
arrangement. The plans were not permissively aggregated under
§1.410(b)‑7(d) for the 2005 plan year. Both plans use the prior year
testing method. Plan O had 300 eligible employees who were NHCEs for the
2005 plan year, and their ADP for that year was 6%. Sixty of the
eligible employees who were NHCEs for the 2005 plan year under Plan O,
terminated their employment during that year. Plan P had 100 eligible
employees who were NHCEs for 2005, and the ADP for those NHCEs for that
plan was 4%. Plan O and Plan P are permissively aggregated under
§1.410(b)‑7(d) for the 2006 plan year.

\(ii\) The permissive aggregation of Plan O and Plan P for the 2006 plan
year under § 1.410(b)‑7(d) is a plan coverage change that results in
treating the plans as one plan (Plan OP) for purposes of
§1.401(k)‑1(b)(4). Therefore, the prior year ADP for the NHCEs under
Plan OP for the 2006 plan year is the weighted average of the ADPs for
the prior year subgroups: the Plan O prior year subgroup and the Plan P
prior year subgroup.

\(iii\) The Plan O prior year subgroup consists of the 300 employees
who, in the 2005 plan year, were eligible NHCEs under Plan O and who
would have been eligible under Plan OP for the 2005 plan year if Plan O
and Plan P had been permissively aggregated for that plan year. The Plan
P prior year subgroup consists of the 100 employees who, in the 2005
plan year, were eligible NHCEs under Plan P and would have been eligible
under Plan OP for the 2005 plan year if Plan O and Plan P had been
permissively aggregated for that plan year.

\(iv\) The weighted average of the ADPs for the prior year subgroups is
the sum of the adjusted ADP for the Plan O prior year subgroup and the
adjusted ADP for the Plan P prior year subgroup. The adjusted ADP for
the Plan O prior year subgroup is 4.5%, calculated as follows: 6% (the
ADP for the NHCEs under Plan O for the 2005 plan year) x 300/400 (the
number of NHCEs in the Plan O prior year subgroup divided by the total
number of NHCEs in all prior year subgroups). The adjusted ADP for the
Plan P prior year subgroup is 1%, calculated as follows: 4% (the ADP for
the NHCEs under Plan P for the 2005 plan year) x 100/400 (the number of
NHCEs in the Plan P prior year subgroup divided by the total number of
NHCEs in all prior year subgroups). Thus, the prior year ADP for NHCEs
under Plan OP for the 2006 plan year is 5.5% (the sum of adjusted ADPs
for the prior year subgroups, 4.5% plus 1%).

\(v\) As provided in paragraph (c)(4)(iii)(B) of this section, the
determination of whether an NHCE is a member of a prior year subgroup is
made without regard to whether that NHCE terminated employed during the
prior year. Thus, the prior ADP for the NHCEs under Plan OP for the 2006
plan year is unaffected by the termination of the 60 NHCEs covered by
Plan O during the 2005 plan year.

[Example 2.]{.underline} (i) The facts are the same as [Example
1]{.underline}, except that the 60 employees who terminated employment
during the 2005 plan are instead spun-off to another plan.

\(ii\) The permissive aggregation of Plan O and Plan P for the 2006 plan
year under §1.410(b)‑7(d) is a plan coverage change that results in
treating the plans as one plan (Plan OP) for purposes of
§1.401(k)‑1(b)(4) and the spin-off of the 60 employees is a plan
coverage change. Therefore, the prior year ADP for the NHCEs under Plan
OP for the 2006 plan year is the weighted average of the ADPs for the
prior year subgroups: the Plan O prior year subgroup and the Plan P
prior year subgroup.

\(iii\) For purposes of determining the prior year subgroups, the
employees who would have been eligible employees in the prior year under
the plan being tested are determined as if both plan coverage changes
had first been effective as of the first day of the prior plan year. The
Plan O prior year subgroup consists of the 240 employees who, in the
2005 plan year, were eligible NHCEs under Plan O and would have been
eligible under Plan OP for the 2005 plan year if the spin-off had
occurred at the beginning of the 2005 plan year and Plan O and Plan P
had been permissively aggregated under §1.410(b)‑7(d) for that plan
year. The Plan P prior year subgroup consists of the 100 employees who,
in the 2005 plan year, were eligible NHCEs under Plan P and would have
been eligible under Plan OP for the 2005 plan year if Plan O and Plan P
had been permissively aggregated under §1.410(b)‑7(d) for that plan
year.

\(iv\) The weighted average of the ADPs for the prior year subgroups is
the sum of the adjusted ADP with respect to the prior year subgroup
consisting of eligible NHCEs from Plan O and the adjusted ADP with
respect to the prior year subgroup consisting of eligible NHCEs from
Plan P. The adjusted ADP for the prior year subgroup consisting of
eligible NHCEs under Plan O is 4.23%, calculated as follows: 6% (the ADP
for the NHCEs under Plan O for the 2005 plan year) x 240/340 (the number
of NHCEs in that prior year subgroup divided by the total number of
NHCEs in all prior year subgroups). The adjusted ADP for the prior year
subgroup consisting of the eligible NHCEs from Plan P is 1.18%,
calculated as follows: 4% (the ADP for the NHCEs under Plan P for the
2005 plan year) x 100/340 (the number of NHCEs in that prior year
subgroup divided by the total number of NHCEs in all prior year
subgroups). Thus, the prior year ADP for NHCEs under Plan OP for the
2006 plan year is 5.41% (the sum of adjusted ADPs for the prior year
subgroups, 4.23% plus 1.18%).

[Example 3]{.underline}. (i) The facts are the same as in [Example
1]{.underline}, except that instead of Plan O and Plan P being
permissively aggregated for the 2006 plan year, 200 of the employees
eligible under Plan O were spun-off from Plan O and merged into Plan P.

\(ii\) The spin-off from Plan O and merger to Plan P for the 2006 plan
year are plan coverage changes for Plan P. Therefore, the prior year ADP
for the NHCEs under Plan P for the 2006 plan year is the weighted
average of the ADPs for the prior year subgroups under Plan P. There are
2 subgroups under Plan P for the 2006 plan year. The Plan O prior year
subgroup consists of the 200 employees who, in the 2005 plan year, were
eligible NHCEs under Plan O and who would have been eligible under Plan
P for the 2005 plan year if the spin-off and merger had occurred on the
first day of the 2005 plan year. The Plan P prior year subgroup consists
of the 100 employees who, in the 2005 plan year, were eligible NHCEs
under Plan P for the 2005 plan year.

\(iii\) The weighted average of the ADPs for the prior year subgroups is
the sum of the adjusted ADP for the Plan O prior year subgroup and the
adjusted ADP for the Plan P prior year subgroup. The adjusted ADP for
the Plan O prior year subgroup is 4.0%, calculated as follows: 6% (the
ADP for the NHCEs under Plan O for the 2005 plan year) x 200/300 (the
number of NHCEs in the Plan O prior year subgroup divided by the total
number of NHCEs in all prior year subgroups). The adjusted ADP for the
Plan P prior year subgroup is 1.33%, calculated as follows: 4% (the ADP
for the NHCEs under Plan P for the 2005 plan year) x 100/300 (the number
of NHCEs in the Plan P prior year subgroup divided by the total number
of NHCEs in all prior year subgroups). Thus, the prior year ADP for
NHCEs under Plan P for the 2006 plan year is 5.33% (the sum of adjusted
ADPs for the 2 prior year subgroups, 4.0% plus 1.33%).

\(iv\) The spin-off from Plan O for the 2006 plan year is a plan
coverage change for Plan O. Therefore, the prior year ADP for the NHCEs
under Plan O for the 2006 plan year is the weighted average of the ADPs
for the prior year subgroups under Plan O. In this case, there is only
one prior year subgroup under Plan O, the employees who were NHCEs of
Employer B for the 2005 plan year and who were eligible for the 2005
plan year under Plan O. Because there is only one prior year subgroup
under Plan O, the weighted average of the ADPs for the prior year
subgroup under Plan O is equal to the NHCE ADP for the prior year (2005
plan year) under Plan O, or 6%.

[Example 4]{.underline}. (i) Employer C maintains a calendar year plan,
Plan Q, which includes a cash or deferred arrangement that uses the
prior year testing method. Plan Q covers employees of Division A and
Division B. In 2005, Plan Q had 500 eligible employees who were NHCEs,
and the ADP for those NHCEs for 2005 was 2%. Effective January 1, 2006,
Employer C amends the eligibility provisions under Plan Q to exclude
employees of Division B effective January 1, 2006. In addition,
effective on that same date, Employer C establishes a new calendar year
plan, Plan R, which includes a cash or deferred arrangement that uses
the prior year testing method. The only eligible employees under Plan R
are the 100 employees of Division B who were eligible employees under
Plan Q.

\(ii\) Plan R is a successor plan, within the meaning of paragraph
(c)(2)(iii) of this section (because all of the employees were eligible
employees under Plan Q in the prior year). Therefore, Plan R cannot use
the first plan year rule set forth in paragraph (c)(2)(i) of this
section.

\(iii\) The amendment to the eligibility provisions of Plan Q and the
establishment of Plan R are plan coverage changes within the meaning of
paragraph (c)(4)(iii)(A) of this section for Plan Q and Plan R.
Accordingly, each plan must determine the NHCE ADP for the 2006 plan
year under the rules set forth in paragraph (c)(4) of this section.

\(iv\) The prior year ADP for NHCEs under Plan Q is the weighted average
of the ADPs for the prior year subgroups. Plan Q has only one prior year
subgroup (because the only NHCEs who would have been eligible employees
under Plan Q for the 2005 plan year if the amendment to the Plan Q
eligibility provisions had occurred as of the first day of that plan
year were eligible employees under Plan Q). Therefore, for purposes of
the 2006 plan year under Plan Q, the ADP for NHCEs for the prior year is
the weighted average of the ADPs for the prior year subgroups, or 2%,
the same as if the plan amendment had not occurred.

\(v\) Similarly, Plan R has only one prior year subgroup (because the
only NHCEs who would have been eligible employees under Plan R for the
2005 plan year if the plan were established as of the first day of that
plan year were eligible employees under Plan Q). Therefore, for purposes
of the 2006 testing year under Plan R, the ADP for NHCEs for the prior
year is the weighted average of the ADPs for the prior year subgroups,
or 2%, the same as that of Plan Q.

[Example 5]{.underline}. (i) The facts are the same as in [Example
4]{.underline}, except that the provisions of Plan R extend eligibility
to 50 hourly employees who previously were not eligible employees under
any qualified cash or deferred arrangement maintained by Employer C.

\(ii\) Plan R is a successor plan (because 100 of Plan R's 150 eligible
employees were eligible employees under another qualified cash or
deferred arrangement maintained by Employer C in the prior year).
Therefore, Plan R cannot use the first plan year rule set forth in
paragraph (c)(2)(i) of this section.

\(iii\) The establishment of Plan R is a plan coverage change that
affects Plan R. Because the 50 hourly employees were not eligible
employees under any qualified cash or deferred arrangement of Employer C
for the prior plan year, they do not comprise a prior year subgroup.
Accordingly, Plan R still has only one prior year subgroup. Therefore,
for purposes of the 2006 testing year under Plan R, the ADP for NHCEs
for the prior year is the weighted average of the ADPs for the prior
year subgroups, or 2%, the same as that of Plan Q.

[§1.401(k)-3 Safe harbor requirements]{.underline}.

\(a\) [ADP test safe harbor]{.underline}. A cash or deferred arrangement
satisfies the ADP safe harbor provision of section 401(k)(12) for a plan
year if the arrangement satisfies the safe harbor contribution
requirement of paragraph (b) or (c) of this section for the plan year,
the notice requirement of paragraph (d) of this section, the plan year
requirements of paragraph (e) of this section, and the additional rules
of paragraphs (f), (g) and (h) of this section, as applicable. Pursuant
to section 401(k)(12)(E)(ii), the safe harbor contribution requirement
of paragraph (b) or (c) of this section must be satisfied without regard
to section 401(l). The contributions made under paragraphs (b) and (c)
of this section are referred to as safe harbor nonelective contributions
and safe harbor matching contributions, respectively.

\(b\) [Safe harbor nonelective contribution
requirement]{.underline}\--(1) [General rule]{.underline}. The safe
harbor nonelective contribution requirement of this paragraph is
satisfied if, under the terms of the plan, the employer is required to
make a qualified nonelective contribution on behalf of each eligible
NHCE equal to at least 3% of the employee's safe harbor compensation.

\(2\) [Safe harbor compensation defined]{.underline}. For purposes of
this section, safe harbor compensation means compensation as defined in
§1.401(k)‑6 (which incorporates the definition of compensation in
§1.414(s)‑1); provided, however, that the rule in the last sentence of
§1.414(s)‑1(d)(2)(iii) (which generally permits a definition of
compensation to exclude all compensation in excess of a specified dollar
amount) does not apply in determining the safe harbor compensation of
NHCEs. Thus, for example, the plan may limit the period used to
determine safe harbor compensation to the eligible employee's period of
participation.

\(c\) [Safe harbor matching contribution requirement]{.underline}\--(1)
[In general]{.underline}. The safe harbor matching contribution
requirement of this paragraph (c) is satisfied if, under the plan,
qualified matching contributions are made on behalf of each eligible
NHCE in an amount determined under the basic matching formula of section
401(k)(12)(B)(i)(I), as described in paragraph (c)(2) of this section,
or under an enhanced matching formula of section 401(k)(12)(B)(i)(II),
as described in paragraph (c)(3) of this section.

\(2\) [Basic matching formula]{.underline}. Under the basic matching
formula, each eligible NHCE receives qualified matching contributions in
an amount equal to the sum of\--

\(i\) 100% of the amount of the employee's elective contributions that
do not exceed 3% of the employee's safe harbor compensation; and

(ii) 50% of the amount of the employee's elective contributions that
exceed 3% of the employee's safe harbor compensation but that do not
exceed 5% of the employee's safe harbor compensation.

\(3\) [Enhanced matching formula]{.underline}. Under an enhanced
matching formula, each eligible NHCE receives a matching contribution
under a formula that, at any rate of elective contributions by the
employee, provides an aggregate amount of qualified matching
contributions at least equal to the aggregate amount of qualified
matching contributions that would have been provided under the basic
matching formula of paragraph (c)(2) of this section. In addition, under
an enhanced matching formula, the ratio of matching contributions on
behalf of an employee under the plan for a plan year to the employee's
elective contributions may not increase as the amount of an employee's
elective contributions increases.

\(4\) [Limitation on HCE matching contributions]{.underline}. The safe
harbor matching contribution requirement of this paragraph (c) is not
satisfied if the ratio of matching contributions made on account of an
HCE's elective contributions under the cash or deferred arrangement for
a plan year to those elective contributions is greater than the ratio of
matching contributions to elective contributions that would apply with
respect to any eligible NHCE with elective contributions at the same
percentage of safe harbor compensation.

\(5\) [Use of safe harbor match not precluded by certain plan
provisions]{.underline}\--(i) [Safe harbor matching contributions on
employee contributions]{.underline}. The safe harbor matching
contribution requirement of this paragraph (c) will not fail to be
satisfied merely because safe harbor matching contributions are made on
both elective contributions and employee contributions if safe harbor
matching contributions are made with respect to the sum of elective
contributions and employee contributions on the same terms as safe
harbor matching contributions are made with respect to elective
contributions. Alternatively, the safe harbor matching contribution
requirement of this paragraph (c) will not fail to be satisfied merely
because safe harbor matching contributions are made on both elective
contributions and employee contributions if safe harbor matching
contributions on elective contributions are not affected by the amount
of employee contributions.

\(ii\) [Periodic matching contributions]{.underline}. The safe harbor
matching contribution requirement of this paragraph (c) will not fail to
be satisfied merely because the plan provides that safe harbor matching
contributions will be made separately with respect to each payroll
period (or with respect to all payroll periods ending with or within
each month or quarter of a plan year) taken into account under the plan
for the plan year, provided that safe harbor matching contributions with
respect to any elective contributions made during a plan year quarter
are contributed to the plan by the last day of the immediately following
plan year quarter.

\(6\) [Permissible restrictions on elective contributions by
NHCEs]{.underline}\--(i) [General rule]{.underline}. The safe harbor
matching contribution requirement of this paragraph (c) is not satisfied
if elective contributions by NHCEs are restricted, unless the
restrictions are permitted by this paragraph (c)(6).

\(ii\) [Restrictions on election periods]{.underline}. A plan may limit
the frequency and duration of periods in which eligible employees may
make or change cash or deferred elections under a plan. However, an
employee must have a reasonable opportunity (including a reasonable
period after receipt of the notice described in paragraph (d) of this
section) to make or change a cash or deferred election for the plan
year. For purposes of this paragraph (c)(6)(ii), a 30‑day period is
deemed to be a reasonable period to make or change a cash or deferred
election.

\(iii\) [Restrictions on amount of elective contributions]{.underline}.
A plan is permitted to limit the amount of elective contributions that
may be made by an eligible employee under a plan, provided that each
NHCE who is an eligible employee is permitted (unless the employee is
restricted under paragraph (c)(6)(v) of this section) to make elective
contributions in an amount that is at least sufficient to receive the
maximum amount of matching contributions available under the plan for
the plan year, and the employee is permitted to elect any lesser amount
of elective contributions. However, a plan may require eligible
employees to make cash or deferred elections in whole percentages of
compensation or whole dollar amounts.

\(iv\) [Restrictions on types of compensation that may be
deferred]{.underline}. A plan may limit the types of compensation that
may be deferred by an eligible employee under a plan, provided that each
eligible NHCE is permitted to make elective contributions under a
definition of compensation that would be a reasonable definition of
compensation within the meaning of §1.414(s)‑1(d)(2). Thus, the
definition of compensation from which elective contributions may be made
is not required to satisfy the nondiscrimination requirement of
§1.414(s)‑1(d)(3).

\(v\) [Restrictions due to limitations under the Internal Revenue
Code]{.underline}. A plan may limit the amount of elective contributions
made by an eligible employee under a plan\--

\(A\) Because of the limitations of section 402(g) or section 415; or

(B) Because, on account of a hardship distribution, an employee's
ability to make elective contributions has been suspended for 6 months
in accordance with §1.401(k)‑1(d)(3)(iv)(E).

\(7\) [Examples]{.underline}. The following examples illustrate the safe
harbor contribution requirement of this paragraph (c):

[Example 1]{.underline}. (i) Beginning January 1, 2006, Employer A
maintains Plan L covering employees (including HCEs and NHCEs) in
Divisions D and E. Plan L contains a cash or deferred arrangement and
provides qualified matching contributions equal to 100% of each eligible
employee's elective contributions up to 3% of compensation and 50% of
the next 2% of compensation. For purposes of the matching contribution
formula, safe harbor compensation is defined as all compensation within
the meaning of section 415(c)(3) (a definition that satisfies section
414(s)). Also, each employee is permitted to make elective contributions
from all safe harbor compensation within the meaning of section
415(c)(3) and may change a cash or deferred election at any time. Plan L
limits the amount of an employee's elective contributions for purposes
of section 402(g) and section 415, and, in the case of a hardship
distribution, suspends an employee's ability to make elective
contributions for 6 months in accordance with §1.401(k)‑1(d)(3)(iv)(E).
All contributions under Plan L are nonforfeitable and are subject to the
withdrawal restrictions of section 401(k)(2)(B). Plan L provides for no
other contributions and Employer A maintains no other plans. Plan L is
maintained on a calendar‑year basis and all contributions for a plan
year are made within 12 months after the end of the plan year.

\(ii\) Based on these facts, matching contributions under Plan L are
safe harbor matching contributions because they are qualified matching
contributions equal to the basic matching formula. Accordingly, Plan L
satisfies the safe harbor contribution requirement of this paragraph
(c).

[Example 2]{.underline}. (i) The facts are the same as in [Example
1]{.underline}, except that instead of providing a basic matching
contribution, Plan L provides a qualified matching contribution equal to
100% of each eligible employee's elective contributions up to 4% of safe
harbor compensation.

\(ii\) Plan L's formula is an enhanced matching formula because each
eligible NHCE receives safe harbor matching contributions at a rate
that, at any rate of elective contributions, provides an aggregate
amount of qualified matching contributions at least equal to the
aggregate amount of qualified matching contributions that would have
been received under the basic safe harbor matching formula, and the rate
of matching contributions does not increase as the rate of an employee's
elective contributions increases. Accordingly, Plan L satisfies the safe
harbor contribution requirement of this paragraph (c).

[Example 3]{.underline}. (i) The facts are the same as in [Example
1]{.underline}, except that instead of permitting each employee to make
elective contributions from all compensation within the meaning of
section 415(c)(3), each employee's elective contributions under Plan L
are limited to 15% of the employee's "basic compensation." Basic
compensation is defined under Plan L as compensation within the meaning
of section 415(c)(3), but excluding overtime pay.

\(ii\) The definition of basic compensation under Plan L is a reasonable
definition of compensation within the meaning of §1.414(s)‑1(d)(2).

\(iii\) Plan L will not fail to satisfy the safe harbor contribution
requirement of this paragraph (c) merely because Plan L limits the
amount of elective contributions and the types of compensation that may
be deferred by eligible employees, provided that each eligible NHCE may
make elective contributions equal to at least 4% of the employee's safe
harbor compensation.

[Example 4]{.underline}. (i) The facts are the same as in [Example
1]{.underline}, except that Plan L provides that only employees employed
on the last day of the plan year will receive a safe harbor matching
contribution.

\(ii\) Even if the plan that provides for employee contributions and
matching contributions satisfies the minimum coverage requirements of
section 410(b)(1) taking into account this last‑day requirement, Plan L
would not satisfy the safe harbor contribution requirement of this
paragraph (c) because safe harbor matching contributions are not made on
behalf of all eligible NHCEs who make elective contributions.

\(iii\) The result would be the same if, instead of providing safe
harbor matching contributions under an enhanced formula, Plan L provides
for a 3% safe harbor nonelective contribution that is restricted to
eligible employees under the cash or deferred arrangement who are
employed on the last day of the plan year.

[Example 5]{.underline}. (i) The facts are the same as in [Example
1]{.underline}, except that instead of providing qualified matching
contributions under the basic matching formula to employees in both
Divisions D and E, employees in Division E are provided qualified
matching contributions under the basic matching formula, while safe
harbor matching contributions continue to be provided to employees in
Division D under the enhanced matching formula described in [Example
2]{.underline}.

\(ii\) Even if Plan L satisfies §1.401(a)(4)‑4 with respect to each rate
of matching contributions available to employees under the plan, the
plan would fail to satisfy the safe harbor contribution requirement of
this paragraph (c) because the rate of matching contributions with
respect to HCEs in Division D at a rate of elective contributions
between 3% and 5% would be greater than that with respect to NHCEs in
Division E at the same rate of elective contributions. For example, an
HCE in Division D who would have a 4% rate of elective contributions
would have a rate of matching contributions of 100% while an NHCE in
Division E who would have the same rate of elective contributions would
have a lower rate of matching contributions.

\(d\) [Notice requirement]{.underline}\--(1) [General rule]{.underline}.
The notice requirement of this paragraph (d) is satisfied for a plan
year if each eligible employee is given written notice of the employee's
rights and obligations under the plan and the notice satisfies the
content requirement of paragraph (d)(2) of this section and the timing
requirement of paragraph (d)(3) of this section.

\(2\) [Content requirement]{.underline}\--(i) [General
rule]{.underline}. The content requirement of this paragraph (d)(2) is
satisfied if the notice is\--

\(A\) Sufficiently accurate and comprehensive to inform the employee of
the employee's rights and obligations under the plan; and

\(B\) Written in a manner calculated to be understood by the average
employee eligible to participate in the plan.

\(ii\) [Minimum content requirement]{.underline}. Subject to the
requirements of paragraph (d)(2)(iii) of this section, a notice is not
considered sufficiently accurate and comprehensive unless the notice
accurately describes\--

\(A\) The safe harbor matching contribution or safe harbor nonelective
contribution formula used under the plan (including a description of the
levels of safe harbor matching contributions, if any, available under
the plan);

\(B\) Any other contributions under the plan or matching contributions
to another plan on account of elective contributions or employee
contributions under the plan (including the potential for discretionary
matching contributions) and the conditions under which such
contributions are made;

(C) The plan to which safe harbor contributions will be made (if
different than the plan containing the cash or deferred arrangement);

\(D\) The type and amount of compensation that may be deferred under the
plan;

(E)  How to make cash or deferred elections, including any
administrative requirements that apply to such elections;

\(F\) The periods available under the plan for making cash or deferred
elections;

\(G\) Withdrawal and vesting provisions applicable to contributions
under the plan; and

\(H\) Information that makes it easy to obtain additional information
about the plan (including an additional copy of the summary plan
description) such as telephone numbers, addresses and, if applicable,
electronic addresses, of individuals or offices from whom employees can
obtain such plan information.

\(iii\) [References to SPD]{.underline}. A plan will not fail to satisfy
the content requirements of this paragraph (d)(2) merely because, in the
case of information described in paragraph (d)(2)(ii)(B) of this section
(relating to any other contributions under the plan), paragraph
(d)(2)(ii)(C) of this section (relating to the plan to which safe harbor
contributions will be made) or paragraph (d)(2)(ii)(D) of this section
(relating to the type and amount of compensation that may be deferred
under the plan), the notice cross-references the relevant portions of a
summary plan description that provides the same information that would
be provided in accordance with such paragraphs and that has been
provided (or is concurrently provided) to employees.

\(3\) [Timing requirement]{.underline}\--(i) [General rule]{.underline}.
The timing requirement of this paragraph (d)(3) is satisfied if the
notice is provided within a reasonable period before the beginning of
the plan year (or, in the year an employee becomes eligible, within a
reasonable period before the employee becomes eligible). The
determination of whether a notice satisfies the timing requirement of
this paragraph (d)(3) is based on all of the relevant facts and
circumstances.

\(ii\) [Deemed satisfaction of timing requirement]{.underline}. The
timing requirement of this paragraph (d)(3) is deemed to be satisfied if
at least 30 days (and no more than 90 days) before the beginning of each
plan year, the notice is given to each eligible employee for the plan
year. In the case of an employee who does not receive the notice within
the period described in the previous sentence because the employee
becomes eligible after the 90th day before the beginning of the plan
year, the timing requirement is deemed to be satisfied if the notice is
provided no more than 90 days before the employee becomes eligible (and
no later than the date the employee becomes eligible). Thus, for
example, the preceding sentence would apply in the case of any employee
eligible for the first plan year under a newly established plan that
provides for elective contributions, or would apply in the case of the
first plan year in which an employee becomes eligible under an existing
plan that provides for elective contributions.

\(e\) [Plan year requirement]{.underline}\--(1) [General
rule]{.underline}. Except as provided in this paragraph (e) or in
paragraph (f) of this section, a plan will fail to satisfy the
requirements of section 401(k)(12) and this section unless plan
provisions that satisfy the rules of this section are adopted before the
first day of the plan year and remain in effect for an entire 12-month
plan year. Moreover, if, as described under paragraph (g)(4) of this
section, safe harbor matching or nonelective contributions will be made
to another plan for a plan year, provisions specifying that the safe
harbor contributions will be made in the other plan and providing that
the contributions will be QNECs or QMACs must also be adopted before the
first day of that plan year.

\(2\) [Initial plan year]{.underline}. A newly established plan (other
than a successor plan within the meaning of §1.401(k)-2(c)(2)(iii)) will
not be treated as violating the requirements of this paragraph (e)
merely because the plan year is less than 12 months, provided that the
plan year is at least 3 months long (or, in the case of a newly
established employer that establishes the plan as soon as
administratively feasible after the employer comes into existence, a
shorter period). Similarly, a cash or deferred arrangement will not fail
to satisfy the requirement of this paragraph (e) if it is added to an
existing profit sharing, stock bonus, or pre-ERISA money purchase
pension plan for the first time during that year provided that\--

\(i\) The plan is not a successor plan; and

\(ii\) The cash or deferred arrangement is made effective no later than
3 months prior to the end of the plan year.

\(3\) [Change of plan year]{.underline}. A plan that has a short plan
year as a result of changing its plan year will not fail to satisfy the
requirements of paragraph (e)(1) of this section merely because the plan
year has less than 12 months, provided that\--

\(i\) The plan satisfied the requirements of this section for the
immediately preceding plan year; and

\(ii\) The plan satisfies the requirements of this section for the
immediately following plan year.

\(4\) [Final plan year]{.underline}. A plan that terminates during a
plan year will not fail to satisfy the requirements of paragraph (e)(1)
of this section merely because the final plan year is less than 12
months, provided that\--

\(i\) The plan would satisfy the requirements of paragraph (g) of this
section, treating the termination of the plan as a reduction or
suspension of safe harbor matching contributions, other than the
requirement that employees have a reasonable opportunity to change their
cash or deferred elections and, if applicable, employee contribution
elections; or

\(ii\) The plan termination is in connection with a transaction
described in section 410(b)(6)(C) or the employer incurs a substantial
business hardship comparable to a substantial business hardship
described in section 412(d).

\(f\) [Plan amendments adopting safe harbor nonelective
contributions]{.underline}\--(1) [General rule]{.underline}.
Notwithstanding paragraph (e)(1) of this section, a plan that provides
for the use of the current year testing method may be amended after the
first day of the plan year and no later than 30 days before the last day
of the plan year to adopt the safe harbor method of this section using
nonelective contributions under paragraph (b) of this section, but only
if the plan provides the contingent and follow-up notices described in
this section. A plan amendment made pursuant to this paragraph (f)(1)
for a plan year may provide for the use of the safe harbor method
described in this section solely for that plan year and a plan sponsor
is not limited in the number of years for which it is permitted to adopt
an amendment providing for the safe harbor method of this section using
nonelective contributions under paragraph (b) of this section.

\(2\) [Contingent notice provided]{.underline}. A plan satisfies the
requirement to provide the contingent notice under this paragraph (f)(2)
if it provides a notice that would satisfy the requirements of paragraph
(d) of this section, except that, in lieu of setting forth the safe
harbor contributions used under the plan as set forth in paragraph
(d)(2)(ii)(A) of this section, the notice specifies that the plan may be
amended during the plan year to include the safe harbor nonelective
contribution and that, if the plan is amended, a follow-up notice will
be provided.

\(3\) [Follow-up notice requirement]{.underline}. A plan satisfies the
requirement to provide a follow-up notice under this paragraph (f)(3)
if, no later than 30 days before the last day of the plan year, each
eligible employee is given a notice that states that the safe harbor
nonelective contributions will be made for the plan year. This notice is
permitted to be combined with a contingent notice provided under
paragraph (f)(2) of this section for the next plan year.

\(g\) [Permissible reduction or suspension of safe harbor matching
contributions]{.underline}--(1) [General rule]{.underline}. A plan that
provides for safe harbor matching contributions will not fail to satisfy
the requirements of section 401(k)(3) for a plan year merely because the
plan is amended during a plan year to reduce or suspend safe harbor
matching contributions on future elective contributions (and, if
applicable, employee contributions) provided that\--

\(i\) All eligible employees are provided the supplemental notice in
accordance with paragraph (g)(2) of this section;

\(ii\) The reduction or suspension of safe harbor matching contributions
is effective no earlier than the later of 30 days after eligible
employees are provided the notice described in paragraph (g)(2) of this
section and the date the amendment is adopted;

\(iii\) Eligible employees are given a reasonable opportunity (including
a reasonable period after receipt of the supplemental notice) prior to
the reduction or suspension of safe harbor matching contributions to
change their cash or deferred elections and, if applicable, their
employee contribution elections;

\(iv\) The plan is amended to provide that the ADP test will be
satisfied for the entire plan year in which the reduction or suspension
occurs using the current year testing method described in
§1.401(k)-2(a)(2)(ii); and

\(v\) The plan satisfies the requirements of this section (other than
this paragraph (g)) with respect to amounts deferred through the
effective date of the amendment.

\(2\) [Notice of suspension requirement]{.underline}. The notice of
suspension requirement of this paragraph (g)(2) is satisfied if each
eligible employee is given a written notice that explains\--

\(i\) The consequences of the amendment which reduces or suspends
matching contributions on future elective contributions and, if
applicable, employee contributions;

\(ii\) The procedures for changing their cash or deferred election and,
if applicable, their employee contribution elections; and

\(iii\) The effective date of the amendment.

\(h\) [Additional rules]{.underline}\--(1) [Contributions taken into
account]{.underline}. A contribution is taken into account for purposes
of this section for a plan year if and only if the contribution would be
taken into account for such plan year under the rules of §1.401(k)-2(a)
or 1.401(m)-2(a). Thus, for example, a safe harbor matching contribution
must be made within 12 months of the end of the plan year. Similarly, an
elective contribution that would be taken into account for a plan year
under §1.401(k)-2(a)(4)(i)(B)([2]{.underline}) must be taken into
account for such plan year for purposes of this section, even if the
compensation would have been received after the close of the plan year.

\(2\) [Use of safe harbor nonelective contributions to satisfy other
nondiscrimination tests]{.underline}. A safe harbor nonelective
contribution used to satisfy the nonelective contribution requirement
under paragraph (b) of this section may also be taken into account for
purposes of determining whether a plan satisfies section 401(a)(4).
Thus, these contributions are not subject to the limitations on
qualified nonelective contributions under §1.401(k)‑2(a)(6)(ii), but are
subject to the rules generally applicable to nonelective contributions
under section 401(a)(4). See §1.401(a)(4)‑1(b)(2)(ii). However, pursuant
to section 401(k)(12)(E)(ii), to the extent they are needed to satisfy
the safe harbor contribution requirement of paragraph (b) of this
section, safe harbor nonelective contributions may not be taken into
account under any plan for purposes of section 401(l) (including the
imputation of permitted disparity under §1.401(a)(4)‑7).

\(3\) [Early participation rules]{.underline}. Section 401(k)(3)(F) and
§1.401(k)-2(a)(1)(iii)(A), which provide an alternative
nondiscrimination rule for certain plans that provide for early
participation, do not apply for purposes of section 401(k)(12) and this
section. Thus, a plan is not treated as satisfying this section with
respect to the eligible employees who have not completed the minimum age
and service requirements of section 410(a)(1)(A) unless the plan
satisfies the requirements of this section with respect to such eligible
employees.

\(4\) [Satisfying safe harbor contribution requirement under another
defined contribution plan]{.underline}. Safe harbor matching or
nonelective contributions may be made to the plan that contains the cash
or deferred arrangement or to another defined contribution plan that
satisfies section 401(a) or 403(a). If safe harbor contributions are
made to another defined contribution plan, the safe harbor plan must
specify the plan to which the safe harbors are made and contribution
requirement of paragraph (b) or (c) of this section must be satisfied in
the other defined contribution plan in the same manner as if the
contributions were made to the plan that contains the cash or deferred
arrangement. Consequently, the plan to which the contributions are made
must have the same plan year as the plan containing the cash and
deferred arrangement and each employee eligible under the plan
containing the cash or deferred arrangement must be eligible under the
same conditions under the other defined contribution plan. The plan to
which the safe harbor contributions are made need not be a plan that can
be aggregated with the plan that contains the cash or deferred
arrangement.

\(5\) [Contributions used only once]{.underline}. Safe harbor matching
or nonelective contributions cannot be used to satisfy the requirements
of this section with respect to more than one plan.

[§1.401(k)-4 SIMPLE 401(k) plan requirements]{.underline}.

\(a\) [General rule]{.underline}. A cash or deferred arrangement
satisfies the SIMPLE 401(k) plan provision of section 401(k)(11) for a
plan year if the arrangement satisfies the requirements of paragraphs
(b) through (i) of this section for that year. A plan that contains a
cash or deferred arrangement that satisfies this section is referred to
as a SIMPLE 401(k) plan. Pursuant to section 401(k)(11), a SIMPLE 401(k)
plan is treated as satisfying the ADP test of section 401(k)(3)(A)(ii)
for that year.

\(b\) [Eligible employer]{.underline}\--(1) [General rule]{.underline}.
A SIMPLE 401(k) plan must be established by an eligible employer.
Eligible employer for purposes of this section means, with respect to
any plan year, an employer that had no more than 100 employees who
received at least \$5,000 of SIMPLE compensation, as defined in
paragraph (e)(5) of this section, from the employer for the prior
calendar year.

\(2\) [Special rule]{.underline}. An eligible employer that establishes
a SIMPLE 401(k) plan for a plan year and that fails to be an eligible
employer for any subsequent plan year, is treated as an eligible
employer for the 2 plan years following the last plan year the employer
was an eligible employer. If the failure is due to any acquisition,
disposition, or similar transaction involving an eligible employer, the
preceding sentence applies only if the provisions of section
410(b)(6)(C)(i) are satisfied.

\(c\) [Exclusive plan]{.underline}\--(1) [General rule]{.underline}. The
SIMPLE 401(k) plan must be the exclusive plan for each SIMPLE 401(k)
plan participant for the plan year. This requirement is satisfied if
there are no contributions made, or benefits accrued, for services
during the plan year on behalf of any SIMPLE 401(k) plan participant
under any other qualified plan maintained by the employer. Other
qualified plan for purposes of this section means any plan, contract,
pension, or trust described in section 219(g)(5)(A) or (B).

\(2\) [Special rule]{.underline}. A SIMPLE 401(k) plan will not be
treated as failing the requirements of this paragraph (c) merely because
any SIMPLE 401(k) plan participant receives an allocation of forfeitures
under another plan of the employer.

\(d\) [Election and notice]{.underline}\--(1) [General
rule]{.underline}. An eligible employer establishing or maintaining a
SIMPLE 401(k) plan must satisfy the election and notice requirements in
paragraphs (d)(2) and (d)(3) of this section.

\(2\) [Employee elections]{.underline}\--(i) [Initial plan year of
participation]{.underline}. For the plan year in which an employee first
becomes eligible under the SIMPLE 401(k) plan, the employee must be
permitted to make a cash or deferred election under the plan during a
60-day period that includes either the day the employee becomes eligible
or the day before.

\(ii\) [Subsequent plan years]{.underline}. For each subsequent plan
year, each eligible employee must be permitted to make or modify his
cash or deferred election during the 60-day period immediately preceding
such plan year.

\(iii\) [Election to terminate]{.underline}. An eligible employee must
be permitted to terminate his cash or deferred election at any time. If
an employee does terminate his cash or deferred election, the plan is
permitted to provide that such employee cannot have elective
contributions made under the plan for the remainder of the plan year.

\(3\) [Employee notices]{.underline}. The employer must notify each
eligible employee within a reasonable time prior to each 60-day election
period, or on the day the election period starts, that he or she can
make a cash or deferred election, or modify a prior election, if
applicable, during that period. The notice must state whether the
eligible employer will make the matching contributions described in
paragraph (e)(3) of this section or the nonelective contributions
described in paragraph (e)(4) of this section.

\(e\) [Contributions]{.underline}\--(1) [General rule]{.underline}. A
SIMPLE 401(k) plan satisfies the contribution requirements of this
paragraph (e) for a plan year only if no contributions may be made to
the SIMPLE 401(k) plan during such year, other than contributions
described in this paragraph (e) and rollover contributions described in
§1.402(c)-2, Q&A-1(a).

\(2\) [Elective contributions]{.underline}. Subject to the limitations
on annual additions under section 415, each eligible employee must be
permitted to make an election to have up to \$10,000 of elective
contributions made on the employee\'s behalf under the SIMPLE 401(k)
plan for a plan year. The \$10,000 limit is increased beginning in 2006
in the same manner as the \$160,000 amount is adjusted under section
415(d), except that pursuant to section 408(p)(2)(E)(ii) the base period
shall be the calendar quarter beginning July 1, 2004 and any increase
which is not a multiple of \$500 is rounded to the next lower multiple
of \$500.

\(3\) [Matching contributions]{.underline}. Each plan year, the eligible
employer must contribute a matching contribution to the account of each
eligible employee on whose behalf elective contributions were made for
the plan year. The amount of the matching contribution must equal the
lesser of the eligible employee\'s elective contributions for the plan
year or 3% of the eligible employee\'s SIMPLE compensation for the
entire plan year.

\(4\) [Nonelective contributions]{.underline}. For any plan year, in
lieu of contributing matching contributions described in paragraph
(e)(3) of this section, an eligible employer may, in accordance with
plan terms, contribute a nonelective contribution to the account of each
eligible employee in an amount equal to 2% of the eligible employee\'s
SIMPLE compensation for the entire plan year. The eligible employer may
limit the nonelective contributions to those eligible employees who
received at least \$5,000 of SIMPLE compensation from the employer for
the entire plan year.

\(5\) [SIMPLE compensation]{.underline}. Except as otherwise provided,
the term SIMPLE compensation for purposes of this section means the sum
of wages, tips, and other compensation from the eligible employer
subject to federal income tax withholding (as described in section
6051(a)(3)) and the employee's elective contributions made under any
other plan, and if applicable, elective deferrals under a section 408(p)
SIMPLE IRA plan, a section 408(k)(6) SARSEP, or a plan or contract that
satisfies the requirements of section 403(b), and compensation deferred
under a section 457 plan, required to be reported by the employer on
Form W-2 (as described in section 6051(a)(8)). For self-employed
individuals, SIMPLE compensation means net earnings from self-employment
determined under section 1402(a) prior to subtracting any contributions
made under the SIMPLE 401(k) plan on behalf of the individual.

\(f\) [Vesting]{.underline}. All benefits attributable to contributions
described in paragraph (e) of this section must be nonforfeitable at all
times.

\(g\) [Plan year]{.underline}. The plan year of a SIMPLE 401(k) plan
must be the whole calendar year. Thus, in general, a SIMPLE 401(k) plan
can be established only on January 1 and can be terminated only on
December 31. However, in the case of an employer that did not previously
maintain a SIMPLE 401(k) plan, the establishment date can be as late as
October 1 (or later in the case of an employer that comes into existence
after October 1 and establishes the SIMPLE 401(k) plan as soon as
administratively feasible after the employer comes into existence).

\(h\) [Other rules]{.underline}. A SIMPLE 401(k) plan is not treated as
a top-heavy plan under section 416. See section 416(g)(4)(G).

[§1.401(k)‑5 Special rules for mergers, acquisitions and similar
events]{.underline}. \[*Reserved*\].

[§1.401(k)‑6 Definitions]{.underline}.

Unless otherwise provided, the definitions of this section govern for
purposes of section 401(k) and the regulations thereunder.

[Actual contribution percentage (ACP) test]{.underline}. [Actual
contribution percentage test]{.underline} or [ACP test]{.underline}
means the test described in §1.401(m)‑2(a)(1).

[Actual deferral percentage (ADP)]{.underline}. [Actual deferral
percentage]{.underline} or [ADP]{.underline} means the ADP of the group
of eligible employees as defined in §1.401(k)‑2(a)(2).

[Actual deferral percentage (ADP) test]{.underline}. [Actual deferral
percentage test]{.underline} or [ADP test]{.underline} means the test
described in §1.401(k)‑2(a)(1).

[Actual deferral ratio (ADR)]{.underline}. [Actual deferral
ratio]{.underline} or [ADR]{.underline} means the ADR of an eligible
employee as defined in §1.401(k)‑2(a)(3).

[Cash or deferred arrangement]{.underline}. [Cash or deferred
arrangement]{.underline} is defined in §1.401(k)-1(a)(2).

[Cash or deferred election]{.underline}. [Cash or deferred
election]{.underline} is defined in §1.401(k)-1(a)(3).

[Compensation]{.underline}. [Compensation]{.underline} means
compensation as defined in section 414(s) and §1.414(s)‑1. The period
used to determine an employee's compensation for a plan year must be
either the plan year or the calendar year ending within the plan year.
Whichever period is selected must be applied uniformly to determine the
compensation of every eligible employee under the plan for that plan
year. A plan may, however, limit the period taken into account under
either method to that portion of the plan year or calendar year in which
the employee was an eligible employee, provided that this limit is
applied uniformly to all eligible employees under the plan for the plan
year. In the case of an HCE whose ADR is determined under
§1.401(k)-2(a)(3)(ii), period of participation includes periods under
another plan for which elective contributions are aggregated under
§1.401(k)-2(a)(3)(ii). See also section 401(a)(17) and
§1.401(a)(17)‑1(c)(1).

[Current year testing method.]{.underline} [Current year testing
method]{.underline} means the testing method described in
§1.401(k)-2(a)(2)(ii) or §1.401(m)-2(a)(2)(ii) under which the
applicable year is the current plan year.

[Elective contributions]{.underline}. [Elective
contributions]{.underline} means employer contributions made to a plan
pursuant to a cash or deferred election under a cash or deferred
arrangement (whether or not the arrangement is a qualified cash or
deferred arrangement under §1.401(k)‑1(a)(4)).

[Eligible employee]{.underline}\--(1) [General rule]{.underline}.
[Eligible employee]{.underline} means an employee who is directly or
indirectly eligible to make a cash or deferred election under the plan
for all or a portion of the plan year. For example, if an employee must
perform purely ministerial or mechanical acts (e.g., formal application
for participation or consent to payroll withholding) in order to be
eligible to make a cash or deferred election for a plan year, the
employee is an eligible employee for the plan year without regard to
whether the employee performs the acts.

\(2\) [Conditions on eligibility]{.underline}. An employee who is unable
to make a cash or deferred election because the employee has not
contributed to another plan is also an eligible employee. By contrast,
if an employee must perform additional service (e.g., satisfy a minimum
period of service requirement) in order to be eligible to make a cash or
deferred election for a plan year, the employee is not an eligible
employee for the plan year unless the service is actually performed. See
§1.401(k)‑1(e)(5), however, for certain limits on the use of minimum
service requirements. An employee who would be eligible to make elective
contributions but for a suspension due to a distribution, a loan, or an
election not to participate in the plan, is treated as an eligible
employee for purposes of section 401(k)(3) for a plan year even though
the employee may not make a cash or deferred election by reason of the
suspension. Finally, an employee does not fail to be treated as an
eligible employee merely because the employee may receive no additional
annual additions because of section 415(c)(1).

\(3\) [Certain one‑time elections]{.underline}. An employee is not an
eligible employee merely because the employee, upon commencing
employment with the employer or upon the employee's first becoming
eligible to make a cash or deferred election under any arrangement of
the employer, is given the one‑time opportunity to elect, and the
employee does in fact elect, not to be eligible to make a cash or
deferred election under the plan or any other plan maintained by the
employer (including plans not yet established) for the duration of the
employee's employment with the employer. This rule applies in addition
to the rules in §1.401(k)-1(a)(3)(v) relating to the definition of a
cash or deferred election. In no event is an election made after
December 23, 1994, treated as a one-time irrevocable election under this
paragraph if the election is made by an employee who previously became
eligible under another plan (whether or not terminated) of the employer.

[Eligible HCE]{.underline}. [Eligible HCE]{.underline} means an eligible
employee who is an HCE.

[Eligible NHCE]{.underline}. [Eligible NHCE]{.underline} means an
eligible employee who is not an HCE.

[Employee]{.underline}. [Employee]{.underline} means an employee within
the meaning of §1.410(b)‑9.

[Employee stock ownership plan (ESOP)]{.underline}. [Employee stock
ownership plan]{.underline} or [ESOP]{.underline} means the portion of a
plan that is an ESOP within the meaning of §1.410(b)‑7(c)(2).

[Employer]{.underline}. [Employer]{.underline} means an employer within
the meaning of §1.410(b)‑9.

[Excess contributions]{.underline}. [Excess contributions]{.underline}
means, with respect to a plan year, the amount of total excess
contributions apportioned to an HCE under §1.401(k)-2(b)(2)(iii).

[Excess deferrals]{.underline}. [Excess deferrals]{.underline} means
excess deferrals as defined in §1.402(g)‑1(e)(3).

[Highly compensated employee (HCE)]{.underline}. [Highly compensated
employee]{.underline} or [HCE]{.underline} has the meaning provided in
section 414(q).

[Matching contributions]{.underline}. [Matching
contributions]{.underline} means matching contributions as defined in
§1.401(m)‑1(a)(2).

[Nonelective contributions]{.underline}. [Nonelective
contributions]{.underline} means employer contributions (other than
matching contributions) with respect to which the employee may not elect
to have the contributions paid to the employee in cash or other benefits
instead of being contributed to the plan.

[Non-employee stock ownership plan (non-ESOP)]{.underline}.
[Non-employee stock ownership plan]{.underline} or
[non-ESOP]{.underline} means the portion of a plan that is not an ESOP
within the meaning of §1.410(b)‑7(c)(2).

[Non-highly compensated employee (NHCE)]{.underline}. [Non-highly
compensated employee]{.underline} or [NHCE]{.underline} means an
employee who is not an HCE.

[Plan]{.underline}. [Plan]{.underline} is defined in §1.401(k)‑1(b)(4).

[Pre-ERISA money purchase pension plan]{.underline}. (1) [Pre-ERISA
money purchase pension plan]{.underline} is a pension plan\--

\(i\) That is a defined contribution plan (as defined in section
414(i));

\(ii\) That was in existence on June 27, 1974, and as in effect on that
date, included a salary reduction agreement; and

\(iii\) Under which neither the employee contributions nor the employer
contributions, including elective contributions, may exceed the levels
(as a percentage of compensation) provided for by the contribution
formula in effect on June 27, 1974.

\(2\) A plan was in existence on June 27, 1974, if it was a written plan
adopted on or before that date, even if no funds had yet been paid to
the trust associated with the plan.

[Prior year testing method]{.underline}. [Prior year
testing]{.underline} method means the testing method under which the
applicable year is the prior plan year, as described in
§1.401(k)‑2(a)(2)(ii) or §1.401(m)-2(a)(2)(ii).

[Qualified matching contributions (QMACs)]{.underline}. [Qualified
matching contributions]{.underline} or [QMACs]{.underline} means
matching contributions that, except as provided otherwise in
§1.401(k)-1(c) and (d), satisfy the requirements of §1.401(k)-1(c) and
(d) as though the contributions were elective contributions, without
regard to whether the contributions are actually taken into account
under the ADP test under §1.401(k)-2(a)(6) or the ACP test under
§1.401(m)-2(a)(6). Thus, the matching contributions must satisfy the
vesting requirements of §1.401(k)-1(c) and be subject to the
distribution requirements of §1.401(k)-1(d) when they are contributed to
the plan. See also §1.401(k)-2(b)(4)(iii) for a rule providing that a
matching contribution does not fail to qualify as a QMAC solely because
it is forfeitable under section 411(a)(3)(G) because it is a matching
contribution with respect to an excess deferral, excess contribution, or
excess aggregate contribution.

[Qualified nonelective contributions (QNECs)]{.underline}. [Qualified
nonelective contributions]{.underline} or [QNECs]{.underline} means
employer contributions, other than elective contributions or matching
contributions, that, except as provided otherwise in §1.401(k)-1(c) and
(d), satisfy the requirements of §1.401(k)-1(c) and (d) as though the
contributions were elective contributions, without regard to whether the
contributions are actually taken into account under the ADP test under
§1.401(k)-2(a)(6) or the ACP test under §1.401(m)-2(a)(6). Thus, the
nonelective contributions must satisfy the vesting requirements of
§1.401(k)-1(c) and be subject to the distribution requirements of
§1.401(k)-1(d) when they are contributed to the plan.

[Rural cooperative plans]{.underline}. [Rural cooperative
plan]{.underline} means a plan described in section 401(k)(7).

Par. 3. Sections 1.401(m)-0 through 1.401(m)-2 are revised and sections
1.401(m)-3 through 1.401(m)-5 are added to read as follows:

[§1.401(m)‑0 Table of contents]{.underline}.

This section contains first a list of section headings and then a list
of the paragraphs in each section in §§1.401(m)-1 through 1.401(m)-5.

LIST OF SECTIONS

§1.401(m)-1 Employee contributions and matching contributions.

§1.401(m)-2 ACP test.

§1.401(m)-3 Safe harbor requirements.

§1.401(m)-4 Special rules for mergers, acquisitions and similar events.
*\[Reserved\]*.

§1.401(m)-5 Definitions.

LIST OF PARAGRAPHS

[§1.401(m)-1 Employee contributions and matching
contributions]{.underline}.

\(a\) General nondiscrimination rules.

\(1\) Nondiscriminatory amount of contributions.

\(i\) Exclusive means of amounts testing.

\(ii\) Testing benefits, rights and features.

\(2\) Matching contributions.

\(i\) In general.

\(ii\) Employer contributions made on account of an employee
contribution or elective deferral.

\(iii\) Employer contributions not on account of an employee
contribution or elective deferral.

\(3\) Employee contributions.

\(i\) In general.

\(ii\) Certain contributions not treated as employee contributions.

\(iii\) Qualified cost-of-living arrangements.

\(b\) Nondiscrimination requirements for amount of contributions.

\(1\) Matching contributions and employee contributions.

\(2\) Automatic satisfaction by certain plans.

\(3\) Anti-abuse provisions.

\(4\) Aggregation and restructuring.

\(i\) In general.

\(ii\) Aggregation of employee contributions and matching contributions
within a plan.

\(iii\) Aggregation of plans.

\(A\) In general.

\(B\) Arrangements with inconsistent ACP testing methods.

\(iv\) Disaggregation of plans and separate testing.

\(A\) In general.

\(B\) Restructuring prohibited.

\(v\) Certain disaggregation rules not applicable.

\(c\) Additional requirements.

\(1\) Separate testing for employee contributions and matching
contributions.

\(2\) Plan provision requirement.

\(d\) Effective date.

[§1.401(m)-2 ACP test]{.underline}.

\(a\) Actual contribution percentage (ACP) test.

\(1\) In general.

\(i\) ACP test formula.

\(ii\) HCEs as sole eligible employees.

\(iii\) Special rule for early participation.

\(2\) Determination of ACP.

\(i\) General rule.

\(ii\) Determination of applicable year under current year and prior
year testing method.

\(3\) Determination of ACR.

\(i\) General rule.

\(ii\) ACR of HCEs eligible under more than one plan.

\(A\) General rule.

\(B\) Plans not permitted to be aggregated.

\(iii\) Example.

\(4\) Employee contributions and matching contributions taken into
account under the ACP test.

\(i\) Employee contributions.

\(ii\) Recharacterized elective contributions.

\(iii\) Matching contributions.

\(5\) Matching contributions not taken into account under the ACP test.

\(i\) General rule.

\(ii\) Disproportionate matching contributions.

\(A\) Matching contributions in excess of 100%.

\(B\) Representative matching rate.

\(C\) Definition of matching rate.

\(iii\) Qualified matching contributions used to satisfy the ADP test.

\(iv\) Matching contributions taken into account under safe harbor
provisions.

\(v\) Treatment of forfeited matching contributions.

\(6\) Qualified nonelective contributions and elective contributions
that may be taken into account under the ACP test.

\(i\) Timing of allocation.

\(ii\) Elective contributions taken into account under the ACP test.

\(iii\) Requirement that amount satisfy section 401(a)(4).

\(iv\) Aggregation must be permitted.

\(v\) Disproportionate contributions not taken into account.

\(A\) General rule.

\(B\) Definition of representative contribution rate.

\(C\) Definition of applicable contribution rate.

\(vi\) Contribution only used once.

\(7\) Examples.

\(b\) Correction of excess aggregate contributions.

\(1\) Permissible correction methods.

\(i\) In general.

\(A\) Additional contributions.

\(B\) Excess aggregate contributions distributed or forfeited.

\(ii\) Combination of correction methods.

\(iii\) Exclusive means of correction.

\(2\) Correction through distribution.

\(i\) General rule.

\(ii\) Calculation of total amount to be distributed.

\(A\) Calculate the dollar amount of excess aggregate contributions for
each HCE.

\(B\) Determination of the total amount of excess aggregate
contributions.

\(C\) Satisfaction of ACP.

\(iii\) Apportionment of total amount of excess aggregate contributions
among the HCEs.

\(A\) Calculate the dollar amount of excess aggregate contributions for
each HCE.

\(B\) Limit on amount apportioned to any HCE.

\(C\) Apportionment to additional HCEs.

\(iv\) Income allocable to excess aggregate contributions.

\(A\) General rule.

\(B\) Method of allocating income.

\(C\) Alternative method of allocating income for the plan year.

\(D\) Safe harbor method of allocating gap period income.

\(E\) Alternative method of allocating plan year and gap period income.

\(F\) Allocable income for recharacterized elective contributions.

\(v\) Distribution and forfeiture.

\(vi\) Tax treatment of corrective distributions.

\(A\) General rule.

\(B\) Rule for de minimis distributions.

\(3\) Other rules.

\(i\) No employee or spousal consent required.

\(ii\) Treatment of corrective distributions and forfeited contributions
as employer contributions.

\(iii\) No reduction of required minimum distribution.

\(iv\) Partial correction.

\(v\) Matching contributions on excess contributions, excess deferrals
and excess aggregate contributions.

\(A\) Corrective distributions not permitted.

\(B\) Coordination with section 401(a)(4).

\(vi\) No requirement for recalculation.

\(4\) Failure to timely correct.

\(i\) Failure to correct within 2½ months after end of plan year.

\(ii\) Failure to correct within 12 months after end of plan year.

\(5\) Examples.

\(c\) Additional rules for prior year testing method.

\(1\) Rules for change in testing method.

\(2\) Calculation of ACP under the prior year testing method for the
first plan year.

\(i\) Plans that are not successor plans.

\(ii\) First plan year defined.

\(iii\) Plans that are successor plans.

\(3\) Plans using different testing methods for the ACP and ADP test.

\(4\) Rules for plan coverage change.

\(i\) In general.

\(ii\) Optional rule for minor plan coverage changes.

\(iii\) Definitions.

\(A\) Plan coverage change.

\(B\) Prior year subgroup.

\(C\) Weighted average of the ACPs for the prior year subgroups.

\(iv\) Examples.

[§1.401(m)-3 Safe harbor requirements]{.underline}.

\(a\) ACP test safe harbor.

\(b\) Safe harbor nonelective contribution requirement.

\(c\) Safe harbor matching contribution requirement.

\(d\) Limitation on contributions.

\(1\) General rule.

\(2\) Matching rate must not increase.

\(3\) Limit on matching contributions.

\(4\) Limitation on rate of match.

\(5\) HCEs participating in multiple plans.

\(6\) Permissible restrictions on elective deferrals by NHCEs.

\(i\) General rule.

\(ii\) Restrictions on election periods.

\(iii\) Restrictions on amount of contributions.

\(iv\) Restrictions on types of compensation that may be deferred.

\(v\) Restrictions due to limitations under the Internal Revenue Code.

\(e\) Notice requirement.

\(f\) Plan year requirement.

\(1\) General rule.

\(2\) Initial plan year.

\(3\) Change of plan year.

\(4\) Final plan year.

\(g\) Plan amendments adopting nonelective safe harbor contributions.

\(h\) Permissible reduction or suspension of safe harbor matching
contributions.

\(1\) General rule.

\(2\) Notice of suspension requirement.

\(i\) Reserved.

\(j\) Other rules.

\(1\) Contributions taken into account.

\(2\) Use of safe harbor nonelective contributions to satisfy other
nondiscrimination tests.

\(3\) Early participation rules.

\(4\) Satisfying safe harbor contribution requirement under another
defined contribution plan.

\(5\) Contributions used only once.

\(6\) Plan must satisfy ACP with respect to employee contributions.

[§1.401(m)-4 Special rules for mergers, acquisitions and similar
events]{.underline}. *\[Reserved\].*

[§1.401(m)-5 Definitions]{.underline}.

[§1.401(m)‑1 Employee contributions and matching
contributions]{.underline}.

\(a\) [General nondiscrimination rules]{.underline}\--(1)
[Nondiscriminatory amount of contributions]{.underline}\--(i) [Exclusive
means of amounts testing]{.underline}. A defined contribution plan does
not satisfy section 401(a) for a plan year unless the amount of employee
contributions and matching contributions to the plan for the plan year
satisfies section 401(a)(4). The amount of employee contributions and
matching contributions under a plan satisfies the requirements of
section 401(a)(4) with respect to amounts if and only if the amount of
employee contributions and matching contributions satisfies the
nondiscrimination test of section 401(m) under paragraph (b) of this
section and the plan satisfies the additional requirements of paragraph
(c) of this section. See §1.401(a)(4)‑1(b)(2)(ii)(B).

\(ii\) [Testing benefits, rights and features]{.underline}. A plan that
provides for employee contributions or matching contributions must
satisfy the requirements of section 401(a)(4) relating to benefits,
rights and features in addition to the requirement regarding amounts
described in paragraph (a)(1)(i) of this section. For example, the right
to make each level of employee contributions and the right to each level
of matching contributions under the plan are benefits, rights or
features subject to the requirements of section 401(a)(4). See
§1.401(a)(4)‑4(e)(3)(i) and (iii)(F) through (G).

\(2\) [Matching contributions]{.underline}\--(i) [In
general]{.underline}. For purposes of section 401(m), this section and
§§1.401(m)-2 through 1.401(m)-5, matching contributions are\--

\(A\) Any employer contribution (including a contribution made at the
employer's discretion) to a defined contribution plan on account of an
employee contribution to a plan maintained by the employer;

\(B\) Any employer contribution (including a contribution made at the
employer's discretion) to a defined contribution plan on account of an
elective deferral; and

\(C\) Any forfeiture allocated on the basis of employee contributions,
matching contributions, or elective deferrals.

\(ii\) [Employer contributions made on account of an employee
contribution or elective deferral]{.underline}. Whether an employer
contribution is made on account of an employee contribution or an
elective deferral is determined on the basis of all the relevant facts
and circumstances, including the relationship between the employer
contribution and employee actions outside the plan. An employer
contribution made to a defined contribution plan on account of
contributions made by an employee under an employer-sponsored savings
arrangement that are not held in a plan that is intended to be a
qualified plan or a plan described in §1.402(g)-1(b) is not a matching
contribution.

\(iii\) [Employer contributions not on account of an employee
contribution or elective deferral]{.underline}. An employer contribution
is not a matching contribution made on account of an elective deferral
if it is contributed before the cash or deferred election is made or
before the employee's performance of services with respect to which the
elective deferral is made (or when the cash that is subject to the cash
or deferred election would be currently available, if earlier). In
addition, an employer contribution is not a matching contribution made
on account of an employee contribution if it is contributed before the
employee contribution.

\(3\) [Employee contributions]{.underline}\--(i) [In
general]{.underline}. For purposes of section 401(m), this section and
§§1.401(m)-2 through 1.401(m)-5, employee contributions are
contributions to a plan that are designated or treated at the time of
contribution as after-tax employee contributions (e.g., by treating the
contributions as taxable income subject to applicable withholding
requirements) and are allocated to an individual account for each
eligible employee to which attributable earnings and losses are
allocated. See §1.401(k)-1(a)(2)(ii). The term [employee
contributions]{.underline} includes\--

\(A\) Employee contributions to the defined contribution portion of a
plan described in section 414(k);

\(B\) Employee contributions applied to the purchase of whole life
insurance protection or survivor benefit protection under a defined
contribution plan;

\(C\) Amounts attributable to excess contributions within the meaning of
section 401(k)(8)(B) that are recharacterized as employee contributions
under §1.401(k)-2(b)(3); and

\(D\) Employee contributions to a plan or contract that satisfies the
requirements of section 403(b).

\(ii\) [Certain contributions not treated as employee
contributions]{.underline}. The term employee contributions does not
include repayment of loans, repayment of distributions described in
section 411(a)(7)(C), or employee contributions that are transferred to
the plan from another plan.

\(iii\) [Qualified cost-of-living arrangements]{.underline}. Employee
contributions to a qualified cost-of-living arrangement described in
section 415(k)(2)(B) are treated as employee contributions to a defined
contribution plan, without regard to the requirement that the employee
contributions be allocated to an individual account to which
attributable earnings and losses are allocated.

\(b\) [Nondiscrimination requirements for amount of
contributions]{.underline}\--(1) [Matching contributions and employee
contributions]{.underline}. The matching contributions and employee
contributions under a plan satisfy this paragraph (b) for a plan year
only if the plan

satisfies\--

(i)The ACP test of section 401(m)(2) described in §1.401(m)-2;

\(ii\) The ACP safe harbor provisions of section 401(m)(11) described in
§1.401(m)-3; or

\(iii\) The SIMPLE 401(k) provisions of sections 401(k)(11) and
401(m)(10) described in §1.401(k)-4.

\(2\) [Automatic satisfaction by certain plans]{.underline}.
Notwithstanding paragraph (b)(1) of this section, the requirements of
this section are treated as satisfied with respect to employee
contributions and matching contributions under a collectively bargained
plan (or the portion of a plan) that automatically satisfies section
410(b). See §§1.401(a)(4)‑1(c)(5) and 1.410(b)‑2(b)(7). Additionally,
the requirements of sections 401(a)(4) and 410(b) do not apply to a
governmental plan (within the meaning of section 414(d)) maintained by a
State or local government or political subdivision thereof (or agency or
instrumentality thereof). See sections 401(a)(5)(G), 403(b)(12)(C) and
410(c)(1)(A).

\(3\) [Anti-abuse provisions]{.underline}. Sections 1.401(m)-1 through
1.401(m)-5 are designed to provide simple, practical rules that
accommodate legitimate plan changes. At the same time, the rules are
intended to be applied by employers in a manner that does not make use
of changes in plan testing procedures or other plan provisions to
inflate inappropriately the ACP for NHCEs (which is used as a benchmark
for testing the ACP for HCEs) or to otherwise manipulate the
nondiscrimination testing requirements of this paragraph (b). Further,
this paragraph (b) is part of the overall requirement that benefits or
contributions not discriminate in favor of HCEs. Therefore, a plan will
not be treated as satisfying the requirements of this paragraph (b) if
there are repeated changes to plan testing procedures or plan provisions
that have the effect of distorting the ACP so as to increase
significantly the permitted ACP for HCEs, or otherwise manipulate the
nondiscrimination rules of this paragraph, if a principal purpose of the
changes was to achieve such a result.

\(4\) [Aggregation and restructuring]{.underline}\--(i) [In
general]{.underline}. This paragraph (b)(4) contains the exclusive rules
for aggregating and disaggregating plans that provide for employee
contributions and matching contributions for purposes of this section
and §§1.401(m)-2 through 1.401(m)-5.

\(ii\) [Aggregation of employee contributions and matching contributions
within a plan]{.underline}. Except as otherwise specifically provided in
this paragraph (b)(4) and §1.401(m)-3(f)(1), a plan must be subject to a
single test under paragraph (b)(1) of this section with respect to all
employee contributions and matching contributions and all eligible
employees under the plan. Thus, for example, if two groups of employees
are eligible for matching contributions under a plan, all employee
contributions and matching contributions under the plan must be subject
to a single test, even if they have significantly different features,
such as different rates of match.

\(iii\) [Aggregation of plans]{.underline}\--(A) [In
general]{.underline}. The term [plan]{.underline} means a plan within
the meaning of §1.410(b)-7(a) and (b), after application of the
mandatory disaggregation rules of §1.410(b)-7(c), and the permissive
aggregation rules of §1.410(b)-7(d), as modified by paragraph (b)(4)(v)
of this section. Thus, for example, two plans (within the meaning of
§1.410(b)-7(b)) that are treated as a single plan pursuant to the
permissive aggregation rules of §1.410(b)-7(d) are treated as a single
plan for purposes of sections 401(k) and 401(m).

\(B\) [Arrangements with inconsistent ACP testing methods]{.underline}.
Pursuant to paragraph (b)(4)(ii) of this section, a single testing
method must apply with respect to all employee contributions and
matching contributions and all eligible employees under a plan. Thus, in
applying the permissive aggregation rules of §1.410(b)-7(d), an employer
may not aggregate plans (within the meaning of §1.410(b)-7(b)) that
apply inconsistent testing methods. For example, a plan (within the
meaning of §1.410(b)-7) that applies the current year testing method may
not be aggregated with another plan that applies the prior year testing
method. Similarly, an employer may not aggregate a plan (within the
meaning of §1.410(b)-7) that is using the ACP safe harbor provisions of
section 401(m)(11) and another plan that is using the ACP test of
section 401(m)(2).

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

\(B\) [Restructuring prohibited]{.underline}. Restructuring under
§1.401(a)(4)-9(c) may not be used to demonstrate compliance with the
requirements of section 401(m). See §1.401(a)(4)-9(c)(3)(ii).

\(v\) [Certain disaggregation rules not applicable]{.underline}. The
mandatory disaggregation rules relating to section 401(k) plans and
section 401(m) plans set forth in §1.410(b)-7(c)(1) and to ESOP and
non-ESOP portions of a plan set forth in §1.410(b)-7(c)(2) shall not
apply for purposes of this section and §§1.401(m)-2 through 1.401(m)-5.
Accordingly, notwithstanding §1.410(b)-7(d)(2), an ESOP and a non-ESOP
which are different plans (within the meaning of §1.410(b)-7(b)) are
permitted to be aggregated for these purposes.

\(c\) [Additional requirements]{.underline}\--(1) [Separate testing for
employee contributions and matching contributions]{.underline}. Under
§1.410(b)-7(c)(1), the group of employees who are eligible to make
employee contributions or eligible to receive matching contributions
must satisfy the requirements of section 410(b) as if those employees
were covered under a separate plan. The determination of whether the
separate plan satisfies the requirements of section 410(b) must be made
without regard to the modifications to the disaggregation rules set
forth in paragraph (b)(4)(v) of this section. In addition, except as
expressly permitted under section 401(k), 410(b)(2)(A)(ii), or
416(c)(2)(A), employee contributions, matching contributions and
elective contributions taken into account under §1.401(m)-2(a)(6) may
not be taken into account for purposes of determining whether any other
contributions under any plan (including the plan to which the employee
contributions or matching contributions are made) satisfy the
requirements of section 401(a). See also §1.401(a)(4)‑11(g)(3)(vii) for
special rules relating to corrections of violations of the minimum
coverage requirements or discriminatory rates of matching contributions.

\(2\) [Plan provision requirement]{.underline}. A plan that provides for
employee contributions or matching contributions satisfies this section
only if it provides that the nondiscrimination requirements of section
401(m) will be met. Thus, the plan must provide for satisfaction of one
of the specific alternatives described in paragraph (b)(1) of this
section and, if with respect to that alternative there are optional
choices, which of the optional choices will apply. For example, a plan
that uses the ACP test of section 401(m)(2), as described in paragraph
(b)(1)(i) of this section, must specify whether it is using the current
year testing method or prior year testing method. Additionally, a plan
that uses the prior year testing method must specify whether the ACP for
eligible NHCEs for the first plan year is 3% or the ACP for the eligible
NHCEs for the first plan year. Similarly, a plan that uses the safe
harbor method of section 401(m)(11), as described in paragraph
(b)(1)(ii) of this section, must specify whether the safe harbor
contribution will be the nonelective safe harbor contribution or the
matching safe harbor contribution and is not permitted to provide that
ACP testing will be used if the requirements for the safe harbor are not
satisfied. For purposes of this paragraph (c)(2), a plan may incorporate
by reference the provisions of section 401(m)(2) and §1.401(m)-2 if that
is the nondiscrimination test being applied.

\(d\) [Effective date]{.underline}. This section and §§1.401(m)-2
through 1.401(m)-5 apply to plan years that begin on or after the date
that is 12 months after the issuance of these regulations in final form.

[§1.401(m)-2 ACP test]{.underline}.

\(a\) [Actual contribution percentage (ACP) test]{.underline}\--(1) [In
general]{.underline}\--(i) [ACP test formula]{.underline}. A plan
satisfies the ACP test for a plan year only if\--

\(A\) The ACP for the eligible HCEs for the plan year is not more than
the ACP for the eligible NHCEs for the applicable year multiplied by
1.25; or

\(B\) The excess of the ACP for the eligible HCEs for the plan year over
the ACP for the eligible NHCEs for the applicable year is not more than
2 percentage points, and the ACP for the eligible HCEs for the plan year
is not more than the ACP for the eligible NHCEs for the applicable year
multiplied by 2.

\(ii\) [HCEs as sole eligible employees]{.underline}. If, for the
applicable year there are no eligible NHCEs (i.e., all of the eligible
employees under the plan for the applicable year are HCEs), the plan is
deemed to satisfy the ACP test.

\(iii\) [Special rule for early participation]{.underline}. If a plan
providing for employee contributions or matching contributions provides
that employees are eligible to participate before they have completed
the minimum age and service requirements of section 410(a)(1)(A), and if
the plan applies section 410(b)(4)(B) in determining whether the plan
meets the requirements of section 410(b)(1), then in determining whether
the plan meets the requirements under paragraph (a)(1) of this section
either\--

\(A\) Pursuant to section 401(m)(5)(C), the ACP test is performed under
the plan (determined without regard to disaggregation under
§1.410(b)-7(c)(3)), using the ACP for all eligible HCEs for the plan
year and the ACP of eligible NHCEs for the applicable year, disregarding
all NHCEs who have not met the minimum age and service requirements of
section 410(a)(1)(A); or

\(B\) Pursuant to §1.401(m)-1(b)(4), the plan is disaggregated into
separate plans and the ACP test is performed separately for all eligible
employees who have completed the minimum age and service requirements of
section 410(a)(1)(A) and for all eligible employees who have not
completed the minimum age and service requirements of section
410(a)(1)(A).

\(2\) [Determination of ACP]{.underline}\--(i) [General
rule]{.underline}. The ACP for a group of eligible employees (either
eligible HCEs or eligible NHCEs) for a plan year or applicable year is
the average of the ACRs of eligible employees in the group for that
year. The ACP for a group of eligible employees is calculated to the
nearest hundredth of a percentage point.

\(ii\) [Determination of applicable year under current year and prior
year testing method]{.underline}. The ACP test is applied using the
prior year testing method or the current year testing method. Under the
prior year testing method, the applicable year for determining the ACP
for the eligible NHCEs is the plan year immediately preceding the plan
year for which the ACP test is being calculated. Under the prior year
testing method, the ACP for the eligible NHCEs is determined using the
ACRs for the eligible employees who were NHCEs in that preceding plan
year, regardless of whether those NHCEs are eligible employees or NHCEs
in the plan year for which the ACP test is being performed. Under the
current year testing method, the applicable year for determining the ACP
for eligible NHCEs is the same plan year as the plan year for which the
ACP test is being calculated. Under either method, the ACP for the
eligible HCEs is the determined using the ACRs of eligible employees who
are HCEs for the plan year for which the ACP test is being performed.
See paragraph (c) of this section for additional rules for the prior
year testing method.

\(3\) [Determination of ACR]{.underline}\--(i) [General
rule]{.underline}. The ACR of an eligible employee for the plan year or
applicable year is the sum of the employee contributions and matching
contributions taken into account with respect to such employee
(determined under the rules of paragraphs (a)(4) and (a)(5) of this
section), and the qualified nonelective and elective contributions taken
into account under paragraph (a)(6) of this section for the year,
divided by the employee's compensation taken into account for the year.
The ACR is calculated to the nearest hundredth of a percentage point. If
no employee contributions, matching contributions, elective
contributions, or qualified nonelective contributions are taken into
account under this section with respect to an eligible employee for the
year, the ACR of the employee is zero.

\(ii\) [ACR of HCEs eligible under more than one plan]{.underline}\--(A)
[General rule]{.underline}. Pursuant to section 401(m)(2)(B), the ACR of
an HCE who is an eligible employee in more than one plan of an employer
to which matching contributions or employee contributions are made is
calculated by treating all contributions with respect to such HCE under
any such plan as being made under the plan being tested. Thus, the ACR
for such an HCE is calculated by accumulating all matching contributions
and employee contributions under any plan (other than a plan described
in paragraph (a)(3)(ii)(B) of this section) that would be taken into
account under this section for the plan year, if the plan under which
the contribution was made applied this section and had the same plan
year. For example, in the case of a plan with a 12-month plan year, the
ACR for the plan year of that plan for an HCE who participates in
multiple plans of the same employer that provide for matching
contributions or employee contributions is the sum of all such
contributions during such 12-month period that would be taken into
account with respect to the HCE under all plans in which the HCE is an
eligible employee, divided by the HCE's compensation for that 12-month
period (determined using the compensation definition for the plan being
tested), without regard to the plan year of the other plans and whether
those plans are satisfying this section or §1.401(m)-3.

\(B\) [Plans not permitted to be aggregated]{.underline}. Contributions
under plans that are not permitted to be aggregated under
§1.401(m)‑1(b)(4) (determined without regard to the prohibition on
aggregating plans with inconsistent testing methods set forth in
§1.401(m)-1(b)(4)(iii)(B) and the prohibition on aggregating plans with
different plan years set forth in §1.410(b)-7(d)(5)) are not aggregated
under this paragraph (a)(3)(ii).

\(iii\) [Example]{.underline}. The following example illustrates the
application of paragraph (a)(3)(ii) of this section. See also
§1.401(k)-2(a)(3)(iii) for additional examples of the application of the
parallel rule under section 401(k)(3)(A). The example is as follows:

[Example]{.underline}. Employee A, an HCE with compensation of
\$120,000, is eligible to make employee contributions under Plan S and
Plan T, two calendar-year profit-sharing plans of Employer H. Plan S and
Plan T use the same definition of compensation. Plan S provides a match
equal to 50% of each employee's contributions and Plan T has no match.
During the current plan year, Employee A elects to contribute \$4,000 in
employee contributions to Plan T and \$4,000 in employee contributions
to Plan S. There are no other contributions made on behalf of Employee
A. Each plan must calculate Employee A's ACR by dividing the total
employee contributions by Employee A and matching contributions under
both plans by \$120,000. Therefore, Employee A's ACR under each plan is
8.33% (\$4,000+ \$4,000+ \$2,000/\$120,000).

\(4\) [Employee contributions and matching contributions taken into
account under the ACP test]{.underline}\--(i) [Employee
contributions]{.underline}. An employee contribution is taken into
account in determining the ACR for an eligible employee for the plan
year or applicable year in which the contribution is made. For purposes
of the preceding sentence, an amount withheld from an employee's pay (or
a payment by the employee to an agent of the plan) is treated as
contributed at the time of such withholding (or payment) if the funds
paid are transmitted to the trust within a reasonable period after the
withholding (or payment).

\(ii\) [Recharacterized elective contributions]{.underline}. Excess
contributions recharacterized in accordance with §1.401(k)-2(b)(3) are
taken into account as employee contributions for the plan year that
includes the time at which the excess contribution is includible in the
gross income of the employee under §1.401(k)-2(b)(3)(ii)(A).

\(iii\) [Matching contributions]{.underline}. A matching contribution is
taken into account in determining the ACR for an eligible employee for a
plan year or applicable year only if each of the following requirements
is satisfied\--

\(A\) The matching contribution is allocated to the employee's account
under the terms of the plan as of a date within that year;

\(B\) The matching contribution is made on account of (or the matching
contribution is allocated on the basis of) the employee's elective
deferrals or employee contributions for that year; and

\(C\) The matching contribution is actually paid to the trust no later
than the end of the 12-month period immediately following the year that
contains that date.

\(5\) [Matching contributions not taken into account under the ACP
test]{.underline}\--(i) [General rule]{.underline}. Matching
contributions that do not satisfy the requirements of paragraph
(a)(4)(iii) of this section may not be taken into account in the ACP
test for the plan year with respect to which the contributions were
made, or for any other plan year. Instead, the amount of the matching
contributions must satisfy the requirements of section 401(a)(4)
(without regard to the ACP test) for the plan year for which they are
allocated under the plan as if they were nonelective contributions and
were the only nonelective contributions for that year. See
§§1.401(a)(4)‑1(b)(2)(ii)(B) and 1.410(b)‑7(c)(1).

\(ii\) [Disproportionate matching contributions]{.underline}\--(A)
[Matching contributions in excess of 100%]{.underline}. A matching
contribution with respect to any employee contribution or elective
deferral for an NHCE is not taken into account under the ACP test to the
extent the matching rate with respect to the employee contribution or
elective deferral exceeds the greater of 100% and 2 times the plan's
representative matching rate.

\(B\) [Representative matching rate]{.underline}. For purposes of this
paragraph (a)(5)(ii), the plan's representative matching rate is the
lowest matching rate for any eligible NHCE among a group of NHCEs that
consists of half of all eligible NHCEs in the plan for the plan year who
make elective deferrals or employee contributions for the plan year (or,
if greater, the lowest matching rate for all eligible NHCEs in the plan
who are employed by the employer on the last day of the plan year and
who make elective deferrals or employee contributions for the plan
year).

\(C\) [Definition of matching rate]{.underline}. For purposes of this
paragraph (a)(5)(ii), the matching rate for an employee is the matching
contributions made for such employee divided by the elective deferrals
or employee contributions that are being matched.

\(iii\) [Qualified matching contributions used to satisfy the ADP
test]{.underline}. Qualified matching contributions that are taken into
account for the ADP test of section 401(k)(3) under §1.401(k)-2(a)(6)
are not taken into account in determining an eligible employee's ACR.

\(iv\) [Matching contributions taken into account under safe harbor
provisions]{.underline}. A plan that satisfies the ACP safe harbor
requirements of section 401(m)(11) for a plan year but nonetheless must
satisfy the requirements of this section because it provides for
employee contributions for such plan year is permitted to apply this
section disregarding all matching contributions with respect to all
eligible employees. In addition, a plan that satisfies the ADP safe
harbor requirements of §1.401(k)-3 for a plan year using qualified
matching contributions but does not satisfy the ACP safe harbor
requirements of section 401(m)(11) for such plan year is permitted to
apply this section by excluding matching contributions with respect to
all eligible employees that do not exceed 4% of each employee's
compensation. If a plan disregards matching contributions pursuant to
this paragraph (a)(5)(iv), the disregard must apply with respect to all
eligible employees.

\(v\) [Treatment of forfeited matching contributions]{.underline}. A
matching contribution that is forfeited because the contribution to
which it relates is treated as an excess contribution, excess deferral,
or excess aggregate contribution is not taken into account for purposes
of this section.

\(6\) [Qualified nonelective contributions and elective contributions
that may be taken into account under the ACP test]{.underline}.
Qualified nonelective contributions and elective contributions may be
taken into account in determining the ACR for an eligible employee for a
plan year or applicable year, but only to the extent the contributions
satisfy the following requirements\--

\(i\) [Timing of allocation]{.underline}. The qualified nonelective
contribution is allocated to the employee's account as of a date within
that year (within the meaning of §1.401(k)-2(a)(4)(i)(A)) and the
elective contribution satisfies §1.401(k)-2(a)(4)(i). Consequently,
under the prior year testing method, in order to be taken into account
in calculating the ACP for the group of eligible NHCEs for the
applicable year, a qualified nonelective contribution must be
contributed no later than the end of the 12-month period following the
applicable year even though the applicable year is different than the
plan year being tested.

\(ii\) [Elective contributions taken into account under the ACP
test]{.underline}. Elective contributions may be taken into account for
the ACP test only if the cash or deferred arrangement under which the
elective contributions are made is required to satisfy the ADP test in
§1.401(k)-2(a)(1) and, then only to the extent that the cash or deferred
arrangement would satisfy that test, including such elective
contributions in the ADP for the plan year or applicable year. Thus, for
example, elective deferrals made pursuant to a salary reduction
agreement under an annuity described in section 403(b) are not permitted
to be taken into account in an ACP test. Similarly, elective
contributions under a cash or deferred arrangement that is using the
section 401(k) safe harbor described in §1.401(k)-3 can not be taken
into account in an ACP test.

\(iii\) [Requirement that amount satisfy section 401(a)(4)]{.underline}.
The amount of nonelective contributions, including those qualified
nonelective contributions taken into account under this paragraph (a)(6)
and those qualified nonelective contributions taken into account for the
ADP test under paragraph §1.401(k)-2(a)(6), and the amount of
nonelective contributions, excluding those qualified nonelective
contributions taken into account under this paragraph (a)(6) for the ACP
test and those qualified nonelective contributions taken into account
for the ADP test under paragraph §1.401(k)-2(a)(6), satisfies the
requirements of section 401(a)(4). See §1.401(a)(4)-1(b)(2). In the case
of an employer that is applying the special rule for employer-wide plans
in §1.414(r)-1(c)(2)(ii) with respect to the plan, the determination of
whether the qualified nonelective contributions satisfy the requirements
of this paragraph (a)(6)(iii) must be made on an employer-wide basis
regardless of whether the plans to which the qualified nonelective
contributions are made are satisfying the requirements of section 410(b)
on an employer-wide basis. Conversely, in the case of an employer that
is treated as operating qualified separate lines of business, and does
not apply the special rule for employer-wide plans in
§1.414(r)-1(c)(2)(ii) with respect to the plan, then the determination
of whether the qualified nonelective contributions satisfy the
requirements of this paragraph (a)(6)(iii) is not permitted to be made
on an employer-wide basis regardless of whether the plans to which the
qualified nonelective contributions are made are satisfying the
requirements of section 410(b) on that basis.

\(iv\) [Aggregation must be permitted]{.underline}. The plan that
provides for employee or matching contributions and the plan or plans to
which the qualified nonelective contributions or elective contributions
are made are plans that would be permitted to be aggregated under
§1.401(m)‑1(b)(4). If the plan year of the plan that provides for
employee or matching contributions is changed to satisfy the requirement
under §1.410(b)-7(d)(5) that aggregated plans have the same plan year,
qualified nonelective contributions and elective contributions may be
taken into account in the resulting short plan year only if such
qualified nonelective and elective contributions could have been taken
into account under an ADP test for a plan with that same short plan
year.

\(v\) [Disproportionate contributions not taken into
account]{.underline}\--(A) [General rule]{.underline}. Qualified
nonelective contributions cannot be taken into account for an applicable
year for an NHCE to the extent such contributions exceed the product
that NHCE's compensation and the greater of 5% and 2 times the plan\'s
representative contribution rate. Any qualified nonelective contribution
taken into account in an ADP test under §1.401(k)-2(a)(6) (including the
determination of the representative contribution rate for purposes of
§1.401(k)-2(a)(6)(iv)(B)) is not permitted to be taken into account for
purposes of this paragraph (a)(6) (including the determination of the
representative contribution rate for purposes of paragraph (a)(6)(v)(B)
of this section).

\(B\) [Definition of representative contribution rate]{.underline}. For
purposes of this paragraph (a)(6)(v), the plan\'s representative
contribution rate is the lowest applicable contribution rate of any
eligible NHCE among a group of eligible NHCEs that consists of half of
all eligible NHCEs for the plan year (or, if greater, the lowest
applicable contribution rate of any eligible NHCE in the group of all
eligible NHCEs for the applicable year and who is employed by the
employer on the last day of the applicable year).

\(C\) [Definition of applicable contribution rate]{.underline}. For
purposes of this paragraph (a)(6)(v), the applicable contribution rate
for an eligible NHCE is the sum of the matching contributions taken into
account under this section for the employee for the plan year and the
qualified nonelective contributions made for that employee for the plan
year, divided by that employee\'s compensation for the same period.

\(vi\) [Contribution only used once]{.underline}. Qualified nonelective
contributions can not be taken into account under this paragraph (a)(6)
to the extent such contributions are taken into account for purposes of
satisfying any other ACP test, any ADP test, or the requirements of
§1.401(k)-3, 1.401(m)-3 or 1.401(k)-4. Thus, for example, qualified
nonelective contributions that are made pursuant to §1.401(k)-3(b)
cannot be taken into account under the ACP test. Similarly, if a plan
switches from the current year testing method to the prior year testing
method pursuant to §1.401(m)-2(c)(1), qualified nonelective
contributions that are taken into account under the current year testing
method for a plan year may not be taken into account under the prior
year testing method for the next plan year.

\(7\) [Examples]{.underline}. The following examples illustrate the
application of this paragraph (a). See §1.401(k)-2(a)(6) for additional
examples of the parallel rules under section 401(k)(3)(A). The examples
are as follows:

[Example 1]{.underline}. (i) Employer L maintains Plan U, a
profit-sharing plan under which \$.50 matching contributions are made
for each dollar of employee contributions. Plan U uses the current year
testing method. The chart below shows the average employee contributions
(as a percentage of compensation) and matching contributions (as a
percentage of compensation) for Plan U's highly compensated employees
and nonhighly compensated employees for the 2006 plan year:

  --------------------- --------------- ----------------- ------------------
                        Employee        Matching          Actual
                        Contributions   Contributions     Contribution
                                                          Percentage

  Highly compensated    4%              2%                6%
  employees                                               

  Nonhighly compensated 3%              1.5%              4.5%
  employees                                               
  --------------------- --------------- ----------------- ------------------

\(ii\) The matching rate for all NHCEs is 50% and thus the matching
contributions are not disproportionate under paragraph (a)(5)(ii) of
this section. Accordingly, they are taken into account in determining
the ACR of eligible employees, as shown in the following table.

\(iii\) Because the ACP for the HCEs (6.0%) exceeds 5.63% (4.5% x 1.25),
Plan U does not satisfy the ACP test under paragraph (a)(1)(i)(A) of
this section. However, because the ACP for the HCEs does not exceed the
ACP for the NHCEs by more than 2 percentage points and the ACP for the
HCEs does not exceed the ACP for the NHCEs multiplied by 2 (4.5% x 2 =
9%), the plan satisfies the ACP test under paragraph (a)(1)(i)(B) of
this section.

[Example 2]{.underline}. (i) Employees A through F are eligible
employees in Plan V, a profit-sharing plan of Employer M that includes a
cash or deferred arrangement and permits employee contributions. Under
Plan V, a \$.50 matching contribution is made for each dollar of
elective contributions and employee contributions. Plan V uses the
current year testing method and does not provide for elective
contributions to be taken into account in determining an eligible
employee's ACR. For the 2006 plan year, Employees A and B are HCEs and
the remaining employees are NHCEs. The compensation, elective
contributions, employee contributions, and matching contributions for
the 2006 plan year are shown in the following table:

  ----------- --------------- --------------- --------------- ---------------
  Employee    Compensation    Elective        Employee        Matching
                              Contributions   Contributions   Contributions

  A           \$190,000       \$15,000        \$3,500         \$9,250

  B           100,000         \$ 5,000        \$10,000        \$7,500

  C           85,000          \$12,000        \$ 0            \$6,000

  D           70,000          \$ 9,500        \$ 0            \$4,750

  E           40,000          \$ 10,000       \$ 0            \$5,000

  F           10,000          \$ 0            \$ 0            \$ 0
  ----------- --------------- --------------- --------------- ---------------

\(ii\) The matching rate for all NHCEs is 50% and thus the matching
contributions are not disproportionate under paragraph (a)(5)(ii) of
this section. Accordingly, they are taken into account in determining
the ACR of eligible employees, as shown in the following table:

  ------------ ---------------- ---------------- --------------- ---------
  Employee     Compensation     Employee         Matching        ACR %
                                Contributions    Contributions   

  A            \$190,000        \$3,500          \$9,250         6.71

  B            100,000          \$10,000         \$7,500         17.50

  C            85,000           \$ 0             \$6,000         7.06

  D            70,000           \$ 0             \$4,750         6.79

  E            40,000           \$ 0             \$ 5,000        12.50

  F            10,000           \$ 0             \$ 0            0
  ------------ ---------------- ---------------- --------------- ---------

\(iii\) The ACP for the HCEs is 12.11% ((6.71% + 17.50%)/2). The ACP for
the NHCEs is 6.59% ((7.06% + 6.79% + 12.50% + 0.%)/4). Plan V fails to
satisfy the ACP test under paragraph (a)(1)(i)(A) of this section
because the ACP of highly compensated employees is more than 125% of the
ACP of the nonhighly compensated employees (6.59% 1.25 = 8.24%). In
addition, Plan V fails to satisfy the ACP test under paragraph
(a)(1)(i)(B) of this section because the ACP for the HCEs exceeds the
ACP of the other employees by more than 2 percentage points (6.59% + 2%
= 8.59%). Therefore, the plan fails to satisfy the requirements of
section 401(m)(2) and paragraph (a)(1) of this section unless the ACP
failure is corrected under paragraph (b) of this section.

[Example 3]{.underline}. (i) The facts are the same as [Example
2]{.underline}, except that the plan provides that the nonhighly
compensated employees' elective contributions may be used to meet the
requirements of section 401(m) to the extent needed under that section.

\(ii\) Pursuant to paragraph (a)(6)(ii) of this section, the \$10,000 of
elective contributions for Employee E may be taken into account in
determining the ACP rather than the ADP to the extent that the plan
satisfies the requirements of §1.401(k)-2(a)(1) excluding from the ADP
this \$10,000. In this case, if the \$10,000 were excluded from the ADP
for the NHCEs, the ADP for the highly compensated employees is 6.45%
(7.89% + 5.00%) /2 and the ADP for the nonhighly compensated employees
would be 6.92% (14.12% + 13.57% + 0% +0%)/4) and the plan would satisfy
the requirements of §1.401(k)-2(a)(1) excluding from the ADP the
elective contributions for NHCEs that are taken into account under
section 401(m).

\(iii\) After taking into account the \$10,000 of elective contributions
for Employee E in the ACP test, the ACP for the nonhighly compensated
employees is 12.84% (7.06% + 6.79% + 37.50 % + 0%) /4. Therefore the
plan satisfies the ACP test because the ACP for the HCEs (12.11%) is
less than 1.25 times the ACP for the nonhighly compensated employees.

[Example 4]{.underline}. (i) The facts are the same as [Example
2]{.underline}, except that Plan V provides for a higher than 50% match
rate on the elective contributions and employee contributions for all
NHCEs. The match rate is defined as the rate, rounded up to the next
whole percent, necessary to allow the plan to satisfy the ACP test, but
not in excess of 100%. In this case, an increase in the match rate from
50% to 74% will be sufficient to allow the plan to satisfy the ACP test.
Thus, for the 2006 plan year, the compensation, elective contributions,
employee contributions, matching contributions at a 74% match rate of
the eligible NHCEs (employees C through F) are shown in the following
table:

  ----------- --------------- --------------- --------------- ---------------
  Employee    Compensation    Elective        Employee        Matching
                              Contributions   Contributions   Contributions

  C           \$ 85,000       \$ 12,000       \$ 0            \$ 8,880

  D           70,000          \$ 9,500        \$ 0            \$ 7,030

  E           40,000          \$ 10,000       \$ 0            \$ 7,400

  F           10,000          \$ 0            \$ 0            \$ 0
  ----------- --------------- --------------- --------------- ---------------

\(ii\) The matching rate for all NHCEs is 74% and thus the matching
contributions are not disproportionate under paragraph (a)(5)(ii) of
this section. Therefore, the matching contributions may be taken into
account in determining the ACP for the NHCEs.

\(iii\) The ACP for the NHCEs is 9.75% (10.45% + 10.04% + 18.50% +
0%)/4. Because the ACP for the HCEs (12.11%) is less than 1.25 times the
ACP for the NHCEs, the plan satisfies the requirements of section
401(m).

[Example 5]{.underline}. (i) The facts are the same as [Example
4]{.underline}, except that: Employee E's elective contributions are
\$2,000 (rather than \$10,000) and pursuant to paragraph (a)(6)(ii) of
this section, the \$2,000 of elective contributions for Employee E are
taken into account in determining the ACP rather than the ADP. In
addition, Plan V provides that the higher match rate is not limited to
100% and applies only for a specified group of nonhighly compensated
employees. The only member of that group is Employee E. Under the plan
provision, the higher match rate is a 400% match. Thus, for the 2006
plan year, the compensation, elective contributions, employee
contributions, matching contributions of the eligible NHCEs (employees C
through F) are shown in the following table:

  ----------- --------------- --------------- --------------- ---------------
  Employee    Compensation    Elective        Employee        Matching
                              Contributions   Contributions   Contributions

  C           \$ 85,000       \$12,000        \$ 0            \$6,000

  D           70,000          \$ 9,500        \$ 0            \$4,750

  E           40,000          \$ 2,000        \$ 0            \$8,000

  F           10,000          \$ 0            \$ 0            \$ 0
  ----------- --------------- --------------- --------------- ---------------

\(ii\) If the entire matching contribution made on behalf of Employee E
were taken into account under the ACP test, Plan V would satisfy the
test, because the ACP for the NHCEs would be 9.71% (7.06% + 6.79% +
25.00% + 0%)/4. Because the ACP for the HCEs (12.11%) is less than 1.25
times what the ACP for the NHCEs would be, the plan would satisfy the
requirements of section 401(m).

\(iii\) Pursuant to paragraph (a)(5)(ii) of this section, however,
matching contributions for an eligible NHCE that are based on a matching
rate in excess of the greater of 100% and twice the plan's
representative matching rate cannot be taken into account in applying
the ACP test. The plan's representative matching rate is the lowest
matching rate for any eligible employee in a group of NHCEs that is at
least half of all eligible employees who are NHCEs in the plan for the
plan year who make elective contributions or employee contributions for
the plan year. For Plan V, the group of NHCEs who make such
contributions consists of Employees C, D and E. The matching rates for
these three employees are 50%, 50% and 400% respectively. The lowest
matching rate for a group of NHCEs that is at least ½ of all the NHCEs
who make elective contributions or employee contributions (or 2 NHCEs)
is 50%. Because 400% is more than twice the plan's representative
matching rate, only the matching contributions made on behalf of
Employee E that do not exceed 100% (or in this case \$2,000) satisfy the
requirements of paragraph (a)(5)(ii) of this section and may be taken
into account under the ACP test. Accordingly, the ACP for the NHCEs is
5.96% (7.06% + 6.79% + 10% + 0%)/4 and the plan fails to satisfy the
requirements of section 401(m)(2) and paragraph (a)(1) of this section
unless the ACP failure is corrected under paragraph (b) of this section.

[Example 6]{.underline}. (i) The facts are the same as [Example
2]{.underline}, except that Plan V provides a QNEC equal to 13% of pay
for Employee F that will be taken into account under the ACP test to the
extent the contributions satisfy the requirements of paragraph (a)(6) of
this section.

\(ii\) Pursuant to paragraph (a)(6)(v) of this section, a QNEC cannot be
taken into account in determining an NHCE's ACR to the extent it exceeds
the greater of 5% and the product of the employee's compensation and the
plan's representative contribution rate. The plan's representative
contribution rate is two times the lowest applicable contribution rate
for any eligible employee in a group of NHCEs that is at least half of
all eligible employees who are NHCEs in the plan for the plan year. For
Plan V, the applicable contribution rates for Employees C, D, E and F
are 7.06%, 6.79%, 12.5% and 13% respectively. The lowest applicable rate
for a group of NHCEs that is at least ½ of all the NHCEs is 12.50% (the
lowest applicable rate for the group of NHCEs that consists of Employees
E and F).

\(iii\) Under paragraph (a)(6)(v)(B) of this section, the plan's
representative contribution rate is 2 times 12.50% or 25.00%.
Accordingly, the QNECs for Employee F can be taken into account under
the ACP test only to the extent they do not exceed 25.00% of
compensation. In this case, all of the QNECs for Employee F may be taken
into account under the ACP test.

\(iv\) After taking into account the QNECs for Employee F, the ACP for
the NHCEs is 9.84% (7.06% + 6.79% + 12.50% + 13%)/4. Because the ACP for
the HCEs (12.11%) is less than 1.25 times the ACP for the NHCEs, the
plan satisfies the requirements of section 401(m)(2) and paragraph
(a)(1) of this section.

\(b\) [Correction of excess aggregate contributions]{.underline}\--(1)
[Permissible correction methods]{.underline}\--(i) [In
general]{.underline}. A plan that provides for employee contributions or
matching contributions does not fail to satisfy the requirements of
section 401(m)(2) and paragraph (a)(1) of this section if the employer,
in accordance with the terms of the plan, uses either of the following
correction methods\--

\(A\) [Additional contributions]{.underline}. The employer makes
additional contributions that are taken into account for the ACP test
under this section that, in combination with the other contributions
taken into account under this section, allow the plan to satisfy the
requirements of paragraph (a)(1) of this section.

\(B\) [Excess aggregate contributions distributed or
forfeited]{.underline}. Excess aggregate contributions are distributed
or forfeited in accordance with paragraph (b)(2) of this section.

\(ii\) [Combination of correction methods]{.underline}. A plan may
provide for the use of either of the correction methods described in
paragraph (b)(1)(i) of this section, may limit employee contributions or
matching contributions in a manner that prevents excess aggregate
contributions from being made, or may use a combination of these
methods, to avoid or correct excess aggregate contributions. If a plan
uses a combination of correction methods, any contributions made under
paragraph (b)(1)(i)(A) of this section must be taken into account before
application of the correction method in paragraph (b)(1)(i)(B) of this
section.

\(iii\) [Exclusive means of correction]{.underline}. A failure to
satisfy the requirements of paragraph (a)(1) of this section may not be
corrected using any method other than one described in paragraph
(b)(1)(i) or (ii) of this section. Thus, excess aggregate contributions
for a plan year may not be corrected by forfeiting vested matching
contributions, distributing nonvested matching contributions,
recharacterizing matching contributions, or not making matching
contributions required under the terms of the plan. Similarly, excess
aggregate contributions for a plan year may not remain unallocated or be
allocated to a suspense account for allocation to one or more employees
in any future year. In addition, excess aggregate contributions may not
be corrected using the retroactive correction rules of
§1.401(a)(4)‑11(g). See §1.401(a)(4)‑11(g)(3)(vii) and (5).

\(2\) [Correction through distribution]{.underline}\--(i) [General
rule]{.underline}. This paragraph (b)(2) contains the rules for
correction of excess aggregate contributions through a distribution from
the plan. Correction through a distribution generally involves a four
step process. First, the plan must determine, in accordance with
paragraph (b)(2)(ii) of this section, the total amount of excess
aggregate contributions that must be distributed under the plan. Second,
the plan must apportion the total amount of excess aggregate
contributions among the HCEs in accordance with paragraph (b)(2)(iii) of
this section. Third, the plan must determine the income allocable to
excess aggregate contributions in accordance with paragraph (b)(2)(iv)
of this section. Finally, the plan must distribute the apportioned
contributions, together with allocable income (or forfeit the
apportioned matching contributions, if forfeitable) in accordance with
paragraph (b)(2)(v) of this section. Paragraph (b)(2)(vi) of this
section provides rules relating to the tax treatment of these
distributions.

\(ii\) [Calculation of total amount to be distributed]{.underline}. The
following procedures must be used to determine the total amount of the
excess aggregate contributions to be

distributed\--

\(A\) [Calculate the dollar amount of excess aggregate contributions for
each HCE]{.underline}. The amount of excess aggregate contributions
attributable to an HCE for a plan year is the amount (if any) by which
the HCE's contributions taken into account under this section must be
reduced for the HCE's ACR to equal the highest permitted ACR under the
plan. To calculate the highest permitted ACR under a plan, the ACR of
the HCE with the highest ACR is reduced by the amount required to cause
that HCE's ACR to equal the ACR of the HCE with the next highest ACR. If
a lesser reduction would enable the plan to satisfy the requirements of
paragraph (b)(2)(ii)(C) of this section, only this lesser reduction
applies.

\(B\) [Determination of the total amount of excess aggregate
contributions]{.underline}. The process described in paragraph
(b)(2)(ii)(A) of this section must be repeated until the plan would
satisfy the requirements of paragraph (b)(2)(ii)(C) of this section. The
sum of all reductions for all HCEs determined under paragraph
(b)(2)(ii)(A) of this section is the total amount of excess aggregate
contributions for the plan year.

\(C\) [Satisfaction of ACP]{.underline}. A plan satisfies this paragraph
(b)(2)(ii)(C) if the plan would satisfy the requirements of paragraph
(a)(1)(i) of this section if the ACR for each HCE were determined after
the reductions described in paragraph (b)(2)(ii)(A) of this section.

\(iii\) [Apportionment of total amount of excess aggregate contributions
among the HCEs]{.underline}. The following procedures must be used in
apportioning the total amount of excess aggregate contributions
determined under paragraph (b)(2)(ii) of this section among the HCEs\--

\(A\) [Calculate the dollar amount of excess aggregate contributions for
each HCE]{.underline}. The contributions with respect to the HCE with
the highest dollar amount of contributions taken account under this
section are reduced by the amount required to cause that HCE's
contributions to equal the dollar amount of contributions taken into
account under this section for the HCE with the next highest dollar
amount of such contributions. If a lesser apportionment to the HCE would
enable the plan to apportion the total amount of excess aggregate
contributions, only the lesser apportionment would apply.

\(B\) [Limit on amount apportioned to any HCE]{.underline}. For purposes
of this paragraph (b)(2)(iii), the contributions for an HCE who is an
eligible employee in more than one plan of an employer to which matching
contributions and employee contributions are made is determined by
adding together all contributions otherwise taken into account in
determining the ACR of the HCE under the rules of paragraph (a)(3)(ii)
of this section. However, the amount of contributions apportioned with
respect to an HCE must not exceed the amount of contributions taken into
account under this section that were actually made on behalf of the HCE
to the plan for the plan year. Thus, in the case of an HCE who is an
eligible employee in more than one plan of the same employer to which
employee contributions or matching contributions are made and whose ACR
is calculated in accordance with paragraph (a)(3)(ii) of this section,
the amount distributed under this paragraph (b)(2)(iii) will not exceed
such contributions actually contributed to the plan for the plan year
that are taken into account under this section for the plan year.

\(C\) [Apportionment to additional HCEs]{.underline}. The procedure in
paragraph (b)(2)(iii)(A) of this section must be repeated until the
total amount of excess aggregate contributions have been apportioned.

\(iv\) [Income allocable to excess aggregate
contributions]{.underline}\--(A) [General rule]{.underline}. The income
allocable to excess aggregate contributions is equal to the sum of the
allocable gain or loss for the plan year and, to the extent the excess
aggregate contributions are or will be credited with allocable gain or
loss for the period after the close of the plan year (the gap period),
the allocable gain or loss for the gap period.

\(B\) [Method of allocating income]{.underline}. A plan may use any
reasonable method for computing the income allocable to excess aggregate
contributions, provided that the method does not violate section
401(a)(4), is used consistently for all participants and for all
corrective distributions under the plan for the plan year, and is used
by the plan for allocating income to participants' accounts. See
§1.401(a)(4)‑1(c)(8).

\(C\) [Alternative method of allocating income for the plan
year]{.underline}. A plan may allocate income to excess aggregate
contributions for the plan year by multiplying the income for the plan
year allocable to employee contributions, matching contributions and
other amounts taken into account under this section (including the
contributions for the year), by a fraction, the numerator of which is
the excess aggregate contributions for the employee for the plan year,
and the denominator of which is the account balance attributable to
employee contributions and matching contributions and other amounts
taken into account under this section as of the beginning of the plan
year (including any additional such contributions for the plan year).

\(D\) [Safe harbor method of allocating gap period income]{.underline}.
A plan may use the safe harbor method in this paragraph (b)(2)(iv)(D) to
determine income on excess aggregate contributions for the gap period.
Under this safe harbor method, income on excess aggregate contributions
for the gap period is equal to 10% of the income allocable to excess
aggregate contributions for the plan year that would be determined under
paragraph (b)(2)(iv)(C) of this section, multiplied by the number of
calendar months that have elapsed since the end of the plan year. For
purposes of calculating the number of calendar months that have elapsed
under the safe harbor method, a corrective distribution that is made on
or before the fifteenth day of a month is treated as made on the last
day of the preceding month and a distribution made after the fifteenth
day of a month is treated as made on the last day of the month.

\(E\) [Alternative method of allocating plan year and gap period
income]{.underline}. A plan may determine the allocable gain or loss for
the aggregate of the plan year and the gap period by applying the
alternative method provided by paragraph (b)(2)(iv)(C) of this section
to that aggregate period. This is accomplished by substituting the
income for the plan year and the gap period for the income for the plan
year and by substituting the contributions taken into account under this
section for the plan year and the gap period for the contributions taken
into account for the plan year in determining the fraction that is
multiplied by that income.

\(F\) [Allocable income for recharacterized elective
contributions]{.underline}. If recharacterized elective contributions
are distributed as excess aggregate contributions, the income allocable
to the excess aggregate contributions is determined as if
recharacterized elective contributions had been distributed as excess
contributions. Thus, income must be allocated to the recharacterized
amounts distributed using the methods in §1.401(k)-2(b)(2)(iv).

\(v\) [Distribution and forfeiture]{.underline}. Within 12 months after
the close of the plan year in which the excess aggregate contribution
arose, the plan must distribute to each HCE the contributions
apportioned to such HCE under paragraph (b)(2)(iii) of this section (and
the allocable income) to the extent they are vested or forfeit such
amounts, if forfeitable. Except as otherwise provided in this paragraph
(b)(2)(v), a distribution of excess aggregate contributions must be in
addition to any other distributions made during the year and must be
designated as a corrective distribution by the employer. In the event of
a complete termination of the plan during the plan year in which an
excess aggregate contribution arose, the corrective distribution must be
made as soon as administratively feasible after the date of termination
of the plan, but in no event later than 12 months after the date of
termination. If the entire account balance of an HCE is distributed
prior to when the plan makes a distribution of excess aggregate
contributions in accordance with this paragraph (b)(2), the distribution
is deemed to have been a corrective distribution of excess aggregate
contributions (and income) to the extent that a corrective distribution
would otherwise have been required.

\(vi\) [Tax treatment of corrective distributions]{.underline}\--(A)
[General rule]{.underline}. Except as otherwise provided in paragraph
(b)(2)(vi)(B) of this section, a corrective distribution of excess
aggregate contributions (and income) that is made within 2½ months after
the end of the plan year for which the excess aggregate contributions
were made is includible in the employee's gross income for the taxable
year of the employee ending with or within the plan year for which the
excess aggregate contributions were made. A corrective distribution of
excess aggregate contributions (and income) that is made more than 2½
months after the plan year for which the excess aggregate contributions
were made is includible in the employee's gross income in the taxable
year of the employee in which distributed. The portion of the
distribution that is treated as an investment in the contract under
section 72 is determined without regard to any plan contributions other
than those distributed as excess aggregate contributions. Regardless of
when the corrective distribution is made, it is not subject to the early
distribution tax of section 72(t). See paragraph (b)(4) of this section
for additional rules relating to the employer excise tax on amounts
distributed more than 2½ months after the end of the plan year. See also
§1.402(c)-2, A-4 prohibiting rollover of distributions that are excess
aggregate contributions.

\(B\) [Rule for de minimis distributions]{.underline}. If the total
amount of excess aggregate contributions determined under this paragraph
(b)(2), and excess contributions determined under §1.401(k)-2(b)(2)
distributed to a recipient under a plan for any plan year is less than
\$100 (excluding income), a corrective distribution of excess aggregate
contributions (and income) is includible in gross income in the
recipient's taxable year in which the corrective distribution is made.

\(3\) [Other rules]{.underline}\--(i) [No employee or spousal consent
required]{.underline}. A distribution of excess aggregate contributions
(and income) may be made under the terms of the plan without regard to
any notice or consent otherwise required under sections 411(a)(11) and
417.

\(ii\) [Treatment of corrective distributions and forfeited
contributions as employer contributions]{.underline}. Excess aggregate
contributions (other than amounts attributable to employee
contributions), including forfeited matching contributions, are treated
as employer contributions for purposes of sections 404 and 415 even if
distributed from the plan. Forfeited matching contributions that are
reallocated to the accounts of other participants for the plan year in
which the forfeiture occurs are treated under section 415 as annual
additions for the participants to whose accounts they are reallocated
and for the participants from whose accounts they are forfeited.

\(iii\) [No reduction of required minimum distribution]{.underline}. A
distribution of excess aggregate contributions (and income) is not
treated as a distribution for purposes of determining whether the plan
satisfies the minimum distribution requirements of section 401(a)(9).
See §1.401(a)(9)-5, A-9(b).

\(iv\) [Partial correction]{.underline}. Any distribution of less than
the entire amount of excess aggregate contributions (and allocable
income) is treated as a pro rata distribution of excess aggregate
contributions and allocable income.

\(v\) [Matching contributions on excess contributions, excess deferrals
and excess aggregate contributions]{.underline}\--(A) [Corrective
distributions not permitted]{.underline}. A matching contribution may
not be distributed merely because the contribution to which it relates
is treated as an excess contribution, excess deferral, or excess
aggregate contribution.

\(B\) [Coordination with section 401(a)(4)]{.underline}. A matching
contribution is taken into account under section 401(a)(4) even if the
match is distributed, unless the distributed contribution is an excess
aggregate contribution. This requires that, after correction of excess
aggregate contributions, each level of matching contributions be
currently and effectively available to a group of employees that
satisfies section 410(b). See §1.401(a)(4)‑4(e)(3)(iii)(G). Thus, a plan
that provides the same rate of matching contributions to all employees
will not meet the requirements of section 401(a)(4) if employee
contributions are distributed under this paragraph (b) to HCEs to the
extent needed to meet the requirements of section 401(m)(2), while
matching contributions attributable to employee contributions remain
allocated to the HCEs' accounts. This is because the level of matching
contributions will be higher for a group of employees that consists
entirely of HCEs. Under section 411(a)(3)(G) and §1.411(a)-4(b)(7), a
plan may forfeit matching contributions attributable to excess
contributions, excess aggregate contributions and excess deferrals to
avoid a violation of section 401(a)(4). See also
§1.401(a)(4)-11(g)(3)(vii)(B) regarding the use of additional
allocations to the accounts of NHCEs for the purpose of correcting a
discriminatory rate of matching contributions. A plan is permitted to
provide for which contributions are to be distributed to satisfy the ACP
test so as to avoid discriminatory matching rates that would otherwise
violate section 401(a)(4). For example, the plan may provide that
unmatched employee contributions will be distributed before matched
employee contributions.

\(vi\) [No requirement for recalculation]{.underline}. If the
distributions and forfeitures described in paragraph (b)(2) of this
section are made, the employee contributions and matching contributions
are treated as meeting the nondiscrimination test of section 401(m)(2)
regardless of whether the ACP for the HCEs, if recalculated after the
distributions and forfeitures, would satisfy section 401(m)(2).

\(4\) [Failure to timely correct]{.underline}\--(i) [Failure to correct
within 2½ months after end of plan year]{.underline}. If a plan does not
correct excess aggregate contributions within 2½ months after the close
of the plan year for which the excess aggregate contributions are made,
the employer will be liable for a 10% excise tax on the amount of the
excess aggregate contributions. See section 4979 and §54.4979‑1 of this
chapter. Qualified nonelective contributions properly taken into account
under paragraph (a)(6) of this section for a plan year may enable a plan
to avoid having excess aggregate contributions, even if the
contributions are made after the close of the 2½ month period.

\(ii\) [Failure to correct within 12 months after end of plan
year]{.underline}. If excess aggregate contributions are not corrected
within 12 months after the close of the plan year for which they were
made, the plan will fail to meet the requirements of section 401(a)(4)
for the plan year for which the excess aggregate contributions were made
and all subsequent plan years in which the excess aggregate
contributions remain in the trust.

\(5\) [Examples]{.underline}. The following examples illustrate the
application of this paragraph. See also §1.401(k)-2(b) for additional
examples of the parallel correction rules applicable to cash or deferred
arrangements. For purposes of these examples, none of the plans provide
for catch-up contributions under section 414(v). The examples are as
follows:

[Example 1]{.underline}. (i) Employer L maintains a plan that provides
for employee contributions and fully vested matching contributions. The
plan provides that failures of the ACP test are corrected by
distribution. In 2006, the ACP for the eligible NHCEs is 6%. Thus, the
ACP for the eligible HCEs may not exceed 8%. The three HCEs who
participate have the following compensation, contributions, and ACRs:

  ----------- -------------- --------------------------- -----------------
  Employee    Compensation   Employee contributions and  Actual
                             matching contributions      Contribution
                                                         Ratio

  A           200,000        14,000                      7%

  B           150,000        13,500                      9

  C           100,000        12,000                      12

                                                         Average 9.33%
  ----------- -------------- --------------------------- -----------------

\(ii\) The total amount of excess aggregate contributions for the HCEs
is determined under paragraph (b)(2)(ii) of this section as follows: the
matching and employee contributions of Employee C (the HCE with the
highest ACR) is reduced by 3% of compensation (or \$3,000) in order to
reduce the ACR of that HCE to 9%, which is the ACR of Employee B.

\(iii\) Because the ACP of the HCEs determined after the \$3,000
reduction still exceeds 8%, further reductions in matching contributions
and employee contributions are necessary in order to reduce the ACP of
the HCEs to 8%. The employee contributions and matching contributions
for Employees B and C are reduced by an additional .5% of compensation
or \$1,250 (\$750 and \$500 respectively). Because the ACP of the HCEs
determined after the reductions now equals 8%, the plan would satisfy
the requirements of (a)(1)(ii) of this section.

\(iv\) The total amount of excess aggregate contributions (\$4,250) is
apportioned among the HCEs under paragraph (b)(2)(iii) of this section
first to the HCE with the highest amount of matching contributions and
employee contributions. Therefore, Employee A is apportioned \$500 (the
amount required to cause A's matching contributions and employee
contributions to equal the next highest dollar amount of matching
contributions and employee contributions).

\(v\) Because the total amount of excess aggregate contributions has not
been apportioned, further apportionment is necessary. The balance
(\$3,750) of the total amount of excess aggregate contributions is
apportioned equally among Employees A and B (\$1,500 to each, the amount
required to cause their contributions to equal the next highest dollar
amount of matching contributions and employee contributions).

\(vi\) Because the total amount of excess aggregate contributions has
not been apportioned, further apportionment is necessary. The balance
(\$750) of the total amount of excess aggregate contributions is
apportioned equally among Employees A, B and C (\$250 to each, the
amount required to allocate the total amount of excess aggregate
contributions for the plan).

\(vii\) Therefore, the plan will satisfy the requirements of paragraph
(a)(1) of this section if, by the end of the 12 month period following
the end of the 2006 plan year, Employee A receives a corrective
distribution of excess aggregate contributions equal to \$ 2,250
(\$500 + \$1,500 + \$250) and allocable income, Employee B receives a
corrective distribution of \$250 and allocable income and Employee C
receives a corrective distribution of \$1,750 (\$1,500 + \$250) and
allocable income.

[Example 2]{.underline}. (i) Employee D is the sole HCE who is eligible
to participate in a cash or deferred arrangement maintained by Employer
M. The plan that includes the arrangement, Plan X, permits employee
contributions and provides a fully vested matching contribution equal to
50% of elective contributions. Plan X is a calendar year plan. Plan X
corrects excess contributions by recharacterization and provides that
failures of the ACP test are corrected by distribution. For the 2006
plan year, D's compensation is \$200,000, and D's elective contributions
are \$15,000. The actual deferral percentages and actual contribution
percentages for Employee D and the other eligible employees under Plan X
are shown in the following table:

  ----------------------- ----------------------- -----------------------
                          Actual Deferral         Actual Contribution
                          Percentage              Percentage

  Employee D              7.5%                    3.75 %

  NHCEs                   4 %                     2%
  ----------------------- ----------------------- -----------------------

\(ii\) In February 2007, Employer M determines that D's actual deferral
ratio must be reduced to 6%, or \$12,000, which requires a
recharacterization of \$3,000 as an employee contribution. This
increases D's actual contribution ratio to 5.25% (\$7,500 in matching
contributions plus \$3,000 recharacterized as employee contributions,
divided by \$200,000 in compensation). Since D's actual contribution
ratio must be limited to 4% for Plan X to satisfy the actual
contribution percentage test, Plan X must distribute 1.25% or \$2,500 of
D's employee contributions and matching contributions together with
allocable income. If \$2,500 in matching contributions and allocable
income is distributed, this will correct the excess aggregate
contributions and will not result in a discriminatory rate of matching
contributions. See [Example 8]{.underline}.

[Example 3]{.underline}. (i) The facts are the same as in [Example
2]{.underline}, except that Employee D also had elective contributions
under Plan Y, maintained by an employer unrelated to M. In January 2007,
D requests and receives a distribution of \$1,200 in excess deferrals
from Plan X. Pursuant to the terms of Plan X, D forfeits the \$600 match
on the excess deferrals to correct a discriminatory rate of match.

\(ii\) The \$3,000 that would otherwise have been recharacterized for
Plan X to satisfy the actual deferral percentage test is reduced by the
\$1,200 already distributed as an excess deferral, leaving \$1,800 to be
recharacterized. See §1.401(k)‑2(b)(4)(i)(A). D's actual contribution
ratio is now 4.35% (\$7,500 in matching contributions plus \$1,800 in
recharacterized contributions less \$600 forfeited matching
contributions attributable to the excess deferrals, divided by \$200,000
in compensation).

\(iii\) The matching and employee contributions for Employee D must be
reduced by .35% of compensation in order to reduce the ACP of the HCEs
to 4%. The plan must provide for forfeiture of additional matching
contributions to prevent a discriminatory rate of matching
contributions. See [Example 8]{.underline}.

[Example 4]{.underline}. (i) The facts are the same as in [Example
3]{.underline}, except that D does not request a distribution of excess
deferrals until March 2007. Employer X has already recharacterized
\$3,000 as employee contributions.

\(ii\) Under §1.402(g)‑1(e)(6), the amount of excess deferrals is
reduced by the amount of excess contributions that are recharacterized.
Because the amount recharacterized is greater than the excess deferrals,
Plan X is neither required nor permitted to make a distribution of
excess deferrals, and the recharacterization has corrected the excess
deferrals.

[Example 5]{.underline}. (i) For the 2006 plan year, Employee F defers
\$10,000 under Plan M and \$6,000 under Plan N. Plans M and N, which
have calendar plan years are maintained by unrelated employers. Plan M
provides a fully vested, 100% matching contribution, does not take
elective contributions into account under section 401(m) or take
matching contributions into account under section 401(k) and provides
that excess contributions and excess aggregate contributions are
corrected by distribution. Under Plan M, Employee F is allocated excess
contributions of \$600 and excess aggregate contributions of \$1,600.
Employee F timely requests and receives a distribution of the \$1,000
excess deferral from Plan M and, pursuant to the terms of Plan M,
forfeits the corresponding \$1,000 matching contribution.

\(ii\) No distribution is required or permitted to correct the excess
contributions because \$1,000 has been distributed by Plan M as excess
deferrals. The distribution required to correct the excess aggregate
contributions (after forfeiting the matching contribution) is \$600
(\$1,600 in excess aggregate contributions minus \$1,000 in forfeited
matching contributions). If Employee F had corrected the excess
deferrals of \$1,000 by withdrawing \$1,000 from Plan N, Plan M would
have had to correct the \$600 excess contributions in Plan M by
distributing \$600. Since Employee F then would have forfeited \$600
(instead of \$1,000) in matching contributions, Employee F would have
had \$1,000 (\$1,600 in excess aggregate contributions minus \$600 in
forfeited matching contributions) remaining of excess aggregate
contributions in Plan M. These would have been corrected by distributing
an additional \$1,000 from Plan M.

[Example 6]{.underline}. (i) Employee G is the sole highly compensated
employee in a profit sharing plan under which the employer matches 100%
of employee contributions up to 2% of compensation, and 50% of employee
contributions up to the next 4% of compensation. For the 2008 plan year,
Employee G has compensation of \$100,000 and makes a 7% employee
contribution of \$7,000. Employee G receives a 4% matching contribution
or \$4,000. Thus, Employee G's actual contribution ratio (ACR) is 11%.
The actual contribution percentage for the nonhighly compensated
employees is 5%, and the employer determines that Employee G's ACR must
be reduced to 7% to comply with the rules of section 401(m).

\(ii\) In this case, the plan satisfies the requirements of section if
it distributes the unmatched employee contributions of \$1,000, and
\$2,000 of matched employee contributions with their related matches of
\$1,000. This would leave Employee G with 4% employee contributions, and
3% matching contributions, for an ACR of 7%. Alternatively, the plan
could distribute all matching contributions and satisfy this section.
However, the plan could not distribute \$4,000 of Employee G's employee
contributions without forfeiting the related matching contributions
because this would result in a discriminatory rate of matching
contributions. See also [Example 7]{.underline}.

[Example 7]{.underline}. (i) Employee H is an HCE in Employer X's profit
sharing plan, which matches 100% of employee contributions up to 5% of
compensation. The matching contribution is vested at the rate of 20% per
year. In 2006, Employee H makes \$5,000 in employee contributions and
receives \$5,000 of matching contributions. Employee H is 60% vested in
the matching contributions at the end of the 2006 plan year. In February
2007, Employer X determines that Employee H has excess aggregate
contributions of \$1,000. The plan provides that only matching
contributions will be distributed as excess aggregate contributions.

\(ii\) Employer X has two options available in distributing Employee H's
excess contributions. The first option is to distribute \$600 of vested
matching contributions and forfeit \$400 of nonvested matching
contributions. These amounts are in proportion to Employee H's vested
and nonvested interests in all matching contributions. The second option
is to distribute \$1,000 of vested matching contributions, leaving the
nonvested matching contributions in the plan.

\(iii\) If the second option is chosen, the plan must also provide a
separate vesting schedule for vesting these nonvested matching
contributions. This is necessary because the nonvested matching
contributions must vest as rapidly as they would have had no
distribution been made. Thus, 50% must vest in each of the next 2 years.

\(iv\) The plan will not satisfy the nondiscriminatory availability
requirement of section 401(a)(4) if only nonvested matching
contributions are distributed because the effect is that matching
contributions for HCEs vest more rapidly than those for NHCEs. See
§1.401(m)‑1(e)(4).

[Example 8]{.underline}. (i) Employer Y maintains a calendar year profit
sharing plan that includes a cash or deferred arrangement. Elective
contributions are matched at the rate of 100%. After‑tax employee
contributions are permitted under the plan only for nonhighly
compensated employees and are matched at the same rate. No employees
make excess deferrals. Employee J, a highly compensated employee, makes
an \$8,000 elective contribution and receives an \$8,000 matching
contribution.

\(ii\) Employer Y performs the actual deferral percentage (ADP) and the
actual contribution percentage (ACP). To correct failures of the ADP and
ACP tests, the plan distributes to A \$1,000 of excess contributions and
\$500 of excess aggregate contributions. After the distributions,
Employee J's contributions for the year are \$7,000 of elective
contributions and \$7,500 of matching contributions. As a result,
Employee J has received a higher effective rate of matching
contributions than nonhighly compensated employees (\$7,000 of elective
contributions matched by \$7,500 is an effective matching rate of 107
percent). If this amount remains in Employee J's account without
correction, it will cause the plan to fail to satisfy section 401(a)(4),
because only a highly compensated employee receives the higher matching
contribution rate. The remaining \$500 matching contribution may be
forfeited (but not distributed) under section 411(a)(3)(G), if the plan
so provides. The plan could instead correct the discriminatory rate of
matching contributions by making additional allocations to the accounts
of nonhighly compensated employees. See §1.401(a)(4)‑11(g)(3)(vii)(B)
and (6), [Example 7]{.underline}.

\(c\) [Additional rules for prior year testing method]{.underline}\--(1)
[Rules for change in testing method]{.underline}. A plan is permitted to
change from the prior year testing method to the current year testing
method for any plan year. A plan is permitted to change from the current
year testing method to the prior year testing method only in situations
described in §1.401(k)-2(c)(1)(ii). For purposes of this paragraph
(c)(1), a plan that uses the safe harbor method described in §1.401(m)-3
or a SIMPLE 401(k) plan is treated as using the current year testing
method for that plan year

\(2\) [Calculation of ACP under the prior year testing method for the
first plan year]{.underline}\--(i) [Plans that are not successor
plans]{.underline}. If, for the first plan year of any plan (other than
a successor plan), a plan uses the prior year testing method, the plan
is permitted to use either that first plan year as the applicable year
for determining the ACP for the eligible NHCEs, or 3% as the ACP for
eligible NHCEs, for applying the ACP test for that first plan year. A
plan (other than a successor plan) that uses the prior year testing
method but has elected for its first plan year to use that year as the
applicable year for determining the ACP for the eligible NHCEs is not
treated as changing its testing method in the second plan year and is
not subject to the limitations on double counting under paragraph
(a)(6)(vi) of this section for the second plan year.

\(ii\) [First plan year defined]{.underline}. For purposes of this
paragraph (c)(2), the first plan year of any plan is the first year in
which the plan provides for employee contributions or matching
contributions. Thus, the rules of this paragraph (c)(2) do not apply to
a plan (within the meaning of §1.410(b)-7) for a plan year if for such
plan year the plan is aggregated under §1.401(m)-1(b)(4) with any other
plan that provides for employee or matching contributions in the prior
year.

\(iii\) [Plans that are successor plans]{.underline}. A plan is a
successor plan if 50% or more of the eligible employees for the first
plan year were eligible employees under another plan maintained by the
employer in the prior year that provides for employee contributions or
matching contributions. If a plan that is a successor plan uses the
prior year testing method for its first plan year, the ACP for the group
of NHCEs for the applicable year must be determined under paragraph
(c)(4) of this section.

\(3\) [Plans using different testing methods for the ACP and ADP
test.]{.underline} Except as otherwise provided in this paragraph
(c)(3), a plan may use the current year testing method or prior year
testing method for the ACP test for a plan year without regard to
whether the current year testing method or prior year testing method is
used for the ADP test for that year. For example, a plan may use the
prior year testing method for the ACP test and the current year testing
method for its ADP test for the plan year. However, plans that use
different testing methods under this paragraph (c)(3) cannot use \--

\(i\) The recharacterization method of §1.401(k)-2(b)(3) to correct
excess contributions for a plan year;

\(ii\) The rules of paragraph (a)(6)(ii) of this section to take
elective contributions into account under the ACP test (rather than the
ADP test); or

\(iii\) The rules of paragraph §1.401(k)-2(a)(6) to take qualified
matching contributions into account under the ADP test (rather than the
ACP test).

\(4\) [Rules for plan coverage change]{.underline}\--(i) [In
general]{.underline}. A plan that uses the prior year testing method
that experiences a plan coverage change during a plan year satisfies the
requirements of this section for that year only if the plan provides
that the ACP for the NHCEs for the plan year is the weighted average of
the ACPs for the prior year subgroups.

\(ii\) [Optional rule for minor plan coverage changes]{.underline}. If a
plan coverage change occurs and 90% or more of the total number of the
NHCEs from all prior year subgroups are from a single prior year
subgroup, then, in lieu of using the weighted averages described in
paragraph (c)(4)(i) of this section, the plan may provide that the ACP
for the group of eligible NHCEs for the prior year under the plan is the
ACP of the NHCEs for the prior year of the plan under which that single
prior year subgroup was eligible.

\(iii\) [Definitions]{.underline}. The following definitions apply for
purposes of this paragraph (c)(4)\--

\(A\) [Plan coverage change]{.underline}. The term [plan coverage
change]{.underline} means a change in the group or groups of eligible
employees under a plan on account of\--

([1]{.underline}) The establishment or amendment of a plan;

([2]{.underline}) A plan merger or spinoff under section 414(l);

([3]{.underline}) A change in the way plans (within the meaning of
§1.410(b)-7) are combined or separated for purposes of §1.401(m)‑1(b)(4)
(e.g., permissively aggregating plans not previously aggregated under
§1.410(b)‑7(d), or ceasing to permissively aggregate plans under
§1.410(b)‑7(d));

([4]{.underline}) A reclassification of a substantial group of employees
that has the same effect as amending the plan (e.g., a transfer of a
substantial group of employees from one division to another division);
or

([5]{.underline}) A combination of any of paragraphs
(c)(4)(iii)(A)([1]{.underline}) through ([4]{.underline}) of this
section.

\(B\) [Prior year subgroup]{.underline}. The term [prior year
subgroup]{.underline} means all NHCEs for the prior plan year who, in
the prior year, were eligible employees under a specific plan that
provides for employee contributions or matching contributions maintained
by the employer and who would have been eligible employees in the prior
year under the plan being tested if the plan coverage change had first
been effective as of the first day of the prior plan year instead of
first being effective during the plan year. The determination of whether
an NHCE is a member of a prior year subgroup is made without regard to
whether the NHCE terminated employment during the prior year.

\(C\) [Weighted average of the ACPs for the prior year
subgroups]{.underline}. The term [weighted average of the ACPs for the
prior year subgroups]{.underline} means the sum, for all prior year
subgroups, of the adjusted ACPs for the plan year. The term [adjusted
ACP with respect to a prior year subgroup]{.underline} means the ACP for
the prior plan year of the specific plan under which the members of the
prior year subgroup were eligible employees on the first day of the
prior plan year, multiplied by a fraction, the numerator of which is the
number of NHCEs in the prior year subgroup and denominator of which is
the total number of NHCEs in all prior year subgroups.

\(iv\) [Example]{.underline}. The following example illustrate the
application of this paragraph (c)(4). See also §1.401(k)-2(c)(4) for
examples of the parallel rules applicable to the ADP test. The example
is as follows:

[Example]{.underline}. (i) Employer B maintains two plans, Plan N and
Plan P, each of which includes a provides for employee contributions or
matching contributions. The plans were not permissively aggregated under
§ 1.410(b)‑7(d) for the 2005 testing year. Both plans use the prior year
testing method. Plan N had 300 eligible employees who were NHCEs for
2005, and their ACP for that year was 6%. Plan P had 100 eligible
employees who were NHCEs for 2005, and the ACP for those NHCEs for that
plan was 4%. Plan N and Plan P are permissively aggregated under
§ 1.410(b)‑7(d) for the 2006 plan year.

\(ii\) The permissive aggregation of Plan N and Plan P for the 2006
testing year under § 1.410(b)‑7(d) is a plan coverage change that
results in treating the plans as one plan (Plan NP). Therefore, the
prior year ACP for the NHCEs under Plan NP for the 2006 testing year is
the weighted average of the ACPs for the prior year subgroups.

\(iii\) The first step in determining the weighted average of the ACPs
for the prior year subgroups is to identify the prior year subgroups.
With respect to the 2006 testing year, an employee is a member of a
prior year subgroup if the employee was an NHCE of Employer B for the
2005 plan year, was an eligible employee for the 2005 plan year under
any section 401(k) plan maintained by Employer B, and would have been an
eligible employee in the 2005 plan year under Plan NP if Plan N and Plan
P had been permissively aggregated under §1.410(b)‑7(d) for that plan
year. The NHCEs who were eligible employees under separate plans for the
2005 plan year comprise separate prior year subgroups. Thus, there are
two prior year subgroups under Plan NP for the 2006 testing year: the
300 NHCEs who were eligible employees under Plan N for the 2005 plan
year and the 100 NHCEs who were eligible employees under Plan P for the
2005 plan year.

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

[§1.401(m)-3 Safe harbor requirements]{.underline}.

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

\(b\) [Safe harbor nonelective contribution requirement]{.underline}. A
plan satisfies the safe harbor nonelective contribution requirement of
this paragraph (b) if it satisfies the safe harbor nonelective
contribution requirement of §1.401(k)-3(b).

\(c\) [Safe harbor matching contribution requirement]{.underline}. A
plan satisfies the safe harbor matching contribution requirement of this
paragraph (c) if it satisfies the safe harbor matching contribution
requirement of §1.401(k)-3(c).

\(d\) [Limitation on contributions]{.underline}--(1) [General
rule]{.underline}. A plan that provides for matching contributions meets
the requirements of this section only if it satisfies the limitations on
contributions set forth in this paragraph (d).

\(2\) [Matching rate must not increase]{.underline}. A plan that
provides for matching contributions meets the requirements of this
paragraph (d) only if the ratio of matching contributions on behalf of
an employee under the plan for a plan year to the employee's elective
deferrals and employee contributions, does not increase as the amount of
an employee's elective deferrals and employee contributions increases.

\(3\) [Limit on matching contributions]{.underline}. A plan that
provides for matching contributions satisfies the requirements of this
section only if\--

\(i\) Matching contributions are not made with respect to elective
deferrals or employee contributions that exceed 6% of the employee's
safe harbor compensation (within the meaning of §1.401(k)-3(b)(2)); and

\(ii\) Matching contributions that are discretionary do not exceed 4% of
the employee's safe harbor compensation.

\(4\) [Limitation on rate of match]{.underline}. A plan meets the
requirements of this section only if the ratio of matching contributions
on behalf of an HCE to that HCE's elective deferrals or employee
contributions (or the sum of elective deferrals and employee
contributions) for that plan year is no greater than the ratio of
matching contributions to elective deferrals or employee contributions
(or the sum of elective deferrals and employee contributions) that would
apply with respect to any NHCE for whom the elective deferrals or
employee contributions (or the sum of elective deferrals and employee
contributions) are the same percentage of safe harbor compensation. An
employee is taken into account for purposes of this paragraph (d)(4) if
the employee is an eligible employee under the cash or deferred
arrangement with respect to which the contributions required by
paragraph (b) or (c) of this section are being made for a plan year. A
plan will not fail to satisfy this paragraph (d)(4) merely because the
plan provides that matching contributions will be made separately with
respect to each payroll period (or with respect to all payroll periods
ending with or within each month or quarter of a plan year) taken into
account under the plan for the plan year, provided that matching
contributions with respect to any elective deferrals or employee
contributions made during a plan year quarter are contributed to the
plan by the last day of the immediately following plan year quarter.

\(5\) [HCEs participating in multiple plans]{.underline}. The rules of
section 401(m)(2)(B) and §1.401(m)-2(a)(3)(ii) apply for purposes of
determining the rate of matching contributions under paragraph (d)(4) of
this section. However, a plan will not fail to satisfy the safe harbor
matching contribution requirements of this section merely because an HCE
participates during the plan year in more than one plan that provides
for matching contributions, provided that \--

\(i\) The HCE is not simultaneously an eligible employee under two plans
that provide for matching contributions maintained by an employer for a
plan year; and

\(ii\) The period used to determine compensation for purposes of
determining matching contributions under each such plan is limited to
periods when the HCE participated in the plan.

\(6\) [Permissible restrictions on elective deferrals by
NHCEs]{.underline}\--(i) [General rule]{.underline}. A plan does not
satisfy the safe harbor requirements of this section, if elective
deferrals or employee contributions by NHCEs are restricted, unless the
restrictions are permitted by this paragraph (d)(6).

\(ii\) [Restrictions on election periods]{.underline}. A plan may limit
the frequency and duration of periods in which eligible employees may
make or change contribution elections under a plan. However, an employee
must have a reasonable opportunity (including a reasonable period after
receipt of the notice described in paragraph (e) of this section) to
make or change a contribution election for the plan year. For purposes
of this section, a 30‑day period is deemed to be a reasonable period to
make or change a contribution election.

\(iii\) [Restrictions on amount of contributions]{.underline}. A plan is
permitted to limit the amount of contributions that may be made by an
eligible employee under a plan, provided that each NHCE who is an
eligible employee is permitted (unless the employee is restricted under
paragraph (d)(6)(v) of this section) to make contributions in an amount
that is at least sufficient to receive the maximum amount of matching
contributions available under the plan for the plan year, and the
employee is permitted to elect any lesser amount of contributions.
However, a plan may require eligible employees to make contribution
elections in whole percentages of compensation or whole dollar amounts.

\(iv\) [Restrictions on types of compensation that may be
deferred]{.underline}. A plan may limit the types of compensation that
may be deferred or contributed by an eligible employee under a plan,
provided that each eligible NHCE is permitted to make contributions
under a definition of compensation that would be a reasonable definition
of compensation within the meaning of §1.414(s)‑1(d)(2). Thus, the
definition of compensation from which contributions may be made is not
required to satisfy the nondiscrimination requirement of
§1.414(s)‑1(d)(3).

\(v\) [Restrictions due to limitations under the Internal Revenue
Code]{.underline}. A plan may limit the amount of contributions made by
an eligible employee under a plan\--

\(A\) Because of the limitations of section 402(g) or section 415; or

(B) Because, on account of a hardship distribution, an employee's
ability to make contributions has been suspended for 6 months in
accordance with §1.401(k)‑1(d)(3)(iv)(E).

\(e\) [Notice requirement]{.underline}. A plan satisfies the notice
requirement of this paragraph (e) if it satisfies the notice requirement
of §1.401(k)-3(d).

\(f\) [Plan year requirement]{.underline} \--(1) [General
rule]{.underline}. Except as provided in this paragraph (f) or in
paragraph (g) of this section, a plan will fail to satisfy the
requirements of section 401(m)(11) and this section unless plan
provisions that satisfy the rules of this section are adopted before the
first day of that plan year and remain in effect for an entire 12-month
plan year. Moreover, if, as described in paragraph (j)(4) of this
section, safe harbor matching or nonelective contributions will be made
to another plan for a plan year, provisions specifying that the safe
harbor contributions will be made in the other plan and providing that
the contributions will be QNECs or QMACs must be also be adopted before
the first day of that plan year.

\(2\) [Initial plan year]{.underline}. A newly established plan (other
than a successor plan within the meaning of §1.401(m)-2(c)(2)(iii)) will
not be treated as violating the requirements of this paragraph (f)
merely because the plan year is less than 12 months, provided that the
plan year is at least 3 months long (or, in the case of a newly
established employer that establishes the plan as soon as
administratively feasible after the employer comes into existence, a
shorter period). Similarly, a plan will not fail to satisfy the
requirements of this paragraph (f) for the first plan year in which
matching contributions are provided under the plan provided that\--

\(i\) The plan is not a successor plan; and

\(ii\) The amendment providing for matching contributions is made
effective at the same time as the adoption of a cash or deferred
arrangement that satisfies the requirements of §1.401(k)-3, taking into
account the rules of §1.401(k)-3(e)(2).

\(3\) [Change of plan year]{.underline}. A plan that has a short plan
year as a result of changing its plan year will not fail to satisfy the
requirements of paragraph (f)(1) of this section merely because the plan
year has less than 12 months, provided that\--

\(i\) The plan satisfied the requirements of this section for the
immediately preceding plan year; and

\(ii\) The plan satisfies the requirements of this section for the
immediately following plan year.

\(4\) [Final plan year]{.underline}. A plan that terminates during a
plan year will not fail to satisfy the requirements of paragraph (f)(1)
of this section merely because the final plan year is less than 12
months, provided that\--

\(i\) The plan would satisfy the requirements of paragraph (h) of this
section, treating the termination of the plan as a reduction or
suspension of safe harbor matching contributions, other than the
requirement that employees have a reasonable opportunity to change their
cash or deferred elections and, if applicable, employee contribution
elections; or

\(ii\) The plan termination is in connection with a transaction
described in section 410(b)(6)(C) or the employer incurs a substantial
business hardship, comparable to a substantial business hardship
described in section 412(d).

\(g\) [Plan amendments adopting nonelective safe harbor
contributions]{.underline}. Notwithstanding paragraph (f)(1) of this
section, a plan that provides for the use of the current year testing
method may be amended after the first day of the plan year and no later
than 30 days before the last day of the plan year to adopt the safe
harbor method of this section using nonelective contributions under
paragraph (b) of this section if the plan satisfies the requirements of
§1.401(k)-3(f).

\(h\) [Permissible reduction or suspension of safe harbor matching
contributions]{.underline}\--(1) [General rule]{.underline}. A plan that
provides for safe harbor matching contributions will not fail to satisfy
the requirements of section 401(m)(2) for a plan year merely because the
plan is amended during a plan year to reduce or suspend safe harbor
matching contributions on future elective deferrals and, if applicable,
employee contributions provided\--

\(i\) All eligible employees are provided the supplemental notice in
accordance with paragraph (h)(2) of this section;

\(ii\) The reduction or suspension of safe harbor matching contributions
is effective no earlier than the later of 30 days after eligible
employees are provided the notice described in paragraph (h)(2) of this
section and the date the amendment is adopted;

\(iii\) Eligible employees are given a reasonable opportunity (including
a reasonable period after receipt of the supplemental notice) prior to
the reduction or suspension of safe harbor matching contributions to
change their cash or deferred elections and, if applicable, their
employee contribution elections;

\(iv\) The plan is amended to provide that the ACP test will be
satisfied for the entire plan year in which the reduction or suspension
occurs using the current year testing method described in
§1.401(m)-2(a)(1)(ii); and

\(v\) The plan satisfies the requirements of this section (other than
this paragraph (h)) with respect to amounts deferred through the
effective date of the amendment.

\(2\) [Notice of suspension requirement]{.underline}. The notice of
suspension requirement of this paragraph (h)(2) is satisfied if each
eligible employee is given a written notice that satisfies the content
requirements of §1.401(k)-3(e)(3).

\(i\) \[Reserved\]

\(j\) [Other rules]{.underline}\--(1) [Contributions taken into
account]{.underline}. A contribution is taken into account for purposes
of this section for a plan year under the same rules as
§1.401(k)-3(h)(1).

\(2\) [Use of safe harbor nonelective contributions to satisfy other
nondiscrimination tests]{.underline}. A safe harbor nonelective
contribution used to satisfy the nonelective contribution requirement
under paragraph (b) of this section may also be taken into account for
purposes of determining whether a plan satisfies section 401(a)(4) under
the same rules as §1.401(k)-3(h)(2).

\(3\) [Early participation rules]{.underline}. Section 401(m)(5)(C) and
§1.401(m)-2(a)(1)(iii)(A) which provide an alternative nondiscrimination
rule for certain plans that provide for early participation, does not
apply for purposes of section 401(m)(11) and this section. Thus, a plan
is not treated as satisfying this section with respect to the eligible
employees who have not completed the minimum age and service
requirements of section 410(a)(1)(A) unless the plan satisfies the
requirements of this section with respect to such eligible employees.

\(4\) [Satisfying safe harbor contribution requirement under another
defined contribution plan]{.underline}. Safe harbor matching or
nonelective contributions may be made to another defined contribution
plan under the same rules as §1.401(k)-3(h)(4). Consequently, each NHCE
under the plan providing for matching contributions must be eligible
under the same conditions under the other defined contribution plan and
the plan to which the contributions are made must have the same plan
year as the plan providing for matching contributions.

\(5\) [Contributions used only once]{.underline}. Safe harbor matching
or nonelective contributions cannot be used to satisfy the requirements
of this section with respect to more than one plan.

\(6\) [Plan must satisfy ACP with respect to employee
contributions]{.underline}. If the plan provides for employee
contributions, in addition to satisfying the requirements of this
section, it must also satisfy the ACP test of §1.401(m)-2. See
§1.401(m)-2(a)(5)(iii) for specials rules under which the ACP test is
permitted to be run taking into account only employee contributions when
this section is satisfied with respect to the matching contributions.

[§1.401(m)‑4 Special rules for mergers, acquisitions and similar
events]{.underline}. *\[Reserved*\]

[§1.401(m)‑5 Definitions]{.underline}.

Unless otherwise provided, the definitions of this section govern for
purposes of section 401(m) and the regulations thereunder.

[Actual contribution percentage (ACP)]{.underline}. [Actual contribution
percentage]{.underline} or [ACP]{.underline} means the ACP of the group
of eligible employees as defined in §1.401(m)‑2(a)(2)(i).

[Actual contribution percentage (ACP) test]{.underline}. [Actual
contribution percentage test]{.underline} or [ACP test]{.underline}
means the test described in §1.401(m)‑2(a)(1).

[Actual contribution ratio (ACR)]{.underline}. [Actual contribution
ratio]{.underline} or [ACR]{.underline} means the ACR of an eligible
employee as defined in §1.401(m)‑2(a)(3).

[Actual deferral percentage (ADP) test]{.underline}. [Actual deferral
percentage test]{.underline} or [ADP test]{.underline} means the test
described in §1.401(k)‑2(a)(1).

[Compensation]{.underline}. [Compensation]{.underline} means
compensation as defined in section 414(s) and §1.414(s)‑1. The period
used to determine an employee's compensation for a plan year must be
either the plan year or the calendar year ending within the plan year.
Whichever period is selected must be applied uniformly to determine the
compensation of every eligible employee under the plan for that plan
year. A plan may, however, limit the period taken into account under
either method to that portion of the plan year or calendar year in which
the employee was an eligible employee, provided that this limit is
applied uniformly to all eligible employees under the plan for the plan
year. See also section 401(a)(17) and §1.401(a)(17)‑1(c)(1). For this
purpose, in case of an HCE whose ACR is determined under
§1.401(m)-2(a)(3)(ii), period of participation includes periods under
another plan for which matching contributions or employee contributions
are aggregated under §1.401(m)-2(a)(3)(ii).

[Current year testing method]{.underline}. [Current year testing
method]{.underline} means the testing method under which the applicable
year is the current plan year, as described in §1.401(m)‑2(a)(2)(ii) or
1.401(k)-2(a)(2)(ii).

[Elective contributions]{.underline}. [Elective
contributions]{.underline} means elective contributions as defined in
§1.401(k)‑6.

[Elective deferrals]{.underline}. [Elective deferrals]{.underline} means
elective deferrals described in section 402(g)(3).

[Eligible employee]{.underline}\--(1) [General rule]{.underline}.
[Eligible employee]{.underline} means an employee who is directly or
indirectly eligible to make an employee contribution or to receive an
allocation of matching contributions (including matching contributions
derived from forfeitures) under the plan for all or a portion of the
plan year. For example, if an employee must perform purely ministerial
or mechanical acts (e.g., formal application for participation or
consent to payroll withholding) in order to be eligible to make an
employee contribution for a plan year, the employee is an eligible
employee for the plan year without regard to whether the employee
performs these acts.

\(2\) [Conditions on eligibility]{.underline}. An employee who is unable
to make employee contributions or to receive an allocation of matching
contributions because the employee has not contributed to another plan
is also an eligible employee. By contrast, if an employee must perform
additional service (e.g., satisfy a minimum period of service
requirement) in order to be eligible to make an employee contribution or
to receive an allocation of matching contributions for a plan year, the
employee is not an eligible employee for the plan year unless the
service is actually performed. An employee who would be eligible to make
employee contributions but for a suspension due to a distribution, a
loan, or an election not to participate in the plan, is treated as an
eligible employee for purposes of section 401(m) for a plan year even
though the employee may not make employee contributions or receive an
allocation of matching contributions by reason of the suspension.
Finally, an employee does not fail to be treated as an eligible employee
merely because the employee may receive no additional annual additions
because of section 415(c)(1).

\(3\) [Certain one‑time elections]{.underline}. An employee is not an
eligible employee merely because the employee, upon commencing
employment with the employer or upon the employee's first becoming
eligible under any plan of the employer providing for employee or
matching contributions, is given a one-time opportunity to elect, and
the employee in fact does elect, not to be eligible to make employee
contributions or to receive allocations of matching contributions under
the plan or any other plan maintained by the employer (including plans
not yet established) for the duration of the employee's employment with
the employer. In no event is an election made after December 23, 1994,
treated as one-time irrevocable election under this paragraph if the
election is made by an employee who previously became eligible under
another plan (whether or not terminated) of the employer.

[Eligible HCE]{.underline}. [Eligible HCE]{.underline} means an eligible
employee who is an HCE.

[Eligible NHCE]{.underline}. [Eligible NHCE]{.underline} means an
eligible employee who is not an HCE. [Employee]{.underline}.
[Employee]{.underline} means an employee within the meaning of
§1.410(b)‑9.

[Employee contributions]{.underline}. [Employee
contributions]{.underline} means employee contributions as defined in
1.401(m)-1(a)(3).

[Employee stock ownership plan (ESOP)]{.underline}. [Employee stock
ownership plan]{.underline} or [ESOP]{.underline} means the portion of a
plan that is an ESOP within the meaning of §1.410(b)‑7(c)(2).

> [Employer]{.underline}. [Employer]{.underline} means an employer
> within the meaning of §1.410(b)‑9.

[Excess aggregate contributions]{.underline}. [Excess aggregate
contributions]{.underline} means, with respect to a plan year, the
amount of excess aggregate contributions apportioned to an HCE under
§1.401(m)-2(b)(2)(iii).

[Excess contributions]{.underline}. [Excess contribution]{.underline}
means with respect to a plan year, the amount of excess contribution
apportioned to an HCE under §1.401(k)-2(b)(2)(iii).

[Excess deferrals]{.underline}. [Excess deferrals]{.underline} means
excess deferrals as defined in §1.402(g)‑1(e)(3).

[Highly compensated employee (HCE)]{.underline}. [Highly compensated
employee]{.underline} or [HCE]{.underline} has the meaning provided in
section 414(q).

[Matching contributions]{.underline}. [Matching
contribution]{.underline} is defined in §1.401(m)-1(a)(2).

[Nonelective contributions]{.underline}. [Nonelective
contributions]{.underline} means employer contributions (other than
matching contributions) with respect to which the employee may not elect
to have the contributions paid to the employee in cash or other benefits
instead of being contributed to the plan.

[Non-employee stock ownership plan (non-ESOP)]{.underline}.
[Non-employee stock ownership plan]{.underline} or
[non-ESOP]{.underline} means the portion of a plan that is not an ESOP
within the meaning of §1.410(b)‑7(c)(2).

[Non-highly compensated employee (NHCE)]{.underline}. [Non-highly
compensated employee]{.underline} or [NHCE]{.underline} means an
employee who is not an HCE.

[Plan]{.underline}. [Plan]{.underline} means plan as defined in
§1.401(m)‑1(b)(4).

[Prior year testing method.]{.underline} [Prior year testing
method]{.underline} means the testing method under which the applicable
year is the prior plan year, as described in §1.401(m)‑2(a)(2)(ii) or
§1.401(k)-2(a)(2)(ii).

[Qualified matching contributions (QMAC)]{.underline}. [Qualified
matching contributions]{.underline} or [QMAC]{.underline} means matching
contributions that satisfy the requirements of §1.401(k)‑1(c) and (d) at
the time the contribution is made, without regard to whether the
contributions are actually taken into account as elective contributions
under §1.401(k)‑2(a)(6). See also §1.401(k)-2(b)(4)(iii) for a rule
providing that a matching contribution does not fail to qualify as a
QMAC solely because it is forfeitable under section 411(a)(3)(G) because
it is a matching contribution with respect to an excess deferral, excess
contribution, or excess aggregate contribution.

[Qualified nonelective contributions (QNEC)]{.underline}. [Qualified
nonelective contributions]{.underline} or [QNEC]{.underline} means
employer contributions, other than elective contributions or matching

contributions, that satisfy the requirements of §1.401(k)‑1(c) and (d)
at the time the contribution is made, without regard to whether the
contributions are actually taken into account under the ADP test under
§1.401(k)‑2(a)(6) or the ADP test under §1.401(m)-2(a)(6).

> Judith B. Tomaso,

Acting Deputy Commissioner for Services and Enforcement.

[^1]: The Department of Labor has advised Treasury and the IRS that,
    under Title I of the Employee Retirement Income Security Act of 1974
    (ERISA), fiduciaries of a plan must ensure that the plan is
    administered prudently and solely in the interest of plan
    participants and beneficiaries. While ERISA section 404(c) may serve
    to relieve certain fiduciaries from liability when participants or
    beneficiaries exercise control over the assets in their individual
    accounts, the Department of Labor has taken the position that a
    participant or beneficiary will not be considered to have exercised
    control when the participant or beneficiary is merely apprised of
    investments that will be made on his or her behalf in the absence of
    instructions to the contrary. See 29 CFR 2550.404c-1 and 57 FR
    46924.

[^2]: Under section 402(c), as amended by the IRS Restructuring and
    Reform Act of 1998, Public Law 105-206 (112 Stat. 685), and EGTRRA,
    a hardship distribution is not an eligible rollover distribution.
    While the change affects distributions from a section 401(k) plan,
    there is no specific reference to the change in these proposed
    regulations because these regulations are under sections 401(k) and
    401(m).

[^3]: With respect to this timing requirement, it should be noted that
    in order to be taken into account for purposes of section 415(c) for
    a limitation year, the contributions will need to be made no later
    than 30 days after the end of the section 404(a)(6) period
    applicable to the taxable year with or within which the limitation
    year ends.